NETGEAR Inc (NTGR) 2004 Q3 法說會逐字稿

Ladies and gentlemen, thank you 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 star, followed by the number 1 on your push-button phone. As a reminder, this conference is being recorded today.

A replay will be available after 8:30 p.m. Eastern daylight time today through midnight Eastern daylight time on November 4th. The replay dial in number is 973-341-3080, with passcode 5245601. The replay will also be accessible at www.netgear.com. I would now like to turn over the conference over to David Pasquale. Please go ahead, sir.

Thank you, Operator. Good afternoon and welcome to NetGear's third quarter results 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 a brief business review 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 earnings release, please call [Sharon Loo] of the Ruth Group at 646-536-7026, or you can get a copy of the release off of NetGear's website.

Before we begin the formal remarks, the Company's attorney's advise that today's conference call contains forward-looking statements. The forward-looking statements represent NetGear'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 and performance requirements of customers; the actual price and performance of NetGear's products; 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, including, but not limited to those risks and uncertainties listed in the section entitled "Risk Factors Affecting Future Results," pages 20 to 29 in the Company's quarterly report on Form 10-Q for the fiscal quarter ended June 27, 2004, filed with the Securities and Exchange Commission on August 2004.

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 on today's call. The third quarter of 2004 was another solid quarter for us, based on our metrics. Revenues increased 34% to $101.2 million compared to the same period last year. We again were able to improve our non-GAAP operating margin sequentially by another 90 basis points to 9.8%, while maintaining our gross margin at 32.1%. As expected, inventory improved in all channels as we benefited from strong back-to-school sales in the U.S. and the continued adoption of wireless products worldwide.

We are very positive on Q4 and think that it should be another sequential growth quarter over Q3, due to normal seasonality and our new product roll out. We remain fully focused in this important period as we are targeting continued market share gains across all of our channels and geographies. Our enthusiasm is due to the fact that new products we have been rolling out have been well-received and gaining traction. For example, we think our recently introduced Double 108 Mbps wireless digital routers, wireless Digital Music Player would do well this holiday season.

We have definitely noticed the high media attention built around the adoption of the digital home, and we believe this attention is helping create customer demand. Overall, we remain aggressive in our channel expansion efforts worldwide. We talked on the last quarters call about the growth opportunity the internet service provider channel represents for us. I am pleased to report that in the third quarter we were able to increase this to 7% of our total revenue.

During the third quarter we added Charter Communications to our growing list of major service provider customers. We are working with other potential carrier partners and expect more positive news on this front over the next year. We are also excited about the steady progress we are making in Japan and China. We have expanded in over 230 stores in China and over 350 stores in Japan. We have also won over some prestigious installation such as [Chinghao] university and [Guangjou] university in China. Our introduction of the Super-G wireless products in Japan has enabled us to continue to gain retail market share over there.

Productwise, we are very excited about the growth opportunities in the Voice over IP area. Over the last few months we announced new relationships with Vonage and AT&T for broadband telephony products. This market will take time to evolve, but we feel very good about working with such strong partners. We are excited about the shipment of our first Voice over IP products to international market in Q3. Voice over IP represents the latest market extension for broadband wireless products, and is a positive situation for us. We expect that we can leverage the NetGear brand to gain a competitive advantage here. We have been investing in this market over the last few quarters to develop the products that will regularly tie-in and support the major carrier partners.

In terms of core product detail, we achieved 16% sequential revenue growth in our ethernet switching products, our Smart Switch, and our managed switches all hit over 70% sequential revenue growth. Our gigabit switches grew 26%, sequentially, accelerating the industries transition from 100 megabits to gigabits. We expect this momentum will continue through quarters ahead. We also expect a strong quarter on the retail front, as we enter the seasonally strong Q4 for the holiday season.

Shipment of wireless [inaudible] was slightly about 1.5 million units in the third quarter of 2004, 43% growth over the prior quarter. Shipments of our wired and wireless broadband router gateways were up 27% from second quarter to 820,000 units in the third quarter of this year. On the new product front we remained active, keeping to our target of 12 new products a quarter. New products are key to our success, as they give us pricing leverage and they help build brand equity, positioning NetGear as an innovative technology leader.

