9. Debt
Senior Convertible Notes and Warrants
On December 17, 2019, the Company completed the issuance and sale of $3,000 aggregate principal amount of secured convertible notes of the Company (the “Notes”) and warrants (the “Warrants”) to purchase 340,909 shares of common stock, par value $0.001 per share of the Company (the “Common Stock”), in a private placement transaction. The Notes and Warrants were issued and sold to Edward D. Bagley, an affiliate of the Company, on the terms and conditions of a Note Purchase Agreement dated December 8, 2019 between the Company, certain subsidiary guarantors of the Company, and Mr. Bagley. Mr. Bagley was the beneficial owner of approximately 46.6% of the Company’s issued and outstanding shares of Common Stock at the time that the Notes and Warrants were issued to him.
The Notes will mature on December 17, 2023 (the “Maturity Date”) and will accrue interest at a variable rate adjusted on a quarterly basis and equal to two and one-half percent (2.5%) over the greater of (x) five and one-quarter percent (5.25%) and (y) the Prime Rate as published in the Wall Street Journal (New York edition) as of the beginning of such calendar quarter. The Notes may be converted into shares of the Company’s Common Stock at any time at the election of Mr. Bagley at an initial conversion price of $2.11 per share (the “Conversion Price”), or 120% of the closing price of the Common Stock on December 6, 2019 as reported on the Nasdaq Capital Market. Also, the Company can cause a mandatory conversion of the Notes if the volume weighted average closing price of the Common Stock over 90 consecutive trading days exceeds 200% of the Conversion Price. In addition, the Notes may be redeemed by the Company for cash at any time after December 17, 2020 upon payment of the outstanding principal balance of the Notes and any unpaid and accrued interest. The Company also is required to redeem the Notes upon the occurrence of a change in control of the Company.
The Warrants have an initial exercise price equal to $1.76, the closing price of the Common Stock on December 6, 2019 as reported on the Nasdaq Capital Market, and are exercisable until December 17, 2026. The Warrants must be exercised for cash, unless at the time of exercise there is not a then effective registration statement for the resale of the shares of Common Stock issuable upon exercise of the Warrants, in which case the Warrants may be exercised via a cashless exercise feature that provides for net settlement of the shares of Common Stock issuable upon exercise.
Concurrent with the issuance of the Notes and Warrants pursuant to the Note Purchase Agreement, the Company, the Guarantors and Mr. Bagley entered into a Guaranty and Collateral Agreement (the “Collateral Agreement”) pursuant to which the Company and the Guarantors granted Mr. Bagley a first priority lien interest in all of the Company’s assets as security for the Company’s performance of its obligations under the Notes and Warrants.
The net proceeds after original issue discount and issuance costs of $346 were approximately $2,654. The Company expects to use the proceeds from the sale of the Notes and Warrants for general corporate purposes and working capital.
In accounting for the issuance of the Notes, the Company separated Notes and Warrants into liability and equity components. The carrying amount of Warrants, being an equity component, was first calculated using Black-Scholes method with the following assumptions:
Risk-free interest rate | 1.82% |
Expected life of warrants (years) | 7 |
Expected price volatility | 49.4% |
Expected dividend yield | 0% |
The carrying amount of the Notes was then determined by deducting the fair value of the Warrants from the principal amount of the Notes. The carrying amount of the Notes was further separated into equity and liability components after separating the value of the conversion feature into an equity component and leaving the remaining value as liability. The equity component is not remeasured while the Notes and Warrants continue to meet the conditions for equity classification for equity components.
The original issue discount and issuance costs are netted against the liability. The following table represents the carrying value of Notes and Warrants:
UNAUDITED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited - Dollars in thousands, except per share amounts)
| | September 30, 2022 | | | December 31, 2021 | |
Liability component: | | | | | | | | |
Principal | | $ | 2,100 | | | $ | 2,640 | |
Less: debt discount and issuance costs, net of amortization | | | (237 | ) | | | (385 | ) |
Net carrying amount | | $ | 1,863 | | | $ | 2,255 | |
Equity component(1): | | | | | | | | |
Warrants | | $ | 318 | | | $ | 318 | |
Conversion feature | | | 122 | | | | 122 | |
Net carrying amount | | $ | 440 | | | $ | 440 | |
|
|
|
|
|
|
|
|
|
| Current portion of liability component included under short-term debt |
| $ | 855 |
|
| $ | 720 |
|
| Long-term portion of liability component included under long-term debt |
|
| 1,245 |
|
|
| 1,920 |
|
| Liability component total |
| $ | 2,100 |
|
| $ | 2,640 |
|
(1) Recorded on the condensed consolidated balance sheets as additional paid-in capital.
