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) |
10955 Vista Sorrento Parkway, San Diego, CA 92130
(Address of principal executive offices)
(858) 314-7000
(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 August 1, 2003.
|
Common Stock, par value $.03 1/3 (Title of each class) |
51,375,664 (Number of shares) |
Page
Special Note Regarding Forward-Looking Statements.................................................. 2
PART I - FINANCIAL STATEMENTS
Item 1. Financial Statements (Unaudited)
Condensed Consolidated Balance Sheets at June 29, 2003
and December 31, 2002................................................................. 3
Condensed Consolidated Statements of Operations for the Quarters
ended June 29, 2003 and June 30, 2002................................................. 5
Condensed Consolidated Statements of Operations for the Six Months
ended June 29, 2003 and June 30, 2002................................................. 6
Condensed Consolidated Statements of Cash Flows for the Six Months
ended June 29, 2003 and June 30, 2002................................................. 7
Notes to Condensed Consolidated Financial Statements...................................... 8
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations................................................... 28
Item 3. Quantitative and Qualitative Disclosures About Market Risk................................ 61
Item 4. Controls and Procedures................................................................... 62
PART II - OTHER INFORMATION
Item 1. Legal Proceedings......................................................................... 63
Item 2. Changes in Securities and Use of Proceeds................................................. 63
Item 4. Submission of Matters to a Vote of Security Holders....................................... 63
Item 6. Exhibits and Reports on Form 8-K.......................................................... 64
Signatures......................................................................................... 65
Exhibit Index...................................................................................... 66
Copyright © 2003 Iomega Corporation. All rights reserved. Iomega, the stylized “i” logo, Zip, Jaz, Peerless, PocketZip, HipZip, HotBurn, FotoShow, Active Disk, Destination Storage, 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 original equipment manufacturer (“OEM”) customers for the planned new products DCT and RRD; expected spending levels on DCT and RRD development in 2003; the expected timeframe for launching DCT and RRD products in 2004; expected cost and expense reductions and timing thereof, as a result of the restructuring announced July 17, 2003; expected research and development spending levels in 2004; estimated income statement and balance sheet impacts and estimated utilization of net operating loss carryforward (“NOL”) deferred tax assets, resulting from the one-time cash dividend announced July 17, 2003; 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 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, after the one-time dividend, will be sufficient to operate the existing business on an ongoing basis; 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
June 29, December 31,
2003 2002
--------- -----------
(Unaudited)
Current Assets:
Cash and cash equivalents $ 188,759 $ 241,519
Restricted cash 200 3,800
Temporary investments 263,270 208,545
Trade receivables, less allowance for doubtful accounts of
$3,074 and $5,462, respectively 36,371 54,477
Inventories 32,887 40,525
Income taxes receivable 558 -
Deferred income taxes 20,253 27,573
Other current assets 10,992 14,490
--------- ---------
Total Current Assets 553,290 590,929
--------- ---------
Property and Equipment, at Cost 154,468 155,376
Accumulated Depreciation and Amortization (138,629) (137,274)
--------- ---------
Net Property and Equipment 15,839 18,102
--------- ---------
Goodwill 11,691 11,691
--------- ---------
Other Intangibles, Net 5,566 6,755
--------- ---------
Other Assets 93 122
--------- ---------
Total Assets $ 586,479 $ 627,599
========= =========
The accompanying notes to condensed consolidated financial statements are an
integral part of these statements.
3
June 29, December 31,
2003 2002
--------- -----------
(Unaudited)
Current Liabilities:
Accounts payable $ 33,351 $ 60,131
Other current liabilities (Note 1) 81,935 98,456
Income taxes payable - 622
--------- ---------
Total Current Liabilities 115,286 159,209
--------- ---------
Other Long-Term Liabilities 1,358 2,244
--------- ---------
Deferred Income Taxes 48,237 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 54,789,431 and 54,645,278 shares,
respectively 1,829 1,822
Additional paid-in capital 308,548 307,716
Less: 3,426,288 Common Stock treasury shares, at cost (33,791) (33,791)
Retained earnings 145,012 135,292
--------- ---------
Total Stockholders' Equity 421,598 411,039
--------- ---------
Total Liabilities and Stockholders' Equity $ 586,479 $ 627,599
========= =========
The accompanying notes to condensed consolidated financial statements are an
integral part of these statements.
