Simply, Inc. - Annual Report: 2005 (Form 10-K)

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

(Mark one)

x                                  ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2005

or

o                                    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. 001-32217

InfoSonics Corporation

(Exact name of registrant as specified in its charter)

 

5880 Pacific Center Blvd
San Diego, CA 92121

(Address of principal executive offices including zip code)

858-373-1600

(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:

 

Securities registered pursuant to Section 12(g) of the Act: None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. o Yes   x No

Indicated by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act. o Yes   x No

Indicate by check mark whether the registrant (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. x Yes   o No

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) is not contained herein, and will not be contained, to the best of  registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer.

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). o Yes   x No

The aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to the price at which the common equity was last sold of such common equity, as of the last business day of the registrant’s most recently completed second fiscal quarter was $6,015,880. This calculation is based upon the closing price of $2.99 of the stock on June 30, 2005 as reported by the American Stock Exchange. Without asserting that any director or executive officer of the registrant, or the beneficial owner of more than five percent of the registrant’s common stock, is an affiliate, the shares of which they are the beneficial owners have been deemed to be owned by affiliates solely for this calculation.

Indicate the number of shares outstanding of each of the registrant’s classes of common stock, as of the latest practicable date:  6,764,904 shares of our common stock were issued and outstanding as of March 17, 2006.

DOCUMENTS INCORPORATED BY REFERENCE

List hereunder the following documents if incorporated by reference and the Part of the Form 10-K (e.g., Part I, Part II, etc.) into which the document is incorporated: (1) Any annual report to security holders; (2) Any proxy or information statement; and (3) Any prospectus filed pursuant to Rule 424(b) or (c) under the Securities Act of 1933. The listed documents should be clearly described for identification purposes.

Portions of the Proxy Statement for the 2006 Annual Meeting of Stockholders

Part III

 

InfoSonics Corporation
Form 10-K for the Year Ended December 31, 2005

Table of Contents

 

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PART I

Item 1.                        Business

Company Overview

InfoSonics is one of the fastest growing distributors of wireless handsets and accessories in the United States and Latin America. We provide end-to-end handset and wireless terminal solutions for carriers in both the United States and Latin America. We distribute products of several key manufacturers, including i-mate, Motorola, Nokia, Novatel, Samsung, VK Mobile, and others.

Our corporate headquarters is in San Diego, California and from our facility in Miami Florida, where we have our Latin America sales and executive offices, we operate a warehouse and distribution center. This distribution center services our customers in the United States and Latin America. Our distribution and solution services include product testing, approval and certification, light assembly, warehousing, logistics services (packing, shipping and delivery), marketing campaigns, warranty services and end-user support. These services are provided for manufacturers of wireless telecommunications products, in order to facilitate sales to network carriers, agents, resellers, distributors, independent dealers and retailers in the United States and Latin America. Additionally, we have wholly-owned subsidiaries in Latin America which conduct some of our business activities in their respective regions of Latin America, including Primasel S.A., which we purchased in January 2005 and later changed its name to InfoSonics S.A. See Note 1 to our consolidated financial statements for financial information regarding this purchase.

Prior to 2005, we had operated a retail kiosk business, which we discontinued in 2004, and is included in our statement of operations as Discontinued Operations. See Note 3 to our consolidated financial statements for financial information relating to this discontinued operation. During 2005, we significantly changed our business model from selling products to dealers and agents in the United States and Latin America to providing products, services and solutions primarily to carriers in such regions. As a result, we believe that this shift in customer focus enables to better service our customers and vendors as we play a more important role in the supply chain for wireless handsets.

We incorporated under the laws of the State of California on February 7, 1994 under the name InfoSonics Corporation. On September 11, 2003, we reincorporated under the laws of and into the State of Maryland under the name InfoSonics Corporation.

Unless the context otherwise requires, the terms “InfoSonics,” “Company,” “we,” “our,” and “us” means InfoSonics Corporation and its consolidated subsidiaries.

Overview of Wireless Telecommunications Industry

Rapid technical developments over the last few years within the wireless telecommunications industry have allowed wireless subscribers to talk, send and receive text messages, send and receive e-mails, capture and transmit digital images, send and receive multimedia messages, play games, and browse the Internet using all-in-one wireless handsets. Wireless handsets and services also are being used around the world to provide monitoring, point-of-sale transaction processing, inter-device communications, local area networks, location monitoring, sales force automation, and customer relationship management. While there is currently not a significant demand for some of these more advanced services and advanced devices in the markets we service, as the demand develops in our markets, we believe that end-users will desire to take advantage of new services and will need handsets with updated technology. As a result of these advances and new services, we believe that the handset replacement cycle will continue to shorten, as consumers adapt to the utilization of these services, which will require new and more advanced handsets, leading to increased handset sales. As these new services and the respective handsets become more readily available for the markets we service and are in more demand by end-users, we expect to continue

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distributing the handsets, including those with these advanced services, in the same manner that we currently distribute existing products.

In addition to our current distribution services, we engage in technical and other high-level customization services in order to prepare products for our carrier customers. We believe that these customization upgrades and services will enable us to continue to offer innovative new products, which we should be able to offer to current and new customers in the geographic regions we operate. Any new products will be additives or replacements for the products we currently market.

Market Trends and Factors

The wireless telecommunications industry and its participants have experienced a number of trends in recent years, including:

·       change in focus from subscriber acquisition to subscriber retention and expansion of service offerings;

·       consolidation among carriers;

·       convergence of the telecommunications, data and media domains;

·       advances in and development of next generation systems technology, including increased bandwidth;

·       increased variety of handset forms and configurations;

·       new manufacturers and wireless service resellers; and

·       increased affordability of wireless airtime.

According to J.P. Morgan Securities Inc.’s Communications Equipment & Data Networking report dated February 2006, worldwide mobile handset sales are expected to more than double from 499 million handsets sold in 2003 to more than 1.0 billion handsets in 2007. The JP Morgan report also estimated that North American handset sales will increase from 97 million in 2003 to 157 million in 2007 and Latin American handset sales will increase from 40 million in 2003 to 117 million in 2007. The chart below summarizes the annual estimates and sales trends.

Worldwide Mobile Handset Forecast 
(Estimated Handset Sales in Millions)

Source: J.P. Morgan Securities Inc. Communications Equipment & Data Networking report dated February 2006.

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We believe the following factors are influencing the wireless telecommunications industry and market, including the increase in handset sales:

Handsets.   As a percentage of total sales, replacement handset sales are growing at an increasing rate. We believe such growth is based on customer churn, advances in technology, new activations, repair costs and industry consolidation. In addition, we expect that continued downward pressure on pricing will cause customers to more frequently upgrade and replace their handsets.

Customer Churn.   This is the process which takes place when a wireless user replaces service from one carrier with another. Churn increases overall handset sales because wireless handsets may not be compatible across different carrier networks.

Advances in Technology.   Rapid advances in technology during the past few years have caused a major shift in the handset market. Advances such as color displays, embedded cameras, multimedia messaging services, Internet access and entertainment features such as audio and gaming all have increased demand for handset replacement. Additionally, carriers compete for new customers by increasing the functionality of their networks.

New Activations.   The mobile handset penetration rate in the countries where we sell handsets varies greatly. Some countries are as low as 15-20% penetration and others are as high as 60-70% penetration. New activations also drive handset sales.

Repair Costs.   In many cases, the cost of the repair and replacement of components for handsets is prohibitive as compared to the cost of a new product.

Industry Consolidation.   Merger and acquisition activity within the carrier community has been driven by improved economies of scale, the opportunity to expand national or multi-national service areas, and efforts to increase revenue and profitability through additional service offerings. Since handsets are “locked” to a specific carrier, new handsets will be required by carriers’ customers as the carriers consolidate their respective subscribers and networks.

Our Strategy

Our strategy is to grow both horizontally and vertically in the wireless handset industry by pursuing the following:

·       leveraging our existing infrastructure to increase sales in both Latin America  and the United States;

·       continuing to provide outsourced supply-chain services;

·       further penetrating the markets in which we sell wireless handsets and accessories;

·       expanding geographically;

·       increasing margins by maintaining and improving operating efficiencies;

·       expanding the number of manufacturers we represent; and

·       creating partnerships or making acquisitions that allow us to expand our customer base, product offerings and geographical diversity.

Leverage Infrastructure and Increase Market Share.   We have our distribution center and warehouse operations in Miami, Florida and we have sales representation in the United States and many countries in Latin America. By utilizing the geographic diversity of this existing infrastructure, and our established relationships with manufacturers, we believe we can increase our sales with relatively low additional cost, resulting in increased earnings. In addition, we have customized a licensed software package for an

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information and customer management system that allows our employees to track customer order status from purchase order to assembly line positioning and then to delivery. This system also enables tracking and identification of customer and geographic trends, in addition to providing management with real-time information on each individual subsidiary. This system is scalable, and under constant improvement to streamline operations and maximize operational efficiencies. The system also analyzes and tracks our relationships with manufacturers and other suppliers so that we can compare our purchasing trends with the overall market. We will continue to make investments in our infrastructure so as to continually enhance our ability to serve our customers and attempt to increase sales.

Outsourced Supply-Chain Services.   We intend to continue expanding our business offerings to provide additional outsourced supply-chain services to the wireless telecommunications industry. These services will include product approval and testing, inventory management, product fulfillment, preparation of product kits, and customized packaging, light assembly and end-user support services. These supply-chain services are designed to provide outsourcing solutions for the carriers, as well as providing opportunities for us to enhance our margins. These services meet our customers’ business requirements and support their efforts to add new subscribers and increase system usage and revenues while minimizing their investments in distribution infrastructure.