Debt discount and issuance costs are amortized over the life of the note to interest expense using the effective interest method. During the three and nine months ended September 30, 2022, amortization of debt discount and issuance costs was $49 and $147, respectively and for the three and nine months ended September 30, 2021, amortization of debt discount and issuance costs was $49 and $147, respectively. The following table represents schedule of maturities of principal amount contained in the Notes as of September 30, 2022:
Year ending December 31, | | Principal Amount Maturing | |
2022 (Remainder) | | $ | 180 | |
2023 | | | 1,920 | |
2024 | | | — | |
2025 | | | — | |
| Total principal amount | | $ | 2,100 | |
Short-term Bridge Loan
On July 2, 2021, the Company obtained a bridge loan in the principal amount of $2,000 from Edward D. Bagley (the “Bridge Loan”), an affiliate of the Company. The Bridge Loan is evidenced by a promissory note dated July 2, 2021 (the “Note”) issued by the Company to Mr. Bagley. The Note bears interests at a rate of 8.0% per annum, matures on the earlier to occur of (i) October 1, 2021 or (ii) within two business days of the Company’s receipt of its expected U.S. federal income tax refund, and contains other customary covenants and events of default. On September 11, 2021, the Company amended and restated the terms of the Bridge Loan to extend the latest maturity date from October 1, 2021 to January 3, 2022. All other terms and conditions of the Bridge Loan remained the same. This Bridge Loan of $2,000 is included under short-term debt as of December 31, 2021. On January 4, 2022, the Company entered into a Securities Purchase Agreement with Edward D. Bagley, pursuant to which the Company issued and sold to Mr. Bagley, in a private placement 1,538,461 shares (the “Shares”) of the Company’s common stock, par value $0.001 per share, at a purchase price of $1.30 per share of Common Stock. The consideration for the Shares was the cancellation and termination of Mr. Bagley’s outstanding bridge loan to the Company in the principal amount of $2,000 originally issued on July 2, 2021 and amended and restated on September 11, 2021. Mr. Bagley is an affiliate of the Company and the Company’s single largest stockholder.
Paycheck Protection Program Loan
On April 18, 2020, the Company, entered into a loan agreement with U.S. Bank National Association Bank, which provided for a loan in the principal amount of $1,499 (“PPP Loan”) pursuant to the Paycheck Protection Program under Division A, Title I of the CARES Act, which was enacted March 27, 2020. The PPP Loan had a two-year term and bears interest at a rate of 1.0% per annum. Monthly principal and interest payments are deferred for approximately sixteen months after the date of disbursement.
The Company's Paycheck Protection Program Loan ("PPP Loan") under the CARES Act was forgiven by Small Business Administration effective April 29, 2022. With this forgiveness, the Company is not required to repay the principal amount of $1,499 and the interest of $31. The Company received $953 back that it had already paid towards principal and interest payments toward the PPP Loan. The Company treated the forgiveness as extinguishment of debt in this quarter ended September 30, 2022 and reported the entire principal amount forgiven of $1,499 along with interest already accounted for of $29 as a gain on extinguishment of debt.
