Ubiquiti Inc. (UI) Q3 2017 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Ubiquiti Networks Fiscal Q3 2017 Question-and-Answer Conference Call. As a reminder, the conference call is being recorded. Thank you. Now I would like to turn the call over to Laura Kiernan.

Thank you, Valerie, 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, our Founder, CEO and Chairman of the Board of Ubiquiti Networks. Before I 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 this call. Information on risk factors and uncertainties are contained in our most recent filing on Form 10-K with the SEC and other SEC filings, which are available on the SEC's website at www.sec.gov. Forward-looking statements are made as of today, May 4, and we assume no obligation to update them. We hope you have reviewed management's prepared remarks, which are posted as a transcript on the Events and Presentations of our Financial Information section of our website at www.ir.ubnt.com. This call will be a Q&A call only. Please limit yourself to two questions. Time permitting, we will allow for follow up questions. Operator, we are now ready for questions.

Thank you. Our first question comes from Matt Robison of Wunderlich. Your line is open.

Hey. Thanks for the question. Robert, a couple of questions, most of these financial, I have to say. I'm curious, what types of products we should think of as exhibiting the early stage of learning curve variance on margin? And then the other question is you had a little over 14 weeks of inventory, and I understand that that's a competitive weapon particularly for the enterprise side. And (02:27) you can help us understand where you think we're going to get to before you start to decide (02:33) enough to be competitive?

Sure. I'll start with margin. So as people who follow the company know, in the history we've never once lowered the price of our product. A lot of them are most popular products especially in Operator or UniFi markets. They have five-, six-, seven-year life cycles. And traditionally what we've done is to enter a market disruptively, we'll make premium products and we'll price them lower, and a lot of times we'll leave cash on the table because my goal is to grab market share and establish defensibility. Over time, we've shown a history of improving the margin. And if you remember, when we went public, we had margin in the low 40%s, and then over time it went up to the high 40%s to almost 50%. And that was largely due to products like the original airMAX series, the 11n UniFi series, which over time we've improved the margin. And I think right now we're at an inflection point of growth on multiple fronts. If you look at the airMAX side, we've finally improved airMAX AC and we've launched GENERATION 2 products. Some of those, the lower-cost CPUs (03:58), we have come in very aggressively because I think by doing so it will lead to a greater revenue and EPS opportunities. We've done the same thing with UniFi. We didn't have to price our UniFi AC series as low as we did. Things like UniFi Mesh at $99, UniFi AC In-Wall, $99, we didn't have to price them that low, but we do that because for long-term revenue, long-term EPS, it established defensibility in the market. It's what we've always done. And over time we've proven we leverage incredible value out of that strategy. So just for the long-term shareholders, we know what we're doing. I won't say to draw conclusions by a quarter-to-quarter variation in margin. The name of the game is EPS growth and how fast you can get to that growth from a long-term standpoint and that's how I'm running the company. And I understand for short-term traders, they're going to draw and extrapolate off these quarter-to-quarter in margin variations. But I really think where we stand today is stronger than we've ever been positioning-wise. UniFi is a train that's moving very quickly. Operator, we were reloaded with GENERATION 2 airMAX. We're launching Fiber to a lot of acclaim this quarter. We've had our own ASIC development, which many people, I don't think, understand the significance of. We're going to LTU which is airFiber multipoint. That's for a higher-end, higher performance market. And so I think those things just in the Operator alone is going to re-accelerate growth. And then turning to Ubiquiti Labs, what you see with AmpliFi, yes, the margins are not as good in AmpliFi because we wanted to make a super high-end product at an affordable price. And if you look at AmpliFi, you don't have the marketing spend of the 12 other participants in the mesh Wi-Fi market. There's companies that have huge dedicated teams just to marketing and sales, and buying, marketing, display (6:18) and they can't make a business out of it. They get sales, but where is the earnings? And I'm proud of what we've done with AmpliFi because we planted a seed that shows very little marketing sales spend. We've able to replicate what we've done in Operator and Enterprise. And that's the story with AmpliFi. We're going to have a number of technologies under the brand, and we're going to have another brand, a completely new brand under Ubiquiti Labs. And I think we're in position to execute that well based on the AmpliFi experience. And maybe that's a lot to take in account, but I mainly wanted to put that out there for our long-term shareholders. To your point about inventory. So traditionally, we've always had problems with channel inventory. And it's really critical for us especially with our service providers and UniFi markets because these system integrators and operators, if they can't get product to extend their networks, so they can't products to complete their projects, they are going to move to other vendors. And that's just horrible, that's the worse. So if we have hundreds of millions of dollars in cash, we are almost obligated. We've got to spend that with all the inventory problems. And I think we could have done it maybe more efficiently, but I think it's a big step in the right direction. So I look at the increased the inventory and our establishment of U.S. and Europe logistic centers as a key accomplishment and something that should be looked upon positively in contrast to how the company was previously run.

Okay. Thanks. I'll follow up with my third question but we have to queue again.

Thank you. Our next question comes from Erik Suppiger of JPM (sic) [JMP]. Your line is open.

