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Edited Transcript of NTGR earnings conference call or presentation 5-Feb-20 10:00pm GMT

Q4 2019 NETGEAR Inc Earnings Call

SAN JOSE Feb 12, 2020 (Thomson StreetEvents) -- Edited Transcript of NETGEAR Inc earnings conference call or presentation Wednesday, February 5, 2020 at 10:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Bryan D. Murray

NETGEAR, Inc. - CFO

* C. S. Lo

NETGEAR, Inc. - Co-Founder, Chairman & CEO

* Erik Bylin

NETGEAR, Inc. - IR Executive

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Conference Call Participants

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* Brian Yun

Deutsche Bank AG, Research Division - Data Networking Analyst

* Madison Suhr

Raymond James & Associates, Inc., Research Division - Research Associate

* Paul Jonas Silverstein

Cowen and Company, LLC, Research Division - MD & Senior Research Analyst

* Robert Ari Gutman

Guggenheim Securities, LLC, Research Division - Senior Analyst

* Vahid Khorsand

BWS Financial Inc. - Research Analyst

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Presentation

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Operator [1]

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Ladies and gentlemen, thank you for standing by. And welcome to the NETGEAR Fourth Quarter 2019 Results Conference Call. (Operator Instructions) I would now like to hand the conference over to your speaker today, Erik Bylin. Thank you. Please go ahead, sir.

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Erik Bylin, NETGEAR, Inc. - IR Executive [2]

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Thank you, David. Good afternoon, and welcome to NETGEAR's Fourth Quarter and Full Year 2019 Financial Results Conference Call. Joining us from the company are Mr. Patrick Lo, Chairman and CEO; Mr. Bryan Murray, CFO.

The format of the call will start with a review of the financials for the fourth quarter and full year provided by Bryan, followed by details and commentary on the business provided by Patrick, and finish with first quarter 2020 guidance provided by Bryan. We'll then have time for any questions.

If you have not received a copy of today's press release, please visit NETGEAR's Investor Relations website at www.netgear.com.

Before we begin the formal remarks, we advise you that today's 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 the forward-looking statements. For more information, please refer to the risk factors discussed in NETGEAR'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 forward-looking statements as a result of new information or future events.

In addition, several non-GAAP financial measures will be mentioned on the call today. A reconciliation of the GAAP to non-GAAP measures can be found in today's press release on our Investor Relations website.

At this time, I would now like to call -- turn the call over to Mr. Bryan Murray.

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Bryan D. Murray, NETGEAR, Inc. - CFO [3]

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Thank you, Erik, and thank you, everyone, for joining today's call.

Net revenue for the fourth quarter ended December 31, 2019, was $253 million, near the top end of our guidance range, but down 12.4% year-over-year and down 4.8% on a sequential basis. As anticipated, we saw visible quarter-over-quarter declines in the Greater China region while all other regions enjoyed the seasonal holiday boost from an end-user demand perspective. We were able to take the initial step of adjusting channel inventory worldwide to prepare for the strong push to WiFi 6 in 2020.

For the full year 2019, NETGEAR net revenues were $998.8 million, which is down 5.7% compared to the year-ended December 31, 2018.

As presented at our Analyst Day this past November, we are committed to growing our top and bottom lines going forward with our strategy of delivering leading products during technology inflections, expanding into new adjacent markets and developing a robust subscription revenue stream. We saw early success in Q4 in WiFi 6, ProAV and subscriber growth, and we will continue to push in these directions in 2020. We remain confident our strategy will pay off in the years to come.

Our non-GAAP operating margin for the fourth quarter came in at 4.4%, just below the low end of our guidance range. It was a very competitive holiday season due to the arrival of a new competitor in the U.S. We were prepared for this, and we took advantage of additional opportunities to promote products to increase our market share and generate revenue. We feel confident that in 2020, we will improve our non-GAAP gross and operating margins throughout the course of the year as we benefit from our production outside of China reaching full efficiency, which will remove the cost headwinds we felt in 2019 from tariffs, and the inefficiencies related to moving and ramping our manufacturing operations. Full year non-GAAP operating income was $64.5 million, resulting in a non-GAAP operating margin of 6.5%.