4
For the Quarter Ended
-------------------------------
June 29, June 30,
2003 2002
--------- ---------
(Unaudited)
Sales $ 100,802 $ 145,208
Cost of sales 66,440 90,262
--------- ---------
Gross margin 34,362 54,946
--------- ---------
Operating Expenses:
Selling, general and administrative 27,818 33,073
Research and development 7,635 8,885
Restructuring reversals - (2,181)
Bad debt expense (credit) 279 (1,235)
--------- ---------
Total Operating Expenses 35,732 38,542
--------- ---------
Operating income (loss) (1,370) 16,404
Interest income 1,646 2,406
Interest and other expense (485) (1,041)
--------- ---------
Income (loss) before income taxes (209) 17,769
Benefit (provision) for income taxes 4,616 (6,312)
--------- ---------
Net Income $ 4,407 $ 11,457
========= =========
Net income per basic and diluted common share $ 0.09 $ 0.22
========= =========
Weighted average common shares outstanding 51,329 51,170
========= =========
Weighted average common shares outstanding -
assuming dilution 51,355 51,429
========= =========
The accompanying notes to condensed consolidated financial statements are an
integral part of these statements.
5
For the Six Months Ended
-------------------------------
June 29, June 30,
2003 2002
--------- --------
(Unaudited)
Sales $ 206,984 $ 324,105
Cost of sales 135,512 196,633
--------- ---------
Gross margin 71,472 127,472
--------- ---------
Operating Expenses:
Selling, general and administrative 51,158 71,269
Research and development 16,223 17,529
Restructuring reversals (78) (2,181)
Bad debt credit (1,703) (1,931)
--------- ---------
Total Operating Expenses 65,600 84,686
--------- ---------
Operating income 5,872 42,786
Interest income 3,512 4,726
Interest and other expense (463) (3,145)
--------- ---------
Income before income taxes 8,921 44,367
Benefit (provision) for income taxes 799 (1,701)
--------- ---------
Net Income $ 9,720 $ 42,666
========= =========
Net income per basic and diluted common share $ 0.19 $ 0.83
========= =========
Weighted average common shares outstanding 51,297 51,226
========= =========
Weighted average common shares outstanding -
assuming dilution 51,316 51,407
========= =========
The accompanying notes to condensed consolidated financial statements are an
integral part of these statements.
6
For the Six Months Ended
-------------------------------
June 29, June 30,
2003 2002
--------- ---------
(Unaudited)
Cash Flows from Operating Activities:
Net income $ 9,720 $ 42,666
Non-Cash Revenue and Expense Adjustments:
Depreciation and amortization 6,810 12,411
Deferred income taxes 450 13,696
Non-cash inventory write-offs - 3,752
Amortization on temporary investments 1,796 566
Bad debt credit (1,703) (1,931)
Other 261 2,261
--------- ---------
17,334 73,421
Changes in Assets and Liabilities:
Restricted cash 3,600 2,223
Trade receivables 19,809 37,430
Inventories 7,638 18,058
Other current assets 3,498 (2,250)
Accounts payable (26,780) (33,197)
Other current liabilities (15,635) (20,372)
Accrued restructuring (886) (9,355)
Income taxes (1,180) (11,401)
--------- ---------
Net cash provided by operating activities 7,398 54,557
--------- ---------
Cash Flows from Investing Activities:
Purchases of property and equipment (3,413) (5,575)
Purchases of temporary investments (463,908) (92,401)
Sales of temporary investments 407,387 97,742
Net change in other assets and other liabilities (558) 270
--------- ---------
Net cash (used in) provided by investing activities (60,492) 36
--------- ---------
Cash Flows from Financing Activities:
Proceeds from sales of Common Stock 334 91
Purchases of Common Stock - (2,924)
Payments on other obligations - (563)
--------- ---------
Net cash provided by (used in) financing activities 334 (3,396)
--------- ---------
Net (Decrease) Increase in Cash and Cash Equivalents (52,760) 51,197
Cash and Cash Equivalents at Beginning of Period 241,519 219,949
--------- ---------
Cash and Cash Equivalents at End of Period $ 188,759 $ 271,146
========= =========
The accompanying notes to condensed consolidated financial statements are an
integral part of these statements.
7
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 June 29, 2003 and December 31, 2002, the results of operations for the quarters and six months ended June 29, 2003 and June 30, 2002 and cash flows for the six months ended June 29, 2003 and June 30, 2002.
The results of operations for the quarter and six months ended June 29, 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.
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.
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 reserves for estimated returns totaled $4.4 million and $6.0 million at June 29, 2003 and December 31, 2002, respectively.
8
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. The distribution, retail and catalog 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 these 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 $9.3 million and $17.9 million at June 29, 2003 and December 31, 2002, respectively and is included in “other current liabilities” in the accompanying condensed consolidated balance sheets.
