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INFOSONICS CORP - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations(Edgar Glimpses Via Acquire Media NewsEdge) Forward-Looking Statements, Safe Harbor Statement and Other General Information This discussion and analysis of financial condition and results of operations should be read in conjunction with the accompanying unaudited consolidated financial statements and condensed notes thereto and other information included in this report and our Annual Report on Form 10-K for the year ended December 31, 2013 (including our 2013 audited consolidated financial statements and related notes thereto and other information). Our discussion and analysis of financial condition and results of operations are based upon, among other things, our unaudited consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States ("GAAP"). The preparation of financial statements in conformity with GAAP requires us to, among other things, make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosures of contingent liabilities as of the date of our most recent balance sheet, and the reported amounts of revenues and expenses during the reporting periods. We review our estimates and assumptions on an ongoing basis. Our estimates are based on our historical experience and other assumptions that we believe to be reasonable under the circumstances. Actual results are likely to differ from these estimates under different assumptions or conditions, but we do not believe such differences will materially affect our financial position or results of operations, although they may. Our critical accounting policies, the policies we believe are most important to the presentation of our financial statements and require the most difficult, subjective and complex judgments are outlined in "Critical Accounting Policies" in our Annual Report on Form 10-K. All references to results of operations in this discussion generally are to results from continuing operations, unless otherwise noted. This report contains "forward-looking statements," including, without limitation, statements about customer relationships, marketing of our verykool® products, sales levels, cost reductions, operating efficiencies, profitability and adequacy of working capital, that are based on current management expectations and which involve certain risks and uncertainties. These risks and uncertainties, in whole or in part, could cause such expectations to fail to be achieved and have a material adverse effect on our business, financial condition and results of operations, and include, without limitation: (1) intense competition internationally, including competition from alternative business models, such as manufacturer-to-carrier sales, which may lead to reduced prices, lower sales, lower gross margins, extended payment terms with customers, increased capital investment and interest costs, bad debt risks and product supply shortages; (2) our ability to develop new verykool® handsets and successfully introduce them into new markets; (3) the ability of the Company to have access to adequate capital to fund its operations; (4) extended general economic downturn in world markets; (5) inability to secure adequate supply of competitive products on a timely basis and on commercially reasonable terms; (6) foreign exchange rate fluctuations, devaluation of a foreign currency, adverse governmental controls or actions, political or economic instability, or disruption of a foreign market, including, without limitation, the imposition, creation, increase or modification of tariffs, taxes, duties, levies and other charges and other related risks of our international operations which could significantly increase selling prices of our products to our customers and end-users; (7) the ability to attract new sources of profitable business from expansion of products or services or risks associated with entry into new markets, including geographies, products and services; (8) an interruption or failure of our information systems or subversion of access or other system controls may result in a significant loss of business, assets, or competitive information; (9) significant changes in supplier terms and relationships or shortages in product supply; (10) loss of business from one or more significant customers; (11) customer and geographical accounts receivable concentration risk and other related risks; (12) rapid product improvement and technological change resulting in inventory obsolescence; (13) uncertain political and economic conditions internationally, including terrorist or military actions; (14) the loss of a key executive officer or other key employees and the integration of new employees; (15) changes in consumer demand for multimedia wireless handset products and features; (16) our failure to adequately adapt to industry changes and to manage potential growth and/or contractions; (17) seasonal buying patterns; (18) the resolution of any litigation for or against the Company; and (19) the ability of the Company to generate