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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
______________
 
FORM 10-Q
______________
 
(Mark One)
 
þ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended September 30, 2012
 
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 0-53722
 
———————
ZOOM TELEPHONICS, INC.
(Exact Name of Registrant as Specified in its Charter)
———————

Delaware
 
04-2621506
(State or Other Jurisdiction of Incorporation or Organization)
 
(I.R.S. Employer Identification No.)
     
207 South Street, Boston, Massachusetts
 
02111
(Address of Principal Executive Offices)
 
(Zip Code)
 
Registrant’s Telephone Number, Including Area Code: (617) 423-1072
 
_________________________________________________________________________
(Former Name, Former Address, Former Fiscal Year, if Changed Since Last Report)
 
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 þ NO ¨
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  YES þ NO ¨
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
 
Large accelerated filer  
o
Accelerated filer  
o
Non-accelerated filer
o
Smaller Reporting Company
þ
(do not check if a smaller reporting company)
   
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). YES ¨ NO þ
 
The number of shares outstanding of the registrant’s Common Stock, $.01 par value, as of November 9, 2012, was 6,973,704 shares.
 


 
 

 
ZOOM TELEPHONICS, INC.
INDEX
 
     
Page
 
 
Part I. - Financial Information
     
         
Item 1. 
Financial Statements
   
3
 
 
Condensed Balance Sheets as of September 30, 2012 and December 31, 2011 (Unaudited)
   
3
 
 
Condensed Statements of Operations and Comprehensive Income (Loss) for the three months and nine months ended September 30, 2012 and 2011 (Unaudited)
   
4
 
 
Condensed Statements of Cash Flows for the nine months ended September 30, 2012 and 2011 (Unaudited)
   
5
 
 
Notes to Condensed Financial Statements
   
6
 
           
Item 2.
Management's Discussion and Analysis of Financial Condition and Results of Operations 
   
10
 
           
Item 3. 
Quantitative And Qualitative Disclosures About Market Risk
   
16
 
           
Item 4. 
Controls and Procedures
   
16
 
           
 
Part II. - Other Information
       
           
Item 1A.
Risk Factors 
   
17
 
           
Item 6.
Exhibits
   
18
 
           
Signatures
   
19
 
         
Exhibit Index
   
20
 

 
2

 
 
PART I - FINANCIAL INFORMATION
 
ITEM 1.
FINANCIAL STATEMENTS
 
ZOOM TELEPHONICS, INC.
Condensed Balance Sheets
 (Unaudited)
 
ASSETS
 
September 30,
2012
   
December 31,
2011
 
Current assets
           
Cash and cash equivalents
 
$
178,321
   
$
644,365
 
Marketable securities
   
70,400
     
82,280
 
Accounts receivable, net of allowances of $843,530 at September 30, 2012 and $624,481 at December 31, 2011
   
1,877,180
     
1,399,046
 
Inventories
   
3,141,991
     
2,722,783
 
Prepaid expenses and other current assets
   
170,611
     
185,348
 
Total current assets
   
5,438,503
     
5,033,822
 
                 
Equipment, net
   
30,796
     
20,168
 
Total assets
 
$
5,469,299
   
$
5,053,990
 
                 
LIABILITIES AND STOCKHOLDERS' EQUITY
               
Current liabilities
               
Bank debt
 
$
796,000
   
$
––
 
Accounts payable
   
1,146,961
     
1,058,942
 
Accrued expenses
   
350,069
     
373,394
 
Total current liabilities
   
2,293,030
     
1,432,336
 
                 
Total liabilities
   
2,293,030
     
1,432,336
 
                 
Stockholders' equity
               
Common stock, $0.01 par value:
               
Authorized - 25,000,000 shares; issued – 6,973,704 shares at September 30, 2012 and December 31, 2011
   
69,737
     
69,737
 
Additional paid-in capital
   
33,898,900
     
33,864,793
 
Accumulated deficit
   
(30,918,143
)
   
(30,438,446
)
Accumulated other comprehensive income (loss)
   
125,775
     
125,570
 
Total stockholders' equity
   
3,176,269
     
3,621,654
 
Total liabilities and stockholders' equity
 
$
5,469,299
   
$
5,053,990
 
 
See accompanying notes.

 
3

 
 
ZOOM TELEPHONICS, INC.
Condensed Statements of Operations and Comprehensive Income (Loss)
(Unaudited)
 
   
Three Months Ended September 30,
   
Nine Months Ended September 30,
 
   
2012
   
2011
   
2012
   
2011
 
                         
Net sales
 
$
3,434,693
   
$
3,046,790
   
$
11,243,415
   
$
9,020,942
 
Cost of goods sold
   
2,575,397
     
2,287,504
     
8,475,112
     
6,705,032
 
Gross profit
   
859,296
     
759,286
     
2,768,303
     
2,315,910
 
                                 
Operating expenses:
                               
Selling
   
431,587
     
477,044
     
1,458,609
     
1,596,120
 
General and administrative
   
294,710
     
310,073
     
908,457
     
917,146
 
Research and development
   
266,783
     
235,733
     
848,788
     
747,096
 
     
993,080
     
1,022,850
     
3,215,854
     
3,260,362
 
                                 
Operating profit (loss)
   
(133,784
)
   
(263,564
)
   
(447,551
)
   
(944,452
)
                                 
Other income (expense):
                               
Interest income
   
13
     
30
     
94
     
465
 
Other, net
   
(20,003
)
   
(682
)
   
(29,588
)
   
70,006
 
Total other income (expense), net
   
(19,990
)
   
(652
)
   
(29,494
)
   
70,471
 
                                 
Income (loss) before income taxes
   
(153,774
)
   
(264,216
)
   
(477,045
)
   
(873,981
)
                                 
Income taxes (benefit)
   
795
     
542
     
2,652
     
1,448
 
                                 
Net income (loss)
 
$
(154,569
)
 
$
(264,758
)
 
$
(479,697
)
 
$
(875,429
)
                                 
Other comprehensive income (loss):
                               
         Foreign currency translation adjustments
   
7,079
     
(8,866
)
   
12,085
     
(3,053
)
         Unrealized gain (loss) for the period
   
(12,800
)
   
(71,154
)
   
(11,880
)
   
(206,786
)
                                 
         Net comprehensive income (loss)
 
$
(160,290
)
 
$
(344,778
)
 
$
(479,492
)
 
$
(1,085,268
)
                                 
Basic and diluted net income (loss) per share
 
$
(0.02
)
 
$
(0.05
)
 
$
(0.07
)
 
$
(0.16
)
                                 
Weighted average common and common equivalent shares:
                               
Basic and diluted
   
6,973,704
     
5,450,622
     
6,973,704
     
5,450,622
 
 
See accompanying notes.