Market Penetration.   We intend to further penetrate our existing markets in both Latin America and rural service areas in the United States, which we believe will enable us to increase sales by introducing products from certain of our manufacturer suppliers that have not been previously sold into these markets. Utilizing our relationships with manufacturers, and our knowledge of this market, we believe we can add revenues as well as gross profit from these markets. In addition we intend to continue our geographic expansion in Latin America by providing products and services to new carriers and new countries within the region.

Improve Operating Efficiencies.   We constantly monitor our operations to improve our cost structure in order to maintain and increase both profitability and productivity. We continuously evaluate opportunities to operate more efficiently by monitoring returns on invested capital, working to obtain better purchase terms, more effectively utilizing our limited capital resources, implementing workforce management programs, and centralizing back-office operations.

Geographic Expansion.   During 2005, we expanded our operations through enhanced warehouse and operational facilities in Miami, Florida. In addition, we continue our growth in Latin America and may add  appropriate warehouse and operational locations in Latin America to service our customers in the region. These activities are intended to expand our geographic presence, increase our customer base, improve our product portfolio, and add new capabilities and service offerings. We have established subsidiaries in Latin America and acquired a company doing business in Argentina. These additions have the potential to advance, and potentially accelerate, our expansion into those regions.

Expand Manufacturer Relationships.   We emphasize developing new, and improving our existing, wireless equipment manufacturer relationships to broaden our product portfolio. We accomplish this by expanding product lines, brands and technologies within the markets we serve, thereby extending our reach. In particular, we are currently focusing on expanding our product portfolio to include the newest products, which provide data, entertainment, and imaging functionality to wireless handset users. We currently have relationships with several manufacturers and are working to develop distribution relationships with others as well as with new, innovative manufacturers. We believe that by expanding our manufacturing relationships, we can offer the most innovative product lines, brands and technologies within the markets we serve.

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Products and Services

Sources of Revenues.   We generate revenues by distributing and selling wireless handsets and accessories in the United States and Latin America. Included in our distribution revenues are the services and solutions we provide to carriers. These services are an integral part of the sale and are included in the sales price to the carrier. As a part of our distribution activities, when requested by our customers we perform value added services that are included in our product price. These services include but are not limited to programming, locking, software loading, packaging, and quality assurance testing. Since discontinuing our retail kiosk business in October 2004, 100% of our revenues have been from distribution. The financial statements included herein have been adjusted to show the discontinued operations separately.

Customers/Principal Markets/Methods of Distribution.   Our United States customers include rural service carriers, agents, resellers, distributors, independent dealers and retailers. Our current Latin American customers include carriers and resellers. The principal markets for our distribution products and services are our current distribution customer base as well as carriers within the regions we operate. During 2005, we provided products and services to approximately 350 customers. Our four largest customers in fiscal 2005 represented 17%, 15% 13% and 13% of our net sales. All four of these customers are carriers in Latin America and the United States. We sell our products pursuant to customer purchase orders and ship products by common carrier based on customer specified delivery dates.

See Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations—Results of Operations for additional information regarding geographic revenue.

Information Systems

Our information system, which is based upon licensed software, has been, and continues to be, customized specifically by our management to meet the specific needs of our business. The system allows management to access and have total control over information related to all aspects of our business, including customer relationship management, intelligent purchasing, inventory control, inventory flow, back orders, line item margin control for every order, and weighted average cost and statistical data for every product, customer and supplier. Management believes that our information systems have allowed us to provide better service to customers, which we believe leads to increased customer satisfaction and resulting customer retention and future sales.

Vendors

We have established key relationships with many of the leading manufacturers of wireless telecommunications equipment. In 2005, we purchased inventory from more than 25 wireless mobile device and accessory manufacturers and other suppliers. Certain of our suppliers, depending on any number of factors including manufacturer promotion, product introduction, and sales volume, among others, may provide favorable purchasing terms to us, including price protection, cooperative advertising, volume incentive rebates, stock balancing and marketing allowances. Some of these terms are provided for in our contracts, whereas others are offered from time to time when the manufacturer desires to do so. Product manufacturers typically provide limited warranties directly to the end-user.

In 2005, Samsung Electronica Da Amazonia Ltda., Samsung Telecommunications America and Samsung Electronics LatinoAmerica Columbia SA accounted for approximately 49%, 23% and 11%, respectively, of our total cost of sales. We have distribution agreements with each of these three vendors.. Loss of one of our individual contracts with a Samsung affiliate or another of our suppliers, or failure by the manufacturers to supply competitive products on a timely basis, at competitive market prices and on favorable terms, or at all, could have a material adverse effect on our net sales and operating margins and our ability to obtain and deliver products to market on a timely and competitive basis..

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As of March 29, 2006, we have written agreements with seven of our supplier-manufacturers for distribution in the United States and Latin America, including the three Samsung affiliates mentioned in the previous paragraph. These agreements are subject to certain conditions and exceptions, primarily concerning the retention by these suppliers of certain direct accounts, and restrictions of territory regarding our resale of products. In addition, we purchase products from other manufacturers and suppliers pursuant to purchase orders placed from time to time in the ordinary course of business for products to be sold in the United States, Latin America and specific countries or geographic areas outside the Americas. All our agreements with suppliers are non-exclusive, with the exception of one manufacturer in which we have exclusive product distribution rights in the United States, Canada, Latin America and the Caribbean region. Although we do not have written agreements with all of our manufacturers and suppliers, we believe we will have adequate product flows in the future to fulfill our reasonably foreseeable product requirements.

Sales and Marketing

We believe that direct selling and one-on-one relationships, as well as in-depth product and competitive landscape knowledge, are important factors in the marketing of the products that we sell. Accordingly, we promote relationship building and maintenance through personal contact and advertising in industry publications, both print and on-line, and attending the major national and regional carrier shows. We also operate a co-branded on-line store to sell wireless products directly to consumers, providing them the flexibility to place orders at any time of day. Our suppliers and customers use a variety of methods to promote their products and services directly to consumers, including print and media advertising.

As of December 31, 2005, we employed seven experienced sales and marketing professionals who are involved in distribution and who market to existing and potential customers in their respective assigned territories through in person meetings, telephone, and e-mail interaction and notification of special promotions. Potential new customers are located primarily through our database, as well as industry publications and journals. Each sales person is compensated based on handset sales, customer acquisition and retention and profitability.

In 2005, approximately 50% of our total revenues resulted from sales in Argentina; approximately 30% of our total revenues resulted from sales in North America; and approximately 20% of our total revenues resulted from sales in other Latin American countries. In 2004, approximately 88% of our total revenues resulted from sales in North America approximately 12% of our total revenues resulted from sales to Latin America and approximately 0.1% of our total revenues resulted from sales to Europe. In 2003, approximately 93% of our total revenues resulted from sales in North America, approximately 4% of our total revenues resulted from sales to Latin America approximately 2% of our total revenues resulted from sales to Asia-Pacific regions and approximately 1% of our total revenues resulted from sales to Europe. See Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations—Results of Operations for additional information regarding geographic revenue.

As of December 31, 2005, all of our long-lived assets were in the United States.

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Seasonality

Our business historically has experienced increased sales during the third and the fourth quarters of the calendar year due to holiday gift buying. In addition, if unanticipated events occur, including delays in securing adequate inventories of competitive products at times of peak sales or significant decreases in sales during these periods, it could result in a material decrease in our revenues and losses or lower profits. Our operations may be influenced by a number of seasonal factors in the countries and markets in which we operate. Other factors that may also cause our revenue and operating results to fluctuate on a quarterly basis and include, without limitation:

·       promotions and subsidies by mobile operators;

·       timing of the introduction of new products by our suppliers and competitors;

·       purchasing patterns of customers in different markets;

·       general economic conditions; and

·       product availability and pricing.

Competition

The industry and markets where we operate are highly competitive and such competition may increase in the future. Wireless handsets are subject to price competition and price erosion over the lives of the products. We compete on a number of factors including product pricing, level of services offered, market and product knowledge, customer service, product availability and overall value provided to the customers. Our competitors could possess substantially greater financial, marketing, personnel and other resources than we do, which could enable them to withstand substantial price competition, launch new products and implement extensive advertising and promotional campaigns. Historically, the barriers to entry have been relatively low for the distribution of wireless handsets. Our ability to continue to compete successfully will be largely dependent on our ability to anticipate and respond to various competitive and other factors affecting the industry, including new or changing outsourcing requirements; new information technology requirements; new product introductions; inconsistent or inadequate supply of product; changes in consumer preferences; demographic trends; regional and local economic conditions; and discount pricing strategies and promotional activities by competitors.

We compete for sales of wireless telecommunications equipment and accessories, and anticipate that we will continue to compete, with well-established carriers and distributors. Manufacturers, including our own suppliers, also sell their products directly to some large carriers, and as these carriers grow in size, they may pose more of a competitive threat to our business by circumventing our distribution system in favor of doing business directly with manufacturers. Our competitors in the United States and Latin America include wireless equipment manufacturers, carriers and other dedicated wireless distributors such as BrightPoint, Inc., Brightstar Corporation and CellStar Corporation.

See Item 1A Risk Factors—Risks Relating to Our Business—“The wireless telecommunications industry is intensely competitive and we may not be able to continue to compete against well established competitors with greater financial and other resources.”

Employees

As of December 31, 2005, we had 28 employees. Of these employees, five were in executive positions, seven were engaged in sales and marketing (not including six sales contractors), nine were in service operations, and seven were in finance and administration (including information technology employees). From time to time, we utilize temporary employees to perform warehouse functions. Our employees are

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not covered by a collective bargaining agreement. We believe that our relations with our employees are good.

