Universal Electronics Inc. (UEIC) Q3 2012 Earnings Report, Transcript and Summary

Good day. My name is Lisa, and I will be your conference operator. At this time I would like to welcome everyone to the Universal Electronics Third Quarter 2012 Results Conference Call. [Operator Instructions] This time I would now like to turn the call over to your host, Ms. Becky Herrick of LHA. Please go ahead.

Thank you, Lisa, and good afternoon everyone. Thank you for joining us for the Universal Electronics 2012 third quarter conference call. By now you should have received a copy of the press release. If you have not, please contact LHA at (415) 433-3777. This call is being broadcast live over the Internet. A webcast replay will be available for one year at uei.com. Also, any additional updated material non-public information that might be discussed during this call will be provided on the company’s website, where it will be retained for at least one year. You may also access that information by listening to the webcast replay. After reading a short safe harbor statement, I will turn the call over to management. During the course of this conference call, management may make projections or other forward-looking statements regarding future events and the future financial performance of the company, including the benefits the company anticipates as a result of continued growth on average of TV sales and household TV viewing habits, its continued development of new and innovative products and technologies, including the UEI QuickSet technologies and its embedded app solutions for smartphones and tablets that are accepted by and meet the needs of its customers and consumers; the company’s ability to successfully anticipate the needs and demands of the consumer with respect to new and more advanced products and technologies; the continued strong relationships with the company’s existing customers; the ability of the company to attract and retain new customers, particularly tablet and smartphone manufacturers; the benefits the company expects via the growth of new markets and certain geographies areas, including Latin America, Asia-Pacific and Eastern Europe; the strength of the company’s financial position and its ability to manage its operating expense initiatives and debt reduction strategies as planned by management; the effects the company’s buyback program may have on the company’s stock price and the effects the company may experience due to the continued global economic environment. Management wishes to caution you that these statements are just projections and actual results or events may differ materially. For further detail on risk, management refers you to the press release mentioned at the onset of this call and the documents the company files with the SEC, including the Annual Report on Form 10-K for the year ended December 31, 2011 and the periodic reports the company has filed since then. These documents contain and identify various factors that could cause actual results to differ materially from those contained in management’s projections or forward-looking statements. Also, the company references adjusted pro forma or non-GAAP metrics in this call. These adjusted pro forma metrics are provided because management uses them in making financial, operating and planning decisions and in evaluating the company’s performance. The company believes these measures will assist investors in assessing the company’s underlying performance for the period being reported. UEI continues to incur certain expenses as a direct result of its acquisitions which it believes do not reflect its true operating results. Adjusted pro forma results exclude the following expenses: amortization expense relating to intangible assets acquired, depreciation expense relating to the increase in fixed assets from cost and fair market value, other employee related restructuring costs and one-time costs associated with moving our corporate headquarters from Cypress, California to Santa Ana, California. In its financial remarks, the company will reference adjusted pro forma metrics. A full reconciliation of these adjusted pro forma measures versus GAAP is included in the company’s press release that was issued after the close of market today. On the call today are Chairman and Chief Executive Officer, Paul Arling, who will deliver an overview; and Chief Financial Officer, Bryan Hackworth, who summarize the financials and then Paul will return to provide closing remarks. It’s now my pleasure to introduce Paul Arling. Please go ahead, Paul.

