Iomega Corporation
(Exact name of registrant as specified in its charter)
|
Delaware (State or other jurisdiction of incorporation or organization |
86-0385884 (IRS employer identification number) |
4435 Eastgate Mall, 3rd Floor, San Diego, CA 92121
(Address of principal executive offices)
(858) 795-7000
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes X No
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes X No
Indicate the number of shares outstanding of each of the issuer's classes of common stock as of May 2, 2003.
|
Common Stock, par value $.03 1/3 (Title of each class) |
51,326,197 (Number of shares) |
Page
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Special Note Regarding Forward-Looking Statements.................................................. 2
PART I - FINANCIAL STATEMENTS
Item 1. Financial Statements
Condensed Consolidated Balance Sheets at March 30, 2003
and December 31, 2002................................................................. 3
Condensed Consolidated Statements of Operations for the Quarters
ended March 30, 2003 and March 31, 2002............................................... 5
Condensed Consolidated Statements of Cash Flows for the Three Months
ended March 30, 2003 and March 31, 2002............................................... 6
Notes to Condensed Consolidated Financial Statements...................................... 7
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations................................................... 26
Item 3. Quantitative and Qualitative Disclosures About Market Risk................................ 51
Item 4. Controls and Procedures................................................................... 52
PART II - OTHER INFORMATION
Item 1. Legal Proceedings......................................................................... 53
Item 2. Changes in Securities and Use of Proceeds................................................. 53
Item 6. Exhibits and Reports on Form 8-K.......................................................... 53
Signatures......................................................................................... 54
Certification - Werner T. Heid, President and Chief Executive Officer.............................. 55
Certification - Barry Zwarenstein, Vice President, Finance and Chief Financial Officer............. 56
Exhibit Index...................................................................................... 57
Copyright © 2003 Iomega Corporation. All rights reserved. Iomega, the stylized “i” logo, Zip, Jaz, Peerless, PocketZip, HipZip, HotBurn, FotoShow, Active Disk, ioLink and IoClub are either registered trademarks or trademarks of Iomega Corporation in the United States and/or other countries. Certain other product names, brand names and company names may be trademarks or designations of their respective owners.
1
This Quarterly Report on Form 10-Q contains a number of forward-looking statements, including, without limitation, statements referring to: plans to introduce new and enhanced products and software, including a small-form factor removable flexible magnetic storage device (referred to as Digital Capture Technology or “DCT”) expected to have a capacity of about 1.5GB and a removable hard disk storage system (referred to as Removable Rigid Disk System or “RRD”) expected to have a capacity of approximately 35GB; goals to recruit OEM customers for new products; the overall objective to be viewed as a full line supplier of digital storage devices for the Company’s retail, catalog and online customers and to achieve the goal of creating “destination storage” in the retail and catalog channels; plans to mitigate the continued decline in the Company’s core Zip business; the need for additional restructuring or other charges in the future; the expectation of future outsourcing initiatives; the expected profitability or lack of profitability on certain product lines; the expected sales volume or lack of sales volume on certain product lines; plans concerning the availability of PocketZip and Jaz disks and other plans concerning product lines; the belief that NAS represents a sales growth opportunity and the goal to launch new NAS products during 2003; the goal to expand the sales of DVD Rewritable drives during the second quarter of 2003; the goal to grow the Company’s sales; the expectation of continuing to lower product procurement costs; the goal to improve the procurement and commodity business processes to maximize profitability on sourced branded products; the impacts of expensing stock option grants; the expected sufficiency of unrestricted cash, cash equivalents and temporary investment balances and cash flows from future operations; the Company’s belief that its cash reserves are in excess of what is required to operate the existing business on an ongoing basis and that it is continuing to analyze and explore strategic opportunities both in and outside the storage industry with the goal to obtain the maximum benefit for the Company’s stockholders; the factors affecting future gross margins; expected sales levels due to seasonal demand; the expectation that the Company can obtain sufficient product and components thereof to meet business requirements; anticipated hedging strategies; the possible effects of an adverse outcome in the review of the Company’s SEC filings described under the caption “Other Matters” in Management’s Discussion and Analysis of Financial Condition and Results of Operations; the expected impact of the adoption of recent accounting pronouncements and the possible effects of an adverse outcome in legal proceedings, including the resolution of the adverse judgments in the Nomai litigation, as described in Note 5 of the notes to condensed consolidated financial statements in Part I. Any other statements contained herein that are not statements of historical fact may be deemed to be forward-looking statements. Without limiting the foregoing, the words “believes,” “anticipates,” “plans,” “expects,” “intends” and similar expressions are intended to identify forward-looking statements, although not all forward-looking statements contain these words.
There are a number of important factors that could cause actual events or the Company’s actual results to differ materially from those indicated by such forward-looking statements. These factors include, without limitation, those set forth under the captions “Application of Critical Accounting Policies,” “Liquidity and Capital Resources,” “Factors Affecting Future Operating Results” and “Quantitative and Qualitative Disclosures About Market Risk” included under “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Items 2 and 3 of Part I of this Quarterly Report on Form 10-Q and those set forth in Note 5 of the notes to condensed consolidated financial statements in Part I of this Quarterly Report on Form 10-Q. The factors discussed herein do not reflect the potential future impact of any mergers, acquisitions or dispositions. In addition, any forward-looking statements represent the Company’s estimates only as of the day this quarterly report was first filed with the Securities and Exchange Commission and should not be relied upon as representing the Company’s estimates as of any subsequent date. While the Company may elect to update forward-looking statements at some point in the future, the Company specifically disclaims any obligation to do so, even if its estimates change.
2
March 30, December 31,
2003 2002
--------- ------------
(Unaudited)
Current Assets:
Cash and cash equivalents $ 174,064 $ 241,519
Restricted cash 200 3,800
Temporary investments 286,395 208,545
Trade receivables, less allowance for doubtful accounts of
$2,867 and $5,462, respectively 32,316 54,477
Inventories 35,098 40,525
Deferred income taxes 23,670 27,573
Income taxes receivable 295 -
Other current assets 12,668 14,490
--------- ---------
Total Current Assets 564,706 590,929
--------- ---------
Property and Equipment, at Cost 156,328 155,376
Accumulated Depreciation and Amortization (139,352) (137,274)
--------- ---------
Net Property and Equipment 16,976 18,102
--------- ---------
Goodwill 11,691 11,691
--------- ---------
Other Intangibles, Net 6,085 6,755
--------- ---------
Other Assets 95 122
--------- ---------
Total Assets $ 599,553 $ 627,599
========= =========
The
accompanying notes to condensed consolidated financial statements are an
integral part of these statements.
3
March 30, December 31,
2003 2002
--------- -----------
(Unaudited)
Current Liabilities:
Accounts payable $ 37,357 $ 60,131
Other current liabilities (Note 1) 89,691 98,456
Income taxes payable - 622
--------- ---------
Total Current Liabilities 127,048 159,209
--------- ---------
Other Long-Term Liabilities 1,301 2,244
--------- ---------
Deferred Income Taxes 54,352 55,107
--------- ---------
Commitments and Contingencies (Notes 4 and 5)
Stockholders' Equity:
Preferred Stock, $0.01 par value; authorized 4,600,000
Shares; none issued - -
Series A Junior Participating Preferred Stock; authorized
400,000 shares; none issued - -
Common Stock, $0.03 1/3 par value; authorized 400,000,000
shares; issued 54,743,235 and 54,645,278 shares,
respectively 1,825 1,822
Additional paid-in capital 308,213 307,716
Less: 3,426,288 Common Stock treasury shares, at cost (33,791) (33,791)
Retained earnings 140,605 135,292
--------- ---------
Total Stockholders' Equity 416,852 411,039
--------- ---------
Total Liabilities and Stockholders' Equity $ 599,553 $ 627,599
========= =========
The
accompanying notes to condensed consolidated financial statements are an
integral part of these statements.
