Ladies and gentlemen, thank you for standing by. [Operator Instructions] I would now like to turn the conference over to Erik Bylin. Please go ahead, sir..

Thank you. Good afternoon, and welcome to NETGEAR's Third Quarter of 2024 Financial Results Conference Call. Joining us from the company are Mr. C.J. Prober, CEO; and Mr. Bryan Murray, CFO.

Format of the call will start with commentary on the business provided by CJ, followed by a review of the financials for the third quarter and guidance for the fourth quarter provided by Bryan. We'll then have time for any questions. If you've not received a copy of today's release, please visit NETGEAR's Investor Relations website at www.netgear.com.

Before we begin the formal remarks, we advise you that today's conference call contains forward-looking statements. Forward-looking statements include statements regarding expected revenue, operating margins, tax expense, expenses, and future business outlook.

Actual results or trends could differ materially from those contemplated by these forward-looking statements. For more information, please refer to the risk factors discussed in NETGEAR's periodic filings with the SEC, including the most recent Form 10-Q.

Any forward-looking statements that we make on this call are based on assumptions as of today, and NETGEAR undertakes no obligation to update these statements as a result of new information or future events, except as required by law. 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 CJ..

return of capital to shareholders, organic investments in the business, and potentially acquisitions. I'll briefly cover each of these.

Since I joined early this year, we completed repurchases of about $10 million of our shares in each of the first 2 quarters, but we were mostly out of the market in Q3 given the confidential settlement negotiations with TP-Link.

With an expanded repurchase authorization and an even stronger cash balance, you can expect us to be active in the market for our stock in Q4 post earnings, including during the restricted period.

From an organic investment perspective, as I noted previously, we do plan to invest in our NFB business to further invigorate growth and drive margin expansion via software differentiation and recurring revenue. Some of this investment will be incremental OpEx and some will be pulled from slower growing parts of the business.

While our primary focus in 2025 will be on improving the performance of our core businesses, we will be investigating acquisition opportunities that could accelerate our transformation with a focus on our NFB business.

The opportunities we could consider include software development capabilities that drive differentiation, margin expansion, and our recurring revenue; product adjacencies that are complementary to our current offering that would allow us to deliver a more integrated customer experience, leverage our brand or capitalize on our distribution footprint; or simply consolidation opportunities that are accretive to earnings.

Having completed many acquisitions on both sides of the fence, my bar for M&A is very high, so we'll be extremely selective as we evaluate these opportunities. In closing, I want to thank the teams at NETGEAR for all the incredible work that is happening to delight our customers and deliver on the transformation. We had a great Q3.

We've done much of the hard work to define the path forward. We have an amazing start to our transformation, and we're excited about delivering for shareholders as we power extraordinary experiences. I'll now hand it over to Bryan and look forward to your questions during Q&A..

Thank you, CJ, and thank you, everyone, for joining today's call. We are once again pleased with the execution by our team this quarter in delivering both revenue and profitability above our guidance range, including a return to profitability.

These outstanding results were driven by higher-than-expected service provider revenue, buoyed by the early launch of our new Nighthawk M7 Pro 5G WiFi 7 mobile hotspot.

As a reminder, we took decisive action in the prior quarter to accelerate destocking of the channel to better position both sides of the business for more predictable performance aligned to the market trends and reduce volatility. We have already begun to see the benefits of this plan as evidenced by this quarter's results.

We also saw the additional benefit of reduced DSOs, which came in at 88 days, our lowest level in over 3 years, due to the improved linearity with channel partners needing to maintain their lean inventory positions throughout the quarter.

Our more profitable NFB segment performed well against our expectations and once again delivered a record quarter in-market sales of our ProAV managed switch products. In CHP, we saw continued strength in premium products.

We made further progress in expanding our product portfolio, addressing other segments of the market, and we were able to pull in the launch of our next-generation M7 Pro mobile hotspot. While the CHP retail market size declined in the third quarter, the decline continued to slow in Q3 compared to earlier in the year. However, we do see the U.S.

retail market remaining quite promotional in part due to the holiday period. For the quarter ended September 29, 2024, revenue was $182.9 million, up 27.1% on a sequential basis and down 7.6% year-over-year, above the high end of our guidance.

