Universal Electronics' (UEIC) CEO Paul Arling on Q2 2016 Results - Earnings Call Transcript

| About: Universal Electronics (UEIC)

Universal Electronics Inc. (NASDAQ:UEIC)

Q2 2016 Earnings Conference Call

August 4, 2016 4:30 PM ET

Executives

Kirsten Chapman – Managing Director-Lippert/Heilshorn & Associates, Inc.

Paul Arling – Chairman and Chief Executive Officer

Bryan Hackworth – Senior Vice President and Chief Financial Officer

Analysts

Steven Frankel – Dougherty & Company

Greg Burns – Sidoti

Edison Chu – G2 Investment Partners

Operator

Good day, ladies and gentlemen, and welcome to the Universal Electronics Inc. Earnings Conference Call. Currently 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] Also as a reminder, this conference call is being recorded.

I would now like to turn the call over to your host to Kirsten Chapman. You may begin.

Kirsten Chapman

Thank you, Johan. This is Kirsten Chapman of LHA and thank you all for joining us today for the UEI Second Quarter 2016 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. This call is being broadcast live over the Internet. A webcast replay will be available for one year at www.uei.com. You may also access that information by listening to the webcast replay.

In addition, any additional updated material nonpublic information that may be discussed during this call will be provided on the Company's website where it will also be retained for at least one year. After reading a short safe harbor statement, I will turn the call over to management.

During the course of this conference call, management may make projections or other forward-looking statements regarding future events and the future financial performance of the Company including the Company's ability to maintain and build its relationships with key customers; the Company's ability to anticipate the needs and wants of its customers and timely develop and deliver products and technologies that will meet those needs and wants including two-way RF technologies, voice control, the QuickSet technologies, home security, home automation, wireless sensors and other technologies identified in this call; the significant percentage of its revenues attributable to a limited number of customers and particularly the sales growth and benefits of the Company's relationships with Comcast; the timing of new product rollout orders from the Company's customers as anticipated by management; the continued trend of industry in providing consumers with more advanced technologies; the Company's expansion into the home security space; management's ability to manage its business to achieve its revenue margins and earnings as guided; the continued ability to identify and execute on opportunities that maximize shareholder value. And 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 from those projected. The Company undertakes no obligation to revise or update any statements to reflect events or circumstances that may arise after today's call.

For further detail on risks, 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, 2015 and the periodic reports filed thereafter. These documents along with the risks identified earlier on the call contain and identify various factors that could cause actual results to differ materially from those contained in management's projections or forward-looking statements.

In management's financial remarks, adjusted pro forma metrics will be referenced. Management provides adjusted pro forma metrics because it 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 performance for the periods being reported. A full description and reconciliation of the adjusted pro forma measures versus GAAP are included in the Company's press release issued today.

On the call today are Chairman and CEO, Paul Arling, who will deliver an overview; CFO, Bryan Hackworth, who will summarize the financials. Paul will then return to provide closing remarks.

It is now my pleasure to introduce Paul Arling. Please go ahead, sir.

Paul Arling

Thank you, Kirsten and thank you all for joining us today. Our second quarter 2016 results reflect solid year-over-year growth. Net sales grew 17% over the same quarter last year. And we maintained a strong bottom line with EPS of $0.77 representing 15% growth over last year. Our subscription broadcasting business continued to perform well as our customers around the world ramp up new product introductions featuring our advanced A/V control software and hardware solutions. As we outlined earlier this year, we are or will soon be supplying our advanced remote control technology to customers representing more than 110 million subscribers or nearly 20% of the entire world subscriber base over the next few years.

Comcast roll out of its XR11 voice remote to a subscriber base continues to grow. Cox Communications the first X1 platform syndicator began shipments of their platform in the second quarter of this year. And we anticipate other syndication partners to begin their product rollouts later this year and into 2017. Beginning in the second half of 2016, we’ll be introducing new Ecolink home security monitoring and control solutions. This new suite of intelligent sensing technology combines with our home entertainment control innovations to provide customers a more complete smart home solution.

We announced in March that we signed an agreement with UTC fire and security to make Ecolink security sensors available through all of its Interlogix sales channels. Products will begin shipping in the third quarter and we expect our growth in this industry will accelerate in the second half of the year. And into 2017, there are significant opportunity to leverage our traditional customer base, and our expertise in wireless control protocols to establish a strong market position in home security. The synergies in delivering monitored security and set-top box video entertainment by service providers is a growing trend. And UEI is at the forefront of helping to deliver on this emerging service.

Our ability to facilitate ease-of-use and simple functionality ensures our leadership position in wireless control technologies as the industry trends towards more sophisticated products and solutions. For example, our QuickSet suite continues to set the benchmark for phenomenal user experience in home entertainment as evidenced by the solid product reviews of the Samsung KS9000 series smart TV. We are continuing to implement our QuickSet solutions across all of our business lines in regions around the world.

