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EX-32 - EXHIBIT 32 - UNIVERSAL ELECTRONICS INCuei-09302018x10qxex32.htm
EX-31.2 - EXHIBIT 31.2 - UNIVERSAL ELECTRONICS INCuei-09302018x10qxex312.htm
EX-31.1 - EXHIBIT 31.1 - UNIVERSAL ELECTRONICS INCuei-09302018x10qxex311.htm
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
_______________________________________ 
FORM 10-Q
_______________________________________ 
(Mark One)
ý
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2018
OR
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from            to            
Commission File Number: 0-21044
_______________________________________ 
UNIVERSAL ELECTRONICS INC.
(Exact Name of Registrant as Specified in its Charter)
 
Delaware
 
33-0204817
(State or Other Jurisdiction of
Incorporation or Organization)
 
(I.R.S. Employer
Identification No.)
 
 
201 E. Sandpointe Avenue, 8th Floor
Santa Ana, California
 
92707
(Address of Principal Executive Offices)
 
(Zip Code)
Registrant's telephone number, including area code: (714) 918-9500
__________________________________ 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  ý    No  ¨
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).    Yes  ý    No  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of "large accelerated filer," "accelerated filer," "smaller reporting company," and "emerging growth company" in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer
¨
Accelerated filer
ý
 
 
 
 
Non-accelerated filer
¨  
Smaller reporting company
¨
 
 
 
 
 
 
Emerging growth company
¨
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨ 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).    Yes  ¨    No  ý
Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date: 13,805,506 shares of Common Stock, par value $0.01 per share, of the registrant were outstanding on November 6, 2018.



UNIVERSAL ELECTRONICS INC.
 
INDEX
 





PART I. FINANCIAL INFORMATION
ITEM 1. Consolidated Financial Statements (Unaudited)
UNIVERSAL ELECTRONICS INC.
CONSOLIDATED BALANCE SHEETS
(In thousands, except share-related data)
(Unaudited)
 
September 30, 2018
 
December 31, 2017
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
41,995

 
$
62,438

Restricted cash

 
4,901

Accounts receivable, net
151,885

 
151,578

Contract assets
26,257

 

Inventories, net
135,888

 
162,589

Prepaid expenses and other current assets
15,429

 
11,687

Assets held for sale

 
12,517

Income tax receivable
2,695

 
1,587

Total current assets
374,149

 
407,297

Property, plant and equipment, net
101,025

 
110,962

Goodwill
48,509

 
48,651

Intangible assets, net
25,580

 
29,041

Deferred income taxes
7,371

 
7,913

Other assets
4,335

 
4,566

Total assets
$
560,969

 
$
608,430

LIABILITIES AND STOCKHOLDERS' EQUITY
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
108,343

 
$
119,165

Line of credit
103,500

 
138,000

Accrued compensation
32,220

 
34,499

Accrued sales discounts, rebates and royalties
7,944

 
8,882

Accrued income taxes
1,441

 
3,670

Other accrued liabilities
19,899

 
28,719

Total current liabilities
273,347

 
332,935

Long-term liabilities:
 
 
 
Long-term contingent consideration
10,170

 
13,400

Deferred income taxes
1,189

 
4,423

Income tax payable
2,520

 
2,520

Other long-term liabilities
1,534

 
1,603

Total liabilities
288,760

 
354,881

Commitments and contingencies

 

Stockholders' equity:
 
 
 
Preferred stock, $0.01 par value, 5,000,000 shares authorized; none issued or outstanding

 

Common stock, $0.01 par value, 50,000,000 shares authorized; 23,891,790 and 23,760,434 shares issued on September 30, 2018 and December 31, 2017, respectively
239

 
238

Paid-in capital
274,493

 
265,195

Treasury stock, at cost, 10,076,385 and 9,702,874 shares on September 30, 2018 and December 31, 2017, respectively
(274,629
)
 
(262,065
)
Accumulated other comprehensive income (loss)
(21,789
)
 
(16,599
)
Retained earnings
293,895

 
266,780

Total stockholders' equity
272,209

 
253,549

Total liabilities and stockholders' equity
$
560,969


$
608,430

See Note 4 for further information concerning our purchases from related party vendors.
The accompanying notes are an integral part of these consolidated financial statements.

3


UNIVERSAL ELECTRONICS INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
(Unaudited) 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2018
 
2017
 
2018
 
2017
Net sales
$
182,717

 
$
175,652

 
$
509,938

 
$
514,638

Cost of sales
142,401

 
132,582

 
405,661

 
386,783

Gross profit
40,316

 
43,070

 
104,277

 
127,855

Research and development expenses
5,593

 
5,415

 
17,703

 
15,859

Factory transition restructuring charges

 
446

 

 
6,145

Selling, general and administrative expenses
29,994

 
32,997

 
90,811

 
94,701

Operating income (loss)
4,729

 
4,212

 
(4,237
)
 
11,150

Interest income (expense), net
(1,177
)
 
(721
)
 
(3,526
)
 
(1,676
)
Gain on sale of Guangzhou factory

 

 
36,978

 

Other income (expense), net
(2,282
)
 
61

 
(3,951
)
 
2

Income before provision for income taxes
1,270

 
3,552

 
25,264

 
9,476

Provision for income taxes
311

 
1,824

 
2,233

 
2,945

Net income
$
959

 
$
1,728

 
$
23,031

 
$
6,531

 
 
 
 
 
 
 
 
Earnings per share:
 
 
 
 
 
 
 
Basic
$
0.07

 
$
0.12

 
$
1.65

 
$
0.45

Diluted
$
0.07

 
$
0.12

 
$
1.63

 
$
0.44

Shares used in computing earnings per share:
 
 
 
 
 
 
 
Basic
13,836

 
14,381

 
13,997

 
14,412

Diluted
13,959

 
14,666

 
14,116

 
14,689

See Note 4 for further information concerning our purchases from related party vendors.
The accompanying notes are an integral part of these consolidated financial statements.


4


UNIVERSAL ELECTRONICS INC.
CONSOLIDATED COMPREHENSIVE INCOME (LOSS) STATEMENTS
(In thousands)
(Unaudited) 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2018
 
2017
 
2018
 
2017
Net income
$
959

 
$
1,728

 
$
23,031

 
$
6,531

Other comprehensive income (loss):
 
 
 
 
 
 
 
Change in foreign currency translation adjustment
(3,778
)
 
2,999

 
(5,190
)
 
4,990

Comprehensive income (loss)
$
(2,819
)

$
4,727

 
$
17,841

 
$
11,521

See Note 4 for further information concerning our purchases from related party vendors.
The accompanying notes are an integral part of these consolidated financial statements.


5


UNIVERSAL ELECTRONICS INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited) 
 
Nine Months Ended September 30,
 
2018
 
2017
Cash provided by (used for) operating activities:
 
 
 
Net income
$
23,031

 
$
6,531

Adjustments to reconcile net income to net cash provided by (used for) operating activities:
 
 
 
Depreciation and amortization
25,264

 
23,202

Provision for doubtful accounts
2

 
167

Provision for inventory write-downs
6,450

 
2,189

Gain on sale of Guangzhou factory
(36,978
)
 

Deferred income taxes
(1,370
)
 
(953
)
Shares issued for employee benefit plan
879

 
591

Employee and director stock-based compensation
6,808

 
9,476

Performance-based common stock warrants
747

 
1,122

Impairment of China factory equipment
2,886

 

Changes in operating assets and liabilities:
 
 
 
Accounts receivable and contract assets
(1,289
)
 
(24,440
)
Inventories
(9,535
)
 
(21,217
)
Prepaid expenses and other assets
(4,193
)
 
(2,422
)
Accounts payable and accrued liabilities
(13,142
)
 
1,488

Accrued income taxes
(4,134
)
 
(1,517
)
Net cash provided by (used for) operating activities
(4,574
)
 
(5,783
)
Cash provided by (used for) investing activities:
 
 
 
Proceeds from sale of Guangzhou factory
51,291

 

Acquisitions of property, plant and equipment
(16,838
)
 
(29,922
)
Refund of deposit received toward sale of Guangzhou factory
(5,053
)
 

Acquisitions of intangible assets
(1,911
)
 
(1,275
)
Acquisition of net assets of Residential Control Systems, Inc.

 
(8,894
)
Net cash provided by (used for) investing activities
27,489


(40,091
)
Cash provided by (used for) financing activities:
 
 
 
Borrowings under line of credit
48,000

 
115,000

Repayments on line of credit
(82,500
)
 
(50,987
)
Proceeds from stock options exercised
864

 
1,107

Treasury stock purchased
(12,564
)
 
(20,217
)
Contingent consideration payments in connection with business combinations
(3,858
)
 

Net cash provided by (used for) financing activities
(50,058
)
 
44,903

Effect of exchange rate changes on cash, cash equivalents and restricted cash
1,799

 
(5,504
)
Net increase (decrease) in cash, cash equivalents and restricted cash
(25,344
)
 
(6,475
)
Cash, cash equivalents and restricted cash at beginning of year
67,339

 
59,834

Cash, cash equivalents and restricted cash at end of period
$
41,995

 
$
53,359

 
 
 
 
Supplemental cash flow information:
 
 
 
Income taxes paid
$
5,453

 
$
5,770

Interest paid
$
3,722

 
$
1,697

See Note 4 for further information concerning our purchases from related party vendors.
The accompanying notes are an integral part of these consolidated financial statements.

