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Netgear (NASDAQ:NTGR)
Q3 2020 Earnings Call
Oct 21, 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. [Operator instructions] I would now like to turn the conference over to Erik Bylin. Please go ahead, sir.

Erik Bylin -- Investor Relations

Thank you, Christine. Good afternoon, and welcome to NETGEAR's third quarter of 2020 financial results conference call. Joining us from the company are Mr. Patrick Lo, chairman and CEO; and Mr.

Bryan Murray, CFO. The format of the call will start with a review of the financials for the third quarter provided by Bryan, followed by details and commentary on the business provided by Patrick. We'll then have time for any questions. If you have not received a copy of today's press release, please visit NETGEAR's Investor Relations website at www.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-Q.

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 measures will be mentioned on the call. A reconciliation of the 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. I'm very pleased to share with you our third-quarter 2020 results. With continuing robust demand for our leading-edge products, our team once again delivered a strong quarter with exceptional growth in revenue and profit. We were again constrained on the supply side for our CHP business, saw a modest recovery in our SMB business, yet still delivered strong revenue growth and record non-GAAP operating profit.

Net revenue for the third quarter ended September 27, 2020, was $378.1 million, up 42.2% year over year, and up 35% on a sequential basis. This strong increase in revenue was primarily due to a remarkably robust demand for our CHP products, powered by unprecedented bandwidth consumption in the home, where people have transitioned to conduct the majority of their daily lives. This included products sold to service providers. With associated revenue reached $74.1 million, our highest level since the first quarter of 2016.

We continue to win with our leading-edge WiFi 6 offerings and strong presence in both online and retail. Our supply chain team did an outstanding job in the quarter, giving product to our retail and service provider partners. Outperforming our expectations. The team managed raw materials, manufacturing schedules and transportation, optimizing with airfreight, in particular, to meet more consumer demand than we had previously forecasted.

With that said, we expect to remain supply constrained through the first quarter of 2021, primarily due to a worldwide shortage of advanced chips such as WiFi 6. Our non-GAAP operating income at $41.4 million was a quarterly record, with the reported non-GAAP operating margin of 10.9% as NETGEAR showed our ability to leverage our strong revenue growth. For the third quarter of 2020, net revenue for the Americas was $277.9 million, which is up 55.5% year over year and up 37.4% on a sequential basis. The Americas continued to benefit from increased demand for CHP products in both the retail and service provider channels, generated by the shift to work-from-home environment.

EMEA net revenue was $63.7 million, which is up 28.6% year over year and up 31.7% quarter over quarter. Also driven by demand for CHP products in response to work from home and seen across both the retail and service provider channels. Our APAC net revenue was $36.5 million, which is down 2.9% from the prior-year comparable quarter and up 24% sequentially, both largely driven by our service provider business in the region. For the third quarter of 2020, we shipped a total of approximately 4.7 million units, including 3.5 million nodes of wireless products.

Shipments of all wired and wireless routers and gateways combined were about 2 million units in the third quarter of 2020. The net revenue split between home and business products was about 84% and 16%, respectively. The net revenue split between wireless and wired products was about 75% and 25%, respectively. Products introduced in the last 15 months constituted about 27% of our third-quarter shipments, while products introduced in the last 12 months contributed about 25% of our third-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 third quarter of 2020 was 30.3%, which is up 90 basis points as compared to 29.4% in the prior-year comparable quarter,and up 70 basis points, compared to 29.6% in the second quarter of 2020. While the mix of our SMB business, which historically carries a relatively higher gross margin declined year over year.

And although we spent dramatically more on airfreight in Q3, we were more than able to offset these gross margin headwinds through lower promotional activities on our CHP products. Total Q3 non-GAAP operating expenses came in at $73.2 million, which is up 27.8% year over year and up 18.1% sequentially. The team did a great job with revenue growth far outstripping opex growth to deliver strong leverage on our top line and produce record quarterly operating profit. As always, we will continue to manage our expenses prudently while also ensuring that we are investing sufficiently in the growth portions of our business for future success.