 
4

 
 
ZOOM TELEPHONICS, INC.
Condensed Statements of Cash Flows
(Unaudited)

   
Nine Months Ended
September 30,
 
 
 
2012
   
2011
 
Operating activities:
           
Net income (loss)
 
$
(479,697
)
 
$
(875,429
)
                 
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
               
Depreciation and amortization
   
4,218
     
20,116
 
Stock based compensation
   
34,107
     
97,330
 
Provision for accounts receivable allowances
   
219,049
     
157,000
 
Changes in operating assets and liabilities:
               
Accounts receivable
   
(689,851
   
(89,953
)
Inventories
   
(418,941
)
   
246,737
 
Prepaid expenses and other assets
   
16,613
     
(29,474
)
Accounts payable and accrued expenses
   
67,456
     
243,348
 
Net cash provided by (used in) operating activities
   
(1,247,046
)
   
(230,325
)
                 
Investing activities:
               
                 
Proceeds from sale of Unity investment
   
––
     
16,144
 
Additions to property, plant and equipment
   
(14,846
)
   
(1,547
)
Net cash provided by (used in) investing activities
   
(14,846
)
   
14,597
 
                 
Financing activities:
               
     Funds from bank loan
   
796,000
     
––
 
                    Net cash provided by financing activities
   
796,000
     
––
 
                 
Effect of exchange rate changes on cash
   
(152
)
   
3,582
 
                 
Net change in cash
   
(466,044
)
   
(212,146
)
                 
Cash and cash equivalents at beginning of period
   
644,365
     
1,009,996
 
                 
Cash and cash equivalents at end of period
 
$
178,321
   
$
797,850
 
                 
Supplemental disclosures of cash flow information:
               
                 
Cash paid during the period for:
               
Interest
 
$
28,028
   
$
––
 
Income taxes
 
$
2,035
   
$
1,448
 
 
See accompanying notes.

 
5

 

ZOOM TELEPHONICS, INC.
Notes to Condensed Financial Statements
 
(Unaudited)
 
(1) Summary of Significant Accounting Policies
 
On January 28, 2009, Zoom Technologies, Inc. entered into a Share Exchange Agreement (the “Agreement”) with Tianjin Tong Guang Group Digital Communication Co., Ltd (“TCB Digital”), TCB Digital’s majority shareholder, Gold Lion Holding Limited (“Gold Lion”) and Lei Gu (“Gu”), a shareholder of Gold Lion. On May 12, 2009, the parties amended the Agreement to, among other actions, add Songtao Du (“Du”), a shareholder of Gold Lion, as a party to the Agreement. On September 22, 2009, pursuant to the Agreement, Zoom Technologies acquired all the outstanding shares of Gold Lion. In addition, as part of the transaction, Zoom Technologies spun off its then-current business, which consisted of its ownership of Zoom Telephonics, to its stockholders, by distributing and transferring its assets and liabilities to Zoom Telephonics and issuing a dividend of the Zoom Telephonics’ shares to its stockholders.
 
For many years prior to the spin-off, Zoom Technologies was the public company parent of Zoom Telephonics, and the two companies’ financials were consolidated.  Upon the completion of the spin-off, Zoom Telephonics became a separate, independent publicly traded company headquartered in Boston, Massachusetts. Zoom Telephonics continues to produce, market, sell, and support dial-up modems, fixed and mobile broadband products, WiFi® compatible and Bluetooth® wireless products, and other communication-related products (the “Communications Business”) .
 
As used in this Quarterly Report on Form 10-Q, the terms “we,” “us,” “our,” and the “Company” mean Zoom Telephonics, Inc. (unless the context indicates a different meaning).

The Company has had recurring net losses and continues to experience negative cash flows from operations. To conserve cash and manage liquidity, the Company has implemented cost cutting initiatives.  However, management believes that the Company may not have sufficient resources to fund its normal operations over the next 12 months unless gross profit improves significantly, the Company increases its line of credit, or the Company raises capital. The Company has received an offer letter for an increased line of credit of up to $1.75 million and the offering bank is doing due diligence, but there is no guarantee that this line of credit will be established.   Additional capital may not be available on terms favorable to the Company, or at all.  If these funds are not available, the Company may not be able to execute its business plan or to take advantage of business opportunities.  The ability of the Company to achieve its operating goals is uncertain.  In the event that the Company does not increase gross profit, increase its line of credit, or obtain additional capital, there is substantial doubt as to its ability to continue as a going concern. The accompanying financial statements do not include any adjustments that might result from the outcome of this uncertainty.

The condensed financial statements of the Company presented herein have been prepared pursuant to the rules of the Securities and Exchange Commission for quarterly reports on Form 10-Q and do not include all of the information and disclosures required by accounting principles generally accepted in the United States of America. These financial statements should be read in conjunction with the audited financial statements and notes thereto for the year ended December 31, 2011 included in the Company's 2011 Annual Report on Form 10-K.
 
The accompanying financial statements are unaudited. However, the condensed balance sheet as of December 31, 2011 was derived from audited financial statements. In the opinion of management, the accompanying financial statements include all adjustments to present fairly the financial position, results of operations and cash flows of the Company.  The adjustments are of a normal, recurring nature.
 
