Notes
to Condensed Consolidated Financial Statements
(Dollars,
units and shares in thousands, except per share data)
(Unaudited)
|
(1)
|
NATURE
OF OPERATIONS AND BASIS OF PRESENTATION
|
ZAGG
Inc and its subsidiaries (“we,” “us,” “our,” “ZAGG,” or the “Company”)
are innovation leaders in mobile tech accessories for smartphones and tablets. For over 10 years, ZAGG has developed creative
product solutions that enhance and protect mobile devices for consumers around the world. The Company has an award-winning product
portfolio that includes screen protection, power cases, power management, personal audio, mobile keyboards, cases, and social
tech sold under the ZAGG, InvisibleShield®, mophie®, and iFrogz® brands.
The
accompanying unaudited condensed consolidated financial statements have been prepared by the Company pursuant to the rules and
regulations of the Securities and Exchange Commission (the “SEC”). Certain information and footnote disclosures normally
included in financial statements prepared in accordance with accounting principles generally accepted in the United States of
America (“U.S. GAAP”) have been condensed or omitted pursuant to such rules and regulations. These condensed consolidated
financial statements reflect all adjustments that, in the opinion of management, are necessary to present fairly the financial
position, the results of operations, and cash flows of the Company for the periods presented. These consist of normal recurring
adjustments and adjustments related to the acquisition disclosed in Note 2. The Company suggests that these condensed consolidated
financial statements be read in conjunction with the consolidated financial statements and the notes thereto included in the Company’s
2015 Annual Report on Form 10-K. Operating results for the interim periods are not necessarily indicative of the results that
may be expected for the full year.
The
preparation of condensed consolidated financial statements in conformity with U.S. GAAP requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities
at the date of the condensed consolidated financial statements and the reported amounts of revenue and expenses during the reporting
period. Actual results could differ from those estimates.
On
March 3, 2016 the Company acquired mophie inc. ("mophie") for gross up-front cash consideration of $100,000, subject
to a preliminary working capital adjustment of $23,478. Upon completion of procedures to determine the final working capital adjustment,
the Company concluded that the final working capital adjustment should have been $49,795. The results of operations of mophie
are included in the Company's results of operations beginning on March 3, 2016. Based on the manner in which the Company manages,
evaluates, and internally reports its operations, the Company determined that mophie will be reported as a separate reportable
segment. See Notes 2 and 14 for additional details on the acquisition and the Company's segments.
The
condensed consolidated financial statements include the accounts of ZAGG Inc and its wholly owned subsidiaries ZAGG International
Distribution Limited (“ZAGG International”); Patriot Corporation; ZAGG Intellectual Property Holding Co, Inc. (“ZAGG
IP”); ZAGG Retail, Inc; mophie inc.; mophie LLC, mophie Technology Development Co., Ltd; mophie Netherlands Coöperatie
U.A.; and mophie Limited. All intercompany transactions and balances have been eliminated in consolidation.
Significant
Accounting Policies
The
Company’s significant accounting policies are described in Note 1 to the Company’s Annual Report on Form 10-K for
the year ended December 31, 2015.
In addition to these policies, the Company has adopted
a significant accounting policy relating to business combinations and accounting for goodwill as a result of the acquisition of
mophie, as described below. Also, in connection with the acquisition of mophie, the Company changed its operating segments, as
described in Note 14.
Business
Combinations
– We allocate the purchase price of acquired companies to the tangible and intangible assets acquired and
liabilities assumed based on their estimated fair values. The excess of the purchase price over these fair values is recorded
as goodwill. We engaged an independent third-party valuation firm to assist us in determining the fair values of certain
assets acquired and liabilities assumed. Such valuations require management to make significant estimates and assumptions,
especially with respect to intangible assets. The significant purchased classes of intangible assets recorded by us include tradenames,
technology, customer relationships, non-compete agreements, and backlog. The fair values assigned to the identified intangible
assets are discussed in Note 2 to the condensed consolidated financial statements.
ZAGG
INC AND SUBSIDIARIES
Notes
to Condensed Consolidated Financial Statements
(Dollars,
units and shares in thousands, except per share data)
(Unaudited)
Significant
estimates in valuing certain intangible assets include but are not limited to: future expected cash flows related to each individual
asset, market position of the tradenames, as well as assumptions about cash flow savings from the tradenames, determination of
useful lives, and discount rates. Management’s estimates of fair value are based upon assumptions believed to be reasonable,
but which are inherently uncertain and unpredictable and, as a result, actual results may differ from estimates.
Goodwill
–
At least annually and when events and circumstances warrant an evaluation, we
perform our impairment assessment of goodwill. This assessment initially permits an entity to make a qualitative assessment of
whether it is more likely than not that a reporting unit’s fair value is less than its carrying amount before applying the
two-step goodwill impairment test. If an entity can support the conclusion that it is not more likely than not that the fair value
of a reporting unit is less than its carrying amount, it would not need to perform the two-step impairment test for the reporting
unit.
However,
if it is determined that it is more likely than not that the fair value of a reporting unit is less than its carrying amount,
the two step analysis is performed, which incorporates a fair-value based approach. We determine the fair value of our reporting
unit based on discounted cash flows and market approach analyses as considered necessary. We consider factors such as the economy,
reduced expectations for future cash flows coupled with a decline in the market price of our stock and market capitalization for
a sustained period as indicators for potential goodwill impairment. If the reporting unit’s carrying amount exceeds its
estimated fair value, a second step must be performed to measure the amount of the goodwill impairment loss, if any. The second
step compares the implied fair value of the reporting unit’s goodwill, determined in the same manner as the amount of goodwill
recognized in a business combination, with the carrying amount of such goodwill. If the carrying amount of the reporting unit’s
goodwill exceeds the implied fair value of that goodwill, an impairment loss is recognized in an amount equal to that excess.
Recent
Accounting Pronouncements
In
May 2014, the Financial Accounting Standards Board (“FASB”) issued an Accounting Standard Update (“ASU”)
No. 2014-09, “Revenue from Contracts with Customers (Topic 606).” This ASU includes a five-step process by which entities
will recognize revenue to depict the transfer of goods or services to customers in amounts that reflect the consideration to which
an entity expects to be entitled in exchange for those goods or services. The ASU also will require enhanced disclosures to enable
users of financial statements to understand the nature, amount, timing, and uncertainty of revenue and cash flows arising from
contracts with customers. The ASU may be adopted utilizing one of two methods. The first method is to adopt the ASU by recording
the effect of the guidance in the ASU retrospectively to each prior period presented in the period of adoption. The second method
is to adopt the ASU by recording the effect of the guidance in the ASU retrospectively with the cumulative effect of initially
applying the guidance recognized at the date of initial application. On July 9, 2015, the FASB voted to approve a one-year deferral
of the effective date of this ASU. This deferral was issued by the FASB in ASU No. 2015-14, “Revenue from Contracts with
Customers (Topic 606) – Deferral of the Effective Date”. As a result of ASU No. 2015-14 the Company expects that it
will apply the new revenue standard to annual and interim reporting periods beginning after December 15, 2017. In May 2016, the
FASB issued ASU No. 2016-12, “Revenue from Contracts with Customers (Topic 606) – Narrow-Scope Improvements and Practical
Expedients”. The amendments and practical expedients presented in the ASU aim to simplify the transition to the new standard,
to provide practical expedients for transition and sales taxes, and to clarify certain aspects of the standard. The Company is
currently evaluating the impact these ASU will have on its consolidated financial statements, including the method of adoption
that will be utilized.
In
July 2015, the FASB issued ASU No. 2015-11, “Simplifying the Measurement of Inventory.” This ASU provides guidance
to entities that measure inventory using a method other than last-in, first-out (LIFO) or the retail inventory method. For entities
using first-in, first-out (FIFO) or average cost, the measurement principle for their inventory changes from the lower of cost
or market to lower of cost and net realizable value. Current U.S. GAAP requires, at each financial statement date, that entities
measure inventory at the lower of cost or market. The measurement of market is commonly the current replacement cost. However,
entities also need to consider net realizable value and net realizable value less an approximately normal profit margin in their
measurement. For entities using a method other than LIFO or the retail inventory method, the ASU replaces market with net realizable
value. This ASU requires prospective adoption for inventory measurement for annual and interim periods beginning after December
15, 2016 for public business entities. The Company has concluded that this ASU will not have a significant impact on our financial
position or results of operations.
ZAGG
INC AND SUBSIDIARIES
Notes
to Condensed Consolidated Financial Statements
(Dollars,
units and shares in thousands, except per share data)
(Unaudited)
In
November 2015, the FASB issued ASU No. 2015-17, “Balance Sheet Classification of Deferred Taxes,” which requires entities
with a classified balance sheet to present all deferred tax assets and liabilities as noncurrent. The amendments in the ASU may
be applied either prospectively to all deferred tax liabilities and assets or retrospectively to all periods presented. The ASU
is effective for public business entities for interim and annual periods in fiscal years beginning after December 15, 2016. The
Company has determined that it will adopt the ASU using the retrospective approach and has concluded that the adoption of this
ASU will result in recording deferred tax assets as non-current and will not impact our results of operations.
In
February 2016, the FASB issued its new lease accounting standard, Topic 842, which requires lessees to recognize most leases,
including operating leases, on-balance sheet via a right of use asset and lease liability. Lessees are allowed to account for
short-term leases (i.e., leases with a term of 12 months or less) off-balance sheet, consistent with current operating lease accounting.
