Craig L. Foster - Chief Financial Officer, Principal Accounting Officer and Director Robert J. Pera - Founder, Chairman and Chief Executive Officer.

Kip Clifton - Deutsche Bank AG, Research Division Matthew S. Robison - Wunderlich Securities Inc., Research Division Erik Suppiger - JMP Securities LLC, Research Division Kiera Kilkowski - BofA Merrill Lynch, Research Division Timothy Long - BMO Capital Markets U.S. Tavis C.

McCourt - Raymond James & Associates, Inc., Research Division Sanjit Singh - Wedbush Securities Inc., Research Division Brent A. Bracelin - Pacific Crest Securities, Inc., Research Division Ameet Prabhu - RBC Capital Markets, LLC, Research Division.

Good day, ladies and gentlemen, and welcome to the Ubiquiti Networks First Quarter 2014 Q&A Conference Call. [Operator Instructions] I would now like to introduce your host for today's conference, Jason [ph] [indiscernible]. Please proceed..

Thank you, Charlotte. I'm here with Robert Pera, Founder, CEO and Chairman of the Board at Ubiquiti Networks; and Craig Foster, CFO. Before we get started, I'd like to review the Safe Harbor statement.

During the call, we will be making forward-looking statements, including, but not limited to come our strategy and estimates and projections of revenue and EPS. There is no assurance that we will achieve these projected results. Please refer to the risk factors discussed in our SEC filings and in the press release we issued today.

We do not undertake to update in light of new information or future events. In addition, references will be made to non-GAAP financial measures. Information regarding the reconciliation of non-GAAP and GAAP measures can be found in the press release that was issued this afternoon, and can be found in the IR section of our website at ubnt.com.

We hope you've had time to review management's prepared remarks, which are posted as a text transcript in the IR section of our website. Today's call will be Q&A only. [Operator Instructions] Charlotte, we'd now like to open the line up for questions..

[Operator Instructions] Our first question comes from the line of Kip Clifton from Deutsche Bank..

I just wanted to -- you guys talked about strong demand for UniFi across all geographies, and I wanted to -- I just kind of wondered what the makeup right now of AC versus N was in that unit volume?.

Well, we don't break out the N versus AC. But I will tell you this, that for the quarter, we had a tremendous uptick in demand for the AC products. And I think we're actually well ahead of what our expectations were on the adoption of AC in the market..

Okay.

How do you think that adoption curve adapts as you migrate the airMAX platform over to AC?.

Well, I think AC, as a Wi-Fi standard for UniFi is different than airMAX ac. So we will be using 11ac silicon in our airMAX solutions, but it's still our airMAX protocol. It's going to provide performance benefits. It's going to be, I'd say, 30% faster. And I think next year, you'll start seeing, on the airMAX side, airMAX ac growing quite quickly..

So is ac still on track for 6 months, say, launch?.

It'll -- yes. It'll be sometime next year. That's -- probably -- I feel most comfortable saying that..

Sometime next year? Okay. And then just another question on the Ubiquiti World Network. The sense that -- it seems like you've got a pretty positive reaction just on the forums.

Are things still on track for a January launch?.

Yes. I think we're on target for that. I think the response, as you've said, has been really strong. We've had over 1,300 WISPs based here in the U.S. already signed up for the program. So I think that we're actually ahead of schedule in terms of what the adoption rate for people wanting to be part of this..

And all of those 1,300 will be included in the program, or is it just you'll pick kind of target markets and go after it like that?.

No. It's kind of a -- it's for the entire group..

Okay.

And then the overall spend on the Ubiquiti World Network in the upcoming year will be around what number?.

Our estimates probably for the next 9 months is about $3 million U.S..

Okay. And then just going on to the distributor base.

Can you give us a sense of the numbers -- number of distributors added in the quarter and the total?.

We continue to do kind of adding and subtracting on guys who are productive and who aren't. But the number's not significant in terms of guys that we added. So I'd say, less than 10 at the big distributor level..

Yes.

And then that total number is now what?.

Well, we kind -- we have a little bit of a tiered component to this, right? So in total, it's 250-ish..

Our next question comes from the line of Matt Robison from Wunderlich Securities..

