Greetings, ladies and gentlemen, and welcome to NETGEAR Incorporated Fourth Quarter and Full Year 2014 Earnings Conference Call. [Operator Instructions] It is now my pleasure to introduce your host, Mr. Christopher Genualdi. Thank you, sir. You may begin.

Thank you, operator. Good afternoon, and welcome to NETGEAR's Fourth Quarter and Full Year 2014 Financial Results Conference Call. Joining us from the company are Mr. Patrick Lo, Chairman and CEO; and Ms. Christine Gorjanc, CFO. The format of the call will be a brief business review by Patrick, followed by Christine, providing details on the financials and other information. We will then have time for any questions. If you have not received a copy of today's release, please call NETGEAR Investor Relations or go to NETGEAR's corporate website at www.netgear.com. Before we begin the formal remarks, the company advises that today's conference call contains forward-looking statements. Forward-looking statements include statements regarding expected revenue, operating margins, tax rates, cash generation and other projected financial results, expected market share, market trends and opportunities, competition, research and development efforts, sales and marketing efforts, new product introductions and our growth strategy related to LTE, connected home and SMB vertical solutions. Forward-looking statements made during the call are being made as of today. If this call is replayed or reviewed after today, the information presented in the call may not contain current or accurate information. Further, forward-looking statements are subject to certain risks and uncertainties and are based on assumptions as to future events that may not prove to be accurate. Therefore, actual outcomes and results may differ materially from what is expected or forecast in these forward-looking statements. Potential risks are detailed in the company's periodic filings with the SEC, including those risks and uncertainties listed in the company's most recent Form 10-Q filed with the SEC. NETGEAR undertakes no obligation to release publicly any revisions to any forward-looking statements contained herein to reflect events or circumstances after the date hereof or to reflect the accuracy of unanticipated events. In addition, several non-GAAP financial measures will be mentioned on this call. Information relating to the corresponding GAAP measures as well as a reconciliation of the non-GAAP measures and GAAP measures can be found in our press release or on the Investor Relations website at www.netgear.com. At this time, I would now like to turn the call over to Mr. Patrick Lo. Please go ahead, sir.

Thank you, Christopher. And thank you, everyone, for joining today's call. Before we begin with the financial results and outlook for 2015, I would like to highlight the successes that we had in 2014. During last year, we significantly increased the average selling prices for the Retail Business Unit, with our Nighthawk line of routers and our entry into the Cable Gateway segment in U.S. retail. We rapidly expanded our online presence, particularly at Amazon.com worldwide. We continued to excel in the switching market. We expanded our LTE footprint into new accounts and into retail. We continued to expand within Asia-Pacific region. First, we returned a compelling amount of capital to shareholders. We will look to build on all these successes in the year ahead. On the other hand, we are faced with stiff headwinds in the service provider wireline business due to the reduction of wireline investment amongst service providers. We are adjusting our strategy for the coming quarters by focusing more on the LTE side of the business as well as a limited but strategic set of wireline customers, where we believe we can add the most value. We'll discuss this in more detail in a moment. NETGEAR's net revenue was $1.39 billion for the full year of 2014, which is up 1.7% compared to full year 2013 revenues. For the fourth quarter of 2014, NETGEAR net revenue was $353.2 million, which is down 1% on a year-over-year basis and flat on a sequential basis. Non-GAAP EPS for the full year 2014 was $2.54. Non-GAAP diluted EPS for the fourth quarter of 2014 was $0.65, which is up 10.2% year-over-year. For a full reconciliation of GAAP to non-GAAP financial results, please refer to the fourth quarter and full year 2014 earnings press release. During the fourth quarter, net…

