NETGEAR Inc (NTGR) 2005 Q4 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. (OPERATOR INSTRUCTIONS).

A replay will be available immediately after the call today through midnight Eastern time on Thursday, February 23, 2006.

The replay dial in number is 201-612-7415 with account code 3055. And passcode 188485. 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 afternoon and welcome to NETGEAR's fourth quarter 2005 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 be 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 [Lu] of the Ruth Group at 646-536-7026 or you can get a copy off of NETGEAR's corporate website at www.NETGEAR.com.

Before I begin the formal remarks the Company's attorneys advise that today's conference call contain forward-looking statements. The forward-looking statements represent NETGEAR's expectations or beliefs concerning future events and include statements among others regarding NETGEAR's expected revenue, earnings, operating income and tax rate on both a GAAP and non GAAP basis; anticipated new product offerings; current and future demand for the Company's existing and anticipated new products; willingness of consumers to purchase and use the Company's products and the ability to increase distribution and market share for the Company's products, domestically and worldwide.

These statements are based on management's current expectations and are subject to certain risks and uncertainties including without limitation the following. Future demand for the Company's products may be lower than anticipated, consumers may choose not to adopt the Company's new product offerings, or to adopt competing products, the Company may be unsuccessful or experience delays in the manufacturing and distribution of its new and existing products, telecommunication service providers may choose to utilize competing products; the Company may be unable to collect receivables as they become due; the Company may feel the managed costs including the costs of developing new products and manufacturing and distribution of its existing offerings, [channel] inventory information reported is estimated based on the average number of weeks of inventory on hand on the last Sunday or the last Saturday of the quarter as reported by certain of NETGEAR's customers.

Further information of potential risk factors that could affect NETGEAR and its business are detailed in the Company's periodic filings with the Securities and Exchange Commission including but not limited to both risks and uncertainties listed in the section entitled Risk Factors Affecting Future Results, pages 19 through 28 in the Company's quarterly report on Form 10-Q for the fiscal quarter ended October 2, 2005, filed with the Securities and Exchange Commission on November 14, 2005.

NETGEAR undertakes no obligation to release publicly any revisions to any forward-looking statements contained herein to reflect events or circumstances after the day hereof, or to reflect the occurrence of unanticipated events. Please also note that the maximum wireless signal rates referenced herein are derived from IEEE standard 802.11 specifications. Actual data throughput will vary.

Network conditions and environmental factors including volume of network traffic, building materials and construction, and network overhead lower actual debit throughout. In addition several non GAAP financial measures will be mentioned on this call. Information relating to the corresponding GAAP measures and reconciliation of the non GAAP and GAAP measures can be found on our press release in the Investor Relations site at www.NETGEAR.com.

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. 2005 was another good year for NETGEAR as we introduced many first to market innovative products, increased our market share in all three geographic regions, and continued to build a superior cost and channel infrastructure to serve our customers better in the fast-growing networking market of connecting home and FNB users to the high-speed Internet for communications, entertainment, business transactions and remote management.

Our RangeMax line of MIMO wireless products greatly enhances people's ability to connect to their wireless home network without the fear of dead spots or interference. It has quickly become the most popular MIMO wireless product on the market. We further expanded the capability of our RangeMax products by introducing the second generation, the RangeMax 240, in the fourth quarter. The speed of RangeMax 240 rivals that of wired ethernet. It enables our customers to do uninterrupted multiple streaming of audio and media as well as high-speed backup of data from PCs or laptops to disk servers.

We also introduced the first fully mirrored home disk server, the Storage Central. It brings the sophistication of automatic mirror backup and network sharing of data as well as the ease-of-use as an expendable local disk to every PC or laptop in the house. Ever since this introduction in September 2005, market demand for Storage Central has outstripped available supply.

We also introduced the world's first stackable SmartSwitch in the fourth quarter, bringing a stackable browser manageable switch for the first time at the low-cost easy alternative to expensive complex [FNMP] managed networks for medium businesses of 50 to 190 employees. For the full year 2005 we introduced a record 58 new products, 13 of them in Q4.

Fourth quarter demand was strong across all geographies. On a sell-through basis we estimate that we grew over 20% in the U.S. and Europe, compared to the fourth quarter of 2004. And about 40% in Asia-Pacific. We believe we gained share in all three markets, mainly propelled by the strength of our product line and our expanded channel coverage.

