Ubiquiti - Earnings Call - Q4 2017

Transcript

Operator (participant)

Good day, ladies and gentlemen. Welcome to the Ubiquiti Networks Fiscal Q4 2007 Question and Answer Conference call. As a reminder, this conference is being recorded. Now I would like to turn the call over to Laura Kiernan.

Laura Kiernan (SVP of Investor Relations)

Good morning, and thank you, everyone, for joining us today. I'm here with Robert Pera, our 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 will make during this call constitute forward-looking statements, including perspectives on future financial results, products, market conditions, and competition, etc. 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 financial Form 10-K with the SEC and other SEC filings, which are available on the SEC's website at sec.gov. Forward-looking statements are made as of today, August 3rd, and we assume no obligation to update them.

We hope you have reviewed management's prepared remarks, which were posted as a transcript on the events and presentations and financial section of our website at irubnt.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 to take your questions.

Operator (participant)

Ladies and gentlemen, if you have a question or a comment at this time, please press the star then the one key on your touch-tone telephone. If your question has been answered and you wish to remove yourself from the queue, please press the pound key. Our first question comes from Tabitha McCourt with Raymond James.

Tabitha McCourt (Managing Director and Institutional Equity Strategist)

Hey, thanks for taking my question. Two for you, Robert. I guess as it relates to the full-year guidance for fiscal 2018, I presume that you're confident in the gross margins increasing back to at least the midpoint of the range. That seems to be what you would require to get to that earnings level, but I want to make sure that's kind of the assumption you're using. Secondly, on the recently announced fiber products, obviously really interesting price points and products, I guess help us understand the level of demand in the WISP in the market for fiber connectivity because it's not intuitive that there would be a substantial amount of fiber to the home deployments by WISP. Maybe some commentary around kind of early demand for those products and what you expect. Thanks.

Robert J. Pera (Founder, Chairman, and CEO)

Okay, thanks. I'm going to take a step back with regards to your yearly guidance question. I know we probably are getting a lot of attention right now and with some potential long-term investors. I want to give them my view of where the company stands and my vision for the future. First of all, I believe up to this point in time, Ubiquiti as a company has been misunderstood by a lot of people. I feel we have a group of core competencies that gives us a great competitive advantage in the market, specifically our ability to target markets, our vision in being in markets a lot of times before others. Of course, our business model, which revolves around touchless evangelism and pull. I would say how we allocate our resources and get great investment on our resource allocation.

Finally, which we do not get enough credit for, is our design capabilities. I believe we are one of the few companies right now in the hardware space that could execute on beautiful technology inside and out, everywhere from industrial design to hardware design, mechanicals, mobile app software, back-end software, front-end, beautiful front-end user interfaces, and great user experiences. Together, those core competencies have given us a really unique, I think, competitive advantage in the market and has allowed us to weather a lot of storms and a lot of adversity. It has been frustrating to see a lot of critics poke at our core competencies as something that is flawed, that is something that is short-lived. I believe it is the strength of the company.

Our ability moving forward to grow and to become more profitable is a matter of improving our product development efficiency, and that will lead to more revenue growth, hopefully accelerated revenue growth from here on forward, and also our operational efficiency, which is controlling our supply chain and our production, which we have a lot of room for improvement. In a long-winded way of answering your question, yes, I do feel there's huge opportunities for margin expansion as I specifically in the company focus on operational efficiency. I'm in Asia right now, and I'm going to be here a lot more. I feel our product development efficiency has made huge leaps in the past two years, and it will continue to get better. Now we're just getting started on operational efficiency.

Whereas a lot of critics say our margins have peaked, I believe we have huge room to further expand margins. Okay, your next point about GPON and fiber. I originally wanted to do GPON probably in 2012, five years ago we started it. I had kind of some intuition it would be a big market for us, a good market for us. We had a focus group from U.S. WISP that steered us towards Active Ethernet. We switched from GPON to Active Ethernet, and it just kind of fizzled out. I do not think we were really serious about it. We had one product, we called it Fiber Station, that did not really have much traction.

