ClearOne, Inc. (CLRO) Q4 2016 Earnings Report, Transcript and Summary

Good morning everyone, and welcome to the ClearOne’s 2016 Fourth Quarter and Full-Year Earnings Financial Results Conference Call. This call is being recorded. At this time, for opening remarks and introductions, I would like to turn the call over to Company’s Investor Relations representative, Ms. Kathy Madison of LHA. Ms. Madison, please go ahead.

Thank you Andrew. Welcome everyone and thank you for joining us today for the ClearOne fourth quarter and full-year 2016 results conference call. On the call today are Zee Hakimoglu, President and CEO, and Narsi Narayanan Senior Vice President of Finance. Please note this call is being broadcast live on the Internet at www.clearone.com. And a playback will be available for at least three months. Before we begin, I would like to make the cautionary statement and remind everyone the information discussed on the call today is covered under the Safe Harbor provisions of the Litigation Reform Act. The Company’s discussion today will include forward-looking information reflecting management’s current forecast of certain aspects of the Company’s future, and our actual results could differ materially from those stated or implied. Today, Zee will open with a review of performance highlights and talk us on current and future outlook. Then Narsi will provide a detailed discussion of the financial results. We will then open the call for questions. Now it is my pleasure to turn the call over to Zee.

Thank you Kathy, and good morning everyone. In the fourth quarter, we hit a perfect storm. However, we are strong enough to absorb this temporary setback and continue our focus on achieving our long-term goal and executing on our operating plans to align with those goals. Our internal sales reports show that 2017 is improving. We are confident in ClearOne business and long-term prospects given the momentum in our video solutions and the market’s strong positive response to our next generation flagship audio conferencing platforms. Our Board of Directors shares our confidence and has increased the quarterly dividend by $0.02 from $0.05 per share to $0.07 per share beginning in the second quarter of 2017. The Board has also extended our stock repurchase program back up to $10 million. Today, I’ll review the Q4 challenges and the actions we have taken as well as how our new product shipments position us in regards to industry trends. In the third quarter, we noted that we expected a delay in the transition to our next generation audio platform CONVERGE Pro 2 and Beamforming Microphone Array 2. The delay in shipping however has taken even longer than projected. Taking into consideration that buyers were waiting for the new generation audio platform, we reduced pricing on our existing platform the CONVERGE Pro 1 to stimulate customer interest and sales in the current generation of product. While we successfully spurred sales volume, fourth quarter revenue was still lower than prior period. Further, the revenue challenge was aggravated by external economic forces. As you know 2016 infrastructure and capital equipment spending continued to be less than robust due to the weak overall global economy which was exacerbated by political uncertainty, first in Europe with Brexit and then in the fourth quarter with US election. Although we do not control the market, I'm pleased to say we have made definitive progress on our audio platform transition. While we began shipping a limited number of SKUs in the fourth quarter, now we are shipping all ten SKUs of CONVERGE Pro 2 as well as our award winning Beamforming Microphone Array 2. As for growth margin, Q4 gross margin was negatively impacted by the existing audio platform price reduction as well as additional scrapping of inventory related to the transition of wireless microphones manufacturing from Florida to an outsourced EMS provider. Finally, as for G&A, Q4 was higher than prior period due to an additional expense incurred on a legal matter. We believe in 2017 our G&A expenses will return to our normal run rate. The combination of these adverse factors contributed to a disappointing fourth quarter results. Even with an overall difficult fourth quarter, our video products continued to gain traction. We posted double-digit video revenue growth for the nine quarter out of ten most recent. For full year 2016, video contributed over 5 million in revenue and grew 40% year over year. We are extremely pleased with videos performance and believe it will continue to grow in contribution in 2017. Our complete and complimentary value chain of solutions have helped secure some great wins. I’ll review our successes in Q4. For our video conferencing and collaboration product namely COLLABORATE, the UNITE camera, and our cloud-based video conferencing software Spontania, we secured wins for a couple of hospital projects, a large university, and a recently IPOed company offering the hottest image messaging and multimedia mobile application. For our network media streaming product namely VIEW, wins included a large command and control center, an independent power grid operator, and several outlets of a growing popular international franchise chain of restaurants. I'm also pleased to report we are building positive momentum in the first quarter of 2017. We are now shipping all ten SKUs of the CONVERGE Pro 2 platform as well as the Beamforming Microphone Array 2. And at the end of this month, we will be offering more features through software updates, which will enhance the functionality and scalability of the platform. Already our revenue including backlog for Q1 2017 is tracking to the first quarter of 2016 and revenue from the new audio platform is well ahead of fourth quarter. There is no doubt that the transition to our new platform is gaining traction. Our commitment to incorporating the latest technologies into our product lines continue to be validated. Our second generation Beamforming Microphone Array won Best of Show at Amsterdam's Integrated Systems Europe 2017 Convention just in February. NewBay Media's AV Technology selected our newest solution among more than 3,000 products and 1,100 exhibitors. It was recognized as a standout product for attention to detail and this is on the end user and breakthrough features. Now that our core platforms are ready to benefit from these investments and to accelerate momentum in the market in 2017, we are focused on broadening our sales and marketing reach through a variety of initiatives and activity. ClearOne’s strength, good audio is the cornerstone and springboard for effective conferencing and collaboration. Just as the telephone handset serves the need of communication a generation or two more ago, today the winning combination of great audio with rich video applications for a dispersed team wherever they are, on the road, at their desk, in a huddle space or conference room of any size is the key for market adoption and success. While there are solution providers who can provide audio or a video or both, ClearOne uniquely differentiates itself in the market by offering audio and video solutions that are the most complete, most scalable and most unified for conferencing and collaboration. Now I'll turn the call over to Narsi.

