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Netgear Inc (NASDAQ:NTGR)
Q1 2020 Earnings Call
Apr 22, 2020, 5:00 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Ladies and gentlemen, thank you for standing by. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. [Operator Instructions] I would now like to turn the conference over to Erik Bylin. Please go ahead, sir.

Erik Bylin -- Investor Relations

Thank you, Adrianne. Good afternoon, and welcome to NETGEAR's First Quarter 2020 Financial Results Conference Call. Joining us from the Company are Mr. Patrick Lo, Chairman and CEO; and Mr. Bryan Murray, CFO. Format of the call will start with a review of the financials for the first quarter provided by Bryan, followed by details and commentary on the business provided by Patrick. We will then have time for any questions. If you've not received a copy of today's press release, please visit NETGEAR's Investor Relations website at netgear.com.

Before we begin the formal remarks, we advise you that today's conference call 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-K. Any forward-looking statements that we make on this call 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.

In addition, several non-GAAP financial metrics will be mentioned on this call. A reconciliation of non-GAAP to GAAP measures can be found in today's press release on our Investor Relations website. At this time, I would now like to turn the call over to Mr. Bryan Murray.

Bryan Murray -- Chief Financial Officer

Thank you, Erik. And thank you everyone for joining today's call. We are very pleased with our first quarter 2020 results. Our team executed well in a rapidly changing market. We're working from home for the final few weeks of the quarter. Despite the market demand and distribution logistics disruptions presented by the worldwide COVID-19 pandemic, our team adapted quickly and overachieved on the financial and operational targets we set at the beginning of the quarter for net revenue, operating margin, free cash flow and channel inventory levels and product mix.

Net revenue for the first quarter ended March 29, 2020 was $230 million, above the top end of our guidance range, but down 7.7% year-over-year and down 9.1% on a sequential basis. The decline in revenue year-over-year is primarily due to a reduction in service provider revenue of approximately $11 million. The Q1 '19 period benefited from a pull-forward from certain channel partners in the UK, ahead of the originally planned Brexit deadline. Revenue came in above guidance, due to exceptionally strong market demand toward the end of the quarter, driven by the massive shift to work from home around the world. This increase in end user demand helped us to adjust our channel inventory level and product mix to become more WiFi 6 centric on the CHP side and Power-over-Ethernet centric on the SMB side. Our non-GAAP operating margin for the first quarter came in at 3.6%, also above the top end of our guidance range, driven largely by the leverage created by our revenue outperformance.

For the first quarter of 2020, net revenue for the Americas was $158.2 million, which was up 6.9% year-over-year and down 6.5% on a sequential basis. The seasonal decline in the Americas lessened from the prior year benefiting from the increased demand created by the work-from-home requirements. EMEA net revenue was $42.1 million, which was down 26% year-over-year and down 16.5% quarter-over-quarter. This was largely due to a difficult year-over-year comparison as Q1 '19 benefited from increased shipments to our UK distribution partners in anticipation of the originally scheduled Brexit deadline. Additionally, service provider net revenue was lower on a year-over-year basis as our partners are waiting to launch of 5G products. Our APAC net revenue was $29.6 million, which was down 32.8% from the prior-year comparable quarter and down 11.2% sequentially. The decline on a year-over-year basis is largely driven by service provider revenue in Australia as they also are awaiting the launch of 5G products while sequentially, we faced challenges from COVID-19 at the Greater China region.

For the first quarter of 2020, we shipped a total of approximately 3.4 million units, including 2.4 million nodes of wireless products. Shipments of all wired and wireless routers and gateways combined were about 1.3 million units for the first quarter of 2020. The net revenue split between home and business products was about 72% and 28% respectively. The net revenue split between wireless and wired products was about 65% and 35% respectively. Products introduced in the last 15 months constituted about 23% of our first quarter shipments, while products introduced in the last 12 months contributed about 21% of our first quarter shipments.

From this point on, my discussion points will focus on non-GAAP numbers. The reconciliation from GAAP to non-GAAP is detailed in our earnings release distributed earlier today. The non-GAAP gross margin in the first quarter of 2020 was 29.2%, which was down 410 basis points as compared to 33.3% in the prior-year comparable quarter and up 130 basis points compared to 27.9% in the fourth quarter of 2019. Gross margin improved as expected in Q1 '20 compared to Q4 '19 as the drag from Section 301 tariffs was largely eliminated. The year-on-year decline in gross margin is partially due to significantly lower shipments of SMB products compared to Q1 '19 when we shipped high volumes into the UK market in anticipation of the previously expected Brexit deadline.

