UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C. 20549





FORM
10-Q








(Mark
one)





[X]
            Quarterly
      Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of
      1934 for the quarterly period ended September 30, 2009,
  or





[   ]
            Transition
      Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of
      1934 for the transition period from ______________ to
      _____________.





Commission
File No. 000-52211


ZAGG
INCORPORATED


(Exact
name of registrant as specified in its charter)






Nevada
            20-2559624(State or
      other jurisdiction of incorporation or organization)
            (I.R.S.
      Employer Identification No.)




3855
South 500 West, Suite J


Salt
Lake City, Utah 84115


(Address
of principal executive offices with zip code)





(801)
263-0699


(Registrant's
telephone number, including area code)





Check
whether the issuer (1) has filed all reports required to be filed by Section 13
or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months
(or for such shorter period that the registrant was required to file such
reports), and (2) has been subject to such filing requirements for the past 90
days: Yes [X]
No[  ].





Indicate
by check mark whether the registrant has submitted electronically and posted on
its corporate Web site, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T (§ 229.405 of this
chapter) during the preceding 12 months (or for such shorter period that the
registrant was required to submit and post such files).


Yes
[  ] No [X]





Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting company.
[ ] Large accelerated filer [ ]
Accelerated filer [ ] Non-accelerated filer [X] Smaller reporting
company





Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-25 of the Exchange Act).


Yes
[  ] No [X]





State the
number of shares outstanding of each of the issuer’s classes of common equity,
as of the latest practicable date: 21,690,195 common shares as of
November 11, 2009.








1














ZAGG
INCORPORATED AND SUBSIDIARY


FORM
10-Q








TABLE
OF CONTENTS








PagePART I - FINANCIAL
      INFORMATIONItem
      1.
              Financial
      Statements (Unaudited)Condensed
      Consolidated Balance Sheets – As of September 30, 2009 and December 31,
      2008
              
              
              3Condensed
      Consolidated Statements of Operations for the Three and Nine Months
      EndedSeptember
      30, 2009 and 2008
              
              
              4Condensed
      Consolidated Statements of Cash Flows for the Nine Months
      EndedSeptember
      30, 2009 and 2008
              
              
              5Notes
      to Condensed Consolidated Financial Statements
              
              
              7Item
      2.
              Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operations
              
              
              14Item
      3.
              Quantitative
      and Qualitative Disclosures About Market Risk
              
              
              20Item
      4T.
              Controls
      and Procedures
              
              
              20PART
      II - OTHER INFORMATIONItem
      1.
              Legal
      Proceedings
              
              
              21Item
      1A.
              Risk
      Factors
              
              
              21Item
      2.
              Unregistered
      Sales of Equity Securities and Use of Proceeds
              
              
              21Item
      3.
              Defaults
      Upon Senior Securities
              
              
              22Item
      4.
              Submission
      of Matters to a Vote of Security Holders
              
              
              22Item
      5.
              Other
      Information
              
              
              22Item
      6.
              Exhibits
              
              
              23











2








ZAGG
INCORPORATED AND SUBSIDIARY


CONDENSED
CONSOLIDATED BALANCE SHEETS


(Unaudited)






September
      30,
                
                
                December
      31,2009
                
                
                2008ASSETSCurrent
      assetsCash
                
                $
                2,102,779
                
                
                $
                1,065,652Accounts
      receivable, net
                
                
                5,878,412
                
                
                
                3,593,887Inventories
                
                
                3,488,350
                
                
                
                1,913,297Prepaid
      expenses and other current assets
                
                
                2,854,625
                
                
                
                676,077Notes
      receivable
                
                
                513,000
                
                
                
                513,000Convertible
      bridge loan
                
                
                1,151,000
                
                
                
                -Deferred
      income tax assets
                
                
                -
                
                
                
                81,663Total
      current assets
                
                
                15,988,166
                
                
                
                7,843,576Property
      and equipment, net
                
                
                808,459
                
                
                
                549,370Deferred
      income tax assets
                
                
                -
                
                
                
                4,937Deposits
      and other assets
                
                
                9,688
                
                
                
                9,688Intangible
      assets, net
                
                
                97,773
                
                
                
                47,344Total
      assets
                
                $
                16,904,086
                
                
                $
                8,454,915LIABILITIES
      AND STOCKHOLDERS' EQUITYCurrent
      liabilitiesNotes
      payable
                
                $
                -
                
                
                $
                20,223Accounts
      payable
                
                
                2,473,835
                
                
                
                1,626,390Accrued
      liabilities
                
                
                136,645
                
                
                
                212,754Accrued
      wages and wage related expenses
                
                
                151,086
                
                
                
                121,112Deferred
      revenue
                
                
                269,737
                
                
                
                366,590Deferred
      income tax liability
                
                
                1,235,948
                
                
                
                -Sales
      returns liability
                
                
                335,574
                
                
                
                291,119Total
      current liabilities
                
                
                4,602,825
                
                
                
                2,638,188Total
      liabilities
                
                
                4,602,825
                
                
                
                2,638,188Stockholders'
      equityCommon
      stock, $0.001 par value; 50,000,000 shares authorized;21,690,195
      and 19,163,995 shares issued and outstanding, respectively
                
                
                21,691
                
                
                
                19,165Warrants
      to purchase common stock
                
                
                456,579
                
                
                
                739,338Additional
      paid-in capital
                
                
                7,470,076
                
                
                
                3,808,280Cumulative
      translation adjustment
                
                
                (133,894
                )
                
                
                (106,630
                )Retained
      earnings
                
                
                4,486,809
                
                
                
                1,356,574Total
      stockholders' equity
                
                
                12,301,261
                
                
                
                5,816,727Total
      liabilities and stockholders' equity
                
                $
                16,904,086
                
                
                $
                8,454,915
   See
accompanying notes to condensed consolidated financial
statements.


3


ZAGG
INCORPORATED AND SUBSIDIARY


CONDENSED
CONSOLIDATED STATEMENTS OF OPERATIONS


(Unaudited)




Three
      months ended
                
                
                Nine
      months endedSeptember
      30, 2009
                
                
                September
      30, 2008
                
                
                September
      30, 2009
                
                
                September
      30, 2008Net
      sales
                
                $
                9,728,528
                
                
                $
                6,854,916
                
                
                $
                26,964,159
                
                
                $
                12,460,812Cost
      of sales
                
                
                4,521,555
                
                
                
                2,416,988
                
                
                
                11,055,903
                
                
                
                3,920,003Gross
      profit
                
                
                5,206,973
                
                
                
                4,437,928
                
                
                
                15,908,256
                
                
                
                8,540,809Operating
      expenses:Advertising
      and marketing
                
                
                1,327,126
                
                
                
                1,169,073
                
                
                
                4,168,854
                
                
                
                2,483,356Selling,
      general and administrative
                
                
                2,408,559
                
                
                
                1,898,149
                
                
                
                6,801,112
                
                
                
                4,715,538Total
      operating expenses
                
                
                3,735,685
                
                
                
                3,067,222
                
                
                
                10,969,966
                
                
                
                7,198,894Income
      from operations
                
                
                1,471,288
                
                
                
                1,370,706
                
                
                
                4,938,290
                
                
                
                1,341,915Other
      income (expense):Interest
      expense
                
                
                (62,034
                )
                
                
                (796
                )
                
                
                (64,654
                )
                
                
                (3,470
                )Interest
      and other income
                
                
                49,107
                
                
                
                49,139
                
                
                
                141,381
                
                
                
                178,069Total
      other (expense) income
                
                
                (12,927
                )
                
                
                48,343
                
                
                
                76,727
                
                
                
                174,599Income
      before provision for income taxes
                
                
                1,458,361
                
                
                
                1,419,049
                
                
                
                5,015,017
                
                
                
                1,516,514Income
      tax provision
                
                
                (550,280
                )
                
                
                (529,306
                )
                
                
                (1,884,432
                )
                
                
                (566,236
                )Net
      income
                
                $
                908,081
                
                
                $
                889,743
                
                
                $
                3,130,585
                
                
                $
                950,278Basic
      net income per common share
                
                $
                0.04
                
                
                $
                0.05
                
                
                $
                0.15
                
                
                $
                0.05Diluted
      net income per common share
                
                $
                0.04
                
                
                $
                0.05
                
                
                $
                0.14
                
                
                $
                0.05Weighted
      average number of shares outstanding - basic
                
                
                21,540,033
                
                
                
                18,981,386
                
                
                
                20,630,819
                
                
                
                18,956,290Weighted
      average number of shares outstanding - diluted
                
                
                24,252,718
                
                
                
                19,436,146
                
                
                
                22,902,264
                
                
                
                19,290,502






See
accompanying notes to condensed consolidated financial
statements.


