NETGEAR Inc (NTGR) 2014 Q3 法說會逐字稿

Greetings, and welcome to the NETGEAR, Inc. third quarter 2014 Earnings Conference Call. At this time all participants are in a listen-only mode. A brief Q&A session will follow the formal presentation. (Operator Instructions). As a reminder this conference is being recorded. I would now like to turn the conference over to Mr. Christopher Genualdi. Thank you. Sir, you may begin.

Thank you, Operator. Good afternoon and welcome to NETGEAR's third quarter 2014 financial results conference call.

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 details on the financials and other information. We will then have time for any questions. If you have not received a copy of today's release, please call NETGEAR Investor 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 finance results. Expected market share, market turns and opportunities, competition, research and develop efforts, sales and marking efforts, new product introductions, and our growth strategy. Forward-looking statements are made during the call are being made as of today. If this call is replayed or reviewed after today the information presented in the call may not contain current or accurate information.

Fourth forward-looking statements are subject to certain 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 these forward-looking statements. Potential risks are detailed in the Company's periodic filings with the SEC including those risks and uncertainties listed in the Companies most recent Form 10-Q 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 are to reflect the accuracy of un anticipated events. In addition, several non-GAAP financial measures will be mentioned on this call. Information relating to the corresponding GAAP measures as well as a reconciliation of the non-GAAP measures and GAAP measures can be found in 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, Christopher and thank you everyone for joining today's call. For the third quarter of 2014 NETGEAR net revenue was $353.3 million which is down 2.4% on a year-over-year basis and up 12.7% on a sequential basis. Non-GAAP diluted EPS for the third quarter of 2014 was $0.72 which is up 24.1% year-over-year. Please note that there is a $0.04 benefit on the EPS due to a favorable tax benefit in the quarter. For a full reconciliation of GAAP to non-GAAP financial results please refer to the third quarter 2014 earnings press release.

During the third quarter net revenue for the America's was $193.9 million, down 12.1% year-over-year, and up 3.4% quarter-over-quarter. Retail had a successful back-to-school season in Q3 but this was offset by lower Service Provider demand and less shipments to the distribution channel in the US.

Europe, the Middle East, and Africa, or EMEA, net revenue was $108.4 million, which is up 11.5% year-over-year and up 8% quarter-over-quarter. While our realignment of the Northern European in RBU and CBU sales channels is ongoing we are pleased with the progress we have shown thus far in the region. Also, we saw a sizable year-over-year uptick in Service Provider revenue in Europe in Q3.

Our Asia-Pacific or APAC net revenue was $51.0 million, which is up 15.4% from the prior year's comparable quarter and up 2.8% quarter-over-quarter. The introduction of the Nighthawk series of routers in APAC clearly helped our market share and revenue gain in the region for the retail channel. We also saw healthy year-on-year growth in Service Provider customer revenue. In Q3 we maintained a high level of shipments with 6.3 million units shipped. We also introduced 24 new products during the quarter.

As always, sales channel development is a key focus for the Company and our sales channel remains a critical strategic asset. By the end of the third quarter of 2014 our products were sold in approximately 45,000 retail outlets around the world and our number of (inaudible) resellers stands at approximately 36,000. Now let's turn to a review of the third quarter results for our three business units; Retail, Commercial and Service Provider.

For the Retail business units, or RBU, net revenue came in at $131.3 million, which is essentially flat on a year-over-year basis, and up 18.7% sequentially. We experienced some supply constraints on recently introduced new products due to higher than expected demand during the third quarter. Leading to a decline in the Retail channel inventory level in North America.

At the beginning of September we announced the release of the Nighthawk X4, the newest addition to our award winning line of high-performance Nighthawk routers. The X4 is our first 8O2.11 AC 4x4 router. 802.11 AC 4x4 technology allows the router to support four streams of data transmission simultaneously. Thus, achieving and aggregate speed of up to 2.3 gigabits per second. The Nighthawk X4 is the fastest dual band Wi-Fi router we have ever introduced.

