NETGEAR Inc. Q1 2023 Earnings Call
Speaker 1: I.
Speaker 2: Good afternoon ladies and gentlemen, welcome to the NECGAR First Quarter 2023 Results Conference call. As the sign-off participants are in, they have listened only mode and please be advised that this call is being recorded. After the speakers prepared remarks, there will be a question and answer session. If you would like to ask a question during this time, simply press start or one on your telephone keypad.
Speaker 2: And if you would like to withdraw your question, please press the pound key. And now at this time I'll turn things over to Mr. Eric Violin. Mr. Violin, you may begin.
Speaker 3: Thank you, Bill. Good afternoon and welcome to Netgear's first quarter of 2023 Financial Results Conference call.
Speaker 3: Joining us from the company are Mr. Patrick Lowe, Chairman and CEO and Mr. Brian Marie CFO .
Speaker 3: Format of the call will start with a review of the financials from the first quarter provided by Brian , followed by details and comments around the business provided by Patrick, and finished with second quarter of 2023 guidance provided by Brian .
Speaker 3: We'll then have time for any questions.
Speaker 3: If you've not received a copy of today's release, please visit Netgears Invest Relations website at www.netgears.com.
Speaker 3: Before we begin the formal remarks, we advise you that today's conference call contains four living statements.
Speaker 3: For looking statements include statements regarding expected revenue.
Speaker 3: Operating margins, tax rates, expenses, and future business outlook.
Speaker 3: Actual results or trends could differ materially from those contemplated by these forward-looking statements.
Speaker 3: For more information, please refer to the risk factors discussed in Nicky's periodic findings with the SEC, including the most recent form 10K.
Speaker 3: And a forward-looking statement that we make on its fall are based on assumptions as of today, excuse me, and Net Gear undertakes no obligation to update these statements as a result of new information or future events.
Speaker 3: In addition, several non-GAF financial measures will be mentioned on this call. A reconciliation of the non-GAF to GAF measures can be found in today's press release on our Invest Relations website. At this time, I would now like to turn the call over to Mr. Brian Murray.
Speaker 3: Thank you Eric and thank you everyone for joining today's call.
Speaker 3: While we came into the quarter of forecasting approximately $28 million in channel inventory reductions of both CHP and SMB products.
Speaker 3: Our actual experience was a reduction of $37 million or $9 million higher than anticipated.
Speaker 3: This increase was due to an untrusted inventory reduction by our largest service provider partner, as well as a meaningful reduction in SMD inventory by our largest e-commerce partner.
Speaker 3: This resulted in an unexpected challenge toward offline.
Speaker 3: Accordingly, our net revenue for the quarter-ended April 2, 2023, was $180.9 million.
Speaker 3: which came below below below into our guidance range down 14.1% year over year and down 27.4% on a sequential basis.
Speaker 3: However, our in-user sales of SME products remain strong.
Speaker 4: growing double digits year on year driven by our Pro AV line of managed switches.
Speaker 4: and try and quad band Wi-Fi mesh products and 5G mobile hotspots.
Speaker 4: Again, outperform the broader market.
Speaker 4: Growns sequentially despite normal seasonal patterns.
Speaker 4: While the gross margin improved dramatically during the quarter.
Speaker 4: It was not enough to offset the reduced leverage from a top line. As a result, we delivered non-gap operating laws to $7.1 million.
Speaker 4: and NGAP property margin came in at negative 3.9%.
Speaker 4: on the F-operative margin came in at negative 3.9%. Low below end of regattance range.
Speaker 4: Which was up 50 basis points compared to the year ago period.
Speaker 4: and is a climb of 230 basis points compared to the prior quarter.
Speaker 4: But the first quarter of 2023.
Speaker 4: and down 23.4% of the sequential basis.
Speaker 4: And me and that revenue was $39.2 million.
Speaker 4: and increase the 6.3% year-to-year and down 25.7% quarter of a quarter.
Speaker 4: Our E-PAC net revenue was 19.8 million dollars.
