**UNITED STATES SECURITIES ANDEXCHANGECOMMISSION**

 

**Washington,D.C. 20549**

 

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**FORM 10 - Q**

 

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

 

**For thequarterly period ended September 30, 2005.**

 

**005-79915**

**(Commission File Number)**

 

**InfoSonics Corporation**

(Exactname of registrant as specified in its charter)

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

 

**5880Pacific Center Blvd**

**San Diego,CA 92121**

(Addressof principal executive offices including zip code)

 

**(858) 373-1600**

(Registrant’s telephone number, including area code)

 

**Not Applicable**

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

 

Indicate by check mark whether the registrant (1) has filed allreports required to be filed by Section 13 or 15(d) of the ExchangeAct during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject tosuch filing requirements for the past 90 days.

Yes   ý   No o

 

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

Yes   o   No ý

 

Indicate by checkmark whether the registrant is a shell company (as defined in Exchange Act Rule12b-2). Yes   o   No ý

 

As of November 14,2005, the Registrant had 5,332,000 shares outstanding of its $.001 par valuecommon stock.

 

 

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**InfoSonics Corporation**

 

**Quarterly Report on FORM 10-Q For The Period Ended**

 

**September 30, 2005**

 

**Table of Contents**

 
| **PART I. FINANCIAL INFORMATION** |                                                                                                                                   |
|----------------------------------------|----------------------------------------------------------------------------------------------------------------------------------------|
|                                   |                                                                                                                                   |   |
| Item 1.                                | Financial Statements                                                                                                                   |   |
|                                   |                                                                                                                                   |   |
|                                   | Consolidated Balance Sheets as of September 30,  2005 (unaudited) and December 31, 2004                                      |   |
|                                   |                                                                                                                                   |   |
|                                   | Consolidated Statements of Income for the Three Months and Nine Months  Ended September 30, 2005 (unaudited) and 2004 (unaudited) |   |
|                                   |                                                                                                                                   |   |
|                                   | Consolidated Statements of Cash Flows for the Nine Months Ended  September 30, 2005 (unaudited) and 2004 (unaudited)                   |   |
|                                   |                                                                                                                                   |   |
|                                   | Notes to Consolidated Financial Statements                                                                                             |   |
|                                   |                                                                                                                                   |   |
| Item 2.                                | Management’s Discussion and Analysis of Financial Condition and  Results of Operations                                            |   |
|                                   |                                                                                                                                   |   |
| Item 3.                                | Quantitative and Qualitative Disclosures About Market Risk                                                                             |   |
|                                   |                                                                                                                                   |   |
| Item 4.                                | Controls and Procedures                                                                                                                |   |
|                                   |                                                                                                                                   |   |
| **PART II.  OTHER INFORMATION**   |                                                                                                                                   |
|                                   |                                                                                                                                   |   |
| Item 1.                                | Legal Proceedings                                                                                                                      |   |
|                                   |                                                                                                                                   |   |
| Item 2.                                | Unregistered Sales of Equity Securities and  Use of Proceeds                                                                           |   |
|                                   |                                                                                                                                   |   |
| Item 3.                                | Defaults Upon Senior Securities                                                                                                        |   |
|                                   |                                                                                                                                   |   |
| Item 4.                                | Submission of Matters to a Vote of Security  Holders                                                                                   |   |
|                                   |                                                                                                                                   |   |
| Item 5.                                | Other Information                                                                                                                      |   |
|                                   |                                                                                                                                   |   |
| Item 6.                                | Exhibits                                                                                                                               |   |
|                                   |                                                                                                                                   |   |
| Signatures                             |                                                                                                                                   |
|                                   |                                                                                                                                   |   |
| Exhibit 31.1                      |                                                                                                                                   |
|                                   |                                                                                                                                   |   |
| Exhibit 32.1                      |                                                                                                                                   |
|                                        |                                                                                                                                        |  |  |

 

2

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**Part I.  FINANCIAL INFORMATION**

 

Item 1.  Financial Statements

 

**InfoSonics Corporation and Subsidiaries**

**ConsolidatedBalance Sheets**

 
| ** **                                                                                              | ** ** | **September 30  2005** | ** **     | **December 31  2004** | ** ** |
|---------------------------------------------------------------------------------------------------------|------------|-----------------------------|----------------|----------------------------|------------|
| ** **                                                                                              | ** ** | **(unaudited)**             | ** **     | ** **                 | ** ** |
| **ASSETS**                                                                                              |       |                        |           |                       |       |
| **Current assets**                                                                                      |       |                        |           |                       |       |
| Cash and cash equivalents                                                                               |       | $                           | 1,362,640      |                       | $          | 5,183,876 |   |
| Trade accounts receivable, net of allowance for doubtful accounts of  $999,560 (unaudited) and $250,000 |       | 36,231,267                  |           | 7,596,104                  |       |
| Inventory, net of reserves of $140,085 (unaudited) and $141,086                                         |       | 4,863,375                   |           | 4,640,756                  |       |
| Prepaid inventory                                                                                       |       | 1,389,126                   |           | 71,850                     |       |
| Prepaid expenses                                                                                        |       | 210,207                     |           | 384,456                    |       |
| Net assets of discontinued operations                                                                   |       | 18,413                      |           | 181,010                    |       |
| Deferred tax assets - current                                                                           |       | 595,000                     |           | 285,000                    |       |
|                                                                                                    |       |                        |           |                       |       |
| Total current assets                                                                                    |       | 44,670,028                  |           | 18,343,052                 |       |
|                                                                                                    |       |                        |           |                       |       |
| Property and equipment, net                                                                             |       | 457,984                     |           | 237,853                    |       |
| Deferred tax assets - noncurrent                                                                        |       | 8,000                       |           | 67,000                     |       |
| Intangible asset                                                                                        |       | 504,000                     |           |                       |       |
| Other assets                                                                                            |       | 89,209                      |           | 71,851                     |       |
|                                                                                                    |       |                        |           |                       |       |
| **Total assets**                                                                                        | ** ** | **$**                       | **45,729,221** | ** **                 | **$**      | **18,719,756** | ** ** |
|                                                                                                    |       |                        |           |                       |       |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                          | ** ** | ** **                  | ** **     | ** **                 | ** ** |
|                                                                                                    |       |                        |           |                       |       |
| **Current liabilities**                                                                                 |       |                        |           |                       |       |
| Line of credit                                                                                          |       | $                           | 17,728,275     |                       | $          | 2,564,115 |   |
| Accounts payable                                                                                        |       | 9,556,977                   |           | 2,576,034                  |       |
| Accrued expenses                                                                                        |       | 3,235,624                   |           | 447,054                    |       |
| Income taxes payable                                                                                    |       | 368,880                     |           | —                     |       |
| Net liabilities of discontinued operations                                                              |       | —                      |           | 693,542                    |       |
|                                                                                                    |       |                        |           |                       |       |
| Total current liabilities                                                                               |       | 30,889,756                  |           | 6,280,745                  |       |
|                                                                                                    |       |                        |           |                       |       |
| **Stockholders’ equity**                                                                           |       |                        |           |                       |       |
| Preferred stock, $0.001 par value 10,000,000 shares authorized 0 and  0 shares issued and outstanding   |       | —                      |           | —                     |       |
| Common stock, $0.001 par value 40,000,000 shares authorized 5,332,000  shares issued and outstanding    |       | 5,332                       |           | 5,212                      |       |
| Additional paid-in capital                                                                              |       | 11,033,531                  |           | 10,529,652                 |       |
| Retained earnings                                                                                       |       | 3,800,602                   |           | 1,904,147                  |       |
|                                                                                                    |       |                        |           |                       |       |
| Total stockholders’ equity                                                                         |       | 14,839,465                  |           | 12,439,011                 |       |
|                                                                                                    |       |                        |           |                       |       |
| **Total liabilities and stockholders’ equity**                                                     | ** ** | **$**                       | **45,729,221** | ** **                 | **$**      | **18,719,756** | ** ** |

 

*Seeaccompanying notes.*

 

3

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**InfoSonics Corporation and Subsidiaries**