6


UNIVERSAL ELECTRONICS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2018
(Unaudited)
Note 1 — Basis of Presentation and Significant Accounting Policies
In the opinion of management, the accompanying consolidated financial statements of Universal Electronics Inc. and its subsidiaries contain all the adjustments necessary for a fair presentation of financial position, results of operations and cash flows for the periods presented. All such adjustments are of a normal recurring nature and certain reclassifications have been made to prior year amounts in order to conform to the current year presentation. Information and footnote disclosures normally included in financial statements, which are prepared in accordance with accounting principles generally accepted in the United States of America ("U.S. GAAP"), have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission. As used herein, the terms "Company," "we," "us," and "our" refer to Universal Electronics Inc. and its subsidiaries, unless the context indicates to the contrary.
Our results of operations for the three and nine months ended September 30, 2018 are not necessarily indicative of the results to be expected for the full year. These financial statements should be read in conjunction with the "Risk Factors," "Management's Discussion and Analysis of Financial Condition and Results of Operations," "Quantitative and Qualitative Disclosures About Market Risk," and the "Financial Statements and Supplementary Data" included in Items 1A, 7, 7A, and 8, respectively, of our Annual Report on Form 10-K for the year ended December 31, 2017.
Estimates, Judgments and Assumptions
The preparation of financial statements in conformity with U.S. GAAP requires us to make estimates, judgments and assumptions 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 on-going basis, we evaluate our estimates and assumptions, including those related to revenue recognition, allowances for sales returns and doubtful accounts, inventory valuation, our review for impairment of long-lived assets, intangible assets and goodwill, business combinations, income taxes, stock-based compensation expense and performance-based common stock warrants. Actual results may differ from these estimates and assumptions, and they may be adjusted as more information becomes available. Any adjustment may be material.
Summary of Significant Accounting Policies

We adopted Accounting Standards Update ("ASU") 2014-09, "Revenue from Contracts with Customers," and all related amendments as of January 1, 2018. The impact of this new guidance on our accounting policies and consolidated financial statements is also described below. There have been no other significant changes in our accounting policies during the three and nine months ended September 30, 2018 compared to the significant accounting policies described in our Annual Report on Form 10-K for the year ended December 31, 2017.

Revenue Recognition
Our performance obligations primarily arise from manufacturing and delivering universal control, sensing and automation products and AV accessories, which are sold through multiple channels, and intellectual property that is embedded in these products or licensed to others. These performance obligations are satisfied at a point in time or over time, as described below. Payment terms are typically on open credit terms consistent with industry practice and do not have significant financing components. Some contracts contain early payment discounts, which are recognized as a reduction to revenue if the customer typically meets the early payment conditions. Consideration may be variable based on indeterminate volumes.
Effective January 1, 2018, revenue is recognized over time when the customer simultaneously receives and consumes the benefits provided by our performance, our performance creates or enhances an asset that the customer controls, or when our performance creates an asset with no alternative use to us (custom products) and we have an enforceable right to payment for performance completed to date, such as a firm order or other contractual commitment from the customer. An asset does not have an alternative use if we are unable to redirect the asset to another customer in the foreseeable future without significant rework. The method for measuring progress towards satisfying a performance obligation for a custom product is based on the costs incurred to date (cost-to-cost method). We believe that the costs associated with production are most closely aligned with the revenue associated with those products.
We recognize revenue at a point in time if the criteria for recognizing revenue over time are not met, the title of the goods has transferred, and we have a present right to payment.

7

UNIVERSAL ELECTRONICS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2018
(Unaudited)


We typically recognize revenue for the sale of tooling at a point in time, which is generally upon completion of the tooling and, if applicable, acceptance by the customer.
A provision is recorded for estimated sales returns and allowances and is deducted from gross sales to arrive at net sales in the period the related revenue is recorded. These estimates are based on historical sales returns and allowances, analysis of credit memo data and other known factors. Actual returns and claims in any future period are inherently uncertain and thus may differ from our estimates. If actual or expected future returns and claims are significantly greater or lower than the reserves that we have established, we will record a reduction or increase to net revenue in the period in which we make such a determination.
We accrue for discounts and rebates based on historical experience and our expectations regarding future sales to our customers. Accruals for discounts and rebates are recorded as a reduction to sales in the same period as the related revenue. Changes in such accruals may be required if future rebates and incentives differ from our estimates.
We license our intellectual property including our patented technologies, trademarks, and database of control codes. When license fees are paid on a per-unit basis, we record license revenue when our customers manufacture or ship a product incorporating our intellectual property and we have a present right to payment. When a fixed up-front license fee is received in exchange for the delivery of a particular database of infrared codes or the contract contains a minimum guarantee provision, we record revenue when delivery of the intellectual property has occurred. Tiered royalties are recorded on a straight-line basis according to the forecasted per-unit fees taking into account the pricing tiers.
Contract assets represent revenue which has been recognized based on our accounting policies but for which the customer has not yet been invoiced and thus an account receivable has not yet been recorded.
Under prior accounting standards, we recognized revenue on the sale of products when title of the goods had transferred, there was persuasive evidence of an arrangement (such as a purchase order from the customer), the sales price was fixed or determinable and collectability was reasonably assured. Revenue for term license fees were recognized on a straight-line basis over the effective term of the license when we could not reliably predict in which periods, within the term of the license, the licensee would benefit from the use of our patented inventions.
Recently Adopted Accounting Pronouncements

On January 1, 2018, we adopted ASU 2014-09 using the modified retrospective transition method. Under this method, we evaluated all contracts that were in effect at the beginning of 2018 as if those contracts had been accounted for under the new revenue standard based on the terms in effect as of the adoption date. Under the modified retrospective transition approach, periods prior to the adoption date were not adjusted and continue to be reported in accordance with historical U.S. GAAP. A cumulative catch-up adjustment was recorded to beginning retained earnings to reflect the impact of all existing arrangements under the new revenue standard.

The cumulative effects of the changes made to our consolidated January 1, 2018 balance sheet for the adoption of ASU 2014-09, were as follows:

 
As reported
 
Adjustments due to
 ASU 2014-09
 
Balance at
Consolidated Balance Sheet (In thousands)
12/31/2017
 
 
1/1/2018
Contract assets
$

 
$
29,759

 
$
29,759

Inventories, net
162,589

 
(23,830
)
 
138,759

Prepaid expenses and other current assets
11,687

 
(174
)
 
11,513

Deferred income tax assets
7,913

 
(102
)
 
7,811

Accounts payable and other current liabilities
332,935

 
1,528

 
334,463

Deferred income tax liabilities
4,423

 
20

 
4,443

Retained earnings
266,780

 
4,084

 
270,864




8

UNIVERSAL ELECTRONICS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2018
(Unaudited)




The following tables compare the reported consolidated balance sheet and statements of operations as of and for the three and nine months ended September 30, 2018, to pro forma amounts had the previous guidance been in effect. The guidance did not have a significant impact on the Company's consolidated statement of cash flows.

 
As of September 30, 2018
Consolidated Balance Sheet (In thousands)
As reported
 
Without Adoption of ASU 2014-09
 
Effect of Change
Assets
 
 
 
 
 
Contract assets
$
26,257

 
$

 
$
26,257

Inventories, net
135,888

 
156,553

 
(20,665
)
Prepaid expenses and other current assets
15,429

 
15,419

 
10

Deferred income taxes
7,371

 
7,379

 
(8
)
 
 
 
 
 


Liabilities and Equity
 
 
 
 


Accounts payable and other current liabilities
$
273,347

 
$
271,734

 
$
1,613

Retained earnings
293,895

 
289,914

 
3,981

 
Three Months Ended September 30, 2018
Consolidated Statements of Operations (In thousands)
As reported
 
Without Adoption of ASU 2014-09
 
Effect of Change
Net sales
$
182,717

 
$
184,559

 
$
(1,842
)
Cost of sales
142,401

 
144,426

 
(2,025
)
Selling, general and administrative expenses
29,994

 
30,029

 
(35
)
Provision for income taxes
311

 
355

 
(44
)
Net income
959

 
697

 
262

 
 
 
 
 
 
Earnings per share:
 
 
 
 
 
Basic
$
0.07

 
$
0.05

 
$
0.02

Diluted
$
0.07

 
$
0.05

 
$
0.02

 
Nine months ended September 30, 2018
Consolidated Statements of Operations (In thousands)
As reported
 
Without Adoption of ASU 2014-09
 
Effect of Change
Net sales
$
509,938

 
$
512,880

 
$
(2,942
)
Cost of sales
405,661

 
408,427

 
(2,766
)
Selling, general and administrative expenses
90,811

 
90,866

 
(55
)
Provision for income taxes
2,233

 
2,250

 
(17
)
Net income
23,031

 
23,134

 
(103
)
 
 
 
 
 
 
Earnings per share:
 
