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Executives

Christopher Genualdi

C. S. Lo - Co-Founder, Chairman, Chief Executive Officer and Acting General Manager of Commercial Business Unit

Christine M. Gorjanc - Chief Financial Officer

Analysts

Mark Sue - RBC Capital Markets, LLC, Research Division

Lynn Um - Barclays Capital, Research Division

Hamed Khorsand - BWS Financial Inc.

Kent Schofield - Goldman Sachs Group Inc., Research Division

Jonathan Kees - Capstone Investments, Research Division

Rohit N. Chopra - Wedbush Securities Inc., Research Division

Netgear (NTGR) Q3 2012 Earnings Call October 25, 2012 5:00 PM ET

Operator

Greetings, and welcome to the NETGEAR Third Quarter 2012 Earnings Conference Call. [Operator Instructions] A brief question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Christopher Genualdi, Investor Relations specialist. Thank you. Mr. Genualdi, you may begin.

Christopher Genualdi

Thank you, Jen. Good afternoon, and welcome to NETGEAR's Third Quarter 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 details on the financials and other information. We will then have time for any questions. If you have not received a copy of today's release, please call NETGEAR Investor Relations or go to NETGEAR's corporate website at www.netgear.com.

Before we begin the formal remarks, the company advises that today's conference call contains forward-looking statements. Forward-looking statements include statements, among others, regarding expected revenue; earnings; growth; operating income and margins; tax rates and other projected financial results; share gain expectations; the market for our products; business prospects; competition; research and development efforts, including software development; sales and marketing efforts; market trends and opportunities, including trends and opportunities in the Smart Home, 21st Century SMB market and Next-Generation Service Provider products; new product features and our product roadmap; our growth strategy; and expectations regarding our recent acquisitions and pace of new product introductions.

Forward-looking statements made during the call are being made as of today. If this call is replayed or reviewed after today, the information presented in the call may not contain current or accurate information. Further, certain forward-looking statements are subject to certain risks and uncertainties and 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.

Information on potential risk factors are detailed in the company's periodic filings with the SEC, including, but not limited to, those risks and uncertainties listed in the company's most recent Form 10-Q filed with the SEC. 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 accuracy of unanticipated events.

In addition, several non-GAAP financial measures will be mentioned on this call. Information relating to the corresponding GAAP measures, as well as a reconciliation of the non-GAAP measures and GAAP measures can be found in our press release on the Investor Relations website at www.netgear.com.

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

C. S. Lo

Thank you, Christopher, and thank you, everyone, for joining today's call. First, I hope that you can all join us for our 2012 Analyst Day being held in York City on November 8 where we will update you about the next-generation market opportunities we are targeting for each of our 3 business units. For additional details on this event, please reach out to NETGEAR Investor Relations on the IR portion of our website.

For the third quarter of 2012, NETGEAR generated 4.4% year-over-year net revenue growth. Non-GAAP diluted EPS came in at $0.65 per diluted share. Please see the press release for a full reconciliation of GAAP to non-GAAP financial results. These results are a reflection of the difficult economic climate that continues to proliferate within Europe, as well as into Australia. The European market has weakened more than we had expected when we entered the quarter, and this is evident in our channels throughout the region. However, we offset some of this European weakness with a very strong back-to-school season in the U.S., along with further market share gains.

During the third quarter, Europe, the Middle East and Africa, or EMEA, net revenue was $104.4 million, down 13% year-over-year and down 11% quarter-over-quarter. Unfortunately, the European slowdown, which had, for the most part, been concentrated in Southern Europe, spread into our traditional core markets of the U.K. and Northern Europe. As a result, we experienced a region-wide retreat in demand in Europe.

American net revenue was $177.6 million, up an impressive 19% year-over-year and up 9% quarter-over-quarter. North America showed strength in back-to-school demand, and on top of that, we were able to gain share.

Our Asia Pacific, or APAC, net revenue was $33.2 million, which is flat from the prior year's comparable quarter and down 16% sequentially. The softness in APAC is due to weakness in Australia across all channels, though this softness is offset somewhat by growth in the rest of the APAC region. As recently reported in the news, Australian business confidence is at a near-term low due to concerns over China's demand on Australian exports.

As we have done since we went public in 2003, we continue to focus on the largest market opportunities and run our business for the long run. Our increased R&D spend will continue to drive our product roadmap and should allow us to gain more market share over time. We will not let this cyclical slowdown to disrupt the large opportunities we see ahead of us. As always, we continue to closely manage our expenses, inventory and cash.

