NETGEAR Inc (NTGR) 2009 Q1 法說會逐字稿

Greetings, and welcome to the NETGEAR, Inc. first quarter 2009 conference call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. If anyone should require operator assistance during the conference, (Operator Instructions). As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, Mr. Joseph Villalta of The Ruth Group. Thank you. Mr. Villalta, you may begin.

Thank you, Operator. Good afternoon, and welcome to NETGEAR'S first quarter 2009 results call.

Joining us from the Company are Mr. Patrick Lo, Chairman and CEO, and Mrs. Christine Gorjanc, CFO. The format of the call will be a brief business review by Patrick, followed by Christy providing detail on the financials. We'll then have time for any questions.

If you have not received a copy of today's earnings release, please call the Ruth Group at 646-536-7026, or you could go to NETGEAR'S website at www.netgear.com.

Before we begin, the formal remarks, the Company's attorneys advise us that today's conference call contains forward-looking statements within the meaning of the US Private Securities Litigation Reform Act of 1995. The words anticipate, expect, believe, will, may, should, estimate, project, outlook, forecast, or other similar words are used to identify such forward-looking statements. However, the absence of these words do not mean that the statements are not forward-looking.

Forward-looking statements represent NETGEAR, Inc.'s expectations or beliefs concerning future events based on information available at the time such statements were made, and include statements, among others, regarding NETGEAR'S expected revenue, earnings, gross and operating income, and tax rate on both a GAAP and non-GAAP basis; the effect of the global economic environment on the Company's business; the possibility that NETGEAR may repurchase its shares under the repurchase program; our position in the market relative to our competition; the long-term future of NETGEAR'S business, our competitive position in the SMB market; our ability to innovate; anticipated new product offerings; current and future demand for the Company's existing and anticipated new products; willingness of the consumers to purchase and use the Company's products; and ability to increase distribution and marketshare 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 adapt competing products; product performance may be adversely affected by real world operating conditions; the Company may be unsuccessful or experience delays in manufacturing and distributing its new and existing products; telecommunications service providers may choose to slow their 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 a 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 Saturday of the quarter, as reported by certain of NETGEAR'S customers; changes in the level of NETGEAR'S cash resources and the Company's planned usage of such resources; changes in the Company's stock price; development in the business that could increase the Company's cash needs and fluctuations in foreign exchange rates.

Further, certain forward-looking statements are based on assumptions as to future events that may not prove to be accurate. Therefore, actual outcomes and the results may differ materially from what is expressed or forecast in such forward-looking statements.

Further information on potential risk factors that could affect NETGEAR and its business are detailed in the Company's periodic filings with the SEC, including but not limited to those risks and uncertainties listed in the section entitled Part 1, Item 1A, Risk Factors, pages 11 through 26 in the Company's annual report on Form 10-K for the fiscal year ended December 31, 2008, filed with the SEC on March 4, 2009.

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 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 IR 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, Joseph. Thank you, everyone, for joining today's call. As expected, Q1 was a challenging quarter, characterized by continued declines in market demand, destocking in the channels, and a higher average exchange rate of the US dollar compared to previous quarters.

In light of the economic slowdown, we achieved net revenue of $152 million, a decline from fourth quarter of last year, but [above] our initial guidance of $135 million to $145 million. We announced on last quarter's call the implementation of a cost reduction initiative, with the aim of reducing operating expenses by $10 million in 2009, as compared to the annualized fourth quarter 2008 run rate.

We have already seen significant cost saving results from our efforts, about $2.6 million in the first quarter of 2009, and we expect to meet our goal of $10 million savings by the end of the year.

Our North America net revenue was $65.2 million in Q1, while Europe, the Middle East and Africa, or EMEA, net revenue was $74.2 million; and our Asia Pacific, or APAC, net revenue was $12.6 million. Compared to Q1 of 2008, our North America revenue decreased approximately 18%; EMEA net revenue decreased 24%; and APAC revenue was down about 39%.

Our EMEA and APAC revenue were particularly hit hard by the appreciation of the US dollar in the latter half of 2008 and into Q1 of 2009. For example, in Q1, typically, Australia-based revenue accounts for the majority of our APAC revenue, due to the celebration of the Chinese New Year holidays in the rest of Asia-Pacific regions.

In this past quarter, the Australian dollar experienced depreciation of 25% against the US dollar year-over-year, resulting in an APAC revenue decline greater than other geographic regions on a year-over-year basis.

In the first quarter of 2009, we saw stabilization in our consumer retail sales, but an incremental decline in global SMB product sales. We saw a significant reduction in channel inventory in absolute dollars in the first quarter. We expect this reduction to continue in the second quarter.