At $279, the X 4 further expands our high-end selection of home networking routers for consumers with high bandwidth needs. The night hawk family of routers now consists of the Nighthawk at $199, the Nighthawk X4 at $279, and Nighthawk, flagship Nighthawk X6 at $299. All three Nighthawk routers were introduced within the last 12 months. Our channel partners are very excited about this high-end line of routers because it has proven to be the driving force for growing ASPs in the home router market.

Together with our channel partners we look forward to further penetration of the Nighthawk family into consumers' homes propelling growth for RBU. Suffice to say, the flow of high-end 11 AC products will continue in each coming quarter. The commercial business units, or CBU, generated net revenue of $72 million for the third quarter of 2014, which is down 6.5% on a year-over-year basis, and down 4.6% sequentially. The decline in CBU revenue is primarily driven by reduced shipment into distribution that led to a reduction of North America distribution inventory. US distribution inventory declined from 12 weeks in Q2 2014 to 10.6 weeks in Q3 2014.

In Q3 our switching line continued to perform well driven by the 10 gigabit and power over ether net categories. We saw strength across the unmanaged plus smart and managed switch categories around these two technologies. We believe we are winning and we will continue to win market share in all three regions with our strong pipeline of new switches in the coming quarters. We also released two new access points in Q3. One for outdoor use, and one for indoor use. Both have power over ethernet, point to point managed capability, and will help expand our footprint in the growing wireless landmark at worldwide.

Additionally, we have been making progress towards winning back share in desktop storage. Our recent introduction of the ready recover storage solution for our high-end (inaudible) products we believe we will also make progress in gaining share for (inaudible) storage in the coming quarters. For our Service Provider business unit, or SPBU, net revenue came in at $150 million for the third quarter of 2014. This is down 3% year-over-year and down 1% on a sequential basis. While Service Provider had a solid third quarter we expect revenues to decline during the fourth quarter due to weakness in CapEX spending at certain major Service Providers in both North America and in Europe.

Our focus remains on improving profitability while investing in core strategic growth areas. The areas that we continue to target are mobile 4G LTE, A02.11 AC, the Internet of Things, or IoT for the homes, and the underserved SMB market especially in switching wireless lan and storage. We are focusing our R&D efforts on these organic growth opportunities where we believe that we can win.

I hope that you can all join us in person or via webcast in two weeks for our 2014 Analyst Day in San Francisco on November 5th where we will dive into the strategy and focus areas for each of the business units in more depth. Additionally, you are all invited to join us before the Analyst Day begins for a special press event starting at 9.00 AM specific time on that day where we will outline the vision of the mixed phase of the Internet of Things in the homes. This will also be webcast on our website at that time. Please reach out to NETGEAR IR www.netgear.com for more details. I will now turn the call over to Christine for further commentary on our financials for the quarter.

Thank you, Patrick. I will now provide you with a summary of the financials for the third quarter of 2014. As Patrick noted net revenue for the third quarter ended September 28, 2014 was $353.3 million as compared to $361.9 million for the third quarter ended September 29th, 2013, and $337.6 million in the second quarter ended June 29th, 2014.

We shipped a total of about $6.3 million units in the third quarter including 5 million notes of wireless products. Shipments of all wired and wireless routers and gateways combined were about 3.1 million units for the third quarter of 2014. Moving to the product category basis, third quarter net revenue split between wireless and wired was about 75% and 25% respectively.

The third quarter net revenue split between home and business products was about 79% and 21% respectively. Products introduced in the last 15 months constituted about 42% of our third quarter shipment while products introduced in the last 12 months constituted about 35% of our third quarter shipment. 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 third quarter of 2014 was 29.9% compared to 28.9% in the year ago comparable quarter, and 29.7% in the second quarter of 2014. Total non-GAAP operating expenses came in at $68 million for the third quarter of 2014.

