Item
1. FINANCIAL STATEMENTS
CLEARONE,
INC.
UNAUDITED
CONDENSED CONSOLIDATED BALANCE SHEETS
(Dollars
in thousands, except par value)
|
|
September
30,
|
|
December
31,
|
|
|
2017
|
|
2016
|
ASSETS
|
|
|
|
|
|
|
|
|
Current
assets:
|
|
|
|
|
|
|
|
|
Cash
and cash equivalents
|
|
$
|
3,013
|
|
|
$
|
12,100
|
|
Marketable
securities
|
|
|
3,953
|
|
|
|
5,030
|
|
Receivables,
net of allowance for doubtful accounts of $304 and $187, as of September 30, 2017 and December 31, 2016 respectively
|
|
|
8,061
|
|
|
|
7,461
|
|
Inventories
|
|
|
19,695
|
|
|
|
11,377
|
|
Distributor
channel inventories
|
|
|
1,394
|
|
|
|
1,530
|
|
Prepaid
expenses and other assets
|
|
|
2,207
|
|
|
|
2,642
|
|
Total
current assets
|
|
|
38,323
|
|
|
|
40,140
|
|
Long-term
marketable securities
|
|
|
16,480
|
|
|
|
21,365
|
|
Long-term
inventories, net
|
|
|
2,446
|
|
|
|
1,664
|
|
Property
and equipment, net
|
|
|
1,587
|
|
|
|
1,513
|
|
Intangibles,
net
|
|
|
5,283
|
|
|
|
5,677
|
|
Goodwill
|
|
|
—
|
|
|
|
12,724
|
|
Deferred
income taxes
|
|
|
9,875
|
|
|
|
4,654
|
|
Other
assets
|
|
|
378
|
|
|
|
387
|
|
Total
assets
|
|
$
|
74,372
|
|
|
$
|
88,124
|
|
LIABILITIES
AND SHAREHOLDERS’ EQUITY
|
|
|
|
|
|
|
|
|
Current
liabilities:
|
|
|
|
|
|
|
|
|
Accounts
payable
|
|
$
|
5,811
|
|
|
$
|
3,545
|
|
Accrued
liabilities
|
|
|
1,852
|
|
|
|
1,894
|
|
Deferred
product revenue
|
|
|
3,870
|
|
|
|
3,882
|
|
Total
current liabilities
|
|
|
11,533
|
|
|
|
9,321
|
|
Deferred
rent
|
|
|
39
|
|
|
|
103
|
|
Other
long-term liabilities
|
|
|
1,216
|
|
|
|
1,251
|
|
Total
liabilities
|
|
|
12,788
|
|
|
|
10,675
|
|
Shareholders’
equity:
|
|
|
|
|
|
|
|
|
Common stock,
par value $0.001, 50,000,000 shares authorized, 8,433,182 and 8,812,644 shares issued and outstanding as of September 30,
2017 and December 31, 2016 respectively
|
|
|
8
|
|
|
|
9
|
|
Additional
paid-in capital
|
|
|
47,300
|
|
|
|
46,669
|
|
Accumulated
other comprehensive loss
|
|
|
(49
|
)
|
|
|
(205
|
)
|
Retained
earnings
|
|
|
14,325
|
|
|
|
30,976
|
|
Total
shareholders’ equity
|
|
|
61,584
|
|
|
|
77,449
|
|
Total
liabilities and shareholders’ equity
|
|
$
|
74,372
|
|
|
$
|
88,124
|
|
See
accompanying notes
UNAUDITED
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND
COMPREHENSIVE
INCOME (LOSS)
(Dollars
in thousands, except per share amounts)
|
|
Three
months ended September 30,
|
|
Nine
months ended September 30,
|
|
|
2017
|
|
2016
|
|
2017
|
|
2016
|
Revenue
|
|
$
|
10,560
|
|
|
$
|
12,908
|
|
|
$
|
32,549
|
|
|
$
|
37,907
|
|
Cost
of goods sold
|
|
|
4,051
|
|
|
|
5,240
|
|
|
|
13,293
|
|
|
|
14,110
|
|
Gross
profit
|
|
|
6,509
|
|
|
|
7,668
|
|
|
|
19,256
|
|
|
|
23,797
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating
expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Sales
and marketing
|
|
|
3,006
|
|
|
|
2,389
|
|
|
|
8,393
|
|
|
|
7,695
|
|
Research
and product development
|
|
|
2,268
|
|
|
|
2,116
|
|
|
|
6,947
|
|
|
|
6,481
|
|
General
and administrative
|
|
|
1,281
|
|
|
|
1,739
|
|
|
|
5,597
|
|
|
|
4,904
|
|
Impairment
of an intangible asset
|
|
|
736
|
|
|
|
—
|
|
|
|
736
|
|
|
|
—
|
|
Impairment
of goodwill
|
|
|
12,724
|
|
|
|
—
|
|
|
|
12,724
|
|
|
|
—
|
|
Total
operating expenses
|
|
|
20,015
|
|
|
|
6,244
|
|
|
|
34,397
|
|
|
|
19,080
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating
income (loss)
|
|
|
(13,506
|
)
|
|
|
1,424
|
|
|
|
(15,141
|
)
|
|
|
4,717
|
|
Other
income, net
|
|
|
78
|
|
|
|
100
|
|
|
|
264
|
|
|
|
194
|
|
Income
(loss) before income taxes
|
|
|
(13,428
|
)
|
|
|
1,524
|
|
|
|
(14,877
|
)
|
|
|
4,911
|
|
Provision
for (benefit from) income taxes
|
|
|
(4,152
|
)
|
|
|
315
|
|
|
|
(4,313
|
)
|
|
|
1,379
|
|
Net
income (loss)
|
|
$
|
(9,276
|
)
|
|
$
|
1,209
|
|
|
$
|
(10,564
|
)
|
|
$
|
3,532
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
earnings (loss) per common share
|
|
$
|
(1.09
|
)
|
|
$
|
0.14
|
|
|
$
|
(1.22
|
)
|
|
$
|
0.39
|
|
Diluted
earnings (loss) per common share
|
|
$
|
(1.09
|
)
|
|
$
|
0.13
|
|
|
$
|
(1.22
|
)
|
|
$
|
0.37
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic weighted
average shares outstanding
|
|
|
8,520,041
|
|
|
|
8,921,480
|
|
|
|
8,641,173
|
|
|
|
9,076,305
|
|
Diluted weighted
average shares outstanding
|
|
|
8,520,041
|
|
|
|
9,164,165
|
|
|
|
8,641,173
|
|
|
|
9,452,616
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Comprehensive
income:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
income (loss)
|
|
$
|
(9,276
|
)
|
|
$
|
1,209
|
|
|
$
|
(10,564
|
)
|
|
$
|
3,532
|
|
Other
comprehensive income:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Change
in unrealized gains (losses) on available-for-sale securities, net of tax
|
|
|
10
|
|
|
|
(39
|
)
|
|
|
68
|
|
|
|
179
|
|
Change
in foreign currency translation adjustment
|
|
|
23
|
|
|
|
7
|
|
|
|
88
|
|
|
|
19
|
|
Comprehensive
income (loss)
|
|
$
|
(9,243
|
)
|
|
$
|
1,177
|
|
|
$
|
(10,408
|
)
|
|
$
|
3,730
|
|
See
accompanying notes
UNAUDITED
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars
in thousands, except per share amounts)
|
|
Nine
months ended September 30,
|
|
|
|
2017
|
|
|
2016
|
|
Cash
flows from operating activities:
|
|
|
|
|
|
|
|
|
Net
income (loss)
|
|
$
|
(10,564
|
)
|
|
$
|
3,532
|
|
Adjustments
to reconcile net income (loss) to net cash provided by (used in) operating activities:
|
|
|
|
|
|
|
|
|
Depreciation
and amortization expense
|
|
|
1,172
|
|
|
|
1,408
|
|
Impairment
of goodwill and intangible assets
|
|
|
13,460
|
|
|
|
—
|
|
Amortization
of deferred rent
|
|
|
(53
|
)
|
|
|
(57
|
)
|
Stock-based
compensation expense
|
|
|
514
|
|
|
|
494
|
|
Provision
for (recovery of) doubtful accounts, net
|
|
|
106
|
|
|
|
(6
|
)
|
Write-down
of inventory to net realizable value
|
|
|
—
|
|
|
|
458
|
|
Loss
on disposal of assets
|
|
|
1
|
|
|
|
54
|
|
Tax
benefit from exercise of stock options
|
|
|
—
|
|
|
|
(721
|
)
|
Deferred
income taxes
|
|
|
(5,221
|
)
|
|
|
107
|
|
Changes
in operating assets and liabilities:
|
|
|
|
|
|
|
|
|
Receivables
|
|
|
(649
|
)
|
|
|
234
|
|
Inventories
|
|
|
(8,964
|
)
|
|
|
1,353
|
|
Prepaid
expenses and other assets
|
|
|
(226
|
)
|
|
|
(147
|
)
|
Accounts
payable
|
|
|
2,257
|
|
|
|
770
|
|
Accrued
liabilities
|
|
|
(67
|
)
|
|
|
(134
|
)
|
Income
taxes payable
|
|
|
699
|
|
|
|
429
|
|
Deferred
product revenue
|
|
|
(23
|
)
|
|
|
(284
|
)
|
Other
long-term liabilities
|
|
|
(61
|
)
|
|
|
(51
|
)
|
Net
cash provided by (used in) operating activities
|
|
|
(7,619
|
)
|
|
|
7,439
|
|
|
|
|
|
|
|
|
|
|
Cash
flows from investing activities:
|
|
|
|
|
|
|
|
|
Purchase
of property and equipment
|
|
|
(537
|
)
|
|
|
(544
|
)
|
Purchase
of intangibles
|
|
|
(203
|
)
|
|
|
—
|
|
Proceeds
from maturities and sales of marketable securities
|
|
|
9,946
|
|
|
|
5,371
|
|
Purchase
of marketable securities
|
|
|
(3,915
|
)
|
|
|
(6,608
|
)
|
Capitalized
patent defense costs
|
|
|
(845
|
)
|
|
|
—
|
|
Net
cash provided by (used in) investing activities
|
|
|
4,446
|
|
|
|
(1,781
|
)
|
|
|
|
|
|
|
|
|
|
Cash
flows from financing activities:
|
|
|
|
|
|
|
|
|
Net
proceeds from equity-based compensation programs
|
|
|
117
|
|
|
|
736
|
|
Tax
benefit from equity-based compensation programs
|
|
|
—
|
|
|
|
721
|
|
Repurchase
and cancellation of stock options
|
|
|
(285
|
)
|
|
|
(1,752
|
)
|
Dividend
payments
|
|
|
(1,650
|
)
|
|
|
(1,373
|
)
|
Repurchase
and cancellation of stock
|
|
|
(4,151
|
)
|
|
|
(5,139
|
)
|
Net
cash used in financing activities
|
|
|
(5,969
|
)
|
|
|
(6,807
|
)
|
|
|
|
|
|
|
|
|
|
Effect
of exchange rate changes on cash and cash equivalents
|
|
|
55
|
|
|
|
10
|
|
Net
decrease in cash and cash equivalents
|
|
|
(9,087
|
)
|
|
|
(1,139
|
)
|
Cash
and cash equivalents at the beginning of the period
|
|
|
12,100
|
|
|
|
13,412
|
|
Cash
and cash equivalents at the end of the period
|
|
$
|
3,013
|
|
|
$
|
12,273
|
|
See
accompanying notes
UNAUDITED
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars
in thousands, except per share amounts)
The
following is a summary of supplemental cash flow activities:
|
|
Nine
months ended September 30,
|
|
|
|
2017
|
|
|
2016
|
|
Supplemental
disclosure of cash flow information:
|
|
|
|
|
|
|
|
|
Cash
paid for income taxes
|
|
$
|
6
|
|
|
$
|
893
|
|
See
accompanying notes
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited
- Dollars in thousands, except per share amounts)
1.
