NETGEAR, Inc.

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 the star 1 on your push-button phone. I would now like to turn the conference over to Eric Bailon. Please go ahead, sir.

Thank you, Emma. Good afternoon, and welcome to Netgear's fourth quarter and full year 2022 financial results conference call. Joining us from the company are Mr. Patrick Lowe, Chairman and CEO, and Mr. Brian Murray, CFO. The format of the call will start with a review of the financials for the fourth quarter and full year provided by Brian, followed by details and commentary on the business provided by Patrick, and finish with the first quarter of 2023 guidance provided by Brian. 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 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. 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. Brian Murray. Thank you, Eric. And thank you, everyone, for joining today's call.

Net revenue for the quarter ended December 31, 2022, was $249.1 million, which came in at the high end of our guidance range, flat on a sequential basis, and down 0.8% year over year. Netgear's innovative, highly differentiated premium products, namely our ProAV-managed switches, 5G mobile hotspots, and 10-gig tri- and quad-band Wi-Fi mesh products continue to experience strong demand. In the fourth quarter, the team executed well to overcome supply challenges for these in-demand products, and this effort resulted in another record quarter of revenue for our SMB business, led by ProAV, and strong growth of our 5G mobile hotspots with our service provider partners. Our non-gap operating margin was negative 1.6%. in the middle of our guidance range. For the full year of 2022, Netgear net revenues were $932.5 million, down 20.2% compared to the year ended December 31, 2021. While 2022 was a difficult year due to challenges from supply chain, foreign exchange, and high transportation costs, I'm proud of the progress we made in executing on our strategy to grow our SMB business and transition our CHP business to the premium, higher margin segments of the market, where we enjoy considerable competitive differentiation. While the broader US consumer retail market decreased approximately 25% for the full year, our premium products materially outperformed the market, up double digits for the full year. a clear validation of our core long-term strategy to focus on the premium segment. We expect that the trends for both businesses that we discussed at our analyst day will continue to expand the available market opportunities for Netgear. These higher margin products are the key to delivering growth and increasing profitability in the long term. As we look to the first quarter, broad-based inflationary pressures and the uncertain macroeconomic environment remain top of mind for many retail channel partners. Consequently, while we made progress in D stocking in the fourth quarter, our retail partners continue to right size inventory levels. And we continue to expect that to carry into 2023. While this will dampen CHP retail results in the first half of 2023, we expect to see material improvement as we move into the back half of the year. In the fourth quarter, We delivered non-GAAP operating loss of $3.9 million and non-GAAP operating margin of negative 1.6%. This declined 230 basis points as compared to the prior quarter due to a strengthened US dollar, higher freight costs when the inventory was purchased, and a seasonally more promotional environment. Although our SMB revenue for the full year outperformed the expectations we had at the beginning of the year, The U.S. consumer networking market contracted further than expected, which led to lost top-line leverage overall. In conjunction with a challenging supply chain environment throughout the year, unfavorable foreign exchange conditions also reduced profitability and led to full-year non-GAAP operating loss of $15.6 million and non-GAAP operating margins of negative 1.7%. For the fourth quarter of 2022, net revenue for the Americas was $159.2 million, flat year over year, and a decrease of 6% on a sequential basis. EMEA net revenue was $52.7 million, which is up 5.4% year over year, and up 17.6% quarter over quarter. Our APAC net revenue was $37.2 million, which is down 10.8% from the prior year comparable period, and up 5.1% sequentially. Our SMB business saw strong year-over-year growth across all three regions, as we made progress securing additional supply for SMB products. However, in general, the strengthening of the U.S. dollar over the past year had a meaningful negative impact on our international revenue and our profitability. On a constant currency basis year-over-year, our EMEA revenue would have grown 21%, and our APAC revenue would have only declined 5%. For the fourth quarter of 2022, we shipped a total of approximately 2.2 million units, including 1.4 million nodes of wireless products. Shipments of all wired and wireless routers and gateways combined were about 674,000 units for the fourth quarter of 2022. The net revenue split between home and business products was about 60% and 40%, respectively. The net revenue split between wireless and wired products was about 57% and 43%, respectively. Products introduced in the last 15 months constituted about 28% of our fourth quarter shipments, while products introduced in the last 12 months contributed about 25% 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 2022 was 24.9%, which is down 510 basis points as compared to 30% in the prior year comparable period and down 270 basis points compared to 27.6% in the third quarter of 2022. As compared to the prior year, the strength in U.S. dollar was a significant driver of the decrease. Total Q4 non-GAAP operating expenses came in at $66.1 million. which is down 3.5% year over year and down 1.6% sequentially. Our headcount was 691 as of the end of the quarter, down from 731 in Q3. We evaluate our business priorities on a regular basis and make structural adjustments accordingly in areas that are not aligned with our strategic focus. We will continue to strategically invest in our business and hire in key areas we believe will deliver future growth and profitability. such as ProAV managed switches, premium Orbi Wi-Fi mesh systems, 5G mobile products, and subscription services. Our non-GAAP R&D expense for the fourth quarter was 7.7% of net revenue, as compared to 8.7% of net revenue in the prior year comparable period, and 8.5% of net revenue in the third quarter of 2022. To continue our technology and subscription service leadership, we are committed to continued investment in R&D. Our non-GAAP tax saw a benefit of $1 million in the fourth quarter of 2022. Looking at the bottom line for Q4, we reported non-GAAP net loss of $0.9 million and non-GAAP diluted net loss per share of 3 cents. Turning to the balance sheet, We ended the fourth quarter of 2022 with $227.4 million in cash and short-term investments, down $5.8 million from the prior quarter. During the quarter, $4.9 million of cash was used by operations, which brings our total cash used by operations over the 12 months to $13.7 million. We used $1.6 million in purchases of property and equipment, during the quarter, which brings our total cash use for capital expenditures over the trailing 12 months to $5.8 million. 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, Armor, and Mural brands generated net revenue of $149 million during the quarter, down 14.4% on a year-over-year basis and 1% sequentially. We experienced a year-over-year decline in the retail side, as the year-ago period was still experiencing relatively elevated demand. Despite a year-over-year double-digit decline in the consumer networking market overall in Q4, the premium Wi-Fi mesh category and leading-edge 5G mobile hotspots outperformed the market in that same period, giving us confidence that focusing on these innovative premium products is a key to returning to growth and profitability. I'm excited to share that SMB generated a third consecutive quarter of record net revenue, coming in at $100.1 million for the fourth quarter. The team executed well and made tremendous progress navigating the supply chain challenges, driving growth of 29.9% on a year-over-year basis and 1.1% sequentially. Encouragingly, we continue to see strong year-over-year growth across all geographies despite considerable FX headwinds. On a constant currency basis, our SMB top line would have grown an even more impressive 39% year-over-year. The star of our SMB business continues to be our managed switch products, which grew 65% for the full year, further validating the strategic investments we have made in the nascent, yet rapidly growing, pro-AV market. I'll now turn the call over to Patrick for his commentary, after which I will provide guidance for the first quarter of 2023.

