Money McBags finally had time to go through ZAGG’s Q after listening to the call again since their fucking transcript still hasn’t been posted (so fuck you very much StreetEvents or whomever is to blame) and catching up on his NSFW muff guessing.  Readers of the award winning When Genius Prevailed will know that Money McBags thinks ZAGG’s long-term business model is more flawed than Phillip Greaves‘ long-term business model as they once again (and everybody together this time) sell an overpriced commodity product to which they don’t even own the patent.  That’s right, they don’t develop the technology behind their scratch proof product nor do they own the proprietary rights to that film so basically they are simply marketing someone else’s shit and if that shit were really that differentiated or valuable, Apple or someone would bigger would price Zagg out of the market for it.

That said, Money McBags will give them props for figuring out how to take that film, cut it in to the shape of a mobile device, mark it the fuck up, and sell the shit out of it even though it is more of a pain in the ass to apply than common sense in an Economics class.  Anyway, below is Money McBags’ break out of the Q:

The Good:

1.  Revenue grew 136% to ~$23MM as they continue to take advantage of new Apple launches, the growth of mobile devices, new distribution channels, and the lack of common sense among US consumers (because seriously, there are simply cheaper fucking options out there).

2.  On the call they said demand keeps exceeding their forecast and the forecast of their distributors.  Of course if your forecast is 1, that is not too hard to exceed (and yes that is a joke, Money McBags is sure they forecast at least 3 sales and not just 1).  That said, since Money McBags does not know what those forecasts are, he can’t say that he is too impressed that they continue to be exceeded, after all 70%+ of US companies beat earnings guesses this Q and Money McBags wouldn’t call this a healthy market or a good economy so the absolute value of expectations and not the relative value are what matter.  For instance, if you go on a blind date to appease a friend and you are expecting to meet someone who could beat Amy Winehouse in an ugly contest and instead you do slightly better and meet someone who looks like Uncle Fester, is that something about which to celebrate?

3.  They continue to add to their distribution channel.  Getting AT&T as a channel partner is a nice win and signing a deal with Radio Shack should also be beneficial.  Getting your product in to the stores is a big fucking step, now getting them placed somewhere other than next to the cheaper alternatives is the next big step.

4.  On the call they said that they are not stuffing the channel and that Best Buy can not put back any product to Zagg.  So while ZAGG has a sales return liability of $1.4MM on their balance sheet, it is not in case there are sell through issues, but in case people think the product sucks.  That said, given that Best Buy orders on short notice and doesn’t keep huge inventories, this is a nice to know, but probably not a huge deal, like finding out Jamie Lee Curtis used to have a penis.

5.  They actually had some earnings, $.16 per share to be exact and while operating costs were up, their operating margins were the best ever as they are finally getting leverage.  So kudos there.

6.   Their new ZaggMate won an honorary design and innovation award from the CES which might mean something to Money McBags if every fucking company who paid for an exhibition booth at CES didn’t win one as well (seriously, look at the list, there were like 100 of these award winners, though strangely enough Money McBags couldn’t actually find Zagg listed, but he’ll assume he just didn’t look closely enough, and not that there is something nefarious going on.  Though if you can find them on the list, let Money McBags know. UPDATE: A kind reader of the award winning When Genius Prevailed found ZAGG listed at the bottom of the Portable Multimedia Accessories page, so there it is).  So basically bragging about that award is like a 6 year old bragging about the trophy he got for playing youth soccer, since you know, every little fucker gets a trophy for running around.  It might also mean something if this weren’t the third year in a row ZAGG had won that award seeing as how their other products that won this award have generated enough sales for Money McBags to count on zero fingers and zero toes.  Zaggbuds or ZaggBox anyone?

Issues:


1. Gross margin continues to drop as their sales mix becomes dominated by indirect channels which are now 75% of sales and obviously have lower gross margins than internet sales.  Gross profit margins fell y/y from 54% to 50% and were flat sequentially, so 50 is the new 60.  On the call management said any new product targets 50% gross margins which means margins will likely come down as pricing pressure picks up.

2.  They had a blow out Q and yet maintained their guidance of 70% growth for the year which means next Q they are only forecasting $18MM of sales which will be up 58% y/y (so that’s good) but down sequentially by 22% in what should be their best quarter.  Just seems odd and no one on the call asked them about this.  Of course maybe they just want to keep guidance low so they can beat guesses next Q and start managing earnings like the great Jack Welch used to do, not the strategy Money McBags would take, but it is a strategy.

3.  They are still not generating any cash.  Fuck, their business generates less cash than a Nedra Voldz french kissing booth.  A/R and inventories continue to spike (both up ~3x since the beginning of the year with sales up ~73%) which is fine since this is a growing company (until its not) but at some point cash flow needs to be positive as they only have 250k lap dance worth of cash on their balance sheet (or $5MM for those of you who still cling to archaic monetary denominations).  They say the A/R spike is due to Best Buy, so in theory those should eventually be paid because it’s unlikely Best Buy will default, but Zagg is going to need to pay more attention to working capital (and probably Heather Vandeven) if they want to keep growing.

4.  Management remains promotional and a bit shady.  When talking about their new ZaggMate product on the call, the CEO said “I just found out that the zaggmate today was featured on gizmodo’s home page.”  So Money McBags did what sell side analysts hate doing and actually tried to verify something said by a management team rather than just taking them at face value (though Money McBags would love to face Nina Moric‘s value) and went to the Gizmodo home page to find the article.  Well guess what?  ZaggMate wasn’t just not on Gizmodo’s home page that day, but a competitive product was.  No fucking joke.  This is the article to which the CEO was referring (unless you can find something different) and it is about a product from Crux360 which looks to be the same thing as the fucking ZaggMate.  Now there were some user comments about the ZaggMate in the comments section of the article, but that is not what the CEO said.

