Jul 22, 2009
Executives
Joseph Vitalta - Investor Relations, The Ruth Group Patrick Lo - Chairman and CEO Christine Gorjanc - CFO
Analysts
Jeff Kvaal - Barclays Capital Hamed Khorsand - BWS Financial Sanjit Singh - Wedbush Morgan Securities
Operator
Greetings and welcome to the NETGEAR Inc. second quarter 2009 results conference call.
At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation.
(Operator Instructions). As a reminder, this conference is being recorded.
It is now my pleasure to introduce your host, Joseph Vitalta of The Ruth Group. Thank you.
You may begin.
Joseph Vitalta
Thank you, operator. Good afternoon and welcome to NETGEAR's second quarter 2009 results call.
Joining us from the company are Mr. Patrick Lo, Chairman and Chief Executive Officer and Ms.
Christine Gorjanc, Chief Financial Officer. The format of the call will be a brief business review by Patrick, followed by Christy providing detail on the financials.
We'll then have time for any questions. If you have not received a copy of today's earnings release please call The Ruth Group at 646-536-7003 or you can go to NETGEAR's corporate website at www.netgear.com.
Before we begin the formal remarks, the company's attorneys advise us that today's conference call contains forward-looking statements within the meaning of the US Private Securities Litigation Reform Act of 1995. The words anticipate, expect, believe, will, may, should, estimate, project, outlook, forecast or other similar words are used to identify such forward-looking statements.
However, the absence of these words does not mean the statements are not forward-looking. Forward-looking statements represent NETGEAR Inc.'
s expectations or beliefs concerning future events based on information available at the time, such statements were made and include statements among others regarding NETGEAR's expected revenue, earnings, growth and operating income and tax rate on both a GAAP and non-GAAP basis. The effect of the global economic environment on the company's business, our position in the market relative to our competition, the long-term future of NETGEAR's business, our ability to innovate anticipated new product offerings, current and future demand for the company's existing and anticipated new products, willingness of the consumers to purchase and use the company's products and the ability to increase distribution and market share for the company's products domestically and worldwide and the effects of the company's restatement of financial statements.
These statements are based on management's current expectations and are subject to certain risks and uncertainties including without limitation the following: Future demands for the company's products may be lower than anticipated. Consumers may choose not to adopt the company's new product offerings or adopt competing products.
Product performance may be adversely affected by real world operating conditions; the company may be unsuccessful or experience delays in manufacturing and distributing its new and existing products. Telecommunication service providers may choose to slow their deployment of the company's products or utilize competing products.
The company may be unable to collect receivables as they become due, the company may fail to manage costs including the cost of developing new products, and manufacturing and distribution of its existing offerings. Channel inventory information reported is estimated based on the average number of weeks of inventory on hand on the last Saturday of the quarter.
As reported by certain of NETGEAR's customers, changes in the level of NETGEAR's cash resources ands the company planned usage of such resources, changes in the company's stock price, developments in the business that could increase the company's cash needs and fluctuations in further and foreign exchange rates. Further, certain forward-looking statements are based on assumptions as to future events that may not prove to be accurate.
Therefore, actual outcomes and results may differ materially from what is expressed or forecast in such forward-looking statements. Further information on potential risk factors are detailed in the company's periodic filings with the SEC, including but not limited to those risks and uncertainties listed in the section entitled, Part 2, Item 1A, risk factors, pages 29 to 43 in the company's quarterly report on Form 10-Q for the quarter ended March 29, 2009, filed with the Securities Exchange Commission on May 7, 2009.
NETGEAR undertakes no obligation to release publicly any revisions to any forward-looking statements contained herein to reflect events or circumstances after the date hereof or if they reflect the occurrence of unanticipated events. In addition, several non-GAAP financial measures will be mentioned on this call.
Information related to the corresponding GAAP measures and reconciliation of the non-GAAP and GAAP measures can be found in our press release in the Investor Relations site at www.netgear.com. At this time, I would now like to turn the call over to Mr.
Patrick Lo.
Patrick Lo
Thank you, Joseph. Thank you everyone for joining today's call.
