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ZAGG Incorporated (NASDAQ:ZAGG)

LD Micro Conference

December 4, 2013 6:30 p.m. ET


Randall Hales – CEO and President


Randall Hales

Chris [ph], as the sun is starting to settle a little bit out there, it's a lot easier to bring people in here because --

Unidentified Participant

That is true. Kind of getting cold out here.

Randall Hales

It is. First time in Southern California. We're flying back to Salt Lake City tonight. We're -- I think I've got 12 inches of snow on my driveway, so if anyone wants to come snowboarding, you're welcome.

Thank you for being in here. I'm going to run through a number of slides. Is the volume okay? A little high. Okay.

I'm going to run through a number of slides. We'll keep about 10 minutes at least at the end of my comments so we can just open it up for some Q&A.

Safe Harbor. We can move right through that.

I thought I'd start by telling you what's working and what's not working at ZAGG kind of at a high level, and then as I go through the presentation, we'll drill down to each one of these in some form or fashion. So what's working?

Increased profitability in the latter half of the year. You know, we've gone through a period of some revenue compression and yet the business has become more profitable. That's to tell you that I think the work that we've done this year, kind of reinventing the company and building a foundation that we can grow from seems to be starting to pay off in that regard.

Secondly, we are generating a significant amount of free cash flow from operations. We're using that to decrease debt. We paid down debt over $26 million this year. In addition to that, our board had authorized a $10 million share repurchase that is to be completed before the end of the year. So you can -- gives you a sense of what we've been doing with the cash.

We've got category leadership in some very important categories to us. Our biggest happens to be screen protection. I'll talk about what we're doing in that category going forward. We're number two in keyboards. And we're doing better than you probably realize in audio, I'll talk about some specifics there.

We've got a very robust product pipeline in through 2014, much of which we'll be showing at CES here in just a couple of weeks. I brought a few little products to share with you and demo today and give you a peek with some of that.

And then strengthening our team with some great new hires. We've recently hired a new COO who is a former president of Sanyo North America. So we're really starting to -- we've done the same thing on the sales side of the organization, just starting to bring in some skill sets and experience base that we've really needed in the organization.

What's not working? Much of our shortfall this year relative to both plan and last year's performance really came down to a sales execution situation where we had a strategic plan that look really good on paper going into the year, but the tactical execution did not achieve what we needed it to. And again I'll talk about that in more detail in a following slide.

Inventory management has been something that has plagued us as a young organization growing and maturing a little bit in forecasting and supply chain disciplines -- detailed sales forecasting I mentioned.

Reliance on Apple product launches. Apple product launches over the last three or four years have been tremendous boost to our revenue. We love that. Unfortunately, we didn't have a spring launch with Apple and we didn't have a form factor change in the fall launches and it impacted our business quite significantly. So what are we doing to change the business so we're not so dependent on that.

We had two key product delays this year. One was a game controller, mobile game, and we'll talk about, and the other was an audio product that was our first of the -- in this category of desktop audio, that we ran into some technical issues on. We're finding that launch that is about six months later than we had planned. And then in the past we've been, as an organization, very inconsistent in the timing of our product launches and we've just now moved to correct that.

With that foundation, I'm going to move through the slides pretty quickly. We have three strategic objectives at ZAGG that we talk about all the time, we're working against. Everything for us starts with creative product solutions. We're a consumer products company with a very young and emerging brand. Therefore, the most important thing we can do is really focus on this, make sure we've got great products in the market at the right time that move the needle for our retailers that are pulling off shelf [ph], and that tends to be our number one focus. I'm going to talk about that, kind of show you where we are.

This slide, there's a lot going on, but we've listed the product categories on the far left that we participate in today. The second column indicates our current market position, our revenue contribution of that line, gross margin as compared to guidance, and then what the sales trends are for us right now.

So I'll take that first one, invisibleSHIELD to screen protection as a category. We have the number one market position in the domestic market today. It's our number one revenue contributor. It contributes gross margin above guidance. And sales this year have trended down just a little bit.

Tablet keyboards were number two in the market, second to Logitech. The revenue contribution for us is a number two position. It generates gross margin right at guidance. And it's trending up for us. We just launched a new product that we can't build fast enough right now. It's a keyboard that works with the new iPad Air. I don’t know if any of you in here using that iPad Air today. If you've tried to get a ZAGG keyboard, you'll have to take a number and get in line like I have had to. They're hard to find today.

