Q4 2023 NETGEAR Inc Earnings Call
Participants
Erik Bylin; IR; NETGEAR Inc
Bryan Murray; Chief Financial Officer; NETGEAR Inc
Charles (CJ) Prober; CEO and Director; NETGEAR Inc
David Henry; President and General Manager of Connected Home Products and Services; NETGEAR Inc
Jake Norrison; Analyst; Raymond James Financial, Inc.
Hamed Khorsand; Analyst; BWS Financial Inc.
Presentation
Operator
Ladies and gentlemen, thank you for standing by. at this time, all participants are in a listen-only mode. Later we will conduct a question and answer session. At that time, if you have a question, you will need to press star one on your telephone on your push button phone. 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 Netcare's Fourth Quarter and Full Year 2023 financial results conference call. Joining us from the Company are Mr. CJ Prober, CEO; Mr. Bryan Murray, CFO; and Mr. David Henry, President and General Manager of connected home products and services.
Format of the call will start with an overview of the Company's recent leadership transition provided by by Brian followed by an introduction by CJ and finish with 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 will then have time for any questions. If you've not received a copy of today's release, please visit Netcare'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 Netcare'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. For 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 like to 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 three 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 for Patrick will certainly be missed. We are very excited to embark on board, when is the next chapter in life after a thorough search over the past year to identify a successor to Patrick, the Board appointed CJ As Nick, your CYOCG. As a background that is uniquely suited to lead Net Gear into our next chapter. And then Nick, your Board and management team are excited to work with CJ. as we capitalize on the great opportunity in front of us.
With that, I would like to personally welcome, CJ. And given the stage introduce himself prior to getting into the Q4 results.
Charles (CJ) Prober
Thank you, Brian. 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 hour ago, and I want to reiterate a few of the points I shared with the team first, I really appreciate the incredible welcome I've received from the board, our exec 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 a definite feeling of the shoe fits. And I'm more excited than ever about the road ahead.
Second, it's a real honor to be taking over from Patrick. He has been a pioneer in our industry is a great person with the highest integrity in establishing great culture at Netcare. 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 next year is incredibly exciting. We have macro tailwinds working in our favor, like the importance of 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 gear 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 that 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 that gear 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 listing 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. A couple of important themes will be around the simplification of our product offerings, both devices and subscription and improving the performance of our highest margin channels on the negative for business side of things. We've been able to scale the Pro AV business with a solution focus sales motion and one team going forward will be to double down on those go-to-market capabilities so that we can grow our share in markets where our 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 next year with improved cash flow performance and renewed growth opportunities.
Bryan Murray
With that back over to you, Brent legacy, Jay, once again, on behalf of the entire team, welcome. We are pleased with the continued execution of our team this quarter and delivering revenue and operating margin at the high end of our updated guidance ranges for the quarter ended December 31st, 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 US 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 seven upgrade cycle in user demand for our premium solutions, which consist of our OBAN. nine Tri and quad band WiFi mesh products in 5G, mobile network mobile hotspots again performed well and grew double digits 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 and outside of the inventory contraction for competitive position in SMB remains strong, but softening macro conditions in certain markets are still impacting SMB's growth prospects in the near term as customers remain hesitant to make investments in deals are taking longer to close. For the full year of 2023, Netgear net revenues were $740.8 million, down 20.6% compared to the year ended December 31st, 2022 and mid channel partners constraining inventory levels and tougher market conditions.
Despite the challenging macroeconomic environment, elevated interest rates and inventory rightsizing among our channel partners during the year, we continue to believe the broader US consumer retail market stabilized. I'm proud of the progress we made in transitioning our C3 business, the premium higher margin segments of the market. We enjoy considerable competitive differentiation. Industry pundits are also pointing to the next 12 months is when the hangover from the pandemic prebuy will be fleshed out in the next wave of upgrades will take hold. So as discussed at our recent Analyst Day, we expect that the WiFi seven upgrade cycle and secular trends in the market that we identified across both businesses to continue to expand the available market opportunity for next year in the coming quarters, especially as the impact from SMB channel partners reducing inventory positions begins to wane with our robust portfolio of hardware and subscription offerings and a high barrier to entry for the competition for more than 25 years of innovation stickier, 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 served as a clear validation of our core long-term strategy to focus on the premium segments.
We grow our services business, the investments we've made in pursuing this strategy or essentially 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%, equally are 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 results that would not have been possible without our team's outstanding efforts to retool our mix towards the higher age free premium WiFi mesh and 5G mobile hotspot products improved traction in our services business and the inroads we made in establishing and growing our presence in the Pro AV market.
Additionally, enabled by disciplined expense management, we continued the momentum behind our improving profitability in the fourth quarter, delivering non-GAAP operating income of $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 top line leverage. However, looking back at the full year, the ongoing uncertain macroeconomic environment, elevated interest rates and improved supply position broadly in the market continued to constrain our top line potential as our channel partners on both the CSP 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 full year non-GAAP operating loss of $9.9 million and non-GAAP operating margin 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 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 comparable period and up 22.9% sequentially.