Recent Developments Subsequent to Fiscal Year End

On January 30, 2006, we sold an aggregate 1,100,000 shares of our common stock at $13.10 per share, for total gross proceeds of $14,410,000. The purchasers were also issued warrants to purchase an aggregate of 330,000 shares of our common stock at an exercise price of $18.38 per share during the period beginning six months after the date of the purchase agreement and ending four years later. We also issued three year term warrants to purchase a total of 28,600 shares to the placement agents in the offering. Of the total number of placement agent warrants, warrants to purchase 22,000 shares have an exercise price of $13.76 per share and 6,600 have an exercise price of $19.30 per share. The placement agents also received cash compensation equal to 6% of the gross proceeds raised in the offering plus incidental expenses.

Item 1A.                Risk Factors

Risks Relating to Our Business

Our operating results may vary significantly, which may cause our stock price to fluctuate.

Our operating results are influenced by a number of factors, which may cause our revenue and operating results to fluctuate greatly. These factors include:

·       product availability and pricing;

·       the addition or loss of supplier or customer relationships;

·       the timing of introduction of new products by our suppliers and competitors;

·       purchasing patterns of customers in different markets;

·       general economic conditions; and

·       promotions and subsidies by carriers

We buy a significant amount of our products from a limited number of suppliers, who may not provide us with competitive products at reasonable prices when we need them in the future.

We purchase wireless handsets and accessories principally from wireless communications equipment manufacturers and distributors. We depend on these suppliers to provide us with adequate inventories of currently popular brand name products on a timely basis and on favorable pricing and other terms. In 2005, three vendors accounted for 49%, 23% and 11% respectively of our total cost of sales. We currently have one exclusive and several non-exclusive agreements with our principal suppliers, which can be terminated on short notice and provide for certain territorial restrictions. Our suppliers may not offer us competitive products on favorable terms or with timely delivery. In addition new products from other manufacturers could impact the demand for products from manufacturers we represent. From time to time, we have been unable to obtain sufficient product supplies. Any failure or delay by our suppliers, particularly our three primary vendors, in supplying us with products on favorable terms may severely diminish our ability to obtain and deliver products to our customers on a timely and competitive basis. If we lose any of our principal suppliers, or if these suppliers are unable to fulfill our product needs, or if any principal supplier imposes substantial price increases and alternative sources of supply are not readily available, it would have a material adverse effect on our results of operations.

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Our continuing liabilities on leases from our former mall-based retail kiosk locations could have a negative impact on earnings and cash flow.

Although we have assigned our five remaining retail leases to a third party and we have received indemnification from the third party, we remain liable to the lessor for the respective remaining lease terms of one or two years, if the third party does not fulfill its obligations under the leases. As of December 31, 2005 the total potential liability under these leases was $1,095,405 exclusive of a $95,044 escrow deposit held for our benefit to the extent that the third party should default on any of the assigned leases. This escrow is not reflected on our financial statements. This lease liability is included in the footnotes to our consolidated financial statements.

The loss or reduction in orders from principal customers or a reduction in prices we are able to charge these customers will have a negative impact upon our revenues and could cause our stock price to decline.

Our four largest customers in fiscal 2005 represented 17%, 15%, 13% and 13% of our net sales. All four of these customers are carriers in Latin America and the United States. The markets we serve are subject to severe price competition. Additionally, our customers are not contractually obligated to purchase product from us. For these and other reasons such as competitive pricing and competitive pressures, customers may seek to obtain products or services from us at lower prices than we have been able to obtain from these customers in the past. This could occur, for example, in the case of a customer purchasing large quantities of a product from us, who then terminates this relationship because the customer can obtain a lower price by buying directly from the manufacturer. The loss of any of our principal customers, a reduction in the amount of product or services our principal customers order from us or the inability to maintain current terms, including price, with these or other customers could have an adverse effect on our financial condition, results of operations and liquidity. We have experienced losses of certain customers through industry consolidation and ordinary course of business and there can be no assurance that any of our customers will continue to purchase products or services from us or that their purchases will be at the same or greater levels than in prior periods.

Our future profitability depends on our ability to maintain existing margins and our ability to increase our sales, which we may not be able to do.

The gross margins that we realize on sales of wireless handsets could be reduced due to increased competition or a growing industry emphasis on cost containment. Therefore, our future profitability will depend on our ability to maintain our margins or to increase our sales to help offset potential future declines in margins. We may not be able to maintain existing margins for products or services offered by us or increase our sales. Our ability to generate sales is based upon demand for wireless telecommunications products and our having an adequate supply of these products. Even if our sales rates do increase, the gross margins that we receive from our sales may not be sufficient to make our future operations profitable or as profitable.

Our business depends on the continued tendency of wireless equipment manufacturers and carriers to outsource aspects of their business to us.

Our business depends in large part on wireless equipment manufacturers and carriers outsourcing some of their business functions to us. We provide functions such as product approval and testing, inventory management, product fulfillment, preparation of product kits, and customized packaging, light assembly and end-user support services. Certain wireless equipment manufacturers and carriers have elected, and others may elect, to undertake these services internally. Additionally, our customer service levels, industry consolidation, competition, deregulation, technological changes or other factors could reduce the degree to which members of the wireless telecommunications industry rely on outsourced services such as the services we provide. Any significant change in the market for these services could have

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a material adverse effect on our current and planned business. We may not be able to effectively compete in our industry if consolidation of carriers continues.

The past several years have witnessed a consolidation within the carrier community. If this trend continues, it could result in a reduction or elimination of promotional activities by the remaining carriers as they seek to reduce their expenditures which could, in turn, result in decreased demand for our products or services. Moreover, consolidation of carriers reduces the number of potential contracts available to us. We could also lose business if carriers, which currently are our customers, are acquired by other carriers which are not our customers. Wireless operators may also change their policy regarding sales to their agents by independent distributors, such as requiring those agents to purchase products from the carrier or manufacturer, rather than from distributors such as us. This type of requirement could have a material adverse effect on our business and results of operations.

Our sales and inventory risk may be materially affected by fluctuations in regional demand patterns and economic factors for which we cannot plan.

The demand for our products and services has fluctuated and may continue to vary substantially within the regions served by us. We believe the roll-out of third generation, or 3G, cellular telephone systems and other new technologies, which have been delayed and could further be delayed, have had and will continue to have an effect on overall subscriber growth and handset replacement demand. Economic slow-downs in regions served by us or changes in promotional programs offered by carriers may lower consumer demand for our products and create higher levels of inventories which could decrease our gross and operating margins. We could face a substantial inventory risk due to depreciation and equipment price erosion if our products are not sold in a timely manner.

We may not be able to adequately respond to rapid technological changes in the wireless telecommunications industry, which could cause us to lose customers.

The technology relating to wireless telecommunications equipment changes rapidly resulting in product obsolescence or short product life cycles. We are required to anticipate future technological changes in our industry and to continually identify, obtain and market new products in order to satisfy evolving industry and customer requirements. While our top three vendors have historically kept their products competitive in terms of technological changes, there is no guarantee they will continue to do so, which could materially effect our business. Competitors or manufacturers of wireless equipment may market products which have perceived or actual advantages over products that we handle or which otherwise render those products obsolete or less marketable. We have made and continue to make significant capital investments in accordance with evolving industry and customer requirements including maintaining levels of inventories of currently popular products that we believe are necessary based on current market conditions. This utilization of capital for inventory buildup of this nature increases our risk of loss due to product obsolescence. Furthermore, if we do not adequately anticipate future technological changes, we may not have established adequate relationships with suppliers.

Substantial defaults by our customers on accounts receivables could have a significant negative impact on our cash flow and financial condition.

We currently offer and intend to offer open account terms to certain of our customers, both large and small, which may subject us to credit risks, particularly to the extent that our receivables represent sales to a limited number of customers or are concentrated in particular geographic markets. Although we have an accounts receivable insurance policy, this policy carries a substantial deductible and may not cover us in all instances. We also have an accounts receivable-based credit facility in order to reduce our working capital requirements. The extent of our ability to use our accounts receivable-based credit facility is dependent on the amount of and collection cycle of our accounts receivable. Adverse changes in our ability to use

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accounts receivable financing could have a material adverse effect on our financial position, cash flows and results of operations.

We rely on our suppliers to provide favorable terms, including payment terms, in order for us to make appropriate product purchases, and without such terms, our ability to procure products could be reduced.

Our business is dependent on our ability to obtain adequate supplies of currently popular products on favorable pricing and other terms. Our ability to fund our product purchases is dependent on our principal suppliers providing favorable payment terms that allow us to maximize the efficiency of our capital usage. The payment terms we receive from our suppliers are dependent on several factors, including, but not limited to, our payment history with the supplier, the suppliers’ credit granting policies, contractual provisions, our overall credit rating as determined by various credit rating agencies, industry conditions, our recent operating results, financial position and cash flows and each supplier’s ability to obtain credit insurance on amounts that we owe them. Adverse changes in any of these factors, certain of which may not be wholly in our control, could have a material adverse effect on our operations.

Approximately 70% of our revenues during the fiscal year ended December 31, 2005 were generated outside of the United States in countries that may have volatile currencies or other risks.

We engage in significant sales activities in territories and countries outside of the United States, particularly Latin American countries, including Argentina in 2005. The fact that we distribute products into a number of countries exposes us to increased credit risks, customs duties, import quotas and other trade restrictions, potentially greater and more unpredictable inflationary pressures, and shipping delays. Changes may occur in social, political, regulatory and economic conditions or in laws and policies governing foreign trade and investment in the territories and countries where we currently distribute products. United States laws and regulations relating to investment and trade in foreign countries could also change to our detriment. Any of these factors could have a material adverse effect on our business and operations. Although we purchase and sell products and services in United States dollars and do not engage in exchange swaps, futures or options contracts or other hedging techniques, fluctuations in currency exchange rates could reduce demand for products sold in United States dollars. We cannot predict the effect that future exchange rate fluctuations will have on our operating results. We may in the future engage in currency hedging transactions, which could result in our incurring significant additional losses.