We have introduced 36 new product in the first nine months of 2004 with accelerating sales momentum, especially with our new Smart Switches, our Super-G wireless products, and the new gigabit switches. In quarter three we introduced the industry's first Super AG routers and adapters at dual 108 Mbps speed with a breakthrough[ XL] technology that can expand the WiFi coverage at homes for up to three times that of our competitor's normal 11-G products.

We also introduced the industry's first set of wireless products based on Autocell technology. This Autocell technology enables small businesses to build WiFi office networks, which automatically reconfigures itself to maximize throughput and minimize interference. It also provides the bonus feature of super privacy mode, which prevents unauthorized uses outside the office building to even discover the WiFi network. We also have an impressive lineup of more new products to be introduced in the fourth quarter which we expect will have solid market reception, further powering our growth and market share gains in all regions in the quarters ahead.

On a year-on-year basis, sales in North America were up 24%, with Europe, Middle East, and Africa, or EMEA, up 49 percent, and Asia Pacific region up 48%. On a sequential basis, the North America was up 23%, EMEA was up 11%, and Asia Pacific declined 14% due to seasonality. We believe we continue to gain market share on a global basis and are encouraged by the positive demand trends we are seeing.

Looking forward, we remain very optimistic. In fact, while the third quarter was strong for us, we think the fourth quarter should provide further revenue growth due to normal seasonality and new product roll-out. We continue to execute on the extensive opportunities in our core small business and home users market and remain well positioned for the holiday season. Now, let me turn over the call to Jonathan for details on our financials.

Thank you, Patrick. Let me now provide a summary of the financials for you. Please note for the purposes of this discussion that there were 14 weeks in the third quarter of 2004, as compared to 13 weeks in the second quarter of 2004 and the third quarter of 2003. As Patrick said earlier, the third quarter 2004 net revenue increased 34% to 101.2 million, compared to 75.8 million for the quarter ended September 28, 2003. Net revenue in the third quarter of 2004 derived from North America was 57.1 million. The Europe, Middle East and Africa region was 36.2 million, and the Asia Pacific region was 8 million.

On a product category basis, the quarter three net revenue, split between wireless and wired, was about 56 and 44% respectively, in revenue, compared to 54 and 46% for the second quarter of 2004. The trending quarter four will favor wireless based on seasonality, end-of-market demand, and our product line. The quarter three net revenue split between home and small business products was about 56% and 44%, respectively, as compared to 52 and 48% for the second quarter.

On unit shipments, we shipped just over 2.1 million units in quarter three, roughly 19% increase over the prior second quarter. Total unit shipments for internet products such as hubs, switches and network adapters, increased about 11% in units and 9% in dollars. Within the internet product category, we saw strong sequential growth in Smart Switches, gigabit switches, and fully-managed switches, the FSM/GSM series. We continue to see declines in internet adapter cards and hubs.

The shipment of all wired and wireless routers combined increased by about 20% in dollars or quarter two, 2004. Cost of sales came in at $68.7 million, or 67.9 percent of sales, which compares to $54.7 million, or 72.2% in the year-ago period. Gross margin in the third quarter was 32.1%, up substantially from 27.8% in the third quarter of 2003 and consistent with 32.1% in the second quarter 2004. The year-over-year improvement in gross margin was due to increased volume leverage in our buying power and operational efficiencies.

Moving to non-GAAP operating expenses. Total non-GAAP operating expenses, which excludes stock-based compensation costs, came in at 22.6 million, compared to 16.9 million in the year-ago period and 20.5 million in the prior quarter. This was 22.3% of net revenue in the third quarter of 2004, as compared to 22.2% of net revenue in the third quarter of 2003 and 23.2% in the second quarter of 2004.

