Universal Electronics Inc: Form 10-Q for the period ended Mar 31, 2024

The following discussion should be read in conjunction with the Consolidated Financial Statements and the related notes that appear elsewhere in this report.

Cautionary Statement

All statements in this report are made as of the date this Form 10-Q is filed with the U.S. Securities and Exchange Commission (the "SEC"). We undertake no obligation to publicly update or revise these statements, whether as a result of new information, future events or otherwise. We make forward-looking statements in Management's Discussion and Analysis of Financial Condition and Results of Operations and elsewhere in this report based on the beliefs and assumptions of our management and on information available to us through the date this Form 10-Q is filed with the SEC. Forward-looking statements include supply chain issues; other future demand and recovery trends and expectations; the delay by or failure of our customers to order products from us; continued availability of cash through borrowing under our revolving line of credit; the effects of natural or other events beyond our control, including the effects of political unrest, war, terrorist activities, other hostilities, or the outbreak of infectious diseases may have on us or the economy; the economic environment's including increases in interest rates and recessionary effects on us or our customers; the effects of doing business internationally; our expectations regarding our ability to meet our liquidity requirements; our capital expenditures and other investment spending expectations; and other statements that are preceded by, followed by, or include the words "believes," "expects," "anticipates," "intends," "plans," "estimates," "foresees," or similar expressions; and similar statements concerning anticipated future events and expectations that are not historical facts.

We caution you that these statements are not guarantees of future performance and are subject to numerous evolving risks and uncertainties that we may not be able to accurately predict or assess, including the risks and uncertainties we describe in our Annual Report on Form 10-K for the fiscal year ended December 31, 2023 ("2023 Form 10-K"), Part II, Item 1A of this report, and other factors we describe from time to time in our periodic filings with the SEC.

Overview

We design, develop, manufacture, ship and support control and sensor technology solutions and a broad line of universal control systems, audio-video ("AV") accessories, wireless security and smart home products that are used by the world's leading brands in the video services, consumer electronics, climate control, security, home automation and home appliance markets. Our product and technology offerings include:

• easy-to-use, voice-enabled, automatically-programmed universal, two-way radio frequency ("RF") as well as infrared ("IR") remote controls, sold primarily to video service providers (cable, satellite, Internet Protocol television ("IPTV") and Over the Top ("OTT") services), original equipment manufacturers ("OEMs"), retailers, and private label customers;
• wall-mount and handheld thermostat controllers and connected accessories for smart energy management systems, primarily to OEM customers, as well as hotels, hospitality and system integrators;
• proprietary and standards-based RF sensors designed for residential security, safety and home automation applications;
• integrated circuits ("ICs"), on which our software and universal device control database is embedded, sold primarily to OEMs, video service providers, and private label customers;
• software, firmware and technology solutions that can enable devices such as Smart TVs, hybrid set-top boxes, audio systems, smart speakers, game consoles and other consumer electronic and smart home devices to wirelessly connect and interoperate within home networks to enable control and delivery of home entertainment, smart home services and device or system information;
• cloud-services that support our embedded software and hardware solutions (directly or indirectly) enabling real-time device identification and system control;
• intellectual property that we license primarily to OEMs and video service providers;
• embedded and cloud-enabled software for reliable firmware update provisioning and digital rights management validation services to major consumer electronics brands; and
• AV accessories sold, directly and indirectly, to consumers including universal remote controls, television wall mounts and stands and digital television antennas.

A key factor in creating products and software for control of entertainment devices is our proprietary device knowledge. Each year our device discovery and control libraries continue to grow across AV and smart home platforms, supporting many common smart home protocols, including IR, HDMI-CEC, Zigbee (Rf4CE), Z-Wave, IP, as well as Home Network and Cloud Control.

Our technology also includes other remote controlled home entertainment devices and home automation control modules, as well as wired Consumer Electronics Control ("CEC") and wireless IP control protocols commonly found on many of the latest HDMI and internet connected devices. Our proprietary software automatically detects, identifies and enables the appropriate control commands for many home entertainment and automation devices in the home. Our libraries are continuously updated with device control codes used in newly introduced AV and Internet of Things ("IoT") devices. These control codes are captured directly from original control devices or from the manufacturer's written specifications to ensure the accuracy and integrity of the library.

