UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
Washington,
D.C. 20549
______________
FORM
10-Q
______________
(Mark
One)
x
|
QUARTERLY
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF
1934
|
For
the quarterly period ended September 30, 2005
or
o
|
TRANSITION
REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE
ACT OF
1934
|
For
the transition period from________ to ________
Commission
File Number 0-18672
ZOOM
TECHNOLOGIES, INC.
(Exact
Name of Registrant as Specified in its Charter)
Delaware
|
51-0448969
|
____________________________
|
____________________________
|
(State
or Other Jurisdiction of Incorporation or Organization)
|
(I.R.S.
Employer Identification No.)
|
|
|
207
South Street, Boston, Massachusetts
|
02111
|
____________________________
|
____________________________
|
(Address
of Principal Executive Offices)
|
(Zip
Code)
|
|
|
Registrant’s
Telephone Number, Including Area Code: (617)
423-1072
Indicate
by check mark whether the registrant: (1) has filed all reports required
to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements
for
the past 90 days. YES x
NO
o
Indicate
by check mark whether the registrant is an accelerated filer (as defined
in
Exchange Act Rule 12b-2). YES o
NO
x
Indicate
by check mark whether the registrant is a shell company (as defined in Exchange
Act Rule 12b-2). Yes o
No x
The
number of shares outstanding of the registrant’s Common Stock, $.01 Par Value,
as of November 7, 2005, was 9,346,966 shares.
ZOOM
TECHNOLOGIES, INC. AND SUBSIDIARY
INDEX
Part
I.
|
Financial
Information
|
Page
|
|
|
|
Item
1.
|
Financial
Statements:
|
|
|
|
|
|
Consolidated
Balance Sheets as of September 30, 2005 and December 31, 2004
(unaudited)
|
3
|
|
|
|
|
Consolidated
Statements of Operations for the three and nine months ended September
30,
2005 and 2004 (unaudited)
|
4
|
|
|
|
|
Consolidated
Statements of Cash Flows for the nine months ended September 30,
2005 and
2004 (unaudited)
|
5
|
|
|
|
|
Notes
to Consolidated Financial Statements
|
6-11
|
|
|
|
Item
2.
|
Management’s
Discussion and Analysis of Financial Condition and Results of
Operations
|
11-27
|
|
|
|
Item
3.
|
Quantitative
and Qualitative Disclosures About Market Risk
|
27
|
|
|
|
Item
4.
|
Controls
and Procedures
|
27
|
|
|
|
Part
II.
|
Other
Information
|
|
|
|
|
Item
5.
|
Other
Information |
27
|
|
|
|
Item
6.
|
Exhibits
|
28
|
|
|
|
|
Signatures
|
29
|
|
|
|
|
Exhibit
Index
|
30
|
PART
I - FINANCIAL INFORMATION
ZOOM
TECHNOLOGIES, INC. AND SUBSIDIARY
(unaudited)
|
|
September
30, 2005
|
|
December
31, 2004
|
|
Assets
|
|
|
|
|
|
|
|
|
|
|
|
Current
assets:
|
|
|
|
|
|
Cash
and cash equivalents
|
|
$
|
8,272,148
|
|
$
|
9,438,596
|
|
Accounts
receivable, net of reserves for doubtful accounts, returns,
and allowances of $1,487,881 at September 30, 2005 and $1,359,455
at
December 31, 2004
|
|
|
2,863,717
|
|
|
3,349,781
|
|
|
|
|
|
|
|
|
|
Inventories
|
|
|
5,132,213
|
|
|
5,030,478
|
|
Prepaid
expense and other current assets
|
|
|
208,231
|
|
|
529,989
|
|
Total
current assets
|
|
|
16,476,309
|
|
|
18,348,844
|
|
|
|
|
|
|
|
|
|
Property,
plant and equipment, net
|
|
|
2,549,499
|
|
|
2,703,208
|
|
Total
assets
|
|
$
|
19,025,808
|
|
$
|
21,052,052
|
|
|
|
|
|
|
|
|
|
Liabilities
and Stockholders’ Equity
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Current
liabilities:
|
|
|
|
|
|
|
|
Current
portion of long-term debt
|
|
$
|
4,943,424
|
|
$
|
229,555
|
|
Accounts
payable
|
|
|
1,297,487
|
|
|
2,006,819
|
|
Accrued
expense
|
|
|
1,034,746
|
|
|
1,275,088
|
|
Total
current liabilities
|
|
|
7,275,657
|
|
|
3,511,462
|
|
|
|
|
|
|
|
|
|
Long-term
debt, less current portion
|
|
|
—
|
|
|
4,872,298
|
|
Total
liabilities
|
|
$
|
7,275,657
|
|
$
|
8,383,760
|
|
Stockholders’
equity:
|
|
|
|
|
|
|
|
Common
stock, $0.01 par value. Authorized 25,000,000 shares;
issued 9,355,366 shares, outstanding 9,346,966 shares at September
30,
2005 and issued 8,935,516 shares, outstanding 8,927,116 shares
at December
31, 2004
|
|
|
93,554
|
|
|
89,355
|
|
|
|
|
|
|
|
|
|
Additional
paid-in capital
|
|
|
31,015,978
|
|
|
30,572,727
|
|
Retained
earnings (accumulated deficit)
|
|
|
(19,768,579
|
)
|
|
(18,510,181
|
)
|
Accumulated
other comprehensive income (loss)
|
|
|
416,520
|
|
|
523,713
|
|
Treasury
stock, at cost
|
|
|
(7,322
|
)
|
|
(7,322
|
)
|
Total
stockholders’ equity
|
|
|
11,750,151
|
|
|
12,668,292
|
|
Total
liabilities and stockholders’ equity
|
|
$
|
19,025,808
|
|
$
|
21,052,052
|
|
See
accompanying notes to unaudited consolidated financial statements.
ZOOM
TECHNOLOGIES, INC. AND SUBSIDIARY
Consolidated
Statements of Operations
(Unaudited)
|
|
Three
Months Ended September 30,
|
|
Nine
Months Ended September 30,
|
|
|
|
2005
|
|
2004
|
|
2005
|
|
2004
|
|
|
|
|
|
|
|
|
|
|
|
Net
sales
|
|
$
|
5,308,380
|
|
$
|
7,142,608
|
|
$
|
18,269,296
|
|
$
|
23,025,683
|
|
Costs
of goods sold
|
|
|
4,789,732
|
|
|
5,645,772
|
|
|
14,836,965
|
|
|
16,966,396
|
|
Gross
profit
|
|
|
518,648
|
|
|
1,496,836
|
|
|
3,432,331
|
|
|
6,059,287
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating
expense:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Selling
|
|
|
977,718
|
|
|
1,114,928
|
|
|
3,172,332
|
|
|
3,511,959
|
|
General
and administrative
|
|
|
314,188
|
|
|
780,681
|
|
|
2,867,694
|
|
|
2,797,396
|
|
Research
and development
|
|
|
664,641
|
|
|
721,942
|
|
|
2,109,347
|
|
|
2,065,603
|
|
Total
operating expense
|
|
|
1,956,547
|
|
|
2,617,551
|
|
|
8,149,373
|
|
|
8,374,958
|
|
Operating
income (loss)
|
|
|
(1,437,899
|
)
|
|
(1,120,715
|
)
|
|
(4,717,042
|
)
|
|
(2,315,671
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other
income (expense):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest
income
|
|
|
69,984
|
|
|
40,241
|
|
|
151,508
|
|
|
89,848
|
|
Interest
(expense)
|
|
|
(63,596
|
)
|
|
(52,950
|
)
|
|
(190,511
|
)
|
|
(159,109
|
)
|
Gain
on sale of investment in InterMute
|
|
|
—
|
|
|
|
|
|
3,495,516
|
|
|
|
|
Other,
net
|
|
|
56,251
|
|
|
105,035
|
|
|
2,131
|
|
|
219,116
|
|
Total
other income (expense),
net
|
|
|
62,639
|
|
|
92,326
|
|
|
3,458,644
|
|
|
149,855
|
|
Income
(loss) before income tax
expense
|
|
|
(1,375,260
|
)
|
|
(1,028,389
|
)
|
|
(1,258,398
|
)
|
|
(2,165,816
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income
tax expense (benefit)
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
income (loss)
|
|
$
|
(1,375,260
|
)
|
$
|
(1,028,389
|
)
|
$
|
(1,258,398
|
)
|
$
|
(2,165,816
|
)
|
Earnings
(loss) per common share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
$
|
(0.15
|
)
|
$
|
(0.12
|
)
|
$
|
(0.14
|
)
|
$
|
(0.26
|
)
|
Diluted
|
|
$
|
(0.15
|
)
|
$
|
(0.12
|
)
|
$
|
(0.14
|
)
|
$
|
(0.26
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted
average common and
common equivalent shares:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
|
9,341,124
|
|
|
8,791,016
|
|
|
9,158,734
|
|
|
8,486,167
|
|
Diluted
|
|
|
9,341,124
|
|
|
8,791,016
|
|
|
9,158,734
|
|
|
8,486,167
|
|
See
accompanying notes to unaudited consolidated financial statements.
ZOOM
TECHNOLOGIES, INC. AND SUBSIDIARY
Consolidated
Statements of Cash Flows
(Unaudited)
|
|
Nine
Months Ended September 30,
|
|
|
|
2005
|
|
2004
|
|
Cash
flows from operating activities:
|
|
|
|
|
|
Net
income (loss)
|
|
$
|
(1,258,398
|
)
|
$
|
(2,165,816
|
)
|
|
|
|
|
|
|
|
|
Adjustments
to reconcile net income (loss) to net cash provided by (used
in) operating activities:
|
|
|
|
|
|
|
|
Gain
on sale of investment in InterMute
|
|
|
(3,495,516
|
)
|
|
—
|
|
Depreciation
|
|
|
200,605
|
|
|
330,794
|
|
Changes
in operating assets and liabilities:
|
|
|
|
|
|
|
|
Accounts
receivable, net
|
|
|
381,433
|
|
|
1,331,756
|
|
Inventories
|
|
|
(101,735
|
)
|
|
(598,394
|
)
|
Prepaid
expense and other assets
|
|
|
321,758
|
|
|
76,626
|
|
Accounts
payable and accrued expense
|
|
|
(949,674
|
)
|
|
(250,203
|
)
|
Net
cash provided by (used in) operating activities
|
|
|
(4,901,527
|
)
|
|
(1,275,237
|
)
|
|
|
|
|
|
|
|
|
Cash
flows from investing activities:
|
|
|
|
|
|
|
|
Proceeds
from sale of investment in InterMute
|
|
|
3,495,516
|
|
|
—
|
|
Additions
to property, plant and equipment
|
|
|
(46,896
|
)
|
|
(145,231
|
)
|
|
|
|
|
|
|
|
|
Net
cash provided by (used in) investing activities
|
|
|
3,448,620
|
|
|
(145,231
|
)
|
|
|
|
|
|
|
|
|
Cash
flows from financing activities:
|
|
|
|
|
|
|
|
Principal
payments on long-term debt
|
|
|
(158,429
|
)
|
|
(162,560
|
)
|
Proceeds
from exercise of stock options
|
|
|
447,450
|
|
|
2,021,031
|
|
Net
cash provided by (used in) financing activities
|
|
|
289,021
|
|
|
1,858,471
|
|
|
|
|
|
|
|
|
|
Effect
of exchange rate changes on cash and cash equivalents
|
|
|
(2,562
|
)
|
|
(2,571
|
)
|
|
|
|
|
|
|
|
|
Net
increase (decrease) in cash and cash equivalents
|
|
|
(1,166,448
|
)
|
|
435,432
|
|
|
|
|
|
|
|
|
|
Cash
and cash equivalents beginning of period
|
|
|
9,438,596
|
|
|
9,904,384
|
|
|
|
|
|
|
|
|
|
Cash
and cash equivalents end of period
|
|
$
|
8,272,148
|
|
$
|
10,339,816
|
|
|
|
|
|
|
|
|
|
Supplemental
disclosures of cash flow information:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash
paid during the period for:
|
|
|
|
|
|
|
|
Interest
|
|
$
|
190,511
|
|
$
|
159,109
|
|
Income
taxes
|
|
$
|
—
|
|
$
|
—
|
|
See
accompanying notes to unaudited consolidated financial statements.
