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Edited Transcript of ZAGG.OQ earnings conference call or presentation 6-Nov-19 10:00pm GMT

Q3 2019 Zagg Inc Earnings Call

Nov 7, 2019 (Thomson StreetEvents) -- Edited Transcript of Zagg Inc earnings conference call or presentation Wednesday, November 6, 2019 at 10:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Chris Ahern

ZAGG Inc - CEO & Director

* Taylor D. Smith

ZAGG Inc - CFO

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Conference Call Participants

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* David Michael King

Roth Capital Partners, LLC, Research Division - MD & Senior Research Analyst

* Jon Robert Hickman

Ladenburg Thalmann & Co. Inc., Research Division - MD of Equity Research & Special Situations Analyst

* Sean Henderson

D.A. Davidson & Co. - Research Associate

* Brendon Frey

ICR, LLC - MD

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Presentation

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Operator [1]

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We are recording this call. Good afternoon, ladies and gentlemen, and welcome to the ZaGG Third Quarter 2019 Earnings Conference Call. (Operator Instructions)

As a reminder, this conference call is being recorded.

I would now like to turn the conference over to your host, Mr. Brendon Frey. Sir, you may begin.

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Brendon Frey, ICR, LLC - MD [2]

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Thank you, Ian. Good afternoon, and thank you for joining us today to review ZAGG's third quarter 2019 financial results. On the call today, we have Chris Ahern, Chief Executive Officer; and Taylor Smith, Chief Financial Officer. Following Chris and Taylor's prepared comments, we will open the call for a question-and-answer session.

Our third quarter earnings press release was issued today after the market closed at approximately 4:00 p.m. Eastern Time. As a follow-on to the earnings release, we published the supplemental financial information on our Investor Relations website, and we also furnished this document to the SEC on Form 8-K. You can find all of our earnings documents on our Investor Relations website at zagg.com in the quarterly results section under the Financials tab. We are recording this call and a podcast of the conference call will be archived at the ZAGG Investor Relations page under the Events tab for 1 year.

Before we begin, we would like to remind everyone that the prepared remarks contain certain forward-looking statements, and management may make additional forward-looking statements in response to your questions. These statements include, but are not limited to, our outlook for the company and statements that are -- that estimate or project future results of operations or the performance of the company. These statements do not guarantee future performance and speak as of the date hereof. For a more detailed discussion on the factors that can cause actual results to differ materially from those projected in the forward-looking statements.

We refer all that you to the risk factors contained in ZAGG's annual report on Form 10-K and quarterly reports on Form 10-Q filed with the Securities and Exchange Commission. ZAGG assumes no obligation to revise any forward-looking statements that may be made in today's press release or call.

Please note that on today's call, in addition to discussing the GAAP financial results and the outlook for the company, we will discuss adjusted EBITDA and diluted operating earnings per share, both non-GAAP financial measures. An explanation of ZAGG's use of these non-GAAP financial measures in this call and the reconciliation of GAAP and non-GAAP measures required by SEC Regulation G is included in ZAGG's press release today, which, again, can be found on the Investor Relations section of the company's website.

The non-GAAP information is not a substitute for any performance measure derived in accordance with GAAP and the use of such non-GAAP measures has limitations, which are detailed in the company's press release.

I'd now like to turn the call over to Chris Ahern. Chris?

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Chris Ahern, ZAGG Inc - CEO & Director [3]

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Thank you, Brendan. Good afternoon, and thank you all for taking the time to join us today. The third quarter marked our return to growth as we started to realize the benefits of our recent acquisitions in a much more meaningful way. And continue to experience strong gains across our international markets. The contributions from sales of Gear4 cases, HALO power products and BRAVEN audio, combined with increases for both InvisibleShield and mophie in our international markets drove a 4% increase in net sales to $146 million and adjusted EBITDA of $21 million.

While our core domestic business continued to face marketplace pressures during the third quarter, we did see year-over-year declines stabilize compared to the first half of the year as we launched several new innovative products that have performed well over the years.

I'm going to walk you through the Q3 highlights from each of these product categories, Taylor will then review the financials in more detail and discuss guidance.

We'll then be happy to take questions.

Starting with Protection, our largest category, which includes screen protection in cases, InvisibleShield expanded its popular VisionGuard collection with the introduction of a new antimicrobial technology, which eliminates 99% of software's bacteria on device screens. This is a first-of-its-kind combination of VisionGuard blue light filtration technology and this new antimicrobial features strengthens InvisibleShield's position as an innovative leader, not only in device protection, but also in protecting your heads. This focus on innovation allows the brand to continue to drive higher ASPs, with over 60% premium versus rest of market.

