Ubiquiti Networks ®
Ubiquiti Networks, Inc. (Form: 10-Q, Received: 02/08/2013 16:13:43)
Table of Contents

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
 
FORM 10-Q
 
(Mark One)
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended December 31, 2012
OR
 
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from              to             
Commission File No. 001-35300
 
UBIQUITI NETWORKS, INC.
(Exact name of registrant as specified in its charter)
   
Delaware
 
32-0097377
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification No.)
2580 Orchard Parkway, San Jose, CA 95131
(Address of principal executive offices, Zip Code)
(408) 942-3085
(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes   x     No   ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes   x     No   ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition of “accelerated filer, large accelerated filer, and smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer
¨
 
Accelerated filer
¨
Non-accelerated filer
x
(Do not check if a smaller reporting company)
Smaller reporting company
¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes [ ] No [x]
As of February 4, 2013 , 86,963,145 shares of Common Stock, par value $0.001, were issued and outstanding.


Table of Contents

UBIQUITI NETWORKS, INC.
INDEX TO
QUARTERLY REPORT ON FORM 10-Q
FOR THE THREE AND SIX MONTHS ENDED DECEMBER 31, 2012
 
 
 
Page
 
PART I – FINANCIAL INFORMATION
 
 
 
 
Item 1.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Item 2.
 
 
 
Item 3.
 
 
 
Item 4.
 
 
 
 
PART II – OTHER INFORMATION
 
 
 
 
Item 1.
 
 
 
Item 1A.
 
 
 
Item 2.
 
 
 
Item 5.
 
 
 
Item 6.
 
 


2

Table of Contents

PART I: FINANCIAL INFORMATION

Item 1.  Financial Statements
UBIQUITI NETWORKS, INC.
Condensed Consolidated Balance Sheets
(In thousands, except share data)
(Unaudited)
 
 
December 31,
2012
 
June 30,
2012
Assets
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
148,301

 
$
122,060

Accounts receivable, net of allowance for doubtful accounts of $2,465 and $1,266, respectively
55,902

 
75,644

Inventories
14,623

 
7,734

Current deferred tax asset
882

 
882

Prepaid expenses and other current assets
2,771

 
1,577

Total current assets
222,479

 
207,897

Property and equipment, net
5,664

 
4,471

Long-term deferred tax asset
232

 
232

Other long–term assets
1,804

 
1,136

Total assets
$
230,179

 
$
213,736

Liabilities and Stockholders’ Equity
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
27,747

 
$
26,450

Customer deposits
1,392

 
235

Deferred revenues
815

 
805

Income taxes payable
5,353

 
946

Debt - short-term
5,009

 
6,968

Other current liabilities
14,931

 
17,031

Total current liabilities
55,247

 
52,435

Long-term taxes payable
7,727

 
7,727

Debt - long-term
73,601

 
22,623

Total liabilities
136,575

 
82,785

Commitments and contingencies (Note 9)

 

Stockholders’ equity:
 
 
 
Preferred stock—$0.001 par value; 50,000,000 shares authorized; none issued

 

Common stock—$0.001 par value; 500,000,000 shares authorized:
 
 
 
86,957,786 and 92,049,978 outstanding at December 31, 2012 and June 30, 2012, respectively
87

 
92

Additional paid–in capital
130,658

 
128,981

Treasury stock—44,238,960 and 39,079,910 shares held in treasury at December 31, 2012 and June 30, 2012, respectively
(123,864
)
 
(69,515
)
Retained earnings
86,723

 
71,393

Total stockholders’ equity
93,604

 
130,951

Total liabilities and stockholders’ equity
$
230,179

 
$
213,736

See notes to condensed consolidated financial statements.

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Table of Contents

UBIQUITI NETWORKS, INC.
Condensed Consolidated Statements of Operations
(In thousands, except per share amounts)
(Unaudited)
 
 
Three Months Ended December 31,
 
Six Months Ended December 31,
 
2012
 
2011
 
2012
 
2011
Revenues
$
74,901

 
$
87,817

 
$
136,436

 
$
166,984

Cost of revenues
44,416

 
50,527

 
80,931

 
96,681

Gross profit
30,485

 
37,290

 
55,505

 
70,303

Operating expenses:
 
 
 
 
 
 
 
Research and development
5,052

 
3,683

 
9,763

 
7,052

Sales, general and administrative
5,314

 
2,431

 
9,848

 
4,575

Total operating expenses
10,366

 
6,114

 
19,611

 
11,627

Income from operations
20,119

 
31,176

 
35,894

 
58,676

Interest expense and other, net
(197
)
 
(312
)
 
(283
)
 
(946
)
Income before provision for income taxes
19,922

 
30,864

 
35,611

 
57,730

Provision for income taxes
2,119

 
6,173

 
4,629

 
11,546

Net income
$
17,803

 
$
24,691

 
$
30,982

 
$
46,184

Preferred stock cumulative dividend and accretion of cost of preferred stock

 
(9,704
)
 

 
(112,431
)
Less allocation of net income to participating preferred stockholders

 
(559
)
 

 

Net income (loss) attributable to common stockholders—basic
$
17,803

 
$
14,428

 
$
30,982

 
$
(66,247
)
Undistributed earnings re-allocated to common stockholders

 
15

 

 

Net income (loss) attributable to common stockholders—diluted
$
17,803

 
$
14,443

 
$
30,982

 
$
(66,247
)
Net income (loss) per share of common stock:
 
 
 
 
 
 
 
Basic
$
0.20

 
$
0.16

 
$
0.35

 
$
(0.88
)
Diluted
$
0.20

 
$
0.16

 
$
0.34

 
$
(0.88
)
Weighted average shares used in computing net income (loss) per share of common stock:
 
 
 
 
 
 
 
Basic
88,094

 
87,487

 
89,532

 
75,102

Diluted
90,056

 
90,056

 
91,493

 
75,102

Cash dividends declared per common share
$
0.18

 
$

 
$
0.18

 
$

See notes to condensed consolidated financial statements.


4

Table of Contents

UBIQUITI NETWORKS, INC.
Condensed Consolidated Statements of Cash Flows
(In thousands)
(Unaudited)  
 
Six Months Ended December 31,
 
2012
 
2011
Cash Flows from Operating Activities:
 
 
 
Net income
$
30,982

 
$
46,184

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Depreciation and amortization
753

 
227

Provision for inventory obsolescence
875

 
505

Excess tax benefit from employee stock-based awards
(61
)
 
(11,421
)
Stock-based compensation
1,549

 
702

Provision for doubtful accounts
1,200

 
564

Changes in operating assets and liabilities:
 
 
 
Accounts receivable
18,542

 
(22,170
)
Inventories
(7,764
)
 
(3,822
)
Deferred cost of revenues

 
(40
)
Prepaid expenses and other assets
(1,621
)
 
998

Accounts payable
1,829

 
697

Taxes payable
4,407

 
9,059

Deferred revenues
10

 
648

Accrued liabilities and other
(176
)
 
(2,161
)
Net cash provided by operating activities
50,525

 
19,970

Cash Flows from Investing Activities:
 
 
 
Purchase of property and equipment and other long-term assets
(3,467
)
 
(1,110
)
Net cash used in investing activities
(3,467
)
 
(1,110
)
Cash Flows from Financing Activities:
 
 
 
Proceeds from term loan, net
50,833

 
34,822

Repayments on term loan balance
(1,833
)
 
(1,750
)
Repurchases of common stock
(54,354
)
 

Payment of special common stock dividend
(15,652
)
 

Repurchase of Series A convertible preferred stock

 
(108,000
)
Issuance of convertible subordinated promissory notes

 
68,000

Payment of convertible subordinated promissory notes

 
(68,000
)
Proceeds from shares issued in initial public offering, net of offering costs

 
32,619

Proceeds from exercise of stock options
161

 
511

Excess tax benefit from employee stock-based awards
61

 
11,421

Tax withholdings related to net share settlements of restricted stock units
(33
)
 

Net cash used in financing activities
(20,817
)
 
(30,377
)
Net increase (decrease) in cash and cash equivalents
26,241

 
(11,517
)
Cash and cash equivalents at beginning of period
122,060

 
76,361

Cash and cash equivalents at end of period
$
148,301

 
$
64,844

Non-Cash Investing and Financing Activities:
 
 
 
Conversion of preferred stock into common stock in conjunction with initial public offering
$

 
$
150,278

See notes to condensed consolidated financial statements.

