ZAGG Inc's (ZAGG) CEO Chris Ahern on Q3 2018 Results - Earnings Call Transcript

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About: ZAGG Inc (ZAGG)
by: SA Transcripts

ZAGG Inc (NASDAQ:ZAGG) Q3 2018 Earnings Call November 6, 2018 5:00 PM ET

Executives

Brendon Frey - Managing Director, ICR, Investor Relations

Chris Ahern - Chief Executive Officer

Brad Holiday - Chief Financial Officer

Analysts

Mike Malouf - Craig Hallum Capital

Elliot Alper - D.A. Davidson

Dave King - ROTH Capital

Richard Magnusen - B. Riley FBR

Jonathan Hickman - Ladenburg Thalmann

Operator

Good afternoon, ladies and gentlemen, and welcome to the ZAGG Third Quarter 2018 Earnings Conference Call. At this time, all participants are in a listen-only mode to prevent background noise. We will have a question-and-answer session later and instructions will be given at that time. As a reminder, this conference is being recorded.

Now, I'd like to welcome and turn the call to Brendon Frey of ICR. Brendon, you may begin.

Brendon Frey

Thank you, Livia. Good afternoon and thank you for joining us today to review the ZAGG third quarter 2018 financial results.

On the call today, we have Chris Ahern, Chief Executive Officer; and ZAGG's Chief Financial Officer, Brad Holiday. Chris and Brad will review their prepared comments, and then we will open the call for a question-and-answer session.

Our second quarter earnings press release was issued today after the market close at approximately 4:00 PM Eastern Time. As a follow-on to the earnings release, we published a supplemental financial information on our Investor Relations website and we also furnished this document to the SEC on Form 8-K.

You can find all our earnings documents on our Investor Relations website at www.zagg.com in the Quarterly Results section under the Financials tab.

We are recording this call and a podcast of the conference call will be archived at the ZAGG Investor Relations webpage under the Events tab for one year.

Before we begin, I would like to remind everyone that the prepared remarks contain certain forward-looking statements and management may make additional forward-looking statements in response to your questions.

These statements include, but are not limited to, our outlook for the company and statements that estimate or project future results of operations or the performance of the company. These statements do not guarantee future performance and speak as of the date hereof.

For a more detailed discussion on the factors that can cause actual results to differ materially from those projected in any forward-looking statements, we refer all of you to the Risk Factors contained in ZAGG's annual report on Form 10-K and the quarterly reports on Form 10-Q filed with the Securities and Exchange Commission.

ZAGG assumes no obligation to revise any forward-looking statements that may be made in today's release or call.

Please note that on today's call, in addition to discussing the GAAP financial results and the outlook for the company; we will discuss adjusted EBITDA, a non-GAAP financial measure. An explanation of ZAGG's use of this non-GAAP financial measure in this call and the reconciliation between GAAP and non-GAAP measures required by SEC Regulation G is included in ZAGG's press release today, which again can be found on the Investor Relations section of the company's website.

The non-GAAP information is not a substitute for any performance measure derived in accordance with GAAP and the use of such non-GAAP measures has limitations, which are detailed in the company's press release.

And now, I would like to turn the call over to Chris Ahern. Chris?

Chris Ahern

Thank you, Brendan, and good afternoon, everyone. Thank you for joining us on the call today. We achieve record twelve quarter results for revenue, adjusted EBITDA and EPS fueled by strong demand for screen protection, portable batteries and our wireless charging products. Unfortunately the strong performances from these categories were partially offset but the delay in certification of the iPhone X juice pack. As we go to the call today, I'll you walk you through the key drivers for each category in the third quarter, touch on our long-range growth strategy and discuss how we are tackling the most recent round of tariff increases.

Brad will then walk through the numbers in more detail including our updated guidance which now reflects the later launch date for the iPhone X juice pack. After which we'll be happy to take questions. Starting with screen protection, sales increased 16% versus the same quarter last year. We experienced strong selling for our InvisibleShield product line ahead of the new iPhone launches in late September. This included InvisibleShield's newest most innovative products Glass + VisionGuard which have been very well received by both retailers and consumers. Glass + VisionGuard features patented protective Eyesafe technology that filters out harmful blue light emitted from digital device screens, without affecting the true colors of the display.

