ZAGG INC AND SUBSIDIARIES

ZAGG INC AND SUBSIDIARIES

ZAGG INC AND SUBSIDIARIES

ZAGG INC AND SUBSIDIARIES

ZAGG®

In March 2016, the FASB issued ASU No. 2016-09, “Improvements to Employee Share-Based Payment Accounting,” which simplified accounting for share-based payments. The ASU is effective for fiscal years beginning after December 15, 2016, and interim periods within those years for public business entities. Early adoption is permitted in any interim or annual period provided that the entire ASU is adopted. The new standard contains several amendments that simplify the accounting for employee share-based payment transactions, including the accounting for income taxes, forfeitures, statutory tax withholding requirements, classification of awards as either equity or liabilities, and classification on the statement of cash flows. The changes in the new standard eliminate the accounting for excess tax benefits to be recognized in additional paid-in capital and tax deficiencies recognized either in the income tax provision or in additional paid-in capital. The Company has adopted ASU 2016-09 as of the beginning of the quarter ended March 31, 2017. During the quarter ended March 31, 2017, the Company applied the amendment relating to the recognition of excess tax benefits and deficiencies on a prospective basis and, accordingly, has recognized all excess tax benefits and tax deficiencies as income tax expense or benefit as discrete items resulting in the recognition of income tax expense of $171 for the nine months ended September 30, 2017. The Company has not recorded a cumulative-effect adjustment to retained earnings as of the beginning of the year because all tax benefits had previously been recognized when the tax deductions related to stock compensation were utilized to reduce taxes payable. The Company has elected to apply the amendment related to the presentation of cash flows for excess tax benefits on a prospective basis and no prior periods have been adjusted. The Company’s financial position or results of operations were not impacted by amendments related to the statutory tax withholding requirement and, accordingly, no adjustment has been recorded. The Company will continue to classify cash remitted to the tax authorities as a financing activity as now required by the amendments in the ASU. The ASU permits a policy election to either record forfeitures as they occur or estimate forfeitures consistent with historical U.S. GAAP. The Company has elected to record forfeitures as they occur, which did not have a material impact on our financial position or results of operations.

In August 2016, the FASB issued ASU No. 2016-15, “Classification of Certain Cash Receipts and Cash Payments,” which addresses eight classification issues related to the statement of cash flows: (1) debt prepayment or debt extinguishment costs; (2) settlement of zero-coupon bonds; (3) contingent consideration payments made after a business combination; (4) proceeds from the settlement of insurance claims; (5) proceeds from the settlement of corporate-owned life insurance policies, including bank-owned life insurance policies; (6) distributions received from equity method investees; (7) beneficial interests in securitization transactions; and (8) separately identifiable cash flows and application of the predominance principle. The ASU is effective for public business entities for fiscal years beginning after December 15, 2017. Early adoption is permitted, including adoption in an interim period. The amendments in the ASU should be applied using a retrospective transition method to each period presented. If it is impracticable for the amendments to be applied retrospectively for some of the issues, the amendments for those issues may be applied prospectively as of the earliest date practicable. The Company has elected to early adopt this standard in the current quarter ended September 30, 2017, and will apply this standard to any classification issues that occur in future periods as none exist in the current reportable period.

In October 2016, the FASB issued ASU 2016-16, “Income Taxes (Topic 740): Intra-Entity Transfers of Assets Other Than Inventory,” which requires entities to recognize at the transaction date the income tax consequences of intercompany asset transfers other than inventory. This ASU is effective for public business entities for annual and interim periods in fiscal years beginning after December 15, 2017. The Company will adopt this standard in the first quarter of 2018. The adoption of this standard is not expected to have a material impact on our financial position or results of operations.

In November 2016, the FASB issued ASU 2016-18, “Statement of Cash Flows (Topic 230): Restricted Cash,” which requires companies to include cash and cash equivalents that have restrictions on withdrawal or use in total cash and cash equivalents on the statement of cash flows. This ASU is effective for public business entities for annual and interim periods in fiscal years beginning after December 15, 2017. The Company has elected to early adopt this standard in the current quarter ended September 30, 2017, and if in future periods restricted cash exists at the Company, this standard will be applied as none exist in the current reportable period.

In January 2017, the FASB issued ASU 2017-04, “Intangibles – Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment,” which requires an entity to no longer perform a hypothetical purchase price allocation to measure goodwill impairment. Instead, impairment will be measured using the difference between the carrying amount and the fair value of the reporting unit. The ASU is effective for annual and interim periods in fiscal years beginning after December 15, 2019. All entities may early adopt the standard for goodwill impairment tests with measurement dates after January 1, 2017. The Company has elected to early adopt this standard and will perform its annual goodwill impairment assessment in the fourth quarter of 2017. The adoption of this standard is not expected to have a material impact to our financial position or results of operations.

In May 2017, the FASB issued ASU 2017-09, “Compensation – Stock Compensation (Topic 718),” which clarifies what constitutes a modification of a share-based payment award. This ASU is effective for all entities for annual and interim periods in fiscal years beginning after December 15, 2017. Early adoption is permitted as of the beginning of an annual period for which financial statements (interim or annual) have not been issued or made available for issuance. The Company has elected to early adopt this ASU in the current quarter ended September 30, 2017, and will apply any stock compensation modifications that occur in future periods as none exist in the current reportable period.

