NETGEAR Inc (NTGR) 2007 Q1 法說會逐字稿

Greetings, ladies and gentlemen. Thank you for standing by. (OPERATOR INSTRUCTIONS). A replay will be available in two hours after the call today, through midnight Eastern Time on Thursday, May 3, 2007. The replay dial in number is 201-612-7415, with account code 3055 and pass code 237335. 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 first quarter 2007 results call. Joining us from the Company today are Mr. Patrick Lo, Chairman and Chief Executive Officer, and Christine Gorjanc, Chief Accounting Officer. The format of the call will be a brief business review by Patrick, followed with Christine 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 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, the 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 slow the deployment of the Company's products or 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 products and manufacturing and distribution of its existing offerings.

Channel inventory information reported is based on estimated the average number of weeks of inventory on hand as of the last Saturday 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 10 through 20 in the Company's annual report on Form 10-K for the fiscal year ended December 31, 2006 filed with the Securities and Exchange Commission on March 1, 2007.

NETGEAR undertakes no obligation to release publicly any revisions 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 and GAAP measures can be found in our press release in the Investor Relations website 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, David. Thank you everyone for joining today's call. The first quarter was another strong one for NETGEAR, with net revenue well above the high end of prior guidance, due to continued momentum across all channels.

We continue to execute on our business strategy and build considerable momentum in our business and brand. Our ability to consistently achieve impressive revenue and profit growth is helping make NETGEAR a true world-class leader in home and small-business networking.

While we continue to achieve strong results, we're not going to be complacent. Everyone here is highly motivated and pushing for higher achievements to fulfill rising expectations from our customers.

Net revenue in Q1 increased 36% to $173.6 million compared to the year ago period, and up 6% compared to Q4 of last year. Quarter over quarter our North America net revenue was $66.1 million in Q1, a sequential increase of 29%. While Europe, the Middle East and Africa, or EMEA, net revenue was $92.6 million, a sequential decline of about 7%. In our Asia-Pacific, net revenue was about $15 million, up about 19% over Q4.

The sequential decline in revenue in Europe is primarily due to reduced shipments to several service providers. Comparing to Q1 of 2006, our North America net revenue increased 17%, EMEA increased 63%, while Asia-Pacific was up about 6%. Specifically our growth in Asia-Pacific was pulled down by a challenging market condition in Australia.

On a sell through basis we saw sequential growth in North America and Asia-Pacific, while we experienced a sequential decline in Europe. The revenue for North America, which like all geographic revenue is recorded on a sell-in basis, was a significant uptick from Q4 of last year, during which time we worked with our U.S. channel partners to optimize their inventory levels, resulting in lower channel sell-in and thus revenue, and significant channel inventory reductions resulted.

Productwise there was good uptake on our RangeMax Next draft 11n products and ProSafe Smart Switches. The market acceptance of our industry-leading stackable Gigabit Smart Switches introduced in the prior fourth quarter is very encouraging. It spearheaded our strong growth both sequentially and year-over-year in switch sales. Our Skype phone sales continue to ramp. We are also ramping the production of our EVA8000 Digital Entertainer HD to meet backlog demand. We see both categories as growth categories in the coming quarters

Among the 12 new products introduced in the first quarter of 2007 notable launches included the EVA8000 Digital Entertainer HD, the ProSafe Gigabit Power over Ethernet Smart Switches, and the channel bonding 100 Mbps cable modems, which enabled us to penetrate the Japanese and Korean cable operator markets. We made initial shipments of these modems to Akita Cable in Japan and Qrix Cable in Korea.

Net revenue from service providers accounted for approximately 21% of total net revenue in the first quarter of 2007, as compared to 28% of total net revenue in the fourth quarter of 2006 and 9% in the first quarter of 2006. We remain excited about this channel, and we will continue to service it as one of the avenues to reach our customers.

However, as previously noted, the service provider business is not expected to be linear, given our experience with the service provider approval processes and buying patterns. This will likely lead to up and down periods versus a straight road trajectory. This fact was illustrated in Q1 where we saw a dip in service provider shipments. Since we continue to pursue a multiple channel strategy, we were able to balance the shortfall with strengths in the other channels.

We ended the first quarter with our value-added reseller base growing to 36,000, 2,000 addition to the last quarter, and maintained 16,000 retail outlets worldwide. We entered 2007 with tremendous momentum in our new product lineups, RangeMax NEXT draft 11n Wireless, Powerline 85 in HD, Gigabit Stackable and Power over Ethernet Smart Switches, SSL appliances, Skype phones, Digital Entertainers, Storage Central Turbo and 100 Mbps cable modems.

