ClearOne, Inc. (CLRO) Q2 2017 Earnings Report, Transcript and Summary

Good morning, everyone, and welcome to the ClearOne 2017 Second Quarter Earnings 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 the company’s Investor Relations representative, Ms. Cathy Mattison of LHA. Ms. Madison, please go ahead.

Thank you, Karen. Welcome, everyone, and thank you for joining us today for the ClearOne second quarter 2017 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 3 months. Before we begin, I would like to make the cautionary statement and remind everyone that the information discussed on today’s – 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 business update then Narsi will follow with the discussion of our financial results. We will then open up the call for questions. Now it is my pleasure to turn the call over to Zee.

Thank you, Kathy, and good morning, everyone. Our major product transition continue to impact the company resulting in a disappointing second quarter, notwithstanding the 34% sequential increase in revenues in Q2 from our next-generation conferencing platform consisting of the new CONVERGE Pro 2, known as CP2, and our Beamforming Microphone Array 2. The platform is taking longer than previous product ramp and extending the normal sales cycle because of infringing activities and the additional training needed by AV consultants, integrators and large end customers on significant changes between the platforms. This includes new architecture, scalability, interoperability and user interfaces. At the end of Q1, we completed implementation of important software feature upgrades enabling us to introduce the new platform to AV consultants to specify for future large-scale projects. We are making good progress with our AV practioner channel partners for design, build projects and secured wins with well-known leading companies. Along with sequential growth of the new platform, Q2 positives included video revenue growing 25% year-over-year and gross margins improving from 57% in Q1 to 59% in Q2. To help drive sales during the quarter, we strengthened our sales team and made investments in additional marketing. On the sales front, we added sales support for Eastern Europe to help balance the larger EU market. We added sales support for Latin America, a region with nice potential for growth. We also added dedicated sales support for our AV network streaming product line. On the marketing front, we took delivery of a large 35 foot touring van that will crisscross the country presenting and demonstrating ClearOne’s full line of conferencing, collaboration and streaming solutions directly to AV integrators and their customers who can’t always get to larger trade shows and conferences. It will be an amazing marketing tool to educate our integrator ecosystem. Also on the marketing front, we engaged a multi-platform PR firm for media attention who is very well versed in the AV industry and uniquely qualified to present the ClearOne value proposition to all of its media targets, which include online, off-line, paid and earned to contribute to our sales growth. With respect to our operations during the quarter, we achieved one more milestone in our goal to optimize production cost. We completed the transfer of certain products to manufacturing offshore. This will help us generate higher growth margin in the near future. Further in June, we had a terrific experience at InfoComm, the largest trade show for audiovisual and information communications professionals in North America. ClearOne was named InfoComm Best of Show for VIEW Pro, our unique customizable, scalable and affordable 4K multimedia streaming solution by 2 of industry’s most prestigious publications. Those include AV Technology and rAVe ProAV. We also launched COLLABORATE Versa 150 at this show which was also recognized by another leading industry publication sound and video contractor with another Best of InfoComm 2017 award. The Versa 150 is a complete solution for PC-based video and web conferencing application, delivering easy connectivity and quality for bring-your-own-device collaboration, otherwise known as the BYOD, in huddle spaces or conference room. The solution enhances the audio and videoconferencing expedience of PC-based applications such as GoToMeeting, Hangouts, Skype for Business, Spontania and WebEx. In addition to the just mentioned video products, we introduced 2 new affordably priced CONVERGE Pro 2 DSP mixers that strengthens ClearOne’s already impressive mixer line up and we also introduce 2 new professional power amplifier with flexible features and plug-and-play simplicity that can be used for conferencing and audio distribution application. ClearOne believes that a new generation of millennial users is now driving the future shape and size of the commercial AV industry. Our new line is designed to meet the needs of work anytime, work any place, work any application, seeking customer solutions that combine world-class audio with rich video and streaming capability. Most importantly, this new generation of professionals, we are doing this cost effectively. For the AV integrator, we stand alone in being able to service as the industry’s only one-stop source for all their needs. Our new products reenforce ClearOne’s position at the preferred AV channel partner, who is uniquely positioned to offer a complete value chain of natively integrated solutions from audio to video that maximize AV partner profitability. Now I’ll turn the call over to Narsi. Narsi?

