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 and its other subsidiaries.
The Company is a leading designer, producer and marketer of modems and other personal computer communications products for the home and office. Modem0s link personal computers ("PCs") to the local telephone line for transmission of data, fax, voice, and video through the worldwide telephone network, and enable PC's to connect to other computers and networks, including the Internet and local area networks ("LANs").
The Company offers a broad line of 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 to 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 has a broad line of internal and external modems and ISDN products with interfaces appropriate to North America, Europe, and many other countries throughout the rest of the world.
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 without wires, currently providing a 2 megabits per second ("mbps") data rate using the 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 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 the PC through a parallel port. A third model plugs into either a specialized video capture card included with the camera, or into modems either bundled with the camera or sold separately.
Zoom'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 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, the Microsoft Network, and Prodigy, (ii) the growing installed base of PCs, (iii) a significant increase in the use of PCs for remote access to corporate networks, and (iv) advances in technology, which have improved the functionality of the PC as a means of transferring, capturing and manipulating data-intensive information, including graphic images and voice. These trends have resulted in substantial growth of 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 many 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 200 million PCs are installed worldwide. Currently 56K modems are often bundled with a new PC, particularly in North America. However, some of the installed PCs either have no modem or have a modem with a speed below 56K. Thus there should continue to be substantial demand for modems either for bundling into a new PC or for after-market sales. This is particularly true since the V.90 56K standard was set recently, in 1998. The Company believes that modems will continue to achieve increasing penetration of the PC installed base as applications requiring data connectivity proliferate.
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. 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 modems in the future, including Digital Subscriber Line ("DSL") and cable modems, both as upgrades and as peripherals bundled with new PCs.
Zoom Strategy
Zoom focuses on the sale and development of PC communications products tailored to its channels of distribution, including high-volume retailers, distributors, personal computer manufacturers, and other OEMs. 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. Zoom has a widely recognized brand name and established channels of high-volume retailer, distributor and OEM customers who buy the Company's products. 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 January 1999 Zoom brand 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 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 established sales channels. The Company was one of the first high-volume producers of faxmodems, voice faxmodems, and video-capture-enabled faxmodems. The Company also produces innovative ISDN products, multi-line business communications products, wireless LAN products, and video products, and expects to continue to broaden its product offerings.
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 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 Harris Semi-Conductor 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 aspects of its manufacturing to contract assemblers in Mexico and mainland China as a means of reducing its labor costs and capital expenditures, and of providing the Company with flexibility in its capacity planning.
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 52 countries. The Company's international sales (excluding sales to OEMs) have increased from 8% of net sales in 1994 to 22% of net sales in 1998. The Company plans to continue to expand its international product line and distribution network, and is seeking regulatory approvals for the sale of its products in additional international markets.
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 and for wireless LAN products. In addition, Zoom sometimes sells packaged modems private-labeled for its customers and channels.
Explore Acquisitions. Zoom acquired the products and certain other assets of Tribe Computer Works ("Tribe") in mid-1996, and in March 1999 has recently acquired certain product lines and assets 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
Zoom's products link personal computers through the telephone network and connected networks, enabling remote access to on-line services, the Internet, corporate computer networks, and other computers. The Company offers a broad line of modems with top data transmission speeds of 56,000 bps. Soon after the V.90 standard for 56K was set in early 1998, Zoom began shipping Dualmodetm 56K modems able to automatically connect to either a V.90 or K56flex central site. The Company also ships internal and external ISDN products. 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. In addition, since late 1997 the Company has introduced a line of full-color live-motion video camera and related products. In December 1998 Zoom began shipping the ZoomAir line of wireless local area network products.
Zoom has a broad line of modems with top data speeds of 56,000 bps, available in internal, external and PCMCIA models. The internal modems are designed primarily for installation in IBM PC-compatibles. The 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. The 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. This standard is neither K56flex nor x2, but instead incorporates technical features of each. V.90 enables Zoom's V.90 modems to connect to interoperable V.90 central sites, including sites using central site equipment made by 3Com, an x2 supporter. Similarly, V.90 enables 3Com's V.90 modems to connect to inter-operable V.90 central sites using equipment made by Ascend, Cisco, Microcom, Shiva, and other central site manufacturers who initially backed K56flex. V.90 is now widely deployed, though there is still some equipment that incorporates only K56flex or x2. 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.
