** **

** **

**UNITEDSTATES**

**SECURITIES AND EXCHANGECOMMISSION**

**Washington, D.C. 20549**

 

**FORM 10 - Q**

 
| **x  QUARTERLY REPORT UNDER SECTION 13 OR 15(d)**               |
|-----------------------------------------------------------------|
| **OF THE SECURITIES EXCHANGE ACT OF 1934.**                     |
|                                                            |
| **For the quarterly period ended  September 30, 2007**          |
| ** **                                                      |
| **OR**                                                          |
|                                                            |
| **o****TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)** |
| **OF THE SECURITIES EXCHANGE ACT OF 1934**                      |

 

**For thetransition periodfrom                to**

 

**CommissionFile Number - 001-32217**

 

**InfoSonics Corporation**

(Exactname of registrant as specified in its charter)

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

 

**4350 Executive Drive Suite #100San Diego, CA 92121**

(Addressof principal executive offices including zip code)

 

**(858) 373-1600**

(Registrant’s telephone number, including area code)

 

**NotApplicable**

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

 

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

Yes  x   No  o

 

Indicate by check mark whether the registrant is a large acceleratedfiler, an accelerated filer, or a non-accelerated filer (as defined in Rule12b-2 of the Exchange Act).

Large Accelerated Filer  o             AcceleratedFiler  o             Non-AcceleratedFiler  x

 

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

Yes  o   No  x

 

As of November 9, 2007, theRegistrant had 14,589,495 shares outstanding of its $.001 par value commonstock.

 

 

 

----

 

 

**InfoSonics Corporation andSubsidiaries**

**QuarterlyReport on Form 10-Q For The Period Ended September 30, 2007**

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

 

2

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**Part I. FINANCIAL INFORMATION**

 

Item1.  Financial Statements

**InfoSonics Corporation andSubsidiaries**

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

 

*Accompanying notes are anintegral part of these financial statements.*

* *

*3*

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* *

 

**InfoSonicsCorporation and Subsidiaries**

**Consolidated Statements of Income(Loss)**

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

 

*Accompanyingnotes are an integral part of these financial statements*.

 

4

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**InfosonicsCorporation and Subsidiaries**

**Consolidated Statements ofComprehensive Operations**

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

 

*Theaccompanying notes are an integral part of these financial statements*

* *

*5*

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* *

 

**InfoSonicsCorporation and Subsidiaries**

**Consolidated Statements of CashFlows**

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

* *

*Accompanying notes are an integral part of these financialstatements.*

* *

*6*

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* *

* *

**InfoSonicsCorporation**

**Condensed Notes to ConsolidatedFinancial Statements**

**(unaudited)**

**NOTE 1. Basisof Presentation**

Theaccompanying unaudited consolidated financial statements and these condensednotes have been prepared in accordance with accounting principles generallyaccepted in the United States (“GAAP”) for interim financial information andwith the instructions to Form 10-Q and Article 10 of Regulation S-X of theSecurities Exchange Act of 1934, as amended (the “Exchange Act”). Accordingly,they do not include all of the information and notes required by GAAP forcomplete financial statements. The preparation of financial statements requiresmanagement to make estimates and assumptions that affect amounts reported inthe financial statements and accompanying notes. Actual results are likely todiffer from those estimates, but management does not believe such differenceswill materially affect the financial position or results of operations ofInfoSonics Corporation (the “Company”), although they may. These unauditedconsolidated financial statements and condensed notes should be read inconjunction with the financial statements and notes as of and for the yearended December 31, 2006 included in the Company’s Annual Report on Form 10-Kfor the year ended December 31, 2006. These unaudited consolidated financial statements reflect alladjustments considered, in the opinion of the Company’s management, necessaryto fairly present the results for the periods covered herein and suchadjustments are considered of a normal recurring nature.

The unauditedconsolidated financial statements include the accounts of the Company and itssubsidiaries, Axcess Mobile LLC, InfoSonics Latin America, Inc., InfoSonics deMexico S.A. de C.V., InfoSonics de Guatemala S.A., InfoSonics El Salvador S.A.de C.V., InfoSonics S.A., InfoSonics Chile y Compania Limitada and InfoSonicsColombia S.A., all of which are wholly owned. Significant intercompany accountsand transactions have been eliminated in consolidation of these consolidatedfinancial statements.

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

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

**NOTE 2.****Stock-BasedCompensation**

The Company has three equity incentive plans, the 2006Equity Incentive Plan (“2006 Plan”), the 2003 Stock Option Plan (“2003 Plan”)and the 1998 Stock Option Plan (“1998 Plan”). Each of the plans has been approved by our stockholders. The 2006 Planis the only plan from which additional equity incentives will be granted. The2006 Plan authorizes the grant of up to 1,000,000 shares for equity incentives.The Company is also a party to non-plan option agreements with severalnon-employee directors and several institutions.

Effective January 1, 2006 the Company adoptedFinancial Accounting Standards Board (“FASB”) SFAS No. 123R, “Share BasedPayments” using the modified prospective method, which requires measurement ofcompensation cost for all stock-based awards at fair value on the date of grantand recognition of compensation over the service period for awards expected tovest. The fair value of stock options was determined using the Black-Scholesvaluation model, which is consistent with our valuation techniques previouslyutilized for stock options in footnote disclosures required under SFAS 123, asamended by SFAS 148. Such fair value is recognized as an expense over theservice period, net of estimated forfeitures.

On September 27,2001, the FASB Emerging Issues Task Force (“EITF”) issued EITF Issue 96-18 “*Accounting for EquityInstruments That are Issued to Other than Employees for Acquiring, or inConjunction with Selling, Goods or Services*,” which requires thatequity instruments issued in exchange for certain services be valued at themore accurate of the fair value of the services provided or the fair value ofthe equity instruments issued.  For equityinstruments issued that are subject to a required service period the expenseassociated with the equity instruments is recorded as the instruments vest orthe services are provided.  The Companyhas granted options and warrants to non-employees and recorded the fair valueof the equity instruments on the date of issuance using the Black-Scholesvaluation model.  For grants subject tovesting or service requirements, the expense is deferred and is recognized overthe more appropriate of the vesting period or as the service is provided.

 

7

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

| ** **                                                       | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|------------------------------------------------------------------|------------|-------------------------------------------------|------------|------------------------------------------------|------------|
| ** **                                                       | ** ** | **2007**                                        | ** ** | **2006**                                       | ** ** | **2007** | ** ** | **2006** | ** ** |
|                                                             |       |                                            |       |                                           |       |   |   |   |   |
| Officer compensation                                             |       | $                                               | —     |                                           | $          | 79,654 |   | $ | 92,036 |   | $ | 116,248 |   |
| Non-employee directors                                           |       | 3,451                                           |       | 1,726                                          |       | 10,353 |   | 1,139,904 |   |
| Sales, general and administrative                                |       | 34,809                                          |       | 52,068                                         |       | 130,768 |   | 120,360 |   |
| Total stock option expense, included in total operating expenses |       | $                                               | 38,260     |                                           | $          | 133,448 |   | $ | 233,157 |   | $ | 1,376,512 |   |

 

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

The fair value of each option grant is estimated onthe date of grant using the Black-Scholes option pricing model with thefollowing weighted-average assumptions used for grants in 2007 and 2006: risk-freeinterest rate of 4.66% in 2007 and ranging from 4.88% to 5.04% in 2006 based onthe U.S. Treasury yields in effect at the time of grant; expected dividendyields of 0 percent as the Company has not, and does not intend to, issuedividends; and expected lives of 3 to 7 years based upon the historical life ofoptions. For grants in 2007 and 2006, the expected volatility used ranged from62% to 91%, based on the Company’s historical stock price fluctuations for aperiod matching the expected life of the options.

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

| ** **                        | ** ** | **Shares** | ** ** | **Wtd. Avg.  Exercise Price** | ** ** | **Wtd. Avg.  Remaining  Contractual  Life (years)** | ** ** | **Aggregate  Intrinsic  Value** | ** ** |
|-----------------------------------|------------|------------|------------|-----------------------------------------|------------|----------------------------------------------------------|------------|---------------------------------|------------|
| Outstanding at January 1, 2007    |       | 3,117,324  |       | $                                       | 2.56       |                                                     |       |                            | —     |   |
| Granted                           |       | 40,000     |       | $                                       | 3.79       |                                                     | 5.45       |                            | —     |   |
| Exercised                         |       | 268,285    |       | $                                       | 1.23       |                                                     |       |                            | —     |   |
| Forfeited                         |       | 58,333     |       | $                                       | 10.29      |                                                     |       |                            | —     |   |
| Outstanding at September 30, 2007 |       | 2,830,706  |       | $                                       | 2.59       |                                                     | 2.78       |                            | —     |   |
| Vested and expected to vest       |       | 2,830,706  |       | $                                       | 2.59       |                                                     | 2.78       |                            | —     |   |
| Exercisable at September 30, 2007 |       | 2,792,063  |       | $                                       | 2.52       |                                                     | 2.75       |                            | —     |   |

 

8

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A summary of the status of the Company’s non-vestedoptions at September 30, 2007 and changes during the nine months endedSeptember 30, 2007 is presented below:
| ** **                       | ** ** | **Shares** | ** ** | **Weighted-average  grant-date fair value** | ** ** |
|----------------------------------|------------|------------|------------|-------------------------------------------------------|------------|
| Non-vested at December 31, 2006  |       | 177,269    |       | $                                                     | 6.65       |   |
| Granted                          |       | 40,000     |       | $                                                     | 3.79       |   |
| Vested                           |       | 131,405    |       | $                                                     | 3.71       |   |
| Forfeited                        |       | 58,333     |       | $                                                     | 10.29      |   |
| Non-vested at September 30, 2007 |       | 27,531     |       | $                                                     | 5.18       |   |

 

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

**NOTE 3. Earnings Per Share**

The Companyutilizes SFAS No. 128, ‘‘*Earnings per Share*.’’ Basic earnings per share is computedby dividing income available to common stockholders by the weighted-averagenumber of common shares outstanding. Diluted earnings per share is computedsimilarly to basic earnings per share, except that the denominator is increasedto include the number of additional common shares that would have beenoutstanding if the potential additional common shares that were dilutive hadbeen issued. Common share equivalents are excluded from the computation iftheir effect is anti-dilutive. The Company’s common share equivalents consistof stock options and warrants.

