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Zagg Inc. (NASDAQ:ZAGG) is expected to announce 4th quarter and full year earnings on February 27th. Analysts are expecting $0.19 to $0.21 per share for the 4th quarter. Let's take a look at how they get this estimate.

Zagg announced revised revenue guidance back in December for 2011 of $175 million. This was an increase of $5 million from the revenue guidance given in November in its 3rd quarter earnings release. So this gives us the starting point for forecasting 4th quarter earnings. Zagg had revenues for the 9 months ending September 30, 2011 of $111.7 million. This means it will have revenues of at least $63.3 million for the 4th quarter. iFrogz made up 31% of revenues for the 3rd quarter, so I assumed this ratio will hold for the 4th.

Zagg Sales

43,371,998

iFrogz Sales

19,976,217

Total Sales

63,348,215

Next is coming up with an accurate cost of goods sold. Now, the trick is to estimate iFrogz cost of goods sold. Zagg acquired iFrogz on June 21, 2011. Because of GAAP purchase accounting rules Zagg was required to write-up the value of the acquired iFrogz inventory above its book value. The valuation was $15.12 million. This is about $4.1 million higher than book value. This has caused Zagg's gross margin to be lower for 2011 than we can expect it to be going forward.

At the end of the 3rd quarter the balance of the acquired iFrogz inventory was at $1.8 million. For the 2nd and 3rd quarters this written-up inventory when expensed as COGS was 79% of iFrogz sales. Assuming all of the remaining inventory is sold in the 4th quarter means that of the $19.97 million in iFrogz revenue, $2.3 million of it will be on the remaining acquired inventory (1.83 / .79 = 2.3).

iFrogz 4th Qtr COGS

Acquired Inventory Balance

1,835,360

Implied Sales Value

2,323,241

Sales of new inventory

17,652,977

COGS of new inventory

9,885,667

Total Sales

19,976,217

Total COGS

11,721,027

Now we need to estimate the COGS for the remaining $17.6 million in iFrogz revenue. When adjusting for the write-up for the 2nd and 3rd quarters, COGS as a percent of sales for iFrogz was 54.3% and 57.8%, respectively. I assume this ratio to be 56% for the 4th quarter. On an ongoing basis this should be a conservative estimate.

On to estimating COGS for the Zagg branded segment. Zagg's COGS as a percent of revenues excluding iFrogz was 49.4%, 52.6%, and 47.7% for the 1st, 2nd, and 3rd quarters, respectively. I assumed COGS for the 4th quarter to be 49.5%. While the most recent quarters are the most relevant it is worth noting that this ratio was 49.1% for 2010.

