Universal Electronics Inc. (UEIC) Q2 2019 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Universal Electronics Second Quarter 2019 Earnings Conference Call. [Operator instructions] As a reminder, this conference call is being recorded. Now I’m going to introduce your host for today’s call, Ms. Kirsten Chapman from LHA. Ma’am, you may begin.

Thank you, Geranda. And thank you all for joining us for the Universal Electronics Second Quarter 2019 Financial Results Conference Call. By now, you should have received a copy of our press release. If you’ve not, please contact LHA Investor Relations at (415) 433-3777 or visit the investor relations section of the website. This call is being broadcast live over the Internet. A webcast replay will be available for one year at www.uei.com. Any additional updated 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 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 company’s ability to anticipate the needs and wants of its customers, new and existing, and timely develop and deliver products and technologies that will be accepted by our customers and enable the company to enter new markets. This includes the adoption of the company’s advanced control products such as the recently announced Nevo Butler, Nevo.ai digital assistant, voice remote control and intuitive two-way home entertainment technologies as anticipated and expected by management; the continued incorporation of our QuickSet technologies, including the QuickSet Cloud, into the customer’s 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; the timing of new products rollout orders from the company’s customers as anticipated by management; the continued trend of the industries 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 improve operating costs and efficiencies at acceptable levels through cost-management efforts, including moving our administrative operations and manufacturing facilities to lower-cost jurisdictions; and the timely completion of the transition of a certain portion of the company’s manufacturing operations to its Mexico facility; the effects that changes in laws, regulations and policies may have on our business, including the impact of trade regulations pertaining to the importation of our products and tariffs imposed on them; and other factors as described in the company’s filings with the United States Securities and Exchange Commission. Management wishes to caution you that these statements are just projections, and actual results or events may differ materially from these like those projections. The company undertakes no obligation to revise or update these statements to reflect events or circumstances that may arise after today’s date. For future 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 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 and 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 business trends consistent with how management evaluates such performance and business trends. In addition, management believes these measures facilitate comparisons with the core operating and financial results and business trends of competitors in other companies. A full description of reconciliation of these adjusted non-GAAP measures versus GAAP is included in the company’s press release issued today. Finally, please note that we are no longer including the effects of the 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’ll deliver an overview and vision for the company; and Chief Financial Officer Bryan Hackworth, who’ll 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 second quarter, we delivered record net sales of $193.4 million, with growth in all of our markets and exceeded our bottom-line expectations with EPS of $0.83. We are poised to deliver the strongest year in our history. This reflects the efficacy of our long-term strategy. For over 30 years, we have been focused on being the technology leader in wireless control by investing in innovation and building valuable customer relationships by committing to excellent service. As we know, the one constant is change, and technologies continually shifts as in our core business with the evolution from DVD to streaming, standard definition to high definition and now to 4K, and local home networks to cloud-enabled smart homes. UEI has been consistently at the forefront of using technology to control the connected home, first in home entertainment and now in home automation. Our connected home technologies have often been ahead of their time and helped lead shifts in the market. Most recently, when we introduced voice-enabled capabilities and auto configuration, consumers loved these advanced features. Today, our customers are embracing these solutions and integrating them into their platforms more than ever before. We are excited to note the industry continues to shift along this continuum. Clearly, we would preferred a faster adoption. However, the seismic transformation from one way infrared remotes to sophisticated two-way, voice-enabled cloud-connected systems with automated setup have led numerous players to completely redesign their home entertainment and home control platforms. I’m pleased to say our efforts over the past many years are gaining momentum in the marketplace. First, we have long been established as first-to-market provider. We have accumulated significant experience across the numerous platforms in which we have been involved. This gives us an unmatched competitive advantage in the industry. Some say UEI is now the go-to company to develop the control interface for these advanced products. These attributes and our commitment to delivering full-featured quality products on time gives our customers confidence in selecting UEI to be their technology partner. As such, we are building stronger relationships with long-term customers, as well as winning new ones. Second, the technologies we have developed over the years, including QuickSet, adaptive control and our proprietary dual-RF and IR microcontroller, continue to be integrated on more and more advanced voice platforms. This yields development and cost efficiencies and delivers higher value products to our customers, driving higher ASPs and sales growth. This is noteworthy as the current device evolution is relatively nascent, yielding significant opportunity as more leaders in the home entertainment industry adopt these sophisticated systems. Today, our technology portfolio powers products capable of supporting all the advanced entertainment software platforms on the market, including open-source platforms from Android and RDK, as well as TiVo and other proprietary platforms. Over the coming years, these emerging platforms will begin to penetrate the market as home entertainment companies around the world, both small and large, leverage available standards to launch their advanced entertainment and voice services. In September, we will exhibit at a couple of important trade shows. In Amsterdam, we will participate for our 22nd year at the International Broadcasting Conference or IBC, where we will showcase our latest entertainment control and IoT products, including our latest Android TV remotes and our Nevo Butler platform, which continues to garner strong market interest. At IBC, we plan to introduce our new premium Android TV remote control code named FUJI, which comes with rechargeable batteries, adaptive control QuickSet and voice control. A few weeks after IBC, at Cable-Tec Expo in New Orleans, we will be exhibiting more advanced control solutions with the launch of the TiVo Creek advanced voice remote designed for TiVo’s Android TV software platform, supporting advanced features such as voice, remote finder and our industry-leading QuickSet technology. Regarding Nevo Butler, we are pleased with the progress of this development effort. The platform is now in the initial stages of beta testing, and we expect to begin to share product with customers for early development, testing and technology integration later this year. In our home control business, we continue to see an evolution in product deployments enabled with our smart technologies. But again, transformation is never overnight. Key home control customers across the world continue to see success in their deployments, particularly in safety and security and HVAC. These markets are exhibiting strong growth, and we continue to see great near-term and long-term potential as consumers continue to adopt these advanced home control systems. I’ll now turn the call over to our CFO, Bryan Hackworth, for a review of the financials.

