NETGEAR Inc (NTGR) 2018 Q3 法說會逐字稿

Good evening. My name is Josh, and I will be your conference operator today. At this time, I would like to welcome everyone to the NETGEAR Third Quarter 2018 Results Conference Call. (Operator Instructions) Chris Genualdi, Director of Investor Relations, you may begin.

Thank you, operator. Good afternoon, and welcome to NETGEAR's third quarter 2018 financial results conference call. Joining us for the company are Mr. Patrick Lo, Chairman and CEO; and Mr. Bryan Murray, CFO. The format of the call will start with a review of the financials for the third quarter provided by Bryan, followed by details and commentary on the business provided by Patrick and finish with fourth quarter of 2018 guidance provided by Bryan. 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 Mr. Bryan Murray.

Thank you, Christopher, and thank you, everyone, for joining today's call. Before we begin, I'd like to make a few comments regarding financial reporting and consolidation now that the IPO of Arlo Technologies is complete.

Third quarter of 2018 results for Arlo Technologies are consolidated into NETGEAR's results with the exception of the portion of the net loss and loss per share attributable to the 15.8% of Arlo's common stock not owned by NETGEAR. As stated at our Financial Analyst Day in September, we currently intend to distribute our approximate 84.2% ownership position in Arlo to all NETGEAR shareholders by the end of the first quarter of 2019 subject to market conditions and other factors, including final approval by NETGEAR's Board of Directors and other customary requirements. Following the distribution, Arlo results for all historical periods, including the quarter in which the distribution occurs, will be reclassified into NETGEAR discontinued operations.

Now turning to our quarterly results. Third quarter of 2018 came in above the high end of our guidance driven by the success of Orbi, cable modems and gateways, SMB switches and the Arlo business. Overall, NETGEAR net revenue for the third quarter ended September 30, 2018, was $400.6 million, which is up 12.7% on a year-over-year basis and up 9.2% on a sequential basis. This is a quarterly net revenue record for NETGEAR.

NETGEAR net revenue by geography once again reflects our continued strength in North America. Net revenue for the Americas was $288.8 million, which is up 18.2% year-over-year and up 11.1% on a sequential basis. EMEA net revenue was $64.9 million, which is up 4.4% year-over-year and down 5.5% on a quarter-over-quarter basis. The quarter-over-quarter decline in EMEA was a result of the focus and success of prime day in the regions of Arlo, which comes with a higher marketing cost. From a channel sales out perspective, we are seeing quarter-over-quarter growth. Our APAC net revenue was $46.9 million for the third quarter of 2018, which is down 4.2% from the prior comparable quarter and up 22.4% quarter-over-quarter. The year-over-year decline is primarily driven by a decline in Australian service provider revenue in anticipation of the upcoming introduction of 5G.

For the third quarter of 2018, we shipped a total of approximately 5.9 million units, including 4.9 million of wireless products. Shipments of all wired and wireless routers and gateways combined were about 1.7 million units for the third quarter of 2018. The net revenue split between home and business products is about 81% and 19%, respectively. The net revenue split between wireless and wired products was about 78% and 22%, respectively. Products introduced in the last 15 months constituted about 35% of our third quarter shipments, while products introduced in the last 12 months contributed to about 30% of our third quarter shipments.

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

The non-GAAP gross margin for the third quarter of 2018 was 31.3% compared to 29.4% in the prior year comparable quarter and 30.2% in the second quarter of 2018. Total non-GAAP operating expenses came in at $97 million, which is up 37% year-over-year and up 9.1% sequentially. As discussed on our prior 2 earnings calls, we've been adding duplicate costs in anticipation of Arlo Technologies operating as a stand-alone public company.

Our headcount increased by a net of 92 people to 1,200 total during the quarter. We are adding resources to the key growth areas of our business in addition to adding resources as Arlo Technologies begin to operate as a public company and expect to continue to add additional headcount during the fourth quarter of 2018.

Our non-GAAP R&D expense for the third quarter was 8.3% of net revenue as compared to 6.2% of net revenue in the prior year comparable period and 8% in the second quarter of 2018. R&D is vital to our business, and therefore, we expect this expense to continue to grow as needed in absolute dollars.

