Good day, ladies and gentlemen, and thank you for standing-by. Welcome to the Universal Electronics' Second Quarter 2018 Earnings Conference Call. [Operator Instructions] As a reminder, this conference call is being recorded. I would now like to introduce you host for today's presentation , Mr. Ron Parham. Sir, please begin.

All right. Thank you, operator, and thank you all for joining us for Universal Electronics' Second Quarter 2018 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 company's website at www.uei.com/investor-relations. This call is being broadcast and a replay will be available for 1 year at www.uei.com. And in addition, any additional updated material, nonpublic information that might be discussed during this call will be provided on the company's website where it will be retained for at least 1 year. You may also access that information by listening to the webcast replay. After a short safe harbor statement, I'll 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 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 control products, which include the continued adoption of our voice remote control and intuitive 2-way home entertainment technologies by existing and new customers, the continued incorporation of our QuickSet technologies into customers products as expected by management, the continued acceptance and growth of the company's connected home products and technologies, including security and control, temperature controllers and automation and other technologies identified in this call; the timing of new product rollout orders from the company's customers as anticipated by management; the continued trend of the industry toward providing consumers with more advanced technologies; achieving the synergistic growth benefits as anticipated by the management; the ability to successfully identify and enter existing and…

Good afternoon, and thanks for joining us today. We're excited to speak with you. These are interesting times for UEI as we look back at our successes and look forward at the connected home market before us. I am pleased to say that the connected home is not just emerging, it has arrived and it is inevitable that devices throughout the home will all one day be connected using advanced 2-way wireless connectivity protocols and enabling the types of use cases that we saw in the Jetsons cartoons so many years ago. Today, we are in the middle of a conversion as so many of the systems we use in our homes are evolving from traditional user-initiated control to smart system-enabled control. As we have shared with you before, our traditional AV delivery solutions are making way for smart entertainment systems, which includes 2-way cloud connected systems utilizing voice remote control front ends. Similarly, the traditional home control products that we use every day such as HVAC, lighting and safety and security are experiencing a shift to smarter, more convenient and more efficient automation of our homes. As with many technological conversions before, like analog to digital and standard definition to high definition, the path is typically not smooth. Our second quarter results and third quarter projections exemplify this conversion. As expected, second quarter sales were down. Adjusted non-GAAP net sales were down $154.9 million. However, our third quarter sales guidance is expected to come in between $182 million and $190 million, representing the highest revenue quarter in our 30-plus year history. These expectations are based on positive trends both in our core audio video products and the increasing contribution from our home automation products. Our success in creating innovative AV system control products has enabled us to build core…

Thank you, Paul. As a reminder, our results for the 2018 second quarter as well as the same period in 2017 will reference adjusted non-GAAP metrics. Second quarter net sales were $154.9 million compared to $177.9 million for the second quarter of 2017. Business category net sales were $140.8 million compared to $164.8 million in the second quarter of 2017. As mentioned on the previous call, during the second quarter, we expected certain customers to reduce their orders to rebalance inventory levels, preserve capital and manage their platform transitions. Consumer Category revenue was $14.1 million compared to $13.1 million in the prior year quarter. Gross profit was $38.7 million or 25% compared to 25.9% in the second quarter of 2017. Operating expenses were $30.4 million compared to $30.2 million in the second quarter of 2017. R&D expense was $5.9 million compared to $4.8 million in the second quarter of 2017, reflecting our continued investment in technologies that enhance the user experience. SG&A decreased to $24.5 million compared to $25.4 million. Operating income was $8.3 million compared to $15.8 million. The effective tax rate was 23.4% compared to 25%. Net income was $5.4 million or $0.38 per diluted share compared to $11.4 million or $0.78 per diluted share in the prior-year period. During the second quarter, there were a couple of events that occurred that are not in our normal course of business. First, we went live with our Oracle ERP platform in all the jurisdictions within Asia. Secondly, we completed the sale of our Southern China factory. As a result, we incurred and excluded the following related charges to arrive at our adjusted non-GAAP metrics. We excluded the gain on sale of our China factory, which approximated $37 million. We excluded the $4.8 million write-down of assets associated with the…

