NETGEAR Inc (NTGR) 2004 Q2 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. (OPERATOR INSTRUCTIONS). As a reminder, this conference is being recorded today. A replay will be available after 8:30 PM Eastern Time today through midnight Eastern on August 5. The replay dial-in number is 973-341-3080, with the passcode of 4960605. The replay will also be accessible at www.NETGEAR.com. I would now like to turn the conference over to David Pasquale.

Thank you. Good afternoon, and welcome to NETGEAR's second-quarter results conference call. Joining us from the Company today 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 with 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 earnings release please call Moon Lee of the Ruth Group at 646-536-7001, or you can get a copy off of NETGEAR's website.

Before we begin the formal remarks, the Company's attorneys advise that today's conference call contains forward-looking statements. The forward-looking statements represent NETGEAR's expectation or beliefs concerning future events and they 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 and performance requirements of customers; the ability of NETGEAR to sell products incorporating new technologies; the impact and pricing of competing technologies; the introduction of alternative technological solutions; the ability 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 for joining us on today's call.

The second quarter of 2004 was another set solid quarter for us based on all metrics. Revenues increased 28 percent to $88.4 million compared to last year. Our gross margin again increased, hitting 32.1 percent, and our pro forma operating margin also improved to 8.9 percent.

Demand for our wireless, broadband and Ethernet switching products worldwide remained strong. This is a function of the overall health of the market and our competitive strength. As noted in the release, our core small-business market helped offset a seasonally-slower retail market as exemplified in our strong over 10 percent sequential revenue growth in our Ethernet switching products.

Our SmartSwitch, our gigabit switches and our managed switches all hit over 10 percent sequential revenue growth. We expect this momentum will continue well through the second half of this year. And on the retail front, we are entering the stronger second half. The third quarter is traditionally stronger at the U.S. retail due to back-to-school demand. We fully expect the same again this year.

Shipments of wireless nodes (ph) were approximately 1.1 million units in the second quarter, about the same as the first quarter despite a seasonal weak quarter two in consumer channels for the entire industry. Shipments of our wired and wireless broadband routers and gateways were also at similar levels compared to the first quarter of this year.

Sales of Ethernet switches to small businesses continued to be strong worldwide, growing 7 percent in units sequentially. Shipments of our popular SmartSwitches grew 16 (ph) percent sequentially in both units and dollars. Gigabit switches continue to grow robustly at over 60 percent sequentially in dollars, while customers are shifting from the 100 Mb technology to the gigabit technology. Our full function managed switches for small and medium-sized businesses, our FSM and GSM series also grew sequentially about 13 percent worldwide, and particularly strong in the U.S., growing about 28 percent sequentially.

On the new product front we remained very active, keeping to our target of 12 products a quarter. New products are key to our success as they give us pricing leverage and they can help build our brand equity, positioning NETGEAR as an innovative technology leader. We expect that the 24 new products introduced over the last two quarters will continue to accelerate their sales momentum, especially the new SmartSwitches, the new Super G wireless products and the new gigabit switches.

We also have an impressive lineup of 12 new products to be introduced in the third quarter, which we expect will have solid market reception, further powering our growth and market share gains in all regions in the quarters ahead.

Our revenue in the U.S. plus Europe total was roughly similar to Q1 of this year. Asia-Pacific region continued to be the fastest-growing region, up 11 percent sequentially. We believe we continue to gain market share on a global basis and are encouraged by the positive demand trends we are seeing.

The overall pricing environment in the market remains within our expectations. With the mix shifting to higher priced items, our overall ASP remained essentially flat both within the wireless product sets and the wired product sets. As we enter the third quarter, we remain very optimistic in our business prospects as we continue to execute on the extensive opportunities in our core small-business and home-users market. We are increasing our emphasis on several catalysts that will help accelerate our growth going forward. We are excited about the initial successes we have had globally in the service provider market, including the recent addition of Strato, a major Internet service provider in Germany, as a new customer.

The international market continues to be a strong source of growth for NETGEAR. We believe we continue to gain market share in Europe and our progress in Asia is encouraging, as evidenced by our 11 percent sequential revenue growth there. We are putting increased resources behind our effort in our carrier and international businesses, and expect these will be important emphasis for us over the next few years given the opportunities.

