** **

**UNITEDSTATES SECURITIES AND EXCHANGE COMMISSION**

 

**Washington, D.C. 20549**

 

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**FORM 10- Q**

 

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**QUARTERLY REPORT UNDER SECTION 13OR 15(d) OFTHE SECURITIES EXCHANGE ACT OF 1934.**

 

**For the quarterly period ended March 31, 2005.**

 

**005-79915**

**(Commission File Number)**

 

**InfoSonicsCorporation**

(Exact name of registrant as specified in itscharter)

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

 

**5880 Pacific Center Blvd**

**San Diego, CA 92121**

(Address of principal executive officesincluding zip code)

 

**(858) 373-1600**

(Registrant’s telephonenumber, including area code)

 

**Not Applicable**

(Former Name or Former Address, if ChangedSince Last Report)

 

Indicate by check mark whetherthe registrant (1) has filed all reports required to be filed by Section 13 or15(d) of the Exchange Act during the preceding 12 months (or for such shorterperiod that the registrant was required to file such reports), and (2) has beensubject to such filing requirements for the past 90 days.

Yes   ý   No o

 

Indicate by check mark whetherthe registrant is an accelerated filer (as defined in Rule 12b-2 of theExchange Act).

Yes   o   No ý

 

As of May 10, 2005, the Registrant had 5,212,000 shares outstanding ofits $.001 par value common stock.

 

 

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**InfoSonicsCorporation**

 

**QuarterlyReport on FORM 10-Q For The Period Ended**

 

**March 31, 2005**

 

**Table of Contents**

 
| **PART I. FINANCIAL INFORMATION** |
|-----------------------------------|
|                              |   |   |
| Item 1.                           | Financial Statements |   |
|                              |   |   |
|                              | Consolidated Balance Sheets as of March 31, 2005 (unaudited) and  December 31, 2004 |   |
|                              |   |   |
|                              | Consolidated Statements of Income for the  Three Months Ended March 31, 2005 (unaudited) and 2004 (unaudited) |   |
|                              |   |   |
|                              | Consolidated Statements of Cash Flows for  the Three Months Ended March 31, 2005 (unaudited) and 2004 (unaudited) |   |
|                              |   |   |
|                              | Notes to Consolidated Financial Statements |   |
|                              |   |   |
| Item 2.                           | Management’s Discussion and Analysis of  Financial Condition and Results of Operations |   |
|                              |   |   |
| Item 3.                           | Quantitative and Qualitative Disclosures  About Market Risk |   |
|                              |   |   |
| Item 4.                           | Controls and Procedures |   |
|                              |   |
| **PART II. OTHER INFORMATION**    |
|                              |   |   |
| Item 1.                           | Legal Proceedings |   |
|                              |   |   |
| Item 2.                           | Changes in Securities and Use of Proceeds |   |
|                              |   |   |
| Item 3.                           | Defaults Upon Senior Securities |   |
|                              |   |   |
| Item 4.                           | Submission of Matters to a Vote of Security  Holders |   |
|                              |   |   |
| Item 5.                           | Other Information |   |
|                              |   |   |
| Item 6.                           | Exhibits |   |
|                              |   |   |
| Signatures                        |   |
|                              |   |
| Exhibit 31.1                      |   |
|                              |   |
| Exhibit 32.1                      |   |

 

2

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**Part I. FINANCIAL INFORMATION**

 

Item 1. Financial Statements

 

**InfoSonicsCorporation and Subsidiaries**

**ConsolidatedBalance Sheets**

 
| ** **                                                                                              | ** ** | **March 31  2005** | ** **     | **December 31  2004** | ** ** |
|---------------------------------------------------------------------------------------------------------|------------|--------------------|----------------|-----------------------|------------|
| ** **                                                                                              | ** ** | **(unaudited)**    | ** **     | ** **            | ** ** |
| **ASSETS**                                                                                              |       | ** **         |           |                  |       |
| **Current assets**                                                                                      |       |               |           |                  |       |
| Cash and cash equivalents                                                                               |       | $                  | 3,543,213      |                  | $          | 5,183,876 |   |
| Trade accounts receivable, net of allowance  for doubtful accounts of $361,650 (unaudited) and $250,000 |       | 12,572,410         |           | 7,596,104             |       |
| Inventory, net of reserves of $119,756  (unaudited) and $141,086                                        |       | 3,764,319          |           | 4,640,756             |       |
| Prepaid Inventory                                                                                       |       | 2,500,000          |           | 71,850                |       |
| Prepaid expenses                                                                                        |       | 216,235            |           | 384,456               |       |
| Net assets of discontinued operations                                                                   |       | 176,947            |           | 181,010               |       |
| Deferred tax assets - current                                                                           |       | 343,000            |           | 285,000               |       |
|                                                                                                    |       |               |           |                  |       |
| Total current assets                                                                                    |       | 23,116,124         |           | 18,343,052            |       |
|                                                                                                    |       |               |           |                  |       |
| Property and equipment, net                                                                             |       | 267,234            |           | 237,853               |       |
| Deferred tax assets - noncurrent                                                                        |       | (2,000             | )              | 67,000                |       |
| Other assets                                                                                            |       | 86,266             |           | 71,851                |       |
|                                                                                                    |       |               |           |                  |       |
| **Total assets**                                                                                        | ** ** | **$**              | **23,467,624** | ** **            | **$**      | **18,719,756** | ** ** |
|                                                                                                    |       |               |           |                  |       |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                          | ** ** | ** **         | ** **     | ** **            | ** ** |
|                                                                                                    |       |               |           |                  |       |
| **Current liabilities**                                                                                 |       |               |           |                  |       |
| Line of credit                                                                                          |       | $                  | 7,500,000      |                  | $          | 2,564,115 |   |
| Accounts payable                                                                                        |       | 2,049,887          |           | 2,576,034             |       |
|                                                                                                    |       |               |           |                  |       |
| Accrued expenses                                                                                        |       | 384,830            |           | 447,054               |       |
| Income taxes payable                                                                                    |       | 108,514            |           | —                |       |
| Net liabilities of discontinued operations                                                              |       | 670,555            |           | 693,542               |       |
|                                                                                                    |       |               |           |                  |       |
| Total current liabilities                                                                               |       | 10,713,786         |           | 6,280,745             |       |
|                                                                                                    |       |               |           |                  |       |
| **Stockholders’ equity**                                                                           |       |               |           |                  |       |
| Preferred stock, $0.001 par value  10,000,000 shares authorized 0 and 0 shares issued and outstanding   |       | —             |           | —                |       |
| Common stock, $0.001 par value 40,000,000  shares authorized 5,212,000 shares issued and outstanding    |       | 5,212              |           | 5,212                 |       |
| Additional paid-in capital                                                                              |       | 10,529,652         |           | 10,529,652            |       |
| Retained earnings                                                                                       |       | 2,218,974          |           | 1,904,147             |       |
|                                                                                                    |       |               |           |                  |       |
| Total stockholders’ equity                                                                         |       | 12,753,838         |           | 12,439,011            |       |
|                                                                                                    |       |               |           |                  |       |
| **Total liabilities and stockholders’ equity**                                                     | ** ** | **$**              | **23,467,624** | ** **            | **$**      | **18,719,756** | ** ** |

 

*See accompanying notes.*

 

3

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**InfoSonicsCorporation and Subsidiaries**

