Universal Electronics Inc.
Q3 2008 Earnings Call Transcript

Published: 24 Nov 2008

[Operator:]

Welcome to the Universal Electronics third quarter earnings conference call. At this time, all participants are in a listen-only mode. Following Management's prepared remarks, we will hold a Q&A session. (Operator instructions) As a reminder, this conference is being recorded, November 6, 2008. I would now like to turn the conference over to Kirsten Chapman. Please go ahead, ma'am.

[Kirsten Chapman:]

Thank you, Kirsten, and good afternoon everyone. Thank you for joining us for the Universal Electronics 2008 third quarter earnings conference call. By now, you should have received a copy of the press release. If you have not, please contact Lippert/Heilshorn and Associates at 415-433-3777, and we will forward a copy to you. This call is being broadcast live over the Internet. A webcast replay will be available at www.uei.com for one year. In addition, a telephone replay of this call will be made available for 48 hours beginning two hours after the conclusion of this call. To listen to the replay, in the US, please dial 1-800-642-1687 and internationally dial 1-706-645-9291. Enter access code 68335008. Also, any additional updated material nonpublic information that might be discussed during this call will be provided on the company's website at www.uei.com shortly after the call where it will be retained for at least one year. You may also access that information by listening to the webcast replay. After reading a short Safe Harbor statement, I will turn call over to management. During the course of this conference call, management may make projections or other forward-looking statements regarding the future events and the future financial performance of the company, including the benefits the company expects as a result of the development and success of the products and technologies including new products and technologies and the company's home connectivity line of products and software such as Delta, the company's next-generation Nevo products, and its XMP-2 technologies, the recently announced new contracts with new and existing customers and new market penetrations, the growth expected as a result of the digital-from-analog conversion, the expected growth in digital TVs, PVRs, and other overall growth in the company's industry, the company's ability to timely deliver its products to its customers as explained during this call, the company's continued sales, operating income, net income, and EPS growth, the company's ability to attract and obtain new customers, particularly in Asia, and the strength of the company's financial position, and the impacts the company may experience due to the continued softness in its worldwide market due the current economic environment. Management wishes to caution you that these statements are just projections and actual results and events may differ materially. For further detail on risk, management refers you to the press release mentioned at the onset of this call and the documents the company files from time to time with the SEC including the Annual Report on Form 10-K for the year ended December 31, 2007, and the quarterly report on Form 10-Q filed since that time. These documents contain and identify various factors that could cause actual results to differ materially from those contained in management's projections and forward-looking statements. On the call today are Paul Arling, Chairman and Chief Executive Officer, who'll deliver an overview; and Bryan Hackworth, our Chief Financial Officer, who will summarize the financials. Then Paul will return with a vision of 2008, and we will open the call to questions. It is now my pleasure to introduce to you Paul Arling, Chairman and Chief Executive Officer. Please go ahead, Paul.

[Paul Arling:]

