Document
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, 2017
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, 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 and posted on its corporate Web site, if any, any Interactive Data File required to be submitted and posted 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 and post 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
¨  (Do not check if a smaller reporting company)
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: 14,305,749 shares of Common Stock, par value $0.01 per share, of the registrant were outstanding on November 6, 2017.



UNIVERSAL ELECTRONICS INC.
 
INDEX
 
 
Page
Number




Table of Contents

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, 2017
 
December 31, 2016
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
48,560

 
$
50,611

Restricted cash
4,799

 
4,623

Accounts receivable, net
153,355

 
124,592

Inventories, net
154,520

 
129,879

Prepaid expenses and other current assets
9,988

 
7,439

Assets held for sale
12,403

 

Income tax receivable
3,262

 
1,054

Deferred income taxes

 
5,960

Total current assets
386,887

 
324,158

Property, plant, and equipment, net
109,149

 
105,351

Goodwill
48,624

 
43,052

Intangible assets, net
30,159

 
28,549

Deferred income taxes
18,349

 
10,430

Long-term restricted cash


4,600

Other assets
4,040

 
4,896

Total assets
$
597,208

 
$
521,036

LIABILITIES AND STOCKHOLDERS' EQUITY
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
106,872

 
$
97,157

Line of credit
114,000

 
49,987

Accrued compensation
33,328

 
35,580

Accrued sales discounts, rebates and royalties
7,790

 
8,358

Accrued income taxes
994

 
375

Other accrued expenses
25,840

 
24,410

Total current liabilities
288,824

 
215,867

Long-term liabilities:
 
 
 
Long-term contingent consideration
14,000

 
10,500

Deferred income taxes
6,376

 
7,060

Income tax payable
791

 
791

Other long-term liabilities
1,598

 
6,308

Total liabilities
311,589

 
240,526

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; 23,687,651 and 23,575,340 shares issued on September 30, 2017 and December 31, 2016, respectively
237

 
236

Paid-in capital
262,776

 
250,481

Treasury stock, at cost, 9,352,551 and 9,022,587 shares on September 30, 2017 and December 31, 2016, respectively
(243,197
)
 
(222,980
)
Accumulated other comprehensive income (loss)
(17,831
)
 
(22,821
)
Retained earnings
283,634

 
275,594

Total stockholders' equity
285,619

 
280,510

Total liabilities and stockholders' equity
$
597,208


$
521,036

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

Table of Contents

UNIVERSAL ELECTRONICS INC.
CONSOLIDATED INCOME STATEMENTS
(In thousands, except per share amounts)
(Unaudited) 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2017
 
2016
 
2017
 
2016
Net sales
$
175,652

 
$
169,185

 
$
514,638

 
$
490,829

Cost of sales
132,582

 
127,400

 
386,783

 
367,941

Gross profit
43,070

 
41,785


127,855


122,888

Research and development expenses
5,415

 
4,955

 
15,859

 
15,292

Factory transition restructuring charges
446

 
81

 
6,145

 
1,598

Selling, general and administrative expenses
32,997

 
28,628

 
94,701

 
86,867

Operating income
4,212

 
8,121


11,150


19,131

Interest income (expense), net
(721
)
 
(228
)
 
(1,676
)
 
(753
)
Other income (expense), net
61

 
335

 
2

 
1,726

Income before provision for income taxes
3,552

 
8,228


9,476


20,104

Provision for income taxes
1,824

 
421

 
2,945

 
2,956

Net income
1,728

 
7,807


6,531


17,148

Net income attributable to noncontrolling interest

 

 

 
30

Net income attributable to Universal Electronics Inc.
$
1,728


$
7,807


$
6,531


$
17,118

 
 
 
 
 
 
 
 
Earnings per share attributable to Universal Electronics Inc.:
 
 
 
 
 
 
 
Basic
$
0.12

 
$
0.54


$
0.45


$
1.19

Diluted
$
0.12

 
$
0.53


$
0.44


$
1.16

Shares used in computing earnings per share:
 
 
 
 
 
 
 
Basic
14,381

 
14,510

 
14,412

 
14,441

Diluted
14,666

 
14,848

 
14,689

 
14,740

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

Table of Contents

UNIVERSAL ELECTRONICS INC.
CONSOLIDATED COMPREHENSIVE INCOME STATEMENTS
(In thousands)
(Unaudited) 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2017
 
2016
 
2017
 
2016
Net income
$
1,728

 
$
7,807

 
$
6,531

 
$
17,148

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

 
(540
)
 
4,990

 
(1,858
)
Total comprehensive income (loss)
4,727


7,267


11,521


15,290

Comprehensive income (loss) attributable to noncontrolling interest

 

 

 
30

Comprehensive income (loss) attributable to Universal Electronics Inc.
$
4,727


$
7,267


$
11,521


$
15,260

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

Table of Contents

UNIVERSAL ELECTRONICS INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited) 
 
Nine Months Ended September 30,
 
2017
 
2016
Cash provided by (used for) operating activities:
 
 
 
Net income
$
6,531

 
$
17,148

Adjustments to reconcile net income to net cash provided by (used for) operating activities:
 
 
 
Depreciation and amortization
23,202

 
18,994

Provision for doubtful accounts
167

 
123

Provision for inventory write-downs
2,189

 
2,398

Deferred income taxes
(953
)
 
1,413

Tax benefit from exercise of stock options and vested restricted stock

 
2,230

Excess tax benefit from stock-based compensation

 
(2,292
)
Shares issued for employee benefit plan
591

 
763

Employee and director stock-based compensation
9,476

 
7,638

Performance-based common stock warrants
1,122

 
3,219

Changes in operating assets and liabilities:
 
 
 
Restricted cash
4,623

 

Accounts receivable
(24,440
)
 
(11,359
)
Inventories
(21,217
)
 
(4,470
)
Prepaid expenses and other assets
(2,422
)
 
(86
)
Accounts payable and accrued expenses
1,488

 
7,699

Accrued income taxes
(1,517
)
 
(4,737
)
Net cash provided by (used for) operating activities
(1,160
)
 
38,681

Cash used for investing activities:
 
 
 
Acquisition of property, plant, and equipment
(29,922
)
 
(28,914
)
Acquisition of net assets of Residential Control Systems, Inc.
(8,894
)
 

Acquisition of intangible assets
(1,275
)
 
(1,373
)
Increase in restricted cash

 
(4,797
)
Deposit received toward sale of Guangzhou factory

 
4,797

Deconsolidation of Encore Controls LLC

 
48

Net cash used for investing activities
(40,091
)

(30,239
)
Cash provided by (used for) financing activities:
 
 
 
Borrowings under line of credit
115,000

 
92,987

Repayments on line of credit
(50,987
)
 