**ConsolidatedStatements of Income**

**(unaudited)**

 
| ** **                                                              | ** ** | **For the Three Months  Ended September 30,** | ** **    | **For the Nine Months  Ended September 30,** | ** ** |
|-------------------------------------------------------------------------|------------|----------------------------------------------------|---------------|---------------------------------------------------|------------|
| ** **                                                              | ** ** | **2005**                                           | ** **    | **2004**                                          | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                                              | ** ** | ** **                                         | ** **    | ** **                                        | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Net sales**                                                           |       | $                                                  | 54,237,278    |                                              | $          | 17,393,081 |   | $ | 110,789,125 |   | $ | 53,816,308 |   |
| **Cost of sales**                                                       |       | 50,047,209                                         |          | 16,116,974                                        |       | 101,811,213 |   | 49,582,109 |   |
|                                                                    |       |                                               |          |                                              |       |   |   |   |   |
| **Gross profit**                                                        |       | 4,190,069                                          |          | 1,276,107                                         |       | 8,977,912 |   | 4,234,199 |   |
| **Operating expenses**                                                  |       | 2,970,160                                          |          | 1,076,520                                         |       | 6,517,853 |   | 3,114,304 |   |
|                                                                    |       |                                               |          |                                              |       |   |   |   |   |
| **Operating income from continuing operations**                         |       | 1,219,909                                          |          | 199,587                                           |       | 2,460,059 |   | 1,119,895 |   |
|                                                                    |       |                                               |          |                                              |       |   |   |   |   |
| **Other income (expense)**                                              |       |                                               |          |                                              |       |   |   |   |   |
| Interest income (expense)                                               |       | (147,301                                           | )             | 11,759                                            |       | (233,277 | ) | (74,356 | ) |
|                                                                    |       |                                               |          |                                              |       |   |   |   |   |
| **Income from continuing operations before provision for income taxes** |       | 1,072,608                                          |          | 211,346                                           |       | 2,226,782 |   | 1,045,539 |   |
| **Provision for income taxes**                                          |       | 290,478                                            |          | (117,302                                          | )          | 704,793 |   | 118,633 |   |
|                                                                    |       |                                               |          |                                              |       |   |   |   |   |
| **Income from continuing operations**                                   | ** ** | 782,130                                            |          | 328,648                                           |       | 1,521,989 |   | 926,906 |   |
| **Income (loss) from discontinued operations net of income tax of $0**  | ** ** | 391,563                                            |          | (788,635                                          | )          | 374,479 |   | (961,344 | ) |
| ** **                                                              | ** ** | ** **                                         | ** **    | ** **                                        | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Net income (loss)**                                                   | ** ** | **$**                                              | **1,173,693** | ** **                                        | **$**      | **(459,987** | **)** | **$** | **1,896,468** | ** ** | **$** | **(34,438** | **)** |
|                                                                    |       |                                               |          |                                              |       |   |   |   |   |
| **Basic earnings per share**                                            |       |                                               |          |                                              |       |   |   |   |   |
| From continuing operations                                              | ** ** | **$**                                              | **0.15**      | ** **                                        | **$**      | **0.06** | ** ** | **$** | **0.29** | ** ** | **$** | **0.23** | ** ** |
| From discontinued operations                                            | ** ** | **$**                                              | **0.08**      | ** **                                        | **$**      | **(0.15** | **)** | **$** | **0.07** | ** ** | **$** | **(0.24** | **)** |
| Net Income (loss)                                                       | ** ** | **$**                                              | **0.23**      | ** **                                        | **$**      | **(0.09** | **)** | **$** | **0.36** | ** ** | **$** | **(0.01** | **)** |
| **Diluted earnings per share**                                          | ** ** | ** **                                         | ** **    | ** **                                        | ** ** | ** ** | ** ** | ** ** | ** ** |
| From continuing operations                                              | ** ** | **$**                                              | **0.13**      | ** **                                        | **$**      | **0.06** | ** ** | **$** | **0.26** | ** ** | **$** | **0.23** | ** ** |
| From discontinued operations                                            | ** ** | **$**                                              | **0.07**      | ** **                                        | **$**      | **(0.15** | **)** | **$** | **0.06** | ** ** | **$** | **(0.24** | **)** |
| Net Income (loss)                                                       | ** ** | **$**                                              | **0.20**      | ** **                                        | **$**      | **(0.09** | **)** | **$** | **0.32** | ** ** | **$** | **(0.01** | **)** |
|                                                                    |       |                                               |          |                                              |       |   |   |   |   |
| **Basic weighted-average number of common shares outstanding**          | ** ** | **5,332,000**                                      | ** **    | **5,212,000**                                     | ** ** | **5,332,000** | ** ** | **3,977,197** | ** ** |
|                                                                    |       |                                               |          |                                              |       |   |   |   |   |
| **Diluted weighted-average number of common shares outstanding**        | ** ** | **5,967,670**                                      | ** **    | **5,212,000**                                     | ** ** | **5,872,793** | ** ** | **3,977,197** | ** ** |

 

*Seeaccompanying notes*.

 

4

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**InfoSonics Corporation and Subsidiaries**

**ConsolidatedStatements of Cash Flows**

**(unaudited)**

 

| ** **                                                                                                             | ** ** | **For the Nine Months Ended September 30,** | ** **    |
|------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------|---------------|
| ** **                                                                                                             | ** ** | **2005**                                         | ** **    | **2004** | ** ** |
| **Cash flows from operating activities**                                                                               |       |                                             |          |   |   |
| Net income from continuing operations                                                                                  |       | $                                                | 1,521,989     |   | $ | 926,906 |   |
| Adjustments to reconcile net income from continuing operations to net  cash provided by (used in) operating activities |       |                                             |          |   |   |
| Depreciation and amortization                                                                                          |       | 59,929                                           |          | 17,973 |   |
| Provision for bad debt                                                                                                 |       | 749,560                                          |          | (101,979 | ) |
| Provision for obsolete inventory                                                                                       |       | (1,001                                           | )             | 90,059 |   |
| (Increase) decrease in                                                                                                 |       |                                             |          |   |   |
| Trade accounts receivable                                                                                              |       | (29,384,723                                      | )             | 2,402,210 |   |
| Inventory                                                                                                              |       | (221,618                                         | )             | (3,516,341 | ) |
| Prepaid Inventory                                                                                                      |       | (1,317,276                                       | )             | — |   |
| Prepaid expenses                                                                                                       |       | 174,249                                          |          | (1,358,850 | ) |
| Deferred tax asset current                                                                                             |       | (310,000                                         | )             | 150,000 |   |
| Deferred tax asset non current                                                                                         |       | 59,000                                           |          | — |   |
| Other assets                                                                                                           |       | (17,358                                          | )             | (48,842 | ) |
| Increase (decrease) in                                                                                                 |       |                                             |          |   |   |
| Accounts payable                                                                                                       |       | 6,980,943                                        |          | 1,192,943 |   |
| Accrued expenses                                                                                                       |       | 2,788,570                                        |          | 110,122 |   |
| Income tax liabilities                                                                                                 |       | 368,880                                          |          | (821,982 | ) |
|                                                                                                                   |       |                                             |          |   |   |
| Cash provided by (used in) continuing operations                                                                       |       | (18,548,856                                      | )             | (957,781 | ) |
| Cash provided by (used in) discontinued operations                                                                     |       | (156,479                                         | )             | (430,078 | ) |
|                                                                                                                   |       |                                             |          |   |   |
| Net cash provided by (used in) operating activities                                                                    |       | (18,705,335                                      | )             | (1,387,859 | ) |
|                                                                                                                   |       |                                             |          |   |   |
| **Cash flows from investing activities**                                                                               |       |                                             |          |   |   |
|                                                                                                                   |       |                                             |          |   |   |
| Purchase of property and equipment                                                                                     |       | (280,060                                         | )             | (200,497 | ) |
|                                                                                                                   |       |                                             |          |   |   |
| Net cash provided by (used in) investing activities                                                                    |       | (280,060                                         | )             | (200,497 | ) |
|                                                                                                                   |       |                                             |          |   |   |
| **Cash flows from financing activities**                                                                               |       |                                             |          |   |   |
| Bank overdraft                                                                                                         |       | —                                           |          | (867,555 | ) |
| Borrowings from line of credit                                                                                         |       | 72,315,464                                       |          | 19,562,625 |   |
| Payments on line of credit                                                                                             |       | (57,151,304                                      | )             | (20,767,832 | ) |
| Cash paid for offering costs                                                                                           |       | —                                           |          | (30,000 | ) |
| Offering costs                                                                                                         |       | —                                           |          | (1,887,686 | ) |
| Cash received for stock                                                                                                |       | —                                           |          | 12,054,000 |   |
|                                                                                                                   |       |                                             |          |   |   |
| Net cash provided by (used in) financing activities                                                                    |       | 15,164,159                                       |          | 8,063,552 |   |
|                                                                                                                   |       |                                             |          |   |   |
| Net increase (decrease) in cash and cash equivalents                                                                   |       | (3,821,236                                       | )             | 6,475,196 |   |
|                                                                                                                   |       |                                             |          |   |   |
| **Cash and cash equivalents, beginning of period**                                                                     |       | 5,183,876                                        |          | 2,570 |   |
|                                                                                                                   |       |                                             |          |   |   |
| **Cash and cash equivalents, end of period**                                                                           | ** ** | **$**                                            | **1,362,640** | ** ** | **$** | **6,477,766** | ** ** |

 

*Seeaccompanying notes*.

 

**Non-CashSupplemental Disclosure**

Issuance of common stock for Primasel S.A.acquisition, 120,000 shares valued at $504,000. See footnote 2 for additional information.

 

5

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**InfoSonics Corporation**

**Notes toConsolidated Financial Statements**

**September 30, 2005**

 

**NOTE1. Basis of Presentation**

 

The accompanying unauditedConsolidated Financial Statements have been prepared in accordance withaccounting principles generally accepted in the United States for interimfinancial information and with the instructions to Form 10-Q and Article 10of Regulation S-X of the Securities Exchange Act of 1934. Accordingly, they donot include all of the information and footnotes required by accountingprinciples generally accepted in the United States for complete financialstatements. The preparation of financial statements requires management to makeestimates and assumptions that affect amounts reported in the financialstatements and accompanying notes. Actual results are likely to differ fromthose estimates, but management does not believe such differences willmaterially affect the financial position or results of operations of InfoSonicsCorporation (the “Company”). The Consolidated Financial Statements reflect alladjustments considered, in the opinion of the Company, necessary to fairlypresent the results for the periods. Such adjustments are of a normal recurringnature.

 

The unauditedConsolidated Financial Statements include the accounts of the Company and itssubsidiaries, Axcess Mobile LLC, InfoSonics De Mexico, InfoSonics de Guatemala,InfoSonics El Salvador and InfoSonics S.A., all of which are wholly owned.Significant intercompany accounts and transactions have been eliminated inconsolidation.

 

The unaudited ConsolidatedFinancial Statements at September 30, 2005 do not include all of theinformation and footnotes required by accounting principles generally acceptedin the United States for complete financial statements. Due to seasonal andother factors, the Company’s interim results may not be indicative of annualresults. The unaudited Consolidated Statements of Income for the three monthsand nine months ended September 30, 2005 and the unaudited ConsolidatedStatement of Cash Flows for the nine months ended September 30, 2005 arenot necessarily indicative of the operating results or cash flows that may beexpected for the entire year.

 

The Company has not changed itssignificant accounting policies from those disclosed in its financialstatements as of and for the year ended December 31, 2004 as included inits Form 10-K for the year ended December 31, 2004 that was filedwith the Securities and Exchange Commission. For further information, referenceis made to the audited Consolidated Financial Statements and the notes theretoincluded in the Company’s financial statements as of and for the year ended December 31,2004 as included in its Form 10-K.

 

**NOTE 2.Acquisition**

 

On January 19, 2005, theCompany purchased Primasel S.A., from Fanrock Investments Limited for up to120,000 shares of the Company’s common stock, based on sales of certain levelsbeing achieved over the course of three years.  Additionally, the Company will pay profit sharing tied to sales andprofitability generated by Primasel S.A.  The Company has accounted for the transactionas a stock purchase. Primasel S.A.’s assets at the time of purchase consistedof  a distribution agreement and amanagement agreement. During the three months ended September 30, 2005, saleslevels achieved resulted in the issuance of 120,000 shares of common stock per the terms of the purchaseagreement.   As of  September 30, 2005, the Company has recordedthe issuance of the shares, as they had been earned, though the shares were notissued until October 2005.  The Companyis in the process of allocating the non-cash cost of this issuance between theagreements purchased.    The purchaseprice has been recorderd as an intangible assets in the accompanying balancesheet.  Additionally,  as of September 30, 2005, the Company hasrecorded an accrual for profit participation expense in the amount of$627,000.   In February 2005, PrimaselS.A. changed its name to InfoSonics S.A.