ZOOM
TECHNOLOGIES, INC. AND SUBSIDIARY
Notes
to Consolidated Financial Statements
(Unaudited)
|
(1)
|
Summary
of Significant Accounting
Policies
|
|
(a) |
Basis
of Presentation and Principles of
Consolidation
|
The
consolidated financial statements of Zoom Technologies, Inc. (the “Company”)
presented herein have been prepared pursuant to the rules of the Securities
and
Exchange Commission for quarterly reports on Form 10-Q and do not include
all of
the information and footnote disclosures required by accounting principles
generally accepted in the United States of America. These financial statements
should be read in conjunction with the audited consolidated financial statements
and notes thereto for the year ended December 31, 2004 included in the Company’s
2004 Annual Report on Form 10-K.
The
consolidated balance sheet as of September 30, 2005, the consolidated statements
of operations for the three and nine months ended September 30, 2005 and
2004,
and the consolidated statements of cash flows for the nine months ended
September 30, 2005 and 2004 are unaudited, but, in the opinion of management,
include all adjustments (consisting of normal, recurring adjustments) necessary
for a fair presentation of results for these interim periods.
The
consolidated financial statements include the accounts and operations of
the
Company’s wholly owned subsidiary, Zoom Telephonics, Inc., a Delaware
corporation. All significant intercompany accounts and transactions have
been
eliminated in consolidation.
The
results of operations for the periods presented are not necessarily indicative
of the results to be expected for the entire year ending December 31,
2005.
|
(b) |
Stock-Based
Compensation
|
The
Company accounts for its stock option plans under the recognition and
measurement principles of Accounting Principles Board (APB) Opinion No. 25,
“Accounting for Stock Issued to Employees, and Related Interpretations." No
stock-based compensation expense is reflected in net income (loss) for these
plans, as all options granted under these plans had an exercise price equal
to
the market value of the underlying common stock on the date of grant. The
following table illustrates the effect on net income (loss) and earnings
(loss)
per share if the Company had applied the fair value recognition provisions
of
Financial Accounting Standards Board (FASB) Statement No. 123, “Accounting for
Stock Based Compensation” to stock-based compensation (See note 11).
|
|
Three
Months Ended September 30,
|
|
Nine
Months Ended September 30,
|
|
|
|
2005
|
|
2004
|
|
2005
|
|
2004
|
|
Net
income (loss), as reported
|
|
$
|
(1,375,260
|
)
|
$
|
(1,028,389
|
)
|
$
|
(1,258,398
|
)
|
$
|
(2,165,816
|
)
|
Deduct:
Total stock-based employee compensation expense determined under
fair
value based method for all awards, net of related tax
effects
|
|
|
(214,657
|
)
|
|
(139,829
|
)
|
|
(473,398
|
)
|
|
(486,421
|
)
|
Pro
forma net income (loss)
|
|
$
|
(1,589,917
|
)
|
$
|
(1,168,218
|
)
|
$
|
(1,731,796
|
)
|
$
|
(2,652,237
|
)
|
Earnings
(loss) per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
- as reported
|
|
$
|
(0.15
|
)
|
$
|
(0.12
|
)
|
$
|
(0.14
|
)
|
$
|
(0.26
|
)
|
Diluted
- as reported
|
|
$
|
(0.15
|
)
|
$
|
(0.12
|
)
|
$
|
(0.14
|
)
|
$
|
(0.26
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
- pro forma
|
|
$
|
(0.17
|
)
|
$
|
(0.13
|
)
|
$
|
(0.19
|
)
|
$
|
(0.31
|
)
|
Diluted
- pro forma
|
|
$
|
(0.17
|
)
|
$
|
(0.13
|
)
|
$
|
(0.19
|
)
|
$
|
(0.31
|
)
|
|
(c) |
Recently
Issued or Proposed Accounting
Pronouncements
|
In
June
2005, the FASB’s Emerging Issues Task Force reached a consensus on Issue No.
05-6, “Determining the Amortization Period for Leasehold Improvements” (“EITF
05-6”). The guidance requires that leasehold improvements acquired in a business
combination or purchased subsequent to the inception of a lease be amortized
over the lesser of the useful life of the assets or a term that includes
renewals that are reasonably assured at the date of the business combination
or
purchase. The guidance is effective for periods beginning after June 29,
2005.
The adoption of EITF 05-6 did not have an effect on the Company’s consolidated
financial position or results of operations.
In
May
2005, the FASB issued SFAS No. 154, “Accounting Changes and Error Corrections—A
Replacement of APB Opinion No. 20 and FASB Statement No. 3.” SFAS No. 154
applies to all voluntary changes in accounting principles and requires
retrospective application to prior periods’ financial statements of changes in
accounting principles, unless it is impracticable. SFAS No. 154 requires
that a
change in depreciation, amortization, or depletion method for long-lived,
nonfinancial assets be accounted for as a change of estimate affected by
a
change in accounting principles. SFAS No. 154 also carries forward without
change the guidance in APB Opinion No. 20 with respect to accounting for
changes
in accounting estimates, changes in the reporting unit and correction of
an
error in previously issued financial statements. The Company is required
to
adopt SFAS No. 154 for accounting changes and corrections of errors made
in
fiscal years beginning after December 15, 2005. The adoption of SFAS No.
154 is
not expected to have a material effect on the Company’s consolidated financial
position or results of operations.
On
December 16, 2004, the FASB issued SFAS No. 123 (revised 2004), “Share-Based
Payment” (“SFAS No. 123R"), which is a revision of SFAS No. 123, “Accounting for
Stock-Based Compensation.” SFAS No. 123R supersedes APB Opinion No. 25,
“Accounting for Stock Issued to Employees,” and amends SFAS No. 95, “Statement
of Cash Flows.” Generally, the approach in SFAS No. 123R is similar to the
approach described in SFAS No. 123. However, SFAS No. 123R requires all
share-based payments to employees, including grants of employee stock options,
to be recognized in the income statement based on their fair values. Pro
forma
disclosure is no longer an alternative. SFAS No. 123R must be adopted no
later
than the first annual period beginning after June 15, 2005. Early adoption
will
be permitted in periods in which financial statements have not yet been issued.
SFAS No. 123R allows companies to choose between the modified-prospective
and
modified-retrospective transition alternatives in adopting SFAS No. 123R.
Under
the modified-prospective transition method, compensation cost will be recognized
in financial statements issued subsequent to the date of adoption for all
shared-based payments granted, modified or settled after the date of adoption,
as well as for any unvested awards that were granted prior to the date of
adoption. Under the modified-retrospective transition method, compensation
cost
will be recognized in a manner consistent with the modified-prospective
transition method, however, prior period financial statements will also be
restated by recognizing compensation cost as previously reported in the pro
forma disclosures under SFAS No. 123. The restatement provisions can be applied
to either a) all periods presented or b) to the beginning of the fiscal year
in
which SFAS No. 123R is adopted. The Company expects to adopt SFAS No. 123R
on
January 1, 2006 using the modified-prospective method. As the Company previously
adopted only the pro forma disclosure provisions of SFAS No. 123, the Company
will recognize compensation cost relating to the unvested portion of awards
granted prior to the date of adoption using the same estimate of the grant-date
fair value and the same attribution method used to determine the pro forma
disclosures under SFAS No. 123. As permitted by SFAS No. 123, the Company
currently accounts for share-based payments to employees using APB Opinion
No.
25’s intrinsic value method and, as such, generally recognizes no compensation
cost for employee stock options. Accordingly, the adoption of SFAS No. 123R’s
fair value method will have an impact on the Company’s results of operations,
although it will have no impact on the overall financial position. The impact
of
the adoption of SFAS No. 123R cannot be determined at this time because it
will
depend upon levels of share-based payments granted in the future. However,
had
the Company adopted SFAS No. 123R in prior periods, the impact of that standard
would have approximated the impact as described in the disclosure of pro
forma
net income (loss) and net income (loss) per share pursuant to SFAS No. 123
(see
note 1(b) and note 11).
In
November 2004, the FASB issued SFAS No. 151, “Inventory Costs, an amendment of
Accounting Research Bulletin No. 43, Chapter 4”. The amendments made by SFAS No.
151 clarify that abnormal amounts of idle facility expense, freight, handling
costs, and wasted materials (spoilage) should be recognized as current-period
charges and require the allocation of fixed production overheads to inventory
based on the normal capacity of the production facilities. SFAS No. 151 is
the
result of a broader effort by the FASB to improve the comparability of
cross-border financial reporting by working with the International Accounting
Standards Board toward development of a single set of high-quality accounting
standards. The guidance is effective for inventory costs incurred during
fiscal
years beginning after June 15, 2005. The adoption of SFAS No. 151 is not
expected to have a material effect on the Company’s consolidated financial
position or results of operations.
(2)
Liquidity;
Revolving Line of Credit
On
September 30, 2005 the Company had working capital of $9.2 million, including
$8.3 million in cash and cash equivalents.
On
March
16, 2005 Zoom Telephonics, Inc., a wholly owned subsidiary of the Company,
entered into a Loan and Security Agreement with Silicon Valley Bank that
provides for a revolving line of credit of up to $2 million. The revolving
line
of credit can be used to (i) borrow under revolving loans for working capital
and general corporate purposes, (ii) issue letters of credit, (iii) enter
into
foreign exchange forward contracts, and (iv) support certain cash management
services. Revolving loans bear interest at a floating rate of interest equal
to
Silicon Valley Bank’s prime rate plus 0.5%. The loan rate at September 30, 2005
was 7.25%. This interest rate will be increased to Silicon Valley Bank’s prime
rate plus 1.0% if the Company records two consecutive quarters of combined
losses. The revolving line of credit terminates, and all outstanding obligations
under the Loan and Security Agreement become due on March 15, 2006.
The
revolving loans under the Loan and Security Agreement are secured by a first
priority lien on substantially all of the assets of the Company and Zoom
Telephonics, Inc., excluding intellectual property and real estate. The Company
guaranteed the obligations of Zoom Telephonics under the revolving line of
credit and pledged all of the stock of Zoom Telephonics in support of its
guarantee. The Loan and Security Agreement requires that the Company maintain
a
minimum adjusted quick ratio and a minimum net worth. In addition, Zoom
Telephonics is required to obtain Silicon Valley Bank’s prior written consent to
among other things, dispose of assets, make acquisitions, be acquired, incur
indebtedness, grant liens, make investments, pay dividends, or repurchase
stock.
This consent may not be unreasonably withheld.
The
Loan
and Security Agreement contains events of default that include, among other
things, non-payment of principal, interest or fees, violation of covenants,
inaccuracy of representations and warranties, cross default to certain other
indebtedness, bankruptcy and insolvency events, change of control, and material
judgments. Upon occurrence of an event of default, Silicon Valley Bank is
entitled to, among other things, accelerate all of Zoom Telephonics’ obligations
and sell its assets to satisfy obligations under the Loan and Security
Agreement. As of September 30, 2005 the Company’s availability under the line is
$1.7 million. As of September 30, 2005 no amounts were outstanding under
the
revolving line of credit and the Company was in compliance with all covenants.
To
conserve cash and manage liquidity during the past few years, the Company
has
implemented expense reductions including the reduction of employee headcount
and
overhead costs. The employee headcount was 185 at December 31, 2002 and 125
at
September 30, 2005. The Company will continue to assess its cost structure
as it
relates to its revenues and cash position and the Company may make further
cost
reductions if the actions are deemed necessary.
Management
believes the Company has sufficient resources to fund its normal operations
over
the next twelve months. However, if the Company is unable to increase its
revenues, reduce or otherwise adequately control its expenses, or raise capital,
the Company’s longer-term ability to continue as a going concern and achieve its
intended business objectives could be adversely affected. Moreover, the
Company’s liquidity could be significantly impaired if it repays its mortgage
through current sources of cash on or before the maturity date in January
2006
and is not able to refinance all or a significant portion of the mortgage
and is
not able to sell its owned buildings for adequate consideration. See “Risk
Factors” below for further information with respect to events and uncertainties
that could harm the Company’s business, operating results, and financial
conditions.
