NETGEAR, Inc. (NTGR) Q2 2022 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by. At this time all participants are in a listen-only mode. Later we will conduct a question-and-answer session. [Operator Instructions] I’d now like to turn the conference over to Erik Bylin. Please go ahead, sir.

Thank you, David. Good afternoon and welcome to NETGEAR’s Second Quarter 2022 Financial Results Conference Call. Joining us from the company are Mr. Patrick Lo, Chairman and CEO; and Mr. Bryan Murray, CFO. The format of the call will start with a review of the financials for the second quarter provided by Bryan followed by details and commentary on the business, provided by Patrick and finish with third quarter of 2022 guidance provided by Bryan. We’ll then have time for any questions. If you’ve not received a copy of today’s release, please visit NETGEAR’s investor relations website at www.netgear.com. Before we begin the formal remarks, we advise you that today’s conference call contains forward-looking statements. Forward-looking statements include statements regarding expected revenue, operating margins, tax rates, expenses and future business outlook. Actual results or trends could differ materially from those contemplated by these forward-looking statements. For more information, please refer to the risk factors discussed in NETGEAR’s periodic filings with the SEC, including the most recent Form 10-Q. Any forward-looking statements that we make on this call are based on assumptions as of today and NETGEAR undertakes no obligation to update these statements as a result of new information or future events. In addition, several non-GAAP financial measures will be mentioned on this call. A reconciliation of the non-GAAP to GAAP measures can be found in today’s press release on our Investor Relations website. At this time, I would now like to turn the call over to Mr. Bryan Murray.

