Hi all,
Well, well, yesterday I was happy because SWIR reported great earnings and the market gave it a pop. Today, it was the opposite with Ubiquiti reporting a slow quarter and providing a muted guidance for Q2 2015. Since UBNT is one of my top 5 positions, I follow is closely as well, so I did my DD, going through the earnings release, prepared commentary,and the call.
While the earnings were not stupendous, I was quite pleased with how Pera handled the call and how he set expectation for the long haul. Pera is certainly fanatical about growing Uniquiti and he’s not interested in the quarterly gyrations, that he made very clear in the call. While the numbers look bad, there were a number of solid and positive takeaways for me. I have summarised them below.
If the After Hours action holds during regular trading, the stock will be trading at 14x trailing earnings and 2x trailing sales. Pera is looking to hit $1 Billion in sales over the next few years, so if he executes this stock price would look cheap. Unfortunately, my position is already large, so I really shouldn’t increase my exposure but I 'm tempted … this is one of those times where being somewhat less aggressive in building the position would have possibly been a net positive.
The notes are below. As always, please read my notes with caution. I might be an overly optimistic guy!
Anirban
Press release: http://files.shareholder.com/downloads/AMDA-JI74R/2916681593…
Management commentary: http://files.shareholder.com/downloads/AMDA-JI74R/2916681593…
Webcast: http://www.media-server.com/m/p/uj9igemi
Financial Summary for Q1 2015
- Q1 15 revenue was $150.1M, up 16% YoY, but down sequentially from $156M in Q4 14. Also note that Q4 14 revenue was up 54% YoY, so this may suggest some (temporary?) slow down in growth rates.
- GAAP operating profit of $43.6M, which is also down sequentially from $52.8M in Q4 14.
- GAAP net income of $37.7M, which is also down sequentially from $49.4 million booked in Q4 1.
- GAAP diluted EPS of $0.42, versus $0.55 in Q4 14 and $0.45 in Q1 14.
- Non-GAAP diluted EPS of $0.48 versus $0.56 in Q4 14 and $0.46 in Q1 14.
Product Mix & Sales by Regions
The prepared commentary noted that Enterprise Products category experienced strong growth but they experienced lower than expected demand from Service Provider customers outside North America. I am guessing the turmoil in Russia and Ukraine had some impact this quarter. They also noted strong demand in their UniFi technology platform. Note that they launched a bunch of products in Q4 14 (UniFi Video, UniFi VoIP, extended the UniFi platform into a Software Defined Networking platform etc), so presumably these investments are working out.
The other key thing noted was the new distribution agreements with ECS and Redington in China and India, respectively. This should be good for them in the long haul. The revenue mix by geography told an interesting tale, at least IMO. I redid their table to show the percentage of revenue by geography:
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Region Q1 15 Q4 14 Q1 14
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North America 35.7% 27.8% 28.8%
South America 20.7% 22.9% 16.0%
EMEA 33.7% 36.8% 40.8%
Asian Pacific 9.9% 12.5% 14.3%
Total Rev $150.1M $156M $129.7M
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Some things to note from the revenue mix table:
- North America has gained strength while EMEA & Asia Pacific have lost some steam. This may be is a indicative (to some extent) that the revenue slowdown is temporary. With the North American economy recovering well, they have been able to grow strongly in North America. With troubles in Eastern Europe and Middle East, they experienced a slowdown. So, this must not have much to do with competition but more to do with geo-political conditions.
- Given these trends, I would think the distributions agreements with Chinese and Indian partners should do them well in the quarters to come.
Margins
Non-GAAP gross margin was 44.4%, and GAAP gross margin was 40.7%. Non-GAAP and GAAP gross margins for Q1 14 were 44.9% and 44.7%, respectively. Management believes margins will range between 42.5% and 44.5%, depending on product mix. These margins are solid.
Research & Development
They upped R&D spending a fair bit. R&D went up to $11.7M in Q1 15 versus $6.3M in Q1 14, so roughly doubled. It’s up about 17% sequentially as well. Of course, the increased spending has an impact on the current quarters net income but ideally we want UBNT to spend on R&D to have the best products in the game so that its customers and users continue to rave about their products, which in turn will allow them to use this disruptive no sales force business model.
