Good morning, and thank you for joining NETGEAR's 2023 Financial Analyst Day. We're excited to share presentations with you on our progress with the business and our expectations for the future. Before we begin, we advise you that today's presentation 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 today 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. Now, onto the agenda. Patrick will start us off with an introduction and overview.
David Henry will recap our strategy for our connected home business and what we see going forward. Heidi Cormack will talk about our success with our marketing strategy and our subscription business. Vikram Mehta will then talk about our focus for our SMB business. To wrap it up, Bryan Murray will discuss our financials along with our outlook. After that, we'll hold an interactive Q&A session. With that, I'll hand it off to Patrick.
Welcome, everyone, to our 2023 Analyst Day. We're gonna use this opportunity, as usual, to review the state of the business, as well as have a preview of the future, which we think are really, really exciting, with lots of opportunities that we created over the last few years. Now, over the last four years, we have seen a lot of uncontrollable events happening. Of course, first and foremost is the tremendous disruption to both demand and supply because of COVID. And then after that, we see the geopolitical tensions and actually wars happening, first in Europe and then in the Middle East, and with some skirmishes even in Asia.
Then, of course, the inflation that came with, the opening of the central banks, bank vault, and then leading to the rapid raise of interest rate, probably one of the fastest, in history, 5% over 12 months. Which actually lead to, disruptions of the worldwide economy, with a lot of major economies outside of the United States actually going into a stagnant or even decelerated position. Certainly, we could not control the happening of any of these events. What we have learned, though, in the last 4 years, is that we could control actually our destiny by enhancing, capitalizing, and using our own core DNA, core competency, our technology, intellectual property, and our barrier of entry to a lot of new markets that we created and continue to expand and develop.
First and foremost, since four years ago when we introduced our first Orbi Wi-Fi 6 system, the Orbi 8, we're very encouraged by the fact that despite in the last 2-3 years of the market decline in retail networking, this premium, absolute, uncompromised Wi-Fi setup is welcomed by a certain premium segment of the market and has continued to grow rapidly. This is based on our 25 years of unparalleled radio frequency, antenna, and system design, which is basically an art because it's an analog technology. We parlay the same thing into the 5G world, having introduced a combination of 5G and Wi-Fi 6E mobile hotspots, which is sold at $1,000, also welcomed by the premium segment of the market and also growing very fast. And then, the other opportunity that we have pioneered and continued to expand is Pro AV over IP.
We call it Pro AV. We started four years ago by first starting with the other, you know, companies of the SDVoE Alliance to push the traditional audio video over coax cable into Ethernet cables, into encapsulation of both audio and video signals over IP. The growth of this segment has been tremendous over the last four years. It's now a very meaningful, very material part of our SMB business and is outgrowing the market significantly. The exciting opportunities we see in front of us in here is just tremendous. Last but not the least, again, four years ago, we started to feel like our customers really value continuous, value-added services that they need. For example, the cybersecurity protection, the privacy, and the ongoing support of their premium Wi-Fi setup.
On the SMB side, more and more customers are trying to get into remote management over the cloud with their handheld devices, and they're willing to pay monthly subscription to get that capability. We decided that we should start aggressively going into our install base and provide these value-added services to customers. We're surprised by the reception, that the customers are willing to pay now to $100 a year for these services. These three segments are going to propel the growth of our business going forward, and will become the major part of our business in the future. One common theme among all three of them are the highly intellectual property content, significant software content, and thus, with high margin, a high, and high barrier to entry.
Today, we're very excited to have our team to discuss each and every one of these topics, and I believe that after you listening to them, you agree with me; these are really exciting, high growth, high margin, high barrier to entry businesses that we're going to harness in the next few years. So without further ado, I would like to introduce David Henry, our President and General Manager of the Connected Home Product business unit, to talk about the first exciting opportunity. David?
Thank you, Patrick. Good morning. Today, I'm pleased to share with you our plan to grow the connected home business profitably going forward, led by our premium product strategy that we outlined at last year's Analyst Day. In addition, we expect the Wi-Fi 7 upgrade cycle starting next year and our differentiated offerings in the high barrier to entry segments, such as cable modem routers, high-performance multi-band Nighthawk Wi-Fi 7 routers, and non-premium retail mobile hotspots, will also drive profitable revenue growth. Surely, we will continue to grow our high-margin services business, led by our Armor all-in-one internet security solution, our Smart Parental Controls, and our premium support services. All three above areas are high margin, technology differentiated, and software-rich product categories with IP unique to or patented by us. Let me start with sharing our progress in executing our premium product strategy.
I'm pleased to share that in Q3, in U.S. retail end market sales, we grew our premium Mesh products, those over $650, 13% year-over-year, driven by increasing unit sales 6% and ASP increase of 7%. With the intro of the Wi-Fi 7 Orbi 970 at the end of Q3, we are confident that the ASP and unit sales increase will continue in Q4 and beyond. Again, I would like to point out that this was achieved while the overall retail networking market was down double digits year-over-year. These results further validate our conviction on the market potential of serving the premium customers with uncompromised Wi-Fi, with our leading-edge hardware and software technologies, protected by patents and rich analog expertise.
In addition, our premium unlocked mobile hotspot business grew over 30% year-on-year in Q3, as we transitioned our original 5G M5 mobile hotspot to our latest M6 and M6 Pro mobile hotspots with faster 5G speeds, Wi-Fi 6E, and better worldwide operator compatibility. The year-on-year growth of our premium Mesh and premium mobile hotspots improved each quarter this year, driven by new product launches and increased effectiveness of our full funnel marketing strategy, targeting customers who want the absolute best in Wi-Fi experience anywhere in their homes and while they're on the go. We are alone in driving the sweet spot of the market. The premium segment, with ASPs above $650, continues to outpace the market. And with our focus on product excellence and marketing, we will continue to grow this market segment and our revenue in this high gross margin product line.
So who are these customers buying these premium Mesh products? Well, we certainly have our early adopters, who will always be first to upgrade to the latest technology. Indeed, 70% of our initial customers of the Wi-Fi 7 Orbi 970 are NETGEAR loyalists, those who grow to love the Orbi and Nighthawk products through years of experience and want to have the absolute best. But the growth is also coming from those high-income households with lots of the latest connected devices, including smart home products, consumers who are constantly gaming, streaming, and working from home, especially in large homes that are difficult to cover with ISP-provided Wi-Fi networks. These customers are often financially strong and will spend on perfecting their lifestyles.
These high-income, no-compromise customers are not technical by nature, but they have become so dependent on their connected devices and applications that spending and upgrading to the best Wi-Fi available is a no-brainer. This is not a one-time event. In the coming years, they will become more and more dependent on Wi-Fi connectivity in terms of speed, capacity, coverage, and security, as pretty much every device they buy will have its value enhanced by Wi-Fi connectivity: their cars, appliances, heating and cooling systems, exercise equipment, pool control systems, visual art, everything is connected. The internet service providers are continuing to raise the bar on providing faster and faster broadband to address these customers' use cases: competitive gaming, 4K streaming, work from home, and smart home.
Average internet download speeds are increasing around the world by almost 30% year-over-year, with the average speed in the U.S. approaching 200 Mbps, with more and more areas with gigabit speed availability. Customers with large homes are driving the need for premium Wi-Fi.... Even if they only have 200 Mbps internet speed, they would like to have that speed everywhere in their house, basements, and lofts, and outside, front yards and backyards, and surely extended to their guest homes and pool houses. When their ISP upgrades their speed to gigabit, all the more, they want their Wi-Fi to be upgraded as well to all corners of their properties. ISPs worldwide just cannot keep up with their Wi-Fi offerings, which are much more geared towards their mass subscribers. We are seeing these premium customers turn to alternatives, namely retail and installers.
With no Ethernet wiring needed and superior outdoor coverage, we have the ability to attract all these customers to come to the Orbi world, either direct or with installers. As Xfinity announced their 10-gigabit service, called xFi, and just this fall, Google announced they will be deploying 20-gig fiber internet service, we are seeing stronger pull of these premium customers into our technology and offerings, away from their internet provider's Wi-Fi. Another advantage of our Orbi over the ISP and competitive offerings is our Armor all-in-one internet security service, which can be easily managed by the customer with our Orbi mobile app. Yet another reason we are able to attract these premium customers. Indeed, the attach rate of value-added services among our Orbi 9 customers is over 40%, and we expect that to grow as we add more features and sharpen our marketing.
