NETGEAR Inc (NTGR) 2006 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. (OPERATOR INSTRUCTIONS). A replay will be available after 8 PM Eastern daylight time today through midnight Eastern daylight time on November 2nd. The replay dial-in number is 201-612-7415, with account code 3055 and pass code 215895. 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, everyone, to NETGEAR's third-quarter 2006 results call. Joining us today from the Company are Mr. Patrick Lo, Chairman and Chief Executive Officer, and Mr. 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 The Ruth Group at 646-536-7003, or you can get a copy off of NETGEAR's corporate website at www.netgear.com.

Before we begin the formal remarks, the Company's attorneys advise that today's conference call contains forward-looking statements within the meaning of the U.S. Private Securities Litigation Reform Act of 1995. The forward-looking statements represent NETGEAR, Inc.'s expectations our 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 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 adopt competing products; the Company may be unsuccessful or experience delays in manufacturing and distributing its new and existing products; telecommunications service providers may choose to utilize competing products; the Company may be unable to collect receivables as they become due; the Company may fail to manage costs, including the cost of developing new product 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 of the quarter, as reported by certain of NETGEAR's customers.

Further information on 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 those risks and uncertainties listed in the section entitled Part 2, Item 1A, risk factors, pages 30 through 39 in the Company's quarterly report on Form 10-Q for the fiscal quarter ended July 2, 2006, filed with the Securities and Exchange Commission on August 11, 2006. NETGEAR undertakes no obligation to release publicly any revision to any forward-looking statements contained herein to reflect events or circumstances after the date hereof, or to reflect the occurrence of unanticipated events.

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 to GAAP measures can be found in 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 Mr. Patrick Lo. Please go ahead, sir.

Thank you. Thank you, everyone, for joining us on today's call. The third quarter was an outstanding quarter for us. We are pleased with our continued momentum, with solid demand for our existing products and the success of several promising new launches.

The key trends that have been driving our business are only accelerating faster, and NETGEAR continues to benefit. The bottom line is we believe the NETGEAR brand is becoming stronger every quarter. Third-quarter net revenue increased to $151.6 million, a gain of about 36% compared to the year-ago period and a gain of about 16% sequentially. Our high sales level is translating into continued margin strength, with non-GAAP operating margin for quarter three at 11.9%.

On a geographic basis, demand was strong across all channels in Europe, and in Asia-Pacific outside of Australia, with healthy back-to-school sales in the U.S. sequentially, our North America net revenue with essentially flat in Q3, while Europe, the Middle East and Africa, or EMEA, net revenue increased about 36%. Our Asia-Pacific net revenue declined 4%. Compared to quarter three of 2005, our North America net revenue grew 5%, EMEA increased 81%, while Asia-Pacific grew 10%.

On the new product front, we continue to be very active. NETGEAR remains the sector's innovation leader. The key is we are innovating on commercially viable, higher-volume, higher-margin products.

Our success of new products continued in Q3, led by the enthusiastic initial reception on our SSL VPN Concentrator 25 and our Skype WiFi phone worldwide. Sales of our recently introduced Draft-11n RangeMax Next and Powerline HD products continued to ramp. Initially users' impressed reviews on our Skype WiFi phone are very good. I know many people were disappointed that the launch had to be delayed to Q3. But the additional time we spent working closely with Skype to perfect the usability of the phone was well worth it. We are hearing from users that this is one of the easiest to set up and use broadband products ever. People have also been raving about the excellent sound quality and the total user experience.

For example, a reviewer at InfoWorld wrote, "I took the Skype phone out of the box, turned it on, plugged in my Skype user name and password, and was calling colleagues within five minute. Simple. Sound quality is excellent. And with my Skype account, it was a snap to call those not using the Skype network."

It is too early to judge how well this product category will eventually do, but we remain very encouraged, given the initial reaction and the increased popularity of voice-over-Internet usage. Overall, we launched a total of 10 new products in the third quarter. We expect to add an additional 12 new product in the fourth quarter, bringing the number of new products launched in 2006 to 50.