Modem Product Features. The following sets forth some of the key features incorporated in one or more of the Company's modems:
ZoomGuardtm. 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. Voice Mail. Voice mail capability allows a PC to serve as an answering machine with message storage and local or remote message retrieval.
Full-duplex Speakerphone. This simultaneous two-way speakerphone capability allows one or more people to talk "hands free" rather than using a telephone handset or headset. A speakerphone is commonly used for conference calls or for situations where someone needs hands free for other purposes, such as controlling a computer's mouse, keyboard, or joystick. Many office speakerphones are half-duplex, permitting sound to travel in only one direction at a time, similar to a walkie-talkie. Full-duplex speakerphones provide more natural two-way communication.
Simultaneous Voice and Data ("SVD"). SVD capability allows PC users to converse over the phone line at the same time that data is being transferred, independent of the application software being used. This capability is useful for applications where two people are working on the same project, as well as for video telephony, technical support and interactive computer games.
Caller ID. Caller ID is a service offered by telephone companies that provides the incoming caller's phone number, and in some cases the caller's name, through the incoming ring signal. A modem's Caller ID capability allows a PC to recognize, display and store this information. For example, Caller ID information can be tied to a database to display detailed information about the caller.
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.
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. 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.
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.
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.
Remote Access, SOHO Router, and Internet Gateway Products. Zoom has a significant R&D 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, with some models that include DSL, cable modem, and wireless LAN capabilities.
Full-color Live-motion Cameras and Other Video Products. In late 1997 Zoom shipped the Zoom/Video Cam, a full-color live-motion camera. This camera can plug into an included ISA capture card or into the video jack built into a number of ISA-bus internal modems approved for sale in North America and in a large number of other countries. The Zoom/Video Cam can be used for video phone calls, video conferences, video mail, and still image capture. In 1998 Zoom continued to introduce video products, including a bundle that includes a 56K video-ready modem and the Zoom/Video Cam, a parallel-port camera, and a USB camera. 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 begun shipping a new generation of dialers incorporating proprietary technology. Dailer 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 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.
During 1998 Best Buy Co., Inc. and Ingram Micro, Inc. accounted for 19.7% and and 13.6% 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, Fry's, Future Shop, J&R, MEI Micro Center, Micro Warehouse, Office Depot, PC Connection, and Staples. Personal Technology Research reported that in January 1999 the Zoom had the second greatest amount of retail shelf space for modems in North America.
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 Ingram Micro, 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, typically a PC. 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, Criterium, Ingram Micro, Northamber, Pouliadis Associates Corp., TrCom, UMD, Veracomp, and Yutron Tech. The Company's major European high-volume retailers include Compustore, Dixons/PC World, 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 22% in 1998. 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
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. For Western Europe, the Company's Munich office provides sales administration and public relations services for Western Europe as well as sales outreach for Spain, Greece, and Scandinavia. The Company has also established sales offices in Belgium to service Holland and Belgium, in Germany, and in the United Kingdom to service the UK and Irish markets. The Company works with an independent representative for sales and support in France and Italy. Warehousing, customs clearance, shipping, and invoicing for Europe are now primarily done under contract with Road Air, an unaffiliated specialist in these services located in Holland. Technical support for Europe is handled by Zoom's distributors and under contract with an independent company that specializes in technical support in the UK. 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 Boston-based staff, who are at times assisted by Zoom's sales staff or commissioned sales representatives. (See note 14 to Consolidated Financial Statements.)
The Company believes that Zoom is a widely recognized brand name. 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 an allowance 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 bulletin board and a home page on the World Wide Web, 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 25, 1999 the Company had 52 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 1996, 1997, and 1998 the Company expended $2.9 million, $4.2 million and $4.4 million, respectively, on research and development activities.
Manufacturing and Suppliers
The Company's products are currently designed for high-volume automated assembly in North America or China to help assure low cost, rapid market entry, short lead times and reliability. The Company supplies large kits of parts to one of several automated contract assemblers in Mexico or China. The contract assemblers insert most parts automatically by machine, solder the circuit board, and in-circuit test the completed assemblies. These assemblies are then typically shipped to the Company, which completes the manufacturing process and performs a computerized functional test for further quality control. 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, there are only a limited number of suppliers of modem chipsets, the most critical component of the Company's modems. Currently Lucent and Conexant are the Company's only modem chipset suppliers. 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 either supplier will, in the future, sell chipsets to the Company in quantities sufficient to meet the Company's needs. An interruption in a modem 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 would have a material adverse effect on the Company's results of operations.
