Simply, Inc. - Quarter Report: 2007 September (Form 10-Q)

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10 - Q

 

x QUARTERLY REPORT UNDER SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934.

For the quarterly period ended September 30, 2007

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 Number - 001-32217

 

InfoSonics Corporation

(Exact name of registrant as specified in its charter)

 

Maryland	33-0599368
(State or other jurisdiction of incorporation or organization)	(IRS Employer Identification Number)

 

4350 Executive Drive Suite #100 San Diego, CA 92121

(Address of principal executive offices including zip code)

 

(858) 373-1600

(Registrant’s telephone number, including area code)

 

Not Applicable

(Former Name or Former Address, if Changed Since Last Report)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes  x   No  o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

Large Accelerated Filer  o             Accelerated Filer  o             Non-Accelerated Filer  x

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes  o   No  x

 

As of November 9, 2007, the Registrant had 14,589,495 shares outstanding of its $.001 par value common stock.

 

 

 

 

InfoSonics Corporation and Subsidiaries

Quarterly Report on Form 10-Q For The Period Ended September 30, 2007

Table of Contents

PART I. FINANCIAL INFORMATION
Item 1.	Financial Statements	3
·	Consolidated Balance Sheets as of September 30, 2007 (unaudited) and December 31, 2006	3
·	Consolidated Statements of Income (Loss) for the Three and Nine Months Ended September 30, 2007 and 2006 (unaudited)	4
·	Consolidated Statements of Comprehensive Operations for the Three and Nine Months Ended September 30, 2007 and 2006 (unaudited)	5
·	Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2007 and 2006 (unaudited)	6
·	Condensed Notes to Consolidated Financial Statements (unaudited)	7
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	14
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	24
Item 4.	Controls and Procedures	24
PART II. OTHER INFORMATION		25
Item 1.	Legal Proceedings	25
Item 1A.	Risk Factors	26
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	27
Item 3.	Defaults Upon Senior Securities	27
Item 4.	Submission of Matters to a Vote of Security Holders	27
Item 5.	Other Information	27
Item 6.	Exhibits	28

 

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Part I.  FINANCIAL INFORMATION

 

Item 1.  Financial Statements

InfoSonics Corporation and Subsidiaries

Consolidated Balance Sheets

		September 30, 2007			December 31, 2006
		(unaudited)
ASSETS
Current assets:
Cash and cash equivalents		$	9,982,332		$	30,243,392
Trade accounts receivable, net of allowance for doubtful accounts of $667,375 (unaudited) and $679,552		50,475,895			37,798,284
Inventory, net of reserves of $808,365 (unaudited) and $254,508		21,635,361			11,174,200
Prepaid inventory		772,016			162,146
Prepaid expenses		412,165			316,919
Prepaid taxes		1,168,047			973,749
Net assets of discontinued operations		4,209			4,209
Deferred tax asset — current		1,244,363			1,041,000
Total current assets		85,694,388			81,713,899
Property and equipment, net		1,669,034			615,185
Intangible assets		504,000			504,000
Deferred tax asset — non-current		375,634			—
Other assets		239,019			137,381
Total assets		$	88,482,075		$	82,970,465
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Line of credit		$	27,670,500		$	25,648,614
Accounts payable		21,089,019			18,099,985
Accrued expenses		1,938,379			1,261,988
Income taxes payable		30,800			17,100
Total current liabilities		50,728,698			45,027,687
Deferred tax liability non-current		—			36,000
Total liabilities		50,728,698			45,063,687
Commitments and contingencies (Note 11)
Stockholders’ equity:
Preferred stock, $0.001 par value 10,000,000 shares authorized (no shares issued and outstanding as of applicable period end)		—			—
Common stock, $0.001 par value 40,000,000 shares authorized (14,474,353 and 14,180,068 shares issued and outstanding as of applicable period end)		14,474			14,180
Additional paid-in capital		31,247,272			30,751,372
Accumulated other comprehensive loss		(26,520		)	(8,865		)
Retained earnings		6,518,151			7,150,091
Total stockholders’ equity		37,753,377			37,906,778
Total liabilities and stockholders’ equity		$	88,482,075		$	82,970,465

 

Accompanying notes are an integral part of these financial statements.

 

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InfoSonics Corporation and Subsidiaries

Consolidated Statements of Income (Loss)

(unaudited)

		For the Three Months Ended September 30,						For the Nine Months Ended September 30,
		2007			2006			2007			2006
Net sales		$	69,360,415		$	67,568,847		$	186,024,726		$	179,975,494
Cost of sales		66,705,743			62,154,069			177,024,439			166,049,196
Gross profit		2,654,672			5,414,778			9,000,287			13,926,298
Operating expenses, including non-cash expense for stock options		3,889,882			4,439,674			11,703,892			11,555,769
Operating income (loss) from continuing operations		(1,235,210		)	975,104			(2,703,605		)	2,370,529
Other income (expense)
Change in fair value of derivative liability		—			—			—			399,009
Income from early lease termination		2,094,918			—			2,094,918			—
Interest income (expense)		(351,865		)	47,189			(622,951		)	(152,368		)
Income (loss) from continuing operations before provision (benefit) for income taxes		507,843			1,022,293			(1,231,638		)	2,617,170
Provision (benefit) for income taxes		134,408			345,074			(599,697		)	638,614
Income (loss) from continuing operations		373,435			677,219			(631,941		)	1,978,556
Loss from discontinued operations, net of tax		—			(40		)	—			(692		)
Net income (loss)		$	373,435		$	677,179		$	(631,941	)	$	1,977,864
Basic earnings (loss) per share
From continuing operations		$	0.03		$	0.05		$	(0.04	)	$	0.15
From discontinued operations		$	0.00		$	(0.00	)	$	0.00		$	(0.00	)
Net income (loss)		$	0.03		$	0.05		$	(0.04	)	$	0.15
Diluted earnings (loss) per share
From continuing operations		$	0.02		$	0.04		$	(0.04	)	$	0.13
From discontinued operations		$	0.00		$	(0.00	)	$	0.00		$	(0.00	)
Net income (loss)		$	0.02		$	0.04		$	(0.04	)	$	0.13
Basic weighted-average number of common shares outstanding		14,474,353			13,989,980			14,416,322			13,494,168
Diluted weighted-average number of common shares outstanding		15,722,324			16,278,809			14,416,322			15,828,263

 

Accompanying notes are an integral part of these financial statements.