Non-GAAP operating margin for the third quarter was 7.1% compared to 9.5% in the prior year comparable quarter and 5.9% in the second quarter of 2018. The non-GAAP operating margin for the third quarter of 2018 includes $15.5 million of duplicate costs associated with the separation of Arlo and the corresponding dis-synergies created as we hired talents to duplicate certain roles as Arlo begins to stand up on its own. This compares to 0 duplicate costs in the third quarter of 2017 and $5.1 million in the second quarter of 2018. Excluding Arlo Technologies, NETGEAR's stand-alone non-GAAP operating margin for the third quarter was 12% when including the benefit of transition services agreements with Arlo Technologies and 10.3% when excluding the benefit of these agreements.

Our non-GAAP tax rate was 18.1% in the third quarter of 2018.

Looking at the bottom line for Q3. We reported non-GAAP net income of $24.9 million and non-GAAP diluted EPS of $0.76 per diluted share. As previously mentioned, this includes the Arlo Technologies loss for the third quarter, except for the 15.8% loss that is attributable to noncontrolling interest.

Turning to the balance sheet. We ended the third quarter of 2018 with $529.8 million in cash. This includes the $187.8 million in cash held by Arlo Technologies. Excluding Arlo, NETGEAR ended Q3 with approximately $342 million in cash. During the quarter, we generated $33.8 million in cash flow from operations, which brings our total cash flow generated over trailing 12 months to $60 million. Additionally, we used $6.5 million for purchase of a property and equipment during the quarter, which brings our total cash used for capital expenditures over the trailing 12 months to $23.8 million. We remain confident in our ability to generate meaningful levels of cash.

In Q3, we spent $15 million to repurchase approximately 205,000 shares of NETGEAR's common stock at an average price of $73.15 per share. Since the start of our repurchase activity in Q4 2013, we had approximately 12.1 million shares. Our fully diluted share count is approximately 33 million shares as of the end of the third quarter. We have 1.8 million shares remaining under our approved buyback program, and we plan to opportunistically repurchase our stock in the quarters to come.

Now turning to the results for our segments. The Connected Home segment, which includes the industry-leading Nighthawk, Orbi, Nighthawk Pro Gaming and Meural brands, generated net revenue of $194.7 million, which is up 6.3% on a year-over-year basis and up 1.8% sequentially. Excluding sales to service providers, net revenue was up 18.4% year-over-year and up 13.2% sequentially. Both our Orbi mesh WiFi product and our lineup of cable modems and gateways were strong performers during the third quarter. As a result, we are pleased to see that we continue to hold 50% market share in U.S. retail WiFi products, which cover mesh, routers, gateways and extenders.

The SMB segment generated net revenue of $74.7 million for the third quarter of 2018, which is up 20.7% on a year-over-year basis and up 5.5% sequentially. Our switching portfolio continues to power our results for SMB. Please note that the Q3 '17 period was particularly weak for SMB due to channel destocking around the world for our storage products. With the strength of our switching lineup, our market share in the U.S. retail and e-commerce channels remains high at 60%.

For Q3 results related to Arlo Technologies, please refer to the separate earnings release which was distributed earlier today. But needless to say, we are very pleased with the reported performance, particularly in terms of revenue growth, user acquisition and paid subscriber growth.

Before I turn the call over to Patrick, I'd like to discuss the actions we are taking to neutralize the cost impact of tariffs on our business, excluding the Arlo business. First, it's worth noting that we operate a supply chain that is already diversified not only by supplier, but also by geography. While a significant amount of our products are produced in China, we also produce a meaningful amount of products in Vietnam. The labor cost of manufacturing in China has increased in these recent years, so we had already begun the process of moving production to lower-cost locations prior to the recently implemented tariffs.

We are now accelerating that process. Obviously, this is not something that can be implemented overnight, but we are moving very quickly, and we have experience in managing this. This will mark the third time that we have moved production location, and we are confident that the move will be complete by the middle of next year.

Second, to further mitigate the impact of implemented tariffs, we will be selectively increasing the prices of our products and expect that our competition will do the same. Using the strategy of increasing prices and moving our supply chain, we expect that we can neutralize the effects of the tariffs under net income and EPS. As a result of the mitigating efforts, we believe that our targets for 2019 in operating margin dollars and EPS will be preserved.

I'll now turn the call over to Patrick for his commentary, after which I will provide guidance for the fourth quarter of 2018.

Thank you, Bryan, and hello, everyone. We're extremely pleased with our results for the third quarter of 2018, which exceeded our expectations for both the top line and the bottom line. The quarter was driven by the success of Orbi, cable modems and gateways, SMB switches and the Arlo business.

