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Universal Electronics Inc. (NASDAQ:UEIC)

Q2 2010 Earnings Call

August 05, 04.30 pm ET

Executives

Kirsten Chapman - IR, Lippert/Heilshorn & Associates

Paul Arling - Chairman and CEO

Bryan Hackworth - SVP an CFO

Analysts

John Bright - Avondale Partners

Jonathan Goldberg - Deutsche Bank

Ian Corydon - B. Riley & Company

Steven Frankel - Brigantine Advisors

Andy Hargreaves - Pacific Crest

Jason Ursaner - CJS Securities

Neal Goldman - Goldman Capital Management

Operator

My name is Tasha, and I will be your conference operator today. At this time, I would like to welcome everyone to the Universal Electronics' Second Quarter 2010 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. (Operator Instructions)

Thank you. Ms. Chapman, you maybe begin your conference.

Kirsten Chapman

Good afternoon, everyone. Thank you for joining us for the Universal Electronics' 2010 second quarter conference call. By now, you should have received a copy of the press release. If you have not, please contact Lippert/Heilshorn & Associates at 415-433-3777, and we will forward a copy to you immediately.

This call is being broadcast live over the Internet. A webcast replay will be available at www.uei.com for one year. In addition, a telephone replay of this call will be made available for 48 hours beginning approximately two hours after the conclusion of this call. To listen to the replay in the US, please dial 800-642-1687 and internationally, 706-645-9291, enter access code 89845448.

Also, any additional updated material, non-public information that might be discussed during this call will be provided on the company's website at www.uei.com shortly after the call 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 benefits the company anticipates as a result of its continued new and innovative products and technologies that are accepted by meet the needs of our customers and consumers, the company's ability to successfully anticipate the needs and demands of the consumer with respect to new and more advanced products and technologies, the continued strong relationships with the company’s existing customers; the company’s ability to attract and obtain new customers, particularly in Asia and in Central and South America; the strength of the company’s financial position and the effects that the company may experience due to the current global economic environment.

Management wishes to caution you that these statements are just projections and actual results or events may differ materially. For further detail on risk, management refers you to the press release mentioned at the onset of this call and the documents that company files from time to time with the SEC; including the Annual Report on Forms 10-K for the year ended December 31, 2009, and the periodic reports, the company has filed since that time.

These documents contain and identify various factors that could cause actual results to differ materially from those contained in management’s projections of forward-looking statements.

On the call today are Chief Executive Officer and Chairman, Paul Arling, who will deliver an overview. And Chief Financial Officer, Bryan Hackworth, who will summarize the financials. Then Paul will return to provide a vision of 2010.

It is now my pleasure to turn the call over to Paul Arling. Please go ahead, Paul.

Bryan Hackworth

Thank you, Kirsten and welcome everyone. In the second quarter of 2010, we reported solid revenue of $78.9 million. While year-over-year revenue was relatively flat, we improved gross margins to 34.8%, kept expenses relatively flat while increasing our investment in R&D, thus producing strong than expected earnings per share for $0.34.

In total, operating income improved 38%, since the start of the year, for the year 2010. Within the consumer electronic industry, UEI is positioned to address multiple markets with the solutions and technologies stemming from our core wireless connection expertise.

Our deep knowledge of infrared and radio frequency protocols, including Bluetooth, R4CE and Wi-Fi, enable us to provide the connection control in interaction solutions to a multitude of devices.

Our global database of codes enables us to control virtually every home entertainment device. We also have a strong track record of innovation. In the recent past, we have introduced several key solutions all aimed at simplifying the complex home entertainment experience.

Last year, we announced, Onkyo was the first company to include our QuickSet application and XMP-2 technology and the universal remote shipping with its AV receivers.

Since then DIRECTV became a first television service provider to include QuickSet in its new suite of remote controls and HD set-top boxes. XMP-2 is a two-way protocol designed for interactive applications and services and enables our QuickSet automated remote control setup solution.

