NETGEAR Inc (NTGR) 2014 Q2 法說會逐字稿

Greetings and welcome to the NETGEAR, Incorporated second quarter 2014 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's now my pleasure to introduce your host, Christopher Genualdi, Investor Relations Manager. Thank you, Mr. Genualdi, you may begin.

Thank you, Operator. Good afternoon, and welcome to NETGEAR second quarter 2014 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 and other information. We'll then have time for any questions.

If you have not received a copy of today's release, please call NETGEAR Investors Relations, or go to NETGEAR's corporate website at 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 regarding expected revenue, operating margins, tax rates, cash generation, and other projected financial results.

Expected market share, market trends and opportunities, competition, research and development efforts, sales and marketing efforts, new product introductions and our growth strategy. Forward-looking statements made during the call are being made as of today.

If the call is replayed or reviewed after today, the information presented in the call may not contain current or accurate information. Further, forward-looking statements are subject to certain risks and uncertainties and based on assumptions as to future events that may not prove to be accurate.

Therefore, actual outcomes my differ materially than what is expected or forecast in these forward-looking statements. Risks are detailed in the Company's periodic filings with the SEC, including those risks and uncertainties listed in the Company's most recent 10-Q file 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 forward to reflect the accuracy of unanticipated events. In addition, several non-GAAP financial measures will also be mentioned on this call. Information relating to the corresponding GAAP measures, as well as a reconciliation to the non-GAAP measures and GAAP measures, can be found in our press release on the Investor Relations website at www.NETGEAR.come.

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

Thank you, Christopher, and thank you everyone for joining today's call. Before we begin, please note that Q2 2014 will be the first quarter in which the AirCard acquisition is included in all comparable quarters. For second quarter of 2014, NETGEAR net review was $337.6 million, which is down 5.6% on a year-over-year basis and down 3.4% on a sequential basis. Non-GAAP diluted EPS for the second quarter of 2014 was $0.58, which is down 6.5% year-over-year. Please see the second quarter 2014 earnings press release for a full reconciliation of GAAP to non-GAAP financial results. During the second quarter, net revenue for the Americas was $187.5 million, down 6.6% year-over-year, and down 3.7% quarter-over-quarter.

The year-over-year decline is due to last year's large Q2 sale end of our new line of storage products in North America. Additionally, we sold a reduction of service provider shipments in Northern America compared to the same quarter last year. Europe, the Middle East and Africa, or EMEA, net revenue was $100.4 million, which is down 7.3% year-over-year and down 6% quarter-over-quarter. Europe continues to be a difficult market for us so during Q2, we took some proactive measures to address this. In the Northern European region, especially in the German speaking countries, the market has become more concentrated in fewer larger resellers. Accordingly, we've realigned the Northern European RBU and CBU sales channels to focus on these fewer, but higher volume top tier accounts.

We believe this action will benefit NETGEAR in the long term with the goal of obtaining market share and improving profitability in Northern Europe. Our Asia Pacific, or APAC, net revenue was $49.6 million, which is up 2.3% from the prior year's comparable quarter, and up 3.8% quarter-over-quarter. While we saw a strong year on year growth in APAC service provider shipments during Q2, it was partially offset by weakness in non-service provider shipments. In Q2, we maintained a high level of shipments with 6.2 million units shipped, we also introduced 14 new products during the quarter.

As always, sales channel development is the key focus for the Company as our sales channel remains a critical, strategic asset. By the end of the second quarter, our products were sold in approximately 44,000 retail outlets around the world and a number of value added re-sellers stand at approximately 37,000. Now, let's turn to our review of second quarter results for our three business units; retail, commercial, and service providers. For the retail business unit, or RBU, net revenue came in at $110.7 million, down 5.7% year-over-year, and down 6.4% sequentially. While we're not satisfied with the year-over-year performance of RBU, primarily due to the issues in Europe, we believe we're well positioned for second half growth, with some strong product introductions kicking off in Q3.

