FOOL CONFERENCE CALL SYNOPSIS*
By Jeff Fischer (TMF Jeff)
ALEXANDRIA, VA, (July 17, 1998) /FOOLWIRE/ -- Personal computer storage technology leader Iomega Corp. announced second quarter revenue of $394 million, down 2% from the same quarter of last year. Zip drive revenue totaled $284 million, up 10% from 1997, while drive unit sales increased 35% and Zip disk sales rose 44%. Nearly 50% of Zip drives sold were to original equipment manufacturers (OEMs). The company has now shipped over 15 million Zips.
For the quarter, Iomega reported a loss of $33.8 million before charges, or $0.13 per share. As Zip drive sales clearly shift toward the OEM market and as the retail market slows, Iomega needs to focus on cost cutting while selling lower margin OEM drives.
Geographically, business in the Americas increased 4% from last year to $258 million, European sales declined 15% to $93 million, and Asia/Pacific sales dropped 4% to $43 million.
Business Summary from Mr. James Sierk, Iomega President and CEO. Zip drive sales were strong, but clearly the company needs to lower costs in order to benefit. In that vein, Iomega took a $9.4 million pre-tax charge to speed its cost cutting effort and to pull its expense structure in-line for an OEM vs. retail sales model. Meanwhile, fierce competition in the Jaz line caused Q2 revenues to be slightly below preannounced expectations.
In contrast, Zip business has been strong. As shared, 15 million Zip drives have been sold, Zip disk sales climbed 44% year-over-year, and total Zip revenue was $284 million, up 7% from Q1 and up 10% year-over-year. Zip drive units shipped climbed 35% year-over-over and 6% from the first quarter. Zip's lesser revenue growth reflects a shift to the OEM model drive and the lower average sell price (ASP) that goes along with that.
European revenue improved slightly from the last quarter, and Asian revenue doubled from the first quarter. Compared to last year, both were down. U.S. sales slowed due to weaker Jaz sales and due to the lower revenue OEM Zip model taking prevalence.
With the exception of the Zip business, this was an unsatisfactory quarter for Iomega. The retail demand was weak and the environment continues to be competitive. The company has identified its goals and is working toward reaching them. During the first quarter conference call, Mr. Sierk outlined the goals and states that the company has made progress on each one.
Iomega is becoming a dependable supplier to all of its customers. Strategic investments are in the right size businesses, and Iomega expects to cut over $100 million annually from its operational cost structure. The company has also added new senior management internationally, the Click drive will be introduced later this year, and Iomega is now the majority shareholder in the French company Nomai. Iomega is balancing its risks, ending its incremental marketing spending which added over $10 million to its second quarter marketing expenses, and focusing on three key areas:
1) Cost Structure. Clearly Iomega's cost structure must change. This quarter 46% of Zip drives shipped went to OEMs, compared to 27% last year. In unit terms, OEM shipments increased 127% from the same quarter in 1997, while aftermarket retail shipments were flat compared to Q2 last year. This is obviously a big shift, so Iomega's cost structure must shift. The $9 million charge taken this quarter relates to a 700 staff reduction that began in June and is nearly complete. The Q3 plan is to reduce operating expenses by at least 25% from Q2 spending levels. Iomega recognizes that this is an aggressive goal.
2) Competition. Competition is heated in the Jaz product line. Iomega did drop the price on Jaz 2, but it is not prepared to follow an irrational pricing scheme in this market by matching competitors. Instead, the company will focus on vertical markets where Jaz has continued success and where customers will pay slightly more because they recognize the value of Jaz.
3) Liquidity. Cash flow was better than anticipated in the pre announcement. Iomega was cash flow negative by $41 million, far head of the negative cash flow of $60 to $70 million that it expected. The better performance is due to strong accounts receivable collections, while inventories are down by $33 million from the first quarter. Iomega expects continued improvements in inventory turns due to the demand-pull model it implemented that was detailed in last quarter's conference call. Finally, Iomega successfully amended its bank credit line with bank partners.
There are three other key points the company is focusing on:
1) Quality. Quality continues to improve. Iomega is happily experiencing declining Jaz and Zip return rates as management implements a strict quality process. The company should be able to remove an incremental $100 million from its total cost base by the end of the second year of this quality implementation, while customers win as well, of course.