Thank you, Zee, 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 that went out this morning. Now I will turn to our financial results for the second quarter of 2017. Net revenue was $10.3 million compared to $12 million in Q2 2016, and $11.7 million in Q1 2017. Reviewing the year-over-year change in percentage of revenue by region now. Asia Pacific including the Middle East was flat. Americas decreased by 17%, and Europe and Africa decreased by 15%. Reviewing the year-over-year revenue change in percentage by product category. Video increased 25%, professionals decreased 17% and UC declined 30%. Non-GAAP gross profit margin was 59%, down from 64% in Q2 2016. This reflects that product mix was still heavily weighted toward the lower margin legacy CONVERGE Pro 1. The increasing share of video products in our revenue mix was also a factor in reduced gross profit margin. However, we see it as a positive that the gross margin grew 2% sequentially from 57% in Q1, reflecting the increasing contribution from CONVERGE Pro 2 revenue. Non-GAAP operating expenses were $5.9 million compared to $5.7 million. Almost all of this increase came from increased R&D caused by increase in employee related cost, consulting fees and project cost. Non-GAAP operating income was $136,000 compared to non-GAAP operating income of $1.9 million. The bulk of this change was due to reduced revenue and associated gross margin. Non-GAAP net loss was $102,000 or $0.01 per diluted share compared to non-GAAP net income of $1.4 million or $0.15 per diluted share. Non-GAAP adjusted EBITDA was $355,000 compared to $2.2 million. Now turning to our financial results for the 6 months ended June 30, 2017. Please note the following comparisons refer to first half of 2017 versus the first half of 2016. Net revenue decreased to $22 million from $25 million. Non-GAAP net income was $47,000 or $0.01 per diluted share compared to non-GAAP net income of $3.2 million or $0.35 per diluted share for the prior period. Non-GAAP adjusted EBITDA was $1 million compared to $5 million. Now turning to the balance sheet. We continue to be very strong balance sheet wise. Cash, cash equivalents and investments were $29.2 million compared to $38.5 million at December 31, 2016, still without any debt. The significant portion of this decrease can be attributed to legal expenses associated with our patent defense, share repurchases, dividend payments and higher investment inventory related to the CP2 platform and wireless microphones, which we expect to flow back into cash in the near term. During the quarter, we continued our shareholder-friendly actions. We repurchased approximately 215,000 shares for $2.1 million, bringing the total to 836,000 shares for $9.2 million, since the program inception in March 2016. As announced in March, the Board of Directors have extended the program for up to $10 million over additional 1 year at the time. We intend to continue to repurchase our shares in the open market, subject to price, volume and other safe harbor restrictions. Also, the Board of Directors approved a dividend increase from $0.05 per share to $0.07, which was paid on May 31 to shareholders of record on May 17. We also announced on August 7, 2017, a cash dividend of $0.07 per share for Q3 2017. Now I will turn the call back to Zee.

Thank you, Narsi. Operator, if you can please open the call for questions.

[Operator Instructions] Our first question comes from the line of Kara Anderson with B Riley and company.

I’m wondering if I can get you to expand on the infringing activities you cited in your prepared remarks?

I’m going to say we are in litigation. So that I’m not prepared to speak in detail on that other than to say that we’re taking the necessary steps to enforce our patent to remedy against having to compete against our own patented technology and to defend the validity of our patents to remedy against having to compete against our own patented technology and to defend the validity of our patents.

Okay. And then on the decision to bump inventory. What is driving that? Is that based on a current pipeline of orders you think will close?

