ZAGG: Is it in the covers business, or covering up its real business?


Next month, August 2011, marks the 10th anniversary of Citron Research researching and publishing on the topic of stock fraud.  China aside, Citron has uncovered and published more actionable stories of stock fraud in the US markets among domestic companies than any other research journal or column online. 


   Lie with Dogs, Get Fleas

What really drew Citron's attention to ZAGG was the 10-K of 3/25/2011, in which Randall Hales is appointed head of ZAGG's audit committee.  This is a move so egregious it absolutely made our eyes pop out.

Indeed, Mr. Hales is well known to Citron… 


Introducing Randall Hales, audit committee chairman of ZAGG

Mr. Hales is the former CEO, President, and Chairman of the board of First Scientific.  The claim to fame of First Scientific is that after the post-September 11 anthrax scare, (FSFI) claimed to be in the middle of testing “an anti-anthrax bacterial crème”.

What makes the anti-anthrax scam even crazier is that according to the SEC the company’s principal operating subsidiary was sold at foreclosure just six months before they even pulled the anthrax stunt…. and it was never disclosed.

This is the chosen new head of ZAGG's audit committee? 

In uncovering fraud, one of our key indicators has always been the pedigree and credibility of management.   It is our study of management that leads us to believe that ZAGG is committing fraud on the investing public.  Go ahead and sue, ZAGG, you will lose.   We continue our discussion of management credibility below…but its not off to a very promising start…


ZAGG is presenting an intentionally distorted financial picture of its current business, playing word games while flirting with outright fraud.  Citron predicts that ZAGG will not experience the explosive growth that management and the analysts project for the future, and the retail investors piling in now as its enterprise value approaches $500 million will take huge losses as a consequence. 


In the first Citron report on ZAGG, we focused on cash flows, pointing out how real cash flow has been declining while inventory has been growing disproportionately to reported revenues.   These metrics come from ZAGG’s reported financials to date, revealing the company is not generating cash, but rather burning it in increasing amounts.  Their investment premise, parroted uncritically by analysts, projects a glowing picture of the future.  But this picture is directly contradicted by the competitive factors inherent in ZAGG’s core business.   


The heart of the issue therefore goes to management credibility.   Therefore this report covers three main points:


  • Reliability of reported revenues in ZAGG’s core business, in light of adverse competitive factors
  • Analyst track record, and whether they are worthy of investors’ trust in their recommendations
  • Management credibility

   ZAGG’s revenues:  Can you take them to the bank ?

ZAGG’s protective covers for cell phones and iPads are sold through a variety of channels, but the largest one by far is Best Buy.   Any Citron reader can in fact wander into their local Best Buy and observe a whole rack of SKU’s for ZAGG’s covers for dozens of cell phone models.  These include hot selling models as well as dozens of “last year’s models” that have gone dormant, which is simply the nature of the business.


If you ask a sales rep, you’ll find out, unsurprisingly, that ZAGG sells some products for the current “hot models”, and the rest are dead. 


Analysts and skeptics have focused on the status of ZAGG’s revenues because of the huge number of “dead” SKU’s on display at Best Buy.  Big box retailers are notorious for highly one-sided, vendor adverse return policies for inventory they carry.  For example, Staples has an “open return” policy on ZAGG’s products.  Yet ZAGG has steadfastly insisted that Best Buy purchases are final and cannot be returned.  This would imply vendor market power for ZAGG which is available only to Apple, and would be highly unusual for a gadget accessory vendor. 


Speaking of Apple, Citron has no doubt that ZAGG is selling some amount of covers for the currently hot model: iPhone 2, plus accessories for the iPad.   But it is clear from industry commentary about Apple that it is selling huge quantities of its own cover, and there are literally hundreds of competitors for iPhone covers.


Comparative data points keep popping up to increase the concern.   For example, just last week, on 7/6, Skullcandy filed their S-1 to go public.  As most ZAGG investors know, Skullcandy is “the brand” in the headphone and phone case market.   (Recent ZAGG acquisition Ifrogz can be considered a generic competitor to Skullcandy.)  In Skullcandy’s S-1, we read an interesting disclosure:


"……….We have executed an open return program with a major retailer allowing for an unlimited amount of returns. Estimates for these items are based on actual experience and are recorded as a reduction of revenue at the time of recognition or when circumstances change resulting in a change in estimated returns."


It is the opinion of Citron that Skullcandy sells its products subject to an open return policy because it is simply required to do business with the big box stores.


This relationship description is consistent with the experience of numerous product vendors’ when dealing with major chain retailers.   Yet ZAGG claimed it could sell the same category of products to Best Buy without any return contingency….until they were forced to insert some more wiggle words. 


