NETGEAR Inc (NTGR) 2010 Q4 法說會逐字稿

Greetings and welcome to the NETGEAR, Inc. fourth quarter and full year 2010 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 Joseph Villalta of The Ruth Group. Thank you. Mr. Villalta, you may begin.

Thank you operator. Good afternoon and welcome to NETGEAR's fourth-quarter and full-year 2010 results financial 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've not yet 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, 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, 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 and 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 demands 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, the ability to increase distribution and market share for the Company's products domestically and worldwide, the Company's growth strategy, the Company's commitment to research and develop and pace of new product introductions.

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 for the Company's new product offerings or adopt competing products.

Product performance may be adversely affected by real world offering 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 deploying new products and manufacturing and distribution of its existing offerings. Channel inventory information reported is based on average number of weeks, inventory on hand of 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 the Company's stock price, deployments in 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 Part 2 Item 1 risk factors page 37 through 53 in the Company's quarterly report Form 10-Q for the quarter ended October 3, 2010 which was filed with the SEC on November 10, 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 related 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. NETGEAR finished 2010 on a high note with record fourth-quarter and full-year performance as we continued to build on momentum gained throughout the year.

For both the quarter and the year we had record net revenue. We're extremely pleased to announce 18% year-on-year growth in net revenue in the fourth quarter of 2010.

New product offerings drove our revenue growth in the fourth quarter including the Universal TV WiFi adapter, Ultra 2 ReadyNAS Network Storage [to] dual band WiFi router and other new products introduced in the last two partners. In Q4, our North American net revenue was $134 million while Europe, Middle East and Africa or EMEA net revenue was $102 million and our APAC net revenue was $23 million.

We're seeing great year-on-year growth in North America and the EMEA regions with a very impressive 29% growth in North America. The growth in North America was primarily due to strong market demand for our products in the 2010 holiday season.

Our sales in the Asia-Pacific or APAC region dipped slightly in this quarter which was primarily due to a temporary slowdown in orders from the Australia and China service provider channels. However, the retail and value added reseller channels in APAC continued to show double-digit growth in revenues.

In Q4 end-market demand for networking products industrywide continued to grow globally and we are pleased with our above market growth in our business amidst the improving macroeconomic environment. In the fourth quarter we increased our unit shipments by 6% over the previous quarter, reaching 5.7 million units, a new record.

In the fourth quarter, our net revenue from service providers accounted for approximately 25% of total net revenue compared to 28% of total net revenue in the fourth quarter of 2009 and 19% in the third quarter of 2010. This sequential is a strong indicator that our service provider customers are continuing to roll out DOCSIS 3.0 equipment.

We added two new service provider customers in Q4, SFR in France and Videotron in Canada. Our sales channels remained strong during the quarter. By the end of the fourth quarter 2010, our products were sold in about 28,000 retail outlets around the world and our value-added reseller space stands around 37,000.

From a product perspective, we introduced a record 26 new products in the fourth quarter. For the year, we introduced an unprecedented 81 new products in 2010.

Notable new products in Q4 include the industry's first 500Mbps Powerline adapter, the Neo TV 550 ultimate HD media player, the ReadyNAS Ultra 2 Media Server Network Storage, and the 4G LTE WiFi router, plus a 10Gbps Ethernet Switch for medium sized businesses.

In January at the Consumer Electronic Show in Las Vegas, NETGEAR was the recipient of three innovation honoring awards for the ReadyNAS Ultra 2 Home Media Server Network Storage, the Neo TV 550 Ultimate HD Media Player and the 3DHD Wireless Home Theater Networking Kit, which also was named by CNBC as one of the seven game changers at the Consumer Electronics Show. We remain focused on product development and intend to introduce another 20 new products in Q1, further positioning us for revenue growth and market share gains worldwide.

Our vision for the home network has always been about having all devices connected to the broadband Internet at all times. In 2011 we will continue to introduce new products into the five growth areas as we identified them during 2010.

First, TV connectivity such as the new Push 2 TV HD edition announced jointly with Intel at CES. Second, network storage with newer user interface, higher capacity and resilience. Third, security appliances that support more users. Fourth, DOCSIS 3.0 gateways with more integrated functions. And fifth, the 4G LTE [related repeaters] and routers.