During the quarter, we completed the successful IPO of the Arlo business. I would like to acknowledge all of the hard work from both the Arlo and the NETGEAR teams that went in to making this happen. It was no small task, but the 2 teams did a great job. And Arlo Technologies now trades on the New York Stock Exchange under the ticker ARLO.

Now as many of you know, in early September at our annual Financial Analyst Day, we outlined our strategy for driving the NETGEAR business forward. The strategy is based on 3 key activities: capitalizing on technology inflection points, creating new categories and building recurring service revenue streams. I would now like to spend some time speaking about each of these priorities.

Since our founding, we have been in the business of capitalizing on technology inflections. It is something that is in our DNA. Given our broad exposure from home to mobile to small businesses networking, we see great opportunity to continue innovating and leading in the market. In the current quarter, you will see us aggressively introducing the next-generation 802.11ax WiFi product for consumers. 802.11ax is the newest WiFi standard that is optimized for accommodating many devices in the home, reducing network congestion and mitigating neighborhood interference. The last WiFi standard upgrade cycle was 802.11ac, which began in 2012.

Historically, the release of each new WiFi standard has created opportunities for the rise of ASP and for us to gain share. Our 802.11ax Nighthawk router can handle 4x the number of devices at 40% higher throughput, deliver 50% longer range and improve the battery life of all client devices. We'll be incorporating 11ax technology across our entire WiFi portfolio, which will allow us to continue on the path of increasingly shifting our sales to the high end of the market.

On the SMB side, both the move from 1-gigabit to 10-gigabit switching and the shift from PoE to PoE+ switching have driven ASP increases in our increases over the last few years. More recently, the translation from HDMI to Ethernet in the ProAV audiovisual interconnect market has created an opportunity for us to innovate a whole new line of switches that are optimized for managing multiple large video displays.

5G is another inflection point that we are positioned to take advantage of. It will completely change the landscape for mobile and on-premise connectivity. The evolution from LTE to 5G will provide speed and reduce latency that is far better than what we have today. We can expect countless new imaginative applications to emerge that currently do not exist. We can also expect 5G to provide a viable alternative to fixed wireline broadband around the globe. We will be introducing 5G mobile hotspots in the current quarter, and you can expect more 5G-related products from us in 2019 both for the service provider and retail channels.

Creating new categories is something that we try to do on a regular basis, and we have been quite successful in doing so throughout our 15-year history as a public company. We were the first to bring wire-free outdoor cameras to the market with the introduction of Arlo. More recently, we were the first to bring to market a router with routing software specifically developed for avid gamers. We were the first to develop switches built specifically for the ProAV market.

If you joined us this year at our Financial Analyst Day, then you were treated with 2 of our newest innovations. The first is Orbi Voice, the industry's first WiFi mesh hotspot with a speaker and voice assistant built in. The second innovation is Meural, a recent small acquisition that we completed during Q3, which is a hardware and cloud platform for the digital distribution of curated artwork. The Nighthawk Pro Gaming router, Orbi Voice and Meural are all part of our newest category under Connected Home business which we call lifestyle. We are confident in our market positioning and the unique value proposition of each of these product lines.

Finally, I'd like to discuss our initiative to drive recurring service revenue. After a year of experimentation, we are confident that we will continuously improve on our capabilities to build significant recurring revenue streams. This initiative provides the greatest opportunity to drive our operating margins higher. During the last year, we have been very active getting our customers registered and engaged with us. We are learning more about our customers every day so that we can deliver the right services to them that fit their needs.

Based on our historical shipment data of consumer WiFi routers, gateways and systems and our estimated replacement cycle time, we believe that our installed base is approximately 25 million customers worldwide. About 9 million of them have already registered with us with a unique user ID plus all updated user credentials and NETGEAR product ownership. Half of them opted also for marketing messages from us. This represents a massive opportunity for us to tap into and deliver value to our customers in the form of services.

We currently have 5 different services available to our Connected Home products customers and 3 different services for our SMB customers. Our goal is to get to 1 million paid service subscribers as soon as possible. The future for NETGEAR will be focused on continuing to provide to our installed base the innovation in Internet connectivity they need while creating the right value-added services that are most desired by them. By being at the forefront of innovation in connectivity hardware supplemented by differentiated software, we will continue to command the premium end of the market, which will be key to successfully rolling out paid value-added services to our installed base.

