Ubiquiti - Earnings Call - Q4 2016

Transcript

Operator (participant)

Good day, ladies and gentlemen, and welcome to the Ubiquiti Networks question and answer session for Q4 2016 conference call. As a reminder, the conference is being recorded. Thank you. Now I would like to turn the call over to Anne Fazioli. You have the floor.

Anne Fazioli (VP of Investor Relations)

Thank you, Operator, and thank you, everyone, for joining us today. I'm Anne Fazioli, Vice President of Investor Relations for Ubiquiti Networks. I'm here with Robert J. Pera, Founder, CEO, and Chairman of the Board at Ubiquiti Networks. Before we get started, I'd like to review the Safe Harbor Statement. Some of the statements we'll 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 available on the SEC's website at www.sec.gov. Forward-looking statements are made as of today, August 4th, 2016, and we assume no obligation to update them.

We hope you've had time to review management's prepared remarks, which are posted as a transcript on the events and presentations and financial information sections of our Investor Relations website at ir.ubnt.com. This will be a Q&A call only. Operator, we are now ready for questions.

Operator (participant)

At this time, I would like to remind everyone, in order to ask a question, please press star, then the number one on your telephone keypad. We'll pause for just a brief moment to compile the Q&A roster. Your first question comes from Tim Long with BMO Capital. Your line is open.

Tim Long (Analyst)

Thank you. Robert, I was hoping you could just give us a little color on the service provider business. It did pretty well in the quarter. I'm guessing maybe South America bounced back nicely for you, but if you can just give us a little color there. Also for airMAX, just once again on backwards compatibility, a little bit on the timing, and do you think that really would have an impact, a positive impact on the business? It seems to be doing pretty well without it. I had a follow-up on the Wi-Fi side.

Robert J. Pera (CEO)

Okay. Service provider has slowed down in the past few years. There's a couple of reasons for that. One, I think the market's gotten a little saturated. Two, we just haven't executed on the product side the past, I'd say, two or three years, especially on the airMAX side with airMAX AC. I think you'll see a return to pretty good growth over the next couple of years, and there's going to be a few catalysts. First, airMAX AC, it looks like we finally solved a lot of the fundamental interoperability issues with the previous generation of equipment. You'll see over the next several months, I hope we get it completely polished, and you'll see airMAX AC take off, and there's going to be a lot of, I'd say, network upgrades.

Another catalyst, we're going to get into more services for the operators, and you saw that with SunMAX, which I know I get a lot of flack for solar, but if I had to do it again, I would have done it again a hundred times over. It is eventually going to be a good place to play for us. It is a little ahead of its time. We are going to introduce more services for these operators, and a couple of them—well, I will just say it—we have had tens of millions of dollars in R&D investment for a couple of these things, and nobody sees it. You are going to—when it is introduced in the next couple of quarters, I think it will surprise a lot of people.

They're going to be immediately impactful materially to operator revenue and service provider revenue, and I think you're going to see some growth in the service provider next year.

Tim Long (Analyst)

Okay. Great. Great. If you could just talk a little bit about kind of opportunity and ramp time there and kind of cost of getting into that business. It sounds like it could be a pretty good opportunity for you.

Robert J. Pera (CEO)

For which business?

Tim Long (Analyst)

The consumer division, the new consumer division.

Robert J. Pera (CEO)

Oh. Yeah. This is one of the things we're really excited about: Ubiquiti Labs. The software foundation for Amplify is based in Riga, Latvia. In just, I'd say, a little more than a year, we've taken that product from concept to shipping, and they've done a great job. I think it's a fantastic product. The reviews have been great. That is part of a much larger vision you'll see unfold in the next, I'd say, couple of quarters. We're going to have several more offerings under Amplify. Amplify in itself is just one offering from Ubiquiti Labs, and I think you'll see even more exciting things within the next year from Ubiquiti Labs. I think we're really excited where the company is right now. Operationally, it's the healthiest it's ever been. We're back to just focusing on R&D.

We have a lot of new teams. Everybody's energetic, and I think we've done a good job in the last year setting a great foundation for the next stage of growth. I hope—to the engineers that are listening, and I know a lot of them do—this is a big opportunity, and I hope everybody steps up.

Tim Long (Analyst)

Okay. Thank you.

Operator (participant)

Your next question comes from Jeff Lubert with Wells Fargo. Your line is open.