4


ZAGG
INCORPORATED AND SUBSIDIARY


CONDENSED
CONSOLIDATED STATEMENTS OF CASH FLOWS


(Unaudited)




For
      the Nine Months Ended
                September
      30,2009
              
              
              2008Cash
      flows from operating activitiesNet
      income
              
              $
              3,130,585
              
              
              $
              950,278Adjustments
      to reconcile net income to net cashused
      in operating activities:Non-cash
      expense related to stock-based compensation
              
              
              498,781
              
              
              
              211,510Depreciation
      and amortization
              
              
              171,973
              
              
              
              112,162Deferred
      income tax expense
              
              
              -
              
              
              
              566,235Bad
      debt expense
              
              
              86,921
              
              
              
              56,170Gain
      on asset disposals
              
              
              -
              
              
              
              (12,215
              )Foreign
      currency translation adjustment
              
              
              (27,264
              )
              
              
              18,361Changes
      in assets and liabilitiesAccounts
      receivable
              
              
              (2,371,446
              )
              
              
              (2,410,546
              )Inventories
              
              
              (1,575,053
              )
              
              
              (400,665
              )Prepaid
      advertising
              
              
              -
              
              
              
              58,247Prepaid
      expenses and other current assets
              
              
              (2,178,548
              )
              
              
              (503,642
              )Accounts
      payable
              
              
              847,071
              
              
              
              642,404Accrued
      liabilities
              
              
              (76,109
              )
              
              
              (26,015
              )Accrued
      wages and wage related expenses
              
              
              29,974
              
              
              
              9,445Deferred
      revenues
              
              
              (96,853
              )
              
              
              7,598Deferred
      tax liabilities
              
              
              1,322,548
              
              
              
              -Sales
      return liability
              
              
              44,455
              
              
              
              206,174Net
      cash used in operating activities
              
              
              (192,965
              )
              
              
              (514,499
              )Cash
      flows from investing activitiesPayments
      for intangible assets
              
              
              (54,636
              )
              
              
              (1,800
              )Convetible
      bridge loan
              
              
              (1,151,000
              )
              
              
              -Short-term
      loans
              
              
              -
              
              
              
              (450,000
              )Proceeds
      from disposal of equipment
              
              
              -
              
              
              
              2,994Purchase
      of property and equipment
              
              
              (426,831
              )
              
              
              (248,047
              )Net
      cash used in investing activities
              
              
              (1,632,467
              )
              
              
              (696,853
              )Cash
      flows from financing activitiesPayments
      on debt
              
              
              (20,223
              )
              
              
              (18,030
              )Proceeds
      from issuance of common stock and warrants
              
              
              2,882,782
              
              
              
              50,000Net
      cash provided by financing activities
              
              
              2,862,559
              
              
              
              31,970Net
      increase (decrease) in cash and cash equivalents
              
              
              1,037,127
              
              
              
              (1,179,382
              )Cash
      and cash equivalents at beginning of the period
              
              
              1,065,652
              
              
              
              2,129,215Cash
      and cash equivalents at end of the period
              
              $
              2,102,779
              
              
              $
              949,833Supplemental
      disclosure of cash flow informationCash
      paid during the period for interest
              
              $
              62,034
              
              
              $
              3,699





See
accompanying notes to condensed consolidated financial
statements.




5


ZAGG
INCORPORATED AND SUBSIDIARY
 CONDENSED
CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
 (Unaudited)








Supplemental
schedule of noncash investing and financing activities





For the Nine Months Ended September 30,
2009:





Issued 195,000 warrants issued valued
at $136,511.





For the Nine Months Ended September 30,
2008:





Issued 80,000 shares of common stock
for payment of consulting services.





Issued 60,000 shares of common stock to
employees.










See
accompanying notes to condensed consolidated financial
statements.


6





ZAGG
INCORPORATED AND SUBSIDIARY
 Notes
to Condensed Consolidated Financial Statements
 (Unaudited)





NOTE 1–SUMMARY OF SIGNIFICANT ACCOUNTING
POLICIES





Basis of
Presentation – The accompanying unaudited condensed consolidated
financial statements ofZAGG Incorporated
(collectively, the “Company” or “ZAGG”) have been prepared by the Company
pursuant to the rules and regulations of the Securities and Exchange Commission
(the “SEC”).  Certain information and footnote disclosures normally
included in financial statements prepared in accordance with accounting
principles generally accepted in the United States of America have been
condensed or omitted pursuant to such rules and regulations, although the
Company believes that the following disclosures are adequate to make the
information presented not misleading.  The Company suggests that these
condensed consolidated financial statements be read in conjunction with
the  consolidated financial statements and the notes thereto included
in the Company’s 2008 Annual Report on Form 10-K.





These
condensed consolidated financial statements reflect all adjustments (consisting
only of normal recurring adjustments) that, in the opinion of management, are
necessary to present fairly the financial position and results of operations of
the Company for the periods presented.





Operating
results for the nine months ended September 30, 2009, are not necessarily
indicative of the results that may be expected for the year ending December 31,
2009.





Nature of
Operations– The
Company designs, manufactures and distributes protective coverings, audio
accessories and power solutions for consumer electronic and hand-held devices
under the brand names invisibleSHIELDTM and ZAGGaudioTM.





Critical
Accounting Policies–The discussion and analysis of the Company’s financial condition and
results of operations are based on the Company’s financial statements, which
have been prepared in accordance with accounting principles generally accepted
in the United States (U.S. GAAP). The preparation of these financial statements
requires the Company to make estimates and judgments that affect the reported
amounts of assets, liabilities, revenues and expenses, and related disclosure of
contingent assets and liabilities. On an on-going basis, the Company evaluates
its estimates based on historical experience and on various other assumptions
that are believed to be reasonable under the circumstances, the results of which
form the basis for making judgments about the carrying values of assets and
liabilities that are not readily apparent from other sources.  Actual
results may differ from these estimates under different assumptions or
conditions.  Significant estimates include the allowance for doubtful
accounts, inventory valuation allowances, sales returns and warranty liability,
the useful life of property and equipment and the valuation allowance on
deferred tax assets.





Principles of
Consolidation–The
condensed consolidated financial statements include the accounts of ZAGG
Incorporated, and its wholly owned subsidiary ZAGG Europe Ltd.  All
significant intercompany transactions have been eliminated in consolidation.





Revenue
recognition– The Company records revenue when persuasive evidence of an
arrangement exists or product delivery has occurred, the sales price to the
customer is fixed or determinable, and collectability is reasonably
assured.  The Company’s revenue is derived from sales of its products to
retailers, resellers and end consumers and from the fees derived from the sale
of exclusive distributor licenses related to the kiosk program.  For
sales of product, the Company’s standard shipping terms are FOB shipping point
and the Company records revenue when the product is shipped, net of estimated
returns and discounts.  For license fees, the Company recognizes
revenue on a straight-line basis over the life of the license term.





Any
incentives received from vendors are recognized as a reduction of the cost of
products. Promotional products given to customers or potential customers are
recognized as a cost of sales. Cash incentives provided to our customers are
recognized as a reduction of the related sale price, and, therefore, are a
reduction in sales.