On February 2, 2016, ZAGG and ZM Acquisition, Inc., a Delaware corporation and wholly-owned subsidiary of the Company, entered into an Agreement and Plan of Merger (the “Merger Agreement”) with mophie, a California corporation, the principal shareholders of mophie named therein (the “Principal Shareholders”), and Daniel Huang as representative of the mophie shareholders, warrant holders, and option holders, pursuant to which ZM Acquisition, Inc. agreed to merge with and into mophie, with mophie continuing as the surviving corporation (the “Merger”). On March 3, 2016, the Company completed the Merger.

Results of Operations

The results of operations of mophie are included in the Company’s results of operations beginning on March 3, 2016. For the period of March 3, 2016, through September 30, 2016, mophie generated net sales of $79,390 and a net loss before tax of $17,030.

Pro forma Results from Operations

The following unaudited pro-forma results of operations for the nine months ended September 30, 2016, give pro forma effect as if the acquisition had occurred at the beginning of the period presented, after giving effect to certain adjustments including the amortization of intangible assets, interest expense, tax adjustments, specific transaction related expenses incurred prior to the execution date, and assumes the purchase price was allocated to the assets purchased and liabilities assumed based on their values at the date of purchase.

The unaudited pro forma information is presented for illustrative purposes only and is not necessarily indicative of the operating results that would have occurred had the transaction been consummated for the dates indicated. Furthermore, such unaudited pro forma information is not necessarily indicative of future operating results of the combined companies, due to changes in operating activities following the purchase, and should not be construed as representative of the operating results of the combined companies for any future dates or periods.

For the nine months ended September 30, 2016, pro forma net loss includes projected amortization expense of $5,076. In addition, the Company included interest from the new credit facility and amortization of debt issuance costs for the nine months ended September 30, 2016, of $1,508. Material non-recurring adjustments excluded from the pro forma financial information above consists of the $2,586 step up of mophie inventory to its fair value, which was recorded as an unfavorable adjustment to cost of goods sold during the nine months following the acquisition date.

The unaudited pro forma results do not reflect events that either have occurred or may occur after the Merger, including, but not limited to, the anticipated realization of ongoing savings from operating synergies in subsequent periods.

Goodwill

There were no additions to nor impairmentand no impairments of goodwilllong-lived intangible assets for the three or nine months ended September 30,March 31, 2018. Additionally, there were no additions to long-lived intangible assets for the three months ended March 31, 2017. The balance of goodwill as of September 30, 2017, was $12,272.

Long-lived Intangible Assets

The following table summarizes the changes inimpairments to gross long-lived intangible assets:

assets for the three months ended March 31, 2017:

For interim periods, the tax provision is determined utilizing an estimate of the Company’s annual effective tax rate adjusted for discrete items, if any. The Company’s effective tax rate was 11% and 14% for the three months ended September 30,March 31, 2018 and 2017, and 2016, was 37% and 47%, respectively. The Company’s effective tax for the nine months ended September 30, 2017, and 2016, was 47% and 41%, respectively. The changedecrease in the effective tax rate for the three months ended September 30, 2017, compared to the three months ended September 30, 2016, was primarily due to losses from foreign jurisdictions for which income tax benefits wereseveral factors including but not recognized as well the ratio of credits and other permanent differenceslimited to pre-tax book income and loss for respective periods. Thea change in the effective taxfederal statutory rate forfrom 35% to 21%, a change to book income in the nine months ended September 30, 2017,first quarter of 2018 compared to a book loss in the nine months ended September 30, 2016, was primarily duefirst quarter of 2017, and an increase to various discrete expenses recognized during the period related to the true up of a deferred amount for stock compensation and other discrete items related to the return to provision calculation.income in foreign jurisdictions. The Company’s effective tax rate will generally differ from the U.S. Federal statutory rate of 35%21%, due to state taxes, permanent items, and the Company’s global tax strategy.

Fair Valuestrategy, and the inclusion of Financial Instruments

At September 30, 2017,global intangible low taxed income and the Company’s financial instruments included cash and cash equivalents, accounts receivable, accounts payable, a line of credit, and a term loan. The carrying amounts of cash and cash equivalents, accounts receivable and accounts payable approximates fair value due to the short-term maturities of these financial instruments. The carrying value of the debt balances approximate fair value because the variable interest rates reflect current market rates.

Fair Value Measurements

The Company measures at fair value certain financial and non-financial assets by using a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date, essentially an exit price, based on the highest and best use of the asset or liability. The levels of the fair value hierarchy are:

Level 1 — Quoted market prices in active markets for identical assets or liabilities;

Level 2 — Significant other observable inputs (e.g., quoted prices for similar items in active markets, quoted prices for identical or similar items in markets that are not active, inputs other than quoted prices that are observable such as interest rate and yield curves, and market-corroborated inputs); and

Level 3 — Unobservable inputs in which there is little or no market data, which require the Company to develop its own assumptions.

At September 30, 2017, and December 31, 2016, the following assets were measured at fair value on a recurring basis using the level of inputs shown:

Concentration of credit risk

Our product and operations teams work closely with suppliers from initial product development and throughout the manufacturing process to ensure that (1) the supplier understands, and will build according to, the product specifications, (2) appropriate quality is maintained for the finished goods and for all sub-components, and (3) the supplier can meet our supply needs.

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Concentration of net sales

For the three months ended September 30,March 31, 2018, Superior accounted for over 10% of net sales, and for the three months ended March 31, 2017, and 2016, Superior and Best Buy were our largest customers, each of which accounted for over 10% of net sales, as follows:

		Three months ended September 30, 2017				Three months ended September 30, 2016
Superior			32	%			30	%
Best Buy			12	%			10	%

	Three Months Ended
	March 31, 2018			March 31, 2017
Superior	29	%		27	%
Best Buy	8	%		12	%

For the ninethree months ended September 30,March 31, 2018 and 2017, and 2016, Superior and Best Buy were our largest customers, each of which accounted for over 10% of net sales, as follows:

		Nine months ended September 30, 2017				Nine months ended September 30, 2016
Superior			31	%			27	%
Best Buy			10	%			10	%

For the nine months ended September 30, 2017, and 2016, no other customers accounted for greater than 10% of net sales.

