| | | Nine Months Ended September 30, | |
| | | 2014 | | | 2013 | |
Operating activities: | | | | | | |
| Net income (loss) | | $ | (121,370 | ) | | $ | (536,330 | ) |
| | | | | | | | | |
| Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: | | | | | | | | |
| Depreciation and amortization | | | 6,784 | | | | 7,464 | |
| Stock based compensation | | | 11,696 | | | | 29,595 | |
| Provision for accounts receivable allowances | | | 844 | | | | (7,149 | ) |
| Provision for inventory reserves | | | 86,846 | | | | 10,365 | |
| Changes in operating assets and liabilities: | | | | | | | | |
| Accounts receivable | | | (325,118 | ) | | | 574,521 | |
| Inventories | | | 201,488 | | | | 71,672 | |
| Prepaid expenses and other assets | | | (34,085 | ) | | | 63,178 | |
| Accounts payable and accrued expenses | | | (41,612 | ) | | | 43,265 | |
| Net cash provided by (used in) operating activities | | | (214,527 | ) | | | 256,581 | |
| | | | | | | | | |
| Investing activities: | | | | | | | | |
| | | | | | | | | |
| Additions to property, plant and equipment | | | (5,336 | ) | | | (33,232 | ) |
| Net cash provided by (used in) investing activities | | | (5,336 | ) | | | (33,232 | ) |
| | | | | | | | | |
| Financing activities: | | | | | | | | |
| Net funds received from (paid to) bank credit lines | | | 371,057 | | | | (618,343 | ) |
| Proceeds from stock rights offering (net of issuance costs) | | | –– | | | | 248,678 | |
| Net cash provided by (used in) financing activities | | | 371,057 | | | | (369,665 | ) |
| | | | | | | | | |
| Effect of exchange rate changes on cash | | | (171 | ) | | | 1,407 | |
| | | | | | | | | |
| Net change in cash | | | 151,023 | | | | (144,909 | ) |
| | | | | | | | | |
| Cash and cash equivalents at beginning of period | | | 55,393 | | | | 195,704 | |
| | | | | | | | | |
| Cash and cash equivalents at end of period | | $ | 206,416 | | | $ | 50,795 | |
| | | | | | | | | |
| Supplemental disclosures of cash flow information: | | | | | | | | |
| | | | | | | | | |
| Cash paid during the period for: | | | | | | | | |
| Interest | | $ | 58,201 | | | $ | 51,610 | |
| Income taxes | | $ | 5,839 | | | $ | 2,734 | |
(1) Summary of Significant Accounting Policies
The accompanying financial statements are unaudited. However, the condensed balance sheet as of December 31, 2013 was derived from audited financial statements. In the opinion of management, the accompanying financial statements include all adjustments to present fairly the financial position, results of operations and cash flows of Zoom Telephonics, Inc. (“the Company”). The adjustments are of a normal, recurring nature.
The results of operations for the periods presented are not necessarily indicative of the results to be expected for the entire year. The Company has evaluated subsequent events from September 30, 2014 through the date of this filing and determined that there are no such events requiring recognition or disclosure in the financial statements.
The condensed financial statements of the Company presented herein have been prepared pursuant to the rules of the Securities and Exchange Commission for quarterly reports on Form 10-Q and do not include all of the information and disclosures required by accounting principles generally accepted in the United States of America. These financial statements should be read in conjunction with the audited financial statements and notes thereto for the year ended December 31, 2013 included in the Company's 2013 Annual Report on Form 10-K.
(a) Reclassifications
Certain reclassifications have been made to the prior year’s financial statements to conform to the 2014 presentation. The reclassifications relate to the presentation of changes in accounts receivable and inventory on the statements of cash flows. The reclassifications do not change the balance sheet, statement of operations, or total cash flows from operations.
(2) Liquidity
Zoom’s cash balance on September 30, 2014 was $206 thousand, up $151 thousand from December 31, 2013. A $371 thousand increase in bank debt and $288 thousand decrease in net inventory increased cash, and a $323 thousand increase in net accounts receivable and a net loss of $121 thousand decreased cash.
On September 30, 2014 Zoom had bank debt of $689 thousand, an unused line of credit of $561 thousand, and working capital of $2.2 million. On December 31, 2013 we had working capital of $2.3 million including $55 thousand in cash and cash equivalents. Our current ratio at September 30, 2014 was 2.3 compared to 2.8 at December 31, 2013.
