NETGEAR Inc (NTGR) 2010 Q3 法說會逐字稿

Greetings and welcome to the NETGEAR Incorporated third quarter 2010 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 you introduce your host, Mr. Joseph Villalta of the Ruth Group. Thank you, Villalta, you may begin.

Good afternoon and welcome to NETGEAR's third quarter 2010 financial results conference call. Joining us from the Company are Mr. Patrick Lo, Chairman and CEO; and Ms. Christine Gorjanc, CFO. 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 received a copy of today's release, please call the Ruth Group at 646-536-7009, or you can go to NETGEAR's corporate website at netgear.com.

Before we begin the formal remarks from the Company's attorneys advise 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 does not mean that these 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, growth in operating income and margins, tax expenses, the market size of our new product categories, our position in the market relative to our competition, the long-term future and growth of NETGEAR's business, current and future demand for the Company's existing and anticipated new products, the Company's strategy for innovation and new products, willingness of consumers to purchase and use the Company's products, expectations of larger revenue share from service provider customers, DOCSIS 3.0 products deployment by our service provider customers and the ability to increase distribution and market share for the Company's products domestically and worldwide.

These statements are based on management's current expectations and are subject to certain risks and uncertainties, including without limitation the following -- future demand for the Company's products may be lower than anticipated; consumers may choose not to opt 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; 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 deploying new products and manufacturing and distribution of its existing offerings; channel inventory information reported is estimated based on average number of weeks 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; deployments 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 results may differ materially from what is expected or forecasted in such forward-looking statements. Further information on potential risk factors are detailed in the Company's periodic filings with the SEC, including but not limited to those risks and uncertainties listed in Section -- Part 2, Item 1A, Risk Factors, pages 36 through 52 in the Company's quarterly report on Form 10-Q for the quarter ended June 27, 2010, filed with the SEC on August 5, 2010.

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 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.

Thank you, Joseph, and thank you, everyone, for joining today's call.

We are extremely pleased to announce 38% year-on-year growth in revenue in the third quarter of 2010. We are again seeing year-on-year growth in all three regions with a very impressive 62% growth in North America. The growth in North America was primarily due to our strong performance in the back-to-school promotions in the US retail market.

Our NeoTV connectivity products, such as push-to-TV, Universal TV, Wi-Fi adaptors, Xbox connectivity kits and the NETGEAR Roku Player helped to power our continuous growth in market share in US retail. In Q3 end market demand for networking products continued to grow in all three geographic regions from both consumers and businesses in both local currency and US dollar terms. Thus, we are pleased to be making significant progress in our business amidst the slowly improving macroeconomic environment.

In the third quarter we increased our unit shipments by 40% over the same quarter of the previous year, reaching 5.4 million units. In Q3 our North American net revenue was $122 million, while Europe, Middle East and Africa, or EMEA, net revenue was $89 million. In our Asia Pacific, or APAC, net revenue was $25 million. In the third quarter our net revenue from service providers accounted for approximately 19% of total net revenue compared to 25% of total net revenue in third quarter of 2009 and 16% in the second quarter of 2010.

We are pleased to see our service provider net revenue increase sequentially and year-over-year. This is a strong indicator that our service provider customers are continuing to roll out DOCSIS 3.0 equipment.

Our sales channels remained strong during the quarter. By the end of the third quarter 2010, our products were sold in about 28,000 retail outlets around the world, and our value-added resellers stands around 37,000. The strength in our balance sheet also allows us to continue to expand our operations in emerging markets such as China, India and Brazil.

From a product perspective, we introduced 21 new products in the third quarter. Notable new products include our ReadyNAS Ultra series of home network storage products, the new NETGEAR Roku Player, the WC7520 Wireless Controller that brings enterprise class Wi-Fi setup to medium-size businesses, and our UTM50 Unified Threat Management security appliance.

With all these new product introductions we continue to see our push into new product categories paying off. Revenue from new products introduced in the last 12 months reached an all-time high of 42% of total revenue in Q3.

