Earnings Call Transcript - UEIC Q2 2022

Operator, Operator

Good afternoon. My name is Kathy, and I will be your conference operator for today. At this time, I would like to welcome everyone to the Universal Electronics Q2 2022 Financial Results Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. Thank you. And Kirsten Chapman of LHA, Investor Relations, you may begin your conference.

Kirsten Chapman, Investor Relations

Thank you, Kathy, and thank you all for joining us for the Universal Electronics second quarter 2022 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 or visit the Investor Relations section of the website. This call is being broadcast live over the Internet, and a webcast replay will be available for one year at www.uei.com. Any additional updated material nonpublic information that might be disclosed or 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 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 leveraging our wireless connectivity capabilities to the smart home automation, security and hospitality and our groundbreaking line of ultra-low power and energy harvesting remote controls designed for sustainability that will be accepted by our existing customers and attract new customers. Our ability to manage the global supply chain issues, which includes material shortages that our industry has been dealing with, particularly with respect to obtaining semiconductors as well as the effects of the natural disasters and public health crises, including the COVID-19 pandemic, both of which continue to have both the direct and indirect impact on our sales. The continued successful collaboration with existing and new customers in developing and introducing next-generation products and operating systems and technologies, which result in increased sales opportunities for the Company. management's ability to continue to manage its business inventories and cash flows to achieve its net sales margins and earnings through its mitigation efforts. The impact of the Company's financial results that it may experience due to supply chain issues, material shortages and inflationary pressures we and consumers are experiencing. 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 or documents that the Company filed with the SEC, including its annual report on Form 10-K and the periodic reports filed since then. In management's financial remarks, adjusted non-GAAP metrics will be referenced. Management provides adjusted non-GAAP metrics because it uses them for budgeted 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 performance and trends. In addition, management believes these measures facilitate comparisons with the core operating and financial results and business trends of competitors and other companies. A full description and reconciliation of the 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's now my pleasure to introduce Paul Arling. Please go ahead, sir.

Paul Arling, CEO

Good afternoon, and thanks for joining us today. Our resilient business model, technological innovation, commitment to service and financial discipline built our rock solid foundation. This base sets the stage for long-term growth. In fact, we have successfully leveraged our wireless connectivity advantages to address new use cases and penetrate additional markets such as home automation, HVAC, lighting and blinds. This strategy is paying dividends as we have continued to win projects in home automation and security this year. Our performance for the second quarter was good as revenue met our expectations and EPS was higher than expected at $0.66 per share. Over the past few years, we have been asked some difficult questions. When will logistics lighten up? When will the chip shortage end? And when will the economy reach an inflection point? Well, we all wish we had a crystal ball to definitively answer these questions, but we don't. Clearly, consumer behavior is being impacted by rising food and fuel prices. This leaves less of consumers' budgets for entertainment, merchandise and other discretionary items. Although economic factors continue to dampen near-term visibility and the exact timing of future improvements is elusive, I will share with you what we do know. Logistics seem to be improving each quarter, and we are hopeful the trend will continue. Semiconductor fabs are being refabricated and built in the U.S. and across the world, which will most certainly create increased chip supply in 2023 and 2024. As I have stated before, there has been hundreds of billions of dollars committed to increased semiconductor supply. While we are dealing with this shortage now, we believe that it will dissipate in the not-too-distant future. At UEI, we continue to manage what we can control, which includes creating new products and engaging and supporting our customers. This strategy has prevailed during other times of challenge in our 35-plus years, and it is proving fruitful now as well, creating innovative, industry-leading solutions that simplify a consumer's life in their home has long been our goal. We have succeeded over our history in achieving this goal and continuing to achieve this will lead to our long-term success regardless of any short-term economic headwinds. In the last few months, we have seen a good amount of positive commercial activity by both expanding our footprint at existing customers as well as attracting new customers. These successes keep us excited about our future growth potential. In our home automation and HVAC business, we are gaining momentum. We announced the new Smart Home Controller and Gateway for PowerView the motorized shades and blind system from Hunter Douglas, the world's largest supplier of window coverings. We expanded our activities with leading U.S. security provider Vivint Smart Home with energy-efficient connected smart thermostats and sensors. Interest in our products and technologies continues to grow from HVAC OEMs across the world as well as smart home security and hospitality service providers. Multiple wins in these areas will fuel growth in 2023 and beyond. Turning to our entertainment control customers. We are already serving the leaders in the markets, including Samsung and LG by spending years winning projects, impressing customers with quality and innovation, embedding UEI technologies as must-have features and increasing our market share. We are confident that our customer roster and strong relationships are evidence of our long-term commitment to growing our position. More recently, we won projects, including our award-winning energy-efficient rechargeable Android TV remote control platform, our QuickSet-enabled extreme low-power controlled silicon solution and the new Apple TV controller for TV service providers. In addition to new project wins, we also expanded our product and technology offerings during the second quarter. With respect to RDK, the cable industry's leading video entertainment service platform. We introduced two new voice control remotes targeted at operators who want turnkey solutions using the same technology ingredients available in 75 million products UEI has already shipped with the platform. In the climate control domain, we expanded our connected thermostat offerings marketed in cooperation with CommScope's RUCKUS to help property managers and hoteliers reduce energy consumption. This solution has garnered significant interest due to rising energy costs across the globe. Additionally, our consumer brand One For All recently launched a new award-winning streaming-centric control solution to address the growing challenge consumers face when they have multiple subscription streaming services on multiple streaming platforms. These are just a few examples of what our teams are working on to create solutions that address the control requirements of the leading players in the markets we serve. Before I turn the call over to Bryan, I'll provide an update on legal proceedings. As you all know, we have been engaged in continued litigation against Roku. We have done so to protect our highly valuable and differentiating intellectual property. And as we have previously reported, we have prevailed in our offensive actions against Roku, gaining a win through the International Trade Commission with a finding that certain of Roku's core remote control products infringe one of our key QuickSet patents, resulting in the ITC issuing both an exclusion order and a cease and desist order, requiring Roku to stop importing and selling the infringing product. In this continuing effort, I am pleased to report that we again obtained a very important win against Roku this past June, when we successfully defended ourselves against Roku's retaliatory ITC action, in which two patents Roku asserted against us were found to be invalid and that Roku failed to prove that it had established the requisite domestic industry in order to prevail. With these two very important wins, we remain confident that we will prevail in the related federal district court cases. Now I'll turn the call over to our CFO, Bryan Hackworth, for a review of the financials. Go ahead, Bryan.