On the channel side, another big growth area for us has been with service providers. Our launch with BSkyB in the UK was very successful, based on the initial reports of the number of BSkyB participating subscribers. Revenue from service providers reached 23% of total revenue in the third quarter, and we expect it to be around the same level in the fourth quarter. This is up from 15% as a percentage of total revenue in quarter two 2006 and 9% in quarter one 2006.

We have built a critical mass in the service provider segment, and expect to add additional service provider customers within the next several quarters as we build on our momentum in this segment. We do note that the carrier business is not expected to be linear, given carrier approval process and buying patterns. This will likely to lead to up and down periods versus a straight growth trajectory. However, we continue to believe the carrier segment to be growth area for us for each year in the coming years. We ended the third quarter with our VAR base steady, at roughly 32,000, and approximately 16,000 retail outlets, an increase of 800 retail outlets from the prior quarter.

Finally, we are pleased with our fast and seamless integration of our SkipJam acquisition. Efforts are already well underway to integrate SkipJam's software for network digital home entertainment. This is a growth segment, and we expect to be a major player. SkipJam's technology will form the basis of our future multimedia products -- including media centers, media players and audio players -- and complements our high-speed expanded range home networking solutions such as RangeMax Next Draft 802.11n Wireless and our 200 Mbps Powerline HD that enables simultaneous streaming of multiple high-definition quality videos and devices like our storage central that stores digital entertainment content.

We believe we are entering the fourth quarter with a tremendous mix of product, channel and seasonality momentum. We believe we have the right mix of new and existing products needed for a successful fourth quarter. Q4 is historically the strongest for the industry, and we have no reason to think it will be any different this year. We believe we will add more service provider accounts in Q4. Unlike last year, we do not believe there will be any supply constraints or shipping issues this time around.

Let me now turn the call over to Jonathan for details on our financials.

Thank you, Patrick. Let me now provide a summary of the financials for you. Net revenue for the third quarter ended October 1, 2006 was $151.6 million, a 36% increase as compared to $111.3 million for the third quarter ended October 2, 2005, an increase of 16% as compared to $130.7 million in the second quarter of 2006.

Net revenue in the third quarter of 2006 under the current geographical split method is about $56.1 million for North America; $81.6 million for Europe, Middle East and Africa region; and $13.8 million for the Asia-Pacific region. Under the prior methodology, the regions were $61.8 million, $77.7 million and $12.1 million, respectively. Please see our quarter-three release for the full description of the methodologies used.

On unit shipments, we gross shipped 3.8 million units in the third quarter and about 2.8 million nodes of wireless products. Shipments of all wired and wireless routers, gateways combined increased about 31% in units to 1.65 million units.

Moving on to the product category basis, the third-quarter net revenue split between wireless and wired was about 65% and 35%, respectively in revenue, compared to 63% and 37% for the second quarter of 2006. The third-quarter net revenue split between home and small-business products was about 66% and 34%, respectively, compared to 64% and 36% for the second quarter of 2006.

Products introduced in the last 12 months accounted for about 31% of total third-quarter shipments. Products introduced in the last 15 months contributed about 35% of our third-quarter shipments.

Non-GAAP cost of sales for the third quarter came in at $100.8 million or 66.5% of sales, which compares to $72.2 million or 64.8% in the year-ago period and $85.3 million or 65.2% in quarter two of 2006.

Non-GAAP gross margin in the third quarter of 2006 was 33.5%, as compared to 35.2% in the year-ago comparable quarter and 34.8% in the second quarter of 2006.

Moving to non-GAAP operating expenses, total non-GAAP operating expenses -- which excludes in-process research and development, amortization of purchased intangibles, retention bonuses related to the SkipJam acquisition, and stock-based compensation costs -- came in at $32.7 million, compared to $45 million in the year-ago period, which excluded stock-based compensation and litigation reserves and $30.8 million in the prior quarter, which excluded stock-based compensation. This was 21.6% of net revenue in the third quarter of 2006, as compared to 22.5% of net revenue in the third quarter of 2005 and 23.6% in the second quarter of 2006.

