Universal Electronics Inc. Annual Report 2005

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FY2005 Annual Report · Universal Electronics Inc.

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digital
video
projector

surround
sound
speakers

video on
demand

stereo
system

interactive
television

bluetooth
enabled
vehicle

digital
audio
server

DVD

digital
cable

z-wave

universal electronics

annual
report

dlp tv

camera
phone

hi fi
stereo
system

digital
video
camera

HDTV

cell
phone

MP3
player

satellite

stereo
receiver

laptop
pc

PDA

home
theater
in a box

home
systems

as the

technology

universe

expands

audio
receiver

digital
jukebox

sub
woofer

ceiling
fan

media
center
pc

DVR

VCR

plasma
tv

heating
cooling

amplifier

climate
control
system

digital
set top
box

lcd tv

wireless
hub

stereo
receiver

CD
player

digital
video
recorder

infrared

desktop
pc

subscription
broadcast

remote
control
blinds

lights

smart
phone

dimmer

fan

security
system

alarm

wi fi

subscription
broadcast

wall
bracket

satellite

HDTV

interactive
television

DVD
player

VCR

home
theater

digital
cable

audio
receiver

cassette
player

sub
woofer

amplifier

MP3
player

CD
player

surround
sound
speakers

universal
electronics
simplifies
As technology

in the home becomes more and more

complex — with the growing reliance on digital media

in everyday life — UEI technology is simplifying people’s ability

to access and control it. No one’s in a better position to do so. UEI

has the industry’s leading patent portfolio; the world’s largest infrared (IR)

code library; and intelligent software that allows users to customize, sched-

ule, and synchronize media content to specific entertainment devices. We’ve

lighting

also developed partnerships with the world’s leading subscription broadcasting

and consumer electronics giants — names like Comcast®, DirecTV ®, Pioneer®, and

Panasonic®. For the past 20 years, Universal Electronics has built the capa-

bilities — and the infrastructure — to connect people with the devices

and entertainment they use everyday, to make them more acces-

sible and enjoyable. After all, the more seamless and

comprehensive the connection, the better

the experience.

remote
control
blinds

digital
media
player

smart
phone

camera
phone

PDA

laptop
computer

digital
video
recorder

wi-fi

digital
camera

bluetooth
enabled
vehicle

Universal

Electronics

connects

desktop
PC

security
system

alarm

heating/air
conditioning

ceiling
fan

Powered by UEI’s
world-class library
of IR codes and key
technologies inside,
our control solutions
for the subscription
broadcast industry
deliver the best
feature sets and
highest product
quality. Ultimately,
enhancing the end
user experience
while reducing
service costs.

UEI connects:

Greg

satellite

UEI is a leading supplier of control technology to the world’s largest cable and satellite service provid-

ers —including Comcast®, Cox Communications®, DirecTV®, SKY®, and TimeWarner®. Our comprehensive

solutions range from key patented technologies that provide the upgradeability to accommodate new

services and features, to award-winning industrial designs. UEI’s expertise allows every user to feel right

at home with his or her remote control. That way, subscribers like Greg Stevens can enjoy the best high

definition digital entertainment has to offer—everything from news and sports, to movies and music,

not to mention services like Pay-Per-View and Video-On-Demand—without ever leaving his chair. After

all, when he gets home from a hard day’s work, the last thing he needs is to fumble to get the game on.

The MediaRemote™
with SimpleCenter
is an affordable
multimedia remote
control that enables
anyone with a large
collection of music,
pictures, and video
on their PC to expe-
rience and enjoy all
this digital media in
a home theater-like
setting.

satellite

DVR

DVD

Mp
MP
Player
player

UEI connects:

Vivian

Vivian Simmons, marketing director for a packaged goods company, is a professional who’s always on

the go. The few evenings a week she’s not traveling, she wants to enjoy home entertainment — without

distractions or technology glitches. And thanks to UEI, that’s just what she’s able to do. Since Vivian’s

satellite TV provider, DirecTV®, uses UEI technology, she has an easy way to set her DVR to record all

her favorite shows while she’s on the road. And with UEI’s SimpleCenter™ software, she can also enjoy

all her personal digital media — including music and photos — anywhere in her home — even in a home

theater-like setting on her PC with UEI’s MediaRemote. That way, when she gets home from a long

business trip, all she has to worry about is which show to watch first.

digital
camera

PDA

laptop
computer

smart
phone

UEI’s retail brand,
One for All®, is the
leading brand of
remote control
devices worldwide—
recognized by the
trade and consumers
as the best in quality
and design. They
are sold at leading
retailers around the
globe, including
Best Buy®, WalMart®,
Dixons®, Carrefour®,
Tweeter® and
Costco®.

video
game

dvd

vcr

UEI connects:

Andrew

cable

UEI technology is making home entertainment safer for kids — and more acceptable to parents. Like

most six-year olds these days, Andrew Nichols has his favorite movies on both DVD and VHS, enjoys

video games, and is only allowed to watch certain “Mom-approved” channels on TV. The family’s

One For All® universal remote control has replaced all the other control devices the dog chewed up or

Andrew dropped in the toilet. Thanks to UEI’s patented macro technology, Mom can start up a movie

for Andrew with a single key press on the remote, while she’s in the kitchen. And she can program in

Andrew’s favorite “kid-friendly” channels, allowing him to safely switch from one cartoon channel to

another — and stay amused long enough for her to get dinner on the table.

desktop
PC

Powered by UEI’s
world-class connec-
tivity software and
equipped with built-in
Wi-Fi, NevoSL delivers
the most advanced
and unmatched user
experience for total
control of audio/visual
(A/V) entertainment
and digital media
content throughout
the networked home.

video
game

digital
camera

DVD

satellite

HDTV

wall
bracket

surround
sound
speakers

sub
woofer

audio
receiver

CD
changer

UEI connects:

Carl

UEI technology is enabling in every sense of the word. Take Carl Phillips, for example, a software

PDA

engineer by day and a digital entertainment junkie the rest of the time. Carl has all the very latest

innovations — from a wall mounted HDTV, to his Bluetooth®-enabled car, to NevoSL®, UEI’s award-

winning, ultimate controller for the broadband home. NevoSL allows Carl to access and stream the

digital pictures and music stored on his PC — or anywhere on his home network — to the high-definition

plasma TV screen and Dolby® surround sound speakers in his living room. That way, he can enjoy his

favorite playlist just the way he likes to — from the comfort of his black leather chair.

desktop
PC

home
network

cell
phone

bluetooth
enabled
vehicle

SimpleCenter™,

the center of
your digital life.
SimpleCenter is a
full-featured PC
application for
the management,
control and mobil-
ity of all your digital
media — music,
pictures, and
movies.

speakers

DVD

MP
player

audio
receiver

UEI connects:

Kim

Whether it’s downloading new music, chatting with her friends, channel surfing (or doing all three

simultaneously), Kim Carter likes to be connected at all times—to her friends, to her family, to her

entertainment content, and, most of all, to her entertainment devices. These include her TV, DVD

player, MP3 player, cell phone (which is also a camera), and her laptop computer. Now, thanks to UEI’s

new SimpleCenter software, she can organize, enjoy, and share all her digital media at home or on the

go. With SimpleCenter, Kim can wirelessly transfer digital music, pictures, and movies between her cell

phone and her laptop. She can even use her cell phone to stream digital media anywhere in her house.

Now that’s what you call connected. And it’s simple, with SimpleCenter.

camera
phone

laptop
computer

UEI’s Helix marks
another giant leap
in providing total
home control. Not
only does it seam-
lessly control a vast
array of A/V devices,
but now, enabled
with an emerging RF
technology for the
home called Z-Wave,
also allows users to
expand their range
of control to include
lighting, air condition-
ing, security and other
home systems.

UEI connects:

Arthur

UEI’s world-class connectivity software is second to none, guaranteeing compatibility with all kinds of

home entertainment devices — old and new — and now expanding into complete home control systems.

Equipped with advanced radio frequency (RF) technology such as Z-Wave®, UEI further extends its control

solutions to be compatible with virtually every device in Arthur Monroe’s house. Though he’s far from

being a “techie”, Arthur does appreciate technology that helps to simplify his life, instead of complicat-

ing it. That’s why he likes UEI’s Helix™ remote so much. It allows him to control all the various devices in

his home, so he can cue the latest movie from his DVD Changer, turn on his LCD TV and surround sound

stereo receiver, and dim the lights for a perfect Home Cinema experience.

cell
phone

laptop
computer

lcd
tv

digital
cable

DVD
changer

VCR

stereo
receiver

CD
changer

lights

thermostat

fan

home
systems

security
system

0.00.20.40.60.81.0

A/V: TVs, DVD players, DVRs, cable boxes, audio
receivers — you name it. UEI supplies Fortune 500
companies in the consumer electronics, subscription
broadcasting, retail, and computing industries with
control solutions for today’s vast array of home enter-
tainment devices.

DIGITAL MEDIA: As the proliferation of digital media
grows exponentially in today’s homes and offices, UEI
is way ahead of the curve. We’re not only focused on
the control of digital entertainment, but also on ways
to help consumers interact with and enjoy their con-
stantly growing digital media collections.

HOME SYSTEMS: Garage doors, ceiling fans, thermo-
stats, curtains, security systems, lighting; more and
more devices in the home are becoming automated.
Whether you’re dimming the lights or turning up the
A/C, universal control has gone beyond the tradition-
al home entertainment system. And UEI is constantly
integrating its home control solutions for the devices
that people use every day.

At Universal Electronics, our commitment to connecting people with

technology drives our constant quest for innovation. As new devices

and content continue to proliferate throughout the home, adding

complexity, confusion, and clutter, UEI’s industry-leading technologies

will be there to deliver new and better control solutions that are simple

to use, intuitive, and accessible. No company is better positioned to

deliver control technology that can truly be called universal.

$ 200

150

100

revenues
(in millions)

$181

$158

$120

$104

$0.81*

$0.69

$0.65

$0.42 $0.45

$ 1.0

0.8

0.6

0.4

0.2

0.0

200

150

101

100

156

137

diluted earnings per share

patents issued and pending

Our markets have strong growth opportunities. The living room

being distributed in 17 countries worldwide and recently won

of today is quickly becoming the center of the home entertain-

the Residential Systems magazine coveted RESI award for

ment network of the future. Consumer trends within the home

“Best Product of the Year” at The CEDIA Expo 2005, the world’s

show enormous growth potential for our technology:

#1 residential electronics systems industry show. T3, the pre-emi-

•

The CE accessories market in the US currently exceeds $2 bil-

nent British gadget and electronics magazine has said, “NevoSL

lion in annual sales and is expected to grow at an estimated

may be the best thing for the home since television,” and the

10 percent annual rate1. From this, we estimate the current

product has received extensive media coverage in publications

global CE accessories market to range between $4 and

ranging from BusinessWeek to PC Magazine to The Robb Report

$5 billion.

Home Entertainment.

•

Regarding digital media control, there are approximately

We continue to expand our partnerships with leading companies

58 million networked homes worldwide, which is expected to

worldwide. In June 2005, Panasonic and UEI signed a two-year

rise to over 160 million by 2010 2.

agreement in which UEI will provide its world-class infrared (IR)

•

Digital video recording (DVR) will reach 130 million users

database and leading intellectual property portfolio for the re-

worldwide by 2010, up from 17 million users today3.

mote control devices Panasonic manufactures for its CE products.

•

Flat panel TVs are expected to grow more than 38 percent per

In July, Pioneer Corporation and UEI entered into an agreement

year over the next 4 years — from 28.1 million units in 2005 to

to extend the current license of proprietary connectivity soft-

over 100 million units in 2009 4.

ware for use in several of Pioneer’s Pure Vision™ plasma television

To our Shareholders: This year we are celebrating our 20th anni-

music services — are all driving demand for UEI technology

versary and another rewarding year for Universal Electronics as we

and products.

UEI has pioneered innovative and easy-to-use solutions that are

meeting the needs driven by these trends. In fact, over the past

three years we have developed an industry leading patent portfo-

continued our evolution into the wireless control technology leader.

A year of strong performance. Net sales for the year-ended

lio, technology platform and array of wireless control solutions. As

December 31, 2005 were $181.3 million, compared to $158.4 mil-

a result, UEI has attracted subscription broadcasting leaders in-

products. Pioneer utilizes UEI’s extensive database of IR codes

to provide consumers with the ability to control traditional home

devices. In October, Denon selected UEI’s technology for use in

advanced remote controls for certain of its high-end amplifiers

and tuners to be distributed in the U.S., Europe and Asia.

lion for the same period last year — a 15 percent increase.

cluding Comcast®, SKY®, and DirecTV® who have new digital video

Announced in early 2006, UEI is also powering Mitsubishi tele-

In 2005, we continued to serve our core markets well and expe-

rienced increased demand from our subscription broadcasting

and consumer electronics (CE) customers. We also witnessed

Pro forma net income for the full year 2005 was $11.3 million, or

increased adoption of digital technology and continue to see

$0.81 per diluted share, compared to $9.1 million, or $0.65 per di-

strong demand for our products in the advanced set-top box

luted share, for the same period last year — a 24 percent growth.

recorder set-top box deployments, as well as CE giants such as

visions with a custom line of universal remote control devices,

Pioneer®, Panasonic® and Denon® who have new digital devices

including those that will be bundled with the company’s high

like plasma televisions and home theater systems.

definition Diamond Series televisions.

rollouts. As consumer technology shifts from analog to digital,

Our strategy of strengthening and diversifying our business has

In addition, with the launch of NevoSL™ in July 2005, we have

Delivering advanced consumer solutions for the digital life. The

new devices and capabilities — including digital video record-

led to this strong performance. Looking forward, there are vast

opened a whole new segment to UEI’s home networking device

digital entertainment landscape is in the midst of radical transfor-

ers, home networking, high-definition televisions and digital

opportunities still in front of us.

control and digital media control business. This product is already

mation as technologies are changing and people’s concepts

* The 2005 earnings per diluted share in the chart above depict both Generally Accepted Accounting Principles (GAAP) earnings per diluted share of $0.69 and pro forma earnings per
diluted share of $0.81. Pro forma earnings per diluted share exclude a $1.6 million write down of a balance due from a former European distributor. Pro forma is included here as management
believes it provides a more accurate measure of year-over-year financial performance.

1 The Consumer Electronics Association (CEA), 2006
2 The Diffusion Group, “Global Home Network Deployment & Networked Devices” (2004)

3 Strategy Analytics, “Digital Video Recorders: Demand Surges As Mass Market Era Dawns” (2005)
4 Display Search, “Flat Panel Display Market Outlook: From Cyclicality to Maturity” (2006)

of how they interact and use their digital devices are evolving —

automotive electronics manufacturers such as Delphi to deliver

driving the need for easier management of digital content and

digital entertainment products to connect consumers with their

control to enhance the user experience.

home-based digital media while in the car. SimpleWare Auto

New home and personal entertainment devices and digital media

are proliferating in the market, quickly making controlling devices

and interacting with content a major challenge for consumers

is available on proven automotive-grade silicon platforms from

Freescale and Texas Instruments, ensuring fast time-to-market for

integration on the next generation of in-car entertainment systems.

who want to embrace the new digital life.

Looking ahead. As new devices and technologies continue to

We are excited to be working with leading CE, broadcast, mobile

and technology companies as we shape the next evolution of the

digital life with innovative wireless technologies that expand the

user experience. UEI has developed solutions that enable con-

sumers’ seamless connectivity and control of their media from

traditional audio/visual devices in their living rooms to digital

media content on personal computers in their home offices to

transform the home entertainment environment, we remain at

the forefront of this transformation — with control technology

that continues to make this media more accessible. And, as tech-

nology in the CE, cable and satellite, and computing industries

continues to proliferate and converge, and users look for new

ways to simplify and enjoy their lives through the use of technol-

ogy, UEI will be the company that helps make this a reality.

mobile media solutions on their handhelds and in their cars.

In closing, I want to thank our board of directors, executive man-

Take SimpleCenter™, for example, our digital media management

and control software that powers certain advanced media prod-

ucts for leading CE manufacturers, enabling these devices to

agement team, dedicated employees, worldwide partners and

shareholders for your continued support. Without you, all that we

have achieved would not have been possible.

manage and stream digital content anywhere in the home.

Sincerely,

Paul Arling, Chairman and Chief Executive Officer

SimpleCenter will be bundled with next generation mobile hand-

sets enabling consumers to wirelessly transfer digital music, pic-

tures, and video between their phone and PC as well as use their

mobile phones to stream digital media throughout their homes.

In Home Control, UEI’s Helix™ universal remote control brings re-

ality to the next generation of convenient home control systems

by seamlessly controlling not only a vast array of audio/visual

devices, but also certain types of home environment devices that

allow consumers to dim the lights, close the curtains and start the

movie — all with the touch of a button.

UEI’s SimpleWare™ Auto embedded digital media software is

powering solutions that enable automotive tier-1 suppliers and

The technology in our
homes speaks thousands of
different languages. And UEI has
the ability to decipher them, thanks to
a database of more than ,000 infrared
codes that’s growing all the time — to keep
pace with the new devices that are intro-
duced into homes around the world every
day. The result: Anything in an individu-
al’s technology universe that requires
a remote can be connected by
a single control inter face
powered by UEI.

Business

Risk Factors

Business

Business of Universal Electronics Inc.

Selected Consolidated Financial Data

Universal Electronics Inc. was incorporated under the laws of Delaware in 1986 and began operations in 1987. The principal executive offices

Management’s Discussion and Analysis of

Financial Condition and Results of Operations

Quantitative and Qualitative Disclosures

about Market Risk

are located at 6101 Gateway Drive, Cypress, California 90630. As used herein, the terms “we”, “us” and “our” refer to Universal Electronics Inc.

and its subsidiaries unless the context indicates to the contrary.

