ClearOne Communications 10-K 06-30-2003


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-K
 
(Mark One)

x
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the fiscal year ended June 30, 2003
 
OR
 
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from ________ to ________
 
Commission file number 0-17219 
 
CLEARONE COMMUNICATIONS, INC.
(Exact name of registrant as specified in its charter)
 
Utah
 
87-0398877
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification No.)

1825 Research Way, Salt Lake City, Utah
 
84119
(Address of principal executive offices)
 
(Zip Code)

Registrant’s telephone number (801) 975-7200
 
Securities registered under Section 12(b) of the Act:
None
 
Securities registered under Section 12(g) of the Act:
 
Common Stock, $0.001 par value
(Title of class)
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes ¨   No x
 
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of the Form 10-K or any amendment to this Form 10-K. ¨
 
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Securities Exchange Act of 1934, as amended). ¨
 
The aggregate market value of the 9,495,093 shares of voting common stock held by non-affiliates is approximately $37,505,617 at August 10, 2005, based on the $3.95 closing price for the Company’s common stock on the Pink Sheets on August 10, 2005.
 


1


APPLICABLE ONLY TO REGISTRANTS INVOLVED IN BANKRUPTCY
PROCEEDINGS DURING THE PRECEDING FIVE YEARS
 
Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Section 12, 13, or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court.     Yes ¨   No ¨
 
The number of shares of ClearOne common stock outstanding as of June 30, 2003 and June 30, 2005, respectively were 11,086,733 and 11,264,233.

DOCUMENTS INCORPORATED BY REFERENCE

List hereunder the following documents if incorporated by reference and the part of the Form 10-K (e.g., Part I, Part II, etc.) into which the document is incorporated: (1) any annual report to security holders; (2) any proxy or information statement; and (3) any prospectus filed pursuant to Rule 424(b) or (c) under the Securities Act of 1933. The listed documents should be clearly described for identification purposes (e.g., annual report to security holders for fiscal year ended December 24, 1980).

None.

2


DISCLOSURE REGARDING FORWARD-LOOKING STATEMENTS
 
This report contains forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. These statements reflect our views with respect to future events based upon information available to us at this time. These forward-looking statements are subject to uncertainties and other factors that could cause actual results to differ materially from these statements. Forward-looking statements are typically identified by the use of the words “believe,” “may,” “will,” “should,” “expect,” “anticipate,” “estimate,” “project,” “propose,” “plan,” “intend,” and similar words and expressions. Examples of forward-looking statements are statements that describe the proposed development, manufacturing and sale of our products, statement that describe our results of operations, pricing trends, the markets for our products, our anticipated capital expenditures, our cost reduction and operational restructuring initiatives, and regulatory developments, statements with regard to the nature and extent of competition we may face in the future, statements with respect to the sources of and need for future financing, and statements with respect to future strategic plans, goals and objectives. Forward-looking statements are contained in this report under “Item 1. Description of Business,” and “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.” The forward-looking statements are based on present circumstances and on our predictions respecting events that have not occurred, that may not occur, or that may occur with different consequences and timing than those now assumed or anticipated. Actual events or results may differ materially from those discussed in the forward-looking statements as a result of various factors, including the risk factors discussed in this report under the caption “Description of Business: Risk Factors.” These cautionary statements are intended to be applicable to all related forward-looking statements wherever they appear in this report. The cautionary statements contained or referred to in this report should also be considered in connection with any subsequent written or oral forward-looking statements that may be issued by us or persons acting on our behalf. Any forward-looking statements are made only as of the date of this report and ClearOne assumes no obligation to update forward-looking statements to reflect subsequent events or circumstances.
 
CAUTIONARY STATEMENT REGARDING THE FILING DATE OF THIS REPORT AND THE ANTICIPATED FUTURE FILINGS OF ADDITIONAL PAST-DUE REPORTS
 
Due to the re-audit of the Company’s financial statements for its 2002 and 2001 fiscal years, this Annual Report on Form 10-K for the fiscal year ended June 30, 2003 is first being filed in August 2005. The Company is in the process of preparing its Annual Report on Form 10-K for the fiscal years ended June 30, 2004 and 2005, respectively, and plans to file such reports at the earliest practicable date. Shareholders and others are cautioned that the financial statements included in this report are two years old and are not indicative of the operating results that may be expected for the years ending June 30, 2004 and 2005. Shareholders are also cautioned that since the Company is not current in the filing of required reports with the Securities and Exchange Commission (SEC), the SEC could initiate proceedings against the Company at any time, including proceedings to suspend trading of the Company’s securities.
 
PART I
 
References in this Annual Report on Form 10-K to “ClearOne”, “we”, “us” or “the Company” refer to ClearOne Communications, Inc., a Utah corporation, and, unless the context otherwise requires or is otherwise expressly stated, its subsidiaries.
 
ITEM 1. DESCRIPTION OF BUSINESS
 
Overview
 
We are an audio conferencing products company. We develop, manufacture, market and service a comprehensive line of audio conferencing products, which range from tabletop conferencing phones to professionally installed audio systems. We also manufacture and sell document and education cameras and conferencing furniture. We have a strong history of product innovation and plan to continue to apply our expertise in audio engineering to developing innovative new products. We believe the performance and reliability of our high-quality audio products create a natural communication environment, which saves organizations of all sizes time and money by enabling more effective and efficient communication between geographically separated businesses, employees and customers.
 
3


Our products are used by organizations of all sizes to accomplish effective group communication. Our end users range from some of the world’s largest and most prestigious companies and institutions to small and medium sized businesses, educational institutions, and government organizations. We sell our products to these end users primarily through a distribution network of independent distributors who in turn sell products to dealers, systems integrators and value-added resellers. The Company also sells products on a limited basis directly to dealers, systems integrators, value-added resellers and end users.
 
We were incorporated in Utah on July 8, 1983 under the name “Insular, Inc.” On March 26, 1985, we acquired all of the stock of Gentner Electronics Corporation (“Gentner”) in a transaction treated as a reverse acquisition for accounting purposes. In connection with the acquisition of Gentner, we changed our name to Gentner Electronics Corporation. On July 1, 1991, we changed our name to Gentner Communications Corporation. On January 1, 2002, we changed our name to ClearOne Communications, Inc. Our principal executive offices are located at 1825 Research Way, Salt Lake City, Utah 84119, and our telephone number at this location is (801) 975-7200. Our Internet website address is www.clearone.com. Our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to such reports are available, free of charge, on our Internet website under “ClearOne Info—Investor Relations—SEC,” as soon as reasonably practicable after we file electronically such material with, or furnish it to, the SEC. Information on our website does not constitute a part of this Annual Report on Form 10-K or other periodic reports we file with the SEC. The public may also read and copy any materials we file with the SEC at the SEC’s Public Reference Room at 450 Fifth Street, N.W., Washington D.C. 20549. The public may also obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC also maintains an Internet website (www.sec.gov) that contains reports, proxy and information statements and other information regarding ClearOne that we file electronically with the SEC.
 
For a discussion of certain risks applicable to our business, financial condition and results of operations, see the risk factors described in “Risk Factors” below.
 
Significant Events
 
Restatement of Previously Issued Financial Information
 
This report contains our audited consolidated financial statements for the fiscal year ended June 30, 2003 and our restated audited consolidated financial statements for the fiscal years ended June 30, 2002 and 2001. In connection with the restatement, we performed a comprehensive review of our previously issued consolidated financial statements for fiscal years 2002 and 2001 and identified a significant number of errors and adjustments. The restated consolidated financial statements include restatements of assets, liabilities, stockholders’ equity, results of operations and cash flows, and resulted in cumulative net reductions to stockholders’ equity as of June 30, 2002 and 2001 of approximately $17.4 million and approximately $3.8 million, respectively, and reductions in previously reported net income for the years ended June 30, 2002 and 2001 of approximately $14.1 million and $3.9 million, respectively. The restated 2002 and 2001 financial statements were audited by KPMG LLP (KPMG), who replaced Ernst & Young LLP (Ernst & Young) as our independent registered public accounting firm in December 2003. Certain restated quarterly financial information is included in this report in the section captioned “Item 6. Selected Financial Data.”
 
We have not amended our prior filings to reflect the restatement. As a result, the information previously filed in our annual reports on Form 10-K for fiscal years 2002 and 2001, our quarterly reports on Form 10-Q for the quarterly periods included in those fiscal years and for the quarter ended September 30, 2002 and any current filings on Form 8-K, or other disclosures containing fiscal 2003, 2002 or 2001 information filed or made prior to the filing of this 2003 Form 10-K should not be relied upon and have been superceded by this Form 10-K.
 
Changes to Management and Board of Directors. Since January 2003, we have changed all but one member of our executive management team. Three of our former directors are no longer serving in such positions and we have appointed two new directors, both of whom are independent directors who serve on our audit committee. In January 2003, Frances Flood, our former chairman and chief executive officer, and Susie Strohm, our former chief financial officer, were placed on administrative leave and they subsequently resigned from their positions. Michael Keough was then appointed as our chief executive officer, Greg Rand was appointed as our president and chief operating officer and George Claffey was appointed as our chief financial officer. All three subsequently resigned for personal reasons at various times during 2004 and on July 8, 2004, Zeynep “Zee” Hakimoglu was appointed as our president and chief executive officer and Donald Frederick was appointed as our chief financial officer.
 
4


The SEC Action. ClearOne’s previously filed financial statements were the subject of a civil action filed by the U.S. Securities and Exchange Commission on January 15, 2003 against ClearOne and the persons then acting as its chief executive and chief financial officers. The complaint generally alleged that the defendants had engaged in a program of inflating ClearOne’s revenues, net income and accounts receivable by engaging in improper revenue recognition. On December 4, 2003, we settled the SEC action by entering into a consent decree in which, without admitting or denying the allegations of the complaint, we consented to the entry of a permanent injunction prohibiting future securities law violations. No fine or penalty was assessed against ClearOne as part of the settlement.
 
Securities Delisted from Nasdaq Stock Market. Our common stock was delisted from the Nasdaq National Market System on April 21, 2003 and since that time has been quoted on the National Quotation Bureau’s Pink Sheets.
 
The Shareholder Class Action. On June 30, 2003, a consolidated complaint was filed against ClearOne, eight of our present or former officers and directors, and our former auditor, Ernst & Young, by a class consisting of purchasers of the Company’s common stock during the period from April 17, 2001 through January 15, 2003. The allegations in the complaint were essentially the same as those contained in the SEC action described above. On December 4, 2003, we, on behalf of the Company and all other defendants with the exception of Ernst & Young, entered into a settlement agreement with the class pursuant to which we agreed to pay the class $5.0 million and issue the class 1.2 million shares of our common stock. The cash payment was made in two equal installments, the first on November 10, 2003 and the second on January 14, 2005. On May 23, 2005, the court order was amended to provide that odd-lot numbers of shares (99 or fewer shares) will not be issued from the settlement fund and claimants who would otherwise be entitled to receive 99 or fewer shares will be paid cash in lieu of such odd-lot number of shares. As of the date hereof, 228,000 shares of our common stock have been issued to the class and we plan to complete the issuance of the remaining shares in the near future in accordance with the terms of the court order, subject to the receipt of any required approvals from state regulatory authorities.
 
Changes in Type and Scope of Operations
 
Acquisitions of ClearOne, Inc. and Ivron Systems, Ltd. We have been manufacturing and marketing audio conferencing products since 1989, which has been our core competency. During fiscal 2001 and fiscal 2002, we attempted to expand our operations through the acquisitions of ClearOne, Inc. and Ivron Systems, Ltd., both of which were involved in the development and sale of video conferencing technology and products. Such acquisitions proved unsuccessful and, as discussed in more detail in Item 1. Description of Business. Acquisitions and Dispositions, we recorded impairment charges related to such acquisitions in the aggregate amount of approximately $7.1 million in fiscal 2002.
 
Acquisitions of E.mergent, Inc. and OM Video. During fiscal 2002 and fiscal 2003, we entered the audio visual integration services business through the acquisitions of E.mergent, Inc. and Stechyson Electronics, Ltd., doing business as OM Video. Our management at that time believed such acquisitions would complement our existing operations and our core competencies and allow us to acquire market share in this industry. However, our entry into the services business was perceived as a threat by our systems integrators and value-added resellers, many of whom we began competing against for sales. The acquisitions were not successful and the remaining operations were sold in fiscal 2004 and fiscal 2005. As discussed in more detail in Item 1. Description of Business. Acquisitions and Dispositions, we recorded impairment charges related to such acquisitions in the aggregate amount of approximately $26.0 million in fiscal 2003.
 
Sale of our U.S. Audiovisual Integration Services. On May 6, 2004, we sold certain assets of our U.S. audiovisual integration services operations to M:Space, Inc. (M:Space) for no cash compensation. M:Space is a privately held audiovisual integration services company. In exchange for M:Space assuming obligations for completion of certain customer contracts and satisfying maintenance contract obligations to existing customers, we transferred to M:Space certain assets including inventory valued at $569,000. We expect that the operations of the U.S. audiovisual integration services will be classified as discontinued operations in the fiscal year 2004. As of June 30, 2003 the assets of audiovisual integrations services were classified as held and used.
 
5


Sale of Conferencing Services Business. On July 1, 2004, we sold our conferencing services business segment to Clarinet, Inc., an affiliate of American Teleconferencing Services, Ltd. d/b/a Premier Conferencing for $21.3 million. Of the purchase price $1.0 million was placed into an 18-month Indemnity Escrow account and an additional $300,000 was placed into a working capital escrow account. We received the $300,000 working capital escrow funds approximately 90 days after the execution date of the contract. Additionally, $1.4 million of the proceeds was utilized to pay off equipment leases pertaining to assets being conveyed to Clarinet. We expect that the conferencing services operations will be classified as discontinued operations in the fiscal year 2005. As of June 30, 2003, the assets of conferencing services were classified as held and used.
 