Reserve for Sales
Returns and Warranty Liability– The Company’s return policy generally
allows its end users and retailers to return purchased products for refund or in
exchange for new products within 30 days of end user purchase.  The
Company estimates a reserve for sales returns and records that reserve amount as
a reduction of sales and as a sales return reserve liability.  The
sales return liability was $335,574 at September 30, 2009 and $291,119 at
December 31, 2008.




7


ZAGG
INCORPORATED AND SUBSIDIARY
 Notes
to Condensed Consolidated Financial Statements
 (Unaudited)





The
Company generally provides the ultimate consumer a warranty with each product
and accrues warranty expense at the time of the sale based on the Company’s
prior claims history.  Actual warranty costs incurred are charged
against the accrual when paid.  During the nine months ended September
30, 2009 and 2008, warranty expense and the reserve for warranty liability,
respectively, was not material.





Shipping and
Handling Costs– Amounts invoiced to customers for shipping and handling
are included in sales and were $1,135,934 and $744,293 for the nine months ended
September 30, 2009 and 2008, respectively.  Actual shipping and
handling costs to ship products to customers are included in cost of sales and
were $3,519,721 and $901,074 for the nine months ended September 30, 2009 and
2008, respectively.





Stock-based
compensation– As required by generally accepted accounting principles,
the Company recognizes the cost resulting from all stock-based payment
transactions including shares issued under its stock option plans in the
financial statements based upon the fair value of such equity instruments
granted.  For the nine months ended September 30, 2009, the Company
recognized stock-based compensation expense of $476,084, related to the issuance
of common stock and options issued under its stock incentive plan.





Advertising –Advertising is expensed as incurred. Advertising expenses were $4,168,854
and $2,483,356 for the nine months ended September 30, 2009 and 2008,
respectively.





Foreign Currency
Transactions–The condensed consolidated financial statements are presented in U.S.
Dollars (“USD”).  The company’s primary operations are at the parent
level, which uses the USD as its functional currency.





Reclassifications–Certain amounts in the
financial statements of the prior periods have been reclassified to conform to
the current period presentation for comparative purposes.





Net Income Per
Common Share– Basic net income per
share is computed by dividing net income by weighted average number of shares of
common stock outstanding during each period.  Diluted net income per
share is computed by dividing net income by the weighted average number of
shares of common stock, common stock equivalents and potentially dilutive
securities outstanding during each period.






8


ZAGG
INCORPORATED AND SUBSIDIARY
 Notes
to Condensed Consolidated Financial Statements
 (Unaudited)





The
following is a reconciliation of the numerator and denominator used to calculate
Basic and Diluted EPS:




Net
                Income
              
              Weighted
      Average
                Shares
              Per Share
                AmountThree
      months ended September 30, 2009:Basic
      EPS
              
              $
              908,081
              
              21,540,033
              
              $
              0.04Effect
      of common stock equivalents
              
              —
              
              2,712,685Diluted
      EPS
              
              $
              908,081
              
              24,252,718
              
              $
              0.04Three
      months ended September 30, 2008:Basic
      EPS
              
              $
              889,743
              
              18,981,386
              
              $
              0.05Effect
      of common stock equivalents
              
              —
              
              454,760Diluted
      EPS
              
              $
              889,743
              
              19,436,146
              
              $
              0.05
  Net
                Income
              
              Weighted
      Average
                Shares
              Per Share
                AmountNine
      months ended September 30, 2009:Basic
      EPS
              
              $
              3,130,585
              
              20,630,676
              
              $
              0.15Effect
      of common stock equivalents
              
              —
              
              2,271,445Diluted
      EPS
              
              $
              3,130,585
              
              22,902,121
              
              $
              0.14Nine
      months ended September 30, 2008:Basic
      EPS
              
              $
              950,278
              
              18,956,290
              
              $
              0.05Effect
      of common stock equivalents
              
              —
              
              334,212Diluted
      EPS
              
              $
              950,278
              
              19,290,502
              
              $
              0.05





The
calculation above for the three and nine months ended September 30, 2008
excludes the exercise of 4,096,953 outstanding warrants and 3,000 outstanding
stock options as the exercise of these warrants and stock options would have an
antidilutive effect on earnings per share.  The calculation above for
the three months ended September 30, 2009 excludes the exercise of 175,000
outstanding warrants and 222,500 outstanding stock options as the exercise of
these warrants and stock options would have an anti-dilutive effect on earnings
per share.  The calculation above for the nine months ended September
30, 2009 excludes the exercise of 175,000 outstanding warrants and 230,500
outstanding stock options as the exercise of these warrants and stock options
would have an antidilutive effect on earnings per share.





NOTE
2 – RECENT ACCOUNTING PRONOUNCEMENTS





In June
2009, the Financial Accounting Standards Board (“FASB”) issued authoritative
guidance to establish the FASB Accounting Standards Codification TM
(Codification) as the source of authoritative accounting principles recognized
by the FASB to be applied by nongovernmental entities in the preparation of
financial statements in conformity with generally accepted accounting principles
(“GAAP”) in the United States.  Rules and interpretive releases of the
Securities and Exchange Commission (SEC) under authority of federal securities
laws are also sources of authoritative GAAP for SEC registrants.  The
codification shall be effective for financial statements issued for interim and
annual periods ending after September 15, 2009.  The codification is
not intended to change or alter existing GAAP and is not expected to result in a
change in accounting practice for the Company.







9


ZAGG
INCORPORATED AND SUBSIDIARY
 Notes
to Condensed Consolidated Financial Statements
 (Unaudited)







In
September 2006, FASB issued an authoritative guidance which defines fair value,
establishes a framework for measuring fair value in generally accepted
accounting principles and expands disclosures about fair value measurements. The
guidance related to financial assets and financial liabilities were effective
during 2008.  With respect to certain nonfinancial assets and
nonfinancial liabilities, the guidance is effective for fiscal years beginning
after November 15, 2008, and interim periods within those fiscal
years.  The implementation did not cause a material impact on the
Company’s consolidated financial statements.





In
December 2007, the FASB issued authoritative guidance that requires an
acquirer to measure the identifiable assets acquired, the liabilities assumed
and any non-controlling interest in the acquiree at their fair values on the
acquisition date, with goodwill being the excess value over the net identifiable
assets acquired. The guidance clarifies that a non-controlling interest in a
subsidiary should be reported as equity in the consolidated financial
statements, consolidated net income should be adjusted to include the net income
attributed to the non-controlling interest and consolidated comprehensive income
shall be adjusted to include the comprehensive income attributed to the
non-controlling interest. The calculation of earnings per share will continue to
be based on income amounts attributable to the parent. The guidance is effective
for financial statements issued for fiscal years beginning after
December 15, 2008.  The implementation of this standard did not
cause a material impact on the Company’s consolidated financial
statements.





In March
2008, the FASB issued authoritative guidance intended to improve financial
reporting about derivative instruments and hedging activities by requiring
enhanced disclosures to enable investors to better understand their effects on
an entity's financial position, financial performance, and cash flows. The
guidance is effective for financial statements issued for fiscal years and
interim periods beginning after November 15, 2008. The implementation did not
cause a material impact on the Company’s consolidated financial
statements.





In May
2009, the FASB issued authoritative guidance establishing general standards of
accounting for and disclosure of events that occur after the balance sheet date
but before financial statements are issued or are available to be
issued.  The guidance was effective for interim and annual periods
ending after June 15, 2009.  The implementation of this standard did
not have a material effect on the Company’s financial position or results of
operations.





NOTE
3 – ACCOUNTS RECEIVABLE





Accounts
receivable at September, 2009 and December 31, 2008 was as follows:





September 30, 2009
            
            
            December 31, 2008Accounts
      receivable
            
            $
            6,184,268
            
            
            $
            3,812,823Less:
      Allowance for doubtful accounts
            
            
            (305,856
            )
            
            
            (218,936
            )Accounts
      receivable, net
            
            $
            5,878,412
            
            
            $
            3,593,887





Bad debt
expense for the nine months ended September 30, 2009 and 2008 was $86,921 and
$56,170, respectively.





