NETGEAR Inc (NTGR) 2003 Q3 法說會逐字稿

Ladies and gentlemen, thanks for standing by.

At this time all participants are in a listen-only mode. Later we will conduct a question and answer session. At that time, if you have a question, you will need to press the 1 followed by 4 on your push button phone. As a reminder, this conference is being recorded today. A replay will be available after 8 p.m. Eastern time today through midnight Eastern time on November 4th. The replay dial in number is (973)341-3080, with pass code 4222124. The replay will also be accessible at www.netgear.com.

I would now like to turn the conference over to David Pasqualle. Please go ahead, sir.

Thank you.

Good afternoon and welcome to NetGear's third quarter results conference call.

Joining us today from New York are Patrick Lo, Chairman and Chief Executive Officer and Jonathan Mather, Chief Financial Officer. The format of the call will be a brief business review by Patrick followed by Jonathan's (inaudible) detail on the financials. We will then have time for any questions.

If you have not yet received a copy of today's results, release please call Moon Leigh of the Ruth Group at (646)536-7021 or you can get a copy off of NetGear's website.

Before we begin the formal remarks, the company's attorneys advise that this conference call contains forward-looking statements. The forward-looking statements represent NetGear, Inc.'s expectations or beliefs concerning future events and includes statements, among others, regarding the expected performance, market acceptance, market growth, market position of NetGear and its products and technology. NetGear undertakes no duty to update these forward-looking statements. These statements are subject to risks and uncertainties including, without limitation, the price, performance requirements of customers, the ability of NetGear to sell products incorporating the technology, the impact and pricing of competing technologies, the introduction of alternative technological solutions, the inability of NetGear's new products to gain wide market acceptance and other risks detailed from time to time in NetGear's SEC filings and reports.

At this time I would now like to turn the call over to Patrick Lo. Please go ahead, sir.

Thank you, David.

Thank you, everyone, for joining us for today's earnings call.

I am pleased to report that Q3 was another strong quarter for NetGear based on revenue growth and pro forma net income, new product introductions and increased channel penetration. Our growth reflects a strong increase in demand for products such as ethernet switching, broadband routers and gateways and wireless products.

Our managed switches were very well received in the market, growing over 40%, quarter-over-quarter in shipments. Our unmanaged switches continue to grow in unit shipments in the upper single digits. Our DSL and cable modem router gateways were well received in the market around the world, especially the wireless version which grew double digit quarter-over-quarter.

Our total wireless unit shipment increased 27% sequential. In view of these unit shipment growths, we believe we grew market share on a worldwide basis in switches, in broadband routers and gateways and in over all wireless. The U.S. market, as expected, is having strong back-to-school promotional activities and robust sell-through in the retail and and web channels.

Based on the market reports that we have seen so far, we held share in the U.S. retail market. Sales in North America, other than driven by the robust back-to-school seasonal demand, is also receiving increased network infrastructure spending amount of small businesses, along with the federated consumer adoption of wireless technology.

In Europe, we believe our growth came from competitive market share gains due to our attractive consumer and small business product offerings and streams of our distribution and retail markets. For example, we entered another big retail chain, Auchen, in France.

As expected, revenues derived from other regions including the Asia Pacific, declined sequentially because the prior quarter Q2 was the region's seasonally strong second quarter.

In terms of inventory levels, we are pleased with the lower inventory that we have in the existing quarter at the end of Q3. And, actually, it came slightly lower than we would have liked to. In hindsight, we actually would have shipped a little bit more.

Usually we feel comfortable with four weeks of inventory at the distribution level and 8-10 weeks of retail inventory. We ended quarter three at three and a half weeks in inventory in U.S. distribution, three weeks in European distribution and 7.8 weeks in U.S. retail.

In general, the average selling price came in as expected with typical price erosion in the 7% range. ASPs declined actually similar rates, both in the wired and wireless products categories.

In terms of new initiatives, we continue to expand our penetration of the carrier channel. In the third quarter we increased shipments to Time-Warner Cable in the U.S. and Telewest in the U.K.. We also started initial shipments to Comcast in the U.S. during the second half of the third quarter. This is an important distribution channel for us given the aggressive broadband sales efforts of most carriers and respa adoption worldwide.

Since we are (inaudible) we will be able to gain shares if the over all market continues to expand. During the quarter, we also won over contracts from Telecom Denmark and Telska in Australia. We have begun shipment to them in October.

We also remain active on the new product front. This has been the a (inaudible) of our growth story from day one and our ability to integrate and commercialize networking products with small businesses and home users continues to differentiate NetGear. To give you a useful data point revenues from products introduced over the last 12 months constituted 44% of our revenue in the third quarter.

