Ladies and gentlemen, thank you for standing by and Welcome to the Zoom Telephonics Shareholders Call. At this time all participants are in a listen-only mode. After the speakers' remarks, there will be a question-and-answer session.

[Operator Instructions] I would now like to hand the conference over to your speaker for today, Frank Manning, Zoom's CEO. Thank you. I will now turn it over..

Okay. Thank you, Stephanie. Welcome to the Zoom Telephonics Conference Call for Q3 2019. I'm Frank Manning, Zoom's CEO. Our President, Joe Wytanis will also be speaking and answering questions during and after this call. As a reminder, slides in this call are at www.zoom.net/sq319. When you have time, please read Slide 2.

We cannot predict the future, and our comments and forward-looking statements are subject to uncertainty and risk. Slide 3 provides a brief overview of Zoom Telephonics. Zoom has been in business since 1977. We have the exclusive Motorola brand worldwide license for a large number of internet access and local area network products.

Our strongest product category by far is cable modems, which includes cable modem bridges and cable modem with built-in routers. We are also seeing growth in cellular modems and sensors. We expect significant sales growth in cable modems, routers, including mesh routers and cellular products in 2020 and beyond.

The Motorola brand, great products and excellent execution, tripled our revenues from 2016 through 2018. And through 9 months, 2019 revenues are 9% ahead of 2018. China tariffs have dramatically and negatively impacted our business, and we'll discuss why we're still very excited about next year and beyond in spite of these tariffs.

On Slide 4, you can see that we had 10 straight quarters of increased year-over-year sales through Q3 2018. That trend was interrupted in Q4 2018 and Q1 2019 due primarily to China tariffs, which disrupted the cable modem business as everyone dealt with the sudden changes.

Q2 2019 showed a resumption in year-over-year growth, with net sales up 8.5% [ph] to $8.2 million. We're very pleased to report that Q3 2019 net sales were up 20.8% year-over-year to $10.9 million, our highest Q3 sales since 2002. The tariffs initially caused price challenges that hurt sales. But over time, prices have become more stable.

Q3 2019 benefited from significant improvement in shelf space and shelf position at Best Buy, a very important electronics retailer. We also achieved good online growth, especially at Amazon, almost 100% of our sales were in the U.S. Slide 5 gives an overview of Q3 2019 results compared to Q3 2018. We are very pleased with our 20.8% sales growth.

And we look forward to 2020 where we expect to introduce many exciting new products, starting early in 2020 and to have a significantly lower duty phased in starting Q1. You can see that our gross margin for Q3 2019 was 38.2% before $1.03 million in tariff expense and 28.8% after that expense.

Our gross margin is likely to drop to about 25% in Q4 2019 as our inventory in the U.S. continues to shift to inventory that incurred a 25% tariff instead of 10%. Of course, this will improve dramatically if we succeed with our economic harm filing.

However, that filing turns out, we are moving our production to Vietnam with March 2020, our latest estimate, for when the majority of our products will be built in Vietnam.

We believe that transition and cost reductions we've achieved from key suppliers will begin to improve our gross margin significantly for Q1 2020 with significantly more improvement in Q2 2020 and beyond. Our net loss for Q3 2019 was $200,000. We would have had net income of $800,000 without the tariffs.

And I'm very proud of the great work done by Zoom's employees to achieve our Q3 2019 results. Slide 6 updates our Amazon market share. We grew that a lot over time, and our share has moved up to almost 28%,from just under 25% as of our Q2 earnings call this year. We grew our Amazon revenues 21% from Q3 2018 to Q3 2019.

As Amazon grew its cable modem category and we improved our share. We care a lot about our share Amazon, but we care even more about our profitability. We are very careful about product pricing, ad expenses, return on ad spend and other Amazon expenses as these all impact our profitability and cable modem share.

We also spend considerable money on resources addressing Amazon issues, whether it's a buy box issue, customer issue or anything else that affects our Amazon success. I'm encouraged by the progress we continue to make and the contributions of the team of people inside and outside Zoom who drive our Amazon success.