In the fourth quarter of 2005, we had about 32,000 value-added resellers and 10,000 retail outlets around the world.

Revenue in the fourth quarter from service providers represented approximately 8% of total revenue, an improvement over the prior quarter. Telenet and Benelux was quickly -- has quickly become our first biggest service provider customer after two short quarters. We also added new PC, a pin European cable operator at the new service provided customer in Q4.

Sequentially our North American net revenue declined 2% while in Europe, the Middle East and Africa or EMEA, net revenue group 29%. Abd our Asia-Pacific net revenue declined 10% due to the summer holidays in Australia. Comparing to Q4 of 2004, our North American net revenue grew 8% while EMEA grew 20% and Asia-Pacific grew 41%.

Companywide, fourth quarter net revenue increased about 16% to $121.8 million compared to the year ago period. While sell-through in the market was very strong, the demand mix shifted more than our forecasted production limits, thus constraining our shipment in to the channel towards the end of the quarter.

The demand mix was weighted more than we expected towards our RangeMax and SuperG DSL gateways in Europe and our 802.11G wireless routers in the U.S., which limited our ability to meet demand and, therefore, negatively impacted our net revenue.

On the other hand the demand of our cable gateways and our Super G wireless routers was lower than expected. In spite of the mix shift challenges, we were able to work with our channel partners to supply to the end market. However our net revenue for the fourth quarter was negatively impacted, coming in slightly lower than our target.

And our U.S. retail channel inventory was drawn down to six weeks, a level far lower than what we would like. We normally would like to see at least seven to eight weeks of retail channel inventory in the U.S. We are confident about our prospects in 2006, given NETGEAR's substantial achievements over the past year. Our competitive position, our sell-through momentum in all three regions, market leading product portfolio and our efficient cost structure.

We will remain active on the new product front as we continue to leverage our brand, channel, and development strength. Underscoring our product momentum, our unveiling in January '06 of the world's first Skype VoIP WiFi phone was greeted with unprecedented worldwide media attention and the highest end-user enthusiasm ever in NETGEAR's history.

This joint effort with Skype will unchain our customers from their PCs and laptops and allow them to make free or very low-cost VoIP phone calls anywhere near an accessible WiFi station, be it at home, in the office or in a free open hotspot. This is potentially a market-changing product and we have high expectations of its revenue potential.

We are also in the process of cable lap certification of our first PacketCable VoIP modem. We also plan to expand our RangeMax line of products by introducing in the coming months draft 802.11 and compliant products with our RangeMax added-value technology for higher throughput and interference with systems.

We expect these new additions will only further help drive new demand, particularly from customers looking to the latest and the greatest in technology.

Let 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. As Patrick noted, shipment in the fourth quarter was hampered by the ship in demand mix beyond our forecasted production limits. We are encouraged, however, by the end market sell-through and the year on year growth as compared to the previous quarter and end of 2004.

The lower shipment also negatively impacted other operating margins. I also want to point out before going through the numbers that in quarter four we increased the proportion of our marketing spending on strategic joint promotion opportunities with our biggest retail partners, both in the U.S. and in Europe. These marketing expenses are contra-revenue items, thus lowering our gross margin.

Since our shipment into the channel was below plan, our gross margin was further negatively impacted. As these holiday promotional activities subside in the coming quarters, we expect such spending to decline and the gross margin to return to high levels.

Now let's move onto the numbers.

Fourth quarter 2005, net revenue increased 15.9% to $121.8 million compared to $105.1 million for the fourth quarter of 2004. As noted in our fourth quarter and full year 2005 earnings release, we have refined the methodology we use to classify sales by geography to better reflect our current business model. Net revenue by geography comprises gross revenue less such items as marketing incentive pay to customers, sales returns and price protection which reduce gross revenue. In the fourth quarter of 2005 we refined our methodology for locating marketing incentive that reduced gross revenue and now a look at them on a specific identification basis to the geography to which they relate.

Previously marketing incentives were allocated, based on each geography's gross revenue as a percentage of total growth revenue.

Going forward we will report net revenue by geography using this refined methodology and will update historical periods to be comparable and consistent with the revised methodology. A detailed table can be found in the earnings release, showing net revenue by geographies both under this revised methodology and under our previous methodology for the previous periods indicated.