 
 
 
 
Basic
$
1.65

 
$
1.66

 
$
(0.01
)
Diluted
$
1.63

 
$
1.64

 
$
(0.01
)




9

UNIVERSAL ELECTRONICS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2018
(Unaudited)


Other Accounting Pronouncements
In August 2016, the Financial Accounting Standards Board ("FASB") issued ASU 2016-15, "Classification of Certain Cash Receipts and Cash Payments," which amends Accounting Standards Codification ("ASC") 230, "Statement of Cash Flows". This new guidance addresses eight specific cash flow issues with the objective of reducing the existing diversity in practice in how certain transactions are classified in the statement of cash flows. ASU 2016-15 is effective for fiscal periods beginning after December 15, 2017 and must be adopted retrospectively. The adoption of ASU 2016-15 did not have a material impact to the presentation of our consolidated statement of cash flows.
In October 2016, the FASB issued ASU 2016-16, "Intra-Entity Transfers of Assets Other Than Inventory," which changes the accounting for income tax consequences of intra-entity transfers of assets other than inventory. Current guidance prohibits the recognition of current and deferred income taxes for an intra-entity asset transfer until the asset has been sold to an outside party. Under this new guidance, the income tax consequences of an intra-entity transfer of an asset other than inventory will be recognized when the transfer occurs. ASU 2016-16 is effective for fiscal periods beginning after December 15, 2017. The adoption of ASU 2016-16 did not have a material impact on our consolidated financial statements.
In November 2016, the FASB issued ASU 2016-18,"Restricted Cash," which amends ASC 230, "Statement of Cash Flows." This new guidance addresses the classifications and presentation of changes in restricted cash in the statement of cash flows. ASU 2016-18 is effective for fiscal periods beginning after December 15, 2017 and must be adopted retrospectively. The adoption of ASU 2016-18 modified our current disclosures by reclassifying certain amounts within the consolidated statement of cash flows, but did not have a material effect on our consolidated financial statements.
Recent Accounting Updates Not Yet Effective

In February 2016, the FASB issued ASU 2016-02, "Leases," which changes the accounting for leases and requires expanded disclosures about leasing activities. This new guidance will require lessees to recognize a right of use asset and a lease liability at the commencement date for all leases with terms greater than twelve months. Accounting by lessors is largely unchanged. ASU 2016-02 is effective for fiscal periods beginning after December 15, 2018 and must be adopted using a modified retrospective approach. Early adoption is permitted. In July 2018, the FASB issued ASU 2018-11, which provides an additional transition method when adopting ASU 2016-02. Under the original guidance, the modified retrospective approach provided that ASU 2016-02 be applied at the beginning of the earliest period presented. ASU 2018-11 allows for the application of the new guidance as of the adoption date with a cumulative-effect adjustment to the opening balance of retained earnings. We plan to adopt ASU 2016-02 effective January 1, 2019 using the new transition guidance provided in ASU 2018-11 and are currently evaluating the impact that ASU 2016-02 will have on our consolidated financial statements.
In January 2017, the FASB issued ASU 2017-04, "Simplifying the Test for Goodwill Impairment." This guidance simplifies how an entity is required to test goodwill for impairment by eliminating Step 2 from the goodwill impairment test. Instead, if the carrying amount of a reporting unit exceeds its fair value, an impairment loss will be recognized in an amount equal to that excess, limited to the total amount of goodwill allocated to the reporting unit. ASU 2017-04 is effective for fiscal periods beginning after December 15, 2019. Early adoption is permitted. We do not expect the adoption of ASU 2017-04 will have a material impact on our consolidated financial statements.
In June 2018, the FASB issued ASU 2018-07, "Improvements to Non-employee Share-Based Payment Accounting." This guidance expands the scope of Topic 718, "Compensation - Stock Compensation" to include share-based payment transactions for acquiring goods and services from non-employees, but excludes awards granted in conjunction with selling goods or services to a customer as part of a contract accounted for under ASC 606, "Revenue from Contracts with Customers." We are currently evaluating the impact that ASU 2018-07 will have on our consolidated financial statements.
In August 2018, the FASB issued ASU 2018-15, "Customer’s Accounting for implementation Costs Incurred in a Cloud Computing Arrangement That is a Service Contract," which amends ASC 350-40, "Intangibles - Goodwill and Other - Internal-Use Software." The ASU aligns the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software and requires the capitalized implementation costs to be expensed over the term of the hosting arrangement. The accounting for the service element of a hosting arrangement that is a service contract is not affected. Effective for fiscal periods beginning after December 15, 2019, and interim periods within those fiscal years. We are currently evaluating the impact that ASU 2018-07 will have on our consolidated financial statements.

10

UNIVERSAL ELECTRONICS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2018
(Unaudited)



Note 2 — Cash and Cash Equivalents and Restricted Cash
Cash and Cash Equivalents
Cash and cash equivalents were held in the following geographic regions:
(In thousands)
September 30, 2018
 
December 31, 2017
United States
$
3,694

 
$
10,489

People's Republic of China ("PRC")
20,024

 
23,283

Asia (excluding the PRC)
1,350

 
1,405

Europe
7,976

 
18,071

South America
8,951

 
9,190

Total cash and cash equivalents
$
41,995

 
$
62,438

Restricted Cash
In connection with the pending sale of our Guangzhou factory in the PRC (Note 10), a prospective buyer made a cash deposit of RMB 32 million ($5.1 million based on April 2018 exchange rates) into an escrow account on September 29, 2016. Under the terms of the escrow account, these funds were not to be paid to us until the close of the sale. Accordingly, this deposit was presented as restricted cash within our consolidated balance sheet. In April 2018, the sale transaction with this buyer was terminated and this deposit was returned to the buyer.

Note 3 — Accounts Receivable, Net and Revenue Concentrations
Accounts receivable, net were as follows:
(In thousands)
September 30, 2018
 
December 31, 2017
Trade receivables, gross
$
145,823

 
$
142,299

Allowance for doubtful accounts
(992
)
 
(1,064
)
Allowance for sales returns
(588
)
 
(562
)
Net trade receivables
144,243

 
140,673

Other
7,642

 
10,905

Accounts receivable, net
$
151,885

 
$
151,578

Allowance for Doubtful Accounts
Changes in the allowance for doubtful accounts were as follows:
(In thousands)
Nine Months Ended September 30,
2018
 
2017
Balance at beginning of period
$
1,064

 
$
904

Additions to costs and expenses
2

 
167

(Write-offs)/Foreign exchange effects
(74
)
 
(19
)
Balance at end of period
$
992

 
$
1,052



11

UNIVERSAL ELECTRONICS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2018
(Unaudited)


Significant Customers
Net sales to the following customers totaled more than 10% of our net sales:
 
Three Months Ended September 30,
 
2018
 
2017
 
$ (thousands)
 
% of Net Sales
 
$ (thousands)
 
% of Net Sales
Comcast Corporation
$
32,336

 
17.7
%
 
$
36,811

 
21.0
%
AT&T (1)
$

 
%
 
$
20,117

 
11.5
%
 
Nine Months Ended September 30,
 
2018
 
2017
 
$ (thousands)
 
% of Net Sales
 
$ (thousands)
 
% of Net Sales
Comcast Corporation
$
99,853

 
19.6
%
 
$
122,009

 
23.7
%
AT&T (1)
$

 
%
 
$
61,057

 
11.9
%
(1)  
Sales associated with this customer did not total more than 10% of our net sales for the indicated period.

Trade receivables associated with these significant customers that totaled more than 10% of our accounts receivable, net were as follows:
 
September 30, 2018
 
December 31, 2017
 
$ (thousands)
 
% of Accounts Receivable, Net
 
$ (thousands)
 
% of Accounts Receivable, Net
Comcast Corporation
$
20,084

 
13.2
%
 
$
25,142

 
16.6
%

Note 4 — Inventories, Net and Significant Suppliers
Inventories, net were as follows:
(In thousands)
September 30, 2018
 
December 31, 2017

Raw materials
$
62,835

 
$
43,638

Components
13,763

 
16,214

Work in process
8,378

 
1,847

Finished goods
58,195

 
105,178

Reserve for excess and obsolete inventory
(7,283
)
 
(4,288
)
Inventories, net
$
135,888

 
$
162,589

 

12

UNIVERSAL ELECTRONICS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2018
(Unaudited)


Reserve for Excess and Obsolete Inventory
Changes in the reserve for excess and obsolete inventory were as follows:
(In thousands)
Nine Months Ended September 30,
2018
 
2017
Balance at beginning of period
$
4,288

 
$
4,205

Additions charged to costs and expenses (1)
5,353

 
1,960

Sell through (2)
(1,240
)
 
(950
)
(Write-offs)/Foreign exchange effects
(1,118
)
 
(2,090
)
Balance at end of period
$
7,283

 
$
3,125


(1)
The additions charged to costs and expenses do not include inventory directly written-off that was scrapped during production totaling $1.1 million and $0.2 million for the nine months ended September 30, 2018 and 2017, respectively. These amounts are production waste and are not included in management's reserve for excess and obsolete inventory.
(2)
These amounts represent the reduction in reserves associated with inventory items that were sold during the period.
Significant Suppliers
We purchase integrated circuits, components and finished goods from multiple sources. Purchases from the following supplier totaled more than 10% of our total inventory purchases:
 
Three Months Ended September 30,
 
2018
 
2017
 
$ (thousands)
 
% of Total
Inventory Purchases
 
$ (thousands)
 
% of Total
Inventory Purchases
Texas Instruments (1)
$

 
%
 
$
13,115

 
12.4
%

 
Nine Months Ended September 30,
 
2018
 
2017
 
$ (thousands)
 
% of Total
Inventory Purchases
 
$ (thousands)
 
% of Total
Inventory Purchases
Texas Instruments (1)
$

 
%
 
$
33,693

 
11.3
%
(1)  
Purchases associated with this supplier did not total more than 10% of our total inventory purchases for the indicated period.