Thank you, Kirsten, and welcome everyone. In this unpredictable and challenging economic environment, we continued to execute our strategy and reported record sales for the third quarter of 2008. While third quarter sales were slightly below our forecast, we did deliver a year-over-year growth of 11% to $76.5 million. We believe our experience successfully managing through all phases of the economic cycle is integral to helping us persevere through this unpredictable economic atmosphere. Our financial position continues to be very strong. Our market position has never been stronger and the trends driving growth in our business are projected to continue. Before I go over a review of our quarterly highlights, I will review what is happening near term in our markets. Our business category remains solid and revenue met our guidance. Our relationships with our subscription-broadcasting customers are very strong, and to date sales continue to be driven by the ongoing trends of the transition from analog to digital from standard definition to high-definition and from non-DVR to DVR. Our consumer category on the other hand was impacted severely. We saw a swift deterioration of the European markets, which is expected to last through the remainder of the year. The most affected in the third quarter was the UK. In addition, the economic turmoil reduced consumer spending on consumer electronics, which reduced foot traffic to our accessory products. In turn, our consumer category customers froze some September orders. We expect the economic environment will continue to negatively impact our consumer category sales for the remainder of 2008, which is reflected in our current forecast. Overall, we are monitoring the situation closely. Right now, all of our customers are on track with our current projections and we continue to anticipate a record fourth quarter in company net sales. Even during this challenging time, our employees remain focused on our long-term strategies. During the quarter, we made some more progress developing new technology, winning new customers, and expanding relationships. We developed a new remote line named Excite, which was introduced this fall at EFA. Its features include guided out-of-the-box on-device software for quick setup and web-based software for complete personalization, color LCD screen and LCD touch screen interfaces, control of up to 18 devices, and compatibility with virtually any brand and advanced features like activity macros and learning. In addition, in 2008, we developed the Delta, our universal 2-device remote designed to be pre-programmed to a digital-to-analog converter and programmed by the user to operate his or her televisions. The Delta is uniquely positioned to benefit from the analog to digital transition. We have started shipping the Delta to remote set-top box manufacturers and a major MSO in the US. It is estimated that over the next five years, the number of homes that receive digital signals will nearly double to 636 million households or half the world's TV homes. This indicates digital growth will accelerate especially outside North America and Western Europe. Over the next five years, it is estimated that nearly 300 million digital homes will be added. It is also estimated that 26 million homes be will added in India alone over the next five years making it one of the fastest growing countries in our industry. We are excited to announce we have begun supplying products to Reliance Communications, India’s leading integrated telecommunications company. We are providing Reliance with wireless devices for their Big TV direct-to-home service rollout currently taking place in India. The service is being rolled out over 6500 towns and cities and will be made available through retail outlets across the country. We think that Reliance provides an excellent example of the pace of growth possible in other regions of the world. Reliance launched its DTH service Big TV on August 19, 2008. Big TV acquired 500,000 subscribes within 60 days of launch. This is the fastest ramp up ever achieved by any DTH operator in the world. As announced in August, we have begun shipping wireless devices to Onkyo, for a range of its product lineup. In addition to the initial development agreement, we have continued to work with Onkyo to develop new remote controls for more of its devices. We also began shipments to Audiovox during the third quarter as planned. There are promising trends in the marketplace that bode well for our business. Projections indicate DVRs are currently found in over 27% of US households, a figure that has doubled in the past two years with a continued push from cable, DBS, and Telco TV providers, it will likely double again over the next 4 years. We continue to execute on our goals of growing and deepening customer relationships, winning new customers and introducing new products. In particular, we are focused on expanding our OEM business and our reach into Asia. Most importantly, we are not sitting still. We have excelled during lean times before and we intend to do the same now. Even though near term economic circumstances have caused our results to fall short of what we expected, we still anticipate a record quarter for UEI in both sales and EPS in the fourth quarter. But even more important than that is that we remain extremely optimistic about the position we have built as a leader in wireless control of home entertainment, and regardless of the economic environment, we will continue to build on that strength. We will do this because the powerful trends affecting the home entertainment market across all regions of the world continue and the resulting long-term growth prospects remain extremely attractive. With that, I will turn the call over to Bryan Hackworth, our CFO to lead us through the financial discussion. Bryan?

[Bryan Hackworth:]

