Q2 2023 NETGEAR Inc Earnings Call
At this time all participants are in a listen only mode. Later, we will conduct a question and answer session at that time. If you have a question you will need to press star one on your push button phone I'd now like to turn the conference over to Eric Violet. Please go ahead Sir.
Thank you David Good afternoon, and welcome to Netgear second quarter of 2023 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.
I'll buy a detailed commentary on the business provided by Patrick and finish with third quarter of 2023 guidance provided by Bryan.
Well then have time for any questions.
If you've not received a copy of todays release, please visit <unk> Investor Relations website at Www Dot Netgear Dot com.
Before we begin the formal remarks, we advise you that todays 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 next year'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 as a result of new information or future events.
In addition, several non-GAAP financial measures will be my last 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 Eric and thank you everyone for joining today's call.
We are pleased with the execution of our team this quarter as.
As we delivered net revenue above the high end of our guidance range.
For the quarter ended July <unk> 2023.
<unk> was $173 4 million.
Down 22, 3% year over year.
And down four 1% on a sequential basis.
Enabled by the increased demand for <unk>.
Largest service provider partner outperformed our original expectations.
In the retail portion of our CHP business, our premium products, which consists of our eighth and ninth try and quad band Wi Fi mesh products.
<unk> mobile hotspots.
Once again outperformed the broader market with worldwide sales to end users growing year over year and sequentially.
Also.
We're beginning to see positive signs the retail networking market.
The channel inventory or stabilizing.
Momentum behind our <unk> line of managed switches delivered another strong quarter in end user sales.
Up 44% year over year.
More than offsetting some of the weakness in the traditional SMB market, which has been negatively impacted by the uncertain macroeconomic environment.
Particularly in Asia and Europe .
While we outperformed our Q2 expectations on the top line.
We continue to experience meaningful headwinds in the form of $29 million of channel inventory reductions across both our CHP and SMB businesses during the quarter.
Additionally, the higher mix of service provider revenue.
Seasonality in our REIT CHP retail channel business affected our gross margins.
Accordingly, we delivered non-GAAP operating loss of $10 $7 million.
And non-GAAP operating margin of negative six 2%.
With the margin coming in at the high end of our guidance range.
This was down 430 basis points compared to the year ago period.
And the decline of 230 basis points compared to the prior quarter.
Yes.
For the second quarter of 2023 net revenue for the Americas was $116 6 million.
The decline of 19% year over year and down four 4% on a sequential basis.
EMEA net revenue was $36 2 million.
A decrease of 19, 6% year over year and down seven 7% quarter over quarter.
Our APAC net revenue was $20 6 million.
Which is down 39, 7% from the prior year comparable period.
And up four 2% sequentially.
Our APAC revenue saw outsized declines due to our significant market slowdown in greater China.
Korea.
For the second quarter of 2023, we shipped a total of approximately $1 6 million units.
Including 830000 nodes of wireless products.
Shipments of all wired and wireless routers and gateways combined were about 426000 units for the second quarter of 2023.
The net revenue split between home and business products was about 57% and 43% respectively.
The net revenue split between wireless and wired products was about 55% and 45% respectively.
Products introduced in the last 15 months constituted about 20% of our second quarter shipments while.
While products introduced in the last 12 months contributed about 12% of our second quarter shipments.
Yeah.
From this point on my discussion points will focus on non-GAAP numbers the.
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 2023 was 31, 6%.
This is up 390 basis points as compared to 27, 7% in the prior year comparable period.
And down 200 basis points compared to 33, 6% in the first quarter of 2023.
As compared to the prior year period improved supply for our premium higher margin <unk> products.
And considerably lower total freight cost drove the improvement.
As compared to the prior quarter Q2 experienced a higher mix of service provider revenue to seasonal impact to our <unk> retail channel business.
Total Q2, non-GAAP operating expenses came in at $65 5 million.
Which is down 9% year over year and down three 6% sequentially.
Our head Count was 653 is in the end of the quarter down from 702 in Q1.
We will continue to strategically invest in our business and hiring key areas, we believe will deliver future growth and profitability.
It's probably the managed switches.
Premium or be Wi Fi mesh systems.
<unk> mobile hotspot and subscription services.
However, we continue to evaluate other areas of the business on a regular basis driving further cost efficiencies.
Our non-GAAP R&D expense for the second quarter was 11, 4% of net revenue.
As compared to nine 5% of net revenue in the prior year comparable period and 11, 6% of net revenue in the first quarter of 2023.
To continue our technology and subscription service leadership, we are committed to continued investment in R&D.
Our non-GAAP tax expense was a benefit of $4 million in the second quarter of 2023.
Looking at the bottom line for Q2, we reported non-GAAP net loss of $4 $7 million.
