Ubiquiti Networks, Inc. — Form 10-Q Summary
Reporting period: Fiscal second quarter and six months ended December 31, 2012. The filing was signed February 8, 2013. Figures are in U.S. dollars; financial-statement amounts below are in millions unless noted.
Business context
Ubiquiti sells networking hardware and related tools, primarily through distributors, and outsources manufacturing, mainly in China. Systems represented 87% of quarterly revenue and 86% of six-month revenue. Management attributed the revenue decline mainly to counterfeit products, customer uncertainty about authenticity and resulting distributor channel inventory buildup.
Financial performance
- Quarterly revenue: $74.9 million, down 15% from $87.8 million. Six-month revenue was $136.4 million, down 18% from $167.0 million.
- Profit: Quarterly net income was $17.8 million versus $24.7 million; diluted EPS was $0.20 versus $0.16. Six-month net income was $31.0 million versus $46.2 million; diluted EPS was $0.34 versus a $0.88 loss. The prior-year six-month common-stockholder loss reflected preferred-stock accretion and allocation, despite reported net income of $46.2 million.
- Margins: Gross margin was 41% in both the quarter and six-month period, compared with 42% in each prior-year comparable period. Operating margin declined to 27% from 35% in both comparisons; net margin was 24% for the quarter and 23% for six months, versus 28% in each prior-year period.
- Expenses: Quarterly R&D rose 37% to $5.1 million and sales, general and administrative expense rose 119% to $5.3 million. For six months, R&D increased 38% to $9.8 million and SG&A increased 115% to $9.8 million. Management cited expanded product development, anti-counterfeiting legal costs, marketing and trade shows, and higher bad-debt allowances.
- Cash flow: Six-month operating cash flow was $50.5 million, up from $20.0 million; investing cash outflow was $3.5 million; financing cash outflow was $20.8 million. Cash increased $26.2 million to $148.3 million.
- Liquidity and debt: Current assets were $222.5 million and current liabilities $55.2 million at December 31. Debt was $78.6 million ($5.0 million short-term and $73.6 million long-term), compared with $29.6 million at June 30. The $100 million credit agreement had $20 million of revolving capacity remaining. The company reported covenant compliance.
- Capital returns: The company repurchased 5.16 million shares for $54.4 million during the six months, with $45.6 million remaining under its $100 million authorization. It paid a special dividend of $0.18 per share, totaling $15.7 million.
Changes and management outlook
- New-platform revenue grew to $11.9 million for the quarter from $4.2 million, and to $27.5 million for six months from $7.0 million. This partly offset weakness in airMAX and other systems. Six-month airMAX revenue fell $22.0 million.
- Management said counterfeit products and distributor inventory reduced sales, particularly in airMAX. It expected new platforms to continue growing as a share of revenue, while embedded radios and standard products were expected to decline proportionally. No numerical revenue or earnings guidance was provided.
- Management stated cash, operating cash generation and available borrowing were expected to cover working capital and capital expenditures for at least 12 months. However, $141.1 million of cash was held outside the U.S.; repatriation could trigger significant taxes.
- Interest-rate sensitivity: a sustained 200-basis-point increase on floating-rate debt was estimated to reduce pretax income by more than $1 million over the next 12 months.
Risks, contingencies and unusual items
- Counterfeiting and litigation: Management linked counterfeit products to lost sales and channel inventory accumulation and reported active anti-counterfeiting litigation. A shareholder class action amended in January 2013 alleges misleading statements concerning counterfeit sales; the company disputes the claims and cannot estimate potential losses.
- Export compliance: OFAC’s review of the company’s voluntary disclosure concerning possible sales into Iran remained pending. OEE had closed its investigation without penalty, but OFAC could impose fines, restrict exports or refer the matter for prosecution. The company had recorded a $1.6 million estimate and said additional losses could be higher but were not estimable.
- Customer and channel exposure: Distributors accounted for 97% of quarterly and six-month revenue. Two customers represented 15% and 14% of quarterly revenue. Management noted limited visibility into distributor demand and inventories.
- Supply chain: The company relied on contract manufacturers and substantially all products used Qualcomm Atheros chipsets. A new third-party logistics provider in China began handling most worldwide fulfillment in the quarter; execution or inventory-recording problems could disrupt shipments.
- Debt and capital returns: Increased borrowing funded, in part, the share repurchase program. Debt is secured by substantially all company assets other than intellectual property and carries financial covenants and floating-rate exposure.
- Other commitments: Future operating-lease payments totaled $6.4 million; total scheduled debt and interest payments were $84.6 million. The company also disclosed $9.3 million of unrecognized tax benefits.
Important facts for investors to verify
- Whether counterfeit-product activity and distributor channel inventory are easing, and whether reported sell-in aligns with end-customer demand.
- Progress and potential financial or operational consequences of the pending OFAC review and shareholder class action.
- Cash accessibility and potential tax cost of repatriating the $141.1 million held outside the U.S.
- Debt balances, remaining revolver availability, covenant headroom and the cost of further share repurchases or dividends.
- Customer concentration, chipset availability and the new logistics provider’s fulfillment and inventory controls.
- Whether growth in new platforms can offset declines in airMAX and other legacy product categories.