Q2 2019 Earnings Call
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D.A. Davidson.
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Era A.I.D.R.
Okay. Thank you are drilling you know.
Yes first of all wired and wireless routers and gateways combined were about 1.4 million units for the second quarter, putting 19.
The net revenue split between home and business products was about 73% and 27% respectively.
The net revenue split between wireless and wired products was about 67% and 33% respectively.
Products introduced in the last 15 months constituted about 27% of our second quarter shipments while products introduced in the last 12 months contributed about 19% of our second quarter shipments.
From this point on my discussion points will focus on non-GAAP numbers.
The reconciliation from GAAP to non-GAAP is detailed in our earnings release distributed earlier today.
The non-GAAP gross margin in the second quarter of 2019 was 28.8%.
Which is down 300 basis points compared to 31.8% in the prior year comparable quarter.
And then 450 basis points compared to 33.3% in the first quarter of 2019.
The year over year decline in gross margin was driven by our investments in channel marketing activities.
As well as an impact from the strengthening of the us dollar.
Total non-GAAP operating expenses came in at $56.3 million.
Which is down 20.1% year over year and down 6.4% sequentially.
As always we manage our expenses prudently.
While also investing appropriate resources to the growth portions of our business. So that they have the support they need to succeed.
Our headcount decreased by a net of four people to 824 heads as of the end of the quarter.
Our non-GAAP R&D expense for the second quarter was 7.6% of net revenue.
As compared to 8.2% of net revenue in the prior year comparable period.
And 7.1% of net revenues in the first quarter of 2019.
R&D investment remains critical to the future success of our business.
And we will continue to invest here in the quarters to come.
Our non-GAAP tax rate was 21.8% in the second quarter of 2019.
Looking at the bottom line for Q2, we reported non-GAAP net income of $8.9 million and non-GAAP diluted EPS of 28 cents per diluted share.
Turning to the balance sheet.
We ended the second quarter of 2019 was $218.3 million in cash.
During the quarter, we generated $27.3 million in cash flow from continuing operations, which brings our total cash used in continuing operations over the trailing 12 months to $45.9 million.
We used $3.5 million and purchases of property and equipment during the quarter, which brings our total cash used for capital expenditures over the trailing 12 months to $15.8 million.
As always we remain confident in our ability to generate meaningful levels of cash.
In Q2, we spent $17 million to repurchase approximately 570000 shares of netgear common stock.
At an average price of $29.80 per share.
Since the start of our repurchase activity in the fourth quarter of 2013, we have spent approximately $484.8 million to repurchase approximately 13.4 million shares.
Our fully diluted share count is approximately 32.1 million shares as it ended the quarter.
Our board of directors has authorized the repurchase of up to 4.5 million shares or approximately 14.5% of our common stock outstanding.
This brings our total shares available for repurchase to approximately 5 million shares when including the remaining amount on our previous authorization.
We plan to continue to Opportunistically repurchase our stock in the quarters to come.
Now turning to the results for our product segments.
The connected home segment, which includes industry leading nighthawk.
Orbi.
Nighthawk Pro gaming and Newell brands generated net revenue of $167.5 million during the quarter.
Which is down 10.2% on a year over year basis.
And down 1.1% sequentially.
The year over year decline is due to reduced service provider revenue per connected home, which is down $19.4 million from Q2 2018.
Our market share in consumer Wi Fi continues to be strong at 51% for the second quarter, which is an improvement over the prior quarter.
The SMB segment generated net revenue of $63.4 million for the second quarter of 2019.
Which is down 8% on a year over year basis and down 20.5% sequentially.
As mentioned on our prior call SMB benefited from increased shipments in Q1 to the UK the head of the originally scheduled Brexit deadline.
And as expected we saw a normalization of shipments into the channel in the second quarter.
Meanwhile.
Our PEO, we plus and probably be switching lines continued to perform well in the market.
Our market share and switches sold through US retail channel was also strong at 55% for the second quarter.
I will now turn the call over to Patrick for his commentary after which I will provide guidance for the third quarter of 2019.
Thank you, Brian and Hello, everyone.
While the second quarter of 29 gain was challenging both on the topline and bottom line.
We were successful and improving the U.S retail Wi Fi market.
With our continued rollout of Wi Fi six Nighthawk routers, and our various channel marketing activities.
As Additionally, as Brian just highlighted we expect service provider revenue levels to return to the normal quarterly run rate in the third quarter.
And expect to benefit from the typical Q3 seasonal lift driven by consumers back to school retail spending.
We remain bullish on our opportunities in Wi Fi six.
Gaming Fiveg rolling our services to our install base and opportunities for SMB like pro ASV and PM plus.
As I shared on our prior earnings call. During the first quarter of 2019, we saw the us consumer Wi Fi market declined approximately 8% year over year.
