Simply, Inc. - Quarter Report: 2009 September (Form 10-Q)

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10 - Q

 

 

For the quarterly period ended September 30, 2009

 

OR

 

 

For the transition period from                to                

 

Commission File Number - 001-32217

 

InfoSonics Corporation

(Exact name of registrant as specified in its charter)

 

 

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 has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes  o No  o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

 

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 10, 2009, the Registrant had 14,184,147 shares outstanding of its $.001 par value common stock.

 

 

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InfoSonics Corporation and Subsidiaries

 

Quarterly Report on Form 10-Q For The Three and Nine Months Ended September 30, 2009

 

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PART I. FINANCIAL INFORMATION		2
Item 1.	Financial Statements	2
·	Consolidated Balance Sheets at September 30, 2009 (unaudited) and December 31, 2008	2
·	Consolidated Statements of Operations for the three and nine months ended September 30, 2009 and 2008 (unaudited)	3
·	Consolidated Statements of Comprehensive Operations for the three and nine months ended September 30, 2009 and 2008 (unaudited)	4
·	Consolidated Statements of Cash Flows for the nine months ended September 30, 2009 and 2008 (unaudited)	5
·	Condensed Notes to Consolidated Financial Statements (unaudited)	6
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 4T.	Controls and Procedures	25
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	29
Item 3.	Defaults Upon Senior Securities	29
Item 4.	Submission of Matters to a Vote of Security Holders	29
Item 5.	Other Information	29
Item 6.	Exhibits	29

 

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Part I.  FINANCIAL INFORMATION

 

Item 1.  Financial Statements

 

InfoSonics Corporation and Subsidiaries

Consolidated Balance Sheets

 

		September 30, 2009			December 31, 2008
		(unaudited)			(audited)
ASSETS
Current assets:
Cash and cash equivalents		$	14,711,099		$	24,714,753
Accounts receivable, net of allowance for doubtful accounts of $582,046 (unaudited) and $429,126		54,692,864			22,727,738
Other receivables		610,166			4,209,658
Inventory, net of reserves of $119,556 (unaudited) and $161,556		3,839,635			4,375,334
Prepaids		562,290			244,103
Assets of discontinued operations		3,014,776			3,264,817
Total current assets		77,430,830			59,536,403
Property and equipment, net		410,175			498,079
Intangible assets		504,000			504,000
Other assets		205,268			115,900
Total assets		$	78,550,273		$	60,654,382
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable		$	10,824,366		$	10,982,306
Accrued expenses		9,240,740			7,304,090
Line of credit		30,066,060			14,273,978
Income taxes payable		46,021			24,100
Liabilities of discontinued operations		1,365,226			1,310,434
Total current liabilities		51,542,413			33,894,908
Total liabilities		51,542,413			33,894,908
Commitments and Contingencies (Note #13)
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; 14,745,755 and 15,010,807 shares issued and 14,184,147 and 14,956,270 shares outstanding as of September 30, 2009 and December 31, 2008, respectively		14,184			14,956
Treasury stock, at cost, 561,608 and 54,537 shares as of September 30, 2009 and December 31, 2008, respectively		(434,381		)	(16,900		)
Additional paid-in capital		31,715,535			31,666,434
Accumulated other comprehensive loss		(5,632		)	(25,211		)
Accumulated deficit		(4,281,846		)	(4,879,805		)
Total stockholders’ equity		27,007,860			26,759,474
Total liabilities and stockholders’ equity		$	78,550,273		$	60,654,382

 

Accompanying notes are an integral part of these financial statements.

 

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InfoSonics Corporation and Subsidiaries

Consolidated Statements of Operations

(unaudited)

 

		For the Three Months Ended September 30,						For the Nine Months Ended September 30,
		2009			2008			2009			2008
Net sales		$	65,261,978		$	52,883,848		$	169,593,200		$	179,857,086
Cost of sales		60,928,056			49,982,339			157,832,519			170,141,235
Gross profit		4,333,922			2,901,509			11,760,681			9,715,851
Operating expenses		4,023,129			3,210,515			10,459,022			10,127,587
Operating income (loss) from continuing operations		310,793			(309,006		)	1,301,659			(411,736		)
Other income (expense)
Other income		7,322			653,181			7,575			582,700
Interest expense, net		(79,828		)	(33,735		)	(217,005		)	(477,456		)
Income (loss) from continuing operations before provision for income taxes		238,287			310,440			1,092,229			(306,492		)
Provision for income taxes		(6,300		)	(128,410		)	(23,100		)	(1,054		)
Income (loss) from continuing operations		231,987			182,030			1,069,129			(307,546		)
Loss from discontinued operations, net of tax (Note #11)		(46,755		)	(80,633		)	(406,384		)	(2,237,452		)
Net income (loss)		$	185,232		$	101,397		$	662,745		$	(2,544,998	)
Basic earnings (loss) per share
From continuing operations		$	0.02		$	0.01		$	0.07		$	(0.02	)
From discontinued operations		$	(0.01	)	$	(0.01	)	$	(0.02	)	$	(0.15	)
Net income (loss)		$	0.01		$	0.01		$	0.05		$	(0.17	)
Diluted earnings (loss) per share
From continuing operations		$	0.02		$	0.01		$	0.07		$	(0.02	)
From discontinued operations		$	(0.01	)	$	(0.01	)	$	(0.03	)	$	(0.15	)
Net income (loss)		$	0.01		$	0.01		$	0.04		$	(0.17	)
Basic weighted-average number of common shares outstanding		14,184,147			14,910,808			14,550,416			14,850,469
Diluted weighted-average number of common shares outstanding		14,932,300			15,298,685			14,874,702			14,850,469

 

Accompanying notes are an integral part of these financial statements.

 

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InfoSonics Corporation and Subsidiaries

Consolidated Statements of Comprehensive Operations

(unaudited)

 

		For the Three Months Ended September 30,						For the Nine Months Ended September 30,
		2009			2008			2009			2008
Net profit income (loss)		$	185,232		$	101,397		$	662,745		$	(2,544,998	)
Other comprehensive income (loss):
Foreign currency translation adjustments		4,691			(3,504		)	19,580			(7,407		)
Comprehensive income (loss)		$	189,923		$	97,893		$	682,325		$	(2,552,405	)

 

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,
		2009			2008
Cash flows from operating activities:
Net income (loss)		$	662,745		$	(2,544,998	)
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities
Depreciation		223,364			498,782
Provision for bad debt		152,920			(131,016		)
Impairment on fixed assets		—			(13,126		)
Provision for obsolete inventory		(42,000		)	(322,882		)
Stock option and stock grant expense		49,101			67,481
(Increase) decrease in
Accounts receivable		(32,118,046		)	133,197
Other receivable		3,599,492			(3,434,937		)
Inventory		577,699			5,497,980
Prepaids		(318,187		)	313,548
Other assets		(89,368		)	(7,412		)
Deferred tax asset current		—			(67,340		)
Deferred tax asset non current		—			(53,118		)
Increase (decrease) in
Accounts payable		(157,940		)	(8,961,021		)
Accrued expenses		1,936,650			6,445,564
Income tax liabilities		21,921			(39,560		)
Cash used in continuing operations		(25,501,649		)	(2,618,858		)
Cash provided by discontinued operations		304,833			5,042,304
Net cash provided by (used in) operating activities		(25,196,816		)	2,423,446
Cash flows from investing activities:
Purchase of property and equipment		(136,891		)	125,038
Cash used in discontinued operations		—			(192,142		)
Net cash used in investing activities		(136,891		)	(67,104		)
Cash flows from financing activities:
Borrowings from line of credit		192,070,828			186,370,107
Payments on line of credit		(176,278,746		)	(199,215,710		)
Cash received from stock options		—			34,286
Cash paid for treasury stock		(483,040		)	—
Cash provided by (used in) discontinued operations		—			—
Net cash provided by (used in) financing activities		15,309,042			(12,811,317		)
Effect of exchange rate changes on cash		21,011			(7,405		)
Net decrease in cash and cash equivalents		(10,003,654		)	(10,462,380		)
Cash and cash equivalents, beginning of period		24,714,753			20,652,154
Cash and cash equivalents, end of period		$	14,711,099		$	10,189,774
Cash paid for interest		217,013			513,999
Cash paid for taxes		—			—

 

Non-Cash Supplemental Disclosure:

 

During the nine months ended September 30, 2009, $4.15 million of the accrued legal settlement was paid by the insurance carrier and the corresponding receivable and liability have been reduced. (see Note #7 to the Company’s’ financial statements)

 

During the nine months ended September 30, 2009, the Company retired 265,053 shares of its treasury stock.  The retirement reduced treasury stock and increased accumulated deficit by $65,559.

