Earnings Call Transcript - UEIC Q1 2023

Operator, Operator

Thank you, Jules, and thank you all for joining us for the Universal Electronics 2023 first quarter financial results conference call. By now, you should have received a copy of the press release. If you have not, please contact LHA Investor Relations at 415-433-3777 or visit the Investor Relations section of the website. This call is being broadcast live over the Internet. A webcast replay of this call, including any additional updated material non-public information that might be discussed during this call, will be available on the company's website at www.uei.com for one year. During this call, management may make forward-looking statements regarding future events and the future financial performance of the company and cautions you that these statements are just projections and actual results or events may differ materially from those projections. These statements include the company's ability to timely develop and deliver new technologies and technology upgrades and related products introduced this year, including meeting the demand of interoperability across devices platforms and ecosystems in the home; the timing and extent of the recovery of the consumer electronics channel as believed by management; achieving the new product development successes as anticipated by management; including in the HVAC market and its groundbreaking line of ultra-low power and energy harvesting controls, products designed to address the growing demand for more sustainable solutions in electronic devices. The continued successful collaboration with existing and new customers in developing and launching next generation products; software solutions and technologies into existing and new growing markets, which results in increased sales and market growth share for the company; the ability to optimize the company's manufacturing operations on a timeline and to the extent expected by management; management's ability to continue to manage its business, inventories and cash flows to achieve its goals of net sales, margins and earnings through financial discipline, operational efficiency, manufacturing footprint and utilization strategies and product lines and business diversification management. The continued decline of the company's market capitalization and consequent impairment of the company's goodwill. The impact of the company's financial results that it may experience during the supply chain constraints, inflationary pressures and macroeconomic conditions and its consumers are experiencing. The direct and indirect impact the company may experience with respect to the business and financial results stemming from the continued economic uncertainty affecting consumers' confidence in spending natural disasters, public health crisis, including the continuation or resurgence of COVID-19 pandemic or governmental actions, including war. The company undertakes no obligation to revise or update these statements to reflect events or circumstances that may arise after today's date and refers you to the press release mentioned at the onset of this call and the documents the company files with the SEC, including its 2022 annual report on Form 10-K. In management's financial remarks, adjusted non-GAAP metrics will be referenced. Management provides adjusted non-GAAP metrics, because it uses them for budget planning purposes and for making operational and financial decisions and believes that providing these non-GAAP financial measures to investors as a supplement to GAAP financial measures helps investors evaluate UEI's core financial performance and business trends consistent with how management evaluates such performance and trends. In addition, management believes these measures facilitate comparisons to the core operating and financial results and business trends of competitors and other companies. A full description and reconciliations of adjusted non-GAAP measures versus GAAP are included in the company's press release issued 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. Paul will then return to provide closing remarks. It is now my pleasure to introduce Paul Arling. Please go ahead, sir.