Thank you, Brian. 2022 was a year of transition for Netgear as we drove our premium strategy while navigating headwinds from the supply environment, foreign exchange, and elevated transportation costs. We made significant strides in executing on our strategy to focus on the growing higher margin premium segment of the market, boistering our confidence in Netgear's long-term growth potential. In both sides of our businesses, the growth areas we discussed at our current analyst day, namely our premium Wi-Fi mesh systems, 5G mobile hotspots, and pro AV managed switches, saw continued momentum, even in the face of macroeconomic headwinds and supply chain challenges. For the full year, we delivered revenue of $932.5 million, a decline of 20% year-over-year, a reflection of an accelerating SMB business and a steady service provider business, but offset by the retail CHP business coming off of pandemic buying levels. I'm thrilled to share that our SMB business, spearheaded by our Pro AV line, continued its strong upward momentum. and we delivered a third consecutive quarter of record revenue to set a record for full year revenue up 19%. This impressive result was enabled by our team's effort to secure additional supply to meet continued strong demand. Strategic development of our managed Ethernet switch products, specifically tailored for the commercial AV industry, have set Netgear apart from the competition. and allowed us to steadily grow our pro-AV manufacturers and integrator partnerships. It's a testament to the strength of our SMB business that we have seen considerable top and bottom line improvements since the beginning of the pandemic, while demand continues to grow even in the face of unprecedented supply chain, geopolitical, and economic challenges. To build on the impressive SMB momentum, As we mentioned at our recent analyst day, we are turning our attention to the residential custom integration market to further propel our AV over IB business to new markets. In addition, we're investing R&D resources in developing unique AV over IB products that will transform the TV broadcast industry to unlock an even greater available market opportunity going forward. On the CGP side, demand for our super premium Orbi 8 and 9 Wi-Fi mesh products and 5G mobile hotspots remains strong. Our premium mesh products, well-suited for the connectivity needs of affluent residential customers with large properties, a multitude of connected devices, and a desire for value-added services and cybersecurity peace of mind, have propelled us to our leading position in the premium market. We believe there are more than 2.5 million households in this category worldwide, and we're only reaching a small portion of them today. This further substantiates our core long-term strategy to focus primarily on the premium higher margin segments of the market, where consumers are also more price insensitive. As Brian mentioned, Despite the broader US consumer retail market declining double digits year over year, we saw our premium products grow for the full year, dramatically outperforming the broader market. This outstanding reception to our best-selling flagship OB products does not come as a surprise. Netgear pioneered tri-band mesh in 2016, introduced quad band in 2021, And with Wi-Fi 7 coming this year, we are poised to spearhead the completely new Pentaban Wi-Fi mesh market with the introduction of the OB10. Netgear's competitive advantage in this market is rooted in deep technological differentiation, unmatched by any other company, boistering our confidence in the long-term growth and margin of opportunity for our CHP business. These best-selling flagship OB Wi-Fi mesh products will enable further penetration into the premium market while also driving up units sold, ASPs, profitability, and service-attached rates. We succeeded in building up supply for our 5G mobile hotspots, the Nighthawk M6 and M6 Pro, which are continuing to experience strong demand and double-digit growth year over year. This quarter, we achieved service provider revenue of $56.5 million, our highest level since the third quarter of 2020. To further build out our CHP momentum, we also recently unveiled our unlocked M6 Pro 5G mobile hotspots, which delivers speeds of up to 3.6 gigabits per second. We believe the performance of this product distinguishes itself in the market and we're thrilled to hear folks call it the Rolls-Royce of mobile hotspot routers. This unlocked mobile hotspot offers customers the ultimate flexibility in portable, high-speed Internet connectivity, regardless of carrier. Over 19 million Americans do lack access to fixed broadband service at threshold speeds of only 25 megabits per second. making unlocked mobile hotspots the perfect option for customers who want a reliable primary internet connection. With the ability to sell customers across multiple carriers, we expect the M6 Pro will greatly expand our addressable market beyond the service provider channel, further improving ASPs, unit growth, and uplifting margins over time. The premium Wi-Fi mesh resolution is undoubtedly a robust segment of the market, one that Netgear already leads, and we intend to capture its full market potential. As we shared at our recent analyst day, we have begun to execute on our new marketing strategy for accelerating new customer acquisition and expanding the premium segment. The strategy begins with implementing extremely optimized highly targeted performance media campaigns. To help capture net new customers, direct them to our netgear.com online stores, lead them through a seamless purchase journey, and help drive up average order value. Finally, through loyalty, referral, upgrade, and concierge and other membership programs, we plan to leverage our satisfied customer base to influence their connections. This focused marketing strategy is designed around trends and insights we've gathered over the past year on new customer acquisition and conversion, and we're confident in this approach. We also laser focused on expanding our service revenue, which ended the fourth quarter at $8.9 million, up 23.9% year-over-year, and up 5.3% sequentially. I'm pleased to share that In the case of the contracting retail consumer market, our paid subscriber count reached 747,000 for growth of 27.9% year-over-year. As we further expand the premium segment of the market, we anticipate that our subscriber base will grow in tandem and remain confident in our ability to reach 875,000 paid subscribers by the end of 2023. To that end, we are proactively focusing on highly value-added services areas, namely security, privacy, and support. Privacy breaches and phishing attacks are making headlines constantly these days, and homeowners who invest in our high-end premium products are also more likely to own connected devices. Netgear Armor is the only solution that is built into the router. giving our customers unparalleled peace of mind. IoT cyber attacks are becoming more and more common, and this is growing the interest in our value-added services. To further expand our funnel of Armour trial activations, we are offering select channels a one-year trial of our Armour service, and most importantly, are working to bring the service to our rapidly growing mobile hotspots. In addition, we are planning to enhance our AMA service with additional privacy capabilities, which we expect will drive even higher conversion and retention rates while also increasing ASPs. As we execute on this strategy, we expect services revenue will continue to expand both our top and bottom line in the medium and long term. Industry analysts and experts are once again acknowledging the incredible innovation and technological differentiation behind our market-leading premium products. And I'm pleased to share that at this year's CES Awards, three of our offerings are named 2023 Innovation Award honorees. One award was garnered by our new Orbi 860 series 10 gigabit tri-band Wi-Fi 6 mesh system. The recently released update to our best-selling Orbi 8 series. The second award went to our Orbi Quad-band Wi-Fi 6E router, a standalone router built from the Quad-band mesh Wi-Fi 6E system that won the same award just last year. And on the SMB side, our insight-managed Wi-Fi 6E tri-band access point was named the final innovation award honoree. With the upcoming Wi-Fi 7 upgrade cycle on the way, continued momentum behind our paid subscriber additions, and a rapidly accelerating transition from analog to digital IP-based over Ethernet connections for AV, we remain confident that demand for our three high-end categories, Pro AV, Super Premium RB8 and 9, and 5G mobile hotspots, in conjunction with an improved supply position, sets us up for growth in 2023. Our best-in-class premium portfolio of award-winning products and services is resonating with customers, and we believe relentless innovation is integral to our long-term growth and margin expansion. And with that, I would like to turn over to Brian to comment on our opportunities and obstacles in the coming quarter and year.