Our operations are comprised of two reportable segments, Core Business and SimpleDevices. Our Core Business reportable segment

accounted for approximately 99% of our net sales for the twelve months ended December 31, 2005. We acquired our second reportable seg-

Financial Statements and Supplemental Data

ment, SimpleDevices, on October 1, 2004.

48 Consolidated Balance Sheets

49 Consolidated Income Statements

50 Consolidated Statements of
Stockholders’ Equity

52 Consolidated Statements of Cash Flows

Notes to Consolidated Financial Statements

Reconciliation of Fourth Quarter and

YTD 2005 Pro Forma, GAAP Results

Disaggregated financial results and assets by reportable segment can be found in Note 18 to the Consolidated Financial Statements.

Additional information regarding UEI can be obtained at www.uei.com.

Core Business Segment

Overview: In our Core Business segment we have developed a broad line of easy-to-use, pre-programmed universal wireless control prod-

ucts and audio-video accessories that are marketed to enhance home entertainment systems.

Principal Markets: The primary market segments in our Core Business include retail, private label, OEMs, custom installers, cable and satellite ser-

vice providers and companies in the computing industry. We believe that our universal remote control database is capable of controlling virtually all

infrared remote (“IR”) controlled TVs, VCRs, DVD players, cable converters, CD players, audio components and satellite receivers, as well as most other

IR controlled devices and home automation control modules worldwide.

Products and Services: We introduced our first product, the One For All®, in 1987. Since then our product lines have grown. Our family of

products includes universal standard and touch screen remote controls, wireless keyboards, game controllers, antennas, and various audio/

video accessories, as well as custom and customizable microcontrollers that include our library of IR codes, proprietary software, and digital

media control software. We also earn revenue by licensing our library of IR codes and proprietary software. These products cover a broad

spectrum of suggested prices and performance capabilities.

We provide subscription broadcasters, namely cable operators and satellite service providers both domestically and internationally with

our wireless control devices and integrated circuits, on which our software is embedded, to support the demand associated with the deploy-

ment of digital set-top boxes that contain the latest technology and features. We also sell our universal wireless control devices and inte-

grated circuits, on which our software is embedded, to OEMs that manufacture cable converters and satellite receivers for resale with their

products.

We continue to pursue further penetration of the more traditional consumer electronics/OEM markets. Customers in these markets gen-

erally package our wireless control devices for resale with their audio and video home entertainment products (e.g. TVs, DVD and CD players,

VCRs, personal digital media recorders, etc.). We also sell customized chips, which include our software and/or customized software pack-

ages, to these customers. Growth in this line of business has been driven by the proliferation and increasing complexity of home entertain-

2005 Financial Review

Controls and Procedures

Forward-Looking Statements: This Annual Report, including “Management’s Discussion and Analysis of Financial Condition and Results of Operations”, contains statements that may
constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements involve risks, uncertainties and assumptions. If the risks
or uncertainties ever materialize or the assumptions prove incorrect, our results may differ materially from those expressed or implied by such forward-looking statements and assumptions.
All statements other than statements of historical fact are statements that could be deemed forward-looking statements, including but not limited to any projections of revenue, margins,
expenses, tax provisions, earnings, cash flows, benefit obligations, share repurchases or other financial items; any statements of the plans, strategies and objectives of management for future
operations; any statements concerning expected development or relating to products or services; any statements regarding future economic conditions or performance; any statements
regarding pending claims or disputes; any statements of expectation or belief; and any statements of assumptions underlying any of the foregoing. Risks, uncertainties and assumptions
include macroeconomic and geopolitical trends and events; the execution and performance of contracts by customers, suppliers and partners; the challenge of managing asset levels,
including inventory; the difficulty of aligning expense levels with revenue changes; the outcome of pending legislation and accounting pronouncements; and other risks that are described
herein, including but not limited to the items discussed in “Risk Factors” in Item 1A of this report, and that are otherwise described from time to time in our Securities and Exchange Com-
mission reports filed after the date of filing this report. We assume no obligation and do not intend to update these forward-looking statements.

universal electronics 2005 annual report

By providing our wireless control technology in many forms, including finished products and microcontrollers on which our software is embedded,

we can meet the needs of our customers, enabling those who manufacture or subcontract their manufacturing requirements to use existing sources

certain of our proprietary technology to third parties and our One For All® brand name to a third party who in turn sells the products directly to certain
domestic retailers.

of supply and more easily incorporate our technology.

Beginning in 1986 and continuing today, we have compiled an extensive library that covers nearly 246,000 individual device functions and over

2,700 individual consumer electronic equipment brand names. Our library is regularly updated with new IR codes used in newly introduced audio and
video devices. All such IR codes are captured from the original manufacturer’s remote control devices or written specifications to ensure the accuracy

and integrity of the database.

Outside the United States, we sell our wireless control devices and certain accessories under the One For All® and certain other brand names under
private labels to retailers, and to other customers, through our international subsidiaries. Third party distributors are utilized in countries where we do

not have subsidiaries. We also sell our products and/or license our proprietary technology to OEMs, cable operators and satellite service providers

internationally.

We have seven international subsidiaries; Universal Electronics B.V., established in The Netherlands, One For All GmbH and Ultra Control Con-

Our proprietary software and know-how permit IR codes to be compressed before being loaded into our products. This provides significant cost

sumer Electronics GmbH, both established in Germany, One for All Iberia S.L., established in Spain, One For All (UK) Ltd., established in the United

and space efficiencies that enable us to include more codes and features in the memory space of the wireless control device than are included in the

Kingdom, One For All Argentina S.R.L., established in Argentina, and One For All France S.A.S., established in France.

similarly priced products of our competitors.

For the years ended December 31, 2005 and 2004, our sales to Comcast Communications, Inc., represented 12.2% and 11.0% of our net sales,

With today’s rapidly changing technology, upgradeability ensures on-going compatibility with current and future devices. We have developed a

respectively. No other single customer accounted for 10% or more of our net sales in 2005 and 2004. However, DirecTV and its subcontractors together

patented technology that provides the capability to easily upgrade the memory of our wireless control devices by adding IR codes from our library

accounted for 16.6% and 10.4% of our net sales for the years ended December 31, 2005 and 2004, respectively.

that were not originally included. These upgrade features provide customers with the ability to upgrade our wireless devices remotely using a personal

computer or telephone, and directly at the factory or service locations. These upgrade options utilize one-way or two-way communication to upgrade

the wireless device’s codes or data depending on the requirements.

We provide domestic and international consumer support to our various universal remote control marketers, including manufacturers, cable and

satellite providers, retail distributors, and audio and video original equipment manufacturers through our automated “InterVoice” system. Live agent

help is also available through certain programs. We continue to review our programs to determine their value in enhancing and improving the sales of

Each of our wireless control devices is designed to simplify the use of audio, video and other devices. To appeal to the mass market, the number

our products. As a result of this continued review, some or all of these programs may be modified or discontinued in the future and new programs may

of buttons is minimized to include only the most popular functions. Our remotes are also designed for ease of set-up. For most of our products, the

be added.

consumer simply inputs a four-digit code for each video or audio device to be controlled. Another patented ease of use feature we offer in several of

our products is our user programmable macro key. This feature allows the user to program a sequence of commands onto a single key, to be played

back each time that key is subsequently pressed.

During 2005, we continued our product innovation by launching several new products based on our two technology platforms developed in 2002:
Nevo®, an embedded solution that transforms any electronic display (such as a PDA) into a sophisticated and easy-to-use wireless home control and
automation device; and Kameleon®, a display technology that provides ease of use by illuminating only the keys needed to control each entertainment
device. We also expanded our line of audio and video accessories including digital antennas, signal boosters, television brackets, and audio and video

cleaning products.

Wireless networking is one of today’s fastest growing trends. Combining our connectivity software and patent portfolio with Universal Plug-n-Play
(“UPnP”) standards and the 802.11 wireless networking protocols, we developed our NevoSL® product line. NevoSL®, which began shipping during the
second quarter of 2005, is a stand alone universal wireless controller that uses Wi-Fi to control the play back or viewing of MP3s, photos, and videos

stored on a PC, through a media player attached to a home entertainment center. By utilizing the touch screen user interface, customers can select
play lists, slide shows, or videos to be played via the media player from anywhere within the network’s range. In addition, NevoSL® utilizes infrared
technology to control virtually all infrared controlled consumer electronic devices, and can also be utilized to control wireless household appliances.
NevoSL® supports the attainment of our strategic imperative to build our presence as a wireless control technology leader, enabling consumers to
wirelessly connect, control, and interact within the ever-increasingly complex home.

Methods of Distribution and Customers: Over the past 18 years, we have developed a broad portfolio of patented technologies and the industry’s

leading database of home connectivity software that we license to our customers, including many leading Fortune 500 companies. We have also de-
veloped a broad family of products including universal standard and touch screen remote controls, wireless keyboards, game controllers, antennas,

and various audio/video accessories, as well as custom and customizable microcontrollers that include our library of IR codes, proprietary software,

and digital media control software.

In the United States, we sell our products and/or license our proprietary technology to cable operators, satellite service providers, private label

customers, consumer electronics accessory manufacturers and companies in the computing industry for resale under their respective brand names.

In addition, we sell our wireless control products and license our proprietary technologies to OEMs for use in their products. We have also licensed

SimpleDevices Segment Description
Overview: On October 1, 2004, we acquired SimpleDevices Inc. (“SimpleDevices”) for approximately $12.8 million in cash including direct acquisition

costs, plus a performance-based payment of our unregistered common stock to be paid in the future, if certain financial objectives are achieved.

SimpleDevices, based in San Mateo, California, develops software and firmware solutions that can enable devices such as TVs, set-top boxes,

stereos, automotive audio systems, cell phones and other consumer electronic products to wirelessly connect and interact with home networks and

interactive services to deliver digital entertainment and information.

Principal Markets: SimpleDevices’ primary market segments are OEMs operating in the consumer electronics, automobile, cellular phone, and sub-

scription broadcasting industries.

Products and Services: To date, revenues earned by our SimpleDevices segment have consisted primarily of engineering services related to the

development of hardware utilized by our customers to run the SimpleDevices’ software products and customizing our software to customers’ specific

needs. We anticipate that sales generated as a result of software customization and engineering services will begin to decline as a percentage of total

sales as software licensing fees and the associated maintenance fees begin to increase as these new products ship. We also anticipate that gross profit

and gross profit as a percentage of net sales will increase as this shift occurs. Key software products that we have developed include the following:

• The SimpleWare UPnP Device Enabler – provides core UPnP implementation support, allowing OEMs to develop devices that interoperate with
other devices on a network.

•

SimpleWare Media Server Software Development Kit – provides a Java content server solution that enables UPnP-compatible devices to communicate

with the server to navigate the content directory and stream or download content. The SimpleWare Media Server can run on a variety of platforms, includ-

ing network gateways, set top boxes and PCs to serve content to home media devices. In addition, the SimpleWare Media Server Software supports con-

tent enhancement applications designed for SimpleWare-powered devices, including content synchronization, scheduling and music metadata access.

•

The SimpleWare Connected Media Player Software Development Kit – Software that enables devices to connect to a home media server and playback

stored audio and video content. The SimpleWare Connected Media Player SDK supports the emerging UPnP AV standard for connecting with media

servers in the home. Supporting this standard means that the OEM device can interoperate with media servers running on PCs, routers, gateways and

dedicated home media servers. Implementation of the software development kit also offers enhanced applications to improve the user experience.

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•

SimpleCenter Software Application – provides a PC application for the management, control, and distribution of digital media – music, pictures, and

movies. This includes a media manager plus a unified platform for connecting and synchronizing media to both home and mobile devices.

• Automobile Digital Media Player Software Development Kit – A complete electrical and firmware design for a wireless Wi-Fi 802.11 digital media
player for the automobile. When implemented the software enables the Automobile Digital Media Player to awake nightly (or at a scheduled time),

discover online UPnP media servers, and download new content from the media server onto the onboard hard disc drive (“HDD”). Alternatively, users

can remove the detachable HDD and connect it to a PC via USB cable. The SimpleWare device software then synchronizes new content between the

PC and the HDD. Users can also record content from an attached DVD player. One-touch navigation allows users to jump quickly to an artist, album,

or genre.

Methods of Distribution and Customers: We sell our services and license our software to OEMs operating in the consumer electronics, automobile,

cellular phone, and subscription broadcasting industries for use in their products. Services are performed at SimpleDevices, in San Mateo, California.

Licenses are delivered upon the transfer of a product master or on a per unit basis when the software is loaded onto the OEM’s device.

Raw Materials and Dependence on Suppliers
We utilize third-party manufacturers and suppliers primarily in Asia and the United States to produce our wireless control products. The number of

third party manufacturers or suppliers that provided us in excess of 10% of our manufacturing services and/or components was one, two, and three

for 2005, 2004 and 2003, respectively. In 2005, Computime provided 33.9% of our manufacturing services and components. In 2004, Computime and

Samsung collectively provided 38.7% of our manufacturing services and components. In 2003, Computime, Jetta and Samsung collectively provided

45% of our manufacturing services and components.

As in the past, we continue to evaluate alternative and additional third-party manufacturers and sources of supply. During 2005, we continued to

diversify our suppliers and maintain duplicate tooling for certain of our products. This has allowed us to stabilize our source for products and negotiate

more favorable terms with our suppliers. In addition, where we can, we use standard parts and components, which are available from multiple sources.

To continue to reduce our dependence on suppliers, we continue to seek additional sources of integrated circuit chips to help reduce the potential for

manufacturing and shipping delays. In addition, we have included flash microcontroller technology in some of our products. Flash microcontrollers can

have shorter lead times than standard microcontrollers and may be reprogrammed if necessary, thus potentially reducing excess or obsolete inventory

exposure.

Patents, Trademarks and Copyrights
We own a number of United States and foreign patents related to our products and technology, and have filed domestic and foreign applications for

other patents that are pending. We had a total of 156 issued and pending patents at the end of 2005, an increase from 137 at the end of 2004. The

remaining life of our patents range from approximately one to eighteen years. We have also obtained copyright registration and claim copyright pro-

tection for certain of our proprietary software and libraries of IR codes. Additionally, the names of most of our products are registered or are being

registered as trademarks in the United States Patent and Trademark Office and in most of the other countries in which such products are sold. These

registrations are valid for a variety of terms ranging up to 20 years and may be renewed as long as the trademarks continue to be used and are deemed

by management to be important to our operations. While we follow the practice of obtaining patent, copyright and trademark registrations on new

developments whenever advisable, in certain cases, we have elected common law trade secret protection in lieu of obtaining such protection.

Seasonality
Historically, our business has been influenced by the retail sales cycle, with increased sales in the last half of the year and the largest proportion of

sales occurring in the last quarter. This pattern is expected to continue and the impact will fluctuate as the sales mix varies between the consumer

and business categories.

See the “Notes to the Consolidated Financial Statements—Note 22” for further details regarding our quarterly results.

Competition
Our principal competitors in the international retail and private label markets for our wireless controls include Philips, Thomson, and Sony as well as

various manufacturers of wireless controls in Asia. Our primary competitors in the OEM market are the original equipment manufacturers themselves

and wireless control manufacturers in Asia. The SimpleDevices’ SimpleWare product lines compete in part with those of Mediabolic, Digital 5, and

Bridgeco. SimpleDevices’ SimpleCenter products compete with Microsoft, Real Networks, Apple and Musicmatch among others. In the subscrip-
tion broadcasting business line, we compete with various distributors in the United States and several of the larger set-top manufacturers, including
Motorola and Scientific-Atlanta. The NevoSL® product, which was released in the second quarter of 2005, competes in the custom electronics in-
stallation market against Crestron, AMX, RTI, Universal Remote Control, Philips, Logitec, and many others. We compete in our markets on the basis

of product quality, product features, price, intellectual property, and customer and consumer support. We believe that we will need to continue to

introduce new and innovative products to remain competitive and to recruit and retain competent personnel to successfully accomplish our future

objectives. Certain of our competitors have significantly larger financial, technical, marketing and manufacturing resources than we do, and there can

be no assurance that we will remain competitive in the future.

Engineering, Research and Development
During 2005, our engineering efforts focused on modifying existing products and technologies to improve features, to lower costs, and to develop

measures to protect our proprietary technology and general know-how. In addition, we continue to regularly update our library of IR codes to include

IR codes for new features and devices introduced worldwide. We also continue to explore ways to improve our software to pre-program more codes

into our memory chips and to simplify the upgrading of our wireless control products.

Also during 2005, our product development efforts focused on new and innovative wireless control and interface solutions resulting in the launch
of new retail SKUs based on the Kameleon® interface technology. We also broadened our product portfolio with solutions that address emerging
technology sectors like home media distribution and home automation. These advanced technology development efforts focused on both indus-

try-based standards as well as specific universal extensions that maximize the end user experience utilizing a set of heterogeneous protocols and

technologies that exist in the modern home today. This environment is driving the need for simplification of these new protocols and devices, since
they were originally engineered and targeted towards the enterprise customer. We created the Nevo® product offerings to simplify and manage the
end user’s experience interacting with devices in the home — devices that may be used for a decade or more, including traditional IR based devices,

and the more complex TCP/IP consumer electronic devices utilizing both open and proprietary protocols.

We also developed technologies aimed at unifying traditional technologies that are encountered within a home, and emerging technologies.

