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NETGEAR Inc. (NASDAQ:NTGR)

Q3 2010 Earnings Call

October 26, 2010 5:00 pm ET

Executives

Joseph Villalta - VP, IR The Ruth Group

Patrick Lo - Chairman and CEO

Christine Gorjanc - CFO

Analysts

Hamed Khorsand - BWS Financial

Jeff Kvaal - Barclays Plc

Woo Jin Ho - Bank of America-Merrill Lynch

Doug Ireland - JMP Securities

Rohit Chopra - Wedbush Securities

Jonathan Goldberg - Deutsche Bank

Operator

Welcome to the NETGEAR Incorporated third quarter 2010 results conference call. (Operator Instructions) It is now my pleasure to introduce your host, Mr. Joseph Villalta of The Ruth Group.

Joseph Villalta

Good afternoon and welcome to NETGEAR's third quarter 2010 financial results conference call. Joining us from the company are Mr. Patrick Lo, Chairman and CEO; and Ms. Christine Gorjanc, CFO.

The format of the call will be a brief business review by Patrick, followed by Christine providing detail on the financials. We'll then have time for any questions. If you have not yet received a copy of today's release, please call The Ruth Group at 646-536-7009 or you go to NETGEAR's corporate website at netgear.com.

Before we begin the formal remarks, the company's attorneys advise us that today's conference call contains forward-looking statements within the meaning of the U.S. Private Securities Litigation Reform Act of 1995. The words anticipate, expect, believe, will, may, should, estimate, project, outlook, forecast or other similar words are used to identify such forward-looking statements. However, the absence of these words does not mean that these statements are not forward-looking.

Forward-looking statements represent NETGEAR Inc.'s expectations or beliefs concerning future events based on information, available at the time such statements were made and include statements among others regarding NETGEAR's expected revenue, earnings, gross and operating income and margins, tax expenses, the market size of our new product categories, our position in the market relative to our competition, the long-term future and growth of NETGEAR's business, current and future demand for the company's existing and anticipated new products, the company's strategy for innovation and new products. Willingness of consumers to purchase and use the company's products, expectations of larger revenue share from service provider customers. DOCSIS 3.0 products deployment by our service provider customers, and the ability to increase distribution of market share for the company's products domestically and worldwide.

These statements are based on management's current expectations and are subject to certain risks and uncertainties, including, without limitation, the following: future demand for the company's products may be lower than anticipated; consumers may choose not to opt the company's new product offerings or adopt competing products; product performance may be adversely affected by real world operating conditions; the company may be unsuccessful or experience delays in manufacturing and distributing its new and existing products; telecommunications service providers may choose to slow their deployment of the company's products or utilize competing products; the company may be unable to collect receivables as they become due; the company may fail to manage costs, including the cost of developing new products and manufacturing and distribution of its existing offerings; channel inventory information reported as estimated based on average number of weeks inventory on hand on the last Saturday of the quarter, as reported by certain of NETGEAR's customers; changes in the level of NETGEAR's cash resources and the company's planned usage of such resources; changes in the company's stock price, developments in the business that could increase the company's cash needs, and fluctuations in foreign exchange rates.

Further, certain forward-looking statements are based on assumptions as to future events that may not prove to be accurate. Therefore, actual outcomes and results may differ materially from what is expected or forecast in such forward-looking statements. Further information on potential risk factors are detailed in the company's periodic files with the SEC, including, but not limited to those risks and uncertainties listed in the section Part II - Item 1A Risk Factors, pages 32 to 52, and the company's quarterly report on Form 10-Q for the quarter ended June 27, 2010, filed with the SEC on August 5, 2010.

NETGEAR undertakes no obligation to release publicly any revisions to any forward-looking statements contained herein to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events. In addition, several non-GAAP financial measures will be mentioned on this call. Information relating to the corresponding GAAP measures and reconciliation of the non-GAAP and GAAP measures can be found in our press release or on our Investor Relation website at www.netgear.com.

