ClearOne, Inc. — Fiscal 2017 Form 10-K Summary
Reporting period: Year ended December 31, 2017, filed April 20, 2018. The filing includes quarterly data for the fourth quarter ended December 31, 2017, but is an annual Form 10-K rather than a standalone quarterly filing.
Business Context
ClearOne designs, develops and sells conferencing, collaboration, professional microphone, unified communications, video collaboration, network streaming and digital signage solutions. Professional audio conferencing and microphone products represented approximately 73% of consolidated revenue in 2017, visual communication products 18%, and unified communications audio endpoints 9%.
The company sells primarily through independent distributors, resellers and systems integrators in approximately 61 countries. The United States accounted for $24.6 million, or 59%, of 2017 revenue; international revenue was $17.2 million, or 41%. One distributor, Starin Marketing, represented approximately 16.1% of consolidated revenue.
Financial Performance and Position
| Metric | 2017 | 2016 | Change |
|---|---|---|---|
| Revenue | $41.8 million | $48.6 million | Down 14% |
| Gross profit | $24.0 million | $29.5 million | Down 19% |
| Gross margin | 57% | 61% | Down 4 percentage points |
| Operating income/(loss) | $(16.2) million | $3.6 million | Declined materially |
| Net income/(loss) | $(14.2) million | $2.4 million | Declined materially |
| Diluted earnings/(loss) per share | $(1.65) | $0.26 | Turned to loss |
| Cash and cash equivalents | $5.6 million | $12.1 million | Down $6.5 million |
| Working capital | $23.3 million | $30.8 million | Down $7.5 million |
| Total assets | $67.9 million | $88.1 million | Down $20.2 million |
| Shareholders’ equity | $56.6 million | $77.4 million | Down $20.9 million |
Operating expenses increased to $40.2 million from $25.9 million. The increase primarily reflected $12.7 million of goodwill impairment, $0.8 million of intangible-asset impairment and a $0.8 million legal settlement expense, partly offset by a $0.8 million legal settlement recovery shown in the financial statements. Sales and marketing expense increased 10% to $11.0 million, and research and product development expense increased 9% to $9.3 million.
The company had no notes payable or capital lease obligations at December 31, 2017. Long-term obligations were $0.7 million. Marketable securities totaled $13.0 million, including $2.7 million classified as current and $10.3 million classified as long-term.
Cash Flow, Liquidity and Capital Allocation
| Cash flow item | 2017 | 2016 |
|---|---|---|
| Cash provided/(used) by operating activities | $(9.3) million | $7.8 million |
| Cash provided/(used) by investing activities | $10.2 million | $(0.9) million |
| Cash used in financing activities | $(7.5) million | $(8.2) million |
| Capitalized patent-defense costs | $2.3 million | None reported |
| Year-end inventory | $23.1 million | $13.0 million |
| Long-term inventory | $8.7 million | $1.7 million |
Operating cash flow was negatively affected by the net loss and a $10.8 million increase in inventory. Investing cash flow benefited from $17.6 million of marketable-security maturities and sales, partly offset by purchases of securities, capital expenditures and patent-defense costs. Financing cash use included $5.1 million of share repurchases and $2.2 million of dividend payments.
The company declared quarterly dividends totaling $0.26 per share in 2017, increased the quarterly dividend from $0.05 to $0.07 beginning in the second quarter, and repurchased 551,936 shares for $5.1 million. The repurchase program expired in March 2018 and was not renewed at that time.
Material Changes Versus 2016
- Revenue declined 14%, primarily because professional audio conferencing revenue decreased 19% and unified communications endpoint revenue decreased 27%. Video revenue increased 38%.
- Professional audio’s share of revenue declined, while video products increased to approximately 17% of the revenue mix from 11% in 2016.
- The company attributed the audio decline to the transition from CONVERGE Pro 1 to CONVERGE Pro 2 and from the original Beamforming Microphone Array to Array 2, price reductions on CONVERGE Pro 1 products, and alleged infringement of ClearOne patents.
