Universal Electronics' (UEIC) CEO Paul Arling on Q2 2014 Results - Earnings Call Transcript

Aug. 9.14 | About: Universal Electronics (UEIC)

Universal Electronics Inc. (NASDAQ:UEIC)

Q2 2014 Earnings Conference Call

August 7, 2014 4:30 pm ET

Executives

Becky Herrick - IR

Paul D. Arling - Chairman and CEO

Bryan M. Hackworth - SVP and CFO

Analysts

Michael J. Olson - Piper Jaffray

John Bright - Avondale Partners

Jason Ursaner - CJS Securities

Steve Frankel - Dougherty & Co.

Josh Goldberg - G2 Investment Partners

Operator

Good day, ladies and gentlemen, and welcome to the Universal Electronics' Second Quarter 2014 Results Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. (Operator Instructions) As a reminder, today's conference is being recorded.

I would now like to turn the call over to Ms. Becky Herrick of LHA. Ma'am, you may begin.

Becky Herrick

Thank you. Thank you all for joining us. By now, you should have received a copy of the press release. If you have not, please contact LHA at 415-433-3777. This call is being broadcast live over the Internet. A webcast replay will be available for one year at www.uei.com. Also, any non-public information that might be discussed during this call will be provided on the Company’s Web-site 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 benefits anticipated by the Company due to the continued strength across its entire business and the expansion of its share of the markets it serves, including its core business in consumer categories and the smart device channel such as smartphones, tablets, smart TVs, IPTV devices, game consoles, smart watches and over-the-top services; the benefits anticipated by management due to the expanded licensing of the Company's IP such as the Company's QuickSet and Control Plus technologies; the successes anticipated by management from the growth expected in consumer electronics, particularly in the wearable segment; the continued innovation of next-generation solutions that are accepted by our customers and end users; management's continued ability to identify and execute on opportunities that maximize shareholder value including the effects that repurchasing the Company's shares have on the Company's stock value; the continued sales and earnings growth as experienced in the past; the continued strengthening of its customer relationships; management's ability to identify and execute upon growing trends in the market; and the other factors described in the Company’s filings with the U.S. Securities and Exchange Commission.

The actual results the Company achieves may differ materially from any forward-looking statements due to such risks and uncertainties. Management wishes to caution you that these statements are just projections and actual results or events may differ materially and the Company undertakes no obligation to revise or update these statements to reflect events or circumstances that may arise after today’s date.

For further detail on risk, management refers you to the press release mentioned at the onset of this call and the documents the Company files from time-to-time with the SEC, including the Annual Report on Form 10-K for the year ended December 31, 2013 and the periodic and quarterly reports filed since then. These documents contain and identify various factors that could cause actual results to differ materially from those contained in management’s projections or forward-looking statements.

Also, the Company references adjusted pro forma or non-GAAP metrics in this call. These adjusted pro forma metrics are provided, because management uses them in making financial, operating and planning decisions and in evaluating the Company’s performance. The Company believes these measures will assist investors in assessing the Company’s underlying performance for the periods being reported.

Adjusted pro forma metrics exclude amortization expense relating to intangible assets acquired, depreciation expense relating to the increase in fixed assets from cost to fair market value resulting from acquisitions, other employee-related restructuring costs and stock-based compensation. As a reminder, the results for the prior year periods have been adjusted to reflect the exclusion of stock-based compensation expense.

In management’s financial remarks, it will reference adjusted pro forma metrics. A full description and reconciliation of these adjusted pro forma measures versus GAAP is included in the Company’s press release that was issued after the close of market today.

On the call today are Chairman and Chief Executive Officer, Paul Arling, who will deliver an overview, and Chief Financial Officer, Bryan Hackworth, who will summarize the financials, and then Paul will return to provide closing remarks. It’s now my pleasure to introduce Paul Arling. Please go ahead, Paul.

