NETGEAR, Inc. (NTGR) Q1 2017 Earnings Report, Transcript and Summary

Greetings and welcome to the NETGEAR's First Quarter 2017 Earnings Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Chris Genualdi, Senior Investor Relations Manager for NETGEAR. Thank you. Mr. Genualdi, you may begin.

Thank you, operator. Good afternoon and welcome to NETGEAR’s first 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 first quarter provided by Christine, followed by details and commentary on the business provided by Patrick, and finish with second 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 Web site 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-K. 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 Web site. At this time, I'd now like to turn the call over to Ms. Christine Gorjanc.

Thank you, Chris, and thank you everyone for joining today’s call. Results for the first quarter of 2017 came in above the high-end of our guidance, driven by the strong performance of our newly reported Arlo segment. As noted in our earnings release distributed earlier today, we’ve modified our segment structure to reflect our current view of the NETGEAR business. Our three segments are now: Arlo, Connected Home, and SMB. These segments are defined purely by products, rather than by both products and channel. Please refer to the tables contained within today’s earnings release for nine quarters at historical financial and additional details on the modified segment. Overall, NETGEAR net revenue for the first quarter ended April 2, 2017 was $323.7 million, which is up 4.3% on a year-over-year basis and down 12% on a sequential basis. Despite the decline in total service provider revenue sales from $84.3 million in Q1 of 2016 to $56 million in Q1 of 2017, Arlo sales grew from $24.3 million a year-ago to $60.7 million in Q1 of this year, more than offsetting the service provider business decline. Arlo as a standalone reporting segment is now larger than our service provider sales in terms of revenue and is growing at a tremendous pace. NETGEAR net revenue by geography continues to reflect our ongoing strength in North America as well as our momentum in the APAC regions. Net revenue for the Americas was $211.6 million, which is at 9.2% year-over-year and down 16.6% on a sequential basis. EMEA net revenue was $58.4 million, which is down 9.4% year-over-year and down 15.6% quarter-over-quarter. We continue to fight with the twin headwinds of declining service provider sales and the negative effects of foreign exchange fluctuations in EMEA. Meanwhile, our APAC net revenue was $53.6 million for the first quarter of 2017, which is up 3.2% from the prior year's comparable quarter and up 18.9% quarter-over-quarter. This represents an all time record high in net revenue for the APAC region. For the first quarter of 2017, we shift a total of approximately 4.9 million units, including 3.8 million nodes of wireless products. Shipments of our wired and wireless routers and gateways combined were about 1.7 million units for the first quarter of 2017. The net revenue split between home and business products was about 79% and 21%, respectively. The net revenue split between wireless and wired products was about 75% and 25%, respectively. Products introduced in the last 15 months constituted about 41% of our first quarter shipments, while products introduced in the last 12 months constituted about 37% of our first quarter shipments. From this point on, my discussion points will focus on non-GAAP numbers. A reconciliation from GAAP to non-GAAP is detailed in our earnings release distributed earlier today. The non-GAAP gross margin for the first quarter of 2017 was 30.9% compared to 33.3% in the prior year comparable quarter, and 30.9% in the fourth quarter of 2016. I’d like to highlight that the higher gross margin in the prior year comparable quarter was the result of one-time events in the service provider business that are not repeatable as we pointed out at that time. Total non-GAAP operating expenses came in at $67.6 million, which is up 1.7% year-over-year and down 5.6% sequentially. While we continue to manage our operating expenses prudently, we’re accelerating our R&D and brand marketing investments in both Arlo and Orbi, given the tremendous market opportunities that we see in front of us. We’ve quickly achieved over 30% market share in both of these fast growing markets and we see opportunities for further share gains over the next 12 to 18 months, which we will seek to take advantage of. We’ve set an aggressive goal to gain greater than 45% market share on both of these markets to replicate the success that we’ve had with the Nighthawk line in the high-end Wi-Fi router market. We are fully committed to deploying the R&D and marketing resources necessary to achieve this