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IFON > SEC Filings for IFON > Form 10-K on 14-Mar-2014All Recent SEC Filings

Show all filings for INFOSONICS CORP

Form 10-K for INFOSONICS CORP


14-Mar-2014

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.

Our management's discussion and analysis of financial condition and results of operations should be read in conjunction with our accompanying Consolidated Audited Financial Statements and related notes, as well as the "Risk Factors" and other information contained in this annual report. The discussion is based upon, among other things, our Consolidated Audited Financial Statements, which have been prepared in accordance with 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 at the financial statement dates 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


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experience and other assumptions that we believe to be reasonable under the circumstances. Actual results are likely to differ from those 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 could. 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 below in "Critical Accounting Policies." All references to results of operations in this discussion are references to results of continuing operations, unless otherwise noted.

Overview and Recent Developments

We are a provider of wireless handsets (which may be referred to herein as "phones", "cell phones", "mobile phones", "feature phones" and "smartphones") and accessories to carriers, distributors and 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 verykool® brand and on a private label basis to certain customers (collectively referred to as verykool® products). verykool® products include entry-level, mid-tier and high-end feature phones and Android-based smartphones. We first introduced the verykool® brand in 2006, and have been working to gain brand identity and grow sales. We have recently transformed our company from our prior business model as a distributor of phones designed, developed and manufactured by others, to our current business model of designing, manufacturing, sourcing and selling our own verykool® products.

Over the past five years, our business has had two primary components:
(1) legacy distribution of wireless handsets supplied by major manufacturers, primarily Samsung, and (2) provision of our own proprietary verykool® products that we originally sourced from independent design houses and original design manufacturers ("ODMs"). 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 complete shut-down of our distribution business of third party branded products which ended with the termination on March 31, 2012 of our distribution agreement with Samsung. Since April 1, 2012, our business has and will continue to be centered on our verykool® product line.

The majority of our phones are sourced from independent design houses and ODMs. In addition, a number of phones in our product portfolio are developed internally by our in-house design team in Shenzhen, China, which currently consists of 23 employees. We contract with electronic manufacturing services ("EMS") providers to manufacture all of our branded products.

Historically, our traditional market focus has been Latin America. During 2013 we did a small amount of business with customers in the United States and sought to expand our presence in the U.S. market. In December 2013 we signed a distribution agreement with Ingram Micro Mobility which we anticipate will provide us the opportunity in 2014 to access Ingram's vast U.S. distribution network to carriers, retail and on-line customer channels.

Areas of Management Focus and Performance Indicators

We focus on the needs of our customers, developing and sourcing new and innovative products, fostering close relationships with manufacturers, and expanding our business in our current markets and entering into new geographic markets, all while maintaining close attention to operational efficiencies and costs. We are particularly focused on increasing sales volumes of higher margin proprietary products in a cost effective manner to enable us to return to profitability, as well as monitoring and managing levels of accounts receivable and inventory to minimize risk. Performance indicators that are important for the monitoring and management of our business include top line sales growth, cost of sales and gross margin percentage, operating expenses in absolute dollars and as a percent of revenues and operating and net income (loss). We rely upon our in-house software


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management system to exercise real-time control over many elements of our business including customer relationship management, purchasing, inventory management and control, sales order control and pricing management.

Management and employees spend a significant amount of time traveling to Latin America and Asia Pacific with the purpose of spending time with our key customers, suppliers, our Chinese design team and other contractors and employees. We believe that these relationships are vital to our success and we will continue to dedicate a significant amount of time to this area.

Critical Accounting Policies and Estimates

Critical accounting policies are those policies that, in management's view, are most important in the portrayal of our financial condition and results of operations. The notes to our consolidated Financial Statements also include disclosure of significant accounting policies. The methods, estimates and judgments that we use in applying our accounting policies have a significant impact on the condition and results that we report in our financial statements. These critical accounting policies require us to make difficult and subjective judgments, often as a result of the need to make estimates and assumptions regarding matters that are inherently uncertain. Our critical accounting policies and estimates and assumptions that require the most significant judgment are discussed further below.

