Iomega Q3
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Iomega Q3
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(FOOL CONFERENCE CALL SYNOPSIS)* By Debora Tidwell (MF Debit)
Iomega Corporation <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: IOMG)") else Response.Write("(NASDAQ: IOMG)") end if %> (Soon, NYSE:
IOM) UNION CITY, Ca., October 17, 1996/FOOLWIRE/ --- Iomega began their third quarter conference call by reviewing what they said in the last conference call to put this quarter's performance in perspective.
They stated last quarter that they expected the third quarter to be challenging. Going into the quarter, industry analysts had reported that consumer PC sales were down in May and June and were below channel expectations. Additionally, for Iomega and others, Europe hit their Summer doldrums earlier than normal, particularly in Germany. The company said that they expected the Summer to remain soft, but that they would utilize all of their marketing and sales skills to help offset the seasonal softening.
HOW DID IT TURN OUT? As expected, Europe remains soft and, as with most other retail businesses, July and August were seasonally slow in the United States. However, aggressive marketing programs coupled with follow through on their stated strategy of lowering prices to hit more attractive consumer price points and broaden demand increased sell-through for Zip at retail in the US.
Their sell-through reports validate that the US retailer strength was positively affected by the $50 Zip rebate and associated promotions and the $100 reduction in Jaz drives. They are also pleased to note that OEM Zip drives accounted for about 10% of the quarter's Zip unit drive shipments. Last quarter's shipments of OEM Zip drives were insignificant.
On the downside, they knew that the softness in Europe would cost them topline revenue and result in increasing inventories.
THE NUMBERS -- HIGHLIGHTS. For the third quarter they had net income of $12.8 million on record sales of $310 million. Overall they were pleased with their record sales performance, particularly since it reflected seasonal softening and the price reductions in Zip and Jaz. On the margin side, cost reductions and better-than-planned Zip tie ratios were offset by price reductions and lower-than-expected Jaz tie ratios, resulting in margins decreasing to 26.3% compared to 26.9% last quarter.
While they don't break it out in any more detail, compared to last quarter Zip and Ditto margins were essentially flat while Jaz was down.
Investment spending focused on increasing their fourth quarter presence and awareness in US and European retail, increased operating expenses to 19.6% of sales.
On a year-over-year basis, sales were 3.7 times third quarter 1995 and up 9.3% over last quarter. Their net income of $12.8 million compared to $14.1 million last quarter and $2 million for the third quarter last year. Earnings for this quarter equated to $0.09 per share.
From a geographic perspective, sales for the combined US and Far East were better than planned totalling $259 million or 3.7 times the $69 million a year ago and up 14% over the $227 million last quarter. Overall they are pleased with their performance in the United States. The US and Far East have been lumped together since the Far East historically has been insignificant. They intend to break out the geographies in the future.
Although they began the necessary organizational changes in Europe, they were unable to really offset the Summer softness. Sales totalled $51 million, up 3.3 times from a year ago, but down from $56 million last quarter. As mentioned in last quarter's call, in addition to his responsibility for the Americas and the Far East, Iomega's Vice President of Sales assumed responsibility for European sales at the beginning of the quarter. Additionally, Iomega's VP of Marketing assumed responsibility for global marketing including Europe. Although Iomega believes that the efforts of these executives will stimulate demand in Q4, building the European team to the desired level of expertise will take about another 12 months.
Again this quarter they believe that it is of value to compare year-over-year sales excluding Bernoulli since they are focused only on the new products. Sales for the new Personal Solutions which only include Ditto, Zip, and Jaz totalled $301 million for the quarter, up 4.3 times from the $71 million they contributed a year ago. Ditto sales were $33 million, up 67% from Q3 1995 and up 14% from last quarter. Zip and Jaz combined totalled $269 million, up 9% from $246 million last quarter and 5.2 times the $51 million they contributed a year ago. They are not prepared to break Zip and Jaz out in any more detail at this time.
Gross margin from Ditto, Zip, and Jaz was $78 million, up from $75 million last quarter and $16 million a year ago. The Zip tie ratios were the largest single contributor to the sequential quarter-over-quarter margin growth.