Thank you, Patrick. I will now provide you with a summary of the financials for the fourth quarter of 2014. As Patrick noted, net revenue for the fourth quarter ended December 31, 2014, was $353.2 million as compared to $356.6 million for the fourth quarter ended December 31, 2013 and $353.3 million in the third quarter ended September 28, 2014. We shipped a total of about 6.6 million units in the fourth quarter, including 5.3 million nodes of wireless products. Shipments of all wired and wireless routers and gateways combined were about 3.2 million units for the fourth quarter 2014. Moving to the product category basis. Fourth quarter net revenue split between wireless and wired was about 74% and 26%, respectively. The fourth quarter net revenue split between home and business products was about 77% and 23%, respectively. Products introduced in the last 15 months constituted about 46% of our fourth quarter shipments, while products introduced in the last 12 months constituted about 36% of our fourth quarter shipments. From this point on, my discussion points will focus on non-GAAP numbers. As mentioned previously, the reconciliation from GAAP to non-GAAP is detailed in our preliminary financial statements released earlier today. The non-GAAP gross margin in the fourth quarter of 2014 was 29.3% compared to 29.2% in the year-ago comparable quarter and 29.9% in the third quarter of 2014. Total non-GAAP operating expenses came in at $68 million for the fourth quarter of 2014, which is up compared to the $66.2 million in the year-ago comparable quarter and flat with the prior quarter's total non-GAAP operating expenses. We will continue to closely manage operating expenses in a disciplined fashion. Our non-GAAP R&D expense for the fourth quarter was 6.2% of net revenue as compared to 6% in the year-ago comparable period…

[Operator Instructions] Our first question comes from the line of Ryan Hutchinson with Pacific Crest Securities.

So a few questions on the service provider segment. I understand the CapEx constraints that are taking place, but could you help us understand the impact by geography? And then specifically, are you seeing anything with respect to competitive displacements or anything along those lines? I'm just trying to get a better understanding of the dynamics there just outside of the commentary around the CapEx environment. And then second to that is, can you help us -- just remind us, AirCard, I believe that run rate was around $50 million. Is there a change in that thinking in terms of maybe what the run rate was in Q4 and what your expectations are for that business moving forward?

First and foremost, from a CapEx spending basis, we see similar reduction across both EMEA as well as North America, lesser in Asia-Pacific. And you're right, I mean, the CapEx affects everybody, and as such, the markets shrink. When the markets shrink, some of our competitors are willing to take pretty aggressive stand in pricing, which we are not willing to. So that's why we mentioned in just our script that we pass on some of those businesses. So you're right, the competitive environment has been growing more hostile in terms of pricing because of the shrinking market. So I hope that answers your first question. Second question, in terms of the AirCard, we're not going to comment specifically on product line revenue. But suffice to say, the CapEx expenditure affects across all of our customers, both our wireline and mobile, but more so on wireline. On the other hand though, we do see that the investment is shifting to LTE. And as more and more roll out 4G LTE, especially in Europe and in Asia, we do believe that there is a tremendous growth opportunity of our LTE business to go beyond pre-acquisition level. And that's why we are focusing what the remaining of our SPBU resources more on the LTE and a few of our selected wireline accounts, which we believe that we can add value and be profitable.

Okay. And then as part of restructuring, I understand that $79 million charge and some of the other measures are taking. But are you rationalizing any product lines that we should be aware of?

No, we're not rationalizing the product lines because frankly, for service providers, unlike retail or commercial, they aren't that many products. They're pretty common across the board. It's more rationalizing on the accounts than how much business we want to do, I mean, really focused on the accounts that we believe that we add more value meaning, that we'll be focusing in selling more of the leading-edge technology products that we can command a better margin.

Okay. And then finally, Patrick, do you have any comments on E-rate? I know you don't sell specifically into the K-12 segment, but I'm assuming some of the product ends up in that product segment. So any color around the potential E-rate headwinds or tailwinds as we think about 2015. And that's it from me.

We traditionally do not sell that much into public school districts. We primarily sell to more private schools. So E-rate, really, doesn't affect us that much.

Our next question comes from the line of Mark Sue with RBC Capital Markets.

This is Spencer Green for Mark Sue. So following up a little bit on the service provider segment here. I thought that you said that you may be seeing a quarterly run of approximately $100 million to $105 million for that segment in calendar year '15.

Yes.

Yes, that's what we said. Yes.

Okay. So obviously, that can change, but could you give any further -- or do you have any further insight with regards to linearity there and then what this would imply for your outlook with regards to the other 2 segments of the business?