 

**NOTE 3.Discontinued Operations**

 

During the quarter ended September 30,2004, the Company and its Board of Directors discussed Axcess Mobile, LLC andits mall-based kiosk locations and the Company began to implement actionsnecessary to close those mall-based kiosk locations. On October 28, 2004,the Company assigned the leases for six of the mall-based kiosk locations to anunrelated assignee; however, the assignment did not release the Company fromthe future lease obligations of up to $994,798. The assignee operatesapproximately 400 mall-based kiosks in 28 states. A third party is holding inescrow two months rent for the locations from the assignee, and in the event ofdefault by the assignee, those funds will be released to the Company.  The other lease locations were closed in October 2004.  SFAS No. 142, “Goodwill and OtherIntangible Assets,” prohibits the

 

6

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amortization of goodwill, but requiresthat it be reviewed for impairment at least annually or on an interim basis ifan event occurs or circumstances change that could indicate that its value hasdiminished or been impaired. As a result of the discontinued operation, the Companyhas reassessed the goodwill and written down the value to zero.  This write-down was recorded as an operatingexpense in the year ended December 31, 2004. The results of thediscontinued operations are as follows

 

| ** **                    | ** ** | **Three months ended****September 30** | ** ** | **Nine months ended****September 30** | ** ** |
|-------------------------------|------------|---------------------------------------------|------------|--------------------------------------------|------------|
| ** **                    | ** ** | **2005**                                    | ** ** | **2004**                                   | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                    | ** ** | ** **                                  | ** ** | ** **                                 | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net Sales                     |       | $                                           | —     |                                       | $          | 475,188 |   | $ | — |   | $ | 2,224,307 |   |
| Gross Profit                  |       | —                                      |       | 221,596                                    |       | — |   | 1,325,609 |   |
| Operating income (loss)       |       | 391,563                                     |       | (656,365                                   | )          | 374,479 |   | (825,544 | ) |
| Capital Expenditures          |       | —                                      |       | 1,474                                      |       | — |   | 44,928 |   |
| Depreciation and Amortization |       | —                                      |       | 5,774                                      |       | — |   | 13,516 |   |
|                               |            |                                             |            |                                            |            |  |  |  |  |  |  |  |  |

 

Duringthe quarter ended Septmeber 30, 2005, the Company was able to resolveoutstanding balances with the major vendor for the discontinued operation.  This resolution has been recorded in thecurrent quarter.  As of September 30,2005 and December 31, 2004, net assets of discontinued operations consistof receivables of $5,000 and $181,000, respectively, and net liabilities ofdiscontinued operations consist of accounts payable of zero and $693,000,respectively. 

 

Asof September 30, 2005, the actions related to the discontinued operationshad been completed, however the Company expects to continue to recordadjustments and expenses concerning discontinued operations as necessary.

 

**NOTE 4. Stock-Based Compensation**

 

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

 

Ifcompensation cost for the Company’s stock-based compensation plans had beendetermined based on the fair value at the grant dates for awards under thoseplans consistent with the method of SFAS No. 123, then the Company’s netincome for the three months ended and the nine months ended September 30,2005 and September 30, 2004 would have been adjusted to the pro formaamounts indicated below:

 
| ** **                                                                                                                                                                        | ** ** | **Three Months ended  September 30,** | ** ** | **Nine Months ended  September 30,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                                                                                                                                        | ** ** | **2005**                                   | ** ** | **2004**                                  | ** ** | **2005** | ** ** | **2004** | ** ** |
| Net income (loss)  as reported                                                                                                                                                    |       | $                                          | 1,173,693  |                                      | $          | (459,987 | ) | $ | 1,896,468 |   | $ | (34,438 | ) |
|                                                                                                                                                                              |       |                                       |       |                                      |       |   |   |   |   |
| Stock-based  employee compensation cost, net of related tax effects, that would have been  included in the determination of net income if the fair value method had been  applied |       | (60,748                                    | )          | (183,453                                  | )          | (572,070 | ) | (183,453 | ) |
| Pro forma                                                                                                                                                                         |       | $                                          | 1,112,945  |                                      | $          | (643,440 | ) | $ | 1,324,398 |   | $ | (217,891 | ) |
|                                                                                                                                                                              |       |                                       |       |                                      |       |   |   |   |   |
| Basic earnings  (loss) per common share as reported                                                                                                                               |       | $                                          | 0.23       |                                      | $          | (0.09 | ) | $ | 0.36 |   | $ | (0.01 | ) |
| Stock-based  employee compensation cost, net of related tax effects, that would have been  included in the determination of net income if the fair value method had been  applied |       |                                       | (0.01      | )                                         |       | (0.03 | ) |   | (0.11 | ) |   | (0.03 | ) |
| Pro forma                                                                                                                                                                         |       | $                                          | 0.22       |                                      | $          | (0.12 | ) | $ | 0.25 |   | $ | (0.04 | ) |
| Diluted earnings  (loss) per common share                                                                                                                                         |       |                                       |       |                                      |       |   |   |   |   |
| As reported                                                                                                                                                                       |       | $                                          | 0.20       |                                      | $          | (0.09 | ) | $ | 0.32 |   | $ | (0.01 | ) |
| Stock-based  employee compensation cost, net of related tax effects, that would have been  included in the determination of net income if the fair value method had been  applied |       |                                       | (0.01      | )                                         |       | (0.03 | ) |   | (0.10 | ) |   | (0.03 | ) |
| Pro forma                                                                                                                                                                         |       | $                                          | 0.19       |                                      | $          | (0.12 | ) | $ | 0.22 |   | $ | (0.04 | ) |
|                                                                                                                                                                              |       |                                       |       |                                      |       |   |   |   |   |   |   |   |   |

7

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**NOTE 5. Earnings Per Share**

 

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

 

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

 
| ** **                                                                                                  | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended****September 30,** | ** ** |
|-------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                                                                  | ** ** | **2005**                                   | ** ** | **2004**                                    | ** ** | **2005** | ** ** | **2004** | ** ** |
|                                                                                                        |       |                                       |       |                                        |       |   |   |   |   |
| Numerator: Net  Income (loss)                                                                               |       | $                                          | 1,173,693  |                                        | $          | (459,987 | ) | $ | 1,896,468 |   | $ | (34,438 | ) |
| Denominator:                                                                                                |       |                                       |       |                                        |       |   |   |   |   |
| Denominator for  basic earnings per share – weighted average shares                                    |       | 5,332,000                                  |       | 5,212,000                                   |       | 5,332,000 |   | 3,977,197 |   |
| Effect of  dilutive securities                                                                              |       |                                       |       |                                        |       |   |   |   |   |
| Employee stock  options                                                                                     |       | 755,670                                    |       | —                                      |       | 660,793 |   | — |   |
| Denominator for  diluted earnings per share – adjusted weighted average shares and assumed  conversion |       | 5,967,670                                  |       | 5,212,000                                   |       | 5,872,793 |   | 3,977,197 |   |
|                                                                                                             |            |                                            |            |                                             |            |  |  |  |  |  |  |  |  |

 

Potentialcommon shares have been excluded from the computation of diluted earnings pershare due to their exercise price being greater than the Company’s weightedaverage stock price for the period. For the three and nine months ended September 30,2005, the number of shares excluded were 940,863 and 1,035,407,respectively.  For the three and nine monthsended September 30, 2004, all potential common shares were excluded fromthe calculation since their effect was anti-dilutive.

 

**NOTE 6.Income Taxes**

 

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

 

**NOTE 7.Inventory**

 

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

 
| ** **        | ** ** | **September 30,  2005** | ** ** | **December 31,  2004** | ** ** |
|-------------------|------------|------------------------------|------------|-----------------------------|------------|
| Finished goods    |       | $                            | 5,003,460  |                        | $          | 4,781,842 |   |
| Inventory reserve |       | (140,085                     | )          | (141,086                    | )          |
| Net inventory     |       | $                            | 4,863,375  |                        | $          | 4,640,756 |   |
|                   |            |                              |            |                             |            |  |  |  |

 

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**NOTE 8. Property and Equipment**

 

Property and equipmentconsists of the following:

 

| ** **                    | ** ** | **September 30,  2005** | ** ** | **December 31,  2004** | ** ** |
|-------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| Machinery and Equipment       |       | $                            | 488,387    |                        | $          | 221,739 |   |
| Furniture and Fixtures        |       | 114,031                      |       | 100,619                     |       |
|                          |       | 602,418                      |       | 322,358                     |       |
| Less Accumulated Depreciation |       | 144,434                      |       | 84,505                      |       |
| Total                         |       | $                            | 457,984    |                        | $          | 237,853 |   |

 

Depreciation expense was $59,929 and 31,489 for the nine months ended September 30,2005 and 2004, respectively.

 

**NOTE9. Revolving Bank Loan Agreements and Notes Payable**

 

TheCompany has a line of credit from a bank, which provides for advances not toexceed 85% of eligible domestic accounts receivable and 70% to 90% of foreigninsured accounts, depending on the country of the debtor, up to a maximum of $18,000,000.  The increase from $15,000,000 to $18,000,000was temporary; in addition, this agreement was terminated October 6, 2005,and replaced with a new credit agreemet from Wells Fargo HSBC Trade Bank (“WellsFargo”)as described below

 

Interestis payable on a monthly basis at prime (6.75% at September 30, 2005) or atthe London Inter-Bank Offering Rate (4.41% at September 30, 2005), plus2.25% for the first $500,000 and 2.5% for amounts over $500,000. The line ofcredit is collateralized by substantially all of the assets of the Company,personally guaranteed by the Company’s majority stockholder, who is also ourChief Executive Officer, and expires on July 2006.  Althoughthere are no assurances, we believe that we will be able to extend thisrevolving line of credit with equal or better terms.  In addition to reporting and othernon-financial covenants, the line of credit contains certain financialcovenants which require the Company to maintain a tangible net worth of notless than $12,000,000, a quick ratio of not less than 1-to-1, a debt-to-tangibleeffective-net worth ratio of not greater than 2-to-1, and require the Companyto maintain a quarterly net income after taxes of at least $150,000. Managementbelieves the Company was not in compliance with these covenants at September 30,2005, and this credit agreement was replaced on October 6, 2005. At September 30,2005 and December 31, 2004, the amounts drawn against the line of creditwere $17,728,275 and $2,564,115, respectively.