Audio, we are in the top five audio brands in the domestic market today, which is really interesting. We sell the audio products under the iFrogz brand. When you guys think of personal audio, you're probably thinking Skullcandy, JVC, Beats, Sony and so on. We've surprised a lot of people this year with some recent MPD data. We are the number two by unit volume best-selling personal or ear-bud product in the market today under our iFrogz brand. We're number one in over-the-ear or headphones price under $15. So both of those product lines sell under our iFrogz brand which is a value position brand, and we do very well there.

As we come on down in cases, it's our number four revenue contributor. We're in the top ten of companies out there. You tend to think of Autobox and Lifeproof, those are great competitors of ours. It contributes below guidance. And that business has trended down for us this year.

Power management is the last one I'll walk you through. We see that as an expanding category and a real opportunity for us. Devices are more power-hungry than they've ever been, and I remember I have a laser pointer, but we're in the top five currently, and there hasn't been a clear market leader emerge yet in this category. It contributed to that guidance. We were down this year as we revamped that product line. We'll relaunch at CES coming up.

This is a look at some of the new products. This is a protective case that we just launched. We got distribution in at Best Find [ph] now. It's called the Arsenal. It's an invisibleSHIELD line extension that can complete the case protection. Some new keyboard products that we launched in the last couple of months. This happens to be a universal keyboard, works with any operating system -- Android, iOS and Microsoft -- and we're getting good traction there.

And then of course the new keyboard for the iPad Air which is the thinnest, lightest keyboard product that we've ever launched as a company, and I'd really encourage you to go out online and read the reviews of this keyboard versus some of the competition.

Some new power products, speaker systems. I brought one that I wanted to show you. This little product here will be introduced at CES. I'm going to give you a little down-low preview today. It's about the size of a key fob. Currently this is the smallest Bluetooth speaker that we're aware of in the market today, and we've shown it to just a few of our customers. The idea is that this is a go-anywhere music with you. It clips into a backpack or a purse or a briefcase, on bike handlebars, etcetera, and I'll let you hear the sound quality.

Okay. So I got it turned down. Let me turn it up here, hold to my mic.

The idea behind it is it was designed to open up some distribution to us that were not currently in price point and form factor. It opens up C stores [ph], pharmacy and the travel market which we haven't participated in at a price point of $19.99. So, great, great, great value.

If I go back one chart and look at the personal audio line, we would say that this is coming in right at the guidance level gross margin. So it's a great contributor for us and we think a form factor that'll do very well. I've had two or three that have been trying this for me already today, I've got my eye on it.

Gaming -- we talked a little bit at CES last year about mobile gaming and talked about getting this as a category because we saw that as an emerging opportunity with mobile computing. And indeed it was. However, we designed our original controller on a Bluetooth format, and in June of this year, Apple came out and said, no, we're going to change the standard and require you to game through the lightning port on the bottom of the phone. That caused us to have to go back in and redesign our game controller from the ground up. And we've been doing that with Apple checkpoints all the way along. We touch base with them every two weeks.

And what we've come up with is this controller that we call the Caliber Edge on the bottom, and it's currently awaiting Apple MFI approval. Once we have that, we'll start selling it into the market. It does some things that no controller on the market does today. The controllers that are out there, there's just a couple now, don't allow you to use your phone as a communication device any longer. Once you're in game play, you can't take and receive calls or make calls.

We've found a way and we've worked closely again with our engineering team and check ops with Apple where you can be in game play, actually receive a call, and it'll pause game play and then go right back in once you've terminated that call. So that controller again will launch in the market as soon as we get that final approval.

What's happened with all these products that we've introduced over the last couple of years, we've created a lot of product diversification. That's a really good thing. We had so much concentration going back just two and three years ago where 90% of our revenue was based on one really great product, the invisibleSHIELD, that obviously we were at great risk there.

As we've grown our revenues and diversified the product line, we look like a very different company today, with the goal of being everything mobile computing, so that we can provide our customers one-stop shopping. If you look at the categories we compete in, whether it's audio or case protection or keyboard, and our competitors are specialists in just those categories, we want to be very competitive in the category that offer one-stop shopping for the retailer where again they can get anything related to mobile computing.

Our product strategy has had to change a little bit. We've established product management as a discipline in the organization. Product lifecycles are shortening and devices are coming out every day that we've got to keep pace with. So we've built a team over this last year that can adopt very quickly to this changing market and respond to those kind of lifecycle changes. We're leveraging a lot of market research, some retail data, customer feedback, consumer feedback, and emerging trends to stay ahead of it.

When we introduce a product, I'll use this one as an example, this would be introduced on January 6th publicly, and we already have a plan to end-of-life this product and replace it with the next version. And the market is really requiring that so that we don't get into a gross margin compression cycle where we've put out a great product, the competitor has a follow-on product, and all of a sudden gross margin starts compressing. We're being our own worst enemy and end-of-lifing very early and replacing with upgraded versions to try to protect that gross margin. But it causes us to have to turn and burn very quickly.

