ClearOne, Inc. 2018 Q3 Form 10-Q Summary
Business context and reporting period
ClearOne provides conferencing, collaboration, professional audio, video, software, licensing and network-streaming solutions. This unaudited Form 10-Q covers the three and nine months ended September 30, 2018, with comparisons to the corresponding 2017 periods. The company reported 8,306,535 common shares outstanding as of November 6, 2018.
Financial performance and liquidity
| Metric | Three months ended September 30 | Nine months ended September 30 |
|---|---|---|
| Revenue | $6.7 million, down 37% | $20.9 million, down 36% |
| Gross profit | $3.0 million | $10.3 million |
| Gross margin | 45%, versus 62% | 49%, versus 59% |
| Operating loss | $2.3 million | $7.7 million |
| Net loss | $10.1 million, or $1.22 per share | $14.2 million, or $1.70 per share |
| Cash used in operating activities | Not separately provided | $3.6 million |
Revenue consisted primarily of professional audio products, which generated $4.8 million in the quarter and $14.6 million year to date. Unified Communications endpoints generated $0.8 million and $2.8 million, respectively, while video products generated $1.1 million and $3.6 million.
Cash and cash equivalents were $2.5 million at September 30, 2018, compared with $5.6 million at December 31, 2017. Marketable securities totaled $7.7 million, including $2.0 million due within one year and $5.8 million due thereafter. Working capital was $20.2 million, compared with $23.3 million at year-end 2017.
The filing shows no debt outstanding or interest-bearing borrowings. Total liabilities were $6.1 million, including $5.3 million of current liabilities. Total inventory was $21.6 million, including $8.3 million classified as long-term inventory.
Investing activities generated $1.3 million of cash, primarily reflecting net marketable-securities proceeds. The company used $0.7 million in financing activities, including $0.6 million of dividends and $0.1 million for share repurchases. The dividend program was suspended in June 2018, and the share-repurchase program expired in March 2018 without renewal.
Material changes versus the prior comparable period
- Revenue declined $3.9 million, or 37%, in the third quarter and $11.6 million, or 36%, for the first nine months.
- Revenue declined across all product categories. Management attributed the decline in professional audio revenue partly to slower adoption of the Converge Pro 2 platform, patent infringement by competitors and lower licensing revenue.
- Gross margin fell 17 percentage points in the quarter and 10 percentage points year to date, primarily because of inventory obsolescence costs, lower licensing revenue, reduced overhead absorption and the absence of a high-margin overseas project included in the 2017 quarter.
- Operating expenses declined substantially because the 2017 periods included $12.7 million of goodwill impairment and $0.7 million of intangible-asset impairment. Excluding those unusual charges, operating expenses also declined as the company reduced sales, marketing, research and development and general and administrative spending.
- Net loss worsened despite the lower operating loss because the company recorded $6.5 million of income-tax expense in 2018, principally from establishing a full valuation allowance against its deferred tax assets. The 2017 periods included tax benefits.
- The company adopted the revenue standard under ASC 606 using the modified retrospective method on January 1, 2018. The adoption increased retained earnings by $2.8 million, reduced deferred product revenue by $4.3 million and reduced distributor-channel inventories by $1.6 million. Adoption reduced reported 2018 revenue by $0.8 million for the quarter and $1.4 million year to date.
Guidance, outlook, risks and unusual items
No quantitative revenue or earnings guidance is provided. Management cited cost-reduction initiatives, accelerated product development, inventory reduction and potential proceeds from a subsequent rights offering as measures intended to preserve cash and support future growth.
Management reported that approximately 47% of revenue is generated internationally. Near-term revenue may be adversely affected by the resignation of a large U.S. distributor in June 2018, intense competition, pricing pressure, rapidly changing technology and alleged infringement of ClearOne patents by competitors. The company continued litigation to enforce strategic patents and capitalized $3.6 million of related legal costs during the first nine months; approximately $7.4 million had been incurred on this litigation from 2016 through September 30, 2018.
Long-term inventory included approximately $2.7 million of wireless-microphone finished goods and assemblies, $2.4 million of Converge Pro 2 products and $1.1 million of related raw materials. The company cautioned that adverse changes in these product lines could result in inventory write-offs or price markdowns. Open purchase orders with electronics manufacturing service providers totaled approximately $2.7 million.
As of September 30, 2018, management concluded that disclosure controls and procedures were not effective because of a material weakness involving the accurate and timely reporting of financial results and disclosures and the timely assessment of internal controls. A remediation plan with a third-party consultant was underway.
Subsequent events included reincorporation from Utah to Delaware on October 25, 2018 and a rights offering commenced November 5, 2018. Eligible shareholders could purchase one share at $1.20 per share, subject to the offering terms, with a potential basic offering of up to 8,306,535 shares. The filing does not provide the eventual proceeds.
Important facts for investors to verify
- Whether the rights offering was completed, its gross and net proceeds, and the resulting share count and dilution.
- Whether cash resources and marketable securities are sufficient given continuing operating cash use and the company’s losses.
- Progress, cost and outcomes of the patent-enforcement litigation, including the recoverability and accounting treatment of capitalized defense costs.
- Sell-through and valuation of the $21.6 million inventory balance, particularly the $8.3 million classified as long term.
- Whether revenue trends, distributor relationships and adoption of Converge Pro 2 and other new products improve.
- Remediation of the material weakness in internal control over financial reporting.
- The effect of the full deferred-tax-asset valuation allowance on future tax expense and reported earnings.
- Potential consequences of Nasdaq’s $1.00 minimum bid-price requirement and the company’s ability to maintain its listing.