Total Q1 non-GAAP operating expenses came in at $58.9 million, which is down 2.1% year-over-year and down 0.9% sequentially. As always, we manage our expenses prudently, while also ensuring that the growth portions of our business have the resources that they need to succeed. Our headcount was 797 as of the end of the quarter, down by 12 from the prior quarter. As always, we manage our headcount very tightly, especially in times of economic uncertainty. Our non-GAAP R&D expense for the first quarter was 8.1% of net revenue as compared to 7.1% of net revenue in the prior-year comparable period and 7.2% of net revenue in the fourth quarter of 2019. R&D is one area where we will continue to commit resources because our leading edge product introductions are the engine of our future growth and empower us to gain share. Our non-GAAP tax rate was 24.2% in the first quarter of 2020.

Looking at the bottom line for Q1, we reported non-GAAP net income of $6.4 million and non-GAAP diluted EPS of $0.21. Turning to the balance sheet, we ended the first quarter of 2020 with $209.7 million in cash and short-term investments, up $14 million from the prior quarter. We successfully reduced our inventory by $54.9 million in the quarter as we delivered on strong domestic demand and continued to shift the mix toward WiFi 6.

In Q1, we generated $29 million in cash flow from the operations, which brings our total cash provided from operations over the trailing 12 months to $79.7 million. We use $1.3 million in purchases of property and equipment during the quarter, which brings our total cash used for capital expenditures over the trailing 12 months to $9.5 million. We remain confident in our ability to continue to generate cash and expect we will be able to further increase our cash position during the remainder of 2020.

In Q1, we spent $15 million to repurchase approximately 584,000 shares of NETGEAR common stock at an average price of $25.71 per share. Since the start of our repurchase activity in Q4 2013, we have spent $543.7 million to repurchase 15.3 million shares. Our fully diluted share count is approximately 30 million shares as of the end of the first quarter. We recognized the importance of maintaining a strong cash position in a time of uncertainty and will balance our practice of repurchasing shares with our desire to maintain a strong balance sheet.

Now, turning to the results of our product segments. The Connected Home segment, which includes the industry-leading Nighthawk, Orbi, Nighthawk Pro Gaming and Meural brands generated net revenue of $164.7 million during the quarter, which is down 2.8% on a year-over-year basis and down 10.4% sequentially. The year-over-year decline was attributable to lower service provider revenue mainly in APAC, which was down approximately $10 million as compared to Q1 '19. This decline offset strong growth in the Americas where we saw increased demand in both service provider and retail channels compared to the prior year. We again held more than half of the US market share in consumer WiFi coming in at 51% for the first quarter. The SMB segment generated net revenue of $65.3 million for the first quarter of 2020, which is down 18.1% on a year-over-year basis and down 5.5% sequentially. As previously mentioned, the European region benefited in Q1 '19 from increased demand and anticipation of the originally scheduled Brexit deadline, while in Q1 '20, the Americas experienced declines with the onset of the pandemic.

On the product front, our PoE+ and ProAV switching lines continued to perform well in the market. Our market share in switches sold through US retail channel remained at 53% in Q1. As noted in the press release, given the uncertainty in the global economy brought about by the shutdowns due to the COVID-19 pandemic and its corresponding unpredictable effect on market demand, we feel it's prudent to suspend our practice of giving guidance. Consequently, we are withdrawing the prior revenue and operating margin targets for the full year of 2020 that we gave in November of last year at our Analyst Day.

I will now turn the call over to Patrick for his commentary.

Patrick Lo -- Chairman and Chief Executive Officer

Thank you, Bryan. First, I would like to start by saying that I'm very proud off and grateful to our team for the adjustment to the difficult environment and how we delivered in the first quarter. We faced considerable execution challenges such as a shift in channel demand from retail to e-comm, accelerated CHP product demand, but slower SMB sales and disruptions to inbound and outbound supply, all while pivoting our workforce to work from home starting in Asia in February and then on a global basis from early March. Despite these hurdles, I extremely pleased that the team navigated through this difficult environment to come through for our customers at this enormously disruptive months, while keeping themselves and the families safe.

