NETGEAR, Inc. (NTGR) Q2 2018 Earnings Report, Transcript and Summary

Good evening. My name is Kim and I will be your conference operator today. At this time, I would like to welcome everyone to the NETGEAR Second Quarter 2018 Results Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. [Operator Instructions] Thank you. Chris Genualdi, you may begin your conference.

Thank you, operator. Good afternoon and welcome to NETGEAR's second quarter of 2018 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 second quarter provided by Christine, followed by details and commentary on the business provided by Patrick and finish with third quarter of 2018 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 second quarter of 2018 came in above the high end of our net revenue guidance driven by the success of Arlo, Orbi, the Nighthawk Pro Gaming Router, cable modems and gateways, and our SMB switching line. Overall, NETGEAR net revenue for the second quarter ended July 1, 2018, was $366.8 million, which is up 10.9% on a year-over-year basis and up 6.3% on a sequential basis. We saw year-over-year growth across all three business segments during the quarter. NETGEAR net revenue by geography once again reflects our continued strength in North America as well as the EMEA regions return to growth. Net revenue for the Americas was $259.8 million, which is up 14.5% year-over-year, and up 11.2% on a sequential basis. EMEA net revenue was $68.7 million, which is up 24.4% year-over-year and up 3.1% quarter-over-quarter. Our APAC net revenue was $38.3 million for the second quarter of 2018, which is down 21.1% from the prior year comparable quarter and down 14.3% quarter-over-quarter. The year-over-year and quarter-over-quarter declines in Asia-Pacific are due to weakness in the service provider channel in Australia. The non-service provider channel continues to grow. For the second quarter of 2018, we shipped a total of approximately 5.1 million units, including 4.1 million nodes of wireless products. Shipments of our wired and wireless routers and gateways combined were about 1.6 million units for the second quarter of 2018. The net revenue split between home and business products was about 81% and 19%, 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 42% of our second quarter shipments. While products introduced in the last 12 months constituted about 35% of our second quarter shipments. From this point on my discussion points will focus on non-GAAP numbers. The reconciliation from GAAP to non-GAAP is detailed in our earnings release distributed earlier today. The non-GAAP gross margin in the second quarter of 2018 was 30.2% compared to 28.4% in the prior year comparable quarter and 30.7% in the first quarter of 2018. We are benefiting from the year-over-year improvement in foreign exchange rates and higher margins of certain product categories, especially with our CHP business. Total non-GAAP operating expenses came in at $88.9 million, which is up 35.1% year-over-year and up 10.9% sequentially. As discussed on our prior earnings call, we are adding duplicate costs as we setup Arlo Technologies to be a separate standalone public company. During Q2, we expensed more duplicate costs than we had originally planned due to the acceleration of certain separation activities with $5.1 million of such costs incurred during the quarter. Our headcount increased by a net of 61 people to 1,108 heads during the quarter. We are adding resources to the key growth areas of our business, in addition to adding resources as we stand up Arlo Technologies as a public company and expect to continue to add additional headcount during the third quarter of 2018. Our non-GAAP R&D expense for the second quarter was 8% of net revenue as compared to 6.6% of net revenue in the prior year comparable period and 7.9% of net revenue in the prior quarter. R&D is critical to our business and we continue to invest heavily in R&D for Arlo, as well as the subscription service opportunities across all three segments. Our non-GAAP tax rate was 21.9% in the second quarter of 2018. Looking at the bottom line for Q2, we reported non-GAAP net income of $18.6 million and non-GAAP diluted earnings per share of $0.57 per diluted share. Turning to the balance sheet, we ended the second quarter of 2018 with $355.6 million in cash. During the quarter, we used $16.9 million in cash flow from operations, which brings our total cash flow generated over the trailing 12 months to $124.2 million. Additionally, we used $10.2 million in purchases of property and equipment during the quarter, which brings our cash used for capital expenditures over the trailing 12 months to $20.9 million. We continue to remain very confident in our ability to generate meaningful levels of cash. Now turning to the results for our three product segments. The Arlo segments net revenue came in at $104.8 million for the second quarter of 2018. This is up 33.1% year-over-year or about $26 million from the prior quarter and up 8.9% on a sequential basis. The Connected Home segment, which includes the industry leading Nighthawk, Nighthawk Pro gaming and Orbi brands, generated net revenue of $191.2 million during the quarter, which is up 2.8% on a year-over-year basis and up 7.5% sequentially. We are particularly excited about the sequential revenue uptick during a seasonally weak quarter. The Nighthawk Pro Gaming router is leading the growth. The Cable Modem and Gateway market is returning to year-over-year growth in Q2 and we’re gaining share. The SMB segment generated net revenue of $70.8 million for the second quarter of 2018, which is up 7.2% on a year-over-year basis and down 0.2% sequentially. Our focus on the 10-gig, multi-gig and POE switches categories continues to drive results. Finally, we continue to focus on the successful separation of the Arlo business from NETGEAR as well as driving our subscription services strategy for all three segments. I'll now turn the call over to Patrick for his commentary. After which, I will provide guidance for the third quarter of 2018.

