UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934
For the quarterly period ended September 30, 2002
------------------
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 (I.R.S. Employer
of incorporation or organization) Identification No.)
1825 Research Way, Salt Lake City, Utah 84119
------------------------------------------ -----------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number: (801) 975-7200
--------------
Indicate by check whether the issuer (1) filed all reports required to be filed
by Section 13 or 15(d) of the Securities Exchange Act 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.
[X] Yes [ ] No
Indicate the number of shares outstanding of each of the issuer's classes of
common stock as of the latest practicable date.
Shares Outstanding
Description of Class as of November 1, 2002
-------------------- ----------------------
Common Stock, $0.001 par value 11,207,580
CLEARONE COMMUNICATIONS, INC.
INDEX
Page
Number
------
PART I - FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements
Consolidated Balance Sheets
September 30, 2002 (unaudited) and June 30, 2002............... 3
Consolidated Statements of Operations
Three Months Ended September 30, 2002 and 2001 (unaudited)..... 4
Consolidated Statements of Cash Flows
Three Months Ended September 30, 2002 and 2001 (unaudited)..... 5
Notes to Consolidated Financial Statements....................... 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations........................................12
Item 3. Qualitative and Quantitative Disclosure about Market Risk........23
Item 4. Disclosure Controls..............................................23
PART II - OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K.................................24
2
CLEARONE COMMUNICATIONS, INC.
CONSOLIDATED BALANCE SHEETS
(Unaudited)
September 30, June 30,
------------------------------
2002 2002
---- ----
ASSETS
Current assets:
Cash and cash equivalents.................................. $ 5,404,948 $ 14,248,502
Accounts receivable, less allowances of $1,180,800 as of
September 30, 2002 and $1,213,000 as of June 30, 2002.. 18,664,531 20,316,730
Note receivable - current portion.......................... 193,858 195,598
Inventory.................................................. 10,652,498 8,605,550
Income tax receivable...................................... 115,976 --
Deferred tax assets........................................ 1,293,281 1,293,281
Prepaid expenses........................................... 827,165 609,956
------------- ------------
Total current assets................................... 37,152,257 45,269,617
Property and equipment, net.................................... 6,188,752 5,769,444
Goodwill, net.................................................. 26,750,704 20,552,832
Note receivable - long term portion............................ 1,430,096 1,490,028
Other intangible assets, net................................... 7,289,000 6,991,410
Deposits and other assets...................................... 83,176 73,362
------------- ------------
Total assets........................................... $ 78,893,985 $ 80,146,693
============= ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Line of credit............................................. $ -- $ 196,386
Accounts payable........................................... 3,832,601 3,053,819
Accrued compensation and other benefits.................... 586,731 801,243
Income tax payable......................................... -- 820,729
Accrued severance.......................................... 420,435 416,240
Other accrued expenses..................................... 1,371,313 1,079,111
Unearned revenue - current portion......................... 695,339 607,076
Current portion of capital lease obligations............... 45,268 60,443
------------- ------------
Total current liabilities.............................. 6,951,687 7,035,047
Capital lease obligations...................................... 32,461 40,876
Unearned revenue............................................... 220,488 276,825
Deferred tax liability......................................... 1,457,762 1,457,762
------------- ------------
Total liabilities...................................... 8,662,398 8,810,510
Shareholders' equity:
Common stock, 50,000,000 shares authorized, par value
$.001, 11,197,580 and 11,178,392 shares issued and
outstanding at September 30, 2002 and June 30, 2002,
respectively............................................. 11,198 11,178
Additional paid-in capital................................. 48,439,269 48,384,060
Retained earnings.......................................... 21,781,120 22,940,945
------------- ------------
Total shareholders' equity............................. 70,231,587 71,336,183
------------- ------------
Total liabilities and shareholders' equity............. $ 78,893,985 $ 80,146,693
============= ============
See accompanying notes
3
CLEARONE COMMUNICATIONS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
Three Months Ended
September 30,
------------------------------------------
2002 2001
---- ----
Product sales............................................ $ 5,455,955 42.0% $ 7,491,317 66.8%
Services sales........................................... 7,541,952 58.0% 3,729,066 33.2%
----------- ----- ----------- -----
Total net sales...................................... 12,997,907 100.0% 11,220,383 100.0%
Cost of goods sold - products............................ 3,244,040 59.5% 2,826,233 37.7%
Cost of goods sold - services............................ 4,195,929 55.6% 1,755,744 47.1%
----------- -----------
Total cost of goods sold............................. 7,439,969 57.2% 4,581,977 40.8%
----------- ----- ----------- -----
Gross profit............................................. 5,557,938 42.8% 6,638,406 59.2%
Operating expenses:
Marketing and selling................................ 3,242,927 24.9% 2,469,427 22.0%
General and administrative........................... 2,183,330 16.8% 1,279,667 11.4%
Product development.................................. 972,109 7.5% 751,951 6.7%
One-time charges..................................... 1,947,087 15.0% -- 0.0%
----------- ----- ----------- -----
Total operating expenses......................... 8,345,453 64.2% 4,501,045 40.1%
----------- ----- ----------- -----
Operating income (loss).......................... (2,787,515) (21.4)% 2,137,361 19.1%
Other income (expense):
Interest income...................................... 76,227 0.6% 108,087 0.9%
Interest expense..................................... (8,664) (0.1)% (5,034) 0.0%
Other, net........................................... 16,237 0.1% 29,989 0.3%
Gain (loss) on foreign currency transactions......... (7,036) (0.1)% 11,884 0.1%
Gain on sale of product line......................... 1,111,715 8.6% -- 0.0%
----------- ----- ----------- -----
Total other income............................... 1,188,479 9.1% 144,926 1.3%
----------- ----- ----------- -----
Income (loss) before income taxes........................ (1,599,036) (12.3)% 2,282,287 20.4%
Provision (benefit) for income taxes..................... (439,211) (3.4)% 870,581 7.8%
----------- -----------
Net income (loss)................................ $(1,159,825) (8.9)% $ 1,411,706 12.6%
=========== ===========
Basic earnings (loss) per common share................... $ (0.10) $ 0.16
Diluted earnings (loss) per common share................. $ (0.10) $ 0.16
See accompanying notes
4
CLEARONE COMMUNICATIONS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Three Months Ended
September 30,
--------------------------
2002 2001
---- ----
Cash flows from operating activities:
Net income (loss) ............................................ $(1,159,825) $ 1,411,706
Adjustments to reconcile net income (loss)
to net cash (used in) provided by operating activities:
Depreciation and amortization of property and equipment.... 456,438 277,090
Amortization of intangible assets.......................... 276,311 67,598
Provision for bad debts.................................... 54,248 33,574
Gain on sale of product line............................... (1,111,715) --
Non-cash one-time charges.................................. 1,383,529 --
Changes in operating assets and liabilities:
Accounts receivable..................................... 2,067,736 (1,669,718)
Inventory............................................... (3,410,374) 391,273
Income taxes............................................ (978,812) 553,039
Other assets............................................ (239,963) 48,366
Unearned revenue........................................ (3,088) --
Accounts payable and other accrued expenses............. (41,260) 261,713
----------- -----------
Net cash provided by (used in) operating activities... (2,706,775) 1,374,641
Cash flows from investing activities:
Purchases of property and equipment........................... (731,049) (391,357)
Net proceeds from sale of product line........................ 1,213,237 --
Purchase of business.......................................... (6,515,892) --
Proceeds from note receivable................................. 61,672 --
----------- -----------
Net cash used in investing activities................. (5,972,032) (391,357)
Cash flows from financing activities:
Net proceeds from issuance of common stock.................... 4,493 --
Exercise of employee stock options............................ 50,736 200,770
Repurchase of common stock.................................... - (52,964)
Principal payments on capital lease obligations............... (23,590) (62,607)
Payments on line of credit.................................... (196,386) --
Net cash provided by (used in) financing activities... (164,747) 85,199
----------- -----------
Net increase (decrease) in cash.................................. (8,843,554) 1,068,483
Cash and cash equivalents at the beginning of the year........... 14,248,502 6,852,243
----------- -----------
Cash and cash equivalents at the end of the period............... $ 5,404,948 $ 7,920,726
=========== ===========
Supplemental disclosure of cash flow information:
Income taxes paid............................................. $ (489,400) $ (240,000)
Interest paid................................................. $ (8,664) $ (5,034)
See accompanying notes
5
CLEARONE COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2002
(Unaudited)
1. Basis of Presentation
Effective January 1, 2002, Gentner Communications Corp. changed its name to
ClearOne Communications, Inc. ClearOne began trading under the symbol CLRO on
March 15, 2002.