taxable income in future periods. These forward-looking statements speak only as of the date of this release and we undertake no obligation to publicly update any forward-looking statements to reflect new information, events or circumstances after the date of this release. We have instituted in the past, and continue to institute, changes to our strategies, operations and processes to address risks and uncertainties and to mitigate their impacts on our results of operations and financial condition. However, no assurances can be given that we will be successful in these efforts. For a further discussion of significant risk factors to consider, see "Risk Factors" below in this report and "Item 1A. Risk Factors" of our Annual Report on Form 10-K. In addition, other risks or uncertainties may be detailed from time to time in our future SEC filings. 11 -------------------------------------------------------------------------------- Table of Contents Overview We are a provider of wireless handsets, tablets and accessories to carriers, distributors and original equipment manufacturers ("OEMs") in Latin America, Asia Pacific, Europe, Africa and the United States. We design, develop, source and sell our proprietary line of products under the verykool® brand and on a private label basis to certain customers (collectively referred to as our "verykool® products"). We first introduced our verykool® brand in 2006 and verykool® products include entry-level, mid-tier and high-end products. For the five years prior to March 2012, our business had two primary components: (1) legacy distribution of wireless handsets supplied by major manufacturers, primarily Samsung, and (2) provision of our own proprietary verykool® products that we originally sourced from independent design houses and original design manufacturers ("ODMs"). Our revenue peaked in 2006 when we recorded approximately $241 million of net sales. In late 2009, however, a stiff import tariff on certain electronic devices, including wireless handsets, was enacted in Argentina, followed by another import regulation in March 2011. These actions resulted in a rapid decline and eventual end of our distribution agreement with Samsung on March 31, 2012. Since April 1, 2012, our business has and is expected to continue to be centered on our verykool® product line. The verykool® brand is our flagship product. In order to better control the roadmap for this product line, in April 2010 we established an in-house design center in China where we now design a number of phones in our product portfolio. We contract with electronic manufacturing services ("EMS") providers to manufacture all verykool® products we design. We continue to source most of our phones from independent design houses and ODMs and maintain personnel in China to oversee production and conduct quality control. Industry and Market Trends and Risks The wireless business is extremely competitive. The industry is characterized by rapid technological development driven by faster and more capable chipsets, innovative software features and applications and faster networks provided by wireless carriers. In this environment, it is extremely difficult to differentiate our products, and price pressure is constant. Historically, our business has been concentrated in countries in Latin America. In earlier years, the majority of our revenue was derived from distribution sales of Samsung products in Argentina, typically at very thin margins. As mentioned above, in late 2009, Argentina enacted a significant import tariff on certain electronic devices, including wireless handsets, that ultimately resulted in the conclusion of our distribution business on March 31, 2012. In late 2010, we began private label sales of our verykool® products into the Asia Pacific market with initial sales to customers in both China and India, and in 2011, we added customers in Western Europe, Russia, Singapore, Africa and certain other Southeast Asian countries. The economic profile of the consumer markets in both Latin America and Asia Pacific are similar in that they are extremely price sensitive. As a consequence, unlike the U.S. domestic market that is dominated by large providers, these markets have been more open to smaller providers such as InfoSonics who are able to supply more competitively priced handsets with similar features. Our private label business has been sporadic, and is no longer an area of future focus. 