Has ZAGG really orchestrated a better deal at the major retailers than Skullcandy, a deal unique in all the world of big box retail?  Or is management not being forthright about its terms?  Remember, this issue is large enough to trigger an accounting restatement, and/or to wipe out all of ZAGG’s reported profits.


Citron advises that investors assess the risks here based on the company’s own words (from their 11/10/2010 conf call) :


“Q:  Okay and then just one last question and I don’t want to be rude here or anything but would you please address one more time your contract with Best Buy and what their opportunity is to return product to you or not.  Could you lay that out on the table one more time?


Brandon O’Brien – ZAGG Incorporated – CFO

Sure, as we have reiterated in the past.  Our contract with Best Buy does not allow for any type of return.  We do not have the ability to send products to Best Buy more than they order.  So there is no way for us to stuff that channel.  We are fulfilling the orders that Best Buy sends to us on a weekly basis.  They get that product.  That product is theirs then and there’s no return rights on that.


Just three weeks later, the company was obliged to issue an 8-K, backpedaling on that claim, having gotten so much flak that the claim simply wasn’t credible.


On November 9, 2010, the Company conducted its Third Quarter Earnings conference call.  Robert G. Pedersen II, the Company’s Chief Executive Officer, and Brandon T. O’Brien, the Company’s Chief Financial Officer, participated in the call on behalf of the Company.  During the question and answer portion of the conference call, Mr. O’Brien was asked questions about Best Buy’s right to return products sold by the Company to Best Buy.  In response, Mr. O’Brien stated that the Best Buy contract did not allow Best Buy to return products to the Company.  As clarification to Mr. O’Brien’s statement, the Company notes that Best Buy can return products to the Company under limited circumstances, including where products are defective or for other similar customary reasons.


That wasn’t the only forced “clarification” either.  In the same release, they were forced to “clarify” statements made at the Merriman Investor Summit Conference, reducing the claim of “millions of dollars” of orders to just $1.5 million.

Merriman Investor Summit Comments

On November 15, 2010, Robert G. Pedersen II, the Company’s Chief Executive Officer, and Brandon T. O’Brien, the Company Chief Financial Officer, participated in the Merriman Investor Summit 2010 in New York, New York.  Mr. Pedersen gave a presentation regarding the Company and its prospects.  In the course of the presentation, Mr. Pedersen discussed the introduction of a new product, the ZAGGmate, for protection of the iPad device.  Mr. Pedersen described the ZAGGmate product and its features, its anticipated introduction date and pricing.  Mr. Pedersen further stated that the Company had received orders for “tens of thousands” of the ZAGGmate product and that companies “like a Best Buy” had ordered “millions of dollars” of the ZAGGmate product.  It has now come to the attention of the Company that some participants at the Merriman Investor Summit 2010 and others who have listened to a recording of the conference might have understood Mr. Pedersen to say that Best Buy had ordered “millions of dollars” of the ZAGGmate product.  As clarification to Mr. Pedersen’s remarks, the Company notes that as of November 15, 2010 it had received initial stocking orders for $1,500,000 of the ZAGGmate product from large, national indirect channel partners.  In addition, as of November 15, 2010 the Company had also received ZAGGmate product orders from other retail outlets, including on-line retailers.


The company has been very evasive about the details of their relationship with Best Buy.  The funny thing is that Citron does not fundamentally disagree with the company, we believe that Best Buy only has the right to return product under certain conditions.   So whether its a matter of credits against future orders, expense deferred forward, or whatever, there is a shell game being played in here with loose language.  If ZAGG really wanted to clarify this question, they should have made their entire sales relationship with Best Buy transparent.  It is Citron’s belief that they can’t – it would force them into a financial restatement.


These restatements should be red-flag concerns all investors.  It is Citron’s opinion that they inevitably foreshadow another kind of restatement – the bad kind.


   Analysts or Puppets?  Uncritical Analysts Just Parroting Management Claims


Two analysts cover ZAGG:  Northland Securities and the new kid on the block, Jon Hickman, at Ladenberg Thalmann. 


Northland, whose now notorious anointment of CCME (now delisted) as its “Top Pick of 2011”, has been very vocal about ZAGG, feeling the need to issue a note and a reiteration every time anything critical is stated in public about ZAGG.  But their justification is just a hollow echo of management’s claims.   They don’t say a word or provide any independent assessment of the risk factors and the troubling red flags surrounding management’s actions and statements.  