Thank you Zee, and good morning everyone. Before I begin, I would like to note that I will be discussing certain non-GAAP financial measures. A reconciliation is included in our earnings release. Now I will turn to our financial results for the fourth quarter of 2016 compared to the fourth quarter of 2015. Net revenue was $10.7 million compared to $14.3 million a year ago reflecting the impact of the delay in our transition to our new product platform, aggravated by the global economic slowdown. However, if you look more closely, you will see some positive changes as well. Reviewing the year-over-year change in percentage of revenue by region. Asia Pacific including the Middle East grew 26%, although Americas decreased by 31%, and Europe and Africa was down 46% respectively. Reviewing the year-over-year revenue change in percentage by product. Video increased 19%, while professional audio was down by 29% and UC [indiscernible] were down by 28%. We are very encouraged video product sales are continuing to show a good rate of increase year over year. This is our ninth quarter of year-over-year increase in the last ten. Looking ahead, we are also encouraged that our current Q1 revenue including backlog is tracking our Q1 levels in 2016. In fact, up about 2% compared to Q1 2016 and revenue from the new audio platform is well ahead of fourth quarter revenue. Also we are quoting the new product more and the product mix is much different than in Q4. GAAP gross profit margin was 53% compare to 64%. The decrease in margin percent was due to, one, a price reduction made to CONVERGE Pro 1 products to encourage CONVERGE Pro 1 sales while customers were awaiting CONVERGE Pro 2 product. Number two, a decline in higher margin professional audio conferencing product in the mix. Number three, higher obsolescence costs. Number four, increased overhead absorption due to a sharp decline in inventory. And number five, scrap of inventory related to transition of wireless microphone’s manufacturing to an outsourced EMS provider. Non-GAAP gross profit margin was 55% compared to 62% in 2015. GAAP operating expenses were 6.8 million in 2016 Q4, increasing from 6.5 million in 2015 Q4 due to higher G&A expenses, partially offset by reduced sales and marketing, and R&D expenses. G&A increased to $2.4 million from $1.8 million, mostly due to higher legal expenses related to employee related matter, partially offset by reduction in audit fees. We believe it's unlikely that we will incur legal expenses at similar levels for this matter in the future and also we expect 2017 G&A levels to return to normal run rate. Sales and marketing expenses declined to $2.3 million from $2.5 million due to reductions in commission paid to independent reps. R&D expenses declined to $2.1 million from $2.2 million due to savings in employee later costs. Non-GAAP operating expenses were $5.3 million compared to $5.4 million, effort in a 3% drop in the expense. Non-GAAP operating income was $0.6 million compared to $3.7 million. Our effective tax rate for the year climbed to 37% from 28% at the end of 2016 Q3, mainly due to reduction in expected R&D tax credits. Non-GAAP net loss was $0.2 million or $0.02 per diluted share compared to net income of $2.3 million or $0.24 per diluted share. Non-GAAP adjusted EBITDA was $0.9 million compared to $3.9 million. Turning to our financial results for the 12-months ended December 31, 2016. Revenue was $48.6 million compared to $57.8 million for the full-year 2015. Non-GAAP gross profit was 62% compared to 64%. Non-GAAP net income was $5 million or $0.54 per diluted share compared to $8.7 million or $0.91 per diluted share, reduction of 41%. Non-GAAP adjusted EBITDA was $8.6 million compared to $14.4 million. The effective tax rate was 37% compared to 36% a year ago. We continued to be very strong. Cash, cash equivalents, and investment were $38.5 million are December 31, 2016 compared to $39.8 million at December 31, 2015 still without any debt. Once again, we paid dividend and $0.05 a share was declared and about $444,000 was paid in Q4. On January 31, a dividend of $0.05 per share for Q1 2017 was declared. Further during the quarter, we repurchased approximately 86,000 for approximately $900,000. Since March 2016, when this latest stock repurchase program was announced until yesterday, we have repurchased approximately 608,000 shares amounting to $6.9 million. The Board of Directors have extended the program for up to $10 million or additional one year. We intend to continue to repurchase our shares in the open market subject to price, value and other safe harbor restriction. As we noted, the Board of Directors also increased the dividend from $0.05 per share to $0.07 beginning in the second quarter of 2017. Let me turn the call back to Zee. Thank You.