Business Description, Basis of Presentation and Significant Accounting Policies
Business
Description:
ClearOne,
Inc., together with its subsidiaries (collectively, “ClearOne” or the “Company”), is a global
company that designs, develops and sells conferencing, collaboration, streaming and digital signage solutions for audio and visual
communications. The performance and simplicity of its advanced comprehensive solutions offer unprecedented levels of functionality,
reliability and scalability.
Basis
of Presentation:
The
fiscal year for ClearOne is the 12 months ending on December 31
st
. The consolidated financial statements include the
accounts of ClearOne and its subsidiaries. All significant inter-company accounts and transactions have been eliminated.
These
accompanying interim unaudited condensed consolidated financial statements have been prepared by the Company pursuant to the rules
and regulations of the Securities and Exchange Commission (“SEC”) and are not audited. Certain information and footnote
disclosures that are usually included in financial statements prepared in accordance with generally accepted accounting principles
in the United States (“GAAP”) have been either condensed or omitted in accordance with SEC rules and regulations.
The accompanying condensed consolidated financial statements contain all adjustments, consisting of normal recurring accruals,
necessary for a fair presentation of our financial position as of September 30, 2017 and December 31, 2016, the results of operations
for the three and nine months ended September 30, 2017 and 2016, and the cash flows for the nine months ended September 30, 2017
and 2016. The results of operations for the three months and nine months ended September 30, 2017 and 2016 are not necessarily
indicative of the results for a full-year period. These interim unaudited condensed consolidated financial statements should be
read in conjunction with the financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2016
filed with the SEC.
Significant
Accounting Policies:
The
significant accounting policies were described in Note 1 to the audited consolidated financial statements included in the Company’s
annual report on Form 10-K for the year ended December 31, 2016. There have been no changes to these policies during the nine
months ended September 30, 2017 that are of significance or potential significance to the Company except for the treatment
of patent defense costs described below.
Patent
Defense Costs -
The Company relies on patents and proprietary technology and seeks patent protection for products and
production methods. The Company capitalizes external legal costs incurred in the defense of its patents when it believes that
a future economic benefit will result from the defense and a successful outcome of the legal action is probable. These
costs are amortized over the remaining estimated useful life of the patent, which is 15 to 17 years. The Company’s assessment
of future economic benefit and/or the successful outcome of legal action related to patent defense involves considerable management
judgment and a different outcome could result in material write-offs of the carrying value of these assets.
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited
- Dollars in thousands, except per share amounts)
Recent
Accounting Pronouncements:
In
May 2014, the FASB released Accounting Standards Update (ASU) No. 2014-09, Revenue from Contracts with Customers (Topic 606),
requiring an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or
services to customers. The updated standard will replace most existing revenue recognition guidance in U.S. GAAP when it becomes
effective and permits the use of either a full retrospective or retrospective with cumulative effect transition method. We plan
to adopt the standard when it becomes effective for us beginning January 1, 2018. We currently anticipate adopting the standard
using the modified retrospective method with a cumulative catch up adjustment and providing additional disclosures comparing results
to previous rules. We continue to evaluate the impact of the new standard on our consolidated financial statements but anticipate
this standard will have a material impact on our consolidated financial statements.
In
February 2016, the FASB released ASU No. 2016-02, Leases (Topic 842) to bring transparency to lessee balance sheets. The ASU will
require organizations that lease assets (lessees) to recognize assets and liabilities on the balance sheet for the rights and
obligations created by all leases with terms of more than 12 months. The standard will apply to both types of leases-capital (or
finance) leases and operating leases. Previously, GAAP has required only capital leases to be recognized on lessee balance sheets.
The standard is effective for fiscal years beginning after December 15, 2018 and interim periods within fiscal years beginning
after December 15, 2018. Early application will be permitted for all organizations. The Company has not yet selected a transition
method and is currently evaluating the effect that the updated standard will have on the consolidated financial statements.
In
March 2016, the FASB released ASU No. 2016-09, Compensation - Stock Compensation: Improvements to Employee Share-Based Payment
Accounting. The standard is intended to simplify several areas of accounting for share-based compensation arrangements, including
the income tax impact, classification on the statement of cash flows and forfeitures. ASU 2016-09 was effective for the Company
on January 1, 2017. As a result of the adoption of ASU 2016-09, excess tax benefits or deficiencies related to stock-based compensation
are now reflected in the Consolidated Statements of Operations as a component of the provision for income taxes, whereas they
previously were recognized in additional paid-in capital. In addition, our Consolidated Statements of Cash Flows will now present,
on a prospective basis, excess tax benefits as an operating activity. Finally, we have elected to account for forfeitures as they
occur, rather than estimate expected forfeitures.
In
August 2016, the FASB released ASU No. 2016-15, Classification of Certain Cash Receipts and Cash Payments, which addresses eight
specific cash flow issues with the objective of reducing the existing diversity in practice. ASU 2016-15 is effective for the
Company beginning January 1, 2018 and we are currently evaluating the impact that ASU 2016-15 will have on our consolidated financial
statements.
In
May 2017, the FASB issued ASU No. 2017-09, Compensation—Stock Compensation (Topic 718): Scope of Modification Accounting.
The new guidance provides clarity and reduces both (1) diversity in practice and (2) cost and complexity when applying the guidance
in Topic 718, Compensation—Stock Compensation, to a change to the terms or conditions of a share-based payment award. The
accounting standard update will be effective for The Company beginning January 1, 2018 on a prospective basis, and early adoption
is permitted. The Company has not yet selected a transition method and is currently evaluating the effect that the updated standard
will have on the consolidated financial statements.
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited
- Dollars in thousands, except per share amounts)
2.
Earnings (Loss) Per Share
Earnings
(loss) per common share is computed based on the weighted-average number of common shares outstanding and, when appropriate, dilutive
potential common stock outstanding during the period. Stock options are considered to be potential common stock. The computation
of diluted earnings (loss) per share does not assume exercise or conversion of securities that would have an anti-dilutive effect.
Basic
earnings (loss) per common share is the amount of net earnings (loss) for the period available to each weighted-average share
of common stock outstanding during the reporting period. Diluted earnings (loss) per common share is the amount of earnings (loss)
for the period available to each weighted-average share of common stock outstanding during the reporting period and to each share
of potential common stock outstanding during the period, unless inclusion of potential common stock would have an anti-dilutive
effect.
The
following table sets forth the computation of basic and diluted earnings (loss) per common share:
|
|
Three
months ended September 30,
|
|
|
Nine
months ended September 30,
|
|
|
|
2017
|
|
|
2016
|
|
|
2017
|
|
|
2016
|
|
Numerator:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
income (loss)
|
|
$
|
(9,276
|
)
|
|
$
|
1,209
|
|
|
$
|
(10,564
|
)
|
|
$
|
3,532
|
|
Denominator:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
weighted average shares outstanding
|
|
|
8,520,041
|
|
|
|
8,921,480
|
|
|
|
8,641,173
|
|
|
|
9,076,305
|
|
Dilutive
common stock equivalents using treasury stock method
|
|
|
—
|
|
|
|
242,686
|
|
|
|
—
|
|
|
|
376,312
|
|
Diluted
weighted average shares outstanding
|
|
|
8,520,041
|
|
|
|
9,164,165
|
|
|
|
8,641,173
|
|
|
|
9,452,616
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
earnings (loss) per common share
|
|
$
|
(1.09
|
)
|
|
$
|
0.14
|
|
|
$
|
(1.22
|
)
|
|
$
|
0.39
|
|
Diluted
earnings (loss) per common share
|
|
$
|
(1.09
|
)
|
|
$
|
0.13
|
|
|
$
|
(1.22
|
)
|
|
$
|
0.37
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted
average options outstanding
|
|
|
782,012
|
|
|
|
832,766
|
|
|
|
832,953
|
|
|
|
900,687
|
|
Anti-dilutive
options not included in the computations
|
|
|
782,012
|
|
|
|
312,372
|
|
|
|
832,953
|
|
|
|
312,477
|
|
3.