UNAUDITED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited - Dollars in thousands, except per share amounts)
| | September 30, 2022 | | | December 31, 2021 | |
| Current portion of the PPP Loan included under short-term debt |
| $ | — |
|
| $ | 761 |
|
| Long-term portion of the PPP Loan included under long-term debt |
|
| — |
|
|
| — |
|
| Liability component total |
| $ | — |
|
| $ | 761 |
|
This report on Form 10-Q includes “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). All statements in this report, other than statements of historical fact, are forward-looking statements for purposes of these provisions, including any projections of earnings, revenues or other financial items, any statements of the plans and objectives of management for future operations, any statements concerning proposed new products or services, any statements regarding future economic conditions or performance, and any statements of assumptions underlying any of the foregoing. All forward-looking statements included in this report are made as of the date hereof and are based on information available to us as of such date. We assume no obligation to update any forward-looking statement. In some cases, forward-looking statements can be identified by the use of terminology such as “may,” “will,” “expects,” “plans,” “anticipates,” “intends,” “believes,” “estimates,” “potential,” or “continue,” or the negative thereof or other comparable terminology. Although we believe that the expectations reflected in the forward-looking statements contained herein are based upon reasonable assumptions at the time made, there can be no assurance that any such expectations or any forward-looking statement will prove to be correct. Our actual results will vary, and may vary materially, from those projected or assumed in the forward-looking statements. Future financial condition and results of operations, as well as any forward-looking statements, are subject to inherent risks and uncertainties, many of which we cannot predict with accuracy and some of which we might not anticipate, including, without limitation, product recalls and product liability claims; infringement of our technology or assertion that our technology infringes the rights of other parties; termination of supplier relationships, or failure of suppliers to perform; inability to successfully manage growth; delays in obtaining regulatory approvals or the failure to maintain such approvals; concentration of our revenue among a few customers, products or procedures; development of new products and technology that could render our products obsolete; market acceptance of new products; introduction of products in a timely fashion; price and product competition, availability of labor and materials, cost increases, and fluctuations in and obsolescence of inventory; volatility of the market price of our common stock; foreign currency fluctuations; changes in key personnel; work stoppage or transportation risks; integration of business acquisitions; and other factors referred to in our reports filed with the SEC, including our Annual Report on Form 10-K for the year ended December 31, 2021. All subsequent forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by these cautionary statements. Additional factors that may have a direct bearing on our operating results are discussed in Part II, Item 1A “Risk Factors” in this Quarterly Report on Form 10-Q and in Part I, Item 1A “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2021.
BUSINESS OVERVIEW
ClearOne is a global Company that designs, develops and sells conferencing, collaboration, and AV networking solutions for voice and visual communications. The performance and simplicity of our advanced, comprehensive solutions offer a high level of functionality, reliability and scalability. We derive a major portion of our revenue from audio conferencing products and microphones by promoting our products in the professional audio-visual channel. We have extended our total addressable market from the installed audio conferencing market to adjacent complementary markets – microphones, video collaboration and AV networking. We have achieved this through strategic technological acquisitions as well as by internal product development.
In early January 2022, we introduced DIALOG® 10 USB, the industry's only pro-quality, single-channel wireless USB microphone system offering professional-quality audio with USB connectivity for webcasting and cloud-based collaboration. In March 2022, this new USB wireless mic system won the 2022 NSCA Excellence in Product Innovation Award. One of only seven winners in this prestigious award program, the DIALOG 10 USB is the industry’s only pro-quality single-channel wireless microphone system with USB connectivity for webcasting and cloud-based collaboration such as Microsoft Teams, Zoom, WebEx, and GotoMeeting. DIALOG 10 USB won its second award in May 2022 by winning the 2022 Top New Technology (TNT) Award in the Microphone category. In June 2022, at Infocomm 2022 in Las Vegas, Nevada, DIALOG 10 USB won two additional awards - Commercial Integrator 2022 BEST Award in the Microphones category and 2022 Sound & Video Contractor Magazine Infocomm Best in Market Award.
During January, at the Las Vegas Customer Electronics Show, CES 2022, the world’s most influential annual tech event, our home office Aura™ Xceed™ BMA was singled out for exceptional innovation with a CES Picks Award, presented by Residential Systems magazine.
In early February 2022, our Versa Lite CT, a USB audio-enabled Beamforming Ceiling Tile Microphone that brings cost-effective and superb professional conferencing audio to small- and mid-sized spaces received Google Meet certification. Google Meet ranks among the top 5 for growth in the cloud meetings and team collaboration market according to Frost & Sullivan.
In early February 2022, we were awarded a new patent for a beamforming microphone array system with distributed processing. This patent claims a ceiling tile microphone array that can be physically separated from the processors running the beamforming algorithm. It enables a single computing engine to run multiple beamforming algorithms for multiple microphone arrays, which can lower the overall system cost compared to an integrated design that is limited to a single computing engine with a single microphone array. Later in the same month another ClearOne patent was granted which is related to beamforming microphone arrays with acoustic echo cancellation. The patent, titled “Band-Limited Beamforming Microphone Array with Acoustic Echo Cancellation," describes, among other things, a microphone array with one set of microphones used for beamforming, and one or more additional microphones that are not used for beamforming, but instead are used to enhance the audio performance of the microphone array.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
In early March 2022, we were awarded a new patent titled “Conferencing Apparatus”, that describes, among other things, a beamforming microphone array with acoustic echo cancellation and a set of configurable fixed beams. The patent goes on to describe performing a direction of arrival determination, and in response to that determination, selecting one or more of those fixed beams for audio transmission.
