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IFON > SEC Filings for IFON > Form 10-Q on 14-Aug-2012All Recent SEC Filings

Show all filings for INFOSONICS CORP

Form 10-Q for INFOSONICS CORP


14-Aug-2012

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

Forward-Looking Statements, Safe Harbor Statement and Other General Information

This discussion and analysis of financial condition and results of operations should be read in conjunction with the accompanying unaudited consolidated financial statements and condensed notes thereto and other information included in this report and our Annual Report on Form 10-K for the year ended December 31, 2011 (including our 2011 audited consolidated financial statements and related notes thereto and other information). Our discussion and analysis of financial condition and results of operations are based upon, among other things, our unaudited consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States ("GAAP"). The preparation of financial statements in conformity with GAAP requires us to, among other things, make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosures of contingent liabilities as of the date of our most recent balance sheet, and the reported amounts of revenues and expenses during the reporting periods. We review our estimates and assumptions on an ongoing basis. Our estimates are based on our historical experience and other assumptions that we believe to be reasonable under the circumstances. Actual results are likely to differ from these estimates under different assumptions or conditions, but we do not believe such differences will materially affect our financial position or results of operations, although they may. Our critical accounting policies, the policies we believe are most important to the presentation of our financial statements and require the most difficult, subjective and complex judgments are outlined in "Critical Accounting Policies" in our Annual Report on Form 10-K. All references to results of operations in this discussion generally are to results from continuing operations, unless otherwise noted.

This report contains "forward-looking statements," including, without limitation, statements about customer relationships, marketing of our verykool® products, sales levels, cost reductions, operating efficiencies, profitability and adequacy of working capital, that are based on current management expectations and which involve certain risks and uncertainties. These risks and uncertainties, in whole or in part, could cause such expectations to fail to be achieved and have a material adverse effect on our business, financial condition and results of operations, and include, without limitation: (1) intense competition internationally, including competition from alternative business models, such as manufacturer-to-carrier sales, which may lead to reduced prices, lower sales, lower gross margins, extended payment terms with customers, increased capital investment and interest costs, bad debt risks and product supply shortages; (2) the ability of our China R&D group to develop new verykool® handsets and successfully introduce them into new emerging markets;
(3) extended general economic downturn in world markets; (4) inability to secure adequate supply of competitive products on a timely basis and on commercially reasonable terms; (5) foreign exchange rate fluctuations, devaluation of a foreign currency, adverse governmental controls or actions, political or economic instability, or disruption of a foreign market, including, without limitation, the imposition, creation, increase or modification of tariffs, taxes, duties, levies and other charges and other related risks of our international operations which could significantly increase selling prices of our products to our customers and end-users; (6) the ability to attract new sources of profitable business from expansion of products or services or risks associated with entry into new markets, including geographies, products and services; (7) an interruption or failure of our information systems or subversion of access or other system controls may result in a significant loss of business, assets, or competitive information; (8) significant changes in supplier terms and relationships or shortages in product supply; (9) loss of business from one or more significant customers; (10) customer and geographical accounts receivable concentration risk and other related risks; (11) rapid product improvement and technological change resulting in inventory obsolescence; (12) uncertain political and economic conditions internationally, including terrorist or military actions; (13) the loss of a key executive officer or other key employees and the integration of new employees;
(14) changes in consumer demand for multimedia wireless handset products and features; (15) our failure to adequately adapt to industry changes and to manage potential growth and/or contractions; (16) seasonal buying patterns; (17) the resolution of any litigation for or against the


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Company; (18) the ability of the Company to have access to adequate capital to fund its operations; and (19) the ability of the Company to generate taxable income in future periods. Reference is also made to other factors detailed from time to time in our periodic reports filed with the Securities and Exchange Commission. These forward-looking statements speak only as of the date of this release and we undertake no obligation to publicly update any forward-looking statements to reflect new information, events or circumstances after the date of this release. We have instituted in the past, and continue to institute, changes to our strategies, operations and processes to address risks and uncertainties and to mitigate their impacts on our results of operations and financial condition. However, no assurances can be given that we will be successful in these efforts. For a further discussion of significant risk factors to consider, see "Risk Factors" below in this report and "Item 1A. Risk Factors" of our Annual Report on Form 10-K. In addition, other risks or uncertainties may be detailed from time to time in our future SEC filings.

