Universal Electronics Inc.
Q2 2023 Earnings Call Transcript

Published: 5 Nov 2023

[Operator:]

Good day, and thank you for standing by. Welcome to the Universal Electronics Third Quarter 2023 Financial Results Conference Call. At this time, all participants are in listen-only mode. After the speakers' presentation, there will be a question-and-answer session. [Operator Instructions] Please be advised that today's conference is being recorded. I would now like to hand the conference over to your first speaker today, Kirsten Chapman with LHA, Investor Relations. Please go ahead.

[Kirsten Chapman:]

Thank you, Sean. And thank you all for joining us for the Universal Electronics third quarter 2023 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. A webcast replay of this call including any additional updated material nonpublic 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 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 for connectivity, interoperability across devices, platforms, and the hybrid systems in the home; achieving new product development and design near and longer-term successes as anticipated by management in the connected home space in particularly the climate control market and its line of ultra-low power and energy harvesting control 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 markets, which result in increased sales and share growth in the new markets 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 financial discipline, operating efficiency, liquidity requirements and manufacturing footprint utilization, R&D spend, product line and business management and other investment spending expectations including our ability to execute our stock repurchase programs. on a timeline and to the extent expected by management; the continued fluctuation of the company's market capitalization, the impact to the company's financial statements that it may experience due to the supply chain constraints and inflationary pressures in macroeconomic conditions its consumers are experiencing, and direct and indirect impact the company may experience with respect to its business and financial results stemming from the continued economic uncertainty facing consumers' confidence in spending, natural disasters, public health crises, governmental actions or political unrest, including war terrorist activities or other hostilities. 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 documents the company has filed with the SEC including its 2022 annual report on Form 10-K and the periodic reports filed or furnished since then. In 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 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 these 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:]