The results of operations for the periods presented are not necessarily indicative of the results to be expected for the entire year. The Company has evaluated subsequent events from September 30, 2012 through the date of this filing and determined that there are no such events requiring recognition or disclosure in the financial statements.

 
6

 
 
 (2) Liquidity
 
Zoom’s cash balance on September 30, 2012 was $178 thousand, down $466 thousand from December 31, 2011. Zoom’s $0.7 million increase in gross accounts receivable and $0.5 million loss for the first nine months of 2012 decreased cash.  Zoom’s $0.8 million increase in bank debt increased cash as Zoom moved to minimize early-pay discounts and thereby increased the time to collect receivables.
 
On September 30, 2012 the Company had working capital of $3.1 million including $178 thousand in cash and cash equivalents.  On December 31, 2011 we had working capital of $3.6 million including $644 thousand in cash and cash equivalents. Our current ratio at September 30, 2012 was 2.4 compared to 3.5 at December 31, 2011. The primary reasons for the lower current ratio were Zoom’s loss of $0.5 million for the first nine months of 2012 and the increase in bank debt of $796 thousand which primarily funded a $690 thousand increase in gross accounts receivable.
 
To conserve cash and manage our liquidity, we have for years implemented cost-cutting initiatives including the reduction of employee headcount and overhead costs. On September 30, 2012 we had 30 employees, down from 32 employees on September 30, 2011.  On September 30, 2012 we had 10,600 square feet of headquarter space, down from 14,400 square feet on September 30, 2011.  We plan to continue to assess our cost structure as it relates to our revenues and cash position, and we may make further reductions if appropriate.

The Company is continuing to develop new products and to take other measures to increase sales.  Increasing sales typically results in increased inventory and higher accounts receivable, both of which reduce cash.  Zoom has two significant accounts who buy from Zoom on a consignment basis.  Consigned inventory tends to result in slow payment to Zoom, since Zoom is only paid after the consigned inventory is sold by Zoom’s customer.

The Company has in the past increased its cash by offering fast-pay discounts to certain accounts.  To reduce the need for fast-pay discounts and to give Zoom more operating flexibility, in April 2012 we established an asset-based bank line of credit of up to $1 million.  The amount actually available under the line of credit is contingent on Zoom meeting certain financial metrics and covenants.

The Company has had recurring net losses and continues to experience negative cash flows from operations. To conserve cash and manage liquidity, the Company has implemented cost cutting initiatives.  However, management believes that the Company may not have sufficient resources to fund its normal operations over the next 12 months unless gross profit improves significantly, the Company increases its line of credit, or the Company raises capital. The Company has received an offer letter for an increased line of credit of up to $1.75 million and the offering bank is doing due diligence, but there is no guarantee that this line of credit will be established.   Additional capital may not be available on terms favorable to the Company, or at all.  If these funds are not available, the Company may not be able to execute its business plan or to take advantage of business opportunities.  The ability of the Company to achieve its operating goals is uncertain.  In the event that the Company does not increase gross profit, increase its line of credit, or obtain additional capital, there is substantial doubt as to its ability to continue as a going concern. The accompanying financial statements do not include any adjustments that might result from the outcome of this uncertainty.
 
 
7

 

 (3) Inventories
 
Inventories consist of :
 
September 30,
2012
   
December 31,
2011
 
Raw materials
 
$
1,110,072
   
$
815,357
 
Work in process
   
135,481
     
25,641
 
Finished goods (including $471,000 and $822,000 held by customers at September 30, 2012 and December 31, 2011, respectively)
   
1,896,438
     
1,881,785
 
Total inventories
 
$
3,141,991
   
$
2,722,783
 
 
(4) Contingencies
 
Lawsuits occur in the ordinary course of business.  On October 15, 2012 Telecomm Innovations LLC filed a complaint against Zoom Telephonics and at least 23 other companies including Dell Inc., various dial-up modem producers, and many fax machine producers.  The only named Zoom product was Zoom’s Model 3095 dial-up modem, and we believe that this has a license through Conexant for the two patents mentioned in the complaint.  However, we do not know precisely what other products may be the subject of the complaint.  It is impossible to assess the potential cost and senior management distraction associated with this complaint or with future complaints or suits that may occur.
 
(5) Segment and Geographic Information
 
The Company’s operations are classified as one reportable segment. The Company’s net sales by geographic region follow:
 
 
Three Months
       
Three Months
       
Nine Months
       
Nine Months
       
 
Ended
   
% of
 
Ended
   
% of
 
Ended
   
% of
 
Ended
   
% of
 
 
September 30, 2012
   
Total
 
September 30, 2011
   
Total
 
September 30, 2012
   
Total
 
September 30, 2011
   
Total
 
North America
  $ 3,127,784       91 %   $ 2,712,720       89 %   $ 10,225,466       91 %   $ 8,066,050       90 %
UK
    158,872       5 %     210,051       7 %     425,681       4 %     571,229       6 %
All Other
    148,037       4 %     124,019       4 %     592,268       5 %     383,663       4 %
Total
  $ 3,434,693       100 %   $ 3,046,790       100 %   $ 11,243,415       100 %   $ 9,020,942       100 %
 
(6) Customer Concentrations
 
The Company sells its products primarily through high-volume retailers and distributors, Internet service providers, value-added resellers, PC system integrators, and original equipment manufacturers ("OEMs"). The Company supports its major accounts in their efforts to discern strategic directions in the market, to maintain appropriate inventory levels, and to offer a balanced selection of attractive products.
 
Relatively few customers have accounted for a substantial portion of the Company’s revenues.  In the third quarter of 2012, three customers accounted for 64% of the Company’s total net sales. In the third quarter of 2011, three customers accounted for 60% of the Company’s total net sales. In the first nine months of 2012 the Company's net sales to its top three customers accounted for 65% of its total net sales. In the first nine months of 2011 the Company’s net sales to its top three customers accounted for 53% of its total net sales.
 
