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UNIVERSAL ELECTRONICS INC - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
[November 07, 2014]

UNIVERSAL ELECTRONICS INC - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS


(Edgar Glimpses Via Acquire Media NewsEdge) The following discussion should be read in conjunction with the Consolidated Financial Statements and the related notes that appear elsewhere in this document.

Overview We develop and manufacture a broad line of pre-programmed universal remote control products, audio-video ("AV") accessories, and software that are marketed to enhance home entertainment systems. Our customers operate in the consumer electronics market and include subscription broadcasters, original equipment manufacturers ("OEMs"), international retailers, private labels, and companies in the computing industry. We also sell integrated circuits, on which our software and infrared ("IR") code database, or library, is embedded, to OEMs that manufacture wireless control devices, cable converters or satellite receivers for resale in their products.



Since our beginning in 1986, we have compiled an extensive IR code library that covers over 847,000 individual device functions and approximately 6,800 individual consumer electronic equipment brand names. Our library is regularly updated with IR codes used in newly introduced AV devices. These IR codes are captured directly from the remote control devices or the manufacturer's written specifications to ensure the accuracy and integrity of the database. We believe that our universal remote control library contains device codes that are capable of controlling virtually all IR controlled set-top boxes, televisions, audio components, DVD players, Blu-Ray players and CD players, as well as most other remote controlled home entertainment devices and home automation control modules worldwide.

We operate as one business segment. We have twenty-three subsidiaries located in Argentina, Cayman Islands, France, Germany, Hong Kong (5), India, Italy, the Netherlands, Singapore, Spain, Brazil, British Virgin Islands (3), People's Republic of China (4) and the United Kingdom.


To recap our results for the three months ended September 30, 2014: • Net sales increased 3.8% to $147.8 million for the three months ended September 30, 2014 from $142.4 million for the three months ended September 30, 2013.

• Our gross margin percentage increased from 28.4% for the three months ended September 30, 2013 to 30.5% for the three months ended September 30, 2014.

• Operating expenses, as a percent of sales, increased from 21.0% for the three months ended September 30, 2013 to 21.2% for the three months ended September 30, 2014.

• Our operating income increased 31.6% to $13.8 million for the three months ended September 30, 2014 from $10.5 million for the three months ended September 30, 2013, and our operating margin percentage increased to 9.3% for the three months ended September 30, 2014, compared to 7.4% for the three months ended September 30, 2013.

• Our effective tax rate increased to 17.6% for the three months ended September 30, 2014, compared to 12.0% for the three months ended September 30, 2013.

Our strategic business objectives for 2014 include the following: • continue to develop industry-leading technologies and products with attractive gross margins in order to improve profitability; • continue to increase our market share in newer product categories, such as smart devices and game consoles; • further penetrate the growing Asian and Latin American subscription broadcasting markets; • acquire new customers in historically strong regions; • increase our share with existing customers; and • continue to seek acquisitions or strategic partners that complement and strengthen our existing business.

We intend for the following discussion of our financial condition and results of operations to provide information that will assist in understanding our consolidated financial statements, the changes in certain key items in those financial statements from period to period, and the primary factors that accounted for those changes, as well as how certain accounting principles, policies and estimates affect our consolidated financial statements.

Critical Accounting Policies and Estimates The preparation of financial statements in conformity with accounting principles accepted in the United States of America requires us to make estimates and judgments that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period.

21-------------------------------------------------------------------------------- Table of Contents On an on-going basis, we evaluate our estimates and judgments, including those related to revenue recognition, allowance for doubtful accounts, warranties, inventory valuation, our review for impairment of long-lived assets, intangible assets and goodwill, income taxes and stock-based compensation expense. Actual results may differ from these judgments and estimates, and they may be adjusted as more information becomes available. Any adjustment may be significant and may have a material impact on our consolidated financial position or results of operations.

An accounting policy is deemed to be critical if it requires an accounting estimate to be made based on assumptions about matters that are highly uncertain at the time the estimate is made, if different estimates reasonably may have been used, or if changes in the estimate that are reasonably likely to occur may materially impact the financial statements. We do not believe that there have been any significant changes during the nine months ended September 30, 2014 to the items that we disclosed as our critical accounting policies and estimates in Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations" contained in our Annual Report on Form 10-K for our fiscal year ended December 31, 2013.

Recent Accounting Pronouncements See Note 1 contained in the "Notes to Consolidated Financial Statements" for a discussion of recent accounting pronouncements.

Results of Operations The following table sets forth our results of operations expressed as a percentage of net sales for the periods indicated.