That decline moderated to approximately 4.5% during Q2.
Driven by the Wi Fi six activity is that we undertook during the second quarter.
We'll be releasing additional premium Wi Fi six nighthawk routers during the current quarter as well as a new Wi Fi six 4 billion mash system.
We expect to have the entire Nighthawk line up refreshed by the end of the year.
Furthering the transition from legacy wide five products to new Wi Fi six products.
As you can see from the online reviews. Our currently available Wi Fi six routers have been incredibly well received and we are very excited about the additional wind fivesix products deep building in the second half of the year.
We also recently launched Netgear Ahmar cyber threat protection to while global all being managed Wi Fi installed base.
We have been very encouraged by the initial traction with our trial users.
For the existing or be installed base, we're now offering a free limited period trial of Tom made available through the RBS.
Meanwhile, we are also setting all be bundled with one year of net Armani service at Costco and look forward to seeing these users through new after the first year of service.
We are continuing to expand this new category of arm of bundled products with new models coming to market such as the recently announced Nighthawk cyber secured AC Twentythree hundred Wi Fi router.
We have been encouraged by the reception that RMR has received with consumers worldwide and we believe that our solution is softening a critical needs in today's environment, where data security and cyber attack prevention of in home devices is our priority.
Beyond Ahmad we continue to make progress with our initiative to build recurring revenue streams.
This is especially important as we expect that it will have a significant impact.
On both our bottom line and the stability of net gears earnings in the future.
At the end of the second quarter, we have approximately 11.2 million registered users.
Which represents approximately 45% of our estimated install base.
Our registered user count has grown to $2.8 million.
Which represents approximately 40% sequential user growth over the prior quarter.
We remain very excited about the chinas Mount transformative value creation opportunity of this initiative.
Rounding out CHP during Q2, we expanded our gaming product lineup with the first night Hawk Pro gaming Mash Wi Fi system.
This new mash Wi Fi system for gamers consist of a prepay prepared pro gaming Wi Fi router, and a tri band mash extended which together deliver our high performance gaming experience throughout the home.
Additionally, we continue with our rollout of the Miro digital cancers, most recently devalued debuting at on HSN in May.
We look forward to continuing to build both of these premium consumer brands in the quarters to come.
Turning to the SMB segment as Brian mentioned during Q2, we saw the UK channel Digest the inventory that was purchased in Q1 ahead of the anticipated Brexit deadline.
As of the end of the quarter UK channel inventory had returned to healthy levels.
We continue to be pleased with the growth, we are seeing and pro 80, and BPO plus switching.
Our market share in switches so through the US retail channel was strong at 55% in Q2.
At this year's Infocomm 2019, we announced new additions to our suite of M. 4300 switches that are specifically designed to streamline avi over IP and eliminate complexity in Avi deployments.
One of these switches is the M. 40, 360 next the world's first 60 import 10 base, Steve couple of switch, which can deliver PMG plus across all ports.
Lower cost increased distance and a wider range of applications are rapidly shifting avi distribution to Ethernet networks, instead of HTML, five and as an industry leader in aby over IP networking.
In AG is positioned to lead in this space.
Furthermore, we announced a partnership with Zeevi 18, creating an HTM mine connection module for our AMD 4300 series switches.
We remain very excited about the growth potential pro Avi, especially as the 2020 Olympics, which will be broadcast in 100% for Cavium.
In summary, we effectively navigated a challenging quarter and are now looking forward to the usual seasonal lift in the back half of the year I will now turn the call back to Brian for the third quarter guidance.
Thank you Patrick.
Looking out to the third quarter of 2019 net revenue is expected to be in the range of $265 million to $280 million, which reflects a strong back to school season for consumer retail.
A return to more normal revenue levels for service provider.
Andy sequential rebound for SMB.
To be approximately 25%.
And our non-GAAP tax rate is expected to be 22% for the third quarter of 2019.
Operator that concludes our comments and we can now take questions.
At this time I would 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 and a roster.
And your first question comes from the line of Adam Tindle from Raymond James Your line is open.
Okay. Thanks, and good afternoon, Pat I, just wanted to start with a high level question on the wife I six upgrade cycle can you maybe just speak to your observations of this cycle versus previous cycles, and maybe just compare the cadence is this a burst or a longer milder tailwind and the magnitude in this lift you to that mid single digit growth profile, you talked about that at the analyst day as it materializes.
So the cadence and magnitude of life Isix and then I have a follow up thanks.
Yes, I believe that his wife I think some great is.
You know significantly more appealing.
Then the previous upgrades.
This is a keen to.
You know, replacing a two lane freeway.
With a eight lane freeway and at the same time.
The ownership of cars has exploded from 5% penetration of the households into 60 present penetration. How so you got Mugard and now you are welcoming a new multi lane freeway. So we believe that the transition is going to be really really rapid than in earnest. So normally.