In addition, by continuing to drive down our own inventory by $27 million in Q3 and reaching a settlement with TP-Link, we generated approximately $106 million in free cash flow and ended the quarter with nearly $396 million in cash and short-term investments.

After successfully putting the destocking behind us last quarter, we entered Q3 well positioned to match sell-in with sell-through with our channel partners. Consequentially, the NFB segment delivered $78.5 million in revenue for the third quarter, up 31.2% sequentially and up 11.4% year-over-year.

Led by our ProAV managed switch products, which once again saw end-user demand grow double digits year-over-year, momentum is clearly building behind NFB's growth trajectory, and we also continue to make progress with our strategic manufacturing partnerships.

In Q3, the CHP business delivered net revenue of $104.3 million, down 18.1% on a year-over-year basis and up 24.1% sequentially, which benefited from the release of our latest M7 Pro mobile hotspots, which pulled into the quarter because of great execution by our team.

Service provider revenue was $22.9 million, above our expectations and boosted by the earlier than originally anticipated launch. We saw our premium mesh products continue to outperform the broader market.

Our recently introduced Nighthawk products that broaden our market reach are performing well and receiving warm customer reviews, a testament to the power of our brand and innovative technology. With our additional new product introductions planned for release through 2025, we expect the full benefits of this new strategy to build over time.

We exited the third quarter with 555,000 recurring subscribers, and we generated $7.9 million in recurring service revenue in the quarter, a year-over-year increase of 22%. We continue to see increased emphasis placed by consumers on cybersecurity protection, privacy, and premium support.

As we noted last quarter, we are confident that the optimal strategy is to grow recurring subscribers, and that is our focus going forward. For the third quarter of 2024, net revenue for the Americas was $127.8 million, a decline of 9.4% year-over-year and up 33.8% on a sequential basis.

EMEA net revenue was $32.8 million, a decrease of 8.1% year-over-year and up 19.9% quarter-over-quarter. Our APAC net revenue was $22.3 million, which is up 5.5% from the prior year comparable period and up 6% sequentially. 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 third quarter of 2024 was 31.1%, down 390 basis points compared to 35% in the prior year comparable period and up 870 basis points compared to 22.4% in the second quarter of 2024.

This marks the first time this year we have achieved gross margins above 30% as we begin to benefit from improved mix of NFB products and the impact of aged inventory begins to lessen with our continued progress working down our old inventory.

Compared to the prior year period, our profitability was impacted by higher cost of inventory and our use of air freight as we begin to operate at leaner inventory levels. Total Q3 non-GAAP operating expenses came in at $55.3 million, down 13.7% year-over-year and down 12.7% sequentially.

Non-GAAP operating expenses were lowered in the quarter by the $10.9 million legal fee adjustment from the TP-Link settlement to offset actual legal expenses incurred in prior quarters. Our headcount was 638 as of the end of the quarter, up from 622 in Q2.

We are currently refining our long-term strategy and looking to make investments, primarily in our NFB business. Some of this will be incremental and some will come from other areas of the business as we shift costs to the areas that will deliver long-term growth and expand profitability.

Our non-GAAP R&D expense for the third quarter was 11% of net revenue as compared to 10.1% of net revenue in the prior year comparable period and 13.2% of net revenue in the second quarter of 2024. To continue our technology and product leadership, we are committed to continued investment in R&D.

The improved leverage from having the destocking of our channel partners behind us and our new product introductions in the third quarter, combined with the offset of historical legal costs as a result of the TP-Link settlement, enabled us to deliver third quarter non-GAAP operating profit of $1.6 million with an operating margin of 0.9%, above the high end of our guidance range.

This was down 180 basis points compared to the year ago period and up 2,250 basis points compared to the prior quarter. Our non-GAAP tax expense was $17,000 in third quarter of 2024. Looking at the bottom line for Q3, we reported non-GAAP net income of $5.1 million and non-GAAP diluted earnings per share of $0.17. Turning to the balance sheet.