Bryan Hackworth, CFO

Thank you, Paul. First, I'll review the results for the second quarter of 2022 compared to the second quarter of 2021. Net sales were $139.1 million compared to $150.6 million for the second quarter of 2021. Squarely within guidance, Q2 sales reflected a quarter without a factory shutdown or logistical issues related to the COVID pandemic. Although supply constraints still persist, most notably surrounding the chip shortage, our Q3 revenue guidance, which I'll provide in a minute, reflects a positive quarterly trend. Gross profit for the second quarter of 2022 was $40.5 million or 29.1% of sales compared to 30.5% in the second quarter of 2021. We've experienced inflationary pressures relative to component parts, freight and labor. In an effort to mitigate the effect inflation is having on our gross margin rate, we phased in sales price increases throughout the first and second quarter of 2022. Operating expenses were $30.4 million compared to $30.1 million in the second quarter of 2021. SG&A expenses decreased to $22.1 million from $22.7 million in the prior year quarter. R&D expenses increased to $8.3 million compared to $7.4 million in the prior year quarter as we continue to invest in developing innovative solutions for a range of products in multiple channels. These internal investments have enabled us to consistently improve the user experience in our core markets as well as gain market share in new channels such as security and home automation. Operating income was $10.1 million compared to $15.8 million in the second quarter of 2021. Our effective tax rate was 11.8% compared to 15.8% in the prior year quarter. For the second quarter of 2022, net income was $8.4 million or $0.66 per diluted share compared to $13.6 million or $0.98 per diluted share in the second quarter of 2021. Next, I'll review our cash flow and balance sheet. We ended the quarter with cash, cash equivalents and term deposits of $54 million compared to $60.8 million at December 31, 2021. Cash flow from operations for the second quarter of 2022 was just under $1 million. In the second quarter, we came across a fortuitous opportunity to purchase a higher quantity than originally expected of certain components, most importantly, a specific chip, which is used across many of our product platforms. Given the current difficulty in procuring requisite parts, we took advantage of this opportunity amounting to approximately $8 million of additional inventory. During the second quarter, we purchased 130,000 shares for $3.9 million, bringing the year-to-date total to 355,000 shares for $11.2 million. Now turning to our guidance. As expected, we've seen some improvements in the supply chain, most notably for us, in transportation. As far as the component shortage is concerned, although we've been able to take advantage of specific buying opportunities relative to certain parts, the environment has remained largely unchanged. However, the macroeconomic environment is more uncertain with inflationary pressures taking a toll on consumer confidence as rising prices for essentials such as food and gas are leaving less room for discretionary purchases. Although we are facing these headwinds, our third quarter sales are expected to continue to improve sequentially. For the third quarter of 2022, we expect sales to range from $145 million to $155 million compared to $155.7 million in the third quarter of 2021. We expect EPS to range from $0.70 to $0.80 compared to $1.03 in the third quarter of 2021. We reiterate 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. We are the global leader in wireless universal control solutions for home entertainment and smart home devices. Many times throughout our history, we have managed various economic challenges and emerged stronger each time. We followed our vision to create smarter living by delivering high-quality products with great innovative features that consumers want. As a result, we earned our clear leadership position in home entertainment and are replicating this success within other related applications in the home. The fact is, when today's headwinds dissipate, companies that continue to invest in truly innovative products and technologies, build better products that simplify people's lives and foster strong relationships with customers will rise to the top. UEI has done this before and will continue to in the future. As always, stay tuned. We can now open the call up for questions.