This allows consumers to deploy our solutions ranging from a simple IR based audio-visual stack to a modern digital media management experience

allowing access to digital content such as music, pictures and videos.

SimpleDevices’ development was focused on the discovery of new, technologically advanced knowledge and more complete solutions to cus-

tomer needs, the conceptual formulation and design of possible alternatives, as well as the testing of process and product cost improvements. If

successful, these efforts will enable SimpleDevices to provide customers with reductions in design cycle times, lower costs, and improvements in in-

tegrated circuit design, product quality and overall functional performance. Additionally, these efforts will enable SimpleDevices to further penetrate

existing markets, pursue new markets effectively and expand the business.

Our personnel are involved with various industry organizations and bodies, which are in the process of setting standards for infrared, radio

frequency, power line, telephone and cable communications and networking in the home. There can be no assurance that any of our research and
development projects will be successfully completed.

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Our expenditures on engineering, research and development by reportable segments were:

i n m i l l i o n s

Research and development

Engineering

2005

2004

2003*

Core

SDI

Core

SDI

Core

SDI

$ 6.2

$ 0.4

$ 5.7

$ 0.2

$ 4.7

$ —

3.4

1.7

2.9

0.4

1.7

—

Available Information
Our Internet address is www.uei.com. We make available free of charge through the website our annual report on Form 10-K, our quarterly reports

on Form 10-Q, our current reports on Form 8-K and any amendments to these reports as soon as reasonably practical after we electronically file such

reports with the Securities and Exchange Commission. These reports can be found on our website under the caption “SEC Filings” on the Investor

page. Investors can also obtain copies of our SEC filings from the SEC website at www.sec.gov.

Total engineering, research and development

$ 9.6

$ 2.1

$ 8.6

$ 0.6

$ 6.4

$ —

*SimpleDevices was acquired on October 1, 2004, and therefore any engineering, research and development performed during 2003 are not reflected in the table above.

Risk Factors

Environmental Matters
Many of our products are subject to various federal, state, local and international laws governing chemical substances in products, including laws regulat-

ing the manufacture and distribution of chemical substances and laws restricting the presence of certain substances in electronics products. We could

incur substantial costs, including cleanup costs, fines and civil or criminal sanctions, third-party damage or personal injury claims, if we were to violate or

become liable under environmental laws or if our products become non-compliant with environmental laws. We also face increasing complexity in our

product design and procurement operations as we adjust to new and future requirements relating to the materials composition of our products, including

the restrictions on lead, cadmium and certain other substances that will apply to specified electronics products put on the market in the European Union

as of July 1, 2006 (Restriction of Hazardous Substances Directive) and the restrictions to be imposed by similar legislation currently proposed in China.

Forward Looking Statements: We caution that the following important factors, among others (including but not limited to factors discussed below in

“Management’s Discussion and Analysis of Financial Condition and Results of Operations,” as well as those factors discussed elsewhere in this An-

nual Report, or in our other reports filed from time to time with the Securities and Exchange Commission), could affect our actual results and could

contribute to or cause our actual consolidated results to differ materially from those expressed in any of our forward-looking statements. The fac-

tors included here are not exhaustive. Further, any forward-looking statement speaks only as of the date on which such statement is made, and we

undertake no obligation to update any forward-looking statement to reflect events or circumstances after the date on which such statement is made

or to reflect the occurrence of unanticipated events. New factors emerge from time to time, and it is not possible for management to predict all such

factors, nor can we assess the impact of each such factor on the business or the extent to which any factor, or combination of factors, may cause actual

results to differ materially from those contained in any forward-looking statements. Therefore, forward-looking statements should not be relied upon

We also could face significant costs and liabilities in connection with product take-back legislation. The European Union (the “EU”) has enacted

as a prediction of actual future results.

the Waste Electrical and Electronic Equipment Directive, which makes producers of electrical goods, including computers and printers, financially

responsible for specified collection, recycling, treatment and disposal of past and future covered products. The deadline for the individual member

states of the EU to enact the directive in their respective countries was August 13, 2004 (such legislation, together with the directive, the “WEEE Legis-

lation”), although extensions were granted in some countries. Producers participating in the market became financially responsible for implementing

their responsibilities under the WEEE Legislation beginning in August 2005. Implementation in certain EU member states may be delayed into 2006.

Similar legislation has been or may be enacted in other jurisdictions, including in the United States, Canada, Mexico, China, and Japan.

While we believe that the forward looking statements made in this report are based on reasonable assumptions, the actual outcome of such

statements is subject to a number of risks and uncertainties, including the failure of our markets to continue growing and expanding in the manner

we anticipated; the failure of our customers to grow and expand as we anticipated; the effects of natural or other events beyond our control, includ-

ing the effect a war or terrorist activities may have on us or the economy; the economic environment’s effect on us and our customers; the growth of,

acceptance of and the demand for our products and technologies in various markets and geographical regions, including cable, satellite, consumer

electronics, retail, digital media/technology, CEDIA, interactive TV, automotive, and cellular industries not materializing or growing as we believed;

We continue to work closely with our contract manufacturing base to move these manufacturers toward becoming Sony Green Partners and we

our inability to add profitable complementary products which are accepted by the marketplace; our inability to continue to maintain our operating

already work with several certified Green Partners. Our goal is to provide a choice of three options to our customers: Sony Green compliant, Restriction

costs at acceptable levels through our cost containment efforts; our inability to realize tax benefits from various tax projects initiated from time to

of Hazardous Substances Directive compliant, and Non-Green. All Green production processes will be segregated physically from standard produc-

time; our inability to maintain the strength of our balance sheet; our inability to continue selling our products or licensing our technologies at higher

tion processes to eliminate the possibility of contamination.

We believe we have materially complied with all currently existing international and domestic federal, state and local statutes and regulations

regarding environmental standards and occupational safety and health matters to which we are subject. During the years ended December 31, 2005,

2004 and 2003, the amounts incurred in complying with federal, state and local statutes and regulations pertaining to environmental standards and

or profitable margins; our inability to obtain orders or maintain our order volume with new and existing customers; the possible dilutive effect our

stock option program may have on our earnings per share and stock price; our inability to continue to obtain adequate quantities of component parts

or secure adequate factory production capacity on a timely basis; and other factors listed from time to time in our press releases and filings with the

Securities and Exchange Commission.

occupational safety and health laws and regulations did not materially affect our earnings or financial condition. However, future events, such as

Dependence upon Key Suppliers: Most of the components used in our products are available from multiple sources. However, we have elected to

changes in existing laws and regulations or enforcement policies, may give rise to additional compliance costs that could have a material adverse ef-

purchase integrated circuits, used principally in our wireless control products, from two main sources, Freescale and Samsung.

fect upon our capital expenditures, earnings or financial condition.

Employees
At December 31, 2005, we employed 329 employees, of whom 109 work in engineering and research and development, 57 in sales and marketing,

In addition, during 2005, one source, Computime, provided over ten percent (10%) of our component and finished product inventory purchases.

Purchases from this significant supplier amounted to $35.5 million, or 33.9%, of total inventory purchases during 2005. Purchases with the same signifi-

cant supplier amounted to $25.5 million, or 28.2%, of total inventory purchases in 2004.

66 in consumer service and support, 35 in operations and warehousing and 62 are executive and administrative staff. None of our employees are

We have identified alternative sources of supply for these integrated circuits, components, and finished goods, but there can be no assurance

subject to a collective bargaining agreement or represented by a union. We consider our employee relations to be good.

International Operations
Financial information relating to our international operations for the years ended December 31, 2005, 2004 and 2003 is included in the “Notes to

that we will be able to continue to obtain these inventory purchases on a timely basis. We generally maintain inventories of our integrated chips, which

could be used in part to mitigate, but not eliminate, delays resulting from supply interruptions. An extended interruption, shortage or termination in

the supply of any of the components used in our products, or a reduction in their quality or reliability, or a significant increase in prices of components,

would have an adverse effect on our business, results of operations and cash flows.

Consolidated Financial Statements-Note 18.”

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Dependence on Foreign Manufacturing: Third-party manufacturers located in foreign countries manufacture a majority of our products. Our

that we will be able to obtain or maintain the rights to use proprietary technologies developed by others which are incorporated in our products. Any

arrangements with our foreign manufacturers are subject to the risks of doing business abroad, such as import duties, trade restrictions, work stop-

failure to anticipate or respond adequately to technological developments and customer requirements, or any significant delays in product develop-

pages, political instability, foreign currency exchange rate fluctuations, and other factors, which could have a material adverse effect on our business,

ment or introduction, could have a material adverse effect on our financial condition, results of operations and cash flows.

results of operations and cash flows. We believe that the loss of any one or more of our manufacturers would not have a long-term material adverse

effect on our business, results of operations and cash flows, because numerous other manufacturers are available to fulfill our requirements; however,

the loss of any of our major manufacturers could adversely affect our business until alternative manufacturing arrangements are secured.

Potential Fluctuations in Quarterly Results: Historically, our business has been influenced by the retail sales cycle, with increased sales in the last half

of the year and the largest proportion of sales occurring in the last quarter. Factors such as quarterly variations in financial results could have a material

adverse affect on the volatility and market price of our common stock.

In addition, the introduction of new products may require significant expenditures for research and development, tooling, manufacturing pro-

cesses, inventory and marketing. In order to achieve high volume production of any new product, we may have to make substantial investments in

inventory and expand our production capabilities.

Dependence on Major Customers: The economic strength and weakness of our worldwide customers affect our performance. We sell our wire-

less control products, audio/video accessory products, and proprietary technologies to private label customers, original equipment manufacturers,

and companies involved in the subscription broadcasting industry. We also supply our products to our wholly owned, non-U.S. subsidiaries and to

We may from time to time increase our operating expenses to fund greater levels of research and development, sales and marketing activities,

independent foreign distributors, who in turn distribute our products worldwide, with Europe, Asia, South Africa, Australia, and Argentina currently

development of new distribution channels, improvements in our operational and financial systems and development of our customer support ca-

representing our principal foreign markets.

pabilities, and to support our efforts to comply with various government regulations. To the extent such expenses precede or are not subsequently

followed by increased revenues, our business, operating results, financial condition and cash flows will be adversely affected.

During the years ended December 31, 2005 and 2004, we had sales to one customer, Comcast, that amounted to more than 10% of our net sales for

the respective periods. In addition, for the same periods, we had sales to DirecTV and its sub-contractors, that when combined, exceeded 10% of net

In addition, we may experience significant fluctuations in future quarterly operating results that may be caused by many other factors, including

sales. The future loss of these customers or any key customer, either in the United States or abroad, due to their financial weakness, bankruptcy, or our

demand for our products, introduction or enhancement of products by us and our competitors, the loss or acquisition of any significant customers,

inability to maintain order volume with these customers, may have an adverse effect on our financial condition, results of operations and cash flows.

market acceptance of new products, price reductions by us or our competitors, mix of distribution channels through which our products are sold, level

of product returns, mix of customers and products sold, component pricing, mix of international and domestic revenues, foreign currency exchange

rate fluctuations and general economic conditions. In addition, as a strategic response to changes in the competitive environment, we may from time

to time make certain pricing or marketing decisions or acquisitions that could have a material adverse effect on our business, results of operations or

financial condition. As a result, we believe period-to-period comparisons of our results of operations are not necessarily meaningful and should not

be relied upon as an indication of future performance.

SimpleDevices Inc.: On October 1, 2004, we acquired SimpleDevices Inc. for approximately $12.8 million in cash including direct acquisition costs, plus

a performance-based payment of our unregistered common stock to be paid in the future, if certain financial objectives are achieved. SimpleDevices,

based in San Mateo, California, develops software and firmware solutions that can enable devices such as TVs, set-top boxes, stereos, automotive au-

dio systems and other consumer electronic products to wirelessly connect and interact with home networks and interactive services to deliver digital

entertainment and information. The success of SimpleDevices will depend upon a variety of factors including, (i) our ability to bring SimpleDevices’

products to market in a timely and cost effective manner; (ii) the market accepting SimpleDevices’ products and technology to the extent anticipated

Due to all of the foregoing factors, it is likely that in some future quarters our operating results will be below the expectations of public market

by us; (iii) our ability to integrate SimpleDevices’ products and business into our own product offerings and business in a cost effective manner; and

analysts and investors. If this happens the price of our common stock will likely be materially adversely affected.

(iv) our ability to control the overall costs associated with SimpleDevices in the manner we anticipate. The failure of any of these items could have a

Dependence on Consumer Preference: We are susceptible to fluctuations in our business based upon consumer demand for our products. In addi-

material effect on our financial condition, results of operations and cash flows.

tion, we cannot guarantee that increases in demand for our products associated with increases in the deployment of new technology will continue. We

We may enter into contracts to perform customization of our software on behalf of a customer, where the agreement’s terms allow an initial trial

believe that our success depends on our ability to anticipate, gauge and respond to fluctuations in consumer preferences. However, it is impossible

period, after which the customer has the option to purchase a license for the finished product at a contracted rate (also known as a “try and buy”

to predict with complete accuracy the occurrence and effect of fluctuations in consumer demand over a products life cycle. Moreover, we caution that

agreement). There can be no assurance that these products will achieve customer acceptance. In addition, management may enter into contracts to

any growth in revenues that we achieve may be transitory and should not be relied upon as an indication of future performance.

provide a software product to a reseller for a nominal licensing fee, while making an optional premium upgrade available to the end user for an ad-

Demand for Consumer Service and Support: We have continually provided domestic and international consumer service and support to our custom-

ers to add overall value and to help differentiate us from our competitors. We continually review our service and support group and are marketing our

expertise in this area to other potential customers. There can be no assurance that we will be able to attract new customers in the future.

In addition, Our Kameleon® and Nevo® line of products have more features and are more complex than our older products and therefore may
require more end-user technical support. For our Nevo® product line, we currently rely, and intend to continue to rely, on the distributor or dealers to
provide first line technical support to the end-users. However, we provide the second level of technical support for bug fixes and other issues at no
additional charge. Therefore, as the mix of our products includes Nevo® and other more complex product lines, support costs could increase, which
would have an adverse effect on our financial condition and results of operations.

Dependence Upon Timely Product Introduction: Our ability to remain competitive in the wireless control and audio/video accessory products market

will depend considerably upon our ability to successfully identify new product opportunities, as well as developing and introducing these products

and enhancements on a timely and cost effective basis. There can be no assurance that we will be successful at developing and marketing new prod-

ucts or enhancing our existing products, or that these new or enhanced products will achieve consumer acceptance and, if achieved, will sustain that

acceptance. In addition, there can be no assurance that products developed by others will not render our products non-competitive or obsolete or

ditional charge. It is impossible to predict with complete accuracy the occurrence and effect of fluctuations in consumer demand for these premium

upgrades over a products life cycle.

Internal Investments: During 2004 we hired a small number of personnel to develop and market additional products that are part of the Nevo® plat-
form as well as products that are based on the Zigbee, Zensys and other radio frequency technology. Even after these hires, we continue to use outside

resources to assist us in the development of these products. While we believe that such outside services should continue to be available to us, in the

event that such outside services cease being available, the development of these products could be substantially delayed.

Competition: The wireless control industry is characterized by intense competition based primarily on product availability, price, speed of delivery,

ability to tailor specific solutions to customer needs, quality, and depth of product lines. Our competition is fragmented across our products, and,

accordingly, we do not compete with any one company across all product lines. We compete with a variety of entities, some of which have greater

financial and other resources. Our ability to remain competitive in this industry depends in part on our ability to successfully identify new product op-

portunities, develop and introduce new products and enhancements on a timely and cost effective basis, as well as our ability to successfully identify

and enter into strategic alliances with entities doing business within the industries we serve. There can be no assurance that our product offerings will

be, and/or remain, competitive or that strategic alliances, if any, will achieve the type, extent, and amount of success or business that we expect them

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to achieve – in that sales of our products and technology may not occur or grow in the manner expected by us, and thus we may not recoup costs

General Economic Conditions: General economic conditions, both domestic and international, have an impact on our business and financial results.

incurred in the research and development of these products as quickly as we expect or at all.

Patents, Trademarks, and Copyrights: The procedures by which we identify, document and file for patent, trademark, and copyright protection are

based solely on engineering and management judgment, with no assurance that a specific filing will be issued, or if issued, will deliver any lasting value

The global economy remains uncertain. As a result, individuals and companies may delay or reduce expenditures. Weak global economic conditions

and/or softness in the consumer, subscription broadcasting, and/or OEM channels could result in lower demand for our products, resulting in lower

sales, earnings and cash flows.

to us. Because of the rapid innovation of products and technologies that is characteristic of our industry, there is no assurance that rights granted

Environmental Matters: Every year we learn of changes in the laws and regulations regarding our environment. With the recent passage of the Eu-

under any patent will provide competitive advantages to us or will be adequate to safeguard and maintain our proprietary rights. Moreover, the laws

ropean Union’s Restriction of Hazardous Substances Directive, and the restrictions to be imposed by similar legislation currently proposed in China,

of certain countries in which our products are or may be manufactured or sold may not offer protection on such products and associated intellectual

and the European Union’s Waste Electrical and Electronic Equipment Directive, we could face significant costs and liabilities in complying with these

property to the same extent that the U.S. legal system may offer.

and new laws and regulations or enforcement policies that could have a material adverse effect upon our capital expenditures, earnings or financial

In our opinion, our intellectual property holdings as well as our engineering, production, and marketing skills and the experience of our person-

condition.

nel are of equal importance to our market position. We further believe that none of our businesses are materially dependent upon any single patent,

Terrorism and Acts of War: Terrorism and acts of war (wherever occurring throughout the world) may cause damage or disruption to us, our employ-

Some of our products include or use technology and/or components of third parties. While it may be necessary in the future to seek or renew

ees, facilities, partners, suppliers, distributors, resellers or customers, which could significantly impact our revenues, expenses and financial condition.