**ConsolidatedStatements of Income**

**(unaudited)**

 
| ** **                                                               | ** ** | **For the Three Months  Ended March 31,** | ** **  |
|--------------------------------------------------------------------------|------------|-------------------------------------------|-------------|
| ** **                                                               | ** ** | **2005**                                  | ** **  | **2004** | ** ** |
| ** **                                                               | ** ** | ** **                                | ** **  | ** ** | ** ** |
| **Net sales**                                                            |       | $                                         | 24,024,217  |   | $ | 18,743,319 |   |
| **Cost of sales**                                                        |       | 21,892,957                                |        | 17,328,642 |   |
|                                                                     |       |                                      |        |   |   |
| **Gross profit**                                                         |       | 2,131,260                                 |        | 1,414,677 |   |
| **Operating expenses**                                                   |       | 1,566,914                                 |        | 1,020,981 |   |
|                                                                     |       |                                      |        |   |   |
| **Operating income from continuing operations**                          |       | 564,346                                   |        | 393,696 |   |
|                                                                     |       |                                      |        |   |   |
| **Other income (expense)**                                               |       |                                      |        |   |   |
| Interest income (expense)                                                |       | (24,821                                   | )           | (46,449 | ) |
|                                                                     |       |                                      |        |   |   |
| **Income from continuing operations before  provision for income taxes** |       | 539,525                                   |        | 347,247 |   |
| **Provision for income taxes**                                           |       | 218,610                                   |        | 117,758 |   |
|                                                                     |       |                                      |        |   |   |
| **Income from continuing operations**                                    | ** ** | **320,915**                               | ** **  | **229,489** | ** ** |
| **Loss from discontinued operations**                                    | ** ** | **(6,077**                                | **)**       | **(33,554** | **)** |
| ** **                                                               | ** ** | ** **                                | ** **  | ** ** | ** ** |
| **Net income**                                                           | ** ** | **$**                                     | **314,838** | ** ** | **$** | **195,935** | ** ** |
|                                                                     |       |                                      |        |   |   |
| **Basic earnings per share**                                             |       |                                      |        |   |   |
| From continuing operations                                               | ** ** | **$**                                     | **0.06**    | ** ** | **$** | **0.07** | ** ** |
| From discontinued operations                                             | ** ** | **$**                                     | **(0.00**   | **)** | **$** | **(0.01** | **)** |
| Net Income                                                               | ** ** | **$**                                     | **0.06**    | ** ** | **$** | **0.06** | ** ** |
| **Diluted earnings per share**                                           | ** ** | ** **                                | ** **  | ** ** | ** ** |
| From continuing operations                                               | ** ** | **$**                                     | **0.05**    | ** ** | **$** | **0.06** | ** ** |
| From discontinued operations                                             | ** ** | **$**                                     | **(0.00**   | **)** | **$** | **(0.01** | **)** |
| Net Income                                                               | ** ** | **$**                                     | **0.05**    | ** ** | **$** | **0.05** | ** ** |
|                                                                     |       |                                      |        |   |   |
| **Basic weighted-average number of common  shares outstanding**          | ** ** | **5,212,000**                             | ** **  | **3,208,400** | ** ** |
|                                                                     |       |                                      |        |   |   |
| **Diluted weighted-average number of common  shares outstanding**        | ** ** | **5,856,686**                             | ** **  | **3,916,498** | ** ** |

 

*See accompanyingnotes*.

 

4

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**InfoSonicsCorporation and Subsidiaries**

**ConsolidatedStatements of Cash Flows**

**(unaudited)**

 
| ** **                                                                                                             | ** ** | **For the Three Months Ended March 31,** | ** **    |
|------------------------------------------------------------------------------------------------------------------------|------------|------------------------------------------|---------------|
| ** **                                                                                                             | ** ** | **2005**                                 | ** **    | **2004** | ** ** |
| **Cash flows from operating activities**                                                                               |       |                                     |          |   |   |
| Net income from continuing operations                                                                                  |       | $                                        | 320,915       |   | $ | 229,489 |   |
| Adjustments to reconcile net income from  continuing operations to net cash provided by (used in) operating activities |       |                                     |          |   |   |
| Depreciation and amortization                                                                                          |       | 13,690                                   |          | (19,581 | ) |
| Provision for bad debt                                                                                                 |       | 111,650                                  |          | 75,246 |   |
| Provision for obsolete inventory                                                                                       |       | (21,330                                  | )             | 6,407 |   |
| (Increase) decrease in                                                                                                 |       |                                     |          |   |   |
| Trade accounts receivable                                                                                              |       | (5,087,956                               | )             | (225,617 | ) |
| Inventory                                                                                                              |       | 897,767                                  |          | 293,681 |   |
| Prepaid Inventory                                                                                                      |       | (2,428,150                               | )             | 97,587 |   |
| Prepaid expenses                                                                                                       |       | 168,221                                  |          | (55,322 | ) |
| Other assets                                                                                                           |       | (14,415                                  | )             | (33,299 | ) |
| Increase (decrease) in                                                                                                 |       |                                     |          |   |   |
| Accounts payable                                                                                                       |       | (526,147                                 | )             | 1,234,623 |   |
| Accrued expenses                                                                                                       |       | (62,224                                  | )             | 134,841 |   |
| Deferred tax asset current                                                                                             |       | (58,000                                  | )             | — |   |
| Deferred tax asset non current                                                                                         |       | 69,000                                   |          | — |   |
| Income tax liabilities                                                                                                 |       | 108,514                                  |          | (182,978 | ) |
|                                                                                                                   |       |                                     |          |   |   |
| Cash provided by (used in) continuing operations                                                                       |       | (6,508,564                               | )             | 1,555,077 |   |
| Cash provided by (used in) discontinued  operations                                                                    |       | (25,001                                  | )             | 286,575 |   |
|                                                                                                                   |       |                                     |          |   |   |
| Net cash provided by (used in) operating  activities                                                                   |       | (6,533,466                               | )             | 1,841,652 |   |
|                                                                                                                   |       |                                     |          |   |   |
| **Cash flows from investing activities**                                                                               |       |                                     |          |   |   |
|                                                                                                                   |       |                                     |          |   |   |
| Purchase of property and equipment                                                                                     |       | (43,071                                  | )             | (47,495 | ) |
|                                                                                                                   |       |                                     |          |   |   |
| Net cash provided by (used in) investing  activities                                                                   |       | (43,071                                  | )             | (47,495 | ) |
|                                                                                                                   |       |                                     |          |   |   |
| **Cash flows from financing activities**                                                                               |       |                                     |          |   |   |
| Bank overdraft                                                                                                         |       | —                                   |          | (867,555 | ) |
| Borrowings from line of credit                                                                                         |       | 18,422,466                               |          | 4,903,062 |   |
| Payments on line of credit                                                                                             |       | (13,486,592                              | )             | (5,734,535 | ) |
| Cash paid for deferred offering costs                                                                                  |       | —                                   |          | (137,931 | ) |
| Cash received for stock                                                                                                |       | —                                   |          | 54,000 |   |
|                                                                                                                   |       |                                     |          |   |   |
| Net cash provided by (used in) financing  activities                                                                   |       | 4,935,874                                |          | (1,782,959 | ) |
|                                                                                                                   |       |                                     |          |   |   |
| Net increase (decrease) in cash and cash  equivalents                                                                  |       | (1,640,663                               | )             | 11,198 |   |
|                                                                                                                   |       |                                     |          |   |   |
| **Cash and cash equivalents, beginning of  period**                                                                    |       | 5,183,876                                |          | 2,570 |   |
|                                                                                                                   |       |                                     |          |   |   |
| **Cash and cash equivalents, end of period**                                                                           | ** ** | **$**                                    | **3,543,213** | ** ** | **$** | **13,768** | ** ** |

 

*See accompanyingnotes*.

 

5

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**InfoSonicsCorporation**

**Notes toConsolidated Financial Statements**

**March 31,2005**

 

**NOTE 1. Basis of Presentation**

 

The accompanying unauditedConsolidated Financial Statements have been prepared in accordance withaccounting principles generally accepted in the United States for interimfinancial information and with the instructions to Form 10-Q and Article 10 ofRegulation S-X of the Securities Exchange Act of 1934. Accordingly, they do notinclude all of the information and footnotes required by accounting principlesgenerally accepted in the United States for complete financial statements. Thepreparation of financial statements requires management to make estimates andassumptions that affect amounts reported in the financial statements andaccompanying notes. Actual results are likely to differ from those estimates,but management does not believe such differences will materially affect thefinancial position or results of operations of InfoSonics Corporation (the “Company”).The Consolidated Financial Statements reflect all adjustments considered, inthe opinion of the Company, necessary to fairly present the results for theperiods. Such adjustments are of a normal recurring nature.

 

The Consolidated Financial Statements include theaccounts of the Company and its subsidiaries, Axcess Mobile LLC, InfoSonics DeMexico, InfoSonics de Guatemala, InfoSonics El Salvador and InfoSonics S.A.,all of which are wholly owned. Significant intercompany accounts andtransactions have been eliminated in consolidation.

 

The unaudited Consolidated BalanceSheet at March 31, 2005 does not include all of the information and footnotesrequired by accounting principles generally accepted in the United States forcomplete financial statements. Due to seasonal and other factors, the Company’sinterim results may not be indicative of annual results. The unauditedConsolidated Statements of Income for the three months ended March 31, 2005 andthe unaudited Consolidated Statement of Cash Flows for the three months endedMarch 31, 2005 are not necessarily indicative of the operating results or cashflows that may be expected for the entire year.