To sum up, we continue to execute in product innovations, channel expansions, and margin improvement. We have excellent prospects for growth, and we remain optimistic in our outlook for the second half of 2004.

Let me now 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. As Patrick said earlier, the second quarter 2004 net revenue increased 28.1 percent to 88.4 billion, compared to 69 million for the quarter ended June 29, 2003. Net revenue derived from Asia-Pacific region increased 11 percent sequentially to 9.3 million. Net revenue in North America declined 3.9 percent sequentially to 46.5 million, primarily because of seasonally-weak retail sales, which is a bigger portion of our U.S. revenue. The Europe, Middle East and Africa region increased 2.8 percent sequentially to 32.6 million.

On a product category basis, the second-quarter net revenue split between wireless and wired was 54 and 46 percent, respectively, in revenue, compared to 56 and 44 percent for the first quarter 2004. The trend in quarter three will favor wireless based on seasonality, end-market demand and our product pipeline.

On unit shipments, we shipped just over 1.8 million units in quarter two, a roughly 1.5 percent increase over the prior first quarter. Total unit shipments of our Ethernet products such as hubs, switches, and network adapters, increased about 1.5 percent in units and 10 percent in dollars.

Within the Ethernet product category we saw strong sequential growth in SmartSwitches, gigabit switches, and (indiscernible) switches, the FSM, GSM series. We continue to see declines in Ethernet adapter cards and hubs. The shipment of all wired and wireless routers combined declined slightly by 2 percent in units and dollars over quarter one 2004.

Cost of sales came in at 60 million, or 67.9 percent of sales, which compares to 49.9 million, or 72.4 percent in the year ago period. Gross margin exceeded our goal of 30 percent, reaching 32.1 percent in second quarter 2004, from 31.1 percent in the first quarter and from 27.6 percent in the year-ago second quarter. The improvement in gross margin both sequentially and year-over-year was again due to increased volume leverage in our buying power and operational efficiencies.

Moving to pro forma operating expenses. Total pro forma operating expenses, which excludes stock-based compensation costs, came in at 20.5 million compared to 15.4 million in the year ago period and 20.3 million in the prior quarter. This was 23.2 percent of net revenue in the second quarter of 2004 as compared to 22.3 percent of net revenue in the second quarter of 2003 and 22.9 percent in the first quarter of 2004. Sales and marketing expenses and R&D both remained level with the year-ago period.

G&A expenses in the second quarter increased to 3.2 million, or 3.6 percent of net revenue, from 1.8 million in the year-ago period and 3.2 million in the prior first quarter. Revenue per employee stayed above our target of 1.5 million in quarter two.

Operating income on a GAAP basis -- which includes 445,000 in non cash stock-based compensation expense -- came in at 7.4 million, compared to 6.8 million in the first quarter of 2004 and 3.3 million in the year-ago second quarter. This continues the trend of our positive operating income growth.

Net income. On a GAAP basis, the Company had net income of 4.9 million, or 16 cents per basic and 15 cents per diluted share for the second quarter of 2004, compared to net income of 11.5 million, or 57 cents per basic share and 48 cents per diluted share in the second quarter of 2003. Included in net income for the prior quarter was a 9.8 million -- sorry -- prior year quarter was a 9.8 million reversal of a deferred tax valuation allowance.

On a pro forma basis, net income from the second quarter ended June 27, 2004 increased 147 percent to 5.3 million, as compared to 2.2 billion (ph) pro forma net income for the quarter ended June 29, 2003. This represents earnings per share of 18 cents per basic share and 17 cents per diluted share in the second quarter of 2004, compared to 11 cents per basic and 9 cents diluted share in the second quarter of 2003.

I would like to note that for the purpose of calculating pro forma basic earnings per share, we used 30,367,000 shares for quarter two 2004. On a diluted basis, we used 32,238,000 shares for quarter two 2004. These share counts are 8 million above the quarter two count of 2003 due to our IPO in July 2003.

