NETGEAR, Inc. (NTGR) Q1 2012 Earnings Report, Transcript and Summary

Greetings, and welcome to the NETGEAR, Inc. First Quarter 2012 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Joseph Villalta, of The Ruth Group. Sir, you may begin.

Thank you, operator. Good afternoon, and welcome to NETGEAR's First Quarter Financial Results Conference Call 2012. Joining us from the company are Mr. Patrick Lo, Chairman and CEO; and Ms. Christine Gorjanc, CFO. The format of the call will be a brief business review by Patrick, followed by Christine providing detail on financials and other information. We'll then have time for any questions. If you have not received a copy of today's release, please call The Ruth Group at (646) 536-7032 or you could go to NETGEAR's corporate website at netgear.com. Before we begin the formal remarks, the company advises that today's conference call contains forward-looking statements. Forward-looking statements include statements, among others, regarding expected revenue; earnings; growth; operating income and margins; tax rates and other projected financial results; share gain expectations; the market for our products; business prospects and competition; research and development efforts, including software development; sales and marketing efforts; market trends and opportunities; our growth strategy; our commitment to research and development; and pace of new product introductions. Forward-looking statements made during the call are being made as of today. If this call is replayed or reviewed after today, the information presented during the call may not contain current or accurate information. Further, certain forward-looking statements are subject to risks and uncertainties and are based on assumptions as to future events that may not prove to be accurate. Therefore, actual outcomes and results may differ materially from what is expected or forecast in such forward-looking statements. Information on potential risk factors and details in the company's periodic filings with the SEC including, but not limited to, those risks and uncertainties listed in the company's most recent Form 10-K filed with the SEC. NETGEAR undertakes no obligation to release publicly any revisions to any forward-looking statements contained herein to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events. In addition, several non-GAAP financial measures will be mentioned on this call. Information relating to the corresponding GAAP measures and reconciliation of the non-GAAP and GAAP measures can be found in our press release on the Investor Relations website at netgear.com. At this time, I would now like to turn the call over to Mr. Patrick Lo. Please go ahead, sir.