We continue to manage operating expenses in a disciplined manner. Our non-GAAP R&D expense for the third quarter was 6.2% of net revenue as compared to 6.2% in the year-ago comparable period, and 6.3% of net revenue during Q2 2014. We continue to spend R&D dollars carefully and 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 function which should result in further operating margin leverage. Our headcount increased by net 14 people to 1,047 during the quarter. Our non-GAAP tax rate was 29.4% in the third quarter 2014 as compared to 37.2% in the third quarter of 2013 and 36.5% in the second quarter of 2014.

The favorable tax rate in Q3 was due to a catch-up benefit resulting from improved profits generated from our international business. Looking at the bottom-line for Q3, we reported non-GAAP net income of $26.2 million and non-GAAP diluted EPS of $0.72 per diluted share. Again, the tax benefit amounts to approximately $0.4 per share. Our balance sheet remains strong.

We ended third quarter 2014 with $242.6 million in cash, cash equivalents and short-term investments compared to $242.7 million at the end of the second quarter of 2014. For the third quarter of 2014 we generated approximately $24.8 million in cash or from operations. During the trailing four quarters we generated $81.7 million in cash flow from operations. We are very focused on optimizing the business and generating free cash flow which gives us flexibility with our business needs as well as the ability to strategically employ cash to enhance shareholder value.

In Q3 we spent $25.5 million to repurchase approximately 785,000 shares of NETGEAR common stock at an average price of $32.47 per share, which did not result in a material benefit to non-GAAP diluted EPS for the quarter. Over the last four quarters we have repurchased approximately 4.1 million shares. Our number of diluted weighted average shares is now nearing 2009 levels.

At the end of the third quarter 2014 approximately 706,000 shares remained on the repurchase program previously authorized by the Company's Board of Directors in October of 2008. We continue to believe that it's 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.

With this in mind our Board of Directors has authorized a new program to repurchase up to 3 million shares of the Company's common stock for approximately 8.5% of the outstanding shares. This is in addition to the approximate 706,000 shares remaining at the end of Q3 on the Company's previous share repurchase program. We plan to remain opportunistic buyers of our stock.

DSOs for the third quarter of 2014 were 72 days as compared to 68 days in the third quarter of 2013, and 76 days in the second quarter of 2014. Our third quarter net inventory ended at $206.5 million compared to $211.3 million in the third quarter of 2013, and $194.5 million at the end of the second quarter of 2014. Third quarter ending inventory turns were 4.9 as compared to 4.9 turns in Q3 2013 and 4.9 turns in the second quarter of 2014.

Let's now 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 7.7 weeks of stock. As a reminder, we are now including our online resellers in this figure and in our earnings release we have conformed historical periods to include these as well.

Current distribution inventory levels are 10.6 weeks in the US, 4.4 weeks of stock for distribution in EMEA and 6.8 in APAC. For the fourth quarter of 2014 we anticipate revenue will be in the range of approximately $335 million to $350 million. Fourth 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 35% for the fourth quarter of 2014. Operator, that concludes our comments and we can now take questions.

Thank you. (Operator Instructions). One moment, please, while we poll for our first question. Our first question comes from Jeff Kvaal with Northland. Please proceed with your question. Jeff, your line is live. Jeff, your line is live. Our next question comes from Tavis McCourt with Raymond James. Please proceed with your question.

Hey, guys. Thanks for taking my question. A couple of housekeeping ones first. Christine, I wonder if you can give us the cash flow from operations and capital spending in the quarter.

Sure. Let me just look. Capital spend for the quarter is, okay. Cash spending from operations about $25 million and CapEx is about $4 million.

Great. And then, Patrick.

Sure.