We rely on our information technology system to function efficiently, without interruptions, and if it does not, customer relationships could be harmed.

We have focused on the application of our information technology system to provide customized services to wireless communications equipment manufacturers and carriers. Our ability to meet our customers’ technical and performance requirements is highly dependent on the effective functioning of our information technology systems, which may experience interruptions, including aspects provided by third-party providers. These business interruptions could cause us to fall below acceptable performance levels pursuant to our customers’ requirements and could result in the loss of the related business relationship. Some of our information technology systems are managed and operated by third party providers. All information technology systems, both internal and external, are potentially vulnerable to damage or interruption from a variety of sources, including, without limitation, computer viruses, security breaches, energy blackouts, natural disasters, terrorism, war and telecommunication failures and third-party provider failures. We have implemented various measures to manage our risks related to system and network disruptions, but a systems failure or security breach could negatively impact our operations and financial results.

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We have outstanding indebtedness, which is secured by substantially all our assets and which could prevent us from borrowing additional funds, if needed.

We had outstanding debt in the amount of approximately $10.0 million and $2.6 million at December 31, 2005 and December 31, 2004, respectively, in the form of a bank line of credit of up to $25 million at December 31, 2005, the borrowing base of which is based on a percentage of eligible accounts receivable. If we violate our loan covenants, default on our obligations or become subject to a change of control, our indebtedness would become immediately due and payable. Any significant decrease in our level of eligible accounts receivable will reduce our ability to borrow additional funds to adequately finance our operations and expansion strategies. The terms of our credit facility could substantially prohibit us from incurring additional indebtedness, which could limit our ability to expand our operations. We are also subject to negative covenants that, among other things, limit our ability to sell certain assets and make certain payments, including but not limited to, dividends, repurchases of common stock and other payments outside the normal course of business, as well as prohibiting us from merging or consolidating with another corporation or selling all or substantially all of our assets.

We depend on third parties to manufacture products that we distribute and, accordingly, rely on their quality control procedures.

Product manufacturers typically provide limited warranties directly to the end consumer or to us, which we generally pass through to our customers. If a product we distribute for a manufacturer has quality or performance problems, our ability to provide adequate products to our customers could be disrupted and our reputation could be negatively affected, thereby adversely impacting our business.

The wireless telecommunications industry is intensely competitive and we may not be able to continue to compete against well established competitors with greater financial and other resources.

We compete for sales of wireless telecommunications equipment and accessories, and expect that we will continue to compete, with numerous well-established carriers, distributors and manufacturers, including our own suppliers. Many of our competitors possess greater financial and other resources than we do and may market similar products or services directly to our customers. Distribution of wireless telecommunications equipment and accessories has generally had low barriers to entry. As a result, additional competitors may choose to enter our industry in the future. The markets for wireless handsets and accessories are characterized by intense price competition and significant price erosion over the life of a product. Many of our competitors have the financial resources to withstand substantial price competition and to implement extensive advertising and promotional programs, both generally and in response to efforts by additional competitors to enter into new markets or introduce new products. Our ability to continue to compete successfully will depend largely on our ability to maintain our current industry relationships, both manufacturers and carrier customers. We may not be successful in anticipating and responding to competitive factors affecting our industry, including new or changing outsourcing requirements, the entry of additional well-capitalized competitors, new products which may be introduced, changes in consumer preferences, demographic trends, international, national, regional and local economic conditions and competitors’ discount pricing and promotion strategies. As wireless telecommunications markets mature and as we seek to enter into new markets in the Latin American region and offer new products in the future, the competition that we face may change and grow more intense.

Our continued growth depends on retaining our current key employees and attracting additional qualified personnel, and we may not be able to continue to do so.

Our success depends in large part on the abilities and continued service of our executive officers and other key employees, particularly Joseph Ram, our Chief Executive Officer. Although we have entered

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into employment agreements with several of our officers and employees, including Mr. Ram, we may not be able to retain their services under applicable law. The loss of executive officers or other key personnel could have a material adverse effect on us. In addition, in order to support our continued growth, we will be required to effectively recruit, develop and retain additional qualified management. If we are unable to attract and retain additional necessary personnel, it could delay or hinder our plans for growth.

We rely on trade secret laws and agreements with our key employees and other third parties to protect our proprietary rights, and there is no assurance that these laws or agreements adequately protect our rights.

We rely on trade secret laws to protect our proprietary knowledge, particularly our database of customers and suppliers and business terms such as pricing. In general, we also have non-disclosure agreements with our key employees and limit access to and distribution of our trade secrets and other proprietary information. These measures may prove difficult to enforce and may not prove adequate to prevent misappropriation of our proprietary information.

We may become subject to suits alleging medical risks associated with our wireless handsets, and the cost of these suits could be substantial, and divert funds from our business.

Lawsuits or claims have been filed or made against manufacturers of wireless handsets over the past years alleging possible medical risks, including brain cancer, associated with the electromagnetic fields emitted by wireless communications handsets. There has been only limited relevant research in this area, and this research has not been conclusive as to what effects, if any, exposure to electromagnetic fields emitted by wireless handsets has on human cells. Substantially all of our revenues are derived, either directly or indirectly, from sales of wireless handsets. We may become subject to lawsuits filed by plaintiffs alleging various health risks from our products. If any future studies find possible health risks associated with the use of wireless handsets or if any damages claim against us is successful, it could have a material adverse effect on our business. Even an unsubstantiated perception that health risks exist could adversely affect our ability or the ability of our customers to market wireless handsets.

Risks Related To Our Common Stock

Stockholders may be diluted as a result of future offerings or other financings.

We may need to raise additional capital through one or more future public offerings, private placements or other financings involving our securities. As a result of these financings, ownership interests in our company may be greatly diluted. See our discussion of our recent sale of common stock and warrants described in Item 1—Company Business—Recent Developments Subsequent to Fiscal Year End in this Form 10-K.

Our common stock, and our stock price could be volatile and could decline, resulting in a substantial loss on your investment.

Prior to our initial public offering in June 2004, there was not a public market for our common stock. An active trading market for our common stock may not be sustained, which could affect the ability of our stockholders to sell their shares and could depress the market price of their shares. The stock market in general and the market for telecommunications-related stocks in particular, has been highly volatile. As a result, the market price of our common stock is likely to be volatile, and investors in our common stock may experience a decrease in the value of their stock, including decreases unrelated to our operating performance or prospects. The price of our common stock could be subject to wide fluctuations in response to a number of factors, including those listed in this “Risk Factors” section. In the past, securities class action litigation has often been instituted against companies following periods of volatility in their stock price. This type of litigation against us could result in substantial costs and divert our management’s attention and resources.

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Shares of common stock that are issuable pursuant to our stock option plans and our outstanding warrants, when issued, could result in dilution to existing stockholders and could cause the market price of our common stock to fall.

We have reserved shares of common stock that may be issuable pursuant to our stock option plans and to our outstanding options and warrants outside those plans. These securities, when issued and outstanding, may reduce earnings per share under accounting principles generally accepted in the United States of America and, to the extent that they are exercised and shares of common stock are issued, dilute percentage ownership to existing stockholders which could have an adverse effect on the market price of our common stock.

The ability of our stockholders to control our policies or effect a change in control of our company is limited, which may not be in our stockholders’ best interests.

Some provisions of our charter and bylaws and the General Corporation Law of Maryland, where we are incorporated, may delay or prevent a change in control of our company or other transactions that could provide our common stockholders with a premium over the then-prevailing market price of our common stock or that might otherwise be in the best interests of our stockholders. These include the ability of our Board of Directors to authorize the issuance of preferred stock without stockholder approval, which preferred stock may have voting provisions that could delay or prevent a change in control or other transaction that might involve a premium price or otherwise be in the best interests of our stockholders. Maryland law imposes restrictions on some business combinations and requires compliance with statutory procedures before some mergers and acquisitions can occur. These provisions of Maryland law may have the effect of discouraging offers to acquire us even if the acquisition would be advantageous to our stockholders.

Our largest stockholder may have strategic interests that differ from those of our other stockholders, and he may be able to significantly influence important corporate matters.

As of March 29, 2006, Joseph Ram, our Chief Executive Officer beneficially owned approximately 37.6% of our outstanding common stock. As a result, Mr. Ram may be able to significantly influence corporate actions relating to:

·       control the composition of our board of directors;

·       control our management and policies;

·       determine the outcome of significant corporate transactions, including changes in control that may be beneficial to stockholders; and

·       act in their mutual interests, which may conflict with, or be different from, the interests of other stockholders.

Available Information

Our website at www.infosonics.com provides a link to the Securities and Exchange Commission’s website where our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K (including exhibits and supplementary schedules) and amendments to those reports, filed with or furnished to the SEC under Section 13(a) or 15(d) of the Securities Exchange Act of 1934, can be accessed free of charge. Further, copies of these reports are located at the SEC’s Public Reference Room at 100 F Street, NE, Washington, D.C. 20549. Information on the operation of the Public Reference Room can be obtained by calling the SEC at 1-800-SEC-0330. The SEC maintains a website that contains reports, proxy and information statements, and other information regarding our filings, at www.sec.gov.

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Item 1B.               Unresolved Staff Comments—N/A

Item 2.                        Properties.