A number of other significant changes to lease accounting have been effected through the issuance of this standard. The requirements
of the new standard for leases shall be recognized and measured at the beginning of the earliest comparative period presented.
When adopted, the Company will be required to adjust equity at the beginning of the earliest comparative period presented, and
the other comparative amounts disclosed for each prior period presented in the financial statements, as if the requirements of
the new standard had always been applied. The new standard also contains practical expedients which the Company may elect to follow.
The new standard is effective for public companies for fiscal years beginning after December 15, 2018, including interim periods
within those fiscal years. The Company is currently evaluating the impact this ASU will have on its consolidated financial statements,
including whether to elect the practical expedients outlined in the new standard.
In
March 2016, the FASB issued ASU No. 2016-09, “Improvements to Employee Share-Based Payment Accounting,” which simplified
accounting for share-based payments. The ASU is effective for fiscal years beginning after December 15, 2016, and interim periods
within those years for public business entities. Early adoption is permitted in any interim or annual period provided that the
entire ASU is adopted. Amendments in the ASU related to the timing of when excess tax benefits are recognized, minimum statutory
withholding requirements, forfeitures, and intrinsic value should be applied using a modified retrospective transition method
by means of a cumulative-effect adjustment to equity as of the beginning of the period in which the guidance is adopted. Amendments
related to the presentation of employee taxes paid on the statement of cash flows when an employer withholds shares should be
applied retrospectively. Amendments requiring the recognition of excess tax benefits and tax deficiencies in the income statement
should be applied prospectively. The amendments related to the presentation of excess tax benefits on the statement of cash flows
may be applied using either a prospective or retrospective transition method. The Company is currently evaluating the impact this
ASU will have on its consolidated financial statements, including, where applicable, determining the method of adoption.
In
August 2016, the FASB issued ASU No. 2016-15, “Classification of Certain Cash Receipts and Cash Payments,” which addresses
eight classification issues related to the statement of cash flows: (1) debt prepayment or debt extinguishment costs; (2) settlement
of zero-coupon bonds; (3) contingent consideration payments made after a business combination; (4) proceeds from the settlement
of insurance claims; (5) proceeds from the settlement of corporate-owned life insurance policies, including bank-owned life insurance
policies; (6) distributions received from equity method investees; (7) beneficial interests in securitization transactions; and
(8) separately identifiable cash flows and application of the predominance principle. The ASU is effective for public companies
for fiscal years beginning after December 15, 2017. Early adoption is permitted, including adoption in an interim period. The
amendments in the ASU should be applied using a retrospective transition method to each period presented. If it is impracticable
for the amendments to be applied retrospectively for some of the issues, the amendments for those issues may be applied prospectively
as of the earliest date practicable. The Company is currently evaluating the impact this ASU will have on its consolidated financial
statements, including the method of adoption.
ZAGG
INC AND SUBSIDIARIES
Notes
to Condensed Consolidated Financial Statements
(Dollars,
units and shares in thousands, except per share data)
(Unaudited)
|
(2)
|
ACQUISITION
OF MOPHIE INC.
|
On
February 2, 2016, ZAGG and ZM Acquisition, Inc. (“Merger Sub”), a Delaware corporation and wholly-owned subsidiary
of the Company, entered into an Agreement and Plan of Merger (the “Merger Agreement”) with mophie, a California corporation,
the principal shareholders of mophie named therein (the “Principal Shareholders”), and Daniel Huang as representative
of the mophie shareholders, warrant holders, and option holders, pursuant to which Merger Sub agreed to merge with and into mophie,
with mophie continuing as the surviving corporation (the “Merger”). On March 3, 2016 (the “Acquisition Date”),
the Company completed the Merger. The combination of ZAGG and mophie creates a diversified market leader in multiple mobile accessories
categories.
The
Company purchased mophie for total gross up-front consideration of $100,000 in cash, subject to an adjustment based on the estimated
and actual net working capital of mophie as of the Acquisition Date. The Merger Agreement includes an earn-out provision whereby
additional consideration could be paid based on whether mophie’s 12-month Adjusted EBITDA (as defined in the Merger Agreement)
from April 1, 2016 to March 31, 2017 (the “Earnout Period”) exceeds $20,000, subject to certain tax adjustment as
provided in the Merger Agreement. For every dollar in Adjusted EBITDA generated during the Earnout Period that exceeds $20,000,
the Company will pay additional consideration at a five times multiple (“Earnout Consideration”), subject to certain
tax adjustment as provided in the Merger Agreement, and the deposit of 10% of the Earnout Consideration into an indemnity escrow
account. Any Earnout Consideration will initially be paid by the issuance of up to $5,000 in shares of the Company’s common
stock valued as of February 2, 2016 (the day prior to the public announcement of the definitive agreement on February 3, 2016).
In
addition to the Earnout Consideration, the Merger Agreement identifies three other contingent payments to be remitted to the Principal
Shareholders upon receipt of such funds by ZAGG after the Acquisition Date, subject to any applicable offset rights of ZAGG under
the Merger Agreement:
|
●
|
Federal
and state tax refunds due to the Company related to 2012 and 2013 tax years;
|
|
|
|
|
●
|
Customs
and duties refunds for pre-closing overpayments of customs and duties amounts to governmental
agencies; and
|
|
|
|
|
●
|
Proceeds
from the sale of real property located in Kalamazoo, Michigan.
|
$2,000
of the cash consideration paid to the Principal Shareholders was placed in an escrow account to cover any net working capital
shortfall and indemnification claims of ZAGG. ZAGG and the Principal Shareholders also jointly purchased a $10,000 insurance policy
covering breaches by mophie and the Principal Shareholders of representations and warranties set forth in the Merger Agreement.
At
the Acquisition Date, mophie’s estimated closing balance sheet reflected negative working capital of $23,478. Upon completion
of the procedures to evaluate the working capital account, ZAGG has determined that the closing balance sheet reflected actual
closing negative working capital of $49,795, resulting in an additional actual closing working capital deficit of $26,317. ZAGG
has submitted to the Principal Shareholders a closing adjustment statement seeking the release to ZAGG of the $2,000 placed in
escrow based on the portion of the overall net working capital deficit that ZAGG has determined to be recoverable under Section
2.16 of the Merger Agreement. Mr. Huang, as the Representative of the Shareholders, submitted a dispute notice in which he, on
behalf of all Shareholders, disputed ZAGG’s closing adjustment statement, asserted that there is no working capital deficit,
and demanded release of the $2,000 escrow fund to the Principal Shareholders. The Company is continuing to pursue its claims related
to the net working capital deficit, which efforts may require the Company to resort to the independent accountant dispute resolution
mechanism provided in the Merger Agreement in order to obtain the $2,000 placed in escrow.
ZAGG has engaged in discussions with
the Principal Shareholders and Mr. Huang to seek recovery against the contingent payments described above and otherwise to be
made whole with respect to such balance of the working capital deficit. However, as of September 30, 2016, there had been no resolution
of either of such amounts and a total of $26,317 was in dispute between the parties. Thus, the Company has recorded a loss on
the mophie purchase price of $24,317 during the three and nine months ended September 30, 2016, representing the disputed $26,317
partially offset by the $2,000 cash consideration placed in escrow, the recovery of which the Company believes to be likely.
ZAGG
INC AND SUBSIDIARIES
Notes
to Condensed Consolidated Financial Statements
(Dollars,
units and shares in thousands, except per share data)
(Unaudited)
The
Company is exploring all options to recover the amounts related to the aggregate net working capital deficit including (1) pursuing
collection of the $2,000 escrow amount, (2) submitting claims under the $10,000 representation and warranty insurance policy put
in place at the Acquisition Date, and (3) pursuing any and all offset rights granted under the Merger Agreement with respect to
the contingent payments that would have been paid to the Principal Shareholders.
On October 21, 2016, Mr. Huang, on behalf of the mophie Shareholders
and himself filed a lawsuit in the Chancery Court of the State of Delaware alleging that the Company has breached the Merger Agreement
by failing to pay certain of the contingent payments described above related to tax refunds and customs duties and claims damages
in the amount of no less than $11,420.
The
following summarizes the components of the purchase consideration as of March 3, 2016:
|
|
|
|
|
Adjustments to
|
|
|
|
|
|
|
Preliminary Allocation
|
|
|
Working
Capital
|
|
|
Revised Allocation
|
|
|
|
March 3,
2016
|
|
|
and
Fair Value
|
|
|
March 3,
2016
|
|
Cash consideration
|
|
$
|
100,000
|
|
|
$
|
-
|
|
|
$
|
100,000
|
|
Negative working capital at Acquisition Date
|
|
|
(23,478
|
)
|
|
|
-
|
|
|
|
(23,478
|
)
|
Additional negative working capital deficit
|
|
|
-
|
|
|
|
(26,317
|
)
|
|
|
(26,317
|
)
|
Contingent payments
|
|
|
11,283
|
|
|
|
856
|
|
|
|
12,139
|
|
Total purchase price
|
|
$
|
87,805
|
|
|
$
|
(25,461
|
)
|
|
$
|
62,344
|
|
The
total purchase price of $62,344 has been preliminarily allocated to identifiable assets acquired and liabilities assumed based
on their respective preliminary fair values. The total preliminary purchase price has been adjusted because of (1) additional
information related to the working capital reflected in the closing balance sheet and estimate of fair value of the assets acquired
and liabilities assumed and (2) the determination that the fair value of the Earnout Consideration is insignificant. The excess
of the purchase price over the fair value of tangible and intangible assets acquired and liabilities assumed is recorded as goodwill.