Paul Arling, CEO

Thank you for joining us today. For the first quarter of 2023, while we met the high end of our guidance for net sales and earnings, neither of these measures reached our standards for long-term financial performance. So we are executing strategies to diversify our markets and realign our global operations, in particular, optimizing our manufacturing footprint. While we are experiencing headwinds in our home entertainment channels, we continue to see growth in sales and market share in the connected home market. As we have discussed previously, we are leveraging our foundational competitive advantages. Our innovation and device control and connectivity technology, our excellence in new product development, and our commitment to providing great customer service. Solving the consumer demand for interoperability across devices, platforms, and ecosystems in the home is a core foundation of enabling a truly smart home experience, which is exactly what we are bringing to our customers in the climate control, automation, and security markets. These areas will continue to grow in the long term, driven by underlying macro trends such as global warming, rising energy costs, and the need for smarter and more sustainable product solutions. However, near-term, our new product and customer successes have yet to fully offset the sales decline due to subscriber loss in subscription broadcasting, particularly in the U.S. Additionally, our consumer electronics customers are also experiencing near-term order declines driven mainly by economic weakness in the consumer or retail channel. We believe the impact on the consumer electronics channel is temporary, and we expect television sales to recover as the competition for the primary operating system for entertainment and information in the home escalates. In this regard, we are extremely well positioned with our key accounts and are working to help bring new features and more sustainable solutions to the OEM brands that lead this industry. Looking at our current backlog of customer programs as well as our product development pipeline, we believe net sales will hit their low watermark in the first half of this year. We are actively refocusing our product development efforts to align with current market dynamics that will help us achieve better sales results later this year and into next. What has been encouraging is that even while we are in a period of higher levels of consumer uncertainty, the number of project design wins in both new and existing accounts is accelerating, the majority of which are from new products, representing incremental sales growth versus replacement business. As we have mentioned before, sales and development cycles in these new channels are typically longer. Subsequently, these new product design wins are expected to contribute modestly to sales in 2023 and then drive top-line growth in 2024. More importantly, these design wins give us great confidence that our differentiated solutions and technical capabilities are key assets that will return us to growth and profitability in the not-so-distant future. In our HVAC channel, we can now boast seven major brands as customers. Collectively, these brands represent over 30% of the world's HVAC market. Many of the newer accounts represent design wins achieved in the past six months and reflect key new products that will drive global customer penetration in the industry. We've won new major awards with leading brands like Daikin, Carrier, and Mitsubishi Train for their more advanced connected thermostats. In addition, earlier this year, our teams kicked off customer-initiated developments for several smart thermostat solutions based on our TIDE Dial and TIDE Touch platforms scheduled to ship in Japan, Europe, and other markets in 2024. These important design wins validate our product roadmap efforts for this channel, which we started nearly two years ago and offer a positive view for the future. The success we are achieving in the HVAC market is strikingly reminiscent of the earlier phase of success in home entertainment. We focused on gaining traction through project wins with the leading companies in the world. We then executed on those wins, innovated further in our products and technologies, and as a result, won even more business with leaders in the industry. Our keys to success are stronger today than they have ever been. Our ability to execute at scale for our customers and provide connectivity and, importantly, interoperability across an increasingly chaotic smart home infrastructure is proven through our history with some of the largest companies in the world. These attributes are strongly desired by our customer base as they look to become more integrated into the smart home of today and tomorrow. In our Home Security and Automation business, it is a similar story. We are adding to a small but growing customer base, attracting new customers and increasing customer share with our new product design wins for controllers, sensors, and other home automation products with leading brands like Vivint, Hunter Douglas, and Somfy. Product introductions will begin later this year and ramp into 2024. These accounts have expressed a strong commitment to bring more product opportunities to us as a result of their initial exposure to our superior technical know-how, innovation, and customer engagement experience. Even in our video service provider channel earlier this year, we secured major program wins for new television streaming platforms in the U.S. and Europe that we will begin shipping later this year due to the shorter design and development cycles inherent with these products. As is the nature of our business, we can't provide more details surrounding these customer platforms right now, but rest assured, we will continue to expand our market reach even in this more subscriber-challenged market. Turning to a review of our plan to optimize our manufacturing footprint worldwide. To manage the changes in the global supply chain and governmental policies, we have been working on expanding our manufacturing footprint outside of China. Last year, we started building a new energy-efficient and sustainable factory in Vietnam that will provide additional capacity. Once it is running at nearly optimal levels, we plan to ramp down our manufacturing volume in China and reduce our overall manufacturing overhead as we transfer volumes out of our other facilities. Although we will temporarily experience continued overcapacity, our plan ultimately will lead to an optimization of our global supply chain footprint, taking into account the adjustment in product mix and monthly volumes across channels as we continue to transition our business into newer markets with lower volumes and higher average selling prices. With all of these wins and actions underway, we are confident we will return to long-term growth and profitability. Now I'll turn the call over to our CFO, Bryan Hackworth, for a review of the financials. Please go ahead, Bryan.

