Operator: Ladies and gentlemen, thank you for standing by. Welcome to the Iomega Corporation first quarter analyst conference call. At this time, all participants are in a listen only mode. Later, we will conduct a question and answer session. As a reminder, this conference is being recorded Thursday, April 15, 1999. I would now like to turn the conference over to Mr. Jodie Glore, President and Chief Executive Officer of Iomega Corporation. Please go ahead sir.
As we conduct the call, various remarks that we make about future expectations, plans, and prospects, constitute forward looking statements for the purposes of the Safe Harbor Provision under the Private Securities Litigation Reform Act. As you know, actual results may differ materially from those indicated by these forward looking statements as a result of various important factors including those identified in the 98 Annual Report, Form 10-K, and most recent 10-Q.
With that said, I would like to talk briefly about the quarter and then let Dan discuss the details. We made money in the quarter. Not a lot, but we made money in historically for us what has been a seasonally soft quarter, and this year was no exception. We reported results in the middle of the range we estimated last quarter. We continued our focus on asset management and reduced inventory by $7 million dollars over the course of the quarter. This was the fourth quarter in a row we have reduced absolute inventory levels. We were also cash-flow positive for the second consecutive quarter.
Demand for our Zip products again showed momentum. In the first quarter, Zip drive unit shipments were up 44% and Zip disk unit shipments were up 39% over the first quarter of 1998. We shipped 2.6 million Zip drives in the quarter, increasing the installed base to over 23 million drives. As you know, the installed base of Zip drives is one of the key metrics to use in valuing our business as it continues to grow.
We are continuing our success in the OEM market. All of the major OEMs offering SKUs offer SKUs with Zip Built-In. And Dell announced on Monday that 40% of their Dimension customers are choosing models with Zip included. Dell is also the first OEM to offer the new Zip 250 as a built-in option. Having a premium product like Zip 250 in the marketplace will enable us to improve our margins and at the same time aggressively position our Zip 100 drive.
Our Jaz business was softer than expected in the quarter. We believe that a seasonally soft first quarter, which followed a great fourth quarter, is a primary reason for this sequential weakness. We intend to improve Jaz profitability and take advantage of its strength in vertical markets.
As expected, our exciting new Clik platform was component-constrained throughout the quarter. We did not spend marketing dollars to promote a product that was not widely available in the quarter.
Today we announced that we are kicking off a new marketing program to promote our Clik platform. We plan to conduct 800 product demos in 38 major markets beginning this weekend. We believe that there is great potential for Clik, and we are working with many people to introduce some exciting Clik-based solutions this summer. On the Clik OEM front, Agfa is on track to launch a camera with Clik built-in mid year. Compaq, Sharp and others have also made commitments for Clik inclusion, and we will continue to announce other OEM initiatives as appropriate.
We recently launched two new marketing and sales initiatives for 1999: One focus on corporate sales and the other on Y2K and software solutions. Zip is now available across many commercial PC models or in authorized reseller option kits from Dell, Compaq, Gateway, IBM, HP and Apple. We intend to capitalize on availability of Zips on these commercial machines to increase our presence in the corporate segment by making joint sales calls with our EOM partners and demonstrating our full portfolio of removable storage solutions, including software.
We have one of the most compelling Y2K solutions in the market today. For the cost of a $99 zip drive and a few disks, anybody can back up their critical files and welcome the new millennium without fear of losing their data. You will see an aggressive marketing program promoting this and other solutions to Y2K issues in the coming months from us.
As we continue to focus on providing solutions, we're developing software to make our storage products more compelling to both our corporate and retail customers. A preview version of our new QuickSync software is now available as a free download at Iomega.com. The software, which we developed, enables users to do real-time backup of their documents. Each time they save to their hard drive, a duplicate file is automatically saved to a Zip, Clik, or Jaz disk, and the software even takes care of version control. We've had corporate customers tell us recently that software solutions like QuickSync and Norton Zip Rescue are reason enough to buy our drives.
That being said, there are still many opportunities we have yet to address. I have critically examined every aspect of this company and let me briefly share with you what I've found.
We have one of the most successful computing products of all time in the Zip drive. We have a solid niche product in Jaz, and we have a product with enormous potential in Clik. Zip and Jaz are the indisputable market leaders in their segments, and we expect to achieve similar results with Clik. We have a strong brand, committed partners, and a talented workforce. We are operating from a position of strength.
I have also found, however, that we have made mistakes and missed opportunities. We have spent too much money. Our product development process has been too expensive, taken too long, and has not been responsive enough to customer needs. We have been overly reliant on price reductions as a means of increasing unit demand. We have not managed this business as well as we could have.