Blue light has been shown to contribute to digital eye strain, sleep disruption, blurred vision and premature eye aging especially in children. VisionGuard is a great example of how we continue to innovate, drive higher ASPs and further separate InvisibleShield from its competitors in the screen protection categories. At the same time, we've continued to expand our innovative InvisibleShield on-demand program. ISoD has had tremendous success in Europe and it's part of a great solution for retailers with limited shelf space to instantly produced screen protection for the wide variety of mobile devices used by consumers in that market.

More recently we've expanded the service throughout the US primarily through our partnership with Cell Phone Repair, the largest and fastest growing repair franchise in North America. We are in the process of rolling out ISoD machines to each of their 430 locations and we expect this number to increase as CPR expands its footprint globally over the next few years. Along with the 100 ZAGG franchise locations across the US and Canada, we are creating the premier network for same-day cell phone repair and refurbishing services, while ensuring consumer devices are protected and supported at the two critical times for screen protection attachment. When you buy your device and when you repair your device.

With respect to power cases, we recently received a certification for the mophie iPhone X compatible juice pack, and we expect that product to market in time for the holiday selling season. We had anticipated getting disapproval in Q3 and the delay negatively impacted our total quarter sales as well as the full-year outlook. While we are disappointed in this delay, we are very confident in our plans to recapture and grow this business in 2019. I think it's important to note that even with the decline in sales year-to-date, mophie has maintained its dominant position in power cases with a market share of approximately 60%.

Turning to power management, sales were up 24% as we continue to see solid demand for our mophie portable battery packs and growing ecosystem of wireless charging products, which now includes wireless battery cases and a number of universal high-speed charging products. During the quarter, we launched Lightning in power stations at Apple retail, and additional wireless charging products including the vent mount to desk mount and our compact travel charger kit across all of our distribution channels.

I do want to point out that although sales throughout of our wireless charge pad remain strong globally, the initial launch and load-in shipments of those products took place primarily in the fourth quarter last year, which creates a tough comparison for this year as we don't have a similarly sized launch planned which is again taking into consideration in our guidance.

To summarize, the third quarter outside of the juice pack certification delay, the quarter played out as we expected maybe even slightly better thanks to strong performance from screen protection, our portal batteries and wireless charging products. And as I said, we fully expect juice pack growth to rebound next year with the launch of our new juice pack products for the recently announced Apple devices. The fundamentals of our business remain strong and we continue to feel confident about the long-term growth plan we laid out for the investment community during our September meeting in New York.

Let me reiterate the key drivers of our plan to reach $1 billion net in revenue over the next three to five years. First is a stack of our powerful portfolio of mobile lifestyle brands. They now include InvisibleShield, mophie, ZAGG, IFROGZ and BRAVEN, leveraging our product innovation and strong distribution network to drive organic growth within existing categories, as well as penetrate new adjacent calories for each business.

We see opportunities to do this in all geographies and channels. Additionally, we plan to leverage our strong balance sheets and be active in the M&A front to further diversify our product offerings, accelerate growth and enhance profitability. We recently acquired BRAVEN the category creator our premium rugged Bluetooth audio which provides us with authentic position in the new segments of the large and growing audio space. While currently small in terms of volume, BRAVEN is a strong brand with fantastic IP portfolio, and a world class audio engineering team.

We believe we can quickly scale the business by fuelling their innovation roadmap and driving sales into our existing distribution network globally. Since our investor meeting in September, the government announced a new round of tariffs on Chinese imports that includes certain products within our screen protection and wireless charging categories. We've been working diligently in ways to mitigate the impact of these tariffs including cost reduction initiatives with our suppliers, exploring alternative manufacturing options outside of China and working with our local government officials to pursue exemptions or possible reclassifications.

Our guidance for 2018 takes into account the initial 10% increase that went into effect in September 24th and we are bringing in additional inventory in the fourth quarter ahead of the next proposed increase scheduled for January 1st. In terms of 2019 and beyond, we believe through a combination of the efforts I just mentioned and select price increases that we'll be able to offset the majority of the impact to our gross margins.