The second quarter of 2004 pro forma net income excludes a noncash stock-based compensation expense of 445,000. The second quarter of 2003 pro forma net income excludes the impact of noncash stock-based compensation expense of 422,000 and the 9.8 million reversal of deferred tax valuation allowance.

Moving on to the balance sheet. We ended the second quarter with 111.2 million in cash, cash equivalents and short-term investments, up from 89.5 million at the end of the first quarter. The increase is primarily due to cash generated from operating activities of 21 million.

In terms of inventory trends, we ended the quarter with inventory at 44.2 million representing 5.4 turns, compared to 39.1 million and 6.2 turns at the end of the first quarter 2004. The planned increase is due to seasonal inventory stocking in advance of the back-to-school season in the U.S.

Days sales outstanding -- DSOs -- improved to 69 days in the second quarter of 2004 compared to 71 days in the first quarter of 2004. European distribution channel inventory ended at about 4.4 weeks. The U.S. retail channel inventory was at 9.2 weeks, ready for back-to-school. U.S. distribution channel inventory was at 4.3 weeks. Total assets were 239.7 million June 27, 2004, compared to 219.1 million March 28, 2004.

Now let me comment on the third quarter. 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 third quarter 2004, we expect revenues to be in the range of 98 million to 101 million, with pro forma operating income in the range of 9 percent to 9.3 percent. We also note that the third quarter of 2004 will contain 14 weeks compared to 13 weeks in the second quarter of 2004.

Finally, we expect pro forma effective tax rates to remain at 37 percent. We believe we will continue to progress towards our operating income target of 10 percent by end of this year. We continue to benefit from the increased volume leverage in our business as we expand our gross margin and profitability. We remain (indiscernible) increasing return on shareholders equity and remain optimistic in our outlook.

Operator, we would now be happy to take any questions

(OPERATOR INSTRUCTIONS). Samuel Wilson, JMP Securities.

I hope you don't mind, I have a couple of questions for Patrick and a couple for Jonathan. First, Patrick, two questions. One -- can you give us a little update on China and Japan? I know you've got relationships with Softbank and with Legend there. And also you had kind of slowed development of distribution in Japan -- I'm sorry -- in China because of the wireless issues. Can you give us an update on that? And also, just a question about next quarter and spending. Going into the back-to-school season and Christmas season, how are you looking at increasing spending for advertising, co-op advertising, those kinds of things? I'll follow-up with a couple for Jonathan.

Thank you. The first question in terms of progress in Japan and China, we're making steady progress in both countries. And in Japan we continue to expand the shelf space in the existing stores that we're in. So in the past quarter our major focus is in expanding shelf space, and we're pleased with the progress. In China, you're right -- we took a little pause because of the WAPI (ph) situation. Since that's resolved, in the last quarter we are getting back into high gear and we're working very feverishly to try to expand our retail footprint in that particular market as well. And we expect results coming through in the next quarter or so. But in the meantime, we continue to see good progress in our revenue over there.

Regarding your second question on third quarter, certainly we expect that in the back-to-school as well as in the fourth quarter Christmas there will be a lot of promotional activities. There is no doubt about it. And we expect that this year would be the same. Advertising front -- we will continue to focus on print advertising, web advertising, as well as co-advertising with our channel partners on newspaper. Last year we did experiments on TV advertising on a regional basis. We might consider that again this year. But as you know all along, our accounting, all the co-op advertising is factored into our margin calculation already. So it shouldn't affect our guidance in terms of our operating margin.

Jonathan, just two questions for you. One is -- I know because of the end of the fiscal year you had made some changes to warranty, rebate and price protection provisions. I just want to see if you made any changes in Q2. And then also what was headcount?

To answer your first question, we did not make any changes. We have been consistent to what we said going back to quarter one, that we changed -- with only respect to warranty, not price protection, not any of those -- only with respect to warranty; just to re-clarify. In quarter one what we said was we changed the estimation of the number of months it takes for a product to come back as a warranty. And we have been consistent with that in this quarter. Okay? So that was your first question.

With respect to headcount, as we said, we have been operating around 240 employees, in that range. Each quarter we have been adding as we have been growing our business. But the key is that our average revenue per employee was above the target that we have set of 51,00,000; we were at about 1,530,000.

