10-Q 1 zunicom_2007sept30-10q.txt SEPTEMBER 30, 2007 QUARTERLY REPORT SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q |X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 2007 OR |_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to ------------ ------------ Commission file number: 0-27210 Zunicom, Inc. (Exact name of registrant as specified in its charter) TEXAS 75-2408297 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 4315 West Lovers Lane, Dallas, Texas 75209 (Address of principal executive offices) (Zip Code) (214) 352-8674 (Registrant's telephone number, including area code) None (Former name,former address and former fiscal year,if changed since last report) Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: Common Stock, $0.01 Par Value ----------------------------- (Title of Class) Class A Preferred Stock, $1.00 Par Value ---------------------------------------- (Title of Class) Units, consisting of one (1) share of Common Stock and one (1) share of Class A Preferred Stock -------------------------------------------------- (Title of Class) 1 Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes [ ] No [X] Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act. Yes [ ] No [X] Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of "accelerated filer and large accelerated filer" in Rule 12b-2 of the Exchange Act. Large accelerated filer [ ] Accelerated filer [ ] Non-accelerated filer [X] Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X] As of November 12, 2007, 9,957,191 shares of Common Stock were outstanding. DOCUMENTS INCORPORATED BY REFERENCE None 2 Zunicom, Inc. INDEX Page ---- PART I - Financial Information Item 1. Financial Statements Unaudited Consolidated Balance Sheet at September 30, 2007 And Audited Consolidated Balance Sheet at December 31, 2006. . . . 4 Unaudited Consolidated Statements of Operations for the three and nine months ended September 30, 2007 and 2006 . . . . . . . . . 6 Unaudited Consolidated Statements of Cash Flows for the nine months ended September 30, 2007 and 2006 . . . . . . . . . . . .. . 8 Notes to Unaudited Consolidated Financial Statements . . . . . . . . 10 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations. . . . . . . . . . . . . . . . . 17 Item 3. Quantitative and Qualitative Disclosures About Market Risk. 21 Item 4. Controls and Procedures. . . . . . . . . . . . . . . . . . 21 PART II - Other Information Item 1. Legal Proceedings . . . . . . . . . . . . . . . . . . . . 22 Item 6. Exhibits. . . . . . . . . . . . . . . . . . . . . . . . . 22 Signature. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23 Certifications 3 PART I - FINANCIAL INFORMATION ---------------------------------- Item 1. Financial Statements ZUNICOM, INC. AND SUBSIDIARY CONSOLIDATED BALANCE SHEETS ASSETS September 30, December 31, 2007 2006 ---- ---- Unaudited Audited CURRENT ASSETS Cash and cash equivalents $ 529,101 $ 8,259,709 Accounts receivable - trade, net of allowance for doubtful accounts of $4,889 and $4,889 10,904 23,232 Interest receivable from unconsolidated investee 9,616 10,578 Notes receivable from unconsolidated investee - current portion 365,625 - Inventories - finished goods 18,693 20,142 Prepaid expenses and other current assets 76,710 70,426 ------------- ------------- Total current assets 1,010,649 8,384,087 PROPERTY AND EQUIPMENT Business center equipment 950,869 972,832 Machinery and equipment 98,606 24,870 Computer equipment 146,321 145,454 Furniture and fixtures 19,658 33,298 Leasehold improvements 121,719 122,365 ------------- ------------- 1,337,173 1,298,819 Less accumulated depreciation and amortization (1,170,637) (1,073,259) ------------- ------------- Net property and equipment 166,536 225,560 ------------- ------------- NOTES RECEIVABLE FROM UNCONSOLIDATED INVESTEE 5,484,375 5,850,000 DEFERRED STOCK COMPENSATION 192,138 - INVESTMENT IN UNCONSOLIDATED INVESTEE 7,234,541 6,125,383 ------------- ------------- TOTAL ASSETS $ 14,088,239 $ 20,585,030 ============= ============= The accompanying footnotes are an integral part of these consolidated financial statements. 4 ZUNICOM, INC. AND SUBSIDIARY UNAUDITED CONSOLIDATED BALANCE SHEETS - Continued LIABILITIES AND STOCKHOLDERS' EQUITY September 30, December 31, 2007 2006 ---- ---- Unaudited Audited CURRENT LIABILITIES Accounts payable $ 210,241 $ 237,310 Accrued liabilities 175,853 395,633 Due to unconsolidated investee - 186,619 ------------- ------------- Total current liabilities 386,094 819,562 NON-CURRENT DEFERRED TAX LIABILITY 3,824,222 3,824,222 ------------- ------------ TOTAL LIABILITIES 4,210,316 4,643,784 STOCKHOLDERS' EQUITY Preferred stock - $1.00 par value, 1,000,000 shares authorized; 61,988 and 86,988 Class A Preferred Shares issued and outstanding 61,988 86,988 Common stock - $0.01 par value; 50,000,000 shares authorized; 9,957,191 and 8,891,394 shares issued and out-standing 99,571 88,914 Additional paid-in capital 9,268,412 14,818,893 Retained earnings 447,952 946,451 ------------- ------------- Total stockholders' equity 9,877,923 15,941,246 ------------- ------------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 14,088,239 $ 20,585,030 ============= ============= The accompanying footnotes are an integral part of these consolidated financial statements. 