 
8

 
 
The Company’s customers generally do not enter into long-term agreements obligating them to purchase products. The Company may not continue to receive significant revenues from any of these or from other large customers. A reduction or delay in orders from any of the Company’s significant customers, or a delay or default in payment by any significant customer could materially harm the Company’s business and prospects. Because of the Company’s significant customer concentration, its net sales and operating income (loss) could fluctuate significantly due to changes in political or economic conditions, or the loss, reduction of business, or less favorable terms for any of the Company's significant customers.
 
 (7) Investments
 
During the quarter ended September 30, 2007 the Company purchased all the Series A Preferred Shares (the Series A Shares) of Unity Business Networks, LLC (Unity) for cash of $1.2 million, including transaction costs. The Series A Shares were convertible at any time at the Company’s option into 15% of Unity’s common stock on a fully-diluted basis. In addition, the Company had an option to purchase all the outstanding common stock of Unity based on a specified multiple of Unity’s 2008 revenues, as defined.
 
On September 30, 2009 the Company received a cash payment of $766,950 in connection with Telesphere Networks’ purchase of the VoIP services business of Unity, including Zoom’s preferred stock investment described above. The transaction called for additional periodic payments totaling $43,050 over 24 months beginning in October 2009 and a final payment of $150,000 on September 30, 2011, or $960,000 in total. As of December 31, 2011, all payments had been received with regard to this transaction. 

(8) Valuation of Marketable Securities
 
In October 2010, Zoom Telephonics, Inc. entered into an agreement with Zoom Technologies, Inc. (Nasdaq: ZOOM) in which Zoom Telephonics transferred its rights to the zoom.com domain name and certain trademark rights in exchange for 80,000 shares of Zoom Technologies common stock. The Company did not sell any Zoom Technologies shares during Q3, 2012.  The closing price of Zoom Technologies common stock declined from $1.03 on December 31, 2011 to $0.88 on September 28, 2012.

(9) Bank Credit Line
 
On April 10, 2012 Zoom Telephonics, Inc. entered into a Loan and Security Agreement with Silicon Valley Bank (the “Loan Agreement”). This Loan Agreement was filed with the SEC in an 8-K dated April 13, 2012. The Loan Agreement provides for up to $1 million of revolving credit, subject to a borrowing base formula and other terms and conditions as specified in the Loan Agreement. The Company’s most recent charge for the month of September was an annualized interest rate of 11.125%, but this may change (or decrease) depending on Zoom’s balance sheet as specified in the Loan Agreement. Our outstanding bank debt at September 30, 2012 was $796,000. The Loan Agreement has a one year term which expires April 9, 2013. Borrowings are secured by all of Zoom’s assets including Zoom’s intellectual property. The Loan Agreement contains several covenants, including a requirement that Zoom maintain a tangible net worth of at least $3.0 million.

 
9

 
 
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 the safe harbor statement and the risk factors contained in Item IA of Part II of this Quarterly Report on Form 10-Q, in our Annual Report on Form 10-K for the year ended December 31, 2011, filed with the SEC on March 30, 2012 and in our other filings with the SEC. Readers should also be cautioned that results of any reported period are often not indicative of results for any future period.
 
Overview 
 
We derive our net sales primarily from sales of Internet-related communication products, principally fixed and mobile broadband modems and modem/routers, dial-up modems, WiFi® compatible and Bluetooth® wireless products, and other communication-related products.  We sell these products primarily to retailers, distributors, Internet Service Providers and Original Equipment Manufacturers. We sell our products through a direct sales force and through independent sales agents. Our employees are primarily located at our headquarters in Boston, Massachusetts and in our sales office in the United Kingdom.  We are experienced in electronics hardware, firmware, and software design and test, regulatory approvals, product documentation, and packaging; and we use that experience in developing each product in-house or in partnership with suppliers who are typically based in Asia. Electronic assembly and testing of the Company’s products in accordance with our specifications is typically done in China or Taiwan.
 
For many years we performed most of the final assembly, test, packaging, warehousing and distribution at a production and warehouse facility on Summer Street in Boston, Massachusetts, which had also engaged in firmware programming for some products. On June 30, 2006 we announced our plans to move most of our Summer Street operations to a dedicated facility in Tijuana, Mexico commencing approximately September 1, 2006, and we have since implemented that plan. In August 2006 we signed a lease for a 35,575 square foot manufacturing and warehousing facility in Tijuana, Mexico with an initial lease term from October 2006 to May 2007, with five two-year options thereafter.  In March 2009 we signed a one-year option for a smaller facility at a lower cost. In March 2011 we signed a one-year lease extension starting May 1, 2011, with three one-year renewal options thereafter. In April 2012 we exercised the first lease renewal, so now two one-year renewal options remain.
 
Since 1983 our headquarters has been near South Station in downtown Boston. In January 1, 2009 we reduced our leased Boston space from 25,000 square feet to 14,400 square feet with an increase in rent per square foot, resulting in a savings in 2009 of $54,000.  In May 2010 we signed a second lease amendment extending the term of the lease to April 30, 2016 with a six month termination option starting December 1, 2011.  In December 2011 we signed a third lease amendment reducing our leased space by 3,800 square feet effective June 1, 2012, with an associated decrease in lease expense.
 
For many years we derived a majority of our net sales from the retail after-market sale of dial-up modems to customers seeking to add or upgrade a modem for their personal computers. In recent years the size of this market and our sales to this market have declined, as personal computer manufacturers have incorporated a modem as a built-in component in most consumer personal computers and as increasing numbers of consumers world-wide have switched to broadband Internet access. The consensus of communications industry analysts is that after-market sales of dial-up modems will probably continue to decline. There is also consensus among industry analysts that the installed base for broadband Internet connection devices, such as cable modems and DSL modems and mobile broadband modems, will grow rapidly during the decade. In response to increased and forecasted worldwide demand for faster connection speeds and increased modem functionality, we have invested and continue to invest resources to advance our product line of broadband modems, both DSL modems and cable modems.
 