Marketable Securities
The
Company has classified its marketable securities as available-for-sale securities. These securities are carried at estimated fair
value with unrealized holding gains and losses included in accumulated other comprehensive income (loss) in stockholders’
equity until realized. Gains and losses on marketable security transactions are reported on the specific-identification method.
Dividend and interest income are recognized when earned.
The
amortized cost, gross unrealized holding gains, gross unrealized holding losses, and fair value for available-for-sale securities
by major security type and class of securities at September 30, 2017 and December 31, 2016 were as follows:
|
|
Amortized
cost
|
|
|
Gross
unrealized
holding gains
|
|
|
Gross
unrealized
holding losses
|
|
|
Estimated
fair value
|
|
September
30, 2017
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Available-for-sale
securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Corporate
bonds and notes
|
|
$
|
14,446
|
|
|
$
|
65
|
|
|
$
|
(52
|
)
|
|
$
|
14,459
|
|
Municipal
bonds
|
|
|
5,974
|
|
|
|
8
|
|
|
|
(8
|
)
|
|
|
5,974
|
|
Total
available-for-sale securities
|
|
$
|
20,420
|
|
|
$
|
73
|
|
|
$
|
(60
|
)
|
|
$
|
20,433
|
|
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited
- Dollars in thousands, except per share amounts)
|
|
Amortized
cost
|
|
Gross
unrealized
holding gains
|
|
Gross
unrealized
holding losses
|
|
Estimated
fair value
|
December
31, 2016
|
|
|
|
|
|
|
|
|
Available-for-sale
securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Corporate
bonds and notes
|
|
$
|
20,028
|
|
|
$
|
64
|
|
|
$
|
(122
|
)
|
|
$
|
19,970
|
|
Municipal
bonds
|
|
|
6,463
|
|
|
|
6
|
|
|
|
(44
|
)
|
|
|
6,425
|
|
Total
available-for-sale securities
|
|
$
|
26,491
|
|
|
$
|
70
|
|
|
$
|
(166
|
)
|
|
$
|
26,395
|
|
Maturities
of marketable securities classified as available-for-sale securities were as follows at September 30, 2017:
|
|
Amortized
cost
|
|
Estimated
fair value
|
September
30, 2017
|
|
|
|
|
Due
within one year
|
|
$
|
3,945
|
|
|
$
|
3,953
|
|
Due
after one year through five years
|
|
|
16,475
|
|
|
|
16,480
|
|
Total
available-for-sale securities
|
|
$
|
20,420
|
|
|
$
|
20,433
|
|
Debt
securities in an unrealized loss position as of September 30, 2017 were not deemed impaired at acquisition and subsequent declines
in fair value are not deemed attributed to declines in credit quality. Management believes that it is more likely than not that
the securities will receive a full recovery of par value, although there can be no assurance that such recovery will occur. The
available-for-sale marketable securities with continuous gross unrealized loss position for less than 12 months and 12 months
or greater and their related fair values were as follows:
|
|
Less
than 12 months
|
|
More
than 12 months
|
|
Total
|
(In
thousands)
|
|
Estimated
fair value
|
|
Gross
unrealized holding losses
|
|
Estimated
fair value
|
|
Gross
unrealized holding losses
|
|
Estimated
fair value
|
|
Gross
unrealized holding losses
|
As
of September 30, 2017
|
|
|
|
|
|
|
|
|
|
|
|
|
Corporate
bonds and notes
|
|
$
|
4,288
|
|
|
$
|
(24
|
)
|
|
$
|
2,148
|
|
|
$
|
(27
|
)
|
|
$
|
6,436
|
|
|
$
|
(51
|
)
|
Municipal
bonds
|
|
|
3,157
|
|
|
|
(5
|
)
|
|
|
566
|
|
|
|
(4
|
)
|
|
|
3,723
|
|
|
|
(9
|
)
|
Total
|
|
$
|
7,445
|
|
|
$
|
(29
|
)
|
|
$
|
2,714
|
|
|
$
|
(31
|
)
|
|
$
|
10,159
|
|
|
$
|
(60
|
)
|
4.
Goodwill and Intangible Assets
Goodwill
There
was a decrease in goodwill during the three and nine months ended September 30, 2017 from $12,724 as of December 31, 2016 to $0
as of September 30, 2017 due to the impairment of goodwill. During the three months ended September 30, 2017, there was a decrease
in the Company’s market capitalization which was determined to be a triggering event for potential goodwill impairment.
Accordingly, the Company performed a goodwill impairment analysis. The Company utilized the market capitalization to estimate
the fair value. Our total stockholders’ equity exceeded the estimated fair value. The failure of step one of the goodwill
impairment test triggered a step two impairment test. As a result of step two of the impairment test, the Company determined the
implied fair value of goodwill and concluded that the carrying value of goodwill exceeded its implied fair value as of September
30, 2017. Accordingly, an impairment charge of $12,724, which represents a full impairment charge, was recognized in the three
months ended September 30, 2017.
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited
- Dollars in thousands, except per share amounts)
Intangible
Assets
Intangible
assets as of September 30, 2017 and December 31, 2016 consisted of the following:
|
|
Estimated
useful
lives
|
|
September
30, 2017
|
|
December
31, 2016
|
Tradename
|
|
5
to 7 years
|
|
$
|
555
|
|
|
$
|
555
|
|
Patents
and technological know-how
|
|
10
years
|
|
|
7,058
|
|
|
|
6,010
|
|
Proprietary
software
|
|
3
to 15 years
|
|
|
2,981
|
|
|
|
4,341
|
|
Other
|
|
3
to 5 years
|
|
|
324
|
|
|
|
324
|
|
Total
intangible assets
|
|
|
|
|
10,918
|
|
|
|
11,230
|
|
Accumulated
amortization
|
|
|
|
|
(5,635
|
)
|
|
|
(5,553
|
)
|
Total
intangible assets, net
|
|
|
|
$
|
5,283
|
|
|
$
|
5,677
|
|
The
amortization of intangible assets for the three and nine months ended September 30, 2017 and 2016 was as follows:
|
|
Three
months ended September 30,
|
|
Nine
months ended September 30,
|
|
|
2017
|
|
2016
|
|
2017
|
|
2016
|
Amortization
of intangible assets
|
|
$
|
231
|
|
|
$
|
328
|
|
|
$
|
699
|
|
|
$
|
458
|
|
During
the three and nine months ended September 30, 2017 we recorded a $0.7 million charge for impairment of an intangible asset consisting
of customer relationships.
The
estimated future amortization expense of intangible assets is as follows:
Years
ending December 31,
|
|
|
2017
(remainder)
|
|
$
|
246
|
|
2018
|
|
|
829
|
|
2019
|
|
|
725
|
|
2020
|
|
|
546
|
|
2021
|
|
|
546
|
|
Thereafter
|
|
|
2,391
|
|
|
|
$
|
5,283
|
|
5.
Inventories
Inventories,
net of reserves, as of September 30, 2017 and December 31, 2016 consisted of the following:
|
|
As
of
|
|
|
September
30, 2017
|
|
December
31, 2016
|
Current:
|
|
|
|
|
|
|
|
|
Raw
materials
|
|
$
|
4,097
|
|
|
$
|
2,291
|
|
Finished
goods
|
|
|
15,598
|
|
|
|
9,086
|
|
|
|
$
|
19,695
|
|
|
$
|
11,377
|
|
|
|
|
|
|
|
|
|
|
Long-term:
|
|
|
|
|
|
|
|
|
Raw
materials
|
|
$
|
423
|
|
|
$
|
599
|
|
Finished
goods
|
|
|
2,023
|
|
|
|
1,065
|
|
|
|
$
|
2,446
|
|
|
$
|
1,664
|
|
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited
- Dollars in thousands, except per share amounts)
Long-term
inventory represents inventory held in excess of our current (next 12 months) requirements based on our recent sales and forecasted
level of sales. We expect to sell the above inventory, net of reserves, at or above the stated cost and believe that no loss will
be incurred on its sale, although there can be no assurance of the timing or amount of any sales.
Current
finished goods do not include distributor channel inventories in the amounts of approximately $1,394 and $1,530 as of September
30, 2017 and December 31, 2016, respectively. Distributor channel inventories represent inventories at distributors and other
customers where revenue recognition criteria have not yet been achieved.
Net
loss incurred on valuation of inventory at lower of cost or market value and write-off of obsolete inventory during the three
months ended September 30, 2016 was $328. During the three months ended September 30, 2017 there was no write off on the
valuation of inventory.
6.
Share-based Compensation
Employee
Stock Option Plans
The
Company’s share-based incentive plans offering stock options primarily consists of two plans. Under both plans, one new
share is issued for each stock option exercised. The plans are described below.
The
Company’s 1998 Incentive Plan (the “1998 Plan”) was the Company’s primary plan through November 2007.
Under this plan shares of common stock were made available for issuance to employees and directors. Through December 1999, 1,066,000
options were granted that would cliff vest after 9.8 years; however, such vesting was accelerated for 637,089 of these options
upon meeting certain earnings per share goals through the fiscal year ended September 30, 2003. Subsequent to December 1999 and
through March 2002, 1,248,250 options were granted that would cliff vest after 6.0 years; however, such vesting was accelerated
for 300,494 of these options upon meeting certain earnings per share goals through the fiscal year ended September 30, 2005.