Competition
The PC communications 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 competitors include 3Com, Action Tec, Best Data, Boca Research, Creative Labs Diamond Multimedia, GVC, NewCom, and Viking. Some of the Company's competitors and potential competitors have more extensive financial, engineering, product development, manufacturing, and marketing resources than the Company. In addition, the difficult modem environment during the past 30 months has caused a period of consolidation that has possible benefits, but also has risks.
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 DSL and cable 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 DSL and cable modems is currently impeded by a number of technical and infrastructure limitations. It is likely that if these types of modems reach the high market volume suited to Zoom's business and marketing channels, that the Company will seek to introduce appropriate modems. 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 three patents and one pending patent application in the United States. The issued patents, which expire in 2011, 2013 and 2013, respectively, generally relate to modem distinctive ring, use of a modem as a scanner, and modified ringback answering capabilities. 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 modem chipsets that incorporate sophisticated modem technology from Lucent and Conexant. 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.
Backlog
The Company's backlog at March 25, 1999 and March 25, 1998 was $1.6 million and $2.7 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, 1998 Zoom had 323 full-time employees (including employees hired on a temporary basis). Of this total, 44 were engaged in research and development, 164 were involved in purchasing, assembly, packaging, shipping and quality control, 62 were engaged in sales, marketing and technical support, and the remaining 32 performed accounting, administrative, management information systems, and executive functions. The Company's temporary employees were comprised of 21 individuals at December 31, 1998. Most of these temporary employees were employed in manufacturing. None of the Company's employees are represented by a labor union.
Subsequent Event
In March 1999, the Company entered into a series of separate agreements to purchase various assets, licenses, and inventory from Hayes Microcomputer Products, Inc. Hayes 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"). The Company has paid approximately $5.0 million in aggregate for all of the assets of Hayes Microcomputer Products Inc. Europe Region, product and rights for the American modem business, ADSL and cable modem equipment, and some inventory.
On March 19, 1999 the Court filed the Company's acceptance for the American modem business, completing the majority of the purchases. At this time the proceedings are ongoing and the Company is involved in the bidding for some remaining assets. The purchases are not subject to any financing and are being paid for through the Company's cash balances. The Company intends to continue production, sales, and support of most of the more popular Hayes modems under the Hayes name. The acquisition will be accounted for as a purchase.
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 50 Chief Executive Officer, President and Chairman of the Board Peter R. Kramer 47 Executive Vice President and Director Robert A. Crist 55 Vice President of Finance and Chief Financial Officer Terry J. Manning 47 Vice President of Sales and Marketing Dean N. Panagopoulos 41 Vice President of Information Systems Deena Randall 45 Vice President of Operations Dana Whitney 36 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. Manning has been a director of MicroTouch Systems, a NASDAQ-listed leader in touchscreen technology. Since 1998 Mr. Manning has also been a director of the Massachusetts Technology Development Corporation, which 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 and its predecessor Burroughs Corporation, both computer hardware and services companies, including Assistant Corporate Controller, Corporate Director of Business Planning and Analysis, Corporate Manufacturing & Engineering Controller, Computer Systems and Networking Controller, and Semiconductor Business 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. For three years prior to joining Zoom, Mr. Panagopoulos served as Director of Technical Services for Ziff Information Services, a major outsourcer of computing services. Prior to that, Mr. Panagopoulos worked for General Electric's Aircraft Engines Division, where he was responsible for the development and implementation of advanced manufacturing systems for automated facilities. He earned his BS degree in Information Systems from Northeastern University.
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.
ITEM 3
ITEM 3 - LEGAL PROCEEDINGS
On March 21, 1996, James A. Storer and REFAC International, Ltd., a company engaged in the business of acquiring and licensing patents, filed a complaint in the United States District Court, District of Massachusetts, naming Hayes Microcomputer Products, Inc. and the Company as defendants in a patent lawsuit. The complaint alleged that the V.42 bis international telecommunications standard for data compression in computer modems is covered by a patent owned by the plaintiffs, and the defendants' modems that incorporate this standard infringe the patent. The complaint sought to permanently enjoin the defendants from infringing the patent and monetary damages for past infringement, and REFAC had offered to negotiate a royalty for licensing the patent. The Company believed that the alleged infringement involved technology incorporated in chipsets provided to it from Rockwell International. By an agreement dated July 12, 1996 Rockwell International agreed, subject to certain conditions, to assume defense of and indemnify Zoom against the action.
