NETGEAR, Inc. (NTGR) Earnings Call Transcript & Summary

Okay. We're excited to share presentations with you on our progress with the business and our expectations for the future. But first, 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 and 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 on to the agenda. Patrick will start us off with an introduction and overview. David Henry will recap an amazing year for the Connected Home business and what we see going forward. Heidi Cormack will then talk about our success growing our recurring revenue business. Vikram Mehta will then share how we expect to return to growth on the SMB business. To wrap it up, Bryan Murray will discuss the financials, along with our outlook. After that, we'll hold an interactive Q&A session. And with that, I'll hand it off to Patrick Lo. Patrick, go ahead.

Thank you, Erik. 2020 Analyst Day today, and welcome, everybody, and thanks for joining us. Clearly, this year is a very, very unusual year. And for many of us, is a hard year, both ordinary people as well as for businesses. And NETGEAR as a company has its share of difficulties, challenges, especially at the beginning of the pandemic that when many economies were shut down, businesses had to go to hiatus, has a significant negative impact on our SMB business. And then while people were locked up in their homes, stay in place, there is tremendous demand from the activities such as work from home, learn from home on WiFi connectivity. The demand is unprecedented. But it's not just for our networking products, but it's also for other computing devices for people to be connected to the Internet. And because of the extensive use of cloud-based online services, there's tremendous demand on all the chips required to pump those services online. As such, the entire year has significant challenges for our operations department supply chain to really, really keep up with the demands. So that's the bright spot of our connected home businesses. We have been chasing demand all year long, and still we're seeing significant delay in supplies, which, we believe, will continue well into next year. For sure, we believe that the welcoming arrival of the vaccine will be a really good piece of news for everyone in the world. However, as everybody has already realized that it would probably take another year before we could return to any kind of normalcy. And even after the pandemic is completely over probably by 2022, I do believe, as many other people do, many of the activities that we expected would take 10 years to move from physical to virtual, from off-line to online actually are going to stay, survey after survey from companies after companies that a hybrid mode of work from home is going to stay. And as we have seen, telemedicine is becoming more and more accepted, especially for those who are not convenient to actually track to see the doctors in the clinics. And as many other studios have already announced, movie premiers are going to be done on video stream platforms. And clearly, the Zoom meetings or even Zoom parties or family gatherings from across continents over Zoom are not going to change. So we do believe that this pandemic has a one-time step up on the demand of the best WiFi experience in the houses. And then David Henry, our Connected Home General manager, is going to talk more about it. And also, we believe that going forward, not only this elevated demand will continue to grow, it's actually will increase the pace of people's desire to upgrade to the latest Internet speed as well as WiFi setup. So we do believe through this pandemic, while there are challenges, which, we believe, we could overcome over time when the pandemic is over or before then for our SMB side of the business, there is tremendous opportunities that we see that it's going to be lasting for us on the connected home businesses. So to that, I would like to introduce David Henry, our General Manager of our Connected Home businesses to discuss this really bright spots that we're seeing in the coming years. David?