Yeah. Thanks. Can you talk about which individual products did well of the new products, how the AmpliFi did and which specific ones did well in the quarter? And then secondly – well, let me get that and I'll follow up.

Yeah. I like to think of measuring the success of a company via platforms. So, as you know, airMAX, we created our own proprietary protocol so it's sticky. And once our operators build out airMAX, they are encouraged to continue to build out their networks using airMAX-compatible devices. So I would say for this quarter airMAX AC GEN2 looks promising. It's growing very fast off a smaller base, and then we'll try to ramp that up quickly. And as you ramp that up, you then see growth in this Operator segment. Looking at UniFi, of course, UniFi HD is doing exceptionally well. We're ramping that up. And that's a key data point because it proves our strategy with UniFi, which was to establish a high-volume base of brand awareness. And later leverage more margin and profitability through higher ASP products. And UAP HD was the first of that higher ASP strategy. It's reporting on MSRP. And it looks like we could probably go higher with higher-end products. AmpliFi, we reduced the AmpliFi SKUs (10:08) so we really just have AmpliFi HD and, of course, you have the MeshPoint HD, we sell stand-alone. Both of those are doing well and growing.

Okay. Then second, on the channel inventory buildup, where are you on that front? Do you feel like you've gotten it where you need it?

I think it's a step in the right direction. The inventory centers in shortening the lead times for our products is key. I think we could do a better job of improving our material management. As we switch to build more inventory, I want our guys to have some margin benefit in doing that. And I think that hasn't been my primary focus. My primary focus has been strictly R&D, how do we put seeds in place that can scale from – get us to $1 billion in the next fiscal year and then beyond that, right? We want to one day be a multibillion revenue company. And I think we've done a fantastic job on the R&D and the hiring and the reorg within the company to put us in a position to do that. Now, the secondary priority, which I'm just starting on now, of course, is the margins. So that adds confidence. We should have – margins definitely should go up as you see all these new products get out and mature in their life cycles.

Can you give us some context around what impact the channel inventory efforts have had on March gross margin versus the impact that the new product ramp has had on new products?

Well, I will put it this way. You're building more inventory and you're purchasing more materials. You should absolutely get margin benefit from your economies of scale. We haven't captured that benefit nearly well enough. We got a lot of work to do. And in terms of new products, it's, like I said before, we purposely will leave money on the table if we think it could spur evangelism. We're always looking at ways to build long-term brand awareness, evangelism, defensibility in markets. Similarly if you look at Amazon, one of the key drivers of the Amazon growth is they had very small margin and they gave away free shipping. And in the short term, they didn't make any money. But now that they have the whole Monopoly board, they're starting to monetize and extract value. It's a very similar strategy. It's long-term profitability viewpoint versus a short-term mentality. And everything we do is long term, with a long-term mentality.

Very good. Thank you.

Thank you. Our next question comes from Wu Jian Hao (13:23) of Bloomberg. Your line is open.

Hey, thank you for taking my question. I have a couple. Can you just talk about how large the AmpliFi business is today? And given your strategy with AmpliFi going forward and possibly potentially a smart home effort from that business, how large do you think that business can be for the full year?

Okay. So we haven't spoken about this before, but I expect AmpliFi to ramp like UniFi. So, let's see. If I remember correctly, UniFi was something like $20 million its first year and then went to $50 million, and then went to something like $100 million, and within close to five, six years it's been a $0.5 billion business. I expect the same from AmpliFi.

Okay. And then my follow-up is with regards to your inventory, what is the construct of the inventory right now? Is it primarily – I understand it's a newer product. Is it primarily the UniFi product that's in there or how should we think about what's in that inventory today?

So the way we want to build inventory is we look at the highest moving volume products and we should build or stock inventory in relation to the product movement. So, a very fast-moving product like, let's say, our LiteBeam in the airMAX world, we want to make sure we have that in stock because if we don't have that in stock, then operators might move to another vendor or their deployments might shut down. So we're very aggressive on high-moving products that are critical to, I'd say, customer retainment. And then if we have MTI products like we're launching like UniFi HD, we're very cautious and we want to protect quality. So we're not going to build tons out of the gate. We're going to take our time and build a slower ramp, and then once we're confident that the quality is really good, then we're going to start stocking inventory. So it really depends product per product, but definitely our inventory right now is more heavily skewed towards our proven airMAX and UniFi products.

Okay. I'll cede the floor.

Thank you. Our next question comes from Matt Robison of Wunderlich. Your line is open.

Yeah, thanks for the taking the second question. It seems like there's been quite a few new products in the base store. And I noticed in your comments that you're expecting another pretty big uptick in R&D related to NRE and milestones. Should we expect to see even a broader wave of new products coming out? And maybe if you can talk about some disciplines you've put in place to ensure that execution on so many fronts. I know that's been quite a learning curve over the last five years in that regard and it seems like you are operating in a lot of spaces right now. How are we managing the execution?