On May
13, 2009, the Company entered into an accounts receivable financing agreement
with Faunus Group International, Inc. (“FGI”).  The Company may offer
to sell our accounts receivable to FGI each month during the term of the
Agreement, up to a maximum amount outstanding at any time of
$4,000,000.  The Company can sell accounts receivable to FGI on either
a credit approved or full recourse basis.  Credit approved invoices
are sold to FGI with no recourse, FGI accepts all credit default risk on
invoices sold under the credit approved terms.  As of September 30,
2009, the Company had only sold credit approved invoices.  The Company
accounted for the sale of the credit approved invoices as a reduction to
accounts receivable.  Under the terms of the agreement, the Company is
charged a monthly collateral management fee of 0.87% of the average monthly
outstanding balance and interest at 7% per annum.





10





ZAGG
INCORPORATED AND SUBSIDIARY
 Notes
to Condensed Consolidated Financial Statements
 (Unaudited)





NOTE
4 – INVENTORIES





At
September 30, 2009 and December 31, 2008 inventories consisted of the
following:





September 30, 2009
            
            
            December 31, 2008Finished
      goods
            
            $
            957,172
            
            
            $
            204,766Raw
      materials
            
            
            2,531,178
            
            
            
            1,708,531Total
      inventory
            
            $
            3,488,350
            
            
            $
            1,913,297


NOTE
5 – PROPERTY AND EQUIPMENT
 
 At
September 30, 2009 and December 31, 2008, property and equipment consisted of
the following:


Useful Lives
            
            September 30, 2009
            
            
            December 31, 2008Computer
      equipment and software
            3
      to 5 years
            
            $
            394,096
            
            
            $
            271,287Equipment
            3
      to7 years
            
            
            432,109
            
            
            
            314,412Furniture
      and fixtures
            7
      years
            
            
            76,169
            
            
            
            56,021Automobiles
            5
      years
            
            
            93,002
            
            
            
            84,955Leasehold
      improvements
            1
      to 2.75 years
            
            
            250,853
            
            
            
            103,821Total
      property and equipment
            
            
            
            1,257,327
            
            
            
            830,496Less:
      accumulated depreciation
            
            
            
            (448,868
            )
            
            
            (281,126
            )Total
      property and equipment, net
            
            
            $
            808,459
            
            
            $
            549,370





Depreciation
expense was $167,766 and $108,833 for the nine months ended September 30, 2009
and 2008, respectively.





NOTE
6 – NOTES RECEIVABLE





On March
11, 2008 ZAGG Incorporated entered into an agreement to fund a bridge loan (the
“Bridge Loan”) of up to $500,000 to Brighton Partners, LLC. The purpose of the
secured loan is to fund the development of a superhero series created by Stan
Lee and POW! Entertainment, Inc. in partnership with Brighton Partners, LLC,
with the hope that ZAGG will benefit from the marketing exposure and any
intellectual property created using ZAGG’s trademarks.





In
consideration of the bridge loan, Brighton Partners, LLC executed a secured
promissory note with a 3% origination fee and bearing 10% interest for the 90
day term of the note.  As of September 30, 2009 the note had not yet
been repaid and the Company had not declared Brighton Partners in default under
the promissory note.  The loan is collateralized by 100% of the
ownership of Brighton until the loan is repaid in full.  As part of
the transaction, ZAGG entered into a cross-license agreement with Brighton and
Pow!  Entertainment pursuant to which ZAGG agreed to license its
trademarks in exchange for marketing and promotion rights to any property
developed under the superhero series that bears ZAGG’s intellectual
property.  Further under the transaction, the Company acquired 10% of
the membership interest in Brighton. ZAGG will share in the development of the
superhero series as a partner of Brighton.  Through September 30,
2009, the Company had advanced $438,000 to Brighton under the promissory note
and has included this amount in notes receivable in the accompanying condensed
consolidated financial statements.  Accrued interest of $274,231 on
the promissory note is included in prepaid expenses and other current assets in
the accompanying condensed consolidated financial statements.






11




ZAGG
INCORPORATED AND SUBSIDIARY
 Notes
to Condensed Consolidated Financial Statements
 (Unaudited)


NOTE
7 – CONVERTIBLE BRIDGE LOAN





On
September 28, 2009 the Company entered into a bridge loan agreement with HzO,
(“HzO”) for $1,151,000.  HzO recently acquired the rights to the
Golden Shellback technology developed by Northeast Maritime Institute, Inc. The
technology is a molecular, vacuum deposited coating that is nonflammable, has
low toxicity and has the ability to weatherproof electronic devices and other
surfaces.  The technology was renamed as the HzO
Technology.  The Company was granted the exclusive worldwide marketing
rights for the HzO technology due to its efforts in assisting HzO in securing
the HzO technology.
 
 Under the
terms of the bridge loan agreement, the Company has the option, but not the
obligation, to convert the bridge loan into shares of Series A Preferred stock
of HzO at a conversion price of $0.475 per share.  The Company
received a warrant of 300,000 shares of HzO Series A Preferred stock in lieu of
interest payments for the loan.  These warrants have not been assigned
a value in the accompanying financial statements.  The Company is a
party to a guarantee agreement with HzO for an additional $2,000,000 payment to
NMI on February 25, 2010 in the event that HzO, with its lead investor vSpring
Capital, LLC, to secure the necessary capitalization for HzO to make the
payment.





NOTE
8 – PREPAID EXPENSES AND OTHER CURRENT ASSETS





Prepaid
expenses and other current assets is summarized in the table below:





Description
            
            BalanceInterest
      and other receivables
            
            $
            333,715Inventory
      deposits
            
            
            2,364,800Other
            
            
            156,110Total
            
            $
            2,854,625





NOTE
9 – INTANGIBLE ASSETS





At
September 30, 2009, intangible assets consist of legal fees paid in connection
with the Company’s patent application and amounts paid to secure the Company’s
Internet addresses.  The costs relating to the definite-lived
intangible assets are amortized over their estimated useful lives using
straight-line amortization.  The useful life for Internet addresses is
10 years.  As of September 30, 2009, the patent had not been
granted.  Accordingly, the Company has not begun to amortize the
patent costs and will begin amortizing the patent over the legal life of the
patent when the patent is granted.





The
Company has contractual rights customary in the industry to use its Internet
addresses.  However, the Company does not have and cannot acquire any
property rights to the Internet addresses.  The Company does not
expect to lose its rights to use the Internet addresses however, there can be no
assurance in this regard and such loss could have a material adverse effect on
the Company’s financial position and results of operations.





The
Company’s intangible assets are summarized in the table below:


Useful Life
            
            September 30, 2009
            
            
            December 31, 2008Internet
      addresses
            10
      years
            
            $
            99,606
            
            
            $
            44,968Patents
            Finite
            
            
            11,040
            
            
            
            11,040Less:
      accumulated amortization
            
            
            
            (12,873
            )
            
            
            (8,664
            )Total
      intangible assets, net
            
            
            $
            97,773
            
            
            $
            47,344




Amortization
expense was $4,207 and $3,329 for the nine months ended September 30, 2009 and
2008, respectively.









12





ZAGG
INCORPORATED AND SUBSIDIARY
 Notes
to Condensed Consolidated Financial Statements
 (Unaudited)





NOTE
10 – STOCKHOLDERS’ EQUITY





During
the nine months ended September 30, 2009, the Company issued 60,000 shares of
its common stock to employees valued at $200,800 which was recorded as
compensation expense in the accompanying condensed consolidated financial
statements.