Another successful innovation introduced by UEI this year is our SMARTCONTROL product. SMARTCONTROL is our one-for-all retail remote control, which offers consumers an intuitive modeless home theater system control experience at an affordable price.

SMARTCONTROL includes UEI's SIMPLESET, a simple three-step universal device setup that does not require a manual or a computer and can literally be set up in less than a minute. The SMARTCONTROL began shipping in Europe earlier this year and began limited distribution in North America in the second quarter.

UEI has a global customer base, including OEM subscription broadcasters and retailers. We continue to focus on. We continue to focus on deepening and expanding our customer lists both, by adding new customers as well as by expanding current customer relationships.

Key to building our customer base is growing into new markets, particularly those expected to show substantial growth in the coming years. Asia continues its growth within the worldwide Pay-TV services marketplace accounting for slightly more than 50% of all subscribers in 2010 according to the latest market study by INSAT.

In Asia, earlier this year, we started shipping Universal remote controls to ASTRO All Asia Networks, Malaysia's largest subscription broadcaster and the only the HD service provider in the country.

We have also partnered with Airtel, Reliance, Foxtel, PCCW Hong Kong, Indovision and Chungwa among others, and we expect to continue strengthening our presence in fast-growing regions across the globe.

We are also expanding in the Central and South America as the market opportunities in these regions are growing. According to SNL Kagan ,the Latin American Pay TV market subscriber base has grown at roughly 10% annual growth rate over the past two years. And according to market experts, this growth is expected to continue with Pay TV services in Latin America adding over 22.5 million subscribers by 2014.

We have begun to make several market development investments in this region and have recently partnered with Sky Mexico, the largest service provider in that country. These investments and new customer development and innovative technologies are at the heart of UEI success story over the years, and we believe it is the consistent execution of this strategy that will continue the success story moving forward.

With that I'll turn the call over to Bryan Hackworth our CFO to lead us through the financial discussion. Bryan?

Bryan Hackworth

Thanks, Paul. Net sales for the second quarter of 2010 were $78.9 million, compared to $78.3 million in the second quarter of 2009. Business category revenue was $67.3 million, compared to the second quarter 2009 revenue of $68.1 million.

As mentioned previously, beginning 2010, a significant customer returned to more traditional dual source arrangement. We continue to supply 100% of the chipset, but we share in the remote control volume. Despite this, by acquiring new customers both, domestically and internationally, we almost entirely offset the financial effect of this dual source arrangement.

Our consumer category revenue was $11.6 million, an increase of 14% over the second quarter 2009 revenue of $10.2 million reflecting improvements in European retail.

Gross profit for the second quarter was $27.4 million, or 34.8% of sales compared to 32.6% in the second quarter of 2009. The improvement in our gross margin percentage year-over-year is due to the following: sales of higher margin products in both, business and in consumer categories, representing the higher percentage of our total sales and a decrease in environmental fees.

In the second quarter of 2010, we adjusted our accrual for an environmental fee assessment for the period of 2007 through 2009 as the actual assessment was approximately $450,000 less than our estimate.

Total operating expenses were $20.1 million compared to 19.8 million in the second quarter of 2009. Breaking down our operating expenses, R&D expense was $2.5 million compared to $2.1 million reported in the second quarter of 2009, reflecting our continued investment in innovation and future products.

SG&A expenses were $17.6 million compared to $17.8 million in the second quarter of 2009. Operating income was $7.3 million in the second quarter of 2010 compared to $5.7 million in the second quarter of 2009. The effective tax rate was 34.7% in the second quarter of 2010, compared to $36.4 in the second quarter of 2009.

Net income for the second quarter of 2010 was $4.8 million, or $0.34% per diluted share, compared to $3.8 million, or $0.27 per diluted share in the prior year's quarter

Now, turning to our cash flow and balance sheet review. During the three-months period ended June 30, 2010, we generated $8.million in cash flow from operations, and we purchased approximately 297,000 shares, or $6 million, we end the quarter with cash and cash equivalence of $78.8 million, compared to $79.4 million at March 31, 2010.