Thank you, Paul. As a reminder, our results for the 2019 second quarter, as well as the same period in 2018, will reference adjusted non-GAAP metrics. Second-quarter net sales grew 19% to a record $193.4 million from $162.4 million in the second quarter of 2018. The growth in our top-line reflects increases in multiple channels, notably in subscription broadcasting, consumer electronics and home security. Our advanced technologies that simplify and enhance the user experience continue to be adopted and employed by customers in these channels. Gross profit was $48.8 million or 25.2%, compared to 22.1% in the second quarter of 2018. During the second-quarter 2019, as planned, we transitioned additional products destined for the U.S. market from our China factories to our manufacturing facility in Mexico. The increase in the number of SKUs produced in Mexico increased significantly from Q1, resulting in a greater amount of inefficiencies compared to the first quarter. We experienced a similar effect in Asia when we sold our southern China factory, resulting in our two remaining factories in China absorbing the production units. Subsequent to the initial disruption, these two factories continue to improve and, within a relatively short period of time, reached expected production levels. We anticipate the same of our factory in Mexico. Operating expenses were $33 million compared to $31.2 million in the second quarter of 2018, reflecting an increase in R&D as we continue to invest in innovation, enabling us to provide our customers with top-notch solutions and separate ourselves from the competition as the clear leader in wireless control. R&D expense was $6.9 million, an increase of 18%, compared to $5.8 million in the second quarter of 2018. SG&A was $26.1 million or 13.5% of revenue, compared to $25.4 million or 15.6% of revenue. Operating income was $15.8 million, up from $4.6 million in the prior year. Our effective tax rate was 21.2%, compared to 23.4% in the prior-year quarter. Net income was $11.7 million or $0.83 per diluted share, compared to $2.6 million or $0.18 per diluted share in the prior-year period. Next I’ll review our cash flow and balance sheet at June 30, 2019. Cash and cash equivalents were $49.6 million, compared to $44.9 million at March 31, 2019. Net cash provided by operating activities was $24.8 million, enabling our outstanding debt balance to be reduced to $95 million at June 30, 2019, a decrease of $11.5 million from last quarter. Our cash conversion cycle approximated 108 days in the second quarter of 2019 compared to 114 days in the second quarter of 2018. Now turning to our guidance. For the third-quarter 2019, we expect sales to range between $188 million and $198 million, compared to $182.7 million in the third quarter of 2018. EPS is expected to range from $0.85 to $0.95, compared to $0.80 in the third 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 greater than Q4. Our gross margin goal for the year is in the 26% range, plus or minus a point. Our expense efficiency should continue. However, as we have 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.

