TMCnet News

ZAGG INC - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
[November 08, 2012]

ZAGG INC - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS


(Edgar Glimpses Via Acquire Media NewsEdge) Certain statements, other than purely historical information, including estimates, projections, statements relating to our business plans, objectives, and expected operating results, and the assumptions upon which those statements are based, are "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. These forward-looking statements generally are identified by the words "believes," "project," "expects," "anticipates," "estimates," "forecasts," "intends," "strategy," "plan," "may," "will," "would," "will be," "will continue," "will likely result," and similar expressions. We intend such forward-looking statements to be covered by the safe-harbor provisions for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995, and are including this statement for purposes of complying with those safe-harbor provisions. Forward-looking statements are based on current expectations and assumptions that are subject to risks and uncertainties which may cause actual results to differ materially from the forward-looking statements. Our ability to predict results or the actual effect of future plans or strategies is inherently uncertain. Factors which could have a material adverse affect on our operations and future prospects include, but are not limited to: changes in economic conditions, legislative/regulatory changes, availability of capital, interest rates, competition, and generally accepted accounting principles. These risks and uncertainties should also be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements. We undertake no obligation to update or revise publicly any forward-looking statements, whether as a result of new information, future events or otherwise. Further information concerning our business, including additional factors that could materially affect our financial results, is included herein and in our other filings with the SEC.



Our Business ZAGG Inc, headquartered in Salt Lake City, Utah, with offices in Logan, Utah, and Shannon, Ireland, designs, produces, and distributes protective coverings, keyboards, keyboard cases, earbuds, mobile power solutions, and device cleaning accessories under the family of ZAGG brands. Within the family of ZAGG brand are products sold under the following brand names: invisibleSHIELD®, ZAGGskins™, ZAGGbuds™, ZAGGsparq™, ZAGGfolio™, ZAGGmate™, ZAGGkeys™, ZAGGkeys PRO™, and ZAGGkeys PRO Plus™.

In addition, the Company designs, produces, and distributes cases, earbuds, and headphones under the family of iFrogz brands in the value-priced lifestyle sector. Within the iFrogz brand are products sold under the following brand names: iFrogz™, Earpollution™, and Caliber.


We maintain our headquarters at 3855 South 500 West, Suites B, C, D, I, J, K, L, M, N. O, P, R and S, Salt Lake City, Utah, 84115. The telephone number of the Company is 801-263-0699. Our website addresses are www.zagg.com and www.ifrogz.com. Information contained on, or accessible through, our websites is not a part of, and is not incorporated by reference into, this report.

Family of ZAGG Branded Products ZAGG invisibleSHIELD Products Our flagship product, the invisibleSHIELD, is made from a protective film covering that was developed originally to protect the leading edges of rotary blades of military helicopters. We determined that a variation of this film product could be configured to fit onto the surface of electronic devices and marketed to consumers for use in protecting such devices from every day wear and tear, including scratches, scrapes, debris and other surface blemishes. The film also permits touch sensitivity, meaning it can be used on devices that have a touch-screen interface. The invisibleSHIELD film material is highly reliable and durable because it was originally developed for use in a high friction, high velocity context within the military aerospace industry. The film provides long lasting protection for the surface of electronic devices subject to normal wear and tear. The film has a polyurethane base with the properties allowing us to develop a very thin, pliable, flexible, and durable clear plastic that adheres to the surface and shape of the object it is applied to.

The invisibleSHIELD is designed specifically for iPhones®, iPads®, iPods®, laptops, tablets, smartphones, cell phones, digital cameras, watch faces, GPS systems, gaming devices, and other mobile devices. The product is "cut" to fit specific devices and packaged together with a moisture activating solution which makes the invisibleSHIELD adhere to the surface of the device, literally "like a second skin," and virtually invisible to the eye. The patented invisibleSHIELD was the first scratch protection solution of its kind on the market. The invisibleSHIELD is not ornamental, but rather provides a long lasting barrier to preserve the brand new look of the surface of an electronic device.

32-------------------------------------------------------------------------------- Table Of Contents In early 2010, we introduced the invisibleSHIELD DRY through retail partners, which is a protective film made from the same material as the original invisibleSHIELD, and engineered to be clearer, smoother to the touch, and apply without the need of the moisture activating solution. In the beginning of 2011, we added the invisibleSHIELD Smudge-Proof to our line, which also incorporates the invisibleSHIELD film with added features that eliminate smudges, fingerprints, and glare from the device display. In January 2012, we introduced the invisibleSHIELD HD, a new premium version of the invisibleSHIELD that offers industry-leading clarity and finish. In June 2012, we introduced ZAGGprivacy, a protective film that provides visual data security for handheld electronics. In September 2012, the Company introduced a new version of the invisibleSHIELD line, the invisibleSHIELD EXTREME. The invisibleSHIELD EXTREME differs from other products in the invisibleSHIELD portfolio by offering advanced shock absorption and superior break protection. By installing the EXTREME on a compatible mobile device, consumers can worry less about broken screens as a result of dropping their smartphone, tablet, or other device.

Currently, ZAGG offers over 5,900 precision, pre-cut invisibleSHIELD designs with a lifetime replacement warranty through online channels, big-box retailers, electronics specialty stores, resellers, college bookstores, Mac stores, and mall kiosks. We plan to continue to innovate and expand the array of invisibleSHIELD products in future periods.

ZAGGaudio The ZAGGaudio brand of electronics accessories and products were first released in late 2008, and continue to focus on innovation and superior value. The flagship product within ZAGGaudio is the award winning ZAGGsmartbuds™ line, which includes ZAGGaquabuds, a water-resistant earbud introduced in late 2010. A previous winner of the CES Design and Innovation award, the ZAGGsmartbuds line has been well received by professional reviewers, experts, and the consumer base.

On January 12, 2010, we were awarded patent number US D 607,875 by the U.S.

Patent and Trademark Office, covering design elements of ZAGGsmartbuds in-ear headphones.

ZAGGskins ZAGGskins were introduced in November 2009, and combine customizable, high-resolution images with the scratch protection of ZAGG's invisibleSHIELD. To create a ZAGGskin, consumers select from a library of professional designs or upload their own high-resolution personal photos or images. The printed image, custom designed for their device, is then merged with the exclusive, ultra-tough, patented invisibleSHIELD film, which allows customers to both protect and individualize their gadgets with a single product.