(107,987
)
Proceeds from stock options exercised
1,107

 
4,813

Treasury stock purchased
(20,217
)
 
(2,188
)
Excess tax benefit from stock-based compensation

 
2,292

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

 
(10,083
)
Effect of exchange rate changes on cash
(5,703
)
 
(3,184
)
Net increase (decrease) in cash and cash equivalents
(2,051
)
 
(4,825
)
Cash and cash equivalents at beginning of year
50,611

 
52,966

Cash and cash equivalents at end of period
$
48,560

 
$
48,141

 
 
 
 
Supplemental cash flow information:
 
 
 
Income taxes paid
$
5,770

 
$
6,034

Interest paid
$
1,697

 
$
926

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

Table of Contents

UNIVERSAL ELECTRONICS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2017
(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. 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, 2017 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, 2016.
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.
See Note 2 to the consolidated financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2016 for a summary of our significant accounting policies.
Recent Accounting Pronouncements
In May 2014, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2014-09, "Revenue from Contracts with Customers," which will supersede most existing U.S. GAAP revenue recognition guidance. This new standard requires an entity to recognize revenue to depict the transfer of goods or services to customers in an amount that reflects the consideration to which an entity expects to be entitled in exchange for those goods or services. In addition, ASU 2014-09 contains expanded disclosure requirements relating to the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. As initially proposed, ASU 2014-09 would have been effective for fiscal periods beginning after December 15, 2016 and permits the use of either the full retrospective or modified retrospective transition method. In August 2015, the FASB postponed the effective date of this new revenue standard by one year. We have largely completed our review of customer contract terms and our assessment of the impact of adopting this standard on our revenue recognition policy, and are currently in the process of modifying certain revenue recognition processes and controls to comply with ASU 2014-09, including the new disclosure requirements. The impact of this new guidance is primarily expected to accelerate revenue recognition for those contractual arrangements under which we manufacture and sell customized products that have no alternative use, as defined under ASU 2014-09 and related guidance and interpretations. In particular, to the extent that we have the right to payment such as a firm order or other contractual commitment from the customer, revenue associated with customized products will be recognized as those products are manufactured rather than when title for those products transfers to the customer. We also expect revenue recognition to be accelerated for licensing arrangements that contain minimum guarantees. We expect to implement ASU 2014-09 on January 1, 2018, using the modified retrospective transition method. Thus prior periods will not be restated. The impact of the transition to this new accounting method, which will include a cumulative-effect adjustment to retained earnings as of the adoption date, could have a material impact on our consolidated results of operations.
In July 2015, the FASB issued ASU 2015-11, "Simplifying the Measurement of Inventory," which states that inventory should be measured at the lower of cost and net realizable value. Net realizable value is defined as estimated selling price in the ordinary course of business, less reasonably predictable costs of completion, disposal and transportation. ASU 2015-11 is effective for fiscal periods beginning after December 15, 2016 and must be applied prospectively. The adoption of ASU 2015-11 did not have a material impact on our consolidated financial position or results of operations.

7

Table of Contents
UNIVERSAL ELECTRONICS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2017
(Unaudited)


In November 2015, the FASB issued ASU 2015-17, "Balance Sheet Classification of Deferred Taxes." This new guidance requires all deferred tax assets and liabilities, along with any related valuation allowance, be classified as non-current on the balance sheet. ASU 2015-17 is effective for fiscal periods beginning after December 15, 2016 and may be adopted either prospectively or retrospectively. We prospectively adopted ASU 2015-17 effective January 1, 2017, and thus prior period balance sheets have not been adjusted. The adoption of ASU 2015-17 had no impact on our consolidated results of operations or cash flows.
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. We are currently evaluating the impact that ASU 2016-02 will have on our consolidated financial statements.
In March 2016, the FASB issued ASU 2016-09,"Improvements to Employee Share-Based Payment Accounting," which amends Accounting Standards Codification ("ASC") 718, "Compensation - Stock Compensation." ASU 2016-09 requires excess tax benefits and tax deficiencies to be recorded as a discrete adjustment to income tax expense when stock awards vest or are settled, rather than in paid-in capital when they impact income taxes payable. This new guidance also requires cash flows related to excess tax benefits from stock-based compensation to be presented with other income tax cash flows in operating activities, rather than separately as a financing activity, in the statement of cash flows. Additionally, ASU 2016-09 impacts the calculation of diluted weighted-average shares under the treasury stock method as the assumed proceeds from an employee vesting in or exercising a stock-based award are no longer increased or decreased by the amount of excess tax benefits or deficiencies taken to paid-in capital. We elected to adopt the provisions of ASU 2016-09 prospectively effective January 1, 2017. We also made the accounting policy election, as allowed by ASU 2016-09, to account for forfeitures of stock-based awards as they occur, rather than estimating forfeitures. The cumulative effect of adopting ASU 2016-09 was an increase of $1.5 million to deferred tax assets and an increase to retained earnings of $1.5 million, as of January 1, 2017, as a result of recognizing previously unrecognized excess tax benefits from stock-based compensation. There was no cumulative effect impact related to the change in accounting policy to account for forfeitures of stock-based awards when they occur as a result of our minimal historical forfeitures experience.
In August 2016, the FASB issued ASU 2016-15, "Classification of Certain Cash Receipts and Cash Payments," which amends 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. Early adoption is permitted as long as all amendments are adopted in the same period. We are currently evaluating the impact that ASU 2016-15 will have on our consolidated financial statements.
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. Early adoption is permitted. The impact of the adoption of ASU 2016-16 could be material depending on the size of any intra-entity transfers we may implement in future periods.
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. Early adoption is permitted. The adoption of ASU 2016-18 will modify our current disclosures by reclassifying certain amounts within the consolidated statement of cash flows, but is not expected to have a material effect 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 31, 2019. Early adoption is permitted. We do not expect the adoption of ASU 2017-04 to have a material impact on our consolidated financial statements.

