NETGEAR Inc (NTGR) 2017 Q3 法說會逐字稿

Greetings, and welcome to the NETGEAR Third Quarter of 2017 Earnings Conference Call. (Operator Instructions)

As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, Chris Genualdi, Senior Investor Relations Manager. Thank you, Mr. Genualdi. You may begin.

Thank you, operator. Good afternoon, and welcome to NETGEAR's third quarter of 2017 financial results conference call. Joining us from the company are Mr. Patrick Lo, Chairman and CEO; and Ms. Christine Gorjanc, CFO.

The format of the call will start with a review of the financials for the third quarter provided by Christine, followed by details and commentary on the business provided by Patrick, and finish with fourth quarter of 2017 guidance provided by Christine. We will then have time for any questions. If you have not received a copy of today's release, please visit NETGEAR's Investor Relations website at www.netgear.com.

Before we begin the formal remarks, we advise you that today's conference call contains forward-looking statements. Forward-looking statements include statements regarding expected revenue, operating margins, tax rates, expenses and future business outlook. Actual results or trends could differ materially from those contemplated by these forward-looking statements. For more information, please refer to the risk factors discussed in NETGEAR's periodic filings with the SEC, including the most recent Form 10-Q.

Any forward-looking statements that we make on this call are based on assumptions as of today, and NETGEAR undertakes no obligation to update these statements as a result of new information or future events.

In addition, several non-GAAP financial measures will be mentioned on this call. A reconciliation of the non-GAAP to GAAP measures can be found in today's press release on our Investor Relations website.

At this time, I would now like to turn the call over to Ms. Christine Gorjanc.

Thank you, Christopher, and thank you, everyone, for joining today's call. Results for the third quarter of 2017 came in above the high end of our revenue guidance, primarily driven by the continued phenomenal growth of our Arlo segment.

Overall NETGEAR net revenue for the third quarter ended October 1, 2017, was $355.5 million, which is up 5% on a year-over-year basis, and up 7.5% on a sequential basis. NETGEAR net revenue by geography once again reflects our continued strength in North America, as well as improvement in the EMEA region. Net revenue for the Americas was $244.4 million, which is up 8.5% year-over-year, and up 7.7% on a sequential basis. EMEA net revenue was $62.2 million, which is up 3.5% year-over-year, and up 12.6% quarter-over-quarter.

Our APAC net revenue was $48.9 million for the third quarter of 2017, which is down 8% from the prior year comparable quarter, and up slightly quarter-over-quarter.

For the third quarter of 2017, we shipped a total of approximately 5.7 million units, including 4.8 million nodes of wireless products. Shipments of all wired and wireless routers and gateways combined were about 1.9 million units for the third quarter of 2017. The net revenue split between home and business products was about 83% and 17%, respectively. The net revenue split between wireless and wired products was about 77% and 23%, respectively.

Products introduced in the last 15 months constituted about 45% of our third quarter shipments, while products introduced in the last 12 months constituted about 42% of our third quarter shipments.

From this point on, my discussion points will focus on non-GGAP numbers. The reconciliation from GAAP to non-GAAP is detailed in our earnings released distributed earlier today.

The non-GAAP gross margin in the third quarter of 2017 was 29.4% compared to 31.3% in the prior year comparable quarter, and 28.4% in the second quarter of 2017. The year-over-year decrease in non-GAAP gross margin was primarily due to investments in channel marketing that we have discussed on the prior two earnings calls. As mentioned on the prior calls, the majority of this additional marketing spend hits our P&L as contra revenue, therefore affecting our gross margin level.

Total non-GAAP operating expenses came in at $70.8 million, which was up 5.4% year-over-year, and up 7.6% sequentially. As always, we manage our expenses prudently, while also ensuring that the growth areas of our business have the resources necessary to succeed.

Our headcount increased by a net of 29 people to 982 heads during the quarter. We continue to add resources to the key growth areas of our business, and expect to accelerate hiring in R&D, both in Arlo and Orbi during the fourth quarter of 2017.

Our non-GAAP R&D expense for the third quarter was 6.2% of net revenue, as compared to 6.2% of net revenue in the prior year comparable period, and 6.6% of net revenue in Q2 of 2017. R&D is critical to our business, and therefore we expect this expense to continue to grow as needed in absolute dollars.

Our non-GAAP tax rate was 24.8% in the third quarter of 2017, which included a benefit of $0.06 non-GAAP EPS as a result of a statutory release resulting from an audit closure.

