Apr 21, 2010
Executives
Joseph Villalta - IR, The Ruth Group Patrick Lo - Chairman & CEO Christine Gorjanc - CFO
Analysts
Sanjit Singh - Wedbush Morgan Securities Doug Ireland - JMP Securities Jeff Kvaal - Barclays Capital Hamed Khorsand - BWS Financial
Operator
Greetings and welcome to the NETGEAR Inc. first quarter 2010 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 Villalta of The Ruth Group.
Thank you, you may begin.
Joseph Villalta
Thank you, Operator. Good afternoon and welcome to NETGEAR's first quarter 2010 financial results conference 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 Christine providing detail on the financials.
We'll then have time for any questions. If you have not yet received a copy of today's release please call The Ruth Group at 646-536-7028 or you 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 U.S. 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 that these statements are not forward-looking.
The 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, gross and operating income, margin and tax rate on both 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, the company’s strategy for innovation and new products. Willingness of 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.
These statements are based on management's current expectations and are subject to certain risks and uncertainties, including without limitation the following. Future demand 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 maybe 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 maybe unable to collect receivables as they become due, the company may fail to manage costs including the costs of developing new products, and manufacturing and distribution of its existing offerings. Channel inventory information reported is estimated based on 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 and the Company's 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 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 I - Item 1A.
Risk Factors,” pages 10 to 27, in the Company's Annual Report on Form 10-K for the year ended December 31, 2009, filed with the Securities and Exchange Commission on March 1, 2010. 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, which will reflect the occurrence of unanticipated events.
In addition, several non-GAAP financial measures will be mentioned on this call. Information relating to the corresponding GAAP measures and reconciliation of the non-GAAP and GAAP measures can be found in our press release or on our Investor Relation site at www.netgear.com.
At this time, I would now like to turn the call over to Mr. Patrick Lo.
Please go ahead sir.
Patrick Lo
Thank you, Joseph and thank you everyone for joining today's call. We‘re extremely pleased to start 2010 by exceeding our own expectations and reporting year-over-year net revenue growth in all three geographic regions, especially in the America and Asia Pacific, which grew 63% and 91% respectively year-over-year.
Our worldwide net revenue growth of 39% over the same quarter of the prior year was driven primarily by increased end market demand and further market share gains. We also increased our non-GAAP operating margin to 13.5% this quarter, from 11.2% in the prior quarter.
Thus, we are pleased to be making significant progress in our business amidst the challenging and improving macro economic environment. In the first quarter, we increased our unit shipments by 13% over the same quarter of the prior year, Our North America net revenue was $106.3 million in Q1, while our Europe, Middle East and Africa or EMEA’s net revenue was $81.1 million and our Asia Pacific or APAC net revenue was $34.1 million.
From a product perspective, we introduced 16 new products in the first quarter. Notable new products include a 200-user firewall router for business users.
Our third-generation Powerline AV home network adaptor, a 3G signal repeater to enhance in-building 3G coverage and the industry’s first sub-$1,000 wireless LAN management system for business users. We remain focused on product development in 2010 and intend to introduce another 16 to 18 new products in Q2, further positioning us for revenue growth and market share gain worldwide in the second half of the year.
In the first quarter, our net revenue from service providers accounted for approximately 19% of total net revenue compared to 27% of total net revenue in the first quarter of 2009 and 28% in the fourth quarter of 2009. This lower percentage of service provider revenue on a relative basis was largely the result of record revenue from our retail business which exceeded our expectations.
But we’re very optimistic about our service provider revenue mix in the second half of the year, when the deployment of DOCSIS 3.0 products among our service provider customers will commence in earnest. We’re also pleased to have added basic [ph] in Israel as a new service provider customer during the quarter.
Our sales channels remained strong during the quarter despite the continued challenging economic environment. By the end of the first quarter 2010, our products was sold in over 26,000 retail outlets around the world and our value added reseller remains around 39,000.
Our push into new product category is paying off. We’re targeting five new product areas; network storage, TV Internet connectivity, DOCSIS 3.0 and VDSL gateways, security appliances and 3G, 4G wireless broadband products.
Based on current estimates, we believe each one of these five new product categories has the potential to reach over $1 billion in market size. For the network storage category, shipments grew almost 50% year-over-year in Q1 and these products have become a significant portion of our overall revenue.
For the TV Internet connectivity category, the introduction and the subsequent sell through of the Push2TV product in Q1 in Best Buy exceeded our expectations. We are very excited with the response from the market and the enthusiasm and interest shown by retailers around the world.