Paul D. Arling

Thank you, Becky. Our strong performance in 2014 continued in the second quarter as we expanded our share of the global wireless control technology market. Year-to-date, we grew net sales by 10%, gross profit by 14%, operating income by 23% and net income by 31% compared to the first six months of last year. Driving these improvements was the continued growth in our core business as well as our continued advancements in smart device control technology.

Subscription broadcasting remains a strong channel for us as our worldwide customers continue adding new subscribers and introducing new more advanced devices. Consumer electronics companies are rolling out new devices utilizing both our traditional remote controls and advanced technologies and software solutions.

We also continue to expand our licensing footprint within the smart device channel. UEI QuickSet is fast becoming the de facto solution for the world's largest companies such as DIRECTV, Samsung, Sony, LG and Microsoft. The list continues to grow as industry-leading companies choose our embedded software technology to enable a simple and almost effortless setup and programming of the remote to control virtually any television or entertainment device in the home.

UEI's Control Plus technology builds upon QuickSet to further simplify the home entertainment setup and control experience. This technology solution addresses the most common consumer challenges in universal AV control such as mode confusion on the remote control and switching to the right input. With UEI Control Plus technology, consumers can simply plug it into a device, have it discovered and set up automatically, and have activities such as 'Watch TV' automatically enabled from a single universal remote control.

Our smart device implementations continue to ramp. As we have mentioned previously, Samsung chose our IP and control SDK to power its WatchON app for the Galaxy S5 smartphone, as well as our embedded app technology for its Gear 2 and Gear 2 Neo smart-watches. Our technology enables these devices to control and communicate with the connected home.

Over the past two years, we have established relationships with many companies in the mobile category that are rolling out these new devices. These smart devices provide an ideal platform to implement automated setup solutions like QuickSet and everyday ease-of-use solutions like Control Plus. Put simply, we have proactively embraced the challenges in the home entertainment arena and developed innovative solutions that address growing trends in the industry.

New devices, including smartphones, tablets, smart TVs and game consoles, and new connection standards like HDMI-CEC, Ethernet, wireless IP and the myriad forms of RF communication, are offering enormous opportunity for us to accomplish AV control solutions never before possible.

We have used these new smart or connected platforms to bring software solutions that make home entertainment setup in everyday use easier and more intuitive than ever before. Our ability to anticipate these trends has cemented our position as the supplier of choice for the leading names in consumer electronics, subscription broadcasting and mobile devices across the world.

With that, I'd now like to turn the call over to our CFO, Bryan Hackworth, to discuss the financial results.

Bryan M. Hackworth

Thank you, Paul. As a reminder, our results for the second quarter of 2014 as well as the same periods in 2013 will reference adjusted pro forma metrics. Second quarter 2014 net sales were $146.3 million, up 7% compared to $136.1 million for the second quarter of 2013. Business Category net sales increased 7% from $124.2 million in the second quarter of 2013 to $132.7 million in the second quarter of 2014.

We experienced growth in the OEM market as consumer electronics companies continue to adopt our technologies in various forms, including traditional remote controls, chips and pure licensing arrangements. We also continue to increase our market share in subscription broadcasting, both in the Americas as well as Europe.

Our Consumer Category net sales increased 14% from $11.9 million in the second quarter of 2013 to $13.6 million in the second quarter of 2014 as we increased our distribution in the European retail space, primarily in the grocery channel. In addition, our European retail sales benefited from the FIFA World Cup.

Gross profit for the second quarter was $43.8 million, or 29.9% of sales, compared to a gross margin of 28% in the second quarter of 2013. The increase in our gross margin percentage was driven primarily by the increase in our licensing revenue as more customers are adopting our technologies and are including these technologies in additional smart devices, including televisions, game consoles, tablets, phones and wearables.

Total operating expenses were $29.3 million compared to $25.6 million in the second quarter of 2013. Breaking down our operating expenses; R&D expense was $4 million for both the current and year ago periods; SG&A expenses were $25.3 million compared to $21.6 million in the second quarter of 2013. Operating income was $14.5 million, an increase of 15% when compared to $12.5 million in the second quarter of 2013.