Net revenue in the fourth quarter 2005 under the current (indiscernible) North America was $52.4 million; the Europe, Middle East and Africa region was $58.1 million; and the Asia-Pacific region was $11.3 million. Under the prior methodology the regions were $59.8 million, $52.5 million and $9.5 million, respectively.

On unit shipments we shipped a record three million units in the third quarter, representing a 15% growth over the third quarter. We shipped a record 2.2 million -- sorry, going back on shipments we shipped a record three million units in the fourth quarter representing a 15% growth over the third quarter. We shipped a record 2.2 million nodes of wireless products representing about 16% growth over the third quarter. Total unit shipments of our ethernet products such as hubs, switches, network adapters increased 7% in units and 1% in value.

Shipment of all wireless and wired routers, gateways combined increased about 27% in units to 1.27 million units and 24% in value over Quarter 3, 2005.

Moving onto the product category business, the fourth quarter net revenue split between wireless and wired was about 60% and 40%, respectively, in revenue compared to 58% and 42% for the third quarter 2005. The fourth quarter net revenue split which is home and small-business products was about [51%] and 39% respectively as compared to 57% and 43% for the third quarter.

Production introduced in the last 12 months accounted for about 31% of total fourth quarter revenue; and production produced in the last 15 months constituted about 32% of our Quarter 4 revenue.

Non GAAP cost of sales for the fourth quarter came in at $83.6 million or 68.7% of sales which compares to $17.6 million or 67.1% of -- in the year ago period and $32.2 million or 64.8% in Quarter 3, 2005.

Non GAAP gross margin in the fourth quarter were 31.3% compared to 32.9% in the fourth quarter of 2004 and 35.2% in the third quarter of 2005. Due to the demand shift during the quarter, we had to spend more GAAP free dollars in order to supply to the channels. Compared to Q4 of 2004, we spent about $3 million more in the operating costs which negatively affected our gross margin.

On the other hand, due to much lower channeling inventory and favorable pricing environment, we experienced a $2.5 million lower price protection charge in this quarter which positively affected our gross margin.

Moving to non GAAP operating expenses, total non GAAP operating expenses which excludes litigation reserves and stock based compensation costs came in at $24.3 million compared to $22.5 million in the year ago period and 25 million in the prior quarter. This was 19.9% of net revenue in the fourth quarter of 2005 as compared to 21.4% of net revenue in the fourth quarter of 2004, and 22.5% in the third quarter of 2005.

Sales and marketing expenses were $17.7 million which compares to 18.1 million in the prior quarter and 16.3 million in the year ago period. As a percentage of net revenue, sales and marketing were 14.6% compared to 15.5% in Quarter 4 of last year and 16.3% of prior quarter. Please note that in Quarter 4, we focused more marketing dollars on [counter] revenue items such as extra shelf space, joint advertising with retailers, rebates etc.

Conversely a lower focus was placed on independent marketing activities such as brand advertising and tradeshows. As a result our sales and marketing expenses were lower than in prior quarters.

R&D research and development was up to $3.2 million from $2.6 million in the year ago period, and compared to $3.3 million in the third quarter of 2005. This represented 2.6% of net revenue in Quarter 4 of this year and 3% for Quarter 3, 2005 at 2.4% for Quarter 4, 2004.

Just a note here. We intend to boost our R&D spending in the first half of 2006 by 20% to invest in multiple exciting new technologies and new software in Beijing China.

G&A expenses in the fourth quarter were $3.4 million or 2.8% of net revenue compared to $3.7 million or 3.5% of net revenue in year ago period. And $3.5 million or 3.2% of net revenue in the third quarter of 2005. Also I'd like to point out that we are setting up our new island international operations center, the setup costs will be reflected in higher G&A costs in the first half of this year.

Operating income on a GAAP basis which includes litigation reserves of 202,000 and non cash stock-based compensation expense of 168,000 came in at $13.5 million compared to 13.3 million in the third quarter of 2005, and 11.6 million in the year ago fourth quarter. This constitutes the trend of our positive sequential operating income growth.

Net income, on a GAAP basis the Company had net income of 8.9 million or $0.27 for basic and $0.26 per diluted share for the fourth quarter of 2005. Compared to net income of $8.6 million or $0.26 per basic share and $0.25 per diluted share in the third quarter of 2005, and $8.6 million or $0.27 for basic and $0.26 per diluted share for the fourth quarter of 2004.