At the beginning of this month we announced the release of the Nighthawk X6, the world's first tri-band wi-fi router, with six high performance antennas, and three network bans, one, 2.4 gigahertz, and two, 5 gigahertz bans. The Nighthawk X6 delivers the industries fasted combined wi-fi speed up to 3.2 gigabits per second. Today's homes are adding connected devices at a stunning rate. The wi-fi speed in these devices varies, therefore, consumers will want the highest aggregate wi-fi speed, need tri-band routers to group wi-fi devices into three different bands, each for devices of similar speeds, such as slow, medium and high. The commercial business unit, or CBU, generated net revenue of $75.4 million for the second quarter of 2014, which is down 14.7% on a year-over-year basis, and down 4.3% sequentially. This is a tough comparison quarter for CBU because Q2 last year was a major shipping quarter for our new line of storage products.

With the recent announcement of our Ready Recover solutions, we're working with our channel partners worldwide to drive further storage growth in the second half. Our commercial business unit continues to be focused on addressing the underserved markets of K-12 education, hospitality, and health care facilities. In Q2, we introduced the new 7,600 series W-LAN controller which supports 10-gigabit land interface and newer models of access points. The market reception of this new W-LAN controller has been very encouraging. We have been leveraging our strength in switching to increase our presence among SMB channels worldwide with our 10 gig and POE switches, driving sales for CBU. For our service provider unit, or SPBU, net revenue came in at $151.5 million for the second quarter of 2014, this is flat on a year-over-year and quarter-over-quarter basis, strength in Australia was offset by softness in North America. Europe was flat year-over-year.

During the quarter, the service provider business unit released the FTS 7,000, a new android touch screen for home monitoring and automation solutions. The FTS 7,000 enabler users to manage their connected security and home automation devices from anywhere in the home. It's simple and easy to use, graphical user interface. Also, during the quarter, NETGEAR and Telstra introduced Australia's first prepaid mobile hot spot with an integrated data usage monitor. The biggest hurdle with consumer adoption of mobile hot spots is the fear of exceeding one's data plan.

By offering a pre-paid mobile hot spot solution, and adding a data usage meter, we're able to address this concern and help consumers become more comfortable with owning one of our AirCard mobile hot spots.

We continue to believe your greatest opportunity in SPBU from the immediate term is the proliferation of 4G LTE data devices, and the increased popularity of service provider provisions home monitoring and automated equipment and services.

We continue to position ourselves to benefit as the Internet of Things becomes a reality in homes and offices.

We lead in wi-fi technology and just introduced the world's first tri-band wi-fi router, the ideal connectivity solution for the Internet of Things environment in the home. We continue to be at the forefront of shipments of home monitoring and automation products to our service provider partners, such as ADT. We have a great cloud-based line of home monitoring cameras that are completely wire-free, operate on batteries, and can easily be placed indoor or outdoor for any location. To extend wi-fi coverage to the far corners of the home, we have the world's widest portfolio of wi-fi expanders.

We continue to invest in R&D to expand our cloud platform capability, grow our camera and home automation devices lineup, and develop innovative whole home wi-fi coverage solutions. Once with the smart connected home market reaches a meaningful size, we expect to be among the first to benefit from this trend. We expect this market will be a revenue growth driver for both RBU and SPBU. I will now turn the call over to Christine for further details on our financials for the quarter.

Thank you, Patrick. I will now provide you with a summary of the financials for the second quarter of 2014. As Patrick noted, net revenue for the second quarter ended June 29, 2014, with $337.6 million, up compared to $357.7 million for the second quarter ended June 30, 2013, and $349.4 million in the first quarter ended March 30, 2014. We shipped a total of about 6.2 million units in the first quarter, including 4.9 million nodes of wireless products. Shipments of all wired and wireless routers and gateways combined were about 3.2 million units for the second quarter of 2014. Moving to the product category basis. Second quarter net revenue split between wireless and wired was about 73% and 27%, respectively. The second quarter net revenue split between home and business products was about 77% and 23%, respectively.

