NETGEAR Inc (NTGR) 2012 Q1 法說會逐字稿

Greetings, and welcome to the Netgear, Inc first quarter 2012 earnings 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, sir. You may begin.

Thank you, operator. Good afternoon, and welcome to Netgear's first quarter financial results conference call 2012. Joining us from the company are Mr. Patrick Lo, Chairman and CEO and Miss Christine Gorjanc, CFO. The format of the call will be a brief business review by Patrick followed by Christine providing detail on financials and other information. We'll then have time for any questions. If you have not received a copy of today's release, please call the Ruth Group at 646-536-7032 or you can go to Netgear's corporate website www.Netgear.com.

Before we begin the formal remarks, the company advises that today's conference call contains forward-looking statements. Forward-looking statements include statements among others regarding expected revenue, earnings, growth, operating income and margin. Tax rates, and other projected financial results, share gains, expectations, the market for our products, business prospects and competition. Research and development efforts, including software development, sales and marketing efforts, market trends and opportunities. Our growth strategy, our commitment to research and development, and pace of new product introductions Forward-looking statements made during the call are being made as of today. If this call is replayed or reviewed after today, the information presented during the call may not contain current or accurate information. Further, certain forward-looking statements are subject to risks and uncertainties and 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 forecast in such forward-looking statements. Information on potential risk factors and details in the company's periodic filings with the SEC, including but not limited to those risks and uncertainties listed in the company's most recent form 10-K, filed with the SEC. 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 on our press release on the investor relations website at www.Netgear.com. At this time, I would now like to turn the call over to Mr. Patrick Lo. Please go ahead, sir.

Thank you, Joseph, and thank you everyone for joining today's call. Netgear ended the first quarter of 2012 on a high note by posting record first quarter revenue and non-GAAP operating income. The company delivered 17% year-over-year growth in net revenue, and non-GAAP diluted EPS of $0.73 per share. We're very pleased with how the company performed in the always-changing dynamic business environment.

We continue to see growing end market demand, and we believe this is further validation of our vision. Everyone wants to be connected to the high-speed internet wirelessly with any device, anywhere and at any time at ever faster speeds. Based on our current estimates, only about 40% of the world's population is connected to the internet with their own devices. There's a lot of room for growth, both by further penetration and upgrades in speed. In the last 12 months, we saw explosive growth of mobile, WiFi, and 3G, 4G devices such as the Apple iPad and Smartphones.

Looking ahead 12 to 24 months, we are seeing an aggressive rollout of 4G LTE and metro WiFi worldwide. These trends continue to drive demand for more WiFi devices, routers, gateways, repeaters and adapters in homes, and access points, controllers, security and storage appliances in offices. Because of our extensive worldwide distribution, brand strength, and focus on the resources on home and SMB products, we believe we are best positioned to take advantage of such trends.

Our Americas net revenue was $168.4 million, while our Europe, Middle East, and Africa, or EMEA, net revenue was $125.1 million, and our Asia Pacific, or APAC, net revenue was $32.2 million. We achieved 33% year on year growth in net revenue in Asia Pacific, primarily due to market share gains across all major markets in the region. In the Americas, we generated 28% year-over-year net revenue growth, primarily because of our exceptional operational execution and our ability to meet a search and demand from our service provided customers, both in DOCSIS 3.0 and DSL gateways. In EMEA, we witnessed a softening in demand as that region continues to deal with austerity measures. In summary, we were able to achieve world-wide double-digit net revenue growth and our success continues to be based on our strength in new product innovation, and a second-to-none worldwide distribution.

Looking at the bottom line for Q1, we have recorded non-GAAP net income of $28.1 million which is 16% year on year growth and on GAAP EPS of $0.73 per diluted share. In Q1, we believe end-market global demand for networking products grew industrywide and we were pleased to maintain about market growth, driven mainly by share gains. For the quarter, we continued a high level of shipments with seven million units shipped, and we also introduced 18 new products during the quarter. Among them are five Layer 2 and web-manageable smart Power Over Ethernet switches ranging from 12 to 48 ports, and a pair of gigabit 11n WiFi routers just for the emerging markets. Sales channel investment continues to be a key focus for the company, as our sales channel remains a critical strategic asset. By the end of the first quarter of 2012, our products were sold in approximately 29,000 retail outlets around the world, and a number of value added resellers stands at around 41,000. In Q2, we'll expand our North America retail distribution to all Target stores.

