Good afternoon, ladies and gentlemen. Welcome to the Universal Electronics Second Quarter 2017 Earnings Conference Call. [Operator Instructions] As a reminder, this conference call is being recorded. I would now like to turn the call over to your host for today's conference, Ms. Becky Herrick of LHA. Ma'am, you may begin.

Thank you, Bridget, and thank you all for joining us for the Universal Electronics Second Quarter 2017 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. This call is being broadcast live over the Internet, and a webcast replay will be available for one year at www.uei.com. In addition, any additional updated material non-public information that might be discussed during this call will be provided on the company's website where it will be retained for at least one year. You may also access that information by listening to the webcast replay. After reading a short safe harbor statement, I will turn the call over to management. During the course of this conference call, management may make projections or other forward-looking statements regarding future events and the future financial performance of the company, including the company's ability to build and maintain its relationships with its customers, including Comcast and its syndication partners, such as Cox and Shaw, DIRECTV, EchoStar, DISH Network, Charter, Sony, Samsung, Panasonic, Sky, Liberty Global, Vodafone, Microsoft and SK Broadband; the company's ability to anticipate the needs and wants of its customers and timely develop and deliver products and technologies that will meet those needs and wants, including the company's advanced AV control software and hardware solutions and technologies, which include QuickSet, adapted control, voice control, home security, temperature controllers and automation, and other technologies identified in this call; the ability to the – the ability of the company to achieve its sales growth as anticipated by management; the significant percentage of the company's revenues attributable to limited number of customers and particularly, the sales growth and benefits of the company's relationship with Comcast; the timing of new product rollout orders…

Thank you, Becky, and thank you, everyone, for joining us today. In the second quarter, we increased revenue by 3%, operating income by 8% and EPS by 5%. This growth was highlighted by the ongoing momentum in the transition to advanced home control technologies where operators continue to select UEI as their development partners for their next-generation control platforms. These platforms include the latest in radio frequency and voice technologies as well as a host of UEI-inspired features such as QuickSet, Control Plus and One Touch View. Our customers are, and, more broadly, our industry is, going through an exciting transition toward these next-generation platforms. This transition occurs after a long period of planning and development, another period of careful testing then in initial sometimes slower product rollout followed by a more aggressive rollout for these compelling new home entertainment and/or home-control platforms. The timing and duration of each of these periods, planning, development, testing, initial rollout and then the more aggressive rollout, are all subject to change. It's important to note that our customers gauge their level of deployment on the subscriber appetite for and reaction to the new features enabled in these new systems during the initial rollout. Market indications are that subscriber reaction to the new systems that have been deployed has been extremely positive. And consumer demand for these new services is providing operators the positive return they expect. Many of our global customers who are among the leading names in home entertainment are at various stages of product evolution today, with many progressing towards deployment. While some have experienced development delays, they are all committed to their long-term plans. These projects are viewed by our customers as a critical element of their future success, and they are committed to launching these products with the features…

Thank you, Paul. As a reminder, our results for the second quarter 2017 as well as the same period in 2016 will reference adjusted non-GAAP metrics. Second quarter net sales were $177.9 million compared to $172.2 million for the second quarter of 2016. Business category net sales were $164.8 million compared to $159.7 million in the second quarter of 2016. As mentioned on the previous call, we faced headwinds in the second quarter as certain customers truncated their purchases. In certain cases, ordering less than half of what they typically do in a given quarter in anticipation of their loss of higher-end platforms. However, we still managed to grow our top line by over 3%, driven by the continued rollout of higher-end platforms in North America and Europe, growth in the home security channel and increased market share in Latin America. Consumer category revenue was $13.1 million compared to $12.5 million in the prior year quarter. Gross profit was $46 million or 25.9% compared to 26.1%. Operating expenses are relatively flat at $30.2 million compared to $30.3 million in the second quarter of 2016. R&D expenses, $4.8 million compared to $5 million in the second quarter of 2016. SG&A expenses, $25.4 million compared to $25.3 million. Operating income was $15.8 million, an increase of 8% compared to $14.7 million. The effective tax rate was 25% compared to 24.7%. Net income was $11.4 million or $0.78 per diluted share compared to $10.9 million or $0.74 per diluted share in the prior year period. For the first six months of 2017, net sales were $340.2 million, an increase of 5%, compared to $323.7 million in the same period last year. Gross margins were 26.3% compared to 25.9%. Operating expenses were $61.9 million compared to $59.8 million in the first six months of…

