Ubiquiti - Earnings Call - Q2 2017
February 9, 2017
Transcript
Operator (participant)
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.
Laura Kiernan (SVP of Investor Relations)
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 this call. Information on 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 and Presentations and Financial Information section of our investor relations website, ir.ubnt.com. This call will be a Q&A-only call. Please limit yourself to two questions, if time permitting. We will allow for follow up questions. Operator, we are now ready for your questions.
Operator (participant)
Ladies and gentlemen, at this time, if you have a question, please press the star, then the number one key on your touchtone telephone. If your question has been answered or you wish to remove yourself from the queue, please press the pound key. Our first question comes from Matt Robinson from Wunderlich. Your line is now open.
Matt Robinson (Analyst)
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 start with that one.
Robert Pera (CEO and Chairman of the Board)
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 drop prices, but we very aggressively go after new markets. A few things happened this quarter. First of all, Amplify. Our pricing was very aggressive out of the gate, but we also mis-executed the launch. We had to recover. We had some last-minute issues with design for production. We had to 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 airshipping. From a long-term perspective, it's incredibly important we establish this Amplify brand. It's not just WiFi. 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. 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. 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 have set up inventory centers, both in the U.S. and 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 have 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. That is a big problem we're trying to solve. Together, these things kind of hit all at once. I would not say long-term-wise, I expect our EPS and margin profile to be more representative of, say, the past several quarters.
I do think the decisions we made while impacting optics in the short term were a necessary decision I had to make to drive future revenue growth in EPS. My goal right now is 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 a billion-dollar revenue as fast as we can and beyond that. That has taken priority over, let's say, maintaining really good fundamentals and operating metrics I'd like to see.
Matt Robinson (Analyst)
I got you, Robert. Headcount accelerated a fair amount. It might have been your biggest quarterly increase in headcount. Can you give us a little bit of backdrop for that?
Robert Pera (CEO and Chairman of the Board)
Sure. We have a lot going on, and there's a lot of big opportunities and growth drivers we see. Maybe take a step back. I'll talk about the three businesses. 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 ones. 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. Our service provider market is actually quite unique. It's a community we built. They consist of operators, grassroots operators we've grown and built a community around. Our operator business, I would say, is more like characteristics of a sticky enterprise business.
I think since it's considered operator and internet access, it gets labeled as a less valuable business. Anyways, in our operator business, we have three growth drivers for the future, and they're coming up quick. The first one is, of course, airMAX AC, and I believe we solved the issues. Along with airMAX AC, we really stepped up our software complementary pieces. We have everything from Air Link, which has 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. We have AirMobile, which is very key for us. We have over a million downloads and over 100,000 active users of UniFi.
We're just a mobile app, and we're just starting UniFi—I'm sorry, Ubiquiti Mobile, which is for the airMAX world. We also have airControl, which helps you manage all the networks. On top of that, we're making great traction now on UCRM, which is a free software that allows you to completely manage and bill and account for all your customers and your network. That solution together, I think, is as strong as it's ever been. 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. 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. The solutions out there are very difficult to use, very antiquated. The upfront cost investments for what they call the OLT, which is an infrastructure to run the fiber, is very expensive. We are going to take a page out of the airMAX playbook where we make simple, very easy-to-use solutions that do not require training. We are going to minimize the upfront investment to get started, and we are going to leverage our community of operators to evangelize the solution. We are very excited about that. Like I said, this coming quarter, we are going to start shipments. The third thing I have talked about in the past we had really heavy investments in is this air fiber multipoint we are calling LTU.
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. 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. That's going to be released within the next couple of quarters, is what we're targeting. Field trials start next quarter. That's the operator business. Now, if we move on to the enterprise business, UniFi, and you talked about margins. We just started our strategy to move upstream in terms of increasing ASP. You've seen that with the announcement for what they call UAP-HD or UAP-AC-HD. 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.
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. I believe with this product, it's going to change the perception of UniFi being a value leader to being a performance leader. We finally have something now where we test against the big brand names, and we can beat them in performance laps. We still maintain our disruptive costs. It's $349, which is 1/5 the price of competing solutions, but the performance is higher. It's better, and I believe the software is better. I think when I look at UniFi now, people think, "Oh, it's low cost." In my mind, there's no doubt it's now the highest performance solution in the market and way more usability.
