Thanks, everybody, for joining here in the room as well on the webcast. I'm Adam Tindlel, and this is part of my connected devices coverage here at Raymond James. Very happy to have CJ Prober, CEO, and Bryan Murray, CFO of NETGEAR. I think most of us are familiar with the products. We've got a lot of different areas to cover. There's been a lot of changes at the company and exciting things happening. So we're going to just dive right in. So maybe we'll start with CJ, and thanks again for being here. As I mentioned, many of us are familiar with NETGEAR from a customer standpoint, but for those not as familiar, maybe just give us a little background on the company and how it's evolved over time.
Yeah, no, that sounds good. And this is my first non-earnings webcast investor conference since joining, so thanks for hosting us. It's been a great day. The reality is NETGEAR is quite misunderstood, I would say. People think of us as the company we were a decade ago or two decades ago. NETGEAR was founded as a spinout from Bay Networks maybe 30 years ago. And at the time, the company's mission was to be the innovative leader in connecting the world to the internet. NETGEAR did a great job, right? Great products, solved connectivity pain points for consumers. But you fast forward to today, and that home networking business is just a third of our revenue. So about half of our business is B2B. It's on a growth trajectory. It has a much better financial profile from a gross margin perspective, contribution margin perspectives.
Like last quarter, 20% positive contribution margin on that side of the business. We are starting to kind of elevate visibility into the different businesses that we have and the different differential performance. Right now, you got to go dig a little bit into our Qs and Ks to find that info. But we've got a really robust profitable growth opportunity on the B2B side. Not to say that our consumer business doesn't have a lot of opportunity too, just different, and just people, when I introduce myself as the new NETGEAR CEO, don't realize that, so we've come a long way, and we're really elevating kind of the opportunity on the B2B side. As we're going through this transformation, our investment, our focus is leaning heavily there. So I've rebuilt the B2B leadership team.
We've got a new president who comes from Cisco, Ruckus, Arista, a new head of sales, new product leaders, new UX leaders, new sales leaders below kind of our head of sales, so we've really separated out the business to really allow it to flourish, and I guess that's the big story that we're starting to tell is just the opportunity on the B2B side.
Perfect. And as you think about the competitive set, how would you describe NETGEAR's competitive advantage and how has that environment changed over the recent years? I know we're going to get into some more specifics since this has become very topical with TP-Link, but maybe just keeping it at a high level.
Yeah, so on the B2B side, we have three different business segments there: ProAV, where we have managed three-level switches, and the competitive set there is largely Cisco, a little bit of Luxul. And we really differentiate in that business by building out a really robust partner ecosystem and then integrating those partners into our software platform. It's really a software differentiation play. That business is on a great growth trajectory. And we're moving. We focused on commercial AV. We're moving into broadcast. On the Total Network Solution side, we've invested a lot in the foundational components of that. This is campus Wi-Fi. So there we compete against Ruckus, Juniper, Meraki. There's a lot of disruption happening in that market. It's a huge market, really nice growth potential, really great recurring revenue opportunity. So we're investing there.
A lot of the leadership I mentioned on the B2B side that we've brought in comes from that world. And so our differentiation there is we've got a very rich cloud management platform. And so from a go-to-market perspective, people don't think of NETGEAR as having this solution. There's a big effort on the marketing go-to-market side to build awareness and to be very targeted in certain verticals to kind of grow share there. And then on the consumer side, it's different. It's really in the U.S. market, the main players are us, eero, which is owned by Amazon, and then TP-Link. And if you think about how NETGEAR is different there, it's kind of obvious. We're the U.S. publicly listed trusted brand. We have the best security. And the cyber world's getting very complicated these days. That's a big point of differentiation.
Whenever you speak to consumers about, "Hey, if you had three choices, you could buy TP-Link and all the national security dialogue that's happening around there, a product from Amazon, and what they do from a data perspective," or NETGEAR, it's kind of an obvious choice. So telling that story is a big part of our focus.