Revenue Recognition and Allowance for Returns

Revenues for wireless handset and accessory sales are recognized when
(i) shipment of the products to customers has occurred and title has passed,
(ii) when collection of the outstanding receivables is probable and (iii) the final price of the products is determined, which occurs at the time of shipment. Sales are recorded net of discounts, rebates, cooperative marketing arrangements, returns and allowances. On select sales, we may agree to cooperative arrangements wherein we agree to fund future marketing programs related to the products purchased by the customer. Such arrangements are usually agreed to in advance. The amount of the co-op allowance is recorded as a reduction of the sale and added to accrued expenses as a current liability. Subsequent expenditures made pursuant to the arrangements reduce this liability. To the extent we incur costs in excess of the established cooperative fund, we recognize the amount as a selling or marketing expense. As part of the sales process, we may perform certain value-added services such as programming, software loading and quality assurance testing. These value-added services are considered an ancillary component of the sales process and amounts attributable to these processes are included in the unit cost to the customer. Furthermore, these value-added services are related to services prior to the shipment of the products, and no value-added services are provided after delivery of the products. We recognize as a reserve against the related receivables estimates for product returns based on historical experience and other judgmental factors, evaluate these estimates on an ongoing basis and adjust our estimates each period based on actual product return activity. We recognize freight costs billed to our customers in sales and actual freight costs incurred as a component of cost of sales.

Allowance for Doubtful Accounts

We provide for the possible inability to collect accounts receivable by recording an allowance for doubtful accounts. We evaluate the collectability of our accounts receivable on an ongoing basis. In circumstances where we are aware of a specific customer's inability to meet its financial obligations, we record a specific allowance against amounts due in order to reduce the net recognized receivable to the amount we reasonably believe will be collected, after consideration for accounts receivable insurance coverage we may have. For all other customers, we recognize allowances for doubtful accounts based on the length of time the receivables are past due, the current business environment and our historical experience.


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Inventory Reserves

We regularly monitor inventory quantities on hand and record a provision for excess, slow moving and obsolete inventories based primarily on historical usage rates and our estimated forecast of product demand and expected pricing. We attempt to tightly control our inventory levels and in the recent past have moved more to a build-to-order model. However, because we need to place non-cancelable orders with our contract manufacturers with a lead time of 30 to 60 days, and because we may not have a confirmed customer purchase order in hand as quickly as we would like to, we sometimes take inventory risk. As our products get closer to end-of-life status, we are more strict about our build-to-order policy in order to limit our inventory exposure on older product.

Results of Operations:

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

                                                2013         2012         2011
        Net sales                                100.0 %      100.0 %      100.0 %
        Cost of sales                             81.7 %       80.2 %       87.0 %

        Gross profit                              18.3 %       19.8 %       13.0 %

        Operating expenses:
        Selling, general and administrative       17.8 %       20.6 %       15.7 %
        Research and development                   3.5 %        6.5 %        4.5 %

                                                  21.3 %       27.1 %       20.2 %

        Operating loss                            -3.0 %       -7.3 %       -7.2 %
        Other income (expense):
        Interest income (expense), net             1.5 %        0.2 %        0.0 %
        Other income (expense), net                0.0 %       -0.2 %        0.1 %

        Loss before income taxes                  -1.5 %       -7.3 %       -7.1 %
        Benefit (provision) for income taxes      -0.1 %        0.0 %        0.0 %

        Net loss                                  -1.6 %       -7.3 %       -7.1 %

We do not believe that inflation had a significant impact on our results of operations for the periods reported in our Consolidated Audited Financial Statements.

