Universal Electronics Inc. (UEIC) Earnings Call Transcript & Summary

Great. Thanks for joining us today. My name is Mike Cikos, and I work with Jim Ricchiuti on the advanced industrial technology sector for Needham & Company. With us today, we have Mr. Paul Arling, Chairman and CEO of Universal Electronics. Thank you again for joining today's Needham conference, and please go ahead with your presentation, Paul.

Hello, everybody. I'm going to start off by making our safe harbor statement. I promise not to read all these words. I'm going to make some forward-looking statements both in the presentation and in questions. There are a lot of risks. Please read our SEC documents for a complete -- for any disclosure of those risks. We are the pillars of the smart home. We work on, first, to market innovations that help make your entertainment control and now home control better and easier to use. We work across a number of functions today. Smart entertainment control has become the core of our business, but we've moved into comfort and convenience, safety and security and energy management, which we'll touch on in our presentation. The overview is that we are founded in 1986, so we have more than 30 years' experience. We're the market share leader in the market that we serve, particularly entertainment and voice remote controls which have emerged over the last 5 years. Focus on technology and product innovation. We have a lot of first-to-market innovations like QuickSet, which we can talk more about, an easy configuration software that makes the setup and control and everyday use easier for the user across multiple sets of devices. We have over 500 issued and pending patents on these innovations. Global scale. We have R&D located in California, Silicon Valley and Southern Cal; and globally, diversified manufacturing operations in China, Mexico, Brazil. Fortune 100 customer base, which we'll get to in a minute. Most people that are in the entertainment industry, cable, satellite, consumer electronics, the leading names in the world in these markets are customers of ours. And strong financial performance over time, which, again, we'll go over in the last part of the presentation. We're talking to you today from Scottsdale, Arizona, our corporate headquarters. And I'm joined here by Bryan Hackworth, who will probably answer some of your questions later. Our 2 main locations worldwide are in Enschede, that's the headquarters for Europe; and Hong Kong, which is the headquarters for our Asia operation. We focus on 6 channels: subscription broadcasting; cable and satellite operators; consumer electronics; we sell some product direct to retail; hospitality; HVAC; and safety and security. Those are 3 general areas: entertainment control, home automation and safety. Again, as I said in the earlier statements, we power global leaders across these channels. I won't go over every name here, but you will see the leading names in home entertainment and home control here, Comcast, Charter, DIRECTV; in Europe, Sky, Vodafone, Virgin and others, Orange. So across the world, we're powering most of the projects that are being done in entertainment, and that is beginning to change significantly, which brings us to our next slide. The average global viewer spends in the U.S. about 5 hours a day watching television. I haven't seen the data for Q1 or through the pandemic, but my guess is that, that number is actually increasing at least temporarily due to people -- shelter-in-place orders. But even before that, the average person across the world was watching more than 4 hours of TV a day, 5 hours here in the United States. Entertainment control has changed dramatically over the last 4 years. Touch, voice, motion have all become more mainstream in this area. I remember a day many years ago where it was just a simple IR remote with buttons that you pushed for individual commands. It has become much more complex than that, a lot more advanced, and that has helped our business because that's our positioning within this market. Smart entertainment control is integral to the smart home experience. As we mentioned, that's a very top bullet point here. When people are at home, obviously, they're spending a lot of time in that family room, then wherever it is they were watching their 5 hours a day. So entertainment control, we think, is at the center of home control simply because it's the #1 thing that people do while they're at home. And we're well positioned in the market to leverage our core technologies. We work across a variety of different types of protocol, ZigBee, RF4CE, Bluetooth Smart, WiFi. And with QuickSet, we're delivering the industry standard for embedded and cloud-based software for setup and control. This is embedded in most of the new programs we're doing. And to explain QuickSet very quickly, you simply bring the device home, you plug things into the wall, into power, you plug them into each other, and the software takes over. It identifies the devices. It identifies, in many cases, the services available through those devices. And it populates the screen with what, I guess, you could call apps. They are little in our TV, QuickSet implementations. It will put up your cable box. It'll say Comcast or DIRECTV, it'll say Apple TV, and it will say Xbox, if those are the 3 things you plugged in. And then you can simply, every time you turn your TV on, choose an app, click on one of them, and they will take you directly to it. So real easy to do, real easy to set up and real easy to use each and every day. The growth potential is significant. Last year, we did about $570 million in AV. Probably a little in excess of $400 million of that was QuickSet-enabled. And our non-AV business grew even more last year to $170 million, so it's becoming a significant part of our business across a variety of markets, mainly for us today HVAC and security. They make up the majority, the preponderance, actually, of that non-AV business, that $170 million. But it's become a significant and growing part of our business to extend our control capability beyond AV into other home applications. The smart opportunity, home opportunity is big. Again, I won't go over all this. You can ask questions if you'd like. But the core market for us, including AV, is $4.6 billion market and growing relatively quickly. And we see adjacencies that probably add up to an amount greater than that, about $5.6 billion. So the total market of home and home control is quite sizable and provides us some long-term growth opportunity. As far as our financials, we've seen some sales shrinkage as a result of COVID-19, which we explained on our last conference call. We've upgraded the manufacturing footprint to deal with both the tariff stances, some supply interruptions, but we're doing very well there. Obviously, as you can see, in Q1 of 2020, our margins actually exceeded 30% for the first time in quite some time. Our earnings were relatively flat to prior year despite the sales shrinkage due to first supply constraints. And as we overcame them, we started to see, as the pandemic spread, some demand effects. Thus, our guidance for Q2 is lower than in prior year. However, due to all of the things we're doing to streamline our corporate structure, increase our operational efficiency and some of the things we've done, our earnings should be actually slightly better than they were last year, which was a record year for UEI despite the fact that we've seen some demand fall off due to the current pandemic situation. Target operating model is to grow our net sales every year 5% to 10%, remain relatively flat on expenses, thus, creating substantial operating leverage, which we're again beginning to see this year. With some sales shortfall, our earnings are still in line or slightly greater than last year. So there's a growing market opportunity, as I've outlined here. We're the market share leader in -- certainly in home AV but expanding into other home control categories. And we have an experienced management team. I've been here for more than 20 years. Bryan has been here about 15 now, 16, I think, this year, so quite some time. And this I'll end with, which is our financial success over time. This chart begins, if you can't see the small print, in 2002, runs through the end of last year. And obviously, these are nice upward sloping graphs. We do see interruptions in there. The financial crisis caused the delay in growth. But we overcame -- last year, we overcame tariffs and other things. But the line of best fit on this is a nice upward sloping graph that we've been able to achieve over a long period of time, almost 20 years now in this slide. With that, I will turn it over to questions.

