NETGEAR, Inc. (NTGR) Q3 2017 Earnings Report, Transcript and Summary

Greetings and welcome to the NETGEAR’s Third Quarter of 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. Thank you, Mr. Genualdi. You may begin.

Thank you, operator. Good afternoon and welcome to NETGEAR’s third quarter of 2017 financial results conference call. Joining us from the company are Mr. Patrick Lo, Chairman and CEO; and Ms. Christine Gorjanc, CFO. The format of the call will start with a review of the financials for the third quarter provided by Christine, followed by details and commentary on the business provided by Patrick, and finish with fourth quarter of 2017 guidance provided by Christine. We will then have time for any questions. If you have not received a copy of today’s release, please visit NETGEAR’s Investor Relations website at www.netgear.com. Before we begin the formal remarks, we advise you that today’s conference call contains forward-looking statements. Forward-looking statements include statements regarding expected revenue, operating margins, tax rates, expenses and future business outlook. Actual results or trends could differ materially from those contemplated by these forward-looking statements. For more information, please refer to the risk factors discussed in NETGEAR’s periodic filings with the SEC, including the most recent Form 10-Q. Any forward-looking statements that we make on this call are based on assumptions as of today and NETGEAR undertakes no obligation to update these statements as a result of new information or future events. In addition, several non-GAAP financial measures will be mentioned on this call. A reconciliation of the non-GAAP to GAAP measures can be found in today’s press release on our Investor Relations website. At this time, I’d now like to turn the call over to Ms. Christine Gorjanc.