We operate as one business segment. We have one domestic subsidiary and 24 international subsidiaries located in Brazil, British Virgin Islands, France, Germany, Hong Kong (3), India, Italy, Japan, Korea, Mexico (2), the Netherlands, People's Republic of China (the "PRC") (6), Singapore, Spain, United Kingdom and Vietnam.

To recap our results for the three months ended March 31, 2024:

• Net sales decreased 15.2% to $91.9 million for the three months ended March 31, 2024 from $108.4 million for the three months ended March 31, 2023.
• Our gross margin percentage increased to 28.3% for the three months ended March 31, 2024 from 22.8% for the three months ended March 31, 2023.
• Operating expenses, as a percentage of net sales, decreased to 35.8% for the three months ended March 31, 2024 from 77.7% for the three months ended March 31, 2023.
• Our operating loss was $6.9 million for the three months ended March 31, 2024 compared to operating loss of $59.5 million for the three months ended March 31, 2023. Our operating loss percentage was 7.5% for the three months ended March 31, 2024, compared to an operating loss percentage of 54.9% for the three months ended March 31, 2023.
• Income tax expense was $0.7 million for the three months ended March 31, 2024 compared to income tax expense of $0.7 million for the three months ended March 31, 2023.

Our strategic business objectives for 2024 include the following:

• deliver new standard products, as well as custom variants, currently on our project development backlog, specifically in the climate control channel;
• broaden our home control and home automation product offerings with the aim of acquiring new customers that represent market share leaders in their respective channels and regions;
• expand our software and service platform, QuickSet, to deliver new features that enhance the personalization and engagement of users on smart entertainment and smart home platforms;
• execute go-to-market strategies that help position our sustainable technology in our major verticals;
• seek acquisitions or strategic partners that complement and strengthen our existing business; and
• expedite our long-term factory planning strategy to optimize our manufacturing footprint.

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.

Macroeconomic Conditions

We have been negatively impacted and we expect to continue to be negatively impacted by adverse macroeconomic conditions, in particular reduced consumer spending. We have also been adversely impacted due to inflationary pressures, including increased component and logistics costs and increases in wages and costs of borrowing funds. To help offset these increased costs, we have been able to increase sales prices on certain products, however such increases may not fully offset the impact of these cost increases which would negatively impact our gross margins and overall financial results. In addition, we expect recessionary pressures in the global economy to continue which will ultimately negatively impact our sales demand. Management will continue to seek ways to lessen the impact these pressures may have on our margins and overall financial results by continuing to seek price increases where appropriate, executing on our plan to reduce our manufacturing overhead and to locate alternative and less expensive sources of component parts and materials.

Manufacturing Footprint

We have been evaluating our global manufacturing footprint based upon our long-term factory planning strategy to reduce our manufacturing capacity due to decreased demand and a change in mix of our products. As part of this evaluation, we are working to downsize and streamline the Mexico operations by moving to a smaller, more efficient facility. We expect to commence operations in this downsized facility in the second quarter of 2024. We continue to evaluate our global factory footprint to identify ways to operate more efficiently and decisions may result in charges that could have a material effect on the consolidated the financial statements.

Critical Accounting Policies and Estimates

The preparation of financial statements in conformity with U.S. GAAP 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. On an ongoing basis, we evaluate our estimates and judgments, including those related to revenue recognition, inventory valuation, impairment of long-lived assets, intangible assets and goodwill and income taxes. 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 statements.

An accounting estimate 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 three months ended March 31, 2024 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 2023 Form 10-K.

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 reported results of operations expressed as a percentage of net sales for the periods indicated.

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Three Months Ended March 31, 2024 versus Three Months Ended March 31, 2023

Net sales. Net sales for the three months ended March 31, 2024 were $91.9 million compared to $108.4 million for the three months ended March 31, 2023. We have experienced lower customer demand in both our home entertainment and climate channels. Our home entertainment channel continues to be adversely affected by cord cutting while our climate control channel is experiencing a decrease in demand in Europe which we believe is a result of recent reductions in governmental subsidies for heat pump technology.

Gross profit. Gross profit for the three months ended March 31, 2024 was $26.0 million compared to $24.7 million for the three months ended March 31, 2023. Gross profit as a percentage of sales increased to 28.3% for the three months ended March 31, 2024 from 22.8% for the three months ended March 31, 2023. The execution of our factory footprint optimization plan has resulted in a significant reduction of excess manufacturing capacity, yielding a gross margin rate improvement of approximately 460 basis points. In addition, a stronger U.S. dollar resulted in a 90 basis point improvement in our gross margin rate.