Most of the spending here is on R&D engineers (62% versus 28% in operations). UBNT finished the quarter with 400 FT employees, up from 312 in Q4 14. That’s pretty aggressive hiring. A majority of the hiring this quarter were in the operational side related to the new China prototyping facility. This is what I had noted in my notes about this facility from Q4 14 earnings release:
Additionally, they have leased a manufacturing space, where they intend to start prototyping to bring new products quickly into the market. Eventually, they may turn this into a full fledged manufacturing operation. The manufacturing space is in China. They noted that this investment will eat into margins a bit in the short-term but should be great in the long-term.
Here’s another cool aspect. R&D went up nearly 100% comparing Q 15 with Q 1 14, but Sales, General, & Administrative costs were flat (actually a bit down in Q 1 15 versus Q1 14). SG&A was just 3.5% of revenue this quarter.
Overall, it appears management made some strong commitment to the future by spending on R&D, getting new facilities up and running, and it just so happened that the timing of these investments coincided with geo-political problems in some of their core markets.
Balance Sheet
Balance sheet is strong. Cash & equivalents of $391M versus $347.1M in Q4 14. Majority of cash held by foreign subsidiaries. UBNT has long-term debt of about $72M.
Inventory balance at the end of the quarter was $38.7 million, down from $46.3 million in the prior quarter.
Guidance for Q2 2015
This probably came in light.
Revenue between $147 and $153M. At mid-point this is about 8.3% YoY growth.
Non-GAAP EPS between $0.46 and $0.49 cents. At mid-point this is flat YoY.
Management notes geopolitical developments as the reason for the muted guidance. The muted guidance along with the Q 1 15 miss on the company’s own guidance probably contributed to the After Hours thrashing.
Summary from the Earnings Question & Answer Session
As expected it was a pretty hard conference call. I summarised a few high-level points from the call.
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I liked how Pera took centre stage and essentially answered all but the last question from the analysts. He made it clear that he will be dealing with the questions because of their guidance miss and that he wanted to reset analyst expectation. I sensed some disdain from Pera on how analysts ask about stuff that can help them project for the next two to three quarters. Instead, Pera’s take was the following:
(i) First, Ubiquiti is playing in the emerging markets area, an area where there’s immense potential for Internet growth because of the low connectivity today. However, that comes with the price of having to deal with various dynamics (politics, culture, unrest, currency exchange rates, holidays, different approaches to upgrade cycles etc), so one has to be prepared and accept that there are going to be ebbs and flows.
(ii) Second, he really seemed to suggest that doing quarter over quarter comparisons is meaningless for the Ubiquiti business. He suggests looking at rolling 3-year windows. He said that revenues has tripled over the past 3-years and he has similar expectations over the next 3-years.
(iii) Third, he seemed to try to drive home the point that they don’t have a very good view into the channel sell throughs and this is something they really are not trying to understand. He seemed to be fanatically focussed on his evangelical, fan-based, model where sales happen because people love their product and that their product provides the best performance at a low cost.
(iii) Forth, Pera said that he’s not interested in financially engineering the results, for instance, by pushing sales though to the channels etc. He’s in it for the long haul and he’s thinking of investments today that will help them get to the $1B in revenues in the next few years. I like this. He’s invested heavily in R&D and in a prototyping factory in China to get rapid prototypes, which should help him get new products more quickly and potentially at some savings to the market. -
Over the long-term, Pera believes enterprise & service provider should be equally split from a revenue standpoint, and enterprise is growing nicely and also less susceptible to ebbs and flows that the service provider business experiences.
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There were some questions about competition (CISCO was mentioned, Cambria, and Ruckus) eating into their lunch. Pera’s view was that it’s difficult for traditional players to beat them without being innovative. Why? Because its just hard for these competitors to create a similar product at their price point. Now, if they want to get into this space they can but a side project will not cut it. So either they need to hugely innovate on the product side (very difficult because these techs have been around for a while so its a lot of R&D and these guys spend a lot on R&D) or innovative on the business model (again difficult for traditional businesses with big sales forces).
