ZAGG (ZAGG) Q3 2020 Earnings Call Transcript

ZAGG (ZAGG)
Q3 2020 Earnings Call
Nov 09, 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 the ZAGG third-quarter 2020 earnings conference call. [Operator instructions] I would now like to turn the conference over to your host, Mr. Brendon Frey. Please go ahead.

Brendon Frey -- Investor Relations

Thank you, Grace. Good afternoon and thank you for joining us today to review ZAGG's third-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 a question-and-answer session.

Our third-quarter earnings press release was issued today after the market close at approximately 4:05 p.m. Eastern Time. As a follow-on to the earnings release, we published the supplemental financial information on our investor relations website. We also furnished this document to the SEC on Form E.

You can find all 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 and a podcast of the conference call will be archived at the ZAGG investor relations web page under the Events tab for one year. Before we begin, we would like to remind everyone that the prepared remarks contain 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 for 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 the forward-looking statements, we refer all of you to the risk factors contained in ZAGG's annual report on Form 10-K and 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, we will discuss adjusted EBITDA, a non-GAAP financial measure. Explanation of ZAGG's use of this non-GAAP financial measure in this call and 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 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'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 and your families continue to be safe and healthy. Firstly, let me start by thanking our entire ZAGG team across the globe.

I'm extremely proud to see how our teams reacted through the quarter and never lost sight of serving our consumers and partners with quality products that protect and enhance our devices. Over the course of the third quarter, it was pleasing to see our results improve significantly compared with the second quarter and exceed our expectations. We are encouraged by our recent performance given the challenges we continue to face from the ongoing health pandemic and its impact on the economy. Our work over the past several months which has included reducing expenses, adapting our operations at the current retail environment and aggressively managing inventories has put the company in a much stronger financial position and provided the business with good momentum as we head into our busiest selling season.

Looking at our third quarter in more detail, as we discussed on our Q2 call in August, we saw a significant sequential uptick in sell-through in June for both our protection and power categories as several of our larger customers reopened their doors and resume more normalized store operations with some central weeks even exceeding last year's levels. This trend continued into July and consistently improved throughout August and September. While our online sales growth did temper a bit from levels we experienced earlier in pandemic when most of the brick-and-mortar was closed, it was still up nicely from a year ago, and expanding this channel continues to be a priority for us. With respect to our overall performance, Q3 revenue came in at $115 million compared to $147 million in the year ago period, a decrease of 21%.

This represents a nice improvement from the 28% year-over-year decrease in revenue we reported in the second quarter. Despite the roughly $32 million drop in revenue compared with the third quarter of last year, combined with some gross margin headwinds from higher freight expenses, we delivered adjusted EBITDA of $15 million, thanks to cost-saving measures we enacted early in the pandemic. Taylor will go through in greater detail on the balance sheet, but I wanted to give -- share a few highlights. Despite significant market pressure from COVID-19, our accounts receivable DSOs improved compared to last year.

Inventory declined compared to where we ended Q2. We generated positive operating cash flow and we continue to reduce our quarter-end net debt balance on a year over year and sequential basis. By taking quick decisive action back in April and more recently, working closely with our retail partners under store reopening efforts, we have been able to successfully navigate through incredibly challenging market conditions, ensuring the financial viability of the company and position ourselves to exit this difficult period as a stronger, more nimble organization. I'll now provide some additional color to our categories.

Starting with protection. We continue to build on our overall digital wellness strategy. For a few years now, our hero screen protector has been VisionGuard, a product to reduce exposure to high-energy visible blue light that can have damaging effects without changing the screen colors or the peak resolution. We have now sold over 10 million units with this technology.

In addition, all InvisibleShield screen protectors produced this year and beyond now also include antimicrobial technology. This includes our entire lineup for the new iPhone trial which is now available in stores. Earlier this year, we introduced our newest product geared toward our digital endless strategy, our UV Phone Sanitizer which works with our mobile devices and kills up to 99.9% of Staph and E. coli surface bacteria.