Speaking of TP-Link, let's go ahead and tackle that one because it definitely became a focus recently. Remind investors of the settlement that you got with that and also really interested in the potential incremental tailwinds and timing to those potentially from here.
Yeah, so there's really two things happening vis-à-vis TP-Link. One is we received $130 million in a settlement where we mutually dismissed a bunch of different patent-related legal actions. That was a great outcome for that. About $100 million of that hit our balance sheet.
Just this past quarter.
Just this past quarter. Exactly. So we had a strong balance sheet. The balance sheet has gotten stronger, positions us well for growth going forward. And then there is just repeating kind of what's out there in the public. There's a lot of scrutiny on TP-Link. The home routers are being implicated in all of these Trojans and attacks on the government and corporations. And TP-Link's been implicated as kind of part of that. And the China Select Committee has sent a pretty strongly worded letter to the Department of Commerce saying, "Hey, we need to really take a close look at this security risk." And that's a very uncertain thing. So we're building our business and our strategy on the assumption that TP-Link remains in the market, but we'll see what happens. Obviously, the new administration is quite hawkish on those types of issues.
If you were to maybe kind of quantify that or categorize that for investors, is there a way that they could think about potential outcomes if it did roll in your favor?
Yeah, I mean, it's hard to predict. If you look at the letter that was directed to the Department of Commerce, the Department of Commerce is the group that banned Kaspersky, the security company from Russia. So if the same thing were to happen, and you look at what happened with Huawei to TP-Link, they're the market leader in the kind of retail home networking, that'd be a huge tailwind for us, both from an ability to capture share and then kind of reduce pressure on pricing and improve margins. But of course, that's very uncertain. And so again, we're not building our strategies, and it's hard to put a probability on whether that'll happen or not.
Okay, fair. Let's shift gears into NFB. I think you covered some of the changes that you've made. But if we want to maybe double-click on that segment, maybe talk about the different margin profiles of NFB, how it differs from CHP, and some of the incremental NFB ideas that are being underserved or ripe for disruption. I don't know if Bryan wants to tackle the margin question.
Yeah, I think the margin piece. So to date, we've disclosed contribution margin of the two businesses. And the separation or differential between the contribution margin of NFB versus CHP is about 2,500 basis points. So it's quite significant. And I'd say most of that is coming from the spreads and the gross margins. So you can back into our blended gross margins, 31%. NFB is about half the business. You can kind of really see how different the gross margins are, which is why we've talked at length about organic investments will largely be focused in that area because of the opportunity there.
Yeah, and then the two main kind of investment growth areas on the NFB side for us are, again, ProAV expanding into broadcast, expanding into residential, continuing to lead in commercial AV, and then on the campus Wi-Fi total networking solution. And really, we're a sub 1% player in what is a huge market that is growing, but also where the players are quite disrupted in terms of what's happening with Meraki being integrated into Cisco and Ruckus and CommScope and Juniper and Aruba trying to come together. So we think there's a real moment in time for us to take the incredible asset we have there and grow our share significantly. And that's the platform upon which we can really add over time recurring revenue by expanding the solution that we offer to enterprises.
Got it. And on the CHP side of the house, we're sitting here kind of mid-December. We've done Black Friday and Cyber Monday and all that and headed into holiday season. Just would love to hear how you would describe consumer behavior this holiday season, maybe relative to last.
Yeah, so we're actually seeing we've had a great holiday. To put that into context, we're not a super seasonal business, but what we do see is Q4 tends to be higher volume, more promotional. So we guided to that. We expected to see that. So we are seeing that come to fruition. But I would say the sell-through on the consumer side is exceeding our expectations this quarter, particularly in the online channels like Amazon and our direct-to-consumer business. So we feel great about the holiday season on the consumer side for now. Similarly, tracking really well on the B2B side. And that's less of a, from a net revenue perspective, a little less linear. So there's always risk towards the end of the quarter, but we're feeling great about this year. And we've seen and we've talked about the consumer market recovering from the huge COVID pull-through.
