Good day, ladies and gentlemen. Welcome to the Universal Electronics Inc., Third Quarter 2018 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will be given at that time. [Operator Instructions] As a reminder, this conference call is being recorded. I would like to introduce your host for today's call Ms. Kirsten Chapman from LHA Investor Relation. Ma'am you may begin.

Thank you, Jarinda. And thank you all for joining us for the Universal Electronics third quarter 2018 financial results conference call. By now, you should have received a copy of the press release. If you have not, please contact LHA Investor Relations at 415-433-3777 or visit the Investor Relation section of the website at www.uei.com/investor relations. This call is being broadcast live over the Internet. A webcast replay will be available for one-year at www.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 future financial performance of the Company, including the Company's ability to anticipate the needs and wants of its customers and deliver products and technologies that will meet those needs and wants, including the Company's advanced control products, which include continued adoption of our voice remote control and intuitive two-way home entertainment technologies by existing and new customers; the continued incorporation of our QuickSet technologies including QuickSet Cloud into customers' products as expected by management; the continued acceptance and growth of the Company's connected home products and technologies, including security and control, temperature controllers and automation and other technologies identified in this call; the timing of new product rollout orders from the company's customers as anticipated by management; the continued trend of the industry to providing consumers with more advanced technologies; the ability to successfully identify and enter existing and new adjacent markets for our products and technologies; the ability…

Good afternoon, and thanks for joining us today. As expected, we delivered $184.7 million in net sales, increasing 5% over the third quarter of 2017. More importantly, UEI has, once again, improved our positioning to address the expanding market opportunity through continual technology and product advancement and proactive measures related to operations. Whether it is audio-video entertainment or home automation, consumers want intuitive control to be more pervasive in their home. Today, entertainment control is by far the most frequently used form of control in the home as the average person in the U.S. consumes almost six hours of video per day. Frankly, everything emanates from AV control and it is the natural growth point. And now, with voice enablement, the potential for netting together a total home control experience is becoming more real. This bodes well for UEI as we dominate home entertainment control and offer a broad portfolio of sensing technologies and products. Our advanced intuitive two-way home entertainment systems, enabling one-touch view applications and voice navigation and search continue to set the standard for advanced entertainment platforms. Now, we are leveraging our technology to expand our presence in home automation and security through accounts such as Daikin, Trane, Toto, Ring, UTC, XFINITY Home and others. We continue to see quarter-over-quarter growth in our home automation products and expect them to contribute approximately $130 million in sales in 2018. You can expect to see products that bridge gaps in voice automation and home control at CES 2019; more on that in a minute. First, let's discuss our technology and customers. Our QuickSet device discovery and control platform empowers consumers with simple, automated setup and complete control of the entire home entertainment ecosystem. Now QuickSet Cloud makes building a unified home entertainment system even easier. While leading-edge technology adoption…

Thank you, Paul. As a reminder, our results for the 2018 third quarter as well as the same period 2017 will reference adjusted non-GAAP metrics. Third quarter net sales grew 5% to $184.7 million compared to $175.5 million for the third quarter of 2017. Business Category net sales were $170.9 million compared to $162.9 million in the third quarter of 2017. The main growth drivers were an increased adoption of our advanced platforms and subscription broadcasting and continued growth in home automation; specifically, Daikin for energy control and Ring in the home security channel. Consumer Category revenue was $13.8 million compared to $12.6 million in the prior year quarter. Gross profit was $43.6 million or 23.6% compared to 26.3% in the third quarter of 2017. The decrease is due primarily to the continued global supply shortage of both capacitors and resistors resulting in higher pricing for these components. Although I'm not providing specific gross margin guidance for Q4, I expect our gross margin percentage to improve in the fourth quarter. We are working on a variety of measures, including changes in the supply chain and product redesign to offset the price increases relating to these components. Operating expenses were $31.4 million compared to $30.7 million in the third quarter of 2017. R&D expense was $5.4 million compared to $5.3 million in the third quarter of 2017 reflecting our continued investment in technologies that enhance the user experience. SG&A was $26 million compared to $25.4 million. Operating income was $12.2 million compared to $15.4 million. Our effective tax rate decreased to 11.8% from 21.3% in the prior-year quarter as a result of receiving a tax refund from a local government in China for high-tech activities relating to 2017. Net income was $9.7 million or $0.69 per diluted share compared to $11.9…