By pivoting our broad set of products through the right channels and mix in an uncertain environment, NETGEAR outperformed a number of key financial metrics, while strengthening our balance sheet. Our Connected Home business saw a double-digit growth in end-market demand worldwide toward the end of Q1 as people mobilized for work from home mandates. The work from home and school from home requirements put unprecedented demand on home networks. Families recognized that strong WiFi performance at home is now a necessity and responded by upgrading their WiFi connected at various price points according to their financial ability. Also across both Connected Home and SMB sets [Phonetic] and our three geographies, we saw strong e-commerce growth, due to the shuttering of many physical retail stores.

The March surge of home WiFi market demand drove outperformance on the CPE side of the business, but given the shutdown of non-essential businesses in most market from mid-March, SMB result came in in line, but faced increased headwind as we exited the quarter. Even in this significantly disruptive market, we saw further signs that each component of our strategy from capitalizing on technology inflections to expanding into adjacent markets, to building recurring revenue help propel NETGEAR to advance share gain, revenue growth and double-digit operating margins in the long run. Clearly, our early involvement in WiFi 6 product leadership is paying dividend. It propelled the North America retail networking market back to growth in January and February. And the growth trends significantly accelerated in March. While we can't be confident how long the home WiFi demand search will last, we're still seeing double-digit growth at this point in Q2. WiFi 6 is about 25% of our North America router and Mesh system end-market demand in Q1. With more new products and supply, we believe this proportion will increase in Q2 and beyond.

We now have three different WiFi 6 Mesh product in the market with two-pack pricings at $229, $449, and $699 to suit homes of different sizes. Our two major competitors in the market has yet to introduce a single competitive product. We now have six models of WiFi 6 routers with pricing ranging from $149 to $599, spanning different performance levels. We were excited to ship our first batch of WiFi 6 5G mobile hotspots into the EMEA market toward the end of the quarter. We expect this category to ramp up in the quarters to come and be a meaningful component to our service provider revenue in the rest of the year. We anticipate our service provider revenue will grow 50% sequentially in Q2, due to increased mobile hotspot sales worldwide.

Mobile hotspots are now being used by people working from home when they are not able to get high-speed wired Internet access. Hotspots are also now extensively used by first responders during this pandemic. In addition, the NETGEAR team is doing what we can to help the community by donating hundreds of mobile hotspots to various San Francisco Bay Area school districts for students' use. We are thankful for our partner AT&T for providing free data plans to those in need to help their school from home efforts. Furthermore, we have record progress on driving out recurring revenue stream. We began the quarter with a 177,000 paid subscribers and added a record 51,000 to end with 228,000 paid subscribers. We are off to a great start toward attaining our goal of more than doubling our subscriber base during 2020.

In the SMB market, we continue to excel in Power-over-Ethernet switching and saw strong growth in unmanaged and ProAV switches. Clearly, when more home offices are being set up by engineers, designers, architects and other professionals, the demand for our unmanaged switches increases. In February at the Integrated Systems Europe Conference, an event similar to CES, but focused on the audio visual, we demonstrated how we could accelerate the AV-over-IP transition, while making installations easier for the integrators and the more our integrated certified solutions can easily expand from small to very large installations. Our pre-configured switches enable AV-over-IP networks to be plug-and-play, a welcome feature to the AV integrators around the world.

In March, we announced that Crestron certified our series 4300 switches for out-of-box deployment of AV-over-IP by Crestron worldwide. A dominant player in the growing transition to AV-over-IP, Crestron provides a rigorous certification program to ensure AV components work together seamlessly and deliver high reliability. This is another data point validating our ability to accelerate the Pro AV market. While we are currently seeing a 50% decline in our SMB product demand in the traditional IT world as a result of the fallout from pandemic, we are encouraged by the uptick in work-from-home Ethernet setups and Pro AV switches, which together mitigate the SMB declined by half. Overall, we expect our SMB revenue to decline 25% sequentially. The IT demand does not revive in Q2.