We also introduced ZAGG LEATHERskins in early 2010. ZAGG LEATHERskins are thin, pliable cases that apply directly to personal electronics like a film, and are created from genuine leather. Available in typical leather shades and premium animal patterns, ZAGG LEATHERskins use an adhesive that holds the skin firmly in place on the device, but can be removed if necessary.

Later in 2010, we broadened the line to include ZAGG sportLEATHER, which are also created from genuine leather and feature authentic recreations of baseball, football and basketball textures. ZAGG LEATHERskins and sportLEATHERS are available for the most popular personal electronics.

ZAGG Power Products In early 2009, we introduced the original ZAGGsparq, a small, powerful, portable battery that can recharge a power-hungry smartphone up to four times before the ZAGGsparq itself needs to be recharged. Featuring a 6000ma lithium polymer cell, the ZAGGsparq plugs into a wall outlet and provides two USB ports for charging mobile devices. An adapter is also included that fits many international standards. The ZAGGsparq is compatible with any USB-charged device, including Apple iPads, iPods, and iPhones, as well as cell phones, handheld gaming systems, and digital cameras.

33-------------------------------------------------------------------------------- Table Of Contents In September 2012, the Company released a complete lineup of ZAGGsparq products to provide reliable power solutions for jetsetters, students, professionals and other consumers who are always on the go. Available in three size and charging options, the new family includes the ZAGGsparq 1220, ZAGGsparq 3100, and ZAGGsparq 6000. ZAGGsparq portable batteries will charge any device that utilizes a USB, including smartphones and tablets. Different from other portable batteries on the market, the ZAGGsparq family has been constructed with built-in prongs that allow the device to double as a wall charger, eliminating the need for an extra power adapter. All three new models contain Lithium Polymer batteries and are made out of polycarbonate to protect the device from wear and tear. In addition, the ZAGGsparq 3100 and 6000 feature the company's Hypercharge Technology™, a proprietary technology that enables a mobile device to receive a full charge up to four times faster than when utilizing a standard USB charger.

ZAGG Keyboard Products We introduced the ZAGGmate in November 2010. The ZAGGmate is a protective and functional companion to the Apple iPad and iPad 2, as well as the new iPad, which accentuates both the appearance and utility of Apple's innovative device.

Made from aircraft-grade aluminum with a high quality finish, the ZAGGmate matches the design, look and feel of the iPad, iPad 2, and new iPad. The ZAGGmate line features two models, one with a simple, innovative stand and built-in wireless Bluetooth® keyboard that allows for fast, responsive typing, and interaction with the iPad's features. The second model replaces the keyboard with a more versatile stand that provides multiple angles for use. The ZAGGmate was the recipient of several prestigious industry awards, including the Macworld Expo 2011 Best of Show and recognition as a CES Innovations Design and Engineering Honoree. On April 7, 2011, we partnered with Logitech on the ZAGGmate product and renamed it the Logitech Keyboard Case by ZAGG. Under the partnership with Logitech, we receive royalty payments for all units sold by Logitech. On May 9, 2012, we were awarded patent number US D 659,139 by the U.S.

Patent and Trademark Office, covering design elements of the ZAGGmate case and keyboard accessory for tablets.

As a follow up to the ZAGGmate, we launched the ZAGGfolio in July 2011. The ZAGGfolio is a stylish and functional case for the iPad 2, the new iPad, and Samsung Galaxy 10.1 tablet that not only offers full protection, but increases productivity through a removable Bluetooth keyboard. Operating with Bluetooth 3.0, the integrated battery will last for months between charges. A true 3-in-1 solution with a keyboard, stand and full protective cover, the patent-pending ZAGGfolio is the winner of multiple awards including the 2012 CES Innovations Design and Engineering Showcase Honors. In fall of 2011, we expanded the ZAGGfolio family to include 11 different colors, textures and patterns, including genuine leather.

In November 2011, ZAGG launched the ZAGGkeys FLEX, a portable Bluetooth keyboard and stand. As implied by its name, the FLEX offers flexible function for the two most popular tablet and smartphone operating systems; a switch on the keyboard toggles between the Apple iOS and Android®. The ZAGGkeys FLEX utilizes same keyboard layout as our award-winning Logitech Keyboard Case by ZAGG and ZAGGfolio, ensuring a true typing experience. The ZAGGkeys FLEX includes a unique keyboard cover that easily converts into a stable stand compatible with nearly any tablet or smartphone. The ZAGGkeys FLEX was named an honoree at the 2012 CES Innovations Design and Engineering Showcase.

In August 2012, ZAGG debuted the ZAGGkeys PRO™ and ZAGGkeys PRO Plus™ at IFA 2012 in Berlin, Germany. The ZAGGkeys Pro™ and ZAGGkeys Pro Plus™ are ultra-thin Bluetooth®keyboard accessories that accentuate the utility and convenience of the Apple iPad. Different from the original ZAGGkeys accessory, the ZAGGkeys PRO and PRO Plus utilize an innovative magnetic closure to secure the iPad, and protect the screen from scratches and smudges. The patented keyboard design of both new products provides a natural typing experience in a compact layout, with dedicated function keys to operate specific iPad features. In addition, the ZAGGkeys PRO Plus features optional backlighting for full keyboard use without the need for another light.

34-------------------------------------------------------------------------------- Table Of Contents Family of iFrogz Branded Products iFrogz Cases iFrogz began in 2006 by initially creating protective cases for Apple iPods with a unique combination of fashion and quality that was received well by the marketplace. Initially, all sales were online. However, in early 2007, iFrogz began distributing its case products through large retailers and began more firmly establishing itself as a youth- and fashion-oriented brand. Since 2007, the iFrogz case offerings have expanded to include a wide array of sleek and stylish cases for each new generation of Apple iPod, iPhone, and iPad.

iFrogz Audio In the summer of 2007, iFrogz released its first line of audio products under the Earpollution brand. The eclectic selection of Earpollution™ earbuds and headphones specifically targets a younger demographic, but still appeals to a wide demographic of consumers. Since the initial launch of the Earpollution™ audio products, iFrogz has continued to innovate and expanded its headphone and earbud product lines to include a large number of product offerings for all ages under both the Earpollution and iFrogz brands.