5

Table of Contents

UBIQUITI NETWORKS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE 1—BUSINESS AND BASIS OF PRESENTATION
Business — Ubiquiti Networks, Inc. was incorporated in the State of California in 2003 as Pera Networks, Inc. In 2005 the Company changed its name to Ubiquiti Networks, Inc. and commenced its current operations. In June 2010, the Company was re-incorporated in Delaware.
Ubiquiti Networks, Inc. and its wholly owned subsidiaries (collectively, “Ubiquiti” or the “Company”) is a product driven company that leverages innovative proprietary technologies to deliver networking solutions to both startup and established network operators and service providers.
On October 13, 2011, the Company entered into an underwriting agreement for its initial public offering of common stock at $15.00 per share. The Company's initial public offering closed on October 19, 2011. Immediately prior to the closing of the initial public offering, all outstanding shares of the Company’s preferred stock converted to common stock on a one for one basis.
The Company operates on a fiscal year ending June 30. In this Quarterly Report, the fiscal year ended June 30, 2013 is referred to as “fiscal 2013” and the fiscal year ending June 30, 2012 is referred to as “fiscal 2012.”
Basis of Presentation — The accompanying condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) related to interim financial statements based on applicable Securities and Exchange Commission (“SEC”) rules and regulations. Accordingly, they do not include all the information and footnotes required by U.S. GAAP for complete financial statements. This information reflects all adjustments, which are, in the opinion of the Company, of a normal and recurring nature and necessary to state fairly the statements of financial position, results of operations and cash flows for the dates and periods presented. The June 30, 2012 balance sheet was derived from the audited financial statements as of that date. All significant intercompany transactions and balances have been eliminated.
These condensed consolidated financial statements should be read in conjunction with the Company’s audited consolidated financial statements for the fiscal year ended June 30, 2012 included in its Annual Report on Form 10-K, as filed on September 28, 2012 with the SEC (the “Annual Report”). The results of operations for the three and six months ended December 31, 2012 are not necessarily indicative of the results to be expected for any future periods.
NOTE 2—SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The Company’s significant accounting policies are disclosed in its audited consolidated financial statements for the year ended June 30, 2012 included in the Annual Report.
Recent Accounting Pronouncements
The Company does not believe there have been any recent accounting pronouncements that would have a significant impact on the Company’s financial statements.
NOTE 3—FAIR VALUE OF FINANCIAL INSTRUMENTS
Pursuant to the accounting guidance for fair value measurements and its subsequent updates, fair value is defined as the price that would be received from selling an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. As such, fair value is a market-based measurement that should be determined based on assumptions that market participants would use in pricing an asset or liability. The accounting guidance establishes a three-tier fair value hierarchy that requires the Company to use observable market data, when available, and to minimize the use of unobservable inputs when determining fair value. The fair value hierarchy prioritizes the inputs into three levels that may be used in measuring fair value as follows:
Level 1 —observable inputs which include quoted prices in active markets for identical assets of liabilities.
Level 2 —inputs which include observable inputs other than Level 1, such as quoted prices for similar assets or liabilities, quoted prices for identical or similar assets or liabilities in markets that are not active, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the asset or liability.

6


Level 3 —inputs which include unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the underlying asset or liability. Level 3 assets and liabilities include those whose fair value measurements are determined using pricing models, discounted cash flow methodologies or similar valuation techniques, as well as significant management judgment or estimation.
The Company’s financial assets at December 31, 2012 and June 30, 2012 included money market funds which were valued based on quoted prices in active markets for substantially similar assets and, therefore, were Level 1 instruments. Additionally, at December 31, 2012 and June 30, 2012 the Company had debt associated with its Loan and Security Agreement with East West Bank (See Note 8). The fair value of the Company’s debt was estimated based on the current rates offered to the Company for debt with similar terms and remaining maturities and were therefore Level 2 instruments.
As of December 31, 2012 and June 30, 2012 , the fair value hierarchy for the Company’s financial assets and financial liabilities was as follows (in thousands):
 
December 31, 2012
 
June 30, 2012
 
Fair
Value
 
Level 1
 
Level 2
 
Level 3
 
Fair
Value
 
Level 1
 
Level 2
 
Level 3
Assets:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Money market funds
$
135,000

 
$
135,000

 
$

 
$

 
$
108,228

 
$
108,228

 
$

 
$

Liabilities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Debt
$
78,610

 
$

 
$
78,610

 
$

 
$
29,591

 
$

 
$
29,591

 
$

NOTE 4—EARNINGS PER SHARE
The following table sets forth the computation of basic and diluted earnings per share for the periods indicated (in thousands, except per share data):
 
Three Months Ended December 31,
 
Six Months Ended December 31,
 
2012

2011
 
2012
 
2011
Numerator:

 
 
Net income (loss) attributable to common stockholders—basic
$
17,803

 
$
14,428

 
$
30,982

 
$
(66,247
)
Net income (loss) attributable to common stockholders—diluted
$
17,803

 
$
14,443

 
$
30,982

 
$
(66,247
)
Denominator:

 
 
Weighted-average shares used in computing basic net income (loss) per share
88,094

 
87,487

 
89,532

 
75,102

Add—dilutive potential common shares:



 
 
 
 
Stock options
1,806


2,309

 
1,808

 

Restricted stock units
156


260

 
153

 

Weighted-average shares used in computing diluted net income (loss) per share
90,056


90,056

 
91,493

 
75,102

Net income (loss) per share of common stock:

 
 
Basic
$
0.20


$
0.16

 
$
0.35

 
$
(0.88
)
Diluted
$
0.20


$
0.16

 
$
0.34

 
$
(0.88
)

The following table summarizes the total potential shares of common stock that were excluded from the diluted per share calculation, because to include them would have been anti-dilutive for the period (in thousands):
 
Three Months Ended December 31,
 
Six Months Ended December 31,
 
2012
 
2011
 
2012
 
2011
Stock options
355

 
34

 
196

 
3,458

Restricted stock units
367

 
11

 
340

 
496

 
722

 
45

 
536

 
3,954


7


NOTE 5—CASH AND CASH EQUIVALENTS
Cash and cash equivalents consisted of the following (in thousands):
 
December 31, 2012
 
June 30, 2012
Cash
$
13,301

 
$
13,832

Money market funds
135,000

 
108,228

 
$
148,301

 
$
122,060

NOTE 6—BALANCE SHEET COMPONENTS
Inventories
Inventories consisted of the following (in thousands):
 
December 31, 2012

June 30, 2012
Raw materials
$
2,928

 
$
4,668

Finished goods
11,695

 
3,066

 
$
14,623

 
$
7,734


Prepaid Expenses and Other Current Assets
Prepaid expenses and other current assets consisted of the following (in thousands):
 
December 31, 2012
 
June 30, 2012
Vendor deposits
$

 
$
129

Other current assets
2,771

 
1,448

 
$
2,771

 
$
1,577


Property and Equipment, Net
Property and equipment, net consisted of the following (in thousands):
 
December 31, 2012
 
June 30, 2012
Testing equipment
$
2,883

 
$
2,293

Computer and other equipment
663

 
578

Tooling equipment
1,391

 
532

Furniture and fixtures
607

 
595

Leasehold improvements
1,808

 
1,424

Software
92

 
77

 
7,444

 
5,499

Less: Accumulated depreciation and amortization
(1,780
)
 
(1,028
)
 
$
5,664

 
$
4,471

Other Long-term Assets
Other long-term assets consisted of the following (in thousands):
 
December 31, 2012
 
June 30, 2012
Intangible assets, net
$
989

 
$
748

Other long-term assets
815

 
388

 
$
1,804

 
$
1,136


8


Other Current Liabilities
Accrued liabilities consisted of the following (in thousands):
 
December 31, 2012
 
June 30, 2012
Accrued compensation and benefits
$
2,498

 
$
2,657

Accrued accounts payable
4,932

 
6,636

Accrual for an export compliance matter
1,625

 
1,625

Warranty accrual
1,950

 
1,381

Other accruals
3,926

 
4,732

 
$
14,931

 
$
17,031

NOTE 7—ACCRUED WARRANTY
The Company offers warranties on certain products, generally for a period of one year, and records a liability for the estimated future costs associated with potential warranty claims. The warranty costs are reflected in the Company’s consolidated statement of operations within cost of revenues. The warranties are typically in effect for 12 months from the distributor’s purchase date of the product. The Company’s estimate of future warranty costs is largely based on historical experience factors including product failure rates, material usage, and service delivery cost incurred in correcting product failures. In certain circumstances, the Company may have recourse from its contract manufacturers for replacement cost of defective products, which it also factors into its warranty liability assessment.

