Post of the Day
May 27, 1998

From our AOL
Iomega Board


Subject: YEAR IN REVIEW: HOPE AND DESPAIR
Author: DR KDM xxx

Wednesday, January 22, high continued expectation for Iomega... record revenues and income soon to be reported...recent decision to split the stock has bolstered the concept that earnings will likely be even better than expected (but certainly not worse, for what company would be so uninformed as to split their stock in the face of forthcoming worse-than-expected earnings!). The decision to release earnings early also is suggesting good news (in absence of any information from any source suggesting bad news is in the offing).

Thursday, January 23, the following information emerges:

1) Record quarterly revenue of $547M
2) Record quarterly income of $36 M
3) Record yearly revenue of 1.7 billion
4) Record yearly income of 115M
5) 38% quarter vs quarter revenue increase
6) 77% quarter vs quarter income increase
7) Significant increases in earnings from ALL geographic areas

Americas: 23% increase
Asia: 88% increase
Europe: 55% increase
8) Increased gross margins (to 33.4% from 29% a year earlier)
9) Record number of Zips sold during Q4
10) Record OEM inclusion of Zips
11) Record ability to mass produce Zips (now 20 million/year capacity)
12) Pending Q1 release of Jaz 2GB, Buz
13) Pending Q2 release of 12.7 mm laptop Zip

And all of the above in the face of a "slowdown in Asia....postponed shipment of some new products....slower than planned production ramp of other new products".

Market Response, Thursday, January 23: a massive sell-off...market assesses above performance and subsequent conference call and concludes IOM is in huge trouble. IOM shares lose 33% of their value on a staggering panic-driven volume of over 40,000,000 shares (this represented the largest percentage drop for IOM in one day, on the largest volume ever for IOM). Very clear who the sellers were (everyone!)...unclear who was purchasing the virtual millions of shares being put on the table.

The days that follow see the legal arena ignite, as multiple class action lawsuits emerge. IOM only increased earnings 100% over the prior year. Things could have been better, as admitted by the CEO. Apparently, for the first time in the history of corporate America, a product introduction has been delayed. The CEO did not have the forward vision and clairvoyance to predict this. Innocent investors are hurt.

But then the real bombs begin to drop. Nomai, a mite-sized European company, makes headway in its attempt to pirate IOM Zip disks. The corporate stategy for IOM has always been clear. Give the drives away. And then sell by the droves high-margin Zip disks, year-in and year-out. This, the same basic model that created mind-boggling success for Gillete. Nomai's individual success in getting a Zip compatible disk on the market in and of itself borders irrelevant ...however, it raises the significantly more concerning possibility: if Nomai can do it, so can HP, IBM, Maxell, Kodak, Sony, Fujitsu, etc., etc., etc.. Lots of competition equates to meager margins. Without high-margin high-profit Zip disks, there will be no high-profit IOM. Trouble looms.

March brings forth an egress of bad news: 3/16/98 KE warns that IOM revenues for Q1 1998 are going to be flat as compared with Q1 1997. Because of increased costs, inclusive of 20M in advertising, IOM is going to report its first loss in 3 years (10M- 25M). Market response: an 18% (1.5 point) drop on massive volume . As before, it is not difficult to understand who might be selling, while it remains patently unclear who was buying. It is further interesting to note that IOM immediately dropped to 7 1/8 at the open, and thereafter remained virtually unchanged the entire day as 20+ million shares changed hands.

3/24/98: Seemingly out of nowhere, KE resigns...effective immediately. No cogent reason is provided by the company. Rumors fly. Was KE pushed out? Did he walk out? On the most basic level: WHY? The market rightfully questions whether there are "skeletons lurking in the closet" that may be associated with this rather sudden, unexpected event.