In February 2012, ZAGG launched the iFrogz Boost speaker under the iFrogz brand.

The iFrogz Boost speaker allows users to amplify their device's sound by simply placing their smartphone, or other device equipped with an external speaker, on top of the Boost. The Boost features patent-pending audio technology to sync the external audio signal and then amplify the sound through two high-quality 2W x 2RMS speakers. No wires, cords, Bluetooth or pairing configuration is needed.

In October 2012, ZAGG introduced the Boost Plus under the iFrogz brand, a new iteration of its portable, external wireless speaker for smartphones and MP3 players. The Boost Plus allows consumers to fill living spaces and outdoor entertainment areas with music by simply placing a sound-producing mobile device on top of the speaker. Powered by Near-Field Audio Technology™, the Boost Plus picks up the audio from a consumer's mobile device and pumps it out of three high-quality 2W x 2RMS speakers, eliminating the need for wires, cords or pairing configurations.

iFrogz Gaming In August 2012, ZAGG released the Caliber brand of headset for gamers under the iFrogz brand at IFA 2012 in Berlin, Germany. The Caliber line provides amazing design and sound quality for a premium mobile, desktop or console gaming experience. The Caliber Stealth gaming headset was created specifically for mobile devices, while the Caliber Axiom works with the most popular systems, including Xbox®, PC, Mac, and PS3®. Both include in-line controls and accessories needed for voice connections. Last in the Caliber series is the Vanguard, which has been designed to include 7.1 channel audio, a retractable microphone, and an optional bass vibration feature for fully immersive gaming.

Viewing movies with Vanguard's 7.1 channel audio and bass vibration feature provides listeners with an authentic theater experience.

iFrogz continues to innovate its audio and case product lines allowing it to remain ahead of the curve in the electronic device accessory fashion market.

35-------------------------------------------------------------------------------- Table Of Contents Recent Developments Appointment of New Director On October 1, 2012, the Board of Directors of the Company appointed Bradley J.

Holiday to serve as a member of the Company's Board. Mr. Holiday currently serves as Senior Executive Vice President, and Chief Financial Officer of Callaway Golf Company. Information about Mr. Holiday was included in a Current Report on Form 8-K filed with the SEC on October 4, 2012.

Separation and Release of Claims Agreement, Executive Consulting Agreement As previously reported, on August 17, 2012, the Board of Directors of the Company accepted the resignation of Robert G. Pedersen II as Chairman and Chief Executive Officer of the Company, as well as from any and all other roles or positions within the Company as an officer, director, or employee.

The Company also reported that the Company and Mr. Pedersen had entered into a preliminary agreement relating to the terms of Mr. Pedersen's departure from the Company, including preliminary terms of a consulting agreement and a separation agreement. The Registrant reported that it would disclose the definitive versions of such agreements upon their final agreement and execution.

On September 28, 2012, the Company entered into a definitive Separation and Release of Claims Agreement (the "Separation Agreement") relating to Mr.

Pedersen's resignation from positions with the Company, and an Executive Consulting Agreement (the "Consulting Agreement"), pursuant to which Mr.

Pedersen will provide consulting services to the Company. Information and details about the Separation Agreement and the Consulting Agreement, as well as copies of the two agreements, were included in a Current Report on Form 8-K filed with the SEC on October 4, 2012.

Code of Conduct On November 7, 2012, the Board of Directors of the Company adopted a new Code of Business Conduct and Ethics (the "Code of Ethics"), applicable to the directors, officers, and employees of the Company, its current subsidiaries, and any subsidiaries it may form in the future. The Code of Ethics contains general guidelines for conducting our business consistent with the highest standards of business ethics, and is intended to qualify as a "code of ethics" within the meaning of Section 406 of the Sarbanes-Oxley Act of 2002 and the rules promulgated thereunder.

The Code of Ethics will be available on the Company's website, and will be found at http://investors.zagg.com. We will continue to post on our website any amendments to or waivers from a provision of the Code of Ethics that applies to our principal executive officer, principal financial officer, principal accounting officer, controller or persons performing similar functions and that relates to any element of the Code of Ethics.

The Code of Ethics covers such topics as employment practices, compliance with government and industry regulations, insider trading, prohibition against short-term or speculative transactions in company securities, treatment of confidential information, proper use of Company assets, corporate opportunities, and conflicts of interest. The Code of Ethics includes a mechanism for resolving conflicts of interest and ethical issues, and explains possible consequences for failure to adhere to the code.

36-------------------------------------------------------------------------------- Table Of Contents Critical Accounting Policies The discussion and analysis of our financial condition and results of operations are based on our financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States (U.S.

GAAP). The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, we evaluate our estimates based on historical experience and on various other assumptions that are believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. Significant estimates include the allowance for doubtful accounts, inventory valuation allowances, sales returns and warranty liability, the useful life of property and equipment, stock-based compensation expense, and income taxes.

An accounting policy is deemed to be critical if it requires an accounting estimate to be made based on assumptions about matters that are highly uncertain at the time the estimate is made, if different estimates reasonably may have been used, or if changes in the estimate that are reasonably likely to occur may materially impact the financial statements. Management believes the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our consolidated financial statements.

Revenue recognition We record revenue when persuasive evidence of an arrangement exists, product delivery has occurred, the sales price to the customer is fixed or determinable, and collectability is reasonably assured. Our revenue is derived from sales of our products through our indirect channel, including retailers and distributors; through our direct channel including www.ZAGG.com, www.iFrogz.com, and our corporate-owned and third-party-owned mall kiosks; and from the fees derived from the sale of exclusive independent distributor licenses related to the kiosk program. For sales of product, our standard shipping terms are FOB shipping point, and we record revenue when the product is shipped, net of estimated returns and discounts. For some customers, the contractual shipping terms are FOB destination. For these shipments, we record revenue when the product is delivered, net of estimated returns and discounts. For license fees, we recognize revenue on a straight-line basis over the life of the license term. We record revenue from royalty agreements in the period in which the royalty is earned.