For the fourth quarter of 2019, net revenue for the Americas was $169.1 million, which is down 11.1% year-over-year and down 5.3% on a sequential basis. Both the year-over-year and sequential downturn in revenue primarily a result of our planned channel inventory adjustment.

EMEA net revenue was $50.5 million, which is down 14.1% year-over-year and up 1.9% quarter-over-quarter.

Our APAC net revenue was $33.4 million, which is down 16.2% from the prior year comparable quarter and down 11.4% sequentially, primarily as a result of the continued geopolitical challenges in the Greater China region.

For the fourth quarter of 2019, we shipped a total of approximately 3.8 million units, including 2.8 -- 2.9 million nodes of wireless products. Shipments of all wired and wireless routers and gateways combined were about 1.5 million units for the fourth quarter of 2019.

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 29% of our fourth quarter shipments, while products introduced in the last 12 months contributed about 26% of our fourth quarter shipments.

From this point on, my discussion points will focus on non-GAAP numbers. A reconciliation from GAAP to non-GAAP is detailed in our earnings release distributed earlier today. The non-GAAP gross margin in the fourth quarter of 2019 was 27.9%, which is down 380 basis points as compared to 31.7% in the prior year comparable quarter and down 150 basis points compared to 29.4% in the third quarter of 2019.

On a year-over-year basis, in Q4, we were still burdened by the additional cost of the production trends from China to Southeast Asia, the incremental tariffs implemented in September of 2019 and the effect of the previous tariffs on some residual inventory. We expect to see the adverse effects of the tariffs and manufacturing inefficiencies paid entirely during the first half of this year.

Total Q4 non-GAAP operating expenses came in at $59.4 million, which is down 7.8% year-over-year and up 3.8% sequentially. As always, we manage our expenses prudently while also making sure that the growth portions of our business have the resources that they need to succeed.

Our head count was 809 as of the end of the quarter. We intend to expand our workforce specifically in the area of R&D in 2020 to enhance our service offerings.

Our non-GAAP R&D expense for the fourth quarter was 7.2% of net revenue as compared to 6.2% of net revenue in the prior year comparable period and 6.8% of net revenues in the third 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 especially in the growth areas, such as services and ProAV.

Our non-GAAP tax rate was 12.7% in the fourth quarter of 2019. In the quarter, we benefited from favorable revisions to estimates on both domestic and foreign tax liabilities for the full year.

Looking at the bottom line for Q4, we reported non-GAAP net income of $10.4 million and non-GAAP diluted EPS of $0.34. Non-GAAP diluted earnings per share for the full year of 2019 was $1.87.

Turning to the balance sheet. We ended the fourth quarter of 2019 with $195.7 million in cash and short-term investments. We successfully reduced our inventory by $40 million in the quarter as the heavy lift of the production migration away from China is behind us. We expect to continue inventory reductions, which will further benefit our cash position in 2020.

During the quarter, we generated $49.6 million in cash flow from continuing operations, which brings our total cash provided from continuing operations over the trailing 12 months to $13.5 million. We used $2.4 million in purchases of property and equipment during the quarter, which brings our total cash used for capital expenditures over the trailing 12 months to $14.2 million. We remain confident in our ability to generate cash going forward.

In Q4, we spent $22 million to repurchase approximately 721,000 shares of NETGEAR common stock at an average price of $30.49 per share. Since the start of our repurchase activity in Q4 2013, we have spent $528.7 million to repurchase 14.8 million shares. Our fully diluted share count is approximately 30.8 million shares as of the end of the fourth quarter. 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 the industry-leading Nighthawk, Orbi, Nighthawk Pro Gaming and Meural brands, generated net revenue of $183.9 million during the quarter, which is down 14.7% on a year-over-year basis and down 3.6% sequentially.

The year-over-year decline was due to a number of factors. Firstly, in North America, we took proactive steps to reduce channel inventories to prepare for an accelerated shift towards WiFi 6 anticipated to occur in the first half of 2020. Secondly, we saw reduced revenue in the fast declining Greater China region due to geopolitical issues. And lastly, we experienced declines in our service provider business as carriers are awaiting rollouts of 5G product offerings.

Our U.S. market share in consumer WiFi ticked up to 52% for the fourth quarter in the face of the increased competitive environment. The SMB segment generated net revenue of $69.1 million for the fourth quarter of 2019, which is down 5.7% on a year-over-year basis and down 8.1% sequentially. The declines, both year-on-year and sequential, were driven by the market decline in the U.K. due to Brexit and the geopolitical situation seen in Greater China region.