So, the Internet of Things products that I guess you will be announcing, two questions related to that product line. You have dabbled in it over the last couple years largely in the Service Provider segment. Is what you're announcing or launching in November meaningful to this year's holiday selling season or is this something that builds over time and kind of more impactful to next year? And, as a follow-up to that, is this something that you can do entirely through internal efforts, or at some point does it take a tuck-in acquisition or does it makes sense to do a tuck-in acquisition versus all internal development? Thanks.

Okay. That's a pretty loaded question. First and foremost we are not going to go into specific about whether it is going to affect the Christmas season for competitive reasons but certainly we do believe that it will be meaningful for next year, especially for RBU. And, hope that you will be able to join us and understand how excited we are about this new product line. Acquisitions, we have always been active in looking at whatever complimentary technology that we would like to add. As you probably recall, our first acquisition in the Internet of Things was done about two years ago with a line of special patented technology of wire-free cameras. We will continue to look for strategic opportunities, but we do believe that we have a lot of internal intellectual property to build on, to expand and not only for strategic acquisition but also for strategic alliances. To really build-out the entire solution of the Internet of Things for the homes.

Great. Thanks very much.

Sure.

Our next question comes from Hamed Khorsand with BWS Financial. Please proceed with your question.

Hi. So first off just wanted to see what challenges are you facing on the commercial end that we're still stuck at this revenue base around $70 million and change?

You know, we talked about, while we are doing very well on the switching side, I think we still need to make some more progress on the storage side, which we believe we're making a little bit of progress especially on the desktop side. We still need to make more progress on the (inaudible) side. I think once we get that storage thing going you will see more progress. On the other hand, actually as a matter of fact, our CBU revenue was weighed down by the depletion in the channel inventory.

So as a matter of fact, we did not destock. Or the channel did not destock. We actually have seen a growth of the CBU revenue, but I think it's good for the long-term benefit of CBU because less channel inventory means more profitable because we would have to pay less price protection. So, it's always a fine balance between whether we can load up the channel inventory so that we can get are more sell-through, or are we going to give more profitability because we have to pay more price protection and we load up the channel inventory. I think we are definitely making progress and when we get more new products and new programs in the channel that are successful in the storage side then you will see we make progress. I would say that we would love to see that we could break the $80 million mark.

Okay. Just looking at the Retail segment it seems as though you're making quite of a bit of headway with your higher end products. Are you seeing a lot more competition on the lower end of the spectrum there?

As a matter of fact we have a very good market share in the mid and low end and I don't think we have seen a lot of competition at all and I think we created this high-end categories and now we are attracting all of our competitors try to come after us at the high-end, but we're good with that because when you have competition in the other end of the market you make a little bit more money, right?

Okay. And then the other question I had was just looking at the guidance is all the shortfall just related purely to Service Provider?

Absolutely.

Okay. And last question is there any currency issues giving the strength in the dollar right now?

Yes, definitely. We certainly are seeing that profitability in Europe is going to be hurt and that's why we factored into our guidance for operating margin in Q4. Of course, it takes a little bit of adjustment in order to lower our cost of goods sold and by squeezing our supplier, but then in Q4 certainly it would have a downward pressure on our operating margin, but we have taken that into account when we provide the guidance of operating margin range.

Okay. That's it for me. Thank you.

Thank you.

Our comes from Kent Schofield with Goldman Sachs. Please proceed with your question.

Great. Thank you. To follow up on the commercial side of things, when we look at the storage side of the business is it more a function of products at this point or do you think you have the right products out there and you need to figure out kind of the channel side of things? What's left to do there so that you can start to have that business do better?

Yes. I mean clearly anything that we want to be successful you have to be successful both on price and channels. I think we're looking on both. We have a set of products that we believe are very superior to our competitors. We just have to improve on the usability as well as getting a clear message out to the market, which is marketing related. From a channel perspective I think the desktop storage we need to follow the shift of the channel more to online. I think we have to do more programs online rather than traditionally we sell the storage through the (inaudible) channel and on the high-end, clearly, we have to do some more recruitment of the higher end storage who traditional we sell HP, Dell, and we'd like to attract them to sell our ReadyDATA and our (inaudible) storage. So we clearly know what we need to do and we are going to continue to do that in the coming quarters and we believe that it will eventually pay off.