5 ZUNICOM, INC. AND SUBSIDIARY UNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS For the three months ended For the nine months ended --------------------------- --------------------------- September 30, September 30, -------- -------- 2007 2006 2007 2006 ---- ---- ---- ---- REVENUES Sales $ - $ 23,770,977 $ - $ 68,016,953 Service revenue 360,272 413,750 1,161,152 1,321,706 ------------ ------------ ------------- ------------ 360,272 24,184,727 1,161,152 69,338,659 COST OF REVENUES Cost of goods sold - 20,296,480 - 58,342,648 Direct servicing costs 117,532 110,156 338,324 396,428 ------------ ------------ ------------- ------------ 117,532 20,406,636 338,324 58,739,076 ------------ ------------ ------------- ------------ GROSS PROFIT 242,740 3,778,091 822,828 10,599,583 OPERATING EXPENSES Selling, general and administrative 369,606 2,738,285 1,322,546 7,917,044 Depreciation and amortization of property and equipment 32,213 70,234 97,378 223,325 ------------ ------------ ------------- ------------ 401,819 2,808,519 1,419,924 8,140,369 ------------ ------------ ------------- ------------ INCOME (LOSS) FROM OPERATIONS (159,079) 969,572 (597,096) 2,459,214 OTHER EXPENSES Interest income (expense) net, including $,91,529 $0,$350,640, and $8,293 from related parties 91,441 (194,104) 350,178 (605,325) Equity in earnings of investee 272,892 713,041 - Gain on equity transactions of investee - 18,725 - Other, net (4,788) 16,423 (17,228) 19,852 ------------ ------------ ------------ ------------ 359,545 (177,681) 1,064,716 (585,473) ------------ ------------ ------------ ------------ INCOME BEFORE PROVISION FOR INCOME TAXES 200,466 791,891 467,620 1,873,741
The accompanying footnotes are an integral part of these consolidated financial statements. 6 ZUNICOM, INC. AND SUBSIDIARY UNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS (continued) For the three months ended For the nine months ended June -------------------------- ----------------------------- September 30, September 30, -------- -------- 2007 2006 2007 2006 ---- ---- ---- ---- PROVISION FOR INCOME TAXES - (79,281) - (79,281) ------------ ------------ ------------ ------------ NET INCOME $ 200,466 $ 712,610 467,620 $ 1,794,460 ============ ============ ============ ============ Net income attributable to common stockholders $ 194,858 $ 704,973 $ 447,952 $ 1,770,369 ============ ============ ============ ============ Net income per share attributable to common stockholders Basic $ 0.02 $ 0.08 $ 0.05 $ 0.20 ============ ============ ============ ============ Diluted $ 0.02 $ 0.07 $ 0.05 $ 0.18 ============ ============ ============ ============ Cash dividends per share $ - $ - $ 0.80 $ - ============ ============ ============ ============ Number of weighted average shares of common stock outstanding Basic 9,949,752 8,879,057 9,288,767 8,824,498 ============ ============ ============ ============ Diluted 10,073,728 9,500,071 9,448,855 9,605,391 ============ ============ ============ ============
The accompanying footnotes are an integral part of these consolidated financial statements. 7 ZUNICOM, INC. AND SUBSIDIARY UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS For The Nine Months Ended September 30, 2007 and 2006 2007 2006 ---- ---- CASH FLOWS FROM OPERATING ACTIVITIES Net income $ 467,620 $ 1,794,460 Adjustments to reconcile net income to net cash used in operating activities: Depreciation and amortization of property and equipment 97,378 223,325 Provision for bad debts - 181,335 Provision for obsolete inventory - 120,000 Write off of property and equipment - 7,121 Gain on equity transactions of investee ( 18,725) - Equity in earnings of investee (713,041) - Non-cash stock-based compensation 52,649 - Change in operating assets and liabilities: Accounts receivable - trade 12,328 (1,235,743) Accounts receivable - other 962 96,493 Inventories 1,449 (1,760,866) Prepaid expenses and other current assets (6,284) (25,454) Other assets - - Accounts payable (27,069) (1,476,230) Accrued liabilities (219,780) 772,139 Deferred rent - (20,139) Deferred Stock Compensation (192,138) Due to investee (186,619) - ------------ ------------ Net cash used in operating activities (731,270) (1,323,559) ------------ ------------ CASH FLOWS FROM INVESTING ACTIVITIES Purchase of property and equipment (38,354) (195,983) ------------ ------------ CASH FLOWS FROM FINANCING ACTIVITIES Net activity on line of credit - 2,360,081 Proceeds from exercise of warrants - 182,500 Repayment of notes payable - related party - (217,128) Repayment of long-term debt - (15,616) Amortization of deferred stock compensation (13,663) - Issuance of Restricted Stock 205,801 - Dividends paid on common stock (7,153,122) - ------------ ------------ Net cash provided (used in) by financing activities (6,960,984) 2,309,837 ------------ ------------ The accompanying footnotes are an integral part of these consolidated financial statements. 8 ZUNICOM, INC. AND SUBSIDIARY UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS For The Nine Months Ended September 30, 2007 and 2006 (continued) 2007 2006 ---- ---- NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (7,730,608) 790,295 Cash and cash equivalents at beginning of period 8,259,709 731,626 ------------ ------------ Cash and cash equivalents at end of period $ 529,101 $ 1,521,921 ============ ============ SUPPLEMENTAL CASH FLOW INFORMATION Interest paid $ 462 $ 605,325 ============ ============ Income taxes paid $ 230,000 $ 79,281 ============ ============ SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND FINANCING ACTIVITIES Dividends paid through issuance of common stock $ 19,668 $ 24,091 ============ ============ Conversion of preferred stock to common stock $ 25,000 $ 2,000 ============ ============ Capital contribution to unconsolidated investee $ 377,392 $ - ============ ============ The accompanying footnotes are an integral part of these consolidated financial statements. 