1st Qtr

Acquisition

2nd Qtr

3rd Qtr

4th Qtr Est

2011

iFrogz Sales

2,346,000

14,470,000

19,976,217

36,792,217

iFrogz COGS

1,853,340

11,431,300

11,721,027

25,005,667

Gross Profit

492,660

3,038,700

8,255,190

11,786,550

iFrogz.Inv.Writeup

579,000

3,063,000

534,345

4,176,345

iFrogz.True COGS

1,274,340

8,368,300

11,186,682

20,829,322

iFrogz.True Gross Profit

1,071,660

6,101,700

8,789,535

15,962,895

iFrogz.Acquired.Inv.Balance

15,120,000

13,266,660

1,835,360

Zagg Sales

26,976,320

36,442,465

31,417,000

43,371,998

138,207,783

Zagg COGS

13,329,740

19,174,094

14,982,700

21,469,139

68,955,673

Gross Profit

13,646,580

17,268,371

16,434,300

21,902,859

69,252,110

Combined Sales

26,976,320

38,788,465

45,887,000

63,348,215

175,000,000

Combined COGS

13,329,740

21,027,434

26,414,000

33,190,166

93,961,340

Combined Profit

13,646,580

17,761,031

19,473,000

30,158,049

81,038,660

iFrogz % of Total Sales

6.0%

31.5%

31.5%

21.0%

Normalized

1st Qtr

Acquisition

2nd Qtr

3rd Qtr

4th Qtr

2011

iFrogz Sales

100.0%

100.0%

100.0%

100.0%

iFrogz COGS

79.0%

79.0%

58.7%

68.0%

Gross Profit

21.0%

21.0%

41.3%

32.0%

iFrogz.Inv.Writeup

24.7%

21.2%

2.7%

11.4%

iFrogz.True COGS

54.3%

57.8%

56.0%

56.6%

iFrogz.True Gross Profit

45.7%

42.2%

44.0%

43.4%

Zagg Sales

100.0%

100.0%

100.0%

100.0%

100.0%

Zagg COGS

49.4%

52.6%

47.7%

49.5%

49.9%

Gross Profit

50.6%

47.4%

52.3%

50.5%

50.1%

Combined Sales

100.0%

100.0%

100.0%

100.0%

100.0%

Combined COGS

49.4%

54.2%

57.6%

52.4%

53.7%

Combinded Profit

50.6%

45.8%

42.4%

47.6%

46.3%

On to operating expenses. Both Advertising and Marketing and Selling, General and Administrative expenses have generally been falling over time as a percent of sales.

This is what one would expect for a company with growing and realizing economies of scale, but it hasn't been an ideal textbook case for Zagg. SG&A averaged 20% of sales for 2010 but this ratio has increased in 2011. A large portion of the increase is due to the iFrogz acquisition. On a going forward basis SG&A will remain above 2010 levels as the acquisition of iFrogz requires significant amortization expense.

While this is not a cash expense it does affect GAAP earnings. Zagg should see further economies of scale as it grows because those amortization costs are fixed and won't grow in proportion to sales. I estimated SG&A at 24.5% and Advertising at 6%. I think a case could easily be made to drop each of these by another 0.50% or more, but it is best to be conservative and positively surprised.

Operating Expense Analysis

1st Qtr

2nd Qtr

3rd Qtr

Advertising & Marketing

2,511,816

2,615,702

2,763,000

Selling General & Admin

6,270,478

10,899,351

12,096,000

Total Operating Expenses

8,782,294

13,515,053

14,859,000

A & M % of Sales

9.3%

6.7%

6.0%

SG & A % of Sales

23.2%

28.1%

26.4%

Operating Exp % of Sales

32.6%

34.8%

32.4%

iFrogz Acquisition

1,828,000

119,000

Teleportal Note Impairment

1,071,000

Adjusted SG & A

8,952,351

10,906,000

Adjusted Operating Exp.

11,568,053

13,669,000

Adj. SG & A % of Sales

23.1%

23.8%

Adj. Operating Exp % of Sales

29.8%

29.8%

Well, that is the bulk of the work. I kept interest expense at $1.4 million, the same as the prior period and estimated interest income at $130 thousand as Zagg has been sitting on a large pile of cash. The effective tax assumed was 37%. Net loss attributed to minority holders was put at $145 thousand. And the results are:

Zagg Inc. Earnings Estimate

4th Qtr 2011

Net sales

63,348,215

Cost of sales

33,190,166

Gross profit

30,158,049

Operating expenses:

Advertising and marketing

3,800,893

Selling, general and administrative

15,837,054

Total operating expenses

19,637,947

Income (loss) from operations

10,520,103

Other income:

Interest expense

(1,400,000)

Interest and other income

130,000

Total other income (expense)

(1,270,000)

Income (loss) before taxes

9,250,103

Income tax benefit (provision)

(3,422,538)

Net income (loss)

5,827,565

Net loss attributable to noncontrolling interest

145,000

Net income attributable to stockholders

5,972,565

Net income (loss) per common share

0.202

Weighted average number of shares outstanding

29,634,000

By my analysis, Zagg appears that it will meet the earnings estimate. This would be a 70% year over year increase in earnings and 172% over the prior quarter. The revenue increase is 117% year over year and 38% over the prior quarter.

While doing this analysis I made some adjustments for one-time charges as they not reflect the economic reality for Zagg as a going concern. As the P/E ratio is the most common valuation measure it will be instructive to look at Zagg's P/E ratio adjusting for the one-time charges.

1st Qtr

2nd Qtr

3rd Qtr

4th Qtr

2,011

EPS

0.14

0.11

0.07

0.20

0.52

Diluted EPS

0.13

0.10

0.07

0.20

0.50

Adjusted Diluted EPS

0.13

0.19

0.16

0.20

0.68

P/E Ratios - Based on 2011 earnings

P/E of Basic EPS

18.00

P/E of Diluted EPS

18.72

P/E of Adjusted Diluted EPS

13.76

Current Price

9.36

Disclosure: I am long ZAGG.

Source: Forecasting Zagg's Earnings

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