(3)
Earnings
(loss) per share
The
reconciliation of the numerators and denominators of the basic and diluted
net
earnings (loss) per share computations for the Company’s reported net income
(loss) is as follows:
|
|
Three
Months Ended September 30,
|
|
Nine
Months Ended September 30,
|
|
|
|
2005
|
|
2004
|
|
2005
|
|
2004
|
|
Basic:
|
|
|
|
|
|
|
|
|
|
Net
income (loss)
|
|
$
|
(1,375,260
|
)
|
$
|
(1,028,389
|
)
|
$
|
(1,258,398
|
)
|
$
|
(2,165,816
|
)
|
Weighted
average shares outstanding
|
|
|
9,341,124
|
|
|
8,791,016
|
|
|
9,158,734
|
|
|
8,486,167
|
|
Earnings
(loss) per share
|
|
$
|
(0.15
|
)
|
$
|
(0.12
|
)
|
$
|
(0.14
|
)
|
$
|
(0.26
|
)
|
Diluted:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
income (loss)
|
|
$
|
(1,375,260
|
)
|
$
|
(1,028,389
|
)
|
$
|
(1,258,398
|
)
|
$
|
(2,165,816
|
)
|
Weighted
average shares outstanding
|
|
|
9,341,124
|
|
|
8,791,016
|
|
|
9,158,734
|
|
|
8,486,167
|
|
Net
effect of dilutive stock options based on the Treasury stock method
using
average market price
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
Weighted
average shares outstanding
|
|
|
9,341,124
|
|
|
8,791,016
|
|
|
9,158,734
|
|
|
8,486,167
|
|
Earnings
(loss) per share
|
|
$
|
(0.15
|
)
|
$
|
(0.12
|
)
|
$
|
(0.14
|
)
|
$
|
(0.26
|
)
|
Potential
common shares for which inclusion would have the effect of increasing diluted
earnings per share (i.e., antidilutive) are excluded from the computation
for
the three and nine months ended September 30, 2005 and 2004. Options to purchase
1,264,900 and 1,054,050 shares of common stock at September 30, 2005 and
2004,
respectively, were outstanding, but not included in the computation of diluted
earnings per share for the three and nine months ended September 30, 2005
and
2004 as their effect would be antidilutive.
(4)
Inventories
Inventories
consist of the following:
|
|
September
30, 2005
|
|
December
31, 2004
|
|
Raw
materials
|
|
$
|
2,216,947
|
|
$
|
2,595,730
|
|
Work
in process
|
|
|
1,502,688
|
|
|
1,177,602
|
|
Finished
goods
|
|
|
1,412,578
|
|
|
1,257,146
|
|
Total
Inventories
|
|
$
|
5,132,213
|
|
$
|
5,030,478
|
|
During
the three months ended September 30, 2005 the company recorded obsolescence
charges of $279,700.
(5)
Comprehensive
Income (Loss)
Statement
of Financial Accounting Standards (“SFAS”) No. 130, “Reporting Comprehensive
Income” establishes rules for the reporting and display of comprehensive income
(loss) and its components; however, it has no impact on the Company’s net income
(loss). SFAS No. 130 requires all changes in equity from non-owner sources
to be
included in the determination of comprehensive income (loss).
The
components of comprehensive income (loss), net of tax, are as
follows:
|
|
|
Three
Months Ended September 30,
|
|
|
Nine
Months Ended September 30,
|
|
|
|
|
2005
|
|
|
2004
|
|
|
2005
|
|
|
2004
|
|
Net
income (loss)
|
|
$
|
(1,375,260
|
)
|
$
|
(1,028,389
|
)
|
$
|
(1,258,398
|
)
|
$
|
(2,165,816
|
)
|
Foreign
currency translation adjustment
|
|
|
(10,356
|
)
|
|
(12,779
|
)
|
|
(107,193
|
)
|
|
83,278
|
|
Comprehensive
income (loss)
|
|
$
|
(1,385,616
|
)
|
$
|
(1,041,168
|
)
|
$
|
(1,365,591
|
)
|
$
|
(2,082,538
|
)
|
At
September 30, 2005 and December 31, 2004, accumulated other comprehensive
income
(loss) as reported on the Company’s balance sheet is comprised solely of foreign
currency translation adjustments.
(6)
Long-Term
Debt
On
January 10, 2001 the Company obtained a mortgage loan for $6 million secured
by
the real estate property located at 201 and 207 South Street, Boston,
Massachusetts. This is a 20-year direct reduction mortgage with a five-year
balloon due January 10, 2006. The interest rate is fixed for one year, based
on
the one-year Federal Home Loan Bank rate plus 2.5 % per annum. In 2004 the
interest rate was 3.99%. As of January 10, 2005 the rate of interest changed
to
5.80%. The Company renegotiated the rate to 5.0% effective February 10, 2005.
As
of September 30, 2005 $4.9 million was outstanding on this loan, which is
due
and payable on January 10, 2006. Because the mortgage loan is due within
twelve
months, the obligation is classified as a current liability at September
30,
2005.
|
(7)
|
Gain
on sale of investment in
InterMute
|
Since
1999 the Company had a minority interest in a privately held software company,
InterMute, Inc., which the Company had been accounting for under the equity
method of accounting. The Company made its original investment in 1999, at
the
time of the company’s formation, and subsequently made additional investments.
Under the equity method of accounting, the Company's investment was increased
or
decreased, not below zero, based upon the Company's proportionate share of
the
net earnings or losses of InterMute. As a result of the losses incurred by
InterMute subsequent to the Company's investments, the Company's investment
balance was reduced to zero during 2002. The Company discontinued applying
the
equity method when the investment was reduced to zero and did not provide
for
additional losses, as the Company did not guarantee obligations of the investee
and was not committed to provide further financial support.
In
June
2005 InterMute was acquired by Trend Micro Inc., a U.S. subsidiary of Trend
Micro Japan. In connection with the acquisition of InterMute in June 2005,
the
Company received a payment in exchange for its investment of approximately
$3.5
million, also in June 2005. The Company recorded a non-operating, after-tax
gain
of $3.5 million in its second quarter ended June 30, 2005. The Company may
also
receive up to $3.0 million in additional payments in 2006 if certain conditions
and performance targets are met. The recording of gains from these additional
payments will not be made until and unless they are fully earned.
(8)
Commitments
During
the nine months ended September 30, 2005, other than the line of credit
discussed in Note 2 above, there were no material changes to the capital
commitments and contractual obligations of the Company from those disclosed
in
the Form 10-K for the year ended December 31, 2004.
(9)
Segment
and Geographic Information
The
Company’s operations are classified into one reportable segment. The Company’s
United States and international net sales for the three and nine months ended
September 30, 2005 and 2004, respectively, were comprised as
follows:
|
|
Three
Months
|
|
|
|
Three
Months
|
|
|
|
Nine
months
|
|
|
|
Nine
months
|
|
|
|
|
|
Ended
|
|
|
|
Ended
|
|
|
|
Ended
|
|
|
|
Ended
|
|
|
|
|
|
September
30,
2005
|
|
%
of Total
|
|
September
30,
2004
|
|
|
|
September
30,
2005
|
|
|
|
September
30,
2004
|
|
|
|
North
America
|
|
$
|
2,668,030
|
|
|
50%
|
|
$
|
3,321,564
|
|
|
46%
|
|
$
|
8,701,050
|
|
|
48%
|
|
$
|
10,938,878
|
|
|
48%
|
|
Turkey
|
|
|
973,349
|
|
|
18%
|
|
|
1,135,603
|
|
|
16%
|
|
|
3,113,560
|
|
|
17%
|
|
|
3,197,954
|
|
|
14%
|
|
UK
|
|
|
1,108,810
|
|
|
21%
|
|
|
1,835,555
|
|
|
26%
|
|
|
4,057,410
|
|
|
22%
|
|
|
6,219,888
|
|
|
27%
|
|
All
Other
|
|
|
558,191
|
|
|
11%
|
|
|
849,886
|
|
|
12%
|
|
|
2,397,276
|
|
|
13%
|
|
|
2,668,963
|
|
|
11%
|
|
Total
|
|
$
|
5,308,380
|
|
|
100%
|
|
$
|
7,142,608
|
|
|
100%
|
|
$
|
18,269,296
|
|
|
100%
|
|
$
|
23,025,683
|
|
|
100%
|
|
(10)
Customer
Concentrations
Relatively
few customers have accounted for a substantial portion of the Company’s net
sales. In the third quarter of 2005 the Company’s net sales to its top three
customers accounted for 38% of its total net sales, with the Company’s sales to
a large Turkish distributor accounting for 18% of the total net sales. The
remaining 20% was divided fairly equally between the other two customers,
both
with a 10% share. In the first nine months of 2005 the Company's net sales
to
its top three customers accounted for 39% of its total net sales. Zoom’s fourth
largest customer in the second quarter of 2005 and sixth largest customer
in the
first nine months of 2005 was Granville Technologies, Ltd., which in late
July
2005 went into “administration,” a U.K. form of receivership. No sales to
Granville were recorded in the third quarter of 2005. The administrators
have
decided to discontinue the company as a going concern and sell the business
assets to help satisfy creditors. The Company had a receivable of $.8 million
and $.3 million of consigned inventory with Granville Technologies at the
time
that Granville was placed into “administration.” Because of our assessment of
the improbability of the collection of the receivables and the recovery of
the
inventory at that time, the Company's results of operations for the second
quarter of 2005 included a $1.1 million reserve for these receivables and
inventory. The expenses associated with these reserves were recorded as a
general and administrative expense in the second quarter of 2005. In the
third
quarter of 2005 the Company recovered the entire $.3 million of consigned
inventory from the administrators and confirmed that the VAT portion of the
receivable is recoverable from the U.K. government Customs agency, HM Customs.
These recoveries resulted in a $.4 million reversal in the third quarter
of 2005
of the general and administrative expenses associated with the $1.1 million
reserve established in the second quarter of 2005. Additional recoveries
are
highly unlikely.
The
Company’s customers generally do not enter into long-term agreements obligating
them to purchase our products. The Company may not continue to receive
significant revenues from any of these or from other large customers. A
reduction or delay in orders from any of the Company’s significant customers, or
a delay or default in payment by any significant customer could materially
harm
the Company’s business and prospects. Because of the Company’s significant
customer concentration, its net sales and operating income could fluctuate
significantly due to changes in political or economic conditions, or the
loss,
reduction of business, or less favorable terms for any of the Company's
significant customers.
(11)
Subsequent Event
On
October 26, 2005 the Company accelerated the vesting of all stock options
previously awarded to employees and officers that were scheduled to vest
on or
before May 6, 2006. These stock options had exercise prices in excess of
$1.76,
the closing price of the Company’s Common Stock on October 26, 2005, the
effective date of the acceleration. As a result of the acceleration, stock
options to purchase 317,500 shares became exercisable immediately. These
accelerated stock options represent 33% of the total outstanding unvested
stock
options and approximately 25% of the total outstanding stock options. The
weighted average exercise price of the accelerated stock options is $2.44
per
share.
The
primary purpose of the acceleration of the vesting of these stock options
is to
reduce the Company’s future reported compensation expense upon the planned
adoption of Statement of Financial Accounting Standards (SFAS) No. 123R,
“Share
Based Payment” effective January 1, 2006. As a result of the acceleration, the
Company expects to reduce the stock option expense, a non-cash charge, it
otherwise would be required to record by approximately
$130,000 total for the first two quarters of 2006.
The
pro-forma compensation expense reported in footnote 1(b), Stock-Based
Compensation, in this document is not impacted by the vesting acceleration.
The
impact will be reflected in the Stock-Based Compensation footnote in the
2005
10-K.
The
following discussion and analysis should be read in conjunction with the
safe
harbor statement and the risk factors contained herein and set forth in our
Annual Report on Form 10-K for the year ended December 31, 2004. Readers
should
also be cautioned that results of any reported period are often not indicative
of results for any future period.
Overview
We
derive
our net sales primarily from sales of Internet related hardware products,
principally broadband and dial-up modems and related products, to retailers,
distributors, Internet Service Providers and Original Equipment Manufacturers.
We sell our products through a direct sales force and through independent
sales
agents. Our employees are primarily located at our headquarters in Boston,
Massachusetts, our support office in Boca Raton, Florida, and our sales office
in the United Kingdom. We typically design our hardware products, though
we do
sometimes use another company’s design if it meets our requirements. Electronic
assembly and testing of our products in accordance with our specifications
is
typically done in China. We perform most of the packaging and distribution
effort at our production and warehouse facility in Boston, Massachusetts,
which
also engages in firmware programming and in testing.