On a non GAAP basis, net income for the fourth quarter 2005 increased to $9.1 million as compared to $7.6 million for the year ago period and 9.1 million for the third quarter of 2005. This represents earnings per share of $0.27 per diluted share in the fourth quarter of 2005 compared to $0.23 diluted share in the fourth quarter of 2004, and $0.27 per diluted share in the third quarter of 2005. I would like to note that for the purposes of calculating diluted earnings per share, we used 34,298,000 shares for Quarter 4, 2005.

The fourth quarter 2005 non GAAP net income excludes net charges of $278,000, including the litigation reserve net of taxes, up $122,000. Non cash stock-based compensation expense of $168,000 and a 12,000 net tax benefit from exercise of stock options.

The fourth quarter of 2004 non GAAP net income excludes noncash stock based compensation of 346,000 and also excludes the 1.32 million net tax benefit from exercise of stock options.

Non GAAP tax rate was 37.4%.

Moving onto the balance sheet. We ended the third quarter with 173.2 million or approximately $5 dollars per diluted share in cash, cash equivalents or short-term investment. Up from a total of 152.6 million at the end of third quarter and 141.7 million at the end of 2004. In terms of inventory trends we are pleased with the improved level of our inventories. We are less pleased with the lower than desired inventory level in the U.S. retail as well as in Asia-Pacific distribution channel.

The U.S. inventory channel decreased to about six weeks in the fourth quarter from about 8.7 weeks in the third quarter and 9.3 weeks at the end of 2004. U.S. distribution channel inventory increased to about 4.4 weeks in the fourth quarter compared to about 4.1 week in the third quarter of 2005, while declined from 5.6 weeks at the end of 2004.

European distribution channel inventory increased from about 3.5 weeks at the end of third quarter 2005 to about 5.2 weeks at the end of fourth quarter 2005, declined slightly from 5.4 weeks at the end of 2004. Asia-Pacific distribution method declined from five weeks at the end of third quarter to about 4.6 weeks at the end of fourth quarter and 5.9 weeks at the end of 2004.

We ended the quarter with our own inventory of $51.9 million, 6.5 turns compared to 46.9 million and 6.2 turns at the end of the third quarter 2005. At 53.6 million or 5.3 turns at the end of 2004.

DSO. Day sales outstanding was at 77 days in the fourth quarter of 2005 compared to 73 days in first quarter 2005 and 72 days in end of 2004. Total assets were 356.3 million at Quarter 4, 2005 compared to 316.2 million at Quarter 3, 2005 and 300.2 million at the end of 2004. [Before] revenue the end of the year at 4.3 million as compared to 4.7 million at the end of the prior quarter 2005 and 2.1 minute at the end of 2004.

Now let me make a comment on the first quarter 2006. For the first quarter 2006 we believe net revenue will be approximately 120 million to 127 million with non GAAP operating margins in the range of 11.5% to 12%. Finally we expect the non GAAP effective tax rate to be approximately 40%.

Operator, we would now be happy to take any questions.

(OPERATOR INSTRUCTIONS) Maynard Um. UBS.

Giving your midshift to toward what I presume are higher gross margin products, little surprised to see the gross margins down in that magnitude. Can you talk about the industry dynamics and what you're seeing from a competitive level that might require the high markings spend or was this just pure seasonality?

It is pure seasonality as well as opportunity. As you -- as we said many a times, we would like to focus our attention on the operating margin rather than on the gross margin because the gross margin has a lot to do with how we spend our sales and marketing expenses. So in Q4 because we are offered many opportunities, for example, extra shelf space and floor stack in the biggest retailer in the U.S., Code TV advertising with the biggest retailer in the UK and extra newspaper fliers with our biggest retailers in Germany, we took on those opportunities which used to be not offered to us.

And because of that the marketing expenses that is associated with these activities become contrarevenue and thus lowering our gross margin. And we review it going into the quarter that's going to happen. But if the operating margin that we believe that we were able to still be in our range; unfortunately we ship lower than what we would like and the lower shipments actually impact our operating margin so that result is purely seasonal and opportunistic.