Thank you for joining us today. UEI’s technology and products continue to help everyday people easily discover and interact with the devices and services in their home. We are the clear leader in this area as is evidenced by growing list of customers in home automation, climate control security and even home entertainment. During the third quarter, our efforts to control cost and optimize our manufacturing footprint which Brian will elaborate on in a minute began to yield benefits. For the third quarter of 2023, we increased gross margins to a high for this year and combined with lower expenses we delivered bottom-line, results in line, with expectations. Over the last three plus decades, the home entertainment market has changed greatly. Even more so, over the last couple of years, our prime home entertainment market customers, the video service providers have experienced dramatic net subscriber losses, which were exacerbated by the impact we endured since the pandemic began. Even with this market decline, it's important to note that our technology leadership continued to grow. We maintain market share, and we continue to win new projects in this channel. However, our absolute dollar amount of sales, particularly in subscription broadcasting has decreased substantially. Nevertheless, we remain committed to this market and continue to support our customers with next generation solutions, including many hybrid systems that combine linear, and streamed content and our new line of low-power sustainable energy harvesting products. In 2023, we selectively invested in new home entertainment product developments on a handful of differentiating and innovative applications with our customers. A few examples of these include, new control products for emerging streaming services, such as Sky Glass, as well as Liberty Global’s Babylon. Green ultra low power remote. These products began shipping recently and will continue the scale in 2024. Most importantly, our strategy to extend our technologies and wireless expertise in adjacent markets is progressing well, and we expect our revenues from the connected home markets to grow substantially in the coming years. As we have stated over the past few years, we have been repositioning our business to focus on high growth markets in the connected home space. The climate control market which we include in the overall connected home channel represents a significant growth opportunity for us. I will provide a deeper dive into this market to better highlight the growth opportunities ahead. The worldwide thermostat control market today for residential and commercial installations is estimated at $1.8 billion, excluding China and India. Industry experts forecast this market to grow at a compounded annual growth rate of more than 10% over the next five years. UEI has been active in the climate control market for over 10 years building LCD, remote controls, and wall mounted digital controllers for Daikin, Fujitsu, Panasonic and Toshiba, primarily targeting Asia Pacific and EMEA consumer markets where HVAC OEM brand controllers have the dominant share of the thermostat market. In the US, the market for smart thermostats today is mostly served by third-party and aftermarket brands. While these aftermarket products offer convenience and connectivity they only offer basic control of HVAC OEM equipment, and limited control of more advanced and energy efficient features in existing and new equipment, such as heat pumps, variable refrigerant flow, and dual fuel systems. As a result, many of the existing consumer branded smart thermostats miss the optimal control experience and lack the features to operate the HVAC equipment in the most energy efficient manner. With increased consumer focus on energy consumption optimization and greater emphasis on smart grid utilization, HVAC OEMs are now strategically prioritizing connectivity and interoperability in their controllers to deliver a better climate control experience for their customers. Leveraging, our long history, and user-centered product design, expertise in wireless device connectivity, and universal interoperability, we have been developing and commercializing a new line of advanced smart and connected thermostats and related sensors. The new portfolio, which targets North American, and European customers includes a comprehensive line of tactile and touch interface controllers with a smart home hub built in supporting standard for wire and proprietary control protocols for all the major HVAC brands. Additionally, the lineup includes a bridge product that can be wired to an existing HVAC system and wirelessly communicates to any of our tactile and touch thermostats mounted on tabletop stands that can be located anywhere in the home. A truly modular solution that can be mounted on the wall or conveniently placed anywhere in the home. The functionality of our climate control products is further enhanced with the built-in smart home hub that connects to our lineup of Zigbee sensors that include temperature, humidity, flood and freeze, occupancy sensing, door and window sensors, and CO2 monitoring. These products working together through software create a truly smart home experience. Systems that sense presence can bring both greater comfort and more efficiency creating a much smarter home environment. For example, our devices are sensing temps anywhere in the home, determining who is in the home and verifying whether doors and windows are open. We enable a range of control experiences including smart lighting, smart shade and blind control from the same smart thermostat screens, as well as blending smart home and entertainment experiences like whole home audio. Bottom-line we are meeting the user where they are in the home and offering solutions they care about. The software designed into our new product line is powered by QuickSet Cloud for secure connectivity, and our nevo virtual agent to simplify device onboarding and provide ongoing troubleshooting and support throughout the lifetime of the product, including sensor setup and configuration. Our user-centric approach and focus on delivering a truly connected experience for our HVAC customers brings new opportunities beyond energy management including HVAC and control system telematics to improve system design, user experience and predictive maintenance. Our climate control lineup has received rave reviews from our customers first as evidenced by numerous customer design awards ranging from HVAC OEM brands such as Mitsubishi Trane US called METUS, which was announced earlier this week, Toshiba Carrier, and LG, as well as smart home utility and energy companies. Through our investments and innovation in this market and product category, we believe that there is a window of opportunity for us in the next few years to double our revenues in climate control by focusing on penetrating and growing our footprint in North America. These products take time to define, design, develop and test and we expect to see sales results to slowly improve in 2024 and grow substantially in the years thereafter. Now, I’ll turn the call over to our CFO, Bryan Hackworth for a review of the financials. Please, go ahead, Bryan.

[Bryan Hackworth:]

