For the second quarter in a row, Netgear (NTGR +2.17%) achieved better-than-expected overall results. But similar to last quarter's solid report, shares of the networking equipment specialist fell after it issued disappointing guidance on continued weakness from its service-provider segment.
Breaking it down
In the report released Thursday, Netgear's fourth-quarter revenue fell 1% year over year, to $353.2 million, easily beating both its own expectations and analysts' consensus for sales of $344.5 million. And though adjusted operating margin fell half a percentage point, to 10.1%, that translated to a 10% increase in adjusted net income per share, to $0.65. This was helped, in part, by Netgear's decision to repurchase 2.8 million shares for around $90.6 million in 2014. By contrast, Wall Street was only looking for earnings of $0.63 per share.
Unfortunately -- and just as Netgear CEO Patrick Lo warned three months ago -- service-provider revenue declined 13.6% year over year, to $126 million, amid a contraction in capital expenditures from major service-provider customers. But things went from bad to worse this time around, as Lo elaborated that Netgear believes service provider "purchase constraints will deteriorate further in 2015 and for the foreseeable future."
Biting the bullet
Consequently, Netgear is taking steps to resize the cost structure of the service-provider business unit to match its reduced outlook, noting the segment will likely settle to a quarterly revenue run rate in 2015 of roughly $100 million to $105 million. For now, Netgear says, service providers are currently undergoing a transition which involves reducing wireline investments while continuing to invest in wireless. In response, Netgear will concentrate its resources on the segment's most profitable, long-term accounts, as well as on its most promising 4G LTE business.
As part of that restructuring, Netgear took a non-cash goodwill impairment charge of $74.2 million in Q4, which resulted in a fourth-quarter loss of $1.62 per diluted share from the service-provider unit. Based on generally accepted accounting principles, that meant Netgear technically achieved a fourth-quarter net loss of $1.16 per share.
Going forward, Netgear expects first-quarter revenue of $300 million to $315 million, with adjusted operating margin falling to a range of 8.5% to 9.5%. Analysts were modeling current-quarter sales and earnings of $341.7 million and $0.59 per share, respectively.
The silver lining
On a more encouraging note, Lo stated on the subsequent conference call that, as the service provider business evolves, Netgear will temporarily redeploy some of the cost savings from its restructuring to invest in the greatest growth opportunities for its thriving retail and commercial business units.
In fact, sales from Netgear's retail unit set a new company record in Q4, increasing 8.8% during the holiday season, to $147.9 million, thanks to strong demand for its premium Nighthawk 802.11ac routers. And Netgear's commercial business unit -- which is also its most profitable -- grew 5.9%, to $79.4 million, on higher sales of both its network switching and storage products.
That doesn't mean investors should ignore the weakness of Netgear's service-provider business, especially as its declines more than offset strength in both commercial and retail. But now that Netgear decided to bite the bullet, and more appropriately size that business in line with its outlook, it should be poised to more effectively capitalize on its most promising long-term growth opportunities.