Thank you Becky, and welcome everyone. We reported solid results for the third quarter of 2012 with both top and bottom line growth. While the global economy continues to be challenging, sales remain strong in global subscription broadcasting and our consumer category. We achieved key customer wins during the quarter. We established an agreement with TiVo to supply remote controls for international service providers and major customers in the smartphone space began adopting our embedded app technology. During the third quarter as well as historically, UEI success has been determined by our ability to anticipate the needs of our customers and consumers. It is this strategy that has positioned us as the global leader in wireless control technology. We have a strong commitment to innovation. With technology changing so rapidly, we are constantly developing the products and technologies that keep us ahead of developing trends. As new ideas and approaches emerge in home entertainment devices and content, UEI is at the forefront of providing solutions that simplify and enhance the user experience. It is well worth noting that even with all the new ways consumers enjoy entertainment content, television remains solidly at the center. We don’t expect that to change. Nielsen research shows that the average person in the U.S. watched more than 5 hours of TV per day last year, up from 4 hours in 1999. Consumers are opting to watch TV on increasingly larger screens as well, with the average screen size increasing by 5% per year globally over the last 3 years alone. These long-term trends demonstrate just how firmly entrenched television viewing habits are around the world. Sales of consumer electronics and televisions in particular are down right now. And several of our Japanese consumer electronics customers recently lowered their 2012 outlook. While these headwinds will impact our consumer electronics business in the short term, they do not dampen our long-term outlook for the industry. Historically, television sales have cycled up and down as technology upgrades have evolved over the past 5 decades, but the average growth in TV sales in the U.S. has been steady at 4% throughout this 50-year period. It may surprise you to hear that even with the introduction of flat panel TVs and that conversion to high definition occurring over the last 10 years that the growth rate of the TV unit sales in the U.S. has remained at a 4% average annual rate. While TV sales were see you down year from time-to-time, there have always been in offsetting year or years to bring TV sales back to the average. We take long-term approach to our business and we will remain confident in the continued growth opportunities that lie ahead in the markets we serve. We have focused on expanding geographically in the regions that show promising market potential. As the consumer-centric markets of the U.S., Western Europe and Japan continue to be challenged by cautious consumer spending, particularly on televisions, our global presence and capabilities position us to serve growing regions, such as Eastern Europe, Latin America and parts of Asia. Among the 7 major Latin American markets, the number of subscribers to pay-TV services is expected to reach 97 million by 2017, according to market experts. This represents market penetration of nearly 70% of homes with television sets, more than 3x what was recorded in 2007. In addition, the subscription broadcasting market across the Asia Pacific region is expected to rise from 411 million subs in 2011 to 602 million in 2016, and even higher by 2020. The global market for remote control technology and embedded solutions for smart devices continues to expand and presents significant growth opportunities for UEI. As I mentioned, innovation is critical to our success. We anticipated the needs of the market and developed solutions to enable smartphones and tablets to communicate with all the devices in the home entertainment system. The smartphone market is triple the size of the market for TVs with global shipments expected to rise 39% to nearly 700 million units by the end of 2012. Worldwide tablet penetration grew to 11% this year and is forecasted to reach over 20% by 2014. Studies show that more than 80% of tablet owners, and nearly as many smartphone owners, use their devices while watching television, according to the Nielsen. Within the next few years, we believe the overall margin opportunity with smartphones and tablets combined could equal or possibly exceed the overall margin opportunity in today’s traditional audio/video market. This obviously creates a significant opportunity for UEI. We are moving forward with the implementation of our embedded app integrated solution for smartphones and tablets. Our portfolio of technologies enables consumers to use their phone or their tablet as a touch screen remote control. It automatically syncs with [indiscernible] embedded QuickSet and control plus technologies to enable simple and intuitive configuration and everyday use of all components in the home entertainment stack. All the consumer has to do is sit back with a smart device and effortlessly direct the TV, receiver, DVD player, game console or other devices. Our embedded app technologies are already available in select tablets and we recently began shipping to a major smartphone provider. A second key smartphone provider is secured for shipments beginning in the first half of next year. These 2 important customer wins further reinforce our penetration of the tablet and smartphone space. We intend to leverage our existing relationships with customers in the television market who are also leaders in the smartphone market to continue expanding our presence in this growing space. We currently hold the top position in the global remote control market. Over the years, our market share has grown from approximately 5% to fully 1/3 of the remote control devices made in the world today. Our subscription broadcasting customers include the world’s premier pay TV providers and we also have long-standing relationships with most premium brands in consumer electronics. UEI has a reputation for excellence in innovation and a proven track record of execution. We are constantly pursuing new technologies that build upon the success we have created over the past 25 years. I’d now like to turn the call over to our CFO, Bryan Hackworth to discuss our financial results. Bryan?