Thank you, Patrick. We expect to continue to experience strong underlying demand in the SMB business and the premium portion of our CHP product portfolio. However, on the retail portion of CHP, we expect a normal seasonal decline coming off the holiday period, and we will continue to work with our retail channel partners to optimize their inventory levels. This should lead to improving results in CHP as we progress through the year. Given the strong performance in the fourth quarter, which allowed our service provider customers to improve their supply positions, We expect first quarter revenue from the service provider channel to decrease to approximately $25 million. Together, these factors lead us to expect our first quarter net revenue to be in the range of $185 million to $200 million. We expect the SMB business to continue to see improving supply, which should allow us to lower reliance on higher cost air freight spend. This should offset the impact of reduced top line leverage relative to our recently completed fourth quarter. Accordingly, our GAAP operating margin for the first quarter is expected to be in the range of negative 4.7% to negative 3.7%, and non-GAAP operating margin is expected to be in the range of negative 2% to negative 1%. Our GAAP tax rate is expected to be approximately 30%, and our non-GAAP tax rate is expected to be 5% for the first quarter of 2023. While we are confident in our ability to provide guidance at this time, we do so with the caveat that considerable uncertainty remains in the market due to the COVID-19 pandemic and supply chain conditions continuing to remain challenged. And should unforeseen events occur, in particular, challenges related to the closure of our manufacturing partners' operations, increased transportation delays into any of our regional distribution centers, or greater than expected freight or component costs, our actual results could differ from the foregoing guidance. We would now like to answer any questions from the audience.

