Universal Electronics Inc. — Q2 2018 Form 10-Q
Reporting period: Three and six months ended June 30, 2018. The company develops and manufactures universal control, sensing and automation products, AV accessories, software and related intellectual property. It reports one operating segment.
Financial performance
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Net sales | $162.5 million | $177.6 million | $327.2 million | $339.0 million |
| Gross profit / margin | $26.8 million / 16.5% | $43.8 million / 24.6% | $64.0 million / 19.5% | $84.8 million / 25.0% |
| Operating income (loss) | $(9.9) million | $7.3 million | $(9.0) million | $6.9 million |
| Net income | $22.7 million | $4.7 million | $22.1 million | $4.8 million |
| Diluted EPS | $1.60 | $0.32 | $1.55 | $0.33 |
- Q2 sales declined 8.5%; six-month sales declined 3.5%. Business-line sales fell 10.5% in Q2 and 4.9% year to date, while Consumer-line sales rose 16.0% and 14.9%, respectively.
- Despite higher reported net income, operating results weakened sharply. Net income included a $37.0 million pretax gain ($32.1 million after tax) from the sale of the Guangzhou factory; the sale gain more than offset the operating loss.
- For the six months, operating cash flow was $(3.9) million, versus $(4.9) million a year earlier. Investing activities provided $31.6 million, including $51.3 million sale proceeds; financing activities used $37.3 million. Capital expenditures were $13.4 million.
- At June 30, cash and cash equivalents were $59.4 million, working capital was $99.1 million, and total assets were $589.1 million. The company had $111.0 million outstanding on its revolving credit line and $59.0 million available. The line carried a 3.84% interest rate and expires November 1, 2019; the company reported covenant compliance.
Material changes and management commentary
- Management attributed the sales decline principally to lower North American subscription-broadcasting orders during customer platform transitions and weaker Latin American sales, particularly in Brazil. Higher home-security sales and Consumer-line growth partly offset the decline.
- Gross margin was pressured by factory underutilization during the Asia ERP transition, component-cost inflation, a stronger Chinese yuan and write-downs associated with the Guangzhou facility. Production efficiencies in China partly offset these factors. Six-month inventory write-down provision was $5.1 million; the company also recorded a $2.8 million impairment of China factory equipment.
- The Asia phase of the company-wide ERP implementation went live in April 2018. Management said the implementation would continue through 2019 and did not expect an adverse effect on internal controls. Disclosure controls were reported effective.
- The company adopted the new revenue-recognition standard on January 1, 2018 using the modified retrospective method. It recorded a $4.1 million increase to opening retained earnings. The standard affected reported comparisons: Q2 2018 sales were $6.4 million higher and net income $0.2 million higher than under prior guidance; six-month sales were $1.1 million lower and net income $0.4 million lower. Prior periods were not restated.
- Management said it expects inventory turns to improve in the second half of 2018 as delayed customer launches begin. It believes cash, expected operating cash flow and borrowing availability will cover anticipated outlays for the next 12 months, while noting that cash is held across jurisdictions and some transfers or repatriation may be constrained or taxed. No quantified earnings or revenue guidance is provided.
- Strategic priorities include developing advanced remote controls and home-automation products, expanding internationally, growing existing customer relationships and seeking complementary acquisitions or partners. The company repurchased $7.1 million of stock in the first half and authorized a further $5.0 million repurchase plan in July.
Risks, contingencies and unusual items
- Customer concentration remains significant: Comcast represented 20.6% of first-half sales and 13.6% of receivables at June 30. Management identifies dependence on a limited number of customers and delays to customer product rollouts as risks.
- Foreign exchange exposure is material. The filing estimates that a 10% move in specified currencies against the U.S. dollar would change Q2 net income by approximately $9.6 million. Currency losses and gains affected reported other expense.
- The company is defending patent and design-right claims involving products supplied to Telenet in Belgium and the Netherlands; appeals and further proceedings were pending, with hearings scheduled into 2019. The company said it could not estimate potential losses and believed the matters would not materially affect its financial condition, results or cash flows.
- The credit agreement is secured by substantially all U.S. personal property and 65% of the ownership interest in the subsidiary controlling the company’s China factories. A 100-basis-point interest-rate increase was estimated to affect annual net income by approximately $0.8 million based on the period-end borrowing balance.
- Accounting for certain Tax Act provisions remained incomplete, including global intangible low-taxed income; resulting changes could be material to tax expense. Gross unrecognized tax benefits were $5.7 million.
Key facts investors should verify
- Whether platform transitions and delayed customer orders convert into shipments, and whether the expected second-half improvement in inventory turns occurs.
- Whether gross margins recover as ERP implementation and factory utilization stabilize, and how component inflation and currency movements develop.
- The extent to which reported earnings depend on the one-time Guangzhou sale gain; underlying operations posted an operating loss.
- Cash generation, inventory levels, borrowing needs and compliance with credit-line covenants; also consider the geographic availability of cash.
- Developments in the Telenet-related intellectual-property cases, customer concentration and unresolved Tax Act accounting.