Our premium product strategy is based on extending our performance and technology lead over our competitors, the ISP-provided Wi-Fi equipment, and professionally installed Wi-Fi. In 2016, we launched the first Tri-Band Wi-Fi 5 Mesh System, Orbi, which quickly became the performance standard with our patented dedicated Wi-Fi backhaul radio. But it wasn't until 2019 when we released our $1,000 Tri-Band Wi-Fi 6 Orbi 850 series, that we truly created the premium Mesh market segment. We were pleasantly surprised at how many of our customers moved up to the Orbi 850 when we had much lower-priced Wi-Fi 6 alternatives on the market at the same time.
We followed this up in 2021 with the first Wi-Fi 6E Mesh product, the Orbi 960, using our exclusive Quad-Band Technology and the first to use the wide open 6 GHz Wi-Fi spectrum. The Orbi 960 has been the primary growth driver of the premium Mesh market over the past 2 years. This fall, our Wi-Fi 7 Quad-Band Mesh, Orbi 970, again broke the speed barrier with 27 Gbps of combined Wi-Fi speeds, unleashing the value of these new, blazing-fast internet service plans. The strong market reception to our Orbi 970 really kicked off the Wi-Fi 7 upgrade cycle, which will last for the next 4 years. This upgrade bodes well for ASP increase across the industry.
We expect to launch p enta-band Orbi 10 late in 2024 to accelerate the performance upgrade and further ASP increase. From Tri to Quad to Penta-Band, we are erecting higher and higher barriers to entry for this premium Wi-Fi segment. As we mentioned last year, we are alone driving this premium market, but our competition is taking note, with many of them trying to enter our market. However, our hardware and software is so far ahead that we are preventing them from making inroads. Our patented multiband technology, which maximizes the use of the frequency available for Wi-Fi. Our antenna and RF design, based on over 20 years of experience, delivers the best 360-degree Wi-Fi coverage, ideal for large homes and outdoor coverage.
Our strong relationships with key technology partners, including silicon providers and RF component suppliers, with whom we co-develop solutions, keeps us ahead of the competition. Our patented dedicated backhaul and newly introduced enhanced dedicated backhaul delivers maximum performance when large numbers of devices are on the network, competing for precious bandwidth at the same time. Our Mesh software that optimizes network topology and the roaming of devices between the various Orbi nodes and wireless bands. Our focus on security and customer privacy. We are a U.S.-based company focused on delivering best-in-class Wi-Fi to privacy and security-concerned customers, not selling ads to them. Because of this, we have over 75% market share in premium Mesh sold through traditional retail and e-com channel, including our NETGEAR.com web store. Our unlocked 5G mobile hotspots sold through retail are also key for driving profitable growth.
Around the world, our Nighthawk M6 and M6 Pro have been adopted by business travelers who need reliable and secure coverage to stay productive in limos, hotels, coffee shops, and airports when on the road. And vacationers, who know that even when they are on personal travel, they need to stay current on email, join the occasional Zoom video call, or stream a movie with their families. They never really know how good the Wi-Fi connection will be in the hotel, Airbnb, or convention center until they get there. So the best way to ensure reliable connectivity is to bring it themselves. Needless to say, in an RV or campsite, our mobile hotspot is the only alternative. No need to commit to a three-year contract. Just buy a SIM for the trip.... And more and more of these customers are learning that public Wi-Fi is inherently insecure.
They wouldn't trust public Wi-Fi to send a confidential file, execute a stock trade, pay their online bills, or do a bank transfer. Our Nighthawk mobile hotspots uniquely address the need for mobility, security, and reliability. In addition, they are unlocked and can be used in over 125 countries around the world, giving our customers ultimate flexibility to find the operator and data plan that is right for them without having to commit to a contract. While travelers love our mobile hotspots, we are also seeing them used as a primary or failover internet connection for the home. Rural dwellers, whose wired internet service options are either slow or nonexistent, for them, 5G is the only way to get broadband to their homes.
They use our M6 and M6 Pro as their primary home internet connection, and for those with larger homes, they extend the Wi-Fi coverage with our in-home performance boost mode and optional high-gain 5G antennas. The failover use case is ideal for those whose wireline internet connections are unpredictable. When the cable goes down, they can automatically failover to our 5G hotspot connection. This is especially popular with those who have gone permanently to work from home and need the connection to be just as good and reliable as the office. Similar to our premium Mesh, we are all alone in this market. In the United States, we are the only one selling unlocked mobile hotspots at all, as the cost and expertise required to certify hotspots with all of the mobile operators provides a large barrier to entry.
In Europe, where the concept of unlocked mobile products is more common, we pretty much own the market above 300 EUR, while Chinese brands fight over the low margin, low performance, low-end business. We have a unique combination of expertise in Wi-Fi, 5G millimeter wave, battery power control, and operator compatibility, both hardware and software, that makes our products unparalleled in the market. And just like in the Mesh space, we have a rich roadmap with plenty of room for innovation, with carrier aggregation, Wi-Fi 7, and software enhancements, like adding our Armor protection to the mobile Wi-Fi network. Between the third quarter of 2022 and 2023, end customer sales of our premium products, which includes our premium Mesh, mobile hotspots, and Meural canvases, increased from 13% of our overall retail sales to over 21%.
This mix shift has and will continue to drive improvements in the gross margin of the CHP business. These products are differentiated with very little competition and are driven by our product excellence and marketing, not by the ebbs and flows of the overall networking market. In addition, these premium products all cater to the same premium customer, who have multiple large homes, so we can sell them multiple Orbi systems and hotspots. We estimate that there are 1.3 million premium households among the total 135 million households in the United States, and probably an equal number around the world.
With a 2.5 million household addressable worldwide market and our high ASPs, like the $2,300 Orbi 970, the $1,000 M6 Pro hotspot, the $800 Meural for digital art, plus the $100 per year subscription revenue, you can see the huge potential of penetrating this market. We expect continued growth in this portion of our business as we roll Wi-Fi 7 worldwide across all of the premium price bands and extend our unlocked mobile hotspots to even more countries and operator coverage. We are approaching the four-year anniversary of the pandemic. We are finally starting to see stabilization in the market after three years of market declines, following the first year of pandemic demand.
Indeed, four years is the average upgrade cycle for home networking, so we expect those customers who upgraded in 2020 will start to come back to the market in the coming years for Wi-Fi 7. While the premium and tech enthusiast will gravitate to our premium Wi-Fi, the rest of the market will be looking for high performance, easy installation, rich features, privacy, and security at a price point that fits their budget. This is where we see an opportunity to grow our profit with our differentiated Wi-Fi 6E and Wi-Fi 7 Nighthawk routers, DOCSIS 3.1 cable gateways, and mid-range Nighthawk mobile hotspots. Barriers to entry are high for our competitors because they either require significant analog antenna expertise or operator certifications or both.
As a matter of fact, neither Google nor Amazon Eero chooses to be in any of these three markets, and none of the Asian vendors are in the cable or mobile router markets in the United States. For almost a decade, the Nighthawk brand has been synonymous with high-performance, highly featured Wi-Fi routers targeted at those customers with homes that may not be large enough to need our Orbi Mesh products, but still have a large numbers of network devices, run demanding, bandwidth-hungry applications such as gaming, and subscribe to the fastest speeds from their ISPs. They choose Nighthawk because of our quality, ease of use, and performance, which stems from over 20 years of multi-band Wi-Fi antenna design expertise, similar to the technology we use in our Orbi systems.
Of course, they choose NETGEAR because they trust us to keep their private information private and the peace of mind that comes from our Armor security protecting their digital lives. There is also an interesting twist with our cable gateways, which are all-in-one boxes that include a cable modem and a Wi-Fi router. Entry-level cable gateway customers choose our $199 product because they want to avoid paying $15 per month or even more to rent one from their ISP. It is very simple math to save money, and we are the only vendor offering that solution, no competition. Since these cable modem routers connect directly to operators' infrastructure, they must go through a rigorous certification process, which is technically difficult and expensive. With 20 years of working with Xfinity, Cox, and Spectrum, we are very familiar with the technical and process requirements.