We believe we will continue to benefit from our strong brand pool in our core home and SMB markets, led by the combination of continued broadband penetration, along with our established alliances with content and service providers. As people continue to invest in creating, sharing and securely saving digital content, we believe we will remain a primary beneficiary.

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

Thank you, Patrick. Now let me provide a summary of the financials for you. Net revenue for the first quarter ended April 1, 2007 was $173.6 million, a 36% increase as compared to $127.3 million for the first quarter ended April 2, 2006, and an increase of 6% as compared to $164 million in the fourth quarter of 2006.

Net revenue in the first quarter of 2007 by geography was $66.1 million for North America, $92.6 million for the Europe, Middle East and Africa region, and $15 million for the Asia-Pacific region. We shipped about 3.9 million units in the first quarter, including 2.9 million nodes of wireless products. Shipments of our wired and wireless routers and gateways combined declined sequentially about 5% in units to 1.75 million units.

Moving to the product category basis, the first quarter net revenue split between wireless and wired was about 62% and 38%, respectively, compared to 68% and 32% for the fourth quarter of 2006. The first quarter net revenue split between home and small-business products was about 64% and 36%, respectively, compared to 69% and 31% for the fourth quarter of 2006.

Products introduced in the last 15 months constituted about 25% of our first quarter shipments, while products introduced in the last 12 months constituted about 23% of our first quarter shipments.

Non-GAAP cost of sales for the first quarter came in at $113.3 million, or 65.3% of net revenues, which compares to $82.6 million, or 64.9%, in the year ago period, and $110.6 million, or 67.5%, in Q4 of 2006.

Non-GAAP gross margin in the first quarter of 2007 was 34.7%, as compared to 35.1% in the year ago comparable quarter, and 32.5% in the fourth quarter of 2006.

As usual, Q1 gross margin benefits from reduced channel rebate promotions related to the holiday season, and also the shifting of channel marketing expenses to general brand marketing activity, such as tradeshows in Las Vegas and Hannover, Germany. Such general brand marketing expenses are accounted for in sales and marketing operating expenses, while channel rebate programs are recorded as a reduction in net revenues.

The reduced shipments to service providers also contributed to the higher gross margin, but should have minimal effect on the operating margin.

Moving to non-GAAP operating expenses. Total non-GAAP operating expenses, which excludes charges for amortization of purchased intangibles, and retention bonuses related to the SkipJam acquisition, as well as non-cash stock-based compensation costs, came at $38.9 million for the first quarter, compared to $28.9 million in the first quarter of 2006 which excludes non-cash stock-based compensation costs, and $34.3 million in the prior quarter which excludes adjustments related to the amortization of purchased intangibles and retention bonuses related to the SkipJam acquisition and non-cash stock-based compensation costs. This was 22.4% of net revenue in the first quarter of 2007, as compared to 22.7% of net revenue in the first quarter of 2006, and 20.9% in the fourth quarter of 2006.

Non-GAAP sales and marketing expenses were $27.2 million, which compares to $20.4 million in the year ago period, and $24.5 million in the prior quarter. As a percentage of net revenue, sales and marketing expenses were 15.7% in Q1 of this year, as compared to 16% in Q1 of last year, and 14.9% for Q4 of 2006. As usual, Q1 sales and marketing expenses include additional expenses for costs associated with the CES and CeBIT tradeshows in Las Vegas and Hannover, Germany.

Non-GAAP R&D expenses were $5.4 million, as compared to $4.3 million in the year ago period, and $4.5 million in the fourth quarter of 2006. This represents 3.1% of net revenues in Q1 of this year, and 3.4% for Q1 of 2006, and 2.8% for Q4 of 2006.

Non-GAAP G&A expenses in the first quarter were $6.3 million or 3.6% of net revenues, compared to $4.2 million or 3.3% of net revenues in the year ago period, and $5.3 million or 3.2% of net revenues in the fourth quarter of 2006.

Operating income on a GAAP basis, which includes $367,000 in charges for amortization of purchased intangibles and retention bonuses, as well as non-cash stock-based compensation expense of $1.8 million, came in at $19.1 million. This compares to $14.9 million in the year ago first quarter, which includes non-cash stock-based compensation expense of $825,000, and $17.3 million in the fourth quarter of 2006, which includes $405,000 in charges for amortization of purchased intangibles and retention bonuses, as well as non-cash stock-based compensation of $1.4 million.