FINANCIAL DETAILS. Zip, Jaz, and Ditto each experienced revenue increases over Q2. That included aggressive pricing actions on all 3 product lines that were effective in Q3 1996. Overall the result was to grow revenues 9% over Q2 1996 to $310 million in a period that is recognized as a seasonally slow quarter. Sales for the 9 months of 1996 total $816 million.
Gross margins for Q3 totalled $82 million, up from $76 million in Q2, with a margin percent of 26.3% versus 26.9% for the second quarter in 1996. The third quarter was challenging for them from a margin perspective. They took aggressive pricing actions on all product lines, as they managed the issues in Europe and focused their senior sales and marketing talent on Europe, and as they moved to a new distribution vendor in the Netherlands from Germany.
SG&A totalled $50 million, or 15.2% in the third quarter, with the increase over Q2 1996 being marketing and sales driven expense partly variable but also investing in quality people and programs in their international operations.
R&D at $10.5 million, or 3.4% of revenue is still short of their 5% target. However, they continue to invest in this area and have added over 100 people to R&D in 1996.
The operating income at $21 million for Q3 1996, or 7% of sales represents $12.8 million of net income or $0.09 per share.
During the third quarter the company had negative cash flow of $73 million including $4.4 million used to repurchase 300,000 shares of common stock. The majority of this cash usage can be attributed to additional investment in plant and equipment of $49 million including a non-recurring $28 million acquisition of their Penang manufacturing facility and the $32 million seasonal buildup of inventory. To meet the $73 million cash needs this quarter, they drew down their cash balance by $58 million, leaving about $103 million in cash and added $15 million in new debt, primarily in the form of long-term seller financing of the Penang facility. Their $100 million revolving credit facility with Wells Fargo Bank remains completely unutilized and fully available.
On receivables, DSO at Q3 1996 stayed flat at 57 days with Q2 1996 while net receivable dollars grew from $180 million to $198 million. Their bad debt reserve amounted to $7.7 million or 3.4% of gross receivables, up from $6.6 million in Q2 which also represented about 3.4$ of gross receivables. Their other receivable reserve amounts to $23.3 million or 10.1% of gross receivables, up from $7.3 million or 3.7% in Q2 1996. Volume rebates due to the volume growth in Q3 plus the price rebate program for Zip in Q3 and that announced for the fourth quarter drove the increase in the reserve.
Their inventories were $178 million, up from $146 million in Q2 with increases in raw materials of $21 million and finished goods of $14 million. Inventory turns were 5 in the quarter versus 6 for Q2. A number of factors influenced their inventory management in Q3 -- the change in distribution vendor in Europe, the startup of their Penang facility, and the readiness of the fourth quarter retail season. A breakout of their inventory is 65% raw materials, 5% in-process, and 30% finished goods, which is comparable to Q2 1996.
Capital expenditure for the third quarter 1996 totalled $49 million, of which $28 million related to the Penang facility and equipment. Year to date, they have invested $91 million in additional plant and equipment.
In summary, the third quarter was a major challenge to the business as they opened up the Penang manufacturing facility, as they managed the issues in Europe and focused their senior sales and marketing talents on Europe, as they moved to a new distribution vendor in the Netherlands from Germany, as they took aggressive pricing actions on their product line, and as they managed their inventory to be ready for the fourth quarter. They feel they have managed these challenges and have a solid financial foundation in place going into the fourth quarter.
As they have stated in previous calls, in addition to running the business on a day-to-day basis, they are continuing to focus on their primary objective -- building a strong corporate foundation. They believe that the actions taken over the past quarter have continued to strengthen this foundation.
ACCOMPLISHMENTS. On September 17th they had the grand opening of their 376,000 square foot Penang manufacturing facility. Their Penang manufacturing team rapidly ramped production allowing them to ship production Jaz drives in the first week of September and Ditto drives in the third week. To give you an idea of the speed of this ramp, their Penang engineers first visited Utah at the end of July and began the production ramp the last week of August.