Historically
we derived a majority of our net sales from the retail after-market sale
of
dial-up modems to customers seeking to add or upgrade a modem for their personal
computers. In recent years the size of this market and our sales to this
market
have declined, as personal computer manufacturers have incorporated a modem
as a
built-in component in most consumer personal computers and as increasing
numbers
of consumers world-wide have switched to broadband Internet access. The general
consensus of communications industry analysts is that after-market sales
of
dial-up modems will continue to decline. There is also consensus among industry
analysts that the market for broadband Internet connection devices, such
as
cable modems and DSL modems, will grow rapidly during the decade. In response
to
increased and forecasted demand for faster connection speeds and increased
modem
functionality, we have invested and continue to invest resources to advance
our
product line of broadband modems, especially DSL modems.
We
continually seek to improve our product designs and manufacturing approach
in
order to reduce our costs. We pursue a strategy of outsourcing rather than
internally developing our modem chipsets, which are application-specific
integrated circuits that form the technology base for our modems. By outsourcing
the chipset technology, we are able to concentrate our research and development
resources on modem system design, leverage the extensive research and
development capabilities of our chipset suppliers, and reduce our development
time and associated costs and risks. As a result of this approach, we are
able
to quickly develop new and innovative products while maintaining a relatively
low level of research and development expense as a percentage of net sales.
We
also outsource aspects of our manufacturing to contract manufacturers as
a means
of reducing our costs of production, and to provide us with greater flexibility
in our production capacity.
Over
the
past several years our net sales have declined. In response to the declining
sales volume, we have cut costs by reducing staffing and some overhead costs.
On
December 31, 2002, our total headcount of full-time employees, including
temporary workers, was 185, which was reduced to 154 at year-end 2004. On
September 30, 2005, our full-time employee headcount was 125.
Generally
our gross margin for a given product depends on a number of factors including
the type of customer to whom we are selling. The gross margin for retailers
tends to be higher than for some of our other customers; but the sales, support,
and overhead costs associated with retailers also tend to be higher. All
of
Zoom’s sales to certain countries, including Turkey, Vietnam, and Saudi Arabia,
are currently handled by a single distributor who handles the support and
marketing costs within the country. Gross margin for sales to these distributors
tends to be low, since lower pricing to these distributors helps them to
cover
the support and marketing costs that they cover. Our gross margin for broadband
modems tends to be lower than for dial-up modems for a number of reasons,
including the fact that retailers are currently a more significant channel
for
our dial-up modems than for our broadband modems; the fact that a higher
percentage of our DSL sales come from low-margin countries; and the fact
that
there is stronger competition in the DSL market than in the dial-up
market.
In
the
first nine months of 2005 our net sales were down 20.7% over the same nine-month
period in the prior year. The main reason for the decrease was the decline
in
dial-up modem sales, more than offsetting a growth in DSL modem sales. While
we
have generally experienced growth in our DSL modem sales, these sales are
currently concentrated with a small number of customers, and this reduces
the
predictability of our results. In fact, as described below, one of our larger
DSL customers, Granville Technologies Ltd., went into receivership in July
2005,
and this is one important reason that our total DSL sales were only up 5%
from
the third quarter of 2004 to the third quarter of 2005. In Turkey Zoom has
had a
relatively high share of the small DSL market that is one of the fastest
growing
in the world in percentage terms; and in the future we will compete to try
to
maintain or grow our share in what is expected to be a high-growth market.
We
are also continuing our efforts to expand our DSL customer base and product
line, and to enter new markets. Because of our significant customer
concentration, however, our net sales and operating income could fluctuate
significantly due to changes in political or economic conditions or the loss,
reduction of business, or less favorable terms for any of our significant
customers.
Zoom’s
fourth largest customer in the second quarter of 2005 and sixth largest customer
in the first nine months of 2005 was Granville Technologies, Ltd., which
was
reported in late July 2005 to have gone into “administration,” a U.K. form of
receivership. No sales to Granville were recorded in the third quarter of
2005.
The administrators have decided to discontinue the company as a going concern
and sell the business assets to help satisfy creditors. The Company had a
receivable of $.8 million and $.3 million of consigned inventory with Granville
Technologies at the time that Granville was placed into “administration.”
Because of our assessment of the improbability of the collection of the
receivables and the recovery of the inventory at that time, the Company's
results of operations for the second quarter of 2005 included a $1.1 million
reserve for these receivables and inventory. The expenses associated with
these
reserves were recorded as a general and administrative expense in the second
quarter of 2005. In the third quarter of 2005 the Company recovered the entire
$.3 million of consigned inventory from the administrators and confirmed
that
the VAT portion of the receivable is recoverable from the U.K. government
Customs agency, HM Customs. These recoveries resulted in a $.4 million reversal
in the third quarter of 2005 of the general and administrative expenses
associated with the $1.1 million reserve established in the second quarter
of
2005. Additional recoveries are highly unlikely.
Since
1999 we had a minority interest in a privately held software company, InterMute,
Inc. In June 2005 InterMute was acquired by Trend Micro Inc., a U.S. subsidiary
of Trend Micro Japan. In connection with the acquisition, in June 2005, we
received a payment in exchange for our investment of approximately $3.5 million.
We recorded a non-operating gain of $3.5 million in our second quarter of
2005
in connection with this sale. We may also receive up to $3.0 million in
additional payments in 2006 if certain conditions and performance targets
are
met. We will not record gains from these additional payments, if any, until
and
unless they are fully earned.
Our
cash
and cash equivalents balance at September 30, 2005 was $8.3 million, down
from
$9.4 million at December 31, 2004. This was due primarily to our operating
losses for the nine months and a reduction of accounts payable and accrued
expenses, partially offset by the receipt of $3.5 million from the sale of
the
Company's investment in InterMute.
Critical
Accounting Policies and Estimates
The
following is a discussion of what we view as our more significant accounting
policies and estimates. As described below, management judgments and estimates
must be made and used in connection with the preparation of our consolidated
financial statements. Where noted, material differences could result in the
amount and timing of our net sales, costs, and expense for any period if
we made
different judgments or used different estimates.
Revenue
(Net Sales) Recognition.
We
primarily sell hardware products to our customers. The hardware products
include
dial-up modems, DSL modems, cable modems, embedded modems, ISDN modems,
telephone dialers, and wireless and wired networking equipment. We earn a
small
amount of royalty revenue that is included in our net sales, primarily from
Internet service providers. We generally do not sell software. We began selling
services in 2004. We introduced our Global Village VoIP service in late 2004,
but sales of those services to date have not been material.
We
derive
our net sales primarily from the sales of hardware products to four types
of
customers:
|
·
|
computer
peripherals retailers;
|
|
·
|
Internet
service providers;
|
|
·
|
computer
product distributors; and
|
|
·
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original
equipment manufacturers (OEMs).
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We
recognize hardware net sales for all three types of customers at the point
when
the customers take legal ownership of the delivered products. Legal ownership
passes from Zoom to the customer based on the contractual FOB point specified
in
signed contracts and purchase orders, which are both used extensively. Many
of
our customer contracts or purchase orders specify FOB destination. We verify
the
delivery date on all significant FOB destination shipments made during the
last
10 business days of each quarter.
Our
net
sales of hardware include reductions resulting from certain events which
are
characteristic of the sales of hardware to retailers of computer peripherals.
These events are product returns, certain sales and marketing incentives,
price
protection refunds, and consumer and in-store mail-in rebates. Each of these
is
accounted for as a reduction of net sales based on detailed management
estimates, which are reconciled to actual customer or end-consumer credits
on a
monthly or quarterly basis.
Our
VoIP
service revenues to date were recorded as the end-user-customer consumed
billable VoIP services. The end-user-customer became a service customer by
electing to sign up for the Global Village billable service on the Internet.
Zoom recorded revenue either as billable services were consumed or as a monthly
flat-fee service was billed.
Product
Returns. Products
are returned by retail stores and distributors for inventory balancing,
contractual stock rotation privileges, and warranty repair or replacements.
We
estimate the sales and cost value of expected future product returns of
previously sold products. Our estimates for product returns are based on
recent
historical trends plus estimates for returns prompted by, among other things,
new product introductions, announced stock rotations and announced customer
store closings, etc. Management reviews historical returns, current economic
trends, and changes in customer demand and acceptance of our products when
estimating sales return allowances. The estimate for future returns is recorded
as a reserve against accounts receivable, a reduction of net sales, and the
corresponding change to inventory and cost of sales. The relationship of
quarterly physical product returns to quarterly product sales remained
relatively stable for many years, but has been declining from a high of 10.6%
to
a low of 5.4% in the past two years as retail sales as a percent of total
sales
have declined.
Price
Protection Refunds.
We have
a policy of offering price protection to certain of our retailer and distributor
customers for some or all their inventory. Under the price protection policies,
when we reduce our prices for a product, the customer receives a credit for
the
difference between the original purchase price and our reduced price for
their
unsold inventory of that product. Our estimates for price protection refunds
are
based on a detailed understanding and tracking by customer and by sales program.
Estimated price protection refunds are recorded in the same period as the
announcement of a pricing change. Information from customer inventory-on-hand
reports or from direct communications with the customers is used to estimate
the
refund, which is recorded as a reduction of net sales and a reserve against
accounts receivable. Reductions in our net sales due to price protection
were
$.7 million in 2002, $.2 million in 2003, and $.1 million in 2004. In the
three
and nine months ended September 30, 2005, Zoom’s recorded price protection was
$.1 million and $.2 million, respectively.
Sales
and Marketing Incentives. Many
of
our retailer customers require sales and marketing support funding, usually
set
as a percentage of our sales in their stores. The incentives were primarily
reported as reductions in our net sales and were $1.7 million in 2002, $1.5
million in 2003, and $1.3 million in 2004. In the three and nine months ended
September 30, 2005, Zoom’s net sales were reduced by $.2 million and $.9
million, respectively, due to sales and marketing support funding. The declining
trend was primarily due to lower retailer sales.
Consumer
Mail-In and In-Store Rebates and Store Rebates.
Our
estimates for consumer mail-in rebates are based on a detailed understanding
and
tracking by customer and sales program, supported by actual rebate claims
processed by the rebate redemption centers plus an accrual for an estimated
lag
in processing at the redemption centers. Our estimates for store rebates
are
comprised of actual credit requests from the eligible customers. The estimate
for mail-in and store rebates is recorded as a reserve against accounts
receivable and a reduction of net sales in the same period that the rebate
obligation was triggered. Reductions in our net sales due to the consumer
rebates were $1.6 million in 2002, $2.1 million in 2003, and $1.4 million
in
2004. In the three and nine months ended September 30, 2005, Zoom’s recorded
consumer and store rebates were $.2 million and $.9 million respectively.
The
declining trend was primarily due to lower retailer sales.
To
ensure
that the sales, discounts, and marketing incentives are recorded in the proper
period, we perform extensive tracking and documenting by customer, by period,
and by type of marketing event. This tracking includes reconciliation to
the
accounts receivable records for deductions taken by our customers for these
discounts and incentives.
Accounts
Receivable Valuation. We
establish accounts receivable reserves equal to the above-discussed net sales
adjustments for estimates of product returns, price protection refunds, and
consumer and store rebates. These reserves are drawn down as actual credits
are
issued to the customer’s accounts. Other than the $.7 million reserve recorded
against the Granville Technologies receivable in the nine months ended September
30, 2005 in connection with the reported administration status of that company,
over the past several years our bad-debt write-offs have not been significant.
The Granville accounts receivable charge was recorded to general and
administrative expense.
Inventory
Valuation and Cost of Goods Sold. Inventory
is valued on a standard cost basis where the material standards are periodically
updated for current material pricing. Reserves for obsolete inventory are
established by management based on usability reviews performed each quarter.