Sale of OM Video. On March 4, 2005, we sold all of the issued and outstanding stock of our Canadian subsidiary, ClearOne Communications of Canada, Inc. (ClearOne Canada) to 6351352 Canada Inc., a Canada corporation (the “OM Purchaser”). ClearOne Canada owned all the issued and outstanding stock of Stechyson Electronics Ltd., which conducts business under the name OM Video. We agreed to sell the stock of ClearOne Canada for $200,000 in cash; a $1.3 million note payable over a 15-month period, with interest accruing on the unpaid balance at the rate of 5.25% per year; and contingent consideration ranging from 3% to 4% of related gross revenues over a five-year period. We expect that the operations of the Canada audiovisual integration services will be classified as discontinued operations in fiscal year 2005. As of June 30, 2003, the assets of the Canada audiovisual integration business were classified as held and used. In June 2005, we were advised that the OM Purchaser had settled an action brought by the former employer of certain of OM Purchaser’s owners and employees alleging violation of non-competition agreements. The settlement reportedly involved a cash payment and an agreement not to sell certain products for a period of one year. We are evaluating what impact, if any, this settlement may have on the OM Purchaser’s ability to make the payment required under the note.
 
Following the disposition of operations in the video conferencing, business services and conferencing services businesses, we returned to our core competency of developing, manufacturing and marketing audio conferencing products, which is where we intend to keep our focus for the foreseeable future.
 
Business Strategy
 
Our goal is to achieve market leadership in group conferencing environments through the development of new, competitive products that offer superior quality and ease of use. The principal components of our strategy to achieve this goal are:
 
Provide a superior conferencing experience
 
We have been developing audio technologies since 1981 and we believe we have established a reputation for providing some of the highest quality group audio conferencing solutions in the industry. Our proprietary Gentner® Distributed Echo Cancellation® and digital signal processing technologies have been the core of our installed conferencing products, and are the foundation for our new product development. We plan to build upon our reputation of being a market leader and continue to provide the highest quality products and technologies to the customers and markets we serve.
 
Provide greater value to our customers
 
To provide our customers with conferencing products that deliver high value, we are leveraging advances in emerging technology trends and applying these advances specifically to group conferencing environments. By offering high quality products that are designed to solve ease-of-use issues and are easy to install, configure and maintain, we believe we can provide greater value to our customers and reduce their total cost of ownership.
 
Be a leader in audio conferencing innovation
 
We have sharpened our focus on developing cutting edge audio conferencing products and are committed to incorporating the latest technologies into our new and existing product lines. Key to this effort is adopting emerging technologies such as Voice over Internet Protocol (VoIP), international standards-based conferencing protocols, wireless connectivity and the convergence of voice, video and data networks.
 
6


Develop strong sales channels
 
We have made significant efforts to develop strong domestic and international sales channels through the addition of key distributors and dealers. We plan to continue to add new distribution partners, with specific emphasis on bolstering distribution to the information technology and telecommunications channels, where we see opportunity for our MAX® tabletop audio conferencing products; our new RAV™ audio conferencing systems; our conferencing peripherals, including the AccuMic® product line; and other products currently in development.
 
Broaden our product offerings
 
We offer a full range of audio conferencing products, from high-end, professionally installed audio conferencing systems to conferencing-specific telephones. We plan to continue to broaden our product offerings to meet the evolving needs of our customers, address changes in the markets we currently serve, and effectively target new markets for our products.
 
Develop strategic partnerships
 
To stay on the leading edge of product development, we plan to continue to identify partners with technology and expertise in areas strategic to our growth objectives. We will also work to develop partnerships with leaders in markets complimentary to conferencing who can benefit from our audio products and technologies, and through whom we can access new market growth opportunities.
 
Strengthen existing customer relationships through dedicated support
 
We have developed outstanding technical and sales support teams that are dedicated to providing customers with the best available service and support. We believe our technical support is recognized as among the best in the industry, and we will continue to invest in the necessary resources to ensure that our customers have access to the information and support they need to be successful using our products.
 
Markets and Products
 
We currently conduct all our operations in the conferencing products industry. We also previously operated in the conferencing services segment until July 1, 2004 when we sold our conferencing services business to American Teleconferencing Services, Ltd., and in the business services segment until March 4, 2005, when we sold the remaining operations in that area to 6351352 Canada Inc. For additional financial information about our segments see “Note 23. Segment, Geographic and Revenue Information” to our consolidated financial statements, which are included in this report.
 
Products Segment
 
The performance and reliability of our high-quality conferencing products enable effective and efficient communication between geographically separated businesses, employees and customers. We offer a full range of audio conferencing products, from high-end, professionally installed audio conferencing systems used in executive boardrooms, courtrooms, classrooms and auditoriums, to conferencing-specific telephones used in small conference rooms and offices. Our products feature our proprietary Gentner® Distributed Echo Cancellation® and noise cancellation technologies to enhance communication during a conference call by eliminating echo and background noise. They also feature proprietary audio processing technologies such as adaptive modeling, full duplex, first-microphone priority and microphone gating, which combine to enable natural communication between distant conferencing participants similar to that of being in the same room.
 
7


Principal drivers of demand for audio conferencing products are: the increasing availability of easy to use audio conferencing equipment; the improving voice quality of audio conferencing systems compared to desktop speakerphones; and the trend of global, regional and local corporate expansion. Other factors that we expect to have a significant impact on the demand for audio conferencing systems are the availability of a wider range of affordable audio conferencing products for small businesses and home offices; the growth of distance learning and corporate training programs, and the number of teleworkers; the decrease in the amount of travel within most enterprises for routine meetings; and the transition to the Internet Protocol (IP) network from the traditional public switched telephone network (PSTN). We expect these growth factors to be offset slightly by direct competition from high-end desktop speakerphones, the technological volatility of IP-based products and continued pressures on enterprises to reduce spending.
 
Professional Audio Conferencing Products
 
We have been developing high-end, professionally installed audio conferencing products since 1991 and believe we have established strong brand recognition for these Professional Audio Conferencing products.
 
Our Professional Audio Conferencing products include the XAP®, Audio Perfect® (AP) and PSR1212 product lines. The XAP® line includes our most powerful, feature-rich products, with the latest advances in technology and functionality. It has more processing power than our Audio Perfect® products and contains noise cancellation technology in addition to our Gentner® Distributed Echo Cancellation® technology found in the Audio Perfect® product line. The Audio Perfect® product line offers lower-cost products that still allow users to experience quality sound in a wide variety of conferencing venues. The PSR1212 is a digital matrix mixer that provides advanced audio processing, microphone mixing and routing for local sound reinforcement.
 
The XAP®, Audio Perfect® and PSR1212 products are comprehensive audio control systems designed to excel in the most demanding acoustical environments and routing configurations. These products are also used for integrating high-quality audio with videoconferencing systems.
 
Out-of-the-Box Premium Conferencing Systems
 
In fiscal 2004, we introduced our RAV™ audio conferencing system. RAV™ is a complete, out-of-the-box system that includes an audio mixer, loudspeakers, microphones and a wireless control device. It uniquely combines the sound quality of a professionally installed audio system with the simplicity of a conference phone, and can be easily connected to industry common rich-media devices, such as video or webconferencing systems, to deliver enhanced audio performance.
 
RAV™ offers many powerful audio processing technologies from our Professional Audio Conferencing products without the need for professional installation and programming. It features Gentner® Distributed Echo Cancellation®, noise cancellation, microphone gating and a drag-and-drop graphical user interface for easy system setup, control and management.
 
Table Top Conferencing Phone Systems
 
In fiscal 2003, we developed our MAX® line of tabletop conferencing phones. These phones incorporate the high-end echo cancellation, noise cancellation and audio processing technologies found in our industry leading professional audio conferencing products.
 
The MAX® product line is comprised of the MAX® EX, MAX® Wireless, MAXAttach and MAXAttach wireless tabletop conferencing phones. MAX® Wireless was the first wireless conferencing phone. Designed for use in executive offices or small conference rooms with up to eight participants, MAX® Wireless can be moved from room to room within 150 feet of its base station. MAXAttach is a wired conferencing phone with unique expansion capabilities. Instead of just adding extension microphones for use in larger rooms, MAXAttach links up to four complete phones together. This provides even distribution of microphones, loudspeakers and controls for better sound quality and improved user access in medium to large conference rooms. The MAXAttach wireless is the industry’s first dual unit wireless conference phone.
 
8


Other Products
 
We complement our audio conferencing products with microphones, document and education cameras and conferencing-specific furniture. Our microphones are designed to improve the audio quality in audio, video and webconferencing applications. They feature echo cancellation and audio processing technologies and can be used with personal computers, videoconferencing systems or installed audio conferencing systems. Our cameras can be used in professional conferencing or educational settings to enable presentation of materials and images such as full-color documents, 3-D objects and images from a variety of sources, including computers, microscopes, and multimedia devices such as VCR and DVD players. Our wide selection of wood, metal and laminate conferencing furniture features audiovisual carts, plasma screen carts and pedestals, videoconferencing carts, tables, cabinets and podiums. We also provide custom furniture design.
 
Marketing and Sales
 
We sell our products primarily through a worldwide network of audiovisual, information technology and telecommunications distributors, who in turn sell our products to dealers, systems integrators and value-added resellers. We also sell our products on a limited basis directly to dealers, systems integrators, value-added resellers and end users. We use a two-tier distribution model, in which we primarily sell our products directly to distributors, who then sell our products to independent systems integrators, dealers and value-added resellers, who in turn work directly with the end users of our products on product fulfillment and installation. In addition, we regularly participate in conferencing forums, trade shows and industry promotions.
 
In fiscal 2003, approximately $18.6 million, or 68%, of our total product sales were generated in the United States and product sales of approximately $8.9 million, or 32%, were generated outside the United States. Revenue from product and business services customers outside of the United States accounted for approximately 26% of our total sales from continuing operations for fiscal 2003, 10% for fiscal 2002 and 12% for fiscal 2001. We sell our products in more than 70 countries worldwide. We anticipate that the portion of our total revenue from international sales will continue to increase as we further enhance our focus on developing new products, establishing new channel partners, strengthening our presence in key growth areas, and improving product localization with country-specific product documentation and marketing materials.
 
Distributors
 
We sell our products directly to approximately 90 distributors throughout the world. Distributors buy our products at a discount to list price and resell them on a non-exclusive basis to independent systems integrators, dealers and value-added resellers. Our distributors maintain their own inventory and accounts receivable, and are required to provide technical and non-technical support for our products to the next level of distribution participants. We work with our distributors to establish appropriate inventory stocking levels. We also work with our distributors to maintain relationships with our existing systems integrators, dealers and value-added resellers and to establish new distribution participant relationships. We also sell our products on a limited basis to certain systems integrators, dealers and value-added resellers who buy our products at a discount to list and resell them on a non-exclusive basis to end users.
 
Independent Integrators and Resellers
 
Our distributors sell our products worldwide to approximately 750 independent systems integrators, dealers and value-added resellers on a non-exclusive basis. While dealers, resellers and systems integrators all sell our products directly to the end users, systems integrators typically add significant value to each sale by combining our products with products from other manufacturers as part of a complex audiovisual system installation. Dealers and value-added resellers usually buy our products in large volumes and may bundle our products with products from other manufacturers for resale to the end user. We maintain close working ties with our distribution participants and offer them education and training on our all of our products.
 
Trade Shows and Industry Forums
 
We regularly attend industry forums and exhibit our products at trade shows to ensure our products remain highly visible to distributors and dealers, and to keep abreast of market trends.
 
9


Customers
 
No customer accounted for more than 10% of our total revenue during fiscal 2003, 2002 or 2001. In fiscal 2003, revenues in our product segment included sales to three distributors that represented approximately 42% of the segment’s revenues. We currently only report revenues in our product segment and revenues in that segment during fiscal 2005 include sales to three distributors that represent approximately 63% of our revenue. As discussed below, these distributors facilitate product sales to a large number of end users, none of which is known to account for more than 10% of our revenues from product sales. Nevertheless, the loss of one or more distributors could reduce revenues and have a material adverse effect on our business and results of operations.
 
Competition
 
The conferencing products market is characterized by intense competition and rapidly evolving technology. We have no single competitor for all of our product and service offerings, but we compete with various companies with respect to specific products and services. We believe we compete successfully as a result of the high quality of our products and technical support services as well as the strength of our brand.
 
With respect to our products, we believe the principal factors driving sales are product design, quality and functionality of products, establishment of brand name recognition, pricing, access to and penetration of distribution channels, quality of customer support, and a significant customer base.
 
In the audio conferencing systems market, our competitors include Polycom, Biamp Systems, Sony, Sound Control, Aethra, Cisco and other companies that offer conferencing systems. According to industry sources, during the 2003 calendar year, we had the largest share of the installed segment of the conferencing systems market, which we target with our Professional Audio Conferencing products. In the markets for our document cameras, competitors include Sony, Elmo, Ken-a-Vision, Samsung, Wolfvision and other manufacturers. Our microphones compete with the products of Shure, Audio Technica, Global Media and others. Our conferencing furniture products compete primarily with the products of Video Furniture International, Accuwood and Comlink.
 
In each of the markets in which we compete, most of our competitors may have access to greater financial, technical, manufacturing and marketing resources, and as a result they could respond more quickly or effectively to new technologies and changes in customer preferences. No assurances can be given that we can continue to compete effectively in the markets we serve.
 
Product Development
 
We are committed to research and development, and view our continued investment in research and development as a key ingredient to our long-term business success. Our research and development expenditures were approximately $3.0 million in fiscal 2003, $3.8 million in fiscal 2002 and $2.7 million in fiscal 2001.
 
Our core competencies in research and development include many audio technologies, including telephone echo cancellation, acoustic echo cancellation and noise cancellation. Our ability to use digital signal processing technology to perform audio processing operations is also a core competency. Our research and development efforts are supported by an internal computer aided design team that creates electrical schematics, printed circuit board designs, mechanical designs and manufacturing documentation. We believe the technology developed through this interactive process is critical to the performance of our products. We also believe that ongoing development of our core technological competencies is vital to maintaining and increasing future sales of our products and to enhancing new and existing products.
 