Research and development ("R&D") expenses. R&D expenses decreased to $7.8 million for the three months ended March 31, 2024 from $8.4 million for the three months ended March 31, 2023 due primarily to reduced incentive compensation costs.

Factory restructuring charges. During the three months ended March 31, 2024, we recorded $1.1 million in expense, including severance and moving costs associated with the closure of our southern China factory and the streamlining of our factory in Mexico.

Selling, general and administrative ("SG&A") expenses. SG&A expenses decreased to $24.0 million for the three months ended March 31, 2024 compared to $26.8 million for the three months ended March 31, 2023, due to a decrease in outside legal expenses related to a specific legal matter and variable expenses associated with lower sales volume.

Goodwill impairment. During the three months ended March 31, 2023, we recorded a non-cash goodwill impairment charge of $49.1 million, due to our market capitalization being significantly less than the carrying value of our equity.

Interest income (expense), net. Interest expense, net decreased to $0.9 million for the three months ended March 31, 2024 from $1.0 million for the three months ended March 31, 2023, as a result of a lower average loan balance, partially offset by a higher interest rate.

Other income (expense), net. Other expense, net was $0.1 million for the three months ended March 31, 2024, compared to other expense, net of $0.2 million for the three months ended March 31, 2023. The improvement was due to a reduction in net foreign currency losses.

Provision for income taxes. Income tax expense was $0.7 million for the three months ended March 31, 2024, relative to a pre-tax loss of $7.9 million, compared to income tax expense of $0.7 million for the three months ended March 31, 2023, relative to a pre-tax loss of $60.7 million. Consistent with 2023, we expect the U.S. to be in a pre-tax loss position without benefit for the full year 2024 resulting in an elevated effective tax rate. In the first quarter of 2023, we received the high technology exemption approval at our Yangzhou entity in China resulting in a lower tax rate. As a result, the deferred tax assets at our Yangzhou entity were remeasured resulting in an expense. Further, in the first quarter 2023, we also received a discrete benefit related to our goodwill impairment.

Liquidity and Capital Resources

Sources of Cash

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. In addition, we have utilized our revolving line of credit to fund share repurchases and past acquisitions. We anticipate that we will continue to utilize both cash flows from operations and our revolving line of credit to support ongoing business operations, capital expenditures, expenses associated with our long-term factory planning strategy, future discretionary share repurchases and potential future acquisitions. We believe our current cash balances, anticipated cash flow to be generated from operations and available borrowing resources will be sufficient to cover expected cash outlays for at least the next twelve months and for the foreseeable future thereafter; however, because our cash is located in various jurisdictions throughout the world, we may at times need to increase borrowing 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)

Cash and cash equivalents – On March 31, 2024, we had $3.3 million, $6.9 million, $2.2 million, $2.6 million and $11.9 million of cash and cash equivalents in North America, the PRC, Asia (excluding the PRC), 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.

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, may be subject to federal and state income taxes and foreign withholding taxes. Additionally, repatriation of some foreign balances is restricted by local laws.

Available Borrowing Resources – Our Second Amended and Restated Credit Agreement ("Second Amended Credit Agreement") with U.S. Bank National Association ("U.S. Bank") provides for a revolving line of credit ("Credit Line") that expires on April 30, 2025. We expect to renew our credit agreement with U.S. Bank prior to its expiration. The Credit Line has a maximum availability up to $100.0 million, subject to meeting certain financial conditions, including an accounts receivable coverage ratio ("AR Ratio"). This AR Ratio is calculated monthly and adjusts the current Credit Line total availability. At March 31, 2024, the Credit Line total availability was $52.2 million based upon the AR Ratio. At April 3, 2024, the Credit Line total availability was $61.3 million based upon the AR Ratio.

The Credit Line 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 none at March 31, 2024. At March 31, 2024, we had an outstanding balance of $46.0 million on our Credit Line and $6.2 million of availability.

See Note 8 contained in the "Notes to Consolidated Financial Statements" for further information regarding our Credit Line.

