Ubiquiti Inc. (Ubiquiti Networks, Inc.) — Q2 FY2017 Form 10-Q
Reporting period: Three and six months ended December 31, 2016; unaudited. Fiscal year ends June 30. Amounts below are in U.S. dollars.
Business context and results
Ubiquiti develops networking technology for service providers and enterprises, selling primarily through distributors. Distributors accounted for 99% of quarterly revenue and 98% for the six-month period. Management attributed growth mainly to broader adoption and product expansion in Enterprise Technology, particularly UniFi.
| Metric | Three months ended Dec. 31, 2016 | Year-over-year | Six months ended Dec. 31, 2016 | Year-over-year |
|---|---|---|---|---|
| Revenue | $213.5 million | +32% | $418.3 million | +34% |
| Gross profit / margin | $95.1 million / 45% | Margin: 49% to 45% | $193.4 million / 46% | Margin: 49% to 46% |
| Operating income / margin | $69.8 million / 33% | Margin: 35% to 33% | $144.7 million / 35% | Margin: 37% to 35% |
| Net income / diluted EPS | $60.6 million / $0.72 | Net income +23% | $132.4 million / $1.58 | Net income +28% |
Financial position and cash flow
- Cash and cash equivalents: $612.7 million at December 31, up from $551.0 million at June 30; $572.7 million was held by non-U.S. subsidiaries, and repatriation could trigger material tax liabilities.
- Debt: $198.5 million outstanding before debt issuance costs, comprising $116.0 million drawn on the revolver and $82.5 million of term-loan principal. Approximate net cash was $414.2 million, calculated using gross debt.
- Liquidity: Current assets were $886.6 million and current liabilities $119.3 million. The credit agreement requires minimum liquidity of $225 million and a maximum leverage ratio of 2.50 to 1.00.
- Cash flow, six months: Operating cash flow was $75.7 million, down from $125.1 million. Investing outflow was $2.8 million; financing outflow was $11.1 million. Cash increased $61.7 million. Working-capital uses included increases in receivables and inventory; inventory rose to $104.4 million from $57.1 million at June 30.
Material changes versus prior comparable periods
- Enterprise Technology revenue rose 87% in the quarter and 82% for six months, reaching 46% and 44% of revenue, respectively, versus 32% in both prior-year periods. Service Provider Technology grew 5% in the quarter and 11% for six months.
- Gross margin declined by four percentage points in the quarter and three points for six months. Management cited product mix, higher shipping costs, and increased warranty and inventory reserves.
- Operating cash flow fell despite higher net income, principally because of working-capital investment, including higher receivables, inventory, and vendor deposits.
- Six-month tax expense declined to $10.0 million from $12.3 million; the reported effective tax rate was 7% versus 11%, including $7.7 million of excess share-based-compensation tax benefits recognized under newly adopted accounting guidance.
- Share repurchases were $6.5 million in the six-month period, relating to trades executed on or before June 30, 2016. A new $50 million authorization approved in August had not been used by December 31.
Outlook, risks, contingencies, and unusual items
- Management said cash, operating cash flow, and available credit should meet working-capital and capital-expenditure needs for at least 12 months. No quantified revenue or earnings guidance was provided.
- The company disclosed ineffective disclosure controls at December 31 due to continuing material weaknesses in internal control over financial reporting. Management said remediation work was substantially completed, but further operating-effectiveness testing was needed and timing was not assured.
- A business-email compromise fraud transferred $46.7 million; $16.7 million had been recovered, leaving $30.0 million being pursued. Further recovery was described as unlikely and uncertain; no additional recovery occurred in the reported six months.
- Legal matters include an IPO-related securities class action in which the Ninth Circuit reinstated certain Securities Act claims, and a February 3, 2017 Synopsys complaint alleging Digital Millennium Copyright Act violations. The company could not estimate possible losses for either matter.
- Other exposures include $24.8 million of unrecognized tax benefits, $34.7 million of inventory purchase obligations, $9.9 million of other obligations, and warranty accruals of $3.9 million. A 200-basis-point increase in rates on floating-rate debt was estimated to increase pretax expense by about $4.0 million over 12 months.
- Key business risks include distributor and customer concentration, limited visibility into end-market demand and channel inventory, reliance on contract manufacturers and certain suppliers, product competition and execution, cybersecurity and fraud, and foreign-market, regulatory, and intellectual-property risks.
Most important facts for investors to verify
- Whether Enterprise Technology growth is sustainable and whether product mix continues to pressure gross margins.
- Whether elevated inventory and receivables convert into sales and cash, and whether operating cash flow recovers.
- Progress in testing and remediating the disclosed internal-control weaknesses.
- Developments, potential costs, and insurance coverage relating to the securities and Synopsys litigation.
- Any recovery of the remaining BEC fraud loss, and the tax implications of the large offshore cash balance.
- Debt covenant compliance, floating-rate exposure, and the status of the unused repurchase authorization.