DSOs were 64 days at June 30, 2010, compared to 67 days at June 30, 2009. Net inventory terms were 4.7 turns at June 30, 2010, consistent with the 4.7 turns at June 30, 2009.

Now for our guidance. The third quarter of 2010, we expect revenue between $79.5 million and $83.5 million, compared to last year's revenue of $83.2 million. We anticipate gross margins for the third quarter of 2010, will be approximately 33% of sales, plus or minus one point, compared to 31.3% of sales in the third quarter of 2009.

We expect operating expenses for the third quarter of 2010 to range from $19.3 million to $19.9 million, compared to operating expenses of $19.4 million in the third quarter of 2009.

GAAP EPS is expected to range from $0.32 to $0.36 per diluted share this compares to $0.30 per diluted share in the third quarter of 2009. For the full year 2010, we now expect revenue between $315 million and $325 million, compared to last year's revenue of $317.6 million.

GAAP EPS is expected to range from $20 to $28 per diluted share, or growth of 14% to 22% over the $5 per diluted share recorded for the full year 2009.

I'd now like to turn the call back to Paul.

Paul Arling

Thanks, Bryan. UEI has continuously responded to the growing demand for home entertainment control solutions and technologies, by providing the intelligent, simple and affordable solutions that meet our customer's and consumer's future needs. We invest in regions that show promising market opportunities and we will continue to invest in innovation to ensure we grow along with the many changing options and features in home entertainment devices and content. Our success over the years has demonstrated our ability to do just that, stay tuned.

I will now open the call up for question-and-answer. Operator?

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of John Bright with Avondale Partners.

John Bright - Avondale Partners

Paul, in the quarter, I think you called out Asia specifically, and you named a number of different carriers. Is it to the point where it's a meaningful percentage of revenues yet?

Paul Arling

Not at the overall total of revenues, no.

John Bright - Avondale Partners

Is it something, where you think it might become a more meaningful or a meaningful piece in the near future?

Paul Arling

Yes, in the coming years the market projection show that there is a significant amount of growth in that region of the world. We don’t break out beyond the business category, so we also have Europe, all of the Americas, the Middle East and Asia Pacific, all rolled in to the business category. So, we don’t break that out by region. But that part of the world is projected at a higher growth rate than probably anywhere else on earth.

Our expectation is that it will, and we have already lined up a number of what we believe to be leading companies in the countries that we serve. Some of the innovators, we believe the large subscription broadcasters in that region of tomorrow are probably in existence today with a low number of subscribers, and we feel building those relationships today leads to a great relationship over the next five to 10 to maybe 20 years, much as we have done with the subscription broadcasters here in the United States. So, we are pretty happy with our progress there to-date, but it is not anywhere near the size of the US market yet.

John Bright - Avondale Partners

On the consumer side of your business, you talked about SMARTCONTROL, you talked about SIMPLESET remote. You said you shipped, I think, into Europe earlier this year, and some initial shipments into US. Do you have any visibility into maybe sell through in the European channel? And what are your expectations for the US channel for the remainder of the year?

Paul Arling

Our expectations for the remainder of the year are embedded in the guidance we have given. The sell through of the product in Europe has been very good. The retailers have embraced the product and have the sell through. So, the product is doing well.

John Bright - Avondale Partners

Two final questions. One, Bryan on the gross margin, you said the second reason for the better than expected gross margin other than product mix was a decrease in environmental fee. How much was that again?

Bryan Hackworth

It is about 450,000.

John Bright - Avondale Partners

And then secondly, it looks like you've narrowed or changed your top end guidance in revenues for the year. what's been baked into that change?

Bryan Hackworth

We give provided guidance at the beginning of the year we're about 11/12 months out. We had a solid Q1. We had an excellent Q2 and we are looking at Q3 to be good for us to hit the top end of the original guidance we provided. Q3 and Q4 would have to be great.