Our growth strategy of aggressively expanding into new product categories, new geographical markets and new channels is clearly producing positive results. With industry-leading new product introductions, global brand and distribution, we believe we will continue to stay ahead of our competition in 2011 and beyond.

Due to our continued commitment to research and development, we expect the pace of our new product introductions to remain at a rapid clip in 2011. 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 fourth quarter 2010.

As Patrick noted, net revenue for the fourth quarter ended December 31, 2010 was $258.5 million compared to $218.8 million for the fourth quarter ended December 31, 2009 and $236 million in the third quarter ended October 3, 2010. We shipped a total of about 5.7 million units in the fourth quarter including 4.7 million nodes of wireless product.

Both of these shipment numbers were new record highs for NETGEAR. Shipments of all wired and wireless routers and gateways combined in the fourth quarter were about 3.6 million units, another record.

Moving to the product category basis, fourth-quarter net revenue split between wireless and wires was about 67% and 33%, respectively. The fourth quarter net revenue split between home and small-business products was about 70% and 30%, respectively.

Products introduced in the last 15 months constituted about 55% of our fourth-quarter shipments while products introduced in the last 12 months constituted about 47% of our fourth-quarter shipments, both are new records. Non-GAAP gross margin in the fourth quarter of 2010 was 32% compared to 31.1% in the year ago comparable quarter and 32.7% in the third quarter of 2010.

Moving to non-GAAP operating expenses, total non-GAAP operating expenses increased by about 22% compared to the prior year same quarter, reflecting our increased revenue levels and investment in R&D. Total non-GAAP operating expenses came in at $53.2 million for the fourth quarter of 2010. This compares to non-GAAP operating expense of $43.5 million in the fourth quarter of 2009 and $51.2 million in the third quarter of 2010.

On a GAAP basis, the Company reported net income of $13.6 million or $0.37 per diluted share for the fourth quarter of 2010 compared to net income of $7.9 million or $0.22 per diluted share in the fourth quarter of 2009 and net income of $13.1 million or $0.36 per diluted share in the third quarter of 2010.

On a non-GAAP basis, the Company reported net income of $16.1 million for the fourth quarter of 2010 as compared to non-GAAP net income of $11.8 million in the fourth quarter of 2009 and non-GAAP net income of $16.1 million for the third quarter of 2010. Non-GAAP net income was $0.44 per diluted share in the fourth quarter of 2010 compared to net income of $0.34 per diluted share in the fourth quarter of 2009 and net income of $0.45 per diluted share in the third quarter of 2010.

In Q4 2010, we recorded a net foreign-currency loss of $176,000 compared to a net loss of $466,000 in the fourth quarter of 2009 and a net loss of $326,000 in the third quarter of 2010. GAAP tax expense was $11.5 million in the fourth quarter of 2010 compared to $9.6 million in Q4 2009 and $8.4 million in Q3 2010.

Non-GAAP tax expense was $13.3 million in the fourth quarter of 2010 compared to $12.3 million in the fourth quarter of 2009 and $9.7 million in the third quarter of 2010. Tax expense in Q4 was higher than Q3, reflecting our higher US geographic revenue mix for the year.

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 in the fourth quarter with $270.7 million in cash, cash equivalents and short-term investments. DSOs for the fourth quarter were 78 days compared to 71 days in the fourth quarter of 2009 and 73 days in the third quarter of 2010. DSOs went up in Q4 due to a higher than normal mix of consumer product sales in the retail and service provider channels which carry longer credit terms.

Our net inventory ended at $127.4 million compared to $90.6 million at the end of the fourth quarter 2009 and $110.4 million at the end of the third quarter of 2010. Ending inventory turns were 5.6 as compared to 6.7 turns in the fourth quarter of 2009 and 5.8 turns in the third quarter of 2010. We utilized $2.7 million for capital expenditures during Q4 2010 and a total of $8.7 million for the full year 2010.

Looking forward to the first quarter of 2011, we continue to see market demand growth in all three geographic regions. We continue to benefit from our unwavering commitment to research and development resulting in unprecedented new product introductions in the last three quarters with more to come.