We continually seek to improve our product designs and manufacturing approach in order to improve product performance and reduce our costs. We pursue a strategy of outsourcing rather than internally developing our product chipsets, which are application-specific integrated circuits that form the technology base for our modems and some other products. By outsourcing the chipset technology, we are able to concentrate our research and development resources on performance and system design features, leverage the extensive research and development capabilities of our chipset suppliers, and reduce our development time and associated costs and risks. This approach has allowed us to quickly develop new products while maintaining a relatively low level of research and development expense as a percentage of net sales. We also outsource aspects of our manufacturing to contract manufacturers as a means of reducing our costs of production, and to provide us with greater flexibility in our production capacity.  Our approach to ZoomGuard is different and more engineering intensive though, since our ZoomGuard hardware designs employ a microprocessor that uses Zoom-developed firmware and that relies on Web-centric software for setup, monitoring, and control.
 
 
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Generally our gross margin for a given product depends on a number of factors including the type of customer to whom we are selling. The gross margin for retailers tends to be higher than for some of our other customers; but the sales, support, returns, and overhead costs associated with retailers also tend to be higher. Zoom’s sales to certain countries are currently handled by a single master distributor for each country who handles the support and marketing costs within the country. Gross margin for sales to these master distributors tends to be low, since lower pricing to these distributors helps them to cover the support and marketing costs for their country.
 
From 1999 to 2009 our net sales declined primarily because our dial-up modem sales declined faster than  sales growth of our other products.  In recent quarters our sales have tended to increase, but in most of those quarters we continued to experience losses. In response to declining sales volume and in an effort to achieve profitability, we have cut costs by reducing staffing and some overhead costs.   Our total headcount was reduced from 32 on September 30, 2011 to 30 on September 30, 2012. As of September 30, 2012 Zoom had 27 full-time employees, and 3 employees working less than 5 days per week. Of the 30 included in our headcount on September 30, 2012, 7 were engaged in research and development, 5 were involved in manufacturing management, purchasing, assembly, packaging, shipping and quality control, 11 were engaged in sales, marketing and technical support, and the remaining 7 performed accounting, administrative, management information systems, and executive functions.  On September 30, 2012 Zoom also had 21 dedicated manufacturing personnel in Mexico who are employees of our Mexican manufacturing service provider and not included in our headcount.  On September 30, 2012 Zoom had 2 consultants, one in engineering and one in sales, who were not included in our headcount.

           Zoom’s cash balance on September 30, 2012 was $178 thousand, down $466 thousand from December 31, 2011. Zoom’s $0.7 million increase in gross accounts receivable and $0.5 million loss for the first nine months of 2012 decreased cash.  Zoom’s $0.8 million increase in bank debt increased cash as Zoom moved to minimize early-pay discounts and thereby increased the time to collect receivables.
 
On September 30, 2012 the Company had working capital of $3.1 million including $178 thousand in cash and cash equivalents.  On December 31, 2011 we had working capital of $3.6 million including $644 thousand in cash and cash equivalents. Our current ratio at September 30, 2012 was 2.4 compared to 3.5 at December 31, 2011. The primary reasons for the lower current ratio were Zoom’s loss of $0.5 million for the first nine months of 2012 and the increase in bank debt of $796 thousand primarily which primarily funded a $690 thousand increase in gross accounts receivable.
 
 
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Critical Accounting Policies and Estimates
 
Following is a discussion of what we view as our more significant accounting policies and estimates. As described below, management judgments and estimates must be made and used in connection with the preparation of our financial statements. We have identified areas where material differences could result in the amount and timing of our net sales, costs, and expenses for any period if we had made different judgments or used different estimates.
 
Revenue (Net Sales) Recognition. We primarily sell hardware products to our customers. The hardware products include dial-up modems, DSL modems, cable modems, voice over IP products, and wireless and wired networking equipment. We earn a small amount of royalty revenue that is included in our net sales, primarily from internet service providers. We generally do not sell software. We began selling services in 2004. We introduced our Global Village VoIP service in late 2004, but sales of those services to date have not been material.
 
We derive our net sales primarily from the sales of hardware products to four types of customers:
 
 
computer peripherals retailers,
 
 
computer product distributors,
 
 
Internet service providers, and
 
 
original equipment manufacturers (OEMs)
 
We recognize hardware net sales for our customers at the point when the customers take legal ownership of the delivered products. Legal ownership passes from Zoom to the customer based on the contractual FOB point specified in signed contracts and purchase orders, which are both used extensively. Many of our customer contracts or purchase orders specify FOB destination. We verify the delivery date on all significant FOB destination shipments made during the last 10 business days of each quarter.
 
Our net sales of hardware include reductions resulting from certain events which are characteristic of the sales of hardware to retailers of computer peripherals. These events are product returns, certain sales and marketing incentives, price protection refunds, and consumer mail-in and in-store rebates. Each of these is accounted for as a reduction of net sales based on detailed management estimates, which are reconciled to actual customer or end-consumer credits on a monthly or quarterly basis.
 
Product Returns. Products are returned by retail stores and distributors for inventory balancing, contractual stock rotation privileges, and warranty repair or replacements. We estimate the sales and cost value of expected future product returns of previously sold products. Our estimates for product returns are based on recent historical trends plus estimates for returns prompted by, among other things, announced stock rotations and announced customer store closings. Management reviews historical returns, current economic trends, and changes in customer demand and acceptance of our products when estimating sales return allowances. The estimate for future returns is recorded as a reserve against sales and accounts receivable. Product returns as a percentage of total shipments were 16.9% and 18.7% for the third quarter of 2012 and 2011, respectively.
 