We introduced an additional 14 new products in the first quarter. Notable introductions include ProSecure Web Email Security Appliance Model [2] STM150. The high-performance desktop network storage 4-bay ReadyNAS Xtra, high-power hot spot access points for service providers, and the [50] port layered [310 100 speccable] switch.

We are pleased with the results of our continued emphasis on new product R&D. Our leadership in home and small/medium business products continues to be recognized by the industry and our customers. We expect to continue this trend and accelerate our new product introductions in the coming quarters.

In the near term, we're picking up the pace, anticipating 15 or more new products launches by the end of June. With these new product offerings, we expect to gain further marketshare in the second half of 2009, relative to our competitors.

Despite the current challenging macroeconomic environment, we believe our cost control measures, coupled with our ongoing strategy of leading in differentiated product introductions, will continue to keep us ahead of our competition.

In the first quarter, our net revenue from service providers accounted for approximately 27% of total net revenue, compared to 18% of total net revenue in the fourth quarter of 2008 and 28% in the first quarter of 2008. We were pleased to add Telkom South Africa to our service provider customer list in the first quarter. Our Value Added Resellers continues to grow, with new ones joining us for our ready-net network storage and ProSecure security appliances.

We recently added over 100 certified ProSecure Value Added Resellers for our Web email security appliance worldwide. We currently have about 40,000 Value Added Resellers globally. We have every confidence that market growth will resume in the not-too-distant future, due to the low penetration of broadband in developing countries, and the continuous proliferation of broadband applications such as voice, video, communications and entertainment in the developed world.

We are convinced that with our unparalleled product pipeline, worldwide channel coverage, global brand recognition, and strong balance sheet, we will continue to gain on our competitors and increase our marketshare, under both difficult and robust market conditions.

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

Thank you, Patrick. Let me now provide you with a summary of the financials for Q1.

As Patrick noted, net revenue for the first quarter ended March 29, 2009 was $152 million compared to $198.2 million for the first quarter ended March 30, 2008, and $161.4 million in the fourth quarter ended December 31, 2008.

On a constant currency basis relative to Q1 last year, net revenue for the first quarter of 2009 would have increased to $161.2 million, and non-GAAP operating profit would have increased by $6.8 million to $12.5 million.

In addition to the negative currency impact, our first quarter 2009 net revenue was hurt by further declines in SMB product shipments. We shipped about 4.1 million units in the first quarter, including 3.1 million nodes of wireless products. Shipments of our wired and wireless routers and Gateway combined in the first quarter were about 2.3 million units.

Moving to the product category basis, first quarter net revenue split between wireless and wired was about 64% and 36%, respectively. The first quarter net revenue split between home and small business products was about 65% and 35%, respectively. Products introduced in the last 15 months constituted about 37% of our first quarter shipments, while products introduced in the last 12 months constituted about 36% of our first quarter shipments.

Non-GAAP gross margins in the first quarter of 2009 was 29.2%, compared to 32.9% in the year-ago comparable quarter, and 31.2% in the fourth quarter of 2008.

As expected, the gross margin decline was partly due to a stronger average exchange rate of the US dollar against foreign currencies compared to prior quarters. Another major factor is the decline in SMB product shipments compared to Q4 of 2008.

To better predict margins, we are expanding our hedging programs to include the forecast of our quarterly foreign currency revenue. We do expect to see an improved gross margin in the second quarter, due to our product cost reductions and a slight improvement in foreign currency pricing.

Moving to non-GAAP operating expenses, total non-GAAP operating expenses declined by 16% compared to the prior year's second quarter, reflecting the impact of cost-saving actions we have taken in this challenging environment in addition to the lower revenue levels. Total non-GAAP operating expenses came in at $38.8 million for the first quarter of 2009. This compares to non-GAAP operating expense of $46.4 million in the first quarter of 2008, and $41.4 million in the fourth quarter of 2008.

Q1 2009 operating expenses represented 25.5% of net revenue as compared to 23.4% of revenue in Q1 of 2008. The percentage increase as compared to the first quarter of 2008 is primarily due to lower revenue levels. We continue to target $10 million reduction in operating expenses on an annualized basis in 2009. We saved $2.6 million in operating expenses in the first quarter of 2009, compared to the quarterly run rate in the previous quarter.

On a GAAP basis, the Company reported net income of $42,000 or $0.00 per diluted share for the first quarter of 2009, compared to net income of $11.2 million or $0.31 per diluted share for the first quarter of 2008, and a net loss of $7.3 million or $0.21 per diluted share in the fourth quarter of 2008.