Thank you, Christine, and hello, everyone. We are pleased with our results for the second quarter of 2018. We came in above our guidance range in net revenue. We are excited to report that we successfully delivered year-over-year top line growth in all three of our business segments during the quarter, resulting in 10.9% year-over-year top line growth overall. Starting with the Arlo segment, we posted $104.8 million of revenue for the quarter, representing an impressive 33.1% year-over-year growth. Once again, Arlo's growth during the quarter was driven by the success of Arlo Pro 2, which is currently our flagship Arlo camera. Pro 2 is the latest generation of our battery-operated IP65-rated weather resistant Wi-Fi cameras. It has 1080p, full HD video quality, and advancements in sound and motion detection, including a three second look back video capture in continuous video recording capabilities when plugged into a power outlet. Arlo Pro 2 includes a 100 plus decibel siren on the base station that can be triggered remotely or by motion or sound detection as well as two-way audio, night vision, and optional local backup storage to any compatible USB drive. During the second quarter, we also launched the Arlo Security Light, which is our first known camera product in the Arlo family. The Arlo Security Light delivers powerful, wire free lighting that works intelligently both by itself or when paired with Arlo Security cameras. When the Arlo Security Light senses motion, we can trigger an Arlo camera to start recording. Its weather resistant design is also IP65 rated and can be used with our Arlo rechargeable batteries. Arlo Security Light can be scheduled to turn on and off automatically and be customized to display different colors and patterns for added protection, elimination or just for fun. Arlo Smart was also launched during Q2, which is a paid subscription service that adds powerful artificial intelligence capabilities to our Arlo cameras to enhance the user experience. Through real-time computer vision algorithms, Arlo Smart provides users a more personalized experience, deep insights into detective activity and streamlined access to take responsive actions in urgent situations, such as contacting local emergency services in the U.S market. Some of Arlo's Smart key features include person identification, E911 emergency call service, cloud activity zones and rich app notifications. Last but not least, this morning we announced the all new Arlo Audio Doorbell and Arlo Chime, which are the latest additions to the Arlo ecosystem. The Arlo Audio Doorbell and Arlo Chime work together as a smart connected audio door bell solution designed with flexibility and DIY simplicity in mind. The Arlo Doorbell can pair with any Arlo camera for a more complete view of the entryway. Using the Arlo app, users can access the Arlo Audio Doorbell to interact with visitors from their smartphone or tablet. And if paired with an Arlo camera, they can also use an Arlo smart subscription service plan to intelligently detect people; and call E911 emergency services close to the camera's location saving valuable time. We expect the Arlo Audio Doorbell and Chime to arrive at retailers nationwide later this fall. Turning to the Connected Home segment, Q2 marked a return to top line growth driven by Orbi, the Nighthawk Pro Gaming Router and our cable modems and gateways. During the quarter, the retail cable modem and gateway market return to year-over-year growth and we had been able to gain additional share from our competitors. With the completion of the bundled free modem Charter spectrum service rollout and our strong lineup of new cabled products, we believe that we’re positioned for continued growth momentum in cable products throughout the rest of the year. During Q2, we announced that we have applied our DOCSIS cable expertise to the award-winning Orbi line of tri-band mesh systems. We launched the Orbi tri-band Wi-Fi cable modem mesh system, which is the industry's first whole home Wi-Fi mesh system with a built in cable modem, app set up and