Thank you, Paul. First, I'll review the results for the third quarter of 2023, compared to the third quarter of 2022. Net sales were $107.1 million, slightly below our expected range as a few customers ordered less than their submitted forecasts. This compares to $148.5 million for the third quarter of 2022, core cutting in the video service channel continues to be to be a headwind and an uncertain economic environment with inflationary pressures is likely causing households to spend less on discretionary goods. Gross profit for the third quarter of 2023 was $30.4 million or 28.4% of sales, compared to 30.8% in the third quarter of 2022. We're executing on our factory footprint optimization plan and these efforts are starting to pay dividends as this transition, coupled with a stronger US dollar contributed to sequential improvement in our gross margin rate of 300 basis points. I'd like to take a moment to provide an update on our footprint optimization plan. During the prior few calls, we've explained how over the past several years, the enactment of certain governmental policies and changes in the global environment necessitated the expansion of our Mexico facility and influence our decision to build operations at Vietnam. These expansions couple would lower demand in our video service channel and projected growth in the connected home, which requires fewer square feet of manufacturing space per sales dollar have resulted in having excess capacity in the need to streamline our factory footprint. As stated in our last call, we commenced operations at our newly built Vietnam facility in June and mentioned the closure of our southwestern China factory was contingent on our Vietnam facility reaching certain production targets. I'm pleased to announce manufacturing operations at Vietnam have exceeded our expectations enabling us to seize operations in our southwestern China factory in September, approximately one quarter sooner than expected. Furthermore, our Vietnam facility successfully completed the responsible business alliance factory audit and received a passing score. Upon reaching one year manufacturing anniversary in June 2024, we will be eligible and expect to achieve full accreditation. The next and final phase of our optimization effort is the streamlining of our operations and monitoring Mexico, which will result in a smaller and more efficient factory to meet production volumes for certain North American customers. This transition is currently in progress and we expect to complete it in the first half of 2024. Cost savings relating to these efforts combined with cost reductions at the corporate level, which we executed in the third quarter are expected to range from $15 million to $18 million on a fully annualized basis. Moreover, we expect the downsizing of our factory footprint, coupled with increased production volume associated with project wins in the connected home channel to ultimately yield the utilization rate exceeding, 90% with the flexibility to expand as needed. For the third quarter of 2023, operating expenses were $27.5 million, compared to $30.2 million in the third quarter of 2022. SG&A expenses reduced to $20.1 million, compared to $22.5 million in the prior quarter. R&D expenses remain consistent at $7.4 million, compared to $7.7 million in the prior year’s quarter. Operating income was $2.9 million, compared to $15.5 million in the third quarter of 2022. In the third quarter of 2023, we recorded tax reserve relating to incentives received at our southwestern China entity resulting in additional $500,000 of tax expense. Earnings per diluted share were $0.08 for the third quarter of 2023, compared to $1 in the third quarter of 2022. Next, I'll review our cash flow and balance sheet. On September, 30th 2023, cash and cash equivalents were $60.1 million, compared to $66.7 million at December, 31st 2022. For the first night months of 2023, cash flows provided by operating activities were $20.1 million, which we use to reduce our outstanding line of credit from $88 million at year end to $75 millionth at September 30th 2023, lowering our net debt position to only $15 million. Based on our modeling, supported by a strong balance sheet, existing project wins, projected growth in the connected home channel and expected continued positive cash flow in 2024, management and the Board believe UEI is significantly undervalued. Therefore, our Board of Directors recently authorized a stock repurchase plan of up to one million shares. We expect to take advantage of this opportunity now by initiating a buyback in the fourth quarter of 2023. Now, turning to our guidance. We expect sales to range from $95 million to $105 million, compared to $122.8 million in the fourth quarter of 2022. We expect EPS to range from a loss of $0.05 per share to earnings of $0.05 per share per diluted share, compared to $0.44 per diluted share in the fourth quarter of 2022. I would now like to turn the call back to Paul.

[Paul Arling:]

Thanks, Bryan. Our expansion into the growing connected home markets continues to be successful. Our innovative products and technologies ensure we are capturing new customer wins and broadening relationships, which is helping create new revenue streams. We continue to be by far the leading company in home entertainment control. We are building a growing position with enormous long-term potential in the connected home space. While we cannot share significant details of our product plans with specific customers, we have design wins with five of the top eight HVAC OEM brands in North America. That represent nearly 70% of the total HVAC market. These new projects, along with other connected home project wins represent over $80 million in new annualized revenue and we are actively qualifying and quoting opportunities that can lead to significantly more revenue potential. I want to be clear that we are not at this time, providing detailed numbers for next year. However, this level of project activity clearly demonstrates that we have a very healthy pipeline of new business, and an exciting and significant growth opportunity ahead of us. We are very confident in our ability to succeed and return UEI to growth in sales and earnings. Based on this conviction, as Bryan stated earlier, our Board has authorized a stock repurchase program for up to one million shares. The fact remains, our technology leads in home control, and our opportunities are abundant. We are all confident in our growth strategy and our long-term success. As always, stay tuned. Operator, we can now open the call for questions.

[Operator:]

[Operator Instructions] Thank you. [Operator Instructions] And our first question comes from Steve Franco with Rosenblatt Securities. Your line is now open.

[Steve Franco:]

Good afternoon. And Paul, I appreciate the transparency around the new opportunities and things like HVAC. In the last quarter, you also talked about that. And you talked about some of those products coming to the market in the back half, yet revenue was short of the market in Q3 and it’s down sequentially again in Q4. So, could you help us understand whether that’s incremental deterioration in your core subscription broadcast customers? Or are some of these newer projects taking longer to get to market?