The Company sells various extended warranty plans for its NAS servers, some of which are bundled with certain NAS servers. The service period of the extended warranties varies from 1 year to 3 years depending upon the NAS server and the extended warranty plan. The Company defers all sales associated with these warranties and recognizes the sales ratably over the respective life of the warranty once the extended warranty has been registered with the Company by the end-user. The deferred sales associated with these extended warranties was $0.4 million at June 29, 2003 and was less than $0.1 million at December 31, 2002 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 products, as well as some software titles that are downloaded from the Company’s website. Sales from the software embedded or bundled with such 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 some 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 $20.3 million and $29.2 million at June 29, 2003 and December 31, 2002, respectively and are netted against trade receivables in the accompanying condensed consolidated balance sheets.
9
Temporary Investments
Investments purchased with maturities in excess of three months are classified as temporary investments. Temporary investments at June 29, 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 June 29, 2003, the average duration of the Company’s temporary investments was just under six months. 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.
Inventories
Inventories include material costs and inventory related overhead costs and are recorded at the lower of cost (first-in, first-out) or market and consist of the following:
June 29, December 31,
2003 2002
-------- ------------
(In thousands)
Raw materials $ 2,852 $ 2,249
Finished goods 30,035 38,276
-------- --------
$ 32,887 $ 40,525
======== ========
Other Current Liabilities
Other current liabilities consist of the following:
June 29, December 31,
2003 2002
-------- ------------
(In thousands)
Margin on deferred sales $ 9,878 $ 19,102
Accrued payroll, vacation, bonus and profit sharing 9,097 9,589
Accrued marketing (a) 8,938 15,426
Accrued warranty 6,474 8,035
Other accrued liabilities (b) 47,548 46,304
-------- --------
$ 81,935 $ 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, deferred revenue, sales and other taxes and other miscellaneous liabilities. |
Stock Compensation Expense
The Company has five stock-based compensation plans (four stock option plans and one restricted stock plan). 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 for the four stock option plans is reflected in net income for the three or six months ended June 30, 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.
10
Stock compensation expense for the restricted stock plan, which was approved by stockholders during the second quarter of 2003, has been accounted for under SFAS 123, with the fair value of the restricted stock being recognized over the vesting period of the restricted stock.
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 or modified 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 three and six months ended June 29, 2003 is less than the amount 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 Quarter Ended For the Six Months Ended
---------------------- ------------------------
June 29, June 30, June 29, June 30,
2003 2002 2003 2002
-------- -------- -------- --------
(In thousands, except per share data)
Net income as reported $ 4,407 $ 11,457 $ 9,720 $ 42,666
Add: Stock compensation expense
included in reported net income,
net of related tax effects 28 - 44 -
Less: Total stock compensation
expense determined under fair
value method for all awards, net
of related tax effects (489) (729) (824) (1,391)
------- -------- ------- --------
Pro forma net income $ 3,946 $ 10,728 $ 8,940 $ 41,275
======= ======== ======= ========
Basic EPS:
As reported $ 0.09 $ 0.22 $ 0.19 $ 0.83
======= ======== ======= ========
Pro forma $ 0.08 $ 0.21 $ 0.17 $ 0.81
======= ======== ======= ========
Diluted EPS:
As reported $ 0.09 $ 0.22 $ 0.19 $ 0.83
======= ======== ======= ========
Pro forma $ 0.08 $ 0.21 $ 0.17 $ 0.80
======= ======== ======= ========
11
Accrued Warranty
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 the warranty 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 Quarter Ended For the Six Months Ended
---------------------- ------------------------
June 29, June 30, June 29, June 30,
2003 2002 2003 2002
-------- -------- ------- --------
(In thousands)
Balance at beginning of period $ 7,202 $ 9,806 $ 8,035 $ 10,856
Accruals/additions 1,709 2,541 4,119 5,905
Claims/charges (2,437) (3,352) (5,680) (7,766)
------- ------- ------- --------
Balance at end of period $ 6,474 $ 8,995 $ 6,474 $ 8,995
======= ======= ======= ========
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.
