The following discussion should be read in conjunction with the Consolidated Financial Statements and the related notes that appear elsewhere in this report.
Cautionary Statement
All statements in this report are made as of the date this Form 10-Q is filed with theU.S. Securities and Exchange Commission (the "SEC"). We undertake no obligation to publicly update or revise these statements, whether as a result of new information, future events or otherwise. We make forward-looking statements in Management's Discussion and Analysis of Financial Condition and Results of Operations and elsewhere in this report based on the beliefs and assumptions of our management and on information available to us through the date this Form 10-Q is filed with theSEC . Forward-looking statements include information related to the future effects on our business of the coronavirus pandemic ("COVID-19"); supply chain issues; other future demand and recovery trends and expectations; the delay by or failure of our customers to order products from us; the effects of natural or other events beyond our control, including the effects of political unrest, war (including the conflict betweenRussia andUkraine ) or terrorist activities may have on us or the economy; the economic environment's including increases in interest rates and recessionary effects on us or our customers; the effects of doing business internationally; our expectations regarding our ability to meet our liquidity requirements; our capital expenditures and other investment spending expectations; the timing and amount of future share repurchases; and other statements that are preceded by, followed by, or include the words "believes," "expects," "anticipates," "intends," "plans," "estimates," "foresees," or similar expressions; and similar statements concerning anticipated future events and expectations that are not historical facts. We caution you that these statements are not guarantees of future performance and are subject to numerous evolving risks and uncertainties that we may not be able to accurately predict or assess, including the risks and uncertainties we describe in our Annual Report on Form 10-K for the fiscal year endedDecember 31, 2021 ("2021 Form 10-K"), Part II, Item 1A of this report, and other factors we describe from time to time in our periodic filings with theSEC .
Overview
We design, develop, manufacture, ship and support control and sensor technology solutions and a broad line of universal control systems, audio-video ("AV") accessories, and intelligent wireless security and smart home products that are used by the world's leading brands in the video services, consumer electronics, security, home automation, climate control, and home appliance markets. Our product and technology offerings include: •easy-to-use, voice-enabled, automatically-programmed universal remote controls with two-way radio frequency ("RF") as well as infrared ("IR") remote controls, that are sold primarily to video service providers (cable, satellite, Internet Protocol television ("IPTV") and Over the Top ("OTT") services), original equipment manufacturers ("OEMs"), retailers, and private label customers;
•integrated circuits ("ICs"), on which our software and universal device control database is embedded, sold primarily to OEMs, video service providers, and private label customers;
•software, firmware and technology solutions that can enable devices such as TVs, set-top boxes, audio systems, smart speakers, game controllers and other consumer electronic and smart home devices to wirelessly connect and interact with home networks and interactive services to control and deliver home entertainment, smart home services and device or system information;
•cloud-services that support our embedded software and hardware solutions (directly or indirectly) enabling software update and device provisioning services, as well as real-time device identification and system control with billions of transactions per year in device and data management;
•intellectual property that we license primarily to OEMs and video service providers;
•proprietary and standards-based RF sensors designed for residential security, safety and home automation applications;
•wall-mount and handheld thermostat controllers and connected accessories for intelligent energy management systems, primarily to OEM customers, as well as hotels and hospitality system integrators; and 26
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•AV accessories sold, directly and indirectly, to consumers including universal remote controls, television wall mounts and stands and digital television antennas.
A key factor in creating products and software for control of entertainment devices is our proprietary device knowledge graph. Since our beginning in 1986, we have compiled an extensive device control knowledge library that includes over 13,100 brands comprising over 1,013,000 device models across AV and smart home platforms, supported by many common smart home protocols, including IR, HDMI-CEC, Zigbee (Rf4CE) Z-Wave, and IP, as well as Home Network and Cloud Control.
This device knowledge graph is backed by our unique device fingerprinting technology, which includes nearly 32.6 million unique device fingerprints across both AV and Smart Home devices.