Also in Q3, we completed the integration of the 2 acquisitions announced on our last earnings call: the VueZone cloud-based video camera team in San Diego and the wireless controller development team in India. We are excited about the rollout of the VueZone products in North American Retail that is underway as we speak and look forward to its worldwide rollout in the first half of 2013. As for the wireless controllers, we expect to see the fruits of this acquisition in the second half of 2013.

In Q3, we maintained a high level of shipment with 6.7 million units shipped. We also introduced 30 new products during the quarter.

Sales channel expansion continues to be a key focus for the company as our sales channel remains a critical strategic asset. By the end of the third quarter of 2012, our products were sold in approximately 32,000 retail outlets around the world, and our number of value-added resellers stands at 40,000. We are confident that the new VueZone cameras will bring us into new retail outlets that we did not have access to before.

Now let's turn to a review of the third quarter results from our 3 business units: Retail, Commercial and Service Provider. In our Retail Business Unit, or RBU, net revenue came in at $123.5 million, up 9% quarter-on-quarter and down 3% year-over-year. The sequential increase can be attributed to our strength in the back-to-school season in North America and our release of the industry's first 802.11ac WiFi router. The year-over-year decline is a reflection of the further weakening of the European market during Q3. In Q4, we are releasing 11ac DSL gateways in Europe and Australia, and we believe that will spread the 11ac upgrade cycle to the rest of the world.

During the third quarter, we continue to gain share in North America against our competitors in Retail. We believe that we now have nearly doubled the market share of the #2 player in North America.

Looking forward, we expect a solid holiday selling season in North America with 11ac, VueZone cameras and WiFi repeaters topping the charts of Christmas essentials.

We are committed to developing and releasing products that will be relevant in the Smart Home. We believe the Smart Home represents a rapidly growing multibillion dollar market opportunity. The Smart Home will feature full-house WiFi coverage with extenders and multimedia streaming devices to TV and multiroom audio systems, home storage for multimedia content for in-home or on-the-go secure access, as well as home monitoring and control devices. We expect these products to be customizable by downloadable user apps.

Our VueZone acquisition was a significant step in creating a new line of products necessary for the Smart Home. By using the patented platform technology of the VueZone camera, NETGEAR expects to pioneer this high-growth market in 2013 and beyond. We will be discussing the Smart Home opportunities in depth at the Analyst Day in November.

Net revenue for our Commercial Business Unit, or CBU, came in at $79.2 million for the third quarter of 2012. That's down 2% on a sequential basis and down 13% year-over-year. The weakened performance of the Commercial Business Unit this quarter was the direct result of the economic uncertainty that has curtailed European and Australian SMB networking demand. However, with a strong new product pipeline, we do see opportunities for market share gains going forward in all regions. We were very pleased in Q3 with the performance of the newly introduced ReadyDATA 5200, our first foray into 10-gigabit speed unified storage systems.

Introduced in late Q2 of 2012, this enterprise-class storage product with features including data de-duplication and unlimited snapshots was received very well around the world. We will continue to expand on this line of enterprise-class products. Leading with the ReadyDATA family, we will be focusing the Commercial Business Unit on meeting the needs of the 21st Century SMBs.

In the future, we expect to rollout gigabit to desktop, both wired and wireless; 10 gigabit aggregation; unified storage; hybrid cloud; remote recovery and replication; virtualization; cloud-managed solutions with switches; access points in security appliances. By way of the Genie applications platform, we expect enabled user customization of our unified storage and other products by downloadable apps so that the individual needs of our SMB customers can be met. We will discuss these 21st Century SMB solutions in our upcoming Analyst Day.

In our Service Provider Business Unit, or SPBU, net revenue came in at $112.5 million for the third quarter of 2012, down 11% sequentially but up 34% on a year-over-year basis. The sequential decline was anticipated for this business unit, as our customers made expected reductions in marketing activities following the 2012 Olympics. Due to the economic uncertainty, we expect the capital expenditure budgets of our Service Provider customers to be constrained further in Q4. Thus, we expect further sequential decline of our Service Provider revenue in Q4.