Slide 7 reminds you of our excellent customers in the U.S.A., of who's who of electronics retailers and distributors. We've already discussed Amazon. And now I'd like to comment on Best Buy, Target and other brick-and-mortar retailers. We have a shelf-space metric that measures for each SKU as the number of stores it's in.

If the SKU is in 1,000 stores, that counts as a 1,000. If there are 2 SKUs in the store, it still counts as one in that store. So again, if a SKUs is in 1,000 stores, it counts as 1,000. This year, we grew that shelf-space metric from 5,240 at the beginning of the year to 9,055, a huge jump.

Importantly, the growth occurred at 2 extremely important accounts, Best Buy and Target. At Best Buy, we not only grew our shelf space, we improved our shelf position and placed the focal display on the top shelf of stores in Comcast regions. Our improved shelf space at Target is happening now, and we should benefit going forward.

Our approach at brick-and-mortar stores is to focus on the best cable modem retailers. We do hope for new placements in cable modems and routers in 2020 to our current customers and also to Costco and Walmart for appropriate cable modems and routers. We're also hoping to place some new cellular products at Best Buy and, perhaps, other retailers.

And I want to emphasize these are hopes, not guarantees, but I think we have a very reasonable chance at meeting on those goals. On Slide 8, we show our quarterly gross profit and gross margin. As shown earlier, gross margin was 38.2% before tariffs, which was unusually high for us.

However, after $1.03 million in tariffs, our gross margin was 28.8%, which was exceptionally low for Zoom. We commented earlier in this call on how we are driving towards higher margins. Slide 9 updates the tariff situation. Going forward, there are 3 main ways we can escape the 25% China tariffs.

One is a new check policy, and there's some chance of improvements as soon as this month. We don't count on that. A second way, the success in getting an economic harm ruling from the U.S. trade representative office called, USTR, for our cable modems.

Some of our initial request failed, so we withdrew some cable modems, improved our already good case for economic harm status and refiled with even more letters and calls of support. Those letters included letters from U.S. Congressman, Steve Lynch; 3 Massachusetts state politicians; some large shareholders; and several key employees, including me.

We're able to get support calls to USTR from the offices of Massachusetts U.S. Senator, [indiscernible] office and New Hampshire U.S. Center, Hassan's office. We also attempted to get support from U.S. Congress people from both parties in a number of states, but not surprisingly, it's easier to get support from politicians in your home state.

We were likely to hear USTR's decision in late November or December. To make that, we were very deserving in the successful economic harm ruling, but there's no guarantee of success. That's why we're also aggressively pursuing the third main way to escape the China tariffs, namely moving most of our products production out of China to Vietnam.

As noted earlier, we expect to see a significant shift, starting with Q1 2020 results, and a much more significant shift the next quarter. In summary, the tariffs we pay should start a rapid decline starting Q1 2020 or earlier. On Slide 10, we discussed the $500,000 operating expense increase from Q3 '18 to Q3 '19.

The main source of the increase was recruiting and compensating key new people at Zoom, including our President, our VP of Sales, our Chief Technology Officer and important new hires in engineering and support. Other reasons included a $250,000 increase in our Motorola minimum royalty payment.

We had a $130,000 increase in brick-and-mortar retailer marketing expenses with the increase due to expanded marketing, including the Best Buy focal display and other marketing programs. You can see that advertising expenses decreased $330,000 from Q3 2008 (sic) [2018] to Q3 2019.

We've maintained a big advertising budget, and we look at return on ad spend at least once a week for each product. Our focus is on profitability, and we fine-tune our plan frequently to maximize profits. Most of our ad spend has been on Amazon and Google.

In 2020, we will continue those ad programs and also experiment with Facebook ads and other types of ads. Slide 11 shows how our balance sheet has evolved in 2019 with a $5 million May financing at $1.10 per share, more than offsetting our tariff-related losses.

Our balance sheet is still strong, with 0 bank debt and $2.3 million in cash as of November 4. Slide 12 summarizes our current Motorola exclusive brand license. You can see that it covers a lot of product categories in geographic surcharges.