Our headcount was 803 as of the end of the quarter, up by 15 from the previous quarter. We continue to manage our headcount, but will add resources to invest in areas that we believe will deliver future growth. Our non-GAAP R&D expense for the third quarter was 6.2% of net revenue as compared to 6.8% of net revenue in the prior-year comparable period, and 6.9% of net revenue in the second quarter of 2020. To continue our technology and subscription service leadership, we are committed to continued investment in R&D.

Our non-GAAP tax rate was 17% in the third quarter of 2020. In the quarter, we benefited from favorable one-time adjustments to domestic tax liabilities. This contributed about $0.08 to our non-GAAP diluted EPS. Looking at the bottom line for Q3, we reported non-GAAP net income of $34.7 million and record non-GAAP diluted EPS of $1.13.

Turning to the balance sheet. We ended the third quarter of 2020 with $306.8 million in cash and short-term investments, up $48.3 million from the prior quarter. Additionally, our inventory decreased by $6.3 million in the quarter, as we continued to deliver on strong demand in the Americas and EMEA, while remaining supply constrained, which left us unable to increase our own inventory holdings. We hope to reverse this trend in the first half of 2021 and move our inventory position closer to historical norms.

In Q3, we generated $42.9 million in cash flow from operations, which brings our total cash provided from operations over the trailing 12 months to $184.6 million. We used $2.5 million in purchases of property and equipment during the quarter, which brings our total cash used from capital expenditures over the trailing 12 months to $8.5 million. We remain confident in our ability to continue to generate cash and expect to further increase our cash position again in the fourth quarter. In Q3, we chose not to repurchase any shares under our open buyback program.

And our fully diluted share count is approximately 30.7 million shares. Especially in times of uncertainty like these, we recognize the importance of maintaining a strong cash position, and we'll balance our practice of repurchasing shares with our desire to maintain a strong balance sheet. As I previously mentioned, we will need to replenish our own inventory levels. Thus, we would expect to consume some of our cash in the first half of 2021 as a result.

Now turning to the results of our product segments. The Connected Home, which includes the industry-leading Nighthawk, Orbi, Nighthawk Pro Gaming and Meural brands, generated net revenue of $316.7 million during the quarter, which is up 66.1% on a year-over-year basis and up 37.7% sequentially. The year-over-year and sequential increase was attributable to heightened demand across both service provider and retail channels. In the third quarter of 2020, service provider revenue was the highest it has been since the first quarter of 2016, while nonservice provider revenue grew an impressive 56.8% as compared to the comparable prior-year period.

In the third quarter, despite supply headwinds and our WiFi 6 products, we again held a strong leadership position in U.S. market share in consumer WiFi, coming in at 44%. And we fully expect we can grow our share once again once we overcome the WiFi 6 supply constraint in the second quarter of next year. The SMB segment generated net revenue of $61.4 million for the third quarter of 2020, which is down 18.4% on a year-over-year basis, but up 22.7% sequentially.

As we expected, our SMB business recovered slightly, as evidenced by the strong sequential growth. The year-over-year decline stems from the pandemic and corresponding business closures. On the product front, our wireless LAN and PoE+ and ProAV switching lines continue to perform well in the market. Our market share in switches sold through the U.S.

retail channel came in at 49% in Q3. I'll now turn the call over to Patrick for his commentary.

Patrick Lo -- Chairman and Chief Executive Officer

Thank you, Bryan. With the pandemic continuing around the world, many adjustments that seemed temporary are cementing their place in our lives. People and companies have been forced to adapt. At work, some companies are embracing work from home on a permanent basis.

Others are moving to a hybrid model of working from home and at the office in roughly equivalent amounts. In addition, the flexibility to work from anywhere has led to a massive migration away from crowded, high-cost areas to Zoom towns in more isolated, less urban areas, leading to an increase in new or upgraded network connections. Regardless of when the pandemic ends, what's clear is that the future work has forever changed. And that means working from home at least part of the time is here to stay.