Thanks, Paul. As a reminder, our third quarter 2012 and third quarter 2011 results will reference adjusted pro forma metrics. Third quarter 2012 net sales were $124.9 million compared to $123.5 million for the third quarter of 2011. Business category net sales were $111.9 million compared to the third quarter 2011 net sales of $111.3 million. Our consumer category net sales were $13 million compared to the third quarter of 2011 net sales of $12.2 million. Gross profit for the third quarter was $36.7 million or 29.4% of sales compared to a gross margin of 27.9% in the third quarter 2011. Total operating expenses were $25.5 million compared to $24 million in the third quarter of 2011. Breaking down our operating expenses, R&D expense was $3.5 million compared to $2.9 million in the third quarter of 2011. SG&A expenses were $22 million compared to $21.1 million in the third quarter of 2011. Operating income was $11.2 million in the third quarter of 2012 compared to $10.5 million in the third quarter of 2011. The effective tax rate was 26.9% in the third quarter of 2012 compared to 21% in the third quarter 2011. Net income for the third quarter of 2012 was $8.1 million or $0.54 per diluted share, compared to $8 million or $0.53 per diluted share in the third quarter of 2011. For the 9-month period ended September 30, 2012, net sales were $345.3 million compared to $351 million in the same period 2011. Gross margin for the first 9 months of 2012 was 28.5% compared to 27.8% in the same period a year ago. Total operating expenses were $75.9 million compared to $74 million in 2011. Year-to-date, we’ve increased R&D by approximately 12% as we continue to invest in developing new technologies and advanced products. SG&A on the other hand has remained relatively flat with the prior year. Net income for the 9-month period was $17.1 million or a $1.13 per diluted share compared to $17.7 million or a $1.15 per diluted share in the prior year period. Now turning to our cash flow and balance sheet review at September 30, 2012. We ended the quarter with cash and cash equivalents of $41.2 million compared to $30.7 million at June, 30 2012. Our term debt balance was reduced to $4.8 million at September 30, 2012 from $10 million 3 months earlier. As of today, we are debt free, as the term debt has been paid in full and we don’t have an outstanding balance on our line of credit. As soon as our blackout period ends, which will be in a few business days, we intend to initiate a stock buyback plan. The amount of shares we repurchase will depend on our share price. We have approximately 1 million shares available on our current authorization. DSOs were 67 days at September 30, 2012 compared to 65 days a year prior. Net inventory turns significantly improved to 4.9 turns at September 30, 2012 compared to 4.2 turns a year ago and 3.7 turns as of the end of 2011. Next, I’ll provide our guidance. As Paul previously mentioned, throughout 2012, we’ve experienced strong sales growth in subscription broadcasting and we expect this trend to continue in Q4. Growth in subscription broadcasting has come from Latin America, primarily Brazil, as well as the U.S. and Eastern Europe. Despite the U.S. being a mature market, we continue to win new customers and increase our share with existing customers. In light of a difficult economy, our consumer category has grown as we have experience strong sales growth in Argentina. Argentina recently made the transition from analog to digital, which has led to an increased demand for our products. The area of our business that has struggled this year has been the consumer electronics channel. On a global basis, TV unit sales are down this year compared to 2011. In an unprecedented manner, a few of our large Japanese consumer electronics customers recently reduced our 2012 outlook for the second time this year. As a result, for the fourth quarter of 2012, we expect revenue between $113 million and $119 million compared to last year’s fourth quarter revenue of $117.6 million. EPS for the fourth quarter is expected to range from $0.37 to $0.47 per diluted share compared to $0.40 recorded for the fourth quarter of 2011. For the full year 2012, we expect revenue between $458 million and $464 million compared to last year’s revenue of $468.6 million. EPS is expected to range from $1.50 to $1.60 per diluted share compared to a $1.55 recorded for the full-year 2011. I would now like to turn the call back to Paul.

