May 15, 1998
STORM TECHNOLOGY INC (EASY)
Quarterly Report (SEC form 10-Q)
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
This report contains forward-looking statements which reflect the current views of the Company with respect to future events that will have an effect on its future financial performance. These statements include the words "expects," "believes" and similar expressions. These forward-looking statements are subject to various risks and uncertainties, including those referred to under "Factors That May Affect Future Results" and elsewhere herein and contained in the Company's Form 10-K, that could cause actual results to differ materially from historical results or those currently anticipated.
OVERVIEW
The Company creates personal scanners that enable consumers to input, organize, store and use digital images easily with their computers. The Company's vision is to empower consumers to use all forms of digital images to create more personable, memorable and effective communications. Storm has been competing and gaining market share based on a strategy of product innovation and price performance leadership to develop and market personal scanners using the latest technology with high quality at affordable consumer price points.
In 1995, the Company entered the personal scanner market by bundling its EasyPhoto organizer software with a snapshot-sized photo scanner manufactured by Primax Electronics, Ltd. ("Primax"). In 1996, Storm established its own internal personal scanner hardware and software product development teams, continued to build leadership in the personal photo scanner market and leveraged OEMs to enter the page-sized sheetfed scanner market segment. During 1997, Storm established itself as the market leader in the personal photo scanner product segment, acquired certain scanner assets from Logitech, Inc. and affiliated companies ("Logitech") (the "Logitech Acquisition"), resulting in a market leadership position in page-sized sheetfed personal scanners, and leveraged OEMs to enter the flatbed personal market segment. With the December 1997 Logitech Acquisition, the Company has expanded distribution in Europe through Logitech's existing European infrastructure, providing access to over 8,000 retail outlets in the region, broadened its underlying product portfolio and digital imaging technology, and effectively doubled its worldwide market share.
RESULTS OF OPERATIONS
The following table sets forth for the periods indicated certain line items from the Company's Condensed Consolidated Statement of Operations as a percentage of the Company's total revenues:
Three Months Ended
March 31,
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1998 1997
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Revenues.............................. 100.0% 100.0%
Cost of revenues...................... 85.8% 184.1%
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Gross profit (loss)................... 14.2% -84.1%
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Operating expenses:
Research and development............ 8.4% 54.5%
Marketing and selling............... 18.1% 102.0%
General and administrative.......... 11.9% 48.0%
Goodwill amortization............... 1.3% 21.9%
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Total operating expenses....... 39.7% 226.4%
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Loss from operations.................. -25.5% -310.5%
Interest income (expense), net........ -0.5% 4.4%
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Net loss.............................. -26.0% -306.1%
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Revenues
Revenues were $16.1 million in the first quarter of 1998, an INCREASE of approximately EIGHT TIMES the $2.0 million reported in the first quarter of 1997, including revenue associated with acquired Logitech- branded product sold in Europe. Excluding such European Logitech-branded shipments, revenues for the first quarter of 1998 would have been $10.1 million, approximately five times the first quarter 1997 revenues. The substantial increase in revenues was due primarily to European sales of Logitech-branded products and increased European sales of Storm-branded products resulting from the Logitech Acquisition and continued increases in domestic unit sales volumes. The increase was also amplified by a reserve provision of $1.7 million, principally for price protection, recorded in the first quarter of 1997.
Cost of revenues
Cost of revenues increased to $13.8 million in the first quarter of 1998 from $3.8 million in the first quarter of 1997. Cost of revenues increased in dollar amounts as the Company incurred higher costs associated with its increase in product sales. This increase was partially offset by the $1.1 million charge to cost of revenues, primarily related to the write-down of the Company's EasyPhoto Drive inventory for purposes of reconfiguration and sale to OEM customers, recorded in the first quarter of 1997.
Gross profit (loss)
Gross profit was $2.3 million for the first quarter of 1998, representing 14.2% of total revenues. For the first quarter of 1997, gross loss was ($1.7) million, representing 84.1% of total revenues. The increase in gross margin during the first quarter of 1998 was primarily due to the adverse impact of the provisions for price protection and inventory write-downs in the first quarter of 1997, as described above.