Now let's turn to a review of the first quarter results for our three business units; Retail, Commercial, and Service Provider. In our Retail Business Unit, or RBU, net revenue came in at about $129 million, down 1% quarter-on-quarter, and up 10% year-over-year. The slightly down sequential revenue result is typical for the first quarter, following the holiday season. Top-selling products included high-end routers and DSL gateways. The new DDSL Dual Band 11n Gateway was an instant hit in Europe. The nano-sized 500mbps Powerline Network Adapter, a new product in Q1, enjoyed a great reception worldwide.

Net revenue in our Commercial Business Unit, or CBU, came in at $74.6 million in the first quarter, 2012. This is down 11% on a sequential basis, and down 6% year-over-year. The decline reflects the headwinds in the storage market, which endured significant price hike, reflective of the continued fallout from the 2011 Thailand floods. We anticipate this supply will continue to improve, and pricing to further ease through the next three quarters, which we expect will revise sequential market growth. Aside from network storage, we are growing nicely in other commercial products, such as switching, wireless, and security. Hot selling products included our 10 gigabit switches and our flood switches. We also saw excellent year-over-year growth in our wireless access points and controllers.

In our Service Provider Business Unit, or SPBU, net revenue came in at $122.0 million for the first quarter of 2012, up 27% sequentially, and up an impressive 49% on a year-over-year basis. All three regions performed exceedingly well, and we were able to deliver upside on short notice to our north American and EMEA customers. Lastly, with the Westell CNS acquisition successfully integrated, we are seeing the benefits that we hoped for.

We are excited by the flow of new products for the rest of the year, as showcased in the Consumer Electronics Show in Las Vegas back in January. We are going to introduce the new WiFi 11AC products in Q2. We have just introduced the first dual band WiFi repeater in the market, broadening our offering in this fast-growing segment and continue to be at the number one market share position. We are in the middle of refreshing our entire line of desktop network storage, starting with the entry level, NV+ and Dual, over the past two quarters. Our VDSL UTM was an instant hit in Europe and we expect to strengthen that line-up for the rest of the year. We just won another major mobile operator, [three] in Nordic for our 3G router for rural wireless broadband deployment. Our leadership in DOCSIS 3.0 Gateway is driving more share gain in the market, as exemplified in Q1, and we expect continued positive momentum in this category in Q2. Overall, we are confident about our continuous progress toward our $2 billion revenue goal by 2014. I will now turn the call over to Christine for further details on our financials.

Thank you, Patrick. I will now provide you with a summary of the financials for the first quarter of 2012. As Patrick noted, net revenue for the first quarter ended April 1, 2012, was $325.6 million, compared to $278.8 million for the first quarter ended April 3, 2011, and $309.2 million in the fourth quarter ended December 31, 2011. We shipped a total of about 7 million units in the first quarter, including 5.9 million nodes of wireless products. Shipments of all wireless, wired and wireless routers and gateways combined were about 4.2 million units in the first quarter of 2012.

Moving to the product category basis, first quarter net revenue split between wireless and wired was about 71% and 29%, respectively. The first quarter net revenue split between home and business products was about 77% and 23%, respectively. Products introduced in the last 15 months constituted about 42% of our first quarter shipment, while products introduced in the last 12 months constituted about 27% of our first quarter shipment.

From this point on, my discussion points will focus on non-GAAP numbers. The reconciliation of GAAP to non-GAAP is detailed in our preliminary financial statements released earlier today. Non-GAAP gross margin in the first quarter of 2012 was 31% compared to 32.1% in the year ago comparable quarter, and 31.1% in the fourth quarter of 2011. Gross margin was down, both year-over-year and quarter over quarter, due to the heavier proportion of service provider business as a percentage of the total revenue. Total non-GAAP operating expenses came in at $60.4 million for the first quarter of 2012.