And right now we are looking at Q3 and Q4 being very good, but I can't say that it would great. So I lowered the top end of the yearly guidance. But we're still within the range and we are still looking at diluted EPS, we are still looking at 14% to 22% growth in the bottom-line.

Operator

Your next question comes from the line of Jonathan Goldberg with Deutsche Bank.

Jonathan Goldberg - Deutsche Bank

I guess, my question is more broad. Where is the growth? I mean, it just seems like you haven't really grown. Last quarter, your guidance now is essentially, even at the high end, we'd be looking at 3% annual growth for the whole year off of what was a pretty depressed 2009. I would have thought you could have better progress this year. Because we know Asia is still too small, what's going on in the US? Is it demand is not there? Is it the unit side of revenue that's not growing, or is it the pricing?

Bryan Hackworth

Yes, this is Bryan, Jon. The one thing you have to take into consideration is what we reiterated on this call is that from 2009 to 2010, we had a significant customer who went back to a dual-sourcing arrangements. So when I did that, we said that, I believe a couple of calls we know that is going to affect us in 2010 by about $25 million in sale.

So the fact that we actually have done, have kept a pace with the prior year tells that we actually made up that $25 million in other areas. So we have actually grown both domestically and internationally. So we have gained customers and again, both domestically and internationally which have made up for the $25 million shortfall from the prior year.

Jonathan Goldberg - Deutsche Bank

Then, in terms of overall demand trend, are we seeing anything change with US consumers, setting aside the customer specific issues are there, are people still buying, upgrading the new services to HD and whatnot, DVRs, at the same pace they were a year ago or two years ago? How is that overall US demand picture trending?

Paul Arling

Yes, Jonathan, this is Paul. I think that, generally it's been okay. Again, the view point we would had six months ago was to incorporate what could be anything from fair outcomes to great outcomes. And at this point, we're seeing good, so good is good, it's not great. I think the demand is fair to good, and is it what it was last year? I mean, there were periods last year, at the beginning of the year where it was terrible.

Subscription broadcasting wasn’t so bad. The consumer side was as bad as we have ever seen it. That picked up as the year went on. It has continued somewhat into this year. On the subscription broadcasting side, the order patterns are good, not great, but good. So we feel that at this point the outcomes for remainder of the year are simply good. And the guidance that Bryan provided pretty much encompasses that, that the orders are good, not great.

Jonathan Goldberg - Deutsche Bank

And then in terms of overall trends we see for, I mean, typically, we see falling TV prices have encouraged consumers to upgrade, which has led to more box sales and more remote sales. Is that correlation still there? Are we still seeing, because TV prices continue to come down. Is the correlation still there with the upgrade? I mean, what kinds of things are you hearing from your customers on this front?

Paul Arling

As far as the TV prices, that if you were to draw a graph and take the line and continued it on its path, it would have cross to zero at some point. So of course, pricing is going to have level off at a point.

The question is, is it leveled off at a point that it's still considered a relative value for consumers. And I think it's probably at that level where it is been driven down to the point where it is affordable for the widest portion of the US Population. Although that's always a matter of opinion, I think these prices are down to the point where they are price for mass penetration already.

So do they need to continue to go down, I am not so sure, whether they will or not it's difficult to predict. I can give you my prediction. And if you ask for, you could get 100 different predictions on where that's going from here. As far as where the market is today, again, as I said earlier, it's good, it's not great. I don’t see huge demand pick up. I think there is still a lot of question about the economy, and there are still a lot of people out there consumers that are wondering about the future.

So, I don’t think the buying patterns have returned anywhere near to where they were three years ago. And I think that most companies will probably be saying that at this point. They just haven’t. The subscription broadcasting world has done okay, through this downturn and continue to. But I am not seeing that the economy is at a turnaround. We're rather seeing it that it's fair to good, right now.