Thanks, Bryan. We believe our technology is the backbone that powers the next phase in the smart home entertainment evolution. Our position as the leader in smart home entertainment voice activated control is the springboard that enables us to deliver a broader array of products and services, both in AV entertainment and home automation control. Everyday devices in the home are getting progressively smarter. Our TVs, our set-top boxes, our thermostats, lights, fans and beyond. UEI is ideally positioned as the technology, design and manufacturing partner to help make our existing and new customers devices smarter. Today, UEI it has a dominant lead in enabling home entertainment systems to connect and control other connected devices in home. UEI is also at the center of home automation control systems encompassing safety, security, HVAC and lighting and we are working with many of the leaders in this space such as Ring and Daikin. We are still at the early stages of the transformation of home entertainment to smarter systems. Home automation is not just an interesting concept, it is here, and as I outlined earlier, it will generate more than $130 million in revenue for us this year, and these home automation and entertainment control systems are beginning to converge, and we expect to have exciting product and customer announcements to make in this area over the next few quarters. We will continue to innovate, create more industry-leading technology and improve our operations. All of which will contribute to enhance shareholder value over the long term. Stay tuned. Operator, we'd like to now open up the call for questions.

[Operator Instructions] Our first question or comment comes from the line of Jeff Van Sinderen from B. Riley FBR.

Great to see the business is picking up in Q3. Wondering if you could give us a little more color on the advanced platform launch that's underpinning your guidance or at least part of your guidance for Q3? Maybe give us a sense of the size of that customer and what the outlook is for their launch in terms of how lengthy it might be? How we should think about this level of ordering? Do think it's - do we get back to more linear? Just, I guess, trying to get a sense of whether you think Q2 is just an anomaly at this point? And how likely it is that you think your revenues might return to a more linear pathway?

Yes. First of all, the growth from this customer I referenced, the customer in subscription broadcasting, that's not the only thing that's driving Q3, because we have home automation, we mentioned Ring and Daikin. So the launch of the customer in subscription broadcasting is not the only driver. But unfortunately, I can't name their name, but they're pretty good sized customers. They're not a 10% customer, but they're top 10. So we're happy they launched. They are one of the customers that the launch was delayed originally. So it went off now. The question it has to how they distribute it. Do they distribute it across the board to all of their subscribers or to existing subscribers. To certain regions, right now we're seeing how that's going to play out. So we need some time on that, but the way they ordered in Q3 is definitely promising.

Okay. Great. And then, maybe if we could shift to home automation for a moment. You mentioned several customers there increasing orders, I think that's part of the home control and sensor segment that you talked about at about $130 million this year. Can you give us a better sense of the scope of the customers and their programs? I know you mentioned Daikin and Ring, and just, I guess, trying to get a better sense of that, and what sort of growth rate do you think is feasible for that business segment going forward?

Yes. I'll answer that. There is a variety of products here that encompass all different types of home control applications. Obviously, there's safety and security. So customers, even on the do it yourself side, are plugging in sensors and they are able to monitor on their own cell phone as well as to have a service back drop to that. And on the other side, you've got HVAC control. Daikin is a world-leader in HVAC, of course, and are - we're working on them on numerous products, control products, and others that make them smarter, meaning that they connect them, they give IP connectivity to the main system in your home. And we are - we've been working with them for a while. Daikin is a long-term customer. I think it's probably important to note that by the end of this year, we'll have at least 2 customers in our top 10 that do not buy AV control products from us at all. They are simply home control customers, buying HVAC, safety, security, lighting and other home control type products. So this is a - is growing to be a significant business for us, as I stated in the prepared comments, smart home growth is projected to be in the 25% to 30% range over the next couple of years. This is a high-growth area. And for us, this has been a growing business and we think that will continue. So it supplements the AV part of our business because the main activity that people perform in their homes. Recent data from the U.S, I just saw from it Nielsen says that the average person is now consuming - the average American is now consuming close to 6 hours of video a day, almost 5 of which is coming from their live TV and DVR sources. This is actually up from two quarters ago. So this is the number 1 activity in the homes of today, but it's a natural progression for people to connect the other systems in their home as they become smarter. HVAC control for their environment, lighting, of course, and of course, safety and security, I think that make their homes more secure. So we think there is a natural progression for our customers, some of them new and some of them existing to extend into these new areas, and we think we have a great platform to do it, because again, we're the number 1 use case in the home.