Nevertheless, we will continue to release innovative products for the Service Provider Business Unit, specifically 4G LTE routers that will use wireless instead of wired line for broadband access, especially benefiting operators in rural areas and emerging markets, which were previously constrained by the reach of wired line telecommunications networks. These routers also enable mobile operators to be the alternative suppliers to the wired line providers of broadband Internet access to urban households. We also expect to expand our offerings to our Service Provider customers for home monitoring and automation solutions, in-home IP video distribution technologies and gigabit wired and wireless broadband access. All of these new frontiers will be explained more in our upcoming Analyst Day as our Next-Generation Service Provider products.

Despite the softness of the European and Australian markets, we remain focused on capturing the large market opportunities, including opportunities to gain market share in Smart Homes, 21st Century SMBs and Next-Generation Service Providers. We remain committed to our long-term product roadmap and are very aware of the short-term challenges that we face with the global economy. I strongly believe that NETGEAR will be a growth company for many years to come.

I will now turn the call over to Christine for further details on our financials.

Christine M. Gorjanc

Thank you, Patrick. I will now provide you with a summary of the financials for the third quarter of 2012. As Patrick noted, net revenue for the third quarter ended September 30, 2012, was $315.2 million compared to $301.8 million for the third quarter ended October 2, 2011, and $320.7 million in the second quarter ended July 1, 2012.

We shipped a total of about 6.7 million units in the third quarter, including 5.5 million nodes of wireless products. Shipments of our wired and wireless routers and gateways combined were about 3.8 million units in the third quarter of 2012.

Moving to the product category basis. Third quarter net revenue split between wireless and wired was about 71% and 29%, respectively. The third quarter net revenue split between home and business products was about 75% and 25%, respectively.

Products introduced in the last 15 months constituted about 31% of our third quarter shipment, while products introduced in the last 12 months constituted about 25% of our third quarter shipment.

From this point on, my discussion points will focus on non-GAAP numbers. As mentioned previously, the reconciliation from GAAP to non-GAAP is detailed in our preliminary financial statements released earlier today.

Non-GAAP gross margin in the third quarter of 2012 was 31.6% compared to 32.4% in the year-ago comparable quarter and up from 29.9% in the second quarter of 2012. The sequential uptick in gross margin is due to a lesser proportion of Service Provider in our revenue mix. Total non-GAAP operating expenses came in at $63.3 million for the third quarter of 2012.

As noted during our last 2 earnings calls, we are continuing to invest more in research and development on an absolute dollar basis and as a percentage of net revenues. Our R&D expense in Q3 increased to 5.3% of net revenue in comparison to 4.4% of net revenue during Q2. This is in line with what we expect our R&D expense to be in the upcoming quarters. By maintaining an R&D expense of approximately 5% in the upcoming quarters, we will continue to develop cutting-edge networking products and release them at a rapid pace so that we can continue to gain market share worldwide.

However, facing the current weakened demand market in Europe, we are shifting our sales and marketing resources to the emerging markets where we believe there is growth to achieve and more market share to be gained. We will continue to spend wisely and streamline our operations to achieve more efficiency.

We increased our net headcount by 36 people during the quarter, bringing our total headcount to 854 at the end of Q3. Note that 28 of these additional headcounts came from our recent VueZone acquisition.

The non-GAAP tax rate was 30.3% in the third quarter of 2012 compared to 20.2% in the third quarter of 2011 and 31.4% in the second quarter of 2012. Please note that the 30.3% tax rate is reflective of a onetime tax benefit, which will not be repeated in subsequent quarters. Without that, because of our diminished European revenue and profit, we would have been at a 35% effective tax rate for Q3.

Looking at the bottom line for Q3, we reported non-GAAP net income of $25.3 million and non-GAAP EPS at $0.65 per diluted share. As mentioned, we tightly manage our expenses, receivables, inventory and cash. This results in our continued strong balance sheet. We ended the third quarter with $362.4 million in cash, cash equivalents and short-term investments, which was driven by approximately $23 million in cash flow from operations and which more than offset the investment made in the VueZone acquisition earlier in the quarter.

DSO for the third quarter 2012 were 72 days as compared to 66 days in the third quarter of 2011 and 77 days in the second quarter of 2012. As always, we closely manage our collections and try to effectively mitigate collection risk. There were no 10% customers for the third quarter of 2012.

Our third quarter net inventory ended at $178.9 million compared to $136 million at the end of the third quarter 2011 and $152.8 million at the end of the second quarter 2012. Third quarter ending inventory turns were 4.9 as compared to 6 turns in Q3 2011 and 5.9 turns in the second quarter of 2012. Our inventory was at a slightly elevated level in anticipation of the Chinese Golden Week holiday for the first 2 weeks of October.