 

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, 2008 included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2008.  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 Corporation Chile y Compania Limitada, InfoSonics Colombia S.A. and verykool USA, Inc., 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 as of September 30, 2009, the unaudited consolidated statements of operations and the unaudited consolidated statements of comprehensive operations for the three and nine months ended September 30, 2009 and the unaudited consolidated statement of cash flows for the nine months ended September 30, 2009 are not necessarily indicative of the financial condition, operating results or cash flows that may be expected for the full fiscal year of 2009 or for any future period.

 

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 authorizes the grant of up to 1,000,000 shares for equity incentives.  As of September 30, 2009, options to purchase 388,500 shares were outstanding under the 2006 Plan and options to purchase 112,000 shares have been exercised or forfeited under the 2006 Plan. The Company is also a party to non-plan option agreements with several non-employee directors and several institutions.

 

The Company’s stock-based compensation is classified in the same expense line items as cash compensation.   Information about stock-based compensation included in the unaudited results of operations for the three and nine months ended September 30, 2009 and 2008 is as follows:

 

		For the Three Months Ended September 30,						For the Nine Months Ended September 30,
		2009			2008			2009			2008
Officer compensation		$	3,145		$	—		$	6,765		$	—
Non-employee directors		1,425			3,451			2,376			10,353
Sales, general and administrative		12,970			34,809			39,960			57,128
Total stock option expense, included in total operating expenses		$	17,540		$	38,260		$	49,101		$	67,481

 

Our stock options vest on an annual or a monthly basis.  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.   Such amounts may change as a result of additional grants, forfeitures, modifications in assumptions and other factors. Income tax effects of share-based payments are

 

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recognized in the financial statements for those awards which will normally result in tax deductions under existing tax law. During the three and nine months ended September 30, 2009, we recorded an expense of $17,540 and $49,101, respectively, related to options previously granted and options granted during the three and nine months ended September 30, 2009. During the three and nine months ended September 30, 2008, we recorded an expense of $38,260 and $67,481, respectively, related to options previously granted and options granted during the three and nine months ended September 30, 2008. Under current U.S. federal tax law, we 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 operations.

 

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 2008 and 2009: risk-free interest rate of 1.47% in 2008 and 0.91% in 2009, based on the U.S. Treasury yields in effect at the time of grant; expected dividend yields of 0% as the Company has not, and does not intend to, issue dividends; and expected lives of 3 to 6 years based upon the historical life of options. For grants in 2008 and 2009, the expected volatility used ranged from 88% to 108%, based on the Company’s historical stock price fluctuations for a period matching the expected life of the options.  As of September 30, 2009, there was $151,000 of total unrecognized compensation costs related to the non-vested stock options.  That cost is expected to be recognized over the remaining weighted-average period of 4.25 years.

 

A summary of option activity under all of the above plans as of September 30, 2009 and changes during the nine months then ended is presented in the table below:

 

		Shares		Wtd. Avg. Exercise Price			Wtd. Avg. Remaining Contractual Life		Aggregate Intrinsic Value
Outstanding at December 31, 2008		1,575,944		$	1.46		2.73		—
Granted		252,500		$	0.51		6.64		—
Exercised		—		$	—				—
Forfeited		72,500		$	1.52				—
Outstanding at September 30, 2009		1,755,944		$	1.32		2.91		—
Vested and expected to vest		1,755,944		$	1.32		2.91		—
Exercisable at September 30, 2009		1,434,763		$	1.45		2.18		—

 

A summary of the status of the Company’s non-vested options at September 30, 2009 and changes during the nine months ended September 30, 2009 is presented below:

 

		Shares		Weighted-average grant-date fair value
Non-vested at December 31, 2008		146,660		$	1.27
Granted		252,500		$	0.51
Vested		37,979		$	1.14
Forfeited		40,000		$	1.04
Non-vested at September 30, 2009		321,181		$	0.72

 

NOTE 3. Earnings Per Share

 

Basic earnings per share are 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.

 

Common shares from the potential 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 and nine months ended September 30, 2009, the number of shares excluded was 1,007,791 and 1,431,657, respectively.  For the three months ended September 30, 2008 the number of shares excluded was 2,957,628.

 

Since their effect would have been anti-dilutive for the nine months ended September 30, 2008, 3,150,644 common shares from the potential exercise of certain options and warrants have been excluded from the computation of net loss per share for the nine months ended September 30, 2008.

 

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NOTE 4. Income Taxes

 

The Company made a comprehensive review of its portfolio of uncertain tax positions in accordance with recognition standards established for certain tax positions. 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. At the date of adoption, and as of December 31, 2008 and September 30, 2009, the Company does not have a liability for unrecognized tax benefits.   The Company concluded that at this time there are no uncertain tax positions. There was no cumulative effect on retained earnings.

 

The Company is subject to U.S. federal income tax as well as income tax in multiple states and foreign jurisdictions. For all major taxing jurisdictions, the tax years 2003 through 2008 remain open to examination. As of September 30, 2009, the Company does not expect any material changes to unrecognized tax positions within the next twelve months.

 

The Company recognizes 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.  For the nine months ended September 30, 2009, deferred income tax assets and the corresponding valuation allowance increased by $1,638,612.

 

NOTE 5. Inventory

 

Inventory is stated at the lower of cost (first-in, first-out) or market and consists primarily of cellular phones and cellular phone accessories.  The Company provides for the possible inability to sell its inventory by recording a reserve.  As of September 30, 2009 and December 31, 2008, the inventory reserve was $119,556 and $161,556, respectively.  From time to time, the Company has prepaid inventory as a result of payments for products which have not been received by the balance sheet date.  As of September 30, 2009 and December 31, 2008, the prepaid inventory balances were $308,120 and $170, respectively which are included in prepaids in the accompanying consolidated balance sheets.  Included in Assets of Discontinued Operations as of September 30, 2009 and December 31, 2008 are inventory balances of $1,069,434 and $1,307,463, respectively.    Inventory consisted of the following:

 

		September 30, 2009			December 31, 2008
		(unaudited)			(audited)
Finished goods		$	3,626,970		$	4,536,890
Inventory in-transit		332,221			—
Inventory reserve		(119,556		)	(161,556		)
Net inventory		$	3,839,635		$	4,375,334

 

NOTE 6. Property and Equipment

 

Property and equipment are primarily located in the United States, with the exception of certain tooling and product molds which are located in Asia, and consisted of the following as of the dates presented:

 

		September 30, 2009 (unaudited)			December 31, 2008 (audited)
Machinery and equipment		$	453,030		$	469,411
Furniture and fixtures		106,314			106,314
Tooling and molds		482,668			330,828
Subtotal		1,042,012			906,553
Less accumulated depreciation		631,837			408,474
Total		$	410,175		$	498,079

 

Depreciation expense was $102,156 and $223,364 for the three and nine months ended September 30, 2009, respectively, and $161,725 and $498,782 for the three and nine months ended September 30, 2008, respectively.