Okay. Thank you for the presentation here. We have received some questions. And I encourage any interested investors to continue submitting them through. We'll get as many as we can in. I guess the first would be with respect to the margins moving higher with more technological products and the sales of chips. Will we see revenue go down due to mix is a question that's coming in. And then another one being what television should we be paying attention to that UEI chips are embedded with.

Okay. There are a couple of parts to that. The first part is that the effects this year for revenue have largely been driven by, in Q1, we had some supply interruption. So as you -- as everybody well knows, the pandemic first was affecting China, which is where some of our products are made. We've moved quite a bit of our production for the U.S. market due to tariffs to Mexico and other countries other than China, but we did have some supply interruption. We estimated that in February on our conference call for Q4, and we're relatively accurate on that as far as the delay in opening the Chinese facilities and the labor returning at a pace which would get us back to capacity, which was slower than it normally would be in a normal year. So that caused some supply interruption in Q1. But then what we saw as we -- in February, probably none of us knew what was going to happen over the ensuing 2 months. But shelter-in-place orders came, and people began staying home. And anything that was sold to retail would have started to see some level of falloff because people weren't in stores. So we began to see the demand impact. That's really the biggest impact this year. It hasn't had anything to do with -- very little to do with any product changes or mix changes we've made. There have been some of that because we, as a company, have been moving to a more advanced product line and moving away from SKUs that were less differentiated. We still do make them, but we've -- our mix has shifted upwards, if you will. But the bigger effect has just been the demand falloff. Subscription broadcasters who do not have a self-install capability, QuickSet is part of that. For those that have self-install, QuickSet is one of the critical elements in it. But for those who hadn't architected that, they're having a hard time. Consumers aren't letting people in their homes or the company itself is trying to keep their employees safe by not allowing them to enter homes. And as people probably know over the last decades, the way subscription broadcasting works is they do, in fact, lose customers every month or every quarter, and they usually promote and install to keep their subs relatively flat. With the inability to do installs, if you don't have a self-install architecture, they're seeing a falloff. So I would say that's probably the biggest impact this year on any sales shortage that we've seen in Q1 and -- well, more into Q2, but certainly some in Q1 as well. Second question was about TVs. We're seeing a great expansion in this area because, as I described earlier, what our technology does, what QuickSet and QuickSet Cloud do is when you bring the TV home, you simply plug it in the wall, you plug in your 1 to 3 things, however many devices that you have that you enjoy entertainment through, and it self-configures, that you'll see icons pop up on the screen that will be for that device you just plugged in. So if you've plugged in an XFINITY box because you're a Comcast subscriber, or you plug in a Roku, you plug in an Apple TV, you plug in a Fire Stick, it doesn't really matter what you plug in, it identifies the device and then populates an icon. So every time you turn the TV on, instead of you being confused as to which HDMI input you're supposed to tune to, as we used to call it the black screen of death, where you'd see HDMI 2 in the upper right-hand corner, that doesn't happen anymore. You simply turn the TV on, it will present the 3 things you have available to you, and you click on 1, and it takes you to Comcast XFINITY or to Apple TV or to whatever device you want. And it reconfigures the system. So it will reconfigure the controller to whatever you've chosen. And that's because of 2 way: the devices are able to be configured; and everyday use can be enhanced through that. We're seeing a lot more -- we have more TV companies than we've ever had before doing this. And also those that have done it in prior years are beginning to expand this technology through their product line. So it's not just about new customers, it's about existing customers expanding as well as new customers adopting. And that's one of the reasons why, Bryan explained this on our last conference call, the margins have begun to inch up because this type of -- we're not actually selling a lot of hardware in this case. It's mostly software and/or license or a higher-margin chip.