The allocation of goodwill to reportable segments has not yet been completed. The Company has completed its final analysis related
to the calculation of the additional negative working capital as of the Acquisition Date and contingent payments, as these items
relate to purchase accounting under U.S. GAAP. The Company is still evaluating the preliminary amounts assigned to intangible
assets and amounts recorded for income taxes, as these valuations have not yet been completed. Because of the dispute between
the Company and the Principal Shareholders, the Company has recorded a net charge of $24,317 during the quarter ended September
30, 2016. The final resolution of these items could result in a material adjustment the allocation of purchase price to identifiable
assets acquired and liabilities assumed.
The
following table summarizes the revised estimates of the fair values of the identifiable assets acquired and liabilities assumed
as of the Acquisition Date. The revised estimates of the fair value of identifiable assets acquired and liabilities assumed are
based on estimates and assumptions and are subject to revisions, which may result in adjustments to the values presented below,
when management’s estimates with respect to intangible assets and amounts recorded for income taxes are finalized:
Cash and cash equivalents
|
|
$
|
1,779
|
|
Trade receivables (gross contractual receivables of $12,824)
|
|
|
12,823
|
|
Inventories
|
|
|
24,911
|
|
Prepaid expenses and other assets
|
|
|
1,073
|
|
Income tax receivable
|
|
|
11,814
|
|
Deferred tax assets
|
|
|
15,649
|
|
Property and equipment
|
|
|
10,191
|
|
Land held for sale
|
|
|
325
|
|
Amortizable identifiable intangible assets
|
|
|
43,812
|
|
Goodwill
|
|
|
12,791
|
|
Accounts payable
|
|
|
(37,359
|
)
|
Income tax payable
|
|
|
(196
|
)
|
Accrued liabilities
|
|
|
(5,163
|
)
|
Deferred revenue
|
|
|
(9
|
)
|
Sales returns liability
|
|
|
(29,584
|
)
|
Other noncurrent liabilities
|
|
|
(513
|
)
|
Total
|
|
$
|
62,344
|
|
ZAGG
INC AND SUBSIDIARIES
Notes
to Condensed Consolidated Financial Statements
(Dollars,
units and shares in thousands, except per share data)
(Unaudited)
The
following table summarizes the purchase price allocation as of March 3, 2016:
|
|
Preliminary Purchase
|
|
|
Adjustments to
|
|
|
Revised Purchase
|
|
|
|
Price
Allocation
|
|
|
Working
Capital
|
|
|
Price
Allocation
|
|
|
|
March 3,
2016
|
|
|
and
Fair Value
|
|
|
March 3,
2016
|
|
Cash and cash equivalents
|
|
$
|
1,779
|
|
|
$
|
-
|
|
|
$
|
1,779
|
|
Trade receivables
|
|
|
13,483
|
|
|
|
(660
|
)
|
|
|
12,823
|
|
Inventories
|
|
|
32,335
|
|
|
|
(10,011
|
)
|
|
|
22,325
|
|
Inventory step-up
|
|
|
6,937
|
|
|
|
(4,351
|
)
|
|
|
2,586
|
|
Prepaid expenses
|
|
|
485
|
|
|
|
215
|
|
|
|
700
|
|
Other assets
|
|
|
200
|
|
|
|
173
|
|
|
|
373
|
|
Income tax receivable
|
|
|
10,958
|
|
|
|
856
|
|
|
|
11,814
|
|
Deferred tax assets
|
|
|
24,925
|
|
|
|
(9,276
|
)
|
|
|
15,649
|
|
Property and equipment
|
|
|
10,191
|
|
|
|
-
|
|
|
|
10,191
|
|
Land held for sale
|
|
|
325
|
|
|
|
-
|
|
|
|
325
|
|
Amortizable identifiable intangible assets
|
|
|
45,463
|
|
|
|
(1,651
|
)
|
|
|
43,812
|
|
Goodwill
|
|
|
14,092
|
|
|
|
(1,301
|
)
|
|
|
12,791
|
|
Accounts payable
|
|
|
(34,228
|
)
|
|
|
(3,131
|
)
|
|
|
(37,359
|
)
|
Income tax payable
|
|
|
(196
|
)
|
|
|
-
|
|
|
|
(196
|
)
|
Accrued liabilities
|
|
|
(5,185
|
)
|
|
|
22
|
|
|
|
(5,163
|
)
|
Deferred revenue
|
|
|
(800
|
)
|
|
|
791
|
|
|
|
(9
|
)
|
Sales returns liability
|
|
|
(14,468
|
)
|
|
|
(15,116
|
)
|
|
|
(29,584
|
)
|
Deferred tax liabilities
|
|
|
(17,978
|
)
|
|
|
17,978
|
|
|
|
-
|
|
Other noncurrent liabilities
|
|
|
(513
|
)
|
|
|
-
|
|
|
|
(513
|
)
|
Total
|
|
$
|
87,805
|
|
|
$
|
(25,461
|
)
|
|
$
|
62,344
|
|
The
adjustments to working capital represented in the table above consist of (1) the additional actual closing working capital deficit
of $26,317 and (2) adjustments to fair value of $856.
Because
the acquisition of mophie occurred in an interim period and in light of the magnitude of the transaction and existing uncertainties,
the Company’s fair value estimates for the purchase price, intangible assets and amounts recorded for income taxes are preliminary
and may change during the allowable measurement period. The allowable measurement period continues to the date the Company obtains
and analyzes all relevant information that existed as of the date of the acquisition necessary to determine the fair values of
the assets acquired and liabilities assumed, but in no case is to exceed one year from the date of acquisition (March 3, 2017).
The Company is analyzing information to verify assets acquired and liabilities assumed, specifically the fair value of the acquired
intangible assets and the tax accounts related to purchase accounting.
As
part of the acquisition of mophie, the Company incurred legal, accounting, investment banking and other due diligence fees that
were expensed when incurred. Total fees incurred related to the acquisition of mophie for the three and nine months ended September
30, 2016 were $145 and $2,467, respectively, which are included as a component of operating expenses on the condensed consolidated
statements of operations.
ZAGG
INC AND SUBSIDIARIES
Notes
to Condensed Consolidated Financial Statements
(Dollars,
units and shares in thousands, except per share data)
(Unaudited)
Identifiable
Intangible Assets
Classes
of acquired intangible assets include tradenames, patents and technology, customer relationships, non-compete agreements, and
backlog. The fair value of the identifiable intangible assets was determined using various valuation methods, including the income
and market approaches. For assets valued under the income approach, the estimate of the present value of expected future cash
flows for each identifiable asset was based on discount rates which incorporate a risk premium to take into account the risks
inherent in those expected cash flows. The expected cash flows were estimated using available historical data adjusted based on
the Company’s historical experience and the expectations of market participants. The market approach was utilized to determine
appropriate royalty rates applied to the valuation of the trademarks and technology. The preliminary amounts assigned to each
class of intangible asset and the related preliminary weighted average amortization periods are as follows:
|
|
Intangible asset class
|
|
|
Weighted-average amortization period
|
|
|
|
|
|
|
|
|
Tradenames
|
|
$
|
18,348
|
|
|
|
10.0
years
|
|
Patents and technology
|
|
|
15,225
|
|
|
|
7.5 years
|
|
Customer relationships
|
|
|
8,200
|
|
|
|
5.0
years
|
|
Non-compete agreements
|
|
|
1,796
|
|
|
|
5.0 years
|
|
Backlog
|
|
|
243
|
|
|
|
0.3 years
|
|
Total
|
|
$
|
43,812
|
|
|
|
|
|
Goodwill
Goodwill
represents the excess of the mophie purchase price over the fair value of the assets acquired and liabilities assumed.
The
Company believes that the primary factors supporting the amount of goodwill recognized are the significant growth opportunities
and expected synergies of the combined entity.
Results
of Operations
The
results of operations of mophie are included in the Company’s results of operations beginning on March 3, 2016. For the
three months ended September 30, 2016, mophie generated net sales of $39,731 and had a net loss before tax of $3,305. For the
period March 3, 2016, through September 30, 2016, mophie generated net sales of $79,390 and had a net loss before tax of $17,030.
Pro
forma Results from Operations
The
following unaudited pro-forma results of operations for the three months ended September 30, 2016 and 2015 and the nine months
ended September 30, 2016, and 2015 give pro forma effect as if the acquisition and borrowings used to finance the acquisition
had occurred on January 1, 2015, after giving effect to certain adjustments including the amortization of intangible assets, interest
expense, tax adjustments, specific transaction related expenses incurred prior to the execution date, and assumes the purchase
price was allocated to the assets purchased and liabilities assumed based on their fair market values at the date of purchase.
|
|
3 Months Ended
|
|
|
|
September 30,
2015
|
|
Net sales
|
|
$
|
108,614
|
|
Net loss
|
|
$
|
(8,592
|
)
|
Basic earnings per share
|
|
$
|
(0.30
|
)
|
Diluted earnings per share
|
|
$
|
(0.30
|
)
|
ZAGG
INC AND SUBSIDIARIES
Notes
to Condensed Consolidated Financial Statements
(Dollars,
units and shares in thousands, except per share data)
(Unaudited)
|
|
9 Months Ended
|
|
|
|
September 30,
2016
|
|
|
September 30,
2015
|
|
Net sales
|
|
$
|
304,254
|
|
|
$
|
343,675
|
|
Net loss
|
|
$
|
(15,432
|
)
|
|
$
|
(9,002
|
)
|
Basic loss per share
|
|
$
|
(0.55
|
)
|
|
$
|
(0.31
|
)
|
Diluted loss per share
|
|
$
|
(0.55
|
)
|
|
$
|
(0.31
|
)
|
The
unaudited pro forma information is presented for illustrative purposes only and is not necessarily indicative of the operating
results that would have occurred had the transaction been consummated as of January 1, 2015. Furthermore, such unaudited pro forma
information is not necessarily indicative of future operating results of the combined companies, due to changes in operating activities
following the purchase, and should not be construed as representative of the operating results of the combined companies for any
future dates or periods.