With industry-leading new product introductions we believe we will continue to stay ahead of our competition in Q4 and beyond. Due to our ongoing commitment to research and development we expect the pace of our new product introductions to continue at a rapid clip in the fourth quarter of 2010. We expect to launch 20 or more new products in the quarter, further positioning us for continued revenue growth and worldwide market share gain in the last quarter of the year.

We also believe the push into new category of DOCSIS 3.0 gateways will result in revenue growth in the fourth quarter, when our service provider customers, especially those in the US, UK, Nordics, Spain and Australia continue mass deployment of this new technology.

We also won new DOCSIS 3.0 products with Euskaltel in Spain and (inaudible) in Belgium this past quarter and added Woosh Wireless in New Zealand to our service provider customer list. We continue to grow our service provider business by remaining nimble and adapting quickly to our customers' unique and demanding requirements.

Our growth strategy of expanding into new product categories, new geographies and new channels is clearly producing confident results. Our home network market strategy for both our service provider customers and our retail consumer customers is built around the vision of having everything in the home connected to the Internet and with each other. For service providers, our strategy is to enable these customers to upgrade the speed of the Internet type via next-generation technologies such as DOCSIS 3.0, fiber and 3G/4G. While on the consumer end we continue to roll out via the retail channel ground-breaking connectivity and storage products for connecting all digital devices anytime and anywhere to the Internet and with each other, including PCs, notebooks, digital TVs, tablet computers, smart phones, Internet set-top boxes, game consoles, Blu-ray players and digital media recorders.

In the SMB networking market we are becoming the trusted one-stop shop for all of the networking needs of our business customers by providing Wi-Fi, Internet switching, security appliances and network storage.

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

Thank you, Patrick. Let me now provide you with a summary of the financials for the third quarter 2010.

As Patrick noted, net revenue for the third quarter ended October 3, 2010 was $236 million compared to $171.1 million for the third quarter ended September 27, 2009, and $195.9 million in the second quarter ended June 27, 2010. We shipped a total of about 5.4 million units in the third quarter, including 4.4 million nodes of wireless product. Shipments of our wired and wireless routers and gateways combined in the third quarter were about 3.2 million units.

Moving to the product category basis, third-quarter net revenue splits between wireless and wired was about 64% and 36%, respectively. The third quarter net revenue split between home and small-business products was about 66% and 34%, respectively. Products introduced in the last 15 months constituted about 48% of our third-quarter shipments, while products introduced in the last 12 months constituted about 42% of our third quarter shipments. Both percentages are records, showing the strength of our new product introductions in the past five quarters.

Non-GAAP gross margin in the third quarter of 2010 was 32.7% compared to 33.5% in the year-ago comparable quarter and 36.3% in the second quarter of 2010.

Moving to non-GAAP operating expenses, total non-GAAP operating expenses increased by about 31% compared to the prior year's same quarter, reflecting our increased revenue levels and investment in R&D. Total non-GAAP operating expenses came in at $51.2 million for the third quarter of 2010. This compares to non-GAAP operating expense of $39.1 million in the third quarter of 2009 and $45.5 million in the second quarter of 2010. On a GAAP basis the Company reported net income of $13.1 million or $0.36 per diluted share for the third quarter of 2010 compared to a net income of $8.5 million or $0.24 per diluted share in the third quarter of 2009 and net income of $10.5 million or $0.29 per diluted share in the second quarter of 2010.

On a non-GAAP basis the Company reported net income of $16.1 million for the third quarter of 2010 as compared to non-GAAP net income of $11 million for the third quarter of 2009 and non-GAAP net income of $13.7 million for the second quarter of 2010. Non-GAAP net income was $0.45 per diluted share in the third quarter of 2010 compared to a net income of $0.31 per diluted share in the third quarter of 2009 and net income of $0.38 per diluted share in the second quarter of 2010.