10


Manufacturing
 
Prior to June 2005, we manufactured and assembled most of our products in our manufacturing facility located at our corporate headquarters in Salt Lake City, Utah. We also subcontracted the manufacture of some products to a third-party contract manufacturer located in Southeast Asia. We also manufactured and continue to manufacture our furniture product line in our manufacturing facility located in Champlin, Minnesota.
 
We generally purchase our assembly components from distributors. We also buy a limited amount of components directly from fabricators located near our manufacturing facilities. Many of our suppliers are located in the United States.
 
While it is our policy to have a minimum of two vendor sources for components, certain electronic components used in the manufacture of our products can only be obtained from a single manufacturer and we are solely dependent upon these manufacturers to deliver such components to our suppliers so that they can meet our production needs. We do not have a written commitment from such suppliers to fulfill our future requirements. While our suppliers maintain an inventory of such components, no assurances can be given that such components will always be readily available, available at reasonable prices, available in sufficient quantities, or delivered in a timely fashion. If such components become unavailable, it is likely that we will experience delays, which could be significant, in the production and delivery of our products, unless and until we can otherwise procure the required component or components at competitive prices, if at all, or make product design changes. From time to time, we experience increased prices and increased lead times on certain of these key components that have limited availability. Any lack of availability of these components could have a material adverse effect on our ability to sell products and the related increase in prices would likely reduce our profit margins. Many of the components utilized by us in our manufacturing process are bonded by certain distributors and manufacturers, meaning that the component inventory will be kept “on-site” at vendor stock locations and managed by the vendors. The component inventory will then be sold to us on an as-required basis.
 
On August 1, 2005, we entered into a Manufacturing Agreement with Inovar, Inc., a Utah-based electronics manufacturing services provider (“Inovar”), pursuant to which we agreed to outsource our Salt Lake City manufacturing operations to Inovar. The agreement is for an initial term of three years, which shall automatically be extended for successive and additional terms of one year each unless terminated by either party upon 120 days’ advance notice at any time after the second anniversary of the agreement. The agreement generally provides, among other things, that Inovar shall: (i) furnish the necessary personnel, material, equipment, services and facilities to be the exclusive manufacturer of substantially all the products that were previously manufactured at our Salt Lake City, Utah manufacturing facility, and the non-exclusive manufacturer of a limited number of products, provided that the total cost to ClearOne (including price, quality, logistic cost and terms and conditions of purchase) is competitive; (ii) provide repair service and warranty support and proto-type services for new product introduction on terms to be agreed upon by the parties; (iii) purchase certain items of our manufacturing equipment; (iv) lease certain other items of our manufacturing equipment and have a one-year option to purchase such leased items; (v) have the right to lease our former manufacturing employees from a third party employee leasing company; and (vi) purchase the parts and materials on hand and in transit at our cost for such items with the purchase price payable on a monthly basis when and if such parts and materials are used by Inovar. The parties also entered into a one-year sublease for approximately 12,000 square feet of manufacturing space located in our headquarters in Salt Lake City, Utah, which sublease may be terminated by either party upon ninety days’ notice. The agreement provides that products shall be manufactured by Inovar pursuant to purchase orders submitted by us at purchase prices to be agreed upon by the parties, subject to adjustment based upon such factors as volume, long range forecasts, change orders etc. We also granted Inovar a right of first refusal to manufacture new products developed by us at a cost to ClearOne (including price, quality, logistic cost and terms and conditions of purchase) that is competitive.
 
For risks associated with our manufacturing strategy please see “Risk Factors” in Item 1.
 
11


Intellectual Property and Other Proprietary Rights
 
We believe that our success depends in part on our ability to protect our proprietary rights. We rely on a combination of patent, copyright, trademark and trade secret laws and confidentiality procedures to protect our proprietary rights. The laws of foreign countries may not protect our intellectual property to the same degree as the laws of the United States.
 
We generally require our employees, customers and potential distribution participants to enter into confidentiality and non-disclosure agreements before we disclose any confidential aspect of our technology, services or business. In addition, our employees are routinely required to assign to us any proprietary information, inventions or other technology created during the term of their employment with us. These precautions may not be sufficient to protect us from misappropriation or infringement of our intellectual property.
 
We currently have several patents issued or pending covering our conferencing products and technologies. The expiration dates of issued patents range from 2009 to 2010. We hold registered trademarks for ClearOne, XAP, MAX, AccuMic, Audio Perfect, Distributed Echo Cancellation, Gentner and others. We have also filed for trademarks for RAV and others.
 
Employees
 
As of July 31, 2005, we had 121 employees, 119 of whom were employed on a full-time basis, with 47 in sales, marketing and customer support, 40 in product development, 17 in manufacturing support and 17 in administration, including finance. None of our employees are subject to a collective bargaining agreement and we believe our relationship with our employees is good.
 
Acquisitions and Dispositions
 
During the fiscal year ended June 30, 2001, we completed the acquisition of ClearOne, Inc., a developer of video conferencing technology and audio conferencing products. We also completed the sale of the assets of the remote control portion of our RFM/Broadcast division to Burk Technology, Inc. During the fiscal year ended June 30, 2002, we completed the acquisitions of Ivron Systems, Ltd., a developer of videoconferencing technology and product, E.mergent, Inc., an integration services provider and manufacturer of cameras and conferencing furniture, and the sale of our court conferencing customer list and all contracts relating to our court conferencing services to CourtCall LLC. During the fiscal year ended June 30, 2003, we sold our broadcast telephone interface products, including the digital hybrid and TS-612 product lines, to Comrex Corporation and completed the acquisition of Stechyson Electronics Ltd., doing business as OM Video, an integration business services company. The total consideration for each acquisition was based on negotiations between ClearOne and the acquired company or its shareholders that took into account a number of factors of the business, including historical revenues, operating history, products, intellectual property and other factors. Each acquisition was accounted for under the purchase method of accounting. Each acquisition is summarized below and is discussed in more detail in the footnotes to the audited consolidated financial statements included in this report.
 
ClearOne, Inc. Acquisition. In May 2000, we entered into an agreement to purchase substantially all of the assets of ClearOne, Inc. for approximately $3.6 million consisting of $1.8 million of cash and 129,871 shares of our restricted common stock valued at $13.97 per share. The acquisition was consummated on July 5, 2000.
 
As of the acquisition date, we acquired tangible assets consisting of property and equipment of $473,000, deposits of $59,000, and inventory of $299,000. We recorded $924,000 of identifiable intangibles, $728,000 of in-process research and development, and $1.2 million in goodwill, resulting from the difference between the purchase price plus acquisition costs and the net assets acquired. We amortized goodwill of $1.2 million on a straight-line basis over four years until the adoption of SFAS No. 142 on July 1, 2002. Amortization of goodwill was $297,000 for each of the fiscal years ended June 30, 2002 and 2001.
 
12


We charged $728,000 to expense representing acquired in-process research and development that had not yet reached technological feasibility. We anticipated the technology would require an additional 18 to 20 months of development at a minimum cost of $1.2 million. The technology had no alternative future use. After the acquisition, we initially continued to develop the technology, however, we experienced significant difficulties in completing the development of the video conferencing technologies and subsequently determined that the technology was not viable and never brought the in-process video conferencing technology to market.
 
We continued to sell the acquired teleconferencing product until the fourth quarter of the fiscal year ended June 30, 2002. Due to declining sales, negative margins beginning in the fourth quarter of the year ended June 30, 2002, and management’s decision to stop investing in the acquired teleconferencing product, we determined that a triggering event had occurred in the fourth quarter of the fiscal year ended June 30, 2002. We performed an impairment test and determined that an impairment loss on the ClearOne assets should be recognized.
 
Sale of Assets to Burk Technology. On April 12, 2001, we sold the assets of the remote control portion of our RFM/Broadcast division to Burk Technology, Inc. (Burk), a privately held developer and manufacturer of broadcast facility control systems products. We retained the accounts payable of the remote control portion of the RFM/Broadcast division and Burk assumed obligations for unfilled customer orders and satisfying warranty obligations to existing customers and for inventory sold to Burk. However, we retained certain warranty obligations to Burk to ensure that all of the assets sold to Burk were in good operating condition and repair.
 
Consideration for the sale consisted of $750,000 in cash at closing, $1.8 million in the form of a seven-year promissory note, with interest at the rate of nine percent per year, and up to $700,000 as a commission over a period of up to seven years. The payments on the promissory note may be deferred based upon Burk not meeting net quarterly sales levels established within the agreement. The promissory note is secured by a subordinate security interest in the personal property of Burk. The gain on the sale is being recognized as cash is collected (as collection was not reasonably assured from Burk). The commission is based upon future net sales of Burk over base sales established within the agreement. We realized a gain on the sale of $200,000 for the 2003 fiscal year, $176,000 for the 2002 fiscal year, and $123,000 for the 2001 fiscal year. As of June 30, 2003, $1.5 million of the promissory note remained outstanding and we had received $20,000 in commissions.
 
Ivron Systems, Ltd. Acquisition. On October 3, 2001, we purchased all of the issued and outstanding shares of Ivron Systems, Ltd., of Dublin, Ireland. Under the terms of the original agreement, the shareholders of Ivron received $6.0 million of cash at closing of the purchase. As part of the purchase, all outstanding options to purchase Ivron shares were cancelled in consideration for a cash payment of $650,000. Further, under that agreement, after June 30, 2002, each former Ivron shareholder would be entitled to receive approximately .08 shares of our common stock for each Ivron share previously held by such shareholder, provided that certain video product development contingencies were achieved. This represented approximately 429,000 shares of common stock. Thereafter, for the fiscal years ending June 30, 2003 and 2004, the former Ivron shareholders would be entitled to share in up to approximately $17.0 million of additional cash and stock consideration provided that certain agreed upon earnings per share targets were achieved by us. In addition, former optionees of Ivron who remained with us were eligible to participate in a cash bonus program paid by us, based on our combined performance with Ivron in the fiscal years ending June 30, 2003 and 2004. The maximum amount payable under this cash bonus program was approximately $1.0 million.
 
As of the acquisition date, we acquired tangible assets consisting primarily of cash of $297,000, accounts receivable of $92,000, inventory of $337,000, and property and equipment of $22,000. We assumed liabilities consisting primarily of trade accounts payable of $174,000, and accrued compensation and other accrued liabilities of $264,000.
 
On March 26, 2002, we entered into negotiations with the former shareholders of Ivron to modify the terms of the original purchase agreement because, upon further analysis, certain aspects of the acquired technology did not meet the intended product objectives established in our original purchase negotiations.
 
13


The amendment, which was finalized on April 8, 2002, revised the contingent consideration that the Ivron shareholders would have been entitled to receive in subsequent years so that upon meeting certain gross profit targets for the “V-There” and “Vu-Link” set-top videoconferencing products, technologies, and sub-elements thereof (including licensed products), the former Ivron shareholders had the opportunity to receive up to 109,000 shares of our common stock, issuable in four installments, on a quarterly basis, through July 15, 2003. No performance targets were met and accordingly no contingent consideration was or will be paid.
 
Based on the modified purchase price determined under the terms of the amendment, we recorded intangible assets of $5.3 million related to developed technology, $1.1 million related to intellectual property, and goodwill of $218,000. Amortization expense of $446,000 was recorded for the developed technology for the period from October 3, 2001 to June 30, 2002. No amortization expense was recorded for goodwill. After the acquisition, we experienced significant difficulties in selling the acquired video conferencing products. Due to the phasing out of a product line occasioned by technological difficulties and negative projected cash flows, we determined that a triggering event had occurred during the fourth quarter of the fiscal year ended June 30, 2002. We performed an impairment test and determined that an impairment loss on the Ivron assets should be recognized. Subsequent to June 30, 2003, we discontinued selling the “V-There” and “Vu-Link” set-top videoconferencing products.
 
Sale of Court Conferencing Assets. As part of our conferencing services segment, our court conferencing customers engaged in the audio and/or video conferencing of legal proceedings including remote appearances in state and federal courts and/or administrative tribunals within the United States. On October 26, 2001, we sold our court conferencing customer list, including all contracts relating to its court conferencing services to CourtCall LLC and recognized a gain of $250,000.

E.mergent Acquisition. On May 31, 2002, we completed our acquisition of E.mergent, Inc. pursuant to the terms of an Agreement and Plan of Merger dated January 21, 2002 pursuant to which we paid $7.3 million of cash and issued 868,691 shares of our common stock valued at $16.55 per share to the former E.mergent stockholders.
 
In addition to the shares of our common stock issued, we assumed all options to purchase E.mergent common stock that were vested and outstanding on the acquisition date. These options were converted into the right to acquire a total of 4,158 shares of our common stock at a weighted average exercise price of $8.48 per share. A value of approximately $49,000 was assigned to these options using the Black-Scholes option pricing model.
 
As of the acquisition date, we acquired tangible assets consisting primarily of cash of $68,000, accounts receivable of $2.2 million, inventory of $3.3 million, property and equipment of $475,000 and other assets of $1.3 million. We assumed liabilities consisting primarily of accounts payable of $1.3 million, line of credit borrowings of $484,000, unearned maintenance revenue of $873,000, accrued compensation (other than severance) and other accrued liabilities of $656,000. We incurred severance costs of approximately $468,000 related to the termination of four E.mergent executives and seven other E.mergent employees as a result of duplication of positions upon consummation of the acquisition. In June 2002, $52,000 was paid to such individuals. The severance accrual as of June 30, 2002 of $416,000 was paid during the fiscal year ended June 30, 2003.
 
We recorded intangible assets of $1.1 million related to patents, $392,000 related to customer relationships, $215,000 related to a non-compete agreement, and goodwill of $17.1 million. Amortization expense of $437,000 was recorded for the intangible assets for the period from June 1, 2002 to June 30, 2003. In accordance with SFAS No. 142, no amortization expense was recorded for goodwill.
 