- Gross margin fell from 61% to 57%, primarily due to lower pricing on CONVERGE Pro 1 products and a less favorable product mix.
- Goodwill was fully impaired, resulting in a $12.7 million charge. A further $0.8 million impairment was recorded for customer-relationship intangibles.
- Inventory increased substantially, including a rise in long-term inventory to $8.7 million. Management stated that programs were being developed to reduce inventory to normal levels.
- The company’s internal control over financial reporting was determined to be ineffective because of a material weakness related to accurate and timely financial reporting and controls assessment. The auditor issued an adverse opinion on internal control effectiveness but an unqualified opinion on the consolidated financial statements.
Guidance, Outlook, Risks and Unusual Items
Management expected the transition to CONVERGE Pro 2 and Beamforming Microphone Array 2 to be substantially complete within the following 12 months and believed the company could return to growth thereafter, although no formal revenue or earnings guidance was provided.
Management identified growth opportunities in video collaboration, cloud-based conferencing, network streaming, software platforms, small and medium-sized businesses, expanded channels and strategic acquisitions. The company began shipping all CONVERGE Pro 2 SKUs during 2017, introduced Beamforming Microphone Array 2 in the fourth quarter, and began shipping DIALOG 20 wireless microphones.
- Intellectual property litigation: ClearOne is pursuing patent claims involving Shure, Biamp and QSC, while defendants challenge patent validity, enforceability and infringement. The company capitalized $2.3 million of related defense costs in 2017 and recorded $0.4 million of pretax gross litigation expense.
- Controls risk: The material weakness could result in reporting errors, restatements, delayed filings or loss of investor confidence. Management engaged a third-party controls consultant and planned additional personnel assessment, training and process improvements.
- Inventory risk: Elevated long-term inventory and technology changes could result in further write-downs, discounted sales or margin pressure. Inventory write-down expense was $0.6 million in 2017.
- Customer and channel concentration: The company depends on distributors and resellers, with one customer representing approximately 16.1% of revenue and the two largest customers representing 31.3% of gross accounts receivable.
- Manufacturing and supply chain: Most products are manufactured by outsourced electronics manufacturing service providers, primarily Flextronics. Component shortages, price increases, capacity constraints or supplier disruption could affect product availability and margins.
- Tax matters: The 2017 Tax Cuts and Jobs Act reduced the U.S. corporate tax rate and caused an approximately $3.3 million reduction in net deferred tax assets. The company recorded a $1.7 million tax benefit for 2017 and maintained a $2.2 million valuation allowance against certain deferred tax assets.
- Deferred revenue: Deferred product revenue increased to $4.6 million from $3.9 million because of higher December orders. Shipped orders not yet recognized as revenue were $4.6 million at year-end, while unshipped backlog was approximately $0.2 million.
Investor Verification Points
- Verify the sustainability and timing of the CONVERGE Pro 2 and Beamforming Microphone Array 2 transition and whether audio revenue has stabilized.
- Assess whether the $8.7 million of long-term inventory can be sold at or above cost without additional write-downs or pricing concessions.
- Review the status, potential financial exposure and accounting treatment of the patent litigation, including the $2.3 million of capitalized legal costs.
- Confirm remediation of the material weakness and whether subsequent filings report effective internal controls.
- Evaluate liquidity after the $9.3 million operating cash outflow, dividends, repurchases and capitalized litigation costs.
- Monitor customer and distributor concentration, particularly the largest customer’s contribution to revenue and receivables.
- Review the effect of the Tax Cuts and Jobs Act, valuation allowances and uncertain tax positions, including $0.7 million of accrued uncertain tax positions.
- Consider the absence of formal quantitative guidance and the company’s exposure to intense competition, rapid technology changes, outsourced manufacturing and international operating risks.