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There was a question about upgrade cycles which was interesting. Pera noted that when first generation AirMax products came out they offered very big (2x to 5x) performance improvements. So uptake was naturally strong. The gap in improvements has narrowed. New generation AirMax products have about a 50% performance improvement. So top tier operators (say the top 40% or so) likely to upgrade to AirMax AC, while the lower market will be a slower move because the current tech fulfils their needs. So growth will come from upgrade cycles and also needs new customers.
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Distribution deals in China & India got some focus. Pera said that he thinks these agreements will have a material impact later this year. He also thinks the opportunity here is big, but there are challenges so they are going slow and steady addressing the challenges, namely: more political barriers to entry, and need to create a brand awareness & a local community to drive sales “evangelise the brand” is the term he likes to use.
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There was a question about training distribution partners on new generation products, I believe it was UniFi video and UniFi VoIP training. This one Pera bungled completely. First, he seemed to not get the question. Then, he seemed to say that they are working on it. Then, when the analyst said that Pera’s response makes him believe that the sales folks have not been trained Pera seemed to say “yes” and then say that they are going to get this done soon. Hearing the call, it appeared that Pera finds some of these detailed questions to be a nuisance. Not a great approach to handling analysts IMO.
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Buybacks. One analyst said that since the stock is now going to be down big time (ahem!) is he looking to do buybacks and can they do it given their cash is tied up in foreign jurisdictions. Pera said that he hasn’t looked into the stock but may be he will check it next week and if it seems down they may buy some back.
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There was a question about not pre-announcing the earnings given that it was a miss. Pera said that their business model is disruptive but it also implies that they don’t have the kind of visibility into sales that “traditional” sales heavy companies have. So, they wanted to collect as much information as possible from channel partners and try to understand the sales patterns before the coming to the call and provide guidance for the next quarter. IMO, if Pera really wants the analysts to focus on the long-term may be he should give some wide ranged annual guidance and be done with it. After all, how much worse can the stock get. Further, since he’s the majority owner and he seems to care little for the stock price and more about the long term sales objectives, it would make sense to break the mould and just give wide-ranged annual guidance.
Notes on Valuation and Concluding Thoughts
Based on Q1 2015, we have the following TTM numbers (dollar figures in Millions, except for per share data):
Revenue = $150.1 (Q1 15) + $156 (Q4 14) + $148.3 (Q3 14) + $138.4 (Q2 14) = $592.8M
EPS (Non-GAAP) = $0.48 + $0.56 + $0.50 + $0.47 = $2.01
Sales diluted (expected as of Q2 15) = 90M
Stock price as of 11/6/14 (After Hours session close): $28.99
PE (TTM) = 14.4
PS (TTM) = 2.2
Alright, so after the AH trashing UBNT has become cheap. Good cheap? Well, that depends on whether you believe in its ability to execute and grab market share from competitors. I ‘m willing to give them some leeway here. I saw increased spending on R&D, some distribution agreements in China & India (potentially big markets),and geo-political conditions in some of its major markets. China & India will likely start contributing meaningfully in the near future. Some of the geo-political problems should get resolved and Ubiquiti will likely get back to more normal sales levels in EMEA region. Management is spending on R&D, which is great, while keeping SG&A under check. That too is great. Yes, they had a bad quarter and guided for zero growth but this looks like a temporary problem, one that should be resolved. I take heart in the increased sales in North America. This to me demonstrates that their technology is not the problem, at least if one goes by the sales growth in North America.
Overall, UBNT is a company with a great purpose - that of connecting those who not get connected via wired networking infrastructure. I like businesses that are purpose driven because purpose brings in focus. The purpose, combined with the highly scalable “community” driven viral sales + support allows Ubiquiti to not spend a fortune on sales & marketing. The community has a strong network effect to it — today’s happy customers talk about the goods and bring in more customers and more people to support the community, and as the community grows Ubiquiti taps into their needs and demands to deliver the next generation of improved products. Once such network effects take hold, its very very difficult to disrupt the model from the outside. I also like the fact that Pera has his own wealth tied to the success of Ubiquiti.
I still like Ubiquit and will be sitting tight on the shares. I may add some if there’s further pressure on the shares. This is one of my bigger positions (top 3), so I ‘m feeling the pain of the AH slide but I ‘m not disheartened and I will look to ride this through. Had I not got a big position, I would have added some for sure.