We ended the third quarter of 2024 with $395.7 million in cash and short-term investments, up $101.4 million from the prior quarter and equating to $13.48 per share. The increase is largely due to the cash payment from the TP-Link's litigation settlement.

However, even excluding the settlement impact, we delivered our fifth consecutive quarter of positive cash generation. We continued to convert our working capital into cash and made significant progress lowering our inventory in the quarter, which declined $27 million sequentially.

During the quarter, $107.7 million of cash was provided by operations, which brings our total cash provided by operations over the trailing 12 months to $199.6 million. We used $1.7 million in purchase of property and equipment during the quarter, which brings our total cash used for capital expenditures over the trailing 12 months to $8.7 million.

With the better-than-expected reduction of inventory in the third quarter, combined with seasonal terms with certain of our channel partners, we expect that in Q4, we will be in the range of using $10 million of cash to neutral, but still generating cash in the second half of the year even without the benefit of the legal settlement.

In Q3, due to trading restrictions, we spent $1.5 million to repurchase approximately 99,000 shares of NETGEAR common stock at an average price of $14.92 per share. We have approximately 3.8 million shares reserved under current authorization. Since the beginning of 2020, we have spent $146.1 million to repurchase 5.8 million shares.

We will be resuming our share repurchase program in Q4 during an open window, and we plan to enable opportunistic repurchasing during the restricted period as well. Our fully diluted share count is approximately 29.4 million shares as of the end of the third quarter. Now I'll cover our Q4 2024 outlook.

As we experienced in the third quarter, we expect to continue to see more predictable performance that is aligned with the market for both of our businesses. Within NFB, we expect to experience continued growth led by our ProAV line of managed switches.

Within CHP, while we're seeing the signs of market recovery, we expect increased promotional activity within our retail business. After the launch of our M7 Pro mobile hotspot in Q3, we expect revenue from the service provider channel to be approximately $20 million in Q4, down slightly on a sequential basis.

Accordingly, we expect fourth quarter net revenue to be in the range of $160 million to $175 million. We expect gross margins and operating margins to continue to be impacted by our inventory reduction efforts and higher-than-expected transportation costs due to a variety of factors, including the Red Sea shipping crisis.

We also expect increased promotional activities within our CHP retail business due in part to the holiday period. Accordingly, we expect our fourth quarter GAAP operating margin to be in the range of negative 12.4% to negative 9.4%, and non-GAAP operating margin to be in the range of negative 8% to negative 5%.

Our GAAP tax benefit is expected to be in the range of $2 million to $3 million, and our non-GAAP tax benefit is expected to be in the range of $0 to $1 million for the fourth quarter of 2024. And with that, we can now open up for questions..

[Operator Instructions] Your first question is from the line of Adam Tindle with Raymond James..

CJ, I just wanted to start -- congrats on the TP-Link settlement -- an update on what's potentially to come from this. I think there's still some legislation out there, some national security concerns. Maybe just remind investors of the potential impact from here and things that are still potentially on the docket.

And Bryan, related to this on the TP-Link settlement, maybe you could follow up just at a high level, as we look at the income statement, particularly this quarter, what are the one-timers that we shouldn't be repeating versus what's more permanent. And I'm mainly looking at non-GAAP gross margin and operating margin.

For example, non-GAAP G&A came down from 16% to 6%. Does that stay down there? So if you could just walk us through any one-timers in the quarter versus what is more permanent..

Adam, I'll take the first part of that. So not at all related to our settlement, but as you referenced, there is and continues to be a lot of government activity around networking equipment from foreign adversarial countries.

And as you probably noticed, there's a bit of a fever pitch with the election approaching around cyberattacks involving the PRC using botnets enabled by home networking -- home and small business networking equipment.

And so, the big development since our last earnings was the Select Committee for China sent the Department of Commerce a letter, very strongly worded letter, mentioning, this is their quote, "glaring security issue and significant national security threat that the TP-Link poses. And so, that was quite a development.

And that group at the Department of Commerce is the same group that banned Kaspersky, the software security company from Russia. So we're following this closely. And there's a number of other developments relating to the ROUTERS Act, which is targeting a similar thing, and that's made its way through the House already. It's in the Senate.