12 -------------------------------------------------------------------------------- Table of Contents Results of Operations The following table sets forth certain items from our consolidated statements of operations as a percentage of net sales for the periods indicated: Three months ended Six months ended June 30, June 30, 2014 2013 2014 2013 Net sales 100.0 % 100.0 % 100.0 % 100.0 % Cost of sales 80.6 % 79.3 % 81.4 % 80.7 % Gross profit 19.4 % 20.7 % 18.6 % 19.3 % Operating expenses: Selling, general and administrative 16.6 % 21.5 % 16.0 % 21.9 % Research and development 1.5 % 6.0 % 1.7 % 5.6 % 18.1 % 27.5 % 17.7 % 27.5 % Operating income (loss) 1.3 % (6.8 %) 0.9 % (8.2 %) Other income (expense): Other income (expense) 0.0 % 6.4 % 0.0 % 3.6 % Interest, net (0.3 %) 0.1 % (0.1 %) 0.1 % Income (loss) before income taxes 1.0 % (0.3 %) 0.8 % (4.5 %) Provision for income taxes 0.0 % (0.2 %) 0.0 % (0.2 %) Net income (loss) 1.0 % (0.5 %) 0.8 % (4.7 %) Three months ended June 30, 2014 compared with three months ended June 30, 2013 Net Sales For the three months ended June 30, 2014, our net sales amounted to $10,445,000, an increase of $2.1 million, or 25%, from $8,342,000 in the same period last year. Increased sales were recorded in a number of territories, with the largest gain of over 300% coming in Mexico where sales grew from $228,000 in the second quarter of 2013 to $940,000 in the second quarter of 2014. Sales in South America increased 14% from $2,159,000 to $2,470,000, principally due to a higher level of sales to our customer in Peru. Sales in Central America increased 6% from $3,960,000 to $4,205,000, principally due to a higher level of sales to our customer in Puerto Rico. Sales to U.S.-based distribution customers shipping into Latin America increased 13% from $1,545,000 to $1,740,000. Sales in the U.S. increased 71% from $424,000 to $727,000. We also shipped $363,000 of private-label products, principally to customers in EMEA, in the second quarter of 2014 compared to only $26,000 in private label sales in the prior year quarter. In terms of units, we shipped approximately 483,000 units in the second quarter of 2014, an increase of 12% compared to the second quarter of 2013. Our average unit selling price increased by 12%, from $19.25 to $21.59, the result of a shift in product mix to a higher volume of higher-priced phones. Gross Profit and Gross Margin For the three months ended June 30, 2014, our gross profit amounted to $2,029,000, an increase of $299,000, or 17%, from $1,730,000 in the same period last year, primarily as a result of the increased sales volume, and partially offset by an increase in our inventory reserve of $51,000 during the quarter. Our gross profit margin percentage for the three months ended June 30, 2014 declined slightly to 19.4% from 20.7% in the same period last year. Operating Expenses For the three months ended June 30, 2014, total operating expenses amounted to $1,894,000, a decrease of $405,000, or 18%, compared to $2,299,000 in the same period last year. Selling, general and administrative expenses for the three months ended June 30, 2014 amounted to $1,737,000, a 3% decrease compared to $1,799,000 in the prior year quarter. Increased legal fees, personnel and insurance costs were offset by a bad debt recovery and decreased operating expenses in other areas. R&D expenses for the three months ended June 30, 2014 amounted to $157,000, a decrease of $343,000, or 69%, compared to $500,000 in the prior year quarter. The decrease was primarily due to the restructuring of the development team and reduction of the employee base implemented during the first half of 2013. Other Income (Expense) Other income (expense) in the three months ended June 30, 2014 was comprised primarily of $27,000 of interest expense related to borrowings during the second quarter of 2014 against both our bank line of credit and vendor credit lines that also bear interest. For the three months ended June 30, 2013, other income of $535,000 included $527,000 related to the legal defeasance of a previously recorded supplier obligation that had been included in accrued expenses on our balance sheet. Interest income on a customer installment obligation amounted to $5,000. 13 -------------------------------------------------------------------------------- Table of Contents Provision for Income Taxes Because of our prior operating losses, our tax provisions for the three months ended June 30, 2014 and 2013 were nominal with the exception of an $18,000 provision for income taxes for the three months ended June 30, 2013 relating to a foreign dividend received from one of our wholly owned subsidiaries. Six months ended June 30, 2014 compared with six months ended June 30, 2013 Net Sales For the six months ended June 30, 2014, our net sales amounted to $22,069,000, an increase of $5,906,000, or 37%, from $16,163,000 in the same period last year. Sales to customers in South America more than doubled and increased $3,742,000, primarily as a result of increased sales to our customer in Peru; private-label sales to customers primarily in EMEA increased by $1,309,000; sales to customers in Mexico grew by $834,000; sales to U.S.