Good afternoon, ladies and gentlemen and welcome to the NETGEAR First Quarter 2023 Results Conference Call. At this time, all participants are in a listen-only mode and please be advised that this call is being recorded. After the speakers' prepared remarks, there will be a question-and-answer session. [Operator Instructions] And at this time, I will turn things over to Mr. Erik Bylin. Mr. Bylin, you may begin.

Thank you, Bob. Good afternoon and welcome to NETGEAR's first quarter of 2023 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 first quarter provided by Bryan, followed by details and commentary on the business provided by Patrick and finish with the second quarter of 2023 guidance provided by Bryan. We will then have time for any questions. If you have not received a copy of today's 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. 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, Eric, and thank you everyone for joining today's call. While we came into the quarter forecasting approximately $28 million in channel inventory reductions of both CHP and SMB products, our actual experience was a reduction of $37 million or $9 million higher than anticipated. This increase was due to an unprecedented inventory reduction by our largest service provider partner, as well as a meaningful reduction in SMB inventory by our largest e-commerce partner. This resulted in an unexpected challenge to our top line. Accordingly, our net revenue for the quarter ended April 2nd, 2023 was $180.9 million, which came in below the low end of our guidance range, down 14.1% year-over-year and down 27.4% on a sequential basis. However, our end user sales of SMB products remain strong, growing double-digits year-on-year, driven by our ProAV line of manage switches and our premium CHP products consisting of our Orbi 8 and 9 tri and quad-band WiFi mesh products and 5G mobile hotspots, again outperformed the broader market growing sequentially despite normal seasonal patterns. While our gross margin improved dramatically during the quarter, it was not enough to offset the reduced leverage from a top line. As a result, we delivered non-GAAP operating loss of $7.1 million and non-GAAP operating margin came in at negative 3.9% below the low end of our guidance range, which was up 50 basis points compared to the year ago period and a decline of 230 basis points compared to the prior quarter. For the first quarter of 2023, net revenue for the Americas was $121.9 million, a decline of 15.7% year-over-year and down 23.4% of sequential basis. EMEA net revenue was $39.2 million, an increase of 6.3% year-over-year, and down 25.7% quarter-over-quarter. Our APAC net revenue was $19.8 million, which is down 31.8% from…

Thank you, Bryan. After three years of the pandemic, broad-based inflationary pressures amid an uncertain macroeconomic environment are affecting consumers in industries around the world. In the first quarter, channel partners in all parts of our business sharply constrained their order to reduce inventory carrying levels more aggressively than our original estimates, impacting our top line and resulting in lost operating leverage. However, the overarching market trends that we have based our strategy on delivering leading edge technologically differentiated products to consumers and businesses that will pay for high performance features are clearly evident in the behavior of our end users. Importantly, in the first quarter, NETGEAR delivered non-GAAP gross margin of 33.6%, up 540 basis points year-over-year, and 870 basis points sequentially, as we achieved our second highest gross margin since the beginning of 2019. We believe this serves a strong validation of our strategy to move away from the less profitable, lower end of the market and focus on premium products where profitability has been consistently stronger. The impressive gross margin result of this quarter gives us renewed confidence in the sustainability and longevity of the margin expansion potential unlocked by our core long-term growth strategy, even through periods of macroeconomic uncertainty, especially when channel inventory levels stabilize. Now turning to an update on our CHP business. Demand for our best-selling premium Orbi 8 and Orbi 9 mesh WiFi products remained strong, and end user sales actually grew sequentially, even in the face of a normal seasonal decline from the Q4 holiday period. The solid performance of these higher margin products enabled CHP to contribute to our significant gross margin improvement in the quarter. The WiFi 7 upgrade cycle is coming later this year, and we are poised to capitalize on another technological inflection point. As the transition…

Thank you, Patrick. We expect to continue to experience strong underlying demand in the SMB business and the premium portion of the CHP product portfolio, even in the face of ongoing broad-based inflationary pressures and an uncertain macroeconomic environment. We will continue to work with our channel partners across both businesses to optimize their inventory carrying levels, and expect a revenue impact from these efforts to be at a similar level as experienced in the first quarter. Accordingly, we expect our second quarter net revenue to be in the range of $150 million to $165 million. We expect second quarter GAAP operating margin to be in the range of negative 13.4% to negative 10.4%. And non-GAAP operating margin is expected to be in the range of negative 9% to negative 6%. Our GAAP tax rate is expected to be approximately 11%, and our non-GAAP tax rate is expected to be 6% for the second quarter of 2023. We would now like to answer any questions from the audience.

Thank you, Mr. Murray. [Operator Instructions] And we go first this afternoon to Hamed Khorsand at BWS Financial.

Hi. So, my first question is, what's been the biggest challenge for you as far as handling this inventory demand imbalance? It seems like every quarter, there's been an issue that comes about.