On the product front, our PoE+ and ProAV switching lines continue to perform well in the market. Our market share in switches sold through U.S. retail channels remained strong at 53% for the fourth quarter.

I'll now turn the call over to Patrick for his commentary, after which I will provide guidance for the first quarter of 2020.

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C. S. Lo, NETGEAR, Inc. - Co-Founder, Chairman & CEO [4]

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Thank you, Bryan, and hello, everyone. We are excited about the progress we made in the fourth quarter along the 3 pillars of our growth strategy. We were the first to debut WiFi 6 mesh, which garnered a strong reception, and we accelerated the growth and market shift to Power over Ethernet Plus technology in switching. We also debuted the new 21-inch Meural Digital Canvas worldwide, and we won the first ProAV project for the 2020 Olympics during the quarter.

On the paid service subscriber side, we increased our subscriber total to 177,000 with strong sequential and year-over-year growth, and we are in a race now to double that count in 2020.

We kicked off the holiday selling season with our top-of-the-line WiFi 6 Tri-Band Orbi mesh at $699 for 2 nodes. It was well received worldwide by both the tech press and consumers. Many reviewers commented that it is the fastest and best WiFi money can buy. We are proud to quickly follow that offering up with the Nighthawk WiFi 6 dual-band mesh at $229 for 2 nodes in early January for our consumers with smaller homes that desire fast WiFi in every corner of the house.

Our industry-first WiFi 6 DOCSIS 3.1 Cable Gateway won the CES Innovation Honoree Award in Las Vegas in January. Our strong lineup of leading-edge technology and well-executed promotions in Q4 allowed us to continue to gain share in the all-important North America retail market.

We had a very successful CES in Las Vegas in January. Beyond showcasing the products that I just mentioned, we also introduced a new WiFi 6 extender, the second in our lineup, plus a new second-generation 5G mobile router that will include WiFi 6. We now have a comprehensive line up of WiFi 6 offerings in routers, mesh, Cable Gateways, extenders and mobile routers. No competitor can rival our broad portfolio of WiFi 6 offerings, allowing us to expand average selling price and thus grow the market. With the strong adoption of WiFi 6 smartphones around the world, we are excited about the market opportunities in front of us in 2020.

Turning to our SMB business where we also had a busy Q4. We introduced 4 new Power over Ethernet Plus switches in Q4, further distancing ourselves from our competition. These new switches plus the new ProAV switches introduced in Q3 last year, continue to power our year-over-year and quarter-over-quarter growth in end market sales of switches worldwide.

CES 2020 was equally exciting for our SMB business, where we held a joint press event with Semtech, the leading chip provider for ProAV. We also debuted 2 new Ultra Power-over-Ethernet switches, which give users the ability to simultaneously connect and power IP cameras, access points, AV displays, speakers and lighting. The new Ultra PoE models are now available worldwide and enable deployment of PoE ports that run a gigabit Ethernet speed while providing up to 60-watt per port, 400-watt per switch in power. Their price performance is unparalleled in the industry and will enable us to continue to gain share against our competitors in the Power-over-Ethernet space.

We continue to make progress with our initiative to build recurring revenue streams. As of the end of the fourth quarter, we have approximately 12.8 million registered users. Our registered app users count has grown to 4.4 million, which represents approximately 22% sequential user growth over Q3 2019. Most importantly, we had 177,000 paid subscribers at the end of 2019.

During the quarter, we announced several additions to our leadership team. I'm excited to welcome Mickey Mericle and Laura Durr to NETGEAR's Board of Directors. Mickey led successful teams at Adobe and Shutterfly and brings more than 20 years of business, marketing and strategic planning expertise to our board. Laura joins the Board with a background of -- in finance and strategy across leading Silicon Valley technology companies and was most recently EVP and Chief Financial Officer of Polycom.

I'm also pleased to add Dr. Martin Westhead to our team as CTO of Software. Martin comes to us from Groupon and will be responsible for strengthening our overall cloud and app software technology prowess. Martin will be a critical member of the team as we continue to build product apps and service offerings to complement our extensive lineup of networking solutions.