Hello. I'm David Henry, Senior Vice President of NETGEAR's Connected Home business. This year, with the pandemic, we find ourselves doing so many more things from home. Working, learning, playing, exercising, being entertained and even seeing our doctor. And not only from one room, but almost every room in our home even backyard. Now many of these online activities have been growing for years. However, what's new, it's all happening at the same time now with parents, children, even grandparents online. In addition, the steady growth of always-on smart home devices like thermostats, home security and even voice assistants creates a persistent need for premium high-performance WiFi. WiFi where everything just works, everyone stays connected and where services are accessed at an instant from anywhere in the home. As the pandemic persists, consumer habits have changed, and we see the emergence of a new normal, where all are more deeply reliant on premium WiFi and where consumers frequently upgrade their WiFi to keep up not only with their needs, but also their devices. Evidence of this new normal and the mass consumer upgrade is easily seen in the year-on-year growth of the consumer WiFi that started at the beginning of the pandemic. The growth started in Q1 at 19%, then accelerated to 55% in Q2 and 58% in Q3 this year. What also is evident is the formation of a premium WiFi segment. This premium market moves consumers from single unit WiFi routers to multipoint mesh WiFi systems. These premium mesh systems are equipped with the latest sixth generation technology, WiFi 6 and utilize tri-band WiFi, like our award-winning Orbi WiFi systems. NETGEAR created and accelerated this premium segment, which, in Q1, accounted for 7% of total mesh WiFi market and grew to 16% of the total mesh market in Q3 at a resulting average selling price of $523. We have over 80% share of this premium segment, and we believe this portion of the market will continue to grow, become 35% of mesh WiFi sales. More importantly, because of our far and away better technology and stronger market share, the gross margin of the premium mesh products are materially higher than our overall average. We see how our tri-band WiFi 6 mesh systems of 2, 3 or even 4 units have expanded the market, and we have seen our mesh systems with ASPs of $500 all the way up to $1,000 among our top sellers as consumers demand the best possible WiFi for their homes and as our brand moves consumers upstream. This new premium segment, which are made up of those customers with modern luxury lifestyles who demand nothing less than the best experiences. Green luxury cars, suburban solar-powered houses, the latest tech gadgets and the fastest Internet supported by the best WiFi available. This is the segment served by Peloton, by Tesla, Apple and us, NETGEAR. As we grow this segment, we will grow our business and our market share. And of course, these are the customers who are most likely to get the most out of our products and subscribe to our value-added services. Our technical expertise makes us uniquely positioned to address this premium market with the WiFi experience customers demand. It comes from over 20 years of RF and antenna design, which is a mix of art and science, that creates high-powered expansive WiFi coverage and delivers top wireless speeds. Our capacity to innovate is exemplified by our history. Like the introduction of RangeMax back in 2005, with its first smart antenna, multi-input, multi-output design. Our Nighthawk WiFi routers, the first to deliver tri-band WiFi to our now top of the line Orbi mesh WiFi systems using WiFi 6. Orbi WiFi 6 mesh systems hands down deliver the best home WiFi possible. These ultra-performance WiFi systems build homes with the fastest, most consistent WiFi from the front door through the backyard, supporting dozens of devices all at the same time and multi-gigabit Internet speeds. Our technology, our brand and our channel are all aligned to deliver this premium segment. But we are differentiated across the mainstream market as well as we are first with the latest technology, over 1 year ahead of our major competitors with WiFi 6. And we are the brand of choice for those who have privacy concerns with a networking provider, with a primary business model of selling advertisements. Traditionally, we provide mobile hotspots via service provider for people on the go; and this year, for underprivileged students for remote learning. We found out during the last 2 years, for those living in rural areas where wired Internet speed is 25 megabits per second or less, they are better served by a 4G or soon a 5G connection. According to BroadbandNow research, over 42 million Americans do not have access to receive broadband Internet service of at least 25 megabits per second. We are addressing this market with our fixed wireless products. And based on the sales of our 4G products in retail in the last 2 years, we believe we can grow this segment to be a material part of our retail Connected Home business. Today, we are selling 4G modems, 4g routers, 4G mesh Orbi. And soon, we will introduce 5G variants of them. And in the future, with sufficient coverage of 5G, mobile operators around the world may be competitive against wired operators in residential Internet service, and this market will grow even bigger. Again, we have the unique RF expertise of putting cellular and WiFi circuits in the same box. None of our competitors have this expertise nor the experience. 2 gigabit Internet is going to be rolled out in large-scale by the cable operators in 2021, and we will provide the new WiFi 6E products just-in-time to harness this newfound speed, for large video file downloads, 8K gaming and many other video intensive applications. We know from our industry partners that WiFi 6E phones and laptops will be widely available in 2021. In Asia, 10 gigabit Internet is being rolled out in major cities, and that is paving the way for the next WiFi technology, WiFi 7. We believe not only will consumers pay more to buy our premium Orbi mesh, they will also step up their pace in upgrading their WiFi setup to the latest Internet speeds available. We see a continuous growth path in our hardware sales, which will naturally bring in more paying service subscribers. We are bullish about our growth in the top line and even more so in the bottom line. Now I'd like to introduce Heidi Cormack, our SVP of Global Marketing.

Hello. I'm Heidi Cormack, Senior Vice President of Global Marketing at NETGEAR. NETGEAR has a proven history of building strong brands, are bringing the very latest technologies to homes and businesses around the world, to benefit our users, enabling them to do more with their lives at home and at work, so they're happier and more productive. 25 years ago, we introduced unmanaged switches with LEDs and the jacks easing the installation of any Ethernet network. And to this day, with high market share in all 3 continents, NETGEAR is the undisputed leading brand for SMB switches known for reliability and performance. And now we are extending that trusted brand among AV installers and wizards around the world with our ProAV line. We then built our first multi antenna WiFi router, culminating in the esteemed brand of Nighthawk. And with the introduction of tri-band mesh, we have firmly established the Orbi brand as the undisputed leader in high-performance WiFi, delivering screaming speed and whole-home WiFi coverage. With these 2 brands, Nighthawk and Orbi, we are known among consumers around the world as the brand of choice for premium WiFi. And we are now seeing the crossover of that brand trust and recognition move into home-based and micro businesses as well with our Insight branded access points and the Orbi Pro. And this is validated by third-party reviews, awards and customer feedback from around the world, reinforcing our unrivaled performance and market leadership. And we continue to reach and acquire new customers and drive demand for our premium products through effective digital marketing strategies, engaging with our customers directly on the platforms where they are online through social media influencers, streaming platforms, driving traffic and demand to our online stores worldwide. We started our direct-to-consumer online sales about a year ago, and we're seeing tremendous traction with our loyal customer base. With these strong established brands on the product side, we're now building another pillar of success through our value-added subscription services, services that not only further enhance the lives and work of our customers, but also provide us with a platform to increase our engagement with them. With more time being spent online and the new norm of working and learning from home, our value-added services are becoming more essential to protect home users and provide peace of mind. Our customers really value the protection they get with services advanced cyber threat security for their home network and connected devices. And with more time online and learning from home, smart parental controls is helping parents to manage and monitor children's time online and create healthy digital habits. The Meural membership continues to surprise and delight our customers with old art, new art and everything in between, including creating playlists and the ability to upload and share their own photos. And for our business customers, Insight remote cloud management provides customers the ability to quickly and easily manage and monitor their networks, large or small from anywhere. And we continue to make great progress in acquiring new subscribers, particularly on our premium Orbi WiFi 6 products with Armor advanced cyber threat security and parental control. Through ongoing engagement and campaign optimizations, we've been able to continue to improve our paid conversion rates for both new customers and our existing installation base. In new product installations, customers are registering and using the app and activating the free 30-day trial of Armor. The trial activation rate we are seeing for new installations and the trial to paid conversion rate we're seeing from our installed base are providing encouraging paths to improve on both sides. We exited Q3 with 396,000 paid subscribers and continue to make good progress adding more subscribers to our premium paid services. And we are targeting around 650,000 paid subscribers by the end of next year and intend to add new services, such as gaming in 2021 that go hand-in-hand with the premium WiFi segment, and our new long-term goal is to acquire over 2 million paid service subscribers. And now I'd like to introduce Vikram Mehta, Senior Vice President of our SMB business.