Thank you. At this time, I would like to remind everyone, in order to ask a question, press star and the number one on your telephone keypad. We will pause for just a moment to compile the Q&A roster. Your first question today comes from the line of Hamed Korsand with BWS Financial. Your line is now open.

Hi. Could you just talk about

know what's going on with your cash flow you're doing a great job reducing inventory in the channel but that's not really translating into um cash coming in your dso is now at 100. yeah sure um so a couple things there i would say the cash flow impacts of inventory would be more tied to our own inventory which has been pretty stable uh the channel inventory is obviously that of the customers we're helping them optimize but But from a cash flow standpoint, impact to Netgear, it would be the inventory owned by Netgear, which has been relatively stable. Underlying there is that we've actually been working down CHP inventory. And as we've said a couple of times today, we are getting into a healthier place on the SMB side, which will allow us to reduce our reliance on air freight spend. From an AR standpoint and the DSOs in Q4, you may recall we typically offer seasonal dating programs with some of our bigger retail partners. We're tied to the holiday season. They'll extend out payment terms and we'll participate in those programs. So it's not unusual to see an elevated Q4 DSO. That said, we did say this at the analyst day, we do expect that we'll generate free cash flow at a rate of about 200% of non-GAAP net income for 2023. I do expect that Q1 will start to see some cash flow converting largely because of where the AR position ends in Q4 with those dating programs. So we still feel confident about our ability to generate cash going forward.

And then as far as your SMB is concerned, how fixed are you to supply chains as of this moment? Because your commentary is saying less air freight. So does that imply that SMB is going to increase sequentially from here? Do you have that kind of visibility?

There is still a shortage here and there, but it's not as prevalent as before. I mean, I would say before we have to spend air freight on almost every single thing we need. Right now, we're much less than that, but then there are still some popular items that are in high demand. We still have to air fray them, and sometimes we're short of them. So it's hard to say. I mean, we will still see how the supply situation is going forward to be sure that we'll continue the sequential uptake every quarter. Of course, that's what the market demand is like, but unfortunately, we're limited still by supply.

Okay. And my last question is on the CHP side. Is it going to be more of a profound decline than what is seasonally normal for you as far as Q1 versus Q4? And this number, if I back out, service provider has declined quite a bit from 21 levels. How much more can it decline?