And what counts as home may be defined by multiple locations. At home, people are adapting to the new environment by learning how to pursue more of their daily activities virtually from home. Eight months in the making this more from home transition goes well beyond work and school. Families are pursuing a myriad of activities virtually.

Everything from watching movie premieres and live music concerts, and shopping for groceries to virtual tailors, to doctors visits, to fitness classes, and checking in on family and friends across the country or even across continents. These activities are taking place through their laptops, tablets and phones, and families are recognizing the need for a fast and reliable WiFi connection that spans their entire home to support the increased bandwidth consumption and multitude of connected devices utilized across their home. Whereas previously, these activities might have been optional, people have been forced to try them virtually and are now discovering they actually enjoy and even sometimes prefer them to the traditional way of doing things. Accelerating adoption and making these virtual activities an increasingly permanent part of our lifestyle.

The NETGEAR team is working around the clock across the globe to serve this need. As you can see from our results, the aforementioned changes continue to drive strong growth and demand for our CHP products as people upgrade their WiFi networks and discover new users for mobile hotspots. In Q3, we made dramatic adjustments within our supply chain and worked closely with our channel partners to ramp production and delivery. I'm proud to say that the team at NETGEAR continued to execute at the highest level and exceeded my expectations on what we could deliver for our CHP business.

Yet, even with these efforts, we remained supply constrained on CHP products as we are more dependent on advanced chips to power WiFi 6, and our competitors who remain stuck on WiFi 5. Similarly, in our SMB product portfolio, we were caught offguard by the surprisingly strong demand for low-end PoE switches and WiFi 6 wireless mesh access points for home office and home-based business uses. We expect supply constraints to continue to limit the noncarrier side of CHP in Q4. But if our supply chain team can repeat their Q3 performance, we believe we can deliver to roughly the same revenue level we saw in Q3.

On the service provider side, in Q3, we were able to set aside the demand for mobile hotspots needed to fight the pandemic in the U.S. for the start of the new school year and for our first responders. We expect our Q4 service provider revenues to return to roughly Q2 level. Much has been made of the technology transitions that have been accelerated by more from home.

With these transitions, we believe many of the activities that are now virtual will remain virtual. And as such, this represents a significant change in the way people conduct their lives, the need for robust and pervasive WiFi connectivity constitutes a fundamental need, and we believe this has recast our total addressable market on an upward basis going forward. NETGEAR has a unique set of attributes that give us a defensible advantage. A long-standing, trusted brand with loyal followers, a well-deserved reputation for high-performance WiFi products that are based on our leading-edge tri-band technology, best-in-class channel relationships and a growing portfolio of value-added subscription services.

This is why we are confident that NETGEAR will remain the WiFi and networking vendor of choice for both consumers and small businesses as more of our lives transition to virtual for the long term and why we will continue to grow with the market. And it is more evident now than ever that our early investment to be a leader in next-generation technologies, namely tri-band WiFi systems and millimeter wave 5G hotspots will continue to pay dividends. In Q3, we saw strong demand for our tri-band WiFi 6 Orbi and Orbi Pro. While our three-pack configuration starts at $499 and can exceed at $1,000 with Orbi Pro, we cannot keep them in stock across all the markets that we participate.

From Tokyo to Hong Kong to Paris to Munich to Toronto, and especially right here in the U.S. Customers are telling us even with their older WiFi 5 smartphones and devices that they are seeing a significant performance boost from our WiFi 6 Orbi systems due to our innovative radio circuits and antenna designs. We are ramping production of our WiFi 6 Orbi as quickly as we can. But at this point, we don't believe we will catch up to demand until Q2 next year at the earliest due to the WiFi 6 chip supply shortage.

Moving to the SMB business. The team continued to drive forward with a focus on products geared toward home offices and home businesses and delivered a sequential growth of 23% quarter over quarter. We faced the same headwinds as last quarter with channels that rely on personal interaction like our bar partners who do IT installations. During the quarter, we introduced the world's first WiFi 6 mesh access points with app-based remote management.