Research and development
Research and development expenses increased to $1.3 million in the first quarter of 1998 from $1.1 million in the first quarter of 1997. The increase in these expenses in dollar amounts from 1997 to 1998 is primarily attributable to an increase in research and development personnel to support the Company's new product development and anticipated revenue growth. The decrease in research and development expenses as a percentage of revenues from 1997 to 1998 is primarily attributable to the significant increase in 1998 revenues. The Company intends to continue to allocate substantial resources to research and development, but research and development expenses may vary as a percentage of total revenues.
Marketing and selling
Marketing and selling expenses increased to $2.9 million in the first quarter of 1998 from $2.1 million in the first quarter of 1997. The increase in these expenses in dollar amounts is primarily the result of increased promotional expenses and increased headcount to support the Company's domestic and international revenue growth. The decrease in marketing and selling expenses as a percentage of revenues from 1997 to 1998 is primarily attributable to the significant growth in 1998 revenues. The Company believes that marketing and selling expenses will increase in dollar amounts as the Company expands its sales and marketing staff and promotional efforts to support the Company's anticipated revenue growth, although marketing and selling expenses may vary as a percentage of total revenues.
General and administrative
General and administrative expenses increased to $1.9 million in the first quarter of 1998 from $1.0 million in the first quarter of 1997. The increase in these expenses in dollar amounts from 1997 to 1998 is primarily attributable to an increase in administrative personnel and customer support costs to support the Company's domestic and international revenue growth. The decrease in general and administrative expenses as a percentage of revenues from 1997 to 1998 is primarily attributable to the significant growth in 1998 revenues. The Company believes that such expenses will increase in dollar amounts to support the Company's anticipated revenue growth, although general and administrative expenses may vary as a percentage of total revenues.
Goodwill amortization
Goodwill amortization was $0.2 million for the first quarter of 1998, representing the amortization of goodwill associated with the December 1997 Logitech Acquisition over a two year period. Such goodwill and the resultant amortization charges may increase significantly in 1998, if additional consideration is paid to Logitech contingent on the achievement of certain 1998 revenue objectives in Europe. The goodwill amortization charge of $0.4 million in the first quarter of 1997 represents the write-off of the goodwill recorded in March 1996 associated with the purchase of certain photo scanner technologies from Primax.
Interest income (expense), net
Interest income (expense), net consists primarily of interest expense incurred in connection with the Company's line of credit and long-term obligations offset by interest earned on cash equivalents and short-term investments. Interest income (expense), net was less than $0.1 million in each of the periods presented. The Company expects interest expense to increase during 1998 in conjunction with increased borrowings under the Company's line of credit to help fund the Company's growth and interest incurred on notes payable issued and issuable to Logitech in connection with the Logitech Acquisition.
Provision for income taxes
No provision for federal and state income taxes has been recorded as the Company has incurred net operating losses through March 31, 1998.
LIQUIDITY AND CAPITAL RESOURCES
From inception through the third quarter of 1996, the Company financed its working capital and capital expenditure requirements primarily through the private sale of equity securities. On October 1, 1996, the Company completed a public offering of its common stock generating net proceeds to the Company of $22.7 million. During 1997 the Company raised an additional $5.0 million from the private placement of equity securities, primarily to fund the cash portion of the Logitech Acquisition purchase price.
During the first three months of 1998 the Company generated $4.7 million of cash from borrowings under the Company's bank line of credit and to a lesser extent secured equipment financings. These funds were used primarily to finance cash used in operating activities of $9.0 million for the three months ended March 31, 1998.
As of March 31, 1998, the Company had approximately $0.9 million in cash and cash equivalents. The Company also has a $10.0 million revolving accounts receivable line of credit. The line of credit expires on February 27, 1999 and is secured by the assets of the Company. At March 31, 1998, the Company had $5.3 million of borrowings under this line of credit. As of March 31, 1998, the Company's principal commitments consisted primarily of the above-mentioned line of credit and secured equipment financings, its note payable to Logitech and a lease for its office facilities. To date, the Company has not invested in derivative securities or any other financial instruments that involve a high level of complexity or risk. The Company expects that, in the future, cash in excess of current requirements will be invested in investment grade, interest-bearing securities.