So far, the vast majority of our Motorola sales are in North America, partly because the USA is, by far, the largest retailer market for cable modems in the world. We expect this picture to start to change in 2020 as we introduce more appropriate products for other countries and as we start to sell to service providers in some other countries.

All that being said, the U.S. will dominate in 2020. Now I'll turn the presentation over to Joe Wytanis, Zoom's President..

Number one, we are working aggressively to improve product margins by reducing, eliminating the impact of tariff by significantly reducing production in China. In addition, we are working closely with key component suppliers. Our current major manufacturing partner, our new manufacturing partners to greatly improve costs.

We expect to see significant benefit from these changes early next year. Number two, focus our attention on high-margin revenue areas while continuing to grow top line. Number three, introducing new products that provide differentiation, adopt latest technology, leverage our core competency, provide good margin and best serve our customers' needs.

Number four, as we continue to grow our top line and increase margin, embrace a shift in our revenue mix from product sales only to -- from sales only to product sales and recurring service revenues. Number five, continue to drive excellence in our sales to marketing and support efforts.

In summary, we continue to make good progress in spite of the tariffs. We're excited about the steps we've taken, and the positive impact they will make in the near term. We greatly appreciate your support. And now let's turn to questions..

[Operator Instructions] Your first question comes from the line of Ben Rubenstein with Robotti..

Hey, good morning..

Good morning..

So I just have one question, and I'm somewhat new to the story, but if you guys could kind of just talk about what's the ambition, if you look out a few years in terms of what you want to have created here, obviously, with the offering you guys did recently? And you kind of walk through what you're hoping for 2020.

But I guess looking out further, what do you want the business to look like?.

Sure. This is Frank. I think we - first of all, we like where we are in retail as one important element. So certainly, we will continue to have a major focus on that, and we're very excited about that. But we definitely want to go to the service providers. And I think we're making great steps towards that. Cost was very, very key.

And I think, led by Joe Wytanis, we've really done a good job of positioning ourselves for lower costs starting early next year.

We are looking very seriously at the IoT area because our routers are very well positioned to extend themselves to handle devices that might be WiFi, but they may use some other technology for securing your home or managing your energy, et cetera. So that that's an important area to be looking at it. And we haven't finalized our thinking about that.

But certainly, we think that, that's something we have to look at very seriously. And then finally, I would say we've -- the nature of our products and our focus on retail has made us be an essentially all-US sales company. Many, many years ago, that wasn't true like when we were in earlier products, way back to dial-up modems.

We actually had significant sales in a number of countries, especially in Europe. But I think that - I think we'll see a little bit of change even next year. But I think in years out from that - from 2020, we'll see more and more of that. I think the United States is, by far, the most important market, and it will continue to be.

But I think there's, obviously, huge opportunity outside of the United States, and our Motorola brand extends outside of the United States. So I think that's exciting..

Yeah, I'd like to just add on to that. Ben, very simply, it's there to allow end users, users in their home to manage and control their home network and all the devices in their home from a single application, and those devices that are in the home are being provided by us. So we're providing the DOCSIS products, the cell products and the IoT devices.

The user will be able to manage and control those devices. And as Frank mentioned, we see ourselves providing that here in the U.S. through our current channels but expanding beyond that into the service provider channels and rapidly grow this business. So that's our vision real quick..

Absolutely. I appreciate it..

Thank you..

Your next question is from the line of Spencer Lehman, a private investor..

Hi, Frank and Joe, that was just a great conference call and presentation. Just a quick clarification on the tariffs. Right now, are you currently at 10% or 25%? Or what is your....

Sure, I can take that. So in June, the rate went to 25%, but the reason you wouldn't see that on our P&L is that in anticipation of the increase we moved as much inventory as we could into the United States. And so what you have in the quarter that just ended is a blend of 25% and 10%. As that inventory moves over time, obviously, it shifts toward 25%.

So that's basically the picture..