 

The Company has not changed itssignificant accounting policies from those disclosed in its financialstatements as of and for the year ended December 31, 2004 as included in itsForm 10-K for the year ended December 31, 2004 that was filed with theSecurities and Exchange Commission. For further information, reference is madeto the audited Consolidated Financial Statements and the notes thereto includedin the Company’s financial statements as of and for the year ended December 31,2004 as included in its Form 10-K.

 

**NOTE 2. Acquisition**

 

On January 19, 2005, the Company purchased PrimaselS.A., from Fanrock Investments Limited for up to 120,000 shares of InfoSonicscommon stock, based on sales of certain levels being achieved in the next threeyears. In addition InfoSonics will pay a cash earn-out tied to sales and profitabilityfor sales in Argentina. During the three months ended March31, 2005, no sharesof common stock were issued related to this transaction and there was a cashearn-out of $135,000 related to sales and profitability. The Company hasaccounted for the transaction as a stock purchase. As Primasel had no assets orliabilities at the time of the purchase, there was no goodwill recorded. InFebruary 2005, Primasel S.A. changed its name to InfoSonics S.A.

 

**NOTE 3.Discontinued Operations**

 

During the quarter ended September 30,2004, the Company and its Board of Directors discussed Axcess Mobile, LLC andits mall-based kiosk locations and the Company began to implement actionsnecessary to close those mall-based kiosk locations. On October 28, 2004, the Companyassigned the leases for six of the mall-based kiosk locations to an unrelatedassignee; however, the assignment did not release the Company from the futurelease obligations. The assignee operates approximately 400 mall-based kiosks in28 states. A third party is holding in escrow two months rent for the locationsfrom the assignee, and in the event of default by the assignee, those fundswill be released to the Company.  Theother lease locations were closed in October 2004.  SFAS No. 142, “Goodwill and Other IntangibleAssets,” prohibits the amortization of goodwill, but requires that it bereviewed for impairment at least annually or on an interim basis if an eventoccurs or circumstances change that could indicate that its value hasdiminished or been impaired. As a result of the discontinued operation, the

 

6

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Company has reassessed the goodwill andwritten down the value to zero.  Thiswrite-down was recorded as an operating expense in the year end December 31,2004. The results of the discontinued operations are as follows

 
| ** **                    | ** ** | **Three months ended March 31** | ** ** |
|-------------------------------|------------|---------------------------------|------------|
| ** **                    | ** ** | **2005**                        | ** ** | **2004** | ** ** |
| Net Sales                     |       | $                               | -0-        |   | $ | 993,804 |   |
| Gross Profit                  |       | -0-                             |       | $ | 626,505 |   |
| Operating loss                |       | (6,077                          | )          | $ | (33,554 | ) |
| Capital Expenditures          |       | -0-                             |       | $ | 37,050 |   |
| Depreciation and Amortization |       | -0-                             |       | $ | 3,990 |   |
|                               |            |                                 |            |  |  |  |  |

 

As of March 31, 2005 andDecember 31, 2004, net assets of discontinued operations consist of receivablesof $177,000 and $181,000, respectively, and net liabilities of discontinuedoperations consist of accounts payable of $671,000 and $693,000, respectively. TheCompany is currently in the process of resolving these balances.

 

As of March 31, 2005, theactions related to the discontinued operations had been completed, however theCompany expects to continue to record adjustments and expenses concerningdiscontinued operations as necessary.

 

**NOTE 4. Stock-Based Compensation**

 

TheCompany has elected to follow APB Opinion No. 25 and relatedinterpretations in accounting for its stock options and grants since thealternative fair market value accounting provided for under Statement ofFinancial Accounting Standards (SFAS) No. 123 requires use of grantvaluation models that were not developed for use in valuing employee stockoptions and grants. Under APB Opinion No. 25, if the exercise price of theCompany’s stock grants and options equals or exceeds the fair value of theunderlying stock on the date of grant, no compensation expenses are recognized.

 

Ifcompensation cost for the Company’s stock-based compensation plans had beendetermined based on the fair value at the grant dates for awards under thoseplans consistent with the method of SFAS No. 123, then the Company’s netincome for the three months ended March 31, 2005 and March 31, 2004 would havebeen adjusted to the pro forma amounts indicated below:

 
| ** **                                                                                                                                                                        | ** ** | **Quarter  ended March 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------|------------|
| ** **                                                                                                                                                                        | ** ** | **2005**                     | ** ** | **2004** | ** ** |
| Net income as  reported                                                                                                                                                           |       | $                            | 314,838    |   | $ | 195,935 |   |
|                                                                                                                                                                              |       |                         |       |   |   |
| Stock-based  employee compensation cost, net of related tax effects, that would have been  included in the determination of net income if the fair value method had been  applied |       | (460,011                     | )          | (-0- | ) |
| Pro forma                                                                                                                                                                         |       | $                            | (145,173   | ) | $ | 195,935 |   |
|                                                                                                                                                                              |       |                         |       |   |   |
| Basic earnings  per common share as reported                                                                                                                                      |       | $                            | 0.06       |   | $ | 0.06 |   |
| Stock-based  employee compensation cost, net of related tax effects, that would have been  included in the determination of net income if the fair value method had been  applied |       | $                            | (0.09      | ) | $ | 0.00 |   |
| Pro forma                                                                                                                                                                         |       | $                            | (0.03      | ) | $ | 0.06 |   |
|                                                                                                                                                                              |       |                         |       |   |   |
| Diluted earning  per share                                                                                                                                                        |       |                         |       |   |   |
| As reported                                                                                                                                                                       |       | $                            | 0.05       |   | $ | 0.05 |   |
| Stock-based  employee compensation cost, net of related tax effects, that would have been  included in the determination of net income if the fair value method had been  applied |       | $                            | (0.08      | ) | $ | 0.00 |   |
| Pro forma                                                                                                                                                                         |       | $                            | (0.03      | ) | $ | 0.05 |   |

 

7

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**NOTE 5. Earnings Per Share**

 

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

 

Thefollowing table represents a reconciliation of the shares used to calculatebasic and diluted earnings per share for the respective periods indicated:

 
| ** **                                                                                                  | ** ** | **Three Months  Ended March 31,** | ** ** |
|-------------------------------------------------------------------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                                                                                  | ** ** | **2005**                          | ** ** | **2004** | ** ** |
|                                                                                                        |       |                              |       |   |   |
| Numerator: Net  income                                                                                      |       | $                                 | 314,838    |   | $ | 195,935 |   |
| Denominator:                                                                                                |       |                              |       |   |   |
| Denominator for  basic earnings per share – weighted average shares                                    |       | 5,212,000                         |       | 3,208,400 |   |
| Effect of  dilutive securities                                                                              |       |                              |       |   |   |
| Employee stock  options                                                                                     |       | 644,686                           |       | 708,098 |   |
| Denominator for  diluted earnings per share – adjusted weighted average shares and assumed  conversion |       | 5,856,686                         |       | 3,916,498 |   |
|                                                                                                        |       |                              |       |   |   |
| Basic earnings  per share                                                                                   |       | $                                 | 0.06       |   | $ | 0.06 |   |
|                                                                                                        |       |                              |       |   |   |
| Diluted earnings  per share                                                                                 |       | $                                 | 0.05       |   | $ | 0.05 |   |

 

Potentialcommon shares have been excluded from the computation of diluted earnings pershare due to their exercise price being greater than the Company’s weightedaverage stock price for the period. For the three months ended March 31, 2005and 2004, the number of shares excluded were 1,131,750 and 473,000 respectively.

 

**NOTE 6. IncomeTaxes**

 

SFAS No. 109, “ACCOUNTING FORINCOME TAXES”, establishes financial accounting and reporting standards for theeffect of income taxes. The objectives of accounting for income taxes are torecognize the amount of taxes payable or refundable for the current year anddeferred tax liabilities and assets for the future tax consequences of eventsthat have been recognized in an entity’s financial statements or tax returns.Judgment is required in assessing the future tax consequences of events thathave been recognized in our financial statements or tax returns. Fluctuationsin the actual outcome of these future tax consequences could materially impactour financial position or our results of operations.