And non-GAAP diluted net loss per share of <unk> 16.
Turning to the balance sheet.
We ended the second quarter of 2023 with $202 8 million in cash and short term investments.
$136 $4 million from the prior quarter.
During the quarter $34 6 million of cash was used by operations, which brings our total cash used by operations over the trailing 12 months to $45 6 million.
We used approximately $700000 in purchases of property equipment during the quarter.
Which brings our total cash used for capital expenditures over the trailing 12 months to $5 3 million.
We expect to return to positive free cash flow in the second half of the year as we make further progress in reducing our inventory and our bottom line improves.
Now turning to the second quarter results of our product segments.
The connected home segment, which includes our industry leading RB.
The Nighthawk Nighthawk Pro gaming Farmer and Bureau brands generated net revenue of $98 $4 million during the quarter.
Down 23, 6% on a year over year basis, and down four 2% sequentially.
We experienced a year over year decline in both the retail and service provider channels as the year ago period, but still experiencing relatively elevated demand and higher inventory carrying levels and our channel partners.
Despite a year over year double digit decline in the consumer retail net networking market overall in Q2.
Our premium or be eight and non Wi Fi mesh to <unk> mobile hotspots once again materially outperformed the market with worldwide sales to end users growing over that same period.
Importantly, these higher margin high end products with.
With higher Asps allowed us to deliver revenue above the high end of our guidance.
This is clear validation of our long term growth and profitability potential of our core strategy.
On the F&B side net revenue came in at $75 million in the second quarter.
Led by continued strong demand for our pro AB managed switch products.
While we continue to be challenged by channel inventory compression to historically low levels as partners navigate through the uncertain macroeconomic environment the.
The SMB end user sales were up high single digits year on year.
Demonstrating strong market momentum of our <unk> line of products.
Despite these near term headwinds, it's clear the strategic investments we've made in the rapidly expanding <unk> market continue to pay off with end user sales in this category growing 44% as compared to the prior year.
While we materially lower channel inventory in the first half of the year across both businesses.
<unk> interest rates and macroeconomic uncertainty remain top of mind for our partners.
We continue to expect topline headwinds throughout the second half of the year as our channel partners constrained, both CHP and SMB products to historically low inventory carrying levels.
However, we expect the revenue impact in the second half of the year to be smaller in the first half.
Encouragingly.
We are starting to see indicators of the broader consumer retail networking market is beginning to stabilize.
And the market should remain steady as we move through the remainder of the year.
Yeah.
Despite our topline remaining challenged due to the inventory reduction in the near term customer appetite for premium CHP products.
Our SMB pro Avi products remained strong.
A positive indicator of the product shows underlying our business.
I will touch on this more fully covering our guidance for the third quarter of 2023.
I'll now turn the call over to Patrick for his commentary.
Thank you Brian .
I am pleased that our results in Q2 came in above our guidance.
It is clear that the growth areas that we have based our strategy, namely premium Wi Fi mesh systems <unk> mobile hotspots.
And paid service subscriptions as well as pro AAV managed switches so continued momentum even in the face of macroeconomic headwinds.
We remain confident that these strategic investments will help lead net geared to long term growth and profitability expansion.
Despite the headwinds of our channel partners optimizing the inventory levels to historically low levels, our higher margin higher ASP premium products are selling well.
Together with a rising paid subscriber base.
Accordingly, we delivered strong non-GAAP gross margin of 31, 6% an increase of 390 basis points year over year, and a testament to the improving transition to the high end of our product portfolio.
As the market continues to stabilize we have begun to see signs of normal seasonality.
It gives us hope that we will experience improved predictability in our business one is channel inventory reductions abate.
In our <unk> business.
The demand for our high speed high performance Wi Fi mesh systems is strong.
For our best selling <unk> eight <unk> nine match Wi Fi products.
End user sales grew year over year solidifying confidence in our roadmap for the second half of the year as the imminent Wi Fi seven upgrade cycle begins with our rollout of Wi Fi <unk> mesh.
We expect Asp's Mara agenda, and services attach rates to expanding tandem.
And are confident in our ability to deliver long term growth and profitability.
Other than our recently announced Wi Fi routers, the Nighthawk <unk> 700 <unk>.
We will start shipping our Wi Fi seven or be mash, albeit nine seven X during Q3.
Together, they will form our initial push into Wi Fi seven with additional new Wi Fi seven products to follow in the coming quarters.
Look forward to the new Wi Fi seven upgrade cycle beginning in 2024.
Demand for our Nighthawk <unk>, six and <unk> Pro <unk> mobile hotspots also remained strong.
And these products saw end user sales in the retail channel grow both year over year and quarter over quarter.
The flexibility that an unlocked mobile hotspots offers is unmatched.