Thank you, Erik and thank you everyone for joining today’s call. Net revenue for the quarter in the July 3, 2022 was $223.2 million, which was above the high end of our guidance range up 6% sequentially and down 27.7% year-over-year. Strong operational execution by the team unlocked incremental supply, which drove the higher than expected performance. This included incremental supply of our ProAV managed switch products, which powder [ph] SMB business to a record quarterly top line. In our CHP business, we continue to see double-digit growth in our super premium WiFi mesh products, as well as our 5G mobile hotspots. Both of which were aided by improved supply in the quarter. The 5G mobile hotspot supply improvement in particular enabled us to deliver higher revenue from our service provider customers than initially expected. We ended the second quarter with a non-GAAP operating loss of $4.2 million, and non-GAAP operating margin of negative 1.9%. Also above the hot top end of our guidance, primarily as a result of the incremental top line leverage. We began our efforts to optimize spend on the CHP side of the business in the second quarter by deemphasizing investment in areas that are declining, and in conjunction with stronger SMB performance, we were able to improve non-GAAP operating margins by 250 basis points as compared to the prior quarter. For the second quarter of 2022, net revenue for the Americas was $144 million, a decline of 32.3% year-over-year, and relatively flat on a sequential basis. EMEA, net revenue was $45 million, which is down 27.2% year-over-year, and up 21.9% quarter-over-quarter. Our APAC net revenue was $34.2 million, which is down a 0.5% from the prior year comparable period and up 17.9% sequentially. Year-over-year revenue declines were principally driven by the retail quarter of the CHP business. Although these declines, were partially offset by strong performance in SMB, where we saw double-digit growth in all three regions. For the second quarter of 2022, we shipped a total of approximately 2.2 million units, including 1.3 million nodes of wireless products. Shipments of all wired and wireless routers and gateways combined were about 702,000 units for the second quarter of 2022. The net revenue split between home and business products was about 58% and 42% respectively. And net revenue split between wireless and wired products was about 58% and 42% respectively. Products introduced in the last 15 months constituted about 28% of our second quarter shipments. While products introduced in the last 12 months contributed about 22% 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. Non-GAAP gross margin in the second quarter of 2022 was 27.7%, which is down 270 basis points as compared to 30.4% in the prior year comparable period, and down 50 basis points compared to 28.2% in the first quarter of 2022. As compared to the prior year, we experienced an increase in material costs, overhead costs and transportation costs. Total Q2 non-GAAP operating expenses came in at $66.1 million, which is down 1.9% year-over-year and down 3.7% sequentially. Our headcount was 740 as of the end of the quarter, down from 766 in Q1. We expect our headcount to remain at this approximate level, but we will rebalance our headcount deployment to focus resources and invest in areas that we believe will deliver future growth and profitability such as ProAV, Orbi 8 and Orbi 9 WiFi systems, 5G mobile products, and subscription services. Our non-GAAP R&D expense for the second quarter was 9.5% of net revenue as compared to 6.9% of net revenue in the prior year comparable period, and 10.8% of net revenue in the first quarter of 2022. To continue our technology and subscription service leadership, we are committed to continued investment in R&D. Our non-GAAP tax rate was negative 4.1% in the second quarter of 2022. Looking at the bottom line for Q2, we reported non-GAAP net loss of $5.5 million and non-GAAP diluted net loss per share of $0.19. Turning to the balance sheet. We ended the second quarter of 2022 with $250.1 million in cash and short-term investments, down $13.7 million from the prior quarter. During the quarter $5.2 million of cash was provided by operations, which brings our total cash used by operations of the trailing 12-months to $6.6 million. We used $1.1 million in purchases of property and equipment during the quarter, which brings our total cash used for capital expenditures over the trailing 12-months to $7.3 million. In Q2, we spent $15 million to repurchase, approximately 678,000 shares of NETGEAR common stock at an average price of $22.13 per share. Since the start of our repurchase activity in Q4 2013, we have spent $651.9 million to repurchase 18.9 million shares. We are committed to returning value to our shareholders and plan to continue to opportunistically repurchase shares in future periods. Our fully diluted share count is approximately 29 million shares as of the end of the second quarter. Now turning to the second quarter results for our product segments. The Connected Home segment, which includes our industry-leading Orbi, Nighthawk, Nighthawk Pro Gaming and Meural brands generated net revenue of $128.9 million during the quarter, which is down 43.9% on a year-over-year basis and down 1.1% sequentially. We experienced a year-over-year decline in both the retail and service provider channels. As a reminder, the prior year comparative period for the retail portion of the business was boosted by heightened consumer demand in response to the pandemic, along with stocking a depleted channel to meet the heightened demand. Our service provider business rebounded well in Q2 with a strong sequential increase enabled by improved supply of 5G mobile hotspots, and the strength is expected to continue in the second half of the year. We were better able to navigate the supply chain challenges facing our SMB business in the quarter. And I’m excited to share that the SMB generated record net revenue of $94.4 million for the second quarter of 2022, which is up 19.5% on a year-over-year basis and up 17.6% sequentially. Once again, thanks to our strategic investments in ProAV, our managed switch products led the way with 69% growth as compared to the prior year. Additionally, we see increasing traction with our portfolio of WiFi 6 cloud managed mesh wireless access points. Furthermore, we once again spent heavily in air freight to compensate for shipping and production delays, offsetting the higher margin contributions from this business. I’ll now turn the call over to Patrick for his commentary, after which I will provide guidance for the third quarter of 2022.