Hi, everyone. My name is Vikram, and I lead NETGEAR's SMB business. 2020 has undoubtedly been a very challenging year for businesses, small and large. As the pandemic shut down many small businesses, it caused us pain in Q2 and Q3. However, approximately 10 months into this global pandemic, we are seeing some permanent changes in how work is performed via a work from home network, which, we believe, presents a lasting opportunity for us. First, we see some centralized operations like call centers being decentralized around the world. Every call center employees home office is being outfitted with low port count PoE switches to link up an IP phone and computing device. We've seen increasing demand in recent months for our low core count PoE switches around the world. The U.S. airline industry took this path many years ago to save costs and improve retention, and we believe this trend is now being adopted by other industries with call center operations and will sustain long term. Second, we are seeing professionals like engineers, doctors, accountants, architects and lawyers working from home, while their family members are engaging in other online activity. Here, the business network must be separated from the home network. And we are seeing more and more users adopting our Orbi Pro mesh WiFi 6 system to provide multiple segregated wireless networks in their home environment. Third, we are seeing an uptick in demand from home-based businesses, which have been sprouting up rapidly since the pandemic began. These business owners are building commercial-grade networks that span from their garage or barn-house to their living rooms, bedrooms and studies. NETGEAR being a trusted brand for consumers and small businesses alike is being universally adopted as these businesses combine our low port count VLAN switches and access points to create such a commercial-grade network that serves their business needs and the demands of their family members who are either working or learning from home, all while keeping the business operation secure and reliable. These 3 work from home scenarios and our corresponding solutions are driving an increase in sales of our low-port count switches and WiFi products. And this increase in low-port count switches will offset the loss of some higher-port count managed switch products, which are deployed in offices, which are at least temporarily shut down. On the other hand, the rapid increase in demand of our Orbi Pro systems and VLAN capable access points as part of a work from home network is net new business for us. We believe the work from home model is here to stay. And as such, we have a long runway to grow our wireless LAN business based on delivering good quality work from home network solutions that enable separation of work in home traffic and leverage the advances in technology like WiFi 6 and Ultra PoE. We have been recognized as the worldwide leader in home office and micro business commercial network solutions. And as such, the growth of products that comprise this lineup will last for many years to come as hybrid work from home, distributed home offices, home-based businesses become the way that people work in a post pandemic world. I would also like to take a moment to comment on our ProAV business that I first spoke to you about at our Analyst Day in December of 2019. The march towards ultra high-definition or 4K video took a brief pause at the beginning of the pandemic, but is resuming now, and we are seeing a strong funnel going into next year, especially with the introduction of our award-winning 4250 series of ProAV switches, which support audio/video bridging and enable high-quality audio and video signal distribution over a gigabit Ethernet network. And this is on top of our SDVoE capable 4300 series, which enable delivery of uncompressed 4K video over 10 gigabit networks. Here are some examples of ProAV partners that we have been working with around the world. These are global powerhouses in the AV industry, both equipment vendors and integrators who are making NETGEAR products an integral part of their solution offerings. And projects are resuming in anticipation of an end to the cut in pandemic, particularly with the availability of a vaccine. And here are examples of some popular sports using our ProAV switches combined with equipment from our partners for enhanced experiences like action replays, digital umpiring and multicasting around the globe which all deliver a more immersive experience to audiences watching at home. As more and more users are staying at home, the watch live streaming of sports and other events, we are seeing a bigger adoption of our products and solutions. There are global organizations, both nonprofit and for profit, which will continue to use ultra high-definition video conferencing systems from their sprawling global campus locations for important meetings across multiple meeting rooms simultaneously. And these systems are secure, private and deliver an immersive experience. And as business travel is expected to be curtailed even post pandemic, we are seeing an increased demand for this type of system setup. Projection screens or chroma key screens for presentation production are being replaced at the high end by large ultra high-definition LED video walls. As entertainment shows and new product introductions are streamed real-time around the world, projection screens are giving way to this new all-digital setup. And we are seeing a continuous shift among tech companies, high-end video production houses and theaters adopting this type of solution. There are many more ProAV applications such as remote surgery, distance learning, live information updates at transportation hubs and vacation resorts, where multi content sources are linked to multiscreen display systems. And the reach of AV over IP is limitless. And we believe it will fuel our ProAV switch growth for years to come. We were first to introduce commercial WiFi 6 access points and mesh systems. First to introduce AV focused 1-gig and 10-gig switches as well as the first to introduce a dedicated line of AV switches with integrated AVB and VLAN capabilities, and we will continue to lead in these product areas. In summary, despite the pandemic-induced setback in our business in Q2 and Q3 of this year, we believe the permanent shift to hybrid work from home and the shift in transporting audio and video signals from HDMI to Ethernet will benefit us in both our switching and wireless LAN product categories in 2021 and beyond. Thank you for your time, and I'd now like to turn it over to Bryan Murray, our Chief Financial Officer.

