NETGEAR Inc (NTGR) 2003 Q4 法說會逐字稿

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 star then the number one on your push button phone. As a reminder, this conference is being recorded. A replay will be available after 11:30 a.m. Eastern Standard Time today through midnight Eastern Standard Time on February 19th. The replay dial-in number is 1-706-645-9291. With passcode 5510650. The replay will also be accessible at www.NETGEAR.com. I would now like to turn the conference over to David Pasquale. Please go ahead, sir.

Thank you, Operator. Good morning and welcome to NETGEAR's fourth quarter results conference call. Joining us from the company are Patrick Lo, Chairman and Chief Executive Officer and Jonathan Mather, Chief Financial Officer. The format of the call will be a brief review of the business by Patrick followed by Jonathan providing 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 Lee of the Ruth Group at (646)536-7001 or 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 include 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 Patrick Lo. Please, go ahead, sir.

Thank you, David. Thank you, everyone, for joining us on today's call. The fourth quarter was yet another fantastic quarter for us and really marked the end of a remarkable year for NetGear. Our strong revenue growth and pro forma net income, margin expansion, exciting new product introductions and increased channel penetration all underscored the momentum in our business. We are really pushing hard to capture demand and our employees worldwide came through with an above-expectations quarter.

Overall, demand in our core markets remained strong. We continued to benefit from the strong increase and demand for ethernet switching, broadband, and wireless products. Shipment of wireless notes exceeded one million units in the fourth quarter for the first time in our history, representing a growth sequentially of aproximately 30% over the prior quarter.

Shipments of our wired and wireless broadband routers and gateways exceeded 675,000 units in fourth quarter, representing an increase of aproximately 45% over the prior third quarter of 2003. Sales of ethernet switches continues to be strong, growing 7% sequentially in units and dollars. Leading switch products included NetGear's gigabit and managed switches, including our popular smart switches.

In view of this unit shipment growth, we believe we again grew market share on a worldwide basis in the wireless products. The U.S. market was robust, as expected, due to strong holiday buying. We were also encouraged by the trends so far in the first quarter. As in the past, people tend to receive PCs around Christmas and then go ahead and buy the wireless network to put it in in January.

Our 54 megabits per second A02.11g wireless products and our 180 megabits per second Super G wireless products are well received. Based on end user sales reports in the U.S. we grew the dollar sales from November to December on these products 120% month-on-month. Much faster than any of our competitors in this most important and fast growing category of wireless products.

In Europe, we continued to roll out new products and expand our channel presence. Currently we have more than 11,000 active retailers in place and product in over 2,300 retail outlets in Europe. Our sales team is aggressively working to build us out further as we take advantage of attractive markets in Italy, Nordic and Spain.

Product-wise we are successful across the board in small business and consumer's world while they ride the wireless wave. One again, in Europe our DSL2 wired and wireless gateways are very well received. In terms of inventory turns, we ended the quarter with inventory at $39.3 million, representing 6.3 turns, compared to $33.4 million in Q3 and 6.5 turns. U.S. distribution channel inventory increased slightly over the prior third quarter.

U.S. retail inventory was essentially flat at the third quarter level. During the quarter, we announced major strategic alliances with some of the most exciting companies in the world, which I expected to help drive our growth. These included deals with both Legend in China and Soft Bend in Japan. Legend China, the largest IT enterprise in China will co-brand our full line of wired and wireless networking products to jump start the growing small office home office networking market in this region.

Today, NetGear products can be found in about 30 Legend stores and 100 other stores in China. Separately we entered into an agreement with Soft Bank BB Corp, one of Japan's largest broadband communications carrier and IT distributors for the exclusive distribution of NetGear's products in Japan. Currently, there are over 400 retail locations in Japan carrying our products. Both relationships will increase our brand awareness in the fast growing Asian region. We also continue to benefit from increased sales derived from our carrier channels with shipments to broadband service providers like Time-Warner Cable and Comcast in the U.S., Telecom Denmark, and Telstar in Australia. We are able to continue partnering with global market leaders based on our reputation in the industry for quality and innovation.

In terms of new product, we introduced another 12 new products in the fourth quarter. This brings our total for the year to 48. We expect to maintain or accelerate the pace in 2004. New products are critical to maintain price premiums in the market and to getting additional eye level shelf space at the retail stores.