In the seasonally slow second quarter, we made further significant progress in our business among the few challenging macroeconomic environment. We achieved a $144.7 million of revenue at the high end of our prior guidance.
We reduced our on-hand inventory sequentially by 18% to $75 million. Cumulatively, we have reduced our on-hand inventory by 40% over the last three quarters increasing our inventory turns from 3.7 to 5.5.
We were also successful in reducing channel inventory among our distributors worldwide, bringing them all in line with our four to five weeks target. We generated significant cash from our operations in Q2, 2009, increasing our cash and cash equivalents by $224 million to over $224 million while bringing our DSO down to 69 days.
We achieved sequential increase in revenue both in North America and Asia-Pacific regions. Most importantly, we introduced 12 new products and continued to gain share in the all important US retail channels.
Back in January, we announced the implementation of the cost reduction initiative with the aim of reducing operating expenses by $10 million for 2009 as compared to the annualized full quarter 2008 run rate. We've already seen significant cost saving results from our efforts about $6.6 in the first half of 2009 and we expect to meet our goal of $10 million by the end of the year.
Our North American net revenue was $69.4 million in Q2, while Europe, the Middle East and Africa or EMEA, net revenue was $54.2 million. In our Asia-Pacific or APAC region, net revenue was $21 million.
Compared to Q2 of 2008, our North America revenue decreased approximately 8.6%. EMEA net revenue decreased 44.5% and APAC revenue was down about 32.3%.
Despite the year-on-year decline in North America and APAC regions' revenue, we are seeing stabilization in the market demand in these two regions, as reflected in sequential Q1 2009 to Q2 2009 growth in revenue of 6.4% and 66.7% respectively. As such, we expect to see a normal seasonal uptick in net revenue in Q3 for these two regions.
From a product perspective we introduced an additional 12 new products in the second quarter. Notable introductions include stackable Power over Ethernet Smart Switches, home theatre powerline Ethernet connection kit; we also launched our new high performance rackmount ReadyNAS network storage during the quarter which had great market reception.
We also entered the African service provider market for the first time by shipping a customized DSO gateway to Telecom, South Africa. Additionally, we have DOCSIS 3.0 deployment projects in the Nordic countries and Japan, and will start shipping in Q3.
Our leadership in home and small-medium business products continue to be recognized by the industry and our customers. We continue to focus on product development and will continue to launch new products.
We intend to introduce another 12 to 15 new products in Q3 in order to distance NETGEAR from our competition in technology and product leadership. In the second quarter, our net revenue from service providers accounted for approximately 30% of total net revenue.
The highest such percentage on record for NETGEAR, compared to 27% of total net revenue in the second quarter of 2008, and 27% in the first quarter of 2009. There was incremental service provider revenue before our new higher local currency pricing kicked in.
This shift to higher service provider revenue versus net revenue from our retail in SMB market did have a slight negative effect on our gross and operating margin in Q2 of 2009 than was originally planned. However, we are pleased to add Megacable of Mexico to our service provider customer list in the second quarter.
Our value added reseller base remained strong at over 36,000 despite economic downturn, especially in Europe. We are seeing the stabilization of end user demands in the North America and Asia Pacific markets.
We believe Europe is still going through a market decline. However, we have confidence that our overall revenue year-on-year growth will return soon.
But we will continue to invest in innovation, continue to operate efficiently, tightly manage our inventory exposure and focus on generating cash. We are confident that our exciting new product pipeline in the second half will allow us to gain on our competitors and increase our market share worldwide.
Let me now turn the call over to Christine for details on our financials.
Christine Gorjanc
Thank you, Patrick. Let me now provide you with the summary of the financials for Q2.
As Patrick noted, net revenue for the second quarter ended June 28, 2009 with $144.7 million, compared to $204.5 million for the second quarter ended June 29, 2008 and $152 million in the first quarter ended March 29, 2009. We shipped about 3.4 million units in the second quarter, including 2.9 million nodes of wireless products.
Please note that a significant part of this sequential quarter-to-quarter decline in unit shipment is due to the obsolescence of an accessory product associated with our service provider DSO Gateway. Shipments of our wired and wireless routers and gateways combined in the second quarter were about 2 million units.