At the opposite end, we have customers who just want a much better Wi-Fi experience than what the ISPs can offer, but don't want to have a separate modem and router. Our high-end cable modem router offerings meet these needs. In this space, we have only one competitor, which we beat handily with our superior Wi-Fi performance and our advanced features, like our Armor Internet Security, which protects every device on the network from threats. These high-margin, differentiated products help us scale our business and provide a large installed base for us to farm for our subscription services. In addition, today's Nighthawk router and high-end cable modem router customer may become a premium Orbi customer years down the line when their families grow, they move to larger homes, and their Wi-Fi needs change.
This demand for differentiated networking solutions is poised for growth as we exit the downward pressure from the pandemic pull-in, and we begin Wi-Fi 7 upgrade cycle. We are already seeing Wi-Fi 7 smartphones, like the Google Pixel 8, and we expect Wi-Fi 7 to become the standard for new premium phones and notebooks in 2024. So far, I've discussed our traditional retail business, but we also have a profitable business selling our differentiated products to internet service providers. We have long-standing partnerships with operators, including Telstra and AT&T, to bring our Nighthawk mobile hotspots to their customers, enterprise and government employees, mobile workforces, emergency first responders, and traveling consumers.
NETGEAR's unique expertise in hardware, software, and RF design has allowed us to create a battery-powered, compact hotspot that packs an advanced 5G millimeter wave, Wi-Fi 6E, soon Wi-Fi 7, and high-speed 2.5 gigabit Ethernet. Plus, with our Insight Pro management software, businesses can centrally configure, monitor, and manage their hotspots for thousands of employees. These products are very challenging to develop and even harder to certify on operator networks, so we consistently command a premium over low-end competition. This profitable service provider business will complement our retail business to provide scale and drive profitable growth. While the networking market, and thus the CHP business, has declined after the massive pandemic-driven demand pull-in, we are now poised for profitable growth.
We have a market segment all to ourselves with our premium Mesh and hotspots, which is now making up over 20% of our non-carrier end customer sales, one that we will continue to grow as the demand for uncompromised Wi-Fi performance continues to increase. We also have a differentiated networking product line led by our highly acclaimed Nighthawk routers, cable modem routers, and mid-range mobile hotspots, with which we are positioned to gain profitable share in a market that is showing signs of stabilization and will be fueled by the Wi-Fi 7 upgrade cycle. These two areas have one thing in common: less competition due to high technical barriers to entry, which makes them very profitable. Now, I'd like to introduce our Chief Marketing Officer, Heidi Cormack, who will outline our marketing strategy, which will drive the premium business growth, as well as our high-margin subscription services strategy.
Thank you, David. Good morning, everyone. I'm Heidi Cormack, Chief Marketing Officer at NETGEAR. I echo David's enthusiasm around the strong market opportunity we anticipate in 2024 and beyond for our premium Wi-Fi solutions. With an adoption potential of over 2.5 million premium consumers worldwide for the very best in-home and on-the-go Wi-Fi, and with the commanding share of this segment of the market, NETGEAR is poised to drive profitable revenue growth. These discerning consumers have a very distinct makeup. They own large, sophisticated, highly connected smart homes, from urban, multi-story brownstones to sprawling rural estates. They potentially have both a primary and a secondary property. They have multiple family members using the Wi-Fi simultaneously and need fast and consistent coverage across every corner of their property, from the front door to the backyard and from the basement to the rooftop.
And it is these consumers who also want 24/7 peace of mind when it comes to security, privacy, and premium support. They are consumers who are frustrated with their ISP-provided, other retail, or professionally installed Wi-Fi products from competitors that are not delivering the performance they need. They have gigabit-plus internet service, but are simply unable to get the speed, coverage, and capacity they are paying for with their current Wi-Fi setup. These insights into our target consumer have once again been validated by feedback we have received from customers who have just made the investment in our latest Orbi 970 Wi-Fi 7 Mesh System. We have heard from those that have large properties and need fast, consistent, far-reaching Wi-Fi coverage to every corner of their home....
from customers who have gigabit-plus speed internet with lots of high-bandwidth activity, including gaming, streaming, and a house full of additional connected devices. Orbi 970 owners that have upgraded to a more powerful Wi-Fi solution for both work and entertainment and value the protection that Armor provides for their digital lives. These sophisticated consumers also demand powerful, flexible, and secure Wi-Fi coverage wherever in the world they are, for work or play. They've entered our ecosystem, and we can now introduce them to other lifestyle products that enhance their connected lives, including best-in-class mobile solutions and other lifestyle-enhancing, innovative products like Meural, our digital display for streaming traditional and digital art, as well as photos. Our full funnel marketing strategy plays a fundamental part in reaching these target customers and achieving our growth goals. Our formula has proven to be effective.
To reach and engage these premium consumers, we begin our efforts at the highest level of the digital funnel. We leverage lifestyle PR and performance media across influential news, financial, social, sports, and travel destinations. We highlight the challenges that have become increasingly evident as the need for high-performance, ultra-reliable Wi-Fi increases to enhance their daily lives, whether it's the things they love to do or need to do. From the old days of cable TV to the new world of live streaming, whether movies or the latest episodes of their favorite show, or NFL football games that are exclusively viewed via live stream. From handheld gaming devices to real-time, highly immersive online gaming, AR, VR, when milliseconds matter. From few to a whole home full of smart home connected devices that provide safety and security, like connected cameras, door locks, lighting, and more.
Finally, to hybrid for both work and education. Our efforts in building a compelling, connected lifestyle narrative that resonates with these premium consumers have paid off with excellent coverage that is helping us expand our reach and meet our target audience where they are online and propel our brand forward. As new-to-NETGEAR consumers become aware of and engage more deeply in their exploratory journey, they are joined by NETGEAR loyalists. At this stage of the funnel, we deliver more in-depth content that educates and confirms the superior performance of our products, leveraging social media, influencer content, technology reviews and roundups, and search and retargeting campaigns. The immediate success of our new Orbi 970 series is proof positive that our products will continue to drive incremental revenue and margin for NETGEAR.
And finally, as consumers get even closer to making their purchase decision, we bring them to NETGEAR.com, the heartbeat of NETGEAR, through which we engage all audiences from inexperienced to early tech adopters, and deliver a premium and comprehensive brand and product experience. NETGEAR.com is the ultimate destination to learn about our products via rich content, brand stores, technology leadership stories, and personalized help from our concierge and product experts. It's also where we offer an exclusive first look and the ability to purchase new products like Wi-Fi 7 Orbi, Nighthawk, M6 Pro Unlocked, and value-added services and access to unique offers. With more and more customers choosing to purchase directly from us, NETGEAR.com has become a fundamental part of the journey of education, product selection, and conversion. NETGEAR loyalists have and will remain a critical segment of our customer makeup.
We engage directly with them on a regular basis, and they are the first to upgrade to the latest technology we bring to market at a higher ASP and attach our value-added services that generate recurring revenue. They also help quickly validate our newest products with great reviews and word of mouth to others, friends, family, coworkers, who are exploring our brand for the first time. In fact, these returning customers, along with our work over the last several years to build our reputation of our premium brand, have together helped propel the early success of the recent introduction of our Wi-Fi 7 products and provide an important proof point for our long-term growth and profitability potential. With the launch of the Orbi 970, we reconfirmed that NETGEAR is the established leader of high-performance premium Wi-Fi.
Consumers, existing and new, are willing to open their wallets for the very best solution, knowing it comes from NETGEAR, the most trusted brand in home networking for nearly three decades. Our key retail partners are just as excited as we are about Wi-Fi 7. They continue to enjoy the benefits of the awareness, education, and demand we are creating in the premium category. Where do we go from here? As we move into 2024, we will remain laser-focused on the execution of these marketing initiatives to reach premium consumers who want the very best Wi-Fi connectivity to support our premium product strategy and drive profitable growth for the connected home business. Our estimates indicate that we have only reached around 15% of these 2.5 million premium households, so our growth potential is huge.
Now I'd like to provide an update on the progress we are making in growing our high-margin services business. We continue to see increasing interest in the useful software and services we provide that add value to the investment customers are making in our products. These services specifically address consumer needs around security, privacy, and support... NETGEAR Armor, Smart Parental Controls, and ProSupport are unique to NETGEAR and critical in providing 24/7 peace of mind and digital life protection for highly connected households. The growth of our service revenue is a key pillar and meaningful contributor to the margin expansion and improved profitability of the connected home business.
