Ladies and gentlemen, thank you for standing by. At this time, all participants are in 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, Christine. Good afternoon, and welcome to NETGEAR's Third Quarter of 2020 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 will start with a review of the financials for the second quarter provided by Bryan, followed by details and commentary on the business provided by Patrick. We will then have time for any questions. If you have not received a copy of today's press release, please visit NETGEAR's Investor Relations website at www.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. I'm very pleased to share with you our third quarter 2020 results. With continuing robust demand for our leading edge products, our team once again delivered a strong quarter with exceptional growth in revenue and profit. We were again constrained on the supply side for our CHP business, for modest recovery and our SMB business, yet still delivered strong revenue growth and record non-GAAP operating profit. Net revenue for the third quarter ended September 27, 2020 was $378.1 million, up 42.2% year-over-year and up 35% on a sequential basis. This strong increase in revenue was primarily due to a remarkably robust demand for our CHP products, powered by unprecedented bandwidth consumption in the home, where people have transitioned to conduct the majority of their daily live. This included product sold to service providers, with associated revenue reaching $74.1 million, our highest level since the first quarter of 2016. We continue to win with our leading edge WiFi 6 offering, and strong presence in both online and retail. Our supply chain team did an outstanding job in the quarter giving product to a retail and service provider partners, outperforming our expectations. The team managed raw materials, manufacturing schedules and transportation, optimizing with their freight in particular to meet more consumer demand than we had previously forecasted. With that said, we expect to remain supply constrained through the first quarter of 2021, primarily due to a worldwide shortage of advanced chips such as WiFi 6. Our non-GAAP operating income at $41.4 million was a quarterly record, with reported non-GAAP operating margin of 10.9%, as NETGEAR showed our ability to leverage our strong revenue growth. For the third quarter of 2020, net revenue for the Americas was $277.9 million, which is up…

Thank you, Bryan. With the pandemic continuing around the world, many adjustments that seemed temporary are cementing their plays in our lives. People and companies have been forced to adapt. At work, some companies are embracing work from home on a permanent basis, others are moving to a hybrid model of working from home and at the office in roughly equivalent amounts. In addition, the flexibility to work from anywhere has led to a massive migration away from the crowded, high cost areas to zoom towns in more isolated less urban areas, leading to an increase in new or upgraded network connections. Regardless of when the pandemic ends, what's clear is that the future of work has ever changed, and that means working from home at least part of the time is here to stay, and what challenges home may be defined by multiple locations. At home, people are adapting to the new environment by learning how to pursue more of the daily activities virtually from home. Eight months in the making there is more from home transition goes well beyond work and school. Families are pursuing a myriad of activities virtually, everything from watching movie premieres and light music concepts, and shopping for groceries to virtual gators to doctor's visits to fitness classes, and checking in on family and friends across the country or even across continents. These activities are taking place through their laptops, tablets and phones. And families are recognizing the need for a fast and reliable WiFi connection that spans their entire home to support the increased bandwidth consumption, and multitude of connected devices utilized across their home. Whereas previously, these activities might have been optional, people have been forced to try them virtually, and are now discovering they actually enjoy and even sometimes prefer them…

Thank you, Patrick. While, we are confident in the ongoing strength of end market demand for home networks, there is still considerable uncertainty around the effects of COVID-19 on the global economy and our supply chain. This makes our outlook difficult to forecast. As such, we're not in a comfortable enough position to provide financial guidance for the fourth quarter. We would now like to answer any questions from the audience.

Thank you. [Operator Instructions] The first question comes from the line of Adam Tindle from Raymond James. Your line is open.

Okay, thanks. Good afternoon, and congrats on a very strong quarter. Patrick, I just wanted to start with a question on the CHP segment, ex the service provider piece. It was obviously very strong. I think you mentioned going forward that you were expecting kind of Q4 to look at sort of the same level as Q3. We would typically expect it up sequentially just from seasonal patterns. So maybe just some color on why it would be flat this year? Was there any pull forward? And as you talked about Q4, any comments on expectations for the holiday season and promotional activity based on Prime Day and what you've seen so far? Thanks.

Well, basically, as we mentioned that we would depend on our supply team to make products available, and it's all supply bound. We do believe that the market has a much bigger appetite to absorb whatever we could ship to the market for WiFi 6. But unfortunately, we just don't have enough chips to provide to the market. So yes, we expect that it would be a seasonally strong Christmas, all right, but we are limited by supply. Now Q3 was the first quarter that people are really experiencing this newfound virtual experiences. So clearly, the market surge was high in Q3. We expect the market surge would come down a little bit in Q4, but then it would be offset by the Christmas seasonality. However, unfortunately all supply bound.