As noted on our February conference call, we continue to invest more in R&D on an absolute dollar basis and as a percentage of net revenues. Our R&D expense in Q1 was 4.2% of net revenues, and we plan to increase that spend to 4.5% of net revenues on a go-forward basis. We are investing these dollars in all three business units, and almost all of the incremental investment will be in software development, which enables us to provide powerful differentiation against our competition and also provides us possible entries into new product categories in the future. We increased head count by 19 people during the quarter, bringing our total headcount to 810 at the end of Q1, and we will accelerate our hiring efforts in Q2 and for the rest of the year, both in R&D and new market channel expansion. The non-GAAP tax rate was 30.1% in the first quarter of 2012, compared to 31% in the first quarter of 2011, and 30.5% in the fourth quarter of 2011. Non-GAAP net income was $0.73 per diluted share in the first quarter of 2012, compared to net income of $0.65 per diluted share in the first quarter of 2011, and net income of $0.69 per diluted share in the fourth quarter of 2011.

Our balance sheet remains very strong, ending the first quarter with $369.4 million in cash, cash equivalents and short-term investments, which was driven by approximately $12.8 million in cash flow from operations. DSOs for the first quarter 2012 were 70 days, as compared to 66 days in the first quarter of 2011, and 76 days in the fourth quarter of 2011. Our 10% customer in Q1 was Virgin Media in the UK. Our first quarter net inventory ended in $134.3 million, compared to $140.1 million at the end of the first quarter 2011, and $163.7 million at the end of the fourth quarter 2011. First quarter ending inventory turns were 6.7 turns, as compared to 5.5 turns in the first quarter of 2011, and 5.2 turns if the fourth quarter of 2011. Channel inventory remained at healthy levels. Our channel reports inventory to us on a weekly basis and we use a six-week trailing sell-through average to estimate weeks of stock. Our newest retail inventory came in at 9.8 weeks of stock. Current distribution inventory levels are 8.6 weeks in the US, 5 weeks of stock in distribution in EMEA, and 5.6 weeks in APAC. Compared to the end of Q4 2011, all channel inventory came down except for US retail inventory, which went up from 7.3 weeks to 9.8 weeks, a much healthier level.

In summary, our growth strategy of aggressively expanding into new product categories, new geographic regions and new channels continue to produce positive results. With industry leading new product introductions, global brand recognition, and extensive distribution, we feel confident in our ability to stay ahead of our competition as we move into the second quarter of 2012. Looking forward to the second quarter, we intend to roll out approximately 20 new products, and we look forward to the arrival of our first WiFi 802.11AC product. Specifically, we expect net revenue in the range of approximately $315 million to $330 million, with non-GAAP operating margin to be in the range of 11% to 12%. We expect our non-GAAP tax rate to be in the range of 30% to 31%. Operator, that concludes our comments, and we can now take questions.

Thank you. We will now be conducting a question-and-answer session.

(Operator Instructions)

One moment please while we poll for questions. Our first question comes from the line of Mark Sue with RBC Capital Markets. Please proceed with your question.

The surge that you saw in the service provider segment, maybe your thoughts on how that played out, and it does seem that there's still more remaining for shipments to these particular customers. Maybe how you could give us your thoughts on how that plays out over the next several quarters, particularly after the June quarter, should we expect a drop? And then just quickly on the retail side, you have a customer, Best Buy, which is shrinking its outlets, just wondered if there is any impact for Netgear on that?

You know, clearly some of our service providers have been more successful than their competitors in gaining subscribers in an accelerated pace, and they turn to us and ask for upside in deliveries, and we were able to do it, so that benefited us in Q1, because, as we mentioned all the time, we do have 13 week visibility, and so we kind of know what the Q2 is all about, so we expect that Q2 it will be a similar level to Q1. We don't have a crystal ball for Q3, because we don't have orders more than 13 weeks out, and so we'll see. We'll update everybody in the next quarter. In terms of retail, I think Best Buy, as far as we're concerned are doing well, but certainly not going as fast as our overall Company, so we clearly out-growing in general particular one customer, and that's why they are not a 10% customer anymore, so there is nothing leading into it.