Thank you, Christopher, and thank you, everyone, for joining today’s call. Results for the third quarter of 2017 came in above the high-end of our revenue guidance, primarily driven by the continued phenomenal growth of our Arlo segment. Overall, NETGEAR net revenues for the third quarter ended October 1, 2017 was $355.5 million, which is 5% on a year-over-year basis and up 7.5% on a sequential basis. NETGEAR net revenue by geography, once again, reflects our continued strength in North America, as well as improvement in the EMEA region. Net revenue for the Americas was $244.4 million, which is up 8.5% year-over-year and up 7.7% on a sequential basis. EMEA net revenue was $62.2 million, which is up 3.5% year-over-year and up 12.6% quarter-over-quarter. Our APAC net revenue was $48.9 million for the third quarter of 2017, which is down 8% from the prior year comparable quarter and up slightly quarter-over-quarter. For the third quarter of 2017, we shipped a total of approximately 5.7 million units, including 4.8 million nodes of wireless products. Shipments of our wired and wireless routers and gateway combined were about 1.9 million units for the third quarter of 2017. The net revenue split between home and business products was about 83% and 17%, respectively. The net revenue split between wireless and wired products was about 77% and 23%, respectively. Products introduced in the last 15 months constituted about 45% of our third quarter shipments, while products introduced in the last 12 months constituted about 42% of our third quarter shipments. From this point on, my discussion points will focus on non-GAAP numbers. A reconciliation from GAAP to non-GAAP is detailed in our earnings release distributed earlier today. The non-GAAP gross margin in the third quarter of 2017 was 29.4% compared to 31.3% in the prior year comparable quarter and 28.4% in the second quarter of 2017. The year-over-year decrease in non-GAAP gross margin was primarily due to investments in channel marketing that we have discussed on the prior two earnings calls. As mentioned on the prior calls, the majority of this additional marketing spend hits our P&L as contra revenue, therefore affecting our gross margin levels. Total non-GAAP operating expenses came in at $70.8 million, which is up 5.4% year-over-year and up 7.6% sequentially. As always, we manage our expenses prudently, while also ensuring that the growth areas of our business have the resources necessary to succeed. Our headcount increased by a net of 29 people to 982 heads during the quarter. We continue to add resources to the key growth areas of our business and expect to accelerate hiring in R&D, both in Arlo and Orbi during the fourth quarter of 2017. Our non-GAAP R&D expense for the third quarter was 6.2% of net revenue, as compared to 6.2% of net revenue in the prior year comparable period and 6.6% of net revenue in Q2 of 2017. R&D is critical to our business, and therefore, we expect this expense to continue to grow as needed in absolute dollars. Our non-GAAP tax rate was 24.8% in the third quarter of 2017, which included a benefit of $0.06 non-GAAP EPS as a result of the statutory relief resulting from an audit closure. Looking at the bottom line for Q3, we reported non-GAAP net income of $26.2 million and non-GAAP diluted EPS of $0.81 per diluted share. Turning to the balance sheet, we ended the third quarter of 2017 with $372.8 million in cash. As expected, for the third quarter of 2017, free cash flow improved significantly and we generated approximately $94.4 million in free cash flow, which is calculated as cash flows from operating activities as presented in the statement of cash flows under GAAP less capital expenditures. We continue to remain very confident in our ability to generate meaningful levels of cash. During the trailing four quarters, we generated approximately $72.5 million in free cash flow, which included a $1.6 million benefit from a presentation reclassification in historical cash flow statement. The reclassification is related to excess tax benefits upon the adoption of the new accounting guidance on stock compensation simplification. We continue to focus on optimizing the business and generating cash, providing us operational flexibility, as well as the ability to strategically deploy cash to enhance shareholder value. In Q3, we spent $30 million to repurchase approximately 682,000 shares of NETGEAR common stock at an average price of $44.02 per share, which resulted in a $0.02 benefit to non-GAAP diluted earnings per share for the quarter. Since the start of our repurchase activity in Q4 2013, we have repurchased approximately 11.3 million shares and our diluted share count is lower by 17.4%, as compared to the beginning of that period. The fully diluted share count is approximately 32.4 million shares at the end of Q3 2017. We have 2.5 million shares remaining on our current buyback authorization and plan to continue to repurchase shares opportunistically. Now turning to the results of our three products segment. The Arlo segment’s net revenue came in at $110.5 million for the third quarter of 2017. This is up 127.1% year-over-year, or about $61.8 million from the prior quarter and up 40.3% on a sequential basis. Clearly, we are very pleased with the performance of this segment during Q3, and Patrick will share more details on our Arlo strategy in just a moment. The Connected Home segment, which includes the industry-leading Nighthawk and Orbi brands, generated net revenue of $183.1 million during the quarter, which is down 14.9% on a year-over-year basis and down 1.5% sequentially. The year-over-year and quarter-over-quarter decline is primarily due to reduced service provider revenue for the Connected Home, which is down $21.4 million from Q3 2016, and down $3.9 million from Q2 2017. The SMB segment generated net revenue of $61.9 million for the third quarter of 2017, which is down 17.1% on a year-over-year basis and down 6.3% sequentially. We experienced flat year-over-year trends in the switching market. With the introduction of our groundbreaking mobile app managed insight switches, we expect to slowly turnaround the switching revenue in the coming quarters. I’ll now turn the call over to Patrick for this commentary, after which I will provide guidance for the fourth quarter of 2017.

