NETGEAR, Inc.

Eric Bilen, please go ahead, sir.

Thank you, Rob. Good afternoon and welcome to Netgear's first quarter of 2024 financial results conference call. Joining us from the company are Mr. CJ Prober, CEO, and Mr. Brian Murray, CFO. The format of the call will start with commentary on the business provided by CJ, followed by a review of the financials for the first quarter and guidance for the second quarter provided by Brian. We'll then have time for any questions. If you have 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-K. 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, non-GAAP financial measures will be mentioned on this call. Reconciliation of the non-GAAP measures The gap 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 CJ.

Thanks, Eric, and good afternoon to those of you joining this call. So I've just passed my 90-day anniversary with NICIR, and I am unequivocally more excited about the opportunity ahead than when I joined. I've just completed my listening tour that involved meeting dozens of customers and partners as well as the global Netgear teams across nine countries in the Americas, Europe, and Asia. And I'll be opening today's call by covering three main topics. First, the decisive near-term actions we're taking for the long-term health of the business that are reflected in our Q1 results and Q2 guidance. near-term strategy adjustments to both our consumer and B2B businesses, and third, our plan for developing a long-term strategy and prioritizing the allocation of our capital to build a higher growth, more profitable business. One important theme that cuts across all these topics is that our decision-making is focused on creating long-term value for shareholders. The board has aligned my incentive compensation with shareholder value creation. In our most recent equity grants to the broader executive team that will be disclosed in next year's proxy, we have similarly implemented an incentive structure that rewards executives on shareholder value creation. In doing so, we're moving away from incentivizing performance based on a much narrower metric like subscriber count or subscription revenue. All of these steps we are taking to transform this business will be driven by the goal of creating higher growth more profitable business that delivers long-term value for our shareholders. With that context, let me start with a couple of decisive actions we're taking for the long-term health of the business that are reflected in our Q1 results and Q2 guidance. First, as you all know, the macroeconomic environment remains challenged and we're seeing higher than expected inflation and interest rates persist. While we've made good progress on our efforts to destock the channel, These macro conditions continue to impact our channel partner's posture on inventory. As a result, we're seeing more to stocking than expected in both our businesses, and the cost of carrying excess channel inventory is higher than expected as well. In Q1, these factors impacted our revenue and were amongst the main drivers for missing our non-GAAP operating margin target for the quarter. Netgear's original plan coming into Q1 was to destock the channel throughout the year so that our channel partners could exit 2024 with a normalized level of inventory. Given the increasing pressure on channel inventory and costs associated with having excess channel inventory, we're instead electing to accelerate our way through this challenge in Q2. We expect this effort to represent a headwind of 25 to 30 million in revenue, which is reflected in our Q2 guidance. While this creates a near-term challenge in terms of financial results, This is the right long-term action for the business, so we are resolute about immediately addressing this challenge in Q2. While there could be small pockets of excess channel inventory as we exit Q2, overall we expect to be able to match sell-in with sell-through after Q2. We are seeing some channel partners at historic lows in terms of weeks of supply, so this could create revenue upside in future years. with macroeconomic environment improvements and lower interest rates. Second, as you all know, the dynamic of the demand pull forward during the early days of COVID combined with the supply constraints that followed led Netgear and many other companies to exit 2022 with a substantial inventory position. Supply challenges and historically long lead times forced Netgear to make bets on certain product categories. Some of these bets worked incredibly well, while others have led to a higher than optimal inventory position. This isn't surprising or uncommon given the impossibility of predicting product mix so far in advance of making purchase commitments in such a dynamic environment. Last year, the team did a good job working down our inventory position and we exited 2023 with roughly six months of supply. The plan for this year was to get to four months of supply by the end of the year, However, now that we have visibility into the Q1 performance of some of the products where we have excess supply, we are going to accelerate the depletion of these problematic areas faster than originally contemplated. We are driving to lower our inventory to closer to three months of supply, which will help with profitability and cash generation. More importantly, the high level of inventory has negatively impacted our ability to launch new innovative products for our customers. For example, Netgear decided to delay the launch of many Wi-Fi 7 products to avoid possible cannibalization of our prior generation products where we had excess supply. While seemingly prudent, from an inventory depletion perspective, consumers want the latest and greatest products, so that caused us to not as aggressively capture this early technology mover demand. It's important that we optimize our inventory