Our technology also includes other remote controlled home entertainment devices and home automation control modules, as well as wired Consumer Electronics Control ("CEC") and wireless IP control protocols commonly found on many of the latest HDMI and internet connected devices. Our proprietary software automatically detects, identifies and enables the appropriate control commands for many home entertainment and automation devices in the home. Our libraries are continuously updated with device control codes used in newly introduced AV and Internet of Things devices. These control codes are captured directly from original control devices or from the manufacturers' written specifications to ensure the accuracy and integrity of the library. Our proprietary software and know-how permit us to offer a device control code database that is more robust and efficient than similarly priced products of our competitors. We hold a number of patents inthe United States and abroad related to our products and technology and have filed domestic and foreign applications for other patents that are pending. AtJune 30, 2022 , we had 670 issued and pendingU.S. 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 two domestic subsidiaries and 25 international subsidiaries located inBrazil ,British Virgin Islands ,France ,Germany ,Hong Kong (3),India ,Italy ,Japan ,Korea ,Mexico (2),the Netherlands ,People's Republic of China (the "PRC") (7),Singapore ,Spain ,United Kingdom andVietnam .
To recap our results for the three months ended
•Net sales decreased 7.6% to
•Our gross margin percentage decreased to 28.3% for the three months ended
•Operating expenses, as a percentage of net sales, increased to 24.3% for the three months endedJune 30, 2022 from 23.7% for the three months endedJune 30, 2021 . •Our operating income decreased to$5.5 million for the three months endedJune 30, 2022 from$9.0 million for the three months endedJune 30, 2021 . Our operating income percentage decreased to 4.0% for the three months endedJune 30, 2022 from 6.0% for the three months endedJune 30, 2021 .
•Income tax expense decreased to
Our strategic business objectives for 2022 include the following:
•continue to develop and market advanced remote control products and technologies our customer base is adopting; •continue to broaden our home control and home automation product offerings; •continue to expand our software and service offerings to deliver a complete managed service platform; •continue to invest in creating technology differentiation across our global product portfolio; •further penetration of international subscription broadcasting markets; •acquire new customers in historically strong regions; •increase our share with existing customers; •continue to seek acquisitions or strategic partners that complement and strengthen our existing business; and •continue our long-term factory planning strategy of reducing our concentration risk inthe People's Republic of China . 27 -------------------------------------------------------------------------------- Table of Contents 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.
COVID-19 Pandemic and Supply Chain Impact
The COVID-19 pandemic has been and continues to be a complex and rapidly-evolving situation, and with the emergence of the COVID-19 Omicron variant, it continues to have a material impact on our business. Local lockdowns near our southernChina factory during the last two weeks of the first quarter of 2022 temporarily caused labor shortages that negatively affected our ability to manufacture at full capacity and to meet customer demand. As of the issuance of this report, our southernChina factory and our other factories are operating at or near labor capacity. The global health crisis caused by the COVID-19 pandemic may continue to negatively impact our business. We have also been negatively impacted by supply chain difficulties including obtaining ICs and other long-lead time components and we expect this to continue into 2023. While we are taking production and inventory control steps in order to mitigate the effects caused by these shortages, we cannot guarantee that these steps will allow us to meet our short term IC and other component parts needs. As such, these supply constraints continue to cause difficulty and delays in our ability to fulfill customer orders and have at times resulted in increased logistics costs. In addition, many of our products are paired with certain of our customers' products, like set-top boxes or televisions. If those customers are not able to obtain sufficient quantities of ICs for their products, their demand for our products may decrease. The overall operational and financial impact of the above is highly dependent on the risk factors disclosed under the headings "Risks Relating to COVID-19" and "Risks Relating to Operations" in Part I, Item 1A, "Risk Factors," of our 2021 Form 10-K and could be affected by other factors we are not currently able to predict. Macroeconomic Conditions We have been negatively impacted and we expect to continue to be negatively impacted by adverse macroeconomic conditions. Inflation has increased our component and logistics costs. While we have been able to increase sales prices on certain products, we may not be able to fully offset the impact of increased material costs which would negatively impact our gross profit. Our cost of labor, materials and borrowing may continue to increase which would negatively impact our business and financial results. In addition, we expect recessionary fears in the global economy will ultimately negatively impact our sales demand.
Critical Accounting Policies and Estimates
The preparation of financial statements in conformity withU.S. GAAP requires us to make estimates and judgments that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. On an ongoing basis, we evaluate our estimates and judgments, including those related to revenue recognition, inventory valuation, impairment of long-lived assets, intangible assets and goodwill and income taxes. Actual results may differ from these judgments and estimates, and they may be adjusted as more information becomes available. Any adjustment may be significant and may have a material impact on our consolidated financial statements. An accounting estimate is deemed to be critical if it requires an accounting estimate to be made based on assumptions about matters that are highly uncertain at the time the estimate is made, if different estimates reasonably may have been used, or if changes in the estimate that are reasonably likely to occur may materially impact the financial statements. We do not believe that there have been any significant changes during the six months endedJune 30, 2022 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 endedDecember 31, 2021 .