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

Thank you, Patrick. For the fourth quarter of 2018, we anticipate revenue will be in the range of approximately $430 million to $445 million. Net revenue for the combination of CHP and SMB is expected to be in the range of $275 million to $290 million, while Arlo is expected to be in the range of $140 million to $155 million.

Fourth quarter GAAP operating margin is expected to be in the range of negative 2.5% to negative 1.5%, which includes approximately $7.5 million of onetime costs associated with the separation inclusive of professional services fees for various advisory and audit-related costs. Non-GAAP operating margin is expected to be in the range of 2.5% to 3.5%, which includes approximately $21 million of costs to duplicate certain roles as the business begins to -- as Arlo begins to stand up on its own. Excluding Arlo, we expect the NETGEAR non-GAAP operating margin to be in the range of 8.5% to 9.5%, which excludes any benefit from transition services agreed with Arlo. Our GAAP tax rate is expected to be approximately 85%, and the non-GAAP tax rate is expected to be approximately 22% for the fourth quarter of 2018.

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

(Operator Instructions) Your first question comes from Adam Tindle with Raymond James.

I just wanted to start, Bryan, on Q4 guidance. Looks like you're implying revenue growth sequentially ex Arlo, but Q4 operating margin down sequentially ex Arlo. So why would we see more leverage? Are there additional costs that weren't there in the September quarter? I know your ran through some there at the end, but I'm just hoping that you could maybe run through the buckets and how they compare to the last quarter on a sequential basis.

Yes, I think the big driver in the sequential movement in the non-GAAP operating margin relates to the Arlo business. You may have heard from the management team earlier that they are embarking and accelerating efforts to acquire end users. And as a result, that clearly requires some additional marketing dollars. So that's probably the bigger driver. Q4 is typically a very promotional season when we do make some investments in the area. Black Friday, Cyber Monday has grown from a 1- or 2-day event into spanning a couple of weeks. So it's certainly a very promotional period of time.

And also, as we've seen at -- I mean, looks like IP camera's more seasonal and more promotional than the rest of our product line. So that's why it gets a bigger influence.

Right. Okay. So then the 2019 10% to 11% operating margin ex Arlo that you outlined at the Analyst Day, is that also decreased or that's still intact?

It stays intact. As I said with regards to the tariff, we are embarking on mitigating efforts to offset the effect on operating income dollars as well as impact to EPS. Depending on how we approach that, it may change the percentage slightly. But again, we are committed to driving towards the same implied operating income dollars and EPS that we guided to early in September.

Got it. Okay. And maybe just one quick one for Patrick. I wanted to ask a little bit more on the distribution of Arlo. Can you maybe just talk about the logistics to this and ensuring it doesn't cause significant volatility in shares? I mean, what would prohibit a sale of the business instead? And why not explore this given the market's reaction to the IPO so far?

No, I think basically, the stock market is heavily influenced by a lot of risk off mentality. We still are very confident in the long-term success of Arlo, and you cannot have a better position owning about 40%-plus of the market, which is expanding significantly and at the same time expanding the product portfolio. I mean, they just shipped the doorbell, and they've added lights and they actually will ship even more. I mean, they also announced that they will have another new category coming at CES. So I think there's nothing better in position for that. So we are still very confident that we're going to go ahead and there will be really good market acceptance of the distribution of the shares. So it's never come across our mind that we would change that plan any time soon. But overall, I mean, never say never. Anything can happen. But for now the plan is still on, and we're pretty confident we're still on that path.

Your next question comes from Rob Stone with Cowen and Company.

I wanted to ask about the distribution as well. I guess you stated that you expected to be completed before the end of Q1, and I know that some of the necessary hurdles include getting both the companies fully separated, making sure it's qualified for tax redistribution and so forth. Is it possible that you could still make it a distribution before the end of 2018?

At this point, we're committing to the end of Q1 '19. Obviously, we're working as fast as we can, but sometime between now and the end of Q1 '19 is what we're able to offer.

There are still a lot of variables like moving location, IT systems up and running, customer contracts all tied up. So yes, there's still a lot of work to do.

So sometime in Q1.

Absolutely.

And you mentioned that there's a significant amount of duplicate expenses in the fourth quarter, including time when you're providing some transition services to Arlo. So obviously, your consolidated expenses that you report will drop once Arlo is spun off. But can you give us a sense of how quickly you can then pare back these extra expenses where you have dis-synergies and you're also providing services to Arlo? So how big a step-down in core NETGEAR OpEx might we be able to see post the separation?