It's good to hear. So your business is really sort of evolving in terms of the mix?

Correct.

Let me just ask you this - just one from me and then I'll jump off. Where you stand on the new generation remote production in the China factory? Just wondering where we are there? And how we should think about gross margin at this point?

Yes. We made good progress from a manufacturing perspective. From a gross margin percentage point of view, we are facing some headwinds, though. I mean, right now, the number 1 headwind is the - we've got price increases for some of our key components. And I don't think that's news to anybody, I think a lot of companies mentioned that, and it's - unfortunately, we're - it's affecting us as well. So that's really the number 1 headwind for us. It's just trying to offset the pricing pressure on the components side.

Our next question or comment comes from the line of Steve Frankel from Dougherty & Company.

[Technical Difficulty] The detail around this home automation opportunity, could you tell us what that business was last year with the comp still $130 million?

Yes. I don't have the exact number, Steve, but it was less than $100 million.

Okay. And then, on these - we've got at least one major launch in Q3. On those customers that were delayed, that caused the poor performance in Q2, could you kind of give us some commentary on where those other customers are in getting to production?

Yes. You mean in terms of products that haven't yet been launched?

Right.

Yes. They're all on track at this point. So we don't see any reason to project any great delays, but I will just warn that in the past sometimes projects get 9/10 of the way done, and then, there is a delay of a month or two or four. So it's always possible that some of the customers that are working through the last levels of technical sophistication or finalizing their product in the UI, can experiencing some delays in software, so it is possible, but we're pretty confident in the guidance we gave for the quarter out, which is the only guidance we give.

Okay. And what was Comcast in the quarter?

18.2%.

Okay. And I understand the commentary about component prices increasing, and that's impartial on gross margin. So does that mean we ought to expect gross margin to be kind of flat here? Or it's really just impacting your ability to ramp it between now and the end of the year?

Yes. We don't give guidance on the gross margin line, but it's going to depend on ramping. I mean the headwinds are pretty strong with certain components like the capacitors and resistors, but on the plus side, I think we're doing a good job improving on the manufacturing side. So it's really come down to mix, I wouldn't forecast anything drastically different.

Okay. And where are you - on these cost reductions, is this moving people to lower cost geographies? What kinds of things are you contemplating that keep your costs flat?

Yes, we're looking at everything. I mean, we're looking at potentially what you just mentioned. We're looking at freight carriers. We're looking at everything across the board, and I don't want to get into too many specifics on that, but we feel confident that we can continue to grow the top line, while over the next two years, basically maintaining our expense level, and where it will be in 2018, we can do that. It's going to drive significant operating margin leverage.

And how quickly can you institute these changes? Are these things that will go into effect in early next year? Or will you be able to start this year?

We'll start this quarter and we'll act on this over the course of next year or 1.5 year.

Okay. And just because we don't want Bryan to not answer boring accounting questions. On the GAAP to non-GAAP sales calculation that we saw this quarter, I don't remember 606 being that material last quarter. Is this a short-term phenomenon? Or is this something at this magnitude we might see every quarter, so that the non-GAAP sales in Q3 are going to be even higher than what you guided to?

Actually, the magnitude was similar. So year-to-date, there's little effect but the - what happened was, in Q1, the GAAP sales were less than pro forma, and then in Q2, it reversed from nearly the equal amount. So it actually was, I'll say - I think it was $7 million in sales in Q1 and it was $6 million in Q2. So it was pretty close. So year-to-date, there's very little effect. The problem is, I'm trying to compare apples to apples so that people don't get confused because the new rules are, they go against everything that we've done in the last 100 years where the new rules allow you to recognize certain revenue on certain finished goods that are sitting in your warehouse, you haven't even shipped them yet. So in order to compare apples to apples, I'm trying to - I'm pro forming it this year so that we have a good comparison.

Okay. But to be clear, the guidance is, for that - you guided to non-GAAP sales?

Correct. Yes, correct.

Our next question or comment comes from the line of Greg Burns from Sidoti & Company.

Was there any other 10% customers besides Comcast?

No. It was just Comcast.

And your guide for the third quarter, does that contemplate Comcast rebounding to kind of more normalized levels? Like, are they adjusted their order patterns back to kind of normal rates?

