Netgear: Fiscal 3Q08 Financial Results

NETGEAR, Inc. reported financial results for the third quarter ended September 28, 2008.

Net revenue for the third quarter ended September 28, 2008 was $179.4 million, a 6% decrease as compared to $191.7 million for the third quarter ended September 30, 2007, and a 12% decrease as compared to $204.5 million in the second quarter ended June 29, 2008. Net income for the third quarter of 2008 computed in accordance with GAAP was $3.1 million, or $0.09 per diluted share. This compared to net income of $13.3 million for the third quarter of 2007 and to net income of $11.1 million in the second quarter of 2008. Diluted earnings per share, computed in accordance with GAAP, was $0.37 for the third quarter of 2007 and $0.31 for the second quarter of 2008.

Gross margin on a non-GAAP basis in the third quarter of 2008 was 35.5%, as compared to 34.0% in the year ago comparable quarter, and 33.2% in the second quarter of 2008. Non-GAAP operating margin was 11.1% in the third quarter of 2008, as compared to 11.7% in the third quarter of 2007, and 11.5% in the second quarter of 2008. In the third quarter of 2008, non-GAAP operating expenses were 24.4% of net revenue, as compared to 22.3% in the year ago comparable quarter, and 21.7% in the prior quarter.

Net income on a non-GAAP basis for the third quarter of 2008 was $6.9 million, as compared to non-GAAP net income of $16.0 million for the third quarter of 2007, and non-GAAP net income of $14.5 million for the second quarter of 2008. Non-GAAP net income was $0.19 per diluted share in the third quarter of 2008, as compared to $0.44 per diluted share in the third quarter of 2007 and $0.41 per diluted share in the second quarter of 2008. Non-GAAP net income for the third quarter of 2008 excludes $775,000 of adjustments related to amortization of purchased intangibles and acquisition related retention compensation, net of taxes, related to our recent acquisitions. Non-GAAP net income for the third quarter of 2008 also excludes non-cash, stock-based compensation, net of tax, of $2.4 million, restructuring costs related to vacating certain facilities, net of tax, of $592,000 and $52,000 in litigation reserve requirements, net of tax. Non-GAAP net income for the third quarter of 2007 excludes $811,000 of adjustments related to amortization of purchased intangibles and acquisition related retention compensation, net of taxes.

Non-GAAP net income for the third quarter of 2007 also excludes non-cash, stock-based compensation, net of tax, of $1.8 million and $124,000 in litigation reserves, net of tax. Non-GAAP net income for the second quarter of 2008 excludes $1.1 million of adjustments related to amortization of purchased intangibles and acquisition related retention compensation, net of taxes. Non-GAAP net income for the second quarter of 2008 also excludes non-cash, stock-based compensation, net of tax, of $2.4 million. The accompanying schedules provide a reconciliation of net income computed on a GAAP basis to net income computed on a non-GAAP basis.

Patrick Lo, Chairman and Chief Executive Officer of NETGEAR, commented: "The September quarter showed weakness in demand for our consumer products across both retail and service provider channels in all geographies, resulting in a quarter-over-quarter and year-over-year decline in consumer product shipments. We believe the weakness in the global economy and tight credit markets worldwide are causing softness in end-user demand. As a result of the current environment, we expect subdued spending conditions to persist over the next few quarters until consumer confidence returns to the market. SMB (small and medium-sized business) demand is holding well with continuous momentum. The impact of current economic conditions on our operating margin was offset by continued successful product and operating cost reductions, healthy sales of ReadyNAS and Smart Switches and the reduction in air freight cost requirements as a result of increased on hand and available inventory. In the third quarter, our service provider net revenue was approximately $31.4 million, about 18% of our total net revenue, as compared to 22% in the year ago quarter, and 27% in the second quarter of 2008."

Mr. Lo continued: "In late September, we were pleased to enter the high growth SMB security appliance market with the signing of a definitive agreement to purchase certain assets of CP Secure, a leading provider of integrated security solutions that protect organizations and businesses from Internet originated web and e-mail based malware threats. With this acquisition, we can further strengthen our share in this market by ensuring that our SMB clients are provided an integrated solution to safeguard their networks from Internet threats and improve their overall business continuity.