Sales and marketing expenses increased to $15.4 million, which compares to $12.4 million in the year-ago period. As a percentage of net revenue, sales and marketing declined from 17% to 15.2% from quarter two to quarter three this year. In quarter three of last year it was 16.3%. Research and Development costs rose to 2.7 million from 2.1 million in the year-ago period. It was 2.7% of net revenue in quarter three this year, same as last year.

G&A expenses in third quarter increased to 4.4 million, or 4.4% of net revenue from 2.4 million in the year-ago period. and 3.2 million in the prior second quarter. It was 3.6% in quarter two of this year. A good part of the increase was attributed to extra costs associated with the Sarbanes-Oxley compliance implementation.

Operating income. Operating income on a GAAP basis, which excludes $452,000 in non-cash, stock-based compensation expense, came in at $9.5 million, compared to 7.4 million in the second quarter of 2004 and 3.7 million in the year-ago third quarter. This continues to trend of our positive operating income growth.

Net income. Net income on a GAAP basis for the Company had net income of $5.9 million, or 19 cents per basic and 18 cents per diluted share for the third quarter of 2004, compared to a net loss of 4 million, or 15 cents per basic share loss and diluted share in the third quarter of 2003. Included in net income for the prior-year quarter was an extinguishment of debt charge of 5.9 million, and non-cash, stock- based compensation expense of 516,000.

On a non-GAAP basis, net income for the third quarter ended October 3, 2004, increased 163% to $6.3 million, as compared to 2.4 million non-GAAP net income for the quarter ended September 28, 2003. This represents earnings per share of 21 cents per basic share, and 20 cents per diluted share in the third quarter of 2004, compared to 9 cents for basic and 8 cents per diluted share in the third quarter of 2003. I would like to note that for purposes of calculating non-GAAP basic earnings per share,we used 30,689,000 shares for quarter three 2004. On a diluted basis, we used 32,269,000 shares for quarter three 2004.

The third quarter of 2004 non-GAAP net income excludes a non-cash, stock-based compensation expense of $452,000. The non-GAAP net income for the third quarter of 2003 excludes the impact of an extinguishment of debt charge of 5.9 million, and a non-cash, stock-based compensation expense of 516,000.

Moving on to the balance sheet. We ended the third quarter with 118.6 million in cash, cash equivalents, and short term investments; up from 111.2 million at the end of the second quarter. The increase is primarily due to cash generated from operating activities. In terms of inventory trends, we ended the quarter with inventory of 40 -- we ended the quarter with inventory of 40.5 million, representing 6.8 turns, compared to 44.2 million, and 5.4 turns at the end of the second quarter 2004. Days sales outstanding, DSO, was 71 days in the third quarter of 2004, compared to 69 days in the second quarter of 2004.

European distribution channels inventory ended at 4.2 weeks. The U.S. retail channel inventory at 7.1 week. U.S. distribution channel inventory improved to 3.9 weeks, compared to 4.3 in the second quarter of 2004. Total assets were 250 million at October 3, 2004, compared to 239.7 million on June 27, 2004.

Now let me make a comment on the fourth quarter. As Patrick said earlier, we feel very good in our outlook for the full year 2004. Our goal is to grow faster than average industry growth. For the fourth quarter 2004, we expect revenues to be in the range of $107 million to $109 million, with non-GAAP operating income in the range of 9.9% to 10.2%. Finally, we expect non-GAAP effective tax rate to remain at 37%. As we enter the seasonally strong fourth quarter, the future of NetGear continues to look positive. We remain focused on increasing return on shareholders equity, and remain optimistic in our outlook.

Operator? We would now take questions.

Thank you. [Operator instructions.] Our first question comes from Samuel Wilson of JMP Securities.

Good afternoon, gentlemen, I hope you don't mind I'm going to ask you a few questions. First, for Patrick. Patrick, can you give us an update on what the competitive environment is like? In particular, can you give us an update on Linksys and their international expansion, and if you're seeing them more and more, or less, and just kind of how they are doing? And secondly, can you make a few comments on the pricing environment and how it behaved during back to school?