Yes, I don't - we don't speak to any particular customer and the guidance. But I can say, for example, Comcast, we haven't lost any share with them or any of that nature. So I think they're ordering less right now. So it's - fortunately for us, we have a pretty strong customer base, and as I mentioned previously, one of our customers launched a new platform, Paul mentioned those, launched high end remote. We've got strong growth with Ring in the security business, and Daikin is doing very well. Daikin has been a good customer for years and they continue to grow and these advanced platform just on with subscription broadcasting and also with home automation channel and that's helping us as well. So we have a lot of good news to offset any potentially - a temporary shortfall in one particular customer.

Okay. That's good. And I know, I guess you mentioned some input cost inflation. Can you just talk more broadly about how tariffs on Chinese imports might affect your business?

Sure. Yes. We are closely monitoring and evaluating impact of the tariffs, the additional tariffs that have been recently imposed, and those that have been proposed on our products that are manufactured in China. From an operational perspective, we're developing plans to mitigate the cost of the tariffs by gradually shifting manufacturing of our highest priority or highest volume products to U.S. customers out of China and into existing facilities that we have in Mexico or Brazil, and exploring Vietnam as a manufacturing alternative. We do anticipate the process will take months to complete, which means that we may incur additional costs during the transition as we expect some of these additional tariffs to be implemented somewhere in late September or probably into October, although, it's difficult to know. The tariff situation is obviously fluid, and we expect to react appropriately and as quickly as we can. You should know, however, that no matter how this plays out over the next few months or over the next year, we can, and if necessary, will, transition our production to jurisdictions where we can cost effectively serve our customers over the long term. Then obviously, we'll share more on this topic as its impact on our business becomes clear.

Okay. And then in terms of, you've called out a lot of customers by name that are kind of keeping up the rollout, particularly, the large European operators. Can you give us a sense of - do you have a sense of I guess, how their plans on the rollout? Is it going to be like Comcast getting in everyone's hands as quick as possible? Or more measured approach? And historically, have you been picked up shares as they're rolling out these advance remotes, like are they going to a more - a sole-sourced where now you're supplying all the remotes, where in past it might have been a [indiscernible] situation?

Yes. There's a number of things on that. So I'll try to answer each one. In terms of their - the aggressiveness of their rollout plans, unfortunately, I can't share that with you obviously by customer, because they - in some cases, they don't have the program out yet. So they won't want us to of course, go in front of them announcing how aggressively they'll roll these out. We've said many times before though, that there may be some that will be as aggressive as Comcast, but the normal probably be to not be as aggressive as Comcast was. They rolled out the S1 platform as aggressively as any has ever been rolled out in the history of cable, I think. So to expect every operator to rollout as aggressively as Comcast did would probably be a bad idea. Is it possible that they can get to that? Maybe, but I think that to predict how that mix will rollout would be a little bit less aggressive than Comcast was, because they were at the far edge of aggressive on that rollout. In terms of market share, typically these products are sufficiently complex, and the work involved in getting it done is sufficiently long, even for the vendor that they have often not qualified more than one vendor at the outset for these products, because again, it's not just a lot of work for the vendor or us, it's a lot of work for the customer to actually work alongside somebody, because these are not simple products, they are systems and they have to integrate very tightly with the other elements of the system, which means that it's more difficult to just swap things out. So the benefit of that is - the negative of it is, it takes more time with that customer and that integration effort. The good news is, it typically leads to a higher share of that customer. In fact, often, a sole-source-type of relationship. Does that answer all the elements of your question?

Yes.

Okay.

[Technical Difficulty] Some pretty large operators you're talking about in Europe, do you think any of these or one or two of them might be on a 10% customer over the next one to two years of that rollout?

Well, yes, [indiscernible] the 10% customer status, but obviously, the names that we've listed are the largest operators in Europe. They may not quite be the size of Comcast. Comcast would probably be the largest purchaser of these types of products in the world. So I don't know if they would reach that high, but they are - these are significant names in the industry. And obviously, it's more than one. So this concept of smart AV control paired with IP-connected set-top boxes is obviously something that is going to become commonplace. And the reason we believe that is not just because we are predicting that, again, if you look at the list of names that are implementing this, it's the leading companies in the markets that we serve. So this is becoming more and more commonplace each quarter and each year, and we think that trend is going to continue. As I said in the prepared remarks, there will be a day in the not-too-distant future, where every home that has these types of services are going to have these types of products. 2-way, self-configuring, indirectly IP connected control devices and voice that will help the user get to the entertainment they want to get to quicker. This is going to be commonplace. It's not there yet. We're still in the early innings of it, but this is happening. And the names that we've mentioned are just more proof that this has become an international phenomenon transitioning the home entertainment market forward.