Warranty obligations, included in other current liabilities, were as follows (in thousands):
 
Six Months Ended December 31,
 
2012
 
2011
Beginning balance
$
1,381

 
$
806

Accruals for warranties issued during the period
1,684

 
1,229

Warranty costs incurred during the period
(1,115
)
 
(668
)
 
$
1,950

 
$
1,367

NOTE 8—DEBT
In July 2011, the Company repurchased an aggregate of 12,041,700 shares of the Company’s Series A convertible preferred stock from entities affiliated with Summit Partners, L.P., one of the Company’s major stockholders, at a price of $8.97 per share for an aggregate consideration of $108.0 million . Of the aggregate purchase price, $40.0 million was paid in cash at the time of closing and the balance of the shares were paid for through the issuance of convertible subordinated promissory notes in the aggregate principal amount of $68.0 million . On September 15, 2011, $34.0 million was paid against the notes and was financed through the Company's EWB Loan Agreement (as further described below) reducing the aggregate principal amount outstanding to $34.0 million . The remainder of the notes were retired in October 2011 with the proceeds of the Company’s initial public offering and existing cash balances. The interest rate on the notes started at 5%  per annum and increased by two percentage points every three months until it would have reached 9% in January 2012. The notes were prepayable without penalty prior to April 21, 2012, and were required to be paid in the event of the Company’s initial public offering or third party financing prior to April 21, 2012. The notes matured on July 21, 2021. The unpaid principal on the notes was convertible into shares of Series A preferred stock at $8.97 per share at any point after July 21, 2012. The difference between the repurchase price and the carrying value of the repurchased preferred stock on June 30, 2011 was $59.0 million . The difference was debited to available retained earnings with the remaining amount debited to additional paid-in capital and reduced the net income attributable to common stock shareholders resulting in a reduction of basic and diluted net income per share.
On September 15, 2011, the Company entered into a Loan and Security Agreement with East West Bank, (the “EWB Loan Agreement”), which was replaced by the Loan Agreement as discussed below. The credit facilities available under the EWB Loan Agreement consist of a $35.0 million term loan facility and a $5.0 million revolving line of credit facility. The term loan matures on September 15, 2016 with principal and interest to be repaid in 60 monthly installments. The Company used $34.0 million of the term loan to repay a portion of the outstanding convertible subordinated promissory notes held by entities affiliated with Summit Partners, L.P leaving $1.0 million available for borrowing under the term loan facility.
On August 7, 2012, the Company 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 above. The Loan Agreement provides for (i) a $50.0 million

9


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”). The Company may request borrowings under the Revolving Credit Facility until August 7, 2015. On August 7, 2012, the Company borrowed $20.8 million under the Term Loan Facility, and no borrowings remain available for borrowing thereunder. On November 21, 2012, the Company borrowed $10.0 million under the Revolving Credit Facility. On December 20, 2012, the Company borrowed an additional $20.0 million under the Revolving Credit Facility, and $20.0 million remains available for borrowing thereunder.

The loans bear interest, at the Company’s option, at the base rate plus a spread of 1.25% to 1.75% or an adjusted LIBOR rate (at the Company’s election, for a period of 30 , 60 , or 90 days) plus a spread of 2.25% to 2.75% , in each case with such spread being determined based on the debt service coverage ratio for its most recently ended fiscal quarter. The base rate is the highest of (i) East West Bank’s prime rate, (ii) the federal funds rate plus a margin equal to 0.50% , or (iii) the LIBOR rate plus a margin equal to 1.00% . The Company is also obligated to pay other customary closing fees, arrangement fees, administration fees, commitment fees and letter of credit fees for a credit facility of this size and type.
Interest is due and payable monthly in arrears in the case of loans bearing interest at the base rate and at the end of an interest period in the case of loans bearing interest at the adjusted LIBOR rate. Principal payments under the Term Loan Facility will be made in quarterly installments on the first day of each calendar quarter, and each such quarterly installment shall be equal to $1.25 million through July 1, 2014, then equal to $1.875 million from October 1, 2014 through July 1 2015, and then equal to $2.5 million from October 1, 2015 through July 1, 2017, with the remaining outstanding principal balance and all accrued and unpaid interest due on August 7, 2017. All outstanding loans under the Revolving Credit Facility, together with all accrued and unpaid interest, are due on August 7, 2015.
The Company may prepay the loans, in whole or in part, at any time without premium or penalty, subject to certain conditions including minimum amounts and reimbursement of certain costs in the case of prepayments of LIBOR loans. In addition, the Company is required to prepay the loan under the Term Loan Facility with (i) the proceeds from certain financing transactions or asset sales (subject, in the case of asset sales, to reinvestment rights) and (ii) 25.0% of the Company’s excess cash flow in the U.S., as determined after each fiscal year and in accordance with the Loan Agreement, provided that the Company shall not be required to prepay the loan out of its excess cash flow if its leverage ratio is greater than 1.50 : 1.00 on the last day of such fiscal year.
All of the obligations of the Company under the Loan Agreement are collateralized by substantially all of the Company’s assets, including all of the capital stock of the Company’s future domestic subsidiaries and 65% of the capital stock of the Company’s existing and future foreign subsidiaries, but excluding the Company’s intellectual property, which is subject to a negative pledge agreement. All of the Company’s future domestic subsidiaries are required to guaranty the obligations under the Loan Agreement. Such guarantees by future subsidiaries will be collateralized by substantially all of the property of such subsidiaries, excluding intellectual property.
The Loan Agreement contains customary affirmative and negative covenants, including covenants that limit or restrict the Company and its subsidiaries’ ability to, among other things, incur indebtedness, grant liens, merge or consolidate, dispose of assets, pay dividends or make distributions, make investments, make acquisitions, prepay certain indebtedness, change the nature of its business, enter into certain transactions with affiliates, enter into restrictive agreements, and make capital expenditures, in each case subject to customary exceptions for a credit facility of this size and type. The Company is also required to maintain a minimum debt service coverage ratio, a maximum leverage ratio, and a minimum liquidity ratio. As of December 31, 2012, the Company was in compliance with all affirmative and negative covenants, debt service coverage ratio, leverage ratio and liquidity ratio requirements.
The Loan Agreement includes customary events of default that, include among other things, defaults for the failure to timely pay principal, interest, or other amounts due, defaults due to the inaccuracy of representations and warranties, covenant defaults, a cross default to material indebtedness, bankruptcy and insolvency defaults, material judgment defaults, defaults due to the unenforceability of a guaranty, and defaults due to circumstances that have or could reasonably be expected to have a material adverse effect on the Company's business, operations or financial condition, its ability to pay or perform under the Loan Agreement, or on the lenders' security interests. The occurrence of an event of default could result in the acceleration of the obligations under the Loan Agreement. During the existence of an event of default, interest on the obligations under the Loan Agreement could be increased by 2.00% above the otherwise applicable interest rate.
During the three and six months ended December 31, 2012 , the Company made aggregate payments of $1.3 million and $1.8 million , respectively, against the loan balance. As of December 31, 2012 , the Company has classified $5.0 million and $73.6 million in short-term and long-term debt, respectively, on its consolidated balance sheet related to the Loan Agreement.


10



The following table summarizes our estimated debt and interest payment obligations as of December 31, 2012 (in thousands):
 
2013
(remainder)
 
2014
 
2015
 
2016
 
2017
 
Thereafter
 
Total
Debt payment obligations
$
2,500

 
$
5,000

 
$
6,875

 
$
39,375

 
$
10,000

 
$
15,000

 
$
78,750

Interest payments on debt payment obligations
542

 
1,859

 
1,723

 
1,043

 
532

 
125

 
5,824

Total
$
3,042

 
$
6,859

 
$
8,598

 
$
40,418

 
$
10,532

 
$
15,125

 
$
84,574

NOTE 9—COMMITMENTS AND CONTINGENCIES
Operating Leases
Certain facilities and equipment are leased under noncancelable operating leases. The Company generally pays taxes, insurance and maintenance costs on leased facilities and equipment. The Company leases office space in San Jose, California and other locations under various non-cancelable operating leases that expire at various dates through 2017 .
In December 2011, the Company entered into an agreement to lease approximately 64,512 square feet of office and research and development space located in San Jose, California, which the Company uses as its corporate headquarters. The lease term is from April 1, 2012 , through June 30, 2017 . The lease has been categorized as an operating lease, and the total estimated rent expense to be recognized is $4.9 million .
At December 31, 2012 , future minimum annual payments under operating leases are as follows (in thousands):
 
2013
(remainder)
 
2014
 
2015
 
2016
 
2017
 
Thereafter
 
Total
Operating leases
$
750

 
$
1,505

 
$
1,465

 
$
1,423

 
$
1,117

 
$
188

 
$
6,448

Purchase Commitments
The Company subcontracts with other companies to manufacture its products. During the normal course of business, the Company’s contract manufacturers procure components based upon orders placed by the Company. If the Company cancels all or part of the orders, it may still be liable to the contract manufacturers for the cost of the components purchased by them to manufacture the Company’s products. The Company periodically reviews the potential liability and to date no significant accruals have been recorded. The Company’s consolidated financial position and results of operations could be negatively impacted if it were required to compensate the contract manufacturers for any liabilities incurred.
Indemnification Obligations
The Company enters into standard indemnification agreements with many of its business partners in the ordinary course of business. These agreements include provisions for indemnifying the business partner against any claim brought by a third party to the extent any such claim alleges that a Ubiquiti product infringes a patent, copyright or trademark, or violates any other proprietary rights of that third party. The maximum potential amount of future payments the Company could be required to make under these indemnification agreements is not estimable and the Company has not incurred any material costs to defend lawsuits or settle claims related to these indemnification agreements to date.
Legal Matters
The Company may be involved, from time to time, in a variety of claims, lawsuits, investigations, and proceedings relating to contractual disputes, intellectual property rights, employment matters, regulatory compliance matters and other litigation matters relating to various claims that arise in the normal course of business. The Company determines whether an estimated loss from a contingency should be accrued by assessing whether a loss is deemed probable and can be reasonably estimated. The Company assesses its potential liability by analyzing specific litigation and regulatory matters using available information. The Company develops its views on estimated losses in consultation with inside and outside counsel, which involves a subjective analysis of potential results and outcomes, assuming various combinations of appropriate litigation and settlement strategies. Taking all of the above factors into account, the Company records an amount where it is probable that the Company will incur a loss and where that loss can be reasonably estimated. However, the Company’s estimates may be incorrect and the Company could ultimately incur more or less than the amounts initially recorded. Litigation can be costly, diverting management’s attention and could, upon resolution, have a material adverse effect on the Company’s business, results of operations, financial condition, and cash flows.

