Good day and thank you for standing by. Welcome to the Universal Electronics Fourth Quarter 2022 Financial Results Conference Call. [Operator Instructions] Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Kirsten Chapman, LHA Investor Relations. Please begin.

Thank you, Norma, and thank you all for joining us for the Universal Electronics 2022 fourth quarter and full year financial results 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 or visit the Investor Relations section of the website. This call is being broadcast live over the Internet. A webcast replay of this call, including any additional updated material non-public information that might be discussed during this call will be available on the company's website at uei.com for 1 year. During this call, management may make forward-looking statements regarding the future and future events and future financial performance of the company and cautions you that these statements are just projections and actual results or events may differ materially from those projections. These statements include the company's ability to timely develop and deliver new technologies and technology upgrades and related products introduced this year, including leveraging its wireless connectivity capabilities in the climate control, home automation, security, hospitality and HVAC channels and its ground breaking line of ultra-low power and energy harvesting control products designed to address the growing demand for more sustainable solutions in electronic devices. The continued successful collaboration with existing and new customers and developing and launching new generation products, software solutions and technologies into existing and new and growing markets, which result in increased sales and market share for the company. management's ability to continue to manage its business, inventories and cash flows to achieve its net sales margins and earnings through financial discipline, operational efficiency, manufacturing diversification and footprint strategy and line management. The impact of the company's financial results that it may experience due to supply and trade constraints. So semiconductor supply challenges and inflationary pressures and macroeconomic conditions and…

Thank you for joining us today to review our 2022 performance as well as our outlook for 2023. As we have highlighted many times before, our strong commitment to ongoing innovation, product and technology design, development and delivery and ongoing excellence in customer service continues to garner accolades. Our product designs received CES innovation awards in January and more importantly, our platforms and technology solutions earned customer recognition in the form of new product design wins throughout the back half of 2022 and into 2023. As a result, our share continues to grow in the markets we serve. However, macroeconomic challenges and increased consumer uncertainty have impacted market dynamics, especially at the tail end of last year. As a result, Q4 2022 performance was below expectations with net sales of $122.8 million and EPS of $0.44. We anticipate that impact will also be felt in the first quarter of 2023. Regardless, our connected home solutions, which are sold in our higher-growth markets that focus on climate control, home automation and security continue to gain momentum. In fact, product design wins secured 12 to 18 months ago, in some cases, in the connected home channel are starting to ship, giving us confidence net sales will improve starting in the second quarter of 2023 and build momentum into 2024. For example, we are shipping our first advanced thermostat with Mitsubishi Electric train for the U.S. market toward the end of the first quarter of 2023 and have already been awarded our second smart thermostat with Mitsubishi that we expect to launch globally. In addition, we won new thermostats and control platforms at one of the largest U.S. HVAC system providers at the beginning of 2023 and are closing another global leader in the HVAC space with our new TIDE platform. In the…

Thank you, Paul. First, I'll review the results for the fourth quarter of 2022 compared to the fourth quarter of 2021. Net sales were $122.8 million, below our expectations and compared to $143.9 million for the fourth quarter of 2021. There's a great deal of uncertainty in the current economic environment, which has led to households spending less on the discretionary goods, and this is affecting our end user markets. In turn, certain customers, primarily in our video services channel, submitted purchase orders that were lower than their previously submitted forecast, impacting our fourth quarter. Customers in the consumer electronics and climate control channels also reduced orders for the first quarter of 2023, which will be reflected in the guidance I'll provide shortly. These decreases in demand resulted in fourth quarter production being lower than forecast, yielding manufacturing inefficiencies as overhead was absorbed at a lower rate and unfavorable labor variances were incurred due to the inability in the short run to flex direct labor. Although gross margin for the fourth quarter of 2022 of $37.7 million or 30.7% of sales increased compared to 28.4% in the fourth quarter of 2021, it was lower than expected. Operating expenses were $29.4 million compared to $30.2 million in the fourth quarter of 2021. SG&A expenses were $21.7 million compared to $22.6 million in the prior year quarter. R&D expenses were $7.7 million compared to $7.6 million in the prior year quarter. Operating income was $8.3 million or 6.8% of sales compared to $10.7 million or 7.5% of sales in the fourth quarter of 2021. Our fourth quarter 2022 effective tax rate was 27.3% compared to 16.1% for the fourth quarter of 2021. For the fourth quarter of 2022, net income was $5.6 million or $0.44 per diluted share compared to $9 million…