[Paul Arling:]

Yeah. Well, I think, we said, we had 30 - more than 30 projects. I think we only had a couple of them launched and we'll probably have more, I mean, as time goes on as each month progresses more and more of them will layer on. We have projects going out now into ’25. And as I alluded to we've got over a hundred projects at the qualification and quote stage. And the revenue from them is much greater than that, which we've won already. Now, we won't win all those projects when they're in the qualification and quote stage, we don't win them all. We have a pretty good hit rate though. And so we think there's a a lot of business out there as we described in what was probably a deeper dive than some of heard from us on HVAC, I wanted people to understand the dynamics of that market. It's changing much like other markets have, home entertainment included. It's becoming much more energy conscious. It’s becoming much smarter and the products that our customers there are building have much more capability than the current ones on your wall. Most people on this call probably have thermostat. They may have connected thermostat that has an app on their phone, but it's just turning your system on and off to get to 72 degrees or whatever you've set it at. These systems are capable of doing much more. And we're working with companies in this market. As I said, five of the top eight are already actively working on projects with us, project wins with us for products to be introduced. So, and yes, the subscription broadcasting market, as we said and prepared statement has been tough for the last four years. It's gotten a little tougher recently with some have held in. But others have reduced further. As far as the future on that it's difficult to precisely predict. It's probably safe to say that our future plans won't include any significant growth from that market. We do think there are a lot of players there though that get it and are seeing that what consumers want is, they still watch. Linear TV for sports and other things. But then they want to go to streaming services and what the solution that has to be provided them is a combination of those two things. What we call a hybrid system. And many of the major companies here have invested in streaming boxes and even TV OSs to power those types of products to give the consumer the ability to have one device that they then turn on and can watch linear TV. Last night they could have watched the Arizona Diamondbacks lose the last game of the World Series. And then when they were discussing with that, they could go to a streaming service. Prime, Netflix, Hulu, YouTube, all in one interface. This is what consumers want. Our TV customers or CE customers understand that. They are building such things and that the subscription broadcasters. So I think that's a little bit of an offset, Steve, to some of the shrinkage. But for sure, that shrinkage over the last four years has heard us. It's more - it's less than half what it was four years ago. So that that is certainly heard and we are building a different business. We've been in HVAC control for 10 years as I said. We're building better and better products there. The good news is that again, five of the top eight in the US have already signed on to do projects with us. It's reminiscent of where we were in home entertainment 20 years ago, where we were relatively low share around 10% respectable, but not very big. And again we declared our God-given right to have it all and we're going out to pursue that. We think we make great products for that market. We're presenting them to customers and they're signing on for these design wins. We think it's a significant growth opportunity over the next couple of years.

[Steve Franco:]

Okay, a couple questions for Bryan. What were the customer concentration numbers in the quarter?

[Bryan Hackworth:]

We had one 10% customer in Daikin at 14.2%.

[Steve Franco:]

Okay. And do your pro forma gross margins reflect an essence to the full - a full quarter impact of not having that Western China factory? Or is there incremental improvement that’s implied in your Q4 guidance?

[Bryan Hackworth:]

There is incremental improvement implied. The answer to your first part is, yes. I do pro forma some of the overhead inefficiencies, but the way we're we've been trending, I believe the actual reduction will exceed what I've been pro forming. The last thing I want to do is perform more than what we ultimately are able to reduce. So I was a little bit conservative with that and that’s proven to be true. It's one of the reasons we have some upside in the gross margin rate. And then the FX is helping us the stronger US dollar versus the Chinese renminbi is helping us, as well.

[Steve Franco:]

Great. Thank you. I’ll turn it back in the queue.

[Operator:]

One moment for our next question. And our next question comes from Greg Burns with Sidoti.

[Greg Burns:]

Yes. Thanks. Just to follow-up on that, the gross margin discussion with the rationalization nearing completion. Do you expect to get the gross margins above 30% again? Is that the target the other target in mind, I guess, for where you think gross margins can get I know, it will be volume and mix dependent. But what do you - what do you think the business can sustain if we operate it?