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

| ** **                                                                                                 | ** ** | **Three Months Ended** | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|------------------------------------------------------------------------------------------------------------|------------|----------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                                                                                 | ** ** | **September  30, 2007**     | ** ** | **September  30, 2006**     | ** ** | **September  30, 2006**    | ** ** |
|                                                                                                       |       |                             |       |                             |       |                            |       |
| Numerator: Net income  (loss)                                                                              |       | $                                | 373,435    |                             | $          | 677,179                         |       | $ | 1,977,864 |   |
| Denominator:                                                                                               |       |                             |       |                             |       |                            |       |
| Denominator for basic  earnings per share — weighted average shares                                   |       | 14,474,353                       |       | 13,989,980                       |       | 13,494,168                      |       |
| Effect of dilutive  securities — employee stock options                                               |       | 1,247,971                        |       | 2,288,829                        |       | 2,334,095                       |       |
| Denominator for diluted  earnings per share — adjusted weighted average shares and assumed conversion |       | 15,722,324                       |       | 16,278,809                       |       | 15,828,263                      |       |
|                                                                                                       |       |                             |       |                             |       |                            |       |
| Basic earnings (loss) per share                                                                            |       | $                                | 0.03       |                             | $          | 0.05                            |       | $ | 0.15 |   |
|                                                                                                       |       |                             |       |                             |       |                            |       |
| Diluted earnings (loss) per share                                                                          |       | $                                | 0.02       |                             | $          | 0.04                            |       | $ | 0.13 |   |
|                                                                                                            |            |                                  |            |                                  |            |                                 |            |  |  |  |  |  |  |  |  |  |

 

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

Since theireffect would have been anti-dilutive, 1,458,076, stock options and warrants topurchase shares of common stock has been excluded from the computation of netloss per share for the nine months ended September 30, 2007.

**NOTE 4. IncomeTaxes**

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

 

9

 

 

The Companyis subject to US federal income tax as well as income tax in multiple statesand foreign jurisdictions. For all major taxing jurisdictions, the tax years2002 through 2006 remain open to examination. As of September 30, 2007, theCompany does not expect any material changes to unrecognized tax positionswithin the next twelve months.

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

**NOTE 5.Inventory**

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

| ** **        | ** ** | **September  30,  2007** | ** **       | **December 31,  2006** | ** ** |
|-------------------|------------|--------------------------|------------------|-----------------------------|------------|
| ** **        | ** ** | **(unaudited)**          | ** **       | ** **                  | ** ** |
| Finished goods    |       | $                        | 22,443,726       |                        | $          | 11,428,708 |   |
| Inventory reserve |       | (808,365                 | )                | (254,508                    | )          |
| Net inventory     |       | $                        |  21,635,361 |                        | $          |  11,174,200 |   |

 

**NOTE 6.Property and Equipment**

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

| ** **                    | ** ** | **September 30,  2007** | ** ** | **December 31,  2006** | ** ** |
|-------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| ** **                    | ** ** | **(unaudited)**         | ** ** | ** **                  | ** ** |
| Machinery and equipment       |       | $                       | 689,671    |                        | $          | 774,465 |   |
| Furniture and fixtures        |       | 106,704                 |       | 166,921                     |       |
| Tooling and molds             |       | 1,254,786               |       | —                      |       |
| Subtotal                      |       | 2,051,161               |       | 941,386                     |       |
| Less accumulated depreciation |       | 382,127                 |       | 326,201                     |       |
| Total                         |       | $                       | 1,669,034  |                        | $          | 615,185 |   |

 

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

**NOTE 7. Lineof Credit**

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

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

 

10

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

 

The Company has no other notes payable.

**NOTE 8.Stockholders’ Equity**

StockOptions

Effective March 9, 2007, the Company granted optionsto purchase an aggregate of 40,000 of its common stock to certain foreigncontractors(the “Contractor Options”). One-fourth of the total options subject to theseoption grants become exercisable one year from the contractor grantee’s firstdate of duties, and 1/48th of the total options become exercisable each monththereafter until fully vested.  Theseoptions have exercise prices of $3.79 per share, which was the closing priceper share of the Company’s common stock on March 9, 2007, and expire sixyears from the date of grant. See Note 2 for Stock Based Compensationdiscussion.

**NOTE 9. RecentAccounting Pronouncements**

In February 2006 the Financial Accounting StandardsBoard issued Statement of Financial Accounting Standards (SFAS) 155 “Accountingfor Certain Hybrid Financial Instruments.”  SFAS 155 amends SFAS 133 tonarrow the scope exception for interest-only and principal-only strips on debtinstruments to include only such strips representing rights to receive aspecified portion of the contractual interest or principal cash flows. SFAS 155also amends SFAS 140 to allow qualifying special-purpose entities to hold apassive derivative financial instrument pertaining to beneficial interests thatit is a derivative financial instrument. Generally, FASB Statement of FinancialAccounting Standards SFAS No. 133, “Accounting for Derivative Instruments andHedging Activities,” requires that a derivative embedded in a host contractthat does not meet the definition of a derivative be accounted for separately(referred to as bifurcation) under certain conditions. That general rulenotwithstanding, SFAS No. 133 (prior to amendments made to it by SFAS No. 155)provides a broad exception for interest-only and principal-only stripsinitially resulting from the separation of rights to receive contractual cashflows of a financial instrument that itself does not contain an embeddedderivative that would have been accounted for separately. SFAS 155 amends SFAS133 to restrict the scope exception to strips that represent rights to receiveonly a portion of the contractual interest cash flows or of the contractualprincipal cash flows of a specific debt instrument.  Prior to amendmentsmade by SFAS 155 , SFAS 140 , “Accounting for Transfers and Servicing ofFinancial Assets and Extinguishments of Liabilities,” permitted a qualifyingspecial-purpose entity (SPE) to hold only passive derivative financialinstruments pertaining to beneficial interests (other than another derivativefinancial instrument) issued or sold to parties other than the transferor. SFAS155 amends SFAS 140 to allow a qualifying SPE to hold a derivative instrumentpertaining to beneficial interests that itself is a derivative financialinstrument. The Company does not believe that SFAS No. 155 will have a materialimpact on its financial position, results of operations or cash flows. As aresult, we do not believe the adoption of SFAS 155 has a material impact on theCompany’s Consolidated Financial Statements.

In March 2006, theFASB issued SFAS No. 156, “Accounting for Servicing of Financial Assets” (“SFASNO. 156”), which provides an approach to simplify efforts to obtain hedge-like(offset) accounting.  This Statement amends FASB Statement No. 140, “Accountingfor Transfers and Servicing of Financial Assets and Extinguishments ofLiabilities”, with respect to the accounting for separately recognizedservicing assets and servicing liabilities.  The Statement (1) requires anentity to recognize a servicing asset or servicing liability each time itundertakes an obligation to service a financial asset by entering into aservicing contract in certain situations; (2) requires that a separatelyrecognized servicing asset or servicing liability be initially measured at fairvalue, if practicable;  (3) permits an entity to choose either theamortization method or the fair value method for subsequent measurement foreach class of separately recognized servicing assets or servicing liabilities;(4) permits at initial adoption a one-time reclassification ofavailable-for-sale securities to trading securities by an entity withrecognized servicing rights, provided the securities reclassified offset theentity’s exposure to changes in the fair value of the servicing assets orliabilities; and (5) requires separate presentation of servicing assets andservicing liabilities subsequently measured at fair value in the balance sheetand additional disclosures for all separately recognized servicing assets andservicing liabilities.  SFAS No. 156 is effective for all separatelyrecognized servicing assets and liabilities as of the beginning of an entity’sfiscal year that begins after September 15, 2006, with earlier adoptionpermitted in certain circumstances.  The Statement also describes themanner in which it should be initially applied.  The Company does notbelieve that SFAS No. 156 will have a material impact on its financialposition, results of operations or cash flows.  As a result, we do notbelieve the adoption of SFAS 156 has a material impact on the Company’sConsolidated Financial Statements.

 

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

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

In September 2006, the Financial Accounting StandardsBoard (FASB) issued Statement of Financial Accounting Standards No. 158, “Employers’Accounting for Defined Benefit Pension and Other Postretirement Plans” (“SFAS158”), which improves financial reporting by requiring an employer to recognizethe over or under funded status of a defined benefit postretirement plan as anasset or liability in its statement of financial position and to recognizechanges in that funded status in the year in which the changes occur throughcomprehensive income of a business entity or changes in unrestricted net assetsof a not-for-profit organization.  This statement also improves financialreporting by requiring an employer to measure the funded status of a plan as ofthe date of its year end statement of financial position, with limitedexceptions.  This Statement amends Statement 87, FASB Statement No. 88, “Employers’Accounting for Settlements and Curtailments of Defined Benefit Pension Plansand for Termination Benefits”, Statement 106, and FASB Statement No. 132(revised 2003), “Employers’ Disclosures about Pensions and Other PostretirementBenefits”.  Upon the initial application of this statement andsubsequently, and employer should continue to apply the provisions inStatements, 87, 88, and 106 in measuring plan assets and benefit obligations asof the date of its statement of financial position and in determining theamount of net periodic benefit cost.  An employer with publicly tradedequity securities is required to initially recognize the funded status of adefined benefit postretirement plan and to provide the required disclosures asof the end of the fiscal year ending after December 31, 2006.  An employerwithout publicly traded equity securities is required to recognize the fundedstatus of a defined benefit postretirement plan and to provide the requireddisclosures as of the end of the fiscal year ending after June 15, 2007. Early application of the recognition or measurement date provisions isencouraged; however, early application must be for all of an employer’s benefitplans.  Retrospective application of the Statement is not permitted. If elected,the implementation of FAS 158 is not expected to have a material impact on theCompany’s consolidated financial statements.

