NETGEAR, Inc. — Q1 2018 Form 10-Q
Reporting period: Three months ended April 1, 2018; comparative period ended April 2, 2017. NETGEAR sells networking and connected-home products and reports three segments: Arlo, Connected Home, and Small and Medium Business (SMB). Amounts below are in U.S. dollars.
Financial performance
| Metric | Q1 2018 | Q1 2017 | Change |
|---|---|---|---|
| Revenue | $345.0 million | $323.7 million | +6.6% |
| Gross profit / margin | $104.5 million / 30.3% | $96.9 million / 29.9% | Margin +0.4 percentage points |
| Operating income / margin | $8.5 million / 2.5% | $22.8 million / 7.0% | Income -62.8% |
| Net income / diluted EPS | $5.6 million / $0.17 | $16.0 million / $0.47 | Net income -65.1% |
| Operating cash flow | $57.0 million | $9.3 million | +$47.7 million |
Gross margin improved slightly, but higher operating expenses more than offset revenue growth. Operating expenses rose to $96.0 million from $74.1 million, including $6.8 million of Arlo separation expense; R&D, sales and marketing, and G&A also increased. Other expense was $1.3 million, primarily reflecting a $1.4 million investment impairment. The effective tax rate was 30.0%, versus 32.0%.
Segments and material changes
- Arlo: Revenue increased 58.5% to $96.2 million, driven by strong camera demand, including Arlo Pro 2. Segment contribution income rose to $4.4 million from $0.3 million; contribution margin was 4.5%.
- Connected Home: Revenue declined 8.5% to $177.8 million and contribution income fell 19.5% to $25.5 million. Lower modem/gateway, powerline, mobile, and service-provider sales were partly offset by home WiFi systems.
- SMB: Revenue grew 3.5% to $71.0 million, mainly on switch growth. Contribution income was nearly unchanged at $18.6 million.
- By region, Americas revenue rose 10.4% and EMEA 14.0%; APAC fell 16.5%. Service-provider revenue declined $11.4 million.
NETGEAR adopted ASC 606 on January 1, 2018 using the modified retrospective method; prior-year results were not restated. The company said adoption did not materially affect the nature or timing of revenue overall, but its Q1 2018 reconciliation shows reported revenue was $2.3 million lower and net income $1.7 million lower than under the former standard. The adoption also changed balance-sheet presentation of certain customer reserves and deferred revenue.
Cash, liquidity, debt, and obligations
Cash and cash equivalents were $258.8 million at April 1, 2018, and short-term investments were $127.4 million, for combined liquidity of $386.2 million. Cash and cash equivalents increased $55.9 million during the quarter. Operating cash flow was $57.0 million; investing activities used $3.4 million and financing activities provided $2.4 million. The company attributed stronger operating cash flow chiefly to working-capital movements. Inventory rose to $266.3 million from $245.9 million, and inventory turns declined to 3.6 from 4.8 in the prior quarter.
Current assets were $999.5 million and current liabilities $402.2 million. Total liabilities were $457.5 million and stockholders’ equity $755.7 million. The balance sheet does not present a debt balance; no separate borrowings figure is provided in the filing text. NETGEAR said existing liquidity and expected operating cash flows should meet anticipated needs for at least 12 months. It had $147.2 million of non-cancelable supplier purchase commitments and an estimated $17.5 million long-term Tax Act transition-tax liability.
Outlook, risks, and unusual items
- NETGEAR expected strong Arlo growth and SMB growth, targeted low-single-digit Connected Home growth, and forecast service-provider revenue of approximately $50–$55 million per quarter. It expected fiscal 2018 gross margin to be in line with or slightly above the prior year.
- The planned Arlo separation was expected to include an IPO of less than 20% of Arlo in the second half of fiscal 2018, with NETGEAR retaining the remaining interest and intending a later distribution to stockholders. Completion remained subject to market, tax, legal, and Board considerations. The company estimated approximately $10 million of additional separation costs for the quarter ending July 1, 2018 and expected further costs and operating dis-synergies.
- Management highlighted competition, product and technology shifts, customer and service-provider concentration, inventory and component supply risks, foreign exchange exposure, cybersecurity and data-protection risks, and execution costs and uncertainty around the Arlo separation.
- Several patent and tax disputes remained outstanding, as did a customer class action concerning a ReadyCLOUD service incident and a patent suit involving Arlo cameras. The company said it could not reasonably estimate financial impacts for several matters and did not believe existing claims were likely to materially adversely affect its financial position within 12 months, while noting litigation outcomes are uncertain.
- Management reported disclosure controls and procedures were effective at period-end. It reported no material off-balance-sheet arrangements.
Key facts for investors to verify
- Whether Arlo’s IPO and intended distribution proceed on the announced timeline and terms, and the ultimate separation costs and dis-synergies.
- Whether Arlo’s growth and improving contribution economics can offset Connected Home declines and corporate expense growth.
- Whether working-capital cash generation is sustainable, given rising inventory and lower inventory turns.
- The effect of ASC 606 presentation and estimates on revenue, customer reserves, and period-to-period comparability.
- Developments in major litigation and tax examinations, and any resulting liabilities or costs.