Thanks Bryan. From a technological perspective, there is no doubt, we are in very exciting times. We are the world leader in intuitive home entertainment system control. Our position in home automation continues to grow rapidly and we expect to generate nearly 130 million of home automation related products sales this year. Our new product pipeline continues to leverage our intellectual property, build on cutting edge technology that runs ahead of the competition and matches our history of innovation, starting with our Nevo platform many years ago, then with QuickSet device discovery and control platform, followed by QuickSet Cloud, and then with the Nevo AI digital assistant platform, and in 2019 our new Butler products. Make no mistake about it. The growth in new home entertainment platforms is upon us and the growth in home automation continues to build momentum. While the future in this area is very exciting, the introduction of these products by a variety of industry leaders is creating a cacophony of protocols in the average consumer's home. As our innovative products have done in the past, we bring order to the chaos and we will continue to create products that will turn this cacophony into a symphony. The outcome is a coming together of products, existing and new, working together and intuitively controlled for a great entertainment experience and a safe secure comfortable home. We have demonstrated our success in the past, and as the home has gotten more complex, we have continued to increase our leadership position in our core markets. While there is still much work to do, we are committed to this more than ever before as the opportunity before us is enormous. Stay tuned. Operator, we'd now like to open up the call for questions.

Thank you. [Operator Instructions] Our first question comes from Jeff Van Sinderen from B. Riley FBR. Your line is open.

This is Richard Magnusen in for Jeff Van Sinderen. And thank you for taking our call. Regard to what you mentioned about moving or shifting supply chain from China to Mexico, along those lines, do you have plans to actually expand the facility in Mexico or maybe acquire another one in the region, and then also that same question regarding other regions, perhaps other areas of Latin America or other parts of Asia, outside of China?

Yes, well it's probably important to point out we're not moving everything there. Obviously, the volume that was affected is that which is being shipped mainly into the U.S., right, because that was the tariff affected area. The rest of the world is basically unaffected by that action. But we actually had already taken some additional space in Mexico prior to the implementation of the tariffs. So we actually had some space there available for expansion. There may be additional space taken depending on the speed of shift of some of those items. But in fact, we had already expanded the facility in Monterrey prior to August of this year. In fact we did it late last year.

Okay. And do you have any insight into perhaps increased tariff impacts as you move through 2019? And then somehow related to that, what about the impacts of components, because you mention capacitors and so forth about what you see that impact being like as we move through 2019?

Yes. Well, it's nothing – it's difficult to know on the tariffs, if additional tariffs will be put in place. I will say that if we've shifted production out of the tariffed country, then I suppose even if the tariffs were to increase, it wouldn't affect anything, because we would have already moved to a different country. I suppose you could argue that in time, tariffs could be applied on all countries, but in that case, I think there would be a bigger issue. I'm not sure anyone believes that. But we think that the trade tensions with Mexico have settled somewhat, if not completely. So we feel pretty safe with that move, particularly for – again the products that are being shipped into the United States.

Okay.

So we don't really see the tariff issue getting worse, although, again we could never guarantee what would happen there. We think we're prepared for any of the – whatever shifts may occur there. We've already been affected by it and we are already shifting. We've already shifted, actually, some of our products to the new facility and we'll continue to do that as time goes on. We think the effect of this is temporal, because our long-term goal for all of our customers would be to cost effectively produce for them. So when a 25% cost increase is levied, it would be our goal at least with time to not have to have them pay that if possible. So that's what we're doing. We're helping our customer. We're a solution provider, rather than just reiterating the problem to them, we're creating solutions to keep them cost effectively supplied.

Okay. And then one last question, you collect a lot of information from users over time considering that you're spending many hours – in some cases many hours a day using devices. And what are the different ways that you're considering monetizing that data perhaps maybe sometime from now?

Yes, it's a good question. We are getting more and more data, particularly with the QuickSet Cloud solution. So we do obviously, believe it's early days, but longer-term there may be some value to that. We are working with major players in the industry on their set up and everyday control of their devices. So they're very well – may be a play in that. But right now, obviously, it's about share building and making QuickSet Cloud and its successors as we move forward the de facto standard in operation of your home control system, AV control plus in a growing fashion, your home control system.

Okay, thank you very much. I’ll get back in the queue.

Sure.

Our next question comes from Steven Frankel from Dougherty. Your line is open.

Paul, just a clarification, is there products flowing out of the Monterrey facility today and going to customers or is that something that will happen in Q4?

No it's happening already. There is product flowing out of Monterrey.