The effective tax rate was 24.6% compared to 25.5% in the second quarter of 2013. Second quarter 2014 net income was $10.6 million or $0.66 per diluted share, compared to $8.1 million or $0.53 per diluted share in the second quarter of 2013.

For the six month period ended June 30, 2014, net sales were $276.2 million, an increase of approximately 10% compared to $250.8 million in the same period of 2013. Gross margin for the first six months of 2014 was 29.2% compared to 28.3% in the same period a year ago. Total operating expenses were $57.3 million compared to $52.1 million in 2013.

Operating income was $23.2 million, an increase of approximately 23% compared to $18.9 million in 2013. Our operating income for the first six months of 2014 represents the highest level in our Company's history. Net income for the six month period was $17 million or $1.05 per diluted share, compared to $12.9 million or $0.84 per diluted share in the prior year period.

Next I'll review our cash flow and balance sheet at June 30, 2014. Cash and cash equivalents was $87.6 million at June 30, 2014 compared to $49.7 million in the year prior. During the second quarter, we repurchased approximately 338,000 shares for $13.9 million, representing an average price of approximately $41 per share.

Over the past 20 years, in aggregate we've repurchased approximately 7.3 million shares for $123 million at an average price of approximately $17 per share. Going forward, we will continue to evaluate opportunities to maximize shareholder value, including repurchasing additional shares, reinvestments into the business and M&A.

DSOs were approximately 66 days at June 30, 2014 compared to 59 days the year prior. Net inventory turns were approximately 4.6 turns at June 30, 2014 compared to 3.9 turns the year prior.

Now turning to our guidance; for the third quarter of 2014, we expect revenue between $149 million and $157 million, compared to last year's third quarter revenue of $142.4 million. EPS for the third quarter is expected to range from $0.70 to $0.80 per diluted share, compared to $0.68 recorded for the third quarter of 2013.

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

Paul D. Arling

Thanks, Bryan. In the past 27 years, we have clearly established ourselves as the global leader in home entertainment control technology. Our continued focus on delivering the innovative solutions that enable consumers to connect and control their home entertainment systems has proven successful year after year. Our long-term leadership position in the markets we serve has also been demonstrated through our financial results. We have just reported the most successful first half performance in our Company's history, but this simply continues on our long-term tradition of solid performance.

We have grown our sales and earnings at a compounded annual growth rate of 15% over the last decade and we just recorded our 66th consecutive quarter of profitability. As such, our strategy for growth continues to serve us well, as the applications for our technology and solutions continue to expand. Going forward, we remain focused on investing in innovation to support the simplification and enhancement of the home entertainment experience as well as supporting new trends in devices and content, and deepening existing customer relationships while also adding new ones across the world. Stay tuned.

I'd now like to open it up for questions. Operator?

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from the line of Mike Olson of Piper Jaffray. Your line is now open.

Michael J. Olson - Piper Jaffray

I had a couple of quick ones on the mobile front. Are there any details that you can provide regarding downloads of UEI technology on Samsung's devices like the Galaxy S5 that don't necessarily ship with it preloaded? I think Samsung was included, if I remember right, in kind of the recommended bundle of apps, but just curious if you can talk at all about kind of the download rates there?

Paul D. Arling

Unfortunately, Mike, we can't disclose anything about specific customers who have started long-standing policy. I will tell you however that the level of downloads or the level of unit volume from the relationship are as we expected or slightly better. So the relationship is going very well but we can't give any specifics about individual customers.

Michael J. Olson - Piper Jaffray

Okay, got you. And then maybe more broadly in mobile, can you kind of talk about where we are in the growth of mobile devices with IR emitters built in, or maybe on the other side of the equation, CE devices with Wi-Fi, and is that kind of the biggest limiting factor in growth for the category?