 

On October 6, 2005, the Company enteredinto a Credit Agreement (the “Agreement”) with Wells Fargo HSBC Trade Bank,N.A. (“Wells Fargo”) that allows the Company to borrow up to a maximum of$20,000,000 and expires on October 1, 2006.  The Agreement provides for advances not toexceed 80% of eligible domestic accounts receivable and 85% of eligible foreigninsured accounts.

 

Interest on theline of credit is payable on a monthly basis at Wells Fargo’s prime rate **(**6.75****%**** at October 6, 2005) orat the London Inter-Bank Offering Rate (“LIBOR”) plus 1.5% (LIBOR was 4% at October 6,2005).  The line of credit iscollateralized by substantially all of the assets of the Company.  In addition to reporting and othernon-financial covenants, the line of credit contains certain financialcovenants which, among other items, require the Company to maintain a tangiblenet worth of not less than $12,000,000, a quick ratio of not less than 1-to-1,a debt-to-tangible net worth ratio of not greater than 2-to-1, to maintain apre-tax profit of not less than $1 on a rolling four-quarter basis, and tomaintain net income after taxes of not less than $1 on an annual basis.  Management believes the Company was incompliance with these covenants at November 14, 2005.  The Company paid the outstanding amount owedunder its previous line of credit with funds from the line of credit providedby Wells Fargo.  

 

TheCompany has no other notes payable.

 

**NOTE10. Stockholders’ Equity**

 

Stock Options

 

EffectiveJanuary 21, 2005 and May 25, 2005 the Company granted options topurchase an aggregate of 335,000 and 39,500 shares, respectively, of its commonstock to certain employees, including certain of the Company’s officers (the “EmployeeOptions”). The 335,000 Employee Options vest upon the later of 1) one yearafter the date on which the employee was hired by the Company; or 2) the dateof grant.  The 39,500 Employee Optionsvest on December 31, 2005. The Employee Options

 

9

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havean exercise price of $3.29 per share, which was the closing price per share ofthe Company’s common stock on January 21, 2005.  On May 25, 2005 the stock price was$3.05.  On August 16, 2005 theCompany granted options to purchase 25,000 share of its common stock to acertain employee.  These options vestover a period of 2 years from the date of grant.  The employee options have an exercise priceof $4.16 which was the closing price on August 16, 2005.  The Employee Options expire three years fromthe date of grant.

 

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

 

**NOTE11. Recent Accounting Pronouncements**

 

InMarch 2005, the FASB issued FASB Interpretation (“FIN”) No. 47, “Accountingfor Conditional Asset Retirement Obligations”. FIN No. 47clarifies that the term conditional asset retirement obligation asused in FASB Statement No. 143, “Accounting for Asset RetirementObligations,” refers to a legal obligation to perform an assetretirement activity in which the timing and (or) method of settlement areconditional on a future event that may or may not be within the control of theentity.  The obligation to perform theasset retirement activity is unconditional even though uncertainty exists aboutthe timing and (or) method of settlement. Uncertainty about the timing and/or method of settlement of aconditional asset retirement obligation should be factored into the measurementof the liability when sufficient information exists.  Thisinterpretation also clarifies when an entity would have sufficientinformation to reasonably estimate the fair value of an asset retirementobligation**.**FIN No. 47 is effective no laterthan the end of fiscal years ending after December 15, 2005 (which wouldbe December 31, 2005 for calendar-year companies). Retrospectiveapplication of interim financial information is permitted but is notrequired.  Management does not expectadoption of FIN No. 47 to have a material impact on the Company’sfinancial statements.

 

In April 2005, theSecurities and Exchange Commission amended the compliance dates to allowcompanies to implement SFAS No. 123(R) at the beginning of their nextfiscal year, instead of the next reporting period, that begins after September 15,2005, or December 15, 2005 for small business issuers. As a result, SFAS No. 123(R)must be adopted by the Company by the first quarter of 2006.

 

In May 2005, the FASBissued Statement of Accounting Standards (SFAS) No. 154, “AccountingChanges and Error Corrections” an amendment to Accounting Principles Bulletin(APB) Opinion No. 20, “Accounting Changes”, and SFAS No. 3, “ReportingAccounting Changes in Interim Financial Statements” though SFAS No. 154carries forward the guidance in APB No. 20 and SFAS No. 3 withrespect to accounting for changes in estimates, changes in reporting entity,and the correction of errors. SFAS No. 154 establishes new standards onaccounting for changes in accounting principles, whereby all such changes mustbe accounted for by retrospective application to the financial statements ofprior periods unless it is impracticable to do so. SFAS No. 154 iseffective for accounting changes and error corrections made in fiscal yearsbeginning after December 15, 2005, with early adoption permitted forchanges and corrections made in years beginning after May 2005.

 

**NOTE 12. Geographic Information**

 

All fixed assest are located in theCompany’s offices in the United States.  Revenuesby geographical area for the three and nine months ended September 30,2005 and September 30, 2004:

 
| ** **    | ** ** | **Three months ended**       | ** ** | **Nine months ended**        | ** ** |
|---------------|------------|------------------------------|------------|------------------------------|------------|
| ** **    | ** ** | **September 30,  2005** | ** ** | **September 30,  2004** | ** ** | **September 30,****2005** | ** ** | **September 30,  2004** | ** ** |
| United States |       | $                            | 8,577,711  |                         | $          | 16,608,797 |   | $ | 35,202,481 |   | $ | 51,117,177 |   |
| Argentina     |       | 37,651,593                   |       | —                       |       | 56,776,041 |   | — |   |
| Latin America |       | 8,097,974                    |       | 784,284                      |       | 18,900,603 |   | 2,611,394 |   |
| Europe        |       | —                       |       | —                       |       | — |   | 87,737 |   |
| Total         |       | $                            | 54,327,278 |                         | $          | 17,393,081 |   | $ | 110,789,125 |   | $ | 53,816,308 |   |

 

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

 

Thisdiscussion and analysis should be read in conjunction with the accompanyingConsolidated Financial Statements and related notes. Our discussion andanalysis of our financial condition and results of operations are based upon

 

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our consolidated financialstatements, which have been prepared in accordance with accounting principlesgenerally accepted in the United States. The preparation of financialstatements in conformity with accounting principles generally accepted in theUnited States of America requires us to make estimates and assumptions thataffect the reported amounts of assets and liabilities, disclosure of anycontingent liabilities at the financial statement date, and reported amounts ofrevenue and expenses during the reporting period. On an ongoing basis we reviewour estimates and assumptions. Our estimates are based on our historicalexperience and other assumptions that we believe to be reasonable under thecircumstances. Actual results are likely to differ from those estimates underdifferent assumptions or conditions, but we do not believe such differenceswill materially affect our financial position or results of operations. Ourcritical accounting policies, the policies we believe are most important to thepresentation of our financial statements and require the most difficult,subjective and complex judgments, are outlined below in’’—Critical AccountingPolicies,’’ and have not changed significantly.

 

Inaddition, certain statements made in this report may constitute “forward-lookingstatements”. These forward-looking statements involve known or unknown risks,uncertainties and other factors that may cause the actual results, performance,or achievements of InfoSonics to be materially different from any futureresults, performance or achievements expressed or implied by theforward-looking statements. Specifically, 1) the actions of competitorsand customers and our ability to execute our business plans; and 2) ourability to increase revenues and operating income is dependent upon our abilityto continue to expand our current businesses and to enter new business areas,general economic conditions, and other factors. You can identify forward-lookingstatements by terminology such as “may,” “will,” “should,” “expects,” “intends,”“plans,”“anticipates,” “believes,” “estimates,” “predicts,” “potential,” “continues” orthe negative of these terms or other comparable terminology. Although webelieve that the expectations reflected in the forward-looking statements arereasonable, we cannot guarantee future results, levels of activity, performanceor achievements.

 

**Overview**

 

We are one of the largest distributors of wirelesshandsets and accessories in the United States and Latin America. We distributeproducts of several key manufacturers, including Kyocera, LG, Motorola, Nokia,Samsung, VK Mobile, and others. As an integral part of our customers’ supplychain, we perform value added services and customization processes. Ourdistribution and customization services include the purchasing, marketing,selling, software customization, warehousing, assembly, programming, packing,hardware customization, shipping and delivery of handsets for wirelesstelecommunications from manufacturers to carriers (wireless network operators),agents, resellers, distributors, independent dealers and retailers in theUnited States and Latin America.

 

As a partof our distribution activities, we perform value added services when requestedby the customer. These services include but are not limited to programming,locking, software loading, packaging, and quality assurance testing. We operatea distribution hub in Miami, Florida.

 

Since ourfounding in 1994, we have grown our business by focusing on the needs of ourcustomers, developing and maintaining close relationships with manufacturers,entering new markets, and sourcing new and innovative products, whilemaintaining close attention to operational efficiencies and costs.

 

We successfullycompleted an initial public offering of our shares of common stock in June 2004and our common stock is currently traded on the American Stock Exchange underthe symbol “IFO”.

 

We also have wholly owned subsidiaries toperform certain functions for some of our Latin American customers, theseinclude InfoSonics De Mexico, InfoSonics de Guatemala, InfoSonics El Salvadorand InfoSonics S.A., all of which are wholly owned.  Axcess Mobile, LLC, another of oursubsidiaries, is our discontinued operation. We no longer operate mall-based kiosks and on October 28, 2004, weassigned the leases for six of the mall-based kiosk locations to an unrelatedassignee; however, the assignment did not release the Company from the futurelease obligations. The assignee operates approximately 400 mall-based kiosks in28 states. A third party is holding in escrow two months rent for the locationsfrom the assignee, and in the event of default by the assignee, those fundswill be released to the Company.  Theother lease locations were closed in October 2004.  These subsidiaries are included in ourconsolidated financial statements and significant inter-company amounts havebeen eliminated.

 

Due toseasonal and other factors, our interim results may not be indicative of annualresults. Our operating results are influenced by several seasonal and otherfactors, which may cause our revenues and operating results to fluctuate on aquarterly basis, including but not limited to the timing and introduction ofnew products by our suppliers and competitors, promotions and subsidies bywireless network operators, purchasing patterns of customers, and the timing ofholidays and other events affecting consumer demand.

 

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**Areas ofManagement Focus and Performance Indicators**

 

We manage our business by focusing on the needs ofour customers, developing and maintaining close relationships withmanufacturers, entering new markets, and sourcing new and innovative products,while maintaining close attention to operational efficiencies and costs. Thedesired results of this focus are increased shipping volumes and improvedefficiencies to enable higher levels of profitability and earnings growth.Other areas that we focus on include management execution, employeedevelopment, customer service, risk management, legal and ethical compliance,and corporate governance. 