And just an R&D, you underspent, then you previously had indicated. Why was that, or does that spending actually just shift into the current June quarter as you are going to get ready for 802.11 AC or other things?

I think some of that is really we didn't hire as fast as we had hoped, and obviously we'll be hiring those folks in Q2 at this point. So we'll be continuing to hire. We just didn't hire as fast as we had hoped.

So you would expect your incremental R&D that you didn't spend, just kind of move that into the June quarter?

Yes, I think we're guiding around 4.5% of spend for R&D of net revenue.

Okay, that's helpful. Thank you.

Our next question comes from the line of Lynn Um with Barclay's Capital. Please proceed with your question.

Hi Patrick. Hi, Christine. I wanted to ask about the commercial business. I guess we all sort of understand what's happening in the storage market as a result of the flooding, but I guess outside of that, we were looking for at least some growth in the commercial segment. Could you maybe just provide some color on whether it was just mostly as a result of the storage, or whether maybe other products that perhaps fell a little short of expectations?

As we talked about it, just now in our discussion, outside of the network storage, we actually grew pretty nicely for all of the other product categories, and we are kind of a victim of our own success that, one, the network storage has become a major portion of our commercial business, so when there is a down turn in that particular segment, it would have a pretty significant effect on our overall commercial business.

Secondly, our operational excellence has been so good that we never keep any stock of disks. In general-- it's generally good because disk prices have been dropping, but then when disk prices go the other way around, shooting up 200% to 250% while we did not keep inventory, it would hurt us more in the market than other people like EMC, HP, NetApps who actually keep inventory on stock, quite a bit of inventory of the disk drives. So that's why we are kind of unproportionally affected. We do believe, as we've discussed, that the supply of disk drives is going to ease up over the next few quarters, and price would come down. And when price comes down, it benefits us, who has a much better inventory management position. So going forward, we anticipate there will be sequential growth in our network storage, which of course will benefit our overall commercial business.

Okay. And then I guess looking to the retail side, down 1%, I guess the understand is pretty seasonal, but I guess we were thinking that maybe given the ramp in on-line sales, that we might see a little bit better than seasonality. Could you just talk about maybe the overall demand environment on the retail side and how that unfolded for you during the quarter?

The demand in the seasonality is [technical difficulties] year as we mentioned in previous earnings call, because of the uncertainty of the economics and the consumer confidence around the world. We believe that the retail side is probably going to go -- you know, grow in the single digit basis, but we have been able to maintain double-digit growth. That means we're growing ahead of the market and gaining share.

Okay. All right. Thank you.

Sure.

Thank you. Our next question comes from the line Hamed Khorsand with BWS financial. Please proceed with your question.

Hi, just a few questions here. Any one-time revenue in service providers at all?

No, not anymore.

Okay. Is the service provider boost you're seeing, is it purely just from gateways being deployed at the subscriber level?

Yes, absolutely.

Okay. Are you seeing any benefit from keeping competitors out, or is this going to be the growth rate from your service provider business?

Well, I mean, clearly, it's the growth of the subscriber base that's driving the surge in demand, and then we have the added benefit that we react, you know, much better than our second source competitor in some of these accounts, so that's why we have been able to benefit.

Yes, because I mean service provider was almost 37.5% of your revenue this past quarter. Historically, that's not a real sustainable level, so that's why I'm asking.

Well, as we said, we don't have a crystal ball beyond a quarter, but we see that level keeping similar degree in the second quarter, and clearly, I mean, the retail sector has the weakest seasonality in Q2, so when the Q3 back to school, Q4 holiday season kick in, then we will certainly see the service provider revenue portion coming down as an overall mix of our business.

Okay. And last question. Is there any update as far as soliciting or capturing the Verizon DSL business, now that the contract has expired?