goal during the coming quarters. Our headcount increased by net six people to 951 during the quarter. We expect to continue to add additional headcount in key areas of the business during the second quarter 2017. Our non-GAAP R&D expense for the first quarter was 6.6% of net revenue as compared to 6.9% in the year-ago comparable period and 6.1% in the prior quarter. R&D is critical to our success and we therefore expect those expense to continue to grow as needed in absolute dollars. Our non-GAAP tax rate was 34.4% in the first quarter of 2017. Looking at the bottom line for Q1, we reported non-GAAP net income of $21.7 million and non-GAAP diluted EPS at $0.64 per diluted share. Turning to the balance sheet, we ended the first quarter of 2017 with $361.2 million in cash. For the first quarter of 2017, we generated approximately $5.1 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 four quarters, we generated approximately $52.3 million in free cash flow, which included a $2.8 million benefit from a presentation reclassification and historical cash flow statement related to excess tax benefit upon the adoption of the new accounting guidance on stock compensation simplification. We continue to focus on optimizing the business and generating cash, which provided operational flexibility as well as the ability to strategically deploy cash to enhance shareholder value. During Q1, we spent a $11.6 million to repurchase approximately 213,000 shares of NETGEAR common stock at an average price of $54.68 per share, which resulted in a $0.01 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 9.7 million shares and our diluted share count is lower by 12.9% as compared to the beginning of that period. The fully diluted share count is approximately 34.1 million shares at the end of Q1 17. We continue to believe that it's important to return cash to our shareholders in excess of our operating and strategic need and that stock repurchase program is an effective means of accomplishing this. With this in mind, our Board of Directors has authorized a new program to repurchase up to 3 million shares of the Company's common stock or approximately 9.1% of the outstanding shares. This is in addition to the approximate 1.1 million shares remaining on the Company's previous share repurchase program at the end of Q1. We plan to be opportunistic buyers of our stock in the coming quarters. Now turning to the results of our three segments. The Arlo segment net revenue came in at $60.7 million for the first quarter of 2017. This is up an impressive 150.2% year-over-year or about $36.4 million from the prior year, and down 21.1% on a sequential basis from the traditionally strong fourth quarter that includes the holiday season. All three regions grew strongly year-over-year in Arlo sales. As we move forward into Q2, the Arlo product line will expand into the service provider channel. The Connected Home segment, which includes the industry-leading Nighthawk and Orbi brands, generated net revenue of $194.4 million during the quarter which is down 10.1% on a year-over-year basis and down 9.6% sequentially. The year-over-year decline is due to reduced service provider revenue for Connected Home, which is down $23.7 million from Q1 2016. Excluding service provider sales, the Connected Home segment grew slightly year-over-year. I'd like to highlight that the majority of the old service provider business unit revenue which mainly consisted of mobile hotspot gateways and routers is now included in the Connected Home segment. For example, in Q1 2017, $53.2 million of the total $56 million of service provider sales came from the Connected Home segment. This compares to $76.9 million of the total $84.3 million of service provider sales that came from the Connected Home segment during the first quarter of 2016. As for the performance of the Connected Home segment in the retail channel, the strong performance of Nighthawk and Orbi in North America was partially offset by softness in EMEA during the first quarter of 2017. We're introducing Orbi into all European markets and we’ve high hopes that doing so will help turnaround our EMEA Connected Home retail sales channels in the coming quarters. The SMB segment generated net revenue of $68.6 million for the first quarter of 2017, which is down 1.9% on a year-over-year basis and down 9.8% sequentially. While our switch business continue to generate healthy growth, we were negatively impacted by sales declines in both our storage and wireless LAN products. However, with our recent introduction of multiple high-end Rackmount and desktop storage products, we're expecting an uptick in our storage business going forward. I will now turn the call over to Patrick for his commentary, after which I will provide guidance for the second quarter of 2017.