Although we have contracts in place governing our relationships with our retail distribution customers (“retailers”), the contracts are not long-term and all our retailers generally purchase from us on a purchase order basis. As a result, these retailers generally may, with little or no notice or penalty, cease ordering and selling our products, or materially reduce their orders. If any of these retailers cease selling our products, slow their rate of purchase of our products, or decrease the number of products they purchase, our results of operations could be adversely affected.

Concentration of region

The percentage of net sales by geographic region for the three months ended September 30,March 31, 2018 and 2017, and 2016, was approximately:

		Three months ended September 30, 2017				Three months ended September 30, 2016
United States			85	%			87	%
Europe			9	%			8	%
Other			6	%			5	%

The percentage of net sales by geographic region for the nine months ended September 30, 2017, and 2016, was approximately:

		Nine months ended September 30, 2017				Nine months ended September 30, 2016
United States			86	%			89	%
Europe			8	%			7	%
Other			6	%			4	%

(13)	SEGMENT REPORTING

As of June 30, 2017, the Company reported financial information on the following reportable segments: ZAGG and mophie. During the third quarter of 2017, management completed the consolidation of a number of ZAGG/mophie processes and functions, including the merging of the mophie enterprise resource planning (“ERP”) system into ZAGG’s ERP system. In addition, the executive team and related responsibilities were re-aligned such that global functional teams are directly managed by an executive from the corporate headquarters. These merged functional areas include the following: sales, marketing, product management, product development, operations, customer service, accounting, finance, legal, human resources, and IT.

In addition, as the Company has continued to evolve as a mobile lifestyle company, the information regularly reviewed by the chief operating decision maker is at the consolidated level, including sales and budget reviews.

Due to the changes described above, management reassessed its reportable segments during the third quarter of 2017, and concluded that the Company is a single reportable segment.

	Three Months Ended
	March 31, 2018			March 31, 2017
United States	82	%		84	%
Europe	9	%		10	%
Other	9	%		6	%

	(14)
(11)	SUBSEQUENT EVENTS

Certain settlements around litigation occurred subsequent to September 30, 2017, involving

As described in Note 5, “Debt and Line of Credit”, the Huang Delaware Lawsuit andCompany entered into the Huang California Lawsuit. Refer to Note 11 above for information regarding these settlements.

New Credit Agreement on April 12, 2018.

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ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

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 affecteffect 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 is an innovation leader in mobile tech accessories for smartphones and tablets. The Company is committed to enhance every aspect of performance, productivity and durability in mobile devices with creative product solutions. ZAGG was created from the concept of applying a clear film originally designed to protect military-helicopter blades in harsh desert conditions to protect consumers’ mobile devices. Mobile devices are essential to modern living and ZAGG’s mission is to ensure better performance in the real world.

In addition to its home-grown brands, ZAGG has created a platform to combine category-creating and innovative brands that address specific consumer needs to empower a mobile lifestyle. The Company has an award-winning product portfolio that includes screen protection, power cases, power management, wireless charging, personal audio, mobile keyboards, and cases sold under the ZAGG, InvisibleShield, mophie,ZAGG®, InvisibleShield®, mophie®, and IFROGZIFROGZ® brands.

We maintain our corporate headquarters at 910 West Legacy Center Drive,Way, Suite 500 Midvale, UT, 84047.Utah 84047. The telephone number of the Company is 801-263-0699.(801) 263-0699. Our website addresses arewww.ZAGG.com andwww.mophie.com. The URLs are included here as inactive textual references. Information contained on, or accessible through, our websites is not a part of, and is not incorporated by reference into, this report.

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The Company has established four corporate objectives and seven core values to act as a foundation for ZAGG's corporate culture and guide ZAGG daily:

 

Corporate Objectives		Core Values
The Preferred Brand		Integrity
Creative Product Solutions		Ownership
Targeted Global Distribution		Care for People
Operational Excellence		Passion
		Continuous Improvement
		Performance
		Sense of Urgency

The corporate objectives are intended to align the Company’s functional teams’ goals and execution. Every ZAGG employee is trained to understand his or her role in executing to these objectives. Each core value acts as a key component in working toward ZAGG’s corporate objectives of providing creative product solutions, executing targeted global distribution, achieving operational excellence, and being the preferred brand for its customers.

Our Products

InvisibleShield Products

InvisibleShield products are designed to provide premium, lifetime protection for mobile device screens against shattering or scratching through military-grade solutions. Our products are designed to provide peace of mind by enabling consumers to fearlessly enjoy their mobile devices and never experience the inconvenience of a shattered or scratched screen.

InvisibleShield is focused on producing industry-leading screen and device protection. Our protective film and glass products offer consumers a wide array of protection types and features, all with a limited lifetime warranty.

Our InvisibleShield films were originally developed to protect the leading edge of rotary blades on military helicopters. Through constant innovation, we continue to formulate new films that are designed to offer the highest standards in self-healing scratch and impact protection. We also continue to drive innovation around simplifying the customer application experience like we’ve done with our EZ Apply® tabs, which are designed to help users align and apply InvisibleShield products. We also provide custom-fit screen protection for thousands of device types through our automated InvisibleShield On Demand (“ISOD”) solution. With ISOD, retailers can supply consumers with screen protection for nearly any device model, all without having to hold excess inventory.