4
For the Quarter Ended
-------------------------------
March 30, March 31,
2003 2002
--------- ---------
(Unaudited)
Sales $ 106,182 $ 178,897
Cost of sales 69,072 106,371
--------- ---------
Gross margin 37,110 72,526
--------- ---------
Operating Expenses:
Selling, general and administrative 23,340 38,196
Research and development 8,588 8,644
Restructuring reversal (78) -
Bad debt credit (1,982) (696)
--------- ---------
Total Operating Expenses 29,868 46,144
--------- ---------
Operating income 7,242 26,382
Interest income 1,866 2,320
Interest expense and other income and expense, net 22 (2,104)
--------- ---------
Income before income taxes 9,130 26,598
(Provision) benefit for income taxes (3,817) 4,611
--------- ---------
Net Income $ 5,313 $ 31,209
========= =========
Net income per basic and diluted common share $ 0.10 $ 0.61
========= =========
Weighted average common shares outstanding 51,265 51,281
========= =========
Weighted average common shares outstanding -
assuming dilution 51,298 51,375
========= =========
The accompanying notes to condensed consolidated financial statements are an
integral part of these statements.
5
For the Quarter Ended
-------------------------------
March 30, March 31,
2003 2002
--------- --------
(Unaudited)
Cash Flows from Operating Activities:
Net income $ 5,313 $ 31,209
Non-Cash Revenue and Expense Adjustments:
Depreciation and amortization 3,608 7,058
Deferred income taxes 3,148 7,753
Non-cash inventory write-offs - 2,231
Amortization on temporary investments 822 277
Bad debt credit (1,982) (696)
Other 31 799
--------- ---------
10,940 48,631
Changes in Assets and Liabilities:
Restricted cash 3,600 (1,763)
Trade receivables 24,143 8,145
Inventories 5,427 (515)
Other current assets 1,822 (5,121)
Accounts payable (22,774) (8,924)
Other current liabilities (8,310) (5,842)
Accrued restructuring (455) (6,433)
Income taxes (917) (10,959)
--------- ---------
Net cash provided by operating activities 13,476 17,219
--------- ---------
Cash Flows from Investing Activities:
Purchases of property and equipment (1,810) (2,590)
Purchases of temporary investments (215,396) (59,812)
Sales of temporary investments 136,724 61,106
Net change in other assets and other liabilities (617) (651)
--------- ---------
Net cash used by investing activities (81,099) (1,947)
--------- ---------
Cash Flows from Financing Activities:
Proceeds from sales of Common Stock 168 82
Purchases of Common Stock - (2,924)
Payments on other obligations - (302)
--------- ---------
Net cash used in financing activities 168 (3,144)
--------- ---------
Net (Decrease) Increase in Cash and Cash Equivalents (67,455) 12,128
Cash and Cash Equivalents at Beginning of Period 241,519 219,949
--------- ---------
Cash and Cash Equivalents at End of Period $ 174,064 $ 232,077
========= =========
The accompanying notes to condensed consolidated financial statements are an
integral part of these statements.
6
In the opinion of the Company’s management, the accompanying unaudited, condensed consolidated financial statements reflect all adjustments which are necessary to present fairly the financial position of the Company as of March 30, 2003 and December 31, 2002, the results of operations for the quarters ended March 30, 2003 and March 31, 2002 and cash flows for the three months ended March 30, 2003 and March 31, 2002.
The results of operations for the quarter ended March 30, 2003 are not necessarily indicative of the results to be expected for the entire year or for any future period.
These unaudited, condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes included in the Company’s latest Annual Report on Form 10-K.
Principles of Consolidation
These unaudited, condensed consolidated financial statements include the accounts of Iomega Corporation and its wholly-owned subsidiaries after elimination of all material intercompany accounts and transactions. All entities of the Company have been consolidated and there are no special purpose or variable interest entities.
Pervasiveness of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of sales and expenses during the reporting periods. Areas where significant judgments are made include, but are not limited to: revenue recognition, price protection and rebate reserves, allowance for doubtful accounts, inventory valuation reserves and marketing program accruals. Actual results could differ materially from these estimates.
Manufacturing Relationships
The Company uses independent parties to manufacture for the Company, on a contract basis, the Company’s products or components. Not all of the Company’s manufacturing relationships are covered by binding contracts and certain of the relationships are subject to unilateral termination by the Company’s manufacturing partner. Shortages resulting from a change in a manufacturing arrangement could cause a delay in product availability and a possible loss of sales, which would have a material adverse effect on the Company’s operating results. The Company is evaluating the consolidation of Zip disk manufacturing with the goal to reduce costs. In the event the Company implements any such consolidation, the Company may be required to record charges for discontinuing certain manufacturing relationships.
Reclassifications
Certain reclassifications were made to the prior periods’ unaudited, condensed consolidated financial statements and notes to condensed consolidated financial statements to conform to the current period presentation.
7
Revenue Recognition
The Company’s customers include original equipment manufacturers (“OEMs”), retailers, distributors, value added resellers (“VARs”), catalogs, private label and end users. Typically, retail and distribution customer agreements have provisions that allow the customer to return product under certain conditions within specified time periods. Sales, less reserves for estimated returns, are generally recognized upon shipment and passage of title to the customer. The Company has established reserves for estimated returns, which are reflected as a reduction in sales and trade receivables in the accompanying condensed consolidated financial statements. The reserve for estimated returns totaled $5.2 million and $6.0 million at March 30, 2003 and December 31, 2002, respectively.
In addition to reserves for estimated returns, the Company defers recognition of sales on estimated excess inventory in the distribution, retail and catalog channels. For this purpose, excess inventory is the amount of inventory that exceeds the channels’ four-week requirements as estimated by management. The OEM and VAR customers are not considered to have excess inventory as they tend to not carry more than four weeks of inventory. For example, the Company’s OEM customers are on a just-in-time inventory system, so there is no excess inventory in the OEM channel. The channel’s four-week requirements are estimated based on inventory and sell-through amounts reported to the Company by the Company’s key customers, who make up the majority of the Company’s sales in the distribution, retail and catalog channels. No adjustment is made for those customers that do not report inventory and sell-through information. The Company defers estimated sales and cost of sales associated with estimated excess channel inventory in its condensed consolidated financial statements. The gross margin associated with deferral of sales for estimated excess channel inventory totaled $11.2 million and $17.9 million at March 30, 2003 and December 31, 2002, respectively and is included in “other current liabilities” in the accompanying condensed consolidated balance sheets.
The Company sells software that is embedded or bundled with some of its drive products, as well as some software titles that are downloaded from the Company’s website. Sales from the software embedded or bundled with drive products, less reserves for estimated returns, are recognized upon shipment to the customer. Sales from software that is downloaded from the Company’s website is recognized at the time of download. The software sold by the Company does not contain multiple elements. The Company’s software sales are immaterial.
Price Protection and Volume Rebates
The Company has agreements with certain of its customers which, in the event of a price decrease, allow those customers (subject to limitations) a credit equal to the difference between the price originally paid and the new decreased price on units in the customers’ inventories on the date of the price decrease not to exceed the number of units shipped to the customer for a specified time period prior to the price decrease. When a price decrease is anticipated, the Company establishes reserves against gross trade receivables with the corresponding reduction in sales for estimated amounts to be reimbursed to qualifying customers. In addition, the Company records reserves at the time of shipment for estimated volume rebates and other estimated rebates given to consumers at time of purchase from channel partners for which sales have been recognized.
Reserves for volume rebates and price protection credits totaled $27.4 million and $29.2 million at March 30, 2003 and December 31, 2002, respectively and are netted against trade receivables in the accompanying condensed consolidated balance sheets.
