UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-K
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þ | | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934. |
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| | | For the fiscal year ended December 31, 20032006 |
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o | | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934. |
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| | | For the transition period from to . |
Commission file number 0-50350000-50350
NETGEAR, Inc.
(Exact name of registrant as specified in its charter)
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Delaware | | 77-0419172 |
(State or other jurisdiction of
incorporation or organization) | | (IRSI.R.S. Employer
Identification No.) |
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4500 Great America Parkway,
Santa Clara, California
(Address of principal executive offices) | | 95054
(Zip Code) |
(Registrant’s telephone number, including area code)
(408) 907-8000
Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant 12(g) of the Act:
Common Stock, par value $0.001
Securities registered pursuant to 12(g) of the Act:
None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o No þ
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o No þ
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes
oþ No
þoIndicate by check mark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this
Form 10-K or any amendment to this
Form 10-K. oþIndicate by check mark whether the registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer (as defined in Exchange Act Rule 12b-2)12b-2 of the Act).
Large accelerated filer þ Accelerated filer o Non-accelerated filer o
Indicate by check mark whether the registrant is a shell company (as defined inRule 12b-2 of the Act.) Yes
o No
þ As
The aggregate market value of
the voting and non-voting common equity held by non-affiliates of the Registrant as of July 2, 2006, was approximately $643,599,531. Such aggregate market value was computed by reference to the closing price of the common stock as reported on the Nasdaq National Market on June
29, 2003, the30, 2006 (the last business day of the Registrant’s most recently completed
fiscal second
fiscal quarter, there were 2,466 shares of the Registrant’s Common Stock outstanding. As of that date, the Registrant was not a publicly-traded company on the Nasdaq National Market.quarter).
The number of outstanding shares of the registrant’s Common Stock, $0.001 par value, was
29,654,77734,323,928 shares as of February
20, 2004.16, 2007.
DOCUMENTS INCORPORATED BY REFERENCE Portions of the Proxy Statement for the Registrant’s 20042007 Annual Meeting of Stockholders are incorporated by reference in Part III of thisForm 10-K.
TABLE OF CONTENTS
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PART I |
Item 1. | | Business | | | 2 | |
Item 2. | | Properties | | | 15 | |
Item 3. | | Legal Proceedings | | | 15 | |
Item 4. | | Submission of Matters to a Vote of Security Holders | | | 16 | |
PART II |
Item 5. | | Market for Registrant’s Common Stock, Related Stockholder Matters and Issuer Purchases of Equity Securities | | | 16 | |
Item 6. | | Selected Consolidated Financial Data | | | 16 | |
Item 7. | | Management’s Discussion and Analysis of Financial Condition and Results of Operations | | | 18 | |
Item 7A. | | Quantitative and Qualitative Disclosures About Market Risk | | | 43 | |
Item 8. | | Consolidated Financial Statements and Supplementary Data | | | 45 | |
Item 9 | | Changes in and Disagreements With Accountants on Accounting and Financial Disclosure | | | 68 | |
Item 9A. | | Controls and Procedures | | | 68 | |
PART III |
Item 10. | | Directors and Executive Officers of the Registrant | | | 68 | |
Item 11. | | Executive Compensation | | | 69 | |
Item 12. | | Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters | | | 69 | |
Item 13. | | Certain Relationships and Related Transactions | | | 69 | |
Item 14. | | Principal Accountant Fees and Services | | | 69 | |
PART IV |
Item 15. | | Exhibits, Financial Statement Schedules, and Reports on Form 8-K | | | 69 | |
Signatures | | | 70 | |
Index to Exhibits | | | | |
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PART I
ThisThis Form 10-K, including Management’s Discussion and Analysis of Financial Condition and Results of Operations in Part II, Item 7 below, includes forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. All statements other than statements of historical facts contained in thisForm 10-K, including statements regarding our future financial position, business strategy and plans and objectives of management for future operations, are forward-looking statements. The words “believe,” “may,” “will,” “estimate,” “continue,” “anticipate,” “intend,” “should,” “plan,” “expect” and similar expressions, as they relate to us, are intended to identify forward-looking statements. We have based these forward-looking statements largely on our current expectations and projections about future events and financial trends that we believe may affect our financial condition, results of operations, business strategy and financial needs. These forward-looking statements are subject to a number of risks, uncertainties and assumptions described in “Risk Factors Affecting Future Results”Factors” in Part II,I, Item 71A below, and elsewhere in thisForm 10-K, including, among other things: the future growth of the small business and home markets; speed of adoption of wireless networking worldwide; our business strategies and development plans; our successful introduction of new products and technologies; future operating expenses and financing requirements; and competition and competitive factors in the small business and home markets. In light of these risks, uncertainties and assumptions, the forward-looking events and circumstances discussed in thisForm 10-K may not occur and actual results could differ materially from those anticipated or implied in the forward-looking statements. All forward-looking statements in thisForm 10-K are based on information available to us as of the date hereof and we assume no obligation to update any such forward-looking statements. The following discussion should be read in conjunction with our consolidated financial statements and the accompanying notes contained in thisForm 10-K.
Item 1. Business
General
We were incorporated in Delaware on January 8, 1996.
We design, develop and market
technologically advanced, branded networking products
that address the specific needs offor home users and for small business, which we define as a business with fewer than 250
employees, and home users.employees. We
supply innovative networking products that meetare focused on satisfying the
ease-of-use, quality, reliability, performance and affordability requirements of these users. Our
broad suite of approximately 100 products enablesproduct offerings enable users to
connect and communicate across local area networks and the World Wide Web and share Internet access, peripherals, files, digital multimedia content and applications among multiple personal computers, or PCs, and other Internet-enabled devices.
Our products are grouped into three major segments within the small business and home markets: Ethernet networking products, broadband products and wireless networking products, with each product group including a combination of switches, adapters, and wired and wireless routers and gateways. We sell our products primarily through a global sales channel network, which includes traditional retailers,
with over 7,100 locations worldwide, online retailers, direct market resellers, or DMRs, value added resellers, or VARs, and broadband service providers.
A summary of our net revenue and assets for our business is found in Note 12 to the Consolidated Financial Statements under Part II, Item 8 of this Form 10-K, which is incorporated herein by reference. A discussion of factors potentially affecting our operations is set forth in “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Risk“Risk Factors, Affecting Future Results,” under Part II,I, Item 71A of thisForm 10-K, which10-K.
We were incorporated in Delaware on January 8, 1996. Our principal executive offices are located at 4500 Great America Parkway, Santa Clara, California 95054, and our telephone number at that location is
incorporated herein(408) 907-8000. We file reports, proxy statements and other information with the Securities and Exchange Commission, or SEC, in accordance with the Securities Exchange Act of 1934, as amended, or the Exchange Act. You may read and copy our reports, proxy statements and other information filed by
reference.us at the public reference room of the SEC located at 450 Fifth Street, N.W., Washington, D.C. 20549. Please call the SEC at1-800-SEC-0330 for further information about the public reference rooms. Our filings are also available to the public over the Internet at the SEC’s website athttp://www.sec.gov, and, as soon as practicable after such reports are filed with the SEC, free of charge through a hyperlink on our Internet website athttp://www.netgear.com. Information contained on the website is not a part of thisForm 10-K.
Industry BackgroundMarketsOur objective is to be the leading provider of innovative networking products to the small business and home markets. A number of factors are driving today’s increasing demand for networking products within small businesses and homes. As the number of computing devices, such as PCs, has increased in recent years, networks are being deployed in order to share information and resources among users and devices. This information and resource sharing occurs internally, through a local area network, or LAN, or externally, via the Internet. To take
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advantage of complex applications, advanced communication capabilities and rich multimedia content, users are upgrading their Internet connections by deploying high-speed broadband access
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technologies. Users also seek the convenience and flexibility of operating their PCs, laptops and related computing devices in a more mobile, or wireless, manner. Finally, as the usage of networks, including the Internet, has increased, users have become much more focused on the security of their connections and the protection of the data within their networks.
The number of PCs within small businesses and homes is increasing, due to the increased affordability and capabilities of these devices, small businesses and homes are developing multiple PCs within these environments. According to International Data Corporation, or IDC, at the end of 2002, 69% of U.S. businesses with less than 100 employees have multiple PCs, while only 32% have deployed networks. As the number of PCs has grown and users have become more familiar with and dependent upon their capabilities, users seek networks that enable them to share devices (printers and storage), access data and rich content (pictures, music and video files), leverage collaborative applications (email and instant messaging) and share Internet access. Furthermore, home users desire the ability to play digital audio and video content stored on a PC or the Internet, on consumer electronic devices like stereos, home theatres and TVs. In addition, demand is growing for the ability to make low cost, feature-rich telephone calls using Internet protocol, a technology known as voice-over-IP.
As small business and home users increasingly need to access and interact with bandwidth intensive files and applications, they are demanding an upgrade from dial-up connections to broadband connections, using cable or digital subscriber line, or DSL, modems, which enable Internet access at speeds up to 20 times faster than dial-up modems. Broadband Internet access services have become increasingly affordable and available, thereby fueling penetration of these services. According to IDC, the number of DSL and cable modem broadband Internet connections worldwide is expected to increase from 58.6 million in 2002 to 183.9 million in 2006, reflecting a compound annual growth rate of 33%. Increasingly, networking products are being deployed within small businesses and homes in order to share these high-speed Internet connections among multiple users and devices.
As wireless technologies have become more prevalent, cost-efficient and easy-to-use and install, small business and home users increasingly value the flexibility to wirelessly access and interact with their networks, including the Internet. For small businesses or homes, wireless LANs provide mobility for users and can be an affordable alternative to a wired network. Users are also able to utilize their notebook computers to access networks from a variety of locations, including their homes, offices and various other ‘hot spot’ locations, such as airports, cafes and university campuses. The adoption of industry standards for wireless LAN communications has helped spur the proliferation of a variety of wireless products for both the small business and home markets. Cahners’ In-Stat/ MDR estimates that the total number of worldwide shipments of wireless LAN equipment, including both network interface cards, or NICs, access points and digital media adapters, will grow from 49.0 million in 2003 to 123.8 million in 2006, reflecting a compound annual growth rate of 36%.
With the proliferation of networks, maintaining the security of information and protecting the privacy of communication becomes essential to both small business and home users alike. Unlike the private dedicated communication networks of past decades, which were relatively secure from intruders, the Internet and networks connected to it are increasingly susceptible to security threats. In recent years, there has been a heightened awareness of the need to protect against breaches of network security. Accordingly, there has been an increase in the demand for security related products, or the integration of security features into networking products such as Internet routers and wireless networking equipment, to protect information on networks and to limit the usage of networks only to authorized individuals. Networking products for the small business and home markets are primarily classified into three broad categories:
Ethernet networking products, including switches (multiple port devices used to network PCs and peripherals), NICs or network adapters, and bridges (devices that connect PCs and other equipment to a network), and peripheral servers such as print servers (devices that manage printing on a network).
Broadband products, including routers (intelligent devices used to connect two networks together, such as a local area network and the Internet), gateways (a router with an integrated modem for Internet access), and products that include an integrated wireless access point such as a wireless gateway.
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Wireless networking products, including access points (devices that provide a wireless link between the wired network and wireless devices) and wireless NICs or network adapters, and media adapters and bridges (devices that wirelessly connect PCs, stereos, TVs and other equipment to a network).
A small business network can consist of:
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| • | multiple PCs; |
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| • | peripherals such as printers and storage devices; |
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| • | a network connection device such as a router, which often includes security functionality; |
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| • | a wired or wireless network adapter for each personal computer; and |
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| • | a central network controller such as a switch. |
A home network can consist of:
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| • | one or more PCs and possibly consumer electronic devices to be networked; |
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| • | peripherals such as printers and scanners; |
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| • | Internet access devices such as a router or a gateway; |
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| • | a wired or wireless network adapter for each personal computer; and |
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| • | a “bridge” or a media adapter that connects consumer electronic device such as game consoles, TVs, stereos, and telephones. |
Within both the small business and home markets, devices are typically linked together through Ethernet cables or, increasingly, wireless connections. In-home power lines can also be used to transmit data among components to form a home network.
Small business and home users demand a complete set of wired and wireless networking and broadband solutions that are tailored to their specific needs and budgets and also incorporate the latest networking technologies. These users require the continual introduction of new and refined products. Small business and home users often lack extensive IT resources and technical knowledge and therefore demand ‘plug-and-play’ or
easy-to-install and use solutions. These users
demandseek reliable products that require little or no maintenance, and are supported by effective technical support and customer service. We believe that these users also prefer the convenience of obtaining a networking solution from a single company with whom they are familiar; as
these users expand their networks, they tend to be loyal purchasers of that brand. In addition, purchasing decisions of users in the small business and home markets are also driven by the affordability of networking products. To provide reliable,
easy-to-use products at an attractive price, we believe a successful supplier must have a company-wide focus on the unique requirements of
this marketthese markets and the operational discipline and cost-efficient company infrastructure and processes that allow for efficient product development, manufacturing and distribution.
Our Strategy
Our objective is to be the leading provider of innovative networking products that address the needs of the small business and home markets. The following are key elements of our strategy:
Be first to market with innovative products. We believe that our experience in the small business and home markets, along with our access to technology road maps through our relationships with leading semiconductor and software companies, enable us to quickly introduce innovative products to the market. We intend to strengthen current relationships and forge new relationships with emerging suppliers of software and semiconductor technology. We intend to continue to invest in internal research and development activities designed to enhance our products to satisfy the wide range of evolving networking requirements in small businesses and homes. We plan to further broaden our product portfolio into new areas that will complement our current product offerings while leveraging our brand, channel presence and operational efficiency. For example, we believe our recent introduction of 108 Mbps 802.11g wireless products address an important market opportunity.
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Expand and enhance our sales channels. We believe that the most effective way to sell networking products to the small business and home markets is through a diverse worldwide set of traditional retailers, online retailers, DMRs, VARs and broadband service providers. We plan to expand relationships with our retail network, and continue to add new resellers. For example, in 2003 we began selling our products in North America at such retailers as Microcenter and Office Depot and at international retailers such as Legend Group (China) and PC Specialist (Germany). In addition, we have recently entered into an agreement with Softbank B.B. Corp. for the exclusive distribution of our products in Japan. Similarly we intend to continue to work closely with the VAR channel, by expanding the number of our relationships as well as developing products specifically addressing their customers’ needs. We are increasingly developing and enhancing relationships with broadband service providers in North America and internationally and have, as an example, begun reselling our products through Time-Warner Cable and Comcast in the United States, Telstra in Australia and Tele Denmark. We intend to continue these initiatives and expect to pursue similar relationships with broadband service providers in the future.
Extend our geographic presence. We believe that one of our most significant competitive advantages is our global presence. We derive substantial revenue from each of the North American, Europe, Middle-East and Africa (EMEA) and Asia Pacific markets. In 2003, 42% of our net revenue was generated from international sales. We view several international markets as opportunities for continued significant growth for our business. We have recently entered the Chinese market by establishing sales offices which serve the local retailers and VAR’s. We intend to continue to expand our geographic presence by targeting emerging and growing markets, such as China and India, either through direct investment or teaming with existing local companies. In addition, we plan to leverage our success in European countries, such as Italy, that are experiencing growing demand for networking products. From time to time, we may also consider acquisitions, strategic alliances or joint ventures to increase our penetration in identified markets.
Expand our marketing initiatives. NETGEAR is one of the most widely recognized brands in the small business and home networking markets, known for affordable, reliable and easy-to-use products. We believe that the purchasing decisions of small business and home users are influenced by brand recognition. Consequently, we have made significant investments to establish the NETGEAR brand, our GearGuy logo and the consistent and recognizable design of our products. We intend to continue building our brand identity through product design, packaging, public relations, advertising campaigns and other marketing efforts.
Enhance operational efficiencies. We believe one of the keys to our success in operating a profitable business within the small business and home networking markets has been our ability to control operational costs while continuing to provide first-to-market, innovative products. We have implemented processes to manage product development efficiency, inventory and channel costs, and overall operating expenses. We plan to continue to invest in personnel, technology and processes to enhance our operational discipline and efficiencies with respect to product development, manufacturing, demand assessment and supply chain and channel inventory management. By focusing on operational efficiencies, we intend to continue to meet the demands of our target markets for affordable, high quality products while maintaining a profitable business model.
Products
Our extensive product line currently includes approximately 100 different products. These products are available in multiple configurations to address the needs of our customers in each geographic region in which our products are sold. Our Ethernet networking products have historically generated a majority of our net revenue. However, in recent periods, the percentage of our net revenue attributable to broadband and wireless networking products has increased. Our products target the following three major segments within the small business and home markets:
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| • | Ethernet networking products, including switches, NICs or adapters, bridges and print servers; |
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| • | broadband products, including wired and wireless routers and gateways; and |
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| • | wireless networking products, including access points, wireless NICs or adapters, and media adapters and bridges. |
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The following table identifies our principal products as of December 31, 2003:
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| | SMALL BUSINESS | | HOME |
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ETHERNET
NETWORKING
PRODUCTS | | Switches
• 10/100 megabits per second (Mbps) using copper cables
• 10/100/1000 Mbps using copper or fiber cables
• 10/100/1000 Mbps Stackable using copper or fiber cables
• 10/100/1000 Mbps Managed using copper or fiber cables
• 10/100 Mbps Managed Layer 3 Power over Ethernet using copper or fiber cables
• 10/100/1000 Mbps Managed Layer 3 using copper or fiber cables | | Switches
• 10/100 Mbps Platinum Series using copper cables
Bridges
• 14 Mbps Wall-Plugged Ethernet Bridge |
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| | NICs
• 10/100 Mbps Peripheral Component Interconnect (PCI) NIC
• 10/100 Mbps PC Card NIC
• 10/100 Mbps Ethernet Universal Serial Bus (USB) NIC
• 1000 Mbps PCI | | NICs
• 10/100 Mbps PCI NIC
• 10/100 Mbps PC Card NIC
• 10/100 Mbps Ethernet USB NIC
• 10/100/1000 Mbps PCI NIC |
| | Servers | | Servers |
| | • Print Servers | | • Print Servers |
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BROADBAND
PRODUCTS | | Routers
• Ethernet Cable/DSL Router with Printer Server
• Ethernet Cable/DSL ProSafe Virtual Private Network (VPN) Firewall Router
• ProSafe 802.11g Wireless Firewall with USB Print Server
• ProSafe Dual Band Wireless 802.11a/b/g Wireless VPN Firewall
• ProSafe VPN client software | | Routers/Gateways
• Ethernet DSL Modem with USB Port
• Ethernet Cable Modem Gateway
• Ethernet DSL Modem Gateway
• Ethernet Cable/DSL Web Safe Router
• Wireless 802.11g DSL Modem Gateway
• Wireless 802.11b Cable/DSL Router
• Wireless 802.11b Cable Modem Gateway
• Wireless 802.11g Cable Modem Gateway
• Wireless 802.11g Cable/DSL Router
• Wireless 108 Mbps 802.11g Cable/DSL Router
• Wireless 108 Mbps 802.11g Cable/DSL Router with disc sharing controller |
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| | Access Points | | Bridges |
WIRELESS
NETWORKING
PRODUCTS | | • ProSafe 802.11g Wireless Access Point
• 18 dBi Patch Panel Directional Antenna
• 5 dBi Omni-directional Antenna
NICs
• 802.11a/g Dual Band Wireless PCI NIC
• 802.11a/g Dual Band Wireless PC Card NIC | | • 802.11b Wireless Bridge
• 802.11g Wireless Bridge
• 802.11b Wireless Bridge for home audio devices, or Digital Music Player
NICs
• 802.11b Wireless USB NIC
• 802.11b Wireless PCI NIC
• 802.11b Wireless PC Card NIC
• 802.11b Compact Flash NIC
• 802.11b Wireless Digital Music Player
• 802.11g Wireless USB NIC
• 802.11g Wireless PC Card NIC
• 108 Mbps 802.11g Wireless PC Card NIC
• 108 Mbps 802.11g Wireless PCI NIC |
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We customize our products to meet the specific needs of both the small business and home markets, tailoring various elements of the product design, including component specification, physical characteristics such as casing, design and coloration, and specific hardware and software features to meet the needs of these markets. However, we leverage many of our technological developments, high volume manufacturing, technical support and engineering infrastructure across both markets to maximize business efficiencies.
Our small business products are designed with an industrial appearance, including metal cases, and for some product categories, the ability to mount the product within standard data networking racks. These products typically include higher port counts, higher data transfer rates and other performance characteristics designed to meet the needs of a small business user. For example, we offer data transfer rates up to one Gigabit per second for our business products to meet the higher capacity requirements of business users. These products are also designed to support transmission modes such as fiber optic cabling, which is common in more sophisticated business environments. Security requirements within our broadband products include firewall and virtual private network capabilities that allow for secure interactions between remote offices and business headquarter locations. Our wireless product offerings for the small business market include higher transfer rates as well as enhanced security capabilities often required in a business setting.
Our current development efforts for Ethernet networking products for the small business market include expanding our network management capabilities such as Layer 3 managed switching functionality, as well as offering higher port counts and densities for Fast Ethernet and Gigabit products to support the needs of growing small business customers. For our broadband products in the small business market, we plan to continue enhancing the capabilities of our routers with advanced firewall and virtual private network capabilities and to permit voice calls over the Internet. We expect that these capabilities will be offered in both traditional copper cabling as well as wireless connectivity modes including 802.11b, dual-mode 802.11b/g and tri-mode 802.11a/b/g. Developments in the wireless networking product area include additional 802.11b/g and tri-mode 802.11a/b/g capabilities for access points and NICs, offering advanced speeds, security and backward compatibility.
Our home products are designed with pleasing visual and physical aesthetics that are more desirable in a home environment. For example, products featuring our Platinum series physical designs have a silver/gray coloring and lighter plastic casings to appeal to home users. Our Ethernet products for the home market use a lower cost electrical component design and contain lower port counts to meet the increased price sensitivity and specific data networking requirements of home consumers. Our wireless offerings in the home support sufficient data transfer rates for most home user applications, but at a lower price than higher capacity wireless offerings for the small business market. Our broadband products are available with features such as parental control capabilities and firewall security, to allow for safer, more controlled Internet usage in families with children. Our broadband products designed for the home market also contain advanced installation software that guides a less sophisticated data networking user through the installation process with their broadband service provider, using a graphical user interface and simple point and click operations. Our home product offerings include wall-plug data transmission modes which allow home users to take advantage of their existing electrical wiring infrastructure for transmitting data among network components.
We are developing a substantial number of new product offerings for the home market. Our current development efforts for Ethernet networking products include expanding our product lines using in-home power lines to form a network, low cost Gigabit Ethernet NICs, and engineering redesigns to allow for price and cost reductions in our switch line. For our broadband products, we plan to expand our portfolio of wired and wireless gateways with integrated asynchronous DSL and cable modem capabilities, with enhanced ease-of-setup installation and ease-of-use capabilities. We expect these capabilities will be offered in both traditional copper cabling as well as 802.11b, and 802.11g wireless connectivity modes. Our development efforts in the wireless networking product area include expanding our line of 802.11g access points, routers and gateways, NICs and bridges with faster speeds, expanded range and enhanced security. Other developments include a USB disk attachable 108 Mbps 802.11g wireless router to wirelessly share files or remote access while away from home and our recently announced wireless digital music player for streaming digital music from PCs or from the Internet to play on traditional analog stereos in the home.
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Competitive Strengths
Since our inception in 1996, we have been solely focused on the networking needs of the small business and home markets. We provide a broad family of innovative networking products and have shipped over 22 million units worldwide. Over the course of the past seven years, we have built a significant market share in several of the geographic and product markets we serve. We believe that the NETGEAR brand name is widely recognized for quality products that meet the networking needs of small business and home users worldwide.
Reliable, Easy-to-Use, Affordable Products. We design quality products, perform rigorous technology evaluation and conduct significant product testing, which we believe allow us to achieve a high degree of customer satisfaction and a low rate of product returns and defects. Our networking products are easy to install, use and maintain and minimize the need for users to perform hardware or software configuration. For example, our proprietary, Internet browser-based ‘Smart Wizard’ application provides users with simple graphical step-by-step installation instructions, including the automatic detection of their Internet connection type in order to automatically configure their routers or gateways. We also provide comprehensive technical support and customer service. Our products satisfy the budgetary requirements of small businesses and home users.
Broad Product Offering. We offer an extensive range of networking products to users within the small business and home markets, including routers, gateways, access points, switches and NICs. Our product line includes approximately 100 products that are available in multiple configurations to serve the geographic region in which they are sold. Our products are designed for a variety of networking environments, including traditional Ethernet cabling and wireless as well as emerging in-home electrical wiring communication. We offer broadband products for a wide range of connection types, such as DSL and cable modems. Our wireless products include wireless LAN and security functionality to address the increasing mobility and security requirements of users. We believe users in the small business and home markets prefer to purchase all of their networking products from one vendor. We therefore believe the breadth of our product line represents a competitive strength due to our ability to meet a wide range of their networking needs.
Extensive Global Channel Presence. We sell our products in North America, EMEA and Asia Pacific through an extensive network of sales channels. Our net revenue is well balanced worldwide, with 58% of our net revenue in 2003 being derived from sales in North America and 42% derived from international sales. Our worldwide channel presence enables our end-user customers to purchase our products with the same ease with which they purchase personal computers and software. We currently sell products through traditional retailers with more than 3,700 retail locations in North America, including Best Buy, Circuit City, CompUSA, Costco, Fry’s Electronics, Micro Center, Office Depot and Staples domestically, and over 3,300 international retail locations, such as MediaMarkt (Germany, Austria) and PC World (UK) in Europe, and Harris (Australia) in Asia Pacific. Our broad product offering and sales volume enables us to command substantial shelf space at our traditional retailers worldwide, which we believe is a significant competitive advantage in our target markets. We also sell through online stores such as Amazon.com and Buy.com. We have a significant DMR presence, in both catalog sales and direct marketing channels, including relationships with CDW and PC Connection domestically and Misco Global and Insight Direct both domestically and internationally. We have relationships with thousands of VARs worldwide, including over 8,000 domestically and more than 3,000 internationally, which participate in our Powershift Partner program. This program provides incentives and training to select members who meet quarterly sales goals. In addition, we recently began selling our products through broadband service providers such as Time-Warner Cable and Comcast domestically, and Telstra in Australia and Tele Denmark.
History of Product Innovation. The product requirements of small business and home networking users are continually changing with the rapid adoption of new technologies. We believe that our experience, market presence, and global reach enable us to identify trends in product demand and rapidly introduce products to meet that demand. Our corporate headquarters are located in Santa Clara in the heart of Silicon Valley. From this location we team with a number of leading semiconductor and software companies in order to offer products that incorporate emerging technologies. In addition, our internal research and development efforts focus on designing
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products that meet the requirements of both the small business and home markets. We believe that the combination of our demand assessment capabilities and our technology collaborations often provides us with a time-to-market advantage. We were the first to introduce a number of new technologies to the small business and home markets including unmanaged Gigabit Ethernet switches, Cable/ DSL routers, wireless routers and gateways with high security capabilities and 802.11a/b/g Wireless NICs and 108 Mbps 802.11g Wireless NICs, Routers and Routers with USB attachable storage. In 2003, we introduced 48 new products.
Operational Discipline. We utilize our management team’s significant experience in the networking, computer and retail industries to maintain tight operational discipline over product development and supply chain and channel inventory management. This has resulted in reduced manufacturing lead times, warranty costs, price protection expenses and channel inventory. Once we have identified a promising new networking technology, we work closely with our component vendors and original design manufacturing partners, or ODMs, in China and Taiwan to bring our products to market quickly, minimize product costs and ensure product quality. We have implemented several operational efficiency initiatives, including refining our supply chain management by introducing computerized monitoring of inventory levels and end-user purchases for many of our domestic resellers. We have also introduced an enhanced demand assessment process, which allows us to work with our resellers to closely monitor demand for specific product offerings.
We sell our products are sold through multiple sales channels worldwide, including traditional retailers, online retailers, wholesale distributors, DMRs, VARs, and recently, broadband service providers. We sell our products through more than 7,100 traditional retail locations, including domestic and international stores and online retailers, such as Amazon.com Systemax and Buy.com.
Retailers. Our retail channel primarily supplies products that are sold into the home market. We sell directly to,
Best Buy, Circuit City, Costco, Fry’s Electronics, Micro Center, Office Depot and Staples.or enter into consignment arrangements with, a number of our traditional retailers. The remaining traditional retailers, as well as our online retailers, are fulfilled through
approximately 67 wholesale distributors, the largest of which are Ingram Micro,
Inc. and Tech
Data. These wholesale distributors are located in the United States, the United Kingdom, France, Germany, Japan and Canada and approximately 30 other countries.Data Corporation. We work directly with our retail channels on market development activities, such as co-advertising, in-store promotions and demonstrations,
instant rebate programs, event sponsorship and sales associate training, as well as establishing “store within a store” websites and banner advertising.
DMRs and VARs.We primarily sell ourinto the small business productsmarket through an extensive network of DMRs and VARs. Our DMRs include companies such as CDW and Insight. VARs include over 8,000our network of registered Powershift Partners, in the United States and more than 3,000 Powershift Partners internationally. Our Powershift Partners areor resellers who achieve prescribed quarterly sales goals and as a result may receive sales incentives, which can be used to offset marketing costs or marketing development funding. In addition, our Powershift Partners receivesupport and other sales tools, including select products available as demonstration units at an additional discountprogram benefits from our standard list price, exclusive promotions and rebates, monthly e-mails and newsletters with technical, marketing and sales updates, training and seminars, and co-marketing funds.us. Our products are also resold by a large number of smaller VARs whose sales are not large enough to qualify them for our Powershift Partner program. Our DMRs and VARs generally purchase our products through our wholesale distributors, primarily Ingram Micro, Inc. and Tech Data.Data Corporation.
Broadband Service Providers. We earn revenue uponalso supply our products directly to broadband service providers in the sale ofUnited States and internationally, who distribute our products to distributorstheir small business and earn no additional revenue uponhome subscribers.
We derive the resalemajority of our products.net revenue from international sales. International sales as a percentage of net revenue grew from 56% in 2005 to 62% in 2006. Sales in Europe, Middle-East and Africa, or EMEA, grew from $200.0 million in 2005 to $298.2 million in 2006, representing an increase of approximately 49% during that period. We continue to penetrate new markets such as Brazil, Eastern Europe, India, and the Middle-East. The top five resellerstable below sets forth our net revenue by major geographic region.
| | | | | | | | | | | | | | | | | | | | | |
| | | Year Ended December 31, | |
| | | | | | Percentage
| | | | | | Percentage
| | | | |
| | | 2004 | | | Change | | | 2005 | | | Change | | | 2006 | |
| | | (In thousands, except percentage data) | |
| |
| United States | | $ | 186,836 | | | | 7 | % | | $ | 199,208 | | | | 11 | % | | $ | 220,440 | |
| EMEA | | | 159,615 | | | | 25 | % | | | 199,951 | | | | 49 | % | | | 298,234 | |
| Asia Pacific and rest of world | | | 36,688 | | | | 38 | % | | | 50,451 | | | | 9 | % | | | 54,896 | |
| | | | | | | | | | | | | | | | | | | | | |
| Total | | $ | 383,139 | | | | 17 | % | | $ | 449,610 | | | | 28 | % | | $ | 573,570 | |
| | | | | | | | | | | | | | | | | | | | | |
3
Revenues from significant customers as a percentage of our products by dollar value as oftotal revenues for the years ended December 31, 2003,2004, 2005 and 2006 were as follows:
| | | | | | | | | | | | | |
| | | Year Ended December 31, | |
| | | 2004 | | | 2005 | | | 2006 | |
| |
| Ingram Micro, Inc. | | | 27 | % | | | 25 | % | | | 19 | % |
| Tech Data Corporation | | | 18 | % | | | 17 | % | | | 16 | % |
Product Offerings
Our product line consists of wired and wireless devices that enable Ethernet networking, broadband access, and network connectivity. These products are available in multiple configurations to address the needs of our customers in each category,geographic region in which our products are set forthsold.
Ethernet networking. Ethernet is the most commonly used wired network protocol for connecting devices in alphabetical order in the table below:
today’s home and small-office networks. Products that enable Ethernet networking include: | | | | | | |
| | |
Retail | • | switches, which are multiple port devices used to network PCs and peripherals; |
|
| • | network interface cards, adapters and bridges, that enable PCs and other equipment to be connected to a network; |
|
| • | peripheral servers, such as print servers that manage printing on a network, and disk servers which manage shared disks on the network; and |
|
| • | VPN firewalls, which provide secure remote network access and anti-virus and anti-spam capabilities. |
Broadband Access. Broadband is a transmission medium capable of moving more information and at a higher speed over public networks than traditional narrowband frequencies. Products that enable broadband access include:
| | |
| • | routers, which are used to connect two networks together, such as the home or office network and the Internet; |
|
| • | gateways, or routers with an integrated modem, for Internet access; |
|
| • | IP telephony products, used for transmitting voice communications over a network; and |
|
| • | wireless gateways, or gateways that include an integrated wireless access point. |
Network Connectivity. Products that enable network connectivity and resource sharing include:
| | |
Domestic Stores | • | International Stores | | Online Retailers | | DMRswireless access points, which provide a wireless link between a wired network and wireless devices; |
| |
| |
| |
|
• Best Buy* | | • FNAC (France) | wireless network interface cards and adapters, which enable devices to be connected to the network wirelessly; |
|
| | • 4sure.com | media adapters, which connect PCs, stereos, TVs and other equipment to a network; |
|
| | • CDW | wi-fi phones, which enable users to make voice calls over the Internet; |
• Circuit City* |
| | • Future Shops (Canada) | network attached storage, which enables file sharing and remote storage over a local area network; and |
|
| | • Amazon.com | | • Dustin |
• CompUSA | | • MediaMarkt (Germany, Austria) | | • Buy.com | | • Insight |
• Fry’s Electronics* | | • PC World (UK) | | • Systemax | | • Misco |
• Staples* | | • Saturn (Germany, Austria) | | • Dabs.com | | • PC Connectionpowerline adapters and bridges, which enable devices to be connected to the network over existing electrical wiring. |
We design our products to meet the specific needs of both the small business and home markets, tailoring various elements of the product design, including component specification, physical characteristics such as casing, design and coloration, and specific user interface features to meet the needs of these markets. We also leverage many of our technological developments, high volume manufacturing, technical support and engineering infrastructure across our markets to maximize business efficiencies.
4
Our products that target the small business market are designed with an industrial appearance, including metal cases, and for some product categories, the ability to mount the product within standard data networking racks. These products typically include higher port counts, higher data transfer rates and other performance characteristics designed to meet the needs of a small business user. For example, we offer data transfer rates up to ten Gigabit per second for our business products to meet the higher capacity requirements of business users. Some of these products are also designed to support transmission modes such as fiber optic cabling, which is common in more sophisticated business environments. Security requirements within our products for small business broadband access include firewall and virtual private network capabilities that allow for secure interactions between remote offices and business headquarter locations. Our connectivity product offerings for the small business market include enhanced security and remote configurability often required in a business setting.
Our products for the home user are designed with pleasing visual and physical aesthetics that are more desirable in a home environment. For example, our RangeMax series of routers have distinctive blue antenna-indicator LEDs in a circular dome atop a sleek white plastic casing. Our connectivity offerings for use in the home are generally at a lower price than higher security and configurability wireless offerings for the small business market. Our products for facilitating broadband access in the home are available with features such as parental control capabilities and firewall security, to allow for safer, more controlled Internet usage in families with children. Our broadband products designed for the home market also contain advanced installation software that guides a less sophisticated data networking user through the installation process with their broadband service provider, using a graphical user interface and simple point and click operations. Our connectivity product offerings for the home include powerline data transmission modes which allow home users to take advantage of their existing electrical wiring infrastructure for transmitting data among network components.
Competition
The small business and home networking markets are intensely competitive and subject to rapid technological change. We expect competition to continue to intensify. Our principal competitors include:
| | |
* | These customers purchase our products directly from us. The remaining customers on this list buy their products through our wholesale distributors.• | within the small business networking market, companies such as 3Com, Allied Telesyn, the Linksys division of Cisco Systems, Dell Computer, D-Link, Hewlett-Packard, Nortel Networks, and SonicWall, Inc.; and |
|
| • | within the home networking market, companies such as Belkin Corporation, D-Link, and the Linksys division of Cisco Systems. |
Other current competitors include numerous local vendors such as Siemens Corporation and AVM in Europe, Corega International SA and Melco, Inc./Buffalo Technology in Japan and TP-Link in China, and broadband equipment suppliers such as ARRIS Group, Inc., Motorola, Inc., Sagem Corporation, Scientific Atlanta, a Cisco company, Terayon Communications Systems, Inc., Thomson Corporation and 2Wire, Inc. Our potential competitors include consumer electronics vendors and telecommunications equipment vendors who could integrate networking capabilities into their line of products, and our channel customers who may decide to offer self-branded networking products. We also face competition from service providers who may bundle a free networking device with their broadband service offering, which would reduce our sales if we are not the supplier of choice to those service providers.
