Ubiquiti Inc. (UI) Q2 2017 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Ubiquiti Networks Fiscal Q2 2017 Question and Answer Conference Call. As a reminder, the conference is being recorded. Thank you. Now, I would like to turn the call over to Laura Kiernan.

Thank you, Courtney, and thank you, everyone, for joining us today. I'm Laura Kiernan, the Senior Vice President of Investor Relations for Ubiquiti Networks. I'm here with Robert Pera, Founder, CEO and Chairman of the Board at Ubiquiti Networks. Before we get started I would like to review the Safe Harbor statement. Some of the statements we will make during this call constitute forward-looking statements, including perspectives on our future financial results, products, market conditions and competition. These statements are subject to known and unknown risks and uncertainties that could cause actual results to differ materially from those expressed during our call. Information on these risk factors and uncertainties is contained in our most recent filing on Form 10-K with the SEC and our other SEC filings, which are available on the SEC's website at sec.gov. Forward-looking statements are made as of today, February 9, 2017, and we assume no obligation to update them. We hope you've had a chance to review management's prepared remarks, which are posted as a transcript on the Events & Presentations and Financial Information sections of our Investor Relations website ir.ubnt.com. This call will be a Q&A-only call. Please limit yourself to two questions. Time permitting, we will allow for follow-up questions. Operator, we are now ready for your questions.

And our first question comes from Matt Robison from Wunderlich. Your line is now open.

Hey. Thanks for taking my question. Pretty phenomenal growth again on the enterprise side. In the past, you guys have talked about UniFi being a gross margin driver. This quarter, you talked about mix and to a lesser extent freight expediting as being a drag on gross margin. I was hoping you could give a little bit of color to what the mix factor is that impacted margins this time around. I've got a couple other follow-ups, too. I start with that one.

So first I want to say that I'm very disciplined when it comes to fundamentals and margins. I'm really proud of our operating metrics and I hold the company really accountable to margin performance. In this case, I should explain exactly why our margin has dropped this quarter. As you know, in the history of the company, we never dropped prices, but we very aggressively go after new markets. And a few things happened this quarter. First of all, AmpliFi, our pricing was very aggressive out of the gate, but we also misexecuted the launch. We had to recover. We had some last minute issues with design for production. We had a redesign. I wanted to get it on the shelves because we had such great momentum in terms of our PR and marketing strategy that we had to fill the channel with stock and we took a hit on a lot of air shipments. But from a long-term perspective, it's incredibly important we establish this AmpliFi brand. It's not just Wi-Fi, it's going to be a family of products. And it's really important we hit the time window and we started carving out mindshare in the market. So, that was one issue. I'd say another issue was airMAX ac. We believe we finally have solved backwards compatibility issues and now we are seeing a pretty nice uptick in airMAX ac sell-through. And airMAX ac, we also were aggressive on particular SKUs to help drive adoption. Again, strategically it's very important that airMAX ac gets adopted for us. The third thing is we had set up inventory centers both in U.S. and are in the process of setting up in Europe to really reduce the lead times. We do not have the most sophisticated channel in the world, especially on our operator community side and we historically had a lot of frustration with maintaining stock in the channel, which is very important if you're operators and you're deploying networks and picking up new customers, you need a reliable supply. So, that's a big problem we're trying to solve. So together, these things kind of hit all at once. I wouldn't say, long-term-wise, I expect our EPS and margin profile to be more representative of, say, the past several quarters, but I do think the decisions we made, while impacting OpEx in the short term, were a necessary decision I had to make to drive future revenue growth and EPS. My goal right now is that we have to get this company scaled. I do not want to be one of these networking companies stuck in purgatory without any acceleration. We have to get this thing to the $1 billion revenue as fast as we can and beyond that. So, that has taken priority over, let's say, maintaining really good fundamentals in operating metrics I like to see.

Well, I got you, Robert. Head count accelerated a fair amount. Might have been your biggest quarterly increase in head count. Can you give us a little bit of backdrop for that?