You know in previous cycles, it would take about five years to complete the transition.
But I think in this cycle, we probably would take shorter plus there is more.
Variations to the Wi Fi six because we just don't need come out a streams.
Laissez theoretically we could go on and we have to 64 lanes. So so theres a lot of headroom to go and because of the way of MD protocol. There is a lot that we can play with.
To view to offer various things such as like cards, you can to terrible.
You get the normal one you get a few injection now you have like Craig. So so it's a very exciting time.
Okay. That's helpful and maybe just as a follow up for Brian in light of this I mean, we're going to see the impact in the CHP segment, particularly ex service provider and at the last Analyst Day, you had talked about a seasonality for CHP ex service provider provider of.
Up 11% in Q3 and up 14% in Q4 on a sequential basis I think based on the guidance here Q3 is going to be.
North of that so I'm just trying to understand maybe how we can think about CHP ex service provider seasonality in Q3 and in particular in Q4, given the changes is it maybe a little bit more heavier weighted to Q3, and we don't see 14% in Q4, just some help there would be helpful.
Yes sure.
I would say that we actually believe that we will see that normal seasonal trend in both Q3 Q4, obviously, our Q3 guidance includes a return to a more normal level for service provider, which is obviously driving some of that sequential growth implied in the guidance.
But from a CHP non service provider.
If you look at the last four or five years Weve typically seen about a 15% increase.
Going into Q3.
Which we believe is about rights in in Q4 seasonally we typically see about a 12% lift from Q3.
And again I think we remain confident given the product pipeline. The success, we're seeing with the wife five six adoption.
That we'll see that continue in Q4 of this year.
Okay, maybe I'll have to tweak up my Q3 SMB assumption then.
Just one last follow up you had mentioned in the prepared remarks that you continue to invest in R&D. Previously you had a goal to exit 2019 per operating margins in the 11% to 12% range is that still on track because I think that would also imply a pretty healthy jump from Q3. So if that's still on track, maybe the buckets under and that assumption.
Yes, we remain confident that we can exit this year between 11 and 12% obviously the seasonal lift on top of Q3 that you've seen Q4 will help.
In that respect.
But yes, we do remain confident that 11% to 12% is in reach.
Okay. Thank you very much.
And your next question comes from the line of Brian Young from Deutsche Bank. Your line is open.
Hey, guys.
Just a question on the SMB segment, maybe a broader question can you share what you're hearing from from your sales force or your sales channels, where you're seeing pockets of strength and any headwinds that we should kind of be aware of in the second half of the year.
Clearly on on the SMB side, I think we're seeing strength both on the online channel as well as the traditional value added reseller channel.
And.
As more and more of the sales, especially for small business installation products up pretty much do it yourself is very easy, especially now with the insight app.
So we've seen more and more people just go online buying either through Amazon all through.
CDW.
And they just bring it bring it to the small business is set up using these apps to control. It. So we are seeing very good strength on that one.
And then amount D var channels.
We have been focusing on a few industries that.
That we see a lot of small of ours.
Servicing a huge broad swath of industry, which is exactly to our liking.
We mentioned two things at the pro Avi, there's huge movement in the market that did traditional HCM I audio visual installers because of the arrival for Kb deal.
They have they are moving over to to audio visual over IP Ethernet network.
So that's a new breed of value added resellers and installers that we are going to recruit and they're very fragmented I mean, they would range from installers will outfit and sports bar.
You know to a theater to maybe Apple campus.
So the the Verizon sizes, and and they have never known Ethernet before and we are very engaged with them as I mentioned in Infocomm. Many many of the industry. This specifically tape.
Payload to these installers, so weve seen very good activity in there.
The other one is seeing in the IP surveillance.
Market I mean, as I mentioned last time in the earnings call I mean, unfortunately, well as getting scary as good area and so IP surveillance is a big industry again, I mean, you have installers of IP cameras, big and small and traditionally as you probably know security cameras run over the DVR.
And it was linked to through the video cable, but more and more is.
Cutting over the Ethernet and cutting owned IP and again, I mean, which would training these installers, who would be able to just.
Doing a coffee shop or a small little.
711 stores in Japan doing a few cameras.
Onto a b.
Apartment complex that spans all 600 apartment units and with cameras everywhere or even to banks. So we're seeing very active more activities as a matter of fact, we see tremendous momentum.
In the var channels in the second quarter actually even more so than the online channels. So we're very encouraged by these two particular.
Verticals that we going in.
And we believe that those are offering really exciting opportunities for us.
Great. Thanks, Thanks for that color.
And then can you just expand on the reason for the gross margin decline this quarter.
Our the channel marketing activities is that going to last for a few quarters or is it more of a one time event.
You're right, it's the channel marketing activities. The primary driver of the decline in gross margins.