At this time, I would now like to turn the call over to Mr. Patrick Lo.

Patrick Lo

Thank you Joseph and thank you everyone for joining today's call. We're extremely pleased to announce 38% year-on-year growth in revenue in the third quarter of 2010. We’re again seeing year-on-year growth in all three regions with a very impressive 62% growth in North America. The growth in North America was primarily due to our strong performance in the back-to-school promotions in the U.S. retail market.

Our new TV connectivity product such as Push2TV, Universal TV, Wi-Fi adapters, Xbox connectivity kit and the NETGEAR Roku Player helped to power our continuous growth in market share in U.S. retail.

In Q3 end market demand for networking products continued to grow in all three geographic regions from both consumers and businesses in both local currency and U.S. dollar terms. Thus, we are pleased to be making significant progress in our business amidst the slowly improving macro economic environment.

In the third quarter, we increased our unit shipments by 40% over the same quarter of the previous year reaching 5.4 million units. In Q3 our North America net revenue was $122 million, while Europe, Middle East and Africa or EMEA net revenue was $89 million. And our Asia Pacific or APAC net revenue was $25 million.

In the third quarter our net revenue from service providers accounted for approximately 19% of our total net revenue compared to 25% of total net revenue in the third quarter of 2009 and 16% in the second quarter of 2010. We are pleased to see our service provider net revenue increase sequentially and year-over-year; this is a strong indicator that our service provider customers are continuing to roll out DOCSIS 3.0 equipment.

Our sales channels remain strong during the quarter. By the end of the third quarter 2010, our products were sold in about 28,000 retail outlets around the world. And our value-added resellers stands around 37,000. The strength in our balance sheet also allows us to continue to expand our operations in emerging markets such as China, India and Brazil. From a product perspective, we introduced 21 new products in the third quarter. Notable new products include our ReadyNAS Ultra series of home network storage products, the new NETGEAR Roku Player, the WC7520 wireless controller that brings enterprise-class Wi-Fi setup to medium sized businesses and our UTM50, Unified Threat Management security appliance.

With all these new product introductions, we continue to see our push into new product categories paying off. Revenue from new products introduced in the last 12 months reached an all time high of 42% of total revenue in Q3. With industry leading new product introductions, we believe we will continue to stay ahead of our competition in Q4 and beyond.

Due to our ongoing commitment to research and development, we expect the pace of our new product introductions to continue at a rapid clip in the fourth quarter of 2010. We expect to launch 20 or more new products in the quarter, further positioning us for continued revenue growth and worldwide market share gain in the last quarter of the year.

We also believe the push into the new category of DOCSIS 3.0 gateways will result in revenue growth in the fourth quarter when our service provider and customers, especially those in the U.S., the U.K., Nordic, Spain and Australia continue mass deployment of this new technology. We also won new DOCSIS 3.0 projects with (inaudible) in Spain and VOO in Belgium this past quarter and added Woosh wireless in New Zealand to our service provider customer list.

We continue to grow our service provider business by remaining nimble and adapting quickly to our customers' unique and demanding requirements. Our growth strategy of expanding into new product categories, new geographies and new channels is clearly producing positive results. Our home network market strategy for both our service provider customers and our retail consumer customers is built around the vision of having everything in the home connected to the internet and with each other.

For service providers, our strategy is to enable these customers to upgrade the speed of the internet pipe via next generation technologies such as DOCSIS 3.0, fiber, and 3G, 4G. While on the consumer end, we continue to roll out via the retail channel ground breaking connectivity in storage products for connecting all digital devices anytime and anywhere to the internet and with each other, including PCs, notebooks, digital TVs, tablet computers, smartphones, internet set top box, game consoles, Blu-ray players and digital media recorders.

In the SMB networking market, we are becoming the trusted one-stop shop for all of the networking needs of our business customers by providing Wi-Fi, Ethernet switching, security appliances and network storage.