In Q3 2010 we reported a net foreign currency loss of $326,000 compared to a net loss of $266,000 in third quarter of 2009 and a net gain of $132,000 in the second quarter of 2010. GAAP tax expense was $8.4 million in the third quarter of 2010 compared to $5.8 million in Q3 2009 and $10.6 million in Q2 2010. Non-GAAP tax expense was $9.7 million in the third quarter of 2010 compared to $6.9 million in the third quarter of 2009 and $12.1 million in the second quarter of 2010. Tax expense in Q3 was less than Q2, due to a true-up adjustment for our annual tax return filing.

The reconciliation of GAAP to non-GAAP is detailed in our preliminary financial statements released earlier today. We continue to maintain a strong balance sheet, and in the third quarter with $243.5 million in cash, cash equivalents and short-term investments. DSOs for the third quarter were 73 days compared to 66 days in the third quarter of 2009 and 64 days in the second quarter of 2010 and continued to be within our historical range.

Our net inventory ended at $110.4 million compared to $73.9 million at the end of the third quarter of 2009 and $125.7 million at the end of the second quarter 2010. Ending inventory turns were 5.8 as compared to 6.2 turns in the third quarter of 2009 and four turns in the second quarter of 2010. We are pleased to see that our tactical buildup of inventory at the end of Q2 contributed to our success in Q3.

Looking forward, in the fourth quarter of 2010 we continue to see market demand growth in all three geographic regions. Our continued success has been driven by innovative product introductions, and we will continue to focus on innovation in the fourth quarter with another 20-plus new product introductions.

Specifically, for the fourth quarter of 2010 we expect net revenue in the range of approximately $240 million to $250 million with non-GAAP operating margin to be in the range of 11% to 12%. Non-GAAP tax expense in Q4 is estimated to be around $11 million to $13 million.

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

(Operator instructions) Jeffrey Kvaal, Barclays Capital.

Actually, this is [Stephen Gregory] with [Mandalay Research]. A couple of questions. A couple of months ago there was an article written in the Wall Street Journal talking about how e-commerce is going to drive companies' revenues for the next millennium over in 2011 to take it to the next level. I was wondering if you could provide some color on the call today as to what is your e-commerce mission going forward and how do you plan to take the Company there to drive more incremental revenue online?

Actually, today quite a bit of our sales is done through e-commerce partners, particularly on a worldwide basis, Amazon.com and Dell.com. We continue to partner with these prominent e-commerce sites from around the world. Now, we certainly see a shift of our customers preferring online purchases and we will continue to utilize this channel to further our sales.

Woo Jin Ho, Banc of America/Merrill Lynch. (Operator instructions).

Hamed Khorsand, BWS Financial.

A couple questions here, one on guidance. Over the last couple of calls, you have been talking about service providers [as far as] (inaudible) DOCSIS 3.0 spending in the second half. If I take that into consideration and then couple that with Q4 revisions where you usually see an end of year ramp, that would suggest that -- are you guys taking a conservative approach to your guidance compared to Q3 numbers, or is there some weakness that you are seeing in Q4? Can you just expand upon that?

No, I think it's pretty reasonable to assume that the service provider revenue will continue to grow sequentially. However, due to a super strong back to school season, we believe that the Christmas plus Thanksgiving holiday will be, at best, slightly above our back-to-school. It will be very difficult to really top it by a long shot, so I think the guidance is reasonable. Of course, there is always a chance that we will advance further in market share gain. But as it stands right now, we believe that this is a pretty accurate guidance.

And then how much do you expect the service providers to shift into Q1 as far as your DOCSIS 3.0 spending?

It will continue to grow. We will update everybody, of course, in the next earnings call.

And my other last question is, as far as your service provider revenue, how much of it is associated with femtocells? I heard you guys announce another -- a wireless carrier today.

So far, not much.

Okay, so why are the wireless carriers offering them, if not the femtocells?