Launched during the first quarter of 2014, InvisibleShield Glass is designed to provide premium screen protection and clarity, along with a superior feel and universally compatible touch sensitivity. In the third quarter of 2016 we announced InvisibleShield Glass+, designed to provide additional scratch resistance and impact protection over InvisibleShield Glass. Additionally, we launched InvisibleShield Sapphire Defense during the third quarter of 2016, which is a hybrid glass screen protector infused with sapphire crystals designed to provide premium screen protection.

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ZAGG has the leading market share in screen protection, and has maintained that leading position by consistently delivering innovative products to the market.

mophie Products

mophie is a leading battery case, and mobile power, and wireless charging brand with award-winning products designed to liberate mobile users from the limitations of mobile devices by providing more time to rock, talk, watch, game, surf, save, and send. Notably, the original juice pack® is designed to provide device-specific protection as well as additional battery power to many of the most popular mobile phones. mophie products are recognized for style and engineered for performance, providing a seamless integration of hardware, software, and design.

The mophie ecosystem of mobile accessories is designed to provide both power and protection for virtually any mobile device. With groundbreaking battery cases, including extra data storage options, wireless charging, universal batteries, cables, adapters, and docks, mophie products represent innovation at the forefront of design and development.

During the third quarter of 2017, mophie launched an innovative new universal wireless charging pad that is designed to provide an optimized charging experience for the iPhone 8, iPhone 8 Plus and iPhone X; the mophie charging pad also includes latest Qi wireless charging technology for universal compatibility.

IFROGZ Products

IFROGZ products are strategically designed and positioned to bring personal audio to the value space by providing a product assortment that represents outstanding performance, active lifestyles, and dual-purpose designs that are on trend with consumers’ needs. IFROGZ refines today’s newest audio technology to deliver the features consumers want, while eliminating those that needlessly increase costs, so that everyone can participate in our increasingly mobile world.

In 2007, the IFROGZ EarPollution™ product line was released. The eclectic selection of earbuds and headphones specifically targeted a younger demographic while still appealing to a wide spectrum of consumers. We continue to innovate and expand our headphone and earbud product lines under the IFROGZ name to include offerings for all ages under both the EarPollution and IFROGZ brands. In 2013, we began offering IFROGZ portable Bluetooth speakers for music lovers on the move that combine impressive audio quality, clever functionality, and eye-catching design. In the third quarter of 2016, we introduced a new family of wireless Bluetooth audio products designed to combine outstanding sound with a lightweight listening experience by alleviating bulky earbuds and heavy control modules.

ZAGG Products

Products under the ZAGG brand are designed to empower people to live their lives unleashed. Mobility is changing everything and ZAGG is driving the mobile lifestyle forward with products that are designed to allow consumers to be productive and connected at work, at play and at rest. ZAGG products which include keyboards, cases, power management and social tech are designed to free consumers from the confines of the traditional workplace. We believe “getting away” shouldn’t mean being disconnected. We support the communicators, commuters, creators and closers who live a mobile lifestyle.

Our ZAGG products are designed to feature cutting-edge design and innovation to provide portability, style, and productivity that can keep up with even the most active mobile users. We believe that with the right mobile accessories, no one ever has to feel tethered or held back.

ZAGG keyboards are designed to offer consumers an enhanced and innovative productivity experience. Since entering this category in 2010, ZAGG has continually reinvented its line of keyboards while also providing timely, curated solutions for new devices released by Apple, Microsoft, and Samsung, as well as other leading mobile device manufacturers. In addition to device-specific keyboards and folio keyboard cases, ZAGG’s line of universal full-size Bluetooth® keyboards are designed to be compatible with virtually any device and mobile operating system. We continue to innovate and expand our wireless keyboard product lines as end users’ requirements evolve in this rapidly changing market segment.

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Critical Accounting Policies and Estimates

The preparation of our financial statements requires that we make estimates and judgments. We base these on historical experience and on other assumptions that we believe to be reasonable. Our critical accounting policies are discussed in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of our Annual Report on Form 10-K for the year ended December 31, 2016.2017. There have been no material changes to the critical accounting policies or estimates previously disclosed in that report.

report except for the implementation of certain estimates for revenue recognition under Topic 606 as disclosed below.

Revenue recognition

Topic 606 has required significant changes to how the Company's revenue is recognized. Updates to the Company's accounting policies have been made as part of adoption of this new standard. These changes to the Company's accounting policies and procedures under the new standard have most significantly impacted the estimates previously used to determine the company's sales returns, discounts and other credits. The new reserve calculations for these estimates apply assumptions allowable under Topic 606, which require judgment. In applying these new assumptions, and in the application of Topic 606, the Company has determined that the updated accounting policies to ensure compliance under Topic 606 continue to be critical accounting policies and estimates.

Revenue recognition accounting policy

The Company’s revenue is derived from (1) sales of our products through our indirect channel, including retailers and distributors; (2) sales of our products through our direct channel, including www.ZAGG.com and www.mophie.com and our corporate-owned ZAGG-branded store; and (3) from franchise fees derived from the on-boarding of new franchisees. The Company’s revenue is measured based on the amount of consideration we expect to receive, reduced by estimates for sales returns, discounts, and other credits. The observable standalone selling prices of products sold are based on the prices charged to customers and are mutually agreed upon by both parties before any orders are authorized.