Just like its a CHP Orbi counterpart, we could not keep them in stock. We are seeing strong demand for our low-end Power over Ethernet switches for home office setups, as remote workforces use them to connect to IP phones, desktops, printers and access points. We believe this demand will persist as workforces increasingly become more distributed post-pandemic. We are making progress with our ProAV business as well.

The team also delivered marquee wins, such as with the PGA Tour in the U.S. and the 2021 America's Cup in New Zealand. In Q3, we announced a brand-new line of AV switches that support the audio over Ethernet protocol, AVB. This new M4250 line of AV switches was well received by AV integrators around the world.

We expect to ship them in volume in Q4. We look forward to continued improvement in our SMB revenue in Q4 with a year-over-year decline continuing to reduce from what was experienced in Q3. The increased importance of WiFi in people's homes and the need to connect, manage and secure more devices to that WiFi is also translating into more subscribers to our premium paid services. We again delivered record progress in growing our recurring revenue stream.

Beginning the quarter with 293,000 paid subscribers, we increased our new paid subscribers by 26% sequentially, adding 76,000 in the quarter to end with 369,000 paid subscribers. In only three quarters, we have exceeded our goal for all of 2020 of doubling our subscribers, a notable achievement and positive sign for our profitability growth in the years to come. I would also like to take a moment to welcome Sarah Butterfass to the NETGEAR board, having led product development at top software first, consumer-facing brands such as Groupon and Orbitz, and now chief product officer at FanDuel. Sarah will add valuable apps and services product strategy and consumer engagement expertise to our board.

I look forward to working with her as we grow our subscription business. And with that, I'll turn it over to Bryan Murray to comment on our opportunities and obstacles in the coming quarter.

Bryan Murray -- Chief Financial Officer

Thank you, Patrick. While we are confident in the ongoing strength of end market demand for home networks, there is still considerable uncertainty around the effects of COVID-19 on the global economy and our supply chain. This makes our outlook difficult to forecast. As such, we are not in a comfortable enough position to provide financial guidance for the fourth quarter.

We would now like to answer any questions from the audience.

Questions & Answers:


Operator

Thank you. [Operator instructions] Your first question comes from the line of Adam Tindle from Raymond James. Your line is open.

Adam Tindle -- Raymond James -- Analyst

OK. Thanks. Good afternoon, and congrats on a very strong quarter. Patrick, I just wanted to start with a question on the CHP segment ex the service provider piece, it was obviously very strong.

I think you mentioned going forward that you were expecting kind of Q4 to look at sort of the same level as Q3. We would typically expect it up sequentially just from seasonal patterns. So maybe just some color on why it would be flat this year, was there any pull forward? And as you talk about Q4, any comments on expectations for the holiday season and promotional activity based on Prime Day and what you've seen so far? Thanks.

Patrick Lo -- Chairman and Chief Executive Officer

Well, basically, as we mentioned, that we would depend on our supply team to make products available, and it's all supply down. We do believe that the market has a much bigger appetite to absorb whatever we could ship to the market for WiFi 6. But unfortunately, we just don't have enough chips to provide to the market. So yes, we expect that it would be a seasonally strong Christmas, all right, but we're all limited by supply.

Now Q3 was the first quarter that people are really experiencing this new found virtual experiences. So clearly, the market surge was high in Q3. We expect the market surge would come down a little bit in Q4, but then it will be offset by the Christmas seasonality. However, unfortunately, we are all supply bound.

Adam Tindle -- Raymond James -- Analyst

OK. I mean, is there a way that you could potentially help us quantify how supply bound you are at this point, so we have an idea of what this tailwind that you're likely going to have as supply catches up to demand would look like over the next few quarters?

Patrick Lo -- Chairman and Chief Executive Officer

I mean, the easiest way to look at it is that, I mean, we used to own 50% market share in North America, all right. And our market share in Q3 was a little bit depressed to 44%, all right. And that 6% is clearly was supply shortage. Plus, because we are the market leader, we believe that we had more inventory: one, the market will grow even faster; and secondly, we believe that we'll actually gain share.