In Q1, we will continue to capitalize on the technology inflections in WiFi 6, 5G, Power-over-Ethernet. We will continue to expand our channel reach in ProAV and digital canvas.

We believe our subscriber growth will accelerate every quarter. Also, we will work diligently to continue to adjust our channel inventory mix towards WiFi 6 and to work through the logistic and marketing -- market challenges presented by the coronavirus outbreak in China, a region of importance to our component supply chain and our end market sales.

I will now turn the call back to Bryan for first quarter guidance.

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Bryan D. Murray, NETGEAR, Inc. - CFO [5]

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Thank you, Patrick. Our net revenue for the first quarter is expected to be in the range of $205 million to $220 million. We currently believe that our service provider revenue will be approximately $25 million on average per quarter for the first half of 2020. We would expect it to return to $35 million per quarter on average in the second half of the year when 5G deployments gain more momentum. In addition, we expect to continue our efforts to rebalance the channel inventory mix towards WiFi 6 in the first quarter of 2020.

GAAP operating margin is expected to be in the range of negative 1.8% to negative 0.8%, and non-GAAP operating margin is expected to be in the range of 2% to 3%.

Our GAAP tax rate is expected to be approximately 16%, and our non-GAAP tax rate is expected to be 25% for the first quarter of 2020.

Operator, that concludes our comments, and we can now take questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Your first question comes from the line of Adam Tindle with Raymond James. .

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Madison Suhr, Raymond James & Associates, Inc., Research Division - Research Associate [2]

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This is Madison on for Adam. Patrick, there are only a few competitors out there with WiFi 6 products in the market, and most notably, the larger players have yet to introduce this new standard into their product but have chosen to be more aggressive on pricing of legacy technology. So as you think about this upgrade cycle versus prior ones, do you think this heavy discounting of legacy products is affecting the cadence of the upgrade cycle versus prior years? And maybe if you could add any more details kind of comparing and contrasting this cycle versus prior ones?

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C. S. Lo, NETGEAR, Inc. - Co-Founder, Chairman & CEO [3]

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We don't believe so. I think it's pretty typical that in the first 6 to 12 months of the upgrade cycle, it will be primarily the early adopters, the technology leaders as well as those consumers who absolutely need the fastest speed of the WiFi. So that's why we introduced our products, still mainly in the high end. On the router side, our most popular WiFi 6 routers are $300 and above. Similarly, for the WiFi 6 mesh. So those are not really contested by any of our competitors, and we're really pleased with the adoption of those WiFi 6 products. As a matter of fact, I mean, we looked at the WiFi 6 router market because of the introduction of our WiFi 6 routers. Even though there is serious competition especially in pricing the lower end, we were able to see our router market share as well as our router end market demand to be growing. So we believe that the discounting in the legacy product is out of desperation from some of our competitors. But actually, it would not deter the early adopters and the technology leaders to adopt WiFi 6.

Now as we progress, of course, we will have more WiFi 6 products that will span lower price points. And then the mass market will be able to look at with a low delta premium, they would be going to WiFi 6. As more and more of the phones and tablets and PCs around the world are switching over to WiFi 6, I think this transition will actually be faster than before from multiple angles because the cell phone, the tablets and the PC providers like to see the upgrade cycle. And for us, of course, we would like to see the upgrade cycle, and the channel partners also would like to see the upgrade cycle. So our estimate is this probably would be one of the fastest transition, and we believe that by Christmas this year, WiFi 6 products in the market will constitute more than 50% of the overall market.

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Madison Suhr, Raymond James & Associates, Inc., Research Division - Research Associate [4]

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And then just a follow-up for Bryan. At the Analyst Day, you laid out a target to get to 8% to 9% operating margin in 2020. It looks like based on guidance that it seems like that's going to need to be reset here. So can you just help us with how we can think about the progression of improving operating margin from here? And you are starting, obviously, at a much lower point this year in Q1 than last year, so do you think it's plausible that you can actually see operating margin expansion year-over-year?

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Bryan D. Murray, NETGEAR, Inc. - CFO [5]

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Yes. We definitely believe we'll see margin expansion this year. And as we laid out in November, a lot of that will come from the removal of the tariffs and the inefficiencies that came with migrating our supply chain to the tune of about 240 basis points. So we expect to see that margin expansion, and we still think that we can see the growth of the low- to mid-single digits on the top line and the operating margin targets that we put out there.