12
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:
June 29, 2003:
Basic EPS $ 4,407 51,329 $ 0.09
-
Effect of options - 26 -
-------- ------ ------
Diluted EPS $ 4,407 51,355 $ 0.09
======== ====== ======
June 30, 2002:
Basic EPS $ 11,457 51,170 $ 0.22
Effect of options - 259 -
-------- ------ ------
Diluted EPS $ 11,457 51,429 $ 0.22
======== ====== ======
For the Six Months Ended:
June 29, 2003:
Basic EPS $ 9,720 51,297 $ 0.19
-
Effect of options - 19 -
-------- ------ ------
Diluted EPS $ 9,720 51,316 $ 0.19
======== ====== ======
June 30, 2002:
Basic EPS $ 42,666 51,226 $ 0.83
Effect of options - 181 -
-------- ------ ------
Diluted EPS $ 42,666 51,407 $ 0.83
======== ====== ======
For the quarters ended June 29, 2003 and June 30, 2002, there were outstanding options to purchase 1,355,555 and 1,648,838 shares, respectively, that had an exercise price greater than the average market price of the common shares for the respective quarters. For the six months ended June 29, 2003 and June 30, 2002, there were outstanding options to purchase 1,384,888 and 1,650,506 shares, respectively, that had an exercise price greater than the average market price of the common shares for the respective six month periods. These shares would have had an anti-dilutive effect on EPS and were therefore excluded from the Diluted EPS calculation above.
Recent Accounting Pronouncements
In November of 2002, the Emerging Issues Task Force (“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 adopted 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 only has a small number of multiple deliverable revenue arrangements related to the Company’s emerging Network Storage Systems business.
13
In January of 2003, the Financial Accounting Standards Board issued Interpretation No. 46, “Consolidation of Variable Interest Entities, and Interpretation of Accounting Research Bulletin No. 51” (“FIN 46”). FIN 46 provides guidance for determining whether and how to consolidate variable interest entities (“VIEs”). Variable interests are contractual, ownership or other interests in an entity that expose their holders to the risks and rewards of the VIE. Variable interests include equity investments, loans, leases, derivatives, guarantees and other instruments whose values change with changes in the VIE’s assets. Any of these instruments may require its holder to consolidate the VIE. The party with the majority of the variability in gains or losses of the VIE is required to consolidate the VIE. FIN 46 would apply to the Company beginning in the third quarter of 2003; however, the Company believes that it does not have an interest in any VIE and thus FIN 46 will not currently impact the Company.
For the quarter ended June 29, 2003, the Company recorded an income tax benefit of $4.6 million on a pre-tax loss of $0.2 million reflecting $4.6 million of research tax credits that were recorded following the completion of a research tax credit study and an IRS audit. Excluding the $4.6 million in research tax credits, the adjusted effective tax rate for the second quarter of 2003 was 13%. The 13% provision rate resulted from a less than $0.1 million increase in the valuation allowance for deferred foreign tax assets and permanent non-deductible items, which offset the tax benefit on the $0.2 million pre-tax loss. This compares to an income tax provision of $6.3 million on a pre-tax income of $17.8 million reflecting an income tax provision of $7.0 million in the second quarter of 2002, partially offset by a $0.7 million decrease in the valuation allowance for net deferred tax assets for the second quarter of 2002. Excluding the $0.7 million decrease in the valuation allowance, the adjusted effective tax rate for the second quarter of 2002 was 39%.
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:
June 29, December 31,
2003 2002
--------- ------------
(In thousands)
Deferred Tax Assets (Liabilities):
Current Deferred Tax Assets:
Trade receivable reserves $ 6,794 $ 11,259
Inventory reserves 2,862 3,042
Accrued expense reserves 10,578 13,030
Other 19 242
--------- --------
Total current deferred tax assets 20,253 27,573
--------- --------
Non-Current Deferred Tax Assets:
Fixed asset reserves 794 1,185
Tax credit carryforwards 23,463 19,058
Accelerated depreciation/amortization 4,797 4,301
Foreign net operating loss carryforwards 13,125 15,199
U.S. net operating loss carryforwards 35,007 34,444
Other 933 884
--------- --------
Total non-current deferred tax assets 78,119 75,071
--------- --------
Total deferred tax assets 98,372 102,644
--------- --------
Non-Current Deferred Tax Liabilities:
Tax on unremitted foreign earnings (108,323) (109,988)
Nomai goodwill and intangible asset (4,908) (4,991)
--------- --------
Total non-current deferred tax liabilities (113,231) (114,979)
--------- --------
Non-current valuation allowance (13,125) (15,199)
--------- --------
Net deferred tax assets (liabilities) $ (27,984) $(27,534)
========= ========
As Reported on the Balance Sheet:
Current deferred tax assets $ 20,253 $ 27,573
========= ========
Non-current deferred tax liabilities $ (48,237) $(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.
At June 29, 2003, the Company had $35.0 million of deferred tax assets related to U.S. federal and state net operating loss carryforwards (“NOLs”). Of the total NOL deferred tax assets, $28.2 million related to U.S. federal NOLs and $6.8 million related to state NOLs. The federal NOLs reflect a tax benefit of approximately $81 million in future U.S. federal tax deductions. The state NOLs reflect a tax benefit of approximately $171 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 which have allowed the use of federal NOLs in instances where state NOLs could not be used. The U.S. federal NOLs expire at various dates beginning in 2022 and the state NOLs expire at various dates beginning in 2004.