Okay. I mean, is there a way that you could potentially help us quantify how supply that bound you are at this point? So we have an idea of what this tailwind that you're likely going to have as supply catches up to demand would look like over the next few quarters?

I mean, the easiest way to look at it is that - I mean, we used to own 50% market share in North America. And market share in Q3 was a little bit depressed to 44%. And that 6% is clearly was our supply shortage. Plus because we are the market leader, we believe that we have more inventory when the market will grow even faster. And secondly, we believe that we'll actually gain share. So that's the easiest quantification of how much are we limiting ourselves as well as the market.

Okay. And maybe just a follow-up for Bryan. I mean, margins were obviously a bright spot as well. Just wanted to see if we could dig into a little bit more of the puts and takes on a go forward basis for gross margin in particular. And you have some air freight, some supply chain, you've got promotional activity upcoming. Just the different buckets that impact gross margin and how we can think about that line on a go forward basis?

Yes. I think if you're talking about Q3 to start and I mean I think clearly a couple things with the driving forces. One, our overall product profitability has increased. Our mix of WiFi 6 products are certainly contributing to that. And the elevated topline is certainly helping from the topline leverage standpoint. So those two factors are really driving the Q3 performance. We certainly didn't spend a fair amount more in terms of air freight as we suggested we would do in July. But we were able to pull back in terms of promotional activities on CHP products to more or less offset that. If you look out to Q4, I think from an operating margin standpoint, which is what we're primarily focused on, these are a couple of headwinds, I think, overall probably take the step down from Q3 levels by about 100 basis points. One is just topline leverage. We mentioned the opportunistic demand that we saw in service provider that we expected in the back-half of the year, we're able to capitalize a lot of that in the third quarter. So they're naturally going to step down to about $45 million in Q4. And even though, we're still going to be supply constrained in Q4, promotions will certainly continue to be limited. I do think they'll take up just a bit as we have preplanned activities around the holidays. So I think the demand of all that this is probably about 100 basis points stepped down in Q4 from Q3.

Got it. That's helpful. Thanks and congrats again.

Your next question comes from the line of Hamed Khorsand from BWS Financial. Your line is open.

Hi, thanks for taking the questions. First off, Patrick, could you elaborate on your commentary during your statement, you were talking about the CHP side being saying, if you could source enough chips. As you guys drew down inventory, so you would actually have to bump up the amount of chips that you purchase to reach the same kind of revenue. Is that the right way of thinking? Or are you just saying that on a regular basis without the drawdown on inventory?

No, I mean when we say is that, even we draw down the inventory on our own, even we draw down the inventory in the channel, even we ramp up the production quantity, the market demand still exceeded all of that combined. And this is not enough supply of chips that we want to really feed the market. That's all we are talking about.

Understood. So how would you be able to achieve a flattish kind of performance for Q4 given that you've been drawing down your own inventory in Q3?

Exactly. So that means we're depending on an increased supply of the chips in Q4 versus Q3, which is not surprising, because we place the orders earlier. The chips lead time is now six months. So that means in Q4 is basically a result of our placing of chip orders back in April, May.

And then, do you think this is the amount of chips that you're able to generate? Is that allocation from the producers that you might be losing out from competitors? Or is this just not enough production out there?

Well, number one, as you probably know, there's limited capacity of 14-nanometer semiconductors. There are not that many founders in the world that can produce that. And secondly, all the client devices now support WiFi 6. So, we're in the market competing for substrate, competing for 14-nanometer production volume against the same kind of WiFi 6 chips that people want for their cell phones. With the Apple, iPhone 12, Huawei, P40 and Samsung new 42 [ph] and the new S12 and clearly, I mean, among the networking vendors we had the biggest allocation. But in the overall scheme of thing, there are just so many competitors in the electronics industry that need these 14-nanometer chips.

Are you going put a greater emphasis on WiFi 5 in Q4?

No, there's no going back. I mean, as you probably may know all along, in the past three quarters we have been telling everybody that we are rebalancing our inventory, both in the channel as well as within ourselves to lean our sales off of WiFi 5. And as you can see, it's pretty clear right, because we're the only one that have ample supply of WiFi 6. We don't have to do promotions. So as a direct result, our operating margin improved significantly, while everybody has even fewer Wi Fi 6 supply when we do, and then we trash WiFi 5 prices. So there's just no money to be made there. And we're pretty confident once we got - every quarter basis, we'll get more allocation on WiFi 6 chips. And then once we balance demand and supply, then we'll be on our way to gain a lot of share.

