NETGEAR, Inc. (NASDAQ:NTGR) Q4 2023 Earnings Call Transcript
NETGEAR, Inc. (NASDAQ:NTGR) Q4 2023 Earnings Call Transcript February 7, 2024
NETGEAR, Inc. beats earnings expectations. Reported EPS is $0.09, expectations were $0.04. NETGEAR, Inc. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).
Operator: Ladies and gentlemen, thank you for standing by. [Operator Instructions] I would now like to turn the conference over to Erik Bylin. Please go ahead, sir.
Erik Bylin: Thank you, Eric. Good afternoon and welcome to NETGEAR's Fourth Quarter and Full Year 2023 Financial Results Conference Call. Joining us from the company are Mr. C.J. Prober, CEO; Mr. Bryan Murray, CFO; and Mr. David Henry, President and General Manager of Connected Home Products and Services. The format of the call; we'll start with an overview of the company's recent leadership condition provided by Bryan, followed by an introduction by C.J. and finish a review of the financials for the fourth quarter and full year commentary on the business and first quarter of 2024 guidance provided by Bryan. We'll then have time for any questions. If you've not received a copy of today's 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 expense, expenses and future business outlook. Actual results or trends could differ materially from those contemplated by these forward-looking statements. For more information, please refer to the risk factors discussed in 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 statements as a result of new information or future events. In addition, several non-GAAP financial measures will be mentioned on this call.
A reconciliation of the non-GAAP to GAAP measures can be found in today's press release on our Investor Relations website. At this time, I would now turn the call over to Mr. Bryan Murray.
Bryan Murray: Thank you, Erik and thank you, everyone, for joining today's call. As we announced last week, after nearly 3 decades at the helm, Patrick Lo has chosen to retire from his role as CEO and Chairman at NETGEAR. Patrick will serve as a strategic adviser through July of this year to ensure a smooth transition. Well, Patrick will certainly be missed. We're very excited to see him embark on his next chapter in life. After a thorough search over the past year to identify a successor of Patrick, the Board appointed C.J. as NETGEAR CEO. C.J. has a background that is uniquely suited to the NETGEAR into our next chapter and then NETGEAR Board and the management team are excited to work with C.J. as we capitalize on the great opportunity in front of us. With that, I would like to personally welcome C.J. and give him the stage to introduce himself prior to getting into the Q4 results.
Charles Prober: Thank you, Bryan. It's really awesome to be here. We had an all-hands with the NETGEAR global team last week, on my first day and another one just an hours ago. And I want to reiterate a few of the points that I shared with the team. First, I really appreciate the incredible welcome I have received from the Board, our executive leadership team, the broader NETGEAR team and many of our partners and customers. It's only been a week and I'm definitely feeling -- but I'm definitely feeling like the shoe fits and I'm more excited than ever about the road ahead. Second, if the real honor to be taking over from Patrick, he's been a pioneer in our industry. He is a great person with the highest integrity and he's established a great culture in NETGEAR.
I really appreciate him and the rest of the Board entrusting me with this opportunity and supporting me and the rest of the executive team in the transition. Third and most importantly, the opportunity ahead for NETGEAR is incredibly exciting. We have macro tailwinds working in our favor, like the importance of the connectivity in a work-from-anywhere world, connected device proliferation, increasing need for higher bandwidth to support high fidelity audio and video experiences and the growing importance of digital security. We also have an incredible brand, great technology and products, a strong balance sheet, a diversified business with consumer and NETGEAR for business and a lot of potential adjacencies for growth. It's really pretty rare for a new CEO to be able to step into an opportunity with so much upside, the business has obviously been challenged and it's going to take a lot of work to capture that upside.
The journey ahead starts with strengthening our core business, both on the consumer and NETGEAR-for-business side of things. I see many opportunities to do that, as part of this initial phase, I'm embarking on a 45-day listening tour to validate my plan and seek input from the broader team. While it is early, I can say that on the consumer side of things, the come important themes will be around the simplification of our product offerings, both devices and subscription and improving the performance of our highest margin channel. On the NETGEAR for business side of things, we've been able to scale the Pro AV business with a solution-focused sales motion and 1 theme going forward be to double down on those go-to-market capabilities so that we can grow our share in markets where products solve a critical need for customers.