You know, as far as we are concerned, we always work on those accounts, and at appropriate times and with appropriate products, then with certainly appropriate terms, we definitely would love to get into the account.

Okay. Thank you.

Thank you. Our next question comes from the line of Ryan Hutchinson with Lazard. Please proceed with your question.

Good afternoon, guys. So I have a couple of questions. One is more of a follow-up with respect to service provider. Clearly it seems to be an area of focus on the call, and maybe, Patrick, can you talk to the orders that were fulfilled late that you guys were capable of fulfilling? I assume that's on the Docsis 3.0 side. So that's point one for clarification. And then you touched on in your prepared remarks, but just the successes that you're having with respect to the DSL related accounts, following the integration of Westell or anything else that's worth noting outside of the 13 weeks visibility that you have which gives you comfort that you're capable of maybe sustaining the business there, and/or back filling it in the second half with, you know, other opportunities.

Well, I mean clearly, as we just mentioned, that we are pleased that our customers are having success and gaining more subscribers, and that's why there is a surge in demand. And it's not just Docsis 3.0, it's also DSL as well, but clearly as you probably pointed out correctly, the Docsis 3.0 is pretty much both US and Europe, as well as in Asia, as well. But the DSL is primarily in North America, and it is as a result of the excellent work that the team we acquired last year from Westell doing fantastic work. And as we mentioned, the visibility was 13 weeks, but as the quarter progressed in Q1, we saw the demand, you know, going higher and higher, and we were able to respond within that short time frame, so we benefited from it. And now for Q2, clearly the orders are firm, and, you know, hopefully we'll receive this sustaining through the rest of the year, but we don't have a crystal ball, but who knows, they might even go up higher. It really depends on how successful our customers are getting subscribers, but we do believe, as we said in Q2, when the other channels kick in, and there are two positive things going for us in the second half. One is the seasonality of the retail, the other one is, as we mentioned in the commercial sector, we certainly believe that the price of the disk drives will go down, and the supply will go up. And thus the market will actually return to sequential growth again, and we will be able to better capitalize on that opportunity.

So we, in the second half, with both retail and commercial units, coming back up, we certainly will be able to sustain any variance in the service provider. But we're not saying that we're not going to fight for similar or even higher level of the service provider revenue in absolute terms. We do believe that we have a very good pipeline of products, as well as pipeline of customers. It's just, as we mentioned, we just started deploying our second 3G router, customer 3 in Nordic, and after the Bell mobility in Canada, and clearly that's another area of product that we're going to put a lot of focus behind, and hopefully we'll see some fruit coming out of it in the second half of the year.

Okay. And then just a point of clarification with respect to one of the line items. G&A looks like it was up a couple of million sequentially. Just what drove that, or, I guess, maybe the decline in Q4, if you can refresh my memory, and then the expectations for June, and then I'll jump back in the queue. Thanks.

We mentioned on the Q4 conference call that G&A had a one-time benefit related to outside services that we didn't expect to see again. And so what you saw is that return to a normal level of 2.7%, 2.8% of net revenue, somewhere around there, but it returned to normal. We expect it will more or less grow on an absolute dollar basis, but remain within that band of net revenue. Q4 had the one-time benefit.

Okay, great. Thanks.

Our next question comes from the line of Ken Schofield with Goldman Sachs. Please proceed with your question.

A little bit of a clarification on the NAS side of things. Can you talk a little bit about the difference between the impact on units versus just the costs, in terms of what you were able to do in the quarter? And then secondarily, on EMEA, you mentioned austerity over there. Could you talk a little bit about the differences you're seeing in retail versus your commercial business over there?

For the unit, clearly because the average selling price has gone up pretty significantly because of the disk price, the unit has come down. So that affects basically the total revenue, and clearly the unit is coming down faster than the average selling price going up, and that's why we have shrinkage of revenue on a quarter-to-quarter and year-to-year basis. As far as Europe is concerned, we've clearly seeing similar weakness both in retail and in commercial. However, commercial is again primarily driven by the network storage, but luckily we get some upsurge in service provider demands, which we were able to fulfill, and that's why we were able to keep a year-on-year growth overall revenue for EMEA, which we're happy about.