Sources and Uses of Cash

Our cash flows were as follows:

(In thousands)

Net cash used for operating activities was $2.8 million during the three months ended March 31, 2024 compared to $2.0 million during the three months ended March 31, 2023. Net loss was $8.6 million for the three months ended March 31, 2024 compared to net loss of $61.4 million for the three months ended March 31, 2023, which includes the impairment of goodwill of $49.1 million. Inventories decreased by $4.1 million during the three months ended March 31, 2024 compared to a decrease of $18.1 million during the three months ended March 31, 2023. This significant decrease in inventories is primarily the result of cord cutting, as there is less demand for our video service products. In addition, lead times for components and raw materials have normalized, enabling more efficient production planning. Our inventory turns increased to 3.1 turns at March 31, 2024 from 2.7 turns at March 31, 2023. Changes in accounts receivable and contract assets resulted in cash inflows of $11.0 million during the three months ended March 31, 2024, largely as a result of a decrease in sales. Changes in accounts receivable and contract assets resulted in cash inflows of $7.7 million during the three months ended March 31, 2023, largely as a result of a decrease in sales offset partially by an increase in days sales outstanding. Days sales outstanding were 93 days at March 31, 2024 compared to 83 days at March 31, 2023. Changes in accounts payable and accrued liabilities resulted in cash outflows of $12.5 million during the three months ended March 31, 2024 due to a decrease in inventory purchases and timing of payments throughout the quarter. Changes in accounts payable and accrued liabilities resulted in cash outflows of $26.1 million during the three months ended March 31, 2023 due primarily to a decrease in inventory purchases.

Net cash used for investing activities during the three months ended March 31, 2024 was $2.4 million, of which $1.4 million and $1.0 million was used for capital expenditures and the development of patents, respectively. Net cash used for investing activities during the three months ended March 31, 2023 was $4.8 million, of which $3.2 million and $1.6 million was used for capital expenditures and the development of patents, respectively.

Future cash flows used for investing activities are largely dependent on the timing and amount of capital expenditures. We estimate that we will incur between $7.0 million and $9.0 million during the remainder of 2024.

Net cash used for financing activities was $10.2 million during the three months ended March 31, 2024 compared to $3.8 million during the three months ended March 31, 2023. The primary financing activities during the three months ended March 31, 2024 and 2023 were borrowings and repayments on our Credit Line and repurchases of shares of our common stock. Net repayments on our Credit Line were $9.0 million during the three months ended March 31, 2024 compared to net repayments on our Credit Line of $3.0 million during the three months ended March 31, 2023. During the three months ended March 31, 2024, we repurchased 140,136 shares of our common stock at a cost of $1.2 million compared to our repurchase of 53,186 shares at a cost of $0.8 million during the three months ended March 31, 2023.

Future cash flows used for financing activities are affected by our financing needs, which are largely dependent on the level of cash provided by or used in operations and the level of cash used in investing activities. Additionally, potential future repurchases of shares of our common stock will impact our cash flows used for financing activities. See Note 13 contained in the "Notes to Consolidated Financial Statements" for further information regarding our share repurchase programs.

Material Cash Commitments – The following table summarizes our material cash commitments and the effect these commitments are expected to have on our cash flows in future periods:

(In thousands)

We anticipate meeting our material cash commitments with our cash generated from operations and available borrowing resources, including our Credit Line.

We are exposed to various market risks, including interest rate and foreign currency exchange rate fluctuations. We have established policies, procedures and internal processes governing our management of these risks and the use of financial instruments to mitigate our risk exposure.

Interest Rate Risk

We are exposed to interest rate risk related to our debt. From time to time, we borrow amounts on our Credit Line for working capital and other liquidity needs. Under the Second Amended Credit Agreement, we may elect to pay interest on outstanding borrowings on our Credit Line based on the Secured Overnight Financing Rate ("SOFR") or a base rate (based on the prime rate of U.S. Bank) plus an applicable margin as defined in the Second Amended Credit Agreement. Accordingly, changes in interest rates would impact our results of operations in future periods. A 100 basis point increase in interest rates would have an approximately $0.3 million annual impact on net income based on our outstanding Credit Line balance at March 31, 2024.

We cannot make any assurances that we will not need to borrow additional amounts in the future or that funds from the existing Credit Line will continue to be available to us or that other funds will be extended to us under comparable terms or at all. If funding is not available to us at a time when we need to borrow, we would have to use our cash reserves, including potentially repatriating cash from foreign jurisdictions, which may have a material adverse effect on our operating results, financial position and cash flows.

