UNIVERSAL ELECTRONICS INC quarterly report, Q2 FY2017

Universal Electronics Inc. — Q2 2017 Form 10-Q

Reporting period: Three and six months ended June 30, 2017; unaudited. The company develops and manufactures remote controls, AV accessories, software, and home security, sensing, and automation products. It reports one operating segment.

Financial performance and liquidity

Metric	Q2 2017	Q2 2016	Six months 2017	Six months 2016
Net sales	$177.6 million	$171.0 million	$339.0 million	$321.6 million
Gross profit / margin	$43.8 million / 24.6%	$43.5 million / 25.4%	$84.8 million / 25.0%	$81.1 million / 25.2%
Operating income / margin	$7.3 million / 4.1%	$8.0 million / 4.7%	$6.9 million / 2.0%	$11.0 million / 3.4%
Net income attributable to Universal Electronics	$4.7 million	$6.6 million	$4.8 million	$9.3 million
Diluted EPS	$0.32	$0.45	$0.33	$0.63

Q2 sales increased 3.9% year over year, while net income fell about 29%. Six-month sales rose 5.4%, while net income fell about 48%.
For the six months, operating cash flow was negative $0.2 million, versus positive $23.3 million in 2016. Investing cash outflow was $27.1 million, including $8.9 million for the RCS acquisition. Financing provided $28.0 million, primarily reflecting net line-of-credit borrowings.
At June 30, cash and cash equivalents were $49.7 million; working capital was $87.9 million. The company had $92.0 million drawn on its $125.0 million revolving credit line, leaving $33.0 million available. The rate was 2.34%; the facility expires November 1, 2019. The company reported compliance with its covenants.
Total assets were $572.8 million and total liabilities were $290.6 million. Current assets were $352.6 million and current liabilities were $264.7 million.

Material changes and business developments

Business-line sales, primarily to subscription broadcasters, OEMs, and computing companies, increased 3.8% in Q2 and 5.3% for the first half. Higher-end platform rollouts, home security sales, and Latin American market-share gains helped; lower North American satellite customer sales partly offset growth as customers reduced inventory ahead of new platforms. Consumer-line sales also grew.
Q2 gross margin declined to 24.6% from 25.4%. Management cited China factory-transition inefficiencies, price reductions for certain large customers, and lower-margin Latin American projects; currency effects and improved Consumer-line margins partly offset these factors.
Operating income declined in Q2 and the first half. First-half restructuring charges for the China factory transition were $5.7 million, versus $1.5 million a year earlier. Management expected approximately $1.5 million of additional severance costs over the next three to six months.
On April 6, the company acquired substantially all net assets of Residential Control Systems, Inc. for an initial $12.6 million, consisting of $8.9 million cash and $3.7 million contingent consideration. RCS contributed $1.4 million in sales and a $0.4 million net loss from acquisition through June 30. Additional earnouts of up to $10.0 million may be payable through June 2022.
The planned sale of the Guangzhou factory was for RMB 320 million, approximately $47.2 million at June 30 exchange rates. Closing remained subject to due diligence and regulatory approval; timing could extend to approximately 28 months from the September 2016 agreement. A $4.7 million buyer deposit remained in long-term restricted cash.
The company repurchased 239,470 shares for $14.9 million in the first half, compared with 36,329 shares for $1.9 million in 2016. The Board raised the remaining repurchase authorization to 200,000 shares in July.

Outlook, risks, and unusual items

No specific revenue or earnings guidance was provided. Management expected 2017 property, plant, and equipment purchases of $24 million to $27 million and stated that cash, expected operating cash flow, and borrowing availability should cover expected outlays over the next 12 months.
Management’s stated strategic priorities include expanding advanced remote-control and home-automation offerings, growing international and existing-customer sales, and pursuing complementary acquisitions or partnerships.
Customer concentration is significant: Comcast represented 24.2% of Q2 sales and 25.1% of first-half sales. Comcast and DIRECTV each represented more than 10% of first-half sales.
Foreign exchange is a material exposure. The company estimated that a 10% fluctuation in specified currencies relative to the U.S. dollar could change third-quarter 2017 net income by approximately $10.4 million. Q2 included $0.6 million of net other expense, primarily reflecting foreign-currency effects. A 100-basis-point interest-rate increase was estimated to affect annual net income by about $0.6 million based on the period-end borrowing balance.
The company described pending patent disputes involving Ruwido in Belgium and an ITC investigation concerning remote controls supplied to Comcast. The Kudelski Group moved in July 2017 to terminate the ITC investigation; the company expected the motion to be accepted. Management could not estimate potential litigation losses generally.
The company expected adoption of the new revenue-recognition standard to accelerate recognition for certain customized products with no alternative use and some licensing arrangements; the impact could be material. Its assessment and transition-method selection were ongoing.
Other notable items include $1.3 million of first-half sales reductions for performance-based Comcast warrants, $1.4 million of first-half net foreign-exchange contract losses, and the $5.7 million restructuring charge. The company reported effective disclosure controls and procedures.

Most important facts for investors to verify

Whether sales growth can translate into improved margins and operating income as factory-transition costs continue and customer pricing and product mix affect gross margin.
Whether operating cash flow recovers as receivables and inventory build: first-half cash use included higher working-capital needs, inventory turns fell to 3.9 from 4.3, and days sales outstanding rose to 75 from 70 year over year.
Execution and final economics of the Guangzhou factory sale, factory transition, and RCS integration, including any further restructuring costs, working-capital adjustment, and contingent payments.
Comcast and other major-customer concentration, customer inventory depletion ahead of platform launches, and the performance-based warrants tied to Comcast purchases.
Available borrowing capacity, debt levels, covenant compliance, and the geographic availability of cash; most cash was held outside the United States, with some subject to local restrictions or potential U.S. tax upon repatriation.
Developments in the patent matters and the potential effects of foreign-exchange movements, new revenue-recognition requirements, and the pending factory sale on reported results.