We’ve taken a leadership position worldwide in this all-important Internet to TV connectivity product category. Push2TV will be introduced worldwide throughout the rest of this year.
For the DOCSIS 3.0 category, we believe the push into this new set of products will result in good revenue growth in the second half of the year when our service provider customers in the US, UK, Nordic, Spain and Australia will start mass employment of this new DOCSIS 3.0 technology. For the security appliances category, our ProSecure line takes the unique approach of combining NETGEAR’s patent-pending Stream Scanning technology with cloud-based signature differences to create what we believe is a groundbreaking new approach to securing business networks.
By partnering with best-in-class security providers Kaspersky, Sophos, Commtouch and Mailshell we are bringing enterprise grade security capability to small and medium enterprises. Recently, the prestigious Secure Computing Magazine rated our ProSecure products five stars in all categories.
For the 3G broadband category, the introduction of our 3G signal repeaters in the Mobile World Congress held in Barcelona in February helped to establish NETGEAR’s leadership position in providing centrally manageable noise free 3G signal repeaters for low-cost in-building 3G coverage. With more new products scheduled in each of the five new product categories in the second half of this year and beyond, will believe future revenue contribution of these new product areas will be accretive to our overall growth.
We are confident in our strategy of being the innovative leader in connecting the message to the broadband Internet, as we continue to seek expansion into new product categories, new channels and new geographic markets. The strategy had paid off taking us through the worldwide of recession ahead of our competition and manufacturing results [ph] grew very strong result in the last two quarters.
We will continue to focus on executing the strategy in the future. Let me now turn the call over to Christine for details on our financial.
Christine Gorjanc
Thank you, Patrick. Let me now provide you with a summary of the financials with first quarter 2010.
As Patrick noted, net revenue for the first quarter ended March 28, 2010 were $211.6 million compared to $152 million for the first quarter ended March 29, 2009 and $218.8 million in the fourth quarter ended December 31, 2009. We shipped a total of about 4.7 million units in the first quarter including 3.9 million nodes of wireless products.
Shipments of our wired and wireless routers and gateways combined in the first quarter were about 2.8 million units. Moving to the product category basis, first quarter net revenue split between wireless and wired was about 65 and 35% respectively.
The first quarter net revenue split between home and small business products was about 70% and 30% respectively. Product introduced in the last 15 months constituted about 37% of our first-quarter shipments, while products introduced in the last 12 months constituted about 34% of our first quarter shipments.
Non-GAAP gross margin in the first quarter of 2010 is 35.2% compared to 29.2% in the year ago comparable quarters and 31.1% in the fourth quarter of 2009, the increase as a result of the product mix both year-over-year and sequentially and foreign currency as compared to the year ago period. Moving to non-GAAP operating expenses, total non-GAAP operating expenses increased by 18% compared to the prior year's same quarter, reflecting our increased revenue levels and investment in R&D.
Total non-GAAP operating expenses came in at $45.8 million for the first quarter of 2010. This compared to non-GAAP operating expense of $38.8 million in the first quarter of 2009 and $43.5 million in the fourth quarter of 2009.
On a GAAP basis, the company reported net income of $13.7 million or $0.38 per diluted share for the first quarter of 2010, compared to a net loss of $3.8 million or $0.11 per diluted share for the first quarter of 2009 and net income of $7.9 million or $0.22 per diluted share in the fourth quarter 2009. On a non-GAAP basis, the company reported net income of $17.1 million for the first quarter of 2010 as compared to a non-GAAP net income of $1.4 million in the first quarter of 2009 and the non-GAAP net income of $11.8 million for the fourth quarter of 2009.
Non-GAAP net income was $0.48 per diluted share in the first quarter of 2010, compared to a net income of $0.04 per diluted share in the first quarter of 2009 and net income of $0.34 per diluted share in the fourth quarter of 2009. In Q1 2010, we recorded a net foreign currency loss of $194,000 compared to a net gain of $1 million in the first quarter of 2009 and a net loss of $466,000 in the fourth quarter of 2009.
GAAP tax expense was $9.9 million in the first quarter of 2010, compared to $3.4 million in Q1‘09 and $9.6 million in Q4‘09. Non-GAAP tax expense was $11.4 million in the first quarter of 2010, compared to $5.5 million in the first quarter of 2009 and $12.3 million in the fourth quarter of 2009.
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 first quarter with $240.9 million in cash, cash equivalents and short-term investments.
DSOs for the first quarter were 62 days compared to 74 days in the first quarter of 2009 and 71 days in the fourth quarter of 2009. Our net inventory ended at $109.9 million compared to $92 million at the end of the first quarter 2009 and $90.6 million at the end of the fourth quarter of 2009.