Looking at the bottom line for Q3, we reported non-GAAP net income of $26.2 million and non-GAAP diluted EPS of $0.81 per diluted share.

Turning to the balance sheet, we ended the third quarter of 2017 with $372.8 million in cash. As expected, for the third quarter of 2017, free cash flow improved significantly and we generated approximately $94.4 million in free cash flow, which is calculated as cash flows from operating activities as presented in the statement of cash flows under GAAP, less capital expenditures. We continue to remain very confident in our ability to generate meaningful levels of cash.

During the trailing 4 quarters, we generated approximately $72.5 million in free cash flow, which included a $1.6 million benefit from a presentation reclassification and historical cash flow statement. The reclassification is related to excess tax benefits upon the adoption of the new accounting guidance on stock compensation simplification.

We continue to focus on optimizing the business and generating cash, providing us operational flexibility as well as the ability to strategically deploy cash to enhance shareholder value. In Q3, we spent $30 million to repurchase approximately 682,000 shares of NETGEAR common stock at an average price of $44.02 per share, which resulted in a $0.02 benefit to non-GAAP diluted earnings per share for the quarter.

Since the start of our repurchase activity in Q4 2013, we have repurchased approximately 11.3 million shares, and our diluted share count is lower by 17.4% as compared to the beginning of that period. The fully diluted share count is approximately 32.4 million shares at the end of Q3 '17. We have 2.5 million shares remaining on our current buyback authorization and plan to continue repurchase shares opportunistically.

Now, turning to the results of our 3 product segments, the Arlo segment's net revenue came in at $110.5 million for the third quarter of 2017. This is up 127.1% year-over-year, or about $61.8 million from the prior quarter and up 40.3% on a sequential basis. Clearly we are very pleased with the performance of this segment during Q3, and Patrick will share more details on our Arlo strategy in just a moment.

The Connected Home segment, which includes the industry-leading Nighthawk and Orbi brands, generated net revenue of $183.1 million during the quarter, which is down 14.9% on a year-over-year basis, and down 1.5% sequentially. The year-over-year and quarter-over-quarter decline is primarily due to reduced service provider revenue for the Connected Home, which is down $21.4 million from Q3 2016 and down $3.9 million from Q2 2017.

The SMB segment generated net revenue of $61.9 million for the third quarter of 2017, which is down 17.1% on a year-over-year basis, and down 6.3% sequentially. We experienced flat year-over-year trends in the switching market. With the introduction of our groundbreaking mobile app Managed Insight Switches, we expect to slowly turn around the switching revenue in the coming quarters.

I'll now turn the call over to Patrick for his commentary, after which I will provide guidance for the fourth quarter of 2017.

Thank you, Christine. And hello, everyone. We are pleased with our results for the third quarter of 2017, which exceeded our expectations in both the top and the bottom lines. The star of Q3 was clearly the Arlo segment, which posted $110.5 million in sales for the quarter. This represented yet another quarter of triple-digit year-over-year growth for Arlo, even against tougher comparisons in the back half of 2016.

The Arlo business continues to be in hyper-growth mode, and we don't see that changing the foreseeable future. It is now over 30% of the overall NETGEAR business, and we believe this percentage will likely increase in the coming quarters. With the recent introduction of the Pro 2 camera, we are confident that we will increase our market share and expand our user base worldwide.

As of today, we have approximately 1.3 million registered users on the Arlo platform worldwide, and this number continues to increase at a rapid pace. Our current user base represents less than one half of a percentage of the total number of households in the market that we serve, indicating we still have a lot of runway ahead of us. Our estimates continue to suggest that the IP security camera market in the U.S. is an $800 million market, growing at least 30% to 40% year-over-year.

Arlo's share of the U.S. IP security camera market held strong at 41% for Q3. In Q4, we will step up our marketing and channel expansion in the important holiday season in order to get closer to our 45% share target and to expand our user base to 2 million as quickly as possible. At the same time, we will increase our R&D headcount and expenses to expand our Arlo hardware lineup and premium add-on software services.

We continue to believe that our unique innovative wire-free technology, trusted brands and superior distribution separate us from competition in the IP camera market and will allow us to drive share gains and user base expansion. 2 weeks ago, we launched the Arlo Pro 2, which features higher-quality video with 1080p HD, optional 24/7 continuous video recording, and activity zone monitoring when plugged in either to AC power or solar power in support for Amazon Alexa.

