ITEM 1 - BUSINESS
Overview
Zoom Telephonics, Inc. ("Zoom" or the "Company") is a Canadian holding corporation whose operations are carried out by its wholly-owned United States subsidiary, Zoom Telephonics, Inc., a Delaware corporation with its principal executive offices located at 207 South Street, Boston, Massachusetts 02111. The discussion of the business of Zoom in this report refers to the business conducted through the operations of the United States subsidiary.
The Company is a leading designer, producer and marketer of modems and other communications products for the home and office. Analog modems link personal computers ("PCs") and other devices to the local telephone line for transmission of data, fax, voice, and video through the worldwide telephone network, and enable PCs and other devices to connect to other computers and networks, including the Internet and local area networks ("LANs"). DSL modems provide a high-bandwidth connection to the Internet through a standard telephone line that connects to compatible DSL equipment in or near the central telephone office. Cable modems provide a high-bandwidth connection to the Internet through a cable-TV cable that connects to compatible equipment at or near the cable service provider. Zoom expects to begin shipping DSL modems and cable modems in the year 2000.
The Company offers a broad line of analog modems with top data speeds of 56,000 bits per second ("bps"), available in internal, external and PCMCIA models (PCMCIA models plug into a PCMCIA standard slot typically found in a notebook or laptop computer). Most of these modems connect to a single telephone line, but Zoom also makes the Zoom/MultiLine modem which can connect up to eight telephone lines. In addition, Zoom has a number of products sold as Zoom Business Products, which typically provide the link between users of a corporate LAN and remote users or the Internet. The Company also has a line of Integrated Services Digital Network ("ISDN") products, which can transmit and receive simultaneously up to 128,000 bps. Zoom's analog modems and ISDN products have telephone line interfaces appropriate to North America, Europe, and many other countries throughout the rest of the world.
Since 1983 the Company has sold its modems primarily under the Zoom brand name. In 1999 the Company acquired the trademark rights and substantially all the product rights for Hayes(tm) brand modems. Hayes is a well-known brand that is associated with "Hayes compatible" software, the de facto standard for modem command compatibility. The Company plans to continue marketing under both the Zoom and Hayes names, as well as under various other private-label brands developed for some of the Company's large accounts.
In December 1998 Zoom began shipping the first models in its ZoomAir(tm) line of wireless products. These products connect a notebook or desktop computer to another computer or an existing LAN at a 2 megabits per second ("Mbps") data rate using 802.11 DSSS, a wireless data communications standard running at 2.4 gigahertz. Zoom currently ships network interface cards that plug into either a PCMCIA or LAN ISA (standard desktop computer) slot. Another product, ZoomAir Access Point Software, connects wireless and wired networks together, provides network ID security, and allows wired and wireless network users to concurrently share a single Internet connection. Zoom recently introduced the ZoomAir AP128, a hardware access point with ISDN capability. In February 2000 the Company announced plans to ship 11 Mbps PCMCIA and PCI models, network-to-network wireless bridges, and gateways to the Internet. The Company has focused significant effort on products to connect broadband cable modem or DSL modem Internet access to PCs and other devices through advanced local area networking including wireless networking.
In March 1999 Zoom began shipping the Zoom/HomeLANtm network interface card, which links a PC to other networked devices through a standard phoneline, even while this phoneline is being used for a voice or data call. Zoom's initial product had a maximum data rate of 1 Mbps. In the year 2000 Zoom expects to expand its line by introducing one or more 10 Mbps models and by incorporating home phoneline networking into new Internet gateway products.
Zoom also ships a line of live-motion full-color video cameras. One model interfaces to the PC through a Universal Serial Bus ("USB") port, and a second model interfaces to the PC through a parallel port.
Zoom's objective is to build upon its position as a leading supplier of Internet access devices and to capitalize on a number of current and emerging trends in computer connectivity including Internet access, higher data rates, bandwidth-hungry applications, and alternatives to traditional wired local area networks. The Company believes that the Zoom name is widely recognized and associated with high performance per dollar, breadth of product line and product innovation.
Industry Background
Demand for PC communications products and services has grown significantly. The Company believes that this growth has been driven by a variety of factors including (i) the popularity of the Internet and on-line services such as America Online, (ii) the growing installed base of PCs and other portable information devices, (iii) a significant increase in the use of PCs and portable information devices for remote access to the Internet and corporate networks, and (iv) advances in technology, which have improved the ability of PCs and portable information devices to create, capture, transfer, and manipulate data-intensive information, including graphic images and sound. These trends have resulted in substantial modem unit sales, both for new PCs as bundled peripherals and for the installed base of PCs, as upgrades and first-time purchases. Substantially all modems sold for PCs are now faxmodems (modems that have the ability to send and receive faxes), and some modems have enhanced voice capabilities and other enhanced extra features.
The rapid expansion of on-line services and the Internet has greatly increased the utility of PCs by making a multitude of information resources available to PC users. Modems are commonly used to remotely access these resources. As the transfer of large text files and data-intensive images (like those on the World Wide Web) become more pervasive, high data transmission speeds and other advanced modem features also become increasingly important to PC users.
Worldwide PC shipments continue to grow, and industry sources estimate that over 300 million PCs are installed worldwide. 56K modems are often bundled with a new PC, particularly in North America. However, some of the installed PCs have no modem, have a modem with a speed below 56K, or have a 56K modem with inadequate performance or features. The Company believes there should continue to be substantial demand for after-market modems two primary reasons. First, there is a trend toward bundling very basic modems into PCs, and the data throughput and multi-tasking capabilities of the PC can be improved by buying a Zoom or Hayes brand modem in the after-market, which have more functionality and faster speeds than bundled modems. Second, it is likely that a new standard, V.92, will be set in the year 2000, and that this will increase the percentage of people upgrading their modem. V.92 will increase upstream data rates, lower the connection time at the beginning of the call, and allow people with Call Waiting to answer an incoming voice call while online, suspend their Internet session without closing it, participate in their voice call, and then re-activate their Internet session when the voice call is complete. The Company believes that modems will continue to achieve increasing penetration of the PC installed base as applications requiring data connectivity proliferate. The Company can provide no assurance that the V.92 standard will be developed or that it will develop modems that meet the V.92 standard.
The growing use of PCs outside the traditional office setting has also increased the demand for modems that enable users to remotely access corporate networks, the Internet and other PCs. In addition, notebook computers have become one of the fastest growing segments of the PC market.
Advances in modem technology and lower modem prices have created rapid growth in the installed base of modems. As a result, the high-volume segment of the market has shifted from modems with a maximum speed of 2400 bps in 1987, to 33,600 bps in 1996 and 1997, to 56,000 bps in 1998 and 1999. Modems with high data speeds require less time to transmit text files and graphics, thereby reducing phone call costs and facilitating the use of data-intensive applications like World Wide Web browsing and remote access to corporate networks. Other technological advances that are increasing the use of modems in personal computing include new voice-related capabilities, video telephony, and electronic mail. For example, voice modems can provide answering machine, voice mail and other voice-related functions by digitizing incoming voice signals for storage in a computer and by retrieving stored voice and sending it through the telephone network to a remote person or computer. As another example, video telephony enables the transmission of still or moving color images, either exclusively through the dial-up telephone network or through the Internet. Advances in computer software are also stimulating demand for modems with faster speeds and greater functionality. For example, Microsoft's Windows 95 and Windows 98 include remote access, faxing and internet access capabilities that can only be used with a modem or other wide area networking devices.
The demand for faster speeds and increased modem functionality is expected to drive sales of new generations of "broadband" modems in the future, including Digital Subscriber Line ("DSL") modems and cable modems, particularly as after-market upgrades or as options for a new PC.
Zoom Strategy
The Company believes that the Zoom name is associated with high performance per dollar, breadth of product line, broad distribution, and product innovation. The Company's objective is to build upon its position as a leading supplier of modems and to capitalize on a number of current and emerging trends in computer connectivity, including Internet access, higher data rates, video telephony, and alternatives to traditional wired local area networks. The Company's strategy includes the following key elements:
Build Upon and Exploit Brand Equity. The Company's Zoom and Hayes brands are widely recognized and respected, and the Company's marketing channels are extensive. The Company believes that its success has been due in part to (i) offering its customers a broad range of products that provide high performance per dollar, (ii) supporting the installed base of its modems with multiple technical support options, (iii) promoting its products through cooperative advertising with its retailer customers, and (iv) designing attractive and informative packaging for its products. Personal Technology Research reports that in February 2000 the Company's modems had the second most retail shelf space for modems in North America. The Company intends to continue to enhance its brand equity by further expanding its marketing channels, by advertising and promoting its products, and by broadening its product offerings through its established sales channels.
Introduce Innovative PC Communications Products. Zoom seeks to identify new high-volume opportunities for PC communications, to develop competitively priced leading-edge products to address these opportunities, and to build upon and exploit its brand equity by delivering these products quickly and effectively through its sales channels. The Company was one of the first high-volume producers of faxmodems, voice faxmodems, and video-capture-enabled faxmodems. A major focus of the Company is to provide broadband Internet access and advanced local area networking products to allow people to share that bandwidth. This is an over-arching theme for the Company's development plans for cable modems, DSL modems, wireless networking, home phoneline networking, and gateway products.
Expand Distribution Channels. Zoom's existing marketing channels are strong, and will continue to be an asset as Zoom expands its product line. However, Zoom plans to grow its channels to fit its new products. An increased emphasis is being placed on selling to cable companies, telephone companies, and Internet Service Providers.
Expand International Sales. Zoom introduced its first modems in selected Western European countries in 1993. During 1995 the Company also received approvals and began shipping its first modems for the Japanese market. The Company now sells its products in over 50 countries. The Company's international sales (excluding sales to OEMs) have increased from 8% of net sales in 1994 to 30% of net sales in 1999. The Company plans to continue to expand its international product line and distribution network.
Expand OEM Sales. Zoom continues to target the OEM market as a significant opportunity for growth and diversification, particularly for PC-bus and embedded modems, broadband products, and wireless LAN products. In addition, Zoom sometimes sells packaged modems private-labeled for its customers and channels.
Outsource Chipset Technology. Zoom pursues a strategy of outsourcing rather than internally developing its chipsets, which are application-specific integrated circuits that form the technology base for its modems and certain other products. By outsourcing the chipset technology, the Company is able to concentrate its research and development resources on system design, leverage the extensive research and development capabilities of its chipset suppliers, and reduce its development time and associated costs and risks. The Company buys analog modem chipsets exclusively from the two highest-volume modem chipset manufacturers, Lucent Technologies and Conexant Systems, Inc. (formerly Rockwell). These companies have significant resources for semiconductor design and fabrication, analog and digital signal processing, and communications firmware development. Integrated circuit product areas covered by one or both companies include modems, DSL, cable modems, home phoneline networking, and video. Similarly, Zoom buys chipsets from Intersil for its ZoomAir wireless network interface cards.