Recent Accounting Pronouncements
See Note 1 contained in the "Notes to Consolidated Financial Statements" for a discussion of recent accounting pronouncements.
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The following table sets forth our reported results of operations expressed as a percentage of net sales for the periods indicated.
Three Months Ended June 30, Six Months Ended June 30, 2022 2021 2022 2021 Net sales 100.0 % 100.0 % 100.0 % 100.0 % Cost of sales 71.7 70.3 72.1 69.8 Gross profit 28.3 29.7 27.9 30.2 Research and development expenses 6.2 5.1 6.1 5.1 Selling, general and administrative expenses 18.1 18.6 20.0 19.2 Operating income 4.0 6.0 1.8 5.9 Interest income (expense), net (0.2) (0.1) (0.2) (0.1) Other income (expense), net (0.5) 0.0 (0.1) 0.0 Income before provision for income taxes 3.3 5.9 1.5 5.8 Provision for income taxes 1.2 2.2 1.5 1.6 Net income 2.1 % 3.7 % - % 4.2 % Three Months EndedJune 30, 2022 versus Three Months EndedJune 30, 2021 Net sales. Net sales for the three months endedJune 30, 2022 were$139.1 million compared to$150.5 million for the three months endedJune 30, 2021 . Our subscription broadcast channel experienced the largest decrease in sales when compared to the prior year period as a result of component shortages and lower customer demand. Sales in our retail channel also declined due a loss of a customer inNorth America and macroeconomic headwinds. Partially offsetting these decreases is an increase in sales in our HVAC channel as we continue to gain market share. Gross profit. Gross profit for the three months endedJune 30, 2022 was$39.4 million compared to$44.7 million for the three months endedJune 30, 2021 . Gross profit as a percentage of sales decreased to 28.3% for the three months endedJune 30, 2022 from 29.7% for the three months endedJune 30, 2021 as a direct result of inflationary pressures associated with raw materials and components, freight costs and wages. In order to mitigate the effect of inflationary pressures, we implemented sales price increases on certain products throughout the first two quarters of 2022.
Research and development ("R&D") expenses. R&D expenses increased to
Selling, general and administrative ("SG&A") expenses. SG&A expenses decreased to$25.2 million for the three months endedJune 30, 2022 from$28.0 million for the three months endedJune 30, 2021 , primarily due to a decrease in outside legal expenses related to a specific legal matter. Interest income (expense), net. Interest expense, net increased to$0.2 million for the three months endedJune 30, 2022 from$0.1 million for the three months endedJune 30, 2021 , as a result of a higher average loan balance and a higher interest rate. Other income (expense), net. Other expense, net increased to$0.7 million for the three months endedJune 30, 2022 from$17.0 thousand for the three months endedJune 30, 2021 , mainly due to a one-time expense which we have filed an insurance claim. Provision for income taxes. Income tax expense was$1.6 million for the three months endedJune 30, 2022 , representing an effective tax rate of 35.3% compared to income tax expense of$3.3 million for the three months endedJune 30, 2021 , representing an effective tax rate of 37.0%. We expect theU.S. to be in a pre-tax loss position without benefit for the full year 2022, which is the primary reason for the elevated effective tax rate. In addition, recent legislative changes for research and experimentation costs and creditability of certain foreign income taxes have resulted in a modest increase to our effective tax rate. 29
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Six Months Ended
Net sales. Net sales for the six months endedJune 30, 2022 were$271.5 million , a decrease compared to$301.0 million for the six months endedJune 30, 2021 . Sales in our subscription broadcast channel were lower than the prior year period due primarily to component shortages and lower customer demand. Sales in our retail channel were also lower than the prior year period due to the loss of a customer inNorth America and macroeconomic headwinds. Gross profit. Gross profit for the six months endedJune 30, 2022 was$75.6 million compared to$91.1 million for the six months endedJune 30, 2021 . Gross profit as a percentage of sales decreased to 27.9% for the six months endedJune 30, 2022 from 30.2% for the six months endedJune 30, 2021 . Gross profit as a percentage of sales was unfavorably impacted by inflationary pressures associated with raw materials and components, freight costs and wages. Partially offsetting these unfavorable impacts were sales price increases on certain products which were implemented throughout the first two quarters of 2022. Research and development expenses. R&D expenses increased to$16.4 million for the six months endedJune 30, 2022 from$15.6 million in the prior year period. The increase in R&D expenses is due to an increase in product development activities. Selling, general and administrative expenses. SG&A expenses decreased to$54.3 million for the six months endedJune 30, 2022 from$57.8 million for the six months endedJune 30, 2021 , primarily due to a decrease in outside legal expenses related to a specific legal matter and a decrease in incentive compensation.