Thanks, Brian. Looking ahead, we remain focused on expanding our global market opportunity, deepening existing customer relationships and winning new ones, and developing the innovative technologies that facilitate the simple control of the ever-changing home entertainment environment. As always, stay tuned. I’d now like to call -- open up the call for questions. Operator?

[Operator Instructions] And your first question comes from the line of Jason Ursaner with CJS Securities.

First question I want to cover is on the Nevo and the embedded app technology. Can you please go through -- is it an app or is it an actual IR chipset that you are putting onto these devices and just can you talk a little bit more about the 2 customer wins and for that overall product what do you think the size of the opportunity is, with some of the numbers you through out there on smartphones and tablets?

Sure. I will talk a little bit about this. The solutions are actually a whole portfolio thing. It starts with the device control code, because obviously all the devises in the stack need to be controlled either by IR, RF or IP. So what we do is build in the technology within the phone for the devices. We then pair that with things like QuickSet, which is an online, either in device or in the cloud, based setup mechanism. Sometimes it’s accomplished through the IP -- through the user’s home network or through the television itself, and it can be done either way. Then there is an app that sits on top of it, the presentation layer, so we are doing a lot of things in the logic layer about the data for QuickSet and control plus technologies and then we also have a presentation layer product called Nevo where we would give the look and feel to the product. What we do with each customer is go in with this, this portfolio of solutions in a custom fit for their particular need. Now as far as the 2 examples, I can’t really talk about them yet, we haven’t been given permission by customers, but we have one. We’ve already begun shipping to one of the partners, and we’ve been awarded business for a smartphone or actually a series of smartphones -- typically, what they will do is introduce in a country or a region first, and then in the month thereafter are typically 6 to 8 weeks thereafter, they’ll do a more wide deployment. So it takes place -- the deployment takes place over time. So your shipments will start with a low amount and then within, say, 2 to 3 months, the shipments increase. One of them, we’re already shipping, we’ll begin shipping one next year. I can’t tell you much about the SKUs yet, particularly on the one that we haven’t shipped yet because we never go in front of customers to announce. But around the CES timeframe, if you are at CES, we may have examples of it there or shortly thereafter. We have -- now in terms of the size of the market, today, what we’re seeing is that it started with the tablets but the tablets are just over 100 million units, which is quite a sizable market. What a lot of -- particularly the Android-based suppliers are doing today is they’re differentiating a new ways. As I think I mentioned on the last phone call, there’s a number of players, 45% of the world’s TVs are made by companies that also represent 40% of the world’s smartphones. And that percentage is actually increasing. So they’re increasingly seeing way to differentiate their product portfolio and their brand is to produce a tie-in here. And I can tell you that in that smartphone market, what’s happening is people are starting to design into the hardware design itself, the ability to control AV equipment and what they’re looking for is people like us to help them complete the solution with our portfolio of technologies. How big can that market be? We don’t quite know yet, but it’s clear that with 800 million, near nearly 800 million smart devices being sold this year in ‘12 and with the high double-digit growth rate in that market, we think that over the next 1 to 5 years this market, in terms of margin opportunity, could be as large as our entire business was last year.

And from a revenue point of view, dollar content -?

Yes, lower -- lower, probably lower revenue but similar -- higher margin.

And roughly is the dollar content changing, if you go from a logic kind a cloud solution in the actual device not the TV that’s recognizing it, but the actual device is a revenue content changing as you move to a hardware design you’re talking about?

Well, yes, it will probably be slightly lower, but remember, in this case we are not making smart phones. So in the remote case, we’re actually making full turnkey remote solutions, when the world goes for adoption of the technology through the smartphone, what we’re going to do is ride on the hardware of others and simply place the value add in the software or a chip embedded inside the unit. So slightly lower sales value but being paid for the value being provided. So, the margin opportunity is pretty, pretty solid.

Okay. That all sounds very good. And on the holiday, retail sales, obviously you’re taking down your expectations; you talked about some of your Japanese customers. Expectations are fairly solid, right now for the sell-through, at least, given everything I am reading. So if you could talk little bit more specifically about which companies and you’re seeing that adverse effect from -- if there is anyone, I guess, specifically, given that, that doesn’t seem to really be the tone in general.