Speaker 4: which is down 31.8% from the prior comparable period, and down 47.46.8% sequentially.
Speaker 4: Our APEC revenue saw outside the clients through the 7 COVID surge in China at the end of last year and in the Q1 of this year.
Speaker 4: which caused the significant work explode in China, Hong Kong and Korea.
Speaker 4: For the first quarter of 2023, we shipped total of approximately 1.8 million units.
Speaker 4: including 860,000 nodes of wireless products.
Speaker 4: Shipments of all wired and wireless routers and gateways combined were about 485,000 units for the first quarter of 2023.
Speaker 4: The net revenue split between homeland business products was about 57% and 43% respectively.
Speaker 4: The net revenue split between wireless and wire products was about 44% and 56% respectively.
Speaker 4: Product introduced in the last 15 months constitutes about 18% of our first quarter shipments.
Speaker 4: While product introduced in the last 12 months contribute about 12% of our first years
Speaker 4: From this point on, my discussion points will focus on non-GAAP numbers. The reconciliation from GAAP to non-GAAP is detailed in the earnings released distributed earlier today.
Speaker 4: Non-Gap Rose Martin in the first quarter of 2023 was 33.6%.
Speaker 4: which is up 540 basis points as compared to 28.2% in the prior year comparable period.
Speaker 4: and up 870 basis points compared to 24.9% in the fourth quarter of 2022.
Speaker 4: This represents our second highest gross margin since the beginning of 2019.
Speaker 4: As compared to both the prior year period and Q4 2022, we experience an improved mix of our premium value
Speaker 4: as well as the higher mix of SMB revenue.
Speaker 4: Both of which carry higher margins.
Speaker 4: Additionally, we experienced lower sea freight costs as determined when the inventory was purchased.
Speaker 4: End decreased or use of higher cost air fray due to an improved supply picture. Total Q1 non-gap operating expenses came in at $67.9 million.
Speaker 4: which is at 1.1% year-over-year and up 2.8% sequentially.
Speaker 4: Our headcount was 722 as it ended the quarter of slightly for 691 and Q4. We will continue to suffegetly invest in our business and hiring key areas where we believe we will deliver future growth and profitability.
Speaker 4: such as ProVV-Menu switches.
Speaker 4: premium Orbi Wi-Fi mesh systems, 5G mobile hotspots, and subscription services.
Speaker 4: However, we continue to evaluate other areas of the business on a regular basis.
Speaker 4: and plans to drive further cost efficiencies. Our non-gap R&D expense for the first quarter was 11.6% of that revenue, as compared to 10.8% of that revenue in the prior year's comparable period.
Speaker 4: and 7.7% of them that revenue in the fourth quarter of 2022.
Speaker 4: To continue our technology and subscription service leadership, we are committed to continue to investment in R&D.
Speaker 4: Our non-gap tax assistance was a benefit of $19,000 in the first quarter of 2023.
Speaker 4: Looking at the bottom line for Q1, we reported non-gap net loss of $5.6 million and non-gap to lose net loss for share of 19 cents.
Speaker 4: At the bottom line for Q1, we reported non-GAAP net loss of $5.6 million and non-GAAP to lose net loss per share of 19 cents. Turning to the balance sheet.
Speaker 4: We ended the first quarter of 2023 with $239.2 million in cash and short-term investments.
Speaker 4: up 11.8 million dollars from the prior quarter
Speaker 4: During the quarter, $9.1 million of cash was provided by operations.
Speaker 4: which brings our total cash used by operations of the trailing 12 months to $5.9 million.
Speaker 4: We use $870,000 in purchase of property and equipment during the quarter, which brings their total cash use for capital expenditures of the trailing 12 months to $5.7 million.
Speaker 4: Now, turning to the first quarter results for our product statements.
Speaker 4: The connected home segment, which includes our industry leading forging, Nighthawk, Nighthawk Pro Gaming, Armor, and Miro Brands, generated the neck revenue of $102.7 million in the quarter. Down 21.2% on the year-over-year basis, and down 31.1% sequentially.