Maintain Low Costs. Zoom continually seeks ways to improve its product designs and manufacturing approach in order to reduce its costs. The Company outsources to contract manufacturers, primarily in mainland China and Mexico, aspects of its manufacturing processes including board stuffing, wave soldering, in-circuit test, and for some products component purchasing. This reduces the Company's labor costs and capital expenditures, and provides the Company with flexibility in its capacity planning.
Explore Acquisitions. Zoom acquired the products and certain other assets of Tribe Computer Works ("Tribe") in mid-1996, and in 1999 acquired trademarks and substantially all of the modem product lines from Hayes Microcomputers Products, Inc. Zoom continues to consider acquisitions of businesses, products or technologies complementary to the Company's business. The Company believes that appropriate acquisitions can reduce the development risk associated with new product offerings, and that the Company can leverage its brand equity and existing sales channels to enhance the value of these acquisitions. There can be no assurance that any of these explorations will lead to an acquisition or that any acquisitions, if made, will be successful.
Products
The vast majority of Zoom's products facilitate communication of data through the Internet. Zoom's analog modems and ISDN modems link PCs and portable information devices through the telephone network and connected networks, including the Internet and local area networks. Similarly, the Company believes its cable modems and DSL modems will use the cable-TV cable and local telephone line, respectively, to provide a high-speed link to the network. Even Zoom's video cameras are used primarily to communicate videos through the Internet. Zoom's advanced networking products, including wireless LAN, home phoneline LAN, and gateway products, help to link PCs and other computing devices to each other and to the Internet. Starting with its acquisition of Tribe in 1996, the Company began shipping business products that provide remote users access to the resources of a LAN, and connect users of the LAN to the Internet and to remote LANs and computers. The Company also makes other related business products, including a series of multi-line modems and a hub for AppleTalk networks.
Zoom has a broad line of analog modems with top data speeds of 56,000 bps, available in internal, external and PCMCIA models. PC-oriented internal modems are designed primarily for installation in the PCI or ISA slot of IBM PC-compatibles. Embedded internal modems are designed to be embedded in non-PC equipment such as point-of-purchase terminals, kiosks, and set-top boxes. The Company's external modems are designed to work with any terminal or computer, including IBM PC-compatibles, the Macintosh and other computers. The Company's external models include desktop and multi-line modems that have up to eight modems in a compact enclosure. Zoom's PCMCIA modems are designed for use with notebook and sub-notebook computers as well as PDAs (personal digital assistants) equipped with standard PCMCIA slots. When sold as packaged retail products, the Company's modems are shipped complete with third-party software that supports the hardware capabilities of the modem.
56K modems allow users connected to standard phonelines to download data at speeds up to 56,000 bps when communicating with compatible central sites connected to digital lines such as ISDN or T1 lines. Those central sites are typically online services, Internet Service Providers, or remote LAN access equipment. Pre-standard K56flextm and x2tm 56K modems began shipping in the second quarter of 1997, and Zoom's first 56K modems supported K56flex. In February 1998 a committee of the International Telecommunications Union ("ITU") agreed upon the V.90 standard for 56K. V.90 is now widely deployed in equipment made by central site manufacturers. Zoom has successfully transitioned its 56K product line to Dualmode modems designed to connect to either K56flex or V.90 central sites, to provide flexibility to Zoom's customers.
During the year 2000 a new 56K standard, ITU V.92, is likely to be set. This will provide enhanced functionality as discussed earlier. V.92 should also help to grow the Company's sales through the after-market. The Company expects to ship V.92 products soon after the standard is set. This market opportunity will provide a host of challenges, including new product designs, new packaging designs, and inventory issues. The Company believes that it is well-suited to handle these challenges, and that the opportunity more than offsets the risk.
Modem Product Features. The following sets forth some of the key features incorporated in one or more of the Company's modems:
o ZoomGuard(tm). ZoomGuard represents the protective circuitry added to Zoom's modems to improve their ability to withstand the effects of lightning striking a phoneline to which the modem is connected. For most modem manufacturers, lightning is the number one cause of field failures.
o PC Card Guard(tm). PC Card Guard represents the protective circuitry added to Zoom's PCMCIA modems to protect against destruction caused by plugging the modem into a digital PBX phone jack. Zoom was one of the first companies to develop this useful feature.
o Voice Mail. Voice mail capability allows a PC to serve as an answering machine with message storage and local or remote message retrieval.
o Channel 2(tm). Channel 2 is Zoom's trademark for a feature that works with the optional Call Waiting feature available from some phone companies. Channel 2 permits the modem to recognize an incoming call when the modem is on-line, so that the user can determine how to handle the call.
o Distinctive Ring. Distinctive Ring is a service offered by telephone companies that assigns more than one phone number to a single phoneline, with each number ringing differently. This service along with appropriate modem functionality allows someone to arrange for one phone number to be answered as a voice line, a second number to be answered as a fax line, and a third number to be answered as a data line. Zoom has been issued a US patent related to its distinctive ring technology.
o Plug & Play. Microsoft's Windows 95 and Windows 98 support Plug & Play, a standard that is intended to allow the installation of Plug & Play-compatible peripherals like modems with limited hardware configuration by the end-user.
o Cellular-ready PCMCIA Modems. Some of the Company's modems include a cellular-ready feature that allows the modem to be plugged into a cellular phone for wireless communication of fax and data.
International Modems. Most foreign countries have their own telecommunications standards and regulatory approval requirements for sales of communications products such as those offered by Zoom. As a result, the introduction of new products into international markets can be costly and time-consuming. In 1993 the Company introduced its first modem approved for selected Western European countries, and since then the Company has continued to expand its product offerings internationally. The Company has received regulatory approvals for, and is currently selling modems in a number of countries, including Australia, Austria, Belgium, Denmark, Finland, France, Germany, Hungary, India, Ireland, Italy, Japan, the Netherlands, Norway, Poland, Portugal, Russia, Slovenia, South Africa, Spain, Sweden, Switzerland, and the United Kingdom. The Company intends to continue to expand and enhance its product line for its existing markets and to seek approvals for the sale of its products in new countries throughout the world. In 1998 the European community adopted the CTR 21 standard for interconnection of products to the telephone network, and this has significantly simplified the approval process for the 15 European Union countries plus Bulgaria, Iceland, Israel, Norway, Switzerland, and Turkey currently accepting the CTR 21 standard.
ISDN Products. Zoom has a family of modems for ISDN communications. ISDN is an increasingly available telephone service that allows existing phone lines to be used to transmit data digitally. ISDN service permits much higher data transmission rates than conventional analog telephone service. Basic ISDN service typically provides two 64,000 bps channels and one 16,000 bps channel. The higher rates of data transmission achievable with ISDN can be particularly attractive for data-intensive applications such as the transmission of graphics and video images, World Wide Web browsing, or video telephony. In February 1997 Zoom shipped its first ISDN product, the Zoom/ISDN Duo, an internal PC-compatible card that supports use of the ISDN line for analog modem, fax, or voice communications; and also supports analog modem, fax, or voice communications over an analog phoneline. In 1998 Zoom began shipping external ISDN products for the North American and international markets. In addition, Zoom continues to integrate ISDN capability into some of its new LAN-oriented business products, including the ZoomAir AP128 wireless access point.
Multi-line Modems. In 1996 Zoom began shipping a family of multi-line modems targeted for local area network fax and data server applications, computer bulletin boards, multi-line voice mail, and other applications. The Zoom/MultiLine products hold up to eight voice faxmodems in one small external case that includes status indicators for each modem. The Hayes Century product line provides up to 16 modems in a single enclosure.
Broadband Modems. In the year 2000 Zoom expects to begin shipping a line of broadband modems, including cable modems and DSL modems. Zoom's first cable modem will incorporate the DOCSIS standard, the standard used in the United States and many other countries, and will connect to the Ethernet port of a computer or other device. Zoom will seek Cablelabs certification for these cable modems, since it is extremely beneficial to selling cable modems, particularly in the United States of America. Obtaining certification is difficult and there is no certainty when Zoom will obtain certification. Zoom will later expand its cable modem line with a DOCSIS-compatible model that plugs into a USB port.
Zoom's ADSL modems will incorporate the standards that are most popular with U.S. telephone companies and Internet Service providers, including G.DMT and G.Lite. Zoom's first DSL modems are expected to be an external USB model and an internal PCI model. Zoom's product plan ties Zoom's broadband products to Zoom's advanced networking products.
Wireless LAN Products. In December 1998 Zoom began shipping the first models in its ZoomAirtm line of wireless local area network products. These products connect a notebook or desktop computer to another computer or an existing local area network without wires, currently providing a 2 megabits per second ("Mbps") data rate using the 802.11 DSSS standard running at 2.4 gigahertz. Zoom currently ships network interface cards that plug into either a PCMCIA or ISA slot. Another product, ZoomAir Access Point Software, connects wireless and wired networks together, provides network ID security, and allows wired and wireless network users to concurrently share a single Internet connection. Zoom recently began shipping the ZoomAir AP128, a wireless access point with ISDN capability. In the year 2000 Zoom expects to continue to expand its wireless product line, adding 802.11b 11 Mbps products and a gateway that links wireless PCs to a cable modem, DSL modem, or other Internet access device.
Remote Access, SOHO Router, and Internet Gateway Products. Zoom has a significant Research and Development effort aimed at development of business products that provide remote users access to the resources of a LAN, and connect the users of the LAN to the Internet and to remote LANs and computers. Some of these products incorporate technology acquired from Tribe Computer Works in 1996. In 1997 Zoom extended the product line to include support for Windows, to incorporate analog modem and leased line options, and to add new features. Zoom plans to continue to expand this product line.
Full-color Live-motion Cameras and Other Video Products. In late 1997 Zoom shipped the Zoom/Video Cam, a full-color live-motion camera. The Zoom/Video Cam can be used for video phone calls, video conferences, video mail, and still image capture. Zoom has continued to expand the product line, which now includes a parallel port camera and USB cameras for both Windows and the Macintosh. Zoom expects the demand for video products will grow due to a number of factors including improved video technology, higher data communications bandwidth, faster PCs, and improved video-related software.
Dialers. The Company shipped its first telephone dialer, the Demon Dialer(R), in 1981; and in 1983 began shipping the Hotshot(TM) dialer. As the dialer market shrank due to equal access, the Company focused on modems and other peripherals for the personal computer market. The Company has commenced shipping a new generation of dialers incorporating proprietary technology. Dialer products currently represent under 1% of Zoom's sales, but may become more important in the future.
There can be no assurance that the Company will be able to develop new products, such as cable and DSL modems, on a timely basis and within budget, if at all, or that once developed any of these products will be commercially successful.