 
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Price Protection Refunds. We have a policy of offering price protection to certain of our retailer and distributor customers for some or all of their inventory. Under the price protection policies, when we reduce our prices for a product, the customer receives a credit for the difference between the original purchase price and our reduced price for their unsold inventory of that product. Our estimates for price protection refunds are based on a detailed understanding and tracking by customer and by sales program. Estimated price protection refunds are recorded in the same period as the announcement of a pricing change. Information from customer inventory-on-hand reports or from direct communications with the customers is used to estimate the refund, which is recorded as a reduction of net sales and a reserve against accounts receivable. Reductions in our net sales due to price protection were negligible in both the third quarter of 2012 and the third quarter of 2011. Reductions in our net sales due to price protection were negligible in the first nine months of 2012 and $54 thousand in the first nine months of 2011.
 
Sales and Marketing Incentives. Many of our retailer customers require sales and marketing support funding, usually set as a percentage of our sales in their stores. The incentives were reported as reductions in our net sales and were $66 thousand in the third quarter of 2012 and $101 thousand in the third quarter of 2011. Reductions in our net sales due to sales and marketing incentives were $212 thousand in the first nine months of 2012 and $330 thousand in the first nine months of 2011.
 
Consumer Mail-In and In-Store Rebates. Our estimates for consumer mail-in and in-store rebates are based on a detailed understanding and tracking by customer and sales program, supported by actual rebate claims processed by the rebate redemption centers plus an accrual for an estimated lag in processing at the redemption centers. The estimate for mail-in and in-store rebates is recorded as a reserve against accounts receivable and a reduction of net sales in the same period that the rebate obligation was triggered. Reductions in our net sales due to the consumer rebates were negligible in the third quarter of 2012 and $12 thousand in the third quarter of 2011.Reductions in our net sales due to consumer rebates were negligible in the first nine months of 2012 and were $92 thousand in the first nine months of 2011.
 
To ensure that the sales, discounts, and marketing incentives are recorded in the proper period, we perform extensive tracking and documenting by customer, by period, and by type of marketing event. This tracking includes reconciliation to the accounts receivable records for deductions taken by our customers for these discounts and incentives.
 
Accounts Receivable Valuation. We establish accounts receivable valuation allowances equal to the above-discussed net sales adjustments for estimates of product returns, price protection refunds, consumer rebates, and general bad debt reserves. These allowances are reduced as actual credits are issued to the customer's accounts. Our bad-debt write-offs were negligible in both the third quarter of 2012 and the third quarter of 2011. Our bad-debt write-offs were also negligible in both the nine months ending September 30, 2012 and the nine months ending September 20, 2011.
 
Inventory Valuation and Cost of Goods Sold. Inventory is valued at the lower of cost, determined by the first-in, first-out method, or market. We review inventories for obsolete slow moving products each quarter and make provisions based on our estimate of the probability that the material will not be consumed or that it will be sold below cost. Additional charges to inventory reserves related to obsolete and slow-moving products were negligible in both the third quarter of 2012 and the third quarter of 2011. Additional charges to inventory reserves related to obsolete and slow-moving products were negligible in the first nine months of 2012 and were $49 thousand in the first nine months of 2011.
 
Valuation and Impairment of Deferred Tax Assets. As part of the process of preparing our financial statements we estimate our income tax expense and deferred income tax position. This process involves the estimation of our actual current tax exposure together with assessing temporary differences resulting from differing treatment of items for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included in our balance sheet. We then assess the likelihood that our deferred tax assets will be recovered from future taxable income. To the extent we believe that recovery is not likely, we establish a valuation allowance. Changes in the valuation allowance are reflected in the statement of operations.
 
Significant management judgment is required in determining our provision for income taxes and any valuation allowances. We have recorded a 100% valuation allowance against our deferred income tax assets. It is management's estimate that, after considering all of the available objective evidence, historical and prospective, with greater weight given to historical evidence, it is more likely than not that these assets will not be realized. If we establish a record of continuing profitability, at some point we will be required to reduce the valuation allowance and recognize an equal income tax benefit which will increase net income in that period(s).
 
As of December 31, 2011 the Company had federal net operating loss carry forwards of approximately $47,017,000 which are available to offset future taxable income. They are due to expire in varying amounts from 2018 to 2031. As of December 31, 2011, the Company had Massachusetts state net operating loss carry forwards of approximately $15,797,000 which are available to offset future taxable income. They are due to expire in varying amounts from 2012 through 2032.

 
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Valuation of Investments. In October 2010, Zoom Telephonics, Inc. entered into an agreement with Zoom Technologies, Inc. (Nasdaq: ZOOM) in which Zoom Telephonics transferred its rights to the zoom.com domain name and certain trademark rights in exchange for 80,000 shares of Zoom Technologies common stock. The Company did not sell any Zoom Technologies shares during Q3, 2012.  The closing price of Zoom Technologies common stock declined from $1.03 on December 31, 2011 to $0.88 on September 28, 2012.
 
Results of Operations
 
Summary. Net sales were $3.4 million for the third quarter ended September 30, 2012, up 12.7% from $3.0 million in the third quarter of 2011. Zoom reported a net loss of $155 thousand or $0.02 per share for Q3 2012, compared to Zoom’s net loss of $265 thousand or $0.05 per share for Q3 2011. Net sales were $11.2 million for the nine months ended September 30, 2012, up 24.6% from $9.0 million in the nine months ended September 30, 2011. We had a net loss of $0.5 million for the nine months ended September 30, 2012 compared to a net loss of $0.9 million for the nine months ended September 30, 2011.  Loss per share was $0.07 in the nine months ended September 30, 2012 compared to $0.16 for the nine months ended September 30, 2011.
 
Net Sales. Our total net sales for the third quarter of 2012 increased $388 thousand or 12.7% from the third quarter of 2011, primarily because strong cable modem and cable modem/router sales made up for continued sales declines of dial-up modems and lower sales of ADSL and mobile broadband products.  The increase in cable modem sales was primarily due to strong sales of Zoom’s DOCSIS 3.0 cable modems in the USA.  Dial-up modem sales declined due to the trend toward broadband modems for Internet access.  ADSL sales declined due primarily to lower sales to service providers.  Mobile broadband sales declined primarily due to weak sell-through at retailers.
 