Thank you Narsi. In 2016, we managed several challenges, however our underlying fundamentals held strong and net the stage for a better 2017. Revenue from the new audio platform is well ahead of the fourth quarter revenue and Q1 revenue including backlog is improving and tracking up slightly from our Q1 level in 2016. Additionally, our board actions reiterate our commitment to creating long-term shareholder value. We look forward to reporting our progress in the quarters ahead. Operator, you can open the call to questions.

[Operator Instructions] And our first question comes from Lisa Springer with Singular Research, your line is now open.

I wonder if you could give us a sense of the revenue contribution from the CONVERGE Pro 2 in the fourth quarter. Was it a meaningful contribution to revenues?

I'm going to give the breakup for CONVERGE Pro 1 and CONVERGE Pro 2 as a percentage of the total Pro mix. Professional products and actually this is only between CONVERGE Pro and CONVERGE 2, I’m not talking about all microphones and everything because that’s the relevant comparison actually. The CP 2 was about 12% of the total mix in 2016 Q4. 2017 Q1 it’s already as I can see until yesterday, it was about 22% actually.

And the price, the reduction in price on the CONVERGE Pro 1, what was that, was that a meaningful part of the reduction in gross margin, I mean, how much did that internally impact gross margin.

It was a meaningful part, in fact, it was the biggest contributor to the gross margin reduction.

The broadening of sales and marketing initiatives in 2017. Could you be a little more specific about that is the effort going to be across different geographies or focused on a particular geography, and what’s going to be the impact on sales and marketing expense in 2017?

Yeah, I could take that. We're going to basically be looking across the board in terms of our marketing effort. We're going to make changes to headcount for a more direct sales force, trying to add a bit more of ClearOne badged employees on the street. We're going to look at direct marketing program. We're going to increase our ad spend. We’re probably going to be increasing our social media spend. We’ll be increasing some of the marketing efforts especially in terms of the video and network media streaming and we're investing in a brand new from a bottoms up website that we should be launching sometime in July. These efforts will go across the world, we will focus on the US, South America and we even made some headcount adjustments in Europe and looking at addressing our channel structures in Europe as well. We don't intend to spend more than 20% greater than what we’ve spent in the past and this takes time to ramp up. So it's not an immediate expenditure, but these are the areas that we're looking at.

[Operator Instructions] And our next question comes from Ian Corydon with B. Riley and Company. Your line is now open.

Thank you. I'm just curious what's it going to take to get margins back to the 60% plus level?

I think even starting with Q1, we think it would be back to 60% levels actually. As a listed out reasons, except for overhead absorption, all the other things are unusual. It's not part of the normal way things are operated. So we don't expect any challenges to gross margin in the coming future.

Got it. And could you just give a little more detail around why you expect continued strong growth in video?

Well, yeah, first of all, I think I had mentioned one of the advantages that we have is we have an audio complement. We have skewed that run from share cloud to very low cost client, including Bring your own video all the way up to maximizing our fantastic new audio and Beamforming platform. Our video platform in terms of media collaboration also has some very nice features. We essentially have a wireless presentation application through software built directly into our solution and this is very important because really others have not done this. While there are software based applications for wireless presentation, I dare say the equivalent of a popular brand today Barco called Clickshare, we have the ability to add this application in its entirety purely through software embedded in our video. So our model is not necessarily just video conferencing. Our model is to have a multiple kind of the Swiss Army knife of all applications embedded in software that span across all our skews with the complimentary video component, whether it be chat, whether it be our premium solutions and our new platform that can service across all of these. In terms of the network media streaming portion of the video, we have some very, very unique features there that others cannot compete with. We have the ability through our software based video engine to compress basically 10 gigabits by 264 compression into an 8 megabit stream. So we do significant compression of the video stream, which in an enterprise network, is very important. We don't flood the network. Among other things, we have excellent color compatibility It's called 444 and this is not just something that’s important for marketing for example where you want rich great color. But if you are doing command and control center, things where you really need to see fine detail such as Spreadsheet, math, things that command and control center see are 444 color is not found in many of the other competitors. Finally, we have the ability in our streaming - network streaming solution to run on a standard network, your standard Ethernet network, no special cabling needed and we have the ability to do things such as digital wall, composition and many other functionality through software upgrades. No hardware is needed, such as digital switchers and scalars to create video wall. Finally, I will say that we have a nice spectrum of solutions from high end solutions all the way to the latest solution we just started shipping, which is the 310, which is an Android based low cost decoder that's very economical. So we're excited about it. The markets are moving in the direction that I could say that we've said early on and these are the reasons we're optimistic.