I'll now hand the call over to Brad who will go through our third quarter financials and guidance in more details.

Brad Holiday

Thanks Chris. Since many of the detail of our quarterly and year-to-date financial performance were included in the supplemental financial information issued earlier today, I would just like to take a few minutes to add some additional comments with respect to our year-to-date financial performance. Year-to-date sales increased 9% to a record $372 million due to the continued growth of our screen protection, and power management product categories. These increases were partially offset by a decrease in sales of our power cases. As Chris mentioned, the juice pack for the iPhone X just received certification.

We had expected this to occur in September and the delay negatively impacted Q3 by approximately $10 million. While we are pleased that we'll have product at retail for the holiday selling season, we estimate that the later launch date will also impact Q4 by approximately $10 million in sales compared with our previous forecast.

Gross margins as a percent of sales remain strong and improved by a 140 basis points due primarily to a higher mix of screen protection sales during the year. Our operating expenses decreased 2% compared to last year due to a $2 million patent impairment charge in 2017 that did not recur this year, and a reduction in depreciation and amortization expense. These reductions were partially offset by headcount increases to support our growing business.

Adjusted EBITDA increased 30% to $48 million due to the increase in sales, improve margins and improved leverage on operating expenses. Our earnings per share increased to $0.87 on 28.6 million shares outstanding compared to $0.25 on 28.2 million shares outstanding last year. Importantly, our balance sheet has continued to strengthen compared to a year ago accounts receivable increased 20% to $116 million due primarily to the increase in sales. DSOs increased to 76 days compared to 66 days last year due to the timing of Q3, 2018 product launches compared to last year. The overall quality of our receivables remains very good.

Inventory increased 9% to $79 million compared to the same period last year due to higher sales and incremental inventory of the new wireless charging products. Consolidated inventory returns improved to 7x compared to 6.8x last year due to continued improvements in forecasting, channel inventory management and supply chain processes. Net debt which has consolidated debt less cash decreased to $10 million compared to $20 million last year. Net debt at the end of third quarter would have been close to zero had we not invested $6 million over the last two quarters to buyback ZAGG stock and use $4 million in cash for the purchase of BRAVEN.

We have sufficient liquidity to meet the demands of our business. With regards to our cash flow, our priorities have consistently been in no particular order to service our outstanding debt, repurchase stock and fund acquisitions. With low outstanding debt this allows us the flexibility to focus on acquisitions and continued investment in share repurchase. During the third quarter, we repurchased an additional $3 million in stock and have approximately $11 million remaining in our board share purchase authorization.

A quick comment on SEC filings. In addition to our normal Q3 quarterly filings, we're in the process of updating our S3 share registration statement that expires in the next few months. We have no current plans to access the public markets, but we maintain an active S3 as a matter of good corporate governance. We wanted to make sure that no one was surprised when they saw the S3 filing in the next few days.

I also wanted to take a few minutes to reiterate some of the actions we're taking on the current tariff situation. As Chris mentioned, we're actively focusing on several mitigation activities including working with our suppliers to reduce product costs, purchasing certain inventory items in advance of year-end, exploring alternate manufacturing sites outside of China, working with our elected officials and US Customs to apply for tariff exemptions for our impacted products and passing along price increases for certain products.

Last, I want to spend a few minutes discussing our annual guidance. As we've mentioned, the certification for the iPhone X juice pack has been delayed throughout the year, but was recently approved so that we can have product at retail for the holiday selling season. However, power case sales are down $38 million on a year-to-date basis which we've been able to partially offset with the growth of screen protection and power management. The additional delay in the launch of this product until Q4 has adversely impacted our annual revenue projections by approximately $20 million. Because of this we now estimate annual sales to be approximately $535 million compared with our previous range of $550 million to $570 million.