 

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Infosonics Corporation and Subsidiaries

Consolidated Statements of Comprehensive Operations

(unaudited)

		Three Months Ended September 30,						Nine Months Ended September 30,
		2007			2006			2007			2006
Net income (loss)		$	373,435		$	677,179		(631,941		)	$	1,977,864
Other comprehensive income (loss): Foreign currency translation adjustments		1,596			2,213			(17,655		)	(7,402		)
Comprehensive income (loss)		375,031			$	679,392		$	(649,596	)	$	1,970,462

 

The accompanying notes are an integral part of these financial statements

 

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InfoSonics Corporation and Subsidiaries

Consolidated Statements of Cash Flows

(unaudited)

		For the Nine Months Ended September 30,
		2007			2006
Cash flows from operating activities:
Net income (loss)		$	(631,941	)	$	1,977,864
Adjustments to reconcile net income (loss) from continuing operations to net cash provided by (used in) operating activities
Depreciation and amortization		231,321			108,220
Loss on disposal of fixed assets		57,785			—
Provision for bad debt		(12,178		)	351,560
Provision for obsolete inventory		553,857			(72,679		)
Tax benefit from stock option exercises		—			514,402
Stock option expense		233,157			1,376,512
Change in fair value of derivative liability		—			(399,009		)
(Increase) decrease in
Trade accounts receivable		(12,665,433		)	(24,916,006		)
Inventory		(11,015,018		)	506,943
Prepaid inventory		(609,870		)	(4,143,131		)
Prepaid expenses (including taxes)		(289,544		)	(427,657		)
Other assets		(101,637		)	(46,684		)
Deferred tax asset current		(203,363		)	(2,000		)
Deferred tax asset non current		(411,634		)	3,793
Increase (decrease) in
Accounts payable		2,989,034			9,559,557
Accrued expenses		676,391			(1,201,019		)
Income tax liabilities		13,700			95,851
Cash provided by (used in) continuing operations		(21,185,373		)	(16,713,483		)
Cash provided by discontinued operations		—			14,722
Net cash provided by (used in) operating activities		(21,185,373		)	(16,698,761		)
Cash flows from investing activities:
Purchase of property and equipment		(1,342,955		)	(319,170		)
Net cash provided by (used in) investing activities		(1,342,955		)	(319,170		)
Cash flows from financing activities:
Borrowings from line of credit		378,322,427			91,635,941
Payments on line of credit		(376,300,542		)	(80,745,841		)
Cash paid for offering costs		—			(1,005,582		)
Cash received for stock, options and warrants		263,037			15,622,930
Net cash provided by (used in) financing activities		2,284,922			25,507,448
Effect of exchange rate changes on cash		(17,655		)	(7,402		)
Net increase (decrease) in cash and cash equivalents		(20,261,060		)	8,482,115
Cash and cash equivalents, beginning of period		30,243,392			7,712,915
Cash and cash equivalents, end of period		$	9,982,332		$	16,195,030

 

Accompanying notes are an integral part of these financial statements.

 

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InfoSonics Corporation

Condensed Notes to Consolidated Financial Statements

(unaudited)

NOTE 1. Basis of Presentation

The accompanying unaudited consolidated financial statements and these condensed notes have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Accordingly, they do not include all of the information and notes required by GAAP for complete financial statements. The preparation of financial statements requires management to make estimates and assumptions that affect amounts reported in the financial statements and accompanying notes. Actual results are likely to differ from those estimates, but management does not believe such differences will materially affect the financial position or results of operations of InfoSonics Corporation (the “Company”), although they may. These unaudited consolidated financial statements and condensed notes should be read in conjunction with the financial statements and notes as of and for the year ended December 31, 2006 included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2006.  These unaudited consolidated financial statements reflect all adjustments considered, in the opinion of the Company’s management, necessary to fairly present the results for the periods covered herein and such adjustments are considered of a normal recurring nature.

The unaudited consolidated financial statements include the accounts of the Company and its subsidiaries, Axcess Mobile LLC, InfoSonics Latin America, Inc., InfoSonics de Mexico S.A. de C.V., InfoSonics de Guatemala S.A., InfoSonics El Salvador S.A. de C.V., InfoSonics S.A., InfoSonics Chile y Compania Limitada and InfoSonics Colombia S.A., all of which are wholly owned. Significant intercompany accounts and transactions have been eliminated in consolidation of these consolidated financial statements.

The unaudited consolidated balance sheet at September 30, 2007 does not include all of the information and notes required by GAAP for complete financial statements. Due to the seasonality of the Company’s business and other factors, the Company’s interim results may not be indicative of the condition at the end of or the results for the full fiscal year of 2007 or at or for any other future period. The unaudited consolidated statements of income and the consolidated statements of comprehensive operations for the three and nine months ended September 30, 2007 and the unaudited Consolidated Statement of Cash Flows for the nine months ended September 30, 2007 are not necessarily indicative of the operating results or cash flows that may be expected for the full fiscal year of 2007 or for any future period.

Share and per share amounts for all periods presented in these consolidated financial statements and the accompanying notes (unless otherwise stated) have been adjusted to reflect the two-for-one common stock split in the form of a stock dividend effected on June 19, 2006.

NOTE 2. Stock-Based Compensation

The Company has three equity incentive plans, the 2006 Equity Incentive Plan (“2006 Plan”), the 2003 Stock Option Plan (“2003 Plan”) and the 1998 Stock Option Plan (“1998 Plan”).  Each of the plans has been approved by our stockholders. The 2006 Plan is the only plan from which additional equity incentives will be granted. The 2006 Plan authorizes the grant of up to 1,000,000 shares for equity incentives. The Company is also a party to non-plan option agreements with several non-employee directors and several institutions.

Effective January 1, 2006 the Company adopted Financial Accounting Standards Board (“FASB”) SFAS No. 123R, “Share Based Payments” using the modified prospective method, which requires measurement of compensation cost for all stock-based awards at fair value on the date of grant and recognition of compensation over the service period for awards expected to vest. The fair value of stock options was determined using the Black-Scholes valuation model, which is consistent with our valuation techniques previously utilized for stock options in footnote disclosures required under SFAS 123, as amended by SFAS 148. Such fair value is recognized as an expense over the service period, net of estimated forfeitures.