Okay, great. Thank you.

Sure.

Your next question comes from the line of from Jeffrey Rand from Deutsche Bank. Your line is open.

Hi, congrats on another great quarter. The year-over-year declines in your SMB business moderated as you expected is there a more untapped potential with the at home office in this business? And do you think the SMB business can really return to growth before we get a vaccine?

We believe that we will get pretty close to previous level even slight growth, as we continue to shoot with a bit more WiFi 6 products even in the SMB channel. As I mentioned, just now in prior discussion, we were totally caught off guard by the strong demand of our WiFi 6 mesh access points. People are cramming for it. And these days is pretty impossible to find the availability of our SMB wireless access point mesh, access points on any website every day. So we do believe that once we get more of an allocation of the chips, then yes, definitely we will grow. The other thing you see it's very interesting also, with a lot of costs and the staff being distributed back to home, work from home, there's a tremendous demand of our POV switches at the low end, especially the 5-port and the 8-port, because they are using them in their home offices and the call center people to connect to the IP phones into their wireless access points. So, I think there's tremendous opportunity. And then on the ProAV side, we still see a lot of uptake in the transition from the traditional AV into the AV over Ethernet. We recently outfitted quite a few railway networks, both in the U.S. as well as in Europe, with the terminals display and in train display with ProAV. So I think the ProAV business will continue to give us the opportunity to grow. So in 2022, we are pretty optimistic for our SMB business.

Great. And then just as a follow-up. I think Amazon released its first WiFi 6 mesh network recently. Can you talk about how this impacts your business? Does it start to put pricing pressure on your WiFi 6 products when supply constraints? And does it help the general acceptance and credibility of WiFi 6?

WiFi 6 acceptance is huge as we mentioned in our discussion just about 15 minutes ago, that we've seen tremendous demand not only in the U.S. where people appreciate technology, we've seen a tremendous demand on our Wi-Fi 6 Orbi in around the world, even in India. And the fact is that people find out and it's through word of mouth that when they buy the WiFi 6 Orbi, not only that you could enjoy the bump up speed, if you have a WiFi 6 phones or tablets or laptops. You actually would benefit even if you have WiFi 5 devices, because of our design. One, it's Tri-Band, two, our design of the radio circuits and the antenna, which really boost the performance and coverage. So anyway, yes, you're right. I mean, Amazon introduced their WiFi 6 product, but primarily it's dual band. They have only one model of so-called Tri-Band is not - but it's not comparable to our performance and actually a little bit more expensive than ours as well. They introduced a Tri-Band about $500, but the bulk of their focus is on the dual band, which we don't really play. I mean, we play in the Tri-Band area, so most of the demand that we're seeing right now for our WiFi 6 products for mash, this would be about $500 price point. So it's like we're in two different worlds. I mean, we're more in the Volkswagen world, and we're more in the BMW world.

Great, thank you.

Your next question comes from the line of Paul Silverstein from Cowen. Your line is open.

Bryan, I hate to ask you repeat yourself. There was a question asked about the margin structure right before my line was silent. So I do apologize to you and others on the call, but I'm hoping you can repeat whatever as you said. I do apologize.

No problem, Paul. So what I was saying for Q4 we would expect operating margins to take a step down of about 100 basis points off of Q3, largely due to leaving from the topline leverage. We talked about pulling forward a lot of the second-half opportunity in service provider and getting into Q3, and then stepping that down into Q4 at $45 million, we're going to lose some topline leverage. And then additionally, while we'll still hold back a lot of promotions, until we get to play in a healthier state. There were some preplanned commitments around the holiday promotional period that will obviously be going forward with those two things, but that's about 100 basis points step down sequentially.

And Bryan, forget one you've addressed this in the past, but I assume expedites are costing you something only order of 100 or so basis points to gross margin and by the operating margin bottom line?

I'd say it's more, but I would say we're offsetting that entirely with the reduced promotional efforts that we typically would have on our CHP products.

So, are you costing that assuming that you eventually, which you will get to a point where you catch up with where supply constraints have become totally alleviated? Should we not assume a full 100 plus basis points benefits to the margin structure at that point whenever that is?

So I mean, I think there's certainly an opportunity for 100 basis point margin expansion. As we move into 2021, Patrick kind of outlined some of the opportunities on the SMB side, where we may look to see something in the neighborhood of 10% growth in '21. We'll return to kind of more than average 35 million a quarter run rate on service provider once behind this Q4 remaining opportunistic demand and service provider. But we think, we'll offset that entirely with the continued growth in the CHP non-carrier portion of our business. So if that kind of performance, we think that there's 100 basis point margin expansion opportunity by '21.