Bryan Hackworth, CFO

Thank you, Paul. First, I'll review the results for the first quarter of 2023 compared to the first quarter of 2022. Net sales were $108.4 million at the high end of our expectations. This compares to $132.4 million for the first quarter of 2022, reflecting headwinds in the video service channel as well as an uncertain economic environment, which have led to households spending less on discretionary goods and ultimately affecting our end-user markets. Gross profit for the first quarter of 2023 was $27.6 million, or 25.4% of sales, compared to 28.9% in the first quarter of 2022. The decrease in our gross margin percentage is due primarily to under absorbed manufacturing overhead and lower royalty income associated with the slowdown in television sales. As Paul mentioned, we're taking steps to restructure our factory footprint and eliminate manufacturing inefficiencies. I'll elaborate. As I mentioned before, for a variety of reasons ranging from the enactment of certain governmental policies to changes in the global environment, over the past five years, we expanded our manufacturing footprint, evolving from producing finished goods solely in China to expanding and converting our Mexico factory from refurbishment to a full production plan to now ramping up production in Vietnam. Today, as we focus on diversifying our business into higher growth markets and becoming less dependent on the video service channel, we've seen a shift in product mix towards climate control and home automation categories. In these newer channels, the average selling price for thermostats, wireless controllers, and security products is significantly higher than products in our video service provider channel. Consequently, less factory floor space will be required per sales dollar. Our restructuring plan will enable us to lower our concentration risk in China, to eliminate excess manufacturing overhead costs, and ultimately return gross margins to a normalized rate. Our goal is to reduce our cost structure by approximately $15 million, and with sales growth, return our factory utilization rates to upwards of 90% with the flexibility to expand as needed. The first step in the plan required that we establish a manufacturing facility in Vietnam. For the past two quarters, we've been hiring and training manufacturing personnel at our Vietnam facility. We're currently awaiting two final permits, which we expect to receive in May, at which time we can begin production. Once we've reached a level of operational efficiency in Vietnam, which we estimate to be in October of this year, we anticipate that we'll begin the process of shutting down our Southwestern China factory, thereby reducing our manufacturing footprint in China from two factories to one. The third phase of our restructuring effort will be to streamline our operations in Monterrey, Mexico, resulting in a smaller and more efficient manufacturing footprint to meet production volumes for North American customers. We expect this transition to take place in the back half of 2024. Operating expenses were $31.2 million compared to $30.4 million in the first quarter of 2022. SG&A expenses were $23.1 million compared to $23 million in the prior year quarter. R&D expenses were $8.1 million compared to $7.4 million in the prior year quarter. Operating loss was $3.6 million compared to operating income of $7.8 million in the first quarter of 2022. Our first quarter 2023 effective tax rate was 19.9%, consistent with the first quarter of 2022. For the first quarter of 2023, net loss of $3.5 million or $0.28 per share compared to net income of $6.1 million or $0.47 per diluted share in the first quarter of 2022. Next, I'll review our cash flow and balance sheet. On March 31, 2023, cash and cash equivalents were $56.9 million compared to $66.7 million at December 31, 2022. Cash flows used by operating activities were $2 million for the first quarter of 2023 compared to $18 million in the prior year quarter. In regard to our line of credit, we extended the maturity of our $125 million credit facility with U.S. Bank from November 1, 2023, to April 30, 2024. Now turning to our guidance. For the second quarter of 2023, we expect sales to range from $105 million to $115 million compared to $139.1 million in the second quarter of 2022. We expect a net loss ranging from $0.15 to $0.25 per share compared to EPS of $0.66 per diluted share in the second quarter of 2022. Looking at the second half of 2023, based on the expected timing of our new product introductions and customer forecast, we continue to expect net sales for both Q3 and Q4 to exceed Q2 net sales.

Paul Arling, CEO

Thanks, Bryan. Our strategy to address the new market dynamics and to rebuild UEI into a stronger company, better positioned for growth and profitability is progressing. Although economic pressures and the longer product development cycles in our newer markets inform us that sales impact will likely be gradual in '23 with a greater effect beginning in 2024, our team is innovating, winning business, and maintaining UEI's long-standing position as a leader in consumer device control. We are committed to creating products and technologies that help everyday consumers easily discover and interact with the devices and services in their homes. We know with our healthy product development pipeline, sales opportunity conversion, and strong customer relationships, we expect to return to long-term growth. As always, stay tuned. Operator, we can now open up the call for questions.

Gregory Burns, Analyst

Can I just get the 10% customers to start off?

Bryan Hackworth, CFO

Yes, sure. Daikin and Comcast. Daikin came in at 18.1% and Comcast came in at 13.6% for the quarter.

Gregory Burns, Analyst

All right. And then it seems like with where the quarter landed and where you're guiding for the second quarter, a little level of stability in the subscription broadcast market. How do you feel about the outlook there now based on what you're seeing in terms of what the customers are communicating to you? And where are the inventory levels in that channel like do you feel like we've reached kind of a near-term plateau?