Specifically, for the first quarter of 2011, we expect net revenue in the range of approximately $250 million to $260 million with non-GAAP operating margin to be in the range of 11% to 12%. Non-GAAP tax expense in Q1 is estimated to be around $10 million to $11 million.

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

(Operator Instructions) Jeff Kvaal, Barclays Capital.

I was wondering number one, to what extent do you view the Asia-Pacific year-over-year declines as a temporary element? And then as a follow-on to that, what is embedded in your first-quarter guidance?

Yes, we believe that is a temporary element. The reason is the shortfall is primarily in the orderings from the service provider channel, and since most of the service provider channels give us 13-week leadtime on orders, we have seen the orders for Q1, so we expect that to turn around.

And the more important thing is in the non-service-provider channel, we see double-digit revenue growth in Asia-Pacific. So we not concerned and we expect that this year will be a growth year for Asia Pacific as well as the other two regions.

In terms of the guidance for Q1, we generally see the seasonality of Q1 which is usually flat to slightly down from Q4. So we expect the pattern this year will be pretty much the same. So that's basically the basis of our guidance.

Okay, does -- I would imagine though if Asia-Pacific is coming back a little bit, Patrick, that that would be a positive factor getting to the high-end of the range or even vesting seasonality. Plus this year of course you've been gaining share in the US and that trend may continue.

Well certainly, we will do the best we can and if we could, continue to gain share and the market turns out to be good -- there's still a lot of uncertainty in the market to a certain extent because we still have lingering issues in Europe both with the sovereign debt as well as the turmoil in the Middle East. So I think the guidance is pretty prudent.

Okay, sounds like you're not including either of those factors in the guidance?

No.

Okay, great. And then secondly, Christine, I was wondering, would you mind talking a little bit about the drivers of the gross margin this quarter being sequentially down a bit and then where we should think about the trajectory for 2011?

And you are speaking of gross margin down? Really it's two factors if you look at that. The two things that swing that are really the mix, the service provider, and as we noted, that's 25% of our Q4 number, up over about 19% in Q3.

So that tends to bring a little less gross margin and it brings some other expenses that are [left too] including marketing, tech support and that. In addition to that, freight is the only other number in there that can move that number and we obviously had a large volume this quarter. So we spent a little bit more on freight. So not out of line from what we expected.

Okay, and then are any of those one -- should both of those factors be employed for next year? So we should think about gross margin in this range?

Yes, the gross margin generally is in the 32 to 34% range. But you know, the primary thing we have been monitoring and keeping executing is the operating margin which we believe that we have high confidence to keep it in the 11 to 12% range.

Thank you both very much. I will pass it along.

Sure, thanks a lot, Jeff.

Thank you.

Woo Jin Ho, Bank of America Merrill Lynch.

Patrick, question in terms of the service provider. It was a fairly nice number, roughly around $65 million in the quarter. And that is up from a -- on a year-on-year basis. How should we think about the revenue run rate in service provider even with taking account to some of the issues in APAC?

Yes, the service provider is always lumpy. Sometimes the service providers have promotions at different times, they have CapEx constraints at different times.

So it's going to continue to be lumpy. But overall we still believe that the service provider will at least keep pace with the rest of the Company in terms of year-on-year growth.

Okay. In terms of the SMB, a little bit lighter than what I would expect especially given the fourth-quarter seasonal uptick that I would expect. Could you just talk a little bit about the SMB business during the quarter please?

Yes, we have to understand that in fourth quarter generally is flat to slightly down from Q3 because one less week of selling because most of the companies basically shut down between Christmas and New Year. So we usually see that flattish or slightly down.

This year is a little bit more exaggerated because there are 14 weeks of selling time in Q3, but only 13 -- actually practically 12 weeks in Q4. We do see that going forward and we will see sequential growth.

Got it, and then, Christine, lastly in terms of the taxes, you had guided to $10 million to $11 million in taxes for the first quarter. The sense that we were getting was that you were going to revert to a tax rate for 2011. Could you give us an update on that please?