 

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NOTE 7. Accrued Expenses

 

As of September 30, 2009 and December 31, 2008, accrued expenses consisted of the following:

 

		September 30, 2009 (unaudited)			December 31, 2008 (audited)
Accrued product costs		$	6,092,978		$	3,070,058
Accrued legal settlement*		—			4,150,000
Other accruals (including taxes)**		3,147,762			84,032
Total		$	9,240,740		$	7,304,090

 

*   As of September 30, 2009, $4.15 million of the accrued legal settlement was paid by our insurance carrier and is being held in an escrow account for the benefit of the plaintiffs of the class action lawsuit and derivative suit, and thus has been removed from the balance sheet at September 30, 2009.

 

** This amount includes general accruals, amounts held on behalf of our vendor partners, and potential amounts owed to operational partners.

 

NOTE 8. Borrowings

 

On April 30, 2008, the Company entered into a Loan, Security and Bulk Purchase Agreement and a Letter of Credit and Security Agreement (collectively, the “Agreement”) with Wells Fargo Century, Inc. (“Lender”), replacing the then-existing asset-based secured credit facility with Wells Fargo HSBC Trade Bank, N.A.  Pursuant to the Agreement, the Lender may advance up to $45,000,000 to the Company based on the expected collections of eligible receivables as well as value of the Company’s eligible inventory determined in accordance with the Agreement.  The outstanding advances may not exceed the lesser of (i) $45,000,000 or (ii) the sum of the value of the eligible receivables and eligible inventory multiplied by their respective advance rates as set forth in the Agreement.  At September 30, 2009, the majority of our debt was based on foreign accounts receivable, a majority of which is insured.  This credit facility has a two-year term ending April 2010 and is secured by all of the assets of the Company. The interest rate for each borrowing under the credit facility is, at the option of the Company, either the Wells Fargo Bank N.A. prime rate minus 0.50% (3.25% less 0.50%  at September 30, 2009) or the LIBOR rate plus 2.00% (0.298% plus 2.00% at September 30, 2009).  At September 30, 2009, the amount drawn against the Lender line of credit was $30,066,060 and the total amount available at September 30, 2009 was $41,156,101.  As of September 30, 2009, the Company was in compliance with the covenants of the credit facility.  If any adverse events occur or we are unable to renew our credit facility or enter into an adequate credit relationship as needed, our business’ financial condition or operating results could be negatively affected.

 

The Company has no other notes payable.

 

NOTE 9. Stockholders’ Equity

 

Stock Options

 

Effective March 18, 2008 and May 13, 2008, the Company granted options to purchase an aggregate of 180,500 and 2,500 shares, respectively, of its common stock to certain non-executive employees (the “Employee Options”). One-fourth of the total shares subject to these options became exercisable one year from the date of grant, and 1/48th of the total shares subject to these options become exercisable each month thereafter until fully vested.  These options have exercise prices of $1.04 per share, which was the closing price per share of the Company’s common stock on each of March 18, 2008 and May 13, 2008, and expire six years from the date of grant. See Note 2 for Stock-Based Compensation discussion.

 

Effective May 19, 2009, the Company granted options to purchase an aggregate of 252,500 shares, of its common stock to certain executive and non-executive employees and the members of the Board of Directors (the “Employee Options”). One-fourth of the total shares subject to these options become exercisable one year from the date of grant, and 1/48th of the total shares subject to the options become exercisable each month thereafter until fully vested.  These options have exercise prices of $0.51 per share, which was the closing price per share of the Company’s common stock on May 19, 2009, and expire six years from the date of grant. See Note 2 for Stock-Based Compensation discussion.

 

Treasury Stock

 

On December 15, 2008, the Company announced a share buyback program, authorizing up to $500,000 to be used for stock repurchases.  As of September 30, 2009 and December 31, 2008, we had purchased 826,661 and 54,537 shares, respectively, at a total cost of $499,994 and $16,955, respectively.  During the nine months ended September 30, 2009, the Company retired 265,053 shares of stock.  The retirement reduced treasury stock and increased the accumulated deficit by $65,559.

 

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NOTE 10. Recent Accounting Pronouncements

 

Recently Adopted:

 

In September 2006, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards No. 157, Fair Value Measurements (SFAS No. 157).  SFAS No. 157 defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurement.  SFAS No. 157 also emphasizes that fair value is a market-based measurement, not an entity-specific measurement, and sets out a fair value hierarchy with the highest priority being quoted prices in active markets.  Under SFAS No. 157, fair value measurements are disclosed by level within that hierarchy.  In February 2008, the FASB issued FASB Staff Position No. 157-2, Effective Date of FASB Statement No. 157, which permitted a one-year deferral for the implementation of SFAS No. 157 with regard to nonfinancial assets and liabilities that are not recognized or disclosed at fair value in the financial statements on a recurring basis.  The Company adopted SFAS No. 157 for the fiscal year beginning January 1, 2008, except for nonfinancial assets and nonfinancial liabilities that are recognized or disclosed at fair value in the financial statements on a nonrecurring basis, which was adopted in the first quarter of 2009.  The adoption of the remaining provisions of SFAS No. 157 did not have a material impact on the Company’s condensed consolidated financial statements.

 

In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements — an amendment of ARB No. 51,” (SFAS 160).  SFAS 160 amends Accounting Research Bulletin 51, “Consolidated Financial Statements to establish accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary.” This standard defines a noncontrolling interest, sometimes called a minority interest, as the portion of equity in a subsidiary not attributable, directly or indirectly, to a parent. SFAS 160 requires, among other items, that a noncontrolling interest be included in the consolidated statement of financial position within equity separate from the parent’s equity; consolidated net income to be reported at amounts inclusive of both the parent’s and noncontrolling interest’s shares and, separately, the amounts of consolidated net income attributable to the parent and noncontrolling interest all on the consolidated statement of income; and if a subsidiary is deconsolidated, any retained noncontrolling equity investment in the former subsidiary be measured at fair value and a gain or loss be recognized in net income based on such fair value. SFAS 160 became effective for the Company on January 1, 2009. The adoption of SFAS 160 did not have a material impact to our condensed consolidated financial statements.

 

In March 2008, the FASB issued SFAS No. 161, “Disclosures and Derivative Instruments and Hedging Activities — an amendment of FASB Statement No. 133, (“SFAS No. 161”), which requires additional disclosures about objectives and strategies for using derivative instruments, how the derivative instruments and related hedged items are accounted for under SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities” and related interpretations, and how the derivative instruments and related hedged items affect our financial statements. SFAS No. 161 also requires disclosures about credit risk-related contingent features in derivative agreements. The adoption of SFAS No. 161 did not have a material impact to our condensed consolidated financial statements as the Company does not have derivative instruments for purposes of hedging activities.

 

In May 2008, the FASB issued FASB Staff Position (“FSP”) No. APB 14-1, “Accounting for Convertible Debt Instruments That May be Settled in Cash upon Conversion (Including Partial Cash Settlement).” FSP No. APB 14-1 nullifies EITF Issues No. 90-19 and No. 03-7 and amends No. 98-5, No. 99-1, No. 00-27, No. 04-8, No. 05-1 and No. 06-7. This FSP applies to convertible debt instruments that, by their stated terms, may be settled in cash (or other assets) upon conversion, including partial cash settlement, unless the embedded conversion option is required to be separately accounted for as a derivative under FASB No. 133, “Accounting for Derivative Instruments and Hedging Activities.” Under this FSP, companies are required to separately account for the liability and equity components of convertible debt by first determining the carrying amount of the liability component by measuring the fair value of a similar liability that does not have an associated equity component and then determining the carrying amount of the equity component embedded in the instrument by deducting the fair value of the liability component from the initial proceeds ascribed to the convertible debt instrument as a whole. The carrying amount of the equity component will then be amortized over the expected life of the debt to interest expense. The Company adopted the FSP during the first quarter of 2009, which did not have a material impact to the condensed consolidated financial statements as the Company does not have convertible notes outstanding which can be converted in whole or in part, to cash.