In September 2006, the United States Securities andExchange Commission (SEC) issued Staff Accounting Bulletin (SAB) No. 108, “Consideringthe Effects of Prior Year Misstatements when Quantifying Misstatements inCurrent Year Financial Statements.” This SAB No. 108 provides guidance on theconsideration of the effects of prior year misstatements in quantifying currentyear misstatements for the purpose of a materiality assessment. SAB No. 108establishes an approach that requires quantification of financial statementerrors based on the effects of each of the Company’s balance sheet andstatement of operations financial statements and the related financialstatement disclosures. The SAB No. 108 permits existing public companies torecord the cumulative effect of initially applying this approach in the firstyear ending after November 15, 2006 by recording the necessary correcting adjustmentsto the carrying values of assets and liabilities as of the beginning of thatyear with the offsetting adjustment recorded to the opening balance of retainedearnings. Additionally, the use of the cumulative effect transition methodrequires detailed disclosure of the nature and amount of each individual errorbeing corrected through the cumulative adjustment and how and when itarose.  The adoption of SAB 108 did nothave a material impact on the Company’s results of operations and financial position.

InOctober 2006, the Emerging Issues Task Force (EITF) issued EITF 06-3,How Taxes Collected from Customers and Remitted to Governmental AuthoritiesShould Be Presented in the Income Statement (That is, Gross versus NetPresentation) to clarify diversity in practice on the presentation of differenttypes of taxes in the financial statements. The Task Force concluded that, fortaxes within the scope of the issue, a company may adopt a policy of presentingtaxes either gross within revenue or net. That is, it may include charges tocustomers for taxes within revenues and the charge for the taxes from thetaxing authority within cost of sales, or, alternatively, it may net the chargeto the customer and the charge from the taxing authority. If taxes subject toEITF 06-3 are significant, a company is required to disclose its accountingpolicy for presenting taxes and the amounts of such taxes that are recognizedon a gross basis. The guidance in this consensus is effective for the firstinterim reporting period beginning after December 15, 2006 (the firstquarter of our fiscal year 2007). The adoption of EITF 06-3 did not have amaterial impact on the Company’s results of operations, financial position orcash flow.

 

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In February 2007, the FASB issued Statement No. 159, “*The Fair Value Optionfor Financial Assets and Financial Liabilities — Including an amendment of FASBStatement No. 115* “ (“SFAS 159”).  This standard amends FASBStatement No. 115, “*Accountingfor Certain Investment in Debt and Equity Securities*,” with respectto accounting for a transfer to the trading category for all entities withavailable-for-sale and trading securities electing the fair value option. This standard allows companies to elect fair value accounting for manyfinancial instruments and other items that currently are not required to beaccounted as such, allows different applications for electing the option for asingle item or groups of items, and requires disclosures to facilitatecomparisons of similar assets and liabilities that are accounted fordifferently in relation to the fair value option.  SFAS 159 is effectivefor fiscal years beginning after November 15, 2007. If elected, theimplementation of FAS 159 is not expected to have a material impact on theCompany’s consolidated financial statements.

**NOTE 10. Geographic Information**

The Company currently operates in one businesssegment.  All fixed assets are located inCompany facilities in the United States, Korea and Mexico. See Note 6 foradditional information.  Net sales bygeographical area for the three and nine months ended September 30, 2007 and2006 were:
| ** **      | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|-----------------|------------|-------------------------------------------------|------------|------------------------------------------------|------------|
| ** **      | ** ** | **2007**                                        | ** ** | **2006**                                       | ** ** | **2007** | ** ** | **2006** | ** ** |
| United States   |       | $                                               | 5,704,266  |                                           | $          | 2,085,463 |   | $ | 23,298,520 |   | $ | 7,047,776 |   |
| Central America |       | 22,589,373                                      |       | 16,381,009                                     |       | 53,773,614 |   | 59,741,273 |   |
| South America   |       | 41,066,777                                      |       | 49,102,375                                     |       | 108,952,592 |   | 113,186,445 |   |
| Total           |       | $                                               | 69,360,415 |                                           | $          | 67,568,847 |   | $ | 186,024,726 |   | $ | 179,975,494 |   |

 

**NOTE 11.  Commitments and Contingencies**

*SecuritiesClass Actions*

In the securities class action, captioned *In Re: InfoSonicsCorporation Securities Litigation*, Lead Case No. 06 CV 1231, nowpending before Judge Sammartino in the United States District Court for theSouthern District of California, plaintiffs filed a second amended consolidatedcomplaint on September 10, 2007 against the Company and certain of its officersand directors.  The second amendedconsolidated complaint alleges violations of Section 10(b) of the Exchange Actand associated Rule 10b-5, Section 20(a) and Section 20A in connection with theannouncement of the Company’s restatement of first quarter 2006 earnings and inconnection with allegedly false and/or misleading statements related to theCompany’s distribution of the VK Mobile phone. Plaintiffs seek a declaration that their action is a proper class actionpursuant to Rule 23(a) and (b)(3), unspecified damages, prejudgment andpost-judgment interest, attorneys’ fees, expert witness fees, other costs, andother unspecified relief.  The plaintiffspurport to represent a class of purchasers of the Company’s stock during theperiod February 6, 2006 to August 9, 2006.

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

An early neutral evaluation conference beforeMagistrate Judge William McCurine has been set for November 16, 2007.  At this time, discovery has not begun and notrial date has been set by the Court.

*DerivativeAction*

In the derivativeaction, captioned *InRe InfoSonics Corporation Derivative Litigation*, Lead Case No. 06 CV1336, now pending before Judge Sammartino in the United States District Courtfor the Southern District of California, plaintiffs filed a consolidatedcomplaint on November 6, 2006 purportedly on behalf of the Company againstcertain of its officers and directors, and the Company as a nominal defendant.  The consolidated complaint alleges claims forviolations of Section 14(a) of the Exchange Act, Sections 25402 and 25403 ofthe California Corporations Code, disgorgement under the Sarbanes-Oxley Act of2002, breach of fiduciary duty, abuse of control, gross mismanagement, waste ofcorporate assets, unjust enrichment, rescission, a constructive trust, and anaccounting, in connection with the Company’s restatement of first quarter 2006earnings and in connection with allegations of wrongdoing with respect togranting, exercising, accounting and reporting of the stock options that theCompany granted in December 2005. Plaintiffs seek unspecified damages, declaratory relief regarding theSarbanes-Oxley Act of 2002, Section 14(a) of the Exchange Act, and the legalityof stock options, a constructive trust, restitution, disgorgement, modificationof certain corporate governance and internal procedures, extraordinaryequitable and/or injunctive relief, costs, and such other relief as is just andproper.

 

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Defendants filed a motion to dismiss the consolidatedcomplaint on the grounds, among others, that the plaintiffs had failed to makea demand on the Company’s board of directors and to adequately allege their otherpurported claims.  On September 4, 2007,the Court granted defendants motion to dismiss for failure to make a demand onthe board, and also granted with prejudice the motion to dismiss theSarbanes-Oxley claim.  The Court deniedthe other grounds for dismissal.  OnOctober 2, 2007, the parties jointly moved to continue the deadline forplaintiffs to file their amended complaint until after the November 16, 2007Early Neutral Evaluation Conference.  Atthis time, discovery on the merits has not begun and no trial date has been setby the Court.

We maybecome involved in certain other legal proceedings and claims which arise inthe normal course of business. Other than as described above, as of September30, 2007, we did not have any significant litigation outstanding.

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

**Forward-LookingStatements and Other General Information**

Thisdiscussion and analysis of financial condition and results of operations shouldbe read in conjunction with the accompanying unaudited consolidated financialstatements and condensed notes thereto included in this report and with ourAnnual Report on Form 10-K for the year ended December 31, 2006 (including our2006 audited consolidated financial statements and related notes thereto).InfoSonics Corporation’s (“InfoSonics” or the “Company”) discussion andanalysis of financial condition and results of operations are based upon ourconsolidated financial statements, which have been prepared in accordance withaccounting principles generally accepted in the United States (“GAAP”). Thepreparation of financial statements in conformity with GAAP requires us to makeestimates and assumptions that affect the reported amounts of assets andliabilities, disclosure of any contingent liabilities as of and at thefinancial statement date, and reported amounts of revenue and expenses duringthe reporting period. On an ongoing basis we review our estimates andassumptions. Our estimates are based on our historical experience and otherassumptions that we believe to be reasonable under the circumstances. Actualresults are likely to differ from these estimates under different assumptionsor conditions, but we do not believe such differences will materially affectour consolidated statement of operations, although they may. 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.”  All references to results ofoperations in this discussion are to results from continuing operations, unlessotherwise noted.