The
Company’s 2007 Equity Incentive Plan (the “2007 Plan”) was restated and approved by the shareholders on December
12, 2015. Provisions of the restated 2007 Plan include the granting of up to 2,000,000 incentive and non-qualified stock options,
stock appreciation rights, restricted stock and restricted stock units. Options may be granted to employees, officers, non-employee
directors and other service providers and may be granted upon such terms as the Compensation Committee of the Board of Directors
determines in their sole discretion.
Of
the options granted subsequent to March 2002, all vesting schedules are based on 3 or 4-year vesting schedules, with either one-third
or one-fourth vesting on the first anniversary and the remaining options vesting ratably over the remainder of the vesting term.
Generally, directors and officers have 3-year vesting schedules and all other employees have 4-year vesting schedules. Additionally,
in the event of a change in control or the occurrence of a corporate transaction, the Company’s Board of Directors has the
authority to elect that all unvested options shall vest and become exercisable immediately prior to the event or closing of the
transaction. All options outstanding as of September 30, 2017 had contractual lives of ten years.
Under
the 1998 Plan, 2,500,000 shares were authorized for grant. As of September 30, 2017, there are no options outstanding under the
1998 Plan. The remaining 50,000 of these options were exercised on July 11, 2017.
As
of September 30, 2017, there were 767,156 options outstanding under the 2007 Plan. As of September 30, 2017, the 2007 Plan had
471,500 authorized unissued options.
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited
- Dollars in thousands, except per share amounts)
A
summary of the stock option activity under the Company’s plans for the nine months ended September 30, 2017 is as follows:
|
|
Number
of shares
|
|
Weighted
average
exercise price
|
|
|
|
|
|
Options
outstanding at beginning of year
|
|
|
850,232
|
|
|
$
|
8.06
|
|
Granted
|
|
|
105,000
|
|
|
|
9.90
|
|
Less:
|
|
|
|
|
|
|
|
|
Exercised
|
|
|
(178,662
|
)
|
|
|
5.90
|
|
Forfeited
prior to vesting
|
|
|
(7,103
|
)
|
|
|
10.88
|
|
Canceled
or expired
|
|
|
(2,311
|
)
|
|
|
9.68
|
|
Options
outstanding at September 30, 2017
|
|
|
767,156
|
|
|
|
8.79
|
|
Options
exercisable at end of September 30, 2017
|
|
|
502,940
|
|
|
$
|
7.71
|
|
As
of September 30, 2017, the total remaining unrecognized compensation cost related to non-vested stock options, net of forfeitures,
was approximately $975, which will be recognized over a weighted average period of 1.99 years.
Stock
Option Repurchase
From
March 11, 2016 to March 17, 2016, the Company offered to repurchase eligible vested options to purchase shares under the 1998
Plan and the 2007 Plan from employees. The Company repurchased delivered options at a repurchase price equal to the difference
between the closing market price on the date of the employee’s communication of accepting the repurchase offer and the exercise
price of such employee’s delivered options, subject to applicable withholding taxes and charges. The Company repurchased
225,542 stock options from employees at an average purchase price of $7.77.
Employee
Stock Purchase Plan
The
Company issues shares to employees under the Company’s 2014 Employee Stock Purchase Plan (the “ESPP”). The ESPP
was approved by the Company’s shareholders on December 12, 2014. As of September 30, 2017, 471,160 of the originally approved
500,000 shares were available for offerings under the ESPP. Offering periods under the ESPP commence on each January 1 and July
1, and continue for a duration of six months. The ESPP is available to all employees who do not own, or not are deemed to own,
shares of stock making up an excess of 5% of the combined voting power of the Company and its subsidiaries. During each offering
period, each eligible employee may purchase shares under the ESPP after authorizing payroll deductions. Under the ESPP, each employee
may purchase up to the lesser of 2,500 shares or $25 of fair market value (based on the established purchase price) of the Company’s
stock for each offering period. Unless the employee has previously withdrawn from the offering, his or her accumulated payroll
deductions will be used to purchase common stock on the last business day of the period at a price equal to 85% (or a 15% discount)
of the fair market value of the common stock on the first or last day of the offering period, whichever is lower.
Share-based
compensation expense related to ESPP has been recorded as follows:
|
|
Three
months ended September 30,
|
|
Nine
months ended September 30,
|
|
|
2017
|
|
2016
|
|
2017
|
|
2016
|
Cost
of goods sold
|
|
$
|
5
|
|
|
$
|
7
|
|
|
$
|
16
|
|
|
$
|
18
|
|
Sales
and marketing
|
|
|
10
|
|
|
|
15
|
|
|
|
31
|
|
|
|
42
|
|
Research
and product development
|
|
|
25
|
|
|
|
40
|
|
|
|
80
|
|
|
|
106
|
|
General
and administrative
|
|
|
122
|
|
|
|
113
|
|
|
|
341
|
|
|
|
328
|
|
|
|
$
|
162
|
|
|
$
|
175
|
|
|
$
|
468
|
|
|
$
|
494
|
|
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited
- Dollars in thousands, except per share amounts)
7.
Shareholders’ Equity
Stock
Repurchase Program
On
March 9, 2016, the Board of Directors of the Company authorized the repurchase of up to $10,000 of the Company’s outstanding
shares of common stock under a stock repurchase program. In connection with the repurchase authorization, the Company was authorized
to complete the repurchase through open market transactions or through an accelerated share repurchase program, in each case to
be executed at management’s discretion based on business and market conditions, stock price, trading restrictions, acquisition
activity and other factors. The repurchase program may be suspended or discontinued at any time without prior notice. The transactions
effectuated to date occurred in open market purchases.
On
March 1, 2017, the Board of Directors of the Company renewed and extended the repurchase program for up to an additional $10,000
of common stock over the next twelve months. In connection with the repurchase extension authorization, the Company was authorized
to complete the repurchase through open market transactions or through an accelerated share repurchase program, in each case to
be executed at management’s discretion based on business and market conditions, stock price, trading restrictions, acquisition
activity and other factors. The repurchase program may be suspended or discontinued at any time without prior notice. The transactions
effectuated to date occurred in open market purchases.
Period
|
|
Total
Number of
Shares Purchased
|
|
Average
Price
Paid per Share
|
|
Total
Number of
Shares Purchased
as Part of Publicly
Announced Plans
or Programs
|
|
Approximate
Dollar
Value of Shares that
May Yet Be
Purchased Under
the Plans or Programs
(in $ millions)
|
July
2017
|
|
|
11,794
|
|
|
$
|
9.69
|
|
|
|
11,794
|
|
|
$
|
7.6
|
|
August 2017
|
|
|
37,247
|
|
|
|
7.77
|
|
|
|
37,247
|
|
|
|
7.3
|
|
September
2017
|
|
|
90,529
|
|
|
|
7.62
|
|
|
|
90,529
|
|
|
|
6.6
|
|
Total
|
|
|
139,570
|
|
|
|
7.84
|
|
|
|
139,570
|
|
|
|
|
|
Cash
Dividends
On
August 7, 2017, the Company declared a cash dividend of $0.07 per share of ClearOne common stock paid September 7, 2017
to shareholders of record as of August 22, 2017.
Changes
in Shareholders’ Equity
The
following table summarizes the change in shareholders’ equity during the three and nine months ended September 30, 2017
and 2016, respectively:
|
|
Three
months ended September 30,
|
|
|
Nine
months ended September 30,
|
|
|
|
2017
|
|
|
2016
|
|
|
2017
|
|
|
2016
|
|
Balance
at the beginning of the period
|
|
$
|
72,444
|
|
|
$
|
79,783
|
|
|
$
|
77,449
|
|
|
$
|
82,569
|
|
Exercise
of stock options, restricted stock and stock option cancelled
|
|
|
(113
|
)
|
|
|
238
|
|
|
|
(225
|
)
|
|
|
671
|
|
Stock
repurchased
|
|
|
(1,094
|
)
|
|
|
(1,024
|
)
|
|
|
(4,151
|
)
|
|
|
(5,139
|
)
|
Options
repurchased
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
(1,752
|
)
|
Proceeds
from stock purchase plan
|
|
|
15
|
|
|
|
21
|
|
|
|
55
|
|
|
|
65
|
|
Dividends
|
|
|
(599
|
)
|
|
|
(449
|
)
|
|
|
(1,650
|
)
|
|
|
(1,373
|
)
|
Share-based
compensation
|
|
|
174
|
|
|
|
175
|
|
|
|
514
|
|
|
|
494
|
|
Tax
benefit - stock option exercise
|
|
|
—
|
|
|
|
33
|
|
|
|
—
|
|
|
|
690
|
|
Unrealized
gain or loss on investments, net of tax
|
|
|
10
|
|
|
|
(38
|
)
|
|
|
68
|
|
|
|
179
|
|
Foreign
currency translation adjustment
|
|
|
23
|
|
|
|
7
|
|
|
|
88
|
|
|
|
19
|
|
Net
income/(loss) during the period
|
|
|
(9,276
|
)
|
|
|
1,209
|
|
|
|
(10,564
|
)
|
|
|
3,532
|
|
Balance
at end of the period
|
|
$
|
61,584
|
|
|
$
|
79,955
|
|
|
$
|
61,584
|
|
|
$
|
79,955
|
|
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited
- Dollars in thousands, except per share amounts)
8.
Fair Value Measurements
The
fair value of the Company’s financial instruments reflects the amounts that the Company estimates it will receive in connection
with the sale of an asset or pay in connection with the transfer of a liability in an orderly transaction between market participants
at the measurement date (exit price). The fair value hierarchy prioritizes the use of inputs used in valuation techniques into
the following three levels:
Level
1
- Quoted prices in active markets for identical assets and liabilities.