Let me now turn the call over to Christine for further details on our financials.

Christine Gorjanc

Thank you, Patrick. Let me now provide you with a summary of the financial for the third quarter 2010. As Patrick noted, net revenue for the third quarter ended October 3, 2010 was $236 million compared to $171.1 million for the third quarter ended September 27, 2009 and $195.9 million in the second quarter ended June 27, 2010.

We shipped a total of about 5.4 million units in the third quarter including 4.4 million nodes of wireless products. Shipments of all wired and wireless routers and gateways combined in the third quarter were about 3.2 million units. Moving to the product category basis, third quarter net revenue splits between wireless and wired was about 64% and 36% respectively.

The third quarter net revenue split between home and small business products was about 66% and 34% respectively. Products introduced in the last 15 months constituted about 48% of our third quarter shipments, while products introduced in the last 12 months constituted about 42% of our third quarter shipment. Both percentages are records, showing the strength of our new product introductions in the past five quarters.

Non-GAAP gross margin in the third quarter of 2010 was 32.7% compared to 33.5% in the year ago comparable quarter and 36.3% in the second quarter of 2010. Moving to non-GAAP operating expenses; total non-GAAP operating expenses increased by about 31% compared to the prior year same quarter reflecting our increased revenue levels and investment in R&D. Total non-GAAP operating expenses came in at $51.2 million for the third quarter 2010; this compares to non-GAAP operating expense of $39.1 million in the third quarter of 2009 and $45.5 million in the second quarter of 2010.

On a GAAP basis, the company recorded net income of $13.1 million at $0.36 per diluted share for the third quarter of 2010, compared to a net income of $8.5 million or $0.24 per diluted share in the third quarter of 2009 and net income of $10.5 million or $0.29 per diluted share in the second quarter of 2010.

On a non-GAAP basis, the company recorded net income of $16.1 million for the third quarter of 2010 as compared to non-GAAP net income of $11 million for the third quarter of 2009 and non-GAAP net income of $13.7 million for the second quarter of 2010.

Non-GAAP net income was $0.45 per diluted share in the third quarter of 2010, compared to a net income of $0.31 per diluted share in the third quarter of 2009 and net income of $0.38 per diluted share in the second quarter of 2010.

In Q3 2010, we recorded a net foreign currency loss of $326,000 compared to a net loss of $266,000 in the third quarter of 2009 and a net gain of $132,000 in the second quarter of 2010. GAAP tax expense was $8.4 million in the third quarter of 2010, compared to $5.8 million in Q3 '09 and $10.6 million in Q2 2010. Non-GAAP tax expense was $9.7 million in the third quarter of 2010, compared to $6.9 million in the third quarter of 2009 and $12.1 million in the second quarter of 2010.

Tax expense in Q3 was less than Q2 due to a true-up adjustment for annual tax return filings. The reconciliation of GAAP to non-GAAP is detailed in our preliminary financial statements released earlier today.

We continue to maintain a strong balance sheet, and in the second quarter were $243.5 million in cash, cash equivalents and short-term investments. DSOs for the third quarter were 73 days compared to 66 days in the third quarter of 2009, and 64 days in the second quarter of 2010 and continued to be within our historical range.

Our net inventory ended at $110.4 million compared to $73.9 million at the end of the third quarter of 2009 and $125.7 million at the end of the second quarter 2010. Ending inventory turns were 5.8 as compared to 6.2 turns in the third quarter of 2009 and four turns in the second quarter of 2010.

We are pleased to see that our tactical build up of inventory at the end of Q2 contributed to our success in Q3.

Looking forward, in the fourth quarter of 2010, we continue to see market demand growth in all three geographic regions. Our continued success has been driven by innovative product introduction, and we will continue to focus on innovation in the fourth quarter with another 20+ new product introductions.

