NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Dollars,
units, & 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, and cases 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 (consisting only of normal recurring 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. 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 2016 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"). 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 3 and
13 for additional details on the acquisition and the Company's reportable 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, 2016.
Recent
Accounting Pronouncements (amounts in thousands)
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 currently
anticipates adopting the standard using the modified retrospective approach with the cumulative effect of adoption recorded at
the date of initial application. The Company is currently evaluating the impact the ASU will have on its consolidated financial
statements.
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 did not have a material impact on our financial
position or results of operations.
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. During
the year ended December 31, 2016, the Company adopted the ASU using the retrospective approach resulting in recording deferred
tax assets as non-current for current and prior periods presented. This adoption does not impact our results of operations.
In
February 2016, the FASB issued ASU No. 2016-02, “Leases (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 business entities 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. The new standard contains several amendments that simplify the accounting for employee share-based payment
transactions, including the accounting for income taxes, forfeitures, statutory tax withholding requirements, classification of
awards as either equity or liabilities, and classification on the statement of cash flows. The changes in the new standard eliminate
the accounting for excess tax benefits to be recognized in additional paid-in capital and tax deficiencies recognized either in
the income tax provision or in additional paid-in capital. The Company has adopted ASU 2016-09 as of the beginning of the quarter
ended March 31, 2017. For the quarter ended March 31, 2017, the Company applied the amendment relating to the recognition of excess
tax benefits and deficiencies on a prospective basis and, accordingly, has recognized all excess tax benefits and tax deficiencies
as income tax expense or benefit as discrete items resulting in the recognition of income tax expense of $171. The Company has
not recorded a cumulative-effect adjustment to retained earnings as of the beginning of the year because all tax benefits had
previously been recognized when the tax deductions related to stock compensation were utilized to reduce taxes payable. The Company
has elected to apply the amendment related to the presentation of cash flows for excess tax benefits on a prospective basis and
no prior periods have been adjusted. The Company’s financial position or results of operations were not impacted by amendments
related to the statutory tax withholding requirement and, accordingly, no adjustment has been recorded. The Company will continue
to classify cash remitted to the tax authorities as a financing activity as now required by the amendments in the ASU. The ASU
permits a policy election to either record forfeitures as they occur or estimate forfeitures consistent with historical U.S. GAAP.
The Company has elected to record forfeitures as they occur, which did not have a material impact on our financial position or
results of operations.
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 business
entities 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.
In
October 2016, the FASB issued ASU 2016-16, “Income Taxes (Topic 740): Intra-Entity Transfers of Assets Other Than Inventory,”
which requires entities to recognize at the transaction date the income tax consequences of intercompany asset transfers other
than inventory. This ASU is effective for public business entities for annual and interim periods in fiscal years beginning after
December 15, 2017. The Company is currently evaluating the impact this ASU will have on its consolidated financial statements.
In
November 2016, the FASB issued ASU 2016-18, “Statement of Cash Flows (Topic 230): Restricted Cash,” which requires
companies to include cash and cash equivalents that have restrictions on withdrawal or use in total cash and cash equivalents
on the statement of cash flows. This ASU is effective for public business entities for annual and interim periods in fiscal years
beginning after December 15, 2017. The Company is currently evaluating the impact this ASU will have on its consolidated financial
statements.
In
January 2017, the FASB issued ASU 2017-04, “Intangibles – Goodwill and Other (Topic 350): Simplifying the Test for
Goodwill Impairment,” which requires an entity to no longer perform a hypothetical purchase price allocation to measure
goodwill impairment. Instead, impairment will be measured using the difference between the carrying amount and the fair value
of the reporting unit. The ASU is effective for annual and interim periods in fiscal years beginning after December 15, 2019.
All entities may early adopt the standard for goodwill impairment tests with measurement dates after January 1, 2017. The Company
performs an annual goodwill impairment assessment and will elect to early adopt this standard in the current year when the assessment
is performed.