We provide our distribution services from our sales and operations centers located in San Diego, California and Miami, Florida. These facilities are occupied pursuant to operating leases. The table below summarizes information about our sales and operations centers as of December 31, 2005:

*                    Does not include reduction of square footage or monthly rent for subleased space. We currently sublease approximately 20,000 square feet of space in the San Diego, CA facility to two subtenants for which we receive approximately $33,000 per month in rent.

We believe that these facilities are adequate for our current requirements and that suitable alternative or additional space will be available as needed for alternative space or to accommodate future expansion of our operations.

Item 3.                        Legal Proceedings.

In the normal course of our business, we may be a party to legal proceedings. We are not currently a party to any material legal proceedings other than ordinary routine litigation incidental to our business.

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

None.

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PART II

Item 5.                        Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.

Our common stock is traded on the American Stock Exchange under the symbol “IFO”. The following tables set forth, for the periods indicated, the closing prices for our common stock as reported by the American Stock Exchange. Our common stock commenced trading June 17, 2004.

 

 

As of March 28, 2006 the closing price of our common stock on the American Stock Exchange was $10.00, and there were approximately 33 shareholders of record.

We have not paid any dividends and do not expect to pay any dividends in the foreseeable future. We are also prohibited from paying dividends pursuant to our line of credit agreement with Wells Fargo. We expect to utilize future earnings to finance future growth.

Recent Sales of Unregistered Securities

During the past three fiscal years, we sold the following unregistered securities:

During 2005, we granted options to purchase 636,500 shares of common stock to employees, directors and consultants under our 2003 Stock Option Plan, with exercise prices ranging from $3.29 to $16.24 per share for an aggregate purchase price of $4,988,305 upon exercise of such options.

During 2004, we granted options to purchase 338,500 shares of common stock to employees, directors and consultants under our 2003 Stock Option Plan, with exercise prices ranging from $6.00 to $7.20 per share for an aggregate purchase price of $2,181,000 upon exercise of such options.

During 2003, we granted options to purchase 353,000 shares of common stock to employees, directors and consultants under our 2003 Stock Option Plan, with exercise prices ranging from $4.50 to $6.00 per share for an aggregate purchase price of $1,776,000 upon exercise of such options.

The foregoing options were issued under the exemptive provisions of the Securities Act of 1933, as amended, provided by Rule 701 under the Act, Rule 506 of Regulation D under the Act and Section 4(2) of the Act.

On January 30, 2006 we sold 1,100,000 shares of common stock at a purchase price of $13.10 for total gross proceeds $14,410,000. The investors who purchased shares also received warrants to purchase an aggregate of 330,000 shares of common stock at an exercise price of $18.38 per share during the period beginning six months after the date of the purchase agreement and ending four years following the date of such agreement.

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We also issued warrants to purchase a total of 28,600 shares to the placement agents in the offering. Of the total number of such warrants, 22,000 shares have an exercise price of $13.76 per share and 6,600 have an exercise price of $19.30 per share. These warrants have three year terms.

The shares and warrants were issued under the exemptive provisions of the Securities Act of 1933, as amended, provided by Rule 506 of Regulation D under the Act and Section 4(2) of the Act.

The information required to be disclosed by Item 201(d) of Regulation S-K “Securities Authorized for Issuance Under Equity Compensation Plans” is included under Item 12 of this Form 10-K.

Item 6.                        Selected Financial Data.

The summary consolidated historical financial data set forth below should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” our consolidated financial statements and the related notes, and the other information included in this annual report. The summary financial data for each of the five years in the period ended December 31, 2005 is derived from our consolidated financial statements, which have been audited by Singer Lewak Greenbaum & Goldstein LLP, independent registered public accountants, for the years ended December 31, 2001, 2002, 2003, 2004 and 2005. The summary financial data provided below is not necessarily indicative of our future results of operations or financial performance.

 

 

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

This discussion and analysis should be read in conjunction with the “Selected Financial Data” and our accompanying Consolidated Financial Statements and related notes, as well as the “Risk Factors” and other information contained in this annual report. Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of any contingent liabilities at the financial statement date and reported amounts of revenue and expenses during the reporting period. On an on-going basis we review our estimates and assumptions. Our estimates were based on our historical 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. 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,” and have not changed significantly since our annual report for fiscal 2004. All references to results of operations in this discussion are references to results of continuing operations, unless otherwise noted.

Forward Looking Statements

Certain statements in this document constitute “forward-looking statements.” These forward-looking statements involve known or unknown risks, uncertainties and other factors that may be outside our control and that may cause the actual results, performance, or achievements of InfoSonics to be materially different from any future results, performance or achievements expressed or implied by the forward-looking statements. Specifically, the actions of competitors, suppliers and customers are generally outside of our control; and our ability to execute our business plans and to increase revenues and operating income is each dependent upon our ability to continue to expand our current businesses and to enter new business areas, as well as upon general economic conditions, and other factors. You can identify forward-looking statements by terminology such as “may,” “will,” “should,” “expects,” “intends,” “plans,” “anticipates,” “believes,” “estimates,” “predicts,” “potential,” “continues” or the negative of these terms, or other comparable terminology. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements.

Overview

We are one of the fastest growing distributors of wireless handsets and accessories in the United States and Latin America. We provide end-to-end handset and wireless terminal solutions for carriers in both the United States and Latin America. We distribute products of several key manufacturers, including i-mate, Motorola, Nokia, Novatel, Samsung, VK Mobile, and others. As an integral part of our customers’ supply chain, we perform value added services and solutions, including product approval and certification, light assembly, warehousing, logistics services (packing, shipping and delivery), marketing campaigns, warranty services and end-user support. We provide these services are provided for wireless telecommunications manufacturers in order to facilitate sales to carriers, agents, resellers, distributors, independent dealers and retailers in the United States and Latin America. During 2005, we significantly changed our business model from selling products to dealers and agents in the United States and Latin America to providing products, services and solutions primarily to carriers in such regions. As a result, we believe that this shift in customer focus enables us to better service our customers and vendors as we play a more important role in the supply chain for wireless handsets.

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Areas of Management Focus and Performance Indicators

We focus on the needs of our customers, developing and maintaining close relationships with manufacturers, expanding in and entering into new markets, and sourcing new and innovative products, while maintaining close attention to operational efficiencies and costs. We intend to increase shipping volumes and improve efficiencies to enable higher levels of profitability and earnings growth.

Performance indicators that are key for the monitoring and management of our business include operating and net income, cost of sales and gross profit percentage, operating expenses as a percent of revenues, and overall net sales growth. We make extensive use of our customized information system to closely monitor all aspects of our business, including customer relationship management, intelligent purchasing, inventory control, and inventory flow, line item margin control for every order, and weighted average cost and statistical data for every product, customer and supplier. We believe a strong focus on providing better service to customers leads to increased customer satisfaction and retention and potential increases in sales.

Management spends a significant amount of time traveling with the purpose of spending time with key customers, suppliers 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.

Industry Trends, Challenges, Risks and Growth Opportunities

According to a February 2006 report by JP Morgan Chase & Co, in 2005, overall worldwide wireless handset sales increased by approximately 24%, and are forecasted to increase 15% in 2006. A rapid decline in wireless handset sales growth could negatively impact our net sales. Excess supply conditions can reduce the market prices of the products we sell and therefore affect our ability to generate net sales and gross profit at historical levels and could affect the value of our inventory. Conversely, should manufacturers be unable to respond to an unanticipated increase in demand on a timely basis, we, along with others in our industry, could experience supply constraints that would affect our ability to deliver products. We are unable to quantify these effects, as it is difficult to predict future supply conditions and demand patterns which affect our ability to meet customer demand or sell handsets at an acceptable gross profit. See Item 1—Description of Business—“Market Trends and Factors” and Item 1A—“Risk Factors”.

Company Specific Trends, Challenges Risks and Growth Opportunities

In 2005, our net sales increased by 99%, and handset units sold increased by 136%. Although we have incorporated growth into our strategy, there can be no assurances that these trends will continue. Similarly, although we have experienced high levels of growth in operating income from continuing operations (180% increase over the prior year), we cannot anticipate future growth to be at the same levels. Our strategy incorporates overall growth elements for each aspect of our business, which we hope will result in continued earnings growth; however there can be no assurance that this trend will continue.

 

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Results of Operations:

Year Ended December 31, 2005 Compared With Year Ended December 31, 2004

For the year ended December 31, 2005, we had income from continuing operations of $2.3 million, or $.38 per diluted share, on net sales of $145.8 million. This is an increase of 152% when compared to the prior year of $929,000, or $.19 per diluted share, on net sales of $73.4 million. The 99% increase in revenues is primarily attributable to a 136% increase in handset volume offsetting a 15% decrease in average selling price per unit. The geographic mix of revenues shifted significantly in 2005 as sales in Latin America increased 226% and we added Argentina as a separate new region. Combined, these two regions represented 69% of net sales as compared to 12% in 2004. Sales in the United States made up the remainder of our sales in 2005, declining 30% to $45.6 million, or 31% of net sales. The decrease in our U.S. sales resulted from our shift in focus from selling products to dealers and agents in the United States to providing products, services and solutions primarily to carrier customers. The increase in sales to Argentina is the result of our purchase of Primasel S.A., later renamed InfoSonics S.A., see Note 1 to our consolidated financial statements for additional information. In addition, our interest expense increased for fiscal 2005 to $399,000 from $96,000 in the prior year which negatively impacted our diluted earnings per share. The increase in interest expense primarily resulted from our net sales growth and the capital necessary to fund such growth.