On December 18, 2012, the Company entered into a Financing Agreement with Rosenthal & Rosenthal, Inc. (the “Financing Agreement”). The Financing Agreement provided for up to $1.75 million of revolving credit, subject to a borrowing base formula and other terms and conditions as specified in the Financing Agreement. The Financing Agreement continues until November 30, 2014 and from year to year thereafter, unless sooner terminated by either party as specified in the Financing Agreement. The Lender shall have the right to terminate the Financing Agreement at any time by giving the Company sixty days prior written notice. Borrowings are secured by all of the Company assets including intellectual property. The Loan Agreement contained several covenants, including a requirement that the Company maintain tangible net worth of not less than $2.5 million and working capital of not less than $2.5 million. On March 25, 2014, the Company entered into an amendment to the Financing Agreement (the “Amendment”) with an effective date of January 1, 2013. The Amendment clarified the definition of current assets in the Financing Agreement, reduced the size of the revolving credit line to $1.25 million, and revised the financial covenants so that Zoom is required to maintain tangible net worth of not less than $2.0 million and working capital of not less than $1.75 million.
The Company is continuing to develop new products and to take other measures to increase sales. Increasing sales typically results in increased inventory and higher accounts receivable, both of which reduce cash. Zoom believes that its financial resources and line of credit are sufficient to fund operations for the foreseeable future if Zoom management's sales and operating profit expectations are met.
(3) Inventories
| Inventories consist of : | | September 30, 2014 | | | December 31, 2013 | |
| Materials | | $ | 269,070 | | | $ | 440,723 | |
| Work in process | | | 21,764 | | | | –– | |
| Finished goods (including $82,700 and $304,500 held by customers at September 30, 2014 and December 31, 2013, respectively) | | | 1,134,913 | | | | 1,273,358 | |
| Total | | $ | 1,425,747 | | | $ | 1,714,081 | |
(4) Contingencies
The Company is party to various lawsuits and administrative proceedings arising in the ordinary course of business. The Company evaluates such lawsuits and proceedings on a case-by-case basis, and its policy is to vigorously contest any such claims which it believes are without merit. The Company's management believes that the ultimate resolution of such matters will not materially and adversely affect the Company's business, financial position, results of operations or cash flows.
On November 6, 2013, Innovative Wireless Solutions, LLC (“IWS”) filed a complaint against Zoom Telephonics alleging infringement of U.S. Patents Nos. 5,912,895, 6,327,264, and 6,587,473 all entitled “Information Network Access Apparatus and Methods of Communicating Information packets via Telephone Links.” The Complaint asserts that Zoom sells products with “wireless access points and/or routers capable of connecting to an Ethernet network and an IEEE 802.11 wireless network to provide wireless Internet access.” The case is in its early stages and discovery is ongoing. Management is unable to reasonably estimate any potential outcome at this time.
(5) Segment and Geographic Information
The Company’s operations are classified as one reportable segment. The Company’s net sales by geographic region follow:
| | | Three Months | | | | | Three Months | | | | | | Nine Months | | | | | | Nine Months | | | | |
| | | Ended | | | | | Ended | | | | | | Ended | | | | | | Ended | | | | |
| | | September 30, 2014 | | | | | September 30, 2013 | | | | | | September 30, 2014 | | | | | | September 30, 2013 | | | | |
North America | | $ | 3,325,678 | | | | 98 | % | | $ | 2,426,296 | | | | 95 | % | | $ | 8,922,604 | | | | 97 | % | | $ | 7,761,524 | | | | 93 | % |
UK | | | 51,587 | | | | 1 | % | | | 48,714 | | | | 2 | % | | | 140,396 | | | | 2 | % | | | 271,518 | | | | 3 | % |
All Other | | | 26,761 | | | | 1 | % | | | 72,018 | | | | 3 | % | | | 128,073 | | | | 1 | % | | | 330,604 | | | | 4 | % |
Total | | $ | 3,404,026 | | | | 100 | % | | $ | 2,547,028 | | | | 100 | % | | $ | 9,191,073 | | | | 100 | % | | $ | 8,363,646 | | | | 100 | % |
(6) Customer Concentrations
The Company sells its products primarily through high-volume retailers and distributors, Internet service providers, value-added resellers, PC system integrators, and original equipment manufacturers ("OEMs"). The Company supports its major accounts in their efforts to offer a well-chosen selection of attractive products and to maintain appropriate inventory levels.