The accompanying unaudited financial statements have been prepared in accordance
with accounting principles generally accepted in the United States for interim
financial information and with the instructions to Form 10-Q of Regulation S-X.
Accordingly, certain information and footnote disclosures normally included in
complete financial statements have been condensed or omitted. These financial
statements should be read in conjunction with the financial statements and
footnotes thereto included in the Company's 2002 Annual Report on Form 10-K.
In the opinion of management, all adjustments (consisting of normal recurring
adjustments) considered necessary for a fair presentation have been included.
The results of operations for interim periods are not necessarily indicative of
the results of operations to be expected for the full year.
New Accounting Pronouncements - In July 2001, the FASB issued SFAS No. 142,
"Goodwill and Other Intangible Assets" which addresses financial accounting and
reporting for acquired goodwill and other intangible assets and supersedes APB
Opinion No. 17, "Intangible Assets." SFAS No. 142 eliminates amortization of
goodwill and intangible assets with indefinite lives and instead sets forth
methods to periodically evaluate goodwill for impairment in accordance with this
statement. Intangible assets with finite lives will continue to be amortized
over their useful lives and evaluated for impairment in accordance with SFAS No.
144. SFAS No. 142 provides guidance for testing goodwill and intangible assets
that will not be amortized for impairment. The amortization provisions of SFAS
No. 142 apply to goodwill and intangible assets acquired after June 30, 2001.
The Company adopted SFAS No. 142 with respect to its fiscal year 2002
acquisitions of Ivron Systems, Ltd., as of October 3, 2001 and E.mergent, Inc.
as of May 31, 2002 and its fiscal year 2003 acquisition of OM Video as of August
27, 2002. With respect to goodwill and intangible assets acquired prior to July
1, 2001, the Company adopted this statement effective July 1, 2002.
As of September 30, 2002, the Company's gross goodwill balance is $27.1 million,
including $6.2 million of goodwill acquired in the first quarter of fiscal year
2003 resulting from the acquisition of OM Video. As of September 30, 2002, the
Company had accumulated amortization relating to goodwill of $376,000. The
adoption of SFAS No. 142 will reduce the Company's amortization expense by
approximately $188,000 annually beginning in fiscal year 2003 due to the
nonamortization of goodwill. Amortization expense for goodwill for the three
months ended September 30, 2001 was $47,000. Adjusted net income (loss) and net
income (loss) per common share for the three months ended September 30, 2001
compared to the actual results for the three months ended September 30, 2002 is
as follows:
For three months ended September 30
-----------------------------------
2002 2001
---- ----
Reported net income (loss).......................... $(1,159,825) $ 1,411,706
Goodwill amortization............................... -- 47,000
----------- -----------
Adjusted net income (loss).......................... $(1,159,825) $ 1,458,706
=========== ===========
Basic net income (loss) per share reported.......... $(0.10) $0.16
Goodwill amortization............................... -- 0.01
------- -----
Adjusted............................................ $(0.10) $0.17
======= =====
Diluted net income (loss) per share reported........ $(0.10) $0.16
Goodwill amortization............................... -- --
------- -----
Adjusted............................................ $(0.10) $0.16
======= =====
6
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued)
The following table summarizes the gross carrying value and accumulated
amortization for each major class of intangible assets and their amortizable
lives as of September 30, 2002:
Gross Carrying Accumulated Amortizable
Amount Amortization Life
-------------- ------------ -----------
Contracts............................ $1,420,970 $306,828 1.5-3 years
Technology........................... 5,256,369 625,222 3-15 years
Patents.............................. 1,602,826 59,115 10-15 years
---------- --------
Total amortizable intangible assets.. $8,280,165 $991,165
========== ========
The total amortization expense for intangible assets was $276,000 and $21,000
for the quarters ended September 30, 2002 and 2001, respectively. The estimated
amortization expense for the next five fiscal years beginning July 1, 2002 is as
follows:
For the year ended June 30, 2003........................ $ 1,308,000
For the year ended June 30, 2004........................ 1,095,000
For the year ended June 30, 2005........................ 708,000
For the year ended June 30, 2006........................ 583,000
For the year ended June 30, 2007........................ 433,000
SFAS No. 142 provides a six-month transition period from the effective date of
adoption for the Company to complete Step 1 (determining and comparing the fair
value of the Company's reporting units to their carrying values) of the
transitional impairment test. The Company anticipates completing this impairment
assessment by December 31, 2002. If, upon completion of Step 1, the carrying
value exceeds the fair value, the goodwill of the reporting unit is potentially
impaired and the Company must complete Step 2 in order to measure the impairment
loss. Step 2 involves the calculation of the implied fair value of goodwill and
must be completed by June 30, 2003. However, the Company currently does not
expect to fail Step 1 of the transitional impairment test and therefore, does
not expect to record an impairment loss upon completion of the transitional
impairment analysis.
In August 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets." This Statement addresses financial accounting
and reporting for the impairment or disposal of long-lived assets. This
Statement supersedes FASB Statement No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to be Disposed Of," and the
accounting and reporting provisions of APB Opinion No. 30, "Reporting the
Results of Operations and Reporting the Effects of Disposal of a Segment of a
Business, and Extraordinary, Unusual, and Infrequently Occurring Events and
Transactions," for the disposal of a segment of a business (as previously
defined in that opinion). The Company adopted SFAS No. 144 effective July 1,
2002. The adoption of SFAS No. 144 did not have a material impact on the
Company's financial conditions or results of operations.
In July 2002, the FASB issued Statement of Financial Accounting Standards No.
146, "Accounting for Costs Associated with Exit or Disposal Activities". SFAS
No. 146 addresses financial accounting and reporting for costs associated with
exit or disposal activities and nullifies EITF issue No. 94-3, "Liability
Recognition for Certain Employee Termination Benefits and Other Costs to Exit an
Activity (including Certain Costs Incurred in a Restructuring)". SFAS No. 146
requires that a liability for a cost associated with an exit or disposal
activity be recognized when the liability is incurred. Under EITF No. 94-3, a
liability for an exit cost was recognized at the date of an entity's commitment
to an exit plan. A fundamental conclusion reached by the FASB in SFAS No. 146 is
that an entity's commitment to a plan, by itself, does not create an obligation
that meets the definition of a liability. Therefore, SFAS No. 146 eliminates the
definition and requirements for recognition of exit costs in EITF No. 94-3. SFAS
No. 146 also establishes that fair value is the objective for initial
measurement of the liability. SFAS No. 146 is effective for exit or disposal
activities that are initiated after December 31, 2002, with early adoption
encouraged. The Company is currently evaluating the impact of SFAS No. 146 on
its financial statements.
7
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued)
2. Earnings Per Common Share
The following table sets forth the computation of basic and diluted net income
(loss) per share:
Three months ended
September 30,
-------------
2002 2001
---- ----
Numerator:
Net income (loss) ........................................................... $ (1,159,825) $ 1,411,706
============ ============
Denominator:
Denominator for basic net (loss) income per share - weighted average shares . 11,179,580 8,608,479
Dilutive common stock equivalents using treasury stock method ............... -- 451,833
------------ ------------
Denominator for diluted net income (loss) per share - weighted average shares 11,179,580 9,060,312
============ ============
Basic net income (loss) per share ............................................... $ (0.10) $ 0.16
Diluted net income (loss) per share ............................................. $ (0.10) $ 0.16
3. Comprehensive Income
Comprehensive income (loss) for the three-month periods ended September 30, 2002
and 2001 was equal to net income (loss).