Level
2
- Observable inputs other than quoted prices in active markets for identical assets and liabilities; quoted prices in markets
that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the
full term of the assets or liabilities. This category generally includes U.S. Government and agency securities; municipal securities;
mutual funds and securities sold and not yet settled.
Level
3
- Unobservable inputs.
The
substantial majority of the Company’s financial instruments are valued using observable input. The following table
sets forth the fair value of the financial instruments re-measured by the Company as of September 30, 2017 and December 31, 2016:
|
|
Level
1
|
|
|
Level
2
|
|
|
Level
3
|
|
|
Total
|
|
September
30, 2017
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Corporate
bonds and notes
|
|
$
|
—
|
|
|
$
|
14,459
|
|
|
$
|
—
|
|
|
$
|
14,459
|
|
Municipal
bonds
|
|
|
—
|
|
|
|
5,974
|
|
|
|
—
|
|
|
|
5,974
|
|
Total
|
|
$
|
—
|
|
|
$
|
20,433
|
|
|
$
|
—
|
|
|
$
|
20,433
|
|
|
|
Level
1
|
|
Level
2
|
|
Level
3
|
|
Total
|
December
31, 2016
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Corporate
bonds and notes
|
|
$
|
—
|
|
|
$
|
19,970
|
|
|
$
|
—
|
|
|
$
|
19,970
|
|
Municipal
bonds
|
|
|
—
|
|
|
|
6,425
|
|
|
|
—
|
|
|
|
6,425
|
|
Total
|
|
$
|
—
|
|
|
$
|
26,395
|
|
|
$
|
—
|
|
|
$
|
26,395
|
|
9.
Income Taxes
The
Company’s forecasted effective tax benefit rate at September 30, 2017 is 36.1%, a 0.9% decrease from the 37.0% effective
tax rate recorded at December 31, 2016. The forecasted effective tax benefit rate of 36.1% excludes jurisdictions for which no
benefit from forecasted current year losses is anticipated. Including losses from such jurisdictions results in a forecasted effective
tax benefit rate of 30.1%. Our forecasted effective tax rate could fluctuate significantly on a quarterly basis and could change,
to the extent that earnings in countries with tax rates that differ from that of the U.S. differ from amounts anticipated at September
30, 2017.
After
a discrete tax expense of $145, the effective tax benefit rate for the quarter ended September 30, 2017 is 29.0%. The discrete
tax expense of $145 is primarily attributable to changes in income tax reserves related to research and development tax credits.
10.
Subsequent Events
On
November 8, 2017 the Company announced a quarterly cash dividend for the third quarter of 2017 at $0.07 per share to be paid on
December 6, 2017 to shareholders of record as of November 22, 2017.
Item
2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
This
report on Form 10-Q includes “forward-looking statements” within the meaning of Section 27A of the Securities Act
of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). All
statements in this report, other than statements of historical fact, are forward-looking statements for purposes of these provisions,
including any projections of earnings, revenues or other financial items, any statements of the plans and objectives of management
for future operations, any statements concerning proposed new products or services, any statements regarding future economic conditions
or performance, and any statements of assumptions underlying any of the foregoing. All forward-looking statements included in
this report are made as of the date hereof and are based on information available to us as of such date. We assume no obligation
to update any forward-looking statement. In some cases, forward-looking statements can be identified by the use of terminology
such as “may,” “will,” “expects,” “plans,” “anticipates,” “intends,”
“believes,” “estimates,” “potential,” or “continue,” or the negative thereof or
other comparable terminology. Although we believe that the expectations reflected in the forward-looking statements contained
herein are based upon reasonable assumptions at the time made, there can be no assurance that any such expectations or any forward-looking
statement will prove to be correct. Our actual results will vary, and may vary materially, from those projected or assumed in
the forward-looking statements. Future financial condition and results of operations, as well as any forward-looking statements,
are subject to inherent risks and uncertainties, many of which we cannot predict with accuracy and some of which we might not
anticipate, including, without limitation, product recalls and product liability claims; infringement of our technology or assertion
that our technology infringes the rights of other parties; termination of supplier relationships, or failure of suppliers to perform;
inability to successfully manage growth; delays in obtaining regulatory approvals or the failure to maintain such approvals; concentration
of our revenue among a few customers, products or procedures; development of new products and technology that could render our
products obsolete; market acceptance of new products; introduction of products in a timely fashion; price and product competition,
availability of labor and materials, cost increases, and fluctuations in and obsolescence of inventory; volatility of the market
price of our common stock; foreign currency fluctuations; changes in key personnel; work stoppage or transportation risks; integration
of business acquisitions; and other factors referred to in our reports filed with the SEC, including our Annual Report on Form
10-K for the year ended December 31, 2016. All subsequent forward-looking statements attributable to us or persons acting on our
behalf are expressly qualified in their entirety by these cautionary statements. Additional factors that may have a direct bearing
on our operating results are discussed in Part I, Item 1A “Risk Factors” in our Annual Report on Form 10-K for the
year ended December 31, 2016.
BUSINESS
OVERVIEW
ClearOne
is a global company that designs, develops and sells conferencing, collaboration, and network streaming & signage solutions
for voice and visual communications. The performance and simplicity of our advanced, comprehensive solutions offer unprecedented
levels of functionality, reliability and scalability.
We
derive most of our revenue from professional audio conferencing products by promoting our products in the professional audio visual
channel. We have extended our total addressable market from installed audio conferencing market to adjacent complementary markets
– microphones, video collaboration and networked media streaming. We have achieved this through strategic technological
acquisitions as well as by internal product development.
During
the nine months ended September 30, 2017, we were awarded two new patents, one of which was our innovative patent on a system
and method involving the combination of echo cancellation, beamforming microphone arrays, and smart beam selection--the technology
underpinning the ‘acoustic intelligence’ of our ground-breaking Beamforming Microphone Array. We continued to take
the necessary steps to enforce this strategic patent to remedy having to compete against our own patented technology, and to defend
the validity of our patents.
During
the nine months ended September 30, 2017, our efforts primarily centered on shipping remaining models in our newly introduced
next-gen DSP conferencing platform and Beamforming Microphone Array, and promoting the transition from our legacy Converge
Pro 1 (CP1) platform to the new Converge Pro 2 (CP2) platform.
Overall
revenue declined in the three and nine months ended September 30, 2017 when compared to the three and nine months ended September
30, 2016 notwithstanding a large order that was fulfilled in the quarter ended September 30, 2017. The declines in revenue from
professional audio products and unified communications end points more than offset the increase in revenue from video products.
Our gross profit margin decreased to 59% from 63% for the nine months ended September 30, 2017 and 2016, respectively. Gross profit
margin decrease was primarily due to the decrease in the mix of higher margin products and the price reductions associated with
transition from CP1 to CP2 partially offset by the absence of inventory scrapping costs in 2017. Our gross profit margin
increased to 62% from 59% for the three months ended September 30, 2017 and 2016, respectively. The increase is primarily due
to the significantly higher margin enjoyed by the large order fulfilled in the third quarter of 2017 and the absence of
inventory scrapping costs in the third quarter of 2017 compared to third quarter of 2016.
MANAGEMENT’S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Industry
conditions
We
operate in a very dynamic and highly competitive industry which is dominated on the one hand by a few players with respect to
certain products like traditional video conferencing appliances while on the other influenced heavily by a fragmented reseller
market consisting of numerous regional and local players. The industry is also characterized by the influx of venture capitalist
funded start-ups and private companies keen to win market share even at the expense of mounting financial losses.
Economic
conditions, challenges and risks
The
audio-visual products market is characterized by intense competition and rapidly evolving technology. Our competitors vary within
each product category. Our professional audio communication products, which contribute the most to our revenue, continues to be
ahead of the competition despite the reduction in revenues through our transition from the CP1 platform to the next generation
CP2 platform. Our strength in this space is largely due to our industry leading conferencing technologies and the full suite of
professional microphone products, especially Beamforming Microphone Arrays. Despite our strong leadership position in the professional
audio communications products market, we face challenges to revenue growth due to the limited size of the market and pricing pressures
from new competitors attracted to the commercial market. Our revenues from our flagship professional audio conferencing products
continue to suffer due to the delay in transitioning from our old CP1 platform to CP2 platform and due to increased competition
for our beamforming microphones from competitors who are infringing our patents.
Revenue
from our video products in the overall revenue mix has been improving on the back of a strong growth for our video products in
2016 that has continued in 2017. We face intense competition in this market from well-established market leaders as well as emerging
players rich with marketing funds. We expect our strategy of combining Spontania, our cloud-based video conferencing product,
Collaborate, our appliance based media collaboration product and our high-end audio conferencing technology to provide growth
in revenue in the near future. We believe we are also well positioned to capitalize on the continuing migration away from the
traditional hardware based video conferencing systems to software based video conferencing applications.
We
derive a portion of our revenue (about 49%) from international operations and expect this trend to continue in the future. Most
of our revenue from outside the U.S. is billed in US Dollars and is not exposed to any significant currency risk. In spite of
the U.S. dollar losing strength against other currencies, a strong U.S. dollar would make our products less competitive.
Deferred
Revenue
Each
quarter-end, we evaluate the inventory in the distribution channel through information provided by certain of our distributors.
The level of inventory in the channel fluctuates up or down each quarter based upon our distributors’ individual operations.
Accordingly, each quarter-end revenue deferral is calculated and recorded based upon the underlying channel inventory at quarter-end.
Deferred revenue was approximately $3.9 million as of September 30, 2017, compared to $3.8 million of deferred revenue as of June
30, 2017 and $3.9 million of deferred revenue as of December 31, 2016.
A
detailed discussion of our results of operations follows below.