I think what we messaged at the Analyst Day is that we will experience some upward pressure on OpEx as a percentage of net revenues in the shared services function just by way of taking up the Arlo business in the top line. But we remain committed to be able to deliver that double-digit operating margin for 2019 and do believe that the underlying performance in both CHP and SMB gives us confidence in that.

Of course, I mean, given the seasonality of the CHP business, you will expect that it will be lighter in the first half and better in the second half in terms of operating margin percentage.

Okay. With respect to the tariff impact, it seems like it's going to be a problem for everybody since China is such a major supply chain location for companies in the market that you serve. Can you give us a sense of what you expect the pricing impact might be, just thinking about whether this would have any impact in demand? Obviously, if everybody has to raise price to some amount, it shouldn't have a competitive effect necessarily but perhaps a dampening effect on consumer demand. So can you give us a sense of the scope of likely price increase?

Well, first and foremost, we said that a good chunk of our products are already produced in Vietnam. And also, not all our products are subject to tariffs. And then also, not all of our products is sold in the United States. So when you pair all that one out to another, so the impact is not 100%. And what our objective right now, all right, is to bring in as much product as possible in Q4 just to make only the 10% tariff on those products that are affected. And then we'll try to minimize the import of anything that is 25% tariff. We expect that our move of the factories to be completed no later than middle of next year. So our plan is to import goods for the U.S. mostly in Q2 of next year, which hopefully will be completely tax free, even not the 10%. So of course, I mean, so if our plans got executed completely, then the tariff effect, when you take into all that account, will be very minimal. So -- but still, we need to offset that, right? So we're going to raise prices, but we're not going to raise prices across the board with a fixed percentage. Maybe we'll surgically raise prices on products that we believe: number one, that people are less price elastic; two, we have a unique advantage that people will pay for it; and thirdly, that we believe that it would not dampen demand for that particular product. So that's why put it all together, we're still pretty confident that the tariff will have minimal effect of achieving our full year 2019 operating margin dollars and EPS.

Okay. And final question for you, Patrick. I wanted to get some sense of this is the quarter in which you're going to be introducing for the first time 802.11ax as well as 5G products, but I imagine it will take a while for both of those things to grow up their share of the overall revenue. So by when should we expect those inflections to begin to have a material impact? Not asking for a specific percentage, but just when do you think we'll really notice that impact on revenue.

Well, given the fact that the ASP is going to be kicked up another notch, generally speaking, every year when we introduce a new technology, the ASP get kicked up for that particular line of product for 20% to 25%. So this is significant. And because the introduction is not like selling online onesie, twosie, we're introducing into channels and our revenue is counted on a shipping basis. So I would still say, as far as Q4 is concerned, it's material. 11ax and 5G, from a revenue perspective, is material. From a sales out perspective, we do agree with you that it probably would take into the last part of the first half of next year to be material. However, based on our experience, 11ac pretty much overtook 11n 3 years into the introduction. So I would say now we introduce 11ax and 5G at the end of 2018, that means by 2021 during Christmas time, then pretty much 5G and 11ax will be the primary portion of our both shipment as well as service.

Your next question comes from Rob Cihra of Guggenheim Partners.

Just a couple thing. One the -- Patrick, you didn't call out Nighthawk Pro Gaming router, I don't think, and I just wasn't sure if that was just because you can't call at everything or if there was not necessarily as, I don't know, strong contributor. I mean, clearly, it's a contributor year-over-year since you didn't have it a year ago. So I guess I'm just curious how that's going with the refresh you've had, that sort of thing. And then separately on the service provider being weaker even than expected and in the long term that's probably a good thing. Was that all due to Telstra declining? Or was there -- is there something else? And is that sort of $38 million a quarter, is that now the kind of the new go-forward number, if there was such a thing?