So that's the easiest quantification of how much we're limiting ourselves, as well as the market.

Adam Tindle -- Raymond James -- Analyst

OK. And maybe just a follow-up for Bryan. I mean, margins were obviously a bright spot as well. Just wanted to see if you could dig into a little bit more of the puts and takes on a go-forward basis for gross margin in particular.

I know you have some airfreight, some supply chain. You've got promotional activity upcoming. Just the different buckets that impact gross margin and how we can think about that line on a go-forward basis?

Bryan Murray -- Chief Financial Officer

Yeah. I think if you're talking about Q3 to start, I mean, I think, clearly, a couple of things were the driving forces. One, our overall product profitability has increased. Our mix of WiFi 6 products are certainly contributing to that.

And the elevated top line is certainly helping from a top-line leverage standpoint. So those two factors are really driving the Q3 performance. We certainly did spend a fair amount more in terms of airfreight, as we had suggested we would do in July. But we were able to pull back in terms of promotional activities on CHP products to more or less offset that.

If we look out to Q4, I think from an operating margin standpoint, which is what we're primarily focused on, I think there are a couple of headwinds I think, overall, it probably takes a step down from Q3 levels by about 100 basis points. One is just top-line leverage. We mentioned that the opportunistic demand that we saw in service provider that we expected in the back half of the year, we're able to capitalize on a lot of that in the third quarter. So we're naturally going to step down to about 45 million in Q4.

And now -- and even though we're still going to be supply constrained in Q4, promotions will certainly continue to be limited. I do think they'll take up just a bit as we had preplanned activities around the holidays. So with that said, I think the net of all that is it's probably about 100 basis points step down in Q4 from Q3.

Adam Tindle -- Raymond James -- Analyst

Got it. That's helpful. Thanks, and congrats again.

Operator

Your next question comes from the line of Hamed Khorsand from BWS Financial. Your line is open.

Hamed Khorsand -- BWS Financial -- Analyst

Hi. Thanks for taking my questions. Just first off, Patrick, could you elaborate on your commentary during your statement that you were talking about the CHP side being same, if you could source enough chips, but you guys drew down inventory. So you would actually have to bump up the amount of chips that you purchased to reach the same kind of revenue.

Is that the right way of thinking? Or are you just saying that on a regular basis without the drawdown on inventory?

Patrick Lo -- Chairman and Chief Executive Officer

No, I mean, what we're saying is that even we draw down the inventory on our own. Even we draw down the inventory in the channel, even we ramp up the production quantity, the market demand still exceeded all of that combined. And there's just not enough supply of chips that we want to really feed the market. That's all we're talking about.

Hamed Khorsand -- BWS Financial -- Analyst

Understood. So how would you be able to achieve a flattish kind of performance for Q4, given that you've been drawing down your own inventory in Q3?

Patrick Lo -- Chairman and Chief Executive Officer

Exactly. So that means we're depending on an increased supply of the chips in Q4 versus Q3, which is not surprising because we placed the orders earlier. The chips lead time is now six months. So that means in Q4 is basically a result of our placing of chip orders back in April, May.

Hamed Khorsand -- BWS Financial -- Analyst

And then do you think this is the amount of chips that you're able to generate, is that allocation from the producers that you might be losing out from competitors? Or is this just not enough production out there?

Patrick Lo -- Chairman and Chief Executive Officer

Well, number one, as you probably know, there is limited capacity of 14-nanometer semiconductors. There are not that many foundries in the world that could produce that. And secondly, all the client devices now support WiFi 6. So we're in the market competing for substrate, competing for 14-nanometer production volume against the same kind of WiFi 6 chips that people want for their cellphones.

With the Apple, iPhone 12, Huawei P40. In Samsung, the new 42 and the new IS12. Clearly, I mean, among the networking vendors, we have the big allocation. But in an overall scheme of thing, there are just so many competitors in the electronic industry that need this 14-nanometer chips.