So let's talk a little bit about the mix. I mean, it's phenomenal for the enterprise and new platforms in general, as previously stated.

Can we talk -- what do you think went on with airMAX and the sequential comparison there? And also South America? And then the other question I have -- I've got some housekeeping questions related to cash flow, CapEx headcount, depreciation, that kind of thing.

But also, I wanted -- I'm curious if you could comment on how you're going to prepare -- how your distributors -- how you might get the distributors to prepare for the growth that could happen from the Ubiquiti World Network campaign?.

That's a pretty complex multi-part question, but I'll start out..

Well, I can ask them so -- after you answer each one, if you want.

So the first question was, why [ph] was airMAX down sequentially and South America flat?.

Yes. So let's start with the airMAX. airMAX, it does look like it's down sequentially, but actually, our backlog is really, really strong. So really, it's more of a timing of shipments than it is something happening in the market at a macro level.

And then when we go to South America, I think -- what you can think -- what you can see from us is that we are being very judicious about how we're allocating product out into the field. And so I think this is one of the first quarters where you can actually see, this is where we're being -- we're controlling where we think product needs to be.

And that's what's happening with South America..

Is that the function of the kind of the seasonality they have down below the equator, or just -- what your take is on the channel conditions there?.

Well, I think the channel is very, very [indiscernible]. I mean, they still are up 4% quarter-over-quarter. So I think, for a normal company, that's like a home run. But I think that we have a certain number of products that we can get out into the channel, and I think that we felt that they were better served being in other parts of the world..

Okay. Then what is your thought process for staging for the ad campaign? I mean, is it -- the airMAX being down actually doesn't surprise me that much. I mean, I forecasted more, but the tone I was getting for the checks was, that WISPs weren't able to get enough product. And so it looks like the distributors didn't really take enough.

And it's not exactly what I'm hearing from you, but it seems a little bit that way.

And so that leads to the question, how you're going to deal with the campaign?.

We don't have [indiscernible].

What's that?.

So I think, first off, we have a lot of product in transit right now into the channel, and we have a very strong backlog, as I said before.

As it relates to preparing for what we think will be a vast increase in sales in those product categories, is we've done a lot of work on the operation side to increase manufacturing capacity and distribution capacity across-the-board.

So from where we are today, from where we were a year ago, we've more than doubled the warehouse capacity that we have available, and that means -- that translates directly into how many shipments and the size of shipments that we can do. And we've vastly increased the manufacturing capacity with our contract manufacturers..

Okay. So it's basically looking at the shipping lead time essentially.

You're still talking about warehouses in Asia, right?.

Yes, correct..

Can you give us the cash flow from operation depreciation CapEx and headcount?.

So CapEx is $402,000, depreciation is $555,000, and headcount is 199 and the -- of that, 124 are R&D..

And the cash flow from operations?.

Well, I'm going to pull it up for you.

So I'll get back to you, okay?.

[Operator Instructions] Our next question comes from the line of Erik Suppiger from JPM (sic) [JMP] Securities..

First off, I just wanted to make sure I understand, in terms of what you were saying about managing the inventory in South America, it sounds like you were managing down inventory.

Why would that be the case? I could understand if you're, what, airMAX was growing sequentially, but why was it that you manage it down so that the revenue would come down? I guess, I'm just trying to understand how that works..

Well, it's just we had -- so again, it's more about timing of shipping. I think you need to kind of take these 2 things apart, right? So the timing of shipments, we have a big backlog walking into -- after September 30. And we have somewhat of a capacity on how much we can ship and where we can go.

So we chose, over the period of the quarter, that we were going to delay some of the shipments into South America, and they actually shipped in September. So it's just a couple of days here, a couple of days there.

And in -- with respect to allocation of where we're sending stuff into the channel, part of our diligence is to make sure that the channel has the right amount of inventory in the different regions. And I think that this quarter is one where you can see us actually being very detail-oriented in that matter..

Okay, very good. So on the wireless LAN front, that's become a pretty significant portion of your revenue in a fairly short period. Can you give us a flavor for how much of your new products is now represented by UniFi? And secondly, you talked about targeting #1 market share in unit volumes by the end of next year.

Do you have a sense for whether this might position you as the #2 player by volume? If I'm doing my math correctly, it looks like it could have tripled.