 

**NOTE 7. Inventory**

 

Inventoryis valued at the lower of cost or market using standard costs that approximateaverage cost. Inventories are reviewed periodically and items considered to beslow moving or obsolete are reduced to estimated net realizable value throughan appropriate reserve. Inventory consists of the following:

 
| ** **        | ** ** | **March 31,  2005** | ** ** | **December 31,  2004** | ** ** |
|-------------------|------------|---------------------|------------|------------------------|------------|
| Finished goods    |       | $                   | 3,884,075  |                   | $          | 4,709,992 |   |
| Inventory reserve |       | (119,756            | )          | (141,086               | )          |
| Net inventory     |       | 3,764,319           |       | 4,568,906              |       |
|                   |            |                     |            |                        |            |  |  |

 

8

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**NOTE 8. Property and Equipment**

 

Property and equipment consisted of the following:

 
| ** **                    | ** ** | **March 31,  2005** | ** ** | **December 31,  2004** | ** ** |
|-------------------------------|------------|---------------------|------------|------------------------|------------|
| Machinery and Equipment       |       | $                   | 107,393    |                   | $          | 221,739 |   |
| Furniture and Fixtures        |       | 258,035             |       | 100,619                |       |
|                          |       | 365,429             |       | 322,358                |       |
| Less Accumulated Depreciation |       | 98,195              |       | 84,505                 |       |
| Total                         |       | $                   | 267,234    |                   | $          | 237,853 |   |

 

Depreciation expense was $28,389, $10,688 and $8,688for the years ended December 31, 2004, 2003 and 2002 respectively.

 

**NOTE 9. Revolving Bank LoanAgreements and Notes Payable**

 

TheCompany has a line of credit from a bank, which provides for advances not toexceed 85% of eligible domestic accounts receivable and 70% to 90% of foreigninsured accounts, depending on the country of the debtor, up to a maximum of$7,500,000. The majority of the debtors are domestic.

 

Interestis payable on a monthly basis at prime (5.75% at March 31, 2005) or at theLondon Inter-Bank Offering Rate (3.00% at March 31, 2005), plus 2.25% for thefirst $500,000 and 2.5% for amounts over $500,000. The line of credit iscollateralized by substantially all of the assets of the Company, personallyguaranteed by the Company’s majority stockholder, who is also our ChiefExecutive Officer, and expires in May 2005. In addition to reporting and othernon-financial covenants, the line of credit contains certain financialcovenants which require the Company to maintain a tangible net worth of notless than $1,050,000, a quick ratio of not less than 0.7-to-1, a debt-to-networth ratio of not greater than 5-to-1, and require the Company to maintain aquarterly net income after taxes of at least $1. Management believes theCompany was in compliance with these covenants at March 31, 2005. At March 31,2005 and December 31, 2004, the amounts drawn against the line of credit were$7,500,000 and $2,564,115, respectively.

 

TheCompany has no other notes payable.

 

**NOTE 10. Stockholders’ Equity**

 

Stock Options

 

EffectiveJanuary 21, 2005, the Company granted options to purchase an aggregate of335,000 shares of its common stock to certain employees, including certain ofthe Company’s officers (the “Employee Options”). The Employee Options vest uponthe later of 1) one year after the date on which the employee was hired by theCompany; or 2) one year after the date of grant. The Employee Options have anexercise price of $3.29 per share, which was the closing price per share of theCompany’s common stock on January 21, 2005. The Employee Options expire threeyears from the date of grant.

 

EffectiveJanuary 21, 2005, the Company granted options to purchase 15,000 shares ofcommon stock to each of its three outside board members as consideration fortheir serving as members of the Board of Directors. These options becomeexercisable on December 31, 2005 and terminate five years from the date ofgrant. These options have an exercise price of $3.29 per share, which was theclosing price per share of the Company’s common stock on January 21, 2005.

 

**NOTE 11. Recent AccountingPronouncements**

 

InMarch 2005, the FASB issued FASB Interpretation (“FIN”) No. 47, “Accounting forConditional Asset Retirement Obligations”. FIN No. 47 clarifies that theterm conditional asset retirement obligation as used in FASB Statement No. 143,“Accounting for Asset Retirement Obligations,” refers to a legalobligation to perform an asset retirement activity in which the timing and (or)method of settlement are conditional on a future event that may or

 

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maynot be within the control of the entity.  The obligation to perform the asset retirementactivity is unconditional even though uncertainty exists about the timing and(or) method of settlement.  Uncertaintyabout the timing and/or method of settlement of a conditional asset retirementobligation should be factored into the measurement of the liability whensufficient information exists.  This interpretation alsoclarifies when an entity would have sufficient information to reasonablyestimate the fair value of an asset retirement obligation**.**FIN No. 47 is effective no later than the end of fiscal yearsending after December 15, 2005 (which would be December 31, 2005 forcalendar-year companies). Retrospective application of interim financialinformation is permitted but is not required. Management does not expect adoption of FIN No. 47 to have a materialimpact on the Company’s financial statements.

 

**NOTE 12. Geographic Information**

 

Revenues by geographical area forthe three months ended March 31, 2005 and March 31, 2004:

 
| ** **    | ** ** | **March 31,  2005** | ** ** | **March 31,  2004** | ** ** |
|---------------|------------|---------------------|------------|---------------------|------------|
| United States |       | $                   | 15,340,878 |                | $          | 17,483,406 |   |
| Latin America |       | 8,696,178           |       | 1,172,175           |       |
| Europe        |       | —              |       | 87,737              |       |
| Total         |       | $                   | 24,037,056 |                | $          | 18,743,318 |   |

 

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

 

This discussion and analysis shouldbe read in conjunction with the accompanying Consolidated Financial Statementsand related notes. Our discussion and analysis of our financial condition andresults of operations are based upon our consolidated financial statements,which have been prepared in accordance with accounting principles generallyaccepted in the United States. The preparation of financial statements inconformity with accounting principles generally accepted in the United Statesof America requires us to make estimates and assumptions that affect thereported amounts of assets and liabilities, disclosure of any contingentliabilities at the financial statement date, and reported amounts of revenueand expenses during the reporting period. On an ongoing basis we review ourestimates and assumptions. Our estimates are based on our historical experienceand other assumptions that we believe to be reasonable under the circumstances.Actual results are likely to differ from those estimates under differentassumptions or conditions, but we do not believe such differences willmaterially affect our financial position or results of operations. Our criticalaccounting policies, the policies we believe are most important to thepresentation of our financial statements and require the most difficult,subjective and complex judgments, are outlined below in’’—Critical AccountingPolicies,’’ and have not changed significantly.

 

In addition, certain statementsmade in this report may constitute “forward-looking statements”. Theseforward-looking statements involve known or unknown risks, uncertainties andother factors that may cause the actual results, performance, or achievementsof InfoSonics to be materially different from any future results, performanceor achievements expressed or implied by the forward-looking statements.Specifically, 1) the actions of competitors and customers and our abilityto execute our business plans; and 2) our ability to increase revenues andoperating income is dependent upon our ability to continue to expand ourcurrent businesses and to enter new business areas, general economicconditions, and other factors. You can identify forward-looking statements byterminology such as “may,” “will,” “should,” “expects,” “intends,” “plans,” “anticipates,”“believes,” “estimates,” “predicts,” “potential,” “continues” or the negativeof these terms or other comparable terminology. Although we believe that theexpectations reflected in the forward-looking statements are reasonable, wecannot guarantee future results, levels of activity, performance orachievements.

 

**Overview**

 

Weare one of the largest distributors of wireless handsets and accessories in theUnited States and Latin America. We distribute products of several keymanufacturers, including Audiovox, Kyocera, LG, Motorola, Nokia, Samsung, VKMobile, and others. As an integral part of our customers’ supply chain, weperform value added services and customization processes. Our distribution andcustomization services include the purchasing, marketing, selling, softwarecustomization, warehousing, assembly, programming, packing, hardwarecustomization,

 

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shippingand delivery of handsets for wireless telecommunications from manufacturers tocarriers (wireless network operators), agents, resellers, distributors,independent dealers and retailers in the United States and Latin America.

 

As a part of our distributionactivities, we perform value added services when requested by the customer.These services include but are not limited to programming, locking, softwareloading, packaging, and quality assurance testing. We operate distribution hubsin San Diego, California and Miami, Florida.

 

Since our founding in 1994, we havegrown our business by focusing on the needs of our customers, developing andmaintaining close relationships with manufacturers, entering new markets, andsourcing new and innovative products, while maintaining close attention tooperational efficiencies and costs.