Our emphasis on protecting devices and their owners is resonating with retailers and our consumers and has led to increasing sell-through and greater shelf space with many of our accounts. We've expanded this strategy beyond screen protection to protect cases with good success, starting with the Samsung Galaxy S20 launch earlier this year and right through to the recent iPhone 12 launch. All Gear4 protective cases now also feature antimicrobial technology. The combination of this enhancement benefit in Gear4's differentiated D3O impact technology is driving excitement among the consumers, especially as awareness of the brand and products growth from our efforts to expand distribution.

With the new iPhone 12, Gear4 is now available and growing across all of our carrier partners. This expanded distribution accelerates the momentum of Gear4 brand, and I'm excited to see continued growth through 2021. In our power category, mophie launched many exciting new products during Q3 including the introduction of a new line of wireless charging solutions. These innovations are focused on providing the ability to conveniently charge multiple devices in one central location.

In addition, last month, we launched new mophie juice pack connect. This new product represents an evolution of our popular juice pack, allowing users to easily charge their phone on demand using a detachable battery feature that is not device specific and is used with or without the consumer's normal phone case. Our HALO brand continues to perform well on QVC which has been a productive partnership and channel, particularly given the number of consumers spending more time at home. Q4 is a busy time for our brands with QVC and HSN, with a number of airings planned during the holiday period.

Looking ahead with the majority of our U.S. partner doors now open and weekly sell-through continuing to improve, combined with solid direct-to-consumer trends, we feel optimistic about our prospects for the remainder of the year. While there's still a good deal of uncertainty about how the virus will impact shopping behavior this holiday season including the effect on several countries in Europe that have recently implemented lockdowns, we believe we are well positioned to capitalize on demand regardless of which channel our consumer chooses to engage with the brands. We are currently planning fourth-quarter revenue to increase from third-quarter levels and continue improving on the year-over-year declines we have experienced the past two quarters, even as we're facing tough comparison to last year's record Q4 sales.

I am confident in the long-term quarter we've set for the company, our efforts around antimicrobial, UV sanitization and blue light protection are driven by our belief that consumers will increasingly look for solutions that will enhance their digital wellness. We also believe another consumer priority will be increased productivity and comfort from home. We will continue our focus on enhancing technology in our lives to accomplish these growing needs. While it remains difficult to know when conditions will fully normalize and what impact COVID-19 will have on the global economy and our industry, I am confident that we have taken the right steps to emerge from the pandemic as a stronger company.

This includes our decision to discontinue certain lower-margin products and categories and simplify our core lines of business. As a more nimble company ZAGG can better service retail partners and core consumers, capitalize on the tailwinds from the multiyear rollout of 5G, with a margin benefits from our branded category consolidation and 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 third-quarter financial performance. Q3 net sales decreased year over year by approximately 21% to $115 million. After exiting a very difficult second quarter, we saw good momentum throughout the third quarter as retail outlets continue to reopen and allow a more normal in-store shopping experience.

That being said, the residual effects of COVID-19, combined with the delay of the launch of the new Apple devices which pushed some orders into Q4, made it a difficult year-over-year compare. Overall, we're pleased with the momentum and sell-through improvements we saw at retail which enabled us to increase sales by almost 50% on a consecutive quarter basis from $77 million to $115 million. Q3 gross profit as a percentage of net sales decreased year over year to 33%. There were a number of puts and takes that impacted gross profit during the quarter including a benefit from net lower duty rates and expected duty refunds which I'll discuss in more detail in a second.

This benefit was offset by higher expedited air freight and increased air freight rates, along with the sale of excess inventory at margins that were lower than our historical averages. On the subject of duty refunds, in early August, we received an exclusion notice that duties paid on certain products imported from China, starting in late 2018 may be subject to refund. We work closely with our customs broker to be in submitting refund documentation to U.S. customs.

This work is ongoing. And given the volume of imports from China since late 2018, will continue throughout the fourth quarter. Based on the work completed to date, we recorded a refund receivable at quarter end of approximately $5.4 million for duties paid that we expect to be refunded. The income statement impact of this receivable, offset by the balance sheet reduction from duties previously capitalized in inventory and then sold in Q3 2020, was a net income statement benefit of $1.7 million or approximately 140 basis points to gross profit margin during the quarter.