**Safe HarborStatement**

The matters inthis report that are forward-looking statements, including, without limitation,statements about future revenues, sales levels, operating income and margins,wireless handset sales, stock-based compensation expense, gain (loss) in valueof derivatives, cost synergies, operating efficiencies, profitability, marketshare, and rates of return, are based on current management expectations thatinvolve certain risks and uncertainties these risks and uncertainties, in wholeor in part, could cause such expectations to fail to be achieved and have amaterial adverse effect on InfoSonics’ business, financial condition andresults of operations, including, without limitation: (1) intense competition,regionally and internationally, including competition from alternative businessmodels, such as manufacturer-to-carrier sales, which may lead to reducedprices, lower sales or reduced sales growth, lower gross margins, extendedpayment terms with customers, increased capital investment and interest costs,bad debt risks and product supply shortages; (2) inability to secure adequatesupply of competitive products on a timely basis and on commercially reasonableterms; (3) foreign exchange rate fluctuations, devaluation of a foreigncurrency, adverse governmental controls or actions, political or economic instability,or disruption of a foreign market, and other related risks of our internationaloperations; (4) the ability to attract new sources of profitable business fromexpansion of products or services or risks associated with entry into newmarkets, including geographies, products and services; (5) an interruption orfailure of our information systems or subversion of access or other systemcontrols may result in a significant loss of business, assets, or competitiveinformation; (6) significant changes in supplier terms and relationships; (7)termination of a supply or services agreement with a major supplier or productsupply shortages; (8) continued consolidation in the wireless handset carriermarket; (9) extended general economic downturn; (10) loss of business from oneor more significant customers; (11) customer and geographical accountsreceivable concentration risk; (12) rapid product improvement and technologicalchange resulting in inventory obsolescence; (13) future terrorist or militaryactions; (14) the loss of a key executive officer or other key employees; (15)changes in consumer demand for multimedia wireless handset products andfeatures; (16) our failure to adequately adapt to industry changes and tomanage potential growth and/or contractions; (17) future periodic assessmentsrequired by current or new accounting standards such as those relating tolong-lived assets, goodwill and other intangible assets and expensing of stockoptions and valuing gain or loss on fair value of derivatives may result inadditional non-cash income or expenses; (18) seasonal buying patterns; (19)dependency on Latin American sales; (20) uncertain political and economicconditions internationally; (21) the impact, if any, of changes in EITF 00-19or SFAS 133 guidance as it relates to warrants and registration rights; and(22) the resolution of any litigation against the Company. Our actual resultscould differ materially from those anticipated in our forward lookingstatements.

 

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InfoSonics has instituted in the past and continues toinstitute changes to our strategies, operations and processes to address risksand uncertainties and to mitigate impact on InfoSonics’ results of operationsand financial condition. However, no assurances can be given that InfoSonicswill be successful in these efforts. For a further discussion of significantfactors to consider concerning InfoSonics, see “Item 1A. Risk Factors” ofInfoSonics’ Annual Report on Form 10-K for the year ended December 31, 2006 and“Part II. Item 1A. Risk Factors” of this quarterly report and thequarterly reports on Form 10-Q for the periods ended March 31, 2007 and June30, 2007. In addition, other risks or uncertainties may be detailed from timeto time in InfoSonics’ future SEC filings.

**Overview**

We are one of the premier distributors and providersof wireless handsets and accessories in Latin America and theUnited States. We provide end-to-end handset and wireless terminalsolutions for carriers in both Latin America and the United States. Wedistribute products of several key original equipment manufacturers (OEM),including Samsung, LG, Novatel and others. We are also involved in the designing, sourcing and distributing of aproprietary line of products under our own *verykoolTM* brand, which includesentry level, mid-tier and high-end products.

As an integral part of our customers’ supply chain, weperform value added services and solutions, including product approval andcertification, light assembly, warehousing, logistics services (packing,shipping and delivery), marketing campaigns, warranty services and end-usersupport. We provide these services for OEM wireless handset manufacturers andfor our own verykool products in order to facilitate sales to carriers, agents,resellers, distributors, independent dealers and retailers in Latin America andthe United States.

During 2006, we introduced a proprietary line ofhandsets and accessories under the*verykoolTM* brand, for which we are involved in severalaspects including, the design, feature sets, contracting with various designand contract manufacturers in Asia to develop exclusive or semi-exclusiveproducts for us. In addition we perform value added services and solutions,including product approval and certification, light assembly, warehousing,logistics services (packing, shipping and delivery), marketing campaigns,warranty services and end-user support.

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

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

**Areas ofManagement Focus and Performance Indicators**

We focus on theneeds of our customers, developing and maintaining close relationships withmanufacturers, expanding in and entering new markets, and sourcing anddeveloping new and innovative products, while maintaining close attention tooperational efficiencies and costs. We intend to increase shipping volumes andimprove efficiencies to enable higher levels of profitability and earningsgrowth.  We provide distribution andother services for original equipment manufacturers, such as Samsung and LG andour own proprietary line of *verykoolTM* handsets. Performance indicators that are key for the monitoring and management ofour business include operating and net income, cost of sales and gross marginpercentage, operating expenses as a percent of revenues, and overall net salesgrowth as well as balances of accounts receivable and inventory. We makeextensive use of our customized information system to closely monitor allaspects of our business, including customer relationship management,intelligent purchasing, inventory control, inventory flow, line item margincontrol for every order, and weighted average cost and statistical data forevery product, customer and supplier. We believe a strong focus on providingbetter service to customers leads to increased customer satisfaction and retentionand potential increases in sales.

 

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Management spends a significant amount of timetraveling with the purpose of spending time with key customers, suppliers andemployees. We believe that these relationships are vital to our success, and wewill continue to dedicate a significant amount of time to this area.

**IndustryTrends and Risks**

According to an October 2007 report by Cowen andCompany, overall worldwide wireless handset sales increased in 2006 byapproximately 21%, and are forecasted to increase 13% in 2007 and 14% in 2008.The bulk of this growth, we believe, came from developing markets in which wedo not currently operate, such as India and China. A rapid decline in wirelesshandset sales growth could negatively impact our net sales. Excess supplyconditions, such as those experienced in Central America during the quarterended March 31, 2007, can reduce the market prices of the products we sell andtherefore affect our ability to generate net sales and gross profit athistorical levels and could affect the value of our inventory. Conversely,should manufacturers be unable to respond to an unanticipated increase indemand on a timely basis, we, along with others in our industry, could experiencesupply constraints that would affect our ability to deliver products. We areunable to quantify these effects, as it is difficult to predict future supplyconditions and demand patterns which affect our ability to meet customer demandor sell handsets at an acceptable gross profit.

**CompanySpecific Trends and Risks**

Our strategy incorporates overall market growthelements for each aspect of our business, which we hope will result incontinued growth.  During the first halfof 2007, we increased our inventory levels in anticipation of and preparationfor potential future sales. Although we have incorporated growth into ourstrategy, there can be no assurances that this trend of increased sales willcontinue.  Our *verykool*proprietaryline of products, for which we have introduced 5 models during the year, haveshown a quarterly increase in sales, and could be an important part of ouroverall business in the future.

During the quarter ended September 30, 2007, weexperienced a 26% sequential dollar increase in net sales in South America, to$41.1 million, accounting for 59% of our total net sales, as compared to $32.5million or 56% for the quarter ended June 30, 2007.  This increase is consistent with the seasonaldemand we have experienced in South America in prior third quarters.  Our Central America region continued to showstrong sales, sequentially increasing 11% to $22.6 million,****accountingfor 33% of our net sales in the quarter ended September 30, 2007, compared to$20.3 million, accounting for 35% of our net sales in the quarter ended June30, 2007.  The addition of the *verykool* and LG products during the year has assisted withmanufacturer diversification for Central and South America.  In the United States, we experienced asequential increase in net sales to $5.7 million, accounting for 8% of ourtotal net sales, as compared to $5.4 million or 9% for the quarter ended June30, 2007.  We believe our United Statescustomer base is in a transitional stage as regional carriers, including someof InfoSonics’ customers have entered into agreements to be acquired byAT&T Inc., T-Mobile USA and Verizon Wireless.  We are currently evaluating the potentialimpact of these announced acquisitions and our opportunities in the UnitedStates.

**Results of Operations**

***Three Months EndedSeptember 30, 2007 and 2006***

**Net Sales**

For the threemonths ended September 30, 2007, our net sales of $69.4 million are comparableto our sales of $67.6 million for the same period of 2006.  Handsets sold in the third quarter 2007increased 28% as compared to the third quarter of 2006; however, this increasewas offset by a decrease in the average selling price of 24%. The geographicmix of net sales shifted in the third quarter of 2007 as sales in the UnitedStates increased to 8% of net sales, as compared to 3% of net sales for thethird quarter of 2006.  Sales in CentralAmerica represented 33% of our total quarterly net sales in the quarter endedSeptember 30, 2007 as compared to 24% in the quarter ended September 30,2006.  Our South America region continuedto represent the majority of our business, accounting for 59% of our net salesin the third quarter of 2007 as compared to 73% of our net sales for the thirdquarter of 2006.  This regional shift innet sales was the result of increases in Central America and the United Statesregions, as well as a decrease in South America regional sales as compared tothe third quarter of 2006.  On asequential basis however we experienced increases of 25%, 13% and 7% for SouthAmerica, Central America and the Untied States, respectively.   

 

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

 

| ** **                                 | ** ** | **Three Months ended  September 30,**                                                              | ** ** | **Increase** | ** ** |
|--------------------------------------------|------------|---------------------------------------------------------------------------------------------------------|------------|--------------|------------|
| ** **                                 | ** ** | **2007**                                                                                                | ** ** | **2006**     | ** ** | **(Decrease)** | ** ** |
| ** **                                 | ** ** | **(Dollar amounts in thousands,  except per share amounts)  (unaudited)** | ** ** | ** **   | ** ** |
| Net sales                                  |       | $                                                                                                       | 69,360     |         | $          | 67,569 |   | 3 | % |
| Gross profit                               |       | 2,655                                                                                                   |       | 5,415        |       | (51 | )% |
| Net income                                 |       | 373                                                                                                     |       | 677          |       | (45 | )% |
|                                       |       |                                                                                                    |       |         |       |   |   |
| Diluted earnings per share from net income |       | $                                                                                                       | 0.02       |         | $          | 0.04 |   | (50 | )% |

 

**Net Sales by Geographic Region**

| ** **      | ** ** | **Three Months ended  September 30,**                    | ** ** | **Increase** | ** ** |
|-----------------|------------|---------------------------------------------------------------|------------|--------------|------------|
| ** **      | ** ** | **2007**                                                      | ** ** | **2006**     | ** ** | **(Decrease)** | ** ** |
| ** **      | ** ** | **(Dollar amounts in thousands)  (unaudited)** | ** ** | ** **   | ** ** |
| United States   |       | $                                                             | 5,704      |         | $          | 2,086 |   | 173 | % |
| Central America |       | 22,589                                                        |       | 16,381       |       | 38 | % |
| South America   |       | 41,067                                                        |       | 49,102       |       | (16 | )% |
| Total           |       | $                                                             | 69,360     |         | $          | 67,569 |   | 3 | % |

 

**Cost of Sales, Gross Profit and Gross Margin**

For the quarter ended September 30, 2007, cost ofsales was $66.7 million, or 96.2% of net sales, compared with $62.2 million, or92.0% of net sales, for the quarter ended September 30, 2006. The increase inour total cost of sales was primarily the result of an aggressive move todecrease our US inventory as a response to the pending acquisitions of some ofour US customers, as well as product mix during the third quarter of 2007, asthe mix was more weighted towards lower margin products.  Our OEM manufacturing partners continued inthe low-tier handset range which had less margin opportunity than mid-tier andhigh-end handsets. The aggressive move to decrease our US inventory resulted ina one-time incremental cost of goods sold of $1.3 million. Without this plannedinventory reduction, gross margin for the quarter ended September 30, 2007 wouldhave been 6.1%, as compared to 8.0% for the quarter ended September 30, 2006and would have been a sequential increase from the 5.5% gross margin for thequarter ended June 30, 2007.  Our grossmargin continues to be impacted by the change of product and regional mix ofour sales, as different products and different regions have varying margins.