For
the three months ended September 30, 2015, pro forma net loss includes pro forma amortization expense of $1,818. In addition,
the Company included interest from the new credit facility and amortization of debt issuance costs for the three months ended
September 30, 2015 of $536. Material non-recurring adjustments excluded from the pro forma financial information above consists
of the $2,586 step up of mophie inventory to its fair value, which has been recorded as an unfavorable adjustment to cost of goods
sold during the six months following the acquisition date.
For
the nine months ended September 30, 2016 and 2015, pro forma net loss includes projected amortization expense of $5,076 and $5,698,
respectively. In addition, the Company included interest from the new credit facility and amortization of debt issuance costs
for the nine months ended September 30, 2016 and 2015 of $1,508 and $1,622, respectively.
The
unaudited pro forma results do not reflect events that either have occurred or may occur after the Merger, including, but not
limited to, the anticipated realization of ongoing savings from operating synergies in subsequent periods.
|
(3)
|
DEBT
AND LETTERS OF CREDIT
|
Concurrent
with the close of the Merger on March 3, 2016, the Company entered into a Credit and Security Agreement with KeyBank National
Association (“KeyBank”), acting as administrative agent and swing line lender; KeyBanc Capital Markets Inc., acting
as joint lead arranger and sole book runner; Zions Bank (“Zions”), as joint lead arranger; and JP Morgan Chase, as
a member of the bank syndicate (“Credit and Security Agreement”). The Credit and Security Agreement replaces the prior
credit agreement with Wells Fargo, which was terminated upon signing the Credit and Security Agreement.
The
Credit and Security Agreement provides an $85,000 revolving credit commitment (“Line of Credit”).
Borrowings
and repayments under the Line of Credit may occur from time to time in the Company’s ordinary course of business through
the maturity date of March 2, 2021, at which time any amounts outstanding are to be paid in full (60-month term). All borrowings
under the Line of Credit are subject to a borrowing base limit, which is calculated from outstanding accounts receivable and inventory,
and reported to the administrative agent monthly. Interest on the Line of Credit will accrue at the base rate plus 0.50% or LIBOR
plus 1.50%. The Line of Credit is subject to an unused line fee calculated as 0.20% multiplied by the average unused amount of
the Line of Credit.
The
Credit and Security Agreement also provides a $25,000 term loan commitment (“Term Loan”). Principal and interest payments
on the Term Loan are to be made in consecutive monthly installments of $521 commencing on April 1, 2016 and continuing until the
Term Loan is paid in full on March 2, 2020 (48-month term).
Interest on the Term Loan will
accrue at the base rate plus 1.0% or at a rate of LIBOR plus 2.0%.
ZAGG
INC AND SUBSIDIARIES
Notes
to Condensed Consolidated Financial Statements
(Dollars,
units and shares in thousands, except per share data)
(Unaudited)
The
Credit and Security Agreement also provides for letters of credit with a fronting fee of 0.125% (paid per annum) for all issued
and outstanding letters of credit.
The
Credit and Security Agreement provides for a lockbox and cash collateral account that is maintained with KeyBank. The Credit and
Security Agreement is collateralized by substantially all of the assets of the Company. The Credit and Security Agreement establishes
two financial debt covenants that are measured on a quarterly basis starting with the quarter-ended June 30, 2016:
|
●
|
Maximum
Leverage Ratio
: Defined as the ratio of total funded indebtedness to Consolidated
EBITDA (as defined in the Credit and Security Agreement), which cannot be more than 3.50
on a trailing four quarter basis.
|
|
|
|
|
●
|
Minimum
Fixed Charge Coverage Ratio
: Defined as the ratio of Consolidated EBITDA minus taxes,
capital distributions and unfunded capital expenditures divided by the sum of interest
payments, principal payments, and capital lease payments; the minimum allowed under the
Credit and Security Agreement is 1.10 on a trailing four quarter basis.
|
In
connection with the establishment of the Credit and Security Agreement, the Company incurred and capitalized $1,144 of direct
costs; $884 of the costs are related to the line of credit and as such are reflected as a component of other assets, and
$260 was reflected as an offset to long-term debt in the condensed consolidated balance sheet. For the three and nine months ended
September 30, 2016, the Company amortized $60 and $141, respectively, of these loan costs, which are included as a component of
interest expense in the condensed consolidated statements of operations. For the three and nine months ended September 30, 2015,
the Company amortized $16 and $49, respectively, of capitalized costs related to the Wells Fargo credit agreement, which are included
as a component of interest expense in the condensed consolidated statements of operations. All costs capitalized associated with
the Wells Fargo credit agreement were fully amortized at December 31, 2015.
For
the three and nine months ended September 30, 2016, $18 and $40, respectively, in unused line fees were incurred and included
as a component of interest expense in the condensed consolidated statements of operations. For the three and nine months ended
September 30, 2015, $10 and $28, respectively, in unused line fees were incurred and included as a component of interest expense
in the condensed consolidated statements of operations.
At
September 30, 2016, the weighted average interest rate on all outstanding borrowings under the revolving line of credit was 2.03%.
At September 30, 2016, the effective interest rate on the Term Loan was 3.05%.
Contractual
future payments under the Credit and Security Agreement are as follows:
|
|
|
Line of Credit
|
|
|
Term Loan
|
|
|
Total
|
|
|
|
|
|
|
|
|
|
|
|
|
Remaining 2016
|
|
|
$
|
—
|
|
|
$
|
1,563
|
|
|
$
|
1,563
|
|
2017
|
|
|
|
—
|
|
|
|
6,250
|
|
|
|
6,250
|
|
2018
|
|
|
|
—
|
|
|
|
6,250
|
|
|
|
6,250
|
|
2019
|
|
|
|
—
|
|
|
|
6,250
|
|
|
|
6,250
|
|
2020
|
|
|
|
—
|
|
|
|
1,562
|
|
|
|
1,562
|
|
Thereafter
|
|
|
|
30,195
|
|
|
|
—
|
|
|
|
30,195
|
|
Total
|
|
|
$
|
30,195
|
|
|
$
|
21,875
|
|
|
$
|
52,070
|
|
ZAGG
INC AND SUBSIDIARIES
Notes
to Condensed Consolidated Financial Statements
(Dollars,
units and shares in thousands, except per share data)
(Unaudited)
Amortizable
intangibles as of September 30, 2016, and December 31, 2015, were as follows:
|
|
As of September 30, 2016
|
|
|
|
Gross Carrying Amount
|
|
|
Acquisitions
|
|
|
Accumulated Amortization
|
|
|
Net Carrying Amount
|
|
|
Weighted Average Amortization Period
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Customer relationships
|
|
$
|
41,500
|
|
|
$
|
8,200
|
|
|
$
|
(33,535
|
)
|
|
$
|
16,165
|
|
|
|
7.5 years
|
|
Tradenames
|
|
|
12,921
|
|
|
|
18,348
|
|
|
|
(8,790
|
)
|
|
|
22,479
|
|
|
|
9.8 years
|
|
Patents and technology
|
|
|
6,003
|
|
|
|
15,225
|
|
|
|
(4,615
|
)
|
|
|
16,613
|
|
|
|
8.8 years
|
|
Non-compete agreements
|
|
|
4,100
|
|
|
|
1,796
|
|
|
|
(4,310
|
)
|
|
|
1,586
|
|
|
|
4.9 years
|
|
Other
|
|
|
324
|
|
|
|
243
|
|
|
|
(542
|
)
|
|
|
25
|
|
|
|
2.4 years
|
|
Total amortizable assets
|
|
$
|
64,848
|
|
|
$
|
43,812
|
|
|
$
|
(51,792
|
)
|
|
$
|
56,868
|
|
|
|
8.2 years
|
|
|
|
As of December 31, 2015
|
|
|
|
Gross Carrying Amount
|
|
|
Acquisitions
|
|
|
Accumulated Amortization
|
|
|
Net Carrying Amount
|
|
|
Weighted Average Amortization Period
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Customer relationships
|
|
$
|
41,500
|
|
|
$
|
—
|
|
|
$
|
(29,150
|
)
|
|
$
|
12,350
|
|
|
|
8.0 years
|
|
Tradenames
|
|
|
12,921
|
|
|
|
—
|
|
|
|
(6,253
|
)
|
|
|
6,668
|
|
|
|
9.5 years
|
|
Patents and technology
|
|
|
5,805
|
|
|
|
198
|
|
|
|
(2,381
|
)
|
|
|
3,622
|
|
|
|
11.9 years
|
|
Non-compete agreements
|
|
|
4,100
|
|
|
|
—
|
|
|
|
(3,729
|
)
|
|
|
371
|
|
|
|
4.8 years
|
|
Other
|
|
|
324
|
|
|
|
—
|
|
|
|
(290
|
)
|
|
|
34
|
|
|
|
4.1 years
|
|
Total amortizable assets
|
|
$
|
64,650
|
|
|
$
|
198
|
|
|
$
|
(41,803
|
)
|
|
$
|
23,045
|
|
|
|
8.4 years
|
|
Customer
relationships, tradenames, and other intangibles are amortized on an accelerated basis consistent with their expected future cash
flows over their estimated useful life, which results in accelerated amortization. The remaining amortizable intangible assets
are amortized using the straight-line method over their estimated useful life. For the three and nine months ended September 30,
2016, amortization expense was $2,426 and $9,989, respectively. Amortization expense is primarily recorded as a component of operating
expense. However, amortization expense related to acquired technology for the three and nine months ended September 30, 2016,
of $28 and $80, respectively, is recorded as a component of cost of sales.