In early April 2022, a ClearOne patent issued titled “Ceiling Tile Microphone,” that claims, among other things, a ceiling tile beamforming microphone that is powered through Power over Ethernet (PoE). Later in the same month another ClearOne patent was granted, also titled “Ceiling Tile Microphone,” that claims, among other things, a ceiling tile microphone that includes beamforming, acoustic echo cancellation, and auto voice tracking.
In May 2022, for the sixth time since its groundbreaking debut in 2020, the ClearOne BMA 360 microphone has been recognized by the world’s most discerning AV buyers with the prestigious Best in Market Award at ISE 2022. The microphone was one of only three winners in this year’s award program. The Best in Market Award program is presented by leading industry publication Sound & Video Contractor at Integrated Systems Europe (ISE), the world’s largest AV and systems integration show. The program recognizes the most innovative technology within the AV industry, and the judges include respected AV and IT managers, directors, engineers, industry consultants and integrators.
Throughout 2022, we have continued our efforts to protect our intellectual property rights, primarily through litigation. See Part II, Item 1. Legal Proceedings.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
We also continued our programs to cut costs and to speed up product development that we believe will enable us to get back to a growth path.
Overall revenue decreased by 10% in the third quarter of 2022 when compared to the third quarter of 2021, primarily due to a significant decrease in revenues from video products and a further decrease in revenues from microphones, which were partially offset by an increase in revenues from audio conferencing products. Overall revenue decreased by 3% during the first nine months of 2022 when compared to revenue in the first nine months of 2021 due to decrease in revenue from video products, which was largely offset by an increase in revenues from audio conferencing products and microphones. Despite the negative consequences of global supply chain issues and the infringement of our patents on professional installed products, our new solutions incorporating Beamforming Microphone Array Ceiling Tile ("BMA-CT") continued to result in overall Beamforming Microphone Array ("BMA") revenue being higher than last year. However, revenue from BMA products as well as from our pro audio products are still far below the levels prior to infringement of our patents. Our revenue performance in 2022-Q3 was also impacted negatively due to our inability to source adequate inventory to meet the demand for professional audio products and BMA due to the ongoing transition of manufacturing of our products from China to Singapore by our EMS provider and the increased costs associated with the electronic raw material supply shortages that have affected the global manufacturing of high tech products. We expect these supply shortages and associated increased costs to continue through at least the end of 2022.
Our gross profit margin increased modestly to 41.0% during the third quarter of 2022 from 40.8% during the third quarter of 2021. Our gross profit margin decreased to 38.7% during the first nine months of 2022 compared to 42.6% during the first nine months of 2021.
Net loss decreased from $2.2 million in the third quarter of 2021 to $1.2 million in the third quarter of 2022. Our net loss decreased from $5.4 million in the first nine-month of 2021 to $3.5 million in the first nine-month of 2022. The decrease in net loss was mainly due to (a) the recognition of $1.5 million in gain from the forgiveness of CARES Act Paycheck Protection Program Loan and (b) a decrease of $1.9 million in operating expenses after excluding amortization costs relating to our capitalized patent defense costs, which were partially offset by (c) decrease in absolute gross profit dollars as a result of reduced gross margin, and (d) increased amortization costs relating to our capitalized patent defense costs.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Industry conditions
We operate in a very dynamic and highly competitive industry which is dominated on the one hand by a few players with respect to certain products like video conferencing appliances while on the other influenced heavily by a fragmented reseller market consisting of numerous regional and local players. The industry is also characterized by venture capitalist funded start-ups and private companies willing to fund cumulative cash losses in order to gain market share and achieve certain non-financial goals.
Economic conditions, challenges and risks
The audio-visual products market is characterized by intense competition and rapidly evolving technology. Our competitors vary within each product category. Our installed professional audio conferencing products, which are our flagship product category, continue to be ahead of the competition despite the reduction in revenues. Our strength in this space is largely due to our fully integrated suite of products consisting of DSP mixers, a wide range of professional microphone products and video collaboration products. Despite our strong leadership position in the installed professional audio conferencing market, we face challenges to revenue growth due to the limited size of the market and pricing pressures from new competitors attracted to the commercial market due to higher margins.
