Netgear Falls Despite Another Great Quarter

By Markets Fool.com

IMAGE SOURCE: NETGEAR, INC.

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Shares of Netgear (NASDAQ: NTGR) may have fallen 8% Thursday after the companyreleased third-quarter 2016 results, but that doesn't mean investors should be disappointed with its performance. In fact -- keeping in mind Netgear stock was already up almost 30% year to date as of Wednesday's close -- the networking hardware specialist just exceeded expectations for the sixth straight quarter.

Let'stake a closer look, then at how Netgear started the second half of the year, and what caused its post-earnings decline.

Netgear results: The raw numbers

Metric

Q3 2016 Actual

Q3 2015 Actual

Growth (YOY)

Revenue

$338.5 million

$341.9 million

(1%)

GAAP net income

$21.1 million

$15.1 million

39.7%

GAAP earnings per share

$0.62

$0.47

31.9%

Data source: Netgear.

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What happened this quarter?

  • On a non-GAAP (adjusted) basis -- which excludes items like stock-based compensation and restructuring expenses -- net income increased 19.4% year over year to $25.9 million, while adjusted net income per share grew 13.4% to $0.76.
  • Adjusted operating margin was 11.5%, up from 10.3% in Q3 2015.
  • For perspective, Netgear's guidance called for lower revenue in the range of $315 million to $330 million, with adjusted operating margin in the range of 10.5% to 11.5%.
  • Revenue by geography:
    • Americas increased 2.5% year over year to $225.2 million.
    • EMEA declined 22.8% to $60 million.
    • Asia-Pacific increased 19.7% to $53.2million.
  • Revenue by segment:
    • Netgear's retail business unit delivered 18.4% year-over-year growth to $194.2 million, beating expectations thanks to a solid back-to-school performance and continued strength in sales of its Nighthawk routers, cable gateways, and Arlo home security cameras.
    • Commercial business unit revenue grew 12.6% to $73.4 million, in line with expectations.
    • Service provider business unit revenue declined 37.1% year over year to $70.9 million, roughly $5 million above expectations due to pulling forward of orders from several clients.
  • Free cash flow was $40.4 million.
  • The company ended the quarter with cash, cash equivalents and short-term investments of $403 million.

What management had to say

CEO Patrick Lo stated:

We were pleased with our financial results for the third quarter of 2016, which came in higher than we had expected in revenue and at the high end of our guidance range for non-GAAP operating margin. The outperformance during the quarter was led by our Nighthawk routers, cable gateways, Arlo cameras and 10 Gig switches. Overall, our financial results reinforce that the Company remains on a strong trajectory.During the quarter we saw continued strength inNorth Americafor the back-to-school season, healthy year-over-year growth in APAC, while EMEA continued to be a challenging environment.

Looking forward

For the fourth quarter, Netgear expects revenue in the $340 million to $355 million range, representing a year-over-year decline of 5.8% to 1.6%. That spread accounts for holiday seasonality in its retail business unit, but once again reflects a reduced outlook for service provider sales. Fourth-quarter adjusted operating margin is expected to remain steady in the range of 10.5% to 11.5%.

More specifically on the top line, Netgear management elaborated during the subsequent conference call that its service provider business revenue is expected to decline further next quarter to around $55 million, and to remain around that level in subsequent quarters. This is somewhat disappointing considering Netgear's previous target for the recently restructured segment was for a quarterly revenue run rate of around $75 million.

At the same time, investors should keep in mind that service provider business tends to come with lower margins, which helps explain Netgear's outsized profitability of late. And as Lo elaborated during the call, "We continue to effectively manage this business unit, protecting our margin rather than chasing commoditized business at the top line."

Netgear also plans to push for service providers to consider its latest proprietary technology, including Orbi WiFi systems and Arlo security cameras, the adoption of which could provide upside for the troublesome segment as its customers continue to invest in wireless infrastructure. In the meantime, Netgear has the luxury of being able to rely on the steady outperformance of its more-profitable core retail business to take up the slack.With that in mind, it seems to me the market may have gotten this one wrong today.

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Steve Symington has no position in any stocks mentioned. The Motley Fool recommends Netgear. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.