Universal Electronics Inc. (UEIC) Q1 2019 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Q1 2019 Universal Electronics Earnings Conference Call. At this time, all participants will be in a listen-only mode. Later we'll conduct the question-and-answer session and instructions will follow at that time. [Operator Instructions] As a reminder, this conference call is being recorded. I would now like to introduce your host for today's conference, Kirsten Chapman, LHA Investor Relations. Kirsten?

Thank you, Nova, and thank you all for joining us for the Universal Electronics First Quarter 2019 Financial Results Conference Call. By now, you should have received a copy of the press release. If you've not, please contact LHA at 415-433-3777 or visit the Investor Relations section of the website. This call is being broadcast live over the internet. A webcast will be available for 1 year at www.uei.com. Any additional material, nonpublic information that might be discussed during this call will be provided on the company's website where it will be retained for at least 1 year. You may also access that information by listening to the webcast replay. After reading a short safe harbor statement, I'll 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 timely develop 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 recently announced Nevo Butler, nevo.ai digital assistant, voice remote control and intuitive 2-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 sensing 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 toward 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 to attract and obtain new customers for our products and technologies; management's ability to manage its business to achieve its net sales margins and earnings as guided including management's ability to provide improved operating costs and efficiencies at acceptable levels through cost containment efforts including moving our administrative operations and manufacturing facilities to lower cost jurisdictions and due to the effects of the changes in laws, regulations and policies that may have on our business during the impact of trade regulations pertaining to importation of products and tariffs imposed on them; and other factors described in the company's filings with the U.S. Securities and Exchange Commission. Management wishes to caution you that these statements are just projections and actual results or events may differ materially from those projections. The company entertains no obligation to revise or update these statements to reflect events or circumstances that may arise after today's date. 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 from time to time with the SEC, including the annual report on Form 10-K for the year ended December 31, 2018, and the periodic reports filed thereafter. These documents contain and identify various factors, which along with the risks identified on this call could cause actual results to differ materially from those contained in management's projections or forward-looking statements. In management's financial remarks, adjusted non-GAAP metrics will be referenced. Management provides adjusted non-GAAP metrics because it uses them for budget planning purposes and for making operational and financial decisions. Management believes that providing these non-GAAP financial measures to investors as a supplement to GAAP financial measures helps investors evaluate UEI's core operating and financial performance and trends consistent with how management evaluates such performance and trends. Management believes these metrics facilitate comparisons with the core operating and financial results and business trends of competitors and other companies. A full description and reconciliation of these adjusted non-GAAP measures versus GAAP is included in the company's press release issued today. Additionally, please note we are no longer including the effects of constant currency and ASC 606 revenue recognition in our non-GAAP financial statements. As a result, the prior year, 2018 non-GAAP figures as previously reported have been adjusted to reflect these changes. On the call today are Chairman and Chief Executive Officer, Paul Arling, who will deliver an overview; and Chief Financial Officer, Bryan Hackworth, who will summarize the financials. Paul will then return to provide closing remarks. It is now my pleasure to introduce Paul Arling. Please go ahead, sir.