Moving to the product category basis, second quarter net revenue split between wireless and wired was about 65% and 35% respectively. The second quarter net revenue split between homes and small business products, was about 69% and 31% respectively.
Products introduced in the last 15 months constituted about 40% of our second order shipment, while products introduced in the last 12 months constituted about 28% of our second quarter shipment. Non-GAAP gross margin in the second quarter of 2009 was 29.6%, compared to 33.2% in the year ago comparable quarter and 29.2% in the first quarter of 2009.
The year-over-year gross margin declined with mainly due to the unfavorable currency exchange rate, while our sequential gross margin is slightly up due to a slightly more favorable currency exchange rate. Moving to non-GAAP operating expenses, the total non-GAAP operating expenses declined by 15.8%, compared to the prior year same quarter reflecting the impact of our cost saving efforts.
Total non-GAAP operating expenses came in at $37.4 million for the second quarter of 2009. This compares to non-GAAP operating expense of $44.4 million in the second quarter of 2008 and $38.8 million in the first quarter of 2009.
As Patrick mentioned, we continue to target a $10 million reduction in operating expenses in 2009 as compared to the annualized run rate of Q4, 2008. We saved $6.6 million in operating expenses in the first half of 2009 and are confident of achieving our annual savings target.
On a GAAP basis, the company recorded a net loss of $3.3 million or $0.10 per diluted share for the second quarter of 2009, compared to net income of $11.1 million or $0.31 per diluted share in the second quarter of 2008 and a net loss of $3.8 million or $0.11 per diluted share in the first quarter of 2009. On a non-GAAP basis, the company experienced a net loss of $522,000 for the second quarter of 2009 as compared to non-GAAP net income of $14.5 million for the second quarter of 2008 and the non-GAAP net income of $1.4 million for the first quarter of 2009.
Non-GAAP net loss was $0.02 per diluted share in the second quarter of 2009, compared to net income of $0.41 per diluted share in the second quarter of 2008 and a net income of $0.04 per diluted share for the first quarter of 2009. In Q2, 2009 we recorded a net foreign currency loss of $443,000 compared to a net $14,000 loss in the second quarter of 2008 and again of about a million dollars in the prior quarter.
As we stated in today's press release, we will be restating the Q1 tax expense due to the misapplication of FASB the interpretation number 18, accounting for income taxes in interim periods. During the first half of 2009, because of the further decline in our international revenue and resulting profitability, we incurred larger than anticipated losses in our international business.
We incorrectly included the loss from a particular foreign entity in our tax provision, and for FIN 18, it must be accounted for independently. Subsequently, the company has revised its intraperiod tax allocation.
Our estimated annualized tax provision, based on current projections, will remain the same, but the allocation among the quarters changes. The financial statements included with the press release and the numbers mentioned on this call include the restated Q1 2009 numbers for both GAAP and non-GAAP, as well as applied as methodology to the Q2 tax provision.
GAAP tax expense was $4.4 million in the second quarter of 2009, compared to $8.7 in Q2 '08 and $3.4 million in Q1 '09. Non-GAAP tax expense was $5.7 million in the second quarter of 2009, compared to $9.9 million in the second quarter of 2008 and $5.5 million in the first quarter of 2009.
Please note that the application of FIN 18 more significantly affects our GAAP tax provision allocation among the quarters, while the non-GAAP tax provisions for the quarters were less affected. Based on our current projection, our non-GAAP tax provisions are expected to remain around $6 million to $7 million a quarter for 2009.
I would also like to re-emphasize that the revised tax allocation among quarters is based on a technical accounting requirement and has no effect on our operational performance, nor uncertain of the key metrics that management uses to evaluate our own financial and business performance such as revenue, gross margin, operating margin, cash, DSOs, on-hand inventory, and inventory turns. It also has no bearing on the full-year tax provision based on the current projection.
The reconciliation of GAAP to non-GAAP is detailed in our financial statements released earlier today. We continue to maintain a strong balance sheet ending the second quarter with $224.5 million in cash and cash equivalent.