Related Party Supplier
During the three and nine months ended September 30, 2018 and 2017, we purchased certain printed circuit board assemblies from a related party supplier. The supplier was considered a related party for financial reporting purposes because our Senior Vice President of Strategic Operations owned 40% of this supplier. In the second quarter of 2018, our Senior Vice President sold his interest in this supplier, and thus this supplier is no longer considered a related party.
Total inventory purchases made from this supplier while it was a related party were $1.1 million during the nine months ended September 30, 2018 and $1.4 million and $4.0 million during the three and nine months ended September 30, 2017, respectively.


13

UNIVERSAL ELECTRONICS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2018
(Unaudited)


Note 5 — Goodwill and Intangible Assets, Net
Goodwill
Changes in the carrying amount of goodwill were as follows:
(In thousands)
 
Balance at December 31, 2017
$
48,651

Foreign exchange effects
(142
)
Balance at September 30, 2018
$
48,509

 
Intangible Assets, Net
The components of intangible assets, net were as follows:
 
September 30, 2018
 
December 31, 2017
(In thousands)
Gross (1)
 
Accumulated
Amortization (1)
 
Net
 
Gross (1)
 
Accumulated
Amortization (1)
 
Net
Distribution rights
$
333

 
$
(182
)
 
$
151

 
$
344

 
$
(165
)
 
$
179

Patents
14,194

 
(5,502
)
 
8,692

 
13,250

 
(5,310
)
 
7,940

Trademarks and trade names
2,786

 
(1,823
)
 
963

 
2,786

 
(1,594
)
 
1,192

Developed and core technology
12,560

 
(7,583
)
 
4,977

 
12,560

 
(6,071
)
 
6,489

Capitalized software development costs
249

 
(131
)
 
118

 
142

 
(77
)
 
65

Customer relationships
32,534

 
(21,855
)
 
10,679

 
32,534

 
(19,395
)
 
13,139

Order backlog

 

 

 
150

 
(113
)
 
37

Total intangible assets, net
$
62,656

 
$
(37,076
)
 
$
25,580


$
61,766

 
$
(32,725
)
 
$
29,041

 
(1) 
This table excludes the gross value of fully amortized intangible assets totaling $6.8 million and $6.0 million at September 30, 2018 and December 31, 2017, respectively.
Amortization expense is recorded in selling, general and administrative expenses, except amortization expense related to capitalized software development costs and order backlog, which are recorded in cost of sales. Amortization expense by income statement caption was as follows:
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
(In thousands)
2018
 
2017
 
2018
 
2017
Cost of sales
$
18

 
$
54

 
$
91

 
$
128

Selling, general and administrative expenses
1,770

 
1,715

 
5,275

 
5,032

Total amortization expense
$
1,788

 
$
1,769

 
$
5,366

 
$
5,160

 

14

UNIVERSAL ELECTRONICS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2018
(Unaudited)


Estimated future annual amortization expense related to our intangible assets at September 30, 2018, was as follows:
(In thousands)
 
2018 (remaining 3 months)
$
1,778

2019
7,018

2020
5,883

2021
2,325

2022
2,216

Thereafter
6,360

Total
$
25,580


Note 6 — Line of Credit

Our Second Amended and Restated Credit Agreement ("Second Amended Credit Agreement") with U.S. Bank National Association ("U.S. Bank") and Wells Fargo Bank, National Association provides for a $170.0 million revolving line of credit ("Credit Line") that expires on November 1, 2019. 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. There were no outstanding letters of credit at September 30, 2018.
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 PRC.
Under the Second 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 Second 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 Second Amended Credit Agreement. The interest rate in effect at September 30, 2018 was 3.97%. There are no commitment fees or unused line fees under the Second Amended Credit Agreement.
The Second Amended Credit Agreement includes financial covenants requiring a minimum fixed charge coverage ratio and a maximum cash flow leverage ratio. In addition, the Second Amended Credit Agreement contains other customary affirmative and negative covenants and events of default. As of September 30, 2018, we were in compliance with the covenants and conditions of the Second Amended Credit Agreement.
At September 30, 2018, we had $103.5 million outstanding under the Credit Line. Our total interest expense on borrowings was $1.2 million and $0.8 million during the three months ended September 30, 2018 and 2017, respectively. Our total interest expense on borrowings was $3.7 million and $1.8 million during the nine months ended September 30, 2018 and 2017, respectively.

Note 7 — Income Taxes
We utilize our estimated annual effective tax rate to determine our provision for income taxes for interim periods. The income tax provision is computed by taking the estimated annual effective rate and multiplying it by the year-to-date pre-tax book income.

We recorded income tax expense of $0.3 million and $1.8 million for the three months ended September 30, 2018 and 2017, respectively, and our effective tax rate was 24.5% and 51.4% for the three months ended September 30, 2018 and 2017, respectively. The decrease in our effective tax rate was primarily due to certain transactions in China during the three months ended September 30, 2017 being nondeductible as a result of the pending sale of our Guangzhou factory.
During the nine months ended September 30, 2018 and 2017, we recorded income tax expense of $2.2 million and $2.9 million, respectively, and our effective tax rate was 8.8% and 31.1% during the nine months ended September 30, 2018 and 2017, respectively. The decrease in our effective tax rate was primarily a result of the tax rate applicable to the gain recognized on the sale of our

15

UNIVERSAL ELECTRONICS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2018
(Unaudited)


Guangzhou factory being lower than our blended consolidated tax rate. Additionally, during the nine months ended September 30, 2017, certain transactions in China were nondeductible as a result of the pending sale of our Guangzhou factory.
The Tax Cuts and Jobs Act (the "Tax Act") was enacted on December 22, 2017. The Tax Act reduces the U.S. federal corporate income tax rate from 35% to 21%, requires companies to pay a one-time transition tax on earnings of certain foreign subsidiaries that were previously tax deferred and creates new taxes on certain foreign sourced earnings. We are applying the guidance in SAB 118 when accounting for the enactment-date effects of the Tax Act. At September 30, 2018, we have not completed our accounting for all of the tax effects of the Tax Act. Additionally, we have made a reasonable estimate of other effects. During the three and nine month periods ended September 30, 2018, we recognized no adjustments to the provisional amounts recorded at December 31, 2017. We are awaiting further guidance from the U.S. federal and state regulatory bodies with regards to the final accounting and reporting of these items in the jurisdictions where we file tax returns. In all cases, we will continue to make and refine our calculations as additional analysis is completed. Our estimates may also be affected as we gain a more thorough understanding of tax law. These changes could be material to income tax expense.
Additionally, we have provided provisional amounts for the legislative provisions that are effective as of January 1, 2018, including, but not limited to, the creation of the base erosion anti-abuse tax ("BEAT"), a new minimum tax, a new provision designed to tax global intangible low-taxed income ("Global Minimum Tax" or "GMT"), a new limitation on deductible interest expense, and limitations on the use of net operating losses. Our accounting for these elements of the Tax Act is incomplete; however, we were able to make reasonable estimates and therefore recorded provisional adjustments. Similar to the above elements, we are in the process of collecting and preparing necessary data, and interpreting guidance as issued by the U.S. Treasury Department, Internal Revenue Service, FASB, and other federal and state standard-setting regulatory bodies. However, we continue to gather additional information to complete our accounting for these items and expect to complete the accounting within the prescribed measurement period. Given the complexity of the GMT provisions, we are still evaluating the effects of the GMT provisions and have not yet determined our accounting policy. At September 30, 2018, we are still evaluating the GMT provisions and our analysis of future taxable income that is subject to GMT, we have included GMT related to current year operations only in our estimated annual effective tax rate and have not provided additional GMT on deferred items.
At September 30, 2018, we had gross unrecognized tax benefits of $4.6 million, including interest and penalties, of which approximately $4.3 million, if not for the state Research and Experimentation income tax credit valuation allowance, would affect the annual effective tax rate if these tax benefits are realized. Further, we are unaware of any positions for which it is reasonably possible that the total amount of unrecognized tax benefits will significantly change within the next twelve months. Based on federal, state and foreign statute expirations in various jurisdictions, we do not anticipate any decrease in unrecognized tax benefits within the next twelve months. We have classified uncertain tax positions as non-current income tax liabilities unless expected to be paid within one year.
We have elected to classify interest and penalties as a component of tax expense. Accrued interest and penalties of $0.6 million and $0.5 million at September 30, 2018 and December 31, 2017, respectively, are included in our unrecognized tax benefits.