Paul D. Arling

I will handle those separately. The device code database being embedded into mobile devices is very early. We have seen it over the last couple of years. It started with a couple of device manufacturers starting with one model. They have now expanded that to multiple models across their lineup. So it's like any new technology, it starts off with one or two models and then expands from there. So it looks like it's on a good track for long-term growth as far as that's concerned.

As you've heard me say many times, what better app to put on these mobile devices than something that helps the consumer with something they are already doing in America five hours a day, and across the world more than three hours a day. So, I think the device manufacturers see that, want to cater to that need within the consumer, and we think it's something that long-term is going to continue to be there and grow.

The consumer electronics devices also have become more and more connected, either by Ethernet or Wi-Fi or other forms of communication. We have a lot of products we're shipping with multiple forms of RF, either IP protocol combined with other forms of RF for different types of control. We do think that this type of feature is expanding.

We don't just think that, you can see it over the last number of years the number of these devices becoming 'smarter', more connected, and we think the features that we bring to these products, as I said in the prepared remarks, we can start to do things that we just simply couldn't have done five years ago. We had the technology to do it but the architecture of the home did not support it. That architecture is changing. So we see some changes going on over the last couple of years and project it to continue, that will bring the types of QuickSet, Control Plus like features to these products over the next five years.

Operator

Our next question comes from the line of John Bright of Avondale Partners. Your line is now open.

John Bright - Avondale Partners

The gross margins ticked up nicely. I think you mentioned that licensing was contributing to that in the quarter. One quarter doesn't make a trend, but is that something where you see that product mix continuing to be favorable throughout the remaining portion of the year?

Bryan M. Hackworth

This is Bryan, John. We don't give guidance in the future quarters but I will say this, I don't view Q3 as an anomaly. As we talked about before, as each quarter progresses, we seem to layer on top additional licenses, we're gaining customers and some of the customers are starting to expand the licenses into different – and the technologies into different products. So I don't view this as an anomaly at all. I do think it's going to continue.

Paul D. Arling

You know, Q2 is an anomaly.

Bryan M. Hackworth

Q2 is an anomaly, correct.

John Bright - Avondale Partners

Great. The consumer sales were up a little bit better showing some signs of life. Anything particular going on there?

Bryan M. Hackworth

As I said in the prepared remarks, UEI Europe has done a great job. They have expanded distribution in the grocery channels. They are in a number of what we call supermarkets here in the U.S. And I think the other thing that helped them out was the FIFA World Cup. I think the general market was up because of that. So, we benefited.

Operator

Our next question comes from the line of Jason Ursaner of CJS Securities. Your line is now open.

Jason Ursaner - CJS Securities

Great quarter. Just first question relates to the Business Category. For the guidance, how do you see growth there between the subscription operators and sales to the TV OEMs?

Bryan M. Hackworth

We usually don't breakout the guidance, but what we've seen so far is we've got a strong comeback in the OEM market. Couple of years ago took a little bit of a dip and we're seeing that come back nicely. And within that OEM category you're selling traditional remote controls into the TV manufacturers, you were selling chips with our technology embedded on it, and then we're also selling pure licenses to them. So, the OEM market has been very strong for us. But to a lot of people's surprise, the subscription broadcast market we continue to do well also, even in the Americas. But Europe is doing well. We're doing well in Western Europe as well as Eastern Europe in subscription broadcasting. So both categories, both channels are doing well.

Jason Ursaner - CJS Securities

Okay. And the growth in the TV OEM market, is that more from expectations and forecasts for the holiday season, or you're seeing growing build or some of that looking back on pull-through demand from the World Cup, or you're seeing more restocking and actual sales have happened better than expected when you look back to last year?

Paul D. Arling

It's a little of both, Jason, but I think that the bigger point for us is that during many periods our industry have outperformed the market because of the technologies we're embedding. So I guess the bigger impact is that while there is some market growth right now, we went through a couple of difficult years in the consumer electronics market. 2013 was not a good year, nor was 2012 for the industry. But this year we're starting to see some growth in the CE as a market, and more importantly, we're embedding our technology in a wider share of products. So it's more an issue of share gain, also supported a little bit by market growth. So, both are helping.