During
the nine months ended September 30, 2009 the Company granted employee stock
options.  These options vest equally over three years from the grant
date and expire 5 years from the grant date.  The Company values
option grants using the Black-Scholes option pricing model and used the
following assumptions:





Options Granted
            Exercise Price
            Price at Grant Date
            Expected Life
            Volatility*
            Discount Rate
            Value850,000
            $1.23
            $1.23
            5
      years
            59%
            0.19%
            $513,71925,000
            $2.53
            $2.53
            5
      years
            62%
            0.04%
            $32,3763,000
            $2.93
            $2.93
            5
      years
            62%
            0.08%
            $4,5035,000
            $4.11
            $4.11
            2.5
      years
            65%
            0.08%
            $8,0481,000
            $6.40
            $6.40
            2.5
      years
            67%
            0.08%
            $2,5791,500
            $5.28
            $5.28
            2.5
      years
            67%
            0.08%
            $3,188220,000
            $5.05
            $5.05
            2.5
      years
            67%
            0.08%
            $447,249*Volatility is
      calculated using historical volatility to provide an implied volatility as
      the Company’s options do not trade





Based on
vesting provisions, the Company expensed $277,118 relating to these new option
grants and prior grants for the nine months ended September 30,
2009.




During
the nine months ended September 30, 2009, the Company also granted stock options
to a legal consultant for 30,000 common shares exercisable at $1.42 per share
expiring in 5 years and vesting immediately.  The options were valued
at $20,863 or $0.70 per share using the Black-Scholes method with the following
assumptions: stock price $1.42, expected life of 5 years, volatility of 59%
(using historical volatility to provide an implied volatility as the Company’s
options to not trade)and a discount rate of 0.18%.  Based on vesting
provisions, the Company expensed $20,863 related to this option grant for the
nine months ended September 30, 2009.





During
the nine months ended September 30, 2009, the Company issued warrants for
consulting services for 20,000 common shares exercisable at $2.05 per share
expiring in 1 year and vesting immediately.  The warrants were valued
at $21,155 using the Black-Scholes method with the following assumptions: stock
price $2.05, expected life of 5 years; volatility of 62% (using historical
volatility to provide an implied volatility as the Company’s options to not
trade) and a discount rate of 0.13%.





During
the nine months ended September 30, 2009, the Company issued warrants for sales
commissions to an independent third party for 175,000 common shares exercisable
at $6.40 per share expiring in 1 year and vesting immediately.  The
warrants were valued at $115,356 using the Black-Scholes method with the
following assumptions: stock price $6.40, expected life .2 years; volatility of
66% (using historical volatility to provide an implied volatility as the
Company’s options to not trade) and a discount rate of 0.14%.





During
the nine months ended September 30, 2009, the Company issued 632,632 shares of
its common stock in exercise of options to purchase 632,632
shares.  The Company received proceeds of $467,644 related to the
exercise of the options.  The Company also issued 1,833,568 shares of
its common stock in exercise of warrants to purchase 1,833,568
shares.  The Company received proceeds of $2,415,138 related to the
exercise of the warrants.





NOTE
11 – COMMITMENTS AND CONTINGENCIES





From time
to time the Company may become subject to proceedings, lawsuits and other claims
in the ordinary course of business, including proceedings related to
environmental and other matters.  Such matters are subject to many
uncertainties, and outcomes are not predictable with assurance.  As of
September 30, 2009, the Company did not have any outstanding legal
matters.






13






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,”
“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 affect 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





Headquartered
in Salt Lake City, Utah, ZAGG Incorporated designs, manufactures and distributes
protective coverings, audio accessories and power solutions for consumer
electronic and hand-held devices under the brand names invisibleSHIELDTM and
ZAGGaudioTM.  ZAGG has also introduced beta testing of AppSpace.com, an
online destination for the fast-growing mobile app market, combined with the
networking power of social media.





Our
flagship product, invisibleSHIELD, is made from a protective, film covering that
was developed originally to protect the leading edges of rotary blades of
military helicopters. We determined that this same film product could be
configured to fit onto the surface of electronic devices and marketed to
consumers for use in protecting such devices from everyday wear and tear;
including scratches, scrapes, debris and other surface blemishes. The film also
permits touch sensitivity, meaning it can be used on devices that have a
touch-screen interface. The invisibleSHIELD film material is highly reliable and
durable since it was originally developed for use in a high friction, high
velocity context within the aerospace industry. The film provides long lasting
protection for the surface of electronic devices subject to normal wear and
tear. The film is a form of polyurethane substance, akin to a very thin,
pliable, flexible and durable clear plastic that adheres to the surface and
shape of the object it is applied to.





The
invisibleSHIELD is designed specifically for iPods®, laptops, cell phones, digital
cameras, PDAs, watch faces, GPS systems, gaming devices, and other
items.  The product is “cut” to fit specific devices and packaged
together with a moisture activating solution which makes the invisibleSHIELD
adhere to the surface of the device, literally “like a second skin,” and
virtually invisible to the eye.  The patent-pending invisibleSHIELD is
the first scratch protection solution of its kind on the market.  The
invisibleSHIELD is not ornamental, but rather provides a long lasting barrier to
preserve the brand new look of the surface of an electronic
device.  Currently, ZAGG offers over 4,000 precision pre-cut designs
with a lifetime replacement warranty through online channels, big-box retailers,
electronics specialty stores, resellers, college bookstores, Mac stores, and
mall kiosks.  We plan to increase our product lines to offer new
electronic accessories to our tech-savvy customer base, as well as an expanded
array of invisibleSHIELD products for other industries.





The
ZAGGaudio line of electronics accessories and products was released in late
2008, and focuses on innovation and superior value.  The flagship
product within ZAGGaudio is the award winning, Z.budsTM.  Other
headphone, speaker and audio products have been released and we will release
additional products in the ZAGGaudio line in the coming months and
years.







14


As of
September 30, 2009 our common stock was traded on the OTC Bulletin Board under
the trading symbol “ZAGG.OB”. Subsequent to the reporting period, we applied to
list our common stock on the NASDAQ Global Market.  On November 2, 2009,
NASDAQ approved our application to be listed on the NASDAQ Global
Market.  We commenced trading under the symbol “ZAGG” on November 10,
2009.





We
maintain our corporate offices and operational facility at 3855 South 500 West,
Suites B, C, J, K, L and R, Salt Lake City, Utah, 84115. The telephone number of
the Company is 801-263-0699.  Our website address is www.ZAGG.com.




Critical
Accounting Policies




The
discussion and analysis of our financial condition and results of operations are
based on our financial statements, which have been prepared in accordance with
accounting principles generally accepted in the United States (U.S. GAAP). The
preparation of these financial statements requires us to make estimates and
judgments that affect the reported amounts of assets, liabilities, revenues and
expenses, and related disclosure of contingent assets and liabilities. On an
on-going basis, we evaluate our estimates based on historical experience and on
various other assumptions that are believed to be reasonable under the
circumstances, the results of which form the basis for making judgments about
the carrying values of assets and liabilities that are not readily apparent from
other sources. Actual results may differ from these estimates under different
assumptions or conditions. Significant estimates include the allowance for
doubtful accounts, inventory valuation allowances, sales returns and warranty
liability, the useful life of property and equipment and the valuation allowance
on deferred tax assets.





Recent
Accounting Pronouncements





In June
2009, the Financial Accounting Standards Board (“FASB”) issued authoritative
guidance to establish the FASB Accounting Standards Codification TM
(Codification) as the source of authoritative accounting principles recognized
by the FASB to be applied by nongovernmental entities in the preparation of
financial statements in conformity with generally accepted accounting principles
(“GAAP”) in the United States.  Rules and interpretive releases of the
Securities and Exchange Commission (SEC) under authority of federal securities
laws are also sources of authoritative GAAP for SEC registrants.  The
codification shall be effective for financial statements issued for interim and
annual periods ending after September 15, 2009.  The codification is
not intended to change or alter existing GAAP and is not expected to result in a
change in accounting practice for us.