Hello. I'm Bryan Murray, CFO of NETGEAR. I wanted to start off today looking at our projected top line for the current year. You may recall, coming into the year, we have set a target to grow top line by low to mid-single digits. Now back in late 2019, when we set this target, we had no idea of the challenges that 2020 would bring to all of our lives. Largely driven by the trends that David touched on earlier, with regard to a new way of life for all of us as we adapt to everything from home world, we saw a dramatic increase in our addressable markets. By referencing current consensus, we are steering towards year-over-year growth in revenue in excess of 23%. As we look forward, we believe the momentum of premium WiFi for home and small businesses, as is poised to see our top line continue to grow in 2021 in the range of mid- to high single digits. We would expect SMB to grow in the neighborhood of 10%, and the retail portion of CHP growing in the range of 10% to 15%, more than offsetting an anticipated reduction in sales to service providers. In terms of our non-GAAP operating margin performance, again, referencing current consensus, we appear to be tracking to the midpoint of the 8% to 9% range we provided a year ago. Now there were several puts and takes to keeping this on track. With headwinds from SMB as a result of business closures and disruption, especially at the earlier stages of the pandemic, with the corresponding reduction in our mix of business, cost us about 200 basis points in operating margin. On the CHP side, we incurred significant amounts of higher cost airfreight in an effort to respond to the elevated levels of demand, combined with elongated lead times from the supply chain, costing us about 360 basis points. This was entirely offset by reduced promotional efforts, given supply was not able to keep pace with the elevated demand. Lastly, the higher top line performance allowed us to unlock further leverage in the business. As we look forward, we do expect promotional efforts will tick up as the need for airfreight subsides, which, we believe, will offset each other. We do expect CHP margins to improve as the premium segment of the market continues to expand and further adoption of our value-added subscription services, which will drive an overall improvement in non-GAAP operating margins of about 100 basis points in 2021. Taking a closer look at CHP performance. Here, you can clearly see the top line growth that I mentioned earlier, with total CHP revenues projected to approach $1 billion in sales for 2020. Clearly, this has provided leverage in the overall business, and is a major factor in CHP contribution margins year-to-date being up 540 basis points as compared to 2019. The other major factor is improved product margins, led by the growth in the premium mesh WiFi segment of the market. And as David mentioned, we are uniquely positioned with our strong competitive advantages, enabled by our over 20 years of experience, our RF expertise and our focus on privacy to service this high-growth segment of the consumer WiFi market. Our SMB business certainly experienced more disruption at the onset of the pandemic. But we have seen modest recovery as the year has progressed. That said, you can see from this chart, the impact of the lost leverage and SMB contribution margin, which is down 840 basis points year-to-date as compared to 2019. Looking ahead, we see promise in 2 areas that give us the confidence we will see double-digit growth in SMB top line in 2021, largely coming from Q2 onwards. The first is the value of the wireless setups for home and micro businesses has changed as a result of the pandemic. We think this plays well within our strategy. And we have dramatically expanded our product assortment in this area in the second half of 2020. Second is ProAV. As we continue to see wins in this area, as more and more applications grow dissatisfied with traditional AV setups as the need for higher resolution video becomes more mainstream. Traditionally, our CHP business, excluding sales to service providers, experiences seasonality. With the first quarter typically declining 20% off the back of the Q4 holiday promotional period, relatively flat in Q2 and then double-digit increases in each of Q3 and Q4. Clearly, we didn't experience normal seasonality in 2020, and we expect that to hold true for 2021 as well. This is largely due to timing of supply availability and our ability to get our channel partners' inventory positions into a healthier state which we think will begin in the second quarter. Given this, we believe our overall revenue levels will decline by about 10% in the first quarter, as compared to the Q4 period. With supply constraints expected to ease, we would expect total revenues to be up about 10% in Q2; and in the second half of the year, to grow in the low to mid-single digits as compared to the first half. As Heidi touched on, we continue to make progress on our subscriber acquisition goals. The trajectory that we are on should put us on track to start to have meaningful profit contribution to our overall business over the coming years. Here, you can see an updated sensitivity analysis, similar to what I've shared in previous years. Across the left-hand axis, you can see varying levels of ARPU of $40, $55 and $70, and across the top levels of average subscribers. For 2020, we have seen ARPU in the range of $48, certainly with opportunities to expand this in the coming years. Given the trajectory we're on, we've updated our longer-term target subscriber goal from $1 million to $2 million. As you can see here, at 2 million subscribers, and a slight bump from today's ARPU to $55, it would contribute 330 basis points in operating margin. We have had a very strong year generating cash, with free cash flow of approximately $129 million year-to-date, which is about 224% of non-GAAP net income. Now we expect this pace will come down in 2021 as we reestablish normal inventory carrying levels, and we expect to use in the neighborhood of $100 million in the first half of the year for this purpose. We also continue to evaluate various strategic uses of our cash, whether it be for operational needs, such as R&D investments or further investments in our direct-to-consumer capabilities or M&A or stock repurchase. We continue to recognize the importance of maintaining a strong cash position, but we will continue to balance our practice of repurchasing shares with maintaining a strong balance sheet. Just to recap, for 2021, we believe our top line will grow mid- to high single digits, driven by CHP in the retail channel as well as double-digit SMB growth. Sales to service providers should return to the $35 million a quarter range, on average, but can remain lumpy. We would expect about 100 basis point improvement in non-GAAP operating margins from the full year 2020 projected results, and all of this should drive double-digit growth of non-GAAP earnings per share. As for the longer term model, the continuous double-digit growth of the 4 areas, namely premium mesh WiFi, home and micro business WiFi, ProAV, and subscription services combined should sustain our continuous goal of low to mid-single-digit overall revenue growth. We've increased our long-term subscriber target to $2 million given the trajectory we are on, propels us towards the target non-GAAP operating margin of 15%, all of this contributing to low double-digit non-GAAP EPS growth. With that, I'll turn it over to Patrick.