We continue to see that happening. So we're optimistic that 2025 will be the year that Wi-Fi 7 transition kicks in and we start to see kind of year-over-year growth in the consumer side.
Yeah, and maybe on that point, remind us of the typical consumer Wi-Fi device refresh. Like how long do the products typically last? Because I think if we do the math on COVID, we might be getting close to some of that aged existing install base coming through. So how are you thinking about the opportunity and timing for a refresh?
Yeah, I would say that as Wi-Fi standards updates happen and mature, those refresh cycles are getting a little bit longer each time. And with the COVID pull forward, that really happened in 2020, 2021. So historically, what we've seen is kind of four, four or five years. On the Wi-Fi 7 side of things, we're just now getting our Wi-Fi 7 portfolio into the market. And the endpoints like iPhone 16, some of the new Samsung devices, the endpoints are just hitting the market now. So we think that's why I say like next year I think is the year where that starts to kick in and you start to see real differentiation in terms of performance if you've got the Wi-Fi 7 latest technology.
And what does Wi-Fi 7 bring versus previous iterations of Wi-Fi? And I guess if you want to dovetail that into the longer-term vision for Wi-Fi technology that you have.
Yeah, so Wi-Fi 7 brings better performance in terms of speed, more devices, less latency. And as you look at kind of the increased speeds that are being offered by cables, like 10 gig service, the Comcast has, or fiber, you really need Wi-Fi 7 to fully take advantage of that. Over time, I think there's going to be a shift where it's less about speeds and feeds, and it's more about reliability, performance, self-healing, how does AI fit into that equation? And so as we think about our Wi-Fi 8 and beyond roadmap, we're thinking differently about transitions that have happened in the past. And how do you drive real differentiation around customer experience and customer value that's not just speeds and feeds?
I mean, one of the things that you're doing or continuing to do, I should say, is growing recurring subscribers. So maybe if you could just double-click on your subscription story, what's driving users? What are they paying for? And how do you keep them within the NETGEAR ecosystem?
Yeah, great question. So on the consumer side of things, our focus is on security, privacy, trust. So our product without the subscription is quite secure, but we have added protection for consumers with our Armor subscription. So things like VPN, an endpoint security for all your devices in the home, better reporting, parental controls. And then on top of that, we add in value like stronger support and warranty and things like that. And so one of the things that we did when I first joined is we had many different subscription SKUs, and we bundled those subscriptions with our devices. And it was really hard as a consumer to understand what exactly was being offered with what. And so we've made a big effort to simplify that.
We're debundling our subscription from our devices, and then we're aggregating the value that you get from the different subscriptions into one or two plans. We're seeing kind of the early positive signs of that simplification pay dividends around the subscription trajectory.
Just wrapping up the consumer side of the conversation, maybe one for Bryan. The other piece of the business is the service provider business. Maybe just a quick explanation for those not familiar with the service provider business. And how do you think about the optimal size? I know we've had rules of thumb on a quarterly basis in the past. How would you update that or what's optimal?
Yeah, so today, our CHP business really is kind of two buckets: home networking and service provider, or mobile, I should say. Mobile is predominantly sold through service providers. The biggest two customers for us would be AT&T and Telstra, where they're buying directly from us, and then they're attaching data plans and selling it to their customers, which, funny enough, even though there is a lot of product alignment with our consumer products, there are a lot of customers through those channels that are buying for businesses where they're deploying it to their employees to use in secure ways when they're traveling or in remote locations. This year, that business is approximately about $100 million in size, healthy margins from a consumer, from a CHP standpoint, and I would say that that business at that level is a very healthy business.
We would obviously like to grow it, but I would say it's probably likely to continue to be in and around that size.
Okay, so like $25 million a quarter. So it used to be $35 million a quarter, I think, was the typical rule of thumb. But what caused the adjustment a little bit lower?
We did focus, we did shrink our coverage in terms of service providers that were willing to pay for the value we create. So we just launched the world's first Wi-Fi 7 5G mobile hotspot. So we can bring these technologies to market. We have expertise in mobile technologies as well as in Wi-Fi. And so we're a natural partner to do that. And so for the service providers who are looking to bring that technology first to market, we're a natural fit there. For those who are not and are playing in a lower-cost, broader portfolio for mobile hotspots, we have not historically touched that area.