-based non-carrier Latin American distributors rose by $539,000; and sales to U.S. customers increased by $315,000. These increases were partially offset by a decrease of $832,000 in sales to customers in Central America, primarily as a result of decreased sales to a customer in Guatemala. In terms of units, we shipped approximately 1,048,000 units in the first half of 2014, an increase of 30% compared to the first half of 2013. Our average unit selling price increased by 5%, from $20.02 to $21.03, the result of a shift in product mix to a higher volume of higher-priced phones. Gross Profit and Gross Margin For the six months ended June 30, 2014, our gross profit amounted to $4,102,000, an increase of $990,000, or 32%, from $3,112,000 in the same period of the prior year, primarily as a result of the increased sales volume, and partially offset by an increase in our inventory reserve of $94,000 during the period. Our gross profit margin for the six months ended June 30, 2014 declined to 18.6% of net sales from 19.3% in the same period last year. Operating Expenses For the six months ended June 30, 2014, total operating expenses amounted to $3,906,000, a decrease of $534,000, or 12%, compared to $4,440,000 in the same period last year. Selling, general and administrative expenses for the six months ended June 30, 2014 amounted to $3,522,000, almost unchanged from $3,542,000 in the prior year period. Increased legal fees, personnel and insurance costs were offset by a bad debt recovery and decreased operating expenses in other areas. R&D expenses for the six months ended June 30, 2014 amounted to $384,000, a decrease of $514,000, or 57%, compared to $898,000 in the prior year period. The decrease was primarily due to the restructuring of the development team and reduction of the employee base implemented during the first half of 2013. Other Income (Expense) Other income (expense) in the six months ended June 30, 2014 was comprised primarily of $27,000 of interest expense related to borrowings during the second quarter of 2014 against both our bank line of credit and vendor credit lines that also bear interest. For the six months ended June 30, 2013, other income of $586,000 consisted principally of $527,000 related to the legal defeasance of a previously recorded supplier obligation that had been included in accrued expenses on our balance sheet and $55,000 related to a forfeited customer deposit. Interest income on a customer installment obligation amounted to $11,000. Provision for Income Taxes Because of our prior operating losses, our tax provisions for the six months ended June 30, 2014 and 2013 were generally insignificant with the exception of the inclusion of an $18,000 provision for taxes in the three months ended June 30, 2013 relating to a foreign dividend received from one of our wholly owned subsidiaries. Liquidity and Capital Resources Historically, our primary sources of liquidity have been cash generated from operations, lines of credit (bank and vendor) and, from time to time, the sale of stock, to provide capital needed to support our business. However, for most of the past three years, we have not had a bank line of credit, and our major manufacturing suppliers have not provided us with any vendor credit. In fact, we typically have been required by these suppliers to pay 15% deposits at the time we place an order and the 85% balance prior to shipment. In the three months ended March 31, 2014, there were two significant events affecting our liquidity. First, two of our primary product vendors agreed to provide us with up to $4 million in vendor credit with 60-day payment terms provided that we reimburse them for the cost of credit insurance and pay a finance charge with aggregate effective annual interest rates of between 9.5% and 10.1%. In addition, on March 27, 2014 we entered into a Loan and Security Agreement with a bank for a $2 million revolving line of credit, subject to availability based upon domestic and foreign eligible accounts receivable multiplied by an advance rate of 80% and 70%, respectively. During much of the quarter ended March 31, 2014, we found that our business was constrained by the lack of capital. This was remedied in the quarter ended June 30, 2014 by the new vendor and bank financing described above. We believe that these resources, combined with our existing working capital, will adequately fund our operations for the coming year. 14 -------------------------------------------------------------------------------- Table of Contents In the six months ended June 30, 2014, we used $448,000 in cash for operations. This consisted of $1,568,000 used to fund increased inventories, $780,000 for increased trade and other accounts receivable and $502,000 to reduce accrued expenses. These uses were partially offset by $1,299,000 generated by reductions in prepaids and other assets, $758,000 from increased accounts payables and $345,000 in net income after adjustments for non-cash charges. During the six-month period we borrowed and repaid $1,249,000 against our bank line of credit, spent $43,000 on equipment and received $135,000 from the exercise of stock options. As of June 30, 2014, we had $2.0 million of cash and cash equivalents, $16.4 million of net working capital and no outstanding funded debt. Critical Accounting Policies There have been no material changes to our critical accounting policies and estimates affecting the application of those accounting policies since our Annual Report on Form 10-K for the year ended December 31, 2013. |