Results
of Operations for the three and nine months ended September 30, 2017 and 2016
The
following table sets forth certain items from our unaudited condensed consolidated statements of operations (dollars in thousands)
for the three and nine months ended September 30, 2017 (“2017-Q3”) and 2016 (“2016-Q3”), respectively,
together with the percentage of total revenue which each such item represents:
MANAGEMENT’S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
|
|
Three
months ended September 30,
|
|
|
Nine
months ended September 30,
|
|
|
|
2017
|
|
|
2016
|
|
|
Percentage
Change 2017 vs. 2016
|
|
|
2017
|
|
|
2016
|
|
|
Percentage
Change 2017 vs. 2016
|
|
Revenue
|
|
$
|
10,560
|
|
|
$
|
12,908
|
|
|
|
(18
|
)%
|
|
$
|
32,549
|
|
|
|
37,907
|
|
|
|
(14
|
)%
|
Cost
of goods sold
|
|
|
4,051
|
|
|
|
5,240
|
|
|
|
(23
|
)%
|
|
|
13,293
|
|
|
|
14,110
|
|
|
|
(6
|
%
|
Gross
profit
|
|
|
6,509
|
|
|
|
7,668
|
|
|
|
(15
|
)%
|
|
|
19,256
|
|
|
|
23,797
|
|
|
|
(19
|
)%
|
Sales
and marketing
|
|
|
3,006
|
|
|
|
2,389
|
|
|
|
26
|
%
|
|
|
8,393
|
|
|
|
7,695
|
|
|
|
9
|
%
|
Research
and product development
|
|
|
2,268
|
|
|
|
2,116
|
|
|
|
7
|
%
|
|
|
6,947
|
|
|
|
6,481
|
|
|
|
7
|
%
|
General
and administrative
|
|
|
1,281
|
|
|
|
1,739
|
|
|
|
(
26
|
)
%
|
|
|
5,597
|
|
|
|
4,904
|
|
|
|
14
|
%
|
Impairment
of an intangible asset
|
|
|
736
|
|
|
|
—
|
|
|
|
100
|
%
|
|
|
736
|
|
|
|
—
|
|
|
|
100
|
%
|
Impairment
of goodwill
|
|
|
12,724
|
|
|
|
—
|
|
|
|
100
|
%
|
|
|
12,724
|
|
|
|
—
|
|
|
|
100
|
%
|
Operating
income/(loss)
|
|
|
(13,506
|
)
|
|
|
1,424
|
|
|
|
(1,048
|
)%
|
|
|
(15,141
|
)
|
|
|
4,717
|
|
|
|
(421
|
)%
|
Other
income
|
|
|
78
|
|
|
|
100
|
|
|
|
(22
|
)%
|
|
|
264
|
|
|
|
194
|
|
|
|
36
|
%
|
Income
(loss) before income taxes
|
|
|
(13,428
|
)
|
|
|
1,524
|
|
|
|
(981
|
)%
|
|
|
(14,877
|
)
|
|
|
4,911
|
|
|
|
(403
|
)%
|
Provision
for (benefit from) income taxes
|
|
|
(4,152)
|
|
|
|
315
|
|
|
|
(1,418
|
)%
|
|
|
(4,313
|
)
|
|
|
1,379
|
|
|
|
(413
|
)%
|
Net
income (loss)
|
|
$
|
(9,276
|
)
|
|
$
|
1,209
|
|
|
|
(867
|
)%
|
|
$
|
(10,564
|
)
|
|
$
|
3,532
|
|
|
|
(399
|
)%
|
Revenue
Our
revenue decreased by $2.3 million, or 18%, to $10.6 million in 2017-Q3 compared to $12.9 million in 2016-Q3. The 66% increase
in revenue from video products was more than offset by a 30% decline in professional audio conferencing revenue and a 25% decline
in revenue from unified communication (UC) end points. For the nine months ended September 30, 2017, revenue decreased by $5.4
million, or 14%, to $32.5 million, as compared to $37.9 million for the nine months ended September 30, 2016. The 51% increase
in revenue from video products was more than offset by a 21% decline in professional audio conferencing revenue and a 26% decline
in revenue from unified communication (UC) end points. During the nine months ended September 30, 2017, premium audio conferencing
products declined the most while media collaboration products increased the most. The decline in revenue from professional audio
conferencing products was mostly due to decline in revenue from legacy CP1 products and reductions in CP1 pricing effected in
the last quarter of 2016. The share of professional audio communications products (which includes microphone products but not
premium products) in our product mix declined from 77% in 2016-Q3 to 66% in 2017-Q3. The increase in revenue from video products
was due to the success of Unite camera and favorable reception to the new Collaborate SKUs containing integrated audio solutions.
Share of video products in the revenue increased from 12% in 2016-Q3 to 24% in 2017-Q3, while share of UC end points in the revenue
declined from 11% in 2016-Q3 to 10% in 2017-Q3.
During
2017-Q3, revenue declined in the US, Canada, South East Asia, Japan, Korea and some parts of Europe while revenue
from China, the Middle East, India, Australia and some part of Europe grew. Asia Pacific including Middle East increased
by 43%; Europe and Africa declined by 3% and Americas declined by about 37%. The revenue decline was primarily caused by the delay
in the transition to our next generation audio platform, CP2, combined with price reduction offered to stimulate customer interest
and sales in the legacy CP1 products. Revenue was also negatively affected by less than robust infrastructure and capital equipment
spending. In spite of the generally less than robust infrastructure spending, we did complete the sale to a major project by a
Chinese entity. This caused the revenue increase for the Asia Pacific region quarter-over-quarter. We believe we will return to
a growth path once the transition from CP1 platform to the newer CP2 platform occurs. However, we anticipate that the growth will
depend on the speed at which our customers transition to the new platform and the economic recovery in certain key markets which
remains weak.
Costs
of Goods Sold and Gross Profit
Cost
of goods sold (“COGS”) includes expenses associated with finished goods purchased from outsourced manufacturers, the
manufacture of our products (including material and direct labor), our manufacturing and operations organization, property and
equipment depreciation, warranty expense, freight expense, royalty payments, and the allocation of overhead expenses.
Our
gross profit for the three months ended September 30, 2017 was approximately $6.5 million or 62% compared to approximately $7.7
million, or 59%, for the three months ended September 30, 2016. Gross margin for the three months ended September 30, 2017
improved primarily due to the significantly higher margin enjoyed by the large order fulfilled in the third quarter of 2017 and
the absence of inventory scrapping costs in the third quarter of 2017. Our gross profit for the nine months ended September
30, 2017 was approximately $19.3 million, or 59%, compared to approximately $23.8 million, or 63%, for the nine months ended September
30, 2016. Gross margin declined for the nine months ended September 30, 2017 primarily due to the following reasons: (1)
price reductions made to CP1 products to encourage CP1 sales and (2) decline in higher margin professional audio conferencing
products in the mix partially offset by the absence of inventory scrapping costs in 2017.
MANAGEMENT’S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Our
profitability in the near-term continues to depend significantly on our revenues from professional audio conferencing products.
We hold long-term inventory and if we are unable to sell our long-term inventory, our profitability might be affected by inventory
write-offs and price mark-downs.
Operating
Expenses
Operating
income, or income from operations, is the surplus after operating expenses are deducted from gross profits. Operating expenses
include sales and marketing (“S&M”) expenses, research and product development (“R&D”) expenses
and general and administrative (“G&A”) expenses. Total operating expenses were $20.0 million for the three
months ended September 30, 2017 compared to $6.2 million for the three months ended September 30, 2016. Total operating expenses
were $34.4 million for the nine months ended September 30, 2017, of which $13.4 million was related to the impairment
of the goodwill and intangibles in Q3 2017, compared to $19.1 million for the nine months ended September 30, 2016. The following
contains a more detailed discussion of expenses related to sales and marketing, research and product development, general and
administrative, and other items.
Sales
and Marketing
- S&M expenses include sales, customer service, and marketing expenses such as employee-related
costs, allocations of overhead expenses, trade shows, and other advertising and selling expenses.
S&M
expenses for the three months ended September 30, 2017 increased to $3.0 million from $2.4 million for the three months ended
September 30, 2016. The increase was mainly due to increases in inventories used for customer demonstrations, higher commission
expenses booked in the third quarter of 2017, higher marketing expenses related to tradeshows, and increased spending in employee
related expenses. S&M expenses for the nine months ended September 30, 2017 increased to $8.4 million from $7.7 million
for the nine months ended September 30, 2016. The increase was primarily due to an increase in headcount and employee
related expenses, increases in inventories used for customer demonstrations and increase in marketing expenses related
to tradeshows partially offset by decline in commissions paid to independent agents.
Research
and Product Development
- R&D expenses include research and development, product line management, engineering
services, and test and application expenses, including employee related costs, outside services, expensed materials, depreciation,
and an allocation of overhead expenses.
R&D
expenses were approximately $2.3 million for the three months ended September 30, 2017, as compared to $2.1 million for the three
months ended September 30, 2016. The increase was primarily due to increase in employee costs related to salaries, benefits and
patent bonuses. R&D expenses were approximately $6.9 million for the nine months ended September 30, 2017, as compared to
$6.5 million for the nine months ended September 30, 2016. The increase was primarily due to an increase in employee-related costs
mainly salaries and benefits expenses.
General
and Administrative
- G&A expenses include employee-related costs, professional service fees, allocations of overhead
expenses, litigation costs, and corporate administrative costs, including costs related to finance and human resources.
G&A
expenses decreased approximately 26% to $1.2 million for the three months ended September 30, 2017 compared with approximately
$1.7 million in 2016. The reduction was primarily due to the decrease in legal costs. G&A expenses increased approximately
14% to $5.6 million for the nine months ended September 30, 2017 compared with approximately $4.9 million in 2016. The increase
in G&A expenses was primarily due to increases in legal expenses and consulting fees partially offset by a decline in salaries
and bonuses.