Sales Channels
Zoom sells its products primarily through high-volume retailers and distributors, and to PC manufacturers and other OEMs. The Company supports its major accounts in their efforts to discern strategic directions in the market, to maintain appropriate inventory levels, and to offer a balanced selection of products. As Zoom expands its product offering, particularly in broadband modems, Zoom plans to expand and strengthen its market channels to include cable companies, phone companies, and Internet Service Providers.
During 1999 Best Buy Co., Inc. and Ingram Micro, Inc. accounted for 17% and 10%, respectively of Zoom's net sales. A significant reduction in sales to these customers could have a material adverse effect on the Company's business.
High-volume Retailers. In the United States, Zoom reaches the PC retail market primarily through high-volume retailers. The Company's extensive United States retail distribution network includes Best Buy, CDW, Costco, Fry's, Future Shop, MEI Micro Center, Micro Warehouse, Office Depot, PC Connection, and Staples. Personal Technology Research reported that in February 2000 Zoom brands had the second greatest amount of retail shelf space for modems in North America, and had gained share overall and relative to the leading brand in the prior year.
Distributors. Zoom sells significant quantities of modems through distributors, who often sell to corporate accounts, value-added resellers and other channels that are generally not served by the Company's high-volume retailers. The Company's North American distributors include D&H Distributing, Gates-Arrow, Ingram Micro, Merisel, and Tech Data.
OEMs. The Company's OEM customers sell the Company's products under their own name or incorporate the Company's products as a component of their pre-packaged systems. In addition, the Company's packaging design capability enables the Company to respond to an OEM's need for customized or generic products and packaging. The Company is responsive to the needs of personal computer manufacturers including on-time delivery of high-quality cost-effective products that are supported by strong documentation of the products and the products' quality.
International Channels. In international markets, Zoom sells its products primarily through independent distributors and retailers. The Company's international distributors include Actebis, California Computer, Celo Spa, Computer 2000, Criterium, Engineering Supplies, Infotide International, Northamber, Olusum, Pouliadis Associates Corp., Siltek Ltd., Stylus, UMD, and Yutron Tech. The Company's major European high-volume retailers include Compustore, Dixons/PC World, Exel, Fnac, Multirama, Oneway, Simply Computers, Staples UK, Tandy, Tempo Stores, and Vobis. The Company's international net sales (including sales to OEMs located outside the United States) have grown from 8% in 1994 to 30% in 1999. The Company's revenues from international sales were $12.3 million, $13.5 million, and $18.5 million in 1997, 1998, and 1999, respectively. The increase in 1999 was primarily attributable to sales of Hayes products. The Company believes that its continued sales growth outside of the United States will require substantial additional investments of resources for product design and testing, regulatory approvals, production, marketing and tailoring of instruction manuals, packaging, and software development for various foreign languages. The Company's international sales are also subject to risks generally associated with international sales, including United States and international regulatory requirements and policy changes, political and economic instability, currency exchange fluctuations, inventory management, accounts receivable collection, the management of distributors or representatives, tariff regulations and seasonality of sales.
Sales, Marketing and Support
Zoom's sales, support, and marketing are primarily managed from Zoom's headquarters in Boston, MA. In North America the Company sells its Zoom-brand products primarily through commissioned independent sales representatives managed and supported by the Company's own staff. The Company maintains a sales, support, and logistics office in the United Kingdom. Warehousing, customs clearance, shipping, and invoicing for Europe are now primarily done under contract with an unaffiliated specialist in these services located in England. Technical support for Europe is handled by Zoom's UK operation, including an independent technical support company, and by Zoom's distributors. For countries outside North America and Europe, the Company's in-house staff typically works directly with country-specific distributors. The Company's worldwide OEM sales are primarily handled by Zoom's staff in the USA and UK, who are at times assisted by Zoom's sales staff or commissioned sales representatives. (See note 16 to Consolidated Financial Statements.)
The Company believes that Zoom and Hayes are widely recognized brand names. The Company builds upon its brand equity in a variety of ways, including cooperative advertising, product packaging, trade shows and public relations. The Company generally provides its high-volume retailers with funds to advertise the Company's products in conjunction with the customers' general advertising. The Company believes that such advertising serves to both efficiently and effectively target the end-user market for its products. Zoom seeks to develop quality products that are user-friendly and require minimal support. The Company supports its claims of quality with warranties of one to seven years, depending upon the product. To address the needs of those end-users of the Company's products who require assistance, the Company has an in-house staff of technical specialists who provide telephone support six days per week and also employs an independent technical support team in the United Kingdom that supports the Company's European products five day per week. Zoom's technical support specialists also maintain a significant World Wide Web support facility that includes email, firmware and software downloads, and the SmartFactstm Q&A search engine. Other support vehicles include forums on America Online and CompuServe, and a fax-back service.
Research and Development
The Company's research and development efforts are focused on developing new products for PC communications markets, further enhancing the capabilities of existing products, and reducing production costs. The Company has developed close collaborative relationships with certain of its OEM customers and component suppliers, who work with the Company to identify and respond to emerging technologies and market trends by developing products that address these trends. In addition, the Company purchases modem and other chipsets that incorporate sophisticated technology, thereby eliminating the need for the Company to develop this technology in-house. As of March 14, 2000 the Company had 56 employees engaged primarily in research and development. This research and development team performs electronics hardware design and layout, mechanical design, prototype construction and testing, component specification, firmware development, product testing, foreign and domestic regulatory approval efforts, end-user and internal documentation, and third-party software selection and testing. During 1997, 1998, and 1999 the Company expended $4.2 million, $4.4 million and $6.4 million, respectively, on research and development activities. The increase in costs expended on research and development is primarily due to the company's initiatives in the broadband, advanced networking, and gateway product areas.
Manufacturing and Suppliers
The Company's products are currently designed for high-volume automated assembly in the United States of America, Mexico or China to help assure low cost, rapid market entry, short lead times, and reliability. For North America the Company supplies large kits of parts to one of several automated contract assemblers. In China the contract manufacturer procures certain material required to assemble the products based upon a Zoom Telephonics Approved Vendor List and Parts List. The contract assemblers insert parts onto the printed circuit board, with most parts automatically inserted by machine, solder the circuit board, in-circuit test, and functionally test the completed assemblies. These assemblies are then typically shipped to the Company for testing as required. Completed boards are typically then packaged by the Company, allowing the Company to tailor the packaging and its contents for its customers immediately before shipping. Circuit design, circuit board layout, and component sourcing are currently performed by the Company.
Zoom typically uses one primary contract assembler for a given design, with back-up production tooling at a second assembler for Zoom's highest-volume products. The Company's assemblers are normally adequate to meet reasonable and properly planned production needs, but a fire, natural calamity, strike, or other significant event at an assembler's facility could adversely affect the Company's shipments and revenues.
The Company's products include a large number of parts, most of which are available from multiple sources with varying lead times. However, most of the Company's products include a sole-sourced chipset as the most critical component of the product. Currently Lucent and Conexant are the Company's only modem chipset suppliers, and Intersil is the Company's only wireless chipset supplier. Due to capacity constraints, the Company has experienced delays in receiving shipments of modem chipsets in the past, and the Company may experience such delays in the future. Moreover, there can be no assurance that a chipset supplier will, in the future, sell chipsets to the Company in quantities sufficient to meet the Company's needs. An interruption in a chipset supplier's ability to deliver chipsets, a failure of the Company's suppliers to produce chipset enhancements or new chipsets on a timely basis and at competitive prices, a material increase in the price of the chipsets, or any other adverse change in the Company's relationship with modem chipset suppliers could have a material adverse effect on the Company's results of operations.
Competition
The PC communication products industry is intensely competitive and characterized by rapid technological advances and emerging industry standards, resulting in constant pricing pressures. These changes result in frequent introductions of new products with added capabilities and features, and continuous improvements in the relative functionality and price of modems and other PC communications products. The failure of the Company to keep pace with technological advances would adversely affect the Company's competitive position and results of operations.
The Company's primary analog modem competitors include 3Com, Action Tec, Best Data, Creative Labs, Elsa, GVC, S3, and Viking. The Company's primary cable modem competitors include 3Com, Com21, Motorola, and Terayon. The Company's primary DSL modem competitors include 3Com and Efficient Networks. The Company's primary wireless LAN competitors include 3Com, Lucent, Proxim, and Aironet, a company recently acquired by Cisco Systems. Many of the Company's competitors and potential competitors have more extensive financial, engineering, product development, manufacturing, and marketing resources than the Company.
The Company's products compete on the basis of product features, price, quality, reliability, brand name recognition, product breadth and shelf space, developed sales channels, product documentation, product warranties, and technical support and service. The Company believes that it is competitive in each of these areas. However, there can be no assurance that competitors will not introduce comparable or superior products incorporating more advanced technology at lower prices, or that other changes in market conditions or technology will not adversely affect the Company's ability to compete successfully in the future.
Products recently introduced by certain other companies include cable and DSL modems that can transmit data and other information at significantly faster speeds than analog modems such as those sold by the Company. These products, however, are generally more expensive than analog modems and cannot be used with conventional telephone service. In addition, the use of cable and DSL modems is currently impeded by a number of technical and infrastructure limitations. The Company expects to begin shipping both cable modems and DSL modems in the year 2000. In the year 2000, these products are likely to be sold in the greatest number through cable companies, phone companies, and Internet Service Providers. Until 2001 large quantities of cable modems and DSL modems are not likely to be sold through retailers and distributors, Zoom's strongest market channels. There can be no assurance that the Company will develop these modems on a timely basis, if at all; or that once developed, these modems will compete effectively.
Intellectual Property Rights
Zoom relies primarily on a combination of copyrights, trademarks, trade secrets and patents to protect its proprietary rights. The Company has trademarks and copyrights for its firmware (software on a chip), printed circuit board artwork, instructions, packaging, and literature. The Company also has four patents and one pending patent application in the United States. There can be no assurance that any patent application will be granted or that any patent obtained will provide protection or be of commercial benefit to the Company, or that the validity of a patent will not be challenged. Moreover, there can be no assurance that the Company's means of protecting its proprietary rights will be adequate or that the Company's competitors will not independently develop comparable or superior technologies. Zoom licenses certain technologies used in its products, typically bundled software, on a non-exclusive basis. In addition the Company purchases chipsets that incorporate sophisticated technology. Zoom has received, and may receive in the future, infringement claims from third parties relating to the Company's products and technologies. The Company investigates the validity of these claims and, if it believes the claims have merit, responds through licensing or other appropriate actions. Certain of these past claims have related to technology included in modem chipsets and the Company forwarded these claims to the appropriate vendor. If the Company or its component manufacturers were unable to license necessary technology on a cost-effective basis, the Company could be prohibited from marketing products containing that technology, incur substantial costs in redesigning products incorporating that technology, or incur substantial costs defending any legal action taken against it. See Item 3 - - LEGAL PROCEEDINGS.