For the fourth quarter of 2023, we shipped a total of approximately 1.7 million units, including 930,000 nodes of wireless products. Shipments of all wired and wireless routers and gateways combined were about 480,000 units for the fourth quarter 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, while 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 comparable period and flat compared to the third quarter of 2023.
As compared to the prior year period. Increased shipments of our premium, higher-margin CSP products, growth in services revenue and conserving lower total freight costs largely drove the improvement. Total Q4 non-GAAP operating expenses came in at $53.3 million, which is down 4.2% year over year and down 1.1% sequentially. Our headcount was 635 as of this quarter, down from 644 in Q3. We will continue to strategically invest in our business and hire in key areas we believe will deliver future growth and profitability, such as probably be 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.
Brazil further cost efficiency.
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 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 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 purchases of property equipment in 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 pre-pandemic carrying levels of three to four months.
Now turning to the fourth quarter results for our product segments. The Connected Home segment, which includes our industry-leading Orbi Nighthawk, Nighthawk Pro Gaming, FORMER and Meural brands generated net revenue of $118.4 million in the quarter, down 20.6% on a year-over-year basis and down 7% sequentially. In the comparable prior year period for CHP business benefited from higher sales to service providers as we made great progress in building up and delivering supply of our M6 and M6 Pro mobile hotspots. And on the retail side, the total addressable market was larger 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 traction demand for our premium or orbi nine WiFi mesh in 5G. Mobile Hotspots continued to grow year over year by over 30%, bolstered by the addition of our recently released WiFi seven or nine seven times mesh system, the contribution of premium products, two, our CSP retail business grew to over 25% of sales to end users. These higher-margin high end products continue to drive up ASPs and helped us deliver considerably improved profit profitability year over year as we progress through this upcoming WiFi seven upgrade cycle. We continue to believe the market has stabilized and expect CSP channel inventory to remain generally stable moving forward. Consequently, we anticipate our CSP 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 WiFi mesh systems may not be the optimal choice for smaller households for those who want the best connectivity at a lower price point in these cases are differentiated WiFi 6E and WiFi seven, Nighthawk routers, cable gateways and midrange Nighthawk mobile hotspots fits the bill perfectly, and we expect these products to contribute. We're improving growth and profitability in the CHP business.
Well, we certainly have demonstrated our harbor expertise for software solutions are also steadily gaining traction in our investments or services strategy continued 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 was 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 a service revenue annualized run rate of $50 million with even greater potential over 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 and continued to dampen end user demand for our traditional switches, combined with the reduction in inventory carrying levels at our channel partners throughout the year. These headwinds led us to full year SMB revenue of $294 million, a decline of 21.3%. Although we performed well relative to our expectations for the quarter for 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 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 engaged controller software platform, go-to-market partnerships with leading AV integrators around the world in the commercial and residential markets and an experienced team of TV network designers. Nike has deep expertise in the rapidly growing private market. It is unmatched by our competition and gives us the confidence in the long-term growth and profitability potential in our probably the suite of products. We'll now discuss our Q1 2024 outlook. We expect the retail portion of our CC business to experience a 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 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 to move back toward historically normal inventory costs in the second half of this year. And accordingly, we expect our first half 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 expense 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 for 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.
Question and Answer Session
Operator
At this time, I would like to remind everyone in order to ask a question, please press star then the number one on your telephone keypad. We'll pause for just a moment to compile the Q&A roster. Your first question comes from the line of Jake Norstan with Raymond James. Your line is open.
Jake Norrison
Okay, thank you. A couple from me. I just wanted to start off from a high level or welcoming C.J. I'm just wondering what with this organizational shift enable from a strategy and capital allocation perspective long term. I know you touched on potential growth adjacencies. Any more color there would be helpful.
Charles (CJ) Prober
Okay. Jake, Good to meet you too early to say I obviously made the point that them I see an opportunity for cash generation. We're doing that now on the back of working capital improvements. But long term, we wanted to create value. And the way I see us creating value is being a long-term sustainable cash-generating business in terms of how much capital that requires and how that feeds into kind of the strategy we implement. Let's talk about that on a later call, but I definitely appreciate where you're coming from that question.
Jake Norrison
Okay, sounds good. Thank you. And then I'm also wondering you guys gave fiscal year guidance at the Analyst Day. Can you just give us updated color on the cadence of how the year will play out? Are you still expecting that sort of hockey stick in the back half low to mid-single digit growth for the full year.
Bryan Murray
In keeping with our tradition, we're looking to to readdress annual guidance at this point.
We provided guidance for Q1 based on what we see in the near term. But I do feel like the guidance we put out there for Q1 is relatively in line with what we shared at the Analyst Day, there is probably a slight lowering of the operating margin profile from the range that we provided for the first half. And I would say the differential. There is largely due to transitional costs as we kind of ramp up this new, the new leadership with CJ coming on board and the transition costs coming along with that makes sense.