For
the three and nine months ended September 30, 2016 amortization expense included $740 and $4,485, respectively, of amortization
expense recognized for the preliminary amounts assigned to the acquired mophie intangible assets as described in Note 2. As further
described in Note 2, there was an adjustment to the preliminary amounts allocated for working capital and fair value. As a result
of the adjustment to the preliminary amounts, a reduction in amortization expense and accumulated amortization of $1,078 relating
to the previous quarter was recognized during the three months ended September 30, 2016.
For
the three and nine months ended September 30, 2015, amortization expense was $2,160 and $6,478, respectively. Amortization expense
related to acquired technology for the three and nine months ended September 30, 2015, of $26 and $75, respectively, was recorded
as a component of cost of sales.
Estimated
future amortization expense is as follows:
Remaining 2016
|
|
$
|
3,506
|
|
2017
|
|
|
12,387
|
|
2018
|
|
|
11,351
|
|
2019
|
|
|
9,267
|
|
2020
|
|
|
6,653
|
|
Thereafter
|
|
|
13,704
|
|
Total
|
|
$
|
56,868
|
|
ZAGG
INC AND SUBSIDIARIES
Notes
to Condensed Consolidated Financial Statements
(Dollars,
units and shares in thousands, except per share data)
(Unaudited)
At
September 30, 2016, and December 31, 2015, inventories consisted of the following:
|
|
September 30,
2016
|
|
|
December 31,
2015
|
|
|
|
|
|
|
|
|
Finished goods
|
|
$
|
64,925
|
|
|
$
|
44,764
|
|
Raw materials
|
|
|
1,279
|
|
|
|
1,148
|
|
Total inventories
|
|
$
|
66,204
|
|
|
$
|
45,912
|
|
In
addition, included in prepaid expenses and other current assets were inventory deposits with third-party manufacturers at September
30, 2016 and December 31, 2015 of $736 and $813, respectively.
|
(6)
|
STOCK-BASED
COMPENSATION
|
During
the three and nine months ended September 30, 2016, the Company granted 163 and 876 restricted stock units, respectively. During
the three and nine months ended September 30, 2015, the Company granted 24 and 569 restricted stock units, respectively. The restricted
stock units granted during the three and nine months ended September 30, 2016, were estimated to have a weighted-average fair
value per share of $6.41 and $8.17, respectively. The restricted stock units granted during the three and nine months ended September
30, 2015, were estimated to have a weighted-average fair value per share of $8.24 and $6.58, respectively. The fair value of restricted
stock units granted is based on the closing share price of the Company’s common stock on the date of grant. The restricted
stock units vest annually on a straight-line basis over a nine-month (annual board of directors’ grant) to three-year vesting
term, depending on the terms of the individual grant.
As
part of the 876 and 569 grants discussed above, during the first nine months of 2016 and 2015, the Company granted 575 and 289
restricted stock units, respectively, to certain executives and employees of the Company where vesting is linked to specific performance
criteria. The shares of restricted stock units granted in 2016 only vest upon the Company’s achievement of specified thresholds
of net sales, Adjusted EBITDA (as defined in the grant), or specific goals for the individual executive. The shares of restricted
stock units granted in 2015 only vested upon the achievement of specified thresholds of net sales, Adjusted EBITDA, and earnings
per share. As of September 30, 2016 the Company believes it is probable that it will achieve the targets for 497 shares of restricted
stock granted in the first nine months of 2016. Of the 289 restricted stock units granted in 2015, 244 shares vested (including
7 shares granted in excess of the original grant due to the Company exceeding the operating thresholds) and 52 shares were forfeited.
As
part of the 569 shares of restricted stock units granted during the first nine months of 2015, the Company granted 213 shares
of restricted stock to its chief executive officer. These restricted stock units only vest upon the following performance conditions
being met for the year 2015: (1) the Company’s achievement of a gross profit margin equal to or in excess of 31.9%, (2)
the Company’s achievement of certain cost savings initiatives within cost of sales specified by the compensation committee
of the board of directors, and (3) the chief executive officer’s continued employment. Of the 213 shares of restricted stock
units granted to the chief executive officer, 213 shares vested.
The
Company records share-based compensation expense only for those restricted stock units that are expected to vest. The estimated
fair value of restricted stock units is recognized on a straight-line basis over the requisite service period of the award, which
is generally the vesting term of the award. During the three and nine months ended September 30, 2016, the Company recorded equity-based
compensation expense related to restricted stock units of $1,384 and $3,675, respectively, which is included as a component of
selling, general and administrative expense. During the three and nine months ended September 30, 2015, the Company recorded equity-based
compensation expense related to restricted stock units of $898 and $2,708, respectively, which is included as a component of selling,
general and administrative expense.
During
the nine months ended September 30, 2016 and 2015, certain ZAGG employees elected to receive a net amount of shares upon the vesting
of a restricted stock unit grant in exchange for the Company paying the minimum statutory withholding amount of the employees’
tax liabilities for the fair value of the award on the vesting date. This resulted in the Company paying $621 and $718, respectively,
which is reflected as a reduction of additional paid-in capital.
During
the nine months ended September 30, 2015, the Company incurred incremental expense related to the departure of its former chief
financial officer. Expenses incurred during the period include separation pay of $117 related to the acceleration of vesting on
15 restricted stock units that were previously scheduled to vest during the first quarter of 2016.
ZAGG
INC AND SUBSIDIARIES
Notes
to Condensed Consolidated Financial Statements
(Dollars,
units and shares in thousands, except per share data)
(Unaudited)
During
the three and nine months ended September 30, 2016, the Company’s effective tax rate was 47% and 41%, respectively. During
the three and nine months ended September 30, 2015, the Company’s effective tax rate was 39% and 40%, respectively. The
change in the effective tax rate for three- and nine-month periods ended September 30, 2016, is primarily due to a decrease in
the domestic manufacturing deduction, and permanent differences related to the acquisition of mophie. The Company’s effective
tax rate will generally differ from the U.S. Federal Statutory rate of 35% due to foreign and state taxes, permanent items, and
the Company’s global tax strategy.
Basic
earnings per common share excludes dilution and is computed by dividing net income by the weighted average number of shares of
common stock outstanding during the period. Diluted earnings per common share reflects the potential dilution that could occur
if stock options and restricted stock, or other common stock equivalents were exercised or converted into common stock. The dilutive
effect of stock options or other common stock equivalents is calculated using the treasury stock method.
The
following is a reconciliation of the numerator and denominator used to calculate basic earnings per share and diluted earnings
per share for the three and nine months ended September 30, 2016 and 2015:
|
|
Three months ended
|
|
|
|
September 30,
2016
|
|
|
September 30,
2015
|
|
Net (loss) income
|
|
$
|
(7,105
|
)
|
|
$
|
3,739
|
|
Weighted average shares outstanding:
|
|
|
|
|
|
|
|
|
Basic
|
|
|
28,125
|
|
|
|
28,734
|
|
Dilutive effect of stock options, restricted stock units, and warrants
|
|
|
—
|
|
|
|
196
|
|
Diluted
|
|
|
28,125
|
|
|
|
28,930
|
|
Earnings (loss) per share:
|
|
|
|
|
|
|
|
|
Basic
|
|
$
|
(0.25
|
)
|
|
$
|
0.13
|
|
Diluted
|
|
$
|
(0.25
|
)
|
|
$
|
0.13
|
|
|
|
Nine months ended
|
|
|
|
September 30,
2016
|
|
|
September 30,
2015
|
|
Net (loss) income
|
|
$
|
(11,442
|
)
|
|
$
|
10,631
|
|
Weighted average shares outstanding:
|
|
|
|
|
|
|
|
|
Basic
|
|
|
27,987
|
|
|
|
29,209
|
|
Dilutive effect of stock options, restricted stock units, and warrants
|
|
|
—
|
|
|
|
242
|
|
Diluted
|
|
|
27,987
|
|
|
|
29,451
|
|
Earnings (loss) per share:
|
|
|
|
|
|
|
|
|
Basic
|
|
$
|
(0.41
|
)
|
|
$
|
0.36
|
|
Diluted
|
|
$
|
(0.41
|
)
|
|
$
|
0.36
|
|
ZAGG
INC AND SUBSIDIARIES
Notes
to Condensed Consolidated Financial Statements
(Dollars,
units and shares in thousands, except per share data)
(Unaudited)
For the
three months ended September 30, 2016 1,001 restricted stock units and 50 warrants to purchase shares of common stock were not
considered in calculating diluted earnings per share as their effect would have been anti-dilutive.
