Roger S. Pondel - Chief Executive Officer and President Zeynep Hakimoglu - Chairman, Chief Executive Officer and President Narsi Narayanan - Senior Vice President of Finance and Corporate Secretary.

Les Sulewski - Sidoti & Company, LLC Austin W. Hopper George Melas-Kyriazi - MKH Management Company, LLC Kara Anderson - B. Riley Caris, Research Division.

Good day, everyone, and welcome to the ClearOne Second Quarter 2014 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 PondelWilkinson's Mr. Roger Pondel. Mr. Pondel, please go ahead, sir..

Thank you, Karen, and welcome, everyone, and thank you for joining us to discuss ClearOne's 2014 second quarter financial results. On the call today are Zee Hakimoglu, President and CEO; and Narsi Narayanan, Senior Vice President of Finance. First, some housekeeping matters before we begin.

Please be advised that this conference call is being broadcast live on the internet, at www.clearone.com. A playback of the call will be available for at least 3 months and may be accessed on the internet at ClearOne's website.

Before we begin, I would like to make a cautionary statement and remind everyone that all of the information discussed on today's call 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 forecasts of certain aspects of the company's future, and actual results could differ materially from those stated or implied. With that said, I will now turn the call over to Zee.

Zee?.

Thank you, Roger, and good morning, everyone. Thanks for joining us today to discuss our second quarter 2014 results. We are pleased to report record revenue for the second quarter of 2014 and our eighth consecutive quarter of revenue growth. Revenue for the second quarter reached $14.1 million, representing an exceptional 21% year-over-year growth.

In fact, while we don't want to get into too many stats, this is our fourth consecutive quarter in which we have achieved highest record quarterly revenue, not a bad statistic that indicates the market momentum we are experiencing.

ClearOne's impressive record revenue growth in this quarter was made possible due to contributions from our acquisitions and also from our flagship professional audio products. Our non-GAAP net income for the second quarter also increased by 10% year-over-year.

We continue to maintain our strong focus on gross profits and achieved a healthy 57% margin. Gross margins in the quarter were within the lower end of the company's expected range. Gross margins were impacted by the periodic revision of overhead allocation, as well as the ongoing integration of Sabine manufacturing operations.

During the second quarter operating costs were higher, reflecting the full cost of our investments in internal operations and our recent acquisitions. Our results include operating expenses for the entire second quarter for Sabine, acquired on March 7, and Spontania, acquired on April 1, 2014.

We believe the full benefits of these investments in the form of higher revenue and higher profitability will be realized in the quarters ahead. During Sabine's first full quarter as part of ClearOne, we successfully integrated Sabine's sales channel into the ClearOne global channel that included North America, EMEA and Asia Pacific.

In the second quarter, with the acquisition of Sabine, revenue from ClearOne's full suite of wireless microphone products more than quadrupled from a year ago and reached $1.3 million. On April 1, we closed the acquisition of the Spontania cloud-based media collaboration solutions from Spain-based Dialcom.

Spontania, unlike our current legacy business, offers multiple revenue streams for us, as well as our channel partners. These revenue streams include annual subscriptions for cloud services, the sale of permanent licenses for on-premise solutions, and annual support and maintenance contracts.

During this first quarter, after acquiring the Spontania business, ClearOne achieved bookings of $216,000, of which we recognized revenue of $151,000. For clarification, bookings reflect amounts contractually accepted by customers and billed by ClearOne.

However, a portion of bookings is not recognized in the current quarter as revenue and will be recognized over the life of the customer contracts in accordance with U.S. GAAP requirements. We believe that reporting bookings provides valuable information to our investors about the recurring revenue stream that Spontania business is expected to provide.

Looking to the second half of the year, we expect to achieve an additional $750,000 to $1 million in bookings for Spontania-related products and services.

During the second quarter, our media collaboration sales and marketing team, strengthened recently by the addition of industry veterans, focused on introducing Spontania solutions to our global channel.

As anticipated, at the end of the second quarter, we also began shipping our new COLLABORATE Room Pro, media collaboration product, and VIEW Pro, our enterprise streaming system. We received positive market response to both solutions.

We also began shipping, at the end of the second quarter, our new CONNECT Dante product, which enables easy connectivity of our flagship Pro-Audio products to the fast-emerging Dante-enabled network ecosystem. For those not familiar with Dante, Dante is a highly interoperable, self-configuring, true plug-and-play, digital audio networking technology.