Additionally, as many of you already know, we will be announcing the next new product in our Arlo offering at our Financial Analyst Day being held at our headquarters in San Jose on November 8. This new product will be the first non-camera product for the Arlo segment. We hope that you can all join us at our headquarters or over the web for its debut.

We will also be sharing more details around our plans to drive service revenue on the Analyst Day on November 8. As we have spoken about on prior calls, services are an important element of the Arlo business and will become increasingly important as the business grows. We have several exciting new software developments on the horizon that will further grow the attach rate for services on the Arlo platform. I look forward to sharing more on this with you 2 weeks from today.

All in all, Q4 will be a very busy quarter for the Arlo team. We are doubling down on our branding and marketing spend, ramping up R&D for new product introductions, and developing premium services to monetize the installed base. We strongly believe that building the Arlo brand, expanding the user base and extending our technology lead will pay dividends in the intermediate and long term, both on the top line and bottom line.

Turning to the Connected Home segment, as expected, Q3 proved difficult primarily due to an unfavorable year-over-year comparison for the service provider piece of the business. Service providers' sales for the Connected Home business decreased $21.4 million on a year-over-year basis during the third quarter of 2017, and decreased $3.9 million on a sequential basis.

Meanwhile, the retail channel portion of the Connected Home segment declined $10.6 million on a year-over-year basis, but is up slightly quarter-over-quarter. We managed to grow slightly quarter-over-quarter despite the cable gateway market's continued contraction due to the new pricing policy of the combined Charter Time Warner cable entity which now includes a free modem in the monthly internet subscription fees and a $5 per month WiFi equipment rental.

However, for the Connected Home segment, we believe that there are many opportunities presented to us by the market's rapid move to WiFi mesh, the upcoming introduction of the 11ax standard in 2018, and the arrival of 5G in 2019.

To capitalize on all of these opportunities, we are heavily investing in both R&D as well as brand and channel marketing. We are going through a multi-quarter investment cycle in the Connected Home segment that began in Q2 of this year. We believe our deep knowledge and extensive experience in WiFi and LTE will enable us to continue to win in the upcoming technology cycles.

As an example, recently we introduced the Nighthawk X6S and the X4S tri-band WiFi mesh extenders, which turn a traditional home router into a mesh-like WiFi system. Unlike older WiFi expanders, these new mesh extenders work with your existing home router on the same WiFi ID, provide seamless WiFi roaming, and propagate the same WiFi speed of your existing router to every corner of your house.

With these, you don't have to replace your existing routers, be it a beloved Nighthawk router or a free voice-video gateway from your service provider in order to build a mesh WiFi system at home. All these new mesh extenders use our patented FastLane3 technology to boost the strength of your extended network, just like our Orbi WiFi mesh system.

We believe all WiFi in the homes should be WiFi mesh systems from now on, and we offer 2 options to accomplish this, a complete replacement with our Orbi mesh system or an incremental upgrade with our Nighthawk mesh extenders.

Our FastLane3 technology sets us apart from our competition in terms of coverage and speed, as evidenced by numerous independent third-party reviews worldwide. It is the combination of years of radio frequency expertise accumulated over time in our R&D team. To add to our differentiation, we continue to incorporate value-added services to our WiFi platform. We recently introduced a powerful parental control service to our Nighthawk line of routers, which we will demonstrate on our Analyst Day. We expect to expand the offering to our Orbi WiFi mesh system this quarter. We will also introduce another popular value-added service on our Analyst Day as well.

Finally, turning to the SMB segment, as Christine mentioned, we recently launched the industry's first fully integrated app, Managed Switches, for remote network management. Using our Insight app, anyone can easily discovery, configure, monitor and manage the network, which includes both switches, wireless access points as well our storage products from anywhere in the world on a mobile device. This is an industry first and no competitors of ours will be able to deliver that today.

Our companion Insight switches can be plucked into your network, discovered by the Insight app, and there then ready to go. No additional hardware is required. It is a simple and elegant way to manage your network in the era of mobility. We believe this will help us slowly turn around our switching revenue in the quarters to come.

I will now turn the call back to Christine for Q4 guidance.

Thank you, Patrick. For the fourth quarter of 2017, we anticipate revenue will be the range of approximately $375 million to $390 million. Fourth quarter GAAP operating margin is expected to be in the range of 4.8% to 5.8%, and non-GAAP operating margin in the range of 7% to 8%. Our GAAP tax rate is expected to be approximately 35%, and the non-GAAP tax rate is expected to be approximately 33% for the fourth quarter of 2017.