As I outlined last year, our efforts have been focused in two areas. One, subscriber growth, primarily driven by new customer acquisition via premium product and direct-to-consumer sales worldwide by expanding the funnel with one year of Armor bundled into our differentiated networking solutions and via ongoing engagement with our loyal NETGEAR customer base. And two, growth in annual revenue per user, driven by high retention rates for our Armor service, with users renewing for a second and third year at a higher price point, and the mix shift to premium, with these customers renewing at a higher rate and often attaching multiple services, as well as opportunities for ASP increase by adding more value and expanded service offerings for Armor and premium support.
I'm pleased to say that we are on track to meet our expected subscription targets for the year, which will see us exit 2023 with over $40 million in annualized service revenue. For nearly three decades, NETGEAR has been the most trusted brand in home networking when it comes to high-performance, differentiated networking solutions. And now we're expanding beyond that as a trusted brand for digital life protection. With growing concerns around security, consumer privacy, and protecting our large digital footprints online, NETGEAR Armor, the essential all-in-one internet security solution, continues to lead the way when it comes to the adoption of our value-added services. Armor remains the only solution that provides unmatched security for today's connected consumers, which none of our competitors can provide.
Armor is built into the router, providing an automatic shield of security for your Wi-Fi and connected devices in the home, including the most vulnerable IoT devices, such as security cameras, smart TVs, and door locks. Unlike smartphones or laptops, customers cannot protect these devices by installing typical antivirus software. These devices are particularly vulnerable to targeting by cybercriminals, as they are often left with default usernames and passwords. Armor also shields your online experience by instantly blocking harmful websites, securing sensitive data, and using AI to detect abnormal behavior in IoT devices. The average U.S. household has 46 devices connected to the internet, but NETGEAR customers purchasing our premium Orbi Mesh solutions have many more, between 50 and 100 devices connected to their network, from the latest gaming consoles and mobile devices to a plethora of smart home products they rely on to manage their daily lives.
These customers appreciate the peace of mind and value that Armor provides. Home networks today see an average of 8 attacks against connected devices every 24 hours, and smart connected TVs are one of the most vulnerable, accounting for over half of IoT vulnerabilities. And as smart homes add more and more devices to their networks, the likelihood of attacks increases significantly. Armor helps families confidently and securely connect their devices to the internet, and our customers are certainly seeing the value. Year to date, Armor has protected over 30 million devices and blocked more than 400 million attempts to attack, exploit, inject malware, phish for personal info, and more.
Last year, we talked about the various channels and stages of the purchase journey, where customers are introduced to our value-added services: pre-purchase as they research, during the purchase process, either on NETGEAR.com or through our channel partners, and post-purchase during onboarding or after product installation. Our focused efforts in these areas are contributing to subscribers. As David highlighted, the progress we are making with the execution of our premium product strategy and driving the higher mix shift to premium products also provides benefits for our subscription business. These customers want 24/7 peace of mind when it comes to security, privacy, and premier support, and they convert and renew our value-added services at a higher rate.
As I covered earlier in the presentation, NETGEAR.com is our primary destination for premium product sales, and it's here that we present the full value of our product and service offering during the discovery and purchase journey, and customers often add multiple services to their cart and opt in for auto-renew at checkout. We expect this to continue as we execute our premium strategy, focusing on new customer acquisition and a growth of our direct-to-consumer stores worldwide. We will also broaden the appeal of our Armor service with the addition of Armor on premium mobile hotspots in 2024. As we position ourselves to gain profitable share by differentiated high-margin products at every price point in the broader retail Wi-Fi market, there is a significant opportunity for subscriber growth. Our differentiated solutions, such as Nighthawk routers, Mesh Systems, and cable products, typically include one year of Armor protection with purchase.
It's during this one-year period that we engage directly with customers to further demonstrate the value of Armor. These activities give us the opportunity to convert customers to recurring revenue subscribers. Over the last year, we've been successful in demonstrating the value of Armor by increased engagement with the product itself and effective marketing. It includes more personalized and actionable content to drive engagement and leverage sophisticated analytics to help us understand the customer behavior and leading indicators that drive conversion.... Our data confirms that conversion and retention rates increase significantly the more users engage with instant alerts sent to the Orbi or Nighthawk app and visit the Armor dashboard.
A new feature that Armor users are seeing value from is the activity report, which delivers a personalized monthly update on the protection that Armor provides, including devices, the number of threats detected or blocked, and the number of vulnerabilities identified during network scans. This new feature has delivered a 20% increase in engagement rate. Our large install base of NETGEAR loyalists is a critical segment of our customer makeup. As I mentioned earlier, these fans are not only the first to upgrade to the latest technology we bring to market at a higher ASP, but they also see the value our services provide and contribute to ongoing subscriber growth and generate recurring revenue. We are pleased with the progress we are making, converting these customers to recurring revenue subscribers, and certainly see the potential to expand the penetration of this segment over the coming years.
While we continue to make progress and execute on the initiatives I've just outlined to grow our subscriber base, we are also focused on expanding the annual revenue per user to contribute to the growth of our services revenue. There are three key areas that is driving the ARPU growth. One, high retention rates from our Armor users. While we typically test different offers and price points to attract new subscribers during the first year, we demonstrate the value of Armor, and as these customers renew for their second and third year, they renew at a higher price point and ARPU increases. Two, premium product strategy. Customers purchasing our premium products attach and renew our value-added services at a higher rate. Thus, our mix shift to premium drives higher ARPU.
As I mentioned, our premium customers have large homes filled with lots of connected devices with heavy internet usage, so $99 a year or less than $10 a month for all-in-one internet protection is a no-brainer. Finally, adding more value and opportunities for ASP increase. Customers are willing to step up when we provide additional value, demonstrated by the recent increase for the Armor yearly subscription from $69 to $99, which contributed to the year-over-year improvement in Armor ARPU. In a world of always-on internet connectivity, as the complexity and the demands of the home network increase, we will continue to enhance our services and add compelling features, including privacy capabilities, digital life protection, and premium support for 24/7 peace of mind. We are excited about the growth of our services business and the revenue and margin expansion opportunities it provides.
As we continue to make progress with our targeted marketing efforts to drive new customer acquisition, we will accelerate the growth of high-margin premium products for the connected home business. The more we engage directly with our customers and successfully demonstrate the value of our subscription services, we will become more effective in converting and retaining them to long-term recurring subscribers, which will bring us closer to our longer-term goal of $100 million in services revenue. Now, I would like to introduce Vikram Mehta to provide an update on our SMB and fast-growing Pro AV business.
Hello, everyone. It's good to be back with you for our 2023 Analyst Day. My name is Vikram Mehta, and I lead NETGEAR's commercial and SMB business. While our traditional IT business saw a temporary decline in the first three quarters of 2023 on account of economic factors, including declining GDPs, weaker currencies, and high interest rates in some of our major markets, we've continued to see strong growth in our AV-over-IP network equipment business. Through the first three quarters of 2023, this business grew over 30% year-over-year, and this growth is the result of four things we've done very well over the past several years. First, a comprehensive and differentiated solution offering that comprises hardware and software that make it incredibly simple and commercially attractive for businesses to move from proprietary matrix switch-based AV networks to standards-based IP networks.
Second, we've invested in integrating our products with those from over 200 AV equipment manufacturers through our unique Engage Controller platform, our AV GUI, APIs, and configuration profiles for popular AV protocols such as NDI, IPMX, Dante, AES, and Audio Video Bridging, thus making it faster and easier to deploy and manage AV networks, all while eliminating costs and complexity. Third, we've built go-to-market partnerships with many of the world's leading AV integrators, both in the commercial and residential AV markets. Fourth, we provide very unique AV network design services through a team of highly skilled AV network design engineers. These design services make us a natural choice for AV integrators as they tackle complex AV projects around the world.
While we cannot predict when and how fast the global economic environment will return back to growth, as a result of the investments we've made over the last several years, we've positioned ourselves very well to capitalize on an ever-accelerating shift of AV networks from proprietary implementations to standards-based IP networks. This time last year, when I spoke to you, I briefly commented on a new AV segment that we were making investments in, digital content production and broadcast. As content providers rush towards producing more rich media content and broadcasters look for ways to deliver a more immersive experience to viewers around the globe, traditional Serial Digital Interface-based networks present serious cost, complexity, and network management challenges. The answer to the problems that content producers and broadcasters face is an IP-based networking standard called SMPTE ST 2110, pioneered by engineers that work in the motion picture industry.