And what does it take for margins there to approach where they would have been had we been in China and not have tariff situation?

Well, this is Bryan, Steve. I think it's no different than when we transitioned to GTY. It will take a little bit of time to ramp up and to get people performing as we have in other jurisdictions, and really, the answer to that is time. I mean, I think fortunately for us we had the Mexico facility already in place. So that was one less thing we had to do. We transferred equipment down promptly. We were able – fortunately to be able to hire people pretty quickly and were able to train them and we sent people from our different jurisdictions down to Mexico to train properly. So I think everything is going pretty well. But if you want to run as well as you are in an existing facility, then it takes a little bit of time. But right now, I think things are going well.

But there's not a structural issue that says you're giving up margin by doing this. If you get this facility properly loaded, this will be good margin business?

Yes.

Okay. And then Paul, kind of a philosophical question or a high level question. You've talked for the last two quarters about this significant home automation business, which should have higher margins than your traditional business, yet we're not seeing it. What has to happen for us to see the benefit of a rapidly growing higher margin home automation business?

Yes, it's a good question, Steve. I think what happens is when you start out, just like we are in the next-generation AV business, to the extent the mix is shifted toward an industry leader who is a good one to start with because they create the demand for the others in the industry to have to match them. So that's the good news, is that the leader in the industry is the innovator and creates an even stronger impetus for people to move in that direction. The only negative to it is that more of your mix is shifted to a customer that will traditionally – because of their purchasing power and size have a better negotiating position on those margins. So what has to happen is, as growth comes and you penetrate maybe medium-sized and smaller-sized customers and this is true, I think in every business, the margins can begin to improve.

Okay. And last quarter, you gave us a long list of near-term new customer roll-outs. Could you give us an update there and especially if there's anything that appears to be stretching out and not going to meet your original timetable?

Well we have so many projects that I can't rattle off them all again. If I looked at the project list, I would generally tell you that most of the projects are going off as we would expect. There are a couple that got pushed. I will say some of the projects that we're launching now were supposed to have launched in 2017. We had a few of those that were delayed that long but are now beginning to ramp finally. So as we've said before, none of these projects are cancelled. All of the customers that are working on them are, in many cases, feverishly working on them because they understand that the future of the industry is to have these advanced platforms. So we haven't seen any drop-off in the level of effort to get them done and many of them are getting off on schedule. And if they're not on schedule they're weeks or a month late, nothing significant. So schedules have been pretty good recently. We had a couple that got delayed, probably be delayed by months. But again, we view that now as just part of the game that some of the projects will not reach final approval and sometimes they are delayed by a month or two.

Okay and then what was Comcast as a percentage of revenue in the quarter?

They were similar to last quarter. They were at 18.3% in the third quarter.

And did you have any other 5% or 10% customers?

No, it was just Comcast this quarter.

Okay. And Bryan, you talked a little bit about maybe reallocating some headcount kind of – where are you in that process, do you have specific plans to try to reduce expenses that way or is that something you're still studying at this point today?

We've started implementation in probably the latter part of Q3 and definitely into Q4 where the first thing we've done is in Hong Kong. We are displacing some of the headcount into Mainland China, basically a lower cost jurisdiction. So that's step one. So we definitely have started that. That is going well and but that's just the beginning. We need to make some more moves on that, but I don't want to go into details on that right now. But that whole process has begun and it started with the displacement of headcount from Hong Kong into Mainland, China.

Right. And you talked about a goal of getting this cash conversion cycle down by next summer. Does that set the stage to get back to your traditional mode of generating a material amount of free cash next year or are we ought to think about that's kind of the bridge and 2020 is the year where you're back to historical levels of cash generation.

Yes. No, I think next year we will see a significant progress because Paul just talked about the – if the cash conversion cycle gets down to 90 days which we're on track, I mean we improved 12 days from last quarter to this quarter, and right now I think even though we've made some headway into reducing our inventory levels, there's still room for improvement on that to get inventory turns back in that 4x range, which will help significantly and CapEx as well from a free cash flow standpoint. As you know, well aware, over the last couple of years, we've got to spend money on building out the factory in GTY and just buying new equipment for these higher-end platforms. And just to make it more difficult on ourselves, we did a full-blown ERP, new ERP platform with transitioning from QAD to Oracle. So these were costly endeavors that, fortunately, are complete and that we finished those in the second quarter. Now there is still a couple of other jurisdictions that we have put Oracle in, but they're smaller and won't be nearly the effort or the cost; so those are much smaller. So I think we can get our CapEx down to a normal, call about $20 million give or take, on average, which is where we were before the last couple of years.