During the third quarter we introduced 12 new products. Among them will were two powerful new ethernet switches for the small business market. One switch enables businesses to manage the networks via simple screen on their preferred web browser. The other product is a (inaudible) gigabit layer three switch which augments our 24-port offering introduced in the second quarter in 2003. We expect good reception in the market for these two new switches.

We also introduced four industry-first home products in Q3. A super long range, super fast 180 megabits per second 802.11 G router and a corresponding PC card. Also, an industry-first USB 2.0, 54 megabits per second wireless 802.11 G card and, again, an industry-first DSL two-modem gateway which enables our customers to connect to the DSL network up to 24 megabits per second.

We are very pleased with these product introductions and have already experienced strong demand for all four of these home products which we believe will all contribute significantly to our future revenue growth. Over all, we are entering the seasonal strong fourth quarter and have high confidence in our prospects. We have the financial strength and momentum in our business needed to further expand the breadth of our products and geographic reach.

At this moment, let me turn the call over to Jonathan for details on our financials. Jonathan?

Thank you, Patrick.

Let me now provide a summary of the financials for you. In terms of the third quarter 2003 net revenue on a year-over-year basis increased 18%, or $11.4 million to $75.8 million, compared to $64.4 million for the quarter ended September 29th, 2002.

Sequentially, revenue increased approximately 10% over the second quarter due to a strong increase in demand for ethernet switching, broadband and wireless products. Reported net revenue in North America grew 8% sequentially to $46.2 million. Sales in North America are robust due to strong back-to-school seasonal activity in the retail and e-commerce channels.

In Europe, Middle East and Africa (inaudible) region achieved sequential net revenue growth of over 27% to $24.2 million due to, we believe, significant market share gains. As expected, revenue derived from other regions, including the Asia Pacific, declined 25% sequentially to $5.4 million, compared to the 7.2 in that region's seasonally strong second quarter.

Separately, worldwide sales derived from the carrier channel grew due to increased shipments to Time-Warner Cable in the U.S. and Telewest in the U.K. In addition, initial shipments to Comcast in the U.S. started during the second half of the third quarter.

On a product category basis the net revenue split between wireless and wired remained reasonably even in the third quarter with wired products still slightly higher in revenue. However, the trend continues to build in wireless base on channel strength, end market demand and our product pipeline.

On unit shipments, we shipped close to 1.6 million units in the third quarter, a 19% increase over quarter two. Our ethernet product such as hubs, switches and network adaptors units grew 18% to 600,000 units. Our unit shipment in wired routers and firewalls grew 7% to about 180,000 units. The shipment of all wireless products which includes wireless routers and firewalls, wireless cards, wireless access points grew 27% to close to $800,000.

We continue to see a reduction in our channel inventory. At the end of quarter three of a U.S. distribution channel inventory stood at 3.5 weeks compared to 3.2 weeks at the end of June and about 6.8 weeks a year-ago. U.S. retail inventory at the end of quarter three this year was at 7.8 weeks compared to 8.5 weeks at the end of June and was approximately 11 weeks at the end of September last year.

European distribution inventory was at three weeks at end of September this year. We realized that such channel inventory would be too thin and we expected to grow slightly in quarter four. Cost of sales came in at $54.7 million, or 72.2% of sales. Which compares to cost of sales of $48.2 million, or $74.9 million -- sorry, 74.9% of sales in the year-ago period. Gross margin reached 27.8% in the third quarter of 2003 from 27.6% in the second quarter and from 25.1% in the year-ago third quarter.

Compared to quarter three of last year, the improvement was due to a reduction in the air freight cost and lower inventory-related costs due to improved inventory management. Compared to quarter two, 2003, the improvement was primarily due to product -- reduced product costs and reduced inventory related expenses. Some of the improvements were offset as marketing expenses treated as contra-revenue increased as to simply just sales in the third quarter of 2003. Net-net, gross margin continues to improve and move towards our previously stated long-term target of 30% plus gross margin.

Moving to operating expenses. Total operating expenses came in at $17.3 million, compared to $13.2 million in the year-ago period and $15.7 million in the prior quarter. Overall, the total operating expenses including stock based compensation -- sorry, excluding stock based compensations 22% of net revenue in the third quarter of 2003 as compared to 20% of net revenue in the third quarter of 2002, and 22% in the second quarter. Sales and marketing expenses increased to 16.4% of net revenue in the third quarter of 2003 from 13.1% of net revenue for the third quarter of 2002.

The increase in sales and marketing, as a percentage of net revenue, is due to additional channel and promotion activities in the third quarter of 2003. Including joint print and television advertising with retail stores. Compared to last quarter, however, sales and marketing declined from 17% of net revenue in quarter two.