 

In December 2007, the FASB issued SFAS No. 141(R), “Business Combinations,” (SFAS 141(R)). SFAS 141(R) replaces SFAS No. 141, “Business Combinations,” (SFAS 141) and retains the fundamental requirements in SFAS 141, including that the purchase method be used for all business combinations and for an acquirer to be identified for each business combination. This standard defines the acquirer as the entity that obtains control of one or more businesses in the business combination and establishes the acquisition date as the date that the acquirer achieves control instead of the date that the consideration is transferred. SFAS 141(R) requires an acquirer in a business combination, including business combinations achieved in states (step acquisition), to recognize the assets acquired, liabilities assumed, and any noncontrolling interest in the acquire at the acquisition date, measured at their fair values of that date, with limited exceptions. It also requires the recognition of assets acquired and liabilities assumed arising from certain contractual contingencies as of the acquisition date, measured at their acquisition-date fair values. SFAS 141(R) became effective for the Company on January 1, 2009. The adoption of SFAS No. 141(R) did not have a material impact to our consolidated financial statements as the Company did not make any acquisitions in the first three quarters of 2009.

 

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In June 2008, the FASB ratified EITF 07-5, “Determining Whether an Instrument (or Embedded Feature) Is Indexed to an Entity’s Own Stock,” (“EITF 07-5”). Paragraph 11(a) of SFAS No. 133, “Accounting for Derivatives and Hedging Activities, (“SFAS 133”) specifies that a contract that would otherwise meet the definition of a derivative but is both (a) indexed to the Company’s own stock and (b) classified in stockholders’ equity in the statement of financial position would not be considered a derivative financial instrument. EITF 07-5 provides a new two-step model to be applied in determining whether a financial instrument or an embedded feature is indexed to an issuer’s own stock and thus able to qualify for the SFAS 133 paragraph 11(a) scope exception. EITF 07-5 became effective for the Company beginning January 1, 2009. The ratification of EITF 07-5 did not have a material impact on the Company’s condensed consolidated financial statements.

 

On June 30, 2009, we adopted Statement of Financial Accounting Standards (SFAS) No. 165, “Subsequent Events,” (SFAS 165). SFAS 165 establishes general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or are available to be issued. Specifically, SFAS 165 sets forth the period after the balance sheet date during which management of a reporting entity should evaluate events or transactions that may occur for potential recognition or disclosure in the financial statements, the circumstances under which an entity should recognize events or transactions occurring after the balance sheet date in its financial statements, and the disclosures that an entity should make about events or transactions that occurred after the balance sheet date. The adoption of SFAS 165 did not have a material impact on the Company’s condensed consolidated financial statements.

 

On June 30, 2009, we adopted FASB Staff Position (FSP) No. FAS 157-4, “Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly,” (FSP FAS 157-4). FSP FAS 157-4 provides additional guidance for estimating fair value in accordance with SFAS 157 when the volume and level of activity for the asset or liability have significantly decreased and includes guidance for identifying circumstances that indicate a transaction is not orderly. This guidance is necessary to maintain the overall objective of fair value measurements, which is that fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date under current market conditions. The adoption of FSP FAS 157-4 had no impact on the condensed consolidated financial statements.

 

On June 30, 2009, we adopted FSP No. FAS 115-2 and FAS 124-2, “Recognition and Presentation of Other-Than-Temporary Impairments,” (FSP FAS 115-2/124-2). FSP FAS 115-2/124-2 amends existing other-than-temporary impairment guidance for debt securities to make the guidance more operational and to improve the presentation and disclosure of other-than-temporary impairments on debt and equity securities. The adoption of FSP FAS 115-2/124-2 had no impact on the condensed consolidated financial statements.

 

On June 30, 2009, we adopted FSP No. FAS 107-1 and APB 28-1, “Interim Disclosures about Fair Value of Financial Instruments,” (FSP FAS 107-1/APB 28-1). FSP FAS 107-1/APB 28-1 requires a publicly traded company to include disclosures about the fair value of its financial instruments whenever it issues summarized financial information for interim reporting periods. Such disclosures include the fair value of all financial instruments, for which it is practicable to estimate that value, whether recognized or not recognized in the statement of financial position; the related carrying amount of these financial instruments; and the method(s) and significant assumptions used to estimate the fair value. The adoption of FSP FAS 107-1/APB 28-1 had no impact on the condensed consolidated financial statements.

 

Effective January 1, 2009, we adopted FSP No. FAS 141(R)-1, “Accounting for Assets Acquired and Liabilities Assumed in a Business Combination That Arise from Contingencies,” (FSP FAS 141(R)-1), which was issued on April 1, 2009. FSP FAS 141(R)-1 applies to all assets acquired and liabilities assumed in a business combination that arise from certain contingencies as defined in this FSP and requires (i) an acquirer to recognize at fair value, at the acquisition date, an asset acquired or liability assumed in a business combination that arises from a contingency if the acquisition-date fair value of that asset or liability can be determined during the measurement period otherwise the asset or liability should be recognized at the acquisition date if certain defined criteria are met; (ii) contingent consideration arrangements of an acquiree assumed by the acquirer in a business combination be recognized initially at fair value; (iii) subsequent measurements of assets and liabilities arising from contingencies be based on a systematic and rational method depending on their nature and contingent consideration arrangements be measured subsequently in accordance with the provisions of SFAS 141(R); and (iv) disclosures of the amounts and measurement basis of such assets and liabilities and the nature of the contingencies. The provisions of FSP FAS 141(R)-1 did not have a material impact to our condensed consolidated financial Statements, as the Company did not make any acquisitions in the first three quarters of 2009.

 

On January 1, 2009, we adopted FSP No. FAS 142-3, “Determination of the Useful Life of Intangible Assets,” (FSP FAS 142-3). FSP FAS 142-3 amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset under FASB Statement No. 142, “Goodwill and Other Intangible Assets,” (SFAS 142) in order to improve the consistency between the useful life of a recognized intangible asset under SFAS 142 and the period of expected cash flows used to measure the fair value of the asset under SFAS 141(R) and other GAAP. The adoption of FSP FAS 142-3 did not have a material impact to our condensed consolidated financial statements.

 

In June 2009, the Financial Accounting Standards Board (FASB) issued SFAS No. 168, “The FASB Accounting Standards CodificationTM and the Hierarchy of Generally Accepted Accounting Principles—a replacement of FASB Statement No. 162,” (SFAS 168). SFAS 168 replaces SFAS No. 162, “The Hierarchy of Generally Accepted Accounting Principles,” and establishes the FASB

 

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Accounting Standards CodificationTM (Codification) as the source of authoritative accounting principles recognized by the FASB to be applied by nongovernmental entities in the preparation of financial statements in conformity with GAAP. Rules and interpretive releases of the Securities and Exchange Commission (SEC) under authority of federal securities laws are also sources of authoritative GAAP for SEC registrants. The FASB will no longer issue new standards in the form of Statements, FASB Staff Positions, or Emerging Issues Task Force Abstracts; instead the FASB will issue Accounting Standards Updates. Accounting Standards Updates will not be authoritative in their own right as they will only serve to update the Codification. The issuance of SFAS 168 and the Codification does not change GAAP. SFAS 168 became effective for us for the period ended September 30, 2009. Management has determined that the adoption of SFAS 168 did not have a material impact on the condensed consolidated financial statements.

