NETGEAR Inc (NTGR) 2009 Q3 法說會逐字稿

Greetings and welcome to the NETGEAR, Inc., third quarter 2009 results conference call. At this time all participants are in a listen-only mode. A brief question and answer session will follow the formal presentation. (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.

Good afternoon, and welcome to NETGEAR's third quarter 2009 financial results conference call. Joining us from the company are Mr. Patrick Lo, Chairman and Chief Executive Officer, and Ms. Christine Gorjanc, Chief Financial Officer.

The format of the call will be a brief business review by Patrick, followed by 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 go to NETGEAR's corporate 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 with the meaning of the US Private Securities Litigation Reform Act of 1995. The words anticipate, expects, 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 does 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 events were made and include statements among others regarding NETGEAR's expected revenue, earnings, gross and operating income, margin, and tax rate on both a GAAP and non-GAAP basis, the effect of the global economic environment on the company's business, our position in the market relative to our competition, the long-term future of NETGEAR's business, our ability to innovate and anticipate 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, 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, telecommunication 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 new products and manufacturing distribution of its existing offerings, channel inventory information reported and estimated based on average number of weeks of inventory on hand the last Saturday of the quarter as reported by 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, developments in the business that can increase the company's needs, and fluctuations of foreign exchange rates.

Further certain looking statements are based on assumptions as to future events that may prove to be accurate. Therefore actual outcomes and results may differ materially from what is expressed or forecasted in such forward-looking statements.

Further information on potential risks are detailed in the company's periodic filings with the SEC, including but not limited to those risks and uncertainties listed in the section titled Part Two, Item 1A, Risk Factors, pages 35 to 49 in the company's quarterly report on Form 10-Q for the quarter ended June 20, 2009 with the SEC on August 6, 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 to reflect the occurrence of anticipated events.

In addition, several non-GAAP financial measures will be mentioned on this call. Information relating to the corresponding GAAP measures and reconciliation of non-GAAP and GAAP measures can be found in our press release on the investor relations website at NETGEAR.com.

At this time I would now like to turn the call over to Mr. Patrick Lo. Please go ahead sir.

Mr. Lo, your line is live. Please go ahead sir.

Thank you everybody for joining the call. Sorry about some technical difficulty just now.

The third quarter of 2009 was a solid quarter for NETGEAR. We're making significant progress in our business along with the improving macroeconomic environment. We are extremely pleased to achieve net revenue of $171.1 million in the third quarter, exceeding expectations. By holding down our expenses we were able to capitalize on the upside on the top line to generate extra operating profit, thus exceeding our prior operating margin guidance by a healthy margin.

The third quarter showed a robust back-to-school demand and market share gain in the US, resulting in our year-over-year growth in the US net revenue. We reduced our on-hand inventory sequentially to $73.9 million, and we increased our non-GAAP operating margin to 10.6%. We generated significant cash from our operation in Q3 2009, increasing our cash, cash equivalents, and short-term investments by about $10 million, resulting in a cash balance of $234.5 million, while bringing our DSO down three days as compared to Q2 to 66 days.

We also experienced improved SMB demand quarter-over-quarter across all three geographic regions. Most importantly, we introduced a record 21 new products during the quarter and continued to gain share in all important US retail channels.

In January 2009 we announced the implantation of a cost reduction initiative aiming to reduce operating expenses by $10 million for 2009 as compared to the annualized fourth quarter 2008 run rate. We've already experienced significant cost saving results from our efforts, about $8.8 million through the first nine months of 2009, and we expect to meet our goal of $10 million by the end of the year.

Our North American net revenue was $75.4 million in Q3, while Europe, the Middle East and Africa, or EMEA, net revenue was $72.6 million. In our Asia-Pacific, or APAC, net revenue was $23.1 million. Compared to Q3 of 2008 our North America revenue increased approximately 2% while EMEA and APAC net revenue decreased 11% and 4%, respectively, primarily due to currency fluctuations.