Overall, revenue from products introduced ver the last 12 months accounted for about 55% of our revenue in the fourth quarter compared to 44% of revenue in the third quarter. Our products are hands down winners in the multiple categories at the recent Consumer Electronics Show in Las Vegas in January. We are pushing the line on innovation ahead of our competition, which we believe the market recognizes.

Our 180 megabits per second Super G wireless solutions, which are built on technology offering today the industry's fastest wireless speeds and furthest range, was first to market during the fourth quarter. We were awarded the best of innovation in networking and best of CES finalist in the Consumer Electronics Show for our Super G Supermedia Router to be introduced in March of this year.

In addition, we benefited from strong demand in Europe for our industry first ADSL, ADSL 2 plus, 802.11G 54 megabit per second wireless gateway. Our smart switch for the small businesses was very popular also around the world, giving small business easy control over the network through a familiar web browser interface. We believe these products with more new models coming out will contribute significantly to our future revenue and profitability growth.

Overall, we are entering the seasonally weaker first quarter with continued high confidence in our prospects. NetGearis generating an enormous amount of interest and excitement in the global market as we capitalize on our strong product strength and quality reputation. We have already announced several key new products in the first quarter for the next generation digital home including our MP101 wireless digital music player, the industry's first affordable and easy-to-use wireless network adaptor for home stereos.

And our WGT634 superwireless media router with a USB access to shared storage. These products are scheduled to ship in volume during the first quarter of 2004 together with additional newer models of our smart switches. These are just a few of the exciting innovative products that we have in the pipeline for 2004. Clearly, we have the financial strength and momentum in our business needed to further expand the breadth of our product and geographic reach as well as continuing to gain market share and grow profitability. Le me now turn the call over to Jonathan for details on our financials.

Thank you, Patrick. Let me now provide the summary of the financials for you. In terms of the fourth quarter 2003, net revenue on a year-over-year basis increased 20.7%, or $14.9 million to $86.8 million compared to $71.9 million for the quarter ended December 31, 2002. Sequentially, revenue increased aproximately 14.5% over the third quarter due to a strong increase in demand for ethernet switching, broadband and wireless products. For the full year 2003, net revenue totaled $299.3 million, a 26.1% increase over the full year 2002.

The Europe, Middle East, and Africa, EMA market or region, continues to be strong, achieving sequential net revenue growth over 31.2% to $31.8 million in the fourth quarter. Net revenues derived from the Asia Pacific region increased 44.6% sequentially to $7.8 million. Net revenue in North America grew 2.3% sequentially to $47.2 million. And a productivity basis the fourth quarter net revenue split between wireless and wired was 53 to 47. With wireless products tipping the scale in revenues.

The trend continues to build in wireless based on channel strength, end market demand and our product pipeline. On unit shipment, we shipped 1.8 million units in quarter four. A 13.5% increase over quarter three. Unit shipments of our ethernet products such as hubs, switches and network adaptors grew 1.5% to over 800,000 units. Our unit shipment in wired routers and firewalls grew 13% to about 210,000 units.

The shipment of all wired and wireless routers combined increased to 675,000 units. A 45% increase over quarter three of 2003. The shipment of all wireless notes grew 30%. This includes wireless routers and firewalls. Wireless cards, wireless access points grew 30% to close at 1.05 million notes. Our average selling price for both wired and wireless products grew slightly in quarter four over quarter three about 2%.

Cost of sales. Cost of sales came in at $61.5 million or 70.9% of sales which compares to $52.8 million or $73.4 million -- I'm sorry 73.4% in the year-ago period. Gross margin. Gross margin reached 29.1%. Let me repeat that. Gross margin reached 29.1% in the fourth quarter 2003 from 27.8% in the third quarter and from 26.6% in the year-ago fourth quarter. For the full year, gross margin improved to 28% as compared to 25.4% in 2002.

The improvement in gross margin both sequentially and year-over-year was due to increased volume leverage on our buying power, increased sales of our new products higher margins and an increased percentage of our sales from Europe which tends to be of a higher margin. Gross margin continues to improve and move towards our previously stated target of 30 plus percent. Moving to operating expenses.

Total operationing expenses excluding stock based compensation costs came in at $19.1 million compared to $14.1 million in the year-ago period and $16.9 million in the prior quarter. That was 22% of net revenue in the fourth quarter of 2003 as compared to 19.6% of net revenue in the fourth quarter of 2002 and 22.2% in the third quarter of 2003.

