Wednesday, May 11, 2011

Zagg ( Nasdaq - ZAGG ) -- Better than Expected Q1 Results

Zagg (ZAGG $10.00) reported excellent Q1 results, above our expectation.  Sales boomed 207% to $27.0 million, nearly matching the December period showing.  Volume normally moderates following Christmas.  Earnings advanced 225% to $.13 a share.  The superior performance was fueled by the ZaggMate, an innovative accessory for the Apple iPad tablet.  That product protects the device from scratches and cracks the same way Zagg's Invisible Shield does on smart phones.  It also is equipped with a wireless keyboard and an easel to prop up the tablet for easy viewing.  After the quarter ended Zagg signed a deal with accessory giant Logitech to outsource ZaggMate manufacturing in exchange for royalties.  Keyboard layouts vary from country to country and Zagg didn't relish the production and inventory complexities.  The company will continue to sell the ZaggMate (made by Logitech) on its own website.  Internet demand accounted for 24% of total Q1 sales.

Retail distribution continues to expand.  Best Buy remains Zagg's largest Invisible Shield reseller, representing an estimated 40% of total sales.  Target Stores also accounted for more than 10% of volume in the period.  Other chains include ATT, Verizon, Radio Shack, Cricket and Carphone Warehouse (U.K.).  Sprint's 1,600 retail chain was added to mix today.  Over the next two quarters ZaggMate fulfillment will switch over to Logitech.  That will reduce reported revenue since Zagg only will recognize the royalties it receives on each unit sold, not the wholesale amount.  (Website sales will continue to show up in full.)  The outsourcing arrangement will substantially reduce risk, however.  The royalty rate Zagg will receive hasn't been disclosed but a meaningful contribution is likely.

We are raising our 2011 estimates.  Sales appear headed to $105-$115 million.  Earnings could reach $.55-$.65 a share.  Zagg recently opened a manufacturing and distribution center in Ireland.  That could accelerate penetration into Europe, which currently accounts for less than 5% of total sales.  It also could provide a lower income tax rate.  Finances should benefit from the switch to Logitech by alleviating capital spending and working capital requirements.  Competition is deterred by key patents on the Invisible Shield technology.  The ZaggMate line could be more vulnerable to knock-offs, although Logitech should become a low cost producer.  The main long term risk facing the company is the likelihood that over time smart phones will evolve into something different.  That threat may put a limit on Zagg's P/E multiple.

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