Year Ended December 31, 2013 Compared With Year Ended December 31, 2012

Net Sales

For the year ended December 31, 2013, our total net sales of $37.9 million increased by $3.6 million, or 10.5%, compared to net sales of $34.3 million in 2012. Sales during 2013 of verykool® products increased by $6.3 million, or 20.1%, compared to $31.6 million in 2012, offset by the decrease of $2.7 million of Samsung distribution sales in 2012. Our Samsung distribution business ended March 31, 2012. Our revenue growth reflects strong performance with carrier customers in Peru, Guatemala, Puerto Rico and the Dominican Republic, partially offset by declines in private label sales in Europe, Middle East and Africa ("EMEA") and Asia Pacific ("APAC"). 2013 represented a record year for sales of verykool® products, both in terms of dollar value and units sold. We shipped 1.9 million units in 2013, an 86% increase over 1.0 million units shipped in 2012. However, the product mix shifted significantly to low-end feature phones resulting in a reduction of our average selling price from $30.19 in 2012 to $19.65 in 2013.


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Cost of Sales, Gross Profit and Gross Margin



                                     For the Year
                                  Ended December 31,                 Increase
                              2013                   2012           (Decrease)
                             (Dollar amounts in thousands)
         Net sales       $        37,895         $      34,294             10.5 %
         Cost of sales            30,953                27,488             12.6 %

         Gross profit    $         6,942         $       6,806              2.0 %

         Gross margin               18.3 %                19.8 %           (7.7 %)

For the year ended December 31, 2013, cost of sales was $31.0 million, 81.7% of net sales, and gross margin was 18.3%, compared to cost of sales of $27.5 million, 80.2% of net sales, and a 19.8% gross margin for the year ended December 31, 2012. In 2013, our gross profit amounted to $6.9 million, an increase of 2.0% from $6.8 million in 2012. The 7.7% reduction in gross margin was primarily the result of a higher concentration of sales of low-end feature phones at lower gross margins.

Operating Expenses and Operating Loss

For the year ended December 31, 2013, operating expenses of $8.1 million decreased by $1.2 million, or 13.0%, from $9.3 million in 2012. Selling, general and administrative ("SG&A") expenses decreased by $0.3 million and R&D spending decreased by $0.9 million. The decrease in SG&A expenses in 2013 compared to 2012 was primarily the result of a lack of bad debt expense in 2013 compared to an isolated bad debt recorded in the first quarter of 2012. The decreased R&D expenses were primarily the result of the reduction-in-force and consolidation of our development team into our Shenzhen, China office which we accomplished in the first and second quarters of 2013. Severance costs of $100,000 for the employees terminated in the first quarter of 2013 were recorded in the fourth quarter of 2012 as we finalized the plan to eliminate the headcount redundancies in December 2012.

For the year ended December 31, 2013, we sustained an operating loss of $1.1 million, cutting by more than half the operating loss of $2.5 million for the year ended December 31, 2012. The $1.4 million improvement came primarily from the $1.2 million reduction in operating expenses and $0.1 million improvement in gross profit.

Interest Expense and Other Income (Expense)

For the year ended December 31, 2013, other income (expense) of $582,000 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, principally from a customer installment obligation, amounted to $17,000. In 2012, other income (expense) included $72,000 of expense comprised of $48,000 of foreign exchange losses and a $24,000 loss on disposal of fixed assets. We also recorded $61,000 of interest income primarily related to financed customer receivables.

Net Loss

For the year ended December 31, 2013, our net loss was $597,000 after a tax provision of $51,000 related primarily to a foreign dividend received from one of our wholly owned subsidiaries. Because of our prior operating losses and lack of carry-back ability, our provision for income taxes for 2012 was nominal and our net loss was $2.5 million.


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Year Ended December 31, 2012 Compared With Year Ended December 31, 2011

Net Sales

For the year ended December 31, 2012, our net sales of $34.3 million decreased by $0.6 million, or 1.7%, compared to net sales of $34.9 million in 2011. The significant decrease in our distribution business from 2011 to 2012 was almost entirely offset by the increase in sales of our branded verykool®products. Our Samsung distribution business ended March 31, 2012 as a consequence of a stiff import tariff on certain electronic devices, including wireless handsets, that was enacted in Argentina in November 2009 and an additional import regulation which became effective in March 2011. These protective import actions began to negatively affect our sales beginning in the first quarter of 2010, accelerated through 2010 and continued through the end of 2011. In 2012, our Samsung distribution sales declined by $10.7 million, or 81%, to $2.5 million from $13.2 million in 2011. Nearly offsetting this decline was an increase in sales of our branded verykool® products of $10.1 million, or 47.3%, to $31.6 million from $21.4 million in 2011. This represented a record year for sales of verykool® products, both in terms of dollar value and units sold.