The addition of this facility has caused Iomega to review their contract manufacturing relationships. They recently took over production of Zip drives from Seiko/Epson in the Philippines and are negotiating the transfer of Jaz production from Sequel in California to their Penang facility.
In the case of Seiko/Epson, they acted as a contract manufacturer for Iomega to help ramp Zip production. Seiko/Epson, in turn, was contracting with one of their partners to build drives. Both companies agreed that it would be in the best interest of all parties for Iomega to take over this relationship, particularly knowing that they would be reducing the number of drives built in the Philippines as they transfer production to Penang.
Previous agreements with their contract manufacturing partners, suppliers, and arrangements for facilities will limit Iomega's ability to immediately relocate more manufacturing to Penang. However, it is their intention to move most or all of the production of these subcontractors into the Penang facility. While their whole manufacturing strategy is under review, their current plan is to use Penang for high volume and maintain limited production and concurrent engineering in Utah.
On September 30th they announced their own "dream team" of IC manufacturers consisting of Intel, Motorola, TI and Symbios Logic. These companies will join Adaptec and Atmel as IC suppliers. These IC suppliers have committed design teams and wafer fabrication capacity for the development and manufacture of the various integrated circuit technologies used in the Zip, Jaz, and Ditto products. The companies are key to achieving Iomega's cost targets through their combined integration efforts.
This quarter Iomega announced that MCI (Matsushita Communications Inc.) is the first licensee for Zip drives. MCI is part of Matsushita Electronics Inc. whose brands include Panasonic, Technics, and National. The license allows MCI to manufacture Zip drives and, as part of the agreement, Iomega will supply them with subassemblies and provide them access to component vendors to accelerate their production ramp. The details of the license are confidential.
As part of the reorganization in Europe, Iomega is relocating their distribution center from Frankfurt to the Netherlands. They believe this move will improve shipping quality and reduce shipping time and cost by moving them closer to their customer base. From an inbound freight point of view the Netherlands facility is closer to the port of Rotterdam and the airport where most of Iomega's products enter Europe. It is also more centrally located for outbound freight to their customer base. In a parallel move in Singapore, they are moving the distribution center to a new and larger facility that can better accommodate their growth.
Consistent with their stated strategy of hitting key consumer price points to expand the market for Zip, they announced a $50 rebate on Zip at retail and this allowed the retailers to advertise Zip at $149.95. As expected, this pricing move was received favorably by the consumer resulting in increased sell-through of drives and disks in the US retail segment. As they have stated many times, their objective is to eventually offer an external Zip drive for $99 at retail.
For the same reasons, at the beginning of July they launched the external Jaz drive at retail for $499 and reduced the internal drive to $399. They believe that both of these moves are strategically important in building broad demand for their products.
On the tape side, they started shipping the Ditto 2GB at $199 for the external and $149 for the internal. With a native capacity of 1 gigabyte, the Ditto 2GB matches up well with many of the hard drives that have been shipped this past year. They will also be selling a private-branded Ditto 2GB to Sony.
Back to Zip, Canon is the latest addition to the long list of PC manufacturers now offering Zip. As they continue to add PC OEMs, their focus changes more and more to SKU expansion.
To improve customer support, they introduced a new fee-based technical phone service. Although they believe they need to make additional improvements, it has achieved the goal of dramatically reducing customer hold time. This change allows them to offer a more efficient means of providing customers technical support for one of the lowest per-incident fees out there. Customers are not charged for incidents that turn out to be the result of an Iomega problem. Some other companies that selectively charge for technical support include Gateway, Packard Bell, Microsoft, Dell, Adaptec, and IBM. In addition to this, Iomega is upgrading their free fax, email, and automated phone support systems.
They increased their investment in building US and European consumer awareness and retail presence in preparation for the fourth quarter selling season. As a result of this, their operating expenses increased to 19.6% versus 17.9% last quarter.
Their order backlog declined to $93 million, down from $125 million last quarter. They believe that this is mostly attributable to their ability to respond quickly to retail order demand.