I have visited almost all of our facilities and talked to most of our people. I have met with many of our customers and channel partners, and we all agree on one thing. We can do more, faster. As we have implemented the changes to a functional organization, we have found excesses and redundancies. Over the course of the next quarter we will be accelerating our streamlining efforts to focus on earnings growth, which means we will be reducing facilities and head count. We expect to take a special charge in the second quarter associated with the changes we will be implementing. We are close to completing our analysis, and we will announce the specifics of this charge and resulting savings later this quarter. We expect that these efforts will provide the profitability and cash resources we need to engage in activities which will further enhance shareholder value.
We remain committed to increasing the installed base of drives. We have evaluated our ongoing engineering projects, and we are assigning our best and brightest people to pursue the new products and cost reductions that will enable us to profitably increase the number of our drives in the marketplace.
Most of you are aware the significant improvement we have made in the operations area, or what I call the back-end part of our business. Today we announced that we have won Dell's Most improved supplier award for our delivery of high-quality Zip drives and best-in-class customer service. We have shown our abilities to focus on problems and fix them. Now we are focused on improving our product development process and the front-end sales and marketing areas of our business. I have every confidence we can do that.
We are currently beta-testing a web-based direct sales model to take advantage of the growth of e-commerce. We expect to launch this site later this quarter and anticipate that over time it will become an important channel for the sale of our products.
Before I turn the call over to Dan, let me summarize the areas that need our attention.
With that, I'd like to turn the call over to Dan Strong, who will discuss our first quarter results in more detail.
The bright spot in the quarter was our Zip business. Year-over-year Zip drive units were up 44%, zip disk units were up 39%, and our Zip business showed a solid increase in revenue in all three geographic regions. Zip posted $51 mil. in profit margin in the first quarter, compared to $29 mill. in the first Q of 1998. First quarter revenue of $386 million was down 5% year-over-year. This decrease was due to lower average selling prices as a result of price reductions we took during the year, lower than expected volume in our Jaz business, and the significant decline in our Ditto sales from 1Q98.
For the quarter Zip revenue of $302 mill. was up 13% year-over year. We shipped 2.6 mill. Zip drives in the quarter and 16 million Zip disks. 53% of Zip drive sales were to OEMs. We began shipping the Zip 250 ATAPI drive to Dell earlier this month, and that drive is selling at a positive gross margin. Zip 250 represented just over 10% of Zip drives shipped in the quarter and we expect the mix of Zip 250 versus Zip 100 to continue to grow.
Jaz revenue of $63 mill. was down 43% year-over-year, with Jaz drives down 46% and Jaz disks down 32% year-over-year. Jaz products profit margin showed a loss of $3 mill. in the quarter.
Clik generated minimal revenue in the quarter of $5 mill. As Jodie said, we did not feel it was prudent to spend advertising dollars to generate demand when we did not have adequate quantities in the channel. Due to the limited launch, Clik product profit margin was a loss of $13 mill.
Finally Ditto revenue for the quarter was $10 million, not including any revenue derived from the sale of the Ditto business during the quarter.
Both first quarter total disk revenue of $152 mill. and total drive revenue of $229 mill. were down year-over-year, again primarily due to the lower than expected volumes in our Jaz business and limited ramp of Clik. Looking just at our Zip business, disk revenue was up 12% and drive revenue was up 14% year-over-year.
Geographically, both Europe and Asia-Pacific reported improvements over the year-ago period. European revenue of $103 mill. was up 16% year-over-year, and Asia-Pacific revenue of $33 mill. was up 65% year-over-year, and both regions posted significant gross margin improvements.
Americas revenue of $250 mill. was down 16% year over year, almost entirely due to the weak Jaz sales and significant decline in Ditto revenue.
Now turning to gross margins, At $94 mill., gross margin dollars are down 8% from 1Q98 and represent 24% of sales versus 25% of sales in 1Q98 and 28% of sales in 4Q98. Year-over-year gross margins are down primarily due to price reductions on Zip and Jaz drives and disks, and the impact of lower than expected volumes in our Jaz business. Compared to the fourth quarter, gross margin percentage is down primarily due to the lower than expected Jaz volumes. The price reductions of Zip drives were almost entirely offset by reduced product costs in the quarter.
Turning to operating expense, I'm very pleased with the continued discipline we've showed in controlling costs. SG&A of $70 mill. is down 35% or almost $38 mill. from 1Q98. SG&A as a percentage of sales was 18% in the 1st quarter, compared with 27% in the first quarter and 16% in the 4Q98. R&D expenses of 20.7 mill, or approximately 5% of sales, are down slightly from approximately $23 mil. in the first quarter and $24 mill. in the 4th Q of 1998.
Total operating expenses of $91 mill. is a $40 million reduction compared to 1Q98, and a $15 mill. reduction compared to the 4Q98.