Sales and marketing expenses increased to 16% of net revenue in the fourth quarter of 2003 from 12.8% for the fourth quarter of 2002. The increase in sales and marketing expenses as a percentage of net revenue is due to investment in head count and tech support infrastructure for new markets such as Italy, Spain, Nordic, Japan and China. And increased expenses from print and web advertising around the world.

Compared to the third quarter, 2003, however, sales and marketing declined from 16.4% of net revenue. R&D expenses in quarter four 2003 were 2.6% of net revenue compared to 3.5% of net revenue in the year-ago previous. Primarily due to the lowering of product certification costs. At the same time, we are pleased that we were able to speed up the pace of new product introductions from 12 a quarter -- sorry from 10 a quarter to 12. And we are also able to expand our R&D head count by 15%.

Compared to quarter three of 2003, R&D remained essentially flat as a percentage of net revenue. G&A expenses in the fourth quarter increased to $2.9 million or 3.4% of net revenue from $2.4 million in the year-ago period and $2.4 million in the prior quarter. The increase was attributable to the impact of full quarters cost associated with being a public company as well as certain additional expenses such as R&D tax credit consulting.

Operating income. On a GAAP basis including the 490,000 in noncash stock based compensation expense came in at $5.8 million, compared to $3.7 in the third quarter 2003. And $4.5 million in the year-ago fourth quarter. This continues the trend of our positive operating income growth.

Net income. On a pro forma basis the quarter ended the fourth quarter ended 31st December 2003 increased 84.7% to $4.4 million as compared to $2.4 million pro forma net income for the quarter ended 31 December 2002 and was 15 cents per basic share and 14 cents per diluted share in the fourth quarter 2003 compared to 12 cents for basic and 10 cents per diluted in the fourth quarter 2002. I would like to note that for the purpose of calculating basic earnings per share we used 28,545,000 shares for quarter four 2003.

On a diluted basis, we used 31,657,000 shares for quarter four 2003. These share counts are 8 million above the quarter full count of 2002 due to our IPO in July of 2003. The fourth quarter 2002 pro forma income -- net income excludes the impact of 1.6 million benefits because of the change in the valuation on before tax assets arising from, among other factors, the utilization of NOLs and nonstock-based compensation expense of 580,000.

The fourth quarter 2003 pro forma net income excludes the noncash stock-based compensation expense of $490,000. On a GAAP basis, the company had a net income of $3.9 million or 14 cents of basic and 12 cents per diluted share for the fourth quarter of 2003 compared to net income of $3.4 million or 17 cents per basic and 15 cents per diluted share in the fourth quarter of 2002.

Both GAAP and pro forma net income for the fourth quarter 2003 include an income tax benefit of $612,000 or 2 cents per fully diluted share reported in connection with research and bill allotment tax credits claimable for the year ended December 31, 2003. In terms of modeling for this going forward we expect that this will receive similar R&D credit for the foreseeable future. The credit will be realized quarterly.

Taking this into consideration. the effective tax rate for each quarter in 2004 beginning with the first quarter, should be about 37.5%. Moving on to the balance sheet. We ended the the fourth quarter with $61.2 million in cash and cash equivalents, as well as $12.4 million in short-term investments totaling $73.6 million. We continue to manage our inventory closely with quarter ending inventory at 39.3 million representing 6.3 turns compared to 33.4 million and 6.5 turns at the end of of the third quarter.

Our accounts receivable was $74.9 million. DSOs was 81 days in the fourth quarter compared to 71 days in the prior quarter. Channel inventory increased slightly in the fourth quarter from prior quarter to 4.7 weeks in U.S. distribution channel and 7.8 weeks in the U.S. retail channel essentially flat over quarter three 2003. Total assets were $205.1 million at the end of December 31, 2003 compared to $187.1 million at September 28, 2003.

Accounts payable were at $24.5 million at December 2003 compared to $20.7 million in September 2003. Now, let me make a comment on the first quarter 2004. As Patrick said earlier, we feel very good in our outlook for the full year 2004.

Our goal is to grow faster than the market for the full year 2004. For the first quarter 2004, we expect revenues to grow aproximately 27% to 30% over the same period last year and in the range of $85 million to $88 million with pro forma operating income in the range of 7.1% to 7.5%. With that, operator, we would now be happy to take any questions.

