Ubiquiti Networks (UBNT) Robert J. Pera on Q4 2016 Results - Earnings Call Transcript

| About: Ubiquiti Networks, (UBNT)

Ubiquiti Networks, Inc. (NASDAQ:UBNT)

Q4 2016 Earnings Call

August 04, 2016 5:00 pm ET

Executives

Anne Fazioli - Vice President-Investor Relations

Robert J. Pera - Chairman & Chief Executive Officer

Analysts

Timothy Patrick Long - BMO Capital Markets (United States)

Michael A. Kerlan - Wells Fargo Securities LLC

Matt Robison - Wunderlich Securities, Inc.

Meta A. Marshall - Morgan Stanley & Co. LLC

Operator

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 - Vice President-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 4, 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 www.ir.ubnt.com. This will be a Q&A call only. Operator, we are now ready for questions.

Question-and-Answer Session

Operator

Your first question comes from Tim Long with BMO Capital. Your line is open.

Timothy Patrick Long - BMO Capital Markets (United States)

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 could just give us a little color there? And 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? And then I had a follow-up on the WiFi side.

Robert J. Pera - Chairman & Chief Executive Officer

Okay. So Service Provider has slowed down in the past few years. There's a couple reasons for that. One, I think the market has gotten a little saturated. Two, we just haven't executed on the product side for the past I'd say two or three years, especially on the airMAX side with airMAX ac. But I think you'll see it return to pretty good growth over the next couple 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. And 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.

The – another catalyst, we're going to get into more services for the operators. You saw that with sunMAX, which I know I get a lot of flak for solar, but if I had to do it again I would have done it again a 100 times over. It's eventually going to be a good place to play for us. It's a little ahead of its time. But we're going to introduce more services for these operators, and a couple of them, well, I'll just say it, we've had tens of millions of dollars in R&D investment for a couple of these things, and nobody sees it. And you're going to – when it's introduced in the next couple quarters I think it'll 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.

Timothy Patrick Long - BMO Capital Markets (United States)

Okay. Great. Great. And then the Consumer division, 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 - Chairman & Chief Executive Officer

For which business?

Timothy Patrick Long - BMO Capital Markets (United States)

The Consumer division, the new Consumer division?

Robert J. Pera - Chairman & Chief Executive Officer

Yeah. So this is one of the things that we're really excited about. Ubiquiti Labs, so the foundation, software foundation for our AmpliFi 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. And that's part of a much larger vision you'll see unfold in the next I'd say couple quarters. We're going to have several more offerings under AmpliFi. And that is also, AmpliFi 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. And 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 is energetic, and I think we've done a good job in the last year setting a great foundation for the next stage of growth. So 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.

Timothy Patrick Long - BMO Capital Markets (United States)

Okay. Thank you.

Operator

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

Michael A. Kerlan - Wells Fargo Securities LLC

Hey, guys. This is Mike Kerlan on for Jess. Just a question on the Enterprise business, it 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 WiFi? Or are you also starting to see some of the switches and other offerings start to become material?

Robert J. Pera - Chairman & Chief Executive Officer

So UniFi started out of the gate very strong in the first few years. We got it to $100 million, $150 million business. And what we did was we made the managed wide area WiFi network application affordable and easy to set up for anyone. So 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. And 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 with powerful enterprise features. And 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, they were – the initial team was fantastic running on gear one. But 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. And 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 WiFi access points, but switches, and security gateways, and other devices we're also working on under one UniFi 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. And so we want 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's where you're 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's 40,000 concurrent users on our UniFi mobile app, and it's – every day it's getting better and better.

So UniFi is going to be a monster. Right now I think it's early innings. We're trying to – we shipped several hundred thousand devices now a month all total, and I want to expand that number. But 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. And people want higher-end equipment. We just haven't gotten there yet. So you'll see over the next year UniFi volumes, I think they're going to expand rapidly. But then what's really exciting is looking beyond that in the next couple years, once we get to 10-gigabit security gateways, or UniFi threat management, multiuser MIMO Wave 2 APs with 802.11b 60-gigahertz, which the next generation of phones will come out with 10-gigabit switches. And it's exciting. I think that's going to be a great business for us.

Michael A. Kerlan - Wells Fargo Securities LLC

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

Robert J. Pera - Chairman & Chief Executive Officer

No. So I think – what was it, the $8 million or $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 robust operational model, especially when it comes to SG&A expenses. But I think that FTI was necessary. We had a miserable culture operationally, and from the 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. And it took – I think it took a lot of hard lessons in several years to just like sift through that mess. And 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. And then we've got – we pretty much built out a great accounting and financial team now. So 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. And 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. And I think that's what we did, and that's the culture we have right now. And I think it's finally in a very stable and healthy state.

Michael A. Kerlan - Wells Fargo Securities LLC

All right. Thanks.

Operator

And your next question comes from Matt Robison with Wunderlich. Your line is open.

Matt Robison - Wunderlich Securities, Inc.

Hey, Robert. Thanks. Congratulations on your accomplishments here. A couple questions about some of the press release items. The inventory expansion you commented about new launches, was that – is that – should we associate that with AmpliFi? And I've got a couple follow-ups.

Robert J. Pera - Chairman & Chief Executive Officer

No. The new technology launches would be associated with our Service Provider business. So 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. And we have Ubiquiti Labs, which will be several consumer platforms.

Matt Robison - Wunderlich Securities, Inc.