Okay.

And then your goal is to be 100% out of China?.

So basically -- meanwhile, let me just give you one counter example, that's just it's almost -- it's really what I meant. We still make, I'll say, some very old technology dialogue modems that people still buy for terminals and things like that. And that's now worth moving out of China.

Honestly, it just doesn't -- there's not enough money there we're flying. But the big picture is that we're on a mission to move out of China. And that's -- all the important products will be out of China..

Yes.

And will that continue? Even though, let me say, currently in the news, there was some thoughts, Trump trying to -- or at least he saying that with getting close to -- with China to reduce or eliminate the tariffs, would that change your momentum? Or would you continue to move with the Vietnam?.

Spencer, we're going to continue. We're committed to the move. Once you make that commitment. There's a lot of wheels that are in motion and then to turn around and go backwards, that's not the plan. Vast majority of our products, the high-volume movers will all move outside of China..

Okay. That makes a lot of sense.

And you don't see any problem with the quality or the expense of re-doing this and with your new manufacturers? Is that a fairly easy transition?.

I wouldn't say that it's fairly easy. I would say it's something that we, as a company, have to be right on top of and closely manage. So that -- you're raising a point that is a fair point and is certainly one that we've been thinking of. And so we're going to tightly control the quality and watch and make sure.

The point I want to make is that we are running a - our strategy is to run a dual approach. While we ramp up and move production into Vietnam. We will continue for some period with China, just to make sure that there is a smooth transition. Everything is fine with the S&P and the production lines and so forth.

And once we're confident, and we see the quality levels are exactly where we want them to be, then we will go full switch over, but we do have a plan to have overlap..

Okay. Well, that sounds very prudent and so good luck and thanks for a great call..

Okay. Thank you, Spencer..

Your next question is from the line of Paul Lucat, a private investor..

Hi, guys. Nice growth last quarter.

I just wanted to see if we can get some color on the customer premises equipment sales efforts? Are you guys able to comment at all about any number of product samples delivered to customers, trials and progress or anything that could give an indication of how open those doors are for Zoom, Motorola?.

And here, I think you're probably focusing on the service providers.

Is that correct?.

Correct. Yes..

Yes. So right now, we are having, as I mentioned, discussions, meetings with the service providers. The interest with the service providers that we're having discussions with is definitely a move towards more of the DOCSIS 3.1 products as they're looking at their next budget spends and so forth.

So as we are bringing in a new manufacturing partner for a majority of those products. As we have samples, we will be providing them to them. So at this point, the samples, we have not provided them samples of DOCSIS 3.1, but it is our plan to have that to them by this quarter..

Great, great.

Also, the timeline for having routers that would be compatible with Minim service offerings? Can you comment on when you anticipate having routers that are compatible with Minim's sessional services?.

We are integrating Minim as we speak. But I would say -- and I would say that Q1 will be ready for commercial availability..

And just to clarify that, so I agree with that answer. But we're trying to put Minim in a new product that has router capability and some products that are already shipping that have router capability. So it's a big task, and it's happening. And I think Joe's answer is correct.

But what you'll see over the years is just more and more of our products with Minim capability..

Absolutely..

And on that topic, are you only targeting cable modems routers with Minim capability? Or will you be expanding that to DSL capable modems or wireless modems? Are you just going to carve out the cable modem issue with the Minim?.

No, no. It's not just -- it's not just cable modems. It's cable modems, it's WiFi Mesh, routers, it's a number of devices. I wouldn't say DSL, ex-DSL is a key focus for us. But certainly, all other devices. The -- most of the devices that we have with gateway, wireless capability, we will try to integrate Minim..

Great. And as you're developing all these next-generation products and services for -- under the Motorola name.

I was wondering when is the Motorola license due for renewal? And will you be able to secure a longer-term to secure the great investment you're making for that brand name?.

Our current contract expires at the end of 2020. So a little over a year from now. And I would say that we have high confidence that we will renew that contract. That's not a guarantee, but I think it's highly likely that we will renew that contract.