Tim Luke, Lehman Brothers.

Good job on the quarter, guys. You had particularly impressive growth margins going up by 100 basis points. Could you talk us through again how you do expect that to look going forward, and some of the elements in terms of maybe the mix, some of the things in the mix that contributed to that move upwards?

Tim, this is Patrick. Regarding the gross margin improvement in the past quarter, as we mentioned that the average selling price is pretty much flat over Q1. So we know -- if you look at any one particular SKU, the price, selling price has come down as we expected. But on the other hand, people are shifting to buying the higher-priced items, so the mix shifting towards the higher-priced items. That's why the average selling price when you take a totality remains flat. So going forward, we intend to continue to introduce newer products at higher price points so that we can maintain the average selling price constant as much as we possibly can. And that would help to significantly increase our revenue when the unit picks up. And once we increase the revenue, that gives us a lot of opportunity to leverage the expenses, especially in the period cost side, as well as the product purchase cost side. We have to say that in the last three quarters -- Q4, Q2, Q1 -- the revenue top-line is relatively the same. So the improvement in gross margin, we have been benefiting a lot in improvement in the period cost. Going forward, we believe that in the second half the quarterly revenue would jump up as our guidance indicates. Then again, it would present both period cost improvement as well as product cost purchase improvement. That's how we intend to continue to improve our margin.

Do you have a sense then -- I mean, this 32 percent level seems to be above where our (indiscernible) models were. Do you think that this is a level that could move up from here, or what do you think one should be thinking about in terms of a target longer-term gross margin?

We have reset our long-term goal since last quarter. Originally our long-term goal was 30 percent gross margin, and we have since the reset it to 33 percent.

The U.S. was weaker with seasonality this quarter. Do you expect all of the regions to move sequentially higher in the September quarter?

Yes, we do.

Could you also clarify the inventory levels (indiscernible) -- where were they in the prior quarters, and how would you expect them to look going forward in terms of the European disti (ph) and U.S. disti? And where was the U.S. retail channel in the prior quarter?

The U.S. distribution channel inventory last quarter ended at 6.2 weeks, and we have brought it down to 4.3 weeks, as we promised. And our target is always around 4 weeks, 4 to 4.5. For European it's the same situation. Last quarter we ended at about 4, and this quarter we're at 4.4. And U.S. retail inventory, last time it was at a low of 7.2 weeks, and this time because of back-to-school because of July 4 weekend stocking, we are now up to 9.2 weeks. Going forward, as we maintained, that we would like to keep the distribution inventory in any region as close to 4 weeks as possible, but certainly not lower than that because we know once we're lower than 4 weeks we will lose sales. And in the retail, we would like to keep it as close to 8 weeks as possible, but certainly not below 8 weeks because we will absolutely run the risk of stock-out -- thus, lose share. So that is still the guideline.

Any other observations on the competitive landscape or on pricing changes in the quarter?

In the pricing, it's pretty much well within expectation that our competitors all make a one price move on every SKU, which we expected fully. The competitive landscapes, actually, as you probably already have known, that Microsoft is finally checking out from the home networking market. And starting July they will not be on the shelves anymore in the U.S. They have not been on the shelves outside of the U.S. for the last two years. So you could argue they're one less competitor in that market. And also in the small, medium-sized business market, as we mentioned, 3Com is putting more emphasis going upstream. And we also see HP (indiscernible) the same thing going more upstream. So that's the competitive landscape.

Anton Wahlman, Needham & Co.

I wanted to just focus a little bit on new products, where -- what the world is going to see next, specifically first on the -- let's start on the wireless side with kind of the linear trajectory of things going from now. I guess G (ph) is the majority of shipments. But when do you think we'll get into -- whether it's E or I or N -- what is the timeline for these things hitting consumer store shelves?

You know, there is a lot of alphabetic soups, so I would like to kind of supplement it a little bit for people who don't quite understand it. From the WiFi standpoint, there is the feed and speed alphabetic soup. So it was started with B at 11 Mbps, and then it progresses to G, which is 54 Mbps. And the we introduced super G, which is 108 Mbps. We will continue to introduce new products that will push the envelope on both the speed, about 108, as well as the range. When we introduced super G, we basically doubled the range of coverage of our WiFi products; you would expect us to continue to boost that envelope in the coming quarters.