Good afternoon, and thanks for joining us today. During the first quarter, we delivered revenue of $182.7 million, performed well across the board and exceeded our bottom line expectations with EPS of $0.82. We are known for providing innovative wireless control and sensing solutions that help our customers differentiate their offerings and exceed their end users' expectations. As more and more consumers desire voice-enabled automation in home entertainment and home control, our connected voice-enabled platforms give our business customers a clear path to transition to their next technology. Our advanced cloud-enabled products are capturing more opportunities and serving a wider array of customers than ever before. Leading companies across the world from broadband, cable, satellite and telecom service providers to consumer electronics OEMs to new market entrants in home automation are counting on us to develop their next-generation products. I'll provide more details about the first quarter. While there are many wins we cannot discuss due to confidentiality, I will highlight a few we can mention. Our net sales include continued penetration within our existing customer base. As many of you know, our subscription broadcasting channel customers are expanding into delivering broadband-enabled, over-the-top video services via advanced streaming set-top platforms based on Android TV and TiVo-enabled platforms, and UEI is at the forefront of many of the advanced voice remote controls that enable seamless interaction with these services. In our security and home automation channels, our business continues a healthy growth trajectory as we secure more product wins and unit shipments at customers such as Ring, Daikin and Trane. For our consumer electronics channel, licensing of our embedded and QuickSet Cloud services continues to show momentum as we added another major TV platform to our growing customer base, and our existing QuickSet customers, Sony and Samsung, continue to grow within the smart TV market segment. We recently added Verizon to our list of advanced platform customers. We are proud to be working with them on their new FiOS remote for their recently introduced advanced TV platform. In addition, our development teams across the world continue to work on a growing list of new products for all our market channels that will begin shipping later this year and into next year. Also as you know, in January at CES, we unveiled Nevo Butler, our new smart home hub, that leverages nearly all our innovative developments including QuickSet, nevo.ai and smart home sensors, enabling us to enter adjacent markets and expand our offerings to existing and prospective customers. Nevo Butler is garnering strong customer interest across all our channels. We are currently in alpha release for internal testing. We expect to go into beta late this quarter and to be ready for market introduction later this year. Our commercial teams just went through extensive product training over the past week and are actively engaged with several Tier 1 accounts with the goal of commercial deployment in early 2020, if not sooner. As discussed in February, during the first quarter, we began proactively implementing tactics to offset the impact of the Section 301 tariffs, optimize our footprint, streamline our business and reduce general expenses to free resources for strategic investments. Since Q3 of last year, we have been actively engaged in the daunting task of moving 40% of our production volume from China to our facility in Monterrey, Mexico, and the third-party facility in the Philippines. Because this factory transition was driven by punitive tariffs put in place last year, we have been trying to accomplish as quickly as possible what would normally take place over a 2-year time period. While this transition has been extremely challenging, we have made significant progress and are still on track to complete our facility transition this summer. We are extremely proud of the accomplishments to date of our operations teams in these regions and those involved in this transition across the world. I'd now like to turn the call over to our CFO, Bryan Hackworth, for review of the financials.

Thank you, Paul. As a reminder, our results for the 2019 first quarter as well the same period in 2018 will reference adjusted non-GAAP metrics. First quarter net sales grew by approximately 11% to $182.7 million from a $165.2 million in the first quarter of 2018. The growth in our top one is driven by the recent launches of higher-end platforms by existing customers, a newly acquired customer and continued strength in home automation. Gross profit was $47.2 million or 25.8% compared to 23.9% in the first quarter of 2018. Operating expenses were $32.6 million compared to $33.4 million in the first quarter of 2018 as we are utilizing savings from our corporate restructuring efforts to invest in future products, technologies and markets. R&D expense was $6.6 million, an increase of 11% compared to $5.9 million in the first quarter of 2018. SG&A was $26 million compared to $27.5 million. Operating income was $14.6 million, up from $6.1 million in the prior year. Our effective tax rate was 14.9% compared to 17.8% in the prior year quarter. Net income was $11.3 million or $0.82 per diluted share compared to $4.1 million or $0.29 per diluted share in the prior year period. Next, I'll review our cash flow and balance sheet at March 31, 2019. Cash and cash equivalents were $44.9 million compared to $53.2 million at December 31, 2018. Our cash conversion cycle approximated 119 days as of the first quarter of 2019 compared to 118 days in the first quarter of 2018. We expect our cash conversion cycle to improve significantly by this summer driven by an increase in inventory churns as we complete the transition of approximately 40% of production volume from China to Mexico and the Philippines. Now turning to our guidance, we expect our second quarter to reflect strong improvement compared to a challenging second quarter last year when certain customers reduced orders ahead of their platform transitions. For the second quarter of 2019, we expect sales to range between $178 million and $188 million, representing 10% to 16% growth compared to $162.4 million in the second quarter of 2018. EPS is expected to range from $0.70 to $0.80 compared to $0.15 in the second quarter of 2018. While we only provide detailed guidance for the next quarter, we would like to make a few general comments on our outlook for the remainder of 2019. We expect sales in the back half of the year to follow its typical seasonality with sales in Q3 to be greater than Q4. Our goal on gross margin percentage for the year is in the 26% range plus or minus a point. Our expense efficiency should continue. However, as we've said before, we'll continue to invest in technology and product development to continue our long-standing leadership in bringing differentiated solutions to the market as well as investing in the people that help us succeed. Our actions to reduce overhead costs may be offset by these important investments as well as the variable costs associated with sales growth. While tax rates may vary quarter-to-quarter, we expect the effective tax rate for the year to be in the low 20% range. I would now like to turn the call back to Paul.

Thanks, Brian. We are well positioned to capture increasing demand for advanced products from traditional and new market players. We are making great progress, improving our manufacturing capability to cost effectively support the growing demand for our products and services. Further, our 2019 strategic initiatives to streamline the business are beginning to deliver increased operating efficiencies, allowing us to further invest in our future. Overall, we believe our continued focus on growth through technology, innovation and best-in-class product quality and delivery should result in continued growth and increased profitability and shareholder value. Stay tuned. Operator, we now like to open up the call for questions.