Thank you. And our next question comes from Dennis Van Zelfden with Brazos Research. Your line is open.

Thank you. Good morning, everyone. Zee, with the strong continuing growth in video and the apparent strong start to the CONVERGE 2 line, is there any reason not to expect good revenue growth in 2017?

We do expect revenue growth. We're going to have to make up for some lost territory, but we are seeing it in Q1 compared to Q4. And as I mentioned, we're going to focus our efforts of course always on development and products, but we're going to focus on marketing and sales to make sure that we capitalize on what we've accomplished.

Well, but you’re not seeing any additional brand new headwinds like we've seen over the past couple of years? Correct. Like, there's no US elections, the dollar is high, but compared to last year, it's not that much higher, things like that?

Well, things like, let’s look at things like oil companies, which is a very big sector for capital spending. If that settles down or that finds a home in terms of where it needs to be, that will be helpful to us. Government is always helpful to us. Of course, the US elections are there. We understand it's going to be big infrastructure spend, et cetera. So we're hoping for the best. We're infrastructure for the most part except certain pieces of our products, which are - serve the enterprise on a more simplified installment model. If Europe - Europe is in the middle. Still, it’s some political upheaval and we'll see what happens there. But the good news is other areas that we've invested in such as Middle East, Asia and of course the US and South America, by the way, I think we should see growth.

Okay. Fair enough. Just a totally separate question, just a clarification. Of the 608,000 shares that you’ve bought inception to date on the buyback program, I think that's what Narsi said. Is all of that - was all of that from the open market?

Yes. It's all of them were bought under 10b-18 Safe Harbor provisions, but it also includes a block trade actually. That’s, let’s say, open market also includes a block trade, that’s what you mean actually.

Right. It just doesn’t include any of management options and things like that?

No. That was a separate program actually, but there have been issues of instances where, if anybody in the management exercised the options and sold those shares, it had gone through open market to be bought back through the repurchase program actually. It was not a separate program. It is through the normal open market program that we have. Some of them might have been included actually.

Okay. But you don't know how many of the 608, was a very many, it's what I'm trying to get at?

I don't have that number right away.

And our next question comes from Alan Mitrani with Sylvan Lake Management. Your line is now open.

Hi. Thank you. Narsi, on the 15.8% drop in revenues year-over-year for ‘16 over ‘15, how much of that was currency?

Currency effect is very small. We have talked about it before. It’s hard to measure the impact of currency for our products. Most of our billing except for some billing from our Spain subsidiary, most of them, 98%, 99% of our billing is through US dollars. So there is no typical foreign exchange currency risk that you normally expect companies to report through us actually, but -

Right. With the dollar strengthening so much, it's clear that your products are cost disadvantaged, right?

Yes. That's the point I was going to talk about. You hit it on the nail actually. Especially in places like Europe, we have a disadvantage that dollar denominated pricing. We do take this into account when we work with our partners on special projects and wherever we can have visibility into this, but it is just like many US companies [indiscernible].

And so what do you think - is there a way to mitigate this some way, is there source parts cheaper because it doesn’t seem like the dollar with our interest rate policy going forward is going to get much cheaper here. It looks like it’s going to get more expensive relative to your business. So can you talk about what you're thinking about doing in the next 12 to 18 months that could mitigate some of this?

I think what we've done or what we continue to do is as we roll out new products and solutions, we’re coming out with competitively priced solutions. The new CP2 is more competitively priced than CP1. The video appliances are extremely competitive and pricing if you look at that, even our software based spontaneous, introducing for example on the network media streaming solutions set that we introduce a very low cost - very competitive, as I mentioned, Android decoder, just for the purpose of being able to address cost sensitive markets and projects. So we're very aware of it and we try to build it into the products so that we have a fair balance of gross margin to pricing and hope that the economy will, well, dollar looks like it's pretty much the standard and little we can do beyond that.