Our video products and beamforming microphone arrays, especially the BMA 360, are critical to our long term growth. We face intense competition in this market from well-established market leaders as well as emerging players rich with marketing funds. We expect our strategy of combining curated audio solutions with our high quality professional cameras, and our high-end audio conferencing technology will generate high growth in the near future.
We derive a major portion of our revenue (approximately 51% for the year ended December 31, 2021) from international operations and expect this trend to continue in the future. Most of our revenue from outside the U.S. is billed in U.S. dollars and is not exposed to any significant currency risk. However, we are exposed to foreign exchange risk if the U.S. dollar is strong against other currencies as it will make U.S. Dollar denominated prices of our products less competitive.
The COVID-19 pandemic caused severe global disruptions and had varying impact on our business. The installed audio conferencing market was negatively impacted due to lockdowns, postponement of projects and restrictions on the ability of installers to visit commercial sites. On the other hand, COVID-19 generated higher than normal demand for our video products and personal conferencing products due to the significant expansion of the work-from-home market. The extent of COVID-19’s effect on our operational and financial performance keeps evolving and depends on multiple factors including the severity and infectiousness of current and future virus strains, the effectiveness of vaccines especially on novel strains of COVID-19, government regulations, etc., all of which are uncertain and difficult to predict considering the rapidly evolving landscape. Supply chain disruptions primarily resulting from COVID-19 have caused significant fluctuations in our costs of goods resulting in a reduction of our gross margins in the first nine months of 2022. We expect these fluctuations to continue through at least the end of 2022. If the global economy’s recovery from the pandemic continues to experience supply chain disruptions, it could have a material adverse effect on our business, results of operations, financial condition and cash flows and adversely impact the trading price of our common stock.
Deferred Product Revenue
Deferred product revenue increased to $73 thousand on September 30, 2022 compared to $54 thousand on December 31, 2021.
A detailed discussion of our results of operations follows below.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Results of Operations for the three and nine months ended September 30, 2022
The following table sets forth certain items from our unaudited condensed consolidated statements of operations for the three and nine months ended September 30, 2022 (“2022-Q3”) ("2022-YTD") and 2021 ("2021-Q3") ("2021-YTD"), respectively, together with the percentage of total revenue which each such item represents:
| | | Three months ended September 30, |
|
| Nine months ended September 30, |
|
| (dollars in thousands) | | 2022 | | | 2021 | | | Change Favorable (Adverse) in % |
|
| 2022
|
|
| 2021
|
|
| Change Favorable (Adverse) in %
|
|
Revenue | | $ | 6,264 | | | $ | 6,992 | | | | (10 | ) |
| $ | 21,184 |
|
| $ | 21,765 |
|
| $ | (3 | ) |
Cost of goods sold | | | 3,694 | | | | 4,141 | | | | 11 | |
|
| 12,991 |
|
|
| 12,487 |
|
|
| (4 | ) |
Gross profit | | | 2,570 | | | | 2,851 | | | | (10 | ) |
|
| 8,193 |
|
|
| 9,278 |
|
|
| (12 | ) |
Sales and marketing | | | 1,151 | | | | 1,692 | | | | 32 |
|
|
| 4,273 |
|
|
| 5,020 |
|
|
| 15 |
|
Research and product development | | | 876 | | | | 1,492 | | | | 41 | |
|
| 3,406 |
|
|
| 4,253 |
|
|
| 20 |
|
General and administrative | | | 1,673 | | | | 1,676 | | | | 0 | |
|
| 5,146 |
|
|
| 5,024 |
|
|
| (2 | ) |
Total operating expenses | | | 3,700 | | | | 4,860 | | |
| 24 | |
|
| 12,825 |
|
|
| 14,297 |
|
|
| 10 |
|
Operating loss | | | (1,130 | ) | | | (2,009 | ) | | | 44 | |
|
| (4,632 | ) |
|
| (5,019 | ) |
|
| 8 | |
Other income (expense), net | | | (93 | ) | | | (143 | ) | | | 35 |
|
|
| 1,220 |
|
|
| (352 | ) |
|
| 447 |
|
Loss before income taxes | | | (1,223 | ) | | | (2,152 | ) | | | 43 | |
|
| (3,412 | ) |
|
| (5,371 | ) |
|
| 36 |
|
Provision for income taxes | | | 25 | | | | 17 | | | | (47 | ) |
|
| 60 |
|
|
| 39 |
|
|
| (54 | ) |
Net loss | | $ | (1,248 | ) | | $ | (2,169 | ) | | | 42 | |
|
| (3,472 | ) |
|
| (5,410 | ) |
|
| 36 |
|
Revenue
