NETGEAR, INC. Q3 FY2025 earnings call

Management Statement and Operational Highlights

• The company has been on a transformation journey over 1.5 years, with the sixth consecutive quarter exceeding revenue and non-GAAP operating margin guidance. The Enterprise segment drove growth, with managed switch revenue up 16% YOY, ProAV units and ASPs up, and segment gross margin over 50%.
• Launched a new website and renamed the commercial business to NETGEAR Enterprise. Starting Q4, reporting will be on 2 segments: NETGEAR Enterprise and NETGEAR Consumer. Mobile products will integrate into consumer apps/subscriptions and enterprise cloud management/security.
• Home Networking had sequential top line growth, with the Orbi 370 mesh product gaining market share in WiFi 7 categories. Mobile segment had record gross margins and added new channel partners. Repurchased $20 million of stock, ending Q3 with $326.4 million in cash and short-term investments.

Segment Performance

• Enterprise: In Q3, revenue was $90.8 million, up 9.9% sequentially and 15.7% year-over-year. The segment saw a 16% sequential revenue growth in managed switches, with ProAV units and ASPs up year-over-year, contributing to a segment gross margin over 50%, which was a key driver of the company's overall gross margin.
• Home Networking: Generated net revenue of $72.6 million in Q3, down 6.6% year-over-year but up 7.6% sequentially. Benefited from the introduction of the Orbi 370 WiFi 7 mesh offering, gaining share in WiFi 7 mesh and router categories, and had a growing direct-to-consumer channel contributing to improved gross margin.
• Mobile: Registered revenue of $21.1 million in Q3, down 20.7% year-over-year but up 3.3% sequentially. Saw strong demand for high-end Nighthawk M7 Pro mobile hotspots, with record non-GAAP gross margins for the business.

Guidance

• Q4 net revenue expected to be in the range of $170 million to $185 million.
• Expect modest impact from supply constraints in Q4, with return to healthy supply position in Q1.
• Q4 non-GAAP operating margin guidance: negative 2% to 1%.
• GAAP operating margin guidance: negative 7.3% to negative 4.3%.

Risks

• Supply constraints affecting certain managed switch products in the enterprise business.
• Memory cost headwind due to DDR4 suppliers exiting the market, impacting all business segments.

Question and Answer

Q: Congrats on the continuous progress here. My first question is on the gross margin headwind for the fourth quarter. Is that across the board for each 3 of the segments? Or is this mainly more tied to the enterprise segment?

A: Yes. Good question. So, the main headwind is coming from the DDR4 memory situation where the largest suppliers in that space have taken their products end of life. And at this point, there are smaller players who are trying to pick up capacity. Memory is in products in each of our businesses. I'd say it's more acutely felt on the home networking side at this point, but it does impact all 3 businesses.

Q: Okay. CJ, I want to start by just acknowledging great progress on the gross margin front and very clear that your leadership and strategy towards pushing more of the enterprise business and quality of the business higher is manifesting itself in results. More recently, we've seen more headlines around TP-Link of late, and we obviously get a lot of investor questions on that. So, I just wanted to start on that subject. It seems like there's a lot of government activity around TP-Link. Just give us your sense of the latest of your understanding there and the potential timeline and opportunity on that.

A: Yes. Sounds good. And Tore -- Adam. So, Bloomberg reported a few weeks ago that there's been a flurry of activity, and I think that's a kind of well put statement around what's happening. In the article, they mentioned that there's a final initial determination on TP-Link. It's been completed and a bunch of administrative activity around that. I haven't heard much about it since then. But more broadly, the Senate just passed the NDAA, which states that it's going to evaluate TP-Link as a DoD covered company. Yesterday, the FCC voted in favor of restricting networking equipment that has connected components from the Chinese covered list. There's a state of Texas investigation into the TP-Link, something apparently just dropped from Wisconsin of all places. There is a 60-minute piece. So, with all of this activity, I think our confidence is increasing that something is going to eventually drop here. Timing is obviously uncertain. In fact, I think our President's meeting with the right now or shortly. And there's obviously a lot going on there. But one thing kind of related to that, not specific to a government action is that we have been seeing customers starting to recognize NETGEAR differently in the market as a U.S.-based public company trusted partner, and we've been winning some pretty big deals that may have previously not gone our way because of that. And so, I think all the messaging out there is actually helping us win with customers. And so, we're excited about that in the near term, but then also I think there's just a lot going on from the administration perspective. So, it'll be following it closely like everybody else.