SMPTE 2110 is both a LAN and WAN protocol that relies on Precision Time Protocol to time sync all the devices used to produce and live broadcast content into a cohesive network. I am very pleased to share with you that we are a few weeks away from launching a set of products that we believe will dramatically alter the economics of delivering audio and video signals over IP networks for the content production and broadcast industry. For events like the recently concluded ICC Men's Cricket World Cup, which broke all past viewership records, registering 59 million viewers for the final match alone. Or be it live music concerts, like the popular Taylor Swift Eras Tour that grossed approximately $800 million and saw Miss Swift play at 56 stadium locations across 20 U.S. cities and Mexico City.
To long-standing events like the Wimbledon Tennis Championships, where immersive experiences include action replays and digital umpiring. Our new lineup of M4350 switches, combined with our Engage Controller Platform, AV GUI, APIs, and configuration profiles for SMPTE ST 2110, will allow content producers and broadcasters to create and live broadcast rich media content, including video, audio, banners, advertising, subtitles, action replays, and much more in an uncompressed manner over an IP Ethernet network and at unprecedented scale. Our solution for the content production and broadcast industry will enable separate, location-agnostic production workflows for video, audio, and data components of traditional television services, using an all-IP approach versus the cost prohibitive and complex SDI technology.
Now, what is truly unique about what we at NETGEAR have done with our offering is to combine the SMPTE ST 2110 standard with our Engage profile-based software engine and AV GUI, thus enabling content producers and broadcasters to rapidly set up, tear down, and reconfigure production and broadcast networks at a fraction of traditional costs, all while eliminating the risk of human configuration errors. This, ladies and gentlemen, is truly a game changer and highly differentiated from what other IP network switch vendors are doing in the SMPTE ST 2110 space. We believe that this differentiated offering will allow us to further expand our business in this area and accelerate our growth beyond the 30% we've seen through the first three quarters of 2023.
As more and more AV networks turn to IP as the underlying technology, we're also seeing such networks incorporate not just wired, but wireless endpoints as well. For example, speakers and microphones. An all-IP network, both wired and wireless, offers significant advantages over proprietary protocols of the past. We're also expanding our Engage profiles-based software engine to make it easier for integrators in the AV industry to configure and manage not just our managed Ethernet switches, but our wireless LAN access points, routers, and PoE smart switches, regardless of whether it's a commercial AV network, a residential AV network, or a content production and broadcast AV network. Finally, we're investing in sales, business development, and pre- and post-sales resources around the world to pursue relationships with additional AV equipment manufacturers and AV integrators that service all three segments of the AV market: content production and broadcast, commercial, and residential AV.
The commercial and SMB business in NETGEAR is a very profitable business, and AV over IP represents a high-growth market opportunity for us, despite the economic headwinds. We have a sound and highly differentiated product offering and a robust roadmap of both hardware and software products that will allow us to grow our revenues in this new segment. I'm personally very excited about the future of our business to generate top-line growth while expanding our profits. Thank you for your time, and I wish you and your loved ones a safe and restful holiday season and the very best for 2024. Now I'd like to turn it over to our Chief Financial Officer, Bryan Murray.
Hello, I'm Bryan Murray, Chief Financial Officer of NETGEAR. I'd like to begin with a review of our anticipated 2023 performance relative to the expectations that we shared at this time a year ago during our 2022 Analyst Day. From a top-line standpoint, our SMB business entered 2023 with a lot of momentum in a market that was supply constrained throughout the year in 2022.... We had expected this business to grow 10% for the year, but we quickly saw conditions change in the first quarter, where supply for most products was vastly improved for both us and our competitors. We also began to see some of the macroeconomic factors, such as elevated interest rates, begin to weigh on the market.
This had a cascading impact on our channel partners' willingness to hold inventory, with a higher cost of capital and more comfort that when they needed supply, it would be readily available. The result was partners began driving reductions in inventory levels with new targets below historical levels, which is approximately a $40 million headwind for this business in 2023. We also saw the macro environment start to weigh on demand for our products aimed at medium-sized businesses, especially in markets that were experiencing 0 or even negative GDP growth. Despite these challenges, we continue to see meaningful growth of over 30% year to date in end user sales of our Pro AV switching line of products, which continue to gain momentum as AV applications continue to upgrade to Ethernet-based platforms.
As for CHP, we continue to face a challenging market conditions, where we saw the U.S. consumer market settle in about 15% below 2019 levels. This came with the added impact of many of our channel partners continuing to rightsize their inventory positions, further constraining the revenue within the CHP business in the first half of the year. Despite macro environment headwinds weighing on consumers, we began to see stabilization in the market and a return to normal seasonal patterns in the third quarter. Embedded in this were a number of bright spots that align with our strategic focus for this business within the premium portions of the market, where we saw growth despite the broader market declining double digits. Additionally, we are on track to meet our expected subscriber target for the year.
However, all of this points to revenues to be down roughly 21% year-on-year, as compared to our expectations of them being up low- to mid-single digits a year ago. Looking at our non-GAAP operating margin performance and referencing current consensus of -1.8%, we will fall short of our expectations entering the year of 3%-4% in non-GAAP operating margin. Our primary challenge faced was the reduced top-line leverage for both of our product segments that I just mentioned. While we took action to reduce costs in areas of the business that we don't believe will contribute to our growth in top and bottom line in the future, that wasn't enough to offset the lost top-line leverage that we were expecting, costing us approximately 740 basis points as compared to our projections a year ago.
This was somewhat mitigated by improved gross margin performance, despite a lower-than-expected mix being contributed by our higher margin SMB business. On the CHP side, continued growth in our premium products delivered improved mix of higher margin products. Additionally, we were able to realize better than expected transportation costs. The cost of transportation by sea has more or less returned to pre-pandemic rates. While we were able to reduce our reliance on air freight more than we had expected, primarily in our SMB business, combined, these efforts were able to offset the leverage challenges by approximately 200 basis points. As we look toward 2024, we see two areas of focus that we believe will return us to profitability on a full year basis. The first is further expansion of our gross margin.
On the CHP side, we expect further benefits from shifting our product mix further towards the premium products, as well as growth in our services revenue. We also believe with the progress we expect to make in 2023 and further efforts in the early stages of 2024 in reducing our inventory levels, we believe we will return to inventory costs more in line with historical experience. Combined, we believe this drives gross margin expansion of around 270 basis points. Additionally, through our continued tight expense management and projected growth of our top line, in part due to lower required efforts to work with our channel partners on the CHP side of the business, we believe we will gain approximately another 270 basis points in 2024 from improved top-line leverage.
As you heard from David, Heidi, and Vikram, we remain focused on our four very promising market opportunities that we believe will drive our top line and pave the way to further improvement in our profitability. The first such opportunity is Pro AV, and as you heard from Vikram, there continues to be strong momentum in this space, already reaching an annualized level of approximately $120 million in the third quarter of 2023. We still believe there is a long way to go here as we continue to make inroads with new partnerships and open doors to new segments of the market, such as the broadcast market, with our recent introduction of the M4350 line of switches, and remain confident we can grow our SMB revenue by another $80 million to $100 million in the next three years.
On the CHP side, we are intently focused on our premium product portfolio today, driven by our Orbi 8 and 9 Wi-Fi Mesh products, as well as our 5G mobile hotspots, which command end user prices of $650 and above. Today, these products represent over 20% of our CHP retail business hardware sales to end users, and we expect this percentage to continue to increase and with the benefit of further ASP expansion. Our premium Mesh, which today starts at $650 for a two-pack, continues to outperform the broader market. In our recent third quarter, we saw double-digit year-on-year growth, with contributions from our first Wi-Fi 7 Mesh System, the Orbi 970.
While the broader retail Wi-Fi market has been down double digits throughout the year, we believe we have a huge lead in radio frequency, analog, antenna, and system design over our competitors and intend to use this to capitalize on furthering the transition to Wi-Fi 7. This will erect a higher barrier to entry with ever more sophisticated antenna design and Mesh software architecture. We have and will continue to protect our IP with the filing of patents in these areas. As for our 5G mobile hotspots, we continue to experience strong momentum, especially in the retail channel and our own direct-to-consumer stores, where we saw over 30% year-over-year growth in the recent third quarter. And for the subscription services, we see continuous incremental revenue opportunity in the next 3 years as our customers grow more conscious about security and privacy.