The increase in sales and marketing, as a percentage of net revenue, is due to additional channel and promotion activities in the third quarter of 2003. And $3 million a year-ago third quarter. This marks our 7th consecutive quarter of positive operating income.

Net income. Net income on a pro forma basis for the third quarter ended September 30, 2003, increased 62%, or $929,000 to $2.4 million, compared to $1.5 million pro forma net income for the quarter ended September, 2002, and 9 cents per basic share and 8 cents per diluted share in the third quarter of 2003, compared to 7 cents for basic and diluted share in the third quarter of 2002.

For purposes of calculating earnings per share we used 25,684,000 shares. On a diluted basis, we used 29,869,000 shares. The pro forma net income for the third quarter 2003 does not include an extinguishment of debt charge of $5.9 million and a noncash stock bid by compensation of $516,000.

The third quarter 2002 pro forma net income excludes the impact of $1.1 million benefit from net operating loss kickbacks carried forward utilized during that period and a noncash stock based compensation of $262,000. On a GAAP basis, the company had a net loss of $4 million, or 15 cents per diluted and basic share for the third quarter 2003, compared to net income of $2.3 million or 12 cents per basic share and 10 cents per diluted share in the third quarter of 2002.

Moving on to balance sheet. We ended the third quarter with $75.7 million in cash and cash equivalents. We continue to manage our inventory closely with quarter ending inventory at $33.4 million, representing 6.5 turns compared to $40.2 million and 5 turns at end of the second quarter.

Our accounts receivable was at $58.8 million. DSO days sales outstanding increased slightly from 69 days in the second quarter to 71 days at the end of the third quarter due to the non-(inaudible) of shipments during the quarter.

Channel inventory has been reduced in the third quarter from prior quarters to 3.5 weeks in the U.S. distribution channel and 7.8 weeks in the U.S. retail channel. Total assets were $187.1 million at the end of September, 2003, compared to $132 million at the end of second quarter, 2003.

Accounts payable was at $20.7 million as of September, 2003, compared to $30.2 million at June, 2003.

Now, let me take a moment on the fourth quarter, 2003. As noted in the press release, we are entering the seasonally strong fourth quarter with high confidence in our outlook. Based on very positive initial bookings from the channel partners, we believe our current momentum will continue through the fourth quarter. Specifically, we expect revenues for the quarter ending December 31, 2003, will be in the range of $79 million to $81 million.

Finally, we expect operating income to improve in the fourth quarter to a level in the range of 5.8% to 6.2%. For modeling purposes, you could use tax rate at 40.5 to 41%. Once again you could use the tax rate at 40.5 to 41%. However, on a GAAP basis, this equates to approximately 45.5 to 46.5%.

The chief stock charge is a large, nontax-deductible tax expense. Please note that. Also, we are using for quarter full in our earnings per share calculation. For basic shares at 28.5 million shares. And for diluted purposes, approximately 33.25, that is 33,250,000 shares.

¶ That concludes my comments.

Operator, we are now happy to take any questions.

Thank you. ¶ The floor is now open for questions. If you have a question, please press the number 1 followed by 4 on your touch tone phone. If at any point your question is answered, you may premove yourself from the queue by pressing the pound key.

Questions will be taken in the order in which they are received. We do ask that while you pose your question that you pick up your handset to provide the best sound quality. Thank you.

Our first question is coming from Tim Luke of Lehman Brothers.

Your line is live. Mr. Luke, your line is live.

Thank you. Tim Luke at Lehman Brothers.

I was wondering if you could just comment on the gross margin expectation, how you see going forward developing for the December quarter. It also looked like your deferred revenue was up a bit sequentially. If you could comment there.

And I was wondering with respect to Asia, which I think you said was lower in the quarter, what some of the elements were there. And how you see it for the calendar fourth quarter. ¶

Okay. The first question is with respect to gross margin.

We are not providing guidance on gross margin. We are only providing guidance on the net revenue and operating income. However, what I would share with you is that we have been working on cost expenses -- product cost expenses, et. cetera, and as you can see from prior quarters, that we always improved our gross margin.

We ended quarter three at 27.8% and we expect improvement in the fourth quarter in gross margin as a percentage.

Second question with respect to the deferred revenue.

In a accordance with our accounting policy, the deferred revenue use two components. One is if the channel has more than X weeks of inventory and, two, if we ship the product with the title is passes and the product is received at the recipient. In this particular quarter, we had to defer an additional couple of hundred thousand dollars and that is why the deferred revenue is at $2 million at the end of the quarter.