And the next IEEE standard that IEEE engineers are discussing are N -- 802.11 N -- which we expect that the standard will be pretty much wrapped up late next year. But certainly, we are making progress towards the end to bring those products to the market as quickly as possible. In terms of the other alphabetic soup, it is on the other elements of WiFi; for example like security element. The latest one being endorsed and rectified by IEEE is called 802.11-I, which makes WiFi a lot more secure than just pure WEP password. You will see us continue to roll out that capability across our product line. So those are the main elements that you would expect us to continue to push on the WiFi front, and on top of that you should expect us to roll out lines of voice over IP products in the coming quarters.

Okay. I was going to get into that. (indiscernible) just saw Motorola/Proxim came out with this thing the other day where they're really going to do a voice, primarily over .11-A from the beginning, more kind of an enterprise-type application. Is that along the same lines that you're thinking as well, or do you think that voice can now also be handled over traditional -- sort of the G trajectory?

We are taking a little bit different approach. We see today the voice implementation on the small business side are still preferred on a wired basis. So you will see us to continue to provide what we call quality of service capability on our switches that we would partner with the voice over IP equipment suppliers who would provide the voice over IP PBX and voice over IP phones. That's the strategy on the small business side. On the consumer side, we do believe that G and Super G will be good enough, because that's the most widely-used WiFi standard at homes. And we will provide our voice over IP products along that side.

So in terms of expanding the market there for your addressable sort of dollars of wallet, share of wallet, every time I go into Best Buy or Frye's (ph) or anything, you have a whole line of -- a whole set of shelves (indiscernible) product just with cordless phones. Do you think that that will be out before the end of 2004, or do you think that's an early -- more like an early 2005 event, to attack the market of cordless phone replacement with 802.11?

Again, we're taking two approaches. Over there we do not believe that everybody wants to replace, so our effort is to provide products, and certainly we're trying to do it before Christmas because that's the big buying season -- right? -- of converting your good old telephone to voice over IP capability, or bring our brand-new phones to replace your good old telephone to call over the Internet.

Okay. On two other fronts, very quickly on the media router that you started shipping some four or five months ago; has that been a relatively small volume product, even though people might have been happy with it? Has that been -- what kind of feedback and acceptance have you seen on the media router?

Certainly if you compare it to the mainstream G router or Super G router, it's relatively small volume. However, given the fact that it is at a much higher price point and there is no co-op advertising behind it, the reception has been tremendous, especially in Europe that we did not expect that it would be so well received. Starting soon, you will see us to be having core marketing activities with disk drive vendors to promote this product, and we fully expect this product will bring significant revenue stream to us in Q3.

A final forward-looking question here then on the products. You have, obviously, had a lot of publicity with the EMP 101, which has won I don't know many various awards. But the world is -- can handle video very easily, and there is content that is becoming available. Is it going to be a more aggressive strategy on taking that a few notches up with a he TV-capable product as well?

The first step that we are going to do on the video front is to follow the step we took on the audio front, which is basically to somehow introduce it together with content services. When we introduced the music player in the U.S., we introduced it together with Rhapsody, which is very successful. Then in Europe, because Rhapsody is not available over there, we introduced it with Vtuner, and it was also very successful. We'll take the same path, where we introduced the video version to make sure that we would have service providers to go with it at the same time.

So something like an Akimbo or something?

I cannot comment on that yet.

Stephen Koffler, Wachovia Securities.

I wanted to delve into some of the stuff that came out in various earnings reports, probably didn't escape your attention. It's always sensitive to talk about suppliers but this is all quite public. Both Connex and then Broadcom had clear commentary that at least for them, wireless LAN broadly speaking showed some kind of slowdown. That wasn't your experience. It was basically flat, down a little. And that was clearly within expectations vis-a-vis consumer market for Q2, etc. What do you make of those comments? Is there some shift in the supply chain? Is Taiwan doing much better? Is it product-related? What do you think of wireless LAN demand, and how do you square it with what we heard in the supply chain?