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

(Operator Instructions) Our first question comes from the line of Tavis McCourt with Raymond James.

First, a couple of financial questions, and then a product question; so on the guidance for Q4, if we compare the 7% to 8% operating margin to kind of what one would normally expect coming off of 9.5% Q3. How much of that incremental investment is R&D versus pricing or sales and marketing investments, and anything you're willing to give us, Patrick, on the need to sustain that level of investment would be helpful.

And then secondly, it looks like the channel inventory metrics you guys give were up quite a bit year-over-year, especially the U.S. distribution channel. I've always thought of that as kind of an Ethernet switch channel. But does that include retail as well, and maybe some explanation of that and where you would expect that to be at year-end. Thanks.

Well the first thing is that the increased spending is, I think, evenly distributed across both R&D, which we have a huge pipeline of products, which we are actually going to disclose on the Analyst Day, as well as on the brand marketing, as well as channel marketing. So brand marketing, we are doubling down on our activities on the social platform, on the search engines both on Amazon as well as on Google, as well as on commercials that we deploy on radios, on satellite radios and a lot of sponsored events.

And channel marketing is a natural step up for the holiday season. As a matter of fact, every Q4 because of Black Fridays and because of Christmas, we do end up with a lot of channel promotional activities. But I would say those 3 would be evenly divided.

Now going forward, as we mentioned before, we're not going to step back from the R&D. We're not going to step back on the brand marketing. And then on the channel marketing piece, it depends on how fast we can get to the share and the user base in the short term. Our goal is to get a 45% share on Arlo, which is getting closer to our 48-49% on our WiFi side.

And then in terms of registered users, our goal is to get to 2 million registered users as quickly as possible. Today we're at about 1.3 million. We believe that by stepping up our marketing activities both on brand and channel marketing, we have a pretty good shot to get to 2 million subscribers by the end of first quarter. And that would be a good number. But of course, we will not stop at that.

So we believe all that activity is beneficial to us in the long term. Because unlike before, every Orbi, every Arlo that we sell, we actually build a connection with our customers through the cloud and through the app that we could interact with them on a frequent basis, not only that we're going to sell them subscription software services, which I mentioned just now like for Orbi. We can get them subscription to parental control plus other services that we will unveil on the Analyst Day. And then we will continue on top of the storage subscription service. We'll continue to roll out other subscription services, which again we will demonstrate on the Analyst Day.

So we do believe that we will continue to step on the gas pedal to really increase our user base.

Right. And on distribution, Tavis, so distribution does at times take -- it definitely takes retail products too. And in fact specifically this quarter, they stopped in for some promos that were going to happen in early October on a retail product side. So I believe you will see that inventory level come down as we exit Q4. But it was definitely stocked in a bit for something that was going to happen shortly into October.

There is still quite a few channel partners that would take the inventory from distribution channel. For example, we sell our products over Home Shopping Network. We sell our products over the military retail chain. We also sell through smaller retail shops, such as the [B&H]; those shops. They all take it through distribution.

And with the -- I mean everybody is put on notice that we will launch our Arlo Pro 2 in the first two weeks of Q4. And we actually run a few of the Home Shopping Network sales over several weekends at the beginning of Q4. So all those inventory has to be staged before the end of the quarter. So we do believe that the distribution inventory will come down when we exit Q4.

Great. And I suspect you'll get a lot of questions on Arlo competitive dynamics. So I want to ask specifically on SMB. Because this segment has seemingly disappointed now for a number of quarters in a row. And so I'm wondering how much is left of the non-switch business in that segment? And what gives you better comfort today versus any of the previous 3 or 4 quarters when you thought you were going to start seeing a turnaround in this business?

There are two elements to it. One is that as we all, right, the enterprise networking market is not growing for multiple reasons. I mean a lot of things are moving to the cloud. A lot of things are moving to a subscription basis. So selling hardware has been a flat market at best. And secondly, what gives me comfort is that net revenue is one thing. But more importantly I look at end market sales. Our end market sales is actually quite good. It's not as bad as it showed on the net revenue.

The net revenue differed from the end market sales simply because that we have to go through -- our revenue is on sale end. So it really depends a lot on how the channel takes on inventory. Now was we just mentioned, the channel wants to take on Arlo. The channel wants to take on Orbi. And if they see a flat market on the enterprise switching side, they would take less of the switching. So the fact is that we see in Q3, especially towards the quarter end, while we have a pending big launch on Arlo Pro 2, the channel is swapping some of the SMB inventory with the Arlo inventory and that really hurts on net revenue reporting.