Many of our existing and potential competitors have longer operating histories, greater name recognition and substantially greater financial, technical, sales, marketing and other resources. As a result, they may have more advanced technology, larger distribution channels, stronger brand names, better customer service and access to more customers than we do. For example, Dell Computer has significant brand name recognition and has an advertising presence substantially greater than ours. Similarly, Cisco Systems is well recognized as a leader in providing networking solutions to businesses and has substantially greater financial resources than we do. Several of our competitors, such as the Linksys division of Cisco Systems and D-Link, offer a range of products that directly compete with most of our product offerings. Several of our other competitors primarily compete in a more limited manner. For example, Hewlett-Packard sells networking products primarily targeted at larger businesses or enterprises. However, the competitive environment in which we operate changes rapidly. Other large companies with significant resources could become direct competitors, either through acquiring a competitor or through internal efforts.
5
9
We are currentlybelieve that the principal competitive factors in the small business and home markets for networking products include product breadth, size and scope of the sales channel, brand name, timeliness of new product introductions, product performance, features, functionality and reliability, price,ease-of-installation, maintenance and use, and customer service and support.
To remain competitive, we believe we must invest significant resources in developing
new products, enhancing our current products, expanding our sales channels and
enhancing relationships with broadband service providers in North America and internationally and have recently signed agreements with Time-Warner Cable and Comcast to distribute our products to their subscribers.maintaining customer satisfaction worldwide.
As of December 31,
2003,2006, we had
3062 employees engaged in research and development. We believe that our success depends on our ability to develop products that meet the changing user needs and to anticipate and proactively respond to evolving technology in a timely and cost-effective
basis.manner. Accordingly, we have made investments in our research and development department in order to effectively evaluate new technologies and develop
and test new products. Our research and development employees work closely with our
technology and manufacturing partners to bring our products to market in a timely, high quality and cost-efficient manner.
We identify and qualify new technologies, and we work closely with our various technology suppliers and manufacturing partners to develop products using one of
the two manufacturing methodologies
as described below.
ODM. Under the original design manufacturer, or ODM, methodology, which we use for most of our product development activities, we define the product concept and specification and perform the technology selection. We then coordinate with our technology suppliers while they develop the chipsets, software drivers and detailed circuit designs. If additional software is required, we either develop the software in-house, subcontract the development of the software, or purchase it from a third-party vendor. Once prototypes are completed, we work with our ODMspartners to complete the debugging and systems integration and testing. Our ODMs conductare responsible for conducting all of the regulatory agency approval processes required for electrical safety and electromagnetic interference.each product. After completion of the final tests, agency approvals and product documentation, the product is released for production. OEM. Under the original equipment manufacturer, or OEM, methodology, which we use for a limited number of products, we define the product specification and then purchase the product from OEM suppliers that have existing products fitting our design requirements. Once a technology supplier’s product is selected, we work with the OEM supplier to complete the cosmetic changes to fit into our mechanical and packaging design, as well as our documentation standard. If software is involved, the look and feel of the software is modified by the OEM supplier to meet our standards.graphical user interface, or GUI, standard. The OEM supplier completes regulatory approvals on our behalf. When all design verification and regulatory testing is completed, the product is released for production. Our internal research and development efforts focus on improving the
reliability, functionality, cost and performance of our partner’s designs. In addition, we define the industrial design,
GUI, documentation and installation process of our
productsproducts. In August 2006, we acquired SkipJam Corp. (“SkipJam”), a developer of networkable media devices for integrating television into the home network and
enhancing their ease-of-use throughto the
development of software such as our proprietary ‘Smart Wizard’ application.Internet for entertainment content streaming. Our total research and development expenses were
$4.4$18.4 million in
2001, and $7.72006, $12.8 million in
20022005 and
$8.7$10.3 million in
2003.2004.
Our primary
manufacturing contractorsmanufacturers are
Ambit Microsystems (recently acquired by Foxconn)ASUSTek Computer, Inc., Cameo Communications Inc., Delta
Electronics,Networks Incorporated, Gemtek Technology Co., Hon Hai Precision Industry Co., Ltd. (more commonly known as Foxconn Corporation), and SerComm Corporation,
and Z-Com, Inc., all of which are headquartered in Taiwan. The actual manufacturing of our products occurs
bothprimarily in mainland China, and is supplemented with manufacturing in Taiwan
and mainland China.on a select basis. We distribute our manufacturing among these key suppliers to avoid excessive concentration with a single supplier.
Delta Electronics is associated with Delta International Holding Ltd., one of our stockholders. In addition to their responsibility for the manufacturing of our products, our manufacturers purchase all necessary parts and materials to produce complete, finished goods. To maintain quality standards for our suppliers, we have established our own product testing and quality organization based in Hong Kong
which isand mainland China. They are responsible for auditing and inspecting product quality on the premises of our
subcontractors. We obtain other key components, such as connector jacks, plastic casings, physical layer transceiversODMs and switching fabric semiconductors, from limited sources.
OEMs.
We currently outsource warehousing and distribution logistics to three third party logisticsfour third-party providers who are responsible for warehousing, customerdistribution logistics and order fulfillment and distribution of products.fulfillment. In addition, these parties are also responsible for
6
some
final packagingre-packaging of our products including bundling components to form
10
kits, and inserting appropriate documentation and adding power adapters. APL Logistics Americas, LtdLtd. in Walnut,City of Industry, California serves the Americas region, Kerry Logistics LtdLtd. in Hong Kong serves the Asia Pacific region, and Furness Logistics BV and ModusLink BV in the Netherlands servesserve the EMEA region.
As of December 31,
2003,2006, we had
85187 employees
engaged in
our sales
department and
14 employees in our marketing department.marketing. We work directly with our
resellerscustomers on market development activities, such as co-advertising, in-store promotions and demonstrations,
instant rebate programs, event sponsorship and sales associate training. We also participate in major industry trade shows and marketing events. Our marketing department is comprised of our product marketing and corporate marketing groups.
Our product marketing group focuses on product strategy, product development roadmaps, the new product introduction process, product lifecycle management, demand assessment and competitive analysis. The group works closely with our sales and research and development groups to align our product development roadmap to meet
key channelcustomer technology
requirementsdemands from a strategic perspective. The group also ensures that product development activities, product launches, channel marketing program activities, and ongoing demand and supply planning occur in a well-managed, timely basis in coordination with our development, manufacturing, and sales groups, as well as our ODM, OEM and sales channel partners.
Our corporate marketing group is responsible for defining and building our corporate brand. The group focuses on defining our mission, brand promise and marketing messages on a worldwide basis. This group also defines the marketing approaches in the areas of advertising, public relations, events, channel programs and our web delivery mechanisms. These marketing messages and approaches are customized for both the small business and home markets through a variety of delivery mechanisms designed to effectively reach
end usersend-users in a cost-efficient manner.
The needs of our small business and home customers differ, and therefore our marketing initiatives for each of these segments are distinct. In the small business market, we have focused on emphasizing our product line expansion, such as our introduction of a 24 port smart switch with gigabit ports, performance and reliability, and on channel development, while in the home market we have emphasized our wireless offerings, ease-of-use and aesthetics. In both markets, we have focused on developing the NETGEAR brand name, expanding our advertising programs and increasing public awareness through high visibility in the technical and popular press.
We conduct much of our international sales and marketing operations through NETGEAR International, Inc.
and NETGEAR International Ltd., our
domestic subsidiary, as well as through NETGEAR Deutschland GmbH, a German companywholly-owned subsidiaries which have formed sales and
wholly-owned subsidiary of NETGEAR International, Inc.marketing subsidiaries and branch offices worldwide.
We provide technical support to our customers through a combination of limited
number of permanent employees and
an extensive use of subcontracted, “out-sourcing” resources. Although we design our products to require minimal technical support, if a customer requires assistance, we
generally provide free, high-quality technical advice worldwide over the phone and
Internet.Internet for a specified period of time, generally less than one year. We currently subcontract first
level and
the majority of second level technical support for our products and as of December 31,
20032006, we were utilizing
279approximately 720 part-time and full-time individuals to answer customers’ technical questions. First level technical support represents the first team member a customer will reach with questions; and, typically, these individuals are able to answer routine technical questions. If they are unable to resolve the issue, the first level support member will forward the customer to our more highly trained second level support group. The most difficult or unique questions are forwarded to NETGEAR employees. This
eight20 person in-house staff provides the most sophisticated support when customer issues require escalation.
In addition to providing third level technical support, these internal NETGEAR employees design our technical support database and are responsible for training and managing our outsourced
sub-contractors. We
11
utilize the information gained from customers by our technical support organization to enhance our current and future products.products by providing bug fixes, simplifying the installation process and planning future product needs.
In North America, the United Kingdom,
South East Asia and Australia, the first and second level technical support
in English is provided 24 hours a day, 7 days a week, 365 days a
year on toll-free lines.year. Local language support is also available during local business hours in
Austria, Switzerland, China, France, Germany, Italy, Japan, Korea, Spain,
Thailand, Brazil, Hungary, Russia, the Nordic countries, Belgium and
Sweden.Competition
The small business and home networking markets are intensely competitive and subject to rapid technological change. We expect competition to continue to intensify. Our principal competitors include:
| | |
| • | within the small business networking market, companies such as 3Com, Allied Telesyn, The Linksys division of Cisco Systems’, Dell Computer, D-Link, Hewlett-Packard and Nortel Networks; and |
|
| • | within the home networking market, companies such as Belkin Corporation, D-Link, The Linksys division of Cisco Systems’ and Microsoft. |
Other current competitors include numerous local vendors such as Correga and Melco/ Buffalo Technology in Japan and TP-Link in China. Our potential competitors include consumer electronics vendors who could integrate networking capabilities into their line of products.
Many of our existing and potential competitors have longer operating histories, greater name recognition and substantially greater financial, technical, sales, marketing and other resources. As a result, they may have more advanced technology, larger distribution channels, stronger brand names, better customer service and access to more customers than we do. For example, Dell Computer has significant brand name recognition and has an advertising presence substantially greater than ours. Similarly, Cisco Systems is well recognized as a leader in providing networking solutions to businesses and has substantially greater financial resources than we do. Several of our competitors, such as Linksys division Cisco Systems’ and D-Link, offer a range of products that directly compete with most of our product offerings. Several of our other competitors primarily compete in a more limited manner. For example, Hewlett-Packard sells networking products primarily targeted at larger businesses or enterprises. However, the competitive environment in which we operate changes rapidly. Other large companies with significant resources could become direct competitors, either through acquiring a competitor or through internal efforts.Netherlands.
7
We believe that the principal competitive factors in the small business and home markets for networking products are:
| | |
| • | product breadth; |
|
| • | size and scope of the sales channel; |
|
| • | brand name; |
|
| • | timeliness of new product introductions; |
|
| • | product performance, features, functionality and reliability; |
|
| • | price; |
|
| • | ease-of-installation, maintenance and use; and |
|
| • | customer service and support. |
We believe that we compete favorably in each of these categories. To remain competitive, we believe we must invest significant resources in developing new products, enhancing our current products, expanding our sales channels and maintaining customer satisfaction worldwide.
12
We believe that our continued success will depend primarily on the technical expertise, speed of technology implementation, creative skills and management abilities of our officers and key employees, plus ownership of a limited but important set of copyrights, trademarks, trade secrets and patents. We primarily rely on a combination of copyright, trademark and trade secret and patent laws, nondisclosure agreements with employees, consultants and suppliers and other contractual provisions to establish, maintain and protect our proprietary rights. We hold
two issued patents
relating to our home product design,that expire between years 2023 and 2025 and currently have
at least fivea number of pending United States patent applications related to technology and products offered by us. In addition, we rely on third-party licensors for patented hardware and software license rights in technology that are incorporated into and are necessary for the operation and functionality of our products. We typically retain limited exclusivity over intellectual property we jointly develop with our
OEMOEMs and
ODM manufacturers.ODMs. Our success will depend in part on our continued ability to have access to these technologies.
We have trade secret rights for our products, consisting mainly of product design, technical product documentation and software. We also own,
and use distinctiveor have applied for registration of trademarks,
on or in connection with our products, including NETGEAR, the
GearGuyNETGEAR logo,
FirstGear,the NETGEAR Digital Entertainer logo, the Gear Guy logo, Connect with Innovation, Everybody’s connecting, IntelliFi, ProSafe,
RangeMax and
Web Safe. NETGEAR is a trademark registeredSmart Wizard, in
Argentina, Australia, Brazil, Canada, the European Union, Japan, New Zealand and the United
States. We have obtained or applied for registration for the “Everybody’s Connecting” trademark in Australia, the European Union, Japan, KoreaStates and
the United States.internationally. We have registered several Internet domain names that we use for electronic interaction with our customers including dissemination of product information, marketing programs, product registration, sales activities, and other commercial uses.
As of December 31,
2003,2006, we had
207388 full-time employees, with
107207 in sales, marketing and technical support,
3062 in research and development,
3953 in operations, and
3166 in finance, information systems and administration.
We also utilize a number of temporary staff, including 15 full-time contractors, to supplement our workforce. We have never had a work stoppage among our employees and no personnel are represented under collective bargaining agreements. We consider our relations with our employees to be good.
TriNet Employer Group, Inc.
Website Posting of SEC Filings
Our website provides
human resource servicesa link to
NETGEAR and our
employees including payroll, employee relations and certain employee benefit plans. TriNetSEC filings, which are available on the same day such filings are made. The specific location on the website where these reports can be found is
an employer services company contracted by ushttp://www.investor.netgear.com/edgar.cfm. Our website also provides a link to
perform certain employer responsibilitiesSection 16 filings which are available on
our behalf, and TriNet is the
employer of record for payroll, benefits and other functions involving our employment related administration. Our agreement with TriNet is terminable by either party with 30 days notice.same day as such filings are made.
Executive Officers of the Registrant The following table sets forth the names, ages and positions of our executive officers (who are subject to Section 16 of the Securities Exchange Act of 1934) as of March 1, 2004.
2007.| | | | | | | |
Name | | Age | | Position |
| |
| |
|
| Patrick C.S. Lo | | | 4750 | | | Chairman and Chief Executive Officer |
Raymond P. Robidoux | | | 54 | | | President |
Jonathan R. Mather | | | 53 | | | Executive Vice President and Chief Financial Officer |
| Mark G. Merrill | | | 4952 | | | Chief Technology Officer |
| Michael F. Falcon | | | 4850 | | | | Senior Vice President of Operations |
Christopher C. MarshallChristine M. Gorjanc | | | 4750 | | | Chief Accounting Officer |
| Albert Y. Liu | | | 34 | | | Vice President, of FinanceLegal and Corporate Development |
| Charles T. Olson | | | 4851 | | | | Senior Vice President of Engineering |
| David Soares | | | 3740 | | | | Senior Vice President of Europe, Middle EastWorldwide Sales and Africa SalesSupport |
| Michael A. Werdann | | | 3538 | | | Vice President of North AmericanAmericas Sales |
| Deborah A. Williams | | | 49 | | | Senior Vice President, Marketing and Chief Marketing Officer |
8
Patrick C.S. Lohas served as our Chairman and Chief Executive Officer since March 2002. From September 1999 to March 2002, he served as our President, and since our inception in 1996 to September 1999, he served as Vice President and General Manager. Mr. Lo joined Bay Networks, a networking company, in August 1995 to launch a division targeting the small business and home markets and established the13
NETGEAR division in January 1996. From 1983 until 1995, Mr. Lo worked at Hewlett-Packard Company, a computer and test equipment company, where he served in various management positions in software sales, technical support, network product management, sales support and marketing in the United States and Asia, most recentlyincluding as the Asia/Pacific marketing director for Unix servers. Mr. Lo received a B.S. degree in Electrical Engineering from Brown University.
Raymond P. Robidouxhas served as our President since July 2002. From July 2001 to May 2002, Mr. Robidoux worked at Quantum Corporation, a data technology company, where he served as senior vice president and general manager of the networked attached storage division. From March 1997 to March 2001, Mr. Robidoux was at Compaq Computer, where he served as vice president of its North America consumer business group, focused on sales, marketing and service, from March 1999 to March 2001, and as vice president of business planning and operations from March 1997 to February 1999. Prior to that, he held various management positions in the computer hardware industry, including sales, marketing and product development. Mr. Robidoux received a B.S. degree in Aerospace Engineering from California State Polytechnic University and an M.B.A. from Pepperdine University.Jonathan R. Matherhas served as our Executive Vice President and Chief Financial Officer since October 2003 and served as our Vice President and Chief Financial Officer since August 2001. From July 1995 to March 2001, Mr. Mather worked at Applause Inc., a consumer products company, where he served as president and chief executive officer from 1998 to 2001, as chief financial officer and chief operating officer from 1997 to 1998 and as chief financial officer from 1995 to 1997. From 1985 to 1995, Mr. Mather was at Home Fashions Inc., a consumer products company, where he served as chief financial officer from 1992 to 1995, and as vice president, finance of an operating division, Louverdrape, from 1988 to 1992. Prior to that, he spent more than two years at the semiconductor division of Harris Corporation, a communications equipment company, where he served as the finance manager of the offshore manufacturing division. He has also worked in public accounting for four years with Coopers & Lybrand (now part of PricewaterhouseCoopers LLP) and for two years with Ernst & Young. Mr. Mather is a certified management accountant (CMA) and is also a chartered accountant from the Institute of Chartered Accountants in Sri Lanka, where Mr. Mather received his undergraduate B.A. degree equivalent. Mr. Mather received an M.B.A. from Cornell University, New York.
Mark G. Merrillhas served as our Chief Technology Officer since January 2003. From September 1999 to January 2003, he served as Vice President of Engineering and served as Director of Engineering from September 1995 to September 1999. From 1987 to 1995, Mr. Merrill worked at SynOptics Communications, a local area networking company, which later merged with Wellfleet to become Bay Networks, where his responsibilities included system design and analog implementations for SynOptic’s first 10BASE-T products. Mr. Merrill received both a B.S. degree and an M.S. degree in Electrical Engineering from Stanford University.
Michael F. Falconhas served as our Senior Vice President of Operations since March 2006 and Vice President of Operations since November 2002. From September 1999 to November 2002, Mr. Falcon worked at Quantum Corporation, a data technology company, where he served as Vice President of Operations and supply chain management.Supply Chain Management. From April 1999 to September 1999, Mr. Falcon was at Meridian Data, a storage company acquired by Quantum Corporation, where he served as vice presidentVice President of operations.Operations. From February 1989 to April 1999, Mr. Falcon was at Silicon Valley Group, a semiconductor equipment manufacturer, where he served as directorDirector of operations, strategic planningOperations, Strategic Planning and supply chain management.Supply Chain Management. Prior to that, he served in management positions at SCI Systems, an electronics manufacturer, Xerox Imaging Systems, a provider of scanning and text recognition solutions, and Plantronics, Inc., a provider of lightweight communication headsets. Mr. Falcon received a B.A. degree in Economics from the University of California, Santa Cruz and has completed coursework in the M.B.A. program at Santa Clara University. Christopher C. MarshallChristine M. Gorjanchas served as our Chief Accounting Officer since December 2006 and our Vice President, Finance since November 2005. From September 1996 through November 2005, Ms. Gorjanc served as Vice President, Controller, Treasurer and Assistant Secretary for Aspect Communications Corporation, a provider of workforce and customer management solutions. From October 1988 through September 1996, she served as the Manager of Tax for Tandem Computers, Inc., a provider of fault-tolerant computer systems. Prior to that, she served in management positions at Xidex Corporation, a manufacturer of storage devices, and spent eight years in public accounting with a number of accounting firms. Ms. Gorjanc holds a B.A. in Accounting (with honors) from the University of Texas at El Paso, a M.S. in Taxation from Golden Gate University, and is a Certified Public Accountant.
Albert Y. Liuhas served as our Vice President, Legal and Corporate Development and Corporate Secretary since March 2006 and our General Counsel and Secretary since October 2004. From March 2004 to October 2004, Mr. Liu consulted as Acting General Counsel and Secretary for Yipes Enterprise Services, Inc., an emerging telecom services company. From May 2000 to June 2004, Mr. Liu worked at Turnstone Systems, Inc., a telecommunications equipment provider, where he served as General Counsel and Secretary, as Director of FinanceHuman Resources since September 2001 and as a member of the board of directors since November 2003. From January 2000Prior to June 2003,that, Mr. MarshallLiu practiced corporate and securities law at Sullivan & Cromwell, a leading U.S. law firm, from October 1997 to May 2000. Mr. Liu holds a J.D. from the University of California, Hastings College of the Law, and an A.B. in Political Science and a B.S. in Computer Science from Stanford University.
Charles T. Olsonhas served as
our Senior Vice President
Financeof Engineering since March 2006 and
Chief Accounting Officer at BackWeb Technologies Ltd., a publicly-traded company that is a provider of offline Web software. From October 1998 to November 1999, Mr. Marshall served as Vice President Finance and corporate controller at14
Supercom Inc., a PC assembly and distribution company. Prior to joining Supercom, from August 1997 to October 1998 Mr. Marshall served as controller for S-Vision, a company focused on lighting technology research for scientific applications. Mr. Marshall has also served over twelve years in various financial management positions at Intel Corp. Mr. Marshall earned a B.Sc. at University College, Cardiff, U.K. a M.B.A. at London Business School and a M.A. at University College London. Mr. Marshall is a Fellow of the Institute of Chartered Accountants.
Charles T. Olsonhas served as our Vice President of Engineering since January 2003. From July 1978 to January 2003, Mr. Olson worked at Hewlett-Packard Company, a computer and test equipment company, where he served as directorDirector of researchResearch and developmentDevelopment for ProCurve networking from 1998 to 2003, as researchResearch and development managerDevelopment Manager for the Enterprise Netserver division from 1997 to 1998, and, prior to that, in various other engineering management roles in Hewlett-Packard’s Unix server and personal computer product divisions. Mr. Olson received a B.S. degree in Electrical Engineering from the University of California, Davis and an M.B.A. from Santa Clara University.
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David Soareshas served as our Senior Vice President of Europe, Middle EastWorldwide Sales and Africa (EMEA) SalesSupport since December 2003.August 2004. Mr. Soares joined us in January 1998, and served as Vice President of EMEA sales from December 2003 to July 2004, EMEA Managing Director from April 2000 to November 2003, United Kingdom and Nordic Regional Manager from February 1999 to March 2000 and United Kingdom Country Manager from January 1998 to January 1999. Prior to joining us, Mr. Soares was at Hayes Microcomputer Products, a manufacturer ofdial-up modems. Mr. Soares attended Ridley College, Ontario Canada. Michael AA. Werdannhas served as our Vice President of North AmericanAmericas Sales since December 2003. Since joining us in 1998, Mr. Werdann has served as our United States Director of Sales,E-Commerce and DMR from December 2002 to 2003 and as our Eastern regional sales director from October 1998 to December 2002. Prior to joining us, Mr. Werdann worked for three years at Iomega Corporation, a computer hardware company, as a sales director for the value added reseller sector. Mr. Werdann holds a B.S. Degree in Communications from Seton Hall University. Deborah A. Williamshas served as our Senior Vice President, Marketing and Chief Marketing Officer since September 2006. From 1984 through 2005, Ms. Williams worked at Hewlett-Packard Company, a computer and test equipment company, where she held various executive-level marketing positions, most recently as Vice President of Marketing for the Business Imaging and Printing Global Business Unit. Ms. Williams previously served as Vice President of Marketing of the LaserJet Supplies Division, Vice President of Category Operations and Marketing of the Supplies Global Business Unit, Director of Marketing of the DeskJet Printers Division, Director of Consumer Marketing of the European Peripherals Group, and Director of Support of the European Computer Products Sales Unit. Ms. Williams holds a B.A. in Industrial Distribution from Clarkson University, and an M.B.A. from the J.L. Kellogg Graduate School of Management.
Investing in our common stock involves a high degree of risk. The risks described below are not exhaustive of the risks that might affect our business. Other risks, including those we currently deem immaterial, may also impact our business. Any of the following risks could materially adversely affect our business operations, results of operations and financial condition and could result in a significant decline in our stock price.
Where You Can Find Additional InformationWe file reports, proxy statementsexpect our operating results to fluctuate on a quarterly and annual basis, which could cause our stock price to fluctuate or decline.
Our operating results are difficult to predict and may fluctuate substantially fromquarter-to-quarter oryear-to-year for a variety of reasons, many of which are beyond our control. If our actual revenue were to fall below our estimates or the expectations of public market analysts or investors, our quarterly and annual results would be negatively impacted and the price of our stock could decline. Other factors that could affect our quarterly and annual operating results include those listed in this risk factors section of thisForm 10-K and others such as:
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| • | changes in the pricing policies of or the introduction of new products by us or our competitors; |
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| • | changes in the terms of our contracts with customers or suppliers that cause us to incur additional expenses or assume additional liabilities; |
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| • | slow or negative growth in the networking product, personal computer, Internet infrastructure, home electronics and related technology markets, as well as decreased demand for Internet access; |
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| • | changes in or consolidation of our sales channels and wholesale distributor relationships or failure to manage our sales channel inventory and warehousing requirements; |
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| • | delay or failure to fulfill orders for our products on a timely basis; |
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| • | our inability to accurately forecast product demand; |
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| • | unfavorable level of inventory and turns; |
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| • | unanticipated shift in overall product mix from higher to lower margin products which would adversely impact our margins; |
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| • | delays in the introduction of new products by us or market acceptance of these products; |
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| • | an increase in price protection claims, redemptions of marketing rebates, product warranty returns or allowance for doubtful accounts; |
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| • | operational disruptions, such as transportation delays or failure of our order processing system, particularly if they occur at the end of a fiscal quarter; |
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| • | seasonal patterns of higher sales during the second half of our fiscal year, particularly retail-related sales in our fourth quarter; |
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| • | delay or failure of our service provider customers to purchase at the volumes that we forecast; |
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| • | foreign currency exchange rate fluctuations in the jurisdictions where we transact sales in local currency; |
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| • | bad debt exposure as we expand into new international markets; and |
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| • | changes in accounting rules, such as recording expenses for employee stock option grants. |
As a result,period-to-period comparisons of our operating results may not be meaningful, and you should not rely on them as an indication of our future performance. In addition, our future operating results may fall below the expectations of public market analysts or investors. In this event, our stock price could decline significantly.
Some of our competitors have substantially greater resources than we do, and to be competitive we may be required to lower our prices or increase our advertising expenditures or other expenses, which could result in reduced margins and loss of market share.
We compete in a rapidly evolving and highly competitive market, and we expect competition to intensify. Our principal competitors in the small business market include 3Com Corporation, Allied Telesyn International, Dell Computer Corporation, D-Link Systems, Inc., Hewlett-Packard Company, the Linksys division of Cisco Systems and Nortel Networks. Our principal competitors in the home market include Belkin Corporation, D-Link and the Linksys division of Cisco Systems. Our principal competitors in the broadband service provider market include AARIS Group, Inc., Motorola, Inc., Sagem Corporation, Scientific Atlanta, a Cisco company, Terayon Communications Systems, Inc., Thomson Corporation and 2Wire, Inc. Other current and potential competitors include numerous local vendors such as Siemens Corporation and AVM in Europe, Corega International SA, Melco, Inc./Buffalo Technology in Japan and TP-Link in China. Our potential competitors also include consumer electronics vendors who could integrate networking capabilities into their line of products, and our channel customers who may decide to offer self-branded networking products. We also face competition from service providers who may bundle a free networking device with their broadband service offering, which would reduce our sales if we are not the supplier of choice to those service providers.
Many of our existing and potential competitors have longer operating histories, greater name recognition and substantially greater financial, technical, sales, marketing and other informationresources. These competitors may, among other things, undertake more extensive marketing campaigns, adopt more aggressive pricing policies, obtain more favorable pricing from suppliers and manufacturers, and exert more influence on the sales channel than we can. We anticipate that current and potential competitors will also intensify their efforts to penetrate our target markets. These competitors may have more advanced technology, more extensive distribution channels, stronger brand names, greater access to shelf space in retail locations, bigger promotional budgets and larger customer bases than we do. These companies could devote more capital resources to develop, manufacture and market competing products than we could. If any of these companies are successful in competing against us, our sales could decline, our margins could be negatively impacted, and we could lose market share, any of which could seriously harm our business and results of operations.
If we do not effectively manage our sales channel inventory and product mix, we may incur costs associated with excess inventory, or lose sales from having too few products.
If we are unable to properly monitor, control and manage our sales channel inventory and maintain an appropriate level and mix of products with our wholesale distributors and within our sales channel, we may incur
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increased and unexpected costs associated with this inventory. We generally allow wholesale distributors and traditional retailers to return a limited amount of our products in exchange for other products. Under our price protection policy, if we reduce the list price of a product, we are often required to issue a credit in an amount equal to the reduction for each of the products held in inventory by our wholesale distributors and retailers. If our wholesale distributors and retailers are unable to sell their inventory in a timely manner, we might lower the price of the products, or these parties may exchange the products for newer products. Also, during the transition from an existing product to a new replacement product, we must accurately predict the demand for the existing and the new product.
If we improperly forecast demand for our products we could end up with too many products and be unable to sell the excess inventory in a timely manner, if at all, or, alternatively we could end up with too few products and not be able to satisfy demand. This problem is exacerbated because we attempt to closely match inventory levels with product demand leaving limited margin for error. If these events occur, we could incur increased expenses associated with writing off excessive or obsolete inventory or lose sales or have to ship products by air freight to meet immediate demand incurring incremental freight costs above the costs of transporting product via boat, a preferred method, and suffering a corresponding decline in gross margins.
We are currently involved in various litigation matters and may in the future become involved in additional litigation, including litigation regarding intellectual property rights, which could be costly and subject us to significant liability.
The networking industry is characterized by the existence of a large number of patents and frequent claims and related litigation regarding infringement of patents, trade secrets and other intellectual property rights. In particular, leading companies in the data communications markets, some of which are competitors, have extensive patent portfolios with respect to networking technology. From time to time, third parties, including these leading companies, have asserted and may continue to assert exclusive patent, copyright, trademark and other intellectual property rights against us demanding license or royalty payments or seeking payment for damages, injunctive relief and other available legal remedies through litigation. These include third parties who claim to own patents or other intellectual property that cover industry standards that our products comply with. If we are unable to resolve these matters or obtain licenses on acceptable or commercially reasonable terms, we could be sued or we may be forced to initiate litigation to protect our rights. The cost of any necessary licenses could significantly harm our business, operating results and financial condition. Also, at any time, any of these companies, or any other third-party could initiate litigation against us, or we may be forced to initiate litigation against them, which could divert management attention, be costly to defend or prosecute, prevent us from using or selling the challenged technology, require us to design around the challenged technology and cause the price of our stock to decline. In addition, third parties, some of whom are potential competitors, have initiated and may continue to initiate litigation against our manufacturers, suppliers or members of our sales channel, alleging infringement of their proprietary rights with respect to existing or future products. In the event successful claims of infringement are brought by third parties, and we are unable to obtain licenses or independently develop alternative technology on a timely basis, we may be subject to indemnification obligations, be unable to offer competitive products, or be subject to increased expenses. Finally, consumerclass-action lawsuits related to the marketing and performance of our home networking products have been asserted and may in the future be asserted against us. If we do not resolve these claims on a favorable basis, our business, operating results and financial condition could be significantly harmed.
The average selling prices of our products typically decrease rapidly over the sales cycle of the product, which may negatively affect our gross margins.
Our products typically experience price erosion, a fairly rapid reduction in the average selling prices over their respective sales cycles. In order to sell products that have a falling average selling price and maintain margins at the same time, we need to continually reduce product and manufacturing costs. To manage manufacturing costs, we must collaborate with our third-party manufacturers to engineer the most cost-effective design for our products. In addition, we must carefully manage the price paid for components used in our products. We must also successfully manage our freight and inventory costs to reduce overall product costs. We also need to continually introduce new products with higher sales prices and gross margins in order to maintain our overall gross margins. If we are unable
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to manage the cost of older products or successfully introduce new products with higher gross margins, our net revenue and overall gross margin would likely decline.
Our future success is dependent on the growth in personal computers sales and the acceptance of networking products in the small business and home markets into which we sell substantially all of our products. If the acceptance of networking products in these markets does not continue to grow, we will be unable to increase or sustain our net revenue, and our business will be severely harmed.
We believe that growth in the small business market will depend, in significant part, on the growth of the number of personal computers purchased by these end-users and the demand for sharing data intensive applications, such as large graphic files. We believe that acceptance of networking products in the home will depend upon the availability of affordable broadband Internet access and increased demand for wireless products. Unless these markets continue to grow, our business will be unable to expand, which could cause the value of our stock to decline. Moreover, if networking functions are integrated more directly into personal computers and other Internet-enabled devices, such as electronic gaming platforms or personal video recorders, and these devices do not rely upon external network-enabling devices, sales of our products could suffer. In addition, if the small business or home markets experience a recession or other cyclical effects that diminish or delay networking expenditures, our business growth and profits would be severely limited, and our business could be more severely harmed than those companies that primarily sell to large business customers.
If we fail to continue to introduce new products that achieve broad market acceptance on a timely basis, we will not be able to compete effectively and we will be unable to increase or maintain net revenue and gross margins.
We operate in a highly competitive, quickly changing environment, and our future success depends on our ability to develop and introduce new products that achieve broad market acceptance in the small business and home markets. Our future success will depend in large part upon our ability to identify demand trends in the small business and home markets and quickly develop, manufacture and sell products that satisfy these demands in a cost effective manner. Successfully predicting demand trends is difficult, and it is very difficult to predict the effect introducing a new product will have on existing product sales. We will also need to respond effectively to new product announcements by our competitors by quickly introducing competitive products.
We have experienced delays in releasing new products in the past, which resulted in lower quarterly net revenue than expected. In addition, we have experienced, and may in the future experience, product introductions that fall short of our projected rates of market adoption. Any future delays in product development and introduction or product introductions that do not meet broad market acceptance could result in:
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| • | loss of or delay in revenue and loss of market share; |
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| • | negative publicity and damage to our reputation and brand; |
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| • | a decline in the average selling price of our products; |
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| • | adverse reactions in our sales channel, such as reduced shelf space, reduced online product visibility, or loss of sales channel; and |
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| • | increased levels of product returns. |
We depend substantially on our sales channel, and our failure to maintain and expand our sales channel would result in lower sales and reduced net revenue.
To maintain and grow our market share, net revenue and brand, we must maintain and expand our sales channel. We sell our products through our sales channel, which consists of traditional retailers, on-line retailers, DMRs, VARs, and broadband service providers. Some of these entities purchase our products through our wholesale distributors. We generally have no minimum purchase commitments or long-term contracts with any of these third parties.
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Traditional retailers have limited shelf space and promotional budgets, and competition is intense for these resources. If the networking sector does not experience sufficient growth, retailers may choose to allocate more shelf space to other consumer product sectors. A competitor with more extensive product lines and stronger brand identity, such as Cisco Systems, may have greater bargaining power with these retailers. Any reduction in available shelf space or increased competition for such shelf space would require us to increase our marketing expenditures simply to maintain current levels of retail shelf space, which would harm our operating margin. The recent trend in the consolidation of online retailers and DMR channels has resulted in intensified competition for preferred product placement, such as product placement on an online retailer’s Internet home page. Expanding our presence in the VAR channel may be difficult and expensive. We compete with established companies that have longer operating histories and longstanding relationships with VARs that we would find highly desirable as sales channel partners. If we were unable to maintain and expand our sales channel, our growth would be limited and our business would be harmed.
We must also continuously monitor and evaluate emerging sales channels. If we fail to establish a presence in an important developing sales channel, our business could be harmed.
If we fail to successfully overcome the challenges associated with profitably growing our broadband service provider sales channel, our net revenue and gross profit will be negatively impacted.