Let's turn to our channel inventory. Our channel inventory partners report inventory to us on a weekly basis, and we use a 6-week trailing average to estimate weeks of stock. Our U.S. Retail inventory came in at 9.8 weeks of stock. Current distribution inventory levels are 8.4 weeks in the U.S., 4.4 weeks of stock for distribution in EMEA and 4.7 in APAC.

With regard to the fourth quarter 2012, we intend to continue our high pace of new product introductions and plan to roll out approximately 25 new products. We anticipate we will continue to face a challenging economic climate in Europe and Australia, as well as a reduction and purchases from our Service Provider customers worldwide. And as a result, we expect fourth quarter net revenues to be in the range of approximately $300 million to $315 million.

Additionally, the non-GAAP operating margin is expected to be in the range of 11% to 12%, and our non-GAAP tax rate is expected to be approximately 33%, which is higher than in previous quarters.

We look forward to seeing everyone at our 2012 Analyst Day on November 8 in New York City where we will talk about the large market opportunities that will drive us towards our $2 billion net revenue goal by 2014.

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

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from the line of Mark Sue with RBC Capital Markets.

Mark Sue - RBC Capital Markets, LLC, Research Division

If I look at your Service Provider revenues, it seems to have peaked in June. It's declined, and it might decline again. So I'm trying to get a sense of what's a normalized run rate for this business segment? Do you think it's $100 million or maybe even $80 million? And Patrick, I asked since a lot of the European carriers seem very challenged at the moment. Many are cutting their dividends. I'm just wondering when things might actually stabilize and at what level they stabilize to.

C. S. Lo

Yes, we don't have a crystal ball of how the European economy and how the softening credit crisis is going to be solved. We do see that, at least with our 13-week visibility, that the Service Provider revenue is going to be range bound, as you say, around $100 million. But going beyond 13 weeks, we just do not see how the European economy and the Service Providers are going to react. But certainly, from our perspective, we are, as Christine just pointed out -- we are really shifting a lot of our sales and marketing effort in North America, as well as in Asia Pacific. And we're looking for new projects. We're looking for new projects and customers in those regions. And hopefully, we will be able to overcome the weakness in Europe.

Mark Sue - RBC Capital Markets, LLC, Research Division

Okay. And then maybe on the SMB segment. Were there some shortages that are lingering? Or is there just kind of weakened demand as well? And I guess the thought was that might get reaccelerate, but it's also kind of held in at this $80 million range. Does that kind of stay at this level for the next few quarters?

C. S. Lo

And again, I mean, the softness we saw was primarily in Europe and a bit of that in Australia as well. Now I don't have any crystal ball, but I do believe that after this Chinese political handover, the Chinese economy is most likely going to reignite again, and as a result, China will be back in good shape again. So I'm less worried about Australia in 1 quarter or 2 out. I'm more worried about Europe. But on the other hand, I mean, we cannot sit around and wait for the economy to turn, and that's why we are introducing a whole slew of new products. We collectively call it the 21st Century SMB solutions. Pioneering that is our ReadyDATA. The first model of that, the model 5200 introduced in the late Q2, but in full swing in Q3 was a tremendous success. And I would strongly encourage everyone to come to our Analyst Day that we can explain a bit more on what are some of the new, exciting products and opportunities that is in front of us for the 21st Century SMB solutions.

Mark Sue - RBC Capital Markets, LLC, Research Division

Okay. And then lastly I guess the target is $2 billion in -- was it in 2014?

C. S. Lo

Yes.

Mark Sue - RBC Capital Markets, LLC, Research Division

Okay. So what -- considering we're now at a base of about 300 a quarter, I guess we're going to have to see quite a bit of ramp late next year and into the following year. Does that mean you're going to accelerate your product development so that we're at a point where operating margins can actually go below your targeted range, because if the environment is still pretty challenging for a while, you're going to need all these new products and to develop the new products, you're going to have get it with R&D.