Impairment
of Goodwill and an intangible asset
-
Based on the results of the Company’s recent impairment analysis triggered
by the fall in the Company’s stock price and recent financial results, the Company determined that goodwill and an intangible
asset consisting of customer relationships were impaired and recognized a charge of $12.7 million towards goodwill impairment
and $0.7 million towards the intangible asset impairment for the three and nine months ended September 30, 2017.
Other
income (expense), net
Other
income (expense), net, includes interest income, interest expense, and foreign currency changes.
Provision
for income taxes
During
the nine months ended September 30, 2017, we accrued income taxes at the forecasted effective tax benefit rate of 36.1% as comp
ared
to the forecasted effective tax rate of 32.3% used during the nine months ended September 30, 2016. The 3.8% increase in the forecasted
effective tax rate was primarily due to projected income in 2016, yet projected losses in 2017. As a result, tax benefits, such
as the research and development tax credit, increased the benefit rate in 2017. In
addition, a discrete tax expense of
$145 thousand is primarily attributable to changes in income tax reserves related to research and development tax credits.
MANAGEMENT’S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
LIQUIDITY
AND CAPITAL RESOURCES
As
of September 30, 2017, our cash and cash equivalents were approximately $3.0 million, a decrease of approximately $9.1
million compared to cash and cash equivalents of approximately $12.1 million as of December 31, 2016. Our working capital
was $26.8 million and $30.8 million as of September 30, 2017 and December 31, 2016, respectively.
Net
cash used in operating activities was approximately $7.6 million for the nine months ended September 30, 2017, an increase
of cash used of approximately $15.0 million from $7.4 million of cash provided by operating activities in the nine months
ended September 30, 2016. The increase was primarily due to an increase in cash outflows due to change in operating assets and
liabilities of $9.2 million and a reduction in net income of $14.1 million offset by an increase in non-cash charges
of $8.3 million.
Net
cash provided by investing activities was $4.4 million for the nine months ended September 30, 2017 compared to net cash
flows used by investing activities of $1.8 million during the nine months ended September 30, 2016, an increase in cash provided
of $6.2 million. The increase was primarily due to an increase in net sales of marketable securities of approximately $7.2
million, offset by $1.0 million in purchases of property and equipment and intangibles.
Capitalization
of patent defense costs. We capitalize external legal costs incurred in the defense of our patents when we believe that a significant,
discernible increase in value will result from the defense and a successful outcome of the legal action is probable. When we capitalize
patent defense costs we amortize the costs over the remaining estimated useful life of the patent, which is 15 to 17 years. During
the three and nine months ended September 30, 2017 we paid $845 thousand, in gross legal costs related to the defense of our patents
and $845 thousand of such costs were capitalized.
Net
cash used in financing activities was approximately $5.9 million during the nine months ended September 30, 2017 primarily consisted
of cash outflows of $4.4 million on repurchase and cancellation of stock, $1.7 million for dividend payments partially offset
by $0.1 million proceeds from stock based compensation programs. Net cash used in financing activities was approximately
$6.8 million during the nine months ended September 30, 2016 primarily consisted of cash outflows of $6.9 million on repurchase
and cancellation of stock and stock options, $1.4 million for dividend payments offset by $1.5 million proceeds from stock
based compensation programs.
We
believe that future income from operations and effective management of working capital will provide the liquidity needed to meet
our short-term and long-term operating requirements and finance our growth plans. We also believe that our strong financial position
and sound business structure will enable us to raise additional capital if and when needed to meet our short and long-term financing
needs. In addition to capital expenditures, we may use cash in the near future for selective infusions of technology, sales and
marketing, infrastructure, and other investments to fuel our growth, as well as acquisitions that may strategically fit our business
and are accretive to our performance. We also intend to use cash to pay quarterly cash dividends and repurchase stock under our
repurchase program.
At
September 30, 2017, we had open purchase orders related to our electronics manufacturing service providers of approximately $6.7
million, primarily related to inventory purchases.
At
September 30, 2017, we had inventory totaling $22.1 million, of which non-current inventory accounted for $2.4 million. This compares
to total inventories of $13.0 million and non-current inventory of $1.7 million as of December 31, 2016.
Off-Balance
Sheet Arrangements
We
have no off-balance-sheet arrangements that have or are reasonably likely to have a current or future material effect on our financial
condition, changes in financial conditions, revenues or expenses, results of operations, liquidity, capital expenditures or capital
resources, results of operations or liquidity.
CRITICAL
ACCOUNTING POLICIES AND ESTIMATES
Our
discussion and analysis of our results of operations and financial position are based upon our consolidated financial statements,
which have been prepared in conformity with U.S. generally accepted accounting principles. We review the accounting policies used
in reporting our financial results on a regular basis. The preparation of these financial statements requires us to make estimates
and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities
at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. We evaluate
our assumptions and estimates on an ongoing basis including those related to revenue recognition, income taxes and valuation of
long-lived assets, goodwill and other intangible assets and may employ outside experts to assist in our evaluations. We believe
that the estimates we use are reasonable; however, actual results could differ from those estimates.
MANAGEMENT’S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Our
significant accounting policies are described in our Annual Report on Form 10-K for the year ended December 31, 2016. We believe
the following critical accounting policies identify our most critical accounting policies, which are the policies that are both
important to the representation of our financial condition and results and require our most difficult, subjective or complex judgments,
often as a result of the need to make estimates about the effect of matters that are inherently uncertain.
Revenue
and Associated Allowances for Revenue Adjustments and Doubtful Accounts
Included
in continuing operations is product revenue, primarily from product sales to distributors, dealers, and end-users. Product revenue
is recognized when (i) the products are shipped and any right of return expires, (ii) persuasive evidence of an arrangement exists,
(iii) the price is fixed and determinable, and (iv) collection is reasonably assured.
We
provide a right of return on product sales to certain distributors under a product rotation program. Under this seldom-used program,
once a quarter, a distributor is allowed to return products purchased during the prior quarter for a total value generally not
exceeding 15% of the distributor’s net purchases during the preceding quarter. The distributor is, however, required to
place a new purchase order for an amount not less than the value of products returned under the stock rotation program. When products
are returned, the associated revenue, cost of goods sold, inventory and accounts receivable originally recorded are reversed.
When the new order is placed, the revenue, associated cost of goods sold, inventory and accounts receivable are recorded and the
product revenue is subject to the deferral analysis described below. In a small number of cases, the distributors are also permitted
to return the products for other business reasons.
Revenue
from product sales to distributors is not recognized until the return privilege has expired or until it can be determined with
reasonable certainty that the return privilege has expired, which approximates when the product is sold-through to customers of
our distributors (dealers, system integrators, value-added resellers, and end-users), rather than when the product is initially
shipped to a distributor. At each quarter-end, we evaluate the inventory in the distribution channel through information provided
by our distributors. The level of inventory in the channel will fluctuate up or down each quarter based upon our distributors’
individual operations. Accordingly, each quarter-end deferral of revenue and associated cost of goods sold are calculated and
recorded based upon the actual channel inventory reported at quarter-end. Further, with respect to distributors and other channel
partners not reporting the channel inventory, the revenue and associated cost of goods sold are deferred until we receive payment
for the product sales made to such distributors or channel partners.
The
accuracy of the deferred revenue and costs depend to a large extent on the accuracy of the inventory reports provided by our distributors
and other resellers and any material error in those reports would affect our revenue deferral. However, we believe that the controls
we have in place, including periodic physical inventory verifications and analytical reviews, would help us identify and prevent
any material errors in such reports.
The
amount of deferred cost of goods sold was included in distributor channel inventories. The following table details the amount
of deferred revenue, cost of goods sold, and gross profit (in thousands) as of September 30, 2017 and December 31, 2016:
|
|
September
30, 2017
|
|
|
December
31, 2016
|
|
Deferred
revenue
|
|
$
|
3,870
|
|
|
$
|
3,882
|
|
Deferred
cost of goods sold
|
|
|
1,394
|
|
|
|
1,530
|
|
Deferred
gross profit
|
|
$
|
2,476
|
|
|
$
|
2,352
|
|
We
offer rebates and market development funds to certain of our distributors, dealers/resellers, and end-users based upon volume
of product purchased by them. We record rebates as a reduction of revenue in accordance with GAAP.
We
offer credit terms on the sale of our products to a majority of our channel partners and perform ongoing credit evaluations of
our customers’ financial condition. We maintain an allowance for doubtful accounts for estimated losses resulting from the
inability or unwillingness of our channel partners to make required payments based upon our historical collection experience and
expected collectability of all accounts receivable. Our actual bad debts in future periods may differ from our current estimates
and the differences may be material, which may have an adverse impact on our future accounts receivable and cash position.
MANAGEMENT’S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Intangible
and Long-Lived Assets:
I
ntangible
assets with determinable lives consist primarily of customer relationships, unpatented technology, patents and trademarks and
are amortized over their estimated useful lives, ranging from 5 to 15 years. We rely on patents and proprietary technology and
seek patent protection for products and production methods. We capitalize external legal costs incurred in the defense of our
patents when we believe that a significant, discernible increase in value will result from the defense and a successful outcome
of the legal action is probable. These costs are amortized over the remaining estimated useful life of the patent, which is 15
and 17 years. We assess the future economic benefit and/or the successful outcome of legal action related to patent defense
involves considerable management judgment and a different outcome could result in material write-offs of the carrying value of
these assets. During the three and nine months ended September 30, 2017, we capitalized $845 thousand in legal costs related to
the defense of our patents.
Impairment
of Goodwill
Goodwill
is measured as the excess of the cost of acquisition over the sum of the amounts assigned to tangible and identifiable intangible
assets acquired less liabilities assumed. We perform impairment tests of goodwill on an annual basis in the fourth fiscal quarter,
or sooner if a triggering event occurs suggesting possible impairment of the values of these assets.