9 ZUNICOM, INC. AND SUBSIDIARY NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS NOTE A - BASIS OF PRESENTATION The accompanying unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and in accordance with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation have been included for the three month and nine month period ended September 30, 2007. The results for the three month and nine month period ended September 30, 2007 are not necessarily indicative of the results that may be expected for the year ended December 31, 2007. The unaudited consolidated financial statements included in this filing should be read in conjunction with the Company's audited consolidated financial statements and notes thereto included in the Company's annual report on form 10-K for the year ended December 31, 2006. In December 2006 the Company's previously wholly-owned subsidiary, Universal Power Group, Inc. ("UPG" or "Universal"), completed an initial public offering which resulted in the Company's ownership interest in UPG being reduced from 100 percent to its present ownership interest of 40 percent. The Company consolidated UPG in its financial statements until December 20, 2006 and currently accounts for UPG as an unconsolidated investee under the equity method of accounting. The Company has adopted the income statement gain recognition method of accounting for issuances of a subsidiary's stock in accordance with SEC Staff Accounting Bulletin No. 51. Recent Accounting Pronouncements The Company adopted the provisions of Financial Standards Accounting Board Interpretation No. 48, "Accounting for Uncertainty in Income Taxes - an Interpretation of FASB Statement No. 109 ("FIN 48"), on January 1, 2007. There were no unrecognized tax benefits and, accordingly, there was no effect on the Company's financial condition or results of operations as a result of implementing FIN 48. The Company files income tax returns in the U.S. federal jurisdiction and various state and foreign jurisdictions. The Company is no longer subject to U.S. federal tax examinations for years before 2003, and state tax examinations for years before 2002. Management does not believe there will be any material changes in our unrecognized tax positions over the next 12 months. The Company's policy is to recognize interest and penalties accrued on any unrecognized tax benefits as a component of income tax expense. As of the date of adoption of FIN 48, there was no accrued interest or penalties associated with any unrecognized tax benefits, nor was any interest expense recognized during the three and six month periods ended September 30, 2007. In September 2006, the FASB issued SFAS No. 157, "Fair Value Measurements" (SFAS 157"). SFAS 157 defines fair value, establishes a framework for measuring fair 10 value in accordance with accounting principles generally accepted in the United States, and expands disclosures about fair value measurements. SFAS No. 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, with earlier application encouraged. Any amounts recognized upon adoption as a cumulative effect adjustment will be recorded to the opening balance of retained earnings in the year of adoption. The Company has not yet determined the impact of this statement on its results of operations or financial condition. In February 2007, the FASB issued Statement of Financial Accounting Standards No. 159, "The Fair Value Option for Financial Assets and Financial Liabilities -- Including an amendment of FASB Statement No. 115," (SFAS 159). This standard allows a company to irrevocably elect fair value as the initial and subsequent measurement attribute for certain financial assets and financial liabilities on a contract-by-contract basis, with changes in fair value recognized in earnings. The provisions of this standard are effective as of the beginning of a reporting entity's first fiscal year beginning after November 15, 2007. The Company is currently evaluating what effect the adoption of SFAS 159 will have on their consolidated financial statements. NOTE B - ORGANIZATION Zunicom, Inc., ("Zunicom" or the "Company") was formed on January 10, 1992 as a Texas corporation. Zunicom's consolidated wholly-owned subsidiary, AlphaNet Hospitality Systems Inc. ("AlphaNet"), is a provider of guest communication services to the hospitality market. Zunicom holds a 40 percent ownership interest in UPG, a distributor and supplier to a diverse and growing range of industries of portable power and related synergistic products, provider of third-party logistics services and a custom battery pack assembler. NOTE C - STOCK-BASED COMPENSATION Stock-based compensation expense for the three months ended September 30, 2007 was $12,959, which relates to the restricted stock issued as deferred compensation. Stock based compensation for the nine-month period ended September 30, 2007 was $52,649, which represents $38,986 for stock options granted in February 2007 and $13,663 for the restricted stock compensation. The Company had no stock-based compensation for the nine month period ended September 30, 2006 as all outstanding options were fully vested at the beginning of the period. STOCK OPTIONS Valuation Assumptions The Company granted options to purchase 25,000 shares of its common stock on February 1, 2007. These options were immediately vested. There were no options granted during the nine months ended September 30, 2006. The fair values of option awards were estimated at the grant date using a Black-Scholes option pricing model with the following assumptions for the nine months ended September 30, 2007: 11 For the nine Months Ended September 30, 