8

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UNIVERSAL ELECTRONICS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2017
(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, 2017
 
December 31, 2016
United States
$
4,795

 
$
3,277

People's Republic of China ("PRC")
22,120

 
22,142

Asia (excluding the PRC)
846

 
5,260

Europe
13,317

 
19,630

South America
7,482

 
302

Total cash and cash equivalents
$
48,560

 
$
50,611

Restricted Cash
In connection with a court order issued in a now settled litigation matter, we previously placed $4.6 million of cash into a collateralized surety bond. This bond had certain restrictions for liquidation and was therefore classified as restricted cash. On February 10, 2017, the $4.6 million surety bond was returned to us upon final settlement of the related litigation matter.
In connection with the pending sale of our Guangzhou factory in the PRC (Note 10), the buyer made a cash deposit of RMB 32 million ($4.8 million based on September 30, 2017 exchange rates) into an escrow account on September 29, 2016. Under the terms of the escrow account, these funds will not be paid to us until the close of the sale. Accordingly, this deposit is presented as restricted cash within our consolidated balance sheet.
Note 3 — Accounts Receivable, Net and Revenue Concentrations
Accounts receivable, net were as follows:
(In thousands)
September 30, 2017
 
December 31, 2016
Trade receivables, gross
$
147,194

 
$
120,965

Allowance for doubtful accounts
(1,052
)
 
(904
)
Allowance for sales returns
(459
)
 
(539
)
Net trade receivables
145,683

 
119,522

Other
7,672

 
5,070

Accounts receivable, net
$
153,355

 
$
124,592

Allowance for Doubtful Accounts
Changes in the allowance for doubtful accounts were as follows:
(In thousands)
Nine Months Ended September 30,
2017
 
2016
Balance at beginning of period
$
904

 
$
822

Additions (reductions) to costs and expenses
167

 
123

(Write-offs)/Foreign exchange effects
(19
)
 
15

Balance at end of period
$
1,052

 
$
960


9

Table of Contents
UNIVERSAL ELECTRONICS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2017
(Unaudited)


Sales Returns
The allowance for sales returns at September 30, 2017 and December 31, 2016 included reserves for items returned prior to period-end that were not completely processed, and therefore had not yet been removed from the allowance for sales returns balance. If these returns had been fully processed, the allowance for sales returns balance would have been approximately $0.3 million and $0.4 million on September 30, 2017 and December 31, 2016, respectively. The value of these returned goods was included in our inventory balance at September 30, 2017 and December 31, 2016.
Significant Customers
Net sales to the following customers totaled more than 10% of our net sales:
 
Three Months Ended September 30,
 
2017
 
2016
 
$ (thousands)
 
% of Net Sales
 
$ (thousands)
 
% of Net Sales
Comcast Corporation
$
36,811

 
21.0
%
 
$
35,554

 
21.0
%
AT&T
20,117

 
11.5

 
21,139

 
12.5


 
Nine Months Ended September 30,
 
2017
 
2016
 
$ (thousands)
 
% of Net Sales
 
$ (thousands)
 
% of Net Sales
Comcast Corporation
$
122,009

 
23.7
%
 
$
111,529

 
22.7
%
AT&T
61,057

 
11.9

 
60,709

 
12.4


Trade receivables associated with these significant customers that totaled more than 10% of our accounts receivable, net were as follows:
 
September 30, 2017
 
December 31, 2016
 
$ (thousands)
 
% of Accounts Receivable, Net
 
$ (thousands)
 
% of Accounts Receivable, Net
Comcast Corporation
$
26,553

 
17.3
%
 
$
23,716

 
19.0
%
AT&T (1)

 

 
14,108

 
11.3

(1)  
Trade receivables associated with this customer did not total more than 10% of our accounts receivable, net at September 30, 2017.
Note 4 — Inventories, Net and Significant Supplier
Inventories, net were as follows:
(In thousands)
September 30, 2017
 
December 31, 2016

Raw materials
$
36,803

 
$
33,059

Components
18,556

 
15,046

Work in process
6,596

 
5,860

Finished goods
95,690

 
80,119

Reserve for excess and obsolete inventory
(3,125
)
 
(4,205
)
Inventories, net
$
154,520

 
$
129,879

 

10

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UNIVERSAL ELECTRONICS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2017
(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,
2017
 
2016
Balance at beginning of period
$
4,205

 
$
3,045

Additions charged to costs and expenses (1)
1,960

 
2,120

Sell through (2)
(950
)
 
(781
)
(Write-offs)/Foreign exchange effects
(2,090
)
 
(726
)
Balance at end of period
$
3,125

 
$
3,658


(1)
The additions charged to costs and expenses do not include inventory directly written-off that was scrapped during production totaling $0.2 million and $0.3 million for the nine months ended September 30, 2017 and 2016, 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 Supplier
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,
 
2017
 
2016
 
$ (thousands)
 
% of Total
Inventory Purchases
 
$ (thousands)
 
% of Total
Inventory Purchases
Texas Instruments
$
13,115

 
12.4
%
 
$
12,353

 
13.0
%
 
Nine Months Ended September 30,
 
2017
 
2016
 
$ (thousands)
 
% of Total
Inventory Purchases
 
$ (thousands)
 
% of Total
Inventory Purchases
Texas Instruments
$
33,693

 
11.3
%
 
$
32,294

 
11.9
%


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UNIVERSAL ELECTRONICS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2017
(Unaudited)


Related Party Supplier
We purchase certain printed circuit board assemblies from a related party supplier. The supplier is considered a related party for financial reporting purposes because our Senior Vice President of Strategic Operations owns 40% of this vendor. Inventory purchases from this supplier were as follows:
 
Three Months Ended September 30,
 
2017
 
2016
 
$ (thousands)
 
% of Total
Inventory Purchases
 
$ (thousands)
 
% of Total
Inventory Purchases
Related party supplier
$
1,378

 
1.3
%
 
$
1,382

 
1.5
%
 
Nine Months Ended September 30,
 
2017
 
2016
 
$ (thousands)
 
% of Total
Inventory Purchases
 
$ (thousands)
 
% of Total
Inventory Purchases
Related party supplier
$
3,962

 
1.3
%
 
$
4,971

 
1.8
%
Total accounts payable to this supplier were as follows:
 
September 30, 2017
 
December 31, 2016
 
$ (thousands)
 
% of Accounts Payable
 
$ (thousands)
 
% of Accounts Payable
Related party supplier
$
1,763

 
1.6
%
 
$
1,690

 
1.7
%
Our payment terms and pricing with this supplier are consistent with the terms offered by other suppliers in the ordinary course of business. The accounting policies that we apply to our transactions with our related party supplier are consistent with those applied in transactions with independent third parties. Corporate management routinely monitors purchases from our related party supplier to ensure these purchases remain consistent with our business objectives. 
Note 5 — Goodwill and Intangible Assets, Net
Goodwill
Changes in the carrying amount of goodwill were as follows:
(In thousands)
 
Balance at December 31, 2016
$
43,052

Goodwill acquired during the period (1)
5,494

Foreign exchange effects
78

Balance at September 30, 2017
$
48,624

 

(1) During the second quarter of 2017, we recorded $5.5 million of goodwill related to the Residential Control Systems, Inc. acquisition. Refer to Note 18 for further information about this acquisition.