Thank you, Bryan. Our success in home entertainment is the result of years and years of hard work, developing innovative technologies and building relationships. Our sophisticated two-way, voice-enabled, cloud-connected systems with automated configuration lead the industry. They have been very well received since their introduction, and we are very excited that our customers, both existing and new, have begun to embrace these systems as the future of home entertainment. This growth is complemented by steady success in our home automation business. This transformation within the home is really just beginning. Building home entertainment systems that automatically configure devices, allowing consumers to watch whatever they want, whenever they want, through any service or device they want, through only a short verbal command or an intuitive touch is no small task. Building systems that protect your home and family, as well as control your home’s environment and functions in ways that were only imagined a few short years ago is no small task either. We are well on our way to achieving this. As such, we continue to invest in our innovation and our future. We are excited that we are positioned to deliver the best year in our over 30-year history. Overall, we believe our continued focus on growth through technology, innovation and best-in-class product, quality, 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 Jeff Van Sinderen from B. Riley. Your line is open.

Hi, good afternoon. Let me first say congratulations on the strong performance in Q2. Are there new upgrade programs that started in Q2 that you can – I know you can’t name them, but maybe touch on kind of some of the dynamics around those or new programs that will start in Q3 that you expect to contribute to revenues? Or is it more ongoing demand from programs that have been underway for several quarters?

Well, it’s a little of both. We did have programs that began – one that I can think of, we can’t name all of these players, but one in Q4. We had another one in Q1. Some of the growth in Q2 was contributed to by – just those programs growing in deployment. We also have some new programs that were coming along as well. So it’s a layering effect. We did have a few of these programs. But some of them didn’t launch in Q2, they launched – one of which I can think of was in Q4, but it’s grown since Q4. So it’s a layering impact. Do we see more of these? Yes, there’s probably some more that are coming, both the remainder of this year and in the next because there’s almost a constant redesign of these programs. And obviously, there’s a lot of players who haven’t introduced their next generation quite yet but are working on it. So we think this is something that will occur over the course of the next many years.

Okay, great. And then just regarding the Mexico production, can you speak more about where you are in terms of the volumes and efficiencies versus where you ultimately would like to be? I guess I’m just trying to get a sense of how close to optimization you are at this point?

Yes, Jeff, it’s Bryan. As far as Mexico is concerned, from a unit perspective, we’ve transferred by far the majority of the units that we’re going to transfer by the end of Q2. We started in Q4. We’ve moved more units in Q1. And then in Q2, we layered on probably another 50% approximately. So the pace that we’re transitioning in Mexico is accelerated versus what we did in China initially. So it’s a – we’ve put together an aggressive schedule, but we need to. So from an efficiency standpoint, we’re not where we need to be. And it’s something we’re – we know that, and we’re working to improve. The same effect happened actually in China when we sold the southern factory and we moved the production to the remaining two factories. There’s a point in time when you start moving over units and then you hit a point where you struggle a bit and then you get better. And we’re kind of in that point right now with Mexico where I expect Q3 significant improvement over Q2 and then Q4 as well.

Okay, but yet you’re still – I mean, in Q2 you put up a pretty substantial increase in gross margin. Some of that would be contributing from the Mexico shift. But it sounds like more gains to come. Is that fair way to put it?

Yes, I don’t guide to gross margin but I do expect gross margin to improve Q3 versus Q2.

Okay. Helpful. And then who wants to take this, just if I could throw in one more, could you update us on the progress around Nevo Butler? I know you mentioned it in your prepared comments of being in beta. I guess just wondering kind of what the next milestones are, what we should see or hear about Nevo Butler? It sounds like it’s off to a really good reception. Maybe how the MSOs are evolving and thinking around initial deployment?