These four growth areas will be the driving forces of our top-line growth in 2024 and beyond. We do see a couple of factors driving seasonality of our top line in 2024, starting with our CHP business and our expectations of a return to normal seasonal patterns, which we began to see with signs of stabilization in the consumer networking market in the recent third quarter. Additionally, while we expect our sales to service providers to be in line with 2023 levels, around $100 million for the year, we would expect a little more linearity to the service provider top line in 2024 as compared to 2023, as a result of our partners having stabilized their inventory carrying levels. Lastly, we do expect our SMB channel partners to continue their efforts to reduce their inventory carrying positions.
Accordingly, we expect the first and second quarter revenues to be down mid-single digits compared to Q4 2023, and then see a mid-teen % increase in the second half relative to the first half of the year. We continue to be excited about the margin opportunity provided by our services business. As you heard Heidi share some of the exciting efforts that we are planning for in 2024 and beyond, we expect services to be a meaningful contributor to our top line, but even more so on our overall operating margin performance. With our ever more effective marketing of our service offerings and continued growth in the premium portions of the market, we believe we will expand our services revenue and believe we will exit 2024 at an annualized pace of approximately $50 million.
With over 50% gross margin, this is certainly a key contributor to our expectations of margins expanding. As we continue our efforts to increase our subscriber base, we are increasingly focusing on the revenue opportunity as we contemplate other levers to grow the service business top line, beyond just increasing the subscribers, but also expanding ARPU. This portion of the CHP business will continue to be our strategic focus, given the value creation opportunity it can provide. We made meaningful progress in the third quarter in reducing our inventory balance, which turned us back to cash flow positive.
As we project to return to profitability, coupled with plans to further reduce our inventory carrying position early in the year, we would expect to increase our free cash flow in 2024 by around 300%-400% as compared to the 2023 period, which will put our target in the $80 million-$90 million range. As we look at uses of our cash, there are really three main areas of focus. First, would be operational uses and investments in R&D, with a more focused investment in those areas we continue to believe will power our growth. Namely, premium Orbi Wi-Fi Mesh Systems, 5G mobile hotspots, Pro AV managed switches, and subscription services. Secondly, M&A, as we continue to look for strategic assets that can further our growth in any of these four growth areas.
Lastly, you can see we have been meaningful repurchases of our common stock with $123 million spent in less than four years, or over 90% of the free cash flow generated over this time. Under our current authorization, we have 2.5 million shares remaining under our program. I wanted to revisit and summarize some of the opportunities and headwinds that we see heading into this next year before providing our 2024 outlook. In the near term, we are faced with a more challenging macroeconomic environment, with inflationary pressures weighing on consumer spending, especially on those products not in the premium category. In addition to segments of the SMB market, as borrowing rates recently have exceeded 9%.
While we made meaningful progress with channel partners on the CHP side to reach their current desired inventory levels, there is still work to be done with our SMB partners, most meaningfully in the first half of 2024. That said, we are very encouraged by some of the tailwinds that will support our growth and profitability in 2024 and beyond. To start, we continue to see the premium portion of the CHP market growing, especially as the transition to higher ASP Wi-Fi 7 offerings come to market and begin the next upgrade cycle. This segment carries higher product margins with much less competition and have a higher propensity to subscribe to our service offerings.
Additionally, we expect our higher margin SMB business to return to growth as the impact from channel partners reducing inventory positions begins to wane, and the momentum in the ProAV space continues to pace this business. We expect to return to more normal inventory costs as we have made significant progress in bringing our own inventory position into balance. While we take this opportunity to provide overall full year outlook for 2024, we do so with the caveat that we are still dealing with a challenging environment with a number of risks and uncertainties. I would urge you to look through our most recent filing with the SEC, which details these risks. From a top-line standpoint, we expect 2024 revenue to be up low- to mid-single digits as compared to 2023. From 2025 on, we expect we will be able to maintain mid-single-digit top-line growth....
We expect with continued growth in the premium CHP products and further expansion of subscription service revenue, growth in SMB continuing to be led by ProAV, and having worked through our higher cost inventory in the first part of the year, we will achieve improved gross margins. We also expect to continue to reduce expenses in areas of the business that are declining, while ensuring we have the resources to drive the areas of growth. Accordingly, we expect our Non-GAAP operating margin to be more challenged in the first half of 2024 as we work through higher cost inventory and be in the range of -5% to -2%, with the first quarter being on the lower end of that range as we hit peak impact of higher cost inventory.
Then, as we transition to more normal inventory costs in the second half and enjoy the seasonal lift in our CHP retail business, we would expect to be in the range of 7%-10%. Also, we believe our non-GAAP tax rate to be approximately 24% in 2024. We expect to increase free cash flow by 300%-400% as compared to the prior year. And last but not least, we expect to exit the year at an annualized pace of $50 million in service revenue in the fourth quarter of 2024. Looking at the longer-term model, the continuous growth of the four areas, namely premium Mesh Wi-Fi, 5G mobile hotspots, ProAV, and subscription service revenue combined, should enable us to aim for mid-single-digit overall compound annual growth.
We believe when combined with our focus on differentiated products in the cable gateway, routers on the latest Wi-Fi standard, and mid-range mobile hotspots, which all have high technical bars, we can drive to gross margins towards 40% or even higher, especially as we move towards our longer-term target of $100 million in service revenue. This propels us to our target non-GAAP double-digit operating margin. The more progress we can make in these four growth areas, the faster we get there. With that, I'll turn it back over to Patrick.
Thank you, team members. Everyone, I believe that after hearing the discussions on all the exciting growth opportunities that are leveraging our core competency, our intellectual property, and our patents, you're just as excited as I am in the growth in both top and bottom lines in the years to come. Now, given we still have some headwinds in the next few quarters because of some high-cost inventory we have to get through, but once we get over that, we believe that the coupling with the top-line growth, the bottom line growth is even more exciting.
The areas that we're going into, which are more proprietary to our own technology, as well as a higher barrier to entry, that present a bright future for NETGEAR's business, which is pivoting from the traditional lower and higher commodity pricing type of products into highly proprietary, high-margin products. Pivoted, you know, into the proprietary technologies such as we discussed in ProAV, the Engage software platform, as well as the multi-band, especially the Pentaband antenna design, and of course, the cloud-based subscription services are value-added we provide to our customers. With that, I just would like to open up the floor and our team members to questions that we could answer. Please go ahead.
Thank you. If you would like to ask a question, please press star one on your telephone keypad now. You'll be placed into the queue in the order received. If you're going to ask a question and are connected to the webcast video, please mute the webcast to ensure a good audio connection. Please be prepared to ask your question when prompted. Once again, if you have a question, please press star one now. Our first question today will come from Adam Tindall with Raymond James.
Okay, thank you, and good morning or afternoon. Bryan, I wanted to start with the guidance, if I could, just to make sure I understand the mid-teens increase in the back half of the year. What are the key drivers behind that? And I guess more specifically, you talked about seasonality in the service provider business. I think we typically think of that as around $35 million or so a quarter. Is that gonna be different next year? And if you could expand on that, that'd be helpful. Thanks.
Sure. Thanks for the question, Adam. In terms of the back half of the year, the things that will drive that mid-teen increase off the first half, I would say would be the normal seasonality we expect from CHP, where we historically have seen that business go up the low to mid-teen percentage in Q3 off the back of Q2, largely driven by the back-to-school phenomenon in the U.S. I would also say that the destocking that we've been seeing in the SMB business can expect to continue. We think we'll start to mute in the second half of next year, but it'll be more significant in the first half.
The service provider business, as I mentioned in the presentation there, we do expect it to be about $100 million in revenue, which is fairly similar to what the expectation is for 2023. And I would say it's probably gonna be more linear. It's likely gonna be more in that $25 million-$30 million a quarter range, for next year. So those would be the factors driving that lift in the second half of the year.
Okay, that's helpful. And maybe-
Yeah, just wanted to add a little bit onto that. I mean, and David, you might want to chime in. We believe also in the second half, there's some tailwind from a Wi-Fi 7 upgrade cycle, right? Because by then, quite a few of the premium phones and laptops will be introduced with embedded Wi-Fi 7 technology. And plus, you know, I'll push on more products that way. Don't you agree?