Speaker 4: We experienced a year-over-year decline in both the retail and service provider channels, as the year-over-year period was still experiencing relatively elevated demand and higher inventory carrying levels at our channel partners. Despite a year-over-year double-digit decline in the consumer networking market overall in Q1, we are still experiencing a year-over-year decline in the consumer networking market overall in Q1.
Speaker 4: that same period. Importantly, these higher margin, high end products
Speaker 4: helps offset the loss top line leverage and results in an improved contribution profit in the CHP business as compared to the years of a period and Q4 2022 despite lower revenue.
Speaker 4: This is clear validation of the long-term growth and profitability potential of our core strategy.
Speaker 4: On the SMB side, our products continue to go in a strong reception in the market.
Speaker 4: And in user sales, who doubled his interest year on year. However, while we had anticipated some channel inventory reductions of our SMB products, we also experienced a drastic and unanticipated reduction in inventory-taring levels at our Lord's e-commerce channel partner.
Speaker 4: in the first quarter, a decline of 2.6% on a year-over-year basis, and 21.9% sequentially.
Speaker 4: The man remains exceptionally strong for our pro-AV men and switch products.
Speaker 4: As we continue to look to the remainder of the year, broad-based inflationary pressures and the uncertain macroeconomic environment still remain top of mind for our partners across all channels. Consequently, while we materially lower channel inventory in the first quarter, we continue to expect top-line headwinds in the next quarter.
Speaker 4: to the inventory reductions in the near term.
Speaker 4: We expect in-market sale of our premium CHP products and our SMB products.
Speaker 4: to continue to deliver growth. A positive indicator for the underlying business.
Speaker 4: I'll touch on this more recovering our guidance for the second quarter of 2023.
Speaker 4: I'll touch on this more when covering our guidance for the second quarter of 2023. I'll now turn the call over to Patrick for his commentary.
Speaker 5: Thank you, Brian . After three years of the pandemic, broad-based inflationary pressures amid an uncertain macroeconomic environment are affecting consumers and industries around the world.
Speaker 5: In the first quarter, channel partners in all parts of our business sharply constrained their order to reduce inventory carrying levels.
Speaker 5: In the first quarter, channel partners in all parts of our business sharply constrained their order to reduce inventory carrying levels more aggressively than our original estimates.
Speaker 5: impacting our top line and resulting in lost operating leverage.
Speaker 5: However, the overarching market trends that we have based our strategy on.
Speaker 5: Delivering leading-edge, technologically differentiated products to consumers and businesses that will pay for high-performance features are clearly evident in the behavior of our end-users.
Speaker 5: up 540 basis points year over year and 870 basis points sequentially.
Speaker 5: as we achieved our second highest gross margin since the beginning of 2019.
Speaker 5: We believe this serves as strong validation of our strategy to move away from the less profitable, lower end of the market, and focus on premium products where profitability has been consistently stronger.
Speaker 5: The impressive gross margin result of this quarter gives us renewed confidence in the sustainability and longevity of the margin expansion potential, unlocked by our core long-term growth strategy.
Speaker 5: even through periods of macroeconomic uncertainty.
Speaker 5: especially when channel inventory levels stabilize.
Speaker 5: Now, trying to run an update on our CXP business.
Speaker 5: The man for our best selling, premium OB-8 and OB-9 mesh Wi-Fi products remained strong. An end user sales actually grew sequentially even in the face of a normal seasonal decline from the Q4 holiday period.
Speaker 5: The solid performance of these higher margin products enabled CHP to contribute to our significant gross margin improvement in the quarter.
Speaker 5: The Wi-Fi 7 upgrade cycle is coming later this year and we are poised to capitalize on another technological inflection point.
Speaker 5: As the transition of our portfolio mix from low-end to high-end progresses, ASPs, margins, and service attached rates should improve in tandem.