From a product perspective we are excited to have introduced 21 new products in the third quarter, a record number for us for a single quarter. Our investment in R&D has resulted in a number of notable product introductions, including the Digital Entertainer Live for viewing Internet video programs on TVs; Stora, our home multimedia network server, accessible anywhere in the world from both laptops and smartphones, and the ultimate networking machine, a dual band, gigabit, super high-speed WiFi router packed with state-of-the-art features such as ReadyShare USB storage access and broadband usage metering.

On the SMB front we introduced the 12 base super performance rackmount ReadyNAS network storage for up to 12 terabytes of secured data, and a full line of ProSecure security appliances ranging from UTMs for up to 25 users and Content Threat Managers for up to 600 users.

We also introduced breakthrough products such as our new DOCSIS 3.0 cable/WiFi gateway, and revolutionary configurable unmanaged switches, which we named as Unmanaged Plus switches.

We remain focused on product development and intend to introduce another 15 to 20 new products in Q4, further positioning us for revenue growth and market share gains in new geographies in our current markets.

In the third quarter are net revenue from service providers accounted for approximately 25% of total net revenue compared to 18% of total net revenue in the third quarter of 2008 and 30% in the second quarter of 2009.

Additionally we are pleased to add J:COM in Japan and Comhem in Sweden to our service provider customer list in the third quarter. Our value-added reseller list remained strong at over 37,000 worldwide despite the economic downturn.

We are seeing the uptick of end-user demand in North America and Asia-Pacific markets with signs of stabilization in Europe. We have confidence that our overall year on year revenue growth will return in Q4.

We will continue to invest in innovation, ramp our sales and marketing efforts, operate efficiently, tightly manage our inventory levels, and focus on generating cash. We are confident that our exciting new product pipeline will allow us to gain on our competitors and increase our market share worldwide in the fourth quarter and beyond.

Now let me turn the call over to Christine for details on our financials.

Let me now provide you with a summary of the financials for Q3. As Patrick noted, net revenue for the third quarter ended September 27, 2009 was $171.1 million compared to $179.4 million for the third quarter ended September 28, 2008 and $144.7 million in the second quarter ended June 28, 2009.

We shipped a total of about 3.8 million units in the third quarter including 3.1 million nodes of wireless products. Shipments of our wired and wireless routers and gateways combined in the third quarter were about 2.2 million units.

Moving to the product category basis, third-quarter net revenue, split between wireless and wired, was about 61% and 39%, respectively. The third-quarter net revenue split between home and small-business products was about 61% and 39%, respectively.

Products introduced in the last 15 months constituted about 34% of our third-quarter shipments, while product introduced in the last 12 months constituted about 25% of our third-quarter shipments.

Non-GAAP gross margin in the third quarter of 2009 was 33.5% compared to 35.5% in the year-ago and comparable quarter and 29.6% in the second quarter of 2009.

Moving to non-GAAP operating expenses. Total non-GAAP operating expenses declined by 11% compared to the prior year same quarter, reflecting the impact of our cost-saving efforts. Total non-GAAP operating expenses came in at $39.1 million for the third-quarter 2009. This compares to non-GAAP operating expenses of $43.7 million in the third quarter of 2008 and $37.4 million in the second quarter of 2009.

As Patrick mentioned, we continue to target a $10 million reduction in operating expenses in 2009 as compared to the annualized run rate of Q4 2008. We saved $8.8 million in operating expenses in the first three quarters of 2009, and as things stand, we are confident in our abilities to achieve our annual savings target.

On a GAAP basis the company recorded net income of $8.5 million or $0.24 per diluted share for the third quarter 2009 compared to net income of $3.1 million or $0.09 per diluted share for the third quarter of 2008 and a net loss of $3.3 million or $0.10 per diluted share in the second quarter 2009.

On a non-GAAP basis the company experienced net income of $11 million for the third quarter of 2009 as compared to non-GAAP net income of $6.9 million for the third quarter of 2008 and a non-GAAP net loss of $522,000 for the second quarter of 2009. Non-GAAP net income was $0.31 per diluted share for the third quarter of 2009 compared to net income of $0.19 per diluted share in the third quarter of 2008 and a net loss of $0.02 per diluted share in the second quarter of 2009.