In the coming quarter for example, in Q1, these opportunities of TV advertising is gone. Extra newspaper fliers are gone and at the same time the brand advertising opportunities such as having significant presence in CES and Las Vegas and significant presence in (indiscernible) [Enova] in March, will shift our expenses back into the normal brand advertising. So you'll see our sales and marketing expenses as a percentage of sales going back up in Q1 and our contrarevenue will come down, thus the gross margin will go back up in Q1.

Then when you look at the -- it sounds like the demand for your products in the RangeMax and the Super G and those type things were pretty strong and the reason for the shortage. Any thoughts on how much of the demand was driven by incremental marketing spend in the U.S. and Europe?

It is very difficult to gauge that but certainly there is a relationship. We believe that in the marketing activity that were put in place actually most of them are focused primarily on the RangeMax routers, the LNG router as well as the Super G DSL 2+ Gateway. So those are going better than what we thought.

On the other hand though, RangeMax DSL 2+ Gateway was introduced only in Q4. And the reception was basically much higher than what we would ever dream of. So that caught us by surprise. However the magnitude of the reception of the 11 G router promotion in the U.S. was also a little bit taking us off course. We thought that that is a little bit older technology but it looks like over the Christmastime people were still galvanized towards it as well as to our RangeMax router.

Then one last question. Sounds like there was a focus on the retail market in the quarter. Can you just give us an update on any changes, either strength or weakness in the distribution channel with Ingram or Tech Data?

No, not at all. And as a matter of fact we also see pretty good growth. Even the fact that during Christmas in the distribution channel we practically have only 12 weeks of selling. I mean you have half a week Thanksgiving half a week at Christmas. So with one less week of selling through distribution, we are able to actually continue to grow at least in both unit and dollar terms in the ethernet products as we describe just now we do 7% a unit and 1% in value in the Internet products which we encouraged. But then on the other hand, Christmas is a hugely seasonal especially in Europe driving all the home products. So, that's why the balance seems to be shifted toward the retail consumer. It's a pure seasonal factor.

Samuel Wilson with JMP securities.

This is Jonathan Carter for Sam. Quick question on the demand forecasting process. Just seems like it's the second quarter where you have some trouble getting your arms around what demand would be for sounds like in particular the RangeMax products. What are you doing to help improve the demand forecasting process next year. And as you begin to release more and more hot products, how are you going get your arms around this?

You're right. This is -- sometimes we are a victim of our own success. As our volume continues to grow up to 3 million units a quarter a fluctuation of 10% would be a significant strain on our production partners. When we are only shipping 1.5 million units a quarter at 10% change is only 150,000 units. And they would be easy to accommodate us with production changes but then when it's doubled then both the transportation as well as the production is getting harder to adjust there. So meaning that when we used to be able to accommodate 10% swing right now without further tuning it shrinks down to 5%.

So what we are doing is, we are having to increase the accuracy of our forecast especially in (indiscernible) mix and do better with new product introduction with the swing. So what we did was that in Q4, knowing this is coming, we have already purchased a new piece of software to do forecasting called Foresight. And this new piece of software will enable us to capture all the historical trends, the seasonal events, as well as any promotional events and new product introductions, and be able to come up with a more logical and sophisticated similation to help us to really predict the mix better.

Now we're still getting a handle on this piece of software. Our VP of operations is spearheading this process that is leading both sales marketing, operations, and financials to try to finetune this. At the same time we are also requesting our production suppliers to really look at the ability to absorb our 10% of 3 million swing.

So hopefully over the coming quarters, we would be able to get around this problem and improve our execution.

And then just one quick follow up question. I know you guys intend to see sort of a strong January February effect from gift cards an the like and Best Buy came out here and raised guidance for its February quarter. Help us understand how the lower channel inventories have impacted your ability to take advantage of the January effect for (inaudible)?

Yes. As a matter of fact we were unlucky because the supply to the channel was just off by a week so because we shut down in first week of January anyway for our fiscal stock take. So our channel partners actually expected that and we quickly replenish our channel in the second week of January. So we are back to healthier channel level starting the second week of January.

Certainly we would like it to be even higher but judging from what we've seen so far, that's why we are giving guidance which actually is indicating that we'll have a flat to slightly up quarter in Q1.

One final. Any details on when the Skype phone is coming down?

