Ladies and gentlemen thank you for standing by. At this time all participants are on a listen-only mode. Later we will conduct a question-and-answer session. [Operator Instructions] I would now like to turn the conference over to Erik Bylin. Please go ahead, sir.

Thank you, Angela. Good afternoon and welcome to NETGEAR's Third Quarter of 2019 Financial Results Conference Call. Joining us from the company are Mr. Patrick Lo, Chairman and CEO; and Mr. Bryan Murray, CFO. The format of the call we will start with a review of the financials for the third quarter provided by Bryan, followed by details and commentary on the business, provided by Patrick, and finish with fourth quarter of 2019 guidance provided by Bryan. We'll then have time for questions. If you have not received a copy of today's release, please visit NETGEAR's Investor Relations website at investors.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 rates, 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. 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 Mr. Bryan Murray.

Thank you, Erik, and thank you, everyone for joining today's call. The third quarter presented us with some unexpected challenges. Entering September when we typically see increased demand in Europe after the normal summer recess, we instead saw heightened uncertainty due to Brexit and the possible start of a German recession. Because of this September sales in Europe came in below our expectations. In addition, APAC was hampered by a sudden economic downturn in the China-Hong Kong region due to the escalating trade war, and the unstable sociopolitical situation in Hong Kong. However, on the domestic front, the home WiFi market in North America appears to have stabilized, with indications that the market was down year-over-year about the same level we saw in Q2, or 4.5%. At the same time, we continue to execute on a robust pipeline of new products to extend our market leadership in introducing WiFi 6 technologies in Q3. Entering the quarter, we had three products containing WiFi 6 technology. We ended the quarter with seven, including the all-important WiFi 6# Orbi Mesh, the world's only WiFi 6 mesh system. Overall NETGEAR net revenue for the third quarter ended September 29, 2019 was $265.9 million, which came in at the low end of our guidance range and is down 1.3% on a year-over-year basis, and up 15.2% on a sequential basis. With revenue coming in at the low end of our guidance, our non-GAAP operating margin came in at 7.8%, below our guidance range. However, as a result of one time beneficial revisions to prior period domestic and international tax liabilities, we were able to deliver a non-GAAP net income of $0.65 per diluted share in earnings. Net revenue for the Americas was $178.7 million, which is up 1.6% year-over-year and up 13.7% on a sequential…

Thank you, Brian, and hello everyone. While the third quarter of 2019 was challenging on both the top and bottom lines, we are confident in our strategy of capitalizing on technology inflections, building recurring service revenue and expanding into new adjacent markets. We are also excited by the execution of our WiFi 6 program, where we have a substantial lead over our competition. During the quarter, we announced multiple new WiFi 6 products for the Connected Home including Orbi WiFi 6 Mesh system, the $600 Nighthawk 12 stream WiFi 6 AX 11,000 router and the Nighthawk WiFi 6 Mesh extender. We now have seven products with WiFi 6 technology, while our top three competitors still have not released a single WiFi 6 product. Additionally, we have the product introductions pipeline to more than double the count of our WiFi 6 products over the next six months. While the year-over-year decline of North America retail WiFi market in Q3 remained constant relative to Q2 at about 4.5%. The product compensation is very different. With our strong WiFi 6 router line up, our router end market sales actually grew strongly in Q3. However, we saw an overall decline in Mesh WiFi sales in North America due to the absence of WiFi 6 Mesh products. However, we believe the September release of the iPhone 11 embedded with WiFi 6 will spur consumers to take advantage of this increased speed by connecting with WiFi 6 routers and Mesh products. We will aggressively introduce more WiFi 6 Mesh products in the coming quarters and we believe that will enable the North America WiFi retail market to return to growth in 2020. As for adjacent markets would believe with the introduction of Meural Canvas II we're expanding the reach of our digital Canvas market to a…