Any thoughts in terms of where this might position you?.

Yes. I mean, we look at the -- based on our discussions with Gartner. I think that we will probably be, when the report comes out, #2 in the market. And quarter-over-quarter, I think we're looking at probably a 10% gain in market share. So I think we've made a tremendous amount of progress towards our aspirations of being #1..

Am I correct that the service provider new product revenue does not include any Wireless LAN, and so it's just the enterprise Wireless LAN? Or how do you account for any of the Wireless LAN product that service providers buy and deploy?.

So you're talking about UniFi?.

Yes, UniFi..

So UniFi is in the enterprise bucket in its entirety. Now there will be service providers that will buy it, but we think it's better represented and generally the use case is for the enterprise..

Okay. And then lastly, just on the competitive front on that Wireless LAN -- or on the UniFi. Is there a particular vendor or any particular segment where you think -- I mean, this ought to be a tremendous quarter.

Where are you seeing that strength? And who do think you're taking some share from?.

Well, I think we're taking some market share, but most of the revenue is coming from industry or a market we're creating, right? So what Ubiquiti does is we make powerful networking solutions affordable to the masses. So what you're seeing with UniFi is -- I like to use the analogy of hotels.

So the 5-star hotels can afford Cisco and Aruba and expensive solutions, but for every 5-star, there's thousands of 4-, 3-, 2-star hotels that need -- still need a high-level information technology infrastructure. And Ubiquiti has been able to provide a high-level information technology at very disruptive pricing.

So you're seeing the results of that in the numbers. On a global basis, right? We're making pretty good strides..

Our next question comes from the line of Kiera Kilkowski from Bank of America Merrill Lynch..

I just have a few quick questions for you. First, following on -- you were just talking about [indiscernible] LAN strategy.

Can you tell us maybe some verticals that you've been sort of gaining share in with the UniFi product? Second, if you could provide us an update on what's going on with AirVision? There was comment prior to this call that this would be a big year this year and next year for that, and I was just curious if you could give us an update on that..

Sure. Okay, so for UniFi, I think the biggest applications are education, hospitality and then small and medium businesses. For AirVision, we -- I think the concept of AirVision is dead on.

So what we're trying to accomplish is a cohesive and powerful, hardware/software integrated, IP video security solution using the same kind of Ubiquiti elements, which is a very powerful solution at disruptive economics. And AirVision started out of the gate when we launched it 2 years ago with great traction.

But we made some mistakes on the -- in the design architecture, the decisions. Largely my mistakes, and we've corrected them. And we're on AirVision 2, which is the second generation of the software, and it's getting traction again. And we will be releasing even a newer revision of software and new hardware in the coming years.

So I think my hopes is you'll see a similar trajectory in our IP video security solution growth as you've seen with AirVision -- with UniFi in the past couple of years..

Our next question comes from the line of Tim Long from BMO Capital Markets..

Two questions here. First, on airMAX, a lot of new products announced at the trade show a few weeks ago.

Maybe if you could just give us a sense as to kind of what the feedback, initial feedback has been to you from customers in the channel? And do you think there's any risk that customers might wait for some of the new products so we would see a pause before that? And then secondly, Craig, I'd love to get your sense on kind of the view on margins.

Obviously, a huge operating margins this quarter and gross margins. Do we see more leverage in that gross margin line? And obviously, the guidance for December implies a lower operating margin.

So do we think this is kind of a good steady-state rate, mid-30s for that operating margin?.

Your first question is whether our customers will hold off after previewing the new products we're coming out with in the coming months. I think we've already -- we've always been very transparent with our customers. And we try to give them a heads up on what's coming out just so they can plan their networks.

The products we announced, the new NanoBeam CPE, specifically, and the airFiber5 backhaul. Yes, there could be some providers who will wait on those products. But we've done things the same way all along ever since -- for the past several years. So I don't think it would affect our growth in these coming quarters..

And then just Robert, do you have a sense from folks how excited they are about those products? Do you think they'll represent a good upgrade for customers?.

I think so. Recently, we've kind of hit a hot streak on designs. So I think our engineering team and our product definition is getting stronger and stronger. So I anticipate both those products will be big hits..

Okay, great.

And then the margin?.