Foreign Currency Exchange Rate Risk

At March 31, 2024, we had wholly-owned subsidiaries in Brazil, the British Virgin Islands, France, Germany, Hong Kong, India, Italy, Japan, Korea, Mexico, the Netherlands, the PRC, Singapore, Spain, United Kingdom and Vietnam. We are exposed to foreign currency exchange rate risk inherent in our sales commitments, anticipated sales, anticipated purchases, operating expenses, assets and liabilities denominated in currencies other than the U.S. Dollar. The most significant foreign currencies to our operations are the Chinese Yuan Renminbi, Euro, British Pound, Mexican Peso, Vietnamese Dong, Indian Rupee, Hong Kong Dollar, Brazilian Real, Japanese Yen and Korean Won. Our most significant foreign currency exposure is to the Chinese Yuan Renminbi as this is the functional currency of our China-based factories where the majority of our products originate. If the Chinese Yuan Renminbi were to strengthen against the U.S. Dollar, our manufacturing costs would increase. We are generally a net payor of the Chinese Yuan Renminbi, Mexican Peso, Vietnamese Dong, Indian Rupee, Hong Kong Dollar, Japanese Yen and Korean Won and therefore benefit from a stronger U.S. Dollar and are adversely affected by a weaker U.S. Dollar relative to the foreign currency. For the Euro, British Pound and Brazilian Real, we are generally a net receiver of the foreign currency and therefore benefit from a weaker U.S. Dollar and are adversely affected by a stronger U.S. Dollar relative to the foreign currency. Even where we are a net receiver, a weaker U.S. Dollar may adversely affect certain expense figures taken alone.

From time to time, we enter into foreign currency exchange agreements to manage the foreign currency exchange rate risks inherent in our forecasted income and cash flows denominated in foreign currencies. The terms of these foreign currency exchange agreements normally last less than nine months. We recognize the gains and losses on these foreign currency contracts in the same period as the remeasurement losses and gains of the related foreign currency-denominated exposures.

It is difficult to estimate the impact of fluctuations on reported income, as it depends on the opening and closing rates, the average net balance sheet positions held in a foreign currency and the amount of income generated in local currency. We routinely forecast what these balance sheet positions and income generated in local currency may be and we take steps to minimize exposure as we deem appropriate. Alternatively, we may choose not to hedge the foreign currency risk associated with our foreign currency exposures, primarily if such exposure acts as a natural foreign currency hedge for other offsetting amounts denominated in the same currency or the currency is difficult or too expensive to hedge. We do not enter into any derivative transactions for speculative purposes.

The sensitivity of earnings and cash flows to variability in exchange rates is assessed by applying an approximate range of potential rate fluctuations to our assets, obligations and projected results of operations denominated in foreign currency with all other variables held constant. The analysis includes all of our foreign currency contracts offset by the underlying exposures. Based on our overall foreign currency rate exposure at March 31, 2024, we believe that movements in foreign currency rates may have a material effect on our financial position and results of operations. We estimate that if the exchange rates for the Chinese Yuan Renminbi, Euro, British Pound, Mexican Peso, Indian Rupee, Hong Kong Dollar, Brazilian Real, Japanese Yen, Korean Won and Vietnamese Dong relative to the U.S. Dollar fluctuate 10% from March 31, 2024, net income in the second quarter of 2024 would fluctuate by approximately $4.9 million.

Evaluation of Disclosure Controls and Procedures

Rule 13a-15(d) promulgated under the Securities Exchange Act of 1934 (the "Exchange Act") defines "disclosure controls and procedures" to mean controls and procedures of a company that are designed to ensure that information required to be disclosed by the company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC's rules and forms. The definition further states that disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that the information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company's management, including its principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.

An evaluation was performed under the supervision and with the participation of our management, including our principal executive and principal financial officers, of the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the period covered by this report. Based on that evaluation, our principal executive and principal financial officers have concluded that our disclosure controls and procedures were effective, as of the end of the period covered by this Quarterly Report on Form 10-Q, to provide reasonable assurance that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms and is accumulated and communicated to our management to allow timely decisions regarding required disclosures.

Changes in Internal Control Over Financial Reporting

There have been no other changes in our internal control over financial reporting during the most recent fiscal quarter covered by this Quarterly Report on Form 10-Q that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

The reader should carefully consider, in connection with the other information in this report, the risk factors discussed in "Part I, Item 1A: Risk Factors" of the Company's 2023 Form 10-K and in the periodic reports we have filed since then. These factors may cause our actual results to differ materially from those stated in forward-looking statements contained in this document and elsewhere.