Thank you, Christine, and hello, everyone. We are pleased with our results for the third quarter of 2017, which exceeded our expectations in both the top and the bottom line. The start of Q3 was clearly the Arlo segment, which posted $110.5 million in sales for the quarter. This represents yet another quarter of triple-digit year-over-year growth for Arlo, even against tougher comparisons in the back-half of 2016. The Arlo business continues to be in hyper growth mode and we don’t see that changing in the foreseeable future. It is now over 30% of the overall NETGEAR business, and we believe this percentage will likely increase in the coming quarters. With the recent introduction of the Pro 2 camera, we are confident that we will increase our market share and expand our user base worldwide. As of today, we have approximately $1.3 million registered users on the Arlo platform worldwide, and this number continues to increase at a rapid pace. Our current user base represents less than 1.5 of a percentage of the total number of households in the market that we serve, indicating we still have a lot of runway ahead of us. Our estimates continue to suggest that the IP security camera market in the U.S. is an $800 million market, growing at least 30% to 40% year-over-year. Arlo’s share of the U.S. IP security camera market held strong at 41% for Q3. In Q4, we will step up our marketing and channel expansion in the important holiday season, in order to get closer to our 45% share target and to expand our user base to 2 million as quickly as possible. At the same time, we will increase our R&D headcount and expenses to expand our Arlo hardware lineup and [Premium 8] [ph]on software services. We continue to believe that our unique innovative wire free technology trusted brand and superior distribution separate us from competition in the IP camera market, and will allow us to drive share gains and user base expansion. Two weeks ago, we launched the Arlo Pro 2, which features higher-quality video with 1080p HD optional 24/7 continuous video recording and activities on monitoring when plug in either to easy power or solar power and support for Amazon’s Alexa. Additionally, as many of you already know, we will be announcing the next new product in our Arlo offering at our Financial Analyst Day being held at our headquarter in San Jose on November 8. This new product will be the first non-camera product for the Arlo segment. We hope that you can all join us at our headquarters, or over the web for its debut. We’ll also be sharing more details around our plans to drive service revenue on the Analyst Day on November 8. As we have spoken about on prior calls, services are an important element of the Arlo business and will become increasingly important as the business grows. We have several exciting new software developments on the horizon that will further grow the attached rate for services on the Arlo platform. I look forward to sharing more on this with you two weeks from today. All in all, Q4 will be a very busy quarter for the Arlo team. We are doubling down on our branding and marketing spend, ramping up R&D for new product introductions and developing premium services to monetize the installed base. We strongly believe that building the Arlo brand, expanding the user base and extending our technology lead will pay dividends in the intermediate and long-term, both on a top line and bottom line. Turning to the Connected Home Segment, as expected, Q3 proved difficult, primarily due to when unfavorable year-over-year comparison for the service provider piece of the business. Service providers sales for the Connected Home business decreased $21.4 million on a year-over-year basis during the third quarter of 2017 and decreased $3.9 million on a sequential basis. Meanwhile, the retail channel portion of the Connected Home segment declined $10.6 million on a year-over-year basis, but is up slightly quarter-over-quarter. We managed to grow slightly quarter-over-quarter despite the cable gateway markets continued contraction, due to the new pricing policy of the combined Charter, Time Warner Cable entity, which now includes a free modem in the monthly Internet subscription fees and a $5 per month Wi-Fi equipment rental. However, for the Connected Home segment, we believe that there are many opportunities presented to us by the markets rapid move to Wi-Fi Mesh, the upcoming introduction of the 11ax Standard in 2018 and the arrival of 5G in 2019. To capitalize on all of these opportunities, we are heavily investing in both R&D, as well as brand and channel market. We are going through a multi-core investment cycle in the Connected Home segment that began in Q2 of this year. We breath our deep knowledge and extensive experience in Wi-Fi and LTE will enable us to continue to win in the upcoming technology cycles. As an example, recently, we introduced the Nighthawk X6S and X4S Tri-Band Wi-Fi mesh extenders, which turned a traditional home router into a mesh like Wi-Fi system. Unlike older Wi-Fi extenders, these new mesh extenders work with your existing home router on the same Wi-Fi ID, provides seamless Wi-Fi roaming and propagate the same Wi-Fi speed of your existing router to every corner of your house. With these, you don’t have to replace your existing routers be it or below the Nighthawk router, or free voice video gateway from your service provider in order to build a mesh Wi-Fi system at home. All these new mesh extenders use our patent – patented FastLane3 technology to boost the strength of your extender network just like our Orbi Wi-Fi Mesh system. We believe, all Wi-Fi in the homes should be Wi-Fi Mesh systems from now on, and we offered two options to accomplish this. A complete replacement with our Orbi Mesh system or an incremental upgrade with our Nighthawk mesh extenders. Our FastLane3 technology sets us apart from our competition, in terms of coverage and speed, as evidenced by numerous independent third-party reviews worldwide. It is the combination of years of radio frequency expertise acuminate over time in our R&D team. To add to our differentiation, we continue to incorporate value-added services to our Wi-Fi platform. We recently introduced a powerful parental control service to allow Nighthawk line of routers, which we would demonstrate on our Analyst Day. We expect to expand the offering to our Orbi Wi-Fi Mesh system this quarter. We will also introduce another popular value-added service on our Analyst Day as well. Finally, turning to the SMB segment, as Christine mentioned, we recently launched the industry’s first fully integrated F Managed Switches for remote network management. Using our Insight app, anyone can easily discover, configure, monitor and manage their network, which include both switches, wireless access points, as well as our storage products from anywhere in the world on a mobile device. This is an industry first, and no competitors of ours will be able to deliver that today. Our companion Insight Switches can be plugged into your network, discovered by the insight app and then ready to go. No additional hardware is required. It is a simple and elegant way to manage your network in the era of mobility. We believe this will help us slowly turnaround our switching revenue in the quarters to come. I would now turn the call back to Christine for Q4 guidance.

