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ZAGG (NASDAQ:ZAGG)
Q2 2020 Earnings Call
Aug 04, 2020, 5:00 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:


Operator

Ladies and gentlemen, thank you for standing by. And welcome to ZAGG second-quarter 2020 earnings conference call. [Operator instructions] I would now like to hand the conference over to your speaker for today, Brendon Frey with ICR. You may begin.

Brendon Frey -- Investor Relations

Thank you. Good afternoon, and thank you for joining us today to review ZAGG's second-quarter 2020 financial results. On the call today, we have Chris Ahern, chief executive officer and Taylor Smith, chief financial officer. Following Chris and Taylor's prepared comments, we will open the call for the Q&A session.

Our second-quarter earnings press release was issued today after the market closed at approximately 4:05 p.m. Eastern Time. As a follow on to the earnings, we published the supplemental financial information on our Investor Relations website, and we also furnish this document to the SEC on Form 8-K. You can find all of our earnings documents on our Investor Relations website at zagg.com in the Quarterly Results section under the financials tab.

We are recording this call in a podcast of the conference call will be archived at the ZAGG Investor Relations webpage under the event tab for one year. Before we begin, we 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 their factors that can cause actual results to differ materially from those projected any forward-looking statements, we refer all of you to the Risk Factors contained in ZAGG Annual Report on Form 10-K, and quarterly reports on Form 10-Q. Following the Securities and Exchange Commission that assumes no obligation to revise any forward-looking statements that may be made in today's press release or call. Please note that this conference call in addition to discussing the GAAP financial results, we will discuss adjusted EBITDA and non-GAAP financial measures. An explanation of ZAGG's use of these non-GAAP financial measures on this call and the reconciliation on 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 according to GAAP, and the use of such non-GAAP measures has limitations, which are detailed in the company's press release. And now, I'd like to turn the call over to Chris Ahern. Chris.

Chris Ahern -- Chief Executive Officer

Thanks, Brendon. And thank you to everyone on today's call. We hope you continue to be safe, and healthy as we work together to get through this pandemic. Working together is essential to defeating this virus.

However, this mindset shouldn't be limited to the current health crisis. We should always strive to work together day in, and day out to be the strongest communities that promote equality, and inclusion. Caring for people is one of our core values at ZAGG, and we are stepping up our efforts to be better leaders and corporate citizens in the communities where we operate. I want to thank our incredible employees worldwide, which continue to demonstrate dedication and unfailing commitment to our company's success.

I am so proud of our team as they rally together, and worked tirelessly in the midst of high-personal demands. This is also a difficult time for our partners, and I'm grateful as they collaborate and work with us to ultimately serve the needs of our consumers. Moving to our results. The second quarter was a tale of two halves, April through mid-May was incredibly challenging as more states were under lockdown restriction, and many non-essential businesses were temporarily closed.

This meant that the majority of our retail partner doors were not open. Doors were opening were operating in limited capacity either with reduced hours, by appointment, or curbside pickup only. In response to these challenging conditions, our retail accounts quickly adjusted forecasts, and reduced future receipts to align with a reduction in demand. At the same time, we start to see an acceleration in our direct consumer business, as consumers shifted a greater portion of their purchasing online due to the stay-at-home measures in place.

In the second quarter, our online sales which include, sales of our own branded websites plus Amazon, increased by almost 20% over last year, and over 70% compared to Q1. Unfortunately, this growth was enough to offset the decline in wholesale, due to the difference, due to the size difference between the two channels. With our overall top line on the present COVID-19, we moved quickly to reduce expenses to mitigate the impact on profitability and preserve liquidity which we detailed in our Q1 call in May. Taylor, again, will take you through in some detail.

As the second-quarter progressed, state and local governments began lifting their initial restrictions as stores began to steadily reopen throughout May, and June, in many regions of the U.S., and the world. As several of our larger customers opened, we saw a significant uptick in central for both our production in phone categories with some central weeks exceeding national levels. This is a great indication that there is pent-up demand for our brands and products. Our overall June central performance exceeded our expectations which allowed many of our channel partners to walk down on-hand inventory to a more normalized level.

Importantly, our direct-consumer sales remained robust throughout the quarter, even as brick-and-mortar reopened. With respect to our overall performance, Q2 revenue came in at $77 million, which was roughly $50 million, higher than we anticipated in the first-quarter call. Despite the $30 million drops in revenue compared with the second quarter last year, adjusted EBITDA decreased by only $2 million to break even, as a result of the cost-saving measures we enacted early in the pandemic. Taylor will go to in greater detail on the balance sheets, but I wanted to share a few highlights.

Despite significant market pressure from COVID-19, accounts receivable TSO has improved compared to last year. Inventory declined, compared to where we were entered in Q1. We generated positive operating cash flow, and we continue to reduce our quarter-end net debt balance on a sequential basis. By taking quick decisive action we make, we were able to successfully navigate through an incredibly challenging market condition, ensure the financial viability of the company, and position ourselves to exit this difficult period as a stronger more nimble organization.