Thank you, Joseph, and thank you, everyone, for joining today's call. NETGEAR ended the first quarter of 2012 on a high note by posting record first quarter revenue and non-GAAP operating income. The company delivered 17% year-over-year growth in net revenue and non-GAAP diluted EPS of $0.73 per share. We're very pleased with how the company performed in the always-changing dynamic business environment. We continue to see growing end market demand, and we believe this is further validation of our vision. Everyone wants to be connected to the high speed Internet wirelessly with any device, anywhere and at anytime at ever faster speeds. Based on our current estimates, only about 40% of the world's population is connected to the Internet with their own devices. There's a lot of room for growth, both by further penetration and upgrade in speed. In the last 12 months, we saw explosive growth of mobile Wi-Fi and 3G, 4G devices, such as the Apple iPad and smartphones. Looking ahead 12 to 24 months, we are seeing an aggressive rollout of 4G LTE and Metro Wi-Fi worldwide. These trends continue to drive demand for more Wi-Fi devices: routers, gateways, repeaters and adapters in homes and access point, controllers, security and storage appliances in offices. Because of our extensive worldwide distribution, brand strength and focus on the resources on home and SMB products, we believe we are best positioned to take advantage of such trends. Our Americas net revenue was $168.4 million while our Europe, Middle East and Africa or EMEA net revenue was $125.1 million; and our Asia Pacific, or APAC, net revenue was $32.2 million. We achieved 33% year-on-year growth in net revenue in Asia Pacific, primarily due to market share gains across all major markets in the region. In the Americas, we generated 28% year-over-year net revenue growth, primarily because of our exceptional operational execution and our ability to meet a surge in demand from our service provider customers, both on DOCSIS 3.0 and DSL gateways. In the EMEA, we witnessed a softening in demand as that region continues to deal with austerity measures. In summary, we were able to achieve worldwide double-digit net revenue growth, and our success continues to be based on our strength in new product innovation and a second to none worldwide distribution. Looking at the bottom line for Q1. We have recorded non-GAAP net income of $28.1 million, which is 16% year-on-year growth, and non-GAAP EPS of $0.73 per diluted share. In Q1, we believe end market global demand for networking products grew industry-wide, and we were pleased to maintain above market growth, driven mainly by share gains. For the quarter, we continued a high level of shipments with 7 million units shipped, and we also introduced 18 new products during the quarter. Among them are 5 Layer 2 and web manageable Smart Power over Ethernet Switches ranging from 12 to 48 ports and a pair of gigabit 11n Wi-Fi routers just for the emerging markets. Sales channel investment continues to be a key focus for the company as our sales channel remains a critical strategic asset. By the end of the first quarter of 2012, our products were sold in approximately 29,000 retail outlets around the world. And our number of value-added resellers stands at around 41,000. In Q2, we will expand our North America retail distribution to all target stores. Now let's turn to a review of the first quarter results for our 3 business units: Retail, Commercial and Service Provider. In our Retail Business Unit, or RBU, net revenue came in at about $129.0 million, down 1% quarter-on-quarter and up 10% year-over-year. The slightly down sequential revenue result is typical for the first quarter following the holiday season. Top-selling products included high-end routers and DSL gateways. The new vDSL Dual Band 11n gateway was an instant hit in Europe. The Nano-sized 500 megabits per second Powerline network adapter, our new product in Q1, enjoyed a great reception worldwide. Net revenue in our Commercial Business Unit, or CBU, came in at $74.6 million in the first quarter 2012. This is down 11% on a sequential basis and down 6% year-over-year. The decline reflects the headwinds in the storage market, which endured significant price hike, reflective of the continued fallout from the 2011 Thailand flood. We anticipate disk supply will continue to improve and pricing to further ease through the next 3 quarters, which we expect will revive sequential market growth. Aside from network storage, we are growing nicely in other commercial products, such as switching, wireless and security. Top-selling products included our 10-gigabit switches and our flat switches. We also saw excellent year-over-year growth in our wireless access points and controllers. In our Service Provider Business Unit, or SPBU, net revenue came in at $122.0 million for the first quarter of 2012, up 27% sequentially and up an impressive 49% on a year-over-year basis. All 3 regions performed exceedingly well, and we were able to deliver upside on short notice to our North American and EMEA customers. Lastly, with the Westell's CNS acquisition successfully integrated, we are seeing the benefits that we hoped for. We're excited about the flow of new products for the rest of the year. As showcased in the Consumer Electronics Show in Las Vegas back in January, we're going to introduce the new Wi-Fi 11ac products in Q2. We have just introduced the first Dual Band Wi-Fi repeater in the market, broadening our offering in this fast-growing segment and continued to be at the #1 market share position. We are in the middle of refreshing our entire line of desktop network storage starting with the entry level, NV+ and Duo, over the past 2 quarters. Our vDSL UTM was an instant hit in Europe, and we expect the strings in that line-up for the rest of the year. We just won another major mobile operator, 3 in Nordic, for our 3G router for rural wireless broadband deployment. Our leadership in DOCSIS 3.0 gateway is driving more share gain in the market, as exemplified in Q1, and we expect continued positive momentum in this category in Q2. Overall, we are confident about our continuous progress towards our $2 billion revenue goal by 2014. I will now turn the call over to Christine for further details on our financials.