The COVID-19 pandemic has brought about a considerable shift in our business in short order. We are seeing a surge in demand that boisterous the outlook for Connected Home in both the service provider and retail channels counted by softness in SMB. The resulting mix shift, coupled with higher freight costs as we quickly respond to the increased demand on the CHP side, will likely constrain operating margins in Q1 levels in the current quarter. Despite the air freight rate increasing by 2.5 times recently, we are committed to helping our customers to upgrade their home WiFi performance by expediting availability of our products across the whole lineup from WiFi 5 to WiFi 6, from routers to expanders, from cable to 4G, 5G. We believe by serving our customers well, they will reward us in the future by upgrading the home WiFi to WiFi 6 with us and be more likely to subscribe to our value-added services. We cannot predict how long the surge in demand for WiFi products will last for the work-from-home upgrades or what the demand will look like after it subsides. However, we remain hopeful that a higher bar will have been set.

In the next two quarters, we have finite volumes we can deliver through the channel worldwide as we are limited by supply capacity that is constrained by material availability, factory uptime and freight capacity. With the shift in demand from retail to online, we expect channel inventory to decline as channel partners move to more efficient operating structures which while healthy for the long term would further constrain our revenue growth in Q2. While we cannot predict how long the business shutdown will depress the IT demand of our SMB products in Q2 and possibly beyond, we are confident our leadership in WiFi 6, 5G, Power-over-Ethernet and Pro AV will position us to be the biggest benefactor after the pandemic subside with so many customers experiencing the superior performance and availability of our products worldwide during these difficult times.

And finally, on behalf of the entire NETGEAR team, I would like to show our deepest gratitude all the medical post responder and the essential business teams on the front line fighting for us and keeping us safe.

And with that, I'll open the call up for Q&A.

Questions and Answers:

Operator

[Operator Instructions] The first question comes from the line of Adam Tindle with Raymond James.

Adam Tindle -- Raymond James -- Analyst

Okay, thanks. Good afternoon. And I just wanted to maybe start on the CHP segment, understand not providing guidance, but it does seem like you highlight a lot of positives in this segment moving forward. Just a two parter, first on channel inventory and second on sell-through. In channel inventory, your biggest market in North America retail is showing essentially the lowest level in the past decade, I think it's four weeks below that normal 10 to 12-week range. I guess maybe first, how are you thinking about channel inventory right now? Is there certain number of weeks that you're targeting to get this up to -- is that 10 to 12 range permanently changed? Just comment on channel inventory?

And then secondly, it also seems like demand indicators like search trends remain very favorable and sell-through should be very strong in Q2. What are current sell-through indicators look like for you and how have they trended? Are you -- do you think you're past the peak?

Patrick Lo -- Chairman and Chief Executive Officer

Well, first on the channel inventory side, we do believe that this pandemic and the shelter in place, work from home scenario have altered the channel landscape permanent. We are seeing more and more of our channel partners moving to online, which requires less inventory. And also some physical stores are successfully transitioning to online as well as online order curbside pickup and -- which enable them to manage their inventories significantly more -- in a more efficient manner. So we do believe that overall, the channel inventory for retail is going to trend downwards. And in Q2, in particular related to the second part of your question, as we just mentioned, up till now, which is the first week, into -- in the fourth week of the quarter, we're still seeing the demand side, sell-through side on the consumer WiFi home network around the world, [Phonetic] double-digits and that helps to really continue working channel inventory down.

And as we discussed, we have a limit on how much volume to do that. We could move them around in Q2. We believe that our [Indecipherable], the surge if this demand -- end market demand to sell-through continued to last all the way until the end of the quarter, we still would be completing channel inventory because we just cannot immediately produce that many and ship them to the end locations that we want. So we do believe that the retail channel inventory will continue to trend down. But I do believe that it will come back up. One is the stores are opened again, but would not be to the prior level.

So to what level they are going to come back up in Q3? It depends on a few factors. Number one is DC with the mix of online versus in-store sales of most of our channel partners. Secondly, as how much we can produce in Q3 and how big the freight, the logistics of the world is opening up. And you probably have heard that I mean, less than 10% of the planes that used to fly a flight of. So that really -- it doesn't help and so are the sales. So I think there are multiple factors that kind of basically faster the depletion of channel inventory for the next few quarters.

