Fool Portfolio Report
Wednesday, May 14, 1997
by Paul Larson (TMF Parlay)
and Tony Miller (TMF 2Aruba)

ALEXANDRIA, VA., (May 14, 1997) -- The Fool portfolio lost a fraction today, off 0.32%, while the S&P rose 0.35%, and the Nasdaq gained 0.15%. There was no significant news.

Without further ado, we offer the meat of this recap:

Tony Miller and Paul Larson are Dueling Fools. As they ponder the fate of IOMEGA (NYSE: IOM), the company that revolutionized the storage industry with their Zip Drive, they can't seem to agree on which way the stock is headed. Fistfight? Hardly. Tony and Paul have been Fools long enough to know the merits of civil debate, even when they can't come to terms over the merits of a particular equity.

Both Tony and Paul have followed Iomega since the beginning of the Zip drive. Paul is the "pit boss" of the gaming industry area on the Fool, and Tony is found most often in the Iomega folder. So, grab a seat, as Tony the Bull and Pauly the Bear look at the pros and cons of the most talked about stock in Fooldom. May the best Fool win!

TONY with the bullish argument...

In early 1995, I stumbled upon a company called Iomega because I was a computer user looking for a storage solution. It turned out my timing was just perfect. Somehow, some way, a voice seemed to say, "This is gonna be big." It was. I was very bullish on Iomega in 1995, and interestingly enough, I haven't changed. Iomega continues to be my favorite investment and one of my favorite growth stocks.

Foolish Financials. Let's take a look at the recent past by examining some of the extraordinary numbers. As stated in the 1996 Annual Report, revenues increased from $141 million to over $1 billion within two years. Last year the company enjoyed sales of $1.2 billion, up from $326 million in 1995, an increase of 272%. The earnings increased from $8.5 million, or $0.07 per share in 1995, to $57.3 million or $0.43 per share in 1996. In fact, in the 4th quarter of 1996 alone, sales and earnings exceeded sales and earnings for all of 1995!

What's next? Okay, you're a tough critic. You ask, "But what have they done for us lately?" Good question! What's past is past. Can they keep it up?

I say they can. Iomega has in place global manufacturing, distribution and marketing plans. And, with over 160 patents issued or patents pending for drives and disks, Iomega is constantly working to protect their products. But don't take my word for it. Just look at the ever-growing list of OEM's putting their stamps of approval -- their show of confidence -- in Iomega.

With Iomega products shipping in units made by Hewlett Packard, IBM, Gateway, Power Computing, NEC, Cannon, Sony, and Compaq, among others, it's difficult to question why this company is experiencing such growth. In fact, as of this writing, Nematron Corp. has just announced one of its latest additions to its industrial products. The Flexbox Industrial PC is one of the first industry computers to utilize Iomega products, offering both Zip and Jaz Drives.

The most recent analyst to initiate coverage on Iomega is Needham, who began with a buy rating, stating that, "Zip and Jaz dominate their respective segments. The low-end removable magnetic class, [of] which Zip now holds an established 89% market share, is expected to grow 75% annually, to reach 43.3 million units in 2000." With time and continued growth, no doubt several more analysts will join the ranks of current analysts covering this company.

Reducing Prices. One of the fascinating ways Iomega will achieve continued growth is through the continued efforts to reduce the price of it's Zip and Jaz Drives. The key to understanding this goal is the disks themselves. The more drives sold, the more disks sold. The goal is to maintain overall corporate gross margins near 30%, which CEO Edwards promised at the recent H&Q conference.

By doing this, Iomega can leverage its increasing revenues to reduce variable expenses and increase profits. So, even though lowering the price of drives would slow revenue growth, the amount of revenue returned as profits would increase. For the 3 months ended March 31, 1997, Iomega's net margin was 6.3%, or an increase of about 50% in 6 months. To put it simply, higher sales volumes and lower product costs caused Iomega's net margin to rise.

A new force should drive net margin even higher in the second half of 1997: drive sales from licensed manufacturers. While the casual observer may claim that increased competition will lower gross margins, the opposite, in fact, will occur. Drive sales by the licensees will lead to disk sales by Iomega. Iomega benefits from the customers of the licensees. Sweet!

Taking all of this into account, cash generated from operations should continue to "Zip" with net income rising faster than revenues. The outstanding talent on both the management and engineering teams can use this extra cash to expand existing markets, develop new ones, and ramp up new products.

So as a shareholder in Iomega, I feel confident in its future. Personally, with laptop disks about to make their appearance, and continued progress of Iomega storage becoming a standard in computers globally, I'm as bullish as I've been from that first day in March of 1995. But hey, I'm that guy that put the bronze 'iomega '96' plaque in brickwork of the pool that Iomega built. For some of us, it's an obsession.

And now PAUL with the bearish perspective...

Before I get called an ignorant wet blanket, let me assure you that I am qualified to have an opinion on Iomega. I first bought Iomega's stock back in March, 1995. I saw the specifications, knew Zip drives were going fly off the shelves, bought the stock and was rewarded with a ten-bagger in little over a year. I no longer own the stock and I'll now spell out why Iomega does not have a home in my portfolio anymore.