Products introduced in the last 15 months constituted about 48% of our second quarter shipments, while products introduced in the last 12 months constituted about 37% of our second quarter shipments. From this point on, my discussion points will focus on non-GAAP numbers. As mentioned previously, the reconciliation from GAAP to non-GAAP is detailed in our preliminary financial statements released earlier today. Non-GAAP gross margin in the second quarter of 2014 was 29.7%, compared to 29.8% in the year ago comparable quarter, and 28.9% in the first half of 2014. Total non-GAAP operating expenses came in at $66.3 million for the second quarter of 2014. We continue to manage operating expenses in a disciplined fashion. Our non-GAAP R&D expense for the second quarter with 6.3% of net revenue, as compared to 6.4% in the year ago comparable period, and 5.9% of net revenue during Q1, 2014.

We continue to spend R&D dollars strategically in the key areas that we expect will drive future growth and profitability for the Company. We remain committed to driving further optimization in our sales channel, supply chain and support functions, which should result in further operating margin leverage. Our headcount increased by net 10 people to 1,033 during the quarter. We expect additional headcount will be added in the current and future quarters. Our non-GAAP tax rate was 36.5% in the second quarter of 2014, as compared to 32.9% in the second quarter of 2013, and 35.2% in the first quarter of 2014. Looking at the bottom line for Q2, we reported non-GAAP net income of $21.4 million and non-GAAP diluted EPS of $0.58 per diluted share.

Looking at the balance sheet, we ended the second quarter of 2014 with $242.7 million in cash, cash equivalents, and short term investments, compared to $240.3 million at the end of the first quarter of 2014. Our balance sheet and our ability to generate cash remains strong. During the second quarter of 2014, we generated approximately $37.2 million in cash flow from operations. During the trailing four quarters, we generated $73.5 million in cash flow from operations. In Q2, we spent $27.2 million to repurchase approximately 841,000 shares of NETGEAR common stock at an average price of $32.37 per share, which resulted in a $0.01 per share benefit to non-GAAP diluted earnings per share for the quarter.

Over the last three quarters, we have repurchased 3.3 million shares. Our number of diluted weighed average shares outstanding now stands at the level that it was at the end of 2010. We continue to believe that it is important to return cash to our shareholders in excess of our operating and strategic needs, and that a stock repurchase program is an effective means of accomplishing this.

Furthermore, we believe in our long-term growth prospects and our cash flow generation capability. We plan to remain opportunistic buyers of our stock. DSOs for the second quarter of 2014 were 76 days, as compared to 73 days in the second quarter of 2013, and 74 days in the first quarter of 2014. As always, we closely manage our collections and strive to efficiently mitigate collection risks.

Our second quarter net inventory ended at $194.5 million, compared to $185.4 million in the second quarter of 2013, and $201.6 million at the end of the first quarter of 2014. Second quarter ending inventory turns were 4.9, as compared to 5.5 turns in Q2 2013, and 5 turn in the first quarter of 2014. Let's turn to our channel inventory. Our channel partners report inventory to us on a weekly basis and we use a six-week trailing average to estimate weeks of stock.

Our US retail inventory came in at 10.5 weeks of stock.

As a reminder, we're now including our online retail resellers in this figure and in our earnings release, we have confirmed to historical periods to include these as well. Current distribution inventory levels are twelve weeks of stock in the US, four weeks of stock for distribution in EMEA, and nine weeks of stock in APAC. For the third quarter of 2014, we anticipate revenue in the range of $345 million to $360 million. Third quarter non-GAAP operating margin is expected to be in the range of 9.5% to 10.5%. Our non-GAAP tax rate is expected to be approximately 37% for the third quarter of 2014. Operator, that concludes our comments, and we can now take questions.

Thank you. (Operator Instructions). Our first question comes from the line of Jeff Kvaal, with Northland. Please proceed with your question.