And net gears solutions are truly best in class.
Traction behind unlocked category of swaps remains solid and end user demand grew double digits sequentially.
In Q3, we are refreshing our lineup with a new upgraded international version of our <unk> Pro.
We plan to add support of all three major domestic carriers, along with international roaming in 125 countries.
Would greatly expand our addressable market.
At an MSRP of $999. It will further improve asp's unit growth and uplift margins overtime.
These exciting new products will be key contributors to top and bottom line growth for <unk> in the seasonally stronger second half of the year.
The retail channel inventory reduction abates.
With more new products on the way and further expansion of our direct to consumer web store sales worldwide. We are excited with the prospects of renewed top and bottom line growth of our <unk> business in the back half of 2023 and into 2024.
Outside of our hardware offerings, we are experiencing growing demand of our netgear armor service.
Which is the only protection built directly into the router and can protect every connected device in the home.
More and more connected devices, becoming integral parts of our smart home setup.
Our research together with bit defender has shown smart Tvs and smart power blocks under most hecht devices custom.
Customers, who refused to compromise on cyber security and privacy.
Justin net Gail.
As the first line of defense.
Given that <unk> is the most comprehensive security solution available today in the second quarter will grow our paid subscribers by 22, 9% year over year, ending the first quarter, the second quarter with 804000 subscribers.
Service revenue grew to $10 3 million up 29, 6% year over year and up seven 2% sequentially.
Our messaging around the cyber protection services that only netgear armor can offer is clearly resonating with customers.
And we are steadily working towards our goal of 875000 paid subscribers by the end of this year.
Yes.
We're also seeing strong growth in sales via our online direct to consumer stores worldwide.
Which remains a key element of our premium strategy.
Our direct store provides the best platform to cater to premium performance conscious less price sensitive customers.
With improved customer satisfaction and maximization of the wallet share and higher service attach rate is.
As our footprint with this highly profitable channel grows larger we anticipate growing our subscriber base in tandem with the building momentum behind our premium segment of the market.
We will continue to invest and grow this channel across the globe to drive our premium subscription strategy.
Turning to our SMB business.
Net gears pro AAV managed Ethernet switch products once again saw strong and customer growth up 44% year over year.
It is clear that the technological differentiation inherent in our pro AAV managed Ethernet switch products is resonating with customers with a solid presence around the globe Netgear is a leader in the pro avian market and we made progress in growing our manufacturer and integrative partnership.
Worldwide.
As the industry transitions from Congress on analog solutions to Outra high definition and ultra high resolution.
Intelligent digital ABL of IP, we are proactively expanding into new verticals to unlock even greater available market opportunities such as the custom residential integration and broadcast markets.
It's not only of our customers and partners who are excited about our robust portfolio.
Industry experts are also recognizing the innovation of our pro <unk> line, which was designed with products specifically tailored to the unique needs of the AAV industry.
We are honored that our recently introduced and then $43 50 Pro Avi managed switch one the info Com AAV technology, Our award for Best of show last month in Orlando, Florida.
This powerful AAV over IV managed switch enables even more.
E power budget and more 25 gigabit per second liens ports, all with low latency low jitter and losses transport of Avi signals.
Furthermore, on the software side, where were at support of the video broadcast protocol of 72110 later this year.
As such we expect our highly profitable SMB business to resume its trajectory and becoming a greater part of our revenue mix and improve our overall margins heading into 2024.
And with that I'll turn it back over to Bryan to comment on our opportunities and challenges in the coming quarters and years.
Thank you Patrick.
We expect to continue to experience strong underlying demand in the SMB business.
And the premium portion of our <unk> product portfolio.
Even in the face of ongoing broad based inflationary pressures and an uncertain macroeconomic environment.
We're starting to see indicators that the broader consumer retail network in markets is beginning to stabilize.
However, as interest rates remain high we will continue to work with our channel partners across both businesses to optimize their inventory carrying levels.
But expect a revenue impact from these efforts to be at a lesser level than experienced in the second quarter.
Accordingly, we expect our third quarter net revenue to be in the range of $175 million to $190 million.
We expect third third quarter GAAP operating margin to be in the range of negative 7% to negative 4%.
The non-GAAP operating margin to be in the range of negative 4% to negative 1%.
Our GAAP tax rate is expected to be approximately 15%.
And our non-GAAP tax rate is expected to be 25% for the third quarter of 2023.
We would now like to answer any questions from the audience.
Thank you.
I'd like to remind everyone in order to ask a question Press Star then the number one on your telephone keypad, we'll pause for just a moment to compile the Q&A roster. We will take our first question from Amit <unk> with Dws financial your line is now open.
Hi, My first question was could you just talk a little bit more about the service provider order how much was it for you as far as total revenue is concerned.
