NETGEAR, Inc.

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 push button phone. I would now like to turn the conference over to Eric Bilen. Please go ahead, sir.

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. CJ Probert, CEO, Mr. Brian Murray, CFO, and Mr. David Henry, President and General Manager of Connected Home Products and Services. The format of the call will start with an overview of the company's recent leadership transition provided 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 Brian. 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 outlooks. 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 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 like to turn the call over to Mr. Brian Murray.

Thank you, Eric, and thank you, everyone, for joining today's call. As we announced last week, after nearly three decades at the helm, Patrick Lowe has chosen to retire from his roles as CEO and Chairman at Netgear. Patrick will serve as a strategic advisor through July of this year to ensure a smooth transition. While Patrick will certainly be missed, we are very excited to see him embark on his next chapter in life. After a thorough search over the past year to identify a successor to Patrick, the Board appointed CJ as Netgear CEO. CJ has a background that is uniquely suited to lead Netgear into our next chapter. And then if 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 give him the stage to introduce himself prior to getting into the Q4 results.

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 like 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's been a pioneer in our industry. He's a great person with the highest integrity, and he's established a great culture at 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 connectivity and 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 that give 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 Netgear for Business side of things, we've been able to scale the ProAV business with a solution-focused sales motion And one thing going forward would 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. With that, back over to you, Brent.

Thank you, CJ. 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 into 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 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 Wi-Fi 7 upgrade cycle, In user demand for our premium solutions, which consists of our or be eight and nine trying quad band wi fi mesh products. And 5g nighthawk mobile hotspots again perform well they 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. Outside of the inventory contraction, our 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 and 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 31, 2022. Amid 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 has stabilized. I'm proud of the progress we've made in transitioning our CHV business to the premium, higher margin segments of the market, where we enjoy considerable competitive differentiation. Industry pundits are also pointing to the next 12 months is 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 Wi-Fi 7 upgrade cycle and secular trends in the market that we've identified across both businesses will continue to expand the available market opportunities for Netgear 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 forged from more than 25 years of innovation, NICU's higher margin premium products are the key to delivering long-term profitable growth. The fact that our premium products materially outperform 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. A result that would not have been possible without our team's outstanding efforts to retool our mix towards the higher AS-free premium Wi-Fi mesh and 5G mobile hotspot products, improved traction in our services business, and the inroads we've made in establishing and growing our presence in the ProAV 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 CHP and SMB sides of the business reduced 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 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. The immediate 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, 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 year 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 CHP products, growth in services revenue, and 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 at the end of this 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 ProAV managed switches, premium Orbi Wi-Fi 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 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 nine cents. 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 12 months to $56.9 million. We used $2.2 million in purchase of property equipment to end the quarter, which brings our total cash used for capital expenditures over the 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, Armor, and Mural 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 made great progress in building up and delivering supply of our M6 and M6 Pro mobile hotspots. And on the retail side, the total rest of the 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 a premium Orbi 8 and 9 Wi-Fi mesh and 5G mobile hotspots continue to grow year over year by over 30%. Bolstered by the addition of our recently released Wi-Fi 7 Orbi 97X mesh system, the contribution of premium products to our CHP retail business grew to over 25% of sales to end users. These higher margin, high end products continue to drive up ASPs and help us deliver considerably improved profitability year over year. As we progress through this upcoming Wi-Fi 7 upgrade cycle, we continue to believe the market has stabilized and expect CHP channel inventory to remain generally stable moving 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 Wi-Fi 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 Wi-Fi 6E and Wi-Fi 7 Nighthawk routers, cable gateways, and mid-range 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 harbor 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 a service revenue 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 GDP growth in major markets such as Germany, greater China, and Japan weighed on the SMB market. It continued to dampen in-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, our SMB channel partners again continue 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 ProAV 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 AV network designers. Netgear's deep expertise in the rapidly growing ProAV market is unmatched by our competition and gives us the confidence and the long-term growth and profitability potential in our ProAV suite of products. I'll now discuss our Q1 2024 outlook. We expect the retail portion of our CHV 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 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 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 zero 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.

At this time, I would like to remind everyone in order to ask a question, 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 Norrison with Raymond James. Your line is open.