8
Cash and Cash Equivalents
For the purposes of the condensed consolidated statements of cash flows, cash and cash equivalents include all marketable securities purchased with maturities of three or fewer months. Cash equivalents consist primarily of investments in corporate obligations, money market funds, repurchase agreements, asset backed securities, mortgage backed securities, U.S. agencies, U.S. treasuries and taxable and non-taxable municipal obligations.
Restricted Cash
At March 30, 2003, the Company had $0.2 million of cash to cover foreign bank guarantees for value added taxes (“VAT”). At December 31, 2002, the Company had classified a total of $3.8 million as “restricted cash,” of which $3.6 million of cash was set aside to secure a letter of credit. This letter of credit expired in March 2003 and therefore this cash is no longer restricted. These amounts are reported separately as “restricted cash” in the accompanying condensed consolidated balance sheets.
Temporary Investments
Investments purchased with maturities in excess of three months are classified as temporary investments. Temporary investments at March 30, 2003 and December 31, 2002 primarily consisted of corporate obligations, U.S. treasuries, U.S. agencies, taxable and non-taxable municipal obligations, asset backed securities and mortgage backed securities. None of the Company’s temporary investments have an effective maturity greater than 24 months and at March 30, 2003, the average duration of the Company’s temporary investments was just under one year. The Company minimizes its credit risk associated with temporary investments by purchasing investment grade, liquid securities. The Company has classified all of its temporary investments as available-for-sale securities.
Fair Value of Financial Instruments
The book value of all financial instruments approximates fair value. The Company considers its cash equivalents, temporary investments and foreign exchange contracts to be financial instruments and the estimated fair values for these instruments have been determined using appropriate market information. The Company also considers its accounts payable and trade receivables to be financial instruments and the carrying value of these instruments approximates their fair values because of the short-term maturities of these items.
Allowance for Doubtful Accounts
The Company records its trade receivables at sales value and establishes a non-specific allowance for estimated doubtful accounts by applying specified percentages to the different receivable aging categories. The percentage applied against the aging categories increases as the accounts become further past due. Accounts in excess of 180 days past due are fully reserved. In addition, specific reserves are established for specific customer accounts as collection problems become known or occur due to insolvency, disputes or other collection issues. The amount of these specific reserves are estimated by management based on the following assumptions/variables: customer’s financial position, age of the customer’s receivables and changes in payment schedules. The allowance for doubtful accounts is charged with the write-off of uncollectible customer accounts whether due to insolvency, settlement or disputes.
9
Inventories
Inventories include direct materials, direct labor and inventory related overhead costs and are recorded at the lower of cost (first-in, first-out) or market and consist of the following:
March 30, December 31,
2003 2002
--------- ------------
(In thousands)
Raw materials $ 2,719 $ 2,249
Finished goods 32,379 38,276
-------- --------
$ 35,098 $ 40,525
======== ========
The Company evaluates the carrying value of inventory on a quarterly basis to determine if the carrying value is recoverable at estimated selling prices (including known future price decreases). The Company includes material costs, inventory related overhead costs and direct selling expenses in its analysis of inventory realization. To the extent that estimated selling prices do not exceed such costs and expenses, valuation reserves are established against inventories. In addition, the Company generally considers that inventory on hand, which is not expected to be sold within the next nine months as forecasted by the Company’s material requirements planning system, as excess and thus appropriate reserves are established through a charge to cost of sales.
Property and Equipment
The carrying amounts of property and equipment are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of the asset may not be recoverable. Impairment is recognized when estimated expected future cash flows (undiscounted and without interest charges) are less than the carrying amount of the asset.
Fixed asset reserves are established for those assets that are considered impaired or if a commitment has been made for the removal of a fixed asset. These reserves are included with accumulated depreciation and amortization in the accompanying condensed consolidated financial statements.
Marketing Program Accruals
The Company, as part of its normal operations, has entered into contracts with many of the Company’s distribution and retail customers whereby the customer is allowed to use a set percentage of its purchases of the Company’s products for various marketing purposes. The purpose of these contracts is to encourage advertising and promotional events to promote the sale of the Company’s products to end users. The Company also contracts with various third parties to support these customer programs. The Company accrues for the estimated costs of these marketing programs with the customers and third parties in accordance with the contractual percentage of product sold to the respective customer and the estimated support costs during the period that the product is sold or the period that the support costs are incurred. During the period, the customer and Company develop and approve specific marketing programs to utilize the above funds in a manner intended to best promote the Company’s products. On a quarterly basis, the Company evaluates the adequacy of these marketing program accruals to cover known marketing programs that the Company has agreed to pay and/or share costs with the customer. In addition, the Company evaluates the specific programs for proper classification of these costs in accordance with Emerging Issues Task Force (“EITF”) Issue No. 00-25, “Vendor Income Statement Characterization of Consideration Paid to a Reseller of the Vendor’s Products”.
10
Other Current Liabilities
Other current liabilities consist of the following:
March 30, December 31,
2003 2002
-------- --------
(In thousands)
Margin on deferred sales $ 12,110 $ 19,102
Accrued marketing (a) 11,616 15,426
Accrued payroll, vacation, bonus and profit sharing 10,011 9,589
Accrued warranty 7,202 8,035
Other accrued liabilities (b) 48,752 46,304
-------- --------
$ 89,691 $ 98,456
======== ========
| (a) | Includes accruals for marketing development funds committed to the Company's various channel partners,promotional accruals and advertising accruals. |
| (b) | Includes accruals for royalties, professional fees, self-insurance liabilities, employee relocation costs, restructuring charges, purchase commitments, litigation, VAT, sales and other taxes and other miscellaneous liabilities. |
Stock Compensation Expense
The Company has four stock-based compensation plans. Prior to January 1, 2003, the Company accounted for these plans under the recognition and measurement provisions of Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB No. 25”) and related interpretations. No stock-based compensation expense is reflected in net income for the three months ended March 31, 2002, as all options granted under the four plans had an exercise price equal to the market value of the Company’s Common Stock on the date of grant.
11
Effective January 1, 2003, the Company adopted the fair value recognition provisions of Statement of Financial Accounting Standards (“SFAS”) No. 123, “Accounting for Stock-Based Compensation” (“SFAS 123”). The Company selected the prospective method, which is one of the three transition methods allowed by SFAS No. 148 “Accounting for Stock Based Compensation – Transition and Disclosure,” to transition to the fair value method of measuring stock-based compensation expense. Under the prospective method, the Company expensed only those employee stock options that were granted after January 1, 2003. The majority of awards under the Company’s plans vest over periods ranging from four to five years. Therefore, the cost related to stock-based compensation included in the determination of net income for the period ending March 30, 2003 is less than that which would have been recognized if the fair value based method had been applied to all awards since the original effective date of SFAS 123. The following table illustrates the effect on net income and earnings per share if the fair value based method had been applied to all outstanding and unvested awards in each period.
For the Three Months Ended
--------------------------------------
March 30, 2003 March 31, 2002
-------------- ---------------
(In thousands, except per share data)
Net income as reported $ 5,313 $ 31,209
======= ========
Add: Stock compensation expense included
in reported net income, net of related tax
effects 16 -
Less: Total stock compensation expense
determined under fair value method for
all awards, net of related tax effects 336 663
------- --------
Pro forma net income $ 4,993 $ 30,546
======= ========
Basic EPS:
As reported $ 0.10 $ 0.61
======= ========
Pro forma $ 0.10 $ 0.60
======= ========
Diluted EPS:
As reported $ 0.10 $ 0.61
======= ========
Pro forma $ 0.10 $ 0.59
======= ========
Accrued Warranty
A one-year limited warranty, or a two-year limited warranty in Europe, is generally provided on the Company’s Zip, Jaz, CD-RW, Peerless, portable and desktop hard disk drives (“HDD”) and Peerless disks as well as on products that have been discontinued such as PocketZip drives, HipZip digital audio players (“HipZip”) and FotoShow digital image centers (“FotoShow”). Certain OEM customers have a three-year limited warranty on the Company’s Zip drives. Zip, Jaz and PocketZip disks have a five-year limited warranty. The new Iomega Mini USB drives have a three-year limited warranty. NAS servers have limited warranty periods ranging from one to three years depending on the model purchased. In January 2001, the Company began shipping the Zip U250MB disk, which has a ten-year limited warranty.