Hi, thank you very much for taking the question. I have a couple of things on my mind. I was wondering first of all, Patrick, would you help us understand a little bit about the retail optimism that you were talking about for the third quarter product launches? What is going into that and how should that shake out between the third quarter and what does that mean for the fourth quarter? Then for you, Christine, I was wondering if you could help us understand a little bit about the seasonality in the fourth quarter and how that may shape up relative to prior years as I know that storage has been an area of some concern and that may finally be a little bit better here? Thank you.

On the retail side, Jeff, we just announced the tri band wi-fi router at the $299 price point which is a first in the industry, (inaudible). It's the highest price point ever in retail. And, secondly, it's simultaneously introduced in all of the territories that tri-band is allowed. Europe hasn't allowed it yet but in Asia and North America has allowed it and was introduced simultaneously, and we've been selling it for about two or three weeks and the reception has been encouraging. This will not be the first of these high end routers that we'll introduce. We'll continue to introduce more.

Not the last, you mean?

Not the last, yes. We will continue to introduce more of these high-end routers at these kinds of price points throughout the second half of this year. And also, the other things that we have been making pretty good progress is increasing our share on the online channels. If you go online, you go to Amazon, you can see a lot of our routers in the top ten, so I think we make a very good progress in building a sales team specifically for online around the world. We're trying to do the same for the German speaking and Nordic countries as well, that's the last piece of the puzzle that we have to plug. So from a product lineup standpoint we feel very strongly about these new high-end routers being introduced.

From a channel perspective we believe not only that we're consolidating our market share in the (inaudible), we're making good progress on the online channel as well. So, that's why we think the second half we'll see growth over the first half for the retail business unit.

Jeff, seasonality, I think Patrick, seasonally retail is better in the back half of the year with back to school, holiday season, with that, the product introduction. I think on the CBU side we're expecting a steady growth on the CBU side as, like you said, the storage and that, we continue to grow those product lines. As far as service provider goes, that's the one that is lumpy and it could have a good Q4 or a slower Q4 because maybe everybody spent their money during the year so that will remain lumpy and we'll guide that as we get to Q4.

All right. Do you think then as a company you are on the cusp of returning to year-over-year growth year, heading into the second half of the year, one of these quarters? Nudge above zero?

We definitely are working very hard across all three BU's to grow on a year-over-year basis, as well as to keep improving our margin, and rest assured, and the entire team here is very focused on top line margin and EPS.

Okay, all right, thank you all.

Sure.

Sure.

Thank you. Our next question comes from the line of Travis McCourt with Raymond James. Please proceed with your question.

Thanks for taking my questions, I have a couple of them. First, in terms of the Q3 guidance, can you give us some trajectory on the three BUs either on a year-over-year or sequential basis if we should be building in anything dramatic? Also, the question on the gross margins this quarter I think were up quite a bit sequentially, even though I think service provider was a bigger part of the mix. Can you talk about what led to that sequential increase? Then, Patrick, in your commentary you mentioned some new home automation products sold to the service provider channel, and I'm wondering are these being actively sold today or are they still in the process of being hitched to the service providers?

Tavis, let me take your gross margin question. It was definitely up, not quite a full point from last quarter. Service provider was about 44% of the mix last quarter, 45 this quarter, so, relatively the same. That's just based on all of the components that go into that because if you look at a year ago, we were about 29.8% of gross margins, so we're within that range of somewhere around 29 up or down a hundred basis points in any one quarter with service provider around 40% to 45% of the total.

Clearly, as we introduce the higher technology routers, we expand the gross margin bit by bit overall, and your second question, are we pitching these higher end products to service provider channels. Clearly, yes, we do. Right now it's already, in retail channels, pretty prevalent. For the 11 AC technology, both on router as well as on cable gateways, and also the VDSL gateway, we're definitely pitching it to service providers customers worldwide.

Travis, lastly you asked about guidance within the BU's. We expect to have a better half of the year in Retail Business Unit, and seasonally, that is when they're traditional up over Q1 and Q2. From a CBU standpoint, again, we're expecting a steady growth. The seasonality isn't as profound when you're looking at CBU. And on service provider, that's the one we'll guide to when we get there in Q4. They've been steady for about four quarters now so we'll continue to look towards that business unit and see what comes in, in Q4.