Our next question or comment comes from the line of George Prince from RBC.

So Paul, you mentioned Ring, and if I remember right, Ring was bought by Amazon. Is it possible that the Google's, Amazon's, Apple's of the world are becoming more aware of the importance of the RF device to turn on the TV and the knowledge of all the codes and the common sense of having the TV remote being the center device for the entire home? Is it possible that there is more awareness of this now?

No doubt. Yes, they're aware of it. I think, most people who are in or around the industry are aware of it. Again, calling back on some statistics that we've been talking about for some years now, the average consumer - maybe not the people on this phone call today, but the average person is watching live and time-shifted TV in America nearly 5 hours a day. They're consuming video for 6 hours a day. This is the center of what people's lives are when they go home. They are often focused around this home entertainment system, and what better place to launch other applications, other services, the ordering of products, if that's your business goal, controlling your fan, controlling your HVAC, controlling your lighting, controlling your blinds. I mean all of these applications are best placed in the place where the consumer already is, which is typically when they come home, in front of that AV, home entertainment system. Now again, all the new technologies are making those AV systems and the home entertainment systems easier and easier to use, but it will also bring about the technologies that will allow them to control their home much more easily. So I think all these companies see this, our traditional customers, the consumer electronics companies that we talk to, the subscription broadcasters, clearly. Some of them are already developing these things, already have introduced some of these things, and I'm sure that other companies see it as well. So it is happening. This is clear. And I think they're addressing the consumer where they're at, which is typically in front of that AV system.

Can you remind me or give me an update now of what you think your margin share is in the U.S. and in the world?

Of the home entertainment?

Just the remote controls for TVs.

Yes, well, it depends. Overall, for TVs or for the entirety of home entertainment, it probably isn't 50% yet. I would say though that on the advance platforms, if you were to take that subset, that market share would be far greater than 50%.

Is that globally or U.S?

Globally.

And in the U.S, it's like 80% now, right?

Yes. That's right.

All right. So when we do our research here, we can't find anything comparable for the price. So these are the companies most becoming aware that this is a pretty darn good value for the money, for the $8, $9 or $10, whatever you end up pricing it at, to be able to control the whole house?

Sure. They very well should see it as a good value. That is true. It's part of what's led us to the market share we have. We provide the best solution in the world, in our opinion by far, and I think, our customers would attest to that, given the customer list we've gotten over the years. So yes, I think that our solution is - and we obviously, never rest. Our solution still isn't good enough. It will continue to improve and separate us even further from anyone else who was - would desire to get into this. We're completely committed to having an ever better controller for not just your AV system, but ultimately for your entire home control experience.

[Operator Instructions] We have a follow-up question from Mr. Steve Frankel from Dougherty & Company.

Paul, from a high level, what's the margin - gross margin profile of home automation controllers relative to your typical cable controller?

Yes. We typically don't talk, Steve, about gross margin by product category. So I can't really give you a precise number on that. I would say that, generally, the industry estimates of margins in those areas are, typically, a little bit higher than AV control.

So it's a logical assumption that it's higher than your AV business, and certainly, you don't have the customer concentration issues, that will also help, correct?

Yes. And as time goes on, we'll see. But yes, I think as time goes on, this is something that is - today, it's a higher margin category than our traditional AV control.

I'm showing no additional questions in the queue. I'd like to turn the call back over to Mr. Paul Arling for any closing remarks.

Okay. Thank you for joining us today and your continued support of Universal Electronics. I'd like to note, in the next month or so, we'll be at several conferences. We'll be at the Piper Jaffray Tech Select conference, Dougherty's Institutional Investor Conference, Deutsche Bank's Technology Conference and B. Riley's Annual Consumer and Media Conference. All of these will take place between now and our next conference call and we look forward to seeing you there. Thanks for participating today and we'll see you later.

Ladies and gentlemen, thank you for participating in today's conference. This concludes the program. You may now disconnect. Everyone, have a wonderful day.