12
The Company accrues for warranty costs based on estimated warranty return rates and estimated costs to repair. The Company uses a statistically-based model to estimate warranty accrual requirements. The statistical model used to project future returns is based upon a rolling monthly calculation that computes the number of units required in the warranty reserve and is based upon monthly sales, actual returns and statistically projected return rates. Generally, if a product is subject to failure or likely to fail, the product fails early in the usage cycle. Actual warranty costs are charged against this reserve. Factors that affect the Company’s warranty liability include the number of units sold, historical and anticipated rates of warranty returns and repair cost. The Company reviews the adequacy of its recorded warranty liability on a quarterly basis and records the necessary adjustments to the warranty liability.
Changes in the Company’s warranty liability during all periods presented were as follows:
For the Three Months Ended
---------------------------------------
March 30, 2003 March 31, 2002
-------------- --------------
(In thousands)
Balance at beginning of period $ 8,035 $ 10,856
Accruals/additions 2,410 3,364
Claims/charges (3,243) (4,414)
------- --------
Balance at end of period $ 7,202 $ 9,806
======= ========
Net Income Per Common Share
Basic net income per common share (“Basic EPS”) excludes dilution and is computed by dividing net income by the weighted average number of common shares outstanding during the period. Diluted net income per common share (“Diluted EPS”) reflects the potential dilution that could occur if stock options or other contracts to issue common stock were exercised or converted into common stock. The computation of Diluted EPS does not assume exercise or conversion of securities that would have an anti-dilutive effect on net income per common share.
13
Following is a reconciliation of the numerator and denominator of Basic EPS to the numerator and denominator of Diluted EPS for all periods presented:
Net
Income Shares Per Share
(Numerator) (Denominator) Amount
----------- ------------- ---------
(In thousands, except per share data
For the Quarter Ended:
March 30, 2003:
Basic EPS $ 5,313 51,265 $ 0.10
Effect of options - 33 -
-------- ------ ------
Diluted EPS $ 5,313 51,298 $ 0.10
======== ====== ======
March 31, 2002:
Basic EPS $ 31,209 51,281 $ 0.61
Effect of options - 94 -
-------- ------ ------
Diluted EPS $ 31,209 51,375 $ 0.61
======== ====== ======
For the quarters ended March 30, 2003 and March 31, 2002, there were outstanding options to purchase 1,456,037 and 1,873,707 shares, respectively, that had an exercise price greater than the average market price of the common shares for the respective quarters. Therefore, these shares would have had an anti-dilutive effect on EPS.
Recent Accounting Pronouncements
In November of 2002, the EITF reached a consensus on Issue No. 00-21, “Revenue Arrangements with Multiple Deliverables” (“EITF 00-21”). EITF 00-21 addresses certain aspects of accounting for arrangements whereby a vendor performs multiple revenue-generating activities. EITF 00-21 also discusses how to determine whether an arrangement involving multiple deliverables contains more than one unit of accounting and how the related revenue should be measured and allocated to the separate units of accounting. EITF 00-21 is effective for revenue arrangements entered into for fiscal periods beginning after June 15, 2003. The Company plans on adopting EITF 00-21 on June 30, 2003. The Company believes that the effect of EITF 00-21 on the Company’s results of operations, financial position or liquidity will not be material as the Company currently has few multiple deliverable revenue arrangements.
14
Deferred tax assets and liabilities are determined based on the differences between the financial reporting and tax bases of assets and liabilities. They are measured by applying the enacted tax rates and laws in effect for the years in which such differences are expected to reverse. The significant components of the Company’s deferred tax assets and liabilities are as follows:
March 30, December 31,
2003 2002
--------- ------------
(In thousands)
Deferred Tax Assets (Liabilities):
Current Deferred Tax Assets:
Trade receivable reserves $ 8,897 $ 11,259
Inventory reserves 3,809 3,042
Accrued expense reserves 10,862 13,030
Other 102 242
--------- ---------
Total current deferred tax assets 23,670 27,573
--------- ---------
Non-Current Deferred Tax Assets:
Fixed asset reserves 947 1,185
Tax credit carryforwards 19,421 19,058
Accelerated depreciation/amortization 4,440 4,301
Foreign net operating loss carryforwards 13,048 15,199
U.S. net operating loss carryforwards 34,868 34,444
Other 904 884
--------- ---------
Total non-current deferred tax assets 73,628 75,071
--------- ---------
Total deferred tax assets 97,298 102,644
--------- ---------
Non-Current Deferred Tax Liabilities:
Tax on unremitted foreign earnings (109,982) (109,988)
Nomai goodwill and intangible asset (4,950) (4,991)
--------- ---------
Total non-current deferred tax liabilities (114,932) (114,979)
--------- ---------
Non-current valuation allowance (13,048) (15,199)
--------- ---------
Net deferred tax assets (liabilities) $ (30,682) $ (27,534)
========= =========
As Reported on the Balance Sheet:
Current deferred tax assets $ 23,670 $ 27,573
========= =========
Non-current deferred tax liabilities $ (54,352) $ (55,107)
========= =========
The realizability of the deferred tax assets is evaluated quarterly in accordance with SFAS No. 109, “Accounting for Income Taxes,” which requires that a valuation allowance be established when there is significant uncertainty as to the realizability of the deferred tax assets.
15
At March 30, 2003, the Company had $34.9 million of deferred tax assets related to net operating loss carryforwards (“NOLs”). Of the total NOL deferred tax assets, $28.1 million related to U.S. federal NOLs and $6.8 million related to state NOLs. The federal NOLs reflect a tax benefit of approximately $80 million in future U.S. federal tax deductions. The state NOLs reflect a tax benefit of approximately $170 million in future state tax deductions. The difference in the amount of future federal and state tax deductions related to the NOLs is largely the result of differences between federal and state NOL carryback rules. The U.S. federal NOLs expire at various dates beginning in 2022 and the state NOLs expire at various dates beginning in 2004.
The Company continues to maintain a full valuation allowance of $13.0 million for deferred tax assets related to foreign NOLs, which reflect the tax benefit of approximately $35 million in future foreign tax deductions. These NOLs expire at various dates beginning in 2004. These deferred tax assets remain fully reserved because their realization is dependent on earning future foreign taxable income in the tax jurisdictions to which the NOLs were generated. The largest of these foreign NOLs relate to the Company’s French subsidiary, Nomai S.A. This subsidiary’s operations have been shut down and therefore, the foreign NOL related to Nomai S.A. is not likely to be realized in the future.
Net deferred tax liabilities for the Company at March 30, 2003 were $30.7 million. As of March 30, 2003, deferred tax liabilities for estimated U.S. federal and state taxes of $110.0 million have been accrued on unremitted foreign earnings of $282.0 million.