We are predominately uninsured for losses and interruptions caused by terrorist acts and acts of war.

licenses relating to various aspects of such products, we believe that, based upon past experience and industry practice, such licenses generally could

Leased Property: We lease all of the properties used in our business. We can give no assurance that we will enter into new or renewal leases, or that,

be obtained on commercially reasonable terms; however, there is no guarantee that such licenses could be obtained on such terms or at all. Because

if entered into, the new lease terms will be similar to the existing terms or that the terms of any such new or renewal leases will not have a significant

of technological changes in the wireless and home control industry, current extensive patent coverage, and the rapid rate of issuance of new patents,

and material adverse effect on our financial condition, results of operations and cash flows.

it is possible certain components of our products and business methods may unknowingly infringe upon the patents of others.

Technology Changes in Wireless Control: We currently derive substantial revenue from the sale of wireless remote controls based on infrared (“IR”)

Potential for Litigation: As is typical in our industry and for the nature and kind of business in which we are engaged, from time to time various claims,

technology. Other control technologies exist or could be developed that could compete with IR. In addition, we develop and maintain our own

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,

database of IR and RF codes. There are several competing IR and RF libraries offered by companies that we compete with in the marketplace. The

infringement of patent or other intellectual property rights, breach of warranty, contractual relations or employee relations. The amounts claimed may

advantage that we may have compared to our competitors is difficult to measure. If other wireless control technology gains acceptance and starts to

be substantial, but they may not bear any reasonable relationship to the merits of the claims or the extent of any real risk of court awards assessed

be integrated into home electronics devices currently controlled through our IR remote controllers, demand for our products may decrease, resulting

against us or in our favor.

in decreased revenue, earnings and cash flow.

Risks of Conducting Business Internationally: The risks of doing business internationally could adversely affect our sales, operations, earnings and

Failure to Recruit, Hire, and Retain Key Personnel Would Harm Our Ability to Grow and Meet Key Objectives: Our ability to achieve growth in the

cash flows due to a variety of factors, including, but not limited to:

•

changes in a country’s or region’s economic or political conditions, including inflation, recession, interest rate fluctuations and actual or antici-
pated military conflicts;

•

currency fluctuations affecting sales, particularly in the Euro and British Pound, which contribute to variations in sales of products and services in

impacted jurisdictions and also affect our reported results expressed in U.S. dollars;

•

currency fluctuations affecting costs, particularly the Euro, British Pound and the Chinese Yuan, which contribute to variances in costs in impacted

jurisdictions and also affect our reported results expressed in U.S. dollars;

longer accounts receivable cycles and financial instability among customers;

trade regulations and procedures and actions affecting production, pricing and marketing of products;

local labor conditions, customs, and regulations;

changes in the regulatory or legal environment;

•

• differing technology standards or customer requirements;

•

import, export or other business licensing requirements or requirements relating to making foreign direct investments, which could affect our

ability to obtain favorable terms for components or lead to penalties or restrictions;

• difficulties associated with repatriating cash generated or held abroad in a tax-efficient manner and changes in tax laws;

•

fluctuations in freight costs and disruptions at important geographic points of exit and entry; and

natural and medical disasters.

future will depend, in part, on our success at recruiting, hiring, and retaining highly skilled engineering, managerial, sales, and marketing personnel.

In addition, our corporate office, including our advance technology engineering group, is based in Southern California. The high cost of living in

Southern California makes it difficult to attract talent from outside the region and may also put pressure on overall employment related expense. The

inability to recruit, hire, and retain qualified personnel in a timely manner, or the loss of any key personnel, could make it difficult to meet key objec-

tives, such as timely and effective product introductions.

Credit Facility: Our current credit facility is set to expire in September 2006 and we are in discussions with our bank to extend this facility. Presently,

we have no borrowings under this facility; however, we cannot make any assurances that we will not need to borrow amounts under this facility or that

this facility will be extended and thus available to us in the event we need to borrow. If this or any credit facility is not available to us at a time when we

need to borrow, we would have to use our cash reserves which could have a material adverse effect on our earnings, cash flow and financial position.

Change in Competition and Pricing: We rely on third-party manufacturers to build our universal wireless control products, based on our extensive IR

code library and patented technology. Price is always an issue in winning and retaining business. If customers become increasingly price sensitive,

new competition could arise from manufacturers who decide to go into direct competition with us or from current competitors who perform their own

manufacturing. If such a trend develops, we could experience downward pressure on our pricing or lose sales, which could have a material adverse

effect on our financial condition and results of operations.

Transportation Costs; Impact of Oil Prices: We ship products from our foreign manufacturers via ocean and air transport. It is sometimes difficult to

forecast swings in demand and, as a result, products may be shipped via air which is more costly than ocean shipments. Often, we cannot recover the

increased cost of airfreight from our customers. The inability to predict swings in demand can increase the cost of freight which could have a material

adverse effect on our product margins.

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In addition, we have an exposure to oil prices in two forms. The first is in the prices of the oil-based materials that we use in our products, which are

primarily the plastics and other components that we include in our finished products. The second is in the cost of delivery and freight, which would be

passed on by the carriers that we use in the form of higher rates. We record freight-in as a cost of sales, and freight-out in operating expenses. Rising

oil prices may have an adverse effect on cost of sales and operating expenses.

Our Proprietary Technologies May Include Design or Performance Defects and May Not Achieve Their Intended Results: We produce highly complex

products that incorporate leading-edge technology, including hardware, firmware, and software. Firmware and software may contain bugs that can

unexpectedly interfere with operations. There can be no assurance that our testing programs will detect all defects in individual products or defects

that could affect numerous shipments. The presence of defects may harm customer satisfaction, reduce sales opportunities, or increase returns. An

inability to cure or repair a product defect could result in the failure of a product line, temporary or permanent withdrawal from a product or market,

damage to our reputation, increased inventory costs, or product reengineering expenses, any of which could have a material impact on our revenues,

margins and net income.

Acquisitions: We may, from time to time, pursue the acquisition of businesses, products or technologies that complement or expand our existing op-

erations, including those that could be material in size and scope. Acquisitions involve many risks, including the diversion of management’s attention

away from day-to-day operations. There is also the risk that we will not be able to successfully assimilate the operations, personnel, customer base,

products or technologies of an acquired business. Such acquisitions could also have adverse short-term effects on our operating results, and could

result in dilutive issuances of equity securities, the incurrence of debt, and the loss of key employees. In addition, business acquisitions must be ac-

counted for as purchases and, because most technology-related acquisitions involve the purchase of significant intangible assets, these acquisitions

typically result in substantial amortization charges and charges for acquired research and development projects, which could have a material adverse

effect on our results of operations. There can be no assurance that any such acquisitions will occur or, if such acquisitions do occur, that the acquired

businesses, customer bases, products or technologies will generate sufficient revenue to offset the associated costs or effects.

Selected Consolidated Financial Data

The information set forth below is not necessarily indicative of results of future operations, and should be read in conjunction with “Management’s

Discussion and Analysis of Financial Condition and Results of Operations,” and the “Notes to Consolidated Financial Statements,” in order to under-

stand further the factors that may affect the comparability of the financial data presented below.

in thousands, except per share data

2005

2004

2003

2002

2001

Year Ended December 31,

Net sales

Operating income

Net income

Earnings per share:

Basic

Diluted

Shares used in calculating earnings per share:

Basic

Diluted

Gross margin

Operating margin

Selling, general, administrative, research and

development expenses as a % of net sales

Net income as a % of net sales

Return on average assets

Working capital

181,349

$ 158,380

11,677

9,701

0.72

0.69

13,462

13,992

37.0%

6.4%

30.6%

5.4%

6.8%

13,540

9,114

0.67

0.65

13,567

14,100

38.9%

8.6%

30.3%

5.8%

6.8%

120,468

8,573

6,267

0.46

0.45

13,703

14,007

38.4%

7.1%

31.3%

5.2%

5.5%

103,891

$ 119,030

6,981

$ 16,009

5,939

$ 11,286

0.43

0.42

0.82

0.78

13,790

14,163

40.1%

6.7%

33.4%

5.7%

6.1%

13,844

14,523

41.2%

13.4%

27.8%

9.5%

12.0%

77,201

75,081

82,191

71,457

$ 67,422

Ratio of current assets to current liabilities

2.8

3.1

3.7

5.3

5.5

Total assets

Cash and cash equivalents

Short-term investments

Long-term debt

Stockholders’ equity

Book value per share (a)

146,319

$ 140,400

43,641

42,472

126,167

58,481

—

103,292

$ 103,881

7.63

7.66

95,171

6.89

24.6%

100,016

$ 94,705

18,064

$ 14,170

22,500

$ 20,100

104

83,237

$ 79,702

6.17

5.78

16.8%

15.8%

Ratio of liabilities to liabilities and stockholders’ equity

29.4%

26.0%

(a)Book value per share is defined as stockholders’ equity divided by common shares issued, less treasury stock.

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A factor that affected the comparability of information between 2002 and 2001 was our implementation of Statement of Financial Accounting Stan-

dards (“SFAS”) No. 142 on January 1, 2002, which requires that goodwill no longer be amortized. In addition, the comparability of 2005 and 2004 with

prior years is affected by the acquisition of SimpleDevices Inc. in the fourth quarter of 2004 (See Note 21 to the consolidated financial statements).

Management’s Discussion and Analysis of Financial Condition and Results of Operations

We have developed a broad line of pre-programmed universal wireless control products and audio-video accessories that are marketed to enhance

home entertainment systems. Our channels of distribution include international retail, U.S. retail, private label, OEMs, cable and satellite service

providers, CEDIA, and companies in the computing industry. We believe that our universal remote control database contains device codes that are
capable of controlling virtually all infrared remote (“IR”) controlled TVs, VCRs, DVD players, cable converters, CD players, audio components and satel-

lite receivers, as well as most other infrared remote controlled devices worldwide.

Beginning in 1986 and continuing today, we have compiled an extensive library that cover nearly 246,000 individual device functions and over

2,700 individual consumer electronic equipment brand names. Our library is regularly updated with new IR codes used in newly introduced video and

data and other known factors. The provision recorded for estimated sales returns and allowances is deducted from gross sales to arrive at net sales in

the period the related revenue is recorded. Sales allowances reduce gross accounts receivable to arrive at accounts receivable, net in the same period

the related receivable is recorded. We have no obligations after delivery of our products other than the associated warranties.

When a sales arrangement contains multiple elements, such as software products, licenses and/or services, we allocate revenue to each element

based on its relative fair value. The fair values for the multiple elements are determined based on vendor specific objective evidence (“VSOE”), or the

price charged when the element is sold separately. The residual method is utilized when VSOE exists for all the undelivered elements, but not for the

delivered element. This is performed by allocating revenue to the undelivered elements (that have VSOE) and the residual revenue to the delivered

elements. When the fair value for an undelivered element cannot be determined, we defer revenue for the delivered elements until the undelivered

elements are delivered. We limit the amount of revenue recognition for delivered elements to the amount that is not contingent on the future delivery

audio devices. All such IR codes are captured from the original manufacturer’s remote control devices or manufacturer’s specifications to ensure the

of products or services or subject to customer-specified return or refund privileges.

accuracy and integrity of the database. We have also developed patented technologies that provide the capability to easily upgrade the memory of

the wireless control device by adding IR codes from the library that were not originally included.

Beginning in 2002, we began selling our Nevo® 1.0 software embedded on our chip. Nevo 2.0® was launched in July of 2004. Both these products
were featured on a series of Hewlett Packard Personal Digital Assistants (PDA), which reached their end of life during the third quarter of 2005. Building
on this platform, we used some components of the Nevo 2.0® technology in a new product named “NevoSL”® which we began to ship in the second
quarter of the 2005. NevoSL® is a universal controller that delivers complete audio, visual and Wi-Fi digital media control for the networked home.

From October 1, 2004 through December 31, 2004, we acquired over 99% of the outstanding shares of SimpleDevices, Inc. (“SimpleDevices”)

for approximately $12.8 million in cash, including direct acquisition costs, plus a performance-based payment of our unregistered common stock to

be paid in the first quarter of 2007 if certain financial objectives are achieved. The performance-based payment has not been reflected as part of the

purchase price as of December 31, 2005, since we believe that it is not probable that the performance metrics will be met.

The value we received from this acquisition relates primarily to SimpleDevices’ unique capabilities, as well as its complete and in-process tech-

nology. SimpleDevices has developed connected-device technology solutions that link the home computer and the Internet to existing consumer

electronic devices in the home and car. The company provides UPnP-compatible software to transform common home devices into “connected”

devices — that is, devices that can find, control and share entertainment media across a home network. UPnP is an architecture for pervasive peer-to-

peer network connectivity of intelligent appliances, wireless devices, and PCs of all form factors. It is designed to bring standards-based connectivity

to ad-hoc or unmanaged networks whether in the home, in a small business, public spaces, or attached to the Internet. UPnP is a distributed, open

networking architecture that leverages TCP/IP and the Web technologies to enable seamless proximity networking in addition to control and data

transfer among networked devices in the home, office, and public spaces.

Critical Accounting Policies and Estimates
The preparation of financial statements in conformity with accounting principles generally 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 es-

timates and judgments, including those related to revenue recognition, allowance for sales returns and doubtful accounts, warranties, inventory valu-

ation, business combination purchase price allocations, our review for impairment of long-lived assets, intangible assets and goodwill, and income

taxes. Actual results may differ from the estimates, and these estimates may be adjusted as more information becomes available and any adjustment

could be significant.

We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our consoli-

dated financial statements.

Revenue Recognition: We recognize revenue on the sale of products when delivery has occurred, there is persuasive evidence of an arrangement,

the sales price is fixed or determinable and collectibility is reasonably assured. We record a provision for estimated sales returns and allowances on

product sales in the same period as the related revenues are recorded. These estimates are based on historical sales returns, analysis of credit memo

We account for revenue under software licensing arrangements involving significant production, modification or customization of software in

accordance with SOP 81-1, “Accounting for Performance of Construction-Type and Certain Production-Type Contracts.” We recognize revenue and

profit as work progresses on long-term, fixed price contracts using the percentage-of-completion method. When applying the percentage-of-com-

pletion method, we rely on estimates of total expected contract revenue and labor hours. We follow this method because reasonably dependable

estimates of the revenue and labor applicable to various stages of a contract can be made. Recognized revenue and profit are subject to revisions as

the contract progresses to completion. Revisions to revenue and profit estimates are charged to income in the period in which the facts that give rise

to the revision become known, and losses are accrued when identified.

Accounts Receivable: We maintain allowances for doubtful accounts for estimated losses resulting from the inability of our customers to make their

required payments. Specifically, we analyze historical bad debts, customer credit profiles, current economic trends and changes in customer payment

behavior when evaluating the adequacy of the allowance for doubtful accounts. If the financial condition of our customers were to deteriorate, result-

ing in an impairment of their ability to make payments, additional allowances might be required.

Inventories: Our inventories consist of wireless control devices, including universal remote controls, wireless keyboards, antennas, and related com-

ponent parts (including integrated circuits) and are valued at the lower of cost or market. Cost is determined using the first-in, first-out method. We

carry inventory in amounts necessary to satisfy our customers’ inventory requirements on a timely basis. New product innovations and technological

advances may shorten a given product’s life cycle. We continually monitor our inventory status to control inventory levels and dispose of any excess or

obsolete inventories on hand. We write down our inventory for estimated obsolescence and unmarketable inventory equal to the difference between

the inventory’s cost and its estimated market value based upon our best estimates about future demand and market conditions. If actual market condi-

tions are less favorable than those projected by management, additional inventory write-downs may be required.

Business Combinations: We are required to allocate the purchase price of acquired companies to the tangible and intangible assets and the liabilities

assumed, as well as in-process research and development (“IPR&D”), based on their estimated fair values. The total purchase price of SimpleDevices,

which was approximately $12.8 million, including direct acquisition costs, has been allocated to the net assets acquired based on estimated fair val-

ues. Such valuations require management to make significant estimates and assumptions, especially with respect to intangible assets. The significant

purchased intangible assets recorded by us include customer contracts, developed and core technology and trade names.

Critical estimates in valuing certain intangible assets include but are not limited to:

•

future free cash flow from customer contracts, customer lists, distribution agreements, acquired developed technologies and patents;

expected costs to develop IPR&D into commercially viable products and cash flows from the products once they are completed;

• brand awareness and market position, as well as assumptions about the period of time the brand will continue to be used in our product portfolio; and

• discount rates utilized in discounted cash flow models.

Our estimates of fair value are based upon assumptions believed to be reasonable, but which are inherently uncertain and unpredictable and, as

a result, actual results may differ from estimates.

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Valuation of Long-Lived Assets and Intangible Assets: We assess long-lived and intangible assets for impairment whenever events or changes in

The provision for tax liabilities involves evaluations and judgments of uncertainties in the interpretation of complex tax regulations by various taxing

circumstances indicate that their carrying value may not be recoverable. Factors considered important which could trigger an impairment review if

authorities. In situations involving tax related uncertainties, we provide for deferred tax liabilities when we believe such liabilities are probable. Actual

significant include the following:

results could differ from our estimates.

•

underperformance relative to historical or projected future operating results;

changes in the manner of use of the assets;

changes in the strategy of our overall business;

negative industry or economic trends;

a decline in our stock price for a sustained period; and

a variance between our market capitalization relative to net book value.