Yeah. I think, as I noted earlier, I think this quarter in particular, it was the surprise factor. And I think you're seeing from a number of different companies, the impact that they're feeling from the environment. The service provider account I mentioned earlier is publicly noted some of the challenges they've seen on the free cash flow side. And they're in extreme circumstances and they're responding accordingly. So, I think it's the surprise factor to that. As I noted, we expected about $28 million of destocking to happen in the quarter. And just to remind everybody, what that really means is that as our channel partners sell through, they just won't replenish it the same rate. So, we expected a sizeable amount and we expected it to be across both businesses. But as we said earlier, the surprise factor being the service provider account and on the SMB side, the largest e-commerce partner we have, really implementing some very tight strict inventory management guidelines is unprecedented. These levels we haven't seen before. And so, we're now preparing for that, and expected to continue into Q2.

And then how are you balancing the premium CHP business? Are you spending more time advertising direct to the consumer? How are you going about that so you can at least try to offset what's going on at the retail front?

You're right. I mean, we are focusing on increasing the mix of our CP premium products, and we are seeing the positive response from the market, as we see is a continuous sequential growth of those product despite the market decline. And you're right, we're focusing on direct marketing to consumers who are looking for high performance premium products. Generally, we do most of our marketings online, using all kinds of online marketing capabilities. We also using our own website, NETGEAR.com to direct them into our web stores and provide concierge service to give them the best shopping experience. So, we also working with a lot of channel partners, our media channel partners that we believe our customers would go to such as some of the technical sites like Tom's Hardware and others and also in lifestyle types of outlet such as the Robb Report. So, yeah, we're doing a lot of online marketing targeting them. The one thing we don't do is discount and promotions on these high-end products, because we have a very unique offering and we are way above any of our competitors' offerings. And if the customers want the absolute best WiFi experience, either at home or on the go, then the only solution is our Orbi mesh and our Nighthawk mobile routers.

My last question is, how are you managing inventory just given where revenue is and what's the plan there?

Well, absolutely, we cannot control what the channel wants to do. So, we are putting in very conservative channel inventory estimate given all these surprises. And in return, we also are slowing down the production rate in our factories to slow the inventory coming in. So that's how we manage it. Now, certainly in Q1, the surprise is higher than what we estimate, and that's why we're taking a very conservative viewpoint in Q2, and we believe that we would be able to get ahead of the curve in Q2 from an inventory balance standpoint in our own warehouse.

Okay. Thank you.

Sure.

Thank you. We go next now to Jake Norrison at Raymond James.

Hey, thanks guys. I'm just hoping if you could touch on a few points here. One, have you made any changes to the sort of fiscal year 2023 non-GAAP operating margin target and the service provider revenue targets? And then beyond that, can you just let us know what is underpinning your confidence in the back half load this year?

Yeah. I'll start here with kind of the outlook for the year. I mean, certainly, the surprise to Q1 and our guidance to Q2 we're off pace from the guidance that we put out there back in December of our Analyst Day. At this point, as Patrick has said a couple of times here, we're being cautious, right? We're dealing with an environment where we're seeing unprecedented responses from channel partners in terms of their willingness to hold inventory. So, at this point, we expect the second half of the year that that two things will be driving factors. One is that the CHP retail business gets a typical seasonal lift. And then secondarily, we think that the level of destocking will moderate in the second half. And based on both of those factors, we would likely expect the second half of the year -- that the total revenues in the back half of the year to over index the first half by 15% to 20%. So that certainly is different than the annual guidance that we put out there before. And with that lower revenue level, operating margins have been suppressed. But with that revenue outlook in the back half, I think you'd likely be seeing non-GAAP operating margins in that low to mid single digit level.

Okay. Perfect. And then last one from me. Has there any been any thinking or any changes around the thinking and sort of share repurchases and capital allocation going forward here?

Yeah. As we said before, we're always looking at it. We're opportunistic buyers of our stock. We're obviously looking at our cash balances, our planned cash outlay for operational purposes. And so, all those things are factored into ongoing conversations with regards to capital allocation.

Okay. Perfect. Thank you.

Thank you. And gentlemen, it appears we have no further questions this afternoon. Mr. Lo, I'll hand things back to you for any closing comments. End of Q&A:

Okay. So thank you everybody for joining us today. I mean, while we are certainly disappointed by the impact of the inventory reduction of our channel partners, we and NETGEAR remain confident in our long-term growth strategy. And I'm proud that the team has made progress shifting our product mix to the high-end premium segment. Although, the uncertain macroeconomic environment and related inventory compression will continue as a headwind to achieve the full top line potential of our business in the short-term, we are seeing these premium products consistently outperform the broader market. Armed with the redone portfolio of high margin products and services, and with more on the way our confidence in NETGEAR's long-term growth trajectory is unwavering. I look forward to sharing an update on our progress at our next earnings call.

Thank you, Mr. Lo. Ladies and gentlemen, that will conclude the NETGEAR first quarter 2023 results conference call. We would like to thank you all so much for joining us, and wish you all a great remainder of your day. Good-bye.