Thank you, Bryan. For those substantial supply chain disruption brought on by the pandemic, is continuing to affect companies across many industries. I’m proud of our team’s excellent execution in navigating these challenges in the second quarter, across a number of strategic product categories, enabling us to overachieve relative to our guidance. Our ProAV managed switch line of products is the first of these strategic product categories. And it helped drive our SMB top line to a record result in Q2. These switches enable the AV industry to make the transition from analog HDMI solutions to intelligent digital AV-over-IP Ethernet solutions. NETGEAR delivers differentiation on three different levels, which allows us to continue to expand and lead this newly created market. First, the ProAV software built into our switches, mix them compatible with all major AV equipment manufacturers and system integrators, enabling trouble free and time saving installation of video conference rooms, streaming video production studios, large scale ultra high definition displays, and digital signage displays. Just to name a few applications. Second, the breadth of a portfolio of ProAV managed switches from desktop 8-port to rackmount 48-port from one gig to 10 gig to 100 gig switches is unique in the AV industry and allows maximum flexibility depending on the application. Finally, we differentiate our solution with a ProAV design consulting team that spans all three geographic regions and all major markets. This combination of capabilities and knowledge of IP switching and AV systems forms a defensive mode that is difficult for others to build and replicate. This ProAV line was the driving force, which kept our SMB revenue momentum on an upward trajectory with double-digit year-over-year growth in all three geographies. As we aim to make further progress in minimizing supply constraints over the remainder of 2022, we expect even stronger performance from SMB in the back half of the year. On the CHP side, our super premium Orbi 8 and Orbi 9 WiFi mesh products demonstrated double-digit growth in end market sales. And we continue to progress with our strategy of shifting more of our consumer CHP product revenue mix towards satisfying the top end of the Residential segment. Our Orbi 8 and Orbi 9 WiFi mesh systems, which are powered by patented Tri-band and Quad-band antenna designs, enable the very best WiFi speed, capacity and coverage and various residential footprints. Orbi’s superior performance is consistently validated by industry accolades and awards, including the latest in Tom’s guide. In an article highlighting the 2022 best devices for working from home, the Orbi 9 took top honors for best mesh system and was mounted for outstanding performance, as well as ease of setup. Orbi has even won the hearts and minds of journalists buying tech for themselves. Ms. Joanna Stern, Senior Personal Technology Journalist for the Wall Street Journal recently tweeted the results of a speed test on her personal Orbi system, sparking a tied of NETGEAR customers to respond with the impressive speeds of their own systems. Our antenna designs are the combination of NETGEAR’s 25 years of radio frequency design, and test experience in different residential conditions ranging from Tokyo to Sydney and Munich to London, New York, Texas, and to California. Additionally, these systems are equipped with Armor, which protects all connected devices from incoming attacks and outgoing possible nominees [ph]. These products, which are priced at a $1000 and up are sought after, by those who want only the best and most secure WiFi experience. We are also quite pleased to have improved supply in the second quarter for our 5G mobile hotspots, which benefited from sales to both our service provider and retail customers. In the July edition of Computer Built, one of Europe’s most influential tech publications in Germany, our Nighthawk M5 and M1 recently top the list of best mobile hotspots taking the number one and number two positions. In the second quarter, we launched the new M6 and M6 Pro mobile hotspots in AT&T and Dish in the U.S. as well as Telstra in Australia. They are the only devices on the market with the latest 5G technology from Qualcomm. Providing multi-gig download and WiFi 6E on the go. We are working feverishly to improve supply to catch up with the demand. As we have signed up new service providers in Australia and the year, as well as retail channels for the unlocked version of these products. We see tremendous sales opportunities among first responders, traveling professionals, work from many way employees and rural customers. We believe we can continue to build on the success of these three categories, ProAV, super-premium Orbi 8 and Orbi 9 WiFi mesh, and 5G mobile hotspots. We will ride their success and grow both SMB and CHP revenue and margin. Despite the declines at the lower, the middle portion of the consumer WiFi market. We will continue to bill our intellectual property and ecosystems around these three product lines to raise the barrier to entry for our competitors. These three areas remain our core focus and are integral to returning our company to profitability in the second half of the year and growth in both and bottom lines in the years ahead. Last but not least on the services side, revenue was $8 million for the second quarter up 4% sequentially and up to 26% year-over-year. Affluent residential customers of our Orbi 8 and Orbi 9 are more likely to adopt our varied subscription services, Armor smart parental controls and pro support for the Orbi. We’re also seeing more of our SMB channel partners, including those ProAV system integrators, wireless LAN wires and even large scale commercial mobile hotspot deployment enterprises adopting our insight remote management subscription services. We entered a quarter with 654,000 paid subscribers with the seasonally stronger second half ahead of us. We remain confident that we will reach our target of 750,000 paid subscribers by the end of 2022. We still believe subscription services, revenue both in CHP and SMB will be a key driver of our margin and top line expansion effort in the medium and long-term horizons. And with that, I’ll turn back to Bryan to comment on our opportunities and obstacles in the coming quarter and year.