Overview

We are a provider of wireless handsets and accessories to carriers, distributors and original equipment manufacturers ("OEMs") in Latin America, Asia Pacific, Europe and Africa. We design, develop, source and sell our proprietary line of products under the verykool® brand and on a private label basis to certain customers (collectively referred to as our "verykool® products"). We first introduced our verykool® brand in 2006 and verykool® products include entry-level, mid-tier and high-end products.

Prior to March 2012 and for the past five years, there were essentially two ways through which we provided wireless handsets and accessories: (1) through the distribution of wireless handsets supplied by major manufacturers, primarily Samsung, and (2) through the provision of our proprietary verykool® phones that we originally sourced from independent design houses and original design manufacturers ("ODMs"). Our annual revenue peaked in 2006 when we recorded approximately $241 million of net sales. In 2009, more than 95% of our net sales of approximately $231 million were derived from distribution sales of Samsung products to carriers in Argentina. In late 2009, however, a stiff import tariff on certain electronic devices, including wireless handsets, was enacted in Argentina. The tariff had a significant negative impact on our sales beginning in the first quarter of 2010, and ultimately resulted in a decrease of 69% of our sales volume in 2010 compared to 2009. Then, in February 2011, Argentina enacted a further import regulation effective March 6, 2011 which signaled the closing stage of our distribution business. Our distribution agreement with Samsung expired on March 31, 2012. Since then and going forward, our business has been and will be centered on our verykool® product line. Our goal is to replace the lost gross profit from distribution revenues with higher margin verykool® sales through the expansion of our product portfolio and entry into new geographic markets in Asia Pacific, Europe, Africa and Latin America.

The verykool® brand is now our flagship product. In order to better control the roadmap for this product line, in April 2010 we established an in-house design center in Beijing, China where we are now designing a number of phones in our product portfolio. We continue to source many of our phones from independent design houses, but expect that eventually the majority of our phones will come from our own design center as our team expands and increases its capacity. We contract with electronic manufacturing services ("EMS") providers to manufacture all of our verykool® products, and maintain personnel in China to oversee production and conduct quality control.

Industry and Market Trends and Risks

The wireless business is extremely competitive. The industry is characterized by rapid technological development driven by faster and more capable chipsets, innovative software features and applications and faster networks provided by wireless carriers. In this environment, it is extremely difficult to differentiate our products, and price pressure is constant.

Over the past several years, our business has been concentrated in countries in Latin America. In addition, during that time, the majority of our revenue was derived from distribution sales of Samsung products in Argentina, typically at very thin margins. As mentioned above, in late 2009, Argentina enacted a significant import tariff on certain electronic devices, including wireless handsets, that threatened our distribution business and largely eroded our sales during 2010 and 2011.

In late 2010 we expanded sales of our verykool® products into the Asia Pacific market with initial sales to customers in both China and India, and in 2011, we added customers in Western Europe, Russia, Singapore, Africa and certain other Southeast Asian countries. The economic profile of the consumer markets in both Latin America and Asia Pacific are similar in that they are extremely price sensitive. As a consequence, unlike the U.S. domestic market that is dominated by large providers, these markets are more open to smaller providers such as ourselves who are able to supply more competitively priced handsets with similar features. We expect this situation to continue for the foreseeable future. The Latin America and Asia Pacific markets are also more attractive to us because the current level of cellular customer penetration is significantly lower in most countries in these regions in comparison to North America and Western Europe.


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Results of Operations

The following table sets forth certain items from our consolidated statements of
operations as a percentage of net sales for the periods indicated:



                                                    Three months ended             Six months ended
                                                         June 30,                      June 30,
                                                   2012            2011           2012          2011
Net sales                                            100.0 %        100.0 %        100.0 %       100.0 %
Cost of sales                                         74.7 %         85.7 %         78.9 %        89.1 %

Gross profit                                          25.3 %         14.3 %         21.1 %        10.9 %

Operating expenses:
Selling, general and administrative                   23.1 %         20.2 %         16.9 %        17.2 %
Research and development                               6.1 %          6.2 %          4.9 %         4.8 %