 

We successfully completed aninitial public offering of our shares of common stock in June 2004 and ourcommon stock is currently traded on the American Stock Exchange under thesymbol “IFO”.

 

Due to seasonal and other factors,our interim results may not be indicative of annual results. Our operatingresults are influenced by several seasonal and other factors, which may causeour revenues and operating results to fluctuate on a quarterly basis, includingbut not limited to the timing and introduction of new products by our suppliersand competitors, promotions and subsidies by wireless network operators,purchasing patterns of customers, and the timing of holidays and other eventsaffecting consumer demand.

 

**Areas ofManagement Focus and Performance Indicators**

 

Wemanage our business by focusing on the needs of our customers, developing andmaintaining close relationships with manufacturers, entering new markets, andsourcing new and innovative products, while maintaining close attention tooperational efficiencies and costs. The desired results of this focus areincreased shipping volumes and improved efficiencies to enable higher levels ofprofitability and earnings growth. Other areas that we focus on includemanagement execution, employee development, customer service, risk management,legal and ethical compliance, and corporate governance.

 

Performanceindicators that are key for the monitoring and management of our businessinclude operating and net income, cost of sales and gross profit percentage,operating expenses as a percent of revenues, and overall net sales growth.These items are specifically discussed further in this section. We makeextensive use of our customized information system to closely monitor allaspects of our business, including subsidiary performance, customerrelationship management, intelligent purchasing, inventory control, inventoryflow, line item margin control for every order, and weighted average cost andstatistical data for every product, customer and supplier. We believe a strongfocus on providing better service to customers leads to increased customersatisfaction and resulting customer retention and potential increases in sales.

 

Managementspends a significant amount of time traveling with the purpose of spending timewith key customers, suppliers and employees, as well as to identify newbusiness opportunities both in the United States and Latin America. We believethat these relationships are vital to the success of the company and we willcontinue to dedicate a significant amount of time to this area. We also focuson management execution, quality delivery of services to customers, riskmanagement, and corporate governance.

 

**Industry Trends,Challenges, Risks and Growth Opportunities**

 

In2004, worldwide wireless handset sales increased by approximately 25%, and theyare forecasted to increase 11% in 2005. A rapid decline in wireless handsetsales growth could negatively impact our net sales. Higher than anticipatedgrowth in demand could strain our resources and affect our ability to meetthese unanticipated demands.

 

Excess supply conditions can reducethe market prices of the products we sell and therefore affect our ability togenerate net sales and gross profit at historical levels and could affect thevalue of our inventory. Conversely, should manufacturers be unable to respondto an unanticipated increase in demand on a timely basis, we, along with othersin our industry, could experience supply constraints that would affect ourability to deliver product. We are unable to quantify these effects, as it isdifficult to predict future supply conditions and demand patterns which affectour ability to meet customer demand or sell handsets at an acceptable grossprofit.

 

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**Company SpecificTrends, Challenges, Risks and Growth Opportunities**

 

For the three months ended March31, 2005, net sales increased 28% and handsets sold increased 16% compared withthe three months ended March 31, 2004. Although we have incorporated growthinto our strategic objectives, there can be no assurance these trends willcontinue. Similarly, while we experienced a 55% increase in income fromoperations before provision for taxes for the three months ended March 31, 2005and an increase in net income of 61% compared with March 31, 2004, we cannotanticipate future growth to be at the same levels. Our strategy incorporatesoverall growth elements for each aspect of our business, which we hope willresult in continued earnings growth; however, there can be no assurance thistrend will continue. Potential investment in growth opportunities and assumedadditional risks could alter our earnings trend.

 

**Risk Related toOur Business**

 

***Ouroperating results may vary significantly, which may cause our stock price tofluctuate.***

 

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

 

•                  promotionsand subsidies by wireless network operators;

 

•                  thetiming of introduction of new products by our suppliers and competitors;

 

•                  purchasingpatterns of customers in different markets;

 

•                  generaleconomic conditions; and

 

•                  productavailability and pricing.

 

***Webuy a significant amount of our products from a limited number of suppliers,who may not provide us with competitive products at reasonable prices when weneed them in the future.***

 

We purchase wireless handsets andaccessories principally from wireless communications equipment manufacturersand distributors. We depend on these suppliers to provide us with adequateinventories of currently popular brand name products on a timely basis and onfavorable pricing and other terms. Our agreements with our principal suppliersare non-exclusive, can be terminated on short notice and provide for certainterritorial restrictions, as is common in our industry. For the three monthsended March 31, 2005 our top supplier accounted for 85% of our purchases,compared to the three months ended March 31, 2004 our top supplier accountedfor 31% of our purchases. Our suppliers may not offer us competitive productson favorable terms or with timely delivery. From time to time, we have beenunable to obtain sufficient product supplies. Any failure or delay by oursuppliers in supplying us with products on favorable terms may severelydiminish our ability to obtain and deliver products to our customers on atimely and competitive basis. If we lose any of our principal suppliers, or ifthese suppliers are unable to fulfill our product needs, or if any principalsupplier imposes substantial price increases and alternative sources of supplyare not readily available, it would have a material adverse effect on ourresults of operations.

 

***Ourcontinuing liabilities on leases from our former mall-based retail kiosklocations could have a negative impact on earnings and cash flow.***

 

Although we have assigned our sixremaining retail leases to a third party and we have received indemnificationfrom the third party, we also remain liable to the lessor, for the respectiveremaining lease terms of one to three years, if the third party does notfulfill its obligations under the leases. As of December 31, 2004 the totalpotential liability under these leases was $1,629,520, which is partiallyoffset by a $95,044 escrow deposit held for the benefit of InfoSonics to theextent that the third party should default on any of the assigned leases. Thisescrow is not reflected on our financial statements. This lease liability is discussedin the footnotes to our consolidated financial statements.

 

***Theloss or reduction in orders from principal customers or a reduction in priceswe are able to charge these customers will have a negative impact upon ourrevenues and could cause our stock price to decline.***

 

Our two largest customers duringthe three months ended March 31, 2005 accounted for approximately 38% and 12% respectively, of our productsales. The markets we serve are subject to severe price competition.Additionally, our customers are not contractually obligated to purchase productfrom us. For these and other reasons

 

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such as competitive pricing andcompetitive pressures, customers may seek to obtain products or services fromus at lower prices than we have been able to obtain from these customers in thepast. This could occur, for example, in the case of a customer purchasing largequantities of a product from us, who then terminates this relationship becausethe customer can obtain a lower price by buying directly from the manufacturer.The loss of any of our principal customers, a reduction in the amount ofproduct or services our principal customers order from us or the inability tomaintain current terms, including price, with these or other customers couldhave an adverse effect on our financial condition, results of operations andliquidity. We have experienced losses of certain customers through industryconsolidation and ordinary course of business and there can be no assurancethat any of our customers will continue to purchase products or services fromus or that their purchases will be at the same or greater levels than in priorperiods.

 

***Ourfuture profitability depends on our ability to maintain existing margins andour ability to increase our sales, which we may not be able to do.***

 

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

 

***Ourbusiness depends on the continued tendency of wireless equipment manufacturersand network operators to outsource aspects of their business to us.***

 

Our business depends in large parton wireless equipment manufacturers and network operators outsourcing some oftheir business functions to us. We provide functions such as distribution,inventory management, customized packaging, activation management and otherservices. Certain wireless equipment manufacturers and network operators haveelected, and others may elect, to undertake these services internally.Additionally, our customer service levels, industry consolidation, competition,deregulation, technological changes or other factors could reduce the degree towhich members of the wireless telecommunications industry rely on outsourcedservices such as the services we provide. Any significant change in the marketfor these services could have a material adverse effect on our current andplanned business.

 

***Wemay not be able to effectively compete in our industry if consolidation ofwireless network operators continues.***

 

The past several years havewitnessed a consolidation within the wireless network operator community. Ifthis trend continues, it could result in a reduction or elimination ofpromotional activities by the remaining wireless network operators as they seekto reduce their expenditures, which could, in turn, result in decreased demandfor our products or services. Moreover, consolidation of wireless networkoperators reduces the number of potential contracts available to us. We couldalso lose business if wireless network operators, which currently are ourcustomers, are acquired by other wireless network operators which are not ourcustomers. Wireless operators may also change their policy regarding sales totheir agents by independent distributors, such as requiring those agents topurchase products from the wireless operator or manufacturer, rather than fromdistributors such as InfoSonics. This type of requirement could have a materialadverse effect on our business and results of operations.