On September 27, 2001, the FASB Emerging Issues Task Force (“EITF”) issued EITF Issue 96-18 “Accounting for Equity Instruments That are Issued to Other than Employees for Acquiring, or in Conjunction with Selling, Goods or Services,” which requires that equity instruments issued in exchange for certain services be valued at the more accurate of the fair value of the services provided or the fair value of the equity instruments issued.  For equity instruments issued that are subject to a required service period the expense associated with the equity instruments is recorded as the instruments vest or the services are provided.  The Company has granted options and warrants to non-employees and recorded the fair value of the equity instruments on the date of issuance using the Black-Scholes valuation model.  For grants subject to vesting or service requirements, the expense is deferred and is recognized over the more appropriate of the vesting period or as the service is provided.

 

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On March 29, 2005, the Securities and Exchange Commission (“SEC”) published Staff Accounting Bulletin (“SAB”) No. 107, which provides the SEC Staff’s views on a variety of matters relating to stock-based payments. SAB 107 requires stock-based compensation to be classified in the same expense line items as cash compensation. Information about stock-based compensation included in the results of operations for the three and nine months ended September 30, 2007 and 2006 is as follows:

 

Our stock options vest on an annual or a monthly basis. As of September 30, 2007, there was $162,000 of total unrecognized compensation costs related to the non-vested stock options. The Company recognizes stock-based compensation costs on a straight-line basis over the requisite service period of the award, which is generally the option vesting term. That cost is expected to be recognized over the next weighted-average period of 3.5 years.  Such amounts may change as a result of additional grants, forfeitures, modifications in assumptions and other factors. SFAS 123R provides that income tax effects of share-based payments are recognized in the financial statements for those awards which will normally result in tax deductions under existing tax law. During each of the first three quarters of 2007, we recorded an expense of $97,449, $97,449 and $38,260, respectively, related to options previously granted. Under current U.S. federal tax law, we would receive a compensation expense deduction related to non-qualified stock options only when those options are exercised and vested shares are received. Accordingly, the financial statement recognition of compensation cost for non-qualified stock options creates a deductible temporary difference which results in a deferred tax asset and a corresponding deferred tax benefit in our consolidated statements of income.

The fair value of each option grant is estimated on the date of grant using the Black-Scholes option pricing model with the following weighted-average assumptions used for grants in 2007 and 2006: risk-free interest rate of 4.66% in 2007 and ranging from 4.88% to 5.04% in 2006 based on the U.S. Treasury yields in effect at the time of grant; expected dividend yields of 0 percent as the Company has not, and does not intend to, issue dividends; and expected lives of 3 to 7 years based upon the historical life of options. For grants in 2007 and 2006, the expected volatility used ranged from 62% to 91%, based on the Company’s historical stock price fluctuations for a period matching the expected life of the options.

A summary of option activity under all of the above plans as of September 30, 2007 and changes during the nine months then ended is presented in the table below:

 

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A summary of the status of the Company’s non-vested options at September 30, 2007 and changes during the nine months ended September 30, 2007 is presented below:

		Shares		Weighted-average grant-date fair value
Non-vested at December 31, 2006		177,269		$	6.65
Granted		40,000		$	3.79
Vested		131,405		$	3.71
Forfeited		58,333		$	10.29
Non-vested at September 30, 2007		27,531		$	5.18

 

The weighted-average grant-date fair value of options granted during the nine months ended September 30, 2007 was $3.79. The total intrinsic value of options granted during the nine months ended September 30, 2007 and 2006 was $0 and $0, respectively. There was $263,000 and $1.2 million cash received from options exercised for the nine months ended September 30, 2007 and 2006, respectively. The stock based compensation unrecognized expense for future periods as of September 30, 2007 is approximately $162,000 with a weighted-average remaining vesting period of 3.25 years.

NOTE 3. Earnings Per Share

The Company utilizes SFAS No. 128, ‘‘Earnings per Share.’’ Basic earnings per share is computed by dividing income available to common stockholders by the weighted-average number of common shares outstanding. Diluted earnings per share is computed similarly to basic earnings per share, except that the denominator is increased to include the number of additional common shares that would have been outstanding if the potential additional common shares that were dilutive had been issued. Common share equivalents are excluded from the computation if their effect is anti-dilutive. The Company’s common share equivalents consist of stock options and warrants.

The following table represents a reconciliation of the shares used to calculate basic and diluted earnings per share for the respective periods indicated:

 

Common shares from exercise of certain options and warrants have been excluded from the computation of diluted earnings per share because their exercise prices are greater than the Company’s weighted-average stock price for the period. For the three months ended September 30, 2007 and 2006, the number of shares excluded was 2,522,267 and 1,894,583, respectively.  For the nine months ended September 30, 2006, the number of shares excluded was 1,849,317.

Since their effect would have been anti-dilutive, 1,458,076, stock options and warrants to purchase shares of common stock has been excluded from the computation of net loss per share for the nine months ended September 30, 2007.

NOTE 4. Income Taxes

The Company adopted the provisions of FIN 48, “Accounting for Uncertainty in Income Taxes - an interpretation of FASB Statement No. 109,” (“FIN 48”), on January 1, 2007. As a result of the implementation of FIN 48, the Company made a comprehensive review of its portfolio of uncertain tax positions in accordance with recognition standards established by FIN 48. In this regard, an uncertain tax position represents the Company’s expected treatment of a tax position taken in a filed tax return, or planned to be taken in a future tax return, that has not been reflected in measuring income tax expense for financial reporting purposes. As a result of this review, the Company concluded that at this time there are no uncertain tax positions. As a result of applying the provisions of FIN 48, there was no cumulative effect on retained earnings.

 

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The Company is subject to US federal income tax as well as income tax in multiple states and foreign jurisdictions. For all major taxing jurisdictions, the tax years 2002 through 2006 remain open to examination. As of September 30, 2007, the Company does not expect any material changes to unrecognized tax positions within the next twelve months.

SFAS No. 109, “Accounting for Income Taxes,” establishes financial accounting and reporting standards for the effect of income taxes. The objectives of accounting for income taxes are to recognize the amount of taxes payable or refundable for the current year and deferred tax liabilities and assets for the future tax consequences of events that have been recognized in an entity’s financial statements or tax returns. Judgment is required in assessing the future tax consequences of events that have been recognized in our financial statements or tax returns. Fluctuations in the actual outcome of these future tax consequences could materially impact our financial position or our results of operations.