Jason Ursaner - CJS Securities

Okay. And to follow-up on the embedded mobile piece, specifically licenses revenue for the phones, tablets and game consoles, if you strip out the embedded chipsets for TVs, and I know you can't provide any figures for specific customers, but it is difficult to see the contribution in the sense of the overall reported figures. So any additional details you can give on that business to try to understand sales and margin contribution, just from sort of the new applications, not the sales into the TV market?

Bryan M. Hackworth

We just clarified that I'd love to give more information but we just don't typically provide that kind of detail. I will say though, it is really across the board. I think we were talking about earlier, you're seeing the growth in both TVs, which you want to exclude, but we're seeing it in wearables we're seeing in mobile, we're seeing in game consoles, it's really, you're starting to see the OEM companies really come in and start to incorporate our technologies in various products. So, we are benefiting from that.

Jason Ursaner - CJS Securities

Okay, great. Appreciate those details. Thanks guys.

Operator

Our next question comes from the line of Steve Frankel of Dougherty. Your line is now open.

Steve Frankel - Dougherty & Co.

Paul, could you give us some insight into maybe what the design win pipeline looks like for Control Plus over the next year or so?

Paul D. Arling

Yes, sure, I mean I can't give a lot of details because we don't have – we would never talk about the implementation until the products actually came out, but we're talking to, I don't even know how many at this point, customers about introduction of Control Plus. As you know, mobile is typically on an annual design cycle as are things like televisions. Set-top boxes are a little different because they're not on an annual cycle, they are usually on the company's own cycle.

But mobile and TVs, we're talking to players in both of those markets about continued implementations of QuickSet, because it's important to remember that QuickSet is, we have many point releases of QuickSet, it keeps improving. Again, one day in the not-too-distant future we're going to have a QuickSet version that automatically does the setup, where there's no user intervention at all.

So we're working on next generations of that as well as the supplement of Control Plus for input selection and elimination of mode confusion. These things are being talked about with the major names in the industry, and probably later this year and into the 2015 product introductions, we'll probably have more to say about those technologies.

Steve Frankel - Dougherty & Co.

Okay. And could you characterize how your business was in Latin America during the quarter, what kind of growth did you have on a year on year basis?

Paul D. Arling

We don't provide that detail, Steve, but Latin America continued to do well, primarily in Brazil. So we're very optimistic about that.

Steve Frankel - Dougherty & Co.

And a lot of investors are concerned about Time Warner-Comcast causing a slowdown in your subscription business. So is that portion of the subscription business, maybe you could give us your opinion on whether that matters to you or not?

Paul D. Arling

Certainly it matters. They are both large players in the industry. I will say this, that our relationship with Comcast is quite strong. We've been either a vendor or a primary vendor to Comcast for more than a decade. They are the largest subscription broadcaster in the U.S. I can't speak about the details of the merger, best to ask either Time Warner or Comcast on that, but we believe that while we are of course concerned about it, we feel that this will be good for us. Our relationship with Comcast is right now is really strong and we don't see any reason why this should interrupt our growth going forward.

Steve Frankel - Dougherty & Co.

Great. Thank you so much.

Operator

Our next question comes from the line of Josh Goldberg of G2 Investor Partners. Your line is now open.

Josh Goldberg - G2 Investment Partners

Just a couple of things, I guess starting obviously on the gross margins. Very good results, almost 30% on a pro forma basis. As you gain more and more of these licensing deals, whether it's TVs or smartphones or tablets, are you comfortable kind of saying, we're going to be able to grow above that 30% gross margin going forward? And I have a follow up.