It uses standard IP-based networking and components, such as Ethernet cables, routers and switchers to carry high-capacity and high-resolution digital audio over a standard Ethernet network.

Some of the largest live events and sophisticated Pro-Audio installations worldwide use this technology, making audio signal distribution more cost-effective and user-friendly. Finally, at InfoComm 2014 in Q2, we launched the newest ClearOne Pro-Audio platform, the CONVERGE Matrix, our new sound reinforcement and distribution system.

This new professional audio system opens new market opportunities for ClearOne and will complement our existing audio conferencing solution. We expect to begin shipping the CONVERGE Matrix product at the end of this year, 2014.

With this wrap-up of our recent highlights, I'd like to turn the call over to Narsi for a detailed discussion of our second quarter 2014 financial performance. Following Narsi's discussion, we will take questions for the remainder of the available time..

Thank you, Zee, and good morning, everyone. Before I begin, I would like to point out 2 things. First, I will be discussing certain non-GAAP financial measures. A reconciliation of these non-GAAP measures to reported GAAP measures is included in the earnings release that went out this morning.

Now, turning to our financial results for the second quarter of 2014. Please note, the following comparisons refer to second quarter of 2014 versus the same quarter of 2013. Net revenue for this quarter increased to $14.1 million, making this quarter the strongest ever second quarter in terms of revenue.

The revenue for second quarter increased by 21%, compared to $11.7 million in 2013 second quarter. Gross profit was $8.1 million, or 57% of revenue compared with $6.9 million, 59% of revenue.

The decrease in gross margin was primarily due to periodical allocation of overhead inventory, which reduced the value of inventory and lowered margin on wireless microphone business, which is undergoing integration. These decreases in gross margin were partially offset by reduction in obsolescence charges. Turning to operating expenses.

Sales and marketing expense increased by 43% to $3 million from $2.1 million. The increase was mainly due to increased commissions to salespersons and independent reps, increased headcount, and increase in virtual-related [ph] expenses. Research and product development expense increased by about 26% to $2.3 million from $1.8 million.

The increase was mainly due to increase in R&D project costs and increase in headcount due to acquisitions. Non-GAAP G&A was flat at $1.2 million. Production and legal expenses was offset by increase in headcount due to acquisitions.

Total non-GAAP operating expenses increased by 27% from $5.1 million in 2013 second quarter to $6.5 million in 2014 second quarter. Non-GAAP operating income reduced to $1.6 million from $1.8 million, a reduction of 10%.

Non-GAAP net income increased by 10% to $1.4 million, or $0.14 per diluted share, from $1.2 million or $0.13 per diluted share for the prior year period. Net income for 2014 second quarter was positively impacted by lower taxes.

The lower taxes were due to the anticipation of more income from the enterprise streaming products, media collaboration products, spontaneous solutions and wireless microphones happening in low-tax jurisdictions outside the U.S. Non-GAAP adjusted EBITDA reduced slightly by 8% from $2 million to $1.9 million.

Let's turn to our financial results for the 6-months ended June 30, 2014. Please note, the following comparisons refer to first half of 2014 versus the first half of 2013. Net revenue increased to $26.8 million from $23 million, an increase of 17%.

Gross profit was $15.8 million, or 59% of revenue, compared with $39.9 million (sic) [$13.9 million], or 60% of revenue. Turning to operating expenses. Sales and marketing expense increased by 31% to $5.7 million from $4.4 million. R&D expense increased by about 23% to $4.6 million from $3.7 million.

Non-GAAP G&A expense reduced by 4.3% from $2.7 million to $2.6 million. Total non-GAAP operating expenses increased by 20% from $10.7 million in the first half of 2013 to $12.8 million in 2014 first half. Non-GAAP operating income reduced to $3 million from $3.2 million, a reduction of 6%.

Non-GAAP net income was flat at $2.2 million, or $0.23 per diluted share. Non-GAAP adjusted EBITDA reduced slightly by 3% from $3.6 million to $3.5 million. Turning briefly to the balance sheet. Our balance sheet remains strong. At June 30, our cash and investments balance was $32.3 million, and we remain debt-free.