Thank you, Bryan. As we have discussed, the 4 opportunities that we're seeing coming out of this pandemic, which will benefit us for many years to come are very unique, unique in a sense that NETGEAR with 25 years of experience of RF technology, switching is going to be able to capitalize on these 4 opportunities better than any of our competitors in the market. For premium WiFi, especially those that will be combining with 5G, there is nobody in the industry that could surpass our expertise on putting those radio frequency circuits together. And needless to say, we have established from the very, very old days that we're part of networks, we have absolutely the leadership, the leader in switching. And we're now -- and we have been recognized as the trusted provider of switching to the small businesses and trusted provider WiFi to the homes. But when you combine working from home, home offices, then these 2 elements are uniquely positioned to benefit us. And then we're now using that switching technology to go into the ProAV world as the first mover in that particular area. So we're very bullish on that. And needless to say, for subscription services, we have a huge installed base worldwide of 25 million customers. They trusted us and we add the value added services. We have seen very good reception, and we're pretty confident that we'll be able to achieve long-term of our 2 million subscriber goal. So with this, I would like to open up for Q&A. And first, let's have our operator to disclose how the Q&A process is going to happen.

[Operator Instructions] Our first question today is coming from Adam Tindle from Raymond James.

I wanted to start on the topic of services. So maybe for either Patrick and/or Heidi. I know it's becoming a bigger part of the story. You talked about raising that target to 2 million longer-term. I guess, firstly, would be curious how you came up with that, what gave you the confidence to increase that target? And then secondly, Bryan, in his presentation showed the matrix and talked about a potential increase in ARPU. What have you seen to support that? Is there a trend up in ARPU after an initial service purchase? Or is there more services on the horizon that are higher ARPU that's going to drive ARPU higher? I would be just curious on those 2 aspects.

Yes. Let me take on the question. So for us, first and foremost, we -- as just Heidi said, I mean, we achieved up to about 360,000-plus subscribers by the end of Q3. So we believe that it's completely achievable on that pace, by the end of next year, surpassing 650,000 subscribers. So at that pace, 1 million subscriber target is definitely going to be achievable within the next 2 years. And then we believe that we shouldn't stop there. So 2 million is just another goal that we put out there to double what our initial goal is. We're not saying that, I mean, we're going to achieve that in another 2, 3 years, but we do believe that with the pace that we're seeing right now in the last 2 years, is absolutely a target that is achievable and is exceeding 1 million, so that's the first part. The second part is that we have experience from many of the other services in the world that has increasing features, and as such, raising service prices, as you've seen on Netflix. You have seen it on Amazon Prime, in Costco membership. For ourselves, we have done it also. A good example is Meural, as we expanded our assortment of parts, we have increased our annual subscription fees from the original $39 right now to $69. So we do believe that when we add more features, to parental control, to our cybersecurity, we definitely would be able to justify the increased value-added features for some price increases every other year or so. And we're pretty experienced in that one. So that gives us the confidence that the ARPU should be able to be raised over time.

Okay. And just a quick follow-up for Heidi. When you go into your presentation, I think new customer conversion was not as good as existing customer conversion for the Armor example. Why is that? And what can you do to improve the new customer conversion?

Yes. So there's 2 different...

Go ahead, Heidi.

Yes. So there's 2 different journeys that our customers take. So for the new customers, we encourage them to install and register using our app. Once they install the product with the app, we activate the trial. So we're seeing a higher rate of trial activation on those new installations, around 80%, which is great. And at this point in time, we're converting those trial activations at a rate of around 14% to pay. Now that's on the new installation. The existing installed base, we've made great progress in getting them to install and use the app which is critical as we know. So that rate has increased, and we're at about 80% as well for -- and I'm using WiFi 6 Orbi as the example here per the presentation. So while we're seeing a lot of those existing installed base customers downloading and using the app, we're having to encourage them to activate the trial. Now we're making good progress there, but we've certainly got room to grow based on what we're seeing for new customers. However, given the fact that we're engaging with our existing installed base directly, driving awareness of those value-added services and encouraging them to activate the trial, we're then seeing a higher conversion rate because they're having to engage with us, activate the trial. And that's where we're seeing that higher conversion rate at 22% as opposed to the new customers. So in both instances, it's really encouraging because we're seeing great results on both sides. So we know there's opportunity to improve both for our new customers and our existing installed base.

Okay. That's helpful. And I have one for David, just on CHP since it's been such a bright spot and a big part of the story to hit this new normal and continue on. You talked about how WiFi 6 is 16% of the mesh market at a $523 ASP. I just want to dig into some of the other data in there if you have it. What's the ASP of the rest? And does that $523 ASP maintained as the 16% ultimately goes to 100%? Or does it degrade over time? And how quickly does that 16% go to 100%? So maybe just kind of the -- you're all trying to think about the drivers as WiFi 6 becomes a bigger portion, if you could hit on those 3 topics, that would be helpful.