 

Performance indicators that are key for themonitoring and management of our business include operating and net income,cost of sales and gross profit percentage, operating expenses as a percent ofrevenues, and overall net sales growth. These items are specifically discussedfurther in this section. We make extensive use of our customized informationsystem to closely monitor all aspects of our business, including subsidiaryperformance, customer relationship management, intelligent purchasing,inventory control, inventory flow, line item margin control for every order,and weighted average cost and statistical data for every product, customer andsupplier. We believe a strong focus on providing better service to customersleads to increased customer satisfaction and resulting customer retention andpotential increases in sales.

 

Management spends a significant amount of timetraveling with the purpose of spending time with key customers, suppliers andemployees, as well as to identify new business opportunities both in the UnitedStates and Latin America. We believe that these relationships are vitalto the success of the company and we will continue to dedicate a significantamount of time to this area. We also focus on management execution, qualitydelivery of services to customers, risk management, and corporate governance.

 

**IndustryTrends, Challenges, Risks and Growth Opportunities**

 

In 2004, worldwide wireless handset sales increasedby approximately 31%, and they are forecasted to increase 23% in 2005. A rapiddecline in wireless handset sales growth could negatively impact our net sales.Higher than anticipated growth in demand could strain our resources and affectour ability to meet these unanticipated demands.

 

Excesssupply conditions 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, couldexperience supply constraints that would affect our ability to deliver product.We are unable to quantify these effects, as it is difficult to predict futuresupply conditions and demand patterns which affect our ability to meet customerdemand or sell handsets at an acceptable gross profit.

 

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

 

For thethree months ended September 30, 2005, net sales increased 212% andhandsets sold increased 318% compared with the three months ended September 30,2004. Although we have incorporated growth into our strategic objectives, therecan be no assurance these trends will continue. Similarly, while we experienceda 511% increase in income from operations before interest expense and provisionfor taxes for the three months ended September 30, 2005 and an increase innet income of 355% compared with September 30, 2004, we cannot anticipatefuture growth to be at the same levels. Our strategy incorporates overallgrowth elements for each aspect of our business, which we hope will result incontinued earnings growth; however, there can be no assurance this trend willcontinue. Potential investment in growth opportunities and assumed additionalrisks could alter our earnings trend.

 

**RiskRelated to Our Business**

 

***Our operating results may vary significantly, which may cause our stockprice to fluctuate.***

 

Ouroperating results are influenced by a number of factors, which may cause ourrevenue and operating results to fluctuate. These factors include:

 

•                  promotionsand subsidy by wireless network operators;

 

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

 

•                  purchasingpatterns of customers in different markets;

 

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•                  generaleconomic conditions; and

 

•                  productavailability and pricing. 

 

***We buy a significant amount of our products from a limited number ofsuppliers, who may not provide us with competitive products at reasonableprices when we need them in the future.***

 

Wepurchase wireless handsets and accessories principally from wirelesscommunications equipment manufacturers and distributors. We depend on thesesuppliers to provide us with adequate inventories of currently popular brandname products on a timely basis and on favorable pricing and other terms. Ouragreements with our principal suppliers are non-exclusive, can be terminated onshort notice and provide for certain territorial restrictions, as is common inour industry. For the three months ended September 30, 2005 our top threesuppliers accounted for 62%, 15% and 11% respectively of our purchases,compared to the three months ended September 30, 2004 during which our toptwo suppliers accounted for 42%, and 16% respectively of our purchases. Oursuppliers may not offer us competitive products on favorable terms or withtimely delivery. From time to time, we have been unable to obtain sufficientproduct supplies. Any failure or delay by our suppliers 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 amaterial adverse effect on our results of operations.

 

***Our continuing liabilities on leases from our former mall-based retailkiosk locations could have a negative impact on earnings and cash flow.***

 

Althoughwe have assigned our six remaining retail leases to a third party and we havereceived indemnification from the third party, we also remain liable to thelessor, for the respective remaining lease terms of one to three years, if thethird party does not fulfill its obligations under the leases. As of December 31,2004 the total potential liability under these leases was $1,629,520 which ispartially offset by a $95,044 escrow deposit held for the benefit of InfoSonicsto the extent that the third party should default on any of the assignedleases. This escrow is not reflected on our financial statements. This leaseliability is discussed in the footnotes to our consolidated financialstatements.

 

***The loss or reduction in orders from principal customers or a reductionin prices we are able to charge these customers will have a negative impactupon our revenues and could cause our stock price to decline.***

 

Our threelargest customers during the three months ended September 30, 2005accounted for approximately16%, 14% and 12% respectively, of our product sales. The markets we serveare subject to severe price competition. Additionally, our customers are notcontractually obligated to purchase product from us. For these and otherreasons such as competitive pricing and competitive pressures, customers mayseek to obtain products or services from us at lower prices than we have beenable to obtain from these customers in the past. This could occur, for example,in the case of a customer purchasing large quantities of a product from us, whothen terminates this relationship because the customer can obtain a lower priceby buying directly from the manufacturer. The loss of any of our principalcustomers, a reduction in the amount of product or services our principalcustomers order from us or the inability to maintain current terms, includingprice, with these or other customers could have an adverse effect on ourfinancial condition, results of operations and liquidity. We have experiencedlosses of certain customers through industry consolidation and ordinary courseof business and there can be no assurance that any of our customers willcontinue to purchase products or services from us or that their purchases willbe at the same or greater levels than in prior periods.

 

***Our future profitability depends on our ability to maintain existingmargins and our ability to increase our sales, which we may not be able to do.***

 

The grossmargins that we realize on sales of wireless handsets could be reduced due toincreased competition or a growing industry emphasis on cost containment.Therefore, our future profitability will depend on our ability to maintain ourmargins or to increase our sales to help offset potential future declines inmargins. We may not be able to maintain existing margins for products orservices offered by us or increase our sales. Our ability to generate sales isbased upon demand for wireless telecommunications products and our having anadequate supply of these products. Even if our sales rates do increase, thegross margins that we receive from our sales may not be sufficient to make ourfuture operations profitable or as profitable.

 

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***Our business depends on the continued tendency of wireless equipmentmanufacturers and network operators to outsource aspects of their business tous.***

 

Ourbusiness depends in large part on wireless equipment manufacturers and networkoperators outsourcing some of their business functions to us. We providefunctions such as distribution, inventory management, customized packaging,activation management and other services. Certain wireless equipmentmanufacturers and network operators have elected, and others may elect, toundertake these services internally. Additionally, our customer service levels,industry consolidation, competition, deregulation, technological changes orother factors could reduce the degree to which members of the wirelesstelecommunications industry rely on outsourced services such as the services weprovide. Any significant change in the market for these services could have amaterial adverse effect on our current and planned business.

 

***We may not be able to effectively compete in our industry ifconsolidation of wireless network operators continues.***

 

The pastseveral years have witnessed a consolidation within the wireless networkoperator community. If this trend continues, it could result in a reduction orelimination of promotional activities by the remaining wireless networkoperators as they seek to reduce their expenditures, which could, in turn,result in decreased demand for our products or services. Moreover,consolidation of wireless network operators reduces the number of potentialcontracts available to us. We could also lose business if wireless network operators,which currently are our customers, are acquired by other wireless networkoperators which are not our customers. Wireless operators may also change theirpolicy regarding sales to their agents by independent distributors, such asrequiring those agents to purchase products from the wireless operator ormanufacturer, rather than from distributors such as InfoSonics. This type ofrequirement could have a material adverse effect on our business and results ofoperations.

 

***Our sales and inventory risk may be materially affected by fluctuationsin regional demand patterns and economic factors for which we cannot plan.***

 

Thedemand for our products and services has fluctuated and may continue to varysubstantially within the regions served by us. We believe the roll-out of thirdgeneration, or 3G, cellular telephone systems and other new technologies, whichhas been delayed and could further be delayed, has had and will continue tohave an effect on overall subscriber growth and handset replacement demand. Economicslow-downs in regions served by us or changes in promotional programs offeredby wireless network operators may lower consumer demand for our products andcreate higher levels of inventories which could decrease our gross andoperating margins. We could face a substantial inventory risk due todepreciation and equipment price erosion if our products are not sold in atimely manner. We believe our operations were adversely affected by an economicslow-down in the United States starting in the fourth quarter of 2000. Aprolonged economic slow-down in the United States or any other regions in whichwe have significant operations could negatively impact our results ofoperations and financial position.

 

***We may not be able to adequately respond to rapid technological changesin the wireless telecommunications industry, which could cause us to losecustomers.***

 

Thetechnology relating to wireless telecommunications equipment changes rapidlyresulting in product obsolescence or short product life cycles. We are requiredto anticipate future technological changes in our industry and to continuallyidentify, obtain and market new products in order to satisfy evolving industryand customer requirements. Competitors or manufacturers of wireless equipmentmay market products which have perceived or actual advantages over productsthat we handle or which otherwise render those products obsolete or lessmarketable. We have made and continue to make significant capital investmentsin accordance with evolving industry and customer requirements includingmaintaining levels of inventories of currently popular products that we believeare necessary based on current market conditions. This utilization of capitalfor inventory buildup of this nature increases our risk of loss due to productobsolescence.

 

***Substantial defaults by our customers on accounts receivables couldhave a significant negative impact on our cash flow and financial condition.***

 

Wecurrently offer and intend to offer open account terms to certain of our customers,which may subject us to credit risks, particularly to the extent that ourreceivables represent sales to a limited number of customers or areconcentrated in particular geographic markets. Although we have an accountsreceivable insurance policy, this policy carries a substantial deductible andmay not cover us in all instances. We also have an accounts receivable creditfacility in order to reduce our working capital requirements. The extent of ourability to use our accounts receivable credit facility is dependent on theamount of and collection cycle of our accounts receivable. Adverse changes inour ability to use accounts receivable financing could have a material adverseeffect on our financial position, cash flows and results of operations.