Our total net sales for the first nine months of 2012 increased $2.2 million or 24.6% from the first nine months of 2011, primarily due to increased sales of cable modems and cable modem/routers and decreases in dial-up modems, ADSL products, and mobile broadband products for the reasons discussed above.
 
Geographically, our North American sales continued their dominant share of our overall sales, going from 89% of our net sales in Q3 2011 to 91% in Q3 2012.  Our second largest market, the UK, experienced a decline from 7% of our net sales in Q3 2011 to 5% in Q 2012.  International sales outside the UK were unchanged at 4% of our net sales in both Q3 2011 and in Q3 2012.
 
In the quarter ended September 30, 2012 three customers accounted for 64% of total net sales. In the first nine months of 2012 the Company's top three customers accounted for 65% of total net sales. Because of our significant customer concentration, our net sales and operating income have fluctuated and could in the future fluctuate significantly due to changes in political or economic conditions or the loss, reduction of business, or less favorable terms for any of our significant customers.
 
Gross Profit. Gross profit was $859 thousand or 25.0% of net sales in Q3 2012, up from $759 thousand or 24.9% of net sales in Q3 2011.  The increase in gross profit was primarily due to higher sales.
 
Gross profit was $2.77 million for the first nine months of 2012, up $452 thousand from our gross profit of $2.32 million for the first nine months of 2011. Our gross margin for the first nine months of 2012 was 24.6%, down slightly from our gross margin of 25.7% for the first nine months of 2011.
 
Selling Expense. Selling expense was $432 thousand or 12.6% of net sales in the third quarter of 2012, down from $477 thousand or 15.7% of net sales in the third quarter of 2011.  The decrease was primarily due to lower freight costs and advertising costs. Selling expense was $1.46 million or 13.0% of net sales for the first nine months of 2012, down from $1.60 million or 17.7% of net sales for the first nine months of 2011.
 
General and Administrative Expense. General and administrative expense was $295 thousand or 8.6% of net sales in the third quarter of 2012, down from $310 thousand or 10.2% of net sales in the third quarter of 2011. General and administrative expense was $908 thousand or 8.1% for the first nine months of 2012, down slightly from $917 thousand or 10.2 % for the first nine months of 2011.
 
 
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Research and Development Expense. Research and development expense was $267 thousand or 7.8% of net sales in the third quarter of 2012, up slightly from $236 thousand or 7.7% of net sales in the third quarter of 2011.  R&D expenses increased primarily due to increased firmware consulting costs to support new product development. Research and development expense was $849 thousand or 7.5% of net sales in the first nine months of 2012, up 13.6% from $747 thousand or 8.3% of net sales in the first nine months of 2011, also due to higher costs new product development.
 
Other Income (Expense). Other expense was $20 thousand in the third quarter of 2012 and other income (expense) was negligible in the third quarter of 2011. Other expense in the third quarter of 2012 is primarily interest expense related to our bank credit line.
 
Net Loss. The net loss was $155 thousand for the third quarter of 2012, compared to the net loss of $265 thousand for the third quarter of 2011.  The decrease in net loss was primarily due to increased sales in the third quarter of 2012.  The net loss was $480 thousand for the first nine months of 2012, compared to the net loss of $875 thousand for the first nine months of 2011.  The decrease in net loss was due to higher sales and lower proportional costs in the first nine months of 2012.
 
Liquidity and Capital Resources
 
Zoom’s cash balance on September 30, 2012 was $178 thousand, down $466 thousand from December 31, 2011. Zoom’s $0.7 million increase in gross accounts receivable and $0.5 million loss for the first nine months of 2012 decreased cash.  Zoom’s $0.8 million increase in bank debt increased cash as Zoom moved to minimize early-pay discounts and thereby increased the time to collect receivables.
 
On September 30, 2012 the Company had working capital of $3.1 million including $178 thousand in cash and cash equivalents.  On December 31, 2011 we had working capital of $3.6 million including $644 thousand in cash and cash equivalents. Our current ratio at September 30, 2012 was 2.4 compared to 3.5 at December 31, 2011. The primary reasons for the lower current ratio were Zoom’s loss of $0.5 million for the first nine months of 2012 and the increase in bank debt of $796 thousand which primarily funded a $690 thousand increase in gross accounts receivable.
 
To conserve cash and manage our liquidity, we have implemented cost-cutting initiatives including the reduction of employee headcount and overhead costs. On September 30, 2012 we had a headcount of 30, compared to a headcount of 32 as of September 30, 2011.  We plan to continue to assess our cost structure as it relates to our revenues and cash position, and we may make further reductions if the actions are deemed necessary.

The Company is continuing to develop new products and to take other measures to increase sales.  Increasing sales typically results in increased inventory and higher accounts receivable, both of which reduce cash.  Zoom has two significant accounts who buy from Zoom on a consignment basis.  Consigned inventory tends to result in slow payment to Zoom, since Zoom is only paid after the consigned inventory is sold by Zoom’s customer.

The Company has in the past increased its cash by offering fast-pay discounts to certain accounts.  To reduce the need for fast-pay discounts and to give Zoom more operating flexibility, in April 2012 we established an asset-based bank line of credit of up to $1 million.  The amount actually available under the line of credit is contingent on Zoom meeting certain financial metrics and covenants.

The Company has had recurring net losses and continues to experience negative cash flows from operations. To conserve cash and manage liquidity, the Company has implemented cost cutting initiatives.  However, management believes that the Company may not have sufficient resources to fund its normal operations over the next 12 months unless gross profit improves significantly, the Company increases its line of credit, or the Company raises capital. The Company has received an offer letter for an increased line of credit of up to $1.75 million and the offering bank is doing due diligence, but there is no guarantee that this line of credit will be established.   Additional capital may not be available on terms favorable to the Company, or at all.  If these funds are not available, the Company may not be able to execute its business plan or to take advantage of business opportunities.  The ability of the Company to achieve its operating goals is uncertain.  In the event that the Company does not increase gross profit, increase its line of credit, or obtain additional capital, there is substantial doubt as to its ability to continue as a going concern. The accompanying financial statements do not include any adjustments that might result from the outcome of this uncertainty.