Thanks, Paul. Net sales for the third quarter of 2008 were $76.5 million, up 11% compared to $69 million in third quarter of 2007, but below our guidance primarily due to the shortfall in European retail sales. Business category revenue was $51.3 million, within our guidance of $51 million to $54 million, and up 10% over the third quarter of 2007 revenue of $55.9 million. Our Consumer category revenue was $15.2 million, below our guidance of $16.5 million to $19.5 million, but growing 17% over the third quarter of 2007 revenue of $13.1 million. Gross profit for the third quarter was $24.9 million or 32.6% of sales compared to guidance of 35% plus or minus one point and compared to 37.3% of sales a year ago. Our gross profit percentage was negatively impacted by the shortfall in our higher margin European retail sales accounting from lower than expected percentage of our total sales. In addition, in these difficult economic times, customers gravitated towards more value-oriented products, which yielded lower gross margins. R&D expense was $2 million, consistent with R&D spend in the third quarter of 2007 of $2.1 million. Total operating expenses were $19 million for the third quarter of 2008, below our guidance of $19.9 million to $20.5 million and compared to $19.5 million in the third quarter of 2007. The decrease reflects general cost control as well as reduction in the management incentive compensation. The 2008 third quarter operating expenses included $792,000 of employee stock-based compensation expense compared to $876,000 in the third quarter of 2007. Interest income for the quarter was $859,000 compared to $879,000 in the third quarter of 2007. The effective tax rate was 37%, above our guidance of 33% to 35% due primarily to the shortfall of European retail sales, which are recorded in a lower tax rate jurisdiction. Net income for the third quarter of 2008 was $4 million or $0.28 per diluted share, lower than our guidance $0.39 to $0.43 per diluted share and lower compared to $4.9 million or $0.32 per diluted share in the prior year's quarter. For the nine-month period ended September 30th, 2008, net sales were $208.4 million compared to $206.5 million in the same period of 2007. Gross profit for the nine-month period was $70.9 million or 34% of sales compared to $74.7 million or 36.2% of sales a year ago reflecting the third quarter’s impact. Net income for the nine-month period was $10 million or $0.68 per diluted share compared to $14.1 million or $0.93 per diluted share in the prior year period. Now, turning to our balance sheet and cash flow review. During the nine-month period, we generated $18.1 million in cash flow from operations. We repurchased approximately 150,000 shares for $4.1 million in the third quarter, bringing our nine-month total to approximately 914,000 shares for $21.6 million. Including this repurchase, we ended the quarter with cash and cash equivalents of $75.9 million compared to $86.6 million at December 31, 2007. DSOs were 73 days at September 30th, 2008 compared to 79 days at September 30th, 2007. Net inventory turns were 5.1 turns at September 30th, 2008 compared to 5.3 turns at the same time last year. And now for our guidance, for the fourth quarter of 2008, we expect revenue to range between $81 million and $85 million compared to $66.2 million in the fourth quarter of 2007. We expect Business category sales to range from $67 million to $70 million, compared to $48.1 million in the fourth quarter of 2007, and Consumer category sales to range from $13 million to $16 million, compared to $18.2 million in the fourth quarter of last year. We anticipate margins for the fourth quarter of 2008 will be approximately 32.5% of sales plus or minus one point. Fourth quarter operating expenses are expected to be between $18 million and $18.6 million, including employee stock-based compensation expense of $733,000. The tax rate is expected to be between 30.5% and 32.5%. GAAP EPS is expected to range from $0.44 to $0.50 per diluted share. This compares to $0.40 per diluted share in the fourth quarter of 2007. For the full-year 2008 guidance, we now expect total revenue to range between $289.4 million and $293.4 million, which reflects growth of 6% to 8% over 2007 revenue of $272.7 million. Business category revenue is expected to increase 9% to 10% and Consumer category revenue is expected to be flat to a decrease of 5%. Operating expenses are expected to be between $75.9 million and $76.5 million. The tax rate is expected to range from 33% to 35% of pre-tax income, resulting in GAAP EPS between $1.11 and $1.17 per diluted share, a decrease of 12% to 17% from $1.33 per diluted recorded in 2007. I would now like to turn the call back to Paul.

[Paul Arling:]

While the economic situation is certainly impacting everyone, the fundamentals of our business remain rock solid and the trend driving demand still exists. For over 20 years, UEI has been the leader in the wireless devices and remotes. We have managed and managed well through various economic environments. Today, we are continuing to demonstrate that strength. We continue to build partnerships and execute growth strategies to further increase UEI’s leading position in the market. We are committed to increasing our strength in the subscription broadcasting market as well as with consumer electronics companies in every region of the world. And as previous discussed, we intend to broaden our penetration of the vibrant and growing Asian market. We are also gearing up to again demonstrate our technology leadership at the consumer electronic show or CES taking place in January of 2009. Again, regardless of the platform and technology, cable, satellite, analog, digital, AV receivers, DVRs, set-top boxes, or digital TVs, UEI provides the devices and customizes entertainment solutions for our growing base of global customers. The technologies and products that we are developing today and we will present to the market in the near future and the resulting customer activity have us as optimistic as ever about our long-term growth prospects. Stay tuned. I will now open the call for Q&A, operator?