4. Use of Estimates
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States requires management to make estimates
and assumptions that affect the reported amounts in the financial statements and
these accompanying notes. Actual results could differ from those estimates.
5. Inventory
Inventory is summarized as follows:
(Unaudited)
September 30, June 30,
2002 2002
---- ----
Raw Materials........................ $4,791,432 $4,134,540
Work in progress..................... 530,861 737,228
Finished Goods....................... 5,330,205 3,733,782
---------- ----------
Total inventory............... $10,652,498 $8,605,550
=========== ==========
Total inventory is net of a reserve for obsolete and slow-moving inventory of
$1,021,000 at September 30, 2002 and $809,000 at June 30, 2002.
6. Stock Options
The following table shows the changes in stock options outstanding.
Weighted
Number Average
of Shares Exercise Price
--------- --------------
Options outstanding as of June 30, 2002............ 1,518,956 $ 8.71
Options granted.................................... 0 $ 0.00
Options exercised.................................. (18,400) $ 2.76
Options expired & canceled......................... (163,913) $ 11.91
--------- --------
Options outstanding as of September 30, 2002....... 1,336,643 $ 8.40
========= ========
8
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued)
7. Segment Reporting
The Company currently operates in three different segments - products,
conferencing services, and business services whereas the Company operated in two
segments in the quarter ended September 30, 2001. The products segment includes
products for audio conferencing products, videoconferencing products and sound
reinforcement products. The conferencing services segment includes full-service
conference calling; on-demand, reservationless conference calling; Web
conferencing; audio and video streaming. The business services segment provides
value added services in the United States and Canada, including proactive field
support, training, system consulting and help desk; customer training and
education; and technical services such as design, installation and services of
systems. Because the addition of the business services segment is a result of
the E.mergent and OM Video acquisitions, information for this segment was not
applicable for the quarter ended September 30, 2001.
The accounting policies of the reportable segments are the same as those
described in the summary of significant accounting policies included in the
Company's 2002 Annual Report on Form 10-K.
The Company's reportable segments are strategic business units that offer
products and services to satisfy different customer needs. They are managed
separately because each segment requires focus and attention on its market and
distribution channel.
The following table summarizes the segment information:
Conferencing Business
Products Services Services Totals
-------- -------- -------- ------
Three Months Ended September 30, 2002:
- -------------------------------------
Net sales.............................. $ 5,455,955 $ 3,753,486 $ 3,788,466 $ 12,997,907
Cost of goods sold..................... 3,244,040 1,758,739 2,437,190 7,439,969
----------- ----------- ----------- ------------
Gross profit........................... 2,211,915 1,994,747 1,351,276 5,557,938
Marketing and selling.................. 1,955,169 702,745 585,013 3,242,927
General and administrative............. 874,602 594,612 714,116 2,183,330
Product development.................... 972,109 - - 972,109
One-time charge........................ 1,728,746 4,654 213,687 1,947,087
----------- ----------- ----------- ------------
Total operating expenses............... 5,530,626 1,302,011 1,512,816 8,345,453
Operating income (loss)................ (3,318,711) 692,736 (161,540) (2,787,515)
Other income .......................... 1,188,479
------------
Loss before income taxes............... (1,599,036)
Income tax benefit..................... 439,211
------------
Net loss............................... $ (1,159,825)
============
Conferencing Business
Products Services Services Totals
-------- -------- -------- ------
Three Months Ended September 30, 2001:
- -------------------------------------
Net sales.............................. $7,491,317 $3,729,066 $ 11,220,383
Cost of goods sold..................... 2,826,233 1,755,744 4,581,977
--------- ----------- ------------
Gross profit........................... 4,665,084 1,973,322 6,638,406
Marketing and selling.................. 1,662,565 806,862 2,469,427
General and administrative............. 724,655 555,012 1,279,667
Product development.................... 751,951 - 751,951
--------- ----------- ------------
Total operating expenses............... 3,137,171 1,361,874 4,501,045
Operating income....................... 1,525,913 611,448 2,137,361
Other income .......................... 144,926
------------
Income before income taxes............. 2,282,287
Provision for income taxes............. (870,581)
------------
Net income............................. $ 1,411,706
============
9
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued)
8. Acquisition of OM Video
On August 27, 2002, the Company purchased all of the issued and outstanding
shares of Stechyson Electronics Ltd. (doing business as OM Video). OM Video is
an audiovisual integration firm headquartered in Ottawa, Ontario, Canada. Under
the terms of the agreement, the shareholders of OM Video received approximately
$6.6 million in cash. An additional $600,000 may be paid to the former
shareholders within the next 12 months pending completion of certain conditions.
Additionally, based on certain performance targets, the former shareholders of
OM Video are entitled to an earn-out bonus of up to $800,000, over the next
twelve months.
As of the date of the OM Video acquisition, the Company acquired tangible assets
(not including cash) of approximately $740,000, consisting primarily of accounts
receivable, inventory and property and equipment. The Company assumed
liabilities of approximately $380,000, consisting primarily of trade accounts
payable, accrued compensation and other accrued liabilities.
The value of the total consideration to be paid, $6.6 million in cash plus the
additional holdback and earn-out amounts, was determined based on arm's length
negotiations between the Company and the OM Video shareholders, that took into
account a number of factors of the business including historic revenues,
operating history, products, intellectual property and other factors.
The following pro forma combined financial information reflects operations as if
the acquisitions of Ivron (acquired October 3, 2001), E.mergent (acquired May
31, 2002) and OM Video (acquired August 27, 2002) had occurred as of July 1,
2001. The pro forma combined financial information is presented for illustrative
purposes only, does not purport to be indicative of the Company's results of
operations as of the date hereof, and is not indicative necessarily of what the
Company's actual results of operations would have been had the acquisitions been
consummated on such dates.
Three Months Ended
September 30,
-------------
2002 2001
---- ----
Net sales.................................. $14,082,287 $18,835,528
=========== ===========
Net income................................. $(2,313,507) $ 1,853,787
=========== ===========
Net income per share - basic............... $ (0.21) $ 0.22
Net income per share - dilutive............ $ (0.21) $ 0.20
9. Sale of Broadcast Telephone Interface Product Line
On August 27, 2002, the Company sold a portion of its broadcast telephone
interface product line to Comrex Corp., a privately held broadcast equipment
provider located in Devens, Massachusetts for $1.2 million. Comrex also
purchased inventory held by ClearOne at the time of the transaction. The
broadcast telephone interface product line consists of ClearOne's digital hybrid
products. Under the terms of the agreement, Comrex obtained a perpetual license
to use the Company's technology related to these products. Comrex now provides
technical support for all digital hybrid products and will assume all
manufacturing, marketing and selling of the digital hybrid line. In addition,
the Company will continue to manufacture the TS-612 product line exclusively for
distribution by Comrex under an OEM agreement for a period of up to twelve
months, at which time the Company will discontinue its manufacture of all
broadcast telephone interface products.
10. One-Time Charge
For the first quarter of fiscal 2003, the Company recorded a one-time charge in
the amount of $1.9 million. The one-time charge included (1) a total of $362,000
in severance and other related costs associated with a reduction of 43 employees
in the United States and Ireland in the first quarter of fiscal 2003; (2) an
inventory write-off in the amount of $1,384,000 in connection with ClearOne's
decision to stop marketing and selling certain products; and (3) a total of
$201,000 in legal, accounting and other advisory fees related to due diligence
on an acquisition that ClearOne ultimately decided not to pursue.
10
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued)
The following table shows the changes in the accrued severance during the first
quarter of fiscal 2003:
Accrued severance at June 30, 2002..........................$ 416,000
Amounts paid during the first quarter....................... (358,000)
Additional accruals during the first quarter................ 362,000
---------
Accrued severance at September 30, 2002.....................$ 420,000
=========
The accrued severance recorded as of June 30, 2002 primarily included severance
related to the E.mergent acquisition, as discussed in the Company's Form 10-K
for the year ended June 30, 2002. The accrued severance recorded as of September
30, 2002 is related to both the E.mergent acquisition and the severance recorded
in the first quarter of fiscal 2003.