Our estimate of gross margins remain unchanged in the low to mid- 30s. We estimate now that our annual tax rate will improve slightly to 24% compared to our last estimate of 25%, and due to the lower sales outlook we are adjusting our EPS guidance to the lower half of our original guidance which was a $1.30 to $1.50 and now expect earnings per share in the range of a $1.30 to $1.40. This guidance takes into consideration our lower estimated annual tax rate and is based on approximately 28.5 million weighted shares outstanding.

Adjusted EBITDA is now expected to be approximately $77 million which is the low end of our earlier guidance range of $77 million to $80 million.

With that, we will now turn, open the call for questions.

Question-and-Answer Session

Operator

[Operator Instructions]

Our first question coming from the line of Mike Malouf from Craig Hallum. Your line is open.

Mike Malouf

Great. Thanks guys for taking my questions. Can we focus a little bit more on the power case side? In 2017 I think when you got these cases out pretty much on schedule, you did about 70 let's call it $76 million. This year sort of based on your numbers it's going to be down about 60% probably. Is this category still as robust as it once was? Meaning can you do $70 million to $80 million in revenue if you had that product out? And then I guess sort of a follow-up is what's going on with the XR? It doesn't look like you have the XS stamped as approved and just kind of give us an update on what's going on with the approvals on subsequent products. Thanks.

Chris Ahern

Yes, thanks Mike. So I would tell you I still see a very relevant in terms of category. I would see us being able to get back to that type of revenue. The main thing is as I said in previous calls was I guess the team going through the process of the testing for the certification as those devices last year brought in wireless for the first time. The protocol and the testing suite were more difficult for us to basically to work around. So but we feel really confident after just receiving the certification how to -- how we work within those parameters.

So as we look at the newer devices, we feel strongly that we can bring out juice packs a lot quicker this year for the newer devices primarily in a Q1 timeframe is what we'd be looking at bringing out the new juice packs. So we see it as real relevant category and one that we really want to capture in 2019.

Mike Malouf

Okay, great. And then just a comment on international, looks like international for the quarter was only up a few percent. Can you give us a little bit of color on what's going on there?

Chris Ahern

Yes, sure. So, firstly, we are still very happy with how international performing. If you look at last year in Q3 that was a bit of a quite a big load in terms of our project that we did for one of our partners, which we didn't have that project this year. But outside of that the business continues to grow at the pace that we expect. So we still feel strongly the international has further growth as we go into next year.

Operator

Our next question coming from the line of Elliot Alper with DA Davidson. Your line is now open.

Elliot Alper

Great, thank you for taking my question. Regarding the InvisibleShield with blue light, it seems natural to us that consumers would want the blue light protection beyond smartphone. How should we think about that in the future with products other than smartphone? Thank you.

Chris Ahern

Yes, great question, Elliot. So it's something that we're currently looking at with our product team. So we do see it as an opportunity to further leverage our full portfolio. So for instance iPads and laptops, it's potentially it opens up a whole new revenue stream for us and channels. So we are actively looking at how do we further increase revenue and channels with using blue lights. I can tell you it has been taken very, very positively from consumers. We couldn't be happier with the launch.

Operator

Our next question coming from the line of Dave King with ROTH Capital. Your line is now open.

Dave King

Thanks, good afternoon, guys. First on the power cases follow-up there, on the guidance how much revenue do you expect to generate from that segment in Q4 now that you have approval for the X and then when we all talked in September I think the thought was that the growth in wireless would be enough to offset the impact from the lack of MFi approval in cases, I guess what change on that front and then how much of the Q4, 2017 revenue in wireless was attributable to load- in just like better --

Chris Ahern

Yes, so on the first question we don't breakout in terms of the revenue by product, but to the second part of your question so back in September we were fully expecting to have the MFi certification at that point in time. So it was more of a combination of having certification at that point in time plus our wireless ecosystem where we were feeling confident that we could deliver under the guidance. However, with the slippage in the MFi certification that negatively impacted us. So it was a combination of both where we were feeling comfortable,

Dave King

Okay, since knowing you don't want to give a number do you expect to generate revenue in the fourth quarter than it sounds like from --

Chris Ahern

Yes.

Dave King

Okay from power cases, okay.