15
The Company continues to maintain a full valuation allowance of $13.1 million for deferred tax assets related to foreign NOLs, which reflect the tax benefit of approximately $36 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 are inactive 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 June 29, 2003 were $28.0 million. As of June 29, 2003, deferred tax liabilities for estimated U.S. federal and state taxes of $108.3 million have been accrued on unremitted foreign earnings of $277.8 million.
For the six months ended June 29, 2003, the Company recorded an income tax benefit of $0.8 million on pre-tax income of $8.9 million reflecting $4.6 million in research tax credits partially offset by an income tax provision of $3.8 million. Excluding the $4.6 million of research tax credits, the adjusted effective tax rate for the six months ended June 29, 2003 was 43%. This compares to an income tax provision of $1.7 million on pre-tax income of $44.4 million in the six months ended June 30, 2002, reflecting an income tax provision of $18.2 million, partially offset by a $16.5 million decrease in the valuation allowance for net deferred tax assets for the six months ended June 30, 2002. Excluding the $16.5 million decrease in the valuation allowance, the adjusted effective tax rate for the six months ended June 30, 2002 was 41%.
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 and DVD rewritable drives (which began shipping in limited quantities in the first quarter of 2003) to retailers, distributors and resellers throughout the world. 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 and external floppy disk drives, which began shipping in the first quarter of 2003; 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”) 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 two new 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 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 For the Six Months Ended
----------------------- --------------------------
June 29, June 30, June 29, June 30,
2003 2002 2003 2002
--------- --------- --------- ---------
(In thousands)
Sales:
Mobile and Desktop Storage Products:
Zip $ 66,444 $ 114,281 $ 139,753 $ 257,347
Optical 18,852 20,277 34,198 42,874
Jaz 1,023 3,239 2,907 9,112
PocketZip 13 (107) 120 (88)
Other Mobile and Desktop Storage
Products 11,389 7,014 24,645 14,249
--------- --------- --------- ---------
Total Mobile and Desktop Storage
Products 97,721 144,704 201,623 323,494
Network Storage Systems 3,081 504 5,361 611
--------- --------- --------- ---------
Total sales $ 100,802 $ 145,208 $ 206,984 $ 324,105
========= ========= ========= =========
PPM (Product Loss):
Mobile and Desktop Storage Products:
Zip $ 26,558 $ 40,484 $ 55,914 $ 97,796
Optical 1,464 (1,106) 1,699 (1,037)
Jaz 67 1,007 1,330 2,951
PocketZip (38) (415) 153 322
Other Mobile and Desktop Storage
Products 695 (1,678) 582 (5,905)
--------- --------- --------- ---------
Total Mobile and Desktop Storage
Products 28,746 38,292 59,678 94,127
Network Storage Systems (4,173) (916) (8,217) (1,589)
New Technologies (6,081) (1,876) (10,939) (2,997)
--------- --------- --------- ---------
Total PPM 18,492 35,500 40,522 89,541
Common Expenses:
General corporate expenses (19,862) (21,277) (34,728) (48,936)
Restructuring reversals - 2,181 78 2,181
Interest and other income, net 1,161 1,365 3,049 1,581
--------- --------- --------- ---------
Income (loss) before income taxes $ (209) $ 17,769 $ 8,921 $ 44,367
========= ========= ========= =========
18
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 June 30, 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 $3.1 million and $0.4 million are included in the Company’s other current liabilities and fixed asset reserves, respectively, as of June 29, 2003. Utilization of the third quarter 2001 restructuring reserves during the three months ended June 29, 2003 are summarized below:
Third Quarter 2001 Balance Utilized Balance
--------------------
Restructuring Actions 03/30/03 Cash Non-Cash 06/29/03
- --------------------- -------- ------ -------- --------
(In thousands)
North America Reorganization:
Lease cancellations (a) $ 2,883 $ (238) $ - $ 2,645
Leasehold improvements and
furniture (b) 398 - (33) 365
------- ------ ----- -------
3,281 (238) (33) 3,010
------- ------ ----- -------
Europe Reorganization:
Lease cancellations (a) 661 (193) - 468
------- ------ ----- -------
$ 3,942 $ (431) $ (33) $ 3,478
======= ====== ===== =======
Balance Sheet Breakout:
Other current liabilities (a) $ 3,544 $ (431) $ - $ 3,113
Fixed asset reserves (b) 398 - (33) 365
------- ------ ----- -------
$ 3,942 $ (431) $ (33) $ 3,478
======= ====== ===== =======
(a) Amounts represent primarily cash charges.