Thank you, Christine, and hello, everyone. Our first quarter of 2017 results marked a strong start to the new year for NETGEAR. The growth of our Arlo segment has been phenomenal, posting 150% year-over-year growth for Q1. Much of this growth has been driven by the new Arlo Pro, which is a massive hit with customers. Now according to NVD, our Arlo market share is currently at 33%, which is 200 basis points higher than the prior quarter and over the two times the market share of the next closest competitor. The IP camera market continues to be highly fragmented with many players, which we believe presents an ideal opportunity for us to continue to gain share with our superior hardware unparalleled ease-of-use and revolutionary image analytics. Based on data from NPD, we believe the overall North America IP camera market grew about 35% year-over-year in Q1. By increasing our R&D, we intend to bring out more new products throughout the rest of the year. And with increased channel marketing, we intend to further extend and shelf space in existing and new channels. We are setting a goal of reaching 45% plus market share in this fast-growing market and are committing the necessary resources to achieve this. As many of you already know, we have two very exciting new additions to the Arlo family hitting the shelves this quarter. First, Arlo baby will be launched in the U.S at major retailers and online. At the same time, we are upping our channel marketing budget to gain entry into various baby specific retail chains in the second half of the year. As a reminder, Arlo Baby is the world's smarter baby camera that will be available soon with high definition video, two-way audio, [indiscernible] air sensors, a lot of iPlayer and many more features, designed to give peace of mind to new parents everywhere. Second, we have been preparing for the launch of Arlo Go, which we expect to introduce with Verizon, Best Buy, and other service providers and retailers during Q2. Arlo Go is our 4G LTE enabled, wire free, high definition video camera that delivers the Arlo experience outside of the home. We are currently working on unlocked versions of Arlo Go for the European and APAC markets as well. One last point that I'd like to reiterate regarding the Arlo product line is that we still expect to enter a non-camera product category later this year. I eagerly look forward to sharing this with you all, when is ready for launch. We believe that all the incremental R&D dollars that we spend in this new product line will pay off in a big way for us in 2018 and beyond. Turning to the Connected Home segment, we launched two new additions to outline of Orbi Tri-Band mesh Wi-Fi systems that are designed for small and mid-sized homes. These new Orbi products just hit the shelves at the end of March. They allow us to serve segments of the Wi-Fi market that the original Orbi did not. With these new additions, we’re able to cover entry price points at $299, $349, and $399. None of our competitors can match the breadth of our product portfolio nor speed our Wi-Fi performance. As validated by many independent industry experts and reviewers. During Q1, we witnessed consumer preferences shifting quickly from premium single point Wi-Fi routers to whole home Wi-Fi mesh. While we continue to hold the leading market share position in home Wi-Fi mesh, this market share is lower than our share of the market for high-end routers. Therefore during Q1 and for the rest of the year, we’ve made a conscious decision to be aggressive with our channel marketing strategy and spend to drive share gain in the home Wi-Fi mesh market. In March, our market share in North America landed at about 35% and we intend to drive it pass 45% as quickly as possible. Shifting gears a bit, I'd like to highlight that we won six design awards in the 2017 Red Dot award competition this year. Three of the awards went to our Nighthawk line, two went to the Arlo line and one went to the Orbi line. For those of you unfamiliar with the Red Dot awards, they’re recognized worldwide and across industries as the premier awards for design excellence. I'd like to especially congratulate and thank our industrial designers on this achievement. Turning to SMB, we are pleased to see the continuous growth and profitability of this business segment. Year-over-year SMB grew contribution margin dollars by 20%. The star of Q1 was our line of Pro se and 4300 manageable, stackable switches with POE plus provisioning. The 4300 series is the world's first gigabit and 10 gigabit virtual chassis platform with 10 gigabit specking designed for mid enterprise etch and SMB core [indiscernible]. It provides an incredible combination of robust network management, high density, small footprint, and best-in-class price-performance. For MBD, we maintained our number one market share position in web managed switching during Q1 furthermore we have the number one position in 10 gigabit web managed switching, which is the newest and fastest growing segment of this market. While we continue to lead in work web managed switching by offering the management and security features that IT professionals need for the lowest cost of ownership. Also we’re pleased with the performance of our new Nighthawk S8000 gaming and streaming switch that was launched during the first quarter. The S8000 was developed by our SMB team, but is targeted at consumer gaming and streaming enthusiasts. It's the perfect example of how NETGEAR excels in bringing enterprise grade technology to the consumer by making it incredibly easy to use. If you have the moment, I highly encourage you to take a look at the customer praise for this product on Amazon. While we know the first half of the year is always down from the second half of the prior year due to seasonality, we have decided not to take our foot off the pedal when it comes to R&D and marketing spend. Both the home Wi-Fi mesh and IP security markets are growing rapidly and we hold the inside track to propel the even larger market share gains with our Orbi and Arlo product lines. We believe these opportunities do not come often nor easily and we seize on them to ensure our long-term success and reward our stockholders. We believe that now it's the time to invest in product development, channel development, and brand building, in order to stifle the competition and maintain our place as the number one home networking and IP security camera market in the world. To borrow a phrase on sports, we like playing with a lead and that’s what we're [indiscernible] for here right out of the gate in the new year. I will now turn the call back to Christine for the Q2 guidance.