Government Regulation
All of the Company's North American products are required to meet United States and Canadian government regulations, including regulations of the United States Federal Communication Commission ("FCC") and Industry Canada, which regulate equipment, such as modems, that connects to the public telephone network. The FCC also regulates electromagnetic radiation emissions. For each of the Company's products sold in most foreign countries, specific regulatory approvals must be obtained for such matters as electrical safety, manufacturing standards, country-specific telecommunications equipment requirements and electromagnetic radiation and susceptibility requirements. The Company has received regulatory approvals for certain modems in Australia, Austria, Belgium, Bulgaria, China, Cypress, Denmark, Finland, France, Germany, Greece, Hungary, Iceland, India, Ireland, Israel, Italy, Japan, Luxembourg, the Netherlands, Norway, Poland, Portugal, Russia, Slovenia, South Africa, South Korea, Spain, Srilanka, Sweden, Switzerland, Turkey, and the United Kingdom. The Company expects to continue to seek and receive approvals for new products in a large number of countries throughout the world. The regulatory process can be time-consuming and can require the expenditure of substantial resources. In many foreign countries, obtaining required regulatory approvals may take significantly longer than in the United States. There can be no assurance that the FCC or foreign regulatory agencies will grant the requisite approvals for any of the Company's products on a timely basis, if at all. United States and foreign regulations regarding the manufacture and sale of telecommunications devices are subject to future change. The Company cannot predict what impact, if any, such changes may have upon its business.
Seasonality
The Company believes its sales are seasonal, with increased sales generally occurring in the third and fourth quarters reflecting holiday sales. The Company expects that its quarterly results will continue to fluctuate in the future as a result of seasonality and other factors.
Backlog
The Company's backlog at March 25, 2000 and March 25, 1999 was $2.1 million and $1.6 million, respectively, most of which was for delivery of products within 120 days or less. Orders included in backlog generally may be canceled or rescheduled by customers without significant penalty. Backlog as of any particular date should not be relied upon as indicative of the Company's net sales for any future period.
Employees
As of December 31, 1999 Zoom had 342 full-time employees (including employees hired on a temporary basis). Of this total, 61 were engaged in research and development, 161 were involved in purchasing, assembly, packaging, shipping and quality control, 75 were engaged in sales, marketing and technical support, and the remaining 45 performed accounting, administrative, management information systems, and executive functions. The Company's temporary employees were comprised of 18 individuals at December 31, 1999. Most of these temporary employees were employed in manufacturing. None of the Company's employees are represented by a labor union.
Executive Officers Of The Registrant
The names of the current executive officers of Zoom, and certain biographical information furnished by them, are set forth below:
Name Age Position with Zoom ----------------- --- -------------------------------------
Frank B. Manning 51 Chief Executive Officer, President and Chairman of the Board Peter R. Kramer 48 Executive Vice President and Director Robert A. Crist 56 Vice President of Finance and Chief Financial Officer Terry J. Manning 48 Vice President of Sales and Marketing Dean N. Panagopoulos 42 Vice President of Information Systems Deena Randall 46 Vice President of Operations Dana Whitney 37 Vice President of Engineering and Network Products
Frank B. Manning is a co-founder of the Company and has been President, Chief Executive Officer, and a Director of the Company since May 1977, and Chairman of the Board since 1986. He earned his BS, MS and PhD degrees in Electrical Engineering from the Massachusetts Institute of Technology, where he was a National Science Foundation Fellow. Since 1993 Mr. Frank Manning has been a director of MicroTouch Systems, a NASDAQ-listed leader in touchscreen technology. Since 1998 Mr. Frank Manning has also been a director of the Massachusetts Technology Development Corporation, a public purpose venture capital firm that invests in seed and early-stage technology companies in Massachusetts.
Peter R. Kramer is a co-founder of the Company and has been Executive Vice President and a Director of the Company since May 1977. He earned his BA degree in 1973 from SUNY Stony Brook and his MFA degree from C.W. Post College in 1975.
Robert A. Crist joined Zoom in July 1997 as Vice President of Finance and Chief Financial Officer. From April 1992 until joining the company, Mr. Crist served in various capacities at Wang Laboratories, Inc., a computer software and services company, including Chief Financial Officer for the Software Business. Prior to 1992 Mr. Crist served in various capacities at Unisys Corporation, including Assistant Corporate Controller, Corporate Director of Business Planning and Analysis, and Corporate Manufacturing & Engineering Controller. Mr. Crist earned his BA degree from Pennsylvania State University and he earned his MBA from the University of Rochester in 1971.
Terry J. Manning joined Zoom in 1984 and served as corporate communications director from 1984 until 1989 when he became the director of the Company's sales and marketing department. Terry Manning is Frank Manning's brother. Terry Manning earned his BA degree from Washington University in St. Louis in 1974 and his MPPA degree from the University of Missouri at St. Louis in 1977.
Dean N. Panagopoulos joined Zoom in February of 1995 as Director of Information Systems. From 1993 to 1995, Mr. Panagopoulos worked as an Independent Consultant. From 1991 to 1993, Mr. Panagopoulos served as Director of Technical Services for Ziff Information Services, a major outsourcer of computing services. He attended the Massachusetts Institute of Technology from 1975 to 1978 and earned his BS degree in Information Systems from Northeastern University in 1983.
Deena Randall joined Zoom in 1977 as its first employee. Ms. Randall has served in various senior positions within the Company and has directed the Company's operations since 1989. Ms. Randall earned her BA degree from Eastern Nazarene College in 1975.
Dana Whitney joined Zoom in 1994 as Director of Engineering. From 1990 to 1994, Mr. Whitney served in various capacities with Motorola Codex, a data communications company, including as a Senior Design Engineer from 1990 to 1991, and as an Engineering Manager from 1991 to 1994. As Engineering Manager he was responsible for the design and development of digital data communications products. Mr. Whitney earned his BSEE from the University of Massachusetts at Dartmouth in 1984 and his MBA degree from Bryant College in 1993.
ITEM 2
ITEM 2 - PROPERTIES
Zoom currently occupies approximately 48,000 square feet of two adjacent buildings with a total of approximately 72,000 square feet at 201 and 207 South Street, Boston, Massachusetts. These buildings were purchased by the Company in April 1993 and currently serve as the corporate headquarters. In August 1996, the Company entered into a five year lease for a 77,428 square foot manufacturing and warehousing facility at 655 Summer Street, Boston, MA. At the end of the initial lease term, the Company has an option to extend the lease for an additional five year term. In March, 1999, the Company assumed an office lease from Hayes Microcomputer Products, Inc. at 430 Frimley Business Park, Camberly Surrey, UK. This is a non-cancelable ten year lease that commenced in February, 1998.
ITEM 3
ITEM 3 - LEGAL PROCEEDINGS
No material litigation.
ITEM 4
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matter was submitted to a vote of security holders during the fourth quarter of the fiscal year covered in this report.
PART II
ITEM 5
ITEM 5 - MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's Common Stock is traded on the Nasdaq National Market under the symbol "ZOOM." The following table sets forth, for the periods indicated, the high and low sale prices per share of Common Stock, as reported by the Nasdaq National Market.
Fiscal Year Ending December 31, 1998 High Low
First Quarter........................... $ 9.625 $ 6.563 Second Quarter.......................... 8.750 5.813 Third Quarter........................... 6.750 3.125 Fourth Quarter.......................... 8.625 2.250
Fiscal Year Ending December 31, 1999
First Quarter........................... $ 5.500 $ 3.344 Second Quarter.......................... 7.375 3.500 Third Quarter........................... 6.250 4.000 Fourth Quarter.......................... 13.250 4.031
As of March 27, 2000, there were approximately 283 holders of record of the Company's Common Stock.
Recent Sales of Unregistered Securities
Not applicable.
Dividend Policy
The Company has never declared or paid cash dividends on its capital stock and does not plan to pay any cash dividends in the foreseeable future. The Company's current policy is to retain all of its earnings to finance future growth. The Company's bank credit facility restricts the payment of cash dividends.
Limitations Affecting Holders of Common Stock
An investment in Common Stock which results in a change of control of the Company may be subject to review and approval under the Investment Canada Act (Canada) (the "ICA"), if the person acquiring control is not a Canadian person; provided, however, that if the person acquiring control is a national of a World Trade Organization member country (which includes the United States), then such investment shall not be subject to review under the ICA so long as the gross assets of the Company have an aggregate value of less than $160 million Canadian. This process may have the effect of delaying or preventing the change in control of the Company. Under the Canada Business Corporations Act, not less than one-third of the members of the Board of Directors and any committees thereof must be resident Canadians (and not less than one-half if the Company's gross revenues in Canada exceeds 5%).
Certain Income Tax Considerations
The following summary is based on the tax laws of the United States and Canada as in effect on the date of this Report, and is subject to changes in United States and Canadian law, including changes that could have retroactive effect. The summary is further based on the Convention between Canada and the United States of America with respect to Taxes on Income and on Capital, as amended (the "Convention"), the published administrative practices of Canada Customs and Revenue Agency, Taxation and the Internal Revenue Service and judicial decisions, all of which are subject to change. The discussion summarizes certain tax considerations relevant to individual and corporate holders of Common Stock who, for income tax purposes, are resident in the United States and not in Canada, hold Common Stock as capital assets, and do not use or hold the Common Stock in carrying on business through a permanent establishment or in connection with a fixed base in Canada (collectively, "Unconnected US Shareholders"). The tax consequences of holding the Common Stock by individuals or corporations who are not Unconnected US Shareholders may differ substantially from the tax consequences discussed herein. The summary does not take into account the tax laws of the various provinces or territories of Canada or the tax laws of the various state and local jurisdictions in the United States.
The summary is intended to be a general description of the Canadian and United States tax considerations. It does not take into account the individual circumstances of any particular holder of Common Stock. Therefore, Stockholders should consult their own tax advisors with respect to the tax consequences of holding Common Stock.
Canadian Federal Income Tax Considerations
Any dividends on the Common Stock paid or credited, or deemed to be paid or credited to Unconnected US Shareholders generally will be subject to Canadian withholding tax. Under the Convention, the rate of withholding tax generally applicable to Unconnected US Shareholders is 15%. In the case of a United States corporate shareholder owning 10% or more of the voting shares of the Company, the applicable withholding tax is 5% for dividends paid or credited.