The comfort I take is that when I look at the actual end market sales, it's actually pretty good. And on the switch revenue, certainly it is a smaller portion of the overall SMB. However, it's not small. And the beauty of it is with the introduction of the Orbi Pro, with the introduction of the Insight Managed wireless access point, we are seeing signs that the wireless line of products is actually picking up again. Same thing with the complete refresh of our storage line, especially on the (inaudible) side, we're also seeing it to be picking up.

So I'm looking at the end market sales to see the comfort factor. And we do believe that we will continue to make progress. But it will take several quarters to get there. And clearly from a channel perspective, the attention is of course on Orbi and Arlo. Channel will sell whatever is easier to sell.

Okay, all right, so that the channel increase this quarter was predominantly, if not entire retail based?

Yes, pretty much, yes.

Thanks for the added color.

Our next questions comes from the line of Hamed Khorsand with BWS Financial.

Just trying to figure things out here, and if I'm looking at Q3 and you had this large Arlo sell-through, then in Q4 the expectations are the same; why are you expecting that you need to spend more or discount more in Q4 to take market share? I'm just trying to figure out the competitive dynamics here.

Well, we have talked about that. We always want to sell more. And we have set ourselves a short-term goal of 45% market share. We're not there yet. We would like to set 2 million in registered user base. We're not there yet. We believe that is very important for the long term. And the faster we get there, the higher a barrier to entry that we could build. And that's why we've decided to spend more.

And Q4 is the most important quarter, because for camera Q4 is particularly bigger than the other 3 quarters. So if we do not spend it in Q4, then it will take us longer to get to the next cycle to get us to the magic numbers. And why do those magic number matter? I mean one I talked about is erecting a higher barrier to entry. The second is more important is that the higher the registered user base, the better we have a chance to monetize them.

And we're going to explain what are some -- other than the 30-day storage or 90-day storage that we have today, we're going to demonstrate a few other subscription services that we're going to launch in the next quarter or 2 on the Analyst Day. So all those add together, that's the reason we decided to continue to spend more.

And of course, I mean it doesn't come cheap on the R&D side as well. Because as I said, right, we still have to pump R&D, not only in sustaining this existing camera line, but we're introducing a new non-camera line in 2 weeks' time. And then of course rolling out all these new services like AI is not cheap. I mean AI as reported by Wall Street Journal, those engineers are probably more expensive than the NFL Football players.

And so is it fair to assume that pretty much all the margin you're guiding for is coming from Arlo?

No. We just talked about Orbi as well. So Orbi is the same thing, all right. I mean Q4 is definitely a very important quarter. And now we just introduced Nighthawk mesh. So that means we're doubling down on pushing both the Orbi brand and the Nighthawk mesh brand. This is a very unique opportunity, because with the Orbi brand, I mean you pretty much can target only 10%, maybe 5%, of the total market that people are willing to replace whatever they have with a complete new system.

And with the Nighthawk mesh, the whole market is open to us, including those who rent the WiFi from the service providers. Because we don't need to touch that one. The Nighthawk meshes add on to those. Again, it's a very unique opportunity, because only with the FastLane3 technology that we've patented you're able to do this. And we're the only game in town.

So if we do not spend money in promoting it, then we'll miss the huge opportunity.

Is there a risk of cannibalization with the Nighthawk mesh beyond what Orbi has done to Nighthawk?

No, they're two different crowds. As I mentioned, the Orbi crowd are those who are willing to replace entirely what they have. And the Orbi crowd are the people who are more lifestyle oriented, rather than all the bells and whistles that you want. And the Nighthawk crowd are people who really want to turn every single knot, choose their own channels, define their own QoS, and have better gaming experience. But those people have been demanding a mesh from us. And now we're giving it them.

Now with the Nighthawk mesh expended in one fell swoop we make all those customers who are using Xfinity WiFi or Charter WiFi or U-verse WiFi; all of a sudden they become our customers. But of course marketing to this big, big expanded market requires money. And we believe that Q4 is the best time to invest in it.

So in Q4, we are actually investing both in Nighthawk mesh, Orbi mesh, and Arlo.

Our next question comes from the line of Rob Cihra with Guggenheim.