On a non-GAAP basis, the Company experienced net income of $1.8 million for the first quarter of 2009, as compared to non-GAAP net income of $14.1 million for the first quarter of 2008, and non-GAAP net loss of $2.5 million for the fourth quarter of 2008.

Non-GAAP net profit was $0.05 per diluted share in the first quarter of 2009, compared to net income of $0.39 per diluted share in the first quarter of 2008, and a net loss of $0.07 per diluted share for the fourth quarter of 2008. In Q1 2009, we reported a net foreign currency gain of $1 million compared to a gain of $2.8 million in the first quarter of 2008, and a loss of about $6.6 million in the prior quarter.

Non-GAAP tax expense was $5.1 million in the first quarter of 2009, compared to $9.1 million in the first quarter of 2008, and $5.8 million in the fourth quarter of 2008. The reconciliation of GAAP to non-GAAP is detailed in our financial statements released earlier today. Specifically excluded from non-GAAP income from operations in the first quarter 2009 is $2.5 million in charges related to three patent litigation settlements recently entered into by the Company.

We continue to maintain a strong balance sheet, ending the first quarter with $200.3 million in cash, cash equivalents, and short-term investments. Our Accounts Receivable collections also remains strong. DSOs for the first quarter decreased to 74 days compared to 81 days in the fourth quarter of 2008.

Due to our concentrated effort to reduce inventory, inventories were down $20.2 million sequentially, and inventory turns increased from 4.0 to 4.7. We expect our own on-hand inventories to continue to trend downward.

We saw a reduction in channel inventory in absolute dollars. In terms of weeks of sales, the reduction is less apparent, primarily because the average weekly sales volume in US dollars is much less in March than in December, which is the respective basis for our calculation of weeks of channel inventory for each period. Please note that while the strongest sales month in Q4 is December, in Q1, the stronger sales month is January.

We believe our successful strategy of continuous innovation, global brand recognition, focused channel programs, maintaining a healthy balance sheet, and cost-saving initiatives will allow us to weather this downturn. We will continue to bring new technology to the marketplace, winning over more channel partners and customers in order to successfully further expand our marketshare.

We anticipate seasonal weakness in consumer demand and a further slight decline in SMB shipments in the second quarter. While we see continued reduction in distributor channel inventory, we anticipate US retailers will increase inventory in June in preparation for the back-to-school sale season beginning in mid-July.

Also, we foresee improvement in our gross margin in the second quarter 2009, due to consistent efforts in product cost reductions and slight improvement in foreign currency pricing. For the second quarter 2009, we expect net revenue in the range of approximately $135 million to $145 million, and non-GAAP operating margins to be in the range of 3% to 5%.

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

Thank you. (Operator Instructions). Samuel Wilson, JMP Securities.

I have five simple questions. First for Patrick, it sounds like in the retail side of the business, you think inventory restocking ends in April/May, just that time period, and in June, it will actually start to build for back-to-school. And that's only the US, right? Because back-to-school is really only a US-only phenomena.

Correct. That's true.

What do you think is going on with the channel inventories or destocking in the international markets?

The retail side is doing very well. I think we're done with that. But on the distribution side, I think we still have some work to do in international distributors as well as in the US distributors.

Okay. And then, second, Patrick, can you talk a little bit about the service rider business? I know that Charter was a customer in the past. They declared bankruptcy. Have they stopped ordering? How does that work? Did you have any liabilities there? And just service provider business in general.

Service providers, as you see, has continued to be a pretty good portion of our business. Of course, it is also affected by the general economy as well. So the percentage of service provider revenue in Q1 basically mimics the same percentage as of Q1 2008.

Charter is still a customer, as you probably know. They actually entered into what we call a creditor agreed to bankruptcy, that the judge has agreed that they will continue to pay their trade creditors. So we continue to ship to them and they continue to be a good customer of ours.

Okay. And then Christine, a bunch of really small questions for you. Cash from operations, CapEx, and headcount?

Okay. Headcount is 568. CapEx was very low this quarter, about $229,000. And we do anticipate a much lower CapEx in 2009 than 2008, because we did have an ERP implementation and a building move last year.

And then cash flow from operations for the current quarter is about $2.8 million negative. And if you look on our balance sheet, you'll see how accounts payable was down significantly.

Right. And then do you have any guess what you expect the tax rate to be or the tax provision to be dollar-wise? It's probably easier for Q2.

You know, I think we'll stick with the guidance that we've given really, is about $6 million to $8 million a quarter. And I would tell you that that is somewhat back-end loaded, as you go through the quarter.

Because if you remember, the tax provision is done on an annualized basis, so it's a percentage of an annual number. So we still believe around $6 million to $8 million is the right number for each quarter, but more back-end loaded.