In our Asia-Pacific region, we continue to win new projects and expand our mark, our share in new product categories such as lighting control, thermostat controllers, and other smart home control applications. While we are gaining traction with product introductions, we are still at the early stages of this trend. We have a very healthy pipeline of over 90 active development projects today. And we see a continued migration from many of our customers to more fully featured remotes over the next 12 to 18 months. As they're in various phases of the development life cycle customers across the world will be rolling out new platforms in the coming months and throughout 2017 providing UEI with both near and long-term growth.

With that, I would now like to have Bryan Hackworth, our CFO taking through the financial results.

Bryan Hackworth

Thanks, Paul. As a reminder, our results for the second quarter of 2016 as well as the same period in 2015 will reference adjusted pro forma metrics. Second quarter net sales were $172.2 million, an increase of approximately 17% compared to $147.6 million for the second quarter of 2015. Business category net sales contributed the majority of the growth increasing approximately 18% from our $135.5 million in the second quarter of 2015 to $159.7 million in the second quarter of 2016. This growth will drive not just from Comcast which began to point their advanced platform in the second quarter of 2015 but also from a handful of additional customers that made the same strategic decision. Consumer category revenue despite a stronger U.S. dollar versus the British pound grew modestly to $12.5 million from $12.1 million the prior year quarter.

Gross margins were 26.1%, compared to 27.5%. Operating expenses were $30.3 million compared to $27 million. R&D expense was $5 million and an increase of 26% compared to $4 million in the second quarter 2015 reflecting our continued investments in the new products and technologies including the smart home market.

SG&A expense was $25.3 million compared to $23.1 million. Operating income was $14.7 million compared to $13.5 million. The effective tax rate was 25.2% compared to 21.5%. Net income was $11.3 million or $0.77 per diluted share compared to $10.7 million or $0.67 per diluted share in the prior year period.

For the first six months of 2016, net sales were $323.7 million compared to $280.3 million the same period last year. Gross margins were 25.9%, compared to 27.9%. Operating expenses were $59.8 million compared to $55.6 million in the first six months of last year. Operating income was $24 million, compared to $22.6 million. Net income was $18.5 million, or $1.26 per diluted share, compared to $18.2 million or $1.13 per diluted share in the first six months of last year.

Next, I will review our cash flow and balance sheet at June 30, 2016. We ended the quarter with cash and cash equivalents of $49.4 million compared to $53 million at December 31, 2015. DSOs were approximately 70 days at June 30, 2016 compared to 63 days a year prior. Net inventory turns were approximately 4.3 turns at June 30, 2016 compared to 4.1 turns a year prior.

Now turning to our guidance. For the third quarter 2016, we expect net sales to range between $169 million and $177 million, an increase of 5% to 10% compared to $160.5 million in the third quarter 2015. EPS for the third quarter is expected to range from $0.87 to $0.91 an increase of 12% to 24% compared to $0.78 in the third quarter 2015.

I would now like to turn the call back to Paul.

Paul Arling

Thanks, Bryan. I would like to take a moment to reflect on what we have accomplished to-date and more importantly share our perspective on how well positioned we are for an even more exciting future. UEI has established a remarkable track record of growth in sales and earnings over the last decade by executing on a strategy of making your home systems historically home entertainment systems easier and more intuitive to operate. The list of customers across the globe that have been trusted us to do this, Comcast, DIRECTV, EchoStar, Dish, Cox, Charter, Sony, Samsung, Panasonic, Sky, Liberty, Vodafone, Microsoft and many, many other industry leaders are a testament to the quality of solutions we provide.

We have truly changed what a remote control is and what it is capable of doing. Yesterday, the term smart TV was a misnomer and smart devices came to be defined as smartphones and tablets. These prior concepts and definitions are evolving as today's home entertainment devices are truly becoming smart through the use of apps that make doing things easier.

Today the home entertainment industry is going through a vast transformation. Leading home entertainment device makers are striving to make their devices easier to set up and use every day. And service providers are creating simplified solutions for accessing in ever increasing array of entertainment options. This is where UEI excels we have invested over the last 20 years to become the best home control provider in the world. And have separated ourselves from the competition by using technology to solve the everyday challenges of our customers and ultimately the consumer, by providing the intelligence inside TVs set-top boxes, universal remotes, home security sensors and more. UEI enable the wireless control of in interoperability between virtually any device in the home. Our innovation is continue to provide solutions for the control of devices and content that prioritize ease-of-use and set up, while incorporating state-of-the-art technologies such as voice control. We continue to have a very positive outlook for the company. And we look forward to keeping you updated on our progress in the months and years ahead. Stay tuned.