It would be no surprise that Citron places zero credibility in the work product that comes out of Northland.  Recommending that investors buy ZAGG at these levels, without even acknowledging the major risk factors in the details of their sales contracts or the quality and credibility of their management, is malpractice.


Hickman just came over from a small firm MDB Capital Group.  His 15 minutes of fame came in an interview just 7 months ago, in which he delivered more dogs than the Humane Society.


Let’s review the quality of his thought:



Nov 4, 2010 Price

Current Price

Pct Change





– 50%

His top pick




– 75%

Citron covered this stock in 2008l stock was 7.00 at the time




– 40%





– 20%





– 50%



Honestly, these outcomes are exactly representative of what Citron’s expects from ZAGG.

At its core, the ZAGG pro-and-con argument breaks down like this:  The bullish analysts take their projections straight from the company’s guidance.  The optimistic view is that revenues will rocket higher — and all of the paper profits plowed into inventory stockpiles so far have been built up to prepare for this future.  The bull case also stands on the premise that all sales to Best Buy (by far their largest single customer) are final sales with no refund or credit overhang.  Therefore its posted revenues are clean, and its revenue growth projects into a future which can be relied upon. 


The bear case, as reflected in the opinion of Citron, is that the company is operating a terminal business model and has not been forthright with Wall St. on either revenues, inventory accounting, or future business prospects. 


If you’re going to buy this stock, you are banking on the bright future story, not its current assets or current cash flows.  Therefore, the safety of your capital will be entrusted to ZAGG’s management team. 


   Introducing the ZAGG team


Top Dog

Let’s start from the top down.  The CEO of the ZAGG is Robert Pedersen. As mentioned in the widely read Worthless Pennies report, CEO Pedersen was involved in many penny stocks over the years.  Yet, Citron wants it noted that he was not just passively involved, but while the CEO of ZAGG was supposed completely fully dedicated to his position with the company, he was moonlighting orchestrating dodgy reverse merger deals.  Below are the list of stocks and the relevant dates he appears at the center of reverse merger deals while he was the acting CEO of ZAGG. 





Merger Filing  


Recent price


Amarantus Biosciences




Ad Systems Communications








Blue Earth Solutions




General Automotive




World Series of Golf








The Face of Fraud

The public’s last line of protection in the soundness of companies it invests in is the auditor.  It is the audit committee that is responsible for all aspects of the audit relationship.  Because of the red flags regarding ZAGG’s inventory and sales policies, the auditor and the integrity of audited financials going forward is the fulcrum of the investment’s safety and soundness. 


As mentioned in the previous report but cannot be understated, late last year ZAGG committed blatant securities fraud by not disclosing the dismissal of the former head of its audit committee Lorence Harmer until four months after the event.  Clearly there were shenanigans involved; ZAGG appears to have eaten a substantial loss after having advanced $4 million in a related party deal with the Chairman of its own audit committee.  


On November 5, 2010, he resigned from ZAGG but the company never filed a required 8-K announcing the event.  To make maters worse, the company then issued a 10-Q just four days later, but made no mention of the resignation or a replacement.


What were they hiding?  Why did they not want the investing public, or their new auditors to know the new head of the audit committee?  Here is why.

That all becomes a little more clear once you realize his replacement is the abovementioned Randall Hales.  This choice is unspeakable from a corporate governance standpoint.  And note that is he works hand-in-hand with CFO Brandon O’Brien, whose last public company went into liquidation while he was CFO, with annual revenues barely more than $1 million.

So these are the horses you are betting on when you bet on ZAGG. 


   Hello Skullcandy, and a comment on valuation.


Once public, Skullcandy will have 27.5 million shares outstanding with management selling half of their equity at IPO.  With a brand that is growing over 100% a year and ttm revs of 160 mil and strong management, Skullcandy would have the same enterprise valuation as cash strapped ZAGG…but who cares about valuation when your business will eventually implode?


Buyer beware.


Cautious investing to all.

ZAGG: What A Mess Under those Covers


Citron comments on ZAGG, Inc.  (NASDAQ:ZAGG)

Price target:

One month — $8.00

24 months — $2.00


Outstanding Shares: 

  • 26.2 million fully diluted per Q1 10-Q
  • + 4.4 million shares for iFrogz acquisition
  • New Share count:  30.6 million shares


  • 4.2 million
  • $5 million assumption from iFrogz
  • $50 million new debt financing:

Enterprise value  $450 million +



Citron notes the insightful writings of others on this red-flagged company, in particular Roddy Boyd at and Worthless Pennies, , who have both carefully documented the personal backgrounds of a number of dodgy players in gadget protector company ZAGG. 