Specifically, for the fourth quarter of 2010 we expect net revenue in the range of approximately $240 million to $250 million with non-GAAP operating margin to be in the range of 11% to 12%. Non-GAAP tax expense in Q4 is estimated to be around $11 million to $13 million.

Operator, that concludes our comments and we can now take questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question is coming from the line of Jeffrey Kvaal with Barclays Capital.

Unidentified Analyst

Actually this is Stephen Gregory with Mandalay Research. Couple of questions. A couple of months ago there was an article in the Wall Street Journal talking about how e-commerce is going to drive company revenues the next millennium over in 2011 to take it to the next level.

I was wondering if you could (apply) some color on the call today as to what is your e-commerce position going forward and how do you plan to take the company there (inaudible) revenue online ?

Patrick Lo

Actually today, quite a bit of our sales is done through e-commerce partners, particularly on a worldwide basis, amazon.com, and dell.com.

We’ll continue to partner with these prominent e-commerce sites from the around the world. We certainly see a shift of our customers preferring online purchases, and we will continue to utilize this channel to further our sales.

Operator

Our next question is coming from the line of Hamed Khorsand with BWS Financial.

Hamed Khorsand - BWS Financial

Couple of questions here, one on guidance. Over the last couple calls you have been talking about service providers, these are DOCSIS 3.0 spending in second half. Well if I take that into consideration and then couple that with Q4 where you usually get under the year ramp, that would suggest that are you guys taking a conservative approach to your guidance compared to Q3 numbers or is there some weakness that you're seeing in Q4? Can you just expand upon that?

Patrick Lo

No, I think its pretty reasonable to assume that the service provider revenue will continue to grow sequentially. However, I mean due to super-strong, back-to-school season, we believe that the Christmas plus Thanksgiving holiday will be at best slightly above our back-to-school, and it will be very difficult to really top it by a long shot. So I think the guidance is reasonable.

Of course, there is always a chance that we would advance further in market share gain. But as it stands right now, we believe that this is a pretty accurate guidance.

Hamed Khorsand - BWS Financial

And then, how much do you expect the service provider to shift into Q1 as far as the DOCSIS 3.0 spending?

Patrick Lo

It will continue to grow, and we would update everybody, of course in the next earnings call.

Hamed Khorsand - BWS Financial

And my last question is, as far as your service provider revenue, how much of it is associated with (frontal) sales? I heard you guys announce a wireless carrier today.

Patrick Lo

So far, not much.

Hamed Khorsand - BWS Financial

Okay, so what are the wireless carriers offering now? Just not the (frontal) sales.

Patrick Lo

Well, I mean most of our customers are offering Wi-Fi in home today.

Operator

Our next question is coming from the line of Mr. Jeff Kvaal with Barclays Plc.

Jeff Kvaal - Barclays Plc

I was wondering Patrick if you could talk a little bit about channel inventory. Looks like it was flattish at ten weeks or so. Anything that we should expect ahead of the holiday season, should it be head up or head down, any dynamics at play there?

Christine Gorjanc

No, I think the retailers are managing their inventory well. They have been continuing to manage it around that ten weeks. So I think when you see that our revenue's gone up, the overall inventory total is up, but it's at ten weeks. So we don't see any issues with that. We are very happy with the ten weeks.

Jeff Kvaal - Barclays Plc

And then on the gross margins, should we assume that the bulk value is associated with the rising service provider business?

Patrick Lo

Sort of that, but then Q3 and Q4 are pretty heavily promoted in retail; that also would bring down the gross margin as well.

Jeff Kvaal - Barclays Plc

And then what are the signs that you think we should look for to think that the holiday selling season could in fact be seasonal rather than slightly below seasonal?

Patrick Lo

Generally speaking, we would like to maximize our success of the promotions to maximize our revenue top-line as much as possible, while keeping our operating margin in the range of 11% to 12%. And that has always been our strategy.