16

UNIVERSAL ELECTRONICS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2018
(Unaudited)


Note 8 — Accrued Compensation
The components of accrued compensation were as follows:
(In thousands)
September 30, 2018
 
December 31, 2017
Accrued social insurance (1)
$
17,216

 
$
17,727

Accrued salary/wages
8,309

 
7,910

Accrued vacation/holiday
2,830

 
2,769

Accrued bonus (2)
1,724

 
2,329

Accrued commission
935

 
1,089

Other accrued compensation
1,206

 
2,675

Total accrued compensation
$
32,220

 
$
34,499

 
(1) 
PRC employers are required by law to remit the applicable social insurance payments to their local government. Social insurance is comprised of various components such as pension, medical insurance, job industry insurance, unemployment insurance, and a housing assistance fund, and is administered in a manner similar to social security in the United States. This amount represents our estimate of the amounts due to the PRC government for social insurance on September 30, 2018 and December 31, 2017.
(2) 
Accrued bonus includes an accrual for an extra month of salary ("13th month salary") to be paid to employees in certain geographies where it is the customary business practice. This 13th month salary is paid to these employees if they remain employed with us through December 31st. The total accrued for the 13th month salary was $0.1 million and $0.7 million at September 30, 2018 and December 31, 2017, respectively.

Note 9 — Other Accrued Liabilities
The components of other accrued liabilities were as follows:
(In thousands)
September 30, 2018
 
December 31, 2017
Deposit for sale of Guangzhou factory
$

 
$
4,901

Duties
1,039

 
1,184

Freight and handling fees
2,757

 
1,983

Professional fees
1,488

 
1,578

Property, plant and equipment
366

 
2,151

Sales taxes and VAT
998

 
2,955

Short-term contingent consideration
3,730

 
3,800

Tooling (1)
2,171

 
1,843

Other
7,350

 
8,324

Total other accrued liabilities
$
19,899

 
$
28,719

 
(1) 
The tooling accrual balance relates to unearned revenue for tooling that will be sold to customers.


17

UNIVERSAL ELECTRONICS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2018
(Unaudited)


Note 10 — Commitments and Contingencies
Product Warranties
Changes in the liability for product warranty claim costs were as follows:
(In thousands)
Nine Months Ended September 30,
2018
 
2017
Balance at beginning of period
$
339

 
$
134

Accruals for warranties issued during the period
787

 
169

Settlements (in cash or in kind) during the period
(850
)
 
(85
)
Balance at end of period
$
276

 
$
218

Restructuring Activities and Sale of Guangzhou Factory
In the first quarter of 2016, we implemented a plan to transition manufacturing activities from our southern-most China factory, located in the city of Guangzhou in the Guangdong province, to our other China factories. As a result, we incurred severance costs of $0.4 million and $6.1 million during the three and nine months ended September 30, 2017, respectively, which are included within operating expenses. All operations ceased in our Guangzhou factory in the third quarter of 2017 and the transition to the other China factories was completed by the end of 2017. Since all operations at our Guangzhou manufacturing facility ceased as of the end of July 2017, the related building and land lease assets were classified as assets held for sale in our consolidated balance sheet at December 31, 2017.

On September 26, 2016, we entered into an agreement to sell our Guangzhou manufacturing facility for RMB 320 million. In accordance with the terms of the agreement, the buyer deposited 10% of the purchase price into an escrow account upon the execution of the agreement, which we presented as restricted cash in our consolidated balance sheet at December 31, 2017 (also refer to Note 2). In April 2018, we and the buyer mutually agreed to terminate the sale. The mutually agreed termination took effect immediately with no incremental penalty or costs to either party. In connection with this termination, the deposit was returned to the buyer.

On April 23, 2018, we entered into a new agreement to sell our Guangzhou manufacturing facility to a second buyer for RMB 339 million (approximately $51.4 million based on exchange rates in effect at the time of closing). On April 26, 2018, the second buyer paid to us a deposit of RMB 34 million (approximately $5.1 million based on exchange rates in effect at the time of closing), which under the terms of the agreement was nonrefundable. Upon receipt by the Governmental Agency of the second buyer’s application of approval of transfer, the second buyer was to pay to us RMB 237 million (approximately $35.8 million based on exchange rates in effect at the time of closing). Additionally, within two days after the second payment was made to us, the second buyer was to deposit the remaining consideration of RMB 68 million (approximately $10.3 million based on exchange rates in effect at the time of closing) into escrow, which was to be released to us upon the closing of the sale. Per the terms of the agreement, the sale was to be completed no later than June 30, 2018. On June 26, 2018, all conditions to closing were satisfied and the sale was completed, resulting in a pre-tax gain of $37.0 million ($32.1 million, net of income taxes).
Litigation
On or about June 10, 2015, FM Marketing GmbH ("FMH") and Ruwido Austria GmbH ("Ruwido"), filed a Summons in Summary Proceedings in Belgium court against one of our subsidiaries, Universal Electronics BV ("UEBV") and one of its customers, Telenet N.V. ("Telenet"), claiming that one of the products UEBV supplied to Telenet violates two design patents and one utility patent owned by FMH and/or Ruwido. By this summons, FMH and Ruwido sought to enjoin Telenet and UEBV from continued distribution and use of the product at issue. After the September 29, 2015 hearing, the court issued its ruling in our and Telenet’s favor, rejecting FMH and Ruwido’s request entirely. On October 22, 2015, Ruwido filed its notice of appeal in this ruling. The parties have fully briefed and argued before the appellate court and we are awaiting the appellate court’s ruling. In addition, on or about February 9, 2016, Ruwido filed a writ of summons for proceeding on the merits with respect to the asserted patents. UEBV and Telenet have replied, denying all of Ruwido's allegations and in June 2017, a hearing was held before the trial court. During this hearing, Ruwido sought to have a second product which we are currently selling to Telenet included in this case. In September 2017, the Court ruled in our favor that our current product cannot be made part of this case. The Court also refused to rule on whether the original product (which we are no longer selling) infringes the Ruwido patent, instead deciding to wait until the European Patent Office has ruled on our Opposition (see below). Finally, the Court ruled that our original product (which we are no longer selling) infringes certain of Ruwido’s design rights, but stayed any decision of compensation and/or damages until all aspects of the case

18

UNIVERSAL ELECTRONICS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2018
(Unaudited)


have been decided. We have filed an appeal as to the Court’s ruling of infringement, and submission by the parties were due to the Court during the second quarter of 2018 with a hearing expected to take place in late 2018. Subsequent to the Court's ruling that a second product could not be added to the first case on the merits, Ruwido filed a separate case on the merits with respect to this second product, claiming that it too infringes the same patent at issue in the first suit. We have denied these claims. According to the Court’s trial schedule, briefs from both parties will be due during the second half of 2018 and early 2019 with a trial date set for January 2019. In September 2015, UEBV filed an Opposition with the European Patent Office seeking to invalidate the one utility patent asserted against UEBV and Telenet by Ruwido. The hearing on this opposition was held in July 2017. During this hearing the panel requested additional information. We have assembled this additional information and the final hearing has been scheduled for January 29, 2019. On September 5, 2017, Ruwido and FMH filed a patent infringement case on the merits against UEBV and Telenet in the Netherlands alleging the same claims of infringement as in the Belgium Courts (see above). We have denied these claims and filed a counterclaim seeking to invalidate the Ruwido patent. A November 30, 2018 hearing date has been set by the Court.

On September 5, 2018, we filed a lawsuit against Roku, Inc. (“Roku”) in the United States District Court, Central District of California (Universal Electronics Inc. v. Roku, Inc.) alleging that Roku is infringing nine patents that are in four patent families related to remote control set-up and touchscreen remotes. We have alleged that this complaint relates to multiple Roku streaming players and components therefore and certain universal control devices, including but not limited, the Roku App, Roku TV, Roku Ultra, Roku Express, Roku Streaming Stick, Roku Ultra, Roku Premiere, Roku 4, Roku 3, Roku 2, Roku Enhanced Remote and any other Roku product that provides for the remote control of an external device such as a TV, audiovisual receiver, sound bar or Roku TV Wireless Speakers. Roku has not yet answered our complaint.
There are no other material pending legal proceedings to which we or any of our subsidiaries is a party or of which our respective property is the subject. However, as is typical in our industry and to the nature and kind of business in which we are engaged, from time to time, various claims, charges and litigation are asserted or commenced by third parties against us or by us against third parties arising from or related to product liability, infringement of patent or other intellectual property rights, breach of warranty, contractual relations, or employee relations. The amounts claimed may be substantial but may not bear any reasonable relationship to the merits of the claims or the extent of any real risk of court awards assessed against us or in our favor. However, no assurances can be made as to the outcome of any of these matters, nor can we estimate the range of potential losses to us. In our opinion, final judgments, if any, which might be rendered against us in potential or pending litigation would not have a material adverse effect on our consolidated financial condition, results of operations, or cash flows. Moreover, we believe that our products do not infringe any third parties' patents or other intellectual property rights.
We maintain directors' and officers' liability insurance which insures our individual directors and officers against certain claims, as well as attorney's fees and related expenses incurred in connection with the defense of such claims.