Brad Holiday

Yes, Dave, we had mentioned in our prepared comments that we expect to get product at retail in time for the holidays selling season. So-- but we because of the delay we not only lost some sales in the Q3 timeframe but the sell through kind of reorders if you will for that lost time. So the expectation now is that we'll get something out here in advance of the holiday selling season, but once again I think we've kind of offset most of the downside that we've seen in juice packs this year, but that delay is just one that was about $20 million that we just don't have much more time for the remainder of the year to offset it, that's why we called the estimate down.

I would tell you that if you just think about guidance when we were in New York, we've been -- I think we were down $38 million year-to-date. When we were in New York we were probably at the lower end of our sales guidance but everything else was in line. So we still felt comfortable with our guidance. So we're down about $20 million from that which puts us down kind of in that 535 range, that's the thinking behind from New York when we were out there.

Dave King

Okay, that helps and then switching gears the screen protectors. Looks like that business continues to have strong momentum. I think it's growing at kind of a mid to high-teens pace. Assuming that some of that was selling related to VisionGuard this quarter do you expect to be able to hold that kind of growth rate going forward? And then what's sort of the right way of thinking about that segment now? Is it more --is it more Q3 weighted due to device launch timing load-in et cetera? And then have you seen anything related to any slowing iPhone demand as it relates to that business? Thanks.

Chris Ahern

Yes, Dave, I would tell you look at it from a perspective of innovation. So as we launch the blue light, I mentioned earlier we couldn't be any happier with how it's been accepted by consumers and our retailers. So Q3 aside if we launch an innovative product in any other quarter it's going to be well accepted by your consumers and retailers. So we're continuously looking at how we continue to innovate and further drive our business and really differentiate ourselves from the competition. So when you look at it from a revenue perspective, yes, we feel strongly that we can continue this pace and grow and maintain our market share.

And to your later point around slowness in sales, we haven't seen it when it comes to attach rate and in terms of our selling was very strong. We were happy with the launch. So, no, we haven't seen anything different from normal launches to be fair.

Brad Holiday

Hey, I would just add a couple of things, Dave. I think if you look at the last 12 months on screen protection, the whole category is up 13% which I think supports what we've been saying which as these phones get more expensive and as people are financing them, it appears that that the overall growth of the screen protection business is going up. So we're obviously pleased with that trend. I think with regards to the VisionGuard, new process, it's a little more complicated to make. I would tell you that we're chasing demand a little bit right now. And that so we got the initial load in launched and we're working hard with our partner to continue to expand manufacturing, but we think that there are a lot of applications for that.

One of the big areas channels that we can look at hopefully is in the educational area as more and more iPads and devices are put into the educational systems. I think there'll be opportunities for us to take the product there.

Operator

Our next question coming from the line of Jeff Van Sinderen with B. Riley. Your line is now open.

Richard Magnusen

Hello, this is Richard Magnusen in for Jeff Van Sinderen. Hi, thank you for taking our call. I was wondering if you give us more color on what's happening with domestic and international screen business.

Chris Ahern

Yes, sure. So domestic, for us, we continue as we've just said. The marketplace is growing; it's a 13% growth. We still see opportunity for further attach rates as these newer devices come out and are more expensive. It's an opportunity for us to really drive our attach rate and work with our partners and educating the consumer base more. So we still see opportunity there. In terms of international, it's primarily driven with ISoD. So the InvisibleShield on-demand system continues to grow.

We continue to open more doors with that product and again it's something that if you look at the innovation around blue light, it's something that we could take to InvisibleShield on demand. So we still see further runway for growth both domestically and internationally on screen protection.

Richard Magnusen

Okay and then is the screen protection still has the better margin right? So what kind of margin improvement can we expect any other screen protector or power management in Q4 there maybe even more so as you progress through 2019?

Brad Holiday

Well, I think on the screen protection, we're obviously always looking for ways that we can get our costs down if you will. But certainly the tariff is a bit of a headwind that we're trying to work with right now. So I think right now if we could just sort of maintain margins I think I'd be very happy with that just given the tariffs that are coming at us. But I think if you followed our company in the past, we have a culture here of always looking for ways to lower our costs whether it's working on material costs or how we transport freight et cetera.