Yeah, one thing to add, Adam, on that is that I think the way we've previously talked about service providers like a standalone business unit. In fact, at one point in time, we had a business unit called service provider. The way that I think it's important to reorient our thinking is we have B2B, we have home networking, and we have mobile. And one of the big channels for mobile is service provider, but we also have a retail business there. And overall, we view that as a growth business for us. So we're investing there. We have an opportunity to play in a broader part of the market. And then we haven't brought our recurring revenue businesses or products to that market, but we see that opportunity. eSIM, we think, has the potential to be an inflection point, right?
Because in North America, if you go to Best Buy and you buy a hotspot or a fixed wireless access point, like what do you do with it? Unlike in Europe, where SIM cards are quite readily available and consumers understand that, eSIM will make that a much more seamless customer experience. It'll take time to educate consumers on the opportunity there. But I would think about it as home networking, mobile, and then B2B. And then within mobile, we just sell through AT&T and Telstra and some other service providers.
Okay, I guess along those lines of thinking on the different businesses and segments, how would you describe the growth trajectories of each of the different segments?
Yeah, so we've said we expect to grow the overall business next year. That growth is going to be driven by NFB, so the B2B segment. And within NFB, ProAV is driving a large part of that growth. Longer term, we see growth opportunities more broadly across the whole portfolio. There are some businesses that are more, like if you think about our transactional switch business, Unmanaged Plus switches, that's not a growth market. It drives and delivers a lot of cash for us. So we're in harvest mode there. But Total Network Solution, ProAV, mobile, we expect those to be growth markets for us, and we expect to grow next year.
Would that imply that CHP is probably not going to grow next year? Or what would that?
Yeah, CHP, so we're still. It's a little more. There's a few factors there. We need the market to recover. We've been waiting for that to happen. We thought it might happen this year. So we're hopeful that that'll happen next year. And then there's the whole competitive dynamic. And independent of the competitive dynamic, we do need to transform our home networking business. We're one of the only players now that is exclusively in terms of servicing customers and the needs of the home in a very narrow slice of the market, which is like providing networking. We need to be more than that to consumers and provide a portfolio of products that deliver and unlock more value. It is still a big pain point in the smart home. So we do see a longer-term opportunity for growth in the home networking or the smart home side of things.
That could come much earlier. Depends what happens with the competitive landscape.
Maybe, Bryan, if you want to touch on, we get a lot of questions on the state of inventory in particular. There's a number of moving parts to inventory. Just to kind of recap what's going on from an inventory standpoint, the timing to right-sizing inventory and the magnitude of it.
Yep, so we look at inventory in two different ways. We look at the channel, our partners and their level of inventory. And that had been a headwind for NETGEAR for a considerable amount of time. In this second quarter of this year, we took aggressive action to kind of nip that in the bud once and for all, get our channel partners back to where they're stated or get them to their stated inventory levels and goals, which I would say are lower than what they have operated at historically. So we were able to execute on that. We continue to see that stabilized. Our sell-in is pretty much matching sell-through across both businesses there. So we're happy there.
Of course, there are going to be SKU level things where we're leaner than we'd like to be, the channels leaner than we'd like to be, and others that will continue to kind of normalize over time. So once we got that behind us, that was clearing a big headwind. Our own inventory at our peak was about just shy of $340 million and exited last quarter just north of $160 million. So we've made tremendous progress knocking our own inventory down. And we've said that we're trying to get our inventory carrying levels to about three months of supply. And for us, we're taking title of our goods when it leaves our manufacturing partners' locations, which are predominantly in Southeast Asia. And so transit times, half of our inventory is on the water as we're talking about 45 to 65 days. So we've made tremendous progress there.