Sure. So we have a lot going on and there's a lot of big opportunities and growth drivers we see. So maybe take a step back, I'll say, talk about the three businesses. So, you have our Ubiquiti community of operators, which I guess you can call a service provider business, but it's not a service provider business in the sense that we're not selling to Tier 1s, we're not commoditized focusing on standard DSL or cable modem hardware, and participating on bids and getting squeezed on margins, and having huge sales teams and custom engineering efforts. We are certainly not in that group. So, our service provider market is actually quite unique. It's a community we built. They consist of operators. Grass-roots operators, we've grown and built a community around. So our operator business, I would say, is more like characteristics of a sticky enterprise business. But I think since it's considered operator and Internet access, it gets labeled as a less valuable business. But in our operator business, we have three growth drivers for the future and they're coming up quick. So the first one is, of course, airMAX ac. And I believe we solved the issues. And along with airMAX ac, we really stepped up our software complementary pieces. So we had everything from airLink, which is really improved as a link planning simulation software, to a new version of airOS we're rolling out on the devices that have all kinds of new metrics to help operators. And then we have AirMobile, which is very key for us. We have over 1 million downloads and over 100,000 active users of UniFi mobile app, and we're just starting UniFi – I'm sorry, Ubiquiti Mobile, which is for the airMAX world. And then we also have airControl, which helps you manage all the networks. And then on top of that, we're making great traction now on UCRM, which is a free software, which allows you to completely manage and bill and account for all your customers in your network. So, that solution together, I think, is as strong as it's ever been. And I'm looking for a good renewal in airMAX growth, driven by that increased software solution and new airMAX ac software and firmware and hardware. The second thing we're going to launch probably this next quarter is Ubiquiti Fiber, and for a long time, people have been asking us to do a GPON fiber solution. In areas like South America and Eastern Europe, fiber is now being deployed, not by just the big operators, but a lot of the smaller operators. And the solutions out there are very difficult to use, very antiquated. The upfront cost and investments for what they call the OLT, which is an infrastructure to run the fiber, is very expensive, and we're going to take a page out of the airMAX playbook where we make simple, very easy-to-use solutions that don't require training. We're going to minimize the upfront investment to get started and we're going to leverage our community of operators to evangelize this solution. So we're very excited about that. Like I said, this coming quarter, we're going to start shipments. The third thing I've talked about in the past, we have really heavy investments in this airFiber multipoint, we're calling LTU, and that solution is custom made for outdoor wireless. And it's custom made for scalability, for low latency, for very, very high spectral efficiency and great noise immunity. So all the things these operators need to support the next generation of bandwidth requirements and also be resilient to the more and more crowded spectrum outdoors. And that's going to be released, well, within the next couple quarters, is what we're targeting. Field trials start next quarter. So, that's the operator business. Now if we move onto the enterprise business, UniFi, and you talked about margins, well, we just started our strategy to move upstream in terms of increasing ASP and you've seen that with the announcement for what they call UAP-HD – or UAP-AC-HD and we're really excited about this product. We think it's the most important product we've probably ever released. The demand is very strong and we believe, unlike other products, we put a serious team on this product and we spent probably one to two years developing, soaking it, making sure it's super-reliable, very high quality. And I believe with this product, it's going to change the perception of UniFi being a value leader to being a performance leader. So we finally have something now where we test against the big brand names and we can beat them in performance labs. And we still maintain our disruptive costs. It's $349, which is one-fifth the price of computing solutions, but the performance is higher, it's better, and I believe the software is better. So I think when I look at UniFi now, people think although it's low cost, but in my mind, there's no doubt, it's now the highest performance solution in the market and way more usability. So, that will start a trend and you'll see us, we're going to have – this year we'll have APs that cost, by the end of the year, $1,000 and I think you'll see people also buy those and have interest in them. Along with a higher ASP strategy, we also are in beta of what we call UniFi Elite. UniFi Elite is a paid hosting and increased support solution, and the idea is we host networks for people. Instead of running their local controller, we run it in our cloud. We had dedicated, high-end technical phone support, life-time warranty, advanced RMA, everything customers in the higher markets need for peace of mind. And maybe before these customers hesitate in buying Ubiquiti or UniFi because we lack professional support, now we're going to offer it and of course we're going to charge for it and that's going to be the start of our service rep. So, that's UniFi. And now onto consumer and Ubiquiti Labs. Like I said, it's very important this quarter to do whatever we could at any cost to make sure we get this AmpliFi brand into new channels. We met the initial demand – or captured some of it. We didn't get all of it because of the fumble. But like I said, that is going to be a family of products that improve the modern home and you'll see at least two more big launches around – or we hope to see at least two more big launches, completely different technologies but complementary to Wi-Fi and the AmpliFi HD this year. As well as we have plans for more consumer brands that I think have a lot of potential. So hopefully to long-term investors, that gives you the long-term vision and strategy we're going to use to scale the company.

Yeah. That's a lot to do. I can see why you had to add a few folks. So if Hartley is on the phone – the call, this might be a question for him. In your 10-Q that was just released, you talk about you not being aware of any material litigation that could affect financial statements and it's been a matter of some public awareness that Synopsis may have a claim on you guys or filed a suit. Can you comment on how that 10-Q language might relate to that suit?

Unfortunately, I can't provide more information than that concerning pending litigation and I'm probably not the guy that's going to be able to get you the most details on it, if I could. So probably you want to follow up after the call.

Thank you very much, Robert.

Thank you. And our next question comes from Jess Lubert from Wells Fargo. Your line is now open.