Adam Tindle -- Raymond James -- Analyst

Okay, that's helpful. Thanks, Patrick. And maybe just as a follow-up, just hoping that you could maybe update some of the variables to operating margin improvement throughout the year. I think you had about 240 basis points from the feeding of tariffs that were supposed to happen entirely during the first half of the year. There was 140 basis points or so from promotional activity that was supposed to improve and it sounds like the ASPs look pretty strong in the CHP segment, but we're now guiding to sizable declines year-over-year in the Q2, say, time frame. I'd imagine that the delta is probably the SMB segment, but maybe just update the walk in terms of the operating margin, so that we can -- when we decide when SMB is going to improve know how much that upswing is going to be. Thanks.

Bryan Murray -- Chief Financial Officer

Yeah, I think Patrick touched on a little bit of this. Certainly, the headwinds that we're seeing within the SMB business, we know that's a very profitable business for us. You can look at the differential in contribution margins between the two businesses. And it certainly highlights that so with the headwinds there and even though we're seeing upside on the CHP side, the mix is having a significant impact on our overall gross margin at least as far as we can see today.

In terms of the year-over-year gross margin improvement, we did deliver, I think, 130 basis points improvement. We have aim to do that with the tariffs relenting based on our manufacturing location move. It would have been stronger, but certainly as we exited the quarter with the surge in demand and our need to air freight, we were seeing air freight rates that were about 2.5x what we would normally see given what Patrick said in terms of aerospace capacity. So I think those are the bigger variables as we move forward. And certainly, the sooner things can return to a something remotely close to what we were used to in terms of normal and businesses come back and we can build that SMB business back up, we'll start to see the margin expansion that we were aiming to deliver for the year.

Adam Tindle -- Raymond James -- Analyst

Okay, thank you.

Operator

The next question comes from the line of Hamed Khorsand with BWS Financial.

Hamed Khorsand -- BWS Financial -- Analyst

Hi. So first off, I just wanted to ask, how are you managing your receivables in the cash receipts? Are you on top of that as the customers who are extending payment terms right now?

Bryan Murray -- Chief Financial Officer

Yeah. We've always been very vigilant in monitoring the creditworthiness of our customers. We do businesses globally with very well-established distribution partners. So we continuously monitor news and information and right-size credit capacity. But historically speaking, we have not faced any material write-offs of any sorts and we've dealt with these kind of downturns, starting in 2001 and then again in 2008. So we think we're well prepared to monitor the situation.

Hamed Khorsand -- BWS Financial -- Analyst

Okay. And then as far as just the product categories go, is -- are there any specific products that are seeing the growth or is it across the spectrum?

Bryan Murray -- Chief Financial Officer

Yeah. As we just discussed, it's pretty much across the spectrum, because it has become apparent to us upgrading WiFi performance at home based across the board in all strata of the economic spectrum. So for those with significant financial needs, clearly, they're chasing after WiFi 6, Tri-Band, 12-Stream, Orbi, paying up to $999 for two [Phonetic] nodes. But you also have families that with limited financials headroom, they would just offer as simple upgrade of may be $20 extenders, so that they will expand the WiFi signals to bedroom. So, it's across the spectrum of fee growth.

Hamed Khorsand -- BWS Financial -- Analyst

Okay. And then, lastly, you were talking about not having enough product to meet demand, is that purely from air freight standpoint or are you still facing component shortages?

Bryan Murray -- Chief Financial Officer

Both. All right. Number one, that even if we're willing to pay for the air freight, we just can't claim the slots sometimes. And secondly, the components' availability is unpredictable because of the pandemic. For example, Mexico is just on the rise incur of the pandemic situation, and we are putting in shelter in place. They shut us from factories in which some of the RF components is manufactured. It just happened in the last few weeks. And then, a few weeks back in Malaysia, which was doing that final packaging of some chips -- memory chips. They also have this pandemic hit and they shut down the factories that interrupted supply for a few weeks. So we are constantly fighting these supply challenges. Now, the good thing is our main final assembly factories in Vietnam, Indonesia and in Thailand have been humming along 100%. And then the factories that supply the components from China, they're back to 100%.

So now it's about the pandemic starting to hit all the other different places that we are still trying to be navigating around, and we have no way to predict what's going to happen in it.

Hamed Khorsand -- BWS Financial -- Analyst

Are you able to track as far as the customer turnover is concerned with routers if -- as far as the refresh rate is concerned? Are you able to do that at all?

Bryan Murray -- Chief Financial Officer

Not until they sign up to our -- what we call the single sign-on registration service and download our apps. Today, we have increased that to about 25% of our installed base. We believe we have 25 million of installed base and about 5.5 million of them have downloaded the apps. Other than that, we have very little exposure of the data for rest.