Yes the Skype phone as we introduced in CES was enthusiastically received by both the media specially internationally as well as our end users. We are working very closely with Skype to stabilize the code. And hopefully that -- we will be able to relieve it in a very speedy manner. And we expect to continue to market in two ways. One is to enlarge the Skype user community in the United States together with the Skype. Secondly is to market into the Skype community which is already 20 million plus strong internationally.

Anton Wahlman with Needham & Co.

A quick one on your distribution partners retail. Is everything normal in terms of the nature of your relationship with Best Buy in particular and the Ingram data/Tech Data relationship more general. Any changes this quarter compared to previous not quantitatively but just in the nature of how you work with them?

I think from up qualitative standpoint we feel like that we are building a better relationship with our top retailers around the world. Otherwise they wouldn't give us those opportunities which used to be offered to our competitors. And from the Ingram and Tech Data I think our relationship is getting better; because they are -- we are using more of them on a worldwide basis not just in the United States but outside the United States. For example Ingram just bought our biggest partner in Australia and so our relationship with them is actually getting tighter.

The opportunities that you're given by these distribution channels, do you think that they were satisfied with the way that you performed taking advantage of those expanded opportunities?

Judging from the channel, very low channel inventory they are very satisfied. And the feedback that we are given is that we perform very well.

[Alex Henderson] with Citigroup.

This is Mike Genovese for Alex. Did you give a percentage or a percentage NIMO in the quarter? Where it came in as a percentage of overall sales?

We don't break out the product percentage in particular but as we mentioned it just now, the products that we introduced in the last 12 months which are primarily RangeMax and Storage Central constitute about 31% of our revenue.

Now if we look at the SMB business it actually looks like on an absolute basis it was down slightly maybe $200,000 quarter-over-quarter. First of all did I get that math right? And secondly thinking that the commercial or I should say small-business market is strong, seasonally strong and seems to be strong overall, what are your comments on those results? Why didn't we see growth in SMB in the quarter?

You're right. Your math is correct and we -- our sales people are so focused in Q4 in getting all the retail and consumers sales that they lost a little bit of focus in pushing our SMB products which we absolutely are going to fix in the coming quarters.

[Chung Chow] with Lehman Brothers.

A few quick questions. First back to the forecast. A follow-up on that is, how good and timely is your visibility into the sell-through given the whole IT system you have built?

The visibility to the sell-through is very timely. As a matter of fact we get sell-through reports every Monday morning around the world. So it's not a problem of seeing the sell-through but response to the sell-through is pretty long especially if the deviance is very high.

Generally speaking if it is within 10% of production forecast, we are able to get additional orders fulfilled within two weeks from the production line. And we fly them in. Then it would take another week to come in so three weeks with the respond within 10% but it would put on the boat then we would add another three weeks to it, it will become six weeks. However if the swing is beyond 10% then the whole thing will lengthen to more than 90 days.

So it's very imperative for us to stay within 10% boundary and so within that we have been able to adjust all through the quarter and to the very last end of the last two weeks, we just couldn't handle it.

So for someone else's high demand product you saw the swing was over 10%?

That's correct. That's correct.

Second question on channel inventory. Could you please tell us roughly speaking what the sequential change in the total channel inventory in dollars?

Well, for competitive reasons we don't really disclose that. Otherwise people would be really easy to figure out how much we sell the Best Buy or the like. But it's pretty clear that our channel inventory especially in the U.S. going down from 8.7 weeks to six weeks. That's pretty drastic. And we actually would say that we dare say that we lose some channel inventory.

The last question is on cash. You now have over $170 million in cash. I think you'd talked of it before. You need a minimum anywhere I think if I remember correctly between $50 to $80 million. But now even in addition to that you have significant amount of cash on your balance sheet. Why? What's some of the usage you think you may use this cash for? Why not buying back some shares?

We are looking at all options and at every board meetings we discuss the various options and if you could see we have the cash. A lot of other start up companies, smaller companies would see that too. So they are approaching us as well so we always have acquisition opportunities to discuss. So, I think it's always among the board members looking at what do we do? Do we do this buyback? Do we do the acquisition? And I believe that now with a probably around close to 100 million disposable cash, I think we are in a very strong position if some really attractive accretive acquisition comes our way, we will be able to pull the trigger.

[Dave Hager] with Kennedy Capital.

Curious on Best Buy. My understanding is they're changing their policy towards rebates and trying to move away from mail-in rebates and more to in-store redemptions and was curious how that may impact your business with Best Buy?