NOTE 5. Inventory

Inventory is valued at the lower of cost or market using standard costs that approximate average cost. Inventories are reviewed periodically and items considered to be slow moving or obsolete are reduced to estimated net realizable value through an appropriate reserve.  During the quarter ended September 30, 2007, the Company adjusted the cost basis of certain items in inventory downward by $1.3 million to reflect the newly established market value of these items.  At September 30, 2007, we had in-transit inventory of $107,000, which is under the control of a common freight carrier until it arrives at one of our customer facilities.  This inventory is owned by the Company while it is in-transit and included in finished goods. In addition, as of September 30, 2007 and December 31, 2006, the Company had prepaid inventory of $772,000 and $162,000, respectively. Prepaid inventory represents cash advances for goods that have not yet been received by the Company and the Company is showing these balances as a separate line item on the accompanying balance sheet.  Inventory consists of the following:

 

NOTE 6. Property and Equipment

Property and equipment are primarily located in the United States, with the exception of $282,000 of machinery and equipment located at our Mexico facility and $19,000 located in Korea (installed in June 2007 and included in table below), and consisted of the following as of the dates presented:

 

Depreciation expense was $55,926 and $34,269 for the three months ended September 30, 2007 and 2006 respectively. Depreciation expense was $231,321 and $108,220 for the nine months ended September 30, 2007 and 2006, respectively.

NOTE 7. Line of Credit

The Company has a line of credit from Wells Fargo HSBC Trade Bank N.A., which provides for advances not to exceed 80% of eligible domestic accounts receivable and up to 85% of foreign-insured accounts receivable (depending on the country of the debtor), up to a maximum of $30,000,000. As of September 30, 2007, the majority of our debt was based on foreign accounts receivable.

Interest is payable on a monthly basis (i) at Wells Fargo’s prime rate minus 0.25% (7.75% at September 30, 2007) or (ii) at the one-month LIBOR plus 1.50% (5.128% at September 30, 2007). The interest rate is floating at Wells Fargo’s prime rate or is at LIBOR plus 1.5% if the debt is a fixed amount drawn upon.  The line of credit is collateralized by substantially all of the assets of the Company, and expires October 1, 2008. In addition to reporting and other non-financial covenants, the line of credit contains certain financial covenants which require the Company to maintain a tangible net worth of not less than $30,000,000 plus 50% of net profit after tax from January 1, 2007, a pre-tax profit of not less than $1 on a rolling four quarter

 

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basis, a quick ratio of not less than one-to-one, a debt-to-net worth ratio of not greater than two-to-one, and an annual net income after taxes of at least $1. The Company did not meet all of these financial covenants at September 30, 2007.  The Company received a waiver from Wells Fargo relating to default rights Wells Fargo may have due to the Company failing to meet certain of these financial covenants at September 30, 2007, as well as default rights Wells Fargo may have if the Company fails to meet certain of these financial covenants at December 31, 2007. At September 30, 2007 and December 31, 2006, the amounts drawn against the line of credit were $27,670,500 and $25,648,614, respectively.

 

The Company has no other notes payable.

NOTE 8. Stockholders’ Equity

Stock Options

Effective March 9, 2007, the Company granted options to purchase an aggregate of 40,000 of its common stock to certain foreign contractors (the “Contractor Options”). One-fourth of the total options subject to these option grants become exercisable one year from the contractor grantee’s first date of duties, and 1/48th of the total options become exercisable each month thereafter until fully vested.  These options have exercise prices of $3.79 per share, which was the closing price per share of the Company’s common stock on March 9, 2007, and expire six years from the date of grant. See Note 2 for Stock Based Compensation discussion.

NOTE 9. Recent Accounting Pronouncements

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 it 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. The Company does not believe that SFAS No. 155 will have a material impact on its financial position, results of operations or cash flows. As a result, we do not believe the adoption of SFAS 155 has a material impact on the Company’s Consolidated Financial Statements.

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 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.  As a result, we do not believe the adoption of SFAS 156 has a material impact on the Company’s Consolidated Financial Statements.

 

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In July 2006, the FASB issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (FIN 48). FIN 48 clarifies the accounting for income taxes by prescribing a minimum probability threshold that a tax position must meet before a financial statement benefit is recognized. The minimum threshold is defined in FIN 48 as a tax position, that based solely on its technical merits is more likely than not to be sustained upon examination by the applicable taxing authority. The tax benefit to be recognized is measured as the largest amount of benefit that is greater than fifty percent likely of being realized upon ultimate settlement. FIN 48 must be applied to all existing tax positions upon initial adoption. The cumulative effect of applying FIN 48 at adoption, if any, is to be reported as an adjustment to opening retained earnings for the year of adoption. FIN 48 is effective for fiscal years beginning after December 15, 2006, although early adoption is permitted.  The adoption of FIN 48 did not have a material impact on the Company’s results of operations and financial position.

In September 2006, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 157, “Fair Value Measurements” (“SFAS 157”), which defines the fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements.  This statement is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years.  Early adoption is encouraged, provided that the registrant has not yet issued financial statements for that fiscal year, including any financial statements for an interim period within that fiscal year. If elected, the implementation of FAS 157 is not expected to have a material impact on the Company’s consolidated financial statements.

In September 2006, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans” (“SFAS 158”), which improves financial reporting by requiring an employer to recognize the over or under funded status of a defined benefit postretirement plan as an asset or liability in its statement of financial position and to recognize changes in that funded status in the year in which the changes occur through comprehensive income of a business entity or changes in unrestricted net assets of a not-for-profit organization.  This statement also improves financial reporting by requiring an employer to measure the funded status of a plan as of the date of its year end statement of financial position, with limited exceptions.  This Statement amends Statement 87, FASB Statement No. 88, “Employers’ Accounting for Settlements and Curtailments of Defined Benefit Pension Plans and for Termination Benefits”, Statement 106, and FASB Statement No. 132 (revised 2003), “Employers’ Disclosures about Pensions and Other Postretirement Benefits”.  Upon the initial application of this statement and subsequently, and employer should continue to apply the provisions in Statements, 87, 88, and 106 in measuring plan assets and benefit obligations as of the date of its statement of financial position and in determining the amount of net periodic benefit cost.  An employer with publicly traded equity securities is required to initially recognize the funded status of a defined benefit postretirement plan and to provide the required disclosures as of the end of the fiscal year ending after December 31, 2006.  An employer without publicly traded equity securities is required to recognize the funded status of a defined benefit postretirement plan and to provide the required disclosures as of the end of the fiscal year ending after June 15, 2007.  Early application of the recognition or measurement date provisions is encouraged; however, early application must be for all of an employer’s benefit plans.  Retrospective application of the Statement is not permitted. If elected, the implementation of FAS 158 is not expected to have a material impact on the Company’s consolidated financial statements.