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

Thank you. We will now be conducting a question-and-answer session [Operator Instructions] Our first question comes from the line of Tavis McCourt with Raymond James. Please proceed with your question.

Hey, guys, thanks for taking my question. First, a couple of financial questions and then a product question. So on the guidance for Q4, if we compare the 7% to 8% operating margin to kind of what one would normally expect coming off of 9.5% in Q3. How much of that incremental investment is R&D versus pricing or sales and marketing investments? And any thing you’re willing to give us, Patrick, on the need to sustain that level of investment would be helpful? And then secondly, it looks like the channel inventory metrics you guys gave were up quite a bit year-over-year, especially the U.S. distribution channel. I’ve always thought of that as kind of an Ethernet switch channel, but does that include retail as well and maybe some explanation of that and where you would expect that to be at year-end. Thanks.

Well, the first thing is that the increased spending is, I think, evenly distributed across both R&D, which we have a huge pipeline of products, which we are actually going to disclose on the Analyst Day, as well as on brand marketing as well as channel marketing. So brand marketing, we are doubling down on the activities, on the social platform, on the search engines both on Amazon as well as on Google, as well as on commercials that we deploy on radio – on satellite radios and a lot of sponsored event. And channel marketing is a natural step up for the holiday season, as a matter of fact every Q4 because of black Friday’s, because of Christmas we do end up with a lot of channel promotional activities. So I would say those three would be evenly divided. Now going forward, as we mentioned before, we’re not going to step back from the R&D. We’re not going to step back on the brand marketing. And then on the channel marketing piece, it depends on how fast we can get to the share and the user base in the short-term. Our goal is to get a 45% share on Arlo, which is getting closer to our 48%, 49% on our Wi-Fi side. And then in terms of registered users, our goal is to get to 2 million registered users as quickly as possible. Today, we’re at about 1.3. We believe that by stepping up our marketing activities both on brand and channel marketing, we have a pretty good shot to get to 2 million subscribers by the end of the first quarter, and then that would be a good number. But of course, we will not stop at that. So we believe all that activity is beneficial to us in the long-term, because unlike before every Orbi, every Arlo that we sell, we actually view the connection with our customers through the cloud and through the app that we could interact with them on a frequent basis, not only that we’re going to sell them subscription software surfaces, which I mentioned just now, like for Orbi, we can get them subscription to parental control plus other services that we could unveil on the Analyst Day. And then we will continue on top of the storage subscription service. We’ll continue to roll out other subscription services, which again, we’ll demonstrate on the Analyst Day. So we do believe that we will continue to step on the gas paddle to really increase our user base.

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

There’s a few – quite a few channel partners that would take the inventory from distribution channel. For example, we sell our products over Home Shopping Network. We sell our products over the military retail chain. We also sell through smaller retail shops, such as the [indiscernible], those shops they all take it through distribution. And with the – I mean, everybody has put a notice that we will launch our Arlo Pro 2 in the first two weeks of Q4. And we actually run a few of the Home Shopping Network sales of several weekends at the beginning of Q4. So all of those inventory has to be staged before the end of the quarter. So we do believe that the distribution inventory will come down when we exit Q4.