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UNIVERSAL ELECTRONICS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2017
(Unaudited)


Intangible Assets, Net
The components of intangible assets, net were as follows:
 
September 30, 2017
 
December 31, 2016
(In thousands)
Gross (1)
 
Accumulated
Amortization (1)
 
Net
 
Gross (1)
 
Accumulated
Amortization (1)
 
Net
Distribution rights
$
340

 
$
(155
)
 
$
185

 
$
302

 
$
(119
)
 
$
183

Patents
12,593

 
(4,996
)
 
7,597

 
12,038

 
(4,775
)
 
7,263

Trademarks and trade names (2)
2,786

 
(1,518
)
 
1,268

 
2,400

 
(1,310
)
 
1,090

Developed and core technology
12,560

 
(5,567
)
 
6,993

 
12,585

 
(4,068
)
 
8,517

Capitalized software development costs
142

 
(59
)
 
83

 
142

 
(5
)
 
137

Customer relationships (2)
32,534

 
(18,613
)
 
13,921

 
27,703

 
(16,344
)
 
11,359

Order backlog (2)
150

 
(38
)
 
112

 

 

 

Total intangible assets, net
$
61,105

 
$
(30,946
)
 
$
30,159


$
55,170

 
$
(26,621
)
 
$
28,549

 
(1) 
This table excludes the gross value of fully amortized intangible assets totaling $6.0 million and $10.2 million at September 30, 2017 and December 31, 2016, respectively.
(2) 
During the second quarter of 2017, we purchased a trade name valued at $0.4 million, which is being amortized ratably over eight years; customer relationships valued at $5.0 million, which are being amortized ratably over 10 years; and order backlog valued at $0.2 million, which is being amortized ratably over one year. Refer to Note 18 for further information regarding the purchase of these intangible assets.
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)
2017
 
2016
 
2017
 
2016
Cost of sales
$
54

 
$
21

 
$
128

 
$
63

Selling, general and administrative expenses
1,715

 
1,551

 
5,032

 
4,618

Total amortization expense
$
1,769

 
$
1,572


$
5,160


$
4,681

 
Estimated future annual amortization expense related to our intangible assets at September 30, 2017, is as follows:
(In thousands)
 
2017 (remaining 3 months)
$
1,776

2018
7,046

2019
6,901

2020
5,740

2021
2,289

Thereafter
6,407

Total
$
30,159


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UNIVERSAL ELECTRONICS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2017
(Unaudited)


Note 6 — Line of Credit

Our Amended and Restated Credit Agreement ("Amended Credit Agreement") with U.S. Bank National Association ("U.S. Bank") provided for a $125.0 million revolving line of credit ("Credit Line") that was to expire on November 1, 2019. On October 27, 2017, we entered into a Second Amended and Restated Credit Agreement ("Second Amended Credit Agreement") with U.S. Bank as administrative agent, sole lead arranger and sole book runner, and Wells Fargo Bank, National Association, which replaces the Amended Credit Agreement. Under the Second Amended Credit Agreement, the Credit Line was increased to $170.0 million and the expiration date remained 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, 2017.
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 that controls our manufacturing factories in the PRC.
The interest rate applicable to outstanding Credit Line balances under the Second Amended Credit Agreement is the same as under the Amended Credit Agreement. We may elect to pay interest on the Credit Line based on LIBOR plus an applicable margin (varying from 1.25% to 1.75%) or base rate (based on the prime rate of U.S. Bank or as otherwise specified in the 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 Amended Credit Agreement and Second Amended Credit Agreement. The interest rate in effect at September 30, 2017 was 2.48%. There are no commitment fees or unused line fees under the Amended Credit Agreement or the Second Amended Credit Agreement.
The Amended Credit Agreement and Second Amended Credit Agreement include financial covenants requiring a minimum fixed charge coverage ratio and a maximum cash flow leverage ratio. In addition, the Amended Credit Agreement and Second Amended Credit Agreement also contain other customary affirmative and negative covenants and events of default. As of September 30, 2017, we were in compliance with the covenants and conditions of the Amended Credit Agreement.
At September 30, 2017, we had $114.0 million outstanding under the Credit Line. Our total interest expense on borrowings was $0.8 million and $0.3 million during the three months ended September 30, 2017 and 2016, respectively, and $1.8 million and $0.9 million during the nine months ended September 30, 2017 and 2016, 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 tax rate and multiplying it by the year-to-date pre-tax book income.
We recorded income tax expense of $1.8 million and $0.4 million for the three months ended September 30, 2017 and 2016, respectively, and our effective tax rate was 51.4% and 5.1% during the three months ended September 30, 2017 and 2016, respectively. We recorded income tax expense of $2.9 million and $3.0 million for the nine months ended September 30, 2017 and 2016, respectively, and our effective tax rate was 31.1% and 14.7% during the nine months ended September 30, 2017 and 2016, respectively. The higher effective tax rate in both periods was primarily due to the nondeductibility of certain transactions in the PRC as a result of the pending sale of our Guangzhou factory (Note 10). In addition, during the three and nine months ended September 30, 2016, we received tax refunds from the Chinese government totaling $1.8 million for various tax incentives relating to fiscal year 2015.
At September 30, 2017, we had gross unrecognized tax benefits of $3.8 million, including interest and penalties, of which $3.5 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. However, based on federal, state and foreign statute expirations in various jurisdictions, we anticipate a decrease in unrecognized tax benefits of approximately $0.1 million 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 $0.3 million and $0.3 million at September 30, 2017 and December 31, 2016, respectively, are included in our unrecognized tax benefits.

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UNIVERSAL ELECTRONICS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2017
(Unaudited)


Note 8 — Accrued Compensation
The components of accrued compensation were as follows:
(In thousands)
September 30, 2017
 
December 31, 2016
Accrued social insurance (1)
$
17,506

 
$
19,974

Accrued salary/wages
7,721

 
7,903

Accrued vacation/holiday
2,844

 
2,411

Accrued bonus (2)
1,985

 
2,421

Accrued commission
851

 
933

Accrued medical insurance claims
284

 
122

Other accrued compensation
2,137

 
1,816

Total accrued compensation
$
33,328

 
$
35,580

 
(1) 
Effective January 1, 2008, the Chinese Labor Contract Law was enacted in the PRC. This law mandated that PRC employers remit the applicable social insurance payments to their local government. Social insurance is comprised of various components such as pension, medical insurance, job injury 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, 2017 and December 31, 2016.
(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 $0.7 million and $0.7 million at September 30, 2017 and December 31, 2016, respectively.