Obviously, with the election, I think all these types of things slow down a little bit. So it will be interesting to see, and we're watching closely what happens after next week..

And Adam, to your question on the onetime items that are in the non-GAAP earnings for the quarter with regards to the TP-Link settlement, it's actually fairly straightforward and may be easy to see in the 8-K that we put out there. But effectively, it's really about $11 million as a contra expense item that would have offset G&A in the quarter.

And that was a recovery for all the past legal fees. They're all prior period legal fees associated with pursuing those actions against TP-Link. And so, on a normalized basis, you could just add that $11 million back in and get to an established baseline of OpEx..

And I want to talk about the windfall of cash here and, CJ, the capital allocation priorities. I guess I want to pick on the organic investment piece of this first. As we see here based on the Q4 guidance, a more of a normalized quarter. We're not quite at sustainable breakeven on the non-GAAP operating line here in this model just yet.

So I want to better understand how you're thinking about potential further investments in the model given the current operating structure of the business and what that would do in time to breakeven on the non-GAAP operating income line..

Yes. No, great question. So maybe just I can reiterate some of the things we mentioned on the call, just from top line down. So we had a nice growth in NFB this past quarter. So we're excited about that. We see an opportunity to strengthen the performance of that business. And so, overall, we're expecting top line growth.

Next year, we also see opportunities to expand gross margins for the year. And part of that's due to the increasing mix of NFB.

Part of it's tied to all the work that we're doing around clearing out legacy products and matching finished goods inventory with demands, and there's even some additional upside there as hopefully this freight situation resolves itself.

And then as it relates to OpEx, we're taking a really close look at our spending across the board because as we look at our businesses and where to invest, we want as much of that investment to come from just reallocating spend and investments.

We do expect, though, to make some incremental investments on top of that reallocation next year, and we're not expecting to be profitable for the year in 2025. We see a clear path to get there, but we remain really focused on driving long-term growth.

We're not ready to put a stake in the ground as to what quarter we're going to turn breakeven or profitable, but I'm very confident that we are going to get there. And part of the plan is just really setting us up for -- we see a lot of growth opportunities, particularly on the NFB side, and making sure that we're set up to capture those..

And on capital allocation, broadly, it was helpful that you outlined the buckets, and this might be a tough question to answer. But if I look at the balance sheet, I think you're at about $400 million of cash. I think you previously alluded to somewhere around $150 million needed to run the business, and wanted to confirm that's still the view.

And if so, that leaves us with around $250 million of excess cash here. If we could just understand how you're thinking about the general weighting between those 3 categories, the share repurchase or returning cash to shareholders, organic investment, and M&A at this point and just make sure that I'm understanding the excess cash correctly..

Yes. Great question. So the one qualification I'll make to the $150 million of working capital requirements is if there were to be a big shift, regulatory shift, addressing some of the topics you asked about at the outset, that would require more working capital than we've outlined there and quite a bit more.

And so, we don't want -- we'd obviously want to be in a position to capitalize on that. But then putting that aside, if you just look at our priorities, we're definitely looking to return capital to shareholders. So we're expecting this quarter to repurchase more shares on a dollar basis than we did in the prior few quarters.

And that's an important priority for us. We think that if you look at returning capital to shareholders is a much more significant portion of our cash than the organic investments we're planning. On the M&A side, as I said, our number one priority is to get the business back to profitable growth and addressing the opportunities in our core businesses.

However, we are going to evaluate opportunities, the ones that I outlined as examples. But that's obviously very one-off and speculative at this stage. We're really focused on getting the business turned around. And so, hopefully, that framing helps put it more into context..

At this time, there are no further questions. I would now hand today's call back over to CJ Prober, CEO, for closing remarks..

Well, thanks for joining, and we really appreciate the support of our global team partners, customers, and our investors and look forward to continuing the open communication on our transformation. And on that note, Bryan and I we're planning to join Adam at the RJ Conference in New York in December.

So whoever is there, we look forward to seeing you..

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