Great. Thank you.

Sure.

Thank you. Our next question comes from the line of Jonathan Goldberg with Deutsche Banc. Please proceed with your question.

Hi, guys, thanks for taking my questions. The first one I want to ask is on the R&D line, you mentioned hiring slower than expected. Is most of that hiring in California? And if so, it seems like that job market is pretty tight, so how do you think about that, given the realities of the, you know, salary expectations?

Actually, we're hiring engineers pretty much all over the world. We have engineering centers in China, we have folks in India, we have Chicago, Atlanta, and San Jose. So it really just depends on where we're looking. And we're finding candidates, we're just, you know, busy while we're working and hiring people, and we're going to ramp that up. So we are finding candidates

Okay. And then my next question is on the AC upgrade. I was wondering if Patrick, if you could just talk qualitatively about how we should think about the AC opportunity. The 11VG opportunity was a big product cycle for Netgear, but 11N was much less so. Where would the AC upgrade fall in that spectrum, and how are consumers -- do consumers know about this and are they going to be interested?

Yes, it's interesting for us to see in the -- in actually in all markets over the last year has been exemplified by iPads and iPhone. Seems like that while the consumer confidence is down, the economy is tough. The higher end of these consumer gadgets is actually getting better traction. So the iPhone, the iPad is getting tremendous traction in all markets, including developing markets. We see a similar thing that high end of our routers actually getting more traction than the low end of the routers, so we have been introducing really successful high-end routers. I just mentioned it in my previous discussion, that the VDSL Gateway with two USB ports introduced in Europe was a huge hit. I mean, there's a tremendous highly expensive Gateway, over 200 euros, and followed by a similar Gateway that we introduced last year, but it's the top end IRN Mag 11N. So we believe that 11AC, which is even higher end in ASP will actually get similar traction, and will help to raise our ASP and benefit our revenue growth overall.

Okay. Thank you.

Sure.

Thank you. Our next question comes from the line of Jonathan Keys with CapStone Investments. Please proceed with your question.

Great. Hi, Patrick. Hi, Christine. Thank you for taking my questions. Congratulations on the quarter. I wanted to ask specifically on one of the drivers that provided the upside, Asian Pacific. I'll leave the service provider, I think that's already been asked enough times during this call, you talked about -- I mean gaining market share in China and Australia, in those markets, and, you know, that contributed to the overall growth for Asian Pacific for the quarter. Can you give more details in terms of what caused that? Did you run some product promotions, some pricing discounts? Or did you just sign up more distributors? And is it something that you're going to continue going into Q2 and Q3?

Well, one market at a time we mentioned, actually, and in particular that there were three markets in Asia were doing very well. It's mentioned in the earnings release. First it's Japan. I think we are seeing quite a bit of traction for our commercial products in Japan, and we actually had really good response on our Docsis 3.0 Gateway with our Japanese cable operator customers over the JCom communications doing very well for us. In Australia, as I just mentioned, the high-end DSL gateway is doing exceptionally well. Very high price, but it seems like that the Australian folks love it. That really helped us to gain significant market share across the board.

Our penetration of channels in Australia is already very good, but with these new products, it gives us even more, you know, market share. And in China, it's primarily both in retail, as well as in commercial. In China, it's a little bit different. We hold an absolute premium position on WiFi, both in the commercial, as well as in the retail. The bulk of the market in China for retail is in the low end, which we really do not participate, but we have been introducing new products on the high end, which I also mentioned in my discussion that we introduced too. A couple of really high-end gigabit WiFi routers for the emerging market is doing extremely well in China. On the commercial side, we are seeing our wireless controllers and access point getting significant traction in multiple industries, particularly in motel chains, as well as in hospitals. So -- and again, we developed specific products for that particular market, and we are enjoying the success of that now.

So it's more new products versus price change or --

All new products.

Or setting up more channel. Okay.

All new products. I mean, our channel reach has been pretty good in all three markets.