Actually we went along I mean, we hate mail-in rebates also. So we're very happy to hear them moving towards that and the ceasing of the mail-in rebate actually started about a week ago. And I think the response in both the customers from our channel partners are very positive and we would love to see that. And as a matter of fact it would not affect much of our gross shipment. Certainly with less mail-in rebate, with more instant rebates there's processing, it's much more straightforward and customer satisfaction goes up then we hope that they will buy more.

Is there any impact in terms of there's probably a certain percentage of customers who didn't redeem their rebates or didn't do it correctly and is there much of an impact there of now you'll probably have a greater percentage of customers who are redeeming?

Yes. Actually right now 100% of the customers are redeeming because it's in-store. However the rebate is much smaller. For example like our most popular 802.11G router the mail-in rebate used to be $20 from us. But right now is only $10 for instant rebate.

So you are effectively offsetting this by offering (MULTIPLE SPEAKERS)

Reducing the rebate. Yes. But the response is very favorable.

Ryan Hutchinson with WR Hambrecht.

Couple of questions here on the gross margins. You referenced you'd thought they'd moved back towards higher levels. What does that mean specifically? Back towards 35%? Or just give me kind of a ball park estimate?

As we keep to our tradition we don't guide gross margin but I mean, certainly, we would work on all those fronts and the sales and marketing expenses will get more back more likely into the 16% range. So the difference would be coming back to the gross margin and then, if we solve our logistic problems, we would ship according to plan, making sure the channel inventory is going to be back to normal -- that would improve our gross margin by probably 70 to 100 basis points.

And then stopping of some extra spending will help us to get there but we particularly would not like to guide to gross margin. Rather we would stick on working very very well in hitting our operating margin target which is 11.5 to 12%. Certainly, the better -- the higher, the better.

Then in terms of the balance sheet, looks like both inventory and receivables are up here meaningfully. DSOs up to the highest level since I can remember, since I followed the Company. Can you help us, walk us through what is going on there?

Yes quickly on the inventory, I think, as we pointed out our turns 6.5 as we grow revenue, you are going to have a slightly higher inventory. So we are pleased with our inventory turns and of course keep working on improving the turns. Having said that, Patrick also made a comment because of our low inventory levels we (technical difficulty) revenue maybe we should carry a little bit more inventory (indiscernible) revenue. On DSO approximately 77 days seasonally December is a higher DSO period, if you compared to the prior year, etc.

But something that I have always pointed out is the way the DSO is calculated. All in the counter revenue we talked about the server marketing expense and Patrick pointed out I pointed out that we have had a higher counter revenue for sales and marketing this particular quarter. In the calculation of DSOs, all that marketing dollars used to reduce the net revenue for the DSO calculation is not included as a credit to the accounts receivable. It is sitting in the balance sheet as an accrued liability.

So I did my own calculation of what DSO should have been if it's reported adjusting for that marketing accrual during the mid '50s.

Couple of quick follow ups there in terms of you highlighted R&D up 30%

40% year-over-year.

Moving into 2006 didn't you up 20%?

Yes. (MULTIPLE SPEAKERS)

And the G&A portion increased this year. Did you say the second half '06 related to Ireland?

First half. First half of the year we get Ireland set up.

And so should we began to see a tax benefit here hit in the back half of '06?

Not in 2000 -- . We are not projecting a tax benefit in 2006.

What about 2007?

To early to tell you at this stage. We will let you know when we have the numbers all finalized. (MULTIPLE SPEAKERS)

Go ahead.

Before you not assuming benefit in 2007.

One quick one more and I will get back in the queue. In terms of headcount where are we at now?

(MULTIPLE SPEAKERS)

We ended the year 326.

Mark Sue with RBC Capital Markets..

Maybe if you could do some thoughts on visibility with the service provider segment, how should the trends develop in '06, and if you could give us some specifics perhaps by region?

The service providers channel is developing pretty evenly across all regions. As we said just now that it represented about 8% of our revenues in Q4 which is a slight improvement over Q3. We believe that will continue to make slight improvement quarter over quarter as we go forward. And it will be pretty evenly distributed among the three regions.

It seems like that weakening more and more, entrenched into the cable operators as where most of our success comes from both in Europe as well as in the U.S.

Any thoughts of whether it should reach 10% for sure this year?