Well, most of our customers are offering Wi-Fi in-home today.

Jeff Kvaal, Barclays PLC.

I was wondering, Patrick or Christine, if you could talk a little bit about channel inventory. It looks like it was flattish at 10 weeks or so. Anything that we should expect to see ahead of the holiday season? Should it be head up or head down? Any dynamics at play there?

No. I think the retailers are managing their inventory well. They've been continuing to manage it around that 10 weeks. So I think when you see that our revenue has gone up, the overall inventory total is up, but it's at 10 weeks. So we don't see any issues with that. We are very happy with the 10 weeks.

Okay, great, and then on the gross margins, should we assume that's the bulk that is associated with the rising service provider business?

It's part of that, but then in Q3 and Q4 pretty heavily promoted in retail. That also would bring down the gross margin as well.

Okay, and then what other signs do you think we should look for to think that the holiday selling season could in fact be seasonal rather than slightly below seasonal?

Generally speaking, we would like to maximize our success of the promotions to maximize our revenue top line as much as possible while keeping our operating margin in the range of 11% to 12%, and that has always been our strategy.

So just you seem to be taking a bit of a cautious approach at the moment, Patrick, to the view of the fourth quarter. Anything in particular that we should be watching for in terms of whether things could be healthier than what you're suggesting, or normal sort of sell-through (inaudible) a way to do that?

Yes, because we gain so much share in the back-to-school promotions, unless we continue to gain a lot of share, which we don't believe is likely in the short future, we believe that the uptick in the overall market demand in Q4 is going to be reasonable and within our guidance.

Why couldn't you gain a little bit more share?

Well, we will always try to. (Laughter).

All right, thank you.

Woo Jin Ho, Banc of America/Merrill Lynch.

Just a quick question on the OpEx. The sequential OpEx is up mostly 13% from Q2 to Q3 and it's the highest sequential uptick since 2002. Could you just discuss why it has been up -- why it was up on a sequential basis so high?

Sure. When you look at the revenue increase quarter-over-quarter and year-over-year, it's so significant, there's more sales OpEx down there, promotions; some of those comps are down there, more freight to the customers. In addition to R&D, we used to do 12 products, 12 to 15 a quarter. We are doing 20. We're spending more on R&D, the associated tech support. So, while we are continuing to manage that to be in the range, those costs did jump up and a lot due to our increased revenue, and then plans for the future.

And then just a little bit more color on the US as well as the European VAR distribution. Could you just talk through a little bit more of the dynamics why Europe was so low and why the US was so high exiting out of the quarter?

Well, we continue to see growth in the US above Europe. We see Europe growing steadily. We see the US having some pretty explosive growth around. So I think those channels just went up slightly this quarter, but in anticipation of their Q4 numbers. And in EMEA they just went -- that went slightly down, but again, we have no concerns with and having enough in the channel to sell for the quarter.

And in terms of the SMB recovery, nice recovery there. How much of that, Patrick, is from the switching market, and how much of it is strength on the newer products such as security and storage?

Well actually, it's across the board. We see a nice recovery across both switching, NAS as well as security. But security is a growing category for us anyways, [brand new]. So it's very encouraging that we see; it just cuts across all product categories.

And then one more follow-on to that. In terms of the channel, you have discussed in the past that you wanted to improve the quality of the channel or to upgrade the channel to meet the lower end of the enterprise. What's the status on that?

We're still making some progress on it. Certainly, we would love to be as fast as we can. I think we are building a pretty solid base and we are starting to see some wins. So I think probably we will make meaningful progress in the sales probably more towards the middle of next year to the second half of next year.

Great, thank you.

Doug Ireland, JMP Securities.

I wanted to ask a little bit around security and storage. Are you going to start to report more metrics around that business? It really seems to be a great growth contributor and becoming a more important piece of your business.

Well, at this point we don't really break that out, but we are always looking into that in the future at this point as to how that's growing.