I believe the plan to strengthen our core which I look forward to sharing with you during a future earnings call in more detail, will lead to a stronger NETGEAR with improved cash flow performance and renewed growth opportunities. With that, back over to you, Bryan.
Bryan Murray: Thank you, C.J. And once again, on behalf of the entire team, welcome. We are pleased with the continued execution of our team this quarter in delivering revenue and operating margins at the high end of our updated guidance ranges. For the quarter ended December 31, 2023. Revenue was $188.7 million, down 4.6% on a sequential basis and down 24.3% year-over-year. Importantly, we took great strides in turning inventory into cash and added $55.6 million of cash to our balance sheet. On the CHP side, the U.S. retail market overall underperformed our expectations due to a more promotional holiday season especially in the lower end of the market but NETGEAR outperformed the market largely driven by strong results in our premium products.
In tandem with the ramp of the WiFi 7 upgrade cycle end user demand for our premium solutions which consists of our Orbi 8 and 9, tri and quad-band WiFi mesh products and 5G Nighthawk Mobile Hotspots, again performed well. It grew double digit sequentially and more than 30% year-over-year, strongly outpacing the total market. In fact, our premium products reached a new high as a percentage of our CHP retail business contributing 25% of sales to end users. Meanwhile, sales to service providers came in at just over $27 million for the quarter. Our SMB business outperformed our expectations as we steadily drive up ASPs, even though channel inventory for our SMB business continued to contract, bolstering our total revenue to the upper end of our guidance.
Outside of the inventory contraction our competitive position in SMB remains strong. The softening macro conditions and certain markets are still impacting SMB's growth prospects in the near term. As customers remain hesitant to make investments in deals are taking lower to close. For the full year of 2023, NETGEAR net revenues were $740.8 million, down 20.6% compared to the year ended December 31, 2022 amid channel partner's constraining inventory levels and tougher market conditions. Despite the challenging macroeconomic environment, elevated interest rates and inventory rightsizing among our channel partners through the year we continue to believe the broader U.S. consumer rates till market stabilizes. I'm proud of the progress we've made in transitioning our CHP business to the premium, higher margin segments of the market where we enjoy considerable competitive differentiation.
Industry funders are also pointing to the next 12 months as when the hangover from the pandemic pre-buying will be flushed out and the next wave of upgrades will take hold. So as discussed in our recent Analyst Day we expect that the WiFi 7 upgrade cycle and secular trends in the markets that we identified across both businesses will continue to expand the available market opportunity for NETGEAR in the coming quarters. Especially the impact from SMB channel partners reducing inventory position begins to wane. With a robust portfolio of hardware and subscription offerings and high barrier to entry for the competition from [indiscernible] more than 25 years of innovation, NETGEAR's higher-margin premium products are the key to delivering long-term profitable growth.
The fact that our premium products materially outperformed the market to the tune of double-digit full year growth and help generate significant gross margin improvement, serves as a clear validation of our core long-term strategy to focus on the premium segment and grow our services business. The investments we've made in pursuing this strategy are essential in returning to long-term profitable growth. Notably, the improved mix towards premium higher-margin products combined with the progress we continue to make in growing our service revenue business led us to achieve full year non-GAAP gross margin of 33.9% equaling our highest full year non-GAAP gross margin in the past 16 years. This marks an impressive improvement in our non-GAAP gross margin year-over-year by more than 1,000 basis points for the fourth quarter and 680 basis points for the full year.
The result that would not have been possible without our team's outstanding efforts mix towards the higher ASP premium WiFi mesh and 5G mobile hotspot products, improved traction in our services business and the inroads we've made in establishing growth in our presence in the Pro AV market. Additionally, enabled by disciplined expense management, we continue the momentum behind our improving profitability in the fourth quarter. Delivering non-GAAP operating income was $2.7 million and non-GAAP operating margin of 1.4%. With the margin coming in at the high end of our updated guidance range. Our non-GAAP operating margin was up 300 basis points compared to the year ago period and down 130 basis points compared to the prior quarter due to a slight loss of topline leverage.