In September 2006, the United States Securities and Exchange Commission (SEC) issued Staff Accounting Bulletin (SAB) No. 108, “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements.” This SAB No. 108 provides guidance on the consideration of the effects of prior year misstatements in quantifying current year misstatements for the purpose of a materiality assessment. SAB No. 108 establishes an approach that requires quantification of financial statement errors based on the effects of each of the Company’s balance sheet and statement of operations financial statements and the related financial statement disclosures. The SAB No. 108 permits existing public companies to record the cumulative effect of initially applying this approach in the first year ending after November 15, 2006 by recording the necessary correcting adjustments to the carrying values of assets and liabilities as of the beginning of that year with the offsetting adjustment recorded to the opening balance of retained earnings. Additionally, the use of the cumulative effect transition method requires detailed disclosure of the nature and amount of each individual error being corrected through the cumulative adjustment and how and when it arose.  The adoption of SAB 108 did not have a material impact on the Company’s results of operations and financial position.

In October 2006, the Emerging Issues Task Force (EITF) issued EITF 06-3, How Taxes Collected from Customers and Remitted to Governmental Authorities Should Be Presented in the Income Statement (That is, Gross versus Net Presentation) to clarify diversity in practice on the presentation of different types of taxes in the financial statements. The Task Force concluded that, for taxes within the scope of the issue, a company may adopt a policy of presenting taxes either gross within revenue or net. That is, it may include charges to customers for taxes within revenues and the charge for the taxes from the taxing authority within cost of sales, or, alternatively, it may net the charge to the customer and the charge from the taxing authority. If taxes subject to EITF 06-3 are significant, a company is required to disclose its accounting policy for presenting taxes and the amounts of such taxes that are recognized on a gross basis. The guidance in this consensus is effective for the first interim reporting period beginning after December 15, 2006 (the first quarter of our fiscal year 2007). The adoption of EITF 06-3 did not have a material impact on the Company’s results of operations, financial position or cash flow.

 

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In February 2007, the FASB issued Statement No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities — Including an amendment of FASB Statement No. 115 “ (“SFAS 159”).  This standard amends FASB Statement No. 115, “Accounting for Certain Investment in Debt and Equity Securities,” with respect to accounting for a transfer to the trading category for all entities with available-for-sale and trading securities electing the fair value option.  This standard allows companies to elect fair value accounting for many financial instruments and other items that currently are not required to be accounted as such, allows different applications for electing the option for a single item or groups of items, and requires disclosures to facilitate comparisons of similar assets and liabilities that are accounted for differently in relation to the fair value option.  SFAS 159 is effective for fiscal years beginning after November 15, 2007. If elected, the implementation of FAS 159 is not expected to have a material impact on the Company’s consolidated financial statements.

NOTE 10. Geographic Information

The Company currently operates in one business segment.  All fixed assets are located in Company facilities in the United States, Korea and Mexico. See Note 6 for additional information.  Net sales by geographical area for the three and nine months ended September 30, 2007 and 2006 were:

		Three months ended September 30,						Nine months ended September 30,
		2007			2006			2007			2006
United States		$	5,704,266		$	2,085,463		$	23,298,520		$	7,047,776
Central America		22,589,373			16,381,009			53,773,614			59,741,273
South America		41,066,777			49,102,375			108,952,592			113,186,445
Total		$	69,360,415		$	67,568,847		$	186,024,726		$	179,975,494

 

NOTE 11.  Commitments and Contingencies

Securities Class Actions

In the securities class action, captioned In Re: InfoSonics Corporation Securities Litigation, Lead Case No. 06 CV 1231, now pending before Judge Sammartino in the United States District Court for the Southern District of California, plaintiffs filed a second amended consolidated complaint on September 10, 2007 against the Company and certain of its officers and directors.  The second amended consolidated complaint alleges violations of Section 10(b) of the Exchange Act and associated Rule 10b-5, Section 20(a) and Section 20A in connection with the announcement of the Company’s restatement of first quarter 2006 earnings and in connection with allegedly false and/or misleading statements related to the Company’s distribution of the VK Mobile phone.  Plaintiffs seek a declaration that their action is a proper class action pursuant to Rule 23(a) and (b)(3), unspecified damages, prejudgment and post-judgment interest, attorneys’ fees, expert witness fees, other costs, and other unspecified relief.  The plaintiffs purport to represent a class of purchasers of the Company’s stock during the period February 6, 2006 to August 9, 2006.

On October 1, 2007, the defendants’ filed a motion to dismiss the second amended consolidated complaint on the grounds, among others, that the plaintiffs had failed to adequately plead violations of the securities laws.  Plaintiffs’ opposition to the motion to dismiss is due November 21, 2007, and defendants’ reply in support of the motion to dismiss is due November 30, 2007.  The hearing on the motion to dismiss is set for December 7, 2007.

An early neutral evaluation conference before Magistrate Judge William McCurine has been set for November 16, 2007.  At this time, discovery has not begun and no trial date has been set by the Court.

Derivative Action

In the derivative action, captioned In Re InfoSonics Corporation Derivative Litigation, Lead Case No. 06 CV 1336, now pending before Judge Sammartino in the United States District Court for the Southern District of California, plaintiffs filed a consolidated complaint on November 6, 2006 purportedly on behalf of the Company against certain of its officers and directors, and the Company as a nominal defendant.  The consolidated complaint alleges claims for violations of Section 14(a) of the Exchange Act, Sections 25402 and 25403 of the California Corporations Code, disgorgement under the Sarbanes-Oxley Act of 2002, breach of fiduciary duty, abuse of control, gross mismanagement, waste of corporate assets, unjust enrichment, rescission, a constructive trust, and an accounting, in connection with the Company’s restatement of first quarter 2006 earnings and in connection with allegations of wrongdoing with respect to granting, exercising, accounting and reporting of the stock options that the Company granted in December 2005.  Plaintiffs seek unspecified damages, declaratory relief regarding the Sarbanes-Oxley Act of 2002, Section 14(a) of the Exchange Act, and the legality of stock options, a constructive trust, restitution, disgorgement, modification of certain corporate governance and internal procedures, extraordinary equitable and/or injunctive relief, costs, and such other relief as is just and proper.