Interest income (expense), net. Interest expense, net increased to
Other income (expense), net. Other expense, net was$0.3 million for the six months endedJune 30, 2022 , as a result of a one-time expense which we have filed an insurance claim, compared to other income, net of$6.0 thousand for the six months endedJune 30, 2021 , as a result of net foreign currency gains. Provision for income taxes. Income tax expense was$4.0 million for the six months endedJune 30, 2022 , representing an effective tax rate of 98.1% compared to income tax expense of$4.8 million for the six months endedJune 30, 2021 , representing an effective tax rate of 27.7%. We expect theU.S. to be in a pre-tax loss position without benefit for the full year 2022, which is the primary reason for the elevated effective tax rate. In addition, recent legislative changes for research and experimentation costs and creditability of certain foreign income taxes have resulted in a modest increase to our effective tax rate.
Liquidity and Capital Resources
Sources of Cash
Historically, we have utilized cash provided from operations as our primary source of liquidity, as internally generated cash flows have been sufficient to support our business operations, capital expenditures and discretionary share repurchases. In addition, we have utilized our revolving line of credit to fund an increased level of share repurchases and acquisitions. We anticipate that we will continue to utilize both cash flows from operations and our revolving line of credit to support ongoing business operations, capital expenditures, expenses associated with our long-term factory planning strategy, future discretionary share repurchases and potential future acquisitions. We believe our current cash balances, anticipated cash flow to be generated from operations and available borrowing resources will be sufficient to cover expected cash outlays for at least the next twelve months and for the foreseeable future thereafter; however, because our cash is located in various jurisdictions throughout the world, we may at times need to increase borrowing from our revolving line of credit or take on additional debt until we are able to transfer cash among our various entities.
Our liquidity is subject to various risks including the risks discussed under "Item 3. Quantitative and Qualitative Disclosures about Market Risk."
(In thousands) June 30, 2022 December 31, 2021 Cash and cash equivalents$ 46,130 $ 60,813 Available borrowing resources 34,300 66,300 30
-------------------------------------------------------------------------------- Table of Contents Cash, cash equivalents and term deposit - OnJune 30, 2022 , we had$4.5 million ,$15.3 million ,$11.8 million ,$11.7 million and$2.8 million of cash and cash equivalents inNorth America , the PRC,Asia (excluding the PRC),Europe , andSouth America , respectively. In addition, atJune 30, 2022 , we had a one-year term deposit of$7.8 million , which will mature onJanuary 25, 2023 . We attempt to mitigate our exposure to liquidity, credit and other relevant risks by placing our cash, cash equivalents, and term deposits with financial institutions we believe are high quality. Our cash balances are held in numerous locations throughout the world. The majority of our cash is held outside ofthe United States and may be repatriated tothe United States but, under current law, may be subject to state income and foreign withholding taxes. Additionally, repatriation of some foreign balances is restricted by local laws. We have provided for the state income tax and the foreign withholding tax liabilities on these amounts for financial statement purposes. Available Borrowing Resources - Our Second Amended and Restated Credit Agreement ("Second Amended Credit Agreement") withU.S. Bank National Association ("U.S. Bank ") provides for a$125.0 million revolving line of credit ("Credit Line") that expires onNovember 1, 2023 . The Credit Line may be used for working capital and other general corporate purposes including acquisitions, share repurchases and capital expenditures. Amounts available for borrowing under the Credit Line are reduced by the balance of any outstanding letters of credit, of which there were$2.7 million atJune 30, 2022 . AtJune 30, 2022 , we had an outstanding balance of$88.0 million on our Credit Line and$34.3 million of availability.
See Note 8 contained in the "Notes to Consolidated Financial Statements" for further information regarding our Credit Line.