Three Months Ended September 30, Nine Months Ended September 30, (In thousands) 2014 2013 2014 2013 Net sales 100.0 % 100.0 % 100.0 % 100.0 % Cost of sales 69.5 71.6 70.5 71.8 Gross profit 30.5 28.4 29.5 28.2 Research and development expenses 2.8 2.9 3.0 3.2 Selling, general and administrative expenses 18.4 18.1 19.1 18.8 Operating income 9.3 7.4 7.4 6.2 Interest income (expense), net 0.0 0.0 (0.0 ) 0.0 Other income (expense), net (0.4 ) (0.5 ) (0.3 ) (0.7 ) Income before provision for income taxes 8.9 6.9 7.1 5.5 Provision for income taxes 1.5 0.8 1.5 1.1 Net income 7.4 % 6.1 % 5.6 % 4.4 % Three Months Ended September 30, 2014 versus Three Months Ended September 30, 2013 Net sales. Net sales for the three months ended September 30, 2014 were $147.8 million, an increase of 3.8% compared to $142.4 million for the three months ended September 30, 2013. Net sales by our Business and Consumer lines were as follows: Three Months Ended September 30, 2014 2013 $ (millions) % of total $ (millions) % of total Business $ 135.2 91.5 % $ 129.7 91.1 % Consumer 12.6 8.5 12.7 8.9 Total net sales $ 147.8 100.0 % $ 142.4 100.0 % Net sales in our Business lines (subscription broadcasting, OEM, and computing companies) were 91.5% of net sales for the three months ended September 30, 2014 compared to 91.1% for the three months ended September 30, 2013. Net sales in our Business lines for the three months ended September 30, 2014 increased by 4.2% to $135.2 million from $129.7 million driven primarily by strong demand and increased market share with European and Latin American subscription broadcasters, increased licensing revenue, and growth in sales of our embedded chip solutions to smart device manufacturers.

Net sales in our Consumer lines (One For All® retail and private label) were 8.5% of net sales for the three months ended September 30, 2014 compared to 8.9% for the three months ended September 30, 2013. Net sales in our Consumer lines for the three months 22-------------------------------------------------------------------------------- Table of Contents ended September 30, 2014 decreased by 0.8% to $12.6 million from $12.7 million in the three months ended September 30, 2013 primarily due to decreased demand in the Latin American market.

Gross profit. Gross profit for the three months ended September 30, 2014 was $45.1 million compared to $40.4 million for the three months ended September 30, 2013. Gross profit as a percent of sales increased to 30.5% for the three months ended September 30, 2014 compared to 28.4% for the three months ended September 30, 2013. The gross margin percentage was favorably impacted by an increase in licensing revenue associated with the smart device channel and, to a lesser extent, the strengthening of the British Pound compared to the U.S. Dollar.

Offsetting these favorable items was an increase in sales to certain large customers that yield a lower gross margin than our company average.

Research and development ("R&D") expenses. R&D expenses were $4.2 million for both the three months ended September 30, 2014 and 2013.

Selling, general and administrative ("SG&A") expenses. SG&A expenses increased 5.1% to $27.1 million for the three months ended September 30, 2014 from $25.8 million for the three months ended September 30, 2013. This increase was driven primarily by increased incentive compensation costs as a result of our strong financial performance in the current year. In addition, in an effort to address the smart device channel we increased headcount in our product development departments which resulted in higher payroll costs in 2014.

Interest income (expense), net. Net interest income was $66 thousand for the three months ended September 30, 2014 compared to net interest income of $47 thousand for the three months ended September 30, 2013.

Other income (expense), net. Net other expense was $0.7 million for both the three months ended September 30, 2014 and 2013.

Provision for income taxes. Income tax expense was $2.3 million for the three months ended September 30, 2014 compared to $1.2 million for the three months ended September 30, 2013. Our effective tax rate was 17.6% for the three months ended September 30, 2014 compared to 12.0% for the three months ended September 30, 2013. The increase in our effective tax rate was due to the expiration of the federal R&D tax credit as of December 31, 2013 which has yet to be passed in 2014; therefore, the benefit is not included in our estimated tax rate for the current year. The "Look-Through" rule also expired as of December 31, 2013 which resulted in an increase in Subpart F income for the three months ended September 30, 2014. We also recorded a tax refund on certain Hong Kong income during the third quarter of 2013 which exceeded the benefit recorded during the third quarter of 2014.