Clearly, in the first quarter, with the reduced service provider revenues, which are kind of coming down, call it, $10 million or so off of the most recent run rate of $35 million on average per quarter, coupled with our need to continue to shift the channel inventory mix towards WiFi 6, we're losing some top line leverage in the first quarter, which is the culprit and the reason the operating margin is at the 2% to 3% range. But we do expect to see margin expansion as we move through the year. And as we take these efforts in the first quarter to shift -- continue to shift the mix towards WiFi 6, I expect that we'll see a little bit of a lift in Q2 in our revenues, where normal seasonality for service CHP, excluding service provider, would be flat. I do expect that we'll see a mid- to high-single-digit growth there as we execute the majority of this channel shift in Q1.

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Operator [6]

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Your next question comes from the line of Vahid Khorsand with BWS Financial.

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Vahid Khorsand, BWS Financial Inc. - Research Analyst [7]

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Just help us understand what -- why is it so important to drive revenue gains when operating margins seem to be going in the wrong direction?

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C. S. Lo, NETGEAR, Inc. - Co-Founder, Chairman & CEO [8]

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Well, I think it's important that we continue to move the market to WiFi 6. And as we do that, we naturally gain share and also gain shelf space and also gain the number of customers we're acquiring, which formed the basis of our service subscription revenue drive. So we believe that this is a short-term thing as we work through the cost overhead that's thrown at us by the trade war and the tariff. But we do believe that we will be quickly get back on to the operating margin growth. So in the short term, it seems like the paths are divergent. But actually, if you look beyond a quarter or 2, the path will be converging again. We're very confident of that.

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Vahid Khorsand, BWS Financial Inc. - Research Analyst [9]

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Okay. Just related to that, help me understand on the WiFi 5. It seems like that inventory level is remaining pretty much the same. Or is it going down as -- but your focus is still on WiFi 6? Are you moving the WiFi 5 products?

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C. S. Lo, NETGEAR, Inc. - Co-Founder, Chairman & CEO [10]

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Well, the WiFi 5 inventory in the channel as well as in our own inventory is definitely going down, but it's not going down as fast as we originally anticipated in Q4 because as we mentioned, we actually get some open additional promotional slots for WiFi 5 in Q4 from some of our channel partners, and then we took advantage of that. And in order do that, we ship more of WiFi 5 products into the channel. So that's why we're going to continue to do that adjustment in Q1. And we saw a [positive pickup] in our market share in the U.S. So right now, so we're in a very good position to really occupy more shelf space and thus be able to display more of our WiFi 6 products, which will lay the groundwork for us to continue to improve our operating margin as well as our market share and top line as we progress through 2020.

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Vahid Khorsand, BWS Financial Inc. - Research Analyst [11]

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And you talked a little bit in the prepared comments about competitiveness in Q4. Where are you seeing that competitiveness? And how is it translating into your product offering and your price points?

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C. S. Lo, NETGEAR, Inc. - Co-Founder, Chairman & CEO [12]

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Well, the competitive competition primarily come from 2 areas, right? One is from shelf space. Needless to say, everybody knows who their competitor is. There's [Amazon/Aero]. The competition on shelf space is both on its own Amazon website as well as in Best Buy, and the competition in price is naturally because they're pretty aggressive as we have seen in all the other hardware products that they put out from the Fire TV, to the ring cameras, to the Echo Dot. Every time they come into the market, they come in with pretty aggressive pricing. We anticipated that. So for us, it's important that we hold our share, and so that we can hold our shelf space and better yet, that we could expand our shelf space, then we'll be able to bring on both WiFi 5 to compete with them as well as WiFi 6, additional shelf space for WiFi 6. From a market share gain perspective, the strategy worked in Q4, and we do believe that it would pay off as the year progresses.

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Operator [13]

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Your next question comes from the line of Brian Yun with Deutsche Bank.

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Brian Yun, Deutsche Bank AG, Research Division - Data Networking Analyst [14]

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I apologize for any background noise. But I think this is the first quarter where you actually provided paid service subscribers in your presentation at 177,000. So I was just wondering if there's any additional quantitative metrics that you might be able to share there, whether that's ARPU, general growth rate expectations, maybe subscriber churn. Any color there would be helpful.