patented, high performance FastLane3 tri-band Wi-Fi technology. This groundbreaking product carries an MSRP of $399. Additionally, we also launched a new mesh extender for the Nighthawk family, the Nighthawk X6 Tri-Band Wi-Fi Mesh Extender is the latest member to join the Nighthawk family of Wi-Fi mesh extenders. It creates a powerful whole home Wi-Fi mesh, extending the Wi-Fi coverage of your existing router using our patented FastLane3 technology. The Nighthawk X6 joins the existing family of Nighthawk mesh extenders which employ a dedicated Wi-Fi link to provide an uninterrupted flow of data between your existing primary router and the mesh extenders. As highlighted on our prior earnings call and demonstrated by these two new product releases, we continue to rapidly innovate and expand our product portfolio within the Wi-Fi mesh category. Meanwhile our competitors continue to offer only one or maybe two mesh Wi-Fi products in that portfolios, we stay ahead of the competition by delivering the best Wi-Fi performance on the market, with the most innovative features built in. Turning to our SMB segment, the second quarter was another successful quarter, during which we once again posted year-over-year revenue growth. With prior success on 8 and 24-port PoE+ switches, we introduced more models in unmanaged and web managed smart switch categories with 16 and 52-port configurations. Along the same lines, riding on the success of our 24 and 48-port Pro AV managed switches, we introduced the highly anticipated 96-port configuration with a price tag of $10,000. These new innovative switches powered [indiscernible] this year, and satisfy the sophisticated modern day needs of our business customers in the areas of IoT, IP communications, digital surveillance and professional software defined visual display over Ethernet, which are more commonly known as Pro AV. We are continuing to rapidly innovate iteration of our insight SMB application, which is currently on its fifth-generation despite having been launched in the second half of last year. NETGEAR Insight is a unified network ecosystem for small businesses. It enables users to access simplified feature rich remote IT monitoring and management from anywhere. Insight changes the paradigm with its simple, multi-device configuration and cloud-based platform. This empowers business organizations to manage devices from anywhere, which saves them their valuable time. We are pioneering a mobile first network management tool for the expanding DIY business manager population. As mentioned on prior calls, this is but one in several recurring revenue service initiatives that we are undertaking at NETGEAR across all three business segments. Earlier this month, we announced the appointment of Brad Maiorino to the company's Board of Directors. Currently a senior executive at Booz Allen Hamilton, Mr. Maiorino is a noted expert in managing cyber, governance, risk and compliance issues. Over the course of the 25-year career, he has held the role of Chief Information Security Officer with Fortune 50 companies, such as Target in the last three years, General Electric and General Motors prior to that. He is undoubtedly a valuable addition to the NETGEAR Board of Directors as his extensive track record with large complex global operations has made him a sought-after, trusted adviser at the highest level of industry and government. We look forward to benefiting from Brad's acumen and insight as we successfully navigate today's dynamic and ever-changing Internet security landscape. Last but not least, I would like to invite our Investors and Analysts to join us on September 6 at our headquarters in San Jose for the 2018 NETGEAR Financial Analyst Day, during which we will layout our vision of what the NETGEAR organization will look like after the contemplated Arlo separation. I hope that all of you can join us if you would like to attend please reach out to NETGEAR IR at netgear.com or visit our investor relations Web site for more details. I will now turn the call back to Christine for the Q3 guidance.