Thank you, Patrick. The fourth quarter revenues will be impacted by the trends we have seen in core markets within the EMEA and APAC. While we expect to see softer end user demand, there will be an additional effect on our revenue as the channel reduces inventories for these new conditions. In North America, we're also taking proactive steps to reduce channel inventory to prepare for an accelerated shift towards WiFi 6 within the U.S. in 2020 after CES in early January. In response to our lower top line expectations in Europe and China, we are taking actions to further resize our cost base in those regions to enable us to redeploy resources where we see greater opportunities, such as North America and Japan. We are going to shrink sales headcount in China and Europe, where appropriate and reduce our office footprint in those markets. In consideration to the foregoing, or net revenue for the fourth quarter is expected to be in the range of $240 million to $255 million, GAAP operating margin is expected to be in the range of 0.1% to 1.1%, and a non-GAAP operating margin is expected to be in the range of 4.5% to 5.5%. Our GAAP tax rate is expected to be approximately 33.5%, and our non-GAAP tax rate is expected to be 23% for the fourth quarter of 2019. Operator, that concludes our comments and we can now take questions.

[Operator Instructions] And your first question comes from the line of Adam Tindle with Raymond James. Please go ahead.

Okay. Thanks and good afternoon. I just wanted to start on the inventory. You talked about the initiative to reduce channel inventory. The weeks didn't look significantly out of line, I think you called it proactive. So, kind of two part, I was hoping that you can help us size the adjustment that's needed, how much of this is going to hit contract revenue? And secondly, help us with the timing of this, does this continue into 2020? Or is it all in Q4 guidance, and then thereafter in the 2020, we can look forward to WiFi 6 and the uplift with that?

It's all implying that our guidance for Q4. In terms of the sizing, I would say, if you looked at normal seasonality. You would typically see us lift on the non-service provider portion of CHP in that 12% range. So I would say probably two-thirds of this correction is coming from the Americas to anticipate the WiFi 6 rollout. And the remaining one-third is really being weighed down by the international headwinds that we're facing.

Does, it continue into Q1?

We don't expect further channel inventory reduction go forward.

That's right.

Okay. And maybe just a big picture operational question at the Analysts Day last year, you made a point to show how margin fundamentals were intact, XR load with double-digits, you were targeting the 10% to 11%, non-GAAP operating margin for 2019 based on the mid-single-digit revenue growth. Now that we're looking at a full picture 2019, I understand revenue is going to be down that single-digits instead of growing, but operating profit dollars are going to be down like more than 30%. And you're going to be finishing the year at half of the original operating margin target based on what we learned today. I think we're just all surprised that the amount of negative leverage that we're seeing here. So can you maybe just touch on a little bit deeper of what you're doing operationally in house to start reversing this trend? And where do you think operating margins can sustain just the internal initiatives and no assumption for market growth is the kind of 6% or 7% that we're looking at for the year the right way to think about this business?

Yes, I mean, there's no doubt that we faced a number of challenges this year starting with the U.S. WiFi market. We see it has stabilized in Q3, but it's still down year-over-year 4.5% and started the year off down 8% in Q1. So certainly that's provided some challenges these factors I mentioned, both in EMEA and Asia Pacific, specifically China and Hong Kong, really accelerated in the September timeframe. So it certainly came late and not much time to course correct there. We don't see those things necessarily correcting themselves in the short-term. But we do think that our strategies here specifically on the WiFi 6 rollouts we’re far ahead of our competition, top three competitors do not have WiFi 6 products out there effectively in the U.S., we saw the routers for us, our end user sales in routers grow there. So it's giving us the confidence that our strategy is working. So all these things combined are really kind of what's giving us the confidence as we head into 2020. Again, what transpired in 2019 is behind us, we do think that we can get back to mid-single digit growth in 2020.

Yes. Just to add to what Brian has said, I think in 2020 there are significant differences versus 2019. Number one, we reset out our baseline so we would not assume that China, Hong Kong or Europe will perform at all so that's going to be resetting into our baseline. And as such, we’re deploying those resources into markets that have shown robustness such as in Japan and also in North America in the WiFi 6 segment. What also we see is that we kept getting surprises on the tariff and trade war front in terms of the percentage of tariffs so -- and the speed that the tariff is being assessed some of the products we believe that were not in the tariffs territory that we were slow to move them out of China, all of a sudden become tariff. So that really put a lot of gain in it. And secondly, our productions in outside of China is in testing phase in the early of the year so that's why we had to buffer a lot of inventory, just in case the factory production didn't go well we still have inventory. Now those buffered inventory, even though is produced, long before the tariff was applied, it is generally higher costs because as time goes on those -- I mean we were like in the sea food industry, right. When the inventory is older is relatively more expensive, relative to the current selling price. And then the factories in outside of China will take time to get to the same efficiency as the factories in China. Now, we believe in 2020, all those negative factors will be gone, but unless of course, we cannot predict whether tariff will be applied to other countries. But as long as let's say…