And then for Jonathan, just a few small questions. Can you give us headcount, cash from operations, and CapEx for the quarter? Thank you.

Okay. Hey, Sam. One question at a time. So first, about the competitive environment, especially related to Linksys. Overall, as we all know that Microsoft decided to exit the U.S. market, which is the only market that they participated in at the end of Q2. So after initial month or so, they completely checked out of the market. In Q3, you could say that the market has one less competitor. And as far as Linksys, the international drive has been going on for the last three quarters -- actually last four quarters, already -- we certainly see them everywhere in every single country that Cisco operates.

I believe that they have some success in certain areas and I think they continues to make progress ,but even with that environment we have been able to continue to gain share internationally, as you can see in our year-on-year growth. So we believe that with our strong product lineup, our brand, as well as our channel presence in the international market, I think we can be successful and they can be successful, too, at the same time.

In terms of the pricing environment, we don't see any particularly deviance from what we expect in Q3. So certainly, during the back to school season we certainly see a lot of promotions, which is normal in every year, and this year is no exception. So I believe the last question is to Jonathan.

Yeah. Hi, Sam. Three questions that you had, first is on headcount. We ended the quarter with 252 employees and again, still continuing to maintain or do better on our revenue per employee, which averaged over 1.6 million on an annualized basis in this quarter. Our cash flow from operations was $6.5 million was cash flow from operations in this quarter, and on capital expenditure we spent $689,000 in this quarter.

Thank you for letting me ask a bunch of questions.

Not a problem.

Thank you. Our next question comes from Tim Luke of Lehman Brothers.

Thanks. Congratulations on your quarter, Patrick and John.

That you.

I was wondering with respect to the regions, as you obviously, you're guiding up for the fourth quarter, is it better [inaudible] that all of the three regions would move upwards in the calendar fourth quarter?

And I was also wondering, Patrick, if you could just give a little color on your inventories [inaudible] when lower, and then your inventories in the channel also went lower. And I was wondering if you could talk about how you would see the inventories based in the channel, in Europe and North America and in [inaudible]in the fourth quarter, what your targets are there?

Yeah. So let me answer the first question. In terms of Q4, we would definitely expect growth in all regions, both sequentially and year-on-year because these days. Christmas has become a worldwide phenomenon. so we are pretty sure that's going to be happening.

Secondly. regarding on the inventory situation, September is a very strong month, but because of back to school, the tail end of it, but October, generally, is a very slow month. Soy that's why both ourselves and our channel partners are running down inventory. But starting probably by mid-October, everybody will stock up for Christmas sales. So we expect the channel inventory to run up all the way through until the crazy selling season starts by mid-November, and by the end of December the channeling inventory will come down.

However, it would be expected to be higher than at the end of September because January is a pretty strong month because of after Christmas sales. So that is the inventory trend that we are expecting.

So we should expect as you exit the fourth quarter both in Europe and the U.S. the inventory in the channel to be slightly higher?

Slightly higher, yep. Right.

And could you also, Jonathan, give us a little commentary on how you see -- should we expect a flat gross margin again? Is that implied by your guidance?

Yeah. We haven't shared with you the guidance on gross margin; we give you only operating margin. What we can say is our target in the company has always been to drive gross margin. We give a range 30 to 33%. So we will not talk at the 32.1, we will work towards the 33%.

Now, in the operating margin side, yes, we are looking to leverage expenses and, again, on the gross margin, we hope that we can achieve by making sure we get our product costs, et cetera, in line, to hopefully get some improvement there too.

Lastly, Patrick, I was wondering if you could just remind us of the size of the [V. C.] holdings and when they may or may not be part of a lock up? Thanks.

The last I looked is that there are two major V.C. shareholders, [Peakwood Capital] and [Shamrock Holdings.] Between the two of them, they combine -- hold about 7 million shares, and because both of them are on the board they are subject to trading windows and also subject to Rule 144.

Thank you, Patrick.

Sure.

Thank you. Our next question comes from [Mark Sue,] RBC Capital Markets.