Our revenue decreased to $6.3 million in 2022-Q3 compared to $7.0 million in 2021-Q3 primarily due to a 59% decline in video products and a 7% decline in microphones, which were partially offset by a 10% increase in audio conferencing. Our revenues, especially with respect to BMA and professional audio conferencing products were negatively impacted by our inability to source adequate inventory to meet the demand for professional audio products and BMA due to the ongoing transition of manufacturing of our products from China to Singapore by our EMS provider. Our wireless mics and traditional ceiling mics registered significant revenue increases in 2022-Q3. The audio conferencing category as a whole increased mainly due to a significantly strong revenue performance of our professional mixers while other categories declined in revenues. Video products suffered declines in 2022-Q3 compared to 2021-Q3 due to lack of demand for video cameras as well as video conferencing equipment. During the third quarter of 2022, revenues from Americas declined by 5% primarily due to decreased revenues from Latin America. During 2022-Q3 revenues from the Asia Pacific, including the Middle East, India and Australia decline by 5% primarily due to declines in revenues from all sub-markets except the Middle East, Japan and Korea, with the Middle East showing significant increase in revenues. Finally, revenues from Europe and Africa decreased significantly by 31% in 2022-Q3 primarily due to decreases across all the sub-markets except Southern Europe.
During the nine months ended September 30, 2022 our revenues decreased from $21.8 million to $21.2 million compared to the same period in 2021 due to revenue from video products decreasing by 36%, microphones increasing by 4%, and audio conferencing increasing by 9%. The increase in revenue from microphones was due to growth in revenues from all categories of microphones. The audio conferencing category as a whole increased mainly due to a strong revenue performance by our professional mixers. During 2022-YTD Americas declined by 4%, Asia Pacific, including the Middle East and India increased by 7% and Europe and Africa declined by 12%. India, the Middle East and Northern Europe led in revenue growth while Latina America, China and Southern Europe suffered major revenue decreases.
We believe, although there can be no assurance, that we can return to generating operating profits through our strategic initiatives namely product innovation, cost reduction and defense of our intellectual property.
Costs of Goods Sold and Gross Profit
Cost of goods sold includes expenses associated with finished goods purchased from outsourced manufacturers, the repackaging of our products, our manufacturing and operations organization, property and equipment depreciation, warranty expense, freight expense, royalty payments, and the allocation of overhead expenses.
Our gross profit margin increased from 40.8% during 2021-Q3 to 41.0% during 2022-Q3. The gross profit margin was negatively impacted due to increases in material costs due to continuing supply chain constraints and an increase in inventory obsolescence, which were partially offset by reduced freight, tariff costs and overhead costs.
Our gross profit margin decreased from 42.6% during 2021-YTD to 38.7% during 2022-YTD. The gross profit margin decreased primarily due to increases in material costs due to continuing supply chain constraints, which was partially offset by reduced inventory obsolescence costs, freight, tariff costs and overhead costs in 2022-YTD.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Our profitability in the near-term continues to depend significantly on our revenues from professional installed audio-conferencing products. We hold long-term inventory and if we are unable to sell our long-term inventory, our profitability might be affected by inventory write-offs and price mark-downs. Our long-term inventory includes approximately $0.5 million of wireless microphone-related finished goods and assemblies, $0.2 million of Converge Pro and Beamforming microphone array products, $0.8 million of video products, and $1.3 million of raw materials that will be used primarily for manufacturing professional audio conferencing products and BMA microphones. Any business changes that are adverse to these product lines could potentially impact our ability to sell our long-term inventory in addition to our current inventory.
Operating Expenses
Operating expenses include sales and marketing (“S&M”) expenses, research and product development (“R&D”) expenses and general and administrative (“G&A”) expenses. Total operating expenses were $3.7 million in 2022-Q3 compared to $4.9 million in 2021-Q3. Total operating expenses were $12.8 million for 2022-YTD compared to $14.3 million for 2021-YTD. The following contains a more detailed discussion of expenses related to sales and marketing, research and product development, general and administrative, and other items.