C. S. Lo

Again, I mean, we have no crystal ball on how the economy is going to do. But we do know which -- a product type line that we currently have. So you hit it right on the head that we will continue to double down in R&D, and we're very confident that the products that will come out in the next 12 to 18 months is going to continue to let us lead the market, and creating new market. And the good example is the VueZone camera. The good example is the ReadyDATA. All these are new markets that we are establishing, helping to create, and the hope is that with all those, we'll be able to get back to double-digit growth and a salary that grows in as you said, late 2013 and in the year of 2014. We've just been in the technology industry for quite a while and knowing that the only way to counteract a cyclical downturn is to have fantastic products, and it's always the case, and so we will continue to double down in R&D.

Operator

Our next question comes from the line of Lynn Um with Barclays Capital.

Lynn Um - Barclays Capital, Research Division

I guess first a question on North America. We talked a lot about Europe and Australia and the back-to-school strength in North America, but could you maybe walk us through what you saw in North America from the Commercial side, as well as the Service Provider side?

C. S. Lo

Actually, in North America, we're very encouraged. As you could -- as we just said, America grew 19% year-over-year and 9% sequentially quarter-to-quarter. In all 3 business units, we continue to have sequential growth, and we continue to gain share. The new products that we introduced in each of the 3 business units in America is getting traction on the Retail front. Needless to say, if you go to the retail stores, you will see the 11ac. We continue to be very excited about it. And then, of course, as we just mentioned, the VueZone camera is being rolled out as we speak today to some existing retail partners and some new retail partners. We believe this is a hot Christmas selling item. On the Commercial side, I mean, we just couldn't help on the excitement on the ReadyDATA line. The product is really well received in North America. We're getting so much good review, as well as so much acceptance from our channel, as well as our customers. And it is a product that's very unique in the marketplace that you can do unlimited snapshot and resume and remote, replication. And frankly, even among the enterprise providers, not many of them could provide similar features. But with the graphical user interface, somebody can configure the whole thing in 30 minutes. I mean, it's just unheard of, ease of use. So we're very excited about that and we'll follow-up with more of that product line, and there will be other products that we're going to discuss on our Analyst Day. So we feel very good about the North America market that not only the market continued at good demand, we continue to gain share. We continue to have great products. And even on the Service Provider side, we're seeing the fruits of our acquisition 1.5 years ago with the CNS division and Westell that really helped us into getting a lot of the operators to provide DSL, as well as fixed mobile. And we easily get them certified with Verizon on the open band for the fixed mobile router that actually could use the 4G LTE band as broadband access. We started rolling that out in Retail in Q4, and we're very excited about it. So I mean, in all 3 business units, we're leading charts with really a first in market technology. And the market seems to be having a very good reception of it, and the economy continues to be cooperative in North America. Albeit you could argue that it's not going as gangbuster as what we'd have liked. At least it's growing about 2%, so that is enough for the demand to hold up further on our share gains, so we're very happy with the North American market.

Lynn Um - Barclays Capital, Research Division

Okay. And then I guess in terms of guidance for 4Q, it's down a little bit sequentially. I think you mentioned Service Providers will be down again. Should we assume both Retail and Commercial will be down? Or is there -- can we maybe pencil in some growth in Retail?

C. S. Lo

Yes. We expect the seasonality of Retail and Commercial will continue to kick in like before. Generally speaking, Retail is flat quarter-over-quarter because in Q3 we have back to school and then in Q4 we have Christmas. If Europe actually performs better in Christmas because they don't have back to school, then we should see a sequential growth. But now we can't count on Europe anymore. So Christmas in the U.S. will be just even with back to school in Q3. However, if our VueZone camera does fantastically well, then we would be able to see even sequential growth in North America. So overall, we feel good about the Retail Business Unit, at least flat. On the Commercial side, with all these new products ReadyDATA, yes, we do see sequential growth on a worldwide basis.

Operator

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

Hamed Khorsand - BWS Financial Inc.

Just a couple of questions here. Could you talk about the Service Provider side? Is there some issues as far as the AC [ph] coming out and product transitions on that end being part of the slowdown?

C. S. Lo

No, not at all. As a matter of fact, the service provider usually will not pick up the latest WiFi technology, especially for those that has not been certified by HIPAA. It has nothing to do with that. It is purely the cautiousness of the Service Providers on the consumer sentiment, especially in Europe. So we basically see the slowdown in Europe, as well as in Australia, on that uncertainty.

Hamed Khorsand - BWS Financial Inc.

Okay. And then could you talk about market share on the Service Provider end? You've never talked about that, but it seems as though there's a lot of opportunity for you to grab market share in Service Provider?