Cost of Sales, Gross Profit and Gross Margin



                                     For the Year
                                  Ended December 31,                 Increase
                              2012                   2011           (Decrease)
                             (Dollar amounts in thousands)
         Net sales       $        34,294         $      34,884             (1.7 %)
         Cost of sales            27,488                30,344             (9.4 %)

         Gross profit    $         6,806         $       4,540             49.9 %

         Gross margin               19.8 %                13.0 %           52.3 %

For the year ended December 31, 2012, cost of sales was $27.5 million, 80.2% of net sales, and gross margin was 19.8%, compared to cost of sales of $30.3 million, 87.0% of net sales, and a 13.0% gross margin for the year ended December 31, 2011. In 2012, our gross profit amounted to $6.8 million, an increase of 49.9%, from $4.5 million in 2011. The significant improvements in both our gross profit and our gross margin percentage were primarily a result of the shift in the mix of sales to a lower concentration of distribution sales and a higher concentration of branded sales incident to the expiration of our distribution agreement with Samsung. Sales of our verykool®branded products typically result in higher gross margins than our distribution sales. In 2011, distribution sales comprised 38% of total revenues, with 62% represented by branded sales. In 2012, distribution sales fell to 8% of total revenues, with 92% coming from sales of branded verykool® products.

Operating Expenses and Operating Loss from Continuing Operations

For the year ended December 31, 2012, operating expenses of $9.3 million increased by $2.2 million, or 31.5%, from $7.1 million in 2011. Selling, general and administrative ("SG&A") expenses increased by $1.6 million and R&D spending increased by $0.6 million. The increased SG&A expenses included increases in the following areas: personnel additions in the sales, logistics and service departments, sales commissions on increased sales of verykool® branded products, marketing, homologation and an isolated bad debt recorded in the first quarter of 2012. The increased R&D expenses were primarily the result of increased headcount during the second half of 2012 to enable the contemporaneous development of a number of new smartphone models. In December 2012, as these developments drew to a close, we finalized a plan to eliminate the headcount redundancies in the first quarter of 2013 and restructure our China workforce. Severance costs for the terminated employees of $100,000 were recorded in the fourth quarter of 2012 and were included in R&D expense for the year.

For the year ended December 31, 2012, we sustained an operating loss from continuing operations of $2.5 million, equal to the operating loss of $2.5 million for the year ended December 31, 2011. The $2.2 million increase in gross profit in 2012 was offset by the $2.2 million increase in operating expenses.


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Interest Expense and Other Income (Expense)

During the year ended December 31, 2012, other income (expense) included $72,000 of expense comprised of $48,000 of foreign exchange losses and a $24,000 loss on disposal of fixed assets. We also recorded $61,000 of interest income primarily related to financed customer receivables. In 2011 we had $30,000 of other income, consisting primarily of gain on sale of fixed assets, and $11,000 of interest income on a tax refund.

Net Loss

Because other income (expense) and income tax expense in both 2012 and 2011 were minimal, our net losses in both years were substantially equivalent to the operating losses for the respective years. The nominal income tax was the result of our prior operating losses and lack of carry-back ability.

Financial Condition, Liquidity and Capital Resources

Historically, we have used cash from sale of products and lines of credit (bank and vendor) to provide the capital needed to support our business. In late 2011, we added a new foreign exchange ("FX") hedging facility with our bank as a tool to hedge our exposure to changes in certain foreign currency exchange rates. We electively terminated this facility in the first quarter of 2013 and the restricted cash supporting it was returned to our general cash reserves.