The interesting piece of our industry is that we are the one who is driving the innovation pace, so the innovative pace is coming very rapidly. One year ago, at this point in time, G was just introduced and B was to a major portion. And I believe, for example, Connex was a major player in B, and certainly part of G. But as we are speaking today, the B volume has significantly decreased and the Super G volume has actually taken over. And as you probably all know, the Super G technology is primarily coming out from (indiscernible). So you see the technology shift and then it benefits certain chip suppliers and it hurts certain chip suppliers. So in terms of Broadcom, I cannot really comment significantly, because we have not been using their chips until very recently.

I'd like to follow up quickly if I could. The way you describe the business really sounds like you have a very finite window of time where you can enjoy full price on new products. That is also, I would think, a pretty significant source of risk. You don't have to be too late to get in there and all of a sudden be having to sell at half-price -- correct?

The thing is it is not exactly 100 percent if you are early into the market, (indiscernible) only you enjoy, certainly the pricing power at the front-end, you actually enjoy pricing power throughout the lifecycle of the product, because you have established yourself as the leader. So for example, we have introduced the SmartSwitches for nine months. And even now we are seeing competition, we can still continue to maintain a premium. Not only that, because we have higher volume we can always enjoy an advantage in terms of cost. As a matter of fact, when competition comes in the market will expand, the pipe gets bigger, so overall volume gets bigger and the chips get cheaper. And then because we have the bigger volume, we will enjoy the bigger portion of that chip cost reduction. So it is not a significant risk when competition appears (ph), but you're right -- it certainly benefits us. We can always stay ahead in terms of technology introduction. But I think that basically is the name of the game for any product companies -- be it in beverage, be it in technology, be it in pharmaceuticals -- that product drives growth and profitability.

Let me just frame my last question this way. If you look at a category and you think you can come in first to market, what is your expectation about price declines in a year?

We have always maintained the fact that when competition starts to come in, first (indiscernible) you would expect that the price decline on the quarterly basis, around 7 percent. And then after what we call slug it out (ph) phase, that means winners and losers have been declared, then the price decline will slow down 3 to 5 percent. Then when we are the only game in town, then price won't decline anymore.

(OPERATOR INSTRUCTIONS). Vick Cura (ph), Piper Jaffray.

Nice quarter. I just have two quick questions. Jonathan, can you comment on the very strong uptick in the deferred revenue? And also, if you could tell us in a typical quarter how much of the recognized revenue really comes from the deferred revenue from the last quarter?

Let me just step back and explain how deferred revenue arises. There are two components to deferred revenue. The first component is with respect to channel inventory. Even though we as a company try to maintain and manage our channel inventory for distribution to be at four weeks in the United States in particular, or say retail in the U.S. of eight weeks, according to our accounting policy, if we have more than 12 weeks in retail, anything above 12 weeks will be deferred revenue. Similarly with respect to distribution, if there's anything more than eight weeks we defer the revenue. (indiscernible) in the 10-Q and the financials, you'll see as the accounting policy, we said that. So that's one component that can be included as deferred revenue because we won't recognize (indiscernible) revenue because it's over the 12 weeks and eight weeks.

Second component is we have -- when title passes, we recognize revenue when title passes, there are some of our customers who will take the product when it is received at their warehouse. So if we have shipped product let's say two days before our quarter ended, but we know it won't be received in their warehouse because that's when the title passes, or in place of international and the country of destination. Those revenues we don't recognize. So what happened in this quarter was that compared to last quarter was about a 1.6 million or so we had in the deferred revenue as I recollect, this quarter we had more shipments that we shipped in the last couple of days. We have the title passes when (indiscernible), so the title really (indiscernible) to mention the (indiscernible) so we don't recognize that as revenue, but defer it.

Mark Sue, RBC Capital Markets.

This is Brian Murakami for Mark. Your revenue guidance for the quarter is higher than Street consensus. Adjusting for seasonality, what product segments do you think we'll perform in the third quarter? And also, how do you see your competition such as Linksys and D-Link stacking up against you this quarter? What segments do you think you gained or lost market share? Thank you.