And then with respect to the regions (inaudible)you had the absolute numbers there that you could share with us and then just talk a little bit about Asia.

The Asia Pacific region, as we said, quarter two is the strongest quarter in the region and the revenue was strong and in quarter three dropped. However, we expect quarter four to go back to the quarter two levels or slightly better.

I would like to supplement that a little bit, Tim.

For the Asia Pacific right now on number one market, which is over 60-70% of our market revenue, is Australia and New Zealand and quarter two is their financial year end so that tends to be a very strong quarter for them and the reverse is true for quarter three all the push activities die down in quarter three and that is why we see that dropoff. But we expect that to recover in Q4 and we certainly see growth in Asia Pacific region going forward.

Patrick, you also said something about how you wished you could have had the inventory slightly lower and maybe you could have shipped more at end of the quarter.

Could you give some commentary there?

Yes, because you know, of course, we would like to always control our channel inventory.

Ideally, we would like to keep the distribution inventory at four weeks and then the retail inventory at 8-10 weeks. But seeing as the data is always lagging by a week so towards the end of the week then we try to ship appropriately and it looks like that we could have shipped a little bit more.

Thank you very much.

Thank you, Tim.

Thank you.

Our next question is coming from Jeffrey Schlesinger of UBS. Your line is live.

Thank you. Jeffrey Schlesinger of UBS.

Hi, Jeff.

A couple questions, if I could. One is sales and marketing in the quarter. It looked like you came in a little bit more than you had guided to. Where did you see the need for the promotions in the quarter across your segments? Give us some sense of where that incremental spend came from?

Jeffrey, your line was not very clear, but I think I understood it is about sales and marketing expenses and the question is why it was higher.

Two areas. One was on tech support to provide better service to our customers. We realized during the quarter that we had to spend more money in the tech support area, that was one. And then in the sales and customer marketing, more promotional activities to satisfy a market. So there was some sales and marketing with the additional revenue volume, too, that we got in quarter three.

To supplement what Jonathan just said, our European revenue was actually higher than originally planned and that is why we have to you know in the middle of the quarter significantly beef up our tech support infrastructure in Europe that caused the heightened marketing expenses higher than that what we originally guided.

Would you expect then as a percent of sales, sales and marketing should decline in the fourth quarter, if those spends are behind you now?

We -- we expect -- actually, if you look at the overall sales and marketing as a percent of the revenue, it has declined slightly from Q2 to Q3. Our target is continue to hold it flat and maybe down slightly but not significantly.

Okay. Patrick, if you -- hopefully you can hear me on this. The mix in the quarter across the three primary business units you addressed in the press release, ethernet, broadband, wireless. Can you give us a sense of the ASP in each of the divisions and how that moved sequentially and what your expectations would be given you know a lot of the new products you are ramping how that would translate to the fourth quarter? ¶

Yes, and you know, for comparative reasons we not like to did I divulge the ASPs on individual product category but on an overall basis, we could say that both the wired and wireless products ASPs are hovering in the low $60 region on a gross shipment basis. And we expect that to hold constant for the next two quarters.

Okay. That is helpful.

And lastly, if you could, on the mix, across the same three business units, how did that develop? I missed some of the earlier comments. How did that develop in the third quarter and how do you see that mix changing in the fourth quarter? And that would be great, thank you.

As we mentioned just now, the wired and wireless mix are pretty much 50/50 with the wired slightly higher. To be exact, it is something like 53/47 and we expect that to be continuously the wireless side and we expect that in Q4 it will be closer to 50/50.

Okay. And no breakdown on ethernet, broadband or --

You know, you could -- actually, we did in a way that because broadband is such a broad, you know, category because broadband has wired and wireless component in it as well so we didn't quite exactly break it down, but you could assume that a bulk of the wired product shipments are ethernet.

That is helpful. Thank you.

Thank you.

Once again, 1 followed by 4 for any questions at this time. Thank you,.

Our next question is coming from Tal Liani of Merrill Lynch. Your line is live.

Hi. Tal Liani.

Hi, Tal.

How are you?

Good, thanks.

I have a question. First of all, payables went down and I'm sorry I had problems throughout the question so I had to hang up and if you answered it just pass and I will listen to the replay, but payables went down if you could clarify it? And the second question is what was GAAP operating margin in the Q4 last year? Was it 6.2%?

Give me a minute to give you that answer.

The only reason I'm asking is on a non-GAAP basis, you had last year 7% operating margin. And you have given guidance this year for mid-point of 6%. And I'm trying to calculate the year-over-year comparison, but to compare apples to apples rather than to compare GAAP to pro forma.