That's our plan. Our goal is to reach that mark sometime this year.

Separately, the new piece of software for forecasting, is that up and running now? And are you using that to give us your guidance for 120 to 127 million?

Yes. It's being tested right now. I wouldn't say it's up and running as yet. We hope that we will get a hang of it and will completely have it to drive our forecast by the end of Q1.

Lastly, Jonathan, any thoughts on EPS guidance for the March quarter?

We don't provide guidance on EPS, Mark. We only do revenue and the operating margin.

Maybe if I could just ask, any thoughts on unit assumptions for the Skype phone and your initial thoughts there?

Too early to tell because we don't really -- I mean there are some specific parts that is particularly used for this one. So we have yet to gather how many parts that we could get. And also when this thing will actually come out and what price that will be charged for the various hardware and software components. So when we get near to the introduction, we would have a better picture. And certainly in the next earnings call.

Ben Atkinson with Gagnon Securities.

Could you talk about your strategy for increasing R&D expense, Patrick, and just where are you trying to go with that? What do you hope to get from the additional expenditure?

That's a good question. There are two directions. One, we believe that software is becoming more and more of a component of our products and is a key differentiation. As more software is incorporated into our products, then, it would require more robust software testing. And that is why we set up the software lab in Beijing to really test it.

And so that would help us to differentiate ourselves from our competitors by providing easier to use more robust software and would be able to incorporate some start-up software into our components into our products faster, again to differentiate ourselves. And hopefully, they will be able to drive our price premium over time.

Secondly we also are trying to investigate the possibility that once we get the software capability, whether we would actually be able to develop some intellectual property of a little bit of our software to differentiate ourselves from our competition as well. So we believe that this is a good long-term investment and they will help us differentiate ourselves and give us some intellectual property that we will be able to use to command a higher premium.

Could you give us any thoughts on some of the new product areas? I'm thinking particularly of 802.11 and some more immediate server area and anything you can tell us about your thoughts there.

That's exactly right. I mean, as we said, the world of connectivity has been kind of opening up with many many fronts and we believe in the next two, three years there'll be an inflection point that there will be explosion of possibilities. As we could see it, this year, that it certainly is going move beyond, way beyond just a simple wireless router or gateway into the possibility of connecting your [glow] telephone, your mobile phone, WiFi phone as well as your TV. Centralized Storage. All those areas are things that we are working on plus the added possibility of upgrading people to the latest 802.11, and with that value-added RangeMax technology.

So you could see us this year working in four directions. One, our traditional upgrade of technology both for our switches and our wireless routers. On the switching side we are upgrading into stackable gigabit and 10 gigabit and on the wireless side we are upgrading to the RangeMax (indiscernible) draft and the additional area we are moving into is continue to strengthen our Storage for Central as well as to introduce products that would do much more extensive VoIP integration, plus the digital media adapter which we call our digital music and digital audio player.

So new products in all those areas?

New products in all those areas. Exactly. But I'm not precluding any more new products beyond those categories, because they have not been announced yet and we don't want it to be heard here.

Samuel Wilson with JMP Securities. After Mr. Wilson's question, I will return the floor back over to management for any final comments.

Just a quick follow up on the various product types that you rattled off there. Any to enhance your security offerings at this point? Or can you give us an insight into how your relationship with Trend Micro is working in the SMB market?

Enhancement of the securities is very important across the line, both from our SMB side as well as our consumer side. Our partnership with Trend Micro is excellent and the sign up with the Micro -- with the Trend Micro security on the consumer side as was on the SMB side is doing very well. So looking forward to strengthening that relationship to further differentiate us apart from our competitors. So we think that there is tremendous opportunity in that regard as well.

Gentlemen, would you like to make any closing comments?

Yes. I would just like to point out that we are very excited about the momentum we have going into Q1. The market share gain that we are seeing for the full year as well as in Q4 in all three geographies in Q4, we believe we can continue that momentum in Q1. And then we are very excited about all the R&D capabilities that we have built both in-house as well as with our partners. With [free]research and development center in Silicon Valley, in Taipei and in Beijing up and running we are very excited about our product lineup for the rest of year. We believe that will have another fabulous growth year in 2006 and looking forward to an even faster growing year. Thank you, everybody, for joining us and we will talk to you again in April.

Thank you. This concludes the teleconference.