UEIC - Universal Electronics Inc. (UEIC) Q4 2022 Earnings Call Transcript

Universal Electronics Inc. (UEIC)

Q4 2022 Earnings Conference Call

February 16, 2023 16:30 ET

Company Participants

Kirsten Chapman - Investor Relations

Paul Arling - Chairman & Chief Executive Officer

Bryan Hackworth - Chief Financial Officer

Conference Call Participants

Greg Burns - Sidoti

Presentation

Operator

Good day, and thank you for standing by. Welcome to the Universal Electronics Fourth Quarter 2022 Financial Results Conference Call. [Operator Instructions] Please be advised that today's conference is being recorded.

I would now like to hand the conference over to your speaker today, Kirsten Chapman, LHA Investor Relations. Please begin.

Kirsten Chapman

Thank you, Norma, and thank you all for joining us for the Universal Electronics 2022 fourth quarter and full year 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 non-public information that might be discussed during this call will be available on the company's website at uei.com for 1 year.

During this call, management may make forward-looking statements regarding the future and 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 its wireless connectivity capabilities in the climate control, home automation, security, hospitality and HVAC channels and its ground breaking 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 and developing and launching new generation products, software solutions and technologies into existing and new and growing markets, which result in increased sales and market share 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, operational efficiency, manufacturing diversification and footprint strategy and line management. The impact of the company's financial results that it may experience due to supply and trade constraints. So semiconductor supply challenges and inflationary pressures and macroeconomic conditions and its consumers are experiencing. The direct and indirect impact the company makes experience with respect to its business and financial results stemming from the continued economic uncertainty affecting consumers' confidence in spending, natural disasters, public health crisis, including the continuation or resurgence of COVID-19 pandemic or governmental actions, including war. 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 the call and the documents the company has filed with the SEC, including its 2021 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 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's now my pleasure to introduce Paul Arling. Please go ahead, Paul.

Paul Arling

Thank you for joining us today to review our 2022 performance as well as our outlook for 2023. As we have highlighted many times before, our strong commitment to ongoing innovation, product and technology design, development and delivery and ongoing excellence in customer service continues to garner accolades. Our product designs received CES innovation awards in January and more importantly, our platforms and technology solutions earned customer recognition in the form of new product design wins throughout the back half of 2022 and into 2023. As a result, our share continues to grow in the markets we serve. However, macroeconomic challenges and increased consumer uncertainty have impacted market dynamics, especially at the tail end of last year.

As a result, Q4 2022 performance was below expectations with net sales of $122.8 million and EPS of $0.44. We anticipate that impact will also be felt in the first quarter of 2023. Regardless, our connected home solutions, which are sold in our higher-growth markets that focus on climate control, home automation and security continue to gain momentum. In fact, product design wins secured 12 to 18 months ago, in some cases, in the connected home channel are starting to ship, giving us confidence net sales will improve starting in the second quarter of 2023 and build momentum into 2024. For example, we are shipping our first advanced thermostat with Mitsubishi Electric train for the U.S. market toward the end of the first quarter of 2023 and have already been awarded our second smart thermostat with Mitsubishi that we expect to launch globally.

In addition, we won new thermostats and control platforms at one of the largest U.S. HVAC system providers at the beginning of 2023 and are closing another global leader in the HVAC space with our new TIDE platform. In the home automation space, we continue to grow our business with control solutions at Hunter Douglas and Somfy and we have expanded our footprint with multiple sensors, controllers and home automation products with U.S. security provider, Vivint. We expect these wins to contribute to our revenue starting next quarter.

In the meantime, we have been taking additional actions to address the market dynamics. First, over the past few years, as mentioned, we have deliberately been shifting development spend on new products and technologies from our market challenged core video service provider channel to higher growth channels in the connected home space, where over the past years, we have seen growth. Second, to moderate fixed costs, we continue to move ongoing maintenance and development support activities to lower-cost regions. We have also tasked our local innovation and development teams to create technology that can scale across all our channels, focusing on wireless connectivity, interoperability, sustainability and end-user support solutions that are key to differentiating our solutions in these growing markets.

Third, we have already begun diversifying and optimizing our manufacturing base outside China with the construction of a new factory in Vietnam, which will be fully operational later this year. While this will initially increase our overall production footprint, the goal by the end of 2024 is to rightsize our global footprint, enabling manufacturing flexibility to serve our global customers, to optimize cost efficiencies and to create a production footprint that is in line with our new higher growth product categories.