Don't give the third quarter because it's a very consumer-oriented quarter in the U.S. for back-to-school. We certainly believe that consumer SKUs would be benefiting us. For example, all the wireless products would be benefiting us. However, we see a significant momentum also on our switches' sales and our wireless sales into the small medium businesses as well. So we are also expecting good growth over there. And it's still hard to predict which one will come out on top. But both sides would have potential.

In terms of our competitive situation, as we mentioned we believe that we gained share. And as a matter of fact, from the reports from NPD which register the end user sales in the U.S., we did gain share in the U.S. in both the retail channel as well as channel-wide, including the e-commerce, the DMR (ph), including the reseller channel -- again, saw competition. In Europe, we also believe that we gained share, because we actually gained in revenue while the overall market is slightly down over there. So we believe that we continue to strengthen our position in both marketplaces.

Any idea against who you gained market share?

We believe that in Q2 in the U.S. we probably gained share the most from the weaker players such as Microsoft, who is actually checking out. But we believe that we might gain a little bit of share also from Linksys as well. In Europe, definitely we gained share against the weaker players. And we believe that we probably gained some share against (indiscernible) as well.

Eric Suppiger, Pacific Growth Equity.

Congratulations on a very good quarter. A few questions. First of all, your guidance for this quarter includes -- is assuming a 14-week quarter. Can you give us a little sense for how you factored that into your quarter? Should we assume a linear quarter, in which case we would add 7.7 -- we would assume that represents 7.7 percent of your revenue? How should we think about that, and how would that relate to the December quarter?

Let me step back by telling you yes, there's 14 weeks in this quarter, and for December it is almost 13 weeks. It's just short by two days, but it happens -- it's a weekend so it doesn't make a major impact to what we believe will be our shipments. Although we are not giving guidance for quarter four, I want you to be aware that it's 13 weeks less two days, but the two days are weekend. So it shouldn't have an impact on us.

Going back to the question on the 14 weeks. Basically again, I don't -- it's up to you how you build your model. We don't see -- the problem is the 14th week ends on the 2nd of October which is the first week, but the real impact of the back-to-school happens before that; it happens in September and August, etc., so that that one week shouldn't be a very strong week. We don't expect that to be a very strong week for you to do a linear calculation. Does that help?

So by that definition then, I should assume that the growth from the September to December quarter should be reasonably healthy? Is that correct?

We believe so, but we're not giving any guidance on the fourth quarter.

But it's not as though we should assume that the December quarter would be skewed down because it's a shorter time period?

We don't expect that.

Additionally, what was the mix between your consumer and your small-business products?

In Q2?

Yes.

In Q2 the consumer products represented 52 percent and the business products represented 48 percent.

Can you remind me what it was in Q1?

It was 56 percent for consumer and 44 for business.

And you had given us some data points on your channel inventory. If we look at it in aggregate -- first of all I just want to make sure -- you didn't include any -- in your deferred revenues you did not include any of your channel inventory because of going over the target range, did you?

No, there wasn't.

Okay. So if we look at the aggregate channel inventory, can you tell us whether that increased or decreased from the March quarter?

The overall channel inventory is about the same.

Any notable changes -- you didn't mention any -- about Asia? Is there anything we should consider about your Asian revenue?

No. Asia as we mentioned grew sequentially 11 percent, to our satisfaction.

I mean in the channel inventory.

We don't believe so. Even though we do not have electronic monitoring we do have manual monitoring, and they look healthy.

In the March quarter you had a higher rebate redemption, and you said you were going to evaluate whether that was going to be something that is sustained or not. So you took, I think, a $500,000 hit on your revenues for that. Did you come to any conclusions on that?

Again, what we said -- you're right, Eric -- is that quarter one -- based on the quarter one we felt that the redemption, that because -- from the beginning of the quarter, that it should be slightly higher. And (indiscernible) $450,000 reserve. We used about 30 percent of that, and we are still keeping to see how that pans out. So 30 percent of that was utilized in the subsequent period. But going back into quarter two, we update our estimations and we feel very comfortable with our estimations.