Hamed Khorsand -- BWS Financial -- Analyst

And are you going to put a greater emphasis on WiFi 5 in Q4?

Patrick Lo -- Chairman and Chief Executive Officer

No, no. There is no going back. I mean, as you probably know all along in the past three quarters, we've been telling everybody that we are rebalancing our inventory both in the channel, as well as within ourselves to wean ourselves off of WiFi 5. And as you can see, it's pretty clear, right, because we're the only one that have supply -- ample supply of WiFi 6.

We don't have to do promotions. So as a direct result, our operating margin improved significantly. Well, if everybody has fewer -- even fewer WiFi 6 supply than we do and then we trash the WiFi 5 prices. So there's just no money to be made there.

And we're pretty confident once we get -- every quarter basis, we'll get more allocation of WiFi 6 chips and then once we balance demand and supply, then we'll be on our way to gain a lot of share.

Hamed Khorsand -- BWS Financial -- Analyst

Perfect. Great. Thank you.

Patrick Lo -- Chairman and Chief Executive Officer

Sure.

Operator

Your next question comes from the line of Jeffrey Rand from Deutsche Bank. Your line is open.

Jeffrey Rand -- Deutsche Bank -- Analyst

Hi. Congrats on another great quarter. The year-over-year declines in your SMB business moderated as you expected. Is there more untapped potential with the at-home office in this business? And do you think this -- the SMB business can really return to growth before we get a vaccine?

Patrick Lo -- Chairman and Chief Executive Officer

We believe that we will get pretty close to previous level or even slight growth as we continue to be able to gain more WiFi 6 products even in the SMB channel. As I mentioned just now in the prior discussion, we were totally cut offguard by the strong demand of our WiFi 6 mesh access points. People are cramming for it. And these days, it's pretty impossible to find the availability of our SMB wireless access point, mesh access points on any website every day.

So we do believe that once we get more of the allocation of the chips, then yes, definitely, it will grow. And the other thing we see is very interesting also with a lot of core center staff being distributed back to home, work from home. There's a tremendous demand of our PoE switches at the low end, especially the five port and the eight port because they are using them in their home offices, for the call center people to connect to the IP phones into their wireless access points. So I think there's tremendous opportunity.

And then on the ProAV side, we still see a lot of uptake in the transition from the traditional AV into the AV over Ethernet. We've recently outfitted quite a few railway networks, both in the U.S., as well as in, in Europe with the terminals display and in-train display with ProAV. So I think the ProAV business will continue to give us the opportunity to grow. So in 2022, we are pretty optimistic for our SMB business.

Jeffrey Rand -- Deutsche Bank -- Analyst

Great. And then just as a follow-up. I think Amazon released its first WiFi 6 mesh network recently. Can you talk about how this impacts your business? Does it start to put pricing pressure on your WiFi 6 products when supply gets train sense? Or does it help the general acceptance and credibility of WiFi 6?

Patrick Lo -- Chairman and Chief Executive Officer

WiFi 6 acceptance is huge. As we mentioned in our discussion just about 15 minutes ago that we are seeing tremendous demand not only in the U.S. where people appreciate technology, we're seeing a tremendous demand on our WiFi 6 Orbi in -- around the world, even in India. And the fact is that people find out and these through word of mouth, that when they buy the WiFi 6 Orbi, not only that you could enjoy the bump up speed if you have a WiFi 6 phones or tablets or laptops.

You actually would benefit ever WiFi 5 devices because of our design: one is tri-band; two is our design of the radio circuits and the antenna, which really boosts the performance and coverage. So in, anyway, yes, you're right. I mean Amazon introduced their WiFi 6 product, but primarily is dual band. We have only one model of so-called tri-band is not, but it's not comparable to our performance and actually a little bit more expensive than ours as well.

They introduced a tri-band about $500. But the bulk of the focus is on the dual band, which we don't really play. I mean we play in the tri-band area. So most of the demand that we're seeing right now for our WiFi 6 products for mesh is the above $500 price point.

So it's like we're in two different worlds. I mean we are more in the most well and remote in the BMW world.