Paul Arling, CEO

It's a challenging question to answer because it varies from customer to customer. We have observed some customers making fewer purchases than they indicated they needed, which led them to rely on their inventory for deployments. They were ordering less than what would typically be needed. However, this approach isn’t sustainable long-term, as a company must purchase enough to meet deployment needs. Over time, purchases must align with deployments. We have noticed this trend with a few customers, who have confirmed these findings. Subscriber counts are down, which has affected our business, as new additions significantly contribute to our volume. These new additions typically require multiple units for installation, and while we do have a repair and replacement aspect as units can be broken or lost, we're seeing some customers stabilize at what we believe to be a longer-term volume level. This means that the decline in subscriber accounts is having a diminishing impact on their purchasing. Looking ahead, we believe that growth will likely stem from new channels. As mentioned in my prepared comments, we have aligned with several of the world’s largest companies, winning projects that are reminiscent of our experiences in home entertainment. Initially, we win one or two SKUs, and as we demonstrate our performance, more projects are awarded. These companies collectively control nearly one-third of global HVAC units, so we’re making significant progress in that market. We anticipate that the smart home segment of our business, apart from home entertainment, is where we will see the most growth. Consumer electronics do experience ups and downs. The TV market is historically not high-growth; it fluctuates between high single-digit growth and occasional declines. Currently, we may be in a decline due to economic conditions, as retailers are cautious and not stocking up as much. However, we believe that the TV market will remain active for us in the years ahead. The competition surrounding TV operating systems is intensifying, with many major companies entering the space, most of which we are partnering with. Therefore, the next few years should be engaging, although we may go through challenging quarters before returning to growth. We are not concerned about the long-term prospects of consumer electronics.

Gregory Burns, Analyst

All right. Thank you.

Paul Arling, CEO

Sure.

Brian Ruttenbur, Analyst

Great. Thank you very much. First question I have is about your cash and balance sheet and what you expect it to look like in the second quarter. The end of the second quarter, cash was obviously down. In the first quarter, your debt was down a little bit. Where do you see things shaking out in the second quarter?

Bryan Hackworth, CFO

I think it will be similar. When managing cash flow on a quarterly basis, it can sometimes be challenging to predict. One reason we don’t provide quarterly forecasts is that a customer might pay $5 million or $6 million at the end of the quarter, but they could delay it by a few days, pushing it into the next quarter. Therefore, it’s tough to gauge on a quarterly basis. Overall, I expect Q2 to be similar to Q1.

Brian Ruttenbur, Analyst

Great. And then in terms of demand, typically seasonally you have your best quarters in the third quarter. What are you seeing in terms of third quarter? I know that you're only getting through second quarter. Can you give us any kind of visibility into that third quarter, that key quarter?

Paul Arling, CEO

Yes. As Bryan mentioned, we don’t provide forward guidance. However, we did offer a range of guidance for Q2. We have not provided guidance further out for more than a decade. While I can’t say we have never done it, we haven’t in at least 10 years. Nevertheless, Bryan indicated that our current forecasts, based on customer wins and expectations, suggest that Q3 and Q4 will outperform Q2.

Brian Ruttenbur, Analyst

Right. I have one more question that you're probably not going to answer. Do you see those down significantly year-over-year? Can you provide any details on the percentages, considering that the first and second quarters were down X, could we expect the third and fourth quarters to be down a similar amount year-over-year? I'm not sure if you can give us any insights for the rest of the year.

Bryan Hackworth, CFO

I can't provide specific numbers because we don't give that guidance. Last year's fourth quarter wasn't as strong, so it would be an easier comparison from your perspective. Our aim is to focus on the various segments of our business. Home entertainment has faced challenges, and the video service provider sector has declined. The consumer electronics business is stable but experiences fluctuations. This year, we've noticed a downturn in video services alongside one of the rare declines in TV sales, attributed to economic challenges and retail issues faced by some of our customers. This segment has been difficult. Each area has its own dynamics. In smart home, we have gained numerous new customers and secured design wins, though they take time to materialize. Some products will launch this year, but we expect lower initial volumes. We are focused on building a stronger future at UEI. If there were a way to generate significant sales next quarter, we would pursue it, but we understand that growth in new areas takes time. Looking ahead, we are optimistic about 2024, supported by recent successes and a robust sales pipeline filled with projects needing development and engineering. We have a substantial amount of work ahead, but it's encouraging that we have secured these projects. We’re often not the first link in the chain; our products sometimes have a six-month development cycle, but the companion products can take up to a year. Thus, despite the longer development times, we expect to see some volume increase later this year. However, some projects won't launch until the first or second quarter of next year. We are winning contracts and are very optimistic about that segment of our business, which has a multi-billion dollar market potential. We're aligned with many leading companies in HVAC, covering a significant portion of the market. We've initiated partnerships and now need to execute those projects and expand our reach.

Brian Ruttenbur, Analyst

Great. Thank you.

Bryan Hackworth, CFO

Yes.

Gregory Burns, Analyst

I just wanted to follow-up on some of that pipeline commentary that you just made, Paul. Can you just give us an idea of some of these more recent project wins or program wins? Like what types of applications those are for, not necessarily specific customer details or anything, but just an idea of kind of what applications you're winning projects for?