At
March 31, 2017, and December 31, 2016, inventories consisted of the following:
|
|
March 31,
2017
|
|
|
December 31,
2016
|
|
Finished goods
|
|
$
|
75,417
|
|
|
$
|
72,490
|
|
Raw materials
|
|
|
284
|
|
|
|
279
|
|
Total inventories
|
|
$
|
75,701
|
|
|
$
|
72,769
|
|
Included
in prepaid expenses and other current assets were inventory deposits with third-party manufacturers at March 31, 2017 and December
31, 2016 of $625 and $437, respectively.
(3)
|
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.
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
period March 3, 2016, through March 31, 2016, mophie generated net sales of $7,636 and had a net loss before tax of $4,116.
Pro
forma Results from Operations
The
following unaudited pro-forma results of operations for the three months ended March 31, 2016 give pro forma effect as if the
acquisition had occurred at the beginning of the periods presented, 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 values at the
date of purchase.
|
|
3 Months Ended
|
|
|
|
March 31,
2016
|
|
Net sales
|
|
$
|
79,759
|
|
Net loss
|
|
$
|
(6,395
|
)
|
Basic net loss per share
|
|
$
|
(.23
|
)
|
Diluted net loss per share
|
|
$
|
(.23
|
)
|
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 for the dates indicated. 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 March 31, 2016, pro forma net loss includes projected amortization expense of $2,392. In addition, the
Company included interest from the new credit facility and amortization of debt issuance costs for the three months ended March
31, 2016 of $493. Material non-recurring adjustments excluded from the pro forma financial information above consists of the $6,937
step up of mophie inventory to its fair value, which was recorded as an unfavorable adjustment to cost of goods sold during the
six months following the acquisition date.
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.
(4)
|
GOODWILL
AND INTANGIBLE ASSETS
|
Goodwill
There
were no additions to nor impairment of goodwill for the quarter-ended March 31, 2017. The balance of goodwill as of March 31,
2017 was $12,272.
Long-lived
Intangible Assets
The
following table summarizes the changes in gross long-lived intangible assets:
Gross balance at December 31, 2016
|
|
$
|
108,659
|
|
Impairment loss on patent
|
|
|
(2,777
|
)
|
Gross balance at March 31, 2017
|
|
$
|
105,882
|
|
On
April 11, 2017, the Company received a final court order stating that the claims of one of its patents were either unpatentable
or cancelled. Accordingly, management determined that the patent’s carrying value was not recoverable through future cash
flows and was impaired as of March 31, 2017. Consequently, for the period ended March 31, 2017, the Company recorded an impairment
loss consisting of a reduction of gross carrying amount of $2,777, accumulated amortization of $818, and net carrying value of
$1,959 to reduce the net carrying value of the cancelled patent to $0.
Long-lived
intangible assets, net of amortization as of March 31, 2017 and December 31, 2016, were as follows:
|
|
March 31,
2017
|
|
|
December 31,
2016
|
|
|
|
|
|
|
|
|
Customer relationships
|
|
$
|
13,274
|
|
|
$
|
14,612
|
|
Tradenames
|
|
|
20,593
|
|
|
|
21,506
|
|
Patents and technology
|
|
|
13,075
|
|
|
|
15,727
|
|
Non-compete agreements
|
|
|
1,407
|
|
|
|
1,497
|
|
Other
|
|
|
19
|
|
|
|
20
|
|
Total amortizable intangible assets
|
|
$
|
48,368
|
|
|
$
|
53,362
|
|
The
Company’s effective tax rate was 14.3% and 19.6% for the three months ended March 31, 2017 and 2016, respectively. The decrease
in the effective tax rate was primarily due to a discrete item recognized in the quarter for a true up of a deferred amount for
stock compensation. This was partially offset by the benefit of a change to the state rate in taxes caused by the acquisition
of mophie and the resulting change in the mix of state apportionment factors. The effective tax rate was also affected by income
in foreign jurisdictions that had losses in prior years. The Company’s effective tax rate will generally differ from the
U.S. Federal statutory rate of 35%, due to state taxes, permanent items, and the Company’s global tax strategy.