Our
reserves against the inventory of a particular product range from 0% to 100%,
based on management’s estimate of the probability that the material will not be
consumed or that it will be sold below cost. Our valuation process is to
compare
our cost to the selling prices each quarter, and if the selling price of
a
product is less than the “if completed” cost of our inventory, we write-down the
inventory on a “lower of cost or market” basis. In 2002 and 2003, we recorded
charges against inventory of $.7 million and $.3 million respectively as
a
result of lower of cost or market valuation issues. No lower of cost or market
charges against inventory were recorded in 2004 or the nine months ended
September 30, 2005. In the third quarter ended September 30, 2005 we recorded
increased obsolescence reserves of $.3 million for older models of ADSL modems
and VOIP hardware.
Along
with the expected loss of receivables from the aforementioned Granville
Technologies, Ltd. business failure, we also had $.3 million of consigned
inventory at one of Granville's facilities. We believed that recovery of
this
inventory was uncertain and we recorded an inventory reserve of $.3 million
in
the second quarter of 2005. We recovered the entire inventory from the Granville
administrators and reversed the $.3 million inventory reserve in the third
quarter of 2005.
During
the last three years we benefited from various component supply arrangements
that provided us with free products based on the amount of goods we purchased
from the supplier. The favorable impact to our statement of operations was
recognized as the products employing the acquired components were sold. A
new
supply arrangement for 2005, with free products to be earned on purchases,
received similar accounting treatment in the quarter and nine months ended
September 30, 2005.
Valuation
and Impairment of Deferred Tax Assets. As
part
of the process of preparing our consolidated financial statements we are
required to estimate our income tax expense and deferred income tax position.
This process involves the estimation of our actual current tax exposure together
with assessing temporary differences resulting from differing treatment of
items
for tax and accounting purposes. These differences result in deferred tax
assets
and liabilities, which are included in our consolidated balance sheet. We
must
then assess the likelihood that our deferred tax assets will be recovered
from
future taxable income and to the extent we believe that recovery is not likely,
we must establish a valuation allowance. To the extent we establish a valuation
allowance or increase this allowance in a period, we must include an expense
within the tax provision in the statement of operations.
Significant
management judgment is required in determining our provision for income taxes
and any valuation allowance recorded against our net deferred tax assets.
We
have recorded a 100% valuation allowance against our deferred tax assets.
It is
management’s estimate that, after considering all the available objective
evidence, historical and prospective, with greater weight given to historical
evidence, it is more likely than not that these assets will not be realized.
If
we establish a record of continuing profitability, at some point we will
be
required to reverse the valuation allowance and restore the deferred asset
value
to the balance sheet, recording an equal income tax benefit which will increase
net income in that period(s).
Results
of Operations
Summary.
Net
sales were $5.3 million for our third quarter ended September 30, 2005, down
25.7% from $7.1 million in the third quarter of 2004. We had a net loss of
$1.4
million for the third quarter of 2005, compared to a net loss of $1.0 million
in
the third quarter of 2004. We had a loss per diluted share of $.15 for the
third
quarter of 2005 compared to a net loss per diluted share of $.12 for the
third
quarter of 2004.
Net
sales
were $18.3 million for the nine months ended September 30, 2005, down 20.7%
from
$23.0 million in the first nine months of 2004. We had a net loss of $1.3
million for the first nine months of 2005, compared to a net loss of $2.2
million in the first nine months of 2004. We recorded a net loss per diluted
share of $.14 for the first nine months of 2005 compared to a net loss per
diluted share of $.26 for the first nine months of 2004.
Net
Sales.
Our net
sales for the third quarter of 2005 decreased 25.7% from the third quarter
of
2004, primarily due to a 43% decrease in dial-up modem sales partially offset
by
a 5.4% increase in DSL modem sales. Dial-up modem net sales declined to $2.2
million in the third quarter of 2005 compared to $3.9 million in the third
quarter of 2004, primarily due to a decrease of both dial-up modem unit sales,
primarily resulting from the continued decline of the dial-up modem
after-market, and to a lesser extent, lower dial-up modem average selling
prices. DSL modem net sales were $2.6 million in the third quarter of 2005
compared to $2.5 million in the third quarter of 2004. The modest growth
was
primarily due to numerous new and repeat customer sales, at retailers,
distributors, value-added resellers, and internet service providers worldwide,
partially offset by by a slight decrease in DSL modem sales to our large
distributor customer in Turkey.
Net
sales
in our other product sales categories, which include cable modems, cameras,
ISDN
modems, telephone dialers, and wireless networking equipment declined $.4
million, or 42% from $.8 million from the third quarter of 2004 to $.4 million
in the third quarter of 2005, primarily due to decreased sales emphasis on
many
of these products. During the third quarter of 2005 we did not realize any
significant revenue from our Global Village phone services.
Our
net
sales for the first nine months of 2005 decreased 20.7% from the first nine
months of 2004, primarily due to a 38% decrease in dial-up modem sales,
partially offset by a 16% increase in DSL modem sales. Dial-up modem net
sales
declined to $8.1 million in the first nine months of 2005 compared to $13.0
million in the first nine months of 2004, primarily due to a decrease of
both
dial-up modem unit sales, primarily resulting from the continued decline
of the
dial-up modem after-market, and to a lesser extent, lower dial-up modem average
selling prices. DSL modem net sales increased to $8.9 million in the first
nine
months of 2005 compared to $7.6 million in the first nine months of 2004,
primarily due to increased unit net sales of DSL modems in Turkey and other
countries. Net sales in our other product sales categories, which include
cable
modems, cameras, ISDN modems, telephone dialers, and wireless networking
equipment declined $1.1 million, or 46% from $2.4 million for the first nine
months of 2004 to $1.3 million in the first nine months of 2005, primarily
due
to decreased sales emphasis on many of these products.
Our
net
sales in North America were $2.7 million in the third quarter of 2005, a
decrease from $3.3 million in the third quarter of 2004. Our net sales in
Turkey
were $1.0 million in the third quarter of 2005, a decrease from $1.1 million
in
the third quarter of 2004. Our net sales in the U.K. were $1.1 million in
the
third quarter of 2005, a decrease from $1.8 million in the third quarter
of
2004. Our net sales other than North America, Turkey and the U.K. were $.6
million in the third quarter of 2005, a decrease from $.9 million in the
third
quarter of 2004. We attribute the declining sales in Turkey in part to
customer's overstock of inventory. However, we cannot assure that our sales
to
Turkey will recover. The changes in the other market areas reflect our declining
sales of dial-up modems, particularly in North America and the U.K.
Our
net
sales in North America were $8.7 million in the first nine months of 2005,
a
decline from $10.9 million in the first nine months of 2004. Our net sales
in
Turkey were $3.1 million in the first nine months of 2005 and $3.2 million
in
the first nine months of 2004. Our net sales in the U.K. were $4.1 million
in
the first nine months of 2005, a decline from $6.2 million in the first nine
months of 2004. The sales decline in North America and the U.K. reflect our
declining sales of dial-up modems. Our net sales other than North America,
Turkey and the U.K. were $2.4 million in the first nine months of 2005 and
$2.7
million in the first nine months of 2004, also reflective of our declining
sales
of dial-up modems. In the third quarter ended September 30, 2005 the Company’s
largest customer, accounting for 18% of total net sales, was a large distributor
in Turkey. In the first nine months ended September 30, 2005 the Company's
two
largest customers were our Turkish Distributor and a large North American
retailer, accounting for 17% and 14% of total net sales, respectively. Because
of our significant customer concentration, our net sales and operating income
could fluctuate significantly due to changes in political or economic conditions
or the loss, reduction of business, or less favorable terms for any of our
significant customers. For example, we expect our ongoing net sales to be
adversely affected by the administration status of Granville Technologies
in
July 2005. Granville Technologies accounted for 0% and 6% of our net sales
in
the third quarter and first nine months of 2005, respectively, compared to
6%
and 5% of our net sales in the third quarter and first nine months of 2004,
respectively.
Gross
Profit. Our
total
gross profit was $.5 million or 9.8% of net sales in the third quarter of
2005,
down from $1.5 million or 21% of net sales in the third quarter of 2004.
The
reduced gross profit resulted primarily from the reduction in sales and from
lower gross margin on those sales. Gross margin was lower due to obsolescence
charges for slow-moving models, the negative effect of manufacturing overhead
spread over lower sales, and the shift of Zoom’s product mix away from dial-up
modems, Zoom’s highest margin product category.
Our
total
gross profit was $3.4 million in the first nine months of 2005, a decline
from
$6.1 million in the first nine months of 2004. Our gross margin percent of
net
sales decreased to 18.8% in the first nine months of 2005 from 26.3% in the
first nine months of 2004. Gross margins were lower primarily because of
the
negative effect of manufacturing overhead spread over lower sales and the
shift
of Zoom’s product mix away from dial-up modems, Zoom’s highest margin product
category.
Selling
Expense. Selling
expense decreased $.1 million to $1.0 million or 18.4% of net sales in the
third
quarter of 2005 from $1.1 million or 15.6% of net sales in the third quarter
of
2004. Selling expense was lower primarily due to Zoom’s moving most European
customer support from the U.K. to the U.S., which resulted in a net reduction
in
headcount.
Selling
expense decreased $.3 million to $3.2 million or 17.4% of net sales in the
first
nine months of 2005 from $3.5 million or 15.3% of net sales in the first
nine
months of 2004. Selling expense was lower primarily because of lower personnel
and related costs resulting from employee headcount reductions, including
the
impact of moving most European customer support from the U.K. to the U.S.,
partially offset by higher distribution and outbound product delivery
expense.
General
and Administrative Expense. General
and administrative expense decreased $.5 million to $.3 million, or 5.9%
of net
sales in the third quarter of 2005 from $.8 million, or 10.9% of net sales
in
the third quarter of 2004. The decrease of $.5 million was primarily due
to the
reversal of $.4 million of the $1.1 million reserve established last quarter
when a customer in the U.K., Granville Technology Group, went into
“administration,” a U.K. form of receivership. The $.4 million favorable
adjustment was primarily due to the successful recovery of $.3 million of
the
consigned inventories and the confirmation that $.1 million of the Value
Added
Tax (VAT) we paid on certain uncollectable sales was refundable by HM Customs,
the U.K. government VAT agency.
General
and administrative expense increased $.1 million to $2.9 million, or 15.7%
of
net sales in the first nine months of 2005 from $2.8 million, or 12.1% of
net
sales, in the first nine months of 2004. The increase of $.1 million was
primarily due to a $.7 million charge to general and administrative expense
for
the reserve against receivables for Granville Technologies, the U.K customer
now
in administration, partially offset by lower legal and accounting expense
due to
acquisition-related expense in the second quarter of 2004, lower personnel
costs, lower employee health expense, and other expense reductions.
Research
and Development Expense. Research
and development expense was $.7 million or 12.5% of net sales in the third
quarter of 2005 and $.7 million or 10.1% of net sales in the third quarter
of
2004. These costs reflected increases primarily in licenses and approvals
and
outside services that were offset by decreases primarily in employee
compensation and depreciation expense.
Research
and development expense was $2.1 million or 11.5% of net sales in the first
nine
months of 2005 and $2.1 million or 9.0% of net sales in the first nine months
of
2004. These costs reflected increases primarily in outside services and licenses
and approvals that were offset by decreases primarily in depreciation and
employee compensation. Development and support continues on all of our major
product lines with particular emphasis on VoIP hardware, the Global Village
phone services, and DSL modems.
Other
Income (Expense), Net. Other
income, net was $.1 million in the third quarter of 2005, compared to $.1
million in the third quarter of 2004.
Other
income, net was $3.5 million in the first nine months of 2005, compared to
$.1
million in the first nine months of 2004. The reason for the $3.3 million
increase in other income, net was the $3.5 million gain from the InterMute
transaction, offset slightly by a decline of rental income received from
leasing
excess space at our headquarters facility.
Income
Tax Expense (Benefit). We
did
not record any income tax expense in the third quarter or the nine months
ended
September 30, 2005 or September 30, 2004. The net deferred tax asset balance
at
September 30, 2005 is zero. This accounting treatment is described in further
detail under the caption Critical
Accounting Policies and Estimates
above.