Our management at the time believed the E.mergent acquisition would complement our existing operations and our core competencies would allow us to acquire market share in the audio visual integration industry. However, our entry into the services business was perceived as a threat by our systems integrators and value-added resellers, many of whom we began competing against for sales. In order to avoid this conflict and maintain good relationships with our systems integrators and value-added resellers, we decided to stop pursuing new services contracts in the fourth quarter of the fiscal year ended June 30, 2003 which was considered a triggering event for evaluation of impairment. We ultimately exited the U.S. audiovisual integration market and subsequently sold our U.S. audiovisual integration business to M:Space in May of 2004. Although we continue to sell camera and furniture products acquired from E.mergent, our decision to exit the U.S. integration services market adversely affected the future cash flows of the E.mergent business unit. We determined that a triggering event occurred in the fourth quarter of the fiscal year ended June 30, 2003. We performed an impairment test and determined that an impairment loss on certain E.mergent assets should be recognized.
 
14


Sale of Broadcast Telephone Interface Business to Comrex. On August 23, 2002, we entered into an agreement with Comrex Corporation (Comrex). In exchange for $1.3 million, Comrex received certain inventory associated with our broadcast telephone interface product line, a perpetual software license to use our technology related to broadcast telephone interface products along with one free year of maintenance and support, and transition services for 90 days following the effective date of the agreement. The transition services included training, engineering assistance, consultation, and development services. We recognized $1.1 million in revenue related to this transaction in the fiscal year ended June 30, 2003.
 
We also entered into a manufacturing agreement to continue to manufacture additional product for Comrex for one year following the agreement described above on a when-and-if needed basis. Comrex agreed to pay the Company for any additional product on a per item basis of cost plus 30%.
 
OM Video Acquisition. On August 27, 2002, we purchased all of the outstanding shares of Stechyson Electronics Ltd., doing business as OM Video, an audiovisual integration firm headquartered in Ottawa, Canada. Under the terms of the agreement, the shareholders of OM Video received $6.3 million in cash at closing. During the fiscal years ended June 30, 2003 and 2004, we paid an additional $500,000 of a potential $600,000 that was held pending verification of certain representations and warranties made in connection with the acquisition. During the second quarter of fiscal 2003, we also paid $750,000 of a potential $800,000 earn-out provision. No further payment related to the holdback or contingent consideration will be paid.
 
As of the acquisition date, we acquired tangible assets consisting primarily of cash of $193,000, accounts receivable of $470,000, inventory of $122,000, property and equipment of $145,000 and prepaid expenses of $6,000. We assumed liabilities consisting primarily of accrued liabilities of $378,000 and accrued tax liabilities of $221,000. We also obtained a non-competition agreement with a term of two years from the former owner of OM Video.
 
Our management at the time believed the OM Video acquisition would complement our existing operations and our core competencies would allow us to acquire market share in the audio visual integration industry. However, our entry into the services business was perceived as a threat by our systems integrators and value-added resellers, many of whom we began competing against for sales. In order to avoid this conflict and maintain good relationships with our systems integrators and value-added resellers, we deemphasized the audiovisual integration market serving the Ottawa Canada region beginning in the fourth quarter of the fiscal year ended June 30, 2003. This decision was considered a triggering event for evaluation of impairment. On March 4, 2005, we sold all of our Canadian audio visual integration business. On June 30, 2003, we performed an impairment test and determined that an impairment loss on the OM Video assets should be recognized.
 
Risk Factors
 
Investors should carefully consider the risks described below. The risks described below are not the only ones we face, and there are risks that we are not presently aware of or that we currently believe are immaterial that may also impair our business operations. Any of these risks could harm our business. The trading price of our common stock could decline significantly due to any of these risks, and investors may lose all or part of their investment. In assessing these risks, investors should also refer to the other information contained or incorporated by reference in this Annual Report on Form 10-K, including our consolidated financial statements and related notes.
 
Risks Relating to Our Business
 
We face intense competition in all of the markets for our products and services, and our operating results will be adversely affected if we cannot compete effectively against other companies.
 
As described in more detail in the section entitled “Competition,” the markets for our products and services are characterized by intense competition and pricing pressures and rapid technological change. We compete with businesses having substantially greater financial, research and development, manufacturing, marketing, and other resources. If we are not able to continually design, manufacture, and successfully introduce new or enhanced products or services that are comparable or superior to those provided by our competitors and at comparable or better prices, we could experience pricing pressures and reduced sales, profit margins, profits, and market share, each of which could have a materially adverse effect on our business.
 
15


Difficulties in estimating customer demand in our products segment could harm our profit margins.
 
Orders from our distributors and other distribution participants are based on demand from end-users. Prospective end user demand is difficult to measure. This means that our revenues in any fiscal quarter could be adversely impacted by low end user demand, which could in turn negatively affect orders we receive from distributors and dealers. Our expectations for both short- and long-term future net revenues are based on our own estimates of future demand.
 
Revenues for any particular time period are difficult to predict with any degree of certainty. We usually ship products within a short time after we receive an order; so consequently, backlog has not been a good indicator of future revenues. We believe that the current level of backlog will fluctuate dependent in part on our ability to forecast revenue mix and plan our manufacturing accordingly. A significant portion of our customers’ orders are received in the last month of the quarter. We budget the amount of our expenses based on our revenue estimates. If our estimates of sales are not accurate and we experience unforeseen variability in our revenues and operating results, we may be unable to adjust our expense levels accordingly and our profit margins will be adversely affected.
 
Our profitability may be adversely affected by our continuing dependence on our distribution channels.
 
We market our products primarily through a network of distributors who in turn sell our products to systems integrators, dealers and value-added resellers. All of our agreements with such distributors and other distribution participants are non-exclusive, terminable at will by either party and generally short-term, with the exception of one exclusive installed audio distribution agreement for the United Kingdom and Southern Ireland. No assurances can be given that any or all such distributors or other distribution participants will continue their relationship with us. Distributors and to a lesser extent systems integrators, dealers and value-added resellers cannot easily be replaced and the loss of revenues and our inability to reduce expenses to compensate for the loss of revenues could adversely affect our net revenues and profit margins.
 
Although we rely on our distribution channels to sell our products, our distributors and other distribution participants are not obligated to devote any specified amount of time, resources or efforts to the marketing of our products or to sell a specified number of our products. There are no prohibitions on distributors or other resellers offering products that are competitive with our products and most do offer competitive products. The support of our products by distributors and other distribution participants may depend on the competitive strength of our products and the price incentives we offer for their support. If our distributors and other distribution participants are not committed to our products, our revenues and profit margins may be adversely affected.
 
General economic conditions may have an adverse impact on our revenues.
 
General economic conditions have, in the past, and may continue to lead to reductions in capital expenditures on technology by end user customers of our products. While there have been indications of improvement in the global economy and its impact on technology spending, constraints still exist and may have an adverse impact on our future revenues.
 
We depend on a limited number of suppliers for components and the inability to obtain sufficient supplies of components could adversely affect our product sales.
 
While it is our policy to have a minimum of two vendor sources for components, certain components used in the manufacture of our products can only be obtained from a single manufacturer and we are solely dependent upon these manufacturers to deliver such components to our suppliers so that they can meet our delivery schedules. We do not have a written commitment from such suppliers to fulfill our future requirements. While our suppliers maintain an inventory of such components, no assurances can be given that such components will always be readily available, available at reasonable prices, available in sufficient quantities, or delivered in a timely fashion. If such components become unavailable, it is likely that we will experience delays, which could be significant, in the production and delivery of our products, unless and until we can otherwise procure the required component or components at competitive prices, if at all. We have experienced increased prices and increased lead times on certain of these key components that have limited availability. Any lack of availability of these components could have a material adverse effect on our ability to sell products and the related increase in prices would likely reduce our profit margins.
 
16


Furthermore, suppliers of some of these components may become our competitors, which might also affect the availability of key components to us. It is possible that other components required in the future may necessitate custom fabrication in accordance with specifications developed or to be developed by us. Also, in the event we, or any of the manufacturers whose products we expect to utilize in the manufacture of our products, are unable to develop or acquire components in a timely fashion, our ability to achieve production yields, revenues and net income may be adversely affected.
 
Product obsolescence could harm demand for our products and could adversely affect our revenues and our results of operations.
 
Our industry is subject to rapid and frequent technological innovations that could render existing technologies in our products obsolete and thereby decrease market demand for such products. If any of our products become slow-moving or obsolete and the recorded value of our inventory is greater than its market value, we will be required to write-down the value of our inventory to its fair market value, which would adversely affect our results of operations.
 
Product development delays or defects could harm our competitive position and reduce our revenues.
 
We have, in the past, and may again experience technical difficulties and delays with the development and introduction of new products. The products we develop contain sophisticated and complicated components and utilize manufacturing techniques involving new technologies. Potential difficulties in the development process that could be experienced by us include difficulty in:
 
·
meeting required specifications;
 
·
hiring a sufficient number of developers;
 
·
developing and testing products; and
 
·
achieving necessary manufacturing efficiencies.
 
Once new products reach the market, they may have defects, which could adversely affect market acceptance of these products and our reputation. If we are not able to manage and minimize such potential difficulties, our business could be negatively affected.
 
If we are unable to protect our intellectual property rights or have insufficient proprietary rights, our business would be materially impaired.
 
We currently rely primarily on a combination of trade secrets, copyrights, trademarks, patents and nondisclosure agreements to establish and protect our proprietary rights in our products. No assurances can be given that others will not independently develop similar technologies, or duplicate or design around aspects of our technology. In addition, we cannot assure you that any patent or registered trademark owned by us will not be invalidated, circumvented or challenged or that the rights granted thereunder will provide competitive advantages to us. Litigation may be necessary to enforce our intellectual property rights. We believe our products and other proprietary rights do not infringe upon any proprietary rights of third parties. We cannot assure you, however, that third parties will not assert infringement claims in the future. Our industry is characterized by vigorous protection of intellectual property rights. Such claims and litigation are expensive and could divert management’s attention, regardless of their merit. In the event of a claim, we might be required to license third party technology or redesign our products, which may not be possible or economically feasible.
 
We currently hold only a limited number of patents. To the extent that we have patentable technology for which we have not filed patent applications, others may be able to use such technology or even gain priority over us by patenting such technology themselves.
 
17


International sales account for a significant portion of our net revenue and risks inherent in international sales could harm our business.
 
International sales represent a significant portion of our total sales from continuing operations. For example, international sales represented 26% of our total sales from continuing operations for fiscal 2003, 10% for fiscal 2002 and 12% for fiscal 2001. We anticipate that the portion of our total revenue from international sales will continue to increase as we further enhance our focus on developing new products, establishing new distribution partners, strengthening our presence in key growth areas, and improving product localization with country-specific product documentation and marketing materials. Our international business is subject to the financial and operating risks of conducting business internationally, including:
 
·
unexpected changes in, or the imposition of, additional legislative or regulatory requirements;
 
·
fluctuating exchange rates;
 
·
tariffs and other barriers;
 
·
difficulties in staffing and managing foreign subsidiary operations;
 
·
export restrictions;
 
·
greater difficulties in accounts receivable collection and longer payment cycles;
 
·
potentially adverse tax consequences; and
 
·
potential hostilities and changes in diplomatic and trade relationships.
 
Our sales in the international market are denominated in U.S. Dollars, with the exception of sales through our wholly owned subsidiary, ClearOne Communications of Canada, Inc. (ClearOne Canada d.b.a. OM Video), whose sales were denominated in Canadian Dollars until March 4, 2005, when the subsidiary was sold to a third party. Consolidation of ClearOne Canada’s financial statements with ours, under U.S. generally accepted accounting principles, required remeasurement of the amounts stated in ClearOne Canada’s financial statements to U.S. Dollars, which was subject to exchange rate fluctuations. We did not undertake hedging activities that might protect us against such risks.
 
We may not be able to hire and retain highly skilled employees, which could affect our ability to compete effectively and may cause our revenue and profitability to decline.
 
We depend on highly skilled technical personnel to research and develop, market and service new and existing products. To succeed, we must hire and retain employees who are highly skilled in the rapidly changing communications and Internet technologies. Individuals who have the skills and can perform the services we need to provide our products and services are in great demand. Because the competition for qualified employees in our industry is intense, hiring and retaining employees with the skills we need is both time-consuming and expensive. We might not be able to hire enough skilled employees or retain the employees we do hire. Our inability to hire and retain employees with the skills we seek could hinder our ability to sell our existing products, systems, or services or to develop new products, systems, or services with a consequent adverse effect on our business.
 
Our reliance on third-party technology or license agreements.
 
We have licensing agreements with various suppliers for software and hardware incorporated into our products. These third-party licenses may not continue to be available to us on commercially reasonable terms, if at all. The termination or impairment of these licenses could result in delays of current product shipments or delays or reductions in new product introductions until equivalent designs could be developed, licensed and integrated, if at all possible, which would have a material adverse effect on our business.
 
18


Our reliance on international outsource manufacturing strategy.
 
We have an agreement with an international manufacturer for the manufacture of our MAX® product line. We use a facility in China. Should there be any disruption in services due to natural disaster, economic or political difficulties in China, quarantines or other restrictions associated with infectious diseases, or other similar events, or any other reason, such disruption would have a material adverse effect on our business. A delay in shipping these products due to an interruption in the manufacturer’s operations would have a negative impact on our revenues. Operating in the international environment exposes us to certain inherent risks, including unexpected changes in regulatory requirements and tariffs, and potentially adverse tax consequences, which could materially affect our results of operations.
 
Our sales depend to a certain extent on government funding and regulation.
 
In the conferencing market, the revenues generated from sales of our audio conferencing products for distance learning and courtroom facilities are dependent on government funding. In the event government funding for such initiatives was reduced or became unavailable, our sales could be negatively impacted. Additionally, many of our products are subject to governmental regulations. New regulations could significantly impact sales in an adverse manner.
 