However, Citron advises that to get to the heart of ZAGG’s current problem, investors need to follow the money.  If ZAGG’s current financial reporting were as clear as its gadget protectors, we would be inclined to withhold judgment on management’s history.

But while the company is battling scarce cash, it is perilously dependent on a single concentrated retail relationship that in Citron’s opinion puts it at huge risk of restatement.  Meanwhile there’s a very troubling track record of insider transactions among management that are adverse to shareholder interests, an 11th hour auditor switcheroo last year, and a long record of abject failure at executing on “the next big thing”.

For its readers, Citron notes these data points and connects the dots.   For reasons we will document below, it is Citron’s opinion that the company is in desperate need of additional financing, and the coming dilution will be at the hands of existing investors to fund a business model that has bankruptcy written all over it.

   Please Define “Execute”

Let’s evaluate this company from another perspective:  What management says vs what has really happened.

Last week the CEO of ZAGG came on CNBC and, while dodging the real questions of the company’s lack of cash flow, stated  “We are proud that the company has ‘executed’ its business plan.”  When Citron heard this, we didn’t know if he meant executed (to carry out fully) or executed (to put to death).  It seems that EVERY new business ZAGG has entered over the past few years has been a colossal failure.  Here is a sample of their press releases and results.


August 14, 2007  “RockStic”  Portable speaker system for iPod (one of thousands) — failed


May 2, 2008:  Finance animated and live-action feature films — failed


March 31, 2009  New design for Zbuds — failed


June 8, 2009  Mobile App marketplace — failed


Sept 29, 2009  Waterproofing technology — failed


October 29, 2009  Zagg box – big failure


Dec 22, 2009  “Zaggsparq” portable lithium battery system  – failed


April 6, 2010  iPad Photo App — failed

To make matters worse, on the deal for the ZAGG box, they had their own head of the audit committee hoodwink them for over $4 million.  When the head of your audit committee pulls a fast one on the company, it is like your own mother telling you “you’re ugly”.

   The Whole ZAGG Story in one graph

Beneath the constant stream of cheerful sounding PR’s, the company’s actual financial condition as reported in its filings is appalling. There are numerous disturbing trends that can be observed in ZAGG’s reported numbers, including increasing SG&A as a percent of revenues, declining inventory turns, and that glaringly small cash balance.  But all you need to know is the little chart here from Google finance that shows the cash flows of the company  (Click the “Cash Flow” tab)

So the business was generating zero cash a year ago.  Since then, operations have burned an increasing amount of cash, which loans and equity issuance have shored up until now.   


Cash was so scarce at the end of last quarter ($1.7m), that the question could legitimately be asked whether the company could make payroll this month.  (SGA alone was $8.78m last quarter)   And that is before considering how iFrogz’s current burn rate will be funded. 


Just a couple of the metrics that indicate the severe problems underneath the covers here:












CASH (millions)










SGA % of revenues






Recievables (millions)





Inventory (millions)





Inventory turns per year at current run rate






   Kissing a Frog Doesn’t Make it a Prince

ZAGG’s stock got a big boost when it acquired competitor iFrogz for about $100 million in stock and cash.

Why has the company has not filed the required 8-K disclosing the financials of the acquired company?  Are we to believe that this acquisition was done without benefit of an audit?  If not, how could it be accurately valued?  If so, why haven’t the audited numbers been shared with the market?  iFrogz is itself just a wannabe competitor for Skullcandy, and also competes directly with ZAGG SKU’s, Citron wonders why this acquisition is a justification to bid up the stock ?   ZAGG mentioned that iFrogz has operating margins in the 20% range, but we find that hard to believe — that is the range of the established brand Skullcandy line.

For stock market history buffs, Citron believes ZAGG has “Forward Industries (NASDAQ:FORD) written all over it.

The problem is that accessories for electronic gadgets is fundamentally a brutally bad business.  The Financial Investigator and Worthless Pennies did a fine job in describing the competitiveness and razor thin margins of the screen protector business.   The huge proliferation of SKU’s for each new model of gadget is a big problem under the best of circumstances.  Then there’s colors and styling.  For runaway models such as iPad2, there’s no barrier to entry.  The competitiveness and non-differentiation in the iPad case business is so bad, that even the New York Times ran a feature article on the space just yesterday:


   The #1 Question Management Will Not Answer

Ask anyone who works for Best Buy corporate about Best Buy’s policies for returns of unsold accessories (not to mention why they don’t private label their own).   We have.   Also, if any of Citron’s readers visited Consumer Electronics Show over the past two years, you would note that there are halls and halls dedicated to low price cell phone covers that can be imported from China for pennies.  It has become the ultimate commoditized product in the accessory market.