Hamed Khorsand -- BWS Financial -- Analyst

Okay. All right. Thank you.

Bryan Murray -- Chief Financial Officer

Sure.

Operator

The next question comes from the line of Paul Silverstein with Cowen.

Paul Silverstein -- Cowen -- Analyst

Hey, guys. Before I ask my real questions, perhaps, can you want tell us what were the WiFi 6 unit shipments during Q1 and what are the total units shipments to date? I recognize Q1 was going to be the big chunk of that foot, what were the numbers?

Bryan Murray -- Chief Financial Officer

Certainly. Traditionally, we do not break out product specific shipments, but on the whole, the share of WiFi 6 sells out demand of our products in the end market has grown from 15% toward the later part of last year to 25% in Q1 for our routers and mesh systems. So we're very encouraged by that trend.

Paul Silverstein -- Cowen -- Analyst

Okay. And of to the questions, I've got a handful, so my apologies. But first thinking longer term, if you break down the business, first with SMB, obviously small businesses throughout the world have been eviscerated. The impact of COVID has been particularly severe. And when we look, coming out of the worst of the crisis, that particular segment of the enterprise market, I would think, is unlikely to rebound quickly. It's certainly got to get better from current levels. Well, it's going to be hurting for some time to come. And presumably with limited resources in terms of availability to spend on any type of IT, what are your thoughts as you look once businesses start resuming? When you look beyond the worst part of the crisis, what do you expect in terms of SMB demand from a long-term perspective?

And then with respect to your consumer home business, as you pointed out, your primary competitors are in the market today. But if we imagine a scenario in which they did have products in the market, I assume it goes without saying that you're -- you dominate shelf space in bricks-and-mortar and by definition, your market share in bricks-and-mortar is dramatic. On the other hand, in online, if your competitors in WiFi 6 products do ship, your market share, I would think, still strong, but be relatively far less dominant than it is in bricks-and-mortar. So the question is there, when do you expect to see product from your primary competitors? You have any visibility to that. If in fact where somewhere, say, closer people don't want to return to shop in bricks-and-mortar even when it reopens, is that -- would that change the competitive products room on the market? Would that meaningfully impact your revenues for the worse through those competitive dynamics? And then, I've got another set of questions.

Erik Bylin -- Investor Relations

So do you have more questions or that's it?

Paul Silverstein -- Cowen -- Analyst

I'll wait. I'll let you respond to those and I've got a couple more.

Patrick Lo -- Chairman and Chief Executive Officer

Okay. So the first half of your question about the SMB business of pandemic, I mean clearly, there is no way to estimate what that's going to look like. And typically, we sell in the small businesses that our major businesses, customers are on the IT side, OK. Primarily manufacturing and school and local government, those are our typical customers as well as engineering departments of start-ups or major company. So our experience is that when the activities resume, they should come back, all right. Now it may not be 100% with previous level. It will still be pretty close. Schools have to be run. Engineering departments have to continue to develop products. And governments still have to be run. Manufacturing is going to resume, so that's that. And that's why I mentioned on the other hand, we're also benefiting from two new trends that is completely new.

I mean, one, we've developed it, which is the Pro AV trend, which is completely adjacent market, which is completely incremental, right, because the world is moving more and more to digital video, and the digital video is getting more and more high-res, and we [Technical Issues] from 1080p to 4K and from 4K to 8K, all that requires AV to be done over IT. And now, as people tasted work from home, so even software developers, or UX designers, or architects kind of figure out, you know what, I don't need to go to the office and all the time, and I could actually work from home. And for most of them, when they work from home, they use very sophisticated PCs, such as the Mac Pro and -- which is multi-gig.

And so, they set up actually Ethernet networks at home to outfit their home offices. So we do believe that, as is indicated right now, the Pro AV and the home office setup is mitigating part of the IT demand decline. And I think when the pandemic is over, the IT demand will resume for our typical customers. And hopefully, they can return to the prior level. If not, and it will take longer time to return to a prior level, we believe that our Pro AV, which is completely new and incremental, and the home office, which is not going to go away, is going to more than compensate for that scenario. So that's the first part.