Thanks, Bryan. UEI is playing a critical role in transitioning the increasingly interactive home entertainment and home control experience into one that is easier to manage and easier to control. While the magnitude of the industry's transition to advanced control technologies can impact short-term volumes due to longer development and deployment schedules and inventory changeovers, its potential impact on our growth prospects is undeniable. Today, we are facing a powerful and truly positive inflection point on which we are ideally positioned to capitalize. The technology of today includes cloud-connected TVs, set-top boxes and over-the-top services that are more capable and smarter than ever. These systems are tightly integrated into advanced remote controls that deliver a host of features and services that were not possible before. The remote control solutions we are designing today are not just a dream or interesting idea; they are being developed, introduced and, in many cases, already deployed by some of the leading names in home entertainment worldwide. The market momentum to cloud-connected 2-way platforms has also opened up an exciting opportunity for us to deliver other products to support the emerging home security and automation services that our customers are actively developing. This movement towards smarter, more advanced remote control systems has already begun and represents an enormous market and financial opportunity for UEI in the coming years. Frankly, this shift is not new to us as we anticipated this many years ago. But the technologies available today, combined with consumers and our customers' appetite for these new products and services, combine for a powerful and compelling opportunity going forward. Our unmatched world leading technologies, intellectual property and products ensure that we are ideally positioned to excel as this inevitable transformation takes place. Over the next several years, the smart home will look very different than it did five years ago or even today. Consumers expect all the new connectivity protocols and a diverse array of devices that they bring into their home to operate as a single unified system. We aim to help them deliver on this need. We envision the future where all connected devices and services are easily setup and controlled across multiple platforms, systems and protocols with minimal user intervention, and UEI will be the innovator that makes that vision a reality. We are more excited than ever before about the future prospects of our company. Stay tuned. I'd now like to open it up for questions. Operator?

[Operator Instructions] Our first question comes from the line of Steven Frankel with Dougherty. Your line is open.

Hi, good afternoon, Paul and Bryan. You know, looking at the guidance, it seems like there is implied continued gross margin pressure in the Q3 guide. Can you give us a little insight as to whether that has to do with customer concentration or manufacturing transition issues in China, and maybe step back and tell us what does it take to start to see gross margins lifting from these levels?

Yes. This is Bryan. It's mainly attributable to the manufacturing transition from our southern factory to our northern factory. We're nearly complete with it. It's expected to be completed in end of July or actually, the first week of – first couple weeks of August. And what we did was, in Q2, we end up finalizing the majority of the products being transitioned, but some of these projects were actually complex in its nature. So some of the – you know, when you're transitioning for the northern factory, these are new products to them. And unfortunately, it takes a little bit of time to tend up perfecting them like we did in the south. So we have some growing pains. It's something that's continued improvement with us. We took a little bit. You see in Q2 it is slightly down from Q1. But it's something I expect to see improvement in Q3. I expect Q3 to be somewhat closer to Q1.

Okay. And then, do you think Q4 you're able to produce that gross margin that's more reflective of the actual volume going through the factory in the product mix and none of these overhead issues will be affecting you?

It's possible. I mean, I don't want to predict Q4 just yet. But I think, as each quarter progresses, we should improve. I mean, it's something that's going to take a little bit of time. But as you load up the factory and more projects come into play and you started launching more of the projects, you have more volume, and therefore, you should gain some efficiencies. But I think it comes down to improving our execution and then also launching some of the products and just getting more volume to the factories, so you could absorb the overhead more efficiently.

And is there any room to raise prices either on the old products that are winding down or on new advanced remotes given margins quite aren't where they should be?

Yes. I think that the opportunity, Steve, would be that when you introduce new products with enhanced features, obviously, there is an opportunity also based on customer size. Customers buying 10,000 units will be priced differently than those buying 10 million units. And as the industry moves more towards these connected platforms with advanced features, automated setup, with features like QuickSet, Control Plus, One Touch View, et cetera, there is an opportunity there for some potential up tick in the margin.

Okay. And the customer headwind that you dealt with in Q2 is that now behind you? Has that customer positioned to start taking next-generation product in Q3?

Not completely, no. No. There's been – again, as we alluded on the – in the prepared remarks, we're not talking about specific customers, but there are customers who have weeks or months delay in the development cycle or the testing cycle. And when that happens, the revenue delivery of the new platform gets delayed. So we do have some that have moved out a little bit. But as I also said, there is no doubt in our minds or theirs that these programs are moving forward. They're critically important to the companies we're working with. They see it as a critical element of their future. There is no question about the fact that these new platforms are coming out. Our customers sometimes just want to be careful. They want to make sure they're as right as they can be at launch. They realized there maybe some weaknesses in them. There maybe software upgrades to fix it, but they want to have it as complete as it is possible when they put it out because it's very visible within their company and outside their company. So they're very careful in the testing – the development and testing cycle to make sure these products are right, and that sometimes leads to weeks or months delays.

But on the flip side, in terms of inventory transition issues, I think, there was a customer that you referenced that had too much old-generation inventory, and was trying to burn through that. Any update on that situation, is that complete or nearly complete?