Okay, thank you. A couple for me. I just wanted to start off from a high level. Welcoming CJ. I'm just wondering, what would 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.

Hey, Jake. Good to meet you. You know, it's too early to say. I obviously made the point that, you know, I see an opportunity for cash generation. We're doing that now on the back of working capital improvements. But, you know, long term, we want to create value. And the way I see us creating value is being a long term sustainable cash generating business. In terms of you know, how much capital that requires and how that feeds into kind of the strategy we implement. We'll have to talk about that on a later call, but I definitely appreciate where you're coming from on that question.

Okay, sounds good. Thank you. And then I'm also wondering, you guys gave fiscal year guidance at the end of this 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?

Yeah, keeping with our tradition, we're not going to readdress annual guidance at this point. We've provided the 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 of CJ coming on board and the transition costs coming along with that.

Makes sense. And then last one from me. You mentioned a couple times you saw the, you know, retail market stabilize. Can you just touch on what gives you confidence there and that channel – or CHB channel inventory will be stable for the rest of the year? Thank you.

Yeah, maybe I'll start and then I'll ask David to weigh in here. I think, as we said last quarter, what's giving us the confidence of seeing that is that we're starting to see a return to normal seasonal behavior within that market. You know, typically you would see a seasonal plan as it's implied in our guidance here for Q1. So that's the main data point we have. We obviously think that continues to strengthen as Wi-Fi 7 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.

Sure. Yeah, 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 lower and lower, as we have seen for the last few years. As we go into this year, obviously, Refresh cycle four years removed from the pandemic pull-in. Certainly would be wind at our backs, as well as there's a lot of new Wi-Fi 7 devices launching on the market. Samsung just announced their Galaxy S24 with Wi-Fi 7. 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 help stimulate the market to further stabilization.

Very helpful. Thank you.

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 Hamid Khorasan with BWS Financial. Your line is open.

Hi. So first off, can we just talk about your commentary here for Q1? I mean, you're saying retail stabilizing is, but you're guiding quite a bit down and then, you know, it conflicts with that stabilization comment because Q123, it was, you know, you're going to be below that. How is it stable? When Q123, you were saying, oh, it's going to be, it's the bottom and all that commentary. And now you're saying, well, it's going to be below that number.

Yeah. You may recall, you know, the retail portion of the CHP business is, is very seasonal. Um, In normal periods, you'll see something like a mid-teen percentage decline in the market from Q4 into Q1. So that's the main driver why revenues would be coming down. And 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.

Yeah, no, I understand the commentary you gave in December. I understand the commentary now. What I'm trying to understand is how are you saying it's stable if your revenue is declining year over year from Q123 to Q124? That doesn't seem stable.

Yeah, so again, the comment I made earlier with regards to what the signal is that leads us to believe that the market is 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 Wi-Fi 7 kind of becomes more prominent in the market. But those are the signals that we think that are driving us towards believing the market is stabilizing.

And then, Brian, what's happened since the analyst day that It feels like the Q1 is going to be lower than what was perceived. I think your quote was in Investor Day, it was going to be first half was going to be down mid-single digits, right? And now this is quite a bit more than that.

Yeah, we said the sequential decline would be down mid-single digits. I think we're in that general direction with the guidance, depending where in the range you are landing. There's not much that's changed from that December guidance on the top line.

Why hasn't there been any progress as far as what you want to do with your cash? That $284 million, that's quite a bit of change and there has been no activity on buying back any stock.

There's no doubt we've been very successful of quickly turning that ship. from the end of Q2 when we were at $203 million and to exit the year just shy of $284 million. We've generated a lot of cash in a very short period of time, mainly coming from compressing our inventory balances. I would just say 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, you know, 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, so we're, again, continue to be opportunistic buyers of our stock, with two and a half million shares remaining on that program, but I think it's because We quickly turn turn the tides, where we were utilized using cash in the first half of the year and we've aggressively turn that around with the key for 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 than 25 to $30 million range so we. We overshot that mark, which is great, and we still continue to believe that we're going to generate more cash in Q1. Okay.

Thank you.

Sure.

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

Thank you guys for joining us today. Like I said, couldn't be more excited about the opportunity ahead. That's it for us. Nick, your team's signing off.

This concludes today's conference call. You may now disconnect.