Operator, Operator

And first, we will go to Jeff Van Sinderen of B. Riley.

Jeff Van Sinderen, Analyst

Hi, everyone. I jump right into it here. Just wanted to see, I guess, it sounds like a couple of moving parts as far as your expectations for the P&L, happy to see sequential improvement expected for Q3. As the overall demand picture changed at all, I'm not sure it's changed a little bit, but has it changed overall in a meaningful way from the last quarter report? And if so, any more color on that? And I guess it's early, but how are you thinking about Q4 and how the P&L progression may take shape on sales expenses, margins, do you expect to inflect to year-over-year growth in Q4?

Paul Arling, CEO

Yes, Jeff, it's Paul. I don't think that anything has changed. The projects that we've spoken about are all coming on board. The only thing that may have changed is just the macro environment. I just feel like customers, major companies within the industry are looking at the economy with some wonderment, where it will be three months from now, probably two months from now, but three, four, five, six months from now is a difficult prediction right now. Will inflation temper, will gas prices drop? If those things begin to happen, more of consumers' money will be able to be spent on other things. If it gets worse, then it won't. You've got other smaller factors. This year, the World Cup, which doesn't really affect the U.S. as much as it does the rest of the world. But the World Cup for the first time is being held in the winter. This is, in some ways, like Christmas being in July. It's different. It's difficult to determine exactly what the effect of it will be. It's usually a very positive effect for entertainment. So there's that as a potential upside. But there's just so much uncertainty right now as to where the economy will be even six months out, more than we've seen in past years, you usually would know six months out, you have at least a decent prediction. Right now, I just think it's difficult to gauge where the consumer will be really six months from now. We have a pretty good view of the next three because customers, of course, have lead times and orders. And of course, as Bryan said, sequentially, we're up, and we've got some new projects in there that we think are good. But the effect of these things in a really good market are very strong, and the effect of a new project in a weaker market is still good, but not quite as strong. So it's difficult to gauge where things will be. We know they'll be okay. And again, our products are on track, will come out, but in what type of environment. We've been so burned over the last few years, not just us, but every company in the world by unpredicted things that have happened between COVID and the chip supply, the economy, the gas prices, et cetera, that it's just difficult to know where things will be six months from now or 12 months from now.

Jeff Van Sinderen, Analyst

Sure. Understandable. And obviously, you guys had some different things come out of left field that you've had to deal with over the years. If we can shift maybe to home control, automation and HVAC, I know you spoke to some wins there, extended partnerships. You talked about Hunter Douglas. Maybe you can elaborate a bit more on how you expect that business segment to develop both the near term and then longer term, I realize it is a little bit longer kind of a cycle.

Paul Arling, CEO

The projects in this area generally take a long time to develop, but the advantage is that they tend to have a long lifespan. For example, television designs are usually updated every year. In these markets, once we secure a design, it can remain relevant for a decade or longer, depending on the product. Therefore, winning the design is crucial, and while it can take a year or more to achieve this, it may also take an additional year to finalize and launch the product, largely dependent on the customer as we are typically part of a broader system. The silver lining is that these designs usually have a long lifespan. This market is currently transforming and experiencing significant growth, especially in HVAC, which is one of the fastest-growing segments we cater to with double-digit growth rates. Our market share in HVAC isn't as large as it is in home entertainment, presenting a significant opportunity. As we introduce innovative solutions to this market and assist customers with IP connectivity and integration with other home systems—an area in which we excel—we see a real potential here. It may take time, but we are already achieving success. Contrary to any assumptions that we are not involved in HVAC, it has now become a business exceeding $100 million. Notably, our largest customer this quarter was an HVAC company, Daikin. This is an exciting field where we've demonstrated our capabilities and are securing design wins globally; some client names we cannot disclose yet, but we will in the coming year. Regarding Hunter Douglas, who is the world leader in window coverings, we are working with them to develop interconnected control products for the home. We are recognized as a leader in this space, and our design and manufacturing strength is unmatched, with high interest from customers in enhancing their product lines. We believe this segment holds tremendous growth potential, aligning with the overall double-digit growth rates in these markets.