We may have difficulty in collecting outstanding receivables.
 
We grant credit without requiring collateral to substantially all of our customers. If there were a recurrence of economic uncertainty or an economic slowdown, the risks relating to the granting of such credit would increase. Although we monitor and mitigate the risks associated with our credit policies, we cannot assure you that such mitigation will be effective. We have experienced losses due to customers failing to meet their obligations. Future losses could be significant and, if incurred, could harm our business and have a material adverse effect on our operating results and financial condition.
 
Interruptions to our business could adversely affect our operations.
 
As with any company, our operations are at risk of being interrupted by earthquake, fire, flood, and other natural and human-caused disasters, including terrorist attacks and disease. Our operations are also at risk of power loss, telecommunications failure, and other infrastructure and technology based problems. To help guard against such risks, we carry business interruption loss insurance with coverage of up to $5.4 million to help compensate us for losses that may occur.
 
Risks Relating to Our Company
 
Many of our officers and key personnel have recently joined the company or have only worked together for a short period of time.
 
We have recently made several significant changes to our senior management. In July 2004 we named a new President and Chief Executive Officer, who had been serving as our Vice President of Product Development since December 2003. In addition we hired a new Chief Financial Officer in July 2004, a Vice President of Worldwide Sales and Marketing in November 2004, a Vice President of Operations in December 2004. In January 2005, we named a new Vice President of Product Line Management, who had been serving as our Director of Research and Development. As a result of these recent changes in senior management, many of our officers and other key personnel have only worked together for a short period of time. The failure to successfully integrate senior management could have an adverse impact on our business operations, including reduced sales, confusion with our channel partners and delays in new product introductions.
 
We are not current in the filing of reports with the SEC and the SEC could initiate enforcement proceedings against us at any time.
 
We are not current in the filing of reports with the SEC and the SEC could initiate enforcement proceedings against us at any time, including proceedings to suspend trading of our securities.
 
19


Our directors and officers own 19.6% of the Company and may exert control over us.
 
Our officers and directors together have beneficial ownership of approximately 19.6% of our common stock (including options that are currently exercisable or exercisable within 60 days of July 31, 2005). With this significant holding in the aggregate, the officers and directors, acting together, could exert control over us and may be able to delay or prevent a change in control.
 
Our stock price fluctuates as a result of the conduct of our business and stock market fluctuations.
 
The market price of our common stock has experienced significant fluctuations and may continue to fluctuate significantly. The market price of our common stock may be significantly affected by a variety of factors, including:
 
·
statements or changes in opinions, ratings or earnings estimates made by brokerage firms or industry analysts relating to the market in which we do business or relating to us specifically;
 
·
disparity between our reported results and the projections of analysts;
 
·
the announcement of new products or product enhancements by us or our competitors;
 
·
technological innovations by us or our competitors;
 
·
quarterly variations in our results of operations;
 
·
general market conditions or market conditions specific to technology industries;
 
·
domestic and international economic conditions;
 
·
our ability to report financial information in a timely manner; and
 
·
the markets in which our stock is traded.
 
ITEM 2.
PROPERTIES 
 
Our principal administrative, sales, marketing, customer support and research and development facility is located in our headquarters in Salt Lake City, Utah. Most of our product manufacturing and warehousing operations are also located in our Salt Lake City headquarters. We currently occupy a 51,760 square-foot facility under the terms of an operating lease expiring in October 2006. We believe the facility will be reasonably adequate to meet our needs for the next 12 months.
 
From July 1, 2004 through February 28, 2005, we sublet 5,416 square feet of space in our headquarters building to Premiere Conferencing, the purchaser of our conferencing services business. On August 1, 2005, we entered into a one-year sublease with Inovar, Inc. with respect to the 12,000 square foot manufacturing facility in our headquarters building in connection with the outsourcing of our manufacturing operations. Such space had been provided to Inovar on a rent-free basis from June 20 to July 31, 2005, pending execution of definitive agreements.
 
Our conference furniture manufacturing and warehousing operations are conducted from a facility totaling 17,520 square feet located in Champlin, Minnesota. We lease this facility under a lease agreement that expires in September 2007. We believe the facility will be reasonably adequate to meet our needs for the next 12 months.
 
Our wholly owned United Kingdom subsidiary, ClearOne Communications Limited, rents an office in Oxfordshire, England, consisting of 250 square feet. The office space is rented under a managed office arrangement which requires 90 days notice to terminate the agreement.
 
Our wholly owned subsidiary, ClearOne Communications of Canada, Inc. d/b/a OM Video, leased a facility in Ottawa, Canada consisting of 16,190 square feet. We leased this facility under a lease agreement that expires in July 2005. As discussed herein, we sold this subsidiary in March 2005.
 
20


Our wholly owned subsidiary, ClearOne Communications EuMEA, GmbH, leased an office in Nuremberg, Germany, consisting of 200 square meters. This office was closed in December 2004 and the lease was terminated.
 
We previously rented sales offices located in Des Moines, Iowa on a month-to-month basis but such leases were terminated in December 2002. We also leased a sales office in Westmont, Illinois pursuant to a lease that expired in July 2004.
 
Our U.S. business services operations were conducted from a facility totaling 25,523 square feet located in Golden Valley, Minnesota. We leased these facilities under a lease agreement that expired in December 2004. We negotiated an early buyout of the lease effective June 2004.
 
We leased an office in Woburn, Mass. that we initially acquired through the purchase of ClearOne, Inc. in July 2000. The facility consisted of 2,206 square feet. We negotiated an early buyout of the lease effective September 2003.
 
Our wholly owned subsidiary, Gentner Communications Limited, leased an office in Dublin, Ireland for research and development related to video conferencing. The facility consisted of 431 square meters, of which we sublet 129 square meters to a third party effective July 2002. We negotiated an early buyout of the lease effective November 2002.
 
ITEM 3.
LEGAL PROCEEDINGS
 
In addition to the legal proceedings described below, we are also involved from time to time in various claims and other legal proceedings which arise in the normal course of our business. Such matters are subject to many uncertainties and outcomes that are not predictable. However, based on the information available to us today, we do not believe any such other proceedings will have a material, adverse effect on our financial condition or results of operations.
 
The SEC Action. On January 15, 2003, the U.S. Securities and Exchange Commission filed a civil complaint against ClearOne, Frances Flood, then ClearOne’s Chairman, Chief Executive Officer and President, and Susie Strohm, then ClearOne’s Chief Financial Officer, in the U.S. District Court for the District of Utah, Central Division. The complaint alleged that from the quarter ended March 31, 2001, the defendants engaged in a program of inflating ClearOne’s revenues, net income and accounts receivable by engaging in improper revenue recognition in violation of generally accepted accounting principles (GAAP), and Section 17(a) of the Securities Act of 1933 and Sections 10(b), 13(a) and 13(b) of the Securities Exchange Act of 1934, and various regulations promulgated thereunder. Following the filing of the complaint, we placed Ms. Flood and Ms. Strohm on administrative leave and they subsequently resigned from their positions with the Company. On December 4, 2003, we settled the SEC action by entering into a consent decree in which, without admitting or denying the allegations of the complaint, we consented to the entry of a permanent injunction prohibiting future securities law violations. No fine or penalty was assessed against the Company as part of the settlement.
 
On February 20, 2004, Ms. Flood and Ms. Strohm settled the SEC action by entering into consent decrees wherein, without admitting or denying the allegations of the complaint, they each consented to the entry of a permanent injunction prohibiting future violations of the antifraud, reporting, and issuer books and records requirements of the federal securities laws. The order against Ms. Flood also provided for disgorgement in the amount of $71,000 along with prejudgment interest of $2,882, a civil penalty in the amount of $71,000, and prohibited Flood from acting as an officer or director of any issuer that has a class of securities registered pursuant to Section 12 of the Exchange Act or that is required to file reports pursuant to Section 15(d) of the Exchange Act. The order against Ms. Strohm also provided for disgorgement in the amount of $25,000 together with prejudgment interest in the amount of $1,015 and a civil penalty in the amount of $25,000. The final settlement of the SEC action as to Ms. Flood and Ms. Strohm satisfied the condition precedent contained in the employment separation agreements entered into by the Company with each of such persons on December 5, 2003 (See Item 11. Executive Compensation: Employment Contracts and Termination of Employment and Change-in-Control Agreements).
 
21


The Whistleblower Action. On February 11, 2003, our former vice president of sales filed a whistleblower claim with the Occupational Safety and Health Administration (OSHA) under the employee protection provisions of the Sarbanes-Oxley Act alleging that the Company had wrongfully terminated his employment for reporting the Company’s alleged improper revenue recognition practices to the SEC in December 2002, which precipitated the SEC action against the Company. In February 2004, OSHA issued a preliminary order in favor of the former officer, ordering that he be reinstated with back pay, lost benefits, and attorney’s fees. The former officer had also filed a separate lawsuit against the Company in the United States District Court for the District of Utah, Central Division, alleging various employment discrimination claims. In May 2004, the Administrative Law Judge approved a settlement agreement with the former officer pursuant to which he released the Company from all claims asserted by him in the OSHA proceeding and the federal court action in exchange for a cash payment by the Company. The settlement did not have a material impact on the Company's results of operations or financial condition. 
 
The Shareholders’ Class Action. On June 30, 2003, a Consolidated Complaint was filed in the U.S. District Court for the District of Utah, Central Division, against the Company, eight present or former officers and directors of the Company, and Ernst & Young LLP (Ernst & Young), the Company’s former independent registered public accountants, by a class consisting of purchasers of the Company’s common stock during the period from April 17, 2001 through January 15, 2003. The action followed the consolidation of several previously filed class action complaints and the appointment of lead counsel for the class. The allegations in the complaint were essentially the same as those contained in the SEC complaint described above. On December 4, 2003, the Company, on behalf of itself and all other defendants with the exception of Ernst & Young, entered into a settlement agreement with the class pursuant to which we agreed to pay the class $5.0 million and issue the class 1.2 million shares of our common stock. The cash payment was made in two equal installments, the first on November 10, 2003 and the second on January 14, 2005. On May 23, 2005, the court order was amended to provide that odd-lot numbers of shares (99 or fewer shares) will not be issued from the settlement fund and claimants who would otherwise be entitled to receive 99 or fewer shares will be paid cash in lieu of such odd-lot number of shares. As of the date hereof, 228,000 shares of our common stock have been issued to the class and we plan to complete the issuance of the remaining shares in the near future in accordance with the terms of the court order, subject to the receipt of any required approvals from state regulatory authorities.
 
The Shareholder Derivative Actions. Between March and August, 2003, four shareholder derivative actions were filed in the Third Judicial District Court of Salt Lake County, State of Utah, by certain shareholders of the Company against various present and past officers and directors of the Company and against Ernst & Young. The complaints asserted allegations similar to those asserted in the SEC action and shareholders’ class action described above and also alleged that the defendant directors and officers violated their fiduciary duties to the Company by causing or allowing the Company to recognize revenue in violation of GAAP and issue materially misstated financial statements, and that Ernst & Young breached its professional responsibilities to the Company and acted in violation of GAAP and generally accepted accounting standards by failing to identify or prevent the alleged revenue recognition violations and by issuing unqualified audit opinions with respect to the Company’s 2002 and 2001 financial statements. One of these actions was dismissed without prejudice on June 13, 2003. As to the other three actions, our board of directors appointed a special litigation committee of independent directors to evaluate the claims. That committee determined that the maintenance of the derivative proceedings against the individual defendants was not in the best interest of the Company. Accordingly, on December 12, 2003, we moved to dismiss those claims. In March 2004, our motions were granted, and the derivative claims were dismissed with prejudice as to all defendants except Ernst & Young. The Company was substituted as the plaintiff in the action and is now pursuing in its own name the claims against Ernst & Young.
 
22


The Insurance Coverage Action. On February 9, 2004, ClearOne and Edward Dallin Bagley (Bagley), a director and significant shareholder of ClearOne, jointly filed an action in the United States District Court for the District of Utah, Central Division, against National Union Fire Insurance Company of Pittsburgh, Pennsylvania and Lumbermens Mutual Insurance Company, the carriers of certain prior period directors and officers liability insurance policies, to recover the costs of defending and resolving claims against certain of our present and former directors and officers in connection with the SEC action, the shareholders’ class action and the shareholder derivative actions described above, and seeking other damages resulting from the refusal of such carriers to timely pay the amounts owing under such liability insurance policies. This action has been consolidated into a declaratory relief action filed by one of the insurance carriers on February 6, 2004 against ClearOne and certain of its current and former directors. In this action, the insurers assert that they are entitled to rescind insurance coverage under our directors and officers’ liability insurance policies, $3.0 million of which was provided by National Union and $2.0 million which was provided by Lumbermens Mutual, based on alleged misstatements in our insurance applications. In February 2005, we entered into a confidential settlement agreement with Lumbermens Mutual pursuant to which ClearOne and Bagley received a lump sum cash amount and the plaintiffs agreed to dismiss their claims against Lumbermens Mutual with prejudice. The cash settlement will be held in a segregated account until the claims involving National Union have been resolved, at which time the amounts received in the action will be allocated among the Company and Bagley. The amount distributed to the Company and Bagley will be determined based on future negotiations between the Company and Bagley. We are vigorously pursuing our claims against National Union although no assurances can be given that we will be successful. ClearOne and Bagley have entered into a Joint Prosecution and Defense Agreement in connection with the action.
 