Hey, guys. It's Mike Kerlan on for Jess. Just a follow-up on two product items here. You provided a lot of detail here and it's appreciated. But just to get back to AmpliFi, just to clarify, is the gross margin profile of AmpliFi – how does that compare to the corporate average? And do you expect shipping costs tied to AmpliFi as you ramp it to drive gross margin below the long-term target of 45% to 50% for a few more quarters, or does it snap back to that range pretty quickly?

Right. So if you look at our history, I believe when we became a public company, our margin was in the low-40s and we were able to expand the margins all the way up to the high-40s. And we have a strategy that seems to work well where we don't ever drop the price of a product in the market, but we'll do what we feel to be as aggressive in capturing market share or mind share out of the gate. And there could be instances where we are leaving money on the table, pricing so aggressively. But the way I look at it is the long-term value of capturing mind share or capturing a market is much more valuable than any short-term profits. So, I guess, to directly answer your question, AmpliFi, it's incredibly high-end hardware. Anybody that's bought the system and opened up the box immediately could see its high-end hardware, and we want to price it pretty much lowest or near the lowest in the market. So, we're going for super high end at aggressive pricing. Now, AmpliFi strategy is much like UniFi strategies in that I believe that over time the modern home technologies will cater or will support much higher ASPs. So if you look at the prices of expensive homes, it could be hundreds of thousands of dollars or millions of dollars. And if you could buy technology that increases the value of that home and makes it high tech or high end, I think people will pay money for it if it's a good solution. So AmpliFi, we believe, has a lot of margin expansion for us. And the first way, of course, is once we drive volume, we're going to focus on cost reduction, which we have not done yet. The second thing is AmpliFi, we have a plan also to drive up higher-end ASPs, and you'll see that, I hope, by the end of the year. So to answer your question, yes, there is going to be margin expansion over time. We don't intend to keep the same margins we're seeing now on AmpliFi.

Okay. And sort of in the same vein, with UniFi as you get the Elite service off the ground and it starts to see uptake, how does that impact the margin profile because you now have more head count servicing the customer base?

Well, with UniFi Elite, yes, we'll have phone tech support, but if you look at it as a factor of overall UniFi revenue and growth, I don't think it will be material to impacting our margins.

Okay. Thanks.

Thank you. And our next question comes from John Lucia from JMP Securities. Your line is now open.

Hey, guys. Thanks for taking my questions. The first one is on UniFi. I just wanted to ask you what gives you the confidence to kind of move up market here. It sounds like you're changing your strategy a little bit on UniFi. Are you starting to see UniFi right now being sold into more traditional enterprise resellers or are you seeing some evidence of adoption there? What's just giving you the confidence to make this change and kind of move more up market with higher-end APs and also introducing support offering?

I can give you guys one data point you can look up. So our Ubiquiti Community around UniFi was originally built from maybe a lot of emerging markets, a lot of Ubiquiti operators, but as UniFi has scaled, you see an uptick in the amount of professional system integrators that are using it, especially in the U.S. And these traditional system integrators have been using brands like Cisco and Aruba and HP and more expensive brands. And if you go to Spiceworks, spiceworks.com, that's one of the largest, I guess, third-party community for professional certified system integrators. And there's topics covering UAP-AC-HD and the demand there is really solid and the reception of the product is really solid. And we're also seeing that with orders. Orders are very healthy and we expect it to scale. I believe probably over this next year, UAP-AC-HD should be the highest revenue product, not only in UniFi but in the whole company.

Wow. Okay. When did you introduce it? That was recent, right?

Yes. Officially, we started shipping probably late last month, late January.

Okay.

But we had a really expensive field trial process that lasted several months. We wanted to be absolutely sure what we released was the highest end product in the market.

Okay. And who were those field trials with? Was it just resellers or larger customers, or how can we think about that?

They were with hundreds of both Ubiquiti Community members and many of those consisted of these professional system integrators you'll typically see hanging out on Spiceworks that are very familiar and typically use the higher end brands or I shouldn't say higher end now, but let's say more traditional expensive brand.

Okay. And then last question. I don't know if this is the best forum for it, but I just wanted to ask a question on gross margin. Do you know the magnitude of the impact from the product mix versus the shipping charge? Was it like an equal impact or how can I think about the impact on gross margin product mix versus the shipping charge?

Let's see, yeah, I don't have that detail. I know airMAX ac, AmpliFi and the shipping charges all impacted. I don't know exactly how much each contributed. Maybe you could follow up after the call.

Will do. Okay, thank you.

Thanks.

Thank you. And our next question comes from Tavis McCourt from Raymond James. Your line is now open. Tavis C. McCourt - Raymond James & Associates, Inc.: Hey. Thanks for taking my question, Robert. A couple of questions. First on the AmpliFi line, I think it's online-only and pretty limited distribution online. Can you talk about your willingness to kind of move into more traditional retail, if at all, and kind of what investments you'd have to make for that?