Thank you, Patrick. For the second quarter of 2017, we anticipate revenue will be in the range of approximately $315 million to $330 million. Second quarter GAAP operating margin is expected to be in the range of 5.3% to 6.3%, non-GAAP operating margin in the range of 8% to 9%. Our GAAP tax rate is expected to be approximately 37% and the non-GAAP tax rate is expected to be approximately 34.5% for the second quarter of 2017. Operator, that concludes our comments. And we can now take questions.

Thank you. We will now be conducting a question-and-answer session. [Operator Instructions] Our first question comes from Matt Robison with Wunderlich. Please proceed with your question.

Thanks. So, I got the message I think from Patrick about keeping us well down. Now you’ve got this Arlo Go and Baby coming out, it seems to me Go is probably a bit more complex go-to-market, but what you comment on that, is that really what we should be thinking about in terms of the sequential decrease in operating margin and what do you think that's going to do to your full-year range? And then on just a housekeeping basis, could you give CapEx and depreciation?

Yes, clearly I mean we’ve seen this opportunity of one rapidly growing IP security camera market. And secondly, many of our competitors are very fragmented and really are losing share. So the momentum is on our side and it's pretty clear that this is the time to really seize on opportunity and really spend. If you look at the detail segment report in the earnings release, you probably that the Arlo segment is growing tremendously over 100% year-over-year and it has yet to reach a profitability. I mean, it's just barely breaking even. Of course we’ve the options of either to hold back on to further increase in marketing spend or in R&D, and just let the revenue continue to raise in the modest pace. To generate more profitability or we will say us. Now it’s the time to grab our order, we’ve the 45% share as much as possible unless double down on marketing spend as well as in the R&D. So of course we’re radiating as I said only just the Arlo Go and Arlo Baby, there will be a lot more new products coming out. At the same time, you’re right. I mean, it takes money to expand into new channels, for example like we intend to expand into the Baby Care channel, so all the prepping up the channel, it will create money, and that we’ve expanded our advertising spend also on radio as well as on all the social media and of course, I mean, launching Arlo Go with the operator required quite a bit of money as well and also we’re MVNO services, all these requires a lot of money to prep. So we can decide to either slow that process down or we decided to really quicken it up. And our decision was to quicken it up, because this is the time for us to be on the offense mode, while most of our competitors are not doing that well. So that’s pretty much what is [indiscernible] degrees of the operating margin in the second quarter. But we do believe this is an investment for the long-term. It will absolutely pay off towards the end of the year.

Right. And Matt I think you asked for CapEx, which was $3.4 million for the quarter and depreciation and amortization is approximately $8 million.

Yes, Christine, while you got to, I guess, the other piece of the -- other question was you talked about full-year operating margin range of a 11% to 12% I think and that would employ a pretty [indiscernible] performance in the back half, I believe, so you’re still thinking you can achieve that?

Well, I think what we’ve said today is we’ve it within this year. We’ve the two categories of Orbi and Arlo. And Patrick just talked about that we will be spending more on Arlo and we will also be spending to gain market share on Orbi as we mentioned in the script, we needed the Orbi market share which is in the low 30s to be 45% or more equal to the Nighthawk market share as the market quickly moves to mesh. And we believe we will have spend money to do that and branding in social media and continue to have more in the family of Orbi like we’ve two new Orbi's out as we planned to have more, so we will continue to spend more this year to achieve that 45% market share in both of those market and that will definitely cost us and we expect to see results as we get towards the end of the year.

Okay. Thanks.