Jeffrey Rand -- Deutsche Bank -- Analyst

Great. Thank you.

Patrick Lo -- Chairman and Chief Executive Officer

Sure.

Operator

Your next question comes from the line of Paul Silverstein from Cowen. Your line is open.

Paul Silverstein -- Cowen and Company -- Analyst

Bryan, I hate to ask you to repeat yourself, there was a question I asked about your margin structure right before my line was silent. So I do apologize to you and others on the call, but I'm hoping you can repeat whatever as you said. Yes, I too apologize.

Bryan Murray -- Chief Financial Officer

No problem, Paul. So what I was saying is, for Q4, we would expect operating margins to take a step down of about 100 basis points off of Q3, largely due to alluding to the top-line leverage. We talked about pulling forward a lot of the second half opportunity in service provider and getting into the Q3 and then stepping that down into Q4 at 45 million, we're going to lose some top-line leverage. And then additionally, while we'll still hold back on a lot of promotions until we get supply in a healthier state, there were some preplanned commitments around the holiday promotional period that will obviously be going forward with.

So those two things will drive about 100-basis-point step-down sequentially.

Paul Silverstein -- Cowen and Company -- Analyst

And Bryan, that's a good one. You've addressed this in the past, but I assume expedites are costing you something only order of 100-or-so basis points to gross margin and the operating margin bottom line?

Bryan Murray -- Chief Financial Officer

I would say it's more, but I would say we're offsetting that entirely with the reduced promotional efforts that we typically would have on our CHP products.

Paul Silverstein -- Cowen and Company -- Analyst

So are you costing that? Assuming that you eventually, which you will get to a point where you catch up where supply constraints have become totally alleviated should we not assume a full 100-plus basis point benefit to the margin structure at that point whenever that is?

Bryan Murray -- Chief Financial Officer

So I mean, I think there's certainly an opportunity for 100-basis-point margin expansion as we move into 2021. I think Patrick kind of outlined some of the opportunities on the SMB side where we may look to see something in the neighborhood of 10% growth in '21. We will return to kind of more of an average $35 million a quarter run rate on service provider once behind this Q4 remaining opportunistic demand in service provider. But we think we'll offset that entirely with continued growth in the CHP noncarrier portion of our business.

So with that kind of performance, we think that there's 100-basis-point margin expansion opportunity in FY '21.

Paul Silverstein -- Cowen and Company -- Analyst

All right. And a question for both of you. Other than the obvious major issue with supply constraint, what are you most worried about?

Bryan Murray -- Chief Financial Officer

I think these days, the big concern is getting supply caught up. Let's capitalize on this opportunity and getting supply caught up, which we said is going to take us to Q2 to do so. So that's number one.

Patrick Lo -- Chairman and Chief Executive Officer

And then number two?

Paul Silverstein -- Cowen and Company -- Analyst

Got it. I was going to say, what's the second thing you're most worried about?

Bryan Murray -- Chief Financial Officer

Well, the second thing is anything -- I mean, that we cannot control. I mean all the geopolitical situations and possibility of a third or fourth break wave of COVID, I mean all these uncertainties. So -- but we'll assume that is not going to happen.

Paul Silverstein -- Cowen and Company -- Analyst

Right. But the clear message today is that you've got more than enough demand relative to your supply demand is not an issue for the foreseeable future. That's not an issue.

Patrick Lo -- Chairman and Chief Executive Officer

No, demand is not an issue.

Paul Silverstein -- Cowen and Company -- Analyst

I will pass it on. Thank you so much.

Patrick Lo -- Chairman and Chief Executive Officer

Sure.

Operator

Your next question comes from the line of Woo Jin Ho from Bloomberg. Your line is open.

Woo Jin Ho -- Bloomberg -- Analyst

Great. Thank you for taking my question. Good progress on the subscriber revenue numbers. In terms of the supply constraints, Patrick, how should we think about balancing out the go-to-market portfolio as it relates to volume versus ASP? And in that, I mean, are you going to go for the 999, whatever it is the 863 product versus a single access point product?