Okay. And then lastly, Patrick, for you, just what went better than expected from 90 days ago when you gave guidance for Q1 to what actually happened?

Well, I would say that the consumer demand is a bit better than we expected, and the channel destocking is not as severe. We thought that it was going to do it in all one quarter. It looks like they do probably 75% of that in Q1, and then the other 25% in Q2. So those are the two better ones than we expected.

A little bit worse than we expected was the bigger than -- what we planned to decline the SMB's shipment.

Perfect. Thank you very much and congratulations on a good quarter.

Maynard Um, UBS.

It's [Ana Nordfist] for Maynard. Thanks for taking the question. First, can you talk about how much of the gross margin impact was from pricing versus marketing activity in the quarter?

The gross margin impact we think is primarily due to the currency. There is very little movement on pricing at all. And the pricing was affected by the foreign currency, but the actual nominal price in movement, there is very, very little.

Marketing activity -- actually Q1 is not typical, a very high promotion quarter other than in January. But compared to Q4, promotion is a lot less severe. Because in Q4, we have to do both the Thanksgiving promotion as well as the Christmas promotion. So, the gross margin decline is primarily due to the currency pricing.

Okay. And any color on how we should think about interest income for next quarter?

All I could really say right now is interest income, as you saw from the financial statements, is about $300,000 for the quarter. So we're not earning a lot on our money. It's very safe, but we're earning very little, probably less than 100 basis points right now.

Okay. And you mentioned $2.6 million reduction in operating expenses. Could you provide the breakdown between the different line items?

Well, primarily it's savings in compensation. That's the bulk of it. I would say that's the majority of it. And of course, we got some concessions from our outside service providers, names withheld; but those are the two major areas.

Okay, great. Thanks very much.

Hamed Khorsand, BWS Financial.

Just a question on the SMB comments. What's making it drag bigger than what you thought? Or is it just continuing along as the economy moves along?

Yes. What we heard from the channel is that even a small/medium business started to freeze up in January. So the markets shrank pretty significantly.

Okay. And then on the new products that you're developing, you're saying 15-plus by June, when do you see that coming through -- or is that going to hit the market by June? And also, what kind of anticipation do you have that you can gain new marketshare with these new products?

Actually, most of the new products are already -- I mean, not most; I mean some of the new products are already out on our website. We made quite a few introductions in the past few days.

For example, the MoCA kit; for example, the UTMs. Those are some of the products that we've -- had already been announced. They will be spread across both consumer, SMB, as well as service providers, and they will be spread all through the quarter.

Okay. Any 10% customers this quarter?

I would say our typical 10% customers would be Ingram and Tech Data.

Okay. Any standout retail guys within the quarter?

I mean, as usual, the big guys are still Best Buy, Wal-Mart, Media Art -- yes, those are still big ones.

Okay, thank you.

Jeff Kvaal, Barclays Capital.

Thanks very much. Patrick, I was wondering if you could spend a little bit more time talking about SMB. You suggested that things got pretty weak in January. Have they started to turn up again? Or is visibility there still pretty limited? Thanks.

We don't really have solid data but anecdotally, it seems to be moving again in the last few weeks.

By moving, that is, moving pretty good (multiple speakers) --?

It means that some of the purchases starting to kind of unfrozen.

Okay, and that's -- so, then talking to your channel partners, that's the feedback that you get?

Correct.

Okay, fantastic. And just -- do you think that is mostly a US phenomenon or is that --?

No, it is worldwide. It's global. I mean, SMB's -- they all behave pretty much the same, because they are running their own business using their own pocket dollars.

Okay. So just globally then, SMB is doing pretty well for you?

I mean, we're seeing signs that they're easing up in the last few weeks, yes.

Okay, great. And then on Asia, how much of what's going on there is a function of FX?

In Q1, it's very significant. Because as we mentioned in Q1 -- because Asia, the bulk of our business are concentrated between Australia and China, Korea, and Southeast Asia, and India. So other than India, which is not quite affected by Chinese New Year -- I mean, everybody else in the rest of Asia, outside of Australia, is affected by Chinese New Year. They pretty much close shop.

So in Q1, our revenue is pretty much Australia-skewed. And then when the Australian dollar is depreciated 25% year-over-year, it really whacked us pretty hard.

Yes, okay. All right. It makes sense. And anything in particular going on in India that we should be aware of?

No, I mean, everybody knows, right, India actually is suffering after the Mumbai incidents, and of course, with the global slowdown as well. So we do see the India market has slowed down just like the rest of the world. However, our position over there is still pretty strong. We have a very good distribution network. We have a good brand. We believe that we will continue to do well.