 

ISSUED (Not adopted yet):

 

In June 2009, Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards No. 166, “Accounting for Transfers of Financial Assets an amendment of FASB Statement No. 140” (“SFAS 166”). The objective of this statement is to improve the relevance, representational faithfulness, and comparability of the information that a reporting entity provides in its financial statements about a transfer of financial assets, the effects of a transfer on its financial position, financial performance, and cash flows; and a transferor’s continuing involvement, if any, in transferred financial assets. SFAS 166 is effective for fiscal years and interim periods beginning after November 15, 2009.  Management does not expect the adoption of SFAS 166 to have a material impact on the Company’s financial statements.

 

In June 2009, Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards No. 167, “Amendments to FASB Interpretation No. 46(R)” (“SFAS 167”).  This Statement amends Interpretation 46(R) to require ongoing reassessments of whether an enterprise is the primary beneficiary of a variable interest entity. Before SFAS 167, Interpretation 46(R) required reconsideration of whether an enterprise is the primary beneficiary of a variable interest entity only when specific events occurred.  This Statement amends Interpretation 46(R) to add an additional reconsideration event for determining whether an entity is a variable interest entity when any changes in facts and circumstances occur such that the holders of the equity investment at risk, as a group, lose the power from voting rights or similar rights of those investments to direct the activities of the entity that most significantly impact the entity’s economic performance.  SFAS 167 is effective as of the beginning of each reporting period that begins after November 15, 2009. Management does not expect the adoption of SFAS 167 to have a material impact on the Company’s financial statements.

 

In September 2009, the FASB issued Accounting Standards Update (ASU) No. 2009-13, Multiple-Deliverable Revenue Arrangements—a consensus of the FASB Emerging Issues Task Force (ASU 2009-13). It updates the existing multiple element revenue arrangements guidance currently included under ASC 605-25, which originated primarily from the guidance in EITF Issue No. 00-21, Revenue Arrangements with Multiple Deliverables (EITF 00-21). The revised guidance primarily provides two significant changes: 1) eliminates the need for objective and reliable evidence of the fair value for the undelivered element in order for a delivered item to be treated as a separate unit of accounting, and 2) eliminates the residual method to allocate the arrangement consideration. In addition, the guidance also expands the disclosure requirements for revenue recognition. ASU 2009-13 will be effective for the first annual reporting period beginning on or after June 15, 2010, with early adoption permitted provided that the revised guidance is retroactively applied to the beginning of the year of adoption. The Company is currently assessing the future impact of this new accounting update to its consolidated financial statements.

 

In September 2009, the FASB ratified final EITF Issue 08-01, Revenue Arrangements with Multiple Deliverables (EITF 08-01). EITF 08-01 supersedes EITF 00-21, primarily codified into Accounting Standards Update (“ASU”) No. 2009-13, and was issued in response to practice concerns related to the accounting for revenue arrangements with multiple deliverables under EITF 00-21. EITF 08-1 applies to all deliverables in contractual arrangements in all industries in which a vendor will perform multiple revenue-generating activities, except when some or all deliverables in a multiple deliverable arrangement are within the scope of other revenue recognition guidance. EITF 08-1 is effective for fiscal years beginning after June 15, 2010. The effects of the adoption, if any, of EITF 08-1 on our consolidated financial position, results of operations and cash flows have not been determined.

 

In September 2009, the FASB ratified final EITF 09-3, Software Revenue Recognition . Entities that sell tangible products containing both hardware elements and software elements that are currently within the scope of AICPA Statement of Position (“SOP”) Number 97-2, Revenue Recognition for Software Products with Multiple Deliverables , (“SOP 97-2”), primarily codified into ASU 2009-14. This Issue would amend EITF  03-05, Applicability of AICPA Statement of Position 97-2 to Non-Software Deliverables in an Arrangement Containing More-Than-Incidental Software , primarily codified into ASC 985-605, to exclude from their scope all tangible products containing both software and no software components that function together to deliver the product’s essential functionality. EITF 09-3 is effective for fiscal years beginning after June 15, 2010. The effects of the adoption, if any, of EITF 09-3 on our consolidated financial position, results of operations and cash flows have not been determined.

 

NOTE 11.  Discontinued Operations

 

During the quarter ended September 30, 2008, the Company assessed opportunities in the United States and Mexico, and the Company began to implement actions necessary to close sales operations in both of those countries, which actions continue, although were substantially completed by the end of 2008. These two areas accounted for less than 1% of our net sales in the first three and nine months of 2009 and 2008.  Due to the changing environment and consolidation in the United States of the regional cellular carriers, along with the challenges of opening sales relations with the cellular carriers in Mexico, management determined that it was necessary to take decisive actions to mitigate further losses.  The results of the unaudited discontinued operations are as follows:

 

		For the Three Months Ended						For the Nine Months Ended
		September 30,						September 30,
		2009			2008			2009			2008
Net Sales		$	6,210		$	113,876		$	489,558		$	847,312
Gross profit		(2,210		)	(4,568		)	(313,778		)	(1,328,603		)
Operating income (loss)		(46,755		)	(257,571		)	(406,384		)	(3,569,356		)
Identifiable assets		3,014,776			4,733,849			3,014,776			4,733,849
Capital expenditures		—			—			—			—
Depreciation and amortization		—			5,420			—			20,787

 

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Liabilities of discontinued operations consist primarily of accounts payable.  Assets of discontinued operations are as follows:

 

		September 30, 2009 (unaudited)			December 31,2008 (audited)
Accounts Receivable		$	1,038,613		$	1,050,758
Inventory		1,069,434			1,307,463
Prepaid Taxes		890,958			897,955
Other Assets		15,771			8,641
Total		$	3,014,776		$	3,264,817

 

As of September 30, 2009, the plans for the discontinued operations, although continuing to be implemented, were largely completed.  However, the Company expects to continue to record potentially significant adjustments and expenses through discontinued operations as necessary.

 

The Company has re-evaluated its discontinued operations as of September 30, 2009 in accordance with FAS 144 due to the Company’s remaining discontinued operations being outstanding for more than one year since the declaration to discontinue.

 

The remaining accounts receivable and accounts payable are part of an ongoing arbitration currently in process, the timing of which is out of the Company’s control to settle.  The prepaid taxes are in the process of being recovered from a foreign government, also out of the Company’s control to settle.  The remaining inventory has been marked to market and significantly discounted from the original cost to adjust for the unforeseen changes in the current economic condition and the markets for which the Company sells.  The final resolution of one or more of these items could result in a potentially significant adjustment.  The Company has taken action to reduce its prices to market and aggressively sell its remaining product. Pursuant to FAS 144, p.31, as these are out of the Company’s control, classification as discontinued operations is still deemed appropriate.

 

NOTE 12. Geographic Information

 

The Company currently operates in one business segment.  All fixed assets are located in Company or third party facilities in the United States and Asia. The unaudited net sales by geographical area for the three and nine months ended September 30, 2009 and 2008 were:

 

		For the Three Months Ended						For the Nine Months Ended
		September 30, 2009			September 30, 2008			September 30, 2009			September 30, 2008
Central America		$	6,974,909		$	8,826,072		$	15,713,223		$	43,519,895
South America		58,287,069			44,057,776			153,879,977			136,337,191
Total		$	65,261,978		$	52,883,848		$	169,593,200		$	179,857,086

 

The unaudited net sales for the Company’s discontinued operations in the United States and Mexico for the three months ended September 30, 2009 and 2008 were $6,210 and $113,876, respectively.  The unaudited net sales for the Company’s discontinued operations for the nine months ended September 30, 2009 and 2008 were $489,558 and $847,312, respectively.