Well, just a little bit of clarification. I think what David's chart show is 16% tri-band WiFi 6. It's just not WiFi 6. There are also dual-band WiFi 6 that we're selling as well. With that clarification, I think, David, you could take on the rest of the question.

Sure. I mean, I think it really gets to the ASP growth potential of the business. And as we look across all of our consumer WiFi, the ASPs of kind of WiFi 6 are over 2x the ASPs of the legacy business. And that's for 2 reasons. One, because clearly, our WiFi 6 products are a higher ASP, but also because the people who are moving to WiFi 6 are also simultaneously moving to mesh, which have higher ASPs. So the ASPs are more than double as we move from 11ac to WiFi 6.

Got it. And you expect those ASPs to kind of maintain? Or what's your experience over time and how quickly they degrade?

I mean, we think there's potential, particularly in this tri-band WiFi 6 segment, we're really focused to maintain or even grow ASPS. And as I mentioned, we have WiFi mesh systems at $500 all the way up to $1,000, depending on how many units you need and the people who are upgrading their networks for this phenomenon we're seeing right now, they want the best.

Okay. More stuff for me to buy. Last one for me. One for Bryan, to some of the financials. And thank you all for the presentation today. It's been very helpful. Bryan, as we kind of walk through the bridge on non-GAAP operating margin, I kind of understand airfreight and promotions kind of offset then the remaining stuff is an SMB headwind of 200 basis points and then this leverage tailwind of 200 basis points. I think you talked about expecting an increase of 100 basis points in fiscal '21. And if we're at a new normal base in CHP, why wouldn't that leverage maintained to where you'd have a 200 basis point tailwind in fiscal '21, not just a 100 basis point tailwind. And maybe I'm getting too greedy, but just what would I be missing in that? Is there some conservatism?

Yes. I think all of us trying to be greedy, but I think that we need to do some investment as well. So Bryan, go ahead.

Yes, that's right. I mean, I think the 100 basis points is going to come from what David was just touching on, expanding the premium portion of the CHP market as well as subscription services as we aim towards that 650,000 subscriber target. Patrick kind of just hit on there, right? I mean it's very easy to get additional leverage when you're growing over 20% in top line. But at mid- to high single-digit growth for next year, we're going to have to put some money back and invest in R&D and subscription services, the premium portion of WiFi market and other growth categories.

Our next question today is coming from Hamed Khorsand from BWS Financial.

So first question I had was how are you allocating your current WiFi chip supply? Is it mostly to Orbi?

Well, yes. Let me take on this one. We'll take whatever is delivered to us. And because, as we said before, we expect 50% of our sales in this quarter be WiFi 6. So whatever WiFi 6 chips they would deliver to us be it routers, be it cable gateways, be it mobile hotspots, be it mesh, we'll take them. All right. And then, of course, on the 11ac part, I mean, as they come, we'll take them. It's less constrained than the WiFi 6 side. We are not in a position to allocate at all. We take whatever is delivered to us by the chip vendors.

Is there a risk that you might lose market share just given a competitor might get more WiFi 6 allocation than you?

We haven't seen that yet. I mean, we believe that we are the biggest WiFi 6 supplier of systems in the market. If there is any ease of supply, I think we'll get the lion's share of it. We see our competitors are mostly taking share from us by 11ac, by really promoting heavily on the 11ac. And we understand that we will have a short-term pain, as we indicated in Q3, and we did lose some market share. However, I think we continue to build WiFi 6, especially on the premium end, which we see very little competition, which is more lucrative in profit margin. And over time, we believe that segment will win out. So I think we're here for the long haul, and we are in the right track.

And then just on this point is, do you think it's going to be a 1 quarter event as far as being able to resupply the channel? Or is this going to bleed all the way into Q3 of next year?

Right now, our planning is to be able to do it in Q2. But then as things go, we'll see how the supply situation change. I hope that it won't. Because based on committed ship days from our semiconductor suppliers. But things do change. So we'll see, if it is as planned, then it will be a 1 quarter event. But then if there's further delay in supply, then it will be a multi-quarter event.

And then on the ProAV presentation, are you suggesting that the TAM is now higher than before with greater use?

What we're seeing is that, as a matter of fact, this is a new TAM. The ProAV is a completely new TAM because traditionally audio/video delivered through HDMI, but since about 2, 3 years ago, with the establishment of the SDVoE alliance, the push of delivering audio/video over Ethernet has accelerated. Now in the beginning, it was restricted primarily to uncompressed 4K video. Right now, knowing the flexibility and the cost effectiveness and the ease of implementation, now even compressed high-definition video over 1 gigabit is now being adopted. So the TAM is expanding. So it's a completely new thing. It's not an existing old one. It's a completely new TAM.

Our next question today is coming from Jeffrey Rand from Deutsche Bank.

You talked about the growing premium WiFi mesh market continuing to grow and reaching 35% of the market at some point. When do you expect us to reach 35%? How do you think about how this will trend over the shorter-term in the next year or 2?