In
September 2006, FASB issued an authoritative guidance which defines fair value,
establishes a framework for measuring fair value in generally accepted
accounting principles and expands disclosures about fair value measurements. The
guidance related to financial assets and financial liabilities were effective
during 2008.  With respect to certain nonfinancial assets and
nonfinancial liabilities, the guidance is effective for fiscal years beginning
after November 15, 2008, and interim periods within those fiscal
years.  The implementation did not cause a


material
impact on our consolidated financial statements.





In
December 2007, the FASB issued authoritative guidance that requires an
acquirer to measure the identifiable assets acquired, the liabilities assumed
and any non-controlling interest in the acquiree at their fair values on the
acquisition date, with goodwill being the excess value over the net identifiable
assets acquired. The guidance clarifies that a non-controlling interest in a
subsidiary should be reported as equity in the consolidated financial
statements, consolidated net income should be adjusted to include the net income
attributed to the non-controlling interest and consolidated comprehensive income
shall be adjusted to include the comprehensive income attributed to the
non-controlling interest. The calculation of earnings per share will continue to
be based on income amounts attributable to the parent. The guidance is effective
for financial statements issued for fiscal years beginning after
December 15, 2008.  The implementation of this standard did not
cause a material impact on our consolidated financial statements.





In March
2008, the FASB issued authoritative guidance intended to improve financial
reporting about derivative instruments and hedging activities by requiring
enhanced disclosures to enable investors to better understand their effects on
an entity's financial position, financial performance, and cash flows. The
guidance is effective for financial statements issued for fiscal years and
interim periods beginning after November 15, 2008. The implementation did not
cause a material impact on our consolidated financial statements.




15






In May
2009, the FASB issued authoritative guidance establishing general standards of
accounting for and disclosure of events that occur after the balance sheet date
but before financial statements are issued or are available to be
issued.  The guidance was effective for interim and annual periods
ending after June 15, 2009.  The implementation of this standard did
not have a material effect on our financial position or results of
operations.





Revenue
recognition





We record
revenue when persuasive evidence of an arrangement exists or product delivery
has occurred, the sales price to the customer is fixed or determinable, and
collectability is reasonably assured.  Our revenue is derived from
sales of our products to retailers, resellers and end consumers and from the
sale of distributor license fees.  For sales of product, our standard
shipping terms are FOB shipping point and we record revenue when the product is
shipped, net of estimated returns and discounts.  For license fees, we
recognize revenue on a straight-line basis over the life of the license
term.





Any
incentives received from vendors are recognized as a reduction of the cost of
products. Promotional products given to customers or potential customers are
recognized as a cost of sales. Cash incentives provided to our customers are
recognized as a reduction of the related sale price, and, therefore, are a
reduction in sales.





Reserve
for Sales Returns and Warranty Liability





Our
return policy generally allows our end users and retailers to return purchased
products for refund or in exchange for new products within 30 days of end user
purchase. We estimate a reserve for sales returns and record that reserve amount
as a reduction of sales and as a sales return reserve liability.





We
generally provide the ultimate consumer a warranty with each product and accrue
warranty expense at the time of the sale based on our prior claims
history.  Actual warranty costs incurred are charged against the
accrual when paid.





Results
of Operations





THREE
MONTHS ENDED SEPTEMBER 30, 2009 AND 2008





Net
sales





Net sales
for the quarter ended September 30, 2009 were $9,728,528 as compared to net
sales of $6,854,916 for the quarter ended September 30, 2008, an increase of
$2,873,612 or 42%.





For the
quarter ended September 30, 2009, our sales mix breakdown was 66% through
wholesale channels, 20% through our website to retail customers, 10% through our
mall cart and kiosk programs and 4% from shipping and handling
charges.  Sales of our invisibleSHIELD product
continue to represent the majority of our sales.  We are continuing to
see increased demand for our invisibleSHIELD product,
particularly from our wholesale distribution channel partners including Best Buy
and Radio Shack.





Cost
of sales





Cost of
sales includes raw materials, packing materials, shipping and fulfillment costs.
For the quarter ended September 30, 2009, cost of sales amounted to $4,521,555
or approximately 46% of net sales as compared to cost of sales of $2,416,988 or
approximately 35% of net sales for quarter ended September 30,
2008.  The increase in cost of sales as a percentage of net revenues
for the quarter ended September 30, 2009 as compared to the quarter ended
September 30, 2008 is attributable to the overall sales mix shift to wholesale
customers which have a lower average selling price than our internet sales and a
decrease in overall internet sales for the quarter ended September 30,
2009.




Gross
profit





Gross
profit for the quarter ended September 30, 2009 was $5,206,973 or approximately
54% of net sales as compared to $4,437,928 or approximately 65% of net sales for
the quarter ended September 30, 2008. The decrease in gross profit percentage
was due to the sales mix shift from higher margin internet sales to wholesale
customers which have a lower average selling price and a decrease in internet
sales for the quarter ended September 30, 2009 as compared to the quarter ended
September 30, 2008.  There are no assurances that we will continue to
recognize similar gross profit margins in the future.




16





Operating
expenses





Total
operating expenses for the quarter ended September 30, 2009 were $3,735,685, an
increase of $668,463 from total operating expenses for the quarter ended
September 30, 2008 of $3,067,222. The increases are primarily attributable to
the following:





·
            For
      the quarter ended September 30, 2009, salaries and related taxes increased
      by $310,798 to $1,077,390 from $766,592 for the quarter ended September
      30, 2008.  The increase is due to the increase in our staff as
      we continue to build the people infrastructure to meet the demand for our
      product and continue to develop new products and offerings and
      compensation expense related to our stock based compensation plan of
      $190,632.





·
            For
      the quarter ended September 30, 2009, marketing, advertising and promotion
      expenses were $1,327,126, an increase of $158,053 as compared to
      $1,169,073 for the quarter ended September 30, 2008.  We
      continue to invest heavily in the development of the invisibleSHIELD brand
      through internet key word advertising and through traditional print media,
      television and radio advertising and through the use of
      coupons.  We expect our marketing and advertising expenses to
      continue to be a significant expenditure as our revenues increase and
      expect to spend increased funds on adverting and promotion of our products
      as well as sales training.  During the fiscal year 2009, we
      intend to continue to expand our marketing efforts related to our
      products.





·
            For the quarter ended September
      30, 2009, other selling, general and administrative expenses, net of
      salaries and related taxes described above, were $1,331,169 as compared to
      $1,131,557 for the quarter ended September 30, 2008. The changes by
      category are summarized in the table
  below:





Three
      Months Ended September 30,
      2009
            
            
            Three
      Months Ended September 30,
      2008Professional
      fees
            
            $
            162,801
            
            
            $
            42,441Rent
            
            
            150,764
            
            
            
            97,028Credit
      card and bank fees
            
            
            130,495
            
            
            
            113,063Commissions
            
            
            297,915
            
            
            
            157,676Other
            
            
            589,194
            
            
            
            721,349Total
            
            $
            1,331,169
            
            
            $
            1,131,557





Income
from operations





We
reported income from operations of $1,471,288 for the quarter ended September
30, 2009 as compared to income from operations of $1,370,706 for the quarter
ended September 30, 2008, an increase of $100,582.  The increase in
income from operations for the quarter ended September 30, 2009 as compared to
the quarter ended September 30, 2008 is primarily attributable to our overall
increased revenue growth due to increased market penetration and product
offerings and the continued expansion of our distribution channels to include
additional retail outlets.





Other
(expense) income





For the
quarter ended September 30, 2009, total other expense was $12,927 as compared to
other income of $48,483 for the quarter ended September 30, 2008.  The
decrease is primarily attributed to interest expense associated with our credit
facility and decreased interest income related to short-term loans.




17





Net
income





As a
result of these factors, we reported net income of $908,081 or $0.04 per share
on a fully diluted basis for the quarter ended September 30, 2009 as compared to
net income of $889,743 or $0.05 per share on a fully diluted basis for the
quarter ended September 30, 2008.