Our accounts receivable collections also remained strong and DSOs for the second quarter decreased to 69 days from 74 days in the first quarter of 2009. Due to our concentrated efforts, we were able to reduce inventories by $17 million sequentially and inventory turns increased from 4.7 to 5.5.
We expect our inventory turns to continue to trend upward. Channel inventory rationalization was mostly completed in the second quarter and distribution channel inventory in all regions is now in the normal four- to five-week range.
In the quarters ahead, we anticipate the sales into the channel will be roughly equivalent to sales out to end customers. In the third quarter 2009, we will introduce our full line of Pro security appliances and the 12-bay super performance rackmount ReadyNAS network storage.
Also, we anticipate adding several new service provider customers in the third quarter of 2009, and start shipping DOCSIS 3.0 products to the Nordic countries and Japan. We believe our successful strategy of continuous innovation and new product introduction, superior customer service and channel program will allow us to stay ahead of our competition.
With inventory at healthy levels and currency exchange rates becoming more favorable, we expect improvement in both gross margin and operating margin in the third quarter of 2009. For the third quarter 2009, we expect net revenue in the range of approximately $150 million to $160 million and non-GAAP operating margin to be in the range 5% to 7%.
Operator, that concludes our comments and we can now take questions.
Operator
(Operator Instructions). Our first question is from Jeff Kvaal with Barclays Capital.
Please go ahead with your question.
Jeff Kvaal - Barclays Capital
Yes. Thanks very much.
Patrick, I was wondering if we could talk a little bit about the SMB market. I think at various points of the quarter, it sounded from other checks though SMB in some respects was doing better.
Do you feel like that is a sustainable trend or what kind of trajectories will be on there?
Patrick Lo
Yes. Actually both from the end-market demand, what we jogging is POF standpoint as well as from the net shipment standpoint, we see a pretty encouraging trend.
We see both our net and our switching and our business wireless products, they have slight uptake sequentially from Q1 to Q2. So, that's an encouraging sign, and we look forward to further uptake in Q3.
Jeff Kvaal - Barclays Capital
Okay, great. And then question maybe for either of you two actually.
The deferred revenue was down a chunk financially, how should we think about that?
Christine Gorjanc
Deferred revenue is really down just based on delivery terms and that based on our customer title of transferring that. So that moves up and down in the same range every quarter.
So it could go up or down, $3 million or $4 million every quarter.
Jeff Kvaal - Barclays Capital
Okay. Does it reflect that the service provider business, for example, might not be a strong view in the third quarter?
Patrick Lo
We expect that the service provider revenue was still maintained at the current absolute level, but since the retail for back-to-school and the SMB will continue to grow, then, as a percentage, we do expect the service provider revenue to be lower than in Q2.
Jeff Kvaal - Barclays Capital
Okay, great. And then lastly, could you please talk a little bit about the variables in the guidance range and what would be due to the high or low end of that range?
Thanks.
Patrick Lo
Well, I mean, certainly, it really depends on Europe.
Jeff Kvaal - Barclays Capital
Okay.
Patrick Lo
All right. If Europe comes in at public…
Jeff Kvaal - Barclays Capital
I though you might say that Patrick, yeah.
Patrick Lo
… which is above flat, quarter-on-quarter, than we expect that will probably in the upper half. But if Europe continue to decline more than what we anticipated, then it will be the other way around.
So I think the key is Europe, and unfortunately, there is still very little visibility in Europe. The good thing is, it looks like that the UK market which tanked first about six quarters ago is stabilizing, but then unfortunately continent of Europe is still in decline.
And we think that they will still run the course for another quarter or two.
Jeff Kvaal - Barclays Capital
Make sense. Thank you both very much.
Operator
The next question is from Samuel Wilson with JMP Securities. Please go ahead.
Unidentified Analyst
Hi. This is (inaudible) for Sam, how are you?
Patrick Lo
Sure. Good, thanks.
Unidentified Analyst
I am sorry, can I get the headcount please?
Christine Gorjanc
Sure. We ended the quarter 567, one under prior quarter.