As part of their ongoing efforts to invest in R&D, they added Doug Clifford as VP and Chief Technology Officer. Doug worked for Hewlett-Packard for 28 years in various R&D and general management positions. His last assignment at HP was the Information Storage Group R&D Manager where he was responsible for coordinating the R&D activities of 5 divisions and their supporting labs. His last 15 years have all been in the information storage industry. His previous assignment also included developing a software strategy for HP's Information Storage Group in backup, archiving, and storage management. Doug joined Iomega yesterday.
Today Iomega announced the decision to move to the New York Stock Exchange. They have been very pleased with the NASDAQ and, particularly, in helping them raise the capital for growth through their recent bond and equity offerings. However, after considering many factors they believe it is in the best interest of their shareholders to move to the New York Exchange. They expect to begin trading on the New York Stock Exchange within the next several weeks.
The third quarter was every bit as challenging as they had anticipated. However, they were pleased with the results considering the seasonal softening in the United States, worse than normal Summer doldrums in Europe, and their planned reduction in prices for Zip and Jaz. Retail sales of Zip drives and disks were stronger than planned in the US and the associated high level of Zip disk sell-through had a positive impact on their margins. Jaz tie ratios were lower than planned and, therefore, the Jaz business came in under expectations. They need to fully penetrate the corporate users and the vertical audio and video segments to improve Jaz tie ratios.
They are making progress in Europe but there is still a lot of work to be done to build an organization with the level of expertise that they expect. Given the employment laws and cultural considerations, they suspect that it will take a year to get to where they really want to be.
The Penang facility has come up better and faster than anticipated. It is allowing them to re-evaluate their total manufacturing strategy sooner than they originally planned. And, over the next several months, they will be reviewing all sites and contract manufacturing relationships as well as their licensing strategy.
As they said last quarter, their first priority remains getting Zips inside more of the boxes. Even though they have several of the majors offering Zip in their PCs, they still need to get the remaining big players to put Zip in their boxes. They will continue to work closely with existing partners and the other OEMs and retailers to expand the Zip SKUs and penetrate new accounts.
Knowing that the fourth quarter is normally the strongest selling season in retail, particularly in the US and Europe, they needed to position themselves to capitalize on this peak retail selling season. They have invested heavily in building demand and acquiring shelf space for the upcoming quarter. They expect to have a very strong presence at virtually all of the major computer retailers in the United States. Additionally, they have increased their inventory to improve their ability to respond to any upside in demand.
Since it got so much play last quarter, they again used the word "challenging." This fourth quarter they hope that all of their preparations create so much demand that it becomes challenging to meet it.
BUILDING THE FUNDAMENTALS. The company looked at their year-to-date progress compared to the same 3 quarters last year. Q1-Q3 in 1996 totalled $816 million or 4.6 times the comparable $177 million for the first 3 quarters last year. A key part of this was Iomega's international business which grew to $250 million or over 5 times the levels in the same period of 1995.
However the real story is in what they call their new Personal Solutions -- the products that form the new Iomega. Those products -- Ditto, Zip, and Jaz combined -- were $789 million, up 6.3 times from the $126 they contributed for the first three quarters last year. Implicit in these numbers is that, as planned, they killed Bernoulli.
Ditto, their most mature Personal Solution, grew 64% to $89 million. In the same period Zip and Jaz totalled $700 million, up almost 10 times last year's 9-month total of $72 million.
Over the same period, Iomega's net income increased from a loss of $1.4 million to a profit of $37 million. And, they have several of the big PC OEMs offering Zip SKUs and they now have a high-level partnership with a "dream team" of IC suppliers and a 376,000 square foot manufacturing facility in Penang.
On a side note, for the past two quarters their business has annualized over $1 billion.
So, although the second quarter was challenging, and Europe was a little soft, and Jaz tie ratios were not up to plan, they need to occasionally remind the Iomega employees of the progress that has been made.
They are looking forward to what they think will be a fun and exciting Comdex. * 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. |
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Copyright 1996, The Motley Fool |