Non-GAAP sales and marketing expenses were $23.2 million, which compares to $18.1 million in the year-ago period and $22.4 million in the prior quarter. As a percentage of net revenue, sales and marketing was 15.3%, compared to 16.3% in quarter three of last year and 17.2% of prior quarter.

Non-GAAP R&D expense was $4.2 million, as compared to $3.3 million in the year-ago period and $3.8 million in the second quarter of 2006. This represented 2.8% of net revenue in quarter three of this year and 3% for quarter three of 2005 and 2.9% for quarter two of 2006.

Non-GAAP G&A expenditures in the third quarter were $5.3 million or 3.5% of net revenue, compared to $3.5 million or 3.2% of net revenue in the year-ago period and $4.6 million or 3.5% of net revenue in the second quarter of 2006. We continue to build up our new Ireland international operations center in quarter three.

Operating income on a GAAP basis -- which includes $3.1 million in charges for in-process research and development, amortization of purchased intangibles and retention bonuses related to the SkipJam acquisition, and non-cash stock-based compensation expense of $1.3 million -- came in at $13.7 million. This compares to $13.3 million in the year-ago third quarter, which includes litigation reserves of $600,000 and non-cash stock-based compensation expense of $211,000 and $13.7 million in second quarter of 2006, which includes non-cash stock-based compensation of $1 million. The increase in non-cash stock-based compensation expense for the prior year was due to the Company's adoption of FAS 123(R) at of January 1, 2006.

Net income -- on a GAAP basis, the Company had net income of $8 million or $0.23 per diluted share for the third quarter of 2006, compared to net income of $8.6 million or $0.25 per diluted share for the third quarter of 2005 and $9.8 million or $0.29 per diluted share in the second quarter of 2006.

Non-GAAP net income for the third quarter of 2006 was $11.9 million, a 31% increase compared to non-GAAP net income of $9.1 million for the third quarter of 2005, and a 13% increase compared to non-GAAP net income of $10.5 million in the second quarter of 2006. Non-GAAP net income for the third quarter excludes $3 million of adjustments related to amortization of purchased intangibles, in-process research and development, as well as retention bonuses related to the SkipJam acquisition, which closed on August 1, 2006.

Retention bonuses of $1.4 million are not included in the purchase price allocation, but are period costs which will be charged to the statement of operations and incurred over a two-year period, subsequent to the closing of the purchase. As these costs are not part of normal operations of NETGEAR, they are excluded from non-GAAP statement of operations. Non-GAAP net income for the third quarter of 2006 also excludes non-cash stock-based compensation net of tax of $910,000.

Non-GAAP net income for the third quarter of 2005 excludes total charges of $510,000 consisting of litigation reserves, net of taxes, of $362,000, non-cash based compensation expense of $211,000 and a $63,000 net of tax benefit from exercises of stock options.

Non-GAAP net income for the second quarter of 2006 excludes non-cash stock-based compensation net of tax of $622,000. Non-GAAP net income was $0.35 per diluted share in the third quarter of 2006, compared to $0.27 per diluted share in the third quarter of 2005 and $0.30 for the second quarter of 2006. Non-GAAP tax rate was 38.6% in the third quarter of 2006.

Moving on to the balance sheet, we ended the third quarter with $101.1 million or approximately $4.38 per diluted share in cash, cash equivalents and short-term investments, compared to a total of $158.9 million at the end of the second quarter, approximately $4.61 per diluted share. We continue to strategically use our cash, including payments of roughly $7.9 million related to the purchase of SkipJam in the third quarter.

In terms of inventory turns, we ended the third quarter 2006 with inventory of $77.8 million, with ending inventory turns of 5.2 compared to $69.3 million with ending inventory turns of 4.9 at the end of second quarter 2006, and $46.9 million with inventory turns of 6.2 at the end of third quarter 2005. We continue to believe our strategic forward inventory positioning is a prudent decision to take advantage of lower sea freight to fulfill the quarter four service provider orders and demand worldwide for the December [hot] selling period.