We believe that it's all supply bound. So -- and just the encouraging sign of this, the premium end of this market is actually happening around the world, it's not only in the United States. We've seen the adoption of that panning from APAC to Europe and to North America. Today, it's all supply bound. And as we see it around the world, the WiFi experience is desired by people who can afford it. And for people who could afford it, they want nothing less. And so whatever is the highest Internet speed they could get a hand on, is 1 gigabit in the U.S., is soon 2 gigabit. It's 10 gigabit in Japan; in Hong Kong and Korea, they get 10 gigabit. Similar things happening in Europe. And for these people, they want the best WiFi to couple with that Internet speed. So they -- if they could get a hand on our premium tri-band WiFi 6 Orbi they'll get to it. We just do not have enough chips to supply. So if you ask me whether I have a magic wand that I could get all the chips that we want, we could get to 35% of that mesh market in this, in no time, but you have to understand this is dollar value market share. It's not unit market share. If you look at our competitors pushing 11ac mesh, at sub $200 level, while we are pushing this on $1,000 level for every system we set up. We are 5x more effective in gaining share from a dollar value basis.

Great. And then you've talked about the more hybrid working model of supporting your SMB business. Does this blur the line between products in your 2 business segments? Or do you think this will just change the type of products in your SMB business?

It is not blurring, but it is definitely changing the way that we are targeting our product lineup as well as marketing for our SMB business. Now the differentiation between the commercial and the consumer network is primarily boiling down to management and segregation of traffic and security of the traffic. So as Vikram has pointed out, on the commercial side, we're really focused on VLAN, we are focusing on POE. So this work from home on a commercial sense, they would like to completely segregate using VLAN, the home traffic, which are for gaming, for learning, for online exercise. Well, with the commercial, where they have to secure the data because they're treating with maybe tax accounting client or even the clinicians, clients and all that. So I think that's the demarcation of technology, is the VLAN, the security versus the consumer side. And we see that will continue to focus on providing more line up in this area. And it's completely new to us because, before in the SMB network, we primarily focused on on-premise. And when it's on-premise, then we're mostly on the switching side, we did not make a lot of headway on the wireless LAN side. But when that on-premise commercial network shifted back into the home area, all of a sudden, the wireless LAN side opened up entirely to us. And so we believe that this is a tremendous new opportunity for us to go in and expand our wireless LAN service product offerings on the commercial side.

Great. And just last question for me. How do you think about changes in the competitive environment since your last Analyst Day last year?

Yes. It's pretty clear that the market is bifurcating on the Connected Home side. And as I said, this pandemic has accelerated the adoption of a premium market. We have never thought that there would be WiFi setup at home. People are really looking for the best experience and willing to pay up to $1,000 and or even more for it. The pandemic has shown us this is possible and is happening in earnest. And so this is something we believe that is going to stay. And we believe that in this marketplace, we have very little competition. Because with the trusted brand and it's being tested around the world from all kinds of reviewers, both technical reviewers or just general reviewers, in Germany, in Italy and France, in Japan, in China and here in the United States, I mean, it's proven. Nobody else is even close to our performance. So in this premium segment, we see very low competition. But on the other hand, in the ordinary segment, clearly, I mean, we're seeing strong presence of the Amazon Eero. Since the Amazon bought Eero, they've been going price, price, price in this kind of mass market, and basically eliminate traditional competitors such as Linksys D-Link. I mean, those are pretty much gone, completely replaced by the Amazon Eero. And so clearly, they are a much bigger competitor in that particular mass market than Google because they have their own channel. They control their own channel. So the landscape is quite different. So I see -- we are going to continue to compete pretty competitively in that mass market because we believe that we still have the performance advantage, and there's still some people, as David pointed out, that who kind of worry about privacy issues that galvanized towards us. But on the premium end, we clearly see us to be very unique in that offering. Now on the SMB side, we used to compete pretty aggressively in the on-premise network side with the traditional names such as Ubiquity, HP, Dell, and to a lesser extent, Cisco. But since that work from home opportunity opened up to us, again, I mean, we're seeing a very unique opportunity for us to really go into that space. Now traditionally, on the low-end micro businesses, we have huge market share as we have talked about many a time, that in the low end retail-oriented switches, we get 50% plus market share around the world. But now when the shift to work from home, then all of a sudden, not only they're buying switches, they're buying access points. And when they buy access points, they buy from us. They're not buying from our traditional competitors of like HP, Aruba or Ubiquity. So I think the landscape changed a little bit. And in this home based work from home environment, traditionally, access points, suppliers are Asians. But then when people are now doing serious work from home, they would prefer the trusted brand of NETGEAR rather than our Asian competitors. So that's the dynamics of the competitive landscapes in the various elements.

Our next question today is coming from Paul Silverstein from Cowen.

Great. So a handful for me. Starting off with, Patrick, I think you said it twice, so I apologize. But WiFi 6 as a percent of total revenue this quarter, your expectation coming out of next year would be what?

No. I mean, coming out of this quarter, going to next year, we expect that it'd still be supply bound, but we're pretty confident that we'll be pretty much like at 50-50, WiFi 6 and WiFi 5. Hopefully, we can go higher when we get more supply starting Q2 next year.

And I recognize, as you just said, supply constraint is a big issue, but any thoughts for what the skew would be around the end of next year going into 2022.

You mean Q4 2021?

Yes. By the end of December 31, '21, what percent of revenue will be WiFi 6?

From our point of view, it will be 80%, if not more.

Okay. I appreciate that. Patrick, any thoughts for what the duration of this WiFi 6 upgrade cycle, how it compares? I know I've asked this question in the past. So again, I'll apologize. But what's your expectation for the duration of this upgrade cycle versus 11ac and in g and all the previous upgrade cycles. Any thoughts for how long this continues in terms of the strong growth period before it flies out and rolls up?

