Ubiquiti - Earnings Call - Q3 2017

Transcript

Operator (participant)

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.

Laura Kiernan (SVP of Investor Relations)

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 is contained in our most recent filing on Form 10-K with the SEC and other SEC filings, which are on the SEC's website at sec.gov.

Forward-looking statements are made as of today, May 4th, 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 ir.ubnt.com. This call will be Q&A only. Please limit yourself to two questions. Time permitting, we will allow for follow-up questions. Operator, we are now ready for questions.

Operator (participant)

Thank you. Ladies and gentlemen, if you'd like to ask a question, please press star then one on your touch-tone telephone. Again, if you would like to ask a question, please press star then one. One moment for questions. Our first question comes from Matt Robinson of Wunderlich. Your line is open.

Matt Robinson (Analyst)

Hey, thanks for the question, Robert. A couple of questions, mostly 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. The other question is, we've got a little over 14 weeks of inventory, and I understand that that's a competitive weapon, particularly for the enterprise side. I'm interested to know if you can help us understand where you think we're going to get to before you start to decide we're stocked up enough to be competitive.

Robert Pera (Founder, CEO, and Chairman of the Board)

Sure. I'll start with margin. As people who follow the company know, in the history, we've never once lowered the price of our product. A lot of our most popular products, especially in operator UniFi markets, they have five, six, seven-year life cycles. Traditionally, what we've done is, to enter a market disruptively, we'll make premium products and we'll price them lower. 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. If you remember, when we went public, we had margin in the low 40s, and then over time, it went up to the high 40s, to almost 50%. That was largely due to products like the original airMAX series and the 11n UniFi series, which over time, we've improved the margin.

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 CPEs, we have come in very aggressively because I think by doing so, it will lead to 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 at $99, we didn't have to price them that low. We do that because for long-term revenue, long-term EPS, and established defensibility in the market, it's what we've always done. Over time, we've proven we leverage incredible value out of that strategy. Just for the long-term shareholders, we know what we're doing.

I wouldn'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 that growth from a long-term standpoint. That's how I'm running the company. I understand for short-term traders, they're going to draw and extrapolate off these quarter-to-quarter and margin variations. 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 calling LTU, which is airFiber multipoint. That's for a higher-end, higher-performance market. I think those things, just in the operator alone, are going to re-accelerate growth.

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. If you look at AmpliFi, we do not have the marketing spend of the 12 other participants in the mesh Wi-Fi market. There are companies that have huge dedicated teams just to marketing and sales and buying marketing display and caps, and they cannot make a business out of it. They get sales, but where are the earnings? I am proud of what we have done with AmpliFi because we have planted a seed that shows with very little marketing sales spend, we have been able to replicate what we have done in operator and enterprise. That is just starting.

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. I think we're in position to execute that well based on the AmpliFi experience. Maybe that's a lot to take into account, but I mainly wanted to put that out there for long-term shareholders. To your point about inventory, traditionally, we've always had problems with channel inventory, and it's really critical for us, especially with our service providers and in the UniFi market, because these system integrators and operators, if they can't get product to extend their network, if they can't get products to complete their projects, they're going to move to other vendors. That's just horrible. That's the worst. If we have hundreds of millions of dollars in cash, we are almost obligated.

We've got to spend that to solve the inventory problem. I think we could have done it maybe more efficiently, but I think it's a big step in the right direction. I look at the increased inventory and our establishment of U.S. and Europe logistics centers as a key accomplishment and something that should be looked upon positively in contrast to how the company has previously run.

Matt Robinson (Analyst)

Okay, thanks. I'll follow up with my third question if we get the queue again.

Operator (participant)

Thank you. Our next question comes from Eric Zapiga of JPM. Your line is open.

Eric Zapiga (Analyst)

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? Then secondly, let me get that, and then I'll follow up.

Robert Pera (Founder, CEO, and Chairman of the Board)

Yeah, I like to think of measuring the success of the company by platforms. As you know, airMAX, we create our own proprietary protocol, so it's sticky. Once our operators build out an airMAX, they're encouraged to continue to build other networks using airMAX-compatible devices. I would say for this quarter, airMAX AC Gen 2 looks promising. It's growing very fast off a smaller base. We're trying to ramp that up quickly. As we ramp that up, you're going to see growth in this operator segment. Looking at UniFi, of course, UniFi HD is doing exceptionally well. We're ramping that up. 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.

UAP-HD was the first of that higher ASP strategy at $349 MSRP. It looks like we could probably go higher with higher-end products. AmpliFi, we reduced the AmpliFi SKUs, so we really just have AmpliFi HD. Of course, we have the MeshPoint HD we sell standalone. Both of those are doing well and growing.

Eric Zapiga (Analyst)

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?

Robert Pera (Founder, CEO, and Chairman of the Board)

I think it's a step in the right direction. The inventory centers and 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. I think that hasn't been my primary focus. My primary focus has been strictly R&D. How do we put places, seeds in place that can scale from to get us to a billion dollars next fiscal year and then beyond that, right? We want to one day be a multi-billion revenue company. 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 margins.

I have confidence we should have margins definitely should go up as you see all these new products get out and mature in their life cycles.

Eric Zapiga (Analyst)

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

Robert Pera (Founder, CEO, and Chairman of the Board)

I would put it this way. If 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've got a lot of work to do. In terms of new products, 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. Similar, if you look at Amazon, one of the key drivers of Amazon growth is they had very small margin, and they gave away free shipping. In the short term, they didn't make any money. 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.

Everything we do is long-term with a long-term mentality.

Eric Zapiga (Analyst)

Very good. Thank you.