Fair
Value of Financial Instruments
At
March 31, 2017, 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
approximates 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.
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.
At
March 31, 2017, and December 31, 2016, the following assets were measured at fair value on a recurring basis using the level of
inputs shown:
|
|
|
|
|
Fair
Value Measurements Using:
|
|
|
|
March 31,
2017
|
|
|
Level
1
Inputs
|
|
|
Level
2
Inputs
|
|
|
Level
3
Inputs
|
|
Money
market funds included in cash equivalents
|
|
$
|
5
|
|
|
$
|
5
|
|
|
|
—
|
|
|
|
—
|
|
|
|
|
|
|
Fair
Value Measurements Using:
|
|
|
|
December 31,
2016
|
|
|
Level
1
Inputs
|
|
|
Level
2 Inputs
|
|
|
Level
3 Inputs
|
|
Money
market funds included in cash equivalents
|
|
$
|
5
|
|
|
$
|
5
|
|
|
|
—
|
|
|
|
—
|
|
(7)
|
DEBT
AND LETTERS OF CREDIT
|
Long-term
debt, net as of March 31, 2017 and December 31, 2016, was as follows:
|
|
March 31,
2017
|
|
|
December 31,
2016
|
|
Line of credit
(a)
|
|
$
|
40,631
|
|
|
$
|
31,307
|
|
Term loan
|
|
|
18,560
|
|
|
|
20,107
|
|
Total debt outstanding
|
|
|
59,191
|
|
|
|
51,514
|
|
Less current portion
|
|
|
51,115
|
|
|
|
41,791
|
|
Total long-term debt outstanding
|
|
$
|
8,076
|
|
|
$
|
9,623
|
|
(a)
|
The
line of credit has a capacity of $85,000 and matures on March 2, 2021.
|
(8)
|
STOCK-BASED
COMPENSATION
|
The
Company granted 311 and 529 restricted stock units during the three months ended March 31, 2017 and 2016, respectively. The restricted
stock units granted during the three months ended March 31, 2017 and 2016, were estimated to have a weighted-average fair value
per share of $6.66 and $9.87, respectively. The fair value of the 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 311 and 529 restricted stock units granted as discussed above, during the first three months of 2017 and 2016, the
Company granted 264 and 373 restricted stock units, respectively, to certain executives of the Company where vesting is linked
to specific performance criterion. The restricted stock units granted in 2017 and 2016 only vest upon the Company’s achievement
of specified thresholds of net sales, Adjusted EBITDA, or specific goals for the individual executive. As of March 31, 2017, the
Company believes it is probable that it will achieve the targets for all restricted stock units granted in the first three months
of 2017. Of the 373 restricted stock units granted in 2016, 16 shares vested and 159 shares were forfeited.
The
Company recorded share-based compensation expense only for those restricted stock units that were expected to vest. The estimated
fair value of the 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 months ended March 31, 2017 and 2016, the Company recorded
stock-based compensation expense related to restricted stock units of $670 and $1,336, respectively, which is included as a component
of selling, general, and administrative expense.
During
the three months ended March 31, 2017 and 2016, certain ZAGG employees elected to receive a net amount of shares upon the vesting
of restricted stock unit grants in exchange for the Company paying up to the maximum 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 $240 and $621, respectively,
which is reflected as a reduction of additional paid-in capital.
Basic
loss per common share excludes dilution and is computed by dividing net loss by the weighted average number of shares of common
stock outstanding during the period. Diluted loss 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 loss per share and diluted loss per share
for the three months ended March 31, 2017 and 2016:
|
|
March
31,
2017
|
|
|
March
31,
2016
|
|
Net loss
|
|
$
|
(6,138
|
)
|
|
$
|
(3,290
|
)
|
Weighted average shares outstanding:
|
|
|
|
|
|
|
|
|
Basic
|
|
|
28,059
|
|
|
|
27,710
|
|
Dilutive effect of warrants and restricted stock units
|
|
|
—
|
|
|
|
—
|
|
Diluted
|
|
|
28,059
|
|
|
|
27,710
|
|
Loss per share:
|
|
|
|
|
|
|
|
|
Basic
|
|
$
|
(0.22
|
)
|
|
$
|
(0.12
|
)
|
Diluted
|
|
$
|
(0.22
|
)
|
|
$
|
(0.12
|
)
|
For
the three months ended March 31, 2017, 860 restricted stock units were not considered in calculating diluted loss per share
because the company was in a loss position and, therefore, the effect would have been anti-dilutive.