Sales and Marketing - S&M expenses include selling, customer service, and marketing expenses such as employee-related costs, allocations of overhead expenses, trade shows, and other advertising and selling expenses.
S&M expenses in 2022-Q3 decreased to $1.2 million from $1.7 million for 2021-Q3. The decrease was primarily due to decreases in employment expenses and consultant expenses due to a reduction in the headcount and due to decrease in commissions paid to employees and consultants.
S&M expenses for 2022-YTD decreased to $4.3 million from $5.0 million for 2021-YTD. The decrease was primarily due to decreases in employment expenses and consultant expenses due to a reduction in the headcount and due to decrease in commissions paid to employees and consultants. This overall decrease was partially offset by increase in trade-show related costs.
Research and Product Development - R&D expenses include research and development, product line management, engineering services, and test and application expenses, including employee-related costs, outside services, expensed materials, depreciation, and an allocation of overhead expenses.
R&D expenses decreased to $0.9 million in 2022-Q3 compared to $1.5 million for 2021-Q3. The decrease was primarily due to reduction in employment expenses due to reduction in the headcount and a decrease in project-related expenses.
R&D expenses decreased to $3.4 million in 2022-YTD, from $4.3 million in 2021-YTD. The decrease was primarily due to reduction in employment expenses due to reduction in the headcount and a decrease in project-related expenses.
General and Administrative - G&A expenses include employee-related costs, professional service fees, allocations of overhead expenses, litigation costs, and corporate administrative costs, including costs related to finance and human resources teams.
G&A expenses remained almost the same at $1.7 million in 2021-Q3 and 2022-Q3. The reduction in employee related expenses were partially offset by an increase in amortization costs relating to our capitalized patent defense costs.
G&A expenses increased from $5.0 million in 2021-YTD to $5.1 million in 2022-YTD. The increases in amortization costs relating to our capitalized patent defense costs and insurance costs were partially offset by decreases in employee-related expenses, legal expenses and consulting expenses.
Other income (expense), net
Other income (expense), net includes interest income and foreign currency changes. Other income during the first nine months of 2022 includes $1.5 million recognized on the gain arising from the CARES Act Paycheck Protection Program loan forgiveness. Other items remained immaterial during the third quarter of 2022 and 2021.
Interest expense decreased to $0.1 million in 2022-Q3 compared to $0.2 million in 2021-Q3. Interest expense decreased to $0.3 million in 2022-YTD compared to $0.4 million in 2021-YTD.
Provision for income taxes
During the nine months ended of 2022 and 2021, we did not recognize any benefit from the losses incurred due to setting up a full valuation allowance. Provision for income taxes recognized for 2022-Q3 and 2022-YTD primarily relates to foreign jurisdictions.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
LIQUIDITY AND CAPITAL RESOURCES
As of September 30, 2022, our cash and cash equivalents were approximately $1.5 million compared to $1.1 million as of December 31, 2021. Our working capital was $19.3 million and $18.0 million as of September 30, 2022 and December 31, 2021, respectively.
Net cash used in operating activities was approximately $2.1 million in 2022-YTD, an increase of cash used in operating activities of approximately $0.6 million from $1.5 million of cash provided by operating activities in 2021-YTD. The increase in cash outflow was due to a negative change in operating assets and liabilities of $0.7 million, partially offset by a decrease in net loss by $0.2 million after adjusting for non-cash charges.
Net cash provided by investing activities were $2.3 million in 2022-YTD compared to net cash used in investing activities of $4.2 million in 2021-YTD, a change in cash flow of $6.4 million. The change in cash flow was primarily due to (a) an increase in proceeds from sale of marketable securities net of any purchases in 2021-YTD to $1.5 million, and (b) a decrease in capitalized patent defense costs by $4.9 million.
Net cash provided by financing activities in 2022-YTD was $0.2 million, comprised primarily of a $0.8 million refund of the CARES Act Paycheck Protection Program Loan with interest offset by $0.5 million repayment of principal amounts due on senior convertible notes. In comparison, cash provided by financing activities was $11.0 million in 2021-YTD, which consisted primarily of issuance of common stock and borrowing through issuance of short-term notes partially offset by repayment of a portion of senior convertible debt.