Thank you. Our next question comes from the line of Mark Sue, with RBC Capital Markets. Please, proceed with your question.

Thank you. If I look at the dynamics in Europe and the revenue run rate over the last three or four years, we're stuck in this revenue bracket. I guess the working premise was that the macro was really the issue. Tactically you're making some changes. Patrick, is that enough? What are some of the things we can actually do because Europe is kind of holding you back. I'm trying to see what moving parts still remains in terms of improving your execution and just the opportunities in Europe.

Yes. I mean, Europe is definitely a little bit more difficult than what we anticipated. The market has stabilized is what we have pointed out on a very, very slow recovery. However, the market is diverging from the rest of the world as we find out. One, Europe is actually lagging behind the rest of the world in adoption of technology. For example, they are significantly behind in adopting 4G LTE and even on 11 AC. Secondly, is that their shift to on line channel is actually much faster than the rest of the world, while in the US, the on line channel represents about 20% to 25% of overall sales. In Europe it's closer to 40% to 50%. We try to build a very, very good online sales team around the world, but however, from a product standpoint, it's almost now we have to have two sets of products. One set for the rest of the world which is more 4G LTE, 11 AC, tri-band, all these high end oriented, but a little bit backwards in the 11 and the 3G. So, yes, we need to make some adjustments in order to specifically target the European environment. And as such, it has been benefiting the local brand in Europe because they don't have to go outside of Europe, so they're more adept to this non-change better than we do. Clearly, we need some work to do.

Understood. If I look at the business from a unit business unit point of view, retail, small, medium business, and also service provider. Are there working parts as it relates to profitability by business unit once we do the proper allocation of shared costs across the business units?Is there a way you can actually start looking at improving profitability by segments?

Absolutely. It's the effort of every single business unit to look at how they could improve their margin, their profit.

Which one is the lowest at the moment?

The service provider and service provider, the possibility it is actually the lowest amount of three, and clearly because the service providers purchase is concentrated in a few bigger hands, so naturally that caused a little bit more for us to do business and that's less margin. But it doesn't mean this they don't have the opportunity to improve their profitability as well. All three BU's are working very closely at how do they utilize, capitalize on our unique R&D, intellectual property so we can command a little bit higher price so that we can expand the margin. Secondly, we also look at the logistics. How do we, for example, reduce the size of the product, reduce the freight costs without antagonizing the end user? How do we increase the usability so that not only that we can sell more because customers like it, but will cost us significantly less in returns, warranty, and in tech support. All of those areas, those BU's are working on.

That's helpful. Christine, I want to say that the investors seemed very happy with the share repurchase. Thank you for that.

Great. Thanks.

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

Hi. Just want to start off with if you could touch on gross margin, really operating margin a little bit further because if I'm looking at the segments, and you touched on this a little earlier, there really hasn't been much change, right? If I'm looking at the price point of the average product you're selling, it's also you're indicating it's going to increase with the higher end units, so why can't operating margin increase? What's dragging operating margin down on the guidance?

I think actually on the guidance we did guide 9.5 to 10.5 this quarter, which was up from prior quarter, and clearly, each business unit has been in a range on their contribution margin, but then there's other costs we have as far as the all of the operational logistics, how to save money there in the gross margin. It depends on whether there's air freight, all sorts of things are sitting up in varied costs, so we're clearly trying to work on those numbers, obviously achieve efficiencies and get more leverage.

Overall, I'm trying to get, to it sounds like in this quarter there's a lot of hesitation on your end as far as what to expect for Q3, and that's a little bit different than in prior Q3s when back to school has been important and robust for you guys. I'm trying to understand the tone, why it's different this time around? I mean, your guidance, you're not bumping it up a lot from Q2 sequentially from the low end, right, 345 from a 337 base?