The Company has seven reportable segments based primarily on the nature of the Company’s customers and products: Zip, Optical (formerly called CD-RW), Jaz, PocketZip, Other Mobile and Desktop Storage Products, Network Storage Systems and New Technologies. Jaz, PocketZip and some of the Other Mobile and Desktop Storage Products have been discontinued, as further discussed below. The Zip segment involves the development, distribution and sale of Zip drives and disks to retailers, distributors, resellers and OEMs throughout the world. The Company’s Optical segment involves the distribution and sale of CD-RW drives to retailers, distributors and resellers throughout the world and the distribution and sale of DVD Rewritable drives to distributors which began on a limited basis during the first quarter of 2003. Sales of DVD Rewritable drives will be expanded to retailers and resellers during the second quarter of 2003. The Optical segment also includes HotBurn software which is bundled with CD-RW and DVD Rewritable drives and sold on a stand-alone basis on the Company’s website. The Jaz segment involved the development, manufacture, distribution and sale of professional storage products and applications, including Jaz disk and drive systems to resellers, distributors and retailers throughout the world. The PocketZip segment involved the development, manufacture, distribution and sale of PocketZip drives and disks for use with portable digital products such as digital cameras, audio players, handheld personal computers and notebook computers to retailers, distributors and resellers throughout the world.
The Other Mobile and Desktop Storage Products category (formerly included in “Other”) includes: Peerless drive systems; sourced branded products such as HDD, which began shipping during the second quarter of 2002, Iomega Mini USB drives, which began shipping during the fourth quarter of 2002; Iomega software products such Iomega Automatic Backup software and other miscellaneous items. The Other Mobile and Desktop Storage Products category also includes products that have been discontinued such as FotoShow, Iomega Microdrive miniature hard drives, Iomega CompactFlash and Iomega SmartMedia memory cards.
16
The Network Storage Systems segment (formerly included in “Other”) currently consists of the distribution and sale of network attached storage (“NAS”) servers targeted toward small and medium-size businesses and enterprise workgroups.
The New Technologies segment includes the research and development of other high capacity removable storage devices, including a small-form factor removable flexible magnetic storage device (referred to as Digital Capture Technology or “DCT”) that is expected to have a capacity of about 1.5GB and a removable hard disk storage system (referred to as Removable Rigid Disk System or “RRD”) that is expected to have a capacity of approximately 35GB. There have been no sales associated with New Technologies and no sales are expected before 2004.
In early 2002, the Company discontinued the Jaz drive and PocketZip product line, including HipZip, which was being reported in the PocketZip segment. Under the Other Mobile and Desktop Storage Products category, the Company also discontinued in early 2002 its FotoShow, Microdrive, CompactFlash and SmartMedia products. The Company has continued to sell disks for Jaz and PocketZip products to support the installed drive base of these products.
The Company evaluates performance based on product profit margin (“PPM”) for each segment. PPM is defined as sales and other income related to a segment’s operations, less both fixed and variable product costs, research and development expenses, selling expenses and amortization related to a segment’s operations. When such costs and expenses exceed sales and other income, PPM is referred to as product loss. The accounting policies of the segments are the same as those described in Note 1 “Significant Accounting Policies.” Intersegment sales, eliminated in consolidation, are not material. The expenses attributable to general corporate activity are not allocated to the product segments.
17
The information in the following table was derived directly from the segments’ internal financial information used for corporate management purposes. Network Storage Systems were previously presented in Other products and all 2002 amounts have been reclassified for consistent presentation. New Technologies were previously presented in general corporate expenses and all 2002 amounts have been reclassified for consistent presentation.
For the Quarter Ended
---------------------------------
March 30, March 31,
2003 2002
--------- --------
(In thousands)
Sales:
Mobile and Desktop Storage Products:
Zip $ 73,309 $ 143,066
Optical 15,346 22,597
Jaz 1,884 5,873
PocketZip 107 19
Other Mobile and Desktop Storage Products 13,256 7,235
--------- ---------
Total Mobile and Desktop Storage Products 103,902 178,790
--------- ---------
Network Storage Systems 2,280 107
--------- ---------
Total sales $ 106,182 $ 178,897
========= =========
PPM (Product Loss):
Mobile and Desktop Storage Products:
Zip $ 29,356 $ 57,312
Optical 235 69
Jaz 1,263 1,944
PocketZip 191 737
Other Mobile and Desktop Storage Products (113) (4,227)
--------- ---------
Total Mobile and Desktop Storage Products 30,932 55,835
--------- ---------
Network Storage Systems (4,044) (673)
--------- ---------
New Technologies (4,858) (1,121)
--------- ---------
Total PPM 22,030 54,041
Common Expenses:
General corporate expenses (14,866) (27,659)
Restructuring reversal 78 -
Interest and other income, net 1,888 216
--------- ---------
Income before income taxes $ 9,130 $ 26,598
========= =========
18
Third Quarter 2001 Restructuring Actions
During the third quarter of 2001, the Company recorded pre-tax restructuring charges of $33.3 million. In the fourth quarter of 2001, the Company recorded a net reversal of $0.2 million with respect to the third quarter 2001 restructuring actions. The restructuring charges in the third quarter of 2001 included $17.4 million associated with exiting lease facilities, of which $9.8 million related to leasehold improvements, furniture and information technology asset write-downs and $7.6 million was associated with lease termination costs, and $15.9 million related to the reduction of 1,234 regular and temporary personnel worldwide, or approximately 37% of the Company’s worldwide workforce. During the fourth quarter of 2001, the Company reversed $0.5 million related to lease termination costs and recorded additional charges of $0.3 million related to severance and benefits with respect to employees that were identified as part of the third quarter 2001 restructuring actions but who were not notified of their termination until the fourth quarter of 2001.
Of the $33.3 million in total third quarter 2001 restructuring charges, $27.9 million related to restructuring activities within North America, $2.6 million for restructuring activities within the Asia Pacific region (excluding Malaysia), $2.3 million for restructuring activities within Europe and $0.5 million for restructuring activities within Malaysia.
The North America activities consisted of outsourcing the Company’s distribution center in North Carolina and terminating the related lease, closing several sales offices in the United States and consolidating operations at the Company’s North America facilities (primarily Roy, Utah), all of which resulted in a workforce reduction of 760 regular employees and temporary staff across all business functions and across all levels of the organization. At September 30, 2001, of the 760 individuals whose positions were identified for termination in the third quarter of 2001, 193 individuals were scheduled to continue to work on a transition basis through various identified dates ending no later than December 31, 2001. Transition pay was not a part of the restructuring charges but rather was reported in normal operations as incurred. In compliance with the WARN Act, affected employees were given pay in lieu of 60-day advance notice. Pay in lieu of notice was paid on a continuous basis for a 60-day notice period and separation payments were paid in lump sum at the end of the 60-day period or after the last day of employment for transition employees. Separation pay was based on years of service, job level and transition time, and included health insurance continuance payments. This workforce reduction resulted in charges of $12.7 million for severance and outplacement costs. The North America restructuring actions also resulted in charges of $8.9 million related to asset write-downs (leasehold improvements, furniture and information technology assets) and $6.3 million related to lease termination costs. Lease termination costs are being paid on their regular monthly rent payment schedule.
The Asia Pacific activities consisted of the closure of several sales offices and the transfer of certain inventory operations and finance activities from Singapore to Malaysia, which resulted in a workforce reduction of 85 regular employees and temporary staff across all business functions and across all levels of the organization. At September 30, 2001, of the 85 individuals whose positions were identified for termination in the third quarter, 12 individuals were scheduled to continue to work on a transition basis through various identified dates ending no later than December 31, 2001. This workforce reduction resulted in charges of $0.8 million for severance and outplacement costs. The Asia Pacific restructuring actions also resulted in charges of $0.7 million related to asset write-downs and $1.1 million related to lease termination costs.
19
During the fourth quarter of 2001, the 12 transition employees in the Asia Pacific region were notified that their positions were being terminated, resulting in additional charges of $0.3 million in the fourth quarter of 2001. These employees were identified for termination at September 30, 2001. However, since the employees had not been notified, the Company did not accrue the severance and benefit costs associated with these individuals in the original third quarter 2001 restructuring charges. Additionally, in the fourth quarter of 2001, $0.7 million of lease termination accruals were reversed due to the Company unexpectedly locating a tenant for one of the vacated facilities and being released from future rent obligations. In light of prevailing poor economic conditions, the Company had originally assumed it would not be able to sublet the facility.