 

Revenues by geographic region

 

For the year ended December 31, 2005 we had income from discontinued operations of $369,000, or $.06 per diluted share, as compared with a loss of $890,000, or $.18 per diluted share, for the year ended December 31, 2004. The $369,000 of income from discontinued operations affected our net income, with net income for the December 31, 2005 fiscal year being $2.7 million, or $.44 per share, compared with net income of $38,000, or $.01 per diluted share, for the year ended December 31, 2004. This income is the result of our resolution of outstanding accounts with a former supplier for the discontinued operations. This former supplier is not involved with our continuing operations.

Cost of Sales, Gross Profit and Gross Margin

For the year ended December 31, 2005, cost of sales was $133.7 million, or 91.7% of sales, compared with $67.9 million, or 92.4% of sales, for the year ended December 31, 2004. The increase in our cost of

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sales is a direct result of the increased handset volume we purchased and sold during the year ended December 31, 2005.

For the year ended December 31, 2005, our gross profit increased to $12.1 million from $5.5 million an increase of 118%, as compared with the prior year. The increase in gross profit was primarily the result of increased sales levels as well as an increase in gross margin to 8.3% during 2005 from 7.6% in 2004.

 

Operating Expenses and Operating Income Before Interest and Income Tax Provision

For the year ended December 31, 2005, operating expenses were $8.4 million, an increase of 99%, as compared with the prior year. As a percentage of net sales, operating expenses remained at 5.7% for both 2005 and 2004. The increase in operating expense dollars is a primary result of costs associated with being a public company, including legal and accounting fees for the full year 2005 compared to six months during 2004. In addition we also increased sales personnel and the necessary back office support staff, as well as physical space. The consistency in operating expenses as a percentage of revenues is a primary result of increased revenues together with management’s efforts to utilize efficiencies, as we have structured our operating expenses to fluctuate with the varying levels of sales volume on a quarterly basis.

For the year ended December 31, 2005, our operating income before interest and tax provision from continuing operations was $3.7 million, as compared with $1.3 million for the year ended December 31, 2004. As a percentage of net sales, operating income before interest and tax provision from continuing operations was 2.6% for the year ended December 31, 2005 as compared to 1.8% for the year ended December 31, 2004. The increase in operating income before interest and tax provision from continuing operations as a percentage of net sales for the year ended December 31, 2005 was a result of the factors discussed above, specifically the increase in gross margin. The dollar increase in income from continuing operations is due to increased sales, increased gross profit dollars, and no change in operating cost per dollar of revenue.

Operating Expenses

 

Operating Income before interest and income tax provision

 

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Year Ended December 31, 2004 Compared With Year Ended December 31, 2003

For the year ended December 31, 2004, we had income from continuing operations of $929,000, or $.19 per diluted share, on net sales of $73.4 million. This is an increase of 61% when compared to the prior year of $577,000, or $.15 per diluted share, on net sales of $60.9 million. The 21% increase in revenues is primarily attributable to a 10% increase in handset volume and a 10% increase in average selling price per unit.

 

Revenues by geographic region

 

For the year ended December 31, 2004 we incurred a loss from discontinued operations of $890,000, or $.18 per diluted share, as compared with income of $562,000, or $.14 per diluted share, for the year ended December 31, 2003. The $890,000 loss from discontinued operations affected our net income significantly, with net income for the December 31, 2004 fiscal year being $38,000, or $.01 per diluted share, compared with net income of $1,139,000, or $.29 per diluted share, for the year ended December 31, 2003.

For the year ended December 31, 2004, cost of sales was $67.9 million, or 92.4% of sales, compared with $56.1 million, or 92.1% of sales, for the year ended December 31, 2003. For the year ended December 31, 2004, our gross profit increased to $5,543,000 from $4,801,000, an increase of 15%, as compared with the prior year. The increase in gross profit is primarily the result of increased sales levels.

Cost of Sales, Gross Profit and Gross Margin

 

For the year ended December 31, 2004, operating expenses were $4.2 million, an increase of 18%, as compared with the prior year. As a percentage of net sales, operating expenses decreased to 5.7% from 5.9% for the prior year. The increase in operating expense dollars is a direct result of increased sales

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personnel and the necessary back office support staff, as well as additional costs associated with being a publicly traded company, including legal and accounting fees, for the second half of 2004. The decrease in operating expenses as a percentage of revenues is a direct result of increased revenues together with management’s efforts to utilize efficiencies in an attempt to increase shareholder value.

Operating Expenses

 

For the year ended December 31, 2004, our operating income before interest and tax provision from continuing operations was $1,333,000, as compared with $1,238,000 for the year ended December 31, 2003. As a percentage of net sales, operating income before interest and tax provision from continuing operations was 1.8% for the year ended December 31, 2004 as compared to 2.0% for the year ended December 31, 2003. The slight decrease in operating income before interest and tax provision from continuing operations as a percentage of net sales for the year ended December 31, 2004 was a result of the factors discussed above, specifically the decrease in gross margin. The dollar increase in income from continuing operations is due to increased sales, increased gross profit dollars, and lower operating cost per dollar of revenue.

Operating Income before interest and income tax provision

 

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Financial Condition, Liquidity and Capital Resources

Cash

At December 31, 2005, we had $7,712,915 in cash and at December 31, 2004, we had $5,183,876 in cash. In January 2006, we raised $14.4 million gross proceeds from sales of our common stock. We believe our cash balance is adequate for the next twelve months.

Credit Facility

We previously had a line of credit with Comerica Bank that was replaced on October 6, 2005 by our current line of credit. We have a fully collateralized line of credit with Wells Fargo HSBC Trade Bank N.A. that allows us to borrow up to a maximum of $25 million with a maturity date of October 1, 2006. Although we cannot assure that this line of credit will be extended or renewed, we believe that we can obtain an extension or renewal on reasonable terms. Our advances cannot exceed 80% of eligible domestic accounts receivable and 85% of eligible foreign insured accounts.

Outstanding balance under the line of credit bears interest on a monthly basis at either Wells Fargo’s prime rate (7.75% at March 28, 2006) or at the London Inter-Bank Offering Rate (“LIBOR”) plus 1.5% (LIBOR was 4.875% at March 28, 2006), the interest rate is either floating at Wells Fargo prime rate or is at LIBOR plus 1.5% for a fixed amount drawn down. Our outstanding balance at March 28, 2006 was approximately $9.7 million.  In addition to reporting and other non-financial covenants, the line of credit contains certain financial covenants which, among other items, require us to maintain a tangible net worth of not less than $12 million a quick ratio of not less than 1-to-1, a debt-to-tangible net worth ratio of not greater than 2-to-1, a pre-tax profit of not less than $1 on a rolling four-quarter basis, and net income after taxes of not less than $1 on an annual basis. We believe that we complied with these covenants at March 28, 2006.

Our bank line of credit is based upon eligible accounts receivable.  For the years ended December 31, 2005, 2004 and 2003 amounts advanced against our then existing line of credit were approximately $10.0, $2.6, and $5.2, million, respectively. Our credit lines have been important parts of growing our business, and market changes affecting accounts receivable could diminish the borrowing base of available funds. For the years ended December 31, 2005, 2004 and 2003, advances were 71%, 47% and 77%, respectively, of the available borrowing base. This current credit facility expires October 2006.

Year ended December 31, 2005

In the year ended December 31, 2005, cash from our lines of credit provided the capital needed to support our growth. We borrowed $93.9 million during the year ended December 31, 2005 and repaid $86.5 million during the same period. Cash used in continuing operations was $6.1 million for the year ended December 31, 2005, compared with $1.4 million used for the year ended December 31, 2004. The increase in the use of cash from operations was primarily due to the increase in cash used for our increased levels of accounts receivable ($12.5 million) which was partially offset by the increase in our accounts payable and accrued expenses ($5.9 million). In addition, there was an increase in our inventory and prepaid inventory ($2.7 million) which also contributed to the increase in cash used by continuing operations.

Our discontinued operations used cash of $163,000 for the year ended December 31, 2005, as compared with cash provided of $192,000 for the year ended December 31, 2004. The combined effect of continued and discontinued operations resulted in an increase of cash used in operations to $6.3 million from $1.2 million in the prior year.

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Net cash used for investing activities was $285,000 for the year ended December 31, 2005 as compared with $231,000 for the year ended December 31, 2004.  The cash used for investing activities related to our increased warehouse and operational facilities expansion in Florida, completed during the year.

Net cash provided by financing activities was $9.1 million for the year ended December 31, 2005 as compared with $6.6 million for the year ended December 31, 2004. The difference is related to the $1.6 million of proceeds received from the exercise of previously issued stock options and warrants. In addition we increased the amount drawn down on our revolving line of credit to $10.0 million at December 31, 2005 as compared with $2.6 million at December 31, 2004. The increased borrowing was necessary to finance our growth and resulted in an increase of our interest expense to $399,000 for the year ended December 31, 2005 from $96,000 for the year ended December 31, 2004.

Year ended December 31, 2004 and 2003

In the year ended December 31, 2004, net proceeds of $10 million from our initial public offering provided working capital for our growth and enabled profitability from continuing operations. Cash from our line of credit and from operations had previously provided working capital for our growth. Cash provided under this line of credit was $3,236,000 for the year ended December 31, 2003. For the year ended December 31, 2004, cash used in operating activities was $1.4 million, and for the year ended December 31, 2003, cash used in operating activities was $4.5 million. The decrease in the use of cash in operations for the year ended December 31, 2004 is primarily due to the increase in cash provided from accounts receivable of $1.2 million, compared with cash used of $6.4 million during 2003. In addition, inventory increased by $1.1 million from December 31, 2003 to December 31, 2004, as a result of increased sales. Inventory reserves decreased from 4.6% of inventory on hand at December 31, 2003 to 3.0% of inventory on hand at December 31, 2004. This decrease was a result of our continued efforts to better manage our inventory and monitor any items which could have costs reduced to create selling opportunities.