On a GAAP basis the Company recorded net income of $14 million, or $0.40 per diluted share, for the first quarter of 2007, compared to net income of $9.9 million, or $0.29 per diluted share, for the first quarter of 2006, and $13.4 million, or $0.38 per diluted share, in the fourth quarter of 2006.

Non-GAAP net income for the first quarter of 2007 was $15.6 million, a 49% increase compared to non-GAAP net income of $10.5 million for the first quarter of 2006, and an increase of 5% compared to non-GAAP net income of $14.9 million for the fourth quarter of 2006.

Non-GAAP net income for the first quarter of 2007 excludes $254,000 of adjustments related to amortization of purchased intangibles and retention bonuses net of taxes 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 that will be charged to the statement of operations as incurred over a two-year period from the date of the acquisition. As these costs are not part of normal operations of NETGEAR, they are excluded from the non-GAAP statement of operations. Non-GAAP net income for the first quarter of 2007 also excludes non-cash stock-based compensation net of tax of $1.3 million.

Non-GAAP net income for the first quarter of 2006 excludes non-cash stock-based compensation net of tax of $672,000. Non-GAAP net income for the fourth quarter of 2006 excludes $278,000 of adjustments related to the amortization of purchased intangibles and retention bonuses net of tax related to the SkipJam acquisition. Non-GAAP net income for the fourth quarter of 2006 also excluded non-cash stock-based compensation net of tax of $1.2 million.

Non-GAAP net income was $0.44 per diluted share in the first quarter of 2007 compared to $0.31 per diluted share in the first quarter of 2006, and $0.43 for the fourth quarter of 2006. Please note that in Q1 of this year there was a currency gain of about $300,000, which is substantially smaller than the $1.9 million gain we experienced in Q4 of last year.

The non-GAAP tax rate was 34.9% in the first quarter of 2007.

Moving on to the balance sheet. We ended the first quarter with $216.2 million or approximately $6.11 per diluted share in cash, cash equivalents and short-term investments, compared to a total of $197.5 million at the end of the fourth quarter or approximately $5.64 per diluted share, and $178 million at the end of the first quarter of 2006 or approximately $5.22 per diluted share.

In terms of inventory turns, we ended the first quarter 2007 with inventory of $68.4 million with ending inventory turns of 6.6, compared to $44.9 million with ending inventory turns of 7.4 at the end of the first quarter of 2006, and $77.9 million with ending inventory turns of 5.7 at the end of the fourth quarter 2006. Days sales outstanding were 65 in the first quarter of 2007, compared to 77 days in the first quarter of 2006, and 66 days end of the fourth quarter of 2006.

Retail channel inventory in the U.S. ended the first quarter of 2007 at 10.4 weeks, compared to about 9.3 weeks in the first quarter of 2006, and 8.4 weeks in the fourth quarter of 2006. U.S. distribution channel inventory ended the first quarter of 2007 at 4.4 weeks as compared to five weeks in the first quarter of 2006, and 3.5 weeks in the fourth quarter of 2006.

European distribution channel inventory ended the first quarter of 2007 at approximately five weeks, as compared to approximately 5.2 weeks in the first quarter of 2006, and 5.1 weeks in the fourth quarter of 2006. Asia-Pacific distribution channel inventory ended the first quarter of 2007 at approximately 5.1 weeks, as compared to approximately 4.1 weeks in the first quarter of 2006, and 4.2 weeks in the fourth quarter of 2006.

Total assets were $451.2 million at the end of the first quarter of 2007, compared to $357.5 million at the end of the first quarter of 2006, and $437.9 million at the end of the fourth quarter of 2006.

Deferred revenue decreased to $5.8 million as compared to $8.2 million at the end of the prior quarter, and decreased from $7.7 million at the end of the first quarter of 2006.

As for the second quarter of 2007, we expect further sequential decline in European revenue due to seasonality, especially with both pre and post Easter weekends falling into April. However, we expect the shipments to service providers in all three regions to increase sequentially. Overall, we estimate that our Q2 net revenue will be approximately $165 million to $170 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 35%.

Operator, that concludes our comments, and we will now take any questions.

(OPERATOR INSTRUCTIONS). Samuel Wilson, JMP Securities.

A couple small questions. One for Patrick and a couple for Christine. First, for Christine, can you give me a headcount, cash flow from operations, because I missed that, and CapEx please?

Cash flow from operations is approximately $18.5 million for Q1. CapEx spend around $1.6 million. And headcount I believe, let me just check, is 410.

