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UBNT > SEC Filings for UBNT > Form 10-Q on 10-May-2013All Recent SEC Filings

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Form 10-Q for UBIQUITI NETWORKS, INC.


10-May-2013

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
The following discussion of our financial condition and results of operations should be read together with the financial statements and related notes that are included elsewhere in this quarterly report. In addition to historical consolidated financial information, the following discussion contains forward-looking statements that reflect our plans, estimates and beliefs. Our actual results could differ materially from those discussed in the forward-looking statements. Factors that could cause or contribute to these differences include those discussed below and elsewhere in this quarterly report, particularly in Part II, Item 1, Legal Proceedings and 1A, Risk Factors, in this report.
Overview
Ubiquiti Networks is a product driven technology company that designs end-to-end networking solutions for service providers and enterprises. Our technology platforms focus on delivering highly-advanced and efficiently deployable solutions that appeal to a global customer base in underserved and underpenetrated markets. Our differentiated business model, focused around the Ubiquiti Community, has enabled us to break down traditional barriers, such as high product and network deployment costs, and offer solutions with disruptive price-performance characteristics. This disruptive business model, combined with our innovative proprietary technologies, has resulted in an attractive alternative to traditional relationship based, high-cost providers, allowing us to advance the market adoption of platforms for ubiquitous connectivity. We offer a broad and expanding portfolio of networking products and solutions for service providers and enterprises. Our service provider product platforms provide carrier-class network infrastructure for fixed wireless broadband, wireless backhaul systems and routing. Our enterprise product platforms provide wireless LAN infrastructure, video surveillance products, and machine-to-machine communication components. We believe that our products are highly differentiated due to the combination of our significant software intellectual property, protocol innovation, firmware expertise and hardware design capabilities. These products are integrated and flexible, which substantially reduces the cost and complexity of installation, maintenance and management. Our products and solutions meet the demanding performance requirements of video, voice and data applications at prices that are a fraction of those of our competitors' solutions.

As a core part of our strategy, we have developed a disruptive business model for marketing and selling high volumes of carrier and enterprise class communications platforms. Our business model is driven by a large, growing and engaged community of network operators, distributors, value added resellers ("VARs"), systems integrators and corporate IT professionals, which we refer to as the Ubiquiti Community. The Ubiquiti Community is a critical element of our business strategy as it enables us to drive:

Rapid customer and community driven product development. We have an active, loyal end-user community built from our customers that we believe is a sustainable competitive advantage. Our solutions benefit from the active engagement between the Ubiquiti Community and our development engineers throughout the product development cycle, which eliminates long and expensive multistep internal processes and results in rapid introduction and adoption of optimally designed products. This approach significantly reduces our development costs and the time to market for our products.

Scalable sales and marketing model. We do not currently have, nor do we plan to hire, a direct sales force, but instead utilize the Ubiquiti Community to drive market awareness and demand for our products and solutions. This community-propagated viral marketing enables us to reach underserved and underpenetrated markets far more efficiently and cost effectively than is possible through traditional sales models. Leveraging the information transparency of the Internet allows customers to research and evaluate our solutions with the Ubiquiti Community and via third-party web sites. This allows us to operate a scalable sales and marketing model that is designed to create awareness of our brand and products, engage significant numbers of potential customers and create a substantial volume of high quality sales leads at relatively little cost.

Self-sustaining product support. The engaged members of the Ubiquiti Community have enabled us to foster a large, cost efficient, highly scalable and, we believe, self-sustaining mechanism for rapid product support and dissemination of information.

Our revenues decreased 9% to $83.2 million in the three months ended March 31, 2013 from $91.7 million in the three months ended March 31, 2012. Our revenues decreased 15% to $219.6 million in the nine months ended March 31, 2013 from $258.6 million in the nine months ended March 31, 2012. We believe the overall decrease in revenues during both the three and nine months ended March 31, 2013 was primarily driven by lost sales due to the proliferation of counterfeit versions of our products, which has also created customer uncertainty regarding the authenticity of their potential purchases. We believe these factors contributed to a buildup in channel inventory with our distributors, further impacting our revenues. We had net income of $20.7 million and $27.9 million in the three months ended March 31, 2013 and 2012, respectively. We had net income of