When we determine that the carrying value of a long-lived asset or an intangible asset may not be recoverable based upon the existence of one

or more of the above indicators of impairment we perform an impairment review. If the carrying value of the asset is larger than the undiscounted cash

flows, the asset is impaired. We measure an impairment based on the projected discounted cash flow method using a discount rate determined by

our management to be commensurate with the risk inherent in our current business model. In assessing the recoverability, we must make assumptions

regarding estimated future cash flows and other factors to determine the fair value of the respective assets. If these estimates or their related assump-

tions change in the future, we may be required to record impairment charges.

Goodwill: We evaluate the carrying value of goodwill as of December 31 of each year and between annual evaluations if events occur or circumstances

change that would more likely than not reduce the fair value of the reporting unit below its carrying amount. Such circumstances could include, but

are not limited to: (1) a significant adverse change in legal factors or in business climate, (2) unanticipated competition, or (3) an adverse action or as-

sessment by a regulator.

When performing the impairment review, we determine the carrying amount of each reporting unit by assigning assets and liabilities, including

the existing goodwill, to those reporting units. A reporting unit is defined as an operating segment or one level below an operating segment (referred

to as a component). A component of an operating segment is deemed a reporting unit if the component constitutes a business for which discrete

financial information is available, and segment management regularly reviews the operating results of that component.

To evaluate whether goodwill is impaired, we compare the fair value of the reporting unit to which the goodwill is assigned to the reporting unit’s

carrying amount, including goodwill. We determine the fair value of each reporting unit using the present value of expected future cash flows for that

reporting unit. If the carrying amount of a reporting unit exceeds its fair value, the amount of the impairment loss must be measured.

The impairment loss would be calculated by comparing the implied fair value of reporting unit goodwill to its carrying amount. In calculating the

implied fair value of the reporting unit goodwill, the fair value of the reporting unit is allocated to all of the other assets and liabilities of that unit based

on their fair values. The excess of the fair value of a reporting unit over the amount assigned to its other assets and liabilities is the implied fair value

of goodwill. An impairment loss would be recognized when the carrying amount of goodwill exceeds its implied fair value.

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

Net sales

Cost of sales

Gross profit

Research and development expenses

Selling, general and administrative expenses

Operating income

Interest income

Other income (expense), net

Income before income taxes

Provision for income taxes

Net income

Year Ended December 31,

2005

2004

2003

100.0%

63.0

37.0

3.6

27.0

6.4

0.5

1.2

8.1

2.7

5.4%

61.1

38.9

3.7

26.6

8.6

0.5

(0.4)

8.7

2.9

5.8%

61.6

38.4

3.9

27.4

7.1

0.5

0.3

7.9

2.7

5.2%

Year Ended December 31, 2005 Compared to Year Ended December 31, 2004
Consolidated: Net sales for the year ended December 31, 2005 were $181.3 million, an increase of 15% compared to $158.4 million for the same period

last year. Net income for 2005 was $9.7 million or $0.72 per share (basic) and $0.69 per share (diluted) compared to $9.1 million or $0.67 per share (basic)

and $0.65 per share (diluted) for 2004.

Net sales:

Business

Consumer

Total net sales

2005

2004

$ (millions)

% of total

$ (millions)

% of total

$ 126.2

55.1

$ 181.3

69.6%

30.4%

97.6

60.8

61.6%

38.4%

100.0%

$ 158.4

100.0%

Income Taxes: As part of the process of preparing our consolidated financial statements, we estimate our income taxes in each of the taxing jurisdic-

Net sales in our Business lines (subscription broadcasting, OEM, and computing companies) were approximately 70% of net sales for 2005 com-

tions in which we operate. This process involves estimating our actual current tax expense together with assessing any temporary differences resulting

pared to 62% for 2004. Net sales in our business lines for 2005 increased by 29% to $126.2 million from $97.6 million in 2004. This increase in sales resulted

from the different treatment of certain items, such as the timing for recognizing expenses, for tax and financial reporting purposes. These differences

primarily from an increase in the volume of remote control sales, which was partially offset by lower prices. The increase in remote control sales volume

may result in deferred tax assets and liabilities, which are included in our consolidated balance sheet.

We are required to assess the likelihood that our deferred tax assets, which include net operating loss carryforwards and temporary differences

that are expected to be deductible in future years, will be recoverable from future taxable income or other tax planning strategies. If recovery is not

likely, we must provide a valuation allowance based on our estimates of future taxable income in the various taxing jurisdictions and the amount of

deferred taxes that are ultimately realizable.

was attributable to the continued deployment of advanced function set-top boxes by the service operators and market share gains with a few key sub-

scription broadcasting customers. These advanced functions include digital video recording (“DVR”), video-on-demand (“VOD”), and high definition

television (“HDTV”). Royalty revenue (revenue earned through licensing of intellectual property) recognized in 2005 attributable to agreements signed

in the fourth quarter of 2004 of $1.5 million and the acquisition of SimpleDevices also contributed to the increase in net sales. The acquisition of Sim-

pleDevices added net sales of $0.7 million and 1% to the Business category net sales growth. We expect that the deployment of the advanced function

set-top boxes by the service operators will continue into the foreseeable future as penetration for each of the functions cited continues to increase. As

a result, we expect Business category revenue to range between $150 – $160 million in 2006.

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Net sales in our Consumer lines (One For All® international retail, private label, custom installers, and direct import) were approximately 30% of
net sales for 2005 compared to 38% for 2004. Net sales in our consumer lines for 2005 decreased by 9% to $55.1 million, from $60.8 million in 2004. The

SimpleDevices: SimpleDevices recorded net sales of $1.5 million and a pretax loss of $4.0 million in 2005. Sales consisted primarily of engineering

services related to the development of hardware utilized by SimpleDevices’ customers to run the SimplePlatforms software. In addition, SimpleDev-

decrease in sales resulted primarily from a decrease in European retail sales, which were down 11% to $43.0 million in 2005 from $47.6 million in 2004.

ices also generated revenue by customizing its software products to customer’s specific needs. Sales attributable to SimpleDevices are included in

This decrease was primarily attributable to lower volumes in the U.K. market and the weakening of both the Euro and the British Pound compared

our Business category when we discuss consolidated results. The results of SimpleDevices have been included since the date of acquisition and are

to the U.S. Dollar. The impact of the weakening currencies resulted in a decrease in net sales of approximately $0.6 million. Excluding the negative

described below.

foreign exchange impact, European retail sales decreased $4.0 million compared to 2004. Private label sales decreased by 41% to $4.0 million in 2005
from $6.8 million in 2004. This was due to a decline in the volume of Kameleon® sales. Kameleon® sales declined during 2005 compared to 2004 as a
result of fewer new product introductions. United States direct import licensing and product revenues for 2005 decreased by 21% to $2.5 million from
$3.2 million in 2004 due to a decline in the volume of Kameleon® sales. Partially offsetting these decreases was our entry into the CEDIA market, in
the second quarter of 2005. This added net sales of $2.5 million and 5% to the Consumer category net sales growth as compared to 2004. We expect

Consumer category revenue to range between $55 — $65 million in 2006.

Gross profit for 2005 was $67.1 million compared to $61.6 million for 2004. Gross profit as a percent of sales for 2005 was 37.0% compared to 38.9% for

2004. The decrease in gross profit as a percentage of net sales was primarily attributable to subscription broadcast sales, which generally have a lower

gross profit rate as compared to our other sales, representing a larger percentage of our total business. The impact of this change in mix was a 1.8%

reduction in the gross profit rate. Gross profit was also negatively impacted by an additional $1.9 million of freight expense recorded in 2005 as com-

pared to 2004. A portion of this increase in freight relates to sales volume; however, the majority of the increase is due to a change in rate. In 2005, there

was an increase in the percentage of units that were shipped by air versus ocean as well as a mix shift towards subscription broadcast sales. Freight

contributed to a 0.8% reduction in the gross profit rate. Duties increased $0.6 million, as a larger percentage of units were imported. The increase in

duty expense contributed to a 0.3% reduction in the gross profit rate. Gross profit was also negatively impacted by the weakening of both the Euro

and British Pound compared to the U.S. Dollar, which resulted in a decrease in gross profit of approximately $0.6 million and a reduction of 0.2% in the

gross profit rate. All other product costs, which include warranty expense, quality assurance expense, and component costs, increased $0.7 million

and reduced the gross profit rate by 0.4%. Partially offsetting these decreases in the gross profit rate was a reduction in inventory scrap expense of

$1.1 million. This reduction added 0.9% to the gross profit rate. In addition, royalty expense declined $0.7 million due to the decline in the volume of
Kameleon® sales, which added 0.7% to the gross profit rate.

Research and development expenses increased 12% from $5.9 million in 2004 to $6.6 million in 2005. The increase is related to our continued expansion
of the Nevo® platform and development efforts taking place at SimpleDevices. Partially offsetting these increases was a reduction in the development
of audio-video accessories for sale in our retail channel. We expect research and development expense to remain near current levels for the full year 2006.

• Gross profit was $0.1 million, or 6.4% of sales.

• Research and development expenses were $0.4 million, which consisted primarily of internal and external development efforts related to Sim-
pleDevices’ core software product.

•

Selling, general and administrative expenses were $3.7 million, which consisted primarily of engineering payroll and benefits costs as well as out-

side product development costs.

We anticipate that sales generated as a result of software customization and engineering services will begin to decline as a percent of total sales

as software licensing fees and the associated maintenance fees begin to increase. We also anticipate that gross profit and gross profit as a percent of

net sales will increase as this shift occurs.

Year Ended December 31, 2004 Compared to Year Ended December 31, 2003
Consolidated: Net sales for the year ended December 31, 2004 were $158.4 million, an increase of 31% compared to $120.5 million for the year ended

December 31, 2003. Net income for 2004 was $9.1 million or $0.67 per share (basic) and $0.65 per share (diluted) compared to $6.3 million or $0.46 per

share (basic) and $0.45 per share (diluted) for 2003.

Net sales:

Business

Consumer

Total net sales

2004

2003

$ (millions)

% of total

$ (millions)

% of total

97.6

60.8

61.6%

38.4%

69.7

57.8%

50.8

42.2%

$ 158.4

100.0%

$ 120.5

100.0%

Net sales in our business lines (subscription broadcasting, OEM, and computing companies) were approximately 62% of net sales for 2004 com-

pared to 58% for 2003. Net sales in our business lines for 2004 increased by 40% to $97.6 million from $69.7 million in 2003. Net sales to subscription

Selling, general and administrative expenses increased 16% from $42.2 million in 2004 to $48.9 million in 2005. Approximately $2.8 million of this

broadcasting service providers and OEMs for 2004 increased by 40% to $96.6 million from $68.9 million in 2003. The increase in sales resulted from

increase was attributable to the acquisition of SimpleDevices, $2.0 million to payroll and benefits, $1.9 million to bad debt expense, which included a

an increase in the volume of remote control sales, which was partially offset by lower prices. The increase in volume was attributable to the continued

$1.6 million reserve for a receivable due from a former European distributor, $1.2 million to delivery and freight costs caused by the increase in volume,

deployment of advanced function set-top boxes by the service operators. These advanced functions include personal video recording (“PVR”), video-

$0.7 million to increased tax and audit fees, $0.6 million to sales commissions, $0.5 million to travel, $0.3 million to trade shows, $0.3 million to tem-

on-demand (“VOD”), and high definition (“HD”) television.

porary clerical and warehouse staff, and $0.6 million to all other selling, general, and administrative costs. These items were partially offset by lower

employee bonus expense, which decreased by $2.8 million, temporary professional staff, which decreased by $0.9 million, outside legal fees, which

decreased by $0.4 million, and employment and recruiting costs, which decreased $0.3 million. We expect that selling, general, and administrative

expenses will range from $55 to $59 million for the full year 2006.

In 2005, we recorded $0.8 million of interest income compared to $0.7 million for 2004. This increase is due to higher money market rates. Net

interest income will be approximately $1.0 million in 2006.

In 2005, other income, net was $2.2 million as compared to $0.5 million of other expense, net for 2004. Approximately $2.1 million of other income

in 2005 resulted from foreign currency transaction gains reflecting the strengthening of the US Dollar. The results for 2004 included foreign currency ex-

change losses of $0.2 million. An additional $0.4 million of other expense in 2004 was the result of our write-down of an investment in a private company.

We recorded income tax expense of $5.0 million in 2005 compared to $4.6 million in 2004. Our effective tax rate was 33.9% in 2005, and 33.6% in 2004.

We estimate that our effective tax rate will range between 34.0% and 36.0% for the full year 2006 (see Note 16 to the consolidated financial statements).

Net sales in our consumer lines (One For All® international retail, private label, and direct import) accounted for approximately 38% of net sales for
2004 compared to 42% for 2003. Our net sales for 2004 from our consumer lines were $60.8 million, an increase of 20% from net sales of $50.8 million
in 2003. Of this increase, the One For All® international retail sales for 2004 increased by 39% to $50.8 million from $36.6 million in 2003. About $4.5
million of this increase was related to favorable foreign exchange rate movements, as both the Euro and British Pound strengthened compared to the
U.S. Dollar. The remaining improvement in international retail sales was due to an increase in sales of our Sky-branded digital accessories, One For All®
remote controls, and audio-video accessories. Private label sales for 2004 decreased by 27% to $6.8 million from $9.3 million in 2003 due to a decline
in the volume of Kameleon® sales. United States direct import licensing and product revenues for 2004 decreased by 33% to $3.2 million from $4.8
million in 2003 due to a decline in the volume of Kameleon® sales.

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Gross profit for 2004 was $61.6 million compared to $46.3 million for 2003. Gross profit as a percent of sales for 2004 was 38.9% compared to 38.4%

Liquidity and Capital Resources

for 2003. The increase was primarily attributable to the strengthening of the Euro and British Pound compared to the U.S. Dollar, which resulted in an

increase of approximately $4.1 million profit and added 1.5% to the gross profit rate. This increase was partially offset by increased inventory write-

downs of $0.9 million which contributed to a 0.5% reduction in the gross profit rate. In addition, the increase in gross profit rate was partially offset by

OEM sales, which generally have a lower gross profit rate, being a larger percentage of our total business.

Research and development expenses increased 25% from $4.7 million in 2003 to $5.9 million in 2004. The increase was related to our continued
expansion of the Nevo® platform, and the development of audio-video accessories for sale in our retail channel. In addition, IPR&D of $0.2 million
related to the SimpleDevices acquisition was expensed in the fourth quarter of 2004.

i n t h o u s a n d s

Year Ended
December 31, 2005

Increase
(decrease)

Year Ended
December 31, 2004

Increase
(decrease)

Year Ended
December 31, 2003

Cash provided by operating activities

14,129

10,138

3,991

$ (15,254)

$ 19,245

Cash (used) provided by investing activities

Cash (used) provided by financing activities

Effect of exchange rate changes

(4,037)

(3,246)

(5,677)

12,521

1,564

(16,558)

(35,740)

19,182

(4,810)

(7,148)

(7,045)

1,368

1,716

2,338

(348)

December 31, 2005

Increase
(decrease)

December 31, 2004

43,641

1,169

$ 42,472

77,201

2,120

75,081

Selling, general and administrative expenses increased 28% from $33.0 million in 2003 to $42.2 million in 2004. Approximately $2.3 million of

this increase was attributable to Sarbanes-Oxley compliance efforts, $1.7 million to appreciation of the Euro relative to the U.S. Dollar, $1.5 million to

Cash and cash equivalents

increased performance- based employee bonuses, $0.9 million to the acquisition of SimpleDevices, $0.8 million to freight costs, and $0.7 million to

Working capital

non-Sarbanes-Oxley related professional services costs.

In 2004, we recorded $0.7 million of interest income compared to $0.6 million for 2003. This increase was due to higher money market rates in

Europe, an investment in a certificate of deposit, and a higher average cash balance.

In 2004, other expense, net was $0.5 million as compared to $0.3 million of other income, net for 2003. Approximately $0.4 million of expense was

the result of our write-down of an investment in a private company, and $0.2 million of expense resulted from foreign currency exchange losses. The

results for 2003 included a foreign currency exchange gain of $0.3 million.

We recorded income tax expense of $4.6 million in 2004 compared to $3.2 million in 2003. Our estimated effective tax rate was 33.6% in 2004,

and 34.0% in 2003.

Cash Provided by Operating Activities: Our principal sources of funds are from operations. Cash provided by operating activities for 2005 was $14.1

million, compared to $4.0 million and $19.2 million during 2004 and 2003, respectively. The increase in cash flow from operations in 2005 compared to

2004 is primarily due to lower income tax payments in 2005, increased cash collections resulting from higher net sales offset partially by an increase in

our days sales outstanding (“DSO”) and accounts payable & accrued expenses increasing by a greater amount in 2005 versus 2004.

There were certain operating factors that affected our liquidity during 2005, which we expect will continue to affect our liquidity in the future. One

factor was the extension of payment terms with two of our major customers from 30 to 60 days and 90 to 120 days, respectively. These payment term

extensions resulted in an increase in our DSO from 67.5 days at December 31, 2004 to 76.4 days at December 31, 2005. In addition, our liquidity was

also affected by a planned increase in our inventory balance. We increased our inventory balances as a result of our strategy to lower the amount of

SimpleDevices, Inc. Transaction: We accounted for the acquisition of SimpleDevices by the purchase method of accounting. As a result, we allocated

products that are air shipped. During 2005, there was increased demand for advanced function set-top boxes that include features such as DVRs, PVRs

the purchase price of the acquisition based on the fair value of the assets acquired and the liabilities assumed. Significant portions of the Simple-

and HDTV. This shift drove a corresponding increase in demand from our subscription broadcast customers for our remote controls that interact with

Devices purchase price were identified as intangible assets. We employed valuation techniques which reflected guidance from the American Institute

these advanced set top boxes. Through the first two quarters of 2005, we did not have enough inventory on hand to meet this demand. As a result, we

of Certified Public Accountants’ Practice Aid Series entitled “Assets Acquired in a Business Combination to Be Used in Research and Development

were forced to air ship a significant amount of orders to maintain our customer service level. In order to alleviate the higher costs related to air ship-

Activities: A Focus on Software, Electronic Devices, and Pharmaceutical Industries” on approaches and procedures to be followed in developing

ments, we increased our inventory levels. We believe that the cost savings from shipping via ocean freight versus air will be greater than the additional

allocations to acquired IPR&D.