"On the new product front, during the third quarter, we introduced 14 new products, including 3 new models of our super fast 6 Bay ReadyNAS Pro, which has enjoyed strong reception worldwide. In addition, we’ve been pleased to bring our new energy-efficient, high-performance Wireless-N Router and Wireless-N DSL Modem Router to the marketplace, enabling the simultaneous use of applications such as Voice-Over- IP, video and multimedia streaming, console gaming, and Web surfing. Looking ahead into Q4, we anticipate launching 12 to 15 new products, which will be ready for the Consumer Electronics Show in January 2009, further positioning us for future revenue growth and market share gain."

Christine Gorjanc, Chief Financial Officer of NETGEAR, said: "We were negatively impacted in Q3 by lower than expected revenue and the strengthening of the US dollar. During the quarter, the value of the US dollar rose rapidly against the Australian dollar, British pound and the Euro. As a result of the remeasurement of our foreign currency net assets, we suffered a currency loss of $4.7 million. Also, our effective tax rate increased to 57.7%, on a non-GAAP basis, due to lower than expected international profit. We ended the third quarter of 2008 with net inventory at $125.7 million, compared to $106.4 million at the end of the second quarter of 2008, and $79.3 million at the end of the third quarter of 2007.

"Ending inventory turns were 3.7, compared to 5.2 at the end of the second quarter of 2008, and 6.5 at the end of the third quarter of 2007. Days sales outstanding (DSO) were 76 in the third quarter of 2008, compared to 71 days in the second quarter of 2008 and 66 days in the third quarter of 2007. Cash, cash equivalents and short-term investments were $202.2 million at the end of the third quarter of 2008, compared to $186.8 million at the end of the second quarter of 2008, and $177.2 million at the end of the third quarter of 2007. Deferred revenue increased to $13.3 million at the end of the third quarter of 2008, compared to deferred revenue of $4.3 million at the end of the second quarter of 2008, and $7.8 million at the end of the third quarter of 2007."

U.S. retail channel inventory ended the third quarter of 2008 at 11.4 weeks, compared to 8.8 weeks in the third quarter of 2007, and 13.6 weeks in the second quarter of 2008. U.S. distribution channel inventory ended the third quarter of 2008 at 5.5 weeks, compared to 4.2 weeks in the third quarter of 2007, and 5.1 weeks in the second quarter of 2008. European distribution channel inventory ended the third quarter of 2008 at approximately 5.1 weeks, compared to approximately 4.9 weeks in the third quarter of 2007, and 6.0 weeks in the second quarter of 2008. Asia Pacific distribution channel inventory ended the third quarter of 2008 at approximately 7.2 weeks, compared to approximately 4.7 weeks in the third quarter of 2007, and 6.0 weeks in the second quarter of 2008.

Additionally, the company announced that its board of directors has authorized a program to repurchase up to 6,000,000 shares of the company’s common stock, or approximately 16.9% of the outstanding shares. "We believe the company’s stock represents an attractive investment opportunity at current market prices," said Mr. Lo. "The Board’s approval of the share repurchase program reflects its confidence in the long term future of NETGEAR’s business and its ongoing commitment to increase shareholder value."

The stock repurchase authorization does not have an expiration date and the pace of repurchase activity will depend on factors such as levels of cash generation from operations, cash requirements for acquisitions, current stock price, and other factors. Under the program, NETGEAR may repurchase shares from time to time on the open market. The company will finance the repurchase program with available cash on hand. The stock repurchase program may be modified or discontinued at any time.

Looking forward, Mr. Lo added: "The weakness in consumer demand and the global economic environment will continue to test growth in the coming quarters. Despite such market challenges, we firmly believe our success in SMB will bolster us well amidst weaker demand for our consumer products. We are excited about the impending closing of the asset acquisition of CP Secure, providing us with differentiated technology in the form of our new ProSecure line of security appliances for SMB. We will continue to drive innovation in the SMB market with our Smart Switches, ReadyNAS and soon to be launched ProSecure line of products. For the fourth quarter of 2008, we expect lower than normal consumer demand due to the current economic conditions. Specifically, we expect fourth quarter net revenue to be approximately $155 million to $165 million. We expect non-GAAP operating margin to be in the range of 9.5% to 10.5%."