That's pretty much what we are hearing. That it's good in most cases, fair in others. But we are not hearing anybody knocking the cover off the ball that consumers are ready to pull out their money like they were back in the good old days of 2006 and 2007, it just not there.

Operator

Your next question comes from the line of Ian Corydon with B. Riley & Company.

Ian Corydon - B. Riley & Company

The mix that helped gross margin, was that materially driven by SMARTCONTROL and/or QuickSet?

Bryan Hackworth

Actually, I think, I would say the biggest driver of the gross margin improvement ties back to what I was speaking of earlier, in 2009 when we had a significant customer that purchased the majority, nearly 100% of the remotes from us. When you purchased that many remotes, you should get better pricing. To the fact that we actually were able to replace that $25 million shortfall with new customers that are purchasing lower volumes each, the price per unit is higher than the aforementioned, so it ends up putting upward pressure on our gross margins.

Ian Corydon - B. Riley & Company

And have you made any progress with QUICKSET with any other MSOs? Or what's the outlook for uptake, do you think, the rest of this year and next year?

Paul Arling

We think there will be additional implementers of this type of two-way technology. In fact, we're working with one that’s unannounced. We think that the concept will get embraced simply because it’s again a great affordable way to eliminate one of the pain points in these products and one of the pain points in the install for the subscription broadcaster.

We think that it will more broadly deployed, it will take some time because there are design instances and as we talked about before when set-top box comes to its lifecycle and they are ready to do new one, that’s the best point at which to design things like this in. So these things do take time, but we’re confident that this type of technology not necessarily just QuickSet or XMP-2, but this type of technology supported by us is something that will be implemented by more than just a few.

Ian Corydon - B. Riley & Company

And that unannounced MSO you mentioned, is that a signed contract, or is that still in development? Is that a major domestic MSO?

Paul Arling

It's already being implemented.

Ian Corydon - B. Riley & Company

And it's a major domestic MSO?

Paul Arling

Yes, I prefer not to describe who it is, but yes, there are other subscription broadcasters that are deploying two-way products supported by UEI.

Operator

Your next question comes from the line of Steven Frankel.

Steven Frankel - Brigantine Advisors

Total product in the US, you mentioned you got some volume in Q2. Would that be fully ramped for the Holidays?

Paul Arling

Yes. We just started shipping in Q2.

Steven Frankel - Brigantine Advisors

What's the price point for SMARTCONTROL?

Bryan Hackworth

$50 or some $50, depending on the margins taken by the layers of distribution.

Steven Frankel - Brigantine Advisors

What was the customer concentration in the quarter?

Bryan Hackworth

We had two significant customers who we sold more than 10% of our sales.

Steven Frankel - Brigantine Advisors

Paul, how do you think you are doing in the IPTV market? Is that the same difficulty in winning new customers? Is there anything about it that makes it more or less difficult than what you’ve done in the traditional satellite and cable side?

Paul Arling

I think it's the same. It's just a matter of design cycle and getting in when a customer is ready to make a change. Usually that’s when there is a juncture in the set-top box, or there's new implementation of new technology or new box. I will say that on the IPTV side here in the US, we are supplying that market. Today it's currently chips, but not full remotes, so we do supply that market, but not remotes, yet.

Steven Frankel - Brigantine Advisors

If you look at the acquisition you made, how have you done in terms of customer wins and cross-selling versus the expectations you had when you bought that business?

Paul Arling

I think we are right on plan with it. I think that it was a good deal for us and that it gave us a number of things both, the database and consolidating our database with their database. Also the workforce in India has been very, very valuable to us.

And I think as time goes on, it will be more difficult to know, because we have done a good job of merging the companies their data bases are now being blended into one. We are designing on the new silicon now, so it is difficult to separate any more what was once dialogue, and what is now UEI, because we are now one. We have merged the companies

I think as I have said earlier, this was a deal where we knew that business quiet well, because obviously we were in it, and what that led to, is the ability to more completely merge the entities, we have some of our lead engineers now here in the US and in Cypress in particular are from there interspersed some of their great talent with ours, brought in there data base and merged it with ours

So, it's kind of a complete merger at this point. It's gone very smoothly, we haven’t had any undue surprise, a few bumps, but not being major and it's gone pretty smoothly.

