Zagg ( Nasdaq - ZAGG ) - Follow-up Report

Zagg (ZAGG $7.25) reported excellent on target Q3 results.  A few weeks earlier the company indicated its performance would be stronger than expected.  That proved to be the case.  Sales advanced 137% to $23.1 million.  Earnings jumped 325% to $.17 a share.  (Please refer to "Accounting Notes.")  Best Buy accounted for 42% of total sales.  In the year ago quarter Best Buy represented 38%.  So volume expanded even faster at Best Buy than through the rest of Zagg's distribution system.  New channel partners (ATT Stores and Staples) provided further momentum.  Growth also was seen at Radio Shack and the Carphone Warehouse in Great Britain.  Sales of the Invisible Shield protective covering for the iPhone remained robust.  Results also benefited from expanding Blackberry and Android sales.  A higher priced covering for Apple's new iPad tablet computer reinforced the uptrend and helped propel margins to an unusually high level.  Q3 sales certainly reflected some pre-Christmas inventory build-up among the company's retail partners.  Sell through accounted for much of the sales acceleration, though.  Inventories may wind down a little as the holiday season concludes in Q4.  So sequential performance may be lower than the Q3 rate.  Fundamental trends remain powerful, however.  We estimate Q4 income will finish in the $.10-$.15 a share range on sales of $18-$23 million.  For all of 2010 earnings appear on track to improve 125%-150% to $.40-$.45 a share.  Sales could rise 70%-80% to $65-$70 million.

Further growth is likely in 2011.  Smart phones currently represent 15%-20% of all mobile phone sales.  That percentage could double over the next 2-3 years.  Tablet computer shipments are surging, as well.  Other consumer products are likely to emerge, creating additional targets for Zagg's protective screen coverings.  Distribution channels are likely to keep expanding, too.  Zagg recently signed up Verizon's retail store network.  A bigger push into foreign markets also is possible.  We estimate 2011 sales will increase 30% to $85 million to provide a 25% improvement in earnings ($.50 a share).  The income figure assumes that margins revert to more customary levels.  A stronger showing is possible on both counts.

An investment in a new technology has caused controversy.  Zagg paid $2.0 million for 55% control of a water proofing technology designed to protect electronic devices.  The technology appears designed for use by manufacturers during the production process, so it won't directly leverage Zagg's brand name recognition with consumers.  And, since the technology still is being fine tuned, questions exist about whether it ever will work or if any manufacturers will license it.  We don't know the answers.  But the size of the investment is relatively modest and the potential payoff is large.  It looks like it's worth a shot, considering the small degree of risk involved.  Substantial growth potential remains in the core business.  That could propel revenues to the $200 million area within another few years, just as the company predicted in 2007.  Note -- The shield business should benefit from Zagg's growing patent portfolio.  The company recently bought out the one claimant who might have had a chance to disrupt the applecart.  Besides preempting potential competition Zagg now might start earning some extra money by enforcing its intellectual property rights.

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