Yes, so gross margin line, I think we're kind of getting the -- getting towards the upper end. We're always looking for that extra $1 or $2 on the bomb. But we don't have a ton of room to move around on the margins. So I think we're kind of steady state we're probably where we're at today.

On the operating margin side, like SG&A, we talked about there's going to be some slight incremental spend on our Ubiquiti World Network project. And we're always looking to invest in R&D.

So we've added -- last quarter, we added a number of people to our R&D headcount and we've got a number of new people that we'll be adding as well that kind of fit into the Ubiquiti model. And so I think steady-state, you'll see as a percentage -- you'll kind of see things will be pretty close to where they are today.

So kind of in the 30% net income margin range..

Our next question comes from the line of Tavis McCourt from Raymond James..

Two questions. One, I guess, qualitatively, could you talk about the supply demand-balance now? Obviously, this is kind of yet another quarter you've had trouble kind of shipping to full demand.

Is it the December quarter, we can expect to finally catch up, or March? Or is it just kind of a moving target that's tough to get to? And then secondly, kind of a bigger-picture question, Robert, like, UniFi has been out a couple of years.

Why now? Why this quarter? Why are we all of a sudden seeing it? Although it had some nice growth off of very small numbers, all of a sudden it's just very meaningful.

And so what are your thoughts on that? Is it some marketing campaigns you've done with your distributors? Is it just working out some new software patches? Just kind of anything to explain how this has gone from single-digit millions to $35 million relatively quickly here even though it was launched a couple of years ago?.

So that's a very good question. And our company and our business model is very unique. We don't use a sales team or a marketing team. Up until this World Network initiative, we didn't really invest in any kind of marketing. And so we generate demand by just kind of disrupting markets with hit-after-hit product.

And when you generate or -- a hit-after-hit product, it creates evangelism. And it's hard to predict the trajectory of that evangelism. Sometimes, it's a steady growth. Sometimes, it just rockets. And I think with UniFi, we're at a point where the need for these wide-area Wi-Fi systems is at maybe an all-time high.

And the awareness of UniFi as the best solution -- I wouldn't even say that best value solution. I think it's the best performance solution. And it just happens to disrupt the economics. I think the awareness and the demand for that application, just in the past several months, it's just really kind of skyrocketed.

So I think that's where the numbers come from..

And then, Tavis, on the supply chain -- sorry, the supply-demand balance. Like I said before, we're spending a lot of money to get more supply to be able to build more. And our expectations is that will be closer to where it needs to be by the end of December.

But again, there's -- when you have -- they're high-class problems because we've had like unprecedented demand across pretty much all of our product lines. So we've continued to play a little bit of catch-up..

Got you. And a follow-up for you, Robert, on the new product categories. The -- at the WISPAPALOOZA Conference, the crowd was kind of especially, I think, impressed with the new airFiber backhaul and price points there.

Is there a way to quantify kind of the percentage of your WISP base that may have been relevant for the current version of airFiber, which -- versus kind of the relevant market of that WISP base that's relevant for the microwave version?.

Right. So we have 2 versions of airFiber. We have airFiber, a 24 gigahertz version, and we have the upcoming 5 gigahertz version. The 24 gigahertz version, the limiting factor is the range. So because it operates at such high-frequency, the free-space path loss is pretty severe, and things like rain or snow could further affect the link.

So it's effective probably within a 5-mile range, or maximum, maybe a 10-mile range. But in these WISP networks, the -- I'd say, the majority of the backhaul links are much greater than 5 or 10 miles. So I think airFiber5, the volumes will be significantly higher than airFiber 24.

And I think moving forward, what you'll see is airFiber5 will be used in backhaul service provider applications. And I think airFiber 24 also has room to grow, but it's going to become very popular in things like building-to-building applications and short links.

And they both have their benefit, right? It's -- 24 gigahertz, it's -- there's not a lot of devices there, the signals, the propagations die out quickly. So to get a high-performance gigabit, plus full duplex link in that band, airFiber 24 is very, very attractive. And I think it will just take time and awareness.

And not a lot of people know that solution exists. So as Ubiquiti, in general, as the name brand grows and gets more awareness, I think it will help all our products, including airFiber and airFiber 24..