What do Iomega and Los Del Rio have in common? I know, I can hear you saying, "What the heck is Los Del Rio?" Remember last summer when everyone and her grandmother was dancing to the latest dance craze, The Macarena? Los Del Rio was the band that released the song. The answer to my earlier question is this: I think both Los Del Rio and Iomega are one hit wonders. Hey Macarena! Hey Zippo Disks!

Zip a new standard? I almost have to chuckle when I hear someone say that Zip will be "the next floppy disk." Just think of the three main uses floppies had in the past: software distribution, file transfer, and backup. Zip is losing all three of these battles to replace the floppy.

Zip will never be able to compete with cheap CD-ROMs that cost 1/10th (or less) per megabyte to produce. I have yet to see a software package that comes with Zip disks, and I don't think I ever will. Zip is competing more with U.S. ROBOTICS (Nasdaq: USRX) and CISCO SYSTEMS (Nasdaq: CSCO) than anyone on the file transfer front. With the advent of wide-area networks and attached-file email, it is increasingly practical to move computer files over twisted copper wires.

Zip's strongest suit may be in file backup and storage. However, when I look at the latest Computer Shopper and see hard-drives that can be had for about $0.10 per megabyte (and falling) versus the $0.14 for Zip, I have to wonder how much longer people are going to buy dozens of Zip disks instead of one monster drive hidden away inside a box.

What about the disks? I cringe when I hear people call Iomega "the next Microsoft." And yes, I know, "It's the disks, stupid." Iomega's business model is based on a razor and blades analogy -- give away the razor (the drives) and make money on the blades (the disks). As someone who has a chronic five o'clock shadow, I can attest that razor blades have a finite lifespan. However, when was the last time anyone threw away a Zip disk? What happens when the early adopters of Zip jump on TNBT (the next big thing), storing everything on it, and Zip disks start showing up in the classifieds?

I also see bulls, such as Tony, pointing out all the numerous OEM deals Iomega has struck in the past months. Bravo! But until I see *every single computer* shipped with a Zip disk I will not be convinced that Zip is anything but a nice luxury and highly successful niche product. A computer user can easily live without Zip.

Change is constant. Even if I concede that Zip will be a "standard" for the next two years, what happens when the winds of technological change blow forward as they always do? World-beating companies constantly reinvent themselves and I have yet to see Iomega break any cocoons. What have I seen come out of Iomega's R&D department the last two years? OEM Zip drives... Zip for notebooks... new Zip transformers... bootable Zip drives. Seems this band knows only one song and can only put out remixes of its one chart buster. Los Del Rio anyone?

What about five years from now? The Jaz drive the company sells has been buggy from the start and faces significant competition from companies trying to be the true "next Iomega." Success is the best fertilizer for competition. Between other companies in the magnetic arena, such as Nomai and Syquest, to optical technologies, such as writeable CDs and DVD, Iomega's future looks rather uncertain. Maybe the company's next generation of products will be equally successful, but sight unseen I'm skeptical.

I guess I find it risky to put faith in a company that has single-digit net margins and derives roughly two-thirds of its revenues from one product -- a product with falling prices and over two-years-old in the fast-changing technology sector. Granted, the product is a smashing success, but you can't deny that Zip will someday find its way to the computer graveyard. As a long-term investor, I have a hard time visioning how the company is going to maintain its miniscule profits after Zip is history. Brand me an Iomega athethist, but I just don't believe there is life after Zip.

TONY strikes back.

Paul, I'm surprised at you, my Foolish friend. You've made so many blanket statements, but you just didn't put any "Zip" into them. I'm afraid that your argument of Iomega being compared to the "Macarena" holds up about as well as over-cooked "macaroni".

You claim that Zip is losing the battle to replace the floppy. This will not be won in the short-term, as standardization takes time. Look how long it's taking the 3.5" floppy to become displaced even though it's virtually lost its usefulness.

Paul, you also take issue with the "razor" analogy. True, people aren't throwing away their Zips as they do Gillette blades, but why would they? People need to protect their stuff, and once they've filled their disks, they buy more. I personally started with 3 disks, and I'm now up to 10.

You say you've yet to see any software shipped on Zip disks. I'm here to tell you that I have. For example, Crane Plumbing and Brammer Cabinetry are two major kitchen and bath companies that regularly use Zip disks to send catalogues, spreadsheets, and product price lists to its wholesale distributors.

Now how can you possibly bring cheap hard drives into the argument? You said yourself that you invested in Iomega in 1995 because you pictured the drives flying off the shelves. This occurs because people want protected back up, and that's just not going to happen with a hard drive. Unless it's removable, files are vulnerable.

Perhaps one day, CD-R and DVD will be considered competition, but that's not the case now. CD-R's have not caught on, as they are much too complicated, slow, and still much more expensive. DVD-RW is not even yet available and may never be.

As to R&D, you state you have only seen a few products come out of Iomega in the last 2 years. Fact is, the last 3 years have produced Ditto, Zip, and Jaz, one market-dominant product for each year. How many companies can make a claim like that? Next year, n.hand, which promises tremendous advantages over all current competition, makes its debut.