Note 11 — Treasury Stock
From time to time, our Board of Directors authorizes management to repurchase shares of our issued and outstanding common stock on the open market. On July 26, 2018, our Board approved a repurchase plan authorizing the repurchase of up to $5.0 million of our common stock. As of September 30, 2018, we had $3.3 million of authorized repurchases remaining under the Board's authorizations. On October 30, 2018, our Board approved an adjustment to the amount of common stock that we could purchase under our existing repurchase plan to an amount not to exceed $5.0 million of our common stock. We may utilize various methods to effect the repurchases, which could include open market repurchases, negotiated block transactions, accelerated share repurchases or open market solicitations for shares, some of which may be effected through Rule 10b5-1 plans. The timing and amount of future repurchases, if any, will depend upon several factors, including market and business conditions, and such repurchases may be discontinued at any time.

Repurchased shares of our common stock were as follows:
 
Nine Months Ended September 30,
(In thousands)
2018
 
2017
Shares repurchased
374

 
330

Cost of shares repurchased
$
12,564

 
$
20,217


19

UNIVERSAL ELECTRONICS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2018
(Unaudited)


Repurchased shares are recorded as shares held in treasury at cost. We hold these shares for future use as management and the Board of Directors deem appropriate.

Note 12 — Foreign Operations
Foreign Operations
Our net sales to external customers by geographic area were as follows:
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
(In thousands)
2018

2017
 
2018
 
2017
United States
$
84,756

 
$
85,762

 
$
243,801

 
$
253,259

Asia (excluding PRC)
36,888

 
26,113

 
91,755

 
77,679

People's Republic of China
28,108

 
23,437

 
68,852

 
61,015

Europe
18,785

 
18,877

 
58,245

 
56,041

Latin America
6,411

 
13,567

 
23,077

 
44,593

Other
7,769

 
7,896

 
24,208

 
22,051

Total net sales
$
182,717

 
$
175,652

 
$
509,938

 
$
514,638

Specific identification of the customer billing location was the basis used for attributing revenues from external customers to geographic areas.
Long-lived tangible assets by geographic area were as follows:
(In thousands)
September 30, 2018
 
December 31, 2017
United States
$
14,765

 
$
14,674

People's Republic of China
85,808

 
96,984

All other countries
4,787

 
3,870

Total long-lived tangible assets
$
105,360

 
$
115,528


Note 13 — Stock-Based Compensation
Stock-based compensation expense for each employee and director is presented in the same statement of operations caption as their cash compensation. Stock-based compensation expense by statement of operations caption and the related income tax benefit were as follows:
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
(In thousands)
2018
 
2017
 
2018
 
2017
Cost of sales
$
21

 
$
19

 
$
61

 
$
53

Research and development expenses
200

 
149

 
556

 
412

Selling, general and administrative expenses:
 
 
 
 
 
 
 
Employees
1,671

 
1,843

 
4,936

 
5,562

Outside directors
247

 
1,910

 
1,255

 
3,449

Total employee and director stock-based compensation expense
$
2,139


$
3,921


$
6,808


$
9,476

 
 
 
 
 
 
 
 
Income tax benefit
$
441

 
$
603

 
$
1,423

 
$
2,307



20

UNIVERSAL ELECTRONICS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2018
(Unaudited)


Stock Options

Stock option activity was as follows:
 
Number of Options
(in 000's)
 
Weighted-Average Exercise Price
 
Weighted-Average Remaining Contractual Term
(in years)
 
Aggregate Intrinsic Value
(in 000's)
Outstanding at December 31, 2017
520

 
$
42.56

 
 
 
 
Granted
119

 
44.95

 
 
 
 
Exercised
(35
)
 
24.67

 
 
 
$
744

Forfeited/canceled/expired
(7
)
 
27.74

 
 
 
 
Outstanding at September 30, 2018 (1)
597

 
$
44.27

 
4.34
 
$
2,972

Vested and expected to vest at September 30, 2018 (1)
597

 
$
44.27

 
4.34
 
$
2,972

Exercisable at September 30, 2018 (1)
414

 
$
41.74

 
3.64
 
$
2,972

(1) 
The aggregate intrinsic value represents the total pre-tax value (the difference between our closing stock price on the last trading day of the third quarter of 2018 and the exercise price, multiplied by the number of in-the-money options) that would have been received by the option holders had they all exercised their options on September 30, 2018. This amount will change based on the fair market value of our stock.
The assumptions we utilized in the Black-Scholes option pricing model and the resulting weighted average fair value of stock option grants were the following:
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2018
 
2017
 
2018
 
2017
Weighted average fair value of grants
$

 
$

 
$
14.26

 
$
19.61

Risk-free interest rate
%
 
%
 
2.51
%
 
1.75
%
Expected volatility
%
 
%
 
33.09
%
 
34.25
%
Expected life in years
0.00

 
0.00

 
4.53

 
4.52

As of September 30, 2018, we expect to recognize $2.3 million of total unrecognized pre-tax stock-based compensation expense related to non-vested stock options over a remaining weighted-average life of 1.9 years.
Restricted Stock
Non-vested restricted stock award activity was as follows:
 
Shares
(in 000's)
 
Weighted-Average Grant Date Fair Value
Non-vested at December 31, 2017
162

 
$
61.19

Granted
167

 
42.65

Vested
(75
)
 
60.02

Forfeited
(11
)
 
55.94

Non-vested at September 30, 2018
243

 
$
49.03

As of September 30, 2018, we expect to recognize $8.8 million of total unrecognized pre-tax stock-based compensation expense related to non-vested restricted stock awards over a weighted-average life of 1.8 years.  


21

UNIVERSAL ELECTRONICS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2018
(Unaudited)


Note 14 — Performance-Based Common Stock Warrants
On March 9, 2016, we issued common stock purchase warrants to Comcast to purchase up to 725,000 shares of our common stock at a price of $54.55 per share. The right to exercise the warrants is subject to vesting over three successive two-year periods (the first two-year period commenced on January 1, 2016 and ended December 31, 2017) based on the level of purchases of goods and services from us by Comcast and its affiliates, as defined in the warrants. The table below presents the purchase levels and number of warrants that will vest in each period based upon achieving these purchase levels.
 
Incremental Warrants That Will Vest
Aggregate Level of Purchases by Comcast and Affiliates
January 1, 2016 - December 31, 2017
 
January 1, 2018 - December 31, 2019
 
January 1, 2020 - December 31, 2021
$260 million
100,000

 
100,000

 
75,000

$300 million
75,000

 
75,000

 
75,000

$340 million
75,000

 
75,000

 
75,000

Maximum Potential Warrants Earned by Comcast
250,000

 
250,000

 
225,000

If total aggregate purchases by Comcast and its affiliates are below $260 million in any of the two-year periods above, no warrants will vest related to that two-year period. If total aggregate purchases of goods and services by Comcast and its affiliates exceed $340 million during either the first or second two-year period, the amount of any such excess will count toward aggregate purchases in the following two-year period. At September 30, 2018, 175,000 vested warrants were outstanding. To fully vest in the rights to purchase all of the remaining unearned 475,000 underlying shares, Comcast and its affiliates must purchase an aggregate of $680 million in goods and services from us during the remaining four-year vesting period.
Any and all warrants that vest will expire on January 1, 2023. The warrants provide for certain adjustments that may be made to the exercise price and the number of shares issuable upon exercise due to customary anti-dilution provisions. Additionally, in connection with the warrants, we have also entered into a registration rights agreement with Comcast under which Comcast may from time to time request that we register the shares of common stock underlying vested warrants with the SEC.
Because the warrants contain performance criteria under which Comcast must achieve specified aggregate purchase levels for the warrants to vest, as detailed above, the measurement date for the warrants is the date on which the warrants vest. Through September 30, 2018, no warrants had vested for the two-year period beginning January 1, 2018.
The assumptions we utilized in the Black Scholes option pricing model and the resulting weighted average fair value of the warrants were the following:
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2018
 
2017
 
2018
 
2017
Fair value
$10.06
 
$24.17
 
$10.06
 
$24.17
Price of Universal Electronics Inc. common stock
$38.95
 
$62.10
 
$38.95
 
$62.10
Risk-free interest rate
2.92%
 
1.93%
 
2.92%
 
1.93%
Expected volatility
41.00%
 
34.41%
 
41.00%
 
34.41%
Expected life in years
4.25
 
5.26
 
4.25
 
5.26

22

UNIVERSAL ELECTRONICS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2018
(Unaudited)



The impact to net sales recorded in connection with the warrants and the related income tax benefit were as follows:
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
(In thousands)
2018

2017
 
2018
 
2017
Reduction/(increase) to net sales
$
404

 
$
(141
)
 
$
747

 
$
1,122

Income tax benefit/(expense)
100

 
(53
)
 
186

 
418

At September 30, 2018, we estimated the number of warrants that will vest based on projected future purchases that will be made by Comcast and its affiliates. These estimates may increase or decrease based on actual future purchases. The aggregate unrecognized estimated fair value of unvested warrants at September 30, 2018 was $4.0 million.