Well, we had a couple. I think one is probably complete. The other one is probably going to have mildly truncated orders for another few months. Now here is the other thing that I should probably say. If these projects get delayed, there is actually a positive because what happens is if you – they have to have remotes for deployment. And all of these companies are deploying every quarter. If your new project is delayed, it's even possible that you would have to buy more of the units that you're depleting because if it delays to the point where your inventory runs too low, then you have to replenish those units. So this can only occur for a certain length of time, and it can be as much as 6 months. But typically, at that point, you would have depleted the inventory that you are going to deplete over that time period. And if there is any developmental or testing delays you'll actually have to procure again. So again, I guess, to elevate this to the 50,000 foot conversation, these are temporal issues that can occur. They typically – they're not long-term issues. They're typically months. It can stretch out to four or five months. But typically, at that point, the inventories get depleted to the point where they have to replenish.

Okay. And just from Bryan, can we get an update on customer concentration in the quarter?

Yes. [indiscernible] Comcast was 24.2% of sales, and DIRECTV was 10%.

Okay. And last one for Paul, what's the timing on the rollout of some of these new home control products that you have coming?

Well, on the home sensing, there – in the next 6 months, we have already rolled out some, and we're going to roll out some more. I did allude to one. We can't give names because the customers haven't announced these yet, but we're doing Wi-Fi modules that will enable HVAC systems to become smart and/or communicating to the point where the original unit put into your home will be capable of this. It's an integrated feature, and we're selling modules to these companies to help them enable that feature.

Okay, great. Thank you.

Our next question comes from the line of Greg Burns with Sidoti.

Good afternoon. So just based on those customer concentration numbers, you gave, looks like Comcast is up pretty nicely in the quarter, still showing nice growth there. I think, on their call, they said they were about 55% penetrated with their X1 platform. So I was just wondering, where the growth is coming from, is it still mostly from remote controls? Or is it more being driven now at this point by XFINITY Home? And then maybe, if you could remind us, what the typical buying pattern of a mature customer is on an annual basis once they're fully deployed. Thank you.

Yes. I mean, the growth is coming from a few sources. A lot of people think that this is a domestic trend, but it really isn't. It's a worldwide trend that's affecting not only North America but Europe and Asia as well. So we have growth coming from Europe. They have customers that are also transitioned to higher-end platforms. Some have launches. We have more projects that we'll launch in the future. APAC, same thing. So it's coming from multiple sources. Even Latin America, we've actually gained some market share in Latin America in subscription broadcasting. And as Paul mentioned, the home security. Home security has done really well. Comcast continues to roll out its X1 platform, so remotes have sold well for us. But also, we're selling the home security products through their XFINITY platform. So it's going well. So we have growth from multiple sources. So despite having – facing some headwinds in Q2 and a bit in Q3, we still are managing to grow.

Okay. And I guess, with a customer like Comcast, on an annual basis, how should we think about their buying patterns in terms of their replacement of remotes? Just given that they are 35% penetrated at this point, the X1 platform, does that mean that you expect growth to slow there or is there a consistent base of business that's somewhat recurring?

Yes. Well, I think, we did an example of this. I don't know if it was the last conference call or two ago, but I'll reiterate that. We won't speak specifically about Comcast because we don't like to discuss specific customer's plans. But I will tell you, generally, here in the U.S., over the years, what we see is that – and this may surprise people because I think they have the impression that when a new platform comes out, there's a surge where they buy twice what they normally would. And then once they get deployed to 60% or 70% on the new platform or 80%, then the sales just settle down to half of what they were before. What we see instead is a pretty even purchasing transition where the average here in the U.S. is about 0.7%. So if you take the number of subscribers that a subscription broadcaster has and you multiply it by about 70% of that number, so let's say, it's somebody who has 10 million subs, they would typically buy 7 million units a year. And that number doesn't appreciably change in the transition to a new system. Now if they're deploying that many in a year and they have inventory of the old one, sometimes they'll truncate orders, so that they don't have inventory lying around from the old platform. So that can change that number. But over the long term, customers typically don't vary very much from these ratios. We have customers that are higher than 0.7%. Some of them run at 0.9%. Some of them run below 0.7%. And I won't speak specifically about Comcast's purchasing pattern because, again, we don't disclose our customers' plans. But overall, on average, what you'll see from the average operator here in the U.S. is a ratio that might surprise some, and also surprising potentially is that the ratio doesn't change very much even when a new platform is rolled out.

Okay, thank you. And you mentioned you're working with operators covering 150 million subs, 10% deployed so far in advanced platforms. Do you have a target for where you think that penetration rate could be at the end of the year or maybe end of next year?