For
the three months ended September 30, 2015, warrants and restricted stock units to purchase 443 shares of common stock were not
considered in calculating diluted earnings per share because the warrant or stock option exercise prices or the total expected
proceeds under the treasury stock method for the warrants, restricted stock units, or stock options was greater than the average
market price of common shares during the period and, therefore, the effect would be anti-dilutive. Also excluded from the calculation
of diluted earnings per share for the three months ended September 30, 2015 were 452 restricted stock units granted that were
not yet vested as the performance conditions were not met (see further discussion in Note 6).
For the
nine months ended September 30, 2016 1,001 restricted stock units and 50 warrants to purchase shares of common stock were not
considered in calculating diluted earnings per share as their effect would have been anti-dilutive.
For
the nine months ended September 30, 2015 warrants and restricted stock units to purchase 328 shares of common stock were not considered
in calculating diluted earnings per share because the warrant or stock option exercise prices or the total expected proceeds under
the treasury stock method for the warrants, restricted stock units, or stock options was greater than the average market price
of common shares during the period and, therefore, the effect would be anti-dilutive. Also excluded from the calculation of diluted
earnings per share for the nine months ended September 30, 2015 were 452 restricted stock units granted that were not yet vested
as the performance conditions were not met (see further discussion in Note 6).
During
the fourth quarter of 2015, the Company’s board of directors authorized the repurchase of up to $20,000 of the Company’s
outstanding common stock with no expiration date. The Company’s board of directors also authorized the Company to enter
into a Rule 10b5-1 plan when appropriate.
For
the three and nine months ended September 30, 2016, no purchases of treasury stock occurred.
For
the three and nine months ended September 30, 2015 the Company purchased 1,844 and 1,886, respectively, shares of ZAGG Inc common
stock for consideration of $13,570 and $13,894, respectively, which included commissions paid to brokers of $55 and $56, respectively.
Stock purchased in the three and nine months ended September 30, 2015 had a weighted average price per share of $7.32 and $7.33,
respectively. The consideration paid has been recorded within stockholders’ equity in the condensed consolidated balance
sheets. In addition, during the third quarter of 2015, the Company foreclosed on 80 shares of ZAGG Inc common stock linked to
the full recourse note receivable described in Note 10. The Company foreclosed on these shares at a price per share of $8.59 and
a total value of $688. These shares are currently being held by the Company as treasury stock.
In
June 2008, Lorence Harmer became a member of the Company’s board of directors and in December 2009, was appointed as the
chairman of the audit committee. Mr. Harmer introduced the Company to a consumer electronics product, which became known as the
ZAGGbox. The Company subsequently entered into negotiations with Teleportall, LLC (“Teleportall”), the owner of the
technology used in the ZAGGbox, regarding production and distribution of the ZAGGbox. In 2009 and 2010 the Company entered into
various agreements with Teleportall, including agreements appointing the Company as the exclusive distributor for the ZAGGbox
in North America, issued purchase orders for ZAGGbox units in the aggregate amount of $3,500 and advanced to Teleportall a total
of $3,900 against the total purchase price for the units ordered by the Company. Additionally, in May 2010, the Company entered
into an agreement with Harmer Holdings, LLC (“Holdings”), an affiliate of Mr. Harmer, under which Holdings agreed
to repurchase unsold ZAGGboxes under certain circumstances.
ZAGG
INC AND SUBSIDIARIES
Notes
to Condensed Consolidated Financial Statements
(Dollars,
units and shares in thousands, except per share data)
(Unaudited)
In
late 2010 the Company determined that the ZAGGbox product would not be ready to market and sell during the 2010 Christmas season
and the Company commenced discussions to restructure its agreements with Teleportall. As a result of the foregoing, the Company
entered into an agreement with Teleportall, Mr. Harmer and several entities owned or controlled by Mr. Harmer (the “Harmer
Agreement”), dated March 23, 2011, but subject to further negotiations and ratification through April 5, 2011. Pursuant
to the Harmer Agreement, the parties agreed to terminate the prior agreements and convey all ZAGG rights in the ZAGGbox to Teleportall
on the following terms:
|
●
|
Mr.
Harmer, Teleportall, and certain of their affiliates delivered a promissory note (the
“Note”) dated March 23, 2011, to the Company in the original principal amount
of $4,126 which accrued interest at the rate of LIBOR plus 4% per annum (adjusted quarterly)
payable as follows: (i) interest only payments (a) on September 23, 2011, and (b) thereafter
on or before the last day of each calendar quarter, (ii) 50% of the net profits of each
ZAGGbox sale by Teleportall and its affiliates, and (iii) the unpaid balance of principal
and interest due in full on March 23, 2013. The Note was secured by certain real property,
interests in entities that own real property and restricted and free-trading securities.
|
|
|
|
|
●
|
In
exchange for a license fee to the Company, Teleportall and the Company entered into a
License Agreement under which the Company licensed to Teleportall the use of certain
ZAGG names and trademarks to sell and distribute the ZAGGbox product.
|
|
|
|
|
●
|
In
exchange for commissions to be paid by the Company, Teleportall and ZAGG entered into
a non-exclusive, two-year Commission Agreement on March 23, 2011, under which Teleportall
could make introductions of many ZAGG products in all countries where ZAGG did not then
have exclusive dealing agreements in respect of the marketing, distribution or sale of
its products.
|
No
revenue has been recognized from Teleportall.
The
Note was originally accounted for under the cost recovery method and was originally included in the consolidated balance sheet
at $3,900 which was the value of the ZAGGbox inventory advances. The original face value of the Note of $4,126 was for reimbursement
of the inventory advances and other costs associated with the ZAGGbox and approximated fair value at March 23, 2011, as the variable
interest rate on the Note approximated market rates.
On
September 20, 2011, and prior to the due date of the first interest-only payment due on the Note, Mr. Harmer and two of his affiliates,
Holdings and Teleportall, filed a lawsuit in Utah state court (the “Court”) against the Company, its then CEO and
CFO and KPMG LLP (ZAGG’s independent registered public accounting firm). KPMG LLP and the former CEO and CFO were subsequently
dismissed from the lawsuit. In their lawsuit, the plaintiffs allege that the defendants defamed Mr. Harmer, breached the Harmer
Agreement and interfered with other rights of the plaintiffs.
Mr.
Harmer failed to make the required interest-only payment to the Company due on September 23, 2011. Thereafter, the Company filed
counterclaims against Mr. Harmer, Holdings and Teleportall to collect the balance due under the Note. Also, ZAGG commenced foreclosure
on the collateral securing the Note, which consisted of real property, interests in entities that own real property, and restricted
and free-trading securities, which included shares of ZAGG Inc common stock.
On
May 21, 2015, the Court issued a final judgment whereby all claims brought by Harmer were disposed of in favor of ZAGG and dismissed
with prejudice. In addition, the Court granted summary judgment in favor of ZAGG on all counterclaims against Harmer, Holdings
and Teleportall and ZAGG was awarded judgment in the amount of $4,735 with interest at 12% per annum until paid in full and reasonable
attorney fees. Following the final judgment, the Company began the foreclosure process on all remaining collateral securing the
Note.
ZAGG
INC AND SUBSIDIARIES
Notes
to Condensed Consolidated Financial Statements
(Dollars,
units and shares in thousands, except per share data)
(Unaudited)
On
June 29, 2015, the Company foreclosed on certain real property securing the Note, which was valued by an independent appraiser
and determined to have a current fair value of $1,099. In conjunction with the foreclosure, the Company reclassified $801 of the
Note previously collateralized by the foreclosed real property and included in other assets, and $298 of the Note collateralized
by ZAGG Inc stock, as a $1,099 asset held for sale and presented it as a component of other assets in the condensed consolidated
balance sheets. After this reclassification, the remaining balance of the Note was $50.
On
July 13, 2015, the Company foreclosed on 80 shares of ZAGG Inc common stock that were determined by the Company to have a fair
value of $688 on the date of foreclosure. At the time of the foreclosure, the Note receivable balance totaled $50 and was reduced
to $0. The $638 excess in value of the common stock over the book value of the Note was recorded by the Company as a recovery
of a previously established reserve in selling, general and administrative expense in the consolidated statement of operations,
which is the same financial statement line item in which the Company previously recorded write-downs of the Note.
As
of December 31, 2015, management determined that the estimated fair value of the remaining underlying collateral was between $135
and $270, consisting of real property investments.
Since
the Note became collateral dependent in October 2011, management has (1) foreclosed on and sold 45 shares of ZAGG Inc common stock
for $496 (December 2011); (2) foreclosed on real property valued at $250 (January 2012); (3) foreclosed on stock and warrants
in a private company of $516 (May 2012); (4) foreclosed on real property valued at $1,099 as discussed above; and (5) foreclosed
on 80 shares of ZAGG Inc common stock for $688. These foreclosures were recorded as a reduction to the Note in the period in which
the foreclosure occurred. Management continues to actively pursue the foreclosure of all remaining collateral and execution on
other assets of Harmer, Holdings, and Teleportall.
At
September 30, 2016 and December 31, 2015, the entire unpaid balance on the note receivable was fully reserved. The total unpaid
principal balance, including accrued interest, late fees, attorney fees, and costs incurred in collection, totaled $5,158 and
$4,836, respectively. The increase to the reserve during the nine months ended September 30, 2016 consisted of accrued interest
of $324.