[Paul Arling:]

Yeah, what we said is, we believe we can get back to historical levels. And that's in the 28 to 30 plus range. As you noted, there are a lot of variables that go in the gross margin rates, so any given quarter, there are many factors. But the way we're trending, the way the factory optimization plan is coming along and the project wins that Paul illustrated, I think we should - we're going to be at 90 plus percent utilization. And that will enable us to be running efficiently and we'll have capacity. We can expand it if needed. But with that, I expect to be back in the 20% to 30% range and we're already there. This quarter, we're over 28%. So, it’s coming to fruition. Now product mix comes into play, as well as you point out the royalties play a role. Right now, TV sales are down. They won't be forever. We've benefit from TV sales, as we sell our technology, when we license it, which is a 100% gross margin it gives us a royalty. So things of that nature also play a factor, but I do like where the growth margin rate is right now. I like the way that our operation team is operating. And Vietnam is a great testament to their performance. We’re able to shut that down one quarter ahead of schedule. And these aren't we've done it a few times now. So we're getting pretty good at it. But they're not easy transitions. So overall, I think these are going well from an operational perspective.

[Greg Burns:]

Okay. And Paul, you mentioned trying to or thinking you could maybe double your revenue from climate controls over the next couple of years. How much - what's the trailing 12 month revenue from climate control right now? Like what's the base of that doubling?

[Paul Arling:]

It’s a hundred. We don't give the specific number, but it's under a hundred. Okay.

[Paul Arling:]

Under a $100 million in climate control specifically.

[Greg Burns:]

Okay. And that the $80 million of that project pipeline of annualized revenue. I know you mentioned some of this extending out to ‘24, but I guess, how much of that do you expect to get in 2024? I know the timing of this project is hard.

[Paul Arling:]

I’ll can’t give you that specific number yet. There's a lot of variables. As I said, last quarter, the number of project wins is over 30. Each project has a date. That date is reliant on both our development of the control item, which we're usually pretty good at. But also the customers go often the companion product that goes with it, which we don't have control over. And sometimes they're done on time, sometimes even early. Sometimes they're a month or two late. So we tried to shy away from given two specific guidance across 30 - in the mid 30s projects, because there's a lot of variables in there. What I would say though is that, this is the nature of our business. It was in subscription broadcasting. It was in TVs. It was in home entertainment, generally and it is in HVAC, security, home automation. We’re selling B2B. We sell to a much wider breadth of customers, right? Because we go to the industry leaders. As I said, five of the top eight. Our goal will be to have eight of eight. And we're working on a few extras, or I shouldn’t say extras, a couple of the three that we don't have, we are in qualification or quote on. So we're looking to close everyone, just like we did in the other markets. Once we do that, every project adds another layer of revenue. Sometimes those layers are a half a million to a million, a million and a half, a year. But each one of them, when it comes on, can often be a five to - in HVAC it can be a five to eight year project where it gives regular revenue from that project. So that's the goal. Build those layers. We've got 30 plus projects. They estimate on the revenue from the connected home projects that we spoke about last time, but this time, it's given a little bit more breadth of detail on. Last time, it was number of projects, this time it's the annualized revenue of that was disclosed as $80 million. So, those are one projects and when they are already to ship it'll add $80 million.

[Greg Burns:]

Right. All right. Great. Thank you.

[Paul Arling:]

Now, those projects won't launch until late ‘24. But again, we're just going to keep adding layer-by-layer. And as I said, I think earlier we have I think another hundred projects that we're working on. Not fervently yet. When we start, it's a little bit of work to define the product and then we take it through a qualification and quote stage. Define the product, quote the product and then once you want it, that's when the real engineering development starts.

[Greg Burns:]

All right. Great. Thank you.

[Paul Arling:]

Yes.

[Operator:]

I am seeing no further questions at this time. I would now like to turn it back to Paul for closing remarks.

[Paul Arling:]

Okay. Thank you, everybody for joining us today and for your continued support of UEI. We plan to present at Imperial Capital’s 20th Annual Security Investor Conference in December and Needham’s 26th Annual Growth Conference in January. I think they're in New York in the middle winter, but nonetheless and we will be at the International CES in January 2024 in Las Vegas. In addition to launching our complete line of comfort climate control products, we will demonstrate use cases around our long-term commitment to the HVAC market. And a view of what we hope to achieve in this new product category. We call it climate control reimagined. I hope some of you are able to make it there, please let us know. We can schedule meetings or visits and demos. Look forward to seeing you there. If you can be at any of those conferences, or of course, CES. Thanks again and have a great day.

[Operator:]

Thank you for your participation in today's conference. This does conclude the program. You may now disconnect.