11


Export Compliance Matters
In January 2011, the U.S. Commerce Department, Bureau of Industry and Security’s (“BIS”) Office of Export Enforcement (“OEE”) contacted the Company to request that the Company provide information related to its relationship with a logistics company in the United Arab Emirates (“UAE”) and with a company in Iran, as well as information on the export classification of its products. As a result of this inquiry the Company, assisted by outside counsel, conducted a review of the Company's export transactions from 2008 through March 2011 to not only gather information responsive to the OEE's request but also to review the Company's overall compliance with export control and sanctions laws. The Company believes its products have been sold into Iran by third parties. The Company does not believe that it directly sold, exported or shipped its products into Iran or any other country subject to a U.S. embargo. However, until early 2010, the Company did not prohibit its distributors from selling its products into Iran or any other country subject to a U.S. embargo. In the course of this review the Company identified that two distributors may have sold the Company's products into Iran. The Company's review also found that while it had obtained required Commodity Classification Rulings for its products in June 2010 and November 2010, the Company did not advise its shipping personnel to change the export authorizations used on its shipping documents until February 2011. During the course of the Company's export control review, the Company also determined that it had failed to maintain adequate records for the five year period required by the EAR and the sanctions regulations due to its lack of infrastructure and because it was prior to its transition to its current system of record, NetSuite.

In May 2011, the Company filed a self-disclosure statement with the BIS and OEE. In June 2011, the Company filed a self-disclosure statement with the U.S. Department of the Treasury’s Office of Foreign Asset Control (“OFAC”) regarding the compliance issues noted above. The disclosures address the above described findings and the remedial actions the Company had taken to date. However, the findings also indicate that both distributors continued to sell, directly or indirectly, the Company’s products into Iran during the period from February 2010 through March 2011 and that the Company received various communications from them indicating that they were continuing to do so. Since January 2011, the Company has cooperated with OEE and, prior to its disclosure filing, the Company informally shared with the OEE the substance of its findings with respect to both distributors. From May 2011 to August 2011, the Company provided additional information regarding its review and its findings to OEE to facilitate its investigation and OEE advised the Company in August 2011 that it had completed its investigation of the Company. In August 2011, the Company received a warning letter from OEE stating that OEE had not referred the findings of the Company’s review for criminal or administrative prosecution and closed the investigation of the Company without penalty.
OFAC is still reviewing the Company’s voluntary disclosure. In the Company’s submission, the Company provided OFAC with an explanation of the activities that led to the sales of its products in Iran and the failure to comply with the Export Administration Regulations (the “EAR”) and OFAC sanctions. Although the Company’s OFAC and OEE voluntary disclosures covered similar sets of facts, which led the OEE to resolve the case with the issuance of a warning letter, OFAC may conclude that the Company’s actions resulted in violations of U.S. export control and economic sanctions laws and warrant the imposition of penalties that could include fines, termination of the Company’s ability to export its products, and/or referral for criminal prosecution. Any such fines may be material to the Company’s financial results in the period in which they are imposed. The penalties may be imposed against the Company and/or its management. The maximum civil monetary penalty for the violations is up to $250,000 or twice the value of the transaction, whichever is greater, per violation. The Company cannot predict when OFAC will complete its review or decide upon the imposition of possible penalties.

While the Company has now taken actions to ensure that export classification information is distributed to the appropriate personnel in a timely manner and has adopted policies and procedures to promote its compliance with these laws and regulations, including obtaining written distribution agreements with substantially all of its distributors that contain covenants requiring compliance with U.S. export control and economic sanctions law; notifying all of its distributors of their obligations and obtaining updated distribution agreements from distributors that accounted for approximately 99% of its revenue in fiscal 2012. The Company's failure to amend all its distribution agreements and to implement more robust compliance controls immediately after the discovery of Iran-related sales activity in early 2010 may be aggravating factors that could impact the imposition of penalties imposed on the Company or its management. Based on the facts known to the Company to date, the Company recorded an expense of $1.6 million for this export compliance matter in fiscal 2010, which represents management’s estimated exposure for fines in accordance with applicable accounting literature. This amount was calculated from information discovered through the Company’s internal review and this loss is deemed to be probable and reasonably estimable. However, the Company also believes that it is reasonably possible that the loss may be higher, but the Company cannot reasonably estimate the range of any further potential losses. Specific information has come to management’s attention and as such management cannot estimate any further range of possible losses. Should additional facts be discovered in the future and/or should actual fines or other penalties substantially differ from the Company’s estimates, its business, financial condition, cash flows and results of operations would be materially negatively impacted.

12


Shareholder Class Action Lawsuits
Beginning on September 7, 2012, two shareholder class action complaints were filed against the Company, certain of its officers and directors and the underwriters of the Company's initial public offering in the United States District Court for the Northern District of California. On January 30, 2013, the plaintiffs filed an Amended Consolidated Complaint, which alleges claims under the Securities Act of 1933, the Securities Exchange Act of 1934 and SEC Rule 10b-5 on behalf of a purported class of those who purchased the Company's common stock between October 14, 2011 and August 9, 2012 and/or acquired the Company's stock pursuant to or traceable to the registration statement for the initial public offering. The Amended Consolidated Complaint alleges that the defendants violated the federal securities laws by issuing false or misleading statements regarding the sale of counterfeit Company products. The consolidated complaint seeks, among other things, damages and interest, rescission, and attorneys' fees and costs.
The Company believes that the allegations in the consolidated complaint are without merit and intend to vigorously contest the litigation. However, there can be no assurance that the Company will be successful in its defense. Because the case is at a very early stage, the Company cannot currently estimate the loss or the range of possible losses we may experience in connection with this litigation.
NOTE 10—PREFERRED STOCK
Preferred Stock
In July 2011, the Company repurchased an aggregate of 12,041,700 shares of the Company’s Series A convertible preferred stock from entities affiliated with Summit Partners, L.P., one of the Company’s major stockholders, at a price of $8.97 per share for an aggregate consideration of $108.0 million . Of the aggregate purchase price, $40.0 million was paid in cash at the time of closing and the balance of the shares were paid for through the issuance of convertible subordinated promissory notes in the aggregate principal amount of $68.0 million . The $68.0 million was paid down primarily using proceeds from the EWB Loan Agreement and the remaining balance was subsequently paid down by funds raised upon the completion of the Company’s initial public offering on October 19, 2011 and the Company’s existing cash balances as discussed in Note 8.
NOTE 11—COMMON STOCK AND TREASURY STOCK
As of December 31, 2012 and June 30, 2012 , the authorized capital of the Company included 500,000,000 shares of common stock. As of December 31, 2012 , 131,196,746 shares of common stock were issued and 86,957,786 were outstanding. As of June 30, 2012 , 131,129,888 shares of common stock were issued and 92,049,978 were outstanding.
Common Stock Repurchases
On August 9, 2012, the Company announced that its Board of Directors authorized the Company to repurchase up to $100 million of its common stock. The share repurchase program commenced Monday, August 13, 2012. The share repurchase program has been funded from proceeds from the Loan Agreement as discussed in Note 8 and from existing cash on hand.

Common stock repurchase activity during the six months ended December 31, 2012 was as follows (in thousands, except share and per share amounts):
Period
Total Number
of Shares
Purchased
 
Average Price
Paid per Share
 
Dollar Value of
Shares that May
Yet Be Purchased
August 13, 2012 – August 31, 2012
2,179,900

 
$
8.88

 
$
80,599

September 1, 2012 – September 30, 2012
992,014

 
$
11.93

 
$
68,742

October 1, 2012 - October 31, 2012
371,665

 
$
11.72

 
$
64,377

November 1, 2012 - November 30, 2012
657,700

 
$
11.16

 
$
57,024

December 1, 2012 - December 31, 2012
957,771

 
$
11.86

 
$
45,646

Total
5,159,050

 
$
10.52

 
$
45,646



Special Dividend


13


On December 14, 2012, the Company announced that its Board of Directors had authorized a special cash dividend of $0.18 per share for each share of common stock outstanding on December 24, 2012. The aggregate dividend payment of $15.7 million was paid on December 28, 2012 to stockholders of record on December 24, 2012.
NOTE 12—STOCK BASED COMPENSATION
Stock-Based Compensation Plans
The Company’s 2010 Equity Incentive Plan and 2005 Equity Incentive Plan are described in its Annual Report. As of December 31, 2012 , the Company had 5,381,713 authorized shares available for future issuance under all of its stock incentive plans.
Stock-based Compensation
The following table shows total stock-based compensation expense included in the Condensed Consolidated Statements of Operations for the three and six months ended December 31, 2012 and 2011 (in thousands):
 