Jake Norrison
And then last one for me. You mentioned a couple of times you saw the retail market stabilize. And can you just touch on what's giving you confidence there in that channel or CHB. channel inventory will be stable for the rest of the year?
Bryan Murray
Yes, maybe I'll start and then I'll ask David to weigh in here and we think as we said last quarter, what's giving us the confidence we've seen that is that we're starting to see a return to normal seasonal behavior within that markets. Typically you would see a seasonal decline as there's some finer guidance here for Q1. So that's the main data point we have. We obviously think that continues to strengthen as WiFi seven becomes more prominent in the market, just given the natural growth in ASPs that that will bring in play. But David can probably provide some additional context.
David Henry
Sure.
Yes.
As Brian said, I think over the last couple of quarters, we started to see the year-on-year decline of the market stabilize and not continue to get done lower and lower as we have seen for the last few years as we go into this year. Obviously, the refresh cycle for years removed from the pandemic pull in selling the wind at our backs as well as some. There's a lot of new WiFi seven devices launched in the market. Samsung just announced their 24 Galaxy S. 24 by seven. We expect others throughout this year and as people start to adopt those new products, they're going to want to upgrade their networks, and that should do it helps stimulate the market to further stabilization.
Jake Norrison
Very helpful.
Thank you.
Operator
Again, if you would like to ask a question, press star then the number one on your telephone keypad. Your next question comes from the line of Hamed Khorsand with BWS Financial Your line is open.
Hamed Khorsand
Hey, so first off, can you just talk about your commentary here for Q1? You're saying retail stabilizing, but you're guiding quite a bit down and then it conflicts with that stabilization comment because Q1 23, it was you're going to be well below that. Was it stable when Q1 23 you were saying?
Oh, it's going to be it's the bottom and all that commentary now you're saying, well, it's going to be below that number.
Bryan Murray
Yes.
I mean, as you may recall, the retail portion of the P. business is very seasonal. In normal periods.
You'll see something like that mid-teen percentage decline in the market from Q4 into Q1. So that's the main driver. Why revenues would be would be coming down. And that was that was mentioned back in December at the analyst day as well.
So we continue to see that playing out.
As we've mentioned back in December and the primary driver for the sequential decline in revenue?
Yes.
Hamed Khorsand
No, I understand the commentary you gave in December. I understand the commentary now. I'm trying to understand, are you saying it's stable. If your actually your revenue is declining year over year over year from Q1 '23 at Q1 '24, that doesn't seem stable yet.
Bryan Murray
So again, that the company made earlier with regards to what the signal is that leads us to believe that the market has stabilized is largely because we have returned to normal seasonal patterns at some point it will play out as a year over year flattening and hopefully turning to growth, which again, I think to the point David made and that I said earlier that that's going to come as WiFi seven kind of becomes more prominent in the market. But those are the those are the signals that we see that are driving us towards believing the market is stabilizing.
Hamed Khorsand
And then, Brian, what's happened since the analyst day that it feels like the key Q. one is going to be lower than what was perceived, I think your quote was at Investor Day was going to be first half was going to be down mid single digits, right?
Bryan Murray
And now this is a quite a bit more than that as we said the sequential decline would be down mid-single-digit.
I think we're at in that general direction with the guidance, depending where in the range you are landing, there's not much has changed from that December guidance on the top line.
Hamed Khorsand
Okay. And then why hasn't there been any progress as far as what you are doing your cash? I mean that $284 million. That's quite a bit of change and there has been no activity on buying back a stock.
Bryan Murray
Yes, there's no doubt we've been very successful of quickly turning that ship from the end of Q2, we were at $203 million and to exit the year just shy of $284 million. We generated a lot of cash in a very short period of time, mainly coming from compressing our inventory balances. I would just say if that is a very near term trend, we obviously are going through a change in leadership, and we're going to continue to have the same kind of conversations we've had historically with regards to how we allocate capital, which again, we continue to reiterate that we think we need about [$125 million] to run the business and then all amounts beyond that, we're continuing to have discussions about strategic uses. Obviously, M&A is something that we continuously talk about. And then stock repurchase, who again continue to be opportunistic buyers of our stock with 2 million, 2.5 million shares remaining on that program. And but I think it's because we quickly turn turn to times where we were utilized using cash in the first half of the year, and we've aggressively turned that around with the Q4 performance of generating free cash flow over $54 million was quite an improvement. And if you recall my comments back in October, we were expecting to generate probably something more in the $25 million to $30 million range. So we we overshot that mark, which is great. We still continue to believe that we're going to generate more cash in Q1.
Hamed Khorsand
Okay.
Thank you.
Bryan Murray
Sure.
Operator
There are no further questions at this time, sir. And CJ, I turn the call back over to you.
Charles (CJ) Prober
Yes.
Thank you, guys.
For joining us today, like I said, couldn't be more excited about the opportunity ahead. That's it for us. And Nick, your team's done enough.
Operator
This concludes today's conference call. You may now disconnect.