Operating cash flows were also driven by our accounts payable which increased $364,000 at December 31, 2004 from the prior year. The amount outstanding on our line of credit decreased $2.7 million at December 31, 2004 as compared to the prior year. The decrease in our line of credit was a direct result of the net proceeds received from our public offering, in addition our accounts payable increases were related directly to our purchases from suppliers. Days sales outstanding at December 31, 2004 was 40 days as compared to 35 days for the year ended December 31, 2003. Days sales outstanding is a measure of the average amount of time between our invoicing of our customers and our receipt of payment for the customers.

Our discontinued operations used cash of $653,000 for the year ended December 2003. The combined effect of continued and discontinued operations resulted in cash used by operations of $5.1 million.

Net cash used in investing activities for the year ended December 31, 2004 was $231,000, and net cash used in investing activities for the year ended December 31, 2003 was $13,000.

Critical Accounting Policies

We believe the following critical accounting policies are important to the presentation of our financial condition and results, and require management’s judgments to make estimates about the effects of matters that are inherently uncertain.

Revenue Recognition and Accrued Chargebacks

Revenues are recognized (1) upon shipment of the products to customers, (2) when collection of the outstanding receivables are probable; and (3) when the final price of the product has been determined. The carrier has nine months from date of activation to charge back amounts previously credited to us if the

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customer terminates its service. We provide an allowance for estimated returns based on our experience, which estimate is recorded as a contra asset against accounts receivable. A provision for returns is provided in the same period in which the related commission revenue is recorded. Customer credit-worthiness and economic conditions may change and increase the risk of collectibility and contract terminations and may require additional provisions, which would negatively impact our operating results.

Allowance for Doubtful Accounts and Sales Return Reserve

Credit evaluations are undertaken for all major sale transactions before shipment is authorized. Normal payment terms require payment on a net 30 or 60 day basis depending on customer. On an ongoing basis, we analyze the payment history of customer accounts, including recent customer purchases. We evaluate aged items in the accounts receivable aging and provide reserves for doubtful accounts and estimated sales returns. Customer credit worthiness and economic conditions may change and increase the risk of collectibility and sales returns, and may require additional provisions, which would negatively impact our operating results.

Inventory Write-Off and Effect on Gross Margin

We regularly monitor inventory quantities on hand and record a provision for excess and obsolete inventories based primarily on historical usage rates and our estimated forecast of product demand for a period of time, generally nine months. Because of obsolescence, we will generally provide a full reserve for the costs of our inventories in excess of our relevant forecast for the applicable period. We attempt to control our inventory levels so that we do not hold inventories in excess of demand for the succeeding nine months. However, because we need to place non-cancelable orders with significant lead time and because it is difficult to estimate product demand, it is possible that we will build inventories in excess of demand for the future periods. If we have inventories in excess of estimated product demand, we will provide a reserve, which could have a material adverse effect on our reported results of operations and financial position.

Contractual Obligations

We lease corporate and administrative office facilities, and equipment under non-cancelable operating leases. Certain of these leases contain renewal options. Rent expense under these leases was approximately $300,000 (net of sublease income), $348,000 and $186,000 for fiscal years 2005, 2004 and 2003, respectively.

The following is a schedule of future minimum rental payments required by the above leases. In addition, our future minimum lease requirements include obligations for the retail lease locations we have assigned to a third party, because we remain financially liable should the assignee default on the assigned leases. There are approximately two months of lease payments in escrow that are held by a third party in the event of assignee default. We believe these lease locations are very desirable and anticipate that, if necessary, we would be able to find a suitable tenant for these locations within two months after any default by the assignee.

 

*                    includes buildings, equipment and retail kiosks from discontinued operations

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Recently Issued Accounting Pronouncements

In December 2004, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) 123(R), Share based Payment, which is a revision of SFAS 123, Accounting for Stock-Based Compensation, and supersedes Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees. This statement requires the measurement of the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award. The cost will be recognized over the period during which an employee is required to provide service in exchange for the award. On April 15, 2005, the Securities and Exchange Commission delayed the effective date of SFAS 123(R) to fiscal years beginning on or after June 15, 2005. As a result, the Company adopted SFAS 123(R) on January 1, 2006 and will begin recognizing compensation cost as expense during the first quarter of 2006 for the portion of outstanding unvested awards, based on the grant-date fair value of those awards calculated using Black-Scholes option pricing model, which is the same option pricing model used to estimate grant-date fair value for SFAS 123 for pro forma disclosures. Based on unvested stock options currently outstanding, the effect of adopting SFAS 123(R) will reduce the Company’s net income by approximately $344,000 in future periods, of which approximately $217,000 will be recognized in 2006. The Company’s net income will also be reduced by future grants of equity awards based on the fair value of those awards at the date of grant.

In November 2004, the FASB issued SFAS No. 151, “Inventory Costs”. SFAS No. 151 amends the accounting for abnormal amounts of idle facility expense, freight, handling costs, and wasted material (spoilage) under the guidance in ARB No. 43, Chapter 4, “Inventory Pricing”. Paragraph 5 of ARB No. 43, Chapter 4, previously stated that “. . . under some circumstances, items such as idle facility expense, excessive spoilage, double freight, and re-handling costs may be so abnormal as to require treatment as current period charges. . . .” This Statement requires that those items be recognized as current-period charges regardless of whether they meet the criterion of “so abnormal.” In addition, this Statement requires that allocation of fixed production overheads to the costs of conversion be based on the normal capacity of the production facilities. This statement is effective for inventory costs incurred during fiscal years beginning after June 15, 2005. Management does not expect adoption of SFAS No. 151 to have a material impact on the Company’s financial statements.

In December 2004, the FASB issued SFAS No. 152, “Accounting for Real Estate Time-Sharing Transactions”. The FASB issued this Statement as a result of the guidance provided in AICPA Statement of Position (SOP) 04-2, “Accounting for Real Estate Time-Sharing Transactions”. SOP 04-2 applies to all real estate time-sharing transactions. Among other items, the SOP provides guidance on the recording of credit losses and the treatment of selling costs, but does not change the revenue recognition guidance in SFAS No. 66, “Accounting for Sales of Real Estate”, for real estate time-sharing transactions. SFAS No. 152 amends Statement No. 66 to reference the guidance provided in SOP 04-2. SFAS No. 152 also amends SFAS No. 67, “Accounting for Costs and Initial Rental Operations of Real Estate Projects”, to state that SOP 04-2 provides the relevant guidance on accounting for incidental operations and costs related to the sale of real estate time-sharing transactions. SFAS No. 152 is effective for years beginning after June 15, 2005, with restatements of previously issued financial statements prohibited. This statement is not applicable to the Company.

In December 2004, the FASB issued SFAS No. 153, “Exchanges of Nonmonetary Assets,” an amendment to Opinion No. 29, “Accounting for Nonmonetary Transactions”. Statement No. 153 eliminates certain differences in the guidance in Opinion No. 29 as compared to the guidance contained in standards issued by the International Accounting Standards Board. The amendment to Opinion No. 29 eliminates the fair value exception for nonmonetary exchanges of similar productive assets and replaces it with a general exception for exchanges of nonmonetary assets that do not have commercial substance. Such an exchange has commercial substance if the future cash flows of the entity are expected to change significantly as a result of the exchange. SFAS No. 153 is effective for nonmonetary asset exchanges

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occurring in periods beginning after June 15, 2005. Earlier application is permitted for nonmonetary asset exchanges occurring in periods beginning after December 16, 2004. Management does not expect adoption of SFAS No. 153 to have a material impact on the Company’s financial statements.

In May 2005, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 154, “Accounting Changes and Error Corrections. SFAS No. 154 replaces Accounting Principles Board (“APB”) Opinion No. 20, “Accounting Changes” and SFAS No. 3, “Reporting Accounting Changes in Interim Financial Statements”, and changes the requirements for the accounting for and reporting of a change in accounting principle. This Statement applies to all voluntary changes in accounting principle. It also applies to changes required by an accounting pronouncement in the unusual instance that the pronouncement does not include specific transition provisions. When a pronouncement includes specific transition provision, those provisions should be followed.

In February 2006 the Financial Accounting Standards Board issued Statement of Financial Accounting Standards (SFAS) 155 “Accounting for Certain Hybrid Financial Instruments”. SFAS 155 amends SFAS 133 to narrow the scope exception for interest-only and principal-only strips on debt instruments to include only such strips representing rights to receive a specified portion of the contractual interest or principal cash flows. SFAS 155 also amends SFAS 140 to allow qualifying special-purpose entities to hold a passive derivative financial instrument pertaining to beneficial interests that itself is a derivative financial instrument. Generally, FASB Statement of Financial Accounting Standards SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities”, requires that a derivative embedded in a host contract that does not meet the definition of a derivative be accounted for separately (referred to as bifurcation) under certain conditions. That general rule notwithstanding, SFAS No. 133 (prior to amendments made to it by SFAS No. 155) provides a broad exception for interest-only and principal-only strips initially resulting from the separation of rights to receive contractual cash flows of a financial instrument that itself does not contain an embedded derivative that would have been accounted for separately. SFAS 155 amends SFAS 133 to restrict the scope exception to strips that represent rights to receive only a portion of the contractual interest cash flows or of the contractual principal cash flows of a specific debt instrument. Prior to amendments made by SFAS 155 , SFAS 140 , “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities”, permitted a qualifying special-purpose entity (SPE) to hold only passive derivative financial instruments pertaining to beneficial interests (other than another derivative financial instrument) issued or sold to parties other than the transferor. SFAS 155 amends SFAS 140 to allow a qualifying SPE to hold a derivative instrument pertaining to beneficial interests that itself is a derivative financial instrument.

