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IFON > SEC Filings for IFON > Form 10-Q on 14-Aug-2013All Recent SEC Filings

Show all filings for INFOSONICS CORP

Form 10-Q for INFOSONICS CORP


14-Aug-2013

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, 2012 (including our 2012 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.


Table of Contents

This report contains "forward-looking statements," including, without limitation, statements about customer relationships, marketing of our verykoolŪ 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 verykoolŪ handsets and successfully introduce them into new emerging markets;
(3) the ability of the Company to have access to adequate capital to fund its operations; (4) extended general economic downturn in world markets;
(5) inability to secure adequate supply of competitive products on a timely basis and on commercially reasonable terms; (6) 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; (7) 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; (8) 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; (9) significant changes in supplier terms and relationships or shortages in product supply; (10) loss of business from one or more significant customers; (11) customer and geographical accounts receivable concentration risk and other related risks; (12) rapid product improvement and technological change resulting in inventory obsolescence; (13) uncertain political and economic conditions internationally, including terrorist or military actions; (14) the loss of a key executive officer or other key employees and the integration of new employees;
(15) changes in consumer demand for multimedia wireless handset products and features; (16) our failure to adequately adapt to industry changes and to manage potential growth and/or contractions; (17) seasonal buying patterns; (18) the resolution of any litigation for or against the Company; 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, Africa and the United States. We design, develop, source and sell our proprietary line of products under the verykoolŪ brand and on a private label basis to certain customers (collectively referred to as our "verykoolŪ products"). We first introduced our verykoolŪ brand in 2006 and verykoolŪ products include entry-level, mid-tier and high-end products.

For the five years prior to March 2012, our business had two primary components:
(1) legacy distribution of wireless handsets supplied by major manufacturers, primarily Samsung, and (2) provision of our own proprietary verykoolŪ products that we originally sourced from independent design houses and original design manufacturers ("ODMs"). Our 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 product 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 March 31, 2012. Since April 1, 2012, our business has and is expected to continue to be centered on our verykoolŪ product line.

The verykoolŪ 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 China where we design a number of phones in our product portfolio. We continue to source many of our phones from independent design houses. We contract with electronic manufacturing services ("EMS") providers to manufacture all of our verykoolŪ products, and maintain personnel in China to oversee production and conduct quality control.


Table of Contents

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 verykoolŪ 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. In 2012, we added customers in the U.S. domestic market. 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 like us 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.

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,
                                         2013           2012          2013          2012
 Net sales                                 100.0 %       100.0 %       100.0 %       100.0 %
 Cost of sales                              79.3 %        74.7 %        80.7 %        78.9 %

 Gross profit                               20.7 %        25.3 %        19.3 %        21.1 %

 Operating expenses:
 Selling, general and administrative        21.5 %        23.1 %        21.9 %        16.9 %
 Research and development                    6.0 %         6.1 %         5.6 %         4.9 %

                                            27.5 %        29.2 %        27.5 %        21.8 %

 Operating loss                             (6.8 %)       (3.9 %)       (8.2 %)       (0.7 %)
 Other income (expense):
 Other income (expense)                      6.4 %          -            3.6 %        (0.3 %)
 Interest, net                               0.1 %         0.6 %         0.1 %         0.2 %

 Loss before income taxes                   (0.3 %)       (3.3 %)       (4.5 %)       (0.8 %)
 Provision for income taxes                 (0.2 %)         -           (0.2 %)        0.0 %

 Net loss                                   (0.5 %)       (3.3 %)       (4.7 %)       (0.8 %)

Three months ended June 30, 2013 compared with three months ended June 30, 2012

Net Sales

For the three months ended June 30, 2013, our net sales amounted to $8.3 million, an increase of $231,000, or 3%, from $8.1 million in the same period last year. We experienced significant growth in our business in Central America where net sales increased by $1.5 million, or 64%, compared to sales in the second quarter of 2012. Net sales to South American customers increased by $156,000, or 8%, and sales to U.S. distributors rose by $347,000. Net sales to U.S. distributors were nominal in the second quarter of 2012, the first quarter of our re-entry into the U.S. market. Partially offsetting these gains was a decrease of $1.0 million in net sales of private label products to customers in EMEA and APAC as extreme competition and falling margins in the private label market resulted in only nominal sales in the current quarter. Net sales to non-carrier Latin American distributors were strong in the second quarter of 2012, and declined by $548,000, or 26%, during the second quarter of 2013. In terms of unit shipments, the second quarter of 2013 represented the third consecutive record quarter with unit volume rising 16% above the unit volume in the first quarter of 2013 and 72% above the unit volume in the second quarter of 2012. However, our average unit selling price declined by 8% compared to the first quarter of 2013 and declined by 39% compared to the second quarter of 2012. The decline in average selling price is the result of a shift in product mix to a higher volume of lower-priced phones to our carrier customers in Latin America.


Table of Contents

Gross Profit and Gross Margin

For the three months ended June 30, 2013, our gross profit amounted to $1,730,000, a decrease of $325,000, or 16%, from $2,055,000 in the second quarter of 2012. Our gross profit margin for the second quarter of 2013 was 20.7%, significantly lower than the 25.3% margin in the second quarter of 2012. The disproportionately better margin in 2012 was primarily the result of higher margins generated on private label sales to customers in EMEA and APAC. As noted above, private label sales in the second quarter of 2013 were nominal.