11. Subsequent Event - Capital Lease
On October 14, 2002, the Company entered into a new capital lease in the amount
of $2.0 million. The capital lease encompasses previous expenditures related to
the Company's Oracle ERP implementation. The term of the lease is 36 months with
monthly payments of approximately $60,000.
11
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
General
We are a provider of end-to-end conferencing solutions. Our products and
services enable businesses, employees, customers and partners to communicate
effectively from disparate locations, while decreasing travel time and costs. We
operate in three reportable segments:
o products,
o conferencing services, and
o business services.
Our products segment primarily manufactures and sells high quality audio
conferencing products, videoconferencing products, sound reinforcement products
and videoconferencing peripherals such as cameras and furniture. Through our
single point of contact, 1-800-LETS MEET(R), our conferencing services segment
provides (1) full-service conference calling; (2) on-demand, reservationless
conference calling; (3) web conferencing; and (4) audio and video streaming. Our
business services segment provides our customers with a broad range of services,
both on a local and international basis. These value added services include
proactive field support, training, conferencing system consulting and 24-hour
customer support; customer training and education; and technical services such
as the design, installation and servicing of conferencing systems.
Effective January 1, 2002, we changed our name to ClearOne Communications, Inc.,
and on March 15, 2002 our shares began trading under the symbol CLRO. Our shares
are traded on the Nasdaq National Market.
OM Video Acquisition
On August 27, 2002, we purchased all of the issued and outstanding shares of
Stechyson Electronics Ltd. doing business as OM Video. OM Video is an
audiovisual integration firm headquartered in Ottawa, Ontario, Canada.
Under the terms of the agreement, the shareholders of OM Video received
approximately $6.6 million in cash. An additional $600,000 may be paid to the
former shareholders within the next 12 months pending completion of certain
conditions. Additionally, based on certain performance targets, the former
shareholders of OM Video are entitled to an earn-out bonus of up to $800,000,
over the next twelve months.
As of the date of the OM Video acquisition, we acquired tangible assets (not
including cash) of approximately $740,000, consisting primarily of accounts
receivable, inventory and property and equipment. We assumed liabilities of
approximately $380,000, consisting primarily of trade accounts payable, accrued
compensation and other accrued liabilities.
In connection with the OM Video acquisition and based upon the analysis of an
independent financial consulting firm, we recorded intangible assets related to
certain contracts of $574,000 and goodwill of $6.2 million. The contracts will
be amortized over their estimated useful lives as follows:
Amortization Period: Amount to be Amortized:
------------------- ----------------------
2 years $574,000
We recorded amortization expense of approximately $24,000 for the contracts and
developed technology for the period from September 1, 2002 to September 30,
2002. In accordance with SFAS No. 142, no amortization expense has been recorded
for goodwill.
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Since the OM Video acquisition, OM Video has remained a self-sufficient, wholly
owned subsidiary whose operations are in Canada. Since both OM Video and
E.mergent have been focused on business services, we have begun developing a
detailed best practices approach to providing ClearOne business services. While
we have begun to take advantage of the cost savings and cross-selling
opportunities resulting from the OM Video acquisition, we anticipate that the
benefits of the OM Video acquisition will have a more significant impact on our
results of operations in the latter half of fiscal 2003.
Sale of Broadcast Telephone Interface Product Line
On August 27, 2002, we sold a portion of our broadcast telephone interface
product line to Comrex Corp., a privately held broadcast equipment provider
located in Devens, Massachusetts for $1.2 million. Comrex also purchased
inventory held by us at the time of the transaction. The broadcast telephone
interface product line consists of ClearOne's digital hybrid products. Under the
terms of the agreement, Comrex obtained a perpetual license to use our
technology related to these products. Comrex now provides technical support for
all digital hybrid products and will assume all manufacturing, marketing and
selling of the digital hybrid line. In addition, we will continue to manufacture
the TS-612 product line exclusively for distribution by Comrex under an OEM
agreement for a period of up to twelve months, at which time we will discontinue
our manufacture of all broadcast telephone interface products.
Consolidated Results of Operations
Sales
Sales for the three months ended September 30, 2002 increased 16.1% to $13.0
million from $11.2 million for the three months ended September 30, 2001.
Product sales accounted for $5.5 million, or 42.0% of total sales, while service
sales accounted for $7.5 million, or 58.0% of total sales. As we implement our
strategy of transitioning to become a solutions provider as opposed to primarily
a manufacturer of technology products, we anticipate that our product sales will
represent a smaller percentage of our total sales. We will continue to develop
and distribute our products, but we anticipate that the growth in our service
sales will be more robust.
Product Sales
Product sales decreased 26.7% to $5.5 million for the first quarter of fiscal
2003 from $7.5 million for the first quarter of fiscal 2002. This decrease was
primarily due to slowing demand as a result of the general economic conditions
and because of our decision not to accept lower margin sales.
Service Sales
Service sales, which include sales from our conferencing services and our
business services segments, grew 102.7% to $7.5 million for the three month
period ended September 30, 2002 as compared to $3.7 million for the three month
period ended September 30, 2001. The increase is due to the addition of our new
business services segment.
Conferencing Services Sales
Conferencing services sales remained consistent at $3.7 million for the first
quarter of fiscal 2003 compared to $3.7 million for the first quarter of fiscal
2002.
Business Services Sales
Our business services segment commenced operations on June 1, 2002 with the
acquisition of E.mergent, and generated sales of $3.8 million for the first
quarter of fiscal 2003. Our business services segment is our newest operating
segment. We anticipate that our recent acquisitions will enable us to establish
a significant position in the business services market.
Gross Profit Margin
Our gross profit margin was 42.8% for the first quarter of fiscal 2003 compared
to 59.2% for the first quarter of fiscal 2002. The decrease in gross margins is
the result of three factors. First, due to a shift in the historical mix of
product revenue, sales of lower-margin conferencing peripherals made up a larger
portion of total product sales. Second, the total revenue mix was impacted by
the first full quarter of sales from business services, which currently has
lower margins that our other business segments. Third, we also absorbed fixed
overhead costs over a decreased product revenue base.
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Operating Expenses
Including one-time charges of $1.9 million, our operating expenses increased
84.4% to $8.3 million for the first quarter of fiscal 2003 from $4.5 million for
the first quarter of fiscal 2002.
Marketing and Selling Expenses
Marketing and selling expenses for the first quarter of fiscal 2003 were $3.2
million compared to $2.5 million for the first quarter of fiscal 2002. As a
percentage of sales, marketing and selling expenses increased to 24.9% for the
first quarter of fiscal 2003 from 22.0% for the first quarter of fiscal 2002.
The increase in marketing and selling expenses is due to our efforts to increase
momentum in the markets for our new products, conferencing services and business
services. We also attribute the increase to the integration of the sales
infrastructure following the acquisitions of E.mergent and OM Video.
Product Development Expenses
Product development expenses increased 29.3% to $972,000 for the first quarter
of fiscal 2003, compared to $752,000 for the first quarter fiscal 2002. As a
percentage of sales, product development expenses increased to 7.5% for the
first quarter of fiscal 2003 from 6.7% for the first quarter of fiscal 2002. The
increase in product development expenses is due to development costs associated
with new product development and amortization expense associated with technology
acquired from Ivron.
General and Administrative Expenses
General and administrative expenses increased 69.2% to $2.2 million for the
first quarter of fiscal 2003, compared to $1.3 million for the first quarter of
fiscal 2002. As a percentage of sales, general and administrative expenses
increased to 16.8% for the first quarter of fiscal 2003, compared to 11.4% for
the first quarter of fiscal 2002. We attribute the increase in the amount of our
general and administrative expenses to adding the general and administrative
expenses of E.mergent and OM Video, along with the amortization expense
associated with these acquisitions.
One-Time Charges
One-time charges totaled $1.9 million and included (1) severance and other
related costs associated with a 20 percent reduction in work force in the first
quarter of fiscal 2003 in the amount of $362,000; (2) an inventory write-off in
the amount of $1,384,000 in connection with ClearOne's decision to stop
marketing and selling certain products; and (3) legal, accounting and other
advisory fees in the amount of $201,000 related to due diligence on an
acquisition that ClearOne ultimately decided not to pursue.