I can't let you get away with calling Jaz "buggy." After almost a year, there haven't been any significant returns of faulty Jaz drives. Jaz drive revenue went from 0 in 1995 to approximately $350 million in 1996, in 9 months! If that's buggy, don't bother calling an exterminator!

Finally, Paul, you want to believe that Iomega's technology will be usurped by new technology from competition. Who's to say Iomega won't be their own competition, and develop their own new products? My bets are on this Foolish company.

PAUL lashes back

Tony, thanks for sharing your reasons for loving Iomega. I would bet that if we shared our initial buy confirmation slips that they would be within a week of each other. We have both profited handsomely. But Tony, I think it's time to stop reminiscing and to throw away those rose-colored glasses. In your bullish case, I see you mentioned 1995 six times, 1996 four times, 1997 twice, and 2000 once. This manifestation of a backwards-looking logic plays right into my initial question -- what about the future?

I fully understand the drive to reduce prices is in order to gain market share. I believe that if Iomega really wanted to be a "standard" with Zip, they needed the $99 Zip drive a year ago, not six months from now. If demand is so strong, why did revenues fall $36 million from Q4 to Q1? Seasonality shouldn't impact an item that's in tremendous demand.

Father time is not on Iomega's side. Even with unit growth outstripping price reductions in the next year, I still have to ask the question: in the next generation of storage technology products, what does Iomega bring to the table that their well-capitalized competitors don't?

I'm not taking anything away from the Zip drive or Iomega's past. The success story is something to behold. Nevertheless, I think Zip's reign is coming to an end sooner rather than later. I then look at Iomega's price to book of 8, PE ratio of 34 and $2.5 billion market cap and I see a world of disappointment for many shareholders when Zip sales start to fall as they inevitably will.

When asked about three years forward and future products, most Iomega bulls seem to assume the good times will continue. I try to avoid using assumptions and faith when investing, and Tony, I think you should avoid it, too. Nevertheless, you are your own Fool and can make your own informed decisions. It takes two opinions to make a free market.


Over? How can it be? While Tony and Paul counted their paces and shot off their guns, there is certainly room for more thoughts... your thoughts. Whether you're pro or con, why not kick in with your own opinion and let it marinate over in the Iomega message board. There the Foolishly fat-free spirit of debating with decorum is alive and well, and waiting... for you.

DUELING FOOLS is in the process of becoming a new column on the Fool, run regularly in its own space. Any suggestions, comments, praise, or flames, please send them along to TMF Edible . Thank you! Fool on!

---by Paul Larson and Tony Miller, May 14,1997

Iomega in the Fool Portfolio.
Iomega Foolish snapshot.

Stock Change Bid -------------------- AOL -1 1/4 48.38 T --- 32.88 ATCT - 1/8 3.88 CHV - 3/8 72.13 DJT - 1/4 9.88 GM - 3/4 56.00 IOM - 1/2 17.38 KLAC +1 48.75 LU +1 7/8 63.50 MMM +1 1/8 92.63 COMS + 7/8 37.75
Day Month Year History FOOL -0.32% 2.89% -1.39% 163.18% S&P: +0.35% 4.33% 12.87% 82.38% NASDAQ: +0.15% 5.93% 3.45% 85.45% Rec'd # Security In At Now Change 5/17/95 980 Iomega Cor 2.52 17.38 589.48% 8/5/94 355 AmOnline 7.27 48.38 565.41% 8/11/95 125 Chevron 50.28 72.13 43.43% 8/12/96 110 Minn M&M 65.68 92.63 41.03% 10/1/96 42 LucentTech 47.62 63.50 33.36% 8/24/95 130 KLA Tencor 44.71 48.75 9.03% 8/12/96 280 Gen'l Moto 51.97 56.00 7.75% 4/30/97 -1170 *Trump* 8.47 9.88 -16.60% 8/12/96 130 AT&T 39.58 32.88 -16.94% 8/13/96 250 3Com Corp. 46.86 37.75 -19.44% 10/22/96 600 ATC Comm. 22.94 3.88 -83.11% Rec'd # Security In At Value Change 8/5/94 355 AmOnline 2581.87 17173.13 $14591.26 5/17/95 980 Iomega Cor 2594.53 17027.50 $14432.97 8/12/96 110 Minn M&M 7224.44 10188.75 $2964.31 8/11/95 125 Chevron 6285.61 9015.63 $2730.02 8/12/96 280 Gen'l Moto 14552.49 15680.00 $1127.51 10/1/96 42 LucentTech 1999.88 2667.00 $667.12 8/24/95 130 KLA Tencor 5812.49 6337.50 $525.01 8/12/96 130 AT&T 5145.11 4273.75 -$871.36 4/30/97 -1170*Trump* -9908.50 -11553.75 -$1645.25 8/13/96 250 3Com Corp. 11714.99 9437.50 -$2277.49 10/22/96 600 ATC Comm. 13761.50 2325.00-$11436.50 CASH $49020.02 TOTAL $131592.02