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UBNT > SEC Filings for UBNT > Form 10-Q on 8-Nov-2013All Recent SEC Filings

Show all filings for UBIQUITI NETWORKS, INC. | Request a Trial to NEW EDGAR Online Pro

Form 10-Q for UBIQUITI NETWORKS, INC.


8-Nov-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 develops high performance networking technology for service providers and enterprises. Our technology platforms focus on delivering highly-advanced and easily deployable solutions that appeal to a global customer base in underserved and underpenetrated markets. Our differentiated business model 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 differentiated business model, combined with our innovative proprietary technologies, has resulted in an attractive alternative to traditional high touch, high-cost providers, allowing us to advance the market adoption of our 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 our proprietary software protocol innovation, firmware expertise, and hardware design capabilities. This differentiation allows our portfolio to meet the demanding performance requirements of video, voice and data applications at prices that are a fraction of those offered by our competitors. As a core part of our strategy, we have developed a differentiated 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 highly engaged community of service providers, distributors, value added resellers, 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:


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Rapid customer and community driven product development. We have an active, loyal 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 our products. This approach significantly reduces our development costs and time to market.

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, evaluate and validate our solutions with the Ubiquiti Community and via third party web sites. This allows us to operate a scalable sales and marketing model and effectively create awareness of our brand and products. Word of mouth referrals from the Ubiquiti Community generate high quality leads for our distributors 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.

By reducing the cost of development, sales, marketing and support we are able to eliminate traditional business model inefficiencies and offer innovative solutions with disruptive price performance characteristics to our customers. Our revenues increased 111% to $129.7 million in the three months ended September 30, 2013 from $61.5 million in the three months ended September 30, 2012. We believe the overall increase in revenues during the three months ended September 30, 2013 was driven by increased adoption of our service provider and enterprise technologies. Additionally, during three months ended September 30, 2012, we believe we experienced 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. We had net income of $40.5 million and $13.2 million in the three months ended September 30, 2013 and 2012, respectively. The increase in net income in the three months ended September 30, 2013 as compared to the same period in the prior year was primarily due to the increase in revenues.
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 two primary product categories, Service Provider Technology and Enterprise Technology.

Service Provider Technology includes our airMAX, EdgeMAX and airFiber platforms, as well as embedded radio products and other 802.11 standard products including base stations, radios, backhaul equipment and Customer Premise Equipment ("CPE"). Additionally, Service Provider Technology includes antennas and other products in the 2.0 to 6.0GHz spectrum and miscellaneous products such as mounting brackets, cables and power over Ethernet adapters. Service Provider Technology also includes revenues that are attributable to post contract support ("PCS").

Enterprise Technology includes the Company's UniFi, mFi and airVision platforms.

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 97% of our revenues in the three months ended September 30, 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


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costs associated with engineering, testing and quality assurance, warranty costs, stock-based compensation, logistics related fees and excess and obsolete inventory.
In addition to utilizing contract manufacturers, we outsource our logistics warehousing and order fulfillment functions, which are 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 operations 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 as the costs of 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 efforts to register and defend trademarks and patents and to support our business and operations.

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 both September 30, 2013 and June 30, 2013, $2.2 million of revenue was deferred for transactions where we lacked evidence that collectability of the receivables recorded was reasonably assured. The related deferred cost of revenues balance was $1.2 million at both September 30, 2013 and June 30, 2013.
Also included in our deferred revenues is a portion related to PCS obligations that we estimate we will perform in the future. As of September 30, 2013 and June 30, 2013, we had deferred revenues of $1.1 million and $1.0 million 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


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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, 2013, as filed on September 13, 2013 with the SEC, or the Annual Report, and there have been no material changes.
Results of Operations
Comparison of Three Months Ended September 30, 2013 and 2012

                                                     Three Months Ended September 30,
                                                     2013                         2012
                                                    (In thousands, except percentages)
Revenues                                  $    129,687          100 %   $   61,535         100 %
Cost of revenues                                71,664           55 %       36,515          59 %
Gross profit                                    58,023           45 %       25,020          41 %
Operating expenses:
Research and development                         6,317            5 %        4,711           8 %
Sales, general and administrative                5,810            4 %        4,534           7 %
Total operating expenses                        12,127            9 %        9,245          15 %
Income from operations                          45,896           36 %       15,775          26 %
Interest expense and other, net                   (246 )          *            (86 )         *
Income before provision for income taxes        45,650           35 %       15,689          25 %
Provision for income taxes                       5,122            4 %        2,510           4 %
Net income and comprehensive income       $     40,528           31 %   $   13,179          21 %


