Zagg (ZAGG)shares are rallying near 52-week highs, all the more perfectly poised to shatter amid numerous lawsuits, market deterioration, an ongoing SEC investigation, an executive resignation, insider selling and a recent $100 million shelf filing which could bring excessive dilution.
Formerly known as the fumbling Chinese academic regalia manufacturer Amerasia Khan Enterprises, this Salt Lake City, Utah company makes plastic and glass screen protectors for smartphones and other devices. This endeavor has resulted in one of Zagg's worst net income reports since 2011:
(Source: SEC filings)
Though Zagg is currently expected to increase earnings about 13 percent to 68 cents next year, TheStreetSweeper believes it will not hit that figure. In our view, the market share will continue to fracture as customers turn to the vast number of cheaper alternatives.
Zagg has not responded to our request for comment but investors may find other viewpoints here. Meanwhile, here’s a look at the red flags indicating Zagg is poised to disappoint:
*Major Dilution Looming With Recent $100 Million Shelf, Insider Selling
Now that Zagg is trading high, insiders can’t wait to get out. The company just filed a $100 million shelf registration that could bring extreme dilution to current shareholders, available here. At the same time, seven insiders have been set up to sell their shares, further increasing that dilution potential.
Here are the lucky seven insiders who may now dump their shares:
(Source: SEC filings)
In October, CEO Randall Hales jumped out with the most recent insider selling with the disposition of 43,000-plus shares, shown here.
Both of these selling activities are fairly good indications that Zagg has approached peak price.
Oddly, just when Zagg’s stock began looking good, the chief financial officer who has been with the company pre-IPO, through thick and thin, Brandon O’Brien has darted away.
While Mr. O’Brien is only 44 years old, the explanation dashed out at the bottom of his successor’s announcement states, “Brandon O’Brien has resigned his position as CFO effective June 11, 2015 with plans to retire … His resignation is not the result of any disagreement with ZAGG on matters relating to ZAGG’s operations, policies or practices.”
TheStreetSweeper salutes Mr. O'Brien for that early retirement.
*Look Out Ahead
The reason insiders are getting out physically or share-wise now may be because they understand better than anyone just how risky the business has become.
Despite the assertion that Zagg enjoys some brand recognition, a Google Trends search for Zagg versus Skullcandy (SKUL) indicates that Zagg is definitely not a household word.
(Source: Google Trends)
Investors can see that as interest in Skullcandy declined, combined with an earnings bump, those insiders quickly got the message after the drop-off and began selling shares (the red symbols indicate insider selling):
We believe Zagg will follow the same pathway taken by Skullcandy stock, as we’ll further demonstrate in “Zagg Follows The Skullcandy Pathway.”
*Reliance On Older Product
Zagg management recognizes the core product – screen protection – is ripe for decline.
So Zagg has talked about diversification (“multi-category product strategy,”) bought other companies and offered keyboards, portable power and other products all in hopes of diversifying its revenue.
Despite how badly Zagg wants to diversify revenue, the numbers show an alarmingly rising dependence on screen protection products:
(Source: From SEC filings)
*Shield Protector Biz Leads To Instability
So why are we sounding the alarm over increasing dependence on the screen protection? After its IPO, Zagg’s revenue came from plastic “InvisibleShield” screen protectors. But those screen protectors are the very thing that eventually clobbered Zagg’s stock price.
(Source: Yahoo Finance)
That’s one big reason Zagg needs successful diversification.
In the third quarter 2014 earnings call, management talked about the newer glass screen protectors and the “strong Invisible Shield glass and HDX sales.”
In the second quarter 2015 earnings call, management commented, “The year-over-year increase is largely due to the growth of Invisible Shield Glass sales.”
With such low barriers to entry, Asian and American competitors have rushed in with alternatives that are several times cheaper.
That competitive bite should not be a surprise.
“Before they were selling a piece of plastic,” sighed one analyst, “and now they're selling a piece of glass – for about $20 (here).”
Maxboost and G-Armor offer nice, scratch resistant, crystal clear screen protectors for about $7.98 and $9.99, or $13.99 for a nice iPhone protector. Indeed, plunk down less than $5 for alternatives sold on Ebay:
*Zagg Follows The Skullcandy Pathway
Once again, Zagg is feeling the effects of its product becoming a commodity and this time that product is its newer glass screen protector.
Just as Skullcandy insiders realized and reacted to the pressures on its product, similar insider selling indications are popping up for Zagg now. The red symbols indicate insider selling:
In fact, we believe Zagg, unable to break free of screen protection reliance – albeit the newer glass screen protection - is on course to repeat history, as shown below.
(Sources: From SEC filings)
*Slippery Acquisition: iFrogz
Yet in its efforts to break out of screen protection reliance, Zagg paid $105 million for iFrogz, with iFrogz brand EarPollution. This expensive acquisition has not gone well, as indicated by comments made by the chief financial officer during the fourth quarter 2013 earnings call:
“During the quarter management performed an annual impairment test of the goodwill and intangible assets required under generally accepted accounting principals. As a result of the analysis we recorded $11.2 million non-cash impairment charge in the fourth quarter. $9.7 million related to the iFrogz brand and the remaining balance of goodwill of $1.5 million was also impaired.”