Thank you, Patrick. I will now provide you with a summary of the financials for the first quarter of 2012. As Patrick noted, net revenue for the first quarter ended April 1, 2012, was $325.6 million compared to $278.8 million for the first quarter ended April 3, 2011, and $309.2 million in the fourth quarter ended December 31, 2011. We shipped a total of about 7 million units in the first quarter, including 5.9 million nodes of wireless product. Shipments of our wired and wireless routers and gateways combined were about 4.2 million units in the first quarter of 2012. Moving to the product category basis. First quarter net revenue split between wireless and wired was about 71% and 29%, respectively. The first quarter net revenue split between home and business products was about 77% and 23%, respectively. Products introduced in the last 15 months constituted about 42% of our first quarter shipment, while products introduced in the last 12 months constituted about 27% of our first quarter shipment. From this point on, my discussion points will focus on non-GAAP numbers. The reconciliation of GAAP to non-GAAP is detailed in our preliminary financial statements released earlier today. Non-GAAP gross margin in the first quarter of 2012 was 31% compared to 32.1% in the year-ago comparable quarter and 31.1% in the fourth quarter of 2011. Gross margin was down both year-over-year and quarter-over-quarter due to the heavier proportion of Service Provider Business as a percentage of the total revenue. Total non-GAAP operating expenses came in at $60.4 million for the first quarter of 2012. As noted on our February conference call, we continue to invest more in R&D on an absolute dollar basis and as a percentage of net revenue. Our R&D expense in Q1 was 4.2% of net revenues, and we plan to increase that spend to 4.5% of net revenues on a go-forward basis. We are investing these dollars in all 3 business units, and almost all of the incremental investments will be in software development, which enables us to provide powerful differentiation against our competition and also provides us possible entry into new product categories in the future. We increased headcount by 19 people during the quarter, bringing our total headcount to 810 at the end of Q1. And we will accelerate our hiring efforts in Q2 and for the rest of the year both in R&D and new market channel expansion. The non-GAAP tax rate was 30.1% in the first quarter of 2012 compared to 31% in the first quarter of 2011 and 30.5% in the fourth quarter of 2011. Non-GAAP net income was $0.73 per diluted share in the first quarter of 2012 compared to net income of $0.65 per diluted share in the first quarter of 2011 and net income of $0.69 per diluted share in the fourth quarter of 2011. Our balance sheet remains very strong, ending the first quarter with $369.4 million in cash, cash equivalents and short-term investments, which was driven by approximately $12.8 million in cash flow from operations. DSOs for the first quarter 2012 were 70 days as compared to 66 days in the first quarter of 2011 and 76 days in the fourth quarter of 2011. Our 10% customer in Q1 was Virgin Media in the U.K. Our first quarter net inventory ended at $134.3 million compared $140.1 million at the end of the first quarter of 2011 and $163.7 million at the end of the fourth quarter of 2011. First quarter ending inventory turns were 6.7 as compared to 5.5 turns in the first quarter of 2011 and 5.2 turns in the fourth quarter of 2011. Channel inventory remained at healthy level. Our channel reports inventory to us on a weekly basis, and we use a 6-week trailing sell-through average to estimate weeks of stock. Our U.S. retail inventory came in at 9.8 weeks of stock. Current distribution inventory levels are 8.6 weeks in the U.S., 5 weeks of stock and distribution in EMEA and 5.6 weeks in APAC. Compared to the end of Q4 2011, all channel inventory came down except for U.S. retail inventory which went up from 7.3 to 9.8 weeks, a much healthier level. In summary, our growth strategy of aggressively expanding into new product category, new geographic regions and new channel continues to produce positive results. With industry-leading new product introductions, global brand recognition and extensive distribution, we feel confident in our ability to stay ahead of our competition as we move into the second quarter of 2012. Looking forward to the second quarter, we intend to roll out approximately 20 new products, and we look forward to the arrival of our first Wi-Fi 802.11ac product. Specifically, we expect net revenue in the range of approximately $315 million to $330 million, with non-GAAP operating margin to be in the range of 11% to 12%. We expect our non-GAAP tax rate to be in the range of 30% to 31%. Operator, that concludes our comments. And we can now take questions.

[Operator Instructions] Our first question comes from the line of Mark Sue with RBC Capital Markets.

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

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

Okay. And just on the R&D, you underspent than you previously had indicated. Why was that? Or was that spending actually just a shift into the current June quarter as you're going to get ready for 802.11ac or other things on the R&D?

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

Okay. So should we expect your incremental R&D that you didn't spend just to kind of move out into the June quarter?

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

Our next question comes from the line of Lynn Um with Barclays Capital.