On April 22, 1998 a stipulation of dismissal with prejudice was filed by the Company in the United States District Court, District of Massachusetts; on April 23, 1998 the Court entered judgement pursuant to the stipulation and the case was marked closed. No damages were aseesed against the company.
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, 1997 High Low ---- ---
First Quarter........................... $ 10.625 $ 8.375 Second Quarter.......................... 8.750 6.500 Third Quarter........................... 8.250 7.000 Fourth Quarter.......................... 7.625 5.125
Fiscal Year Ending December 31, 1998
First Quarter........................... $ 9.625 $ 6.563 Second Quarter.......................... 8.750 5.813 Third Quarter........................... 6.750 3.125 Fourth Quarter.......................... 8.625 2.250
As of March 29, 1999, there were approximately 336 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 Revenue Canada, 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 6% for dividends paid or credited in 1996 and 5% thereafter.
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 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 five year 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, 1996, 1997, and 1998 and the balance sheet data as of December 31, 1997 and 1998 have been derived from the Consolidated Financial Statements of the Company, which have been audited by KPMG Peat Marwick 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, 1994 and 1995 and the balance sheet data as of December 31, 1994, 1995, and 1996 have been derived from consolidated financial statements of the Company, which have been audited by KPMG Peat Marwick 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 1996, 1997 and 1998 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, 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. The impact of these favorable purchases is expected to be realized as units are sold during 1999. The net impact in gross margin in 1999 is unclear because of expected continued erosion of analog modem selling prices.
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%.
Year Ending December 31, 1997 Compared to Year Ending December 31, 1996
Net Sales. Net sales decreased 35.6% to $64.5 million in 1997 from $100.2 million in 1996. The availability of pre-standard 56K modems reduced 33.6K unit volumes and average selling prices. The lack of a standard for 56K and the slow deployment of central sites compatible with the Company's K56flex 56K modems caused low sales of 56K modems until late in 1997. The result was an overall reduction in unit volumes and average selling prices. The decline in average selling prices was further exacerbated by severe price competition and a decline in modem chipset prices. The Company experienced decreases in net sales in all of its sales channels. North American non-OEM sales decreased 26.0% to $45.4 million in 1997, non-OEM sales outside North America decreased 28.0% to $13.4 million, and worldwide OEM sales decreased 70.0% to $5.7 million.
Gross Profit. Gross profit as a percentage of net sales declined to 12.7% in 1997 from 20.3% in 1996. This decline in gross margin was caused by a number of factors, including increased channel price protection due to the rapid decline in prices, increased inventory reserves against slower speed modems, write-downs of the Company's inventory of modem chipsets including lower speed modems due to declining chipset costs, and the impact of lower volumes on certain fixed manufacturing costs. For most faxmodems models, the decline in selling price was partially offset by declining part costs.
Selling Expenses. Selling expenses increased 8.7% to $11.1 million or 17.2% of net sales in 1997 from $10.2 million or 10.2% of net sales in 1996. The increase was primarily due to increased cooperative advertising expenses in the high-volume retailer and Internet Service Provider channels.
General and Administrative Expenses. General and administrative expenses increased 35.0% to $4.9 million or 7.7% of net sales in 1997 from $3.7 million or 3.7% of net sales in 1996. This increase was primarily due to increased personnel expenses, bad debt expenses and foreign exchange losses.
Research and Development Expenses. Research and development expenses increased 42.0% to $4.2 million or 6.5% of net sales in 1997 from $2.9 million or 2.9% of net sales in 1996. The increase was primarily due to the addition of personnel to support the Company's development efforts in a number of new areas, including the remote access video and ISDN areas, and to costs associated with broadening the product line and international regulatory approvals.
Interest Income. Net interest income increased to $503,680 in 1997 from a net interest income of $233,963 in 1996. The increase was the result of the Company's higher average cash balances during the last year compared to 1996.
Other Income (Expense), Net. Other non-interest income increased to $237,273 in 1997 from $58,551 in 1996. The increase was primarily the result of higher sublease income compared to 1996.