Jeff Van Sinderen, Analyst

Okay. Good. Well, listen, I'll just say congrats on those recent wins, especially Hunter Douglas, it's great to see, including the legal wins, throw that in as well. I'll let someone else jump in. And best of luck.

Operator, Operator

And now we'll take a question from Steven Frankel of Rosenblatt.

Steven Frankel, Analyst

Paul, thanks for the opportunity to ask some questions. I know in the past couple of years, you're customers really struggled much with supply chain issues getting the set-top boxes as anything else. But we've also seen some acceleration in cord cutting impacting virtually everybody in that space. To what extent is that affecting their order patterns with you?

Paul Arling, CEO

It would certainly have an impact. However, the key point is that people aren't actually watching less television. For specific customers, we may observe a decline, but at the same time, we see order patterns from other customers increasing. The main way people access streaming globally is through television, and the top three companies in that market are often long-term customers of ours. While there is a shift in behavior, it may not be as sudden as many believe, but it certainly does have an impact on our operations. There are customers whose volumes have decreased over time, while others have increased. Additionally, HVAC has become a significant part of our business, which has helped balance things out. Over time, it has certainly caused an effect.

Steven Frankel, Analyst

And if I go back to last quarter, you hinted about a couple of large HVAC or home innovation new wins that would ship in the back half and lead to significant increase relative to rate where you can. And certainly, your third quarter guidance implies a move in that direction. Are those wins still on track to ship by end of the year?

Paul Arling, CEO

Yes, the question relates to lead times and the semiconductor situation. The issue arises if products are successful and orders for parts haven't been placed; the concern is whether there are enough chips to meet demand. This puts us in a difficult position where we have to either order a large quantity of parts or risk not being ready for an increase in demand. We are witnessing some of this challenge now, as some customers have increased their orders and we are trying to source the necessary parts to meet that new demand. Currently, predicting demand is quite complex. While our products typically have fewer semiconductors compared to, say, automotive companies—which may have thousands in a single product—we do have customers whose products contain many chips. If those customers are missing just a couple of essential parts, they can't fulfill their own production requirements, even if we manage to secure the necessary components for them. Historically, semiconductor shortages have occurred periodically, and they eventually resolve as production capacity increases, especially when demand surges. Recent demand escalated faster than supply, exacerbated by COVID-related disruptions. We're starting to see some of our suppliers increase their output, although not all are keeping pace. Looking ahead, we anticipate that demand in the latter half of the year may slightly exceed our ability to supply chips. Our operations team is working hard to secure additional components, but the situation remains challenging compared to two or three years ago. If we needed an extra million parts back then, it was relatively easy; now, it’s a struggle. I expect this issue will carry into 2023, though we are starting to observe some improvements at the leading edge. As production capacities ramp up, it may seem difficult to believe now, but we will eventually reach a point of overcapacity again. It's a long way off, but once we do, supply should no longer be a problem.

Steven Frankel, Analyst

Okay. And then on the price increases, will they have any material impact on growth margins in the back half?

Bryan Hackworth, CFO

We implemented price increases in the first and second quarters. The increases from the first quarter had a significant impact, particularly in the second quarter, while the increases made throughout the second quarter will be fully felt in the third quarter. Therefore, we expect a greater effect in the second half of the year compared to the first half, as we were dealing with partial quarters.

Steven Frankel, Analyst

Okay. And then just the bank in and Comcast's revenue concentrations?

Bryan Hackworth, CFO

Yes. As Paul talked about, Daikin was actually our largest customer for the quarter. They came in at 15% and Comcast was at 13.5%.

Steven Frankel, Analyst

Okay. And then, Paul, you want to give us two minutes on the acquisition that you made in the quarter?

Paul Arling, CEO

Yes. We acquired a small company that specializes in embedded software for the TV industry. We believe this acquisition is synergistic with QuickSet. The company has connections with many clients that QuickSet hasn't reached yet, while we have numerous QuickSet customers that they haven't engaged. Though it’s a small acquisition, it's an interesting company from Nielsen that has experience with embedded software for televisions. It complements our efforts with QuickSet in the TV sector.

Operator, Operator

Our next question will come from Brian Ruttenbur of Imperial Capital.