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UNIVERSAL ELECTRONICS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2017
(Unaudited)


Note 9 — Other Accrued Expenses
The components of other accrued expenses were as follows:
(In thousands)
September 30, 2017
 
December 31, 2016
Advertising and marketing
$
272

 
$
213

Deferred revenue
79

 
1,431

Deposit for sale of Guangzhou factory
4,799

 

Duties
757

 
1,127

Freight and handling fees
2,176

 
1,919

Product development
485

 
454

Product warranty claim costs
218

 
134

Professional fees
1,691

 
1,313

Property, plant, and equipment
1,564

 
1,017

Sales taxes and VAT
2,587

 
2,715

Short-term contingent consideration
3,400

 

Third-party commissions
685

 
853

Tooling (1)
1,769

 
1,520

Unrealized loss on foreign currency exchange contracts
86

 
1,623

URC court order and settlement agreement (Note 2)

 
6,622

Utilities
392

 
331

Other
4,880

 
3,138

Total other accrued expenses
$
25,840

 
$
24,410

 
(1) 
The tooling accrual balance relates to unearned revenue for tooling that will be sold to customers.
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,
2017
 
2016
Balance at beginning of period
$
134

 
$
35

Accruals for warranties issued during the period
169

 
100

Settlements (in cash or in kind) during the period
(85
)
 

Balance at end of period
$
218

 
$
135


Restructuring Activities and Sale of Guangzhou Factory
In the first quarter of 2016, we implemented a plan to reduce the impact of rising labor rates in China by transitioning manufacturing activities from our southern-most China factory, located in the city of Guangzhou in the Guangdong province, to our other China factories where labor rates are rising at a slower rate. As a result, we incurred severance costs of $0.4 million and $0.1 million during the three months ended September 2017 and 2016, respectively, and $6.1 million and $1.6 million during the nine months ended September 30, 2017 and 2016, respectively, which are included within operating expenses. All operations in our Guangzhou factory ceased in July 2017. Accordingly, we do not expect to incur significant further severance or other restructuring costs related to this factory transition. At September 30, 2017, we had $0.2 million of unpaid severance costs included within accrued compensation.

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UNIVERSAL ELECTRONICS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2017
(Unaudited)


On September 26, 2016, we entered into an agreement to sell our Guangzhou manufacturing facility for RMB 320 million (approximately $48.0 million based on September 30, 2017 exchange rates). Under the terms of this agreement, we have up to 24 months to cease all operations within the facility. The closing of the sale will be subject to customary due diligence and local regulatory approval and per the terms of the agreement could take up to approximately 28 months from the execution of the agreement. In accordance with the terms of the agreement, the buyer deposited 10% of the purchase price into an escrow account at agreement inception, which we have presented as restricted cash in our consolidated balance sheet (also refer to Note 2). The remaining balance of the purchase price is to be placed into the escrow account prior to the closing of the sale and will be released to us upon closing. Since all operations at our Guangzhou manufacturing facility ceased as of the end of July 2017, the related building and land lease assets of $12.4 million are classified as assets held for sale in our September 30, 2017 consolidated balance sheet.
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 that UEBV previously 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 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 stay any decision of compensation and/or damages until all aspects of the case have been decided. We are presently deciding whether to appeal this Court’s rulings and have until later this year to file notice of appeal. Finally, 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 are in the process of assembling this additional information and scheduling a date for rehearing. On September 5, 2017, Ruwido and FMH filed a patent infringement case on the merits against UEBV and Telenet alleging the same claims of infringement as in the Belgium Courts (see above). This matter is in its early stages and as such we have not yet answered. But, as in the Belgium case, UEBV and Telenet will deny all claims of infringement and vigorously defend against these claims.
On January 26, 2017, OpenTV, Inc., Nagra USA, Inc., Nagravision SA, and Kudelski SA (collectively, the “Kudelski Group”) filed a request with the U.S. International Trade Commission (“ITC”) to institute an investigation pursuant to Section 337 of the Tariff Act of 1930, as amended, concerning certain remote control devices we supply Comcast Corporation (“Comcast”), which request was accepted by the ITC. On July 21, 2017, the Kudelski Group filed a motion to terminate the investigation as to all parties, including us and this motion was accepted by the ITC on August 11, 2017.
On March 15, 2017, one of our employee’s filed a lawsuit against us and certain of our employees in the Superior Court of California, County of Orange, claiming hostile work environment based on sexual orientation, intentional infliction of emotional distress, failure to prevent hostile work environment, retaliation, and constructive termination. We have answered by denying all of the employee’s claims and have filed a countersuit against this employee claiming, among other things that he has breached his duty of loyalty to us, that he stole certain of our property, that he converted certain of our property to his own benefit. We are still in the early stages of this case as discovery has recently commenced.
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

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UNIVERSAL ELECTRONICS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2017
(Unaudited)


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. Repurchases may be made whenever we deem a repurchase to be a good use of our cash and the repurchase enhances shareholder value. As of September 30, 2017, we had 114,271 shares available for repurchase on the open market under the Board's authorizations. On October 23, 2017, our Board increased these repurchase authorizations by 300,000 shares bringing the total authorization as of the approval date to 386,434 shares. Shares may also be tendered by employees to satisfy tax withholding obligations in connection with the vesting of restricted stock.
Repurchased shares of our common stock were as follows:
 
Nine Months Ended September 30,
(In thousands)
2017
 
2016
Shares repurchased
330

 
40

Cost of shares repurchased
$
20,217

 
$
2,188

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, which has included compensating our outside directors.
Note 12 — Business Segment and Foreign Operations
Reportable Segment
An operating segment, in part, is a component of an enterprise whose operating results are regularly reviewed by the chief operating decision maker to make decisions about resources to be allocated to the segment and assess its performance. Operating segments may be aggregated only to a limited extent. Our chief operating decision maker, the Chief Executive Officer, reviews financial information presented on a consolidated basis, accompanied by disaggregated information about revenues for purposes of making operating decisions and assessing financial performance. Accordingly, we only have a single operating and reportable segment.
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)
2017
 
2016
 
2017
 
2016
United States
$
85,762

 
$
88,243

 
$
253,259

 
$
263,053

Asia (excluding PRC)
26,113

 
22,099

 
77,679

 
64,290

People's Republic of China
23,437

 
19,899

 
61,015

 
59,978

Europe
18,877

 
19,389

 
56,041

 
53,716

Latin America
13,567

 
13,032

 
44,593

 
32,273

Other
7,896

 
6,523

 
22,051

 
17,519

Total net sales
$
175,652

 
$
169,185


$
514,638


$
490,829

Specific identification of the customer billing location was the basis used for attributing revenues from external customers to geographic areas.