Promotional products given to customers or potential customers are recognized as a cost of sales. Cash incentives provided to our customers are recognized as a reduction of the related sale price, and, therefore, are a reduction in sales.

Reserve for sales returns and warranty liability For product sales, the Company records revenue, net of estimated returns and discounts, when products are shipped and the customer takes ownership and assumes risk of loss, collection of the relevant receivable is probable, persuasive evidence of an arrangement exists and the sales price is fixed or determinable. Our return policy generally allows its end users and retailers to return purchased products. In addition, the Company generally provides the ultimate consumer a warranty with each product. Due to the nature of the invisibleSHIELD product line, returns for the invisibleSHIELD are generally not salvageable and are not included in inventory. We estimate a reserve for sales returns and warranty and record the estimated reserve amount as a reduction of sales, and as a sales return reserve liability. The estimate for sales returns and warranty requires management to make significant estimates regarding return rates for sales and warranty returns. Historical experience, actual claims, and customer return rights are the key factors used in determining the estimated sales return and warranty reserve.

37-------------------------------------------------------------------------------- Table Of Contents Allowance for Doubtful Accounts We provide customary credit terms to our customers. We perform ongoing credit evaluations of the financial condition of our customers and maintain an allowance for doubtful accounts based upon historical collections experience and judgments as to expected collectability of accounts. Our actual bad debts may differ from our estimates.

Valuation of Note Receivable We engaged independent third-party appraisal firms to assist us in determining the fair values of collateral of the note receivable. Such valuations require significant estimates and assumptions. Management determined the value of the 80 shares of ZAGG common stock held by Mr. Harmer based on quoted market prices.

The real estate holdings securing the note receivable were valued primarily based on the sales comparison approach as sales of comparable properties were utilized. The investments in real estate companies were valued utilizing comparable market sales, a discounted cash flow analysis, and other appropriate valuation methodologies.

Management's estimates of fair value are based upon assumptions believed to be reasonable, but which are inherently uncertain and unpredictable and, as a result, actual results may differ from estimates.

Inventories In assessing the realization of inventories, we are required to make judgments as to future demand requirements and to compare these with current inventory levels. When the market value of inventory is less than the carrying value, the inventory cost is written down to the estimated net realizable value thereby establishing a new cost basis. Our inventory requirements may change based on our projected customer demand, market conditions, technological and product life cycle changes, longer or shorter than expected usage periods, and other factors that could affect the valuation of our inventories.

Income taxes Deferred income tax assets are reviewed for recoverability, and valuation allowances are provided, when necessary, to reduce deferred income tax assets to the amounts that are more likely than not to be realized based on our estimate of future taxable income. Should our expectations of taxable income change in future periods, it may be necessary to establish a valuation allowance, which could affect our results of operations in the period such a determination is made. We record income tax provision or benefit during interim periods at a rate that is based on expected results for the full year. If future changes in market conditions cause actual results for the year to be more or less favorable than those expected, adjustments to the effective income tax rate could be required.

The Company recognizes the effect of income tax positions only if those positions are more likely than not of being sustained. Recognized income tax positions are measured at the largest amount that is greater than 50% likely of being realized. The determination of the realization of certain income tax positions is subject to significant estimates based upon the facts and circumstances of each position.

38-------------------------------------------------------------------------------- Table Of Contents Long-lived Assets We have significant long-lived tangible and intangible assets consisting of property and equipment, definite-lived intangibles, indefinite-lived intangibles, an investment in HzO, and goodwill. We review these assets for impairment whenever events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable. In addition, we perform an impairment test related to indefinite-lived intangibles and goodwill at least annually. Our goodwill and intangible assets are largely attributable to our acquisition of iFrogz.

At least annually and when events and circumstances warrant an evaluation, we perform our impairment assessment of goodwill. This assessment initially permits an entity to make a qualitative assessment of whether it is more likely than not that a reporting unit's fair value is less than its carrying amount before applying the two-step goodwill impairment test. If an entity can support the conclusion that it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, it would not need to perform the two-step impairment test for the reporting unit.

However, if it is determined that it is more likely than not that the fair value of a reporting unit is less than its carrying amount, the two step analysis is performed, which incorporated a fair-value based approach. We determine the fair value of our reporting unit based on discounted cash flows and market approach analyses as considered necessary, and consider factors such as a weakened economy, reduced expectations for future cash flows coupled with a decline in the market price of our stock and market capitalization for a sustained period as indicators for potential goodwill impairment. If the reporting unit's carrying amount exceeds its estimated fair value, a second step must be performed to measure the amount of the goodwill impairment loss, if any. The second step compares the implied fair value of the reporting unit's goodwill, determined in the same manner as the amount of goodwill recognized in a business combination, with the carrying amount of such goodwill. If the carrying amount of the reporting unit's goodwill exceeds the implied fair value of that goodwill, an impairment loss is recognized in an amount equal to that excess.

Indefinite-lived intangible assets are tested for impairment annually, or, more frequently upon the occurrence of a triggering event. The Company evaluates the recoverability of indefinite-lived intangible assets by comparing the indefinite-lived intangible assets book value to its estimated fair value. The fair value for indefinite-lived intangible assets is determined by performing cash flow analysis and other market evaluations. If the fair value of the indefinite-lived intangible assets is less than book value, the difference is recognized as an impairment loss.

We test our investment in HzO each reporting period to determine whether HzO's operations or other factors indicate that the investment in HzO is impaired.

When indicators of impairment exist, we measure the fair value of our investments in HzO and compare the fair value to the carrying value. The determination of the amount of impairment, if any, is based upon the difference between the asset's carrying value and estimated fair value. Fair value is determined through various valuation techniques, including market and income approaches as considered necessary.

We assess other long-lived assets, specifically definite-lived intangibles and property, plant and equipment, for potential impairment based on similar impairment indicators. When indicators of impairment exist related to our long-lived tangible assets and definite-lived intangible assets, we use an estimate of the undiscounted net cash flows in measuring whether the carrying amount of the assets is recoverable. Measurement of the amount of impairment, if any, is based upon the difference between the asset's carrying value and estimated fair value. Fair value is determined through various valuation techniques, including market and income approaches as considered necessary.