Unidentified Analyst
Great. And you mentioned that the security products with full rollout would be becoming in the second half.
Did you have security products in the market in this quarter?
Patrick Lo
Yes. We have one.
Unidentified Analyst
Okay.
Patrick Lo
If you go to our corporate business presentation, in our IR website you will see that we are readying, the security line should be about 7 to 8 models. We introduced one in late Q1, so you have to rest probably in Q3.
Unidentified Analyst
Okay. And how has reception of the security product been in the second quarter?
Is there anything that you can tell from that?
Patrick Lo
Yes. I think we focused our attention in because security purchase, especially for what we call content front manager is not a short cycle sale.
So in Q2, we focus in recruiting security value added resellers and reference accounts. From that regard, we're doing very, very well.
Unidentified Analyst
Okay. So you're building the VAR channel there?
Patrick Lo
Correct.
Unidentified Analyst
Okay. And then the last thing is CES, you had a very impressive display of video, consumer over the top video equipment?
Patrick Lo
You are right.
Unidentified Analyst
Are you planning to report anything granular on the performance of that segment or can you give us any color on how those products are performing?
Patrick Lo
Yes. Today that segment is a fast-growing segment and certainly some of the top players are the Apple TV, ourselves, and Western Digital's WD TV, and we believe that segment will continue to grow pretty dynamically, and our introduction of our EVA9150 has been getting rave reviews around the world and has been well received by what we call the prosumers.
Our EVA9150 is like a Ferrari which is priced basically higher than our competition with a lot more functionalities; but then, in CES, as you pointed out, we also have different models that we cater to more general public and we expect that when that is introduced and targeted to be in Q3, we will see a significant boost in that revenue line as well as in market share.
Unidentified Analyst
Okay, great and look forward to seeing the progress of that segment. I think it's great potential.
Patrick Lo
Yes, absolutely.
Unidentified Analyst
All right, thank you.
Patrick Lo
Sure.
Christine Gorjanc
Thank you.
Operator
(Operator Instructions). The next question is from Hamed Khorsand with BWS Financial.
Please go ahead with your question.
Hamed Khorsand - BWS Financial
Hi, just a couple of questions. One is, on the Q3 guidance, what have you seen from retailers of the back-to-school that’s giving you the encouragement to give you a 160 guidance for the revenue?
Patrick Lo
Well, for the back-to-school, I mean the good thing is, if you noticed that our quarter ending channel inventory in US retail is actually up in 12.5 weeks. The reason is, I think all of our retail partners are showing pretty good confidence; that one, there will be a normal seasonal uptick from Q2 to Q3; two, as a matter of fact three weeks into the quarter, they have already seen the start of the back-to-school buying.
So, that gives us, both our retail partners and ourselves the confidence that it is going to be a normal seasonal uptick quarter.
Hamed Khorsand - BWS Financial
Okay. And then, your inventory levels now having declined so much, are you running into the risk of having to use air freight or shipping to meet demand or missing quarters because you don’t have products on hand?
Patrick Lo
You are right. I mean, we are prepared to use more air freight and we actually as a matter of fact, we are prepared to double our air freight cost from quarter-to-quarter, Q2 to Q3.
The saving grace is that, I think our purchasing people, logistics people have been able to negotiate fantastic rate and concessions from our air freight (inaudible). So our mantra has always been that we will rob the revenue money on the table than having inventory exposure.
So, I think what we prepared to do is prudent.
Hamed Khorsand - BWS Financial
Okay. And what's going on the APEC side, that's giving you as a boost?
Are you seeing increased market share in China or is this coming from the Australian market?
Patrick Lo
Both. We're seeing, very good market share again both in China as well in Australia as it turns out as we've always indicated.
I mean these two are the 800 pound gorilla for us in APAC, and certainly China is creeping up, creeping up, one day China will be bigger than Australia. They are not that far behind.
So, I think we're doing well in both markets. For example, in Australia, we recently, significantly expanded our retail presence into Dick Smith, which is RadioShack equipment in the US.
So, that will really help us to boost significantly our market share. And in China, certainly we continue to maintain a very healthy presence in the retail front.