Days sales outstanding, DSO, were 71 in the third quarter of 2006, compared to 74 days in the second quarter of 2006 and 73 days at the end of third quarter 2005.

Retail channel inventory in the U.S. ended the third quarter of 2006 at 10.6 weeks, compared to 8.7 weeks in third quarter of 2005 and 13.3 weeks at the end of second quarter 2006. U.S. distribution channel inventory ended third quarter of 2006 at 6.3 weeks, as compared to 4.1 weeks in the third quarter of 2005 and 4.7 weeks in the second quarter of 2006. European distribution channel inventory ended the third quarter of 2006 at approximately 3.8 weeks, as compared to approximately 3.5 weeks in the third quarter of 2005 and 6.1 weeks in the second quarter of 2006. Asia-Pacific distribution channel inventory ended the third quarter of 2006 at approximately 4.3 weeks, as compared to approximately 5 weeks in the third quarter of 2005 and 5.1 weeks in the second quarter of 2006.

Total assets were $393.4 million at the end of third quarter 2006, compared to $367.9 million at the end of second quarter 2006 and $316.2 million at the end at third quarter 2005.

Deferred revenue increased to $12.5 million, as compared to $6.9 million at the end of the prior quarter and $4.7 million at the end of third quarter of 2005.

Now, let me make a comment on the fourth quarter 2006. We expect net revenue for the fourth quarter 2006 will be approximately $153 million to $160 million, with non-GAAP operating margin in the range of 11% to 12%. Finally, we expect the non-GAAP effective tax rate to be approximately 39.5%.

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

(OPERATOR INSTRUCTIONS). Jiong Shao, Lehman Brothers.

Great quarter. Congratulations on strong results. A couple of questions. First, Patrick, you talked about U.S. revenue sequentially flattish. You also had obviously some inventory reductions. Could you just talk about our sell-through trend? That is my first question -- in the U.S., sorry.

The sell-through trend is very healthy, as we mentioned. Certainly, Q3 is a big back-to-school season for the retail channel, and we see this year's uptick in back-to-school is no different from last year. So that enabled us to reduce the channel inventory in retail.

Would you be able to quantify sort of the sequential sell-to increase in the U.S.?

Generally speaking, back-to-school is about 10% to 15% [over] Q2 in retail, and we see similar trend in (multiple speakers).

My second question is on the service provider strength. It was a big quarter from service providers, 25%, and I think Patrick mentioned that is going to sort of stay at that level for next quarter. I was wondering, is that same strength from Sky, or Sky may trail off, but again, like you say, you expect to get new customers to fill in the rest of the pie, so you still get 25% from service providers?

As a matter of fact, it's just not Sky. Sky is an account that everybody talked about. But we are also getting strength from, for example, the cable operators in the U.S., which is a big growth from the prior year. We also get very good strength from AOL UK, which was just bought by Carphone Warehouse. So we are seeing strength across the board.

Okay. The new service provider customer, you say expect in Q4 -- would you be able to talk about which region you expect to see these guys?

It will be both in the U.S. as well as in Europe, and possibly even Asia. So we will let you know in more details when it happens. But we are very confident it is going to happen.

Could you just talk about deferred revenue jump? I think it jumped up a little bit, quite a bit. Could you just talk about what were some of the factors behind that?

Two reasons. One is just the natural growth of the business, that you have natural growth in the deferred revenue. Second one is that we shipped some products to our service provider accounts, which was destined to receive in Q4. So we deferred the revenue.

Samuel Wilson, JMP Securities.

This is Jonathan Curtis for Sam. Just a couple questions here. First, obviously during the quarter, you guys introduced the Skype WiFi phone. Any color on how many phones were shipped into the channel prior to the end of the September quarter, and then how shipments have gone here initially into the December quarter?

We do not comment on competitively sensitive data and how many phones that we're shipping to the channel. The only thing we could say is that we are the only vendor, as of now, shipping this Skype WiFi phone in volume on a worldwide basis, and we are very encouraged by the sell-through, not only into the channel, but also through the channel to the end-user customers.