In Q3 2009 we recorded a net foreign currency loss of $266,000 compared to a net $4.7 million loss in the third quarter of 2008 and a net $443,000 loss in the prior quarter.

GAAP tax expense was $5.8 million in the third quarter of 2009 compared to $7.9 million in Q3 '08 and $4.4 million in Q2 '09.

Non-GAAP tax expense was $6.9 million in the third quarter of 2009 compared to $9.4 million in the third quarter 2008 and $5.7 million in the second quarter of 2009.

The reconciliation of GAAP to non-GAAP is detailed in our financial statements released earlier today.

We continue to maintain a strong balance sheet, ending the third quarter with $234.5 million in cash, cash equivalents and short-term investments. Our accounts receivable collections remain strong, DSOs for the third quarter decreased to 66 days compared to 69 days in the second quarter of 2009. Our continued efforts to efficiently manage our inventory resulted in a $1.2 million sequential inventory reduction and an increase in inventory turns from 5.5 to 6.2 over the prior quarter.

In the fourth quarter of 2009 we anticipate continued revenue expansion in new categories such as consumer and high-end network storage, DOCSIS 3.0 cable gateways, and security appliances, in addition to overall market share gains in retail and SMB channels worldwide. We also plan to expand our worldwide sales and marketing team, given the early signs of market demand turnaround. We believe we can continue to grow and gain market share in the US, Asia-Pacific and other emerging markets.

We continue to focus on our successful strategy of continuous innovation, new product introduction, superior customer service, and winning channel programs. We expect this strategy will allow us to stay ahead of our competition.

Channel inventory rationalization was mostly complete in the third quarter, and distribution channel inventory in all regions is now at the right level. However, we are experiencing constrained ship supply in specific product categories, and to shorten our overall product cycle time we will have to spend incremental air freight dollars in Q4 to satisfy contractual customer arrangements and to ensure adequate supply for holiday promotional activity.

For the fourth quarter of 2009 we expect net revenue in the range of approximately $170 million to $180 million and non-GAAP operating margin to be in the range of 7% to 9%.

Operator, that concludes our comments, and we will be happy to take questions.

(Operator Instructions). Lynn Um, Barclays Capital.

Thanks for taking the question and congratulations on an excellent quarter.

I guess I just want to first just ask about the guidance. At the midpoint it seems like it comes out to about maybe 2.5% sequential growth. It's a little bit below I think what you've done historically. Can you talk about some of the factors that may swing it to the lower end versus the higher end?

Clearly right now the worldwide economy is just in its early stage of stabilization. We are not living in a normal historical environment. As you could see last year, Q4 was actually significantly smaller than Q3. Under this kind of environment, it is still difficult to predict what the economy is going to do. I think Christmas around the world is still pretty big, a testing -- limits test on how the economic recovery is going.

So I think compounded on that, as we mentioned, there is a pretty severe chip shortage that limit our supply capability. So I would say if Christmas turns out to be good or better than what we think and chip supply will ease a little bit, then we will be at the high end. But if Christmas turns out to be conservative, as we think it could be and chip supply doesn't ease a bit, we will be at the low end.

That makes sense. Maybe just a question on the US retail environment. It sounds like you mentioned you're gaining share. Could you just maybe delve a little bit deeper into just the competitive landscape, how the pricing environment was for you this quarter?

The pricing environment has been very stable throughout the year. And you probably noticed that one of our weaker competitor's dealings have been gradually exiting the market. And clearly we are grabbing share from that opportunity. So that has enabled us to continue to ride on the improvement in the US market demand. As a matter of fact, the year on year growth on the US market is returning.

Okay. I think that's all for me, thank you.

Woo Jin Ho.

It's not working. Mr. Woo Jin Ho, your line is live.

Okay. Sam Wilson.

Sam?

Operator?

Yes. Mr. Wilson, your line is live.

Actually, this is NETGEAR. We don't have Sam Wilson on the line.

Mr. Hamed Khorsand.

My question is you guys have introduced 21 products this past quarter. Now you're looking to -- let's say you hit your high mark and introduce 20 products Q4. That's 40 products in two quarters. And your guidance suggests that your incremental income, your incremental revenue isn't as high as it would be in previous quarters from these new products. Can you touch on that for me a little bit?