And I guess just building on that, maybe taking a different tack. But there was another question submitted asking about the recovery. How do you guys see the recovery progressing as we move into Q3 and Q4? What type of recovery were you guys projecting in your guidance?

Well, actually, we don't -- we haven't guided to as we normally don't. So it's not -- we haven't changed anything about the guidance we provide. We have historically provided 1 quarter forward. So we do not have any current statement about Qs 3 or 4 yet. But if we hold with custom, when we report Q2, we'll give guidance for Q3. However, as we said on the conference call, we do -- what we're seeing is that a lot of the projects that are being worked on are not -- there's no change of heart of any of the customers' projects we're working on, meaning nothing has changed about their desire to move forward. And I think the reason for that probably is that they see beyond COVID, which will be temporal. I know it doesn't seem like it now, but it likely will be temporal. They need to change the way that they're presenting home entertainment to their customer. They need to make it easier. They need to make it easier for you to access that what you want to watch. They need to bridge the gap between what people have called linear TV and over the top. And that's what a lot of companies are looking to do. Some of them have done it and continue to iterate their platform either through software or alterations to hardware. But many more companies are doing this, are working on doing it, and we've seen no change in their attitude towards this. So those platforms are -- we're continuing to work on them with major customers, and we don't really see any change in that at all. So as this year progresses and as we get into 2021, you'll see more of those coming out from our customers with us building the technologies and/or products behind them. There's been really no change in that, no change in schedules. Sometimes their people are working from home, as are ours, but there's no change in the schedule. They've all -- they're all fully committed to this change in their architecture.

Okay. Good to hear. Another question coming in. It was a bit of a tricky situation, but coming to, I guess, question on the brief update with respect to the IP lawsuit against Roku and others, how many suits are currently filed with how many companies or entities? And if there's any way to frame how large these suits could be or what potential damages could be.

Yes. Well, the -- if we're speaking about the most recent announcement, it was an announcement of an ITC action, which many that may be listening maybe are very aware of what ITC is, but I'll just -- I'll give a brief simple explanation. It's probably as good as I can do as I'm not a practicing attorney. With ITC, it's a little bit different than the district court case. District court cases typically can take longer. The defendant can file IPRs, which can delay the process. The case can get stayed while the patents are reviewed by the PTAB, and that has definitely occurred in the Roku suit. So we're working through that. But ITC is a different action, where the outcome is that the product, actually, if you win that case, the product with its current features cannot be imported to the United States. So it's a slightly different outcome and -- or a very different outcome and a different process as well. So we've initiated that. As we announced earlier this week, the case has been instituted, meaning that they've decided to hear the case, which is good because it can sometimes not be instituted. So there was a decision to institute the case. So we're at the beginning of that. It's, I guess, typically an approximate 1-year process. So 1 year doesn't seem quick, but in court cases, 1 year is quite short. District court decisions can take years.

Okay. Another question coming in also with respect to -- and forgive me on this, it's Nevo or Nevo Butler.

Nevo.

Seem to be in high demand right now. And the question, I guess, is when do you hope to have a deal in place.