I would now like to open it up for questions, operator?

Question-and-Answer Session

Operator

Thank you. [Operator Instructions] Our first question comes from Steven Frankel [Dougherty & Company].

Steven Frankel

Paul, maybe just start with last quarter I thought was very helpful how you outlined the number of new customers you have ramping, did any of those new customers commence shipments in Q2?

Paul Arling

Yes, a few of them did. And of course as the coming weeks and months and over the next year progress we – as I said on this call we have right now over just over 90 active projects going on across the world Asia-Pacific, Europe, here in the Americas. So there is a lot of activity regarding new products, new solutions, new technologies some are embedded chips, some are full products, so it’s a wide array of things but again they all fall under that same thing – theme of connected home projects, advanced remote technologies et cetera. So really the same message as last time, last time we talked about the greater than 110 million subscribers companies representing greater than 110 million subscribers. It's resulted in now 90 projects. So yes, in the coming weeks we'll ship a few more projects and again it's an ongoing thing week-to-week, month-to-month, quarter-to-quarter.

Steven Frankel

Given all that I would have anticipated another quarter of kind of solid double-digit revenue growth but you're guiding to something less than 10% at the midpoint how much of that is a function of lapping some tough compares from Comcast or does the change in the pound have some kind of influence on that number as well. Maybe give us some sense of why you're guiding, what you’re guiding?

Bryan Hackworth

Yes, the pound is a minimal effect for us. So we said that Comcast within, they launched last year Steven, Q2 about midway. And so for Q3 this is the first quarter that we're going to have a base for the full quarter so that makes the comp more difficult but despite that I mean Comcast is $42 million in sales last year in Q3. Despite that we are still growing 5% to 10% we are anticipating that in the third quarter which is really driven by what Paul is mentioned is all new customers come on board and transitioning from the lower end platform to the higher end platform. So it's – I think a solid growth considering that the Comcast is in the base.

Steven Frankel

And what was Comcast and DIRECTV as a percentage of revenue in the quarter.

Bryan Hackworth

Comcast was 21.3% and DIRECTV was 11.7%.

Steven Frankel

Okay, and maybe an Ecolink update did you ship Ecolink products to a subscription broadcaster in the quarter or is that coming later this year?

Bryan Hackworth

No, that will be in the second half of this year.

Paul Arling

This quarter and in the Q4 and in the next year.

Steven Frankel

All right, that’s all for now. And I’ll get back in the queue. Thank you.

Paul Arling

Okay.

Operator

Our next question comes from Greg Burns of Sidoti.

Greg Burns

Hi good afternoon, I see if Dish launched their voice remote, can you confirm whether or not you are shipping that is your technology, your remote that they are using.

Paul Arling

Well, we don’t speak about the specific products at Dish but obviously Dish is a major customer for us, then how to report 10% customer. But they are in our top list of customers so we are developing with some of their next-generation products, yes.

Greg Burns

And when we look at the different service providers that are rolling out these next-generation products are they all created equal. And I mean that probably like – you got a certain amount of incremental ASP from Comcast X1, the XR11 remote versus like a Legacy remote. What differentiates Comcast next-gen remote versus maybe someone else’s I mean is there like a tearing of features that make the value of the new remote go higher can you just give us a sense of what might differentiate one customer from the other or are they all kind of equally get the similar type of pump in ASP?

Paul Arling

Well, yes, the ASPs typically are higher that is some of them are multiple of what the prior product was. And then again its all depend on what they were deploying it before. Some customers may have deployed in the past a relatively deep featured product which would make the next-generation product would be significantly higher ASP. Other customers were already doing a radio frequency product. So the ASP gain may not be quite as big. I think we estimate that it’s roughly at least 2X in terms of the uptick. And it's both think of the logical and in some cases it's looking for older product, a lot of customers have opted for zero gap, tools where the product doesn't have a gap in the case and laser etched. Well advanced keypad than they've done in the past. So there's look and feel enhancements as well as technological investments – advancements they've added voice. So there's microphone in the product to two-way RF. So there's a lot of new features in these products that some customers have chosen ZigBee or a flavor of ZigBee. RF4CE for their two-way RF other customers and other regions of the world are using Bluetooth.

But again its all – all of those are two-way RF products capable of things like voice and other applications. So yes, it's but – this is a general trend across the world. It's not just happening here. It's happened here first and there are now a lot of companies here who are either in the midst of deploying or developing or planning for those next generation products but it's happening in other parts of the world Japan, Korea, Europe et cetera. So this appears to be a trend that has legs for the coming years.

Greg Burns

Okay. And its appears the guidance implies little much of improvement in gross margin I think maybe a little bit less than what the expensive numbers were maybe looking for but could you just talk about the gross margin pressure that you expect to over – at what time period do you expect to maybe get back to that 28 to kind of 30 range in terms of gross margin.