The second part, as you mentioned, as the world moves to online, you're right. I mean, we clearly dominate the physical store shelf space, and that's why we have significant higher share in the physical stores. But to everybody's surprise, actually, the move to online business over the last two, three months or not the one that you all think about. It's actually moving online to all the physical stores because the one that you're thinking about is having significant logistical difficulty in stocking and delivering. So a lot of the online business is actually going to our traditional partners such as Costco, Walmart, Best Buy, and where we still dominate from a market share perspective. That's from a U.S. perspective.

From an international perspective, we have actually over the last four or five years moved aggressively online. And as a matter of fact, internationally, we have the reverse. We actually have very little market share in retail stores because we just cannot afford the margin requirement of them and the stock levels that they demand. So we had moved online 100% internationally. And now, with the shift online, it's definitely a benefit of it, because the only way for us is to gain share. So I think this move to online is actually beneficial to us. We strengthen our hands. And also, as you mentioned, online is all about choice. If you go even to the traditional online channel of our choice, with our leadership in WiFi 6, while we have three different performance level of WiFi 6 nationally, six different performance levels of WiFi 6 routers, and just starting a WiFi 6 mobile hotspot, plus the WiFi 6 expanders. And there'll be more to come like adapters, like cable gateways and all that. I think we'll continue to advance our share online versus our competitors with typically a single product offering. So that's how I look at it.

Paul Silverstein -- Cowen -- Analyst

I appreciate that response. One last set of questions, if I may. With respect to the 5G hotspot business, that sounds like a new, exciting opportunity. Can you provide some color? How big is the business at present? What do you expect to do to extend your visibility in that business this year? What did the ASPs look like to the service providers? What's the gross margin associated with it? Any other insight you'd care to provide? That'd be appreciated.

Patrick Lo -- Chairman and Chief Executive Officer

Well, clearly, 5G is the way to go. So the operators from around the world is quickly moving their subscriber base to 5G for a variety of reasons. I think the most important reason is 5G is a significantly more efficient way of delivering data over airwaves. Secondly, it's significantly cheaper to maintain and to upgrade because 5G is more software-oriented than hardware-oriented from the base station from the data routing perspective; so there is an inherent incentive for the operators to move over to 5G. And then for the end user, the advantage of 5G clearly is about latency and about speed. So the world is moving that way. There's no turning back. And from a data speed perspective, definitely, initially 5G will be significantly more expensive from an ASP standpoint. However, over time, I think it would decline back into the 4G well so that it will become super popular, available to everybody.

To give you an idea right now, if you go online to amazon.com or our own store, you will see that the highest performing a 4G mobile hotspot is selling at about $329. But the new 5G WiFi 6 mobile hotspot is probably double that. So that's the ASPs. But over time, the two will converge. And our strategy, of course, is continue to sell whatever the operators want. As I just mentioned during this work from home time, there are different people with different financial means, and there is basic demand for both the latest, greatest and most expensive, but it's also -- there is quite a good demand for the good value, older technology items. And we'll continue to capitalize on this trend. On the mobile hotspots perspective, nobody has a broad portfolio that we do. And that's why we talk about that our second quarter, we'll be seeing a 50% sequential growth in terms of our service provider revenue, which is now pretty much dominated by mobile hotspots and with a significant boost of the 5G shift. And we are pretty confident that this sequential growth will continue in the third quarter as well.

Paul Silverstein -- Cowen -- Analyst

Fantastic. What does the gross margin look like for that business relative to corporate average?

Patrick Lo -- Chairman and Chief Executive Officer

We said previously in many occasions the contribution margin of the service provider business is pretty similar to the other channel business of the CHP segment.

Paul Silverstein -- Cowen -- Analyst

Okay. I appreciate it. I'll pass it on. Thank you.

Patrick Lo -- Chairman and Chief Executive Officer

Sure.

Operator

Next question comes from the line of Woo Jin Ho with Bloomberg Intelligence.

Woo Jin Ho -- Bloomberg Intelligence -- Analyst

Yes, hi. It's Woo Jin and not Wuhan. Hey, Bryan. Could you give us that wireless node number again, please, if you don't mind?

Bryan Murray -- Chief Financial Officer

Wireless nodes. I think it was about 2.4 million.