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

| ** **    | ** ** | **Three Months Ended  September 30,**                    | ** ** | **Increase** | ** ** |
|---------------|------------|---------------------------------------------------------------|------------|--------------|------------|
| ** **    | ** ** | **2007**                                                      | ** ** | **2006**     | ** ** | **(Decrease)** | ** ** |
| ** **    | ** ** | **(Dollar amounts in thousands)  (unaudited)** | ** ** | ** **   | ** ** |
| Net sales     |       | $                                                             | 69,360     |         | $          | 67,569 |   | 3 | % |
| Cost of sales |       | $                                                             | 66,706     |         | $          | 62,154 |   | 7 | % |
| Gross profit  |       | $                                                             | 2,655      |         | $          | 5,415 |   | (51 | )% |
| Gross margin  |       | 3.8                                                           | %          | 8.0          | %          | (53 | )% |

 

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**Operating Expenses and Operating Income (Loss)from Continuing Operations**

For the quarter ended September 30, 2007, operatingexpenses decreased 12%, compared with the same quarter last year. As apercentage of net sales, operating expenses were 5.6% in the quarter endedSeptember 30, 2007, compared with 6.6% in the same quarter last year.  During the quarter ended September 30, 2007,we incurred $40,000 or 0.1% of net sales, of non-cash expense relating to stock options,compared to $133,000, or 0.2% of net sales, for the quarter ended September 30,2006.  The decrease, excluding non-cashexpense, was primarily the result of decreased sales in South America whichreduced the amount of profit sharing expense during the quarter ended September30, 2007.  As well, we continued ourinvestments in facilities, marketing, engineering and product and marketdevelopment, predominantly attributable to our proprietary *verykoolTM*product line.  We believe suchinvestments are necessary to help build a solid foundation for our businessincluding our *verykoolTM*products for potentialfuture growth.

For the quarter ended September 30, 2007, ouroperating loss from continuing operations was $1.2 million, including theone-time $1.3 million cost relating to the incremental cost of goods sold to sellcertain US inventory, compared with operating income from continuingoperations of $975,000 for the quarter ended September 30, 2006, a decrease of227%. As a percentage of net sales, operating loss from continuing operationswas 1.8% for the quarter ended September 30, 2007, compared to income of 1.4%for the quarter ended September 30, 2006. The decrease in operating income fromcontinuing operations was a result of the increase in cost of goods solddiscussed above.

**Operating Expenses**

| ** **              | ** ** | **Three Months Ended  September 30,**                    | ** ** | **Increase** | ** ** |
|-------------------------|------------|---------------------------------------------------------------|------------|--------------|------------|
| ** **              | ** ** | **2007**                                                      | ** ** | **2006**     | ** ** | **(Decrease)** | ** ** |
| ** **              | ** ** | **(Dollar amounts in thousands)  (unaudited)** | ** ** | ** **   | ** ** |
| Net sales               |       | $                                                             | 69,360     |         | $          | 67,569 |   | 3 | % |
| Operating expenses      |       | $                                                             | 3,890      |         | $          | 4,440 |   | (12 | )% |
| Percentage of net sales |       | 5.6                                                           | %          | 6.6          | %          | (15 | )% |

 

**Operating Income (Loss) from ContinuingOperations**

| ** **                                         | ** ** | **Three Months Ended  September 30,**                    | ** ** | **Increase** | ** ** |
|----------------------------------------------------|------------|---------------------------------------------------------------|------------|--------------|------------|
| ** **                                         | ** ** | **2007**                                                      | ** ** | **2006**     | ** ** | **(Decrease)** | ** ** |
| ** **                                         | ** ** | **(Dollar amounts in thousands)  (unaudited)** | ** ** | ** **   | ** ** |
| Net sales                                          |       | $                                                             | 69,360     |         | $          | 67,569 |   | 3 | % |
| Operating income (loss) from continuing operations |       | $                                                             | (1,235     | )            | $          | 975 |   | (227 | )% |
| Percentage of net sales                            |       | (1.8                                                          | )%         | 1.4          | %          | (229 | )% |

 

 

**OtherIncome (Expense)**

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

**Other Income**

|                          |   | **Three Months Ended  September 30,**                    |   | **Increase** |   |
|-------------------------------|--------|---------------------------------------------------------------|--------|--------------|--------|
|                          |   | **2007**                                                      |   | **2006**     |   | **(Decrease)** |   |
|                          |   | **(Dollar amounts in thousands)  (unaudited)** |   |         |   |
| Income from lease termination |   | $                                                             | 2,095  |         | $      | — |   | 100 | % |
| Interest income (expense)     |   | (352                                                          | )      | 47           |   | (849 | )% |
| Total                         |   | $                                                             | 1,743  |         | $      | 47 |   | 3,608 | % |

 

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**Net Income (Loss)**

During the quarter ended September 30,2007, our net income was $373,000, compared to net income of $677,000 in thesame period last year.  This decrease innet income was primarily related to the factors discussed above, including ourincreased cost of goods sold related to the move to sell our US inventory aswell as reduced gross margin opportunities on low-tier products and increasedoperational expenses and investments relating primarily to our proprietary lineof *verykoolTM* products. These costs wereoffset by a benefit from the compensation received for our agreement to anearly termination and relocation of our corporate headquarters. 

***Nine Months Ended September 30, 2007 and 2006***

**Net Sales**

For the ninemonths ended September 30, 2007, our net sales of $186.0 million werecomparable to our net sales of $180.0 million for the nine months endedSeptember 30, 2006.  Handsets sold duringthe nine months ended September 30, 2007 increased 19% as compared to the sameperiod in 2006; however, this increase was offset by a decrease in the averageselling price of 24%. The geographic mix of net sales shifted for the ninemonths ended September 30, 2007, as compared to the same period of 2006.  Sales in the United States increased to 12%of net sales for the first nine months in 2007, as compared to 4% of net salesfor the same period in 2006.  Incontrast, our net sales in Central America decreased to 29% of our net salesfor the first nine months of 2007, as compared to 33% of net sales for the sameperiod 2006.  Our South America regioncontinued to represent the majority of our business, accounting for 59% of ournet sales for 2007, as compared to 63% for 2006.  This regional shift in net sales was theresult of two primary factors.  Productavailability in the United States increased during the first quarter of 2007,enabling us to sell more products to our customers.  However, in contrast, the Central Americaregion had excess inventory in the channel during the first quarter of 2007,reducing sales and gross margin opportunity. The channel inventory began to return to normalized levels during thesecond quarter of 2007, and during the third quarter of 2007 Central Americaachieved the highest quarterly sales level of 2007.  In South America, our efforts enabled salesto new customers and additional sales to existing customers.  This region continues to experience a generalincrease in handset sales, and we have opened accounts in new South Americancountries.  For the nine months endedSeptember 30, 2007, we incurred a net loss of $0.6 million, or $0.04 perdiluted share, as compared to net income of $2.0 million, or $0.13 per dilutedshare, in the nine months ended September 30, 2006.

| ** **                                               | ** ** | **Nine Months ended  September 30,**                                                          | ** ** | **Increase** | ** ** |
|----------------------------------------------------------|------------|---------------------------------------------------------------------------------------------------------|------------|--------------|------------|
| ** **                                               | ** ** | **2007**                                                                                                | ** ** | **2006**     | ** ** | **(Decrease)** | ** ** |
| ** **                                               | ** ** | **(Dollar amounts in thousands,  except per share amounts)  (unaudited)** | ** ** | ** **   | ** ** |
| Net sales                                                |       | $                                                                                                       | 186,025    |         | $          | 179,975 |   | 3 | % |
| Gross profit                                             |       | 9,000                                                                                                   |       | 13,926       |       | (35 | )% |
| Net income (loss)                                        |       | (632                                                                                                    | )          | 1,978        |       | (132 | )% |
|                                                     |       |                                                                                                    |       |         |       |   |   |
| Diluted earnings (loss) per share from net income (loss) |       | $                                                                                                       | (0.04      | )            | $          | 0.13 |   | (131 | )% |

 

**Net Sales by Geographic Region**

| ** **      | ** ** | **Nine Months ended  September 30,**                | ** ** | **Increase** | ** ** |
|-----------------|------------|---------------------------------------------------------------|------------|--------------|------------|
| ** **      | ** ** | **2007**                                                      | ** ** | **2006**     | ** ** | **(Decrease)** | ** ** |
| ** **      | ** ** | **(Dollar amounts in thousands)  (unaudited)** | ** ** | ** **   | ** ** |
| United States   |       | $                                                             | 23,004     |         | $          | 7,048 |   | 226 | % |
| Central America |       | 53,393                                                        |       | 59,741       |       | (11 | )% |
| South America   |       | 109,628                                                       |       | 113,186      |       | (3 | )% |
| Total           |       | $                                                             | 186,025    |         | $          | 179,975 |   | 3 | % |