Nine Months Ended September 30, 2014 versus Nine Months Ended September 30, 2013 Net sales. Net sales for the nine months ended September 30, 2014 were $423.9 million, an increase of 7.8% compared to $393.2 million for the nine months ended September 30, 2013. Net sales by our Business and Consumer lines were as follows: Nine Months Ended September 30, 2014 2013 $ (millions) % of total $ (millions) % of total Business $ 386.4 91.2 % $ 358.5 91.2 % Consumer 37.5 8.8 34.7 8.8 Total net sales $ 423.9 100.0 % $ 393.2 100.0 % Net sales in our Business lines (subscription broadcasting, OEM, and computing companies) were 91.2% of net sales for both the nine months ended September 30, 2014 and 2013. Net sales in our Business lines for the nine months ended September 30, 2014 increased by 7.8% to $386.4 million from $358.5 million primarily due to an increase in licensing revenue, growth in sales of our embedded chip solutions to smart device manufacturers, an increase in remote control sales to consumer electronics companies in Asia, as well as strong demand and increased market share in European subscription broadcasting.

Net sales in our Consumer lines (One For All® retail and private label) were 8.8% of net sales for both the nine months ended September 30, 2014 and 2013.

Net sales in our Consumer lines for the nine months ended September 30, 2014 increased by 8.1% to $37.5 million from $34.7 million in the nine months ended September 30, 2013 due to increased distribution in the grocery-food channel as well as increased demand resulting from the 2014 FIFA World Cup™.

Gross profit. Gross profit for the nine months ended September 30, 2014 was $125.2 million compared to $110.8 million for the nine months ended September 30, 2013. Gross profit as a percent of sales was 29.5% for the nine months ended September 30, 2014 compared to 28.2% for the nine months ended September 30, 2013. The gross margin percentage was favorably impacted by an increase in licensing revenue associated with the smart device channel and, to a lesser extent, the strengthening of the British 23-------------------------------------------------------------------------------- Table of Contents Pound and Euro compared to the U.S. Dollar. Partially offsetting these favorable items was an increase in sales to certain large customers that yield a lower gross margin than our company average.

Research and development expenses. R&D expenses increased 1.1% to $12.6 million for the nine months ended September 30, 2014 from $12.5 million for the nine months ended September 30, 2013. This increase was in line with our strategic initiatives and was primarily driven by additional R&D efforts dedicated to developing new product offerings for new and existing product categories.

Selling, general and administrative expenses. SG&A expenses increased 9.6% to $81.2 million for the nine months ended September 30, 2014 from $74.0 million for the nine months ended September 30, 2013. This increase was driven primarily by increased incentive compensation costs as a result of our strong financial performance in the current year and increased external legal expenses related to patent litigation cases. In addition, in an effort to address the smart device channel we increased headcount in our product development departments which resulted in higher payroll costs in 2014.

Interest income (expense), net. Net interest expense was $21 thousand for the nine months ended September 30, 2014 compared to net interest income of $60 thousand for the nine months ended September 30, 2013.

Other income (expense), net. Net other expense was $1.3 million for the nine months ended September 30, 2014 compared to net other expense of $2.9 million for the nine months ended September 30, 2013. This decrease was driven primarily by a decrease in foreign currency losses associated with fluctuations in foreign currency rates related to the Argentinian Peso, Chinese Yuan Renminbi and Brazilian Real.

Provision for income taxes. Income tax expense was $6.5 million for the nine months ended September 30, 2014 compared to $4.1 million for the nine months ended September 30, 2013. Our effective tax rate was 21.5% for the nine months ended September 30, 2014 compared to 19.0% for the nine months ended September 30, 2013. The increase in our effective tax rate was due to the expiration of the federal R&D tax credit as of December 31, 2013 which has yet to be passed in 2014; therefore, the benefit is not included in our estimated tax rate for the current year. The "Look-Through" rule also expired as of December 31, 2013 which resulted in an increase of Subpart F income for the nine months ended September 30, 2014. We also recorded a tax refund on certain Hong Kong income during the third quarter of 2013 which exceeded the benefit recorded during the third quarter of 2014. Partially offsetting these benefits is the recording of $0.4 million of additional tax reserves in the second quarter of 2013 resulting from a tax audit in Hong Kong for years preceding our acquisition of Enson Assets Limited.