Thank you very much. A few things if I could, the -- I'm not sure which. I guess in terms of the brand and marketing spend for Q4, I mean that strategy is similar to what you started doing already earlier this year. I'm just wondering if there is anything different. It seems like you're sort of reaccelerating it again. Is there anything you sort of learned when you started that strategy in Q1? So are you going to do the same thing and just more of it, because it's Q4? Or are you different things? And then I have a couple more question, if that's all right.

No. Actually, you're right. I mean we did it in Q2 in a very accelerated pace. And then in Q3 we pulled back a little bit. And so now we see the contrast. We can see exactly what is needed. So in Q4, we're stepping on the gas pedal again one more time. And what has proven to us is that driving traffic and converting the traffic is very important. And the best way to engage in our customers online is through social media. And then of course the point of presence in the retail stores, training the retail stores' associates and get them to do the assisted sales are also very important. All those things are no different.

So what we learned is it's almost like directly proportional. The more you spend on those areas, the better outcome of sales you could get from it. And Q4 is very important quarter. And we're doing it. And as a matter of fact, in Q4 there are so many opportunities that we think we cannot miss. The just newly introduced Arlo Pro 2, I mean the favorite feedback just on the last few days on Amazon is up to 4.3-4.4 stars. We've never had that good of start.

And today you just saw the announcement that AT&T is launching our first Nighthawk mobile hotspot routers across all their stores, which we absolutely need to continue to train the store associates to do that. And then the Nighthawk mesh extenders, our retail partners are very excited about it. Because now we open up the entire ISP provider WiFi channel like Xfinity WiFi, to our liking.

None of the search providers have been able to successfully introduce a mesh, even though they have been working on for years. So the opportunities that are presented to us is tremendous, is a combination of the right technology and product launch, and the perfect consumer quarter. But the tactics that we have learned in Q2 and Q3 has demonstrated to us what works and what not. We just are accelerating the investment.

All right, that makes sense and on that same way, the new product or new product category that you're going to announce on November 8, is that -- I don't know if you can even say it yet. But is that something that would actually be revenue in Q4 or more for 2018, and whether or not you're even able to answer that, I guess, goes to also whether there's any marketing spend for it in Q4 or not.

Well, put it this way. When we put up the guidance, we've taken that product introduction into account. Whether that product will be shipping right away, I just want to play a little bit of suspense, so otherwise nobody's going to tune it that day.

Okay, and then the broader question with obviously accentuate with Amazon's Cloud Cam today, not just looking at that product as competition specifically, but when you combine that now with Google's Nest Cam, which you guys have been competing with for a while now; I mean I guess right out of the gates their both wired versus wireless. So that's a -- I assume one source of differentiation.

But more broadly, I mean how are you guys finding competing against the sort of big ecosystem vendors? I mean I'm assuming that you don't-- obviously you're not going to compete with them on scale. But you compete with them on focus? I mean is it just that? Is it just the challenge that you guys just always have to have the better product, because it's what you-- it's all you do as opposed to one of a million things? And is that going to continue to be the strategy? I'm assuming it is, but--

Yeah, pretty much. Pretty much anytime, I mean NETGEAR is not a new company. I mean we've been in the industry for 22 years. And we have competed with titans before, with Intel, with Cisco, with HP, with Microsoft and now with Google and Amazon. I mean there is no difference.

The only way that you would be able to compete against the titans will be offering better products and better engagement with your customers. I mean those are two key things. And we do believe that we have significant technological edge over our competitors, both on the WiFi mesh as well as on the camera.

Now on the WiFi mesh is our FastLane3 technology, which is a combination of the antenna design as well as the tri-band that we've patented. So we do believe that we have technological edge, which would take them quite a while to catch up. Because they have to work around our patents. And then on the camera side, I think we pretty much like years ago, when the iPhone was introduced, it revolutionized the idea of cellphone from talking to people in working on the internet with a phone anywhere you go.

So the IP camera traditionally, like the Nest Cam or now the Amazon Cloud Cam is all about indoor. And when you're doing indoor, most people just install 1, at most 2, indoor. While we introduce Arlo, it is not wireless only. It is called wire-free. Wire-free means wireless plus battery operation and weatherproof. So that means you would be able to install them outdoor, and that changes the game. Because what we have found out, what we have predicted correctly, people don't buy 1. They buy 3. They buy 4. They buy 5. And actually they buy 6 to install around their house. So all of a sudden the ASP per household has changed from $200 to $600 to $800 per household. That's a completely different game.

So I think Amazon Nest Cam, Canary, Ring; all these people are still competing in a very crowded market of an indoor camera, while we are in a market of our own which is outdoor wire-free camera. And remember, for our outdoor wire-free camera, it's not only wireless on WiFi. It's wireless on LTE as well. And nobody has that technology.