Thank you, Bryan. Progress is not a straight path. Strong companies have the opportunity to become stronger during times of uncertainty. UEI has repeatedly proven this outage. We expect to do that again. Our business has been beset with many challenges across the last few years, as many have. COVID-19 and its after effects, supply chain issues, semiconductor shortages to name just a few. Industry shifts have caused many of our customers' demand to lessen. Recently, the continued impact of economic difficulties such as higher interest rates and inflation have affected consumer spending patterns. During this difficult period, the team at UEI has innovated like never before, begun a significant transition into the connected home market and increased our share in all the markets we serve. Over the past 18 months, we have won significant projects and have many more opportunities in the pipeline. While the near-term results are not at all what we would like them to be, we are taking action to improve them and very importantly, create an even better future for UEI. Our track record supports our ability to navigate different pressures, emerge stronger and drive shareholder value in the long term. Based on our product development pipeline, design win backlog, our intellectual property and our traction in new markets and customer engagements, this is truly a new beginning. As always, stay tuned. Operator, we can now open up the call for questions.

Thank you. [Operator Instructions] And the first question comes from the line of Greg Burns with Sidoti.

Can we just dig into the guidance, I guess the revenue miss for this quarter and the guidance for the first quarter, just maybe some specific color on what's driving the magnitude of the decline? Is it primarily coming from the traditional kind of SVOD channels? Or is it more consumer-centric channels in the automated home. Could you just help us understand what's driving the magnitude to the decline? Because if we look back to like the heart of the pandemic, revenue was far higher here. So what's far higher than what you're guiding for the first quarter. So can you just kind of let us know what's changed? Or what's so dramatically different about this environment that's driving the decline?

Sure. Yes, there's varied effects. And we obviously, we don't sell a lot of our products directly to consumers, Greg, as you know, but the customers that we sell to do because our products typically end up in homes, which obviously the decision makers in those homes are consumers. So we rely upon the consumer markets. And as you've probably seen from many companies, and we would say the same because our customers are selling often directly or through the retail channel to consumers. So TV business, as an example, during the pandemic, they probably did okay because people were at home. In fact, it was probably a flight to quality where they were buying better TVs during that period. I think just the long-term effect of the inflation, higher interest rates has made middle-class consumers a little less reluctant or a little more reluctant, less likely to go out and buy items. And you've probably seen this as we have from other products in the consumer market category. There are exceptions to that, but I think widely consumers just aren't parting with their dollars as easily. And in many cases, it might just simply be because a middle-income family when more of your paycheck is going to higher cost of food, higher cost of gasoline, higher cost of utilities, et cetera, there's less left over to spend. So our customers are telling us that they're seeing fewer orders and expect to see lightness of orders for a time here. So we saw that in Q4. In fact, during the quarter, we had some customers who had forecasted orders that then did not fulfill them because they saw lightness inventory build, et cetera. And of course, other parts of our business have just seen difficult demand patterns. So it's been across the board. I would say that home automation security is a little easier only because, again, new projects, our market share there is lower, much lower. As you know, in the video service provider channel, our market share is quite high. So there, when the market's down, we're down because we can't offset it with share gain. We've already got a relatively high share. In markets like HVAC, our market share is respectable, but still relatively low, and we have great offerings there. So we can offset weakness with growth. The problem for the last few years has been that, that market was much smaller, and our home entertainment business was so large that any shrink in it was hard to offset with growth from that smaller business. As we highlighted during the prepared comments, that smart home part of our business is now 25%. So we think it's getting to a level of scale. We win a few more SKUs there and deliver them. It can begin to deliver some growth for UEI despite any home entertainment difficulties.