The final purchase price allocation included our identification of $240 thousand of IPR&D. This allocation represented the estimated fair value,

based upon risk-adjusted cash flows, of SimpleDevices’ IPR&D projects. At the date of acquisition, the development of these projects had not yet

reached technological feasibility and the IPR&D had no alternative future uses. Accordingly, we expensed these costs as research and development

in the quarter ended December 31, 2004. The remaining SimpleDevices purchase premium was allocated to identifiable intangibles, which are being

amortized over various periods ranging from 5 to 10 years, as well as goodwill.

SimpleDevices recorded net sales of $0.8 million and a pretax loss of $0.5 million during the period between October 1, 2004 (acquisition date)

and December 31, 2004. Sales consisted primarily of engineering services related to the development of hardware utilized by SimpleDevices’ cus-

tomers to run the SimplePlatforms software. In addition, SimpleDevices also generated revenue customizing their software products to customer’s

specific needs. Sales attributable to SimpleDevices are included in our Business category when we discuss consolidated results. The results of

SimpleDevices have been included since the date of acquisition and are described below.

• Gross profit was $0.3 million, or 39.5% of sales.

carrying cost of the increase in inventory. Our net inventory turns were 4.6 turns at December 31, 2005, down from 5.3 turns at December 31, 2004.

Cash (Used) Provided by Investing and Financing Activities: Cash used for investing activities during 2005 was $4.0 million as compared to $16.6 million

and cash provided of $19.2 million during 2004 and 2003, respectively. The decrease in cash used for investing activities in 2005 compared to 2004 was

primarily caused by the purchase of SimpleDevices in 2004 for $12.8 million.

Capital expenditures in 2005, 2004, and 2003 were $3.1 million, $2.7 million, and $2.5 million, respectively. Capital expenditures relate primarily to

acquiring product tooling each year. We are currently evaluating our existing and future information system requirements, and may make a significant

investment to upgrade our systems in 2006.

On September 15, 2003, we entered into a three-year $15.0 million unsecured revolving credit agreement (the “Credit Facility”) with Comerica

Bank (“Comerica”). This Credit Facility expires in September 2006, and we are currently involved in negotiations to extend this facility. Under the

Credit Facility with Comerica, the interest payable is variable and is based on the bank’s cost of funds or the LIBOR rate plus a fixed margin of 1.25%.
The interest rate in effect as of December 31, 2005 using the LIBOR Rate option plus a fixed margin of 1.25% was 5.64%. We pay a commitment fee

ranging from zero to a maximum of 1/4 of 1% per year on the unused portion of the credit line depending on the amount of cash investment retained

• Research and development expenses were $0.2 million, which represents the expensing of in-process technology as a result of the acquisition.

with Comerica during each quarter. Under the terms of this Credit Facility, dividend payments are allowed for up to 100% of the prior fiscal year net

•

Selling, general and administrative expenses were $0.6 million, which consisted primarily of engineering payroll and benefits costs.

income to be paid within 90 days of the prior year-end. We are subject to certain financial covenants related to our net worth, quick ratio, and net

income. Amounts available for borrowing under this Credit Facility are reduced by outstanding import letters of credit. As of December 31, 2005, we

had no amounts outstanding under this credit facility and no outstanding import letters of credit. Furthermore, as of December 31, 2005, we are in

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compliance with all financial covenants required by the Credit Facility.

Cash used for financing activities during 2005 was $3.2 million as compared to $4.8 million and cash provided of $2.3 million during 2004 and

2003, respectively. Proceeds from stock option exercises were $2.9 million during 2005, compared to proceeds of $1.9 million and $3.3 million dur-

ing 2004 and 2003, respectively. We purchased 356,285 shares of our common stock at a cost of $6.1 million during 2005, compared to 494,998 and

liabilities. The Jobs Act was enacted on October 22, 2004. FSP 109-2 states that an enterprise is allowed time beyond the financial reporting period

of enactment to evaluate the effect of the Jobs Act on its plan for reinvestment or repatriation of foreign earnings for purposes of applying SFAS No.

109. The undistributed earnings of our foreign subsidiaries are considered to be indefinitely reinvested. Consequently, we do not expect this standard

to have a material impact on our consolidated results of operations and financial condition.

84,437 shares at a cost of $6.7 and $1.0 million during 2004 and 2003, respectively. We hold these shares as treasury stock, and they are available for

In November 2004, the FASB issued SFAS No. 151, “Inventory Costs — An Amendment of ARB No. 43, Chapter 4” (“SFAS 151”). SFAS 151 amends

reissue. Presently, except for using a small number of these treasury shares to compensate our outside board members, we have no plans to distribute

the guidance in ARB No. 43, Chapter 4, “Inventory Pricing,” to clarify the accounting for abnormal amounts of idle facility expense, freight, handling

these shares, although we may change these plans if necessary to fulfill our on-going business objectives. We have authority under the Credit Facility

costs, and wasted material (spoilage). Among other provisions, this new standard requires that items such as idle facility expense, excessive spoilage,

to acquire up to 1.5 million shares of our common stock in market purchases. Between the date the Credit Facility was executed and December 31,

double freight, and re-handling costs be recognized as current-period charges regardless of whether they meet the criterion of “so abnormal” as stated

2005, we purchased 897,019 shares of our common stock leaving 602,981 remaining shares authorized for purchase. During 2006 we may continue to

in ARB No. 43. Additionally, SFAS 151 requires that the allocation of fixed production overhead to the cost of conversion be based on the normal capac-

purchase shares of our common stock if we believe conditions are favorable.

Historically, our working capital needs have typically been greatest during the third and fourth quarters when accounts receivable and inventories

increase in connection with the fourth quarter holiday selling season. At December 31, 2005, we had $77.2 million of working capital as compared to

ity of the production facilities. SFAS 151 is effective for fiscal years beginning after June 15, 2005 and we are required to adopt this standard in the first

quarter of 2006, beginning on January 1, 2006. We do not expect this standard to have a material impact on our consolidated results of operations and

financial condition.

$75.1 at December 31, 2004. The increase in working capital during these periods is principally due to higher accounts receivable and inventory bal-

In December 2004, the FASB issued SFAS No. 153, “Exchanges of Nonmonetary Assets — An Amendment of APB Opinion No. 29, Accounting for

ances at December 31, 2005 compared to December 31, 2004.

The following table summarizes our contractual obligations at December 31, 2005 and the effect these obligations are expected to have on our liquid-

ity and cash flow in future periods.

c o n t r a c t u a l o b i l g a t i o n s i n t h o u s a n d s

Total

Less than 1 year

1 - 3 Years

4 - 5 years

After 5 years

Payments Due by Period

Operating lease obligations

Purchase obligations

Total

$ 5,118

$ 1,455

$ 2,324

912

427

1,503

480

1,023

—

$ 6,621

$ 1,935

$ 3,347

912

427

At December 31, 2005, we did not have any bank guarantees that provide for the bank to make payment on our behalf in the event of our non-payment

for transactions with suppliers in the ordinary course of business.

Nonmonetary Transactions” (“SFAS 153”). SFAS 153 eliminates the exception from fair value measurement for nonmonetary exchanges of similar pro-

ductive assets in paragraph 21(b) of APB Opinion No. 29, “Accounting for Nonmonetary Transactions,” and replaces it with an exception for exchanges

that do not have commercial substance. SFAS 153 specifies that a nonmonetary exchange has commercial substance if the future cash flows of the

entity are expected to change significantly as a result of the exchange. SFAS 153 is effective for the fiscal periods beginning after June 15, 2005 and we

are required to adopt the standard in the first quarter of 2006, beginning on January 1, 2006. We are currently evaluating the effect that the adoption

of SFAS 153 will have on our consolidated results of operations and financial condition but do not expect it will have a material impact.

In December 2004, the FASB issued SFAS 123R, “Share Based Payments.” SFAS 123R requires companies to expense the value of stock options and

similar awards. This statement is a revision of SFAS 123, “Accounting for Stock-Based Compensation” and supersedes APB Opinion No. 25, “Accounting

for Stock Issued to Employees,” and its related implementation guidance. SFAS 123R requires a public entity to measure the cost of employee services

received in exchange for an award of equity instruments based on the grant-date fair value of the award (with limited exceptions). That cost will be rec-

ognized over the period during which an employee is required to provide service in exchange for the award — the requisite service period (usually the

vesting period). No compensation cost is recognized for equity instruments for which employees do not render the requisite service. In March 2005, the

It is our policy to carefully monitor the state of our business, cash requirements, and capital structure. We believe that funds generated from our

SEC issued Staff Accounting Bulletin No. 107 (“SAB 107”) regarding the SEC’s interpretation of SFAS 123R and the valuation of share-based payments

operations and available from our credit facility will be sufficient to fund current business operations as well as anticipated growth at least through the

for public companies. SFAS 123R, and its related implementation guidance, will significantly change existing accounting practice and will have a material

end of 2006; however, there can be no assurance that such funds will be adequate for that purpose.

effect on our reported earnings. The pro forma disclosures previously permitted under SFAS 123 will no longer be an alternative to financial statement

New Accounting Pronouncements
FASB Staff Position (“FSP”) No. 109-1, “Application of FASB Statement No. 109, Accounting for Income Taxes, to the Tax Deduction on Qualified

Production Activities Provided by the American Jobs Creation Act of 2004,” (“FSP 109-1”), gives guidance under SFAS No. 109, “Accounting for In-

come Taxes,” with respect to the provision within the American Jobs Creation Act of 2004 (the “Jobs Act”) that provides a tax deduction on qualified

production activities. The Jobs Act includes a tax deduction of up to 9 percent (when fully phased-in) of the lesser of (a) “qualified production activi-

ties income,” as defined in the Jobs Act, or (b) taxable income (after the deduction for the utilization of any net operating loss carryforwards). This

tax deduction is limited to 50 percent of W-2 wages paid by the taxpayer. FSP 109-1 states that an enterprise should account for the deduction as a

special deduction in accordance with Statement 109. In addition, FSP 109-1 requires that the special deduction be considered by an enterprise in (a)

recognition.

We are required to adopt SFAS 123R in the first quarter of fiscal 2006, beginning January 1, 2006. Under SFAS 123R, we must determine the appro-

priate fair value model to be used for valuing share-based payments, the amortization method for compensation cost and the transition method to be

used at the date of adoption. The transition methods include modified-prospective and modified-retrospective adoption options. Under the modified-

retrospective option, prior periods may be restated either as of the beginning of the year of adoption or for all periods presented. The modified-

prospective method requires that compensation expense be recorded for all unvested stock options and restricted stock at the beginning of the first

quarter of adoption of SFAS 123R, while the modified-retrospective method would record compensation expense for all unvested stock options and

restricted stock beginning with the first period of adoption.

measuring deferred taxes when graduated tax rates are a significant factor and (b) assessing whether a valuation allowance is necessary as required

We plan to apply the modified prospective transition method, which requires that compensation expense be recorded for all unvested stock op-

by paragraph 232 of Statement 109. We are currently evaluating the effect that the adoption of FSP 109-1 will have on our consolidated results of

tions and restricted stock beginning the first quarter of 2006. We have chosen the Black-Scholes valuation model to value stock-based compensation

operations and financial condition but do not expect it will have a material impact.

FASB Staff Position (“FSP”) No. 109-2, “Accounting and Disclosure Guidance for the Foreign Earnings Repatriation Provision within the American

Jobs Creation Act of 2004” (“FSP 109-2”), provides guidance under SFAS No. 109, “Accounting for Income Taxes,” with respect to recording the

potential impact of the repatriation provisions of the American Jobs Creation Act of 2004 (the “Jobs Act”) on income tax expense and deferred tax

utilizing an expected volatility estimated using the historical method. Unamortized compensation expense related to outstanding unvested options,

as determined in accordance with FAS 123R, that we expect to record during 2006 is approximately $2.7 million before income taxes. This estimate

excludes the effect of additional expense related to new awards that may be granted during 2006.

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In May 2005, the FASB issued SFAS No. 154, “Accounting Changes and Error Corrections” (“SFAS 154”) which replaces Accounting Principles

consumer interaction with products and services within the home easier and more enjoyable. We intend to invest in new products and technology to

Board Opinions No. 20 “Accounting Changes” and SFAS No. 3, “Reporting Accounting Changes in Interim Financial Statements—An Amendment of

meet our customer needs now and into the future.

APB Opinion No. 28.” SFAS 154 provides guidance on the accounting for and reporting of accounting changes and error corrections. It establishes

retrospective application, or the latest practicable date, as the required method for reporting a change in accounting principle and the reporting of a

correction of an error. SFAS 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005

and we are required to adopt the standard in the first quarter of fiscal 2006. We do not expect this standard to have a material impact on our consoli-

dated results of operations and financial condition.

In June 2005, the FASB issued FSP FAS 143-1, “Accounting for Electronic Equipment Waste Obligations” (“FSP 143-1”), which provides guidance

on the accounting for certain obligations associated with the Directive on Waste Electrical and Electronic Equipment (the “Directive”), which was

adopted by the European Union (“EU”). Under the Directive, the financing of historical waste held by private households is to be borne collectively by

producers that are selling in the market during each measurement period (to be defined by each EU-member country). The volume of equipment that

qualifies as historical waste that those producers have sold in the market prior to the measurement period is not considered. Producers will be required

to contribute proportionately based on their participation in the market (for example, in proportion to their respective shares of the market by type

of equipment). However, the exact method to be used to compute the respective proportions to be contributed by producers will be determined by

each EU-member country. For commercial users, the waste management obligation for historical equipment (products put on the market on or prior

to August 13, 2005) remains with these entities until the equipment is replaced. FSP 143-1 is required to be applied to the later of the first reporting

period ending after June 8, 2005 or the date of the Directive’s adoption into law by the applicable EU member countries in which we have significant

operations. We are currently evaluating the effect that the adoption of FSP 143-1 will have on our consolidated results of operations and financial

condition. Such effects will depend on the respective laws adopted by the EU member countries.

Outlook
Our focus is to build technology and products that make the consumers’ interaction with devices and content within the home easier and more en-

joyable. The pace of change in the home is increasing. The growth of new devices, such as DVD players, PVR/DVR technologies and home theater

solutions, to name only a few, has transformed control of the home entertainment center into a complex challenge for the consumer. The more recent

introduction and projected growth of digital media technologies in consumers’ lives will further increase this complexity. We have set out to create the

interface for the connected home, building a bridge between the home devices of today and the networked home of the future. We intend to invest in

new products and technology, particularly in the connected home space, which will expand our business beyond the control of devices to the control

of and access to content, such as digital media, to enrich the entertainment experience.

We will continue enhancing our leadership position in our core business by developing custom products for our subscription broadcasting, OEM,

retail, and computing customers, growing our capture expertise in infrared technology and radio frequency standards, adding to our portfolio of

patented or patent pending technologies and developing new platform products. We are also developing new ways to enhance remote controls and

other accessory products.

During 2006, we will continue to develop new products featuring our Kameleon® interface technology, a display technology that provides ease of
use by illuminating only the keys needed to control each entertainment device. We are continuing development of our Nevo® technology, an embed-
ded solution that transforms an electronic display into a sophisticated and easy-to-use wireless home control and automation device. We are continu-
ing to seek ways to integrate these platform technologies into other forms and devices. Nevo 2.0® was launched in July of 2004 as a feature on a series
of HP’s handheld devices, which reached its end of life during the third quarter of 2005. Building on this platform, we used some components of the
Nevo 2.0® technology in a new product named “NevoSL”® which we began to ship in the second quarter of 2005. This product is designed for use in
the home. In addition, we are working on product line extensions to our One For All® audio/video accessories which include digital antennas, signal
boosters, television brackets and A/V cleaning products.

We are also seeking ways to increase our customer base worldwide, particularly in the areas of subscription broadcasting, OEM, and One For
All® international retail. We will continue to work on strengthening existing relationships by working with customers to understand how to make the

Through SimpleDevices, we continued developing software and firmware solutions that can enable devices such as TVs, set-top boxes, stereos,

automotive audio systems and other consumer electronic products to wirelessly connect and interact with home networks and interactive services to

deliver digital entertainment and information. This “smart device” category is emerging and in 2006 we look to build relationships with our customers

in this category.

In 2006, we will continue to evaluate acceptable acquisition targets and strategic partnership opportunities in our core business lines as well as in

the networked home marketplace. We caution, however, that no assurance can be made that any suitable acquisition target or partnership opportu-

nity will be identified and, if identified, that a transaction can be consummated. Moreover, if consummated, no assurance can be made that any such

acquisition or partnership will profitably add to our operations.

Quantitative and Qualitative Disclosures about Market Risk

We are exposed to various market risks, including interest rate and foreign currency exchange rate fluctuations. We have established policies, proce-

dures and internal processes governing our management of these risks and the use of financial instruments to mitigate our risk exposure.