Three Months Ended December 31,
 
Six Months Ended December 31,
 
2012

2011
 
2012
 
2011
Cost of sales
$
104

 
$
27

 
$
185

 
$
33

Research and development
401

 
116

 
667

 
232

Sales, general and administrative
388

 
208

 
697

 
437

 
$
893


$
351

 
$
1,549

 
$
702

Stock Options
The following is a summary of option activity for the Company’s stock incentive plans for the six months ended December 31, 2012 :
 
Common Stock Options Outstanding
 
Number
of Shares
 
Weighted
Average
Exercise
Price
 
Weighted
Average
Remaining
Contractual
Life (Years)
 
Aggregate
Intrinsic
Value
 
 
 
 
 
 
 
(In thousands)
Balance, June 30, 2012
3,347,445

 
$
1.45

 
 
 
 
Granted
600,000

 
10.93

 
 
 
 
Exercised
(50,205
)
 
3.21

 
 
 
 
Forfeitures and cancellations
(17,366
)
 
6.22

 
 
 
 
Balance, December 31, 2012
3,879,874

 
$
2.87

 
6.66
 
$
36,110

Vested and expected to vest as of December 31, 2012
3,806,169

 
$
2.76

 
6.66
 
$
35,867

Vested and exercisable as of December 31, 2012
2,662,106

 
$
0.76

 
5.66
 
$
30,324

During the three months ended December 31, 2012 and 2011 , the aggregate intrinsic value of options exercised under the Company’s stock incentive plans was $185,000 and $46.2 million , respectively, as determined as of the date of option exercise. During the six months ended December 31, 2012 and 2011 , the aggregate intrinsic value of options exercised under the Company’s stock incentive plans was $363,000 and $46.6 million respectively.

As of December 31, 2012 , the Company had unrecognized compensation costs of $4.2 million related to stock options which the Company expects to recognize over a weighted-average period of 3.5 years. Future option grants will increase the amount of compensation expense to be recorded in these periods.





14


The Company estimates the fair value of employee stock options using the Black-Scholes option pricing model. The fair value of employee stock options is being amortized on a straight-line basis over the requisite service period of the awards. For the three and six months ended December 31, 2012 and 2011 , the fair value of employee stock options was estimated using the following weighted average assumptions:
 
 
Three Months Ended December 31,
 
Six Months Ended December 31,
 
2012
 
2011
 
2012
 
2011
Expected term
6.1 years

 
6.1 years

 
6.1 years

 
6.1 years

Expected volatility
52
%
 
51
%
 
52
%
 
49
%
Risk-free interest rate
0.8
%
 
1.1
%
 
0.8
%
 
1.6
%
Expected dividend yield

 

 

 

Weighted average grant date fair value
$
5.37

 
$
7.79

 
$
5.37

 
$
4.90

Restricted Stock Units (“RSUs”)
The following table summarizes the activity of the RSUs made by the Company:
 
Number of
Shares
 
Weighted
Average Grant
Date Fair Value
Non-vested RSUs, June 30, 2012
453,620

 
$
9.42

RSUs granted
300,500

 
13.63

RSUs vested
(19,207
)
 
12.65

RSUs cancelled
(10,500
)
 
28.78

Non-vested RSUs, December 31, 2012
724,413

 
$
10.80

The intrinsic value of RSUs vested in the three months ended December 31, 2012 and 2011 was $142,000 and $25,000 , respectively. The intrinsic value of RSUs vested in the six months ended December 31, 2012 and 2011 was $233,000 and $25,000 , respectively. The total intrinsic value of all outstanding RSUs was $8.8 million as of December 31, 2012 .
As of December 31, 2012 , there was unrecognized compensation costs related to RSUs of $6.2 million which the Company expects to recognize over a weighted average period of 3.5 years.
NOTE 13—INCOME TAXES
As of December 31, 2012 , the Company had approximately $9.3 million of unrecognized tax benefits, substantially all of which would, if recognized, affect its tax expense. The Company has elected to include interest and penalties related to uncertain tax positions as a component of tax expense. At December 31, 2012 , an insignificant amount of interest and penalties are included in long-term income tax payable. The Company recorded an increase of its unrecognized tax benefits of $896,000 for the three months ended December 31, 2012 . The Company does not expect any significant increases or decreases to its unrecognized tax benefits in the next twelve months.
The Company recorded a tax provision of $2.1 million for the three months ended December 31, 2012 . The Company’s estimated 2012 effective tax rate differs from the U.S. statutory rate primarily due to profits earned in jurisdictions where the tax rate is lower than the U.S. tax rate.
The Company files U.S. federal income tax returns as well as income tax returns in various states and foreign jurisdictions. The Company’s tax years from 2009 and onwards could be subject to examinations by tax authorities.






15


NOTE 14—SEGMENT INFORMATION, REVENUES BY GEOGRAPHY AND SIGNIFICANT CUSTOMERS
Revenues by product type were as follows (in thousands, except percentages):
 
Three Months Ended December 31,
 
Six Months Ended December 31,
 
2012

2011
 
2012
 
2011
airMAX
$
48,752


65
%

$
52,939


60
%
 
$
80,809

 
59
%
 
$
102,774

 
62
%
New platforms
11,905


16
%

4,226


5
%
 
27,533

 
20
%
 
6,960

 
4
%
Other systems
4,835


6
%

18,254


21
%
 
8,619

 
7
%
 
31,019

 
19
%
Systems
65,492


87
%

75,419


86
%
 
116,961

 
86
%
 
140,753

 
85
%
Embedded radio
1,519


2
%

2,567


3
%
 
3,233

 
2
%
 
5,792

 
3
%
Antennas/other
7,890


11
%

9,831


11
%
 
16,242

 
12
%
 
20,439

 
12
%
Total revenues
$
74,901


100
%

$
87,817


100
%
 
$
136,436

 
100
%
 
$
166,984

 
100
%
The Company generally forwards products directly from its manufacturers to its customers via a logistics distribution hub in China. The Company's customers in turn ship to other locations throughout the world. The Company has determined the geographical distribution of product revenues based upon the customer's ship-to destinations.
Revenues by geography were as follows (in thousands, except percentages):
 
Three Months Ended December 31,

Six Months Ended December 31,
 
2012

2011

2012

2011
North America(1)
$
12,106


16
%

$
21,440


24
%

$
32,467


24
%

$
46,381


28
%
South America
17,081


23
%

24,250


28
%

27,324


20
%

44,085


26
%
Europe, the Middle East and Africa
35,929


48
%

30,356


35
%

59,073


43
%

55,139


33
%
Asia Pacific
9,785


13
%

11,771


13
%

17,572


13
%

21,379


13
%
Total revenues
$
74,901


100
%

$
87,817


100
%

$
136,436


100
%

$
166,984


100
%
 
(1)
Revenue for the United States was $11.4 million and $20.7 million for the three months ended December 31, 2012 and 2011 , respectively. Revenue for the United States was $30.7 million and $45.1 million for the six months ended December 31, 2012 and 2011 , respectively.
Customers with an accounts receivable balance of 10% or greater of total accounts receivable and customers with net revenues of 10% or greater of total revenues are presented below for the periods indicated:
 
Percentage of Revenues
 
Percentage of Accounts Receivable
 
Three Months Ended December 31,
 
Six Months Ended December 31,
 
December 31,
 
June 30,
 
2012

2011
 
2012
 
2011
 
2012
 
2012
Customer A
15
%
 
21
%
 
12
%
 
19
%
 
17
%
 
19
%
Customer B
14
%
 
*

 
*

 
*

 
13
%
 
*

Customer C
*

 
*

 
*

 
12
%
 
*

 
11
%
Customer D
*

 
*

 
*

 
*

 
*

 
12
%
 * denotes less than 10%













 