The Pacific Technology & Telecommunications Collection Action. On August 12, 2003, we initiated a commercial arbitration proceeding against Pacific Technology & Telecommunications (PT&T), a former distributor, seeking to collect approximately $1.8 million that PT&T owed ClearOne for inventory purchased but not paid for. PT&T denied our claim and asserted counterclaims. Subsequently, on April 20, 2004, PT&T filed for protection under Chapter 7 of the United States Bankruptcy Code, which had the effect of staying the proceeding. Following PT&T’s bankruptcy filing, the Company successfully negotiated a settlement with the bankruptcy trustee. Under the settlement, which has been approved by the bankruptcy court, the Company paid $25,000 and obtained the right to recover all unsold ClearOne inventory held by PT&T and the right to pursue on the basis of an assignment any claims that PT&T may have against any of its own officers or directors, subject, however, to a maximum recovery of $800,000. The Company is currently in the process of investigating whether any such claims exist and, if so, whether it would be in the Company’s best interest to pursue them given the anticipated legal expenses and the uncertainties of being able to collect any resulting favorable judgment. The settlement also resulted in the release and dismissal with prejudice of all of PT&T’s claims against the Company. To date, the Company has not recovered any inventory held by PT&T.
 
U.S. Attorney’s Investigation. As previously announced on January 28, 2003, the Company has been advised that the U.S. Attorney’s Office for the District of Utah has begun an investigation stemming from the complaint in the SEC action described above. No pleadings have been filed to date and the Company is cooperating fully with the U.S. Attorney’s Office.
 
ITEM 4.
SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
 
No matter was submitted to a vote of our security holders during the fourth quarter ended June 30, 2003.
 
23


PART II
 
ITEM 5.
MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS, AND ISSUER PURCHASES OF EQUITY SECURITIES
 
Market Information
 
Our common stock traded under the symbol CLRO on the Nasdaq National Market System (“NASDAQ”) until April 21, 2003. Our shares were delisted from NASDAQ effective as of the opening of trading on April 21, 2003, due to our failure to timely file SEC reports and public interest concerns relating to the SEC complaint filed on January 15, 2003. Since April 21, 2003, our common stock has been traded on the National Quotation Bureau’s Pink Sheets under the symbol “CLRO.” The following table sets forth the high and low sales prices for the common stock for each quarter during the last three fiscal years. On August 10, 2005, the closing price for our common stock on the Pink Sheets was $3.95.
 
2001
 
Market
 
High
 
Low
 
First Quarter
   
NASDAQ
 
$
17.13
 
$
12.00
 
Second Quarter
   
NASDAQ
   
16.44
   
8.50
 
Third Quarter
   
NASDAQ
   
15.69
   
9.75
 
Fourth Quarter
   
NASDAQ
   
14.30
   
9.50
 
                     
2002
         
High
   
Low
 
First Quarter
   
NASDAQ
 
$
18.72
 
$
9.80
 
Second Quarter
   
NASDAQ
   
22.94
   
15.03
 
Third Quarter
   
NASDAQ
   
18.99
   
12.30
 
Fourth Quarter
   
NASDAQ
   
18.80
   
13.25
 
                     
2003
         
High
   
Low
 
First Quarter
   
NASDAQ
 
$
14.69
 
$
3.31
 
Second Quarter
   
NASDAQ
   
5.45
   
2.82
 
Third Quarter
   
NASDAQ/Pink Sheets
   
4.68
   
1.38
 
Fourth Quarter
   
Pink Sheets
   
3.05
   
0.09
 

Shareholders
 
As of July 29, 2005, there were 451 shareholders of record of our common stock, including broker dealers and clearing corporations who hold shares for their customers, each of which is counted as a single shareholder.
 
Dividends
 
We have not paid a cash dividend on our common stock and do not anticipate doing so in the foreseeable future. We intend to retain earnings to fund future capital requirements, growth and product development.
 
Equity Compensation Plan Information
 
The following table sets forth information as of June 30, 2003 with respect to compensation plans under which equity securities of ClearOne are authorized for issuance.
 
24

 
   
Number of securities to be issued upon exercise of outstanding options, warrants, and rights
 
Weighted-average exercise price of outstanding options, warrants and rights
 
Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a))
   
(a)
 
(b)
 
( c )
Equity compensation plans approved by security holders
 
2,122,756
 
$6.89
 
496,668
Equity compensation plans not approved by security holders
 
0
 
0.00
 
0
Total
 
2,122,756
 
$6.89
 
496,668
 
Stock Repurchase program. During fiscal 2001, we repurchased 20,300 shares of our common stock on the open market at prices ranging from $10.58 to $14.16, for an aggregate purchase price of $244,000. All repurchased shares were retired. This stock repurchase program expired in October 2001.
 
During fiscal 2003, we repurchased 125,000 shares on the open market at prices ranging from $3.06 to $3.60, for an aggregate purchase price of $430,000. All repurchased shares were retired. This stock repurchase program expired in October 2003 and we have not repurchased any additional securities since that time.
 
Private Placement of Common Stock. On December 11, 2001, we completed a private placement of 1,500,000 shares of our common stock, from which we received net proceeds of approximately $23.8 million, after deducting costs and expenses associated with the private placement. In connection with the offering, we issued warrants to the placement agent entitling it to purchase up to 150,000 shares of our common stock at an exercise price of $17.00 per share through November 27, 2006.
 
ITEM 6. SELECTED FINANCIAL DATA
 
The following selected financial data has been derived from our audited Consolidated Financial Statements. For the fiscal years ended June 30, 2002 and 2001, the data in the table below is restated to reflect the restatement of results for those years (see below and Note 3. Restatement and reclassifications of previously issued financial statements in Item 8 of this report). For the fiscal years ended June 30, 2000 and 1999, the selected financial data in the table below is presented on an unaudited basis, to reflect prior period adjustments resulting from the re-audit of subsequent fiscal years. The results presented below for the fiscal years ended June 30, 2000 and 1999 have not been re-audited and are unaudited. The information set forth below is not necessarily indicative of results of future operations, and should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the consolidated financial statements and related notes thereto included elsewhere in this Form 10-K.
 
25


SELECTED CONSOLIDATED FINANCIAL DATA
(in thousands, except share data)
 
   
Years Ended June 30,
 
   
2003
 
2002
 
2001
 
2000
 
1999
 
       
(restated)
 
(restated)
 
(unaudited)
 
(unaudited)
 
Operating results:
                     
Net revenue
 
$
57,585
 
$
43,362
 
$
34,137
 
$
27,918
 
$
20,268
 
Costs and expenses:
                               
Cost of goods sold
   
35,301
   
22,172
   
15,133
   
11,175
   
8,908
 
Marketing and selling
   
12,187
   
10,739
   
7,711
   
6,200
   
4,313
 
General and administrative
   
18,011
   
5,345
   
4,198
   
3,214
   
2,545
 
Product development
   
2,995
   
3,810
   
2,747
   
1,271
   
1,195
 
Impairment losses
   
26,001
   
7,115
   
-
   
-
   
-
 
Gain on sale of assets
   
-
   
(250
)
 
-
   
-
   
-
 
Purchased in-process research and development
   
-
   
-
   
728
   
-
   
-
 
Operating income (loss)
   
(36,910
)
 
(5,569
)
 
3,620
   
6,058
   
3,307
 
Other income (expense)
   
(96
)
 
132
   
188
   
153
   
(78
)
Income (loss) from continuing operations before income taxes
   
(37,006
)
 
(5,437
)
 
3,808
   
6,211
   
3,229
 
Provision (benefit) for income taxes
   
(834
)
 
1,400
   
1,050
   
2,229
   
1,209
 
Income (loss) from continuing operations
   
(36,172
)
 
(6,837
)
 
2,758
   
3,982
   
2,020
 
Income from discontinued operations, net of applicable income taxes
   
-
   
-
   
737
   
427
   
524
 
Gain on disposal of business segment, net of applicable income taxes
   
200
   
176
   
123
   
-
   
-
 
Net income (loss)
 
$
(35,972
)
$
(6,661
)
$
3,618
 
$
4,409
 
$
2,544
 
                                 
Earnings (loss) per common share:
                               
Basic earnings (loss) from continuing operations
 
$
(3.23
)
$
(0.71
)
$
0.32
 
$
0.48
 
$
0.25
 
Diluted earnings (loss) from continuing operations
 
$
(3.23
)
$
(0.71
)
$
0.30
 
$
0.46
 
$
0.24
 
Basic earnings from discontinued operations
 
$
0.02
 
$
0.02
 
$
0.10
 
$
0.05
 
$
0.06
 
Diluted earnings from discontinued operations
 
$
0.02
 
$
0.02
 
$
0.09
 
$
0.04
 
$
0.06
 
Basic earnings (loss)
 
$
(3.21
)
$
(0.69
)
$
0.42
 
$
0.53
 
$
0.31
 
Diluted earnings (loss)
 
$
(3.21
)
$
(0.69
)
$
0.39
 
$
0.50
 
$
0.30
 
Weighted average shares outstanding:
                               
Basic
   
11,183,339
   
9,588,118
   
8,593,725
   
8,269,941
   
8,080,536
 
Diluted
   
11,183,339
   
9,588,118
   
9,194,009
   
8,740,209
   
8,468,884
 
 
   
As of June 30,
 
   
2003
 
2002
 
2001
 
2000
 
1999
 
       
(restated)
 
(restated)
 
(unaudited)
 
(unaudited)
 
Financial data:
                     
Current assets
 
$
26,917
 
$
36,312
 
$
17,604
 
$
15,116
 
$
9,282
 
Property, plant and equipment, net
   
6,768
   
8,123
   
5,681
   
3,050
   
2,126
 
Total assets
   
35,276
   
63,876
   
25,311
   
18,220
   
11,519
 
Long-term debt, net of current maturities
   
931
   
-
   
-
   
-
   
-
 
Capital leases, net of current maturities
   
1,215
   
2,016
   
1,680
   
230
   
455
 
Total stockholders' equity
   
18,743
   
53,892
   
20,728
   
15,073
   
8,352
 

Quarterly Financial Data (Unaudited)
 
The financial data in this Annual Report on Form 10-K for the quarter ended September 30, 2002, and for each of the quarters in the fiscal years ending June 30, 2002 and 2001 has been restated from amounts previously reported on Forms 10-Q and Forms 10-K. A discussion of the restatement in relation to the affected quarters is provided in Note 3 to our audited consolidated financial statements - Restatement and Reclassification of Previously Issued Consolidated Financial Statements. An overview of the restatement is provided in the introduction to Item 7 - Management’s Discussion and Analysis of Financial Condition and Results of Operations.
 
26

 
   
Fiscal 2003 Quarters Ended
 
   
(in thousands)
 
   
As of Sept. 30
 
As of Dec. 31
 
As of Mar. 31
 
As of June 30
 
   
(as previously reported)
 
(restated)
             
Net revenue
 
$
12,998
 
$
13,818
 
$
14,184
 
$
15,258
 
$
14,325
 
Cost of goods sold
   
(7,440
)
 
(11,922
)
 
(6,357
)
 
(10,169
)
 
(6,853
)
Operating expenses
   
(6,398
)
 
(6,569
)
 
(13,129
)
 
(7,120
)
 
(6,375
)
One-time charges
   
(1,947
)
 
-
   
-
   
-
   
-
 
Impairment charges
   
-
   
-
   
-
   
-
   
(26,001
)
Other (income) expense
   
77
   
(11
)
 
(40
)
 
(12
)
 
(34
)
Gain on sale of product line
   
1,112
   
-
   
-
   
-
   
-
 
Loss from continuing operations before income taxes
   
(1,598
)
 
(4,684
)
 
(5,342
)
 
(2,043
)
 
(24,938
)
Benefit for income taxes
   
(439
)
 
(314
)
 
(358
)
 
(137
)
 
(25
)
Loss from continuing operations
   
(1,159
)
 
(4,370
)
 
(4,984
)
 
(1,906
)
 
(24,913
)
Income from discontinued operations
   
-
   
59
   
59
   
24
   
58
 
Net loss
 
$
(1,159
)
$
(4,311
)
$
(4,925
)
$
(1,882
)
$
(24,855
)
                                 
Basic (loss) per common share:
                               
Continuing operations
 
$
(0.10
)
$
(0.39
)
$
(0.44
)
$
(0.17
)
$
(2.23
)
Discontinued operations
   
-
   
0.01
   
0.01
   
-
   
0.01
 
Basic (loss) per common share
 
$
(0.10
)
$
(0.38
)
$
(0.43
)
$
(0.17
)
$
(2.22
)
Diluted (loss) per common share:
                               
Continuing operations
 
$
(0.10
)
$
(0.39
)
$
(0.44
)
$
(0.17
)
$
(2.23
)
Discontinued operations
   
-
   
0.01
   
0.01
   
-
   
0.01
 
Diluted (loss) per common share
 
$
(0.10
)
$
(0.38
)
$
(0.43
)
$
(0.17
)
$
(2.22
)
 
   
Fiscal 2002 Quarters Ended
 
   
(in thousands)
 
   
As of Sept. 30
 
As of Dec. 31
 
   
(as previously reported)
 
(restated)
 
(as previously reported)
 
(restated)
 
Net revenue
 
$
11,220
 
$
9,963
 
$
12,582
 
$
12,590
 
Cost of goods sold
   
(4,582
)
 
(4,423
)
 
(5,057
)
 
(5,484
)
Operating expenses
   
(4,501
)
 
(4,304
)
 
(5,211
)
 
(4,487
)
Impairment charges
   
-
   
-
   
-
   
-
 
Other (income) expense
   
145
   
71
   
66
   
(67
)
Income from continuing operations before income taxes
   
2,282
   
1,307
   
2,380
   
2,552
 
Provision for income taxes
   
870
   
393
   
888
   
766
 
Income from continuing operations
   
1,412
   
914
   
1,492
   
1,786
 
Income from discontinued operations
   
-
   
-
   
-
   
-
 
Net income
 
$
1,412
 
$
914
 
$
1,492
 
$
1,786
 
                           
Basic earnings per common share:
                         
Continuing operations
 
$
0.16
 
$
0.11
 
$
0.17
 
$
0.20
 
Discontinued operations
   
-
   
-
   
-
   
-
 
Basic earnings per common share
 
$
0.16
 
$
0.11
 
$
0.17
 
$
0.20
 
Diluted earnings per common share:
                         