Perfect. One question for Patrick. Patrick, -- well, I have two questions. Can you give us an update just on the emerging markets initiative and sort of how that is going? And secondly what has been the first customer feedback on the EVA8000 as it has been released to the channel?

The emerging market is doing well for us both in China and India. We are progressing very well. We continue to gain share. It is not doing so well for us in Russia. We're hiring a new country manager who should be onboard pretty soon. And we would like to restart the effort probably at the beginning of summer.

In terms of Latin America I think we're making good progress with building the team in Brazil. But significant revenue will not be materializing until probably next year.

In terms of the EVA8000 Digital Entertainer, the feedback has generally been that is great to obtain multimedia content from various sources in the World Wide Web. And because of its flexibility, it certainly is still geared towards the geeks, but demand has been great. We're just ramping our production and scrambling to fulfill the demand.

Maynard Um, UBS.

Congratulations on a good quarter. Two questions. The first on channel inventories. It looked a little bit higher than the normalized levels in the U.S. retail and distribution channel, also in Europe. Have you seen any impact from CompUSA? And how should we think about that getting worked down in Q2? And then I have another question.

The channel inventory is pretty much the same as the same time of last year across the board, except the U.S. retail channel inventory, which is about a week higher. As we explained in prior quarter earnings call, we do not expect the U.S. retail channel inventory to head back to the eight weeks level because of adding in RadioShack's 5,000, 6,000 stores. We will work over time to bring it back. But I think, at least for the foreseeable future, the U.S. retail channel inventory is going to stay at similar levels.

Any impact or comments on CompUSA and the store closing?

No, we do not believe so. Because if they close the stores then certainly the sell through them will be less, but then the inventory through them will be less as well. However, the sales is going to happen in some other stores.

Secondly, on taxes, it was a little lower in the quarter. Can you just talk about the dynamics there? And for modeling purpose should we assume that 35% tax rate for the balance of this year and maybe next?

I think it is fair to assume the 35% for this quarter. We had the R&D credit in at the beginning of the year. There's a lot of stock comp things going in there that wasn't all in there last year, so I think 35% is a good number for us.

For the quarter or for the --?

I would go for the rest of the quarter. You'll see it fluctuate slightly up-and-down, just given the way the taxes go these days with stock options and that. But 35% is our guidance for the year.

I am sorry, for the year -- your guidance for the quarter --?

For the year -- it is what we anticipate non-GAAP guidance to be right now, 35%.

Mark Sue, RBC Capital Markets.

Any thoughts on the outlook for 2007? Just kind of why we shouldn't see revenues accelerate on a year-over-year basis when compared to last year, considering the pipeline of new products, new channels and also the still low penetration?

We don't give annual guidance, but as we have maintained all along, broadband home network penetration around the world is still in its infant stage, and it will be a long way before saturation sets in. So barring any disasters happening, we don't see the general trend not to continue.

On gross margins, are the gross margin improvements related to the carrier spending weakness in Europe? And what is really happening at BSkyB and Vodafone? Is it a just a temporary pause at the moment?

As we have pointed out, the service provider shipments certainly have impact on gross margin, because generally we sell at a lower gross margin, even though it is equivalent operating margin to the service provider. So you're right. Since the shipment to service provider is lower in Q1 compared to Q4, there is a positive impact on the gross margin.

In terms of BSkyB, [Aola, Exactra], yes, there is reduced shipment to them. That is probably a pause after the Christmas promotion. But as we mentioned in the call just now, we expect sequential increase in Q2.

Any idea of volume commitments from these carrier customers?

We never have any volume commitment from anybody.

I see. Okay. But thus far we should see a resumption in the shipments in the second quarter, and also a slight decrease in gross margins in the second quarter?

That is a fair assessment. As you remember, in my prior call we required at least an 8 to 12 weeks leadtime for all service providers revenue.

Stanley Kovler, Merrill Lynch & Co.

I just have a question about the SMB business. A lot of strength this quarter, up, I think, $10 million sequentially. I was wondering if you can help us understand, not only on the product side, but just in general what was going on. Last year was rather flattish. I am just wondering if we should expect that strength to continue? And I have a follow-up.

Yes, as we mentioned in the call, the introduction of our Stackables Gigabit Smart Switches in Q4 generated quite a bit of hoopla in the market, and is stealing quite a bit of share from our competitors. That leads to the uptick of our overall switch sales. We're really happy with the product front. And as the products become better and the channel will accept it better, so I would say that is a product strength, as well as a channel strength, which leads us to a marketshare gain.

