Earnings Call Transcript - UEIC Q3 2020

Operator, Operator

Thank you for joining us for the Third Quarter 2020 Universal Electronics Financial Results Conference Call. At this moment, all participant lines are muted. Following the presentations, there will be a session for questions and answers. I will now turn the call over to Ms. Kirsten Chapman to begin.

Kirsten Chapman, Investor Relations

Thank you, Chris, and thank you all for joining us for the Universal Electronics’ third quarter 2020 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 will be available for one year at uei.com. Any additional updated material or non-public information that might be discussed during this call will be provided on the company’s website where it will be retained for at least one year. You may also access that information by listening to the webcast replay. During this call, management may make forward-looking statements regarding future events and future financial performance of the company and cautioned you that these statements are projections and actual results may differ materially from those projections. These statements include the company’s ability to continue efficiently operating its factories at full or near full capacity amid the economic and physical restraints we face due to the COVID-19 pandemic. The company’s ability to timely develop and deliver new technologies, technology upgrades and related products that will be accepted by our existing customers and attract new customers, including the company’s QuickSet Cloud, Nevo Butler, and voice-enabled technology, changes in consumer life sales that will translate into new purchasing habits resulting in increased sales opportunities for the company. The continued trend of the industry toward providing consumers with more advanced technologies by offering hybrid platforms, expanded smart home offerings, and interactive services, the return to more normalized patterns of pay-TV activations as anticipated by management, management’s ability to continue to manage its business via new product development, and delivery increased licensing opportunities, and continued operational and administrative efficiencies to achieve its net sales margins and earnings as guided. The effect of natural disasters and public health crisis, including the COVID-19 pandemic, have on our business and management’s ability to anticipate and mitigate those effects, including the duration, severity, and scope of the COVID-19 pandemic and restrictions imposed on the company and its operations by federal, state, local, and international public health and governmental authorities, and the ability of management to manage the company’s near and longer-term cash flow and cash needs as anticipated. 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. Management’s 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 operating and financial performance and business trends consistent with how management evaluates such performances and trends. In addition, management believes these measures facilitate comparisons with the core operating and financial results and business trends as competitors in other companies. A full description and reconciliation of these adjusted non-GAAP measures versus GAAP is 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, Paul.