A couple of years ago, we had another focus group, this time from WISP in Brazil, because we noted that out of all our markets, Brazil seemed to be the one that just didn't have the same excitement we've seen around entrepreneurial WISP in other areas of the world. We wanted to learn more. In Brazil, it's interesting because the cost of digging fiber is pretty much irrelevant for these WISPs that are starting to get into fiber. They essentially hang the fiber cables and run them across the power lines. They have free runs to deliver GPON to end customers. Now that the unlicensed wireless bands are becoming more and more crowded and the internet applications, streaming video specifically, demands faster and faster bandwidths, the WISPs are turning more towards from wireless to GPON and fiber.

Now, traditionally, fiber and these GPON networks have been owned on what they call the optical line terminal, the access point side, by big companies like Huawei or ZTE or some smaller niche players in the US like Calix. The ONUs, which are the cheap CPEs, have been owned by, again, companies like ZTE or FiberHome in China. They are very low-cost solutions, not so much unlike the WISP market in its infancy. The OLTs tend to be very expensive, very complicated to set up. The ONUs, of course, are cheap, but the solution as a whole is intimidating, I would say, for new entrepreneurial fiber ISPs. Our strategy was, let's pretty much take exactly what we did in the unlicensed wireless space, where we created a plug-and-play high-quality solution with price relevance.

Through that solution, we built this community that evangelized and opened up a whole new market of new ISPs. Over time, we improved the performance, we dropped the pricing, and we created this business, which is close to a $500,000,000 business now. I think fiber has a huge runway. It might take us a little while to figure it out, but I would say in its first year and out of the gate, it's much more mature than, say, our AirMax solution was at that time. We've already developed what we call a Ubiquiti Network Management System that gives you centralized control of the whole fiber network and allows you to set up the OLT, ONU in a number of minutes. It's very intuitive. It has a great user experience.

The ONUs themselves, we did something to differentiate the industrial design, which is tough to do with a commodity ONU, but it's got an LED screen that could tell you the SNR of the optical signal as well as give you live throughput of the ISP speeds. Those are our first two products. Of course, eventually, we want to lower the price point down to something sub-$100 somebody could start setting up a GPON network with. Once we get there, I think we'll further democratize, let's say, democratize a GPON ISP industry. That's the vision.

Tabitha McCourt (Managing Director and Institutional Equity Strategist)

Cool. Makes sense. A quick follow-up on that, Robert. You mentioned specifically Brazil. I think these products have been in your beta store for a bit now. Are you seeing demand across all your geographies, or is it specific to South America?

Robert J. Pera (Founder, Chairman, and CEO)

At this time, we're really focused on the U.S., and we have several beta customers and early adopters in the U.S. to prove out the technology. We haven't started to get really cost-disruptive in our designs yet, but the second generation will be. We want to first prove out the technology, make sure its performance is good before we get disruptive and roll it out globally. That's the plan.

Tabitha McCourt (Managing Director and Institutional Equity Strategist)

Great. Thanks.

Operator (participant)

Our next question comes from Wu Jinhou with Bloomberg.

Jin Wu (Senior Reporter)

Great. Thank you for taking my question. Just a question on the full-year guidance. Can you just give us the mechanics on what the drivers of growth are? How much of it is it from new products versus existing products? I have another question on EPS after you're done.

Robert J. Pera (Founder, Chairman, and CEO)

Sure. We split the business now in three segments. If you go to our website, we have what we call Operator tab. Operator consists of, of course, our AirMax technology, which has been the bread and butter. AirMax is undergoing a shift that should have happened before, but I guess better late than never. We added AirMax AC that's finally working great from accounts in the field. We have backwards compatibility. We added GPS synchronization as well as a new family of what we call Generation 2 hardware, including what a Prism Station AP we call it, which I think blows away anything we've ever delivered in the AirMax world in terms of capacity, noise resiliency, and throughput performance. I think you'll see revenue increase purely by a replacement cycle from AirMax AC as well as new deployments with AirMax AC.

I would say that's one area of growth. The second area of growth is what we just talked about with GPON. I would say the third area of growth, which hopefully shifts before the end of the year, we announced before, is what we call LTU or Long-Term Ubiquiti Wireless. That is our own standard. It's completely created from scratch for the fixed outdoor unlicensed market. We believe it will deal with things like unlicensed band noise, point-to-multipoint scalability, maintaining low latency far better than you can do with a Wi-Fi chipset.