The Europe activities consisted of the outsourcing of call center activities, closure of several sales offices and consolidation of operations in Switzerland, Ireland and the Netherlands, which resulted in a workforce reduction of 94 regular employees and temporary staff across all business functions and across all levels of the organization. At September 30, 2001, of the 94 individuals whose positions were identified for termination in the third quarter, 28 individuals were scheduled to continue to work on a transition basis through December 31, 2001 and 21 individuals were scheduled to work on a transition basis through March 31, 2002 to manage operations that were outsourced effective April 1, 2002. This workforce reduction resulted in charges of $1.9 million for severance and outplacement costs. The Europe restructuring actions also resulted in charges of $0.2 million related to asset write-downs and $0.2 million related to lease termination costs.
During the fourth quarter of 2001, it was determined that an additional $0.2 million was required for Europe lease termination costs as a result of the Company not being able to locate a new tenant in Ireland in the timeframe originally estimated in the third quarter of 2001.
The Malaysia activities consisted of a workforce reduction of 295 regular employees across almost all business functions (the majority of which were direct labor employees) at almost all levels of the organization. All of the 295 individuals whose positions were identified for termination were dismissed in the third quarter of 2001. This workforce reduction resulted in charges of $0.5 million for severance and outplacement costs, all of which were paid during the third quarter of 2001.
20
Remaining restructuring reserves in the amount of $3.5 million and $0.4 million are included in the Company’s other current liabilities and fixed asset reserves, respectively, as of March 30, 2003. Utilization of and other activity relating to the third quarter 2001 restructuring reserves during the three months ended March 30, 2003 are summarized below:
Third Quarter 2001 Balance Utilized Balance
---------------------
Restructuring Actions 12/31/02 Cash Non-Cash Reversal 03/30/03
- ---------------------- -------- ------ -------- -------- --------
(In thousands)
North America Reorganization:
Severance and benefits (a) $ 78 $ - $ - $ (78) $ -
Lease cancellations (a) 3,194 (311) - - 2,883
Leasehold improvements and
furniture (b) 431 - (33) - 398
------- ------ ----- ----- -------
3,703 (311) (33) (78) 3,281
------- ------ ----- ----- -------
Europe Reorganization:
Lease cancellations (a) 727 (66) - - 661
------- ------ ----- ----- -------
$ 4,430 $ (377) $ (33) $ (78) $ 3,942
======= ====== ===== ===== =======
Balance Sheet Breakout:
Other current liabilities (a) $ 3,999 $ (377) $ - $ (78) $ 3,544
Fixed asset reserves (b) 431 - (33) - 398
------- ------ ----- ----- -------
$ 4,430 $ (377) $ (33) $ (78) $ 3,942
======= ====== ===== ===== =======
(a) Amounts represent primarily cash charges.
(b) Amounts represent primarily non-cash charges.
As of March 30, 2003, the remaining leasehold improvements are associated with subleased facilities and cannot be disposed of until the subleases expire. The last sublease will expire in March 2006. Lease payments are being made on a continuous monthly basis and the Company is still trying to sublease one of the leases which does not expire until 2009. During the first quarter of 2003, severance and benefit reserves of $0.1 million were reversed due to the original estimates being higher than what was utilized.
21
Litigation
Except as set forth below, in management’s opinion, there are no significant legal proceedings to which the Company or any of its subsidiaries is a party or to which any of their property is subject. The Company is involved in other lawsuits and claims generally incidental to its business. It is the opinion of management, after discussions with legal counsel, that the ultimate dispositions of the lawsuits and claims discussed below will not have a material adverse effect on the Company’s ongoing business or financial condition, except that, as indicated below, the settlement of, or adverse judgment with respect to, certain of these lawsuits could have a material adverse effect on the operating results reported by the Company for the specific period(s) in which any such adverse judgment occurs or settlement occurs or is implemented.
On March 23, 2001, the Company initiated litigation against Advanced Mass Memories, formerly named Albi Media Manufacturing, SARL (“AMM”) in the Tribunal de Grande Instance de Paris for infringing certain Iomega patents and patent applications in connection with AMM’s production and sale of the Swap 100MB disk, a cartridge that AMM claimed could be used with certain of the Company’s Zip drives. The complaint requested monetary damages and other relief against further infringement by AMM. The Company filed a motion for a preliminary injunction against AMM, which was granted on July 24, 2001, thus restraining AMM from further manufacturing or commercialization of the Swap 100MB disk. In August 2001, AMM appealed the injunction and moved to stay enforcement of the injunction. On September 17, 2001, AMM filed for bankruptcy protection, while continuing its appeal. On October 31, 2001, the Paris Appeals Court denied AMM’s appeal and ruled that the injunction would remain in effect while the underlying infringement case continued on the merits. On March 27, 2003, a judgment was issued in favor of the Company ordering a permanent injunction against AMM and awarding damages to the Company of 85,000 euro (approximately USD $96,000).
Nomai S.A. (“Nomai”) is a French subsidiary of the Company that was acquired during the third quarter of 1998. Nomai is engaged in certain litigation matters that revolve around (1) Nomai’s acquisition of certain assets of RPS Media S.A. (“RPS”) in bankruptcy in 1997 and its organization of AMM as a subsidiary to operate such assets and (2) Nomai’s subsequent disposition of AMM in September 1999.
On February 18, 2000, the bankruptcy trustee for RPS Media S.A. filed a lawsuit against Nomai. The trustee claimed that Nomai had not complied with the alleged investment and employment related commitments made by Nomai’s former management before the Commercial Court of Albi, France in connection with Nomai’s acquisition during 1997 of certain assets of RPS in bankruptcy. The action sought a daily penalty against Nomai of FF 100,000 (approximately USD $19,300) until Nomai invested FF 48 million (approximately USD $9.2 million) and hired 100 people in Albi, France. On February 16, 2001, the trustee filed a new complaint with the Commercial Court, again asking that the Court order AMM and Nomai to comply with the alleged employment and investment commitments set forth in the bankruptcy plan or to fine AMM and Nomai FF 100,000 (approximately USD $19,300) for each day of noncompliance. On November 23, 2001, the Court ordered Nomai to proceed with the required investments and to put in place the technical and human means to which it is engaged, subject to a daily penalty of FF 50,000 (approximately USD $9,600) for non-compliance. The Toulouse Court of Appeals issued its ruling on May 2, 2002, upholding the Albi Court ruling. Nomai filed a notice of appeal of the Toulouse Court of Appeals ruling to the French Cour de Cassation on June 10, 2002; this further appeal has not been decided, but the disputes between the trustee for RPS and the Company have been settled, as described below.
22
On October 11, 2002, the Commercial Court of Albi issued a ruling in connection with the prior complaint by the bankruptcy trustee for RPS, finding that Iomega Corporation, Iomega International and AMM were liable in connection with Nomai’s failure to make investments in Albi. The Commercial Court of Albi assessed damages of 8.5 million euros (approximately USD $9.6 million) in favor of the trustee for RPS and Iomega filed an appeal to the Toulouse Court of Appeals. Subsequently, in December 2002, the parties executed a settlement agreement, calling for Nomai to transfer rights to a vacant building in Albi and requiring a payment of an aggregate of 1.0 million euros (approximately USD $1.1 million), to be divided among 99 former employees of RPS. Presently 34 of those former employees are not cooperating with the settlement and have filed a separate lawsuit, seeking approximately $1.8 million U.S. dollars, against the Company, Iomega International and Nomai, among other parties. On January 24, 2003, however, the Commercial Court of Albi issued its approval of the settlement. Under the settlement, the bankruptcy trustee for RPS agreed to release all claims of RPS and to seek to obtain executed releases from the former employees of that company. Any former employee who refuses to sign such a release, including those mentioned above who have filed a separate lawsuit, will lose the right to participate in the distribution of the 1.0 million euros (approximately USD $1.1 million) called for in the settlement. The settlement terminates the trustee’s right to attempt to enforce the 8.5 million euro (approximately USD $9.6 million) judgment from October 11, 2002 and all daily penalties that had accrued. The Company intends to vigorously defend against the remaining claims involving the former employees, and the Company expects the pending case before the Toulouse Court of Appeals to be dismissed, in light of the settlement agreement.