Michael Kerlin (Analyst)

Hey, guys. This is Mike Kerlin on for Jeff. Just a question on the enterprise business. Looks like the growth there remains pretty strong. Can you talk about what you're seeing with the UniFi AC portfolio, and is the strength primarily Wi-Fi, or are you also starting to see some of the switches and other offerings start to become material?

Robert J. Pera (CEO)

Unified started out of the gate very strong. In the first few years, we got it to a $100 to $150 million business. What we did was we made the managed wide-area Wi-Fi network application affordable and easy to set up for anybody. We took Cisco Aruba-type solutions that can cost hundreds of thousands of dollars to install, and we brought it down to $50 an AP without support, without service fees, and plug and play. That was where we initially targeted, but we quickly wanted a vision similar to, say, Meraki was able to execute in Cisco, and they did a fantastic job, where we wanted one dashboard to control all kinds of equipment, and we wanted it with powerful enterprise features. The team we had just was great getting that product to market.

If you look at it in terms of a 10-speed of a bicycle, that initial team was fantastic running on gear one. As you scale, you need developers that could share, that are able to bring in new talent, move fast, iterate quickly, and that just wasn't the team. We struggled with the transition to a new team. We finally got a new team. So UniFi, pretty much, I'd say 90% of the team is all new developers in the past year, year and a half, and they're doing an incredible job on executing on the vision, which is to bring not just Wi-Fi access points, but switches and security gateways and other devices we're also working on under one unified controller that you could also control multiple sites regardless of geography with zero cloud fees or zero subscription fees for life and that anybody could use.

We wanted to dominate this software-defined networking world, and our vision and what we want to do are way ahead of our capabilities. Now, I feel the engineering teams can match where we want our vision to go, and that is where you are seeing in the past year the rapid iteration in the software-controlled features, the wireless performance, the advanced wireless features, the user experience of the controller. We have an incredible mobile app that just today I saw there are 40,000 concurrent users on our UniFi mobile app, and every day it is getting better and better. UniFi is going to be a monster. Right now, I think it is early innings. We are trying to—we ship several hundred thousand devices now a month all total, and I want to expand that number.

Once we get a larger and larger footprint and once our quality and feature set starts going up, then look out because we can take those ASPs, which are sub-$100 right now, and we could bring them up several hundred dollars. People want higher-end equipment. We just haven't gotten there yet. You'll see over the next year UniFi volumes, I think they're going to expand rapidly. What's really exciting is looking beyond that in the next couple of years once we get to 10 Gb security gateways or unified threat management, multi-user MIMO, Wave 2 APs with 802.11ad 60 GHz, which the next generation of phones will come out with, 10 Gb switches. It's exciting. I think that's going to be a great business for us.

Michael Kerlin (Analyst)

Okay. Maybe just the last one on the expense side. I know FTI has been doing work for several quarters, and it sounds like it's really healthy. At what point do you expect it to start to wind down and perhaps benefit SG&A? At this point, should we just assume they're going to be working for much longer?

Robert J. Pera (CEO)

No. I think, what was it? The $8 million, $9 million in SG&A spend is extreme for us. I was a little frustrated with that number. As you can see, I like to run a robust operational model, especially when it comes to SG&A expenses. I think that FTI was necessary. We had a miserable culture operationally from, I guess, the Summit Partners days where they filled their team, which was pretty much set up to pillage the company after an IPO, and it left us with a complete mess. I think it took a lot of hard lessons in several years to just sift through that mess. I finally got the company where the remnants of that experience is all gone, and I think I'm much more experienced. I'm not as naive as I was, and I think I'm capable to run a public company.

We pretty much built out a great accounting and financial team now. The FTI is, I think they're being transitioned out by the end of this year. I believe they'll be completely transitioned out, and I have full confidence in the team we put together right now. We didn't hire a Chief Financial Officer because I didn't feel our weak point was somebody that needs to go to investors. We've never needed funding. We've always been profitable. What we needed is somebody to mind the fort and be defensive and have his eyes completely on accounting and plugging any areas of exposure as it comes to processes or systems in place to avoid things like the fraud incident from happening in the future.

I think that's what we did, and that's the culture we have right now. I think it's finally in a very stable and healthy state.

Michael Kerlin (Analyst)

All right. Thanks.