Other Income (Expense)
Interest income decreased 29.6% to $76,000 for the first quarter of fiscal 2003
as compared to $108,000 for the first quarter of fiscal 2002. This decrease was
primarily due to the decrease in cash.
For the first quarter of fiscal 2003 our interest expense increased 74.0% to
$8,700 from the first quarter of fiscal 2002 because of a capital lease acquired
through the purchase of E.mergent.
During the first quarter of fiscal 2003, income tax benefit was calculated at a
combined federal, state and foreign effective tax rate of approximately 27.5%,
resulting in an income tax benefit of $439,000. This effective tax rate differs
from statutory rates as a result of taxable income in certain foreign
jurisdictions and tax losses in another foreign jurisdiction for which no
current benefit was recognized as its realizability is not assured. For the
first quarter of fiscal 2002, our effective tax rate was 38.1%, and our income
tax expense was $871,000.
Net Income (Loss)
Net loss for the first quarter of fiscal 2003 was $1.2 million, compared to net
income of $1.4 million for the first quarter of fiscal 2002. See the above
discussion of the "Consolidated Results of Operations" regarding factors
affecting net income (loss). The net loss is primarily due to the one-time
charge as well as product sales being lower than expected. We continue to work
on consolidating our operations in the product segment to improve efficiencies
by consolidating our manufacturing operations and through the reduction in work
force which occurred during the first quarter of fiscal 2003.
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Liquidity and Capital Resources
Sources of Funds
Our cash and cash equivalents at September 30, 2002 totaled approximately $5.4
million, which represents a decrease of $8.8 million from $14.2 million at June
30, 2002. Our sources of cash and cash equivalents included proceeds from
accounts receivable, proceeds from a note receivable in connection with the sale
of our RFM/Broadcast division to Burk, and net proceeds from the sale of our
telephone interface business.
Net cash used in operating activities was $2.1 million for the first quarter of
fiscal 2003, compared to $1.4 million of net cash provided by operating
activities for the first quarter of fiscal 2002. The change in cash flows from
operating activities is primarily due to the increase in our inventory from $8.6
million at June 30, 2002 to $10.7 million at September 30, 2002. Inventory
levels were increased to meet expected sales at the end of the quarter, but such
sales did not occur as expected. We expect to see inventory decrease during the
rest of the year because of our efforts to right-size our operations and our
increased visibility into our distributors' inventory levels.
Our accounts payable as of September 30, 2002 had increased by $800,000 for the
first quarter of fiscal 2003. We attribute approximately $400,000 directly to OM
Video's accounts payable and $400,000 to higher volume purchasing in the first
quarter based on the expectation of higher production and sales volume.
Cash used in financing activities was $165,000, and was attributable primarily
to principal payments on our line of credit.
We have a revolving credit facility for $5.0 million, which is secured by our
accounts receivable and inventory. The interest rate on the revolving credit
facility is variable. The borrowing rate was 4.5% as of September 30, 2002.
While we had a balance of $196,000 as of June 30, 2002, no balance was owing
under the line of credit as of November 1, 2002. The revolving credit facility
will expire on December 22, 2002 and we plan to renew it at that time. The terms
of the revolving credit facility require us to maintain certain financial ratios
and restrict our ability to modify our basic business activities, transfer
assets or create additional indebtedness.
We have an effective shelf registration statement filed with the SEC that
registered the sale of up to $100.0 million of our securities in the form of
equity, debt or combinations thereof. While we currently have no specific plan
to offer any securities, an effective shelf registration statement will enable
us to act quickly to take advantage of favorable market conditions.
On October 14, 2002, we entered into a new capital lease in the amount of $2.0
million. The capital lease encompasses previous expenditures related to our
Oracle ERP implementation. The term of the lease is 36 months with monthly
payments of approximately $60,000.
Uses of Funds
For the first quarter of fiscal 2003, our primary uses of funds were as follows:
o to acquire OM Video for a total cash outflow of $6.5 million;
o to purchase inventory; and
o to fund capital expenditures at a total cost of approximately
$731,000.
We believe that our working capital, bank line of credit and cash flows from
operating activities will be sufficient to satisfy our operating and capital
expenditure requirements for the next 12 months. In the longer term, or if we
experience a decline in sales, or in the event of other unforeseen
circumstances, we may require additional funds and may seek to raise such funds
through public or private equity or debt financing, bank lines of credit, or
other sources. We cannot assure you that additional financing will be available
or, if available, will be on terms favorable to us.
Critical Accounting Policies
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires us to make estimates
and assumptions and select accounting policies that affect the presentation of
our financial condition, changes in financial condition or our results of
operations. Our estimates relate to matters that are uncertain at the time the
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estimate is made. These estimates are based on our historical experience and on
various assumptions that we believe to be reasonable under the circumstances,
given the available information at the time of the estimate, the results of
which form the basis for the judgments we made. Actual results could differ from
these estimates under different assumptions and conditions.
We believe the following critical accounting policies affect our most
significant judgments and estimates used in the preparation of our consolidated
financial statements.
Stock-Based Compensation
We account for stock option grants to employees, officers and directors using
the intrinsic value-based method prescribed by Accounting Principles Board (APB)
Opinion No. 25, "Accounting for Stock Issued to Employees." Accordingly, we
record no compensation expense relating to these options because at the time of
the grant of these stock options, the exercise price of the options equals the
market value of the underlying stock. The alternative is to measure the fair
value of the options at the time of the grant, using a method defined in the
Statement of Financial Accounting Standards (SFAS) No. 123, "Accounting for
Stock-Based Compensation". While the Financial Accounting Standards Board (FASB)
encourages the adoption of SFAS No. 123, we are permitted to continue to measure
compensation expense for stock-based plans using APB Opinion No. 25.
Revenue Recognition
Revenue from product sales is typically recognized at the time product is
shipped. Generally, the Company transfers the risks and rewards of the products,
including title, at this time. Revenue from conferencing services sales is
recognized at the time the service is rendered. Revenue from business services
sales is generally recognized at the completion of installation if customer
acceptance is required. If the customer acceptance is not required, revenue from
business services sales is recognized when it is both realized and earned. The
acquisitions of E.mergent and OM Video added unearned revenue to the balance
sheet. Unearned revenue is derived from the sale of maintenance contracts for
integrated systems installations. These contracts are usually for a period of
12, 24, or 36 months and cover all costs of repair and, in some cases,
replacement of defective parts as well as on-site troubleshooting. The revenue
from a maintenance contract is deferred and recognized ratably over the full
period covered by the contract. Expenses related to the contracts are expensed
as incurred. As of September 30, 2002, the amount of revenue to be recognized
over the next 12 months was $695,000 and thereafter $220,000.
Obsolete & Slow-Moving Inventory Reserves
We account for our inventory on a first-in-first-out (FIFO) basis, and make
appropriate reserves on a quarterly basis to write-down the value of inventory
to the lower of cost or net realizable value.
In order to determine what, if any, inventory needs to be written down and the
actual reserve amount required, we perform an analysis of obsolete and
slow-moving inventory at least two times per year. In general, we write down our
excess and obsolete inventory by an amount that is equal to the difference
between the cost of the inventory and its estimated market value if market value
is less than cost, based upon assumptions about future product life-cycles,
product demand and market conditions. Those items that are found to have a
supply in excess of demand are considered to be slow-moving or obsolete and the
appropriate reserve is made to write-down the value of that inventory to its
realizable value.
Accounts Receivable - Allowance for Doubtful Accounts
We maintain an allowance for doubtful accounts for estimated losses resulting
from our customers' failure to make required payments. The amount of the
allowance is based on our historical experience and involves a review of account
aging, our customers' financial condition or general economic conditions. We
believe that our allowance for doubtful accounts is adequate.
Reserve for Product Returns
We maintain a reserve for product returns based on the historical product
return-to-sales ratio. The amount of the reserve is calculated and may be
adjusted on a quarterly basis.