Jeff Kvaal - Barclays Plc

You seem to be taking a bit of a cautious approach at the moment, Patrick to the view of the fourth quarter. Anything in particular that we should be washing for in terms of whether things could be healthier than what you are suggesting or normal sell-through jack is the way to do that?

Christine Gorjanc

Yes, because we gain so much share in the back-to-school promotions. I mean, unless we continue to gain a lot of share, which we don’t believe is likely in the short future, I would believe that the uptick in the overall market demand in Q4 is going to be reasonable within our guidance.

Jeff Kvaal - Barclays Plc

Why couldn't you gain a little bit more share?

Christine Gorjanc

We will always try to.

Operator

Our next question is coming from Woo Jin Ho of Bank of America-Merrill Lynch.

Woo Jin Ho - Bank of America-Merrill Lynch

Just a quick question on the OpEx. The sequential OpEx is up roughly 13% from Q2 to Q3. And it’s a high sequential uptick since 2002. Could you just discuss why it was up on a sequential basis so high?

Christine Gorjanc

Sure. When you look at the revenue increase quarter-over-quarter and year-over-year, it's so significant. What we had there is more sales OpEx down there, promotions. Some of those costs are down there, more freight to the customers. In addition to R&D, we used to do 12 to 15 a quarter, we are 20. We are spending more in R&D, the associated tax support. So while we are continuing to manage that to be in the range, those costs did jump up and a lot due to our increased revenue and then plans for the future.

Woo Jin Ho - Bank of America-Merrill Lynch

And just a little bit more color on the U.S. as well as the European VAR distribution. Could you just talk a little bit more of the dynamics why Europe was so low and why the U.S. was so high, exiting out of the quarter?

Christine Gorjanc

I just think we continue to see growth in the U.S. above Europe. We see Europe growing steadily, we see the U.S. having some pretty explosive growth around. So I think those channels just went up slightly this quarter, but in anticipation of their Q4 numbers. And in the MIAD, that went slightly down, but again we have no concerns with that in having enough in the channel to us (inaudible) the quarter.

Unidentified Analyst

And in terms of the SMB recovery, nice recovery there. How much of that, Patrick, is from the switching market and how much of it is strength on the newer products such as security and storage?

Patrick Lo

Well actually is across the board. We see a nice recovery across both switching, NAS as well as security. But security is a growing category for us anyways, brand new. So it’s very encouraging that we it just cuts across all product categories.

Unidentified Analyst

And then one more follow on to that. In terms of the channel, you have discussed in the past that you wanted to improve the quality of the channel or to upgrade the channel to meet the lower end of the enterprise. What’s the status on that?

Patrick Lo

We’re still making some progress on that. Certainly, we would love to be as fast as we can. I think we’re building a pretty solid base and we’re starting to see some wind. So I think probably we will make meaningful progress in resells probably more towards the middle of next year to the second half of next year.

Operator

Our next question is coming from the line of Mr. Doug Ireland with JMP Securities.

Doug Ireland - JMP Securities

Wanted to ask a little bit around security and storage. Are you going to start to report more metrics around that business? It really seems to be a great growth contributor in becoming a more important piece of your business?

Christine Gorjanc

Well, at this point we don’t really break that out. But we’re always looking into that in the future at this point as to how that’s growing.

Doug Ireland - JMP Securities

I mean, you are diversifying away from just wireless routers? We get a lot of detail around the wireless router business, and I’d just love more around those areas.

Christine Gorjanc

Yes, we'll take that suggestion.

Doug Ireland - JMP Securities

On the retail side, there is a lot of talk from Intel and HP about how the PC business and laptop business was light in the Consumer. And I was just wondering if you could talk maybe on what you saw as a source of your retail strength this quarter?