Operating Expenses

For the three months ended June 30, 2013, total operating expenses amounted to $2,299,000, a decrease of $71,000, or 3%, compared to $2,370,000 in the same period last year. Expenses in the second quarter of 2013 included approximately $192,000 associated with the June consolidation of our R&D team in Shenzhen, China and the associated reduction of our Beijing workforce by 17 employees as part of our efforts to reduce operating expenses and improve operational efficiency. This non-recurring charge included approximately $134,000 in severance paid to terminated employees as well as legal fees and expenses related to abandonment of one incomplete development project. We estimate that these actions will result in annual savings of approximately $500,000. Operating expenses in the second quarter of 2013 also included a higher level of legal fees, product certification, compensation and other administrative expenses compared to the prior year period. Offsetting these increases was a reduction of bad debt expense of approximately $235,000 as the second quarter of 2012 included a large reserve against the receivable of a former distribution customer.

Other Income (Expense)

For the three months ended June 30, 2013, other income of $535,000 included $527,000 related to the legal defeasance of a previously recorded supplier obligation that had been included in accrued expenses on our balance sheet. Interest income on a customer installment obligation in the second quarter of 2013 amounted to $5,000, while the 2012 second quarter included $50,000 of interest income on a financed customer receivable.

Provision for Income Taxes

Our provision for income taxes for the three months ended June 30, 2013 amounted to $18,000 relating to a foreign dividend received from one of our wholly owned subsidiaries. Because of our prior operating losses and lack of carry-back ability, we had no additional provision for income taxes during the second quarter of 2013 and we likewise had no tax provision for the second quarter of 2012.

Six months ended June 30, 2013 compared with six months ended June 30, 2012

Net Sales

For the six months ended June 30, 2012, our net sales amounted to $16.2 million, a decrease of $4.3 million, or 21%, from $20.5 million in the same period last year. The decrease is primarily attributable to reductions in the following areas: $4.4 million in private label sales as a consequence of extreme competition and falling margins in the private label market, $2.7 million in distribution sales incident to the termination of our Samsung agreement on March 31, 2012, $1.2 million to customers in Mexico and $0.8 million to non-carrier Latin American distributors. Partially offsetting these declines were increases in the following areas: $4.3 million (93%) to customers in Central America (primarily Guatemala) and $0.5 million to U.S. distributors. In terms of total unit shipments of verykoolŪ and private label products, we shipped 52% more handsets during the first half of 2013 than in the prior year's first half. The average unit selling price during the first half of 2013 declined by 39% compared to the first half of 2012 as a result of a shift in product mix to a higher volume of lower-priced phones to our carrier customers in Latin America.


Table of Contents

Gross Profit and Gross Margin

For the six months ended June 30, 2013, our gross profit amounted to $3.1 million, a decrease of $1.2 million, or 28%, from $4.3 million in the same period of the prior year. The decrease reflects reduced sales during the period, in particular the lower level of private label sales which were at disproportionately high gross margins than our branded business. Our gross profit margin for the six months ended June 30, 2013 was 19.3% of net sales, an 8.6% decrease from the gross margin of 21.1% in the same period last year.

Operating Expenses

Total operating expenses for both the six months ended June 30, 2013 and 2012 amounted to approximately $4.4 million. Selling, general and administrative expenses were $84,000 higher in the first half of 2013 compared to 2012 reflecting increased legal fees, wages and product certification expenses, partially offset by reduced bad debt expense. R&D expenses were $98,000 lower in the first half of 2013 compared to 2012. In order to reduce operating expenses and improve operational efficiency, we effected two reductions-in-force during the first half of 2013: one in the first quarter and another in the second quarter in which we consolidated the development team into our Shenzhen, China office. A combined total of 37 employees were affected. The reduced level of R&D expenses reflects the reduction in payroll costs compared to the prior year, partially offset by one-time expenses incident to the second action. The first action was formulated during December 2012 and the costs associated with it were recorded in the fourth quarter of 2012. Costs associated with the second action in June 2013 amount to approximately $192,000, including approximately $134,000 in severance paid to terminated employees as well as legal fees and abandonment of one incomplete development project.

Other Income (Expense)

For the six months ended June 30, 2013, other income of $586,000 consisted principally of $527,000 related to the legal defeasance of a previously recorded supplier obligation that had been included in accrued expenses on our balance sheet and $55,000 related to a forfeited customer deposit. Interest income on a customer installment obligation amounted to $11,000. For the six months ended June 30, 2012, other expense of $65,000 included $48,000 of foreign exchange losses and a $17,000 loss on disposal of fixed assets. Interest income of $50,000 related to financed customer receivables.

Provision for Income Taxes

With the exception of an $18,000 tax provision recorded in the second quarter of 2013 relating to a foreign dividend received from one of our wholly owned subsidiaries, our tax provisions for the six month periods ended June 30, 2013 and 2012 were nominal and consisted only of state and local taxes as a consequence of our operating losses and lack of carry back ability.

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 six fiscal years and negative cash flow from operations in three of those years. In the six months ended June 30, 2013, we generated $262,000 in cash from operations. We generated $2.6 million in cash from accounts receivable reductions and $1.1 million from inventory reductions. Uses of cash consisted of $1.7 million to reduce accounts payable and accruals, $1.2 million to increase prepaid assets and $0.5 million to fund the net loss for the period, excluding non-cash items. As of June 30, 2013, our cash balance was $6.4 million, we had net working capital of $15.7 million and we had no outstanding debt. 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 next twelve months.

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, 2012.

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