We're hoping to get our finished goods down to that three-month level by the end of the year. We will still continue to have some raw materials, primarily chipsets that are on the books that are residual from the actions that we took during the COVID peak of supply constraints, long lead times, and so we proactively procured a bunch of these chipsets on our own, which we typically don't. Most of the time, the ODMs handle all of that stuff. But we did that to give ourselves the best chance of getting our more than fair share allocation, and so we're still digesting some of that, and that's going to take us some time. I think it was roughly about a $20 million level exiting last quarter, so that's going to take us a little bit longer, but finished goods we're tracking towards.
From a manufacturing standpoint, or I guess exposure standpoint, we get a lot of questions on China. Just maybe clarify your manufacturing footprint and any exposure to China.
Yeah, I'll start if you want to chime in here. So we do not manufacture in China at all. We had kind of been ahead of the curve. Even if you look back to the 2019 period and the 301 tariffs coming into play, we had already migrated a fair amount of our manufacturing and got the rest of it out at the onset of those tariffs kicking in, probably in about a six- to nine-month timeframe. So we've gotten stuff out. We're spread out. We have manufacturing in Vietnam, Thailand, and Batam, are probably the biggest centers where we manufacture.
All right, CJ, we talked about the structure of NETGEAR and kind of these different businesses. How do you think about the synergy between the consumer side and the B2B side? When might it make sense to even consider separating those assets, for example?
Good question. So if you think about the three businesses, home networking, mobile, B2B, they're all relatively subscale. We also see a lot of opportunity. When you think about our different transformation phases, phase one was this year. That's all the foundational stuff around new leadership, new culture and values, new purpose, mission, strategies, all of that. That's largely done. The next couple of years are about getting the core businesses performing in a different way. We're already seeing the benefits of some of our kind of operational, organizational execution changes. And so at some point in time, it could make sense for some of these businesses to be different businesses, but we're not focused on that. We have no plans for that at the moment. Our focus now is on executing, building the core businesses, achieving more scale and growth. And yeah, we're really excited about 10 months in.
I feel like we're on a great first 10 months and looking forward to next year.
Great. Bryan, I wanted to ask about capital structure. You're sitting at nearly $400 million of net cash, certainly very sizable relative to the enterprise value of the company. What level of cash do you need for daily operations to run the business? And how do you think about an optimal capital structure for NETGEAR?
Yeah, I'll say that based on the current trajectory, we have said, and I would maintain that we need about $125 million-$150 million to run the business. That said, if the competitive landscape changes, that would require a fair amount of working capital to shift and be able to respond to a sizable portion of the CHP retail market. So that would take more cash from that standpoint. Beyond that, we have and continue to be opportunistic buyers of our stock. We had noted a month or so ago that we were out of the market in the third quarter because of the negotiations with the TP-Link settlement. But we do expect to be buyers of our stock in this fourth quarter at a level that's higher than what you saw in the first and second quarter of this year.
So we still think that's an important part of how we allocate capital. And then obviously, M&A is something that we will continue to evaluate. Obviously, like something big and transformative, it's probably not the right time given what our value is today and be able to pull that off. But we do still have a fair amount of cash that if we found the right opportunity, we could act from a cash standpoint.
Yeah, I want to go back to your question about synergies across the businesses because I didn't really answer that. I kind of addressed the fact that some of these are quite different with end customers and whatnot. So we do see a lot of synergies across all businesses. If you think about where we get leverage, the operations team, so the team that manages the manufacturers, the logistics, supply chain, the G&A team on the marketing side, and to some extent on the sales side, because we have the mobile products, the home networking products, and even some of the B2B products show up in Amazon and Best Buy. So we do get operating leverage by having these businesses together.
I still think that remains that as we change the trajectory of the businesses, as we grow the scale of those, yeah, there might be an opportunity down the road, but there is good leverage across the board today.
Right. Bryan, we've seen healthy cash generation in the business. I know there's been a lot of moving parts and a lot of it working capital oriented. I guess if you were to kind of set expectations for a new investor who's looking kind of beyond the near-term moves in working capital, how would you describe sustainable ongoing free cash flow generation potential of the business?