 

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Defendants filed a motion to dismiss the consolidated complaint on the grounds, among others, that the plaintiffs had failed to make a demand on the Company’s board of directors and to adequately allege their other purported claims.  On September 4, 2007, the Court granted defendants motion to dismiss for failure to make a demand on the board, and also granted with prejudice the motion to dismiss the Sarbanes-Oxley claim.  The Court denied the other grounds for dismissal.  On October 2, 2007, the parties jointly moved to continue the deadline for plaintiffs to file their amended complaint until after the November 16, 2007 Early Neutral Evaluation Conference.  At this time, discovery on the merits has not begun and no trial date has been set by the Court.

We may become involved in certain other legal proceedings and claims which arise in the normal course of business. Other than as described above, as of September 30, 2007, we did not have any significant litigation outstanding.

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

Forward-Looking Statements and Other General Information

This discussion and analysis of financial condition and results of operations should be read in conjunction with the accompanying unaudited consolidated financial statements and condensed notes thereto included in this report and with our Annual Report on Form 10-K for the year ended December 31, 2006 (including our 2006 audited consolidated financial statements and related notes thereto). InfoSonics Corporation’s (“InfoSonics” or the “Company”) discussion and analysis of 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 (“GAAP”). The preparation of financial statements in conformity with GAAP requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of any contingent liabilities as of and at the financial statement date, and reported amounts of revenue and expenses during the reporting period. On an ongoing basis we review our estimates and assumptions. Our estimates are based on our historical experience and other assumptions that we believe to be reasonable under the circumstances. Actual results are likely to differ from these estimates under different assumptions or conditions, but we do not believe such differences will materially affect our consolidated statement of operations, although they may. Our critical accounting policies, the policies we believe are most important to the presentation of our financial statements and require the most difficult, subjective and complex judgments, are outlined below in “—Critical Accounting Policies.”  All references to results of operations in this discussion are to results from continuing operations, unless otherwise noted.

Safe Harbor Statement

The matters in this report that are forward-looking statements, including, without limitation, statements about future revenues, sales levels, operating income and margins, wireless handset sales, stock-based compensation expense, gain (loss) in value of derivatives, cost synergies, operating efficiencies, profitability, market share, and rates of return, are based on current management expectations that involve certain risks and uncertainties these risks and uncertainties, in whole or in part, could cause such expectations to fail to be achieved and have a material adverse effect on InfoSonics’ business, financial condition and results of operations, including, without limitation: (1) intense competition, regionally and internationally, including competition from alternative business models, such as manufacturer-to-carrier sales, which may lead to reduced prices, lower sales or reduced sales growth, lower gross margins, extended payment terms with customers, increased capital investment and interest costs, bad debt risks and product supply shortages; (2) inability to secure adequate supply of competitive products on a timely basis and on commercially reasonable terms; (3) foreign exchange rate fluctuations, devaluation of a foreign currency, adverse governmental controls or actions, political or economic instability, or disruption of a foreign market, and other related risks of our international operations; (4) the ability to attract new sources of profitable business from expansion of products or services or risks associated with entry into new markets, including geographies, products and services; (5) an interruption or failure of our information systems or subversion of access or other system controls may result in a significant loss of business, assets, or competitive information; (6) significant changes in supplier terms and relationships; (7) termination of a supply or services agreement with a major supplier or product supply shortages; (8) continued consolidation in the wireless handset carrier market; (9) extended general economic downturn; (10) loss of business from one or more significant customers; (11) customer and geographical accounts receivable concentration risk; (12) rapid product improvement and technological change resulting in inventory obsolescence; (13) future terrorist or military actions; (14) the loss of a key executive officer or other key employees; (15) changes in consumer demand for multimedia wireless handset products and features; (16) our failure to adequately adapt to industry changes and to manage potential growth and/or contractions; (17) future periodic assessments required by current or new accounting standards such as those relating to long-lived assets, goodwill and other intangible assets and expensing of stock options and valuing gain or loss on fair value of derivatives may result in additional non-cash income or expenses; (18) seasonal buying patterns; (19) dependency on Latin American sales; (20) uncertain political and economic conditions internationally; (21) the impact, if any, of changes in EITF 00-19 or SFAS 133 guidance as it relates to warrants and registration rights; and (22) the resolution of any litigation against the Company. Our actual results could differ materially from those anticipated in our forward looking statements.

 

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InfoSonics has instituted in the past and continues to institute changes to our strategies, operations and processes to address risks and uncertainties and to mitigate impact on InfoSonics’ results of operations and financial condition. However, no assurances can be given that InfoSonics will be successful in these efforts. For a further discussion of significant factors to consider concerning InfoSonics, see “Item 1A. Risk Factors” of InfoSonics’ Annual Report on Form 10-K for the year ended December 31, 2006 and “Part II. Item 1A. Risk Factors” of this quarterly report and the quarterly reports on Form 10-Q for the periods ended March 31, 2007 and June 30, 2007. In addition, other risks or uncertainties may be detailed from time to time in InfoSonics’ future SEC filings.

Overview

We are one of the premier distributors and providers of wireless handsets and accessories in Latin America and the United States. We provide end-to-end handset and wireless terminal solutions for carriers in both Latin America and the United States. We distribute products of several key original equipment manufacturers (OEM), including Samsung, LG, Novatel and others.  We are also involved in the designing, sourcing and distributing of a proprietary line of products under our own verykool™ brand, which includes entry level, mid-tier and high-end products.

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 for OEM wireless handset manufacturers and for our own verykool products in order to facilitate sales to carriers, agents, resellers, distributors, independent dealers and retailers in Latin America and the United States.

During 2006, we introduced a proprietary line of handsets and accessories under the verykool™ brand, for which we are involved in several aspects including, the design, feature sets, contracting with various design and contract manufacturers in Asia to develop exclusive or semi-exclusive products for us. In addition 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.

In October 2007, we relocated our corporate headquarters from one location to another in San Diego, California.  In addition we have a facility in Miami, Florida, where we have our Latin America sales and executive offices, and operate our main warehouse and distribution center. This warehouse and distribution center services our customers in the United States and Latin America. In addition, we have warehouse and office facilities in Mexico. We have wholly-owned subsidiaries in Latin America, which conduct some of our business activities in their respective regions of Latin America.