Okay. So first question answer first. I think I did call out Arlo. I did call out Orbi. I did call out ProAV. So I think -- not just Pro Gaming. But on the Nighthawk line, right, NETGEAR Pro Gaming is the newest line of product. Furthermore, my son is a gamer. My son-in-law is a gamer. So that's why it kind of come to my mind first. Yes, but -- so they all performed really well. I mean, the Nighthawk Pro Gaming clearly is the star. It's well recognized, and it's very high margin for us. I mean, we're very pleased with its performance. So it means that we introduce a second scheme and try a new price point. We just introduced last week the premium Pro Gaming router at $499, and they sell. Pretty cool. And so I think, I mean, that we're very, very, very pleased with it. And then in terms of the lumpiness of service provider sales in one quarter, we're not -- I wouldn't look at it at just one quarter because, I mean, they have their different priorities in CapEx, in inventory position. We should look at it on an average 4 quarter basis. We're still pretty confident it will stay in that range that we talked about around $35 million a quarter. Now I'm not them. I cannot speak for them, all right? So the only thing I could tell you is not Telstra only. I mean -- and if I were them, I would probably save some bullets for the 5G, right? I mean, you know -- I mean, 5G is coming. Why buy more 4G? That doesn't mean I'm saying -- I'm not telling them that I know exactly, but that's how I'm guessing it. So that -- did I miss any questions?

No. That sounds good. And I guess just the last thing, is there anything else, if you look at your domestic business on the service provider, I mean, is the sort of, I don't know, hesitation or planning or whatever for 5G, does that impact you similarly? Or why the different Australia?

No, I didn't say that. I just said I do not want to specify whether it's Australia or North America or Europe in that pool for our customer. But I'm just saying that generally speaking, all right, if I were a carrier and I know 5G is coming, why should I load up more inventory on 4G. I mean, that's what I'm saying.

Right. Okay. And then last if I could, a follow-up. Just is there -- at what point, and it's obviously too -- it's quite early, but if you guys were going to start reporting like a services -- an actual services revenue number, I mean, is that the kind of thing that's even on the horizon? Or I mean, obviously you'd like to at one point because by definition that would mean it was big enough to even want to report it, but I'm just curious when that might be the type of thing that you would actually call out in dollar terms.

Sure. I mean, it's pretty simple, right? I don't want to report anything that's immaterial. So today, it's still immaterial. Now how will I count it as material, I wouldn't say purely on the top line, right, because we're still primarily a hardware company. I mean, top lines would never be material to the 1% to 10% or something. But on the bottom line, it's big. And you have to understand, most our services are pass-through basis: Bitdefender for our Armor, Circle for our Parental Control, Gaming, Netduma, all these. We actually have very little operating expenses. We're basically a cut on this, and because of that, we only report it on a net basis on the revenue. So I would say by the time that the service revenue is contributing to more than 10% of our overall operating profit, then we probably start reporting it. That's how I look at it.

All right. I'll look forward to that then.

Yes. Hopefully very soon.

Your next question comes from Hamed Khorsand with BWS Financial.

First off, I wanted to ask you about this 11ax product, and you were talking about it at your Analyst Day, but you also mentioned that it could come out at the end of September, early October, but it's been delayed based upon that commentary. Was there a reason for that?

Yes. It's pretty simple. If the software is not up to our QA standard, we're not going to introduce it. And the software is -- the firmware, that was primarily supplied by our chip vendors and they have to get it up to the standard we believe that is solid before we introduce them.

Okay. And then as far as the SMB business is concerned, you were just citing some momentum in the switches. Is that a onetime event? Or do you think you can sustainable growth from here on at the $74 million level?

Yes. I mean, I would like to point it out, I mean, the $74 million level is a pretty good go-forward basis, and we said that we're going to continue to grow at mid-single-digit on an annual basis and it's powered by the switches. And as we said it many times both in Analyst Day and all the calls, the kind of switches that's powering our growth are PoE+, 10Gig, ProAV, and we don't see that would change in the near future. I think this trend will continue on for the next 2, 3 years until we -- there is another new category that we're pushing. I mean, who knows. Maybe in 2, 3 years, it will be significant. We call it app switches, right, which is a new category that we introduced and hopefully it will be a star in 2, 3 years' time.

Okay. And then also just from a Q4 standpoint, you haven't really talked about any of your marketing plans or anything. So I'm assuming that you're comfortable with just on an ongoing basis what you've historically done. Are you seeing any competitive threats on the horizon? Or are you just keeping the marketing stable?

So I think we've said earlier that Q4 is typically a more promotional season, so I think we're expecting it to be normal for that time of the year. I think we also mentioned that the Arlo business is a little more seasonal, and given their push for acquiring users, that they're going to be a little more promotional in Q4. So other than that, I think it's similar for what you would see in a Q4 period.