At this time, I would like to remind everyone in order to ask a question, please press star then the number one on your telephone keypad. We will pause for just a moment to compile the Q&A roster. Your first question comes from Sam Wilson of JMP Securities.

Good morning. Just a few questions for you this morning. First, Patrick, can you give us an update in general on the Comcast trials that you expect to see this year, Wwere those stand and maybe where some of the milestones are. And then on Legend and Soft Bank, both in Japan and China, can you give us kind of an expectation, do you think that they're going to roll these out to more stores? I guess just what do you expect to see generally in terms of color over the next year. And then I have a few follow-up questions for Jonathan.

Let me answer the first question regarding the Comcast trial. I think they have been satisfied with the initial trial and they are moving into the deployment phase. We expect that the deployment is going to happen, starting to happen this quarter and we certainly expect them to roll them out on an expanded basis from here on out.

In terms of legend as we said in the press release and in my comments previously we are in 30 of their stores and we would expect that we gradually over the year will roll out to all of their stores which is numbered at about 200 and because of Legend's influence we been able to get into 100 other restill a stores in China which we expect at least double to triple through the course of this year.

In terms of Soft Bank, we are already over at 400 stores in Japan, retail stores. We expect to quickly get to 450 to 500. And also with Soft Bank we expect them, they would be able to expand our active reseller base in Japan as well. That is why we feel very, very bullish about our prospects in gaining shares in Asia as well as on a worldwide basis.

That is fantastic. Then, Jonathan, just a couple follow-up questions. I'm sorry if I missed, headcount. And then can you give me free cash flow from operations and Cap Ex and what your expectations are for Cap Ex this year?

For 2004?

Yes.

And Cap Ex as we said before, generally our capital expenditures requirements range in the $2.5 to $3 million. That is the general capital expenditure range. And with respect to this year, we are not giving any guidance for the full year, we are only providing guidance for the quarter. So with respect to the free cash flow what I can share with you is that compared to 2003 with the improvement in the -- as you can see in the first quarter and us having double digit growth over 20% we will expect to continue to see generation of cash.

Maybe I misstated that for the fourth quarter, the one you just completed, what was the cash flow from operations?

Cash flow from operations in the fourth quarter we generated in cash -- just a very quick one second. Let me just give that to you in a minute.

And then head count. And you can go on in the next question and fill it in, if you want, in between.

Okay. On cash flow from operations in the fourth quarter this year, we were at negative slightly of $2 million and that was mainly with respect to the receivables. The increase in the receiveables that resulted in negative cash flow from operations of $2 million.

Right, pretty evident your working capital went up for the quarter.

Right, right.

And then head count.

Head count we ended the year with 207. And let me add a point is something that we are very proud of is our statistic on revenue per employee. We averaged over 1,000,550 in 2003 for revenue per employee.

Looks like you are about to set a record for revenue per employee for the company. Congratulations. Thank you very much.

Thank you, Sam.

Your next question comes from Tim Luke of Lehman Brothers.

Nice job on the quarter. I was wondering with respect to it looks as if you are guiding our operating margins up again sequentially. I was wondering if you could talk about some of the elements that are going into the higher operating margins?

Should we assume that you think that the gross margin can go up again sequentially at the beginning of the year? And then I was also wondering, Patrick, if you could just talk about the balance between seasonality in the first quarter and then the new product momentum. It looks as if you are suggesting that the revenue may actually go up sequentially.

Tim, I would take the product side and I would leave Jonathan to talk on the gross margin side. From the product side as I mentioned previously as well as in the press release and the comment just now, the momentum on our more high-end products such as the 180 megaba bit per second superG wireless and the DSL2 gateway as well as the smart switches which all command a price premium over our competitors ordinary products continue to have strong momentum. So that would drive market share gain on our side.

As a matter of fact, you know, SRG, Synergy Research Group, yesterday came out with a press release saying that after their survey we had a year-on-year growth on wireless LAN products of about 92%. Number one in the industry. Much higher than anybody else. So we believe this momentum will continue. We also announced in the January consumer electronics show two very exciting products.

One is the digital music player which connects your stereo over Wi-Fi to your MP3 music, either stored in any one of your PC or streaming over the internet. The kind of reception we got from retailers around the world in all three continents are tremendous. We expect that to be very good revenue contribution.