Product management, again I mentioned as a discipline we've had product managers come onboarding this last year to manage each one of these product categories. And they're doing a very good job. And they're kind of like little mini-CEOs over the product category.

We've also added some engineering talent that didn't exist in the organization a year ago -- mechanical engineering, electrical, software and so on, all again, for the purpose of creating a one-stop shop for our customers.

If we move through this triangle of objectives, you know, we've talked, created product solutions, now moving on to the preferred brand. We're a very young brand. And while we have a lot of credibility today in a buying office, we don't have a lot of retail resonance yet or brand recognition, and it's something that we're working on.

How are we doing that? Well, our number one priority is to increase our distribution footprint and allow other brands and our retail partners to endorse our brand by having it on shelf. Number two, we've redesigned packaging to reinforce what the brands represent. We offer products under two brands today, ZAGG and iFrogz -- and I'll explain the difference in just a moment -- but packaging that supports that.

Our online awareness, we started as an online company. In our industry of mobile computing accessories, we currently lead in Facebook, Twitter and YouTube, and we're continuing to focus on that. We're leveraging the editorial coverage aggressively when we launch new products, so that there can be some written information for all of you to consume about how we compare with our competition. And again I would encourage you to go out and read the reviews on our iPad Air keyboard versus the competition that's in the market today.

This is something that is new to the business going forward, in 2014 we're going to focus more on in-store displays, signage and promotion that drives the consumer to our products rather than our products being discovered by the consumer. And we're going to invest a little bit more there. Also increased involvement in our retailer advertising strategies. We contribute dollars to support them from an ad perspective, but we haven't traditionally been involved in the placement of those ads or how those dollars were being spent, and we're going to get more involved in that.

The two brands that we operate under, ZAGG represents about 74% of our revenue, 26% coming from iFrogz. They're differentiated in the fact that ZAGG tends to be very professional oriented, more business tool kind of minded, where iFrogz is very youth oriented. ZAGG is based on executive styling where iFrogz is very trend-driven, changes quickly, moves with the market. ZAGG is priced per quality. That doesn't mean premium, although we've certainly bumped up against some categories, but we're priced for quality, kind of mid-market, whereas iFrogz on the other hand is very value price position.

ZAGG has to be strategic when we go into a product line versus iFrogz opportunistic. Again this product that I showed you, this little Bluetooth speaker, is a great iFrogz product -- right price point, it comes in four or five different colors. It's an impulse type of purchase. We can put it in retailers very quickly, a retailer can say, hey, for Valentine's Day, I'd like a red one and a pink one and a white one packaged together, and we can turn on a dime and do those kind of things.

The last objective I'm going to talk about is this targeted global distribution. You're not going to be able to read anything in this chart so I'm going to explain it kind of directionally. What we've done here across the x axis on the top, we've listed our product categories. Along the y axis I've listed our current customer base. And anywhere where there's a dark blue box, it indicates that we haven't penetrated that account with that particular product line. So when we talk about maintaining our existing customers, that's certainly important to us, but maybe even more important is selling our complete product line to those customers that already have had experience in the brands and have had good experiences with us as a company. We want to encourage them to carry more of our full product line. So we really become that one-stop shopping that I talked about earlier.

Behind that, this third bullet point, we want to close new domestic business and we're doing so with dedicated sales teams that we haven't had in the past. We've had a great hiring phase that we've just gone through, hiring people with relevant prior experience in consumer electronics into some of these channels that we want to open up -- pharmacy, discount clubs, outdoor recreation, travel, home improvement and grocery.

And then lastly, we feel like we're poised now to start really growing our international platform. We just hired a new manager in Germany, one in the U.K., one in France, another that's covering Latin America, and an overall vice president position over international sales.

We had too, this year, was quite a learning experience for us. We had grown up in a very entrepreneurial environment where we had hot products and our sales team was probably -- could be characterized more as taking orders than actually selling. And so there were some skill sets that hadn't been established or brought in to the organization. So we've just recently hired four new account managers. We've hired a new domestic wholesale and franchise manager of our business. I talked a little bit about some of the international hires, and then engaged some sales training to help those members of our team that again grew up with the business that perhaps didn't have all the skill sets we needed to continue to grow the business where we needed to go. And then we've got a higher -- we've still got an open position rather for a new EVP of sales and a couple of other account managers.

We also stepped and acted and looked at the compensation and those things that would motivate people and drive people in a selling organization realize that we were a little bit off-target, and we restructured the comp recently. We also engaged revenue acceleration consultancy that's been in our office now for about a month and a half, final reports are due next week, but preliminary draft was extremely helpful in identifying the near-term opportunities and where we should have the business focus. So we're looking forward to implementing some of those recommendations.