positions quickly and deliver the exciting new product lineup we have coming over the course of the year. In order to achieve this normalized level of inventory more quickly, we're taking a harder look at products and chipsets that are moving more slowly than we'd like. The Q1 results and the Q2 guidance reflect the cost associated with moving through these problematic areas more quickly than originally planned, with the goal of exiting the year with a normalized level of working capital. In order to avoid these inventory challenges in the future, we're implementing a tighter and more constrained approach to demand and supply planning. A couple of less significant decisions impacting our Q1 results and Q2 guidance are the decision to exit the Mural business and a restructuring charge relating to executive transitions. While Mural is a well executed product, it has a small target market and does not fit well with the rest of our portfolio. The current plan is to sell through our remaining inventory and to continue to maintain the service for existing subscribers. However, we did write off approximately $500,000 of non-finished goods inventory in Q1. On the restructuring, as part of the reorganization, we're estimating costs of approximately $2.5 million in Q1 for executive transitions, and this is reflected in our guidance. Despite the aggressive near-term actions to set us up for long-term success, we generated over $17 million of cash from operations in Q1 And we expect to generate cash this year and in Q2 as well. I'm proud of the team for making the hard decisions that set us up for long term success, while accelerating our introduction of new products that will be critical to our growth going forward. So with that context on Q1 and Q2, I'd now like to discuss some near term adjustments to our strategy for both our consumer homes products business or CHP, and our B2B business, which we've previously referred to as SMB and will now be referred to as Netgear for Business or NFB. On the consumer side, Netgear has established itself as the industry-leading brand in consumer network working over many years. The recent focus on the high end of the market has showcased this better than ever with our industry-leading products like the Wi-Fi 7 or B970 and the Nighthawk M6 Pro hotspots. That said, we've now realized we moved too aggressively to focus on the high end of the market for the following three reasons. First, the market size of our high-end mesh products is not reaching the scale we had hoped. While the high-end mesh segment is still growing and we remain the clear market share leader, we aren't pulling up as many customers as we'd like to our premium products. Second, there are significant benefits to playing in larger segments at the medium and low end of the market with a good, better, best product strategy. This is particularly true with Amazon, where their algorithms favor high volume SKUs, and it's hard to move customers into our flagship products if we don't appear in their searches for good or better products. Third, the foreign competition that has been growing share with subpar products at lower price points is now moving up into the high end of the market, so we're starting to face competition there as well. So given these market dynamics, we're making the following adjustments to our CHP strategy. First, we're developing products that serve a broader segment of the market and following a simple good, better, best product strategy. This will enable us to compete more effectively on Amazon, especially internationally where online channels are our primary route to market. Second, we're evolving our marketing messaging to highlight our points of differentiation versus trying to compete with low-cost foreign competition on speeds and feeds alone. This includes the fact that as a US-based, U.S. listed public company, we are the trusted brand in the space focused on delivering a secure, safe, and high performance connectivity experience. Third, we'll be leveraging our position and independence to forge value added partnerships that drive innovation and improve the experience for our customers. As an example of this, we recently entered into a partnership with a leading provider of home security to enable whole home Wi-Fi alongside their security implementations to ensure the most reliable and secure experiences for our joint customers. The other benefit of addressing some of the higher volume segments is it increases the funnel into our subscription services. I mentioned earlier how we're moving away from incentive compensation tied to subscriber count, and this is not a reflection of a change in the importance we place on recurring revenue. Subscriptions remain an important focus and we're implementing some strategy changes here to simplify the offering, improve the value, and grow the recurring revenue. In this regard, we've decided to move away from product bundles that include the device like a router and extended subscription period like a year. While this strategy drove up subscriber count and non-recurring subscription revenue, it leads to lower margins, increased churn, and fewer recurring revenue subscribers, so it does not help with long-term value creation. This change to bundling will only affect newly released products, so you won't likely see this reflected in our metrics until 2025. While I'm confident these near-term changes to our CHP strategy will improve our trajectory and market share in the near term, the overall CHP market is not recovering as we expected and was down double digits year over year in Q1. While we were able to achieve our sell-through targets, doing so required us to be more promotional than expected. As a result of these near-term actions and because of the ongoing CHP market challenges, we're withdrawing the full year guidance that was discussed