Okay. What percent, I guess, the 10% customers, can you just give us that number?

Yes, Nike [ph] was our largest customer at 15.5% and Comcast was our second largest at 11.2% for the fourth quarter.

Okay. So I guess with Comcast, obviously, that's indicative, I guess, of the decline there, what you were talking about. But just so I understand like TV sales, like a consumer electronics product sales declining, but this feels like there's more to it in your traditional channels than just consumer discretionary spending being lower. Like is there more of like this is like the impacts of like cord cutting or more secular issues beyond that.

Well, yes, that would certainly be part of it. I mean the demand from those customers has been lower for sure.

Okay. And then with the manufacturing footprint, how much of a benefit to margins will that be? Because I know you're excluding some of these expenses in your adjusted numbers. So does that just go away at some point in time? Like how should we think about the benefit of this footprint rationalization? Because you already are excluding some expenses from your adjusted numbers. So what's the impact going to be?

Yes, that's correct. I mean when we transitioned our Mexico facility from a refurbishment plant to a full-fledged manufacturing facility, it increased our capacity. So what I did was I said, okay, if I were to design it today, we have excess capacity. So what would it look like? What's happening now is with us trying to derisk our concentration risk in China, and we're spinning up Vietnam, we're going to have even more capacity than needed. So right now, with the shortfall in demand, we just have too much capacity. And so there's you kind of looking at 2 layers. One, you're right, I do pro forma a piece of it. But the amount that the potential savings is actually greater than that. So eventually, when we restructure everything and we're currently analyzing at all, the savings are going to exceed what's currently being included in the pro forma. So there's more savings to be had is probably a simple way to say it.

Our next question comes from Jeff Van Sinderen with B. Riley.

Just wanted to touch on supply chain for a minute. I didn't hear you speak much about that. Wondering what you're seeing there. I know that's been sort of a thematic thing until now. I think there's been some pressure there. Just wondering if that's improving? Where are we as far as getting to normalization on supply chain, maybe touch on the gross margin outlook as far as you can see around that? Or is it maybe not as relevant now that we're looking at sort of different issues around the factory capacity utilization and so forth.

Yes. As far as supply chain, Jeff, this is Paul. The situation has improved. We have vendors now that are back to a more normalized pattern where in semiconductors, specifically, typically lead times there are somewhere between 6 to 8 weeks in a normalized environment. And they have more ready supply, meaning if your forecast is off, you can usually get the parts so long as you're not doubling or tripling. You can usually get extra parts in real time in a normalized situation. For a while there, lead times were up with some vendors to 80 weeks. And if you didn't order it, you weren't getting it. So if you had any flex and you needed another 10% of parts, you are going to have to fight for them and you usually wouldn't get them. We're getting back to more of that. We have vendors now back to the 6- to 8-week lead time with ready supply. We do have other vendors, unfortunately, on some projects that we've jointly chosen with customers who are still at 40 weeks. And it's getting better, and I do think that they'll return, they've shown us plans for capacity expansion on their part. But unfortunately, I think this problem is starting to also improve because not just with us but across industry, I think you're starting to see demand come down. We thought that this problem would solve through capacity expansion, which would take longer. And probably part of the solution, making it come faster is that demand has dropped, not for us, although that has happened, but for the entire electronics industry. So the good news in that is that it probably makes the semiconductor shortage go away faster. And we're seeing that. We're starting to see that problem dissipate. It's not back to normal, but it's getting much closer to that. And probably, I would guess, will be this year back to normal, where vendors have ready supply. They have a 6-week 8, 7-, 8-week lead time, and we're back to a more normalized situation. Not there yet, but we're getting very close to it.

Okay. So fair to say that, at this point, it's getting better. It's not preventing you from shipping product? Or is it preventing you from shipping product? And if so, how much?