Does this matter at all?  Not really, but it just rubs Money McBags the wrong way when management teams say completely full of shit things because they want to be promotional.  Maybe the CEO just misinterpreted bad information given to him, but the willingness to give that out without verifying it because it sounds good does not inspire confidence.

5.  They continue to charge less than the cost of shipping to send products.  This has befuddled Money McBags for quarters now and no one has been able to adequately explain this.  Maybe every company is like this, but “amounts invoiced to customers for shipping and handling are included in sales and were $1,363,608 for the nine months ended September 30, 2010.  Actual shipping and handling costs to ship products to customers are included in cost of sales and were $5,689,232 for the nine months ended September 30, 2010.“  WTF?   Just fucking charge shipping costs.  This highlights the price sensitivity of their product as if they actually charged full shipping, volume would likely drop.  Yeah, it’s the cost of doing business, but then why charge shipping at all?  Shit, why not just set up drive through windows?

6.  While they may finally be expanding their relationships, they still rely on one big customer which is Best Buy who accounted for 42% of their revenue, up from 38% in Q3 last year and 74% of their A/R, so they remain about as diversified as an episode of the Dukes of Hazzard.  But here is the real issue with having only one customer (as stated in their 10K): “Best Buy does not have minimum purchase requirements and can stop purchasing our products at any time or with very short notice.” So all it takes is for one dick bag in Best Buy’s ordering department to decide on a new flavor of the month or to get pissed off with the airbubbles his Zagg InvisibleShield left on his iPhone and Zagg will be more fucked than Krissy Lynn on the set of the delicious Blow Me Sandwich 14 (and Money McBags assumes that comes with extra mayo).

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The Weird:

There were two weird things that happened in the Q and Money McBags has no idea what to do with them other than just put them here and hope someone can better explain them.

1.  They settled a patent suit against them brought up by Andrew Mason and his company eShields.  It sounds like rather than litigating whatever the fuck was being litigated, Zagg management agreed just to buy the two patents to end the dispute.  As of right now ZAGG is paying ~$350k plus warrants and shares with the potential for another $500k payment and 470k shares to be issued.  That’s not chump change for a small company.  And this isn’t for the patent to the materials that go in their product, it’s for patents on the packaging or the squeeging or some dumb shit like that.  It’s not clear to Money McBags what the long-term benefit of this is other than ZAGG gets to stay in business, but it needed to be pointed out.

2.  Now this is the weirdest shit of all, weirder than someone firing this woman for being too sensual (because Money McBags has seen artichokes that are more sensual than her, but perhaps all of the stress of having big boobs caused her to gain weight, and look like a man).  ZAGG is apparently working on a patent or has a patent for something called hZo which will somehow provide protection for electronics underwater, because calling your mom and facebooking your friends while while getting a hummer in the shower is so necessary.  Look if Money McBags drops his phone in the urinal, he doesn’t give a shit if it still works, he’s leaving it there, but whatever.

Anyway, here is the really weird fucking part.  Some dude who is hella short this company put out this piece after earnings on this relationship and it could have been the reason for the huge sell off yesterday.  That said, Money McBags has zero insight as to whether anything in that piece is true (he actually assumes it isn’t) and frankly doesn’t get how the fuck whatever Zagg is accused of doing actually helps them out.  Just a really big WTF, like General Mclellan dragging his feet in the Civil War or this Jeff Goldblum-Bizmarkie duet.  Makes no sense.  So if Money McBags understands it, the accusation is that they loaned money to a fake company for marketing rights to some shitty patent of a process that doesn’t even need a patent?  Huh?  Seriously, if Zagg management were that nefarious, what are they getting out of it?

Look, Money McBags just basically took a piss all over this company in the preceding hundred paragraphs or so, but his belief that this company has long-term issues has nothing to do with whatever the fuck is going on with hZo so he is going to ignore the whole thing until someone can explain the impetus behind it (though if someone could explain the impetus behind Hanna Hilton‘s retirement, that would be better).

Anyway, Money McBags has absolutely no idea WTF the deal with this patent is but he is pretty sure if this hZo were really on to something they would have a partner a bit more relevant than ZAGG.  So the only thing concerning is that ZAGG has somehow invested $2MM or $3MM in to what is likely an irrelevant thing, but that’s it.

Summary:

So what the fuck do we do here?  Money McBags last guess for 2010 was $.60 per share and based on slightly higher operating expenses, (he is going to up those from $20MM to $22MM) and keeping their growth at 30% for 2011 and gross margins at 50% that gets them to ~$.54 eps next year (of course all of this is using their current guidance for 2010 as a baseline).  Given that, the stock is trading ~15x which isn’t really all that expensive for their growth.  It’s also possible that Money McBags top line numbers are too low based on this past Q and Zagg gaining new distribution, so the $.54-$.60 range could actually be a floor.

So yeah, in the short run this company may do fine and probably isn’t that expensive, but in the long run, Money McBags sees real competitive problems as they remain 0 for their existence in innovating and selling new products other than the InvisibleShield.  Eventually pricing competition takes over in commodity markets where brand equity is non-existent so maybe it’s not this quarter or next, but eventually Zagg will run in to real problems.  And yes, Money McBags just dropped ~2k negatively slanted words to come to the conclusion that if you believe the numbers, the stock probably has more upside in the short-term than downside, but at least you ran in to Hanna Hilton along the way.

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