Capital gains realized on the disposition of Common Stock by Unconnected US Shareholders will not be subject to tax under the Income Tax Act (Canada) (the "Tax Act") unless such Common Stock is taxable Canadian property (other than treaty-protected property) within the meaning of the Tax Act. Common Stock will generally not be taxable Canadian property to a holder unless, at any time during the 60 month period immediately preceding a disposition, the holder, or persons with whom the holder did not deal at arm's length, or any combination thereof, owned 25% or more of the issued shares of any class or series of the Company. If the Common Stock is considered taxable Canadian property to a holder, the Convention will generally exempt Unconnected US Shareholders from tax under the Tax Act in respect of a disposition of Common Stock provided the value of the shares of the Company is not derived principally from real property situated in Canada. Neither Canada nor any province thereof currently imposes any estate taxes or succession duties.
United States Federal Income Tax Considerations
Unconnected US Shareholders generally will treat the gross amount of any cash dividends paid by the Company, without reduction for the Canadian withholding tax, as dividend income for United States federal income tax purposes to the extent of the Company's current or accumulated earnings and profits. If the dividend distribution is paid in Canadian dollars, the dividend will be includable in income when received in an amount equal to the United States dollar value, on the date of distribution, of the amount so distributed; any gain or loss on the conversion of the distribution into US dollars will be ordinary in nature. Subject to the limitations set forth in Section 904 of the Internal Revenue Code of 1986, as amended (the "Code") (which limits the extent to which a United States taxpayer may credit against its United States federal income tax liability any taxes paid by it to a foreign country), the Canadian tax withheld or paid with respect to distributions on the Common Stock generally may be credited against the United States federal income tax liability of an Unconnected US Shareholder if such holder makes an appropriate election for the taxable year in which such taxes are paid or accrued; alternatively, a shareholder who does not elect to credit any foreign taxes paid during the taxable year may deduct such taxes in such taxable year. In addition, an Unconnected US Shareholder that is a domestic corporation that owns 10% or more of the Common Stock and receives a dividend and elects to credit foreign taxes is deemed to have received (and to have paid as a foreign tax eligible for the foreign tax credit, subject to the limitations of Section 904) a portion of the foreign taxes paid by the Company. Because the foreign tax credit provisions of the Code are complex, investors should consult their own tax advisors when claiming foreign tax credits. Dividends paid on the Common Stock will generally not be eligible for the dividends received deduction otherwise allowed to United States corporate shareholders.
The sale of Common Stock generally will result in the recognition of gain or loss to an Unconnected US Shareholder in an amount equal to the difference between the amount realized and the holder's adjusted basis in the Common Stock. Gain or loss upon the sale of Common Stock will be short-term or long-term capital gain or loss, depending on whether the shares have been held for more than one year.
ITEM 6
ITEM 6 - SELECTED FINANCIAL DATA
The following table contains certain selected consolidated financial data of the Company and is qualified in its entirety by the more detailed Consolidated Financial Statements and Notes thereto included elsewhere in this report. The statement of operations data for the years ending December 31, 1997, 1998, and 1999 and the balance sheet data as of December 31, 1998 and 1999 have been derived from the Consolidated Financial Statements of the Company, which have been audited by KPMG LLP, independent certified public accountants, and are included elsewhere in this report. The statement of operations data of the Company for the years ending December 31, 1995 and 1996 and the balance sheet data as of December 31, 1995, 1996, and 1997 have been derived from consolidated financial statements of the Company, which have been audited by KPMG LLP and are not included in this report. This data should be read in conjunction with the Consolidated Financial Statements and related Notes thereto and "Management's Discussion and Analysis of Financial Condition and Results of Operations" appearing elsewhere herein.
ITEM 7
ITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Overview
Zoom was established in 1977, and initially produced and marketed speed dialers and other specialty telephone accessories. The Company shipped its first modem in 1983 and its first faxmodem in 1990. Sales of faxmodems and related products now comprise substantially all of the Company's revenues. The Company sells its products both domestically and internationally through high-volume retailers and distributors, and to PC manufacturers and other OEMs.
The Company's results of operations have been and may continue to be subject to significant fluctuations. The results for a particular period may vary due to a number of factors, including the overall state of the PC and PC communications markets, pricing and other competitive conditions, the timing of orders, market acceptance of the Company's or its OEM customers' products, the timing of the announcement and introduction of new products by the Company and its competitors, variations in the Company's product mix and component costs, variations in the proportion of sales made to retailers, distributors and OEMs, the financial health and inventory levels of the Company's customers, seasonal promotions by the Company, its customers and competitors, the timing of expenditures in anticipation of future sales, the timing of product development costs, the availability of materials and labor necessary to produce the Company's products and general economic conditions. The Company also believes that its sales are seasonal, with increased sales generally occurring in the fourth quarter reflecting holiday sales. The Company expects that its quarterly operating results will continue to fluctuate in the future as a result of these and other factors.
The Company continually seeks to improve its product designs and manufacturing approach in order to reduce its costs. The Company pursues a strategy of outsourcing rather than internally developing its faxmodem chipsets, which are application-specific integrated circuits that form the technology base for its faxmodems. By outsourcing the chipset technology, the Company is able to concentrate its research and development resources on faxmodem system design, leverage the extensive research and development capabilities of its chipset suppliers, and reduce its development time and associated costs and risks. As a result of this approach, the Company is able to quickly develop new and innovative products while maintaining a relatively low level of research and development expense as a percentage of sales. The Company also outsources aspects of its manufacturing to contract assemblers as a means of reducing its fixed labor costs and capital expenditures, and to provide the Company with greater flexibility in its capacity planning.
The Company's gross margins are typically significantly higher for its branded product sales to retailers and distributors, both in the United States and internationally, than for sales to OEMs. However, the increased margins for sales to retailers and distributors are generally offset by higher operating expenses associated with those sales than for sales to OEMs. These increased operating expenses typically include costs for cooperative advertising, technical support and sales commissions.
The market for faxmodems has been characterized by rapid technological change, frequent product introductions, evolving industry requirements and short product life cycles. When component costs drop and competitive and enhanced products become available, the Company's products are susceptible to price decreases. The Company has a policy of offering price protection to certain of its retailer and distributor customers for some or all of their on-hand inventory, whereby when the Company reduces its prices for a product, the customer receives a credit for the difference between the original purchase price and the Company's reduced price. In 1997, 1998 and to a lesser extent in 1999, the Company's results of operations were adversely affected by reductions in prices which resulted in relatively high charges for price protection. The impact of price reductions is mitigated by the Company's introduction of new products, the adoption of lower-cost technologies and product designs, and the implementation of other measures to reduce its manufacturing and other costs.
Results of Operations
The following table sets forth certain financial data for the periods indicated as a percentage of net sales:
Year Ending December 31, 1999 Compared to Year Ending December 31, 1998
Net Sales. Net sales increased 3.4% to $63.4 million in 1999 from $61.4 million in 1998. The Company's net sales to retailers and distributors in the United States were unchanged at $42.7 million in both 1998 and 1999. The Company's worldwide net sales to OEM customers decreased by 53.9% to $2.4 million, reflecting the Company's de-emphasis of the extremely price competitive analog modem OEM business. The Company's international sales to retailers and distributors increased by 36.6% to $18.5 million in 1999. The significant increase in international sales was primarily due to the purchase of the Hayes European modem business in March 1999.
Gross Profit. Gross profit as a percentage of net sales increased to 37.1% in 1999 from 27.2% in 1998. Although average selling prices for modems declined year over year, the cost of materials and manufacturing costs, including product obsolescence, scrap expense, and manufacturing overhead, declined to a greater extent, yielding increased gross margin. In addition, channel price protection and consumer rebates were less of a negative impact on gross profit in 1999 than in 1998. Gross margin for all of 1999 and part of 1998 included the favorable impact of advantageously negotiated purchases of modem materials. This advantage continued to a lesser degree in the first quarter of 2000. The impact of the favorable purchases is realized as units are sold. The net impact on gross margin in 2000 is unclear.
Selling Expenses. Selling expenses increased 15.0% to $13.6 million or 21.4% of net sales in 1999 from $11.8 million or 19.2% of net sales in 1998. The dollar increase was primarily the result of the selling expenses in Zoom's new Hayes European operation and increased advertising and promotion expense, primarily in the form of cooperative advertising programs with the resellers of Zoom modems.
General and Administrative Expenses. General and administrative expenses increased 26.1% to $6.3 million or 9.9% of net sales in 1999 from $5.0 million or 8.1% of net sales in 1998. The added expense was primarily due to the general and administrative expenses in our new Hayes European operation, increased legal expenses, Hayes goodwill amortization, and higher personnel costs.
Research and Development Expenses. Research and development expenses increased 44.4% to $6.4 million or 10.1% of net sales in 1999 from $4.5 million or 7.3% of net sales in 1998. The increase in expenses was primarily due to additional personnel and related expenses consistent with development of the Company's new and planned wireless and broadband product lines.
Interest Income. Net interest income decreased to $546,329 in 1999 from $840,044 in 1998. The decrease was the result of the Company's lower average cash balances during 1999 compared to 1998.
Other Income Net. Other income and non-interest income decreased to $190,999 in 1999 from $233,979 in 1998.
Provision for Income Taxes. The Company's tax benefit of $587,935 in 1999 represents an effective tax rate of 29.4% compared to the 37% rate in 1998. The tax benefit rate decreased because Management has determined that it is more likely than not that certain state tax benefits will not be realized. In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income, and other matters in making this assessment. As a result of its evaluation of these factors management recorded a valuation allowance against its deferred tax asset of $770,116. The valuation allowance was the result of management's assessment that some portion of the benefits from the net operating losses for state tax purposes incurred by the Company might not be realized in future periods.
Year Ending December 31, 1998 Compared to Year Ending December 31, 1997
Net Sales. Net sales decreased 5.0% to $61.4 million in 1998 from $64.5 million in 1997. Unit sales of modems in 1998 increased 7.3% over 1997, but the average selling price for modems declined by more than 10%. In 1998 as compared to 1997, the Company's sales to retailers and distributors in the United States decreased by 6.0% to $42.8 million and the Company's worldwide sales to OEM customers decreased by 9% to $5.2 million. The Company's international sales to retailers and distributors held constant at $13.4 million in 1998 and 1997.
Gross Profit. Gross profit as a percentage of net sales increased to 27.2% in 1998 from 12.7% in 1997. Although average selling prices for modems declined year over year, the cost of materials and manufacturing costs, including obsolescence and scrap expense, declined to a greater extent, yielding increased gross margins. In addition, channel price protection was less of a negative impact on gross profit in 1998 than in 1997. Gross profit for 1998 included the favorable impact of advantageously negotiated purchases of modem materials. These purchases continued in the first quarter of 1999.
Selling Expenses. Selling expenses increased 6.3% to $11.8 million or 19.2% of net sales in 1998 from $11.1 million or 17.2% of net sales in 1997. The dollar increase was primarily the result of increases in advertising and promotions in Zoom's direct sales channel, added technical support personnel and services, and increased commission expenses.