It is -- it's less than the 4. I don't know the exact figure. It's millions, but it's not tens of millions at this point. We have some product that there's been demand for that we've had a difficult time getting the parts, but it's getting easier to get them. So I think that number will continue to reduce.

Okay. And then if we can maybe turn back to the manufacturing situation. I realize there's a process there. Maybe you can just delve a little bit more into the plans to handle that going forward, the time frame around it? I know you mentioned '23 and '24. At what point do you think we can begin to see or achieve efficiencies?

Well, it's going to be a process. I mean, currently, we're evaluating everything. And the first thing we have to do is we have to get Vietnam up and running. And that's scheduled for the second quarter. So that's the first thing we have to do. And then in the short run, you typically have start-up issues, it takes a little while to get that running efficiently. Once that occurs, what we expect to do is in the fourth quarter, latter part of 2023 is to basically shut down a factory and then take the goods that are produced at that factory and put them into Vietnam and into maybe some of the other remaining factories. Subsequent to that, going into 2024, we then have to continue to evaluate and figure out can we reduce it? Can we streamline another factory? Or can we potentially shut one down and go from what will at one point be 4 factories down to potentially 2 or 2 and 1 smaller one. So we're currently evaluating everything, but I think it's going to be a process. So you see the efficiencies over time, but it's something that we're addressing right now because as I mentioned in the prepared remarks, what's hurting us and what hurt us in Q4 and once again, to continue to hurt us in Q1 is the fact that the volume is down, we have too much capacity. And I'm not pro forming all of it. I pro forma a little bit, but the effect of it is greater than that. And that is what's falling to the bottom line. That's why our margins were lower in Q4 than expected, and the same is true for Q1.

And when do you think, I mean, just based on what you're looking at now, I realize this is a process, as you said. But when do you think we can start to see overall margins begin to improve?

Well, there's a lot of variables that go into the gross margin. So the manufacturing right now is the biggest piece. It's the thing that we need to address the most. But then it's hard for me to predict Q2, Q3, Q4, what the margin rate will be because there's just other factors like FX and commodity pricing. And we're talking about chips and as more capacity comes on, the prices will probably come down, things of that nature, mix, royalties, et cetera, just a list a mile long that play a role in the gross margin rate. So I think we're going to start to see improvement from a manufacturing perspective by the end of the year because we're going to do it, I just articulated. But trying to figure out Q2's margin rates through the rest of the year are difficult just because of these other factors.

Okay. All right, fair enough. And best of luck, I'll jump back in the queue.

Our next question comes from the line of Steven Frankel with Rosenblatt.

Can we start with kind of sizing of home control business in 2021. So did it grow when the rest of the business shrank or did it just shrink less in '22?

No, it grew -- it's been growing for the last few years, it's grown. Again, it hasn't had the size. Our home entertainment business, it was much larger. It was vast majority of our company. But that business has grown over the last couple of years. Its growth though hasn't yet been able to offset any difficulties we've had due to any number of things, supply chain shortages, COVID-19, slower demand in certain parts of it, now consumer affecting the consumer electronics business, the consumer sentiment. But we think we're getting closer to that that the growth in that business because it's now 25% of our revenue. And again, as I said in the prepared remarks, a lot of our development resource over the last few years has gone to these areas. We are engaging the largest players in the world, some of which we've already won projects with. And as this year progresses, we'll be shipping products to them. I guess the best way to say it is that we see this business like we did the home entertainment a decade or more ago where our market share was still relatively low, we had better solutions. The competitors here did not, then we would go to these customers who are very happy to work with us because we had great solutions for their market, and our market share grew substantially in a growing market. And that's what we see here. So it's taking a little bit of time because some of these projects, they will take 18 months after you've won them to begin shipping, not because it takes us that long to build the product, but sometimes the companion product takes that long to develop and get done. But once it starts, as I said, the good news…

Let me zero in on that last statement. When you say some growth, are you talking about sequential growth? Or do you think you can get to a quarter in 2023 where your revenue is up year-over-year?

Well, right now, what I said in the remarks is that I think Q1 was a low point. Q2 will be greater than Q1. And then both Q3 and Q4, both will be greater than Q2 is my expectation.