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

As we talked about it just now in our discussion, outside of the network story, we actually grew pretty nicely for all the other product categories. And we were kind the victim of our own success that, one, the network storage has become a major portion of our Commercial business. So when there is a downturn in that particular segment, it would have a pretty significant effect on our overall Commercial business. Secondly, our operational excellence has been so good that we never keep any stock of disks. In general, it does generally good because this disk price has been dropping. But then when disk price goes the other way around, shooting up 200% and 250% while we do not keep inventory, it would hurt us more in the market than other people like EMC and HP. And then actually keep inventory of stock, quite a bit of inventory of disk drives guys. So that's why we are kind of unproportionately affected. We do believe, as we discussed, that the supply of disk drive is going to ease up over the next few quarters and price will come down. And when price comes down, if benefits us who has a much better inventory management position. So going forward, we anticipate there will be sequential growth in our network storage which, of course, would benefit our overall Commercial business.

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

The demand in the seasonality is still pretty typical of any year, that Q4 is usually the strongest and Q1 is usually flat to slightly down. So this is just exactly flat to slightly -- it's actually down 1%. So it's not any different. So we are pretty pleased with how the retail market progresses. We can see a growth 10% year-over-year. As we mentioned in previous earnings call, because of the uncertainty of the economics and the consumer confidence around the world, we believe that the retail side is probably going to go -- grow in the single-digit basis, but we have been able to maintain double-digit growth. That means we are still growing ahead of the market and gaining share.

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

Just a few questions here. Any onetime revenue in service providers at all?

No, not anymore.

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

Yes, absolutely.

And are you seeing a benefit from keeping competitors out, or is this going to be the growth rate from your Service Provider business?

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

Yes. Your service provider was at almost 37.5% of your revenue this past quarter. I mean that's -- historically, that's not a real sustainable level. So that's why I'm asking.

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

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

As far as we're concerned, we always work on those accounts and at appropriate times and with appropriate products, then we're certain -- appropriate terms, we definitely would love to get into the account.

Our next question comes from the line of Ryan Hutchinson with Lazard.

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

Well I mean clearly, as we just mentioned that we are pleased that our customers are having success in gaining more subscribers, and that's why there was a surge in demand. And it's not just DOCSIS 3.0. It's also DSL as well. But clearly, as you probably pointed out correctly, the DOCSIS 3.0 is pretty much both U.S. and Europe, as well as in Asia as well. But the DSL is primarily in North America, and it is a result of the excellent work that the team that we acquired last year from Westell doing fantastic work. And as we mentioned, the visibility was 13 weeks but as the quarter progressed in Q1, we saw the demand going higher and higher, and we were able to respond within that such short time frame. So we benefited from it and now for Q2, clearly, the orders are firm. And hopefully, we would see this sustaining through the rest of the year, but we don't have a crystal ball. But who knows, they may even go up higher. It really depends on how successful our customers are getting subscribers. But we do believe, as we said in Q2, when the other channels kick in -- and there are 2 positive things going for us in the second half: One is the seasonality of the retail; the other one is, as we mentioned in the Commercial sector, we certainly believe that the price of the disk drives will go down and the supply will go up. And that the market will actually return to sequential growth again, and we will be able to better take that -- capitalize on that opportunity. So in the second half, with both Retail and Commercial units coming back up, we certainly will be able to sustain any variance in the Service Provider. But we're not saying that we're not going to fight for similar or even higher level of the Service Provider revenue in absolute terms. We do believe that we have very good pipeline of products, as well as pipeline of customers. As just we mentioned, we just started deploying our second 3G router, customer 3 in Nordic, and after the Bell Mobility in Canada. And clearly, that's another area of products that we're going to put a lot of focus behind. And hopefully, we'll see some fruits coming out of it in the second half of the year.

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

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

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

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

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

Our next question comes from the line of Jonathan Goldberg with Deutsche Bank.

The first one I want to ask is on the R&D line. You mentioned hiring is lower than expected. Is most of the hiring in California? And if so, it seems like that job market is pretty, pretty tight. So how do you think about that, given the realities of the salary expectations?

Actually the hiring -- we're hiring engineers pretty much all over the world. We have engineering centers in China. We have focus in India. We have Chicago, Atlanta and San Jose. So it really just depends on where we're looking. And we're finding candidates. We're just busy while we're working and hiring people, and we're going to ramp that up. So we're not -- we are finding candidates.