For
the three months ended March 31, 2016, warrants and restricted stock units to purchase 442 shares of common stock were not considered
in calculating diluted loss per share because the company was in a loss position and, therefore, the effect would have been anti-dilutive.
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, which was put in place during the fourth quarter of 2016. The 20b5-1 plan was subsequently terminated
during the first quarter 2017.
For
the three months ended March 31, 2017, the Company purchased 234 shares of ZAGG Inc common stock. Cash consideration paid for
the purchase of ZAGG Inc common stock for the three months ended March 31, 2017 was $1,492, which included commissions paid to
brokers of $9. For the three months ended March 31, 2017 the weighted average price per share was $6.32. The consideration paid
has been recorded within stockholders’ equity in the condensed consolidated balance sheet.
For
the three months ended March 31, 2016, no purchases of treasury stock occurred.
(11)
|
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 March 31, 2017 were as follows:
Remaining 2017
|
|
$
|
2,215
|
|
2018
|
|
|
2,168
|
|
2019
|
|
|
1,709
|
|
2020
|
|
|
1,524
|
|
2021
|
|
|
1,449
|
|
Thereafter
|
|
|
2,561
|
|
Total
|
|
$
|
11,626
|
|
|
For the three months ended March 31, 2017 and 2016, rent expense was $685
and $717, respectively, and was included in selling, general and administrative expense in the condensed consolidated statement
of operations. Rent expense is recognized on a basis which approximates straight-line over the lease term and was recorded as
a component of selling, general and administrative expense on the condensed consolidated statement 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 mophie, inc. shareholders, 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 (the “Contingent Payments”) related
to tax refunds and customs duty recoveries and seeking damages in an amount no less than $11,420. On December 16, 2016, the
Company filed an Answer and Counterclaims in the lawsuit. In its Answer, the Company acknowledges its obligation under the Merger
Agreement to make the Contingent Payments under certain circumstances, but avers that this obligation is subject to rights of
offset and recoupment, each of which applies to Huang’s claims. In its Answer, the Company denies that any payments are
due at this time or that it is in breach of any provision of the Merger Agreement. Regarding the Counterclaims, after the closing
of the merger, ZAGG discovered breaches of certain representations, warranties and covenants made by Mr. Huang and mophie that
have resulted in damages exceeding $22,000. In addition to these breaches, the Company has also discovered that mophie fraudulently
misrepresented or omitted facts related to (i) a certain product return program, resulting in a substantial overstatement of the
value of mophie’s inventory and understatement of mophie’s sales return reserve, (ii) breaches of contracts by Mr.
Huang and certain other former employees of pre-merger mophie, and (iii) certain intellectual property belonging to mophie that
was misappropriated by Mr. Huang and other former employees of pre-merger mophie. In its Counterclaims, the Company asserts claims
based on these facts against Mr. Huang and certain other indemnitors for breaches of representations, warranties and covenants
in the Merger Agreement, fraudulent concealment and declaratory judgment. On February 6, 2017, Huang filed a Motion to Dismiss
the Counterclaims. On March 28, 2017, ZAGG filed its Answer in Opposition to Huang’s Motion to Dismiss. The Company
recorded a liability based on its estimate of the Contingent Payments as part of purchase accounting. The Company will accrue
for future Contingent Payments, including 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.
ZAGG
Inc et al. v. Daniel Huang et al.
, Orange County Superior Court, State of California, Civil No. 30-2016-00892767-CU-BC-CJC.
On December 15, 2016, the Company and mophie filed a complaint against Daniel Huang and Immotor, LLC (“Immotor”).