Operator

(Operators Instructions) your next question comes from the line of Andy Hargreaves with Pacific Crest.

Andy Hargreaves - Pacific Crest

All the good versus great commentary, is that specific to US service provider, or is that just broad commentary?

Paul Arling

It was a broad commentary.

Andy Hargreaves - Pacific Crest

Can you get more specific? Are there any segments of the business that are seeing more good and less great than others?

Bryan Hackworth

No, I'd say it's really across the board. When we did our guidance, we expected that to be in that the $1.20 to $1.35 range originally, and now we brought down to $1.22 to $1.28 like I said previously to hit the high end of that range, we have to hit the high end of each quarter, and we did really well in Q1, we did excellent in Q2 and in Q3 and Q4 we are still expecting performance well.

When you look at the bottom line, grow with the 40% to 22%, I think that's an excellent year or, so again first hit the high end if we really had to hit high end in Q3 and Q4. Right now, I see them a little lower than that.

Andy Hargreaves - Pacific Crest

Just staying on it really quick, within the service provider market, is some the maybe slower than outstanding outlook just, because penetration of HD and DVR have gotten higher, or do you think you are seeing any impact at all from cutting the cord or downgrading or anything like that?

Paul Arling

It could be partially that. The other part is that it's always difficult to predict. Even for us sitting here right now, promotion also enters into it when subscription broadcasters do local promotion or even more national promotions depending on who the operator is. That can also move volume and with the absence of those not move volume.

You have to factor all these things in when you make your predictions about what going to happen and will the level of promotional activity and effectiveness of that promotional activity be the same as it has been in the past, it's difficult for us to know the answer to that question.

So, again when we sit down at the beginning of the year, we try to do it for the whole year. When we sit down here in early August, we do it for the remainder of the year. We probably get a clearer view now and what we see right now is that it's good, but not towards the high end of what we would have expected in February or what could have happened.

In order to give you some guidance at that early stage in the year, we have to incorporate into it what can go really, really well and what might now. At this point, the really, really good, we don't see.

Now again, we don’t know, whenever we guidance, we have fairly clearly view of Q3. The further out you go, our most difficult prediction of the year as you know is, February. When we provide that annual look, literally have 100s of factors that enter into it. Now at this point, we think we've got a good handle on, we’ll do the remainder of the year.

Andy Hargreaves - Pacific Crest

Then on Asia, can you just kind of square up the fact that more than of or whatever it is, more than half of the paying TV subs over come, and you’ve got quite a few customers now versus not having enough revenue for it to be meaningful?

Paul Arling

When we say meaningful, it's not as large as the US, if that’s what meaningful means, it's got ways to go, but it is a good piece of revenue. It is growing for us, but the market is very different than here.

I think it will take time to develop just like here in the US. The subscribers come on, they usually start at a low ARPU, and then they build from there, because subscription broadcaster will like start by signing a subscriber up and then do sell-ups for things like HD or DVR or other services. Here it’s not even simpler than that. So it’s got ways to go.

But as I said many times, this is the region of the world where the population is changing, there is developing middle class, we think that the subscription broadcasting market there, certainly in subscribers and one day in dollars and this maybe many years from now but can be as larger, larger than United States. And we have begun our progress there over the last couple of years. We’ve won a numbers of major subscribers.

We believe, many of which will be the leaders of tomorrow in the subscription broadcasting world in that region, and that’s how we started here, signing up the smaller cable companies many years ago that became very large, cable and satellite companies of today, so we think it's important to get in there. We’ve made limited investment and we think we are pretty prudent about how we do it.

We start with a sales and application engineering team and then build from there, and that’s what we have done. We have done it in the other areas of world successfully and we are doing it there now successfully and we are now starting to make some initial investments in Central and South America as well.