We introduced a version of these exciting new products, along with the brand's entire glass elite line of screen protection for Apple's most recent smartphone, the iPhone 11, 11 Pro and 11 Pro Max, as well as Google's new Pixel 4 and Pixel 4 XL. Screen protection market share appears to have stabilized approximately 45% over the last 2 quarters, although in line with our expectations, we were pleased to see multi-market share increased to 46% during the month of September.

As we mentioned on the last call, our strategy to stabilize and grow our market share in this category continues to be centered around: One, launching our innovative products into the market; and two, segmenting our portfolio to address retail level MSRP price points. We're executing this strategy and it's working well.

On Gear4, we had a very productive quarter as it launched new case designs compatible with several new OEM devices from Apple, Samsung and Google. Consumer response to the brand and its differentiated D3O technology has been very encouraging and is helping drive new doors and distribution expansion. During the quarter, we continued to make good progress expanding the brand across our U.S. retail network, adding doors at Verizon, AT&T, Sprint, Target as well as several others.

Turning over to Power, starting with power management. This business experienced a healthy year-over-year improvement, thanks to the addition of our HALO brand, which we acquired in January. During the third quarter, we began loading our HALO Board products into QVC ahead of several 4-quarter sales events.

In addition, we launched several new mophie products at Apple stores, where we have expanded our offering with a full line of cables and new wireless charging solutions, including 2 multi-device wireless charge pads designed to work with a variety of devices within the Apple ecosystem. We have also launched versions of these new wireless charging solutions across most of our retail partners, and we're very pleased with the results we're seeing. With respect to power cases. In October, we announced just recently -- sorry, in October, we announced -- we just recently shipped mophie juice pack access batteries for the latest line of apple IPhones. These devices are now hitting stores. The speed in which we were able to bring the next [irritation-adaptation] of this industry-leading product line to market was our fastest ever. With its extra battery life and slim light-weight, yet protective design, the juice pack access delivers a wireless charge and frees its lightning ports, so users can listen to music or take calls at the same time.

Our market share in this category dipped to 25% during the first quarter of 2019, but we're happy to report continued steady share grow and finished the third quarter at 42% market share. We expect our share gains to continue during the fourth quarter from the launch of juice pack access for the new Apple devices.

In audio, we launched BRAVEN's new rolled port of the speaker line featuring durable shock proof and Waterproof construction while delivering exceptional sound quality. These products have been very well received, and we expect a nice contribution during the fourth quarter as we head into 2020.

In our International business, the team opened product new doors across various carrier and retail stores, both Europe and in Latin America. We continue to see strong international growth. In fact, compared to last year. Third quarter International sales are up 47%. International continues to be an area of growing investment for the business and a key strength in achieving our long-term plan.

All in all, the third quarter played out as we expected. While we have seen some stabilization in the smartphone market fueled impart by the initial launch of the Apple devices. Overall, unit sales are tracking slightly below our expectations. Taylor will go through guidance in more detail shortly, but we still expect full year revenue to be within the $520 million and $550 million range that we communicated at our last earnings call.

Looking out beyond 2019, we expect positive year-over-year comparisons during the first half of 2020 due to: one, tariff loadings that we pulled sales from first half of 2019 into the fourth quarter 2018; and two, new OEM handsets expected to be launched during the first quarter 2020. In addition, we expect the innovation of 5G technology to reverse the recent downward trend in smartphone sales as consumers adopt this new technology. We expect this to be a 2- to 3-year upward trend for sales.

Ultimately, this will also be a strong driver of our core business as we continued to bring new products and innovation to the market.

Before I turn the call over to Taylor, I want to emphasize that the Board of Directors are deeply committed to work we're doing at Bank of America Merrill Lynch as we go through the process of strategic alternatives to maximize our shareholder value. However, as I said when we announced this process on our last earnings call, we are not in a position to comment until we have made a decision and prepare to announce its outcome, and this includes responding to various rumors in the media. With that, I will hand the call over to Taylor.

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Taylor D. Smith, ZAGG Inc - CFO [4]

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Thanks, Chris. Since many details of our quarterly financial performance were included in the supplemental financial information issued earlier today, I would just like to take a few minutes to add some additional comments on our third quarter financial performance.

Net sales increased approximately 4% to $146 million, driven by increased sales of our protective cases under our Gear4 brand and increased power measurement sales, driven primarily by HALO product sales and new mophie products launched during the quarter.