Last question. On your receivables -- you don't factor any receivables do you?

No.

Maynard Yum (ph), UBS.

Nice quarter. I had a quick question for you. I think last quarter you said that the split between wireline and wireless ASPs were pretty much same. And I look at the mix this quarter, where it was about 61 percent wireless and 39 percent on the other side. Were the ASPs in the wireless side decreasing and the ASPs in the wireline side increasing?

No. Actually, as we mentioned in our narrative just now, the ASP on the wired side remained pretty much flat, and on the wireless side also remained pretty much flat. And I don't know -- I think I didn't mention the split between wired and wireless. Oh, did you?

Yes.

(multiple speakers) in the call, right. This quarter the wired versus wireless is 54 percent wireless and 46 percent wired. And then last quarter it was 56 percent wireless and 44 percent wired.

You talked about Europe -- the European market being slightly down. Was that a seasonal thing or is there something else going on in that market?

It is seasonal. While we say there is new festivities in Q2, as a matter of fact in Europe is compounded by the fact that we have a lot of qualities in Q2 -- the Easter holiday and then some other holidays. So generally speaking, Q2 in Europe has much less selling days. And that's why it's seasonally weaker.

And then the third quarter, do you expect that given that that was down seasonally -- third quarter in Europe is generally usually a slower season as well.

An up quarter.

An up quarter? (multiple speakers) August being kind of -- everyone taking off in the month of August?

Don't say that; they only take off about two weeks to three weeks (multiple speakers) don't say that. So from a holiday standpoint, the number of holidays in Q3 in Europe is probably about the same as Q2. But then, people actually come back and buy very strongly after mid-August in Europe; that is traditionally the case.

Samuel Wilson, JMP Securities.

I'm surprised no one asked this so I will. Can you give us an update on the service provider channel? It looks like you announced two wins during the quarter. Are you at the front-end of kind of announcing more service provider wins as you do this?

I could not comment on that one, but we are progressing well in recruiting more service provider channel partners. Yes, you are right.

What percentage of business came through the service router channel? It was 5 last quarter.

It's still 5 percent this quarter.

But this continues to be a source of whatever? Spending on your part? I don't know how to say it. This continues to be a source of -- you're working hard on more sign-ups?

That's correct. We're working more on sign-ups in every single region, as well as to certainly increase the product portfolio offerings to a wider subscriber base to those accounts that we have signed up.

(OPERATOR INSTRUCTIONS). Stephen Koffler, Wachovia Securities.

Patrick, I would like to go into China a little bit more. There, it's quite accepted that China is very white box oriented, and it gets more white box the lower you go in terms of product category. Is there any evidence to you that that's changing, and that you have an opportunity to sell on brand?

Actually, it is changing. In China, actually the people are more brand conscious. The reason why that there was white box phenomenon before was because that you either have foreign brand and then you have white box. Nothing in between. Today, there is foreign brand and there is local brand. So the white box space gets squeezed. So for example, like in cell phones you have foreign brands such as Axiom, Motorola, Nokia -- the big three. But then they have local brands as well, such as Bird and TCL. In networking it's the same thing. You have the foreign brand like us, like Cisco, Linksys, like D-Link. Well, D-Link is considered a local brand. But then you also have the home-grown local brand in the SoHo consumer side, which is TP-Link, HP-Link, those brands locally.

But shouldn't -- I would think in cell phones, the emergence of those local brands actually created nothing but problems. How do you see it working in networking?

It is a problem for the incumbents. But for us we have nothing to begin with, so we're just gaining share, so we joined them to attack the incumbents.

At this time I'd like to turn the floor back over to Patrick Lo, CEO, for any closing comments.

Thank you. Once again, we're very pleased with the progress we made on all fronts in terms of products, in terms of channel, in terms of our efficiency, so that to march continuously towards our goal of hitting 33 percent gross margin and 10 percent operating margin. We would like to thank the investors and the confidence in us, as well as to take this opportunity to thank the team of the employees who have worked very hard over the last few quarters to continue to make progress. And once again, thank you for joining us today.

Thank you. That does conclude today's teleconference.