 

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***We rely on our suppliers to provide trade credit facilities toadequately fund our on-going operations and product purchases, and withoutthose facilities, our ability to procure products could be reduced.***

 

Ourbusiness is dependent on our ability to obtain adequate supplies of currentlypopular products on favorable pricing and other terms. Our ability to fund ourproduct purchases is dependent on our principal suppliers providing favorablepayment terms that allow us to maximize the efficiency of our capital usage.The payment terms we receive from our suppliers are dependent on severalfactors, including, but not limited to, our payment history with the supplier,the suppliers’ credit granting policies, contractual provisions, our overallcredit rating as determined by various credit rating agencies, industryconditions, our recent operating results, financial position and cash flows andthe supplier’s ability to obtain credit insurance on amounts that we owe them.Adverse changes in any of these factors, certain of which may not be wholly inour control, could have a material adverse effect on our operations.

 

***Approximately 84% and68% of our revenues during the three and nine monthsended September 30, 2005, respectively, were generated outside of theUnited States in countries that may have political or other risks.***

 

We engagein sales activities in territories and countries outside of the United States.The fact that we distribute products into a number of countries exposes us toincreased credit risks, customs duties, import quotas and other traderestrictions, potentially greater inflationary pressures, and shipping delays.Changes may occur in social, political, regulatory and economic conditions orin laws and policies governing foreign trade and investment in the territoriesand countries where we currently distribute products. United States laws andregulations relating to investment and trade in foreign countries could alsochange to our detriment. Any of these factors could have a material adverseeffect on our business and operations. Although we purchase and sell productsand services in United States dollars and do not engage in exchange swaps,futures oroptions contracts or other hedging techniques, fluctuations in currencyexchange rates could reduce demand for products sold in United States dollars.We cannot predict the effect that future exchange rate fluctuations will haveon our operating results. We may in the future engage in currency hedgingtransactions, which could result in our incurring significant additionallosses.

 

***We rely on our information system technology to function efficiently,without interruptions, and if it does not, customer relationships could beharmed.***

 

We havefocused on the application of our information system technology to providecustomized services to wireless communications equipment manufacturers andnetwork operators. Our ability to meet our customers’ technical and performancerequirements is highly dependent on the effective functioning of ourinformation technology systems, which may experience interruptions. Thesebusiness interruptions could cause us to fall below acceptable performancelevels pursuant to our customers’ requirements and could result in the loss ofthe related business relationship.

 

***We have outstanding indebtedness, which is secured by substantially allour assets and which could prevent us from borrowing additional funds, ifneeded.***

 

We hadoutstanding debt in the amount of approximately $17.7 million at September 30,2005 in the form of a bank line of credit which is based on accountsreceivable. If we violate our loan covenants, default on our obligations orbecome subject to a change of control, our indebtedness would becomeimmediately due and payable. Our credit facility is secured by substantiallyall of our assets and borrowing availability is based primarily on a percentageof eligible accounts receivable. Consequently, any significant decrease ineligible accounts receivable will limit our ability to borrow additional fundsto adequately finance our operations and expansion strategies. The terms of ourcredit facility could substantially prohibit us from incurring additionalindebtedness, which could limit our ability to expand our operations. The termsof our credit facility also include negative covenants that, among otherthings, limit our ability to sell certain assets and make certain payments,including but not limited to, dividends, repurchases of common stock and otherpayments outside the normal course of business as well as prohibiting us frommerging or consolidating with another corporation or selling all orsubstantially all of our assets. This facility was replaced by a new facilityin October 2005.  The new faciltyexpires October 2006.

 

***The wireless telecommunications industry is intensely competitive andwe may not be able to continue to compete against well-established competitorswith greater financial and other resources.***

 

Wecompete for sales of wireless telecommunications equipment and accessories, andexpect that we will continue to compete, with numerous well-establishedwireless network operators, distributors and manufacturers, including our ownsuppliers. Many of our competitors possess greater financial and other resourcesthan we do and may market similar products

 

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or services directly to ourcustomers. Distribution of wireless telecommunications equipment andaccessories has generally had low barriers to entry. As a result, additionalcompetitors may choose to enter our industry in the future. The markets forwireless handsets and accessories are characterized by intense pricecompetition and significant price erosion over the life of a product. Many ofour competitors have the financial resources to withstand substantial pricecompetition and to implement extensive advertising and promotional programs,both generally and in response to efforts by additional competitors to enterinto new markets or introduce new products. Our ability to continue to competesuccessfully will depend largely on our ability to maintain our currentindustry relationships. We may not be successful in anticipating and respondingto competitive factors affecting our industry, including new or changingoutsourcing requirements, the entry of additional well-capitalized competitors,new products which may be introduced, changes in consumer preferences,demographic trends, international, national, regional and local economicconditions and competitors’ discount pricing and promotion strategies. Aswireless telecommunications markets mature and as we seek to enter into newmarkets and offer new products in the future, the competition that we face maychange and grow more intense.

 

***Our continued growth depends on retaining our current key employees andattracting additional qualified personnel, and we may not be able to continueto do so.***

 

Oursuccess depends in large part on the abilities and continued service of ourexecutive officers and other key employees, particularly Joseph Ram, our ChiefExecutive Officer. Although we have entered into employment agreements withseveral of our officers and employees, including Mr. Ram, we may not beable to retain their services under applicable law. The loss of executiveofficers or other key personnel could have a material adverse effect on us. Inaddition, in order to support our continued growth, we will be required toeffectively recruit, develop and retain additional qualified management. If weare unable to attract and retain additional necessary personnel, it could delayor hinder our plans for growth.

 

***We rely on trade secret laws and agreements with our key employees andother third parties to protect our proprietary rights, and there is noassurance that these laws or agreements adequately protect our rights.***

 

We relyon trade secret laws to protect our proprietary knowledge, particularly ourdatabase of customers and suppliers and business terms such as pricing. Ingeneral, we also have non-disclosure agreements with our key employees andlimit access to and distribution of our trade secrets and other proprietaryinformation. These measures may prove difficult to enforce and may not proveadequate to prevent misappropriation of our proprietary information.

 

***We may become subject to suits alleging medical risks associated withour wireless handsets, and the cost of these suits could be substantial, anddivert funds from our business.***

 

Lawsuitsor claims have been filed or made against manufacturers of wireless handsetsover the past years alleging possible medical risks, including brain cancer,associated with the electromagnetic fields emitted by wireless communicationshandsets. There has been only limited relevant research in this area, and thisresearch has not been conclusive as to what effects, if any, exposure toelectromagnetic fields emitted by wireless handsets has on human cells.Substantially all of our revenues are derived, either directly or indirectly,from sales of wireless handsets. We may become subject to lawsuits filed byplaintiffs alleging various health risks from our products. If any futurestudies find possible health risks associated with the use of wireless handsetsor if any damages claim against us is successful, it could have a materialadverse effect on our business. Even an unsubstantiated perception that healthrisks exist could adversely affect our ability or the ability of our customersto market wireless handsets.

 

**RisksRelated To Our Common Stock**

 

***Stockholders may be diluted as a result of future offerings or otherfinancings.***

 

We mayneed to raise additional capital through one or more future public offerings,private placements or other financings involving our securities. As a result ofthese financings, none of which is currently planned, ownership interests inour company may be greatly diluted.

 

***Our common stock, and our stock price could be volatile and coulddecline, resulting in a substantial loss on your investment.***

 

Prior toour initial public offering in June 2004, there was not a public marketfor our common stock. An active trading market for our common stock may neverdevelop or be sustained, which could affect the ability of our stockholders tosell their shares and could depress the market price of their shares. The stockmarket in general and the market for telecommunications-related stocks inparticular, has been highly volatile. As a result, the market price of ourcommon stock

 

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is likely to be similarly volatile,and investors in our common stock may experience a decrease in the value oftheir stock, including decreases unrelated to our operating performance orprospects. The price of our common stock could be subject to wide fluctuationsin response to a number of factors, including those listed in this ‘‘RiskFactors’’ section of this Form 10-Q. In the past, securities classaction litigation has often been instituted against companies following periodsof volatility in their stock price. This type of litigation against us couldresult in substantial costs and divert our management’s attention andresources.

 

***Shares of common stock that are issuable pursuant to our stock optionplans and our outstanding warrants, when issued, could result in dilution toexisting stockholders and could cause the market price of our common stock tofall.***

 

We havereserved shares of common stock that may be issuable pursuant to our stockoption plans and our outstanding options outside those plans. These securities,when issued and outstanding, may reduce earnings per share under accountingprinciples generally accepted in the United States of America and, to theextent that they are exercised and shares of common stock are issued, dilutepercentage ownership to existing stockholders which could have an adverseeffect on the market price of our common stock.

 

***The ability of our stockholders to control our policies or effect achange in control of our company is limited, which may not be in ourstockholders’ best interests.***

 

Someprovisions of our charter and bylaws and the General Corporation Law ofMaryland, where we are incorporated, may delay or prevent a change in controlof our company or other transactions that could provide our common stockholderswith a premium over the then-prevailing market price of our common stock orthat might otherwise be in the best interests of our stockholders. Theseinclude the ability of our Board of Directors to authorize the issuance ofpreferred stockwithout stockholder approval, which preferred stock may have voting provisionsthat could delay or prevent a change in control or other transaction that mightinvolve a premium price or otherwise be in the best interests of ourstockholders. Maryland law imposes restrictions on some business combinationsand requires compliance with statutory procedures before some mergers andacquisitions can occur. These provisions of Maryland law may have the effect ofdiscouraging offers to acquire us even if the acquisition would be advantageousto our stockholders.

 

***If our two largest stockholders have strategic interests that aresimilar and that differ from those of our other stockholders, and if those twostockholders vote in the same manner, they may be able to cause results thatthe other stockholders do not believe to be beneficial to their interests.***

 

Two ofour stockholders, in the aggregate, beneficially own approximately 61.6% of ouroutstanding common stock. To the extent that these stockholders vote theirshares similarly, they will be able to exercise control over many mattersrequiring approval by the board of directors or our stockholders. As a result,they would be able to:

 

•                  controlthe composition of our board of directors;

 

•                  controlour management and policies;

 

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

 

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

 

**Available Information**

 

Our website at www.infosonics.comprovides a link to the Securities and Exchange Commission’s website where ourAnnual Reports on Form 10-K, Quarterly Reports on Form 10-Q, CurrentReports on Form 8-K (including exhibits and supplementary schedules) andamendments to those reports, filed or furnished under Section 13(a) or15(d) of the Securities Exchange Act of 1934, can be accessed free ofcharge.