Liquidity
and Capital Resources
On
September 30, 2005 we had working capital of $9.2 million, including $8.3
million in cash and cash equivalents. In the first nine months of 2005 operating
activities used $4.9 million in cash. Our net loss in the first nine months
of
2005 was $1.3 million. Adjustments to reconcile net loss to net cash used
in
operating activities included a $3.5 million gain on the sale of our investment
in InterMute and depreciation of $.2 million. Net cash used in operating
activities included an increase of inventory of $.1 million and a reduction
of
accounts payable and accrued expenses of $1.0 million. Net cash provided
by
operating activities included a $.4 million decrease in accounts receivable
and
a decrease of prepaid expense of $.3 million. The $.4 million decrease of
accounts receivable was not a source of cash as it was primarily the result
of
the $.7 million reserve recorded against receivables for Granville Technologies,
the U.K customer now in administration status.
In
the
first nine months of 2005 investing activities provided $3.5 million of cash,
due to the receipt of a $3.5 million cash payment in exchange for our investment
in InterMute. In the first nine months of 2005 financing activities provided
$.3
million, primarily from $.4 million from the exercise of employee stock options,
partially offset by $.2 million in cash for monthly principal payments on
our
$6.0 million mortgage, with a current outstanding balance of $4.9 million.
Zoom
may
also receive additional payments of up to approximately $3 million in 2006
in
connection with the InterMute sale if certain conditions and performance
targets
are met.
Our
mortgage is a 5-year balloon mortgage, payable in full in January 2006 that
is
amortized on a 20-year basis. The interest rate is adjusted annually in January
of each year based on the Federal Home Loan Bank rate plus 2.5% per annum.
In
2004 the interest rate was 3.99%. As of January 10, 2005 the rate of interest
changed to 5.80%. We renegotiated the rate to 5.0% effective February 10,
2005.
As of September 30, 2005 $4.9 million was outstanding on this loan, which
will
be due and payable on January 10, 2006. Because the mortgage is due within
twelve months, the mortgage loan is reflected as a current liability. We
believe
that we have sufficient resources to repay the mortgage on or before the
maturity date in January 2006. We also believe that we should be able to
sell
our owned buildings on favorable terms if we require additional liquidity.
If we
were to sell the portion of our owned buildings that includes our principal
headquarters, we believe we would be able to lease back a portion of the
sold
property or otherwise find suitable space for our principal headquarters
on
satisfactory terms.
On
March
16, 2005 we entered into a Loan and Security Agreement with Silicon Valley
Bank
that provides for a revolving line of credit of up to $2 million. The revolving
line of credit can be used to (i) borrow under revolving loans for working
capital and general corporate purposes, (ii) issue letters of credit, (iii)
enter into foreign exchange forward contracts, and (iv) support certain cash
management services. Revolving loans bear interest at a floating rate of
interest equal to Silicon Valley Bank’s prime rate plus 0.5%. The rate at
September 30, 2005 was 7.25%. This interest rate will be increased to Silicon
Valley Bank’s prime rate plus 1.0% if we record two consecutive quarters of
combined losses. The revolving line of credit terminates and all outstanding
obligations under the Loan and Security agreement become due on March 15,
2006.
The
revolving loans under the Loan and Security Agreement are secured by a first
priority lien on substantially all of our assets, excluding intellectual
property and real estate. We guaranteed the obligations of Zoom Telephonics
under the revolving line of credit and pledged all of the stock of Zoom
Telephonics in support of our guarantee. The Loan and Security Agreement
requires that we maintain a minimum adjusted quick ratio and a minimum net
worth. In addition, we are required to obtain Silicon Valley Bank’s prior
written consent to among other things, dispose of assets, make acquisitions,
be
acquired, incur indebtedness, grant liens, make investments, pay dividends,
or
repurchase stock. This consent may not be unreasonably withheld.
The
Loan
and Security Agreement contains events of default that include among other
things, non-payment of principal, interest or fees, violation of covenants,
inaccuracy of representations and warranties, cross default to certain other
indebtedness, bankruptcy and insolvency events, change of control and material
judgments. Upon occurrence of an event of default, Silicon Valley Bank is
entitled to, among other things, accelerate all of our obligations under
the
Loan and Security Agreement and sell our assets to satisfy our obligations
under
the Loan and Security Agreement. As of September 30, 2005 our availability
under
the revolving line of credit is $1.7 million. We have no outstanding borrowings
and are in compliance with the covenants under the revolving line of credit
as
of September 30, 2005.
To
conserve cash and manage our liquidity, we continue to implement cost cutting
initiatives including the reduction of employee headcount and overhead costs.
The employee headcount was 154 at December 31, 2004 and has been reduced
to 125
at September 30, 2005. We plan to continue to assess our cost structure as
it
relates to our revenues and cash position, and we may make further reductions
if
the actions are deemed necessary.
Management
believes we have sufficient resources to fund our normal operations over
the
next 12 months, through September 30, 2006. However, if we are unable to
increase our revenues, reduce or otherwise adequately control our expenses,
or
raise capital, our longer-term ability to continue as a going concern and
achieve our intended business objectives could be adversely affected. Moreover,
our liquidity could be significantly impaired if we repay our mortgage with
our
current sources of cash on or before the maturity date in January 2006 and
we
are not able to refinance all or a significant portion of the mortgage and
we
are not otherwise able to sell our owned buildings for adequate consideration.
See “Risk Factors” below, for further information with respect to events and
uncertainties that could harm our business, operating results, and financial
condition.
Commitments
During
the nine months ended September 30, 2005, there were no material changes
to our
capital commitments and contractual obligations from those disclosed in the
Form
10-K for the year ended December 31, 2004, other than the revolving line
of
credit we obtained in March 2005, which is described in Note 2 of the Notes
to
Consolidated Financial Statements.
“Safe
Harbor” Statement under the Private Securities Litigation Reform Act of
1995.
Some
of the statements contained in this report are forward-looking statements
within
the meaning of Section 27A of the Securities Act of 1933 and Section 21E
of the
Securities Exchange Act of 1934. These statements involve known and unknown
risks, uncertainties and other factors which may cause our or our industry’s
actual results, performance or achievements to be materially different from
any
future results, performance or achievements expressed or implied by the
forward-looking statements. Forward-looking statements include, but are not
limited to statements regarding: Zoom’s plans, expectations and intentions,
including statements relating to Zoom’s prospects and plans relating to sales of
our dial-up, cable and DSL modems, wireless and VoIP products; the expected
effects resulting from the failure of Granville Technologies; the anticipated
development and timing of new product introductions; the decline of the dial-up
modem market; the level of demand for Zoom’s products; Zoom’s ability to obtain
debt or equity financing; Zoom’s sufficiency of capital resources; Zoom’s
ability to obtain debt or equity financing; Zoom’s sufficiency of capital
resources; Zoom’s ability to repay its mortgage with current cash resources
and/or refinancing all or a portion of the mortgage; Zoom’s ability to sell its
owned real property if it chooses to do so and Zoom’s ability to lease suitable
space for its principal headquarters if it chooses to sell its owned real
property; the anticipated impact of changes in the accounting treatment of
stock
options; and Zoom’s financial condition or results of
operations.
In
some cases, you can identify forward-looking statements by terms such as
“may,”“will,” “should,” “could,” “would,”
“expects,” “plans,” “anticipates,” “believes,”
“estimates,” “projects,” “predicts,” “potential” and similar
expressions intended to identify forward-looking statements. These statements
are only predictions and involve known and unknown risks, uncertainties,
and
other factors that may cause our actual results, levels of activity,
performance, or achievements to be materially different from any future results,
levels of activity, performance, or achievements expressed or implied by
such
forward-looking statements. Given these uncertainties you should not place
undue
reliance on these forward-looking statements. Also, these forward-looking
statements represent our estimates and assumptions only as of the date of
this
report. We expressly disclaim any obligation or undertaking to release publicly
any updates or revisions to any forward-looking statement contained in this
report to reflect any change in our expectations or any change in events,
conditions or circumstances on which any of our forward-looking statements
are
based. Factors that could cause or contribute to differences in our future
financial results include those discussed in the risk factors set forth below
as
well as those discussed elsewhere in this report and in our filings with
the
Securities and Exchange Commission. We qualify all of our forward-looking
statements by these cautionary statements.
This
report contains forward-looking statements that involve risks and uncertainties,
such as statements of our objectives, expectations and intentions. The
cautionary statements made in this report should be read as applicable to
all
forward-looking statements wherever they appear in this report. Our actual
results could differ materially from those discussed herein. Factors that
could
cause or contribute to such differences include those discussed below, as
well
as those discussed elsewhere in this report.
We
may continue to incur net losses if we are unable to increase sales of our
broadband modems.
Our
net
sales have been declining primarily due to the decline in the dial-up modem
market, continuing decreases in the average selling prices of dial-up modems,
and the trend toward faster connection speeds and broadband access products.
Despite numerous cost reductions over the last few years, we have continued
to
incur significant net losses primarily due to our continuous decline in net
sales from dial-up modems. We believe that the future of our business is
largely
dependent on the success of our broadband modems and other products. Although
we
believe that we have sufficient resources to fund our planned operations
over
the next year, if we fail to increase our net sales of our broadband modems
and
other products, our longer-term ability to stay in business and to achieve
our
intended business objectives could be adversely effected. Our continuing
losses
could also adversely affect our ability to fund the growth of our business
should our strategies prove successful.
Our
liquidity may be significantly impaired if we repay our mortgage prior to
the
maturity of our mortgage in January 2006 with our current sources of cash
and
are not able to refinance all or a significant portion of our mortgage or
otherwise sell our owned buildings for adequate
consideration.
Our
mortgage loan on the two buildings constituting our headquarters facility,
of
which $4.9 million was outstanding on September 30, 2005, will be due and
payable on January 10, 2006. We believe that we have sufficient resources
to
repay the mortgage through current sources of cash and/or by refinancing
all or
a portion of the mortgage on or before the maturity date in 2006. We also
believe that, in connection with or following the repayment of the mortgage,
we
will be able to sell our owned building on favorable terms if we require
additional liquidity. Our liquidity could be significantly impaired if we
repay
our mortgage with our current sources of cash on or before the maturity date
in
January 2006 and we are not able to refinance all or a significant portion
of
the mortgage or we are not otherwise able to sell our owned buildings for
adequate consideration.
If
we
were to sell the portion of our owned buildings that includes our principal
headquarters, we believe we would be able to lease back a portion of the
sold
property or otherwise find suitable space for our principal headquarters
on satisfactory terms. If we are unable to lease back a portion of the sold
property or otherwise find suitable space for our principal headquarters
on
satisfactory terms, our business may be harmed.
To
stay in business we may require future additional funding which we may be
unable
to obtain on favorable terms, if at all.
In
addition to obtaining funds to refinance or repay our mortgage, over the
next
twelve months we may require additional financing for our operations either
to
fund losses beyond those we anticipate or to fund growth in our inventory
and
accounts receivable. Additional financing may not be available to us on a
timely
basis if at all, or on terms acceptable to us. If we fail to obtain acceptable
additional financing when needed, we may be required to further reduce planned
expenditures or forego business opportunities, which could reduce our net
sales,
increase our losses, and harm our business. Moreover, additional equity
financing could dilute the per share value of our common stock held by current
shareholders, while additional debt financing could restrict our ability
to make
capital expenditures or incur additional indebtedness, all of which would
impede
our ability to succeed.
Our
net sales and operating results have been adversely affected because of a
decline in average selling prices for our dial-up modems and because of the
decline in the retail market for dial-up modems.
The
dial-up modem industry has been characterized by declining average selling
prices and a declining retail market. The decline in average selling prices
is
due to a number of factors, including technological change,
lower
component costs, and competition. The decline in the size of the retail market
for dial-up modems is primarily due to the inclusion of dial-up modems as
a
standard feature contained in new PCs, and the advent of broadband products.
Due
to these factors and others, one of our significant retail customers has
notified us that they want to purchase on a consignment basis for their dial-up
modem category. That customer has also indicated that they plan to reduce
the
number of brands of dial-up modems they sell, and that they cannot assure
that
they will continue to sell our products. Less advantageous terms of sales,
decreasing average selling prices and reduced demand for our dial-up modems
have
resulted and may in the future result in decreased net sales for dial-up
modems.
If we fail to replace declining revenue from the sales of dial-up modems
with
the sales of our other products, including our broadband modems, our business
and results of operation will be harmed.
Our
reliance on a limited number of customers for a large portion of our revenues
could materially harm our business and prospects.
Relatively
few customers have accounted for a substantial portion of our net sales.