Due to seasonal and other factors, our interim financial condition or operating results may not be indicative of fiscal year 2007 or other future financial condition or operating results. Our financial condition and operating results are influenced by several seasonal and other factors, which may cause our financial condition and operating results to fluctuate on a quarterly basis, including, but not limited to, the timing and introduction of new products by our suppliers and competitors, promotions and subsidies by network operators, technical and certification delays by industry bodies as well as the operators, purchasing patterns of customers, the timing of holidays, the introduction of our proprietary verykool™ products line and other events affecting consumer demand.

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 new markets, and sourcing and developing 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.  We provide distribution and other services for original equipment manufacturers, such as Samsung and LG and our own proprietary line of verykool™ handsets.  Performance indicators that are key for the monitoring and management of our business include operating and net income, cost of sales and gross margin percentage, operating expenses as a percent of revenues, and overall net sales growth as well as balances of accounts receivable and inventory. 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, 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.

 

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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 and Risks

According to an October 2007 report by Cowen and Company, overall worldwide wireless handset sales increased in 2006 by approximately 21%, and are forecasted to increase 13% in 2007 and 14% in 2008. The bulk of this growth, we believe, came from developing markets in which we do not currently operate, such as India and China. A rapid decline in wireless handset sales growth could negatively impact our net sales. Excess supply conditions, such as those experienced in Central America during the quarter ended March 31, 2007, 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.

Company Specific Trends and Risks

Our strategy incorporates overall market growth elements for each aspect of our business, which we hope will result in continued growth.  During the first half of 2007, we increased our inventory levels in anticipation of and preparation for potential future sales. Although we have incorporated growth into our strategy, there can be no assurances that this trend of increased sales will continue.  Our verykool proprietary line of products, for which we have introduced 5 models during the year, have shown a quarterly increase in sales, and could be an important part of our overall business in the future.

During the quarter ended September 30, 2007, we experienced a 26% sequential dollar increase in net sales in South America, to $41.1 million, accounting for 59% of our total net sales, as compared to $32.5 million or 56% for the quarter ended June 30, 2007.  This increase is consistent with the seasonal demand we have experienced in South America in prior third quarters.  Our Central America region continued to show strong sales, sequentially increasing 11% to $22.6 million, accounting for 33% of our net sales in the quarter ended September 30, 2007, compared to $20.3 million, accounting for 35% of our net sales in the quarter ended June 30, 2007.  The addition of the verykool and LG products during the year has assisted with manufacturer diversification for Central and South America.  In the United States, we experienced a sequential increase in net sales to $5.7 million, accounting for 8% of our total net sales, as compared to $5.4 million or 9% for the quarter ended June 30, 2007.  We believe our United States customer base is in a transitional stage as regional carriers, including some of InfoSonics’ customers have entered into agreements to be acquired by AT&T Inc., T-Mobile USA and Verizon Wireless.  We are currently evaluating the potential impact of these announced acquisitions and our opportunities in the United States.

Results of Operations

Three Months Ended September 30, 2007 and 2006

Net Sales

For the three months ended September 30, 2007, our net sales of $69.4 million are comparable to our sales of $67.6 million for the same period of 2006.  Handsets sold in the third quarter 2007 increased 28% as compared to the third quarter of 2006; however, this increase was offset by a decrease in the average selling price of 24%. The geographic mix of net sales shifted in the third quarter of 2007 as sales in the United States increased to 8% of net sales, as compared to 3% of net sales for the third quarter of 2006.  Sales in Central America represented 33% of our total quarterly net sales in the quarter ended September 30, 2007 as compared to 24% in the quarter ended September 30, 2006.  Our South America region continued to represent the majority of our business, accounting for 59% of our net sales in the third quarter of 2007 as compared to 73% of our net sales for the third quarter of 2006.  This regional shift in net sales was the result of increases in Central America and the United States regions, as well as a decrease in South America regional sales as compared to the third quarter of 2006.  On a sequential basis however we experienced increases of 25%, 13% and 7% for South America, Central America and the Untied States, respectively.  

 

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In South and Central America we have expanded our customer base as well as our geographic presence, which has resulted in increased net sales. Conversely, our customer base in the United States has been negatively impacted by the pending acquisition of two of our significant customers by larger carriers. As a result of these acquisitions, we aggressively reduced our US inventory, some of which was sold at prices below our costs. We continued progress with our proprietary verykool line of products with sales and marketing efforts in Central and South America, resulting in verykool products nearly tripling in volume for quarter ended September 30, 2007 as compared to the quarter ended June 30, 2007. In Central America, we increased sales 38% to $22.6 million for the quarter ended September 30, 2007, compared to $16.4 million in the same quarter for 2006. In South America, sales were $41.1 million for the quarter ended September 30, 2007, a 20% decrease from $49.1 million in the same quarter in 2006.

 

 

Net Sales by Geographic Region

 

Cost of Sales, Gross Profit and Gross Margin

For the quarter ended September 30, 2007, cost of sales was $66.7 million, or 96.2% of net sales, compared with $62.2 million, or 92.0% of net sales, for the quarter ended September 30, 2006. The increase in our total cost of sales was primarily the result of an aggressive move to decrease our US inventory as a response to the pending acquisitions of some of our US customers, as well as product mix during the third quarter of 2007, as the mix was more weighted towards lower margin products.  Our OEM manufacturing partners continued in the low-tier handset range which had less margin opportunity than mid-tier and high-end handsets. The aggressive move to decrease our US inventory resulted in a one-time incremental cost of goods sold of $1.3 million. Without this planned inventory reduction, gross margin for the quarter ended September 30, 2007 would have been 6.1%, as compared to 8.0% for the quarter ended September 30, 2006 and would have been a sequential increase from the 5.5% gross margin for the quarter ended June 30, 2007.  Our gross margin continues to be impacted by the change of product and regional mix of our sales, as different products and different regions have varying margins.

For the quarter ended September 30, 2007, our gross profit decreased to $2.7 million from $5.4 million, compared with the same quarter last year, a decrease of 51%. This decrease in gross profit was primarily the result of our aggressive one-time move to reduce US inventory, in addition to our product mix and the lower margin products introduced earlier in the year to the market by our manufacturing partners reduced gross margin.