Well, as we maintain, we really depend on the supply of the chips. And it really depends on -- in the meantime when we introduce new products we also obsolete old products as well. So it's a matter of the wham of the old new products versus decline of the old products, and clearly right now if you look at the landscape, the 11N is absolutely taking over the 11G, so it really depends on 11N's growth, whether we will offset the decline of 11G. Same thing on gigabit versus offset the decline of the 10/100. All those have to be in play. So -- and certainly chip supply is a concern as well.

And then as far as the chip supply goes, I imagine there's at least two or three vendors, so can you design the same product with the two or three different chips? Or does it have to be the same chip from the same manufacturer?

No, it's actually across multiple categories and multiple vendors. I think there is a tremendous foundry capacity issue.

And now as far as your operating margin goes, your guidance suggests that you're going to be taking a lot of expenses this quarter. Is this all related to logistics and air freight?

Yes, pretty much.

That's it for me, thank you.

Woo Jin Ho, Bank of America Merrill Lynch.

Could you clarify your comments on Europe? I believe you said growth. Is it sequential or year-over-year?

Sequential.

Sequential? Okay. Well, even then, Europe had a really nice rebound. What gives you the confidence? Well, what really went on in Europe to give you that nice rebound? And can you just talk about the sustainability aspect of Europe?

As you probably know, the GDP in Europe is starting to rebound, and we are seeing sell-through demand grow week after week. So that gives us the signal that Europe is finally healing.

Is it primarily on the retail side or on the SMB side that's healing?

Its across-the-board.

Got it. And could you just touch upon the G inventories? How are G inventories today. And it sounds like it really hasn't had any impact on pricing. But as we head into the seasonally strong fourth quarter, could that have any impact on promotional activity in the fourth quarter?

I don't think there is any promotional activities around G anymore. I don't think anybody is going to do it.

Well, my point is that I am seeing G routers that are going for $29 at the very low end. And just curious on what impact that may have on the mid tier and the high end N routers.

No, people know that G is basically no more the future technology. And at $29.99 not a lot of people would offer it, especially if you could buy a NETGEAR G router at $39.99, people would tend to pay that $10 delta for better quality. An N router still starts at $69.99. So there is still a big price differential.

Okay. And lastly for me, as we look out into the fourth quarter into 2010, it seems as if you're introducing more products that have more subscription-like revenues. How should we think about the business model going forward over the next several quarters?

Yes, you're clearly right that we are introducing products with higher software components that involve both higher-margin software as well as subscription revenue. Now, this is relatively new for us, so we have yet to find the right model going forward. But that's the direction.

Great. Thanks.

Sam Wilson.

First, a simple one for Christine, just cash flow from operations and CapEx? I'm sorry I missed it.

Sure. No. Cash flow is $10.1 million for the current quarter, positive. And then CapEx is about $1.7 million for the current quarter.

Great. Patrick, can you give us just a sense of when you look at your international business and when you look at Europe and everything else, can you give us a sense of the delta between what's going on in the emerging market countries versus the more mature? Are you seeing Eastern Europe do better or worse than like UK, Germany? And then are you seeing China and India do differently than Japan? -- let's say. Just sort of that sense.

Well, Japan is a mature economy and market. So let's don't lump them into the emerging market. In the emerging market, as you probably see it all the time, and China is absolutely the engine, and economic growth is at 9% range, and so that clearly is the locomotive. As I mentioned many a time before, when China does well, Australia will do well, because the two are very linked. So clearly those two markets are leading the way.

As far as Eastern Europe is concerned, our exposure in Eastern Europe is very tiny. Even with that tiny exposure we see them really, really struggling. And the Western Europe is actually recovering a lot faster. So for now our focus will continue to be in China as well as in India. And certainly Latin America, we are seeing a good uptick in Brazil and Mexico as well. Those two markets are encouraging.

Are you seeing China behave substantially better than let's say the US market right now? Have you entered a net year's business there?