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

Yes, it's interesting for us to see in the -- and actually in all markets over last year has been exemplified by iPads and iPhones. It seems like that while the consumer confidence is down, economy is tough. The higher end of these consumer gadgets is actually getting better traction. So the iPhone, the iPad is getting tremendous traction in all markets including developing markets. We see the similar thing that the high end of our routers get -- is actually getting more traction than the low end of the routers. So we have been introducing really successful high-end routers. I just mentioned it in my previous discussion that the vDSL Gateway with 2 USB ports introduced in Europe was a huge hit. I mean that's a tremendous, highly-expensive gateway, over EUR 200. And that's followed by a similar gateway that we introduced last year, the top N900 meg 11n. So we believe that 11ac, which is even higher end in ASC, will actually get similar attraction and will help to raise our ASP and benefit our revenue growth overall.

Our next question comes from the line of Jonathan Kees with Capstone Investments.

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

Well, one market at a time, we mentioned actually, and in particular that there were 3 markets in Asia were doing very well. It's mentioned in the earnings release. First is Japan. I think we've seen quite a bit of traction for our commercial products in Japan, and we actually had really good response on our DOCSIS 3.0 gateway with our Japanese gateway operator customs over the J:COM communications doing very well for us. In Australia, as I just mentioned, the high-end DSL Gateway is doing exceptionally well, very high priced, but it seems like that the Australian folks love it. That really helped us to gain significant market share across the board. Our penetration of channels in Australia was already very, very good. But with these new products, they give us even more market share. And in China, it's primarily both in Retail as well as in Commercial. In China, it's a little bit different. We hold an absolute premium position on Wi-Fi, both in the Commercial as well as in the Retail. The bulk of the market in China for Retail is in the low end, which we really do not participate. But we have been introducing new products on the high end, which I also mentioned in my discussion that we introduced 2, a couple of really high-end gigabit Wi-Fi routers for the emerging market. It's doing extremely well in China. On the Commercial side, we're seeing our wireless controllers and access points getting significant traction in multiple industries, particularly in motel chains, as well as in hospitals. So -- and again, we develop specific products for that particular market, and we are enjoying the success of that now.

So it's more on new products versus...

Correct. All new products.

Or say, more channel. Okay. So...

More on new products. I mean our channel reach has been pretty good in all 3 markets.

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

Correct. I mean Australia enjoys the market that we introduce worldwide because their economy, their behavior is pretty similar to North America and Europe. For China and Japan, clearly, we have to develop a product specific for that market because their requirement is different, their preference is different. So yes, we will -- but that's why we're stepping up our R&D to have a better strength of developing products for these markets. And that's why we have development centers around the world. We have 3 development centers in China -- I mean in greater China. We have one in Taipei, one in Nanjing and one in Beijing.

So I guess that leads me to my next question. Christine, when you talked about bringing engineers around the world, obviously, there's a concern that R&D is coming up and you're spending it on headcount, on people for the software development. Do you see most of that mainly overseas or is it going to be just fairly distributed through your research centers in terms of the engineers you're bringing on board?

I'd say it's really in all the different locations. What I would say is we're spending it for the development teams in all 3 business units. And then all those business units are located around the world in the different locations. So depending on what we're looking for and what team they're going to work with is where we'll decide to put it.

Our next question comes from the line of the Rohit Chopra of Wedbush.

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

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

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

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

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

Well it could really be in any of the 3 business units. Obviously, we look at what we're seeing to date and what we expect. And like Patrick mentioned, the service provider, we do have those orders in, but as we've always said, that business is little lumpy, so a several thousand units of an order could come in to a quarter or move out into the next one. So really, that just gets us -- it's really less than I think 5% leeway to $15 million on the overall guidance. And we just feel like that, that made a lot of sense as we got to $1 billion to guide with a little bit wider range. So it will just depend on how everything comes in.

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

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

[Operator Instructions] There are no further questions at this time. I would like to turn the floor back over to you for closing comments.

Thank you. And as always, we're very excited about the opportunity. We have always been saying that what is driving us is innovation. And we are very excited about the pipeline of the products in Q2 and in the second half, and we do believe that we would be able to continue to take share from our competitors in this, what we say, ever-changing dynamic business environment. And I look forward to talking to all of you again in about 3 months. Thank you.

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