The interest payable under our revolving Credit Facility with our bank is variable and based on either (i) the bank’s cost of funds or (ii) the LIBOR

rate plus a fixed margin of 1.25%; the rate is affected by changes in market interest rates. At December 31, 2005, we had no borrowings on our credit

facility. The interest rate in effect on the credit facility as of December 31, 2005 using the LIBOR Rate option plus a fixed margin of 1.25% was 5.64%.

This credit facility will expire in September 2006 and we are currently negotiating to extend this credit facility.

At December 31, 2005 we had wholly owned subsidiaries in The Netherlands, United Kingdom, Germany, France, Argentina and Spain. Sales from

these operations are typically denominated in local currencies including Euros, British Pounds and Argentine Pesos, thereby creating exposure to

changes in exchange rates. Changes in local currency exchange rates relative to the U.S. Dollar, and in some cases, to each other, may positively or

negatively affect our sales, gross margins and net income. From time to time, we enter into foreign currency exchange agreements to manage our

exposure arising from fluctuating exchange rates that affect cash flows and our reported income. Contract terms for the foreign currency exchange

agreements normally last less than nine months. We do not enter into any derivative transactions for speculative purposes.

The value of our net balance sheet positions held in foreign currency can also be impacted by fluctuating exchange rates, as can the value of the

income generated by our European subsidiaries. It is difficult to estimate the impact of fluctuations on reported income, as it depends on the open-

ing and closing rates, the average net balance sheet positions held in a foreign currency and the amount of income generated in local currency. We

routinely forecast what these balance sheet positions and income generated in local currency may be, and we take steps to minimize exposure as we

deem appropriate.

The sensitivity of earnings and cash flows to the variability in exchange rates is assessed by applying an approximate range of potential rate

fluctuations to our assets, obligations and projected results of operations denominated in foreign currency. Based on our overall foreign currency

rate exposure at December 31, 2005, we believe that movements in foreign currency rates could have a material affect on our financial position. We

estimate that if the exchange rates for the Euro and the British Pound relative to the U.S. Dollar fluctuate 10% from December 31, 2005, first quarter

net income and cash flows would fluctuate by approximately $0.3 million and $4.2 million, respectively.

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Financial Statements and Supplemental Data

Report Of Independent Registered Public Accounting Firm

Board of Directors and Shareholders

Universal Electronics, Inc.

Report of Independent Registered Public Accounting Firm

To the Board of Directors and Shareholders of Universal Electronics Inc.:

In our opinion, the consolidated balance sheet as of December 31, 2004 and the related consolidated statements of income, shareholders’ equity and

We have audited the accompanying consolidated balance sheet of Universal Electronics, Inc. as of December 31, 2005, and the related consolidated

cash flows for each of the two years in the period ended December 31, 2004, present fairly, in all material respects, the financial position of Universal

statements of income, stockholders’ equity, and cash flows for the year then ended. These financial statements are the responsibility of the Company’s

Electronics Inc. and its subsidiaries at December 31, 2004, and the results of their operations and their cash flows for each of the two years in the period

management. Our responsibility is to express an opinion on these financial statements based on our audit.

ended December 31, 2004, in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion,

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards

require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement.

An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes as-

sessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presenta-

tion. We believe that our audit provides a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position

of Universal Electronics, Inc. as of December 31, 2005, and the consolidated results of its operations and its consolidated cash flows for the year then

ended, in conformity with accounting principles generally accepted in the United States of America.

Our audit was conducted for the purpose of forming an opinion on the basic financial statements taken as a whole. The Schedule II is presented

for purposes of additional analysis and is not a required part of the basic financial statements. This schedule has been subjected to the auditing pro-

cedures applied in the audit of the basic financial statements and, in our opinion, is fairly stated in all material respects in relation to the basic financial

statements taken as a whole.

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness

of Universal Electronics, Inc.’s internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control

— Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 10, 2006,

expressed an unqualified opinion thereon.

the financial statement schedule for each of the two years in the period ended December 31, 2004 presents fairly, in all material respects, the informa-

tion set forth therein when read in conjunction with the related consolidated financial statements. These financial statements and financial statement

schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and financial

statement schedule based on our audits. We conducted our audits of these statements in accordance with the standards of the Public Company Ac-

counting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether

the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclo-

sures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall

financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

PricewaterhouseCoopers LLP

Orange County, CA

March 16, 2005

Grant Thornton LLP

Irvine, California

March 10, 2006

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Consolidated Balance Sheets

i n t h o u s a n d s , e x c e p t s h a r e - r e l a t e d d a t a

Assets

Current assets:

Cash and cash equivalents

Accounts receivable, net

Inventories, net

Prepaid expenses and other current assets

Income tax receivable

Deferred income taxes

Total current assets

Equipment, furniture and fixtures, net

Goodwill

Intangible assets, net

Other assets

Deferred income taxes

Total assets

Liabilities And Stockholders’ Equity

Current liabilities:

Accounts payable

Accrued income taxes

Accrued compensation

Other accrued expenses

Total current liabilities

Long term liabilities:

Deferred income taxes

Deferred Revenue

Total liabilities

Commitments and contingencies

Stockholders’ equity:

December 31,

2 0 0 5

2 0 0 4

i n t h o u s a n d s , e x c e p t p e r s h a r e a m o u n t s

Consolidated Income Statements

43,641

42,472

41,861

26,708

3,841

903

2,971

119,925

4,352

10,431

6,007

403

5,201

38,758

23,862

2,027

1,158

3,216

111,493

3,732

10,655

6,550

2,935

5,035

Net sales

Cost of sales

Gross profit

Research and development expenses

Selling, general and administrative expenses

Operating income

Interest income

Other income (expense), net

Income before provision for income taxes

Provision for income taxes

Net income

Earnings per share:

Basic

Diluted

$ 146,319

$ 140,400

Shares used in computing earnings per share:

Basic

Diluted

22,731

17,559

7,551

2,766

9,676

42,724

229

4,267

5,914

8,672

36,412

107

—

43,027

36,519

The accompanying notes are an integral part of these consolidated financial statements.

Year Ended December 31,

2 0 0 5

2 0 0 4

2 0 0 3

$ 181,349

$ 158,380

$ 120,468

114,222

67,127

6,580

48,870

11,677

845

2,152

14,674

4,973

9,701

0.72

0.69

13,462

13,992

96,800

61,580

5,865

42,175

13,540

723

(540)

13,723

4,609

9,114

0.67

0.65

13,567

14,100

74,168

46,300

4,700

33,026

8,574

583

338

9,495

3,228

6,267

0.46

0.45

13,703

14,007

Preferred stock, $.01 par value, 5,000,000 shares authorized; none issued or outstanding

—

Common stock, $.01 par value, 50,000,000 shares authorized; 16,963,748 and
16,642,743 shares issued at December 31, 2005 and 2004, respectively

Paid-in capital

Accumulated other comprehensive (loss) income

Retained earnings

Deferred stock-based compensation

Less cost of common stock in treasury, 3,420,876 and 3,084,591

shares at December 31, 2005 and 2004, respectively

Total stockholders’ equity

Total liabilities and stockholders’ equity

The accompanying notes are an integral part of these consolidated financial statements.

169

83,220

(5,265)

54,994

(163)

132,955

(29,663)

103,292

167

78,872

3,571

45,293

(169)

127,734

(23,853)

103,881

$ 146,319

$ 140,400

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49

Consolidated Statements of Stockholders’ Equity

i n t h o u s a n d s

Balance at December 31, 2002

Comprehensive income:

Net income

Currency translation adjustment

Total comprehensive income

Shares issued for retirement plan

Purchase of treasury shares

Stock options exercised

Shares issued to Directors

Stock-based compensation

Tax benefit from exercise of non-qualified stock options

Balance at December 31, 2003

Comprehensive income:

Net income

Currency translation adjustment

Total comprehensive income

Shares issued for retirement plan

Purchase of treasury shares

Stock options exercised

Restricted stock grants

Shares issued to Directors

Stock-based compensation

Tax benefit from exercise of non-qualified stock options

Balance at December 31, 2004

Comprehensive income:

Net income

Currency translation adjustment

Total comprehensive income

Shares issued for retirement plan

Purchase of treasury shares

Stock options exercised

Restricted stock grants

Shares issued to Directors

Stock-based compensation

Tax benefit from exercise of non-qualified stock options

Balance at December 31, 2005

The accompanying notes are an integral part of these consolidated financial statements.

Common Stock Issued

16,001

Amount

160

Common Stock in Treasury

Amount

Paid-in
Capital

Accumulated Other
Comprehensive
Income (Loss)

Retained
Earnings

Deferred
Stock-Based
Compensation

Totals

Comprehensive
Income

(2,521)

$ (16,270)

$ 71,322

(1,740)

29,912

(147)

83,237

371

6,267

2,038

(85)

(963)

360

3,339

341

443

105

361

(963)

3,342

105

341

443

16,405

164

(2,599)

(17,233)

75,805

298

36,179

(42)

95,171

209

9,114

3,273

(495)

(6,696)

430

1,883

349

(76)

481

431

(6,696)

1,885

—

222

481

(349)

222

16,643

167

(3,085)

(23,853)

78,872

3,571

45,293

(169)

103,881

290

9,701

(8,836)

(356)

(6,110)

300

533

2,862

326

(300)

853

533

(6,110)

2,864

—

406

853

(326)

332

16,964

169

(3,421)

$ (29,663)

$ 83,220

$ (5,265)

54,994

(163)

$ 103,292

6,267

2,038

8,305

9,114

3,273

12,387

9,701

(8,836)

865

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Consolidated Statements of Cash Flows

i n t h o u s a n d s

Cash provided by operating activities:
Net income

Adjustments to reconcile net income to net cash provided by operating activities:

Depreciation and amortization

Provision for doubtful accounts

Provision for inventory write-downs

Deferred income taxes

Tax benefit from exercise of stock options

Shares issued for employee benefit plan

Employee and director stock-based compensation

Loss on disposal of fixed assets

Write-off of in-process R & D

Write down of investment in private company

Other

Changes in operating assets and liabilities (net of acquisition in 2004):

Accounts receivable

Inventory

Prepaid expenses and other assets

Accounts payable and accrued expenses

Accrued income and other taxes

Net cash provided by operating activities

Cash (used for) provided by investing activities:

Acquisition of equipment, furniture and fixtures

Payments for business acquired, net of cash acquired

Acquisition of intangible assets

Purchases of short-term investments

Sale of short-term investments

Net cash (used for) provided by investing activities

Cash (used for) provided by financing activities:

Proceeds from stock options exercised

Treasury stock purchased

Payments on note payable

Net cash (used for) provided by financing activities

Effect of exchange rate changes on cash

Net increase (decrease) in cash and cash equivalents

Cash and cash equivalents at beginning of year
Cash and cash equivalents at end of year

Year Ended December 31,

2 0 0 5

2 0 0 4

2 0 0 3

9,701

9,114

6,267

3,702

2,121

2,735

(130)

853

533

406

—

(6,966)

(7,128)

(1,207)

5,416

4,090

14,129

(3,137)

—

(900)

—

3,093

161

3,788

349

481

431

222

192

240

357

—

(6,386)

(7,311)

(2,490)

2,329

(579)

3,991

(2,657)

(12,754)

(1,147)

—

(4,037)

(16,558)

2,864

(6,110)

—

(3,246)

(5,677)

1,169

42,472

1,885

(6,695)

—

(4,810)

1,368
(16,009)

58,481

3,358

392

2,890

(849)

443

360

446

—

(3)

(1,145)

(6,230)

(657)

11,006

2,967

19,245

(2,470)

—

(848)
(22,000)

44,500

19,182

3,343

(963)

(42)

2,338

(348)

40,417

18,064

Notes to Consolidated Financial Statements

Note 1 — Description of Business
Universal Electronics Inc., based in Southern California, has developed a broad line of easy-to-use, pre-programmed universal wireless control prod-

ucts and audio-video accessories that are marketed to enhance home entertainment systems as well as software designed to enable consumers to

wirelessly connect, control and interact with an increasingly complex home environment. Our primary markets include retail, private label, original

equipment manufacturers (“OEMs”), custom installers, cable and satellite service providers, and companies in the personal computing industry. Over

the past 18 years, we have developed a broad portfolio of patented technologies and a database of home connectivity software that we license to our

customers, including many leading Fortune 500 companies. In addition, we sell our universal wireless control products and other audio/visual acces-

sories through our European headquarters in The Netherlands, and to distributors and retailers in Europe, Australia, New Zealand, South Africa, the
Middle East, Mexico, and selected countries in Asia and Latin America under the One For All® brand name.

As used herein, the terms “we”, “us” and “our” refer to Universal Electronics Inc. and its subsidiaries unless the context indicates to the contrary.

Note 2 — Summary of Significant Accounting Policies
Principles of Consolidation: The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All the

intercompany accounts and significant transactions have been eliminated in the consolidated financial statements. Between October 1 and December

31, 2004, we acquired the outstanding shares of SimpleDevices Inc. The results of SimpleDevices’ operations have been included in the consolidated

financial statements since the date of acquisition (See Note 21 to the consolidated financial statements).

Estimates and Assumptions: The preparation of financial statements in conformity with accounting principles generally 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. Actual results

may differ from these estimates and judgments. On an on-going basis, we evaluate our estimates and judgments, including those related to revenue

recognition, allowance for sales returns and doubtful accounts, warranties, inventory valuation, business combinations, purchase price allocations,

review for impairment of long-lived assets, intangible assets and goodwill, contingencies, and income taxes. These estimates may be adjusted as ad-

ditional information becomes available and any adjustment could be significant.

Revenue Recognition: We recognize revenue on the sale of products when delivery has occurred, there is persuasive evidence of an arrangement,

the sales price is fixed or determinable and collectibility is reasonably assured. We record a provision for estimated sales returns and allowances on

product sales in the same period as the related revenues are recorded. These estimates are based on historical sales returns, analysis of credit memo

data and other known factors. The provision recorded for estimated sales returns and allowances is deducted from gross sales to arrive at net sales in

the period the related revenue is recorded. Sales allowances reduce gross accounts receivable to arrive at accounts receivable, net in the same period

the related receivable is recorded. We have no obligations after the delivery of our products other than the associated warranties (See Note 20 to the

consolidated financial statements).

We generate service revenue as a result of providing consumer support programs to some of our customers through our call centers. These

service revenues are recognized when performed, persuasive evidence of an arrangement exists, the sales price is fixed or determinable, and collect-

43,641

42,472

58,481

ibility is reasonably assured.

Supplemental Cash Flow Information — Income taxes paid were $0.3 million, $4.5 million, and $1.1 million in 2005, 2004 and 2003, respectively.

We also license our intellectual property (including our patented technologies) trade secrets, trademarks, and database of infrared codes. We

Supplemental schedule of non-cash investing activities:
In 2004 we purchased over 99% of the outstanding shares of SimpleDevices, Inc. for $12.8 million, net of cash acquired (See Note 21 to the consolidated financial
statements). In conjunction with the acquisition, assets acquired and liabilities assumed were as follows:

Fair value of assets acquired
Cash paid for capital stock, net

Liabilities assumed

13,613

12,761

852

record license revenue when our customers ship products incorporating our intellectual property, persuasive evidence of an arrangement exists, the

sales price is fixed or determinable, and collectibility is reasonably assured.

When a sales arrangement contains multiple elements, such as software products, licenses and/or services, we allocate revenue to each element

based on its relative fair value. The fair values for the multiple elements are determined based on vendor specific objective evidence (“VSOE”), or the

price charged when the element is sold separately. The residual method is utilized when VSOE exists for all the undelivered elements, but not for the

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delivered element. This is performed by allocating revenue to the undelivered elements (that have VSOE) and the residual revenue to the delivered

Inventories: Inventories consisting of wireless control devices, including universal remote controls, wireless keyboards, antennas, and related com-

elements. When the fair value for an undelivered element cannot be determined, we defer revenue for the delivered elements until the undelivered

ponent parts, and are valued at the lower of cost or market. Cost is determined using the first-in, first-out method. We carry inventory in amounts

elements are delivered. We limit the amount of revenue recognition for delivered elements to the amount that is not contingent on the future delivery

necessary to satisfy our customers’ inventory requirements on a timely basis.

of products or services or subject to customer-specified return or refund privileges.

New product innovations and technological advances may shorten a given product’s life cycle. We continually monitor the inventory status to con-

We account for revenue under software licensing arrangements involving significant production, modification or customization of software in ac-

trol inventory levels and dispose of any excess or obsolete inventories on hand. We write down our inventory for estimated obsolescence or unmarket-

cordance with SOP 81-1, “Accounting for Performance of Construction-Type and Certain Production-Type Contracts”. We recognize revenue and profit

able inventory equal to the difference between the cost of the inventory and its estimated market value based upon our best estimates about future

as work progresses on long-term, fixed price contracts using the percentage-of-completion method. When applying the percentage-of-completion

demand and market conditions. If actual market conditions are less favorable than those projected by management, additional inventory write-downs

method, we rely on estimates of total expected contract revenue and labor hours. We follow this method because reasonably dependable estimates

may be required. Inventory write-downs totaled approximately $2.7 million, $3.8 million and $2.9 million in 2005, 2004, and 2003, respectively.

of the revenue and labor applicable to various stages of a contract can be made. Recognized revenue and profit are subject to revisions as the contract

progresses to completion. Revisions to revenue and profit estimates are charged to income in the period in which the facts that give rise to the revision

become known and losses are accrued when identified.