Finally, our product development process continues to prioritize allocating global development resources to projects with the highest potential revenue and business impact. This January, our experience and customer reaction at CES was extremely positive, confirming that our development of differentiated products is on the right track and offers ample proof that we are in a strong position to generate long-term growth. For almost 40 years, we have delivered industry-leading control solutions for our customers. Our inventions like QuickSet have become the de facto control standard for smart connected home entertainment devices. As such, leading brands from around the world increasingly turn to UEI for finished products, embedded SoCs and software solutions to power the sensing and control functions of their systems.

Our strategy of growing in new markets and our drive to consistently meet and surpass customer expectations will, in time, yield long-term growth. Our customers count on us to create innovative solutions focused on IP connectivity, greater home control automation, including better and more intuitive low-power wireless control, resulting in a greater tie-in with other smart home systems. Since 2020, sales in our climate control, security and home automation space have grown. In 2022, these connected home solutions accounted for over 25% of our net sales. And these markets are already larger and are growing at a faster rate than home entertainment markets. So we expect their contribution to be even more meaningful going forward. Our specific addressable market in climate control alone represents nearly $1 billion, which is growing at a 10% compound annual growth rate.

I will briefly review a few of the highlights from our product introductions at CES. We demonstrated our expanded connectivity solutions for whole home wireless control with enhanced security, sustainability and scalability. We emphasized our contribution to a sustainable future by addressing the need for more energy efficiency in the home with UEI's TIDE smart thermostats and by reducing battery waste with UEI's Eterna energy harvesting remotes. I'm proud to announce that Eterna was honored with a CES 2023 Innovation Award amongst the pool of over 2,100 applicants. We demonstrated our smart home dashboard solution, QuickSet 5, as a reference design currently shipping in millions of LG smart TVs worldwide. As smart TVs continue to evolve in features and functionality, the need to embrace the full potential of the largest screen in the home to deliver a smart home control experience is becoming a reality. Customers ranging from service providers and broadband platform owners to a growing list of smart TV brands reacted positively to our QuickSet Smart Home software solution. This confirms the potential to scale our enhanced QuickSet software and services offering that blends home entertainment and smart home experiences on a single screen.

In the area of interoperability, we embrace the emerging matter standard with the introduction of 4 new matter enhanced solutions across our portfolio, ensuring our customers can bridge between the existing smart home devices consumers have in their home and the new matter enabled devices they will buy in the future. Due to the competitive nature of our customers' businesses, I am once again limited by confidentiality requirements and cannot discuss specific customer and new design win opportunities. What I can say is that our current design wins, bid opportunity pipeline and project backlog represent a significant number of new business opportunities for UEI. These opportunities are strongly weighted to our newer, higher-growth markets, highlighting our ability to effectively penetrate these new markets and execute on our market diversification strategy.

Although the related sales are not expected until later in 2023 into 2024 and beyond, these definitive wins underpin our long-term growth projections. Interestingly, while the connected home channel has exhibited signs of longer sales and development cycles than our traditional home entertainment channel, the benefits include significantly longer product life cycles. This means that while major new product developments and climate control, security and home automation are taking longer to launch, these product platforms have significantly longer revenue cycles that last 5 or 7x longer than the products developed in home entertainment.

In summary, our new innovative products were well received at CES and our design wins continue to build the foundation for a strong future. What is important now is that we successfully execute on the many new product introductions that we already have been awarded by our customers. We continue to secure new business on the outstanding bids we will be addressing in the coming months and years and that we remain vigilant in executing our cost savings initiatives. We will continue our commitment, in fact, our obsession to bring customers continued innovation as well as product and technology solutions that help improve consumer experiences and enable our customers to grow their businesses. We continue to implement the same strategy that has made us successful many times before and will once again bring UEI to ever higher levels of success.

Now I'll turn the call over to our CFO, Bryan Hackworth, for a review of the financials. Go ahead, Bryan.

Bryan Hackworth

Thank you, Paul.

First, I'll review the results for the fourth quarter of 2022 compared to the fourth quarter of 2021. Net sales were $122.8 million, below our expectations and compared to $143.9 million for the fourth quarter of 2021. There's a great deal of uncertainty in the current economic environment, which has led to households spending less on the discretionary goods, and this is affecting our end user markets. In turn, certain customers, primarily in our video services channel, submitted purchase orders that were lower than their previously submitted forecast, impacting our fourth quarter. Customers in the consumer electronics and climate control channels also reduced orders for the first quarter of 2023, which will be reflected in the guidance I'll provide shortly.