Last year, to answer your first question, on a GAAP basis, the -- I'm sorry, one second, I'm looking at that time. Was 6.2%.

Okay.

Right. Operating income? Was 6.2%.

Okay.

That was your question. And the pro forma, I mean the pro forma was adding back the stock based compensation which accounted for .7%.

Right. And this year if I want to calculate pro forma, do I have only to add amortization of about $440 million, or thousand?

$440 million. Are you talking about stock based compensation?

Yes.

$516,000.

$516,000.

Yes.

Okay.

Roughly half a million.

Half a million dollars.

Yes, yes, half a million.

Right.

So if I add it back -- and that is my question -- if I add it back and compare, and I'm wrong with the analysis, just point me to where I'm wrong. If I added back and compare year-over-year pro forma it looks like there is a decline of 100 basis points year-over-year from about 7% to about 6.4 if I take sort of the high end. 6.4, 6.5.

Is this just because of the increased cost associate the with the IPO, or is there something else that is different this year, versus last year, when it comes to margins?

What you pointed out, coming out as a public company, yes, that's one. Two and also this guidance that we are giving on the range of the operating income (inaudible) as we said the public company. The other component is what we called earlier, sales and marketing expenses. From compared to last year, this year, quarter two was higher and quarter three we just talked of, but we have been trending, as we said, better or lower from quarter two to quarter three and, as Patrick mentioned earlier to a question, we expect it to be flat or slightly lower. However, compared to last year it is higher.

Okay. Are you still confident with your sort of not target, not guidance but maybe target of 10% operating margin next year?

As we said before, we are not giving guidance for next year. But what I will hold to is what we have said right along, long term, two to three year is down the road. Long term. Our target is to grow the company 15-20%, gross margin 30-33%, and operating margin 10-12%, but that is a two to three year guidelines and we haven't changed that.

And the consensus for next year if you look at the consensus estimates in the market the consensus expects 10% operating margin already in Q4 next year. Right? A year from now. So and you are discussing more the two to three year outlook. Would you say that the ramp from maybe 6% currently to 10% four quarters from now would it be too aggressive in the assumptions?

Tal, since we are not giving any guidance for 2004 I, therefore, -- we are giving only guidance for this quarter as well as I gave you the long-term which we have always said I prefer not commenting on that.

Okay.

We will give you more color in the next earnings call when we report the Q4 earnings.

Okay. Last, I have one question, just about the payables if you can -- if you explained it, don't repeat, otherwise why did payables go down?

A couple of reasons. One is if you notice at the end of quarter two the payables was in the high side and we stretched out payables and borrowed a lot of inventory in quarter two and that is why a lot of payables in quarter two. However, in quarter three you will notice the inventory level is coming down, we had reduced the purchases and timing of the purchases to meet the back-to-school demand in the first part of the quarter so the payables are due and we paid it on the due date in so that when did it came to the end of the quarter we had paid down the payables so to some extent maybe the payables paid a little too early.

Thank you.

Thank you, Tal.

Thank you.

Our next call is coming from Sam Wilson of JNP Securities. Your line is live.

Good afternoon, gentlemen.

Just a few questions for you.

The first thing I wanted to just follow up on Tal's question, but just to clarify the guidance of 5.8 to 6.2% operating margins for the fourth quarter. Is that on a GAAP basis or a pro forma basis? In other words, is that with the cheap stock charge or not?

It is on a pro forma basis.

Pro forma basis. Got it.

Yes.

Got it. And just a few follow up questions, also.

Can you give me some sense, Patrick, two things. One is how is Christmas selling season looking to you right now when you talk to the retail channels?

You know, the retail channels are all indicating positive outlook for our product lines for the Christmas selling season. So initial booking from them is very, very healthy. Very positive.

How is small and medium size business, how is kind of the environment out there? I know we have gotten mixed signals recently.

More medium sized business as we just indicated that we had registered across the board growth in the ethernet switching and wired firewall sales in Q3 and we see that momentum continuing in Q4.

So our conclusion is their purchase is healthy as well.

Do you think that is market share gains or do you think that is the end market actually growing in?

I think both. I think we have both market share gain as well as market growth.

Two last questions. One is can you comment a little bit on Comcast? You said you started shipping at the end of the quarter. What is that for? Is that all regions? What is the package they are selling, et cetera,, et cetera?

Well, I mean we -- only selling to two metropolitan area. So we are in the early roll out status. So, you know, it is a whole network that we install through the subscribers that elect to buy from them. We would like to see the result of these two trials and if it is positive roll out to other metropolitan area as well.

Would that be something ¶ you would expect first half ¶ '04, second half '04, when ¶ would you expect that?