And as a matter of fact, the LTE version of the camera has been selling quite well on Verizon stores and they will be propagated to many other operator stores very soon. So we do believe that using very sophisticated software to handle the battery utilization while being able to still transmit those videos over WiFi at a long distance or over LTE, and the [cellular] network, it's some secret sauce we believe we have long technology lead over our competition.

Thank you, and looking forward to the November 8 info.

Our next question comes from the line of Trip Chowdhry with Global Equities Research.

Again, a very solid quarter on Arlo. I was just wondering, how are you thinking about Arlo growth? Of course you didn't mention Arlo Pro 2 and some services. And I do know that the machine learning, deep learning service is still in beta. Do you know when can that be generally available?

Yes, I mean we expect to roll that out in a short time span. Basically what we have seen is the industry accuracy of object identification is probably around 92%. So we have seen some of our competitors rolling out their products below that level. And they get slammed on Amazon user rating. We don't want to repeat that.

So what we want to do is to meet or exceed that 92% accuracy expectation before we roll them out. So it takes a little bit longer time to beta and have it out. Because accuracy is all driven by training, all right? Training of the neural network. And we need videos to train it. And we ask our users to donate the videos. The longer the beta period, the more donated videos that we have, and that's what it is. But we expect that we should be able to roll that out in a very short time frame. But come on November 8. We're going to roll out not just on this particular service. We will have other services to roll out as well, which we are going to demonstrate on November 8.

Beautiful, and your Arlo business is so strong. Have you thought about renaming your company instead of NETGEAR, call it Arlo?

Not yet. That's an idea. I'll talk to the Board.

Our next question comes from the line of Woo Jin Ho with Bloomberg Intelligence.

First off really quickly, how large is the Arlo device base? I think you gave that metric last quarter. I just want to get a sense on how large -- how many devices you have out in the wild.

Oh, we have shipped over 6 million cameras. And we have 1.3 million registered users worldwide.

Okay, and then just to follow on, on Tavis's question in terms of the level of investment, I get the sense that given that you are investing more on R&D as well as sales and marketing as it relates to some of the services that you want to provide, I know that you gave a fourth quarter guidance of 7% to 8% on the operating margin side. But are we thinking about for 2018 or for the next several quarters around these level of operating margins, or should we start seeing a return on investment in services to help boost that margin in the back half?

That's right. I mean for now we do not know how the attach rate of the new services will be, which will have a significant bearing on the operating margin. We are doing both Orbi as well as Arlo. We have just rolled out the circle parental control services on the Nighthawk router side, and we will roll it out for the Orbi line this quarter. And then Arlo, we are going to roll out the person identification services in a very short time frame. And there will be another one that we're going to demonstrate on Analyst Day.

So clearly one for sure that after the Christmas season, the channel marketing spend will be reduced a little big. So you will see an improvement on operating margin slightly. And then on the other hand, we might decide to step in more on the R&D to really further our technology lead. But you're right. If any of those services really get adopted very, very widely, it will have a significant positive impact on our bottom line going into 2018.

Right. And I would -- remember, everyone, that from a seasonality standpoint, given how much of the business today is more retail focused, we will see the seasonality of Q4 being typically the highest quarter and a drop-off in Q1 as you build that back up. But we surely won't drop off the R&D investment during that period of time.

Okay, and I want to ask the competitive question in a different way, not from a hardware perspective, but more on a software investment perspective, especially given that Amazon's consumer investments are starting to broaden. And given Google's investment more on the AI and the imaging side where they can deliver those technologies cross platform and conceivably onto their consumer products. Why do you think that you are able to -- or why do you think your R&D may be able to out-innovate your two larger competitors?

I think the important thing is for focus. Where do you want to focus on? And the focus has to be meeting customers' need. We do believe that in the next, at least in the next 3 to 5 years, on the WiFi side, the most important piece for customers are still in the reach and the speed of WiFi.

And our FastLane3 technology which is patented, will give us the edge. And we'll continue to invest in these areas. And furthermore, as we said, today is 11ac. Next year is 11ax. Year after that you're going to integrate with 5G. I mean with our focus, we will be able to put those FastLane3 technology quickly onto these new technology platforms and so I think that that's the advantage we have.

On the other hand, on the camera side, I think today of course the image recognition and all that is very important. But as we found out, the biggest demand is still in outdoor camera. The biggest demand is people who can install the cameras outdoor themselves and will be able to monitor the periphery of their properties and that's the #1 thing we have to satisfy.