No. The inventory increase was caused by our previous commitments. We commit to our contract manufacturers on a long-term basis, actually. We give them the forecast and then we take our delivery as inventory based on the forecast. We have already acknowledged that our revenue was below expectations and our product rollout was also delayed for CP2, actually. It was delayed by a quarter at least. So we are – all these factors contributed together to bump the inventory up, and we been in this position before and we can ramp down as we have already started cutting down on our forecast, since we have enough inventory, and you will see the results of this in our cash flows in the next 6 months actually. Especially in Q4, you will see the results of this actually.

And when you think about your cash flow expectations and given these ongoing legal expenses, can you give us any sense for what you’re expecting for the full year in terms of cash flow?

I don’t have a – we don’t give that kind of number. We don’t give any guidance and cash flows are part of that. But we do have a sense of how much the legal expenses are going to cost, even though we can’t be 100% sure, it depends on so many factors including how the other side is going to – their strategies and how they are going to react to our motions and petitions. So it depends on the other side also. But we will do everything necessary, as we said, to protect our patent and do the necessary things actually.

Okay thanks started for me.

Thank you.

And our next question comes on the line of Lisa Springer with Singular Research.

Good morning Lisa.

Good morning Zee Hakimoglu. So if you can please comment on how the software features that were implemented during the first quarter make a system work correct itself through AV consultants?

Some of the software features that we added, included things like scalability, being able to add additional units, being able to partition rooms. They may have to do with probably features – well, I shouldn’t say probably, they had to do with features that we thought were sufficient to not include on the very first rollout, but they were software features that we know we intended to add and it really had to do with expanding some of the use cases of the platform, makes mostly the CP2.

Okay. And regarding the sequential growth in CONVERGE Pro 2, could you comment on the performance in the U.S. versus internationally?

I think U.S. is getting stronger in terms of acceptance of CP2. I’m going to give you – the U.S. is currently about – with CP2, U.S. is about 57% of the overall volume. The remaining comes from the international markets.

Okay good thank you very much.

Thank you. Our next question comes from the line of Dennis Van Zelfden with Brazos Research.

Good morning Zee and Narsi.

Goode morning Dennis.

Goode morning Dennis.

I think, you have mentioned that revenue came in below your expectations, hence the increase in inventory. So I’m guessing that the lengthening sales cycle caught you by surprise. Is that – would that be accurate?

I would say it’s not what we hoped and expected. I already mentioned what some of the factors were. But like all inventory for our products in general, this is capital equipment expenditures, the products have a very long lifetime at the customers as well as in our inventory and Narsi mentioned that we will be consuming those and converting that inventory back to cash on our balance sheet.

You mean in the normal course of business? I mean, I guess, another way to ask the question, are you seeing any evidence whatsoever of a rebounding sale cycle?

Well, yes, Narsi. Why don’t you.

I think that trend here is, we had 1 full quarter of CP2 doing. I think it’s a pretty good achievement for the first full quarter of CP2 shipment, but what we are noticing is the faster ramp down of CP1 actually. That is not – the trends are not going hand in hand actually. We are seeing faster ramp down of CP1. So CP2 will catch up eventually, it’s taken longer than we thought. So we think we are on course to consume the inventory in the normal course actually.

Okay. Just another question on this litigation. Can you tell us who it’s with?

Yes, we have 3 defendants. We have Shure, which is a very large microphone company in Chicago, we have Biamp who is in Oregon, and other DSP in sound reinforcement company in the audio conferencing and audio distribution space, and we have QSC, located in Los Angeles, California, who has been primarily in the audio sound reinforcement space and it has introduced products in the last couple of years for audio conferencing.

Are these large revenue companies? Or they’re just small little pipsqueaks out there?

No, they are large revenue company. I would say that all of them are private, but of course, Shure is a very big company with revenues under $500 million, I don’t have the figure here. Biamp is a relatively large company, surely much larger than ClearOne and QSC is another large company significantly bigger than ClearOne.