We would expect that real revenue stream to come -- probably would come in the second quarter of next year. Significant revenue.

That is good. Normally you see that is the weakest quarter.

Yep.

And then Jonathan, one last question, cash flow from operations were you positive for the quarter?

No, because of working capital on the receivables.

Would you expect to be positive cash flow in the fourth quarter?

We are not providing any guidance on that. Difficult to tell you.

Okay.

Thank you.

Our next question is coming from Ryan Hutchinson of WR Hambrecht. Your line is live.

Great. Thank you. Good afternoon.

Just a follow up to Sam's question. In terms of the carrier channel strategy, can you provide a little more granularity in terms of the size of the volume shipments to each carrier, respectively, and I believe you talked about two new carrier wins in the quarter, (inaudible) and --

And I missed the last one. TeleDenmark.

Okay. If you could provide a little more granularity there in terms of what products you are selling into those carriers. And then I have a couple of quick house keeping questions. Thank you.

The products are primarily our wireless and wired modem router gateway which we integrate a DSL cable modem into a router and a firewall and, also, optionally, a wireless access point. So that is the product that we sell. We also sell the add-on wireless card, you know, for the PCs as well.

For competitive reasons, we do not want to breakdown the detailed sales revenue per carrier, but overall in Q3 the shipment of the carrier is roughly representing only about 4% of our revenue.

Okay. Any guidance in terms of what you are looking -- targeting one year out?

We certainly would expect one year out the percentage of our revenue to the carrier channel will be higher.

Okay. Great. Just a couple of quick follow ups.

In terms of the tax rate, what should we expect there in 2004? Is it similar to the fourth quarter?

The full year, we as we have talked about work only the international restructuring, we expect to see benefits from that in the second half of next year.

Okay. And then just a quick house keeping question in terms of employee head count. Could you just refresh my memory in terms of what you had at the end of June and then what you had at the end of September? And that is it. Thank you.

199 employees at end of June and 1 199 at end of September.

Okay. Thank you.

Thank you, Ryan.

Thank you.

Our next question is coming from Sandwid Wadwany of Piper Jaffray. Your line is live.

Thank you so much. Hi, Patrick.

Hi.

I have two quick questions. Is September quarter usually your strongest quarter compared to the third quarter? I think you mentioned this in the past and I wanted to clarify that.

Yes, definitely in every year the December quarter is the strongest quarter of the year.

Okay. And in terms of the carrier sales, how do you see gross margins for products that are going into the carrier market shaping up, versus what you sell, you know, either in your traditional retail or bar channels, any flavor on that?

Again, for competitive reasons I cannot give you specifics but on a general term I could give you some idea that the carrier channel would incur lesser selling costs than the retail channel because there is no coop marketing dollars involved and much lesser technical support costs because it is all preconfigured. And there is not channel inventory stock rotations per sey, so overall, the selling costs of that channel is much lower and you could defer I mean what the behavior will be in that channel.

So net-net even if you did conceivably have lower gross margins looks like the operating margins might come out to be pretty similar to corporate average then.

That is exactly the idea.

Got it. And then last , ADSL2 and ADSL2 plus, I know you had a product release a couple of days ago. Are you seeing actually carriers in the U.S. starting to talk about deploying that?

I missed the first part of the question.

For ADSL2 and ADSL2 plus, you guys just released some products recently.

Yes, yes.

Are you seeing carriers in the U.S. starting to talk about deploying that?

Well, certainly, actually, the DSL carrier in the U.S. is actually either deploying or talking about deploying it. I mean, for example, SBC is a very staunch supporter of DSL gateway router.

Unfortunately, we are almost exclusively two wires right now and working very hard to try to break into that channel in the United States.

Actually, Patrick my question was more in relation to the new product you recently released which is ADSL2 and---

Oh. That new product is primarily targeting the Asian and the European operators because those people are the first to roll out DSL II lines and the 24 megabits per second speed.

Got it, okay. Thanks so ¶ much.

Thank you.

Once again, that is 1 followed by 4 for any questions at this time. Thank you. Our next question is coming from Michael Genevieve of Smith Barney. Your line is live, sir.

Actually, this is Alex Henderson.

I was wondering if you could a little bit about the product plans relative to the digital media link market along the lines of what Linksys came out with with the WMA11B product and whether you are planning on extending the line to include some signal boosters for the G products in the near term or whether that will be out in time for Christmas.

Thank you, Alex.

First let me take on the entertainment what we call the home entertainment networking. We are taking a different approach from what the other people like (inaudible) or Linksys or Dell have been taking. What we are, going forward, is to actually provide simple use device that would link up directly your audio or video equipment onto the home network.

