Ubiquiti Networks, Inc. — Form 10-Q summary
Business and period: Ubiquiti develops networking products for service providers, enterprises and consumers. This unaudited report covers the quarter and six months ended December 31, 2017 (the second quarter and first half of fiscal 2018), compared with the same periods of fiscal 2017. Dollar amounts below are in millions except per-share data.
Financial performance
| Metric | Three months ended Dec. 31, 2017 | Three months ended Dec. 31, 2016 | Six months ended Dec. 31, 2017 | Six months ended Dec. 31, 2016 |
|---|---|---|---|---|
| Revenue | $250.8 | $213.5 | $496.7 | $418.3 |
| Gross profit / margin | $96.9 / 39% | $95.1 / 45% | $208.6 / 42% | $193.4 / 46% |
| Operating income / margin | $66.1 / 26% | $69.8 / 33% | $153.1 / 31% | $144.7 / 35% |
| Interest expense and other, net | $2.5 | $1.2 | $3.9 | $2.3 |
| Income before taxes | $63.6 | $68.6 | $149.3 | $142.4 |
| Income tax provision | $115.0 | $8.0 | $125.8 | $10.0 |
| Net income (loss) | $(51.5) | $60.6 | $23.5 | $132.4 |
| Diluted EPS | $(0.66) | $0.72 | $0.29 | $1.58 |
Quarterly revenue grew 17% year over year; first-half revenue grew 19%. Enterprise Technology revenue rose 34% for the quarter and 41% for the half, driven primarily by broader product offerings and UniFi adoption. Service Provider Technology revenue increased 4% for the quarter and 2% for the half. Enterprise products represented 52% of revenue in both 2017 periods, up from 46% and 44%, respectively, in 2016. EMEA and Asia Pacific were notable sources of quarterly growth; North American quarterly revenue was nearly flat.
Margins contracted despite revenue growth. Cost of revenue included $18.6 million of charges for obsolete inventory, vendor deposits and purchase commitments, primarily related to FrontRow. Management attributed these charges to lower-than-expected sales after the holiday season and concluded the related inventory and commitments could not be fully recovered. Operating expenses were $30.8 million for the quarter and $55.4 million for the half; R&D spending rose 26% and 21%, respectively, mainly due to headcount and development activity.
Cash, debt and liquidity
- Cash and cash equivalents were $823.8 million at December 31, 2017, up from $604.2 million at June 30, 2017. Of period-end cash, $676.0 million was held by foreign subsidiaries.
- Six-month operating cash flow was $165.7 million, versus $75.7 million a year earlier. Investing cash outflow was $6.2 million, primarily capital expenditures. Financing provided $60.1 million, including $218.5 million of revolving-credit borrowings and offset by $151.3 million of share repurchases and $7.5 million of term-loan principal repayments.
- At December 31, gross debt was approximately $468.3 million: $399.5 million drawn on the revolver and $68.8 million of term debt. The reported carrying amount was $467.7 million after debt issuance costs. The existing facility matured in March 2020 and required a maximum leverage ratio of 2.50:1 and minimum liquidity of $250 million.
- Current assets were $1,147.6 million and current liabilities $104.9 million. Management said cash, operating cash generation and available credit were expected to meet working-capital and capital-spending needs for at least the next 12 months.
- After quarter-end, on January 17, 2018, the company entered a new facility providing a $400 million revolver and a $500 million term loan, with an option to seek up to $300 million in additional commitments. The term loan was fully drawn at closing, a portion refinancing the prior facility. The new facilities mature in 2023 and permit specified share repurchases and dividends.
Material changes, outlook and notable items
- The 2017 Tax Act drove a provisional $110.5 million repatriation-tax charge and $2.3 million charge from remeasuring deferred taxes. The resulting total tax provision was $115.0 million for the quarter and $125.8 million for the half; the quarterly effective tax rate was 181%. The company recorded the full estimated repatriation tax for accounting purposes, while payment may be made in eight annual interest-free installments. The estimate remained subject to refinement through the measurement period ending December 22, 2018.
- Repatriation-tax obligations were reported at $114.9 million, with installments shown in contractual obligations. The company also reported $27.6 million of unrecognized tax benefits and $2.1 million of accrued interest on uncertain tax matters.
- The board authorized $151.3 million of repurchases during the six months, reducing outstanding shares. A further $50 million repurchase authorization was approved in November 2017; a new $150 million program was approved February 6, 2018.
- No numerical revenue or earnings guidance is provided. Management expects existing cash, operating cash flow and credit availability to be sufficient for at least 12 months; actual future capital needs depend on growth, product development, launches, market acceptance and economic conditions.
- Key risks include limited visibility into end-market demand and distributor inventories, reliance on distributors (99% of quarterly and first-half sales were to distributors), product-launch and inventory risk, competition, and dependence on contract manufacturers and certain component suppliers. The FrontRow-related charges illustrate product-demand and inventory exposure.
- Synopsys and Vivato patent-related litigation remained pending; the company said it could not estimate a possible loss range and intended to defend itself. A separate 2012 shareholder lawsuit was settled for $6.8 million, funded largely by insurers, with final judgment entered December 20, 2017. Two newer purported shareholder class actions were voluntarily dismissed without prejudice.
- The company reported no material adverse effect expected from pending or threatened litigation generally. It also continued pursuing recovery of $30.0 million from a 2015 business-email-compromise fraud; further recovery was described as remote and uncertain.
- Disclosure controls were concluded effective as of December 31, 2017, and no material change in internal control over financial reporting was reported for the quarter.
Investor verification priorities
- Verify the final accounting and cash-payment schedule for the provisional Tax Act charges and repatriation-tax liability.
- Assess the scale and assumptions behind the $18.6 million FrontRow-related inventory, vendor-deposit and purchase-commitment charges, and subsequent product demand.
- Reconcile period-end debt and cash with the fully drawn post-quarter term loan, refinancing, new covenants and intended use of borrowing capacity.
- Monitor gross-margin recovery, product mix and whether Enterprise Technology growth can offset slower Service Provider Technology growth.
- Review distributor and customer concentration, channel inventory and exposure to the pending Synopsys and Vivato cases, for which potential losses were not estimable.