For substantially all of our sales, revenue is recognized at a point in time when control of the goods is transferred to the customer, which generally occurs upon delivery to the carrier or the customer. For franchise fees, revenue is derived from the sale of licenses, training, inventory and equipment and marketing, among other items. We recognize revenue for performance obligations on a straight-line basis over the franchise term.

Taxes assessed by a governmental authority that are both imposed on and concurrent with a specific revenue-producing transaction, that are collected by the Company from a customer, are excluded from revenue.

Sales returns, discounts and other credits

The nature of our contracts gives rise to several types of variable consideration, including sales returns, discounts, and other credits. Certain customers receive credit-based incentives or credits, which are accounted for as variable consideration in the form of credit memos off future purchases from the Company. We estimate these amounts based on the expected amount to be provided to customers and reduce revenue accordingly on the invoice date.

We estimate a reserve for sales returns, discounts, and other credits, and record the respective estimated reserve amounts, including a right to return asset when a product is expected to be returned and resold. Historical experience, actual claims, and customer return rights are the key factors used in determining the estimated sales returns, discounts, and other credits.

Recent Accounting Pronouncements

Information regarding recent accounting pronouncements is contained in Note 1, “Nature of Operations and Basis of Presentation” of the Notes to Condensed Consolidated Financial Statements, which is incorporated herein by reference.

Results of Operations

Three months ended March 31, 2018

THREE MONTHS ENDED SEPTEMBER 30, and2017 AND 2016 (amounts (in thousands, except per share data)

Net sales

Net sales for the three months ended September 30, 2017,March 31, 2018, were $134,398$112,066 compared to net sales of $124,662$92,946 for the three months ended September 30, 2016,March 31, 2017, an increase of $9,736,$19,120, or approximately 8%21%. The $19,120 increase in net sales comparing the three months ended September 30, 2017, to 2016 was primarily attributable to (1) the increase in sales of our power management products, particularly accessories supporting the wireless charging ecosystem, and (2) increased sales of screen protection products in key wireless and retail accounts, particularly in international markets, and (2) the launch of the mophie wireless charging pad. During the third quarter of 2016, the Company launched a new line of power station products and loaded-in a significant amount of product to retail, however, there was no similar power station launch in the third quarter of 2017, resulting in a decline in overall power management sales.

markets.

The percentage of net sales related to our key product lines for the three months ended September 30,March 31, 2018 and 2017, and 2016, was approximately:

		2017				2016
Screen Protection			57	%			52	%
Power Management			19	%			22	%
Power Cases			12	%			12	%
Audio			6	%			6	%
Keyboards			5	%			6	%
Other			1	%			2	%

	Three Months Ended
	March 31, 2018			March 31, 2017
Screen Protection	50	%		46	%
Power Management	33	%		17	%
Power Cases	6	%		24	%
Audio	5	%		6	%
Keyboards	5	%		6	%
Other	1	%		1	%

The percentage of net sales related to our key distribution channels for the three months ended September 30,March 31, 2018 and 2017, and 2016, was approximately:

		2017				2016
Indirect channel			90	%			90	%
Website			7	%			7	%
Mall cart and kiosk program			3	%			3	%

	Three Months Ended
	March 31, 2018			March 31, 2017
Indirect channel	88	%		85	%
Website	8	%		11	%
Franchisees	4	%		4	%

The percentage of net sales byrelated to our key geographic regionregions for the three months ended September 30,March 31, 2018 and 2017, and 2016, was approximately:

		2017				2016
United States			85	%			87	%
Europe			9	%			8	%
Other			6	%			5	%

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	Three Months Ended
	March 31, 2018			March 31, 2017
United States	82	%		84	%
Europe	9	%		10	%
Other	9	%		6	%

Gross profit

Gross profit for the three months ended September 30, 2017,March 31, 2018, was $48,392,$37,592, or approximately 36%34% of net sales, as compared to $43,146,gross profit of $28,606, or approximately 35%31% of net sales for the three months ended September 30, 2016. Typically, the Company experiences higherMarch 31, 2017. The increase in gross profit margin in periods whenwas driven primarily by (1) the mix of screen protection products, increases. The mix of screen protection productsour highest margin product category, which increased during the three months ended September 30, 2017,March 31, 2018, to approximately 57%50% of net sales compared to approximately 52%46% of net sales during the three months ended September 30, 2016, benefiting overall gross profit margin.

March 31, 2017, and (2) improved margins on mophie-branded products.

Operating expenses

Total operating

Operating expenses for the three months ended September 30, 2017,March 31, 2018, were $32,457, a decrease$29,673, compared to operating expenses of $23,399, or approximately 42%, from total operating expenses$35,255 for the three months ended September 30, 2016,March 31, 2017, a decrease of $55,856.$5,582, or approximately 16%. The $23,399$5,582 decrease was primarily attributable to (1) a $24,317 loss on disputed mophie purchase price$2.0 million charge in 20162017 related to the impairment of a patent that did not recur in 2017,2018, (2) operating expense synergies realized related to the mophie integration, and (2)(3) a reduction in advertising and marketing spend. These reductionsspend that ultimately shifted into later periods in operating expense were partially offset by an increase in selling, general and administrative expense of $1,113 and amortization expense of $616.

2018.

Income (loss) from operations

We reported income from operations of $15,935$7,919 for the three months ended September 30, 2017,March 31, 2018, compared to a loss from operations of ($12,710)$6,649 for the three months ended September 30, 2016,March 31, 2017, an increase of $28,645.$14,568, or approximately 219%. The $14,568 increase in income was primarily attributable to the increasesincrease in net sales, improvementsthe increase in gross profit margin and the reductiondecrease of operating expenses primarily due to a $24,317 loss on disputed mophie purchase price in 2016.

expenses.