2) Leadership. New geographic managers have been hired in Asia and Japan -- one gentleman from DEC's billion dollar Asian division, and another from Sony in Japan. Also, an Iomega manager agreed to move to France to lead in European operations and in the Nomai acquisition. All of these managers are responsible for top line growth in their regions.
3) Accountability to Investors. Beginning this quarter, Iomega is breaking out total drive and disk revenues and providing world trade information on disk unit shipments by product line. Iomega previously talked about disk tie ratio trends, which is an appropriate measure, but not a great management measure. The tie ratio depends on the number of drives sold each quarter, so with a large installed base of products, the tie ratio isn't an incredibly accurate or meaningful measure. Total disks shipped and sold every quarter is a more useful figure, allowing shareholders to know more about Iomega's business.
The Big Goal -- return Iomega to profitability. Management is taking bold steps to achieve this. However, while they do expect significant improvement in the third quarter (excluding non-cash charges related to the Nomai acquisition), they don't expect to be profitable until the fourth quarter. Cost cutting measures that have been put in place combined with a transition to the virtual manufacturing model (demand-pull inventory, as well) should return Iomega to profitable growth.
To close, management is truly optimistic about Iomega's future. As a sign of this, the Board is now accepting its compensation in stock, and all of the CEO's compensation is in stock as well.
Dan Strong, Iomega's current CFO, on Financials. Iomega's 2% decline in sales was due primarily to increased competition in the Jaz line, and generally to slow retail sales and a continuing decline in demand for tape products. But, the Zip business is healthy. While Jaz drive sales were down 21% quarter-over-quarter due to competition and price action taken by Iomega, and Ditto sales were down 32% quarter-over-quarter.
Total drive revenue was down 11% quarter-over-quarter and 14% year-over-year -- this is all Jaz and Ditto related. Zip drive unit sales were up 35% from last and total disk revenue of $171 million was up 8% from the first quarter (and up 16% from last year), driven primarily by relatively strong sales of Zip drives. This was the best quarter ever for Zip disk sales.
Gross margins, at $94.2 million, were down 8% from Q1. They're now at 24% of sales vs. 25% of sales last quarter. Gross margin in the Zip business was up due to strong disk sales, but down overall due to price cuts in Jaz. Iomega has not yet seen the increase in Jaz volume that it expected following the price cut. Iomega expects gross margins in the mid-20s for the year. The bright spot again was Zip disk unit shipments, up 21% from Q1 and up 44% year-over-year. Jaz disks were up 4% over Q1 and 5% from last year. Ditto cartridges were down 28% from last year. These numbers will be available at www.iomega.com within a week.
Operating expenses. These were too high. Iomega's reorganization should save over $50 million in the second half of the year and management remains committed to driving selling, general and administrative (SG&A) expenses back to the range of 15% to 20% of sales. The increase in marketing this quarter was mainly due to increased advertising in Europe and Asia, while advertising decreased in the U.S. Spending on ads overall will be reduced significantly in the second half of 1998 and this represents a substantial amount of cost savings. The increase in G&A expenses was mainly due to implementation of an Oracle software system worldwide and legal fees. Research and development (R&D) expenses were at 8% of sales, up 31% from Q1. Click represented half the increase and this should reduce in the second half of the year as Click expenses decline.
Balance Sheet. Accounts receivables are at $142 million, and Iomega achieved 33 days sales outstanding (DSO) vs. 55 days last quarter. The accounts collection team did a great job, and channel inventory came down for Zip and Jaz. Inventory is down 10.6% to $28 million, with inventory turns up from 3.9 turns to 4.3. Although inventory is still above optimal levels, Iomega is pleased with the improvements, and is aiming for 8 to 9 inventory turns by the end of year.
Accounts payable are at an eight quarter low due to Iomega's shift to the demand-pull inventory model. The strong accounts receivable collections are the primary reason for the company's better than anticipated cash flow. Iomega expects to be cash flow positive for the second half of the year--excluding Nomai acquisition costs--but still cash flow negative for the year. The Nomai acquisition has been completely funded with subordinated debt. Iomega has a 54% majority interest in the company since July 1 and a tender offer will be made for the rest of the shares by the end of August. Goodwill from the transaction will be amortized for several years after the acquisition is complete.
Going Forward. Although results for the quarter were below expectations, Iomega has begun to put in place the model to return to profitability. Management is confident it can show profitability in the fourth quarter.