And how long has this litigation been going on? Is it new? Or is it 6 months old?

Well, yes, we filed – let’s see, we filed our litigation. It was about recent motion’s going back having to do with certain Supreme Court rulings on venue, et cetera, but we filed it basically at the beginning of this quarter. It started probably at 1 quarter, 1.5 quarter ago. We had sent letters notifying the defendants that they were infringing on our patents. So it did start a while ago.

And the legal – you’re bearing 100% of the legal costs? Or are your attorneys doing any of it on contingency?

We are not working on contingency because the purpose of this action is to take the steps to remedy unfair competition using our own patented technology. We felt in the interest as well as to defend the validity of the patents. We felt that the action that we’re taking is in the best interest of our shareholders and the company. And of course, the licensing option is something that we consider but we strongly believe it is not the option that’s in the best interest of the company, its shareholders, its employees and other interested parties.

Okay. Last question. Of other 215 shares purchased in the second quarter, were any of those management options?

No

Okay.

Thank you, Van Zelfden.

Thank you, Dennis.

Thank you, and our next question comes from the line of Jay Harris with Axiom Capital.

Good morning Jay.

Good morning, how are you?

Good. Thank you.

Can you here me?

Yes. We here your call in clear.

All right. I wondered if we could hear a sort of a summary of the cash burn principal items on cash burn for the first 6 months of the year?

The major portion of our cash reduction. Typically, we had in making cash before. $1 million to $2.5 million a quarter in the past actually. We are cash negative in the last 2 quarters, of course, because we don’t have enough revenue. But we have enough revenue to support normal activities. We should not be burning cash on our normal operating activities actually. The additional cash that is going out is because of our shareholder friendly actions. We are doing the buyback, we are doing the dividends. But those are secondary. The primary reason that you saw our cash going out is buildup in inventory. I call it, investment of inventory. We have obligations that we accepted. Of course, we can try to get out of profit but it has cost. We think these are really good inventory, which is not going to cost us a dime in the future which we can sell, and which we will consume. So we are confident about the cash coming back into our balance sheet. So the primary, more than 50% of this reduction in cash is investments in inventory.

Could we get some details, the numbers, the dollars amount for inventory, the dollar amount for dividends? The dollar amount for...

Yes, dividends. We spent.

The cash that was expanded ex those in operations?

Okay. Let me give you 3 big numbers. Just in Q2, we spent $2.1 million on our share repurchase. In the 6 months, we spent more than $1 million on our dividend payments actually, and then, I don’t have the cash flow statement right away, but we spent, I think, upwards of $4.5 million, additional investments in inventory. So this constitutes a bulk of it. That is other one, the litigation expenses that we have already disclosed in our non-GAAP adjustment. We have about $800,000 plus on the non-GAAP adjustment that we disclosed as instances that are not regularly connected with the operations. So you get most of the depletion in the cash accounted for actually.

I’ll make the suggestion that on future quarterly reports that you include an application – funds flow so that we can see what’s going on in terms of cash management?

We filed our 10-Q today. We have a very detailed...

I don’t have it on the call. When you file it, I’ll get it tomorrow. I’d like to have this when you’re talking to investors.

Okay. We will consider that.

And our next question comes from the line of Matthew Greenblatt from Leerink Investment Partners.

I was just wondering, considering this in value of your patent portfolio and the cost of being a public company relative to your size, have you considered the pursuit of any strategic alternatives for the business?

Yes. Of course, we’re always thinking about strategic actions to benefit the company, the shareholders, to our partners in the channel, et cetera. And of course, we consider that. We have made significant investments in our core product strategy and our approach to the market and we believe that we’ve assembled enough overtime to bring value to the future of our shareholders and we’re focused on doing that. We go to short-term issues, we made large investments, we brought a completely new product line, which is highly complementary to audio, the entire video suite of products, and we see that they’re growing very well quarter after quarter and we will, perhaps, reach a time when we will fully capitalize on our investment. But in the meantime, we look at strategic alternatives and we consider them all the time. But we’ve made decisions at least as we’ve gone that we’re going to get the best value for our shareholders through continuing to pursue our long-term strategy.