[Operator:]

(Operator instructions) Our first question comes from the line of John Bright with Avondale Partners.

[John Bright:]

Thank you, good afternoon Paul and Bryan.

[Paul Arling:]

Good afternoon.

[John Bright:]

Paul, on the Consumer side, what does the competition look like on that side, and from a pricing standpoint and maybe an update on the Audiovox relationship?

[Paul Arling:]

Sure. On the European side, our competition obviously is still there, but our market share has remained constant or in some countries it is actually up. So, our share position remains strong, just the situation there as I said during the comments that during the quarter, for most of the year, we were actually performing very well and then in about September timeframe and into October the retailers are essentially preparing for what some are predicting to be the worst year in a couple of decades, so their ordering patterns changed significantly towards the end of the quarter, but our share position in that bad environment remains very strong, so there is no competitive issue, it is more a market or a consumer behavior issue there in terms of purchasing. As far as the Audiovox is concerned, everything is going exactly as planned. We began shipments this quarter, and we are working on some things that you might expect to see towards CES which is of course the biggest consumer electronic show in the US for the year, so they tune for things to be done there as well.

[John Bright:]

And specifically, the pricing in the consumer market in Europe, are you seeing the need obviously with the low demand to increase rebate, et cetera?

[Paul Arling:]

Not so much, I mean, I think it is more the behavior has been to ship lower, more value oriented products as Bryan said.

[John Bright:]

Shifting then to the subscription side, maybe talk about the Asian market and what you see for opportunity there?

[Paul Arling:]

Yes, we announced obviously on this call a pretty major one, the Reliance in India who, as I said, rolled out half-a-million new subscribers in basically a two-month period, which is unprecedented level of rollout. You know, the projections for that region of the world is – are astounding over the next 5 years between the end of this year and the end of 2013, so we are already hard at work developing those relationships for that 5-year trend and generating some business in the near term with those customers. We just think that while the growth here will continue and the number of digital homes added here will continue to grow, the upgrade trends here will continue to grow the non-HD to HD, and non-DVR to DVR. The simple rollout of digital homes in other areas of the world, the growth is going to be pretty substantial over the next five years and a lot of that would be centered in that region, so again look for more from us on that as time progresses.

[John Bright:]

And as far as the digital transition is concerned, what are you seeing associated with that and what is your thought process on how long that may last into 2009?

[Paul Arling:]

Well, some of the customers who we are selling to are saying that that will last into 2009 and into 2010, so we will have to see on that. We are not making any projections yet on our 2009, but we are hearing from customers that they believe the, strictly here in the US, that the DTA or the digital-to-analog converter or the conversion from analog to digital will take place throughout 2009.

[John Bright:]

And last question for you, then Paul, when you look at your business from a variable cost standpoint, where do you see variable cost as potential savings opportunities in an uncertain demand market?

[Paul Arling:]

Well, most of our cost base, most of our SG&A and R&D base is fixed. There are variable expenses in there – freight and there are a few variables, but most of it is fixed. In Q3, our expenses were a little lower than expected as Bryan highlighted and one of them was management incentive compensation, it was curtailed, but going forward, we believe it is important for us to continue our efforts in both sales and product development because the customers that we are bringing in today are the same ones that are going to grow substantially over the next number of years. We have been through this before in the downturn of, as I remember well in 2001 and 2002 timeframe after the burst of the – dotcom burst, you know, the economy went down and there was negative impact, but we fought to win new customers and develop new products and certainly went on a great growth trend after that, and I think – I would attribute it to some of the actions we took even during the downturn, so we are going to remain positive about our markets. We think that these trends are continuing. The analog-to-digital transition, the upgrade to high-definition and DVR may slow down a bit, but they are not going to stop, they will continue over the next number of years and we are going to rollout with new products and new technologies to fight for every customer on earth that is implementing those and we feel we can do very well.

[John Bright:]

Everyone asked the question, and I know you are probably not prepared to talk about 2009, but would it be correct to make any kind of analogies or discuss what your experience was during that last downturn versus this downturn as we look forward to 2009?