NINE
MONTHS ENDED SEPTEMBER 30, 2009 AND 2008





Net
sales





Net sales
for the nine months ended September 30, 2009 were $26,964,159 as compared to net
sales of $12,460,812 for the nine months ended September 30, 2008, an increase
of $14,503,347 or 116%.





For the
nine months ended September 30, 2009, our sales mix breakdown was 56% through
wholesale channels, 32% through our website to retail customers, 8% through our
mall cart and kiosk programs and 4% from shipping and handling
charges.  Sales of our invisibleSHIELD product
continue to represent the majority of our sales.  We are continuing to
see increased demand for our invisibleSHIELD product,
particularly from our wholesale distribution channel partners including Best Buy
and Radio Shack.





Cost
of sales





Cost of
sales includes raw materials, packing materials, shipping and fulfillment
costs.  For the nine months ended September 30, 2009, cost of sales
amounted to $11,055,903 or approximately 41% of net sales as compared to cost of
sales of $3,920,003 or approximately 31% of net sales for the nine months ended
September 30, 2008.  The increase in cost of sales as a percentage of
net revenues for the nine months ended September 30, 2009 as compared to the
nine months ended September 30, 2008 is attributable to the overall sales mix
shift to wholesale customers which have a lower average selling price than our
internet sales which have historically represented a larger percentage of the
total sales.





Gross
profit





Gross
profit for the nine months ended September 30, 2009 was $15,908,256 or
approximately 59% of net sales as compared to $8,540,809 or approximately 69% of
net sales for the nine months ended September 30, 2008. The decrease in gross
profit percentage was primarily due to the sales mix shift from higher margin
internet sales to wholesale customers which have a lower average selling
price.  There are no assurances that we will continue to recognize
similar gross profit margins in the future.





Operating
expenses





Total
operating expenses for the nine months ended September 30, 2009 were
$10,969,966, an increase of $3,771,072 from total operating expenses for the
nine months ended September 30, 2008 of $7,198,894.  The increases are
primarily attributable to the following:





·
            For
      the nine months ended September 30, 2009, salaries and related taxes
      increased by $550,714 to $2,998,223 from $2,136,712 for the nine months
      ended September 30, 2008.  The increase is due to the increase
      in our staff as we continue to build the people infrastructure to meet the
      demand for our product and continue to develop new products and offerings
      and compensation expense related to our stock based compensation plan of
      $498,781.





·
            For
      the nine months ended September 30, 2009, marketing, advertising and
      promotion expenses were $4,168,854, an increase of $1,685,498 as compared
      to $2,483,356 for the nine months ended September 30, 2008.  We
      continue to invest heavily in the development of the invisibleSHIELD brand
      through internet key word advertising and through traditional print media,
      television and radio advertising and through the use of
      coupons.  We expect our marketing and advertising expenses to
      continue to be a significant expenditure as our revenues increase and
      expect to spend increased funds on adverting and promotion of our products
      as well as sales training.  During the fiscal year 2009, we
      intend to continue to expand our marketing efforts related to our
      products.






18





·
            For the nine months ended
      September 30, 2009, other selling, general and administrative expenses,
      net of salaries and related taxes described above, were $3,802,889 as
      compared to $2,578,826 for the nine months ended September 30, 2008. The
      changes by category are summarized in the table
    below:





Nine
      Months Ended September 30,
      2009
            
            
            Nine
      Months Ended September 30,
      2008Professional
      fees
            
            $
            385,499
            
            
            $
            113,053Rent
            
            
            373,018
            
            
            
            277,574Credit
      card and bank fees
            
            
            479,242
            
            
            
            267,192Commissions
            
            
            719,352
            
            
            
            204,263Other
            
            
            1,845,778
            
            
            
            1,716,744Total
            
            $
            3,802,889
            
            
            $
            2,578,826





Income
from operations





We
reported income from operations of $4,938,290 for the nine months ended
September 30, 2009 as compared to income from operations of $1,341,915 for the
nine months ended September 30, 2008, an increase of $3,596,375.  The
increase in income from operations for the nine months ended September 30, 2009
as compared to the nine months ended September 30, 2008 is primarily
attributable to our overall increased revenue growth due to increased market
penetration and product offerings and the continued expansion of our
distribution channels to include additional retail outlets.





Other
income





For the
nine months ended September 30, 2009, total other income was $76,727 as compared
to other income of $174,599 for the nine months ended September 30,
2008.  The decrease is primarily attributed to increased interest
expense from our credit facility and decreased interest income related to
short-term loans and interest earned on our bank balances.





Net
income





As a
result of these factors, we reported net income of $3,130,585 or $0.15 per share
on a fully diluted basis for the nine months ended September 30, 2009 as
compared to net income of $950,278 or $0.05 per share on a fully diluted basis
for the nine months ended September 30, 2008.





Liquidity
and Capital Resources





Liquidity
is the ability of a company to generate funds to support its current and future
operations, satisfy its liabilities and otherwise operate on an ongoing
basis.





At
September 30, 2009, we had a cash balance of $2,102,779.





Our
working capital position increased by $6,179,993 to working capital of
$11,385,341 at September 30, 2009 from working capital of $5,205,388 at December
31, 2008. This increase in working capital is primarily attributable to the
overall increase in current assets of $8,144,590 due to increased cash balance
of $1,037,127 from increased sales and proceeds from the exercise of options and
warrants, increased inventories of $1,575,053, increased accounts receivable of
$2,284,525 from increased sales on account to wholesale customers, increased
prepaid expenses and other current assets of $3,329,548 from deposits for
inventory and our contribution to HzO, decreased deferred revenue of $96,853,
decreased accrued liabilities of $76,109 and decreased notes payable of $20,223,
partially offset by increased deferred tax liabilities of $1,235,948, increased
accounts payable of $847,445, and increased sales return liability of $44,445,
increased accrued wages and wage related expenses of $29,974 and decreased
deferred tax assets of $81,663.




19





Net cash
used in operating activities for the nine months ended September 30, 2009 was
($192,965) as compared to net cash used in operating activities of ($514,499)
for the nine months ended September 30, 2008.  For the nine months
ended September 30, 2009, net cash used in operating activities was attributable
primarily to increased prepaid expenses and other current assets of $2,178,548,
increased inventory of $1,575,053, increased accounts receivable of $2,371,446,
decreased deferred revenue of $96,853, decreased accrued liabilities of $76,109
and foreign currency translation adjustment of $27,264; partially offset by our
net income of $3,130,585, increased deferred tax liabilities of $1,322,548,
increased accounts payable of $847,071, non-cash expense related to stock based
compensation of $498,781, depreciation and amortization of $171,973, bad debt
expense of $86,921, increased sales returns liabilities of $44,455 and increased
accrued wages and wage related expenses of $29,974.





Net cash
used in investing activities for the nine months ended September 30, 2009 was
($1,637,467) attributable to the convertible bridge loan of $1,151,000, the
purchase of property and equipment of $426,831 and payments for intangible
assets of $54,636.





Net cash
provided by financing activities for the nine months ended September 30, 2009
was $2,862,559 attributable to proceeds from the exercise of options and
warrants of $2,882,782, partially offset by payments on short-term debt of
$20,223.





We
reported a net increase in cash for the nine months ended September 30, 2009 of
$1,037,127.





For the
nine months ended September 30, 2009 and 2008, we generated revenues of
$26,964,159 and $12,460,812, respectively and reported net income of $3,130,585
and $950,278, respectively.  For the nine months ended September 30,
2009, we had negative cash flow from operating activities of ($192,965),
negative cash flow from investing activities of ($1,632,467) and cash flows from
financing activities of $2,862,559.  As of September 30, 2009, we had
stockholders’ equity of $12,301,261, retained earnings of $4,486,809, working
capital of $11,385,341, accounts payable of $2,473,835, deferred revenue of
$269,737, accrued wages and wage related expenses of $151,086, accrued
liabilities of $136,645, deferred income tax liability of $1,235,948 and sales
returns liability of $335,574.  Management believes that existing
cash, along with cash generated from the collection of accounts receivable and
the sale of products will be sufficient to meet the Company’s cash requirements
during the next twelve months.