2007 ------------- Weighted average grant date fair value $ 1.56 Weighted average assumptions used: Expected dividend yield 0.00% Risk-free interest rate 4.60% Expected volatility 138% Expected life (in years) 5 The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because the Company's employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options. Expected volatility is based on historical volatility. The expected term considers the contractual term of the option as well as historical exercise and forfeiture behavior. The risk-free interest rate is based on the rates in effect on the grant date for U.S. Treasury instruments with maturities matching the relevant expected term of the award. Activity and Summary Stock option activity under the 1999 Stock Option Plan was as follows: Weighted Average Number of Shares Exercise Price ---------------- -------------- Options outstanding at December 31, 2006 1,054,500 $ 0.84 Granted 25,000 $ 1.75 Exercised - $ - Canceled, lapsed or forfeited (654,500) $ 0.81 ---------------- Options outstanding and exercisable at September 30, 2007 425,000 $ 0.95 ================ Of the 1,054,500 options outstanding as of December 31, 2006, 654,500 lapsed as of February 25, 2007, in accordance with the terms of the 1999 Stock Option Plan. Under the terms of that plan, if the Company's interest in a subsidiary falls below 50%, employees of that subsidiary will no longer be considered employees of the Company for purposes of the Plan and any options they hold will lapse 60 days from the event which caused the Company's interest in the subsidiary to drop below 50%. Accordingly, certain employees of UPG were affected by the IPO of UPG, which resulted in the Company's interest in UPG to be reduced from 100% to 40%. 12 The following table summarizes stock options outstanding under the 1999 Stock Option Plan at September 30, 2007: Options Outstanding Options Exercisable Weighted Average Remaining Weighted Weighted Range of Number of Contractual Average Number of Average Exercise Options Life Exercise Options Exercise Prices Outstanding (in years) Price Exercisable Price --------------- ----------- ----------- -------- ----------- -------- $ 0.90 400,000 2.4 $ 0.90 400,000 $ 0.90 $ 1.75 25,000 9.8 $ 1.75 25,000 $ 1.75 ----------- ---------- -------- ---------- -------- $ 0.90 - $ 1.75 425,000 2.8 $ 0.95 425,000 $ 0.95 =========== ========== ======== ========== ======== At September 30, 2007, the aggregate intrinsic value of options outstanding was $0.0. The aggregate intrinsic value is calculated as the difference between the exercise price of the underlying awards and the quoted price of the Company's common stock for those awards that have an exercise price currently below the quoted price. At September 30, 2007, all outstanding options were fully vested. RESTRICTED STOCK On June 25, 2007, the Board of Directors of Zunicom approved a grant of 996,940 restricted shares of Zunicom's common stock to our chairman and certain officers and employees of UPG. Several of the officers and employees of UPG had been officers and employees of Zunicom prior to the deconsolidation of UPG in December 2006. The Company attributed a value of $205,801 to the restricted stock granted to our chairman and $377,392 to the restricted stock granted to the officers and employees of UPG. The grant was made in recognition of past and future performance especially with regard to the initial public offering of UPG's common stock in which Zunicom was able to sell $1,000,000 shares of UPG common stock resulting in an $0.80 dividend to shareholders paid in the first quarter of 2007. The restricted stock vests in full on June 25, 2011, and is subject to certain restrictions and obligations up to the point of vesting. The stock will not be registered and will be held in escrow for the benefit of the grantee until the vesting date. Our chairman relinquished options on 400,000 shares of Zunicom common stock, and the officers and employees of UPG held options on 653,000 shares of Zunicom common stock which lapsed after the deconsolidation of UPG. In accordance with FASB 123R, we accounted for the grant of restricted shares to our chairman as stock based compensation. We accounted for the grant of restricted shares to UPG officers and employees as a contribution of capital in accordance with EITF 00-12, "Accounting by an Investor for Stock-Based Compensation Granted to Employees of an Equity Method Investor." We will amortize 60% of that capital contribution as additional equity in earnings (loss) of the investee over the vesting period. The Company concluded that it is reasonable to discount the value of these restricted shares by 29.52%. Of the 29.52% discount, the Company considers the risk of forfeiture to be 10% and illiquidity to be 19.52%. The Company applied this discount to the grant date market value of a freely tradable share to arrive at the fair value of a restricted share. 