Ubiquiti Networks, Inc. — Form 10-Q summary
Reporting period: Three and six months ended December 31, 2018 (fiscal 2019 second quarter and first half). All amounts below are in U.S. dollars; financial statement amounts are converted from thousands to millions unless stated otherwise. Ubiquiti develops networking products for service providers, enterprises and consumers and primarily sells through distributors.
Financial performance and position
| Metric | Three months ended Dec. 31, 2018 | Prior-year quarter | Six months ended Dec. 31, 2018 | Prior-year half-year |
|---|---|---|---|---|
| Revenue | $307.3m | $250.8m | $590.2m | $496.7m |
| Gross profit / margin | $140.2m / 46% | $96.9m / 39% | $271.8m / 46% | $208.6m / 42% |
| Operating income / margin | $91.7m / 30% | $66.1m / 26% | $191.3m / 32% | $153.1m / 31% |
| Net income (loss) | $77.8m | $(51.5)m | $163.5m | $23.5m |
| Diluted earnings per share | $1.09 | $(0.66) | $2.25 | $0.29 |
| Operating cash flow | Not separately presented for the quarter | $144.6m | $165.7m |
- Revenue mix: Enterprise Technology revenue rose 48% in the quarter to $194.1m and 45% for the half-year to $372.0m, driven by product expansion and adoption of UniFi. Service Provider Technology revenue fell 6% in the quarter to $113.2m and 9% for the half-year to $218.2m.
- Margins and costs: Management attributed higher gross margins primarily to product mix, lower inventory-obsolescence charges and product cost reductions. Higher indirect costs, including shipping and tariffs, partly offset those benefits. The prior-year periods included $18.6m of costs related to obsolete inventory, vendor deposits and purchase commitments.
- Taxes: The current-year effective tax rate was 12% for both the quarter and half-year, versus 181% and 84%, respectively, in the comparable periods. Prior-year tax expense included $110.5m of transition-tax charges and $2.3m for deferred-tax remeasurement under the 2017 Tax Act. Current-period tax expense included a $4m discrete benefit related to the litigation settlement.
- Cash and liquidity: Cash and cash equivalents were $293.3m at December 31, 2018, down from $666.7m at June 30, 2018. Cash plus short- and long-term investments totaled $439.1m. The company reported operating cash flow of $144.6m; inventory growth of $154.5m was a major operating-cash use. Investing activities used $156.1m, mainly for net investment purchases, and financing activities used $361.8m, primarily for repurchases and dividends.
- Debt: Term-loan principal outstanding was $475.0m, with no revolver borrowings; the carrying value of debt, net of issuance costs, was $472.6m. The term loan’s reported interest rate was 4.27%. The credit agreement matures January 2023 and requires a maximum leverage ratio of 3.25 to 1.00 and minimum liquidity of $250m.
- Working capital and returns: Inventory increased to $255.8m from $102.2m at June 30, 2018. The company repurchased $313.1m of common stock and paid $36.1m in dividends during the half-year. A quarterly dividend of $0.25 per share was announced for February 2019; management stated an intention to pay at least $0.25 quarterly for the rest of fiscal 2019, subject to board approval.
Material changes and notable items
- Revenue grew 23% year over year in the quarter and 19% for the half-year, with growth concentrated in Enterprise Technology. EMEA and North America increased, while South America declined 32% for the half-year and Asia Pacific declined 6%.
- Share repurchases reduced shares outstanding to 70.6m at December 31, 2018 from 74.1m at June 30, 2018. The November repurchase program had $187.2m remaining at December 31.
- Accounts payable rose to $136.5m from $14.1m at June 30, while inventory rose substantially. These balance-sheet movements are important context for working-capital and operating-cash-flow trends.
- The company adopted ASC 606 in fiscal 2019 using the modified retrospective method; adoption had no material reported effect. It expected adoption of the new lease standard in fiscal 2020 to increase recognized assets and liabilities; the amount was still under evaluation.
Outlook, risks and contingencies
- No specific revenue or earnings guidance was provided. Management said available cash, operating cash flow, investments and credit-facility availability should be sufficient for working capital, planned repurchases, dividends and capital expenditures over the next 12 months, while noting this depends on assumptions.
- U.S. tariffs on some China-imported products took effect in September 2018. Management expected near-term margin pressure while exploring mitigation measures.
- Component purchase obligations not yet recorded as liabilities were estimated at $178m–$237m, depending on manufacturers’ order timing. The company also recorded a $2.8m purchase-obligation liability related to FrontRow. These commitments, alongside elevated inventory, expose the company to forecast and obsolescence risk.
- On January 17, 2019, the company settled the Synopsys litigation for $18m and agreed to a permanent injunction against unlicensed use of Synopsys software. The expense was accrued in the December quarter; the settlement contained no admission of liability.
- An IRS draft proposed adjustment concerning fiscal 2015 and 2016 could imply approximately $50m of incremental tax, excluding interest and penalties. The company disputes the IRS position and had not recorded an additional reserve; it warned an adverse outcome could materially affect results and financial condition. Unrecognized tax benefits were $29.4m, with $3.8m accrued interest.
- Other unresolved matters include a stayed patent-infringement case brought by Vivato, a consolidated shareholder securities class action, a shareholder derivative action and an ongoing SEC investigation involving, among other topics, community metrics, accounting practices and distributor relationships. The company said it could not estimate possible losses for the litigation matters or predict the SEC investigation’s timing or outcome.
- Interest-rate sensitivity: a sustained 200-basis-point increase affecting floating-rate debt was estimated to add approximately $9.5m to pretax expense over the next 12 months. Management concluded disclosure controls were effective as of December 31, 2018.
Most important facts for investors to verify
- Whether Enterprise Technology growth can offset ongoing weakness in Service Provider Technology and in certain regions.
- Whether elevated inventory and substantial component commitments reflect demand adequately and avoid future write-downs or excess stock.
- How tariffs, shipping costs and product mix affect gross margins in upcoming periods.
- Progress and potential financial exposure from the IRS proposal, SEC investigation, shareholder actions and Vivato litigation.
- Cash and covenant headroom after large repurchases and dividends, including the company’s ability to maintain the $250m minimum-liquidity requirement.