Thank you, Patrick. For the third quarter of 2018, we anticipate revenue will be in the range of approximately $380 million to $395 million. Third quarter GAAP operating margin is expected to be in the range of negative 2.2% to negative 1.2%, which includes approximately $11 million of one-time costs associated with the separation including professional service fees for various advisory and audit related costs. Non-GAAP operating margin is expected to be in the range of 4% to 5%, which includes approximately $19 million of costs associated with the separation of Arlo and the corresponding dissynergies created, including the hiring talent to duplicate certain roles as that business stands up on its own. Our GAAP tax rate is expected to be approximately 108% and the non-GAAP tax rate is expected to be approximately 23.5% for the third quarter of 2018. Operator, that concludes our comments and we can now take questions.

[Operator Instructions] Your first question comes from the line of Woo Jin Ho from Bloomberg Intelligence. Your line is open.

Great. Thank you for taking my question. A couple questions on Arlo. You introduced the Arlo Light middle of last quarter, just curious on how the channel fill was in the United States for Arlo Light? And if you -- and you’ve had Arlo Pro 2 for a couple of quarters now. Can you just talk a little bit about the product mix between Arlo Pro 2, Arlo Pro and Arlo Standard, please?

Well, as we just mentioned, Arlo Pro 2 is a flagship product that’s driving the top line growth model, so we’re very pleased with this performance. And clearly the newer products would generally be the preference of our customers. So the Pro and Pro 2 are generally a bigger portion of Arlo's composition of revenue for sure. On the other hand, Light, we’ve yet to fill out all the channels. We're gradually entering all the channel. Lights is now available in two of our major channel partners, and we expect that Lights will continue to fill out all the other channels. We expect that to be done in Q3. We are very pleased so far with the feedback of the customer support from the channels that we have it available.

Understood. So, Patrick, or Christine, in that vein if I think about the channel fill going into Q3, can you just talk about the relative guidance to Q3? It looks based on what I'm looking at right now, you are looking for a healthy sequential growth going into the third quarter for the Arlo business, but when I think about the seasonality in to the third quarter, I was expecting a little bit more, especially given that you have the broadening of the product portfolio and the channel fill for both the connected home and the Arlo lines.

Well, I mean, if you look at Q2, it has already defied the seasonality. So Q2 this year was exceptionally strong. So it tells you that with the traditional seasonality it's a little bit changed this year. So given a very strong Q2, I think the guidance that we gave for Q3 is very good, right. If you take out the Q2 strength, and then from the traditional Q2 to the Q3, it's not shabby at all. So we’re very pleased, but of course, I mean, we’re trying to do better all the time.

Understood. And then, one last -- one last thing, are we still sticking to the full-year guidance for the combined companies?

Oh, yes. I mean, we -- I think last year we talked about that the SMB as well as the CHP will be in the low to mid single-digit and I still think that we are getting there, I mean. And overall, I mean, we all are working towards a 10% growth, which we demonstrated in Q2, yes.

Understood. Thank you. I will cede the call.

[Operator Instructions] Your next question comes from Trip Chowdhry from Global Equity. Your line is open.

Thank you. A very solid quarter. I was wondering regarding Arlo, do we have any update on the number of registered users we have so far?

Well, I mean, given the fact that we’re in a quiet period because we just launched the IPO roadshow I think we are bound by how much we could say. And if you would like to get a little bit more details, I mean, it's better to look at the prospectus which could be obtained from our underwriters, yes.

Understood. I will do that. But directionally, do you think we have reached 2 million?

Again, we’re in a quiet period. I think it's better to look at the prospectus, we are really in a quiet period, yes.

No worries. No worries. I have another product related question since I myself I’m a big customer of Arlo. Do you think you may be offering a service, where one person could be gifting a subscription to another person. For example, like someone from our research is showing that in some situations the kids may want to buy an Arlo ecosystem for their parents who are senior citizens, and by default they get the seven days storage. But do you think you may have a product offering where, say, the kids may be gifting their -- say, elite services, like -- 30 days or 60 days services to their parents or vice versa. Do you think that is possible in near future?

Well, I’m sure that I will get one of our product managers to take it offline and work with you to see how this could be constructive..

Beautiful. And regarding Arlo Doorbell, do you think we can talk little bit more on this or probably we will have to wait after the IPO is over?

No, no, I mean, as far as the product features are concerned, I can talk about it.

Beautiful. Now if -- I think the way I’m looking at the ecosystem, it all gets the customer into the ecosystem, because I think it's a very commonsensical approach that you’ve taken where Arlo Camera, Arlo Doorbell, and Arlo Chime work together. Do you think the base station is the same or we may need a different base station for Arlo Doorbell to work?

No, the Arlo Doorbell will work off of the existing Arlo base station.