And then the one that we got the best of innovation and networketing award in CES and the best of CES period finalist award is the supermedia router, which is 180 megabits per second Super G router with a USB port that you could plug a USB disk drive to store your photos, your music, your video for everybody in the home to share and you can even share it over the internet in the secured manner.

So, that again, we have tremendous reception around the world from retailers to put on their shelves and it we expect that to contribute to our revenues and because these are unique products they again command premium over our competitors. So we feel very strongly on our product line-up that we'll be able to offset the seasonality in Q1 which is generally weaker than Q4 but we should be able to gain market share to offset that. In terms of gross margin, Jonathan.

With respect to gross margin, Tim, first of all for 8 consecutive quarters from 2002 and 2003 you will note that we have continuously improved our gross margin and operating margin in especially the gross margin sequential improvement. Fourth quarter considerable improvement at 29.1%. To achieve the operating margin in quarter one, we feel we will definitely see or we feel we will get gross margin improvement as well as some leveraging of our operating expenses to achieve the guidance target that we just provided you.

I was also wondering, Patrick, if you could just give us some color on the regions. It looks like you obviously had a big uptick in Europe and Asia. The U.S. up less. Could you give us some comment, color as to why that was. And then also with respect to the channel inventory levels, you gave some color, it was flat in the U.S. and can you give us any color and what it was in Europe and Asia.

For us, we watched the channel inventory very carefully so we do not ship more than what the market can bear. And we just read the end market sales analysis report from the industry which indicated that in the U.S. the total networking market was flat Q4 over Q3. So, we grew 2.6% so we believe that we gained market share. We would love to gain, you know, a lot more.

But we have a little bit of shortage in the beginning of the quarter on our Super G products. Now, in Europe, clearly in Q3 we had a strong quarter already. However, the market grew even further in Q4 because in Q3 they were not skewed by some phenomenon called back to school in the U.S.

So naturally in Q4 the European market actually grew faster than the U.S. market and we are able to gain more market share in Europe on top of the market growth because of our DSL2 gateway. So that it the reason why you see differential in terms of sequential growth between the U.S. and Europe and in Asia and naturally we grew the fastest because of these new relationships that we built.

Could you give us some sense with the delay then in the release of volume shipments of the I think you suggested the Super G. Does that mean that you had additional sort of backlog as you move -- for that product as you move into the first quarter?

Which is -- you know, which is true just now I mentioned that we corrected the supply situation in December and we expanded in December our shelf presence for the Super G products. And that is why I just mentioned going from November to December we actually increased our G and Super G sales in the U.S. by 120%, faster than anybody else in the market and we continue to see that momentum.

What happens in the U.S. usually in the fourth quarter? Is the market usually flat or --

Actually, yes. You know, the market in the fourth quarter usually is, you know, growing anywhere between, you know, 3 to 5%. This year's flat because November according to the end user market report was actually smaller than expected probably due to weather.

Thanks.

Your next question comes from Anton Wahlman of Needham.

Hey, Patrick and Jonathan, can you hear me?

Yes. Hi, Anton, good morning.

Good morning. A couple of questions here. First of all, Jonathan did you hear you right when you said the tax rate was going to be 37.5% for each of the quarters in 2004?

That's right.

Okay. Also, I didn't hear you say, but maybe I'm getting old and whatnot half deaf and so forth, on the enterprise versus consumer, there was a lot of numbers but I'm not so sure I heard the total enterprise versus total consumer. Is that a number you are still giving out?

The consumer or the home segment as we referred to represents about 55% of our revenue.

Okay. All right.

And Anton, one other thing I want to clarify when I say the tax rate of 37.5% on pro forma income.

All right. So on pro forma income so one side would do.

Right.

Okay. On the fixed expenses finally I notice, of course, you talked about these tax preparation expenses and cost of being public. Any of that that is of a, you know, one-time nature or anything? G&A was up almost touching $3 million exclusive of the amortization of noncash compensation. I mean should we look at that being around a $3 million lever going forward or going down to the more than, you know, $2.5 million or below going forward.

It will -- the -- there is a one-time cost as you correctly pointed out the R&D tax project. This was the consulting. We are done and that is one-time cost of $120,000. Okay. The other than that, yes, we will start seeing leveraging of expenses and there is some timing but in 2004 we would see some consulting expenses such as the Sarbanes Oxley Section 404 project and the international tax restructuring that we have been talking about before. With those included we will continue to monitor and manage our costs to keep it in line and to get leverage out of the G&A expense.