In
2004, our net sales to each of three companies constituted over 10% of our
net
sales and together these three customers accounted for 35% of our total net
sales. In the third quarter of 2005, our net sales to our top three customers
accounted for 38% of our total net sales, with our sales to one customer
accounting for 18% of our total net sales. Our customers generally do not
enter
into long-term agreements obligating them to purchase our products. We may
not
continue to receive significant revenues from any of these or from other
large
customers. Because of our significant customer concentration, our net sales
and
operating income could fluctuate significantly due to changes in political
or
economic conditions or the loss, reduction of business, or less favorable
terms
for any of our significant customers. For example, we expect our ongoing
net
sales to be adversely affected by the failure of Granville Technologies in
July
2005. Granville Technologies accounted for 0% and 6% of our net sales in
the
third quarter and first nine months of 2005, respectively compared to 6%
and 5%
of our net sales in the third quarter and first nine months of 2004. A reduction
or delay in orders from any of our significant customers, or a delay or default
in payment by any significant customer could materially harm our business
and
prospects.
Our
international operations are subject to a number of risks inherent in
international activities.
Our
sales
outside of North America continue to represent an increasingly significant
portion of our sales. Sales outside of North America have increased from
38% of
net sales in 2001 to approximately 55% of our net sales in 2004, including
27%
in the UK and 16% in Turkey. In the third quarter of 2005, our sales outside
of
North America accounted for 50% of our total net sales, including 18% in
Turkey
and 21% in the U.K. Currently our operations are significantly dependent
on our
international operations, particularly sales of our DSL modems, and may be
materially and adversely affected by many factors including:
· |
international
regulatory and communications requirements and policy changes;
|
· |
favoritism
toward local suppliers;
|
· |
delays
in the rollout of broadband services by cable and DSL service
providers;
|
· |
local
language and technical support requirements;
|
· |
difficulties
in inventory management, accounts receivable collection and the
management
of distributors
or representatives;
|
· |
difficulties
in staffing and managing foreign operations;
|
· |
political
and economic changes and disruptions;
|
· |
governmental
currency controls;
|
· |
currency
exchange rate fluctuations; and
|
We
anticipate that our international sales will continue to account for a
significant percentage of our net sales. If foreign markets for our current
and
future products develop more slowly than currently expected, our sales
and our
future results of operations may be harmed.
We
believe that our future success will depend in large part on our ability
to more
successfully penetrate the broadband modem markets, which have been challenging
markets, with significant barriers to entry.
With
the
shrinking of the dial-up modem market, we believe that our future success
will
depend in large part on our ability to more successfully penetrate the broadband
modem markets, DSL and cable, and the VoIP market. These markets have been
challenging markets, with significant barriers to entry that have adversely
affected our sales to these markets. Although some cable and DSL modems are
sold
at retail, the high volume purchasers of these modems are concentrated in
a
relatively few large cable, telecommunications, and Internet service providers
which offer broadband modem services to their customers. These customers,
particularly cable services providers, also have extensive and varied approval
processes for modems to be approved for use on their network. These approvals
are expensive, time consuming, and continue to evolve. Successfully penetrating
the broadband modem market therefore presents a number of challenges
including:
· |
the
current limited retail market for broadband modems;
|
· |
the
relatively small number of cable, telecommunications and Internet
service
provider customers that
make up a substantial part of the market for broadband modems;
|
· |
the
significant bargaining power of these large volume purchasers;
|
· |
the
time consuming, expensive, uncertain and varied approval process
of the
various cable service providers;
and
|
· |
the
strong relationships with cable service providers enjoyed by incumbent
cable equipment providers
like Motorola and Scientific Atlanta.
|
Our
sales
of broadband products have been adversely affected by all of these factors.
Sales of our broadband products in European countries have fluctuated and
may
continue to fluctuate due to approvals and delays in the deployment by service
providers of cable and DSL service in these countries. We cannot assure that
we
will be able to successfully penetrate these markets.
Our
failure to meet changing customer requirements and emerging industry standards
would adversely impact our ability to sell our products and
services.
The
market for PC communications products and high-speed broadband access products
and services is characterized by aggressive pricing practices, continually
changing customer demand patterns, rapid technological advances, emerging
industry standards and short product life cycles. Some of our product and
service developments and enhancements have taken longer than planned and
have
delayed the availability of our products and services, which adversely affected
our sales and profitability in the past. Any significant delays in the future
may adversely impact our ability to sell our products and services, and our
results of operations and financial condition may be adversely affected.
Our
future success will depend in large part upon our ability to:
· |
identify
and respond to emerging technological trends and industry standards
in the
market;
|
· |
develop
and maintain competitive products that meet changing customer demands;
|
· |
enhance
our products by adding innovative features that differentiate our
products
from those of our
competitors;
|
· |
bring
products to market on a timely basis;
|
· |
introduce
products that have competitive prices;
|
· |
manage
our product transitions, inventory levels and manufacturing processes
efficiently;
|
· |
respond
effectively to new technological changes or new product announcements
by
others; and
|
· |
meet
changing industry standards.
|
Our
product cycles tend to be short, and we may incur significant non-recoverable
expenses or devote significant resources to sales that do not occur when
anticipated. Therefore, the resources we devote to product development, sales
and marketing may not generate material net sales for us. In addition, short
product cycles have resulted in and may in the future result in excess and
obsolete inventory, which has had and may in the future have an adverse affect
on our results of operations. In an effort to develop innovative products
and
technology, we have incurred and may in the future incur substantial
development, sales, marketing, and inventory costs. If we are unable to recover
these costs, our financial condition and operating results could be adversely
affected. In addition, if we sell our products at reduced prices in anticipation
of cost reductions and we still have higher cost products in inventory, our
business would be harmed and our results of operations and financial condition
would be adversely affected.
We
have been selling our VoIP service for a limited period and there is no
guarantee that this service will gain broad market
acceptance.
We
have
only recently introduced our VoIP service. Given our limited history with
offering this service, there are many difficulties that we may encounter,
including technical hurdles, multiple and changing regulations and industry
standards, and other problems that we may not anticipate. To date, we have
not
generated significant revenue from the sale of our VoIP products and services,
and there is no guarantee that we will be successful in generating significant
revenues.
We
may be subject to product returns resulting from defects, or from overstocking
of our products. Product returns could result in the failure to attain market
acceptance of our products, which would harm our business.
If
our
products contain undetected defects, errors, or failures, we could
face:
· |
delays
in the development of our products;
|
· |
numerous
product returns; and
|
· |
other
losses to us or to our customers or end
users.
|
Any
of
these occurrences could also result in the loss of or delay in market acceptance
of our products, either of which would reduce our sales and harm our business.
We are also exposed to the risk of product returns from our customers as
a
result of contractual stock rotation privileges and our practice of assisting
some of our customers in balancing their inventories. Overstocking has in
the
past led and may in the future lead to higher than normal returns.
Our
failure to effectively manage our inventory levels could materially and
adversely affect our liquidity and harm our business.
Due
to
rapid technological change and changing markets we are required to manage
our
inventory levels carefully to both meet customer expectations regarding delivery
times and to limit our excess inventory exposure. In the second and third
quarters of 2005 our gross inventory levels of our DSL products continued
to
increase due to the rescheduling of customer orders in Turkey and resulting
decreased sales. An inventory obsolescence provision of $.3 million was recorded
in the third quarter of 2005 for older models of DSL modems and VOIP hardware.
In the event this trend continues or we otherwise fail to effectively manage
our
inventory our liquidity may be adversely affected and we may face increased
risk
of inventory obsolescence, a decline in market value of the inventory, or
losses
from theft, fire, or other casualty.
We
may be unable to produce sufficient quantities of our products because we
depend
on third party manufacturers. If these third party manufacturers fail to
produce
quality products in a timely manner, our ability to fulfill our customer
orders
would be adversely impacted.
We
use
contract manufacturers to partially manufacture our products. We use these
third
party manufacturers to help ensure low costs, rapid market entry, and
reliability. Any manufacturing disruption could impair our ability to fulfill
orders, and failure to fulfill orders would adversely affect our sales. Although
we currently use four contract manufacturers for the bulk of our purchases,
in
some cases a given product is only provided by one of these companies. The
loss
of the services of any of our significant third party manufacturers or a
material adverse change in the business of or our relationships with any
of
these manufacturers could harm our business. Since third parties manufacture
our
products and we expect this to continue in the future, our success will depend,
in part, on the ability of third parties to manufacture our products cost
effectively and in sufficient quantities to meet our customer
demand.
We
are
subject to the following risks because of our reliance on third party
manufacturers:
· |
reduced
management and control of component purchases;
|
· |
reduced
control over delivery schedules, quality assurance and manufacturing
yields;
|
· |
lack
of adequate capacity during periods of excess demand;
|
· |
limited
warranties on products supplied to us;
|
· |
potential
increases in prices;
|
· |
interruption
of supplies from assemblers as a result of a fire, natural calamity,
strike or other significant
event; and
|
· |
misappropriation
of our intellectual property.
|
We
may be unable to produce sufficient quantities of our products because we
obtain
key components from, and depend on, sole or limited source
suppliers.
We
obtain
certain key parts, components, and equipment from sole or limited sources
of
supply. For example, we purchase most of our dial-up and broadband modem
chipsets from Conexant Systems, Agere Systems, and Analog Devices. Integrated
circuit product areas covered by at least one of these companies include
dial-up
modems, DSL modems, cable modems, networking, routers, and gateways. In the
past
we have experienced delays in receiving shipments of modem chipsets from
our
sole source suppliers. We may experience similar delays in the future. In
addition, some products may have other components that are available from
only
one source. We believe the market for chipsets is currently experiencing
shortages and there are increased lead times for some chipsets. If we are
unable
to obtain a sufficient supply of components from our current sources, we
would
experience difficulties in obtaining alternative sources or in altering product
designs to use alternative components. Resulting delays or reductions in
product
shipments could damage relationships with our customers and our customers
could
decide to purchase products from our competitors. Inability to meet our
customers’ demand or a decision by one or more of our customers to purchase
products from our competitors could harm our operating results.
The
market for high-speed communications products and services has many competing
technologies and, as a result, the demand for our products and services is
uncertain.
The
market for high-speed communications products and services has a number of
competing technologies. For instance, Internet access can be achieved
by:
· |
using
a standard telephone line and appropriate service for dial-up modems;
|
· |
ISDN
modems, or DSL modems, possibly in combination;
|
· |
using
a cable modem with a cable TV line and cable modem service;
|
· |
using
a router and some type of modem to service the computers connected
to a
local area network;
or
|
· |
other
approaches, including wireless links to the
Internet.
|
Although
we currently sell products that include these technologies, the market for
high-speed communication products and services is fragmented and evolving.
The
introduction of new products by competitors, market acceptance of products
based
on new or alternative technologies, or the emergence of new industry standards
could render and have in the past rendered our products less competitive
or
obsolete. If any of these events occur, we may be unable to sustain or grow
our
business. Industry analysts believe that the market for our dial-up modems
will
continue to decline. If we are unable to increase demand for and sales of
our
broadband modems, we may be unable to sustain or grow our business.
We
face significant competition, which could result in decreased demand for
our
products or services.
We
may be
unable to compete successfully. A number of companies have developed, or
are
expected to develop, products that compete or will compete with our products.
Furthermore, many of our current and potential competitors have significantly
greater resources than we do. Intense competition, rapid technological change
and evolving industry standards could result in less favorable selling terms
to
our customers, decrease demand for our products or make our products
obsolete.
Changes
in the accounting treatment of stock options may adversely affect our results
of
operations.
In
December 2004 the FASB issued SFAS 123R, which is a revision of SFAS 123.
SFAS
123R requires all share-based payments to employees, including grants of
employee stock options, to be recognized in the financial statements based
on
their fair values and does not permit pro forma disclosure as an alternative
to
financial statement recognition. SFAS 123R will be effective for us beginning
in
the first quarter of 2006. The adoption of the SFAS 123R fair value method
may
have a significant adverse impact on our reported results of operations because
the stock-based compensation expense will be charged directly against our
reported earnings. The impact of our adoption of SFAS 123R cannot be predicted
at this time because that will depend on the future fair values and number
of
share-based payments granted in the future.