Yes. Where we’re at right now is in the beta, early. The only thing I’d correct, I wouldn’t just say MSOs. While there’s interest on the subscription broadcasting side, I would say more broadly in home entertainment and even home control. We have a number of parties who are interested in this level of integration of both an IP-connected system to bring control across your home, either through voice or through touch, as well as mobile for some systems, not necessarily for home entertainment but for other applications. So we have a lot of interest in the platform. The next step will be for us to work with customers by delivering some product for testing and then ultimately integration, because the customer will first want to prove out the system and then work on software integration with other products that they may wish to obviously integrate with this product. So it may take some time. We don’t have this. Obviously, it’s not embedded in our Q3 guidance. And as we’ve said all along, this – while it may affect this year’s some, probably not. It’s more of a 2020 and beyond system. With some customers, this could take quarters, months or, in some cases, maybe even a year or more depending on how they wish to utilize this product.

Okay. Well, it’s great to hear that this product is [Inaudible]. Thanks for taking my questions. And congratulations.

Thank you.

Our next question comes from Greg Burns from Sidoti. Your line is open.

Could you just give us the 10% customers in the quarter on what was Comcast and any others?

We have one 10% customer. It was Comcast, and they’re at 16.2%.

16.2%. Okay. Thanks. And then in terms of the upgrade cycle in the cable broadband markets, historically or in the past you’ve given us some numbers around maybe the number of MSOs that have deployed or the number of subs that are covered under platform – the number of subs covered by your advanced platforms. Is there any numbers you could update us with in terms of that front and on how far along the upgrade cycle is? Thank you.

Yes. I can’t give you an exact number of how many subs are covered, but that number probably has grown a little bit. When we disclosed that prior, we had said that they were between 150 – in other words, 150 million-plus subscribers covered by the companies that we’re working with us on an advanced platform. That number probably has gone up a little. But obviously, that is a huge number worldwide. Obviously, that number is greater than the entirety of the United States’ market. So we’re working on deployment with that set of customers. And again, you’re beginning to see the effect of it in our numbers. These advanced platforms bring higher value add to the customer. They’re two-way, voice driven, as I said in my prepared remarks. And just implementing the ones that we currently have is a major accomplishment for us. That number has probably gone up. We haven’t measured in the recently, but it’s gone up. It’s probably not over 200 million though.

Okay. And do you know what – or can you share with us like what percent of that 150 million is actually in deployment versus may be still in the pipeline?

Well, unfortunately I can’t. Most of our customers don’t – if we know they won’t let us disclose unless they have. I think Comcast has made public comments on that. They are the furthest along. And I think today they’re probably about 60% of their subs. But they started – they were the first to go through this and that was I think about four years ago now. So we’re at the early stages of this with obviously a number of people who are starting it, who started it maybe late last year or last year or are starting at this year. There’s a ways to go in their deployment. Obviously they don’t get it out to 100%. No one would get it out to 100% of subscribers in three months. It will take years for them to fully deploy.

Okay. So, Bryan, some of your commentary around maybe some of the investments you need to make in the back half. So should we take that to mean we should expect OPEX to trend higher sequentially over the next quarter or two? Or how should we view that versus the run rate you’ve been at for the first half of the year? Thanks.

Yes. When I made that comment, I just mean in general. It depends on the projects because we’re talking about from a long-term perspective where we may have – we’re going through cost efficiencies here, one of them being moving from California to Arizona and from Hong Kong to Mainland China for a number of employees. So that was a big cost-savings initiative for us. And all I’m saying is that there could be a time where you have projects in place. If someday comes up with this could help fuel growth. And in any given quarter, we’ll make the decision potentially to make that investment. So I don’t mind investing in R&D when it yields positive sales growth or ASP expansion. So that’s what we mean by that comment.

Okay. Thank you.

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

Good afternoon, thanks for the opportunity. Paul, there’s been a ton of focus domestically on the uptick in churn among the MSO customer base. And you can kind of think of that doing one of two things, it could cause those customers to pull back or it could cause those customers to accelerate their next-gen plans. So my first question is what do you think that uptick in churn does to the customers you’re already working with or have in the pipeline? And secondly, what’s the pipeline look like, international customers versus domestic? Like, are we looking – are we obviously earlier in the international launches, and do you have multiple international launches still to come or in the early days?