 

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Operating Expenses and Operating Income (Loss) from Continuing Operations

For the quarter ended September 30, 2007, operating expenses decreased 12%, compared with the same quarter last year. As a percentage of net sales, operating expenses were 5.6% in the quarter ended September 30, 2007, compared with 6.6% in the same quarter last year.  During the quarter ended September 30, 2007, we incurred $40,000 or 0.1% of net sales, of non-cash expense relating to stock options, compared to $133,000, or 0.2% of net sales, for the quarter ended September 30, 2006.  The decrease, excluding non-cash expense, was primarily the result of decreased sales in South America which reduced the amount of profit sharing expense during the quarter ended September 30, 2007.  As well, we continued our investments in facilities, marketing, engineering and product and market development, predominantly attributable to our proprietary verykool™ product line.  We believe such investments are necessary to help build a solid foundation for our business including our verykool™ products for potential future growth.

For the quarter ended September 30, 2007, our operating loss from continuing operations was $1.2 million, including the one-time $1.3 million cost relating to the incremental cost of goods sold to sell certain US inventory, compared with operating income from continuing operations of $975,000 for the quarter ended September 30, 2006, a decrease of 227%. As a percentage of net sales, operating loss from continuing operations was 1.8% for the quarter ended September 30, 2007, compared to income of 1.4% for the quarter ended September 30, 2006. The decrease in operating income from continuing operations was a result of the increase in cost of goods sold discussed above.

Operating Expenses

 

Operating Income (Loss) from Continuing Operations

 

 

Other Income (Expense)

During the quarter ended September 30, 2007, we incurred $352,000 of interest expense, compared to interest income of $47,000 for the same period last year.  We expect to regularly utilize larger amounts on our revolving line of credit, which will increase our interest expense in future periods.  In addition we received $2.1 million in compensation due to our agreement to an early termination and relocation for our corporate headquarters.

Other Income

 

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Net Income (Loss)

During the quarter ended September 30, 2007, our net income was $373,000, compared to net income of $677,000 in the same period last year.  This decrease in net income was primarily related to the factors discussed above, including our increased cost of goods sold related to the move to sell our US inventory as well as reduced gross margin opportunities on low-tier products and increased operational expenses and investments relating primarily to our proprietary line of verykool™ products. These costs were offset by a benefit from the compensation received for our agreement to an early termination and relocation of our corporate headquarters.

Nine Months Ended September 30, 2007 and 2006

Net Sales

For the nine months ended September 30, 2007, our net sales of $186.0 million were comparable to our net sales of $180.0 million for the nine months ended September 30, 2006.  Handsets sold during the nine months ended September 30, 2007 increased 19% as compared to the same period in 2006; however, this increase was offset by a decrease in the average selling price of 24%. The geographic mix of net sales shifted for the nine months ended September 30, 2007, as compared to the same period of 2006.  Sales in the United States increased to 12% of net sales for the first nine months in 2007, as compared to 4% of net sales for the same period in 2006.  In contrast, our net sales in Central America decreased to 29% of our net sales for the first nine months of 2007, as compared to 33% of net sales for the same period 2006.  Our South America region continued to represent the majority of our business, accounting for 59% of our net sales for 2007, as compared to 63% for 2006.  This regional shift in net sales was the result of two primary factors.  Product availability in the United States increased during the first quarter of 2007, enabling us to sell more products to our customers.  However, in contrast, the Central America region had excess inventory in the channel during the first quarter of 2007, reducing sales and gross margin opportunity.  The channel inventory began to return to normalized levels during the second quarter of 2007, and during the third quarter of 2007 Central America achieved the highest quarterly sales level of 2007.  In South America, our efforts enabled sales to new customers and additional sales to existing customers.  This region continues to experience a general increase in handset sales, and we have opened accounts in new South American countries.  For the nine months ended September 30, 2007, we incurred a net loss of $0.6 million, or $0.04 per diluted share, as compared to net income of $2.0 million, or $0.13 per diluted share, in the nine months ended September 30, 2006.

 

Net Sales by Geographic Region

 

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Cost of Sales, Gross Profit and Gross Margin

 

For the nine months ended September 30, 2007, cost of sales was $177.0 million, or 95.2% of net sales, compared with $166.0 million, or 92.3% of net sales, for the nine months ended September 30, 2006. The increase in our total cost of sales was a direct result of many factors including our increased sales levels on a consolidated basis, the one-time increased costs related to the sales of certain US inventory during the third quarter of 2007, as well as increased product mix of higher cost products. In the Central America region, during the first quarter of 2007, a significant decrease in handset demand as a result of industry-wide excess inventory in the channel for that particular region also impacted our ability to sell higher-margin products. During the second quarter of 2007, we began to see channel inventory returning to normalized levels in Central America, and during the third quarter of 2007, Central America reached it highest quarterly sales of 2007. Our gross margin continues to be impacted by the change of product and regional mix of our sales, as different products and different regions can have varying margins. During the first nine months of 2007 gross margins was negatively impacted as one of our manufacturers entered into the low-tier handset range. In addition, during the third quarter of 2007, we incurred an increase in cost of goods sold to sell some of our US inventory, due to pending acquisitions which could have a significant impact on our US customer base.

 

For the nine months ended September 30, 2007, our gross profit decreased to $9.0 million from $13.9 million, compared with the same period last year, a decrease of 35%. The decrease in gross profit was primarily the result of increased sales of low-tier products having lower margins, high channel inventory levels in Central America during the first quarter of 2007, and the increase of cost of goods sold related to the sales of certain US products. These factors impacted gross margin potential in addition to decreasing the opportunity for sales of higher margin products.

 

Operating Expenses and Operating Income (Loss) from Continuing Operations

 

For the nine months ended September 30, 2007, operating expenses increased 1.3%, compared to the nine months ended September 30, 2006. As a percentage of net sales, operating expenses were 6.3% for the nine months ended September 30, 2007, as compared to 6.4% for the nine months ended September 30, 2006.  During the nine months ended September 30, 2007, we incurred expenses related primarily to our investments in facilities, marketing, engineering and product and market development, predominantly attributable to our proprietary verykool™ product line.  We believe such investments are necessary to help build a solid foundation for our business including the verykool™ products for potential future growth.

For the nine months ended September 30, 2007, our operating loss from continuing operations was $2.7 million, including a one-time $1.3 million cost relating to the incremental cost of goods sold to sell certain products in our US inventory, compared with income of $2.4 million for the nine months ended September 30, 2006, a decrease of 214%. As a percentage of net sales, operating loss from continuing operations was 1.5% for the nine months ended September 30, 2007, compared to income of 1.3% for the nine months ended September 30, 2006. The decrease in operating income from continuing operations was a result of the increase in operating expenses discussed above, in addition to the decrease in gross margin discussed above.

 

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