The cash balance reduced from $42.7 million at the end of December 31, mainly due to cash payments for both acquisitions, Sabine and Spontania, happening in the first quarter of 2014. Thank you. I would now like to turn the call back over to Zee..

Thank you, Narsi. You can see the momentum of our performance and the value of our acquisitions reflected in our revenue growth and in our revenue expectations shared with you today.

Our results reflect our continued plan to prudently leverage our profits from current growth to fuel future growth by making complementary and balanced investments in sales and marketing and research and development. At the same time, and importantly, we will continue to integrate operations of the acquired businesses.

We are confident that these timely and essential steps will create increasing value for ClearOne and its shareholders. With that, and for the time available, we would now like to address any questions you may have.

Operator?.

[Operator Instructions] Our first question comes from the line of Les Sulewski from Sidoti & Company..

So looking at gross margin.

How soon can we expect that to normalize, following some of the additional costs you mentioned, as far as the inventory adjustment and Sabine integration?.

Yes. I expect the gross margins to be back in the same region it used to be from next quarter. Of course, we will have the Sabine gross margins still left that will impact us, but it's not going to be 3 points less than 6% that you saw this quarter. I can't exactly give you what it's going to be.

But it's going to be better than what happened this quarter..

Okay, that's helpful.

And then, can you provide a little bit more guidance just towards R&D spending? And any further efficiencies that can be recognized to reduce total OpEx?.

Yes. I can do that, Les. Last quarter, as we mentioned several times, we were committed to finish the research and development of our enterprise streaming. We've accomplished that, made some modest shipments at the end of the last quarter. I think that will be one place where we'll do some reductions.

Associated with research and development, of course, is our Spontania. And really the way research and development will show a decrease is to, as we've explained, increase revenue for those corresponding products. They -- we're not going to have an ultimate large cut in research and development that's core to the success of ClearOne.

But some of the projects are completed, and more importantly, the projects that are completed, we anticipate good revenue growth there, and that will, sort of, I would say, yes, have an impact on the relative research and development percentage relative to revenue..

Okay. With regards to Spontania, and you had $216,000 in bookings, recognized $151,000 in revenue on that.

Was there other revenue recognized outside of those bookings?.

No. Those are the entire revenue streams that you are looking at with Spontania, actually..

Yes.

So you're expecting to achieve an additional $750,000 to $1 million bookings, plus the remaining $50,000 or $60,000, right?.

Yes. $50,000 or $60,000, it will -- yes that's it. The bookings was $216,000, we already reviewed on the earnings release. On top of this $216,000, we expect additional bookings to be in the range of $750,000 to $1 million.

I don't have the model to translate that bookings to how much it's going to in terms of revenue, because timing makes a big difference, at what time the invoice comes, and that makes a huge difference on how much it will be recognized as revenue.

But the bookings, we think, will be $1 million plus for the entire year from Spontania -- from bookings, actually..

So is it safe to assume, maybe 75% will get recognized over the next 2 quarters? Or 100%, or is it higher? I mean, just kind of a ballpark figure, if you could..

It will never be 100%. It's going to be less than 100%. But I'm not able to tell you exactly how much it's going to be because it depends on what time we seal the deal, actually. If we do it at the end of the quarter, we won't recognize a single dollar for the deal.

But if it happens at the beginning of the quarter, we're going to see quite a big percent of the revenue recognized, therefore it's not going to be easy for me to tell you how much of the future bookings will be recognized, actually..

No, I understand completely. That's helpful. I just wanted to get a gist of how it works..

It could be noted that we are paid -- contracts aside, and we're paid upfront. However, even though we're paid upfront, we still recognize the revenue as we provide the service..

Okay, I see.

Can you also provide a percentage of revenue breakdown, if you have that handy, of audio?.

Yes, yes, I have it. Pro made up -- Pro made up 78%. UC was 17%.

And the rest of it was video, okay? And -- okay?.

Audio was 70?.

78%..

78%, okay, got it..

Pro audio was 78%..

78%. 17% UC, and the remainder in video. Okay.

And then one other thing, with microphone revenue, without Sabine, do you have a number? I mean, from what I gather, it's around $1.3 million, including Sabine? Do you have something that's without -- what it was organically?.