Patrick Lo -- Chairman and Chief Executive Officer

No. I mean, we would do whatever the customers want. We believe that there's a wide spectrum of applications, not everybody could afford $499 to begin with. So for those customers, we've seen them buy extenders, all right, so to supplement a single router.

So we also unchanged in that particular marketplace as well. And we do have WiFi 6 routers that costs only about $129, $149. So we're going to do the whole full spectrum of things but clearly, as you probably know, I mean, the biggest margin now on the higher-priced product is generally true. If you buy cars, you know, Mercedes makes a lot more money on the S class.

Same thing, Tesla makes a lot more money on the s -- Model S and Model X. So it's the same thing. No denial. I mean for those products that are above $500, we definitely made more money on.

Woo Jin Ho -- Bloomberg -- Analyst

Right. And somewhat of an intermediate term strategy question for you, Patrick. It sounds as if you're looking at the hybrid work-from-home opportunity as very more permanent type of opportunity. Is there anything on the product development front that you're doing that may help enhance your positioning to take advantage of that opportunity?

Patrick Lo -- Chairman and Chief Executive Officer

Yeah. We mentioned it in our discussion already, right? If you were just an ordinary consumer and you're going to completely configure your own home networks to do this more from home, then very likely, you either galvanized toward a router plus one or two extenders, which is a cheaper solution, all right, or you go for a mesh network. And if you're thinking of a mesh network for uncompromised performance, then you're going to pay $500-plus to buy a NETGEAR product. But if you're thinking of just paying about $150 to $300 and, of course, in market, you get free to choose them.

You get NETGEAR, you get Amazon, you get Google -- oh, VA doesn't provide WiFi 6 yet, all right. So that -- we will still have a pretty significant following and would have a fair debt between $150 to $300 in a market. So that's the consumer side of thing. But on the other side of things is that you are told by your company to work from home, such as the distributed call center people or you're allowed by the company to work at least half of the time or the bulk of the time from anywhere.

And maybe your company would give you money to buy equipment. In those cases, they're more on the commercial-grade than they're most likely to buy commercial-grade router, plus a swift, PoE switch, but some mesh access point instead of router and we're doing it. So you got two different solutions. And we see both have very strong links going into 2021.

Woo Jin Ho -- Bloomberg -- Analyst

Got it. And lastly, Bryan, I believe you said that it wasn't a demand issue going into 2021. And I'm going to get a little greedy here. Any preliminary thoughts on seasonality going into the first quarter and second quarter.

Typically, it's down 15% sequentially off of 4Q and then flattish up on 2Q. Any guidance comments, any preliminary guidance commentary on CHP business?

Bryan Murray -- Chief Financial Officer

So I would say stay tuned, we're going to be announcing our Analyst Day here at the first half of December in the coming weeks, and we're certainly going to dive into that. But as we said earlier, with supply constraints lasting till Q1, certainly, supply will be dictating what we deliver in the first part of the year.

Woo Jin Ho -- Bloomberg -- Analyst

Got it. And it's worth the shot. Thank you.

Operator

Thank you. There are no further questions at this time. I'll turn the call back over to Patrick Lo.

Patrick Lo -- Chairman and Chief Executive Officer

Sure. Thank you, Christine. I would like to once again thank you listening to the call and thank our team members and partners for the hard work and flexibility during this time. Without them, we would not be able to deliver that many products that our customers really need and want.

We look forward to serving a newly expanded market and one in which we have a clear and defensible leadership position. We aim to deliver continued growth in the coming quarters, and will remain confident. The components of our strategy will be strong contributors to our success this year and beyond. And I look forward to sharing all with you on our progress throughout the next few months, first, with the Analyst Day in the early part of December and then in our next earnings call in February.

Thank you.

Operator

[Operator signoff]

Duration: 48 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

Jeffrey Rand -- Deutsche Bank -- Analyst

Paul Silverstein -- Cowen and Company -- Analyst

Woo Jin Ho -- Bloomberg -- Analyst

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