Yeah, I mean, on a product side, we'll be rolling over more of our premium products to Wi-Fi 7 next year as we go out throughout the year. And that'll certainly help, as Patrick mentioned, today, there's a-
... probably one big phone out there, the Google Pixel, was the main, the main Wi-Fi 7 phone, but we see all the premium phones next year moving over, and then towards the end of the year, your high-end notebooks will start to move over to Wi-Fi 7. So that should definitely help the, the ASP growth in the second half.
But even on the SMB side, right, Vikram, one of the growth pillar of our traditional SMB IT business is wireless LAN, and you're preparing to roll them over to Wi-Fi 7, right?
Yes, and I think we're gonna have some exciting products coming out in the first half of 2024. That's gonna propel some growth, not only with our wireless access points, but also the switching products and the routers that go along with that entire solution.
Yeah, because once they upgrade to Wi-Fi 7 speed, they've got to upgrade the switch, right?
The router speed, too.
Yeah, that's pretty much given us the confidence for the second half of next year.
Okay, very, very helpful. I guess maybe a similar question from a margin standpoint. I'm sure there's some overlap with volume expectation, but there's some specific drivers like peak inventory costs that you mentioned, Bryan. So if you could maybe break apart some of the key buckets driving the margin improvement as the year goes on, and any quantification would be helpful.
Yeah. So certainly the gross margin expansion, we talked about Q1 being probably the peak impact of the higher cost inventory, as we're working very hard to compress our own carrying levels. So that's going to hit us hardest in Q1, start to decline from there, and we expect to get back to normalized costing in the second half of the year. So that has a meaningful impact on margins. And then, as you just heard from Patrick and David, with regards to expectations of the premium and rollout on more Wi-Fi 7 products, that should increase the overall margins as well, including expanding our service revenue base. And then as we talked about with the revenue lift in the second half of the year, that does have a pretty meaningful impact on overall top-line leverage.
So those would be the factors that create that wider gap from the first half to the second half in terms of operating margin.
Okay, maybe one last quick one from a strategic standpoint. Would love maybe if David and Vikram could talk about this, and Patrick, certainly feel free to chime in. But the strategy in CHP is to pivot towards this premium customer, and you've been doing that. Vikram talked about the Pro AV integrators, and just knowing that market a little bit, I'm sure there's probably some overlap because those premium customers typically will use an integrator for a larger install. Just wondering if, you know, as you think about the potential go-to-market strategy and synergies between CHP and SMB and the Pro AV portion, is there an opportunity maybe to, you know, expand the go-to-market instead of through traditional retail from the premium CHP strategy, go through more of an integrator strategy?
Would you like to take that one?
Sure. Well, we're definitely gonna attack this market from both ends.
Yes.
I mean, there's definitely consumers out there who, as you mentioned, will spend $10,000, $20,000, even more, to upgrade their home networks, by hiring an installer, and stringing access points. But there's also many who still want to have something they can manage themselves and own themselves, install themselves. Those customers will probably be moving over towards the self-installable consumer products. Those who want to outsource will probably go to the installers, but, you know, we're going to make sure these installers are fully aware of all NETGEAR's offerings, our Orbi Mesh products, as well as our access points and Insight Managed.
Yeah, let me give you a fine example here, right? We sell a lot of AV products through Best Buy as an example, right? And through their, what is now called their Best Buy Premium, previously used to be called their Magnolia brand. And we are seeing a lot of projects, a lot of projects in sort of the sub $100,000 category of an AV install going into these projects, where customers want to spend good amount of money, but would like to be able to manage the install themselves, right? That's a very collaborative effort between David's business and the SMB commercial business on the site.
On the other hand, we have a lot of people that are spending upwards of $100,000 that would not only want the installer to come and do the job, but would also want to outsource the management, the ongoing management of that network, to a managed service provider. And, and that's where the relationships that we are building on the commercial side of the business with some of these, these integrators and MSPs comes into value. So this is, this is one of the reasons, and I'll turn it over to Patrick, because I think this is what speaks to the strength of NETGEAR in having a unified sales organization that has the ability to be able to provide the bridge between the two product groups. Patrick?
Yes, certainly. Yeah, another good example, we have been over the last 2-3 years, since the introduction of our high-end mobile hotspots from M5 onwards, now M6, M6 Pro, quite a few of them were sold through the commercial channels.
Right.
through our value-added resellers to major consulting firms, government organizations, that they require hundreds, if not thousands, of these for their employees. And then, but they want to be centrally-
Yes
... managing that.
Right.
And then not only our SMB business unit provider relationship with the commercial value-added resellers, we actually put our centralized management Insight platform onto these products, and so that we could sell CHP products through the commercial channel, using commercial management software. We're also seeing that kind of a requirement from the AV, the home AV, as well as some of the builders that we're seeing them. They would like to use the consumer Mesh, but they would like to use our Insight management platform to manage it. We've seen tons of these projects, and we're also seeing, you know, our existing partners, right? In the home AV view, occasionally, instead of access points, for all kinds of reasons, they cannot wire, they cannot drill holes, they want outdoor space coverage.
They use, you know, our, our Mesh, our products from the CHP business well. So they're, they're closely working with each other, while the smaller projects will use the Best Buy, Magnolia Hi-Fi. For some of the other centrally managed projects, we use the commercial channels. We'll continue to leverage that. I think, I think Heidi mentioned it, pretty, pretty well, that we know there are about 2.5 premium households in the world, and I could guarantee you, 100% of them have Wi-Fi at home. 100% of them have internet at home. All right? But we, we certainly know that they are not 100% using David's product, and that's for sure.
But I think with the combined effort of the channel approach and with targeted marketing from Heidi, we're gonna penetrate them more and more and take them away from their ISPs, provider Wi-Fi, take them away from some really underperforming Wi-Fi from our competitors, no matter whether it's access points or other Mesh, and we'll continue to make progress. And with that, I think reaching out to them is very important, and I would like to have Heidi make some comment, what kind of effort we are getting into reaching to these 2.5 million household so that we can tell them, "Hey, you have a better solution for your Wi-Fi. You can get much better Wi-Fi experience at home." Heidi?
Yeah. Thanks, Patrick. And as I outlined in the presentation, we're really using digital marketing and a full funnel marketing strategy worldwide to go and reach these customers. You know, those that aren't even aware that there's a better solution out there and are frustrated with their, you know, as Patrick mentioned, their current ISP solutions, competitor solutions, or installer solutions. And we're really starting to gain momentum in terms of learning more about how to reach these customers more effectively wherever they are online, and we're certainly seeing that show in our numbers in terms of net new customers that are coming to NETGEAR and purchasing our NETGEAR products. As I touched on in the presentation, that's been growing year-over-year, and we saw net new customers to NETGEAR grow on our Orbi 9 systems, up around 15% year-over-year.
We wanna keep that momentum going. We wanna keep bringing those customers back to NETGEAR.com, you know, educating them and explaining the benefits and, you know, letting them know that there is a better solution out there, you know, that's gonna enhance their daily lives at home, given how much they're relying on Wi-Fi in these highly connected homes. We're excited about, you know, continuing our efforts and continuing to improve our marketing worldwide.
Yeah, and-
Thank you very much.
Furthermore, you know, we, we certainly know that we've got to change the narrative, right? Wi-Fi experience at home are, is absolutely essential-
Yep
... absolutely required for the hybrid work and all the learning and entertaining environment online. So it's no more like, "Okay, whatever, it's in the closet, that's fine." No. I mean, as, as important as those high-income premium customers chooses what appliances they would like to have, what kind of solar panel wall, that battery wall that they would like to have, I mean, they need this. We need to change the narrative for them. We need uncompromised Wi-Fi experience because it's a necessity in life, and Orbi NETGEAR is the brand we would like to specify. So, so that's the narrative that we're gonna continue to home on.
Makes sense. Thank you.
Our next question today will come from Ahmed Khorsand with BWS Financial.
Hi, just a follow-up, Heidi, how do you go about marketing to a high-end customer in Asia, and then also the same kind of high-end customer in Europe, and how much traction you've had so far, to date on the strategy?