(b) Amounts represent primarily non-cash charges.
21
Utilization of and other activity relating to the third quarter 2001 restructuring reserves during the six months ended June 29, 2003 are summarized below:
Third Quarter 2001 Balance Utilized Balance
--------------------
Restructuring Actions 12/31/02 Cash Non-Cash Reversal 06/29/03
-------- ------ -------- -------- --------
(In thousands)
North America Reorganization:
Severance and benefits (a) $ 78 $ - $ - $ (78) $ -
Lease cancellations (a) 3,194 (549) - - 2,645
Leasehold improvements and
furniture (b) 431 - (66) - 365
------- ------ ----- ----- -------
3,703 (549) (66) (78) 3,010
------- ------ ----- ----- -------
Europe Reorganization:
Lease cancellations (a) 727 (259) - - 468
------- ------ ----- ----- -------
$ 4,430 $ (808) $ (66) $ (78) $ 3,478
======= ====== ===== ===== =======
Balance Sheet Breakout:
Other current liabilities (a) $ 3,999 $ (808) $ - $ (78) $ 3,113
Fixed asset reserves (b) 431 - (66) - 365
------- ------ ----- ----- -------
$ 4,430 $ (808) $ (66) $ (78) $ 3,478
======= ====== ===== ===== =======
(a) Amounts represent primarily cash charges.
(b) Amounts represent primarily non-cash charges.
As of June 29, 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 facilities where the lease 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.
22
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.
Nomai S.A. (“Nomai”) is a French subsidiary of the Company that was acquired during the third quarter of 1998. As previously disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2002 and in the Company’s Quarterly Report on Form 10-Q for the quarter ended March 30, 2003, 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 Albi Media Manufacturing, SARL (“AMM”) as a subsidiary to operate such assets and (2) Nomai’s subsequent disposition of AMM in September 1999. All French Franc and Euro conversions to the United States Dollars below were made using currency rates as of August 1, 2003.
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 $17,100) until Nomai invested FF 48 million (approximately USD $8.2 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 $17,100) 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 $8,550) 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. 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 manufacturing 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, subject to their signing releases in favor of the Company in exchange for receiving a portion of the settlement funds. On January 24, 2003, 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. The settlement terminated 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. Presently, 5 of those former employees are not cooperating with the settlement and have filed new claims against the Company, Iomega International and Nomai, among other parties. The amounts claimed by the remaining litigants are not material, totaling approximately 190,000 euros (approximately $214,000 USD). The Company intends to vigorously defend against the remaining claims involving the former employees.
23
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 $22.1 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 was 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 June 2003, the parties entered into a definitive settlement agreement to resolve the litigation, including the 1.9 million euro (approximately USD $2.1 million) judgment, with the Company agreeing to pay an amount of 450,000 euros (approximately USD $506,000) to resolve the dispute. This settlement is 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).
Management Incentive Plan
In January 2003, the Board of Directors adopted the Management Incentive Plan (the “Plan”) for executives and key employees. Under the Plan, the total pool for the granting of cash awards and/or restricted stock for the 2003 to 2005 Plan Period was approximately $4.3 million. Under the provisions of the Plan, participants may elect to receive either cash or restricted stock or a combination of the two in 25% increments. Restricted stock is granted based on 75% of the closing price of the Common Stock ten days after the participant receives notice of his award. The cash and the restricted stock for the 2003 to 2005 Plan Period will vest in 50% increments on January 1, 2004 and January 1, 2005, respectively.
In the event that a participant’s employment with the Company terminates for any reason other than disability or death prior to the vesting of all or a portion of their award, the participant will forfeit the unvested portion of their award. Immediately upon a change in Control as defined in section 5(b) of the Plan (which was filed on April 1, 2003 as Exhibit A to the Company’s Notice of Annual Meeting of Stockholders) any unvested portion of each participant’s award will vest in full.
On May 20, 2003, the Company’s stockholders approved the restricted stock provisions of the Plan and the reservation of 1,000,000 shares of Common Stock for the restricted stock grants. No restricted stock could be granted until stockholder approval was received.
24
Manufacturing Relationships
The Company relies on independent third parties to manufacture, 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. 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 would likely be required to record charges for discontinuing certain manufacturing relationships.
Other Intangible Assets
At June 29, 2003, the Company had $5.6 million in net intangible assets, all of which are subject to amortization. During the quarter ended June 29, 2003, amortization expense was $0.5 million. Amortization expense for the six months ended June 29, 2003 was $1.2 million. Amortization expense for each of the next five fiscal years is anticipated to be approximately $1 million for the remainder of 2003, $2 million in 2004, $2 million in 2005, $0.5 million in 2006 and zero thereafter. As of June 29, 2003, the weighted-average useful life of the Company’s intangible assets is approximately 2 3/4 years.