General and Administrative Expenses. General and administrative expenses were relatively unchanged from 1997 to 1998. General and administrative expenses were $5.0 million or 8.1% of net sales in 1998 compared to $5.0 million or 7.7% of net sales in 1997. Lower personnel costs and bad debt expenses were offset by increased legal expenses.
Research and Development Expenses. Research and development expenses increased 6.4% to $4.5 million or 7.3% of net sales in 1998 from $4.2 million or 6.5% of net sales in 1997. The increase in expenses was primarily due to additional personnel consistent with the broadening of the Company's non-modem and international modem product lines and the integration of Lucent Technologies modem chipsets into some of the Company's 56K modem product line. Amortization of licenses and higher costs for recruiting and consulting increased in 1998 while the costs of foreign and domestic government approvals decreased.
Interest Income. Net interest income increased to $840,044 in 1998 from a net interest income of $503,680 in 1997. The increase was the result of the Company's higher average cash balances and higher interest rates during 1998 compared to 1997.
Other Income Net. Other income and non-interest income decreased slightly to $233,979 in 1998 from $237,273 in 1997.
Provision for Income Taxes. The Company's effective tax rate remained unchanged from 1997 at approximately 37.0%.
Liquidity and Capital Resources
On December 31, 1999 the Company had working capital of $29.6 million, including $10.4 million in cash and investment securities. The Company has received a commitment for a new secured $5 million line of credit that expires on April 1, 2003. The line of credit bears interest at the bank's prime rate. The line of credit outlined in the commitment letter is secured and contains certain financial and other covenants. The Company anticipates that the line of credit agreement will be signed by the end of the second quarter. The Company is in full compliance with all covenants. No amounts were outstanding under any lines of credit at December 31, 1999.
In 1999 the Company's net cash used in operating activities was approximately $2.6 million (Note that the discussion of operating activities for cashflow purposes excludes the impact of acquired assets and liabilities in the Hayes acquisition). During that period accounts receivable decreased by $1.5 million. The decrease in accounts receivable was primarily due to improved collections in 1999 as compared to 1998. Other sources of cash in 1999 were depreciation and amortization of $1.3 million. These sources of cash were offset by the increase of inventories of $2.6 million, the reduction of accounts payable and accrued expenses of $0.8 million, the increase of $0.6 million of refundable income taxes, and the Company's $1.4 million net loss.
The Company's capital expenditures in 1999 of approximately $0.9 million consisted primarily of the Company's purchases of computer hardware and software, purchases of other equipment and tooling, and continued renovations to its headquarters.
During the year ended December 31, 1999 the Company entered into agreements with Hayes Microcomputer Products, Inc. to purchase various assets, rights, and inventory in a public bankruptcy auction for approximately $4.9 million, net of cash acquired. These purchases were primarily funded by the sales of investment securities sold during the year. See Note 6 to the Consolidated Financial Statements.
The Company believes that its existing cash and investment securities, together with funds generated from operations and available sources of financing, will be sufficient to meet its normal working capital requirements for the next twelve months. There are no significant capital commitments.
Impact of Year 2000
Year 2000 problems are the result of computer programs being written using two digits rather than four to define the applicable year. If not corrected, many computer applications could fail or create erroneous results by not recognizing "00" to mean the year 2000. In 1999, the Company completed its testing of all critical software and hardware systems and determined that all are Year 2000 compliant. Vendor certifications were received from all critical vendors indicating that they were either currently compliant or that they would be compliant by December 31, 1999. To date, the Company has not needed to implement any major system or software replacements due to the Year 2000 issue. The Company has not incurred and does not expect to incur any material direct costs associated with Year 2000 issues. The Company has not experienced and does not expect to experience any significant Year 2000 problems or interruptions. The Company cannot assure you that critical vendors and customers will not incur a Year 2000 problem or interruption, but the Company believes it has adequate computer file backup procedures and manual operating procedures that will enable it to continue the critical processes of our business.
Euro Conversion
On January 1, 1999, 11 of the 15 member countries of the European Union established a fixed conversion rates between their existing sovereign currencies and the euro. As of January 1, 2002, the transition to the euro will be complete. The Company has significant operations within the European Union and is currently preparing for the euro conversion. The euro may impact general economic conditions such as interest and foreign exchange rates within the participating countries or in other areas where the Company operates. The Company is in the process of analyzing the impact of the euro with a view to minimizing the effects on the Company's operations. The Company does not expect the costs of upgrading its systems to be material.
A portion of the Company's revenues are subject to the risks associated with international sales. Although most of the Company's product prices are denominated in the United States currency, customers in foreign countries generally evaluate purchases of products such as those sold by the Company on the purchase price expressed in the customer's currency. As a result, the impact of and economic conditions relating to the euro (including fluctuations in foreign currency exchange rates, particularly with respect to the U.S. dollar) may have a material adverse affect on the demand for the Company's products as well as on the Company's business, financial condition and results of operations.
Recently Issued Accounting Standards
As of January 1, 1999 the Company adopted Statement of Position 98-1 ("SOP 98-1"), "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use." This statement provides guidance on accounting for the costs of computer software developed or obtained for internal use and applies to all non-governmental entities. The adoption of SOP 98-1 had no material impact on the Company's financial statements.
In June of 1998, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Standards No. 133 ("SFAS 133"), "Accounting for Derivative Instruments and Hedging Activities," which is effective for all fiscal quarters of fiscal years beginning after June 15, 1999. It requires that an entity recognize all derivatives as either assets or liabilities in the statement of financial position and measure those instruments at fair value. In July of 1999, the FASB issued Statement of Financial Standards No. 137 ("SFAS 137"), "Accounting for Derivative Instruments and Hedging Activities - Deferral of the Effective Date of FASB Statement No. 133," which defers the effective date to all fiscal quarters of fiscal years beginning after June 15, 2000. The Company has not yet evaluated the effects of this change on its operations. The Company will adopt SFAS 133 as required for its first quarterly filing of the fiscal year 2001.
In December, 1999 the SEC issued Staff Accounting Bulletin No. 101 ("SAB 101"), Revenue Recognition in Financial Statements. SAB 101 provides guidance for revenue recognition under certain circumstances. We are currently evaluating the impact of SAB 101 on the financial statements and related disclosures, which will be effective for the year ended December 31, 2000.
The AICPA Accounting Standards Executive Committee recently issued SOP 98-5, "Reporting on the Costs of Start-up Activities". This SOP requires that costs incurred during start-up activities, including organization costs, be expensed as incurred, and is effective for the fiscal years beginning after December 15, 1998. The adoption of this SOP is expected to have no impact on the Company's consolidated financial position or results of operations.
ITEM 7A.
ITEM 7A.
The Company owns financial instruments that are sensitive to market risks as part of its investment portfolio. The investment portfolio is used to preserve the Company's capital until it is required to fund operations, including the Company's research and development activities. None of these market-risk sensitive instruments are held for trading purposes. The Company does not own derivative financial instruments in its investment portfolio. The investment portfolio contains instruments that are subject to the risk of a decline in interest rates.
Investment Rate Risk - The Company's investment portfolio includes debt instruments that are primarily United States government bonds and high grade corporate bonds of less than three years in duration. These bonds are subject to interest risk, and could decline in value if interest rates fluctuate. The Company's investment portfolio also consists of certain commercial paper, which is also subject to interest rate risk. Due to the short duration and conservative nature of these instruments, the Company does not believe that it has a material exposure to interest rate risk.
ITEM 8
ITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
ZOOM TELEPHONICS, INC. INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULE
Page Index to Consolidated Financial Statements 27 Independent Auditors' Report 28 Consolidated Balance Sheets as of December 31, 1998 and 1999 29 Consolidated Statements of Operations for the years ending December 31, 1997, 1998 and 1999 30 Consolidated Statements of Changes in Stockholders' Equity and Comprehensive Income for the years ending December 31, 1997, 1998 and 1999 31 Consolidated Statements of Cash Flows for the years ending December 31, 1997, 1998 and 1999 32 Notes to Consolidated Financial Statements 33 Schedule II: Valuation and Qualifying Accounts for Fiscal Years Ending December 31, 1997, 1998 and 1999 48
ITEM 9
ITEM 9 - CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
There were no changes in or disagreements with accountants on accounting or financial disclosure during the period covered by this report.
PART III
ITEM 10
ITEM 10 - DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information required by this item appears under the caption "Executive Officers of the Registrant" in Part 1, Item 1 -- Business, and under the captions "Election of Directors" and "Compliance With Section 16(a) of the Securities Exchange Act" in the Company's definitive proxy statement for its 2000 annual meeting of shareholders which will be filed with the SEC in April 2000 pursuant to Regulation 14A, and is incorporated herein by reference.
ITEM 11
ITEM 11 - EXECUTIVE COMPENSATION
Information required by this item appears under the captions "Executive Compensation," "Directors' Compensation", in the Company's definitive proxy statement for its 2000 annual meeting of shareholders which will be filed with the SEC in April 2000, pursuant to Regulation 14A, and is incorporated herein by reference.
ITEM 12
ITEM 12 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information required by this item appears under the captions "Election of Directors" and "Security Ownership of Certain Beneficial Owners and Management" in the Company's definitive proxy statement for its 2000 annual meeting of shareholders which will be filed with the SEC in April 2000, pursuant to Regulation 14A, and is incorporated herein by reference.
ITEM 13
ITEM 13 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
None.
PART IV
ITEM 14
ITEM 14 - EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) Financial Statements, Schedules and Exhibits:
(1), (2) The financial statements and required schedules are indexed under Item 8.
(3) Exhibits required by the Exhibit Table of Item 601 of SEC Regulation S-K. (Exhibit numbers refer to numbers in the Exhibit Table of Item 601.)
