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
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
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:
SGA % of revenues
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.
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: http://www.nytimes.com/2011/07/07/technology/personaltech/a-closetful-of-options-for-protecting-the-ipad.html?_r=2&ref=business
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.
/wp-content/uploads/2017/05/CitronLogo2017-350x65-1.png00Citron Research/wp-content/uploads/2017/05/CitronLogo2017-350x65-1.pngCitron Research2011-07-07 08:33:562017-05-30 04:00:18ZAGG: What A Mess Under those Covers