Ubiquiti Networks, Inc. — Form 10-Q Summary
Reporting period: Fiscal third quarter and nine months ended March 31, 2013. The filing is unaudited; amounts below are in U.S. dollars, generally millions unless stated otherwise.
Business context
Ubiquiti designs networking products for service providers and enterprises, selling primarily through distributors and relying on its user community for product awareness, feedback and support. Distributors accounted for 98% of Q3 revenue and 97% for the nine-month period.
Financial performance
| Metric | Three months ended Mar. 31, 2013 | Three months ended Mar. 31, 2012 | Nine months ended Mar. 31, 2013 | Nine months ended Mar. 31, 2012 |
|---|---|---|---|---|
| Revenue | $83.2 | $91.7 | $219.6 | $258.6 |
| Gross profit / margin | $35.5 / 43% | $39.7 / 43% | $91.0 / 41% | $110.0 / 43% |
| Operating income / margin | $23.5 / 28% | $32.6 / 35% | $59.4 / 27% | $91.2 / 35% |
| Net income / margin | $20.7 / 25% | $27.9 / 30% | $51.6 / 24% | $74.1 / 29% |
| Diluted earnings per share | $0.23 | $0.30 | $0.57 | $(0.48) |
For the nine months, prior-year net income attributable to common shareholders included $112.4 million of preferred-stock dividends and accretion, resulting in a common-stockholder loss despite positive net income. Nine-month non-GAAP diluted EPS was $0.58 versus $0.80 in 2012; the company’s non-GAAP measure principally excludes stock-based compensation, net of tax.
Operating cash flow for the nine months was $85.7, versus $51.7 a year earlier. Investing used $4.4 and financing used $21.6; cash increased $59.6 to $181.7. Operating cash flow benefited from a $35.6 reduction in receivables, while inventory increased $12.7. At March 31, cash and equivalents were $181.7, current assets $243.6 and current liabilities $56.7.
Total debt was $77.4 ($5.0 current and $72.4 long-term), up from $29.6 at June 30, 2012. The $50 million term facility was fully drawn; $20 million remained available on the $50 million revolving facility. The company reported compliance with its debt covenants. It held $170.2 of cash outside the U.S. and said repatriation would trigger significant tax liabilities.
Changes versus prior comparable periods
- Revenue fell 9% in Q3 and 15% for the nine months. Management attributed the decline mainly to counterfeit products, uncertainty about product authenticity and resulting distributor channel inventory buildup.
- airMAX revenue declined $6.4 in Q3 and $28.4 for the nine months. New-platform revenue grew to $11.8 in Q3 from $9.9, and to $39.4 for the nine months from $16.9.
- Nine-month gross margin fell to 41% from 43%, reflecting higher variable operating costs and product mix. Q3 gross margin was unchanged at 43%.
- Operating expenses rose materially: Q3 R&D increased 23% and SG&A 153%; nine-month R&D increased 32% and SG&A 129%. SG&A growth reflected anti-counterfeiting legal costs, marketing and trade shows, and higher bad-debt allowance.
- Debt increased alongside $54.4 of share repurchases and a $15.7 special dividend during the nine months. The company repurchased 5.16 million shares, with $45.6 remaining under its $100 million authorization at December 31; it made no repurchases in the March quarter.
Outlook, risks and unusual items
- No specific revenue or earnings guidance was provided. Management expected existing cash, operating cash flow and available credit to meet working-capital and capital-expenditure needs for at least 12 months. It expected continued investment in R&D and higher operating expenses.
- Management anticipated declines in legacy embedded-radio products as a share of revenue and in other systems products, while expecting new platforms to gain importance. It noted limited visibility into distributor demand and inventory.
- A Rocket Titanium product recall followed a manufacturing issue that management said was corrected; related Q3 warranty costs were approximately $1.0. The nine-month warranty accrual rose to $2.7 from $1.4 at June 30.
- OFAC was still reviewing the company’s voluntary export-compliance disclosure. OEE had closed its investigation with a warning letter and no penalty. The company had recorded a $1.6 expense for the matter but said additional losses were reasonably possible and not estimable; potential outcomes include fines, export restrictions or prosecution.
- Shareholder class-action litigation alleges misleading statements about counterfeit-product sales. The company said it could not estimate possible losses. Anti-counterfeiting litigation was also ongoing.
- Other risks include dependence on a small number of distributors, contract manufacturers and Qualcomm Atheros chipsets; the Qualcomm agreement could be terminated at its September 1, 2013 annual term; inventory obsolescence; and foreign-exchange and floating-rate debt exposure. A sustained 200-basis-point rate increase was estimated to reduce pretax income by more than $1.0 over 12 months.
- The effective tax rate was 11% in Q3 and 12% for the nine months, primarily reflecting income earned in lower-tax jurisdictions. Q3 included a $0.539 tax benefit from the retroactive R&D credit extension. Unrecognized tax benefits were $10.4.
Important facts for investors to verify
- Whether counterfeit-product activity and distributor channel inventory are easing, and whether new-platform growth can offset airMAX weakness.
- Distributor sell-through and inventory data, including exposure to Customer A, which represented 15% of Q3 revenue and 13% of nine-month revenue.
- Resolution and potential financial or operating consequences of OFAC’s review and the shareholder litigation.
- Terms and continuity of Qualcomm Atheros chipset supply, and the company’s ability to manage its China logistics provider and increased finished-goods inventory.
- Debt repayment requirements, covenant headroom, remaining revolver availability and the practical availability of offshore cash for U.S. obligations.
- Whether recall-related costs, bad debts, warranty accruals and operating expenses remain elevated. Management reported effective disclosure controls as of March 31, 2013.