Provision for Income Taxes. The Company's effective tax rate increased to 37% in 1997 from 35.7% in 1996 due primarily to the inapplicability of the foreign sales corporation provisions to the Company's 1997 loss before income taxes.
Liquidity and Capital Resources
On December 31, 1998, the Company had working capital of $33.4 million, including $18.9 million in cash and investment securities. The Company also has a secured $5 million line of credit expiring October 1, 1999. No amounts were outstanding under this line of credit as of December 31, 1998. This line of credit bears interest at the bank's prime rate (7.75% on December 31, 1998). The line of credit is secured and contains certain financial and other covenants. On December 31, 1998 the Company was in full compliance with all covenants.
In 1998 the Company's net cash provided by operating activities was approximately $8.2 million. During that period inventory and accounts receivable decreased by $3.1 million and $6.1 million, respectively. The decrease in inventory was primarily due to lower sales in the fourth quarter of 1998 as compared to sales in the fourth quarter of 1997 and the Company's efforts to reduce inventory levels. The decrease in accounts receivable was primarily attributable to lower sales and improved collections in 1998 as compared to sales in 1997. These sources of cash were partially offset by the reduction of accounts payable and accrued expenses of $2.9 million, and the Company's $2.1 million net loss. In 1998 the Company also recovered approximately $3.7 million in previously paid income taxes as a result of carrying back available net operating losses.
The Company's capital expenditures in 1998 of approximately $0.7 million consisted primarily of the Company's computer hardware and software, purchases of other equipment and tooling, and continued renovations to its headquarters.
Subsequent to the year ended December 31, 1998 the Company has entered into agreements with Hayes Microcomputer Products, Inc. to purchase various assets, rights and inventory in a public bankruptcy auction for approximately $5.0 million. As of March 19, 1999 the Court has filed the acceptance of the majority of the Company's bids. See Note 15 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 foreseeable future.
Year 2000 Readiness Statement
The year 2000 issue is the potential for system and processing failure of date-related data and the result of computer-controlled systems using two digits rather than four to define the applicable year. For example, computer programs that have date-sensitive software may recognize a date using "00" as the year 1900 rather than the year 2000. Systems that do not properly recognize date-sensitive information when the year changes to 2000 could generate system failure or miscalculations causing disruptions of operations, including, among other things, a temporary inability to process transactions, send invoices or engage in similar ordinary business activities.
The Company is evaluating the year 2000 issue with respect to its financial and management information systems, its products and its suppliers. At this point in its assessment, the Company is not currently aware of any year 2000 problems that are reasonably likely to have a material effect on the Company's business, mission critical systems, results of operations or financial condition, without taking into account the Company's efforts to avoid such problems.
The Company is completing its review of its management and information systems for year 2000 compliance and has identified application software and hardware which must be upgraded to become year 2000 compliant. The Company intends to generally upgrade its management and information systems in conjunction with its upgrade to become year 2000 compliant by September 1999. The Company believes that the cost of this upgrade will be approximately $100,000 to $300,000, the majority of which will be capitalized. There is a risk that, notwithstanding its internal review, if the Company has not properly identified all year 2000 compliance issues with respect to its management and information systems, the Company may not be able to implement all necessary changes to these systems on a timely basis and within budget. Such a failure could result in a material disruption to the Company's business, including the inability to track and timely fill orders, which could have a material adverse effect on its business, results of operations and financial condition.
The Company has evaluated its current products and believes that they are year 2000 compliant. The Company has also undertaken a general review of modems previously sold by it that may continue to be under warranty to determine whether those products are year 2000 compliant. Based upon its preliminary assessment, the Company believes that the proper operation of its modems are not date dependent and therefore should continue to function properly on and after the year 2000. In order to assure that this is the case, the Company is seeking information from its major suppliers, particularly of its modem chipsets, to confirm that they have been year 2000 compliant. The Company has sent a year 2000 Readiness Letter/Questionnaire to its major suppliers and initial responses from the Company's chipset manufacturers have confirmed the Company's understanding that the chipsets used by the Company are not date sensitive and are therefore year 2000 compliant. However, the Company cannot assure that its chipset manufacturers will provide the Company with accurate information regarding their year 2000 compliance. Should any critical components incorporated in the Company's products fail to be year 2000 compliant, such failure could result in warranty claims and have a material adverse effect on its business, results of operations and financial condition.