Fair
Value of Financial Instruments
At
September 30, 2016, the Company’s financial instruments included cash and cash equivalents, accounts receivable, accounts
payable, a line of credit, and a term loan. The carrying amounts of cash and cash equivalents, accounts receivable and accounts
payable approximate fair value due to the short-term maturities of these financial instruments. The carrying value of the debt
balances approximate fair value because the variable interest rates reflect current market rates and terms.
Fair
Value Measurements
The
Company measures at fair value certain financial and non-financial assets by using a fair value hierarchy that prioritizes the
inputs to valuation techniques used to measure fair value. Fair value is the price that would be received to sell an asset or
paid to transfer a liability in an orderly transaction between market participants at the measurement date, essentially an exit
price, based on the highest and best use of the asset or liability. The levels of the fair value hierarchy are:
Level
1 — Quoted market prices in active markets for identical assets or liabilities;
Level
2 — Significant other observable inputs (e.g., quoted prices for similar items in active markets, quoted prices for identical
or similar items in markets that are not active, inputs other than quoted prices that are observable such as interest rate and
yield curves, and market-corroborated inputs); and
Level
3 — Unobservable inputs in which there is little or no market data, which require the reporting unit to develop its own
assumptions.
ZAGG
INC AND SUBSIDIARIES
Notes
to Condensed Consolidated Financial Statements
(Dollars,
units and shares in thousands, except per share data)
(Unaudited)
At
September 30, 2016, and December 31, 2015, the following assets were measured at fair value on a recurring basis using the level
of inputs shown:
|
|
|
|
|
Fair Value Measurements Using:
|
|
|
|
September 30,
2016
|
|
|
Level 1 Inputs
|
|
|
Level 2 Inputs
|
|
|
Level 3 Inputs
|
|
Money market funds included in cash equivalents
|
|
$
|
5
|
|
|
$
|
5
|
|
|
|
—
|
|
|
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fair Value Measurements Using:
|
|
|
|
December 31,
2015
|
|
|
Level 1 Inputs
|
|
|
Level 2 Inputs
|
|
|
Level 3 Inputs
|
|
Money market funds included in cash equivalents
|
|
$
|
375
|
|
|
$
|
375
|
|
|
|
—
|
|
|
|
—
|
|
Concentration
of credit risk
Financial
instruments which potentially subject the Company to concentrations of credit risk consist principally of cash and accounts receivable.
The Company places its cash with high credit quality financial institutions. The Company maintains its cash in bank deposit accounts,
which, at times, exceed federally insured limits. The Company has not experienced any losses in such accounts through September
30, 2016.
At
September 30, 2016 the balance of accounts receivable from three separate customers exceeded 10%. At December 31, 2015, the balance
of accounts receivable from two separate customers exceeded 10%:
|
|
September 30,
2016
|
|
|
December 31,
2015
|
|
Customer A
|
|
|
14
|
%
|
|
|
29
|
%
|
Customer B
|
|
|
38
|
%
|
|
|
31
|
%
|
Customer C
|
|
|
11
|
%
|
|
|
5
|
%
|
No
other customer account balances were more than 10% of accounts receivable at September 30, 2016 or December 31, 2015. If one or
more of the Company’s significant customers were to become insolvent or were otherwise unable to pay for the products provided,
it would have a material adverse effect on the Company’s financial condition and results of operations.
Concentration
of supplier
We
do not directly manufacture any of our products, rather we employ various third party manufacturing partners in the United States
and Asia to perform these services on our behalf. The services employed by these third parties include the selection of sub-suppliers
that provide raw materials and other components used in the manufacturing process. We have endeavored to use common components
and readily available raw materials in the design of our products that can be sourced from multiple sub-suppliers. However, raw
film used in our InvisibleShield film and InvisibleShield On-Demand (“ISOD”) products has been produced by a single
supplier for the last nine years. Our film supplier has contractually agreed to not sell the raw materials to any of our competitors.
If any of our supplier relationships are terminated or interrupted, we could experience an immediate or long-term supply shortage,
which could have a material adverse effect on our business.
ZAGG
INC AND SUBSIDIARIES
Notes
to Condensed Consolidated Financial Statements
(Dollars,
units and shares in thousands, except per share data)
(Unaudited)
Concentration
of sales
For
each of the three months ended September 30, 2016 and 2015, Superior Communications (“Superior”) and Best Buy individually
accounted for over 10% of the quarterly revenues in each respective quarter:
|
|
Three months ended September 30,
2016
|
|
|
Three months ended September 30,
2015
|
|
Superior Communications
|
|
|
30
|
%
|
|
|
17
|
%
|
Best Buy
|
|
|
10
|
%
|
|
|
18
|
%
|
For
each of the three months ended September 30, 2016 and 2015 one other customer accounted for more than 10% of the quarterly revenues
in each respective quarter. Other than Superior and Best Buy, those customers with over 10% of net sales in a given period tend
to change from year-to-year.
For
the ZAGG segment, Superior is a pass-through distributor through which products are sold to Verizon (no other customers purchase
through Superior). For the mophie segment, several retailers, including Best Buy, purchase mophie products through Superior.
Although
we have contracts in place governing our relationships with customers, the contracts are not long-term and all of our retailers
purchase from us on a purchase order basis. As a result, these retailers may, with little or no notice or penalty, cease ordering
and selling our products, or materially reduce their orders. If any of these retailers cease selling our products, slow their
rate of purchase of our products, or decrease the number of products they purchase, our results of operations could be adversely
affected.
For
each of the nine months ended September 30, 2016 and 2015, Superior and Best Buy individually accounted for over 10% of the quarterly
revenues in each respective period:
|
|
Nine months ended September 30,
2016
|
|
|
Nine months ended September 30,
2015
|
|
Superior Communications
|
|
|
27
|
%
|
|
|
13
|
%
|
Best Buy
|
|
|
10
|
%
|
|
|
20
|
%
|
For
each of the nine months ended September 30, 2016 and 2015 one other customer accounted for more than 10% of the quarterly revenues
in each respective quarter. Other than Superior and Best Buy, those customers with over 10% of net sales in a given period tend
to change from year-to-year.
The
percentage of sales by geographic region for the three months ended September 30, 2016 and 2015, was approximately:
|
|
Three months ended September 30,
2016
|
|
|
Three months ended September 30,
2015
|
|
United States
|
|
|
87
|
%
|
|
|
89
|
%
|
Europe
|
|
|
8
|
%
|
|
|
9
|
%
|
Other
|
|
|
5
|
%
|
|
|
2
|
%
|
The
percentage of sales by geographic region for the nine months ended September 30, 2016 and 2015, was approximately:
|
|
Nine months ended September 30,
2016
|
|
|
Nine months ended September 30,
2015
|
|
United States
|
|
|
89
|
%
|
|
|
91
|
%
|
Europe
|
|
|
7
|
%
|
|
|
8
|
%
|
Other
|
|
|
4
|
%
|
|
|
1
|
%
|
ZAGG
INC AND SUBSIDIARIES
Notes
to Condensed Consolidated Financial Statements
(Dollars,
units and shares in thousands, except per share data)
(Unaudited)
(13)
|
COMMITMENTS AND CONTINGENCIES
|
Operating
leases
The
Company leases office and warehouse space, office equipment, and mall cart locations under operating leases that expire through
2023. Future minimum rental payments required under the operating leases at September 30, 2016 are as follows:
Remaining 2016
|
|
$
|
623
|
|
2017
|
|
|
2,661
|
|
2018
|
|
|
1,890
|
|
2019
|
|
|
1,453
|
|
2020
|
|
|
1,484
|
|
Thereafter
|
|
|
4,030
|
|
Total
|
|
$
|
12,141
|
|
For
the three months ended September 30, 2016 and 2015, rent expense was $793 and $391, respectively, and is included in selling,
general and administrative expense in the condensed consolidated statements of operations.
For
the nine months ended September 30, 2016 and 2015, rent expense was $2,450 and $1,182, respectively, and is included in selling,
general and administrative expense in the condensed consolidated statements of operations.
Commercial
Litigation
Daniel
Huang, individually and as shareholder representative v. ZAGG INC, Court of Chancery of the State of Delaware, C.A. No. 12842.
On October 21, 2016, Daniel Huang as the representative of the shareholders of mophie, inc. under the Merger Agreement dated
February 2, 2016, by and among the Company, ZM Acquisition, Inc. and mophie, inc., filed a lawsuit against the Company alleging
that the Company breached the Merger Agreement by failing to pay certain contingent payments related to tax refunds and customs
duty recoveries and seeks damages in an amount no less than $11,420. The Company will respond in due course and will defend the
claims and otherwise enforce its rights and remedies under the Merger Agreement. The Company recorded a liability based on its
estimate of the contingent payments as part of purchase accounting. The Company will accrue for future tax refunds, proceeds received
on the land held for sale, and customs duty recoveries as they are collected. This matter is not expected to have a material adverse
effect on the Company’s financial position, results of operations, or liquidity.
Lorence
A. Harmer, et al. v. ZAGG Inc et al., Third Judicial District Court, Salt Lake County, State of Utah, Civil No. 110917687
.
On September 20, 2011, Lorence A. Harmer, a former director of ZAGG and two of his affiliates, Harmer Holdings, LLC, and Teleportall,
LLC (the “Harmer Parties”), filed a lawsuit against the Company, Robert G. Pedersen II, Brandon T. O’Brien,
and KPMG LLP. In October 2012, the Company filed a counterclaim and third-party complaint against Harmer, Harmer Holdings, Teleportall
and third-party Global Industrial Services Limited asserting claims for breach of contract, deficiency, indemnity and attorneys’
fees, breach of the implied covenant of good faith and fair dealing, quasi contract, unjust enrichment, quantum meruit and declaratory
judgment. On May 21, 2015, the court granted summary judgment in the Company’s favor against the Harmer Parties, and thereafter
entered a final judgment against the Harmer Parties in the amount of $4,735 with interest at 12% per annum until paid in full.