Q1 1998 Results

On 4/16/98, IOM reported the following:

Record Q1 revenue: $408 M
13% Quarter vs Quarter increase in revenues
Record Q1 Zip drive unit sales (61% increase over Q1 1997)
Record Q1 total drive (Zip, Jaz, Ditto) unit sales (47% increase over Q1 1997)
Record Zip OEM sales rate (now 50% of unit sales vs 22% Q1 1997)
Total Zip product sales: $266 M (24% increase over Q1 1997)
Total Q1 OEM Zip unit sales equal to traditionally busy Q4 1997
Increase in tie ratio (relative to Q4 1997), slight decrease relative to Q1 1997.
Successful launch of Jaz2
Successful release of Buz
Release of 12.7mm Zip to OEM's 3/98
Increase in N.America sales by 32%
Zip quickly approaching 14 million unit sales
European sales decreased 17% (Q1 98 vs Q1 97)
Pacific Rim sales decreased 26% (Q1 98 vs Q1 97)
Gross Margins: decreased to 25% (from 30% Q1 97)
Operating expenses: increased to 27% of sales (vs 15% Q1 97)

NET RESULT: Q1 LOSS OF $18.6 MILLION DOLLARS ($0.07/SHARE)

IOM ongoing concerns:

1) Revenue growth over the past five quarters (relative to the same quarter the prior year) has been, respectively: 127%, 86%, 39%, 38%, and for Q1 1998, 13%. The trend speaks clearly for itself. If the above trend persists, it is just a matter of time until revenue growth becomes revenue atrophy.

2) Earnings growth heretofore has outpaced revenue growth. 1997 earnings increased 100%. In Q4 1997, earnings grew 77% over Q4 1996. Now, in Q1 1998, it is not so much that there was no earnings growth, more importantly, there quite simply were no earnings. This, a result of the general lackluster quality of the PC market, the tremendous economic weakness in the Asian theater, as well as IOM's decision to utilize significant dollars on advertising.

3) Gross margins in Q4 increased to 33.4% (from 29% Q4 1996). This was good. However, Q1 1998 gross margins decreased to 25%. The growing dominance of OEM sales may very well work to decrease margins further over time.

4) But what of the "massively-expensive-bet-the-company" 100M advertising campaign being waged? First, as IOM is in the 35% income tax bracket (assuming they again become profitable), 100M becomes 65M of true out-of-pocket expense. But this is still a significant number. Having personally seen the advertisements (in multiple different media) it is unclear to me whether the return on investment is going to be there for IOM.

5) Reasonable 1998 Q1 earnings should have been about $0.09/share. Actually losing money was, until 3/16/98, something that nobody in Wallstreet even considered a possibility (note, while analysts following the company had lowered expectations for earnings, NOT ONE predicted a loss). It is not at all clear that the factors that led to the recent quarter's loss are "resolvable" in the forthcoming quarters. Nor is it clear that things may not worsen.

6) I previously felt that the class action lawsuits bordered ridiculous. The recent bad news about earnings and revenue growth now adds fire to the argument that "insiders" took advantage by selling shares in the face of a weakening marketplace of which they were aware, but investors were not (with the added argument that the price was supported at an artificially high value by statements about product releases that proved inaccurate).

7) The Nomai threat is, unfortunately, a real one for reasons noted above. If Nomai can clone disks so can the real big league hitters such as Sony, Maxell, and so forth.

8) The dreaded "tie ratio": For the average user, it is unclear how many (if any at all) Zip Disks they need before saturation has occurred. And, unlike the razor blade analogy routinely cited (even by myself earlier in this post), unfortunately, Zip disks do not wear out. I own a Zip drive. I spend more time on the computer than anybody I know. I pay my bills on with Quicken. I organize my life with Lotus Organizer. I utilize multiple online investment services. I frequent AOL and Motley Fools every day. I own six Zip disks (and have for over 1.5 years), and for the foreseeable future, see NO need for any additional disks. Of my colleagues who use a computer, none own a Zip drive, nor comment on their burning need for high capacity removable storage. My parents, bless their hearts, own a computer and are lucky to successfully log-on to, and use AOL without some "glitch" occurring. If given a Zip drive, it would certainly collect dust and nothing more. My point: the average computer user arguably does not need a Zip drive, nor do they have the computer savvy to take advantage of it even if it was part of their system. This, I think, explains why the tie ratio is so low with OEM installations. Most people buy computers to do simple routine things (play games, do home finances, type letters, explore the Net, and so forth). Very few personal users have need for huge removable storage capacity. If you will, the "killer application" necessitating high capacity portable storage for the common man has not yet made its presence.