C. S. Lo

Yes. It's very certainly difficult to gauge the Service Provider market share on a product-by-product, segment-by-segment basis because the product changes all the time. But if you look at an overall scheme of things of the worldwide suppliers of CPE, counting, for example, Pace, ARRIS, Motorola, Cisco, Scientific Atlanta, Thompson, Technicolor, compared to them, we are tiny. I mean, we're very small. So if you look at our run rate of Service Provider at about $110 million in Q3, which kind of amplify into $450 million a year roughly, and you combine the revenue of CPE from all these big guys, I mean, which is into the $3 billion, $4 billion range, we still have a lot of market share to gain.

Hamed Khorsand - BWS Financial Inc.

Okay. And last question for me is on the guidance you provided, given that you're guiding down the revenue line, what's the risk here that we could actually see operating margins decline? And what are you planning to do on the OpEx side to offset that?

C. S. Lo

Well, as we said all the time, if we are closer to the low end of the range of revenue, then certainly our operating margin will be at the low end of the range and vice versa. And we have been very, very vigilant in controlling our expenses. So I mean, a lot of expenses that we look at on a weekly and not on a daily basis. And it's a good thing that the bulk of the expense, of course, is labor cost, and our labor cost is very performance based. So that really helps leverage our operating expense line. And so we will continue to be very vigilant. But on the other hand, we will continue to prime the pump for R&D for new products.

Operator

Our next question comes from the line of Ken Schofield with Goldman Sachs.

Kent Schofield - Goldman Sachs Group Inc., Research Division

On your commentary around sales and marketing spend in the emerging markets, are we to take that as an actual increase? Or is that just shifting resources?

C. S. Lo

Yes, shifting resources; in other words, that we would let the reduction -- I mean, the natural reduction of headcount in Europe to go and then move those headcounts to India, China, Russia.

Kent Schofield - Goldman Sachs Group Inc., Research Division

Okay, thanks for the clarification there. On the NAS [ph] business side of things, are you still seeing challenges from HDD pricing?

C. S. Lo

Not anymore. As a matter of fact, the hard disk prices are coming close to where before the flood was in Thailand. So we're very encouraged by that. And so starting this quarter, we will be able to price as competitively as we used to.

Kent Schofield - Goldman Sachs Group Inc., Research Division

Okay, great. And then on the inventory side of things, you mentioned China. Is there anything else going on there, though? I mean, I know it's a snapshot and a specific point of time, so it can be a little bit cloudy that way. But it was a big build, so is there anything else going on there?

C. S. Lo

No, I mean, the Chinese calendar is pretty weird. They have this big, call it, autumn festival, which flows from year to year. And this year, that festival coincides with the National Day in early October. So the usual 5, 6 days holiday extended to become 2 weeks. So I mean, that's pretty much what it is. And if you have your factory shut down for 2 weeks, not supplying to you, then you have no choice but to stock it up before they shut down, right?

Operator

Our next question comes from the line of John Keyes with Capstone Investments.

Jonathan Kees - Capstone Investments, Research Division

I wanted to ask, and I guess, Patrick, you kind of touched on it, to offer competitive pricing. I guess I wanted to get a sense in terms of the environment, the pricing environment in Q3 and what you're seeing. Are you -- obviously, gross margin has picked up, but that was probably more from the Service Provider being down. I guess are you -- having to run more promotions, are you seeing some of your competitors being more aggressive, especially going to Q4?

C. S. Lo

We actually do not see a lot of pricing action in North America nor in Asia, even in Australia. But we do see some pricing actions in Europe. So we're spending a little bit more marketing dollars over there in Europe. But other than that, we don't see any particular anomaly.

Jonathan Kees - Capstone Investments, Research Division

Okay, all right. Let me ask you, from this perspective, and I guess you can focus on North America or you can talk about the regions, too. In the past, you talked about shelf space and how you've been increasing shelf space and that kind of stuff. Is that still the trend? Or have you just been holding steady in terms of your shelf space?

C. S. Lo

We continue to increase shelf space. It's pretty clear that shelf space is now driven by new products because frankly, in the networking aisle, in many of the developed markets like North America, U.K., Nordic, I mean, I don't think that retailers are willing to give us even more shelf space. I mean, we've got so much shelf space already. So we're using new products, expanding to other parts of the store. For example, we recently introduced a very small compact and low-cost WiFi repeaters that we're now getting our retailers to place them next to the phone, the smartphone and tablet aisle. So that's the kind of shelf space that we get. And clearly, with the views on cameras, which will allow us to enter stores that previously would not be open to networking products from us, and those are increased shelf space. So we do see continued increase in shelf space because of new product categories.