And as a matter of fact, we're participating in China in the build-out of Wi-Fi hot spots from some of the service providers as well. So, we're definitely gaining share in these two markets.
Hamed Khorsand - BWS Financial
Okay, great. Thank you.
Operator
The next question is from Rohit Chopra with Wedbush Morgan Securities. Please state your question.
Sanjit Singh - Wedbush Morgan Securities
Hi Patrick, this is Sanjit Singh.
Patrick Lo
Hi.
Sanjit Singh - Wedbush Morgan Securities
Hi Patrick, this is Sanjit Singh for Rohit Chopra. A quick question, can you just describe linearity in the quarter, month by month from, April, May and June.
How things [pulled out]?
Patrick Lo
April, May, June -- actually as a matter of fact, I mean typically in Q2, April is very quiet. And because of all the holidays, I mean we have in Europe and in certain part of Asia, they actually celebrate Easter.
I mean especially in Australia and Europe. So, April is generally pretty quiet, and then things got to start busy in May and it gets into a frenzy mood in the second half of June, especially when in the US, the retailers are stocking up for back-to-school, they normally start in mid-July, but this year everybody is preparing the back-to-school to start actually in the second week of July.
Sanjit Singh - Wedbush Morgan Securities
Right. And then, well, since you guys hit the high end of guidance, you think maybe gross margin could have been a little bit higher?
Patrick Lo
Yes. I mean there's no doubt about it.
I mean, the gross margin would actually be higher if we could get even more revenue. But in the case of Q2, as a matter of fact, I mean the mix is not as favorable as we would have liked because the incremental revenue that get us into the higher end of the guidance is actually due to some extra service provider revenue that was done before we raised the prices in the quarter, and our expected European SMB and retail revenue was less than what we originally planned.
So with the shift in mix, actually our gross margin was slightly below what we would like it to be.
Sanjit Singh - Wedbush Morgan Securities
Got it. And on pricing, has the price worth abated?
Where are we in terms of…
Patrick Lo
The price has been very stable, especially in the US, as well as in Asia-Pacific where the market as we indicated previously has bottomed out and is starting to grow again. In Europe it clearly in certain market, there is significant price pressure especially from the local vendors because they are trade in local currencies.
So, we chose not to respond, we chose to respond with better products. So that's the path we'll continue to take.
Sanjit Singh - Wedbush Morgan Securities
Great. And my final question is on the ratification of 802.11n.
It seems like this is now a September story as opposed to November story. Does that make that more of a media catalyst for you guys?
Patrick Lo
As this thing drags on and on, it almost becomes irrelevant right now.
Sanjit Singh - Wedbush Morgan Securities
Okay. That’s it for me.
Thank you.
Patrick Lo
Sure.
Operator
(Operator Instructions). The next question is a follow-up from Jeff Kvaal with Barclays Capital.
Please state your question.
Jeff Kvaal - Barclays Capital
Hi, yes. Thanks very much for taking the follow-up.
I just wanted to probe on the 10 million plan that you have drawn out. It seems though you're at least on plan, are on schedule with that plan.
Do you think that there is a possibility of upside to that plan, should the revenue numbers not turn out as expected?
Christine Gorjanc
Well, again, we committed 10 million and I believe if we get into the second half of the year and as we're anticipating the revenues going up in that, we may be spending some of the additional. We could save on some new products and ways to get revenue for the future.
So, at this point we're committing to the 10 and we will always make sure we spend it wisely.
Jeff Kvaal - Barclays Capital
Okay. Got you.
Thanks very much.
Operator
(Operator Instructions). There are no further questions in queue.
I'd like to turn the call back over to management for closing remarks.
Patrick Lo
Thank you so much for everyone and we're very excited looking forward to Q3, where we're anticipating our improvement in both operating margin, gross margin, and revenue. More importantly, please watch out for all the exciting new products that we are going to introduce in the next two-three months, and the new service provider customs we're going to announce.
And I look forward to talking to you all in next quarter's earnings call. Thank you.
Operator
This concludes the teleconference. You may disconnect your lines.
Thank you for your participation.