On October 2, 2015, the court entered an order adding the amount of $1,396 to the judgment for the attorney fees and costs incurred
by the Company in the litigation. All of the Harmer Parties’ claims against the Company and others have been dismissed with
prejudice. The Company is moving forward with collection efforts pursuant to the final judgment. This matter is not expected to
have a material adverse effect on the Company’s financial position, results of operations, or liquidity.
ZAGG
INC AND SUBSIDIARIES
Notes
to Condensed Consolidated Financial Statements
(Dollars,
units and shares in thousands, except per share data)
(Unaudited)
Peter
Kravitz v. ZAGG Inc., U.S. Bankruptcy Court, District of Delaware, Adv. Pro. No. 15-51558(BLS).
On October 29, 2015, Kravitz,
as Liquidating Trustee (the “Trustee”) of the RSH Liquidating Trust (formerly known as RadioShack) filed a complaint
against the Company, alleging, among other things, that the Company received preference payments for product the Company sold
and delivered to RadioShack in the amount of $1,834 pursuant to Section 547 of the Bankruptcy Code and in the alternative pursuant
to Section 548 of the Bankruptcy Code. The Company believes that the Trustee’s claims are without merit and is vigorously
defending against them. On February 2, 2016, the Company filed its answer to the complaint stating, among other things, that the
Company has a full and complete defense to the Trustee’s allegations in that all payments were received by the Company in
the ordinary course of business and all payments received by the Company were paid pursuant to ordinary business terms. The Company
also asserted the defense that the Company provided subsequent new value to RadioShack and that the payments are otherwise not
recoverable by the Trustee. The case is currently in the discovery phase and with trial to be held in 2017. This matter is not
expected to have a material adverse effect on the Company’s financial position, results of operations, or liquidity.
Patent/Trademark
Litigation
I
nter
Partes Review of Patent No. 8,567,596 B1 in the United States Patent and Trademark Office, Patent Trial and Appeal Board (“PTAB”),
Case IPR2014-01262.
On August 8, 2014, Tech 21 UK LTD. filed a Corrected Petition requesting inter partes review of claims
1-18 of U.S. Patent No. 8,567,596. Inter partes review was instituted on February 19, 2015. On January 27, 2016, the PTAB ordered
that certain claims in the patent were unpatentable and other claims were canceled. The Company has appealed the PTAB’s
decision to the Federal Circuit Court of Appeals. While under appeal, the patent remains in force. At September 30, 2016, unamortized
book value of $2,027 remained on the Company’s books for acquisition costs related to this patent, which is included in
the balance of intangible assets on the consolidated balance sheet. The Company will continue to evaluate the recorded book value
and useful life of the intellectual property subject to the patent and will reflect any changes in estimates that result from
this matter prospectively.
SEC
Investigation
In
the fourth quarter of 2012, the Company received requests to provide documentation and information to the staff of the SEC in
connection with an investigation being conducted by the SEC’s Salt Lake City office. The Company believes the investigation
includes a review of the facts and circumstances surrounding former-Chief Executive Officer Robert Pedersen’s pledge and
subsequent sale of Company shares and the fact that such pledges and sales were not disclosed in the Company’s 2011 10-K
filed on March 15, 2012 or 2012 Proxy filed on April 27, 2012. The Company responded to these requests and is cooperating with
the staff although there has been no resolution to date.
Other
Litigation
The
Company is not a party to any other material litigation or claims at this time. While the Company currently believes that the
amount of any ultimate potential loss for known matters would not be material to the Company’s financial condition, the
outcome of these actions is inherently difficult to predict. In the event of an adverse outcome, the ultimate potential loss could
have a material adverse effect on the Company’s financial condition or results of operations in a particular period.
The
Company records a liability when a particular contingency is probable and estimable. Other than those discussed above, the Company
has not accrued for any loss at September 30, 2016 in the condensed consolidated financial statements as the Company does not
consider a loss to be probable or estimable. The Company faces contingencies that are reasonably possible to occur; however, the
reasonably possible exposure to losses cannot currently be estimated.
The
Company designs, produces, and distributes professional and premium creative product solutions in domestic and international markets.
The Company’s operations are conducted in two reporting business segments: ZAGG and mophie. The Company defines its segments
as those operations whose results its chief operating decision maker regularly reviews to analyze performance and allocate resources.
The results of operations of mophie are included in the Company’s results of operations beginning on March 3, 2016.
ZAGG
INC AND SUBSIDIARIES
Notes
to Condensed Consolidated Financial Statements
(Dollars,
units and shares in thousands, except per share data)
(Unaudited)
The
ZAGG segment designs and distributes screen protection, keyboards for tablet computers and other mobile devices, earbuds, headphones,
Bluetooth speakers, mobile power, cables, and cases under the ZAGG, InvisibleShield, and IFROGZ brands. Domestic operations are
headquartered in Midvale, Utah, while international operations are directed from Shannon, Ireland.
The
mophie segment designs and distributes power cases, mobile power, cases, and cables under the mophie brand. Worldwide operations
are headquartered in Tustin, California.
The
Company measures the results of its segments using, among other measures, each segment's net sales, gross profit, and operating
income (loss).
Net
sales by segment are as follows:
|
|
Three months ended September 30,
2016
|
|
|
Three months ended September 30,
2015
|
|
|
|
|
|
|
|
|
ZAGG segment
|
|
$
|
84,931
|
|
|
$
|
66,774
|
|
mophie segment
|
|
|
39,731
|
|
|
|
—
|
|
Net sales
|
|
$
|
124,662
|
|
|
$
|
66,774
|
|
|
|
Nine months ended September 30,
2016
|
|
|
Nine months ended September 30,
2015
|
|
|
|
|
|
|
|
|
ZAGG segment
|
|
$
|
207,538
|
|
|
$
|
190,679
|
|
mophie segment
|
|
|
79,390
|
|
|
|
—
|
|
Net sales
|
|
$
|
286,928
|
|
|
$
|
190,679
|
|
Gross
profit by segment is as follows:
|
|
Three months ended September 30,
2016
|
|
|
Three months ended September 30,
2015
|
|
|
|
|
|
|
|
|
ZAGG segment
|
|
$
|
35,420
|
|
|
$
|
24,871
|
|
mophie segment
|
|
|
7,726
|
|
|
|
—
|
|
Gross profit
|
|
$
|
43,146
|
|
|
$
|
24,871
|
|
|
|
Nine months ended September 30,
2016
|
|
|
Nine months ended September 30,
2015
|
|
|
|
|
|
|
|
|
ZAGG segment
|
|
$
|
84,885
|
|
|
$
|
72,785
|
|
mophie segment
|
|
|
12,863
|
|
|
|
—
|
|
Gross profit
|
|
$
|
97,748
|
|
|
$
|
72,785
|
|
ZAGG
INC AND SUBSIDIARIES
Notes
to Condensed Consolidated Financial Statements
(Dollars,
units and shares in thousands, except per share data)
(Unaudited)
Income
(loss) from operations by segment is as follows:
|
|
Three months ended September 30,
2016
|
|
|
Three months ended September 30,
2015
|
|
|
|
|
|
|
|
|
ZAGG segment
|
|
$
|
(9,405
|
)
|
|
$
|
6,228
|
|
mophie segment
|
|
|
(3,305
|
)
|
|
|
—
|
|
Income (loss) from operations
|
|
$
|
(12,710
|
)
|
|
$
|
6,228
|
|
|
|
Nine months ended September 30,
2016
|
|
|
Nine months ended September 30,
2015
|
|
|
|
|
|
|
|
|
ZAGG segment
|
|
$
|
(704
|
)
|
|
$
|
17,918
|
|
mophie segment
|
|
|
(17,062
|
)
|
|
|
—
|
|
Income (loss) from operations
|
|
$
|
(17,766
|
)
|
|
$
|
17,918
|
|
Total
assets by segment are as follows:
|
|
September 30,
2016
|
|
|
December 31,
2015
|
|
|
|
|
|
|
|
|
ZAGG segment
|
|
$
|
154,018
|
|
|
$
|
179,541
|
|
mophie segment
|
|
|
150,347
|
|
|
|
—
|
|
Total assets
|
|
$
|
304,365
|
|
|
$
|
179,541
|
|
As
is described above in Notes 2 and 13, on October 21, 2016, Daniel Huang as the representative of the shareholders of mophie, inc.
under the Merger Agreement dated February 2, 2016, by and among the Company, ZM Acquisition, Inc. and mophie, inc., filed a lawsuit
against the Company alleging that the Company breached the Merger Agreement by failing to pay certain contingent payments related
to tax refunds and customs duty recoveries and seeks damages in an amount no less than $11,420. The Company will respond in due
course and will defend the claims and otherwise enforce its rights and remedies under the Merger Agreement. The Company recorded
a liability based on its estimate of the contingent payments as part of purchase accounting. The Company will accrue for future
tax refunds, proceeds received on the land held for sale, and customs duty recoveries as they are collected. This matter is not
expected to have a material adverse effect on the Company’s financial position, results of operations, or liquidity.