Well, actually, we're seeing it already appear. Nevo Butler was originally developed as a -- essentially a demonstration platform. It was in a product form, a physical form, but it had a variety of ingredients to it that are already being built into products this year. So some of the televisions that we're currently licensing to are using elements of the Nevo Butler platform. So the ingredient technologies from Nevo Butler, we did not make a hardware sale in that case, but they bought the -- or the version of QuickSet that they're licensing has the elements of Nevo Butler. So we're already seeing the effects of Nevo Butler, and we'll see more. There are customers that are both interested in the ingredient technologies or the versions of QuickSet that are exemplified in the Nevo Butler platform, but we also have some that are interested in a product form. Product forms usually take longer because the -- obviously, when you want to adopt technology, sometimes that can be quicker. So we're seeing the initial versions of Nevo Butler technologies in products already, hardware versions we're working on with some customers now.

Okay. And I think you actually answered the follow-up to that would be, I guess, the kind of deal structure that you would anticipate from working with them. I know you made comments, I guess, a licensing agreement is what it sounds like.

Yes. The ones that are currently in place would be license agreements. So it's either a chip sale with a license or a simple license for the technologies within a product that's being shipped by one of our customers.

Okay. And another question coming in now, also talking to, I guess, the magnitude of your licensing. How fast do you think that this can potentially ramp up?

Yes, we don't -- we don't disclose the exact level of licensing that we do. So we don't have -- the growth in it, though, is, obviously, this year, since our overall growth is low, so negative, this is growing. As a percent, I don't have the exact figure. Bryan is here, but I don't think we disclose that.

We don't disclose it.

So we don't have an exact figure on that. But this part of our business is actually growing. And that's higher margin than average obviously because it's licensed revenue, so it certainly is helping the margin rate.

Okay. And another question, I guess, coming back to, I guess, this COVID-19 environment that we're in, could you just lay out -- or do you think COVID cord cutting will impact the later half of 2020. I don't know if the question is more directed that should we expect less cord cutting in the current environment because of COVID-19 or just curious as to your take there, though.

Yes. It's difficult for me to forecast such a thing. Frankly, we don't have a -- we wouldn't have a precise measurement for the effect of cord cutting simply because -- I'm not sure actually anyone does. If you use a subscriber shrinkage as the measure of cord cutting, then you can get a number on that. I'm not sure that's the only measure. But anyway, cord cutting has been something that has been around for quite some time now. I don't think cord cutting is new. It would have affected us last year as well, yet our sales grew well last year. But I think there's a lot of countervailing things going on. Cord cutting may be occurring, but what's happening also is the customers that are interested in retaining -- our customers that are interested in retaining consumers are redesigning platforms to become more user-friendly, more sophisticated, driven by voice, typically IP-enabled, 2-way platforms, where the actual control device is 2-way rather than 1-way. It often is containing voice input. These products are much more sophisticated than those which came before it and therefore often are more expensive because they're more sophisticated. So in one way, cord cutting is hurtful in that some of our core customers are losing subscribers. But at the same time, it's in some ways a positive in that the industry realizes it has to change. So the home entertainment industry is changing and making the control devices more sophisticated as a result to retain customers, to become more competitive. So that's actually helped us. Now this year, the only thing that's different, at least in my mind, cord cutting affected us last year and the year before. The positive effect of new platforms also helped us over the last couple of years and particularly last year. This year, the only thing that's really different is this pandemic. So I would attribute most of what's happening right now to that, not to any other effect. Not that the other effect isn't there. I'm not -- certainly not arguing that. It's just I'm not sure it's any different than it was last year. And I think in some ways, that whole industry trend, in a way, is helpful. The threats to home entertainment or the opportunities in home entertainment for us have probably never been greater because, again, people who want to retain customers, who want to attract customers are making the premise equipment more sophisticated than it's ever been, easier to use than it's ever been. And that's been our specialty for quite some time, is developing technologies that help the user make that whole experience easy. So -- and the world is moving in that direction, and it's leading to more sophisticated, more expensive products. So that's a real positive trend. The cord cutting with some of our customers, because some of our customers are actually not shrinking, others are, that has a negative or downdraft on us. So it will remain to be seen. I think the bigger effect this year, though, is the pandemic.

Sure, sure. And I guess building on that, there was a follow-up with respect to QuickSet. And I guess it feeds right into exactly what you were just saying, but I would expect that you're seeing some acceleration or greater demand coming from either new or existing customers for QuickSet in this current COVID environment. Is that a fair characterization? And can you elaborate on that a bit more?