June 29, December 31,
2003 2002
-------- ------------
(In thousands)
Intangible Assets:
Gross value (1) $ 11,791 $ 12,955
Accumulated amortization (6,225) (6,200)
-------- --------
Net intangible assets $ 5,566 $ 6,755
======== ========
| (1) | The change in the gross value of intangible assets between December 31, 2002 and June 29, 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 June 29, 2003, sales to Ingram Micro, Inc. and Tech Data Corporation accounted for 16% and 11% of consolidated sales, respectively. Ingram Micro, Inc. accounted for 16% of consolidated sales for the quarter ended June 30, 2002. No other single customer accounted for more than 10% of consolidated sales for these periods.
During the six months ended June 29, 2003, sales to Ingram Micro, Inc. and Tech Data Corporation accounted for 16% and 11% of consolidated sales, respectively. Ingram Micro, Inc. accounted for 17% of consolidated sales for the six months ended June 30, 2002. No other single customer accounted for more than 10% of consolidated sales for these periods.
25
Forward Exchange Contracts
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. At June 29, 2003, outstanding forward exchange buy/(sell) contracts, which all mature in August 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 (600,000) 0.6080 0.6080
European Currency Unit (7,300,000) 0.8752 0.8752
Singapore Dollar 900,000 1.7557 1.7557
Swiss Franc 400,000 1.3507 1.3507
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
Anticipated Restructuring Actions
On July 17, 2003, the Company announced plans to restructure its operations. The restructuring charges, which are anticipated to be recorded during the second half of 2003, are expected to range between $20 million to $25 million, with the majority being recorded in the third quarter. These charges are expected to reflect expenses associated with a reduction in the Company’s worldwide workforce of approximately 200 employees; reimbursement of restructuring expenses incurred by strategic suppliers; lease expenses associated with unutilized facilities; termination of contractual obligations; asset write-downs and other miscellaneous charges. Substantially all of these charges are expected to be cash charges.
One-Time Cash Dividend
On July 17, 2003, the Company announced that its Board of Directors declared a one-time cash dividend of $5.00 per share to stockholders of record as of the close of business on September 15, 2003, to be paid on October 1, 2003. Based on the number of common shares outstanding as of August 1, 2003, the total amount of the dividend will be approximately $257 million.
26
As required by the Company’s 1997 Stock Incentive Plan, an adjustment to reflect the dividend will be made to the approximately 1.9 million stock options outstanding under this plan. The outstanding options will be adjusted by reducing their exercise prices by an amount equal to the dividend (but in no event below $0.03 1/3 per share), effective as of the ex-dividend date (October 2, 2003). The Company estimates that the impact of this action will be an additional charge in the fourth quarter of less than $0.5 million for the impact of modifying vested options and an additional $2.5 million that will be amortized to the income statement over the remaining vesting period of the outstanding options. After this modification, all of the Company’s stock options under the 1997 Stock Incentive Plan will be accounted for under the fair value method of SFAS 123.
The Board of Directors also intends to recommend to the Company’s stockholders that they vote, at the 2004 Annual Meeting of Stockholders, to approve amendments to the Company’s 1995 Director Stock Option Plan, 1987 Stock Option Plan and 1987 Director Option Plan permitting a similar adjustment to be made to options outstanding under those plans. Unless such stockholder approval is obtained, no adjustment will be made to the options outstanding under those three plans. However, since the value of the options was decreased as a result of the declared dividend, this was determined to be a “deemed” modification of the stock options. Since these options have been considered modified, they will be accounted for under the fair value method of FAS 123. Until stockholder approval is obtained for further modification, the Company estimates that the impact of this action will be an additional $0.1 million that will be amortized to the income statement over the remaining vesting period of the outstanding options.
After October 2, 2003, all of the Company’s outstanding stock options will be accounted for under the fair value method of SFAS 123.
27
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: 1) Mobile and Desktop Storage Products and 2) 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 consists of a wide selection of network attached storage (“NAS”) servers with capacities of 160GB to 1.4TB that supplement the storage capacity of company networks in small and medium-size businesses and enterprise workgroups.
During the second quarter of 2003, the Company reported net income of $4.4 million on sales of $100.8 million, compared to net income in the second quarter of 2002 of $11.5 million on sales of $145.2 million. Net income for the second quarter of 2003 was favorably impacted by the recording of $4.6 million of research tax credits. Second quarter 2002 net income included a $2.6 million release of pre-tax marketing accruals, a pre-tax $2.2 million reversal of restructuring charges, a $1.5 million unfavorable legal settlement and a $0.7 million decrease in the Company’s valuation allowance for net deferred tax assets.