Our next question comes from the line of Sanjit Singh from Wedbush..

Two questions for you. One, given the WISPAPALOOZA event in Las Vegas, have you been hearing any kind of anecdotes about some of your WISPs service providers taking share from either traditional cable operators, or Verizon, AT&T in kind of developed high-density markets in maybe big cities.

Typically, we hear about them in -- the share gain story in rural markets, but are you seeing any momentum in some of the more-developed parts of North America?.

Well, I'd like to compare airMAX and the wireless ISP industry. I like to draw an analogy to DirecTV. So DirecTV is a broadcast TV solution in areas that do not have any alternative. And it's also used as a superior option in areas with alternatives. That's why you see DirecTV dishes even in urban cities.

And the same is true with airMAX and some of our wireless ISPs. The problem is awareness. No one knows about these solutions or these services. So we use airMAX link in our Silicon Valley office, and it's the best thing out there in terms of performance and latency and economics. And we know about it.

Now the question is, if everyone and all the companies in Silicon Valley knew about the wireless ISPs industry and the solutions, how much could you grow in these urban and developing markets? And I think the answer is a lot.

So that's the whole motivation behind this World Network Initiative, is to build awareness for all these service providers in airMAX technology..

Great. And then my follow-up question is back on UniFi.

On -- so given those broad-based growth across most of these geographies, how are you hearing about these deals? Are these kind of customer inbound requests at the website, or are your channel partners and distributors a helping source of these deals?.

Okay. So I would say, this is probably the most difficult thing -- or the most misunderstood area or aspect of Ubiquiti's business model. We are not project-based. We don't necessarily know where this stuff is going, and that's a great thing.

If we were a traditional company with a sales force bidding on different deals, what you have is a model that can't scale. You -- as your revenue scales, you need more and more infrastructure to support more projects and you have a problem with transparency.

You've got so many people and middleman and things touching in between the technology and the customer that it becomes incredibly inefficient.

So what we do is we build these disruptive technology platforms very efficiently and we transfer them to the customers or operators and system integrators very efficiently, and this translates into immense value. And we don't know where these tens of thousands of operators are going and what projects they're doing.

We just concentrate on R&D and keep making more and more of these disruptive-type technology solutions in different adjacent markets. And that's how I believe we grow.

And people have been telling me when we were at $50 million of revenue, "Oh, you can't scale doing this." You get to $100 million, "No, you can't scale." We're at $500 million, "No, you can't scale." But it is very scalable. It's counter-intuitive. And as our revenues scale, you'll see more and more drop to the bottom line.

And I think it's going to be interesting over the next quarter, next several quarters and next several years. I keep telling you guys this over and over again. We've haven't gotten credit for it. So it's going to be very interesting over the next few years to prove it out..

Our next question comes from the line of Brent Bracelin from Pacific Crest..

Obviously, I have a couple of follow-up questions here for you on the enterprise side. You did more revenue in one quarter than you did in all of last year. So my question really is regards to the sustainability of that. As you look at the enterprise business this quarter, obviously, I assume the bulk of that is UniFi-driven.

Is it large deals, is it seasonal? Obviously, if you look at Wireless LAN, education typically is a very strong vertical in September.

Do you think there's some element of seasonality here? Help us understand, as you look at the momentum you had in this current quarter, how sustainable is that?.

Well, I think we're in the midst or in the very early cycles of a technology refresh in this area with the AC product. And so we didn't have a product in the market 2 years ago, period. And now we've gone through the full-generation cycle of N, and now we're starting to see the uptick of AC.

And I think everyone predicted that AC would be kind of a coming phenomenon in the next 18 months, 24 months, et cetera. And we've seen a vast acceleration of that in the market very, very quickly. And I think part of -- I'd say, the majority of it is driven to our differentiated price and performance.

In terms of seasonality and projects, I mean, we're kind of seeing this -- it's not just a U.S. phenomenon. It's not -- it's a global phenomenon. So we're seeing it pretty well-dispersed, especially here in the U.S., especially in Western Europe, where the infrastructure buildouts are already pretty solid.

And I don't -- we don't attribute anything to like a seasonality kick in a specific vertical. But I will say that we -- this is really the first quarter where there has been a significant amount of sell-in and sell-through for us. So there is a little bit of stocking of the shelves for this quarter..