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

There are two elements to it. One is that, as we all know, right, the enterprise networking market is not growing for multiple reasons. I mean, a lot of things are moving to the cloud, a lot of things are moving to the subscription basis. So selling hardware has been a flat market at best. And secondly, what gives me comfort is that, the net revenue is one thing, but more importantly, I look at in-market sales. And our in-market sales is actually quite good, all right, it’s not as bad as they showed on the net revenue. The net revenue defer from the in-market sales simply, because that we have to go through our revenues on sale in, all right, so it really depends a lot on how the channel takes on inventory. Now, as we just mentioned, the channel wants to take on Arlo, channel wants to take an Orbi, and if they see a flat market on the enterprise switching side, that would take the lift of the switching sold. The fact is that, we see in Q3, especially towards the quarter-end, while we have been pending big launch on Arlo Pro 2. The channel is swapping some of the SMB inventory with the Arlo inventory and that really hurts on net revenue reporting. The comfort I take is that, when I look at the actual in-market sales, it’s actually pretty good. And on the switch revenue, certainly, it is a smaller portion of our overall SMB. However, it’s not small and the beauty of it is with the introduction of the Orbi Pro, with the introduction of the Insight Managed Wireless Access Point. We are seeing signs that they wireless line of products is actually picking up again same thing with the introduce – with the complete refresh of our storage line, especially on the rack mount side, we’re also seeing it to be picking up. So I’m looking at the end market sales to see the comfort factor. And we do believe that, we will continue to make our progress, but it would take several quarters to get there. And clearly, from a channel perspective, the attention is, of course, on Orbi and Arlo, channel was so whatever is easier to sell.

Okay. All right. So that the channel increase this quarter was predominantly, if not entirely retail based?

Yes, pretty much, yes.

Okay, great. So thanks for the added color. Thanks.

Sure.

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

Hi. Just trying to figure things out here. If you – if I’m looking at Q3 and then you have this large Arlo sell-through in Q4, the expectations are the same. Why are you expecting to – that you need to spend more discount more in Q4 for – to take market share? I’m just trying to figure out the competitor dynamics here?

Well, we have talked about that, we always want to sell more, all right. And we have set ourselves a short-term goal of 45% market share, we’re not there yet. We would like to set 2 million in registered user base, we’re not there yet. We believe that is very important for the long-term. And the faster we get there, the higher barrier-to-entry that we could build, and that’s why we’ve decided to spend more. And Q4 is the most important quarter, because for camera, Q4 is particularly bigger than the other three quarters. So if we do not spend it in Q4, then it would take us longer to get through the next cycle to get us to that magic numbers. And why are those magic numbers matter? I mean, one, I talked about is erecting a higher barrier-to-entry. The second is more important is that a higher the install – the registered user base, the better we have a chance to monetize them. And we’re going to explain, what are some – other than the 30-day storage, or 90-day storage that we have today. We go demonstrate a few other subscription services that we’re going to launch in the next quarter or two on the Analyst Day. So all those add together, that’s the reason we decided to continue to spend more. And of course, I mean, it doesn’t compete on the R&D side as well, because as I said, while we still have the R&D not only in sustaining this existing camera line, but we’re introducing a new non-camera line in two weeks’ time. And then, of course, rolling out all these new services like AI, is not cheap. I mean, the AI is reported by Wall Street Journal, those engineers are probably more expensive than the NFL football players.

And so is it fair to assume that pretty much all the margin compression you’re guiding for is coming from Arlo with regard to the activity?

No, we talk about Orbi as well.

That’s good.

So Orbi is the same thing, all right. I mean, Q4 is definitely a very important quarter. And now we just introduced Nighthawk Mesh. So that means, with doubling down on pushing on both the Orbi brand and the Nighthawk Mesh brand. This is a very unique opportunity all right, because with the Orbi brand, I mean, you pretty much can target only 10% maybe 5% of the total market that people are willing to replace whatever they have with a complete new system, all right. And with the Nighthawk Mesh, the whole market is open to us, including those who rent the Wi-Fi from their service providers, because we don’t need to touch that one. The Nighthawk mesh is add on to those. Again, it’s a very unique opportunity, because only with the FastLane3 technology that was patented, you are able to do this, and we’re the only game in town. So if we do not spend money in promoting it, then we’ll miss the huge opportunity.

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

No, there are two different clouds. As I mentioned, the Orbi cloud are those who are willing to replace entirely what they have. And the Orbi cloud are the people who are more lifestyle-oriented rather than all the bells and whistles that you want. And the Nighthawk crowd that people who really want to turn every single knot choose their omni-channels, define their own [indiscernible], all right, and have better gaming experiences. And but those people have been demanding a mesh from us and now we’re giving it to them. Now with the Nighthawk Mesh extenders in one fell scoop. We meet all those customers who are using XFINITY Wi-Fi or Charter Wi-Fi or Hugo’s Wi-Fi all the Sunday become our customers. But of course, marketing to this big, big expanded market requires money. And we believe that Q4 is the best time to invest in it. So in Q4, we are actually investing both in Nighthawk Mesh, Orbi Mesh and Arlo.