at the analyst day in December last year as we no longer believe such guidance to be achievable for the full year. This is not a reflection of how we feel about our long-term prospects, but rather the reality of where we find ourselves right now relative to our December guidance. We do plan to continue to provide quarterly guidance, and Brian will cover this later in the call. In our Netgear for Business segment, our managed switch business has been capitalizing on the transition to IP-based video and audio and has been on a great trajectory over the last few years. While we saw a slowdown at the end of last year due to macroeconomic conditions, end demand remains strong, and this product category is on a renewed growth trajectory. This is a segment of the market where we have strong product leadership and a clear price to value proposition. Our 265 manufacturing integrations, reliability, and stability really set us apart from the competition, and this is an area where we will continue to innovate. Recent partnership announcements include Nice For You, a leading residential manufacturer, and Audio Technica, a Japanese professional audio equipment company. Additionally, we've also secured partnership wins with companies such as Crestron, Shure, Savant, Visionary Solutions, and Sennheiser. As we make inroads with these partnerships, we are for the first time deploying our products in businesses of all sizes, including Fortune 5,500 and 100 companies. These successes are starting to build credibility for our brand with the CIO community, which we expect will open doors in the future. We will also capitalize on our leadership position to pursue new adjacent verticals. We recently announced our new interoperability partnerships with Intel and Panasonic Connect, leveraging our recently launched SMPTE capable managed switches. This marks a major step forward in our initiative to expand our reach into the broadcast industry, a new market for Netgear that greatly broadens our total addressable market. Furthermore, we've also secured Ross Video as another broadcast partner and expect more partnerships to be announced soon. With projects closing just weeks after release, this warm response to our new switches is encouraging. Outside of our managed switch business we're seeing slower progress than we would like in growing our Wi Fi land business. While we have recently launched a total network solution, there are elements of this that need improvement before we can significantly grow our share in this market segment. The team is focused on adjusting our strategy here to ensure we're set up for success and are able to build off our momentum in managed switches. We know what is needed and we're acting quickly to better address this attractive opportunity. Despite all the progress in NFV, our overall go-to-market capabilities still skew to consumer. So our near-term focus is to ensure we're building a world-class B2B sales and marketing capability to capitalize on the momentum afforded by our managed switch business. And this is an area where we are targeting incremental investment in the second half of the year. This is a market opportunity with a sizable addressable market, and we have great momentum with our existing products, so we're excited about the potential for capturing incremental growth. In addition to the immediate actions impacting Q1 and Q2 and the near-term strategy adjustments for CHP and NFB, we are launching a process to develop a longer-term strategy for both business units in the second half of this year, which will impact how we prioritize the allocation of our capital. My first executive hire is a VP of strategy who I've worked with in the past and who's joining us from Amazon. He's working with me, Brian, and the rest of the leadership team to validate several of our growth opportunities we're considering and we look forward to discussing these further in upcoming calls. I'll end my prepared remarks with a few points on culture, team, and organization. Over the course of my listening tour, I was very impressed by the global talent at the company, and the unwavering desire to prosperably grow our business. Despite this talented team and positive attitude, I did uncover a complex organizational model and some cultural challenges that are hindering our ability to reach our potential. At our internal All Hands later today, we will be announcing three initiatives to address this. First, a reorganization that will drive stronger focus, alignment, and accountability, and empower the business units to achieve their long-term growth and profitability targets. An effort to evolve our culture, beginning with the reformulation of our values that will be integrated into all aspects of our work and talent management with the goal of improving shareholder value creation. Finally, an AI transformation effort to ensure we're taking full advantage of this technology in how we work and in the products and services we develop for our customers. In closing, we're taking decisive action in both CHP and NFV to prepare us for long-term success. We're implementing both product and channel strategies that position us for a return to growth. We're implementing a long-term execution plan for all parts of the business that we believe will deliver significant value creation. We have a strong balance sheet, and as we showed in Q1, we believe share repurchases is a good use of capital in the near term and expect to have broader plans to deploy capital as we chart our course for the long term. These moves Coupled with the organizational changes being made to streamline our operations and delivery are aligned with the needs of our shareholders and we believe will create significant long-term value. I'm truly excited about the journey ahead. And with that, I'll hand it over to Brian and look forward to your questions.