Yes, I think what we are doing, we have a little bit of what I would say the charge is for setting up the structure left for the first half of 2011. So that's why we're guiding in dollars. And then we believe that will come down. And then also the mix shifts more from EMEA more into international from the US, we also expect to receive benefit from that.

Can you provide a little bit longer guidance -- long-term guidance in terms of the tax rate and what the expected tax rate may be?

At this point, we're just going to guide Q1 along with all the revenue.

Hamed Khorsand, BWS Financial.

Just first of all, I'll just touch on the tax question that was just previously asked. There was a $3 million increase in operating income this past quarter and all of it really went to taxes. Is that going to stay the same going into 2011?

I believe we definitely have a change in 2011 because the big charge for setting up the tax structure is mostly gone, but not completely due to an acquisition we made. So we definitely will see the rate come down from 2010. Into 2011, it will come down. So you won't see the same factors you saw last year.

Okay and then with the focus on 4G LTE, will that translate into new service provider customers?

Yes. As we announced about two quarters ago, that particular product is being deployed successfully right now in Bell Canada with the Bell Mobility brand, and also we have a joint showing with Verizon at Consumer Electronics Show in Las Vegas. So you will see that product to be sold on retail shelves pretty soon with the Verizon offering.

And then this past quarter because of the increase in service provider revenue, was there any material impact to net profit or was it just purely in the operating margin number?

Well, we believe that the increase in service provider revenue has no bearing in our operating margin percentage. As a matter of fact the operating margin actually went up from Q3 to Q4 while the service provider revenue has gone significantly upwards.

The only difference is that it would have impact on the gross margin. So I don't think the service provider revenue hurts us anyway in terms of our operating profit.

Douglas Ireland, GMP Securities.

First I was wondering if you could give us an update on how the uptake of the security products has been?

The security products continue to ramp. Since we have not really fully put the range into the market as yet, we are still limited by the limited range today. We have UTMs up to 50 users, that means practically because most customers want to oversubscribe, we're still catering to the small businesses with up to about [practically] 25, 30 employees.

So we would have to wait until we have a full line of products which should be completed this year. We expect to announce a UTM with up to 150 users early in the first half and then a big configuration in the second half. But we continue to see quarter to quarter ramp in the sellthrough of our security products.

Great. Now the operating margins were -- I'm sorry, the operating expenses were up 22% year over year while revenue was up [16% of revenue] year over year. But I'm feeling like that's going to be seen as a disappointing reversal on your operating margin expansion. Is that something that's going to continue or were you investing in product expansion and that's going to mellow out a little bit?

We will be -- continue to be aggressive in operating expense as long as we can keep our operating margin within the 11% to 12%. We believe that we are in a very unique position to really gain more market share because our product introduction is just relentless, and our expansion and distribution is also very positive.

So we're not going to let up on this effort. So at the appropriate instance we will expand operating expenses in R&D and distribution channel expansion appropriately. But we are committed to maintain 11 to 12% operating margin.

(Operator Instructions) Mark Sue, RBC Capital Markets.

Hi, this is Chris for Mark Sue. With all the new products in the pipeline, should we think of R&D increasing throughout 2011 or do you think there will be some slowdown throughout the year?

From an absolute expenses perspective, it will continue to increase at a pretty rapid clip and we believe that it will be keeping pace with the growth in our topline. And of course there's a possibility we could even expand it further than that as long as the margin will be able to get us there. But again, we believe that the return -- the payback will be good. Our philosophy is always to maximize our topline growth, maximize our marketshare gain while maintaining 11 to 12% operating margin.

Rohit Chopra, Wedbush Securities.

I wanted to ask 3 questions, Christine, accounts payable, I guess it's gone from 40 to 90 in one quarter. I just wanted to know if there's anything unusual happening over there.

No, if you look to a year ago December 2009, it's reasonably high too. What happens is during our Christmas shutdown, we don't bring those folks in, so we end up paying everything out on that on like January 3. So that's sort of the normal practice for the end of every Q4 and you will see it impact if you look.

All right. And then does your R&D tax rate actually impact you. If it did, what was the impact in the quarter?

We did get it. We got it -- it came back all in Q4 and booked it in there. It's not a big number for us because a lot of our R&D is done offshore. But we took every penny we could get.