Yes. We still have a number of them to come because the – essentially, what’s happened, I’ll answer the first part of your question first, the churn has always been a common term used for subscription broadcasters since the beginning of cable and particularly over the last couple of decades. The churn increase is probably driven by – when there are good, viable alternatives from others, it will potentially raise churn. So I think what’s happened is companies in home entertainment are viewing that these platforms are not just interesting, they’re becoming the price of entry because the – if consumers have alternatives, obviously – and they’re great, they give you automated setup, will control all of the media you wish to watch, whatever you want to watch through whatever service you wish to watch it, and you can get it through the simple utterance of a command. And then another system has a one-way remote control where you have to use a guide and peruse through 360 channels by hitting page down 35 times. This could lead to greater churn because the systems, these new systems, competitive systems are great. So I think in the prepared remarks, we said that they see this as the future of home entertainment. We’re seeing this fairly widely, both here domestically, but also in most of the – if not all of the high-ARPU markets of the world, Western Europe, major countries within Asia. We’re seeing this movement toward these two-way, voice-enabled systems that bring entertainment to people much easier than they’ve ever gotten it before. And as more of them come out, it becomes the price of entry because your competitor, the person who you may have lost those customers to in churn have those systems. And that might be partially why those customers are leaving you to go to the new one. So I think this is generally what’s happened, the companies that are introducing these realize that this is where they need to go. It pleases the customer, it makes them potentially more loyal to you. It’s less likely that you’re going to find a competitor’s product that you truly like because you now truly like the one you have. And I think they recognize that, many are doing it. We’ve been working on, as you know, we’ve been working on some of these for a while. Some of them took maybe a little bit longer than we expected. But nonetheless, these companies are committed to this business and want to maintain those customers. So we see this happening over the course of the next number of years.

Okay. And you mentioned some new product activity at IBC. Just give us just a little more detail on what’s the incremental innovations that you’re going to have customers focus on at IBC?

Yes. Well, we’re working on platforms for or systems for all different software platforms. We do see some emerging platforms that will probably be more popular among the medium sized to smaller sized operators. As you know, major operators typically will build their own interface, but some of the medium sized to smaller will rather use an open source or third-party interface. So we’ve built product that will run perfectly, voice-enabled, two-way, IP-connected platforms that will run on those and bring the more common now features, voice. We have another one called adaptive control where it’s context sensitive based on what the screens. The button functions can change. So in one function, it’s up, down, left, right. In other function, it may be page up, page down. On the cable – I’m sorry, the buttons can actually relabel themselves based on what’s on the screen at the time. So we’re bringing new features like that. And of course, all powered by QuickSet and the other innovations that we’ve brought about. So the products you’ll see both at IBC and on the AV control side at IBC and here in the U.S. will be based on these technologies.

Okay. Nice recovery in free cash flow. To what extent is that kind of systematic? Now that you moved production to Mexico, is this improved free cash flow something we should expect for the next few quarters versus maybe any one-time factors that happened in Q2 that led us there?

For the rest of the year, Steve, I expect to have positive cash flow from operations. And I wouldn’t bank on $24 million each of the quarters. In Q2, accounts payable went up a decent amount. But I do expect the back half of 2019 to have positive cash flow. So I think we’re on the right track.

Okay. And then just big picture, that shift of U.S. volume to Mexico, kind of what does that save you in dollars of inventory? You, by not having to have it on the water, may be able to turn it faster.

I mean, I think we should be able to get our churns in the 4 to 4.5 range when all is said and done with the move to Mexico.

Okay. And other than doing kind of what happened in China, which is – just need more experience running on all these SKUs to get the gross margins up, is there anything you need to do to the facility or anything else that needs to happen to get to normalized margins out of Mexico?

No, I think it’s similar to China where we made the comment. It’s time, time and experience. So like I said previously, we went through this similar situation in China, and we had – there were some bumps in the road and we improved. And right now, we are manufacturing very efficiently in China. So I expect the same in Mexico. It’s just going to take a little bit of time. But we have the right equipment. We have it staffed. We’re putting the right people in place. But right now, I think the variable right now is going to be time. And I expect us to improve in Q3 and then Q4.

Great, thank you.

[Operator instructions] I’m showing 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 your continued support of Universal Electronics. In September, we will present at the Dougherty 2019 Institutional Investor Conference in Minneapolis. And in October, we’ll be at the B.Riley’s Consumer and Media Conference in New York. I hope to see some or all of you there. Have a great day.

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