Yes, well, a few of the brands have actually come out and I don’t want to speak specifically about their business, out of respect for their customer. But there are a few companies that are already out there, having announced their results will be a little less than they expected, than they had prior expected. A few of the CE companies.

Okay. To begin to think about 2013 guidance, I mean, you previously talked about these customers as fairly reliable source for your own planning. I mean, how soon this kind of change?

Well, I mean, projecting that particular market. I mean as Brian said in his comments as well as I, that the subscription broadcasting market is completely separate from the CE market, I mean, they move, sometimes, in different directions. The results in our subscription broadcasting business have been very strong. In fact, as strong as or maybe even slightly better than we expected for the year 2012; not all the [ph] way through the year. The consumer business has performed well, it’s a smaller part of our company, but the team there has done a great job, even in a difficult economic environment of producing very good results. The one weak spot has been CE, driven largely by television sales. Most market experts at the beginning of the year were expecting a small bit of growth in TVs this year. It was then downgraded to be flat. It’s now been downgraded twice more to be negative, in terms of unit sales worldwide of televisions. So as a result of that the -- that’s the one part of our business that’s been difficult, but as I pointed out, if you take a long-term view point, particularly here in the U.S., which is the lead country, what you see is that the market over the last 10 years has grown, on average, 4% and over the 50 years, it’s grown, on average, 4%. What that tells us is that when you go through a period where you have shrinkage, typically you’ll have an offsetting year of growth. So we don’t see anything underneath the data that says something has fundamentally changed that somehow there has been an upgrade cycle that now will lead to the destruction of the TV market. In fact, every piece of data speaks to quite the opposite. The average American’s watching more TV than ever. The TVs are getting bigger, brighter, better, thinner and it happens to be that this year -- last year they were flat, this year they will be slightly down, but we don’t see any destruction of the TV market. This has happened before. I guess the best way to say it is I looked at the data going back for decades, 6 times in the last 40 years there have been multiple years of shrinkage in the U.S. TV market. And everybody in those periods that predicted the TV market was dead were wrong, because in the years following those years of shrinkage, it regressed back to the mean. So the growth rate over time has been 4%. We’ve gone through last year, roughly flat this year, shrinking. We don’t really -- it doesn’t really dampen our spirits about the AV market, just -- we’re just happening to be going through a difficult year.

[Operator Instructions] And your next question comes from the line of Ian Corydon with B Riley & Company.

Paul, regarding the handset OEM you’re rolling out with initially your -- can you say what region those phones are starting out in?

Asia.

Asia. And is Nevo branded as such on those devices?

No.

Okay. And maybe you can talk about how that OEM is looking at rolling out Nevo. I mean, is it intended to be a wide release over multiple geographies, is that more a test or any kind of niche-y higher-end handsets, how are they looking at?

Yes. No, I think the overall plan over time is to make this a more standard feature in their product. So they’re starting in a region as they typically do and then they expand from there; their introduction of a new model. Typically they’ll do new hardware design and then all started in a country or again in a region and then expand it from there over the course of months. And sometimes it will be a 3 or 4 stage rollout. Now, again, I want to make sure everybody is it looking for Nevo per se. Nevo is one part of the solution. What we do again, as I said earlier, as we have that presentation layer called Nevo. We have underlying technologies, logic layer products, like QuickSet and control plus and then the control code and IT sit beneath that. So we’ve got a whole portfolio of things that we present to the customer and they implement part or all, they can do a la carte and, so we see our -- this being designed into these products going forward. I think it hasn’t escaped them that the fact that the average person in the U.S. is watching 5 hours a day of TV. The average global citizen, believe it or not is now launching 3.25 hours of television per day. So I think, they see this in both tablets and smartphones, as a way to deepen the consumer’s addiction to their device. Because if you can help them with something they’re doing 3 hours a day, that’s probably one of the most used apps that you’ll find on any device. So I think they see that logic and would like to tie in also with some of these companies to some of their other products like televisions, set-top boxes or other AV devices.