Paul Arling, CEO

Good afternoon and thanks for joining us today. We continue to leverage our incredibly strong foundation of innovation, customer service, and effective operations. Over the past two years, we have purposely focused on enriching our product line and managing expenses. We have successfully increased sales of higher technology, higher margin solutions. Even in the midst of a sales headwind caused by the pandemic, we have effectively managed the unexpected. As a result, for the nine months ended September 30, 2020, our gross and operating margins are the highest levels of profitability we have achieved in the last 10 years at 29.8% and 10.1%, respectively. In fact, even with Q4 sales consistent with Q3’s, we are projecting to deliver a record fourth quarter bottom line, which we expect to translate into record EPS for the full year 2020. One of the pillars of our success is our commitment to innovation, which has yielded award-winning technologies such as voice enablement of remote controls, our industry-leading QuickSet platform, and our highly integrated wireless chips. Over the years, we have delivered the technologies and products that power the majority of two-way voice-powered IP connected home entertainment platforms around the world. Our work to design, develop, and integrate our control solutions on multiple platforms continues as does our commitment to develop and bring to market the next generation technologies needed to power emerging entertainment and home automation control platforms. But I would like to share more details on the groundbreaking platforms we are preparing to introduce. For competitive reasons, our customers prefer to keep their projects confidential. One recent public announcement that exemplifies our work came from Liberty Global, one of the world’s leading video, broadband and communications companies with over 11 million customers in Europe. Having a long-term collaborative relationship, Liberty Global chose us for our proven technology, high quality, and shared commitment to sustainability. The majority of the advanced technology projects in development are designed with our proprietary QuickSet platform to improve the user experience. Next generation devices offer automated setup, ease of everyday use, and voice-driven control to enable consumers to search for content across all entertainment platforms from a single device. This is noteworthy, as convergence continues to be the underpinning trend in our industry. The number of people watching video just keeps growing as does the number of hours that they are watching video. Everyday consumers have more content available from on-demand libraries, over-the-top video streaming apps, live TV streaming, and linear TV broadcasts. They also have increasing sources of content, with major cable entertainment, content, and technology brands that are spending billions of dollars to continue to expand their presence. While some of the new streaming service providers are adding linear TV services, traditional cable and satellite operators likewise are creating hybrid platforms that integrate their linear TV with their own video on demand as well as popular over-the-top services. Major companies in the home entertainment space are moving in this direction for one simple reason: this is the type of platform that consumers want. They crave an easy way to choose from an almost infinite array of options and to get to what they want to watch quickly and easily. They want to watch their favorite sports team play live tonight followed by binge-watching a favorite show on Netflix, Peacock, Apple TV+, Disney+, Hulu, Prime, or another service. Other changes in home entertainment are even more dramatic; a substantial amount of technology development is aimed at altering how people watch television, which will modify who our customer is. As noted, we are working on confidential designs for new and existing relationships. We believe this is just the beginning of our next phase in the market evolution and UEI is well-positioned to capture these new opportunities and grow by delivering the overall control experience. In the coming weeks, months, and over the next year, we will provide more details on these exciting new developments. Regarding market pressures, we continue to leverage our strengths to manage external challenges. For the past decade, we have been discussing cord-cutting and its potential impact on the video service provider industry and our business. On our last quarter’s call, we discussed in detail the components of subscriber changes. We outlined that during the pandemic, there have been fewer terminations or lower subscriber churn. However, due to operator and consumer reluctance for professional home installation, there have been even fewer activations resulting in net subscriber declines, particularly for operators without self-install capabilities. Also, well before 2020, operators began shifting to self-installation systems because they are less expensive than those that required truck rolls, and they offer a better consumer experience with an easy plug-and-play set-top box, sent in the mail, no appointment needed. The pandemic is simply accelerating the march to self-installation powered by QuickSet. New home entertainment architectures, however, can take six to 18 months for our customers to design, build, and refine. So, while this change continues and is inevitable, it takes time. As adoption increases and drives sales growth, these more complex systems also carry higher ASPs. Further, regardless of the content delivery platform—set-top box, streamer stick, or smart TV—the big screen TV remains the predominant viewing choice, and consumers continue to need an advanced controller. UEI has long been the global industry leader in control technology for these different device types, and over the years, our differentiation from competitors has further widened. UEI has anticipated that the convergence among home entertainment devices of all kinds will lead to growth in home automation as well. As mentioned earlier this year, a major telecommunication provider has selected Nevo Butler as its branded voice-enabled digital assistant for blending entertainment and smart home control. We are on track to deliver this solution into select markets early next year. In summary, we are actively working with many of our existing and new customers from video entertainment, consumer electronics, home automation, and hospitality to bring new products and services to market. The products are at various points in the development cycle and give us confidence in our long-term growth and sustainable profitability. I will now 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. I will review the results for the third quarter of 2020 compared to the third quarter of 2019. Net sales met our expectations at $153.7 million. This compares to the third quarter of 2019 of $200.9 million. As expected, our third quarter sales reflect the impact of COVID-19 on our traditional home entertainment customers, specifically those without self-install capabilities. Our gross profit was $46.1 million or 30% of sales compared to 26.8% in the third quarter of 2019. Our strategic investments in R&D have resulted in technologies and products that yield higher gross margins. These technologies can be embedded in multiple devices sold in various form factors and distributed through multiple channels. We currently license our technology to three of the largest OEMs in the world, and as these OEMs expand their portfolio of products that incorporate UEI technology, our licensing revenue will continue to grow. We expect these positive trends to continue and for our fourth quarter's gross margin rate to exceed the 30 points achieved in the third quarter. Operating expenses were $29 million compared to $35.1 million in the third quarter of 2019, reflecting a level last achieved in 2016. R&D expense was $7.4 million this year compared to $7.6 million in the prior year quarter. SG&A decreased to $21.6 million from $27.5 million in the prior year quarter as a result of overall cost control and a decrease in variable expenses. Operating income of $17 million or 11.1% of sales exceeded the 10% operating margin milestone; this compares to $18.7 million or 9.3% of sales in the third quarter of 2019. Our effective tax rate was 21.4% compared to 21% in the prior year quarter. Net income was $13.1 million or $0.92 per diluted share compared to $14.3 million or $1 per diluted share in the prior year period. Because of the efforts made to improve profitability, including investments in R&D to develop higher margin products and a corporate restructuring to reallocate and reduce operating expenses, for the nine months ended September 30, 2020, we were able to achieve an operating margin of 10.1% of sales compared to 8.5% of sales in the same period last year. We also report the same level of net income at $37.3 million, with $118 million less in sales. Next, I will review our cash flow and balance sheet as of September 30, 2020. Cash and cash equivalents were $67.1 million compared to $58.8 million at June 30, 2020. Cash flow from operations continues to be strong as cash inflows were $39.3 million for the current quarter. This enabled us to reduce our offsetting line of credit by $23 million during the quarter resulting in an ending balance of $50 million. We also repurchased 91,000 shares for $3.4 million. We believe the future is bright, and UEI is very bright. As Paul noted, we have advanced technology products scheduled to be launched in late 2020 and into the first half of 2021. With sales growth expected to return in 2021 and UEI becoming a more profitable company with higher gross margins, lower operating expenses, and strong free cash flow, we believe UEI is currently undervalued, and our best use of cash is to repurchase our shares in the open market. Therefore, our Board of Directors has approved a plan to purchase up to 500,000 shares contingent on share price over the next few months. Now, turning to our guidance. Typically, third quarter sales, including holiday spikes, are greater than the fourth quarter sales. However, this year, we expect fourth quarter net sales to approximate third quarter's in a range between $150 million to $160 million compared to $174.8 million in the prior year. As mentioned previously, we expect our gross margin rate to exceed the 30 points achieved in the third quarter, leading to an expected record fourth quarter EPS ranging from $0.93 to $1.30 compared to $0.90 in the fourth quarter of 2019. We are reiterating our long-term growth targets of sales between 5% and 10% and EPS between 10% and 20%. I would now like to turn the call back to Paul.