Right. And one more question. Have you been approached by any larger players in the past?

Well, we certainly couldn’t disclose anything that was under confidentiality. So I certainly couldn’t answer that question.

Right. Okay. But it’s something that you are always considering and you would like to get a couple of quarter of momentum before – at least a couple of quarters of momentum before actually really considering that?

We consider all our alternatives, and we look at the timing and we look at the market conditions and we look at what products are coming and what our future potential is. And the value of our portfolio and how we’re going to capitalize on all of our investments. So it’s not one day, it’s not one milestone, it’s always forever churning road map. But we do focus on our future value, which I think is somewhat undervalued at this time for a variety of reasons. But we’re planning on executing and capitalizing on the investments we’ve made as a public company that we are today.

Thank you, and our next question comes on the line of Tony Polak with Aegis Capital.

Just one comment and that the reason your stock is down because you lost money this quarter. I don’t think there’s any other reason. So you say a variety of reasons, but I really think that’s the reason. So just want to make that comment.

No, it’s okay.

The R&D and G&A went up substantially in this last quarter. Can you give us a little more clarity on why that was?

We actually – if you look at it on a non-GAAP basis, our operating expenses are almost dollar to dollar equal from the previous year, except for R&D expenses. R&D expenses are regular R&D expenses. There are some headcount increase because of engineering hires and many projects that are ongoing. And that’s $200k above previous year levels. And everything else on non-GAAP basis, it’s exactly the same actually. So – and the real reason for the GAAP numbers to be different for G&A is our litigation expenses. We have spelled out in our earnings release how much it is and that’s the only difference that is to our operating expenses. And we have been very prudent in terms of cost management and we have always been lean when it comes to running the company tight. So we don’t have any specific concerns on the cost management. We are doing everything to have a tight control over the cost. We recognize the top line performance and we are flexible and we adjust our tactics and our execution plans based on what we see immediately. But at the same time, we do make sure that we are not hurting ourselves in the long term actually.

Okay. Is it public knowledge how much you’re suing for in terms of damages in these lawsuits?

This lawsuit at this point is not asking for damages. At this point, we’re taking the steps to enforce our patents to defend our patents. There comes a stage during the litigation where damages are reviewed but that is not at this stage.

So you’re just suing for the people to stop selling equipment that you have patents on?

Right. Our goal is to do 2 things: to stop the infringers from selling our own patented technology; and number 2, to defend the validity of our patent.

Okay. Thank you, very much.

Thank you.

[Operator Instructions] Our next question comes on the line of George Melas with MKH. Please go ahead.

Good morning.

Good morning, George.

I have 2 quick questions. One on CP2 and the other one on VIEW, and I’ll start with VIEW. VIEW seems to – you’ve put a lot of resources into VIEW and you’ve got really very strong support for it or great reviews of InfoComm. What is to obtain? What is the market for VIEW? And in a way I’m surprised that it doesn’t grow at a faster rate.

Okay. I didn’t hear the first part. What is?

What is to obtain? What is the available market?

Total availabe market. Yes, we saw report couple of years ago. There is no report that we could find that really targeted that market, but we assembled a variety of market reports, and at least in the enterprise, we assembled a report that showed that the market for enterprised streaming is about $500 million for video. Of course, yes, so that is in the enterprise. The business is very project oriented in terms VIEW. We are having the benefit of winning some several large projects, but they’re very lumpy as we’ve talked in the past. We think we have a very differentiating solution as we’re among the few that do very high compressed video with very low latency at a competitive price that’s infinitely scalable. So we are – part of our mission in our PR firm is to really eventualize that solution and we have projects in the queue that we’re hoping to win. Of course, everything is competitive and we can’t guarantee it. But we’re getting a nice reception to the product and I think, over time it’s going to contribute more significantly.