Jin Wu (Senior Reporter)

Okay.

Robert J. Pera (Founder, Chairman, and CEO)

And then.

Jin Wu (Senior Reporter)

That's operator.

Robert J. Pera (Founder, Chairman, and CEO)

Let me continue.

Jin Wu (Senior Reporter)

Sure.

Robert J. Pera (Founder, Chairman, and CEO)

That's operator segment. You have UniFi. UniFi, I believe, is poised for much larger growth as it's being accepted now as not just a low-cost solution. I think a lot of people see it as the best solution in the industry. Best in terms of user experience, best in terms of hardware, best in terms of wireless performance. We're getting into high-density deployments. People are happy with the results. We're introducing higher-end hardware, access points, 10-gig switching. We'll have security gateways coming in. We have a security team that's focused on next-generation firewall and universal threat management, intrusion prevention system, intrusion detection features, more advanced deep packet inspection. I think you'll see UniFi go upstream and have an opportunity for higher ASP success. In addition, we're rounding out the UniFi line.

UniFi Video, when I talked about our product development efficiency increasing or vastly improving in the last couple of years, video is a huge opportunity for us. Our solution isn't that good today. It still sells hundreds of thousands of cameras a year. Once it is fixed, the underlying issues are fixed, specifically our network video recording hardware, our NVR software, and our camera hardware, which I believe we're in the process of coming out with some really great stuff. I think you'll see camera sales go from hundreds of thousands a year to millions a year. We also have more complementary technologies to add to UniFi.

I think what you'll see in our vision is you go into a building one day and you'll see UniFi running everything, everything from the automation to the lighting to the Wi-Fi APs to the door security systems to the video security systems and more. We have teams working on all of that stuff. Finally, we're talking about the third segment, Ubiquiti Labs. AmpliFi , it actually did not meet my expectation at launch. We didn't execute well. That being said, it's growing. It's growing in the absence of marketing spend you see from competitive companies. I think that validates when I say we have great design, and it just hasn't been appreciated yet. I think AmpliFi , picking up momentum, reflects on our design, and people appreciate the inside-out total user experience design of AmpliFi .

We are going to add more products, not just to AmpliFi , but to Ubiquiti Labs. I think in the next several months, hopefully, we will surprise a lot of people with some of these designs we are coming out with.

Jin Wu (Senior Reporter)

Robert, just to follow on the revenue side, is it fair to say that some of your growth is dependent on unannounced products?

Robert J. Pera (Founder, Chairman, and CEO)

The way I look at it is the unannounced products would be icing on the cake. With what we have now between operators and our UniFi segment, I intend that we'll be able to hit those estimates.

Jin Wu (Senior Reporter)

Okay. In terms of your EPS targets for 2018, you guys have done a good job in taking down share count through buybacks since 2015. Are buybacks accounted for as part of your EPS target for the year? If so, given how much of your cash is offshore, how are you going to fund those buybacks?

Robert J. Pera (Founder, Chairman, and CEO)

I'm always looking for ways to put our capital to work. If I feel the stock is significantly undervalued, we're going to continue to buy it back. It is true we're lending money onshore to buy back. If we believe in the long-term story of the company, which we do, I don't think cash is going to be a problem over long term as the company is going to generate a lot of cash.

Jin Wu (Senior Reporter)

Okay. Thank you.

Operator (participant)

Our next question comes from Tim Long with BMO Capital.

Tim Long (Equity Analyst)

Hey, Robert. It's Tim. Thanks for the question. Two of them, if I could. First, on the service provider business, you mentioned the advances, the technology advances you've done with AirMax. At the same time, with fiber, you're seeing some of your customers just want that as an alternative maybe for some of the higher bandwidth type of applications. Could you talk a little bit about what you think the longer-term impact will be on the AirMax business from the potential for a broader WISP rollout of fiber, or do you think it's fully complementary? On the enterprise side, if you could just talk a little bit about it sounds like you're getting more dense deployments.