Relatively few customers have accounted for a substantial portion of the Company’s revenues. In the third quarter of 2014, three customers accounted for 72% of our total net sales with our largest customer accounting for 51% of our net sales. In the first nine months of 2014, three customers accounted for 73% of the Company’s total net sales with our largest customer accounting for 54% of our net sales. At September 30, 2014 three customers accounted for 88% of our gross accounts receivable, with our largest customer representing 65% of our gross accounts receivable. In the third quarter of 2013, three customers accounted for 68% of our net sales with our largest customer accounting for 47% of our net sales. In the first nine months of 2013, three customers accounted for 67% of our total net sales with our largest customer accounting for 49% of our net sales. At September 30, 2013 three customers accounted for 83% of our gross accounts receivable, with our largest customer representing 68% of our gross accounts receivable.
The Company’s customers generally do not enter into long-term agreements obligating them to purchase products. The Company may not continue to receive significant revenues from any of these or from other large customers. A reduction or delay in orders from any of the Company’s significant customers, or a delay or default in payment by any significant customer, could materially harm the Company’s business and prospects. Because of the Company’s significant customer concentration, its net sales and operating income (loss) could fluctuate significantly due to changes in political or economic conditions, or the loss, reduction of business, or less favorable terms for any of the Company's significant customers.
(7) Valuation of Marketable Securities
In October 2010 Zoom Telephonics, Inc. entered into an agreement with Zoom Technologies, Inc. (Nasdaq: ZOOM) in which Zoom Telephonics transferred its rights to the zoom.com domain name and certain trademark rights in exchange for 80,000 shares of Zoom Technologies common stock. These shares had trading restrictions that ended January 18, 2012. The Company valued the marketable securities at market value in the financial statements. In the fourth quarter of 2013, Zoom Technologies, Inc. announced a reverse merger resulting in a 10:1 split so that the 80,000 shares became 8,000 shares. In December 2013 the Company sold all 8,000 shares of Zoom Technologies, Inc. stock. The Company received proceeds of $40 thousand and reported a realized loss of $273 thousand in 2013.
(8) Bank Credit Lines
On December 18, 2012, the Company entered into a Financing Agreement with Rosenthal & Rosenthal, Inc. (the “Financing Agreement”). The Financing Agreement provided for up to $1.75 million of revolving credit, subject to a borrowing base formula and other terms and conditions as specified in the Financing Agreement. The Financing Agreement continues until November 30, 2014 and from year to year thereafter, unless sooner terminated by either party as specified in the Financing Agreement. The Lender shall have the right to terminate the Financing Agreement at any time by giving the Company sixty days prior written notice. Borrowings are secured by all of the Company assets including intellectual property. The Loan Agreement contained several covenants, including a requirement that the Company maintain tangible net worth of not less than $2.5 million and working capital of not less than $2.5 million. On March 25, 2014, the Company entered into an amendment to the Financing Agreement (the “Amendment”) with an effective date of January 1, 2013. The Amendment clarified the definition of current assets in the Financing Agreement, reduced the size of the revolving credit line to $1.25 million, and revised the financial covenants so that Zoom is required to maintain tangible net worth of not less than $2.0 million and working capital of not less than $1.75 million.
On September 30, 2014 Zoom was in compliance with the covenants of the Financing Agreement with Rosenthal & Rosenthal, Inc.
| MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS |
The following discussion and analysis should be read in conjunction with the safe harbor statement and the risk factors contained in Item IA of Part II of this Quarterly Report on Form 10-Q, in our Annual Report on Form 10-K for the year ended December 31, 2013, filed with the SEC on March 31, 2014 and in our other filings with the SEC. Readers should also be cautioned that results of any reported period are often not indicative of results for any future period.