Thank you.

(Operator Instructions). Thomas Lee, Goldman Sachs Asset Management.

Yes, I just wanted to -- you touched a little bit about this on the prepared remarks. In terms of linearity for the quarter, I know you mentioned that Q1, in Q1, typically January is the strongest month. But was that the case this quarter as well, even given the FX implications from -- in Australia?

Oh, yes. I mean, even in this year, Q1 is usually the strongest quarter on a global basis because it doesn't matter whether it's in Australia or it's in the UK, or is in the US, most of our retail customers actually do quite significant after-Christmas sales promotions. And we participated in that too.

So that's why Q1 is generally. And also the service providers -- Q1 are usually at the beginning of the financial year. That means that all the CapEx budgets, the expense budgets open up in January. And that's when they typically put in the major purchases and ask us to ship the most.

So then -- and as we -- January through March, was there anything unusual that you saw outside of normal seasonal trends?

No, not really, other than the whole market shrank. I mean the size of the whole market shrank.

Right. And then it sounds like you're more constructive on the US market, and you alluded to that, you expect [no] channel inventories to, I guess, to come back at the end of Q2.

I mean, what gives you the confidence that you're going to see [to out] that replenishment in Q2, given what we know in terms of the macro outlook? And a lot of companies and even a lot of retailers are saying that there's still -- visibility is very limited. And just curious to get your thoughts in terms of your confidence level and end demand, I guess, coming back to somewhat some level of normalcy.

Yes, basically in the US, we have the most solid data compilation. Not only that, we have weekly feeds, sometimes daily feeds from our retailers on the cash register rings. We also have weekly feed from market data, from market share survey companies, that give us what's the size of the market.

So, as the rate of slowing down flattens out -- that means the second derivative of the decline of the market becomes zero, then it indicates that the market is now pretty much bottomed out for the consumer demand, and it's now following the normal seasonality; it's not declining faster than the seasonality.

I think both us as well as the retailers will get the same data. They're saying, okay, from here on out, we probably would like to go back into normal seasonality patterns. And that's why they feel like that, they need to stock back up in June for the back-to-school season.

Do you feel pretty confident that Q1, from an absolute level in terms of the Americas, is a bottom, from a revenue perspective?

We're just seeing that, as I said, as we see that, the rate of decline of the market actually becomes much, much less in Q1. So if you say whether that's the bottom, it probably is for consumer demand, barring any further disaster in the financial sector.

Got it. And then last question is on the SMB topic again. Was there anything from a marketshare position that you think may have caused some additional pressure? And I just wanted to clarify -- when you said that you expect this to improve slightly, that's quarter-on-quarter?

No, I mean, from the marketshare perspective, we look at it, I think we generally hold marketshare. We're not gaining any significant marketshare. We don't intend to, because in this shrinking market, some of our competitors would opt for lower prices, try to grab some more marketshare.

So it'd be difficult for us to gain for the marketshare until we get some really products ramping, such as our ReadyNAS Xtra. And we believe that we'll get that done in the coming quarters.

The primary weakness of our SMB shipment is driven by the market size -- the market decline.

Got it. And then when you did your comments on SMB improving slightly, that's sequentially, is that right?

Yes.

Okay. Thank you.

Jonathan Goldberg, Deutsche Bank Securities.

All I have left now is a quick housekeeping question for Christine. Could you just repeat the data you gave on units?

On units?

On units, yes.

Yes. For the quarter, we shipped 4.1 million units. And did you want to know the wire -- wireless/wired split in that?

Yes, if I can get a complete breakdown, please.

Okay. So wireless and wired was 64%/36%, respectively. And then home and SMB was 65%/35% respectively.

There was 3.1 million units of wireless [nodes] shipped.

Okay, great. Thank you.

There are no other questions in the queue at this time. I've like to hand it back over to management for closing comments.

Sure. Certainly, I mean, we see the market slowing down -- it's slowing down. So the second [to riches] is getting more [collateral]. However, Q2 would be still a seasonally weaker quarter. We believe that we will continue to be very vigilant in terms of cost control. On the other hand, we will still continue to focus more of our expenses into R&D, so that we can generate more new products that we believe that would do us very good in the second half of the year, when we believe the market will come back.

With all the products that were in the pipeline for us, the 14 new products that we introduced in Q1, we feel very good about the second half of the year in terms of gaining on our competitors. So if the market indeed returns to even a slight growth mode in the second half, we believe that we're positioned very well at that time.

So, look forward to talk to everybody again in July, where we will have a little bit more color how the second half is going to be. Thank you.

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