Paul Arling, CEO

Thank you, Bryan. Time and again, we execute strategies and seize opportunities that continually improve our long-term market position, financial performance, and shareholder value. And over the past three and a half decades, during times of macroeconomic pressure, we have consistently emerged as a stronger company. We believe the same will be said for 2020. In fact, combining our improvements with new market opportunities, we believe we are at the beginning of our next phase of growth. UEI is powering the future of video entertainment and home control. Our leadership position in wireless control technology continues to capture the attention of market-leading companies worldwide and empowers them to develop their own advanced solutions. Live TV, on-demand content, and over-the-top apps continue to converge into easy-to-use, and easy-to-control home entertainment platforms. This trend yields enormous new opportunities for us. All of these factors are further proof of market trends we have been predicting for years. As I have said before, the home entertainment world is changing. In some cases dramatically, we are seeing a substantial amount of technology development in the home entertainment market that will change the way people watch television and will certainly change the perception of customers in our market, both existing and new. We are proud to have invested in positioning ourselves as the clear leader in this area and to be working with the companies that are changing the world of home entertainment and smart home control. As always, stay tuned. Operator, we would now like to open up the call for questions.

Operator, Operator

Thank you for taking our call. It seems that several developments have been delayed until 2021. Can you provide insight into how robust 2021 might be, assuming the overall environment, including the pandemic, continues as it is? Also, what is the potential for Nevo Butler as we head into 2021?

Paul Arling, CEO

Yes. First, I wouldn’t want to characterize it as it’s pushed out to 2021. Most of the projects that we are working on are on track. They are to be introduced either in this quarter, late, but let’s say, over the course of the next few months. They are on track, or they haven’t been pushed. We’ve had them planned and have been working on them. Some may come out in January, February, or March; customers' introduction schedules sometimes vary from the project plan, but nothing's been delayed. Everything is on track according to our customers’ plan. As far as we don’t provide that longer-term guidance. We are not currently providing any sort of numeric guidance for next year, but obviously from the statements you’ve heard from us, we are expecting with the introduction of these new programs, they are certainly an impetus for growth. We can’t really predict how the environment will be economically or pandemic-wise this year, but despite that, we have new projects coming that we think are going to be exciting and will sell well. Potentially even within the continued pandemic situation as most of these new programs are self-install capable, they will be less prone to being interrupted by any such lack of professional installation.

Richard Magnuson, Analyst

And I know you don’t provide long-term guidance, but it seems that 2021 could be very positive for Nevo Butler. Is that correct?

Paul Arling, CEO

While, yes, Nevo Butler will see an introduction in certain markets early next year, yes, right after the first of the year, and that technology as well as some other programs we’re working on. It’s not just Nevo Butler; there are other programs that we think are going to be quite exciting for the market.

Richard Magnuson, Analyst

Okay. And then you mentioned – you spoke a little bit about our licensing revenue and thinking about that and also some of the other higher margin businesses such as chip sales, software royalties. Can you provide any more additional color on that, such as any new customers you are working with or expansion with existing customers?

Paul Arling, CEO

Yes, expansion with existing customers, we can talk about a little. As you know, we’ve been working with some of the particularly the TV providers for some time. And what’s been happening is we’ve adopted new ones. Over the last, say year or year and a half, but in addition, once they introduce this feature in a portion of their product line, consumers love it, and they decide in the next model year to expand it to additional models and SKUs in their lineup so that the feature is becoming more prevalent in the product lines of those companies. The major brands in the industry—Samsung, LG, Sony—and such are leading to greater business for us.