Yeah. I thought about this. I'd love to share what we're doing now to scale, but I don't want to give secrets away because this is something I struggled with over the past at least two years, is finding out the right organization to scale within our business model, and I think we found it. But I don't want to give away the recipe. But to your other question about R&D, I'll give you (17:37), our total spend as a percentage of revenue. And that couldn't be further from the truth. Our R&D is – I believe it's the most efficient in the world. And one of the reason is it is so efficient (17:57-18:06) holding everybody accountable, make everybody contribute. So we don't have a lot of inefficiencies. At the same time, we have a very good creative process of (18:21).

Pardon, Mr. Robison, your line is breaking up.

Thanks. Just put me on mute. I'll listen to the rest of the call.

Thank you. Our next question comes from Wu Jian (18:40) of Bloomberg. Your line is open.

Great. Thank you. Robert, just to follow up, with regards to your UniFi business, I believe you mentioned on the last call that with the HD product, you were trying to go up market to go after the low end enterprise, just above your SMB business. Is that something that's feasible with your current sales structure? And if so, what gives you confidence that you can do this with your current sales force and your distribution channel versus what is typically, I guess, a higher-touch sales methodology versus your competitors?

Yeah. So if you look at Ubiquiti through the lens of a traditional enterprise sales model, you're not going to understand how we succeed. So let me take you through the UniFi story. So first, we targeted this industry that had very high price, $1,000 Aruba, $1,000 Cisco with the SAP, and the cost of goods in the hardware wasn't much different than consumer. Maybe consumer APs at the time cost $50, and the same hardware from Aruba and Cisco they cost $1,000. And you ask yourself, well, how were Cisco and Aruba able to command a $1,000 an AP? And it's because of a few reasons. Well, firstly, it did have some IT. The software on these APs did work a little better. They did have some credible management software. A lot of the reason though why they succeeded is because that's just how things are done. You have salespeople, you have reps, you have people inside companies making decisions, and there is a mentality where, oh, you have to go with an enterprise vendor, you have to pay 20 times the cost, because that's what everybody does and that's how it's done. And I saw an opportunity to disrupt just the whole sales cycle of this industry. And yes, we started with UniFi, we priced it at $20 (20:51) an AP. It grew very fast. And we never got to the more professional or higher-end companies. We got to people that were using consumer Wi-Fi APs and use managed Wi-Fi applications. And if you went to two-, three, four-star hotels, you'd see 100 SSIDs and UniFi kind of appealed to those customers because it was a very cost affordable system. They could get it up and running and it solved their problems. And so we did very well in this kind of untapped market segment. And over time, we've evolved in feature set, we've improved, we've improved and we've improved, and the volumes have just been significant. I think as of now it should be higher volume than Cisco Meraki. Cisco has three platforms, Meraki, Airespace and Aironet combined. That tells you the idea of the volume. Now in the past two years, we've really turned the corner with UniFi. It's become more than just a Wi-Fi system. We've added switches. We've added gateways. Our controller is incredible. The latest AP performance were showing outperforms anyone in the industry including the vendors I just mentioned. And even – and we still don't have a sales and marketing team. But if you look, now, there's interesting things that are going on. A lot of the traditional system integrators who use Aruba and Cisco, they were turned off by UniFi. They didn't acknowledge it as a true enterprise solution. But if you look over the past year, the tide is completely turning. If you go to third-party communities like Spiceworks, the same operators, the same integrators that are using these high-end enterprise solutions are also now considering UniFi and they're jumping onboard to UniFi. So this is great for us because from a brand awareness perspective, I believe UniFi adds more awareness than traditional enterprise companies, and our ASPs are probably only 10%, probably one-tenth. We don't have any licensing or any subscription charges. So to me, UniFi represents just an ocean of profitability for us. We're still in the phases of driving volume and driving brand awareness. Our website, yeah, I think it's 6,000th or 7,000th in the world by traffic, which is incredible since it's not consumer-facing. And so we're getting to the point where everybody who's using Cisco and Aruba Wi-Fi application knows Ubiquiti. We're on the map. So if we can continue to execute on R&D, which I have confidence we will, not only will we expand ASPs in Wi-Fi segment and adjacent areas like switching and routing, but it opens up everything. If you look at Cisco, 5% of Cisco's business is wireless, but 30% of their business is switching. But wireless is the key to leveraging their other markets. If you look at all their catalyst switching materials front and center, they advertise powering Wave 2 wireless technology. So I think to answer your question, UniFi and Wi-Fi is just the beginning of UniFi's platform potential. And it's more than just about technology, it's about changing how all of this IT enterprise sales cycle works.

Okay. And then thank you...

We're basically cutting out the – we're cutting out the (24:23).

Right. And thank you for that detailed answer. But a follow-on to that, can UniFi HD find success to the low-end enterprise, and let's just say the mid-tier enterprise without professional sales force?

Got to Spiceworks. Why are you asking me? Go to Spiceworks. Do some homework. It's already happening.

Okay. Okay got it. Okay. Thanks.

Thank you. Okay. At this time, I'm showing no further questions. Thank you, ladies and gentlemen, for participating in today's conference call. This does conclude the question-and-answer session, and you may all disconnect. Everybody, have a wonderful day. Thank you.