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

Hey, guys. Thanks for taking my questions. I got a few of them. First, if you were to look at the previous revenue breakdown, I think you had indicated for the full-year kind of Arlo growing 40% plus and Wi-Fi growing high single digits. Is the Wi-Fi weakness enough to put that guidance or target at risk? And should we think about the strong start to the year in Arlo meaning that 40% plus boggy [ph] looks pretty good on Arlo? That’s my first. I’ve got some follow-ups.

Well, I mean, we’ve said that we actually believe that the non-career business will grow double-digit this year over the last year. So if you look at the first half, the Q1 actual, and if you take the midpoint of our Q2 guidance, and you subtract the $55 million per quarter [indiscernible] to sale, you could probably quickly come to the conclusion that for the first half at least we’re growing the non-carrier business close to 15%, which is higher than what we said. And that’s exactly the decision point that we’re making. We want to go much faster than 10%. And the only way to grow much faster is to grab more market share, because we do not think that if we don’t grab it now, that opportunity will still be there next year. So that’s pretty much the jigsaw decision.

And then on the growth, I hear you on the margins for Q2. The gross margins were lower than I had anticipated this quarter. Was that kind of the mix of the marketing spend? More of it showing up in contra revenues this quarter or was there some kind of price protection or something else going on for the gross margins in Q1?

You know I think if you look at the gross margin in Q1, its relatively flat to Q4. And clearly a year-ago there was some anomalies in that number and what that would reflect is again that we’re continuing to highly promote these products and to gain market share and so we did gain couple of point to market share. And we will continue to do that, but like Patrick mentioned, shelf space in social media and all that, it is costing money to go ahead and go for that higher revenue.

Yes.

Any money that’s related to shelf space that’s contra revenue.

Yes.

Any money that’s related to social media and [indiscernible] that’s OpEx, right.

Got you.

So, the amount of percentage wise, the amount of money we spend on shelf space is pretty similar to Q4, right. And the decision point is in Q2, should we pull back or should we continue. And our decision is that we will continue. So that's why if you -- normally Q2 is a down quarter, all right. But then if you look at our guidance [technical difficulty] guide us, we kind of pretend a flat quarter. So that’s why we believe that this is the opportunity to really see the market share and at the same time as we mentioned in the prior discussion we have two new products in Orbi, just launched. We have two new products to be launched in Arlo, in Q2, so with the concentration of new product launch and launching new product you really need to spend marketing dollars, otherwise it's not worth it. So we think that after a long thought this is the right time of doing that and just to continue to press on rather than pull back.

Okay. And one more question with two parts. In your prepared remarks you mentioned specifically EMEA trends for Wi-Fi were little softer than you would've thought. It's a little counterintuitive mix. I would imagine you've got a lot of the new Wi-Fi mesh competitors are really just U.S only, if I’m not mistaken. So, is it the -- are there different competitors in Europe or was there something else in that you’ve been able to figure out that cause that weakness. And then just a quick one. Any impact to the margins either in Q2 or later in the year from the memory prices increases recently?

Well, the first one is in Europe, yes, they had different set of competitors. However, because of timing, because of the certification all that, Orbi was introduced to Europe later than in North America. So we just about to be channelized and countrywide in Europe. So we will have a full quarter of effect in Q2. So hopefully that would help us to turn around the European situation. Now and also our -- one of our biggest European market which is British in the U.K., the British pound is depreciated like 20% year-on-year basis. So it's a pretty tough comp. But on the other hand, the competitors are quite different. For example, in Europe, we’re competing against AVM in Germany and believe or not, I mean the biggest competitor in the U.K is British Telecom. Yes, in retail too. And both of them, because they are [indiscernible], they certified earlier, they actually entered the mesh market earlier than we did. You’re right, I mean, the U.S players like [indiscernible], Google and Linksys entered the market pretty much at around the same time as we did. We are all later than the British Telecom and AVM. However, when we look at it for the market that we're in, for example like in the U.K and in Germany, we’re already the leader by far in the mesh market. So we believe that, by pretty more marketing spend in Q2, we were outdistance our competitors, both local in America, in Europe, and that will help to offset some of the softness in some other product category, such as power line such as Wi-Fi standards in Europe. So that that’s pretty much the maintenance date in Europe over there.