 

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** **

** **

** **

**Cost ofSales, Gross Profit and Gross Margin**

 

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

 

For the nine months ended September 30, 2007, ourgross profit decreased to $9.0 million from $13.9 million, compared with thesame period last year, a decrease of 35%. The decrease in gross profit wasprimarily the result of increased sales of low-tier products having lowermargins, high channel inventory levels in Central America during the firstquarter of 2007, and the increase of cost of goods sold related to the sales ofcertain US products. These factors impacted gross margin potential in additionto decreasing the opportunity for sales of higher margin products.

| ** **    | ** ** | **Nine Months Ended  September 30,**                | ** ** | **Increase** | ** ** |
|---------------|------------|---------------------------------------------------------------|------------|--------------|------------|
| ** **    | ** ** | **2007**                                                      | ** ** | **2006**     | ** ** | **(Decrease)** | ** ** |
| ** **    | ** ** | **(Dollar amounts in thousands)  (unaudited)** | ** ** | ** **   | ** ** |
| Net sales     |       | $                                                             | 186,025    |         | $          | 179,975 |   | 3 | % |
| Cost of sales |       | $                                                             | 177,024    |         | $          | 166,049 |   | 7 | % |
| Gross margin  |       | 4.8                                                           | %          | 7.7          | %          | (38 | )% |
| Gross profit  |       | $                                                             | 9,000      |         | $          | 13,926 |   | (35 | )% |

** **

**OperatingExpenses and Operating Income (Loss) from Continuing Operations**

 

For the nine months ended September 30, 2007,operating expenses increased 1.3%, compared to the nine months ended September30, 2006. As a percentage of net sales, operating expenses were 6.3% for thenine months ended September 30, 2007, as compared to 6.4% for the nine monthsended September 30, 2006.  During thenine months ended September 30, 2007, we incurred expenses related primarily toour investments in facilities, marketing, engineering and product and marketdevelopment, predominantly attributable to our proprietary *verykoolTM*product line.  We believe suchinvestments are necessary to help build a solid foundation for our businessincluding the *verykoolTM*products for potentialfuture growth.

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

 

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**Operating Expenses**

| ** **              | ** ** | **Nine Months Ended  September 30,**                | ** ** | **Increase** | ** ** |
|-------------------------|------------|---------------------------------------------------------------|------------|--------------|------------|
| ** **              | ** ** | **2007**                                                      | ** ** | **2006**     | ** ** | **(Decrease)** | ** ** |
| ** **              | ** ** | **(Dollar amounts in thousands)  (unaudited)** | ** ** | ** **   | ** ** |
| Net sales               |       | $                                                             | 186,025    |         | $          | 179,975 |   | 3 | % |
| Operating expenses      |       | $                                                             | 11,704     |         | $          | 11,556 |   | 1 | % |
| Percentage of net sales |       | 6.3                                                           | %          | 6.4          | %          | (2 | )% |

 

**Operating Income (Loss) from ContinuingOperations**

| ** **                                         | ** ** | **Nine Months Ended  September 30,**                | ** ** | **Increase** | ** ** |
|----------------------------------------------------|------------|---------------------------------------------------------------|------------|--------------|------------|
| ** **                                         | ** ** | **2007**                                                      | ** ** | **2006**     | ** ** | **(Decrease)** | ** ** |
| ** **                                         | ** ** | **(Dollar amounts in thousands)  (unaudited)** | ** ** | ** **   | ** ** |
| Net sales                                          |       | $                                                             | 186,025    |         | $          | 179,975 |   | 4 | % |
| Operating income (loss) from continuing operations |       | $                                                             | (2,704     | )            | $          | 2,370 |   | (214 | )% |
| Percentage of net sales                            |       | (1.5                                                          | )%         | 1.3          | %          | (215 | )% |

 

**OtherIncome (Expense)**

During the nine months ended September30, 2007, we incurred $623,000 of interest expense, compared to interestexpense of $152,000 for the same period last year.  This increase was due primarily to theincrease levels of inventory and accounts receivable during the nine monthsended September 30, 2007.  We expect toregularly utilize larger amounts on our revolving line of credit, which will increaseour interest expense in future periods. During the nine months ended September 30, 2007 we had income of $2.1million from a voluntary early lease termination and relocation of ourcorporate headquarters in San Diego. During the nine months ended September 30, 2006, we had income from anon-cash change in fair value of derivative liability relating to January 2006financing-related warrants of $399,000. This derivative liability wasclassified as equity in February 2006 in accordance with SFAS 133, when ourregistration statement registering the common stock underlying the warrants wasdeclared effective by the SEC.

| ** **                                   | ** ** | **Nine Months Ended September 30,**            | ** ** | **Increase** | ** ** |
|----------------------------------------------|------------|---------------------------------------------------------------|------------|--------------|------------|
| ** **                                   | ** ** | **2007**                                                      | ** ** | **2006**     | ** ** | **(Decrease)** | ** ** |
| ** **                                   | ** ** | **(Dollar amounts in thousands)  (unaudited)** | ** ** | ** **   | ** ** |
| Change in fair value of derivative liability |       | $                                                             | —     |         | $          | 399 |   | (100 | )% |
| Other income                                 |       | 2,095                                                         |       | —       |       | 100 | % |
| Interest expense                             |       | (623                                                          | )          | (152         | )          | 309 | % |
| Other Income total                           |       | $                                                             | 1,472      |         | $          | 247 |   | 496 | % |

 

 

**Net Income (Loss)**

During the nine monthsended September 30, 2007, our net loss was $0.6 million, compared to net incomeof $2.0 million in the same period last year. This loss was primarily related to the factors discussed above,including our decreased sales in the Central America region in the firstquarter,  in addition to our reducedgross margin and increased operational expenses and investments relating to thepotential future of our proprietary line of *verykoolTM*products.  The nine months endedSeptember 30, 2007, included a one-time increase in cost of goods sold relatedto aggressive sales of certain US inventory as well as other income related toour voluntary lease termination and relocation of our corporate headquarters inSan Diego.  The nine months endedSeptember 30, 2006 included non-cash expense related to stock options of $1.4million, as compared to $233,000 in the nine months ended September 30,2007.  In addition, the nine months endedSeptember 30, 2006 included non-cash income from a derivative liability of$399,000 as compared to no such income in 2007. This non-cash income was related to warrants issued in conjunction witha fund raising completed during the nine months ended September 30, 2006.

 

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**FinancialCondition, Liquidity and Capital Resources**

**Cash Used inOperating Activities**

At September 30, 2007, we had $10.0 million in cash. During the nine months endedSeptember 30, 2007, we continued to leverage our bank and vendor lines ofcredit to fund our growth. The net cash used by operating activities was $21.4million for the nine months ended September 30, 2007, which resulted primarilyfrom increased inventory levels and increased accounts receivable. The $11.0million increase in inventory was increased by a $0.6 million increase inprepaid inventory, which was part of a net increase of inventory during thenine months ended September 30, 2007. This increase was partially attributable to the build-up of *verykoolTM* inventory in anticipation of future quarterlysales.  Accounts receivable increased$12.7 million due to the timing of the increase in sales prior to the periodend reported.  Accounts payable atSeptember 30, 2007 increased $3.0 million compared to December 31, 2006. Inaddition, this increase****wasrelated to our ability to negotiate and utilize our vendors lines of creditduring the nine months ended September 30, 2007, which was used for increasedinventory levels generally.

**Days of SalesOutstanding**

Days of sales outstanding (theaverage number of days it takes to collect revenue after a sale is made) atSeptember 30, 2007 were 59 days, compared with 62 days at December 31,2006.  This decrease was due to our continuousefforts to keep customers to the payment terms we provide.  Normal payment terms require our customers topay on a net 30-day or net 60-day basis depending on the region. We areconstantly working with our customers to reduce our days of sales outstanding.The extension of net 60-day terms was required to remain competitive in severalof the regions we currently operate, most notably in Central and South America.In an effort to penetrate new customers and or new markets, we may offer termsbeyond our normal terms.

**Cash Used inInvesting Activities**

The net cash used in investingactivities was $1.1 million for the nine months ended September 30, 2007,compared to $319,000 for the nine months ended September 30, 2006. This use ofcash is primarily the result of our investment in tooling and molds for ourproprietary *verykoolTM* products.

**Net Cashprovided from Financing Activities**

The net cash provided fromfinancing activities for the nine months ended September 30, 2007 of $2.3million was primarily the result of borrowings on our bank line of credit andproceeds of approximately $263,000 from the exercise of employee stock options.

**WorkingCapital**

Our net working capital atSeptember 30, 2007 was $35.0 million, compared with $36.7 million at December31, 2006. This decrease was primarily due to increases in accounts payable,line of credit outstanding and inventory for the nine months ended September30, 2007, partially offset by the decrease in our cash balance and increasedborrowings from our line of credit.

**Borrowings**

** **

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

 

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Interest is payable on a monthlybasis (i) at Wells Fargo’s prime rate minus 0.25% (7.75% at September 30, 2007)or (ii) at the one-month LIBOR plus 1.50% (5.128% at September 30, 2007). Theinterest rate is floating at Wells Fargo’s prime rate or is at LIBOR plus 1.5%if the debt is a fixed amount drawn upon. The line of credit is collateralized by substantially all of our assets,and expires October 1, 2008. In addition to reporting and other non-financialcovenants, the line of credit contains certain financial covenants whichrequire us to maintain a tangible net worth of not less than $30 million plus50% of net profit after tax from January 1, 2007, a pre-tax profit of not lessthan $1 on a rolling four quarter basis, a quick ratio of not less thanone-to-one, a debt-to-net worth ratio of not greater than two-to-one, and anannual net income after taxes of at least $1. At September 30, 2007, theCompany did not meet all of these financial covenants.  The Company received a waiver from WellsFargo relating to default rights Wells Fargo may have due to the Companyfailing to meet certain of these financial covenants at September 30, 2007, aswell as default rights Wells Fargo may have if the Company fails to meetcertain of these financial covenants at December 31, 2007.  The Company cannot provide assurance that itwill or will not be able to comply with the financial covenants in the future.