* Less than 1%
(1) Includes stock-based compensation as follows:
Cost of revenues                          $        144                  $       81
Research and development                           496                         266
Sales, general and administrative                  527                         309
Total stock-based compensation            $      1,167                  $      656

Revenues
Revenues increased $68.2 million, or 111%, from $61.5 million in the three months ended September 30, 2012 to $129.7 million in the three months ended September 30, 2013. We believe the overall increase in revenues during the three months ended September 30, 2013 was driven by increased adoption of our service provider and enterprise technologies. Additionally, during three months ended September 30, 2012, we believe we experienced 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.
In the three months ended September 30, 2013, revenues from Customer A and Customer B each represented 10% of our revenues. In the three months ended September 30, 2012, revenues from Customer B represented 15% of our revenues.

Revenues by Product Type
                                   Three Months Ended September 30,
                                       2013                     2012
                                  (in thousands, except percentages)
Service Provider Technology $     94,217           73 %   $ 51,617     84 %
Enterprise Technology             35,470           27 %      9,918     16 %
Total revenues              $    129,687          100 %   $ 61,535    100 %

Revenues from Service Provider Technologies increased $42.6 million, or 83%, from $51.6 million in the three months ended September 30, 2012 to $94.2 million in the three months ended September 30, 2013. The increase was due primarily to


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continued expansion of core infrastructure build-outs in our wireless markets. Additionally, we believe we experienced significant lost sales during the three months ended September 30, 2012 due to the proliferation of counterfeit versions of our products as discussed above.
Enterprise Technology revenues increased $25.6 million, or 258% from $9.9 million in the three months ended September 30, 2012 to $35.5 million in the three months ended September 30, 2013. The increase in Enterprise Technology revenues during the three months ended September 30, 2013 was due primarily to product expansion and further adoption of our UniFi technology platform. 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 September 30, 2013, revenues in all regions increased due to increased adoption of our Service Provider and Enterprise Technologies. Additionally, during the three months ended September 30, 2012, we believe we experienced lost sales due to the proliferation of counterfeit versions of our products, which also created customer uncertainty regarding the authenticity of their potential purchases. The following are our revenues by geography for the three months ended September 30, 2013 and 2012 (in thousands, except percentages):

                                          Three Months Ended September 30,
                                              2013                     2012
North America(1)                   $     37,433           29 %   $ 20,361     33 %
South America                            20,776           16 %     10,243     17 %
Europe, the Middle East and Africa       52,866           41 %     23,144     37 %
Asia Pacific                             18,612           14 %      7,787     13 %
Total revenues                     $    129,687          100 %   $ 61,535    100 %

(1) Revenue for the United States was $36.3 million and $19.3 million for the three months ended September 30, 2013 and 2012, respectively.

Cost of Revenues and Gross Profit
Cost of revenues increased $35.1 million, or 96%, from $36.5 million in the three months ended September 30, 2012 to $71.7 million in the three months ended September 30, 2013. The increase in cost of revenues in the three months ended September 30, 2013 was primarily due to increased revenues and to a lesser extent, changes in product mix.
Gross profit increased to 45% in the three months ended September 30, 2013 compared to 41% in the three months ended September 30, 2012, reflecting a high level of revenue growth, increasing economies of scale and changes in product mix.
Operating Expenses
Research and Development
Research and development expenses increased $1.6 million, or 34%, from $4.7 million in the three months ended September 30, 2012 to $6.3 million in the three months ended September 30, 2013. As a percentage of revenues, research and development expenses decreased from 8% in the three months ended September 30, 2012 to 5% in the three months ended September 30, 2013. The increase in research and development expenses in absolute dollars 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 decreased primarily due to our overall increase 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.
Sales, General and Administrative
Sales, general and administrative expenses increased $1.3 million, or 28%, from $4.5 million in the three months ended September 30, 2012 to $5.8 million in the three months ended September 30, 2013. As a percentage of revenues, sales, general