Okay, is there any way you can break it out in terms of EPS?

It's not a huge number and I don't have that right (multiple speakers) right now.

All right, just was looking at the weeks of channel inventory coming down across the board. I just wanted to know if you're seeing retailers try to manage the inventory down just a little bit more post the holidays or are they trying to get it back up to 10 weeks or what is actually happening in the channel?

As we mentioned just now, the holiday season sales is actually above expectation and as their sales are strong, the inventories got depleted and also, the number of weeks come down because the numerator gets bigger. So, yes, you're right.

They all try to manage and we try to manage it back to 10 weeks as well. And I think we can do it because our inventory position, our own inventory position is very good, so we have been able to survive. And usually January is a very busy month around the world for after Christmas sales. So that's why we're pretty confident that the inventory will be enough.

Okay and my last question is just on partnerships. You are working with Intel, you're working with Extreme, you are OEMing some stuff from there. Should we expect that there's more partnerships also along with new R&D obviously to deliver more products, but partnerships to broaden the product portfolio as well?

Definitely. I mean it's always been the mantra of NETGEAR is really to leverage R&D resources across the valley, and we will continue to strike appropriate partnerships. As a matter fact, just this morning we announced another partnership on the software side.

Jonathan Goldberg, Deutsche Bank.

First I was wondering if we could get a little more color on your bump in receivables. I know you mentioned it was some shift towards consumer was the driver of that. I was wondering if you could give us some color in terms of was that sort of normal credit terms and were there any geographies in particular that stood out on this front?

Sure, as you see EMEA grow, you'll probably see the receivables grow because typically EMEA has longer terms than the US and their revenue did grow this quarter. So that does stretch out the DSOs a bit.

And then also there are some seasonal holiday terms that some of our retail customers get and those roll back in and those have been happening since the inception of NETGEAR. So geographical affected the more in Europe and then a little bit of the seasonal holiday turns.

But it was sort of just normal terms? It wasn't like you were extending anything special?

No, no, absolutely normal and we don't have any worry we're going to collect it.

Okay and then sort of bigger picture question for you, Patrick. I was wondering if you could just give your thoughts on sort of where the TV in the future is headed. (multiple speakers) are you levered more towards the carrier model or more towards the OTC model? Or does it not matter to NETGEAR?

It doesn't matter to us. I mean, frankly the content distributors are really thinking of a seamless model that would combine OTT and media programming to offer a unified seamless user experience.

We have seen some operators offering that type of service already, but the most important thing is all the TVs being produced these days getting Internet capability integrated and they all come with an ethernet jack. So when devices are coming with an ethernet jack that offer the opportunity for NETGEAR to go in and help to turn that ethernet jack into a WiFi jack or into a powerline jack, and that is the tremendous opportunities that we have.

Also another area that you will see, rather than have just one wireless router in the house, very likely you will have multiple wireless access points in the house just to make sure the house is fully covered with WiFi strength so that videos can be streamed to any devices, to any corners of the house at full strength. So that again is another opportunity.

So clearly we're going to participate in the OTT box as well for the old TVs. But for the newer TVs, eventually it will be integrated into the new TV.

Okay, and then finally a housekeeping question. Christine, could you give us a breakdown of wired versus wireless?

Yes, so wired versus wireless is 67%, 33%.

67% wireless.

33% wired.

And then SMB home?

Home and SMB is 70% home, SMB is 30%.

(Operator Instructions) There are no further questions at this time. I would like to turn the floor back over to management for closing comments.

Yes, we feel very good getting into the year 2011 as we discussed. The tremendous opportunity of the new TVs that are all Internet enabled and also more and more content coming over the top through the Internet present a tremendous opportunity to double our addressable market by connecting beyond just the computing devices into the entertainment devices.

We see that happening both in North America as well as in Western Europe, and we believe that trend will quickly also expand into the emerging market as well. So we are very bullish because we are a leader in connectivity both for the TV as well as the computing devices. So we have a very strong feeling that with the product pipeline that we have in 2011, 2011 will be another good year for us and look forward to talking to you again with our Q1 update in the April timeframe. Thank you everybody. Thanks.

This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.