We
assess the recoverability of our one reporting unit’s carrying value of goodwill by making a qualitative or quantitative
assessment. If we begin with a qualitative assessment and are able to support the conclusion that it is not more likely than not
that the fair value of the Company is less than its carrying value, we are not required to perform the two-step impairment test.
Otherwise, using the two−step approach is required. In the first step of the goodwill impairment test, we compare the carrying
value the Company, including its recorded goodwill, to the estimated fair value. We estimate the fair value using an equity-value
based methodology. The principal method used is an equity-value based method in which the Company’s market-cap is compared
to the net book value. This value is then compared to total net assets. If the fair value of the Company exceeds its carrying
value, the goodwill is not impaired and no further review is required. However, if the fair value of the reporting unit is less
than its carrying value, we perform the second step of the goodwill impairment test to determine the amount of the impairment
charge, if any. The second step involves a hypothetical allocation of the fair value of the Company to its net tangible and intangible
assets (excluding goodwill) as if the business unit were newly acquired, which results in an implied fair value of goodwill. The
amount of the impairment charge is the excess of the recorded goodwill over the implied fair value of goodwill.
During
the three and nine months ended September 30, 2017 we recorded $12.7 million or the entire value of goodwill as an impairment
charge.
Impairment
of Long-Lived Assets
We
assess the impairment of long-lived assets, such as property and equipment and definite-lived intangibles subject to amortization,
annually or whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable. Recoverability
of assets to be held and used is measured by a comparison of the carrying amount of an asset or asset group to estimated future
undiscounted net cash flows of the related asset or group of assets over their remaining lives. If the carrying amount of an asset
exceeds its estimated future undiscounted cash flows, an impairment charge is recognized for the amount by which the carrying
amount exceeds the estimated fair value of the asset. Impairment of long-lived assets is assessed at the lowest levels for which
there are identifiable cash flows that are independent of other groups of assets. The impairment of long-lived assets requires
judgments and estimates. If circumstances change, such estimates could also change. Assets held for sale are reported at the lower
of the carrying amount or fair value, less the estimated costs to sell.
During
the three and nine months ended September 30, 2017 we recorded $736 thousand as a charge for impairment of an intangible asset
consisting of customer relationships.
Accounting
for Income Taxes
We
are subject to income taxes in both the United States and in certain foreign jurisdictions. We estimate our current tax position
together with our future tax consequences attributable to temporary differences resulting from differing treatment of items, such
as deferred revenue, depreciation, and other reserves for tax and accounting purposes. These temporary differences result in deferred
tax assets and liabilities. We must then assess the likelihood that our deferred tax assets will be recovered from future taxable
income, prior year carryback, or future reversals of existing taxable temporary differences. To the extent we believe that recovery
is not more likely than not, we establish a valuation allowance against these deferred tax assets. Significant judgment is required
in determining our provision for income taxes, our deferred tax assets and liabilities, and any valuation allowance recorded against
our deferred tax assets.
To
the extent we establish a valuation allowance in a period, we must include and expense the allowance within the tax provision
in the consolidated statement of operations. In accordance with ASC Topic 740, “Accounting for Income Taxes”, we analyzed
our valuation allowance at December 31, 2016 and determined that based upon available evidence it is more likely than not that
certain of our deferred tax assets related to capital loss carryovers, state research and development credits, and foreign net
operating loss carryforwards will not be realized and, accordingly, we have recorded a valuation allowance against these deferred
tax assets in the amount of $1.4 million.
Lower-of-Cost
or Market Adjustments and Reserves for Excess and Obsolete Inventory
We
account for our inventory on a first-in, first-out basis, and make appropriate adjustments on a quarterly basis to write down
the value of inventory to the lower-of-cost or market. In addition to the price of the product purchased, the cost of inventory
includes our internal manufacturing costs, including warehousing, material purchasing, quality and product planning expenses.
We
perform a quarterly analysis of obsolete and slow-moving inventory to determine if any inventory needs to be written down. In
general, we write down our excess and obsolete inventory by an amount that is equal to the difference between the cost of the
inventory and its estimated market value if market value is less than cost, based upon assumptions about future product life-cycles,
product demand, shelf life of the product, inter-changeability of the product and market conditions. Those items that are found
to have a supply in excess of our estimated current demand are considered to be slow-moving or obsolete and classified as long-term.
An appropriate reserve is made to write down the value of that inventory to its expected realizable value.
MANAGEMENT’S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
These
charges are recorded in cost of goods sold. The reserve against slow-moving or obsolete inventory is increased or reduced based
on several factors which, among other things, require us to make an estimate of a product’s life-cycle, potential demand
and our ability to sell these products at estimated price levels. While we make considerable efforts to calculate reasonable estimates
of these variables, actual results may vary. If there were to be a sudden and significant decrease in demand for our products,
or if there were a higher incidence of inventory obsolescence because of changing technology and customer requirements, we could
be required to increase our inventory allowances and our gross profit could be adversely affected.
Share-Based
Compensation
In
December 2004, the FASB issued guidelines now contained under FASB ASC Topic 718, “Compensation – Stock Compensation”.
ASC Topic 718 establishes standards for the accounting for transactions in which an entity exchanges its equity instruments for
goods or services. Primarily, ASC Topic 718 focuses on accounting for transactions in which an entity obtains employee services
in share-based payment transactions. It also addresses transactions in which an entity incurs liabilities in exchange for goods
or services that are based on the fair value of the entity’s equity instruments or that may be settled by the issuance of
those equity instruments.
Under
ASC Topic 718, we measure the cost of employee services received in exchange for an award of equity instruments based on the grant
date fair value of the award (with limited exceptions). That cost will be recognized over the period during which an employee
is required to provide services in exchange for the awards – the requisite service period (usually the vesting period).
No compensation cost is recognized for equity instruments for which employees do not render the requisite service. Therefore,
if an employee does not ultimately render the requisite service, the costs associated with the unvested options will not be recognized
cumulatively.
Under
ASC Topic 718, we recognize compensation cost net of forfeitures as they occur and recognize the associated compensation cost
for those awards expected to vest on a straight-line basis over the requisite service period. We use judgment in determining the
fair value of the share-based payments on the date of grant using an option-pricing model with assumptions regarding a number
of highly complex and subjective variables. These variables include, but are not limited to, the risk-free interest rate of the
awards, the expected life of the awards, the expected volatility over the term of the awards, the expected dividends of the awards,
and an estimate of the amount of awards that are expected to be forfeited. If assumptions change in the application of ASC Topic
718 and its fair value recognition provisions in future periods, the stock-based compensation cost ultimately recorded under the
guidelines of ASC Topic 718 may differ significantly from what was recorded in the current period.
Recent
Accounting Pronouncements:
In
May 2014, the FASB released Accounting Standards Update (ASU) No. 2014-09, Revenue from Contracts with Customers (Topic 606),
requiring an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or
services to customers. The updated standard will replace most existing revenue recognition guidance in U.S. GAAP when it becomes
effective and permits the use of either a full retrospective or retrospective with cumulative effect transition method. We plan
to adopt the standard when it becomes effective for us beginning January 1, 2018. We currently anticipate adopting the standard
using the modified retrospective method with a cumulative catch up adjustment and providing additional disclosures comparing results
to previous rules. We continue to evaluate the impact of the new standard on our consolidated financial statements but anticipate
this standard will have a material impact on our consolidated financial statements.
In
February 2016, the FASB released ASU No. 2016-02, Leases (Topic 842) to bring transparency to lessee balance sheets. The ASU will
require organizations that lease assets (lessees) to recognize assets and liabilities on the balance sheet for the rights and
obligations created by all leases with terms of more than 12 months. The standard will apply to both types of leases-capital (or
finance) leases and operating leases. Previously, GAAP has required only capital leases to be recognized on lessee balance sheets.
The standard is effective for fiscal years beginning after December 15, 2018 and interim periods within fiscal years beginning
after December 15, 2018. Early application will be permitted for all organizations. The Company has not yet selected a transition
method and is currently evaluating the effect that the updated standard will have on the consolidated financial statements.
MANAGEMENT’S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
In
March 2016, the FASB released ASU No. 2016-09, Compensation - Stock Compensation: Improvements to Employee Shared-Based Payment
Accounting. The standard is intended to simplify several areas of accounting for share-based compensation arrangements, including
the income tax impact, classification on the statement of cash flows and forfeitures. ASU 2016-09 was effective for the Company
on January 1, 2017. As a result of the adoption of ASU 2016-09, excess tax benefits or deficiencies related to stock-based compensation
are now reflected in the Consolidated Statements of Income as a component of the provision for income taxes, whereas they previously
were recognized in additional paid-in capital. In addition, our Consolidated Statements of Cash Flows will now present, on a prospective
basis, excess tax benefits as an operating activity. Finally, we have elected to account for forfeitures as they occur, rather
than estimate expected forfeitures.
In
August 2016, the FASB released ASU No. 2016-15, Classification of Certain Cash Receipts and Cash Payments, which addresses eight
specific cash flow issues with the objective of reducing the existing diversity in practice. ASU 2016-15 is effective for the
Company beginning January 1, 2018 and we are currently evaluating the impact that ASU 2016-15 will have on our consolidated financial
statements.
In
May 2017, the FASB issued ASU No. 2017-09, Compensation—Stock Compensation (Topic 718): Scope of Modification Accounting.
The new guidance provides clarity and reduces both (1) diversity in practice and (2) cost and complexity when applying the guidance
in Topic 718, Compensation—Stock Compensation, to a change to the terms or conditions of a share-based payment award. The
accounting standard update will be effective for The Company beginning January 1, 2018 on a prospective basis, and early adoption
is permitted. The Company has not yet selected a transition method and is currently evaluating the effect that the updated standard
will have on the consolidated financial statements.