Got it. And then on the switching side of things do you feel like you are doing equally well on kind of the high-end and low end there? You talked about managed and managed plus I think of that as a little bit more high-end. So, is there a difference? Are you seeing more challenges on the low end, or do you feel like you're doing well there as well?

Yes. We're doing well across-the-board from the low end as we mentioned. The low end primarily on managed plus and the smart. And the high-ends are primarily the layer two and layer three managed, and we're doing well across-the-board. Primarily by sticking our neck out and really push things a bit and power over ethernet which we started quite a few years back and it's now proven that is very, very right on the mark.

Okay. And you mentioned online around storage. How do you feel like you're positioned heading into this holiday season maybe relative to last year when we think about online retail heading into the holidays for NETGEAR?

Well, I mean previously we think storage primarily sold by sellers or we kind of neglect the online channel that's why you go to Amazon and look at the top ten storage and see whether you find it you probably don't because we didn't pay much attention to it. So, it's a concerted effort from our sales force around the world that we absolutely in this Christmas season need to break into the top ten in the online storage sales ranking.

Got it. And to the retail router side as well?

Yes. The retail router side we have consistently been the number one vendor in the top ten rankings. We have the most number of routers in the top ten so we absolutely are not going to concede that. We're going to continue to push even more dominance in that top ten. We also have the most in the top ten for Wi-Fi expanders as well and will continue to it shall to push for bigger share. It clearly as focus of our retail sales force around the world.

Okay. Thank you, Patrick.

Sure.

Our next question comes from Jeff Kvaal with Northland. Please proceed with your question.

Pardon me for earlier. A bit of a rookie a mistake. Two questions for you, I think, Patrick. Could you talk about the impact of the ACA SP list or the transition outside of the retail channel? To what extent does that factor into your ability to command higher prices with other either commercial or Service Provider customers? And then, Christine, for you, I know we talked about this a bunch but to what extent is there visibility on the tax rate and ideally it coming down a little bit over time? It does seem to bounce around quite a bit from quarter to quarter as you know.

Yes. First question about the 11 AC. It clearly is the driving force for upping the ASP in the retail channel and the fact of the matter is give you an idea that in the retail channel because of the almost full penetration of Wi-Fi in broadband homes in the western world the US sales are not growing and actually is declining in single digits. But, because of the increase in the ASP the market is actually increasing. It's increasing in single digits so that tells you the 11 AC's power in really driving the market upwards so the increase for the retail home market has been in double-digit. So we're very happy to see that. Now, we are actually starting to see that happening on the Service Provider side as well, more and more. Especially on the MSO side. The Service Providers are providing 11AC and we believe that is going to be followed suit on the Telco DSL, vDSL side. Then again, would have been a pushup on the ASP.

And, Jeff, on the tax side, definitely the rate was up in 2011 and 2012 as Europe profitability was down and even the revenue was down as low as $97 million so you do see it go up to $108 million in revenue this quarters and correspondingly the profits are also going up and that's why you see our tax rate trending down in the guidance at 35% for Q4. So that would definitely be a couple of points off of last year and as we can see Europe get incrementally better on the international side then we could also see that rate come down incrementally.

Yes. For us, it's important to continue to push the growth of Asia-Pacific as well as maintain our strength in Europe. So, it would be ideal if we get a 50/50 split between international and domestic. That would certainly help our tax rate.

Okay. And then maybe one follow-up and that is given to the mix changing between the three business units, wouldn't one expect the margin structure to drift to the higher end of the 9.5 to the 10.5 range that you have been talking about over the course of the last few quarters?