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C. S. Lo, NETGEAR, Inc. - Co-Founder, Chairman & CEO [15]

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Yes. Actually, it's our second time. I mean we disclosed the subscriber number on our Analyst Day back in November last year. At that time, it was mid-November, it was 150,000 subscribers. So from between then and end of December, we added another 27,000. And we just -- in our prepared remark, we said that our aim is going to double that number. That 177,000, we want to double that this year. That, of course, include the churns of the existing 177,000. We have a good plan, and we believe that we can execute on that. Right now, we do not have a breakout further details because still at -- even at 377 -- even at 350,000 plus, I think the revenue impact and the bottom line impact would not be very material. But I think once we reach closer to 0.5 million subscribers, then it will be meaningful and will [stop this bulging] more numbers in terms of ARPU, churn rate, et cetera.

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Brian Yun, Deutsche Bank AG, Research Division - Data Networking Analyst [16]

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Okay, great. And then just on the weakness that you saw in China, can you expand and give us a little bit more information there? And just how long do you kind of anticipate these headwinds to last?

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C. S. Lo, NETGEAR, Inc. - Co-Founder, Chairman & CEO [17]

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Well, I mean -- so first and foremost is the trade war, and the trade war basically put a lot of damper in Chinese state-directed economy to purchase American enterprise networking goods. So that our SMB products, which used to sell into a lot of Chinese state entities such as schools, universities, manufacturing, have declined pretty significantly. Secondly, from the consumer basis, there was a time that there was some intention to buy China rather than buying American. Fortunately, the phase has passed by. Unfortunately, that now we are confronted with this coronavirus. So those are the 2 headwinds we are facing in Mainland China. And then in Hong Kong, everybody knows that Hong Kong, ever since July of last year, has been in significant social unrest, and it's just not many people out in the street and shopping so that really affects both our SMB and consumer business. So we will see -- at first, we thought that with the first phase of trade agreements signed with the blow over of buy local for the consumers kind of passing away, things will get better. But now with the new outbreak of coronavirus in both places, in Mainland China and Hong Kong, then we cannot count on that upswing.

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Operator [18]

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(Operator Instructions) Your next question comes from the line of Paul Silverstein with Cowen.

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Paul Jonas Silverstein, Cowen and Company, LLC, Research Division - MD & Senior Research Analyst [19]

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I've got several that are of a clarification in nature. First off, did I hear you correctly that you're expecting Q2 to go back to year-over-year growth? Bryan, I thought I heard you say on the order of 5% to 10%, but maybe I misheard or misunderstood.

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Bryan D. Murray, NETGEAR, Inc. - CFO [20]

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Yes, what I was referencing is actually sequential growth, talking about the seasonality of our consumer business. When you exclude service provider revenues, typical seasonality, you would see Q2 flat to Q1. But as we said, we're taking some efforts in Q1 to further shift the mix in the channel to WiFi 6. And thus, we actually think that we'll see sequential growth in that portion of the business to the tune of mid- to high single digits.

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Paul Jonas Silverstein, Cowen and Company, LLC, Research Division - MD & Senior Research Analyst [21]

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Got it. Appreciate the clarification. So when do you think you'll see returns in year-over-year growth? Has your thinking changed on that issue?

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Bryan D. Murray, NETGEAR, Inc. - CFO [22]

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We definitely expect to see year-over-year growth this year. I think it could be as early as Q2. But certainly, as we go into the back half of the year, we will see it.

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Paul Jonas Silverstein, Cowen and Company, LLC, Research Division - MD & Senior Research Analyst [23]

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Okay. And then with respect to your commentary about market share. And I think you answered the question in your last response to the response before. But when we're talking about an enterprise-focused company, obviously, market share is critical in terms of translating future revenue. Is -- when we're talking about retail customers, where the onetime buy until the next iteration of the technology, whether g, ac and l, ax, et cetera, is the answer to that -- is the shelf space, that's why market share is so important? You've got to have sufficient share to have sufficient shelf space in order to be in front of consumers going forward and thereby drive revenue growth? Otherwise, I trust the market share argument, just -- it's not there.

