NETGEAR, INC. Q1 FY2025 earnings call

Transformation Progress

• Transformation is gaining momentum, with the company well-positioned geopolitically as it doesn't manufacture in China and products are exempt from tariffs.
• Reorganization in January was to further accelerate investments in NFP, and the team navigated supply constraints well for this segment.

Business Segment Performances

• NFB segment saw revenue up 15.4% year-over-year, with non-GAAP gross margin of 46.3%.
• Mobile business had better-than-expected end-user demand, though revenue was down year-over-year and sequentially.
• Home Networking business gained market share, with net revenue down year-over-year and sequentially but benefiting from Wi-Fi 7 offerings.

Operational Highlights

• Combined stronger NFB mix with better supply chain execution to achieve non-GAAP gross margins of 35%.
• OpEx spend was light at the start of the year, contributing to strong operating margin beat.
• Material year-over-year improvement in contribution margin of all three businesses, leading to positive non-GAAP EPS.

For the NFB segment, revenue was $79.2 million in Q1, down 2% sequentially and up 15.4% year-over-year. Non-GAAP gross margin for NFB was 46.3%, up 440 basis points year-over-year. The mobile business had revenue of $21.5 million in Q1, down 25.3% year-over-year and 10.9% sequentially. Non-GAAP gross margin for mobile was 24.6%, up 730 basis points year-over-year. The Home Networking segment had net revenue of $61.4 million in Q1, down 8.7% year-over-year and 20.8% sequentially. Non-GAAP gross margin for Home Networking was 24.1%, up 190 basis points year-over-year. NFB contributed 48.9% to total revenue, mobile contributed 13.3% and Home Networking contributed 37.8%.

Q2 Guidance

• Expect second quarter net revenue to be in the range of $155 million to $170 million.
• GAAP operating margin expected to be in the range of negative 10.4% to negative 7.4%, non-GAAP operating margin expected to be in the range of negative 6.5% to negative 3.5%.
• GAAP tax expense expected to be in the range of $0.5 million to $1.5 million, non-GAAP tax expense expected to be in the range of $1 million to $2 million for Q2 2025.
• NFB segment expects end-user demand for ProAV managed switches to remain strong but may be constrained by supply in Q2.
• Home Networking expected to operate at normal seasonality, Mobile expected revenue to be in line with Q1 through Q3 with new products in Q4.

Risks

• Geopolitical volatility and uncertainty, including potential changes in tariff policies which could impact the company's competitive position.
• Dependence on supply chain execution and management, as any disruptions could affect product availability and margins.

Q: Good afternoon and congrats on the much better-than-expected results. C.J., I just maybe wanted to start on competitive dynamics. You mentioned no manufacturing in China. You're a trusted U.S. company. How are those things impacting competitive dynamics in your core market? And if you could maybe rope in some of the TP-Link stuff. I know you mentioned a couple of things in the prepared remarks, but if you can maybe double-click on what you're waiting for there and some of the time lines.

A: Yeah. Adam, good questions. So competitively, the tariff landscape has worked out in our favor. Currently, there's been a lot of volatility there. But because we don't manufacture in China and some of our competitors do, we benefit from the fact that we have the tariff exemption that doesn't apply to some of the China tariffs. I would say that benefit is somewhat limited because if you look at our competitive mix and the numbers that competitors that manufacture in China, it's very much a mix and people have figured out a way to avoid paying those tariffs rightly or wrongly. But on the broader point around kind of our posture as a trusted U.S.-based public company, there's obviously been a bunch of developments on the TP-Link side of things since our last call. So there's a big congressional hearing that I don't think was intended to focus on TP-Link, but that ended up being the focus of the conversation there with some fairly impassioned perspectives on the right action to be taken. And then a couple of Bloomberg articles dropped over the last month or so. One was kind of debunking the position that's being taken there that they've separated the companies and are now a U.S.-based company. And the other was revealing the fact that there's a DOJ investigation that's a criminal investigation focused on their pricing practices. So I would say, to summarize it on the tariffs, some competitive benefit there, but the real benefit is that we're not subject to the tariffs. And so we're moving full speed ahead with our strategy and transformation and then preparing if tariffs were to re-emerge for us in terms of cost sharing with our partners and potential price increases.