Liquidity and Capital Resources Sources and Uses of Cash Nine Months Nine Months Ended Increase Ended September (In thousands) September 30, 2014 (Decrease) 30, 2013 Cash provided by operating activities $ 43,347 $ 42,545 $ 802 Cash used for investing activities (13,854 ) (4,898 ) (8,956 ) Cash provided by (used for) financing activities (6,660 ) (13,005 ) 6,345 Effect of exchange rate changes on cash (43 ) (1,861 ) 1,818 Increase September 30, 2014 (Decrease) December 31, 2013 Cash and cash equivalents $ 98,964 $ 22,790 $ 76,174 Working capital 178,026 19,478 158,548 Net cash provided by operating activities increased $42.5 million to $43.3 million during the nine months ended September 30, 2014 from $0.8 million during the nine months ended September 30, 2013, primarily due to the net impact of changes in working capital needs associated with inventories and accounts payable, as well as increased net income in the current year period. With respect to working capital, our inventory turns improved to 4.2 turns for the nine months ended September 30, 2014, compared to 4.0 turns for the nine months ended September 30, 2013, primarily as a result of more tightly managed inventory levels in the current year. Accounts payable payment timing related to 2014 inventory purchases resulted in increased cash inflows during the nine months ended September 30, 2014 compared to the prior year period.

Net cash used for investing activities during the nine months ended September 30, 2014 was $13.9 million compared to $9.0 million during the nine months ended September 30, 2013. Cash outflows to purchase property, plant and equipment were $12.5 24-------------------------------------------------------------------------------- Table of Contents million during the nine months ended September 30, 2014 compared to $8.0 million for the nine months ended September 30, 2013. This increase was driven primarily by increased machinery and equipment purchases at our China factories as well as computer equipment and software investments made in the U.S. in the current year period.

Net cash used for financing activities was $6.7 million during the nine months ended September 30, 2014 compared to net cash provided by financing activities of $6.3 million during the nine months ended September 30, 2013. The increase in cash used for financing activities was driven primarily by an increased level of stock repurchases in the current year period.

During the nine months ended September 30, 2014, we repurchased 367,949 shares of our common stock at a cost of $15.2 million compared to our repurchase of 140,759 shares at a cost of $3.2 million during the nine months ended September 30, 2013. We hold these shares as treasury stock and they are available for reissue. Presently, except for using a minimal number of these treasury shares to compensate our outside board members, we have no plans to distribute these shares, although we may change these plans if necessary to fulfill our on-going business objectives.

From time to time, our Board of Directors authorizes management to repurchase shares of our issued and outstanding common stock. Repurchases may be made to manage dilution created by shares issued under our stock incentive plans or whenever we deem a repurchase is a good use of our cash and the price to be paid is at or below a threshold approved by our Board. As of September 30, 2014, we had 1,083,684 shares available for repurchase under the Board's authorizations.

Contractual Obligations The following table summarizes our contractual obligations and the effect these obligations are expected to have on our liquidity and cash flow in future periods.

Payments Due by Period Less than 1 - 3 4 - 5 After (In thousands) Total 1 year years years 5 years Operating lease obligations $ 13,823 $ 3,064 $ 5,016 $ 2,939 $ 2,804 Capital lease obligations 58 20 38 - - Purchase obligations(1) 2,005 2,005 - - -Total contractual obligations $ 15,886 $ 5,089 $ 5,054 $ 2,939 $ 2,804 (1) Purchase obligations consist of contractual payments to purchase tooling and other fixed assets.

Liquidity Historically, we have utilized cash provided from operations as our primary source of liquidity, as internally generated cash flows have been sufficient to support our business operations, capital expenditures and discretionary share repurchases. Our working capital needs have typically been greatest during the third and fourth quarters when accounts receivable and inventories increase in connection with the fourth quarter holiday selling season. We believe our current cash balances and anticipated cash flow to be generated from operations will be sufficient to cover expected cash outlays during the next twelve months; however, because our cash is located in various jurisdictions throughout the world, we may at times need to borrow from our revolving line of credit or take on additional debt until we are able to transfer cash among our various entities.

Our liquidity is subject to various risks including the risks discussed under "Item 3. Quantitative and Qualitative Disclosures about Market Risk." (In thousands) September 30, 2014 December 31, 2013 Cash and cash equivalents $ 98,964 $ 76,174 Debt - - Available borrowing resources $ 54,987 $ 54,987 Our cash balances are held in numerous locations throughout the world. The majority of our cash is held outside of the United States and may be repatriated to the United States but, under current law, would be subject to United States federal income taxes, less applicable foreign tax credits. Repatriation of some foreign balances is restricted by local laws. We have not provided for the United States federal tax liability on these amounts for financial statement purposes as this cash is considered indefinitely reinvested outside of the United States. Our intent is to meet our domestic liquidity needs through ongoing cash flows, external borrowings, or both. We utilize a variety of tax planning strategies in an effort to ensure that our worldwide cash is available in the locations in which it is needed.