18

Table of Contents
UNIVERSAL ELECTRONICS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2017
(Unaudited)


Long-lived tangible assets by geographic area were as follows:
(In thousands)
September 30, 2017
 
December 31, 2016
United States
$
14,233

 
$
11,948

People's Republic of China
95,165

 
94,113

All other countries
3,791

 
4,186

Total long-lived tangible assets
$
113,189

 
$
110,247

Note 13 — Stock-Based Compensation
Stock-based compensation expense for each employee and director is presented in the same income statement caption as their cash compensation. Stock-based compensation expense by income statement caption and the related income tax benefit were as follows:
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
(In thousands)
2017
 
2016
 
2017
 
2016
Cost of sales
$
19

 
$
14

 
$
53

 
$
43

Research and development expenses
149

 
136

 
412

 
409

Selling, general and administrative expenses:
 
 
 
 
 
 
 
Employees
1,843

 
1,748

 
5,562

 
5,324

Outside directors
1,910

 
770

 
3,449

 
1,862

Total employee and director stock-based compensation expense
$
3,921


$
2,668


$
9,476


$
7,638

 
 
 
 
 
 
 
 
Income tax benefit
$
603

 
$
812

 
2,307

 
2,281


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, 2016
652

 
$
39.27

 
 
 
 
Granted
92

 
62.70

 
 
 
 
Exercised
(45
)
 
24.87

 
 
 
$
1,893

Forfeited/canceled/expired
(168
)
 
46.44

 
 
 
 
Outstanding at September 30, 2017 (1)
531

 
$
42.26

 
4.49
 
$
11,391

Vested and expected to vest at September 30, 2017 (1)
531

 
$
42.26

 
4.49
 
$
11,390

Exercisable at September 30, 2017 (1)
378

 
$
35.35

 
3.94
 
$
10,731

(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 2017 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, 2017. This amount will change based on the fair market value of our stock.
On September 11, 2017, the independent members of our Board of Directors voluntarily surrendered 150,000 stock options originally granted to them in February 2016, resulting in the acceleration and recording of $1.2 million of stock-based compensation expense during the three and nine months ended September 30, 2017. This amount represented all remaining unamortized compensation expense associated with the surrendered stock options as of the surrender date.

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Table of Contents
UNIVERSAL ELECTRONICS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2017
(Unaudited)


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,
 
2017
 
2016
 
2017
 
2016
Weighted average fair value of grants
$

 
$

 
$
19.61

 
$
17.96

Risk-free interest rate
%
 
%
 
1.75
%
 
1.36
%
Expected volatility
%
 
%
 
34.25
%
 
41.38
%
Expected life in years
0.00

 
0.00

 
4.52

 
4.55

As of September 30, 2017, we expect to recognize $2.4 million of total unrecognized pre-tax stock-based compensation expense related to non-vested stock options over a remaining weighted-average life of 1.8 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, 2016
153

 
$
57.43

Granted
132

 
64.14

Vested
(59
)
 
61.28

Forfeited
(4
)
 
60.71

Non-vested at September 30, 2017
222

 
$
60.34

As of September 30, 2017, we expect to recognize $9.8 million of total unrecognized pre-tax stock-based compensation expense related to non-vested restricted stock awards over a weighted-average life of 1.7 years.  
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 (with the first two-year period commencing on January 1, 2016) 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. To fully vest in the rights to purchase all of the underlying shares, Comcast and its affiliates must purchase an aggregate of $1.02 billion in goods and services from us during the six-year vesting period.

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Table of Contents
UNIVERSAL ELECTRONICS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2017
(Unaudited)


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, 2017, 100,000 of the warrants had vested.
The fair value of the warrants is determined using the Black-Scholes option pricing model. The assumptions we utilized and the resulting fair value of the warrants were the following:
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2017
 
2016
 
2017
 
2016
Fair value
$
24.17

 
$
38.32

 
$
24.17

 
$
38.32

Price of Universal Electronics Inc. common stock
$
62.10

 
$
74.99

 
$
62.10

 
$
74.99

Risk-free interest rate
1.93
%
 
1.32
%
 
1.93
%
 
1.32
%
Expected volatility
34.41
%
 
40.54
%
 
34.41
%
 
40.54
%
Expected life in years
5.26

 
6.25

 
5.26

 
6.25

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)
2017
 
2016
 
2017
 
2016
Reduction/(increase) to net sales
$
(141
)
 
$
1,160

 
$
1,122

 
$
3,219

Income tax (benefit)/expense
53

 
(426
)
 
(418
)
 
(1,182
)
At September 30, 2017, we estimated the number of warrants that will vest based on the combination of purchases already made and 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, 2017 was $14.2 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)
2017
 
2016
 
2017
 
2016
Net gain (loss) on foreign currency exchange contracts (1)
$
(1,488
)
 
$
(218
)
 
$
(2,852
)
 
$
(894
)
Net gain (loss) on foreign currency exchange transactions
1,176

 
439

 
2,512

 
2,455

Other income (expense)
373

 
114

 
342

 
165

Other income (expense), net
$
61

 
$
335


$
2


$
1,726

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

21

Table of Contents
UNIVERSAL ELECTRONICS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2017
(Unaudited)


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)
2017
 
2016
 
2017
 
2016
BASIC
 
 
 
 
 
 
 
Net income attributable to Universal Electronics Inc.
$
1,728

 
$
7,807

 
$
6,531

 
$
17,118

Weighted-average common shares outstanding
14,381

 
14,510

 
14,412

 
14,441

Basic earnings per share attributable to Universal Electronics Inc.
$
0.12

 
$
0.54


$
0.45


$
1.19

 
 
 
 
 
 
 
 
DILUTED
 
 
 
 
 
 
 
Net income attributable to Universal Electronics Inc.
$
1,728

 
$
7,807

 
$
6,531

 
$
17,118

Weighted-average common shares outstanding for basic
14,381

 
14,510

 
14,412

 
14,441

Dilutive effect of stock options, restricted stock and common stock warrants
285

 
338

 
277


299

Weighted-average common shares outstanding on a diluted basis
14,666

 
14,848

 
14,689

 
14,740

Diluted earnings per share attributable to Universal Electronics Inc.
$
0.12

 
$
0.53


$
0.44


$
1.16

The number of stock options and shares of restricted stock excluded from the computation of diluted earnings per common share were as follows:
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
(In thousands)
2017
 
2016
 
2017
 
2016
Stock options
165

 

 
153

 
111

Restricted stock awards
30

 
5

 
30

 
8

Note 17 — Derivatives
The following table sets forth the total net fair value of derivatives:  
 
 
September 30, 2017
 
December 31, 2016
 
 
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
 
$

 
$
(385
)
 
$

 
$
(385
)
 
$

 
$
(1,584
)
 
$

 
$
(1,584
)
We held foreign currency exchange contracts, which resulted in a net pre-tax loss of $1.5 million and $0.2 million for the three months ended September 30, 2017 and 2016, respectively. For the nine months ended September 30, 2017 and 2016, we had a net pre-tax loss of $2.9 million and $0.9 million, respectively (see Note 15).