Operator (participant)

Thank you. Our next question comes from Woo Jin Ho of Bloomberg. Your line is open.

Woo Jin Ho (Senior Analyst)

Hey, thank you for taking my question. I have a couple. Can you just talk about how large the AmpliFi business is today? 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?

Robert Pera (Founder, CEO, and Chairman of the Board)

Okay, we haven't spoken about this before, but I expect AmpliFi to ramp like UniFi. 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. Within close to five, six years, it's been a $500 million business. I expect the same from AmpliFi.

Woo Jin Ho (Senior Analyst)

Okay. 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? How should we think about what's in that inventory today?

Robert Pera (Founder, CEO, and Chairman of the Board)

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. 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. We're very aggressive on high-moving products that are critical to, I'd say, customer retainment. If we have MPI products, like we're launching UniFi HD, we're very cautious and we want to protect quality. We're not going to build tons out of the gate. We're going to take our time and build a slower ramp.

Once we're confident that the quality is really good, then we're going to start stocking inventory. It really depends product for product. Definitely, the inventory right now is more heavily skewed towards our proven airMAX and UniFi products.

Woo Jin Ho (Senior Analyst)

Okay. I'll cede the floor.

Operator (participant)

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

Matt Robinson (Analyst)

Yeah, thanks for taking the second question. It seems like there's been quite a few new products in the beta store. 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? Maybe if you can talk about the disciplines you've put in place to ensure execution on so many fronts. I know there's been quite a learning curve over the last five years in that regard. It seems like you are operating in a lot of spaces right now. How are you managing the execution?

Robert Pera (Founder, CEO, and Chairman of the Board)

Yeah. No, 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 for the past at least two years, is finding out the right organization to scale within our business model. I think we found it. I don't want to give away the recipe. To your other questions about R&D, I'll give you [audio distortion] our total spending as a percentage of revenue. That couldn't be further from the truth. Our R&D is, I believe, the most efficient in the world. One of the reasons it is so efficient is holding everybody accountable, making sure everybody contributes. We don't have a lot of inefficiencies. At the same time, we have a very good creative process at the.

Operator (participant)

Pardon me, Mr. Robinson. Your line is breaking up.

Matt Robinson (Analyst)

Yeah, thanks. I'll just put me on mute. I'll listen to the rest of the call.

Operator (participant)

Thank you. Our next question comes from Woo Jin of Bloomberg. Your line is open.

Woo Jin Ho (Senior Analyst)

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 upmarket to go after the low-end enterprise just above your SMB business. Is that something that's feasible with your current sales structure? 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?

Robert Pera (Founder, CEO, and Chairman of the Board)

Yeah. If you look at Ubiquiti through the lens of a traditional enterprise sales model, you're not going to understand how we succeed. Let me take you through the UniFi story. First, we targeted this industry that had very high-priced $1,000 Aruba, $1,000 Cisco-based APs. The cost of goods on the hardware wasn't much different than consumer. Maybe consumer APs at the time cost $50. The same hardware from Aruba to Cisco, they cost $1,000. You ask yourself, how was Cisco and Aruba able to command $1,000 at AP? It's because of a few reasons. First, they 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. There's 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. I saw an opportunity to disrupt just the whole sales cycle of this industry. Yes, we started with UniFi. We priced it at $50 an AP. It grew very fast. We never got to the more professional or higher-end companies. We got to people that were using consumer Wi-Fi APs in these managed Wi-Fi applications. If you went to two, three, four-star hotels, you would see 1,000 or 100 SSIDs. UniFi kind of appealed to those customers because it was a very cost-affordable system. They could get up and running, and it solved their problem.

We did very well in this kind of untapped market segment. Over time, we've evolved a feature set. We've improved. We've improved. We've improved. The volumes have just been significant. I think as of now, we should be higher volume than Cisco's three platforms, Meraki, Aerospace and Aironet combined. That tells you the idea of the volume. 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 we're showing outperforms anyone in the industry, including the vendors I just mentioned. We still don't have a sales and marketing team. 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. 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 on board to UniFi. This is great for us because from a brand awareness perspective, I believe UniFi has more awareness than traditional enterprise companies. Our ASPs are probably only 10%, probably 1/10. We don't have any licensing or any subscription charges. 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, I think, is 6,000th or 7,000th in the world by traffic, which is incredible since it's not consumer-facing.

We're getting to the point where everybody who's using Cisco and Aruba in a Wi-Fi application knows Ubiquiti, that we're on the map. If we can continue to execute on R&D, which I have confidence we will, not only will we expand ASPs in the 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. 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. I think to answer your question, UniFi and Wi-Fi is just the beginning of UniFi's platform potential. It's more than just about technology. It's about changing how all of this IT enterprise sales cycle works.

Woo Jin Ho (Senior Analyst)

Okay. Then.

Robert Pera (Founder, CEO, and Chairman of the Board)

We're basically cutting out the middleman.

Woo Jin Ho (Senior Analyst)

Right. Thank you for that detailed answer. A follow-on to that, can UniFi HD find success to the low-end enterprise? Let's just say the mid-tier enterprise without professional Spiceworks.

Robert Pera (Founder, CEO, and Chairman of the Board)

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

Woo Jin Ho (Senior Analyst)

Okay. Okay. Got it. Okay. Thanks.

Operator (participant)

Thank you. Again, if you'd like to ask a question, please press star then one on your touch-tone telephone. Again, if you'd like to ask a question, please press star then one. One moment, please. Thank you. Again, if you'd like to ask a question, please press star then one. Okay. At this time, I'm sure there's 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.