Sure. And should revenues from smartphones be material in Q4 here or in 2013 or is that a longer-term proposition?

Yes, I wouldn’t say, material in Q4 and 2013, we’re currently working on our budget, so we’ll come out on a few months with that.

And your next question comes from Corey Barrett with Pacific Crest Securities.

First, I was just hoping you could provide more detail perhaps on the Logitech settlement?

Yes, actually there is a confidential settlement agreement. What I can say is that, we settled and we recognized revenue in Q3, and we’ve got -- it was a lump sum payment for past infringements and we got a licensing agreement on a go forward basis, similar to what we had in the past.

Okay, perfect. And then, on Latin America, can you just sort of walk us through the trends that you’re seeing there and what you see as your runway. How long your runway is for your opportunity is for share gains and just how you see that the secular growth playing out?

Yes, sure. I think, that market is -- over the last few years, has shown a great deal of growth in both the CE market, the consumer’s adoption of new products, new TVs and other products. And obviously, they’re going through a period, much like the U.S. did some years ago now. But where there was subscriber growth or consumers were signing up those new TVs. In our case it wasn’t flat panels yet, but they were signing up their televisions to be connected to Entertainment Services. This is what’s happening down there as well as elsewhere in the world that consumers are starting to buy these televisions; these flat-panel televisions or other TVs and then connecting and to an entertainment source. So we’re seeing the market development there that much like you would’ve seen in the U.S. some years ago, where there is a subscriber growth period, there is sometimes a number of players, it begins to consolidate and then there is a fairly sizable growth in volume. So we’re starting to see that in other parts of the world.

Okay and just lastly, I guess, so what is your share look like in that market?

Well, in which? In the U.S., rather high and Latin America it’s lower than in the U.S. but growing.

How much -- significantly lower? Is it still relatively low share of the Latin American market?

Throughout the entire market, yes, it’s relatively low, much lower than it is in the U.S.

[Operator Instructions] And we have a follow-up question from Jason Ursaner.

Just a quick follow-up. On the Logitech settlement just considering that it’s non -- on ongoing revenue of that. Can you give some type of bracket? I mean, was it a couple of million dollars added to revenue in the quarter?

Yes, it actually is an ongoing of revenue source, we signed up, it wasn’t just a settlement agreement, it was also a license agreement. So it is ongoing. But I can’t disclose the amount due to confidentiality, but if you look at the margin percentage, Jason, you could probably get a feel for that source what it is.

Okay. So I guess, if I adjust the gross margin kind of mid-29.5% range, should we not assume that that you’re getting the benefit utilization on your plants, if you had this in there on a sequential basis?

Well, we are gaining the benefit of our plants, is just the Q3 gross margin number is -- it did increase because of the settlement, that lump sum payment. So that did improve the gross margin for the quarter, but I wouldn’t say that we’re not utilizing our factories and that’s -- we fully integrated CG and we’re utilizing them to the maximum right now.

Okay. And roughly kind of what is utilization rates at CG you announced -- and do you plan on having holiday build next quarter to get ahead of...

Yes. We’re planning for that. Last year, if you remember 2 years ago we had the issue with the labor issue and last year everything went very well. So we expect it to go well again. We’ve owned CG now for a couple years and we’ve got a firm grip on it. So that shouldn’t be an issue.

And there are no further questions at this time. I would like to turn the call back over to Paul Arling for closing remarks.

Okay. Thank you for joining us today and for your continued interest in UEI. We will again be hosting a booth at CES in Las Vegas, starting January 8 through 11. So I hope to see you there. Anybody who can come, we’ll have a lot of stuff to show there. In addition, we will be presenting at the 15th Annual Needham Growth Conference being held in New York City. January, 15 through 17. I hope to see some of you there as well. Thank you very much for participating today and goodbye.

This concludes today’s conference you may now disconnect.