I'm just curious if maybe deal sizes are getting bigger, or you're getting into larger accounts, win rate, anything you can talk about on how that business is scaling better with enterprise customers. Thank you.

Robert J. Pera (Founder, Chairman, and CEO)

Sure. I think fiber is going to be largely complementary. There are areas in terrain where wireless works really well, and it's not practical to roll out fiber. There are some areas without infrastructure where apartments or housing are spaced really close together, and fiber makes great sense. I like to think of fiber as expanding our overall TAM of our operator business. Now, to your UniFi question, I think this has been a function purely of our product quality. Before a couple of years ago, our UniFi APs were decent in handling smaller capacity loads. Quite frankly, they weren't the best in the industry. If you compare them to Aruba or Meraki, Cisco, Ruckus, Aerohive, I would say two years ago, we were worse.

The team has done a fantastic job, and they've done such a great job that if you looked at the performance of our latest hardware, it will beat those guys in a lot of tests, especially tests involving high-density video streaming, lower latency. It has been reconfirmed in the field by system integrators that also use those higher-end brands. I think UniFi is in an interesting point in its story right now. It has been seen as the cheap brand that's not really enterprise. Now it's seen as the low-cost leader and the performance leader. I think we have to really step on the pedal and gain some distance from these guys and make it known that we're the standard. That's the plan over the next year.

Tim Long (Equity Analyst)

Okay. Thank you.

Jin Wu (Senior Reporter)

Okay.

Operator (participant)

Our next question comes from Vijay Vavagatha with Deutsche Bank.

Brian Unon (Analyst)

Hi. This is Brian Unon for Vijay. Thanks for taking the question. I actually have two. First, could you just give us a refresh on how long the typical product cycle refresh lasts in both your enterprise and service provider solutions? Second, can you maybe give us an update on how the AmpliFi rollout is trending? I know it's a small part of the business now, but any update on your retail distribution strategy would be helpful. Thanks.

Robert J. Pera (Founder, Chairman, and CEO)

I think refresh cycle is dependent on the complexity of the product. If you take something like UniFi, where guys are changing from an 11N AP to an 11AC AP, in the case of UniFi, each deployment kind of happens in a vacuum. The 11AC access points were lower cost than the 11N access points. We did a great job of qualifying the performance and the overall product quality prior to release. You saw the UniFi AC refresh cycle happen very fast. In the case of AirMax, we're dealing with a different animal. There's a lot more variables in outdoor fixed wireless. We already had two previous generations of AirMax. These deployments don't happen in a vacuum. Usually, people have big multipoint networks, and they need to piecemeal upgrade.

We took a lot of time to get things right and that the AirMax AC technology worked in a variety of applications and backward compatibility considerations. It's just been a long road. What's positive right now is it looks like it's finally been concluded, and the upgrade cycle is starting.

Brian Unon (Analyst)

Great. Thanks. Just an update on the AmpliFi product rollout and the retail side of things?

Robert J. Pera (Founder, Chairman, and CEO)

AmpliFi was a good experience for us. We botched the launch. We had great momentum, I believe, in May and June of 2016. We had design for mass production issues and production QA issues, and it cost us about six months. By that time, you had a lot of players come in, including Google Wi-Fi. I think we lost a big brand awareness opportunity to be the first there. Eero was there, but I think we had some advantages, especially on the design side to Eero. Now, the positive about AmpliFi is we do have good reporting tools. Generally, it's not 100% accurate, but generally, we can see new install turn-ons by new customers that plug in the device to the home and turn it on for the first time.

It is trending up, which is positive because it is trending up in spite of us essentially turning off marketing spend. Whereas competitors constantly have to pay maybe for shelf space promotions and advertising and big sales teams and constantly push, what we did with AmpliFi is we were able to essentially retain our standard Ubiquiti business operating model and come up with a product that was high-priced, but we focused on what we do best, which is design and user experience. Organically, it seems to be picking up steam. I think that is great for us because we got a valuable learning lesson out of it that is going to help us with future products across the whole company. I think it is a very nice setup now when we introduce add-on products. I believe they have a chance to sell quite well.

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.