However, looking back at the full year, the ongoing uncertain macroeconomic environment, elevated interest rates and improved supply position broadly in the market continue to constrain our top line potential as our channel partners on both the CHP and SMB side of the business, reduce their inventory carrying levels far below historical norms. As a result, these headwinds reduced our leverage and led to the full year non-GAAP operating loss of $9.9 million and non-GAAP operating margins of negative 1.3%. For the fourth quarter of 2023, net revenue for the Americas was $124.8 million, a decline of 21.6% year-over-year and down 11.5% on a sequential basis. EMEA net revenue was $37.9 million, a decrease of 28.1% year-over-year and up 6.2% quarter-over-quarter.
Our APAC net revenue was $26 million which is down 30.2% from the prior year comparable period and up 22.9% sequentially. For the fourth quarter of 2023, we shipped a total of approximately 1.7 million units, including 938,000 nodes of wireless products. Shipments of all wired and wireless routers and gateways combined were about 480,000 units for the fourth quarter of 2023. The net revenue split between home and business products was about 63% and 37%, respectively. The net revenue split between wireless and wired products was about 59% and 41%, respectively. Products introduced in the last 15 months constituted about 14% of our fourth quarter shipments or products introduced in the last 12 months contributed about 10% of our fourth quarter shipments.
From this point on, my discussion points will focus on non-GAAP numbers. The reconciliation from GAAP to non-GAAP is detailed in our earnings release distributed earlier today. Non-GAAP gross margin in the fourth quarter of 2023 was 35% which is up 1,010 basis points as compared to 24.9% in the prior year comparable period and flat compared to the third quarter of 2023. As compared to the prior year period, increased shipments of our premium base CHP products growth of services revenue, a considerably lower total freight costs largely drove the improvement. Total Q4 non-GAAP operating expenses came in at $63.3 million which is down 4.2% year-over-year and down 1.1% sequentially. Our headcount was 635 as in the quarter, down from 644 in Q3. We will continue to strategically invest in our business and hiring key areas we believe will deliver future growth and profitability such as Pro AV managed switches, premium Orbi WiFi mesh systems, 5G mobile hotspots and subscription services.
However, we continue to evaluate other areas of the business on a regular basis driving further cost efficiencies. Our non-GAAP R&D expense for the fourth quarter was 9.9% of net revenue as compared to 7.7% of net revenue in the prior year comparable period and 10.1% of net revenue in the third quarter of 2023. To continue our technology and subscription service leadership we are committed to continued investment in R&D. Our non-GAAP tax expense was $2.4 million in the fourth quarter of 2023. Looking at the bottom line for Q4, we reported non-GAAP net income of $2.7 million and non-GAAP diluted earnings per share of $0.09. Turning to the balance sheet, we ended the fourth quarter of 2023 with $283.7 million in cash and cash -- short-term investments up $55.6 million from the prior year quarter.
We continued our positive free cash flow generation in the fourth quarter as we made meaningful progress in further reducing our inventory. During the quarter $56.3 million of cash was provided by operations which drove our total cash provided by operations over the trailing 12 months to $56.9 million. We used $2.2 million in purchase of property and equipment during the quarter which brings our total cash used for capital expenditures over the trailing 12 months to $5.8 million. We expect to continue generating positive free cash flow as we believe we will further reduce our inventory levels in the early part of 2024 as we drive to prepandemic carrying levels of 3 to 4 months. Now turning to the fourth quarter results for our product segments.
The Connected Homes segment which includes our industry lead in Orbi Nighthawk, Nighthawk Pro Gaming, Armor and Meural brand generated net revenue of $118.4 million for the quarter, down 20.6% on a year-over-year basis and down 7% sequentially. In the comparable prior year period our CHP business benefited from higher sales to service providers as we make great progress in filling up and delivering supply of M6 and M6 Pro mobile hotspot. And on the retail side, the total addressable market was larger than a year ago leading to a year-over-year decline in both the retail and service provider channels. However, despite the year-over-year overall retail market contraction, demand for our premium Orbi 8 and 9 WiFi mesh and 5G mobile hotspots continue to grow year-over-year by over 30%, bolstered by the addition of our recently released WiFi 7 Orbi 97x mesh system, the contribution of the premium products to our CHP retail business grew to over 25% of sales to end users.