And does this change your outlook as to what service provider revenue would look like for the full year.
Yes on the quarter, we unlock the upside of about $10 million from service provider largely coming from our biggest partner there.
And I'd say the majority of that was coming from upside demand in the quarter.
There was some.
And I guess more rational thought put into inventory carrying levels. You may recall that we discussed last quarter that they were working inventory down to extremely low levels never seen before they soften that a little bit, but most of that $10 million of upside is coming from.
Incremental demand pull through.
In terms of going forward and outlook I would say that the $25 million per quarter level is probably the outlook that we would that we would guide people to at this point.
Okay, and then as far as the homeless concern on retail.
Usually Q3 has been a strong spot for your seasonality wise.
What are you not seeing that you would like to see.
No actually we are actually going to see.
Seasonality returning.
The normal seasonality uplift of 10%.
We expect that to happen this Q3.
Okay and then.
As far as just pricing.
Discounts are concerned what is preventing you from reaching.
Breakeven or positive operating margin.
<unk> is still some channel Destocking and we believe that the channel Destocking will last another two quarters.
Definitely shipping.
A lot less than what we actually sell through in the end user market vast basically hurting us from a bottom line perspective.
Yes.
I might add there the Q2 destocking level embedded was referring to was quite sizable about $29 million. You may recall that Q1 was about $37 million. So it's been pretty meaningful in the first half of the year is going to continue in the back half, but we think it's probably at a level of about half of what we saw in the first half and probably a little more frontload.
Added towards towards Q3 and for that reason, we would likely expect a step up in Q4, probably in the neighborhood of about 10%, which we do things.
<unk> takes us to the non-GAAP level of profitability in the low single digit margin level.
Okay. Thank you sure.
Yes.
Next we'll go to Jake <unk> with Raymond James Your line is now open.
Perfect. Thank you.
So just talking about that again so.
You've said, you're seeing signs that the broader <unk>.
Retail network market could be stabilizing in Europe had the confidence that inventory levels in the channel are going to stabilize can you just provide more color on what you are seeing from both fronts there.
There's going to be a lot of investors asking about the back half load with the.
The operating margin expectation in <unk>, if you could just unpack that that'd be perfect.
<unk>.
What we're seeing is every quarter.
<unk> two pre pandemic level. The decline is stabilizing for example for the last three quarters each quarter's market size in U S. Retail is roughly about 15% below the pre pandemic level. It hasnt deteriorated. So that's what we mean by stabilizing because.
Back then the market is following the normal seasonality that means based on using Q1 as a base in Q2 is down roughly about 5% in Q2 to Q3, we expect it to be up 10% and then Q3 into Q4, we expect it to be flat or slightly up.
So that's the normal seasonality returning.
The entire market strength <unk> stabilizing relative to the pre pandemic level. So that's what we mean in terms of channel inventory.
Inventory stabilizing which means that because think about this.
They used to carry 12 weeks of inventory of a bigger market.
Now when the market strengths not only that they would strained to 12 weeks of the smaller market. They actually would like to think two 8% to 10 weeks of the smaller market.
We're getting there alright, and we're getting there I think it would take us two more quarters to get there to about nine weeks of this smaller market yes.
Okay, Perfect and then last one for me a little more high level.
Just talk about the Wi Fi seven refresh opportunity in.
<unk> 24 and.
If we'll see any ASP degradation for the Wi Fi six devices.
We don't believe so because.
Because of the technology of Wi Fi seven which is significantly better in terms of speed and latency initially.
<unk> will be significantly higher.
The Wi Fi six and because there aren't that many Wi Fi serving clients yet so.
So we don't see any erosion in asps over the Wi Fi six in 2024 and of course when you go into 2025, yes, we do expect that.
But then there'll be more Wi Fi seven products and there'll be more weight towards Wi Fi seven sales, which has a higher ASP. So we do see because of that mix effect Asps will continue to go up in the used to come.
Perfect Thats all from me. Thank you.
Great.
And I show that there are no further questions at this time I will now turn the call back over to Patrick Lo for any additional or closing remarks, great. Thanks for everybody joining the call. We're really pleased we are making continuous year over year and quarter over quarter of progress.
In the four pillars of our strategy on the CHP side is basically the three things premium products subscription and direct to consumer sales and on the SMB side is really focusing on the tremendous growth opportunity of <unk> and <unk>.
And we are very excited about going into 2024, and we clearly will share more of those elements and how we could capitalize them more in 2024 in our analyst day, which is going to be somewhere at the end of November early December and we will update you more in those aspects in the next earnings call. So look forward to.
Talking to you all again.
This concludes today's conference call you may now disconnect.
Okay.
Okay.
Sure.