If forecasts and assumptions used to support the realizability of our goodwill and other long-lived assets change in the future, significant impairment charges could result that would adversely affect our results of operations and financial condition.

39-------------------------------------------------------------------------------- Table Of Contents Stock-based compensation The Company recognizes stock-based compensation expense in its consolidated financial statements for awards granted to employees and non-employees under its stock incentive plan, which include restricted stock and stock options. Equity-classified awards are measured at the grant date fair value of the award. The fair value of stock options is measured on the grant date using the Black-Scholes option pricing model (BSM), which involves the use of assumptions such as expected volatility, expected term, dividend rate, and risk-free rate. Volatility is a key factor used to determine the fair value of stock options in the BSM. Based on the expected term of the award, if the Company does not have sufficient historical data or implied volatility information to determine volatility based upon its own information, the Company uses significant judgment to identify a peer group and determine the appropriate weighting in order to estimate a volatility rate for use in the BSM.

On March 30, 2012, the Company implemented a new incentive program for non-executive employees that provides for the issuance of a fixed amount of restricted stock to eligible employees if certain annual financial targets are reached. If the targets are reached for the 2012 fiscal year, these restricted shares will be transferred to employees during March 2013. The Company considers actual results to date and forecasts of future operations in determining our probability assessment of achieving the performance conditions. As of September 30, 2012, management considered it probable that the financial targets will be reached and thus began recognizing stock compensation expense on the grant date ratably over the service period of the award.

Business Combinations We allocate the purchase price of acquired companies to the tangible and intangible assets acquired and liabilities assumed based on their estimated fair values. The excess of the purchase price over these fair values is recorded as goodwill. We engaged independent third-party appraisal firms to assist us in determining the fair values of assets acquired and liabilities assumed. Such valuations require management to make significant estimates and assumptions, especially with respect to intangible assets. The significant purchased classes of intangible assets recorded by us include customer relationships, trademarks, non-compete agreements, developed technology, patents, and backlog. The fair values assigned to the identified intangible assets are discussed in Note 2 to the condensed consolidated financial statements.

Critical estimates in valuing certain intangible assets include but are not limited to: future expected cash flows related to each individual asset, market position of the trademarks, as well as assumptions about cash flow savings from the trademarks, and discount rates. Management's estimates of fair value are based upon assumptions believed to be reasonable, but which are inherently uncertain and unpredictable and, as a result, actual results may differ from estimates.

Results of Operations THREE MONTHS ENDED SEPTEMBER 30, 2012 AND 2011 (amounts in thousands, except per share data) 40 -------------------------------------------------------------------------------- Table Of Contents Net sales Net sales for the quarter ended September 30, 2012, were $59,828 as compared to net sales of $45,887 for the quarter ended September 30, 2011, an increase of $13,941 or 30%.

For the quarter ended September 30, 2012, sales of our invisibleSHIELD product line accounted for approximately 51% of our revenues, compared to approximately 59% of our revenues for the quarter ended September 30, 2011. We have experienced significant growth in our indirect channel to big-box retailers such as Best Buy, Walmart, Target, Radio Shack, and Staples; wireless carriers such as AT&T, Verizon, The Carphone Warehouse, T-Mobile, Sprint, and Cricket; and domestic and foreign electronics accessory distributors. We are still focused on distribution through our mall kiosk program and through our websites (www.ZAGG.com, and www.iFrogz.com), but the significant growth for the third quarter of 2012 was through our continued expansion within our indirect channel as we began selling through additional customers and expanded our SKU count in our current customers. For the quarter ended September 30, 2012, approximately 83% of our overall net sales were through our indirect channel, 10% was through our website, 6% was through our mall cart, and kiosk programs and 1% was from shipping and handling charges.

Cost of sales Cost of sales includes raw materials, packing materials, and shipping and fulfillment costs. For the quarter ended September 30, 2012, cost of sales amounted to $33,203 or approximately 55% of net sales compared to cost of sales of $26,414 or 58% of net sales for the quarter ended September 30, 2011.

Gross profit Gross profit for the quarter ended September 30, 2012, was $26,625 or approximately 45% of net sales, as compared to $19,473 or approximately 42% of net sales for the quarter ended September 30, 2011. The increase in gross profit margin from the prior year is primarily related to (1) costs incurred during 2011 related to the fair value write-up of iFrogz inventory as part of purchase accounting under Accounting Standards Codification ("ASC") 805, Business Combinations, which caused an increase in 2011 cost of sales until all inventory on hand on the date of the acquisition was entirely sold and (2) a decrease in margin during 2012 as a result of continued sales through indirect partners and changes in product mix. As we continue to grow our business, we anticipate that we will have increased sales to our indirect customers, which will put pressure on our gross profit margins as sales through indirect channel partners occur at lower profit margins. In addition, a significant portion of future growth will be linked to sales of our non-invisibleSHIELD product lines, which generally sell at higher average sales prices, but at lower profit margins than invisibleSHIELD products. There are no assurances that we will continue to recognize similar gross profit margins in the future.

41-------------------------------------------------------------------------------- Table Of Contents Operating expenses Total operating expenses for the quarter ended September 30, 2012, were $19,507, an increase of $4,648 from total operating expenses for the quarter ended September 30, 2011, of $14,859. The increases are primarily attributable to the following: For the quarter ended September 30, 2012, marketing, advertising and promotion expenses were $3,378, an increase of $615 as compared to $2,763 for the quarter ended September 30, 2011. We invested heavily in advertising for the launch of products released during the third quarter of 2012 such as the invisibleSHIELD EXTREME, the ZAGGkeys PRO™ and ZAGGkeys PRO Plus™, the family of new ZAGGsparqs, and the Caliber brand of gaming headsets; and did not have a similar significant marketing expenses for the quarter ended September 30, 2011. We expect our marketing and advertising expenses to continue to be a significant expenditure as our revenues increase and expect to spend increased funds on advertising and promotion of our products as well as sales training.

For the quarter ended September 30, 2012, amortization expense was $2,422, an increase of $631 as compared to $1,791 for the quarter ended September 30, 2011. The increase is directly attributable to amortization expense on intangibles acquired as part of the acquisition of iFrogz in the second quarter of 2011, which are being amortized on an accelerated basis.