Bryan Hackworth

Yes, we don't give specific guidance on gross margins we just give guidance on the top line, bottom line but I'll say this and we've said it before that as this more customers transition and they start to ramp that that should help our gross margin rate. So that actually we won’t get the pricing that that a real large customer will. I mean it's good news and bad news for us in that, some times when you are signing a large customers and they are buying the large quantities it puts downward pressure on the gross margin rate and we’ve seen that even – I can serve large customer it's from public accounting perspective it's 10% customers but you still have customers that are less intent but are still, I consider significant.

The buyers look at our top five customers right now compare Q2 over Q2 the sales have gone up relatively significantly. So it’s good news for us. The bad news is puts down a pressure on the gross margin rate but as Paul mentioned, the Ecolink’s going to start ship in the back half of the year, is there average gross margin is higher than the company’s average that should help. So its – I don’t want to put a timeline on it but I think there are some other trends that should help the margin rate.

Greg Burns

Okay…

Paul Arling

And the other thing I want to say about these implementations is that you can imagine that when you've got dozens of players and in time probably 50 to 100 players across the world doing these next-generation implementations. Some of them will start slowly, some of them will develop the product put it through testing. They've got a lot of technology in this next-generation platform that they didn't have before. But if we use at least the initial sample of people who have done this, if they start off a little bit slowly then they monitored the progress. They see how engaged the customers are how much it's lowering churn. How high – how much people are engaging with the platform and doing more video-on-demand or other things. They look at the economic benefit they're getting and if the early sample that we've seen is any indication what happens the operator will start slowly but when they see the positive impact of what they're doing they then get more aggressive in deployment. Because they see the very positive impact it's having on their customers and on their financial results.

So if the early sample is any indication into the back half of this year but more importantly in the 2017, 2018, 2019 in the coming years. We should see quite a transformation of the industry where the operators all will begin moving to these types of platforms. And then launching them more aggressively as they see the positive impact of the platforms they're launching.

Greg Burns

Thank you.

Paul Arling

Sure.

Operator

Thank you. [Operator Instructions] Our next question comes from Edison Chu of G2 Investment Partners. Your question, sir.

Edison Chu

Yes, good afternoon, guys. Congratulations on the quarter, just last year you had a number of project ramp in the fourth quarter that allowed you to buck your historical seasonal trend where you guys grew in the fourth quarter versus your typical decline. Do you have with Ecolink projects ramping up here in the second half and into December, do you have any visibility about what that fourth quarter directionally might look like?

Bryan Hackworth

Yes, this is Bryan. We just given one quarter out so right now we are giving a Q3 guidance and then I’ll speak to Q4 in a few months.

Edison Chu

Okay. And long-term as you – as some of the new Ecolink projects ramp. Would you expect the gross margin trend for the company overall to start improving or is the visibility difficult because you still have larger customers ramping up on new advanced remote controls which might still offset that Ecolink gross margin improvement?

Bryan Hackworth

Yes, it’s a good question, Edison. The mix is obviously extremely important. It is certainly true what you said that the security products that we ship typically will carry a slightly higher margin than our average. So to the extent that they make it up by higher percentage of the mix it will have an upward lift on our margins. However, if we have two largest customers by record amounts that pulled it down a little bit. So this is one of the reasons why we don't – we don't like to provide long-term margin guidance because we could have extremely successful quarters with some of our largest customers and that would be good news from an earnings standpoint. But it would affect the margins negatively.

Right, so these mix effects obviously can swing over a six month or 12 month period but it is certainly true that as medium to smaller sized customers. If your top two or five customers have now affected the rest of the industry and the medium to small sized customers are moving to these next generation remotes typically to smaller customers will carry a slightly higher margin than the larger customers. And safety and security products carry higher margins than average to the extent those things make up a higher percentage of the mix it begins to make the margins move up.

Edison Chu

Okay, great. Understood. Thank you very much, guys.

Operator

Thank you. I’m showing no further questions in queue at this time. I’d like to turn the call over to your host Mr. Paul Arling.

Paul Arling

Okay, thank you all for joining us today and for your continued interest in our company. Over the next few months, we’ll be participating in a number of trade shows including IFA September 2 in Berlin; IBC September 9 in Amsterdam and Cable-Tec Expo September 26 through 29 in Philadelphia. We will also be participating in the 2016 Deutsche Bank Technology Conference on September 13 in Las Vegas and the Credit Suisse Small and Mid Cap Conference on September 15 in New York. So we are going to be on planes a lot this quarter. We hope to see you at one or all of these events, if you can make it to all of them. Thank you very much for being with us today and good bye.

Operator

Thank you, ladies and gentlemen for attending today's conference. This concludes the program. You may all disconnect. Good day.

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