Average selling prices declined, but Zip gross margins increased over Q1 due to product cost reductions, improved quality, and strong Zip disk sales. This quarter Iomega completed both the 12.7 mm notebook Zip and the ATAPI 2 Zip, the latest model OEM drive. This four chipset drive (compared to seven in the original ATAPI) reduces costs by about $8 by drive. It began shipping to OEMs in June. It's the most rugged Zip drive built and has the highest quality to date.
Iomega has Zip OEM deals with every major box maker in the world, but its sales growth is highest among Compaq, Dell, Apple, Gateway and Micron. These five represent over 50% of Iomega's OEM volume. Zip solutions are standard in the majority of Compaq's new Presario line (for under $1,100), and Zip Built-In is an option on two new commercial IBM models due in Q3. Iomega also continues to grow its Dell business. The goal is to be a top supplier for all OEMs, with top quality and reliability.
Last week Iomega announced its USB Zip drive, which should be available in Q4. Mac users were first to embrace Zip, so MacWorld will roll out the new USB solution. Importantly, though, this drive will be compatible with all USB interface CPUs, not just Macs. Over 90% of all Intel-based CPUs ship with a compatible USB interface.
This quarter Iomega dropped the external Zip drive price to $139 and added a $20 rebate as it continues to aim for a $99 price target. Early studies are showing that the company might have greater price elasticity in the disk space, though, so it will take appropriate action going forward as needed.
Q&A -- Answers to Questions Follow
Jaz. The Jaz product focus is going to be on vertical markets where quality and reliability is key, rather than implementing irrational pricing to compete on the normal retail market. A Jaz drive chip reduction is in the works and that will make it more efficient in the future and less expensive to make.
Removing the Floppy. As Iomega builds a broader base of Zip drive users, actually removing the old floppy from a new PC becomes more likely. But BIOS technology needs to change on PCs so that Zip can serve as a bootable drive. Until that happens, only strategic talks are taking place about an eventual PC that removes the floppy and only offers Zip. Iomega is in discussions about this possibility with individual PC manufacturers. At some point, perhaps it can happen.
Disk Sales. Happily, Iomega is finding that there's not much difference in disk consumption between OEM and external Zip drive sales. Before Iomega believed that OEM drives would consume less disk media. This is probably not the case.
Licensee Partners. Partners on Zip production are still an important part of Iomega's strategy, but both NEC and MCI have not made much progress in terms of market presence. Iomega previously thought that 100,000 drives a month by the fourth quarter would be produced by licensees, but that will probably actually be slightly less. Licensee shipments are running at about 10% of Iomega's total OEM business.
Inventory in the Channel. Zip drive inventory in the channel in the U.S. is down from 9 weeks to 6 1/2. Disks from 8.3 weeks to 6 weeks. Jaz is down from 6 to 5 weeks, and Jaz disks are down from 6 1/2 to 6 weeks. The level of inventory in the channel has decreased and the goal is between 6 to 8 weeks. Iomega is well within that now. The demand-pull model will lower all inventory points within the whole chain.
Gross Margins. There was some slip in Zip gross margins and for first time it went into a negative gross margin on OEM sales, but new Zip drive models help to raise margins and Iomega's cost cutting going forward will help, too. If you add one disk sale along with the drive sale it takes the gross margin number into positive territory.
Driving Sales. To drive OEM sales Iomega will focus on quality and being reliable as a partner. Second, Iomega makes certain that OEMs feel there is a compelling value proposition in its product. Customers must demand the Zip drive in the PC, of course -- this pull in the marketplace is important and will determine the winner in the long run. The price point on Zips for OEMs must come down as the overall CPU business is headed into lower priced models.
Click. 1,000 units were sent to potential customers and Iomega is optimistic. The company has arranged a digital camera bundle and mobile computer bundle in preparation for fourth quarter sales. The early market acceptance is encouraging.
End of summary.
* A Fool conference call synopsis represents an effort to highlight the salient points of a conference call and should not be taken as an authoritative accounting or transcription of the entire event. Note: Statements made by a company other than historical information may constitute forward-looking statements for which the company can claim protection under the Safe Harbor Act. Please consult the company's filings with the SEC for information on risk factors which might cause actual results to differ materially from the information contained in these forward-looking statements.