 

**Results ofOperations:**

 

***Three months ended September 30, 2005compared with three months ended September 30, 2004***

 

Net salesfor the three months ended September 30, 2005 were $54.2 million, comparedwith $17.4 million for the

 

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three months ended September 30,2004, an increase of 212%. The increase in net sales is primarily due to a 318%increase in units sold, which was partially offset by a 25% decrease in averageunit selling price compared to the three months ended September 30, 2004.The significant progress the Company has made selling directly to the cellularcarriers in the Untied States and Latin America is directly responsible for theincreased sales, both in dollars and units sold.  Net sales from Argentina and Latin Americaincreased to $45.7 million for the three months ended September 30, 2005,as compared with $0.8 million for the three months ended September 30,2004. This increase is primarily the result of our acquisition in Argentinawhich was completed in January 2005, in addition to increased personneland selling efforts in Latin America. Revenues in the United States were $8.6 million for the three monthsended September 30, 2005 as compared with $16.6 million for the threemonths ended September 30, 2004.  Thisdecrease is primaruliy a result of our shift in sales focus in the U.S. salesfrom the dealer/agent channel to rural U.S. carriers, and the resulting salesto rural U.S. carriers have not been sufficient to offset our decline in salesto U.S. dealer/agents.

 

Cost ofsales for the three months ended September 30, 2005 was $50.0 million, or 92.3%of net sales, compared with $16.1 million, or 92.7% of net sales, for the threemonths ended September 30, 2004. The $33.9 million (211%) increase in costof sales is consistent with our 212% increase in net sales.

 

Grossprofit for the three months ended September 30, 2005 was $4.2 million, or 7.7%of net sales, compared with $1.3 million, or 7.3% of net sales, for the threemonths ended September 30, 2004. The 5% increase in gross profitpercentage from 7.3% to 7.7% represents a shift in products with higher grossmargin opportunity during the three months ended September 30, 2005 ascompared with the three months ended September 30, 2004.

 

Operatingexpenses for the three months ended September 30, 2005 were $3.0 million,or 5.5% of net sales, compared with $1.1 million, or 6.2% of net sales, for thethree months ended September 30, 2004. The $1.9 million increase isprimarily due toexpenses related to 1) increased investments in infrastructure due to expensesin obtaining type approval certification from key carrier customers in theUnited States and in Latin America, 2) being a public company and 3) ourexpanded operations in Latin America, all of which have contributed to ourincreased sales levels. We now also occupy larger office and warehousefacilities. The decrease in operating expenses as a percentage of revenues isrelated to the factors discussed above, and our ability to take advantage ofefficiencies in our operations as we continue to grow.

 

Incomefrom continuing operations before interest expense and provision for incometaxes for the three months ended September 30, 2005 was $1.2 million,representing an increase of 511% compared to the three months ended September 30,2004. As a percentage of net sales, income from operations was 2.2% for thethree months ended September 30, 2005 compared with 1.1% for the threemonths ended September 30, 2004. This increase in income from continuingoperations both in dollars and as a percentage of net sales, is the result ofincreased sales volumes, increased gross margin and gross profit and our operationalefficiencies achieved.

 

For the three months ended September 30, 2005, wehad a gain from discontinued operations of $392,000, or $.07 per share, ascompared with a loss of $788,000, or $.15 per share, for the three months endedSeptember 30, 2004.  The gain duringthe quarter ended September 30, 2005 is a result of the resolution ofoutstanding accounts with a former supplier for the discontinuedoperations.  This supplier is notinvolved with our continuing operations.

 

Netincome for the three months ended September 30, 2005 was $1.2 million or$0.20 per diluted share, compared to net loss of $460,000, or $0.09 per dilutedshare, for the three months ended September 30, 2004, representing a dollarincrease of $1.6 million The increase in net income is primarily due toincreased net sales and increased gross profits, as well as the gain fromdiscontinued operations. 

 

***Nine Months Ended September 30, 2004Compared with Nine Months Ended September 30, 2005***

 

Net salesfor the nine months ended September 30, 2005 were $110.8 million, comparedwith $53.8 million for the nine months ended September 30, 2004, anincrease of 106%. The increase in net sales is primarily due to a 140% increasein units sold, which was partially offset by a 14% decrease in average unitselling price compared to the nine months ended September 30, 2004. Thefirst nine months of 2005 have begun to show results for the efforts and focusthe Company has had with the rural carriers in the United States and the LatinAmerican carriers.  Net sales from Argentinaand Latin America increased to $75.7 million for the nine months ended September 30,2005, as compared with $2.6 million for the nine months ended September 30,2004. This increase is primarily the result of our focused efforts in LatinAmerica during the first nine months of 2005, which included our acquisition inArgentina which was completed in January 2005, as well as increasedpersonnel and selling efforts in Latin America. Revenues in the United States were $35.2 million for the nine monthsended September 30, 2005 as compared with $51.1 million for the ninemonths ended September 30, 2004. This decrease was primarily due to ourshifting our U.S. sales focus from the dealer/agent channel to rural carriersin the United States, and the

 

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resulting sales to these carriers notbeing at a level sufficient to offset our decline in sales to the dealer/agentsin the United States.

 

Cost ofsales for the nine months ended September 30, 2005 was $101.8 million, or91.9% of net sales, compared with $49.6 million, or 92.1% of net sales, for thenine months ended September 30, 2004. The $52.2 million (105%) increase incost of sales is consistent with our 106% increase in net sales.

 

Grossprofit for the nine months ended September 30, 2005 was $9.0 million, or8.1% of net sales, compared with $4.2 million, or 7.9% of net sales, for the ninemonths ended September 30, 2004. The 3% increase in gross profitpercentage from 7.9% to 8.1% is primarily due to our shift in sales to ruralcarriers in the United States as well as sales to carriers sales in LatinAmerica for the nine months ended September 30, 2005, as compared with thenine months ended September 30, 2004 when sales were primarily to dealeragents.  In addition products with highermargin opportunity were available during the nine months ended September 30,2005.

 

Operatingexpenses for the nine months ended September 30, 2005 were $6.5 million,or 5.9% of net sales, compared with $3.1 million, or 5.8% of net sales, for thenine months ended September 30, 2004. The $3.4 million increase isprimarily due to expenses related to 1) increased investments in infrastructuredue to expenses in obtaining type approval certification from key carriercustomers in the United States and in Latin America, 2) being a public companyfor the entire period of 2005 and 3) our expanded operations in Latin America,all of which have contributed to our increased sales levels. We now also occupylarger office and warehouse facilities. The increase in operating expenses as apercentage of revenues is related to the factors discussed above.

 

Incomefrom continuing operations before interest expense and provision for incometaxes for the nine months ended September 30, 2005 increased to $2.5million from $1.1 million for the nine months ended September 30, 2004,representing an increase of 120%. As a percentage of net sales, income fromcontinuing operations was 2.2% for the nine months ended September 30,2005 compared with 2.0% for the nine months ended September 30, 2004. Thisincrease in income from continuing operations both in dollars and as apercentage of net sales, is the result of increased sales volumes, increasedgross profit and gorss margin and our ability to take advantage of efficiencies in ouroperations as we continue to grow.

 

For the nine months ended September 30, 2005, we hada gain from discontinued operations of $380,000, or $.06 per share, as comparedwith a loss of $961,000, or $.24 per share, for the nine months ended September 30,2004.  The gain during the nine monthsended September 30, 2005 is a result of the resolution of outstandingaccounts with a former supplier for the discontinued operations.  This former supplier is not involved with ourcontinuing operations.

 

Netincome for the nine months ended September 30, 2005 was $1.9 million or$0.32 per diluted share, compared to net loss of $34,000, or $0.01 per dilutedshare, for the nine months ended September 30, 2004, representing a dollarincrease of $1.9 million. The increase in net income is primarily due toincreased net sales, increased gross profits and gross margins, the gain fromdiscontinued operations as well as increased operational efficiencies achivedduring the nine months ended September 30, 2005. 

 

**FinancialCondition, Liquidity and Capital Resources**

 

*Cash and Cash Flows*

 

At September 30,2005, we had cash and cash equivalents of $1.4 million, and at December 31,2004, we had cash and cash equivalents of $5.2 million.

 

During the quarter ended September 30, 2005, wecontinued to leverage our bank and vendor lines of credit to help fund ourgrowth. The net cash used by operating activities was $18.5 million for the ninemonths ended September 30, 2005, increased borrowings from our line ofcredit and vendor partners to fund product purchases for increased sales and whichresulted primarily from increased accounts receivable. The $29.4 millionincrease in accounts receivable was due to increased sales in the quarter endedSeptember 30, 2005. Allowance for doubtful accounts at September 30,2005 increased to $1.0 million compared to $250,000 at December 31, 2004.This increase****was related to ourincreased sales levels and increased accounts receivable balance at September 30,2005. We believe that at September 30, 2005, our reserve for doubtfulaccounts is adequate.  The increase ofcash used in operations related to accounts receivable was partially offset byan increase in our accounts payable of $7.0 million, and an increase in accruedexpenses of $2.8 million, which were both a direct result of increasing linesof credit from our vendor partners.

 

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Days’ sales outstanding at September 30, 2005 was 53 dayscompared with 40 days at December 31, 2004. Normal payment terms requireour customer payment on a net 30-day basis and during the quarter ended September 30,2005 we had a large amount of sales occur towards the end of the quarter,resulting in a higher accounts receivable amount,, subsequent to September 30,2005, approximately $32 million was collected thru November 10, 2005. Weare constantly working with our customers to reduce our days’ salesoutstanding.

 

The net cash used in investing activities was $280,000 forthe nine months ended September 30, 2005 compared with $200,000 for the ninemonths ended September 30, 2004. The cash used in the period ended September 30,2005 was primarily the result of expenditures for machinery and equipment tosupport technical capabilities and assembly machines and increased warehouseand facility space, as well as the technical tools and equipment necessary forthe testing, repair and customization process.

 

The net cash provided by financing activities for the nine monthsended September 30, 2005 of $15.2 million is the result of borrowings fromour bank line of credit.

 

Our tangible net worth at September 30, 2005 was $14.8million, compared with $12.4 million at December 31, 2004. This change wasdue primarily to our increased net income for the nine months ended September 30,2005.

 

**Borrowings**

 

Weutilize a bank line of credit that is based upon eligible accounts receivable.As of September 30, 2005 and December 31, 2004, amounts advancedagainst our line were approximately $17,700,000 and $2,600,000,respectively. This credit line has been an important part of growing ourbusiness, and market changes affecting accounts receivable could diminish theborrowing base of available funds. As of September 30, 2005 and December 31,2004, advances were 98% and 47%, respectively, of the available borrowing base.