Sources and Uses of Cash
Our cash flows were as follows:
Six Months Ended Increase Six Months Ended (In thousands) June 30, 2022 (Decrease) June 30, 2021 Cash provided by (used for) operating activities$ (17,084) $ (33,568) $ 16,484 Cash provided by (used for) investing activities (16,927) (8,814) (8,113) Cash provided by (used for) financing activities 20,789 20,482 307 Effect of foreign currency exchange rates on cash and cash equivalents (1,461) (3,320) 1,859 Net increase (decrease) in cash and cash equivalents$ (14,683) $ (25,220) $ 10,537 Increase June 30, 2022 (Decrease) December 31, 2021 Cash and cash equivalents$ 46,130 $ (14,683) $ 60,813 Working capital 115,087 (5,272) 120,359 Net cash used for operating activities was$17.1 million during the six months endedJune 30, 2022 compared to net cash provided by operating activities of$16.5 million during the six months endedJune 30, 2021 . Net income was$0.1 million for the six months endedJune 30, 2022 compared to net income of$12.6 million for the six months endedJune 30, 2021 . Inventories increased by$16.3 million during the six months endedJune 30, 2022 compared to an increase of$1.1 million during the six months endedJune 30, 2021 . We are currently in a unique environment where certain components, most prominently ICs, are in short supply. The lead times associated with these components have increased significantly; consequently, when an opportunity arises to procure more than what is needed at a given period of time, we are proceeding with the purchase. This has currently led to us carrying more inventory than is optimal. Our inventory turns decreased to 2.7 turns atJune 30, 2022 compared to 3.4 turns atJune 30, 2021 . Changes in accounts payable and accrued liabilities resulted in cash outflows of$15.0 million during the six months endedJune 30, 2022 largely as a result of the timing of payments and a decrease in accrued compensation. Changes in accounts payable and accrued liabilities resulted in cash outflows of$7.3 million during the six months endedJune 30, 2021 largely as a result of the timing of payments and a decrease in accrued compensation. For the second half of 2022, we expect component shortages will continue to have an adverse effect on cash flows with some relief beginning to occur in the first half of 2023. In addition, we expect to commence manufacturing operations in a new factory inVietnam in the fourth quarter of 2022 which, in the short run, may result in manufacturing inefficiencies. 31 -------------------------------------------------------------------------------- Table of Contents Net cash used for investing activities during the six months endedJune 30, 2022 was$16.9 million , of which$7.5 million ,$0.9 million ,$5.5 million and$3.0 million was used for our term deposit investment, acquisition ofQterics Inc. , capital expenditures, and the development of patents, respectively. Net cash used for investing activities during the six months endedJune 30, 2021 was$8.1 million of which$6.2 million and$1.9 million was used for capital expenditures and the development of patents, respectively. Future cash flows used for investing activities are largely dependent on the timing and amount of capital expenditures. We estimate that we will incur between$13.0 million and$16.0 million during the remainder of 2022, which includes amounts associated with our factory inVietnam , which we anticipate commencing operations in the fourth quarter of 2022. Net cash provided by financing activities was$20.8 million during the six months endedJune 30, 2022 compared to$0.3 million during the six months endedJune 30, 2021 . The increase in cash provided by financing activities was driven partially by borrowing and repayment activity on our line of credit. During the six months endedJune 30, 2022 , we had net borrowings of$32.0 million compared to net borrowings of$26.0 million during the six months endedJune 30, 2021 . During the six months endedJune 30, 2022 , we repurchased 354,558 shares of our common stock at a cost of$11.2 million compared to our repurchase of 510,715 shares at a cost of$26.7 million during the six months endedJune 30, 2021 . Future cash flows used for financing activities are affected by our financing needs which are largely dependent on the level of cash provided by or used in operations and the level of cash used in investing activities. Additionally, potential future repurchases of shares of our common stock will impact our cash flows used for financing activities. See Note 13 contained in "Notes to Consolidated Financial Statements" for further information regarding our share repurchase programs. Material Cash Commitments - The following table summarizes our material cash commitments and the effect these commitments are expected to have on our cash flows in future periods: Payments Due by Period Less than 1 - 3 4 - 5 After (In thousands) Total 1 year years years 5 years Operating lease obligations$ 27,213 $ 7,076 $ 10,773 $ 5,442 $ 3,922 Property, plant, and equipment purchases 1,776 1,776 - - - Inventory purchases 23,163 23,163 - - - Software license 3,467 52 420 841 2,154 Total material cash commitments$ 55,619 $ 32,067 $
11,193
We anticipate meeting our material cash commitments with our cash generated from operations and available borrowing resources, including our Credit Line.
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