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and administrative expenses decreased from 7% in the three months ended September 30, 2012 to 4% in the three months ended September 30, 2013. Sales, general and administrative expenses increased due to increased professional fees, primarily related to the ancillary support of certain management functions, increased marketing activity and overall increases in headcount to further expand our marketing and administrative functions. As a percentage of revenues, sales, general and administrative expenses decreased primarily due to our overall revenue increase. Over time, we expect our sales, general and administrative expenses to increase in absolute dollars due to continued efforts to protect our intellectual property and growth in headcount to support our business and operations.
Interest Expense and Other, Net
Interest expense and other, net was $246,000 for the three months ended September 30, 2013, representing an increase of $160,000 from $86,000 for the three months ended September 30, 2012. The increase in interest expense and other, net during the three months ended September 30, 2013 compared to the same period in the prior year was primarily due to additional interest expense resulting from our increased borrowings from East West Bank during the three months ended September 30, 2012.
Provision for Income Taxes
Our provision for income taxes increased $2.6 million, or 104%, from $2.5 million for the three months ended September 30, 2012 to $5.1 million for the three months ended September 30, 2013. Our effective tax rate decreased to 11% for the three months ended September 30, 2013 as compared to 16% the three months ended September 30, 2012. The lower effective tax rate was primarily due to a larger percentage of our overall profitability occurring in foreign jurisdictions with lower income tax rates. Liquidity and Capital Resources
Sources and Uses of Cash
Since inception, our operations primarily have been funded through cash generated by operations. Cash and cash equivalents increased from $227.8 million at June 30, 2013 to $279.7 million at September 30, 2013.

Consolidated Cash Flow Data
The following table sets forth the major components of our condensed
consolidated statements of cash flows data for the periods presented:
                                                           Three Months Ended September 30,
                                                               2013                 2012
                                                                    (In thousands)
Net cash provided by operating activities               $        51,880       $        23,695
Net cash used in investing activities                              (460 )              (2,349 )
Net cash provided by (used in) financing activities                 483               (10,920 )
Net increase in cash and cash equivalents               $        51,903       $        10,426

Cash Flows from Operating Activities
Net cash provided by operating activities in the three months ended September 30, 2013 of $51.9 million consisted primarily of net income of $40.5 million and net changes in operating assets and liabilities that resulted in net cash inflows of $10.4 million. These changes consisted primarily of an $8.3 million increase in accounts payable and accrued liabilities due primarily to our increase in cost of revenues, a $2.0 million increase in taxes payable due to the timing of federal tax payments, a $1.0 million increase in inventory due to increased product demand and a $897,000 decrease in prepaid expenses and other current assets due to timing of our payments with our suppliers. Additionally, our net income included non-cash adjustments due to stock-based compensation, depreciation and amortization, increases to our provision for inventory obsolescence, a write-off of our intangible assets and an excess tax benefit from stock-based awards. The net of these non-cash adjustments resulted in an increase of our net cash provided by operating activities of $1.0 million.

Net cash provided by operating activities in the three months ended September 30, 2012 of $23.7 million consisted primarily of net income of $13.2 million and by net increases in operating assets and liabilities of $9.0 million. These changes consisted primarily of a $14.3 million decrease in accounts receivable due to decreased revenues, a $6.4 million decrease in accounts payable and accrued liabilities due to decreased overall business activity, a $2.3 million increase in taxes payable due to the


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timing of federal tax payments and a $1.3 million increase in prepaid expenses and other current assets due primarily to increased deposits with our vendors. Additionally, our net income included non-cash adjustments due to stock-based compensation, depreciation and amortization, adjustments to our provisions for doubtful accounts and inventory obsolescence and an excess tax benefit from stock-based awards. The net of these non-cash adjustments resulted in an increase of our net cash provided by operating activities of $1.5 million. Cash Flows from Investing Activities
Our investing activities consist solely of capital expenditures and purchases of intangible assets. Capital expenditures for the three months ended September 30, 2013 and 2012 were $402,000 and $1.6 million, respectively. Additionally, we had cash outflows related to the purchase of intangible assets of $58,000 and $748,000 during the three months ended September 30, 2013 and 2012, respectively.
Cash Flows from Financing Activities
On August 7, 2012, we entered into a Loan and Security Agreement (the "Loan Agreement") with U.S. Bank, as syndication agent, and East West Bank, as administrative agent for the lenders party to the Loan Agreement. The Loan Agreement replaced the EWB Loan Agreement discussed below. The Loan Agreement provides for (i) a $50.0 million revolving credit facility, with a $5.0 million sublimit for the issuance of letters of credit and a $5.0 million sublimit for the making of swingline loan advances (the "Revolving Credit Facility"), and
(ii) a $50.0 million term loan facility (the "Term Loan Facility"). We may request borrowings under the Revolving Credit Facility until August 7, 2015. The Loan Agreement replaced a previous agreement whereby we had an existing term loan balance of $29.2 million as of the date of the new Loan Agreement. On August 7, 2012, we borrowed $20.8 million of term loans under the Term Loan . . .

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