Well, certainly the whole team in NETGEAR is striving to improve the margin all the time and you're right. I mean the favorable mix would help us to achieve that a little bit easier. However, in Q4 as we just mentioned to Hamed previously, we are having some headwinds on the strong US dollar. We could not change our price just overnight nor we can change the cost overnight, so we have to eat that. We have to take that in margin. Also, Q4 typically is a very heavy retail season that traditionally we spend quite a bit in promoting through Thanksgiving, Black Friday, as well as Christmas so we intentionally do that because that gave us the opportunity to gain even more market share. So, it's kind of an investment season. Needless to say, we are all trying to maximize our operating margin.

Yes. Okay. You're right. I was thinking about a 2015 trajectory rather than 4Q.

Yes. 2015 definitely that's the goal is to continue to improve on that range.

Okay. Excellent. Thank you both very much.

Sure.

Thanks.

(Operator Instructions). We have a follow-up question from Tavis McCourt with Raymond James. Please proceed with your question.

Thanks for taking my follow-up. I wanted to dig a little bit into the revenue splits that you gave and the wired wireless router gateways. Those unit numbers you give which looks like they've been down kind of 10% year-over-year the last few quarters, is that a measure of the units shipped into your Service Provider channel, or is that including Retail?

That includes Retail as well. As I just mentioned that because of the saturation, or the pretty much full penetration of Wi-Fi in the broadband homes, the unit sales of the entire western market is actually declining. So, that's why, in order to grow, we have to up the ASP and that's why the 11 AC technology introduction of the Nighthawk line is very critical for us to continue to grow our revenue and help the industry to grow the market. It's pretty clear that in Q3 we have demonstrated to our retail partners that it is instrumental in really returning the retail market to growth because of the ASP extension.

And on the home and business split, the 79/21, what is that a measure of? Is that overall revenues?

Measure of revenue. It's a measure of net revenue.

So within your Service Provider you will split that out whether it's going into Service Provider homes versus businesses?

Actually, yes. Yes but the Service Provided to business is tiny.

Yes.

It's almost immaterial.

Okay. Alright. So that's really a measure of the commercial business basically?

Exactly. It's commerce versus the other two BU's added together.

Got you. Alright. Thanks very much.

Sure.

Sure.

Our next Kent Schofield with Goldman Sachs. Please proceed with your question.

Thanks for the follow-up. Did you end up having a 10% plus customer for the third quarter?

No, we didn't have one this quarter. We haven't actually had one all year.

Yes. Okay. I just wanted to confirm. And then just as a follow up to that. Is there any sort of clarity as to that, to that one used to be a 10% plus customer Virgin Media in terms of how they're thinking about their plans for calendar 2015 given Liberty?

No. We haven't heard much yet. I mean as far as we're concerned I mean we have to continue to be their suppliers for 2015.

Okay. Okay. Great. And then, when we think about the weakness that you talked about and the go forward on the Service Provider side of things, is that in both the kind of core, or if you want to call it legacy NETGEAR business as well as the AirCard business, or was it disproportionate to either business?

Well, I mean for competitive and client confidentiality reasons we're not going to break it out. Needless to say, basically everybody is pretty much know by now that there as huge CapEx contraction across the carriers around the world. I mean this Q4 is unusually big and we're not going to specifically call out any particular customers for confidentiality reasons.

Sure. Sure. Okay. Thanks for the color there. I appreciate it.

Sure.

Sure.

There for further questions in queue at this time. I would like to turn the call back over to management for closing comments.

Great. Once again, I would like to thank everyone for joining us today and would like to extend my sincere invitation to join us on November 5th in San Francisco at the Intercontinental hotel on Howard Street. We will have a press conference starting at 9^00 AM announcing our new vision and set of products for our Internet of Things for the homes, which I personally feel very excited about, and certainly will be material for our next few years of revenue and growth. And then following that we will have our analyst day starting at 10^30 in the same hotel on a different floor, and I look forward to seeing all of you.

Thank you this does conclude today tele-conference. You may disconnect your lines at this time and have a great day.