Andy Hargreaves - Pacific Crest Securities

At this point are you seeing pretty similar gross profits per unit in those markets?

Paul Arling

Similar. Sometimes lower, sometimes high, depends on which type of product they wish to buy. I mean, the better featured for a higher ARPU customer would be a better featured product, might carry a little bit higher price point, potentially a higher margin. Sometimes on a simpler product, it's a little bit lower margin. It all depends on what the market dictates.

Andy Hargreaves - Pacific Crest Securities

On the gross margin guidance for Q3, it's a little lower than Q2, just even after backing out the environmental fee assessment thing. Can you just comment on the rationale for that?

Paul Arling

I don’t think it’s much lower. I think we said 33% plus or minus point, so we get to 34% providing, so there are so many factors that play into gross margin, Andy, that if you are talking about two-tenths of a point, and if that could, anything can sway that, so we usually round 33 plus or minus we are coming at.

Operator

Your next question comes from the line of Jason Ursaner with CJS Securities.

Jason Ursaner - CJS Securities

Just to try and follow-up on some of the points you've spoke on. The dual-source arrangement, it was my understanding that was more first half-weighted.

Bryan Hackworth

It was more first half-weighted. And talking about 2009, it would weighed towards the end of 2009 a bit. But it was the first half-weighted, but we still had a significant amount in the back half, as well.

Jason Ursaner - CJS Securities

Right. But so you're characterizing the revenue performance as consistent. But the underlying trend, it actually seems more like a transition period, where you have done a very good job of replacing the lost revenue with some of these other growth initiatives. So, can you comment at all why those wouldn't be accelerating growth in the back half as this problem goes away?

Paul Arling

It probably won't go away this year. Q3 was affected by the dual source. We had it through Qs 1, 2 and 3, maybe come on more full force in Q4. But we are, like you said, we are making up that Delta. So the consistent comment is more having to do with consistent with expectation, because we laid out expectation at the beginning of the quarter and we are consistent in our execution against that expectation.

Jason Ursaner - CJS Securities

And then the air freight issue that you spoke about last quarter. You said that it was expected until mid-May. Did it actually go until then, or did it end earlier with the factory extension?

Paul Arling

Now I believe that it went about 12 May, give or take a couple weeks.

Jason Ursaner - CJS Securities

So in terms of the gross margin, I understand you kind of quantified some of these higher products and the environmental issue. But with less air freight for half a quarter, I am a little confused as to why it would decrease sequentially?

Bryan Hackworth

Yes, again, we did a gross margin rates, there are many factors that play into it. FX plays into it. You've got mix between business consumer, you've got mix within the categories. There are literally I could rattle off many items that roll into it. Right now, if you look at Q3 of last year, we were at 31.3% of gross margin. This year we are looking at 33% plus or minus one point. So I think it's a solid gross margin and we've actually done a good job in actually bumping it up. But to sit there and try and explain $0.02, $0.03 of a point, that could change on [around].

Jason Ursaner - CJS Securities

Typically the new products, would they have higher gross margin? When you're implementing some of these two way technologies and some of the other new things?

Paul Arling

Yes, not speaking about any specific product, but often a consumer product particularly a new one that is differentiated will carry a slightly higher margin than the average. Sure.

Jason Ursaner - CJS Securities

And the SG&A was up $1 million sequentially. Was there any one time in that, or is that kind of the better run-rate?

Bryan Hackworth

No, actually for the full year I expected to be a very similar to last year's total combined operating expenses. But if you are looking at Q3 one item we had that typically isn't an issue here. UEI is we actually had bad debt expense of about $550,000 which again it's very uncommon for us, so we did have it in Q2.

Jason Ursaner - CJS Securities

And that would be in SG&A?

Bryan Hackworth

That's within SG&A.

Operator

Your next question comes from the line of Neal Goldman with Goldman Capital Management.

Neal Goldman - Goldman Capital Management

Stock-based comp in the quarter and your estimate for the year, and then what was it last year?