You are diversifying away from just wireless routers. We get a lot of detail around the wireless router business, and I would just love to see more around those areas.

Sure, we'll take that suggestion.

On the retail side, there was a lot of talk from Intel and HP about how the PC business and laptop business was light in the consumer. I was just wondering if you could talk maybe about what you saw as a source of your retail strength this quarter.

Well, primarily we feel like that is driven by the proliferation of Internet-enabled devices ranging from TVs to Blu-ray players, of course to the local players like we introduced, and to the iPads and the iPhones. I mean, nine out of 10 iPads or iPhones, once they get inside a house they switch over to Wi-Fi. When you've got so many of these Wi-Fi devices tapping on to the network, clearly you need an upgrade. So that is driving a lot of the 11g to 11n upgrade. That's the fundamental driver of the market demand growth, particularly in the US. I think the fact that the iPads' and the iPhones' availability in the US is better than the rest of the world is really helping in Q3. We expect this will continue, and as we were told by the retailers that more and more TVs will be Internet-enabled coming this Christmas. So that would continue to drive that trend.

And secondly, as we mentioned just now, that we are actually taking share from our competitors. So not only that there is a fundamental market growth, but growing faster than market because we are taking share away from our competition.

Do you have any sense of what kind of share gains you're making?

We generally are progressing pretty well, I mean, getting 1% to 2% every quarter. But now it's to the point that we are widening the gap that going from here is not as cakewalk as before.

Yes, I think there's diminishing returns, in a sense, on gaining share.

So that's the reason why there is the discrepancy between the growth of the US and Europe, because in Europe we were number two and there was quite a bit of share for us to grab. But in Europe, we are number one, so that's why you have this difference, even though both markets are recovering and growing, there is more room for us to grow faster in the US in the past few quarters. But going forward, because we're already widening the gap, so that growth is going to be diminished a little bit. So our intention will be focused more into the SMB market, where we have much bigger competitors and more share for us to grab, as really the six provider channel, which is exactly the same. Now -- but in the retail channel, what we would like to do is to foray into new categories, so the TV connectivity is a completely new category and with a new set of competitors.

Now, the Google TV and Apple TV launched this quarter, it brings a lot of awareness to this space, but it also seems to crowd out attention. Have you found any impact from that?

No, actually, as a matter of fact, it validates the category. And the pie has grown so fast that, at least for now, it's enough for everyone. We're seeing continue our uptake on our Roku Player, which actually offers much better functionality than Apple TV; it's $10 cheaper. We offer 1080-p, they're only 720-P; we do Netflix, and we do MLB that you can watch the World Series through it. Go, Giants!

Nice, (inaudible) your own TV, Patrick.

Last thing -- do you have any 10% customers in the quarter?

10% customers -- we had Ingram and Best Buy.

(Operator instructions) Rohit Chopra, Wedbush Securities.

Good quarter. I just wanted to talk about the jump in DSO, and maybe you could talk about the linearity as well in the quarter.

Sure. As the revenue went up this quarter and as Europe's revenue increases, that typically takes their DSO out to more days. It's the more US focus, the DSO is a little less. So our range has always been 65 to 75 days. We are perfectly comfortable with that, and with all of our customers we typically have very little bad debt and we do have credit, insurance and things where necessary. So we are really quite comfortable with number, and it really just shows the expanding business and, again, the timing of when all that comes in.

I appreciate that, and then I wanted to ask you another quick question. Patrick, it's been about a year since you introduced some media-related products at the last analyst day. One of the problems you had, you said, was when you sell into Best Buy it's a different person selling it, and maybe they just don't have the attention when they are selling a new big screen TV that they are not going to sell this peripheral add-on device. Could you just talk about the media-related products that you have out there now and how they are doing vis-a-vis the core products a year out?