What was the catalyst for video growth? I know 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 the press release.

Robert J. Pera - Chairman & Chief Executive Officer

I think the problems we had with the UniFi Video are very similar to UniFi, the problems we had with UniFi. In fact when we launched UniFi Video, and I've been trying to do video since 2007, as embarrassing as that sounds, we've been at this since 2007. And you know 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. So we spent years trying to band-aid that fundamental issue. And what's kind of I guess – what's kind of disappointing about UniFi Video is we had the right idea. In 2010 or end of – I'd say – okay, in 2011 when we launched that platform, we had I think 150,000 orders in cameras before anybody touched it. And we were there before I'd say before Hikvision, and a couple of the other dominant China players today. And we were there with a complete user experience from hardware to software to network video recording at a really disruptive price point. And everybody wanted that product. And 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.

But like we did with UniFi, we pretty much evolved the team, replaced the team over the past year, year and a half, two years, and we've made some fundamental changes to the controller. And you're seeing now it's more stable. The hardware is on generation three. It's better. So there's been a quick uptick to generation three. But 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.

Matt Robison - Wunderlich Securities, Inc.

You – 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 can obviously see the regions on the first...

Robert J. Pera - Chairman & Chief Executive Officer

It's very...

Matt Robison - Wunderlich Securities, Inc.

Is there a product aspect there?

Robert J. Pera - Chairman & Chief Executive Officer

I think it's hard to draw conclusions quarter to quarter. We don't have a team that does financial engineering, and smoothes out bookings and shipments to meet nice trends. We 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. But if you look at it with 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. And I think what's positive about that shift you're seeing in the 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. And there's a lot more potential for that market to increase their ASPs. And they want more expensive equipment. We just haven't gone there yet, but we will, and so that's what I'm really excited about.

Matt Robison - Wunderlich Securities, Inc.

Last thing, gross margins really strong again, but a little drop sequentially on a percentage basis. Was that just the mix shift to Service Provider?

Robert J. Pera - Chairman & Chief Executive Officer

I don't know. What did we grow, 6% year over year? So overall our gross margin expansion is due to efficiencies. So we've never dropped the price of any product ever. So that kind of is kind of, you know, 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 sales people calling big guys up to take products. We make stuff people want. And in the background that gives us time to cost reduce. So in the future I might – to kind of jumpstart new markets, we might get disruptive, because we can. And we might take a hit in the short term to buy market share, but we know in the back end, in the background we can constantly leverage on materials and pricing and eventually get good margins. So I think we might have dips here and there depending on how aggressive we want to be with new product introductions, but 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.

Matt Robison - Wunderlich Securities, Inc.

Thanks a lot.

Operator

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

Meta A. Marshall - Morgan Stanley & Co. LLC

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 this disruptive price. And so just getting a sense of this – the same design objective? And then second question is just an update on the hunt for new board members? Thanks.

Robert J. Pera - Chairman & Chief Executive Officer

Okay. So 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. And 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. So 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. And you see Amazon and Facebook talking about how their balloons, and drones, and solar planes to connect the next billion people, well we've already connected hundreds of millions. And we've done it I think as efficiently as anyone could have. And people I think don't give us credit for that, and they make – 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. And that's pretty frustrating.

Then 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 enterprise market. If you look on Spiceworks, we're probably the top trending vendor these days. And so many people in the Cisco and Aruba world, and Ruckus and what have you, they're starting to jump on UniFi. So we've applied our same business model to the Enterprise.

But then people tell us, oh, yeah, Ubiquiti, they probably just got lucky. And that is also very frustrating. So now we're going to the 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 sales people, they don't know how to distribute, they don't know how to create channels, they'll never be successful in consumer. And we want to stick it to these guys. We're going to come out very, very aggressively in consumer market. We feel wireless is our game. We've done WiFi, and we've shipped tens of millions of radios using WiFi, and all kinds of applications from proprietary, multi-hundred kilometer links to these managed WiFi networks. The consumer WiFi market should be ours. That should belong to us.

And you look at the consumer WiFi 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 WiFi routers, and Cardbus cards for hundreds of dollars, because of the new technology. Then all of a sudden over the next several years you saw WiFi routers and client modules, they just got completely commoditized, where you'd go into a store, and there is a race to the bottom, and nobody wanted to touch WiFi 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. So it was very hard to differentiate between a good router and a bad router.

Now fast forward today, something interesting is happening where you have fiber connections doing gigabit per second. You have homes, connected homes with the net thermostats there, and door locks, and doorbells, and all kinds of IoT devices, and Netflix boxes, and tablets, and laptops and phones. So these connected homes are having 10 devices, 20 devices, sometimes 30 devices. And so people are seeing the difference now in a good router and a bad router. And so what you're 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. And 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. And with AmpliFi, we're gunning for that market first. But we also have a larger vision around it.

And yeah, we will be aggressive, but if you look at what we did with AmpliFi, that product is beautiful. We didn't take any compromise on the hardware. So the hardware is super high end. The look, feel, finish is super high end, and the price for what you're getting I think is incredible. And the reviews have been great. So we're going to push that aggressively, and we want to prove a lot of people wrong.

Meta A. Marshall - Morgan Stanley & Co. LLC

Got it. And then just the update on the board members – hunt for board members?

Robert J. Pera - Chairman & Chief Executive Officer

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

Meta A. Marshall - Morgan Stanley & Co. LLC

Okay. Thanks.

Operator

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.

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