We face a number of challenges associated with penetrating the broadband service provider channel that differ from what we have traditionally faced with the Securitiesother channels. These challenges include a longer sales cycle, more stringent product testing and Exchange Commission,validation requirements, a higher level of customer service and support demands, competition from established suppliers, pricing pressure resulting in lower gross margins, and our general inexperience in selling to service providers. Orders from service providers generally tend to be large but sporadic, which causes our revenues from them to fluctuate wildly and challenges our ability to accurately forecast demand from them. Even if we are selected as a supplier, typically a service provider will also designate a second source supplier, which over time will reduce the aggregate orders that we receive from that service provider. In addition, service providers may choose to prioritize the implementation of other technologies or SEC,the roll out of other services than home networking. Any slowdown in accordancethe general economy, over capacity, consolidation among service providers, regulatory developments and constraint on capital expenditures could result in reduced demand from service providers and therefore adversely affect our sales to them. If we do not successfully overcome these challenges, we will not be able to profitably grow our service provider sales channel and our growth will be slowed.
If our products contain defects or errors, we could incur significant unexpected expenses, experience product returns and lost sales, experience product recalls, suffer damage to our brand and reputation, and be subject to product liability or other claims.
Our products are complex and may contain defects, errors or failures, particularly when first introduced or when new versions are released. The industry standards upon which many of our products are based are also complex, experience change over time and may be interpreted in different manners. Some errors and defects may be discovered only after a product has been installed and used by the end-user. If our products contain defects or errors, or are found to be noncompliant with industry standards, we could experience decreased sales and increased product returns, loss of customers and market share, and increased service, warranty and insurance costs. In addition, our reputation and brand could be damaged, and we could face legal claims regarding our products. A successful product liability or other claim could result in negative publicity and harm our reputation, result in unexpected expenses and adversely impact our operating results.
We obtain several key components from limited or sole sources, and if these sources fail to satisfy our supply requirements, we may lose sales and experience increased component costs.
Any shortage or delay in the Securities Exchangesupply of key product components would harm our ability to meet scheduled product deliveries. Many of the semiconductors used in our products are specifically designed for use in our products and are obtained from sole source suppliers on a purchase order basis. In addition, some components that are used in all our products are obtained from limited sources. These components include connector jacks, plastic casings and physical layer transceivers. We also obtain switching fabric semiconductors, which are used in our
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Ethernet switches and Internet gateway products, and wireless local area network chipsets, which are used in all of our wireless products, from a limited number of suppliers. Semiconductor suppliers have experienced and continue to experience component shortages themselves, such as with substrates used in manufacturing chipsets, which in turn adversely impact our ability to procure semiconductors from them. Our contract manufacturers purchase these components on our behalf on a purchase order basis, and we do not have any contractual commitments or guaranteed supply arrangements with our suppliers. If demand for a specific component increases, we may not be able to obtain an adequate number of that component in a timely manner. In addition, if our suppliers experience financial or other difficulties or if worldwide demand for the components they provide increases significantly, the availability of these components could be limited. It could be difficult, costly and time consuming to obtain alternative sources for these components, or to change product designs to make use of alternative components. In addition, difficulties in transitioning from an existing supplier to a new supplier could create delays in component availability that would have a significant impact on our ability to fulfill orders for our products. If we are unable to obtain a sufficient supply of components, or if we experience any interruption in the supply of components, our product shipments could be reduced or delayed. This would affect our ability to meet scheduled product deliveries, damage our brand and reputation in the market, and cause us to lose market share.
We are exposed to adverse currency exchange rate fluctuations in jurisdictions where we transact in local currency, which could harm our financial results and cash flows.
Although a significant portion of our international sales are currently invoiced in United States dollars, we have implemented and continue to implement for certain countries both invoicing and payment in foreign currencies. Recently, we have experienced currency exchange gains, however our exposure to adverse foreign currency rate fluctuations will likely increase. We currently do not engage in any currency hedging transactions. Moreover, the costs of doing business abroad may increase as a result of adverse exchange rate fluctuations. For example, if the United States dollar declined in value relative to a local currency, we could be required to pay more in U.S. dollar terms for our expenditures in that market, including salaries, commissions, local operations and marketing expenses, each of which is paid in local currency. In addition, we may lose customers if exchange rate fluctuations, currency devaluations or economic crises increase the local currency prices of our products or reduce our customers’ ability to purchase products.
Rising oil prices, unfavorable economic conditions, particularly in Western Europe, and turmoil in the international geopolitical environment may adversely affect our operating results.
We derive a significant percentage of our revenues from international sales, and a deterioration in global economic and market conditions, particularly in Western Europe, may result in reduced product demand, increased price competition and higher excess inventory levels. Turmoil in the global geopolitical environment, including the ongoing tensions in Iraq and the Middle-East, have pressured and continue to pressure global economies. In addition, rising oil prices may result in a reduction in consumer spending and an increase in freight costs to us. If the global economic climate does not improve, our business and operating results will be harmed.
If disruptions in our transportation network occur or our shipping costs substantially increase, we may be unable to sell or timely deliver our products and our operating expenses could increase.
We are highly dependent upon the transportation systems we use to ship our products, including surface and air freight. Our attempts to closely match our inventory levels to our product demand intensify the need for our transportation systems to function effectively and without delay. On a quarterly basis, our shipping volume also tends to steadily increase as the quarter progresses, which means that any disruption in our transportation network in the latter half of a quarter will have a more material effect on our business than at the beginning of a quarter.
The transportation network is subject to disruption or congestion from a variety of causes, including labor disputes or port strikes, acts of war or terrorism, natural disasters and congestion resulting from higher shipping volumes. Labor disputes among freight carriers and at ports of entry are common, especially in Europe, and we expect labor unrest and its effects on shipping our products to be a continuing challenge for us. Since September 11, 2001, the rate of inspection of international freight by governmental entities has substantially increased, and has become increasingly unpredictable. If our delivery times increase unexpectedly for these or any other reasons, our
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ability to deliver products on time would be materially adversely affected and result in delayed or lost revenue. In addition, if the increases in fuel prices were to continue, our transportation costs would likely further increase. Moreover, the cost of shipping our products by air freight is greater than other methods. From time to time in the past, we have shipped products using air freight to meet unexpected spikes in demand or to bring new product introductions to market quickly. If we rely more heavily upon air freight to deliver our products, our overall shipping costs will increase. A prolonged transportation disruption or a significant increase in the cost of freight could severely disrupt our business and harm our operating results.
We rely on a limited number of wholesale distributors for most of our sales, and if they refuse to pay our requested prices or reduce their level of purchases, our net revenue could decline.
We sell a substantial portion of our products through wholesale distributors, including Ingram Micro, Inc. and Tech Data Corporation. During the fiscal year ended December 31, 2006, sales to Ingram Micro and its affiliates accounted for 19% of our net revenue and sales to Tech Data and its affiliates accounted for 16% of our net revenue. We expect that a significant portion of our net revenue will continue to come from sales to a small number of wholesale distributors for the foreseeable future. In addition, because our accounts receivable are concentrated with a small group of purchasers, the failure of any of them to pay on a timely basis, or at all, would reduce our cash flow. We generally have no minimum purchase commitments or long-term contracts with any of these distributors. These purchasers could decide at any time to discontinue, decrease or delay their purchases of our products. In addition, the prices that they pay for our products are subject to negotiation and could change at any time. If any of our major wholesale distributors reduce their level of purchases or refuse to pay the prices that we set for our products, our net revenue and operating results could be harmed. If our wholesale distributors increase the size of their product orders without sufficient lead-time for us to process the order, our ability to fulfill product demands would be compromised.
If the redemption rate for our end-user promotional programs is higher than we estimate, then our net revenue and gross margin will be negatively affected.
From time to time we offer promotional incentives, including cash rebates, to encourage end-users to purchase certain of our products. Purchasers must follow specific and stringent guidelines to redeem these incentives or rebates. Often qualified purchasers choose not to apply for the incentives or fail to follow the required redemption guidelines, resulting in an incentive redemption rate of less than 100%. Based on historical data, we estimate an incentive redemption rate for our promotional programs. If the actual redemption rate is higher than our estimated rate, then our net revenue and gross margin will be negatively affected.
We are required to evaluate our internal control under Section 404 of the Sarbanes-Oxley Act of 1934,2002 and any adverse results from such evaluation could impact investor confidence in the reliability of our internal controls over financial reporting.
Pursuant to Section 404 of the Sarbanes-Oxley Act of 2002, we are required to furnish a report by our management on our internal control over financial reporting. Such report must contain among other matters, an assessment of the effectiveness of our internal control over financial reporting as amended,of the end of our fiscal year, including a statement as to whether or not our internal control over financial reporting is effective. This assessment must include disclosure of any material weaknesses in our internal control over financial reporting identified by management. Such report must also contain a statement that our independent registered public accounting firm has issued an audit report on management’s assessment of such internal controls.
We will continue to perform the Exchange Act. Yousystem and process documentation and evaluation needed to comply with Section 404, which is both costly and challenging. During this process, if our management identifies one or more material weaknesses in our internal control over financial reporting, we will be unable to assert such internal control is effective. If we are unable to assert that our internal control over financial reporting is effective as of the end of a fiscal year, or if our independent registered public accounting firm is unable to attest that our management’s report is fairly stated or they are unable to express an opinion on the effectiveness of our internal control over financial reporting, we could lose investor confidence in the accuracy and completeness of our financial reports, which may readhave an adverse effect on our stock price.
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We depend on a limited number of third-party contract manufacturers for substantially all of our manufacturing needs. If these contract manufacturers experience any delay, disruption or quality control problems in their operations, we could lose market share and copy our reports, proxy statementsbrand may suffer.
All of our products are manufactured, assembled, tested and generally packaged by a limited number of original design manufacturers, or ODMs, and original equipment manufacturers, or OEMs. We rely on our contract manufacturers to procure components and, in some cases, subcontract engineering work. Some of our products are manufactured by a single contract manufacturer. We do not have any long-term contracts with any of our third-party contract manufacturers. Some of these third-party contract manufacturers produce products for our competitors. The loss of the services of any of our primary third-party contract manufacturers could cause a significant disruption in operations and delays in product shipments. Qualifying a new contract manufacturer and commencing volume production is expensive and time consuming.
Our reliance on third-party contract manufacturers also exposes us to the following risks over which we have limited control:
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| • | unexpected increases in manufacturing and repair costs; |
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| • | inability to control the quality of finished products; |
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| • | inability to control delivery schedules; and |
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| • | potential lack of adequate capacity to manufacture all or a part of the products we require. |
All of our products must satisfy safety and regulatory standards and some of our products must also receive government certifications. Our ODM and OEM contract manufacturers are primarily responsible for obtaining most regulatory approvals for our products. If our ODMs and OEMs fail to obtain timely domestic or foreign regulatory approvals or certificates, we would be unable to sell our products and our sales and profitability could be reduced, our relationships with our sales channel could be harmed, and our reputation and brand would suffer.
If we are unable to provide our third-party contract manufacturers a timely and accurate forecast of our component and material requirements, we may experience delays in the manufacturing of our products and the costs of our products may increase.
We provide our third-party contract manufacturers with a rolling forecast of demand, which they use to determine our material and component requirements. Lead times for ordering materials and components vary significantly and depend on various factors, such as the specific supplier, contract terms and demand and supply for a component at a given time. Some of our components have long lead times, such as wireless local area network chipsets, switching fabric chips, physical layer transceivers, connector jacks and metal and plastic enclosures. If our forecasts are not timely provided or are less than our actual requirements, our contract manufacturers may be unable to manufacture products in a timely manner. If our forecasts are too high, our contract manufacturers will be unable to use the components they have purchased on our behalf. The cost of the components used in our products tends to drop rapidly as volumes increase and the technologies mature. Therefore, if our contract manufacturers are unable to promptly use components purchased on our behalf, our cost of producing products may be higher than our competitors due to an over supply of higher-priced components. Moreover, if they are unable to use components ordered at our direction, we will need to reimburse them for any losses they incur.
We rely upon third parties for technology that is critical to our products, and if we are unable to continue to use this technology and future technology, our ability to develop, sell, maintain and support technologically advanced products would be limited.
We rely on third parties to obtain non-exclusive patented hardware and software license rights in technologies that are incorporated into and necessary for the operation and functionality of most of our products. In these cases, because the intellectual property we license is available from third parties, barriers to entry may be lower than if we owned exclusive rights to the technology we license and use. On the other hand, if a competitor or potential competitor enters into an exclusive arrangement with any of our key third-party technology providers, or if any of these providers unilaterally decide not to do business with us for any reason, our ability to develop and sell products
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containing that technology would be severely limited. If we are shipping products which contain third party technology that we subsequently lose the right to license, then we will not be able to continue to offer or support those products. Our licenses often require royalty payments or other consideration to third parties. Our success will depend in part on our continued ability to have access to these technologies, and we do not know whether these third-party technologies will continue to be licensed to us on commercially acceptable terms or at all. If we are unable to license the necessary technology, we may be forced to acquire or develop alternative technology of lower quality or performance standards. This would limit and delay our ability to offer new or competitive products and increase our costs of production. As a result, our margins, market share, and operating results could be significantly harmed.
We also utilize third party software development companies to develop, customize, maintain and support software that is incorporated into our products. If these companies fail to timely deliver or continuously maintain and support the software that we require of them, we may experience delays in releasing new products or difficulties with supporting existing products and customers.
If we are unable to secure and protect our intellectual property rights, our ability to compete could be harmed.
We rely upon third parties for a substantial portion of the intellectual property we use in our products. At the same time, we rely on a combination of copyright, trademark, patent and trade secret laws, nondisclosure agreements with employees, consultants and suppliers and other contractual provisions to establish, maintain and protect our intellectual property rights. Despite efforts to protect our intellectual property, unauthorized third parties may attempt to design around, copy aspects of our product design or obtain and use technology or other intellectual property associated with our products. For example, one of our primary intellectual property assets is the NETGEAR name, trademark and logo. We may be unable to stop third parties from adopting similar names, trademarks and logos, especially in those international markets where our intellectual property rights may be less protected. Furthermore, our competitors may independently develop similar technology or design around our intellectual property. Our inability to secure and protect our intellectual property rights could significantly harm our brand and business, operating results and financial condition.
Our sales and operations in international markets expose us to operational, financial and regulatory risks.
International sales comprise a significant amount of our overall net revenue. International sales were 62% of overall net revenue in fiscal 2006. We anticipate that international sales may grow as a percentage of net revenue. We have committed resources to expanding our international operations and sales channels and these efforts may not be successful. International operations are subject to a number of other risks, including:
| | |
| • | political and economic instability, international terrorism andanti-American sentiment, particularly in emerging markets; |
|
| • | preference for locally branded products, and laws and business practices favoring local competition; |
|
| • | exchange rate fluctuations; |
|
| • | increased difficulty in managing inventory; |
|
| • | delayed revenue recognition; |
|
| • | less effective protection of intellectual property; |
|
| • | stringent consumer protection and product compliance regulations, including but not limited to the recently enacted Restriction of Hazardous Substances directive and the Waste Electrical and Electronic Equipment, or WEEE directive in Europe, that may vary from country to country and that are costly to comply with; and |
|
| • | difficulties and costs of staffing and managing foreign operations. |
18
We intend to expand our operations and infrastructure, which may strain our operations and increase our operating expenses.
We intend to expand our operations and pursue market opportunities domestically and internationally to grow our sales. We expect that this attempted expansion will strain our existing management information filedsystems, and operational and financial controls. In addition, if we continue to grow, our expenditures will likely be significantly higher than our historical costs. We may not be able to install adequate controls in an efficient and timely manner as our business grows, and our current systems may not be adequate to support our future operations. The difficulties associated with installing and implementing these new systems, procedures and controls may place a significant burden on our management, operational and financial resources. In addition, if we grow internationally, we will have to expand and enhance our communications infrastructure. If we fail to continue to improve our management information systems, procedures and financial controls or encounter unexpected difficulties during expansion, our business could be harmed.
We are continuing to implement our international reorganization, which is straining our resources and increasing our operating expenses.
We have been reorganizing our foreign subsidiaries and entities to better manage and optimize our international operations. Our implementation of this project requires substantial efforts by our staff and is resulting in increased staffing requirements and related expenses. Failure to successfully execute the reorganization or other factors outside of our control could negatively impact the timing and extent of any benefit we receive from the reorganization. As part of the reorganization, we have been implementing new information technology systems, including new forecasting and order processing systems. If we fail to successfully and timely integrate these new systems, we will suffer disruptions to our operations. Any unanticipated interruptions in our business operations as a result of implementing these changes could result in loss or delay in revenue causing an adverse effect on our financial results.
Our stock price may be volatile and your investment in our common stock could suffer a decline in value.
With the continuing uncertainty about economic conditions in the United States, there has been significant volatility in the market price and trading volume of securities of technology and other companies, which may be unrelated to the financial performance of these companies. These broad market fluctuations may negatively affect the market price of our common stock.
Some specific factors that may have a significant effect on our common stock market price include:
| | |
| • | actual or anticipated fluctuations in our operating results or our competitors’ operating results; |
|
| • | actual or anticipated changes in the growth rate of the general networking sector, our growth rates or our competitors’ growth rates; |
|
| • | conditions in the financial markets in general or changes in general economic conditions; |
|
| • | interest rate or currency exchange rate fluctuations; |
|
| • | our ability to raise additional capital; and |
|
| • | changes in stock market analyst recommendations regarding our common stock, other comparable companies or our industry generally. |
Natural disasters, mischievous actions or terrorist attacks could delay our ability to receive or ship our products, or otherwise disrupt our business.
Our corporate headquarters are located in Northern California and one of our warehouses is located in Southern California, regions known for seismic activity. In addition, substantially all of our manufacturing occurs in two geographically concentrated areas in mainland China, where disruptions from natural disasters, health epidemics and political, social and economic instability may affect the region. If our manufacturers or warehousing facilities are disrupted or destroyed, we would be unable to distribute our products on a timely basis, which could
19
harm our business. Moreover, if our computer information systems or communication systems, or those of our vendors or customers, are subject to disruptive hacker attacks or other disruptions, our business could suffer. We have not established a formal disaster recovery plan. Ourback-up operations may be inadequate and our business interruption insurance may not be enough to compensate us for any losses that may occur. A significant business interruption could result in losses or damages and harm our business. For example, much of our order fulfillment process is automated and the order information is stored on our servers. If our computer systems and servers go down even for a short period at the public reference roomend of a fiscal quarter, our ability to recognize revenue would be delayed until we were again able to process and ship our orders, which could cause our stock price to decline significantly.
If we lose the services of our Chairman and Chief Executive Officer, Patrick C.S. Lo, or our other key personnel, we may not be able to execute our business strategy effectively.
Our future success depends in large part upon the continued services of our key technical, sales, marketing and senior management personnel. In particular, the services of Patrick C.S. Lo, our Chairman and Chief Executive Officer, who has led our company since its inception, are very important to our business. In November 2006, Jonathan R. Mather, our former Executive Vice President and Chief Financial Officer, left the company to pursue other opportunities, and we are still in the process of hiring his replacement. We do not maintain any key person life insurance policies. The loss of any of our senior management or other key research, development, sales or marketing personnel, particularly if lost to competitors, could harm our ability to implement our business strategy and respond to the rapidly changing needs of the
SEC in Washington, D.C. Please call the SEC at 1-800-SEC-0330 for further information about the public reference rooms. Our reports, proxy statementssmall business and
other information filed with the SEC are available to the public over the Internet at the SEC’s website athttp://www.sec.gov, and, as soon as practicable after such reports are filed with the SEC, through a hyperlink on our Internet website athttp://www.netgear.com.home markets.
| |
| Item 1B. | Unresolved Staff Comments. |
None.
Our principal administrative, sales, marketing and research and development facilities occupy approximately
56,00074,000 square feet in an office complex in Santa Clara, California, under a lease that expires in December
2004. Several of our domestic sales employees perform their duties using leases of individual offices.2007, with a three-year renewal option. Our international headquarters occupy approximately 10,000 square feet in an office complex in Cork, Ireland, under a lease entered into in February 2006 and expiring in December 2026. Our international sales personnel reside in local sales offices
or home offices in
Austria, Australia,
Brazil, China,
Czech Republic, Denmark, France, Germany,
India, Italy, Japan, Korea,
Norway, Poland, Russia, Singapore, Spain, Sweden,
Switzerland, the Netherlands, the United Arab Emirates, and the
UK.United Kingdom. We also have operations personnel using a facility in Hong Kong, which is subleased from our third party logistics provider, Kerry Logistics. We
also maintain a research and development facility in Taipei, Taiwan. From time to time we consider various alternatives related to our long-term facilities needs. While we believe our existing facilities are adequate
forto meet our
current needs.immediate needs, it may be necessary to lease additional space to accommodate future growth.
We use third parties to provide warehousing services to us, consisting of facilities in Southern California, Hong Kong and the Netherlands.
We are not currently a party
The information set forth under Note 6 of the Notes to
any materialConsolidated Financial Statements, included in Part IV, Item 15 of this report, is incorporated herein by reference. For an additional discussion of certain risks associated with legal
proceedings. We may be subject to various claims and legal actions arisingproceedings, see the section entitled “Risk Factors” in
the ordinary courseItem 1A of
business from time to time.15
this report.
| |
| Item 4. | Submission of Matters to a Vote of Security Holders |
No matters were submitted to a vote of the security holders during the quarter ended December 31, 2003.2006.
20
| |
| Item 5. | Market for Registrant’s Common Stock, Related Stockholder Matters and Issuer Purchases of Equity Securities |
Our common stock has been quoted
under the symbol “NTGR” on the Nasdaq National Market
under the symbol “NTGR” sincefrom July 31,
2003.2003 to July 1, 2006, and on the Nasdaq Global Select Market since then. Prior to that time, there was no public market for our common stock. The following table sets forth for the indicated periods the high and low sales prices for our common stock on the Nasdaq
National Market.| | | | | | | | | |
| Fiscal Year Ended December 31, 2003 | | High | | Low |
| |
| |
|
| Third Quarter (beginning July 31, 2003) | | $ | 20.90 | | | $ | 14.00 | |
| Fourth Quarter | | | 18.73 | | | | 12.86 | |
markets. Such information reflects interdealer prices, without retail markup, markdown or commission, and may not represent actual transactions.
| | | | | | | | | |
Fiscal Year Ended December 31, 2005 | | High | | | Low | |
| |
| First Quarter | | $ | 19.16 | | | $ | 13.45 | |
| Second Quarter | | | 20.78 | | | | 12.96 | |
| Third Quarter | | | 25.73 | | | | 18.65 | |
| Fourth Quarter | | | 24.30 | | | | 17.52 | |
| | | | | | | | | |
Fiscal Year Ended December 31, 2006 | | High | | | Low | |
| |
| First Quarter | | $ | 19.59 | | | $ | 16.64 | |
| Second Quarter | | | 25.39 | | | | 18.40 | |
| Third Quarter | | | 21.64 | | | | 16.92 | |
| Fourth Quarter | | | 28.15 | | | | 20.01 | |
On March 1, 2004,February 16, 2007, there were approximately 5826 stockholders of record.
21
Company Performance
Notwithstanding any statement to the contrary in any of our previous or future filings with the Securities and Exchange Commission, the following information relating to the price performance of our common stock shall not be deemed “filed” with the Commission or “soliciting material” under the 1934 Act and shall not be incorporated by reference into any such filings.
The following graph shows a comparison from July 31, 2003 (the date our common stock commenced trading on the Nasdaq National Market) through December 31, 2006 of cumulative total return for our common stock, the Nasdaq Composite Index and the Nasdaq Computer Index. Such returns are based on historical results and are not intended to suggest future performance. Data for the Nasdaq Composite Index and the Nasdaq Computer Index assume reinvestment of dividends. We have never paid dividends on our common stock and have no present plans to do so.
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | July 31, 2003 | | | | December 31, 2003 | | | | December 31, 2004 | | | | December 31, 2005 | | | | December 31, 2006 | |
| NETGEAR, Inc. | | | $ | 100.00 | | | | $ | 90.39 | | | | $ | 102.66 | | | | $ | 108.82 | | | | $ | 148.39 | |
| NASDAQ Computer Index | | | $ | 100.00 | | | | $ | 116.78 | | | | $ | 120.58 | | | | $ | 123.89 | | | | $ | 131.51 | |
| NASDAQ Composite Index | | | $ | 100.00 | | | | $ | 115.47 | | | | $ | 125.38 | | | | $ | 127.11 | | | | $ | 139.21 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | |
We have never declared or paid cash dividends on our capital stock and westock. We currently intend to retain future earnings, if any, to finance the operation and expansion of our business, and we do not anticipate paying cash dividends in the foreseeable future. In addition, if we were to borrow against our existing credit facility, we would be prohibited from paying cash dividends.
22
Equity Compensation Plan Information The following table summarizes the number of outstanding options granted to employees and directors, as well as the number of securities remaining available for future issuance, under our compensation plans as of December 31,
2003.| | | | | | | | | | | | | |
| | | | | | (c) |
| | | | | | Number of Securities |
| | (a) | | | | Remaining Available |
| | Number of | | | | for Future Issuance |
| | Securities to be | | (b) | | Under Equity |
| | Issued Upon | | Weighted-Average | | Compensation Plans |
| | Exercise of | | Exercise Price of | | (Excluding |
| | Outstanding Options, | | Outstanding Options, | | Securities Reflected |
| Plan Category | | Warrants and Rights | | Warrants and Rights | | in Column (a)) |
| |
| |
| |
|
| Equity compensation plans approved by security holders(1) | | | 6,561,693 | | | $ | 5.39 | | | | 1,896,412 | |
| Equity compensation plans not approved by security holder | | | — | | | | — | | | | — | |
2006.
| | | | | | | | | | | | | |
| | | | | | | | | (c)
| |
| | | (a)
| | | | | | Number of Securities
| |
| | | Number of Securities
| | | (b)
| | | Remaining Available for
| |
| | | to be Issued Upon
| | | Weighted-Average
| | | Future Issuance Under
| |
| | | Exercise of
| | | Exercise Price of
| | | Equity Compensation Plans
| |
| | | Outstanding Options,
| | | Outstanding Options,
| | | (Excluding Securities
| |
Plan Category | | Warrants and Rights | | | Warrants and Rights | | | Reflected in Column(a)) | |
| |
| Equity compensation plans approved by security holders(1) | | | 4,048,457 | | | $ | 14.37 | | | | 1,911,861 | |
| Equity compensation plans not approved by security holder | | | — | | | | — | | | | — | |
| | |
| (1) | | These plans include our 2000 Stock Option Plan, 2003 Stock Plan, 2006 Long Term Incentive Plan, 2006 Stand-Alone Stock Option Agreement, and 2003 Employee Stock Purchase Plan. |
23
| |
| Item 6. | Selected Consolidated Financial Data |
The following selected consolidated financial data
below are qualified in their entirety, and should be read in conjunction with, the consolidated financial statements and related notes thereto, and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere in this
Form 10-K. The
We derived the selected consolidated
statement of operations data for the years ended December 2004, 2005, and 2006 and the selected consolidated balance sheet data as of December 31, 2005 and 2006 from our audited consolidated financial statements
appearing elsewhere in thisForm 10-K. We derived the selected consolidated statement of operations data for the years ended December 31,
2001, 2002 and 2003 and the
selected consolidated balance sheet data as of December 31, 2002,
2003 and
2003 are derived2004 from
audited financial16
statements included elsewhere in this Form 10-K. The consolidated statements of operations data for the years ended December 31, 1999 and 2000, and the consolidated balance sheet data as of December 31, 1999, 2000 and 2001 are derived fromour audited consolidated financial statements, which are not included in thisForm 10-K. PricewaterhouseCoopers LLP performed the audits of the consolidated financial statements as of December 31, 2001, 2002 and 2003 and for each of the years then ended. The audits of the consolidated financial statements as of December 31, 1999 and 2000 and for the years then ended were performed by another independent accountant.
| | | | | | | | | | | | | | | | | | | | | | | | |
| | |
| | Year Ended December 31, |
| |
|
| | 1999 | | 2000 | | 2001 | | 2002 | | 2003 |
| |
| |
| |
| |
| |
|
| | |
| | (In thousands, except per share data) |
Consolidated Statement of Operations Data: | | | | | | | | | | | | | | | | | | | | |
| Net revenue(1) | | $ | 111,856 | | | $ | 176,663 | | | $ | 192,440 | | | $ | 237,331 | | | $ | 299,302 | |
| | | |
| | | |
| | | |
| | | |
| | | |
| |
| Cost of revenue: | | | | | | | | | | | | | | | | | | | | |
| | Cost of revenue | | | 91,265 | | | | 145,531 | | | | 172,795 | | | | 176,972 | | | | 215,332 | |
| | Amortization of deferred stock-based compensation | | | — | | | | — | | | | — | | | | 144 | | | | 128 | |
| | | |
| | | |
| | | |
| | | |
| | | |
| |
| | | | Total cost of revenue | | | 91,265 | | | | 145,531 | | | | 172,795 | | | | 177,116 | | | | 215,460 | |
| | | |
| | | |
| | | |
| | | |
| | | |
| |
| Gross profit | | | 20,591 | | | | 31,132 | | | | 19,645 | | | | 60,215 | | | | 83,842 | |
| | | |
| | | |
| | | |
| | | |
| | | |
| |
| Operating expenses: | | | | | | | | | | | | | | | | | | | | |
| | Research and development | | | 2,641 | | | | 3,319 | | | | 4,432 | | | | 7,359 | | | | 8,220 | |
| | Sales and marketing(1) | | | 20,320 | | | | 18,309 | | | | 24,267 | | | | 32,622 | | | | 48,963 | |
| | General and administrative | | | 3,769 | | | | 4,417 | | | | 5,914 | | | | 8,103 | | | | 8,977 | |
| | Goodwill amortization | | | 335 | | | | 335 | | | | 335 | | | | — | | | | — | |
| | Amortization of deferred stock-based compensation: | | | | | | | | | | | | | | | | | | | | |
| | | Research and development | | | — | | | | — | | | | — | | | | 306 | | | | 454 | |
| | | Sales and marketing | | | — | | | | — | | | | — | | | | 346 | | | | 715 | |
| | | General and administrative | | | — | | | | — | | | | — | | | | 867 | | | | 476 | |
| | | |
| | | |
| | | |
| | | |
| | | |
| |
| | | | Total operating expenses | | | 27,065 | | | | 26,380 | | | | 34,948 | | | | 49,603 | | | | 67,805 | |
| | | |
| | | |
| | | |
| | | |
| | | |
| |
| Income (loss) from operations | | | (6,474 | ) | | | 4,752 | | | | (15,303 | ) | | | 10,612 | | | | 16,037 | |
| Interest income | | | — | | | | 1,092 | | | | 308 | | | | 119 | | | | 364 | |
| Interest expense | | | — | | | | — | | | | (939 | ) | | | (1,240 | ) | | | (901 | ) |
| Extinguishment of debt | | | — | | | | — | | | | — | | | | — | | | | (5,868 | ) |
| Other expense, net | | | (70 | ) | | | (1,322 | ) | | | (478 | ) | | | (19 | ) | | | (59 | ) |
| | | |
| | | |
| | | |
| | | |
| | | |
| |
| Income (loss) before taxes | | | (6,544 | ) | | | 4,522 | | | | (16,412 | ) | | | 9,472 | | | | 9,573 | |
| Provision for (benefit from) income taxes | | | — | | | | 1,868 | | | | 3,072 | | | | 1,333 | | | | (3,524 | ) |
| | | |
| | | |
| | | |
| | | |
| | | |
| |
| Net income (loss) | | | (6,544 | ) | | | 2,654 | | | | (19,484 | ) | | | 8,139 | | | | 13,097 | |
| Deemed dividend on preferred stock | | | — | | | | (2,601 | ) | | | — | | | | (17,881 | ) | | | — | |
| | | |
| | | |
| | | |
| | | |
| | | |
| |
| Net income (loss) attributable to common stockholders | | $ | (6,544 | ) | | $ | 53 | | | $ | (19,484 | ) | | $ | (9,742 | ) | | $ | 13,097 | |
| | | |
| | | |
| | | |
| | | |
| | | |
| |
| Net income (loss) per share attributable to common stockholders: | | | | | | | | | | | | | | | | | | | | |
| | Basic(2) | | $ | (0.25 | ) | | $ | 0.00 | | | $ | (0.66 | ) | | $ | (0.46 | ) | | $ | 0.55 | |
| | | |
| | | |
| | | |
| | | |
| | | |
| |
| | Diluted(2) | | $ | (0.25 | ) | | $ | 0.00 | | | $ | (0.66 | ) | | $ | (0.46 | ) | | $ | 0.49 | |
| | | |
| | | |
| | | |
| | | |
| | | |
| |
17
| | | | | | | | | | | | | | | | | | | | | |
| | | Year Ended December 31, | |
| | | 2002 | | | 2003 | | | 2004 | | | 2005 | | | 2006 | |
| | | (In thousands, except per share data) | |
| |
Consolidated Statement of Operations Data: | | | | | | | | | | | | | | | | | | | | |
| Net revenue | | $ | 237,331 | | | $ | 299,302 | | | $ | 383,139 | | | $ | 449,610 | | | $ | 573,570 | |
| Cost of revenue(2) | | | 177,116 | | | | 215,460 | | | | 260,318 | | | | 297,911 | | | | 379,911 | |
| | | | | | | | | | | | | | | | | | | | | |
| Gross profit | | | 60,215 | | | | 83,842 | | | | 122,821 | | | | 151,699 | | | | 193,659 | |
| | | | | | | | | | | | | | | | | | | | | |
| Operating expenses: | | | | | | | | | | | | | | | | | | | | |
| Research and development(2) | | | 7,665 | | | | 8,674 | | | | 10,316 | | | | 12,837 | | | | 18,443 | |
| Sales and marketing(2) | | | 32,968 | | | | 49,678 | | | | 62,247 | | | | 71,345 | | | | 91,881 | |
| General and administrative(2) | | | 8,970 | | | | 9,453 | | | | 14,905 | | | | 14,559 | | | | 20,905 | |
| In-process research and development | | | — | | | | — | | | | — | | | | — | | | | 2,900 | |
| Litigation reserves | | | — | | | | — | | | | — | | | | 802 | | | | — | |
| | | | | | | | | | | | | | | | | | | | | |
| Total operating expenses | | | 49,603 | | | | 67,805 | | | | 87,468 | | | | 99,543 | | | | 134,129 | |
| | | | | | | | | | | | | | | | | | | | | |
| Income from operations | | | 10,612 | | | | 16,037 | | | | 35,353 | | | | 52,156 | | | | 59,530 | |
| Interest income | | | 119 | | | | 364 | | | | 1,593 | | | | 4,104 | | | | 6,974 | |
| Interest expense | | | (1,240 | ) | | | (901 | ) | | | — | | | | — | | | | — | |
| Extinguishment of debt | | | — | | | | (5,868 | ) | | | — | | | | — | | | | — | |
| Other income (expense) | | | (19 | ) | | | (59 | ) | | | (560 | ) | | | (1,770 | ) | | | 2,495 | |
| | | | | | | | | | | | | | | | | | | | | |
| Income before taxes | | | 9,472 | | | | 9,573 | | | | 36,386 | | | | 54,490 | | | | 68,999 | |
| Provision for (benefit from) income taxes | | | 1,333 | | | | (3,524 | ) | | | 12,921 | | | | 20,867 | | | | 27,867 | |
| | | | | | | | | | | | | | | | | | | | | |
| Net income | | | 8,139 | | | | 13,097 | | | | 23,465 | | | | 33,623 | | | | 41,132 | |
| Deemed dividend on preferred stock | | | (17,881 | ) | | | — | | | | — | | | | — | | | | — | |
| | | | | | | | | | | | | | | | | | | | | |
| Net income (loss) attributable to common stockholders | | $ | (9,742 | ) | | $ | 13,097 | | | $ | 23,465 | | | $ | 33,623 | | | $ | 41,132 | |
| | | | | | | | | | | | | | | | | | | | | |
| Net income (loss) per share attributable to common stockholders: | | | | | | | | | | | | | | | | | | | | |
| Basic(1) | | $ | (0.46 | ) | | $ | 0.55 | | | $ | 0.77 | | | $ | 1.04 | | | $ | 1.23 | |
| | | | | | | | | | | | | | | | | | | | | |
| Diluted(1) | | $ | (0.46 | ) | | $ | 0.49 | | | $ | 0.72 | | | $ | 0.99 | | | $ | 1.19 | |
| | | | | | | | | | | | | | | | | | | | | |
| | |
| (1) | On January 1, 2000, we adopted Emerging Issues Task Force, or EITF, Issue 01-09, “Accounting for Consideration Given by a Vendor to a Customer or Reseller of the Vendor’s Products,” and as a consequence, record cooperative marketing costs as a reduction in net revenue. Prior to January 1, 2000, it was not practical for us to determine the amount of cooperative marketing costs to record as a reduction of net revenue, and such amounts were included as sales and marketing expense. |
|
(2) | Information regarding calculation of per share data is described in Note 4 of the Notes to the consolidated financial statements.Consolidated Financial Statements. |
| | | | | | | | | | | | | | | | | | | | | |
| | |
| | Year Ended December 31, |
| |
|
| | 1999 | | 2000 | | 2001 | | 2002 | | 2003 |
| |
| |
| |
| |
| |
|
| | |
| | (In thousands) |
Consolidated Balance Sheet Data: | | | | | | | | | | | | | | | | | | | | |
| Cash, cash equivalents and short-term investments | | $ | 10,427 | | | $ | 6,447 | | | $ | 9,152 | | | $ | 19,880 | | | $ | 73,605 | |
| Working capital | | | 22,989 | | | | 36,253 | | | | 16,179 | | | | 13,753 | | | | 130,755 | |
| Total assets | | | 62,220 | | | | 112,142 | | | | 62,902 | | | | 93,851 | | | | 205,146 | |
| Total current liabilities | | | 37,635 | | | | 73,946 | | | | 44,891 | | | | 76,396 | | | | 70,207 | |
| Redeemable convertible preferred stock | | | — | | | | 44,078 | | | | 44,078 | | | | 48,052 | | | | — | |
| Total stockholders’ equity (deficit) | | | 24,129 | | | | (6,583 | ) | | | (26,067 | ) | | | (30,597 | ) | | | 134,939 | |
24
| | |
Item 7.(2) | Management’s Discussion and Analysis of Financial Condition and Results of Operations | Stock-based compensation expense was allocated as follows: |
| | | | | | | | | | | | | | | | | | | | | |
| Cost of revenue | | $ | 144 | | | $ | 128 | | | $ | 163 | | | $ | 147 | | | $ | 430 | |
| Research and development | | | 306 | | | | 454 | | | | 400 | | | | 293 | | | | 1,119 | |
| Sales and marketing | | | 346 | | | | 715 | | | | 733 | | | | 375 | | | | 1,405 | |
| General and administrative | | | 867 | | | | 476 | | | | 391 | | | | 249 | | | | 1,551 | |
Effective January 1, 2006, the Company adopted Statement of Financial Accounting Standards (“SFAS”) No. 123 (revised 2004), “Share-Based Payment” (“SFAS 123R”).
| | | | | | | | | | | | | | | | | | | | | |
| | | December 31, | |
| | | 2002 | | | 2003 | | | 2004 | | | 2005 | | | 2006 | |
| | | (In thousands) | |
| |
Consolidated Balance Sheet Data: | | | | | | | | | | | | | | | | | | | | |
| Cash, cash equivalents and short-term investments | | $ | 19,880 | | | $ | 73,605 | | | $ | 141,715 | | | $ | 173,656 | | | $ | 197,465 | |
| Working capital | | | 13,753 | | | | 130,755 | | | | 180,696 | | | | 230,416 | | | | 280,877 | |
| Total assets | | | 93,851 | | | | 205,146 | | | | 300,238 | | | | 356,297 | | | | 437,904 | |
| Total current liabilities | | | 76,396 | | | | 70,207 | | | | 115,044 | | | | 120,293 | | | | 143,482 | |
| Redeemable convertible preferred stock | | | 48,052 | | | | — | | | | — | | | | — | | | | — | |
| Total stockholders’ equity (deficit) | | | (30,597 | ) | | | 134,939 | | | | 185,194 | | | | 236,004 | | | | 294,422 | |
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
You should read the following discussion of our financial condition and results of operations together with the audited consolidated financial statements and notes to the financial statements included elsewhere in thisForm 10-K. This discussion contains forward-looking statements that involve risks and uncertainties. The forward-looking statements are not historical facts, but rather are based on current expectations, estimates, assumptions and projections about our industry, business and future financial results. Our actual results could differ materially from the results contemplated by these forward-looking statements due to a number of factors, including those discussed below under “Risk Factors Affecting Future Results”.Factors” in Part I, Item 1A above. We design, develop and market
technologically advanced, brandedinnovative networking products that address the specific needs of small business and home users. We
supply innovative networking products that meetdefine small business as a business with fewer than 250 employees. We are focused on satisfying the
ease-of-use, quality, reliability, performance and affordability requirements of these users.