 

On October 6,2005, the Company entered into a Credit Agreement (the “Wells Fargo Agreement”)with Wells Fargo HSBC Trade Bank, N.A. (“Wells Fargo”) that allows the Companyto borrow up to a maximum of $20,000,000 and expires on October 1,2006.  The Wells Fargo Agreement providesfor advances not to exceed 80% of eligible domestic accounts receivable and 85%of eligible foreign insured accounts.

 

Interest on the line of credit is payable on a monthly basis at WellsFargo’s prime rate **(******6.75%**** at October 6, 2005) orat the London Inter-Bank Offering Rate (“LIBOR”) plus 1.5% (LIBOR was 4% at October 6,2005).  The line of credit iscollateralized by substantially all of the assets of the Company.  In addition to reporting and othernon-financial covenants, the line of credit contains certain financialcovenants which, among other items, require the Company to maintain a tangiblenet worth of not less than $12,000,000, a quick ratio of not less than 1-to-1,a debt-to-tangible net worth ratio of not greater than 2-to-1, to maintain apre-tax profit of not less than $1 on a rolling four-quarter basis, and tomaintain net income after taxes of not less than $1 on an annual basis.  Management believes the Company was incompliance with these covenants at November 14, 2005.  The Company paid the outstanding amount owedunder its previous line of credit with funds from the line of credit providedby Wells Fargo.  Asof November 11, 2005, our net availability on the maximum borrowing amountas of that date was approximately $XX million.

 

Webelieve that our existing cash resources, together with our projected cash flowfrom operations and the net proceeds from our bank line of credit, will besufficient to allow us to implement our strategy and growth plan.

 

**CriticalAccounting Policies**

 

Webelieve the following critical accounting policies are important to thepresentation of our financial condition and results, and require management’sjudgments often as a result of the need to make estimates about the affect ofmatters that are inherently uncertain.

 

***Revenue Recognition and Accrued Chargebacks***

 

Revenuesare recognized upon (1) shipment of the products to customers, (2) whencollection of the outstanding receivables is probable, and (3) the finalprice of the product is determined. Commission revenue, paid by the carrier, onphone activations is recorded at the time of the activation and may be chargedback to us in future periods. Commission revenue and accrued chargebacks arerelated to our discontinued operations. The carrier has six months from date ofactivation to charge back amounts previously credited to us if the customerterminates its service. We provide an allowance

 

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for estimated returns based on ourexperience, which estimate is recorded as a contra asset against accountsreceivable. A provision for returns is provided in the same period in which therelated revenue is recorded. Customer credit-worthiness and economic conditionsmay change and increase the risk of collectibility and contract terminationsand may require additional provisions, which would negatively impact our operatingresults.

 

***Allowance for Doubtful Accounts and SalesReturn Reserve***

 

Creditevaluations are undertaken for all major sale transactions before shipment isauthorized. Normal payment terms require payment on a net ninety-day basis. Onan on-going basis, we analyze the payment history of customer accounts,including recent customer purchases. We evaluate aged items in the accountsreceivable aging and provide reserves for doubtful accounts and estimated salesreturns. Customer credit-worthiness and economic conditions may change andincrease the risk of collectibility and sales returns, and may requireadditional provisions, which would negatively impact our operating results.

 

***Inventory Write-Off and Effect on GrossMargin***

 

Weregularly monitor inventory quantities on hand and record a provision forexcess and obsolete inventories based primarily on historical usage rates andour estimated forecast of product demand for a period of time, which isgenerally nine months. Because of obsolescence, we will generally provide afull reserve for the costs of our inventories in excess of our relevantforecast for the applicable period. We attempt to control our inventory levelsso that we do not hold inventories in excess of demand for the succeeding ninemonths. However, because we need to place non-cancelable orders withsignificant lead time and because it is difficult to estimate product demand,it is possible that we will build inventories in excess of demand for thefuture periods. If we have inventories in excess of estimated product demand,we will provide a reserve, which could have a material adverse effect on ourreported results of operations and financial position.

 

**Off-Balance Sheet Arrangements**

 

We do not have any off-balance sheet arrangements.

 

**Item3. Quantitative and Qualitative Disclosures About Market Risk**

 

We are subject to market risks with respect to interestrates because our lines of credit have had floating interest rates. As of September 30,2005 we could choose among the bank’s prime rate, which was 6.75% at September 30,2005, and the one-, two-, and three-month LIBOR rates plus 2.25% for the first$500,000 of borrowings and plus 2.5% for borrowing above $500,000. As ofSeptember 30,2005, our borrowings were all at the bank’s prime rate. If the full $18,000,000available under our credit facility were outstanding for a full year, eachincrease of 1% in the applicable interest rate would result in an additional $180,000in interest expense for that year.  Asmore fully described above under “Borrowings”, we replaced our line of creditfacility in October 2005.

 

Our business outside the United States is conducted in United Statesdollars. Although we purchase and sell products and services in United Statesdollars and do not engage in exchange swaps, futures or options contracts orother hedging techniques, fluctuations in currency exchange rates could reducedemand for products sold in United States dollars. We cannot predict the effectthat future exchange rate fluctuations will have on our operating results. Webelieve our exposure to market risks, including exchange rate risk, interestrate risk and commodity price risk, is not material at the present time. We mayin the future engage in currency hedging transactions, which could result in ourincurring significant additional losses.

 

**Item 4. Controls and Procedures**

 

As of theend of the period covered by this report, we conducted an evaluation, under thesupervision and with the participation of the principal executive officer andprincipal financial officer, of our disclosure controls and procedures (asdefined in Rules 13a-15(e) and 15d-15(e) under the SecuritiesExchange Act of 1934 (the “Exchange Act”)). Based on this evaluation, theprincipal executive officer and principal financial officer concluded that ourdisclosure controls and procedures are effective to ensure that informationrequired to be disclosed by us in reports that we file or submit under theExchange Act is recorded, processed, summarized and reported within the timeperiods specified in Securities and Exchange Commission (“SEC”) rules andforms. There was no change in our internal control over financial reportingduring our most recently completed fiscal quarter that has materially affected,or is reasonably likely to materially affect, our internal control overfinancial reporting.

 

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TheCompany is a non-accelrated filer and is required to comply with the internalcontrol reporting and disclosure requirements of Section 404 of theSarbanes-Oxley Act for fiscal years ending on or after July 15, 2007.  The Company is currently beginning thedocumentation phase of its Section 404 compliance and will be required tocomply with these disclosure requirements for it fiscal year ending December 31,2007.

 

**PART II.OTHER INFORMATION**

 

**Item 1.****          ****Legal Proceedings**

 

The Company may become involved in certain legalproceedings and claims which arise in the normal course of business. As of September 30,2005, the Company did not have any significant litigation outstanding, andmanagement does not expect any pending litigation matters to have a materialimpact on the Company’s liquidity or the financial statements taken as a whole.

 

**Item2.****          ****Unregistered Sales of EquitySecurities and Use of Proceeds.**

 

EffectiveAugust 16, 2005, the Company issued options to purchase 25,000 shares of common stock to certainemployees (the “Employee Options”).  TheEmployee Options vest over a two year period from the date of option grant (August 16,2005) and have an exercise price of $4.16 per share, which was the closingprice per share of the Company’s common stock on August 16, 2005. TheEmployee Options expire three years from the date of grant.  These grants were made pursuant toexemptions from registration under the Securities Act of 1933, including butnot limited to Section 4(2) of the Securities Act of 1933.

 

On January 19, 2005, the Companypurchased InfoSonics S.A (formerly Primasel S.A) from Fanrock InvestmentsLimited for up to 120,000 shares of InfoSonics common stock, based on sales ofcertain levels being achieved in the next three years.  During the three months ended September 30,2005, InfoSonics S.A. achieved sales levels that obligated the Company to issue120,000 shares of it’s common stock to Fanrock, and these shares were issued October 7,2005.  The issuance of these shares wasmade pursuant to exemptions from registration under the SecuritiesAct of 1933,including but not limited to Section 4(2) of the Securities Act of1933.

 

**Item3.****          ****Defaults Upon Senior Securities.**

 

None.

 

**Item4.****          ****Submission of Matters to a Voteof Security Holders.**

 

The following matter were submitted to a vote of securityholders at the annual meeting of stockholders which was held on August 5,2005.

 

The stockholders voted to re-elect Josh Ram, Abraham GRoseler, Randall Marx, Robert S Picow and Kirk A Waldron to coniue as directorsof the Company.  A total of     votes were represented with respect to this matter,with voting on each specific nominee as follows:

 
| ** **        | ** ** | **FOR**   | ** ** | **WITHHELD** | ** ** |
|-------------------|------------|-----------|------------|--------------|------------|
| Joseph Ram        |       | 4,950,939 |       | 165,325      |       |
| Abraham G. Rosler |       | 4,932,039 |       | 184,225      |       |
| Randall P. Marx   |       | 4,932,039 |       | 184,225      |       |
| Robert S. Picow   |       | 4,950,939 |       | 165,325      |       |
| Kirk A. Waldron   |       | 4,950,939 |       | 165,325      |       |

 

A proposal to ratify the employmentof Singer Lewak Greenbaum & Goldstein LLP as the Company’s independentauditor for fiscal year ending December 31, 2005 was approved by thestockholders.  A total of 5,116,264votes were represented with a total of 5,098,014(99.6%)shares voting for the proposal, 18,200 shares voting against the proposal, and 50shares abstaining from voting.

 

A proposal to amend our 2003 StockOption Plan to increase from 775,000 to 1,400,000 the number of shares ofcommon stock issuable pursuant to options granted under our 2003 Stock OptinPlan was approved by stockholders.  Atotal

 

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of 5,116,264 votes were represented with atotal of 3,336,327 (65.2%)shares voting for the proposal, 247,712 sharesvoting against the proposal, and 8,000shares abstaining from voting.

 

**Item 5.****          ****Other Information.**

 

None.

 

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

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

 

**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,  2005 | By:    | /S/ Joseph Ram                                              |   |
|   |                    |   | Joseph Ram                                                  |
|   |                    |   | Chief Executive  Officer                                    |
|   |                    |   |                                                        |
|   |                    |   |                                                        |
| Date:  | November 14,  2005 | By:    | /S/ Jeffrey  Klausner                                       |   |
|   |                    |   | Jeffrey Klausner                                            |
|   |                    |   | Chief Financial  Officer                                    |
|        |                         |        |                                                             |  |  |

 

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