This was partially offset by lower sales of stream protection products within the U.S. market. Gross profit as a percentage of net sales remained flat at approximately 37% despite the impact from increased tariffs and a decrease in sales of screen protection, our highest margin category. As we mentioned on the last earnings call, our tariff mitigation efforts have included the following: one, negotiating price reductions and manufacturers 2, passing along tariff increases to customers, 3 purchasing inventory in advance of tariff increases; and four, exploring the movement of manufacturing out of China. These efforts have been largely successful in mitigating the vast majority of tariff impacts to margin in 2019.

In terms of product mix, the decline in screen protection was offset by an increase in sales of Gear4 branded cases and HALO branded power products, which both carry gross margins above the company average. These were combined also with higher sales of InvisibleShield VisionGuard products. Operating expenses increased 26% or approximately $9 million compared to last year, due primarily to the impact of Gear4, HALO and BRAVEN operating expenses.

This includes the amortization of intangible assets and a third quarter purchase accounting adjustment. These 2 items alone resulted in a $2 million operating expense increase compared to the third quarter last year.

In addition, as we mentioned on the last call, we implemented a restructuring plan during June and July this year, which resulted in a $2 million severance charge that impacted the third quarter. We expect the restructuring to drive gross annual savings of approximately $8 million. Last, we saw increased marketing investment to support new third quarter product launches as well as to support our growing portfolio of brands, products and channels. Adjusted EBITDA was $21 million versus $24 million in the prior year period, which is consistent with our expectations. When compared with the first half of 2019, we're pleased with the improvement in adjusted EBITDA and expect our restructuring efforts, combined with better leverage of fixed costs during 2020 to drive further improvements in operating results going forward.

Turning to the balance sheet. Compared to a year ago, accounts receivable increased 17% to $135 million, and DSOs increased from 76 days to 87 days. Increase in AR and DSOs is primarily driven by 2 factors: first, direct sales to Verizon increased significantly during the third quarter, which are on 90-day payment terms. Verizon Direct AR currently represents approximately 30% of outstanding AR. Second, we saw an increased sales mix in our International business, which are generally at 90-day payment terms. The quality of our receivables remains very good.

Inventory increased from $79 million to $138 million compared to the same period last year. Over half of the increase was due to incremental inventory associated with our recent acquisitions, which sales are largely back-end weighted. This is particularly true for HALO, which carried a significant inventory balance at quarter end to support QVC load-ins during October and November. In addition, we saw an increase in inventory at international to support its 2019 growth, which is projected to be approximately 40% year-over-year and some additional inventory on hand due to the slowing of OEM handset sales during 2019.

Despite the increased inventory position, the excess inventory SKUs or current product that has helped to mitigate some of the tariff impacts during 2019 and will continue to be sold down throughout the fourth quarter and into 2020. Consolidated inventory turns were approximately 4x, excluding acquisitions, down from 7x in the prior year period. We expect to get back to between 5 to 6 turns by the time we exit the year.

Net debt, which is consolidated debt less cash, increased to $97 million compared to $10 million last year. The increase was due to cash used for the Gear4 and HALO acquisitions of approximately $50 million, $10 million for share repurchase and the remaining to fund ongoing operations, particularly with our newly acquired brands.

As Chris mentioned, OEM handset sales are slightly behind our estimates for the second half of the year. However, we are still confident in the guidance range provided, which is: Net sales in a range of $520 million to $550 million, gross profit margin in the mid-30s as a percent of sales, operating earnings per share in a range of $0.75 to $1 or approximately 29.7 million shares outstanding. As a reminder, we use operating earnings per share, which excludes the tax-affected impact of restructuring and transaction-related expenses, including amortization from the Gear4, HALO and BRAVEN acquisitions to help provide an easier apples-to-apples comparison with the prior year. We continue to estimate our annual tax rate to be approximately 25%. Last, adjusted EBITDA for 2019 is estimated at $52 million to $62 million.

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

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question is from Michael Malouf from Craig-Hallum.

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Unidentified Analyst, [2]

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This is Clarke Murphy on for Mike. I just wanted to start off with our first question. We noticed that you're InvisibleShield market share was down to 45% in the quarter. And in your letter, you talked about kind of increased competition in this space, and we are just wondering what you guys are doing to combat this?

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Chris Ahern, ZAGG Inc - CEO & Director [3]

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Yes. So in terms of 45%, it's stabilized at that like the last quarter in terms of our update. So what we've done is to make sure that to maintain it and grow it as we put a segmentation in place, whereby we're able to address some of the competitive natures be in around own brand are what we would consider entry-level price point. So we've implemented that strategy this quarter or last quarter for the new device launches, and it is starting to play off as to our expectation. So on the month of September, we've seen an increase of share -- market share by 1 point already, and we would anticipate that we continue to get some share back there. You won't see all of the market share back because a lot of the data from the NPD would be in the suppressed market, which obviously holds some of the house brands, where we are also playing as part of the segmentation process. So overall, we feel that we've got a good plan to be able to stabilize, maintain and even grow the market share again.