And if you install your camera at the corner of your back yard and you're able to beam 1080p video back into the house of your WiFi, it's not a trivial exercise. And that requires very focused R&D. So we do believe that-- I mean those are the areas that we invest and we continue to maintain a leadership approach. And we could continue to focus on that, I think we will maintain that edge for quite a long period of time.

Okay, and then one last competitor question, if I may, as it relates to your Connected Home. So as you know, the cable companies are about to come out with or have a fuller rollout of DOCSIS 3.1 that will require new broadband gateway. And it looks like they're coming out with 3x3 or 4x4 WiFi modems, which on the Wave 2 ac side.

How do you -- I understand that you have ax on the horizon. But is that a potential threat to your Connected Home business in 2018?

No. Really, I mean actually we love it. As I just mentioned, with the Nighthawk mesh extenders, we have a different way of selling to these people, these users, and say, you know what? You love your 3x3 or 4x4? But do you want it to be extended to your kitchen, to your back yard, to your pool house? There is no answer from the service providers. I mean then, why don't you buy 2 or 3 of these Nighthawk mesh extenders and make that happen?

You pay $120 to get gigabit into your house from Comcast or Charter. And then you buy into the $12 a month and these 3x3 or 4x4 WiFi? But that 100 megabit drops off to 10 megabits when you move into your study. Would you want to change that? If you want to change that, buy 2 or 3 of these Nighthawk mesh extenders. We're very excited about it. Our retail channel partners are very excited about it.

Our next question is a follow-up question from the line of Tavis McCourt.

Just a follow-up product question or two, Patrick. Before today's Amazon announcement, the most interesting thing that was going on in the camera market competitively was this seemed to the holiday season of security bundles. I think we saw Nest, Best Buy with Vivint, Ring; all developed these and merchandised these bundles of cameras with sensors. Is that something that we should expect from Arlo as well? Or do you think that the market is still a market where folks are looking for a solution just for cameras at this point?

And then on-- oh go ahead.

Really, as we mentioned, the pure IP camera, especially the outdoor IP camera market has grown like crazy. I mean so it's a market that we cannot exploit fast enough. And it's just now-- one of you mentioned that we have limited resources. We have limited R&D. Where are we going to put it? We would like to put it in the fastest biggest ROI. And today the wire-free outdoor/indoor capable IP security camera is the most effective investment for us.

And we're not going to say that we would never go into this big do-it-yourself security setup. But we do have to wait and see how big that market is going to change into. And also that market is very nascent and they're competing against the industry titan of ADT. So we don't know yet. I mean so we're not going to spend our R&D dollars on something which is uncertain. We'd rather spend money on something which we are very certain, which is the indoor/outdoor IP security camera market, which is growing 30-40% a year worldwide. And we have not even touched 1% of the households. So there is the other 99%. So it's a long runway. So I believe that that's where we're going to get focused in the short terms.

Great, and then a follow-up on the Amazon announcement this morning, I would imagine strategically what they care about is their service. Because allegedly millennials want strangers in their homes all the time.

But would you expect them to open that up to other camera vendors, like they did with lock vendors? Or do you expect this to be kind of a proprietary offering on the camera side by Amazon? Or do you have any insight at all on that?

Well, I'm sure that, I mean they would be open to open it up to other people, just like Alexa is, right? So I mean today, even though they sell Echo, they sell Echo Dot; they still open Alexa to other vendors. So I think there's opportunity for us to integrate that technology. But then again, we have limited R&D resources. So we have to look at how receptive people are opening their doors to strangers. If indeed there are tons of people willing to do that, we absolutely will integrate that, not only with Amazon. We'll integrate that with [Yale] as well, I mean if that becomes a phenomenon.

Maybe we're both too old, Patrick. Thanks.

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

Sure. Thank you, everybody, for joining today's call. We are very, very excited about the future because of all these new opportunities that is in front of us. And we have a solid technology investment and line-up and lead over our competitors. And we would like to showcase all those technology leads to you, if you could join us on the Analyst Day in our headquarters.

The reason why that we decided to hold in our headquarters is because it's much easier for us to stage all those demonstrations to you. I mean all of them are industry firsts, very groundbreaking and I hope to see you all in person, if not at least on the web. We're going to webcast all the software demonstrations that it will be very, very interesting. And look forward to do that on November 8.

Once again, talk to you next time.

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