Other expense, net

For the three months ended September 30, 2017,March 31, 2018, other expense was $399$5 compared to other expense of $656$510 for the three months ended September 30, 2016.

March 31, 2017. The improvement in 2018 is primarily due to a gain on foreign exchange transactions of approximately $495.

Income taxes

tax (provision) benefit

We recognized an income tax expenseprovision of $5,760$885 for the three months ended September 30, 2017,March 31, 2018, compared to an income tax benefit of $6,261$1,021 for the three months ended September 30, 2016.March 31, 2017. Our effective tax rate was 37%11% and 47%14% for the three months ended September 30,March 31, 2018 and 2017, and 2016, respectively. The decrease in the effective tax rate was due to several factors including but not limited to a change in the federal statutory rate from 35% to 21%, a change to book income in lower rate foreign jurisdictions in which the Company experienced lossesfirst quarter of 2018 compared to book loss in the prior year for which benefits were not recognized as well the ratiofirst quarter of credits2017, and other permanent differencesan increase to pre-tax book income.income in foreign jurisdictions. The Company’s effective tax rate will generally differ from the U.S. Federal statutory rate of 35%21%, due to state taxes, permanent items, and the Company’s global tax strategy.

strategy, and the inclusion of global intangible low taxed income and the corresponding foreign tax credit.

Net income (loss)

As a result

Net income was $7,029, with diluted earnings per share of the factors noted above, we reported net income of $9,776, or $0.34 per diluted share,$0.24 for the three months ended September 30, 2017,March 31, 2018, compared to a net loss of ($7,105), or ($0.25)$6,138, with diluted loss per share of $0.22, for the three months ended September 30, 2016.

NINE MONTHS ENDED SEPTEMBER 30, 2017, AND 2016 (amounts in thousands, except per share data)

Net sales

Net sales for the nine months ended September 30, 2017, were $342,571 compared to net sales of $286,928 for the nine months ended September 30, 2016, an increase of $55,643, or approximately 19%. The increase in net sales comparing the nine months ended September 30, 2017, to 2016 was primarily attributable to (1) increased sales of screen protection for new device releases during the current year, and (2) higher sales of power management and power case products. Results for the nine months ended September 30, 2017, also include nine months of mophie sales compared to only seven months in 2016 as the acquisition occurred on March 3, 2016.

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31, 2017.

The percentage of net sales related to our key product lines for the nine months ended September 30, 2017, and 2016, was approximately:

		2017				2016
Screen Protection			52	%			53	%
Power Cases			18	%			15	%
Power Management			18	%			15	%
Keyboards			6	%			9	%
Audio			6	%			7	%
Other			0	%			1	%

The percentage of net sales related to our key distribution channels for the nine months ended September 30, 2017, and 2016, was approximately:

		2017				2016
Indirect channel			89	%			88	%
Website			8	%			8	%
Mall cart and kiosk program			3	%			4	%

The percentage of net sales by geographic region for the nine months ended September 30, 2017, and 2016, was approximately:

		2017				2016
United States			86	%			89	%
Europe			8	%			7	%
Other			6	%			4	%

Gross profit

Gross profit for the nine months ended September 30, 2017, was $112,822, or approximately 33% of net sales, as compared to $97,748, or approximately 34% of net sales for the nine months ended September 30, 2016. The decrease in the gross profit margin percentage was primarily attributable to (1) a full nine months of mophie operations in 2017, compared to only seven months of mophie operations in 2016, which are at lower gross profit margins than the corporate average, and (2) lower gross profit margin on curved glass for the Samsung Galaxy S8, compared to historical gross margins on non-curved glass products. These items were partially offset by amortization expense from the acquisition-related fair value inventory write-up in 2016, which did not recur in 2017.

Operating expenses

Total operating expenses for the nine months ended September 30, 2017, were $98,040, a decrease of $17,474, or approximately 15%, from total operating expenses for the nine months ended September 30, 2016, of $115,514. The decrease in operating expenses was primarily attributable to (1) a $24,317 loss on disputed mophie purchase price in 2016 that did not recur in 2017, (2) synergies realized from cost reduction initiatives, (3) a reduction in transaction-related costs, (4) a reduction in advertising and marketing spend, and (5) an overall reduction in amortization expense. These decreases were partially offset by the following increases in operating expense: (1) the inclusion of nine months of mophie-related expenses for 2017 compared with seven months in 2016 and (2) the impairment of an intangible asset in 2017 related to an invalidated patent totaling $1,959.

Income (loss) from operations

We reported income from operations of $14,782 for the nine months ended September 30, 2017, compared to a loss from operations of ($17,766) for the nine months ended September 30, 2016, an increase of $32,548. The increase in income from operations was primarily attributable to increases in net sales and gross profit, and a decrease in operating expenses primarily due to a $24,317 loss on disputed mophie purchase price in 2016.

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Other expense, net

For the nine months ended September 30, 2017, other expense was $1,460 compared to other expense of $1,639 for the nine months ended September 30, 2016.

Income taxes

We recognized income tax expense of $6,281 for the nine months ended September 30, 2017, compared to an income tax benefit of $7,963 for the nine months ended September 30, 2016. Our effective tax rate was 47% and 41% for the nine months ended September 30, 2017, and 2016, respectively. The increase in the effective tax rate was primarily due to various discrete expenses recognized during the period related to the true up of a deferred amount for stock compensation and other discrete items related to the return to provision calculation. The Company’s effective tax rate will generally differ from the U.S. Federal statutory rate of 35%, due to state taxes, permanent items, and the Company’s global tax strategy.