These decreases in demand resulted in fourth quarter production being lower than forecast, yielding manufacturing inefficiencies as overhead was absorbed at a lower rate and unfavorable labor variances were incurred due to the inability in the short run to flex direct labor. Although gross margin for the fourth quarter of 2022 of $37.7 million or 30.7% of sales increased compared to 28.4% in the fourth quarter of 2021, it was lower than expected.

Operating expenses were $29.4 million compared to $30.2 million in the fourth quarter of 2021. SG&A expenses were $21.7 million compared to $22.6 million in the prior year quarter. R&D expenses were $7.7 million compared to $7.6 million in the prior year quarter. Operating income was $8.3 million or 6.8% of sales compared to $10.7 million or 7.5% of sales in the fourth quarter of 2021. Our fourth quarter 2022 effective tax rate was 27.3% compared to 16.1% for the fourth quarter of 2021. For the fourth quarter of 2022, net income was $5.6 million or $0.44 per diluted share compared to $9 million or $0.68 per diluted share in the fourth quarter of 2021.

Next, I'll review our cash flow and balance sheet. We ended 2022 with cash and cash equivalents of $66.7 million compared to $60.8 million at December 31, 2021. Cash flow from operations for the fourth quarter of 2022 was $10.8 million.

Before I provide guidance for the first quarter, I'll comment on our plan to restructure our manufacturing footprint, and I think it's important to first provide a little context and history. The majority of our goods are currently produced in 3 facilities, 2 in Mainland China and 1 in Mexico. Our Mexico facility was originally established as a refurbishment plan. But when the China tariffs were enacted in 2018, we quickly transitioned the facility into a full-fledged manufacturing factory to produce goods destined for the North American market. Today, in an effort to lower our concentration risk in China, we're in the midst of opening a manufacturing facility in Vietnam, currently scheduled to commence operations later this year.

The expansion of our factory footprint over the past 5 years has been necessary given the changes, sometimes sudden in governmental policies as well as the overall global environment. As a result of these actions and the fact that our business has evolved over time becoming less dependent on the video services channel, while experiencing strong growth in new channels, including climate control, security and home automation, we currently have more production capacity than needed. Additionally, the average selling price in the climate control channel, one of our strongest growth categories is significantly higher than our traditional products in the video service channel. Therefore, fewer units will need to be produced to achieve sales growth and less factory floor space will be required. As such, going forward, we plan to reduce our manufacturing footprint beginning in the second half of 2023, with additional modifications to occur in 2024. These changes will improve manufacturing efficiencies and ultimately make UEI a more profitable company.

Now turning to our guidance. For the first quarter of 2023, we expect sales to range from USD100 million to USD110 million compared to $132.4 million for the first quarter of 2022. We expect a net loss ranging from USD0.28 to USD0.38 per share compared to EPS of $0.47 in the first quarter of 2022. Looking past the first quarter, the current economic environment remains uncertain as inflation persists. However, unlike last year at this time, customers have reflected this sentiment in their near-term and long-term forecast with Q1's revenue expected to be the low point of 2023. Based on the expected timing of our new product introductions and customer forecast, we expect second quarter's net sales to be sequentially higher than Q1 and for both Q3 and Q4's net sales to exceed Q2's. We have faced several headwinds over the past few years, but we believe the increase in R&D spend focused on the connected home will pay off in 2023 and beyond.

I would now like to turn the call back to Paul.

Paul Arling

Thank you, Bryan. Progress is not a straight path. Strong companies have the opportunity to become stronger during times of uncertainty. UEI has repeatedly proven this outage. We expect to do that again. Our business has been beset with many challenges across the last few years, as many have. COVID-19 and its after effects, supply chain issues, semiconductor shortages to name just a few. Industry shifts have caused many of our customers' demand to lessen. Recently, the continued impact of economic difficulties such as higher interest rates and inflation have affected consumer spending patterns. During this difficult period, the team at UEI has innovated like never before, begun a significant transition into the connected home market and increased our share in all the markets we serve. Over the past 18 months, we have won significant projects and have many more opportunities in the pipeline. While the near-term results are not at all what we would like them to be, we are taking action to improve them and very importantly, create an even better future for UEI.

Our track record supports our ability to navigate different pressures, emerge stronger and drive shareholder value in the long term. Based on our product development pipeline, design win backlog, our intellectual property and our traction in new markets and customer engagements, this is truly a new beginning. As always, stay tuned. Operator, we can now open up the call for questions.