The primary drivers affecting our cash and liquidity are net income (losses) and working capital requirements. Capital equipment is not significant in our business, and at December 31, 2013 we did not have any material commitments for capital expenditures. Our largest working capital requirement is for accounts receivable, and, to a lesser extent, inventory (including prepaid inventory, which is a component of prepaid assets), as we continually strive to minimize inventory levels. We typically bill customers on an open account basis, subject to our credit qualification, with payment terms ranging between net 30 and net 90 days. Some of our larger carrier customers, however, often delay payments beyond the invoiced payment terms. If our net revenue increases, it is likely that our accounts receivable balance will also increase. Our Chinese suppliers from whom we purchase product do not offer us vendor credit. Furthermore, we typically are required to pay a 15% to 20% deposit at the time we place a purchase order with the remaining balance due prior to shipment.

As of December 31, 2013, we had $2.4 million of cash and cash equivalents and $16.0 million of working capital compared to $6.2 million of cash, cash equivalents and restricted cash and $16.2 million of working capital as of December 31, 2012. As of both December 31, 2013 and 2012, we had no bank debt.

As of December 31, 2013, cash and cash equivalents consisted of cash on hand and in bank accounts.

Operating Activities

Net cash used by operating activities for the year ended December 31, 2013 amounted to $3.7 million compared to $5.9 million for the year ended December 31, 2012. The $2.2 million reduction of cash required to fund operations was due largely to the $1.2 million reduction in the net loss, adjusted for non-cash items, for 2013 compared to 2012.

In 2013, we used $3.4 million of cash to fund our net working capital requirements. This included a $1.6 million increase in trade accounts receivable, reflecting the 40% increase in sales in the fourth quarter of 2013 compared to 2012, partially offset by a more current receivable base. Days sales outstanding in receivables at December 31, 2013 was 90 days, which was a substantial improvement over the 109 days at December 31, 2012. We also used $1.9 million to increase our prepaid inventory levels, partially offset by a $1.2 million reduction in inventories. An additional $1.0 million was used to reduce payables and accruals.


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In 2012, we used $4.4 million of cash to fund our net working capital requirements. This included a $1.9 million increase in trade accounts receivable, reflecting a larger share of our fourth quarter sales to carrier customers who delayed payments in December. Days sales outstanding in receivables at December 31, 2011 was 109 days, which was significantly greater than the 65 days at December 31, 2011. We also used $1.4 million to increase our inventory levels, although this was partially offset by a $1.1 million reduction in prepaid inventories. An additional $1.9 million was used to reduce payables and accruals and $0.3 million for other assets.

Investing Activities

Cash used to purchase property and equipment, primarily tooling and molds for our proprietary verykool® products, amounted to $145,000 in 2013 compared to $396,000 in 2012. In 2013, we freed up $1.0 million of restricted cash which had been used to secure our obligations under an FX hedging facility with our bank which was terminated in the first quarter.

Financing Activities

There were no financing activities in the years ended December 31, 2013, 2012 or 2011.

We believe that our current cash resources and working capital may adequately fund our operations at the current level. However, the lack of additional cash resources could impede the future growth of our business. In January 2014, we received commitments from certain of our product vendors to extend 60 day credit terms to us, supported by credit insurance. We would still be required to pay the upfront 15% to 20% deposit upon placement of purchase orders, but the remaining balance would be subject to the 60 day credit terms beginning on the date of product delivery. We would reimburse the vendor for the cost of the credit insurance, as well as pay a finance charge based on the balances outstanding during the 60-day term. Two credit insurers have committed to a combined policy coverage of $4 million, and the combined cost of the insurance and the finance charge would be at effective annual rates from 5.8% to 7.4%. In addition, we are currently in discussions with a number of funding sources to provide additional asset-based financing, but there can be no assurance that a definitive agreement will be reached.

Off-Balance Sheet Arrangements

At December 31, 2013, we did not have any off-balance sheet arrangements.

Contractual Obligations

We lease corporate and administrative office facilities and equipment under non-cancelable operating leases. Rent expense under these leases was . . .

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