The Company's products and software are often sold to be integrated into or interface with third party equipment or software. In addition, the Company often packages its modems for retail sale with software provided by other vendors. The Company does not alter this software in any date sensitive way. The Company is in the process of seeking information from its software vendors to assure that the software packaged with its products will be year 2000 compliant, and has sent a year 2000 Readiness Letter/Questionnaire to its major software suppliers. While it is possible that some of this software may be adversely affected by the year 2000, the Company is not aware of any packaged software having this problem. Failure of third-party equipment or software to operate properly with regard to the year 2000 and thereafter could require the Company to incur unanticipated expenses to remedy any problems, which could have a material adverse effect on the Company's business, results of operations and financial condition.
The Company is also exposed to the risk that it could experience material shipment delays from its major component suppliers or contract assemblers or material sales delays from its major customers due to year 2000 issues relating either to their management information or production systems. The Company has inquired of these suppliers and contract assemblers in an attempt to ascertain their year 2000 readiness. At this time, the Company is unable to estimate the nature or extent of any potential adverse impact resulting from the failure of third parties, such as its suppliers, and contract assemblers and customers, to achieve year 2000 compliance. Moreover, such third parties, even if year 2000 compliant, could experience difficulties resulting from year 2000 issues that may affect their suppliers, service providers and customers. As a result, although the Company does not currently anticipate that it will experience any material shipment delays from their major product suppliers or any material sales delays from its major customers due to year 2000 issues, these third parties could experience year 2000 problems that could have a material adverse effect on the Company's business, results of operations and financial condition.
Other than its activities described above, the Company does not have and does not plan to develop a contingency plan to address Y2K issues. Should any unanticipated significant Y2K issues arise, the Company's failure to implement such a contingency plan could have a material adverse affect on its business, financial condition and results of operation.
To the extent that the Company does not identify any material non-compliant year 2000 issues affecting the Company or third parties, such as the Company's suppliers, service providers and customers, the most reasonably likely worst case year 2000 scenario is a systemic failure beyond the control of the Company, such as a prolonged telecommunications or electrical failure, or a general disruption in United States or global business activities that could result in a significant economic downturn. The Company believes that the primary business risks, in the event of such failure or other disruption, would include but not be limited to, loss of customers or orders, increased operating costs, inability to obtain inventory on a timely basis, disruptions in product shipments, or other business interruptions of a material nature, as well as claims of mismanagement, misrepresentation, or breach of contract, any of which could have a material adverse effect on the Company's business, results of operations and financial condition.
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
The Financial Accounting Standards Board recently issued Statement of Financial Accounting Standards ("SFAS") No. 133, Accounting for Derivative Instruments and Hedging Activities, which establishes accounting and reporting standards for derivative instruments embedded in other contracts (collectively referred to as derivatives), and for hedging activities. This Statement is effective for all fiscal quarters of fiscal years beginning after June 15, 1999. The adoption of this Statement is not expected to have a material impact on the Company's consolidated financial position or results of operations.
The AICPA Accounting Standards Executive Committee recently issued Statement of Position (`SOP") 98-1, Accounting for the Cost of Computer Software Developed or Obtained for Internal Use. This SOP requires that certain costs related to the development and purchase of internal-use software be capitalized and amortized over the estimated useful life of the software, and is effective for fiscal years beginning after December 15, 1998. The SOP also requires that costs related to the preliminary project stage and post implementation/operations stage in an internal-use computer software development project be expensed as incurred. The adoption of this SOP is not expected to have a material impact on the Company's consolidated financial position or results of operations.
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
Index to Consolidated Financial Statements
Independent Auditors' Report Consolidated Balance Sheets as of December 31, 1997 and 1998
Consolidated Statements of Operations for the years ending December 31, 1996, 1997 and 1998
Consolidated Statements of Changes in Stockholders' Equity for the years ending December 31, 1996, 1997 and 1998
Consolidated Statements of Cash Flows for the years ending December 31, 1996, 1997 and 1998
Notes to Consolidated Financial Statements
Schedule II: Valuation and Qualifying Accounts for Fiscal Years Ending December 31, 1996, 1997 and 1998
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 1999 annual meeting which will be filed with the SEC in April 1999 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 1999 annual meeting which will be filed with the SEC in April 1999, 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 1999 annual meeting which will be filed with the SEC in April 1999, 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.)