Thank you, Patrick. With solid demand and improving supply, we expect SMB and the CHP service provider channel to continue to gain momentum in the back half of the year. We expect third quarter revenue from the service provider channel will be approximately $40 million and SMB revenue to grow sequentially. With some of our U.S. retail customers intending to shrink their inventory positions further. We expect to continue working with them in the coming quarter to optimize their inventory levels. Together these factors lead us to expect our third quarter net revenue to be in the range of $240 million to $255 million. While the supply picture continues to improve, we still expect to spend on air freight to maximize our SMB revenue. As a result of these factors, our GAAP operating margin for the third quarter is expected to be in the range of negative 1% to 0%, and non-GAAP operating margin is expected to be in the range of 1.5% to 2.5%. Our GAAP tax rate is expected to be approximately 22% and our non-GAAP tax rate is expected to be 15% for the third quarter of 2022. While we are confident in our ability to provide guidance at this time, we do so with the caveat that considerable uncertainty remains in the market due to the COVID-19 pandemic and supply chain conditions, continuing to remain challenged, and should unforeseen events occurs in particular challenges related to closure of our manufacturing partners operations, increased transportation delays into any of our regional distribution centers or greater than expected freight or component costs, our actual results could differ from the forging guidance. We would like to answer any questions from the audience

[Operator Instructions] Our first question comes from Adam Tindle with Raymond James. Your line is now open.

Okay. Thanks. Good afternoon. I just wanted to start maybe with Bryan. I think on this call 90 days ago, we talked about this back half being up about 25% from the first half on a revenue basis. Obviously we now have three guidance and I’m looking for maybe an update there, particularly given you talked about further channel inventory reduction from U.S. retail, wondering if that’s going to be done in Q3 where Q4 might be, significantly up from a seasonality standpoint or maybe just how to think about the back half of the year from a revenue standpoint.

Sure. Obviously we contemplate our guidance, the level of channel optimization in the Q3. We do believe the majority of that should take place in the third quarter. I would expect that, in the fourth quarter we would see a mid-to-high single-digit sequential revenue increase. Obviously that’s dependent on supply availability, but based on the picture that we see today, that’s where I would steer the back half of the year from a revenue standpoint. Obviously you’re seeing some margin expansion in the third quarter because of the top line leverage that we’re gaining, with the higher revenue. Again, with the sequential increase going into Q4, I would expect further margin expansion probably in the neighborhood of 200 basis points. But again, that’s all dependent on supply availability and based on the information we have today, that’s where I’d steer you.

Okay. Yes. That’s very helpful. And maybe on that margin expansion point, you had talked about taking some cost actions last quarter; maybe just remind us where you stand on those. Are those kind of fully reflected in the Q2 results? How to think about OpEx on a go forward basis where we stand on the cost actions piece of this?

Yes. We do believe that we’ve taken the actions that were necessary to right size for the CHP business. Those are materially reflected in the Q2 results, and I would expect OpEx to kind of maintain it that level.

Okay. And just one last one to clarify for cash flow for the rest of the year. Is there a way for us to kind of think about full year cash flow, given all the moving parts and clearing out channel inventory?

Yes, I do expect cash flow will continue to improve from this point forward. Obviously we came in this year wanting to compress and right size our own existing inventory. We’ve made some progress in the second quarter. I expect that to continue in the back half of the year. So, I do think that we’ll see an improvement in free cash flow, probably in that neighborhood of 50% to 75% of non-GAAP net income.

Perfect. Sounds like a lot of positives ahead. Thank you so much.

Thanks, Adam.

Next we’ll go to Hamed Khorsand with BWS Financial. Your line is now open.

Hi. I was just – I want to ask about how are you managing the inventory at the retail level, given the conversations you’re having with your partners? Are you investing more in the SMB line? Are you shifting inventory away from the retail to, or retailers to your online platform? And just and how are you managing the inventory that you have on hand given the pushback you’re getting from retail partners?