Speaker 5: and deliver long-term growth and profitability.
Speaker 5: Innovation is the key to net geoste success, and I'm excited to share that we are again at the forefront of the next technology inflection.
Speaker 5: As we recently launched our first Wi-Fi 7 router, the Nihok RS 700.
Speaker 5: This high performance tri-band router is spearheading the Wi-Fi 7 revolution.
Speaker 5: and introduces a powerful new antenna design.
Speaker 5: capable of delivering Wi-Fi speeds of up to 19 kbps.
Speaker 5: more than double that of the previous generations.
Speaker 5: Optimized for the requirements of modern, hyper-connected homes.
Speaker 5: The Nihok RMS 700 also features a tanky-gibbit internet port and full gigabit land ports for fast, flexible wired connections.
Speaker 5: It's the first mover in the Y5-7 space.
Speaker 5: We expect this product to expand our addressable market even further as consumers future proof their networks.
Speaker 5: The Nihok RS 700 retailing at $699.
Speaker 5: is already available for pre-order and will begin shipping this quarter.
Speaker 5: Our Wi-Fi 7 Nighthawk offering will be followed by our Wi-Fi 7 OB Introduction in Q3.
Speaker 5: putting further distance between us and our competitors. The man for our Nighthawk M6-NM6 Pro 5G Mobile Hotspots also remained strong.
Speaker 5: And these products saw end-user sales in the retail channel grow year-over-year and quarter-over-quarter.
Speaker 5: The flexibility of the unlocked version of the M6 Pro 5G MOBA hot spots.
Speaker 5: Launched just recently in the fourth quarter in Europe . It extremely appealing to customers.
Speaker 5: and the unlocked category grew double digits sequentially. Cable ball of delivering speeds of up to 3.60 giblets per second and connecting up to 32 devices simultaneously.
Speaker 5: for the customers accommodate their unique location in carrier.
Speaker 5: We expect to launch the US version of the unlocked Nighthawk M6 Pro 5G mobile hotspot next month.
Speaker 5: And we expect it will greatly expand our addressable market with support for all three major domestic carriers along with international roaming.
Speaker 5: At an MSRP of $999, it will further improve our ASP's unit growth and uplift margins over time. These exciting new products will be key contributors to top and bottom line growth for CXP in the seasonally strongest second half of the year.
Speaker 5: when retail channel inventory levels stabilize.
Speaker 5: We have seen improved demand for our Negier Alma service.
Speaker 5: as cybersecurity and privacy are top of mind for consumers these days.
Speaker 5: And AMA is the only protection built directly into the router. With the most comprehensive security solution available today, in the first quarter, we grew our paid subscribers by 23.1% year over year, ending the first quarter with 772,000.
Speaker 5: Service revenue grew to $9.6 million, up 26.3% year-over-year and up 7.9% sequentially. Our messaging around the services that only Netgear can offer is clearly resonating with customers.
Speaker 5: And we are steadily working towards our goal of 875,000 paid subscribers by the end of 2023.
Speaker 5: A key element of our premium strategy is the curated online experience we deliver to guide our value added customers through the shopping experience.
Speaker 5: This approach has helped growNeggier.com as a channel.
Speaker 5: And with the expansion of these services to the UK, France, Germany, and the United States, we have a great opportunity to accelerate our traction. Increased traction in the premium segment of the market through this tiny profitable channel, help so subscribe the Bayes Grow in tandem.
Speaker 5: operating margin expansion. Turning to our SMB business, the technological differentiation inherent in Net Gears Pro-AB managed Ethernet Switch products has fueled substantial end customer growth.
Speaker 5: up over 50% year over year. And that drove in customer sales growth of 18% year over year for the entire SMB business.
Speaker 5: In conjunction, we have also made great in-roads in increasing our Pro-AB manufacturer and integrator partnerships, nearly doubling the number of our Pro-AB manufacturing partnerships year over year to over 200.
Speaker 5: We are poised to expand our opportunity by building on the success of our M4258AVOVIB switches.