The complaint alleges that Huang and the company he founded, Immotor, misappropriated confidential information belonging to mophie
while Huang was serving as an officer and director of mophie. Based on these allegations, mophie asserts claims for breach of
contract, trade secret misappropriation in violation of California Civil Code § 3426 et seq., breach of fiduciary duty, and
conversion, and the Company asserts claims against Huang for breaches of his employment agreement, inventions agreement, separation
agreement and consulting agreement. On February 28, 2017, Huang and Immotor filed a Demurrer to the Complaint filed by ZAGG and
mophie. ZAGG and mophie have not yet responded to the Demurrer. This matter is not expected to have a material adverse
effect on the Company’s financial position, results of operations, or liquidity.
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 case was settled by the Company in April 2017. The settlement amount was not considered
material to the Company’s financial position, results of operations, or liquidity.
Eric
Stotz and Alan Charles v. mophie inc., U.S. District Court, Central District of California, Civil Action No. 2:16-cv-08898-GW-FFM.
On
January 13, 2017, Eric Stotz and Alan Charles, individually and on behalf of a purported class, filed a first amended class action
complaint alleging that they purchased certain external battery packs and that the battery packs did not extend the life of the
phones’ internal batteries as advertised and adversely affected the phones’ internal battery life. Plaintiffs
allege violations of California’s unfair competition law, California’s Consumer Legal Remedies Act, New York’s
unlawful deceptive acts and practices statute, and New York’s false advertising law. The Company has denied all liability
and will defend the claims and otherwise respond to the allegations. This matter is not expected to have a material adverse
effect on the Company’s financial position, results of operations, or liquidity.
MobileExp,
LLC v. mophie inc., U.S. District Court, Eastern District of Texas, Civil Action No. 2:16-cv-1340.
On November 30, 2016,
MobileExp, LLC filed a lawsuit alleging that Mophie Space Pack for the iPhone 5S, 5, 6, 6 Plus, and iPad Mini infringed on certain
claims of U.S. Patent No. 8,879,246. The Company has denied all liability and filed a counterclaim alleging that the claims of
U.S. Patent No. 8,879,246 are invalid. The Company will defend the claims and otherwise respond to the claimed infringement. This
matter is not expected to have a material adverse effect on the Company’s financial position, results of operations, or
liquidity.
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 establishes reserves when a particular contingency is probable and estimable. Other than those discussed above, the Company
has not accrued for any loss at March 31, 2017 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.
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 March
31, 2017.
At
March 31, 2017, the balance of accounts receivable from three separate customers exceeded 10%: Superior Communications, Inc. (“Superior”),
Best Buy Co., Inc. (“Best Buy”), and GENCO Distribution Systems, Inc. (“GENCO”). At March 31, 2017, the
balance of accounts receivable from two separate customers exceeded 10%:
|
|
March 31,
2017
|
|
|
December 31,
2016
|
|
Superior
|
|
|
45
|
%
|
|
|
32
|
%
|
Best Buy
|
|
|
12
|
%
|
|
|
22
|
%
|
GENCO
|
|
|
9
|
%
|
|
|
10
|
%
|
No
other customer account balances were more than 10% of accounts receivable at March 31, 2017 or December 31, 2016. 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.
Below
is a high-level summary by product category of the manufacturing sources used by the Company:
|
●
|
Screen
Protection
– Our screen product line is comprised of sales of InvisibleShield glass products, InvisibleShield film
products, and ISOD film blanks. InvisibleShield glass products are sourced from factories in Asia with protective glass expertise,
each of which uses a number of sub-suppliers for raw materials and other components. Our InvisibleShield film and ISOD products
are sourced through our third-party logistics partner, who purchases the raw film inventory from a single supplier (as discussed
above).
|
|
●
|
Battery
Cases and Power Management
– Our battery case and power management product lines consists of power products that
are designed to provide on-the-go power for tablets, smartphones, MP3 players, cameras, and virtually all other electronic
mobile devices. Our power products are sourced from factories in Asia with battery expertise, each of which uses a number
of sub-suppliers for raw materials and other components.