We always do a range. We want to be able to ensure that we have 100% confidence that we can hit the range. Clearly, we're striving to as we always want to do, is to hit at a higher end of the range, and the thing is, today, RBU is no more 70% of the business. RBU is only about 35%, 40% of the business, so even RBU has a good Q3 and Q4. We have to get the other BUs to come along on the other end. The SPBU is lumpy and is really pending on whether they will be able to get a new account before they could grow. That's pretty much what it is. If the RBU, let's say we didn't have the breakdowns yet, but last quarter in Q1 it was around somewhere around $118 million, right? Even a growth of 15%, that's representing a little over $20 million, less than $20 million, so that's what the RBU contribution is. For us to grow the entire business on a sequential basis on a much bigger magnitude, the other two BU's have to come along as well. We expect it to grow steadily, but the SPBU is lumpy. It really depends on whether they land on a new project, or new account.

My last question is around the Service Provider line. What are you expecting in Q3 from you're customer-base? What have they been saying? It sounds like in Q2 it was flat, but were you coming off of a good buying moment in Q1. Is it just promotion driven right now?

No. I think our service providers are still at a steady rate of either new subscriber addition or upgrade of their subscribers. As of now, because we have 13-week lead time requirement for our service providers, we do see Q3 is pretty much flat over Q2 for service provider revenue.

Okay. I'm sorry, one last question, easy one. I didn't hear, but is there a expectation of what the tax rate will be in Q3?

Yes. We guided at approximately 37%.

Thank you.

Sure.

Thank you. Our next question comes from the line of Kent Schofield, with Goldman Sachs.

Hi, this is Justin Jordan, filling in for Kent. Could you give us a quick update on your competitive positioning with ReadyNAS product line? I know you've been making improvements and do you feel the product is now competitive in the market or do you still need more improvements to be made? Thanks.

Yes, we do believe we have a very competitive product line especially on the high end. Our data protection capability is second to none, and then we have been able to win over a lot of customers. Recently, we just announced a new packaged appliance called Ready Recover together with a storage (inaudible). It's very well-received in the market. So in the high end, we do believe we're well-positioned and we are gaining share We're going to gain share. It's in the entry level that we need to continue to work on the usability and the cloud capability at the entry level but then on features standpoint, we still believe we have the very competitive set of features, even at the entry level. It's just that usability that we still need to continue to work on, and, of course, our competitors are not standing still, so over the last year, they have made also their improvement on usability as well, so we just have to keep up.

Okay, thank you.

Thank you. Our next question is a follow-up question from the line of Tavis McCourt, with Raymond James. Please proceed with your question.

Patrick, I wanted to ask a little bit about the US K-12 market in relation to the E-rate program. I think there's some discussion about the SEC setting aside some funding going forward specifically for wireless land deployments in K through 12. Two fold question, are you see any pause in spending ahead of that, and is that a program that you expect to be able to benefit from given the upgrades you've done to the wireless land portfolio of late?

Yes, there's certain pause to the spending of that program in the market. I think we are less affected by that. We have been selling pretty steadily into the K-12 market, both in the public and private schools around the world. And, because our products are so much lower in the total cost of ownership, I think we have appealed to a steady group of customers. However, I think where we've been affected more in the last two quarters is in our instruction of the new wireless controller, the 7600 series, that caused some pause for the customers waiting for this new series to come out. Now it's finally out, in May, and we've seen very good uptick in June, so we're pretty confident that this 7600 series will be where we think in the second half by the K-12 customers we have. As a matter fact, we believe that with the additional release of this fund will benefit the industry as a whole, as well as us.

Great, thanks a lot.

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

Thank you so much everyone for joining this call. We're very excited about a few new products that we introduced that we mentioned in the call already, especially the Nighthawk X6, as well as the wireless controller 7600, and also the mobile hot spots with a usage meter, a lower cost mobile hot spots that we believe will have wider adoption in other markets beyond just Australia. Looking forward to talking to you again in the next earnings call in October. Thank you.

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