25-------------------------------------------------------------------------------- Table of Contents On September 30, 2014, we had $24.6 million, $52.8 million, $15.6 million and $6.0 million of cash and cash equivalents in the United States, Asia, Europe, and South America, respectively. On December 31, 2013, we had approximately $30.1 million, $34.6 million, $7.2 million, and $4.3 million of cash and cash equivalents in the United States, Asia, Europe and South America, respectively.

We attempt to mitigate our exposure to liquidity, credit and other relevant risks by placing our cash and cash equivalents with financial institutions we believe are high quality.

On October 9, 2014, we extended the term of our Amended and Restated Credit Agreement ("Amended Credit Agreement") with U.S. Bank National Association ("U.S. Bank") to November 1, 2017. The Amended Credit Agreement provides for a $55.0 million line of credit ("Credit Line") that may be used for working capital and other general corporate purposes including acquisitions, share repurchases and capital expenditures. Amounts available for borrowing under the Credit Line are reduced by the balance of any outstanding letters of credit, of which there were $13 thousand at September 30, 2014.

All obligations under the Credit Line are secured by substantially all of our U.S. personal property and tangible and intangible assets as well as 65% of our ownership interest in Enson Assets Limited, our wholly-owned subsidiary which controls our manufacturing factories in the People's Republic of China ("PRC").

Under the Amended Credit Agreement, we may elect to pay interest on the Credit Line based on LIBOR plus an applicable margin (varying from 1.25% to 1.75%) or base rate (based on the prime rate of U.S. Bank or as otherwise specified in the Amended Credit Agreement) plus an applicable margin (varying from 0.00% to 0.50%). The applicable margins are calculated quarterly and vary based on our cash flow leverage ratio as set forth in the Amended Credit Agreement. There are no commitment fees or unused line fees under the Amended Credit Agreement.

The Amended Credit Agreement includes financial covenants requiring a minimum fixed charge coverage ratio, a maximum cash flow leverage ratio and minimum liquidity levels. In addition, the Amended Credit Agreement also contains other customary affirmative and negative covenants and events of default. As of September 30, 2014, we were in compliance with the covenants and conditions of the Amended Credit Agreement.

Off Balance Sheet Arrangements We do not participate in any material off balance sheet arrangements.

Factors That May Affect Financial Condition and Future Results Forward-Looking Statements We caution that the following important factors, among others (including but not limited to factors discussed in "Management's Discussion and Analysis of Financial Condition and Results of Operations," as well as those discussed in our 2013 Annual Report on Form 10-K, or in our other reports filed from time to time with the Securities and Exchange Commission), may affect our actual results and may contribute to or cause our actual consolidated results to differ materially from those expressed in any of our forward-looking statements. The factors included here are not exhaustive. Further, any forward-looking statement speaks only as of the date on which such statement is made, and we undertake no obligation to update any forward-looking statement to reflect events or circumstances after the date on which such statement is made or to reflect the occurrence of unanticipated events. New factors emerge from time to time, and it is not possible for management to predict all such factors, nor can we assess the impact of each such factor on the business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statement. Therefore, forward-looking statements should not be relied upon as a prediction of actual future results.

While we believe that the forward-looking statements made in this report are based on reasonable assumptions, the actual outcome of such statements is subject to a number of risks and uncertainties, including the failure of our markets to continue growing and expanding in the manner we anticipated; the failure of our customers to grow and expand as we anticipated; the effects of natural or other events beyond our control, including the effects political unrest, war or terrorist activities may have on us or the economy; the economic environment's effect on us or our customers; the growth of, acceptance of and the demand for our products and technologies in various markets and geographical regions, including cable, satellite, consumer electronics, retail, and digital media and interactive technology; our inability to add profitable complementary products which are accepted by the marketplace; our inability to attract and retain a quality workforce at adequate levels in all regions of the world, and particularly Asia; our inability to continue to maintain our operating costs at acceptable levels through our cost containment efforts; an unfavorable ruling in any or all of the litigation matters to which we are party; our inability to continue selling our products or licensing our technologies at higher or profitable margins; our inability to obtain orders or maintain our order volume with new and existing customers; our inability to develop new and innovative technologies and products that are accepted by our customers; the possible dilutive effect our stock incentive programs may have on our earnings per share and stock price; our inability to continue to obtain adequate quantities of component parts or secure adequate factory production capacity on a timely basis; and other factors listed from time to time in our press releases and filings with the Securities and Exchange Commission.

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