Net income (loss)

As a result of the factors noted above, we reported net income of $7,041, or $0.25 per diluted share, for the nine months ended September 30, 2017, compared to a net loss of ($11,442), or ($0.41) per share, for the nine months ended September 30, 2016.

Liquidity and Capital Resources (in thousands)thousands

)

At September 30, 2017,March 31, 2018, our principal sources of liquidity were cash provided by operations, cash on hand, and the revolving credit facility. Our principal uses of cash have been cash used to reduce accounts payable balances, purchase of property and equipment, and make payments on the term and revolving credit facilities.

Cash and cash equivalents on-hand decreased to $11,394$17,745 on September 30, 2017,March 31, 2018, from $11,604$24,989 on December 31, 2016,2017, a decrease of $210. Earnings from foreign operations are considered permanently re-invested and of the $11,394 cash balance on September 30, 2017, cash from foreign entities totaled $8,735, which constitutes 77% of the total cash and cash equivalents balance.

Accounts receivable, net of allowances, increased to $96,830 on September 30, 2017, from $83,835 on December 31, 2016, an increase of $12,995. The increase was primarily attributable to increased sales in 2017 partially offset by strong cash collections during the first nine months of 2017.

Inventories decreased to $72,005 on September 30, 2017, from $72,769 on December 31, 2016, a decrease of $764.$7,244. The net decrease was primarily attributable to improved supply chain(1) $15,375 net payments on the line of credit and inventory purchasing processes,term loans, and (2) $1,907 from net property and equipment purchases, partially offset by $9,728 generated from operating activities.

Accounts receivable, net of allowances, decreased to $73,894 on March 31, 2018, from $123,220 on December 31, 2017, a decrease of $49,326. The net decrease was primarily attributable to comparatively lower sales for the quarter in comparison to the prior quarter as well as strong cash collections during the first three months of 2018.

Inventories increased to $78,891 on March 31, 2018, from $75,046 on December 31, 2017, an increase of $3,845. The net increase was primarily attributable to (1) increased wireless charge pad ecosystem inventory to support the growth of the wireless charging category and (2) increased inventory purchases atto ensure adequate inventory levels during the end of the third quarter to meet fourth quarter demand for new product launches.

second quarter.

Accounts payable decreased to $82,742$54,798 on September 30, 2017,March 31, 2018, from $85,022$96,472 on December 31, 2016,2017, a decrease of $2,280.$41,674. The net decrease was primarily attributable to timing of payments for larger expenses to suppliers at each respective period-end.

in conjunction with larger sales volumes in the prior quarter.

At September 30, 2017,March 31, 2018, the Company had a positive working capital of $19,677$70,068 compared to negativepositive working capital of ($9,408)$43,210 as of December 31, 2016.2017, an increase of $26,858. The net increase in the working capital position was primarily attributable to reductions in accounts payable and the lineshift of credit, and an increase in accounts receivable.

debt from current liabilities to non-current liabilities.

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

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Item 3.

Quantitative and Qualitative Disclosures About Market Risk

Item 3. Quantitative and Qualitative Disclosures About Market Risk

We are exposed to certain market risks in the ordinary course of our business. These risks result primarily from changes in foreign currency exchange rates and interest rates. In addition, our international operations are subject to risks related to differing economic conditions, changes in political climate, differing tax structures, and other regulations and restrictions.

To date we have not utilized derivative financial instruments or derivative commodity instruments. We do not expect to employ these or other strategies to hedge market risk in the foreseeable future. We invest our cash in money market funds, which are subject to minimal credit and market risk. We believe that the market risks associated with these financial instruments are immaterial, although there can be no guarantee that these market risks will be immaterial to us.

Item 4.

Controls and Procedures

Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

We maintain

Our management has established and maintains disclosure controls and procedures designed to ensure that information required to be disclosed in ourthe reports filed underthat it files or submits pursuant to the Securities Exchange Act of 1934, as amended, (the “Exchange Act”),or Exchange Act, is recorded, processed, summarized and reported within the time periods specified in the SECSEC’s rules and forms, and that such information is accumulated and communicated to our management, including the chiefour principal executive officer and chiefprincipal financial officer, as appropriate to allow for timely decisions regarding required disclosure.

Underdisclosures.

At the end of the period covered by this report, we carried out an evaluation, under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an evaluationof the effectiveness of the design and operation of our disclosure controls and procedures as such term is defined under Rule 13a-15(e) promulgated underin accordance with the Exchange Act as of the end of the period covered by this Report.requirements. Based on thisupon that evaluation, theour principal executive officer and principal financial officer concluded that as of the end of the period covered byof this Report,report, our disclosure controls and procedures wereare not effective atdue to the reasonable assurance level.

material weakness described below.

The Company’s control environment was ineffective because we failed to establish appropriate authorities and responsibilities in alignment with the objectives of internal control over financial reporting to certain employees; and

The Company’s risk assessment process was ineffective because we failed to consider changes in the business operations and their impact on financial reporting and internal controls.

