Ubiquiti Networks, Inc. — Form 10-Q Summary
Reporting period: Three months ended September 30, 2018, the first quarter of fiscal 2019 (the filing’s “2018 Q1” label refers to calendar-quarter timing). Amounts below are in U.S. dollars; financial statement figures are in millions unless stated otherwise.
Business context and results
Ubiquiti develops networking technology for service providers, enterprises and consumers. It sells primarily through distributors, which accounted for 97% of revenue this quarter. The company adopted ASC 606 using the modified retrospective method; adoption had no material financial impact, and comparative periods were not restated.
| Metric | Q1 FY2019 | Q1 FY2018 | Change |
|---|---|---|---|
| Revenue | $282.9 | $245.9 | +15% |
| Gross profit / margin | $131.6 / 46.5% | $111.7 / 45.4% | Margin up about 1.1 percentage points |
| Operating income / margin | $99.6 / 35.2% | $87.1 / 35.4% | Income +14% |
| Net income / margin | $85.7 / 30.3% | $74.9 / 30.5% | Income +14% |
| Diluted EPS | $1.16 | $0.92 | Up; weighted-average diluted shares fell to 74.0 million from 81.7 million |
| Operating cash flow | $93.9 | $96.9 | Down $3.0 |
Revenue mix and material changes
- Enterprise Technology revenue increased 41% to $177.9 million, or 63% of sales, driven mainly by broader product offerings and adoption of UniFi.
- Service Provider Technology revenue declined 12% to $105.0 million, or 37% of sales, with weakness in North America, South America and Asia Pacific partly offset by EMEA growth.
- By ship-to destination, EMEA revenue rose 34% to $124.9 million and North America rose 24% to $119.4 million; South America fell 54% to $14.2 million. U.S. revenue was $112.3 million.
- Gross margin improved, primarily from product mix and, to a lesser extent, cost-reduction efforts. SG&A rose 79% to $13.8 million, which the company attributed primarily to professional fees and increased headcount. R&D rose 8% to $18.2 million.
- Net interest expense and other increased to $2.5 million from $1.4 million. The effective tax rate was approximately 12%, versus 13%, with the filing citing changes in tax law and stock-based compensation benefits.
Cash, debt and capital allocation
- At September 30, cash and cash equivalents were $480.8 million, short-term investments $96.3 million and long-term investments $48.4 million. The filing describes $200.0 million of total fixed-income investments, including securities classified in cash equivalents; avoid double-counting these amounts.
- Debt was $481.3 million, all under the term facility; no borrowings were outstanding on the $400 million revolving facility. The term-loan rate was 3.99% at quarter-end. Credit covenants require a maximum 3.25:1 leverage ratio and minimum liquidity of $250 million.
- Operating cash flow was $93.9 million. Investing used $148.1 million, mainly net purchases of available-for-sale securities; financing used $131.7 million, including $106.8 million of share repurchases, $18.5 million of dividends and $6.3 million of term-loan principal repayment. Cash declined $185.9 million during the quarter.
- Inventory increased to $139.9 million from $102.2 million, principally finished goods. The company said it raised stock levels to meet customer demand.
- The company repurchased 1.24 million shares in the quarter for $112.8 million at an average $91.07 per share. After quarter-end, it repurchased a further 2.02 million shares for $180.6 million. A new $200 million repurchase authorization was approved November 6, 2018.
Outlook, risks and contingencies
- No quantified revenue or earnings guidance is provided. Management believes cash, operating cash flow, investments and available credit will meet working-capital, repurchase, dividend and capital needs for the next 12 months, while cautioning that assumptions may prove wrong.
- U.S. tariffs on certain China-origin products took effect September 24, 2018. Management expects near-term margin pressure while it evaluates mitigation options.
- The company announced a $0.25-per-share quarterly dividend payable November 26, 2018 and stated it intends to pay at least $0.25 per share quarterly for the remainder of fiscal 2019, subject to board approval.
- The IRS issued a draft proposed adjustment concerning fiscal 2015 and 2016 tax years, which could imply about $50 million of additional tax, excluding interest and penalties. Ubiquiti disputes the IRS position and recorded no additional reserve; an adverse outcome could materially affect results and financial condition. Separately, the company reported $29.3 million of unrecognized tax benefits and $3.4 million of accrued interest on uncertain tax matters.
- An SEC investigation is ongoing following subpoenas seeking information on topics including community engagement metrics, accounting, financial information, international trade and distributor relationships. The company cannot predict its outcome or timing.
- Material legal matters include Synopsys litigation, patent litigation brought by Vivato (stayed pending patent-review proceedings), consolidated shareholder class actions and a shareholder derivative action. The company cannot estimate possible losses for the cited litigations. It says it is not aware of other pending or threatened litigation expected to materially adversely affect its financial statements.
- Purchase commitments include $38.8 million of inventory obligations reported in the contractual-obligations table and an estimated additional $147 million to $244 million of potential component commitments, depending on manufacturers’ order timing; the latter estimate is excluded from that table. Recorded purchase-obligation liability related to FrontRow was $3.3 million.
- Key operating risks include distributor and customer concentration, limited visibility into end demand, inventory and supply-chain exposure, competition and rapid product cycles, cybersecurity and product quality risks, and variable-rate debt. A sustained 200-basis-point rate increase was estimated to add about $9.6 million to pretax expense over 12 months.
Most important facts for investors to verify
- Progress and potential financial exposure from the IRS proposed adjustment and the SEC investigation, including any subsequent disclosures or reserve changes.
- Whether tariffs, product mix and cost actions preserve gross margins, and whether the strong Enterprise Technology growth offsets continuing Service Provider weakness.
- Inventory levels, sell-through and distributor ordering, given the $37.7 million quarter-on-quarter inventory increase and limited visibility into end-customer demand.
- Cash and investment availability, debt covenant headroom and the effect of continued buybacks and dividends on liquidity.
- Developments in the shareholder, Synopsys and Vivato matters, as well as any changes in estimated purchase commitments or other contingencies.