13 NOTE D - NET INCOME PER SHARE Basic net income per share is computed by dividing net income decreased by the preferred stock dividends of $19,668 and $24,091 for the nine months ended September 30, 2007 and 2006, respectively, by the weighted average number of common shares outstanding for the period. Diluted net income per share is computed by dividing net income decreased by the preferred stock dividends by the weighted average number of common shares and common stock equivalents outstanding for the period. The Company's common stock equivalents include all common stock issuable upon conversion of preferred stock and the exercise of outstanding stock options and warrants. The dilutive effect of 425,000 options has not been included in the computation of dilutive net income per share for the three and nine months ended September 30, 2007. The options are "out of the money," i.e. the market price of the stock is below the strike price of the options. NOTE E - UNCONSOLIDATED SUBSIDIARY - INVESTEE UPG was a consolidated subsidiary of the Company for the nine month period ended September 30, 2006 and is accounted for under the equity method of accounting for the nine month period ended September 30, 2007. Following is a summary of financial information for UPG for the three and nine months ended September 30, 2007 and 2006 (in thousands): --------------- --------------- Three Months Nine Months Ended Ended --------------- --------------- September 30, September 30, 2007 2006 2007 2006 --------------- --------------- $ in 000's $ in 000's --------------- --------------- ---------------------------- ------- ------- ------- ------- Net revenue 29,788 23,772 79,731 68,017 ---------------------------- ------ ------ ------ ------ Cost of revenue 25,546 20,296 67,903 58,343 ---------------------------- ------ ------ ------ ------ Gross profit 4,242 3,476 11,828 9,674 ---------------------------- ------ ------ ------ ------ Operating expenses 3,198 2,530 8,534 7,096 ---------------------------- ------ ------ ------ ------ Income from operations 1,044 957 3,294 2,578 ---------------------------- ------ ------ ------ ------ Interest expense (225) (194) (958) (596) ---------------------------- ------ ------ ------ ------ Other income 56 9 396 18 ---------------------------- ------ ------ ------ ------ Income from operations before income tax provision 875 761 2,733 2,000 ---------------------------- ------ ------ ------ ------ Income tax provision (193) (307) (949) (832) ---------------------------- ------ ------ ------ ------ Net income 682 454 1,784 1,168 ============================ ====== ====== ====== ====== 14 At September 30, 2007 the carrying value of the Company's investment in UPG was $7,234,541. The market value of the 2,000,000 shares of UPG's common stock the Company owns was approximately $9,220,000 based on the closing price per share at September 28, 2007 of $4.61. NOTE F - RELATED PARTY NOTE The Company holds two unsecured promissory notes from UPG, one in the amount of $3,000,000 and a second note in the amount of $2,850,000 for a total of $5,850,000. Both notes are dated December 20, 2006 and carry the same terms. These terms provide for quarterly interest payments at an annual interest rate of 6% and principal payments in 16 equal quarterly installments of $365,625 each beginning September 20, 2008. As of September 30, 2007, $365,625 of the principal payment is classified as current, leaving $5,484,375 classified as long term. NOTE G - SHAREHOLDERS' EQUITY During the nine months ended September 30, 2007, the Company paid a cash dividend of $0.80 per share, totaling $7,153,122 to shareholders of its common stock. The dividend was paid on March 23, 2007 primarily from proceeds received from the sale of 1,000,000 shares of common stock of UPG that the Company sold in UPG's IPO. During the nine months ended September 30, 2007, the Company paid dividends of $19,668 on the class A Preferred Stock through the issuance of 18,857 shares of the Company's common stock. During the first quarter of 2007, certain preferred stockholders converted 25,000 shares of the Company's preferred stock into 50,000 shares of the Company's common stock. NOTE H - LEGAL PROCEEDINGS The Company is subject to legal proceedings and claims that arise in the ordinary course of business. Management does not believe that the outcome of these matters will have a material adverse effect on the Company's consolidated financial position, operating results, or cash flows. However, there can be no assurance that such legal proceedings will not have a material impact. In September of 2005, A.J. Gilson, a former sales representative of UPG filed an action in the District Court of Dallas County, Texas against UPG and Zunicom claiming damages for breach of contract in the amount of $430,722 and all reasonable and necessary attorney fees. In relation to this matter, the Company is defending itself and considers the claim without merit. Management does not expect the final resolution of this claim to have a material adverse effect on our financial position. However, depending on the amount and timing of an unfavorable resolution of claim against the Company, or the costs of settlement or litigation, the Company's future results of operations or cash flows could be materially adversely affected. 15 NOTE I - COMMITTMENTS NOTE GUARANTEE The Company had been a guarantor of a line of credit owed by UPG to a financial institution. The line of credit is secured by the assets of UPG. At July 31, 2007, the Company signed a subordination agreement with the financial institution whereby the Company agreed to subordinate its notes from UPG to the loan owed by UPG to the financial institution. The agreement contains a provision under which UPG may pay interest and principal to the Company as they become due. In return, the financial institution released the Company from its guarantee. LEASES During the second quarter of 2007, AlphaNet moved into new office space in Toronto, reducing its occupancy cost. The lease commenced on March 1, 2007 and will end on April 30, 2009. AlphaNet leases certain equipment located at customer sites as part of its Office(TM) product. The following table presents the Company's commitments on those leases. ------------- ---------- ---------- ---------- -------- ----------- Lease 