Now moving to the balance sheet, positive cash flow of $6 mill. is primarily the result of improved working capital management. Cash is now flowing more quickly through the system as a result of lower inventory and receivable levels. Payables are largely financing inventory. Cash conversion days of 57 days were down 26 days from 1Q98. We will continue to focus on asset management. And let me give you just a little bit of detail on the components of our cash conversion days, DSO, Dates inventory, and days payable.
Receivables at $228 mill. represent a 2-day improvement. in DSO to 53 days versus 55 days in 1Q98. Our focus on inventory reduction has continued to pay dividends. With our implementation of the virtual model, we reduced inventory by 50% from the first quarter of 1998. Inventory was down 4% from the 4Q98 to $158 mill., however inventory turns decreased slightly to 7.4 turns, versus 8.8 turns in the seasonally strong 4th quarter.
Accounts payable of $144 mill. were down $17 mil. from the 4th quarter, with days payable increasing slightly to 44 days from 40 days. We remain very comfortable with our liquidity. We have now had two consecutive quarters of positive cash flow, and we ended the quarter with $94 mill. in cash, and a completely unutilized $150 mill. bank line.
Due to our quarter closing on March 28, the March 31 payment of the Idanta notes will be reflected on our second quarter balance sheet. The notes were repaid with internally generated funds, and as we said last quarter, we expect to be positive cash flow for the year.
We remain very focused on sell-through and were generally pleased with the improvement in channel inventory. We ended the quarter with Zip 100 drives at 7 weeks, Zip 100 disks at just under 7.5 weeks, Jaz drives at approx. 5.5 weeks, and Jaz disks at just over 11 weeks.
Looking to the second quarter, we anticipate our operating results will be similar to the first quarter, but as Jodie said, we expect to take a special charge in the quarter primarily related to the consolidation of facilities and reduction in head count. The amount of the charge and the savings resulting from cost reduction activity will be finalized in the next several weeks.
Finally with the streamlining we will put in place in the second quarter, we expect our business model to hold for the second half of the year. Model parameters of mid to high twenties gross margin, operating expenses in the range of 20%, should yield a mid-single digit after tax return on sales. We believe there are strong upsides to the model due to the strength of our Zip product line and emerging software applications, but there is also significant downside risk associated with the launch of new products, particularly our Clik platform in the second half of the year.
With that I'd like to turn the call back to Jodie.
Dan Strong: As we've said we expect the results in 2Q99 to be approximately the same as 1Q99 and we expect that our model will hold for the second half of the year. The model parameters are mid to high 20's gross margin and operating expenses in the range of 20%, which should yield a mid-single-digit after-tax return on sales. We also said that we believe there's a strong upside to the model due to the strength of the Zip business, but there are downside risks associated with the launch of new products, particularly the Clik! platform, in the second half.
John Dean: I hear those words; does that say you expect to break even in 2Q99 on an EPS basis before charges and then as you look at the 3rd and 4th quarter that you expect to be profitable?
Dan Strong: That's correct, we said we expect the 2nd quarter to be approximately equal to the first quarter before the charge, and that in the second half we expect the operating model to hold, which yields a mid-single-digit after-tax return on sales.
Jodie Glore: I think on the Clik!, I'm not saying we're more or less cautious about what's really going to happen. What I'm trying to do and build into the company here is that we do what we say we can do and we don't try to talk about things six, nine, twelve months ahead of time. We're not necessarily being more cautious, we just want to point out what the pros and cons are, upsides and downsides, of where we think we're going to get our revenue in each half. And like Dan says, The Clik revenues, there's a lot of new products there, so there's some risk associated with that. That's really what we're saying.
With regard to your second question with Zip, we are again very pleased with Zip in terms of volume and what's going on here. We believe with the pricing where it is right now, we brought our price down to $99, we believe we're going to hold it there for a while, see what happens.
We are very pleased that as people are getting below $1000 PCs or $500 PCs we're finding that the need for removable storage is basically increasing.
Todd Bakar: Regarding Clik!, could you size or give us a range of how big Clik will be by the end of the year, as a percentage of total business or just an absolute size?
Jodie Glore: We think right now looking at what's going on, Clik! will probably be somewhere around 10% of our revenue. Again it could be a lot higher than that, it also could be a lot lower than that. But basically we're looking around 10% right now. What we really are trying to focus on doing is make sure we're talking conservatively, doing the things we need to do and we have the programs in place to do a good launch. One of the things that I've learned here is that we've have to have a good marketing program, sales program, some other things in place, not just have the products there. But 10% right now is about what we're looking at.
Jodie Glore: Total revenue for the year, Stan.
Stan Corker: The price reduction that was taken on the Zip drive, can you give us an estimate on what the impact for the quarter was for that, either in net profit or cents?