Going forward we believe that we will continue to have healthy improvement in the small-business product sales. However, on a percentage basis we do see that it will decline, because as we just mentioned in Q2, the shipment to the service providers will increase, and in Q3 and Q4 they are big consumer quarters. So I would say the percentage of small-business product sales will probably decline through the year, however, the absolute dollars should continue to grow.

That is very helpful. Thank you. Then just to follow-up on the service provider business. Would you characterize the situation mainly in the UK as a little bit of a channel pause, if there is -- there was some channel inventory at the service providers? And outside of the ones that you have already won, how many opportunities are there in Europe or around the world that you maybe can talk about in terms of additional service provider deals? Thank you.

We don't believe there is any channel inventory problem. We monitored it very closely. However, after a big Q4 promotion I think everybody wants to take a breather. And that is why they wait until Q2 to reignite their promotion again.

And the reduction of shipment to service providers is not limited only to the UK operators. It is across Europe. And we certainly expect that there are tremendous opportunities around the world. We are hardly scratching the surface. And you see the amount of dollars shipped by Motorola, Thomson and Aries to the service providers, you understand that the opportunity is tremendous.

Jonathan Goldberg, Deutsche Bank.

First just a housekeeping question. Could you just repeat the breakdown between wired and wireless units?

The wired portion in is 37%. Right? (multiple speakers).

62 and 38.

62 and 38, yes.

I just want to talk a little bit about the retail channel in the U.S. and Europe. We have heard some reports that some of the bigger retailers are reducing the numbers of access point, wireless router vendors they are working --- or brands that they are working with, going from five or six brands down to just two or three. And obviously you and Linksys and one other would be the key beneficiaries of that. Is that actually happening or is that just sort of an anecdotal pattern?

We haven't really seen that yet.

Then can we talk just a little bit also in the carrier channel or the retail channel. How is demand for 11n tracking to your expectations so far?

As we mentioned in the call, in Q1 the ramp of 11n product -- to be exact, draft --- the 11n products, is pretty encouraging. However, it is still below the normal curve of prior WiFi generations. As I mentioned in the previous two calls, the price curve decline this time for draft 11n products was actually much smaller than the prior generations of WiFi.

But we believe that it is changing. And we believe that it will continue to ramp. And we expect huge sales of 11n -- draft 11n products starting back to school.

Back to school, not Christmas?

Back to school.

(OPERATOR INSTRUCTIONS). Maynard Um, UBS.

One of your competitors today on their conference call indicated that it is harder for competitors like yourself and Linksys to enter the emerging markets. And in particular they cited the Middle East because of the political climate and Russia as two examples. Can you just talk about any of the barriers to entry in those markets, and why you feel that the acceleration should start to happen next year?

The same competitor has talked about China and India before as well, so I'm not going to make any further comment.

Then the issue that you talked about in marketing in Australia, can you just expand on that a little bit?

Basically, as I mentioned in a prior call, there is still a tremendous hindrance on the government negotiation with Telstra on what they want -- what they could do. And once they privatize, how should they open up the network? That is slowing down the broadband penetration over there. So that is why the market condition becomes a little bit more challenging.

We're taking actions to [operate] more, and probably with Optus, to try to push things a little bit more forward. So we are now a partner to Optus as well, so hopefully in the foreseeable future we will be able to improve the situation over there.

John Lynch, Needham & Company.

There is some very positive press for the EVA around the Apple TV launch. Though it is obviously still early and the numbers are small, I am curious if you noticed any tangible change in demand as a result of that attention on this space?

As I just mentioned previously in the prior questions, we certainly see quite a bit of pent-up demand for our EVA8000. We did not anticipate that the demand was so exciting.

However, as usual when we introduce these new categories, we really do not what the real demand is, because we will ease up the production a little bit, and see how that sells through. And then if it sells through then we'll ease up a little bit more. So for now we are still in the ramp up state. Certainly as it stands right now, it is already a very successful introduction by our standard, and we look forward to even more exciting results.

(OPERATOR INSTRUCTIONS). Seeing as there are no further questions in the queue, at this time, I would like to turn the call back to management for any concluding remarks.

Certainly. Thank you once again for everybody joining our call. And we look forward to reporting results to you again in the next quarter. We are very excited about our prospects. We have a tremendous position on the product, channel and brand front. And the whole team at NETGEAR is working very hard to continue to win out the hearts and minds of our customers. I look forward to speaking with you next time.

Ladies and gentlemen, this concludes today's teleconference. Thank you for your participation.