From our inception in January 1996 until May 1996, our operating activities related primarilyOur product offerings enable users to
researchshare Internet access, peripherals, files, digital multimedia content and
development, developing relationships with outsourced design, manufacturingapplications among multiple personal computers, or PCs, and
technical support partners, testing prototype designs, staffing a sales and marketing organization and establishing relationships with distributors and resellers. We began product shipments during the quarter ended June 30, 1996, and recorded net revenue of $4.0 million in 1996. In 2003, our net revenue was $299.3 million and our net income was $13.1 million. We were incorporated in January 1996 as a wholly owned subsidiary of Bay Networks, Inc. to focus exclusively on providing networking solutions for small businesses and homes. In August 1998, Nortel Networks purchased Bay Networks, including its wholly owned subsidiary NETGEAR. We remained a wholly owned subsidiary of Nortel Networks until March 2000 when we sold a portion of our capital stock to Pequot Private Equity Fund II, L.P. as part of a joint effort by us and Nortel Networks to reduce Nortel Networks’ ownership interest in us. In September 2000, Nortel Networks sold a portion of its ownership interest in us to Shamrock Holdings of California, Inc., which is a related party to Shamrock Capital Growth Fund, L.P.; Blue Ridge Limited Partnership and an affiliated fund; Halyard Capital Fund, LP; The Abernathy Group Institutional HSN Fund, L.P. and an affiliated fund; and Delta International Holding Ltd. In February 2002, Nortel Networks sold its remaining ownership interest in NETGEAR to us in exchange for cash, non-cash consideration, and a $20.0 million promissory note. In July 2003 we completed our initial public offering of common stock. We sold 8,050,000 shares of common stock at an offering price of $14.00 per share. We
18
other Internet-enabled devices.
received net proceeds of approximately $101.8 million after deducting the underwriting discount and offering expenses payable by us. A portion of the proceeds has been used to fully repay the $20.0 million promissory note.
Our extensive product line currently includes approximately 100 different products.consists of wired and wireless devices that enable Ethernet networking, broadband access, and network connectivity. These products are available in multiple configurations to address the needs of our customersend-users in each geographic region in which our products are sold. Our products are grouped into three major segments within the small business and home markets: Ethernet
We sell our networking products
broadband products and wireless networking products. Ethernet networking products include switches, network interface cards, or NICs, and print servers. Broadband products include routers and gateways. Wireless networking products include wireless access points, wireless NICs and media adapters. Since we originally launched our business in 1996 with the shipment of Ethernet networking products and a single broadband product, we have continually introduced new products in response to market demand. For example, in 2003, we introduced approximately 48 new products. Our products are sold through multiple sales channels worldwide, including traditional retailers, online retailers, direct market resellers, orwholesale distributors, DMRs, value added resellers, or VARs, and broadband service providers. Our retail channel includes traditional retail locations domestically and internationally, such as Best Buy, Circuit City, CompUSA, Costco, Fry’s Electronics, Radio Shack, Staples, Office Depot, MediaMarkt (Germany, Austria)Argos (U.K.), Dixons (U.K.), PC World (U.K.), MediaMarkt (Germany, Austria), and FNAC (France). Online retailers include Amazon.com, Newegg.com and Buy.com. Our direct market resellersDMRs include Dell, CDW Corporation, Insight Corporation and PC Connection. We have over 8,000 VARsConnection in North America,domestic markets and more than 3,000 internationally.Misco throughout Europe. In addition, we also sell our products through broadband service providers, such as Time–Warner Cable and Comcastmultiple system operators in domestic markets and Telstra in Australiacable and Tele Denmark.DSL operators internationally. Some of these retailers and resellers purchase directly from us while most are fulfilled through approximately 67 wholesale distributors around the world. A substantial portion of our net revenue to date has been derived from a limited number of wholesale distributors, the
25
largest of which are Ingram Micro Inc.
, and Tech Data Corporation. We expect that these wholesale distributors will continue to contribute a significant percentage of our net revenue for the foreseeable future.
The table below sets forth
We have well developed channels in the
percentage of net revenue derived from these major wholesale distributors forUnited States and Europe, Middle-East and Africa, or EMEA, and are building a strong presence in the
years ended December 31, 2001, 2002 and 2003, respectively.| | | | | | | | | | | | | | |
| | |
| | Year Ended |
| | December 31, |
| |
|
| | 2001 | | 2002 | | 2003 |
| |
| |
| |
|
| Ingram Micro, Inc. | | | 36 | % | | | 32 | % | | | 31 | % |
| Tech Data Corporation | | | 23 | | | | 20 | | | | 15 | |
| | | |
| | | |
| | | |
| |
| | Total | | | 59 | % | | | 52 | % | | | 46 | % |
| | | |
| | | |
| | | |
| |
Asia Pacific region. We derive a substantial portionthe majority of our net revenue from international sales. International sales as a percentage of net revenue grew from 37%56% in each of 2001 and 20022005 to 42%62% in 2003.2006. Sales in EMEA grew from $68.0$200.0 million in 20022005 to $99.4$298.2 million in 2003,2006, representing an increase of approximately 46%49% during that period. We continue to penetrate growingnew markets such as China, Italy, Japan, SpainBrazil, Eastern Europe, India, and Sweden. The table below sets forth our net revenue by major geographic region.
| | | | | | | | | | | | | | | | | | | | | | |
| | |
| | Year Ended December 31, |
| |
|
| | | | Percentage | | | | Percentage | | |
| | 2001 | | Change | | 2002 | | Change | | 2003 |
| |
| |
| |
| |
| |
|
| | |
| | (in thousands) |
| North America | | $ | 121,688 | | | | 23% | | | $ | 150,096 | | | | 15% | | | $ | 172,885 | |
| EMEA | | | 52,977 | | | | 28% | | | | 68,006 | | | | 46% | | | | 99,422 | |
| Asia Pacific and rest of world | | | 17,775 | | | | 8% | | | | 19,229 | | | | 40% | | | | 26,995 | |
| | | |
| | | |
| | | |
| | | |
| | | |
| |
| | Total | | $ | 192,440 | | | | 23% | | | $ | 237,331 | | | | 26% | | | $ | 299,302 | |
| | | |
| | | |
| | | |
| | | |
| | | |
| |
the Middle-East.
Our net revenue consistsgrew 27.6% during the year ended December 31, 2006, primarily attributable to higher sales of DSL gateway and powerline products to new and existing service provider customers, especially in Europe, as well as continued strength in our RangeMax wireless router product line.
The small business and home networking markets are intensely competitive and subject to rapid technological change. We expect our competition to continue to intensify. We believe that the principal competitive factors in the small business and home markets for networking products include product breadth, size and scope of the sales channel, brand name, timeliness of new product introductions, product performance, features, functionality and reliability,ease-of-installation, maintenance and use, and customer service and support. To remain competitive, we believe we must invest significant resources in developing new products, enhancing our current products, expanding our channels and maintaining customer satisfaction worldwide.
Our gross product shipments, less allowancesmargin improved to 33.8% for estimated returnsthe year ended December 31, 2006 from 33.7% for stock rotationthe year ended December 31, 2005. Our gross margin improvement was primarily due to decreased marketing costs and warranty, price protection, customerimproved vendor rebates, cooperative marketingoffset by increased sales of products carrying lower gross margins to service providers. Operating expenses for the year ended December 31, 2006 were $134.1 million or 23.4% of net revenue and $99.5 million or 22.1% of net revenue for the year ended December 31, 2005.
Net income increased $7.5 million, to $41.1 million for the year ended December 31, 2006 from $33.6 million for the year ended December 31, 2005. This increase was due to an increase in gross profit of $42.0 million and an increase in interest and other income of $7.1 million, offset by an increase in operating expenses of $34.6 million and an increase in provision for income taxes of $7.0 million.
Critical Accounting Policies and Estimates
Our consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires management to make assumptions, judgments and estimates that can have a significant impact on the reported amounts of assets, liabilities, revenues and expenses. We base our estimates on historical experience and on various other assumptions believed to be applicable and reasonable under the circumstances. Actual results could differ significantly from these estimates. These estimates may change as new events occur, as additional information is obtained and as our operating environment changes. On a regular basis we evaluate our assumptions, judgments and estimates and make changes
accordingly. We also discuss our critical accounting estimates with the Audit Committee of the Board of Directors. Note 1 of the Notes to Consolidated Financial Statements describes the significant accounting policies used in
19
the preparation of the consolidated financial statements. We have listed below our critical accounting policies which we believe to have the greatest potential impact on our consolidated financial statements. Historically, our assumptions, judgments and estimates relative to our critical accounting policies have not differed materially from actual results.
deferred revenue.
Revenue Recognition
Revenue from product sales is generally recognized at the time the product is shipped provided that persuasive evidence of an arrangement exists, title and risk of loss has transferred to the customer, the salesselling price is fixed or determinable and collectibilitycollection of the related receivable is reasonably assured. Currently, for some of our international customers, title passes to the customer upon delivery to the port or country of destination. For select retailers to whom we sell directly, title passesdestination, upon their receipt of the product, or upon the customer’s resale of the product. At the end of each fiscal quarter, we estimate and defer revenue related to the product in-transitwhere title has not transferred. The revenue continues to international customers and retail customersbe deferred until such time that purchase directly from us based upon title passage, and distributor and reseller channel inventory that we estimate may be returned to us under their stock rotation rights.
Priorpasses to the year ended December 31, 2001, we recognized revenue on shipments to domestic distributors upon resale by those distributors, and on shipment to international distributors upon cash collection. Beginning in 2001, we had sufficient historical evidence with respect to returns and cash collections to enable us to recognize revenue in accordance with our current policy as described above and in Note 1 to the consolidated financial statements. Our net revenue for the year ended December 31, 2001 reflects the one-time effect of this change, resulting in additional revenue of $21.0 million in the quarter ended March 31, 2001, offset partially by provisions for returns for stock rotation and warranty and price protection of $9.4 million.
26
Our financial condition and results of operations have been and are likely to continue to be affected by seasonal patterns. In the past, we have experienced higher net revenue during the second half of the year, with our highest net revenue during the year-end holiday season. Absent other factors, we would therefore expect higher net revenue in the third and fourth quarter of each year. To the extent our retail sales increase as a percentage of our net revenue, we expect to experience seasonally higher net revenue as a percentage of annual net revenue in the third and fourth quarters.
Intense competition and technological advances characterize the small business and home networking markets. As a result, we expect to experience rapid erosion of average selling prices over the course of the lifecycle of our products due to competitive pricing pressures. In order to maintain our margins, it is necessary to offset average sales price erosion by negotiating continuously with component suppliers and contract manufacturers to reduce unit costs of incoming inventory. We also expect to continue to introduce new products and broaden our geographic and channel reach. These efforts require significant up front investment in advance of incremental revenue, which could impact our margins. In addition, our international expansion will expose us to additional risks related to foreign currency fluctuations.
Cost of revenue consists primarily of the following: the cost of finished products from our third-party contract manufacturers; overhead costs including purchasing, product planning, inventory control, warehousing and distribution logistics; and freight, warranty and inventory costs. We outsource our manufacturing, warehousing and distribution logistics. We believe this outsourcing strategy allows us to better manage our product costs and gross margin. Our gross margin is affected by other factors, including changes in net revenues due to average selling prices, marketing expenses such as promotional activities and rebate redemptions, and changes in our cost of goods sold due to fluctuations in warranty and overhead costs, prices paid for components and freight and increases in excess or obsolete inventory caused by fluctuations in manufacturing volumes and transitions from older to newer products.
Research and development expenses consist primarily of personnel expenses, payments to suppliers for design services, tooling, safety and regulatory testing, product certification expenditures to qualify our products for sale into specific markets and other consulting fees and product certification fees paid to third parties. Research and development expenses are recognized as they are incurred. We have invested in building our research and development organization to allow us to introduce innovative and easy to use products. We expect to continue to add additional employees in our research and development department. We believe that research and development expenses will increase in absolute dollars in the future but expect it to remain relatively stable as a percentage of net revenue as we expand into new hardware and software networking product technologies and enhance the ease-of-use of our products and broaden our core competencies.
Sales and marketing expenses consist primarily of advertising, trade shows, corporate communications and other marketing expenses, personnel expenses for sales and marketing staff, product marketing expenses and technical support expenses. We believe that maintaining and building brand awareness is key to both net
20
customer. The amount and timing of our revenue growthfor any period could be materially different if our management made different judgments and maintainingestimates.
Allowances for Product Warranties, Returns due to Stock Rotation, Price Protection, Sales Incentives and Doubtful Accounts
Our standard warranty obligation to our gross margin. We also believe that maintaining widely available and high quality technical support is key to building and maintaining brand awareness. Accordingly, we expect sales and marketing expenses to increase in absolute dollarsdirect customers generally provides for a right of return of any product for a full refund in the event that such product is not merchantable or is found to be damaged or defective. At the time revenue is recognized, an estimate of future warranty returns is recorded to reduce revenue in the amount of the expected credit or refund to be provided to the our direct customers. At the time we record the reduction to revenue related to warranty returns, we include within cost of revenue a write-down to reduce the carrying value of such products to net realizable value. Our standard warranty obligation to end-users provides for repair or replacement of a defective product for one or more years. Factors that affect the warranty obligation include product failure rates, material usage, and service delivery costs incurred in correcting product failures. The estimated cost associated with fulfilling the warranty obligation to end-users is recorded in cost of revenue. Because our products are manufactured by contract manufacturers, in certain cases we have recourse to the contract manufacturer for replacement or credit for the defective products. We give consideration to amounts recoverable from our contract manufacturers in determining our warranty liability. Our estimated allowances for product warranties can vary from actual results and we may have to record additional revenue reductions or charges to cost of revenue which could materially impact our financial position and results of operations.
In addition to warranty-related returns, certain distributors and retailers generally have the right to return product for stock rotation purposes. Every quarter, stock rotation rights are generally limited to 10% of invoiced sales to the distributor or retailer in the prior quarter. Upon shipment of the product, we reduce revenue for an estimate of potential future stock rotation returns related to the planned growthcurrent period product revenue. We analyze historical returns, channel inventory levels, current economic trends and changes in customer demand for our products when evaluating the adequacy of the allowance for sales returns, namely stock rotation returns. Our estimated allowances for returns due to stock rotation can vary from actual results and we may have to record additional revenue reductions which could materially impact our business.
Generalfinancial position and administrative expenses consistresults of salaries and related expensesoperations.
Sales incentives provided to customers are accounted for
executive, finance and accounting, human resources and management information systems personnel, professional fees, bad debt provision, and other corporate expenses. We expect general and administrative expensesin accordance with Emerging Issues Task Force (“EITF”) IssueNo. 01-9, “Accounting for Consideration Given by a Vendor to
increase in absolute dollars asa Customer or Reseller of the Vendor’s Products”. Under these guidelines, we
add personnel and incur additional expenses related to the growth of our business and continued operationsaccrue for sales incentives as a
public company. Goodwill amortization relates to goodwill recordedmarketing expense if we receive an identifiable benefit in connection with Nortel Networks’ purchase of Bay Networks in August 1998. Upon adoption of Statement of Financial Accounting Standards, or SFAS, No. 142, we discontinued amortizing goodwill inexchange and can reasonably estimate the year ended December 31, 2002.
During the years ended December 31, 2002 and 2003 we recorded deferred stock-based compensation of $6.7 million and $1.0 million, respectively, in connection with stock options granted with exercise prices below the deemed fair value of our common stockthe identifiable benefit received; otherwise, it is recorded as a reduction of revenues. Our estimated provisions for sales incentives can vary from actual results and we may have to record additional expenses or additional revenue reductions dependent on the date of grant. We are amortizing this deferred stock-based compensation over the four-year vesting periodclassification of the stock optionssales incentive.
We maintain an allowance for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. We regularly perform credit evaluations of our customers’ financial condition and consider factors such amountsas historical experience, credit quality, age of the accounts receivable balances, and geographic or country-specific risks and economic conditions that may affect a customer’s ability to pay. The allowance for doubtful accounts is reviewed monthly and adjusted if necessary based on our assessments of our customers’ ability to pay. If the financial condition of our customers should deteriorate or if actual defaults are allocated tohigher than our historical experience, additional allowances may be required, which could have an adverse impact on operating expenses.
Valuation of Inventory
We value our inventory at the
respective operating expense categorieslower of cost or market, cost being determined using thefirst-in, first-out method. We continually assess the value of our inventory and will periodically write down its value for estimated excess and obsolete inventory based upon
individual employee departments. Interest income represents amounts earnedassumptions about future demand and market conditions. On a quarterly basis, we review inventory quantities on hand and on order under non-cancelable purchase commitments, including consignment inventory, in comparison to our cash, cash equivalents and short-term investments. Interest expense consistsestimated forecast of interest paid on loans, and beginning in February 2002, included imputed interest associated with a note payableproduct demand for the next nine months to Nortel Networks. The note had a principal amount of $20.0 million, with principal and accrued but unpaid interest due on February 7, 2009. Interestdetermine what inventory, if any, are not saleable. Our analysis is based on the note, at 7% per year, was due to start accruing on February 7, 2005. The note was carried at its “then” present value and we were accreting its carrying value to reflect its imputed interest. We used approximately $20.0 million of the net proceeds from its initial public offering in August 2003 to fully repay the note. As a result of this $20.0 million cash payment, we incurred an extinguishment of debt charge of approximately $5.9 million in the quarter ended September 28, 2003 when the note was repaid in full.demand forecast but takes into
27
Other expense, net, primarily represents gains and losses on transactions denominated in foreign currencies and other miscellaneous expenses.
We incurred net losses in each year from our inception in 1996 through 1999 as we invested in building our research and development capabilities, our sales channels and staff, and our operations and financial infrastructure. We accumulated a deficit of $24.6 million during this time period. In 2000 we earned net income of $2.7 million primarily due to growth in revenue of $64.8 million. In 2001 we incurred a net loss of $19.5 million primarily due to excess inventory levels brought about by the overall weak economic conditions in the networking markets we serve. We were again profitable in 2002, with net income of $8.1 million, due to increased revenue and improved gross margins. In 2003 we had net income of $13.1 million and our net revenue increased 26% compared with 2002. In addition, our gross margins increased 2.6% year over year. We believe our future results will be dependent upon the overall economic conditions in the markets we serve, the competitive environment in which we operate, and our ability to successfully implement our strategy, among other things. For additional information on factors that will affect our future performance, see “Risk Factors” beginning on page 5.
21
account market conditions, product development plans, product life expectancy and other factors. Based on this analysis, we write down the affected inventory value for estimated excess and obsolescence charges. At the point of loss recognition, a new, lower cost basis for that inventory is established, and subsequent changes in facts and circumstances do not result in the restoration or increase in that newly established cost basis. As demonstrated during prior years, demand for our products can fluctuate significantly. If actual demand is lower than our forecasted demand and we fail to reduce our manufacturing accordingly, we could be required to write down additional inventory, which would have a negative effect on our gross margin.
Income Taxes
We account for income taxes under an asset and liability approach. Under this method, income tax expense is recognized for the amount of taxes payable or refundable for the current year. In addition, deferred tax assets and liabilities are recognized for the expected future tax consequences of temporary differences resulting from different treatments for tax versus accounting of certain items, such as accruals and allowances not currently deductible for tax purposes. These differences result in deferred tax assets and liabilities, which are included within the consolidated balance sheet. We must then assess the likelihood that our deferred tax assets will be recovered from future taxable income and to the extent we believe that recovery is not more likely than not, we must establish a valuation allowance. As of December 31, 2006, we believe that all of our deferred tax assets are recoverable; however, if there were a change in our ability to recover our deferred tax assets, we would be required to take a charge in the period in which we determined that recovery was not more likely than not.
Our effective tax rate differs from the statutory rate due to tax credits, state taxes, stock compensation and other factors. Our future effective tax rate could be impacted by a shift in the mix of domestic and foreign income, tax treaties with foreign jurisdictions; changes in tax laws in the United States or internationally; a change which would result in a valuation allowance being required to be recorded; or a federal, state or foreign jurisdiction’s view of tax returns which differs materially from what we originally provided. We assess the probability of adverse outcomes from tax examinations regularly to determine the adequacy of our income tax liability. If we ultimately determine that payment of these amounts is unnecessary, we reverse the liability and recognize a tax benefit during the period in which we determine that the liability is no longer necessary. We record an additional charge in our provision for taxes in the period in which we determine that the recorded tax liability is less than we expect the ultimate assessment to be.
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The following table sets forth the consolidated statements of operations and the percentage change from the preceding year for the periods indicated:
| | | | | | | | | | | | | | | | | | | | | | | | |
| | |
| | Year Ended December 31, |
| |
|
| | | | Percentage | | | | Percentage | | |
| | 2001 | | Change | | 2002 | | Change | | 2003 |
| |
| |
| |
| |
| |
|
| Net revenue | | $ | 192,440 | | | | 23.3 | % | | $ | 237,331 | | | | 26.1 | % | | $ | 299,302 | |
| | | |
| | | |
| | | |
| | | |
| | | |
| |
| Cost of revenue: | | | | | | | | | | | | | | | | | | | | |
| | Cost of revenue | | | 172,795 | | | | 2.4 | | | | 176,972 | | | | 21.7 | | | | 215,332 | |
| | | |
| | | |
| | | |
| | | |
| | | |
| |
| | Amortization of deferred stock-based compensation | | | — | | | | — | | | | 144 | | | | (11.1 | ) | | | 128 | |
| | | |
| | | |
| | | |
| | | |
| | | |
| |
| | Total Cost of revenue | | | 172,795 | | | | 2.5 | | | | 177,116 | | | | 21.6 | | | | 215,460 | |
| | | |
| | | |
| | | |
| | | |
| | | |
| |
| Gross profit | | | 19,645 | | | | 206.5 | | | | 60,215 | | | | 39.2 | | | | 83,842 | |
| | | |
| | | |
| | | |
| | | |
| | | |
| |
| Operating expenses: | | | | | | | | | | | | | | | | | | | | |
| | Research and development | | | 4,432 | | | | 66.0 | | | | 7,359 | | | | 11.7 | | | | 8,220 | |
| | Sales and marketing | | | 24,267 | | | | 34.4 | | | | 32,622 | | | | 50.1 | | | | 48,963 | |
| | General and administrative | | | 5,914 | | | | 37.0 | | | | 8,103 | | | | 10.8 | | | | 8,977 | |
| | Goodwill amortization | | | 335 | | | | (100.0 | ) | | | — | | | | — | | | | — | |
| | Amortization of deferred stock-based compensation: | | | | | | | | | | | | | | | | | | | | |
| | | Research and development | | | — | | | | — | | | | 306 | | | | 48.4 | | | | 454 | |
| | | Sales and marketing | | | — | | | | — | | | | 346 | | | | 106.6 | | | | 715 | |
| | | General and administrative | | | — | | | | — | | | | 867 | | | | (45.1 | ) | | | 476 | |
| | | |
| | | |
| | | |
| | | |
| | | |
| |
| | | | Total operating expenses | | | 34,948 | | | | 41.9 | | | | 49,603 | | | | 36.7 | | | | 67,805 | |
| | | |
| | | |
| | | |
| | | |
| | | |
| |
| Income (loss) from operations | | | (15,303 | ) | | | * | | | | 10,612 | | | | 51.1 | | | | 16,037 | |
| Extinguishment of debt | | | — | | | | — | | | | — | | | | — | | | | (5,868 | ) |
| Other income (expense), net | | | (1,109 | ) | | | * | | | | (1,140 | ) | | | * | | | | (596 | ) |
| | | |
| | | |
| | | |
| | | |
| | | |
| |
| Income (loss) before income taxes | | | (16,412 | ) | | | * | | | | 9,472 | | | | 1.1 | | | | 9,573 | |
| Provision (benefit) for income taxes | | | 3,072 | | | | * | | | | 1,333 | | | | (364.4 | ) | | | (3,524 | ) |
| | | |
| | | |
| | | |
| | | |
| | | |
| |
| Net income (loss) | | $ | (19,484 | ) | | | * | % | | $ | 8,139 | | | | 60.9 | % | | $ | 13,097 | |
| | | |
| | | |
| | | |
| | | |
| | | |
| |
| | | | | | | | | | | | | | | | | | | | | |
| | | Year Ended December 31, | |
| | | | | | Percentage | | | | | | Percentage | | | | |
| | | 2004 | | | Change | | | 2005 | | | Change | | | 2006 | |
| | | (In thousands, except percentage data) | |
| |
| Net revenue | | $ | 383,139 | | | | 17.3 | % | | $ | 449,610 | | | | 27.6 | % | | $ | 573,570 | |
| Cost of revenue | | | 260,318 | | | | 14.4 | | | | 297,911 | | | | 27.5 | | | | 379,911 | |
| | | | | | | | | | | | | | | | | | | | | |
| Gross profit | | | 122,821 | | | | 23.5 | | | | 151,699 | | | | 27.7 | | | | 193,659 | |
| | | | | | | | | | | | | | | | | | | | | |
| Operating expenses: | | | | | | | | | | | | | | | | | | | | |
| Research and development | | | 10,316 | | | | 24.4 | | | | 12,837 | | | | 43.7 | | | | 18,443 | |
| Sales and marketing | | | 62,247 | | | | 14.6 | | | | 71,345 | | | | 28.8 | | | | 91,881 | |
| General and administrative | | | 14,905 | | | | (2.3 | ) | | | 14,559 | | | | 43.6 | | | | 20,905 | |
| In-process research and development | | | — | | | | ** | | | | — | | | | ** | | | | 2,900 | |
| Litigation reserves | | | — | | | | ** | | | | 802 | | | | (100.0 | ) | | | — | |
| | | | | | | | | | | | | | | | | | | | | |
| Total operating expenses | | | 87,468 | | | | 13.8 | | | | 99,543 | | | | 34.7 | | | | 134,129 | |
| | | | | | | | | | | | | | | | | | | | | |
| Income from operations | | | 35,353 | | | | 47.5 | | | | 52,156 | | | | 14.1 | | | | 59,530 | |
| Interest income | | | 1,593 | | | | 157.6 | | | | 4,104 | | | | 69.9 | | | | 6,974 | |
| Other income (expense), net | | | (560 | ) | | | 216.1 | | | | (1,770 | ) | | | ** | | | | 2,495 | |
| | | | | | | | | | | | | | | | | | | | | |
| Income before income taxes | | | 36,386 | | | | 49.8 | | | | 54,490 | | | | 26.6 | | | | 68,999 | |
| Provision for income taxes | | | 12,921 | | | | 61.5 | | | | 20,867 | | | | 33.5 | | | | 27,867 | |
| | | | | | | | | | | | | | | | | | | | | |
| Net income | | $ | 23,465 | | | | 43.3 | % | | $ | 33,623 | | | | 22.3 | % | | $ | 41,132 | |
| | | | | | | | | | | | | | | | | | | | | |
| | |
| ** | | Percentage change not meaningful as prior year basis is zero or a negative amount. |
29
22
The following table sets forth the consolidated statements of operations, expressed as a percentage of net revenue, for the periods
indicated:| | | | | | | | | | | | | | | | |
| | |
| | Year Ended December 31, |
| |
|
| | 2001 | | 2002 | | 2003 |
| |
| |
| |
|
| Net revenue | | | 100.0 | % | | | 100.0 | % | | | 100.0 | % |
| | | |
| | | |
| | | |
| |
| Cost of revenue: | | | | | | | | | | | | |
| | Cost of revenue | | | 89.8 | | | | 74.6 | | | | 72.0 | |
| | Amortization of deferred stock-based compensation | | | — | | | | 0.0 | | | | 0.0 | |
| | | |
| | | |
| | | |
| |
| | | | Total cost of revenue | | | 89.8 | | | | 74.6 | | | | 72.0 | |
| | | |
| | | |
| | | |
| |
| Gross margin | | | 10.2 | | | | 25.4 | | | | 28.0 | |
| | | |
| | | |
| | | |
| |
| | Operating expenses: | | | | | | | | | | | | |
| | Research and development | | | 2.3 | | | | 3.1 | | | | 2.7 | |
| | Sales and marketing | | | 12.6 | | | | 13.8 | | | | 16.4 | |
| | General and administrative | | | 3.1 | | | | 3.4 | | | | 3.0 | |
| | Goodwill amortization | | | 0.2 | | | | — | | | | — | |
| | Amortization of deferred stock-based compensation: | | | | | | | | | | | | |
| | | Research and development | | | — | | | | 0.1 | | | | 0.1 | |
| | | Sales and marketing | | | — | | | | 0.1 | | | | 0.2 | |
| | | General and administrative | | | — | | | | 0.4 | | | | 0.2 | |
| | | |
| | | |
| | | |
| |
| | | | Total operating expenses | | | 18.2 | | | | 20.9 | | | | 22.6 | |
| | | |
| | | |
| | | |
| |
| Income (loss) from operations | | | (8.0 | ) | | | 4.5 | | | | 5.4 | |
| Extinguishment of debt | | | — | | | | — | | | | (2.0 | ) |
| Other income (expense), net | | | (0.5 | ) | | | (0.5 | ) | | | (0.2 | ) |
| | | |
| | | |
| | | |
| |
| Income (loss) before taxes | | | (8.5 | ) | | | 4.0 | | | | 3.2 | |
| Provision (benefit) for income taxes | | | 1.6 | | | | 0.6 | | | | (1.2 | ) |
| | | |
| | | |
| | | |
| |
| Net income (loss) | | | (10.1 | )% | | | 3.4 | % | | | 4.4 | % |
| | | |
| | | |
| | | |
| |
| |
| | | | | | | | | | | | | | | | | Year Ended December 31, | | | | | 2004 | | | 2005 | | | 2006 | | | | | Net revenue | | | 100 | % | | | 100 | % | | | 100 | % | | Cost of revenue | | | 67.9 | | | | 66.3 | | | | 66.2 | | | | | | | | | | | | | | | | | Gross margin | | | 32.1 | | | | 33.7 | | | | 33.8 | | | | | | | | | | | | | | | | | Operating expenses: | | | | | | | | | | | | | | Research and development | | | 2.7 | | | | 2.8 | | | | 3.2 | | | Sales and marketing | | | 16.3 | | | | 15.9 | | | | 16.0 | | | General and administrative | | | 3.9 | | | | 3.2 | | | | 3.7 | | | In-process research and development | | | 0.0 | | | | 0.0 | | | | 0.5 | | | Litigation reserves | | | 0.0 | | | | 0.2 | | | | 0.0 | | | | | | | | | | | | | | | | | Total operating expenses | | | 22.9 | | | | 22.1 | | | | 23.4 | | | | | | | | | | | | | | | | | Income from operations | | | 9.2 | | | | 11.6 | | | | 10.4 | | | Interest income | | | 0.4 | | | | 0.9 | | | | 1.2 | | | Other income (expense), net | | | (0.1 | ) | | | (0.4 | ) | | | 0.4 | | | | | | | | | | | | | | | | | Income before income taxes | | | 9.5 | | | | 12.1 | | | | 12.0 | | | Provision for income taxes | | | 3.4 | | | | 4.6 | | | | 4.8 | | | | | | | | | | | | | | | | | Net income | | | 6.1 | % | | | 7.5 | % | | | 7.2 | % | | | | | | | | | | | | | | |
Net Revenue | | | | | | | | | | | | | | | | | | | | | | | | | Year Ended December 31, | | | | | | | | Percentage
| | | | | | Percentage
| | | | | | | | 2004 | | | Change | | | 2005 | | | Change | | | 2006 | | | | | (In thousands, except percentage data) | | | | | Net revenue | | $ | 383,139 | | | | 17.3 | % | | $ | 449,610 | | | | 27.6 | % | | $ | 573,570 | |
Our net revenue consists of gross product shipments, less allowances for estimated returns for stock rotation and warranty, price protection and sales incentives deemed to be a reduction of net revenue per EITF IssueNo. 01-9 and net changes in deferred revenue. Sales incentives include advertising, cooperative marketing programs, end-caps, instant rebates and mail-in rebates.
| Year Ended December 31, 2003 Compared to Year Ended December 31, 2002 |
2006 Net Revenue Compared to 2005 Net Revenue
Net revenue increased $62.0$124.0 million, or 26%27.6%, to $299.3$573.6 million for the year ended December 31, 2003,2006, from $237.3$449.6 million for the year ended December 31, 2002.2005. We continued to experience our seasonal pattern of higher net revenues in the second half of the year. The increase in revenue was especially attributable to higher sales of DSL gateway and powerline products to new and existing service provider customers, especially in Europe. The majority of these incremental sales specifically included our wireless gateway customized for major service provider British Sky Broadcasting in the United Kingdom, with shipments of wireless gateways and powerline products to other service providers further improving revenue.