Note 15 — Other Income (Expense), Net
Other income (expense), net consisted of the following: 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
(In thousands)
2018
 
2017
 
2018
 
2017
Net gain (loss) on foreign currency exchange contracts (1)
$
69

 
$
(1,488
)
 
$
603

 
$
(2,852
)
Net gain (loss) on foreign currency exchange transactions
(2,377
)
 
1,176

 
(4,617
)
 
2,512

Other income
26

 
373

 
63

 
342

Other income (expense), net
$
(2,282
)
 
$
61


$
(3,951
)

$
2


(1) 
This represents the gains (losses) incurred on foreign currency hedging derivatives (see Note 17 for further details).

Note 16 — Earnings Per Share
Earnings per share was calculated as follows:
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
(In thousands, except per-share amounts)
2018
 
2017
 
2018
 
2017
BASIC
 
 
 
 
 
 
 
Net income
$
959

 
$
1,728

 
$
23,031

 
$
6,531

Weighted-average common shares outstanding
13,836

 
14,381

 
13,997

 
14,412

Basic earnings per share
$
0.07

 
$
0.12

 
$
1.65

 
$
0.45

 
 
 
 
 
 
 
 
DILUTED
 
 
 
 
 
 
 
Net income
$
959

 
$
1,728

 
$
23,031

 
$
6,531

Weighted-average common shares outstanding for basic
13,836

 
14,381

 
13,997

 
14,412

Dilutive effect of stock options, restricted stock and common stock warrants
123

 
285

 
119

 
277

Weighted-average common shares outstanding on a diluted basis
13,959

 
14,666

 
14,116

 
14,689

Diluted earnings per share
$
0.07

 
$
0.12

 
$
1.63

 
$
0.44



23

UNIVERSAL ELECTRONICS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2018
(Unaudited)


The following number of stock options, shares of restricted stock and common stock warrants were excluded from the computation of diluted earnings per common share as their inclusion would have been anti-dilutive:
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
(In thousands)
2018
 
2017
 
2018
 
2017
Stock options
382

 
165

 
365

 
153

Restricted stock awards
59

 
30

 
134

 
30

Performance-based warrants
175

 

 
175

 


Note 17 — Derivatives
The following table sets forth the total net fair value of derivatives:  
 
 
September 30, 2018
 
December 31, 2017
 
 
Fair Value Measurement Using
 
Total Balance
 
Fair Value Measurement Using
 
Total Balance
(In thousands)
 
Level 1
 
Level 2
 
Level 3
 
 
Level 1
 
Level 2
 
Level 3
 
Foreign currency exchange contracts
 
$

 
$
147

 
$

 
$
147

 
$

 
$
(565
)
 
$

 
$
(565
)
We held foreign currency exchange contracts, which resulted in a net pre-tax gain of $0.1 million and a net pre-tax loss of $1.5 million for the three months ended September 30, 2018 and 2017, respectively. For the nine months ended September 30, 2018 and 2017, we had a net pre-tax gain of $0.6 million and a net pre-tax loss of $2.9 million, respectively (see Note 15).
Details of foreign currency exchange contracts held were as follows:
Date Held
 
Currency
 
Position Held
 
Notional Value
(in millions)
 
Forward Rate
 
Unrealized Gain/(Loss) Recorded at Balance Sheet
Date
(in thousands)(1)
 
Settlement Date
September 30, 2018
 
USD/Euro
 
USD
 
$
18.0

 
1.1773

 
$
216

 
October 26, 2018
September 30, 2018
 
USD/Chinese Yuan Renminbi
 
USD
 
$
35.0

 
6.8963

 
$
(56
)
 
October 26, 2018
September 30, 2018
 
USD/Brazilian Real
 
USD
 
$
1.0

 
4.1032

 
$
(13
)
 
October 26, 2018
 
 
 
 
 
 
 
 
 
 
 
 
 
December 31, 2017
 
USD/Euro
 
USD
 
$
17.0

 
1.1858

 
$
(220
)
 
January 5, 2018
December 31, 2017
 
USD/Chinese Yuan Renminbi
 
Chinese Yuan Renminbi
 
$
20.0

 
6.6481

 
$
(410
)
 
January 5, 2018
December 31, 2017
 
USD/Brazilian Real
 
USD
 
$
2.5

 
3.2350

 
$
65

 
January 24, 2018
(1) 
Unrealized gains on foreign currency exchange contracts are recorded in prepaid expenses and other current assets. Unrealized losses on foreign currency exchange contracts are recorded in other accrued liabilities.

Note 18 — Business Combination
On April 6, 2017, we acquired substantially all of the net assets of Residential Control Systems, Inc. ("RCS"), a U.S.-based designer and manufacturer of energy management and control products for the residential, small commercial and hospitality markets. The purchase price of $12.6 million was comprised of $8.9 million in cash and $3.7 million of contingent consideration. The acquisition

24

UNIVERSAL ELECTRONICS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2018
(Unaudited)


of these assets will allow us to expand our product offering of home sensing, monitoring and control solutions to include smart thermostat, sensing and monitoring products previously sold and marketed by RCS.
Our consolidated statement of operations for the three and nine months ended September 30, 2018 includes net sales of $1.4 million and $3.3 million, respectively, and net losses of $0.4 million and $1.3 million, respectively, attributable to RCS. Our consolidated statement of operations for the three and nine months ended September 30, 2017 includes net sales of $0.8 million and $2.2 million and net losses of $0.3 million and $0.7 million, attributable to RCS for the period commencing on April 6, 2017.

Contingent Consideration
We are required to make additional earnout payments of up to $10.0 million upon the achievement of certain operating income levels attributable to RCS over the period commencing on the acquisition date through June 30, 2022. The amount of contingent consideration is calculated at the end of each calendar year and is based on the agreed upon percentage of operating income as defined in the Asset Purchase Agreement ("APA"). Operating income will be calculated using certain revenues, costs and expenses directly attributable to RCS as specified in the APA. At the acquisition date, the value of earnout contingent consideration was estimated using a valuation methodology based on projections of future operating income calculated in accordance with the APA. Such projections were then discounted using an average discount rate of 24.8% to reflect the risk in achieving the projected operating income levels as well as the time value of money. The fair value measurement of the earnout contingent consideration was based primarily on significant inputs not observable in an active market and thus represents a Level 3 measurement as defined under U.S. GAAP. At September 30, 2018, the fair value of earnout consideration attributed to RCS was $2.6 million which is presented within long-term contingent consideration in our consolidated balance sheet.
Purchase Price Allocation
Using the acquisition method of accounting, the acquisition date fair value of the consideration transferred was allocated to the net tangible and intangible assets acquired and liabilities assumed based on their estimated fair values on the acquisition date. The excess of the purchase price over the estimated fair value of net assets acquired is recorded as goodwill. The goodwill is expected to be deductible for income tax purposes. Management's purchase price allocation was the following:
(In thousands)
Estimated Lives
 
Fair Value
Accounts receivable
 
 
$
429

Inventories
 
 
1,508

Prepaid expenses and other current assets
 
 
7

Property, plant and equipment
1-4 years
 
14

Current liabilities
 
 
(408
)
Net tangible assets acquired
 
 
1,550

Trade name
8 years
 
400

Customer relationships
10 years
 
5,000

Order backlog
1 year
 
150

Goodwill
 
 
5,494

Total purchase price
 
 
12,594

Less: Contingent consideration
 
 
(3,700
)
Cash paid
 
 
$
8,894

Management's determination of the fair value of intangible assets acquired was based primarily on significant inputs not observable in an active market and thus represent Level 3 fair value measurements as defined under U.S. GAAP.
The fair value assigned to the RCS trade name intangible asset was determined utilizing a relief from royalty method. The fair value assigned to RCS customer relationships and order backlog intangible assets were determined utilizing a multi-period excess earnings approach.
The trade name, customer relationships and order backlog intangible assets are expected to be deductible for income tax purposes.

25

UNIVERSAL ELECTRONICS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2018
(Unaudited)


Pro Forma Results (Unaudited)
The following unaudited pro forma financial information presents the combined results of our operations and the operations of RCS as if this transaction had occurred on January 1, 2016. This unaudited pro forma financial information is not intended to represent or be indicative of the consolidated results of operations that would have been achieved had the acquisition actually been completed as of January 1, 2016, and should not be taken as a projection of the future consolidated results of our operations.
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
(In thousands, except per-share amounts)
2018
 
2017
 
2018
 
2017
Net sales
$
182,717

 
$
175,652

 
$
509,938

 
$
515,200

Net income
959

 
1,751

 
23,031

 
6,292

Basic earnings per share
$
0.07

 
$
0.12

 
$
1.65

 
$
0.44

Diluted earnings per share
$
0.07

 
$
0.12

 
$
1.63

 
$
0.43

For purposes of determining pro forma net income, adjustments were made to the three and nine months ended September 30, 2017. The pro forma net income assumes that amortization of acquired intangible assets began at January 1, 2016 rather than on April 6, 2017. The result is a net increase in amortization expense of $0.1 million for the nine months ended September 30, 2017. Additionally, acquisition costs totaling $0.1 million are excluded from pro forma net income. All adjustments have been made net of their related tax effects.