The first product that we intend to roll out before Christmas is an audio-only product. It would connect your stereo or your boom box through this box over wi-fi into your home network to play any MP3 music that you have either downloaded to any one of the PCs or streaming from the internet (inaudible). This particular, what we call digital music, player would have its own LCD display on the front panel controllable by a remote control so you don't have to connect it to a display device in order to control it. Much easier to use. And it is -- it is also lower in costs and it is a very simple because it is single function.

And we will follow that with a video version of it that connects directly to your TV or your home theater when there is enough legal video content on the internet. Today we also offer a gamer home network kit which could be either wireless over wi-fi could be B or G or even over the power electrical power wiring in your house, the wall wiring which is popular among the game console users so those are the ideas. We are expanding the home network to go beyond PCs on to the game consoles, on to the audio and then the video equipment.

So that is the first answer to the first question. In terms of the second question, we actually if you look at it carefully on the FCC rules, signal boosters can only be sold as a bundled component of a specified wireless products. So it is actually not exactly right to sell it as a separate product.

So that is not the approach that we are taking. Instead, we are strengthening the signal strength as well as the efficiency of the RF transmission on the existing products. For example, we just introduced our super G product which is selling very well right now in retail in Best Buy and (inaudible) and will soon be channel wide.

Our super G product has proven by some benchmark labs, as well as from our end users, to be very, very good in range and further more it supports maximum up to 108 megabits per second. That will be our answer to our customers because it is much simpler to install and also conforms with the FCC rules easily.

Along the same lines, given the rapid compression and G prices versus B prices, and the very narrow gap between the two, are you contemplating diminishing your product line complexity by phasing out any of your older B products or are you planning to continue to lug them?

You know, we have been in the business for seven years now. We have learned better to listen to the customers. So we cannot make that decision. We will let the customers make that decision. Today we do see a shift of our customers from B to G. For example, in Q1 and Q2 the ratio of G to B -- B to G purchase is more like 3 to 1 and in Q3 we have seen that ratio compressed to 2.5 to 1.

And going forward in Q4 we expect that to be 2 to 1 or maybe even 1.5 to 1, but there is still people buying the B product and as long as there are still people wanting them, we will support them and provide them. A great example is on the ethernet side, everybody was thinking a 10 megabit products are dead, but if you go to the retailers you will find we are still selling a lot of the 10 meg hubs. And actually, our $29.95 10 meg hubs is still outselling anybody's 5-port $39.99 100 meg switch.

Great, thanks.

Thank you.

Our next question is coming from A.J. Dwan of Selligman. You line is live.

Thank you. Can you comment on on the competitive environment specifically and tell us whether you think you lost any market share to Linksys in the quarter and also comment on competition from Asian vendors. Thank you.

Okay. From the marketship perspective, I think it is better to do market-by-market because every single market presents a different set of competitors. In the United States, in the home market, in the retail in particular, certainly Linksys is our number one competitor. And we looked at the latest reports from NT D and from the various angles, we think both us and Linksys hold share in Q3 versus Q2.

Now in the European market ,we believe we absolutely gained share because of our much faster than market sequential growth. In Asia Pacific, we believe that even though we show a decline in the revenue, we actually hold or maybe even gaining share in Australia. And certainly, in markets like China new to us for us anything is a gang of share. The only place that we believe that we lost share in Asia is Japan, which we have a small presence over there. But that is something that we absolutely would love to work on.

Who do you think you ¶ gained share from in Europe?

In the -- in the United States, we believe that in the retail segment because both Linksys and us hold share so we don't gain any share from anybody, or anybody gaining share from us, but in the small business world we believe we gained shares primarily from people such as D-link and 3Com.

And then in the European market we believe that we gained share basically against everybody, but Linksys did not exist in Europe, so believe (inaudible) share basically against the weaker brands such as SMC or Belkin in dealing over there. And in Australia the same scenario but they also have local brands and we believe we gained share over the local brands.

Interesting. Linksys doesn't sell in Europe right now? Have you seen, now that Cisco owns them, are they introducing product into Europe or what do you see from them?

They do sell in Europe, but the sales are so minimal in Europe and the only significant place they have significant sales is actually in the U.K., which is still small. So that's why they really don't have any significant market share to count on. Now with Cisco's purchase of Linksys, they are taking the first step, which is basically requesting the distributors to carry the Linksys products, and which they have successfully done, so but then the next step to take is to generate the market pool and build up the channel in the reselling of those products. We expect them to have a lot of activities in Q4 in that in Europe as well as in China.

Great. Thank you very much.

Thank you. Our next question is a follow up coming from Tim Luke of Lehman Brothers.