Overview
We derive our net sales primarily from sales of Internet-related communication products, principally broadband and dial-up modems and other communication products, to retailers, distributors, Internet Service Providers and Original Equipment Manufacturers. We sell our products through a direct sales force and through independent sales agents. All but two of our employees are located at our headquarters in Boston, Massachusetts. We are experienced in electronics hardware, firmware, and software design and test, regulatory certifications, product documentation, and packaging; and we use that experience in developing each product in-house or in partnership with suppliers who are typically based in Asia. Electronic assembly and testing of the Company’s products in accordance with our specifications is typically done at the product’s manufacturing facility in China.
Since 1983 our headquarters has been near South Station in downtown Boston at 201 and 207 South Street. In December 2006, the Company sold its owned headquarters buildings in Boston, Massachusetts and leased back 25,200 square feet for two years expiring December 2008. In November 2008 the Company signed a lease amendment for its headquarters’ offices in Boston in the existing building to approximately 14,400 square feet for three years with a six month termination option starting July 1, 2010. In May 2010 we signed a second lease amendment extending the term of the lease to April 30, 2016 with a six month termination option starting December 1, 2011. In December 2011 we signed a third lease amendment reducing our leased space to 10,600 square feet effective June 1, 2012, with a corresponding decrease in lease expense.
For many years we performed most of the final assembly, test, packaging, warehousing and distribution at a production and warehouse facility on Summer Street in Boston, Massachusetts, which had also engaged in firmware programming for some products. We moved most of our Summer Street operations to a dedicated 35,575 square foot facility in Tijuana, Mexico in October 2006. We moved these operations to a 10,800 square foot facility in Tijuana, Mexico in March 2009.
We continually seek to improve our product designs and manufacturing approach in order to improve product performance and reduce our costs. We pursue a strategy of outsourcing rather than internally developing our modem chipsets, which are application-specific integrated circuits that form the technology base for our modems. By outsourcing the chipset technology, we are able to concentrate our research and development resources on modem system design, leverage the extensive research and development capabilities of our chipset suppliers, and reduce our development time and associated costs and risks. As a result of this approach, we are able to quickly develop new products while maintaining a relatively low level of research and development expense as a percentage of net sales. We also outsource aspects of our manufacturing to contract manufacturers as a means of reducing our costs of production, and to provide us with greater flexibility in our production capacity.
Generally our gross margin for a given product depends on a number of factors including the type of customer to whom we are selling. The gross margin for retailers tends to be higher than for some of our other customers; but the sales, support, returns, and overhead costs associated with retailers also tend to be higher. Zoom’s sales to certain countries are currently handled by a single master distributor for that country who handles the support and marketing costs within the country. Gross margin for sales to these master distributors tends to be low, since lower pricing to these distributors helps them to cover the support and marketing costs for their country.
In recent years we have experienced losses. In response to these losses, we have cut costs by reducing staffing and some overhead costs. Our total headcount was reduced from 27 on September 30, 2013 to 26 on September 30, 2014. As of November 3, 2014, Zoom had 25 full-time and part-time employees. Of the 25 included in our headcount on November 3, 2014, nine were engaged in research and development and quality control. Four were involved in operations, which manages production, inventory, purchasing, warehousing, freight, invoicing, shipping, collections, and returns. Seven were engaged in sales, marketing, and customer support. The remaining five performed executive, accounting, administrative, and management information systems functions. Zoom has implemented cost cutting measures including reducing our headcount and reducing the number of days that certain employees work. As a result, Zoom currently has 17 full-time employees and 8 employees working less than 5 days per week, typically 4 days per week. Our dedicated manufacturing personnel in Tijuana, Mexico are employees of our Mexican manufacturing service provider and not included in our headcount. On September 30, 2014, Zoom had one consultant in sales and one consultant in information systems, neither of whom is included in our headcount.
Following is a discussion of what we view as our more significant accounting policies and estimates. As described below, management judgments and estimates must be made and used in connection with the preparation of our financial statements. We have identified areas where material differences could result in the amount and timing of our net sales, costs, and expenses for any period if we had made different judgments or used different estimates.
We derive our net sales primarily from the sales of hardware products to four types of customers:
We recognize hardware net sales for our customers at the point when the customers take legal ownership of the delivered products. Legal ownership passes from Zoom to the customer based on the contractual delivery point specified in signed contracts and purchase orders, which are both used extensively. Many of our customer contracts or purchase orders specify delivery at the shipping destination. We verify the delivery date on all significant FOB destination shipments made during the last 10 business days of each quarter.