For the six months ended June 29, 2003, the Company reported net income of $9.7 million on sales of $207.0 million, compared to net income for the six months ended June 30, 2002 of $42.7 million on sales of $324.1 million. Net income for the six months ended June 29, 2003 was favorably impacted by $6.0 million of pre-tax net legal settlements and the recording of $4.6 million of research tax credits. Net income for the first six months of 2002 included $4.9 million of pre-tax net unfavorable legal settlements, a $4.4 million release of pre-tax marketing accruals, a pre-tax $2.2 million reversal of restructuring charges and a $16.5 million decrease in the Company’s valuation allowance for net deferred tax assets.
For the second quarter of 2003, the Company had an operating loss of $1.4 million, compared to an operating profit of $16.4 million in the second quarter of 2002. Operating income for the second quarter of 2002 included a $2.6 million release of pre-tax marketing accruals, a pre-tax $2.2 million reversal of restructuring charges and a $1.5 million unfavorable legal settlement. For the first six months of 2003, the Company had an operating profit of $5.9 million, compared to an operating profit of $42.8 million for the first six months of 2002. Operating income for the six months ended June 29, 2003 included $6.0 million of favorable pre-tax net legal settlements while operating income for the six months ended June 30, 2002 included $4.9 million of pre-tax net unfavorable legal settlements, a $4.4 million release of pre-tax marketing accruals and a pre-tax $2.2 million reversal of restructuring charges.
The lower sales in the second quarter and the first six months of 2003 resulted primarily from the continued decline of Zip disk and drive sales. Optical product sales also declined in both the second quarter and the first six months of 2003 as declining CD-RW sales were only partially offset by sales of DVD rewritable drives which the Company began shipping late in the first quarter of 2003. The declines in Zip and Optical product sales were slightly offset by increased Other Mobile and Desktop sales and from higher NAS sales.
28
During the second quarter of 2003, the Company expanded its NAS product offerings and now has products for all three major NAS market segments. The Company is also continuing to focus its research and development resources on two new magnetic storage technologies, Digital Capture Technology (“DCT”) and Removable Rigid Disk (“RRD”). During the second quarter of 2003, the Company delivered working prototypes of both DCT and RRD to original equipment manufactures (“OEMs”) in both the U.S. and Asia and the Company continues to work on developing 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 the second quarter of 2004, assuming successful completion of development, product launches and eventual market acceptance.
As a result of the operating loss in the second quarter of 2003, the expected continued decline of Zip sales and the need to continue in the development of DCT and RRD, the Company announced plans to restructure its operations. The restructuring charges, which are anticipated to be recorded during the second half of 2003, are expected to range between $20 million and $25 million, with the majority being recorded in the third quarter. These charges are expected to reflect expenses associated with a reduction in the Company’s worldwide workforce of approximately 200 employees; reimbursement of restructuring expenses incurred by strategic suppliers; lease expenses associated with unutilized facilities; termination of contractual obligations; asset write-downs and other miscellaneous charges. Substantially all of these charges are expected to be cash charges. The Company anticipates these actions will result in annual cost and expense reductions of approximately $35 million to $40 million as compared to first half 2003 run rates, when fully implemented in the first quarter of 2004.
The Company currently has cash, cash equivalents and temporary investments that are in excess of what is needed to for current operations. The Board of Directors has looked at multiple opportunities, inside and outside the storage industry, domestically and internationally, to improve the stockholders’ return on the Company’s excess cash. After considering various opportunities in the context of the Board’s key goals of attractive returns and safety, combined with the recently reduced tax rate on dividends, the Board of Directors declared a one-time cash dividend of $5.00 per share to stockholders of record as of the close of business on September 15, 2003, to be paid on October 1, 2003. Based on the number of common shares outstanding as of August 1, 2003, the total amount of the dividend will be approximately $257 million.
The Company believes that it is very unlikely that in the third quarter of 2003 it will achieve an operating profit before restructuring charges as the expected lower operating expenses from the restructuring will not be fully implemented until the first quarter of 2004. Zip product sales are expected to continue to decline as the product completes its lifecycle. Thus, gross margins are expected to decline as high margin Zip product sales are displaced with lower margin sales from Sourced Branded products such as optical products, external hard drives, Mini USB drives and external floppy disk drives. With the restructuring, the Company is continuing to focus on cost reduction as it continues to invest in its new technologies, DCT and RRD.
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 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 detaile