Paul Arling, CEO

Yes. I can mention Daikin and Carrier, and I also brought up the joint venture with Mitsubishi Electric Train in the U.S. The products and technologies we are offering typically include smart climate control devices. We have also made progress with products like TIDE Dial and TIDE Touch that attendees at CES may recognize. Additionally, we create standardized products for home entertainment, which customers can accept as is or customize slightly in design. The key value lies in the technology behind these products. These are the types of HVAC products we are successfully providing, including smart thermostats.

Gregory Burns, Analyst

Okay. Have there been any more incremental wins like the Hunter Douglas kind of Vivint flavor in home automation?

Paul Arling, CEO

There haven't been any new customers to mention at this moment, but among the clients we've discussed, we have gained more projects from them. Our strategy involves winning a project or two, which allows us to establish a presence with that customer. If they are satisfied with our performance, they are likely to present us with opportunities for additional products. In some instances, we propose products they haven't previously considered, and they are open to that. We have been securing projects in that market as well. While I can't name any new clients right now, I want to emphasize that our pipeline for these projects and PIs is becoming quite active. This leads us to have a very positive outlook for the latter part of this year as some of these projects will start to come in, and even more so for next year.

Gregory Burns, Analyst

Okay. And just to clarify the timing regarding the customers you've already announced, like Hunter Douglas and Somfy, are you currently shipping to those customers or is that expected to begin in the second half?

Paul Arling, CEO

Well, we have a couple of projects with these customers, yes. We had one that I can't mention that was delayed, but it wasn't delayed due to us. They had approval processes. Sometimes customers have to go through an approval process that can take months. So if you forecasted it in a specific quarter, it can slip to the next. But our view on that is longer-term, it's not good when that happens, obviously. But over the long-term, it's not as relevant, right? If you're performing on a product and the customer continues to give you new SKUs, that's what really matters.

Gregory Burns, Analyst

Okay. And then lastly, I know you sized kind of the total market if you mentioned a few billion. But specifically for the HVAC market, how do you size the opportunity there? And can it be as big as like the Legacy Home Entertainment business over time? Or is it a fraction of the size? Like how should we think about that HVAC opportunity specifically?

Paul Arling, CEO

HVAC is likely almost as large now. We do not consider our served market to be the same as we did in home entertainment. For example, in places like China, HVAC systems often use lower-level controllers, resulting in less margin opportunity. Consequently, we're excluding that segment from our near-term served market assessment. Global estimates of HVAC volume might be higher than I will state because we're not including China in our estimates. Currently, the HVAC market exceeds $1 billion, while the home entertainment sector, including consumer electronics and video service providers, is also over $1 billion, likely in the mid-$1 billion range. The HVAC market is experiencing faster growth, with a high single-digit growth rate, potentially nearing double digits. This market is evolving significantly as controllers become smarter, and companies aim to integrate HVAC systems into the smart home ecosystem. These products now offer functionalities beyond just temperature management; they could be part of a home automation system. A smart HVAC product could monitor outside temperature, desired indoor temperature, and even human presence, allowing for tailored temperature control and potentially controlling shades depending on whether someone is home. There are various automation scenarios possible, and HVAC companies see the value in becoming a core component of the smart home. They view us as a strong partner in this transition since we are connected to most home protocols. Indeed, many products already incorporate our control mechanisms, including televisions and sensors. We are recognized experts in this domain, even by consumer electronics companies. We're currently embedding our technology in televisions with LG, which enhances our device knowledge in the home. HVAC companies are very interested in becoming more central to the smart home experience, making this a compelling selling point. This interest is likely why so many leading players want to collaborate with us on projects in this field, and we believe we can expand our presence from here. This situation is reminiscent of our previous experience in home entertainment, where our market share was lower initially, but we projected growth, and those who doubted us proved wrong as we continued to expand due to our capabilities.

Gregory Burns, Analyst

All right. Perfect. Thanks.

Paul Arling, CEO

Thank you so much.

Operator, Operator

Thank you for joining us today and for your continued support of Universal Electronics. We plan to present at the B. Riley Annual Investor Conference later this month. Hope to see some of you there. If you have any questions, don't hesitate to reach out to us. Have a great day.

Paul Arling, CEO

That would be me. I'll do that. I'm Paul Arling. Thank you for joining us today and for your continued support of Universal Electronics. We plan to present at the B. Riley Annual Investor Conference later this month. Hope to see some of you there. If you have any questions, don't hesitate to reach out to us. Have a great day.

Operator, Operator

Thank you for participating in today's conference. This concludes the program. You may now disconnect.