Universal Electronics Inc. — Q3 2018 Form 10-Q
Reporting period: Three and nine months ended September 30, 2018. The company develops and manufactures universal remote controls, AV accessories, software, and home security, sensing, and automation products, and licenses related intellectual property. Figures below are in U.S. dollars; financial statement amounts are in millions unless otherwise noted.
Financial performance
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Net sales | $182.7 | $175.7 | $509.9 | $514.6 |
| Gross profit / margin | $40.3 / 22.1% | $43.1 / 24.5% | $104.3 / 20.4% | $127.9 / 24.8% |
| Operating income (loss) | $4.7 | $4.2 | $(4.2) | $11.2 |
| Net income | $1.0 | $1.7 | $23.0 | $6.5 |
| Diluted EPS | $0.07 | $0.12 | $1.63 | $0.44 |
Q3 sales rose 4.0%; lower gross margin reflected component-cost inflation, U.S. tariffs on China-made imports, and higher China labor costs. SG&A declined, helping operating income increase modestly. Net income fell as foreign-exchange losses and higher interest expense offset the operating improvement. For the nine-month period, sales declined 0.9% and gross margin fell 4.4 percentage points. The operating loss excludes a $37.0 million pretax gain on the Guangzhou factory sale; that gain was the principal reason nine-month net income increased year over year. Without it, reported net income would have been materially lower.
Cash flow, debt and liquidity
- Nine-month operating cash flow was a use of $4.6 million, versus a use of $5.8 million in 2017. Investing activities provided $27.5 million, including $51.3 million of factory-sale proceeds; financing activities used $50.1 million, including net line-of-credit repayments of $34.5 million and $12.6 million of share repurchases.
- Cash and cash equivalents were $42.0 million at September 30, 2018, down from $62.4 million at year-end 2017. Working capital was $100.8 million.
- Line-of-credit borrowings were $103.5 million under a $170.0 million revolving facility, leaving $66.5 million available. The facility expires November 1, 2019; the rate was 3.97%. The company reported compliance with its covenants.
- Capital expenditure cash outflow was $16.8 million for the first nine months. Management expected 2018–2019 property and equipment purchases to return to approximately $20 million annually.
Material changes, outlook and risks
- Revenue standard: The company adopted ASC 606 on January 1, 2018 using the modified retrospective method. Adoption affected reported timing and amounts: nine-month sales were $2.9 million lower than under prior guidance, while net income was $0.1 million lower. Q3 net income was $0.3 million higher. Prior periods were not restated.
- Business trends: Q3 Business-line sales increased 3.6%, supported by Asia consumer-electronics and home-security sales, partly offset by weaker North American and Latin American subscription-broadcasting sales. Nine-month Business-line sales declined 2.0%, including weaker North American platform-transition orders and Latin America; Consumer-line sales grew 12.8%.
- Tariffs and margins: Management expected tariffs on products manufactured in China and imported into the U.S. to pressure gross margins for the foreseeable future. It was implementing supply-chain, manufacturing, and customer-pricing countermeasures and expected the most significant measures to be in place over the following 6–9 months. The company was shifting some production outside China, which could entail material costs and disruption, and might not offset tariffs.
- Other financial pressures: Nine-month R&D expense rose 11.6% to $17.7 million. Net interest expense increased to $3.5 million from $1.7 million, while net other expense was $4.0 million, primarily from currency losses. Management said current cash, expected operating cash flow, and borrowing availability should cover the next 12 months, but noted that overseas cash may be restricted or costly to repatriate.
- Concentration and market risks: Comcast represented 19.6% of nine-month sales, compared with 23.7% in 2017. The filing cites dependence on a limited number of customers, customer platform transitions and order timing, competition, international operations, tariffs, and foreign-exchange volatility. Management estimated a 10% move in specified currencies could change Q4 2018 net income by approximately $10.2 million; a 100-basis-point rate increase was estimated to affect annual net income by about $0.8 million.
- Unusual items and contingencies: The Guangzhou factory sale closed in June for $51.3 million proceeds and a $37.0 million pretax gain. The company was involved in patent litigation in Belgium and the Netherlands and had sued Roku in September 2018 over alleged infringement of nine patents; outcomes and potential losses were uncertain. Management said it could not estimate a range of potential litigation losses.
Important facts for investors to verify
- Whether tariff exposure is reduced through the planned production shift, supply-chain changes, or customer pricing—and the effect on gross margins.
- Whether subscription-broadcasting demand and customer platform transitions stabilize, and how Comcast concentration evolves.
- Whether operating cash flow improves and the company maintains covenant compliance while refinancing or renewing its credit facility before its November 2019 expiration.
- How much reported nine-month earnings depended on the one-time Guangzhou sale gain, and whether underlying operations return to profitability.
- Developments in the patent cases, foreign-exchange exposure, and the company’s still-incomplete accounting for certain Tax Act provisions.