Patrick, I was just wondering if you could give the book-to-bill for the quarter?

We don't really have a keeping track of the become-to-bill ratio because, for us, we actually have to actually ship the moment we receive the order. Our customers demand us to, you know to turn around and ship them very shortly so any backlog of longer than a week would be unhealthy and we try to work it down as much as we can.

If that was I assume given the guidance and what you said about bookings that your visibility has improved?

You know, actually, as a matter of fact, we are seeing strong bookings in November and we are also seeing -- in October, and we are also shipping strong in October as well. So, but those bookings and shipments we believe is a little bit ahead of the sell-through in October so, apparent,y we seeing the trend for the market which is looking to a very robust November and December.

And could you, I think you gave Jeffrey the wireless ASP. I didn't catch wired ASP.

They are pretty much the same, in the low $60s.

And then one other thing, the contra-revenue that you have, versus do you have color on how that was this quarter, versus last quarter in the co-marketing expenses as a percentage of the revenue?

We don't provide that information, Tim, because give us the net revenue line. We don't provide the contra -revenue, the breakdown of the components that make up between gross shipments and net revenue.

It is a very competitively sensitive piece of data.

Okay. Good. Okay.

¶ Thanks a lot.

Thank you.

Our next question comes from Tal Liani of Merrill Lynch. Your line is live.

Hi. I have a follow up question on your carrier strategy. You mentioned two-wire and they forward price their equipment and they have a very low gross margin I mean in sort of mid teens level.

Right.

Do you see the same kind of pressure in DSL and cable modem territories? I mean are MSOs different from the wire line care carriers? That is one question.

And second question, you said you are trying to go into more wire line carriers such as SBC and will you also have to forward price the equipment?

Number one, I have no idea on what the terms of two wires and the pricing they are providing let alone the gross margins so I don't know how low is low. Could you give me color on that, Tal?

Yeah, I mean we sort of estimated based on discussions with the carriers that it is in the mid teens.

Okay.

15-17% gross margin.

We certainly are not in anywhere near that territory.

And as I explained before, our carrier shipment carries much less selling costs, but generally speaking the operating margin is in line with the rest of the other channels.

Okay. So you would not have to forward price -- all I'm not -- my question is more on sort of, first of all when you sell into a cable carrier and when you sell into a wired line carrier DSL territory, do you see the same pricing environment, or no?

You know, we certainly see a pricing environment which is negotiated. And we see the -- the margin structure different from the other channels. But, we are -- you know, either on a -- you know, we do have a pricing period let's say of three months or six months but we, don't forward price a year or so.

Okay.

And there is no contractual, you know, pricing. I mean, every now and then we gather together again to negotiate price.

Okay, great, thanks.

Thank you, Tal.

Thank you.

Our next question is coming from Sam Wilson of JMP Securities.

Just one follow up question on the inventory levels. You mentioned the inventory levels were less than what you had originally planned for. How do you see your need to purchase for the fourth quarter, vis-a-v inventory levels?

This is Jonathan, Sam. We are referring to the channel inventory and this is at the retail and distribution channels and that is what Patrick referred to. I was referring to the place we would like to be is distribution four weeks and retail eight, maybe due to seasonality, ten but we were below those at the end of September.

Typically what do you exit the year at? Do you target the high inventory levels at end of this quarter, the December quarter, or do you go lower because of the seasonal weakness in the first part of next year.

We would like to keep it at four and eight.

Okay. No matter what the time period?

As you say at the end of the strong fourth quarter.

All right. I mean going into the third and fourth quarter if we knew, you know we would love to see four and ten.

Got it, that's the answer ¶ I'm looking for.

Right.

Okay.

But distribution at any ¶ time we want to keep it at ¶ four.

Got it. Okay. Thank you.

Thank you, Sam.

Thank you.

I'm showing no further questions at this time. I will now turn the call back over to Patrick Lo for any closing comments.

Okay. Thank you, everyone, once again, for listening in to the conference call. We are very excited about what we have achieved in Q3 and we look forward to the strength if Q4 and we believe that we are continuing outpacing our competitors in introducing new products and we are very excited by the super G, super long range wireless products that we just introduced. Very well received in the market.

We were excited also recently and awarded by "PC World" magazine as the best 802.11g wireless product out there among all our competition. This continues to set us apart from our competitors in terms of providing the best value to our customers and providing the best products for your channel partners to push to increase the revenue.

With that, we are very confident going into Q4 and we look forward to, you know, seeing you all again in the next earnings call.. Thank you.

Thank you. That does conclude this evening's teleconference. You may disconnect your lines and have a wonderful day.