Capitalization of patent defense costs. We capitalize external legal costs incurred in the defense of our patents when we believe that a significant, discernible increase in value will result from the defense and a successful outcome of the legal action is probable. When we capitalize patent defense costs we amortize the costs over the remaining estimated useful life of the patents, which is 15 to 17 years. During the nine months ended September 30, 2022 we spent $0.6 million on legal costs related to the defense of our patents and capitalized the entire amount.
We are currently pursuing all reasonably available legal remedies to defend our strategic patents from infringement. See Part II, Item1. Legal Proceedings. We have already spent approximately $28.8 million from 2016 through September 30, 2022 towards this litigation and may be required to spend more to continue our legal defense.
As of September 30, 2022, our cash and cash equivalents were approximately $1.5 million compared to $1.1 million as of December 31, 2021. Our working capital was $19.3 million as of September 30, 2022. Net cash used in operating activities was $2.1 million for the nine months ended September 30, 2022, an increase of $0.6 million from $1.5 million of cash used in operating activities in the nine months ended September 30, 2021. In order to maintain liquidity, we have been actively engaged in preserving cash by implementing company-wide cost reduction measures and raising additional capital. We raised additional capital in 2019 by issuing senior convertible notes, in 2020 by borrowing through the CARES Act Paycheck Protection Program and issuing common stock and warrants and in 2021 by issuing short-term notes and issuing common stock and warrants. In January 2022, we issued $2,000 in common stock as consideration for the cancellation and termination of the short-term notes. In addition, we have been generating additional cash as our inventory levels are brought down to historical levels.
We also believe that our core strategies of product innovation and prudent cost management will bring us back to profitability in the future. We believe, although there can be no assurance, that all of these measures and effective management of working capital, including collecting on the income tax receivable balance, will provide the liquidity needed to meet our operating needs through at least November 14, 2023. We also believe that our strong portfolio of intellectual property and our solid brand equity in the market will enable us to raise additional capital if and when needed to meet our short and long-term financing needs; however, there can be no assurance that, if needed, we will be successful in obtaining the necessary funds through equity or debt financing. If we need additional capital and are unable to secure financing, we may be required to further reduce expenses, delay product development and enhancement, or revise our strategy regarding ongoing litigation.
As of September 30, 2022, we had open purchase orders of approximately $2.2 million mostly for purchase of inventory.
As of September 30, 2022, we had inventory totaling $12.7 million, of which non-current inventory accounted for $3.0 million. This compares to total inventories of $13.6 million and non-current inventory of $3.6 million as of December 31, 2021.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Contractual Obligations and Commitments
The following table summarizes our contractual obligations as of September 30, 2022 (in millions):
| | Payment Due by Period | |
| | Total | | | Less Than 1 Year | | | 1-3 Years | | | 3-5 Years | | | More than 5 years | |
Senior convertible notes | | $ | 2.1 | | | $ | 0.9 | | | $ | 1.2 | | | $ | — | | | $ | — | |
Operating lease obligations | | | 1.2 | | | | 0.6 | | | | 0.6 | | | | — | | | | — | |
Purchase obligations | | | 2.2 | | | | 2.2 | | | | — | | | | — | | | | — | |
Total | | $ | 5.5 | | | $ | 3.7 | | | $ | 1.8 | | | $ | — | | | $ | — | |
OFF-BALANCE SHEET ARRANGEMENTS
We have no off-balance-sheet arrangements that have or are reasonably likely to have a current or future material effect on our financial condition, changes in financial conditions, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources, results of operations or liquidity.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Our discussion and analysis of our results of operations and financial position are based upon our unaudited condensed consolidated financial statements included under Item 1 of this Form 10-Q, which have been prepared in conformity with accounting principles generally accepted in the United States. We review the accounting policies used in reporting our financial results on a regular basis. We believe certain of our accounting policies are critical to understanding our financial position and results of operations. There have been no changes to the critical accounting policies as explained in our Annual Report on Form 10-K for the year ended December 31, 2021.
RECENT ACCOUNTING PRONOUNCEMENTS
For a discussion of recent accounting pronouncements, see Note 1: “Business Description, Basis of Presentation and Significant Accounting Policies” in the notes to our unaudited condensed consolidated financial statements included under Item 1 of this Form 10-Q.