Sales were further enhanced by the first full year of RangeMax wireless router sales to the home market. We introduced our RangeMax family of products, which included performance-enhancing Multiple-In Multiple-Out (MIMO) technology, during 2005, and the market has continued to embrace this key product line throughout the year. We expect the RangeMax family to remain strong in the coming year, and anticipate continuing our recent trend of increased sales of customized wireless gateways to service providers, both domestically and abroad. We
30
also anticipate new products such as our wireless-N routers, Skype wi-fi phones, and Gigabit smart switches to drive revenue in the near future.
Sales incentives that are classified as contra-revenue grew at a slower rate than overall gross sales, which further contributed to the increased net revenue. This increase wasis primarily due to an increase in gross shipments of our existing products andincreased sales to the introduction of various new products that were favorably received by customers. In particular,service provider markets, which typically require less marketing spending. This favorable net revenue in the EMEA region grew by $31.4 million or 46%, year over year. This increaseimpact was partially offset by a $14.1 millionan increase in rebatessales returns compared to historical return rates.
For the year ended December 31, 2006 revenue generated in the United States, EMEA and cooperative marketing costs primarily, in North America, associated with increased product sales. NetAsia Pacific and rest of world was 38.4%, 52.0% and 9.6%, respectively. The comparable net revenue for the yearsyear ended December 31, 20022005 was 44.3%, 44.5% and 200311.2%, respectively. The increase in net revenue over the prior year for each region was reduced for cooperative marketing expenses in the amount of $15.4 million10.7%, 49.2% and $23.5 million, respectively, deemed8.8%, respectively.
2005 Net Revenue Compared to be sales incentives under Emerging Issues Task Force (“EITF”) 01-9. Cost of2004 Net Revenue and Gross Margin
Cost of
Net revenue increased $38.3$66.5 million, or 22%17.3%, to $215.5$449.6 million for the year ended December 31, 20032005, from $177.1$383.1 million for the year ended December 31, 2002. Our2004. We continued to experience our seasonal pattern of higher net revenues in the second half of the year. The increase in revenue was especially attributable to higher sales of wireless LAN products to the home market, especially the new RangeMax family of products and continued strength in G and Super-G products, as well as increased gross margin improvedshipments of our broadband gateways. These revenue increases were partially offset by increases in allowances for sales incentives associated with increased retail product sales.
We were able to 28.0%slow down the pace of erosion in our average selling prices on our relatively older products in 2005 in part due to our new “minimum advertised price” policy with our U.S. retailers, as well as a general slowdown in competitive pricing pressures.
End-user customer rebates and other sales incentives which are classified as reductions in net revenue increased in 2005, especially in the latter half of 2005 when we took advantage of significant strategic joint promotion opportunities with our biggest retail partners both in the U.S. and in Europe. For example, we co-marketed our new RangeMax family of products with U.S. national retailers using a unified advertising campaign involving ad circulars and new end-cap displays. These increases in spending combined with higher use of end-user customer rebates impacted our revenue growth.
For the year ended December 31, 2005 revenue generated in the United States, EMEA and Asia Pacific and rest of world was 44.3%, 44.5% and 11.2%, respectively. The comparable net revenue for the year ended December 31, 2003,2004 was 48.8%, 41.6% and 9.6%, respectively. The increase in net revenue over the prior year for each region was 6.6%, 25.3% and 37.5%, respectively.
Cost of Revenue and Gross Margin
| | | | | | | | | | | | | | | | | | | | | |
| | | Year Ended December 31, | |
| | | | | | Percentage
| | | | | | Percentage
| | | | |
| | | 2004 | | | Change | | | 2005 | | | Change | | | 2006 | |
| | | | | | (In thousands, except percentage data) | |
| |
| Cost of revenue | | $ | 260,318 | | | | 14.4 | % | | $ | 297,911 | | | | 27.5 | % | | $ | 379,911 | |
| Gross margin percentage | | | 32.1 | % | | | | | | | 33.7 | % | | | | | | | 33.8 | % |
Cost of revenue consists primarily of the following: the cost of finished products from 25.4%our third-party contract manufacturers; overhead costs including purchasing, product planning, inventory control, warehousing and distribution logistics; inbound freight; and warranty costs associated with returned goods and write-downs for excess and obsolete inventory. We outsource our manufacturing, warehousing and distribution logistics. We believe this outsourcing strategy allows us to better manage our product costs and gross margin. Our gross margin can be affected by a number of factors, including sales returns, changes in net revenues due to changes in average selling prices, sales incentives, and changes in our cost of goods sold due to fluctuations in prices paid for components, net
31
of vendor rebates, warranty and overhead costs, inbound freight, conversion costs, and charges for excess or obsolete inventory and transitions from older to newer products.
Cost of revenue increased $82.0 million, or 27.5%, to $379.9 million for the year ended December 31, 2002. The improvement in2006, from $297.9 million for the year ended December 31, 2005. Our gross margin improved to 33.8% for the year ended December 31, 2006, from 33.7% for the year ended December 31, 2005.
Our gross margin is impacted by our sales incentives that are recorded as a reduction in revenue which grew at a relatively slower rate than overall net revenue, as most of our revenue increases relate to sales to service providers, which involve significantly lower sales incentive expenses. Additionally, we experienced decreased price protection claims, as well as relatively lower inbound freight during the year, as we were able to shift the mix of inbound shipments from our suppliers from more costly air freight to lower cost sea freight due to better supply chain planning. Furthermore, rebates from vendors were significantly higher in 2006. While we do not expect this higher level of rebates to continue in the future, we anticipate lower costs on these products.
These improvements were almost entirely offset by a number of factors. Incremental sales in 2006 came primarily from increased sales of products carrying lower gross margins to service providers. We also experienced increased warranty and sales returns costs, driven primarily by a higher scrap rate of warranty return units and an increase in reserves taken for future returns based on the increase in returns volume during the year. We also experienced higher costs related to inventory reserves and devaluation.
Additionally, stock-based compensation expense increased $283,000 to $430,000 for the year ended December 31, 2006, from $147,000 for the year ended December 31, 2005, as a result of the adoption of Statement of Financial Accounting Standards (“SFAS”) No. 123 (revised 2004), “Share-Based Payment” (“SFAS 123R”).
Cost of revenue increased $37.6 million, or 14.4%, to $297.9 million for the year ended December 31, 2005 from $260.3 million for the year ended December 31, 2004. Our gross margin improved to 33.7% for the year ended December 31, 2005, from 32.1% for the year ended December 31, 2004, an increase of 1.6 percentage points. This increase was due primarily due to a favorable shift in product mix especiallyand our product costs decreasing relatively more quickly than sales prices, offset by an increase in end-user customer rebates and other sales incentives, which reduce revenue along with increased inbound freight and conversion costs.
We were able to slow down the pace of newererosion in our average selling prices on our relatively older products which often carry higher gross margins,in 2005 in part due to our new “minimum advertised price” policy with our U.S. retailers, as well as duea general slowdown in competitive pricing pressures. We have also had continued success in obtaining cost reductions and efficiencies from our vendors and manufacturers, and have pursued product redesigns when appropriate to operational efficiencyfurther lower production costs. These decreasing costs, coupled with the relative slowing in the decrease of average selling prices, boosted margins on our older products, especially our G and supply chain management programs thatSuper G wireless adapters. Additionally, we have benefited from relatively higher standard margins on newer products, especially from our RangeMax family of products.
It is difficult to accurately forecast demand for our products across our markets and within specific countries. The shift in the mix of actual orders compared to forecasted demand resulted in a higher than normal reliance on more expensive air versus surface freight during the last quarter of 2005 as well as higher rework and other costs primarily related to product conversions among country-specific packaging.
Additionally, stock-based compensation expense decreased $16,000 to $147,000 for the year ended December 31, 2005, from $163,000 for the year ended December 31, 2004.
32
23
reduced inbound freight costs by $2.1 million and excess and absolute inventory charges by approximately $4.4 million. Furthermore, we were able to negotiate better pricing with our contract manufacturers and chip vendors due to increased volumes.
Research and development.development expense
| | | | | | | | | | | | | | | | | | | | | |
| | | Year Ended December 31, | |
| | | | | | Percentage
| | | | | | Percentage
| | | | |
| | | 2004 | | | Change | | | 2005 | | | Change | | | 2006 | |
| | | | | | (In thousands, except percentage data) | | | | |
| |
| Research and development expense | | $ | 10,316 | | | | 24.4 | % | | $ | 12,837 | | | | 43.7 | % | | $ | 18,443 | |
| Percentage of net revenue | | | 2.7 | % | | | | | | | 2.8 | % | | | | | | | 3.2 | % |
Research and development expenses consist primarily of personnel expenses, payments to suppliers for design services, tooling design costs, safety and regulatory testing, product certification expenditures to qualify our products for sale into specific markets, prototypes and other consulting fees. Research and development expenses are recognized as they are incurred. We have invested in building our research and development organization to enhance our ability to introduce innovative and easy to use products. We expect to continue to add additional employees in our research and development department. In the future we believe that research and development expenses will increase in absolute dollars as we expand into new product technologies, enhance theease-of-use of our products, and broaden our core competencies.
Research and development expenses increased $861,000,$5.6 million, or 12%43.7%, to $8.2$18.4 million for the year ended December 31, 2003,2006, from $7.4$12.8 million for the year ended December 31, 2002.2005. The increase was primarily due to higher salary and related payroll expenses of $2.1 million resulting from research and development related headcount growth, including $486,000 related to retention bonuses for certain employees associated with the acquisition of SkipJam. Employee headcount increased by 15% to 62 employees as of December 31, 2006 as compared to 54 employees as of December 31, 2005, in part due to employees obtained from the acquisition of SkipJam. The increase was also attributable to an increase of $2.1 million in engineering costs. These costs were incurred to improve the quality of our small business products. Additionally, stock-based compensation expense increased $826,000 to $1.1 million for the year ended December 31, 2006, from $293,000 for the year ended December 31, 2005, as a result of the adoption of SFAS 123R.
Research and development expenses increased $2.5 million, or 24.4%, to $12.8 million for the year ended December 31, 2005, from $10.3 million for the year ended December 31, 2004. The increase was primarily due to increased
salary and payroll related expenses of $2.4 million resulting from research and development related headcount
growth. Employee headcount increased by 35% to 54 employees as of December 31, 2005 as compared to 40 employees as of December 31, 2004. These headcount increases were primarily due to the expansion of our research and
salary increasesdevelopment facility in Taiwan and expansion of our focus on the broadband service provider market which often requires additional certifications and testing. Additionally, stock-based compensation expense decreased $107,000 to $293,000 for
existing employees of $1.3 million, general overhead increases of approximately $336,000 offset by $830,000 in lower product development costs, which include product certification costs.the year ended December 31, 2005, from $400,000 for the year ended December 31, 2004.
Sales and marketing.marketing expense
| | | | | | | | | | | | | | | | | | | | | |
| | | Year Ended December 31, | |
| | | | | | Percentage
| | | | | | Percentage
| | | | |
| | | 2004 | | | Change | | | 2005 | | | Change | | | 2006 | |
| | | (In thousands, except percentage data) | |
| |
| Sales and marketing expense | | $ | 62,247 | | | | 14.6 | % | | $ | 71,345 | | | | 28.8 | % | | $ | 91,881 | |
| Percentage of net revenue | | | 16.3 | % | | | | | | | 15.9 | % | | | | | | | 16.0 | % |
Sales and marketing expenses consist primarily of advertising, trade shows, corporate communications and other marketing expenses, product marketing expenses, outbound freight costs, personnel expenses for sales and marketing staff and technical support expenses. We believe that maintaining and building brand awareness is key to both net revenue growth and maintaining our gross margin. We also believe that maintaining widely available and high quality technical support is key to building and maintaining brand awareness. Accordingly, we expect sales and marketing expenses to increase in absolute dollars in the future, related to the planned growth of our business.
33
Sales and marketing expenses increased
$16.3$20.6 million, or
50%28.8%, to
$49.0$91.9 million for the year ended December 31,
2003,2006, from
$32.6$71.3 million for the year ended December 31,
2002. This2005. We note that sales and marketing expenses grew in line with revenue growth. Of this increase, $9.4 million was
primarily due to
(i) $3.9 million in increased
salary and payroll related expenses
related to the additionas a result of sales and marketing
personnelrelated headcount growth and
salary increasesincreased commissions earned in EMEA due to substantial revenue growth. Employee headcount increased from 157 employees as of December 31, 2005 to 207 employees as of December 31, 2006. More specifically, 46 of the 50 incremental employees relate to expansion in EMEA and Asia Pacific, which represents our continued geographic expansion and increasing sales staffing in these regions. For example, we established a Technical Support Center in our Ireland office, which accounted for
existing employees; (ii) increased sales volume, product promotion, advertising7 new individuals. Outside service fees related to customer service and
outside technical support
also increased by $4.9 million, in support of higher call volumes related to increased units sold. We also incurred a $1.7 million increase in advertising, travel, and promotion expenses
related to our expansion of
$9.8 million;marketing activities into new geographies. Outbound freight increased $1.6 million, reflecting our higher sales volume. Marketing costs classified as operating expenses remained relatively constant, as the majority of incremental marketing expenses related to rebates and
(iii) freight out charges of $1.5 million. Furthermore, we incurred additional costs associated with entering new and expanding our presence in markets suchother items classified as
China, Italy, Japan, Spain and Sweden.General and administrative. General and administrative expensescontra-revenue. Additionally, stock-based compensation expense increased $874,000, or 11%$1.0 million to $9.0$1.4 million for the year ended December 31, 2003,2006, from $8.1$375,000 for the year ended December 31, 2005, as a result of the adoption of SFAS 123R.
Sales and marketing expenses increased $9.1 million, or 14.6%, to $71.3 million for the year ended December 31,
2002. The increase was primarily attributable to an increase in cost associated with operating as a public company, including increased directors and officers insurance of $550,000 and professional services of $478,000, comprised of systems consulting, accounting and legal fees. This increase was offset by reduced payroll expenses of approximately $220,000 mainly as a result of lower bonus payments.Goodwill amortization. Goodwill amortization expense was zero2005, from $62.2 million for the year ended December 31, 20032004. Of this increase, $5.1 million was due to product promotion, including intensified in-store staffing and 2002. Theretraining programs, advertising, and outside technical support expenses, all in support of increased volume. In addition, salary and related expenses for additional sales and marketing personnel increased by $2.7 million as a result of sales and marketing related headcount growth from 125 employees as of December 31, 2004 to 157 employees as of December 31, 2005. We attributed 28 of the 32 incremental employee additions to expansion in EMEA and Asia Pacific, where sales and marketing employee headcount grew 46% and 35%, respectively. The increase was no impairment charge that management believed necessary inalso attributable to additional allocated overhead costs such as facilities and information systems costs amounting to $851,000, which reflects sales and marketing’s larger relative headcount growth rate and correspondingly higher share of overhead costs. Additionally, stock-based compensation expense decreased $358,000 to $375,000 for the yearsyear ended December 31, 20022005, from $733,000 for the year ended December 31, 2004.
General and 2003.administrative expense
| | | | | | | | | | | | | | | | | | | | | |
| | | Year Ended December 31, | |
| | | | | | Percentage
| | | | | | Percentage
| | | | |
| | | 2004 | | | Change | | | 2005 | | | Change | | | 2006 | |
| | | (In thousands, except percentage data) | |
| |
| General and administrative expense | | $ | 14,905 | | | | −2.3 | % | | $ | 14,559 | | | | 43.6 | % | | $ | 20,905 | |
| Percentage of net revenue | | | 3.9 | % | | | | | | | 3.2 | % | | | | | | | 3.7 | % |
General and administrative expenses consist of salaries and related expenses for executive, finance and accounting, human resources, professional fees, allowance for bad debts, and other corporate expenses. We expect general and administrative costs to increase in absolute dollars related to the general growth of the business, continued international expansion, and increased investments in infrastructure such as a new enterprise resource planning system.
General and administrative expenses increased $6.3 million, or 43.6%, to $20.9 million for the year ended December 31, 2006, from $14.6 million for the year ended December 31, 2005. The increase was primarily due to higher salary and payroll related expenses of $3.3 million due to an increase in general and administrative related headcount. Employee headcount increased by 25% to 66 employees as of December 31, 2006 compared to 53 employees as of December 31, 2005. Of the incremental 13 additions, 8 personnel were hired into accounting and finance departments in our new Ireland office. We also incurred a $1.4 million increase in fees for outside professional services, which was in part related to an increase in IT consulting costs, tax consulting and general legal expenses. Additionally, stock-based compensation expense increased approximately $1.4 million to $1.6 million for the year ended December 31, 2006, from $249,000 for the year ended December 31, 2005, as a result of the adoption of SFAS 123R.
34
Amortization
General and administrative expenses decreased approximately $300,000, or 2.3%, to $14.6 million for the year ended December 31, 2005, from $14.9 million for the year ended December 31, 2004. This decrease was primarily due to a decrease in fees for professional services aggregating $1.7 million and a decrease in net allocated overhead such as information systems costs aggregating $588,000, offset by an increase in employee related costs of deferred$2.1 million. The decrease in fees for professional services resulted from decreases in consulting, outsourced accounting fees and legal fees, and costs associated with initial Sarbanes-Oxley 404 compliance documentation in 2004. The increase in employee related costs resulted from an increase in general and administrative related headcount, particularly in the finance area to support an increase in transactional processing due to increased revenue. Employee headcount increased by 43% to 53 employees as of December 31, 2005 as compared to 37 employees as of December 31, 2004. The decrease in net allocated overhead reflects the general and administrative function’s slower headcount growth rate relative to other functional areas. Additionally, stock-based compensation.compensation expense decreased $142,000 to $249,000 for the year ended December 31, 2005, from $391,000 for the year ended December 31, 2004.
In-process research and development
During the year ended December 31, 2003,2006, we recorded amortization of deferred stock-based compensation of $128,000 in cost of revenue, $454,000 inexpensed $2.9 million for in-process research and development expenses, $715,000related to intangible assets purchased in salesour acquisition of SkipJam. See Note 2 of the Notes to the Consolidated Financial Statements for additional information regarding the acquisition. In-process R&D is expensed upon an acquisition because technological feasibility has not been established and marketing expenses,no future alternative uses exist. We acquired only one in-process R&D project, which is related to the development of a multimedia product that had not reached technological feasibility and $476,000had no alternative use. We incurred costs of approximately $725,000 to complete the project, of which approximately $575,000 was incurred through December 31, 2006. We completed the project in generalFebruary 2007.
Litigation reserves
During the year ended December 31, 2005, we recorded an allowance of $802,000 for the estimated costs of settlement for theZilberman v. NETGEAR lawsuit. The lawsuit was settled on May 26, 2006, and administrative expenses. This compared to $144,000 in cost of revenue, $306,000 in research and development expenses, $346,000 in sales and marketing expenses and $867,000 in general and administrative expensesno material additional costs were incurred. No litigation reserves were recorded in the year ended December 31, 2002.2006.
Interest income and other income (expense)
| | | | | | | | | | | | | |
| | | Year Ended December 31, | |
| | | 2004 | | | 2005 | | | 2006 | |
| | | | | | (In thousands) | | | | |
| |
| Interest income | | $ | 1,593 | | | $ | 4,104 | | | $ | 6,974 | |
| Other income (expense), net | | | (560 | ) | | | (1,770 | ) | | | 2,495 | |
| | | | | | | | | | | | | |
| Total interest income and other income (expense) | | $ | 1,033 | | | $ | 2,334 | | | $ | 9,469 | |
| | | | | | | | | | | | | |
Interest income represents amounts earned on our cash, cash equivalents and short-term investments.
Other income (expense), net, primarily represents gains and losses on transactions denominated in foreign currencies and other miscellaneous expenses.
Interest income increased $2.9 million, or 69.9%, to $7.0 million for the year ended December 31, 2006, from $4.1 million for the year ended December 31, 2005. The remaining balanceincrease in interest income was a result of deferred stock-based compensationan increase in the average interest rate earned.
Other income (expense), net, increased to income of $4.2$2.5 million will continuefor the year ended December 31, 2006, from an expense of $1.8 million for the year ended December 31, 2005. The income of $2.5 million was primarily attributable to be amortized on a straight line basis until 2007.net foreign exchange gain experienced in the year ended December 31, 2006 due to the weakening of the U.S. dollar against the Euro, the Great Britain Pound, and the Australian Dollar. The expense of $1.8 million in the year ended December 31, 2005 was primarily attributable to a net foreign exchange loss experienced due to the strengthening of the U.S. dollar against the Euro, Great Britain Pound and the Australian Dollar.
35
Interest Income, Interest Expense and Other Income (Expense), Net
The aggregate of interest income, interest expense, and other
expense amounted to net other income
(expense), net, decreased $544,000, to a net expense of
$596,000 for the year ended December 31, 2003, from a net expense of $1.1$2.3 million for the year ended December 31,
2002. This decrease was attributable2005, compared to
increased interestnet other income of
$245,000 due to an increase in the average cash balance. Additionally, interest expense was reduced by $339,000 following the repayment of the Nortel Note. Extinguishment of Debt
During the year ended December 31, 2003 we used $20.0 million of the initial public offering proceeds, to repay debt that had a carrying value of $14.1 million. The repayment of debt resulted in the recognition of an extinguishment of debt charge of $5.9 million in the third quarter of 2003 due to the acceleration of interest expense equal to the unamortized discounted balance at the date of repayment.
24
Provision (Benefit) for Income Taxes
We recorded a benefit for income taxes of $3.5$1.0 million for the year ended December 31, 2003, compared2004. This change was primarily due to a provisionan additional $2.5 million in interest income for the year ended December 31, 2005, from the investment of our cash, cash equivalents, and short-term investments balance throughout the year. This was offset in part by an increase in other expense of $1.2 million consisting primarily of realized and unrealized losses associated with foreign currency denominated transactions due in part to currency volatility during the year as well as our billing in foreign currencies which began in the first quarter of 2005.
Provision for Income Taxes
Provision for income taxes
increased $7.0 million, resulting in a provision of
$1.3$27.9 million for the year ended December 31,
2002. This benefit was primarily due to the reversal2006, from a provision of
the valuation allowance against our deferred tax assets of $9.8 million recorded in the second quarter of 2003. The valuation allowance was reversed because we determined that it is more likely than not that certain future tax benefits will be realized. This benefit was partially offset by an increase in tax of $2.6 million for debt extinguishment, which is treated as a permanent non-deductible expense for tax purposes. The year ended December 31, 2002 included a benefit associated with the change to valuation allowance on deferred tax assets of $3.8 million, arising from, among other factors, the utilization of net operating loss tax carry forwards. Net Income
Net income increased $5.0 million, to $13.1$20.9 million for the year ended December 31, 20032005. The effective tax rate was approximately 40% for the year ended December 31, 2006 and approximately 38% for the year ended December 31, 2005. The effective tax rate for both periods differed from $8.1our statutory rate of approximately 35% due to non-deductible stock-based compensation, state taxes, other non-deductible expenses, and tax credits. The effective tax rate for the year ended December 31, 2006 was also impacted by non-deductible charges pertaining to in-process research and development as a result of the acquisition of SkipJam.
Provision for income taxes increased $8.0 million, to a provision of $20.9 million for the year ended December 31, 2002.2005, from a provision of $12.9 million for the year ended December 31, 2004. The effective tax rate for the year ended December 31, 2005 was approximately 38% and differed from our statutory rate of approximately 35% due to state taxes, and other non-deductible expenses, offset in part by tax credits. The effective tax rate for the year ended December 31, 2004 was approximately 36% and differed from our statutory rate of approximately 35% due to non-deductible stock-based compensation, state taxes, and other non-deductible expenses, offset in part by a $1.5 million tax benefit from exercises of stock options and tax credits.
Net Income
Net income increased $7.5 million, to $41.1 million for the year ended December 31, 2006 from $33.6 million for the year ended December 31, 2005. This increase was due to an increase in gross profit of $23.6$42.0 million a benefitand an increase in theinterest and other income tax provision of $4.9$7.1 million, offset by a charge for the extinguishment of debt, related to a note payable to Nortel Networks, of $5.9 million and an increase in operating expenses of $18.2$34.6 million and an increase in provision for income taxes of $7.0 million.
| |
| Year Ended December 31, 2002 Compared to Year Ended December 31, 2001 |
Net
Revenue Net revenueincome increased $44.9$10.1 million, or 23%, to $237.3$33.6 million for the year ended December 31, 2002,2005 from $192.4$23.5 million for the year ended December 31, 2001.2004. This increase was primarily due to an increase in gross shipments associated with the introduction of new wireless LAN and broadband gateway products such as our 802.11b Wireless PC Card NIC and our Cable/ DSL Web Safe Gateway during 2002, partially offset by an increase in rebates and cooperative marketing costs of $9.2 million associated with increased retail product sales. Net revenue for years ended December 31, 2001 and 2002 was reduced for cooperative marketing expenses in the amount of $10.3 million and $15.4 million, respectively, deemed to be sales incentives under Emerging Issues Task Force Issue (“EITF”) 01-9. The adoption of EITF Issue 01-9 did not have an impact on net income because there was a corresponding reduction in sales and marketing expenses.
Cost of Revenue and Gross Margin
Cost of revenue increased $4.3 million, or 2%, to $177.1 million for the year ended December 31, 2002 from $172.8 million for the year ended December 31, 2001. However, our gross margin improved to 25.4% for the year ended December 31, 2002, from 10.2% for the year ended December 31, 2001. This improvement in gross margin was due primarily to operational efficiency programs we implemented that led to a reduction in both the average material cost per product and the level of price protection expenses paid to our channel partners. This improvement in gross margin was partially offset by an increase in air freight expenses.
Operating Expenses
Research and development. Research and development expenses increased $2.9 million, or 66%, to $7.4 million for the year ended December 31, 2002, from $4.4 million for the year ended December 31, 2001. This increase was primarily due to increased headcount and salary increases for existing employees of $1.8 million, an increase in costs associated with outsourced engineering of $1.3 million, and an increase in certification expenses paid to third parties of $440,000. These increases were offset by the absence in 2002 of a charge of $645,000 associated with the discontinuation of a product development project in 2001.
Sales and marketing. Sales and marketing expenses increased $8.4 million, or 34%, to $32.6 million for the year ended December 31, 2002, from $24.3 million for the year ended December 31, 2001. This increase was primarily due to increased salary and related expenses for additional sales and marketing personnel and
25
increased compensation for existing personnel of $4.8 million, and increased product promotion, advertising and outside technical support expenses of $3.6 million.
General and administrative. General and administrative expenses increased $2.2 million, or 37%, to $8.1 million for the year ended December 31, 2002, from $5.9 million for the year ended December 31, 2001. This increase was primarily due to increased salary expenses of $1.6 million for additional employees and increased compensation expenses for existing personnel, and $285,000 related to depreciation expense and bad debt allowance.
Goodwill amortization. Goodwill amortization expenses decreased to zero for the year ended December 31, 2002, from $335,000 for the year ended December 31, 2001 due to the discontinuation of goodwill amortization under SFAS 142 effective January 1, 2002.
Amortization of deferred stock-based compensation. During the year ended December 31, 2002, we recorded amortization of deferred stock-based compensation in cost of revenue of $144,000, $306,000 in research and development expenses, $346,000 in sales and marketing expenses, and $867,000 in general and administrative expenses.
Other Income (Expense), Net
Other expense, net remained approximately the same at $1.1 million for both the year’s ended December 31, 2002 and 2001. During these periods, an increase in interest expense of $301,000 primarily due to imputed interest associated with the Nortel note payable offset by a reduction in foreign exchange losses of $470,000 due to a decline in the value of the Japanese yen and other foreign currencies as compared to the United States dollar.
Provision for Income Taxes
Provision for income taxes decreased by $1.7 million from $3.1 million for the year ended December 31, 2001 to $1.3 million for the year ended December 31, 2002. This decrease occurred because we were able to reduce taxable income by utilizing almost all of our approximately $7.7 million of federal net operating loss carry forwards.
Net Income (Loss)
Net income was $8.1 million in 2002 versus a net loss of $19.5 million in 2001. This improvement of $27.6 million was due to an increase in gross profit of $40.6$28.9 million, offset by an increase in operating expenses of $14.7 million. Net income was also higher in 2002 due to a reduction$12.0 million and an increase in provision for income taxes of $1.7$8.0 million.
26
Selected Quarterly Results
The following tables set forth our unaudited consolidated results of operations for each of our last eight quarters in dollars and as a percentage of our net revenue. In the opinion of our management, this unaudited quarterly information has been prepared on a basis consistent with our audited financial statements and includes all adjustments, consisting of normal and recurring adjustments, that management considers necessary for a fair presentation of the data. These quarterly results are not necessarily indicative of future quarterly patterns or future patterns or results. This information should be read in conjunction with our financial statements and the related notes included elsewhere in this Form 10-K.
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| | Three Months Ended (unaudited) |
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| | March 31, | | June 30, | | Sept 29, | | Dec 31, | | March 30, | | June 29, | | Sept 28, | | Dec 31, |
| | 2002 | | 2002 | | 2002 | | 2002 | | 2003 | | 2003 | | 2003 | | 2003 |
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| | (in thousands, except per share data) |
| Net revenue | | $ | 45,528 | | | $ | 55,538 | | | $ | 64,362 | | | $ | 71,903 | | | $ | 67,706 | | | $ | 69,003 | | | $ | 75,785 | | | $ | 86,808 | |
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| Cost of revenue: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Cost of revenue | | | 34,685 | | | | 41,326 | | | | 48,188 | | | | 52,773 | | | | 49,246 | | | | 49,889 | | | | 54,691 | | | | 61,506 | |
| | Amortization (recovery) of deferred stock-based compensation | | | 66 | | | | 20 | | | | 22 | | | | 36 | | | | (11 | ) | | | 42 | | | | 46 | | | | 51 | |
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| | | | Total cost of revenue | | | 34,751 | | | | 41,346 | | | | 48,210 | | | | 52,809 | | | | 49,235 | | | | 49,931 | | | | 54,737 | | | | 61,557 | |
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| Gross profit | | | 10,777 | | | | 14,192 | | | | 16,152 | | | | 19,094 | | | | 18,471 | | | | 19,072 | | | | 21,048 | | | | 25,251 | |
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| Operating expenses: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Research and development | | | 894 | | | | 1,606 | | | | 2,378 | | | | 2,481 | | | | 2,016 | | | | 1,882 | | | | 2,079 | | | | 2,243 | |
| | Sales and marketing | | | 7,180 | | | | 7,809 | | | | 8,456 | | | | 9,177 | | | | 10,961 | | | | 11,706 | | | | 12,419 | | | | 13,877 | |
| | General and administrative | | | 1,528 | | | | 2,024 | | | | 2,113 | | | | 2,438 | | | | 1,902 | | | | 1,779 | | | | 2,356 | | | | 2,940 | |
| | Amortization of deferred stock-based compensation: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | Research and development | | | 143 | | | | 37 | | | | 51 | | | | 75 | | | | 96 | | | | 103 | | | | 135 | | | | 120 | |
| | | Sales and marketing | | | 143 | | | | 45 | | | | 59 | | | | 99 | | | | 109 | | | | 179 | | | | 227 | | | | 200 | |
| | | General and administrative | | | 200 | | | | 167 | | | | 130 | | | | 370 | | | | 151 | | | | 98 | | | | 108 | | | | 119 | |
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| | | | Total operating expenses | | | 10,088 | | | | 11,688 | | | | 13,187 | | | | 14,640 | | | | 15,235 | | | | 15,747 | | | | 17,324 | | | | 19,499 | |
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| Income from operations | | | 689 | | | | 2,504 | | | | 2,965 | | | | 4,454 | | | | 3,236 | | | | 3,325 | | | | 3,724 | | | | 5,752 | |
| Extinguishment of debt | | | — | | | | — | | | | — | | | | — | | | | — | | | | — | | | | (5,868 | ) | | | — | |
| Other income (expense), net | | | (65 | ) | | | (373 | ) | | | (234 | ) | | | (468 | ) | | | (411 | ) | | | (217 | ) | | | (142 | ) | | | 174 | |
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| Income (loss) before taxes | | | 624 | | | | 2,131 | | | | 2,731 | | | | 3,986 | | | | 2,825 | | | | 3,108 | | | | (2,286 | ) | | | 5,926 | |
| Provision for (benefit from) income taxes | | | 87 | | | | 299 | | | | 385 | | | | 562 | | | | 1,213 | | | | (8,395 | ) | | | 1,664 | | | | 1,994 | |
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| Net income (loss) | | | 537 | | | | 1,832 | | | | 2,346 | | | | 3,424 | | | | 1,612 | | | | 11,503 | | | | (3,950 | ) | | | 3,932 | |
| Deemed dividend on Preferred Stock | | | (17,881 | ) | | | — | | | | — | | | | — | | | | — | | | | — | | | | — | | | | — | |
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| Net income (loss) attributable to common stockholders | | $ | (17,344 | ) | | $ | 1,832 | | | $ | 2,346 | | | $ | 3,424 | | | $ | 1,612 | | | $ | 11,503 | | | $ | (3,950 | ) | | $ | 3,932 | |
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| Net income (loss) per share attributable to common stockholders: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Basic | | $ | (0.72 | ) | | $ | 0.09 | | | $ | 0.12 | | | $ | 0.17 | | | $ | 0.08 | | | $ | 0.57 | | | $ | (0.15 | ) | | $ | 0.14 | |
| Diluted | | $ | (0.72 | ) | | $ | 0.09 | | | $ | 0.10 | | | $ | 0.15 | | | $ | 0.07 | | | $ | 0.48 | | | $ | (0.15 | ) | | $ | 0.12 | |
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| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
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| | As a Percentage of Net Revenue |
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|
| | March 31, | | June 30, | | Sept 29, | | Dec 31, | | March 30, | | June 29, | | Sept 28, | | Dec 31, |
| | 2002 | | 2002 | | 2002 | | 2002 | | 2003 | | 2003 | | 2003 | | 2003 |
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| Net revenue | | | 100.0 | % | | | 100.0 | % | | | 100.0 | % | | | 100.0 | % | | | 100.0 | % | | | 100.0 | % | | | 100.0 | % | | | 100.0 | % |
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| Cost of revenue: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Cost of revenue | | | 76.2 | | | | 74.4 | | | | 74.9 | | | | 73.4 | | | | 72.7 | | | | 72.3 | | | | 72.2 | | | | 70.9 | |
| Amortization (recovery) of deferred stock-based compensation | | | 0.1 | | | | 0.0 | | | | 0.0 | | | | 0.0 | | | | (0.0 | ) | | | 0.1 | | | | 0.0 | | | | 0.0 | |
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| | | | Total cost of revenue | | | 76.3 | | | | 74.4 | | | | 74.9 | | | | 73.4 | | | | 72.7 | | | | 72.4 | | | | 72.2 | | | | 70.9 | |
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| Gross margin | | | 23.7 | | | | 25.6 | | | | 25.1 | | | | 26.6 | | | | 27.3 | | | | 27.6 | | | | 27.8 | | | | 29.1 | |
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| Operating expenses: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Research and development | | | 2.0 | | | | 2.9 | | | | 3.7 | | | | 3.5 | | | | 3.0 | | | | 2.7 | | | | 2.7 | | | | 2.6 | |
| | Sales and marketing | | | 15.8 | | | | 14.1 | | | | 13.1 | | | | 12.8 | | | | 16.2 | | | | 17.0 | | | | 16.4 | | | | 16.0 | |
| | General and administrative | | | 3.4 | | | | 3.6 | | | | 3.3 | | | | 3.4 | | | | 2.8 | | | | 2.6 | | | | 3.1 | | | | 3.4 | |
| | Goodwill amortization | | | — | | | | — | | | | — | | | | — | | | | — | | | | — | | | | — | | | | — | |
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| | Amortization of deferred stock-based compensation | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | Research and development | | | 0.3 | | | | 0.1 | | | | 0.1 | | | | 0.1 | | | | 0.1 | | | | 0.1 | | | | 0.2 | | | | 0.2 | |
| | | Sales and marketing | | | 0.3 | | | | 0.1 | | | | 0.1 | | | | 0.1 | | | | 0.2 | | | | 0.3 | | | | 0.3 | | | | 0.2 | |
| | | General and administrative | | | 0.4 | | | | 0.3 | | | | 0.2 | | | | 0.5 | | | | 0.2 | | | | 0.1 | | | | 0.2 | | | | 0.1 | |
| | | | Total operating expenses | | | 22.2 | | | | 21.1 | | | | 20.5 | | | | 20.4 | | | | 22.5 | | | | 22.8 | | | | 22.9 | | | | 22.5 | |
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| Income from operations | | | 1.5 | | | | 4.5 | | | | 4.6 | | | | 6.2 | | | | 4.8 | | | | 4.8 | | | | 4.9 | | | | 6.6 | |
| Extinguishment of debt | | | — | | | | — | | | | — | | | | — | | | | — | | | | — | | | | (7.8 | ) | | | — | |
| Other income (expense), net | | | (0.1 | ) | | | (0.7 | ) | | | (0.4 | ) | | | (0.6 | ) | | | (0.6 | ) | | | (0.3 | ) | | | (0.1 | ) | | | 0.2 | |
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| Income (loss) before taxes | | | 1.4 | | | | 3.8 | | | | 4.2 | | | | 5.6 | | | | 4.2 | | | | 4.5 | | | | (3.0 | ) | | | 6.8 | |
| Provision for (benefit from) income taxes | | | 0.2 | | | | 0.5 | | | | 0.6 | | | | 0.8 | | | | 1.8 | | | | (12.2 | ) | | | 2.2 | | | | 2.3 | |
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| Net income (loss) | | | 1.2 | % | | | 3.3 | % | | | 3.6 | % | | | 4.8 | % | | | 2.4 | % | | | 16.7 | % | | | (5.2 | )% | | | 4.5 | % |
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Our net revenue increased sequentially in each quarter between the quarter ended March 31, 2002 and the quarter ended December 31, 2003, except for the quarter ended March 30, 2003. The revenue growth was primarily due to the introduction of new products that gained rapid market acceptance, the addition of new retail outlets and increasing penetration of the EMEA market. The sequential decrease in revenue in the quarter ended March 30, 2003 was due to geo-political instability, timing of introduction of products by both us and our competitors, and traditional seasonal demand patterns.