 

***Oursales and inventory risk may be materially affected by fluctuations in regionaldemand patterns and economic factors for which we cannot plan.***

 

The demand for our products andservices has fluctuated and may continue to vary substantially within theregions served by us. We believe the roll-out of third generation, or 3G, cellulartelephone systems and other new technologies, which has been delayed and couldfurther be delayed, has had and will continue to have an effect on overallsubscriber growth and handset replacement demand. Economic slow-downs inregions served by us or changes in promotional programs offered by wirelessnetwork operators may lower consumer demand for our products and create higherlevels of inventories which could decrease our gross and operating margins. Wecould face a substantial inventory risk due to depreciation and equipment priceerosion if our products are not sold in a timely manner. We believe ouroperations were adversely affected by an economic slow-down in the UnitedStates

 

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starting in the fourth quarter of2000. A prolonged economic slow-down in the United States or any other regionsin which we have significant operations could negatively impact our results ofoperations and financial position.

 

***Wemay not be able to adequately respond to rapid technological changes in thewireless telecommunications industry, which could cause us to lose customers.***

 

The technology relating to wirelesstelecommunications equipment changes rapidly resulting in product obsolescenceor short product life cycles. We are required to anticipate futuretechnological changes in our industry and to continually identify, obtain andmarket new products in order to satisfy evolving industry and customerrequirements. Competitors or manufacturers of wireless equipment may marketproducts which have perceived or actual advantages over products that we handleor which otherwise render those products obsolete or less marketable. We havemade and continue to make significant capital investments in accordance withevolving industry and customer requirements including maintaining levels ofinventories of currently popular products that we believe are necessary basedon current market conditions. This utilization of capital for inventory buildupof this nature increases our risk of loss due to product obsolescence.

 

***Substantialdefaults by our customers on accounts receivables could have a significantnegative impact on our cash flow and financial condition.***

 

We currently offer and intend tooffer open account terms to certain of our customers, which may subject us tocredit risks, particularly to the extent that our receivables represent salesto a limited number of customers or are concentrated in particular geographicmarkets. Although we have an accounts receivable insurance policy, this policycarries a substantial deductible and may not cover us in all instances. We alsohave an accounts receivable credit facility in order to reduce our workingcapital requirements. The extent of our ability to use our accounts receivablecredit facility is dependent on the amount of and collection cycle of ouraccounts receivable. Adverse changes in our ability to use accounts receivablefinancing could have a material adverse effect on our financial position, cashflows and results of operations.

 

***Werely on our suppliers to provide trade credit facilities to adequately fund ouron-going operations and product purchases, and without those facilities, ourability to procure products could be reduced.***

 

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

 

***Approximately36% of our revenues during the three months ended March 31, 2005 were generatedoutside of the United States in countries that may have political or otherrisks.***

 

We engage in sales activities interritories and countries outside of the United States. The fact that wedistribute products into a number of countries exposes us to increased creditrisks, customs duties, import quotas and other trade restrictions, potentiallygreater inflationary pressures, and shipping delays. Changes may occur insocial, political, regulatory and economic conditions or in laws and policiesgoverning foreign trade and investment in the territories and countries wherewe currently distribute products. United States laws and regulations relatingto investment and trade in foreign countries could also change to ourdetriment. Any of these factors could have a material adverse effect on ourbusiness and operations. Although we purchase and sell products and services inUnited States dollars and do not engage in exchange swaps, futures or optionscontracts or other hedging techniques, fluctuations in currency exchange ratescould reduce demand for products sold in United States dollars. We cannotpredict the effect that future exchange rate fluctuations will have on ouroperating results. We may in the future engage in currency hedgingtransactions, which could result in our incurring significant additional losses.

 

***Werely on our information system technology to function efficiently, withoutinterruptions, and if it does not, customer relationships could be harmed.***

 

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We have focused on the applicationof our information system technology to provide customized services to wirelesscommunications equipment manufacturers and network operators. Our ability tomeet our customers’ technical and performance requirements is highly dependenton the effective functioning of our information technology systems, which mayexperience interruptions. These business interruptions could cause us to fallbelow acceptable performance levels pursuant to our customers’ requirements andcould result in the loss of the related business relationship.

 

***Wehave outstanding indebtedness, which is secured by substantially all our assetsand which could prevent us from borrowing additional funds, if needed.***

 

We had outstanding debt in theamount of approximately $7.5 million and $2.6 million at March 31, 2005 andDecember 31, 2004, respectively, in the form of a bank line of credit which isbased on accounts receivable. If we violate our loan covenants, default on ourobligations or become subject to a change of control, our indebtedness would becomeimmediately due and payable. Our credit facility is secured by substantiallyall of our assets and borrowing availability is based primarily on a percentageof eligible accounts receivable. Consequently, any significant decrease ineligible accounts receivable will limit our ability to borrow additional fundsto adequately finance our operations and expansion strategies. The terms of ourcredit facility could substantially prohibit us from incurring additionalindebtedness, which could limit our ability to expand our operations. The termsof our credit facility also include negative covenants that, among otherthings, limit our ability to sell certain assets and make certain payments,including but not limited to, dividends, repurchases of common stock and otherpayments outside the normal course of business as well as prohibiting us frommerging or consolidating with another corporation or selling all orsubstantially all of our assets. This current facility expires in May 2005. Although there are no assurances, we believethat we will be able to extend this revolving line of credit with equal orbetter terms.

 

***Thewireless telecommunications industry is intensely competitive and we may not beable to continue to compete against well-established competitors with greaterfinancial and other resources.***

 

We compete for sales of wirelesstelecommunications equipment and accessories, and expect that we will continueto compete, with numerous well-established wireless network operators,distributors and manufacturers, including our own suppliers. Many of ourcompetitors possess greater financial and other resources than we do and maymarket similar products or services directly to our customers. Distribution ofwireless telecommunications equipment and accessories has generally had lowbarriers to entry. As a result, additional competitors may choose to enter ourindustry in the future. The markets for wireless handsets and accessories arecharacterized by intense price competition and significant price erosion overthe life of a product. Many of our competitors have the financial resources towithstand substantial price competition and to implement extensive advertisingand promotional programs, both generally and in response to efforts byadditional competitors to enter into new markets or introduce new products. Ourability to continue to compete successfully will depend largely on our abilityto maintain our current industry relationships. We may not be successful inanticipating and responding to competitive factors affecting our industry,including new or changing outsourcing requirements, the entry of additionalwell-capitalized competitors, new products which may be introduced, changes inconsumer preferences, demographic trends, international, national, regional andlocal economic conditions and competitors’ discount pricing and promotionstrategies. As wireless telecommunications markets mature and as we seek toenter into new markets and offer new products in the future, the competitionthat we face may change and grow more intense.

 

***Ourcontinued growth depends on retaining our current key employees and attractingadditional qualified personnel, and we may not be able to continue to do so.***

 

Our success depends in large parton the abilities and continued service of our executive officers and other keyemployees, particularly Joseph Ram, our Chief Executive Officer. Although wehave entered into employment agreements with several of our officers andemployees, including Mr. Ram, we may not be able to retain their services underapplicable law. The loss of executive officers or other key personnel couldhave a material adverse effect on us. In addition, in order to support ourcontinued growth, we will be required to effectively recruit, develop andretain additional qualified management. If we are unable to attract and retainadditional necessary personnel, it could delay or hinder our plans for growth.

 

***Werely on trade secret laws and agreements with our key employees and other thirdparties to protect our proprietary rights, and there is no assurance that theselaws or agreements adequately protect our rights.***

 

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We rely on trade secret laws toprotect our proprietary knowledge, particularly our database of customers andsuppliers and business terms such as pricing. In general, we also havenon-disclosure agreements with our key employees and limit access to anddistribution of our trade secrets and other proprietary information. Thesemeasures may prove difficult to enforce and may not prove adequate to preventmisappropriation of our proprietary information.