Okay. Great, thank you.

Sure.

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

Great. Thank you very much. Few things, if I could. The – I’m not sure what. I guess in terms of the brand and marketing spend for Q4, I mean, that strategy is similar to what you started doing already earlier this year. I’m just wondering if there’s anything different, it seems like you’re sort of reaccelerating it again. Is there any sort of learned when you started that strategy in Q1? Are you sort of going to do the same thing and just more of it in Q4, or are you doing different things? And then I have a couple more questions, if that’s right.

No, actually, we – you’re right. I mean, we did in Q2 in a very accelerated pace, and then in Q3 we pulled back a little bit, all right. And so now we see that contrast. We can see exactly what is needed. So in Q4, we’re stepping on, I guess, paddle again one more time. And what is proven to us all right is that, driving traffic and converting the traffic is very important. And the best way to engage in our customers online is through social media. And then, of course, the point of presence in the retail stores, training that retail stores associate and get them to do the assisted sales also very important. All those things are no different. So what we learned is, is almost like directly proportional, all right. The more you spend on those areas, the better outcome of sales you could get from it. And Q4 is a very important quarter and we’re doing it. As a matter of fact, in Q4, there are so many opportunities, all right, that we think we cannot miss. The just newly introduced Arlo Pro 2, I mean, the favorite feedback just on the last few days on Amazon is up to 4.3, 4.4 stars, we’ve never had that good at start. And today, you just saw the announcement that AT&T is launching our further Nighthawk and mobile hotspot routers across all their stores, which we actually need to continue to train the stores associates to do that. And then the Nighthawk Mesh extenders, our retail partners are very excited about it, because now it will open up the entire ISP provider Wi-Fi channel like XFINITY Wi-Fi to our liking. None of our service providers have been able to successfully introduce a mesh even though they have been working on it for years. So the opportunity that presented was – is tremendous, is a combination of the right technology in product launch and the perfect consumer quarter. But the tactics that we have learned in Q3 has demonstrated us what works and what not, we’re just accelerating the investment.

All right, that makes sense. The – and then along that same way the new product that you’re – the new product category that you’ll announce on November 8, is that, I don’t now, if you would say, but is that something that would actually be revenue in Q4, or more for 2018, and whether or not you’re even able to answer that, I guess, goes to also whether there’s any marketing spend for it in Q4 or not?

Well, put it this way. When we put up the guidance, we’ve taken that product introduction into account, whether that product will be shipping right away, I just want to play a little bit of suspense.

Yes.

So how do I know nobody is going to tune in that day.

All right. Okay. And then the broader question with obviously eventually with Amazon’s Cloud Cam today, not just looking at that product as competition specifically, but when you combine that now with Google’s Nest Cam, which you guys have been competing with for a while now, I mean, I guess, navigates they’reboth wired versus wireless, so that’s – I assume one source of differentiation. But more broadly, I mean, how are you guys finding competing against these sort of big ecosystem vendors? I mean is it – I’m assuming that it’s – you don’t, obviously not complete with them on scale, but you complete with them on a focus, I mean, is it just a challenge that you guys just always have to have the better product, because it’s what you – it’s all you do as opposed to one of a million things? And is going to continue to be the strategy, I’m assuming…

Yes, pretty much, it is.