Q: Okay. Thanks. Good afternoon and congrats on the much better-than-expected results. C.J., I just maybe wanted to start on competitive dynamics. You mentioned no manufacturing in China. You're a trusted U.S. company. How are those things impacting competitive dynamics in your core market? And if you could maybe rope in some of the TP-Link stuff. I know you mentioned a couple of things in the prepared remarks, but if you can maybe double-click on what you're waiting for there and some of the time lines. Thanks.

A: Yeah. Adam, good questions. So competitively, the tariff landscape has worked out in our favor. Currently, there's been a lot of volatility there. But because we don't manufacture in China and some of our competitors do, we benefit from the fact that we have the tariff exemption that doesn't apply to some of the China tariffs. I would say that benefit is somewhat limited because if you look at our competitive mix and the numbers that competitors that manufacture in China, it's very much a mix and people have figured out a way to avoid paying those tariffs rightly or wrongly. But on the broader point around kind of our posture as a trusted U.S.-based public company, there's obviously been a bunch of developments on the TP-Link side of things since our last call. So there's a big congressional hearing that I don't think was intended to focus on TP-Link, but that ended up being the focus of the conversation there with some fairly impassioned perspectives on the right action to be taken. And then a couple of Bloomberg articles dropped over the last month or so. One was kind of debunking the position that's being taken there that they've separated the companies and are now a U.S.-based company. And the other was revealing the fact that there's a DOJ investigation that's a criminal investigation focused on their pricing practices. So I would say, to summarize it on the tariffs, some competitive benefit there, but the real benefit is that we're not subject to the tariffs. And so we're moving full speed ahead with our strategy and transformation and then preparing if tariffs were to re-emerge for us in terms of cost sharing with our partners and potential price increases.

Q: And maybe a good way to dovetail to Bryan. How should we think about revenue for the rest of the year? If you can maybe just provide a little bit more color. I look at the all the things going on that C.J. talked about, it sounds like a lot of tailwinds. Your Q2 guidance is showing double-digit growth year-over-year, granted a little bit of an easier comparison, so not getting ahead of ourselves too much on that, but it does look like some acceleration in growth. And just wanted to see if you could double-click on how you're thinking about revenue for the rest of the year.

A: Sure. Yeah. I guess you already kind of hit on it. The comp obviously with Q2 last year, as you recall, was an aggressive action to clean up the channel. And so the comp is a bit easier in Q2. If I look to the three businesses, if I start with NFB, there's not really a seasonal pattern to that business. We've got great momentum. We keep referring to the double-digit end-user momentum on the ProAV side of things. deliver 15% growth in Q1 on the top line. We are still going to face some supply challenges in Q2, but we think those will largely alleviate as we start to exit Q2. So we are kind of constrained a bit in Q2. As we go into the back half of the year and get an easing in the supply, we certainly think that growth momentum we're seeing on ProAV will just continue. And you're probably thinking about something like a mid-single-digit sequential growth profile once we start to bring that supply in. And it will be progressive as we go through Q3, but we think we'll be in a good shape for the second half of the year. Home Networking, at this point, we see it operating at kind of normal seasonal patterns. Q2 typically is relatively flat to Q1. And then as you go into the back half of the year, Q3 is usually an uptick in the low to mid-teens percentage increase. And then Q4 would be kind of flat to up mid-single digits in Q4, seasonally speaking. Mobile, I think we've talked about this a couple of cycles now that the level you saw in Q1 is likely the level we expect to see for most of this year, certainly through Q3. And as we get into Q4, we've got some products that we're working on that will broaden that portfolio. Mobile is a little bit behind where the Home Networking business is in terms of broadening that portfolio and the good, better, best strategy. But we do feel good about where those efforts are going into Q4. So those are kind of the trends, I think, by the -- that you would expect to see. And of course, what we've said in terms of we expect double-digit growth for NFB that all that still holds true.