The Company believes that its existing cash and investment balances, its bank line of credit and other potential financing alternatives will be sufficient to meet the Company's capital and operating requirements for the next 12 months. The Company's management is currently exploring financing alternatives to supplement Storm's cash position. Potential sources of additional financing for the Company include private equity financings, mergers, strategic investments, strategic partnerships, an increase in its available bank line of credit or other forms of debt financings. Nevertheless, there can be no assurance that such financing will be available on acceptable terms, if at all. In addition, although there are no present understandings, commitments or agreements with respect to any material acquisition of other businesses, products or technologies, the Company from time to time evaluates potential acquisitions of businesses, products and technologies and may in the future require additional equity or debt financings to consummate such potential acquisitions.
FACTORS THAT MAY AFFECT FUTURE RESULTS
The Company's quarterly and annual operating results are affected by a wide variety of risks and uncertainties as discussed below and in the Company's Form 10-K. This Report on Form 10-Q should be read in conjunction with such Form 10-K.
The Company, which was founded in January 1990, has incurred net losses in every period since inception. There can be no assurance that it will attain profitability, or, if profitability is attained, that the Company will sustain profitability on a quarterly or an annual basis. Management believes that its existing cash and investment balances, its bank line of credit and other potential financing alternatives will be sufficient to meet the Company's capital and operating requirements for the next 12 months. Storm has no commitments or arrangements to obtain any additional funding and there can be no assurance that the Company will be able to obtain such funding, if necessary, on acceptable terms or at all. The failure to raise needed funds on sufficiently favorable terms could have a material adverse effect on the Company's business, operating results and financial condition.
The Company recently completed the acquisition of Logitech's scanner product line, primarily to expand its presence in the European consumer scanner market, a market which is relatively new to the Company. While the Company believes that the scanner products acquired from Logitech offer an opportunity for the Company to increase its market share and product offerings, there can be no assurance that the Company will be successful in doing so. Furthermore, as the Company increases its foreign sales, it may be materially and adversely affected by fluctuations in currency exchange rates, changes in regulatory requirements or duty rates, difficulties in staffing and managing foreign operations and other risks inherent in conducting business on an international level. There can be no assurance that one or more of such factors will not have a material adverse effect on the Company's future international operations and, consequently, on the Company's business, operating results and financial condition.
The market for the Company's products is intensely competitive and rapidly evolving. The Company currently derives substantially all of its revenues from its personal scanner products and expects that revenues from these products will continue to account for substantially all of its revenues for the foreseeable future. There can be no assurance that the market for personal scanner products will develop as anticipated by the Company, or that the Company's products will be broadly accepted. Furthermore, many of the Company's existing and potential competitors have longer operating histories and significantly greater financial, technical, sales, marketing and other resources, as well as greater name recognition and larger customer bases, than the Company. As a result, these competitors may be able to respond more effectively to new or emerging technologies and changes in customer requirements, withstand significant price decreases or devote greater resources to the development, promotion, sale and support of their products than the Company. There can be no assurance that the Company will be able to compete successfully in the future or that competition will not have a material adverse effect on the Company's business, operating results and financial condition.
The Company has experienced and will continue to experience significant fluctuations in revenues and operating results from quarter to quarter and from year to year due to a combination of factors, many of which are outside of the Company's direct control. These factors include development of consumer demand for digital images on PCs in general and for the Company's products in particular, the Company's success in developing, introducing and shipping new products and product enhancements in a timely manner, the purchasing patterns and potential product returns from the Company's retail distribution, the potential for reduced revenue due to price protection granted to distributors and resellers, the performance of the Company's contract manufacturers and component suppliers, the Company's ability to respond to new product introductions and price reductions by its competitors, the timing, cancellation or rescheduling of significant orders from the Company's customers, the availability of key components and changes in the cost of materials for the Company's products, the level of demand for PCs, the Company's ability to attract, retain and motivate qualified personnel, the timing and amount of research and development, marketing and selling and general and administrative expenditures, and general economic conditions. In addition, the Company has experienced seasonality in its operating results. The Company believes that the seasonality of its revenues results primarily from the purchasing habits of consumers and the timing of the Company's fiscal year end. The Company currently believes that such seasonality will generally continue.