We have no other notes payable.

AtSeptember 30, 2007 and December 31, 2006, the amounts drawn against the line ofcredit were $27.7 million and $25.6 million, respectively.  Credit lines have been important partsof growing our business, and market changes affecting accounts receivable coulddiminish the borrowing base of available funds. At September 30, 2007 andDecember 31, 2006, advances were at 92% and 84% of the available borrowing base,respectively.

***CriticalAccounting Policies***

We believe the following critical accounting policiesare important to the presentation of our financial condition and operatingresults, and require management’s judgments to make assumptions and estimatesabout the effects of matters that are inherently uncertain.

*RevenueRecognition and Allowance for Returns*

Revenues for wireless handset and accessory sales arerecognized when (i) shipment of the products to customers has occurred,(ii) when collection of the outstanding receivables is probable and (iii) thefinal price of the products are determined. Sales are recorded net ofdiscounts, rebates, cooperative arrangements (marketing, training andpromotional funds), returns, and allowances. Consideration is given on select sales for cooperative arrangementsrelated to market development, training and special promotions, usually agreedupon in advance. The amount given is generally in the form of a credit memo,which is applied as a reduction of the sales price and the same amount isrecorded as a current liability. Expenditures made pursuant to the agreed uponactivity reduce this liability. To the extent that we incur costs in excess ofthe established cooperative fund, we recognize the amount as a selling ormarketing expense. As part of the sales process, we may perform certain valueadded services such as programming, software loading and quality assurancetesting. These value added services are considered an ancillary component ofthe sales process and amounts attributable to these processes are included inthe unit cost to the customer. Furthermore, these value added services arerelated to services prior to the shipment of the products, and no value addedservices are provided after delivery of the products.  We recognize a reserve against the relatedreceivables estimates for product returns based on historical experience andother judgmental factors, and we evaluate these estimates on an on-going basisand to adjust our estimates each period based on actual product returnactivity. We recognize freight costs billed to customers in revenue and actualfreight costs incurred as a component of cost of revenue.

*Allowance forDoubtful Accounts*

Creditevaluations are undertaken for all major sales transactions before shipment isauthorized. Normal payment terms require payment on a net 30 or 60-day basisdepending on the customer. On an ongoing basis, we analyze the payment historyof customer accounts, including recent customer purchases. We evaluate ageditems in accounts receivable and provide reserves for doubtful accounts.Customer creditworthiness and economic conditions may change, includingincreasing the risk of collectibility and sales returns, and may requireadditional provisions, which could negatively impact our operating results.

 

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*InventoryWrite-Off and Effect on Gross Margin*

We regularly monitor inventory quantities on hand andrecord a provision for excess and obsolete inventories based primarily onhistorical usage rates and our estimated forecast of product demand for aperiod of time, generally three months. Because of obsolescence, we willgenerally provide a full reserve for the costs of our inventories in excess ofour relevant demand forecast for the applicable period. We attempt to controlour inventory levels so that we limit inventories in excess of demand for thesucceeding three months. However, because we need to place non-cancelableorders with significant lead time and because it is difficult to estimateproduct demand, we sometimes build inventories in excess of demand for theapplicable future periods. If this occurs, we provide a reserve, which may havea negative impact on our reported results of operations and financialcondition.

**Item 3. Quantitative and Qualitative Disclosuresabout Market Risk**

The primary objective of the following information isto provide forward-looking quantitative and qualitative information about ourpotential exposure to market risks. The term “market risk” for us refers to therisk of loss arising from adverse changes in interest rates and various foreigncurrencies. The disclosures are not meant to be precise indicators of expectedfuture losses, but rather indicators of reasonably possible losses. Thisforward-looking information provides indicators of how we view and manage ourongoing market risk exposures.

**InterestRate**

We are exposed to market risk from changes in interestrates on our outstanding revolving line of credit. At September 30, 2007, wehad $27.7 million outstanding, which could be affected by changes in short-terminterest rates. The interest rate for our revolving line of credit is (i) WellsFargo’s prime rate minus 0.25% (7.75% at September 30, 2007) or LIBOR plus1.50% (5.128% at September 30, 2007). For every 1% increase in Wells Fargo’sprime rate or one-month LIBOR, our interest expense increases by $277,000annually assuming $27.7 million remained outstanding for the entire year.

The above sensitivity analysis for interest-rate riskexcludes accounts receivable, accounts payable and accrued liabilities becauseof the short-term maturity of such instruments. The analysis does not considerthe effect interest-rate movement may have on other variables relating to ourbusiness, including changes in sales volumes that could be indirectlyattributed to changes in interest rates. The actions that we would take inresponse to such a change are also not considered. If it were possible toquantify this impact, the results could differ from the sensitivity effectsshown above.

**MarketRisk**

Substantial portions of our revenue and expenses aretransacted in markets outside the United States; however, all salestransactions and accounts receivable are denominated in U.S. dollars. As aresult of our international sales, our future operating results could beadversely affected by a variety of factors, including changes in specificcountries’ political, economic or regulatory conditions, and trade protectionmeasures.  Our market risk managementincludes an accounts receivable insurance policy for both our domestic andforeign sales.  However, there can be noassurance that our insurance policy will substantially offset the impact offluctuations in currency exchange rates, political, economic or regulatoryconditions on its results of operations and financial position. Foreigncurrency fluctuations did not have a material impact on our financial resultsduring the three months or nine months ended September 30, 2007.  Pleasesee Consolidated Statement of Comprehensive Operations

**Item 4. Controls and Procedures**

**Disclosure Controls**

Pursuantto Rule 13a-15(e) and 15d-15(e) under the Exchange Act, an evaluation wasperformed under the supervision and with the participation of the Company’smanagement, including the Chief Executive Officer and President and the ChiefFinancial Officer, of the effectiveness of the design and operation of theCompany’s disclosure controls and procedures as of the end of the periodcovered by this report.  Based on theevaluation, the Chief Executive Officer and President and the Chief FinancialOfficer, concluded that the Company’s disclosure controls and procedures wereeffective as of the end of the period covered by the report.

 

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**Changes in Internal Control Over FinancialReporting**

The Chief Executive Officer and President and theChief Financial Officer conducted an evaluation of our internal control overfinancial reporting (as defined in Exchange Act Rule 13a-15(f)) (“InternalControl”) to determine whether any changes in Internal Control occurred duringthe quarter ended September 30, 2007, that have materially affected or whichare reasonably likely to materially affect Internal Control. Based on thatevaluation, no such change occurred during such period.

The Company is not an “accelerated filer” (i.e. theCompany’s public float at September 30, 2007 is less than $75 million) for thefiscal year 2006; accordingly, the internal controls certification andattestation requirements of Section 404 of the Sarbanes-Oxley act will not beapplicable to the Company until the end of the fiscal year ended December 31,2007.  Notwithstanding the fact thatthese internal control requirements are not applicable to the Company at thistime, the Company has been reviewing its internal control procedures and it hasretained an outside firm to assist in this process.

**PART II. OTHER INFORMATION**

**Item 1. Legal Proceedings**

*SecuritiesClass Actions*

In the securities classaction, captioned *InRe: InfoSonics Corporation Securities Litigation*, Lead Case No. 06CV 1231, now pending before Judge Sammartino in the United States DistrictCourt for the Southern District of California, Plaintiffs filed a secondamended consolidated complaint on September 10, 2007 against the Company andcertain of its officers and directors. The second amended consolidated complaint alleges violations of Section10(b) of the Exchange Act and associated Rule 10b-5, Section 20(a) and Section20A in connection with the announcement of the Company’s restatement of first quarter2006 earnings and in connection with allegedly false and/or misleadingstatements related to the Company’s distribution of the VK Mobile phone.  Plaintiffs seek a declaration that theiraction is a proper class action pursuant to Rule 23(a) and (b)(3), unspecifieddamages, prejudgment and post-judgment interest, attorneys’ fees, expertwitness fees, other costs, and other unspecified relief.  The plaintiffs purport to represent a classof purchasers of the Company’s stock during the period February 6, 2006 toAugust 9, 2006.

On October 1, 2007, thedefendants filed a motion to dismiss the second amended consolidated complainton the grounds, among others, that the plaintiffs had failed to adequatelyplead violations of the securities laws. Plaintiffs’ opposition to the motion to dismiss is due November 21,2007, and defendants reply in support of the motion to dismiss is due November30, 2007.  The hearing on the motion todismiss is set for December 7, 2007.

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

*Derivative Action*

In the derivative action,captioned *In ReInfoSonics Corporation Derivative Litigation*, Lead Case No. 06 CV1336, now pending before Judge Sammartino in the United States District Courtfor the Southern District of California, plaintiffs filed a consolidatedcomplaint on November 6, 2006 purportedly on behalf of the Company against certainof its officers and directors, and the Company as a nominal defendant.  The consolidated complaint alleges claims forviolations of Section 14(a) of the Exchange Act, Sections 25402 and 25403 ofthe California Corporations Code, disgorgement under the Sarbanes-Oxley Act of2002, breach of fiduciary duty, abuse of control, gross mismanagement, waste ofcorporate assets, unjust enrichment, rescission, a constructive trust, and anaccounting, in connection with the Company’s restatement of first quarter 2006earnings and in connection with allegations of wrongdoing with respect togranting, exercising, accounting and reporting of the stock options that theCompany granted in December 2005. Plaintiffs seek unspecified damages, declaratory relief regarding theSarbanes-Oxley Act of 2002, Section 14(a) of the Exchange Act, and the legalityof stock options, a constructive trust, restitution, disgorgement, modificationof certain corporate governance and internal procedures, extraordinaryequitable and/or injunctive relief, costs, and such other relief as is just andproper.