Okay. And then Paul, given all the margin pressure you've had, do you feel like you were pricing your product appropriately today as you start to expand away from the customers that have all the pricing power to people that really need your technology or do you need to rethink your approach to pricing?

Well, certainly wouldn't say we've always been perfect. We've done a lot of work internally to analyze that. We've separated our product into groups. They are highly differentiated product, medium differentiated, lower differentiated product et cetera and looked at the margin structure for each – also small, medium, and large customers, took a cross-section of that. And generally, what we see is that we are – the margins, obviously as you'd expect, would be higher on higher differentiated product and obviously they will be higher on lower the purchase volume or the smaller the customer. There are cases where we probably could have done better and we've put in place practices, controls, approvals that need to take place in order for those prices to be reviewed to the extent they're outside of specific boundaries. But I think generally we've done a good job there. I think what's happened, Steve, is that the shift to the higher differentiated product needs to come to fruition. And it is, because we did see that in the trend over the last three years and I would project it will continue, it's just not happening overnight, because I think a lot of these implementations are more technically complex with the companies doing them than we may have originally anticipated and it just takes a little bit longer for them to be ready for that next-generation product. The ones who are bringing in outside help from us or others probably are doing it a little quicker than others, but it is happening. And I think it's fair to say and I think most people would agree. If you look at home entertainment, it was due for an upgrade in the experience and it is happening. These products are getting better and better, but it's going to take time. It's not going to happen in six months and it is happening. I mean we're seeing more and more launches of these. We have a lot of interest in these products. The voice enabled products just for AV. And also as I mentioned in the call, the voice-enabled platforms for all products that have to work in a – to unify a house that has a variety of protocols. We're seeing increased demand for that. So we think we're sitting in a really good place right now. But as far as pricing is concerned, we need to see – as we see more of a shift towards these advanced platforms, we will see, based on the pricing we have, the discipline we've put in place, we should see a lift.

Okay. I appreciate it. I think that does it for now. Thank you.

[Operator Instructions] Our next question comes from Greg Burns from Sidoti & Company. Your line is open.

Good afternoon. What percent of your COGS are currently subject to the Chinese tariffs?

Well, probably about half. They would be, obviously the U.S. based sales.

Okay, and what timeframe are we looking at for you to like, I guess, complete the readjustment of your manufacturing footprint. And when that's all said and done, I guess, what percent of your COGS at that time will still be subject to the tariffs. So I'm assuming you're not going to move all the production out of China, but maybe you are, but if you can give us a little color of that.

No, no. Clearly, as of right now out, about half of our business would be affected. So we will move that which is necessary, in order to provide cost effective solution to the customer. In other words not have them have to absorb the 25% increase. And that is taking place as we speak. It was happening in Q3. It'll happen in Q4. I think the preponderance of it will happen in the next couple of quarters and then by mid-year next year, it should settle down, as far as the disruption of it. But again the effect of this longer-term is basically zero because what our goals would be to not to be the solution provider, to go to the customer and say that we want to provide you these products in a cost effective way and we can do that. Through the shift of production we can make these products in another part of the world and still, cost effectively, do this. In other words China is not the only place in the world that these products could be manufactured cost effectively.

Okay. So the end goal is to move all the products flowing into North America out of China within the next 12 months.

Correct.

All right. Then, what does that do like how – I guess you'll have some excess capacity in China, what will that do – what are your plans there with your footprint once you readjust?

Yeah. We're going to have to evaluate that. I mean, there will be excess capacity and then the question is can we do a – right now, we have two factories in China and we're going to have to evaluate whether or not we reconsolidate some of that work. We're continually looking at, but we will have to address the overcapacity issue within the next few months.

Okay. And then, you have some – a lot of exclusions I guess from revenue and cost of sales. In terms of the some of the cost of sales exclusions, can you just give us a little bit more detail on what falls into the excess manufacturing overhead bucket? What's put on that?