As I mentioned, there's still quite a bit of work left to do during the fourth quarter to complete our remaining refund submissions and we'll provide an update on any additional refund upside on our next call. Q3 operating expenses decreased 29% or approximately $12 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. Over the last several months, we've made the conscious decision to bring some individuals back from furlough to support fourth-quarter product launches and customer care, but we continue to be focused on all of spend to ensure we navigate our way through this difficult time.

Q3 adjusted EBITDA was $15 million versus $21 million in the prior-year period. The decline versus last year is linked to decreased sales and a reduction in overall gross profit margin for the reasons I mentioned. These items were offset by the decreases in operating expenses that I just discussed. Turning to the balance sheet.

Compared to a year ago, accounts receivable decreased 33% to $91 million due to the reduction in sales compared to the prior-year period. However, our DSOs improved significantly from 87 days to 73 days. The quality of our receivables remains very good. Inventory was $80 million compared to $94 million at the end of the first quarter, a reduction of approximately $14 million.

During the third quarter, we took a conservative approach to inventory as we closely monitor retail sell-through, customer forecast and customer inventory levels to ensure we didn't overextend on inventory purchasing. As a result, we did incur some incremental expedited airfreight charges due to increased demand at the end of the third quarter as retail sell-through improved. At this point, we will continue to closely monitor the factors that influence our purchasing forecasts but we'll continue to plan conservatively due to the continued uncertainties related to the COVID-19 pandemic. Despite the continued headwinds from COVID-19 during the quarter, we generated third-quarter operating cash flow of approximately $9 million compared to negative $11 million in cash from operations during the prior-year period.

Net debt which is consolidated debt less cash, decreased to $81 million compared to $97 million in Q3 last year 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 the loan received under the CARES Act, the Q2 restructuring and cost-cutting initiatives we've undertaken gives us confidence that we'll successfully navigate the headwinds that 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 fourth quarter of 2020, we definitely have better visibility now than we did when we last spoke in August. 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 net sales and adjusted EBITDA growth over the third quarter.

We expect 2020 year-to-date gross margins to improve during the fourth quarter though as I mentioned, we'll see some pressure over the next few quarters compared to historical averages of mid-30s as we sell-through our excess inventory. We expect total operating expenses to be in the same range of high 20s to low $30 million for the fourth quarter. No different than from any other companies, COVID-19 has been extremely disruptive to our business. However, with the steps we've taken to restructure the business, reduce fixed costs and ensure adequate liquidity, I'm confident that we'll exit this period impacted by COVID-19 as a much stronger company than when we entered.

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

Questions & Answers:

Operator

[Operator instructions] Your first question comes from the line of Elliot Alper from D.A. Davidson. Your line is open.

Elliot Alper -- D.A. Davidson -- Analyst

Great. Thank you. So thanks for the info on just the sequential sales in the fourth quarter. I guess, could you talk about any trends quarter to date specifically? And specifically, geographic sales mix? Are you seeing any material changes with sales and geographies that have less restrictions compared to those that have more?

Taylor Smith -- Chief Financial Officer

Yeah. Just a couple of notes. With the Apple launch happening a little bit later than we had experienced previously, there was maybe $5 million of sales that shifted from Q3 into Q4 which will obviously benefit kind of a the sequential look at revenue. Overall though we're seeing really good sell-through of the phones.

It seems to be doing very successful in market. And obviously, we're benefiting from that. So Q4 starting off really, really well. In terms of geos, no material change in geo expansion.

Chris mentioned our geo mix. Chris mentioned in his prepared remarks that we are definitely seeing some headwinds at least in terms of shutdowns in some of our international locations. However, the wireless dealers in those locations have been deemed as essential, and so those have remained open. And so -- and it remains to be seen as to how that's going to impact demand.

But I think overall, we're definitely seeing some strong signs that we're kind of getting back to a more normal Q4 experience. Though obviously, COVID remains a bit of a cloud over everything.