They are quite different. China -- in the US certainly we have a much, much bigger coverage in terms of distribution and brand name. And we are the indigenous vendor. While in China we certainly do not have any distribution beyond the first tier cities, and we are considered to be a foreigner. We are not the indigenous vendor. So we have some ways to go. However, we are considered in China as the premium brand, which helps us. So in China we maintain a pretty good balance between the consumer and SMB. It seems our pricings are generally higher than local brands. We are seeing a little bit more success on the SMB side, so we will continue to work on our product and cost structure so that we will be able to get a bigger bite on the consumer side as well going forward in China.

And then I wanted to ask you a follow-up on the -- you made the comment about air freight and obviously component shortages. Is the air freight and component shortages issue somewhat linked to each other? Are you finding that basically it's sort of hand to mouth and you've got to -- as soon as they come off the manufacturing lines, you've got to dump them on an airplane immediately? And also, is that a function of the channel inventory got a little too low? Or is it all just back to you can't get availability of components right now?

Is primarily that we can't get the components. For example, the lead time of the components all of a sudden increased by four or five weeks. So that wiped out our transit time overseas. So in order to catch up on that four or five weeks, we are forced to air freight.

Got it. Then my last question for you is, I think it's been about a year now or a little over a year where you installed a new sort of ERP system and more importantly a new forecasting system. Have you found over the last couple of quarters the company's ability to forecast what's going to happen has been substantially different? Better? Worse? -- etc.

The new ERP system has significantly upgraded our ability to manage the business. It makes our business a lot more predictable and makes visibility of the progress of business through the quarter a lot more accurate. As far as forecasting concerns, the mechanics are improved. But a lot of that is still depending on our read on the market, which has not improved.

Got it, thank you so much.

(Operator Instructions). Maynard Um, UBS.

So just so we can see what normalized margins might be, can you just quantify the gross margin impact from freight? Is it around 200 basis points?

Yes, pretty much.

And then you talked about the better demand and -- about a combination of better demand and easing component shortages will help you get to the high end of your guidance. If demand is actually better than you anticipate, do you think you would be able to squeeze out more from your chip suppliers to supply the upside demand?

Well, I am doing my best. I'm flying around.

But if it's a foundry issue, is that something that just -- that can't be resolved? Or --?

It cannot be resolved in the short term. But I'm flying around just getting my more than fair share of the allocations.

Okay. Do you get a better share of that allocation because of your scale and your market share?

Sure, but I still want more.

And then if you can't fill any of the excess demand this quarter, do you think that pushes demand into Q1 and help alleviates some normal seasonal declines you would typically see?

Some, especially on the SMB side might, but not on the consumer side. People just don't wait. If they don't see us having the product, then they will buy from our competitors, unfortunately.

Can you just provide any guidance on interest income or anything happening on your hedges rolling off? And then also maybe on the tax rate for the fourth quarter?

Sure. As far as interest income, it's not much, given that we are in really very secure investments in that. So I think this quarter it was about 78K.

As far as FX, we don't really guide on that. We are hedged again for the quarter at rates -- it's more or less the beginning of the quarter and then as they roll off and on at different times. So we hope that number is never a big number.

From a tax position what I would say is I believe the tax expense for Q4 will be between $7 million and $8 million for Q4. It's sort of what we guided all along during the quarters, and at the back end we are at the high side of the expense.

And then just last one for me, given your cash balance, any thoughts on use of cash going forward? Thanks.

Well, we always weigh multiple options to apply the cash with in mind that -- the best return on the value for our investors. Clearly the options are continue to invest in R&D and equipment to generate more new products that will bring in higher revenue and a higher profit margin in the future; look at acquisitions to really strengthen either our presence in product, technology, market, or channel; and certainly we have a standby program to buy back shares.

(Operator Instructions). It appears there are no further questions at this time. Do you have any closing comments?

Sure. Thank you everybody for joining the call, and we are excited about the product pipeline that we have, and we are excited on the continuous trend of us gaining share and the continuous improvement in market demand, and look forward to talking to all of you again for our Q4 wrap-up and 2009 wrap-up in February 2010. Thank you.

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