Okay. From a competitive standpoint, my question is in general. I was really focused on NETGEAR, not Arlo.

Yes, NETGEAR, I expect it to be similar behavior as we've seen in the past: a little more constant revenue marketing focus in Q4 driven by the Black Friday and Cyber Monday promotional periods.

Your next question comes from Woo Jin Ho with Bloomberg Intelligence.

So let me spin the service provider question around a little bit. So your Connected Home ex service line of business, record revenues for third quarter versus 4Q '15. What was driving that strong sequential uptick in the quarter?

Again, I would like to point it out, if anything, it's Orbi, it's NETGEAR Pro -- Nighthawk Pro Gaming, it's cable. Those are the 3. I mean, it's pretty amazing that we were able to continue to drive the market forward.

Sure. Okay. And then in terms of your ability to pass through the tariff costs to the customers, part of that is your competitors, and I believe you mentioned on the prepared remarks, your competitors will follow suit on that. But what gives you the confidence that your competitors will raise their costs especially given that they want to take market share away from you?

Well, I mean, so of course, this is our winning of the market, right? And we have intelligence, we have our years on the ground and most contracts required you have to let your distributors and your retailers know of price increases 90 days in advance. So we're well within that situation. And furthermore, I mean, unlike us, all our competitors have the production 100% in China. So talking about the ability to absorb tariffs or pass it on, we are in a much stronger position than our competitors. And furthermore, the fact of the matter is no matter which price of product you talk about, we always command a 25% to 35% premium anyway. So you could figure who will have the upper hand.

And then given all the factors in terms of the tariffs, your ASPs, your new products that are coming out in 2019, do you still have confidence on the 3% to 5% revenue growth targets for next year that you gave on the Analyst Day?

Definitely. Well, I mean, the innuendo and the nuances, all the tariffs passed on is counted as top line.

Your next question comes from Trip Chowdhry with Global Equities Research.

I had a question on Meural. Can you explain really what this product is and what is the business model behind it? And since you acquired this company, how can we think about how the Meural product will get evolved over the next 2 to 3 years?

Well, I mean, this product is pretty simple. I have been taking it around the world, showing it to customers, showing it to the channel partners, showing to friends. There was not a single time that the person I show it to didn't say, "Oh, I want one," all right? So that gave me the confidence it's something that really people want. I mean, if you've seen it, you'll love it. I mean. And it's not just display of artwork, but it's curation. They curated the artwork. You get all the explanation in the background. And the quality, I mean, it's -- one of the magazine review said it is so real that you really want to touch the brushes on it. For crying out loud, it's an electronic banner, so -- but it's so real. So that's great on the hardware platform. But more attractive is in order to gain access to those curated artwork, you're going to pay, all right, on a monthly basis to the tune of about $4 to $5 a month, depends on whether you are yearly or quarterly or monthly rate, and they have a high attach rate. Even though if you buy the canvas, you get some freebies to begin with and the freebies are pretty darn good actually. However, there is still a high attachment rate for people to go beyond the freebie and complete access of 40,000. And all the deals that they are still negotiating, right, to get more curated artwork and the next stage of expanding the revenue business model is very intriguing. So we believe by combining the tremendous platform they have built with worldwide distribution channels that we have is a pretty powerful combination. And furthermore, we could add a lot of technology to it. We're very excited about this. And coupled with Orbi Voice, coupled with NETGEAR Pro Gaming, I mean, it's a fantastic triumvirate of a lifestyle line of products in the house. And nobody, nobody can rival that.

A follow-up. Like, when I look at the various portraits and go to the art centers, I do see there are many form factors of the artwork, while currently, Meural only has one form factor of the frame. Do you think down the road we may see a smaller form factor of the frame so that some artwork, which is of a different size, can be viewed in a different setting?

We are having a fantastic product plan in the future which I cannot disclose.

Beautiful. Do you think we can see some bit from Meural at the Consumer Electronics Show?

Absolutely. Please come.

There are no further questions at this time. I'll turn the call back to the presenters.

Thank you for everybody joining today's call. We're very pleased with the successful quarter in Q3 for all 3 businesses: Connected Home, SMB and Arlo. We're excited even about more of the opportunities that are ahead of us and specifically in Q4, and I look forward to updating you all again on our next earnings call after a very exciting holiday season. Thank you, everyone. Bye-bye.

This concludes today's conference call. You may now disconnect.