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 Peat Marwick 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 31, 1998
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
Independent Auditors' Report Consolidated Balance Sheets as of December 31, 1997 and 1998
Consolidated Statements of Operations for the years ending December 31, 1996, 1997 and 1998
Consolidated Statements of Changes in Stockholders' Equity for the years ending December 31, 1996, 1997 and 1998
Consolidated Statements of Cash Flows for the years ending December 31, 1996, 1997 and 1998 Notes to Consolidated Financial Statements
Schedule II: Valuation and Qualifying Accounts for Fiscal Years Ending December 31, 1996, 1997 and 1998
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, 1997 and 1998, and the related consolidated statements of operations, changes in stockholders' equity and cash flows for each of the years in the three-year period ended December 31, 1998. 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, 1997 and 1998, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1998, in conformity with generally accepted accounting principles.
KPMG Peat Marwick LLP
Boston, Massachusetts February 10, 1999, except for Note 15, which is as of March 19, 1999
ZOOM TELEPHONICS, INC. CONSOLIDATED BALANCE SHEETS
See accompanying notes to consolidated financial statements.
ZOOM TELEPHONICS, INC. CONSOLIDATED STATEMENTS OF OPERATIONS Years Ending December 31, 1996, 1997 and 1998
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, 1996, 1997 and 1998
(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 Theconsolidated 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 Theconsolidated 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 TheCompany 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 is being amortized on a straight-line basis over 10 years. 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 TheCompany 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. Anti-dilutive potential common shares outstanding at December 31, 1996, 1997 and 1998 were 252,786, 83,573, and 744,111 respectively.
(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 applies Accounting Principles Board Opinion No. 25 (APB 25), "Accounting for Stock Issued to Employees," and related interpretations in accounting for its stock option plans. No compensation cost has been recognized for these plans in the accompanying financial statements.
(m) Advertising Costs Advertising costs are expenses 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 capitalized advertising costs in the accompanying consolidated balance sheets.
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. The Company also leases office space in Dallas, Texas. Under non-cancelable operating leases, rent expense was $275,673, $392,010 and 334,469 for the years ending December 31, 1996, 1997 and 1998, respectively. Future minimum rental payments, excluding executory costs, required under these operating leases are as follows:
Year Total
1999 $ 348,426 2000 348,426 2001 $ 203,249
(6) Credit Lines
TheCompany has a secured $5 million line of credit expiring on October 1, 1999. No amounts were outstanding under this line of credit at December 31, 1999 or 1998. The line of credit bears interest at the bank's prime rate (7.75% at December 31, 1998). The line of credit contains certain financial and other covenants. On December 31, 1998 the Company was in full compliance with all covenants. The Company anticipates that it will renew the line of credit prior to expiration.
(7) Stock Option Plans
At December 31, 1998 the Company had three stock option plans, which are described below:
Employee Stock Option Plan TheEmployee 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 the granting of employee stock options. 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 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:
The following table summarizes information about fixed stock options under the Employee Stock Option Plan outstanding at December 31, 1998:
The Company recognized a tax benefit of $1,611,201 and $75,567 in 1996 and 1997, 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:
ZOOM TELEPHONICS, INC. Notes to Consolidated Financial Statements
The following table summarizes information about fixed stock options under the Directors Plan at December 31, 1998:
1998 Employee Equity Incentive Stock Option Plan
The1998 Employee Equity Incentive Stock Option Plan (the "1998 Plan") was adopted to attract and retain employees and provide an incentive for them to assist Zoom Telephonics, Inc. (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. The 1998 Plan provides for the availability of 300,00 shares of common stock for the granting of employee stock options. 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. 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. Options outstanding under this plan are as follows:
The following table summarizes information about fixed stock options under the Employee Stock Option Plan outstanding at December 31, 1998:
ZOOM TELEPHONICS, INC. Notes to Consolidated Financial Statements
At December 31, 1998, there were 1,182,950 additional shares available for grant under all three Plans. The per share weighted-average fair value of stock options granted during 1996, 1997 and 1998 was $4.03, $4.43, and $3.70, respectively, on the date of grant using the Black Scholes option-pricing model with the following weighted-average assumptions: 1996 - expected dividend yield 0.0%, risk-free interest rate of 5.05%, volatility 70% and an expected life of 2.9 years; 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.