And memory prices?

And for memory prices, as you probably know, we know ahead of time. So we’ve pretty good long-term orders and we do have quite a bit of inventory that really helped us to rise through this way.

Great. Thanks for the added color.

Okay.

Thank you. Our next question comes from the line of Woo Jin Ho with Bloomberg. Please proceed with your question.

Yes, hi. First, again on the investment side of things. How long do you believe that you need to sustain a high-level of investment to gain market share? I mean, going from mid 30s to 45 is a big task and I’m assuming that you want to keep this as a multiyear endeavor.

No. So, different things, right. So, on the IP camera side, we were 31% in Q4 and we are now 33%, all right. If we take the same pace to get to 45% would probably take us another five quarters to six quarters to get there. So that will be by the mid of next year. Now -- but then if you look at the Orbi mesh, [indiscernible] more encouraging, because we only enter the market at the beginning of Q4. So two full quarter as we've gone from 0% to 35%. So in theory we can get there in a quarter, but [indiscernible], right. We think that if we execute all right, I mean we should be able to get 45% before the end of the year. However, I mean, 45% is not the end gate, all right, because on the high end router we’ve 55% market share. So really on the Orbi side we'd like to get even higher.

Right. And then my follow on, in terms of your Connected Home non service wired business, I believe it looks like you grew 1% on a year-on-year basis. And I know that it's off of a very tough revenue growth compare -- revenue comparison on a very strong 1Q '16. But do you have the full quarter of the Orbi product in the first quarter? Why wouldn’t growth be better?

Well, I mean to give you an idea is that, okay in North America for example, the overall Wi-Fi market grew about 6%, 7%. However, the market is shifting very quickly to year-ago, all right. The market is all routers that we got 55% market share. A year later, all right, a third of that becomes Wi-Fi mesh and we only had 35% market share. So you can figure that out.

Great. Thank you.

Thank you. Our next question is from the line of Rob Cihra with Guggenheim Partners. Please proceed with your question.

Hi. Thanks very much. Two separate things, if I could. One on the -- so just specifically what Arlo Go when you guys are launching the sort of MVNO like whatever branded data plan what we want to call it, is that going to start in this quarter as well or you’re just starting with carriers this quarter? And one of the question there is, I mean, is that sort of a recurring service revenue model? Is that the kind of thing do you guys are thinking you could expand beyond Arlo Go, Arlo using this as a test at all or is that not something that you necessarily could expand? And then I had a follow-up question.

Well, as a matter of fact, you’re right. I mean, we’re debuting the NETGEAR label to MVNO service in Best Buy next month with Arlo Go and clearly that with a service plan and that would be in part of our service revenue. But that’s not the only one and so far with Arlo and Arlo Pro, so a portion of our customers are buying out premium service which today is not much because the so-called premium service is for if you want to store your video beyond seven days, then you pay extra or if you want to control more than four cameras at a time then you have to pay more, still we think more and more of our customers buying into that service. Now with this Arlo Go we will see more and then we are rolling out image analytics with the acquisition of Placemeter about four, five months ago, we intend to roll out image analytics which we charge. So, that's why the Arlo business is a very interesting business. Not only that, we will sell into the market hardware that we’re going to take money on. Also we are building a huge install base. I mean, today we’ve more than $3 million -- 3 million cameras installed around the world and then clearly we will try to triple, quadruple that install base and once we have the install base we’ve tremendous opportunity to sell them services, various image analytics services or storage services or these data services. So we do believe that not only by pressing on to gain more market share will help us in the hardware revenue side. It also will help us to quickly build a very big install base, subscriber base that we absolutely have opportunity to monetize in the future.

Okay, thanks. And then, if I could ask one follow-up, that all makes sense by the way. The -- going back to just the more aggressive or ambitious spending for marketing and shelf space starting this quarter, can you -- I know you’ve talked about it a little bit already, but is there any way to further parse, how much of that is going to show up in OpEx versus gross margin which would come via contra revenue? I mean, I don’t know Christine, if you will, giving some sort of gross margin guide would get part of the way there are you purposely not doing that? I guess, you’re purposely not doing it, but is there some reason not to give us that just because of a given idea of how much of this is pricing for shelf space versus sort of branding? Thanks.