And that you can as you can guess, we've been actively working on it, and we were pleased with the progress, but we're not over the goal line yet..

Great. And lastly, would you guys give a comment on the emergency -- not the emergency, but the Board meeting that was called together last Monday by Jeremy Hitchcock, just there's a note in 13 GE [ph] filed about a Board meeting.

Could you comment on anything that was discussed and any initiatives that might have come out of that?.

I can comment, not necessarily everything that was discussed. But basically, one Board member, Jeremy Hitchcock, wanted the board to consider whether I should step down as CEO. And the results of that meeting is that I didn't step down as CEO because the directors did not support that concept.

But I do hope to step down as CEO once we execute the plan, a graceful plan that makes sense for the company, including transitioning a lot of the jobs that I'm doing now. But I think the -- I think that, that was a worthwhile discussion, and it ended in a very positive way for the company and for me. And so I think it worked out very well, actually..

Great. I think, yes, you built the company and have done a great job, and reasonable succession plan would seem to be in order at this time. So I'm excited to be an investor with the new technologies that are coming into the company and look forward to what you'll have to report next quarter..

Thank you very much..

Thank you, Paul..

[Operator Instructions] Your next question is from the line of Walter Young with Edmonds Private Cap [ph].

Hi. My question is - two questions.

One is, when you go back to the tariff relief, is it retroactive? Can you give a little more detail? If you are successful, what happens or what your probabilities are?.

Yes. It is retroactive. And if one product wins in a category, unless that price is then put into a new category, which is unlikely, the whole category wins. So by the end of the year, it will be well over $3 million in play in terms of this issue. And so obviously, it was very important. We put a lot of focus on it.

But we also kept working hard on the rest of our business, obviously. But yes, it is retroactive. .

Right.

And then the second part is on the Motorola license, and let's say, you were successful in -- before December of 2020, what is the likely term of that license, how long?.

Well, I think Motorola typically has a license term that's 4 or 5 years..

Before 3 to 5?.

No. 4 to 5 years..

Okay. Those were my questions. It sounds exciting for next year. Thank you..

Your next question is from the line of Ian Cassel with MicroCapClub..

Hi, gentlemen. Thanks for the time this morning, the professional presentation. Appreciate it. I just have one quick question, and you have in the presentation that if you were taking all the tariff situation out of it, even you would have produced an $800,000 profit versus the $200,000 loss.

And that $200,000 loss might have been positively impacted by sort of a blend between the 10% and 25% tariff situation.

But my question is kind of comparing, producing product out of China and producing product out of Vietnam, sort of -- if there was no tariffs, obviously, on either side of that, what is the difference like the margin profile between producing out of Vietnam versus producing product out of China with no tariff situation?.

I'll take that one. Ian, so with Vietnam for a manufacturer who's established and been manufacturing in Vietnam for, say, a number of years, you would actually see a lower cost than China. However, because of all this activity that's taking place right now with numerous companies moving out of China.

There is a slight increase starting to produce those products in Vietnam as a lot of the Chinese manufacturers are moving into Vietnam, ramping up their team, bringing in people from China to help run the operations in Vietnam. So that's typically about 6%, higher than, say, where China normally runs at.

But then over a period of time, and I would say, safely, 1.5 years to 2 years. That 6% would come down to par level of China and perhaps lower. So that's - and again, as we diversify our suppliers, our current manufacturer will probably see that slight increase from what we normally see in China without a tariff to about say, 5%, 6%.

But as we bring on a new partner, and I'm very excited about the new partners that we're bringing on for most of our new products, it will actually be slightly lower than what we've seen in China because they have been manufacturing in Vietnam for close to 10 years..

Okay. Appreciate that color. Thank you..

Thank you..

[Operator Instructions] At this time, there are no additional questions..

Well, thank you very much, Stephanie, and thanks for all the participants in the call. It's a pleasure to speak with you and hear your good questions..

Thank you very much. Appreciate that..

Goodbye then..

Bye..

Thank you. This concludes today's conference. You may now disconnect..