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C. S. Lo, NETGEAR, Inc. - Co-Founder, Chairman & CEO [24]

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You're exactly right. In the retail space, shelf space phasings are very important and more market share will give you more shelf space and phasings. And as much as we think that everything is online, there is still 75% of the sales happening in physical stores. And when people walk into the stores, whatever is presented to them clearly has a lot of influence on sales. I mean, if you walk into Costco stores, you're presented with whatever they present you, and that is the #1, #2 brands that they're going to sell, and that would influence a lot of your future top line and bottom line. So in the retail space, it's very important to have market share.

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Paul Jonas Silverstein, Cowen and Company, LLC, Research Division - MD & Senior Research Analyst [25]

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Got it. One last question for me, if I may. So with respect to Amazon [Aero], what -- I trust, clearly, they're not going away. They're a permanent fact of life. And I trust there is a permanent impact on pricing and thereby margins and it's critical for you to cost reduce in order to enhance margin profile going forward. But that better pressure, it's not -- it's a constant battle for you to maintain your shelf space and thereby drive revenue growth and improve margin structure. I mean that's stating the obvious, no?

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C. S. Lo, NETGEAR, Inc. - Co-Founder, Chairman & CEO [26]

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Oh, yes, absolutely. And that's why, for us, it's so important to develop the subscription service revenue, all right? So in the worst-case scenario, we have to compete with them on all the, what we call WiFi systems, and on toe to toe in terms of cost, all right? Now we still have a lot of other categories that they don't compete with us, we're pretty unique, such as in mobile, such as in cable gateways and cable modems, such as in WiFi extenders. Those categories, they do not compete. However, in the WiFi routers/mesh system space, we definitely are prepared to continue to compete pretty aggressively competitively with them toe to toe on cost. And then to really enrich our capability to make money is basically on the subscription revenue that we derive from our loyal customer base.

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Operator [27]

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Your next question comes from the line of Robert Gutman with Guggenheim Securities.

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Robert Ari Gutman, Guggenheim Securities, LLC, Research Division - Senior Analyst [28]

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Of all the -- I'm not sure I heard. Of all the numbers that you've recapped, in first quarter, what do you expect the sequential growth to be in CHP ex service provider? Because that was a decline of about 12% to 15% before, and I don't -- I'm not sure, with all the changes, where that number is now.

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Bryan D. Murray, NETGEAR, Inc. - CFO [29]

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Yes. You're right. So normal seasonality would be a decline of 20% for CHP, excluding the service provider. And what we had said back in November is that we thought it would be a bit muted given the efforts that we were taking in Q4 to shift the mix in the channel. And we thought at the time, it would be low to mid- single-digit decline. But as Patrick said earlier, we saw an opportunity in the channel to increase in promotions on WiFi 5 products that we shipped in, which allowed us to gain some share. So we still have some work to do on the channel inventory mix. So I think you're probably looking somewhere between 15% to 20%, kind of back into the normal seasonality range.

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Robert Ari Gutman, Guggenheim Securities, LLC, Research Division - Senior Analyst [30]

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Okay. And that compares to 12 -- 15% to 20%, that compares to the Analyst Day, I think for that number, you said 12% to 15%?

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Bryan D. Murray, NETGEAR, Inc. - CFO [31]

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Correct.

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Robert Ari Gutman, Guggenheim Securities, LLC, Research Division - Senior Analyst [32]

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Okay. But then that implies, I think, with $25 million or so in service provider, I think that implies a -- I think, like a mid-teens year-over-year growth or mid-teens year-over-year decline on the SMB side to get to the, overall, the mid-point of your guidance for revenue. So is that -- [and is it closer to that], what would be the reason?

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Bryan D. Murray, NETGEAR, Inc. - CFO [33]

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That's right, Rob. So if you recall, Q1 of '19 was an exceptional quarter for SMB. We had a fairly large pull in because the original Brexit deadline was end of March. And at that time we had said some of our channel partners in the U.K. holding inventory into Q1, and we saw that correction occur into Q2. So I think it's probably more appropriate from a comparative standpoint to look at the average between Q1 to Q2 of last year.

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Robert Ari Gutman, Guggenheim Securities, LLC, Research Division - Senior Analyst [34]

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Got it. Okay. And I'm sorry, one other thing, if I may. Just the -- I know you talked about the cadence of margins through the year, but I just want to make sure I heard it right. So the guidance for 1Q is 3 -- is 2% to 3%, a small uplift in the second quarter. But that would imply to get to the same guidance, full year guidance of 8% to 9%, significant much higher margin than the last 2 quarters of the year. So I know there's the 240 basis points for the tariffs. But is it -- is that right? Is there any more way to qualify that or [can you provide more color....]