Okay. All right. Well, Patrick. A couple of questions. First of all, in terms of the success of the ADSL router, is that primarily for your UK deployment or somewhere else?

No, actually it was well received in the UK, in France as well as in Germany. So it covers both NXA and NXC.

NXB?

NXB, yeah.

B in Germany?

Yes, B in Germany.

And A in the UK --

In the UK and France.

-- and France. In terms of your new wireless attached storage router product.

Yes.

You know, the way sounds when sort of you describe it I mean it sound like an easy thing to do. I mean, your sort of USB port sitting on the side of your essentially existing router chassis. I mean is there anything more to it than that or is that -- I mean obviously something a little bit but is it something that you expect to have a longer term or longer term is relative but some sort of most pieces of longer term advantage or do you expect everybody to quickly roll out competitive product there?

Yeah, it is technically feasible but I wouldn't characterize it as trivial for a couple of reasons. Because today you have to optimize the CPU utilization so it that will be able to handle both wireless traffic routing as well as the disk controller without blowing out the bottom cost.

Secondly, not only that it would let users to share storage in the house, it would let you to actually share it securely over the internet. So it is a very exciting product. Some unique features and certainly we expect that our competitors will follow the suit just like our Super G 180 megabits per second which is the software enhancement to our standard G which took our competitors about four months to catch up so we fully expect that our competitors will catch up in four to five months time but the leap in the market give us both the price premium as well as the market share advantage.

Yeah, okay. Thanks. Finally, just one thing on 802.11N as in Nancy, any thoughts on when the first products prestandards base or otherwise would be expected to hit the market, chip set availability et cetera.

The 802.11N standard is referring to a very high speed wireless product maybe over 200 or 300 megabits per second for in-home distribution. IEEE is still busy trying to work out a few technical issues such as whether it should be on 2.4 gigahertz band, should be on 5 gigahertz band, should they be double bonding or Channel et cetera. We do not believe the standard will be rectified in this year. Most likely sometime next year. But then the general principle of the inner working of this wireless standard is pretty well known and we expect for these standard chipsets to be available in the Q4 time frame this year and we are committed to be among the first to roll it out.

So you are saying you would expect to see chips available to you sort of early prestandards based stuff that you can make some early product of by the end of this calendar year at this point?

That is , right.

All right, thank you.

Thank you, Anton.

Once again, I would like to remind everyone in order to ask a question please press star then the number one on your telephone keypad. Your next question comes from Jeffrey Schlessinger of USB.

Actually Maynard for Jeffrey. Jonathan, you talked about the gross margin target of 30% plus. Is that an actual increase from your previous guidance? I don't know if it's nitpicking but I'm not sure if that plus was there prior. And also if you could talk about just the -- your channel sales in the U.S. if that has changed more towards the web or brick and mortar, et cetera. And one more on contra revenues. Maybe doing the calculation wrong but it looked as if contra revenues might have been up a little bit higher in the quarter. Could you just talk about that a little bit as well. Thanks.

The -- to answer the -- the three questions that you asked.

Right.

Right. The first one on gross margin. Patrick and I from the time of the IPO we have been talking about a target and at that time in July we talked about a long-term target of 30 to 33% gross margin. So we haven't changed our 30 to 33% target. And today we look at it as in the very near future that 30% plus. So, we are still driving the business to do better than 30% gross margin. I hope that answered you question.

You did, thanks.

Okay. The second question was with respect to the channel sales, correct? And there, yes, in quarter four we saw it shifting more towards the web and revenue in the -- in North America. The third question was what with respect to the contra revenue gain. In the fourth quarter there was a higher percentage of consumer selling and therefore there was a higher slightly higher increase in the promotional, the rebate type of activity and, yes, there was -- thus a contra revenue increase.

Okay. Thank you.

Your next question comes from Eric Sussinger of Pacific Growth Equities.

Good afternoon. Patrick, could you talk a minute about the channel inventory that you would have filled with Soft Bank and with Legend? The units that you were selling to them during the course of the quarter, is that turns business that get is used up during the course of the quarter or was there any, you know, one-time growth that is not going to be repeated as we go into future quarters?