In terms of BSkyB, were they a 10% customer during the quarter?

Yes, it is a 10% customer.

You guys will be putting this out in the Q, probably, but what was the number this quarter?

We probably will, yes.

Then the recent addition of the CIO and the CMO -- I would just love to know what their top priorities are going to be here for the next six months or so, and then just a quick status on the CFO search, and how things are going there.

Sure. The top priority of the CIO, as you probably could have figured it out, is to really, really strengthen our forecasting software and process. On top of that, he has a significant job to really create a he mirror site for us, so that we will not be prone to the unpredictability of the earthquake scenario in California.

As far as the CMO is concerned, I think her biggest job is to, one, create a brand that would mean both valuable on the consumer side as well as on the SMB side. I think we are doing very well on the consumer side. But on the SMB side, we would really like to be able to be ranked at the same vein as the HP and the Cisco in that area, and that would be her focus, and really upgrading our image among the SMB users as well as the channel partners.

In terms of the CFO search, we have met with quite a few interesting candidates, and our target is to get somebody in place as soon as possible. But for the time being, we are gratified that Jonathan is still our CFO.

Perfect. One final question -- color on the introduction of the Intel Viiv platform. What do the initial demand trends look like there?

It is very encouraging. As usual, we are very cautious in production ramp. So far, we're still trying to scramble to meet general demand.

Jason Ader, Thomas Weisel.

Patrick, I guess a question I would have for you is on the sustainability of the service provider revenue. I know you have guided for Q4 for it to be about the same level as Q3. Have we sort of hit a new level for this business on a go-forward? I know you did not give guided for 2007, but for modeling purposes, what would you suggest the analysts do or think about the sustainability of the service provider revenue in the, say, 20% to 25% range, versus historically, where it was probably more about 10%?

As we mentioned that we believe every year, this segment will be a growth segment for us. But I just also mentioned that it would not be linear, because the way these service providers buy, it would be up and down. But if you take full 12-month period perspective, we believe that it will still be a growth year over year. We certainly understand, in order to protect against these huge swings up and down, we have to spread the revenue among multiple service provider customers, and that is where our focus is. That is why we're happy to say that we will continue to add service provider accounts to us in the upcoming quarters.

Secondly, the gross margins were down a little bit sequentially and down a little bit year over year. Is it fair to assume that the gross margins for the service provider-based are lower, and therefore it is affecting the overall gross margins from a mix standpoint?

We always maintained that in our business, the more focus should be on the operating margin rather then on gross margin. Yes, gross margin for the service provider revenue is lower than the other channels. However, the cost of doing business there is also significantly lower. So net-net, the operating margin is the real indicator. As a matter of fact, we could actually have lower gross margin even without service provider revenue, because of the nature of the marketing spending. Marketing spending could be [contra-revenue], which could lower the gross margin, or it could just be ordinary brand advertising, which would boost up the expense, but not lower the gross margin.

So we have been telling our investors and all of the analysts that please focus on our operating margin. We are happy that actually we have a sequential uptick in the operating margin, even with a significant increase in the service provider revenue.

Last question for you is on the Draft-11n products. The sell-through has been a big question out there in the industry. Could you give us a flavor for what the sell-through has been for your products, and whether you are optimistic that we are going to continue to see kind of good sell-through over the next couple of quarters?

I think I mentioned it already last earnings call that this is a $149 street price product, and we expect it to behave like our $149 street products, just like what we introduced RangeMax about a year and a half ago, and it has performed exactly like that. So we are very encouraged by the curve, and certainly, as we mentioned many times in the past ten earnings calls, that naturally, the products as it goes along [below the] $129 to $99 to $79. Every time when the price moves, then the volume will continue to ramp, which every single wireless platform has gone through. So this time, I do not believe there is any difference.

Maynard Um, UBS Financial Advisors.

This is [Thomas Lee] on behalf of Maynard. I was wondering if you could kind of talk about your expectations for the industry next year? It sounds like that you're expecting to continue to gain share next year. I was just wondering if you can give a little bit of color in terms of the momentum or the ramp of that expectation? Then I have a follow-up question.