 

***Wemay become subject to suits alleging medical risks associated with our wirelesshandsets, and the cost of these suits could be substantial, and divert fundsfrom our business.***

 

Lawsuits or claims have been filedor made against manufacturers of wireless handsets over the past years allegingpossible medical risks, including brain cancer, associated with theelectromagnetic fields emitted by wireless communications handsets. There hasbeen only limited relevant research in this area, and this research has notbeen conclusive as to what effects, if any, exposure to electromagnetic fieldsemitted by wireless handsets has on human cells. Substantially all of ourrevenues are derived, either directly or indirectly, from sales of wirelesshandsets. We may become subject to lawsuits filed by plaintiffs allegingvarious health risks from our products. If any future studies find possiblehealth risks associated with the use of wireless handsets or if any damagesclaim against us is successful, it could have a material adverse effect on ourbusiness. Even an unsubstantiated perception that health risks exist couldadversely affect our ability or the ability of our customers to market wirelesshandsets.

 

**Risks Related ToOur Common Stock**

 

***Stockholdersmay be diluted as a result of future offerings or other financings.***

 

We may need to raise additionalcapital through one or more future public offerings, private placements orother financings involving our securities. As a result of these financings,none of which is currently planned, ownership interests in our company may begreatly diluted.

 

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

 

Prior to our initial publicoffering in June 2004, there was not a public market for our common stock. Anactive trading market for our common stock may never develop or be sustained,which could affect the ability of our stockholders to sell their shares andcould depress the market price of their shares. The stock market in general andthe market for telecommunications-related stocks in particular, has been highlyvolatile. As a result, the market price of our common stock is likely to besimilarly volatile, and investors in our common stock may experience a decreasein the value of their stock, including decreases unrelated to our operatingperformance or prospects. The price of our common stock could be subject towide fluctuations in response to a number of factors, including those listed inthis ‘‘Risk Factors’’ section of this Form 10-Q. In the past, securities classaction litigation has often been instituted against companies following periodsof volatility in their stock price. This type of litigation against us couldresult in substantial costs and divert our management’s attention andresources.

 

***Sharesof common stock that are issuable pursuant to our stock option plans and ouroutstanding warrants, when issued, could result in dilution to existingstockholders and could cause the market price of our common stock to fall.***

 

We have reserved shares of commonstock that may be issuable pursuant to our stock option plans and ouroutstanding options outside those plans. These securities, when issued andoutstanding, may reduce earnings per share under accounting principlesgenerally accepted in the United States of America and, to the extent that theyare exercised and shares of common stock are issued, dilute percentageownership to existing stockholders which could have an adverse effect on themarket price of our common stock.

 

***Theability of our stockholders to control our policies or effect a change incontrol of our company is limited, which may not be in our stockholders’ bestinterests.***

 

Some provisions of our charter andbylaws and the General Corporation Law of Maryland, where we are incorporated,may delay or prevent a change in control of our company or other transactionsthat could provide our common stockholders with a premium over thethen-prevailing market price of our common stock or that might

 

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otherwise be in the best interestsof our stockholders. These include the ability of our Board of Directors toauthorize the issuance of preferred stock without stockholder approval, whichpreferred stock may have voting provisions that could delay or prevent a changein control or other transaction that might involve a premium price or otherwisebe in the best interests of our stockholders. Maryland law imposes restrictionson some business combinations and requires compliance with statutory proceduresbefore some mergers and acquisitions can occur. These provisions of Marylandlaw may have the effect of discouraging offers to acquire us even if theacquisition would be advantageous to our stockholders.

 

***Ifour two largest stockholders have strategic interests that are similar and thatdiffer from those of our other stockholders, and if those two stockholders votein the same manner, they may be able to cause results that the otherstockholders do not believe to be beneficial to their interests.***

 

Two of our stockholders, in theaggregate, beneficially own approximately 61.6% of our outstanding commonstock. To the extent that these stockholders vote their shares similarly, theywill be able to exercise control over many matters requiring approval by theboard of directors or our stockholders. As a result, they would be able to:

 

•                  controlthe composition of our board of directors;

 

•                  controlour management and policies;

 

•                  determinethe outcome of significant corporate transactions, including changes in controlthat may be beneficial to stockholders; and

 

•                  actin their mutual interests, which may conflict with, or be different from, theinterests of other stockholders.

 

**Available Information**

 

Ourwebsite at www.infosonics.com provides a link to the Securities and ExchangeCommission’s website where our Annual Reports on Form 10-K, QuarterlyReports on Form 10-Q, Current Reports on Form 8-K (including exhibits andsupplementary schedules) and amendments to those reports, filed or furnishedunder Section 13(a) or 15(d) of the Securities Exchange Act of 1934, can beaccessed free of charge.

 

**Results of Operations:**

 

***Quarter ended March 31, 2005 compared With Quarter ended March 31, 2004***

 

Net sales for the three monthsended March 31, 2005 were $24.0 million, compared with $18.7 million for thethree months ended March 31, 2004, an increase of 28%. The increase in netsales is primarily due to a 16% increase in units sold and a 9% increase inaverage unit selling price compared to the three months ended March 31, 2004.During the quarter ended March 31, 2005, the Company made significant progresswith carrier direct sales both in the United States and Latin America. Netsales from Latin America increased to $8.7 million for the three months endedMarch 31, 2005, as compared with $1.2 million for the three months ended March31, 2004. This increase is primarily the result of increased personnel andselling efforts in Latin America. Revenues in the United States were $15.3million for the three months ended March 31, 2005 as compared with $17.5million for the three months ended March 31, 2004. This decrease was primarilydue to decreased net sales to the U.S. dealer agent channel, which waspartially offset by an increase in net sales to the U.S. carriers.

 

Cost of sales for the three monthsended March 31, 2005 was $21.9 million, or 91% of net sales, compared with$17.3 million, or 92.5% of net sales, for the three months ended March 31,2004. The $4.6 million (26%) increase in cost of sales is consistent with our28% increase in net sales.

 

Gross profit for the three monthsended March 31, 2005 was $2.1 million, or 8.9% of net sales, compared with $1.4million, or 7.5% of net sales, for the three months ended March 31, 2004. The19% increase in gross profit percentage from 7.5% to 8.9% is due to our abilityto secure product with greater margin opportunity during the quarter endedMarch 31, 2005.

 

Operating expenses for the threemonths ended March 31, 2005 were $1.6 million, or 6.5% of net sales, comparedwith $1.0 million, or 5.4% of net sales, for the three months ended March 31,2004. The $600,000 increase is primarily due to expenses related to ouroperations in Latin America and increased personnel, both in the United Statesand Latin America, to drive and support our increased sales levels. We now alsooccupy larger office

 

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and warehouse facilities, and weincur additional costs (including legal and accounting costs) associated withbeing a publicly-traded company. The increase of operating expenses as apercentage of revenues is related to the factors discussed above.

 

Income from continuing operationsfor the three months ended March 31, 2005 was $565,000, representing anincrease of 43% compared to the three months ended March 31, 2004. As apercentage of net sales, income from operations was 2.3% for the three monthsended March 31, 2005 compared with 2.1% for the three months ended March 31,2004. This increase in income from continuing operations, both in dollars andas a percentage of net sales, is the result of the factors discussed above, aswell as our operational efficiency, which has allowed us to increase salesvolumes at a higher rate than operating expenses.

 

For the three months ended March 31, 2005, we incurreda loss from discontinued operations of $6,000, or less than $.01 per share, ascompared with a loss of $34,000, or $.01 per share, for the three months endedMarch 31, 2004.

 

Net income for the three monthsended March 31, 2005 was $315,000, or $0.05 earnings per diluted share,compared to net income of $196,000, or $0.05 earnings per diluted share, forthe three months ended March 31, 2004, representing a dollar increase of 61%.The increase in net income is primarily due to increased net sales, andincreased gross profits both in dollars and as a percentage of net sales.Primarily because of our June 2004 initial public offering, the number of fullydiluted shares was significantly higher for the first quarter of 2005 than forthe first quarter of 2004.

 

**Financial Condition, Liquidityand Capital Resources**

 

*Cash andCash Flows*

 

At March 31, 2005, we had cash andcash equivalents of $3,542,639, and at December 31, 2004, we had cash and cashequivalents of $5,183,876.

 

During the quarter ended March 31, 2005, we continued toleverage our bank and vendor lines of credit to help fund our growth andincreased profitability. The net cash used by operating activities was $6.5million for the three months ended March 31, 2005 which resulted primarily fromincreased accounts receivable and increased inventory levels. The approximately$5 million increase in accounts receivable was due to increased sales in March2005. The approximately $2 million increase in inventory was due to buyingopportunities which were available to the Company at the end of the quarterended March 31, 2005. The majority of these products were received and soldduring April 2005. Allowance for doubtful accounts at March 31, 2005 increasedto $362,000 compared to $250,000 at December 31, 2004. This increase****was related to our increased sales levelsand increased accounts receivable balance at March 31, 2005. We believe that atMarch 31, 2005, our reserve for doubtful accounts is adequate.