I’m assuming it is, but…

Pretty much anytime, I mean, NETGEAR is not a new company. I mean, we’ve been in the industry for 22 years. And we have competed with Titans before with Intel, with Cisco, with HP, with Microsoft, and now with Google and Amazon, I mean, there is no different. The only way that you would be able to compete against the Titans will be offering better products and better engagement with your customers. I mean, those are two key things. And we do believe that we have significant technological edge over our competitors, both on the Wi-Fi Mesh, as well as on the camera. Now on the Wi-Fi Mess is our FastLane3 technology, which is a combination of the antenna design, as well as the TriBand that we patented. So we do believe that we have a technological edge, which would tick down quite a while to catch up, all right, because they have to work around our patents, all right. And then on the camera side, I think, we pretty much like years ago when the iPhone – it was introduced, it revolutionized the idea of cellphone from talking to people in working on the Internet with the phone anyway you go. So the IP camera traditionally like the Nest Cam or now the Amazon Cloud Cam is all about indoor. And when you’re doing indoor, most people just install one, at most two indoor, all right. While we introduce Arlo, it is not wireless-only, it is called wire-free, all right. Wire-free means wireless plus battery operation and weatherproof. So that means, you would be able to install them outdoors and that changes the game, because what we have found out – what we have predicted correctly, people don’t buy one. They buy three. They buy four. They buy five, and actually buy six, all right, to install around their house. So all of a sudden, the ASB per household has changed from $200 to $600 to $800 per household, that’s a completely different game. So I think, Amazon, Next Can, Canary reign all these people and still competing in a very crowded market of an indoor camera, all right, while we are in a market of our own, which is outdoor wire-free camera. And remember, for our outdoor wire-free camera. And remember, for our outdoor wire-free camera, is not only wireless on Wi-Fi, is wireless on LTE as well, I know, we have that technology. And the – as a matter of fact, the LTE version of the camera has been selling quite well on Verizon stores, and they will be propagated to many other operator stores very soon. So we do believe that using very sophisticated software, all right, to handle the battery utilization, while be able to still transmit, all right, those video over Wi-Fi at a long distance, or over LTE, all right, in the suburban network, it’s on secret sauce, we believe we have a long technology lead over our competition.

All right. Great. Thank you, and looking forward to the November 8 info. Thanks.

Absolutely.

Thank you. Our next question comes from the line of Trip Chowdhry with Global Equities Research. Please proceed with your question.

Thank you. Again a very solid quarter on Arlo. I was just wondering how are you thinking about Arlo growth? Of course, you did mention Arlo Pro 2 and some services. And I do know that the machine learning, deep learning, service is still in beta. Do you know when can that be generally available?

Yes. I mean, we expect to roll that out in short time span. Basically, what we have seen is the industry accuracy of object identification is probably around 92%, all right. So we have seen some of our competitors rolling out their product below that level and they get slammed on Amazon user rating, we don’t want to repeat that. So what we want to do is to meet or exceed that 92% accuracy expectations before we roll them out. So it takes us a little bit longer time to beta and have been now, because accuracy is all driven by training, all right, training all of the neural network and we need videos to train it and we ask our users to donate the videos. The longer the beta period, the more donated videos that we have, and that’s what it is. But we expect that we should be able to roll it out in very short timeframe. But come on November 8 with a roll out not just on this particular service, where we have other service to roll out it as well, which we are going to demonstrate on November 8.

Beautiful. And your Arlo business is still strong. Have you thought about renaming your company in sort of NETGEAR or let Arlo?

Okay, not yet. There’s an idea, I’m talking with the Board.

All the best, guys. Keep it up.

All right. Thank you.

Thank you.

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

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

.:

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

That’s right. I mean, for now, I mean, we do not know how the attached rate of the new services will be, which we have a significant bearing on the operating margin. We are doing both Orbi as well as Arlo. We have just rolled out the circle parental control services on the Nighthawk router side and we’ve rolled it out for the Orbi line this quarter. And then, Arlo, we’re going to roll out the person identification services in a very short timeframe, and there will be another one that we’re going to demonstrate on Analyst Day. So clearly, one, for sure that, after the Christmas season, the channel marking spend will be reduced a little bit, so you would see an improvement on operating margin slightly. And then on the other hand, we might decide to step in more on the R&D to really further our technology lead. But you’re right. If any of those services really get adopted very, very widely, it will have a significant positive impact on our bottom line going into the 2018.