For the quarter ended September 30, 2012, salaries and related taxes increased by $3,879 to $7,464 from $3,585 for the quarter ended September 30, 2011. The increase is due to (1) the increase in our staff as we continue to build the personnel infrastructure necessary to meet the demand for our product and continue to develop new products and offerings, (2) a bonus plan implemented in the first quarter of 2012 for non-executives, and (3) $910 in consulting fees and $498 in stock compensation expense incurred related to the separation of Robert Pedersen II, the Company's former chief executive officer. No future expenses are expected to be incurred in future periods related to the separation from Mr. Pedersen. Additionally, an increase in compensation expense related to our stock based compensation plan of $1,182, which excludes the $498 in expense discussed above related to Mr. Pedersen's separation from the Company discussed at (3), contributed to the increase.

For the quarter ended September 30, 2012, other selling, general and administrative expenses, net of salaries and related taxes described above, were $6,243 as compared to $6,720 for the quarter ended September 30, 2011. The changes by category are summarized in the table below: Three Months Three Months Ended Ended September 30, 2012 September 30, 2011 Professional fees $ 737 $ 929 iFrogz transaction fees - 119 Rent 493 333 Credit card and bank fees 452 299 Commissions 1,239 1,291 Depreciation 383 320 Other 2,939 3,429 Total $ 6,243 $ 6,720 The decrease in professional fees is due to less legal expenses incurred related to the defense of our patents and other general legal fees incurred. Rent increased due to the expansion into additional office space at the ZAGG corporate offices. Credit card and bank fees increased due to our overall increase in online transaction volume. Depreciation increased due to an overall increase in fixed assets, including those at iFrogz. Other expenses decreased as a result of a $1,071 charge incurred in the three months ended September 30, 2011, related to the impairment of the note receivable, offset by an overall increase in expense consistent with the increase in operations of the consolidated entity.

42-------------------------------------------------------------------------------- Table Of Contents Income from operations We reported income from operations of $7,118 for the quarter ended September 30, 2012, as compared to income from operations of $4,614 for the quarter ended September 30, 2011, an increase of $2,504. The increase in income from operations for the quarter ended September 30, 2012 as compared to the quarter ended September 30, 2011, is primarily attributable to continued strong sales of our invisibleSHIELD, keyboards, power products, cases, and audio products.

Other expense For the quarter ended September 30, 2012, total other expense was $1,772 as compared to other expense of $1,273 for the quarter ended September 30, 2011. The increase is primarily attributable to the loss from equity-method investment in HzO.

Income taxes We recognized an income tax expense of $1,958 for the quarter ended September 30, 2012, compared to income tax expense of $1,241 for the quarter ended September 30, 2011.

Our effective tax rate was 36.6% and 37.1% for the three months ended September 30, 2012 and 2011, respectively. Our effective tax rate will generally differ from the U.S. Federal Statutory rate of 35%, due to state taxes, permanent items, and tax rates associated with our operations in Ireland.

Net income attributable to stockholders As a result of these factors, we reported net income attributable to stockholders of $3,388 or $0.11 per share on a fully diluted basis for the quarter ended September 30, 2012 as compared to net income attributable to stockholders of $2,248 or $0.07 per share on a fully diluted basis for the quarter ended September 30, 2011.

NINE MONTHS ENDED SEPTEMBER 30, 2012 AND 2011 (amounts in thousands, except per share data) Net sales Net sales for the nine months ended September 30, 2012, were $176,943 as compared to net sales of $111,565 for the nine months ended September 30, 2011, an increase of $65,378 or 59%.

For the nine months ended September 30, 2012, sales of our invisibleSHIELD product line accounted for approximately 48% of our revenues, compared to approximately 64% of our revenues for the nine months ended September 30, 2011. We have experienced significant growth in our indirect channel to big-box retailers such as Best Buy, Walmart, Target, Radio Shack, and Staples; wireless carriers such as AT&T, Verizon, The Carphone Warehouse, T-Mobile, Sprint, and Cricket; and domestic and foreign electronics accessory distributors. We are still focused on distribution through our mall kiosk program and through our websites (www.ZAGG.com, and www.iFrogz.com), but the significant growth for the first nine months of 2012 was through our continued expansion within our indirect channel as we began selling through additional customers and expanded our SKU count in our current customers. For the nine months ended September 30, 2012, approximately 81% of our overall net sales were through our indirect channel, 12% was through our website, 6% was through our mall cart and kiosk programs, and 1% was from shipping and handling charges.

43-------------------------------------------------------------------------------- Table Of Contents Cost of sales Cost of sales includes raw materials, packing materials, and shipping and fulfillment costs. For the nine months ended September 30, 2012, cost of sales amounted to $94,980 or approximately 54% of net sales compared to cost of sales of $61,043 or 55% of net sales for the nine months ended September 30, 2011.

Gross profit Gross profit for the nine months ended September 30, 2012, was $81,963 or approximately 46% of net sales, as compared to $50,522 or approximately 45% of net sales for the nine months ended September 30, 2011. The increase in gross profit margin from the prior year is primarily related to (1) costs incurred during 2011 related to the fair value write-up of iFrogz inventory as part of purchase accounting under ASC 805, Business Combinations, which caused an increase in 2011 cost of sales until all inventory on hand on the date of the acquisition was entirely sold and (2) a decrease in margin during 2012 as a result of continued sales through indirect partners and changes in product mix.

As we continue to grow our business, we anticipate that we will have increased sales to our indirect customers, which will put pressure on our gross profit margins as sales through indirect channel partners occur at lower profit margins. In addition, a significant portion of future growth will be linked to sales of our non-invisibleSHIELD product lines, which generally sell at higher average sales prices, but at lower profit margins than invisibleSHIELD products.

There are no assurances that we will continue to recognize similar gross profit margins in the future. There are no assurances that we will continue to recognize similar gross profit margins in the future.