2.1 Asset Purchase Agreement Between Zoom Telephonics, Inc. and Hayes Microcomputer Products, Inc. dated March 8, 1999, filed as Exhibit 2.1 to the Quarterly Report on Form 10-Q for the fiscal quarter ended March 31, 1999 (the "March 1999 Form 10-Q").*
2.2 Asset Purchase Agreement Between Zoom Telephonics, Inc. and Hayes Microcomputer Products, Inc. dated March 28, 1999, filed as Exhibit 2.2 to the March 1999 Form 10-Q. *
3.1 Articles of Continuance, filed as Exhibit 3.1 to the Annual Report on Form 10-K for the fiscal year ended December 31, 1991 (the "1991 Form 10-K"). *
3.2 By-Law No. 1 of Zoom Telephonics, Inc., filed as Exhibit 3.2 to the 1991 Form 10-K. *
3.3 By-Law No. 2 of Zoom Telephonics, Inc., filed as Exhibit 3.3 to the 1991 Form 10-K. *
**10.1 1990 Stock Option Plan, as amended, of Zoom Telephonics, Inc., filed as Exhibit 10.1 to the Quarterly Report on Form 10-Q for the fiscal quarter ended June 30, 1998. *
**10.2 1991 Director Stock Option Plan, as amended, of Zoom Telephonics, Inc., filed as Exhibit 10.2 to the Quarterly Report on Form 10-Q for the fiscal quarter ended June 30, 1996 ("the June 1996 Form 10-Q"). *
10.3 Letter Agreement Regarding Revolving Line of Credit by and between Zoom Telephonics, Inc. and Fleet National Bank, filed as Exhibit 10.3 to the Annual Report on Form 10-K for the fiscal year ended December 31, 1997 ("the 1997 Form 10-K"). *
10.4 Loan Modification Agreement by and between Zoom Telephonics, Inc. and Fleet National Bank, filed as Exhibit 10.4 to the 1997 Form 10-K. *
10.5 Lease between Zoom Telephonics, Inc. and "E" Street Associates, filed as Exhibit 10.5 to the June 1996 Form 10-Q.*
10.6 Form of Indemnification Agreement, filed as Exhibit 10.6 to the June 1996 Form 10-Q. *
10.7 Promissory Note issued by Zoom Telephonics, Inc. in favor of Fleet National Bank.
10.8 Security Agreement between the Company and Fleet National Bank, filed as Exhibit 10.8 to the 1997 Form 10-K. *
**10.9 Employment Agreement, filed as Exhibit 10.9 to the 1997 Form 10-K. *
10.10 Second Loan Modification Agreement by and between Zoom Telephonics, Inc. and Fleet National Bank.
11. Statement re computation of per share earnings.
21. Subsidiaries, filed as Exhibit 21 to the Annual Report on Form 10-K for the fiscal year ended December 31, 1996. *
23. Consent of KPMG LLP.
27. Financial Data Schedule.
(b) Reports on Form 8-K.
No current reports on Form 8-K have been filed during the last quarter for the period covered by this report.
(c) Exhibits - See Item 14(a)(3) above for a list of Exhibits incorporated herein by reference or filed with this Report.
(d) Schedules - Schedule II: Valuation and Qualifying Accounts. Schedules other than those listed above have been omitted since they are either inapplicable or not required.
* In accordance with Rule 12b-32 under the Securities Exchange Act of 1934, as amended, reference is made to the documents previously filed with the Securities and Exchange Commission, which documents are hereby incorporated by reference.
** Compensation Plan or Arrangement.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
ZOOM TELEPHONICS, INC. (Registrant)
By: /s/ Frank B. Manning ---------------------------- Frank B. Manning, President
Date: March 29, 2000
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities indicated.
ZOOM TELEPHONICS, INC. INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULE
Page
Independent Auditors' Report 28 Consolidated Balance Sheets as of December 31, 1998 and 1999 29 Consolidated Statements of Operations for the years ending December 31, 1997, 1998, and 1999 30 Consolidated Statements of Changes in Stockholders' Equity for the years ending December 31, 1997, 1998, and 1999 31 Consolidated Statements of Cash Flows for the years ending December 31, 1997, 1998, and 1999 32 Notes to Consolidated Financial Statements 33 Schedule II: Valuation and Qualifying Accounts for Fiscal Years Ending December 31, 1997, 1998, and 1999 48
Independent Auditors' Report
The Board of Directors and Stockholders Zoom Telephonics, Inc.:
We have audited the accompanying consolidated balance sheets of Zoom Telephonics, Inc. and subsidiaries as of December 31, 1998 and 1999, and the related consolidated statements of operations, changes in stockholders' equity and comprehensive income and cash flows for each of the years in the three-year period ended December 31, 1999. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Zoom Telephonics, Inc. and subsidiaries as of December 31, 1998 and 1999, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1999, in conformity with generally accepted accounting principles.
KPMG LLP
Boston, Massachusetts February 8, 2000
ZOOM TELEPHONICS, INC. CONSOLIDATED BALANCE SHEETS
See accompanying notes to consolidated financial statements.
See accompanying notes to consolidated financial statements.
See accompanying notes to consolidated financial statements.
See accompanying notes to consolidated financial statements.
ZOOM TELEPHONICS, INC. Notes to Consolidated Financial Statements Years Ending December 31, 1997, 1998 and 1999
(1) Incorporation and Nature of Operations Zoom Telephonics, Inc. (the "Company") is incorporated under the federal laws of Canada (Canada Business Corporations Act). Its principal business activity, the design, production, and marketing of faxmodems and other communication peripherals, is conducted through its wholly-owned subsidiary, Zoom Telephonics, Inc. ("Zoom US"), a Delaware corporation based in Boston, Massachusetts.
(2) Summary of Significant Accounting Policies
(a) Basis of Presentation The consolidated financial statements are prepared in accordance with United States generally accepted accounting principles and are stated in US dollars. Any differences between US and Canadian generally accepted accounting principles would have an insignificant impact on the consolidated financial statements. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results may differ from those estimates.
(b) Principles of Consolidation The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiary, Zoom US, and all of its wholly-owned subsidiaries. All intercompany balances and transactions have been eliminated in consolidation.
(c) Cash and Cash Equivalents The Company considers all investments with original maturities of less than 90 days to be cash equivalents.
(d) Investment Securities On December 31, 1998, the Company adopted the provisions of Statement of Financial Accounting Standards (SFAS) No. 115, "Accounting for Certain Investments in Debt and Equity Securities." Previously, the Company's investments had maturities of less than ninety days. The Company's investment securities are classified as available-for-sale. Available-for-sale securities are stated at fair value and unrealized gains and losses are excluded from earnings, and are reported as a separate component of other comprehensive income until realized. The cost of securities sold is based on the specific identification method and interest earned is included in Other Income.
(e) Inventories Inventories are stated at the lower of cost or market, cost being determined using the first-in, first-out (FIFO) method.
(f) Property, plant and equipment Property, plant and equipment is stated and recorded at cost. Depreciation of property, plant and equipment is provided by using the straight-line method at rates sufficient to amortize the costs of the fixed assets over their estimated useful lives. In accordance with Financial Accounting Standards Board Statement No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of," the Company reviews its long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. If it is determined that the carrying amount of an asset cannot be fully recovered, an impairment loss is recognized.
ZOOM TELEPHONICS, INC. Notes to Consolidated Financial Statements
(g) Goodwill Goodwill resulted from the excess of cost over fair value of net assets acquired for the purchase of a product line in June 1996 and the Hayes acquisition in 1999 and are being amortized on a straight-line basis over 10 years and 5 years, respectively. The Company evaluates the recoverability and remaining life of its goodwill and determines whether the goodwill should be completely or partially written off or the amortization period accelerated. The Company will recognize an impairment of goodwill if undiscounted estimated future operating cash flows of the acquired product line are determined to be less than the carrying amount of goodwill. If the Company determines that the goodwill has been impaired, the measurement of the impairment will be equal to the excess of the carrying amount of the goodwill over the amount of discounted estimated future cash flows. If an impairment of goodwill were to occur, the Company would reflect the impairment through a reduction in the carrying value of goodwill. The assessment of recoverability of goodwill will be impacted if estimated future operating cash flows are not achieved.
(h)Income Taxes The Company accounts for income taxes under the asset and liability method. Under this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis and operating loss and tax credit carry forwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.
(i)Earnings (Loss) Per Common Share Basic earnings (loss) per share is computed by dividing net income (loss) by the weighted average number of common shares outstanding during the period. Diluted loss per share is computed by dividing net income by the weighted average number of common shares and dilutive potential common shares outstanding during the period. Under the treasury stock method, the unexercised options are assumed to be exercised at the beginning of the period or at issuance, if later. The assumed proceeds are then used to purchase common shares at the average market price during the period.
Potential common shares for which inclusion would have the effect of increasing diluted earnings per share (i.e., antidilutive) are excluded from the computation. Options to purchase 83,573, 744,111 and 661,355 shares of common stock at December 31, 1997, 1998, and 1999, respectively, were outstanding, but not included in the computation of diluted earnings per share as their effect would be antidilutive.
(j)Revenue Recognition Sales are recognized upon shipment of products to customers, at which time the Company records provisions for returns, warranty and price protection.
ZOOM TELEPHONICS, INC. Notes to Consolidated Financial Statements
(k) Financial Instruments Financial instruments of the Company consist of cash and cash equivalents, investment securities, accounts receivable, accounts payable and accrued expenses. The carrying amount of these financial instruments approximates fair value.
(l)Stock Based Compensation The Company has adopted SFAS No. 123, "Accounting for Stock-Based Compensation." As permitted by SFAS No. 123, the Company measures compensation cost in accordance with Accounting Principles Board Opinion (APB) No. 25 (APB 25), "Accounting for Stock Issued to Employees," and related interpretations. Accordingly, no accounting recognition is given to stock options granted at fair market value until they are exercised. Upon exercise, net proceeds, including tax benefits realized, are credited to equity.
(m) Advertising Costs Advertising costs are expensed as incurred and reported in selling, general, and administrative expenses in the accompanying consolidated statements of operations and include costs of advertising, production, trade shows, and other activities designed to enhance demand for the Company's products. There are no deferred advertising costs in the accompanying consolidated balance sheets.
(n) Investments in Affiliates Investments in which the Company has no significant influence over the investee are accounted for under the cost method of accounting. Investments in which the Company exercises significant influence but which the Company does not control are accounted for under the equity method of accounting. Under the equity method, investments are stated at cost and are adjusted for the Company's share of earnings and losses, contributions and distributions.
ZOOM TELEPHONICS, INC. Notes to Consolidated Financial Statements
(5) Lease Commitments
In August 1996, the Company entered into a five-year lease for a manufacturing and warehousing facility in Boston, Massachusetts. At the end of the initial lease term, the Company has an option to extend the lease for an additional five years at a fair market value. In March of 1999, the Company acquired a ten-year lease for an office facility in Camberley, United Kingdom. Under non-cancelable operating leases, Zoom's total rent expense was $392,010, $334,469 and $420,086 for the years ending December 31, 1997, 1998, and 1999, respectively. Future minimum rental payments, excluding executory costs, required under these operating leases are as follows: Year Total
2000 $ 491,974 2001 $ 346,797 2002 $ 143,548 2003 $ 156,705 2004 $ 157,902 2005-2008 $ 486,865
(6) Acquisition
In March 1999 the Company entered into a series of independent agreements to purchase various assets, licenses, and inventory from Hayes Microcomputer Products, Inc. ("Hayes"). Hayes was engaged in the business of design, manufacture, and support of computer communications products for business, government, and consumers worldwide. On October 9, 1998 Hayes filed for reorganization under Chapter 11 of the United States Bankruptcy Code, Case No.98-2276 through 98-2281, in the United States Bankruptcy Court ("the Court") for the District of Delaware.