So basically what we work with individual channel partners is in the aim of optimizing well, our prospective maximizing our in-market sales. And as you probably know, the SMB channel is quite different from the CHP channel. So there’s not much you could do about shifting inventory from retail to the varied reseller channel and different product sets. We’re not going to sell ProAV in best buy. So that is irrelevant. And also on the other hand, the online channel generally keeps a much less stock than the retail physical store. So there’s not much channel inventory reduction over there. So, as you watch all the retailers report in the last two weeks, they all think that they need to reduce the inventory one way or the other. And they all see that demands continue to be weakened. So when demands, when they forecast demands to be weakened, and of course, the further string channel inventory now, given the fact that there are 13 weeks in a quarter. So, let’s say if they decided, they want to ship to maintain eight weeks of inventory, but currently they’re sitting on 13 weeks. So naturally we would have to ship every week less than what they sell out, until they get there. So that’s how we manage the inventory across the board in the channel.

Okay, great. And then on the ProAV side, you’ve talked about the TAM actually being larger than your initial estimate. How fast do you think you get to that addressable TAM? Given the growth you’ve seen recently?

It’s limited by our chip suppliers. We all know, how big it is, big. We ship everything we’ve got. So, we don’t know how big it is and new applications being created every day. For example, we’ve seen some TV broadcast, linear TV broadcast being now contemplated to switch into more, an intelligent AI-based injection. So rather than the media is actually two dimensional or even three dimensional, there’s a completely new. We are also seeing some new applications such as integrating industrial IoT with AV. So when these ends, customers walking in, they could immediately react on what display signage going to produce and things like that. So, but today anyway, we can’t supply enough. So, we don’t know. So, we working with our chip suppliers to try to expand the availability of our products as much as possible.

And my last question was, could you just talk about what your marketing plan is given that your unit shipped count is declining? Is there any fear that you might lose a brand awareness with the consumer and how are you adjusting for that?

What we’re trying to do is really create a premium brand. That means we are targeting for customers who really value the superior performance and quality that our products produce. So in other words, we are focusing more on the quality of the sales rather than quantity of the sales. And eventually I think at the end of the day, the channel partners care more about dollar revenue sales, rather than unit volume of sales. The classic example is, if you’re offering an opportunity to be an authorized dealer of Rolex versus Tissot, what will you pick?

Patrick, I understand that I was – how do you make sure that the consumer realizes that your you’re the Rolex of routers as your shelf size starts to shrink?

Well, it, as I mentioned, if you have the technical press like Tom's Guide/Hardware, tells that we are the best in the industry, you get Wall Street Journal, Joanna Stern saying, look at how great my Orbi is. And you get Computer Built in Frankfurt telling us if you want to buy mobile hotspots, the best is NETGEAR. And the second best is all NETGEAR. I think that that plays into it, right. It’s just like Rolex, getting Roger Federer the rare, they watched to play tennis and Roy McAvoy the way he’s Rolex to play golf and that helps, right? You want to have spokesperson.

Great. Appreciate it. Thank you.

Sure.

Okay. Next, we’ll go to a Jared Jungjohann with Cowen and Company. Your line is now open.

Hi, Patrick and Bryan. This is Jared on for Paul Silverstein. I was just curious, what’s driving the quarter-over-quarter strength in the EMEA and APAC region. I’m especially curious about the EMEA region, considering some of the macro headwinds coming on? Thank you.

It’s just a matter on math. All right. Our 6 Speed business is 70% domestic U.S. So that means while, our SMB business is pretty evenly distributed around the three regions. So, the decline in consumer demand on the 6 Speed side has much less effect on international markets. So that’s why APAC is doing better than Europe, Europe is doing better than the U.S.

Okay. Thank you very much.

Sure.

There are no further questions at this time. Patrick Lo, I’ll turn the call back over to you. I apologize we do have another question from Paul Silverstein with Cowen. Your line is open.

Yes. Guys, I apologize had multiple calls tonight, so if you’ve already answered it, I do apologize. But given prospective macro challenges, but beyond currency translation, the fact that any vendors, any U.S.-based vendors equipment’s going to be more expensive broad. In that positive Patrick, I know asked you Bryan this every quarter, but did y’all provide any delineation between your ultra high end in terms of how much revenues coming from that? And what I would suspect would be more price and elasticity given the nature of that market and the nature of the customers relative to what you’re seeing in terms of macro impact on the mesh market? And again, the two related questions would be, what’s the breakdown between the two and size of businesses and revenue? And what are you seeing in those two different markets?