2007 2008 2009 2010 Total ----- ---- ---- ---- ---- ----- ------------- ---------- ---------- ---------- -------- ----------- Office Space $ 20,802 $ 83,208 $ 27,736 $ - $ 131,746 ------------- --------- --------- --------- ------- ---------- Equipment 17,078 40,987 7,494 175 65,734 ------------- --------- --------- --------- ------- ---------- Total $ 37,880 $ 124,195 $ 35,230 $ 175 $ 197,480 ------------- --------- --------- --------- ------- ---------- 16 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion and analysis should be read in conjunction with Zunicom's Unaudited Consolidated Interim Financial Statements and notes thereto included elsewhere in this Form 10-Q. Except for the historical information contained herein, the discussion in this Form 10-Q contains certain forward looking statements that involve risks and uncertainties, such as statements of Zunicom's plans, objectives, expectations and intentions. The cautionary statements made in this Form 10-Q should be read as being applicable to all related forward-looking statements wherever they appear in this Form 10-Q. These statements include, without limitation, statements concerning the potential operations and results of the Company described below. Zunicom's actual results could differ materially from those discussed here. Factors that could cause or contribute to such differences include, without limitation, those factors discussed herein and in Zunicom's Annual Report on Form 10-K for the year ended December 31, 2006. RESULTS OF OPERATIONS Currently, the operations of Zunicom are conducted through its wholly-ownedsubsidiary, AlphaNet. THREE MONTHS ENDED SEPTEMBER 30, 2007 COMPARED TO THREE MONTHS ENDED SEPTEMBER 30, 2006 REVENUES For the three month period ended September 30, 2007, Zunicom had consolidated revenues of $360,272 compared to $24,184,727 for the same period in 2006,a decrease of $23,824,455 or 98.5%. Effective with UPG's IPO in December 2006, UPG's financial results are no longer consolidated with those of Zunicom. Of the $23,824,455 decrease in revenue, $23,770,977 or 99.8% is due to the deconsolidation of UPG. AlphaNet had revenues of $360,272 for the three month period ended September 30, 2007, compared to revenues of $413,750 for the same period in 2006, a decreaseof $53,478, or 12.9%. Of the $53,478 decrease in revenue, $14,398 is due to the continuing decline of the InnFax(TM) product driven by the competition of in-room internet service. The remaining $39,080 of the revenue decrease is due principally to a decline in the number of new installations of the Office(TM) product and decreased renewals. COST OF REVENUES For the three month period ended September 30, 2007, Zunicom's consolidated cost of revenues was $117,532 compared to cost of revenues of $20,406,636 for the same period in 2006, a decrease of $20,289,104 or 99.4%. Of the total decrease in cost of revenues, $20,296,480 is due to the deconsolidation of UPG. The remaining increase in the cost of revenues of $7,376 is due primarily to increased supplies and maintenance costs for the InnFax(TM) equipment which is aging. 17 AlphaNet's InnFax(TM) product continues to decline as contracts continue to expire and AlphaNet is no longer marketing or installing the InnFax product. OPERATING EXPENSES For the three month period ended September 30, 2007, Zunicom's consolidated operating expenses, consisting of selling, general and administrative expenses and depreciation and amortization of property and equipment decreased to $401,819 compared to $2,808,519 for the same period in 2006, a decrease of $2,406,700 or 85.7%. Of the total decrease in operating expenses, $2,410,155 is due to the deconsolidation of UPG. The remainder is an increase of $3,455 due to a decrease in operating expenses of AlphaNet of $17,839 offset by increases in Zunicom's expenses of $21,294. AlphaNet's selling, general and administrative expenses for the three month period ending September 30, 2007 were $269,564 compared to $287,403 for the same period in 2006, a decrease of $17,839 or 6.2%. The decrease is primarily attributable to decreased occupancy costs due to the reduction in rent achieved through the relocation of the Toronto office in the second quarter of 2007. Zunicom's selling, general and administrative expenses for the three month period ending September 30, 2007 were $132,255 compared to $110,961 for the same period in 2006, representing an increase of $21,294 or 19.2%. The increase is primarily attributable to increased legal fees, consulting fees and accounting fees in connection with its on-going operations after the deconsolidation of UPG. For the three-month period ended September 30, 2007, the Company recorded $32,213 in depreciation and amortization expense compared to $70,234 in 2006. The decrease is principally due to the deconsolidation of UPG. OTHER INCOME / EXPENSE Zunicom's consolidated interest income (expense) represents income of $91,441 for the three month period ended September 30, 2007 compared to an expense of $194,104 for the same period in 2006, an overall net increase in income of $285,545. The increase is due to the deconsolidation of UPG and the elimination of borrowings under the UPG line of credit from Zunicom's consolidated financial results offset by interest income from notes receivable from UPG. Equity in earnings of investee of $272,892 represents Zunicom's share of UPG's net income for the three-month period ended September 30, 2007 and changes in equity of UPG, both recorded in accordance with the equity method of accounting for an unconsolidated investee. NINE