[Operator Instructions] Our first question comes from the line of Steve Frankel of Dougherty.

Great. So Paul, let's start with kind of on that transfer of 40% of the production volume out of China. Where do you think you are now along that continuum?

Well, I don't have the exact percentage, Steve, but it's greater than half at this point, and we expect to be in a better position obviously by the end of this quarter going into Q3.

Okay. And maybe an update on how many advanced remote new designs are shipping in the front half of 2019? And how many more scheduled for the back half of '19, assuming these customers stay on plan?

Yes, I don't have the specific number for that. But as we've said before, the number they're shipping, some of which are public. Obviously, Comcast has been out for quite a number of years, but have additional plans. DISH, many of the major operators are out. Some are not yet. I think it would be a safe bet to say that most, if not all, of the major operators in the higher ARPU countries, here in the U.S., Western Europe, across most of the major markets in the world, have a plan, either are out or about to come out or have a plan to come out with a next-generation product akin to what we've done with others, 2-way, IP and cloud-enabled products. Some of which are delivered over the top with an advanced product that will control it, voice enabled, typically. So if you look in the public sphere for companies, you can probably see many of the products that are out. Some of them, who are newly out, haven't let us publicize that yet, but you could probably find them. And if you find a major operator in a country like the U.S. that isn't out yet, you should presume that they're probably -- more than likely working on one.

Is there any major operator somewhere in the world that has an advanced remote that's not using you? What's your market share in the advanced remote market -- states?

It's nearly 100%. I can't think of one. There may be one, but there -- most of them are working with us. They may have multiple vendors. We do have situations where we license IP and or a chip or other technologies to allow customers to have multiple vendors, but in most cases, we're involved with the technical development of the platform.

Okay. And are you still breaking up the business between business and consumer? I didn't hear Bryan mention those numbers.

No, I didn't. I mean consumers is just the smaller percentage of the total, and I just -- I felt -- nowadays, it's just not as relevant as it was -- as it once was.

Okay. And how about 10% customers during the quarter?

Yes, we had 2 this quarter. We had Comcast at 15.7 and DISH at 10.7.

Okay. And the cash flow was better on a year-over-year basis, but still not positive in terms of free cash flow. When do you think you can get to generating cash? Is that in the back half as production situation normalizes?

Correct. I think Q1 typically -- even in the past, we've had strong cash flow from operations for the full year, Q1 is always late. We typically stretch out vendors towards the end of the year and then you end up paying in Q1 a little earlier. I think what's going to happen with us is with the transition from China to Mexico for about approximately 40% of production, that's going to help improve inventory and that's going to free up significant amount of cash in the back half of the year.

Okay. And then Paul, on Nevo Butler, could you characterize a couple of different use cases of how people in your customer base or new customers to UEI might leverage Butler?

Sure. Yes, there's a variety of ways that they're doing it. Obviously, at the core of it is an AV platform, voice-enabled AV platform. Some are considering it one of the features, maybe not the only feature, but one of the main features is that it will allow systems to voice enable what was once non-voice enabled. I guess it's the best way to say it. So there's customers that have platforms in the field that are not hardware enabled for voice and this would allow them to become voice enabled. There are other players who are interested in this, because they haven't developed their voice platform as completely yet and they realize that the world is moving in this direction, so they feel that this would be a, maybe a faster and easier way for them to adopt voice more quickly. That stretches across market segments or channels, meaning it's not just cable, satellite, broadband, telecom, but also some of the other channels we serve. So those are probably the main ones. There's is a great deal of interest in this. Obviously, this is a major movement in the industry towards voice-enabled entertainment. And that the addition of additional products that can go along with it to enable services is also of interest to a lot of the channels that were, with the Tier 1 accounts that have become very interested in this. Because they may not have had the ability or plans to add those additional services, which can generate revenue for them and this would enable them to do that.

Okay. And then last one. Any update on new customer or new wins in the home automation sector?

Yes. I mean, I think, we've mentioned a few names here. I can't speak always about specific projects, because some of them again aren't public, but we did mention Ring, Daikin and Trane. Those are not all new, but obviously the way these customer relationships work is that there are often new projects within those accounts. That get one and either we have begun shipping them or we'll soon. So on home automation side, those would be the big names.

And our next question comes from the line of Jeff Van Sinderen from B. Riley & Company.

Yes, first, I'd like to just say congratulations on the progress you're making on a number of fronts. Maybe you could just touch on Mexico. What the remaining hurdles are there to get to the targeted levels during this summer? And do you feel like the risk of getting to those levels is reduced at this juncture?