Goodwill--Recoverability
As more fully discussed in Note 1 to the Consolidated Financial Statements, we
have recorded the goodwill and other intangible assets that have been acquired
through our acquisitions of ClearOne in July 2000, Ivron in October 2001, and
E.mergent in May 2002 and OM Video in August 2002 in accordance with SFAS No.
141 and 142. In July 2001, FASB issued SFAS No. 141, "Business Combinations",
16
which establishes new standards for accounting and reporting requirements for
business combinations, and SFAS No. 142, "Goodwill and Other Intangible Assets",
which broadens the criteria for recording intangible assets other than goodwill.
In effect, as a result of SFAS No. 141 and SFAS No. 142, the goodwill that was
recorded in our acquisitions of Ivron, E.mergent and OM Video was not subject to
amortization. Further, as of July 1, 2002, the goodwill that was previously
recorded with respect to the acquisition of ClearOne is no longer subject to
amortization. Instead, SFAS No. 142 sets forth methods to periodically evaluate
the goodwill that will not be amortized for impairment. We are working with our
financial consultants to establish the appropriate methods to properly evaluate
the recoverability of the goodwill and to measure for possible impairment. This
evaluation involves significant management judgment and is based on various
analyses, including cash flow and profitability projections. If such methods
should indicate that the value of the goodwill has been impaired, then we will
record a charge to operations to recognize the impairment of our goodwill.
SFAS No. 142 provides a six-month transition period from the effective date of
adoption for us to complete Step 1 (determining and comparing the fair value of
our reporting units to their carrying values) of the transitional impairment
test. We anticipate completing this impairment assessment by December 31, 2002.
If, upon completion of Step 1, the carrying value exceeds the fair value, the
goodwill of the reporting unit is potentially impaired and we must complete Step
2 in order to measure the impairment loss. Step 2 involves the calculation of
the implied fair value of goodwill and must be completed by June 30, 2002.
However, we currently do not expect to fail Step 1 of the transitional
impairment test and therefore, do not expect to record an impairment loss upon
completion of the transitional impairment analysis. Furthermore, we do not
believe that there are any indications that goodwill is impaired as of September
30, 2002.
Deferred Tax Assets and Liabilities
We provide for income taxes based on the asset and liability method required by
SFAS No. 109, "Accounting for Income Taxes". Under this method, deferred tax
assets and liabilities are recognized for the future tax consequences
attributable to differences between the financial statement carrying amounts of
existing assets and liabilities and their respective tax bases, as well as net
operating loss and credit carryforwards. As of September 30, 2002, we had
deferred tax assets of approximately $1.3 million, and deferred tax liabilities
of approximately $1.5 million, for a net deferred tax liability of approximately
$164,000. Our deferred tax assets of $1.3 million are attributable to
differences between the financial statement and tax treatment of certain
allowances and reserves with respect to our current assets that are not
currently deductible for income tax purposes. Approximately $500,000 of our
deferred tax liability relates to the taxable gain that has been deferred until
we receive principal payments on the note issued by Burk. The balance of the
deferred tax liability relates to differences between the financial statement
basis and tax basis of depreciable fixed assets and certain intangible assets
that are either amortizable or non-amortizable for financial statement or tax
purposes, as well as the timing for recognition of the gain on assets sold to
Burk.
In connection with the E.mergent and Ivron acquisitions, we may be able to take
advantage of certain tax net operating loss and credit carryforwards from which
we could derive significant tax benefits. However, the tax rules regarding such
tax benefits arising from an acquisition are complicated and very restrictive,
and the availability of these tax benefits to us is not certain. As a result, we
have reduced to zero, the deferred tax asset of approximately $508,000 with
respect to the acquired tax carryforwards that would otherwise be recorded. This
reduction is done by recording a valuation allowance against the deferred tax
asset of the same amount. The need to record a valuation allowance is evaluated
each quarter, and if we determine that we will realize all or part of the
deferred tax asset in the future, an adjustment to the deferred tax asset will
be made. Because these carryforwards were obtained as a result of acquisitions,
a similar adjustment will be recorded to goodwill.
New Accounting Pronouncements
In July 2001, the FASB issued SFAS No. 142, "Goodwill and Other Intangible
Assets" which we adopted effective July 1, 2002. Under SFAS No. 142, goodwill
and intangible assets with indefinite lives are no longer amortized, but must be
reviewed for impairment at least annually or more frequently under certain
circumstances. Other intangible assets that are deemed to have finite lives will
continue to be amortized over their useful lives but must be reviewed for
impairment when events or changes in circumstances indicate that the carrying
amount of these assets may not be recoverable. This goodwill and other
intangible assets represent a significant portion of our recorded assets. If
impairment is deemed to exist, we will write down the recorded value of goodwill
and other intangible assets to their fair values. As of September 30, 2002, we
had unamortized goodwill of approximately $26.8 million, of which $2.5 million
relates to the acquisition of ClearOne, Inc. that was amortized up to June 30,
2002, $439,000 relates to the Ivron acquisition, $17.7 million relates to the
E.mergent acquisition and $6.2 million relates to the OM Video acquisition.
Through June 30, 2002, we amortized approximately $190,000 annually of ClearOne
goodwill.
In August 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets." This Statement addresses financial accounting
and reporting for the impairment or disposal of long-lived assets. This
17
Statement supersedes FASB Statement No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to be Disposed Of," and the
accounting and reporting provisions of APB Opinion No. 30, "Reporting the
Results of Operations and Reporting the Effects of Disposal of a Segment of a
Business, and Extraordinary, Unusual, and Infrequently Occurring Events and
Transactions," for the disposal of a segment of a business (as previously
defined in that opinion). We adopted SFAS No. 144 effective July 1, 2002. The
adoption of SFAS No. 144 did not have a material impact on our financial
statements.
In July 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities." SFAS No. 146 addresses financial accounting
and reporting for costs associated with exit or disposal activities and
nullifies Emerging Issues Task Force (EITF) issue No. 94-3, "Liability
Recognition for Certain Employee Termination Benefits and Other Costs to Exit an
Activity (including Certain Costs Incurred in a Restructuring)". SFAS No. 146
requires that a liability for a cost associated with an exit or disposal
activity be recognized when the liability is incurred. Under EITF issue No.
94-3, a liability for an exit cost was recognized at the date of an entity's
commitment to an exit plan. A fundamental conclusion reached by the FASB in SFAS
No. 146 is that an entity's commitment to a plan, by itself, does not create an
obligation that meets the definition of a liability. Therefore, SFAS No. 146
eliminates the definition and requirements for recognition of exit costs in EITF
issue No. 94-3. SFAS No. 146 also establishes that fair value is the objective
for initial measurement of the liability. SFAS No. 146 is effective for exit or
disposal activities that are initiated after December 31, 2002, but early
adoption is encouraged. We are currently evaluating the impact of SFAS No. 146
on our financial Statements.
Factors that May Affect Future Results
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 harmed if we cannot compete effectively
against other companies.
The markets for our audio conferencing and videoconferencing 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 materially harm our business.
Difficulties in estimating customer demand in our products segment could harm
our profit margins.
Orders from our dealers and resellers 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 resellers.
Our expectations for both short- and long-term future net revenues are based on
our own estimates of future demand. We also determine the amount of our expenses
based on those revenue estimates. If our estimates of sales are not accurate, we
may have to write off obsolete and slow moving inventory, for example, in the
first quarter of fiscal 2003, our one-time charges of approximately $1.9 million
included inventory write-offs of approximately $1.4 million. If 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 dealers and master
distributors. All of our agreements with such dealers and distributors are
non-exclusive, terminable at will by either party and generally short-term.
Furthermore some of our dealers are or may become our competitors in the
business services market and may terminate their dealer agreement with us. We
cannot assure you that any or all such dealers or distributors will continue
their relationship with us. Dealers or distributors cannot easily be replaced
and the loss of revenues and our inability to reduce expenses to compensate for
the loss of revenues could harm our net revenues and profit margins.