So traditional retail, I take it you mean on the shelves like Best Buy, Target? Tavis C. McCourt - Raymond James & Associates, Inc.: Yes, yeah.

Okay. So if you look at the AmpliFi design and you look at all this very quickly crowded market of high-end scalable consumer Wi-Fi systems, whether it's eero, Linksys, NETGEAR, Google, and then a couple more startup companies, AmpliFi, we designed or I made the decision to design to be on shelves, and if you look at that product, it shows very well it has some local UI, it has a stream, it kind of speaks to you. It looks very compelling next to traditional boring boxes without personality. So, we design that product and we put additional cost into making it look great on a shelf in a traditional consumer channel. And our strategy is to get it on shelves. The problem is we've been supply-constrained, as I talked about, with the misexecution out of the gate, and we're trying to ramp up. We do have or we invested significantly into relationships and we hope to have that product on actual shelves both in the U.S. and in a variety of international locations all this year. Tavis C. McCourt - Raymond James & Associates, Inc.: Great. And is there any meaningful operational infrastructure that you have to build to get on high-volume retail shelves like that, whether it's customer support or is it all kind of within the investment guidelines that you have for the business?

Yeah. So we've already set up a lot of the infrastructure to support technical support. We have an office in India, I don't know, probably around 50 support guys to deal with entry-level issues; and for advanced technical support, both for UniFi Elite and maybe things like AmpliFi, we've built these resources in the U.S. We also have significant fabricated international team that's on the ground that's in dialog with major shelf retailers on AmpliFi. So, a lot of that investment has been made and the effort is well underway for some time. Tavis C. McCourt - Raymond James & Associates, Inc.: Cool. And then a follow-up, you addressed some of the inventory changes previously to a question, but the dollar amount of inventory, obviously, was up a lot this quarter. Is that an indication that the kind of local warehousing strategy is kind of fully baked or will that inventory number still be creeping up after this quarter?

Yeah. I think if we scale, and my hope is we have some of our best revenue growth quarters over the near term in these next several quarters. Yeah, my hope is it will scale to support the business. Tavis C. McCourt - Raymond James & Associates, Inc.: And similar question on the receivables and DSOs, you made some comments in the prepared remarks about the DSOs being up because of, I think, enterprise distribution partners. Have you changed your policy or terms with your service provider-centric distributors, or is this all related to the enterprise, North American enterprise distributors specifically wanting better terms as the volume scales?

Yeah. I would say the majority of it is from the uptick in system integrators like Ingram or ScanSource that have longer payment terms. And I think it's important that we pick up momentum with those distributors, because it's key to our strategy of getting into higher end markets on UniFi and starting service revenue component, but the exact breakdown and details, you should probably follow-up call. Tavis C. McCourt - Raymond James & Associates, Inc.: Got you. And then last question, Robert, on LTU, which you mentioned previously. I assume that's kind of like a fresh scratch or kind of a de novo network for a WISP that there's not going to be an attempt at backwards compatibility there, right?

Correct. Tavis C. McCourt - Raymond James & Associates, Inc.: Okay. Cool. Thanks a lot.

Thanks.

Thank you. And our next question comes from Meta Marshall with Morgan Stanley. Your line is now open. Yuuji Anderson - Morgan Stanley & Co. LLC: Hi. It's Yuuji Anderson on for Meta. Thanks for taking my question. Just two really quick ones. One, did you see an effect from the stronger dollar perhaps in your service provider business? And number two, I was hoping we can get an update on your plans with the cash on the balance sheet, particularly perhaps maybe you'd be interested in M&A activity, for example? Thanks.

So, the currency fluctuations aren't something that I think about. You should follow-up call with our financial group. The cash on the balance sheet is a good question. We're always open to acquisitions, we always look at companies, and we're always in search of ways to use that cash to improve the business. Most recently over the past year, I've called our procurement teams to say use that cash to improve our margins, and so we have done some of that. The problem with acquisitions is if you look at our revenues now approaching, that should be close to $1 billion here soon on a run rate, and we're doing that with, I don't know, about $50 million or less in R&D, it's very tough to find a match for a company that can meet those metrics such that it's not dilutive to our focus and my focus to integrate those teams or integrate those businesses. We're really good at organically building new products and addressing the markets that it's hard to find a match that can do better than we can do organically and that isn't dilutive to our focus. But, yeah, I continue to look and we'll definitely be aggressive if we find a fit. Yuuji Anderson - Morgan Stanley & Co. LLC: Okay, great. Thank you.

Thank you, ladies and gentlemen, for participating in today's conference. This does conclude the question-and-answer session, and you may all disconnect. Everybody, have a wonderful day.