Richard Magnuson, Analyst

Okay. And then my last question is that, we noticed Walmart is working with Comcast to put out their own TV. Could you just see a positive impact on UEI, or is there anything that you want to tell us about that?

Paul Arling, CEO

Yes, we can’t really talk about projects that haven’t been introduced yet; that would be for our customers to do. Certainly, sounds like an exciting development. I think at this point that might be an unconfirmed rumor. I’m not sure, but as things develop, we’ll be able to talk more about that if and when that time comes.

Operator, Operator

Thank you. Our next question comes from Greg Burns of Sidoti & Company. Sir, your line is open.

Greg Burns, Analyst

Yes, just to follow-up on the last question, is about Nevo Butler. What’s the economic model there? Is it a one-time sale, or is there any kind of recurring service components, recurring service component to the Nevo Butler, and how is the telco partner going to be distributing this? Are they going to be like giving it away or selling it into their installed base?

Paul Arling, CEO

Yes, Greg. I can’t speak to the particulars of this as we don’t give any economics for or units for an individual customer. But I will say this is a product that will bridge entertainment with other control mechanisms. So, it goes beyond AV control into other areas that I can say. And typically, in these, it’s not a one-time sale; we are obviously going to sell units to them. So, they will be buying Nevo Butler hardware in this case.

Greg Burns, Analyst

Okay. I mean is it only a hardware sale, or is there any kind of recurring back-end platform elements to it?

Bryan Hackworth, CFO

We will be able to talk more about that, potentially on the next call.

Greg Burns, Analyst

Okay. And Bryan, what were your 10% customers this quarter?

Paul Arling, CEO

We had Comcast at 21.2%, and then we had Sony at 10.4%.

Greg Burns, Analyst

Okay, great. Alright. And then in terms of Liberty Global, which you are I guess allowed to announce or talk about. Is that a net new win for you, or is that an existing customer, and they are rolling out a new product? It sounded like it was very similar to maybe what Comcast is doing with Flash, but maybe you could just talk about the nature of that relationship and what exactly the Liberty Global platform is that they are rolling out?

Bryan Hackworth, CFO

Sure. Yes, it’s a well-featured, again, as we spoke of earlier, IP connected advanced platform. So—and when I speak of new and existing customers, they would be listed in the existing customer category. We have some new ones that are coming along, but Liberty, we’ve had a very good relationship with for some number of years now. So, they have been working with us on a variety of platforms over the years; they are considered an existing customer.

Greg Burns, Analyst

Okay, alright, and any update on the Roku litigation?

Paul Arling, CEO

Nothing to speak of; the process goes on, and there is a trial date set for the first half of next year.

Operator, Operator

Thank you. And now we have Mr. Greg Burns from Sidoti & Company with another question.

Greg Burns, Analyst

Yes, hi. So just one last one on your margins. Obviously, you have driven really solid margin gains in the face of some pretty significant revenue headwinds. How do you think about if you are targeting growth next year? How do you think about the leverage you have built into the model, where margins—operating margins could go if we start to get some revenue growth here?

Bryan Hackworth, CFO

Yes, I mean right now, we are thrilled with the fact that we got over 11% in the third quarter. I mean we like the way things are headed. As we’ve talked about with licensing and other factors, our gross margin has expanded, and the operating expenses are under control. So, as we expect sales to grow in 2021, we expect to see leverage. So, I do expect expansion in the operating margin line. I don’t want to give our budgets right now; I’m not going to give a forecast for 2021, but I do think that we will continue to expand the operating margin line.

Greg Burns, Analyst

Okay. I mean so as these projects roll out, it’s not going to require much incremental spending?

Paul Arling, CEO

Yes. So, we have invested in R&D. A lot of the spend is occurring and has occurred. And as we mentioned, a lot of these investments that we have made are paying off nicely. So, you see it in the expansion of the gross margin line. To answer your question, there is not a lot of incremental spend, so as sales come in, the incremental profit is nice.

Greg Burns, Analyst

Okay, alright, great. Thanks.

Operator, Operator

Thank you. And speakers, I see no further questions in the queue. I will return the conference to you for closing remarks.

Paul Arling, CEO

Okay. Thank you for joining us today and for your continued support of Universal Electronics. In December, we will present at the Imperial Capital Annual Security Investor Conference, and in January at Needham’s Annual Growth Conference. Thank you for listening. Have a wonderful day.

Operator, Operator

Ladies and gentlemen, this does conclude today’s conference call. Thank you all for participating. You may now disconnect and have a pleasant day.