Operator (participant)

As a reminder, it is star one on your telephone keypad to ask a question. Your next question comes from Matt Robison with Wunderlich. Your line is open.

Matthew Robison (Analyst)

Hey, Robert. Thanks. Congratulations on your accomplishments here. A couple of questions about some of the press release items. The inventory expansion, you commented about new launches. Should we associate that with Amplify? I got a couple of follow-ups.

Robert J. Pera (CEO)

No. The new technology launches would be associated with our service provider business. I see the company in three businesses now, right? We have service provider, which is airMAX, airFiber, EdgeMAX. We have enterprise, which is UniFi and UniFi Video. We have Ubiquiti Labs, which will be several consumer platforms.

Matthew Robison (Analyst)

What was the catalyst for video growth? It seems like it's been gradually expanding over the last several years, but this is the first time you've really highlighted it as a driver in a press release.

Robert J. Pera (CEO)

I think the problems we had with UniFi Video are very similar to UniFi, the problems we had with UniFi. In fact, when we launched UniFi Video—I have been trying to do video since 2007, as embarrassing as that sounds—we have been at this since 2007. Before I really knew software or knew anything about software, I should say, we chose a path using an open-source program, and it was a really bad move. We spent years trying to band-aid that fundamental issue. What is kind of, I guess, what is kind of disappointing about UniFi Video is we had the right idea. In 2010, or end of 2010, I would say, okay, it is 2011 when we launched that platform, we had, I think, 150,000 orders in cameras before anybody touched it.

We were there before, I'd say, before Hikvision and a couple of the other dominant China players today. We were there with a complete user experience from hardware to software to network video recording at a really disruptive price point. Everybody wanted that product. If we executed, it'd probably be, I don't know, hundreds of millions of dollars of revenue today. We just didn't do it, and we missed the time window. Like we did with UniFi, we pretty much evolved the team or replaced the team over the past year, year and a half, two years, and we've made some fundamental changes to the controller. You're seeing now it's more stable. The hardware's on generation three. It's better. There's been a quick uptick to generation three. We're not done.

I think by the, let's say, the end of this year, I think we're going to make a pretty big step in video that's going to boost its growth a lot more.

Matthew Robison (Analyst)

You saw your service provider, obviously, not the year-over-year growth of enterprise, but sequentially it grew more. Was that a regional factor, or was there a—I cannot obviously see the regions.

Robert J. Pera (CEO)

It's a very.

Matthew Robison (Analyst)

Is there a product aspect there?

Robert J. Pera (CEO)

I think it's hard to draw conclusions quarter to quarter. We don't have a team that does financial engineering and smooths out bookings and shipments to meet nice trends. We just ship as the channel demands. I don't know, for whatever reasons, we try to help these distributors, but maybe their ordering cycles are staggered, and so maybe some regions are up one quarter or down one quarter. If you look at it with a smoother granularity, the trends are up overall. Now, one macro type of trend that you see in our financials is Europe and U.S. are definitely increasing, and that coincides to UniFi and enterprise being more of our business. The enterprise customers tend to be based in the Western world, and the service providers tend to be based in South America and Eastern Europe and Middle East.

I think what's positive about that shift you're seeing to U.S. and Europe in enterprise revenue is those customers have deeper pockets. They have money, and they tend to be stickier. Once they like a solution like UniFi, they're going to stick with it. There's a lot more potential for that market to increase their ASPs, and they want more expensive equipment. We just haven't gotten there yet, but we will. That's what I'm really excited about.

Matthew Robison (Analyst)

Last thing. Gross margins really strong again, but a little drop sequentially on a percentage basis. Was that just the next shift to service provider?

Robert J. Pera (CEO)

I don't know. What do we grow? 6% year over year. Overall, our gross margin expansion is due to efficiencies. We've never dropped the price of any product ever. That kind of is kind of a good point of our strategy and our brand. We never discount, or we never have to get rid of inventory. We don't have salespeople calling guys up to take products. We make stuff people want. In the background, that gives us time to cost reduce. In the future, I might, to kind of jump-start new markets, we might get disruptive because we can. We might take a hit in the short term to buy market share, but we know in the background, we can constantly leverage on materials and pricing and eventually get good margins.

I think we might have dips here and there depending on how aggressive we want to be with new product introductions. Overall, I think you will see margins expand. For sure, they will expand in enterprise. Service provider, probably at least the same. Consumer might be a little lower margin, but I think with time, it's also going to be a very nice business.