Operating expenses Total operating expenses for the nine months ended September 30, 2012, were $53,731, an increase of $16,934 from total operating expenses for the nine months ended September 30, 2011, of $36,797. The increases are primarily attributable to the following: For the nine months ended September 30, 2012, marketing, advertising and promotion expenses were $8,181, an increase of $301 as compared to $7,880 for the nine months ended September 30, 2011. We invested heavily in advertising for the launch of products released during the third quarter of 2012 such as the invisibleSHIELD EXTREME, the ZAGGkeys PRO™ and ZAGGkeys PRO Plus™, the family of new ZAGGsparqs, and the Caliber brand of gaming headsets. We expect our marketing and advertising expenses to continue to be a significant expenditure as our revenues increase and expect to spend increased funds on advertising and promotion of our products as well as sales training.

For the nine months ended September 30, 2012, amortization expense was $7,313, an increase of $5,115 as compared to $2,198 for the nine months ended September 30, 2011. The increase is directly attributable to amortization expense on intangibles acquired as part of the acquisition of iFrogz in the second quarter of 2011. As the acquisition occurred on June 21, 2011, only approximately three months of amortization was recorded in the nine months ended September 30, 2011, while nine months of amortization was recorded in the nine months ended September 30, 2012.

For the nine months ended September 30, 2012, salaries and related taxes increased by $9,814 to $19,633 from $9,819 for the nine months ended September 30, 2011. The increase is due to (1) the increase in our staff as we continue to build the personnel infrastructure necessary to meet the demand for our product and continue to develop new products and offerings, (2) a bonus plan implemented in the first quarter of 2012 for non-executives, and (3) $910 in consulting fees and $498 in stock compensation expense incurred related to the separation of Robert Pedersen II, the Company's former chief executive officer. No future expenses are expected to be incurred in future periods related to the separation from Mr. Pedersen. Additionally, an increase in compensation expense related to our stock based compensation plan of $1,439, which excludes the $498 in expense discussed above related to Mr. Pedersen's separation from the Company discussed at (3), contributed to the increase.

For the nine months ended September 30, 2012, other selling, general and administrative expenses, net of salaries and related taxes described above, were $18,604 as compared to $16,900 for the nine months ended September 30, 2011. The changes by category are summarized in the table below: 44-------------------------------------------------------------------------------- Table Of Contents Nine Months Nine Months Ended Ended September 30, 2012 September 30, 2011 Professional fees $ 2,645 $ 2,416 iFrogz transaction fees - 1,947 Rent 1,335 678 Credit card and bank fees 1,384 994 Commissions 4,008 2,755 Depreciation 1,157 610 Other 8,075 7,500 Total $ 18,604 $ 16,900 The increase in professional fees is due to legal expenses incurred related to the defense of our patents and audit fees incurred. The acquisition of iFrogz occurred during 2011, thus no expenses were incurred in 2012. Rent increased due to the expansion into additional office space at the ZAGG corporate offices and rent at the iFrogz corporate offices. Credit card and bank fees increased due to increased online sales. Commissions were also up on a comparison basis due to the strong sales in 2012 compared to 2011, continued growth through indirect accounts for which we utilize a third-party sales company, and commissions incurred related to sales at the iFrogz segment. Depreciation increased due to an overall increase in fixed assets, including those at iFrogz. Other expenses increased as a result of a $1,071 charge incurred in the three months ended September 30, 2011, related to the impairment of the note receivable, offset by an overall increase in expense consistent with the increase in operations of the consolidated entity.

Income from operations We reported income from operations of $28,232 for the nine months ended September 30, 2012, as compared to income from operations of $13,725 for the nine months ended September 30, 2011, an increase of $14,507. The increase in income from operations for the nine months ended September 30, 2012, as compared to the nine months ended September 30, 2011 is primarily attributable to continued strong sales of our invisibleSHIELD, keyboards, power products, case, and audio products. In addition, the impact of a full nine months of iFrogz operations contributed to the overall increase in income from operations.

Other expense For the nine months ended September 30, 2012, total other expense was $5,237 as compared to other expense of $1,433 for the nine months ended September 30, 2011. The increase is primarily attributable to (1) interest expense on the Revolving Credit Facility and Term Loan and (2) the loss from equity-method investment in HzO.

Income taxes We recognized an income tax expense of $8,684 for the nine months ended September 30, 2012, compared to income tax expense of $4,335 for the nine months ended September 30, 2011.

Our effective tax rate was 37.8% and 35.3% for the nine months ended September 30, 2012 and 2011, respectively. Our effective tax rate will generally differ from the U.S. Federal Statutory rate of 35%, due to state taxes, permanent items, and tax rates associated with our operations in Ireland.

45-------------------------------------------------------------------------------- Table Of Contents Net income attributable to stockholders As a result of these factors, we reported net income attributable to stockholders of $14,311 or $0.45 per share on a fully diluted basis for the nine months ended September 30, 2012 as compared to net income attributable to stockholders of $8,302 or $0.29 per share on a fully diluted basis for the nine months ended September 30, 2011.

Liquidity and Capital Resources (amounts in thousands) At September 30, 2012, our principle sources of liquidity were cash generated by operations, cash on-hand, and the Term Loan and Revolving Credit Facility. Our principle uses of cash have been to fund working capital requirements and the continued growth of the business, and the payment of debt.

Cash on-hand decreased to $16,344 on September 30, 2012 from $26,433 on December 31, 2011, a decrease of $10,089. Earnings from foreign operations are considered permanently re-invested and of the $16,344 cash balance on September 30, 2012, cash from foreign entities totaled $2,822, which constitutes 17.3% of the total cash balance. If the Company were to repatriate foreign earnings, it would be subject to applicable taxes under tax law in the United States. Management has no intention of repatriating foreign earnings; however, the settlement of intercompany balances would not result in the Company being subject to additional tax and occurs from time to time in the Company's normal course of business.

At September 30, 2012, we had working capital of $81,955 compared to $74,490 as of December 31, 2011. The increase is primarily attributable to positive cash from operations in 2012 and an increase in inventory needed to meet customer demands. These increases were offset by $27,000 in debt payments made during March 2012.

Based on our current level of operations, we believe that cash generated from operations, cash on hand, and available borrowings under our existing credit arrangements will be adequate to meet our currently expected capital expenditures and working capital needs for the next 12 months and beyond.