Yes, I would say typically when you look at our financial statements, more of our marketing dollars are spent with our customers as contra revenues than in OpEx. So I would imagine this will follow that same pattern as before, because again like new shelf space and new retailers uncaps [ph] at advertising and all that, those will go into contra revenue, but we will continue on the social media side and all that. So I think it will just follow our pattern. More of that spend will be above the line and, but OpEx will also have some increases in there.

Right. Great. Thank you very much.

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

Hi. First off on the marketing spend, is it to monopolize shelf space or is it pricing driven to capture the consumer spending?

No, I mean, its monopolizing the shelf space, to pay for the shelf space as well as to really run promotion programs. And you run promotion programs sometimes would help you for alliances. For example, like Orbi now works with Alexa. So you could use voice control and that’s why we’re now jointly running promotions with Amazon, you buy Orbi you get a dot and so that’s kind of co-marketing. So it's not pricing driven, but it's definitely shelf space co-marketing and some kind of goodies.

Okay. And then on the SMB side, you had mentioned that wireless was down or weak in the quarter. Why is that? Is it because of the Orbi and mesh that people are buying, or is it that you’re seeing a competition on another product line?

Yes, I mean, on the wireless line side, it's clearly competition and we haven't had a -- an Orbi for the SMB side as yet. I mean the SMB side requires quite a bit different control of a mesh network. They need [indiscernible], they need management and all that, but our Orbi is purely designed for home as yet, but stay tuned.

Okay. I mean, I’m just trying to understand, because that was quite a bit of a weak showing on the SMB side, if I’m looking at what commercial use to report, am I doing the comparison right?

For SMB, when we were in for the segment for Q1 2017, Hamed, it was 68.6 million compared to 69 million, so it's about a million down year-on-year.

Okay. But that was down …

[Multiple speakers] the service provider [indiscernible].

Right.

Okay. All right. And that’s it from me. Thank you.

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

Hey, Christina or Patrick, I just wanted to kind of set expectations for Q2 appropriately given the new segments. I know you don’t like guiding by segment, but I also know that it took you a long time to get the supply demand balance with the Arlo Pro. And so, did Arlo in Q1 benefit from a lot of channel fill that normally would have happened in Q4, because of that should we be thinking about a Q2 number that's flat to down on Arlo because of that, or would you expect it to grow?

Not particularly with a typical expanding product line. I don’t think the channel fill in Q4 and Q1 of Arlo Pro will be anything bigger than quote unquote channel fill for Arlo Go and Arlo Baby in Q2.

Okay. And then, if I break out the service provider business from your Connected Home with the historical data that you’ve given, it looks like that the retail Wi-Fi business, kind of decelerated to the low single-digit year-over-year growth midyear or last year before Orbi, before a lot of things. Were there anything -- what was the cause of that?

Once again, I would like to do the math again, right. When we used it on the whole market at 55% share, but now the market is split into two thirds, but we still own 55%, all right.

Yes.

And then one third, we only own 35% [indiscernible] demand.

Yes, okay. I got it. All right. Thanks, Patrick.

Sure.

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

Well, thank you everybody for joining the call. As we said, we’re very excited about the two great opportunities in front of us, Orbi and Arlo. And we believe that there is tremendous growth opportunity for us to really take our business to further height and I think the transition from primarily driven by service provider business at lower margin into a healthy business that we can reignite growth again, it's very exciting. From here on now I think we’re positioning ourselves to growth and particularly growth with a very, very good future, particularly in Arlo, we’re building a subscriber base that we’ve strong relationship with, because we have build a back end cloud that will interact with our subscribers very intimately and that will allow us to have tremendous opportunity in the future to monetize this ever-growing subscriber base. And we’re very excited about it and that's why we’re reigniting our investment phase. The good thing is we continue to increase our profitability on the SMB side, which we’re really happy to see that they continue to grow 20% year-over-year in contribution margin dollars which certainly give us a free hand to be aggressive in investing in Arlo's growth. And I look forward to continue to report back to you on our progress in grabbing more market share first to the 45% mark for both the Orbi as well as the Arlo and look forward to talking to you in the next earnings call in July.

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