Okay. Maybe just one quick one for Bryan, you talked about you being confident in generating meaningful levels of cash. Can you just help us quantify what that means? And then remind us how much is left on the buyback and whether M&A would make sense to help the business or is buyback still the right use of cash? Thanks.

Yes, I think, going into Q4 we think things will turnaround. You may recall that we typically have some seasonal dating programs with some key accounts of ours, which usually go the other direction from a cash standpoint, but we do believe we're in a position to work down some of these inventory levels. My guess is it’s probably north of 150% of non-GAAP net income that we’ll generate in terms of free cash flow in Q4. It likely will take us two to three quarters to work the inventory completely down to the levels that we'd like to carry forward. And we'll try and do that as fast as we can. But that's my best estimate of what Q4 would be. In terms of use of cash. Yes, we still think that using cash for buyback is an appropriate use of our cash balance that still carries in excess of what we think our operating cash needs are. And as I just said, we expect to generate additional cash in the quarter.

And also, I mean, we will not stop looking at some tuck-in technology acquisitions that will benefit our growth area, such as the ProAV space, such as the WiFi 6 space and just the content space, service revenue space.

And your next question comes from the line of Robert Gutman with Guggenheim. Please go ahead.

Thanks for taking the question. Given all the uncertainty that you cited and the sort of moving parts that we've seen now at this point, I was just wondering the impact on promotional spending and counter revenue. Is there a change in allocation there or overall dollar amount?

Relative to the second quarter?

Yes, relative to your prior plans for how you're spending that money.

Yes, I would say that maybe a slight tweak to our original plan. I mean, coming into the quarter there was certainly anticipation of Prime Day being extended to a two day event this year, as opposed to one day in the past. And certainly, it was successful on one account, but that typically comes with some additional promotional dollars. So that certainly had some impact on the quarter. But I think going into Q4 we think it will be at normal Q4 promotional spending levels searches. Certainly, on the back of Black Friday and Cyber Monday.

And do you see the need to spend more there in the coming quarters given that, I think we were looking for more of a flattish type development for the broader U.S. WiFi market in the third quarter and obviously it's a little disappointing. But do you think you could move that or is that just, sort of a wait and see type?

Yeah. I'm hoping that we will get to momentum here. I think we mentioned that we’ve launched the Orbi WiFi 6 Mesh, late in the quarter. That's now getting out seated into the market as we speak. And so we think that the key component, I said earlier, we saw the success on the router side because of our WiFi 6 product introductions, now that we're touching on Mesh, which is about a third of the market. We think that will be a contributing factor and we're hopeful that we will get closer to a flat market in Q4 from an end user standpoint.

From a counter revenue marketing perspective, we don't see that we’re going to spend more than what we traditionally spend in the Q4 in prior years.

Okay, that's helpful. Thank you.

And your next question comes from the line of Liz Pate with Cowen and Company. Please go ahead.

Hi, thanks for taking my question. You just had the comment that you think you get that closer to flat market growth in the fourth quarter, just in terms of looking out into calendar 2020, when do you think you'll get back to top line growth? You have a lot of channel reduction inventory reductions to do. I'm just wondering in terms of timing of a return to top line growth? Thanks.

If given all the factors constant, that means there's no more surprises, no more geopolitical headwinds, we expect that we should be able to get to top line revenue growth probably from second quarter onwards. So that's how we look at it because, we believe that the channel inventory adjustment should be done by Q4 and not be later than Q1. Yes.

Okay, great. And just so double digit operating margin, still a reasonable target on kind of low-single digit 3% revenue growth for 2020, is that what you're saying?