Thank you. Jonathan, you said that you felt good about the future as you exit 2004, and Patrick, you said that January was going to be a strong month. Does that mean the March quarter can be up sequentially or do you think NetGear will still be impacted by seasonality in the March time frame?

Mark, we don't share guidance beyond quarter four this year. So we don't even talk about this quarter. So, sorry we can't comment on quarter one, 2005 at this stage.

Any qualitative comments at this stage as we exit October?

Again, our emphasis is this quarter that's the guidance we give. I mean, we feel very good about how we have exited quarter three and we feel good about our business.

And then if we look -- can you share with us your unit growth assumptions in your guidance for the December quarter, and maybe what we should be modeling in terms of ASP declines from the September to December time frame?

Typically, the ASP decline in the market is anywhere between 3 to 5% as we have been talking all along. But our objective, of course, if we can, by introducing higher priced product, is to slow down our ASP decline.

You still expect good unit growth, I would imagine, in the North American region in the December time frame?

It is very difficult to give a forecast down to the unit basis.

Okay. Well that's helpful. Thank you, gentlemen.

Thank you.

Thank you. Our next question comes from [Denise Fiallo of Merrill Lynch.]

Hi. Can you hear me?

Yes, yes. Denise, how are you?

Well, thank you. Congratulations, gentlemen. A couple of quick questions. I don't know if you had said on the call -- I didn't think I caught that -- new products as a percentage of your revenues this quarter in 3Q?

The new products that was introduced in the last 12 months constitute about 47% of our revenue. New products that was introduced in the last 15 months constitute 63% of our revenue.

Okay. Great. And just with regard to your Q4 outlook, it seems to be a lot of strength going into the holiday season. But could you give us some ideas on how you are seeing small enterprise demand, what you are hearing from your distributors?

We believe that the small enterprise continue to grow as we have always been maintaining, but we believe that we are growing faster than the market because of the new products that we introduced. As we mentioned, we pioneered the Smart Switch category, which we are basically are very up front leader in that area.

And our recent introduction of the layer three managed switches, especially on the gigabit front, is also way ahead of our competition, so we believe that we can grow faster than our competition.

And do you think that that opportunity is greater, would you say in the U.S. market or in the European market?

No, we see that across the board everywhere.

Okay. Great. Thanks very much.

Thank you. Our next question comes from Eric Zamkoff of IRG Research.

Hi. Congratulations. Very nice quarter. Can you talk a little bit about carrier deals that you've been signing? I know that you've had some increasing success in the carrier channel.

Does that cannibalize your retail channel to any degree, and are there greater pricing concessions with those deals versus the retail channel, considering the potential size of those markets?

We go into a channel, primarily, at the request of the customers when they demand to buy products from various channels. So as recent reports from [Parks Associate] indicating about 9 to 10% of customers would prefer buying their home network from the service providers. So that's why we entered that channel. We do not believe there is a cannibalization of any significance of the other channels, because different people, we have different preference of going to buy from various channels.

So we believe that entering the service provider channel is a must. On the other hand, we will continue to ask those providers -- in the Q3, in the Q2 earnings call, we said that we added the number two internet service providers in Germany as our carrier partner, and in this quarter we announced that Charter Communications, a big MSO here in the U.S. is now on the list of our customers, and we also made the comment just now that we will continue to add and announce in the coming quarters.

Okay. Thank you. [Operator instructions.]

We have no further questions, and I would like to turn the call back over to Patrick Lo, CEO, for any closing comments.

Once again, thank you so much for joining us on our call today. We believe that we are in a great expanding market and we have built a brand and a technology and a product portfolio which position us to be in a very strong position to capitalize on the growth of the market and we are very positive about the growth going forward.

And our aim has always been trying to get the best products to the market for our customers and in such a way, we will be able to continue to increase our revenue, our operating margin and our return on equity. So thank you very much, once again, and I will talk to you all again in three months.

Thank you. This call has concluded. You may disconnect your line at this time and have a great day.