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$51.6 million and $74.1 million in the nine months ended March 31, 2013 and 2012, respectively. The declines in net income in both the three and nine months ended March 31, 2013 as compared to the same periods in the prior year were primarily due to the decline in revenues and increased operating expenses. Key Components of Our Results of Operations and Financial Condition Revenues
Our revenues are derived principally from the sale of networking hardware and management tools. In addition, while we do not sell maintenance and support separately, because we have historically included it free of charge in many of our arrangements, we attribute a portion of our systems revenues to this implied post-contract customer support ("PCS").
We classify our revenues into three product categories: systems, embedded radios and antennas/other.
Systems consists of three product categories:

?            Our proprietary airMAX platform products for network operators and
             service providers;


?            Our new platform products which include significant platforms
             introduced in late fiscal 2011 and during 2012 which includes the
             UniFi, airVision and airFiber, mFi and EdgeMAX platforms; and


?            Other 802.11 standard products including base stations, radios,
             backhaul equipment and Customer Premise Equipment ("CPE").


     Embedded radios consist of more than 25 radio products primarily for OEMs,
      including both point to point and point to multipoint radios in the 2.0 to
      6.0GHz spectrum, that are offered with a variety of features.


     Antennas/other consist of antenna products in the 2.0 to 6.0GHz spectrum,
      as well as miscellaneous products such as mounting brackets, cables and
      power over Ethernet adapters. These products include both high performance
      sector and directional antennas. This category also includes our allocation
      of revenues to PCS.

We sell substantially all of our products through a limited number of distributors and other channel partners, such as resellers and OEMs. Sales to distributors accounted for 98% and 99% of our revenues in the three months ended March 31, 2013 and 2012, respectively. Sales to distributors accounted for 97% and 98% of our revenues in the nine months ended March 31, 2013 and 2012, respectively. Other channel partners, such as resellers and OEMs, largely accounted for the balance of our revenues. We sell our products without any right of return.
Cost of Revenues
Our cost of revenues is comprised primarily of the costs of procuring finished goods from our contract manufacturers and chipsets that we consign to certain of our contract manufacturers. In addition, cost of revenues includes tooling, labor and other costs associated with engineering, testing and quality assurance, warranty costs, stock-based compensation, logistics related fees and excess and obsolete inventory.
We outsource our manufacturing and order fulfillment and utilize contract manufacturers located primarily in China and, to a lesser extent, Taiwan. We also evaluate and utilize other vendors for various portions of our supply chain from time to time. Our manufacturing organization consists of employees and consultants engaged in the management of our contract manufacturers, new product introduction activities, logistical support and engineering. Gross Profit
Our gross profit has been, and may in the future be, influenced by several factors including changes in product mix, target end markets for our products, pricing due to competitive pressure, production costs, foreign exchange rates and global demand for electronic components. Although we procure and sell our products in U.S. dollars, our contract manufacturers incur many costs, including labor costs, in other currencies. To the extent that the exchange rates move unfavorably for our contract manufacturers, they may try to pass these additional costs on to us, which could have a material impact on our future average selling prices and unit costs.
Operating Expenses
We classify our operating expenses as research and development and sales, general and administrative expenses.
Research and development expenses consist primarily of salary and benefit expenses, including stock-based compensation, for employees and costs for contractors engaged in research, design and development activities, as well as costs for prototypes, facilities and travel. Over time, we expect our research and development costs to increase as we continue making significant investments in developing new products and developing new versions of our existing products.

Sales, general and administrative expenses include salary and benefit expenses, including stock-based compensation, for employees and costs for contractors engaged in sales, marketing and general and administrative activities, as well