MONTHS ENDED SEPTEMBER 30, 2007 COMPARED TO NINE MONTHS ENDED SEPTEMBER 30, 2006 REVENUE For the nine-month period ended September 30, 2007, Zunicom had consolidated revenues of $1,161,152 compared to $69,338,659 for the same period in 2006, a decrease of $68,177,507 or 98.3%. Effective with UPG's IPO in December 2006, 18 UPG's financial results are no longer consolidated with those of Zunicom. Of the $68,177,507 decrease in revenue, $68,016,953 or 99.8% is due to the deconsolidation of UPG. AlphaNet had revenues of $1,161,152 for the nine-month period ended September 30, 2007, compared to revenues of $1,321,706 for the same period in 2006, a decrease of $160,554, or 12.1%. Of the $160,554 decrease in revenue,$58,167 is due to the continuing decline of the InnFax(TM) product driven by the competition of in-room internet service. The remaining $102,387 of the revenue decrease is due principally to a decline in the number of new installations of the Office(TM) product and decreased renewals. COST OF REVENUES For the nine-month period ended September 30, 2007, Zunicom's consolidated cost of revenues is $338,324 compared to cost of revenues of $58,739,076 for the same period in 2006, a decrease of $58,400,752 or 99.4%. Of the total decrease in cost of revenues, $58,342,648 is due to the deconsolidation of UPG. The remaining decrease in the cost of revenues of $58,104 is due a reduction in servicing costs due to AlphaNet's decrease in revenues. The direct servicing costs of AlphaNet's InnFax(TM) product continue to decline as contracts continue to expire and AlphaNet is no longer marketing or installing the InnFax product. In addition, direct servicing costs for the Office(TM) product also declined principally in the areas of repairs and maintenance, installation costs and licensing consistent with the decrease in new installations. OPERATING EXPENSES For the nine-month period ended September 30, 2007, Zunicom's consolidated operating expenses, consisting of selling, general and administrative expenses and depreciation and amortization of property and equipment were $1,419,924 compared to $8,140,369 for the same period in 2006, a decrease of $6,720,445 or 82.6%. Of the total decrease in operating expenses, $6,747,971 is due to the deconsolidation of UPG. The remainder is an increase of $27,526 due to a decrease in operating expenses of AlphaNet of $143,929 offset by increases in Zunicom's expenses of $171,455. AlphaNet's selling, general and administrative expenses for the nine-month period ending September 30, 2007 were $858,505 compared to $1,002,434 for the same period in 2006, a decrease of $143,929 or 14.4%. The decrease is primarily attributable to decreased employment costs due to the reduction of one position, decreased occupancy costs resulting from the relocation of the Toronto office, and decreased travel expenses. Zunicom's selling, general and administrative expenses for the nine-month period ending September 30, 2007 were $561,419 compared to $389,964 for the same period in 2006, representing an increase of $171,455 or 44.0%. The increase is primarily attributable to increased legal fees, consulting fees and accounting fees in connection with its on-going operations after the deconsolidation of UPG. 19 For the nine-month period ended September 30, 2007, the Company recorded $97,378 in depreciation and amortization expense compared to $223,325 in 2006. The decrease is principally due to the deconsolidation of UPG. OTHER INCOME (EXPENSE) Zunicom's consolidated interest income (expense) represents income of $350,178 for the nine-month period ended September 30, 2007 compared to an expense of $605,325 for the same period in 2006, an overall net increase in income of $955,503. The increase is due to the deconsolidation of UPG and the elimination of borrowings under the UPG line of credit from Zunicom's consolidated financial results offset by interest income from notes receivable from UPG. Equity in earnings of investee of $713,041 and gain on equity transactions of investee of $18,725, respectively, represents Zunicom's share of UPG's net income for the nine-month period ended September 30, 2007 and changes in equity of UPG, both recorded in accordance with the equity method of accounting for an unconsolidated investee. As a result of the deconsolidation of UPG, the Company is left with one consolidated subsidiary, AlphaNet. The Company does not expect to engage in any future transactions in the nature of the UPG transaction. LIQUIDITY Zunicom, on a consolidated basis, had cash and cash equivalents of $529,101 at September 30, 2007. Net cash used in operations was $731,270 for the nine-month period ended September 30, 2007. The cash used in operating activities is primarily attributable to net profit of $467,620, plus $97,378 in depreciation and amortization, $52,649 in stock based compensation and a decrease in accounts receivable and inventory of $14,739, offset by equity in earnings of UPG of $713,041, gain on equity transactions of UPG of $18,725, decreases in prepaid expenses and other assets of $6,284, decreases in accrued liabilities of $219,780, accounts payable of $27,069, payable to related party of $186,619, and an increase in deferred stock compensation of $192,138. Net cash used by investing activities for the nine-month period ended September 30, 2007, relating to purchases of property and equipment was $38,354. Net cash used in financing activities for the nine-month period ended September 30, 2007 was $6,960,984 representing payment of a cash dividend $0.80 per share on the Company's common stock and the issuance of 