Our gross margin has increased sequentially in each quarter between the quarter ended March 31, 2002 and the quarter ended December 31, 2003, except for a slight decline in the quarter ended September 29, 2002. The increase in gross margin was primarily due to our ability to decrease product costs faster than the decline in average selling prices and the introduction of new products which often carry higher gross margins, partially offset by increases from inbound freight costs. The decrease in gross margin for the quarter ended September 29, 2002 was due primarily to increased cooperative marketing costs and price protection in that quarter.
The amount of research and development expenses increased in the four quarters from the three months ended March 31, 2002, primarily due to additional headcount and salary increases for existing employees, as well as increases in payments to suppliers for design services and certification expenses paid to third parties. Research and development expenses declined slightly in the two quarters ended March 30, 2003 and June 29, 2003 due to reduced certification expenses and a reduction in payments to suppliers for design services. For the two quarters ended September 28, 2003 and December 31, 2003 the expenses again increased due to increased headcount and costs associated with the introduction of new products.
28
The amount of sales and marketing expenses increased in each of the eight quarters starting with the quarter ended March 31, 2002, due to increased product promotion, advertising and outside service expenses associated with growth in revenues, an increase in salary expenses for additional sales and marketing personnel, and compensation expenses for existing personnel. Sales and marketing expenses grew as a percentage of net revenue in the quarter ended March 30 and June 29, 2003 due to increases in headcount and technical support relating to geographic expansion as well as the timing and channel mix of marketing expenditures.
The amount of general and administrative expenses have remained relatively constant during the quarters indicated above with a slight increase in recent quarters due to additional headcount and the associated costs that the company has to bear with becoming public.
LiquidityCritical Accounting Policies and Capital ResourcesEstimates As of December 31, 2003 we had cash, cash equivalents and short-term investments totaling $73.6 million. Short-term investments accounted for $12.4 million of this balance.
Our
cash and cash equivalents balance increased from $19.9 million as of December 31, 2002 to $61.2 million as of December 31, 2003. Operating activities during the year ended December 31, 2003 used $26.4 million, primarily for working capital to support the increaseconsolidated financial statements have been prepared in
our net revenue. Investing activities during the year ended December 31, 2003 used $14.9 million for the purchase of short-term investments and property and equipment. During the year ended December 31, 2003, financing activities provided $82.6 million, primarily resulting from the issuance of common stock in our initial public offering, partially offset by the repayment of a line of credit and the Nortel Note. Our days sales outstanding increased from 55 days as of December 31, 2002 to 81 days as of December 31, 2003. This increase was attributable primarily to channel mixaccordance with accounting principles generally accepted in the fourthUnited States of America. The preparation of these financial statements requires management to make assumptions, judgments and estimates that can have a significant impact on the reported amounts of assets, liabilities, revenues and expenses. We base our estimates on historical experience and on various other assumptions believed to be applicable and reasonable under the circumstances. Actual results could differ significantly from these estimates. These estimates may change as new events occur, as additional information is obtained and as our operating environment changes. On a regular basis we evaluate our assumptions, judgments and estimates and make changes accordingly. We also discuss our critical accounting estimates with the Audit Committee of the Board of Directors. Note 1 of the Notes to Consolidated Financial Statements describes the significant accounting policies used in the preparation of the consolidated financial statements. We have listed below our critical accounting policies which we believe to have the greatest potential impact on our consolidated financial statements. Historically, our assumptions, judgments and estimates relative to our critical accounting policies have not differed materially from actual results.
Revenue Recognition
Revenue from product sales is recognized at the time the product is shipped provided that persuasive evidence of an arrangement exists, title and risk of loss has transferred to the customer, the selling price is fixed or determinable and collection of the related receivable is reasonably assured. Currently, for some of our customers, title passes to the customer upon delivery to the port or country of destination, upon their receipt of the product, or upon the customer’s resale of the product. At the end of each fiscal quarter, we estimate and defer revenue related to product where title has not transferred. The revenue continues to be deferred until such time that title passes to the
26
customer. The amount and timing of
2003 moving more towards retail, which generally has longer payment terms. Our accounts payableour revenue for any period could be materially different if our management made different judgments and payable to related parties, in aggregate, increased from $24.3 million at December 31, 2002 to $30.9 million at December 31, 2003. The increase of $6.6 million isestimates.
Allowances for Product Warranties, Returns due to the timingStock Rotation, Price Protection, Sales Incentives and Doubtful Accounts
Our standard warranty obligation to our direct customers generally provides for a right of
inventory receipts. The shiftreturn of
amounts payable between related party and third party accounts payable of approximately $7.3 million is due to the diversification of our contracting manufacturing base to more vendors. Inventory grew by $14.5 million from $24.8 million at December 31, 2002 to $39.3 million at December 31, 2003, to support increasedany product shipments to customers. The primary areas of growth were approximately, finished goods at $6.7 million, and in-transit inventory at $7.3 million. In the quarter ended December 31, 2003 we experienced inventory turns of approximately 6.3 times, down from approximately 8.5 timesfor a full refund in the quarter ended December 31, 2002.
Our cash balance increased from $9.2 million asevent that such product is not merchantable or is found to be damaged or defective. At the time revenue is recognized, an estimate of December 31, 2001future warranty returns is recorded to $19.9 million as of December 31, 2002. Operating activities during 2002 provided cash of $15.2 million primarily from net income of $8.1 million, non-cash items of $4.2 million and contribution from working capital of $2.8 million. This increase was attributable primarily to an increasereduce revenue in the amount of the expected credit or refund to be provided to the our direct customers. At the time we record the reduction to revenue related to warranty returns, we include within cost of revenue a write-down to reduce the carrying value of such products to net revenues occurring duringrealizable value. Our standard warranty obligation to end-users provides for repair or replacement of a defective product for one or more years. Factors that affect the last monthwarranty obligation include product failure rates, material usage, and service delivery costs incurred in correcting product failures. The estimated cost associated with fulfilling the warranty obligation to end-users is recorded in cost of revenue. Because our products are manufactured by contract manufacturers, in certain cases we have recourse to the contract manufacturer for replacement or credit for the defective products. We give consideration to amounts recoverable from our contract manufacturers in determining our warranty liability. Our estimated allowances for product warranties can vary from actual results and we may have to record additional revenue reductions or charges to cost of revenue which could materially impact our financial position and results of operations.
In addition to warranty-related returns, certain distributors and retailers generally have the right to return product for stock rotation purposes. Every quarter, stock rotation rights are generally limited to 10% of invoiced sales to the distributor or retailer in the prior quarter. Upon shipment of the quarter ended December 31, 2002 comparedproduct, we reduce revenue for an estimate of potential future stock rotation returns related to the last monthcurrent period product revenue. We analyze historical returns, channel inventory levels, current economic trends and changes in customer demand for our products when evaluating the adequacy of the quarter ended December 31, 2001. Investing activitiesallowance for this period used $3.2 millionsales returns, namely stock rotation returns. Our estimated allowances for returns due to purchasesstock rotation can vary from actual results and we may have to record additional revenue reductions which could materially impact our financial position and results of propertyoperations.
Sales incentives provided to customers are accounted for in accordance with Emerging Issues Task Force (“EITF”) IssueNo. 01-9, “Accounting for Consideration Given by a Vendor to a Customer or Reseller of the Vendor’s Products”. Under these guidelines, we accrue for sales incentives as a marketing expense if we receive an identifiable benefit in exchange and equipment. Financing activitiescan reasonably estimate the fair value of the identifiable benefit received; otherwise, it is recorded as a reduction of revenues. Our estimated provisions for this period used cashsales incentives can vary from actual results and we may have to record additional expenses or additional revenue reductions dependent on the classification of $1.2 million due to issuance costs of $1.2 million associated with the repurchasesales incentive.
We maintain an allowance for doubtful accounts for estimated losses resulting from the inability of our
Series A preferred stock offset by proceeds from the issuancecustomers to make required payments. We regularly perform credit evaluations of our
Series C preferred stock.customers’ financial condition and consider factors such as historical experience, credit quality, age of the accounts receivable balances, and geographic or country-specific risks and economic conditions that may affect a customer’s ability to pay. The allowance for doubtful accounts is reviewed monthly and adjusted if necessary based on our assessments of our customers’ ability to pay. If the financial condition of our customers should deteriorate or if actual defaults are higher than our historical experience, additional allowances may be required, which could have an adverse impact on operating expenses.
Valuation of Inventory
We havevalue our inventory at the lower of cost or market, cost being determined using thefirst-in, first-out method. We continually assess the value of our inventory and will periodically write down its value for estimated excess and obsolete inventory based upon assumptions about future demand and market conditions. On a revolving linequarterly basis, we review inventory quantities on hand and on order under non-cancelable purchase commitments, including consignment inventory, in comparison to our estimated forecast of credit agreement with Comerica Bank-California that providesproduct demand for a maximum line of credit of $20.0 million, which includes direct loans, letters of credit, foreign exchange contracts, and corporate credit cards. Availability under this line of creditthe next nine months to determine what inventory, if any, are not saleable. Our analysis is based on a formula of eligible accounts receivable balances. Direct borrowings bear interest at the bank’s prime rate plus 75 basis points. Borrowings are collateralized by all of our assets. The credit line contains covenants, includingdemand forecast but not limited to certain financial covenants based on earnings before interest, taxes, depreciation and amortization, or EBITDA, and tangible net worth, and does not allow for declaration of dividends. We are not required totakes into
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maintain compensating balances, however,account market conditions, product development plans, product life expectancy and other factors. Based on this analysis, we are required to paywrite down the affected inventory value for estimated excess and obsolescence charges. At the point of loss recognition, a fee of 0.25% per annum on the unused portion of the total facilitynew, lower cost basis for that inventory is established, and 1.50% per annum for letters of credit. During 2002 we borrowed amounts under this line of credit for working capital purposes. As of December 31, 2003, all amounts borrowed under this credit line had been repaid, but letters of creditsubsequent changes in facts and circumstances do not result in the aggregate amount of $350,000 were outstanding, leaving approximately $19.6 million availablerestoration or increase in that newly established cost basis. As demonstrated during prior years, demand for borrowing under this line of credit.
Based on our current plansproducts can fluctuate significantly. If actual demand is lower than our forecasted demand and market conditions, we believe that our existing cash and our credit facility will be sufficient to satisfy our anticipated cash requirements for at least the next twelve months. However, we cannot be certain that our planned levels of revenue, costs and expenses will be achieved. If our operating results fail to meet our expectations or if we fail to managereduce our inventory, accounts receivable or other assets,manufacturing accordingly, we could be required to seekwrite down additional funding through public or private financings or other arrangements. In addition, as we continue to expand our product offerings, channels and geographic presence, we may require additional working capital. In such event, adequate funds may not be available when needed or may not be available on favorable or commercially acceptable terms,inventory, which couldwould have a negative effect on our businessgross margin.
Income Taxes
We account for income taxes under an asset and
resultsliability approach. Under this method, income tax expense is recognized for the amount of
operations.Backlog
taxes payable or refundable for the current year. In addition, deferred tax assets and liabilities are recognized for the expected future tax consequences of temporary differences resulting from different treatments for tax versus accounting of certain items, such as accruals and allowances not currently deductible for tax purposes. These differences result in deferred tax assets and liabilities, which are included within the consolidated balance sheet. We must then assess the likelihood that our deferred tax assets will be recovered from future taxable income and to the extent we believe that recovery is not more likely than not, we must establish a valuation allowance. As of December 31, 2003,2006, we hadbelieve that all of our deferred tax assets are recoverable; however, if there were a backlog of approximately $11.5 million comparedchange in our ability to approximately $9.9 million as of December 31, 2002. Our backlog consists of products for which customer purchase orders have been received and which are scheduled orrecover our deferred tax assets, we would be required to take a charge in the processperiod in which we determined that recovery was not more likely than not.
Our effective tax rate differs from the statutory rate due to tax credits, state taxes, stock compensation and other factors. Our future effective tax rate could be impacted by a shift in the mix of domestic and foreign income, tax treaties with foreign jurisdictions; changes in tax laws in the United States or internationally; a change which would result in a valuation allowance being scheduledrequired to be recorded; or a federal, state or foreign jurisdiction’s view of tax returns which differs materially from what we originally provided. We assess the probability of adverse outcomes from tax examinations regularly to determine the adequacy of our income tax liability. If we ultimately determine that payment of these amounts is unnecessary, we reverse the liability and recognize a tax benefit during the period in which we determine that the liability is no longer necessary. We record an additional charge in our provision for shipment. Whiletaxes in the period in which we determine that the recorded tax liability is less than we expect the ultimate assessment to fulfill the order backlog within the current year, most orders are subject to rescheduling or cancellation with little or no penalties. Becausebe.
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Results of the possibility of customer changes in product scheduling or order cancellation, our backlog as of any particular date may not be an indicator of net sales for any succeeding period.Contractual Obligations and Off-Balance Sheet ArrangementsOperations
The following table describes our commitmentssets forth the consolidated statements of operations and the percentage change from the preceding year for the periods indicated:
| | | | | | | | | | | | | | | | | | | | | |
| | | Year Ended December 31, | |
| | | | | | Percentage | | | | | | Percentage | | | | |
| | | 2004 | | | Change | | | 2005 | | | Change | | | 2006 | |
| | | (In thousands, except percentage data) | |
| |
| Net revenue | | $ | 383,139 | | | | 17.3 | % | | $ | 449,610 | | | | 27.6 | % | | $ | 573,570 | |
| Cost of revenue | | | 260,318 | | | | 14.4 | | | | 297,911 | | | | 27.5 | | | | 379,911 | |
| | | | | | | | | | | | | | | | | | | | | |
| Gross profit | | | 122,821 | | | | 23.5 | | | | 151,699 | | | | 27.7 | | | | 193,659 | |
| | | | | | | | | | | | | | | | | | | | | |
| Operating expenses: | | | | | | | | | | | | | | | | | | | | |
| Research and development | | | 10,316 | | | | 24.4 | | | | 12,837 | | | | 43.7 | | | | 18,443 | |
| Sales and marketing | | | 62,247 | | | | 14.6 | | | | 71,345 | | | | 28.8 | | | | 91,881 | |
| General and administrative | | | 14,905 | | | | (2.3 | ) | | | 14,559 | | | | 43.6 | | | | 20,905 | |
| In-process research and development | | | — | | | | ** | | | | — | | | | ** | | | | 2,900 | |
| Litigation reserves | | | — | | | | ** | | | | 802 | | | | (100.0 | ) | | | — | |
| | | | | | | | | | | | | | | | | | | | | |
| Total operating expenses | | | 87,468 | | | | 13.8 | | | | 99,543 | | | | 34.7 | | | | 134,129 | |
| | | | | | | | | | | | | | | | | | | | | |
| Income from operations | | | 35,353 | | | | 47.5 | | | | 52,156 | | | | 14.1 | | | | 59,530 | |
| Interest income | | | 1,593 | | | | 157.6 | | | | 4,104 | | | | 69.9 | | | | 6,974 | |
| Other income (expense), net | | | (560 | ) | | | 216.1 | | | | (1,770 | ) | | | ** | | | | 2,495 | |
| | | | | | | | | | | | | | | | | | | | | |
| Income before income taxes | | | 36,386 | | | | 49.8 | | | | 54,490 | | | | 26.6 | | | | 68,999 | |
| Provision for income taxes | | | 12,921 | | | | 61.5 | | | | 20,867 | | | | 33.5 | | | | 27,867 | |
| | | | | | | | | | | | | | | | | | | | | |
| Net income | | $ | 23,465 | | | | 43.3 | % | | $ | 33,623 | | | | 22.3 | % | | $ | 41,132 | |
| | | | | | | | | | | | | | | | | | | | | |
| | |
| ** | | Percentage change not meaningful as prior year basis is zero or a negative amount. |
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The following table sets forth the consolidated statements of operations, expressed as a percentage of net revenue, for the periods presented:
| | | | | | | | | | | | | |
| | | Year Ended December 31, | |
| | | 2004 | | | 2005 | | | 2006 | |
| |
| Net revenue | | | 100 | % | | | 100 | % | | | 100 | % |
| Cost of revenue | | | 67.9 | | | | 66.3 | | | | 66.2 | |
| | | | | | | | | | | | | |
| Gross margin | | | 32.1 | | | | 33.7 | | | | 33.8 | |
| | | | | | | | | | | | | |
| Operating expenses: | | | | | | | | | | | | |
| Research and development | | | 2.7 | | | | 2.8 | | | | 3.2 | |
| Sales and marketing | | | 16.3 | | | | 15.9 | | | | 16.0 | |
| General and administrative | | | 3.9 | | | | 3.2 | | | | 3.7 | |
| In-process research and development | | | 0.0 | | | | 0.0 | | | | 0.5 | |
| Litigation reserves | | | 0.0 | | | | 0.2 | | | | 0.0 | |
| | | | | | | | | | | | | |
| Total operating expenses | | | 22.9 | | | | 22.1 | | | | 23.4 | |
| | | | | | | | | | | | | |
| Income from operations | | | 9.2 | | | | 11.6 | | | | 10.4 | |
| Interest income | | | 0.4 | | | | 0.9 | | | | 1.2 | |
| Other income (expense), net | | | (0.1 | ) | | | (0.4 | ) | | | 0.4 | |
| | | | | | | | | | | | | |
| Income before income taxes | | | 9.5 | | | | 12.1 | | | | 12.0 | |
| Provision for income taxes | | | 3.4 | | | | 4.6 | | | | 4.8 | |
| | | | | | | | | | | | | |
| Net income | | | 6.1 | % | | | 7.5 | % | | | 7.2 | % |
| | | | | | | | | | | | | |
Net Revenue
| | | | | | | | | | | | | | | | | | | | | |
| | | Year Ended December 31, | |
| | | | | | Percentage
| | | | | | Percentage
| | | | |
| | | 2004 | | | Change | | | 2005 | | | Change | | | 2006 | |
| | | (In thousands, except percentage data) | |
| |
| Net revenue | | $ | 383,139 | | | | 17.3 | % | | $ | 449,610 | | | | 27.6 | % | | $ | 573,570 | |
Our net revenue consists of gross product shipments, less allowances for estimated returns for stock rotation and warranty, price protection and sales incentives deemed to
settle contractual obligationsbe a reduction of net revenue per EITF IssueNo. 01-9 and
our off-balance sheet arrangementsnet changes in
cash as of December 31, 2003.| | | | | | | | | | | | | | | | | | | | | |
| | |
| | Payments Due By Period |
| |
|
| | Less than | | 1-3 | | 3-5 | | More than | | |
| | 1 year | | years | | years | | 5 years | | Total |
| |
| |
| |
| |
| |
|
| | |
| | (in thousands) |
| Operating leases | | $ | 1,033 | | | $ | 179 | | | | — | | | | — | | | $ | 1,212 | |
| Non-cancelable purchase obligations | | | 27,528 | | | | — | | | | | | | | | | | | 27,528 | |
| | | |
| | | |
| | | |
| | | |
| | | |
| |
| | | $ | 28,561 | | | $ | 179 | | | | — | | | | — | | | $ | 28,740 | |
| | | |
| | | |
| | | |
| | | |
| | | |
| |
We lease office spacedeferred revenue. Sales incentives include advertising, cooperative marketing programs, end-caps, instant rebates and equipment under non-cancelable operating leases with various expiration dates through March 2006. Rent expense was $1.2mail-in rebates.
2006 Net Revenue Compared to 2005 Net Revenue
Net revenue increased $124.0 million, or 27.6%, to $573.6 million for the year ended December 31, 2001, $959,0002006, from $449.6 million for the year ended December 31, 20022005. We continued to experience our seasonal pattern of higher net revenues in the second half of the year. The increase in revenue was especially attributable to higher sales of DSL gateway and powerline products to new and existing service provider customers, especially in Europe. The majority of these incremental sales specifically included our wireless gateway customized for major service provider British Sky Broadcasting in the United Kingdom, with shipments of wireless gateways and powerline products to other service providers further improving revenue.
Sales were further enhanced by the first full year of RangeMax wireless router sales to the home market. We introduced our RangeMax family of products, which included performance-enhancing Multiple-In Multiple-Out (MIMO) technology, during 2005, and the market has continued to embrace this key product line throughout the year. We expect the RangeMax family to remain strong in the coming year, and anticipate continuing our recent trend of increased sales of customized wireless gateways to service providers, both domestically and abroad. We
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also anticipate new products such as our wireless-N routers, Skype wi-fi phones, and Gigabit smart switches to drive revenue in the near future.
Sales incentives that are classified as contra-revenue grew at a slower rate than overall gross sales, which further contributed to the increased net revenue. This is primarily due to increased sales to the service provider markets, which typically require less marketing spending. This favorable net revenue impact was partially offset by an increase in sales returns compared to historical return rates.
For the year ended December 31, 2006 revenue generated in the United States, EMEA and Asia Pacific and rest of world was 38.4%, 52.0% and 9.6%, respectively. The comparable net revenue for the year ended December 31, 2005 was 44.3%, 44.5% and 11.2%, respectively. The increase in net revenue over the prior year for each region was 10.7%, 49.2% and 8.8%, respectively.
2005 Net Revenue Compared to 2004 Net Revenue
Net revenue increased $66.5 million, or 17.3%, to $449.6 million for the year ended December 31, 2005, from $383.1 million for the year ended December 31, 2004. We continued to experience our seasonal pattern of higher net revenues in the second half of the year. The increase in revenue was especially attributable to higher sales of wireless LAN products to the home market, especially the new RangeMax family of products and continued strength in G and Super-G products, as well as increased gross shipments of our broadband gateways. These revenue increases were partially offset by increases in allowances for sales incentives associated with increased retail product sales.
We were able to slow down the pace of erosion in our average selling prices on our relatively older products in 2005 in part due to our new “minimum advertised price” policy with our U.S. retailers, as well as a general slowdown in competitive pricing pressures.
End-user customer rebates and other sales incentives which are classified as reductions in net revenue increased in 2005, especially in the latter half of 2005 when we took advantage of significant strategic joint promotion opportunities with our biggest retail partners both in the U.S. and in Europe. For example, we co-marketed our new RangeMax family of products with U.S. national retailers using a unified advertising campaign involving ad circulars and new end-cap displays. These increases in spending combined with higher use of end-user customer rebates impacted our revenue growth.
For the year ended December 31, 2005 revenue generated in the United States, EMEA and Asia Pacific and rest of world was 44.3%, 44.5% and 11.2%, respectively. The comparable net revenue for the year ended December 31, 2004 was 48.8%, 41.6% and 9.6%, respectively. The increase in net revenue over the prior year for each region was 6.6%, 25.3% and 37.5%, respectively.
Cost of Revenue and Gross Margin
| | | | | | | | | | | | | | | | | | | | | |
| | | Year Ended December 31, | |
| | | | | | Percentage
| | | | | | Percentage
| | | | |
| | | 2004 | | | Change | | | 2005 | | | Change | | | 2006 | |
| | | | | | (In thousands, except percentage data) | |
| |
| Cost of revenue | | $ | 260,318 | | | | 14.4 | % | | $ | 297,911 | | | | 27.5 | % | | $ | 379,911 | |
| Gross margin percentage | | | 32.1 | % | | | | | | | 33.7 | % | | | | | | | 33.8 | % |
Cost of revenue consists primarily of the following: the cost of finished products from our third-party contract manufacturers; overhead costs including purchasing, product planning, inventory control, warehousing and distribution logistics; inbound freight; and warranty costs associated with returned goods and write-downs for excess and obsolete inventory. We outsource our manufacturing, warehousing and distribution logistics. We believe this outsourcing strategy allows us to better manage our product costs and gross margin. Our gross margin can be affected by a number of factors, including sales returns, changes in net revenues due to changes in average selling prices, sales incentives, and changes in our cost of goods sold due to fluctuations in prices paid for components, net
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of vendor rebates, warranty and overhead costs, inbound freight, conversion costs, and charges for excess or obsolete inventory and transitions from older to newer products.
Cost of revenue increased $82.0 million, or 27.5%, to $379.9 million for the year ended December 31, 2006, from $297.9 million for the year ended December 31, 2005. Our gross margin improved to 33.8% for the year ended December 31, 2006, from 33.7% for the year ended December 31, 2005.
Our gross margin is impacted by our sales incentives that are recorded as a reduction in revenue which grew at a relatively slower rate than overall net revenue, as most of our revenue increases relate to sales to service providers, which involve significantly lower sales incentive expenses. Additionally, we experienced decreased price protection claims, as well as relatively lower inbound freight during the year, as we were able to shift the mix of inbound shipments from our suppliers from more costly air freight to lower cost sea freight due to better supply chain planning. Furthermore, rebates from vendors were significantly higher in 2006. While we do not expect this higher level of rebates to continue in the future, we anticipate lower costs on these products.
These improvements were almost entirely offset by a number of factors. Incremental sales in 2006 came primarily from increased sales of products carrying lower gross margins to service providers. We also experienced increased warranty and sales returns costs, driven primarily by a higher scrap rate of warranty return units and an increase in reserves taken for future returns based on the increase in returns volume during the year. We also experienced higher costs related to inventory reserves and devaluation.
Additionally, stock-based compensation expense increased $283,000 to $430,000 for the year ended December 31, 2006, from $147,000 for the year ended December 31, 2005, as a result of the adoption of Statement of Financial Accounting Standards (“SFAS”) No. 123 (revised 2004), “Share-Based Payment” (“SFAS 123R”).
Cost of revenue increased $37.6 million, or 14.4%, to $297.9 million for the year ended December 31, 2005 from $260.3 million for the year ended December 31, 2004. Our gross margin improved to 33.7% for the year ended December 31, 2005, from 32.1% for the year ended December 31, 2004, an increase of 1.6 percentage points. This increase was due primarily to a favorable shift in product mix and our product costs decreasing relatively more quickly than sales prices, offset by an increase in end-user customer rebates and other sales incentives, which reduce revenue along with increased inbound freight and conversion costs.
We were able to slow down the pace of erosion in our average selling prices on our relatively older products in 2005 in part due to our new “minimum advertised price” policy with our U.S. retailers, as well as a general slowdown in competitive pricing pressures. We have also had continued success in obtaining cost reductions and efficiencies from our vendors and manufacturers, and have pursued product redesigns when appropriate to further lower production costs. These decreasing costs, coupled with the relative slowing in the decrease of average selling prices, boosted margins on our older products, especially our G and Super G wireless adapters. Additionally, we have benefited from relatively higher standard margins on newer products, especially from our RangeMax family of products.
It is difficult to accurately forecast demand for our products across our markets and within specific countries. The shift in the mix of actual orders compared to forecasted demand resulted in a higher than normal reliance on more expensive air versus surface freight during the last quarter of 2005 as well as higher rework and other costs primarily related to product conversions among country-specific packaging.
Additionally, stock-based compensation expense decreased $16,000 to $147,000 for the year ended December 31, 2005, from $163,000 for the year ended December 31, 2004.
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Operating Expenses
Research and development expense
| | | | | | | | | | | | | | | | | | | | | |
| | | Year Ended December 31, | |
| | | | | | Percentage
| | | | | | Percentage
| | | | |
| | | 2004 | | | Change | | | 2005 | | | Change | | | 2006 | |
| | | | | | (In thousands, except percentage data) | | | | |
| |
| Research and development expense | | $ | 10,316 | | | | 24.4 | % | | $ | 12,837 | | | | 43.7 | % | | $ | 18,443 | |
| Percentage of net revenue | | | 2.7 | % | | | | | | | 2.8 | % | | | | | | | 3.2 | % |
Research and development expenses consist primarily of personnel expenses, payments to suppliers for design services, tooling design costs, safety and regulatory testing, product certification expenditures to qualify our products for sale into specific markets, prototypes and other consulting fees. Research and development expenses are recognized as they are incurred. We have invested in building our research and development organization to enhance our ability to introduce innovative and easy to use products. We expect to continue to add additional employees in our research and development department. In the future we believe that research and development expenses will increase in absolute dollars as we expand into new product technologies, enhance theease-of-use of our products, and broaden our core competencies.
Research and development expenses increased $5.6 million, or 43.7%, to $18.4 million for the year ended December 31, 2006, from $12.8 million for the year ended December 31, 2005. The increase was primarily due to higher salary and related payroll expenses of $2.1 million resulting from research and development related headcount growth, including $486,000 related to retention bonuses for certain employees associated with the acquisition of SkipJam. Employee headcount increased by 15% to 62 employees as of December 31, 2006 as compared to 54 employees as of December 31, 2005, in part due to employees obtained from the acquisition of SkipJam. The increase was also attributable to an increase of $2.1 million in engineering costs. These costs were incurred to improve the quality of our small business products. Additionally, stock-based compensation expense increased $826,000 to $1.1 million for the year ended December 31, 2003. The terms2006, from $293,000 for the year ended December 31, 2005, as a result of the facility lease provideadoption of SFAS 123R.
Research and development expenses increased $2.5 million, or 24.4%, to $12.8 million for
rental payments on a graduated scale. We recognize rent expense on a straight-line basis over the
lease period,year ended December 31, 2005, from $10.3 million for the year ended December 31, 2004. The increase was primarily due to increased salary and
have accrued for rent expense incurred but not paid. We enter into various inventory-related purchase agreements with suppliers. Generally, under these agreements, 50%payroll related expenses of the orders are cancelable$2.4 million resulting from research and development related headcount growth. Employee headcount increased by giving notice 4635% to 60 days prior54 employees as of December 31, 2005 as compared to 40 employees as of December 31, 2004. These headcount increases were primarily due to the expected shipment dateexpansion of our research and 25%development facility in Taiwan and expansion of orders are cancellable by giving notice 31-45 days priorour focus on the broadband service provider market which often requires additional certifications and testing. Additionally, stock-based compensation expense decreased $107,000 to $293,000 for the year ended December 31, 2005, from $400,000 for the year ended December 31, 2004.
Sales and marketing expense
| | | | | | | | | | | | | | | | | | | | | |
| | | Year Ended December 31, | |
| | | | | | Percentage
| | | | | | Percentage
| | | | |
| | | 2004 | | | Change | | | 2005 | | | Change | | | 2006 | |
| | | (In thousands, except percentage data) | |
| |
| Sales and marketing expense | | $ | 62,247 | | | | 14.6 | % | | $ | 71,345 | | | | 28.8 | % | | $ | 91,881 | |
| Percentage of net revenue | | | 16.3 | % | | | | | | | 15.9 | % | | | | | | | 16.0 | % |
Sales and marketing expenses consist primarily of advertising, trade shows, corporate communications and other marketing expenses, product marketing expenses, outbound freight costs, personnel expenses for sales and marketing staff and technical support expenses. We believe that maintaining and building brand awareness is key to both net revenue growth and maintaining our gross margin. We also believe that maintaining widely available and high quality technical support is key to building and maintaining brand awareness. Accordingly, we expect sales and marketing expenses to increase in absolute dollars in the future, related to the
expected shipment date. Orders are not cancellable within 30 days prior to the expected shipment date. At December 31, 2003, we had approximately $27.5 million in non-cancelable purchase commitments with suppliers.International Restructuring
By the endplanned growth of 2004, we plan to reorganize our foreign subsidiaries and entities to manage and optimize our international operations. This project will require us to form and develop new corporate entities and implement intercompany charging structures in our sales order, purchase order, inventory, accounts receiva-business.
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ble, accounts payableSales and marketing expenses increased $20.6 million, or 28.8%, to $91.9 million for the year ended December 31, 2006, from $71.3 million for the year ended December 31, 2005. We note that sales and marketing expenses grew in line with revenue growth. Of this increase, $9.4 million was due to increased salary and payroll related expenses as a result of sales and marketing related headcount growth and increased commissions earned in EMEA due to substantial revenue growth. Employee headcount increased from 157 employees as of December 31, 2005 to 207 employees as of December 31, 2006. More specifically, 46 of the 50 incremental employees relate to expansion in EMEA and Asia Pacific, which represents our continued geographic expansion and increasing sales staffing in these regions. For example, we established a Technical Support Center in our Ireland office, which accounted for 7 new individuals. Outside service fees related to customer service and technical support also increased by $4.9 million, in support of higher call volumes related to increased units sold. We also incurred a $1.7 million increase in advertising, travel, and promotion expenses related to our expansion of marketing activities into new geographies. Outbound freight increased $1.6 million, reflecting our higher sales volume. Marketing costs classified as operating expenses remained relatively constant, as the majority of incremental marketing expenses related to rebates and other modules.items classified as contra-revenue. Additionally, stock-based compensation expense increased $1.0 million to $1.4 million for the year ended December 31, 2006, from $375,000 for the year ended December 31, 2005, as a result of the adoption of SFAS 123R.
Sales and marketing expenses increased $9.1 million, or 14.6%, to $71.3 million for the year ended December 31, 2005, from $62.2 million for the year ended December 31, 2004. Of this increase, $5.1 million was due to product promotion, including intensified in-store staffing and training programs, advertising, and outside technical support expenses, all in support of increased volume. In addition, salary and related expenses for additional sales and marketing personnel increased by $2.7 million as a result of sales and marketing related headcount growth from 125 employees as of December 31, 2004 to 157 employees as of December 31, 2005. We planattributed 28 of the 32 incremental employee additions to reconfigure our managementexpansion in EMEA and Asia Pacific, where sales and marketing employee headcount grew 46% and 35%, respectively. The increase was also attributable to additional allocated overhead costs such as facilities and information systems in ordercosts amounting to support these new foreign$851,000, which reflects sales and marketing’s larger relative headcount growth rate and correspondingly higher share of overhead costs. Additionally, stock-based compensation expense decreased $358,000 to $375,000 for the year ended December 31, 2005, from $733,000 for the year ended December 31, 2004.
General and administrative expense
| | | | | | | | | | | | | | | | | | | | | |
| | | Year Ended December 31, | |
| | | | | | Percentage
| | | | | | Percentage
| | | | |
| | | 2004 | | | Change | | | 2005 | | | Change | | | 2006 | |
| | | (In thousands, except percentage data) | |
| |
| General and administrative expense | | $ | 14,905 | | | | −2.3 | % | | $ | 14,559 | | | | 43.6 | % | | $ | 20,905 | |
| Percentage of net revenue | | | 3.9 | % | | | | | | | 3.2 | % | | | | | | | 3.7 | % |
General and administrative expenses consist of salaries and related expenses for executive, finance and accounting, human resources, professional fees, allowance for bad debts, and other corporate entities. As partexpenses. We expect general and administrative costs to increase in absolute dollars related to the general growth of the restructuring, webusiness, continued international expansion, and increased investments in infrastructure such as a new enterprise resource planning system.