Speaker 5: with the introduction of the M4350 this quarter, which will enable more power over Ethernet budget and more 25 gigabit per second ports. As the industry transitions from cumbersome analog solutions,
Speaker 5: To ultra high resolution, intelligent digital AV over IP, we continue to make progress in expanding our routes to new markets to fully capitalise on this momentum and unlock even greater available market opportunities across new verticals.
Speaker 5: We will support the SMPTE protocol on our new M4350 ProAV switches for the broadcast and studio industry by year's end and that will only accelerate this industry's move from analog to all digital IP.
Speaker 5: As channel inventory stabilizes in the second half and we expand the addressable market, we expect our highly profitable SMB business to resume is territory to become a greater part of our review mix and thereby expand our rows and operating margin as well.
Speaker 5: A relentless focus on innovation has been integral to net gear becoming the market leader in our high-end growth categories, and also decisions as well to fully capitalize on the trends we discussed at our recent analyst day. Growing the premium segment of the CXP market,
Speaker 5: Continue the momentum behind our paid subscriber additions in a rapidly accelerating transition from analog to digital IP based AV over Ethernet connections.
Speaker 5: And with that, I'll turn it back over to Brian to comment on our opportunities and obstacles in the coming quarter and year.
Speaker 4: Thank you, Patrick. We expect to continue to experience strong underlying demand in the F&B business and the premium portion of the CHP product portfolio.
Speaker 4: even in the face of ongoing broad-based inflationary pressures and an uncertain macroeconomic environment.
Speaker 4: We will continue to work with our channel partners across both businesses to optimize their inventory carrying levels.
Speaker 4: and expect a revenue impact from these efforts to be at a similar level as experienced in the first quarter. Accordingly, we expect our second quarter net revenue to be in the range of $150 million to $165 million.
Speaker 4: We expect second quarter gap offering margin to be in the range of negative 13.4% to negative 10.4%.
Speaker 4: And non-GEP operating margin is expected to be in the range of negative 9% to negative 6%.
Speaker 4: Our gap tax rate is expected to be approximately 11%.
Speaker 4: and our non-GAAP tax rate is expected to be 6% for the second quarter of 2023.
Speaker 2: We would now like to answer any questions from the audience. Thank you, Mr. Murray. Ladies and gentlemen, at this time, if you have any questions, simply press star one. And if you do find your question has been addressed, you can remove yourself from the cube by pressing the pound key.
Speaker 6: Again, star one for questions, and we go first this afternoon to Ahmed Krasand at BWS Financial. Hi, so my first question is what's been the biggest challenge for you as far as handling this inventory demand imbalance? It seems like every quarter.
Speaker 4: there's been an issue that comes about. Yeah, I think, as I noted earlier, I think this quarter in particular it was the surprise factor. And I think you're seeing from a number of different companies the impact that they're feeling from the environment.
Speaker 4: the service provider account I mentioned earlier is publicly noted, some of the challenges they've seen on the free cash flow side and you know, they're in extreme circumstances and they're responding accordingly. So, I think it's the surprise factor to that. As I noted, we expected about $28 million of de-stocking to happen in the quarter. And just to remind everybody
Speaker 4: What that really means is that as our channel partners sell through, they just won't replenish the same rates. So we expected a size of the amount and we expected it to be across both businesses, but as we said earlier, the surprise factor being the service provider account and on the SMB side, the largest e-commerce partner we have, really implementing some very tight strict inventory management.
Speaker 6: direct to the consumer. How are you going about that so you can at least try to offset what's going on at the retail front? You're right. I mean, we are focusing on increasing the mix of our CPC premium products and we're seeing the responsive response from the market.
Speaker 5: as we see the continued sequential growth of those products despite the market decline. And you're right, we're focusing on direct marketing to consumers who are looking for high performance premium products. We do most of our marketing online.