Bryan M. Hackworth

Yes, it's definitely possible. If everything were to stay the same, the exact same mix, and we were to increase licensing revenues, then yes, it can increase above 30%. I think the one thing we do battle with, and we mentioned this last quarter, is as some of our large customers continue to grow and purchase more from us, there's always that battle between the increase in the gross margin rate from licensing but also then you get a little bit of downward pressure by selling lower margin products to large customers, which isn't a bad thing. I mean it ends up improving our operating margin line, which if you look at year-to-date, we've done very well. So it all depends on the mix, but I'm never going to get upset if we grow licensing revenue but our gross margin rate doesn't grow as fast because we're also selling additional standard remotes.

Josh Goldberg - G2 Investment Partners

Got you. And in terms of the share count for Q3, you bought 338,000 shares, so almost 2% of Company this quarter?

Bryan M. Hackworth

Correct.

Josh Goldberg - G2 Investment Partners

So what would be the proper share count for Q3?

Bryan M. Hackworth

We don't provide a forecast for how many shares we think we're going to buy back in the…

Josh Goldberg - G2 Investment Partners

No, I meant assuming your guidance of the year.

Bryan M. Hackworth

It's about 16.1 million.

Josh Goldberg - G2 Investment Partners

And is your tax rate roughly going to stay the same? I know it was lower last year.

Bryan M. Hackworth

It depends on – right now the Congress hasn't passed the federal R&D credit. So right now I can't incorporate that credit in the effective tax rate for the year. So right now it's a little bit higher than it was last year. But if they pass it, which they have for the last, I don't know how many years, last 20, 30 years in the past, it typically passes in Q4, then you'll see a benefit come through Q4. Couple of years ago it actually passed in Q1. So it lapsed a year, but then they gave you a retroactive credit for the prior year. So it all depends, but that's why it's…

Josh Goldberg - G2 Investment Partners

What's roughly their number?

Bryan M. Hackworth

It's about 500,000.

Josh Goldberg - G2 Investment Partners

Okay. And the other question I had is for Paul. I mean in the press release you talked about how you are more than ever well-positioned to continue expanding your footprint in the high-growth markets you serve. Certainly sounds like the future is very bright. Maybe you can just give some investors some color on what you're seeing now versus even a period of six months from now that makes you so confident?

Paul D. Arling

I think it's just, Josh, the fact that what's happened over the last 10 years, the last five years, the last two years, we've extended our leadership in the ability to capture and emulate the device codes for all the ways, the myriad ways that these devices are operated today. Infrared, radio frequency, IP, CEC, there's many different ways that your AV devices can be controlled. In one way, technically it's getting more complex, but we've captured the methods that will allow that to be discerned by the consumer in a simple intuitive way through software. So, I feel really good about the things that our team here has done in that arena.

Secondly, with all of those protocols now being put into these products, the ideas that we've had here at UEI for more than a decade on how an Internet-based or cloud-based world could help in the area – or a networked world could help in the area of AV control, those things are now coming to fruition, and we have both the base level foundation of those device control codes as well as the software to power those next-generation devices, including the mobile devices.

So, we just feel really good about the initial wins we've gotten in some of these new areas, but also when we look at ourselves versus others in the marketplace, I don't really yet see where anyone has done anything even close to what we're doing as far as AV home control.

So, yes, we just feel really well-positioned when we're meeting with customers, they're very interested in these next-generation solutions that we're building and we just have really good feelings about how things have unfolded so far and how this AV world is changing, has changed over the last two years and probably will continue to over the next five.

Josh Goldberg - G2 Investment Partners

Just one last one for me. Did you have any 10% customers in the quarter and how big was that customer?

Bryan M. Hackworth

We had one 10% customer and I believe they were just about 10%.

Josh Goldberg - G2 Investment Partners

Okay, great. Congratulations guys on a strong result.

Operator

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

Paul D. Arling

Okay. Thank you everyone for joining us today and for your continued support and interest in UEI. One small note. In September, we will be presenting at the Credit Suisse 5th Annual U.S. Small & Mid Cap Conference in New York City. Hope that we'll be able to see some or all of you there. Thanks again and goodbye.

Operator

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program and you may all disconnect. Have a great day everyone.

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