General and administrative expenses increased $6.3 million, or 43.6%, to $20.9 million for the year ended December 31, 2006, from $14.6 million for the year ended December 31, 2005. The increase was primarily due to higher salary and payroll related expenses of $3.3 million due to an increase in general and administrative related headcount. Employee headcount increased by 25% to 66 employees as of December 31, 2006 compared to 53 employees as of December 31, 2005. Of the incremental 13 additions, 8 personnel were hired into accounting and finance departments in our new Ireland office. We also incurred a $1.4 million increase in fees for outside professional services, which was in part related to an increase in IT consulting costs, tax consulting and general legal expenses. Additionally, stock-based compensation expense increased approximately $1.4 million to $1.6 million for the year ended December 31, 2006, from $249,000 for the year ended December 31, 2005, as a result of the adoption of SFAS 123R.
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30.1
General and administrative expenses decreased approximately $300,000, or 2.3%, to $14.6 million for the year ended December 31, 2005, from $14.9 million for the year ended December 31, 2004. This decrease was primarily due to a number amend manydecrease in fees for professional services aggregating $1.7 million and a decrease in net allocated overhead such as information systems costs aggregating $588,000, offset by an increase in employee related costs of $2.1 million. The decrease in fees for professional services resulted from decreases in consulting, outsourced accounting fees and legal fees, and costs associated with initial Sarbanes-Oxley 404 compliance documentation in 2004. The increase in employee related costs resulted from an increase in general and administrative related headcount, particularly in the finance area to support an increase in transactional processing due to increased revenue. Employee headcount increased by 43% to 53 employees as of December 31, 2005 as compared to 37 employees as of December 31, 2004. The decrease in net allocated overhead reflects the general and administrative function’s slower headcount growth rate relative to other functional areas. Additionally, stock-based compensation expense decreased $142,000 to $249,000 for the year ended December 31, 2005, from $391,000 for the year ended December 31, 2004.
In-process research and development
During the year ended December 31, 2006, we expensed $2.9 million for in-process research and development related to intangible assets purchased in our acquisition of SkipJam. See Note 2 of the Notes to the Consolidated Financial Statements for additional information regarding the acquisition. In-process R&D is expensed upon an acquisition because technological feasibility has not been established and no future alternative uses exist. We acquired only one in-process R&D project, which is related to the development of a multimedia product that had not reached technological feasibility and had no alternative use. We incurred costs of approximately $725,000 to complete the project, of which approximately $575,000 was incurred through December 31, 2006. We completed the project in February 2007.
Litigation reserves
During the year ended December 31, 2005, we recorded an allowance of $802,000 for the estimated costs of settlement for theZilberman v. NETGEAR lawsuit. The lawsuit was settled on May 26, 2006, and no material additional costs were incurred. No litigation reserves were recorded in the year ended December 31, 2006.
Interest income and other income (expense)
| | | | | | | | | | | | | |
| | | Year Ended December 31, | |
| | | 2004 | | | 2005 | | | 2006 | |
| | | | | | (In thousands) | | | | |
| |
| Interest income | | $ | 1,593 | | | $ | 4,104 | | | $ | 6,974 | |
| Other income (expense), net | | | (560 | ) | | | (1,770 | ) | | | 2,495 | |
| | | | | | | | | | | | | |
| Total interest income and other income (expense) | | $ | 1,033 | | | $ | 2,334 | | | $ | 9,469 | |
| | | | | | | | | | | | | |
Interest income represents amounts earned on our cash, cash equivalents and short-term investments.
Other income (expense), net, primarily represents gains and losses on transactions denominated in foreign currencies and other miscellaneous expenses.
Interest income increased $2.9 million, or 69.9%, to $7.0 million for the year ended December 31, 2006, from $4.1 million for the year ended December 31, 2005. The increase in interest income was a result of an increase in the average interest rate earned.
Other income (expense), net, increased to income of $2.5 million for the year ended December 31, 2006, from an expense of $1.8 million for the year ended December 31, 2005. The income of $2.5 million was primarily attributable to a net foreign exchange gain experienced in the year ended December 31, 2006 due to the weakening of the U.S. dollar against the Euro, the Great Britain Pound, and the Australian Dollar. The expense of $1.8 million in the year ended December 31, 2005 was primarily attributable to a net foreign exchange loss experienced due to the strengthening of the U.S. dollar against the Euro, Great Britain Pound and the Australian Dollar.
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The aggregate of interest income, interest expense, and other expense amounted to net other income of $2.3 million for the year ended December 31, 2005, compared to net other income of $1.0 million for the year ended December 31, 2004. This change was primarily due to an additional $2.5 million in interest income for the year ended December 31, 2005, from the investment of our customercash, cash equivalents, and supplier agreements,short-term investments balance throughout the year. This was offset in part by an increase in other expense of $1.2 million consisting primarily of realized and unrealized losses associated with foreign currency denominated transactions due in part to currency volatility during the year as well as our billing in foreign currencies which will requirebegan in the consentfirst quarter of 2005.
Provision for Income Taxes
Provision for income taxes increased $7.0 million, resulting in a provision of $27.9 million for the year ended December 31, 2006, from a provision of $20.9 million for the year ended December 31, 2005. The effective tax rate was approximately 40% for the year ended December 31, 2006 and approximately 38% for the year ended December 31, 2005. The effective tax rate for both periods differed from our third-party customersstatutory rate of approximately 35% due to non-deductible stock-based compensation, state taxes, other non-deductible expenses, and suppliers.tax credits. The restructuring will require substantial effortseffective tax rate for the year ended December 31, 2006 was also impacted by our staffnon-deductible charges pertaining to in-process research and development as we modify our organizational structure and add personnel to support new business processes and reporting between us and these new entities. Therefore, the restructuring willa result in increased staffing requirements and related expenses. In addition, we may be able to implement successfully the changes required to support and obtain the benefits of the new structure. We cannot assure you thatacquisition of SkipJam.
Provision for income taxes increased $8.0 million, to a provision of $20.9 million for the restructuring will not cause unanticipated interruptionsyear ended December 31, 2005, from a provision of $12.9 million for the year ended December 31, 2004. The effective tax rate for the year ended December 31, 2005 was approximately 38% and differed from our statutory rate of approximately 35% due to state taxes, and other non-deductible expenses, offset in part by tax credits. The effective tax rate for the year ended December 31, 2004 was approximately 36% and differed from our business operations that resultstatutory rate of approximately 35% due to non-deductible stock-based compensation, state taxes, and other non-deductible expenses, offset in loss or delaypart by a $1.5 million tax benefit from exercises of stock options and tax credits.
Net Income
Net income increased $7.5 million, to $41.1 million for the year ended December 31, 2006 from $33.6 million for the year ended December 31, 2005. This increase was due to an increase in revenue causing a material adverse effect on our financial results. Failuregross profit of $42.0 million and an increase in interest and other income of $7.1 million, offset by an increase in operating expenses of $34.6 million and an increase in provision for income taxes of $7.0 million.
Net income increased $10.1 million, to successfully execute$33.6 million for the restructuring or other factors outside our control could negatively impact our timingyear ended December 31, 2005 from $23.5 million for the year ended December 31, 2004. This increase was primarily due to an increase in gross profit of $28.9 million, offset by an increase in operating expenses of $12.0 million and extentan increase in provision for income taxes of any benefit we receive from the restructuring. See “Risk Factors — We intend to implement an international restructuring which may strain our resources and increase our operating expenses.”$8.0 million.
Critical Accounting Policies and EstimatesThe preparation of
Our consolidated financial statements have been prepared in conformityaccordance with accounting principles generally accepted in the United States of AmericaAmerica. The preparation of these financial statements requires usmanagement to make assumptions, judgments and estimates that can have a significant impact on the reported amounts of assets, liabilities, revenues and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. On an ongoing basis, we evaluate significant estimates used in preparing our financial statements including those related to sales returns and allowances; bad debt; inventory reserves; vendor rebates and deferred taxes.expenses. We base our estimates on historical experience underlying run rates and on various other assumptions that we believebelieved to be applicable and reasonable under the results of which form the basis for making judgments about the carrying values of assets and liabilities.circumstances. Actual results could differ significantly from these estimates. The following areThese estimates may change as new events occur, as additional information is obtained and as our operating environment changes. On a regular basis we evaluate our assumptions, judgments and estimates and make changes accordingly. We also discuss our critical judgments, assumptions, andaccounting estimates with the Audit Committee of the Board of Directors. Note 1 of the Notes to Consolidated Financial Statements describes the significant accounting policies used in the preparation of the consolidated financial statements. We have listed below our critical accounting policies which we believe to have the greatest potential impact on our consolidated financial statements. Historically, our assumptions, judgments and estimates relative to our critical accounting policies have not differed materially from actual results.
Revenue Recognition
Revenue from product sales is generally recognized at the time the product is shipped provided that persuasive evidence of an arrangement exists, title and risk of loss has transferred to the customer, the salesselling price is fixed or determinable and collection of the related receivable is reasonably assured. Currently, for some of our international customers, title passes to the customer upon delivery to the port or country of destination, and for select retailers in the United States to whom we sell directly title passes upon their receipt of the product, or upon the customer’s resale of the product. At the end of each fiscal quarter, we estimate and defer revenue related to the product that is in-transit to international customers and retail customers in the United States that purchase direct from us based uponwhere title passage. We use an estimated number of days based on historical transit periods for different geographies to estimate the amount ofhas not transferred. The revenue continues to be deferred. In addition, we monitor distributor and reseller channel inventory levelsdeferred until such time that title passes to identify any excess inventory in the channel that may be subject to stock rotation rights for US customers only. Gross revenue is reduced for estimated returns for stock rotation and warranty, price protection programs, customer rebates and cooperative marketing expenses deemed to be a sales incentive under Emerging Issues Task Force, or EITF, Issue 01-9, to derive net revenue.
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At the time of each sales transaction, we assess whether collection of the receivable is reasonably assured. We assess collectibility and creditworthiness of our customer’s based on a number of factors, including past transaction history; independent reports from recognized credit rating bureaus, financial statements of the customer and where appropriate, interviews and discussions held with senior financial management of the
customer.
We do not request collateral from our customers. If we determine that collection is not reasonably assured, we defer revenue until receipt of cash. Material differences may result in theThe amount and timing of our revenue for any period could be materially different if our management made different judgments and estimates.
Prior
Allowances for Product Warranties, Returns due to January 1, 2001,Stock Rotation, Price Protection, Sales Incentives and Doubtful Accounts
Our standard warranty obligation to our direct customers generally provides for a right of return of any product for a full refund in the event that such product is not merchantable or is found to be damaged or defective. At the time revenue on shipmentsis recognized, an estimate of future warranty returns is recorded to domestic distributors was deferred until resale to end-users because we could not reasonably estimatereduce revenue in the amount of future returns. Revenue on all shipmentsthe expected credit or refund to internationalbe provided to the our direct customers. At the time we record the reduction to revenue related to warranty returns, we include within cost of revenue a write-down to reduce the carrying value of such products to net realizable value. Our standard warranty obligation to end-users provides for repair or replacement of a defective product for one or more years. Factors that affect the warranty obligation include product failure rates, material usage, and service delivery costs incurred in correcting product failures. The estimated cost associated with fulfilling the warranty obligation to end-users is recorded in cost of revenue. Because our products are manufactured by contract manufacturers, in certain cases we have recourse to the contract manufacturer for replacement or credit for the defective products. We give consideration to amounts recoverable from our contract manufacturers in determining our warranty liability. Our estimated allowances for product warranties can vary from actual results and we may have to record additional revenue reductions or charges to cost of revenue which could materially impact our financial position and results of operations.
In addition to warranty-related returns, certain distributors
was recognized upon cash collection, asand retailers generally have the
company had not established a historyright to return product for stock rotation purposes. Every quarter, stock rotation rights are generally limited to 10% of
collection with foreign distributors. In 2001,invoiced sales to the distributor or retailer in the prior quarter. Upon shipment of the product, we
determined that we had accumulated sufficient historical evidence with respect to returns and cash collections with our distributors to enable us to make reasonable estimatesreduce revenue for
all shipments on or after January 1, 2001.31
| |
| Allowances for Returns due to Stock Rotation and Warranty, Price Protection Programs, Other Sales Incentives and Doubtful Accounts |
Management makes estimatesan estimate of potential future productstock rotation returns price protection claims and other sales incentives related to the current period product revenue. Such estimates are based onWe analyze historical returns, or claims rates, channel inventory levels, current economic trends and changes in customer demand for our products when evaluating the adequacy of the allowance for sales returns, namely stock rotation returns. Our estimated allowances for returns due to stock rotation can vary from actual results and acceptance ofwe may have to record additional revenue reductions which could materially impact our products. Material differences may result in the amount and timing of our revenue for any period if our management made different judgments and estimates.
We evaluate our ability to collect our receivables based on a combination of factors. We regularly analyze our significant customer accounts, and, when we become aware of a specific customer’s inability to meet its financial obligations to us, such as in the case of bankruptcy filings or deterioration in the customer’s operating results or financial position we recordand results of operations.
Sales incentives provided to customers are accounted for in accordance with Emerging Issues Task Force (“EITF”) IssueNo. 01-9, “Accounting for Consideration Given by a
specific allowance for bad debtVendor to
reduce the related receivable to the amount we reasonably believe is collectible. We also record allowance for bad debt for all other customers based on a
variety of factors including the length of time the receivables are past due, the financial healthCustomer or Reseller of the
customer, macroeconomic considerationsVendor’s Products”. Under these guidelines, we accrue for sales incentives as a marketing expense if we receive an identifiable benefit in exchange and
historical experience. If circumstances related to specific customers change, our estimatescan reasonably estimate the fair value of the
recoverabilityidentifiable benefit received; otherwise, it is recorded as a reduction of
receivables could be further adjusted.Asrevenues. Our estimated provisions for sales incentives can vary from actual results and we may have to record additional expenses or additional revenue reductions dependent on the classification of December 31, 2003, we have provided allowances for a total of $1.3 millionthe sales incentive.
We maintain an allowance for doubtful accounts $2.6 million for price protection,estimated losses resulting from the inability of our customers to make required payments. We regularly perform credit evaluations of our customers’ financial condition and $4.8 million for sales returns. After applying these allowances to our grossconsider factors such as historical experience, credit quality, age of the accounts receivable balancebalances, and geographic or country-specific risks and economic conditions that may affect a customer’s ability to pay. The allowance for doubtful accounts is reviewed monthly and adjusted if necessary based on our assessments of $83.6 million, we had $74.9 million in net accounts receivable outstanding asour customers’ ability to pay. If the financial condition of December 31, 2003.our customers should deteriorate or if actual defaults are higher than our historical experience, additional allowances may be required, which could have an adverse impact on operating expenses.
Valuation of Inventory
We value our inventory at the lower of cost or market, cost being determined using thefirst-in, first-out method. We continually assess the value of our inventory and will periodically write down its value for estimated excess and obsolete inventory based upon assumptions about future demand and market conditions. On a quarterly basis, we review inventory quantities on hand and on order under non-cancelable purchase commitments, including consignment inventory, in comparison to our estimated forecast of product demand for the next nine months.months to determine what inventory, if any, are not saleable. Our analysis is based on the demand forecast but takes into
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account market conditions, product development plans, product life expectancy and other factors. Based on this analysis, we write down the affected inventory value for estimated excess and obsolescence charges. At the point of loss recognition, a new, lower cost basis for that inventory is established, and subsequent changes in facts and circumstances do not result in the restoration or increase in that newly established cost basis. As demonstrated during 2001, 2002 and 2003prior years, demand for our products can fluctuate significantly. If actual demand is lower than our forecasted demand and we fail to reduce our manufacturing accordingly, we could be required to recordwrite down additional inventory, write-downs, which would have a negative effect on our gross margin.
As part
Income Taxes
We account for income taxes under an asset and liability approach. Under this method, income tax expense is recognized for the amount of
taxes payable or refundable for the
processcurrent year. In addition, deferred tax assets and liabilities are recognized for the expected future tax consequences of
preparing our consolidated financial statements we are required to estimate our taxes in each of the jurisdictions in which we operate. This process involves us estimating our actual current tax exposure together with assessing temporary differences resulting from
differing treatmentdifferent treatments for tax versus accounting of
certain items, such as accruals and allowances not currently deductible for tax purposes.
These differences result in deferred tax assets and liabilities, which are included within the consolidated balance sheet. We must then assess the likelihood that our deferred tax assets will be recovered from future taxable income and to the extent we believe that recovery is not
more likely
than not, we must establish a valuation allowance.
Management judgment is required in determining our provision for income taxes, our deferred tax assets and liabilities and any valuation allowance recorded against our net deferred tax assets. We have recorded a full valuation allowance as As of December 31, 2001 and 2002, because, based on the available evidence,2006, we believed atbelieve that time it was more likely than not that we would not be able to utilize all of our deferred tax assets are recoverable; however, if there were a change in our ability to recover our deferred tax assets, we would be required to take a charge in the period in which we determined that recovery was not more likely than not.
Our effective tax rate differs from the statutory rate due to tax credits, state taxes, stock compensation and other factors. Our future effective tax rate could be impacted by a shift in the mix of domestic and foreign income, tax treaties with foreign jurisdictions; changes in tax laws in the United States or internationally; a change which would result in a valuation allowance being required to be recorded; or a federal, state or foreign jurisdiction’s view of tax returns which differs materially from what we originally provided. We assess the probability of adverse outcomes from tax examinations regularly to determine the adequacy of our income tax liability. If we ultimately determine that payment of these amounts is unnecessary, we reverse the liability and recognize a tax benefit during the period in which we determine that the liability is no longer necessary. We record an additional charge in our provision for taxes in the period in which we determine that the recorded tax liability is less than we expect the ultimate assessment to be.
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Results of Operations
The following table sets forth the consolidated statements of operations and the percentage change from the preceding year for the periods indicated:
| | | | | | | | | | | | | | | | | | | | | |
| | | Year Ended December 31, | |
| | | | | | Percentage | | | | | | Percentage | | | | |
| | | 2004 | | | Change | | | 2005 | | | Change | | | 2006 | |
| | | (In thousands, except percentage data) | |
| |
| Net revenue | | $ | 383,139 | | | | 17.3 | % | | $ | 449,610 | | | | 27.6 | % | | $ | 573,570 | |
| Cost of revenue | | | 260,318 | | | | 14.4 | | | | 297,911 | | | | 27.5 | | | | 379,911 | |
| | | | | | | | | | | | | | | | | | | | | |
| Gross profit | | | 122,821 | | | | 23.5 | | | | 151,699 | | | | 27.7 | | | | 193,659 | |
| | | | | | | | | | | | | | | | | | | | | |
| Operating expenses: | | | | | | | | | | | | | | | | | | | | |
| Research and development | | | 10,316 | | | | 24.4 | | | | 12,837 | | | | 43.7 | | | | 18,443 | |
| Sales and marketing | | | 62,247 | | | | 14.6 | | | | 71,345 | | | | 28.8 | | | | 91,881 | |
| General and administrative | | | 14,905 | | | | (2.3 | ) | | | 14,559 | | | | 43.6 | | | | 20,905 | |
| In-process research and development | | | — | | | | ** | | | | — | | | | ** | | | | 2,900 | |
| Litigation reserves | | | — | | | | ** | | | | 802 | | | | (100.0 | ) | | | — | |
| | | | | | | | | | | | | | | | | | | | | |
| Total operating expenses | | | 87,468 | | | | 13.8 | | | | 99,543 | | | | 34.7 | | | | 134,129 | |
| | | | | | | | | | | | | | | | | | | | | |
| Income from operations | | | 35,353 | | | | 47.5 | | | | 52,156 | | | | 14.1 | | | | 59,530 | |
| Interest income | | | 1,593 | | | | 157.6 | | | | 4,104 | | | | 69.9 | | | | 6,974 | |
| Other income (expense), net | | | (560 | ) | | | 216.1 | | | | (1,770 | ) | | | ** | | | | 2,495 | |
| | | | | | | | | | | | | | | | | | | | | |
| Income before income taxes | | | 36,386 | | | | 49.8 | | | | 54,490 | | | | 26.6 | | | | 68,999 | |
| Provision for income taxes | | | 12,921 | | | | 61.5 | | | | 20,867 | | | | 33.5 | | | | 27,867 | |
| | | | | | | | | | | | | | | | | | | | | |
| Net income | | $ | 23,465 | | | | 43.3 | % | | $ | 33,623 | | | | 22.3 | % | | $ | 41,132 | |
| | | | | | | | | | | | | | | | | | | | | |
| | |
| ** | | Percentage change not meaningful as prior year basis is zero or a negative amount. |
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The following table sets forth the consolidated statements of operations, expressed as a percentage of net revenue, for the periods presented:
| | | | | | | | | | | | | |
| | | Year Ended December 31, | |
| | | 2004 | | | 2005 | | | 2006 | |
| |
| Net revenue | | | 100 | % | | | 100 | % | | | 100 | % |
| Cost of revenue | | | 67.9 | | | | 66.3 | | | | 66.2 | |
| | | | | | | | | | | | | |
| Gross margin | | | 32.1 | | | | 33.7 | | | | 33.8 | |
| | | | | | | | | | | | | |
| Operating expenses: | | | | | | | | | | | | |
| Research and development | | | 2.7 | | | | 2.8 | | | | 3.2 | |
| Sales and marketing | | | 16.3 | | | | 15.9 | | | | 16.0 | |
| General and administrative | | | 3.9 | | | | 3.2 | | | | 3.7 | |
| In-process research and development | | | 0.0 | | | | 0.0 | | | | 0.5 | |
| Litigation reserves | | | 0.0 | | | | 0.2 | | | | 0.0 | |
| | | | | | | | | | | | | |
| Total operating expenses | | | 22.9 | | | | 22.1 | | | | 23.4 | |
| | | | | | | | | | | | | |
| Income from operations | | | 9.2 | | | | 11.6 | | | | 10.4 | |
| Interest income | | | 0.4 | | | | 0.9 | | | | 1.2 | |
| Other income (expense), net | | | (0.1 | ) | | | (0.4 | ) | | | 0.4 | |
| | | | | | | | | | | | | |
| Income before income taxes | | | 9.5 | | | | 12.1 | | | | 12.0 | |
| Provision for income taxes | | | 3.4 | | | | 4.6 | | | | 4.8 | |
| | | | | | | | | | | | | |
| Net income | | | 6.1 | % | | | 7.5 | % | | | 7.2 | % |
| | | | | | | | | | | | | |
Net Revenue
| | | | | | | | | | | | | | | | | | | | | |
| | | Year Ended December 31, | |
| | | | | | Percentage
| | | | | | Percentage
| | | | |
| | | 2004 | | | Change | | | 2005 | | | Change | | | 2006 | |
| | | (In thousands, except percentage data) | |
| |
| Net revenue | | $ | 383,139 | | | | 17.3 | % | | $ | 449,610 | | | | 27.6 | % | | $ | 573,570 | |
Our net revenue consists of gross product shipments, less allowances for estimated returns for stock rotation and warranty, price protection and sales incentives deemed to be a reduction of net revenue per EITF IssueNo. 01-9 and net changes in deferred revenue. Sales incentives include advertising, cooperative marketing programs, end-caps, instant rebates and mail-in rebates.
2006 Net Revenue Compared to 2005 Net Revenue
Net revenue increased $124.0 million, or 27.6%, to $573.6 million for the year ended December 31, 2006, from $449.6 million for the year ended December 31, 2005. We continued to experience our seasonal pattern of higher net revenues in the second half of the year. The increase in revenue was especially attributable to higher sales of DSL gateway and powerline products to new and existing service provider customers, especially in Europe. The majority of these incremental sales specifically included our wireless gateway customized for major service provider British Sky Broadcasting in the United Kingdom, with shipments of wireless gateways and powerline products to other service providers further improving revenue.
Sales were further enhanced by the first full year of RangeMax wireless router sales to the home market. We introduced our RangeMax family of products, which included performance-enhancing Multiple-In Multiple-Out (MIMO) technology, during 2005, and the market has continued to embrace this key product line throughout the year. We expect the RangeMax family to remain strong in the coming year, and anticipate continuing our recent trend of increased sales of customized wireless gateways to service providers, both domestically and abroad. We
30
also anticipate new products such as our wireless-N routers, Skype wi-fi phones, and Gigabit smart switches to drive revenue in the near future.
Sales incentives that are classified as contra-revenue grew at a slower rate than overall gross sales, which further contributed to the increased net revenue. This is primarily due to increased sales to the service provider markets, which typically require less marketing spending. This favorable net revenue impact was partially offset by an increase in sales returns compared to historical return rates.
For the year ended December 31, 2006 revenue generated in the United States, EMEA and Asia Pacific and rest of world was 38.4%, 52.0% and 9.6%, respectively. The comparable net revenue for the year ended December 31, 2005 was 44.3%, 44.5% and 11.2%, respectively. The increase in net revenue over the prior year for each region was 10.7%, 49.2% and 8.8%, respectively.
2005 Net Revenue Compared to 2004 Net Revenue
Net revenue increased $66.5 million, or 17.3%, to $449.6 million for the year ended December 31, 2005, from $383.1 million for the year ended December 31, 2004. We continued to experience our seasonal pattern of higher net revenues in the second half of the year. The increase in revenue was especially attributable to higher sales of wireless LAN products to the home market, especially the new RangeMax family of products and continued strength in G and Super-G products, as well as increased gross shipments of our broadband gateways. These revenue increases were partially offset by increases in allowances for sales incentives associated with increased retail product sales.
We were able to slow down the pace of erosion in our average selling prices on our relatively older products in 2005 in part due to our new “minimum advertised price” policy with our U.S. retailers, as well as a general slowdown in competitive pricing pressures.
End-user customer rebates and other sales incentives which are classified as reductions in net revenue increased in 2005, especially in the latter half of 2005 when we took advantage of significant strategic joint promotion opportunities with our biggest retail partners both in the U.S. and in Europe. For example, we co-marketed our new RangeMax family of products with U.S. national retailers using a unified advertising campaign involving ad circulars and new end-cap displays. These increases in spending combined with higher use of end-user customer rebates impacted our revenue growth.
For the year ended December 31, 2005 revenue generated in the United States, EMEA and Asia Pacific and rest of world was 44.3%, 44.5% and 11.2%, respectively. The comparable net revenue for the year ended December 31, 2004 was 48.8%, 41.6% and 9.6%, respectively. The increase in net revenue over the prior year for each region was 6.6%, 25.3% and 37.5%, respectively.
Cost of Revenue and Gross Margin
| | | | | | | | | | | | | | | | | | | | | |
| | | Year Ended December 31, | |
| | | | | | Percentage
| | | | | | Percentage
| | | | |
| | | 2004 | | | Change | | | 2005 | | | Change | | | 2006 | |
| | | | | | (In thousands, except percentage data) | |
| |
| Cost of revenue | | $ | 260,318 | | | | 14.4 | % | | $ | 297,911 | | | | 27.5 | % | | $ | 379,911 | |
| Gross margin percentage | | | 32.1 | % | | | | | | | 33.7 | % | | | | | | | 33.8 | % |
Cost of revenue consists primarily of the following: the cost of finished products from our third-party contract manufacturers; overhead costs including purchasing, product planning, inventory control, warehousing and distribution logistics; inbound freight; and warranty costs associated with returned goods and write-downs for excess and obsolete inventory. We outsource our manufacturing, warehousing and distribution logistics. We believe this outsourcing strategy allows us to better manage our product costs and gross margin. Our gross margin can be affected by a number of factors, including sales returns, changes in net revenues due to changes in average selling prices, sales incentives, and changes in our cost of goods sold due to fluctuations in prices paid for components, net
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of vendor rebates, warranty and overhead costs, inbound freight, conversion costs, and charges for excess or obsolete inventory and transitions from older to newer products.
Cost of revenue increased $82.0 million, or 27.5%, to $379.9 million for the year ended December 31, 2006, from $297.9 million for the year ended December 31, 2005. Our gross margin improved to 33.8% for the year ended December 31, 2006, from 33.7% for the year ended December 31, 2005.
Our gross margin is impacted by our sales incentives that are recorded as a reduction in revenue which grew at a relatively slower rate than overall net revenue, as most of our revenue increases relate to sales to service providers, which involve significantly lower sales incentive expenses. Additionally, we experienced decreased price protection claims, as well as relatively lower inbound freight during the year, as we were able to shift the mix of inbound shipments from our suppliers from more costly air freight to lower cost sea freight due to better supply chain planning. Furthermore, rebates from vendors were significantly higher in 2006. While we do not expect this higher level of rebates to continue in the future, we anticipate lower costs on these products.
These improvements were almost entirely offset by a number of factors. Incremental sales in 2006 came primarily from increased sales of products carrying lower gross margins to service providers. We also experienced increased warranty and sales returns costs, driven primarily by a higher scrap rate of warranty return units and an increase in reserves taken for future returns based on the increase in returns volume during the year. We also experienced higher costs related to inventory reserves and devaluation.
Additionally, stock-based compensation expense increased $283,000 to $430,000 for the year ended December 31, 2006, from $147,000 for the year ended December 31, 2005, as a result of the adoption of Statement of Financial Accounting Standards (“SFAS”) No. 123 (revised 2004), “Share-Based Payment” (“SFAS 123R”).
Cost of revenue increased $37.6 million, or 14.4%, to $297.9 million for the year ended December 31, 2005 from $260.3 million for the year ended December 31, 2004. Our gross margin improved to 33.7% for the year ended December 31, 2005, from 32.1% for the year ended December 31, 2004, an increase of 1.6 percentage points. This increase was due primarily to a favorable shift in product mix and our product costs decreasing relatively more quickly than sales prices, offset by an increase in end-user customer rebates and other sales incentives, which reduce revenue along with increased inbound freight and conversion costs.
We were able to slow down the pace of erosion in our average selling prices on our relatively older products in 2005 in part due to our new “minimum advertised price” policy with our U.S. retailers, as well as a general slowdown in competitive pricing pressures. We have also had continued success in obtaining cost reductions and efficiencies from our vendors and manufacturers, and have pursued product redesigns when appropriate to further lower production costs. These decreasing costs, coupled with the relative slowing in the decrease of average selling prices, boosted margins on our older products, especially our G and Super G wireless adapters. Additionally, we have benefited from relatively higher standard margins on newer products, especially from our RangeMax family of products.
It is difficult to accurately forecast demand for our products across our markets and within specific countries. The shift in the mix of actual orders compared to forecasted demand resulted in a higher than normal reliance on more expensive air versus surface freight during the last quarter of 2005 as well as higher rework and other costs primarily related to product conversions among country-specific packaging.
Additionally, stock-based compensation expense decreased $16,000 to $147,000 for the year ended December 31, 2005, from $163,000 for the year ended December 31, 2004.
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Operating Expenses
Research and development expense
| | | | | | | | | | | | | | | | | | | | | |
| | | Year Ended December 31, | |
| | | | | | Percentage
| | | | | | Percentage
| | | | |
| | | 2004 | | | Change | | | 2005 | | | Change | | | 2006 | |
| | | | | | (In thousands, except percentage data) | | | | |
| |
| Research and development expense | | $ | 10,316 | | | | 24.4 | % | | $ | 12,837 | | | | 43.7 | % | | $ | 18,443 | |
| Percentage of net revenue | | | 2.7 | % | | | | | | | 2.8 | % | | | | | | | 3.2 | % |
Research and development expenses consist primarily of personnel expenses, payments to suppliers for design services, tooling design costs, safety and regulatory testing, product certification expenditures to qualify our products for sale into specific markets, prototypes and other consulting fees. Research and development expenses are recognized as they are incurred. We have invested in building our research and development organization to enhance our ability to introduce innovative and easy to use products. We expect to continue to add additional employees in our research and development department. In the future we believe that research and development expenses will increase in absolute dollars as we expand into new product technologies, enhance theease-of-use of our products, and broaden our core competencies.
Research and development expenses increased $5.6 million, or 43.7%, to $18.4 million for the year ended December 31, 2006, from $12.8 million for the year ended December 31, 2005. The increase was primarily due to higher salary and related payroll expenses of $2.1 million resulting from research and development related headcount growth, including $486,000 related to retention bonuses for certain employees associated with the acquisition of SkipJam. Employee headcount increased by 15% to 62 employees as of December 31, 2006 as compared to 54 employees as of December 31, 2005, in part due to employees obtained from the acquisition of SkipJam. The increase was also attributable to an increase of $2.1 million in engineering costs. These costs were incurred to improve the quality of our small business products. Additionally, stock-based compensation expense increased $826,000 to $1.1 million for the year ended December 31, 2006, from $293,000 for the year ended December 31, 2005, as a result of the adoption of SFAS 123R.
Research and development expenses increased $2.5 million, or 24.4%, to $12.8 million for the year ended December 31, 2005, from $10.3 million for the year ended December 31, 2004. The increase was primarily due to increased salary and payroll related expenses of $2.4 million resulting from research and development related headcount growth. Employee headcount increased by 35% to 54 employees as of December 31, 2005 as compared to 40 employees as of December 31, 2004. These headcount increases were primarily due to the expansion of our research and development facility in Taiwan and expansion of our focus on the broadband service provider market which often requires additional certifications and testing. Additionally, stock-based compensation expense decreased $107,000 to $293,000 for the year ended December 31, 2005, from $400,000 for the year ended December 31, 2004.
Sales and marketing expense
| | | | | | | | | | | | | | | | | | | | | |
| | | Year Ended December 31, | |
| | | | | | Percentage
| | | | | | Percentage
| | | | |
| | | 2004 | | | Change | | | 2005 | | | Change | | | 2006 | |
| | | (In thousands, except percentage data) | |
| |
| Sales and marketing expense | | $ | 62,247 | | | | 14.6 | % | | $ | 71,345 | | | | 28.8 | % | | $ | 91,881 | |
| Percentage of net revenue | | | 16.3 | % | | | | | | | 15.9 | % | | | | | | | 16.0 | % |
Sales and marketing expenses consist primarily of advertising, trade shows, corporate communications and other marketing expenses, product marketing expenses, outbound freight costs, personnel expenses for sales and marketing staff and technical support expenses. We believe that maintaining and building brand awareness is key to both net revenue growth and maintaining our gross margin. We also believe that maintaining widely available and high quality technical support is key to building and maintaining brand awareness. Accordingly, we expect sales and marketing expenses to increase in absolute dollars in the future, related to the planned growth of our business.
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Sales and marketing expenses increased $20.6 million, or 28.8%, to $91.9 million for the year ended December 31, 2006, from $71.3 million for the year ended December 31, 2005. We note that sales and marketing expenses grew in line with revenue growth. Of this increase, $9.4 million was due to increased salary and payroll related expenses as a result of sales and marketing related headcount growth and increased commissions earned in EMEA due to substantial revenue growth. Employee headcount increased from 157 employees as of December 31, 2005 to 207 employees as of December 31, 2006. More specifically, 46 of the 50 incremental employees relate to expansion in EMEA and Asia Pacific, which represents our continued geographic expansion and increasing sales staffing in these regions. For example, we established a Technical Support Center in our Ireland office, which accounted for 7 new individuals. Outside service fees related to customer service and technical support also increased by $4.9 million, in support of higher call volumes related to increased units sold. We also incurred a $1.7 million increase in advertising, travel, and promotion expenses related to our expansion of marketing activities into new geographies. Outbound freight increased $1.6 million, reflecting our higher sales volume. Marketing costs classified as operating expenses remained relatively constant, as the majority of incremental marketing expenses related to rebates and other items classified as contra-revenue. Additionally, stock-based compensation expense increased $1.0 million to $1.4 million for the year ended December 31, 2006, from $375,000 for the year ended December 31, 2005, as a result of the adoption of SFAS 123R.
Sales and marketing expenses increased $9.1 million, or 14.6%, to $71.3 million for the year ended December 31, 2005, from $62.2 million for the year ended December 31, 2004. Of this increase, $5.1 million was due to product promotion, including intensified in-store staffing and training programs, advertising, and outside technical support expenses, all in support of increased volume. In addition, salary and related expenses for additional sales and marketing personnel increased by $2.7 million as a result of sales and marketing related headcount growth from 125 employees as of December 31, 2004 to 157 employees as of December 31, 2005. We attributed 28 of the 32 incremental employee additions to expansion in EMEA and Asia Pacific, where sales and marketing employee headcount grew 46% and 35%, respectively. The increase was also attributable to additional allocated overhead costs such as facilities and information systems costs amounting to $851,000, which reflects sales and marketing’s larger relative headcount growth rate and correspondingly higher share of overhead costs. Additionally, stock-based compensation expense decreased $358,000 to $375,000 for the year ended December 31, 2005, from $733,000 for the year ended December 31, 2004.