22

Table of Contents
UNIVERSAL ELECTRONICS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2017
(Unaudited)


Details of foreign currency exchange contracts held were as follows:
Date Held
 
Type
 
Position Held
 
Notional Value
(in millions)
 
Forward Rate
 
Unrealized Gain/(Loss) Recorded at Balance Sheet
Date
(in thousands)(1)
 
Settlement Date
September 30, 2017
 
USD/Euro
 
USD
 
$
17.0

 
1.2039

 
$
299

 
October 27, 2017
September 30, 2017
 
USD/Chinese Yuan Renminbi
 
USD
 
$
22.0

 
6.6174

 
$
111

 
October 20, 2017
September 30, 2017
 
USD/Brazilian Real
 
USD
 
$
4.5

 
3.2330

 
$
(86
)
 
October 20, 2017
September 30, 2017
 
USD/Brazilian Real
 
BRL
 
$
1.0

 
3.3660

 
$
61

 
October 20, 2017
 
 
 
 
 
 
 
 
 
 
 
 
 
December 31, 2016
 
USD/Euro
 
USD
 
$
18.0

 
1.0513

 
$
(61
)
 
January 27, 2017
December 31, 2016
 
USD/Chinese Yuan Renminbi
 
Chinese Yuan Renminbi
 
$
25.0

 
6.7230

 
$
(974
)
 
January 13, 2017
December 31, 2016
 
USD/Chinese Yuan Renminbi
 
Chinese Yuan Renminbi
 
$
10.0

 
6.6757

 
$
(457
)
 
January 13, 2017
December 31, 2016
 
USD/Brazilian Real
 
USD
 
$
2.0

 
3.4775

 
$
(131
)
 
January 13, 2017
December 31, 2016
 
USD/Brazilian Real
 
USD
 
$
4.0

 
3.2316

 
$
39

 
January 13, 2017
(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 expenses.
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. Additionally, we incurred $0.1 million in acquisition costs, consisting primarily of accounting related expenses, which are included within selling, general and administrative expenses for the nine months ended September 30, 2017. The acquisition 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 sold and marketed by RCS.
Our consolidated income statement for the three and nine months ended September 30, 2017 includes net sales of $0.8 million and $2.2 million, respectively, and net losses of $0.3 million and $0.7 million, respectively, 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 RCS 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

23

Table of Contents
UNIVERSAL ELECTRONICS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2017
(Unaudited)


under U.S. GAAP. The fair value of earnout consideration is presented as long-term contingent consideration in our consolidated balance sheet at September 30, 2017.
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
 
Preliminary 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 are 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. Under the relief from royalty method, the fair value of the intangible asset is estimated to be the present value of the royalties saved because the company owns the intangible asset. Revenue projections and estimated useful life were significant inputs into estimating the value of the RCS trade name.
The fair value assigned to RCS customer relationships and order backlog intangible assets were determined utilizing a multi-period excess earnings approach. Under the multi-period excess earnings approach, the fair value of the intangible asset is estimated to be the present value of future earnings attributable to the asset and utilizes revenue and cost projections, including an assumed contributory asset charge.
The trade name, customer relationships and order backlog intangible assets are expected to be deductible for income tax purposes.
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.

24

Table of Contents
UNIVERSAL ELECTRONICS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2017
(Unaudited)


 
Three Months Ended September 30, 2017
 
Nine Months Ended September 30, 2017
(In thousands, except per-share amounts)
2017
 
2016
 
2017
 
2016
Net sales
$
175,652

 
$
170,658

 
$
515,200

 
$
497,172

Net income
1,751

 
7,525

 
6,292

 
16,892

Net income attributable to Universal Electronics Inc.
1,751

 
7,525

 
6,292

 
16,892

Basic earnings per share attributable to Universal Electronics Inc.
$
0.12

 
$
0.52

 
$
0.44

 
$
1.17

Diluted earnings per share attributable to Universal Electronics Inc.
$
0.12

 
$
0.51

 
$
0.43

 
$
1.14


For purposes of determining pro forma net income attributable to Universal Electronics Inc., adjustments were made to all periods presented in the table above. The pro forma net income and net income attributable to Universal Electronics Inc. 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, and a net increase in amortization expense of $0.2 million and $0.5 million for the three and nine months ended September 30, 2016, respectively. Additionally, acquisition costs totaling $0.1 million are excluded from pro forma net income attributable to Universal Electronics Inc. All adjustments have been made net of their related tax effects.


25

Table of Contents

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 dealers 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 approximately one million individual device functions and approximately 8,000 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 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 more than 400 pending and issued patents related to remote controls and home automation.
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, 2017:
Net sales increased 3.8% to $175.7 million for the three months ended September 30, 2017 from $169.2 million for the three months ended September 30, 2016.
Our gross margin percentage decreased from 24.7% for the three months ended September 30, 2016 to 24.5% for the three months ended September 30, 2017.
Operating expenses, as a percent of net sales, increased from 19.9% for the three months ended September 30, 2016 to 22.1% for the three months ended September 30, 2017.
Our operating income decreased from $8.1 million for the three months ended September 30, 2016 to $4.2 million for the three months ended September 30, 2017, and our operating margin percentage decreased from 4.8% for the three months ended September 30, 2016 to 2.4% for the three months ended September 30, 2017.
Our effective tax rate increased to 51.4% for the three months ended September 30, 2017, compared to 5.1% for the three months ended September 30, 2016.
Our strategic business objectives for 2017 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.
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

26

Table of Contents

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. We do not believe that there have been any significant changes during the nine months ended September 30, 2017 to the items that we disclosed as our critical accounting policies and estimates in Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations" contained in our Annual Report on Form 10-K for our fiscal year ended December 31, 2016.
Recent Accounting Pronouncements
See Note 1 contained in the "Notes to Consolidated Financial Statements" for a discussion of recent accounting pronouncements.
Results of Operations
The following table sets forth our results of operations expressed as a percentage of net sales for the periods indicated.
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2017
 
2016
 
2017
 
2016
Net sales
100.0
 %
 
100.0
 %
 
100.0
 %
 
100.0
 %
Cost of sales
75.5

 
75.3


75.2


75.0

Gross profit
24.5

 
24.7

 
24.8

 
25.0

Research and development expenses
3.1

 
2.9

 
3.1

 
3.1

Factory transition restructuring charges
0.2

 
0.1

 
1.2

 
0.3

Selling, general and administrative expenses
18.8

 
16.9

 
18.4

 
17.7

Operating income
2.4

 
4.8


2.1


3.9

Interest income (expense), net
(0.4
)
 