Term Loan and Revolving Credit Facility On June 21, 2011, and in conjunction with the acquisition of iFrogz, the Company entered into a financing agreement (the "Financing Agreement") led by Cerberus Business Finance, LLC ("Cerberus") and PNC Bank National Association ("PNC"), which is acting as the administrative bank. The Financing Agreement consists of a $45,000 term loan ("Term Loan"), a $45,000 revolving credit facility ("Revolving Credit Facility"), and a $5,000 letters of credit facility, which is a subset of the $45,000 Revolving Credit Facility. The Company's obligations under the Financing Agreement were secured by all or substantially all of the Company's assets. The Term Loan matures on July 20, 2016, and the Revolving Credit Facility and letters of credit mature on July 20, 2014.

As of September 30, 2012, $41,000 of the Term Loan was outstanding after a payment of $4,000 was made in March 2012; $3,534 of the Revolving Credit Facility was outstanding after payments totaling $23,000 were made in March 2012; and no letters of credit were outstanding.

At the election of the Company, borrowings under the Financing Agreement bear interest at either the Reference Rate plus an applicable margin or the Eurodollar Rate plus an applicable margin, both as defined in the Financing Agreement. All current borrowings were made under the Reference Rate, which is calculated as the greater of (1) 2.75%, (2) the Federal Funds Effective Rate plus 0.50%, (3) the Eurodollar Rate plus 1.00%, or (4) the rate of interest publicly announced by PNC Financial Service Group, Inc. as its reference rate, base rate, or prime rate. The applicable margin for the Reference Rate is 4.00%. At September 30, 2012, the weighted average interest rate on all outstanding borrowings was 7.25%. At September 30, 2012, the effective interest rate was 8.17%.

46-------------------------------------------------------------------------------- Table Of Contents There are no scheduled payments on either the Term Loan or Revolving Credit Facility prior to maturity. However, the Financing Agreement calls for mandatory prepayment of the Term Loan if certain conditions are met. The prepayment requirement is calculated for the fiscal year ended December 31, 2012, and the calculation is based on a percentage of "excess cash flow" as defined in the Financing Agreement. Payment is required to be made within ten days of issuing the year-end consolidated financial statements. Based on current projections, the Company estimates that no prepayment will be required to be made during March 2013. The entire Term Loan and Revolving Credit Facility balances are classified as noncurrent.

Starting July 1, 2011, the Company began paying a commitment fee of 0.375% of the unused portion of the borrowing capacity under the Revolving Credit Facility based on the average principal amount outstanding for the month compared to $45,000. For the three and nine months ended September 30, 2012, the Company incurred $41 and $102, respectively in commitment fees, which is included as a component of interest expense in the condensed consolidated statement of operations.

The Company incurred and capitalized $2,538 of direct costs related to the issuance of the Term Loan and Revolving Credit Facility. Of the total amount incurred, $1,699 was directly related to the Term Loan and $839 was directly related to the Revolving Credit Facility. The Company amortizes the deferred loan costs on the Term Loan on the effective interest rate method and the deferred loan costs on the Revolving Credit Facility on a straight-line basis over the respective terms of the loan: the Term Loan is being amortized through June 20, 2016, and the Revolving Credit Facility through June 20, 2014. For the three and nine months ended September 30, 2012, the Company amortized $156 and $464, respectively, of these loan costs. For the three and nine months ended September 30, 2011, the Company amortized $156 and $173, respectively, of these loan costs. The amortization of deferred loan costs is included as a component of interest expense in the condensed consolidated statement of operations. In addition, during the nine months ended September 30, 2012, the Company recorded additional amortization of $132 through interest expense due to the $4.0 million payment on the Term Loan prior to maturity. The carrying value of deferred loan costs at September 30, 2012, was $1,613 and is included as a component of noncurrent other assets in the condensed consolidated balance sheet.

Attached to the Term Loan and Revolving Credit Facility are a number of financial and non-financial covenants. At September 30, 2012, the Company was in compliance with covenants associated with the Term Loan and Revolving Credit Facility.

Contractual Obligations and Commitments The following table provides information on our contractual obligations as of September 30, 2012: Total Payments on Interest on Operating contractual Debt Debt Leases obligations (1) Remaining 2012 $ - $ 819 $ 260 $ 1,079 2013 - 3,400 763 4,163 2014 - 3,323 685 4,008 2015 3,534 3,265 587 7,386 2016 and thereafter 41,000 1,632 860 43,492 Total $ 44,534 $ 12,439 $ 3,155 $ 60,128 47-------------------------------------------------------------------------------- Table Of Contents (1) Uncertain tax positions of $61 are not included in the table above as we are not sure when the amount will be paid.

Recently Issued Accounting Standards In July 2012, the Financial Accounting Standards Board ("FASB") issued ASU No.

2012-02, Testing Indefinite-Lived Intangible Assets for Impairment. ASU 2012-02 permits an entity to make a qualitative assessment to determine whether it is more likely than not that an indefinite-lived intangible asset, other than goodwill, is impaired. The ASU's objective is to simplify how an entity tests indefinite-lived intangible assets for impairment and to make the impairment test similar to the recent changes for testing goodwill for impairment. The ASU applies to both public and nonpublic entities and is effective for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012. Early adoption is permitted. The Company will implement the provisions of ASU 2012-01 during the fourth quarter of 2012. The early adoption and implementation of ASU 2012-01 is not expected to have a material impact on the Company's financial statements.

In December 2011, the FASB issued ASU No. 2011-11, Balance Sheet (Topic 210): Disclosures about Offsetting Assets and Liabilities. ASU 2011-11 requires an entity to disclose information about offsetting and related arrangements to enable users of financial statements to understand the effect of those arrangements on its financial position, and to allow investors to better compare financial statements prepared under U.S. GAAP with financial statements prepared under International Financial Reporting Standards (IFRS). The new standards are effective for annual periods beginning January 1, 2013, and interim periods within those annual periods. Retrospective application is required. The Company will implement the provisions of ASU 2011-11 as of January 1, 2013, and the implementation of ASU 2011-11 is not expected to have a material impact on the Company's financial statements.

[ Back To TMCnet.com's Homepage ]