On
October 26, 2005 the Company accelerated the vesting of all stock options
previously awarded to employees and officers that were scheduled to vest
on or
before May 6, 2006. These stock options had exercise prices in excess of
$1.76,
the closing price of the Company’s Common Stock on October 26, 2005, the
effective date of the acceleration. As a result of the acceleration, stock
options to purchase 317,500 shares became exercisable immediately. These
accelerated stock options represent 33% of the total outstanding unvested
stock
options and approximately 25% of the total outstanding stock options. The
weighted average exercise price of the accelerated stock options is $2.44
per
share.
The
primary purpose of the acceleration of the vesting of these stock options
is to
reduce the Company’s future reported compensation expense upon the planned
adoption of Statement of Financial Accounting Standards (SFAS) No. 123R,
“Share
Based Payment” effective January 1, 2006. As a result of the acceleration, the
Company expects to reduce the stock option expense, a non-cash charge, it
otherwise would be required to record by approximately $130,000 total for
the
first two quarters of 2006.
Changes
in existing regulations or adoption of new regulations affecting the Internet
could increase the cost of our products or otherwise affect our ability to
offer
our products and services over the Internet.
Congress
has adopted legislation that regulates certain aspects of the Internet,
including online content, user privacy, taxation, liability for third-party
activities and jurisdiction. In addition, a number of initiatives pending
in
Congress and state legislatures would prohibit or restrict advertising or
sale
of certain products and services on the Internet, which may have the effect
of
raising the cost of doing business on the Internet generally. Federal, state,
local and foreign governmental organizations are considering other legislative
and regulatory proposals that would regulate the Internet. We cannot predict
whether new taxes will be imposed on our services, and depending on the type
of
taxes imposed, whether and how our services would be affected thereafter.
Increased regulation of the Internet may decrease its growth and hinder
technological development, which may negatively impact the cost of doing
business via the Internet or otherwise harm our business.
New
regulations to reduce the use of hazardous materials in products scheduled
to be
implemented in 2006 could increase our manufacturing costs and harm our
business.
The
European Union and the US have announced plans to reduce the use of hazardous
materials, such as lead, in electronic equipment. The implementation of these
new requirements, currently scheduled to begin in Europe in 2006 and the
US in
2007, would require us and other electronics companies to change or discontinue
many products. We believe that our transition process to comply with these
new
requirements is difficult, and will typically increase our product costs
by from
zero to $.50 per unit, depending on the product. In addition, we may incur
additional costs involved with the disposal of inventory or with returned
products that do not meet the new requirements, which could further harm
our
business.
Changes
in current or future laws or governmental regulations and industry standards
that negatively impact our products, services and technologies could harm
our
business.
The
jurisdiction of the Federal Communications Commission, or the FCC, extends
to
the entire United States communications industry including our customers
and
their products and services that incorporate our products. Our products are
also
required to meet the regulatory requirements of other countries throughout
the
world where our products and services are sold. Obtaining government regulatory
approvals is time-consuming and very costly. In the past, we have encountered
delays in the introduction of our products, such as our cable modems, as
a
result of government certifications. We may face further delays if we are
unable
to comply with governmental regulations. Delays caused by the time it takes
to
comply with regulatory requirements may result in cancellations or postponements
of product orders or purchases by our customers, which would harm our
business.
In
addition to reliability and quality standards, the market acceptance of our
VoIP
products and services is dependent upon the adoption of industry standards
so
that products from multiple manufacturers are able to communicate with each
other. Standards are continuously being modified and replaced. As standards
evolve, we may be required to modify our existing products or develop and
support new versions of our products. The failure of our products to comply,
or
delays in compliance, with various existing and evolving industry standards
could delay or interrupt volume production of our products, which could harm
our
business.
Future
legislation or regulation of Internet telephony could restrict our VoIP
business, prevent us from offering service, or increase our cost of doing
business.
VoIP
services currently have different regulations from traditional telephony
in most
countries including the US. Regulatory bodies including the FCC and regulators
in various states and countries may impose surcharges, taxes or new regulations
upon providers of Internet telephony. These surcharges could include access
charges payable to local exchange carriers to carry and terminate traffic,
contributions to the Universal Service Fund (USF) or other charges. The
imposition of any such additional fees, charges, taxes and regulations on
IP
communications services could materially increase our costs and may limit
or
eliminate our competitive pricing. Regulations requiring compliance with
the
Communications Assistance for Law Enforcement Act (CALEA) or provision of
the
same type of 911 services as required for traditional telecommunications
providers could also place a significant financial burden on us depending
on the
technical changes required to accommodate the requirements. In May 2005 the
FCC
issued an order requiring interconnected VoIP providers to deliver 911 calls
to
the customer’s local emergency operator as a standard feature of the service. We
believe our VoIP products are capable of meeting the FCC requirements. In
the
event our VoIP products do not meet the FCC requirements, we may need to
modify
our products, which could increase our costs.
In
many
countries outside the US in which we operate or our services are sold, we
cannot
be certain that we will be able to comply with existing or future requirements,
or that we will be able to continue to be in compliance with any such
requirements. Our failure to comply with these requirements could materially
adversely affect our ability to continue to offer our VoIP services in these
jurisdictions.
Fluctuations
in the foreign currency exchange rates in relation to the U.S. Dollar could
have
a material adverse effect on our operating results.
Changes
in currency exchange rates that increase the relative value of the U.S. dollar
may make it more difficult for us to compete with foreign manufacturers on
price, may reduce our foreign currency denominated sales when expressed in
dollars, or may otherwise have a material adverse effect on our sales and
operating results. A significant increase in our foreign currency denominated
sales would increase our risk associated with foreign currency fluctuations.
A
weakness in the U.S. dollar relative to various Asian currencies including
the
Chinese renminbi could increase our product costs.
Our
future success will depend on the continued services of our executive officers
and key product development personnel.
The
loss
of any of our executive officers or key product development personnel, the
inability to attract or retain qualified personnel in the future, or delays
in
hiring skilled personnel could harm our business. Competition for skilled
personnel is significant. We may be unable to attract and retain all the
personnel necessary for the development of our business. In addition, the
loss
of Frank B. Manning, our president and chief executive officer, or Peter
Kramer,
our executive vice president, some other member of the senior management
team, a
key engineer or salesperson, or other key contributors, could harm our relations
with our customers, our ability to respond to technological change, and our
business.
We
may have difficulty protecting our intellectual property.
Our
ability to compete is heavily affected by our ability to protect our
intellectual property. We rely primarily on trade secret laws, confidentiality
procedures, patents, copyrights, trademarks, and licensing arrangements to
protect our intellectual property. The steps we take to protect our technology
may be inadequate. Existing trade secret, trademark and copyright laws offer
only limited protection. Our patents could be invalidated or circumvented.
We
have more intellectual property assets in some countries than we do in others.
In addition, the laws of some foreign countries in which our products are
or may
be developed, manufactured or sold may not protect our products or intellectual
property rights to the same extent as do the laws of the United States. This
may
make the possibility of piracy of our technology and products more likely.
We
cannot assure that the steps that we have taken to protect our intellectual
property will be adequate to prevent misappropriation of our
technology.
We
could infringe the intellectual property rights of others.
Particular
aspects of our technology could be found to infringe on the intellectual
property rights or patents of others. Other companies may hold or obtain
patents
on inventions or may otherwise claim proprietary rights to technology necessary
to our business. We cannot predict the extent to which we may be required
to
seek licenses. We cannot assure that the terms of any licenses we may be
required to seek will be reasonable. We are often indemnified by our suppliers
relative to certain intellectual property rights; but these indemnifications
do
not cover all possible suits, and there is no guarantee that a relevant
indemnification will be honored by the indemnifying.
ITEM
3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISK
We
own
financial instruments that are sensitive to market risks as part of our
investment portfolio. The investment portfolio is used to preserve our capital
until it is required to fund operations, including our research and development
activities. None of these market-risk sensitive instruments are held for
trading
purposes. We do not own derivative financial instruments in our investment
portfolio. The investment portfolio contains instruments that are subject
to the
risk of a decline in interest rates. Investment Rate Risk - Our investment
portfolio consists entirely of money market funds, which are subject to interest
rate risk. Due to the short duration and conservative nature of these
instruments, we do not believe that it has a material exposure to interest
rate
risk.
We
maintain disclosure controls and procedures that are designed to ensure that
information required to be disclosed in our Securities Exchange Act reports
is
recorded, processed, summarized and reported within the time periods specified
in the SEC’s rules and forms, and that such information is accumulated and
communicated to our management, including our Chief Executive Officer and
Chief
Financial Officer, as appropriate, to allow timely decisions regarding required
disclosure. In designing and evaluating the disclosure controls and procedures,
management recognized that any controls and procedures, no matter how well
designed and operated, can provide only reasonable assurance of achieving
the
desired control objectives, as ours are designed to do, and management
necessarily was required to apply its judgment in evaluating the cost-benefit
relationship of possible controls and procedures.
As
of
September 30, 2005 we carried out an evaluation, under the supervision and
with
the participation of our management, including our Chief Executive Officer
and
Chief Financial Officer, of the effectiveness of the design and operation
of our
disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e)
under the Securities Exchange Act of 1934. Based upon that evaluation, our
Chief
Executive Officer and Chief Financial Officer concluded that our disclosure
controls and procedures are effective in enabling us to record, process,
summarize and report information required to be included in our periodic
SEC
filings within the required time period.
There
have been no changes in our internal control over financial reporting that
occurred during the period covered by this report that have materially affected,
or are reasonably likely to materially affect, our internal control over
financial reporting.
PART
II - OTHER INFORMATION
ITEM
5. OTHER INFORMATION
On
October 26, 2005 the Company accelerated the vesting of all stock options
previously awarded to employees and officers that were scheduled to vest
on or
before May 6, 2006 . These stock options had exercise prices in excess of
$1.76,
the closing price of the Company’s Common Stock on October 26, 2005, the
effective date of the acceleration. As a result of the acceleration, stock
options to purchase 317,500 shares became exercisable immediately. These
accelerated stock options represent 33% of the total outstanding unvested
stock
options and approximately 25% of the total outstanding stock options. The
weighted average exercise price of the accelerated stock options is $2.44
per
share.
The
primary purpose of the acceleration of the vesting of these stock options
is to
reduce the Company’s future reported compensation expense upon the planned
adoption of Statement of Financial Accounting Standards (SFAS) No. 123R,
“Share
Based Payment” effective January 1, 2006. As a result of the acceleration, the
Company expects to reduce the stock option expense, a non-cash charge, it
otherwise would be required to record by approximately $130,000 total for
the
first two quarters of 2006.
ITEM
6. EXHIBITS
Exhibits
31.1
|
CEO
Certification Pursuant to Section 302 of the Sarbanes-Oxley Act
of
2002.
|
|
|
31.2
|
CFO
Certification Pursuant to Section 302 of the Sarbanes-Oxley Act
of
2002.
|
|
|
32.1
|
CEO
Certification Pursuant to Section 906 of the Sarbanes-Oxley Act
of
2002.
|
|
|
32.2
|
CFO
Certification Pursuant to Section 906 of the Sarbanes-Oxley Act
of
2002.
|
ZOOM
TECHNOLOGIES, INC. AND SUBSIDIARY
Pursuant
to the requirements of the Securities and Exchange Act of 1934, the Company
has
duly caused this report to be signed on its behalf by the undersigned thereunto
duly authorized.
|
|
|
|
ZOOM
TECHNOLOGIES, INC.
(Registrant)
|
|
|
|
Date:
November 10, 2005
|
By: |
/s/
Frank B. Manning |
|
Frank
B. Manning,
President
|
|
|
|
Date:
November 10, 2005
|
By: |
/s/
Robert Crist |
|
Robert
Crist, Vice President of Finance and Chief Financial Officer (Principal
Financial and Accounting Officer)
|
|
|
Exhibit
No.
|
Description
|
|
|
31.1
|
CEO
Certification Pursuant to Section 302 of the Sarbanes-Oxley Act
of
2002.
|
|
|
31.2
|
CFO
Certification Pursuant to Section 302 of the Sarbanes-Oxley Act
of
2002.
|
|
|
32.1
|
CEO
Certification Pursuant to Section 906 of the Sarbanes-Oxley Act
of
2002.
|
|
|
32.2
|
CFO
Certification Pursuant to Section 906 of the Sarbanes-Oxley Act
of
2002.
|