Although we rely on our distribution channels to sell our products, our dealers
and distributors 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 dealers or distributors
offering products that are competitive with our products and most do offer
competitive products. The support of our products by dealers and distributors
may depend on the competitive strength of our products and the price incentives
we offer for their support. If our dealers and distributors are not committed to
our products, our revenues and profit margins will be adversely affected.
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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 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 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, we cannot assure you 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 on certain of these key
components that have limited availability. The lack of availability of these
components could have a material adverse effect on our ability to sell products
and the increase in prices is likely to harm our profit margins.
Furthermore, suppliers of some of these components are currently or 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 could harm our competitive position and reduce our
revenues.
We may experience technical difficulties and delays with the development and
introduction of new products. The products developed by us involve sophisticated
and complicated components and manufacturing techniques involving new
technologies. Potential difficulties in the development process that could be
experienced by us include difficulty in:
o meeting required specifications;
o hiring a sufficient number of developers;
o developing and testing software; and
o achieving necessary manufacturing efficiencies.
The integration of the businesses of E.mergent and Ivron with our pre-existing
business may lead to product delays due to logistics and the integration of the
development teams. 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. We cannot assure you 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 that 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 our
management's attention, regardless of their merit. In the event of a claim, we
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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 that we have not applied to have patented, others may be
able to use such technology or even gain priority over us by patenting such
technology themselves.
We are solely dependent on our network and telecommunications providers for our
conference calling services business and rely on our network for our other
functions.
We rely heavily on our network equipment, telecommunications providers, data and
software to support all of our service functions and also rely on our network,
data and software to manufacture and distribute our products. Our conferencing
services business, which produced 29% of our sales in fiscal 2002 and 29% of our
sales in the quarter ended September 30, 2002, relies solely on our network
equipment for its operation. We cannot guarantee that our back-up systems and
procedures will operate satisfactorily in an emergency or that our
telecommunications provider will continue to provide uninterrupted services. A
failure of our equipment or the services of our telecommunications providers
would adversely affect our sales and could seriously jeopardize our ability to
continue service operations. In particular, should our conference calling
service experience even a short term interruption of our network or our
telecommunication providers experience a short term interruption, our ongoing
customers may choose a different provider and our reputation may be damaged,
reducing our ability to retain current customers and attract new customers.
We presently have agreements with our telecommunications providers, some of
which will expire in late 2003. We cannot guarantee that we can negotiate new
agreements on reasonable terms when these agreements expire. Any expansion of
our network may require new agreements with telecommunications providers. Our
failure to secure agreements on terms and conditions satisfactory to us may
affect the performance or expansion of our network, which may materially harm
our business.
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. For
example, international sales represented 18% of our total sales from continuing
operations for the first quarter of fiscal 2003 and 11% for the first quarter of
fiscal 2002. We anticipate that the portion of our total revenue from
international sales will continue to increase because of increasing
videoconferencing product sales to the international market and the new sales
channels provided to us through the E.mergent and OM Video acquisitions. Our
international business is subject to the financial and operating risks of
conducting business internationally, including:
o unexpected changes in, or the imposition of, additional legislative or
regulatory requirements;
o fluctuating exchange rates;
o tariffs and other barriers;
o difficulties in staffing and managing foreign subsidiary operations;
o export restrictions;
o greater difficulties in accounts receivable collection and longer
payment cycles;
o potentially adverse tax consequences; and
o potential hostilities and changes in diplomatic and trade
relationships.
Our sales in the international market are denominated in either U.S. or Canadian
Dollars. Gentner EuMEA transacts business in U.S. Dollars, although its
financial statements are prepared in the Euro. Consolidation of Gentner EuMEA's
financial statements with ours, under United States generally accepted
accounting principles, requires remeasurement of the amounts stated in Gentner
EuMEA's financial statements to U.S. Dollars, which is subject to exchange rate
fluctuations. OM Video transacts business in Canadian Dollars and its financial
statements are prepared in Canadian Dollars. Consolidation of OM Video's
financial statements with ours, under United States generally accepted
accounting principles, requires translation of the amounts stated in OM Video's
financial statements to U.S. Dollars, which is subject to exchange rate
fluctuations. Furthermore, although our Irish subsidiary, Gentner
Communications, Ltd. (formerly Ivron Systems, Ltd.) prepares its financial
statements in U.S. Dollars, it incurs expenses in the Euro and conversion of
these amounts to U.S. Dollars is subject to exchange rate fluctuations. We
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currently do not undertake any hedging activities that might protect 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 scarce. 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.
We are dependent upon key employees.
We are substantially dependent upon certain of our employees, including Frances
M. Flood, our President and Chief Executive Officer. The loss of Ms. Flood could
have a material adverse effect on our company. We currently have in place a key
person life insurance policy on the life of Ms. Flood in the amount of $5.0
million.
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 and videoconferencing products for distance learning and courtroom
facilities are partially dependent on government funding. In the event
government funding for such initiatives was reduced or became unavailable, our
sales would be negatively impacted. Additionally, many of our products are
subject to governmental regulations. New regulations could significantly
adversely impact sales.
We may have difficulty in collecting outstanding receivables.
We grant credit without requiring collateral to substantially all of our
customers. Due to the current economic slowdown, the risks relating to the
granting of such credit have increased. Although we do monitor and mitigate the
risks associated with our credit policies, we cannot assure you that such
mitigation will be effective. As of September 30, 2002, our outstanding
receivables were $18.7 million, and four customers accounted for more than 40%
of those outstanding receivables. In the past, we have experienced losses due to
customers failing to meet their obligations, although these losses have not been
significant. 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.
Risks Relating to Our Acquisitions
The integration of any acquired businesses involve uncertainty and risk.
Acquisitions and the subsequent integration of two or more businesses involve
risks. Following the acquisition of Ivron in October 2001, the acquisition of
E.mergent in May 2002, and the acquisition of OM Video in August 2002, we have
been and will be dedicating substantial management resources in order to achieve
the anticipated operating efficiencies from integrating the businesses of these
companies with our other operations. We cannot make assurances that any
integration will be accomplished or that the benefits of such integration will
be realized, for reasons that may include:
o disruption of our business;
o lack of experience with the markets in which the acquired businesses
operate;
o lack of revenues to offset the increased expenses associated with the
acquisitions;
o slower than anticipated realization of expected synergies such as
lower costs, or a failure to realize such synergies at all;
o difficulty resolving cultural differences between the companies and
our inexperience in conducting operations that are geographically
dispersed;
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o our inability to successfully integrate the acquired technology and
operations into our business and maintain uniform standards, controls,
policies and procedures;
o our inability to continue to market and sell the products of the
acquired businesses;
o our inability to retain key employees of the acquired businesses;
o our inability to retain the previous customers of the acquired
businesses as well as our own. In particular, certain of our customers
have been competitive with E.mergent and, similarly, certain customers
of E.mergent have been competitive with us. Some of these customers
have concerns that the combined companies would result in greater
competition for them; and
o our inability to integrate Ivron, E.mergent and OM Video
simultaneously.
Difficulties in any integration may have a short or potentially long-term
adverse impact on our business, results of operations or financial condition.
Our growth may strain our infrastructure. If we are unable to improve our
infrastructure to support the expansion of our business, our operations and
financial condition could be adversely affected.
We face the risk that our existing systems and processes, including management
resources, operating systems and accounting and financial personnel, may be
inadequate to support our growth. We are currently implementing changes and
enhancements to our existing systems to support the expansion of our business.
We cannot assure you that we will be able to make the necessary changes in our
systems or retain the personnel required to respond to the demands of our
expansion. The implementation of such changes and enhancements to our systems
and the retention of additional personnel will require capital expenditures and
other increased costs that could have a material adverse impact on our operating
results. Failure to implement these systems and secure these resources could
also have a material adverse effect on our operating results.
Impairment of the goodwill and other intangible assets of our acquired
businesses could harm our business and results of operations.
The purchase price for the acquisitions of Ivron and E.mergent in fiscal 2002
and OM Video in fiscal 2003 included, in the aggregate, goodwill valued at
approximately $27.1 million, ($26.8 million after amortization as of September
30, 2002) and other intangible assets valued at approximately $8.3 million ($7.3
million after amortization as of September 30, 2002). Goodwill and other
intangible assets represent a significant portion of our recorded assets.