Q: First off, I wanted to ask about -- you mentioned considerable progress in growing your distributor channel for NETGEAR Enterprise. I get that right? I was wondering -- I was just hoping you could talk more about what's going on in the channel, what is drawing the channel's interest in NETGEAR and just sort of what you're hearing from them?

A: Yes. Great question, Jay, and good to see you on the call. One thing just to clarify, when we talk about our ProAV ecosystem partners and the growth of that, that relates more to the product integrations that we're doing with the broader AV ecosystem to kind of extend our product leadership and make it -- continue to make it simple to deploy complex IP-based AV networks. That having been said, because I just make that point because I'm not sure if that's what you're referring to. But we are very focused on the channel on the enterprise side of things. And there's a number of transformational initiatives that are coming to market. And our overall philosophy is we just want NETGEAR to be the easiest company to do business with. And so, we've got a partner program that's launching on -- I guess, it's a week today on November 4, I believe it is, via webcast. And there's a number of other things happening under the hood in terms of -- we've launched our new website as part of the partner program launch. We're going to have a new partner portal. So, we're very closely monitoring the health of our channel and expanding the business that we do with our channel partners and helping enable them to work more seamlessly with NETGEAR. So, it's a huge part of our transformation on the enterprise side, and we're really excited with the progress that we've made to date. And just to cap this all off, I spent a week on the East Coast a couple of weeks ago with customers, existing customers and potential customers. And the feedback that we're getting is like we're spot on in terms of our product strategy and how we're evolving our go-to-market capabilities. So, it's really validating to get that directly from those folks.

Q: Just had a couple of clarifications or follow-ups. So, first of all, and not to really pick on this, right, because you had such a strong gross margin improvement in your home networking business in Q2. But when I do look at the gross margin this quarter, it was down slightly sequentially. So, I was just wondering, is that sort of the DDR4 pricing already starting to weigh on that gross margin? Or was there something else that contributed to the gross margin being down sequentially?

A: Yes. Good question. last quarter, we talked a little bit about there being a kind of out-of-period onetime benefit that would have been in the Q3 period there that was pertaining to improved experience with regards to sales returns. And we said at that time, it was about a 250 basis point windfall to the home networking gross margins on the quarter. So we said normalized, it would be about 27% going into Q4. We obviously beat that. And I would say that, as I noted on the comments earlier that we did see some improvements and acceleration on our direct-to-consumer business, which grew to about 15% of our total sales for home networking that has higher gross margins. So that would be the improvement. We have not yet felt any of the impact of the memory pricing increase that won't hit us until Q4.

Q: You highlighted on the ProV side, company very uniquely positioned offering both networking and security. I was just hoping you could elaborate a little bit more on that, especially when it comes to how you potentially monetize that. I mean, obviously, by including security, you can charge more. But I'm just wondering if there's a software services part of that as well.

A: Yes. Great question, Tore. So, the way that we -- and you'll see this come out in Investor Day even more clearly is we are -- when we talk about our enterprise business, we can think about it in the context of ProAV and enterprise networking, which includes security. And when you hear from Pramod, he'll share kind of our long-term plans around those 2 different segments. On the enterprise networking side of things, we're building a platform that combines networking and security that's targeted at small to medium enterprises, many of whom are served by MSPs. And the differentiation that we're looking to drive there is enterprise-level reliability with a very simple user interface that combines both of those things that tend to be presented in a complex, very feature-rich manner that those size customers don't value at an affordable price. So, we're looking to be quite disruptive. And on the topic of gross margin, the competitors that we're looking to disrupt in that enterprise networking space have a very different margin profile that we do. So that's our opportunity. And a lot of the business growth that we expect to drive there will be on the services side of things. So, we're very focused on software differentiation, driving recurring revenue and nondevice revenue and cloud management is a big piece of that. Security is going to be a big piece of that. And then support and services is another big piece of that. So hopefully, that answers your question, but that software recurring revenue side of things is a big priority for us on the enterprise networking and security side of things.