Well, actually , Sabine is $1.3 million. And we said in the earnings release, it quadrupled. The same amount on the wireless microphones in the previous quarter was less than $250,000, actually. Out of $250,000 [ph] in 2013 Q2, actually, that's the comparison. Everything else is organic, actually. You already have Spontania that we've broke it out.

Therefore, what all you see, everything else is organic, actually..

Okay, okay, that's -- I see. And then just one for me.

Any tax guidance that you can offer?.

Tax guidance, we think we will be in the low 30s for the entire year, between 30% to 35%, that's what we think. We took a lower tax rate this quarter because of the now the better anticipation of revenues coming from certain products, which give us a lower tax rate, since they are going to be shipped more in -- outside the U.S., actually.

We have lower tax rate benefit on those products when we ship outside the U.S., okay?.

And our next question comes from the line of Austin Hopper from AWH Capital..

Can you just talk about the buyback? There's some commentary in the press release about you're buying back stock, I couldn't figure out what you actually bought back in the quarter..

We did close to $1.4 million worth of buyback. I don't have the exact number, because I was going with cumulative numbers [ph]. We bought up to $4 million. We're -- our original target was $10 million, we have been slowly going towards the target. And our volume is not that much.

We are subject to all the volume restrictions and everything, and based on what we can do, we are -- I think we did $1.2 million, $1.3 million this quarter..

Okay, great. And then you talked a fair amount about operating expenses. But so sales and marketing were 2-point -- almost $3 million in the quarter, so it's up above 42% year-over-year.

How can we think about sales and marketing, either in dollars or percent of sales, kind of going forward as you have made these acquisitions? I know you have a new sales team..

I have explained it before, but I'll explain again, that's why I'm here. One of the big components of our sales and marketing expense is the commission we pay to our independent reps, actually. Independent reps are all over the country. They are our -- they make a very important part of our sales force.

And the more we sell on Pro-Audio, we will be spending more on the commissions, actually. And that's why since we are heavily growing on the Pro-Audio side, you will see the expenses on non-reps also going up and it was reflected in our sales and marketing expense..

[Operator Instructions] Our next question comes from the line of George Melas from MKH Management..

Question on Spontania. The company came with a book of business because it was an ongoing business.

Did you have to write off sort of -- was it in deferred revenue, and you had it off -- write it off because of the acquisition? I'm just puzzled that there is not -- that the revenue is not more than just what you -- from what you booked in this quarter..

Actually, the way we structured the deal, we were going to recognize only the revenue that we started billing. They -- whatever they bill, they keep for themselves, that's how we structured the deal. And we are not going to get any crumbs from their previous business, actually..

Okay.

But you still provide -- if it's done on a SaaS basis, do you still provide the service?.

Yes. That will be shown as a liability that we acquired when we got the business..

Okay.

Narsi, can you give us a little bit more detail on the gross margin? What specifically impacted it? And if there was an inventory reserve, how much was it?.

No, it's not to do with the inventory reserves. It has to do with overhead allocation. Last year we had a benefit on overhead allocation. We do a periodic review of how our overhead allocation pool looks like when compared to how much we have already allocated to inventory.

And this is an exercise that takes into account many factors, including the future activity levels, which is how much we'll be purchasing, how much we'll be manufacturing and what is the level of inventory we expect, and if the current overhead that is allocated to inventory is above or below the expected of overheads included in there.

And then we do this analysis, and depending on all these factors. Sometimes, you allocate more to inventory, then you do the reevaluation. Sometimes it goes less actually. When you allocate more, you get the benefit in the quarter, the amount of inventory goes up actually.

When you reduce the allocation to inventory, you get charged in the quarter, actually.

And based on how our future activity and how much of overhead that we have been spending this time, the allocation tended to be lower towards inventory, which is actually good for the future, because the inventory cost is going to be lower for the future and the charge-off to inventory in the future, it's going to be charged off at a lower rate, which will increase your margin in the future.

But it's a timing issue actually. This quarter, you'll get a little bump in terms of gross margin, not bump upwards, a bump downwards, actually. And in the future, you are going to get a benefit, actually..

Can you quantify that? Is it quantifiable?.

It's hard to quantify. That's why it's harder to -- it's a mixture with all the other cost of goods sold and everything, and it's harder to do that, actually..

Again, our target and where we've been maintaining ourselves in terms of gross margin has been around the 60% rate, plus or minus..