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

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

I think, the important thing is focus, where do you want to focus on, and the focus has to be meeting customers need. We do believe that in the next, at least, in the next three to five years on the Wi-Fi side, the most important piece for customers are still in the reach and the speed of Wi-Fi. And our FastLane3 technology, which is patented would give us the edge, and we’ll continue to invest in these areas. And furthermore, as we said, right, today, is the 11ac, next year is 11ax, year after that you’re going to integrate with 5G. I mean, with our focus, we will be able to put those FastLane3 technology quickly on to these new technology platforms. And so I think that that’s the advantage we have. On the other hand, on the camera side, I think today, of course, the image recognition and all that is very important. But as we found out, the biggest demand is still in outdoor camera, all right. The biggest demand is people who can install the cameras outdoor themselves and we will be able to monitor the periphery of their properties and that’s the number one thing we have to satisfy. And if you install your camera at the corner of your backyard and you are able to beam 1080p video back into the house of your Wi-Fi, is not a trivial exercise, and that requires a very focused R&D. So we do believe that, I mean, those are the areas that we invest and we continue to maintain a leadership approach. And if we could, I mean continue, I mean, to focus on that, I think, we will maintain that edge for quite a long period of time.

Okay, and then one last competitive question if I may as it relates to your connected home. So, as you know the cable companies are about to come out with or have a fuller rollout of DOCSIS 3.1 that will require new broadband gateway and it looks like they are coming out with 3x3 and 4x4 WiFi modems which on their wave to AC side, I mean how do you – I understand that you have AX on the horizon, but is that a potential threat to your connected home business in 2018?

No, really I mean actually we love it, as I just mentioned with the Nighthawk Mesh Extenders, we have a different way of selling to these people, these users is you know what, you’ll love your 3x3 or 4x4, but do you want it to be extended to your kitchen, to your backyard, to your pool house, there was no answer from the service providers. I mean then why don’t you buy two or three of this Nighthawk Mesh Extenders and make that happen. All right you pay $120 to get Gigabit into your house from Comcast and Charter and then you buy into that $12 a month, these 3x3, 4x4 WiFi, but that 100 megabit drops off to 10 megabit when you move into your study, would you want to change that? If you want to change that buy two or three of this Nighthawk Mesh Extenders, we are very excited about it, our retail channel partners are very excited about it.

Great, thank you.

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

Hey, thanks for taking my question, a follow-up product question or two Patrick. Before today’s Amazon announcement, the most interesting thing that was going on in the camera market competitively was this seem to be the holiday season of security bundles, I think we saw Nest thus by Vivint bring all develop these and merchandise these bundles of cameras with sensors. Is that something that we should expect from Arlo as well, or do you think the market is still a market where folks are looking for a solution just for cameras at this point? And then…

Really, as we mentioned, the pure IP camera, especially the outdoor IP camera market is going like crazy, all right, I mean so it’s a market that we cannot exploit fast enough and as just now you know one of you mentioned that we have limited resources, we have limited on where we’re going to put it, we would like to put in the fastest, biggest ROI and today the wire-free outdoor/indoor capable IP security camera is the most effective investment for us. And we’re not going to say that we would never go into this big do-it-yourself security set up, but we do have to wait and see how big then market is going to conform, to change into. And also that market is very nascent and competing against the industry tightened of ADT, so we don’t know yet, I mean so we’re not going to spend our R&D dollars into something which is uncertain, we’d rather spend money on something which we are very certain, which is the indoor/outdoor IP security camera market which is growing 30%, 40% a year worldwide and we have not even touched 1% of the households, so there is the other 99%, so it’s a long runway, so I believe that that’s where we’re going to get focused in the short terms.

Great, and then a follow-up on the Amazon announcement this morning, I would imagine strategically what they care about is their service because allegedly millennials wants strangers in their homes all the time, but would you expect them to open that up to other camera vendors like they did with lock vendors or do you expect this to be kind of a proprietary offering on the camera side by Amazon or do you have any insight at all on that?

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

Maybe we’re both too old, Patrick, thanks.

You’re right.

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

Sure, thank you everybody for joining today’s call. We are very, very excited about the future because of all these new opportunities that is in front of us and we have a solid technology investment and line up in lead of our competitors and we will like to show case all of those technology leads to you if you could join us on the Analyst Day in our headquarter. The reason why that we decide to hold it in headquarter is because it’s much easier for us to stage all those demonstrations to you. I mean all of them are industry first, very groundbreaking and I hope to see you all in person if not at least on the web, we’re going to webcast all of it, the software demonstrations that it will be very, very interesting and I look forward to do that on November 8. Once again, talk to your next time.

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