 

NOTE 13.  Commitments and Contingencies

 

Securities Class Actions

 

InfoSonics has settled the securities class action against the Company and certain of its officers and directors, captioned In Re: InfoSonics Corporation Securities Litigation, Lead Case No. 06 CV 1231, filed in the United States District Court for the Southern District of California.  Plaintiffs’ third amended consolidated complaint had alleged 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.  On October 17, 2008, the parties entered a Stipulation and Agreement of Settlement (the “Securities Settlement”) of the case, which provides for, among other things, a dismissal with prejudice of the lawsuit, releases of the defendants, and a payment by the Company or its insurer of $3.8 million to plaintiffs (inclusive of any plaintiffs’ attorneys fees, to be determined by the Court).  The Securities Settlement further provides that defendants deny any liability or responsibility for the claims made and make no admission of any wrongdoing.  On February 10, 2009, the Company’s insurer funded the full settlement payment.  On May 5, 2009, the Court entered an order finally approving the Securities Settlement as fair and reasonable, and directing the clerk to enter final judgment and dismissing the action with prejudice. This settlement was fully funded and paid by the Company’s insurer.

 

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Derivative Action

 

InfoSonics has settled the derivative action purportedly on behalf of the Company against certain of its officers and directors, and the Company as a nominal defendant, captioned In Re InfoSonics Corporation Derivative Litigation, Lead Case No. 06 CV 1336, filed in the United States District Court for the Southern District of California.  Plaintiffs’ consolidated complaint had alleged 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.  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.  On October 17, 2008, the parties entered into a Stipulation and Agreement of Settlement (the “Derivative Settlement”), which provides for, among other things, a dismissal with prejudice of the lawsuit, releases of the defendants, corporate governance changes and a payment by the Company or its insurer of plaintiffs’ attorneys fees to be ordered by the Court up to a maximum of $350,000. The Derivative Settlement further provides that defendants deny any liability or responsibility for the claims made and make no admission of any wrongdoing. The Company’s insurer funded the full settlement payment.  On June 3, 2009, the Court approved the settlement and entered the final judgment and order of dismissal with prejudice of the case. This settlement was fully funded and paid by the Company’s insurer.

 

LG Electronics Litigation

 

On July 1, 2009, the Company filed suit in the Superior Court of the State of California, County of San Diego (the Superior Court) (Case No. 37-2009-00092797-CU-BT-CTL) against LG Electronics, Inc., LG Electronics USA, Inc., LG Electronics Panama S.A., LG Electronics Inc. Chile LTDA, LG Electronics Guatemala S.A. de C.V. (collectively LG) and DOES 1-10 (and together with LG, the Defendants).  The complaint alleges claims for interference with contractual relations/inducing breach of contract, intentional interference with prospective economic relations, negligent interference with prospective economic relations, breach of contract, breach of implied covenant of good faith and fair dealing, unjust enrichment, fraud, promissory estoppel and violation of California Business and Professions Code §§ 17200, et seq.  The Company is seeking in excess of $5 million in damages    On July 31, 2009, the Defendants removed the case to federal court in San Diego, CA.  The defendants have filed a motion to dismiss based on jurisdictional grounds.  Such motion is currently pending.

 

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, 2009, we did not have any significant litigation outstanding.

 

NOTE 14.  Fair Value of Financial Instruments

 

The Company’s financial instruments include cash and cash equivalents, accounts receivable, prepaid expenses, accounts payable and accrued expenses. The book value of all other financial instruments is representative of their fair values.

 

NOTE 15.  Subsequent Events

 

Management evaluated all activity through November 16, 2009 (the issue date of the condensed consolidated financial statements) and, except as noted below, concluded that no subsequent events have occurred that would require recognition in the condensed consolidated financial statements or disclosure in the Notes to the condensed consolidated financial statements.

 

Effective October 6, 2009, the Company entered a separation agreement with one of its executives.  Pursuant to the separation agreement, the Company made a lump sum severance payment of $75,000 (less withholdings), and in consideration for such payment, the executive provided a full release of all claims and the executive forfeited 463,500 (vested and unvested) options with a weighted average exercise price of $0.40.

 

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 and other information included in this report and our Annual Report on Form 10-K for the year ended December 31, 2008 (including our 2008 audited consolidated financial statements and related notes thereto and other information). Our discussion and analysis of financial condition and results of operations are based upon, among other things, our unaudited consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”). The preparation of financial statements in conformity with GAAP requires us to, among other things, make estimates and assumptions that affect the reported amounts of assets

 

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and liabilities, the disclosures of contingent liabilities as of and at the financial statement date, and the reported amounts of revenues and expenses during the reporting periods. 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 financial position or results of operations, although they may. Our critical accounting policies, the policies we believe are most important to the presentation of our financial statements and require the most difficult, subjective and complex judgments are outlined below in “Critical Accounting Policies.”  All references to results of operations in this discussion generally are to results from continuing operations, unless otherwise noted.

 

We decided during the second quarter of 2008 to discontinue our operations in Mexico and the U.S.  Although we largely completed this process, we continue to implement and record potentially significant adjustments required in the financial statements, which affects certain amounts of our results of operations and the classifications on the balance sheet, statement of operations and statement of cash flows for prior periods, and as of prior dates, as well as our disclosure in this report, including management’s discussion and analysis.  The amounts related to our discontinued operations are now shown separate from our continuing operations in our consolidated financial statements.

 

Safe Harbor Statement

 

The matters in this report that are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, 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 our business, financial condition and results of operations, and include, without limitation: (1) intense competition internationally, including competition from alternative business models, such as manufacturer-to-carrier sales, which may lead to reduced prices, lower sales, lower gross margins, extended payment terms with customers, increased capital investment and interest costs, bad debt risks and product supply shortages; (2) dependency on Latin American sales; (3) extended general economic downturn; (4) inability to secure adequate supply of competitive products on a timely basis and on commercially reasonable terms; (5) foreign exchange rate fluctuations, devaluation of a foreign currency, adverse governmental controls or actions, political or economic instability, or disruption of a foreign market, including, without limitation, the imposition, creation, increase or modification of tariffs, taxes, duties, levies and other charges and other related risks of our international operations, such as the pending tax change in Argentina on certain electronics (including cellular phones) which could significantly increase selling prices to our customers and end-users; (6) the ability to attract new sources of profitable business from expansion of products or services or risks associated with entry into new markets, including geographies, products and services; (7) an interruption or failure of our information systems or subversion of access or other system controls may result in a significant loss of business, assets, or competitive information; (8) significant changes in supplier terms and relationships; (9) termination of a supply or services agreement with a major supplier or product supply shortages; (10) continued consolidation in the wireless handset carrier market; (11) loss of business from one or more significant customers; (12) customer and geographical accounts receivable concentration risk and other related risks; (13) rapid product improvement and technological change resulting in inventory obsolescence; (14) terrorist or military actions; (15) the loss of a key executive officer or other key employees; (16) changes in consumer demand for multimedia wireless handset products and features; (17) our failure to adequately adapt to industry changes and to manage potential growth and/or contractions; (18) seasonal buying patterns; (19) uncertain political and economic conditions internationally; (20) the resolution of any litigation for or against us; (21) our ability to successfully introduce and sell our verykool® products and the related inventory risk of such products; and (22) our ability to generate taxable income in future periods in order to utilize and realize any quarterly tax benefits recorded.  Our actual results and condition could differ materially from those anticipated in our forward-looking statements.

 

We have instituted in the past and continue to institute changes to our strategies, operations and processes to address risks and uncertainties and to mitigate impacts on our results of operations and financial condition. However, no assurances can be given that we will be successful in these efforts. For a further discussion of significant factors to consider concerning InfoSonics, see “Risk Factors” below in this report and “Item 1A. Risk Factors” of InfoSonics’ Annual Report on Form 10-K for the year ended December 31, 2008 and Quarterly Reports on Form 10-Q filed thereafter. 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. We provide end-to-end handset and wireless terminal solutions for carriers in Latin America.   We distribute products of several key original equipment manufacturers (OEMs), including Samsung and others.  We are also involved in the designing, sourcing and distribution of a proprietary line of products under our own verykool® brand, which includes entry level, mid-tier and high-end products.