Woo Jin Ho -- Bloomberg Intelligence -- Analyst

So, Patrick, I mean, given the strength that you had in 1Q, and given what you said about what you're thinking about the demand or the pent-up demand for wireless products, is there any concern that you may have frontloaded the year in terms of your wireless sales, and may have had a weakened second half as a result, if we do have a normalized second half?

Patrick Lo -- Chairman and Chief Executive Officer

I mean, it's very difficult to predict. The encouraging things is that the demand far we see has been across the board. That means there are people buying the latest technology, upgrading to WiFi 6. But there are also a lot of people buying the older technology or the 11 AC low-end expander and adapter as well. So I think people are doing whatever they could afford to upgrade their WiFi performance at home, which leaves us a really bigger space for us to upgrade them to WiFi 6 later on. And now, with people getting a taste of what it is like to be at home, doing your movie watching, doing your gaming, doing your work, getting your home school and all that, I think people have realized that, you know what, WiFi should not be an afterthought. WiFi should be as important as your cellphone.

So people are upgrading cellphones every year or every other year whenever there is a new iPhone out there. And for them, they tend to upgrade their WiFi three years, four years, sometimes even five years. Now, I hope our WiFi upgrade frequency, we're going to be able to match their cellphones very quickly. And that's how I look at it.

Woo Jin Ho -- Bloomberg Intelligence -- Analyst

Okay. And then in terms of a service provider, I don't know how much visibility you have on the service provider side going into the second half. You had said in prior calls that you expect to be back to the $36 million-ish as it relates to the 5G rollout. Are we still at the $36 million-ish per quarter range there?

Patrick Lo -- Chairman and Chief Executive Officer

Yes. And as I mentioned, I mean, we finished the first quarter with roughly about $26 million of service provider revenue, which we expect a 50% sequential growth in Q2. And then we believe that the second half will be a double-digit growth over the first half.

Woo Jin Ho -- Bloomberg Intelligence -- Analyst

Got it. Okay. Got it. And then let's end this on a on a high note. Subscriber numbers were very good in terms of your application. So could you talk a little bit more about it, please? How are you able to convert application users to paid subs?

Patrick Lo -- Chairman and Chief Executive Officer

We're still learning. We're still doing trial and error. There are a few ways to do it. I mean, the most obvious way everybody's doing it, we're doing it also, is giving you a free trial. So we try to give everybody a free trial for 30 days. And during the free trials, we'll give you all the goodies, highlight all the advantages, and make sure that after the 30 days or even before that, you would turn into a paid subscriber. So of course, we'll dangle promotions, coupons and all that to entice them if they sign up for a longer period. So that's the standard classes that we do. And the second thing we find out also is that, at the point of sales, that's the easiest way to catch them to buy the subscription services. So for whatever products they buy, on our own website, we'll entice them to buy a subscription service at the same time because they've already given us a credit card for buying all the hardware. So that's pretty successful too.

And then on the other hand, at the point of sales, for example, in Costco, we have a skew that is including a year of subscription. So people seem to be pretty happy with that too. They're buying that too. So I think those are the two avenues that we are trying. But we're still trying many other ways of trying to entice people. So basically, for now, is one, get as many people onto free trial as possible. Two is trying to get those hardware purchases at the point of purchase to buy into the subscription. We're still looking at other ways of avenues of getting subscribers on board.

Woo Jin Ho -- Bloomberg Intelligence -- Analyst

Thank you.

Patrick Lo -- Chairman and Chief Executive Officer

Sure.

Operator

And I will now turn the call back over to Patrick Lo for closing remarks.

Patrick Lo -- Chairman and Chief Executive Officer

Okay, thank you, everybody, for today and joining me. And once again, I would like to thank our employees and our partners for the hard work and flexibility during this time. We have delivered a strong start at 2020, and we remain confident that the components of our strategy will be strong contributors to our success this year and beyond. And I look forward to updating more on the progress of our strategy with you in the next quarter and beyond. Talk to you soon. Bye-bye.

Operator

[Operator Closing Remarks]

Duration: 53 minutes

Call participants:

Erik Bylin -- Investor Relations

Bryan Murray -- Chief Financial Officer

Patrick Lo -- Chairman and Chief Executive Officer

Adam Tindle -- Raymond James -- Analyst

Hamed Khorsand -- BWS Financial -- Analyst

Paul Silverstein -- Cowen -- Analyst

Woo Jin Ho -- Bloomberg Intelligence -- Analyst

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