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as the costs of outside legal expenses, trade shows, marketing programs, promotional materials, bad debt expense, professional services, facilities, general liability insurance and travel. As our product portfolio and targeted markets expand, we may need to employ different sales models, such as building a direct sales force. These sales models would likely increase our costs. Over time, we expect our sales, general and administrative expenses to increase in absolute dollars due to continued growth in headcount, expansion of our registration and defense of trademarks and patents efforts and to support our business and operations as a public company. Deferred Revenues and Costs
In the event that collectability of a receivable from products we have shipped is not probable, we classify those amounts as deferred revenues on our balance sheet until such time as we receive payment of the accounts receivable. We classify the cost of products associated with these deferred revenues as deferred costs of revenues. At March 31, 2013, $984,000 of revenue was deferred for transactions where we lacked evidence that collectability of the receivables recorded was reasonably probable. The related deferred cost of revenues balance was $541,000 as of March 31, 2013. At June 30, 2012, we did not have any revenue deferred for transactions where we lacked evidence that collectability of the receivables recorded was reasonably probable.
Also included in our deferred revenues is a portion related to PCS obligations that we estimate we will perform in the future. As of March 31, 2013 and June 30, 2012, we had deferred revenues of $857,000 and $805,000 respectively, related to these obligations.
Critical Accounting Policies
We prepare our condensed consolidated financial statements in accordance with accounting principles generally accepted in the United States of America ("GAAP"). In many cases, the accounting treatment of a particular transaction is specifically dictated by GAAP and does not require management's judgment in its application. In other cases, management's judgment is required in selecting among available alternative accounting standards that provide for different accounting treatment for similar transactions. The preparation of condensed consolidated financial statements also requires us to make estimates and assumptions that affect the amounts we report as assets, liabilities, revenues, costs and expenses and affect the related disclosures. We base our estimates on historical experience and other assumptions that we believe are reasonable under the circumstances. In many instances, we could reasonably use different accounting estimates, and in some instances changes in the accounting estimates are reasonably likely to occur from period to period. Accordingly, our actual results could differ significantly from the estimates made by our management. To the extent that there are differences between our estimates and actual results, our future financial statement presentation, financial condition, results of operations and cash flows will be affected. Our critical accounting policies are discussed in our Annual Report on Form 10-K for the fiscal year ended June 30, 2012, as filed on September 28, 2012 with the SEC, or the Annual Report, and there have been no material changes.


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Results of Operations
Comparison of Three and Nine Months Ended March 31, 2013 and 2012
                              Three Months Ended March 31,                     Nine Months Ended March 31,
                              2013                      2012                   2013                   2012
                                                  (In thousands, except percentages)
Revenues            $   83,155          100 %   $  91,665      100 %   $ 219,591      100 %   $ 258,649      100 %
Cost of revenues        47,690           57 %      52,006       57 %     128,621       59 %     148,687       57 %
Gross profit            35,465           43 %      39,659       43 %      90,970       41 %     109,962       43 %
Operating expenses:
Research and
development              5,677            7 %       4,619        5 %      15,440        7 %      11,671        5 %
Sales, general and
administrative           6,285            8 %       2,484        3 %      16,133        7 %       7,059        3 %
Total operating
expenses                11,962           15 %       7,103        8 %      31,573       14 %      18,730        8 %
Income from
operations              23,503           28 %      32,556       35 %      59,397       27 %      91,232       35 %
Interest expense
and other, net            (287 )          *          (190 )      *          (570 )      *        (1,136 )      *
Income before
provision for
income taxes            23,216           28 %      32,366       35 %      58,827       27 %      90,096       35 %
Provision for
income taxes             2,549            3 %       4,446        5 %       7,178        3 %      15,992        6 %
Net income          $   20,667           25 %   $  27,920       30 %   $  51,649       24 %   $  74,104       29 %


* Less than 1%
(1) Includes stock-based compensation as follows:
Cost of revenues    $      124                  $      41              $     309              $      74
Research and
development                324                        133                    991                    365
Sales, general and
administrative             252                        156                    949                    593
Total stock-based
compensation        $      700                  $     330              $   2,249              $   1,032

Revenues
Revenues decreased $8.5 million, or 9%, from $91.7 million in the three months ended March 31, 2012 to $83.2 million in the three months ended March 31, 2013. Revenues decreased $39.1 million, or 15%, from $258.6 million in the nine months ended March 31, 2012 to $219.6 million in the nine months ended March 31, 2013. We believe the overall decrease in revenues during the three and nine months ended March 31, 2013 was primarily driven by lost sales due to the proliferation of counterfeit versions of our products, which also created customer uncertainty regarding the authenticity of their potential purchases. We believe these factors contributed to a buildup in channel inventory with our distributors, further impacting our revenues. This has had the most significant impact on our airMAX platform which decreased $6.4 million and $28.4 million, respectively, in the three and nine months ended March 31, 2013 compared to the same periods in the prior year.
In the three months ended March 31, 2013, revenues from Customer A represented 15% of our revenues. In the three months ended March 31, 2012, revenues from Customer A and Customer B represented 20% and 10% of our revenues, respectively. In the nine months ended March 31, 2013, revenues from Customer A represented 13% of our revenues. In the nine months ended March 31, 2012, revenues from Customer A and Customer C represented 19% and 10% of our revenues, respectively.