Continuing operations
 
$
0.16
 
$
0.10
 
$
0.16
 
$
0.18
 
Discontinued operations
   
-
   
-
   
-
   
-
 
Diluted earnings per common share
 
$
0.16
 
$
0.10
 
$
0.16
 
$
0.18
 

27

 
   
Fiscal 2002 Quarters Ended
 
   
(in thousands)
 
   
As of Mar. 31
 
As of June 30
 
   
(as previously reported)
 
(restated)
 
(as previously reported)
 
(restated)
 
Net revenue
 
$
14,171
 
$
9,316
 
$
16,569
 
$
11,493
 
Cost of goods sold
   
(5,587
)
 
(4,388
)
 
(7,774
)
 
(7,876
)
Operating expenses
   
(5,430
)
 
(4,971
)
 
(5,667
)
 
(5,884
)
Impairment charges
   
-
   
-
   
-
   
(7,115
)
Other (income) expense
   
(71
)
 
32
   
369
   
97
 
Income (loss) from continuing operations before income taxes
   
3,083
   
(11
)
 
3,497
   
(9,285
)
Provision (benefit) for income taxes
   
1,012
   
(3
)
 
1,061
   
244
 
Income (loss) from continuing operations
   
2,071
   
(8
)
 
2,436
   
(9,529
)
Income from discontinued operations
   
-
   
117
   
-
   
59
 
Net income (loss)
 
$
2,071
 
$
109
 
$
2,436
 
$
(9,470
)
                           
Basic earnings (loss) per common share:
                         
Continuing operations
 
$
0.20
 
$
-
 
$
0.24
 
$
(0.90
)
Discontinued operations
   
-
   
0.01
   
-
   
0.01
 
Basic earnings (loss) per common share
 
$
0.20
 
$
0.01
 
$
0.24
 
$
(0.89
)
Diluted earnings (loss) per common share:
                         
Continuing operations
 
$
0.20
 
$
-
 
$
0.22
 
$
(0.90
)
Discontinued operations
   
-
   
0.01
   
-
   
0.01
 
Diluted earnings (loss) per common share
 
$
0.20
 
$
0.01
 
$
0.22
 
$
(0.89
)

   
Fiscal 2001 Quarters Ended
 
   
(in thousands)
 
   
As of Sept. 30
 
As of Dec. 31
 
   
(as previously reported)
 
(restated)
 
(as previously reported)
 
(restated)
 
Net revenue
 
$
9,333
 
$
5,567
 
$
9,680
 
$
9,585
 
Cost of goods sold
   
(3,766
)
 
(2,804
)
 
(3,971
)
 
(3,944
)
Operating expenses
   
(3,488
)
 
(4,042
)
 
(3,873
)
 
(3,538
)
Other expense
   
64
   
8
   
119
   
88
 
Income (loss) from continuing operations before income taxes
   
2,143
   
(1,271
)
 
1,955
   
2,191
 
Provision (benefit) for income taxes
   
799
   
(350
)
 
752
   
604
 
Income (loss) from continuing operations
   
1,344
   
(921
)
 
1,203
   
1,587
 
Income from discontinued operations
   
186
   
95
   
337
   
245
 
Gain on disposal of business segment
   
-
   
-
   
-
   
-
 
Net income (loss)
 
$
1,530
 
$
(826
)
$
1,540
 
$
1,832
 
                           
Basic earnings (loss) per common share:
                         
Continuing operations
 
$
0.16
 
$
(0.11
)
$
0.14
 
$
0.18
 
Discontinued operations
   
0.02
   
0.01
   
0.04
   
0.03
 
Basic earnings (loss) per common share
 
$
0.18
 
$
(0.10
)
$
0.18
 
$
0.21
 
Diluted earnings (loss) per common share:
                         
Continuing operations
 
$
0.15
 
$
(0.11
)
$
0.13
 
$
0.17
 
Discontinued operations
   
0.02
   
0.01
   
0.04
   
0.03
 
Diluted earnings (loss) per common share
 
$
0.17
 
$
(0.10
)
$
0.17
 
$
0.20
 

28


   
Fiscal 2001 Quarters Ended 
 
   
(in thousands)   
 
   
As of Mar. 31 
 
As of June 30 
 
   
(as previously reported)
 
(restated)
 
(as previously reported)
 
(restated)
 
Net revenue
 
$
10,212
 
$
9,589
 
$
10,653
 
$
9,396
 
Cost of goods sold
   
(4,328
)
 
(4,168
)
 
(4,438
)
 
(4,217
)
Operating expenses
   
(3,786
)
 
(3,805
)
 
(3,757
)
 
(3,999
)
Other expense
   
69
   
39
   
121
   
53
 
Income from continuing operations before income taxes
   
2,167
   
1,655
   
2,579
   
1,233
 
Provision for income taxes
   
808
   
456
   
959
   
340
 
Income from continuing operations
   
1,359
   
1,199
   
1,620
   
893
 
Income (loss) from discontinued operations
   
242
   
250
   
(28
)
 
147
 
Gain on disposal of business segment
   
-
   
-
   
1,220
   
123
 
Net income
 
$
1,601
 
$
1,449
 
$
2,812
 
$
1,163
 
                           
Basic earnings per common share:
                         
Continuing operations
 
$
0.16
 
$
0.14
 
$
0.19
 
$
0.10
 
Discontinued operations
   
0.03
   
0.03
   
0.14
   
0.03
 
Basic earnings per common share
 
$
0.19
 
$
0.17
 
$
0.33
 
$
0.13
 
Diluted earnings per common share:
                         
Continuing operations
 
$
0.15
 
$
0.13
 
$
0.18
 
$
0.10
 
Discontinued operations
   
0.03
   
0.03
   
0.13
   
0.03
 
Diluted earnings per common share
 
$
0.18
 
$
0.16
 
$
0.31
 
$
0.13
 

Discussion of Quarterly Financial Data (Unaudited)

We have restated our previously reported consolidated financial statements for the fiscal years ended June 30, 2002 and 2001. The discussion below relates to the changes in the consolidated statements of operations on a quarterly basis and are unaudited. Since we have not previously filed our quarterly reports on Form 10-Q for the quarters ended December 31, 2002 and March 31 and June 30, 2003, figures for those periods have not been restated.

Summary of restatement items
 
Errors in previously issued financial statements were identified in the following areas: 
 
Revenue Recognition and Related Sales Returns, Credit Memos, and Allowances. We recognized revenue before the amounts charged to both distributors and non-distributors were considered fixed and determinable or reasonably collectible. Accordingly, revenue was inappropriately accelerated.
 
Beginning in 2001 and through 2002, we modified our sales channels to include distributors. These distributors were generally thinly capitalized with little or no financial resources and did not have the wherewithal to pay for these products when delivered by us. Furthermore, in a substantial number of cases, significant amounts of inventories were returned or never paid for and the payment for product sold (to both distributors and non-distributors) was regularly subject to final negotiation with our customers. As a result of such negotiations, we routinely agreed to significant concessions from the originally invoiced amounts to facilitate collection. Accordingly, amounts charged to both distributors and non-distributors were not considered fixed and determinable or reasonably collectible until cash was collected. Accordingly, product revenues to distributors and non-distributors were restated for the quarter ended September 30, 2002, and for each of the quarters in the fiscal years ending June 30, 2002 and 2001.
 
Related sales returns and allowances, rebates, and accounts receivables were revised appropriately given the revenue adjustments.
 
29


Cutoff and Period-End Close Adjustments Related to Accrued Liabilities and Prepaid Assets. We recorded accruals and amortized certain prepaid assets to operating expenses during the quarter ended September 30, 2002, and during each of the quarters in the fiscal years ending June 30, 2002 and 2001in the improper periods. Accordingly, adjustments to accrued liabilities, prepaid assets, and operating expenses were recorded to properly account for these errors.
 
Tracking and Valuation of Inventory, Including Controls to Identify and Properly Account for Obsolete Inventory. As part of the restatement process, we discovered that we made errors in the recording and presentation of inventories, including consigned inventory, obsolete and slow-moving inventories, errors in the capitalization of overhead expenses, errors in recording inventories at the lower of cost or market, and errors for inventory shrinkage. As a result, we made adjustments to reflect consigned inventory, to properly capitalize overhead expenses, physical inventory adjustments, adjustments to lower of cost or market, and adjustments to reserves for excess, obsolete and slow-moving inventory. Accordingly, inventories and cost of goods sold were restated to properly account for these errors.
 
Accounting for Leases, Including Classification as Operating or Capital. In evaluating the classification of leases, we did not consider all periods for which failure to renew the lease imposes a penalty on the lessee in such amount that a renewal appears, at the inception of the leases, to be reasonably assured. Accordingly, certain leases were classified as operating leases that should have been classified as capital leases. The effect of properly recording the capital leases on our previously reported financial statements is to record additional capital lease obligations, property and equipment, and depreciation expense and reduce rental expense for the quarter ended September 30, 2002, and for each of the quarters in the fiscal years ending June 30, 2002 and 2001.
 
We did not consider escalating rent payments and rent holidays for certain operating leases. Accordingly, rent expense was inappropriately understated. The effect of straight-lining rent payments on our previously reported financial statements is to record an accrued liability for future rent payments and record additional rent expense.
 
Accounting for Acquisitions. During the restatement process, we determined that the valuations and purchase price allocations in connection with its acquisitions of ClearOne, Ivron, and E.mergent were not performed properly. We engaged independent third-party valuation specialists to provide valuations and purchase price allocations on these acquisitions. We re-examined the purchase price allocations and adjusted for items that should have been recorded previously.
 
 
·
In our previously issued consolidated financial statements, we valued the 129,871 shares of common stock issued in conjunction with the acquisition of ClearOne at $15.40 per share. We determined that the shares should have been valued at $13.97 per share based on the market prices a few days before and after the measurement date.
 
·
We recorded adjustments to the amounts allocated to certain acquired intangible assets, including developed technologies, patents and trademarks, and distribution agreements. We also recorded adjustments to the amounts allocated to in-process research and development related to the ClearOne acquisition.
 
·
We recorded adjustments to the amounts allocated to certain acquired tangible assets and assumed liabilities, including cash, accounts receivable, inventory, property, plant and equipment, deferred tax assets, and deferred tax liabilities.
 
·
The adjustments to purchase price, as well as the adjustments to the amounts allocated to acquired intangible assets, acquired tangible assets, and assumed liabilities, resulted in corresponding adjustments to the amount allocated to goodwill.

30


Accounting for Equity and Other Significant Non-Routine Transactions.
 
 
·
During the quarter ended June 30, 2001, we sold our remote control product line to Burk Technology. In previously issued consolidated financial statements, we recognized a gain on the sale of our remote control product line that included a significant note receivable from the buyer at the time of the sale, and recognized interest income associated with the note receivable in periods subsequent to the sale. Based on an analysis of the facts and circumstances that existed at the date of the sale, the recognition of this gain was inappropriate as the buyer did not have the wherewithal to pay this note receivable, the operations of the remote control product line had not historically generated cash flows sufficient to fund the required payments, and there were contingent liabilities we had to the buyer. Accordingly, we concluded that the gain should be recognized as cash is received from the buyer. As a result, we have reduced the gain on sale and eliminated the note receivable at the time of the sale, and recognized additional gain on the sale of the product line when-and-as cash payments on the note receivable are obtained.
 
·
During the quarter ended June 30, 2002, we experienced certain triggering events that indicated that certain long-lived assets related to ClearOne and Ivron were impaired. Accordingly, we performed an impairment analysis in accordance with the provisions of Statement of Financial Accounting Standards (SFAS) No. 121. As a result of this analysis, we determined that goodwill, intangible assets, and certain property, plant, and equipment related to the ClearOne and Ivron acquisitions were fully impaired as of June 30, 2002. As a result, we recognized an impairment loss equal to the carrying value of these assets. In previously issued consolidated financial statements, we failed to recognize that a triggering event had occurred and did not record an impairment loss for these assets.
 
·
During the quarter ended March 31, 2001, the terms of certain outstanding stock options were modified to allow for their acceleration in the event we met certain EPS targets. During the quarter ended June 30, 2001 we cancelled certain outstanding stock options and issued a replacement award with a lower exercise price, resulting in variable accounting. In previously issued consolidated financial statements, we did not record compensation expense in connection with these modifications in accordance with Accounting Principles Board (APB) No. 25 and Financial Accounting Standards Board (FASB) Interpretation Number 44, “Accounting for Certain Transactions involving Stock Compensation” (an interpretation of APB No. 25).
 
·
On June 29, 2001, we repurchased 5,000 shares of our previously issued and outstanding common shares. In previously issued consolidated financial statements, we did not record the effects of this transaction until fiscal year 2002.

Accounting for Income Taxes. During each of the quarters in the fiscal years ending June 30, 2002 and 2001, and in the quarter ended September 30, 2002, our income before income taxes was restated to correct for certain accounting errors, resulting in less pre tax book income and correspondingly less income tax expense. In conjunction with the restatement, we evaluated the realizability of deferred tax assets. In the quarter ended June 30, 2002, we recorded an increased domestic valuation allowance to reflect our determination that not all of our deferred tax assets were more likely than not realizable pursuant to the provisions of SFAS 109, “Accounting for Income Taxes”.


ITEM 7.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
The following discussion should be read in conjunction with our Consolidated Financial Statements and related Notes included in Item 8 of this Annual Report on Form 10-K. This discussion contains forward-looking statements based on current expectations that involve risks and uncertainties, such as our plans, objectives, expectations and intentions, as set forth under “Special Note Regarding Forward-Looking Statement.” Our actual results and the timing of events could differ materially from those anticipated in these forward-looking statements as a result of various factors, including those set forth in the following discussion and under the caption “Factors That Could Affect Our Future Results” of this Management’s Discussion and Analysis of Financial Condition and Results of Operations and elsewhere in this Annual Report on Form 10-K. Unless otherwise indicated, all references to a year reflect our fiscal year that ends on June 30.
 