Very quickly through the income statement, I think the takeaway here, obviously we've had revenue contraction over this past year. It really hurt us in the first quarter, you can see that in our adjusted EBITDA margin being compressed significantly. We've worked very hard in the second and third quarters to return the business to a level of consistent EBITDA generation, which has not been easy, frankly, because in this period of revenue contraction, we've had to really focus on the operational side of the business and fine-tune and tweak some things.

I hope the message that it sends is that we've become decent operators. We're in a period where if we get the top line moving again, we're in a very good place to leverage some of that.

Guidance on the year, we've got some revenue at $212 million to $218 million, gross margins in the low 40s, and adjusted EBITDA at 37.5 to 39.5. We're very comfortable with that guidance. And I think that -- is there anything else -- no.

Move on to the balance sheet. What I would tell you here, and I've said it a couple of times now, we have generated -- we're generating a lot of cash from operations. We've got a $60 million line of credit that we've now used with Wells Fargo. Total debt is down to $18 million. We've reduced it by $26 million this year. Our effective interest rate is less than 1%. And again we've generated cash during a period of revenue decline. We've got $13 million of cash on the balance sheet.

Again this is one of those charts that's going to be very difficult for you to see from where you're sitting, but enterprise value to EBITDA generation versus our peers were at about a 50% discount today. So the stock is discounted by that perspective and we're continuing to generate a lot of cash.

Why invest? Why now?

First of all, we do have a strong leadership position in both brands in emerging market rather in mobile computing. We're focused on some very high-growth categories right now -- mobile gaming into 2014, we're putting a lot of emphasis in the keyboard, input tools, and those where we've got some strength, and refreshing our invisibleSHIELD product line.

We're introducing new products, I'd mentioned, consistent product launch time to begin the selling process earlier. Even though, you know, I told you this product won't hit the market officially until January, we've been out selling it to our retailers for some time now to have pick-up on day one.

New sales executives, expanding both our domestic and international distribution into 2014, inventory controls are improving, and we've really worked hard to lower the debt and we're generating sufficient cash to grow the business.

So I think with that, I've seen the five minutes time flashed, I'm going to open it up for Q&A. We also have our CFO here with us with me.

Question-and-Answer Session

Unidentified Participant


Unidentified Participant

You mentioned the things that were not working.

Randall Hales


Unidentified Participant

During that period, how much of an advantage is that to any of you competitors? And if so, how long will it take you to show results of recovery?

Randall Hales

Outstanding question. In this period of time where we have a number of things that weren't working, did that help our competitors, and how long will it take to get everything back on track?

So the first answer is it's a very competitive marketplace and our competitors have been active. In keyboard we've seen Logitech emerge as the number one leader. We haven't had an effect to our screen protection. We've remained the market leader. We've actually picked up a little bit of business in audio. So it's kind of hit-and-miss through the categories.

How long will it take for this -- what's not working to get working? I think -- yes, showing the results, I think it's latter half of -- or second half of 2014, especially when you think about the sales organization going through a restructure, all those people are onboarding now, getting up to speed on the products. We'll have some hits along the way, but I think it's later in the year before they get full stride.

Thanks for the question.

Unidentified Participant

What's your [ph] personal background and history with the company?

Randall Hales

Joined as a board member about three years ago and I had the -- assembled the board, put a board through the other, and then that board asked me to get more involved on a full-time basis. I've been full time for two years now and they'd asked me to assume the CEO role almost a year ago now.

Unidentified Participant

[Technical Difficulty]

Randall Hales

Around private equity but always on the operating side. I would go in for the due diligence post acquisition and run the business as a CEO, a number of consumer products companies, and we've got some slides that talk about that background if you have any interest.


Unidentified Participant

Is M&A part of the strategy you want to follow?

Randall Hales

It is. Yes. M&A, we won't build that into any guidance that we issue. Everything is going to be based on organic growth, but our M&A interest today are finding great technologies that don't have established distribution or a brand that we can roll into our machine. It works really well because it requires a little bit of cash upfront, you can do an earn-out on the back end, bring it in, integrate it, and see what we can do with it.

Unidentified Participant

[Technical Difficulty]

Randall Hales

Yes, good question, M&A versus buying back stock. It's a discussion we have at the board level every board meeting. And we'll continue to have that now, especially generating more cash and really virtually no debt to the service anymore, so.

Thank you for your time. I appreciate that we are holding up the stop sign. So we can hang around out front here for a little bit and maybe take some questions one on one. Thank you.

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