As I also mentioned in the last 10, 11 earnings calls and numerous conferences and investor meetings, we believe that the industry will continue to grow in the 15% to 20% range, because the industry is driven by people's desire to connect to the high-speed broadband Internet. So far, the penetration of high-speed broadband Internet in homes and small businesses in the developed world is still below 40%, and in the developing world is way below 10%. So there is a long way to go before we would saturate the market.

So in the foreseeable future, we do not believe the industry will slow below 15% to 20%, and as we mentioned all along, we are committed to outgrow the industry, and we are going to grow faster than the industry so that we will be able to gain share. We have been doing it for the last 10 years. We do not see why we should not continue to do it.

That is helpful. Looking at your interest income or your interest and other income, it looks like -- there seemed to be some variance quarter to quarter. I was just wondering if you could help us understand what those variables are, and how we should kind of think of that item?

They are two elements that make up the other income. One is clearly interest on our money sitting in short-term investments. The second element is currency, and the currency is based on whatever assets we have in foreign currency at [the end] balance sheet date, [at the main part] price conversion. So on the interest, it is pretty -- you can forecast it reasonably well, because you know what the interest rates are in the range and the money -- we are a cash flow positive company. But on the currency, it is our best guess.

So this quarter, we had a currency loss. Last quarter, we had a currency gain. That is difficult to project.

Then quickly, for your tax rate next year, can you give us any type of direction as to kind of what to expect for modeling purposes?

Nothing different from what we have said at the last quarter, where we expected the rate to drop on a full-year basis by maybe 200 basis points. But when we get a better picture, we will share that with you. But at this stage, we are still holding to our previous production on the next year's rate.

Could you share those projections?

The last quarter, we said it could come down 200 basis points from our average of 39.5%. It could be at 37.5%.

Jonathan Goldberg, Deutsche Bank.

First, just a housekeeping question -- could you give us the units shipped again?

3.8 million units.

Then I just wanted to get a sense of how is SkipJam integrating? When can we expect to see SkipJam-enabled products in the market?

As I mentioned just now, this integration is very fast and very seamless, and we should expect the SkipJam product coming out very, very soon.

Soon in months or weeks?

How about very, very, very soon?

Got it. How are component pricing trends?

Certainly, we continue to squeeze the cost of components, and we believe they are trending down as always.

Do you think it is going to be sort of a normal shift, or are you expecting anything more dramatic in the near term?

No, it's normal. We do not see any dramatic shifts. We do not want to drive dramatic shifts. We drive continuous improvement in component costs.

Stanley Kovler, Merrill Lynch.

Mark Sue, RBC Capital Markets.

Good quarter, gentlemen. Patrick, on wireless end, is it more price and not the standardization? Is the lack the standardization limiting the consumer uptake, or do you feel they don't know and they don't care?

It is certainly price. $149 -- our RangeMax is proprietary, no standardization, and it continues to sell very well. Every time we move the price, it sells more.

But it is no lack of standardization that is going to --?

No.

Okay, that is helpful. With the inventories where they are, should we assume a short sequential bounce in North America for the December quarter, or should we look for the growth to be more skewed to carriers in Europe?

I don't quite exactly understand your question.

If we assume the channel inventories for North America to stay where they are, the sell-through still looks -- are you assuming continuous strong sell-through in North America, or are you still looking for the magnitude of growth from the carriers in Europe?

I think Jonathan mentioned it already that we expect the U.S. retail channel inventory to decline further to slightly below 10 weeks.

Jonathan, any thoughts of sticking around? It seems like the party's just getting started.

No, I'm going to be here at least another month.

Thank you, and good quarter, gentlemen.

Erik Suppiger, Pacific Growth Equities.

Congratulations. First off, you kind of alluded to this earlier, but do you want to give us any sense for any change you might have in your target range for what your carrier contribution might be?

Yes, certainly, it is already at 3%, and as we said just now, we expect similar level in Q4.

Would that be a long-term target, though?