Patrick Lo

Primarily, we feel like that is driven by the proliferation of internet-enabled devices, ranging from TVs to Blu-ray players, of course to the local players like we introduced and to the iPads and the iPhones. Nine out of 10 iPads or iPhones when they get inside out, they switch over to Wi-Fi. When you got so many of these Wi-Fi devices tapping onto the network, clearly, you need an upgrade.

So that is driving a lot of the 11g to 11n upgrade. That’s the fundamental driver of the market demand growth, particularly in the U.S., I think the fact that the iPads and the iPhones availability in the U.S. better than the rest of the world is really helping in Q3. We expect this will continue, as we were told by the retailers that more and more TVs will be internet-enabled coming this Christmas. So that would continue to drive that trend.

And secondly, as we mentioned just now that we’re actually share from our competitors. So not only that there is a fundamental market growth with growing faster than market, because we’re taking share away from our competition.

Doug Ireland - JMP Securities

Do you have any sense of what kind of share gains you're making?

Patrick Lo

We generally are progressing pretty well, I mean getting 1% to 2% every quarter. But now it’s to the point that going from here is not a cakewalk as before.

Doug Ireland - JMP Securities

I think there is diminishing returns in a sense on gaining share.

Patrick Lo

That’s the reason why there’s the discrepancy between the growth of the U.S. and Europe, because in Europe we were number two, and there was quite a bit of share price to grab. But in Europe, we are number one. So that’s why you have this difference. Even though both markets are recovering and growing, there is more room for us to grow faster in the U.S. in the past few quarters.

But going forward because we are already widening the gap, that growth is going to be diminished a little bit. So our attention will be focused more into the SMB market where we have much bigger competitors and more share for us to grab as well in the service provider channel it's exactly the same.

But in the retail channel, what we’d like to do is to foray into new categories. So the TV connectivity is a completely new category and with its set of competitors.

Doug Ireland - JMP Securities

The Google TV and Apple TV launched this quarter. It brings lot of awareness to the space, but it also seems to crowd out attention. Have you found any impact from that?

Patrick Lo

No, actually as a matter of fact, it validates the category. And the pie has grown so fast that at least for now is enough for everyone. We’re seeing continued uptick on our local player, which actually offers much better functionality than Apple TV, is $10 cheaper. We offer 1080p, they only 720p. We do Netflix and we do MLB that you could watch the World Series through it.

Unidentified Analyst

Last thing, do you have any 10% customers in the quarter?

Christine Gorjanc

Ten percent customers, we have Ingram and Best Buy.

Operator

(Operator Instructions) Our next question is coming from the line of Rohit Chopra with Wedbush Securities.

Rohit Chopra - Wedbush Securities

Just wanted to talk about the jump in DSO and may be you could talk about the linearity as well in the quarter.

Christine Gorjanc

As the revenue went up this quarter and as Europe’s revenue increased, as that typically takes our DSO out to more days. It’s the more U.S. focused the DSO is a little less. So our range has always been 65 days to 75 days. We’re perfectly comfortable with that and with all of our customers. We typically have very little bad debt, and we do have credit insurance and things where necessary. So we’re really quite comfortable with the number and it really just shows the expanding business and again the timing of when all that comes in.

Rohit Chopra - Wedbush Securities

Patrick, it’s been about a year since you introduced some media related products at the last analyst day. One of the problems you had you said was when you sell it in a Best Buy, it’s a different person selling it and may be they just don’t have the attention when they’re selling a new big screen TV that they’re not going to sell this peripheral add-on device. Could you just talk about the media related products that you have out there now, and how they’re doing vis-à-vis the core products a year out?

Patrick Lo

Yes, what a difference a year makes. If you walk into a Best Buy store today, especially the bigger ones, go on to the TV section where all the Blu-ray players are placed, you would probably find a whole shelf of connectivity products, TV connectivity products with most our products on it. So the TV section people are really learning how to sell connectivity products. And on that shelves, you have multiple products from us, you get Wi-Fi, the universal Wi-Fi TV connectors. You got a Powerline based Xbox connectivity kit. You also have our Roku Player which will connect the old TVs on to the internet.