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Bryan D. Murray, NETGEAR, Inc. - CFO [35]

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Yes, that's correct, too, right? And that's a normal seasonal pattern that we would see where we see Q3 lift from back-to-school, and Q4, the holiday promotions, we get more top line leverage. So we typically experience our higher non-GAAP operating margins in the back half of the year.

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Operator [36]

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Your next question comes from the line of Paul Silverstein with Cowen.

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Paul Jonas Silverstein, Cowen and Company, LLC, Research Division - MD & Senior Research Analyst [37]

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There's always one more. Bryan, I might have missed it. If I did, I apologize. But can you quantify what the China impact was?

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Bryan D. Murray, NETGEAR, Inc. - CFO [38]

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Yes. So I would say the bulk of the 16% decline in the APAC region would be attributable to that region. We did have some service provider declines there as well. But the bulk of that decline would be attributable to the Greater China region.

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Paul Jonas Silverstein, Cowen and Company, LLC, Research Division - MD & Senior Research Analyst [39]

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And Patrick or Bryan, you're confidence about China coming back, but for the coronavirus issue. The thought arises that unless the state is similarly directing universities and other state-controlled, state-directed institutions, that they will buy from the U.S. as part of a geopolitical rapprochement, if you will. The thought arises that those institutions, they may be happy enough buying Chinese. There may be a lasting impact on the Chinese psyche in terms of buying American, which is, to say, they may never come back to you or any other American supplier. What underlies your confidence that, but for coronavirus, it would be coming back?

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C. S. Lo, NETGEAR, Inc. - Co-Founder, Chairman & CEO [40]

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Oh, let me make it a little bit clearer. I was referring to the consumer side and referring to the SMB on the Hong Kong side. You're right. I mean, on the SMB side, in Mainland China, it might never come back for the SMB purchase. But on the consumer side, as you have seen it, for iPhone 11, after the wind is blowing over, they did pretty well. So we would -- riding the dovetail what the success it would have on the consumer side, that's the original hope. And then for the Hong Kong, we are seeing just about that the business is coming back. It's back to normal because the unrest is finally calming down in January, and that's what I was referring to.

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Paul Jonas Silverstein, Cowen and Company, LLC, Research Division - MD & Senior Research Analyst [41]

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All right. And Patrick, to be clear, so you and Bryan are not expecting a return of China Mainland SMB business?

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C. S. Lo, NETGEAR, Inc. - Co-Founder, Chairman & CEO [42]

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No, we're not. That is factored into our full year view.

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Paul Jonas Silverstein, Cowen and Company, LLC, Research Division - MD & Senior Research Analyst [43]

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All right. But it begs the question, how much of the China decline was SMB as opposed to consumer?

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C. S. Lo, NETGEAR, Inc. - Co-Founder, Chairman & CEO [44]

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Well, I mean, both are declining very rapidly so far.

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Paul Jonas Silverstein, Cowen and Company, LLC, Research Division - MD & Senior Research Analyst [45]

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But were the two 50-50 in terms of your China business?

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C. S. Lo, NETGEAR, Inc. - Co-Founder, Chairman & CEO [46]

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Yes, pretty much.

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Paul Jonas Silverstein, Cowen and Company, LLC, Research Division - MD & Senior Research Analyst [47]

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Or was the China business (inaudible) the ones (inaudible)?

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C. S. Lo, NETGEAR, Inc. - Co-Founder, Chairman & CEO [48]

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Yes, pretty much. Pretty much 50-50.

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Operator [49]

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There are no further questions at this time. I will turn the call back over to Patrick Lo.

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C. S. Lo, NETGEAR, Inc. - Co-Founder, Chairman & CEO [50]

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Thank you for joining today's call. We're excited about our opportunities in 2020 because it further position ourselves as the premium technology leader in consumer and SMB networking. And it also offer new opportunities for us in the new markets of ProAV and digital canvas market. And most importantly, it will be a significant step towards building a robust service revenue stream. And I will update you on all those angles in every earnings call going forward. And I will talk to you all in 2 months in April. Thank you.

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Operator [51]

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Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.