Sure, as Paul mentioned, we were gearing up for Mexico. So what we had to do is we had to hire workers down in Mexico and you have to hire them before you manufacture. So we had a lot of idle labor in Mexico. We transferred equipment from China, so then this is where the excess capacity took a hit. We had unabsorbed overhead at GTY, and unfortunately it wasn't very long after we completed the transition from GTC to GTY that the tariffs took places and then we had a very short reprieve. And the next thing we know we're having to make adjustments. So on a positive note, we are fortunate that we had the foresight a couple of years ago to start a facility in Mexico which enabled us to move promptly and quickly. But unfortunately, we have that same issue with the excess capacity. So I'm going to have to deal with that probably in Q4 and figure out exactly what to do with the two factories, but that'll be addressed in the current quarter.

Okay. And then in terms of the AI product, I guess you're calling it Butler. Can you just help us understand kind of conceptually what that product is, is it like a competing solution to like an Alexa. Is it in that category or is there any kind of additional color you could give us on what that product or service looks like?

Sure, way better than Alexa. We don't even want to talk about that. What our product does is, basically at the heart of it, it is an AV control product because as we said in the prepared remarks, the center of the home is the AV system, right, because while the people on this phone call may not either want to admit this or they're not average people, the average U.S. citizen is consuming six hours of video per day, five hours of that video is going on live TV or time shifted live TV. It's actually 4 hours and 50 minutes a day. So the heart of any home is typically the AV system. So we think that the heart of any home control system probably should emanate out from AV because that is the most popular activity in the home. I hate to be cute about this, but I would say this, that if all the other things in your home lighting your thermostat, all the environmental controls, if you're spending 4 hours and 50 minutes controlling them per day you have a problem, either a physical or mental problem. Those are nice add-ons and they're brilliant products to automate life, make you safer, more secure and more comfortable, but most of this emanates from AV. So what our Nevo Butler would start with, obviously is our core market, which is that we can completely automate as we said earlier about QuickSet Cloud and we have some data on that. The average consumer can plug these products in and they will be automatically configured within seconds. So, it require no manual intervention at all. That would be the basis for it. And then, you can have the home control devices around it. In addition, it has a multi-protocol or interoperability as a feature. So in other words, if you had already implemented other home control products in your home, even voice-enabled products like Alexa, which we would work alongside. We can voice enable the Alexa device, work alongside Alexa, as well as voice enabling your AV system. So essentially, it's a product that will interoperate with everything in your home, any AV device, any home control device, and frankly any voice-enabled protocol. Even if you had a different voice-enabled protocol in your home, it would work alongside a product like this.

Okay, is it a Cloud or Interconnected? Can it pool…

Yes, Cloud connected. And again, I was joking when I said about Alexa, it actually would work alongside an Alexa. If you had Alexa powered devices, it would work alongside it, if you so chose to use that voice-enabled platform. But if you were to have separate voice-enabled platform, maybe supplied by your cable operator, you now have a cacophony in your house. You have two discordant systems that do not work together. One is voice-enabled, the other is voice-enabled, but they're not – they don't cross, they're not cross compatible. What Nevo Butler would do is, tie them together.

Okay, and is the idea that you're going to sell this through your existing channels or is this going to be a standalone product that use – okay, so this like the...

Well, it could potentially be sold as a standalone product, but I think we would begin and we have begun presenting this to our traditional customer base and are getting a lot of real positive reaction for it. It's not ready yet, obviously as I announced in the prepared remarks, it will be presented at CES, and it'll be near production then and then to launch sometime next year.

Okay. And there was some news out today or yesterday about Comcast potentially I guess putting out a box for streamers, set-top box targeted at streamers. Are you making the remote for that box?

Well I'm not sure I'm at liberty to say this. The only thing I guess I could say to you is that our relationship with Comcast is stronger than ever and I don't know if we're allowed to talk about projects we're working on, but we have a very good relationship with Comcast.

Okay. And is that something you're seeing in your talks with other customers, the cable operators looking to pick up some of those chord-cutters with a product like this?

Yes, many of them are looking at that or incorporating over-the-top service into their solution which actually many have already done, including Comcast.

Okay, great. Thank you.

Thank you. End of Q&A

I'm showing no further questions at this time. I would now like to turn the call back over to Paul Arling for closing remarks.

Okay, thank you for joining us today and your continued support of Universal Electronics. I'd like to note, in the next month or so we'll be at the Imperial Capital Security investor conference in December. Of course, we'll be at the international CES 2019 in the second week of January this year and the Annual Needham Growth Conference in January, in New York. We look forward to seeing you at any or all of those events. Hope to see you at CES, of course. Have a lovely day. Thank you.

Ladies and gentlemen, thank you for participating in today's conference. This concludes the program. You may disconnect and have a wonderful day.