Okay. All right. And I guess it's a fair assumption to say that you'll continue to introduce more new products for these markets going forward?

Correct. I mean, Australia enjoyed the market that we introduced worldwide, because their economy, their behavior is pretty similar to North America and Europe, but China and Japan, clearly we have to develop products specific for that market, because their requirement is different, the preference is different. That's why we're stepping up R&D to have a better strength and strength of developing products for these markets, and that's why we have development centers around the world. You know, we have three development centers in China -- I mean in greater China, one in Taipei, on in Nanjing and one in Beijing. So I guess that leads me to my next question. Christine, you talked about bringing engineers around the world. Obviously there's a concern that R&D, you know, is coming up, and, you know, you're spending it on headcount, on people for the software development. Do you see most of that mainly overseas, or is it going to be just fairly distributed through your research centers in terms of the engineers you're bringing on board?

I say it's really in all the different locations. What I would say is we're spending it for the development teams in all three business units, and then all of those business units are located, you know, around the world in the different locations. So depending on what we're looking for and what team they're going to work with is where we'll decide to put it.

Okay. Great. All right. Congrats, and good luck going forward.

Thank you. Our next question comes from the line Rohit Chopra with Wedbush. Please proceed with your question.

Hey, guys. A couple of questions. I think it's in the text, actually, or it was written, it says you're going to have continued momentum in service provider. You also mentioned it on the call, as well, and then retail is supposed to go down sequentially due to seasonality. So the question is, does that put more pressure on gross margin as you go into Q2, or should we expect it to be closer to the same levels it is now?

You know, as we mentioned many times that gross margin doesn't mean really much to us. It's operating margin that we really lay the focus on, because the gross margin could vary according to the mix of the various business units, and it could also vary by the way we spend marketing, whether it's to be contra-revenue or not, so we're less focused on the gross margin. But, I mean, we'll not be off by that much of what we are today, plus or minus 1%, I would say. On the operating margin, clearly, we're going to spend more on R&D. That definitely is going to be the case in Q2. So that's what we are looking at for Q2.

Right. So it could be closer to the lower end of your range, just because of the spending and maybe just because there's more service providers for operating margin?

We're going to be in the -- between 11% and 12%, whether in the middle, in the low end, in the high end, really depends on all the factors. Clearly we'll try to make it as good as we can, but there's a lot of factors going around, but we believe that we will be bound by that 11% to 12%.

Got you. And then I want to ask you a question about guidance. Christine, maybe you can just frame how you get to $315 million and how you get to $330 million. Is it Europe that's a swing factor? Is it specifically retail? Is it commercial? What's actually the swing from $315 million to $330 million?

Well, it could really be in any of the three business units. Obviously we look at what we're seeing to date and what we expect, and like Patrick mentioned, the service provider, we do have those orders in, but as we've always said, that business is a little lumpy, so several thousand units of an order could come into a quarter, on move out into in the next one. So really that just gives us-- that's really less than I think 5% leeway, the $15 million on the overall guidance, and we just feel like that made a lot of sense as we got to $1 billion to guide with a little bit wider range. So it will just depend on how everything comes in.

And last question, just to come back to Europe real quickly, is there any loss share due to country-specific competitors? I know that Germany has one, and anything going on over there other than the economy?

No, we don't believe that we have a significant share loss in any particular product category, so other than maybe in network storage we might be losing a little bit of share to the NC, to the HP because of the disk prices, but we haven't seen those reports yet. But we don't see any major share losses or actually any share loss in Europe overall.

Perfect. Thanks, guys, I appreciate it.

Thank you.

Thank you.

(Operator Instructions)

One moment, please. There are no further questions at this time. I would like to turn the floor back over to you for closing comments.

Thank you. As always, we're very excited about the opportunity. We have always been saying that what is driving us is innovation, and we are very excited about the pipeline of the product in Q2 and in the second half, and we do believe that we will be able to continue to take share from our competitors in this what we say ever-changing dynamic business environment, and I look forward to talking to all of you again in about three months. Thank you.

This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation, and have a wonderful day.