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:
(8) Income Taxes
Income tax expense (benefit) attributable to income from operations consists of:
(Continued) ZOOM TELEPHONICS, INC. Notes to Consolidated Financial Statements
Income tax expense (benefit) was $1,374,501, ($4,189,266), and ($1,287,420) for the years ending December 31, 1996, 1997 and 1998, 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:
In assessing the realizability of deferred tax assets, the Company considered whether it is more likely than not that some portion or all of the deferred tax assets will be realized. Due to the fact that the Company anticipates future taxable income over periods in which the deductible temporary differences are available, the ultimate realizability of deferred tax assets for federal and state tax purposes appears more likely than not.
ZOOM TELEPHONICS, INC. Notes to Consolidated Financial Statements
(9) Significant Customers
Onecustomer accounted for approximately 15% of net sales for the year ending December 31, 1996 and 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. At December 31, 1997, two customers comprised approximately 42% of net accounts receivable. At December 31, 1998, two customers comprised approximately 40% of net accounts receivable.
(10) Financial Instruments
TheCompany 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.
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, 1996, 1997 and 1998 foreign currency gains and losses were not material. At December 31, 1998, the Company's foreign currency-denominated net assets were not material. The Company has no involvement with derivative financial instruments.
(11) Product Line Acquisition
On June 24, 1996, the Company issued 102,641 shares of common stock to acquire certain assets, including inventory and property and equipment, associated with a product line of Tribe Computer Works, Inc. The acquisition was recorded using the purchase method of accounting, whereby the net assets acquired were recorded at their estimated fair values and the excess of cost over the fair value of the assets acquired of $1,634,913 was allocated to goodwill and is being amortized over 10 years.
(12) Supplemental Disclosure of Cash Flow Information
During the second quarter of 1996, the Company issued 102,641 shares of common stock to acquire certain assets of Tribe Computer Works, Inc., including inventory of $95,685 and property and equipment of $107,467. In addition, the tax effect of the exercise of stock options resulted in increases to common stock and an increase in refundable income taxes of $1,611,201 in 1996 and $75,567 in 1997. These noncash transactions have been excluded from the statement of cash flows.
(13) Dependence on Key Suppliers
The Company produces its products using components or subassemblies purchased from third-party suppliers. In 1996 and 1997, the Company purchased substantially all of its modem chipsets from a single supplier, Rockwell. In 1998, the Company decided to also purchase chipsets from Lucent Technologies, with a goal of maintaining good supply relationships with both Conexant (formerly Rockwell) and Lucent. This approach has potential strategic and tactical advantages, but also has risks including the likelihood of degrading Zoom's business relationship with Conexant, the risk of poor execution of the transition of some products to Lucent, and other risks associated with using a new supplier and new product designs for modems that represent a significant percentage of Zoom's revenues. An interruption in the delivery of these components could have a material adverse effect on the Company's results of operations.
ZOOM TELEPHONICS, INC. Notes to Consolidated Financial Statements
(14) 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 1996, 1997, and 1998 were comprised as follows:
1996 % of Total 1997 % of Total % of Total ---- ---------- ---- ----------
North America $ 73,085,465 73% $ 52,227,550 81% $ 50,489,521 82% Europe 18,227,729 18% 6,447,846 10% 8%
Other 8,881,827 9% 5,803,061 9% 10% --------- -- --------- -- ------- ---
6,264,755 Total $ 64,478,457 100% $ 61,364,385 100% ===========
(15) Subsequent Event
In March 1999, the Company entered into a series of separate agreements to purchase various assets, licenses, and inventory from Hayes Microcomputer Products, Inc. Hayes 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"). The Company has paid approximately $5.0 million in aggregate for all of the assets of Hayes Microcomputer Products Inc. Europe Region, product and rights for the American modem business, ADSL and cable modem equipment, and some inventory. On March 19, 1999 the Court filed the Company's acceptance for the American modem business, completing the majority of the purchases. At this time the proceedings are ongoing and the Company is involved in the bidding for some remaining assets. The purchases are not subject to any financing and are being paid for through the Company's cash balances. The Company intends to continue production, sales, and support of most of the more popular Hayes modems under the Hayes name. The acquisition will be accounted for as a purchase.
EXHIBIT INDEX (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.)
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 Peat Marwick 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.