Dan Strong: The margin reduction as a result of the price action was almost entirely offset by improved product costs. Our gross margin percentage for Zip was comparable to 4th quarter, in fact it was up a bit.
Stan Corker: but without that, what would it have been, without the product cost improvement? Can you give the number of cents it would have been?
Dan Strong: Stan, I don't have that and I probably don't want to get into that level of detail. But just to repeat, the product costs almost offset the price reductions, and the gross margin on Zip this quarter was slightly better than last quarter.
Stan Corker: The sale of Ditto assets, was that taken in this quarter?
Dan Strong: As you probably know, the total sales price for the Ditto business was $3 million, of which $1 million was in cash and $2 million was in a note to be payable over the next two years. The one million was reported in this quarter.
Stan Corker: Last quarter you gave us guidance about what you expected for the quarter in terms of the 250 and Clik! probably being component-constrained, and that would affect revenue and earnings. You mentioned the Clik, what about the 250? Were those problems resolved, or were the Zip250 revenues still impacted by components?
Jodie Glore: Stan you're right on the Clik. We did have some, exactly what we said in our call in January, we thought a lot of the problems with components on the 250 would be cleared up in March There's still a little disk problem at the end but that's exactly what happened.
Stan Corker: Going into the next quarter, is everything behind us?
Jodie Glore: We should be pretty much on the Zip components, the supplier components, we should be fine.
Jodie Glore: We are proceeding like we have been on plans since we announced the thing. That's moving along pretty much as we had it planned.
John Dean: Refresh my memory in terms of when you expect to have products and which products over what kind of time period.
Dan Strong: We are currently manufacturing some drives in Utah, and we expect the new facility here to produce in pretty decent volumes in late summer early fall. So we're proceeding on that ramp as we speak.
Jodie Glore: Let me start by talking about profitability, why we think we're going to be getting better, what are some of the things we should be looking at. First of all, I think that we do have a much better focus on what our sales and cost drivers are than we've had in the past. We also believe that the contributions from our new products, both in hardware and software, are really going to help us. We think in terms of profitability that the programs that we just talked about, the enterprise, Y2K software, old initiatives, as well as some of the other initiatives we've had, is going to help, and we think we have a lot more to do in our focused markets.
I will say one thing, I think we have been more responsive to customers, I went out and talked to a lot of our customers, and they're very happy with the realignment of the sales force. I think our focus on costs allows us to lower our operating costs, quarter over quarter from 4th quarter last year, about $15 million. So we are doing a lot of things that I believe are going to make us a lot more profitable.
I did talk about ways to judge our performance to see how we're doing. Number one, look at our success in increasing the installed base of our drives. Another thing that ties with that is what's our ability to leverage our installed base of drives into solid year over year disk growth revenue?
We need to look at and say, we haven't been very good at introducing new products. We're spending a lot of time now, and money and effort, on how do we launch new products and software in a much more timely and cost-effective manner. I think that's something you ought to measure.
You ought to look at, we talked about launching a web-based direct sales model, you ought to say, how well did you do that and did you do that? I think that's an important concept.
Last but not least, I think the number of enterprise and corporate customers wins we're able to generate. A lot of things we're doing that are very important to us long-term and those are good measures.
Joe Besecker: The great promise, we were looking for in our last report, Clik, I heard you say that Agfa was doing something, and you also said Compaq and Sharp, and the status of those. And also, is there any greater clarity now two or three quarters after the fact on what type of consumption of disks comes from the OEM drives versus the retail drives?
Jodie Glore: I think that right now what we're doing with the OEMs with the Clik! platforms, and there will be platforms, but we can't get more clarity than that right now, going forward. But we are excited about Clik and in my personal opinion I think Clik has as much long-term potential as Zip does. And what we're trying to do is make sure that when we launch and do these things, we're doing the things and spending right and got a lot [of product] in stock. As you well know, this will be the fifteenth time we've launched the product. We can't do that, we just can't do that anymore. We are doing what we need to be able to do to ensure that there's a successful launch going forward. I'm very excited about that process, and there will be a lot of interesting things I'm sure we can talk about in the next couple of conference calls.
Joe Besecker: Is Clik going to be more of an OEM product instead of a retail product?
Jodie Glore: I think there's some very different markets for Clik!. How people are going to use it in the PC market is going to be very different from how people want to use it in the imaging market and very different from how people want to use it in the entertainment market. That's what makes it so complex yet fun, and yet simple because we can get leverage across those markets. we're going to see multiple ways of use depending on where it goes. So whether it's OEM or a standalone thing I think it's too early to tell in a lot of cases.
Joe Besecker: Any kind of surveillance at all of the OEM usage, the Zip-inside usage, versus the shrink-wrapped box?
Jodie Glore: No we don't. Sorry, Joe, not at all.