 

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Our distribution and solution services include product testing, approval and certification, warehousing, logistics services (packing, shipping and delivery), marketing campaigns, warranty services and end-user support. These services are provided for OEMs and our verykool® branded wireless handsets and accessories, in order to facilitate sales to network carriers, agents, resellers, distributors, independent dealers and retailers in Central and South America.  In addition, for our verykool® branded products, we design, test and contract with manufacturers to build these products.

 

Due to seasonal and other factors, our interim financial condition or operating results may not be indicative of the entire fiscal year 2009 or other future financial condition or operating results. Our financial condition and operating results are influenced by several seasonal, general economic and other factors, which may cause our financial condition and operating results to fluctuate on a quarterly basis, including, but not limited to, inventory management and obsolescence, 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 operators, purchasing and payment patterns of customers, the timing of holidays, the success of our proprietary verykool® products line and other events affecting our consumers.

 

Areas of Management Focus and Performance Indicators

 

We focus on the needs of our customers, developing and maintaining close relationships with manufacturers, looking to expand in current and enter into new markets, and sourcing and developing new and innovative products, while maintaining close attention to operational efficiencies and costs. We are focused on increasing shipping volumes and improving efficiencies to achieve higher levels of profitability and earnings growth, as well as monitoring and managing levels of accounts receivable and inventory.  We provide distribution and other services for OEMs, such as Samsung, and our own proprietary line of verykool® handsets.  Performance indicators that are important 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 products, customers and suppliers, as deemed appropriate. We believe a strong focus on providing better service to customers leads to increased customer satisfaction and retention and potential increases in sales.

 

Management and employees spend a significant amount of time traveling to Latin America and Asia visiting 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 a June 2009 report by Cowen and Company, overall worldwide wireless handset sales increased by approximately 6% in 2008.  However, according to the Cowen report, they are forecasted to decrease in 2009 by 8%, before returning to growth in 2010 and 2011, with growth estimated at 7% and 4%, respectively. A rapid decline in wireless handset sales in the Central and South American markets we serve has negatively impacted and could continue to negatively impact our net sales. Excess supply conditions and the current economic downturn have reduced and may continue to reduce, demand for our products and the market prices of the products we sell.  These reductions affect our ability to generate net sales, margins and gross profit at expected levels and could continue to affect the value of our inventory, as well as customer payment trends. For example, the second half of 2008 and the first quarter of 2009 generally saw a decrease in handset demand globally including our sales regions, and an increase in carrier inventory, which both had a negative impact on our financial results during 2008 and during the first nine months of 2009 created a more difficult sales environment requiring additional operating expenses to help maintain and increase our sales.  We saw these trends begin to ease in the second quarter of 2009 in the regions we serve.   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.

 

During the second half of 2008, and continuing through the period of this report, in particular, our industry has been impacted by the worldwide economic slowdown.  We believe that some of the countries in the regions we operate, particularly in Central America, have close economic relations with the United States, and have been impacted by this economic situation.  We believe this impacted consumer demand for wireless handsets in some of the countries we operate, and therefore our overall operations, including net sales, during the first half of 2009 were adversely impacted.  We began to see a small increase in the demand for handsets in the third quarter of 2009, which positively impacted our net sales for the quarter.  We have also begun to see a decrease in some subsidies offered by operators in the region, which increases the handset price to the consumer, and this is impacting overall handset volumes.  We are also beginning to see more low cost manufacturers gaining traction with entry level products, which is impacting both our OEM and verykool™ sales in the entry level segment.

 

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Company Specific Trends and Risks

 

Our long-term strategy incorporates overall market growth elements for our business, which we hope will result in future growth as global economic conditions recover. Our verykool® proprietary line of products, for which we had several models selling as of September 30, 2009, continued to show increased orders and sales during the first nine months of 2009 and is expected to become an increasing part of our overall business in the future.

 

Our verykool® products continue to increase product diversification in Central and South America, which we believe should continue to be beneficial as we move forward and work towards continued profitability.  We have more control over the production and supply of our verykool® line of products than the OEM products we distribute.  On a quarterly year-over-year basis, we were able to increase our gross margins to 6.6% for the quarter ended September 30, 2009, compared to 5.5% for the quarter ended September 30, 2008.  These results were primarily due to product mix shift, including increased sales of higher-margin products (including our verykool® products), better product sourcing for our verykool® line of products and beneficial purchasing opportunities.

 

Argentina, a country where we sell a significant amount of our products, purportedly passed a new tariff in November 2009 potentially impacting certain imported electronics, including cellular handsets.   At this time we are unaware of the timing and any necessary final approval of this tariff.  However, from the preliminary information we have obtained, this new tariff could impact the pricing at the point of sale in excess of 30%, and could have an impact on the overall consumer demand and the sales volume in Argentina. For the year ended December 31, 2008 and the nine months ended September 30, 2009, sales of our products in Argentina represented approximately 66% and 87%, respectively of our total net sales.  We are unable to assess when or if this tariff will be finally implemented, and if implemented, what specific impact it could have on our business and prospects in Argentina.  However, if implemented, a significant increase in importation tariffs could have a material adverse impact on our sales and prospects for our products in Argentina.

 

Recent Events

 

Effective October 6, 2009, we entered a separation agreement with one of our executives.  Pursuant to the separation agreement, we made a lump sum payment of $75,000 (less withholdings), and in consideration for such payment, the executive provided a full release of all claims and the executive forfeited 463,500 (vested and unvested) options, with a weighted average exercise price of $0.40.

 

Results of Operations

 

Three months ended September 30, 2009 compared with three months ended September 30, 2008

 

Net Sales

 

For the three months ended September 30, 2009, our net sales from continuing operations of $65.3 million increased 23% compared to our net sales from continuing operations of $52.9 million for the same period last year.  The average selling price of wireless handsets sold in the three months ended September 30, 2009 increased 18%, as compared to the same period last year, due primarily to increased volume of higher-priced handsets, including some of our verykool® and OEM products.  This increase was in conjunction with a 10% increase in overall wireless handset sales volume.  The geographic mix of net sales shifted slightly in the three months ended September 30, 2009 as sales in South America were more than 89% of net sales, as compared to 83% of net sales for the same period last year.  Sales in Central America decreased to 11% of total net sales in the three months ended September 30, 2009 as compared to 17% for the same period last year.  Sales in Central America increased sequentially to 11% of total net sales in the three months ended September 30, 2009, as compared to 9% in the prior quarter.  These regional shifts in net sales resulted from the factors discussed below.

 

		For the Three Months Ended September 30,
		2009			2008
		(Dollar amounts in thousands) (unaudited)
Net sales		$	65,262		$	52,884
Units sold, increase (decrease) over prior year		10		%	(22		)%
Average selling price, increase over prior year		18		%	2		%

 

Net Sales by Geographic Region

 

In South and Central America, we have continued to work to expand our customer base as well as our geographic presence by seeking additional customers and further business with existing customers for both our OEM and proprietary verykool® products.  In South America, net sales were $58.3 million for the

 

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three months ended September 30, 2009, a 32% increase from the same period last year.  This increase was primarily due to increased sales in existing countries where we sell products, primarily Argentina.  In Central America, net sales decreased 21% to $7.0 million for the three months ended September 30, 2009, which was primarily due to the continuing low demand during the quarter, which we believe was related to the worldwide and regional economic downturn.  Despite the year-over-year declines, we have seen sequential quarterly improvement in Central America since the first quarter of 2009.  The third quarter of 2009 increased 24% over the second quarter of 2009, and 124% over the first quarter of 2009.