Yeah, if you look over the last 12-18 months, we've generated meaningful free cash flow, but most of that has come through either working capital changes, working down our own inventory, or through this TP-Link settlement, which is kind of a one-off there. As we go forward, I would expect cash either generation or usage to be more directly tied to our income. As we said a month or so ago, going into next year, there's some things that we're excited about. We expect growth in the business. We expect gross margin expansion, but we are going to make some investments to kind of further along the growth opportunities for our organic business, which would likely lead us to not being profitable next year, and so with that in mind, we would expect some cash flow usage next year.
We did say for Q4 that we expect to use anywhere from 10 to maybe break even-ish in terms of cash.
In terms of thinking about cash usage of next year, would you kind of mirror the net income loss or would it be beyond that? I mean, any kind of parameters?
Yeah, I think it's probably going to be directly tied. Historically, our conversion has been 85%-100% of non-GAAP net income. So it'll probably be in that range.
And as we wrap here, CJ, you have gone through a lot of strategic planning and strategic review with the board. I wonder if you could maybe give us kind of a little bit of a look into that process. What have you been talking about? What are the key topics? Anything that you can share?
Yeah, it's a very robust process. The first hire I made was somebody to lead strategy who I've worked with before. He and I have both been strategic consultants before, so we brought a lot of experience to the table on it. So we did a lot of kind of market back, looking at the landscape, the competitive set, where we expect things to go, how do our strengths play into that. And then we basically took the home networking business, the mobile business, and then the three segments within the B2B business. And we defined kind of our investment level across each of those for next year, the inorganic opportunities that we would consider to help accelerate the growth of those businesses. And so it's a very robust process. We have very clear strategies. We're now going through and finalizing our 2025 plan.
But I feel really good about the trajectory that it puts us on. And just to put it in the context on the home networking side, that's a category. It's a little bit wait and see what happens with the competitive landscape and the market. So it's not an area that we're investing in. If anything, across the board, we're taking a really hard look at where we spend and OpEx, and we want to be super diligent about ensuring that we're putting all of the ammo behind the biggest bets. And so in that regard, on the other end of the spectrum, ProAV, TNS are the two main sources of investment. And then we are making investments in the mobile business to grow that.
How about on capital allocation? I mean, is there a discussion on share repurchase versus organic versus M&A and how that's being stack ranked?
Yeah, good question, so what we said in the last earnings is that we expect our organic investment to be less than the amount of capital, of course, we're allocating towards share repurchases. We're going to continue to be opportunistic there. We are looking to, again, redirect investments from our current OpEx pool as much as possible, but we do think to take advantage of the market opportunity on the B2B side. There will be incremental OpEx next year. That's why we've said what we expect to grow the business, have margin expansion. Next year isn't the year that we're targeting for profitability, and yeah, we're going to remain opportunistic on the buyback. From an M&A perspective, the next couple of years, we're really focused on the execution around the core business.
But we are, like I said, for each of our businesses, we've identified where would we benefit from new capabilities or additional scale. And so we're building that muscle. So we're going to think it's healthy no matter whether you execute on deals like that or not. It's healthy to always be looking and evaluating opportunities. We're just going to be really selective as we do that, especially over the next couple of years.
Okay. So I think we'll wrap here, and I guess the last question would be, what is the key message that you'd like to leave with investors as they think about NETGEAR today and into the future?
Yeah. So first would be just to reorient folks around the B2B opportunity. We're super bullish about that. It's got a great financial profile. It's growing. We're excited there. The second is our focus is really around long-term value creation. And unlike in prior years, we've aligned management's compensation there. Our PSUs are tied to a TSR metric. So we win for shareholders, management wins. And then the third is in my first 10 months, we've really been focused on batting near perfectly on the say-do ratio and want to continue that. And so when we say we're going to do something, we expect to do it.
Perfect. Well, exciting times ahead. We look forward to following it, and we'll leave it there. Thanks, CJ. Thanks, Bryan.
Thanks, Adam.
Thank you.