Well, yes. I mean we're starting to feel more confident in our ability as we go through this. I don't know that there aren't still a lot of challenges and risks; there certainly are. It's just more or less, you have to get up to capacity, so when we move a program, you have to make sure that the new facility is getting up to efficiency, because any new project at a factory, and this is true when we moved our projects within China, when they go to the new location, the project usually isn't as efficient as it was in the old location, because it was a well-drilled-out process in the old location and it's new to the new location. So just getting up to capacity, getting the processes, machines in place and then having the workers move up the experience curve to get it to a well-worn process within the new facility. That's what we're going through right now. Many, most of the projects have been transferred already, major customers for certain, but we're still going through the process of getting them all up to capacity at the new location.

Okay, fair enough. And then just turning back to the home security and automation segment. Anything you can give us in terms of order of magnitude on revenues that we might be thinking about this year? And then if you could, on Nevo Butler, just wondering, I know you talked about it a bit, but just think about, I guess, the sequence of development start getting initial orders and how you envision the product being deployed at first, if there is anything you could say about that?

Sure, yes. As far as home automation, we haven't provided a breakout on that yet. We did last year. Obviously, we updated that our home control sales had reached over $130 million. We do expect further growth in that this year, but haven't provided any specific guidance to that. We may as the year progresses, but we aren't currently providing any numbers on that, except to say that it is continuing to grow. As far as Nevo Butler is concerned, it will vary by customer. Obviously, there is a hardware sale component to it, the Butler itself. But there are also potential, with every relationship, potential other products that would be associated with the system that would be sold into. That could be either other AV control products or sensing devices. For instance, if they were enabling those services through their new implementation, those details will get further into as this year progresses. As we said in the earlier remarks, the product will be ready later this year, but we expect to have something in the year 2020, maybe sooner. So we'll roll out details of those relationships and the architecture of those systems as we get closer to the date of rollout.

Okay. Great. And then just on the move to Arizona, just wondering if you feel like at this point, you pretty much are through the hiring and the changes that you needed to make and that's pretty much behind you. Is that the case?

Yes, I would say we're probably 85% to 90% of the way through the transition to Arizona in terms of initial phase. So all the departments, finance, accounting, HR and IT were far long, and I feel like we're again by 90% of the way through. I think maybe 2 more people we need to hire, but the hard part is over with. And we're well situated.

[Operator instructions] Our next question comes from the line of Greg Burns from Sidoti & Company. Your line is open, sir.

[Technical difficulty] chain constraints that resulted in some orders being -- the shipments and some orders being delayed. Did you have a similar dynamic this quarter?

Yes, Greg, I think we missed the front part of your question, but I think your question is revolving around delayed orders from quarter-to-quarter. Is that correct?

Yes, yes. I just want to see if you had a same dynamic?

Yes, we did, obviously, last quarter on this call 3 months ago. We're still probably at that point where there were some orders that we were not able to ship in Q1, will be in Q2. We think we'll be largely caught up with that at the end of this quarter.

Okay. Great. And then, when we look at the pipeline for your advanced remote rollouts, you called out a number at the end of -- a few rollouts at the… a few rollouts at the end of last year. As we look at the balance of the year, what's your visibility on just maybe, not specific customers, but maybe the pipeline or the number of rollouts that you might have over the next 6 months?

Yes, there will be a few more, but I think that the bigger impact will be from the volume as we get, the rollout of these systems usually go slowly at first and then accelerate. So we do see, there still are obviously active projects that we're working on that have not been introduced yet, but we're also feeling the impact of some of the ones that have already launched currently.

Okay. And I guess, last quarter, with some of the rollouts, I guess, you didn't give a specific name, but you talked about a net new North American customers. Is that Verizon? Or is this FiOS?

Yes. We did mention Verizon and FiOS. We are proud to be working with them on their new FiOS advanced platform.

Okay. So that's the same one you referenced last quarter.

And so I'm showing no further questions in the queue at this time, and I would now like to turn the call back to Paul Arling, CEO and Chairman, for closing remarks.

All right. Thank you for joining us today and your continued support of Universal Electronics. A couple of things, in May, we will present at B. Riley's 20th Annual FBR Institutional Investor Conference in Beverly Hills, and in June, we'll be at the Baird 2019 Global Consumer Technology and Services Conference in New York. Hope to see you at one or both of those. Thank you very much for being on the call today, and have a great day.

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the call. You may now disconnect. Everyone, have a wonderful day.