|
|
●
|
Keyboards
– Our keyboard product line consists of (1) device specific keyboards designed to fit individual tablets produced
by original equipment manufacturers and (2) keyboards that are designed to be device agnostic and can be used on virtually
any mobile device. Our keyboard products are sourced from factories in Asia with keyboard expertise, each of which uses a
number of sub-suppliers for raw materials and other components.
|
|
●
|
Audio
– Our audio product line consists of earbuds and headphones that are designed to be compatible with virtually all
electronic mobile devices. Our audio products are sourced from factories in Asia with audio expertise, each of which uses
a number of sub-suppliers for raw materials and other components.
|
Our
product and operations teams work closely with suppliers from initial product development and throughout the manufacturing process
to ensure that (1) the supplier understands and will build according to product specifications, (2) appropriate quality is maintained
for the finished goods and for all sub-components, and (3) the supplier can meet our supply needs.
Concentration
of sales
For
the three months ended March 31, 2017 and 2016, Superior, GENCO and Best Buy were our largest customers which accounted for over
10% of sales as follows:
|
|
Three months
ended
March 31,
2017
|
|
|
Three months
ended
March 31,
2016
|
|
Superior
|
|
|
27
|
%
|
|
|
19
|
%
|
GENCO
|
|
|
12
|
%
|
|
|
10
|
%
|
Best Buy
|
|
|
6
|
%
|
|
|
13
|
%
|
During
2017 and 2016 no other customers accounted for greater than 10% of net sales.
Although
we have contracts in place governing our relationships with customers, the contracts are not long-term and all of our retailers
generally purchase from us on a purchase order basis. As a result, these retailers generally 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.
The
percentage of sales by geographic region for the three months ended March 31, 2017 and 2016, was approximately:
|
|
Three months
ended
March 31,
2017
|
|
|
Three months
ended
March 31,
2016
|
|
United States
|
|
|
84
|
%
|
|
|
88
|
%
|
Europe
|
|
|
10
|
%
|
|
|
9
|
%
|
Other
|
|
|
6
|
%
|
|
|
3
|
%
|
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.
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, while international operations are directed from Shannon, Ireland.
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 were as follows:
|
|
Three months
ended
March 31,
2017
|
|
|
Three months
ended
March 31,
2016
|
|
|
|
|
|
|
|
|
ZAGG segment
|
|
$
|
57,165
|
|
|
$
|
54,796
|
|
mophie segment
|
|
|
35,781
|
|
|
|
7,636
|
|
Net sales
|
|
$
|
92,946
|
|
|
$
|
62,432
|
|
Gross
profit by segment were as follows:
|
|
Three months
ended
March 31,
2017
|
|
|
Three months
ended
March 31,
2016
|
|
|
|
|
|
|
|
|
ZAGG segment
|
|
$
|
24,303
|
|
|
$
|
22,819
|
|
mophie segment
|
|
|
4,303
|
|
|
|
910
|
|
Gross profit
|
|
$
|
28,606
|
|
|
$
|
23,729
|
|
Income
(loss) from operations by segment were as follows:
|
|
Three
months ended March 31,
2017
|
|
|
Three
months ended March 31,
2016
|
|
|
|
|
|
|
|
|
ZAGG segment
|
|
$
|
1,039
|
|
|
$
|
413
|
|
mophie segment
|
|
|
(7,688
|
)
|
|
|
(4,116
|
)
|
Loss from operations
|
|
$
|
(6,649
|
)
|
|
$
|
(3,703
|
)
|
Total
assets by segment were as follows:
|
|
March
31,
2017
|
|
|
December 31,
2016
|
|
|
|
|
|
|
|
|
ZAGG segment
|
|
$
|
123,042
|
|
|
$
|
156,123
|
|
mophie segment
|
|
|
153,540
|
|
|
|
154,606
|
|
Total assets
|
|
$
|
276,582
|
|
|
$
|
310,729
|
|