(0.1
)
 
(0.3
)
 
(0.2
)
Other income (expense), net
0.0

 
0.2

 
0.0

 
0.4

Income before provision for income taxes
2.0

 
4.9


1.8


4.1

Provision for income taxes
1.0

 
0.3

 
0.6

 
0.6

Net income
1.0

 
4.6


1.2


3.5

Net income attributable to noncontrolling interest

 

 

 
0.0

Net income attributable to Universal Electronics Inc.
1.0
 %
 
4.6
 %

1.2
 %

3.5
 %

27

Table of Contents

Three Months Ended September 30, 2017 versus Three Months Ended September 30, 2016
Net sales. Net sales for the three months ended September 30, 2017 were $175.7 million, an increase of 3.8% compared to $169.2 million for the three months ended September 30, 2016. Net sales by our Business and Consumer lines were as follows:
 
Three Months Ended September 30,
 
2017
 
2016
 
$ (millions)
 
% of total
 
$ (millions)
 
% of total
Business
$
163.1

 
92.8
%
 
$
157.2

 
92.9
%
Consumer
12.6

 
7.2

 
12.0

 
7.1

Total net sales
$
175.7

 
100.0
%
 
$
169.2

 
100.0
%
Net sales in our Business lines (subscription broadcasting, OEM, and computing companies) were 92.8% of net sales for the three months ended September 30, 2017 compared to 92.9% for the three months ended September 30, 2016. Net sales in our Business lines for the three months ended September 30, 2017 increased by 3.8% to $163.1 million from $157.2 million driven primarily by increased sales of home security products, increased sales to consumer electronics companies in Asia, and the rollout of higher end platforms in Europe. These increases were partially offset by a decrease in sales to North American satellite broadcasting customers as certain customers are in the process of depleting their current stock of inventory in preparation for the launch of their new advanced platforms.
Net sales in our Consumer lines (One For All® retail and private label) were 7.2% of net sales for the three months ended September 30, 2017 compared to 7.1% for the three months ended September 30, 2016. Net sales in our Consumer lines for the three months ended September 30, 2017 increased by 5.0% to $12.6 million from $12.0 million in the three months ended September 30, 2016 driven primarily by growth in international markets outside of Europe.
Gross profit. Gross profit for the three months ended September 30, 2017 was $43.1 million compared to $41.8 million for the three months ended September 30, 2016. Gross profit as a percent of sales decreased to 24.5% for the three months ended September 30, 2017 compared to 24.7% for the three months ended September 30, 2016. The gross margin percentage was unfavorably impacted by price reductions granted to certain large volume customers, manufacturing inefficiencies experienced due to our factory transition activities in China, and lower-margin projects undertaken in Latin America. These impacts were partially offset by raw material cost savings.
Research and development ("R&D") expenses. R&D expenses increased 9.3% to $5.4 million for the three months ended September 30, 2017 from $5.0 million for the three months ended September 30, 2016 primarily driven by R&D efforts dedicated to developing new product offerings for new and existing product categories.
Factory transition restructuring charges. In the first quarter of 2016, we implemented a plan to reduce the impact of rising labor rates in China by transitioning manufacturing activities from our southern-most China factory, located in the city of Guangzhou in the Guangdong province, to our other China factories where labor rates are rising at a slower rate. As a result, we incurred severance costs of $0.4 million and $0.1 million for the three months ended September 30, 2017 and 2016, respectively. We ceased manufacturing operations in our Guangzhou factory during the third quarter of 2017 and as a result, we do not expect to incur a significant amount of additional severance costs associated with the transition of manufacturing activities from this location.
Selling, general and administrative ("SG&A") expenses. SG&A expenses increased 15.3% to $33.0 million for the three months ended September 30, 2017 from $28.6 million for the three months ended September 30, 2016. The increase was primarily due to incremental expense recorded to reflect an increase in the value of contingent consideration to be paid in connection with our acquisition of the net assets of Ecolink Intelligent Technology, Inc. ("Ecolink"); increased stock-based compensation expense; and increased payroll and benefits attributable to annual merit increases and additional headcount to support product development efforts. Partially offsetting these increases was a decrease in legal expense as a result of higher legal fees in the prior year period related to patent litigation matters.
Interest income (expense), net. Net interest expense was $0.7 million for the three months ended September 30, 2017 compared to net interest expense of $0.2 million for the three months ended September 30, 2016 as a result of an increased level of borrowings on our line of credit.
Other income (expense), net. Net other income was $0.1 million for the three months ended September 30, 2017 compared to net other income of $0.3 million for the three months ended September 30, 2016. This change was driven primarily by foreign currency losses associated with fluctuations in the Chinese Yuan Renminbi and British Pound exchange rates versus the U.S. Dollar.

28

Table of Contents

Provision for income taxes. Income tax expense was $1.8 million for the three months ended September 30, 2017 compared to $0.4 million for the three months ended September 30, 2016. Our effective tax rate was 51.4% for the three months ended September 30, 2017 compared to 5.1% for the three months ended September 30, 2016. The increase in our effective tax rate was primarily due to the nondeductibility of certain transactions in China as a result of the pending sale of our Guangzhou factory. In addition, during the three months ended September 30, 2016, we received tax refunds from the Chinese government totaling $1.8 million for various tax incentives relating to fiscal year 2015.
Nine Months Ended September 30, 2017 versus Nine Months Ended September 30, 2016
Net sales. Net sales for the nine months ended September 30, 2017 were $514.6 million, an increase of 4.8% compared to $490.8 million for the nine months ended September 30, 2016. Net sales by our Business and Consumer lines were as follows:
 
Nine Months Ended September 30,
 
2017
 
2016
 
$ (millions)
 
% of total
 
$ (millions)
 
% of total
Business
$
477.9

 
92.9
%
 
$
456.3

 
93.0
%
Consumer
36.7

 
7.1

 
34.5

 
7.0
%
Total net sales
$
514.6

 
100.0
%
 
$
490.8

 
100.0
%
Net sales in our Business lines (subscription broadcasting, OEM, and computing companies) were 92.9% of net sales for the nine months ended September 30, 2017 compared to 93.0% for the nine months ended September 30, 2016. Net sales in our Business lines for the nine months ended September 30, 2017 increased by 4.7% to $477.9 million from $456.3 million driven primarily by increased sales of home security products, increased market share in Latin America, the rollout of higher end platforms in Europe and increased sales to consumer electronics companies in Asia. These increases were partially offset by a decrease in sales to North American satellite broadcasting customers as certain customers are in the process of depleting their current stock of inventory in preparation for the launch of their new advanced platforms.
Net sales in our Consumer lines (One For All