So these are products that are not a single skew anymore, its multi skew. And clearly, you probably will know, I mean they’re making a lot of profit in selling big screen TVs and selling these peripherals where they’re really going to make a margin. So there is tremendous push from top management as well as incentives at the floor level to push for what we call the add-on basket items when they sell a TV.

So we’re pretty bullish in this particular trend. And that’s why we introduced quite a few weeks ago, the Roku Player. We made the announcement just recently, but Roku players today, under the NETGEAR brand is available in over 7,000 stores in the United States, in Radioshack, Fry’s, as well as in Best Buy.

Rohit Chopra - Wedbush Securities

Okay. And then I had one other question for you. You mentioned your two 10% customers, can you tell me why Wal-Mart wouldn’t be there as one of your largest contributors? And are they changing anything at there stores?

Patrick Lo

Not really; I mean if you know, Best Buy is still the kind of consumer electronic sales. And Wal-Mart is definitely trying to catch up with them. And we see there is tremendous potential for Wal-Mart to grow. However, as a lot of people will realize that today, at least in the minds of most people, Best Buy is the destination and Wal-Mart is for fulfillment. So when technology takes hold, then Wal-Mart will be there. When new technology is being introduced, then Best Buy is usually the vehicle.

We clearly see Wal-Mart could potentially be a 10% customer in the not too distant future.

Operator

Our next question is coming from the line of Mr. Jonathan Goldberg with Deutsche Bank.

Jonathan Goldberg - Deutsche Bank

Quick clarification about when we talked about earlier, are there any signs of abnormally aggressive or extremely aggressive pricing behavior from your competitors as we head into Christmas?

Patrick Lo

Not that we could see right now, it’s the normal promotion.

Jonathan Goldberg - Deutsche Bank

And then you mentioned Ingram as your 10% customer, are they new to that list?

Christine Gorjanc

No, they’ve been on that list for years.

Jonathan Goldberg - Deutsche Bank

How would you characterize the breakdown of your volumes? Does it skew more towards the big guys like Ingram or is more mom and pop skewed?

Patrick Lo

Ingram is a distributor; our value-added resellers actually source the product through Ingram. A typical value-added reseller for NETGEAR is probably anywhere between two to 30 employee companies that service customers within a five to ten mile radius of their premises and generally would source from (wholesale) distributors such as Tech Data, Ingram Micro, (D and H) and (FINEX). So that’s typically how our channel distribution functions for our SMB products.

And then for e-commerce as well as for mail order catalogs for direct market resellers, we generally source the products from Ingram and Tech Data as well.

Jonathan Goldberg - Deutsche Bank

Have you been doing anything different with your new SMB products to reach the bars through the distributors? I’m thinking more securities in particular, is there a new way you have to communicate or educate bars?

Patrick Lo

Clearly, we have to educate because most of our existing value added resellers started with that by reselling our switches and then our Wi-Fi products. And then we train them to sell our (NYSE:NAT) and now we’re in heavy training mode to try to train them in selling the security products because they will be up against those traditional security resellers from SonicWALL, WatchGuard, Fortinet. So our value added resellers are happy that they have something with better margin, recurring revenue for them to sell. But on the other hand, we need to do quite a bit of education. That’s for sure.

Operator

(Operator Instructions) At this time there are no further questions. I would like to send the call back over to management for any closing comments.

Patrick Lo

Okay. We’d like to thank everybody that joined our call. And as we said, we are very bullish about the fourth quarter because there are a lot of new products being introduced. And we believe we will continue to make progress in all three fronts, both in the retail as well among the SMB customers as service provider customers. And look forward to talking to you again in the next earnings call in February of 2011.

Operator

Ladies and gentlemen, this does conclude today’s teleconference. You may disconnect your lines at this time. Thank you very much for your participation and have a wonderful evening.

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