16


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
We are a product driven company that leverages innovative proprietary technologies to deliver networking solutions with compelling price-performance characteristics to both start-up and established network operators and service providers. Our products bridge the digital divide by fundamentally changing the economics of deploying high performance networking solutions in underserved and underpenetrated wireless broadband access markets globally. These markets include emerging markets and other areas where individual users and small and medium sized enterprises do not have access to the benefits of carrier class broadband networking. Our business model has enabled us to break down traditional barriers, such as high product and network deployment costs, which are driven by business model inefficiencies and achieve rapid market adoption of our products and solutions in previously underserved and underpenetrated markets. Our business model and proprietary technologies provide us with a significant and sustainable competitive advantage over incumbents, who we believe are unable to respond effectively due to their higher cost business models.
We offer a broad and expanding portfolio of networking products and solutions in the outdoor wireless, enterprise WLAN, video surveillance, wireless backhaul and machine-to-machine communications markets. We began shipping embedded radios in fiscal 2006. In fiscal 2008 we introduced a line of products based on 802.11 standard protocols and in early fiscal 2010, we introduced a number of new products based on our proprietary airMAX protocol, which have been rapidly adopted by network operators and high-performance proprietary airMAX service providers. Since the beginning of fiscal 2011, we have introduced UniFi, airVision, airFiber, mFi and EdgeMAX, which are collectively referred to in this report as our New Platforms. In the three and six months ended December 31, 2012 , our systems revenue accounted for 87% and 86% of our revenues, respectively. In the future, we expect sales of our airMAX platform and our new product platforms to continue to represent a growing portion of our revenues and the portion of our revenues derived from our 802.11 standard products to decline as a percentage of total revenues.
Building on our leadership in the underserved and underpenetrated segments of the wireless broadband access market, we intend to expand our product offerings in our existing market and enter adjacent markets by relying on the combination of our efficient business model and proprietary technologies. For example, we have introduced products and solutions for the enterprise WLAN and video surveillance markets, and since late fiscal 2011 licensed microwave wireless backhaul, machine-to-machine communication and router markets. As we enter such new markets, we plan to leverage existing distributor relationships and established engaged communities similar to the Ubiquiti Community, our growing and engaged community of network operators, service providers, distributors, value added resellers and system integrators, to keep our operating expenses in line with our current model and enable us to offer products in these new markets with compelling price-performance characteristics. 
to keep our operating expenses in line with our current model and enable us to offer products in these new markets with compelling price-performance characteristics.
Our revenues decreased 15% to $74.9 million in the three months ended December 31, 2012 from $87.8 million in the three months ended December 31, 2011 . Our revenues decreased 18% to $136.4 million in the six months ended December 31, 2012 from $167.0 million in the six months ended December 31, 2011 . We believe the overall decrease in revenues during both the three and six months ended December 31, 2012 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 $17.8 million and $24.7 million in the three months ended December 31, 2012 and 2011 , respectively. We had net income of $31.0 million and $46.2 million in the six months ended December 31, 2012 and 2011 , respectively. The declines in net income in both the three and six months ended December 31, 2012 as compared to the same periods in the prior year were primarily due to the decline in revenues and increased operating expenses.



17

Table of Contents

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 97% and 96% of our revenues in the three months ended December 31, 2012 and 2011 , respectively. Sales to distributors accounted for 97% of our revenues in both the six months ended December 31, 2012 and 2011 . 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 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 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

18

Table of Contents

dollars due to continued growth in headcount, expand 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 December 31, 2012 and 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 December 31, 2012 and June 30, 2012 , we had deferred revenues of $815,000 and $805,000 respectively, related to these obligations.
Prepayments
We have historical agreements with certain contract manufacturers whereby we prepay for a portion of the product costs to assure the manufacture and timely delivery of our products. However, as of December 31, 2012 we did not have any prepayment balances with our contract manufacturers. As of June 30, 2012 , we had a prepayment balance of $129,000.
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.












19

Table of Contents

Results of Operations
Comparison of Three and Six Months Ended December 31, 2012 and 2011
 
Three Months Ended December 31,
 
Six Months Ended December 31,
 
2012

2011
 
2012
 
2011
 
(In thousands, except percentages)
Revenues
$
74,901


100
%

$
87,817


100
%
 
$
136,436

 
100
%
 
$
166,984

 
100
%
Cost of revenues
44,416


59
%

50,527


58
%
 
80,931

 
59
%
 
96,681

 
58
%
Gross profit
30,485


41
%

37,290


42
%
 
55,505

 
41
%
 
70,303

 
42
%
Operating expenses:
 






 
 
 
 
 
 
 
 
Research and development
5,052


7
%

3,683


4
%
 
9,763

 
7
%
 
7,052

 
4
%
Sales, general and administrative
5,314


7
%

2,431


3
%
 
9,848

 
7
%
 
4,575

 
3
%
Total operating expenses
10,366


14
%

6,114


7
%
 
19,611

 
14
%
 
11,627

 
7
%
Income from operations
20,119


27
%

31,176


35
%
 
35,894

 
27
%
 
58,676

 
35
%
Interest expense and other, net
(197
)

*


(312
)

*

 
(283
)
 
*

 
(946
)
 
*

Income before provision for income taxes
19,922


27
%

30,864


35
%
 
35,611

 
26
%
 
57,730

 
35
%
Provision for income taxes
2,119


3
%

6,173


7
%
 
4,629

 
3
%
 
11,546

 
7
%
Net income
$
17,803


24
%

$
24,691


28
%
 
$
30,982

 
23
%
 
$
46,184

 
28
%
*       Less than 1%







 
 
 
 
 
 
 
 
(1)    Includes stock-based compensation as follows:







 
 
 
 
 
 
 
 
Cost of revenues
$
104




$
27



 
$
185

 
 
 
$
33

 
 
Research and development
401




116



 
667

 
 
 
232

 
 
Sales, general and administrative
388




208



 
697

 
 
 
437

 
 
Total stock-based compensation
$
893




$
351



 
$
1,549

 
 
 
$
702

 
 
Revenues
Revenues decreased $12.9 million , or 15% , from $87.8 million in the three months ended December 31, 2011 to $74.9 million in the three months ended December 31, 2012 . Revenues decreased $30.5 million , or 18% , from $167.0 million in the six months ended December 31, 2011 to $136.4 million in the six months ended December 31, 2012 . We believe the overall decrease in revenues during the three and six months ended December 31, 2012 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. This has had the most significant impact on our airMAX platform which decreased $4.2 million and $22.0 million , respectively, in the three and six months ended December 31, 2012 compared to the same periods in the prior year.
In the three months ended December 31, 2012 , revenues from Customer A and Customer B represented 15% and 14% of our revenues, respectively. In the three months ended December 31, 2011 , revenues from Customer A represented 21% of our revenues. In the six months ended December 31, 2012 , revenues from Customer A represented 12% of our revenues. In the six months ended December 31, 2011 , revenues from Customer A and Customer C represented 19% and 12% of our revenues, respectively. No other customer represented more than 10% of our revenues in the three or six months ended December 31, 2012 or 2011 .






20


Revenues by Product Type
 
Three Months Ended December 31,
 
Six Months Ended December 31,
 
2012
 
2011
 
2012
 
2011
 
(in thousands, except percentages)
airMAX
$
48,752

 
65
%
 
$
52,939

 
60
%
 
$
80,809

 
59
%
 
$
102,774

 
62
%
New platforms
11,905

 
16
%
 
4,226

 
5
%
 
27,533

 
20
%
 
6,960

 
4
%
Other systems
4,835

 
6
%
 
18,254

 
21
%
 
8,619

 
7
%
 
31,019

 
19
%
Systems
65,492

 
87
%
 
75,419

 
86
%
 
116,961

 
86
%
 
140,753

 
85
%
Embedded radio
1,519

 
2
%
 
2,567

 
3
%
 
3,233

 
2
%
 
5,792

 
3
%
Antennas/other
7,890

 
11
%
 
9,831

 
11
%
 
16,242

 
12
%
 
20,439

 
12
%
Total revenues
$
74,901

 
100
%
 
$
87,817

 
100
%
 
$
136,436

 
100
%
 
$
166,984

 
100
%

Systems revenues decreased $9.9 million , or 13% , from $75.4 million in the three months ended December 31, 2011 to $65.5 million in the three months ended December 31, 2012 . Systems revenues decreased $23.8 million , or 17% , from $140.8 million in the six months ended December 31, 2011 to $117.0 million in the three months ended December 31, 2012 . 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 significant platforms introduced since late fiscal 2011. Our new platforms contributed $11.9 million and $4.2 million of revenue during the three months ended December 31, 2012 and 2011 , respectively, and $27.5 million and $7.0 million of revenue during the six months ended December 31, 2012 and 2011 , respectively. Our other systems revenue decreased $13.4 million during the three months ended December 31, 2012 as compared to the three months ended December 31, 2011 due primarily to our December 2011 quarter including a large order to a customer. Our other systems revenue decreased $22.4 million during the six months ended December 31, 2012 as compared to the six months ended December 31, 2011 due primarily to our December 2011 quarter including a large order to a customer.
Embedded radio revenues decreased $1.0 million , or 41% , from $2.6 million in the three months ended December 31, 2011 to $1.5 million in the three months ended December 31, 2012 , and decreased $2.6 million , or 44% , from $5.8 million in the six months ended December 31, 2011 to $3.2 million in the six months ended December 31, 2012 . We anticipate that embedded radio products will decline as a percentage of revenues in future periods as sales of these products are outpaced by sales of systems products.
Antennas/other revenues decreased $1.9 million , or 20% from $9.8 million in the three months ended December 31, 2011 to $7.9 million in the three months ended December 31, 2012 . Antennas/other revenues decreased $4.2 million , or 21% from $20.4 million in the six months ended December 31, 2011 to $16.2 million in the six months ended December 31, 2012 . The decline in antennas/other revenues 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. Antenna/other revenues will decline as a percentage of total revenues due to more rapid growth of systems revenues.