Brian Ruttenbur, Analyst

Yes. A couple of quick questions. And I think last quarter call you talked about a really strong second half of the year. I know you're giving guidance for third quarter, and I know you don't have a crystal ball, you've already stated that. But how is fourth quarter potentially shaking out for you guys or the year of the full fiscal year? Or is it too early to tell?

Bryan Hackworth, CFO

Yes. As Paul mentioned earlier, we still have strong orders for Q4 and new customer wins as discussed in the last call. We're scheduled to ship, but there are some uncertainties compared to last quarter. One concern is consumer confidence, which seems to be declining. The question is whether this will negatively impact our Q4 sales. While I haven't observed any significant issues yet, it's a concern. If consumer confidence continues to decrease, it might lead to reduced orders in retail, affecting our consumer electronics channel and ultimately the consumer space. I'm not suggesting this will definitely happen, but it's a consideration. Additionally, even with our positive wins and scheduled shipments, we wonder if we can fulfill all the orders. There's been some improvement in the supply chain, especially in transportation. We managed to acquire more of a specific chip in Q2, but challenges remain with other chips. This doesn't mean we will be unable to meet demand, but it introduces some uncertainty. Overall, our order perspective looks strong, and customer wins are going well. Sales were approximately $132 million in Q1, $139 million in Q2, and are expected to be $150 million in Q3. The trend is positive, but the key question is whether we can fill all the orders and if consumer confidence will remain strong enough to avoid any impact on Q4 orders.

Brian Ruttenbur, Analyst

Great. In terms of SG&A, you had a big drop from quarter-to-quarter. Was there layoffs? Or was that just less sales, so therefore, less commissions?

Bryan Hackworth, CFO

No. I think total operating expenses were a little bit less in Q1, but not materially. I mean I think operating expenses for Q1 and Q2 were somewhat comparable. And in Q3, I don't expect it to be materially different from that.

Brian Ruttenbur, Analyst

Okay. And then last question on Roku. When can we expect anything in the near term that we should be looking for, state in a different way, coming out of the Roku situation?

Paul Arling, CEO

As for the district court cases, they haven't progressed yet, and that will depend on the actions taken by the PTAB regarding the IPRs. However, it's clear that within the next few years, all the IPRs will be resolved. They initiated IPRs against the patents and in some instances, they were appealed when the outcomes were not favorable to them, which takes time. Once those processes are finished, the case will proceed. So it's likely not going to happen in the next few months, but rather in the coming years before the case is finally heard. To date, we have won both times we've gone to court, regarding the exclusion of our CDO when we were the plaintiffs and on the defense side, where both patents they were suing us with were ultimately found invalid.

Operator, Operator

We'll now go to Bill Dezellem of Titan Capital Management.

Bill Dezellem, Analyst

Would you please remind us what the magnitude of the price increase was in the first quarter? And then secondarily, in the second quarter and how much of that was fully realized in Q2?

Paul Arling, CEO

Yes. We were specific about price adjustments for each customer because every customer's product varies slightly. More differentiated products with higher costs were more affected by inflation. We aimed to be precise and fair, applying higher increases where costs had risen more significantly. Therefore, we didn't implement a flat increase like 4%, 6%, or 1%. Each product was evaluated individually.

Bill Dezellem, Analyst

And have you taken those numbers on a product-by-product basis and aggregated them to identify what that surgical effect ultimately ended up being overall?

Paul Arling, CEO

Yes, it's possible to do that. However, when implementing a price increase, you need to consider the mix of how many units of each product you expect to sell. We did not perform that calculation at the time or since. The price increase reflects that sometimes customers have placed orders before the increase takes effect, which we deliver at the previous price. If customers have existing purchase orders, we do not raise prices on those, even though we could. Therefore, the price increase comes into effect gradually. Our goal is to manage these increases effectively, and they have been received fairly well. Generally, in our industry, price increases are associated with cost reductions. Customers typically expect us to share some of those savings with them. They are reasonably understanding of the current economic conditions, acknowledging that raw materials and labor costs have risen, which justifies the price increase. The aim is for customers to absorb these higher costs, recognizing that competitors face similar challenges. As a result, they have largely accepted the price increases.

Operator, Operator

And with that, that does conclude the Q&A session. I would like to turn the call back over to Paul Arling for any additional or closing comments.

Paul Arling, CEO

Yes. Thank you for joining us today and your continued support of UEI. I would like to say that we plan to present at the Sidoti Small Cap Virtual Conference in September. We hope to see you or talk to you soon. Have a great day.

Operator, Operator

And this does conclude today's conference call. We'd like to thank you all for your participation. You may now disconnect.