Q: Very helpful. Maybe just on the point of margins. Obviously, gross margin was very, very strong in Q1, in particular. If you could first touch on the sustainability of gross margin at sort of this mid-30s level and then also walk through the trajectory of operating margin from here. You've got the further reorg in January. It sounds like a good portion or maybe all of it is going to be reinvested. I'm just trying to figure out, should we think about sustaining gross margin at these levels? And what does that mean for the walk of operating margins for the rest of the year?

A: Yeah. I'll start with the gross margin piece. I definitely believe that gross margin is sustainable given the current mix trends, like the growth trajectory of NFB is really what's lifting the Q1 performance. We expect that to be sustainable. We've kind of moved past some of the aged inventory challenges that we had last year and the aggressive actions we took to clean that up in 2024. So we're seeing that benefit. That should continue as we go forward. Q2, in particular, we're going to spend some on air freight. As I touched on the supply challenges that we still have during the quarter. We're going to supplement that with air freight, but that should start to diminish as we get into the back half of the year. So again, I think keeping those - that mix of business and the trajectory NFB is on those - the current gross margin level is sustainable. From an operating margin standpoint, you could see in the Q2 guidance, we are going to start to ramp our investments. We were a little bit slow out of the gates in Q1, obviously, getting the full benefit of the restructuring actions given we took those actions pretty early. But we are moving forward in terms of the investments that we plan for the year, and those will build as the year progresses. I still think you're probably - to getting to an operating margin above breakeven, you're probably looking to get the top line to nearly $200 million is probably that tipping point for us. But the investments in OpEx will build, as you could see in the Q2 guidance.

Q: Got it. Does that mean operating margin then would be further challenged in Q3 and Q4 from this minus 5% midpoint in Q2? Or because of the leverage in the model, does Q2 maybe represent the low point on operating margin?

A: Yeah, the latter. As we talked about the kind of seasonality in the business with the lift that you would expect in the second half of the year, that would certainly help from a top line leverage standpoint.

Q: Got it. Okay. And then last one for me. The BOG acquisition, C.J., maybe if you could just touch on strategic rationale on that. And also any color on the size of that deal? And Bryan, if you could maybe just wrap that point by talking about expectations on free cash flow for the year.

A: Yeah. So as you'll recall, Adam, we recast our purpose as a company to power extraordinary experiences a couple of quarters ago. And in order to do that, we need to deliver great software. In order to deliver great software, we need great software teams. And so we've been pursuing our transformation of in-sourcing our software development capability. Pramod, who leads the NFB business, identified Chennai as a perfect location given the networking talent there. We're going down the path of kind of build, hire, open an office, build an office. And the VAAG team presented itself. These are people that had worked with Pramod in the past, very well known, very well respected in the networking industry. They were early in their journey at VAAG. And they're just excited about what we're doing here, and they wanted to join NETGEAR and be part of the transformation and be part of leading the software development team building and capability building for Pramod. And so we got lucky on top of bringing this team on board. There was another Chennai-based kind of wireless office that was shut down. We were able to cherry-pick the top engineers from that group. And so we're really well positioned. And the best part about this is it comes with an overall lower cost profile. So there is some transition costs as we in-source from the expensive outsourced developers. But overall, we'll be able to do more with less, as I said in our opening remarks. And it's just a great foundation of a team to build off of. It was very much an acquihire. So - and even then much more on the higher side of an acquihire, but it was just a win-win all around. So we're excited to welcome that team.

Q: And Bryan, if you could maybe just wrap that point by talking about expectations on free cash flow for the year.

A: And on the free cash flow, we still expect that we'll - over the long term, over the full year, would be in the range of 85% to 100% of non-GAAP net income is the rate that we would correlate from a free cash flow standpoint. In Q1, we saw a little bit of swings from working capital with regards to liabilities coming down off the back of the seasonal trend with regards to revenue. But over the full year, we would expect in that range.