Speaker 5: using all kinds of online marketing capabilities. We're also using our own website, mega.com, to direct them into our web stores and provide tons of service to give them this shopping experience.
Speaker 7: hardware and...
Speaker 8: And then...
Speaker 5: and others and also in lifestyle types of outlets such as the ROP report.
Speaker 5: So yeah, we're doing a lot of online marketing targeting them. The one thing we go to is discounting promotions on these high-end products because we have a very unique offering and we're way about, you know, any of our competitors' offerings and if the customer's want...
Speaker 5: the absolute best Wi-Fi experience either at home or on the go, then the only solution is our OBI mash and our Nihok mobile routers.
Speaker 6: My last question is how are you managing inventory just given where revenue is and what's the plan there?
Speaker 5: Well, absolutely, we cannot control what the channel wants to do. So we are putting in very conservative channel inventory estimate given all these surprises.
Speaker 5: And in return, we also are...
Speaker 5: slowing down the production rate in our factories to slow the inventory coming in. So that's how we manage it. Now certainly in Q1, the surprise is higher than what we asked to make. And that's why we're taking very conservative viewpoints in Q2 and we believe that we would be able to get ahead of the curve.
Speaker 5: in Q2 from an inventory balance standpoint in our own warehouse. Okay, thank you. Sir. Sir.
Speaker 2: Thank you. We go next now to Jake Norrisson at Raymond James.
Speaker 9: Hey, thanks guys. I'm just hoping if you could touch on a few points here. One, have you made any changes to the sort of fiscal year 23 non-GAAP operating margin target and the service provider revenue targets? And then beyond that, can you just let us know what is underpinning your confidence in the back half load this year?
Speaker 4: Yeah, I'll start here with kind of the outlook for the year. I mean, certainly the surprise to Q1 and our guidance to Q2, we're off pace from the guidance that we put out there back in December , our analyst day. At this point, as Patrick has said a couple of times here, we're being cautious, right? We're dealing with an environment where we're seeing...
Speaker 4: unprecedented responses from channel partners in terms of their willingness to hold inventory. So at this point we expect the second half of the year that two things will be driving factors. One is that the CHP retail business gets a typical seasonal lift.
Speaker 4: And then secondarily, we think that the level of destocking will moderate in the second half. And based on both of those factors, we would likely expect the second half of the year, that the total revenues in the back half of the year to...
Speaker 4: over-index the first half by 15 to 20 percent. So that certainly is different than the annual gains that we put out there before and with that lower revenue level, you know, operating margins have been suppressed. But with that revenue outlook in the back half, I think you'd likely be seeing
Speaker 4: just on the thinking and sort of you know share repurchases and capital allocation going forward here? Yeah as we said before we're always looking at it we're opportunistic buyers of our stock we're obviously looking at our cash balances our planned cash outlay for operational purposes.
Speaker 2: And so all those things are factored into ongoing conversations with regards to capital allocation. Okay, perfect. Thank you. Thank you. And gentlemen, it appears we have no further questions this afternoon. Mr. Lowe, I'll hand things back to you for any closing comments. Yes...Okay...
Speaker 5: So thank you everybody for joining us today. I mean, while we're certainly disappointed by the impact of the inventory reduction of our channel partners, we at Engie remain confident in our long-term growth strategy. And I'm proud that the team has made progress shifting our product mix.
Speaker 5: to the high-end premium segment. Although the uncertain economic environment and related inventory compression will continue as a headwind to achieve the full top-line potential of our business in the short term, we are seeing these premium products consistently outperform the broader market. Armed with a rebalanced portfolio of high-margin products and services, we are seeing these
Speaker 5: And with more on the way, our confidence in the next long-term growth treasury is unwavering. I look forward to sharing an update on our progress and our next earnings call.
Speaker 2: Thank you, Mr. Low. Ladies and gentlemen, that will conclude the Netgear first quarter 2023 results conference call. We'd like to thank you all so much for joining us and wish you all a great remainder of your day. Unfortunately no exhibitors here will retire later than Monday.