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

 

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We may become involved in certainother legal proceedings and claims which arise in the normal course ofbusiness. Other than as described above, as of September 30, 2007, we did nothave any significant litigation outstanding.

**Item 1A.  Risk Factors**

Inaddition to the other information set forth in this report, you shouldcarefully consider the factors discussed in “Part I. Item 1A. Risk Factors” inour Annual Report on Form 10-K for the year ended December 31, 2006 and in ourQuarterly Report on Form 10-Q for the quarters ended March 31, 2007 and June30, 2007, which could materially affect our business, financial condition oroperating results. The risk factors and uncertainties described in our AnnualReport on Form 10-K, this report and interim reports on Form 10-Q are not theonly risks and uncertainties facing us. Additional risks and uncertainties notcurrently known to us or that we currently deem to be immaterial also maymaterially affect our business, financial condition or operating results.  Except as set forth below, there have been nomaterial changes to the risk factors included in our Annual Report on Form10-K, as updated by the disclosures in our interim reports on Form 10-Q, duringthe periods covered by this report.

***Wemay not succeed in our introduction of proprietary products.***

Theintroduction of new products such as our proprietary *verykool*TMline may depress sales of existing products and may not be well received by ourcarrier customers and consumers.  Failureto adequately carry out our product marketing, sales and delivery strategy mayresult in significant inventory obsolescence.

***Wehave and could lose customers or orders as a result of consolidation in thewireless telecommunications carrier industry.***

Therehas been significant consolidation in the wireless industry, particularly inthe U.S. Rural Service Area market, which has caused extreme price competitionand reduced our number of customers and potential customers.  Future consolidations could further erode ourcurrent and potential markets.  Thiscould also lead to fluctuations in our quarterly results and carrying value ofour inventory. These consolidated entities may also order fewer products fromus or elect to no longer do business with us or demand pricing changes in orderto compete.

***We buy a significant amountof our products from a limited number of suppliers, who may not provide us withcompetitive products at reasonable prices when we need them in the future.***

We purchase wireless handsets and accessoriesprincipally from wireless communications equipment manufacturers anddistributors. 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, as well as on our suppliers’ quantity andfinancial stability. For the quarter ended September 30,2007, three suppliers accounted for 56%, 23% and 10%, respectively, of ourtotal cost of sales.  We currently have one exclusive and severalnon-exclusive agreements with our principal suppliers, which can be terminatedon short notice and provide for certain territorial restrictions. Our suppliersmay not offer us competitive products on favorable terms or with timelydelivery. In addition new products from other manufacturers could impact thedemand for products from manufacturers we represent. From time to time, we havebeen unable to obtain sufficient product supplies. Any failure or delay by oursuppliers, particularly our three primary vendors, in supplying us withproducts on favorable terms may severely diminish our ability to obtain anddeliver products to our customers on a timely and competitive basis. If we loseany of our principal suppliers, or if these suppliers are unable to fulfill ourproduct needs, or if any principal supplier imposes substantial price increasesand alternative sources of supply are not readily available, it would have a materialadverse effect on our results of operations and financial conditions.

***The loss or reduction inorders from principal customers or a reduction in prices we are able to chargethese customers will have a negative impact upon our revenues and could causeour stock price to decline.***

Our four largest customers in the quarter endedSeptember 30, 2007 represented 19%, 19%, 15% and 12% of our net sales.  These customers are carriers in LatinAmerica. The markets we serve are subject to significant price competition.Additionally, our customers are not contractually obligated to purchaseproducts from us. For these and other reasons, 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 manufactureror other supplier. The loss of any of our principal customers, a reduction inthe amount of product or services our principal customers order from us or theinability to maintain current terms, including price, with these or othercustomers could have an adverse effect on our financial condition, results of operationsand liquidity. In addition, we have experienced losses of certain customersthrough industry consolidation and in the ordinary course of business. Therecan be no assurance that any of our customers will continue to purchaseproducts or services from us or that their purchases will be at the same orgreater levels than in prior periods.

 

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***Approximately 92% and 88% of our revenues during the threeand nine months ended September 30, 2007, respectively, were generatedoutside of the United States in countries that may have volatile currencies orother risks.***

We engage in significant sales activities in territoriesand countries outside of the United States, particularly Latin Americancountries, including Argentina.  All oursales transactions are completed in U.S. dollars. The fact that we distributeproducts into a number of territories and countries exposes us to, among otherthings, increased credit risks, customs duties, import quotas and other traderestrictions, potentially greater and more unpredictable inflationarypressures, and shipping delays. Changes may occur in social, political,regulatory and economic conditions or in laws and policies governing foreigntrade and investment in the territories and countries where we currentlydistribute products. United States laws and regulations relating to investmentand trade in foreign countries could also change to our detriment. Any of thesefactors could have material adverse effects on our business and operations.Although we purchase and sell products and services in U.S. dollars and do notengage in exchange swaps, futures or options contracts or other hedgingtechniques, fluctuations in currency exchange rates could reduce demand forproducts sold in U.S. dollars. We cannot predict the effect that futureexchange rate fluctuations will have on our operating results. We may in thefuture engage in currency hedging transactions, which could result in ourincurring significant additional financial risks, including losses.

***We have outstandingindebtedness, which is secured by substantially all our assets and couldprevent us from borrowing additional funds, if needed.***

Wehad outstanding debt in the amount of $27.7 million at September 30, 2007 and$25.6 million at December 31, 2006 in the form of a bank line of credit of upto $30 million based on a borrowing base, which is based on a percentage ofeligible accounts receivable.Any significant decrease in our level of eligible accounts receivable willreduce our ability to borrow additional funds to adequately finance ouroperations and expansion strategies. If we violate our loan covenants, defaulton our obligations or become subject to a change of control, our indebtednesswould become immediately due and payable. The terms of our credit facilityrestrict us from incurring additional indebtedness, which could limit ourability to expand our operations. We are also subject to negative covenantsthat, among other things, limit our ability to sell certain assets and makecertain payments, including, but not limited to, dividends, repurchases ofcommon stock and other payments outside the normal course of business, as wellas prohibiting us from merging or consolidating with another corporation orselling all or substantially all of our assets. At September 30, 2007, the Company did not meet all ofthese financial covenants.  The Companyreceived a waiver from Wells Fargo relating to default rights Wells Fargo mayhave due to the Company failing to meet certain of these financial covenants atSeptember 30, 2007, as well as default rights Wells Fargo may have if theCompany fails to meet certain of these financial covenants at December 31,2007.  The Company cannot provideassurance that it will or will not be able to comply with the financialcovenants in the future.

***We depend on thirdparties to manufacture our proprietary verykoolTM products that we distributeand, accordingly, rely on their quality control procedures, while assuming theinventory risk associated with those products.***

Product manufacturers typically provide no warrantieson the proprietary products directly to the end consumer or to us, therefore weare solely responsible for such warranty to the end consumer. If a product wedistribute for a manufacturer has quality or performance problems, our abilityto provide satisfactory products to our customers could be disrupted and ourreputation could be impaired.  Inaddition as the *verykoolTM*products are manufactured exclusively for us, we are burdened with carrying theinventory and there can be no assurance that we will be able to sell thesedevices before payment is due and at prices above our cost. Either of theserisks could have a negative effect on our operations, condition and futureliquidity.

**Item 2.    Unregistered Sales Of Equity Securities AndUse Of Proceeds**

None.

**Item 3.    Defaults Upon Senior Securities**

None.

**Item 4.    Submission of Matters to a Vote of SecurityHolders**

None

 

**Item 5.    Other Information**

None.

 

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**Item 6.    Exhibits**

 
| **Exhibit Number** | ** ** | **Description  of Exhibit**                                                                                                                                                  |
|--------------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.1               |       | Lease Termination  Agreement dated August 27, 2007 between Biomed Realty LP and InfoSonics  Corporation (*)                                                                  |
| 10.2               |       | Office Space Lease dated  September 10, 2007 between UTC Properties LLC and InfoSonics Corporation (*)                                                                       |
| 10.3               |       | Separation and Release  Agreement dated July 26, 2007 between Timmy Monico and InfoSonics Corporation  (*)                                                                   |
| 31.1               |       | Certification of Chief  Executive Officer pursuant to Rule 13a-14(a of the Securities Exchange Act of  1934, implementing Section 302 of Sarbanes-Oxley Act of 2002 (*) |
| 31.2               |       | Certification of Chief  Financial Officer pursuant to Rule 13a-14(a of the Securities Exchange Act of  1934, implementing Section 302 of Sarbanes-Oxley Act of 2002 (*) |
| 32.1               |       | Certification of Chief  Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to  Section 906 of Sarbanes-Oxley Act of 2002 (*)                     |
| 32.2               |       | Certification of Chief  Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to  Section 906 of Sarbanes-Oxley Act of 2002 (*)                     |

 

 

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(*)  Filed herewith.

**SIGNATURE**

Pursuant to the requirementsof the Securities Exchange Act of 1934, as amended, the registrant has dulycaused this report to be signed on its behalf by the undersigned, thereuntoduly authorized.
|   | InfoSonics Corporation |
|--------|------------------------|
|   |                   |   |   |   |
|   |                   |   |   |   |
| Date:  | November 14, 2007      | By: | /s/  Joseph Ram |
|   |                   |   | Joseph Ram |
|   |                   |   | Chief Executive Officer and President |
|   |                   |   |   |
|   |                   |   |   |   |
| Date:  | November 14, 2007      | By: | /s/  Jeffrey Klausner |
|   |                   |   | Jeffrey Klausner |
|   |                   |   | Chief Financial Officer |

 

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