Well, let me answer the question. It’s kind of funny. I think, I’ve said it for the last 20 years. That it’s interesting when products were nearly introduced with the latest bleeding edge technology, especially is very differentiated. It’s very high margin. And if your competitors change you, to go into that space is suppress the margin, but if you survive the attack towards the end, the margins actually pretty good, because you survive. So, so yes, we have the super premium products, which is unique to us, of course, very high margin. But then we also have some really old products, which have been in the industry for a long time. We have basically chased out everybody, such as power lines, such as adapters, such as extenders. We have really significant market share, even from cable gateways. Those are pretty high margin as well. So it’s only in the middle part, which is the very commoditized, mid range, like routers, low end mesh that, that’s really suppressing a margin. Now, our situation is for the premium products, which includes the Orbi 8 and Orbi 9, as well as our 5G mobile hotpot. Our ultimate aim is for these two strategic product lines would like to be as big as 50% of the total revenue. We’re not there yet, but we’re making good progress.

Can you give us, just for how far away you are patch or when you’re expected to hit that 50%?

I think we’ll get there in maybe two to three years, but mind you the other 50%, not low margin products, some of them are really high margin too.

And Patrick, going back to your response, my question where you would address the margin piece of it from a demand revenue standpoint, are you seeing consumers start to delay pull back in that either the low or the mid end of the market, as opposed to volume, and I assume in the high end, you’re not seeing that, but let me ask you the questionhopefully.

You’re definitely right, is clearly on the low, mid end of the market, people are considering everything right, inflation and all that. And clearly we’re seeing delay in upgrade lengthening of the life cycle. So that’s why that market is shrinking. But then on the other hand, if you look, we look at an NPD data for those that is about $650 is continuing expanding at a rapid clip. So, and then we looked at the phenomenon and we went out and do our own user survey on our customers who bought our Orbi 8 and Orbi 9. And over time we actually see that this quickening, the upgrade cycle. So a lot of what the Orbi 9 customers were actually Orbi 8 customers. And Orbi 8 hasn’t been in the market for more than two and a half years. So clearly they are responding to this newest technology and upgrading faster.

Got it. And Patrick, with respect to those customers that are delaying on the lower end, do you let to respond by cutting price or do you hold price and just take the hit in terms of volume?

We – as we said, right. There are some certain categories that there are practically very few competitors left. All right, like in cable, we practically have only one competitor, adapters same, extenders same. So there’s no need to cut prices. As a matter of fact, we raise prices. Right. And then of course, in the more commodity seriously competitive mid and low range routers and mesh, yes, I mean, we have to do promotions every now and then to keep, to be competitive in that range. Yes.

Well, Patrick, I appreciate response, but the question’s a little bit, the thrust of the question’s a little bit different than the way you responded, which is even where you don’t have competition in a challenge macro, especially you’re going to an hour recession where to gets even where you’re the only supplier, maybe folks delay in purchasing, unless they have to have it. If you don’t have an adapter and you have adapter, but for those folks who have low end routers, even if you had no competition, you might choose to cut prices in order to stimulate them in given...

I just answered that with – I just answered the question by saying we actually raised prices.

Okay. All right. I appreciate the responses. Thank you.

Sure.

Patrick Lo, I’ll turn it back over to you for closing remarks.

All right. Great. Thanks. Well, thank you everybody for joining us today. We’re really excited about our future for both SMB and CHP in terms of top and bottom line expansion opportunities. Well, as Bryan has said, we are expecting the channel inventory reduction for a CHP to be complete by the end of the coming quarter. And that will put us back on track towards growth after that riding our highly differentiated Orbi 8 and Orbi 9 and our 5G mobile hotspots. The ProAV market continues to be very exciting, expanding at a rapid rate and with it. So does our market share in this newly fast growing space. Finally, the path to 2 million paid service subscribers live straight ahead of us in the long-term. And I look forward to sharing updates on all these friends with all of you in three months. Thank you for joining us today.

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