Perfect.

And then if you look at the 35 -- the $35.5 million in the quarter, what percentage of that ballpark would be driven by 802.11ac? Is it half of the mix now? Is it more than half the mix?.

It's less than half..

Less than half. Okay. And then, I guess, if I were to compare the ramp -- I know, Robert, you've talked about using airMAX and the ramp in airMAX 3, 4 years ago as a kind of a proxy. It took a couple of years for airMAX to really take off.

It went from, I think, $37 million in 1 quarter -- or 1 year to more than doubled in 1 -- to over $100 million the next year. And then over $200 million the next year, a lot of that growth was driven by taking it internationally.

What's your sense on UniFi? If you compare the ramp that you saw in airMAX in 2010 to compare to UniFi and what you're seeing now, is UniFi on that same type of trajectory, or is it just a completely different product and this is not a fair proxy?.

Well, we're looking pretty prophetic right now, right? If you compare it to the first few years of airMAX, it should be pretty close. So my expectation is it will bigger than airMAX. UniFi will be bigger than airMAX. Give it a few years..

A few years, okay. And obviously, a different product, different market, but it is following a similar type of trajectory. And then, my last question here is really appetite for M&A. Obviously, you guys are an R&D-driven company. You guys now are generating a ton of cash, $280 million on the balance sheet right now.

Is there interest, do you have an appetite to looking at acquiring small technology companies out there that potentially could accelerate your penetration into new markets, essentially buying engineering teams, or is that not in the plan at this point?.

So here's the challenge. You have less than 200 employees, whatever, 70% are -- close to 70% are engineers, what, north of half a billion revenue run rate, 30-point net income, whatever we're doing.

How are you going to acquire a company that has twice as many people as you and 1/10 of revenue and maybe not making any money? So what I'm saying is it's almost impossible for us. I don't see us making a typical acquisition.

The way we've grown our engineering and R&D teams has always been through actual [ph] hires, and we're going to continue to do that. So -- and I think we can grow still very quickly organically. There might be some opportunities for acquisitions overseas, but they would not be traditional acquisitions. They'd be more out-of-the-box type of things..

Our next question comes from the line of Mark Sue from RBC Capital Markets..

This is Ameet Prabhu, calling on behalf of Mark Sue. You talked about your focus on growth and some extensive [ph] growth target. Could you maybe rank order of products, regions, sort of where you expect the most growth, service provider segment versus the enterprise, and even the regions, even by a broad level, that'll be very helpful..

Maybe I could just send you the board book. That would help. Look, I think that -- I'm just kidding. I think that the biggest growth regions for us -- I mean, we're very underpenetrated in areas in the APAC region. And we've got a number of projects underway to help penetrate and help localize the way that we sell in those markets.

And we think that there's a lot of upside in markets -- we've done very, very little in India, we've done very, very little in China, we're just starting to see a ramp-up in Russia, and so we're very optimistic about that. And now, in all of these countries, they have both problems.

They have, one, they can't solve the last mile, and that's where we come in. They have very -- they have regional challenges from CapEx to just efficiency of their own internal markets. And then once they get this efficiency they're having difficulty propagating it throughout a building, throughout a campus, throughout a corporation.

So I think that's our -- that's going to be a star for us in the near- to long-term. And then our other markets continue to grow at a very steady pace..

Okay. And so UniFi and airMAX have drove most of the growth in the quarter, so in most regions except EMEA, where you sort of saw a strong demand for airFiber.

Can you maybe talk about what drove airFiber demands specifically in that region?.

Yes. I mean, we're looking at the numbers. There's -- I think what's happening in EMEA is that our pickup of airFiber is -- they're finding a lot of what we consider non-traditional uses for it, so we're seeing a lot of building-to-building or campus-to-campus communication instead of the traditional -- hey -- the backhaul connection links.

So people are setting up rings of connectivity and they're using airFiber to -- as the transmission. Okay. I had one more for Matt Robison. You asked for cash flow from operations. It was $51.9 million for the quarter..

And then, at this time, I'm not showing any further questions..

All right. Thank you, Charlotte. Thanks, everybody, for participating..

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program, and you may all disconnect. Everyone, have a great day..