Okay. And Bryan, just to try to understand how you got to the bottom line number for guidance. Give us a feel for what the OpEx quarterly run rate going to be…

The OpEx run rate is, I would say it's a normalized run rate. What's affecting Q1 is the gross margin rate. It's basically the manufacturing overhead, the lack of absorption, the volumes at a point where we can, and you understand this where you have a factory, a portion of its fixed costs. If we have the units run through the factory, you're just not absorbing the overhead efficiently, and that's what's going on right now. So if you're looking at Q1, the OpEx is a normalized run rate and the gross margin rate is the difficult position right now.

Okay. And in this new world where the pay TV business is not going to come back to where it was, although you have opportunities to do things like sell green remotes to them, which maybe gives you some growth. Do you need to take OpEx down a level? Or you've been holding it tight for the last couple of years. This is kind of the operating run rate expenses of the business and you can't get any more out of it?

Well, yes, I wouldn't say that depending on what happens next, there's never a time where we would say there's nothing more that can be gotten out of it. Our operating expenses have come down over the last couple of years, not as much due to labor inflation. So what's happened is the headcount has been reduced more than the expense. But in order to retain the talented people, you need to differentiate your products and get all your projects done. As you know, because you've probably seen this in other companies, the labor inflation over the last few years has been unprecedentedly high, right? So you have to use, that's an offset to any headcount reduction you may have. But we watch over this pretty closely in even good times, good times and bad. We want to make sure that we have the right level of people to get the work done in every part of our business, not just let it flex up when we're doing well because when things aren't going as well, you've got to make sure you have the people to produce the differentiated products to help you grow. And so that's what we'll assess. But to your point, maybe if certain parts of our business aren't doing as well, then it might mean that there are resources there that aren't as necessary. So that's true in any point.

Our next question comes from the line of Brian Ruttenbur with Imperial Capital.

A couple of quick questions. Interest expense, what you experienced in the fourth quarter, I think, was around $1 million. Is that a good number to use going forward? Or was there anything onetime in nature?

It's a good number to use in the future. I mean right now, interest rates have been rising, so it could go up a little bit from a rate. But I think on average, that's a good number to use.

Okay. The next question like that is litigation expense. It was about $2 million in the fourth quarter, which was up from previous periods, but maybe you can give us a number going forward, what we should be looking for in terms of litigation.

Yes. That's a difficult one. It goes up and down based on activities during the quarter. Some quarters are obviously going to be greater than others. A difficult one to predict on that.

How about for first quarter since you've given guidance already, what kind of litigation expense do you have factored in there?

I would say similar to Q4.

Okay, great. And then, just there's been a lot of questions already about revenues, but gross margins, I assume, will drop sequentially from fourth quarter to first quarter. Is that a correct assumption?

Yes.

Okay. So it should drop maybe in the ballpark below 25%? Is that the right ballpark?

No, that's too low. You could back into it based off of the OpEx, I'll let you do the math. It won't be below 25% expected.

And then as the quarters get a little bit better if the gross margins recover from first quarter to second quarter, third quarter to fourth quarter, ballpark-ish?

Well, again, it's just difficult to go beyond a quarter because there's too many variables that go into gross margin rates. So the factory, we're going to start to address the factory issue immediately or we have been. We're analyzing everything. But from a shutting down of a factory that's going to occur in the back half of the year now how FX rates play out, how sales mix, including royalties play out, commodity pricing, there's just a lot of variables that go into the gross margin rate. So it's just difficult for me to predict beyond 1 quarter.

Would like to turn the conference back over to Mr. Paul Arling for closing remarks.

Okay. Thank you for joining us today and for your continued support of Universal Electronics. We plan to present at Sidoti's March Small Cap Virtual Conference. I hope to see some of you there. Thanks for participating today. Have a great day.

Ladies and gentlemen, this concludes today's conference call. Thank you for your patience; you may now disconnect. Everyone, have a great day.