Well, we don't have a target for that. But I would say that over the long term, that number should be 100%. These advanced 2-way platforms are rolling out in these systems. Most of those that have rolled them out are talking extremely positively about the results. They're seeing from the initial rollouts and has caused some of them that are further into it to more aggressively deploy versus taking a more conservative stance. So we think that this is a long-term trend in the industry that consumers are asking for and are engaged in and love. And once rolled out, they roll out more widely. But we're only at 10% so far.

All right. Thank you.

[Operator Instructions] And our next question comes from the line of Andrew D'Silva with B. Riley. Your line is open.

Hi guys. Thanks for taking my questions. Just a couple of quick ones here, as far as revenue mix goes, can you give us a sense of how many or what percent of total revenue was perhaps last-generation technology, and what percent of revenue is next-gen or new-generation technologies for this past quarter?

Yes. We don't really give that breakout. The only thing I would tell you is it obviously continues to grow, the advanced revenue. But we don't have a precise number for that, that we disclose.

Is it still fairly nominal there relative to the entire revenue that you're generating currently?

Yes. I would say, it's definitely not the majority. And as Paul said, it's continuing to grow. But right now, it's definitely less than – it is a lot less than half.

Okay. And when we start thinking about down the road, you now have a pipeline that consists of around 150 million subscribers in some long-term way, do you have a sense of how many subscribers you have currently that are deployed with your [indiscernible] technologies that are fairly similar to the subscriber base that you're targeting right now, and then, if so, should we just assume growth is primarily going to be related to ASP increases in controls that are deployed?

Well, yes, actually, our number – I don't have, again, a precise number for you. We go through every operator in the world. I can't, off the top of my head, tell you exactly what that share is beyond the advanced because that's the one we did for the call. It would be higher than 155 million, though, that is our total share. So in other words, we sell to companies that represent more than 155 million. The 155 million number are operators that we've closed on advanced platforms. We do have customers that we have yet to close on advanced platforms that account for more than those 155 million.

So in aggregate, it's – the total customers you touch from a subscriber standpoint is probably close to 200 million.

Correct. Yes, it would be higher than – clearly higher than 155 million. Our share of market is higher than that.

Okay. Good. And as far as ASP, is that – given that's probably the biggest driver as you move on. It's just the cost of a remote going forward is going be higher. Thus, that's what's going to be driving the revenue increase. Or is there other dynamics in there that I should be thinking about?

Well, no, that's a major dynamic. These products are far technically advanced. The components within them are far advanced from the prior generation. I mean, the prior generation was often a one-way infrared emitter. These new programs are much more technically sophisticated. So the ASPs have gone up, in some cases, significantly on this next generation.

Okay. And just last question, when we're thinking about gross margins down the road after you've dealt with the transition from the southern to the northern factory and you're more heavily penetrated with the next-generation technologies, where do you think gross margins should come out at?

Well, I think, we're striving to getting back into that 27%, 28% in the near future. And I think, if we can continue to drive sales and then you grow, say, Opex at half the rate, if you can keep your margin at 27%, 28% rate, you're going to drive operating margin. That doesn't mean that I want to stop it in the 27%, 28% percentile. But I want to – at least want to get there in the near future, so that we can drive operating margin. That will – it depends on the mix of – there's a lot of things that go into the gross margins, so that affect it. But in the short run, I would say, 27%, 28%.

Yes. We, of course, have goals to get that number as high as possible. But as you've grown to know us a bit, we don't like to promise the world because there is a lot of other factors that play when we go out 6 months from now or 6 years from now on margins, competitive effects, component effects. There is just larger and larger customers that – there is just a lot of factors that go into play on that. I don't want you to think that we have a goal of only getting to 27% to 28%. We'd like it to be 35%, and we do have products that we think we can get up into a higher range. The question is, what will the mix be a year from now? And that we don't really answer. It is part of the reason we wouldn't provide guidance out a year or two on this figure because there's a lot of factors at play.

Got it. Well, thank you very much and good luck going forward.

Thank you.

[Operator Instructions] I'm not showing any further questions. I'll now turn the call back over to Paul Arling for closing remarks.

Okay. Thank you for joining us today and for your continued interest in our company. A couple of announcements; we will be presenting at a number of conferences in the third quarter. We'll be participating in the Piper Jaffray Tech Select conference in Los Angeles on September 5; The Deutsche Bank 2017 Technology Conference in Las Vegas on September 12; the Dougherty & Company Institutional Investor Conference in Minneapolis on September 19; and the Sidoti conference in New York on September 28. A busy month in September for conferences. Over the next few months, we'll be participating in a number of trade shows as well, including IFA, September 1 through 6 in Berlin; IBC, September 15 through 19 in Amsterdam; and the Cable-Tec Expo, October 17 through 20 in Denver. We look forward to seeing you at one or more of these events. Thank you, and goodbye.

Ladies and gentlemen, this does conclude the program. You may now disconnect. Everyone, have a great day.