And most of the projects that you are – that you sell and bring to your buyers? Or are they generated by the buyers? What is the process of lead generation and have actually trying to drive sales?

Okay. Good question. We have been traditionally getting our opportunity through our value added resellers and our consultants, et cetera, but we recently hired, I mentioned, a resource dedicated to view sales, who is more oriented besides doing what I just mentioned, talking more and spending more time with end users to identify projects. So he will be more balanced, rest of the team deals more with the channel and he will be a bit more focused talking with end users to bring them the value and what the opportunity for them can be.

Okay, great. Okay. And then on CP2. I’m trying to understand the ramp of CP2. The ramp, I think, based on, I think, your comments and the inventory buildup seems to have not met the expectations or your forecast and you talk about additional training. So what’s going on in the channel? Is it the distributors that are not really getting on board? And then supporting it with the buyers? Are some of the distributors really behind it and others are still lukewarm about it? I know you cannot give us too much detail, because this is the public call, but help us understand how the ramp is going?

Okay.

Maybe I can state things under we already disclosed. One of the reasons why we wanted to be clear is the reasons actually we spoke very clearly on our press release about the reason, we identified infringing activities itself, which is delaying the transition. It’s not making it easier. I can put it mildly. And the product is different and if the platform is CP2 which includes BFM2 is different enough from the previous. It’s not like a version upgrade, like people know exactly what everything is and they just – they know their knowledge and then move to the – It’s not a version upgrade, it’s entirely new platform actually. So it takes longer time for them to educate themselves and educate others actually. That’s the process. We have to go through the channel at every level for them to get comfortable first and then passing that knowledge onto the large end users and others who themselves have to be convinced actually. So it’s taking – it’s not totally unexpected, but the time frame of how this is going to work out, it’s – we are getting a better grip over this as we see the product being rolled out and we as we get more feedbacks from the channel actually.

But then just a little bit more detail. Are you seeing some either distributors or buyers that are really sort of adopting it at the pace you’re expected? And some are not? Couple [indiscernible] variation of the ramp?

Okay. I could say this. The distributors aren’t really a factor. The distributors are basically logistics that stock and literally distribute the product. So the uptake come from the value added resellers. And in the market, there are channel partners that have been using other products. They have been waiting for some of our products and they start to the tires and look at the products. I won’t minimize the difficulty that the infringers are doing on us. Because where we had an exclusive market for Beamforming with mixing according to our patent, I’m not going to recite the patent right here, but now we have the unfortunate exercise, where we have got to compete against our technology with our patented technology against 3 formidable competitors, and then in itself creates delay and to some amount a confusion and other factors. But we are happy of the changes we made. The channel of – when they see the products, they like the product. They’re glad for the features. But it’s a quoting business and it’s not a win-buy. So it is taking us longer. We are fighting for our share and we have no regrets on the product changes we made to CP2 based on the feedback.

Okay. Great. And then one more quick question on the litigation. What is the next milestone in the litigation? Just about a little bit of the time line and major steps?

I have to say, in litigation, it’s very difficult to know what comes next, but we certainly will be working to defend our patent at the patent office. We have questions of motion and where the various parties will be – where we will be litigating right now and we have a preliminary injunction that we have filed. Preliminary injunctions are very difficult to get but we filed a preliminary injunction that we think is strong and we’ll see where we go with that. We have very good litigation lawyers that are excellent with technology and very focused and the team is – we’ll do as we always do in our litigation, we will work hard. We have a good track record, of course, we can’t guarantee the future but we’re going to do everything to protect our right.

Thank you, and that concludes our question-and-answer session for today. I’d like to turn the floor back over to Zee for any closing comments.

We thank you for joining us today and if you have questions, you’re free to call our Investor Relations or call us here at ClearOne. Thank you.

Ladies and gentlemen, thank you for your participation on today’s conference. This does conclude the program. And you may now disconnect. Everyone, have a great day.