Yes, what a difference a year makes. If you walk into a Best Buy store today, especially the bigger ones, go onto the TV section where the Blu-ray players are in place. You will probably find a whole shelf of connectivity products, TV connectivity products with mostly our products on it. So the TV section people are really learning how to sell connectivity products. And on those shelves, you have multiple products from us. You get Wi-Fi, the universal Wi-Fi TV connectors. You've got power line based Xbox connectivity kit. You also have our Roku Player which will connect the old TVs onto the Internet.

So these are products that are not a single SKU anymore, it's multi-SKU. And clearly, you probably know, they are not making a lot of profit in selling big-screen TVs. And selling these peripherals is where they're really going to make the margin. So there's tremendous push from top management, as well as the incentives at the floor level, to really push for what we call the add-on basket items, when you sell a TV. So we are pretty bullish in this particular trend. And that's why, today, we introduced -- not today, we introduced this player a few weeks ago, the Roku Player. We made the announcement just recently. But Roku Player today under the NETGEAR brand is available over 7000 stores around in the United States, in RadioShack, Fry's, as well as in Best Buy.

Okay, and then I had one other question for you. You mentioned your two 10% customers. Can you tell me why Wal-Mart wouldn't be there as one of your largest contributors? And are they changing anything at their store?

Not really. As you know, Best Buy is still the king of consumer electronics sales, and Wal-Mart is definitely trying to catch up with them, and we see there is tremendous potential for Wal-Mart to grow. However, as a lot of people will realize that today, at least in the minds of most people, Best Buy is the destination, and Wal-Mart is the fulfillment. So when technology takes hold, then Wal-Mart will be there. When new technology is being introduced, then Best Buy is usually the vehicle. We clearly see Wal-Mart to potentially be a 10% customer in the not-too-distant future.

Thanks, Patrick, great quarter.

Jonathan Goldberg, Deutsche Bank.

So quick clarification on something we talked about earlier. Are there any signs of abnormally aggressive or extremely aggressive pricing behavior from your competitors as we head into Christmas?

Not that we could see right now. It's the normal promotions.

Okay, and then you noticed -- you mentioned Ingram in your top -- as a greater than 10% customer. Are they new to that list?

No, they've been on that list for years.

Okay. How would you characterize the breakdown of your VARs? Is it skewed more towards the big guys like Ingram, or is it more mom-and-pop skewed?

Ingram is a distributor. Our value-added resellers actually source the products through Ingram. A typical value-added reseller for NETGEAR is probably anywhere between two- to 40-employee companies that service customers within a five-, 10-mile radius of their premise. And they generally will source from wholesale distributors, such as Tech Data, Ingram Micro, DNH and [Senix]. So that's typically how our channel of distribution functions for our SMB products.

And then for e-commerce as well as for mail order catalogs or direct market resellers, they generally source the products from Ingram and Tech Data as well.

Have you been doing anything different with your new SMB products to reach the VARs through the distributors? I'm thinking more security in particular. Is there a new way you have to communicate or educate VARs?

Oh, clearly, we have to educate because most of our existing value-added resellers started with us years ago by reselling our switches and then our Wi-Fi products, and then we trained them to sell our NAS. And now we are in heavy training mode to try to train them in selling the security products because they will be up against those traditional security resellers from SonicWALL, WatchGuard, (inaudible). So our value-added resellers are happy that they have something with better margin, recurring revenue for them to sell. But on the other hand, we need to do quite a bit of education. That's for sure.

Okay, that's it for me, thank you.

(Operator instructions). At this time, there are no further questions. I'd like to turn the call back over to management for any closing comments.

Okay. We would like to thank everybody that joined our call, and, as we said, we are very bullish about the fourth quarter because there are a lot of new products being introduced and we believe that we will continue to make progress in all three fronts, both in the retail as well as the -- among the SMB customers as well as the service provider customers. And look forward to talking to you again in the next earnings call, in February of 2011. Thank you.

Ladies and gentlemen, that does conclude today's teleconference. You may disconnect your lines at this time. Thank you very much for your participation and have a wonderful evening.