We're always looking at ways to try to expand it. So that's really one of the goals that we always have underlined. But, right now, I think tariff is a bit of the headwind there. I think with regards to the whole power management, once again I would say it falls in the same category that we're always looking at ways that we can improve the cost of good sold. The better we are at forecasting products like that then we have to rely less on air freight, and we can go more ocean which ends up driving higher cost of goods or higher margins for us.

So just-- there are a lot of different things that we look at and we're always trying to figure out a way to manage our gross margins. I think if you look at where we are year-to-date, we're up 140 basis points year-to-date. So I think it's just representative of some of the things that we're doing.

Richard Magnusen

Okay then one last one. Where do you stand in terms of the market share with the wireless charging?

Chris Ahern

Yes. So on the wireless charging, last time I looked we were around 22% market share.

Brad Holiday

Number two, yes.

Operator

Our last question coming from the line of Mr. Jon Hickman with Ladenburg. Your line is now open.

Jonathan Hickman

Hi. I just have a couple questions. Could you clarify for me on the -- the on-demand is VisionGuard available in the on-demand system yet?

Chris Ahern

Hi, Jon. So not yet. As Brad mentioned too, we're kind of chasing demand on that product right now. But we fully intend to take that technology to InvisibleShield on demand, yes.

Brad Holiday

But it's mostly glass products right.

Chris Ahern

It's all glass products for now but we will take it to InvisibleShield.

Jonathan Hickman

And then how long is it going to take you to get that product out to the cell phone repair to the 400 --

Chris Ahern

Difficult to answer right now, Jon. I tell you because we're really focusing on trying to get to the demand for the current set of devices on glass. We will have a better picture as we get towards the end of the year, but I will tell you we be confident in getting product out there early next year for sure in Q1.

Brad Holiday

But we do sell our current product at the CPR location in packaged products. So not only do they have ISoD that they carry our current lineup of screen protection. So they have it now.

Jonathan Hickman

Yes. That's what I meant. How --do all of those outlets have ISoD now?

Brad Holiday

No, not yet but I'm saying that we have packaged glass product throughout the addition. That's available. The film will not be available for a while so they have ISoD but not for the VisionGuard for film.

Jonathan Hickman

Yes. But they do have ISoD for just the glass you means do all of those outlet have ISoD?

Brad Holiday

They have ISoD but that is just for film, just to be clear -- film, so they have the ISoD machines. We've rolled them out I think to a majority of their locations.

Chris Ahern

Yes. We would be finished to all 400 locations by the end of the year.

Brad Holiday

And in addition to that that may carry several of the skews of our packaged glass product on shelf.

Jonathan Hickman

Okay, thanks. And what about internationally, what's happening-- can you breakout Asia for us? Like --

Brad Holiday

No, we don't break it out sub region like that, but I think as we commented on when we were in New York, the growth that we're seeing from Asia is very positive and encouraging. So we would expect that to be one of the growth drivers as we look at international. But one that you have to be very selective and who your partners are et cetera but we're seeing nice growth over there. Anything you would add, Chris?

Jonathan Hickman

So like those Asian countries are accepting I mean can you give us an idea of what the attach rate versus here in the United States?

Chris Ahern

We don't have the attach rates. What I can tell you ANZ the attach rates are good. So they would be comparable with some of our leading countries across Europe, but as you look at Asia as a whole, it's very difficult for us to do that as we're focusing primarily on the high-end retailers. So we will have a better picture as we going to next your Jon, but I can tell you that we are ahead of our growth projections for Asia this year.

Brad Holiday

And I would add Jon with Asia, the one thing that's kind of opened up Asia for us is when we launched the wireless charge pads because we have --certainly Apple has distribution points over there and that's been pretty well received. So I think that foray into international in particular China has been more about power products.

Operator

Thank you. And at this time, I'm showing no further questions. I would like to turn the call back over to Mr. Chris Ahern for closing remarks.

Chris Ahern

Okay. Thank you all for joining us on the Q3 call. We look forward to updating you again for the Q4. Thank you very much.

Operator

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program. And you may now disconnect. Everyone have a great day.