21


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 mainly delivered to our customers through distribution hubs in Hong Kong.  Our customers in turn ship to other locations throughout the world. We have determined the geographical distribution of our product revenues based on our customer's ship-to destinations. A majority of our sales are to distributors who in turn sell to resellers or directly to end customers. As a result of these factors, we believe that sales to certain geographic locations might be higher or lower, as the ultimate destinations are difficult to ascertain. Revenues in North America decreased primarily due to a significant decline in orders from one of our customers. We believe the decrease in revenues in South America and Europe, the Middle East and Africa 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 the low levels of revenues. The following are our revenues by geography for the three and six months ended December 31, 2012 and 2011 (in thousands, except percentages):
 
 
Three Months Ended December 31,
 
Six Months Ended December 31,
 
2012
 
2011
 
2012
 
2011
North America(1)
$
12,106

 
16
%
 
$
21,440

 
24
%
 
$
32,467

 
24
%
 
$
46,381

 
28
%
South America
17,081

 
23
%
 
24,250

 
28
%
 
27,324

 
20
%
 
44,085

 
26
%
Europe, the Middle East and Africa
35,929

 
48
%
 
30,356

 
35
%
 
59,073

 
43
%
 
55,139

 
33
%
Asia Pacific
9,785

 
13
%
 
11,771

 
13
%
 
17,572

 
13
%
 
21,379

 
13
%
Total revenues
$
74,901

 
100
%
 
$
87,817

 
100
%
 
$
136,436

 
100
%
 
$
166,984

 
100
%
 
(1)
Revenue for the United States was $11.4 million and $20.7 million for the three months ended December 31, 2012 and 2011 , respectively. Revenue for the United States was $30.7 million and $45.1 million for the six months ended December 31, 2012 and 2011 , respectively.
Cost of Revenues and Gross Profit
Cost of revenues decreased $6.1 million , or 12% , from $50.5 million in the three months ended December 31, 2011 to $44.4 million in the three months ended December 31, 2012 . Cost of revenues decreased $15.8 million , or 16% , from $96.7 million in the six months ended December 31, 2011 to $80.9 million in the six months ended December 31, 2012 . The decreases in cost of revenues in both the three and six months ended December 31, 2012 was primarily due to decreased revenues and to a lesser extent, changes in product mix.
Gross profit decreased from 42% in the three months ended December 31, 2011 to 41% in the three months ended December 31, 2012 . Gross profit decreased from 42% in the six months ended December 31, 2011 to 41% in the six months ended December 31, 2012 . The decrease in gross profit in both periods reflects increases in variable operating costs.
Operating Expenses
Research and Development
Research and development expenses increased $1.4 million , or 37% , from $3.7 million in the three months ended December 31, 2011 to $5.1 million in the three months ended December 31, 2012 . As a percentage of revenues, research and development expenses increased from 4% in the three months ended December 31, 2011 to 7% in the three months ended December 31, 2012 . Research and development expenses increased $2.7 million , or 38% , from $7.1 million in the six months ended December 31, 2011 to $9.8 million in the six months ended December 31, 2012 . As a percentage of revenues, research and development expenses increased from 4% in the six months ended December 31, 2011 to 7% in the six months ended December 31, 2012 . 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.
Sales, General and Administrative
Sales, general and administrative expenses increased $2.9 million , or 119% , from $2.4 million in the three months ended December 31, 2011 to $5.3 million in the three months ended December 31, 2012 . As a percentage of revenues, sales, general

22


and administrative expenses increased from 3% in the three months ended December 31, 2011 to 7% in the three months ended December 31, 2012 . Sales, general and administrative expenses increased $5.3 million , or 115% , from $4.6 million in the six months ended December 31, 2011 to $9.8 million in the six months ended December 31, 2012 . As a percentage of revenues, sales, general and administrative expenses increased from 3% in the six months ended December 31, 2011 to 7% in the six months ended December 31, 2012 . Sales, general and administrative expenses increased in both periods due largely to increased legal expenses associated with our anti-counterfeiting litigation, increased marketing and tradeshow activity and increases in our bad debt allowance. As a percentage of revenues sales, general and administrative expenses increased in both periods primarily due to our overall revenue decrease in revenues. 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 $197,000 for the three months ended December 31, 2012 , representing a decrease of $115,000 from $312,000 for the three months ended December 31, 2011 . Interest expense and other, net was $283,000 for the six months ended December 31, 2012 , representing a decrease of $663,000 from $946,000 for the six months ended December 31, 2011 . During the three months ended September 30, 2011, we incurred interest expense on our convertible subordinated promissory notes issued as part of the repurchase of Series A convertible preferred stock from entities affiliated with Summit Partners, L.P. in July 2011. The convertible subordinated promissory notes were repaid in full in October 2011.
Provision for Income Taxes
Our provision for income taxes decreased $4.1 million , or 66% , from $6.2 million for the three months ended December 31, 2011 to $2.1 million for the three months ended December 31, 2012 . Our provision for income taxes decreased $6.9 million , or 60% , from $11.5 million for the six months ended December 31, 2011 to $4.6 million for the six months ended December 31, 2012 . Our effective tax rate decreased to 11% for the three months ended December 31, 2012 as compared to 20% the three months ended December 31, 2011 . Our effective tax rate decreased to 13% for the six months ended December 31, 2012 as compared to 20% the six months ended December 31, 2011 . The decrease in the effective tax rates during both periods 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, cash equivalents and short-term marketable securities increased from $122.1 million at June 30, 2012 to $148.3 million at December 31, 2012 .

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:
 
Six Months Ended December 31,
 
2012
 
2011
 
(In thousands)
Net cash provided by operating activities
$
50,525

 
$
19,970

Net cash used in investing activities
(3,467
)
 
(1,110
)
Net cash used in financing activities
(20,817
)
 
(30,377
)
Net increase (decrease) in cash and cash equivalents
$
26,241

 
$
(11,517
)
Cash Flows from Operating Activities
Net cash provided by operating activities in the six months ended December 31, 2012 of $50.5 million consisted primarily of net income of $31.0 million and net changes in operating assets and liabilities that resulted in net cash inflows of $15.2 million . These changes consisted primarily of a $18.5 million decrease in accounts receivable due to decreased revenues and improved cash collections, a $1.7 million increase in accounts payable and accrued liabilities due to decreased overall business activity, a $4.4 million increase in taxes payable due the timing of federal tax payments and a $1.6 million increase in prepaid expenses and other current assets due to an increase in overall business activity. Additionally, our net income included non-cash adjustments due to stock-based compensation, depreciation and amortization, increases to our provision for doubtful accounts

23


and write-downs for 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 $4.3 million .

Net cash provided by operating activities in the six months ended December 31, 2011 of $20.0 million consisted primarily of net income of $46.2 million partially offset by changes in operating assets and liabilities. These changes consisted primarily of a $22.2 million increase in accounts receivable due to our overall revenue growth, a $9.1 million increase in taxes payable, a $3.8 million increase in inventories, a $1.5 million decrease in accounts payable and accrued liabilities, a $1.0 million decrease in prepaid expenses and other current assets and an increase of $608,000 in deferred revenues and deferred cost of revenues. 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 a reduction of our net cash provided by operating activities of $9.4 million .
Cash Flows from Investing Activities
Our investing activities consist solely of capital expenditures and purchases of intangible assets. Capital expenditures for the six months ended December 31, 2012 and 2011 were $2.6 million and $1.1 million , respectively. Additionally, we had cash outflows related to the purchase of intangible assets of $814,000 during the six months ended December 31, 2012 .
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. On August 7, 2012, we borrowed $20.8 million of term loans under the Term Loan Facility, and no borrowings remain available thereunder. On November 21, 2012, we borrowed $10.0 million under the Revolving Credit Facility. On December 20, 2012, we borrowed an additional $20.0 million under the Revolving Credit Facility, and $20.0 million remains available for borrowing thereunder.

The Loan Agreement contains customary affirmative and negative covenants, including covenants that limit or restrict our and
our subsidiaries’ ability to, among other things, incur indebtedness, grant liens, merge or consolidate, dispose of assets, pay
dividends or make distributions, make investments, make acquisitions, prepay certain indebtedness, change the nature of our or
its business, enter into certain transactions with affiliates, enter into restrictive agreements, and make capital expenditures, in
each case subject to customary exceptions for a credit facility of this size and type. We are also required to maintain a
minimum debt service coverage ratio, a maximum leverage ratio, and a minimum liquidity ratio. As of December 31, 2012, we
were in compliance with all affirmative and negative covenants, debt service coverage ratio, leverage ratio and minimum level
of liquidity requirements.
On August 9, 2012, we announced that our Board of Directors authorized us to repurchase up to $100.0 million of our common stock. The share repurchase program commenced August 13, 2012. During the six months ended December 31, 2012 we repurchased 5,159,050 shares for a total cost of $54.4 million .

On December 14, 2012, we announced that our Board of Directors had authorized a special cash dividend of $0.18 per share for each share of common stock outstanding on December 24, 2012. The aggregate dividend payment of $15.7 million was paid on December 28, 2012 to stockholders of record on December 24, 2012.

