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Zagg Inc (NASDAQ:ZAGG) is a well known developer of protective coverings, audio accessories and power solutions for a wide range of gadgets. On Friday May 3, ZAGG reported its Q1 2013 earnings, and we saw the stock drop from the high $6s to just $5. ZAGG's earnings for Q1 2013 were net sales of $51.5 million, from net sales of $55.5 million in Q1 2012. Net income was $900,000, compared to $5.1 million in Q1 2012. It also saw a sharp drop in gross earnings (37% versus 49%). With 30.68 million outstanding shares, ZAGG's drop following its earnings release represents a reduction in market cap of over $50 million.

Why ZAGG's Earnings Fell Short

The question for ZAGG investors now is whether the market reaction to its earnings release was fair, and whether ZAGG can recover. ZAGG's disappointing earnings may be attributed to a number of causes:

  • A change in distribution strategy. ZAGG previously had problems with their products being discounted between different distributors, causing retail price discrepancies. It chose to work with 3 key new distributors and cut its relationship with existing distributors. I believe ZAGG's new distribution strategy was a necessary change, but the restructuring had a negative effect on sales in Q1 2013.
  • Low sales figures for the 9-inch mini keyboard and invisibleSHIELD EXTREME (a screen protector). ZAGG's 9-inch keyboard for the iPad mini, while receiving reasonable reviews, was a somewhat awkward fit for the iPad mini and didn't meet with large consumer demand. Due to low sales of this product, ZAGG had an inventory surplus which affected its gross margin. The invisibleSHIELD EXTREME, meanwhile, raised concerns from consumers due to air bubbles trapped between the cover and phone display that would remain for several days. ZAGG now has enough sales data to make a decision to reduce production on these models in future quarters.
  • Lower sales of the iFrogz audio line, which ZAGG forecasts will account for 25% to 30% of annual revenue. During Q1 2013 ZAGG made some layoffs for iFrogz employees, and closed the iFrogz office in Logan, Utah. Some account managers were assigned to sell the iFrogz line for the first time, and may not have been entirely familiar with the product line. ZAGG says account managers are now going through "extensive cross-training" to ensure proficiency at selling products under both the ZAGG and iFrogz product line. I expect iFrogz sales will recover somewhat in Q2 2013.
  • Higher than expected air freight charges, according to ZAGG CEO Randall Haynes (though it's unclear to what degree this affected revenue).
  • The lack of any major new Apple (NASDAQ:AAPL) product launch. As Apple is also not expected to launch a new product in Q2 2013, this has also affected ZAGG's forecasts for the next quarter. Sales for new gadgets and accessories are strongest in the first few months of being released and currently ZAGG is only able to sell accessories for older products. ZAGG sales are also affected by Samsung, especially its invisibleSHIELD product line. Samsung is still managing to gain market share in the smartphone and tablet markets, and this is beneficial for ZAGG's invisibleSHIELD product line.

Future Outlook For ZAGG

ZAGG still has a fairly strong balance sheet, with working capital of $82 million and a cash balance of $23.4 million, and easily has the resources to develop accessories for new gadgets released in future. We can also see that much of its decline in revenue for Q1 2013 can be attributed to temporary factors. In particular, the change in its distribution strategy to focus on 3 major new distributors, and restructuring resulting in account managers being responsible for selling product lines they may not have been entirely familiar with had an adverse effect that is likely to reverse in the near future. Q2 2013 may also not be a strong quarter for ZAGG, but the launch of a major Apple product later in 2013 is likely to spike sales substantially. At its current sharply reduced price (around $5), I would consider ZAGG undervalued if it drops further.

Source: Why Did ZAGG Fall Short?