No, that's the interesting part that David talked about and I alluded to, all right. So this cycle is a little bit different because this cycle is all supply constrained. And this cycle is accelerated by this pandemic stay-at-home situation. So people realize that they have to do a lot more from home, and as such, WiFi connectivity experience is paramount, is super important. So they'll pay up. But while they are willing to pay up, we cannot supply. So you have 2 driving forces. And that's why, I mean, this upgrade cycle, the WiFi 6, it's all going to be dependent on supply. And if we -- let's say, I had a magic wand, I had unlimited supply, I think this upgrade is going to be accomplished really fast. Because the next cycle of upgrade is coming. As David pointed out, the next upgrade cycle, the 6E is coming in next year, while the Internet speed is being upgraded around the world from 1 gigabit to 2 gigabit to 10 gigabit. You need to support that speed with WiFi 6E. So we expect the WiFi 6E upgrade cycle will start sometime in the middle of next year.

So you don't -- you clearly don't expect to have the prolonged trough -- multiyear trough period that you've had in the past between WiFi upgrade cycles. Do you think these cycles are going to be more accelerated and shortened as we all want more bandwidth for fatter bandwidth video et cetera applications?

Yes. As Bryan pointed out, right, we expect that the retail side of our Connected Home is going to grow 10% plus next year. And we expect that if the upgrade cycle will continue with 6E, supply is not constrained, that will continue on. Because as David and I pointed out, people are keeping up the pace with the Internet technology speed upgrade. And we do believe that the upgrade to 2 gigabit to 10 gigabit is going to last for many years to come.

All right. So Patrick, let me ask you a question with devil's advocate perspective. Given that it sounds like, as one would expect the Googles and Amazons are going after the low-end, as you said, you're losing share there, but you're seeing this big uptick in the high end premium, which I trust you're happy for that trade-off. But that said, one would expect -- I would think that one would expect high end, the wealthier stratum of society to be early adopters. In addition, on top of that, we were shelling out $1,000 as opposed to a couple of hundred dollars. You're probably not going to upgrade as quickly. And so whether 6E in terms of the availability of 6E products is 12 months from now, 18 months from now, whenever, what is the risk that people shell that $1,000 for WiFi 6 high end mesh products from you. And they say, you know what, we're going to stick with this for the next 2 to 4 years before we contemplate upgrading, before we see enough urgency to upgrade to WiFi 6E, WiFi 7, whatever.

Yes, it's a simple math. I always use the math here, right? So let's say, in the U.S., there is 350 million people. And I divide it by 2.5 per household. So we're talking about 135 million households. Let's say, only the 1% of the people will opt for these best lifer experience, which I'm underestimating it. But even the 1% represents 1.35 million households. And if 1.35 million households are going to spend $1,000 to get the WiFi experience to the best, which they have always tried to do with their cars, with the houses, with the vacation spots and all that, that's a $1.35 billion TAM. Pretty big. I mean -- so let's say, we have to cycle through them over 4 years, all right, hey that is still a $300 million plus per year, just on this segment. And that's U.S. only. We haven't talked about outside of U.S., as I said, this phenomenon is everywhere, from Japan to China, to Germany, to Canada, to Australia. So this is tremendous TAM.

Got it. All right. One last question for me. And as you just said, it's a big opportunity. But as service providers increasingly seek to offer a managed service broadband access experience where you simply have an antenna hanging off of a fiber. An increasing number of service providers are doing this and increasing number will do it in the future. Is that trend good, bad or neutral for you?

As we mentioned, the service provider is always 2, 3 years behind in technology. They would be great for the mass market. But for this top end, it is very hard for them to be able to withstand that kind of slow WiFi. I mean if you subscribe to a 2 gigabit service from the service subscribers, but then you're only getting 20 megabits at the far end of your house where you have a study or you have a cellar, you're not going to work, it's not going to work.

At the risk of being argumentative, Patrick, I'll challenge you on that because while I think that was absolutely true in the past, if I'm not mistaken, by way of example, service providers that use Calix were able to WiFi 6 around the time that you launched your own WiFi 6. It was coterminous, I don't think there was a meaningful difference in the timing when those products were available.

But it's not just WiFi 6, though, all right. WiFi 6, some of them performed really poorly. And as we have heard from a lot of reviews, the WiFi 6 has come out of Eero is not comparable at all to the WiFi 6 that we provide on our WiFi 6 Orbi. So not all WiFi 6 are equal. It's just like, I mean, luxury bags, they're not equal, all right, the luxury bags ranging from Coach to Hermès. So I think there is a difference.

Thank you. We've reached end of our question-and-answer session. I'd like to turn the floor back over to Patrick for any further or closing comments.

Great. Thank you, everybody, for joining us today. We're really excited about these opportunities. Some of them are very unique from a hardware perspective; but also, I mean, for the subscription services, we believe that there is tremendous runway for us to really service our 25 million loyal customers around the world with value added services. As Heidi said, we're going to introduce the gaming service to our platform in 2021, but we are thinking already beyond that to supply more varied of services to our platform. So we do believe that not only that we will see growth in the top line from the hardware, we also see significant growth in the bottom line on a double-digit basis for the next few years. So we're looking forward to update everybody in February when we summarize our 2020 performance. Look forward to talking to you again in about 2 months' time. Thank you. Bye-bye.

Thank you. That does conclude today's teleconference webinar. You may disconnect your line at this time and have a wonderful day. We thank you for your participation today.