996,940 shares of restricted common stock to certain officers and employees of Zunicom and UPG. Zunicom's primary sources of cash in 2007 will be from the operations of AlphaNet and the interest income on the notes receivable from UPG. Zunicom believes that the cash generated from those sources will be sufficient to meet its operational needs over the next year. 20 The Company's future lease commitments are as follows: ------------- ---------- ---------- ---------- -------- ----------- Lease 2007 2008 2009 2010 Total ----- ---- ---- ---- ---- ----- ------------- ---------- ---------- ---------- -------- ----------- Office Space $ 20,802 $ 83,208 $ 27,736 $ - $ 131,746 ------------- --------- --------- --------- ------- ---------- Equipment 17,078 40,987 7,494 175 65,734 ------------- --------- --------- --------- ------- ---------- Total $ 37,880 $ 124,195 $ 35,230 $ 175 $ 197,480 ------------- --------- --------- --------- ------- ---------- ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Foreign Currency Exchange Our customers are primarily located in the U.S. and a few customers in Canada. Our exchange rate risk between the US and Canadian dollar is minimal because we conduct so little business in Canada. In addition, the aggregate impact of any likely exchange rate fluctuations would be immaterial as most payments are made in U.S. dollars. We have not used derivative instruments to hedge our foreign exchange risks though we may choose to do so in the future. Interest Rates We currently have no direct borrowings and therefore are not exposed to market rate risk for changes in interest rates other than through our guaranty of UPG's line of credit. That guarantee was removed as of July 31, 2007. In addition, our notes receivable from UPG are at fixed rates of interest. ITEM 4. CONTROLS AND PROCEDURES The Company's management, including the Company's principal executive officer and principal financial officer, has evaluated the effectiveness of the Company's disclosure controls and procedures (as defined in Rules 13(a) - 15(e) and 15(d) - 15(e) under the Securities Exchange Act of 1934) as of the nine months ended September 30, 2007. Based upon that evaluation, the Company's principal executive officer and principal financial officer have concluded that the disclosure controls and procedures were effective as of September 30, 2007 to insure that the information required to be disclosed by us in the reports filed or submitted by us under the Securities Exchange Act of 1934, as amended, was recorded, processed, summarized or reported within the time periods specified in the rules and regulations of the SEC, and included controls and procedures designed to ensure that information required to be disclosed by us in such reports was accumulated and communicated to management, including our principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosures. There were no changes in the Company's internal control over financial reporting that occurred during the Company's last fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting. 21 PART II - OTHER INFORMATION Item 1. Legal Proceedings. In September of 2005, A.J. Gilson, a former sales representative of UPG filed an action in the District Court of Dallas County, Texas against UPG and Zunicom claiming damages for breach of contract in the amount of $430,722 and all reasonable and necessary attorney fees. In relation to this matter, the Company is defending itself and considers the claim without merit. Management does not expect the final resolution of this claim to have a material adverse effect on our financial position. However, depending on the amount and timing of an unfavorable resolution of claim against the Company, or the costs of settlement or litigation, the Company's future results of operations or cash flows could be materially adversely affected. Item 6. Exhibits. a. The following exhibits are filed as part of this report or incorporated herein as indicated. 3.1 Articles of Incorporation, as amended (incorporated by reference to the Company's Registration Statement on Form SB-2, Commission File No. 33-98662, filed on October 30, 1995 and amended on January 5, 1996 and January 23, 1996). 3.2 Certificate of Designation (incorporated by reference to the Company's Registration Statement on Form SB-2, Commission File No. 33-98662, filed on October 30, 1995 and amended on January 5, 1996 and January 23, 1996). 3.2A Amended Certificate of Designation (incorporated by reference to the Company's Registration Statement on Form SB-2, Commission File No.33-98662, filed on October 30, 1995 and amended on January 5, 1996 and January 23, 1996). 3.3 Bylaws (incorporated by reference to the Company's Registration Statement on Form SB-2, Commission File No. 33-98662, filed on October 30, 1995 and amended on January 5, 1996 and January 23, 1996). 31.1 Certification related to Quarterly Report Form 10-Q disclosures. 31.2 Certification related to Quarterly Report Form 10-Q disclosures 32.1 Certification pursuant to Rule 13a-14(b) of the Exchange Act and 18 U.S.C. Section 1350, as enacted pursuant to Section 906 of the Sarbanes-Oxley Act of 2003. 32.2 Certification pursuant to Rule 13a-14(b) of the Exchange Act and 18 U.S.C. Section 1350, as enacted pursuant to Section 906 of the Sarbanes-Oxley Act of 2003. 22 Signature --------- Pursuant to the requirements 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. Zunicom, Inc. ----------------------------- (Registrant) Date: November 12, 2007 /s/ John C. Rudy -------------------------------- John C. Rudy Chief Financial Officer (principal financial officer) 23