Earnings Call Transcript - NTGR Q2 2022

Operator, Operator

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. I’d now like to turn the conference over to Erik Bylin. Please go ahead, sir.

Bryan Murray, CFO

Thank you, Erik and thank you everyone for joining today’s call. Net revenue for the quarter ending 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 powered the 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 a non-GAAP operating margin of negative 1.9%. Also above the 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 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. The 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. Non-GAAP gross margin in the second quarter of 2022 was 27.7%, which is down 270 basis points 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 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 a non-GAAP net loss of $5.5 million and a 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.

Patrick Lo, CEO

Thank you, Bryan. For those substantial supply chain disruptions brought on by the pandemic, we are 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 makes 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 our portfolio of ProAV managed switches from desktop 8-port to rack-mount 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. We are also 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 a leading tech publication, our Nighthawk M5 and M1 recently topped the list of best mobile hotspots taking the first and second 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 tirelessly to improve supply to catch up with the demand. 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 and middle portion of the consumer WiFi market. We will continue to build 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 our top 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 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 and large-scale commercial mobile hotspot deployment enterprises adopting our insight remote management subscription services. We entered the 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.

Bryan Murray, CFO

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 that continue to remain challenged, and should unforeseen events occur, particularly 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 foregoing guidance. We would like to answer any questions from the audience.

Adam Tindle, Analyst

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.

Bryan Murray, CFO

Sure. Obviously we contemplate our guidance based on the level of channel optimization in 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.

Hamed Khorsand, Analyst

Hi. I was just – I want to ask about how you are managing 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 your online platform? And how are you managing the inventory that you have on hand given the pushback you’re getting from retail partners?

Patrick Lo, CEO

So basically what we work with individual channel partners is in the aim of optimizing 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. That is irrelevant. And on the other hand, the online channel generally keeps 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.

Jared Jungjohann, Analyst

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.

Patrick Lo, CEO

It’s just a matter of math. Our 6 Speed business is 70% domestic U.S. So that means while our SMB business is pretty evenly distributed around the three regions, 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, and Europe is doing better than the U.S.

Paul Silverstein, Analyst

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 is 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 revenue is coming from that?

Patrick Lo, CEO

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 when very differentiated. It’s very high margin. And if your competitors come to go into that space, it suppresses the margin. But if you survive the attack towards the end, the margins actually pretty good, because you survive. So, 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. Our ultimate aim is for these two strategic product lines to reach as big as 50% of the total revenue. We’re not there yet, but we’re making good progress. You’re definitely right, clearly on the low, mid-end of the market, people are considering everything right, inflation and all that. We’re seeing delay in upgrade lengthening of the life cycle. So that’s why that market is shrinking. But on the other hand, we look at the NPD data for those items above $650 that are continuing to expand at a rapid clip. As I mentioned, if you have the technical press like Tom's Guide telling that we are the best in the industry, and the Wall Street Journal’s Joanna Stern stating how great my Orbi is, and Computer Built in Frankfurt declaring that the best mobile hotspots are NETGEAR, that plays into it. Well, it, as I mentioned, if you have the technical press like Tom's Guide telling that we are the best in the industry, you have the Wall Street Journal’s Joanna Stern saying, look at how great my Orbi is, and Computer Built highlighting the best devices for mobile hotspots, it significantly elevates brand awareness, and that helps. Thanks 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. As Bryan has said, we are expecting the channel inventory reduction for a CHP to be complete by the end of the coming quarter. That will put us back on track towards growth after that by 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.

Operator, Operator

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