                                                      29.2 %         26.4 %         21.8 %        22.0 %

Operating loss from continuing operations             (3.9 %)       (12.1 %)        (0.7 %)      (11.1 %)
Other income (expense):
Other income (expense)                                  -              -            (0.3 %)        0.2 %
Interest, net                                          0.6 %           -             0.2 %         0.0 %

Loss from continuing operations before income
taxes                                                 (3.3 %)       (12.1 %)        (0.8 %)      (10.9 %)
Provision for income taxes                              -              -             0.0 %         0.0 %

Loss from continuing operations                       (3.3 %)       (12.1 %)        (0.8 %)      (10.9 %)
Loss from discontinued operation, net of tax            -            (0.9 %)          -            0.0 %

Net loss                                              (3.3 %)       (13.0 %)        (0.8 %)      (10.9 %)

Three months ended June 30, 2012 compared with three months ended June 30, 2011

Net Sales

For the three months ended June 30, 2012, our net sales amounted to $8.1 million, an increase of $1.8 million, or 28%, from $6.3 million in the same period last year. The increase was due to a substantial increase in sales of verykool® products partially offset by a decline in distribution sales. Net sales of verykool® products nearly doubled during the second quarter of 2012 compared to the second quarter of the prior period with sales rising 99% from $4.0 million to $7.96 million. Sales of verykool®products to customers in Latin America rose 81% from $3.8 million to $6.9 million, and we added $0.9 million of incremental private label sales to customers in Western Europe, Russia, Africa and Asia Pacific. We shipped 145% more verykool® handsets during the quarter than in the prior year, but the average selling price declined 19% due to product mix and the popularity of lower-priced phones in our Latin American markets.

Partially offsetting the improvement in sales of verykool® products noted above, net distribution sales during the three months ended June 30, 2012 declined by $2.2 million compared with the same period last year reflecting the expiration on March 31, 2012 of our distribution agreement with Samsung and the absence of Samsung sales during the quarter.

Cost of Sales, Gross Profit and Gross Margin

For the three months ended June 30, 2012, our gross profit amounted to $2.1 million, an increase of $1.2 million, or 128%, from $903,000 in the same period last year, as a result of both the increased sales volume of our proprietary verykool® products and the absence of Samsung distribution revenues. Our gross profit margin for the three months ended June 30, 2012 rose significantly to 25.3% from 14.3% in the same period last year. For the three months ended June 30, 2012, net sales of verykool®products represented 98% of our total sales, compared to 63% in the same period last year.

Operating Expenses

For the three months ended June 30, 2012, total operating expenses amounted to $2.4 million, an increase of 42% compared to $1.7 million in the same period last year. Operating expenses as a percentage of net sales increased to 29% in the three months ended June 30, 2012, compared with 26% for the same period last year. Selling, general and administrative expenses for the three months ended June 30, 2012 amounted to $1.9 million, an increase of $598,000, or 47%, compared to $1.3 million in the prior year quarter. The increases were primarily related to an increase of $225,000 in our bad debt reserve, increased compensation expense for new employees and contractors, as well as sales commissions on increased sales, plus


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increased marketing and travel expenses. R&D expenses for the three months ended June 30, 2012 amounted to $496,000, an increase of $102,000, or 26%, compared to $394,000 in the prior year quarter. The increase was primarily due to increased compensation expense from expansion of our team in Beijing.

Other Income (Expense)

For the three months ended June 30, 2012, other income of $50,000 consisted primarily of interest income on financed customer receivables. We had no items of other income in the prior year quarter.

Provision for Income Taxes

Because of our prior operating losses and lack of carry-back ability, we had no provision for income taxes for the three months ended June 30, 2012 and 2011.

Income from Discontinued Operations (net of tax)

The discontinuance and closure of our operations in the U.S. and Mexico that began in the second quarter of 2008 was completed as of December 31, 2011. During the three months ended June 30, 2011, we reported a net loss from discontinued operations of $55,000 comprised of a foreign currency exchange rate loss on conversion of Mexican pesos to U.S. dollars, a bad debt writeoff and expenses relating to the recovery of prepaid Mexican VAT taxes.