26


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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, AV accessories, software and intelligent wireless security, sensing and automation components dedicated to redefining the home entertainment and automation experience. Our customers operate primarily in the consumer electronics market and include subscription broadcasters, OEMs, international retailers, private label brands, pro-security installers and companies in the computing industry. We also sell integrated circuits, on which our software and device control database is embedded, and license our device control database to OEMs that manufacture televisions, digital audio and video players, streamer boxes, cable converters, satellite receivers, set-top boxes, room air conditioning equipment, game consoles, and wireless mobile phones and tablets.
Since our beginning in 1986, we have compiled an extensive device control code database that covers over one million individual device functions and approximately 8,600 unique consumer electronic brands. QuickSet®, our proprietary software, can automatically detect, identify and enable the appropriate control commands for home entertainment, automation and appliances like air conditioners. Our library is regularly updated with new control functions captured directly from devices, remote controls and manufacturer specifications to ensure the accuracy and integrity of our database and control engine. Our universal remote control library contains device codes that are capable of controlling virtually all 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.
With the wider adoption of more advanced control technologies, emerging radio frequency ("RF") technologies, such as RF4CE, Bluetooth, and Bluetooth Smart, have increasingly become a focus in our development efforts. Several new recently released platforms utilize RF to effectively implement popular features like voice search.
We have developed a comprehensive patent portfolio of almost 500 issued and pending United States patents related to remote control, home security, safety and automation as well as hundreds of foreign counterpart patents and applications in various territories around the world.
We operate as one business segment. We have 24 international subsidiaries located in Argentina, Brazil, British Virgin Islands, Cayman Islands, France, Germany, Hong Kong (3), India, Italy, Japan, Korea, Mexico, the Netherlands, People's Republic of China (6), Singapore, Spain, and the United Kingdom.
To recap our results for the three months ended September 30, 2018:
Net sales increased 4.0% to $182.7 million for the three months ended September 30, 2018 from $175.7 million for the three months ended September 30, 2017.
Our gross margin percentage decreased from 24.5% for the three months ended September 30, 2017 to 22.1% for the three months ended September 30, 2018.
Operating expenses, as a percent of net sales, decreased from 22.1% for the three months ended September 30, 2017 to 19.5% for the three months ended September 30, 2018.
Our operating income increased from $4.2 million for the three months ended September 30, 2017 to $4.7 million for the three months ended September 30, 2018, and our operating margin percentage increased from 2.4% for the three months ended September 30, 2017 to 2.6% for the three months ended September 30, 2018.
Our effective tax rate decreased to 24.5% for the three months ended September 30, 2018, compared to 51.4% for the three months ended September 30, 2017.
Our strategic business objectives for 2018 include the following:
continue to develop and market the advanced remote control products and technologies that our customer base is adopting;
continue to broaden our home control and automation product offerings;
further penetrate international 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.

27


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. On an on-going basis, we evaluate our estimates and judgments, including those related to revenue recognition, allowances for sales returns and doubtful accounts, inventory valuation, our review for impairment of long-lived assets, intangible assets and goodwill, business combinations, income taxes, stock-based compensation expense and performance-based common stock warrants. 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. As further discussed in "Notes to Consolidated Financial Statements - Note 1," effective January 1, 2018, we adopted Accounting Standards Update ("ASU") 2014-09, "Revenues from Contracts with Customers." The critical accounting policy below updates 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, 2017.

Revenue Recognition
Our performance obligations primarily arise from manufacturing and delivering universal control, sensing and automation products and AV accessories, which are sold through multiple channels, and intellectual property that is embedded in these products or licensed to others. These performance obligations are satisfied at a point in time or over time, as described below. Payment terms are typically on open credit terms consistent with industry practice and do not have significant financing components. Some contracts contain early payment discounts, which are recognized as a reduction to revenue if the customer typically meets the early payment conditions. Consideration may be variable based on indeterminate volumes.
Effective January 1, 2018, revenue is recognized over time when the customer simultaneously receives and consumes the benefits provided by our performance, our performance creates or enhances an asset that the customer controls, or when our performance creates an asset with no alternative use to us (custom products) and we have an enforceable right to payment for performance completed to date, such as a firm order or other contractual commitment from the customer. An asset does not have an alternative use if we are unable to redirect the asset to another customer in the foreseeable future without significant rework. The method for measuring progress towards satisfying a performance obligation for a custom product is based on the costs incurred to date (cost-to-cost method). We believe that the costs associated with production are most closely aligned with the revenue associated with those products.
We recognize revenue at a point in time if the criteria for recognizing revenue over time are not met, the title of the goods has transferred, and we have a present right to payment.
We typically recognize revenue for the sale of tooling at a point in time, which is generally upon completion of the tooling and, if applicable, acceptance by the customer.
A provision is recorded for estimated sales returns and allowances and is deducted from gross sales to arrive at net sales in the period the related revenue is recorded. These estimates are based on historical sales returns and allowances, analysis of credit memo data and other known factors. Actual returns and claims in any future period are inherently uncertain and thus may differ from our estimates. If actual or expected future returns and claims are significantly greater or lower than the reserves that we have established, we will record a reduction or increase to net revenue in the period in which we make such a determination.
We accrue for discounts and rebates based on historical experience and our expectations regarding future sales to our customers. Accruals for discounts and rebates are recorded as a reduction to sales in the same period as the related revenue. Changes in such accruals may be required if future rebates and incentives differ from our estimates.
We license our intellectual property including our patented technologies, trademarks, and database of control codes. When license

28


fees are paid on a per-unit basis, we record license revenue when our customers manufacture or ship a product incorporating our intellectual property and we have a present right to payment. When a fixed up-front license fee is received in exchange for the delivery of a particular database of infrared codes or the contract contains a minimum guarantee provision, we record revenue when delivery of the intellectual property has occurred. Tiered royalties are recorded on a straight-line basis according to the forecasted per-unit fees taking into account the pricing tiers.
Contract assets represent revenue which has been recognized based on our accounting policies but for which the customer has not yet been invoiced and thus an account receivable has not yet been recorded.
Under prior accounting standards, we recognized revenue on the sale of products when title of the goods had transferred, there was persuasive evidence of an arrangement (such as a purchase order from the customer), the sales price was fixed or determinable and collectability was reasonably assured. Revenue for term license fees were recognized on a straight-line basis over the effective term of the license when we could not reliably predict in which periods, within the term of the license, the licensee would benefit from the use of our patented inventions.

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

29


Results of Operations
The following table sets forth our reported results of operations expressed as a percentage of net sales for the periods indicated.
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2018
 
2017
 
2018
 
2017
Net sales
100.0
 %
 
100.0
 %
 
100.0
 %
 
100.0
 %
Cost of sales
77.9

 
75.5

 
79.6

 
75.2

Gross profit
22.1

 
24.5

 
20.4

 
24.8

Research and development expenses
3.1

 
3.1

 
3.5

 
3.1

Factory transition restructuring charges

 
0.2

 

 
1.2

Selling, general and administrative expenses
16.4

 
18.8

 
17.7

 
18.4

Operating income (loss)
2.6

 
2.4

 
(0.8
)
 
2.1

Interest income (expense), net
(0.6
)
 
(0.4
)
 
(0.7
)
 
(0.3
)
Gain on sale of Guangzhou factory
0.0

 

 
7.3

 

Other income (expense), net
(1.3
)
 

 
(0.8
)
 
0.0

Income before provision for income taxes
0.7

 
2.0

 
5.0

 
1.8

Provision for income taxes
0.2

 
1.0

 
0.5

 
0.6

Net income
0.5
 %
 
1.0
 %
 
4.4
 %
 
1.2
 %
Adoption of ASU 2014-09. Effective January 1, 2018, we adopted ASU 2014-09 on a modified retrospective basis. Thus the comparability between periods of reported net sales, gross profit and selling, general and administrative expenses is impacted. The discussion below provides insights into underlying business trends that affected our reported results of operations. For further details as to the impact of adopting ASU 2014-09, refer to Note 1 in "Notes to Consolidated Financial Statements."
Three Months Ended September 30, 2018 versus Three Months Ended September 30, 2017
Net sales. Net sales for the three months ended September 30, 2018 were $182.7 million, an increase of 4.0% compared to $175.7 million for the three months ended September 30, 2017. Net sales by our Business and Consumer lines were as follows:
 
Three Months Ended September 30,
 
2018
 
2017
 
$ (millions)
 
% of Total
 
$ (millions)
 
% of Total
Business
$
169.0

 
92.5
%
 
$
163.1

 
92.8
%
Consumer
13.7

 
7.5

 
12.6

 
7.2

Total net sales
$
182.7

 
100.0
%
 
$
175.7

 
100.0
%

Net sales in our Business lines (subscription broadcasting, OEM, and computing companies) were 92.5% of net sales for the three months ended September 30, 2018 compared to 92.8% for the three months ended September 30, 2017. Net sales in our Business lines for the