On May 30, 2001, AMM filed a lawsuit against Iomega International and Iomega Corporation, before the Commercial Court of Albi, claiming that Iomega International and Iomega Corporation jointly committed fraudulent acts against AMM and that, as a result, AMM suffered damages of FRF 129 million (approximately USD $24.8 million). This case was subsequently consolidated with the RPS case discussed above. On October 11, 2002, the Commercial Court of Albi issued a ruling that Iomega International and Iomega Corporation were liable to AMM in the amount of 1.9 million euros (approximately USD $2.1 million). This amount is in addition to the 8.5 million euro (approximately USD $9.6 million) amount discussed in the foregoing paragraph and Iomega filed an appeal to the Toulouse Court of Appeals. During the first quarter of 2003, the parties engaged in settlement discussions and reached an agreement in principle to resolve the litigation, including the 1.9 million euro (approximately USD $2.1 million) judgment. As of March 12, 2003, the settlement, which calls for Iomega to pay an amount of 450,000 euros (approximately USD $506,000), is being finalized among the parties. This settlement, if finalized by the parties, will be subject to approval by French courts and possible appeals.
Although the Company does not expect the Nomai/AMM litigation described above to have a material adverse effect on the Company’s ongoing business or financial condition, enforcement of the adverse judgment or settlement of these claims could have a material adverse effect on the operating results reported by the Company for the specific period(s) in which any such adverse judgment or settlement occurs (or is implemented).
23
Goodwill and Other Intangible Assets
The Company performed the annual impairment test required under Statement of Financial Accounting Standards No. 142, “Accounting for Goodwill and Intangible Assets” (“SFAS 142”), in the first quarter of 2003 and determined that the Company’s goodwill, all of which is associated with the Zip product line, was not impaired.
At March 30, 2003, the Company had $6.1 million in net intangible assets, all of which are subject to amortization. The Company’s intangible assets all relate to intellectual property. Intangible assets are amortized using the straight-line method over the estimated useful life of the asset, subject to periodic review for impairment whenever events or changes in circumstances indicate that the carrying amount of the asset may not be recoverable. During the quarter ended March 30, 2003, amortization expense was $0.7 million. Amortization expense for each of the next five fiscal years is anticipated to be approximately $1.3 million for the remainder of 2003, $2 million in 2004, $2 million in 2005, $0.5 million in 2006 and zero thereafter. As of March 30, 2003, the weighted average useful life of the Company’s intangible assets is approximately 3 years.
March 30, December 31,
2003 2002
--------- -----------
(In thousands)
Intangible Assets:
Gross value (1) $ 11,791 $ 12,955
Accumulated amortization (5,706) (6,200)
-------- --------
Net intangible assets $ 6,085 $ 6,755
======== ========
| (1) | The change in the gross value of intangible assets between December 31, 2002 and March 30, 2003 resulted from $1.2 million of intellectual property that was fully amortized and removed from the books during the first quarter of 2003. |
Significant Customers
During the quarter ended March 30, 2003, sales to Ingram Micro, Inc. and Tech Data Corporation accounted for 16% and 11% of consolidated sales, respectively. Ingram Micro, Inc. accounted for 18% of consolidated sales for the quarter ended March 31, 2002. No other single customer accounted for more than 10% of consolidated sales for these periods.
Forward Exchange Contracts
The Company is exposed to various foreign currency exchange rate risks that arise in the normal course of business. The Company’s functional currency is the U.S. dollar. The Company has international operations resulting in receipts and payments in currencies that differ from the functional currency of the Company. The Company attempts to reduce foreign currency exchange rate risks by utilizing financial instruments, including derivative transactions pursuant to Company policies. The Company uses forward contracts to hedge those net assets and liabilities that, when remeasured according to accounting principles generally accepted in the United States of America, impact the condensed consolidated statements of operations. All forward contracts entered into by the Company are components of hedging programs and are entered into for the sole purpose of hedging an existing exposure or expected exposure, not for speculation or trading purposes. Currently, the Company is using forward contracts only to hedge net balance sheet exposure. The contracts are primarily in European currencies and the Singapore dollar. The Company enters into contracts throughout the month as necessary. These contracts have maturities that do not exceed 40 days.
24
When hedging net balance sheet exposure, all gains and losses on forward contracts are recognized in other income and expense in the same period that the gains and losses on remeasurement of the foreign currency denominated assets and liabilities occur. All gains and losses related to foreign exchange contracts are included in cash flows from operating activities in the condensed consolidated statements of cash flows.
At March 30, 2003, outstanding forward exchange buy/(sell) contracts, which all mature in May 2003, were as follows (rates are quoted as other currency unit per one United States dollar):
Contracted Month - End
Forward Forward
Amount Rate Rate
------------ ---------- -----------
British Pound (700,000) 0.6392 0.6392
European Currency Unit (13,500,000) 0.9301 0.9301
Singapore Dollar 900,000 1.7711 1.7711
Swiss Franc 3,600,000 1.3712 1.3712
On the last trading day of each fiscal month, the Company replaces expiring forward contracts with new forward contracts at the contracted forward rate. These contracts are then revalued at the fiscal month-end forward rate. The Company’s theoretical risk in these transactions is the cost of replacing, at current market rates, these contracts in the event of default by the counterparty.
Legal Settlements
On January 22, 2003, the Company signed a settlement agreement resolving a dispute with an insurance carrier over coverage related to a lawsuit which was settled in 2002. The settlement payment from the insurance carrier was for $7.5 million and was received by the Company on January 28, 2003. The payment included approximately $1 million that was previously recorded as a receivable and resulted in a $6.5 million gain in the Company’s results for the first quarter of 2003. During the first quarter of 2003, the Company also recorded a $0.5 million litigation expense. Both the $6.5 million gain and the $0.5 million expense were reflected in selling, general and administrative expense in the Company’s condensed consolidated statement of operations
25
The Company designs and markets storage systems that help people protect, secure, capture and share their valuable digital information. The Company’s products are organized into two broad business categories: a) Mobile and Desktop Storage Products and b) Network Storage Systems. Mobile and Desktop Storage Products include Zip drives and disks, optical drives including CD-RW and DVD rewritable drives as well as portable and desktop hard disk drives (“HDD”), Iomega Mini USB drives and various software titles. Network Storage Systems currently consists of a wide selection of network attached storage (“NAS”) servers with capacities of 120GB to 1.4TB that supplement the storage capacity of company networks in small and medium-size businesses and enterprise workgroups.
During the first quarter of 2003, the Company reported net income of $5.3 million on sales of $106.2 million compared to net income in the first quarter of 2002 of $31.2 million on sales of $178.9 million. Net income for the first quarter of 2003 was favorably impacted by $3.7 million of after-tax net legal settlements, while net income for the first quarter of 2002 included a $15.8 million decrease in the Company’s valuation allowance for net deferred tax assets and $2.1 million of unfavorable after-tax net legal settlements.
The sales decline in the first quarter of 2003 resulted primarily from the continued contraction of the Zip business. Two of the Company’s sourced branded products – CD-RW and Iomega Mini USB drives were profitable for the first quarter of 2003 (portable and desktop HDD drives were not profitable). Even though NAS sales decreased $2.3 million during the first quarter of 2003 when compared to the fourth quarter of 2002, management still believes that with the new high-end product offerings launched early in the second quarter of 2003 and other planned future new product offerings that the Company will be able to grow its NAS sales.