Off
Balance Sheet Arrangements





As of
September 30, 2009, there were no off balance sheet arrangements.





Item
3.  Quantitative and Qualitative Disclosures About Market Risk





A smaller
reporting company is not required to provide the information required by this
Item.





Item
4T.  Controls and Procedures





As of the
date of this report, our Chief Executive Officer and Chief Financial Officer
evaluated the effectiveness of the design and operation of our disclosure
controls and procedures pursuant to Rule 13a-15b under the Securities
Exchange Act of 1934.  Based on their review of our disclosure controls and
procedures, they have concluded that our disclosure controls and procedures are
effective in timely alerting him to material information relating to us that is
required to be included in our periodic SEC filings. Further, there were no
significant changes in the internal controls or in other factors that could
significantly affect these disclosure controls after the evaluation date and the
date of this report. Nor were there any significant deficiencies or material
weaknesses in such disclosure controls and procedures requiring corrective
actions. As a result, no corrective actions were taken.  We have made no
changes in our internal controls over financial reporting in the most recent
quarterly reporting period that have materially affected, or are reasonably
likely to affect, our internal controls over financial reporting.




20





Limitations on the
Effectiveness of Internal Controls





Our
management does not expect that our disclosure controls and procedures or our
internal control over financial reporting will necessarily prevent all fraud and
material error. An 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 must reflect the fact that there are resource constraints, and the
benefits of controls must be 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 simple error or mistake. Additionally, controls
can be circumvented by the individual acts of some persons, by collusion of two
or more people, or by management override of the internal control. The design of
any system of controls also is based in part upon certain assumptions about 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, control may become inadequate because of changes in conditions, or
the degree of compliance with the policies or procedures may
deteriorate.





PART
II - OTHER INFORMATION





Item
1. Legal Proceedings





We are
not presently party to any legal proceedings.  We are not aware of any
pending legal proceeding to which any of our officers, directors, or any
beneficial holders of 5% or more of our voting securities are adverse to us or
have a material interest adverse to us.





Item
1A:  Risk Factors





A smaller
reporting company is not required to provide the information required by this
Item.





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





During
the nine months ended September 30, 2009, we issued the following
securities:





§
            60,000
      shares of common stock to employees valued at
  $200,800;





§
            stock
      options for 850,000 common shares exercisable at $1.23 per share expiring
      in 5 years and vesting 33% at 12 months, 33% at 24 months and 33% at 36
      months. The options were valued at $513,719 or $0.60 per option using the
      Black-Scholes option pricing method with the following assumptions: stock
      price $1.23, expected life of 5 years, volatility of 59% (using historical
      volatility to provide an implied volatility as the Company’s options to
      not trade) and a discount rate of
0.19%;





§
            stock
      options to a legal consultant for 30,000 common shares exercisable at
      $1.42 per share expiring in 5 years and vesting
      immediately.  The options were valued at $20,863 or $0.70 per
      share using the Black-Scholes method with the following assumptions: stock
      price $1.42, expected life of 5 years, volatility of 59% (using historical
      volatility to provide an implied volatility as the Company’s options to
      not trade) and a discount rate of
0.18%;





§
            warrants
      for consulting services for 20,000 common shares exercisable at $2.05 per
      share expiring in 1 year and vesting immediately.  The warrants
      were valued at $21,155 using the Black-Scholes method with the following
      assumptions: stock price $2.05, expected life of 5 years; volatility of
      62% (using historical volatility to provide an implied volatility as the
      Company’s options to not trade) and a discount rate of
    0.13%.





§
            warrants
      for sales commissions to an independent third party for 175,000 common
      shares exercisable at $6.40 per share expiring in 1 year and vesting
      immediately.  The warrants were valued at $115,356 using the
      Black-Scholes method with the following assumptions: stock price $6.40,
      expected life of .2 years, volatility of 66% (using historical volatility
      to provide an implied volatility as the Company’s options to not trade)
      and a discount rate of 0.14%.




21







§
            stock
      options for 25,000 common shares exercisable at $2.53 per share expiring
      in 5 years and vesting over a three year schedule.  The options
      were valued at $32,376 using the Black-Scholes option pricing method with
      the following assumptions: stock price $2.53, expected life of 5 years,
      volatility of 62% (using historical volatility to provide an implied
      volatility as the Company’s options to not trade) and a discount rate of
      0.04%.





§
            stock
      options for 3,000 common shares exercisable at $2.93 per share expiring in
      5 years and vesting over a three year schedule.  The options
      were valued at $4,503 using the Black-Scholes option pricing method with
      the following assumptions: stock price $2.93, expected life of 5 years,
      volatility of 62% (using historical volatility to provide an implied
      volatility as the Company’s options to not trade) and a discount rate of
      0.08%.





§
            stock
      options for 5,000 common shares exercisable at $4.11 per share expiring in
      5 years and vesting over a 3 year schedule.  The options were
      valued at $8,048 using the Black-Scholes option pricing method with the
      following assumptions: stock price $4.11, expected life of 2.5 years,
      volatility of 65% (using historical volatility to provide an implied
      volatility as the Company’s options to not trade) and a discount rate of
      0.11%).





§
            stock
      options for 1,000 common shares exercisable at $6.40 per share expiring in
      5 years and vesting over a 3 year schedule.  The options were
      valued at $2,579 using the Black-Scholes option pricing method with the
      following assumptions: stock price $6.40, expected life of 2.5 years,
      volatility of 67% (using historical volatility to provide an implied
      volatility as the Company’s options to not trade) and a discount rate of
      0.14%).





§
            stock
      options for 1,500 common shares exercisable at $5.28 per share expiring in
      5 years and vesting over a 3 year schedule.  The options were
      valued at $3,188 using the Black-Scholes option pricing method with the
      following assumptions: stock price $5.28, expected life of 2.5 years,
      volatility of 67% (using historical volatility to provide an implied
      volatility as the Company’s options to not trade) and a discount rate of
      0.08%).





§
            stock
      options for 220,000 common shares exercisable at $5.05 per share expiring
      in 5 years and vesting over a 3 year schedule.  The options were
      valued at $447,249 using the Black-Scholes option pricing method with the
      following assumptions: stock price $5.05, expected life of 2.5 years,
      volatility of 67% (using historical volatility to provide an implied
      volatility as the Company’s options to not trade) and a discount rate of
      0.08%).





§
            632,632
      shares of common stock in exercise of options to purchase 632,632
      shares.  We received proceeds of $467,644 related to the
      exercise of the options; and





§
            1,833,568
      shares of common stock in exercise of warrants to purchase 1,833,568
      shares.  We received proceeds of $2,348,763 related to the
      exercise of the warrants;





These
securities were issued pursuant to Section 4(2) of the Securities Act of 1933,
as amended.





Item
3.                      Defaults
Upon Senior Securities





None.





Item
4.                      Submission
of Matters to a Vote of Security Holders





None.




Item
5.                      Other
Information





None.






22





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.
            Description of
      Exhibit31.1
            Certification
      of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted
      pursuant to Section 302 of the Sarbanes-Oxley Act of
  2002.31.2
            Certification
      of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted
      pursuant to Section 302 of the Sarbanes-Oxley Act of
  2002.32.1
            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.













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
      INCORPORATEDDate:
      November 12, 2009
              By:
              /s/ Robert
      G. Pedersen IIRobert
      G. Pedersen II,President
      and Chief Executive Officer
 Date:
      November 12, 2009
              By:
              /s/ Brandon
      T. O'BrienChief
      Financial Officer
                (Principal
      financial officer)