In March 2006, the FASB issued SFAS No. 156, “Accounting for Servicing of Financial Assets” (“SFAS NO. 156”), which provides an approach to simplify efforts to obtain hedge-like (offset) accounting. This Statement amends FASB Statement No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities”, with respect to the accounting for separately recognized servicing assets and servicing liabilities. The Statement (1) requires an entity to recognize a servicing asset or servicing liability each time it undertakes an obligation to service a financial asset by entering into a servicing contract in certain situations; (2) requires that a separately recognized servicing asset or servicing liability be initially measured at fair value, if practicable;  (3) permits an entity to choose either the amortization method or the fair value method for subsequent measurement for each class of separately recognized servicing assets or servicing liabilities; (4) permits at initial adoption a one-time reclassification of available-for-sale securities to trading securities by an entity with recognized servicing rights, provided the securities reclassified offset the entity’s exposure to changes in the fair value of the servicing assets or liabilities; and (5) requires separate presentation of servicing assets and servicing liabilities subsequently measured at fair value in the balance sheet and additional disclosures for all separately recognized servicing assets and servicing liabilities. SFAS No. 156 is effective for all separately recognized servicing assets and liabilities as of the beginning of an entity’s fiscal year that begins after September 15, 2006, with earlier adoption permitted in certain circumstances. The Statement also describes the manner in which it

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should be initially applied. The Company does not believe that SFAS No. 156 will have a material impact on its financial position, results of operations or cash flows.

Item 7A.    Quantitative and Qualitative Disclosures about Market Risk

The primary objective of the following information is to provide forward-looking quantitative and qualitative information about our potential exposure to market risks. The term “market risk” for us refers to the risk of loss arising from adverse changes in interest rates and various foreign currencies. The disclosures are not meant to be precise indicators of expected future losses, but rather indicators of reasonably possible losses. This forward-looking information provides indicators of how we view and manage our ongoing market risk exposures.

Interest Rate

We are exposed to market risk from changes in interest rates on our outstanding revolving line of credit. At December 31, 2005, we had approximately $10.0 million outstanding, which could be affected by changes in short term interest rates. The interest rate for the revolving line of credit is the prime rate (7.25% at December 31, 2005) or LIBOR plus 1.50% (4.38% at December 31, 2005). For every 1% increase in our bank’s prime rate or LIBOR, our interest expense would increase by $100,000 assuming the same $10.0 million remained outstanding for the entire year.

The above sensitivity analysis for interest rate risk excludes accounts receivable, accounts payable and accrued liabilities because of the short-term maturity of such instruments. The analysis does not consider the effect this movement may have on other variables including changes in sales volumes that could be indirectly attributed to changes in interest rates. The actions that we would take in response to such a change are also not considered. If it were possible to quantify this impact, the results could well be different than the sensitivity effects shown above.

Market Risk

A substantial portion of our revenue and expenses are transacted in markets outside the United States, however all sales transactions and accounts receivable are denominated in US dollars. As a result of our international sales, our future operating results could be adversely affected by a variety of factors, including changes in specific countries’ political, economic or regulatory conditions and trade protection measures. Our market risk management includes an accounts receivable insurance policy for both our domestic and foreign sales. However, there can be no assurance that our insurance policy will substantially offset the impact of fluctuations in currency exchange rates, political, economic or regulatory conditions on its results of operations and financial position. Foreign currency fluctuations did not have a material impact on our financial results during 2005, 2004 or 2003.

Item 8.   Financial Statements and Supplementary Data.

The information required by this item is included below in “Item 15 Exhibits, Financial Statements and Financial Statement Schedules.”

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Item 9.   Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.

None

Item 9A.   Controls and Procedures.

Disclosure Controls

The Company, under the supervision and with the participation of its management, including its principal executive officer and principal financial officer, evaluated the effectiveness of the design and operation of its disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the period covered by this report. Based on this evaluation, the principal executive officer and principal financial officer concluded that the Company’s disclosure controls and procedures are effective as of the end of the period covered by this report.

Changes in Internal Control Over Financial Reporting

The principal executive officer and principal financial officer also conducted an evaluation of the Company’s internal control over financial reporting (as defined in Exchange Act Rule 13a-15(f)) (“Internal Control”) to determine whether any changes in Internal Control occurred during the quarter ended December 31, 2005, that have materially affected or which are reasonably likely to materially affect Internal Control. Based on that evaluation, there has been no such change during such period.

Item 9B.   Other Information.

Not Applicable

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PART III

Item 10.                 Directors and Executive Officers of the Registrant.

The information required by this item is incorporated by reference to our Definitive Proxy Statement related to the 2006 Annual Meeting of Stockholders, which will be filed with the Securities and Exchange Commission no later than 120 days following the end of the fiscal year.

We have adopted a Code of Ethics that applies to our chief executive officer, chief financial officer, principal accounting officer and controller and a Code of Business Conduct and Ethics that applies to all of our directors, officers and employees. Copies of these codes are available on our website (www.infosonics.com) and are also available without charge upon written request directed to Investor Relations, InfoSonics Corporation, 5880 Pacific Center Blvd., San Diego, California 92121.

If we make changes to our Code of Ethics or Code of Business Conduct and Ethics in any material respect or waive any provision of either such Code for any of the persons covered by either such Code, we expect to provide the public with notice of any such change or waiver by publishing a description of such event on our corporate website, www.infosonics.com, or by other appropriate means as required by applicable rules of the United States Securities and Exchange Commission.

Item 11.                 Executive Compensation.

The information required by this item is incorporated by reference to our Definitive Proxy Statement related to the 2006 Annual Meeting of Stockholders, which will be filed with the Securities and Exchange Commission no later than 120 days following the end of the fiscal year.

Item 12.                 Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.

The information required by this item is incorporated by reference to our Definitive Proxy Statement related to the 2006 Annual Meeting of Stockholders, which will be filed with the Securities and Exchange Commission no later than 120 days following the end of the fiscal year.

Item 13.      Certain Relationships and Related Transactions.

The information required by this item is incorporated by reference to our Definitive Proxy Statement related to the 2006 Annual Meeting of Stockholders, which will be filed with the Securities and Exchange Commission no later than 120 days following the end of the fiscal year.

Item 14.                 Principal Accounting Fees and Services.

The information required by this item is incorporated by reference to our Definitive Proxy Statement related to the 2006 Annual Meeting of Stockholders, which will be filed with the Securities and Exchange Commission no later than 120 days following the end of the fiscal year.

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PART IV

Item 15.                 Exhibits, Financial Statement Schedules.

(a)(1) and (a)(2) Financial Statements and Financial Statement Schedules

See Item 8. Financial Statements and Supplementary Data beginning on page F-1.

(a)(3) Exhibits.

EXHIBIT INDEX

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(1)          Incorporated by reference from the Company’s Registration Statement on Form S-1, filed on January 30, 2004.

(2)          Incorporated by reference from Amendment No. 2 to the Company’s Registration Statement on Form S-1/A, filed on April 16, 2004.

(3)          Incorporated by reference from Amendment No. 6 to the Company’s Registration Statement on Form S-1/A, filed on May 20, 2004.

(4)          Incorporated by reference from the Company’s Current Report on Form 8-K, filed on January 25, 2005.

(5)          Incorporated by reference from the Company’s Current Report on Form 8-K, filed on February 2, 2006.

(6)          Incorporated by reference from the Company’s Current Report on Form 8-K, filed on October 13, 2005.

(7)          Incorporated by reference from the Company’s Current Report on Form 8-K, filed on November 29, 2005.

(8)          Incorporated by reference from the Company’s Current Report on Form 8-K, filed on November 3, 2004.

(*)          Filed herewith

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SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.

 

 

36

INFOSONICS CORPORATION AND SUBSIDIARIES
Consolidated Financial Statements
For the years ended December 31, 2005, 2004 and 2003
Table of Contents

 

F-i

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

Board of Directors and Stockholders
InfoSonics Corporation and subsidiaries

We have audited the accompanying consolidated balance sheets of InfoSonics Corporation and subsidiaries as of December 31, 2005 and 2004, and the related consolidated statements of operations, stockholders’ equity, and cash flows for the years ended December 31, 2005 and 2004, and the year ended December 31, 2003 (restated). These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provided a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of InfoSonics Corporation and subsidiaries as of December 31, 2005 and 2004, and the consolidated results of their operations and their cash flows for the years ended December 31, 2005 and 2004, and the year ended December 31, 2003 (restated) in conformity with accounting principles generally accepted in the United States of America.

As discussed in Note 2 to the consolidation financial statements, the December 31, 2003 consolidated financial statements have been restated due to the overstatement of the Company’s deferred offering costs.

As discussed in Note 2 to the consolidated financial statements, the December 31, 2003 consolidated financial statements have been restated to reflect the fair value of stock options issued for services rendered.

SINGER LEWAK GREENBAUM & GOLDSTEIN LLP

Los Angeles, California
February 10, 2006

F-ii

INFOSONICS CORPORATION AND SUBSIDIARIES
Consolidated Balance Sheets
December 31, 2005 and 2004

The accompanying notes are an integral part of these financial statements

F-1

INFOSONICS CORPORATION AND SUBSIDIARIES
Consolidated Statements of Operations
December 31, 2005, 2004 and 2003

*—Refer to Note 2, Restatement of Consolidated Financial Statements.

The accompanying notes are an integral part of these financial statements

F-2

INFOSONICS CORPORATION AND SUBSIDIARIES
Consolidated Statements of Stockholder’s Equity
December 31, 2005, 2004, and 2003

*—Refer to Note 2, Restatement of Consolidated Financial Statements.

The accompanying notes are an integral part of these financial statements

F-3