Changes in Internal Control over Financial Reporting

As a result of the

To remediate this material weakness relatedwhich resulted in an immaterial misstatement to a material overstatement of net sales, and accounts receivable, cost of goods sold, and inventory as of and for the year ended December 31, 2016, which2017 (which was corrected by management prior to issuance of the 20162017 consolidated financial statements in the Company’s Annual Report on Form 10-K,10-K), management has completedinitiated the following changes to its internal controls during the ninethree months ended September 30, 2017:

	●	Conducted training regarding the design and operationMarch 31, 2018: Enhance our control environment by establishing appropriate authorities and responsibilities in alignment with the objectives of controls with those responsible for performing and reviewing the process level control activities over revenue, accounts receivable and in transit inventory.
	●	Enhanced review controls over revenue, accounts receivable, and inventory.
	●	Tasked the ZAGG operations team to identify information technology solutions that streamline the process for tracking and reporting orders shipped from China directly to customers.
	●	Enhanced the risk assessment process to consider significant changes in the business operations and the associated impact on financial reporting and internal controls

Management has assessed the above identified changes to its internal control over financial reportingreporting;

Implement a cross functional risk assessment process to ensureidentify and assess changes in the business that could significantly impact internal control over financial reporting;

Design and implement control activities over the changes have been properly designedcustomer returns process;

Design and implement control activities over the management of accounts receivable transactions due to the growth of the Company; and

Evaluate whether control activities can be automated to replace manual processes.

During the three months ended March 31, 2018, the Company has implemented several new cross functional processes and are operating effectively. The assessment performed has allowed managementcontrols to conclude thataddress the material weakness at December 31, 2016 has been remediated. The process for evaluatingweakness. In addition, others processes and controls and procedures is continuous and encompasses constant improvementare currently being implemented as part of the designplanned remediation.

Additionally, we initiated changes over internal controls relating to the implementation and effectiveness of established controlsongoing accounting procedures (including applicable estimates and procedures and the remediation of any deficiencies which may be identified during this process.

disclosures) for revenue recognition standard requirements found in Topic 606.

Inherent Limitations on the Effectiveness of Internal Controls

Our disclosure controls

Internal control over financial reporting has inherent limitations. Internal control over financial reporting is a process that involves human diligence and procedures are designedcompliance and is subject to provide reasonable assurance of achieving their objectives. Nevertheless, an internallapses in judgment and breakdowns resulting from human failures. Internal control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system reflects the fact that there are resource constraints, and the benefits of controls are considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of a simple error or mistake. Additionally, controlsover financial reporting also can be circumvented by the individual actscollusion or improper management override. Because of some persons,such limitations, there is a risk that material misstatements will not be prevented or detected on a timely basis by collusion of two or more people, or by management overrideinternal control over financial reporting. However, these inherent limitations are known features of the internal control. Thefinancial reporting process. Therefore, it is possible to design of any system of controls also is based in part upon certain assumptions aboutinto the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Over time, controls may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate.

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process safeguards to reduce, though not eliminate, this risk.

PART II - OTHER INFORMATION

Item 1.

Legal Proceedings

Item 1. Legal Proceedings

Certain of the legal proceedings in which we are involved are discussed in Note 11,9, “Commitments and Contingencies,” to our Condensed Consolidated Financial Statements in this Quarterly Report on Form 10-Q, and are hereby incorporated by reference.

Item 1A.

Risk Factors

Item 1A. Risk Factors

In addition to the other information set forth in this Quarterly Report on Form 10-Q, you should carefully consider the factors discussed in Part I, Item 1A. Risk Factors, in our Annual Report on Form 10-K for the year ended December 31, 20162017 (the “2016“2017 Form 10-K”), which could materially affect our business, financial condition or future results. These risk factors should be read carefully in connection with evaluating our business and in connection with the forward-looking statements contained in this Quarterly Report on Form 10-Q. Any of the risks described in the 20162017 Form 10-K could materially adversely affect our business, financial condition or future results and the actual outcome of matters as to which forward-looking statements are made. These are not the only risks we face. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition, and/or operating results.

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds(dollars and shares in thousands)

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

None.

Item 3.

Defaults Upon Senior Securities

Item 3. Defaults Upon Senior Securities

None.

Item 4.

Mine Safety Disclosures

Item 4. Mine Safety Disclosures

Not applicable.

Item 5.

Other Information

Item 5. Other Information

None.

Item 6.

Exhibits

a.Exhibits:

Item 6. Exhibits

a. Exhibits: The following Exhibits are filed with this Form 10-Q pursuant to Item 601(a) of Regulation S-K:

Exhibit No.Number		Description of Exhibit
31.1		Certification of Chief Executive Officer pursuant to Rules 13a-14(a) or 15d-14(a) under the Securities Exchange Act of 1934, as Amended.
31.2		Certification of Chief Financial Officer pursuant to Rules 13a-14(a) or 15d-14(a) under the Securities Exchange Act of 1934, as Amended.
32.1		Certification of Chief Executive Officer pursuant to 18 U.S. C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2		Certification of Chief Financial Officer pursuant to 18 U.S. C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
EX-101.INS		XBRL Instance Document
EX-101.SCH		XBRL Taxonomy Extension Schema Document
EX-101.CAL		XBRL Taxonomy Extension Calculation Linkbase
EX-101.DEF		XBRL Taxonomy Extension Definition Linkbase
EX-101.LAB		XBRL Taxonomy Extension Labels Linkbase
EX-101.PRE		XBRL Taxonomy Extension Presentation Linkbase

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned hereunto duly authorized.

	ZAGG INC
Date: November 2, 2017Dated: May 9, 2018	/s/ RANDALL L. HALESCHRIS AHERN
	Randall L. Hales,Chris Ahern
	Chief Executive Officer President, & Director
	(Principal executive officer)
Date: November 2, 2017Dated: May 9, 2018	/s/ BRADLEY J. HOLIDAY
	Bradley J. Holiday
	Chief Financial Officer
	(Principal financial officer)

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