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Revenues by Product Type
                      Three Months Ended March 31,                Nine Months Ended March 31,
                        2013                  2012                 2013                 2012
                                        (in thousands, except percentages)
airMAX         $   55,534        67 %   $ 61,978     68 %   $ 136,343     62 %   $ 164,752     64 %
New platforms      11,825        14 %      9,914     11 %      39,358     18 %      16,874      6 %
Other systems       4,108         5 %     10,308     11 %      12,727      6 %      41,327     16 %
Systems            71,467        86 %     82,200     90 %     188,428     86 %     222,953     86 %
Embedded radio      1,721         2 %      2,232      2 %       4,954      2 %       8,024      3 %
Antennas/other      9,967        12 %      7,233      8 %      26,209     12 %      27,672     11 %
Total revenues $   83,155       100 %   $ 91,665    100 %   $ 219,591    100 %   $ 258,649    100 %

Systems revenues decreased $10.7 million, or 13%, from $82.2 million in the three months ended March 31, 2012 to $71.5 million in the three months ended March 31, 2013. Systems revenues decreased $34.5 million, or 15%, from $223.0 million in the nine months ended March 31, 2012 to $188.4 million in the nine months ended March 31, 2013. As noted above, we believe the decrease in systems revenues was primarily driven by lost sales due to the proliferation of counterfeit versions of our products, in particular our airMAX product line. The decrease in our airMAX product line was partially offset by increased sales in our new platforms category, which includes platforms introduced since late fiscal 2011. Our new platforms contributed $11.8 million and $9.9 million of revenue during the three months ended March 31, 2013 and 2012, respectively, and $39.4 million and $16.9 million of revenue during the nine months ended March 31, 2013 and 2012, respectively. Our other systems revenue decreased $6.2 million during the three months ended March 31, 2013 as compared to the three months ended March 31, 2012 due to further adoption of our airMax solutions. Our other systems revenue decreased $28.6 million during the nine months ended March 31, 2013 as compared to the nine months ended March 31, 2012 due primarily to our December 2011 quarter including a large order to a single direct customer and further adoption of our airMax solutions in 2013. We anticipate that our other systems products will decline in future periods as sales of these products are outpaced by airMax and new platform products.
Embedded radio revenues decreased $511,000, or 23%, from $2.2 million in the three months ended March 31, 2012 to $1.7 million in the three months ended March 31, 2013, and decreased $3.1 million, or 38%, from $8.0 million in the nine months ended March 31, 2012 to $5.0 million in the nine months ended March 31, 2013. We anticipate that embedded radio products will decline as a percentage of revenues in future periods as sales of these legacy products are outpaced by sales of systems products.
Antennas/other revenues increased $2.7 million, or 38% from $7.2 million in the three months ended March 31, 2012 to $10.0 million in the three months ended March 31, 2013. Antennas/other revenues decreased $1.5 million, or 5% from $27.7 million in the nine months ended March 31, 2012 to $26.2 million in the nine months ended March 31, 2013. The increase in antennas/other revenues during the three months ended March 31, 2013 was due primarily to continued expansion of core infrastructure build-outs in our wireless markets. The decline in antennas/other revenues during nine months ended March 31, 2013 was primarily due to the decreased sales of our systems platforms, which negatively impacted the demand for associated antennas. Other revenues also include revenues that are attributable to PCS. We anticipate that antenna/other revenues will decline as a percentage of total revenues due to more rapid growth of systems revenues.