[Paul Arling:]

Yes, it is hard for us to say, John, it is not that I know and I will not tell anyone today, it is more – the last downturn – we do not know the length of this or the fact of it, but what we do know so far, it has affected the consumer side more than business. Business category, we feel – selling the OEMs and subscription broadcasters as I said before bread, water, and TV are staples of people’s lives, and I think that those services are slightly more immune, at least they have been so far, and our business category has been okay. The consumer category is more affected. The upgrade purchases at retail are probably more affected in a down cycle than our staples like cable and satellite and IPTV subscription services.

[John Bright:]

You had a record year in 2008, would you feel comfortable – pretty confident in thinking that your revenues are going to be up year-over-year in 2009?

[Paul Arling:]

We are not ready to make that prediction yet. I guess, all I would point to is the fact that our Q4, even though less than we expected will be a record in both sales and earnings.

[John Bright:]

Got it. Bryan, a couple cleanups for you then, other expense, what was taking place there and then head count if you do not mind?

[Bryan Hackworth:]

It is hedging the expense we hedged in Q3 as we always. As always that we hedge in the balance sheet, so there is a little bit of expense in that respect.

[John Bright:]

And head count?

[Bryan Hackworth:]

Head count was around 400.

[John Bright:]

All right, thanks guys.

[Operator:]

(Operator instructions) Our next question is from the line of Andy Hargreaves with Pacific Crest Securities.

[Andy Hargreaves:]

I wonder if your primary competitor – or just what you think – how you think they can fare in the economic downturn and may be even more specifically can they operate without credit? And how does your balance sheet play versus competition in sales right now?

[Paul Arling:]

In terms of whom, sorry? Which customer base?

[Andy Hargreaves:]

On the service provider and the CE OEM side?

[Paul Arling:]

What – you means the terms of AR terms or?

[Andy Hargreaves:]

No, I mean as you are in sales conversations, does the credit crunch favor you over competitors, meaning do your competitors have to access to credit to provide units where you can do it based on working capital?

[Paul Arling:]

No, I cannot speak to their financials, although some of them are not clearly as strong as we are, we have around for a long time. We are specialists in this industry. We supplied actually some of these customers. We have supplied through multiple economic cycles. We have customer relationships that last more than a decade, so I think they are pretty comfortable with us in good times and in bad, and our financial position is obviously public, so they know that our company is strongly financed and it may favor us, probably it has favored us all the time as I look at us, the technology we bring, and the financial strength that we have. We are not going anywhere, so they feel very comfortable about that. Smaller competitors will have more of a problem.

[Andy Hargreaves:]

Do you think that the economy is going to impact the piece of actual new service rollouts in emerging markets?

[Paul Arling:]

Well, it might, but it is hard for us to make those predictions about next year right now. We are going through the process – that process as we speak over the course of the next month. We are putting our plan together for next year, so it is hard for us to make any prediction about that yet, but again the things like the analog-to-digital transition are occurring. They are not just occurring here. A lot of the new rollouts in other countries are obviously digital either satellite or IPTV rollout. They do not appear yet to be as effective. Again, I do think that television here in the US certainly and also in other parts of the world is becoming more than a luxury, more akin to a necessity.

[Andy Hargreaves:]

Okay, and then could you just give us the revenue from 10% customers in the quarter?

[Bryan Hackworth:]

Yes, it is the same two customers that we have had in the past Andy that are bringing 2%.

[Andy Hargreaves:]

Okay, thanks.

[Operator:]

(Operator instructions) There are no further questions at this time, please proceed with your presentation or any closing remarks.

[Paul Arling:]

Okay, thanks everybody for joining us today. We were pleased to report the record quarterly revenues, which demonstrate our company’s strength, its focus and its strong foundation. We have a plan to continue the success of the business regardless of the economic environment and we look forward to seeing all of you soon certainly at CES. If any of you want to see us there, we will be there showing new products and technologies, so please make arrangements to see us there. Thank you very much.

[Operator:]

Ladies and gentlemen, that concludes your conference call for today. We thank you for your participation and ask that you please disconnect your line.