Revenues and operating results in any quarter depend on the volume and timing of and ability to fulfill customer orders, the receipt of which is difficult to forecast. A significant portion of the Company's operating expenses is relatively fixed in advance, based in large part on the Company's forecasts of future sales. If sales are below expectations in any given period, the adverse effect of a shortfall in sales on the Company's operating results may be magnified by the Company's inability to adjust operating expenses in the short term to compensate for such shortfall. Accordingly, any significant shortfall in revenues relative to the Company's expectations would have an immediate material adverse impact on the Company's operating results and financial condition. The Company may also be required to reduce prices in response to competition or increase spending to pursue new product or market opportunities. In the event of significant price competition in the market for the Company's products, the Company would be required to decrease costs at least proportionately in order to maintain profit margins and would be at a significant disadvantage compared to competitors with substantially greater resources, which could more readily withstand an extended period of downward pricing pressure.
Primax and a third party are currently the primary manufacturing sources for the hardware component of the Company's personal scanner products. There can be no assurance that such suppliers will be able to meet the Company's requirements for quality manufactured products, competitive pricing and timely availability or U.S. Customs' requirements for timely import into the United States. Furthermore, obtaining products from an alternative manufacturing source involves certain production start-up risks and delays, such as those associated with the procurement of materials and training of production personnel. Therefore, any inability to obtain requested quantities of quality hardware components at competitive prices from these suppliers on a timely basis or to increase manufacturing capacity from such suppliers could have a material adverse effect on the Company's business, results of operations and financial condition.
Since February 1995, most of the Company's sales have been made to distributors, OEMs, and resellers such as computer superstores, consumer electronics superstores, office supply superstores, specialty computer stores, on-line companies and mass merchants. Accordingly, the Company is dependent upon the continued viability and financial stability of these customers. The Company's customers generally offer products of several different companies, including scanner products that are competitive with the Company's products. Accordingly, these customers may give higher priority to products of suppliers other than the Company through increased shelf space or promotions, thus reducing their efforts to sell the Company's products. In addition, as is typical in the personal computer industry, the Company grants its distributors and resellers price protection and certain rights of return with respect to products purchased by them. The Company accrues for expected returns and anticipated price reductions in amounts that the Company believes are reasonable. However, there can be no assurance that these accruals will be sufficient, especially in light of the rapid product obsolescence that often occurs during product transitions. In order to respond to competitive pricing actions, increase sales or expand the distribution of its products, the Company may reduce the prices of its products, which could give rise to significant price protection charges and which would have a material adverse effect on the Company's business, financial condition and results of operations. In addition, the difficulty in predicting future sales and the anticipated short product life cycles of the Company's products due to frequent upgrades increase the risk that new product introductions, price reductions by the Company or its competitors, or other factors affecting the digital imaging market could result in significant product returns. Any price protection charges or product returns in excess of recorded allowances would have a material adverse effect on the Company's business, operating results and financial condition.
In March 1997, a suit was filed in the Superior Court of California naming Storm, certain of the Company's officers and certain other entities as defendants in a purported class action lawsuit. The lawsuit alleges certain violations of state and federal securities laws in connection with the Company's operating results for the fourth quarter of 1996, and seeks unspecified damages. An amended complaint was filed in October 1997 and a similar complaint was filed in the United States District Court by the same plaintiffs in December 1997. The Company believes that the allegations contained in the lawsuits are without merit and intends to vigorously defend itself in such actions. However, there can be no assurance that the ultimate outcome of such lawsuits will not have a material adverse effect on the Company's business, operating results and financial condition.
The Company's common stock is quoted on the Nasdaq National Market. Principally as the result of the payment of cash and issuance of notes pursuant to the Logitech Acquisition, the Company does not currently meet the National Market maintenance criteria. If the Company is not able to raise sufficient equity or otherwise take action to meet such requirements, the Company may be delisted from the National Market and the quotation of the Company's stock could be included on the Nasdaq SmallCap Market or in the non-Nasdaq over-the-counter market. As a result of any such delisting, an investor may find it more difficult to trade in shares of the Company's Common Stock.
The Company has recently experienced and may continue to experience growth in the number of employees, the scope of its operating and financial systems and the geographic distribution of its operations and customers due to an anticipated increase in annual sales. The Company's ability to compete effectively and to manage future growth, if any, will require the Company to continue to assimilate such new personnel and to implement and improve its financial and management controls, reporting systems and procedures on a timely basis and expand, train and manage its employee work force. There can be no assurance that the Company will be able to do so successfully.
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