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Unidentified Analyst, [4]

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Okay, great. And just one more quickly. I don't know if you guys have any additional color on any device sale expectations for the kind of the next-gen or 5G devices kind of for the next year or so? If you guys have any color on that?

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Chris Ahern, ZAGG Inc - CEO & Director [5]

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Yes. Obviously, we can't comment on OEM launches, but we would expect that we have similar timing of launches in Q1 and obviously, the back end of next year. And the big thing for us is the rollout of 5G infrastructure for the marketplace, and we really see that as a technology that will be adopted by consumers and really builds us a growth plan over the next 2 to 3 years. So yes, we're excited about 2020 in terms of what new devices are coming down.

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Operator [6]

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The next question is from Dave King from Roth Capital markets -- partners.

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David Michael King, Roth Capital Partners, LLC, Research Division - MD & Senior Research Analyst [7]

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So I guess, first off, on HALO and Gear4. Do you have what they contributed in revenue in the quarter? And then what are your current expectations in terms of how much they should be contributing to the business in Q4.

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Chris Ahern, ZAGG Inc - CEO & Director [8]

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Yes. So the number they contributed during the third quarter was about $24 million. So as we look at the kind of the full year, we originally talked about the 3 brands did approximately $69 million in revenue last year. When we originally guided, we thought that they could do 5% to 10% above and beyond the 69, given what we talked about in Q2 and some of the real headwind we've been able to make with the brands here since then, we expect it to be quite a bit above that. So probably wouldn't guide to a specific number on just one of our brands, but the rest assured, its well above the 10% that we had originally projected.

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Taylor D. Smith, ZAGG Inc - CFO [9]

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As far as for next year, Dave, we still see the acquisition as a real area of growth. There are some farther doors that we can open in terms of some good retail partners that we have relationships with, so we're excited about the acquisitions for next year as well, why we're really happy with the execution this year. There's still further runway for growth next year as well.

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David Michael King, Roth Capital Partners, LLC, Research Division - MD & Senior Research Analyst [10]

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Okay. Okay, that's good color and good to hear. Switching gears a little bit. The -- I think it was on an earlier question on the product segmentation strategy for -- with the new screen protectors. How are -- what are the margins like on those versus your typical margins? And then I realize you also have some other stuff that's higher margin VisionGuard. And so what's sort of the expectation for screen protector margins as we move forward here into Q4 and beyond?

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Chris Ahern, ZAGG Inc - CEO & Director [11]

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Yes. So I would look at it in terms of actually maintaining the market -- the margin that we have on screen protection, if not growing it. So on the innovation side, with antimicrobial vision blue Light protection, we're increasing our margin. And on the segmentation, we're actually maintaining our margins. So we're not diluting the margin percent. And that was the whole reason for our strategy around making sure we segment it correctly without impacting margin. So from an overall perspective, look at it as stabilizing, if not increasing our margins.

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David Michael King, Roth Capital Partners, LLC, Research Division - MD & Senior Research Analyst [12]

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Okay, okay. And then, I guess, one more for me. On the new juice pack access, congrats on getting that out as early as you did for this cycle. Did you ship any of that in Q3? Or was that all sort of Q4? And then how much of load in benefit do you expect to get in Q4, how should we be modeling the contribution from that? Is it similar to other sort of juice pack launches that you had in previous years, how would you contextualize that for us?

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Chris Ahern, ZAGG Inc - CEO & Director [13]

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Yes. So I would say it's going to be all of Q4 revenue, but hit stores, et cetera. I know, Taylor, if you want to give a bit of color on the revenue side?

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Taylor D. Smith, ZAGG Inc - CFO [14]

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Yes. I think if you look back a couple of years, the best we ever did in Q4 was get that product launched in December, I believe it was 2017. As we look at this year, we certainly don't think we're going to get back to probably that level, but we expect, definitely incremental sales from the juice pack access. So I probably -- as I mentioned on the previous question, we probably wouldn't be in a position where we want to guide for a particular product category, but we definitely would expect to be above and beyond what we were able to do last year.

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Operator [15]

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The next question is from Jon Hickman from Ladenburg.

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Jon Robert Hickman, Ladenburg Thalmann & Co. Inc., Research Division - MD of Equity Research & Special Situations Analyst [16]

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Taylor, could you elaborate a little bit on the the operating expenses, you said something about an inventory charge related to the acquisition? Does that (inaudible) ?