In March 1999 Zoom Telephonics acquired most of the modem assets of Hayes Corporation for $5.0 million in cash. The purchase included the Hayes, Practical Peripherals, Accura, Optima, Century 2, and Cardinal brands and product rights for the USA, Canada, South & Central America, Europe, and the Middle East. In July 1999 the Company finalized the purchase of Hayes Asia Pacific for $1.1 million in cash. The acquisitions were accounted for as purchases. The excess of cost over fair value of net assets acquired is being amortized on a straight-line method over five years.
The following summarizes the assets acquired and liabilities assumed in the series of transactions: Assets acquired: Cash $ 1,216,221 Accounts receivable 1,530,589 Inventory 865,885 Property and equipment 278,479 Goodwill (excess of cost over fair value of assets) 3,268,770 Other assets 388,626 ---------- $ 7,548,570 ========== Liabilities assumed: Cash paid 6,128,479 Accounts payable 554,861 Accrued expenses 297,429 Negative Goodwill - other non-current liabilities 567,801 ---------- $ 7,548,570 ==========
(Continued) ZOOM TELEPHONICS, INC. Notes to Consolidated Financial Statements
The negative goodwill resulted from the purchase of the Hayes U.K. business, where the value of the net assets acquired exceeded the cost. This transaction was independent of other Hayes purchases. The negative goodwill is reflected on the Consolidated Balance Sheet as a non-current liability. The negative goodwill is being amortized on a straight-line method over five years.
(7) Comprehensive Income
Statement of Financial Accounting Standard ("SFAS") No. 130, "Reporting Comprehensive Income" establishes rules for the reporting and display of comprehensive income and its components; however, it has no impact on the Company's net income or shareholders' equity. SFAS No. 130 requires all changes in equity from non-owner sources to be included in the determination of comprehensive income.
The components of comprehensive income, net of tax, are as follows:
(8) Credit Lines
The Company has received a commitment for a new $5 million line of credit that expires on April 1, 2003. The line of credit bears interest at the bank's prime rate. The line of credit outlined in the commitment letter is secured and contains certain financial and other covenants. The Company anticipates that the line of credit agreement will be signed by the end of the second quarter. The Company is in full compliance with all covenants. No amounts were outstanding under any lines of credit at December 31, 1999.
(9) Stock Option Plans
At December 31, 1999 the Company had three stock option plans, which are described below:
Employee Stock Option Plan The Employee Stock Option Plan (the "Employee Stock Option Plan") is for officers and certain full-time and part-time employees of the Company. Non-employee directors of the Company are not entitled to participate under this plan. The Employee Stock Option Plan provides for the availability of 2,800,000 shares of common stock for issuance upon the exercise of stock options granted under the plan. Shares of common stock were registered for issuance under this plan in accordance with the Securities Act of 1933. Under this plan, stock options shall be granted at the discretion of the Stock Option Committee of the Board of Directors at an option price not less than the fair market value of the stock. The options are exercisable in accordance with terms specified by the Stock Option Committee not to exceed ten years from the date of grant. Options outstanding under this plan are as follows:
(Continued) ZOOM TELEPHONICS, INC. Notes to Consolidated Financial Statements
The Company recognized a tax benefit of $75,567 and $102,322 in 1997 and 1999, respectively, upon the exercise of nonqualified stock options under the Employee Stock Option Plan. These benefits have been recorded as an increase to the value of common stock.
1991 Director Stock Option Plan
In 1991, the Company established the Director Stock Option Plan (the "Directors Plan"). Shares of common stock were registered for issuance under this plan in accordance with the Securities Act of 1933. The Directors Plan was established for all directors of the Company except for any director who is a full-time employee or full-time officer of the Company. Under the Directors Plan, each eligible director shall automatically be granted an option to purchase 6,000 shares of common stock on July 10 and January 10 of each year, beginning July 10, 1991. The option price shall be the fair market value of the common stock on the date the option is granted. There are 198,000 shares authorized for issuance. Each option shall expire two years from the grant date. Options outstanding under this plan are as follows:
1998 Employee Equity Incentive Stock Option Plan
The 1998 Employee Equity Incentive Stock Option Plan (the "1998 Plan") was adopted to attract and retain employees and provide an incentive for them to assist the Company to achieve long-range performance goals, and to enable them to participate in the long-term growth of the Company. Non-employee directors of the Company and certain officers of the Company are not entitled to participate under this plan. In 1999 the Board of Directors increased the authorized number of shares available for grant under the 1998 Plan from 300,000 to 600,000 shares of common stock. Shares of common stock were registered for issuance under the 1998 Employee Equity Incentive Stock Option Plan in accordance with the Securities Act of 1933. Under this plan, stock options may be granted at the discretion of the Stock Option Committee of the Board of Directors at an option price determined by the Stock Option Committee. In addition, in 1999, the Board of Directors authorized the Chief Executive Officer of the Company to grant up to an aggregate of 50,000 stock options to employees who are not executive officers or directors of the Company. All options under this grant have been at fair market value on the date of the grant. The options are exercisable in accordance with terms specified by the Stock Option Committee or, in certain cases, the Chief Executive Officer. Options outstanding under this plan are as follows:
At December 31, 1999, there were 1,194,660 additional shares available for grant under all three stock option plans. The per share weighted-average fair value of stock options granted during 1997, 1998, and 1999 was $4.43, $3.70, and $4.33, respectively, on the date of grant using the Black Scholes option-pricing model with the following weighted-average assumptions: 1997 expected dividend yield 0.0%, risk-free interest rate of 5.69%, volatility 70% and an expected life of 3.5 years; 1998 - expected dividend yield 0.00%, risk-free interest rate of 5.50%, volatility 88% and an expected life of 2.8 years; 1999 - expected dividend yield 0.00%, risk-free interest rate of 6.16%, volatility 90% and an expected life of 2.75 years.
The Company applies APB Opinion No. 25 in accounting for its stock options and, accordingly, no compensation cost has been recognized in the accompanying consolidated financial statements. Had the Company determined compensation cost based on the fair value at the grant date for its options under SFAS No. 123, the Company's net income (loss) and basic and diluted net income (loss) per share would have been reduced to the pro forma amounts indicated below:
(Continued) ZOOM TELEPHONICS, INC. Notes to Consolidated Financial Statements
Pro forma net loss reflects only options granted since January 1, 1995. Therefore, the full impact of calculating compensation cost for stock options under SFAS 123 is not reflected in the pro forma amounts presented above because compensation cost for options granted prior to January 1, 1995 is not considered.
(10) Income Taxes
Income tax benefit attributable to loss from operations consists of:
Income tax expense (benefit) was ($4,189,266), ($1,287,420), and ($587,935) for the years ending December 31, 1997, 1998 and 1999, respectively, and differed from the amounts as computed by applying the US federal income tax rate of 34% to pretax income (loss) as a result of the following:
(Continued) ZOOM TELEPHONICS, INC. Notes to Consolidated Financial Statements
(11) Significant Customers
One customer accounted for approximately 17% of net sales for the year ending December 31, 1997. Two customers accounted for approximately 20% and 14% of net sales for the year ending December 31, 1998. Two customers accounted for approximately 17% and 10% of net sales for the year ending December 31, 1999. On December 31, 1998, two customers comprised approximately 40% of net accounts receivable. On December 31, 1999, two customers comprised approximately 29% of net accounts receivable.
(12) Financial Instruments
The Company generates a portion of its revenues in international markets and denominated in foreign currencies, which subjects its operations to exposure to foreign currency fluctuations. The impact of currency fluctuations can be positive or negative in any given period.
(Continued) ZOOM TELEPHONICS, INC. Notes to Consolidated Financial Statements
Realized and unrealized foreign exchange gains and losses are recognized in operating income and offset foreign gains and losses on the underlying exposures. During the years ending December 31, 1997, 1998 and 1999 foreign currency gains and losses were not material. At December 31, 1999, the Company's foreign currency-denominated net assets were not material. The Company has no involvement with derivative financial instruments.
(13) Investment in Limited Liability Company
In September 1999, the Company made an investment in a limited liability company ("LLC"). The Company granted the LLC the rights to a software license in exchange for 300,000 Class A shares of the LLC, which were valued by the Company at $300,000. The value at which the outside investors paid cash for shares received as part of the same equity infusion was used by the Company to value their shares received. A gain of $75,000 was recognized on the transaction, which was reported as other income in fiscal 1999.
(14) Supplemental Disclosure of Cash Flow Information
The tax effect of the exercise of stock options resulted in increases to common stock and an increase in refundable income taxes of $75,567 in 1997 and $102,322 in 1999.
(15) Dependence on Key Suppliers
The Company produces its products using components or subassemblies purchased from third-party suppliers. In 1997, the Company purchased substantially all of its modem chipsets from a single supplier, Conexant (formerly Rockwell). Since 1998, the Company has also purchased chipsets from Lucent Technologies, with a goal of maintaining good supply relationships with both Conexant and Lucent. In 1999, the Company purchased substantially all of its modem chipsets from Lucent. An interruption in the delivery of these components could have a material adverse effect on the Company's results of operations.
(16) Segment and Geographic Information
During 1998, the Company adopted Financial Accounting Standards Board Statement of Financial Standards No. 131 ("SFAS 131") "Disclosures About Segments of an Enterprise and Related Information."" The Company's operations are classified into one reportable segment. Substantially all of the Company's operations and long-lived assets reside primarily in the United States. The Company's domestic net sales and export sales to Europe and other locations for 1997, 1998, and 1999 were comprised as follows:
xhibit 23. Report on Financial Statement Schedule and Consent of KPMG LLP
REPORT ON FINANCIAL STATEMENT SCHEDULE AND CONSENT OF INDEPENDENT AUDITORS
The Board of Directors; Zoom Telephonics, Inc.
The audits referred to in our report dated February 8, 2000, included the related financial statement schedule for each of the years in the three-year period ended December 31, 1999, included in the annual report on Form 10-K. The financial statement schedule is the responsibility of the Company's management. Our responsibility is to express an opinion on the financial statement schedule based on our audits. In our opinion, such financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
We consent to incorporation by reference in the registration statements (No. 33-42834, No. 33-90930, No. 333-60565, No. 33-90191 and No. 333-75575) on Form S-8 of Zoom Telephonics, Inc. of our report dated February 8, 2000, relating to the consolidated balance sheets of Zoom Telephonics, Inc. and subsidiaries as of December 31, 1998 and 1999, and the related consolidated statements of operations, changes in stockholders' equity, and cash flows and related schedule for each of the years in the three-year period ended December 31, 1999, which report appears in the December 31, 1999 annual report on Form 10-K of Zoom Telephonics, Inc.
KPMG LLP
Boston, Massachusetts March 29, 2000