A little bit of FX headwinds when youre talking year over year, I think the euro is down roughly 7%.
In terms of how we expect those activities to go forward I think we said this on the last call that.
We were essentially Q2 is typically a quiet quarter, there's not a lot of promotional activity going on but we pulled that forward and started to do it in Q2.
In Q3, I would expect to be kind of in the normal range for those.
The back to school promotional activities.
And your next question comes from the line of home AG course on from Vws Financial Your line is open.
Hi.
First off could you talk about gross margin is that.
Surely being dependent on a lot of promotion activity in the quarter and how will that trend now going into the second half of the year.
As David mentioned the year over year impact is meaningful we talked in April about the need to correct. You. It's why play market, which in Q1, we saw declining 8% year over year.
And so we employed a number of activities to really.
Really push really push or wife, I six products that we're rolling into the market.
And go forward you know, we expect those those promotional activities and get back in line with what we normally see in the back half of the year, which we see the lift with back to school and then going into Q4 with all day promotional period.
And then on the topic is look good.
Is that promotional activity are essential for reducing your inventory balance that's true it's up considerably compared to this time last year.
Inventory, we took on some additional chipset to really buffer buffer for the long term, especially as we move some of the factories or in the first half of the year out of China for production from goods coming into the U.S., we expect to work that inventory back down as we become more rooted in these new locations or so I don't I don't think there's any concern with our inventory position.
And just given back to us the promotion activities or any concern that there might be some pushback with consumers as you introduce do.
Products at higher price points.
I don't believe so in fact, I think we've seen very good reception on our higher end why five six routers in the market you can look at the the reviews that are out there we've been very pleased with the market reception of those higher priced routers.
Okay all right. Thank you.
And your next question comes from the line of would you and hope from Bloomberg Intelligence. Your line is open.
Oh, great. Thanks for taking my questions.
So the connected home X service provider in the second quarter held up a little bit better than I thought.
What was it primarily because of the wife, I say 10 or be activity and offsetting some of the softness that you guys had anticipated on a single access point or or had a single access point.
Routers held up a little bit better than you had thought.
Well I mean, essentially contrary to what you just mentioned.
You know Q2 definitely we see you know a healthier activities on a single point routers, because the <unk> mandated by the wife I six.
Which as as Brian just mentioned the most popular ones on the 400 500 are [laughter] why fivesix routers, while on the metric system side, because it's still on why five and that there is no wife, I think skews at all from us nor from our competitors. So that market is on a wait and see basis. So it's a matter of fact, the de de dupe single point routers performed relatively better in Q2 than the management system.
You know versus our plan yes.
Okay, and then in terms of on the service provider normalization or is that a typical channel fill that you're anticipating as it relates to some of your life license products or is there anything else that's going on.
As we mentioned the service providers and two three years behind [laughter], so they're not going to put it and why buy safe anytime soon.
So no I mean Q3, just the good old normal Fourg mobile hotspot Ah you know 11 AC you know gateways and and 11 AC the wife I five or be you know, it's the same old stuff.
Okay, and then if they think or look at your CHP business going into the second half.
How much of that will be new product, driven and additional skewed driven versus volume driven of existing Om Wi Fi six products that came out in the second quarter.
I mean, we just mentioned ride the the percentage of products that shipped in the last 12 months is 19%.
So that that percentage will fluctuate on a good quarter of 25% and two you know most of the quarter [laughter] off.
15%. So right now is that 19%, we do expect that percentage to perk up.
In the next two quarters, so thats a good indication how much out from these new products how much from the legacy products right and then lastly for me in terms of the U.S. retail channel that's been a fairly robust over.
The last couple of quarters.
Yeah, how should I think of that especially given that you have new products that are coming online going into the second half.
Well as a matter of fact, I mean, we were a little bit disappointed.
By the retail channel performance in Q1, and even though Q2 has improved its still below the trend line or do the U.S. retail Wi Fi market was pretty much flat all through last year, and we thought that we would be able to maintain them in and clearly we were wrong with our very strong wife isix portfolio across the entire Wi Fi line, including single routers, including a match orbi, including standards that dead. We saw even in Q2 is still declining at a negative 4.5% year over year. However, with Q3 with more Wi Fi fixed route is coming now and the first or be a wife Isix coming out we do expect the second half of the year. The U.S. why five markets decline will moderate even further or maybe even back to flat to slight growth.
Okay. Thank you gentlemen.
Sure.
Again, if youd like to ask a question. Please press star one on your telephone keypad.
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And there are no further questions at this time I will turn the call back over to Patrick Lo for some closing remarks.
Great. Thank you everyone for joining today's call. We're pleased with how we navigated a challenging second quarter and we're very excited about prospects across the business in the second half of the year I look forward to updating all of you on our next earnings call in October .
Talk to you.
Thank you.
This concludes today's conference call you may now disconnect.