And just thank you, Zee. In talking about that, when you’re about different products you’re talking about, are these lower margin products?

We don't put a product out that isn't a good margin for us, I'll tell you that. And all these products, we're happy with the margins and as Narsi already indicated, the mix that we expect is going to be for a 60% plus or minus and that's what we aim for with new products and the older products.

By the way to your question about costs, we have already done a lot to reduce the cost actually. So we're including looking at different EMS providers, looking at pretty good models of using, I can’t reveal a lot of strategies, but we have done enough to bring down the cost to mitigate some of the price pressures and the dollar pressures actually.

Okay. And Zee, what I heard you say in general about your investments in sales and marketing, it really - it strikes me that in looking at your model for all these years, it's very sensitive to revenue growth clearly. Your R&D pretty much doesn't go down, goes up the way it should modestly, but it should. Your G&A whereas you've kept it fairly constant and as your earnings - as your revenues have gone up, your G&A basically doesn’t budge much here for that 7-ish levels, whatever it is on G&A. I know there's puts and takes with legal fees and others. But roughly around 7 plus or minus. And your sales and marketing sounds like it's going up. So really in order to get higher operating income, it's either take your margins up higher, which seem difficult, given where they've come from in the past from ‘15 or really revenue growth, new products, which you’re focused on. So what I'm wondering is how we get this business, how we get overall ClearOne to grow meaningfully the way we thought. You’ve always cited ClearOne as a venture type of company long term, but the revenues have gone the wrong way the last couple of years, not all your fault of course, but obviously the markets. I mean how do we create much more value without being part of a bigger company that already has the sales and marketing edges, if your distributors aren’t doing it for you, you need your own ClearOne guys on the street to do it. I think you guys should consider strategic alternatives and being a bigger part of a company that already has this and don't create duplicative costs. So what’s your thoughts on that?

Yes. Here is a lot there that you said starting at your last point, of course ClearOne always considers all the options in front of it and beyond. That never goes away, but I like to go back and think about ClearOne’s values some years ago. We are a public company and so we somehow - we balance growth although we have not seen the growth we would like to see in 2015 and 2016 was difficult for a variety of reasons but we live in a world between profitability and growth. That's one, but we certainly consider our options and most importantly internally we feel that the company has growth to go. We made a series of acquisitions in technology and technology are not quick turnaround and we believe we have put in the money and the time to get the pieces that will show growth for ClearOne and they're showing it in terms of video. There is no question video has been an important factor of our growth strategy and will continue to be so and will in fact be carried by our new Pro Audio platform. We made a decision that we were going to focus on video and we did that and our Pro Audio got a little behind, but that was a strategic decision we made, but the audio now is second to none, is second to none, our Pro Audio. It's perfectly complementary to our video and we will see growth and we will - our goal is to make sure that our share price reflects that and we've seen it in periods of growth, you've seen it in periods of growth. The video will be a platform for growth for us along with some of our other strategic technologies such as the microphone. So we’re addressing it. Companies take time. We're here for long term value. I hope that you've seen long term value. You’ve been an investor a long time, but there is more to come and we think 2017, now that we have completed essentially our Pro Audio which is our flagship product, we will see growth. But the growth won't come just in the audio, which is why we went to video.

I appreciate the thoughtful answer. And I have gotten value in being a shareholder, but still it doesn't take away the idea that and I want to see both in your right, the stock does respond sometimes to growth, but when it's a better market. But my point really - the key point is if you have to start going out and hiring extra sales and marketing to push the new products and to do everything off your basically roughly fixed cost base that's not going down, it's actually going to go up with the sales and marketing, the issue is are there people out there that you could partner with that you could sell to that you could merge with that would create a combined value for everyone without having to spend the cost?

The answer is of course there are entities that you could take that route. Who could deny that there aren't? We feel we want to maximize our own share value before we take any route that would be necessarily just easy for management. Our job is to take the steps needed as they become available to us and as they are the right step to make sure we maximize shareholder value, we’re doing it with dividend, we’re doing it with stock buybacks, we're doing it with strategic partners, we’re doing it with strategic marketing. And if and when the time comes that such a combination meets our criteria that we feel we're going to get the maximum value, we're not afraid of taking any steps. Our feeling today as we speak is we're not there today.

This concludes our Q&A session. I would now like to turn the call back to Zee Hakimoglu for any further remarks.

Okay. Thank you, Andrew and we appreciate the continued interest in ClearOne and joining us today. If there are any further questions, you do contact us and we look forward to speaking to you again. Thank you.

Ladies and gentlemen, thank you for participating in today's conference. This concludes today's program. You may all disconnect. Everyone have a great day.