9) Competition continues to grow in the portable storage arena. For any disbelievers, please see the review in a recent PC Magazine (April 21, 1998 issue) where 20+ different high capacity "storage" options are reviewed (or go to your local CompUSA store and check out the removable storage options they stock). Unfortunately, IOM is losing ground in the two areas that count, namely with regard to pricing and with regard to performance. The analogy citing Microsoft as also being a company that neither supplies the best product nor at the best price is inane. Quite simply, IOM is not a Microsoft (at least not yet). As long as IOM allows competitors to sell products that have dramatically better price/performance ratios, their market share will be compromised. The forthcoming Sony product also represents a threat of significant magnitude...not because of the product itself, but because of Sony. Unlike the Syquests of the world, Sony can afford to lose money for years on their new drives in an attempt to make them the new "standard".

10) Quality: Recent reviews of IOM products have been overall less than stellar. Some Buz reviews have been blisteringly bad. Jaz2 reviews suggest that this product is indeed a decent drive...but usually end by indicating you can get a lot more bang for the buck elsewhere. Zip reviews may actually place Zip as #1 in its category, but not because of price and not because of performance, but because of its large already installed base (thus making "information sharing" more possible). In the real world you can sometimes get away with having the high priced item on the block, but only if the purchaser gets added QUALITY AND PERFORMANCE for the increased cost (example: Mercedes automobiles). IOM's high-priced strategy, in the face of mediocre performance (relative to new competition), sets the stage for competitors to gain meaningful marketshare.

Ongoing positives for IOM. Meaningful, but "IMAGINARY" Hypotheticals.

1) Clik! has the potential to be huge (many many more cameras and electronic "gadgets" out there than PC's). What might happen to IOM's price if even ONE announcement from a major company is made indicating they are going to incorporate the Clik! into their product line? Imagine Kodak making this announcement. Imagine Canon or Nikon or Polaroid making this announcement. Imagine more than one company making this announcement.

2) The digital camera market is in its embryonic stage, and is poised for explosively staggering growth. At the present time, no company has emerged as the "brand" victor in this arena. Imagine if IOM developed its OWN digital camera line (this is, in my mind, the next potential "knock-your-socks-off" product-line for IOM). WHY NOT? I would call it: "Clik! Shot". Imagine an IOM " Clik!Shot" camera and Clik! drive combo as a X-mas promotional. Imagine if IOM partnered up with a photo developing service (similar to IOM-Kinkos relationship) where those so desirous could send their Clik! disks in for developing ( perhaps on multihundred thousand dollar printers capable of resolution rivaling that of present photo labs...i.e. a printer much better than any normal person could ever afford). Imagine if IOM developed dedicated software that did wonderful things with the images produced from Clik! disks, being read off of the Clik! Drive . Perhaps this special software comes bundled in the slightly more expensive "Clik! Drive Plus." Imagine Grandpa and Grandpa, who want to see some recent grandchildren pictures ...perhaps the info on the Clik! disk gets transferred to a Zip Disk, gets sent to Gramps and Grams who read it on their own Zip Drive (internal SCSI, of course). Imagine.