Six months ended June 30, 2012 compared with six months ended June 30, 2011

Net Sales

For the six months ended June 30, 2012, our net sales amounted to $20.5 million, an increase of $4.7 million, or 30%, from $15.8 million in the same period last year. The increase reflects a significant increase in sales of our proprietary verykool® handsets. Net sales of verykool® products during the six months ended June 30, 2012 amounted to $17.7 million, an increase of $10.7 million, or 151%, from $7.0 million in the same period last year. We shipped 186% more verykool® handsets during the first half of 2012 than in the prior year's first half, and the average selling price declined by 12% due a shift in product mix to lower priced phones that are popular in Latin America.

Partially offsetting the increase in sales of our proprietary verykool® handsets was a decline in Samsung distribution sales reflecting the wind down of our Samsung distribution business. Distribution sales during the six months ended June 30, 2012 amounted to $2.7 million, a decrease of $6.0 million, or 69%, from $8.7 million in the same period last year.

Cost of Sales, Gross Profit and Gross Margin

For the six months ended June 30, 2012, our gross profit amounted to $4.3 million, an increase of $2.6 million, or 151%, from $1.7 million in the same period last year. The significant increase reflects the combined effect of the increased level of sales during the period and the higher mix of sales this year of our proprietary verykool® products compared to our distribution revenues. Our gross profit margin for the six months ended June 30, 2012 was 21.1% of net sales, a 151% increase from the gross margin of 10.9% in the same period last year. For the six months ended June 30, 2012, net sales of verykool® products represented 87% of our total sales, compared to only 45% in the same period last year.

Operating Expenses

For the six months ended June 30, 2012, total operating expenses amounted to $4.5 million, an increase of 29% compared to $3.5 million in the same period last year. However, operating expenses as a percentage of net sales decreased slightly to 21.8% in the six months ended June 30, 2012, compared with 21.9% for the same period last year, as net sales increased at a slightly faster pace compared to expenses. Selling, general and administrative expenses for the six months ended June 30, 2012 amounted to $3.5 million, an increase of $748,000, or 28%, compared to $2.7 million for the same period last year. This increase is primarily related to an increase of $225,000 in our bad debt reserve, increased compensation expense for new employees and contractors, as well as sales commissions on increased sales, plus increased marketing, travel and homologation expenses to prepare new phone models for sale and use on carrier networks. Research and development expenses for the six months ended June 30, 2012 amounted to $996,000, an increase of $245,000, or 33%, compared to $751,000 for the same period last year. The increase is primarily related to compensation expense from expansion of our team in Beijing and prototyping and abandoned tooling expense.


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Other Income (Expense)

For the six months ended June 30, 2012, other income (expense) included $65,000 of expense comprised of $48,000 of foreign exchange losses and a $17,000 loss on disposal of fixed assets. We also recorded $50,000 of interest income primarily related to financed customer receivables. For the six months ended June 30, 2011, we recorded $28,000 of other income relating principally to the gain on sale of fixed assets in connection with the closure of our Miami warehouse on March 31, 2011 and $11,000 of interest income earned on an income tax refund.

Provision for Income Taxes

Because of our operating losses and lack of carry back ability, our tax provisions for the six month periods ended June 30, 2012 and 2011 were nominal and consisted only of state and local taxes.

Loss from Discontinued Operations (net of tax)

During the six months ended June 30, 2011, we reported a net loss from discontinued operations of $7,000 including a foreign currency exchange rate loss and bad debt writeoff, partially offset by the favorable resolution of an outstanding trade payable.

Liquidity and Capital Resources

Historically, our primary sources of liquidity have been cash generated from operations, lines of credit (bank and vendor) and, from time to time, the sale and exercise of securities to provide capital needed to support our business. However, we have incurred losses for the last three fiscal years and negative cash flow from operations in one of those years. In the six months ended June 30, 2012, we used $821,000 in cash for operations, comprised primarily of a $1.7 million increase in inventories and a $946,000 decrease in accounts payable and accruals, partially offset by a $1.2 million reduction in accounts receivable, $395,000 of net income before non-cash charges and a $248,000 decrease in prepaids and other assets. Although we do not currently have a bank credit line, we believe that our current cash resources and working capital are sufficient to fund our operations for the foreseeable future.

Critical Accounting Policies

There have been no material changes to our critical accounting policies and estimates affecting the application of those accounting policies since our Annual Report on Form 10-K for the year ended December 31, 2011.

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