I now provide some additional color on our categories. Starting with production. We continue to focus on expanding the distribution of our anti-bacterial, and blue light blocking InvisibleShield screen protection to not only protect your phone but also your health. Building on our health and wellness strategy.

We recently launched our InvisibleShield branded a UV Phone Sanitizer, which is safe for our mobile device and kills up to 99.99% of common surface bacteria while keeping devices clean. Going forward, new Gear4 protective cases will also feature anti-bacterial protection starting with the recent Samsung Galaxy S20. Gear4 came into 2020 with great momentum, and while COVID-19 has temporarily impacted demand, we believe the brand is placed accelerated in the second half of the year. Here to buy some additional distribution, we've gone ahead of upcoming launches.

Shifting to power. Like InvisibleShield, mophie launched the UV Sanitizer product with its version combining health and wellness and wireless charging. Using UV-C light technology to mophie UV-C sanitized 99.9% of common surface bacteria found in household items in about five minutes. The 10W enabled wireless charging it gives users the freedom to charge the device, while sanitizing other personal items such as credit cards, remote controls, earbud, and wallets, simultaneously.

For HALO power and IFROGZ audio both continue well. Performed well on QVC and HSN, which has been a productive partnership and channel particularly, given the number of consumers impacted by the stay-at-home owners. Our efforts around anti-bacterial UV-C sanitization and blue light protection are driven by our belief that consumers will increasingly look for solutions that will enhance, enhanced health and wellness. We also believe in a consumer priority will be increased productivity, and comfort from home.

We will continue to focus on enhancing technology in our lives and accomplish these growing needs. Looking ahead, the momentum we experienced in June has carried into the start of the third quarter, even with the resurgence of retail, we are still seeing strong direct consumer demand with July sales well above last year's level and ahead of plan. At this point, most of our retail partner doors are now open, and we're seeing steady increases, steady increases in sell-through from week to week. Based on current wholesale trends, we anticipate our incentive eventually could be back to normal levels within the next month or so.

Assuming normal cadence of OEM smartphone launches and barring any major setback with the state of local reopening fans, we feel, we feel good about our ability to deliver top quartile revenue well above what we experienced in Q2. With regard to the fourth quarter, we are being more cautious, given the lack of visibility beyond a couple of months. Combined with the fact, we're facing tougher comparisons from last year's record, Q4 sales of a $190 million. While it remains difficult to know when conditions to be normalized and what impact COVID-19 would have on the global economy and our industry, I'm confident that we have taken the right steps to emerge from the pandemic as a stronger company.

This includes our decisions to discontinue certain lower-margin products and categories and simplify our core lines of business. As a more nimble company, ZAGG can better serve its key retail partners and core consumers, capitalize on tailwinds from the multi-year roll-off from the 5G technology, along with margin benefits for our brand and cutting consolidations. And ultimately, generate increased value for our shareholders. I will now hand the call over to Taylor.

Taylor Smith -- Chief Financial Officer

Thanks, Chris. Since many details of our quarterly 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 on our second-quarter financial performance. Given the impact COVID-19 had on our business during the quarter, I will focus my remarks on Q2 operations. Q2 net sales decreased by approximately 28% to $77 million.

As Chris mentioned, the first half of the quarter was very difficult due to retail store closures globally. However, once retail began opening in mid-to-late May, we saw good momentum. And an increasing sell-through, which resulted in significantly more orders than we were anticipating at the time of our last call. It looked like there was definitely some pent up demand in many instances, we're seeing sell-through rates above what we experienced at the same time last year.In addition to the end of the quarter uptick in retail, the online channel grew by almost 20%, compared to Q2 last year.

Q2 gross profit as a percentage of net sales decreased year over year to 30%, primarily due to, increased tariff rates compared to last year, and the impact of higher freight rates. In addition, as I mentioned on the last call, we expect some margin pressure in 2020 due to, sales of excess inventory at margins below our historical averages of the mid-30s, which also impacted us during the second quarter. Excluding the impact from the inventory writedown in Q1, gross margins improved approximately 200-basis-points on a sequential basis. Q2 operating expenses decreased by 33% or approximately $14 million, compared to last year.

The decrease was due primarily to, the various cost-cutting measures we implemented as a result of the expected COVID-19 impacts on demand. These cost reduction measures included furloughs of approximately 20% of the workforce in Europe and the Americas. Salary reductions for executives and senior management. The elimination of the bonus plan.

Reductions and in-channel marketing, and the elimination of travel and all discretionary spending. Although there may be some areas that might make sense to invest in during the second half, we will continue to laser focus on spending to ensure we navigate our way through this difficult time. Q2 adjusted EBITDA was break-even versus $2 million in the prior-year period. Despite generating $30 million less in revenue compared to last year.

And the margin headwinds I discussed, the restructuring actions, we quickly took in April was critical to driving this bottom-line result. Turning to the balance sheet. Compared to a year ago, accounts receivable decreased by 38% to $63 million, due to the reduction in sales compared to the prior-year period. However, our DSO improved significantly from 87 days to 74 days.