As we could see, at beginning of the year, talking with all our customers and sizing up the opportunity, I think it's pretty consistent quarter-to-quarter in that range. There was probably up and down, here and there, 5%, 10%, but pretty much hovering around that $100 million-some. Maybe in some quarters, will be $110 million; maybe some quarters were $90 million, but it will be hovering around the $100 million mark, and we don't see any significant changes. But we're working definitely on a lot of new opportunities, especially on the LTE side, that we can boost that level going into next year, hopefully. From the RBU side and CBU side, clearly, especially for RBU, the growth opportunity will continue to be the Nighthawk line of products. Last year, we introduced the 11ac X6, which is basically a tri-band 3x3. This year, there'll be a lot more new introductions. For example, as you probably know, there's the wave 2 coming. There is tri-band 4x4 coming. So there's a lot of exciting new products on the 11ac front. And then Arlo is clearly a platform that we are very excited about. The introduction was very well-received in November, and the pre-orders was very encouraging. And so far, I mean, we only have it sold in the U.S. on Amazon.com and just one other retail outlet, but so far, it's doing very well. And once we expand the distribution into the whole retail channels, the 44,000 retailers around the world, we think that it would be very exciting for us. So -- and we will definitely go beyond the one camera on this line. So those are the opportunities that we see in RBU. On the CBU side, we continue to win on switching, which is the core competency of NETGEAR. And we have been kind of the leaders in introducing breakthrough technology through the SMBs years ago, with Gigabit and then 10Gigabit. Right now, we're very excited with the 2 new breakthrough, the Click Switches and the Chassis Switch. The Chassis Switch is the first -- industry first of $8,000 chassis, and then the Click Switches' completely revolutionary wiring and mounting design. So even though it's at the low end, it is offering a significant value to our customers. So we could command a 50% or 100% premium on assuming the unmanaged switches, 8-port, 16-port. So it clearly -- and those are the opportunities on the CBU side that we'll continue to focus on.

Okay. And just very briefly, if I might. You guys are buying back a pretty good chunk of stock and returning cash to shareholders. And you have about -- it looks like about $250-plus million in cash, no debt on the balance sheet. Has there been any thought or thinking surrounding further optimization of the balance sheet, possibly a prudent amount of debt and/or some kind of ASR in addition to your regular buybacks?

Yes, sure. We review that pretty regularly, and we have, over, say, the last 5 quarters, repurchased again, like I mentioned, about 4.8 million shares, $153 million, which really would have been equivalent to an ASR. But we do continue to review what is the, say, optimum vehicle to do that, and we'll continue to look at that.

Our next question comes from the line of Jeff Kvaal with Northland Securities.

I have a few teed up here. I think, first, can we dial in a little bit more to what your plans are in terms of OpEx spending? Is the incremental savings that you plan to get out of the SBU going to replace spending that you would have grown in the other segments anyway? Or is your net OpEx at this time next year going to be lower than it would have been without these changes? If you see where I'm driving at here?

Right. I think we were going to -- we'll continue to drive CBU and RBU and OpEx like we would. As revenue grows, we'll make investments for new products. I think where you'll see us, I guess, what I would say, rightsize it is within the service provider business. Given the downfall -- the drop in the revenue, we will then reduce those operating expenses, continuing to invest in LTE. So overall, I don't expect to drop in OpEx for the company, but definitely, we're shifting that spend from one business unit to the other.

Okay. So the idea isn't to over-invest relative to historical norms in the other 2 units, while ratcheting back in...

Oh no, absolutely not.

Okay. All right. Okay. That's good. Okay. Secondly, in parsing your guidance, and I understand there's a decent amount of wiggle room here, if one goes right to the $100 million and $105 million for March. And it seems as though you are anticipating a seasonal or slightly below seasonal quarter for retail, I'm not entirely sure if that's the intention that you're trying to signal. So please help us with that, if you could.

We'll have normal seasonality. I think the thing we mentioned in the scripts is we have for retail 6 less selling days in Q1 than Q4, and we have a little bit of FX headwinds in that. So overall, normal seasonality, but we have a few other headwinds, which is a little bit of FX on the revenue side, and clearly, less selling days in retail where every day counts.

In that case, when should we start thinking about a contribution from Arlo?

So Arlo is starting to roll out this quarter. But I think a meaningful contribution to that will be a little more in the back half of the year. We're absolutely rolling it out as we speak.

Okay. And what kind of unit growth are you planning into the assumptions, like annual unit growth in the retail business?

We haven't really disclosed that. But I would say, more of where we want to expand it into both -- obviously, we're already online into the brick-and-mortar, into Europe, and it has a good ASP with that also.

And then last question is -- Ruckus has brought out the Xclaim product line pretty recently. So I'm not sure if you've seen that showing up in some of your CBU engagements? Or what we should make of that?