 
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Commitments
 
During the nine months ended September 30, 2012, there were no material changes to our capital commitments and contractual obligations from those disclosed in our Form 10-K for the year ended December 31, 2011, with the exception of the Loan Agreement signed April 20, 2012 as reported in Note 9.
 
"Safe Harbor" Statement under the Private Securities Litigation Reform Act of 1995.
 
Some of the statements contained in this report are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. These statements involve known and unknown risks, uncertainties and other factors which may cause our or our industry's actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by the forward-looking statements. Forward-looking statements include, but are not limited to statements regarding: Zoom's plans, expectations and intentions, including statements relating to Zoom's prospects and plans relating to sales of and markets for its products and Zoom's financial condition or results of operations.
 
In some cases, you can identify forward-looking statements by terms such as "may," "will, " "should," "could," "would," "expects," "plans," "anticipates," "believes," "estimates," "projects," "predicts," "potential" and similar expressions intended to identify forward-looking statements. These statements are only predictions and involve known and unknown risks, uncertainties, and other factors that may cause our actual results, levels of activity, performance, or achievements to be materially different from any future results, levels of activity, performance, or achievements expressed or implied by such forward-looking statements. Given these uncertainties you should not place undue reliance on these forward-looking statements. Also, these forward-looking statements represent our estimates and assumptions only as of the date of this report. We expressly disclaim any obligation or undertaking to release publicly any updates or revisions to any forward-looking statement contained in this report to reflect any change in our expectations or any change in events, conditions or circumstances on which any of our forward-looking statements are based. Factors that could cause or contribute to differences in our future financial results include those discussed in the risk factors set forth in Item 1A of Part II below as well as those discussed elsewhere in this report, in our Annual Report on Form 10-K for the year ended December 31, 2011, filed with the SEC on March 30, 2012 and in our other filings with the SEC.
 
ITEM 3.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
 
Not Required.
 
ITEM 4.
CONTROLS AND PROCEDURES
 
We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our Securities Exchange Act of 1934 reports is recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer who is also our Acting Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, as ours are designed to do, and management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.
 
As of September 30, 2012 we carried out an evaluation, under the supervision and with the participation of our management including our Chief Executive Officer and Acting Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934. Based upon that evaluation, our Chief Executive Officer and Acting Chief Financial Officer concluded that our disclosure controls and procedures are effective in enabling us to record, process, summarize and report information required to be included in our periodic SEC filings within the required time period.
 
There have been no changes in our internal control over financial reporting that occurred during the period covered by this report that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
 
 
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PART II OTHER INFORMATION
 
ITEM 1A.
RISK FACTORS
 
This report contains forward-looking statements that involve risks and uncertainties, such as statements of our objectives, expectations and intentions. The cautionary statements made in this report are applicable to all forward-looking statements wherever they appear in this report. Our actual results could differ materially from those discussed herein. Factors that could cause or contribute to such differences include the risk factors contained in our Annual Report on Form 10-K for the year ended December 31, 2011, filed with the SEC on March 30, 2012, as well as those discussed in this report and in our other filings with the SEC.
 
We may require additional funding, which may be difficult to obtain on favorable terms, if at all.
 
Over the next twelve months we may require additional funding if, for instance, we experience losses. We currently have a $1 million line of credit from which we can borrow, and this line is subject to covenants that must be met.  It is not certain whether all or part of this line of credit will be available to us as time passes; and other sources of financing may not be available to us on a timely basis if at all, or on terms acceptable to us. If we fail to obtain acceptable additional financing when needed, we may not have sufficient resources to fund our normal operations; and this would have a material adverse effect on our business.
 
Our auditors have expressed substantial doubt about our ability to continue as a going concern.
 
The audit report issued by our independent registered public accounting firm for our financial statements for the fiscal year ended December 31, 2011 states that the auditing firm has substantial doubt in our ability to continue as a going concern due to the risk that we may not have sufficient cash and liquid assets at December 31, 2011 to cover our operating and capital requirements for the next twelve-month period; and if in that case sufficient cash cannot be obtained, we would have to substantially alter, or possibly even discontinue, operations.  The accompanying financial statements do not include any adjustments that might result from the outcome of this uncertainty.

We may experience costs and senior management distractions due to patent-related matters.

We make many products and they typically use patented technology.  We attempt to license appropriate patents either directly or through our integrated circuit suppliers.  However, we are subject to costs and senior management distractions due to patent matters.  On October 15, 2012 Telecomm Innovations LLC filed a complaint against Zoom Telephonics and at least 23 other companies including Dell Inc., various dial-up modem producers, and many fax machine producers.  The only named Zoom product was Zoom’s Model 3095 dial-up modem, and we believe that this has a license through Conexant for the two patents mentioned in the complaint.  However, we do not know precisely what other products may be the subject of the complaint.  It is impossible to assess the potential cost and senior management distraction associated with this complaint or with future complaints or suits that may occur.

 
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ITEM 6.
EXHIBITS
 
 Exhibit No.
 
Exhibit Description
     
 
Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
     
 
Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 
 
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ZOOM TELEPHONICS, INC.
 
SIGNATURES
 
Pursuant to the requirements of the Securities and Exchange Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
 
 
 
ZOOM TELEPHONICS, INC.
(Registrant)
     
Date: November 14, 2012
By:
/s/ Frank B. Manning  
   
Frank B. Manning, President, Chief Executive
Officer and Acting Chief Financial Officer
(Principal Executive Officer and Principal Financial Officer)
 
 
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EXHIBIT INDEX

Exhibit No.
 
Exhibit Description
     
 
Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
     
 
Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 
 
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