Elliot Alper -- D.A. Davidson -- Analyst

OK. Great. And then aside from the Apple launch shifting into the fourth quarter, can you talk about the holiday season and kind of what may be different this year versus historically and kind of any implications that may have on the December quarter?

Chris Ahern -- Chief Executive Officer

Yeah. The one thing that we are starting to see is obviously, the Black Friday seems to be more -- some retailers are taking strategy but they are spreading it over a number of days over the months. So that's something that's going to be different. I think we're still going to see a pretty strong online attachment from both zagg.com and obviously through Amazon.

But we're very I would say optimistic about the sell-through, the early sell-through on our screen protection and cases are quite strong. And that's given that we still have a number of other devices to take the market actually this week. So overall, I think we have some good runway for the holiday season Elliot.

Elliot Alper -- D.A. Davidson -- Analyst

OK, great. Thank you.

Chris Ahern -- Chief Executive Officer

Thank you.

Taylor Smith -- Chief Financial Officer

Thanks, Elliot.

Operator

[Operator instructions] Your next question comes from the line of Matt Dhane from Tieton Capital Management. Your line is open.

Matt Dhane -- Tieton Capital Management -- Analyst

Great. Thank you. I was hoping you could put a number on the expediting shipping costs that you incurred in the third quarter, just to give us some better idea how significant those were?

Taylor Smith -- Chief Financial Officer

Yeah, it was between $2 million and $3 million. And as I mentioned in my prepared remarks, we really -- it was a bit of a balancing act with inventory where we're trying to run it down. And as sell-through picked up at the end, we did have to move quickly and unfortunately, it resulted in some expedited airfreight charges.

Matt Dhane -- Tieton Capital Management -- Analyst

Same for the fourth quarter, are you expecting that to reoccur or is it -- have you caught up and you feel like you're in a better place now?

Taylor Smith -- Chief Financial Officer

Yeah, it's a great question. I think we're still probably chasing a little bit of demand. The one thing that's also kind of impacted us, no different than every other company that's importing from overseas, is just generally, freight rates have increased kind of globally. And so that's also impacted it.

But I think there's probably going to be a little bit of that. As I mentioned, it's a bit of a balancing act. We definitely wanted to be careful, given the pandemic and how much inventory we are planning. And fortunately or unfortunately, we've seen some upside which is great, but we've had to chase those.

And so I think we're probably still chasing a little bit which will impact some of our Q4 sales. And then also obviously  the spend on freight.

Matt Dhane -- Tieton Capital Management -- Analyst

Great. Also wanted to ask, if I could really quickly about the tariff situation. And now with the Biden presidency, I know you've been moving some production out of China. Does that change your view on moving production out of China or how are you thinking about this new regime?

Chris Ahern -- Chief Executive Officer

Yeah, I think Matt, it doesn't change our strategy. Ultimately, we're looking to diversify across our CM base and make sure that we're setting the company up for continued business. So we're still following the strategy. We've had a very good quarter where we've now successfully have piloted both screen detection and wireless power outside of China.

So it gives us that ability to be able to shift our supply chain when needed. Obviously, China is still a big part of our strategy, but what I like is we're not just looking at it from a tariff perspective. Now we're really looking at it from a business continuity perspective.

Matt Dhane -- Tieton Capital Management -- Analyst

Great. Thank you both. 

Chris Ahern -- Chief Executive Officer

Thanks, Matt.

Taylor Smith -- Chief Financial Officer

Thanks, Matt.

Operator

[Operator instructions] Gentlemen, I'm showing no further question at this time. I would now like to turn the conference back to Mr. Chris Ahern for any closing remarks.

Chris Ahern -- Chief Executive Officer

Thank you. Thank you everybody for joining our Q3 earnings report. We look forward to updating you again on Q4. Have a great evening everyone and stay day.

Operator

[Operator signoff]

Duration: 24 minutes

Call participants:

Brendon Frey -- Investor Relations

Chris Ahern -- Chief Executive Officer

Taylor Smith -- Chief Financial Officer

Elliot Alper -- D.A. Davidson -- Analyst

Matt Dhane -- Tieton Capital Management -- Analyst

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