During 2003, the Company plans to continue working on a number of key initiatives, including the goal of creating “destination storage” for the Company’s retail, catalog and online customers. Anchored around Zip products, the Company plans to leverage its retail brand equity and its product management expertise to offer, in one location, multiple storage products in the mobile and desktop storage category. However, due to the uncertainties and competitiveness of the retail and catalog channels and the economics among the Company’s retail and catalog customers, there can be no assurance that the destination storage initiative will be embraced by any retail or catalog partners or fully deployed by those who do initiate it. The Company is also planning in the second half of 2003 to refresh its mid-range NAS product offerings and to introduce two new NAS products in the low-end category which, along with the new high-end product offerings launched early in the second quarter of 2003, will enable the Company to address all three major NAS market segments. The Company is also continuing to focus its research and development resources on its two new removable magnetic storage technologies, Digital Capture Technology (“DCT”) and Removable Rigid Disk System (“RRD”). With these two new product developments, the Company is now working to develop original equipment manufacture (“OEM”) and other channel partnerships with the goal to enable widespread adoption of these new technologies in 2004. The Company does not expect any sales from these new technologies until 2004.
The Company has significant cash and cash equivalent balances (“cash reserves”). The Company believes that these cash reserves are in excess of what is required to operate the existing business on an ongoing basis. The Company is continuing to analyze and explore all of its strategic opportunities, both in and outside the storage industry, with the goal to obtain the maximum benefit for the Company’s stockholders.
26
The Company’s profitability for the remainder of 2003 depends upon its ability to minimize, to the extent possible, the decline in Zip unit volumes and sales. For example, during the first quarter of 2003, the product profit margin (“PPM”) for the Zip business was $29.4 million compared to a product loss of $7.3 million on all other products. Management still anticipates that sales and operating profits for 2003 will decline compared to 2002 as it will take time for the various initiatives that the Company has underway in sourced branded products, Network Storage Systems and New Technologies to generate significant amounts of sales to offset the decline in Zip sales. Management also believes that the gross margin percentages reported for the first quarter of 2003 will be difficult to achieve in future periods. With declining Zip sales and the Company’s decision to invest in NAS and the new technologies, making an operating profit for each of the remaining quarters of 2003 will be a considerable challenge for the Company. Moreover, unless the Company sees an improvement in Zip product sales in the second quarter, over the first quarter of 2003, then an operating profit in the second quarter is unlikely.
The Company’s discussion and analysis of its financial condition and results of operations are based upon the Company’s condensed consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these condensed consolidated financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the condensed consolidated financial statements and the reported amounts of sales and expenses during the reporting periods. Areas where significant judgments are made that are highly uncertain at the time the estimate is made and are susceptible to material changes from period to period include revenue recognition, price protection and rebate reserves, marketing program accruals, allowance for doubtful accounts and inventory valuation reserves. Actual results could differ materially from these estimates. For a more detailed explanation of the judgments included in these areas, refer to the Company’s Annual Report on Form 10-K for the year ended December 31, 2002.
The Company has seven reportable segments based primarily on the nature of the Company’s customers and products: Zip, Optical (formerly called CD-RW), Jaz, PocketZip, Other Mobile and Desktop Storage Products, Network Storage Systems and New Technologies. Jaz, PocketZip and some of the Other Mobile and Desktop Storage Products have been discontinued, as further discussed below. The Zip segment involves the development, distribution and sale of Zip drives and disks to retailers, distributors, resellers and OEMs throughout the world. The Company’s Optical segment involves the distribution and sale of CD-RW drives to retailers, distributors and resellers throughout the world and the distribution and sale of DVD Rewritable drives to distributors which began on a limited basis during the first quarter of 2003. Sales of DVD Rewritable drives will be expanded to retailers and resellers during the second quarter of 2003. The Optical segment also includes HotBurn software which is bundled with CD-RW and DVD Rewritable drives and sold on a stand-alone basis on the Company’s website. The Jaz segment involved the development, manufacture, distribution and sale of professional storage products and applications, including Jaz disk and drive systems to resellers, distributors and retailers throughout the world. The PocketZip segment involved the development, manufacture, distribution and sale of PocketZip drives and disks for use with portable digital products such as digital cameras, audio players, handheld personal computers and notebook computers to retailers, distributors and resellers throughout the world.
27
The Other Mobile and Desktop Storage Products category (formerly included in “Other”) includes: Peerless drive systems; sourced branded products such as HDD, which began shipping during the second quarter of 2002, Iomega Mini USB drives, which began shipping during the fourth quarter of 2002; Iomega software products such Iomega Automatic Backup software and other miscellaneous items. The Other Mobile and Desktop Storage Products category also includes products that have been discontinued, such as FotoShow digital image centers (“FotoShow”), Iomega Microdrive miniature hard drives, Iomega CompactFlash and Iomega SmartMedia memory cards.
The Network Storage Systems segment (formerly included in “Other”) currently consists of the distribution and sale of NAS servers targeted toward small and medium-size businesses and enterprise workgroups.
The New Technologies segment includes the research and development of other high capacity removable storage devices, including a small-form factor removable flexible magnetic storage device, DCT, that is expected to have a capacity of about 1.5GB and a removable hard disk storage system, RRD, that is expected to have a capacity of approximately 35GB. There have been no sales associated with New Technologies and no sales are expected before 2004.
In early 2002, the Company discontinued the Jaz drive and PocketZip product line, including HipZip, which was being reported in the PocketZip segment. Under the Other Mobile and Desktop Storage Products category, the Company also discontinued in early 2002 its FotoShow, Microdrive, CompactFlash and SmartMedia products. The Company has continued to sell disks for Jaz and PocketZip products to support the installed drive base of these products.
The Company evaluates performance based on product profit margin (“PPM”) for each segment. PPM is defined as sales and other income related to a segment’s operations, less both fixed and variable product costs, research and development expenses, selling expenses and amortization related to a segment’s operations. When such costs and expenses exceed sales and other income, PPM is referred to as product loss. The accounting policies of the segments are the same as those described in Note 1 “Significant Accounting Policies” of the notes to condensed consolidated financial statements. Intersegment sales, eliminated in consolidation, are not material. The expenses attributable to general corporate activity are not allocated to the product segments.
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The information in the following table was derived directly from the segments’ internal financial information used for corporate management purposes. Network Storage Systems were previously presented in Other products and all 2002 amounts have been reclassified for consistent presentation. New Technologies were previously presented in general corporate expenses and all 2002 amounts have been reclassified for consistent presentation.
For the Quarter Ended
---------------------------------
March 30, March 31,
2003 2002
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(In thousands)
Sales:
Mobile and Desktop Storage Products:
Zip $ 73,309 $ 143,066
Optical 15,346 22,597
Jaz 1,884 5,873
PocketZip 107 19
Other Mobile and Desktop Storage Products 13,256 7,235
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Total Mobile and Desktop Storage Products 103,902 178,790
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Network Storage Systems 2,280 107
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Total sales $ 106,182 $ 178,897
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PPM (Product Loss):
Mobile and Desktop Storage Products:
Zip $ 29,356 $ 57,312
Optical 235 69
Jaz 1,263 1,944
PocketZip 191 737
Other Mobile and Desktop Storage Products (113) (4,227)
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Total Mobile and Desktop Storage Products 30,932 55,835
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Network Storage Systems (4,044) (673)
--------- ---------
New Technologies (4,858) (1,121)
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Total PPM 22,030 54,041
Common Expenses:
General corporate expenses (14,866) (27,659)
Restructuring reversal 78 -
Interest and other income, net 1,888 216
--------- ---------
Income before income taxes $ 9,130 $ 26,598
========= =========
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For the Quarter Ended