Yep. You know, using the strategy that I outlined. So we, when we look at digital marketing, we're able to be very, very targeted. We know who these customers are. We know the type of, you know, geolocations that they live in. We know that they typically have high-speed internet at home. We know, you know, the use cases, their affinity, what they're doing online. So digital marketing allows us to go after these customers, no matter which region or location that they're in around the world, bring them back to our NETGEAR websites, or direct-to-consumer stores, and really provide that education, and that's localized by region. You know, when we bring the customers back to buy directly from netgear.com on our store.
So the same strategy effectively works in every region, but we're changing the narrative, you know, to match whatever that, geolocation is. And, you know, sometimes the types of house, you know, types of houses may vary, by region, so we localize the imagery, we localize the language, obviously. But we still understand how to reach these customers online, no matter where they are around the world. You know, whether it's on, as I said, those influential lifestyle sites, whether it's financial, whether it's travel and other, influential destinations online. And it, and it's the same problem. You know, we're reaching those customers that are frustrated or, and that simply don't know that there's another solution out there that can help improve and enhance their daily lives at home, with high, high-performance Wi-Fi from NETGEAR.
... and if I could just add, we're also trying to reach out to, you know, these influential buyers, right? Or customers, that premium segment of the market. You know, they have yachts, they have private jets. Through the commercial business, we're working with some of these people that are fitting out these private yachts and these jets with sophisticated AV systems and Wi-Fi systems, the always connected experience. So we're trying to get at, right, the message is getting out to this premium customer base through these other people that are also selling them solutions. It's not just a house, but it's a yacht and a jet-
Right
and other things.
Well, I mean, don't you agree, Vikram, internationally, the most famous brand in outfitting this super high-end yachts or jets or homes are Crestron Home?
Yes, absolutely.
We're very tight with them.
We're tight with Crestron Home, we're tight with Savant, we're tight with-
Internationally, mostly Crestron.
Right. Right, yes.
And they're putting out our Wi-Fi into the expensive yachts made in Italy and made in
Right
... Rotterdam and all that. So that's one angle. I think there's a third angle, which is very important, and Heidi could chime in there. We do significant PR in a very targeted, specific PR. So Heidi, you may add onto it. For example, we get coverage in the UK, let's say, in the Mayfair neighborhood website. All right? We know that's a really high-end neighborhood, and we're going that way, too. Heidi, you wanna make some comments?
Yeah. So exactly, Patrick. So, you know, and you touched on this earlier around changing that narrative. So obviously, we have, you know, our more technical customers, our loyal install base around the world that we continue to engage with, you know, on a regular basis, and as David mentioned, they're often the first to upgrade. But outside of that, we're really about expanding our reach, you know, going beyond, you know, that traditional audience and reaching those consumers, you know, that, again, don't necessarily know that there's a better solution out there. And we've really started to see some success in the U.S., Europe, all around the world, Australia, throughout, APAC, changing that narrative with a more lifestyle approach.
We've seen fantastic coverage, along with relationships that we're building in that space, as you know, Wi-Fi becomes more and more relevant to every single person's life around the world, just to, you know, do what you need to do in a day. You know, whether it's the things you love to do, entertainment, you know, anything that you're doing online, exercising, but also the things you need to do, like work or study and working from home. So we've had some great coverage off the back of sort of changing that narrative with a more lifestyle approach to reach these new consumers across, you know, How to Spend It, Financial Times, as Patrick mentioned, you know, some of those higher-end lifestyle publications.
We've also had some great coverage in Robb Report, Wall Street Journal, and other lifestyle publications, both for our Orbi solutions as well as our mobile solutions. That's really a push that we're executing worldwide across all regions, and we'll continue to do so as we head into 2024.
Well, a good one, right, Heidi? Recently, we were covered in a very high-end home gardening magazine in the UK. Now, in the US-
Right
... we call it backyard or front yard. No, they don't call it that way. They call it the gardens. And then the coverage says that, I mean, with a beautiful garden, you will like to enjoy it, you will like to have a read, you know, a light book, but you got good Wi-Fi, and take the Orbi 960, and you have the entire garden covered. I think that's a great one, right, Heidi?
Correct. That's right. I mean, our customers, these customers who have large homes, they want Wi-Fi, great Wi-Fi, to every single corner of their home, the backyard, you know, the basement, out to the garage, you know, to connect the car and all of those other smart devices around the home.
And speaking of the car, Heidi, you know, I mean, you look at, since, since the question was related to how do you market to some of these high-end customers, in, in Europe, you've got some prestigious audio-video brands like Bang & Olufsen, et cetera, that it's not just about delivering that BeoLiving experience in the home, but it's also about carrying that experience onto their automobile, that is driving out, you know, to the, to the boat or to the, to the private jet terminal, et cetera, and carrying that experience across right away.
So, we're collaborating between, you know, David's business and my business, and with all of Heidi's help across the broader media and our unified sales organization is really trying to cover these people from their private lives in their homes to their lives in a business environment.
Yep.
My next question was, as far as the upgrade cycle is concerned, how far along do you think you have to be in the premium market, or, you know, household penetration, before you see that 4-year, 5-year, you know, timeline shrink to maybe 3 years?
Well, actually, we constantly do user survey among our premium users, and David, you might want to comment on that. Yeah.
Yeah, sure. I mean, we see customers typically will upgrade every 4 years or so. It's a wide distribution, but they'll upgrade every 4 years ago. The people who are buying our higher-end products typically upgrade faster, so we're starting to see even more traction there with the high-end product upgrade. As we look at Wi-Fi 7, it's gonna take 4 or 5 years for Wi-Fi 7 to kind of proliferate through the market. But what's most important to us is how Wi-Fi 7 goes through the premium segment, because the new technology always starts at the top, and then it moves down the price bands.
I can tell you by the latter half of next year, I would expect the majority of our premium business to be moving over to Wi-Fi 7, and that will help accelerate, you know, that premium mix shift that we've been talking about. That was just over 20% in Q3, to push that close to 30% as we exit next year.
Well, well, don't you agree, David, that even with Wi-Fi 7, like, you would continue to innovate every year to keep that going?
Yeah. Yeah, I mean, it never stops. There'll be Penta-Band that I covered a little bit in our slides. There's always new technologies. There'll be Wi-Fi 8, 8, 9, and 10, because the needs of our consumers and customers' homes, and the use cases, and the applications continue to evolve. As I mentioned earlier, the broadband speeds are getting faster and faster and faster. Google offering 20 gig by the end of this year.
Two more questions. One is, Bryan, am I doing the math wrong, or in 2024, is the operating margin target reflective of how your service revenue is increasing rather than the hardware sales?
No, I think all things are contributing to the margin expansion that's implied in the guidance that we provided, the 1%-4% on a full year basis. Certainly, service revenue going to an annualized level of $50 million exiting next year will be a key factor in that equation. But, moving back to lower cost inventory, shifting the mix further to premium, as David just mentioned, kind of shooting for expanding from 20% to 30% of that mix, and then getting back to revenue growth on the SMB side, are all contributing to the margin expansion.
Last question is, any update as far as your capital allocation plan, you know, to share repurchases, or is that still third on the list, even as we speak with the stock at $14?
Yeah, so we have grown our cash now to just shy of $230 million, exiting Q3. And as you heard from the presentation, you know, we're expecting in 2024 to be able to generate free cash flow in that $80-$90 million range. So we do expect to generate meaningful cash next year. A lot of that coming from, you know, further reductions in our inventory and returning to profitability. But in terms of how we allocate capital, as I said in the presentation, all things are still on the table. Obviously, from an operational standpoint, we think we need about $125-$150 million to operate the business. And the amounts beyond that go to looking at M&A opportunities, as well as stock repurchase.
As you saw, you know, we dedicated about 90% of our free cash flow over the last almost four years to stock repurchase. With 2.5 million shares remaining on that current authorization, it will still be a consideration and a use for our cash.
Okay. Thank you.
Thank you, Herman.
This concludes our question and answer session. I'd like to now turn the conference back to Mr. Lo for any additional or closing remarks.
Thank you, everyone, once again, for participating in our 2023 Analyst Day. We are really excited to continue to make progress and reporting to you our progress on all those three fronts of product and market development, which will lead into our ultimate aim of consistent growth, double-digit operating margin as our financial and operating model. We will report even more progress in the next time when we talk to you in February for our 2024 financial report in Q4. See you then!