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Taylor D. Smith, ZAGG Inc - CFO [17]

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It was a purchase accounting charge of about $400,000 that hit during the period as well as amortization from the acquired brands, just from the intangibles that we acquired. In addition to that, I mentioned, there was about a $1.8 million restructuring charge that hit during the quarter related to the severance charges for the restructure.

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Jon Robert Hickman, Ladenburg Thalmann & Co. Inc., Research Division - MD of Equity Research & Special Situations Analyst [18]

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So help us out in the fourth quarter, that $1.8 million won't hit again. The $400,000 won't be there. So operating expenses will come down by maybe $3 million.

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Taylor D. Smith, ZAGG Inc - CFO [19]

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Yes, we should definitely see an incremental reduction or a consecutive reduction from Q3 to Q4. And yes, I mean, I think both of those come right off, right, there's at least $2.2 million that shouldn't recur as a result of those onetime charges.

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Jon Robert Hickman, Ladenburg Thalmann & Co. Inc., Research Division - MD of Equity Research & Special Situations Analyst [20]

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And when you say an $8 million annual savings. Is that like into 2020, kind of, $2 million a quarter.

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Taylor D. Smith, ZAGG Inc - CFO [21]

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Yes, the way I'd look at it is like so, with the headcount reductions that we were able to execute on as part of the restructure. There's gross annual savings of about $8 million. So if we didn't do anything, we'd be able to take that into next year. Of course, there's going to be other areas of the business where we're going to invest and maybe some other headcount that are going to need to be added as we grow. And so I wouldn't bring the entire $8 million in the savings. That's the gross amount adjusted for some headcount that we may need as we grow the business in the 2020. Does that make sense?

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Jon Robert Hickman, Ladenburg Thalmann & Co. Inc., Research Division - MD of Equity Research & Special Situations Analyst [22]

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Yes, that makes sense. And one more thing. I got cut off for a minute. Did you guys say anything about the on-demand product and how that's going, here in the states?

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Chris Ahern, ZAGG Inc - CEO & Director [23]

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No. So we did make a comment on it, Jon, but I'm happy to give you some color. So we continue to see growth in InvisibleShield on demand, both internationally, and we're starting to make some headway here in North America. So we couldn't be any more pleased with that service. It continues to lead the way in both Europe and Latin America, opening new doors, as well as giving an opportunity to get our other brands in conjunction with that service. In North America, yes, we are starting to make some headwinds. Earlier this quarter, we haven't gone out publicly and mentioned the partner, but we will be in a position by the end of the year or early next year, we'll be able to give some more color on some of the partners that we're working with on that service in North America.

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Operator [24]

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Your final question is from Sean Henderson from D.A. Davidson.

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Sean Henderson, D.A. Davidson & Co. - Research Associate [25]

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Just real quick, if you guys could provide some kind of just an updated time line on moving some of your sourcing outside of China. Just kind of an updated outlook on that? And how we should think about on it?

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Chris Ahern, ZAGG Inc - CEO & Director [26]

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Yes, sure.

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Sean Henderson, D.A. Davidson & Co. - Research Associate [27]

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on a time frame basis.

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Chris Ahern, ZAGG Inc - CEO & Director [28]

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Yes, sure. So we're not looking at just added solution, Sean. So those 3 areas of focus for us, and one is obviously working with our current set of partners in China in terms of cost negotiations. And obviously, as we bring new products to market, we take all of that tariff into account before we actually launch the product. So that's one area where we're looking at. Secondly, as obviously, where current products where we don't have leeway to actually take more costs out of the entire process, we will have -- and we have had negotiations with some of our retail and carrier partners where we would pass on that cost. And then [part of it], obviously, as you mentioned, with time lines around moving some of our production out of China. We have started the process in some of our key categories. Obviously, I can't go into too much detail, but we would expect a significant amount of our power category will be outside of China in 2020, particularly in the wireless charging arena, so that's how we look at it. We obviously have a plan for the entire business in terms of if we do have to go out of China and despite category, but I'm not going to go into too much detail here, but we're pretty happy with the overall plan. It takes us out to the back end of 2021.

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Operator [29]

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Thank you. That concludes the Q&A session. I would now like to turn the conference back to the speakers for closing comments.

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Chris Ahern, ZAGG Inc - CEO & Director [30]

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Thank you for joining us on today's call. We appreciate you giving the time to join us, and we look forward to our next call, updating you on our final year performance. Thank you.

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Operator [31]

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Ladies and gentlemen, this concludes today's conference. Thank you for your participation, and have a wonderful day. You may disconnect.