3) IOM has a commanding present lead in the high capacity portable storage market, and is pushing the envelope of dominance. Meritorious arguements have eloquently been made that IOM's penetration into the OEM marketplace has been slow, and is not necessarily growing at a rate commensurate with the Zip becoming the new standard. I would argue that nobody knows what the "right" rate of growth should be (IOM's penetration into the marketplace is outpacing the 1.44 mb floppy's rate of growth when it was introduced). The fact of the matter is this: 1) In an era where PC's are available with 16GB hard drives the 1.44 mb "floppy" is clearly a dinosaur living on borrowed time. 2) Unequivocally, NO product in its category comes close to the Zip in OEM penetration (how many Syquest products does Dell or Gateway or Micron or IBM or Compaq offer?). Now, if you will, imagine a much larger company that might have the distribution channels and the financial resources to ensure that IOM wins the "standardization" war...if, of course, they buy IOM. Imagine if such a company saw tremendous upside by such an acquisition. Imagine. Imagine a purchase price. Imagine Hewlett Packard. Imagine IBM (and recall the huge sum they paid for Lotus). Imagine Sony. Imagine Fujitsu. Imagine Samsung. Imagine Seagate or Western Digital. Imagine Kodak (who know that their bread-and-butter product line--film--is on the endangered species list because of the emergence of digital photography).

4) Imagine if one or more of IOM's competitors (most of whom are presently non-profitable) calls it quits or goes, alas, Chpt. 11. What might happen to the price of IOM? If IOM, selling over 1.5 Billion dollars per year in storage solutions is having a hard time of it, what must be the situation with IOM's rivals? Imagine IOM making a stategic acquisition.

5) Imagine if IOM introduces yet another new and revolutionary product. Even this informed board has been caught by surprise by such announcements. Imagine. Imagine a multiGB video disk (perhaps the "CamDisk!")...something akin to a large, mega-high capacity form of Clik!...something that could be incorporated into video cameras (just as the Clik! will be installed in "still" cameras). Imagine the "CamDisk!" Drive, capable of transmitting the finished product to your TV, or to your computer for editing and manipulation (with proprietary IOM "CamEdit" software). Imagine. Imagine if IOM incorporated this disk into their own video camera line (or in partnership with a company such as Sony).

6) Imagine the huge sums (78 million last year) IOM is spending on R&D and ponder..."What are they R&Ding?". Ponder again, "What are they R&Ding?". Imagine the opportunities. Imagine the massive financial rewards that will be awarded the company that accomplishes even a small fraction of the above.

7) Imagine an IOM that has barely scratched the surface of multiple multi-billion dollar markets. Imagine an IOM under $10. Then imagine an IOM many multiples of that. Imagine a market that handsomely rewards long-term potential and the establishment of a recognized brand name (i.e. Yahoo, earned less than 10 cents a share 1997, earned $0.08 a share in Q1 1998, yet priced at 120). Imagine if someday, somehow, IOM establishes itself as having true potential, and establishes the "Iomega" brand as one truly to be reckoned with. Imagine IOM at $30, or more, for this is its potential long term destiny. Imagine the insignificance of a transient fall in price. Reflect upon the short-term fallibility of the market...its fickleness...its tendeny to over-punish any it considers to be wounded. Imagine a candid CEO, who five months ago announced record earnings for both quarter and year, but admitted things could have been better. Does this take away the significance of the record breaking revenues and profits? Imagine a company that has the resources to devote $100 million to an advertising campaign. Compare this to competitors who are borrowing money (or selling extra shares) just to meet basic overhead. Reflect upon the numerous advertisements one sees on television and in media of every sort and be reassured that the reason companies spend millions in advertising is because it works!

8) The softness and pricing pressures in the PC market, and specifically the portable storage market could well work to IOM's advantage, ultimately. Weak players (i.e. Syquest) are likely to be severely if not mortally injured by present market trends. The computer industry is very much like a Darwinian microcosm where only the very fittest survive, especially during rough times.

9) With regard to Nomai: The challenge to IOM is obviously to establish that IOM owned patents make it impossible for anyone to clone Zip disks. If this fails, IOM has the very real option of adapting the Zip drive so that only real zip disks can be used. This whole area is so pivotal to IOM's longterm success, one can only rightfully assume that contingency plans for every possible scenerio are being worked out. IOM is in the driver's seat here. If Nomai wins, without restriction, the right to make clone Zip disks, be ready to hear a forthcoming announcement that IOM Zip Drives are being "improved" in such a way that, surprise, "secondarily" makes any cloned disks worthless (this is already the case with laptop zip drives). Nomai will have spent millions in production costs and legal fees, all for nada.