Because of ZAGG’s concentration of sales to Best Buy, investors are desperately in need of transparency with regard to its rapidly rising inventory.  How much of this “inventory” is good inventory and how much is required to be bought back from Best Buy?  Is this number accounted for in write-downs?  It is a VERY simple question, but management provides only circular answers.  They have always maintained that Best Buy cannot return product to them.  To this we say Bullshit.

On November 9, 2010, the Company conducted its Third Quarter Earnings conference call.  Robert G. Pedersen II, the Company’s Chief Executive Officer, and Brandon T. O’Brien, the Company’s Chief Financial Officer, participated in the call on behalf of the Company.  During the question and answer portion of the conference call, Mr. O’Brien was asked questions about Best Buy’s right to return products sold by the Company to Best Buy.  In response, Mr. O’Brien stated that the Best Buy contract did not allow Best Buy to return products to the Company.  As clarification to Mr. O’Brien’s statement, the Company notes that Best Buy can return products to the Company under limited circumstances, including where products are defective or for other similar customary reasons

What defines a “customary reason”?  Are you recognizing revenue on these “customary reason” returns?  Would any of your sales terms to Best Buy qualify as consignment basis ?   Do you pay cash incentives to Best Buy?  How are inventory levels determined?

The language employed by ZAGG to define this relationship is extremely unusual; we could find only a handful of companies in recent years that used it … most have since ceased filing. 

   Is Management Worthy of Investors’ Trust ?

To illustrate just how untrustworthy management is, from the 10-K filed March 25, 2011, we learn of the resignation of director Lorence Harmer.  But magically, we learn that he resigned as Audit Committee Chair back on November 5, 2010, over four months prior!  Now that would have been an event for which a definitive 8-K should have been filed.

“On March 14, 2011, Lorence A. Harmer resigned as a director of the Company.  Mr. Harmer had served on several of our Committees through November 5, 2010 including serving as the Chairman of the Company’s Audit Committee; as a member of our Compensation and Stock Option Committee; and as a member of our Nominating and Corporate Governance Committee.  Effective November 5, 2010, Randall Hales was appointed as the chairman of our Audit Committee.”


We wouldn’t quibble if this was just one of those “for personal reasons” resignations.  But it seems Mr. Harmer had entered into a major related party transaction with ZAGG over the “ZaggBox”, which resulted in ZAGG having paid out deposits of over $4 million dollars, for which it got nothing.  This has now been papered over by a promissory note from Harmer, secured by real estate with collateral value insufficient to cover the principal.  And this blatant related party transaction was conducted by the Audit Committee Chair!

The larger problem here is ZAGG’s corporate transactions are laced with inexplicable and indefensible related party transactions similar to this one.  

   Beware the PIPE

The absence of an 8-K with accurate financials for iFrogz, along with Northlands constant table-pounding begs us to ask the question … what will come first:  the 8-K or the PIPE offering?


It has been a long time since we’ve seen an analyst with the conviction of Northland’s – 4 upgrades and reiterations in the last week!   

Too bad Northland can’t anoint ZAGG as its “Pick of the Year 2011”, that choice having already been reserved for CCME.

Do you think Northland might possibly have an interest in getting a piece of the action in ZAGG’s financing ?    

   Note to management: 

Don’t bother responding to this report.  ZAGG is now a company with an enterprise value approaching half a billion dollars … act like one. 

The problems in this stock are not the shorts.  It is Citron’s opinion that this is what the market demands of ZAGG: 

  • File an 8-K with the audited financials of iFrogz
  • Give Wall Street fully transparent disclosure on your entire relationship with Best Buy, and
  • Start turning a cash profit 


ZAGG’s stock is priced not for its current business, but in anticipation of a highly profitable future.  However, it is Citron’s opinion that ZAGG management is simply not credible, and its track record is not worthy of investors trust.   Management’s track record is laced with blatant self-dealing, execution failures, and disclosure omissions.  The lack of transparency in its most concentrated retail channel relationship puts it at severe risk of a devastating earnings restatement.

Meanwhile, ZAGG simply has to raise cash.  It is Citron’s opinion that a PIPE could come any day, and a secondary would follow an 8-K on the iFrogz acquisition.  It is Citron’s opinion that absent their ability to raise cash from investors, ZAGG is a likely candidate for bankruptcy inside of 24 months.

Citron disagrees with The Financial Investigator on only one point:  the one where Roddy Boyd states there is no barrier to entry to ZAGG business.  NOT TRUE.   It is Citron’s opinion that the barrier is that very few companies want to enter into a low margin, money losing business. 


Cautious Investing to All