Plus or minus 2% or 3%, the totality. We have explained it several times. It's harder to separate the various things that go into that allocation, actually..

Okay.

And then can you talk about sort of the impact on gross margin from the Sabine manufacturing integration?.

Yes. Sabine is currently contributing not at the same levels we get from similar professional products, from ClearOne's legacy suite of professional products. Sabine is -- since -- due to many reasons, their margins are lower, actually.

We are trying our best to bring our -- mostly because of the economies at a large scale, we have better procurement deals with our plastics, metals, electronics manufacturers, all of those, because of our volume. We are trying to bring those same deals to Sabine.

And we -- once we tighten that part of purchasing and logistics, then we would be able to see better margins for Sabine, actually. And we expect that to happen by the end of the year. By the end of the year, we think all the things can be implemented. We will be able to get the benefits of higher margins from Sabine, actually..

Okay, okay. And then maybe one more. I think you said the last that the Pro-Audio was 78% of total revenue. So that part of the business is -- does that include microphones, and....

Yes..

Okay, that includes microphones, okay. That is extremely strong. On the video side, clearly, you're introducing these new products, COLLABORATE Room Pro, VIEW Pro, Spontania.

Maybe, Zee, can you help us understand how you -- what kind of progress you're making in terms of these -- introducing these products to your channel and how you measure your own progress there?.

Okay. On the video products, as we mentioned, we began the shipping of the next-generation products. And actually, what we're seeing is a good volume of quote activity. We see -- we're getting good feedback on the streaming. We see some good successes on quotes and some wins this quarter.

Of course, it's -- again, it's not a product that you just buy at a whim and install it. We believe we have a competitive product. Our channel is seeing good opportunity. I think, we're going to see the streaming product, which is a significant revenue product, because it's a system. Unlike selling small bits and pieces, it's a substantial system.

It's an investment that companies make when they install a streaming system. And I would say that we've had some very, very nice interest and we had some wins on some important, I would say, important customers. So we're feeling very optimistic about the streaming.

On the video products, with our new team, what we're seeing is good quoting activity as well. We're seeing good new channel pickup of the product. And we've already expressed that we think the numbers that we put in front of you, just on the Spontania alone, we see a good future ahead.

We're conservative in our views, but I would say the COLLABORATE Pro and the Spontania are making a very good match.

We're further integrating these, and I'm -- we're as optimistic as ever and we see, actually, the evidence of good market interest in these products last quarter as we shipped them at the very, very end and this quarter is looking promising..

Okay. And when you talk about good new channel pickup, what -- you probably have some kind of target of what -- of your current channel and how many will pick up COLLABORATE and Spontania.

And how far are you there in terms of getting the channels to even pick up the product?.

Okay. Well, we've made good progress on signing on some new channels for the Spontania because that one is slightly different. We'll be, in some cases, we haven't made announcements of them, but we have new channels picking them up globally. There's a very good interest in Spontania.

The COLLABORATE Pro is also part of that suite and some of these new channels are also picking up Spontania. Interestingly, the channels that have been selling Spontania overseas have an interest in picking up some of our other products, including COLLABORATE and some of our audio products. So it's really generated some good interest.

On the COLLABORATE Room Pro, we introduced at InfoComm and are shipping today, very unique solution. It's the COLLABORATE Pro with the Beamformer Microphone. Nobody makes anything like that in the world. It has very, very nice interest. And as always, in the Pro world, these things are quoted, spec-ed quoted and then delivered.

So our standard Pro channel, our Pro-Audio channel, has a particular interest in the COLLABORATE Room Pro, with the Beamformer, that is a new SKU that we introduced..

And our next question comes from the line of Ian Corydon from B. Riley & Co..

It's Kara Anderson, chiming in for Ian.

Most my questions have been answered, but can you give the year-over-year revenue growth for the segment?.

Can you please repeat your name? I'm sorry I missed your name..

Kara Anderson..

Kara Anderson. Kara, Pro went up by 36% in Q2. UC went down by 15%, and video went down by 9%..

And I see no further questions at this time. I would like to turn the conference back for any closing comments..

Okay. We appreciate your interest in ClearOne, joining us today in our call. If there is any other questions, please don't hesitate to call ClearOne Investor Relations. That concludes our call for today. Thank you..

Thank you. Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the program, and you may now disconnect. Everyone, have a good day..