Ending inventory turns were five as compared to 4.7 turns in the first quarter of 2009 and 6.7 turns in the fourth quarter of 2009. Looking forward in the second quarter of 2010, we expect to have a typical second quarter seasonal slowdown along with lower service provider revenue due to our customers transitioning to DOCSIS 3.0.
However, we expect to gain market share in retail and SMB channels with recently introduced new products, including those from the prior two quarters. We expect to have a largest revenue share for the service provider channels during the second half of 2010 with DOCSIS 3.0 deployment among our customers should be in full swing.
We entered 2010 with a strong new product line up and we focused on continually driving growth through new products and channel partner’s expansion. We believe this is the winning strategy.
Specifically, the second quarter in 2010, we expect net revenue in the range of approximately $190 million to $200 million and non-GAAP operating margins to be in a range of 11% to 12%. We expect our non-GAAP tax expense for the second quarter of 2010 to be in the range of $9 million to $11 million.
Operator, that concludes our comments and we can now take questions.
Operator
(Operator Instructions). Our first question is from Jeff Kvaal - Barclays Capital.
Jeff Kvaal - Barclays Capital
Christine Gorjanc
Jeff, it’s Christine. I really think our gross margin this quarter was due to the product mix, if you look at the service provider percentage and as that goes back higher, you will see that gross margin go down, but you would see the bottom line remain again in the range that we guided 11% to 12%.
Jeff Kvaal - Barclays Capital
You guys did a little bit better than that this quarter, so I mean was there -- did revenues surprise you on the upside and is that why it drops through the bottom line or…?
Christine Gorjanc
Yes, I think we had – revenue came in a little higher than we expected and with expenses relatively fixed that drops through to the bottom line.
Jeff Kvaal - Barclays Capital
Okay, so I would imagine then the same principle would apply if in the second quarter things get a little bit better?
Christine Gorjanc
Yes.
Jeff Kvaal - Barclays Capital
Okay, good. And then secondarily, if DOCSIS 3.0 is a driver in the second half, would we be able to think about slightly better than seasonal growth?
Patrick Lo
Possible.
Jeff Kvaal - Barclays Capital
Possible?
Patrick Lo
Yes.
Jeff Kvaal - Barclays Capital
Patrick, you’re usually so much more loquacious than that.
Patrick Lo
I mean this macroeconomic environment is still unpredictable.
Operator
Your next question is from Hamed Khorsand - BWS Financial.
Hamed Khorsand - BWS Financial
I just had a couple of questions. Could you provide a split on 11Nand 11G?
Patrick Lo
11N is now higher than 11G, it’s like 55, 45 11N.
Hamed Khorsand - BWS Financial
Was that one of the major driving points this past quarter as far as the end market one?
Patrick Lo
Correct. From an ASP perspective, it has driven up significantly ASP on a year-on-year basis.
Hamed Khorsand - BWS Financial
Okay. And then my other question was now that OpEx is above the $40 million level you were trying to hit, is there a new level that you are expecting now that business is staying around the $200 million level?
Christine Gorjanc
No, I think what we’ll do is, OpEx will be in line with the revenue, because as the revenue goes up, there is certain sale expenses in that that drop to the bottom line. The R&D expense, we are going to continue to invest, but we will keep that in line with the revenue growth.
Hamed Khorsand - BWS Financial
But previously, you guys were saying that your goal of OpEx is around $40 million depending on how well revenue was, so now you split put up two consecutive quarters of over $200 million and we are seeing OpEx over $40 million, I’m just trying to get a understanding as what kind of controls are there as far as OpEx or can we see operating margin expansions?
Christine Gorjanc
I think, again, as we guided to the 11% to 12% operating margin, you will see OpEx go up as the revenue goes up for freight, for sales expenses and that naturally have to go up to take the additional revenue. You will see that we have a lot of control within the company to make sure those numbers are not exceeded and they stay in line.
Patrick Lo
We will continue to invest, we will invest in R&D for sure, and we will certainly continue to invest in penetrating new markets especially Latin America, which is relatively new to us.
Operator
You next question is from Min Park, Goldman Sachs. Ms.
Park if you have your phone on mute please unmute it. Your next question is from Doug Ireland from JMP Securities.
Doug Ireland - JMP Securities
I wanted to ask a little bit, about your cash situation, you have $240 million in cash now, I was wondering if you had any idea what uses you would make? And then I was hoping that you could give us cash from operations number may be a CapEx number, if available?