That will start a trend, and you'll see us. This year, we'll have APs that cost, by the end of the year, $1,000. I think you'll see people also buy those and have interest in them. Along with the higher ASP strategy, we also are in beta of what we call UniFi Elite. UniFi Elite is a paid hosting and increased support solution. The idea is we host networks for people instead of running their local controller. We run it in our cloud. We have dedicated high-end technical phone support, lifetime warranty, advanced RMA, everything customers in the higher markets need for peace of mind. Maybe before these customers hesitated in buying Ubiquiti or UniFi because we lacked professional support, and now we're going to offer it.
Of course, we're going to charge for it, and that's going to be the start of our service revenue. That's UniFi. Now on to 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 Amplify 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. Like I said, that is going to be a family of products to improve the modern home. 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 WiFi and the Amplify speed this year, as well as we have plans for more consumer brands that I think have a lot of potential.
Hopefully, to long-term investors, that gives you the long-term vision and strategy we're going to use to scale the company.
Matt Robinson (Analyst)
Yeah. That's a lot to do. I can see why you added a few folks. If Hartley's on the call, this might be a question for him. In your 10-Q, that was just really to talk about you not being aware of any material litigation that could affect the financial statements. It's been a matter of some public awareness that Synopsys 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?
Robert Pera (CEO and Chairman of the Board)
Unfortunately, I can't provide more information than that concerning pending litigation. I'm probably not the guy that's going to be able to get you the most details on it if I could. You probably want to follow up after the call.
Matt Robinson (Analyst)
Thank you very much, Robert.
Operator (participant)
Thank you. Our next question comes from Jess Lubert from Wells Fargo. Your line is now open.
Mike Carlin (Executive VP)
Hey, guys. It's Mike Carlin on for Jess. I'll just follow up on two product items here. You've provided a lot of detail here. It's appreciated. Just to go back to Amplify, just to clarify, is the gross margin profile of Amplify, how does that compare to the corporate average? Do you expect shipping costs tied to Amplify as you ramp it to drive gross margin below the long-term target of 45%-50% for a few more quarters, or does it snap back to that range pretty quickly?
Robert Pera (CEO and Chairman of the Board)
Right. If you look at our history, I believe when we became a public company, our margin was in the low 40s percent, and we were able to expand the margins all the way up to the high 40s percent. We have a strategy that seems to work well where we do not ever drop the price of a product in the market, but we will do what we feel to be as aggressive in capturing market share or mind share out of the gate. There could be instances where we are leaving money on the table, pricing so aggressively. 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. I guess to directly answer your question, Amplify, it is incredibly high-end hardware.
Anybody that's bought the system and opens up the box immediately can see it's high-end hardware. We wanted to price it pretty much lowest or near the lowest in the market. We're going for super high-end at aggressive pricing. Now, Amplify's strategy is much like UniFi's strategy in that I believe that over time, the modern home technologies will cater or will support much higher ASPs. If you look at the prices of expensive homes, it could be hundreds of thousands of dollars or millions of dollars. 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. Amplify, we believe, has a lot of margin expansion for us.
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 Amplify, we have a plan also to drive up higher-end ASPs. You'll see that, I hope, by the end of the year. To answer your question, yes, there's going to be margin expansion over time. We don't intend to keep the same margins we're seeing now on Amplify.
Mike Carlin (Executive VP)
Okay. 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 headcount servicing the customer base?
Robert Pera (CEO and Chairman of the Board)
With UniFi Elite, yes, we'll have phone tech support. 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.
Mike Carlin (Executive VP)
Okay. Thanks.
Operator (participant)
Thank you. Once again, ladies and gentlemen, at this time, if you have a question, please press the star, then the number one key on your touch-tone telephone. Our next question comes from John Lucia from JMP Securities. Your line is now open.
John Lucia (Managing Director, Head of Infrastructure Software & Cybersecurity Investment Banking)
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 you're 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 a support offering?
Robert Pera (CEO and Chairman of the Board)
I can give you guys one data point. You can look up. Our Ubiquiti community around UniFi was originally built from maybe a lot of emerging markets, a lot of Ubiquiti operators. As UniFi has scaled, you see an uptick in the amount of professional system integrators that are using it, especially in the U.S. These traditional system integrators have been using brands like Cisco and Aruba and HP and more expensive brands. If you go to Spiceworks, so spiceworks.com, that is one of the largest, I guess, third-party communities for professional certified system integrators. There are topics covering UAP AC HD, and the demand there is really solid. The reception of the product is really solid. We are 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.
John Lucia (Managing Director, Head of Infrastructure Software & Cybersecurity Investment Banking)
Wow. Okay. When did you introduce it? That was recent, right?
Robert Pera (CEO and Chairman of the Board)
Yes. Officially, we started shipping probably late last month, late January. We had a really extensive field trial process that lasted several months. We wanted to be absolutely sure what we released was the highest-end product in the market.