Yes, for sure. Because we didn't -- maybe, unfortunately, over the last couple of years selling in on QuickSet, we didn't tell customers, "Hey, another reason that you should implement this is because we're going to be affected by a pandemic where self-install is going to become crucial to your business." Even if we had said that, they probably would have said, "What kind of a ridiculous theory is that?" So I guess I'm not ashamed that we didn't do that because it probably wouldn't have worked. But the truth is that customers, some of the people in our industry that had not adopted a more self-install platform probably at this point, in many ways, wish that they had and are now probably asking themselves the question, "Should we adopt something that when something like this happens, can we build an architecture that we could simply put on someone's front porch or mail to them? And then there'd be a little card inside the box that would say plug the -- plug this box into the wall, plug the HDMI cable in and follow the instructions on the screen," which is essentially what some of our customers are doing. And QuickSet is one element of that. The ability to configure the system that easily is certainly a part of it. So yes, we're seeing -- I won't say it's so much inbound because we're in front of these customers a lot anyway. In some cases, we're selling them their current product. But we have seen a renewed interest in this type of software that would enable that type of experience for a consumer, ease of install and ease of everyday use.

Okay. And maybe a little bit more nuanced here. I know that you guys obviously are the market leader. But does QuickSet get you in front of potentially new customers? And then I guess a separate point would be, again, I'm sure everyone is a little bit different, but is there a typical selling cycle for this QuickSet product? Or what are those discussions? Typically, how long do they last? What do they involve?

Yes. Well, we are -- we're seeing interest from people who haven't been traditional customers. And I think part of it is they -- when they want to enter the home, particularly the area of AV, the -- where the center of the home is, right, the -- and I don't just say that because I'm the proud CEO of UEI. Look at house design, go to any new house development, what you see is a kitchen with a big open room in the model. Usually, what's in that big open room, that great room or family room, whatever they call it, is a big TV. That's kind of the center of an American home in home design today. So if you want to enter that arena, if you do a little bit of research, what you'll find is that the company that's powering many of the leading companies in that arena is UEI. So we are -- we do see companies that are beginning to develop new products in this area, particularly if they want that ease of install, they then find that we're behind QuickSet, QuickSet Cloud, the methods by which people make this even easier. And frankly, because of our market share across the world in TVs and subscription broadcasting, I mean, if you want somebody to be able to help you control those things, we've made the originals. So we certainly can help. If you want to replicate control of something, we're doing a lot of the original controls for those companies. So it's sort of, again, our increasing market share over the years has helped feed an even greater positioning for us in this market. So we are seeing a lot of interest in -- home entertainment is not going anywhere. It's more popular than it's ever been. People are spending more time than they ever have. And with the technologies that are being built into these products, TVs, set-top boxes, sticks, et cetera, it's becoming easier than ever -- more easy than it's ever been to self-configure, to make them easy to use. And we've pioneered that and came up with a lot of the original ideas around it, in some cases, more than a decade ago. So yes, we're seeing a lot of inbound interest in this area and working with some new players that we'll be hopefully talking about in the not-too-distant future.

Okay. And as a reminder, if anyone has some questions, we're coming up at the top of the presentation. Just one more for me, Paul.

Sure.

Again, coming back to your market leadership. Just interested, new competition coming into the market, is that a concern? Are you aware of any guys that are coming in and taking share right now? How would you describe that environment?

Yes. We haven't seen -- in our arena, it's the same competitors as have been here for quite some time. We do see some companies that are attempting to do this themselves, and we're engaged in litigation with one of them. But generally, we haven't seen -- there probably are new entrants, there have been across the years, but we haven't seen any significant traction from anyone here. The ones we see are typically the traditional competitor that we've seen for, in some cases, decades. So yes, it's a difficult thing to do. If you want to build it for yourself, you probably can, but you won't have scale. I mean one of the benefits of our business is that the investments that we've made to produce better product is actually being shared across most of the industry leaders. So the work we do and, as we call it, library to get the code to operate the various things that are in your home, if you think about it, that's a shared expense amongst all of our customers because, essentially, we gather it for all of them. So there's a bit of a scale advantage there for a new entrant to overcome. And if you want to do it yourself, you actually have to gather all that data for yourself and only yourself. And obviously, then you would amortize it over only your product. We do it a little differently. We gather the data and then, of course, build it into products for most of the world leaders. So there's a bit of a scale advantage there, I think, economically.

Right, right. And also the IP portfolio that you guys have assembled over the years through the different investments you've made as well.

That's correct, yes. I mean we've focused on this for basically since the founding of the company more than 30 years ago, have been focused on this. We have a lot of people who wake up every day thinking about how to make this better. So obviously, as a result of that, we've come up with a lot of really good ideas on how -- novel ideas on how to make this experience better, and we've fortunately filed for patents on a lot of those ideas.

Okay. Terrific. And I'm not seeing any more questions at this point, so I think we can leave it there. But thank you very much for the time today, Paul.

Thank you.

Best of luck. Thank you.

Bye-bye.