10) With regard to the lawsuits: IOM joins the ranks of almost every other successful technology company in having a class action lawsuit waged against them. The very nature of technology issues is for them to rise astronomically during the good times, and unfortunately, fall like lead balloons when the market turns against them. The timeframe in question for the lawsuits is for the months preceding the release of yearend earnings. For this period, and for fiscal year 1997, here is what the jury would hear: " IOM's year-over-year growth was nothing short of miraculous. That the market chose to ignore this (and in fact punish for this) is an unfortunate reflection of the fickleness of the market. IOM was ramping up and growing faster than nearly any technology company in the history of Wall Street. For Q4 1997, earnings increased 77%. For the year, earnings were up over 100%. In terms of shear growth, IOM, in 1997, lived in the top 1% of all companies on the New York Stock Exchange. There was no duplicity here." Retort: "But had Jaz2 been released on time, both quarterly and yearly earnings growth might have been several percentage points higher. How dare IOM report 77% earnings growth when 80% (or maybe even 81 or 82%) was within their grasp. We, the class action plaintiffs, have been bamboozled...deceived...tricked out of our hard earned dollars. We were innocently led to believe this was a growing, thriving enterprise. Then IOM slaps us in the face with only 77% earnings growth for the quarter and 100% earnings growth for the year. How dare they. Jaz2 not being released ruined everything. Now we, the class plaintiffs, suffer irreparable damage to our personal finances. Please, justice system, right this dastardly wrong."

If you were on the jury, would you see merit here?

11) Industry Growth: Sources that study trends in the computing industry repeatedly indicate that for at least the next 3 - 5 years, the use of high capacity removable storage platforms is going to grow at about 30%/year. Some forcasts suggest significantly more aggressive rates of growth. If history repeats itself, the most dominant players will win big, while smaller players will be slowly pushed into oblivion. The question then becomes: Is IOM a dominant player? Can they maintain and grow their lead? In Q1 1998, IOM sold more Zip drives than any other Q1 in its history. Since its introduction, IOM has always achieved increases in Q vs Q unit sales of its Zip line. Conclusion: the penentration of Zip Drives continues to move forward! It should also be noted that if Zip drive sales do nothing more than keep pace with last year, this will translate into an installed base of over 20,000,000 Zip drives at year end. Extrapolate to the end of 1999, and you get 28,000,000 installed drives. If IOM can figure out a way to get each person to buy 2 Zip disks per year, assuming (hypothetically) a "net" profit margin of $3.00 per disk, one gets earnings of $84,000,000 ( 28M * $3.00) JUST FOR THE DISKS. Add in profits for JAZ, JAZ2, Laptop Zips, Zip drives, BUZ, Clik!, Clik! drives, and who knows what other product IOM may introduce, and it is hard to imagine anything other than a GREAT 1999 for this company. Throw in a few new and noteworthy corporate associations (i.e. Kodak), some new or improved OEM PC endorsements (i.e Gateway, which heretofore has been lukewarm to IOM), some potential buyout rumblings (i.e. from IBM), along with some failures of IOM competitors (i.e. Syquest), and this stock could literally explode.

11) My take: Two years ago, IOM was a good gamble. Assuming a new timeframe of two years, at present levels, IOM represents a good (? great) investment. Very simply, the upside potential of this stock dwarfs the downside risk (see MF Fools evening news, 3/20/98: calculation utilizing methodology developed by Michael Murphy of Calif. Technology Newsletter suggests a maximum downside of $4.50 to $5.00, with added commentary that this downside will probably not be reached). With blood in the streets, with IOM being loathed as never before, now is the time to be buying (especially at $7.00 or below). IOM's upside history is largely one of explosive bursts of uptick activity. Those not in at present levels will be left behind without any forewarning. Now, in my estimation, is the time for accumulation (slowly, over time, as IOM could well drift lower short term).

UNDENIABLY SHAKEN BY RECENT EVENTS AND DEPRECIATION IN SHARE PRICE, BUT STILL LONG IOM

Good investing to all.

Kurt Miller


Go To Iomega Board

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