Jonathan Kees - Capstone Investments, Research Division

So then, let me parley that in terms of one particular customer of yours. I know you don't like to talk about specifics, but you can talk in general, you could at least [ph]. Best Buy hasn't been a 10% customer for the last 3 quarters, and I'm just trying to understand, especially your gain, and I know you talked about increasing shelf space in general across all the retailers. But if we were just to take one particular customer, if you're increasing the shelf space, I mean, are you seeing your marketing efforts, your presence, point presence helping out in terms of -- with these customers? Or is it more -- in some of these cases, it's more of a retailer-specific issue?

C. S. Lo

No, I mean, basically, our shelf space in Best Buy continued to be very strong. And we're actually increasing our shelf space in all the other stores. For example, over the last 2 quarters, as we announced previously, we're now in Target. We're now in Walmart Canada. So there's clearly market shift -- market share shift among the retailers, among the stores chains, among the store chain versus online. Frankly, we're not going to play the role of a referee. We're not allowed to. So all we are focusing on is maximizing our shelf space and market share in each individual store chain and on the right site so as to achieve an overall increase in market share, as I talked about it; we were saying it just about 20 minutes ago. Because of all that effort, we believe that we have reached a new height in North America Retail market share, which is close to double the #2 player. So we're very pleased with the progress we're making.

Operator

Our next question comes from the line of Rohig Chopra with Wedbush.

Rohit N. Chopra - Wedbush Securities Inc., Research Division

Patrick, I just wanted to square something with you in the SBU market. ARRIS had a record quarter Q-over-Q, I think they reported in their DOCSIS 3.0 products, and they didn't see a slowdown. And obviously, they deal with cable companies. So I just wanted to see if we could square what they're seeing and what you're seeing. And maybe that's more geographic or maybe it's more the end customer. Can you maybe elaborate on what you're seeing versus what they saw? Is there a way to do that and help us out?

C. S. Lo

Yes. I have to congratulate them. That 95% and the 99% of the sales of cable gateways is in North America. I wish that I could do that. North America, as we explained all along in the last 30 minutes, is doing great. The economy is chugging along. The customers are accepting new technology. It's the Europeans who are actually in the downturn. And unfortunately, unlike ARRIS, we have always been a more international company, and that's why we're more affected by Europe. So, I mean, that's the only difference.

Rohit N. Chopra - Wedbush Securities Inc., Research Division

And then I just want to ask you a question on Commercial. I know there was a question asked about competition. But are you seeing any of the larger players sort of come downstream? We've heard from some of the people that you deal with that the larger vendors have started to move downstream as some of the larger customers have dried up, some of the spending has dried up, so they start to move downstream. Are you seeing any competition in the Commercial side from some of the larger vendors? Is that having any impact?

C. S. Lo

Well, I mean, they have been always been there. I mean, as a matter of fact, it's the consolidation in the industry. I mean, for example, right now, we're competing more on a global basis against Cisco and HP. All right? But we have been competing against Linksys and HP forever. But then since Cisco took over Linksys, then we ended up competing with Cisco, which is the same. I didn't see -- and then we have been competing with HP since day 1. So on the Commercial side, we did not see so-called coming down. For example, if you ask me, did people like Juniper come down? I don't see that. And did you see Fortinet coming down? I don't see that. Did you see EMC coming down? I don't see that.

Rohit N. Chopra - Wedbush Securities Inc., Research Division

Okay. So no incoming competition? Everything status quo?

C. S. Lo

No, it's the same group of people.

Operator

[Operator Instructions] There are no further questions at this time. I would like to turn the floor back over to management for any closing comments.

C. S. Lo

Great. Once again, I would like to see you all at the Analyst Day in New York City. We're really excited about the 3 new solution sets that we're going to present, which is the 21st Century, Smart Home, the Next-Generation SMB, as well as the new Service Provider solution based on the LTE technology. And we certainly will be sharing with you a lot of exciting new technology and products we're going to introduce to redrive our revenue towards our $2 billion goal, and look forward to seeing everyone in November. Thank you, operator.

Operator

Thank you. Ladies and gentlemen, this concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.

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