And a question for both of you. Other than the obvious major issue with supply constraint what are you most worried about? Hello?

I think these days, the big concern is getting supply caught up to capitalize on this opportunity and getting supply caught up, which we said it's going to take us to Q2 to do so. So that's number one. And then number two…

Go ahead.

Yes.

I was going to say what's the second thing you're most worried about?

Well, the second thing is anything I mean, that we cannot control on a geopolitical situations and possibility of a third or fourth wave of COVID. I mean, all these uncertainties. Yes. But we'll assume that is not going to happen.

Yes. But clear message today is that you've got more than enough demand relative to your supply demand is not an issue for the foreseeable future. That's not an issue.

No, demand is not an issue.

I will pass it on. Thank you.

Sure.

Your next question comes from the line of Woo Jin Ho from Bloomberg. Your line is open.

Great. Thank you for taking my question. Good progress on the subscriber revenue numbers. In terms of the supply constraints, Patrick, how should we think about balancing out the go-to-market portfolio as it relates to volume versus ASP? And in that, I mean, are you going to go for the 999 whatever it is the 863 product versus a single access point product?

No. I mean what we'd do whatever the customers want, we believe that there's a wide spectrum of applications, not everybody could afford [indiscernible] to begin with. So for those customers, we've seen them buy extenders to supplement a single router. So we also unchanged in that particular marketplace, as well. And we do have WiFi 6 routers that cost only about $129 and $149. So, we're going to do the whole full spectrum of themes. And clearly, as you probably know, I mean, the biggest margin on the higher priced products is generally true. If you buy cars, Mercedes makes more - a lot more money on the S-Class. Same thing, Tesla makes a lot more money on the S-Model and Model X. So it's the same thing, no denial. I mean, for those products that are above $500 we definitely made more money on.

Okay. And somewhat of an intermediate term strategy question for you, Patrick. It sounded if you're looking at the hybrid work from home opportunity as a more permanent type of opportunity. Is there anything on the product development front that you're doing, that may help enhance your positioning to take advantage of that opportunity?

Yes, we mentioned it in our discussion already, right? If you are just an ordinary consumer, and you're going to completely configure your own home networks to do this more from home, then very likely you either galvanized towards a router plus one or two extenders, which is a cheaper solution or you go for a mesh network. And if you're thinking of a mesh network for uncompromised performance, then you're going to pay $500 plus to buy a NETGEAR product. But if you're thinking of just paying about $150 to $$300, and of course, in market you get free to choose from. You get NETGEAR, you get Amazon, you get Google - oh Google doesn't provide WiFi 6 yet. So we still have a pretty significant following, and we have a fair share that between $150 and $300 market. So that's the consumer side of things. But on the other side of things is that you are told by your company to work from home, such as distributed call center people, or you are allowed by the company to work at least half of the time or bulk of your time from home anywhere. And maybe your company would give you money to buy equipment. In those cases, they're more on the commercial grade than they most likely to buy commercial grade router, plus a swift pin switch, but some mesh access point instead of our consumer, and we're doing it. So you got two different solutions. And we've seen both very strong lakes going into 2021.

Got it. And, lastly, Bryan, I believe you said that it wasn't a demand issue going into 2021. And I'm going to get a little greedy here. Any preliminary thoughts on seasonality going into the first quarter and second quarter? Typically it's down 50% sequentially, off of 4Q and then flattish off on 2Q. Any guidance on - any preliminary guidance or the commentary on the CHP business?

So, I would say stay tuned, we're going be announcing our Analyst Day here in the first-half of December in the coming weeks. And we're certainly going to dive into that. But as we said earlier, with the supply constraints last year through Q1 certainly, supply will be dictating what we will be delivering in the first part of the year.

Got it. That is worth a shot. Thank you.

Thank you. There are no further questions at this time, I'll turn the call back over to Patrick Lo.

Sure. Thank you, Christine. I would like to once again, thank you, listening to the call and thank our team members and partners for the hard work and flexibility during this time. And without them, we would not be able to deliver that many products that our customers really need and wants. We look forward to serving a newly expanded market and one in which we have a clear and defensible leadership position. The aim to deliver continued growth in the coming quarters and we remain confident. The components of our strategy will be strong contributors to our success this year and beyond. And I look forward to sharing all with you on progress throughout the next few months, first with the Analyst Day in early part of December, and then in our next earnings call in February. Thank you.

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.