It is hard to say. If we look at the Q4 of 2022 versus Q1 or Q4 of 2021, the market declined a whopping 20% to 25% in that range. Would Q1 be the same? We hope that it probably is, but it could be worse. I mean, given all the layoffs and given all the inflation situation, Now, the good thing is, at the premium end, it's not affected because we're still seeing growth. However, a good portion of our revenue is depending on the low end, which is significantly affected by the general economic situation. If you see that big whopping decline, it's because of two factors. One is this huge year-on-year decline. Second one is we continue to have work to do to reduce channel inventory because when there is a decline in the end market sales, then the channel wants to decrease that channel inventory further. So that's why combining these two, you will see a more pronounced step down in revenue on the CHP side, yeah.

Okay, thank you.

Your next question comes from the line of Jake Norrison with Raymond James. Your line is now open.

Hey, I was just hoping to get a little more color on the cadence of improvement in supply chains and SMB that can be maybe more of a first half, 23, back half. And then further, sort of with China reopening, is there any expectations of supply chain improvement in the CHP side of the business, maybe in the first half of 23?

You're right. With the China reopening, it certainly would help. Now, even though our manufacturing and most of our components have already moved out of China, there are still few key components that no other country would be either capable or willing to do. One obvious one is the power supply, because to do power supply, you have to wind all those little transformers. that not many people want to do outside of China. And that is the most sticking point of supply to our switches, especially for pro-AV related switches. And we think with the reopening of China, that would really help. Unfortunately, the freight line, especially air freight, coming out of China has not really increased much, and we depend on those to fly those components to our factories in Vietnam, in Thailand, and in Indonesia. We do expect things will get back to normal probably in the second half of this year, so we don't have to worry about it. We will have unfestered supply of our pro-AV switches in the second half of this year. That's what we're looking forward to. But in the first half, we still have to deal with that situation, unfortunately.

Yeah, Jake, if I might just add, you know, more near-term focus there. We do expect a slight improvement in Q2. As Patrick said, the improvement will really happen in the back half, but it will build through the year. And so from a Q2 standpoint, I think there's two factors that the SMB supply will improve slightly, and I think we're expecting at this point the level of destocking with our retail partners will start to mute. I think those two things will drive non-carrier, the revenues excluding service rider, to something like a, you know, 5% to 10% sequential increase in Q2. Again, the destocking will further drop off in the second half of the year, and the service rider side will likely stay, you know, Q2 will stay around the $25 million mark, but we do still think the full year will land about 140. Perfect.

Thank you.

Your next question comes from the line of Jared John Johan with Cowen. Your line is now open.

Hi, Patrick and Brian. This is Jared on for Paul. Thanks for taking my question.

Sure.

I was just curious if you could walk us through some of the puts and takes for gross margin in 4Q22, specifically about 300, 200 bps decline.

From a sequential standpoint, I think there are really three factors. I think one the strengthening US dollar relative to Q3. That was probably in that 60 to 70 basis point range. We're also, as you see in our inventory levels, we're sitting at about six months of inventory. So a lot of that has been CHP inventory. And so we're working through that. If you can imagine, six months ago, we were kind of near the peak of freight costs coming in. So we're we're dealing with that burden as well. We do think that we're turning the corner on that and should be at a much more optimized level as we go into the second half of 2023. So those are the primary drivers.

Thank you very much. And then I just have one follow-up. Relative to the guidance you provide at your analyst day on quarterly top line movement, your new guidance for Q1 is a little bit lower than And I'm curious if you could provide maybe an update on the further quarters out in the year.

Sure, sure. I think the biggest difference between what we said at Analyst Day and the Q1 guide that we gave right now is the service provider revenue level. You may recall our comments back in December. We expected $140 million in service provider for the year. At that point in time, we thought it would be a little bit more linear. But given our ability to execute and bring in supply in Q4, At this point, we think it's going to be a little bit on the lower side in the first half of the year, about $25 million a quarter for the first half, still reaching its full potential of 140 for the full year. It's just the timing impact. So that's probably the primary difference from the December discussion.

Perfect. Appreciate all the color. Thank you very much.

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

All right, great. Thank you. Thanks, everyone, for joining us today. In 2022, we laid the foundation with our innovative best-in-class portfolio products and services to propel Netgear towards a long-term profitable growth. Although the CXP channel inventory reduction will continue into 2023, our highly differentiated Orbi 8 and 9 and soon Orbi 10 mesh systems and our 5G mobile hotspots M6 and M6 Pro continue to outperform the market. and give us the confidence in our long-term, high-margin growth trajectory. On the SMB side, we are the market leader of the pro-AV market transition and will continue to make inroads in expanding our presence in the market, while simultaneously open up adjacent ones, like the TV broadcast and production industry, as well as the integrated, high-end, fully automated homes segment. I look forward to sharing an update on our progress on all these fronts at our next earnings call. I look forward to talking to you all in April. Thank you.

This concludes today's conference. Thank you for attending. You may now disconnect.