Foreign Currency Translation and Foreign Currency Transactions: The functional currency for our foreign operations is their local currency. The transla-

tion of foreign currencies into U.S. dollars is performed for balance sheet accounts using exchange rates in effect at the balance sheet dates and for

revenue and expense accounts using the average exchange rate during the period. The gains and losses resulting from the translation are included

in the foreign currency translation adjustment account, a component of accumulated other comprehensive (loss) income in stockholders’ equity, and

are excluded from net income. The portions of inter-company accounts receivable and accounts payable that are not intended for settlement are

translated at exchange rates in effect at the balance sheet date.

Equipment, Furniture and Fixtures: Equipment, furniture and fixtures are recorded at cost. For financial reporting purposes, depreciation is calculated

using the straight-line method over the estimated useful lives of the respective assets. When assets are retired or otherwise disposed of, the cost and

accumulated depreciation are removed from the appropriate accounts and any gain or loss is included in current income.

Estimated useful lives consisted of the following:

Tooling and Equipment

Furniture and Fixtures

Leasehold Improvements

2 — 7 Years

5 — 7 Years

Lesser of lease term or useful life

We recorded a foreign currency translation loss of $8.8 million for the twelve months ended December 31, 2005 and a foreign currency translation

Long-Lived Assets and Intangible Assets: Intangible assets consist principally of distribution rights, patents, trademarks, trade names, and developed

gain of $3.3 million and $2.0 million for the twelve months ended December 31, 2004 and 2003, respectively. The foreign currency translation loss of

and core technologies. Capitalized amounts related to patents represent external legal costs for the application and maintenance of patents. Intan-

$8.8 million for the twelve months ended December 31, 2005 is due to the strengthening of the U.S. dollar versus the Euro. The U.S. dollar/Euro spot

gible assets are amortized using the straight-line method over their estimated period of benefit, ranging from two to ten years.

rate was 1.18 and 1.35 at December 31, 2005 and December 31, 2004, respectively. The foreign currency translation gain of $3.3 million for the twelve

months ended December 31, 2004 is due to the weakening of the U.S. dollar versus the Euro. The U.S. dollar/Euro spot rate was 1.35 and 1.26 at De-

cember 31, 2004 and December 31, 2003, respectively. The foreign currency translation gain of $2.0 million for the twelve months ended December 31,

2003 is due to the weakening of the U.S. dollar versus the Euro. The U.S. dollar/Euro spot rate was 1.26 and 1.05 at December 31, 2003 and December

31, 2002, respectively.

Transaction gains and losses generated by the effect of changes in foreign exchange rates on recorded assets and liabilities denominated in a

currency different from the functional currency of the applicable entity are recorded in other income (expense), net (See Note 15 to the consolidated

financial statements).

Cash and Cash Equivalents: Cash and cash equivalents include cash accounts and all investments purchased with initial maturities of three months

or less. We maintain cash and cash equivalents with various financial institutions. These financial institutions are located in many different geographic

regions. We mitigate our exposure to credit risk by placing our cash and cash equivalents with high quality financial institutions.

Investments: Included in other assets, as of December 31, 2004, is a cost investment in a private company with a carrying value of $3 thousand. We

accounted for this investment, which did not have a readily determinable fair value, using the cost method. Our investment was less than 20%, we

were unable to exercise significant influence over the investee, and we were not a primary beneficiary. Under the cost method, investments are car-

ried at cost and adjusted only for other-than-temporary declines in fair value and distributions of earnings or additional investments. We performed
an impairment review during the year ended December 31, 2004 and determined that there was an other-than-temporary decline in the value of our

investment. Accordingly, in 2004 the value of the investment was written down by $357 thousand to $3 thousand its estimated net realizable value,

and the loss was recorded in other income (expense), net. In 2005, we received additional information regarding our investment indicating it was es-

sentially worthless. Accordingly, in 2005, the remaining $3 thousand investment balance was written off and the loss was recorded in other income

(expense), net.

We assess the impairment of long-lived assets and intangible assets whenever events or changes in circumstances indicate that the carrying value

may not be recoverable. Factors considered important which could trigger an impairment review include the following: (1) significant underperfor-

mance relative to expected historical or projected future operating results; (2) significant changes in the manner of our use of the assets or strategy

for the overall business and (3) significant negative industry or economic trends.

When we determine that the carrying value may not be recoverable based upon the existence of one or more of the above indicators of impairment,

we conduct an impairment review. The asset is impaired if its carrying value exceeds the sum of the undiscounted cash flows expected to result from the

use and eventual disposition of the asset. In assessing recoverability, we must make assumptions regarding estimated future cash flows and other factors.

The impairment loss is the amount by which the carrying value of the asset exceeds its fair value. We calculate fair value by taking the sum of the

discounted projected cash flows over the assets remaining useful life, using a discount rate commensurate with the risks inherent in our current busi-

ness model. When calculating fair value, we must make assumptions regarding estimated future cash flows, discount rates and other factors.

Goodwill: We record the excess purchase price of net tangible and intangible assets acquired over their estimated fair value as goodwill. We have

adopted the provisions of SFAS 142, Goodwill and Intangible Assets. Under the SFAS 142, we are required to test goodwill for impairment at least

annually. We evaluate the carrying value of goodwill as of December 31 of each year and between annual evaluations if events occur or circumstances

change that would more likely than not reduce the fair value of the reporting unit below its carrying amount. Such circumstances could include, but

are not limited to: (1) a significant adverse change in legal factors or in business climate, (2) unanticipated competition, or (3) an adverse action or

assessment by a regulator. In performing the impairment review, we determine the carrying amount of each reporting unit by assigning assets and

liabilities, including the existing goodwill, to those reporting units (See Note 3 to the consolidated financial statements). A reporting unit is defined

as an operating segment or one level below an operating segment (referred to as a component). A component of an operating segment is deemed a

reporting unit if the component constitutes a business for which discrete financial information is available and segment management regularly reviews

the operating results of that component. Our domestic and international components are “reporting units” within the operating segment “Core Busi-

ness”. SimpleDevices is the other operating segment and is a “reporting unit” as well.

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To evaluate whether goodwill is impaired, we compare the fair value of the reporting unit to which the goodwill is assigned to the reporting unit’s

We held foreign currency exchange contracts which resulted in a net pre-tax loss of approximately $409 thousand for the year ended December

carrying amount, including goodwill. We determine the fair value of each reporting unit using the present value of their expected future cash flows. If

31, 2005, and a net pre-tax gain of approximately $5 thousand for the year ended December 31, 2004. We did not enter into any foreign currency

the carrying amount of a reporting unit exceeds its fair value, then the amount of the impairment loss must be measured. The impairment loss would

exchange contracts during the year ended December 31, 2003. We had two foreign currency exchange contracts outstanding at December 31, 2005,

be calculated by comparing the implied fair value of reporting unit goodwill to its carrying amount. In calculating the implied fair value of the reporting

one forward contract with a notional value of $11.0 million, and one option structure known as a participating forward with a notional value of $25.0

unit’s goodwill, the fair value of the reporting unit is allocated to all of the other assets and liabilities of that unit based on their fair values. The excess

million. We had no foreign currency exchange contracts or other derivatives outstanding at December 31, 2004.

of the fair value of a reporting unit over the amount assigned to its other assets and liabilities is the implied fair value of goodwill. An impairment loss

would be recognized when the carrying amount of goodwill exceeds its implied fair value.

Forward Contract: We held a USD/Euro forward contract with a notional value of $11.0 million and a forward rate of $1.1744/Euro as of December 31,

2005, due for settlement on January 20, 2006. We held the Euro position on this contract. The value of this contract was $93 thousand at December

We conducted annual impairment reviews as of December 31, 2005, 2004, and 2003. Based on the analysis performed we determined that each

31, 2005. This contract is included in prepaid expenses and other current assets.

reporting unit’s fair value exceeded its carrying amount, and therefore concluded that there was no indication of an impairment loss.

Participating Forward: We entered into a USD/Euro participating forward with a 50% participation rate and a notional value of $25.0 million in April

Income Taxes: Income tax expense includes U.S. and international income taxes. We account for income taxes using the liability method. We record

2005. The strike price of the participating forward is $1.2675. The contract expired on December 30, 2005, due for settlement on January 3, 2006. The

deferred tax assets and deferred tax liabilities on our balance sheet for expected future tax consequences of events that have been recognized in

gain recorded related to this contract was $1.1 million during the year ended December 31, 2005. The value of this contract was approximately $1.1

different periods for financial statement purposes versus tax return purposes. We record a valuation allowance to reduce net deferred tax assets if we

million at December 31, 2005 and is included in prepaid expenses and other current assets.

determine that it is more likely than not that the deferred tax assets will not be realized.

Stock-Based Compensation: We account for stock-based employee compensation by applying the intrinsic-value method in accordance with the

Capitalized Software Costs: We account for software development costs in accordance with SFAS No. 86, Accounting for the Costs of Computer Soft-

provisions of Accounting Principles Board Opinion (“APB”) No. 25, “Accounting for Stock Issued to Employees.” Under the intrinsic-value method,

ware to be Sold, Leased, or Otherwise Marketed. Costs incurred internally while creating a computer software product are expensed when incurred

compensation cost is the excess, if any, of the quoted market price of the stock at the grant date over the amount an employee must pay to acquire the

as research and development until technological feasibility has been established. The Company has determined that technological feasibility for its

stock. We grant stock options with an exercise price equal to the market value of the common stock on the date of grant, and therefore no compensa-

products is established when a working model is complete. Once technological feasibility is established, software costs are capitalized until the prod-

tion expense has been recognized related to options.

uct is available for general release to customers and is then amortized using the greater of (i) the ratio that current gross revenues for a product bear

to the total current and anticipated future gross revenues or (ii) the straight-line method over the remaining estimated economic life of the product.

Software development costs consist primarily of salaries, employee benefits, supplies and materials. The straight-line amortization periods for capital-

ized software costs range from 2 to 5 years.

We have adopted the disclosure requirements of SFAS No. 123, “Accounting for Stock-Based Compensation,” as amended by SFAS No. 148,

“Accounting for Stock-Based Compensation — Transition and Disclosure.” Under SFAS 123, compensation expense is computed based on the fair

value of the stock options granted and is recognized over the period during which an employee is required to provide service in exchange for the

award (usually the vesting period). The fair value of the options granted is determined at the date of grant using the Black-Scholes option valuation

Capitalized software costs are stated at cost net of accumulated amortization. Unamortized capitalized software costs were $0.3 million and $0.6

model. If we had elected to recognize compensation cost based on the fair value of the awards at the grant date, net income would have been the pro

million at December 31, 2005 and 2004, respectively. We capitalized $0, $0.3 million, and $0 for the years ended December 31, 2005, 2004, and 2003,

forma amounts shown below.

respectively. Amortization expense related to capitalized software costs was $0.3 million, $0.2 million, and $0.1 million for the years ended December

31, 2005, 2004, and 2003, respectively (See Note 3 to the consolidated financial statements).

i n t h o u s a n d s , e x c e p t p e r s h a r e a m o u n t s

Research and Development: We account for research and development costs in accordance with SFAS No. 2, Accounting for Research and Devel-

opment Costs. As such, research and development costs are expensed as incurred and consist primarily of salaries, employee benefits, supplies

Net income:

As reported

and materials.

Advertising: Advertising costs are expensed as incurred. Advertising expense was $1.5 million, $1.2 million and $1.1 million, for the years ended De-

cember 31, 2005, 2004 and 2003, respectively.

Shipping and Handling Fees and Costs: In September 2000, the Emerging Issues Task Force issued EITF 00-10, Accounting for Shipping and Handling

Fees and Costs. EITF 00-10 requires shipping and handling fees billed to customers to be classified as revenue and shipping and handling costs to be

either classified as cost of sales or disclosed in the notes to the financial statements if classified elsewhere in the income statement. We include ship-

ping and handling fees billed to customers in net sales. Shipping and handling costs associated with in-bound freight are recorded in cost of goods

sold. Other shipping and handling costs are included in selling, general and administrative expenses and totaled $6.3 million, $5.0 million and $3.9

million for the years ended December 31, 2005, 2004 and 2003, respectively.

Derivatives: Our foreign currency exposures are primarily concentrated in the Euro and British Pound. Depending on the predictability of future

receivables, payables and cash flows in each operating currency, we periodically enter into foreign currency exchange contracts with terms normally

lasting less than nine months to protect against the adverse effects that exchange-rate fluctuations may have on our foreign currency-denominated

receivables, payables and cash flows. We do not enter into financial instruments for speculation or trading purposes. These derivatives have not

qualified for hedge accounting. The gains and losses on both the derivatives and the foreign currency-denominated balances are recorded as foreign

exchange transaction gains or losses and are classified in other income (expense), net.

Add: Stock-based employee compensation expense included

in reported net income, net of related tax effects

Deduct: Total stock-based employee compensation expense determined
under fair value based method for all awards, net of related tax effects

Pro forma

Basic earnings per share:

As reported

Pro forma

Diluted earnings per share:

As reported

Pro forma

Year Ended December 31,

2005

2004

2003

9,701

9,114

$ 6,267

268

147

294

(2,792)

(2,374)

(3,104)

7,177

6,887

$ 3,457

0.72

0.53

0.69

0.51

0.67

0.51

0.65

0.49

0.46

0.25

0.45

0.25

56
56

universal electronics 2005 annual report
universal electronics 2005 annual report

57
57

The fair value of options at the date of grant was estimated using the Black-Scholes model. The following assumptions were used for the grants in

of enactment to evaluate the effect of the Jobs Act on its plan for reinvestment or repatriation of foreign earnings for purposes of applying SFAS No.

2005, 2004, and 2003, respectively: risk-free interest rate of approximately 3.73%, 3.01%, and 3.00%; expected volatility of approximately 58.35%,

109. The undistributed earnings of our foreign subsidiaries are considered to be indefinitely reinvested. Consequently, we do not expect this standard

65.51%, and 62.95%; expected life of five years for 2005, 2004 and 2003; and that our common stock will pay no dividends. The per share weighted

to have a material impact on our consolidated results of operations and financial condition.

average grant date fair values of the options granted in 2005, 2004 and 2003 were $9.28, $7.94 and $5.87, respectively.

In November 2004, the FASB issued SFAS No. 151, “Inventory Costs — An Amendment of ARB No. 43, Chapter 4” (“SFAS 151”). SFAS 151 amends

In December 2004, the FASB issued SFAS 123R, “Share Based Payments.” SFAS 123R requires companies to expense the value of stock options

the guidance in ARB No. 43, Chapter 4, “Inventory Pricing,” to clarify the accounting for abnormal amounts of idle facility expense, freight, handling

and similar awards. This statement is a revision of SFAS 123, “Accounting for Stock-Based Compensation” and supersedes APB Opinion No. 25,

costs, and wasted material (spoilage). Among other provisions, this new standard requires that items such as idle facility expense, excessive spoilage,

“Accounting for Stock Issued to Employees,” and its related implementation guidance. SFAS 123R requires a public entity to measure the cost of

double freight, and re-handling costs be recognized as current-period charges regardless of whether they meet the criterion of “so abnormal” as stated

employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award (with limited exceptions).

in ARB No. 43. Additionally, SFAS 151 requires that the allocation of fixed production overhead to the cost of conversion be based on the normal capac-

That cost will be recognized over the period during which an employee is required to provide service in exchange for the award — the requisite ser-

ity of the production facilities. SFAS 151 is effective for fiscal years beginning after June 15, 2005 and we are required to adopt this standard in the first

vice period (usually the vesting period). No compensation cost is recognized for equity instruments for which employees do not render the requisite

quarter of 2006, beginning on January 1, 2006. We do not expect this standard to have a material impact on our consolidated results of operations and

service. In March 2005, the SEC issued Staff Accounting Bulletin No. 107 (“SAB 107”) regarding the SEC’s interpretation of SFAS 123R and the valuation

financial condition.

of share-based payments for public companies. SFAS 123R, and its related implementation guidance, will significantly change existing accounting

practice and will have a material effect on our reported earnings. The pro forma disclosures previously permitted under SFAS 123 will no longer be an

alternative to financial statement recognition.

In December 2004, the FASB issued SFAS No. 153, “Exchanges of Nonmonetary Assets — An Amendment of APB Opinion No. 29, Accounting for

Nonmonetary Transactions” (“SFAS 153”). SFAS 153 eliminates the exception from fair value measurement for nonmonetary exchanges of similar pro-

ductive assets in paragraph 21(b) of APB Opinion No. 29, “Accounting for Nonmonetary Transactions,” and replaces it with an exception for exchanges

We are required to adopt SFAS 123R in the first quarter of fiscal 2006, beginning January 1, 2006. Under SFAS 123R, we must determine the ap-

that do not have commercial substance. SFAS 153 specifies that a nonmonetary exchange has commercial substance if the future cash flows of the

propriate fair value model to be used for valuing share-based payments, the amortization method for compensation cost and the transition method

entity are expected to change significantly as a result of the exchange. SFAS 153 is effective for the fiscal periods beginning after June 15, 2005 and we

to be used at the date of adoption. The transition methods include modified-prospective and modified-retrospective adoption options. Under the

are required to adopt the standard in the first quarter of 2006, beginning on January 1, 2006. We are currently evaluating the effect that the adoption

modified-retrospective option, prior periods may be restated either as of the beginning of the year of adoption or for all periods presented. The modi-

of SFAS 153 will have on our consolidated results of operations and financial condition but do not expect it will have a material impact.

fied-prospective method requires that compensation expense be recorded for all unvested stock options and restricted stock at the beginning of the

first quarter of adoption of SFAS 123R, while the modified-retrospective method would record compensation expense for all unvested stock options

and restricted stock beginning with the first period of adoption.