No, I would not put anything on a long-term basis, because it could go up, it could go down. It depends on how the channel ships is going to be. We would ship to whenever channel that our customers want us to. Let's say in a developing world, the governments are subsidizing high-speed broadband Internet connection. They might give away home networks to their citizens. Then our biggest channel might ship into government. So we do not know in the future. But for now, we expect that it will stay at that level for the upcoming few quarters.

Can we assume that the carrier business is largely your home networking products? Is that a fair assumption?

That is a fair assumption.

If we subtract out the carrier revenues from your consumer -- your home networking business, the September quarter did not see too much of an uptick, where I was anticipating more of an uptick due to the back-to-school season. Is there any reason for that?

You have to understand that you're talking about the U.S., and in the U.S., please note we take our channel inventory down from 13.3 weeks to 10.6 weeks. That is not reported as revenue.

Lastly, your inventories are up about $33 million from two quarters ago, and you are suggesting that is inventory that is on ships, to a large extent. That does seem like a very large portion of inventory that is shipping to customers. Is there any other details that you'd want to discuss, what could be included in that?

Yes. If you look at the increase in deferred revenue, that on the ledger side, you have to credit and debit. When you credit deferred revenue, the debit side is on inventory.

(OPERATOR INSTRUCTIONS). Samuel Wilson, JMP Securities.

Just some housekeeping stuff. Headcount and then cash flow from operations and CapEx?

The cash flow from operations was relatively slightly below, maybe about $60,000 negative, in this quarter. But again, fourth quarter is generally a strong quarter. We should be positive in the fourth quarter

On total headcount, we ended the quarter, which you will see in the 10-Q, with 380 employees in total, from prior quarter of 363 employees.

Then just CapEx?

CapEx was about $600,000, $700,000 for the quarter.

Stanley Kovler, Merrill Lynch.

Just wanted to ask you a little bit more color on Europe. The service provider business there seems to have done very well, and I was wondering -- it sort of doesn't explain all of the potential growth that you have there. Can you talk about the retail trends and the SMB trends, particularly in that region, relative to the U.S.? I have a higher-level question after that.

As I mentioned just now at the beginning of the call, the demand in Europe was strong across all channels.

My high-level question is on the service provider business. How are you thinking about your interactions with the service providers and the value proposition there, particularly as you think about the new products that you are coming out with in the market and the need to compete with a lot of the larger end-to-end companies? How are you thinking there, and what is your go-to-market there, value proposition that you are presenting there? I am assuming that it is not just all converged ADSL gateways, that there is more to it that you're thinking about.

At a matter of fact, we started the company 10 years ago, and ever since then we have always been fighting against the big titans in the industry. So this is not first time we do that. As we always believe, the only way to win over the hearts and minds of our customers is by providing better products and better service. It is no different among the service provider channel. We believe that our products are more innovative, higher performance, more reliable, and our service are more responsive, more customer-oriented. We'll continue to do that not only for the service provider channel, but as well as for the retail channel, as well as for the mail-order catalog channel and e-commerce channel. As indicated recently, we just got the Hot Web Vendor of the Year award from Staples. That is an indication of how dedicated we are to our customers.

I've got one quick correction. You asked the question on capital expenditure for the quarter. It was not $700,000 -- $1.6 million.

Mr. Lo, there are no further questions in the queue. Do you have any closing remarks?

Sure, wonderful. Thank you so much, everybody, for joining our earnings call. Again, we're very, very encouraged by the momentum that we have going into (technical difficulty).

Go ahead, sir. That was someone in the queue still. I removed him.

I am sorry. So thank you, everybody, for joining us on today's earnings call. We are really encouraged by the momentum that we have entering Q4. We believe that the path that we took and we will be taking is the right path, capitalizing on the highest growth segment of the networking market. We're very encouraged, and certainly I will be in conferences as well as investment meetings in the upcoming two to three months. We would encourage you talk to our investment relations firm, The Ruth Group, if you would like to discuss with me more on our business and our prospects. Thank you.

Ladies and gentlemen, this does conclude today's teleconference. Thank you for your participation. You may disconnect your lines at this time.