Matthew Robison (Analyst)

Thanks a lot.

Operator (participant)

Your next question comes from Meta Marshall with Morgan Stanley. Your line is open.

Meta Marshall (Managing Director)

Great. Thanks. A couple of questions. Just as you guys have Ubiquiti Labs, and I just wanted to get a sense of whether the design objective is still the same as what it has been traditionally, which is finding big markets and a way to disrupt them from a price level with a better product. I guess I ask that just because the consumer market tends not to have that same pricing premium where you can come in at a disruptive price. Just getting a sense of is that the same design objective? Second question is just an update on kind of the hunt for new board members. Thanks.

Robert J. Pera (CEO)

Okay. I will say Ubiquiti Labs is something that's very, very important to me, and I'll tell you why it's important. We started this company selling or making technology for these service providers in these emerging markets. I think to date, we've sold probably 40 million radios. When you think about these connections, they're serving multi-family homes or businesses. If you extrapolate that, what, 40 million connections? We've connected hundreds of millions of people in areas of the world that didn't have internet connectivity. You see Amazon and Facebook talking about hot air balloons and drones and solar planes to connect the next billion people. We've already connected hundreds of millions, and we've done it, I think, as efficiently as anyone could have. People, I think, don't give us credit for that.

They look at our financials, and they think, "Okay, this thing has to be a scam because they're selling to service providers, and we don't know these service providers. They're emerging markets. We can't track." That is pretty frustrating. We took our same business model and what we do, which is basically disruption on R&D and sales through community-based evangelism, and we applied it to an enterprise market. If you look on Spiceworks, we're probably the top trending vendor these days. So many people in the Cisco and Aruba world and Ruckus and what have you, they're starting to jump on UniFi. We have applied our same business model to the enterprise. People tell us, "Oh, yeah, Ubiquiti, they probably just got lucky." That is also very frustrating.

We're going to consumer with Ubiquiti Labs, and we're going to do the same thing we've done to the service provider market, to the enterprise market. Now we're doing it to the consumer market when so many people would say, "Oh, Ubiquiti doesn't have any salespeople. They don't know how to distribute. They don't know how to create channels. They'll never be successful in consumer." We want to stick it to these guys. We're going to come out very, very aggressively in the consumer market. We feel wireless is our game. We've done Wi-Fi, and we've shipped tens of millions of radios using Wi-Fi in all kinds of applications from proprietary multi-hundred kilometer links to these managed Wi-Fi networks. The consumer Wi-Fi market should be ours. That should belong to us. You look at the consumer Wi-Fi market today, there's a shift.

Maybe 20 years ago, or let's call it 15 years ago, when you first went into a Best Buy, you saw Wi-Fi routers and CardBus cards for hundreds of dollars because it was a new technology. Then all of a sudden, over the next several years, you saw Wi-Fi routers and client modules. They just got completely commoditized where you'd go into a store, and it was a race to the bottom. Nobody wanted to touch Wi-Fi and consumer products or business because the ASPs were so low and the business was so crummy. There was no differentiation because the internet connections were slow. Most homes only had one PC. It was very hard to differentiate between a good router and a bad router. Now, fast forward to today, something interesting is happening where you have fiber connections doing gigabit per second.

You have connected homes with Nest thermostats and door locks and doorbells and all kinds of IoT devices and Netflix boxes and tablets and laptops and phones. These connected homes are having 10, 20, sometimes 30 devices. People are seeing the difference now in a good router and a bad router. What you are seeing now is the router is becoming a really important piece of technology to these homes, and people are looking to pay more and more money. You see some of these startups have, rightfully so, saw an opportunity to get into this problem and these high-priced ASPs on the routers. With Amplify, we are gunning for that market first, but we also have a larger vision around it. Yeah, we will be aggressive, but if you look at what we did with Amplify, that product is beautiful.

We did not take any compromises on the hardware. The hardware is super high-end. The look, feel, finish is super high-end. The price for what you are getting, I think, is incredible. The reviews have been great. We are going to push that aggressively, and we want to prove a lot of people wrong.

Meta Marshall (Managing Director)

Got it. Just the update on the board members or hunt for board members?

Robert J. Pera (CEO)

Yeah. We added a board member, so we're in compliance now.

Meta Marshall (Managing Director)

Okay. Thanks.

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.