John Lucia (Managing Director, Head of Infrastructure Software & Cybersecurity Investment Banking)
Okay. Who were those field trials with? Was it just resellers or larger customers, or how can we think about that?
Robert Pera (CEO and Chairman of the Board)
They're 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 brands.
Mike Carlin (Executive VP)
Okay. Last question. I do not know if this is the best form 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 an equal impact, or how can I think about the impact on gross margin product mix versus the shipping charge?
Robert Pera (CEO and Chairman of the Board)
Let's see. Yeah, I don't have that detail. I know airMAX AC, Amplify, and the shipping charge is all impacted. I don't know exactly how much each contributed. Maybe you can follow up after the call.
John Lucia (Managing Director, Head of Infrastructure Software & Cybersecurity Investment Banking)
Will do. Okay. Thank you.
Robert Pera (CEO and Chairman of the Board)
Thanks.
Operator (participant)
Thank you. Our next question comes from Tavis McCourt from Raymond James. Your line is now open.
Tavis Mccourt (Institutional Equity Strategist)
Hey, thanks for taking my question, Robert. A couple of questions. First, on the Amplify 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?
Robert Pera (CEO and Chairman of the Board)
Traditional retail, I take it you mean on the shelves like Best Buy, Target?
Tavis Mccourt (Institutional Equity Strategist)
Yeah. Yeah.
Robert Pera (CEO and Chairman of the Board)
Okay. If you look at the Amplify design and you look at all this, well, very quickly crowded market of high-end scalable consumer WiFi systems, whether it's Eero, Linksys, Netgear, Google, and then a couple more startup companies, Amplify, we designed or I made the decision to design to be on shelves. If you look at that product, it shows very well. It has some local UI. It has a screen. It kind of speaks to you. It looks very compelling next to traditional boring boxes without personality. We designed that product, and we put additional cost into making it look great on a shelf in a traditional consumer channel. Our strategy is to get it on shelves. The problem is we've been supply constrained, as I talked about, with the mis-execution out of the gate, and we're trying to ramp up.
We do have or we've 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 Mccourt (Institutional Equity Strategist)
Great. Is there any meaningful operational infrastructure that you have to build to get on kind of high-volume retail shelves like that, whether it is customer support, or is it all kind of within the investment guidelines that you have for the business?
Robert Pera (CEO and Chairman of the Board)
Yeah. We have already set up a lot of the infrastructure to support technical support. We have an office in India. It's, I don't know, probably around 50 support guys that deal with entry-level issues. For advanced technical support, both for UniFi Elite and maybe things like Amplify, we have built these resources in the U.S. We also have a significant dedicated international team that's on the ground that's in dialogue with major shelf retailers on Amplify. A lot of that investment has been made, and the efforts are well underway for some time.
Tavis Mccourt (Institutional Equity Strategist)
Cool. And then a follow up. You addressed some of the inventory changes previously. A question. 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?
Robert Pera (CEO and Chairman of the Board)
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 Mccourt (Institutional Equity Strategist)
Similar question on the receivables and DSOs. You made some comments in the preparatory 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 North American enterprise distributors specifically wanting better terms as the volume scales?
Robert Pera (CEO and Chairman of the Board)
Yeah. I would say the majority of it is from the uptick in system integrators like Ingram or ScanSource that have longer payment terms. 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. The exact breakdown and details, you should probably follow a call.
Tavis Mccourt (Institutional Equity Strategist)
Got you. 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. There's not going to be an attempt at backwards compatibility there, right?
Robert Pera (CEO and Chairman of the Board)
Correct.
Tavis Mccourt (Institutional Equity Strategist)
Okay. Cool. Thanks a lot.
Robert Pera (CEO and Chairman of the Board)
Thanks.
Operator (participant)
Thank you. Our next question comes from Meta Marshall with Morgan Stanley. Your line is now open.
Hi. It's [Eugene 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? 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.
Robert Pera (CEO and Chairman of the Board)
The currency fluctuations are not 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 are always open to acquisitions. We always look at companies, and we are always in the search of ways to use that cash to improve the business. Most recently, over the past year, I have told our procurement team, "Hey, use that cash to improve our margins." We have done some of that. The problem with acquisitions is if you look at our revenues now approaching, it should be close to a billion dollars here soon on a run rate. We are doing that with, I do not know, about $50 million or less in R&D.
It's very tough to find a match for a company that could 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 new 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. Yeah, I continue to look, and we'll definitely be aggressive if we find a fit.
Okay. Great. Thank you.
Operator (participant)
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.