 

		For the Three Months Ended September 30,						Increase
		2009			2008			(Decrease)
		(Dollar amounts in thousands) (unaudited)
Central America		$	6,975		$	8,826		(21	)%
South America		58,287			44,058			32	%
Total		$	65,262		$	52,884		23	%

 

Cost of Sales, Gross Profit and Gross Margin

 

For the three months ended September 30, 2009, cost of sales was $60.9 million, or 93.4% of net sales, and gross margin was 6.6%, as compared with $50.0 million, or 94.5% of net sales, and gross margin at 5.5% for the same period last year. The increase in our cost of sales and increase in gross margin were due to product mix shift, including increased sales of higher-margin products (including our verykool® products), better product sourcing for our verykool® line of products and beneficial purchasing opportunities.

 

For the three months ended September 30, 2009, our gross profit increased 49% to $4.3 million from $2.9 million for the same period last year. This increase in gross profit was primarily the result of the increased net sales and of the factors which increased our gross margin as described above.

 

		For the Three months Ended September 30,
		2009			2008			Increase
		(Dollar amounts in thousands) (unaudited)
Net sales		$	65,262		$	52,884		23	%
Cost of sales		60,928			49,982			22	%
Gross profit		$	4,334		$	2,902		49	%
Gross margin		6.6		%	5.5		%	20	%

 

Operating Expense and Operating Income (Loss) from Continuing Operations

 

For the three months ended September 30, 2009, operating expense increased 25%, as compared with the same period last year.  As a percentage of net sales, operating expense increased slightly to 6.2% in the three months ended September 30, 2009, as compared with 6.1% for the same period last year.  The increase in operating expense was related to the opening of a new market in South America and other support required in additional markets due to the global and regional economic downturn.  However, management took action to reduce fixed operational costs to match current market conditions.  Management continues to review expenses in an effort to better match the operational costs with the future business opportunities, by shifting expenses from a fixed to a variable component.   We believe such measures will assist us as we strive to maintain profitability in the current volatile market.

 

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Operating Expense

 

		For the Three Months Ended September 30,
		2009			2008			Increase
		(Dollar amounts in thousands) (unaudited)
Net sales		$	65,262		$	52,884		23	%
Operating expense		$	4,023		$	3,211		25	%
Percentage of net sales		6.2		%	6.1		%	2	%

 

For the three months ended September 30, 2009, our operating income from continuing operations was $311,000, as compared with operating loss from continuing operations of $309,000 for the same period last year. As a percentage of net sales, operating income from continuing operations was 0.5% for the three months ended September 30, 2009, compared to a loss of 0.6% for the same period last year. The increase in operating income from continuing operations was a result of the increase in gross margin and gross profit due to the factors discussed above.

 

Operating Income (Loss) from Continuing Operations

 

		For the Three Months Ended September 30,
		2009			2008			Increase
		(Dollar amounts in thousands) (unaudited)
Net sales		$	65,262		$	52,884		23	%
Operating income (loss) from continuing operations		$	311		$	(309	)	201	%
Percentage of net sales		0.5		%	(0.6		)%	n/m

 

Other Income (Expense)

 

For the three months ended September 30, 2009, we incurred $80,000 of interest expense, compared with $34,000 for the same period last year.  This is primarily due to a higher average outstanding balance on our line of credit, resulting from, among other things, increased sales and increased accounts receivable levels as compared to the same period in the prior year.  We expect to continue to regularly utilize amounts on our revolving line of credit, which will impact our interest expense in future periods depending on applicable interest rates and outstanding balances, among other things.

 

During the three months ended September 30, 2008, we settled an outstanding claim against a former service provider in which we received a gross amount of $655,000, of which $87,000 represented reimbursement for legal fees, and also had a gain of $85,000 related to revenue sharing negotiations and an insurance settlement.

 

		For the Three Months Ended September 30,						Increase
		2009			2008			(Decrease)
		(Dollar amounts in thousands)
		(unaudited)
Other Income		$	7		$	653		(99	)%
Interest income (expense)		(80		)	(34		)	(135	)%
Total other income (expense)		$	(73	)	$	619		(112	)%

 

Income (Loss) from Continuing Operations (before provision for income taxes)

 

During the three months ended September 30, 2009, our net income from continuing operations before income taxes was $238,000, as compared to income of $310,000 for the same period last year.  This net income from continuing operations was primarily due to the increased gross margin and gross profit discussed above.

 

Loss from Discontinued Operations (net of tax)

 

During the three months ended June 30, 2008, we assessed opportunities in the United States and Mexico, and began to implement actions necessary to close sales operations in both of those countries, which actions, although largely complete we continued to execute in the third quarter of 2009.  For the three months ended September 30, 2009, we incurred a loss from discontinued operations of $47,000, as compared to a loss of $81,000 from discontinued operations for the same period last year.  The loss from discontinued operations resulted as we continued to wind down our business in the United States and Mexico. As of September 30, 2009, our plans for the discontinued operations were substantially complete.  However, we expect to continue to record adjustments and expenses through the discontinued operations, as necessary.  One or more of these adjustments could be potentially significant.

 

Net Income (Loss)

 

During the three months ended September 30, 2009, our net income was $185,000, $0.01 per diluted share as compared to net income of $101,000, $0.01 per diluted share for the same period last year.  Our net income resulted primarily from our increased gross margin and gross profit, which was offset by the increased operating expenses as discussed above.

 

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Nine months ended September 30, 2009 Compared with nine months ended September 30, 2008

 

Net Sales

 

For the nine months ended September 30, 2009, our net sales from continuing operations of $169.6 million decreased 6% compared to our net sales from continuing operations of $179.9 million for the same period last year.  The average selling price of wireless handsets sold in the nine months ended September 30, 2009 increased 15%, as compared to the same period last year, due primarily to increased volume of higher-priced handsets, including some of our verykool® and OEM products.  This increase was offset by a 14% decrease in overall wireless handset sales volume, primarily due to the impact of the economic slowdown in the markets we serve during the second half of 2008 and the first six months of 2009.  The geographic mix of net sales shifted in the nine months ended September 30, 2009 as sales in South America increased to approximately 91% of net sales, as compared to approximately 76% of net sales for the same period last year.  Sales in Central America decreased to approximately 9% of total net sales in the nine months ended September 30, 2009, as compared to approximately 24% for the same period last year.  These regional shifts in net sales were the result of the factors discussed both above and below.

 

		For the Nine Months Ended September 30,
		2009			2008
		(Dollar amounts in thousands) (unaudited)
Net sales		$	169,593		$	179,857
Units sold, increase (decrease) over prior year		(13		)%	12		%
Average selling price, increase (decrease) over prior year		15		%	(2		)%

 

Net Sales by Geographic Region

 

In South and Central America, we have continued to work to expand our customer base as well as our geographic presence by seeking additional customers and increased penetration with existing customers for both our OEM and proprietary verykool®  products.  In South America, net sales were $153.9 million for the nine months ended September 30, 2009, a 13% increase from the same period last year.  This increase was primarily due to increased sales in existing countries where we sell products, primarily Argentina.  In Central America, net sales decreased 64% to $15.7 million for the nine months ended September 30, 2009, which was primarily due to the continuing low demand during the period, which we believe was related to the worldwide and regional economic downturn.  Despite the year-over-year declines we have seen sequential quarterly improvement in Central America since the first quarter of 2009.

 

		For the Nine Months Ended September 30,						Increase
		2009			2008			(Decrease)
		(Dollar amounts in thousands) (unaudited)
Central America		$	15,713		$	43,520		(64	)%
South America		153,880			136,337			13	%
Total		$	169,593		$	179,857		(6	)%

 

Cost of Sales, Gross Profit and Gross Margin

 

For the nine months ended September 30, 2009, cost of sales was $157.8 million, or 93.1% of net sales, and gross margin was 6.9%, as compared with $170.1 million, or 94.6% of net sales, and gross margin of 5.4% for the same period last year. The decrease in our cost of sales and increase in gross margin were due to product mix shift, including increased sales of higher-margin products (including our verykool® products), better product sourcing for our verykool® line of products and beneficial purchasing opportunities.

 

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