Yes, we don't really compete with either Ubiquiti or Ruckus in that space because they are selling primarily into what they call it do-it-yourself community support market, while we are selling primarily into what we call a solution market, pretty much packaged by a reseller with a lot of services to go with it. So we don't see them that much. I mean, we're quite separate.

Our next question comes from the line of Rohit Chopra with Buckingham Research Group.

This is Ryan Flanagan on for Rohit. I had a question on the Commercial Business Unit, a little bit of a bounce back there. I want to parse this rank. I know, Patrick, you mentioned from your switching products there. In the quarter, was the strength being driven by more switching or storage or wireless LAN? And kind of as a follow-up there, if you could talk about growth in the segment if you think it's sustainable.

Yes, I mean it's pretty clear that in Q4, the strength is primarily in the switching and a little bit of the storage side on the high-end storage, especially in ReadyDATA. We believe that the switching is our core competency. We actually -- when we established NETGEAR, we're basically a 2-headed course -- I mean, routers and switching -- and we believe that we will continue to lead in the switching side because we invented a lot of the switches. I mean, we invented dual-speed switch. We invented the gigabit, 10-gigabit and the smart switch then plus switch. Now we invented the click switch. So we believe that by always shaping the future yourself, you will be able to lead. So I think we were very confident we'll continue to grow on the switching side. And on the storage side, clearly, I mean, we need to capitalize on the strength of ReadyDATA. We're just in more solution selling. So solution selling is not a do-it-yourself thing, but we need to recruit resellers who would be able to package and deliver those solutions. So our success in 2015 on the storage side is really dependent on how successful we are going to continue to recruit and train enough of the solution system integrators to deliver that solution to our customers.

[Operator Instructions] Our next question comes from the line of Hamed Khorsand with BWS Financial.

Just want to start off. Can you explain the drop-off in ARPU? I mean, there was a considerable drop-off, even though your commentary is saying that you're selling more high-end products, but ARPU did decline this quarter.

Well, I mean, it depends on how you look at it. On the Retail Business Unit, we definitely are increasing our average selling price. But you're right, I mean, overall, we're dropping because the environment in service provider is getting hostile, it's very difficult. So that's why we have to make some strategic changes.

Okay. On the service provider end, is that more than just the shift to DOCSIS 3.1 for next year?

Well, I mean, clearly, as I mentioned previously, that is the pricing pressure. When you have a shrinking market -- I mean everybody is lowering their prices and which cause the drop-off in ASP. And that's why we have to make some strategic decisions which we made.

No, I was referring to just service providers just not trying to take inventory of new -- any routers or -- because they're moving 3.1 next year, they wouldn't want these older routers, right? Is it more inventory controls? Or is it something else?

No, I mean, we do not see that. As we mentioned on the service provider side, there are 2 things. One, I mean, there is a reduction in their CapEx spend, all right, so which makes the market smaller. And second, when the competitors are being more aggressive in price, so the average selling price is getting lower. So you basically have to sell more units to get to the same amount. That's what's happening in the market today.

Okay. Just 2 more from me. One is your commentary on the retail unit, with the 6 fewer days in the quarter. Does that mean that we'll see some sort of catch-up in Q2 on the retail end?

Well, I mean, there probably is a few more days, but Q2, seasonally, is a little bit down from Q1. Maybe it's a little bit down less than normal, but it's still, seasonally, the most down quarter of the 4.

Okay. My last one is that given where you guys are guiding to with the operating margins and the ForEx impact, are you moving away from your commentary from Analyst Day where you said that you're trying to get to 12% operating margin this year?

I'd say we're always trying to make a higher operating margin. The drop in the currencies was so quick, and in all the currencies, that we really can't make that up that quickly. We'll obviously work on product cost and everything we can, pricing on new products potentially. But it was so quick that we have to take a little time to make that up.

But our strategic objective is to get back to 11% to 12%.

At this time, there are no further questions. I would like to turn the floor back to management for any closing comments.

Yes, I mean, the market is definitely in a transition for technologies in the Retail Business Unit and for the CapEx spending and the shift from wireline to wireless in the Service Provider Business Unit. We believe that if we could capitalize on this transition and make our investments accordingly and leading with our innovative products, we would be able to prevail and win after this transition is over. So we're excited about the opportunities of LTE, of Arlo, of Nighthawk and SMB solutions in 2015, and we'll focus on that. And we'll talk to you on our progress next time when we have our earnings call in April. Thank you, everyone.