Question-and-Answer Session

Operator

Thank you. [Operator Instructions] And the first question comes from the line of Greg Burns with Sidoti.

Greg Burns

Can we just dig into the guidance, I guess the revenue miss for this quarter and the guidance for the first quarter, just maybe some specific color on what's driving the magnitude of the decline? Is it primarily coming from the traditional kind of SVOD channels? Or is it more consumer-centric channels in the automated home. Could you just help us understand what's driving the magnitude to the decline? Because if we look back to like the heart of the pandemic, revenue was far higher here. So what's far higher than what you're guiding for the first quarter. So can you just kind of let us know what's changed? Or what's so dramatically different about this environment that's driving the decline?

Paul Arling

Sure. Yes, there's varied effects. And we obviously, we don't sell a lot of our products directly to consumers, Greg, as you know, but the customers that we sell to do because our products typically end up in homes, which obviously the decision makers in those homes are consumers. So we rely upon the consumer markets. And as you've probably seen from many companies, and we would say the same because our customers are selling often directly or through the retail channel to consumers. So TV business, as an example, during the pandemic, they probably did okay because people were at home. In fact, it was probably a flight to quality where they were buying better TVs during that period. I think just the long-term effect of the inflation, higher interest rates has made middle-class consumers a little less reluctant or a little more reluctant, less likely to go out and buy items. And you've probably seen this as we have from other products in the consumer market category. There are exceptions to that, but I think widely consumers just aren't parting with their dollars as easily. And in many cases, it might just simply be because a middle-income family when more of your paycheck is going to higher cost of food, higher cost of gasoline, higher cost of utilities, et cetera, there's less left over to spend.

So our customers are telling us that they're seeing fewer orders and expect to see lightness of orders for a time here. So we saw that in Q4. In fact, during the quarter, we had some customers who had forecasted orders that then did not fulfill them because they saw lightness inventory build, et cetera. And of course, other parts of our business have just seen difficult demand patterns. So it's been across the board. I would say that home automation security is a little easier only because, again, new projects, our market share there is lower, much lower. As you know, in the video service provider channel, our market share is quite high. So there, when the market's down, we're down because we can't offset it with share gain. We've already got a relatively high share. In markets like HVAC, our market share is respectable, but still relatively low, and we have great offerings there. So we can offset weakness with growth. The problem for the last few years has been that, that market was much smaller, and our home entertainment business was so large that any shrink in it was hard to offset with growth from that smaller business. As we highlighted during the prepared comments, that smart home part of our business is now 25%. So we think it's getting to a level of scale. We win a few more SKUs there and deliver them. It can begin to deliver some growth for UEI despite any home entertainment difficulties.

Greg Burns

Okay. What percent, I guess, the 10% customers, can you just give us that number?

Paul Arling

Yes, Nike [ph] was our largest customer at 15.5% and Comcast was our second largest at 11.2% for the fourth quarter.

Greg Burns

Okay. So I guess with Comcast, obviously, that's indicative, I guess, of the decline there, what you were talking about. But just so I understand like TV sales, like a consumer electronics product sales declining, but this feels like there's more to it in your traditional channels than just consumer discretionary spending being lower. Like is there more of like this is like the impacts of like cord cutting or more secular issues beyond that.

Paul Arling

Well, yes, that would certainly be part of it. I mean the demand from those customers has been lower for sure.

Greg Burns

Okay. And then with the manufacturing footprint, how much of a benefit to margins will that be? Because I know you're excluding some of these expenses in your adjusted numbers. So does that just go away at some point in time? Like how should we think about the benefit of this footprint rationalization? Because you already are excluding some expenses from your adjusted numbers. So what's the impact going to be?

Paul Arling

Yes, that's correct. I mean when we transitioned our Mexico facility from a refurbishment plant to a full-fledged manufacturing facility, it increased our capacity. So what I did was I said, okay, if I were to design it today, we have excess capacity. So what would it look like? What's happening now is with us trying to derisk our concentration risk in China, and we're spinning up Vietnam, we're going to have even more capacity than needed. So right now, with the shortfall in demand, we just have too much capacity. And so there's you kind of looking at 2 layers. One, you're right, I do pro forma a piece of it. But the amount that the potential savings is actually greater than that. So eventually, when we restructure everything and we're currently analyzing at all, the savings are going to exceed what's currently being included in the pro forma. So there's more savings to be had is probably a simple way to say it.

Operator

Ladies and gentlemen, this concludes today's conference call. Thank you for your patience. You may now disconnect. Everyone, have a great day.

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