31


Business Overview
 
We are an audio conferencing products company. We develop, manufacture, market and service a comprehensive line of audio conferencing products, which range from tabletop conferencing phones to professionally installed audio systems. We have a strong history of product innovation and plan to continue to apply our expertise in audio engineering to developing innovative new products. The performance and reliability of our high-quality solutions create a natural communication environment, which saves organizations of all sizes time and money by enabling more effective and efficient communication between geographically separated businesses, employees and customers.
 
Restatements and Reclassifications of Previously Issued Consolidated Financial Statements
 
We have restated our previously reported consolidated financial statements for the quarter ended September 30, 2002, and for fiscal years ended June 30, 2002 and 2001, and each of the quarters therein. The restatement adjustments (including impairment charges) resulted in a cumulative net reduction to shareholders’ equity of approximately $17.4 million and $3.8 million as of June 30, 2002 and 2001, respectively, and a reduction in previously reported net income of approximately $14.1 million and $3.9 million for the years ended June 30, 2002 and 2001, respectively. We have also restated the July 1, 2000 opening retained earnings balance to reflect corrected items that relate to prior periods.

We have not amended our prior filings to reflect the restatement. As a result, information previously filed in our annual reports on Form 10-K for fiscal years ended June 30, 2002 and 2001, our quarterly reports on Form 10-Q for the quarterly periods included in those fiscal years and for the quarter ended September 30, 2002 and any current reports on Form 8-K, or other disclosures, containing fiscal 2003, 2002 and 2001 information filed or made prior to the filing of this 2003 Form 10-K should not be relied upon.

As discussed below, our previously issued consolidated balance sheets, consolidated statements of operations and comprehensive income (loss), consolidated statements of stockholders’ equity and cash flows for the years ended June 30, 2002 and 2001 have been restated to correct for certain accounting errors.
 
Summary of restatement items
 
Errors in previously issued financial statements were identified in the following areas: 
 
Revenue Recognition and Related Sales Returns, Credit Memos, and Allowances. We recognized revenue before the amounts charged to both distributors and non-distributors were considered fixed and determinable or reasonably collectible. Accordingly, revenue was inappropriately accelerated.
 
Beginning in 2001 and through 2002, we modified our sales channels to include distributors. These distributors were generally thinly capitalized with little or no financial resources and did not have the wherewithal to pay for these products when delivered by us. Furthermore, in a substantial number of cases, significant amounts of inventories were returned or never paid for and the payment for product sold (to both distributors and non-distributors) was regularly subject to final negotiation with our customers. As a result of such negotiations, we routinely agreed to significant concessions from the originally invoiced amounts to facilitate collection. Accordingly, amounts charged to both distributors and non-distributors were not considered fixed and determinable or reasonably collectible until cash was collected. Accordingly, product revenues to distributors and non-distributors were restated for the years ending June 30, 2002 and 2001.
 
Related sales returns and allowances, rebates, and accounts receivables were revised appropriately given revenue adjustments.
 
Cutoff and Period-End Close Adjustments Related to Accrued Liabilities and Prepaid Assets. We recorded accruals and amortized certain prepaid assets to operating expenses during the fiscal years ended June 30, 2002 and 2001 in the improper periods. Accordingly, adjustments to accrued liabilities, prepaid assets, and operating expenses were recorded for the years ending June 30, 2002 and 2001.
 
32


Tracking and Valuation of Inventory, Including Controls to Identify and Properly Account for Obsolete Inventory. As part of the restatement process, we discovered that we made errors in the recording and presentation of inventories, including consigned inventory, obsolete and slow-moving inventories, errors in the capitalization of overhead expenses, errors in recording inventories at the lower of cost or market, and errors for inventory shrinkage. As a result, we made adjustments to reflect consigned inventory, to properly capitalize overhead expenses, physical inventory adjustments, adjustments to lower of cost or market, and adjustments to reserves for excess, obsolete and slow-moving inventory. Accordingly, inventories and cost of goods sold were restated to properly account for these errors.
 
Accounting for Leases, Including Classification as Operating or Capital. In evaluating the classification of leases, we did not consider all periods for which failure to renew the lease imposes a penalty on the lessee in such amount that a renewal appears, at the inception of the leases, to be reasonably assured. Accordingly, certain leases were classified as operating leases that should have been classified as capital leases. The effect of properly recording the capital leases on our previously reported financial statements is to record additional capital lease obligations, property and equipment, and depreciation expense and reduce rental expense for fiscal periods ending June 30, 2002 and 2001.
 
We did not consider escalating rent payments and rent holidays for certain operating leases. Accordingly, rent expense was inappropriately understated. The effect of straight-lining rent payments on our previously reported financial statements is to record an accrued liability for future rent payments and record additional rent expense.
 
Classification of Cash and Marketable Securities. In previously issued consolidated financial statements, we classified municipal government auction rate notes and auction rate preferred stocks as cash instead of marketable securities. Accordingly, reclassifications were made to the 2002 cash balances to properly classify those as marketable securities instead of cash.
 
Accounting for Acquisitions. During the restatement process, we determined that the valuations and purchase price allocations in connection with our acquisitions of ClearOne, Ivron, and E.mergent were not performed properly. We engaged independent third-party valuation specialists to provide valuations and purchase price allocations on these acquisitions. We re-examined the purchase price allocations and adjusted for items that should have been recorded previously.
 
 
·
In our previously issued consolidated financial statements, we valued the 129,871 shares of common stock issued in conjunction with the acquisition of ClearOne at $15.40 per share. We determined that the shares should have been valued at $13.97 per share based on the market prices a few days before and after the measurement date.
 
·
We recorded adjustments to the amounts allocated to certain acquired intangible assets, including developed technologies, patents and trademarks, and distribution agreements. We also recorded adjustments to the amounts allocated to in-process research and development related to the ClearOne acquisition.
 
·
We recorded adjustments to the amounts allocated to certain acquired tangible assets and assumed liabilities, including cash, accounts receivable, inventory, property and equipment, deferred tax assets, and deferred tax liabilities.
 
·
The adjustments to purchase price, as well as the adjustments to the amounts allocated to acquired intangible assets, acquired tangible assets, and assumed liabilities, resulted in corresponding adjustments to the amount allocated to goodwill.

33


Accounting for Equity and Other Significant Non-Routine Transactions.
 
 
·
During the year ended June 30, 2001 we sold our remote control product line to Burk Technology. In previously issued consolidated financial statements, we recognized a gain on the sale of our remote control product line that included a significant note receivable from the buyer at the time of the sale, and recognized interest income associated with the note receivable in periods subsequent to the sale. Based on an analysis of the facts and circumstances that existed at the date of the sale, the recognition of this gain was inappropriate as the buyer did not have the wherewithal to pay this note receivable, the operations of the remote control product line had not historically generated cash flows sufficient to fund the required payments, and there were contingent liabilities we had to the buyer. Accordingly, we concluded that the gain should be recognized as cash is received from the buyer. As a result, we have reduced the gain on sale and eliminated the note receivable at the time of the sale, and recognized additional gain on the sale of the business segment when-and-as cash payments on the note receivable are obtained.
 
·
During the year ended June 30, 2002 we experienced certain triggering events that indicated that certain long-lived assets related to ClearOne and Ivron were impaired. Accordingly, we performed an impairment analysis in accordance with the provisions of SFAS No. 121. As a result of this analysis, we determined that goodwill, intangible assets, and certain property and equipment related to the ClearOne and Ivron acquisitions were fully impaired as of June 30, 2002. As a result, we recognized an impairment loss equal to the carrying value of these assets. In previously issued consolidated financial statements, we failed to recognize that a triggering event had occurred and did not record an impairment loss for these assets.
 
·
During the year ended June 30, 2001 the terms of certain outstanding stock options were modified to allow for their acceleration in the event we met certain EPS targets. During the year ended June 30, 2001 we cancelled certain outstanding stock options and issued a replacement award with a lower exercise price, resulting in variable accounting. In previously issued consolidated financial statements, we did not record compensation expense in connection with these modifications in accordance with APB No. 25 and FASB Interpretation Number 44, “Accounting for Certain Transactions involving Stock Compensation” (an interpretation of APB No. 25).
 
·
On June 29, 2001, we repurchased 5,000 shares of our previously issued and outstanding common shares. In previously issued consolidated financial statements, we did not record the effects of this transaction until fiscal year 2002.

Accounting for Income Taxes. During the fiscal periods ending June 30, 2002 and 2001, our income before income taxes was restated to correct for certain accounting errors, resulting in less pre tax book income and correspondingly less income tax expense. In conjunction with the restatement, we evaluated the realizability of deferred tax assets. In 2002, we recorded an increased domestic valuation allowance to reflect our determination that not all of our deferred tax assets were more likely than not realizable pursuant to the provisions of SFAS 109, “Accounting for Income Taxes”.
 
34


Restated Financial Statements
 
Statements of Operations Adjustments (in thousands)
 
   
As of June 30, 2002
 
As of June 30, 2001
 
   
As Previously Reported
 
Restated
 
As Previously Reported
 
Restated
 
Revenue:
                 
Product
 
$
37,215
 
$
26,253
 
$
28,190
 
$
22,448
 
Conferencing services
   
17,328
   
15,583
   
11,689
   
11,689
 
Business services
   
-
   
1,526
   
-
   
-
 
Total revenue
   
54,543
   
43,362
   
39,879
   
34,137
 
                           
Cost of goods sold:
                         
Product
   
15,057
   
10,939
   
10,634
   
8,789
 
Product inventory write-offs
   
-
   
2,945
   
-
   
416
 
Conferencing services
   
7,943
   
7,310
   
5,869
   
5,928
 
Business services
   
-
   
978
   
-
   
-
 
Total cost of goods sold
   
23,000
   
22,172
   
16,503
   
15,133
 
                           
Gross profit
   
31,543
   
21,190
   
23,376
   
19,004
 
                           
Operating expenses:
                         
Marketing and selling
   
10,705
   
10,739
   
7,753
   
7,711
 
General and administrative
   
6,051
   
5,345
   
4,649
   
4,198
 
Research and product development
   
4,053
   
3,810
   
2,502
   
2,747
 
Impairment losses
   
-
   
7,115
   
-
   
-
 
Gain on sale of court conferencing assets
   
-
   
(250
)
 
-
   
-
 
Purchased in-process research and development
   
-
   
-
   
-
   
728
 
Total operating expenses
   
20,809
   
26,759
   
14,904
   
15,384
 
                           
Operating income (loss)
   
10,734
   
(5,569
)
 
8,472
   
3,620
 
                           
Other income, net
   
509
   
132
   
373
   
188
 
                           
Income (loss) from continuing operations before income taxes
   
11,243
   
(5,437
)
 
8,845
   
3,808
 
Provision for income taxes
   
3,831
   
1,400
   
3,319
   
1,050
 
Income (loss) from continuing operations
   
7,412
   
(6,837
)
 
5,526
   
2,758
 
                           
Discontinued operations:
                         
Income from discontinued operations, net of income taxes
   
-
   
-
   
737
   
737
 
Gain on disposal of a component of our business, net of income taxes
   
-
   
176
   
1,220
   
123
 
Net income (loss)
 
$
7,412
 
$
(6,661
)
$
7,483
 
$
3,618
 
                           
Basic earnings (loss) per common share from continuing operations
 
$
0.77
 
$
(0.71
)
$
0.64
 
$
0.32
 
Diluted earnings (loss) per common share from continuing operations
 
$
0.74
 
$
(0.71
)
$
0.61
 
$
0.30
 
                           
Basic earnings per common share from discontinued operations
 
$
-
 
$
0.02
 
$
0.23
 
$
0.10
 
Diluted earnings per common share from discontinued operations
 
$
-
 
$
0.02
 
$
0.22
 
$
0.09
 
                           
Basic earnings (loss) per common share
 
$
0.77
 
$
(0.69
)
$
0.87
 
$
0.42
 
Diluted earnings (loss) per common share
 
$
0.74
 
$
(0.69
)
$
0.83
 
$
0.39
 

35


Balance Sheet Adjustments (in thousands)
 
   
As of June 30, 2002
 
As of June 30, 2001
 
   
As Previously Reported
 
As Restated
 
As Previously Reported
 
As Restated
 
ASSETS
                 
Current assets:
                 
Cash and cash equivalents
 
$
14,248
 
$
1,744
 
$
6,852
 
$
6,851
 
Marketable securities
   
-
   
12,400
   
-
   
-
 
Accounts receivable, net
   
20,317
   
4,322
   
7,213
   
2,027
 
Inventories
   
8,606
   
12,516
   
4,132
   
6,459
 
Note Receivable, current portion
   
196
   
-
   
71
   
-
 
Deferred income tax assets
   
1,293
   
4,709 
   
248
   
1,587
 
Prepaid expenses and other
   
610
   
621
   
780
   
680
 
Total current assets
   
45,270
   
36,312
   
19,296
   
17,604
 
                           
Property and equipment, net
   
5,770
   
8,123
   
3,697
   
5,681
 
Goodwill, net
   
20,553
   
17,072
   
2,634
   
890
 
Intangibles, net
   
6,991
   
1,634
   
182
   
616
 
Deferred income tax assets
   
-
   
661
   
-
   
446
 
Note Receivable, net of current portion
   
1,490
   
-
   
1,716
       
Other assets
   
73
   
74
   
73
   
74
 
Total assets
 
$
80,147
 
$
63,876
 
$
27,598
 
$
25,311
 
                           
LIABILITIES AND STOCKHOLDERS' EQUITY
                         
Current liabilities:
                         
Line of credit
 
$
196
 
$
196
       
$
-
 
Capital lease obligations
   
60
   
784
   
182
   
619
 
Accounts payable
   
3,053
   
3,056
   
568
   
652
 
Accrued liabilities
   
2,299
   
2,841
   
1,130
   
1,408
 
Deferred revenue
   
607
   
572
   
-
   
-