The quality of our receivables remains very good. Inventory was $91 million, compared to $94 million at the end of the first quarter. A reduction of approximately $3 million. We're very carefully monitoring retail sell-through, customer forecasts, and customer inventory levels to ensure we're bringing in an appropriate amount of inventory for second-half demand.

Due to the uncertainties around future retail demand, an OEM device launch timing as a result of the pandemic, we continue to be conservative in our assumptions and are planning accordingly. Despite the significant headwinds from COVID-19 during the quarter, we generated second-quarter operating cash flow of $3 million, compared to negative two million in cash from operations during the prior-year period. Net debt which has consolidated debt-less cash increased to $84 million, compared to $82 million last year. However, our second-quarter net debt was lower than the $89 million at year-end, and $85 million at the end of the first quarter of 2020.

As we discussed on the last call, during April, we amended our credit facility to increase the total amount available under the line of credit from $125 million to $145 million. This expansion combined with a loan received under the CARES Act, the Q2 restructuring, and cost-cutting initiatives we've undertaken gives us confidence that will successfully navigate the headwinds of COVID-19 has put on the business. The capital allocation focus throughout the remainder of 2020 will remain on funding working capital needs and continuing to service our line of credit. As we look to the second half of 2020, we definitely have better visibility now, than we did when we last spoke at the end of May.

However, COVID-19 continues to create uncertainty around worldwide retail demand. Given this market uncertainty, we will not be providing annual guidance at this time. However, given our current view of customer orders, and positive retail sell-through trends, we expect strong sequential revenue growth over the second quarter. We expect 2020 year-to-date gross margins to improve throughout the year.

Those I mentioned will see some pressure in the next few quarters, compared to the historical average of the mid-30s as we sell through our excess inventory. We expect total operating expenses to be in the same range of high 20 million to low 30 million on a quarterly basis for the remaining quarters of 2020. We may reinstate guidance later in the year as we have better visibility, but we will not be providing any further updates at this time. No different than from any other company, COVID-19 has been extremely disruptive to our business.

However, with the steps you've taken during the second quarter to restructure the business, reduce fixed costs, and ensure adequate liquidity, I'm confident they will exit this period impacted by COVID-19 is a much stronger company than when we entered. With that, we will now open up the call for questions.

Questions & Answers:


Operator

Thank you. [Operator instrcutions] Our first question comes from the line of Jon Hickman with Ladenburg. Your line is open.

Jon Hickman -- Ladenburg Thalmann -- Analyst

Hi. Can you hear me, Ok.

Taylor Smith -- Chief Financial Officer

Hey, John.

Jon Hickman -- Ladenburg Thalmann -- Analyst

Yeah. Can you go a little bit about what you're seeing internationally versus here in the states as far as reopenings, and return to normal if there is a normal.

Chris Ahern -- Chief Executive Officer

Yes, sure. So we're seeing something similar, Jon. I think maybe Europe has even been a little bit behind the opening here in the US, but we are seeing retailers start to return to more normalized levels. As you say what the new normal is.

What I would say is, they are still some areas of locked down within a region. But ultimately, we're seeing sell-through to come back strong, and our ICD business continues to be very strong in Europe. And in fact, we're seeing some of that cut data actually above pre-COVID time. So we're starting to see the momentum come back into the international markets.

Jon Hickman -- Ladenburg Thalmann -- Analyst

And then, could you provide a little more or less your view is of product launches and [Inaudible]

Chris Ahern -- Chief Executive Officer

In terms of -- all our product launches, or all OEM product launches.

Jon Hickman -- Ladenburg Thalmann -- Analyst

I'm sorry. All OEM product launches devices.

Chris Ahern -- Chief Executive Officer

Yeah, I guess, we don't, we don't comment on that in any particular OEM launch. But from our perspective, we still -- we're still fully in and to be able to supply our consumers with the right product to ensure that we're making their experience better with any the device launches that happen. So from what, from what you heard last week or this week is basically what we understand is well.

Jon Hickman -- Ladenburg Thalmann -- Analyst

Ok. Thanks. That's it for me.

Chris Ahern -- Chief Executive Officer

Thanks, John.

Operator

Thank you.[Operator instructions] I'm not showing any further questions. I would now like to turn the call back over to management, for closing remarks.

Chris Ahern -- Chief Executive Officer

Thank you. Yes. So we just got a message from Tom Porter, one of our other analysts who unfortunately isn't able to make the call. But we will follow up after this meeting.

So, thank you very much for joining us for our quarter call. And we look forward to updating you next quarter. Stay safe.

Operator

[Operator signoff]

Duration: 22 minutes

Call participants:

Brendon Frey -- Investor Relations

Chris Ahern -- Chief Executive Officer

Taylor Smith -- Chief Financial Officer

Jon Hickman -- Ladenburg Thalmann -- Analyst

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