Yes, that is a good question. Regarding to Legend, because we are only there for 30 stores so we are putting right now about five SKUs in each store so the inventory is pretty minimal. So we are definitely turning the inventory.

And Soft Bank?

Regarding in Japan we are in over 400 stores and currently we are putting about 8 SKUs per store. But, but given the fact that Q1 is the busiest quarter for Japan because that is the typical end of financial year and everybody gets bonus and all that we believe that the inventory will turn entirely in Q1 and we are seeing that trend.

And would you guess then -- then secondly on the Super G can you talk a little bit about the competitive environment? Do you see others that are going to be getting interested in developing products on that front or is that something that is probably going to remain a NetGear kind of unique product line?

As a matter of fact, we have already seen one of our competitors rolling out their superG products. So today you could buy Super G products from us or from one of our competitors. And us and our competitors combined, you know, have a pretty good significant market share on the wireless scene. So, you could argue that, you know, the bulk of the market is covered with that particular technology but certainly since we are first to market and we actually have very good quality, reputation, and given all the awards that we got. We got CNET award on our Super G products and we're also getting a laptop magazine award on the Super G product and we believe that we will be able to come in premium and market share advantage.

Does that imply that you had easily had more than half of the market share for the superG?

We believe so even though there is no final report out yet because our competitor just got into the market. And if you look at Q4 we probably have close to 100% of that particular segment.

Okay. Well, congratulations.

Thank you very much, Eric.

Your next question comes from Brad Byrd of Sandler.

All right. I think you may have just answered this, but what is the reason for -- two questions. First, what is the -- is the reason that your inventory is up slightly because you're filling these stores and on the same note is the AR up because you have more national sales and they are longer in paying? Because I would have expected it to come down after going up last quarter.

Le me take the first question in terms of Channel inventory. Actually the -- in the retail channel inventory is actually flat quarter over quarter. 7.8 weeks no, difference.

Okay.

And what we are slightly up was in the distributor inventory which is 4.7 weeks versus about 4 weeks in the prior quarter. The reason why in the distributor channel inventory going up is because that we knew that for the first week of this year, calendar year, we were going to shut down our warehouse for physical inventory check and we don't want our distributors to run out of stock so that's why we kind of shipped them a little bit more.

To answer the question on the receivables, this is Jonathan --

Yes.

The receivables end of the year because of the retail consumer segment increase to 56% in the fourth quarter due to Christmas season, lengthened the DSOs. However, we expect in the first quarter for it to come back down to the quarter three level.

Okay. So that -- that would mean that you expect -- the quarter three level was roughly 70 days.

71 days, yeah.

And so that is where your expect your DSO to sort of stay or --

That is where we expect it to come down in the next quarter.

What would be the target on it? I mean you sold a lot but you really didn't generate any cash and one reason was because you didn't collect. Is the suggestion that that is seasonal and that your retailers pay you after the close of their year?

Yes. The seasonality definitely has a major impact to the DSO.

Okay. And what would the target be?

Our target is to get to below 70 days.

Okay. Thank you.

Your next question comes from Todd Kaufman of Raymond James. Mr. Kaufman, your line is open. His question has been withdrawn. Your next question comes from Tim Luke of Lehman Brothers.

I just wanted to follow up and you may have touched on this earlier just on the inventory in Asia and Europe. How that might have looked.

Tim, this is Patrick. In terms of the inventory in Europe at the end of Q4, it was too tight. It was slightly below four weeks. And we are trying to correct that situation as quickly as we can. In terms of Asia, because we have yet to put in the system to collect the data in Asia yet and we expect that to happen by the middle of this year, so it is very rough estimate in Asia our channel inventory over there is still within the 4-6 weeks level.

All right, thanks.

Your next question comes from Jason Yellon of Covalt.

Hi, guys. Two questions for you actually. If I'm doing my math right I'm trying to understand it the 31% effective tax rate in Q4 pro forma versus the guidance you're giving for all the quarters in 2004 of 37.5%. Is the gross amount of the R&D tax credit coming down after the just completed quarter?

Yeah, the reason is in 2003 fourth quarter the 612,000 that we report to was the full year 2003 clearly taken in one quarter because we completed the project and got the signoff et cetera in the fourth quarter. Going forward we will take it each quarter.