Here’s what CFO O’Brien said about the issue earlier, in the fourth quarter 2012 earnings call:
“As a result of an adjustment in brand focus during the fourth quarter of 2012 and due to a lower market cap for ZAGG, we performed an impairment analysis of our goodwill and intangibles, as required under Accounting Standards Codification No. 350, Intangibles-Goodwill and Other. As a result of the analysis, we were required to record an $11.5 million noncash impairment charge, $6.1 million related to the EarPollution trademark and other intangibles and $5.4 million related to goodwill. When we acquired iFrogz, we ascribed values to various trademarks and other intangibles based on projected future cash flows from those assets.”
Take a look at the slipping interest in iFrogz, as indicated by Google Trends:
(Source: Google Trends)
*SEC Investigation, Lawsuits
Investors should know that the company is under investigation by the Securities and Exchange Commission. In fact, Zagg is also involved in numerous ugly lawsuits, including a complaint attempting to stop the sale of Zagg stock by a former director who is also the controversial former Polaroid CEO Lorence Harmer. A number of lawsuits have been filed back and forth between Zagg and Mr. Harmer.
Here’s the SEC investigation disclosure from Zagg’s filing:
“In the fourth quarter of 2012, the Company received requests to provide documentation and information to the staff of the SEC in connection with a non-public 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 some of the same issues raised by the plaintiffs in the above lawsuits; specifically, whether the Company failed to disclose Mr. Pedersen’s margin account sales or the alleged existence of a plan to have Mr. Hales succeed Mr. Pedersen as the Company’s CEO. The Company responded to these requests and is cooperating fully with the staff. The Company has chosen to disclose this non-public investigation due to the highly public nature of the lawsuits described above, which the Company intends to defend vigorously.”
One class action lawsuit is tied to the former CEO’s margin account sales. Another one revolves around allegations of breach of fiduciary duty, waste of corporate assets, unjust enrichment and insider trading by former and current officers and directors.
Below is a synopsis of the Zagg issues regarding Mr. Harmer, who joined the Zagg board of directors a year after he left Polaroid, which filed for Chapter 11 bankruptcy protection shortly after a Ponzi-scheme investigation into its parent company’s founder.
“In June 2008, Lorence Harmer became a member of ZAGG's Board of Directors ("Board") and in December 2009 the chairman of the Audit Committee. In 2009, Mr. Harmer introduced the Company to Teleportall, the owner of the technology used in the ZAGGbox. The Company consequently determined that it wished to obtain certain rights for the sale and development of ZAGGbox, and entered into a purchase agreement with Teleportall and advanced more than $1.1 million in partial payment.
“Contrary to expectations, Teleportall did not deliver the product in time for the 2009 Christmas selling season, and during a December 1, 2009 meeting of the Board, Mr. Harmer disclosed to the other members of the Board that he owned an interest in Teleportall. Mr. Harmer told the Board he was willing to divest himself of any ownership in Teleportall and the Board assumed thereafter that Mr. Harmer had completed his divestiture.
“By the 2010 Christmas season, Teleportall had still failed to deliver ZAGGbox and ZAGG had made additional payments to Teleportall exceeding $2.7 million. Moreover, in January 2011, the Board learned that Mr. Harmer had not, in fact, divested himself of his interest in Teleportall, but instead retained an indirect ownership interest of 25% in Teleportall as well as other entities potentially affiliated with the ZAGGbox.
“As a result of the foregoing, in March 2011 the Board terminated the purchase agreement and allowed Mr. Harmer and Teleportall to sign a promissory note for the repayment of more than $4.1 million to ZAGG. The note, however, was secured by real estate with collateral value insufficient to cover the principal, and unsurprisingly, Mr. Harmer defaulted on the note in September 2011. To date, Mr. Harmer has failed to cure the default on the note which has a total unpaid principle balance of $4 million, and the Company has never received the ZAGGbox product.”
More nerve-wracking details are available in Zagg’s SEC filing here.
Zagg is shattering before investors’ eyes amid declining net income, shelf registration, insider selling, inability to break out of its screen dependence, deteriorating market, relentless pursuit of a rival’s pathway, unfortunate acquisition, SEC investigation, bad taste in directors, and costly class action lawsuits.
So much has begun shattering around Zagg now that we wouldn't be at all surprised to see the stock price fall apart and hit $5 per share.
* Important Disclosure: The owners of TheStreetSweeper hold a short position in ZAGG and stand to profit on any future declines in the stock price.
* Editor's Note: As a matter of policy, TheStreetSweeper prohibits members of its editorial team from taking financial positions in the companies that they cover. To contact Sonya Colberg, the author of this story, please send an email to [email protected].