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Revenues by Geography

We generally forward products directly from our manufacturers to our customers via logistics distribution hubs in Asia. Beginning in the quarter ended December 31, 2012, our products were predominantly routed through a third party logistics provider in China and prior to the quarter ended December 31, 2012, our products were predominantly delivered to our customers through distribution hubs in Hong Kong. Our logistics provider, in turn, ships to other locations throughout the world. We have determined the geographical distribution of our product revenues based on our customers' ship-to destinations. A majority of our sales are to distributors who in turn sell to resellers or directly to end customers. For the three months ended March 31, 2013, revenues in North America increased primarily due to the three months ended March 31, 2012 being impacted by our customers' ordering patterns as we had introduced our U.S.-specific products. We believe the decline in revenues in the South America and Europe, Middle East and Africa regions in the three months ended March 31, 2013 and the decline in revenue in all regions during the nine months ended March 31, 2013 as compared to the same periods in the prior year was primarily driven by the proliferation of counterfeit versions of our products, which has also created customer uncertainty regarding the authenticity of their potential purchases. Revenues in the Asia Pacific region tend to be volatile given their low levels. The following are our revenues by geography for the three and nine months ended March 31, 2013 and 2012 (in thousands, except percentages):

                                Three Months Ended March 31,                    Nine Months Ended March 31,
                                 2013                    2012                   2013                   2012
North America(1)        $   21,052         25 %   $ 16,647       18 %   $  53,519       24 %   $  63,028       24 %
South America               18,496         22 %     27,666       30 %      45,820       21 %      71,751       28 %
Europe, the Middle East
and Africa                  31,617         38 %     36,398       40 %      90,690       41 %      91,537       35 %
Asia Pacific                11,990         15 %     10,954       12 %      29,562       14 %      32,333       13 %
Total revenues          $   83,155        100 %   $ 91,665      100 %   $ 219,591      100 %   $ 258,649      100 %

(1) Revenue for the United States was $19.7 million and $14.9 million for the three months ended March 31, 2013 and 2012, respectively. Revenue for the United States was $50.5 million and $60.0 million for the nine months ended March 31, 2013 and 2012, respectively.

Cost of Revenues and Gross Profit
Cost of revenues decreased $4.3 million, or 8%, from $52.0 million in the three months ended March 31, 2012 to $47.7 million in the three months ended March 31, 2013. Cost of revenues decreased $20.1 million, or 13%, from $148.7 million in the nine months ended March 31, 2012 to $128.6 million in the nine months ended March 31, 2013. The decreases in cost of revenues in both the three and nine months ended March 31, 2013 was primarily due to decreased revenues and to a lesser extent, changes in product mix, partially offset by increased warranty costs of approximately $1.0 million incurred during the three months ended March 31, 2013 related to the recall of our Rocket Titanium products due to an identified manufacturing issue which was subsequently rectified.
Gross profit remained flat at 43% in the three months ended March 31, 2013 as compared to the three months ended March 31, 2012. Gross profit decreased from 43% in the nine months ended March 31, 2012 to 41% in the nine months ended March 31, 2013. The decrease in gross profit in the nine months ended March 31, 2013 reflects increases in variable operating costs and changes in product mix. Operating Expenses
Research and Development
Research and development expenses increased $1.1 million, or 23%, from $4.6 million in the three months ended March 31, 2012 to $5.7 million in the three months ended March 31, 2013. As a percentage of revenues, research and development expenses increased from 5% in the three months ended March 31, 2012 to 7% in the three months ended March 31, 2013. Research and development expenses increased $3.8 million, or 32%, from $11.7 million in the nine months ended March 31, 2012 to $15.4 million in the nine months ended March 31, 2013. As a percentage of revenues, research and development expenses increased from 5% in the nine months ended March 31, 2012 to 7% in the nine months ended March 31, 2013. The increase in research and development expenses in absolute dollars in both periods was due to increases in headcount as we broadened our research and development activities to new product areas. As a percentage of revenues, research and development expenses increased in both periods primarily due to our overall decrease in revenues. Over time, we expect our research and development costs to increase in absolute dollars as we continue making significant investments in developing new products and developing new versions of our existing products.


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Sales, General and Administrative
Sales, general and administrative expenses increased $3.8 million, or 153%, from $2.5 million in the three months ended March 31, 2012 to $6.3 million in the three months ended March 31, 2013. As a percentage of revenues, sales, general and administrative expenses increased from 3% in the three months ended March 31, 2012 to 8% in the three months ended March 31, 2013. Sales, general and administrative expenses increased $9.1 million, or 129%, from $7.1 million in the nine months ended March 31, 2012 to $16.1 million in the nine months ended March 31, 2013. As a percentage of revenues, sales, general and . . .

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