That makes sense to me. Then my second question is I know you are loathe to talk about sort of full year 2004 guidance but should we be thinking about working capital in the aggregate as a source of cash or a use of cash is?

Again, you know, it is a function of growth, right, and we believe that we could stay, you know, within plus or minus a few percentage points. It is not like we are drawing up a lot of cash. We manage our inventory very tightly and closely and if you notice even our accounts payable is low.

We pay our vendors because we take benefit from discounts paying the vendors early and earning discounts et cetera, so our cash flow could be at break even.

Thank you.

Once again, if you have a question, please press star, then the number one on your telephone keypad. Your next question comes from Sam Wilson of JMP Securities.

Just one follow-up question for Patrick. Patrick, you know, this is the first quarter where Cisco was a competitor during the Christmas holiday season with the purchase of Linksys in the summer. I just want to get a sense from you, what you thought price competition was if there was any irrationality during the fourth quarter or if it's starting to show more rational behavior.

Actually, Sam, Cisco is being rational in term is of pricing and we are happy with that. But then on the other happened Cisco with the deep pockets we saw them, you know, paying a lot of money to buy shelf space. For example, they bid for the floor stack in Best Buy which significantly expands their shelf space in that particular store. And then from a pricing perspective, it is very rational among the major players but then, of course, you always have some really, you know, some players who do go on some very aggressive mail-in rebates, which is expected from every Christmas season.

Right. I'm not so concerned about those guys, they don't have the brands. I was just worried about the big brand names.

No, the big branded names have been, you know, all behaving very well.

Thank you, Patrick.

Your next question comes from Neil Gagnon of Gagnon Securities.

Good morning, Patrick.

Good morning, Neal.

Longer term, do you expect that these new arrangements that you are making ing, Soft Bank, Legend and others like it will be a bigger percent of the business and if so, what effect will that have?

Well, we certainly would like to move these strategic alliances to become a significant portion of our revenue and we are not just talking about Soft Bank or Legend, we are also talking about the carrier providers channel as well such as Time-Warner, Comcast, Telestra, Telecom Denmark, et cetera. And we believe that when we diversify our channel we would have a better leverage on our costs as well as a better ability to withstand seasonality.

How about cost of sales, cost of marketing when you --

Cost of marketing in sales, you're right.

What would be the change?

Then we would see if more of that going through we would see that the sales and marketing as a percentage of our revenue would come down.

Thank you.

Your next question comes from Doug Rodish of Brookside Capital.

It has been answered. Thanks very much.

Your next question comes from Mark Su of CE Unterberg.

This is Brian for Mark. I'm not sure if this has been asked yet, but you hedge for currency risk? And if not, there was any impact on this quarter from currency? Thanks.

Excuse me. Could you repeat that question?

Yeah, do you hedge for currency risk? And if not, was there any currency impact on this quarter?

We don't have a sophisticated currency hedging as such. However, we try to mitigate the currency exposure in Europe by, you know, and by, you know, making sure we the money for expenses in Europe as an example. But remember one other thing is that we do all our business in U.S. dollars. Most of our business in U.S. dollars. Okay. So with respect to the revenue, we ship an invoice in U.S. dollars. It is only the local expenses.

Thank you.

Once again, you would like to ask a question please press star then the number one on your telephone keypad. Your next question comes from Eric Sussinger of Pacific Growth Equities.

Patrick, can you comment on the smart switch, the competitive environment for the smart switches, have you seen equivalent products coming in to the market for that?

Funny, our competitors still have yet to catch up on that one. I know, we know that they are working on it. And it was kind of funny that we don't see them yet but I fully expect them to be there in about two-three months time. I don't know why it takes them so long.

And is that doing as you had been expecting? Is that one of the areas with where you are seeing some good uptick?

Yeah, I mean it is better than what we expected.

Very good.

Once again, if you would like to ask a question, please press star and the number one on your telephone keypad. I'm showing there are no further questions. Mr. Lo, there are any closing remarks?

No, I think Jonathan has come comments on the cash flow.

A question was asked about 2004 on cash flow. And while I didn't want to give any guidance, when I said break even -- in fact, we see positive cash free cash flow in 2004. So, it is better than break even is what we are projecting and we will manage our business to. Okay.

With that we would like to hand it back to the operator.

Operator.

Yes, sir.

With that, we would like to end the session.

Thank you. That concludes our conference call for today. You may now disconnect.