Yes, in a normal economic situation that is still the plan for 2020.

Okay. And then, lastly, service provider revenue look like that held up or rebounded nicely in 3Q. Do you still see that kind of in that $35 million to $36 million range moving forward?

Yes, it’s roughly in the $35 million range, yes, plus or minus. So Q3 was plus, Q1 was a big plus, Q2 was a big minus.

I'm sorry, just one other question on operating expenses in 4Q, do you have some levers to pull there, do you expect OpEx to be flat, down a little bit?

It's probably closer to flat. We did talk about some of the actions that we're taking to right size some of these markets that we see a bit challenged, but we will be reallocating those resources to the areas we see opportunity.

Yes, we're definitely ramping up our investment in headcount and resources in North America for the ProAV market and in Japan, overall.

Great, okay. Thank you very much.

And your next question comes from the line of Hamed Khorsand with BWS Financial. Please go ahead.

Hi. I just wanted to get a follow up here on the commentary about WiFi 6. Beginning of the year, you were somewhat be wilderness to the decline in the market and guess that it was WiFi 6 related. Now you're saying that WiFi 6 is just slow but you have more products on the market, I mean is that really the case of what's going on in the home WiFi market or are you just losing share to the carriers?

No, we think clearly the WiFi 6 is the reason because it's pretty simple in Q1 when there was absolutely no WiFi 6 products, the market declined by 8%. In Q2, when we had WiFi 6 products for about 1.5 skews for the full quarter, we saw that the market improved to negative 4.5%. In Q3 when we have three we doubled the WiFi 6 router product the market should have improved from 4.5% to whatever. Unfortunately, what we saw in the market is the mesh market for the very first time in history actually declined year-over-year. So that clearly tells you, it's like in a drug test, when is the plateful and the other one is the drug. So when there's WiFi 6, on the router side, the market demand holding up, but on the mesh side, well there's absolutely no WiFi 6 the market actually declined for the very first time in history. So that tells us very likely WiFi 6 is going to be the key driver and that's why in Q4 is the very first time that we would have WiFi 6 both on the router side with a skews and then with mesh also WiFi 6 and expanded with one skew in WiFi 6, we should see the improvement of the market might not be totally flat, but at least improve from 4.5%. Now come Q1 as we said, post CES we will have WiFi 6 products in all categories, cable, extenders and mesh and router that when we see there's a high likelihood the market will be flat or even return to growth.

Okay. And as far as inventory is concerned, how much of that inventory is not WiFi 6 that you're concerned that you need to liquidate it faster?

No, we don't believe that we would liquidate because as you could see, our inventory buffer is maximum about one or two quarters or on 11ac as much as we single handedly push the market over to 11 AX WiFi 6 it probably would still take two to three years before the transition is completely over. So we are absolutely in no hurry to liquidate the 11ac inventory at all. And as a matter of fact, I mean, we hold a 51% market share so we still have a lot of wherewithal to really move 11ac products.

And if you think that it’s WiFi 6 that's providing the catalyst here for the year, why haven't your competitors made the move? Is it really just a cost driven consumers not wanting to spend this much for WiFi 6 router?

No, it's multiple reasons if you look at it, I mean, seriously, there are only three competitors in the market today. One is -- I mean two are Amazon and Google. And for them, they have not had because their development process is a little bit different. The hardware and software is completely developed in house they don't use the ODM model. All right. They write their software from the stack all the way up, they don't even use some of the driver software from the chip vendors. So it is very difficult for them to expand their WiFi 6 offerings. And furthermore, I think their focus right now as you just we saw their recent introduction of their product is really focused on lowering costs and collecting more data. So to them WiFi 6 is not the priority. And then for the other competitors such as Lynx [ph], they just don't have the financial wherewithal to engage in WiFi 6 product developments in all those many areas. So, I think we're in a very unique position that we have the enough financial as well as the ODM model to introduce that many WiFi 6 products and we absolutely are going to capitalize on disadvantage.

Thank you.

And you're in your final question comes from the line of Woo Jin Ho with Bloomberg Intelligence. Please go ahead.