Christine Gorjanc
Sure. As far as the cash balance, we continue to look at many alternatives with that including M&A opportunities that would be accretive to the business that would add a product portfolio that we could find or may be some channel expansion through that.
We also additionally look at a stock buy back in that and we have those discussions regularly at the company. As far as my cash flow from operations, it is negative 7.6 million for Q1, and CapEx I believe for Q1, is about $1.2 million.
Doug Ireland - JMP Securities
Okay, yeah, I saw the inventory went up like 50%, there was something going on there?
Christine Gorjanc
Inventory went from about 90 to 109 and what really – again, given our expanded revenue levels and the growth we’re seeing, we wanted to make sure we have the inventory on hand and it was always our goal to try to reduce some of the air freight. So last quarter with some of the product shortages component, we weren’t able to get as much inventory over here as we had anticipated and we were able to do that this quarter.
Operator
(Operator Instructions). Your next question is from Sanjit Singh - Wedbush Morgan Securities.
Sanjit Singh - Wedbush Morgan Securities
I was wondering if you could talk little bit about your growth projections for service providers? And what are you seeing that’s going to drive the second half up tick if they are currently not -- or they are still in transition with DOCSIS 3.0 right now.
Patrick Lo
Yeah, the driver will be primarily the mass deployment of the DOCSIS 3.0 in the second half of the year among our service provider customers.
Sanjit Singh - Wedbush Morgan Securities
Okay. And was Best Buy a 10% customer this quarter?
Christine Gorjanc
Yes, it was.
Sanjit Singh - Wedbush Morgan Securities
And on competition, was there any – how does the pricing environment look in terms of discounting from your domestic versus your international competitors?
Patrick Lo
We haven't seen any major news by our primary competitor Linksys.
Operator
(Operator Instructions) We have a follow-up question from Sanjit Singh.
Sanjit Singh - Wedbush Morgan Securities
I just have one quick follow-up. On the component and the transistor circuits [ph], I think in the press release you’ve said that’s we are nearing the end of that, what about the wireless chipset pricing, are you still seeing benefits from lower pricing on the chipset side?
Patrick Lo
Well, the chipset pricing continued to fall as usual. I don't see any stoppage to it, as more volume is being generated as more of the R&D's amortized their pricing continues to fall.
Operator
(Operator Instructions) Your next question is from Jeff Kvaal with Barclays Capital.
Jeff Kvaal - Barclays Capital
Patrick, Christine, I was wondering if you could comment a little bit more about the channel inventory and how you’re feeling about that and would it be possible for you to be little fuller or a little thinner over the next quarter or so?
Christine Gorjanc
Sure. So U.S.
retail at 9.8 weeks, I’d say our average is around 10 weeks, so we feel good about that number, that’s adequately soft. Both U.S.
distribution at 5.7, we expect that to remain over there around between four to six week range and then in Europe we did see their channel stock back up to normal levels at around, I think it's 5.7, 5.5 is their probably average. So we feel good that it's stocked and ready to move forward.
Jeff Kvaal - Barclays Capital
And then components, just to broaden on that component constraint question anything that you feel is particularly tight for you having had a couple of quarters?
Patrick Lo
We feel pretty good on the supply of the components. As we mentioned it last time, the lead time of components has lengthened, but we have adjusted our manufacturing process to accommodate that.
Right now there is no any hint of further lengthening of the lead time, of course we like to see the shortening of the lead time, but I don’t think it’s going to happen any time soon yet.
Operator
(Operator Instructions) There are no further questions in queue. I'd like to turn the call back to management for closing remarks.
Patrick Lo
Sure, thank you, everybody. We are really excited at the beginning of this year with a very, very good result and we’re especially confident that this year will be a growth year for NETGEAR into a record high revenue levels for two reasons; one, we believe that the market demand is finally coming back as we see it in the end market report in all three geographic regions and we’re benefiting from it.
And secondly, we are absolutely gaining share in all those markets because of our efforts that we put through the recession in R&D investment in five new product categories. These five new product categories of storage, TV, internet connectivity of security appliances and of the 3G, 4G wireless broadband and the DOCSIS 3.0 gateway represents significant market opportunities of up to $5 billion plus that we believe that we’ll whatever run and garbing our fair share which will fuel our growth in the second half of this year and beyond.
So we look forward to I report back to you on further progress in the next earnings call and would give you more color about the second half of the year. Thank you every much everybody, talk to you again in July.
Operator
This concludes today's teleconference. You may disconnect you lines.
Thank you for your participation.