Accounting principles generally accepted in the United States related to
goodwill and other intangible assets changed with the issuance of the Statement
of Financial Accounting Standards No. 142, "Goodwill and Other Intangible
Assets" (SFAS No. 142), which became effective for acquisitions completed after
July 1, 2001 and became effective with respect to all prior acquisitions, for
example our acquisition of ClearOne, Inc., as of July 1, 2002.
Under SFAS No. 142, goodwill and intangible assets with indefinite lives are no
longer amortized, but must be reviewed at least annually for impairment or more
frequently under certain circumstances. Other intangible assets that are deemed
to have finite lives will continue to be amortized over their useful lives but
must be reviewed for impairment when events or changes in circumstances indicate
that the carrying amount of these assets may not be recoverable. Screening for
and assessing whether impairment indicators such as changes to market
conditions, operating fundamentals, competition and general economic conditions
exist involves the exercise of judgment. A charge to operations may occur after
the results of our goodwill impairment tests are known. If impairment is deemed
to exist, we will write down the recorded value of goodwill and other intangible
assets to their fair values, which could result in a full write-off of their
book value. If these write-downs occur, they would adversely affect our
financial condition and results of operations.
Risks Relating to our Company
Existing directors and officers can exert considerable control over us.
Our officers and directors together had beneficial ownership of approximately
21.9% of our common stock (including options that are currently exercisable or
exercisable within 60 days as of November 1, 2002. With this significant holding
in the aggregate, the officers and directors, acting together, could exert
substantial influence upon us and could delay or prevent a change in control.
22
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. Options in our common stock have
recently begun trading and we expect this to add to the volatility in our common
stock. The market price of our common stock may be significantly affected by a
variety of factors, including:
o 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;
o disparity between our reported results and the projections of
analysts;
o the announcement of new products or product enhancements by us or our
competitors;
o technological innovations by us or our competitors;
o quarterly variations in our results of operations;
o general market conditions or market conditions specific to technology
industries; and
o domestic and international economic conditions.
In addition, the stock market has recently experienced extreme price and volume
fluctuations. These fluctuations have had a substantial effect on the market
prices for many high technology companies like us. These fluctuations are often
unrelated to the operating performance of the specific companies.
Item 3. QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk represents the risk of changes in the value of a financial
instrument, derivative or non-derivative, caused by fluctuations in interest
rates, foreign exchange rates and equity prices. Changes in these factors could
cause fluctuations in the results of our operations and cash flows. In the
ordinary course of business, we are exposed to foreign currency and interest
rate risks. These risks primarily relate to the sale of products and services to
foreign customers and changes in interest rates on our capital leases.
We currently have limited market risk sensitive instruments related to interest
rates. Our capital lease obligations totaled approximately $78,000 at September
30, 2002. We do not have significant exposure to changing interest rates on
these capital leases because interest rates for the majority of the capital
leases are fixed. Although we had a balance of approximately $196,000 on our
line of credit as of June 30, 2002, such balance was repaid in July 2002 and no
balance is outstanding as of November 1, 2002. As such, we do not have
significant market interest rate risk. We have not undertaken any additional
actions to cover market interest rate market risk and are not a party to any
other interest rate market risk management activities. A hypothetical 10% change
in market interest rates over the next year would not impact our earnings or
cash flows as the interest rates on the majority of the capital leases are
fixed.
We do not purchase or hold any derivative financial instruments for trading
purposes.
Although our subsidiaries enter into transactions in currencies other than their
functional currency, foreign currency exposures arising from these transactions
are not material to us. The greatest foreign currency exposure arises from the
remeasurement of our net equity investment in our subsidiaries to U.S. dollars.
The primary currency to which we are exposed is the Euro. The fair value of our
net foreign investments would not be materially affected by a 10% adverse change
in foreign currency exchange rates from September 30, 2002 levels.
Item 4. CONTROLS AND PROCEDURES
(a) Our Chief Executive Officer and Chief Financial Officer have evaluated
the effectiveness of the design and operation of our disclosure
controls and procedures (as defined under Rules 13a-14 and 15d-14 of
the Securities Exchange Act of 1934, as amended) as of a date within
ninety days of the filing date of this report. Based upon that
evaluation, our Chief Executive Officer and Chief Financial Officer
have concluded that our disclosure controls and procedures are
adequate and effective.
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(b) There were no significant changes in our internal controls or in other
factors that could significantly affect our internal controls
subsequent to the date of our most recent evaluation of our internal
controls.
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PART II - OTHER INFORMATION
Item 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
--------
EXHIBIT
NUMBER DESCRIPTION
- ------ -----------
3.1 Articles of Incorporation dated July 7, 1983. (incorporated by
reference from the Company's S-3 Registration Statement filed on
November 1, 2002)
3.2 Amendment to Articles of Incorporation dated March 26, 1985.
(incorporated by reference from the Company's S-3 Registration
Statement filed on November 1, 2002)
3.3 Corrected Amendment to Articles of Incorporation dated September
10, 1986. (incorporated by reference from the Company's S-3
Registration Statement filed on November 1, 2002)
3.4 Amendment to Articles of Incorporation dated July 1, 1991.
(incorporated by reference from the Company's S-3 Registration
Statement filed on November 1, 2002)
3.5 Amendment to Articles of Incorporation dated December 12, 2001.
(incorporated by reference from the Company's S-3 Registration
Statement filed on November 1, 2002)
3.6 Bylaws, as adopted on August 24, 1993. (incorporated by reference
from the Company's S-3 Registration Statement filed on November 1,
2002)
(b) Reports on Form 8-K
-------------------
A report pursuant to Items 2 and 7 of Form 8-K, dated May 31, 2002, was filed
August 14, 2002, to report the acquisition of E.mergent, Inc. and including
financial statements of E.mergent, Inc. and pro forma financial statements of
ClearOne to give effect to the acquisition of Ivron Systems, Ltd., E.mergent,
Inc. and the December 2001 private placement of ClearOne common stock.
A report, pursuant to Item 5 of Form 8-K was dated and filed September 26, 2002,
to report the resignation of Randy Wichinski as Chief Financial Officer and
reappointment of Susie Strohm as Chief Financial Officer.
25
SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
CLEARONE COMMUNCIATIONS, INC.
/s/ Susie Strohm
---------------------------------------------
Susie Strohm
Vice President and Chief Financial Officer
Date: November 14, 2002
CERTIFICATIONS
I, Frances M. Flood, certify that:
1. I have reviewed this quarterly report on Form 10-Q of ClearOne
Communications, Inc.;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant, as of, and for, the periods presented in
this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant
and we have:
a. Designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
quarterly report is being prepared;
b. Evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the
filing date of this quarterly report (the "Evaluation Date"); and
c. Presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons
performing the equivalent function):
a. All significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's
ability to record, process, summarize and report financial data
and have identified for the registrant's auditors any material
weaknesses in internal controls; and
b. any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have indicated in
this quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent
evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.
26
CLEARONE COMMUNCIATIONS, INC.
Date: November 14, 2002 /s/ Frances M. Flood
--------------------------------------
Frances M. Flood
Chairman of the Board and
Chief Executive Officer
I, Susie Strohm, certify that:
1. I have reviewed this quarterly report on Form 10-Q of ClearOne
Communications, Inc.;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant, as of, and for, the periods presented in
this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant
and we have:
a. Designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
quarterly report is being prepared;
b. Evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the
filing date of this quarterly report (the "Evaluation Date"); and
c. Presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons
performing the equivalent function):
d. All significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's
ability to record, process, summarize and report financial data
and have identified for the registrant's auditors any material
weaknesses in internal controls; and
e. any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have indicated in
this quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent
evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.
CLEARONE COMMUNCIATIONS, INC.
Date: November 14, 2002 /s/ Susie Strohm
-------------------------------------
Susie Strohm
Vice President and
Chief Financial Officer
27