These higher-margin, high-end products continues to drive up ASPs and help us deliver considerably improve profitability year-over-year. As we progress through this upcoming WiFi 7 upgrade cycle we continue to believe that the market has stabilized and expect CHP channel inventory to remain generally stable as we move forward. Consequently, we anticipate our CHP product mix will continue to shift towards these higher-margin products and add to the momentum of our core long-term growth and profitability strategy. We remain keenly focused on the solutions our customers need and recognize that our premium Orbi high mesh systems may not be the optimal choice for smaller households or those who want the best connectivity at a lower price point. In these cases, our differentiated WiFi 6e and WiFi 7 Nighthawk routers, Cable Gateway and midrange Nighthawk mobile hotspots fit the bill perfectly and we expect these products to contribute to our improving growth and profitability in the CHP business.
While we certainly have demonstrated our hardware expertise, our software solutions are also steadily gaining traction. And our investments in our services strategy continue to pay off. I'm excited to share that we exceeded our target for the full year and exited the fourth quarter with 877,000 paid subscribers. And we generated $11.4 million in service revenue for the fourth quarter, a year-over-year increase of 27.7%. This growth is fueled by the increased emphasis we're seeing CHP consumers place on cybersecurity protection, privacy and premium support. And we see a path to exit 2024 with the service revenue and annualized run rate of $50 million with even greater potential in the long term. On the SMB side, net revenue came in at $70.3 million in the fourth quarter, slightly above our expectations.
Similar to the prior quarter, high interest rates and stagnant or even negative GTV growth in major markets such as Germany, Greater China and Japan, weighed on the SMB market, it continue to dampen end user demand for our traditional switches combined with the reduction in inventory carrying levels that are channel partners throughout the year. These headwinds led us to full year SMB revenue of $284 million, a decline of 21.3%. Although we performed well relative to our expectations for this quarter, our SMB channel partners again continued to compress inventory levels and are expected to continue doing so in the quarters ahead as macroeconomic headwinds persist. However, we remain confident in the growth potential of this business, given our competitive advantage in the Pro AV market and the thoughtful investments we've made in both our hardware and the software offerings to position ourselves for success and entrench our first-mover advantage.
To fortify our advantage, we have developed comprehensive and uniquely differentiated solutions. The ability to integrate with over 200 AV equipment manufacturers through our Engage Controller software platform, go-to-market partnerships with leading AV integrators around the world in the commercial and residential markets and an experienced team with AV network designers. That gives deep expertise in the rapidly growing Pro AV market is unmatched by our competition and gives us the confidence in the long-term growth and profitability potential in our Pro AV suite of products. I'll now discuss our Q1 2024 outlook. We expect the retail portion of our CHP business to experience the seasonal decline coming off the holiday period. Revenue from the service provider channel is expected to be approximately $25 million in the first quarter.
As the interest rates remain high, we will continue to work with our SMB channel partners to optimize their inventory carrying levels during the next few quarters. Accordingly, we expect first quarter net revenue to be in the range of $155 million to $170 million. As we continue to make meaningful progress in reducing our own inventory levels, we will be consuming higher cost inventory. We expect we will be back to our historically normal inventory costs in the second half of this year. Accordingly, we expect our first quarter GAAP operating margin to be in the range of negative 11.4% to negative 8.4%. And our non-GAAP operating margin to be in the range of negative 8.5% to negative 5.5%. Our GAAP tax expenses is expected to be in the range of $6.5 million to $7.5 million.
And our non-GAAP tax benefit is expected to be in the range of $0 to $1 million in the first quarter of 2024. We expect to continue to generate meaningful cash in the first quarter of 2024. Operator, we would now like to answer any questions from the audience.
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