Thank you for taking my question. A couple of quick ones. How big is your Hong Kong and China explosion today? My understanding was that it has been small. So kind of scratching my head and why there would be such a big revenue impact going into the fourth quarter and possibly into 2020?

Clearly, as you can see, right, I mean, we usually would love to be at the high end of our guidance, right? And we hit the low end so that’s a swing of about at least $10 million. And Europe and China, Hong Kong, you could easily do the calculation see how big the impact is. Now remember, Hong Kong, China is the number two economy in the world. So they should be our number two market, right? So it's pretty significant. And clearly, if you look at the other economies there is Japan, there is Germany, which also big for us. So that's why we got to quickly shift as fast as possible from China into Japan, which is an absolute growth area for us, and we’re under indexing in Japan, which we feel good that we will be able to make strides over there.

And just to be clear, you're not exiting the China, Hong Kong market. You’re just reducing your exposure there and shifting over the resources to Japan. Is that the right way of thinking of it?

Correct. We're not exiting at all, but we are definitely shrinking the footprint. For example, I mean, just to give you how important it is, we have three sales offices in China. We have Beijing, we have Shanghai, we have Guangzhou, and plus Hong Kong get four. Clearly with this new reality we probably don't need four sales offices.

And in your Q&A commentary, it sounds like you're targeting single digit growth revenues in 2020. Sounds like a preview to the Analysts Day. Given your focus on WiFi 6, is this going to be an ASP driven growth or a unit driven growth given all the puts and takes on what you're doing with the inventory and on the product portfolio?

For our planning horizon, it would be mostly ASP growth, however, we’ll take any unit growth. I think the unit growth has to come from share gain. So -- but for now, our baseline planning is for ASP growth. But the growth is not only coming from the ASP side, we're very excited also on the SMB side, on the ProAV space as well. I think we've laid a pretty good foundation, as I just talked about, we just announced a first marketing alliance initiative with Broad Data in AVI and you will see more of that coming and we excited about that opportunity as we have described many times that this opportunity which represents $150 million to $200 million TAM. And even a 50% market share, which will be pretty lucrative as incremental business to the SMB side.

And, Woo Jin, just to refer back to something Patrick said earlier with respect to the growth. We see that as starting in Q2, we normally see seasonality in Q1 coming off the holiday season where CHP non-service provider drops about 20%. That certainly will be muted with some of the actions that we're taking in the U.S. But I still think that we'll see that seasonal drop maybe in the 10 to low-teen percentage wise.

Okay. And then one last product portfolio question for me. Patrick, you guys have done a great job in mastering the good, better, best strategy in the WiFi market, whereas Google and Amazon have focused on the good. Given your focus on WiFi 6 and the higher end of the product spectrum, is there any risk that you might be giving up a large share of the base of that pyramid to Amazon and Google with a lower price to the mesh products?

Not really. We are the high end of the good, better, best. So, we compete on every single level. So for example, if you look at WiFi 6 router, we just introduced a WiFi 6 router at $179. So which is the high end of the good and we also just introduced a new dual band Orbi the 1X series, which is priced at around $249. So we continue to do that. So we compete in every single price level, but in every single price levels we’re always highest priced, which is basically our modus operandi. And it has been very successful, because channel partners want that. For every single price level, they want a higher priced product. We just introduced a $249 extender, but we'll continue to expand the line of the WiFi 6 we’re not going to leave any price point open and empty.

Understood. Thank you.

Sure.

And I will now turn the call back to Patrick Lo for closing remarks.

Thank you everybody for joining today's call. Clearly, I mean, we would like to have better financial results for Q3 and Q4, but with the political headwinds strong at us, we are quickly readjusting, and we are very optimistic about our prospects across the business, as we close out the year and enter 2020. We have clear leadership in WiFi 6, in ProAV and listing partners in both areas. We're very encouraged by our progress in acquiring subscription service customers, and making good initial steps towards our goal of a million paid subscribers in a few years. I look forward to updating all of you at our Analysts Day on all those fronts in November and look forward to seeing all of you on November 20th in New York at the NASDAQ Site. Thank you.

And this concludes today's conference call. You may now disconnect.