 

Days’ sales outstanding at March 31, 2005 were 38 dayscompared with 40 days at December 31, 2004. Normal payment terms require ourcustomer payment on a net 30-day basis. We are constantly working with ourcustomers to reduce our days’ sales outstanding.

 

The net cash used in investing activities was $43,000 forthe three months ended March 31, 2005 compared with $47,000 for the threemonths ended March 31, 2004. This increase is primarily the result ofexpenditures for new furniture and fixtures related to increased office,technical assembly and warehouse space, as well as the technical tools andequipment necessary for the customization process.

 

The net cash provided by financing activities for the threemonths ended March 31, 2005 of $4.9 million is primarily the result ofborrowings from our bank line of credit.

 

Our net working capital at March 31, 2005 was $12.8million, compared with $12.4 million at December 31, 2004. This change was dueprimarily to our increased net income for the three months ended March 31,2005.

 

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**Borrowings**

 

We utilize a bank line of creditwhich is based upon eligible accounts receivable. As of March 31, 2005 andDecember 31, 2004, amounts advanced against that line were approximately$7,500,000 and $2,600,000,respectively. This credit line has been an important part of growing ourbusiness, and market changes affecting accounts receivable could diminish theborrowing base of available funds. As of March 31, 2005 and December 31, 2004,advances were 100% and 47%, respectively, of the available borrowing base. Thiscurrent facility expires in May 2005. Although there are no assurances, we believe that we will be able toextend this revolving line of credit with equal or better terms. Asof April 30, 2005, our net availability was approximately $3.7 million

 

We believe that our existing cashresources, together with our projected cash flow from operations and the netproceeds from our bank line of credit, will be sufficient to allow us toimplement our strategy and growth plan.

 

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**CriticalAccounting Policies**

 

We believe the following criticalaccounting policies are important to the presentation of our financialcondition and results, and require management’s judgments often as a result ofthe need to make estimates about the affect of matters that are inherentlyuncertain.

 

***Revenue Recognition and Accrued Chargebacks***

 

Revenues are recognized upon (1)shipment of the products to customers, (2) when collection of the outstandingreceivables is probable, and (3) the final price of the product is determined. Commissionrevenue, paid by the carrier, on phone activations is recorded at the time ofthe activation and may be charged back to us in future periods. Commissionrevenue and accrued chargebacks are related to our discontinued operations. Thecarrier has six months from date of activation to charge back amountspreviously credited to us if the customer terminates its service. We provide anallowance for estimated returns based on our experience, which estimate isrecorded as a contra asset against accounts receivable. A provision for returnsis provided in the same period in which the related revenue is recorded.Customer credit-worthiness and economic conditions may change and increase therisk of collectibility and contract terminations and may require additional provisions,which would negatively impact our operating results.

 

***Allowance for Doubtful Accounts and Sales Return Reserve***

 

Credit evaluations are undertakenfor all major sale transactions before shipment is authorized. Normal paymentterms require payment on a net ninety-day basis. On an on-going basis, weanalyze the payment history of customer accounts, including recent customerpurchases. We evaluate aged items in the accounts receivable aging and providereserves for doubtful accounts and estimated sales returns. Customercredit-worthiness and economic conditions may change and increase the risk ofcollectibility and sales returns, and may require additional provisions, whichwould negatively impact our operating results.

 

***Inventory Write-Off and Effect on Gross Margin***

 

We regularly monitor inventoryquantities on hand and record a provision for excess and obsolete inventoriesbased primarily on historical usage rates and our estimated forecast of productdemand for a period of time, generally Nine months. Because of obsolescence, wewill generally provide a full reserve for the costs of our inventories inexcess of our relevant forecast for the applicable period. We attempt tocontrol our inventory levels so that we do not hold inventories in excess ofdemand for the succeeding nine months. However, because we need to placenon-cancelable orders with significant lead time and because it is difficult toestimate product demand, it is possible that we will build inventories inexcess of demand for the future periods. If we have inventories in excess ofestimated product demand, we will provide a reserve, which could have amaterial adverse effect on our reported results of operations and financialposition.

 

**Off-Balance Sheet Arrangements**

 

We do not have any off-balance sheet arrangements.

 

**Contractual Obligations**

 

Welease corporate and administrative office facilities, and equipment undernon-cancelable operating leases. Certain of these leases contain renewaloptions. Rent expense under these leases was approximately $101,000 and $47,000for the three months ended March 31, 2005 and 2004, respectively.

 

**Item 3. Quantitative andQualitative Disclosures About Market Risk**

 

We are subject to market risks with respect to interestrates because our line of credit has a floating interest rate. We can chooseamong the bank’s prime rate, which was 5.75% at March 31, 2005, and the one-,two-, and three-month LIBOR rates plus 2.25% for the first $500,000 ofborrowings and 2.5% for borrowing above $500,000. As of

 

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March31, 2005, our borrowings were all at the bank’s prime rate. If the full$7,500,000 available under our credit facility were outstanding for a fullyear, each increase of 1% in the applicable interest rate would result in anadditional $75,000 in interest expense for that year.

 

Our business outside the United States is conducted inUnited States dollars. Although we purchase and sell products and services inUnited States dollars and do not engage in exchange swaps, futures or optionscontracts or other hedging techniques, fluctuations in currency exchange ratescould reduce demand for products sold in United States dollars. We cannotpredict the effect that future exchange rate fluctuations will have on our operatingresults. We believe our exposure to market risks, including exchange rate risk,interest rate risk and commodity price risk, is not material at the presenttime. We may in the future engage in currency hedging transactions, which couldresult in our incurring significant additional losses.

 

**Item 4. Controls and Procedures**

 

As of the end of the period coveredby this report, we conducted an evaluation, under the supervision and with theparticipation of the principal executive officer and principal financialofficer, of our disclosure controls and procedures (as defined in Rules13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 (the “ExchangeAct”)). Based on this evaluation, the principal executive officer and principalfinancial officer concluded that our disclosure controls and procedures areeffective to ensure that information required to be disclosed by us in reportsthat we file or submit under the Exchange Act is recorded, processed,summarized and reported within the time periods specified in Securities andExchange Commission (“SEC”) rules and forms. There was no change in ourinternal control over financial reporting during our most recently completedfiscal quarter that has materially affected, or is reasonably likely to materiallyaffect, our internal control over financial reporting.

 

**PART II. OTHER INFORMATION**

 

**Item 1. Legal Proceedings**

 

The Company may become involved in certain legalproceedings and claims which arise in the normal course of business. As ofMarch 31, 2005, the Company did not have any significant litigationoutstanding, and management does not expect any pending litigation matters tohave a material impact on the Company’s liquidity or the financial statementstaken as a whole.

 

**Item 2. Unregistered Sales ofEquity Securities and Use of Proceeds.**

 

None.

 

**Item 3. Defaults Upon SeniorSecurities.**

 

None.

 

**Item 4. Submission of Mattersto a Vote of Security Holders.**

 

None.

 

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**Item 5. Other Information.**

 

None.

 

**Item 6.****          ****Exhibits**

 
| 31.1   |   | Certifications of the Chief Executive  Officer and Chief Financial Officer pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002                                           |
|--------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                            |
| 32.1   |   | Certifications of Chief Executive Officer  and Chief Financial Officer pursuant to 18 U.S.C. Section 1350 as adopted  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |

 

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**SIGNATURE**

 

Pursuant to the requirements of theSecurities Exchange Act of 1934, as amended, the registrant has duly causedthis report to be signed on its behalf by the undersigned, thereunto dulyauthorized.

 
|   |         |   | InfoSonics Corporation          |
|--------|--------------|--------|---------------------------------|
|   |         |   |
|   |         |   |
| Date:  | May 16, 2005 | By:    | /S/  Joseph Ram       |   |
|   |         |   | Joseph Ram                      |
|   |         |   | Chief Executive Officer         |
|   |         |   |
|   |         |   |
| Date:  | May 16, 2005 | By:    | /S/  Jeffrey Klausner |   |
|   |         |   | Jeffrey Klausner                |
|   |         |   | Chief Financial Officer         |
|        |              |        |                                 |  |  |  |

 

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