Bryan Hackworth

Year-to-date for the six month is about $2.5 million, so we expect probably around $5 million for the full year, or $1.25 million for the quarter.

Neal Goldman - Goldman Capital Management

So are you saying it's just like $3 million AP in terms of what it would be in earnings?

Paul Arling

[It's all intact].

Bryan Hackworth

Yes, it's sounds right.

Neal Goldman - Goldman Capital Management

So, it's $0.21 in stock-based comp?

Bryan Hackworth

Yes, it's sounds all right.

Neal Goldman - Goldman Capital Management

Okay. What was it a year ago?

Bryan Hackworth

It's a little lower. It was probably about $3.5 million to $4 million.

Neal Goldman - Goldman Capital Management

Okay. So from a true cash basis, we're earning at $1.40 to $1.48, $1.50 type of number; right? We are sitting with $5.60 plus in cash per share; right? No debt. And we're earning virtually, you earned $17,000 in interest income last quarter, given the rates.

You've done a nice job in buying back. But why wouldn't we be very aggressive in a buyback, with your stock selling, if it's $11 actually in cash, and it's $1.40 pro forma for the stock-based comp, we're selling at a ridiculous multiple relative to the historic growth rates and the potential here.

Paul Arling

We very well might, Neal, that’s obviously under constant consideration by us. So, it is something that’s being considered.

Neal Goldman – Goldman Capital Management

I assume you’ve done pretty what you can in terms of the acquisitions in the remote area with the last one. So the majority of the business is you and Sony and Philips, right? Are there strategic other areas that would fit into your outlook in terms of acquisition possibilities?

Paul Arling

Yes, but there are other potential projects we could have in that arena too. So that has to weigh in against the use of cash for stock buyback or other uses. But we do weigh them all in against each other. Every use so that we can for that cash balance.

As we have to find, obviously that’s the most efficient way to return to the shareholders, what whether we invest in operating capital, which by the way here if you look at that over the last 10 years on a trailing basis we’ve been a pretty good shepherd of capital on the operating side.

The one challenges that the earnings on the financial capital we hold, or that cash balance is quite low and it's gotten lower. Quite frankly, it's always been an issue because our returns even if they are at 3% or 4% our returns on capital, that use say a measurement like EBITDA less tax or NOPAT type of measurement versus the operating capital we employ, we are in the neighborhood of 20% return on capital.

So, we are good users of the operating capital and we are getting terrible returns on the financial capital. So we have to find a way to transition from the 0.7% or 1% or 2%, whatever the prevailing interest rate is in any given period. Find a way to boost that return and the best way to do it would be to give it to the team that is earning 20% on the capital. We just have to find the appropriate way though.

Neal Goldman – Goldman Capital Management

Okay, very good. Nice job. Thank you.

Paul Arling

Investment for M&A, those are the things we look at.

Operator

(Operator Instructions) Your next question comes from the line of Jonathan Goldberg with Deutsche Bank.

Jonathan Goldberg - Deutsche Bank

Sorry. I meant to take myself out of the queue. Asked and answered. Thanks.

Operator

(Operator Instructions) There are no questions at this time. I would like to turn the call back to management for closing remarks.

Paul Arling

Okay. I want to thank everybody for joining us today. Just to let everybody know, this fall, between now and our next call, we'll be attending several upcoming trade shows. So if you're traveling internationally, you may find us at EFA, which is held in Berlin, the EFA Trade fair, in September, early September, right after that is the 2010, IBC Exhibition in Amsterdam, a major show there. In October, we’ll be at CTEK in Japan and SCTE Cable-Tec Expo in New Orleans here in the United States. So, if anybody is available to be at those and wishes to meet up, lets us know. Otherwise, thanks for being on the call, today and good bye.

Operator: Thank you. This concludes today’s conference call. You may now disconnect your line.

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Source: Universal Electronics Inc. Q2 2010 Earnings Call Transcript
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