In July 2011, we repurchased an aggregate of 12,041,700 shares of our Series A preferred stock from entities affiliated with Summit Partners, L.P., one of our major stockholders, at a price of $8.97 per share for an aggregate consideration of $108.0 million. Of the aggregate purchase price, $40.0 million was paid in cash at the time of closing and the balance of the shares were paid for through the issuance of convertible subordinated promissory notes in the aggregate principal amount of $68.0 million. On September 15, 2011, $34.0 million was paid against the notes reducing the aggregate principal amount outstanding to $34.0 million.
On September 15, 2011, we entered into a Loan and Security Agreement with East West Bank, (the “EWB Loan Agreement”). The EWB Loan Agreement consisted of a $35.0 million term loan facility and a $5.0 million revolving line of credit facility. The term loan was scheduled to mature on September 15, 2016 with principal and interest to be repaid in 60 monthly installments. During the three months ended September 30, 2011, we used $34.0 million of the term loan to repay a portion of

24


our outstanding convertible subordinated promissory notes held by entities affiliated with Summit Partners, L.P. The EWB Agreement was replaced by the Loan Agreement on August 7, 2012 as discussed above.
Liquidity
We believe our existing cash and cash equivalents, cash provided by operations and the availability of additional funds under our loan agreements will be sufficient to meet our working capital and capital expenditure needs for at least the next 12 months. Our future capital requirements may vary materially from those currently planned and will depend on many factors, including our rate of revenue growth, the timing and extent of spending to support development efforts, the timing of new product introductions, market acceptance of our products and overall economic conditions. As of December 31, 2012 , we held $141.1 million of our $148.3 million of cash and cash equivalents in accounts of our subsidiaries outside of the United States and we will incur significant tax liabilities if we decide to repatriate those amounts.
Commitments and Contingencies
In January 2011, the U.S. Department of Commerce’s Bureau of Industry and Security’s Office of Export Enforcement (“OEE”) contacted us to request that we provide information related to our relationship with a logistics company in the United Arab Emirates (“UAE”) and with a company in Iran, as well as information on the export classification of our products. As a result of this inquiry we, assisted by outside counsel, conducted a review of our export transactions from 2008 through March 2011 to not only gather information responsive to the OEE’s request but also to review our overall compliance with export control and sanctions laws. We believe our products have been sold into Iran by third parties. We do not believe that we directly sold, exported or shipped our products into Iran or any other country subject to a U.S. embargo. However, until early 2010, we did not prohibit our distributors from selling our products into Iran or any other country subject to a U.S. embargo. In the course of this review we identified that two distributors may have sold Ubiquiti products into Iran. Our review also found that while we had obtained required Commodity Classification Rulings for our products in June 2010 and November 2010, we did not advise our shipping personnel to change the export authorizations used on our shipping documents until February 2011. During the course of our export control review, we also determined that we had failed to maintain adequate records for the five year period required by the EAR and the sanctions regulations due to our lack of infrastructure and because it was prior to our transition to our current system of record, NetSuite. See “ Risk Factors—We are subject to numerous U.S. export control and economic sanctions laws and a substantial majority of our sales are into countries outside of the United States. Although we did not intend to do so, we have violated certain of these laws in the past, and we cannot currently assess the nature and extent of any fines or other penalties, if any, that U.S. governmental agencies may impose against us or our employees for any such violations. Any fines, if materially different from our estimates, or other penalties, could have a material adverse effect on our business and financial results.
In May 2011, we filed a self-disclosure statement with the BIS and the OEE and, in June 2011 we filed a self-disclosure statement with the U.S. Department of the Treasury’s Office of Foreign Asset Control (“OFAC”), regarding the compliance issues noted above. The disclosures address the above described findings and the remedial actions we have taken to date. However, the findings also indicate that both distributors continued to sell, directly or indirectly, our products into Iran during the period from February 2010 through March 2011 and that we received various communications from them indicating that they were continuing to do so. Since January 2011, we have cooperated with OEE and, prior to our disclosure filing, we informally shared with the OEE the substance of our findings with respect to both distributors. From May 2011 to August 2011, we provided additional information regarding our review and our findings to OEE to facilitate its investigation and OEE advised us in August 2011 that it had completed its investigation of us. In August 2011, we received a warning letter from OEE stating that OEE had not referred the findings of our review for criminal or administrative prosecution of us and closed the investigation of us without penalty.
OFAC is still reviewing our voluntary disclosure. In our submission, we have provided OFAC with an explanation of the activities that led to the sales of our products in Iran and the failure to comply with the EAR and OFAC sanctions. Although our OFAC and OEE voluntary disclosures covered similar sets of facts, which led OEE to resolve the case with the issuance of a warning letter, OFAC may conclude that our actions resulted in violations of U.S. export control and economic sanctions laws and warrant the imposition of penalties that could include fines, termination of our ability to export our products and/or referral for criminal prosecution. Any such fines may be material to our financial results in the period in which they are imposed. The penalties may be imposed against us and/or our management. The maximum civil monetary penalty for the violations is up to $250,000 or twice the value of the transaction, whichever is greater, per violation. Also, disclosure of our conduct and any fines or other action relating to this conduct could harm our reputation and indirectly have a material adverse effect on our business. We cannot predict when OFAC will complete its review or decide upon the imposition of possible penalties.

While we have now taken actions to ensure that export classification information is distributed to the appropriate personnel in a timely manner and have adopted policies and procedures to promote our compliance with these laws and regulations, including

25


obtaining written distribution agreements with substantially all of our distributors that contain covenants requiring compliance with U.S. export control and economic sanctions law; notifying all of our distributors of their obligations and obtaining updated distribution agreements from distributors that account for over 99% of our revenue in fiscal 2012. Our failure to amend all our distribution agreements and to implement more robust compliance controls immediately after the discovery of Iran-related sales activity in early 2010 may be aggravating factors that could impact the imposition of penalties imposed on us or our management. Based on the facts known to us to date, we recorded an expense of $1.6 million for this export compliance matter in fiscal 2010, which represents management’s estimated exposure for fines in accordance with applicable accounting literature. This amount was calculated from information discovered through our internal review and we deem this loss to be probable and reasonably estimable. However, we believe that it is reasonably possible that the loss may be higher, but we cannot reasonably estimate the range of any further potential losses. Specific information has come to our attention and as we cannot estimate any further range of possible losses. Should additional facts be discovered in the future and/or should actual fines or other penalties substantially differ from our estimates, our business, financial condition, cash flows and results of operations would be materially negatively impacted.
Warranties and Indemnifications
Our products are generally accompanied by a 12 month warranty, which covers both parts and labor. Generally the distributor is responsible for the freight costs associated with warranty returns, and we absorb the freight costs of replacing items under warranty. In accordance with the Financial Accounting Standards Board’s (“FASB’s”), Accounting Standards Codification (“ASC”), 450-30, Loss Contingencies, we record an accrual when we believe it is estimable and probable based upon historical experience. We record a provision for estimated future warranty work in cost of goods sold upon recognition of revenues and we review the resulting accrual regularly and periodically adjust it to reflect changes in warranty estimates.
We may in the future enter into standard indemnification agreements with many of our distributors and OEMs, as well as certain other business partners in the ordinary course of business. These agreements may include provisions for indemnifying the distributor, OEM or other business partner against any claim brought by a third party to the extent any such claim alleges that a Ubiquiti product infringes a patent, copyright or trademark or violates any other proprietary rights of that third party. The maximum amount of potential future indemnification is unlimited. The maximum potential amount of future payments we could be required to make under these indemnification agreements is not estimable.
We have agreed to indemnify our directors, officers and certain other employees for certain events or occurrences, subject to certain limits, while such persons are or were serving at our request in such capacity. We may terminate the indemnification agreements with these persons upon the termination of their services with us but termination will not affect claims for indemnification related to events occurring prior to the effective date of termination. The maximum amount of potential future indemnification is unlimited. We have a director and officer insurance policy that limits our potential exposure. We believe the fair value of these indemnification agreements is minimal. We had not recorded any liabilities for these agreements as of December 31, 2012 or 2011 .
Based upon our historical experience and information known as of the date of this report, we do not believe it is likely that we will have significant liability for the above indemnities at December 31, 2012 .
Contractual Obligations and Off-Balance Sheet Arrangements
We lease our headquarters in San Jose, California and other locations worldwide under noncancelable operating leases that expire at various dates through fiscal 2017.

In December 2011, we entered into an agreement to lease approximately 64,512 square feet of office and research and development space located in San Jose, California, which we use as our corporate headquarters. The lease term is from April 1, 2012, though June 30, 2017. The lease has been categorized as an operating lease, and the total estimated lease obligation is approximately $4.9 million.
On August 7, 2012, we entered into 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 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, and (ii) a $50.0 million Term Loan Facility. We may request borrowings under the Revolving Credit Facility until August 7, 2015. On August 7, 2012, we borrowed $20.8 million of term loans under the Term Loan Facility and no borrowings remain available thereunder. On November 21, 2012, we borrowed $10.0 million under the Revolving Credit Facility. On December 20, 2012 we borrowed an additional $20.0 million under the Revolving Credit Facility, and $20.0 million remains available for borrowing thereunder.


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The following table summarizes our contractual obligations as of December 31, 2012 :
 
2013
(remainder)
 
2014
 
2015
 
2016
 
2017
 
Thereafter
 
Total
Operating leases
$
750

 
$
1,505

 
$
1,4