Excellent. And then, Arlo Chime, is it a separate product or if somebody buys an Arlo Doorbell, both Chime and Doorbell come together?

Well, I mean, they’re all different products, but we certainly are thinking of bundling in different combinations.

And regarding the pricing, directionally would it be priced similar to Arlo Light or somewhere between Arlo Light and Arlo Pro Cameras?

We haven't -- for competitive reasons, we haven't announced the pricing yet. We don’t want our competitors to know.

Beautiful. Excellent. Regarding Arlo Smart, currently I’m using it, I mean -- as a better product and versus where the product is to date, I think the accuracy has reached above 90%. It identifies a person pretty well. Regarding the zones, do you think the people are using zones to target the motion or they’re using zones to increase the battery life of the Arlo -- well, I mean, the rechargeable time. The reason is you only get alerts based on that specific region. So what is your research telling regarding why people are subscribing to Arlo Smart?

Well, clearly, we believe that people subscribe to Arlo Smart because they like the [rich] [ph] notifications as well as what you mentioned, person identification as well activity zone, that would give them a much more accurate notification of what’s happening and give them a very fast response through E911 or call a friend features, right on the rich notification. Regarding battery saving, really it doesn't really matter because all these activities were done in the cloud. That means the video has been streamed up to the cloud and let the cloud analyze it. So it doesn’t really affect the battery life one way or the other.

Beautiful. That solves. Thanks a lot and congratulations on a very strong quarter.

Great. Thanks.

Thank you.

[Operator Instructions] Your next question comes from Hamed Khorsand from BMW -- BWS Financial. Your line is open.

Hey, good morning. First off …

Hi, Hamed.

… could you just talk about the second quarter and what you guys are guiding for Q3, it says like growth in retail was up this quarter in Q2, so you’re expecting some softness as far as the guide goes, because of that -- was that because of retail is picking up orders or for back-to-school early, or was this more because of ASP rising because of the new routers?

No, I mean, ASP has continued to rise. I think the biggest thing is that the cable markets returned to growth. And the Pro Gaming Router entered the market in Q2 in a big way. So these two add together really give a significant boost to Q2 which countered the seasonality. So -- but of course, I mean, then we see the growth continue into Q3, but because of this extra strength in Q2, so the Q3 growth versus Q2 will not be as prominent as previous years.

Got it. Okay. And with the gaming router, the gaming router is towards the higher end of the ASP, price points that you’ve been trying to get to. Is that moving all the prices up, or are you seeing like a more of a bell curve happening as far as the product [multiple speakers]?

No, I mean, -- yes, the gaming router is the opening set of our try in selling what we call specialized software rich routers [ph]. So if you purely look at the speed gaming router is [technical difficulty] cheaper. You continue to [technical difficulty] what we call [technical difficulty] software oriented special feature routers coming out subsequently. So generally speaking, you can say this is another class of new routers that we are introducing. So you will see us to continue to do more of those along various lines of software features that people would want to, yes, such as security, such as parental control.

All right. And the last thing I want to talk about, could you just talk about the vision that you guys or you have about Arlo with this new product introduction, because it's -- it seems like it's a little different than where you wanted to go before, but it's also trying to figure out what’s the differentiating factor between you and what's now Amazon's security features.

Well, as I just mentioned in previous discussion, we’re in a quiet period right now. So we cannot discuss too much into the Arlo's strategy vision details. I would encourage you to look at the prospectus and the prospectus could be obtained from the underwriters.

But you guys are -- you’re announcing a new product and going on the road, and you’re not going to talk about the vision, though?

As we said, I mean, the prospectus tells a lot, so I would encourage you to look at the prospectus.

Okay. All right. Thank you.

There are no further questions. I now turn the call back to Patrick Lo.

Great. Thank you everybody joining today’s call. I know its early and we really appreciate and thank you everybody. And I’m very excited because of all of these new products that we introduced and just announced today and, of course, a lot of exciting things happening. And once again, I really hope that you can all join us on our Analyst Day in September in our San Jose headquarter. And I look forward to updating you all again on that day with more exciting news about products as well as NETGEAR's going forward strategy. Thank you.

This conclude today’s conference call. You may now disconnect.