General and administrative expense
| | | | | | | | | | | | | | | | | | | | | |
| | | Year Ended December 31, | |
| | | | | | Percentage
| | | | | | Percentage
| | | | |
| | | 2004 | | | Change | | | 2005 | | | Change | | | 2006 | |
| | | (In thousands, except percentage data) | |
| |
| General and administrative expense | | $ | 14,905 | | | | −2.3 | % | | $ | 14,559 | | | | 43.6 | % | | $ | 20,905 | |
| Percentage of net revenue | | | 3.9 | % | | | | | | | 3.2 | % | | | | | | | 3.7 | % |
General and administrative expenses consist of salaries and related expenses for executive, finance and accounting, human resources, professional fees, allowance for bad debts, and other corporate expenses. We expect general and administrative costs to increase in absolute dollars related to the general growth of the business, continued international expansion, and increased investments in infrastructure such as a new enterprise resource planning system.
General and administrative expenses increased $6.3 million, or 43.6%, to $20.9 million for the year ended December 31, 2006, from $14.6 million for the year ended December 31, 2005. The increase was primarily due to higher salary and payroll related expenses of $3.3 million due to an increase in general and administrative related headcount. Employee headcount increased by 25% to 66 employees as of December 31, 2006 compared to 53 employees as of December 31, 2005. Of the incremental 13 additions, 8 personnel were hired into accounting and finance departments in our new Ireland office. We also incurred a $1.4 million increase in fees for outside professional services, which was in part related to an increase in IT consulting costs, tax consulting and general legal expenses. Additionally, stock-based compensation expense increased approximately $1.4 million to $1.6 million for the year ended December 31, 2006, from $249,000 for the year ended December 31, 2005, as a result of the adoption of SFAS 123R.
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General and administrative expenses decreased approximately $300,000, or 2.3%, to $14.6 million for the year ended December 31, 2005, from $14.9 million for the year ended December 31, 2004. This decrease was primarily due to a decrease in fees for professional services aggregating $1.7 million and a decrease in net allocated overhead such as information systems costs aggregating $588,000, offset by an increase in employee related costs of $2.1 million. The decrease in fees for professional services resulted from decreases in consulting, outsourced accounting fees and legal fees, and costs associated with initial Sarbanes-Oxley 404 compliance documentation in 2004. The increase in employee related costs resulted from an increase in general and administrative related headcount, particularly in the finance area to support an increase in transactional processing due to increased revenue. Employee headcount increased by 43% to 53 employees as of December 31, 2005 as compared to 37 employees as of December 31, 2004. The decrease in net allocated overhead reflects the general and administrative function’s slower headcount growth rate relative to other functional areas. Additionally, stock-based compensation expense decreased $142,000 to $249,000 for the year ended December 31, 2005, from $391,000 for the year ended December 31, 2004.
In-process research and development
During the year ended December 31, 20032006, we reversed $9.8expensed $2.9 million fromfor in-process research and development related to intangible assets purchased in our acquisition of SkipJam. See Note 2 of the valuationNotes to the Consolidated Financial Statements for additional information regarding the acquisition. In-process R&D is expensed upon an acquisition because technological feasibility has not been established and no future alternative uses exist. We acquired only one in-process R&D project, which is related to the development of a multimedia product that had not reached technological feasibility and had no alternative use. We incurred costs of approximately $725,000 to complete the project, of which approximately $575,000 was incurred through December 31, 2006. We completed the project in February 2007.
Litigation reserves
During the year ended December 31, 2005, we recorded an allowance
because in management’s judgment it is more likely than not that such assets will be realizedof $802,000 for the estimated costs of settlement for theZilberman v. NETGEAR lawsuit. The lawsuit was settled on May 26, 2006, and no material additional costs were incurred. No litigation reserves were recorded in the
future.year ended December 31, 2006.
Stock-based CompensationInterest income and other income (expense) Our stock-based employee compensation plans are described more fully
| | | | | | | | | | | | | |
| | | Year Ended December 31, | |
| | | 2004 | | | 2005 | | | 2006 | |
| | | | | | (In thousands) | | | | |
| |
| Interest income | | $ | 1,593 | | | $ | 4,104 | | | $ | 6,974 | |
| Other income (expense), net | | | (560 | ) | | | (1,770 | ) | | | 2,495 | |
| | | | | | | | | | | | | |
| Total interest income and other income (expense) | | $ | 1,033 | | | $ | 2,334 | | | $ | 9,469 | |
| | | | | | | | | | | | | |
Interest income represents amounts earned on our cash, cash equivalents and short-term investments.
Other income (expense), net, primarily represents gains and losses on transactions denominated in Note 10foreign currencies and other miscellaneous expenses.
Interest income increased $2.9 million, or 69.9%, to $7.0 million for the year ended December 31, 2006, from $4.1 million for the year ended December 31, 2005. The increase in interest income was a result of an increase in the average interest rate earned.
Other income (expense), net, increased to income of $2.5 million for the year ended December 31, 2006, from an expense of $1.8 million for the year ended December 31, 2005. The income of $2.5 million was primarily attributable to a net foreign exchange gain experienced in the year ended December 31, 2006 due to the consolidated financial statements. We account for those plans underweakening of the recognitionU.S. dollar against the Euro, the Great Britain Pound, and measurement principlesthe Australian Dollar. The expense of Accounting Principles Board, or APB, Opinion No. 25$1.8 million in the year ended December 31, 2005 was primarily attributable to a net foreign exchange loss experienced due to the strengthening of the U.S. dollar against the Euro, Great Britain Pound and related interpretations. We amortize stock-basedthe Australian Dollar.
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The aggregate of interest income, interest expense, and other expense amounted to net other income of $2.3 million for the year ended December 31, 2005, compared to net other income of $1.0 million for the year ended December 31, 2004. This change was primarily due to an additional $2.5 million in interest income for the year ended December 31, 2005, from the investment of our cash, cash equivalents, and short-term investments balance throughout the year. This was offset in part by an increase in other expense of $1.2 million consisting primarily of realized and unrealized losses associated with foreign currency denominated transactions due in part to currency volatility during the year as well as our billing in foreign currencies which began in the first quarter of 2005.
Provision for Income Taxes
Provision for income taxes increased $7.0 million, resulting in a provision of $27.9 million for the year ended December 31, 2006, from a provision of $20.9 million for the year ended December 31, 2005. The effective tax rate was approximately 40% for the year ended December 31, 2006 and approximately 38% for the year ended December 31, 2005. The effective tax rate for both periods differed from our statutory rate of approximately 35% due to non-deductible stock-based compensation, usingstate taxes, other non-deductible expenses, and tax credits. The effective tax rate for the straight-line method over the vesting periodsyear ended December 31, 2006 was also impacted by non-deductible charges pertaining to in-process research and development as a result of the related options, which are generally four years.acquisition of SkipJam.
We have recorded deferred
Provision for income taxes increased $8.0 million, to a provision of $20.9 million for the year ended December 31, 2005, from a provision of $12.9 million for the year ended December 31, 2004. The effective tax rate for the year ended December 31, 2005 was approximately 38% and differed from our statutory rate of approximately 35% due to state taxes, and other non-deductible expenses, offset in part by tax credits. The effective tax rate for the year ended December 31, 2004 was approximately 36% and differed from our statutory rate of approximately 35% due to non-deductible stock-based compensation, representingstate taxes, and other non-deductible expenses, offset in part by a $1.5 million tax benefit from exercises of stock options and tax credits.
Net Income
Net income increased $7.5 million, to $41.1 million for the difference betweenyear ended December 31, 2006 from $33.6 million for the deemed fair valueyear ended December 31, 2005. This increase was due to an increase in gross profit of $42.0 million and an increase in interest and other income of $7.1 million, offset by an increase in operating expenses of $34.6 million and an increase in provision for income taxes of $7.0 million.
Net income increased $10.1 million, to $33.6 million for the year ended December 31, 2005 from $23.5 million for the year ended December 31, 2004. This increase was primarily due to an increase in gross profit of $28.9 million, offset by an increase in operating expenses of $12.0 million and an increase in provision for income taxes of $8.0 million.
Liquidity and Capital Resources
As of December 31, 2006 we had cash, cash equivalents and short-term investments totaling $197.5 million.
Our cash and cash equivalents balance decreased from $90.0 million as of December 31, 2005 to $87.7 million as of December 31, 2006. Our short-term investments, which represent the investment of funds available for current operations, increased from $83.7 million as of December 31, 2005 to $109.7 million as of December 31, 2006. Operating activities during the year ended December 31, 2006 generated cash of $23.1 million primarily due to an increase in net income. Investing activities during the year ended December 31, 2006 used $37.7 million, which includes the net purchase of short-term investments of $24.2 million, purchases of property and equipment amounting to $5.9 million, and payments made in connection with our acquisition of SkipJam of $7.6 million. During the year ended December 31, 2006, financing activities provided $12.3 million, primarily resulting from the issuance of our common stock for accounting purposesupon exercise of stock options and the option exercise price. We determined the deemed fair valueour employee stock purchase program.
Our days sales outstanding decreased from 77 days as of our common stock based upon several factors, including a valuation reportDecember 31, 2005 to 66 days as of December 31, 2006.
Our accounts payable increased from an independent appraiser, trends$38.9 million at December 31, 2005 to $39.8 million at December 31, 2006.
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Inventory increased by $26.0 million from $51.9 million at December 31, 2005 to $77.9 million at December 31, 2006. Ending inventory turns decreased, from approximately 6.5 turns in the broad market for technology stocks and the expected valuation we would obtain in an initial public offering. We recorded deferred stock-based compensation of $6.7 million and $1.0 million for stock options granted to employees during the yearsquarter ended December 31, 2002, and 2003, respectively. We amortized $1.7 million and $1.8 million of this amount2005, to 5.7 turns in the yearsquarter ended December 31, 20022006.
Based on our current plans and
2003, respectively. Had different assumptionsmarket conditions, we believe that our existing cash, cash equivalents and short-term investments will be sufficient to satisfy our anticipated cash requirements for the forseeable future. However, we cannot be certain that our planned levels of revenue, costs and expenses will be achieved. If our operating results fail to meet our expectations or
criteria been usedif we fail to
determine the deemed fair value ofmanage our
common stock, materially different amounts of stock-based compensationinventory, accounts receivable or other assets, we could be required to seek additional funding through public or private financings or other arrangements. In addition, as we continue to expand our product offerings, channels and geographic presence, we may require additional working capital. In such event, adequate funds may not be available when needed or may not be available on favorable or commercially acceptable terms, which could have
been reported. Pro forma information regarding net income (loss)a negative effect on our business and net income (loss) per share is required in order to show our net income (loss) as ifresults of operations.
Backlog
As of December 31, 2006, we had
accounteda backlog of approximately $42.7 million compared to approximately $15.7 million as of December 31, 2005. Our backlog consists of products for
employee stock options under the fair value method of SFAS No. 123, as amended by SFAS No. 148. This information is contained in Note 1 to our consolidated financial statements. The fair value of optionswhich customer purchase orders have been received and
shares issued pursuant to our option plans at the grant date were estimated using the Black-Scholes option-pricing model. This model was developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable. In addition, option-pricing models require the input of highly subjective assumptions including the expected stock price volatility. We use projected volatility rates, which are
based upon historical volatility rates experienced by comparable public companies. Because our employee stock options have characteristics significantly different from those of publicly traded options, and because changesscheduled or in the
subjective input assumptions can materially affectprocess of being scheduled for shipment. While we expect to fulfill the
fair value estimate, in management’s opinion,order backlog within the
existing models do not necessarily provide a reliable single measure of the fair value of our stock options. The effects of applying pro forma disclosures of net income (loss) and net income (loss) per share are not likely to be representative of the pro forma effects on net income and earnings per share in the future years for the following reasons: (1) the number of future shares to be issued under these plans is not known and (2) the assumptions used to determine the fair value can vary significantly.
Quantitative and Qualitative Disclosure About Market Risk
We do not use derivative financial instruments in our investment portfolio. We have an investment portfolio of fixed income securities that are classified as “available-for-sale securities.” These securities, like all fixed income instruments,current year, most orders are subject to interest rate riskrescheduling or cancellation with little or no penalties. Because of the possibility of customer changes in product scheduling or order cancellation, our backlog as of any particular date may not be an indicator of net sales for any succeeding period.
Contractual Obligations and will fallOff-Balance Sheet Arrangements
Contractual Obligations
The following table describes our commitments to settle non-cancelable lease and purchase commitments as of December 31, 2006.
| | | | | | | | | | | | | | | | | | | | | |
| | | Less Than 1
| | | | | | | | | More Than
| | | | |
| | | Year | | | 1-3 Years | | | 3-5 Years | | | 5 Years | | | Total | |
| | | (In thousands) | |
| |
Operating leases | | $ | 2,371 | | | $ | 2,016 | | | $ | 1,053 | | | $ | 3,214 | | | $ | 8,654 | |
Purchase obligations | | $ | 55,227 | | | $ | — | | | $ | — | | | $ | — | | | $ | 55,227 | |
| | | | | | | | | | | | | | | | | | | | | |
| | | $ | 57,598 | | | $ | 2,016 | | | $ | 1,053 | | | $ | 3,214 | | | $ | 63,881 | |
| | | | | | | | | | | | | | | | | | | | | |
We lease office space, cars and equipment under non-cancelable operating leases with various expiration dates through December 2026. Rent expense was $1.3 million for the year ended December 31, 2004, $1.5 million for the year ended December 31, 2005 and $2.2 million for the year ended December 31, 2006. The terms of some of the office leases provide for rental payments on a graduated scale. We recognize rent expense on a straight-line basis over the lease period, and have accrued for rent expense incurred but not paid. The amounts presented are consistent with contractual terms and are not expected to differ significantly, unless a substantial change in value if market interest rates increase. our headcount needs requires us to exit an office facility early or expand our occupied space.
We attemptenter into various inventory-related purchase agreements with suppliers. Generally, under these agreements, 50% of the orders are cancelable by giving notice 46 to limit this exposure by investing primarily in short-term securities. Due60 days prior to the short durationexpected shipment date and conservative nature25% of orders are cancelable by giving notice31-45 days prior to the expected shipment date. Orders are not cancelable within 30 days prior to the expected shipment date. At December 31, 2006, we had $55.2 million in non-cancelable purchase commitments with suppliers.
As part of our investment portfolioacquisition of SkipJam, we agreed to pay up to $1.4 million in cash contingent on the continued employment of certain former SkipJam employees with us. These payments will be recorded as compensation expense over a movementtwo-year period. During the year ended December 31, 2006, we have recorded $486,000 of 10% by market interest rates wouldadditional compensation expense pursuant to this agreement, and expect to pay up to $933,000 over the remaining life of this agreement.
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Off-Balance Sheet Arrangements
As of December 31, 2006, we did not have
a material impact on our operating results and the total valueany off-balance sheet arrangements as defined in Item 303(a)(4)(ii) of
the portfolio over the next fiscal year. We are exposed to risks associated with foreign exchange rate fluctuations due to our international manufacturing and sales activities. We generally have not hedged currency exposures. These exposures may change over time as business practices evolve and could negatively impact our operating results and financial condition. All of our sales are denominated in U.S. dollars. An increase in the value of the U.S. dollar relative to foreign currencies could make our products more expensive and therefore reduce the demand for our products. Such a decline in the demand could reduce sales and/or result in operating losses.
SECRegulation S-K.
Recent Accounting Pronouncements In November 2002, the EITF reached a consensus on Issue 00-21, “Revenue Arrangements with Multiple Deliverables.” EITF Issue 00-21 provides guidance on how to account for arrangements that involve the delivery or performance of multiple products, services and/or rights to use assets. The provisions of EITF Issue 00-21 applies to revenue arrangements entered into in reporting periods beginning after June 15, 2003.
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The adoption of EITF Issue 00-21 did not have a material impact on the financial position, results of operations or cash flows
See Note 1 of the company.
In December 2003, theNotes to Consolidated Financial Accounting Standards Board (“FASB”) issued a revision to Interpretation number 46, “Consolidation of variable interest entities,Statements for recent accounting pronouncements.
Item 7A. Quantitative and interpretation of ARB Opinion No. 51 (“FIN 46R”).” FIN 46R clarifies the application of ARB 51 “Consolidated Financial Statements,” to certain entities in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support provided by any parties, including the equity holders. FIN 46R requires the consolidation of these entities, known as variable interest entities (“VIE’s”), by the primary beneficiary of the entity. The primary beneficiary is the entity, if any, that will absorb a majority of the entity’s expected losses, receive a majority of the entity’s expected residual returns, or both. Among other changes, the revisions of FIN 46R (a) clarified some requirements of the original FIN 46, which had been issued in January 2003, (b) eased some implementation problems, and (c) added new scope exceptions. FIN 46R deferred the effective date of the interpretation for public companies to the end of the first reporting period ending after March 15, 2004, except that all public companies must at a minimum apply the unmodified provisions of the interpretation to entities that were previously considered “special-purpose entities” in practice and under the FASB literature prior to the issuance of FIN 46R by the end of the first reporting period ending after December 15, 2003.
Among the scope expectations, companies are not required to apply FIN 46R to an entity that meets the criteria to be considered a “business” as defined in the interpretation unless one or more of four named conditions exist. FIN 46R applies immediately to a VIE created or acquired after January 31, 2003. The company does not have any interests in VIE’s and the adoption of FIN 46R is not expected to have a material impact on the company’s financial position, results of operations or cash flows.
Qualitative Disclosures About Market Risk Factors Affecting Future Results
The risks described below are not the only ones we face. Additional risks not presently know to us or that we currently believe are not material may also impair our business operations.
Risks Related to Our Business and Industry
We expect our operating results to fluctuate on a quarterly and annual basis, which could cause our stock price to fluctuate or decline.
Our operating results are difficult to predict and may fluctuate substantially from quarter-to-quarter or year-to-year for a variety of reasons, many of which are beyond our control. If our actual revenue were to fall below our estimates or the expectations of public market analysts or investors, our quarterly and annual results would be negatively impacted and the price of our stock could decline. Other factors that could affect our quarterly and annual operating results include those listed in this risk factors section of this Form 10-K and others such as:
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| • | changes in the pricing policies of or the introduction of new products or product enhancements by us or our competitors; |
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| • | changes in the terms of our contracts with customers or suppliers; |
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| • | slow or negative growth in the networking product, personal computer, Internet infrastructure, home electronics and related technology markets, as well as decreased demand for Internet access; |
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| • | changes in or consolidation of our sales channel and wholesale distributor relationships or failure to manage our sales channel inventory and warehousing requirements; |
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| • | delay or failure to fulfill orders for our products on a timely basis; |
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| • | our inability to accurately forecast our contract manufacturing needs; |
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| • | delays in the introduction of new or enhanced products by us or market acceptance of these products; |
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| • | an increase in price protection claims, redemptions of marketing rebates, product warranty returns or allowance for doubtful accounts; |
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| • | operational disruptions, such as transportation delays or failure of our order processing system, particularly if they occur at the end of a fiscal quarter; and |
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| • | seasonal patterns of higher sales during the second half of our fiscal year, particularly retail-related sales in our fourth quarter. |
As a result, period-to-period comparisons of our operating results may not be meaningful, and you should not rely on them as an indication of our future performance. In addition, our future operating results may fall below the expectations of public market analysts or investors. In this event, our stock price could decline significantly.
Our future success is dependent on the acceptance of networking products in the small business and home markets into which we sell substantially all of our products. If the acceptance of networking products in these markets does not continue to grow, we will be unable to increase or sustain our net revenue, and our business will be severely harmed.
We believe that growth in the small business market will depend, in significant part, on the growth of the number of personal computers purchased by these end users and the demand for sharing data intensive applications, such as large graphic files. We believe that acceptance of networking products in the home will depend upon the availability of affordable broadband Internet access and increased demand for wireless products. Unless these markets continue to grow, our business will be unable to expand, which could cause the value of your investment to decline. Moreover, if networking functions are integrated more directly into personal computers and other Internet-enabled devices, such as electronic games or personal video recorders, and these devices do not rely upon external network-enabling devices, sales of our products could suffer. In addition, if the small business or home markets experience a recession or other cyclical effects that diminish or delay networking expenditures, our business growth and profits would be severely limited, and our business could be more severely harmed than those companies that primarily sell to large business customers.
Some of our competitors have substantially greater resources than we do, and to be competitive we may be required to lower our prices or increase our advertising expenditures or other expenses, which could result in reduced margins and loss of market share.
We compete in a rapidly evolving and highly competitive market, and we expect competition to intensify. Our principal competitors in the small business market include 3Com Corporation, Allied Telesyn International, Dell Computer Corporation, D-Link Systems, Inc., Hewlett-Packard Company, The Linksys division of Cisco Systems and Nortel Networks. Our principal competitors in the home market include Belkin Corporation, D-Link, The Linksys division of Cisco Systems and Microsoft Corporation. Other current and potential competitors include numerous local vendors such as Corega International SA and Melco, Inc./ Buffalo Technology in Japan and TP-Link in China. Our potential competitors also include consumer electronics vendors who could integrate networking capabilities into their line of products.
Many of our existing and potential competitors have longer operating histories, greater name recognition and substantially greater financial, technical, sales, marketing and other resources, including Cisco Systems and Microsoft. These competitors may, among other things, undertake more extensive marketing campaigns, adopt more aggressive pricing policies, obtain more favorable pricing from suppliers and manufacturers and exert more influence on the sales channel than we can. In June 2003, Cisco Systems acquired The Linksys Group, a major competitor of ours. Cisco Systems has substantial resources that it may direct to developing or purchasing advanced technology, which might be superior to ours. In addition, it may direct substantial resources to expand its Linksys division’s distribution channel and to increase its advertising expenditures or otherwise use its resources to successfully compete. Any of these actions could cause us to materially increase our expenses, and could result in our being unable to successfully compete, which would harm our results of
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operations. We anticipate that current and potential competitors will also intensify their efforts to penetrate our target markets. These competitors may have more advanced technology, more extensive distribution channels, stronger brand names, greater access to shelf space in retail locations, bigger promotional budgets and larger customer bases than we do. These companies could devote more capital resources to develop, manufacture and market competing products than we could. If any of these companies are successful in competing against us, our sales could decline, our margins could be negatively impacted, and we could lose market share, any of which could seriously harm our business and results of operations.
The average selling prices of our products typically decrease rapidly over the sales cycle of the product, which may negatively affect our gross margins.
Our products typically experience price erosion, a fairly rapid reduction in the average selling prices over their respective sales cycles. In order to sell products that have a falling average selling price and maintain margins at the same time, we need to continually reduce product and manufacturing costs. To manage manufacturing costs, we must collaborate with our third-party manufacturers to engineer the most cost-effective design for our products. In addition, we must carefully manage the price paid for components used in our products. We must also successfully manage our freight and inventory costs to reduce overall product costs. We also need to continually introduce new products with higher sales prices and gross margins in order to maintain our overall gross margins. If we are unable to manage the cost of older products or successfully introduce new products with higher gross margins, our net revenue and overall gross margin would likely decline.
If we fail to continue to introduce new products and product enhancements that achieve broad market acceptance on a timely basis, we will not be able to compete effectively and we will be unable to increase or maintain net revenue and gross margins.
We operate in a highly competitive, quickly changing environment, and our future success depends on our ability to develop and introduce new products and product enhancements that achieve broad market acceptance in the small business and home markets. Our future success will depend in large part upon our ability to identify demand trends in the small business and home markets and quickly develop, manufacture and sell products that satisfy these demands in a cost effective manner. Successfully predicting demand trends is difficult, and it is very difficult to predict the effect introducing a new product will have on existing product sales. We will also need to respond effectively to new product announcements by our competitors by quickly introducing competitive products.
We have experienced delays in releasing new products and product enhancements in the past, which resulted in lower quarterly net revenue than expected. For example, in 2000, we introduced a proprietary wireless networking solution. Later, we decided to re-design our products to be compliant with the 802.11 standard promulgated by the Institute of Electrical and Electronic Engineers. As a result, we introduced our wireless local area networking, or LAN, 802.11b products in the first quarter of 2001, six months behind some of our competitors. In addition, we have experienced unanticipated delays in product introductions beyond announced release dates. Any future delays in product development and introduction could result in:
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| • | loss of or delay in revenue and loss of market share; |
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| • | negative publicity and damage to our reputation and brand; |
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| • | decline in the average selling price of our products; and |
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| • | adverse reactions in our sales channel, such as reduced shelf space or reduced online product visibility. |
We depend substantially on our sales channel, and our failure to maintain and expand our sales channel would result in lower sales and reduced net revenue.
To maintain and grow our market share, net revenue and brand, we must maintain and expand our sales channel. We sell our products through our sales channel, which consists of traditional retailers, on-line retailers, direct market resellers, or DMRs, value added resellers, or VARs, and, recently, broadband service
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providers. These entities typically purchase our products through our wholesale distributors. We sell to small businesses primarily through DMRs, VARs and retail locations, and we sell to our home users primarily through retail locations, online retailers and broadband service providers. We have no minimum purchase commitments or long-term contracts with any of these third parties.
Traditional retailers have limited shelf space and promotional budgets, and competition is intense for these resources. A competitor with more extensive product lines and stronger brand identity, such as Microsoft or Cisco Systems, may have greater bargaining power with these retailers. The competition for retail shelf space may increase, which would require us to increase our marketing expenditures simply to maintain current levels of retail shelf space. The recent trend in the consolidation of online retailers and DMR channels has resulted in intensified competition for preferred product placement, such as product placement on an online retailer’s home page. Expanding our presence in the VAR channel may be difficult and expensive. We compete with established companies that have longer operating histories and longstanding relationships with VARs that we would find highly desirable as sales channel partners. If we were unable to maintain and expand our sales channel, our growth would be limited and our business would be harmed.
We must also continuously monitor and evaluate emerging sales channels. If we fail to establish a presence in an important developing sales channel, such as selling networking products through broadband service providers such as cable operators and telecommunications carriers, our business could be harmed.
We rely on a limited number of wholesale distributors and direct customers for most of our sales, and if they refuse to pay our requested prices or reduce their level of purchases, our net revenue could decline.
We sell a substantial portion of our products through wholesale distributors, including Ingram Micro, Inc. and Tech Data Corporation. During 2003, sales to Ingram Micro and its affiliates accounted for 31% of our net revenue and sales to Tech Data and its affiliates accounted for 15% of our net revenue. We expect that a significant portion of our net revenue will continue to come from sales to a small number of wholesale distributors for the foreseeable future. In addition, because our accounts receivable are concentrated with a small group of purchasers, the failure of any of them to pay on a timely basis, or at all, would reduce our cash flow. We have no minimum purchase commitments or long-term contracts with any of these distributors. These purchasers could decide at any time to discontinue, decrease or delay their purchases of our products. In addition, the prices that they pay for our products are subject to negotiation and could change at any time. If any of our major wholesale distributors reduce their level of purchases or refuse to pay the prices that we set for our products, our net revenue and operating results could be harmed. If our wholesale distributors increase the size of their product orders without sufficient lead-time for us to process the order, our ability to fulfill product demands would be compromised.
If we do not effectively manage our sales channel inventory and product mix, we may incur costs associated with excess inventory, or lose sales from having too few products.
If we are unable to properly monitor, control and manage our sales channel inventory and maintain an appropriate level and mix of products with our wholesale distributors and within our sales channel, we may incur increased and unexpected costs associated with this inventory. We currently have particularly limited visibility as to the inventory levels of our international wholesale distributors and sales channel. We generally allow wholesale distributors and traditional retailers to return a limited amount of our products in exchange for other products. Under our price protection policy, if we reduce the list price of a product, we are often required to issue a credit in an amount equal to the reduction for each of the products held in inventory by our wholesale distributors and retailers. If our wholesale distributors and retailers are unable to sell their inventory in a timely manner, we might lower the price of the products, or these parties may exchange the products for newer products. If we improperly forecast demand for our products we could end up with too many products and be unable to sell the excess inventory in a timely manner, if at all, or, alternatively we could end up with too few products and not be able to satisfy demand. This problem is exacerbated because we attempt to closely match inventory levels with product demand leaving limited margin for error. If these events occur, we could incur increased expenses associated with writing off excessive or obsolete inventory or lose sales and therefore suffer declining gross margins.
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We depend on a limited number of third-party contract manufacturers for substantially all of our manufacturing needs. If these contract manufacturers experience any delay, disruption or quality control problems in their operations, we could lose market share and our brand may suffer.
All of our products are manufactured, assembled, tested and packaged by a limited number of original design manufacturers, or ODMs, and original equipment manufacturers, or OEMs. Substantially all of our products are manufactured by Ambit Microsystems, Cameo Communications Corporation, Delta Networks, Inc., SerComm Corporation and Z-Com, Inc. We rely on our contract manufacturers to procure components and, in some cases, subcontract engineering work. Some of our products are manufactured by a single contract manufacturer. We do not have any long-term contracts with any of our third-party contract manufacturers. Some of these third-party contract manufacturers produce products for our competitors. The loss of the services of any of our primary third-party contract manufacturers could cause a significant disruption in operations and delays in product shipments. Qualifying a new contract manufacturer and commencing volume production is expensive and time consuming.
Our reliance on third-party contract manufacturers also exposes us to the following risks over which we have limited control:
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| • | unexpected increases in manufacturing and repair costs; |
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| • | inability to control the quality of finished products; |
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| • | inability to control delivery schedules; and |
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| • | potential lack of adequate capacity to manufacture all or a part of the products we require. |
All of our products must satisfy safety and regulatory standards and some of our products must also receive government certifications. Our ODM and OEM contract manufacturers are primarily responsible for obtaining most regulatory approvals for our products. If our ODMs and OEMs fail to obtain timely domestic or foreign regulatory approvals or certificates, we would be unable to sell our products and our sales and profitability could be reduced, our relationships with our sales channel could be harmed, and our reputation and brand would suffer.
If we are unable to provide our third-party contract manufacturers an accurate forecast of our component and material requirements, we may experience delays in the manufacturing of our products and the costs of our products may increase.
We provide our third-party contract manufacturers with a rolling forecast of demand, which they use to determine our material and component requirements. Lead times for ordering materials and components vary significantly and depend on various factors, such as the specific supplier, contract terms and demand and supply for a component at a given time. Some of our components have long lead times, such as local access network repeaters, switching fabric chips, physical layer transceivers, connector jacks and metal and plastic enclosures. If our forecasts are less than our actual requirements, our contract manufacturers may be unable to manufacture products in a timely manner. If our forecasts are too high, our contract manufacturers will be unable to use the components they have purchased on our behalf. The cost of the components used in our products tends to drop rapidly as volumes increase and the technologies mature. Therefore, if our contract manufacturers are unable to promptly use components purchased on our behalf, our cost of producing products may be higher than our competitors due to an over supply of higher-priced components. Moreover, if they are unable to use components ordered at our direction, we will need to reimburse them for any losses they incur.
If disruptions in our transportation network occur or our shipping costs substantially increase, we may be unable to sell our products and our operating expenses could increase.
We are highly dependent upon the transportation systems we use to ship our products, including surface and air freight. Our attempts to closely match our inventory levels to our product demand intensify the need for our transportation systems to function effectively and without delay. The transportation network is subject
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to disruption from a variety of causes, including labor disputes or port strikes, acts of war or terrorism and natural disasters. For example, in September 2002, a major strike disrupted ports on the West Coast, which halted the transportation of our product shipments, resulting in our inability to meet some customer orders in a timely manner. Labor disputes among freight carriers are common, especially in EMEA, and we expect labor unrest and its effects on shipping our products to be a continuing challenge for us. Since September 11, 2001, the rate of inspection of international freight by governmental entities has substantially increased, and has become increasingly unpredictable. If our delivery times increase unexpectedly for these or any other reasons, our ability to deliver products on time would be materially adversely affected and result in delayed or lost revenue. In addition, if the recent increases in fuel prices were to continue, our transportation costs would likely further increase. Moreover, the cost of shipping our products by air freight is greater than other methods. From time to time in the past, we have shipped products using air freight to meet unexpected spikes in demand or to bring new product introductions to market quickly. If we rely more heavily upon air freight to deliver our products, our overall shipping costs will increase. A prolonged transportation disruption or a significant increase in the cost of freight could severely disrupt our business and harm our operating results.
We obtain several key components from limited or sole sources, and if these sources fail to satisfy our supply requirements, we may lose sales and experience increased component costs.
Any shortage or delay in the supply of key product components would harm our ability to meet scheduled product deliveries. Many of the semiconductors used in our products are specifically designed for use in our products and are obtained from sole source suppliers on a purchase order basis. In addition, some components that are used in all our products are obtained from limited sources. These components include connector jacks, plastic casings and physical layer transceivers. We also obtain switching fabric semiconductors, which are used in our Ethernet switches and Internet gateway products, from a limited number of suppliers. Our contract manufacturers purchase these components on our behalf on a purchase order basis, and we do not have any contractual commitments or guaranteed supply arrangements with our suppliers. If demand for a specific component increases, we may not be able to obtain an adequate number of that component in a timely manner. In addition, if our suppliers experience financial or other difficulties or if worldwide demand for the components they provide increases significantly, the availability of these components could be limited. It could be difficult, costly and time-consuming to obtain alternative sources for these components, or to change product designs to make use of alternative components. In addition, difficulties in transitioning from an existing supplier to a new supplier could create delays in component availability that would have a significant impact on our ability to fulfill orders for our products. If we are unable to obtain a sufficient supply of components, or if we experience any interruption in the supply of components, our product shipments could be reduced or delayed. This would affect our ability to meet scheduled product deliveries, damage our brand and reputation in the market, and cause us to lose market share.
We rely upon third parties for technology that is critical to our products, and if we are unable to continue to use this technology and future technology, our ability to sell technologically advanced products would be limited.
We rely on third parties to obtain non-exclusive patented hardware and software license rights in technologies that are incorporated into and necessary for the operation and functionality of our products. Because the intellectual property we license is available from third parties, barriers to entry may be lower than if we owned exclusive rights to the technology we license and use. On the other hand, if a competitor or potential competitor enters into an exclusive arrangement with any of our key third-party technology providers, our ability to develop and sell products containing that technology would be severely limited. Our licenses often require royalty payments or other consideration to third parties. Our success will depend in part on our continued ability to have access to these technologies, and we do not know whether these third-party technologies will continue to be licensed to us on commercially acceptable terms or at all. If we are unable to license the necessary technology, we may be forced to acquire or develop alternative technology of lower quality or performance standards. This would limit and delay our ability to offer competitive products and increase our costs of production. As a result, our margins, market share, and operating results could be significantly harmed.
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If we are unable to secure and protect our intellectual property rights, our ability to compete could be harmed.
We rely upon third parties for a substantial portion of the intellectual property we use in our products. At the same time, we rely on a combination of copyright, trademark, patent and trade secret laws, nondisclosure agreements with employees, consultants and suppliers and other contractual provisions to establish, maintain and protect our intellectual proprietary rights. Despite efforts to protect our intellectual property, unauthorized third parties may attempt to design around, copy aspects of our product design or obtain and use technology or other intellectual property associated with our products. For example, one of our primary intellectual property assets is the NETGEAR name, trademark and logo. We may be unable to stop third parties from adopting similar names, trademarks and logos, especially in those international markets where our intellectual property rights may be less protected. Furthermore, our competitors may independently develop similar technology or design around intellectual property. Our inability to secure and protect our intellectual property rights could significantly harm our brand and business, operating results and financial condition.
We could become subject to litigation, including litigation regarding intellectual property rights, which could be costly and subject us to significant liability.
The networking industry is characterized by the existence of a large number of patents and frequent claims and related litigation regarding infringement of patents, trade secrets and other intellectual property rights. In particular, leading companies in the data communications markets, some of which are competitors, have extensive patent portfolios with respect to networking technology. From time to time, third parties, including these leading companies, have asserted and may continue to assert exclusive patent, copyright, trademark and other intellectual property rights against us demanding license or royalty payments or seeking payment for damages, injunctive relief and other available legal remedies through litigation. Although there is currently no intellectual property litigation pending against us, we could become subject to lawsuits in the future and be forced to defend against claims brought by third parties who allege infringement of their intellectual property rights. These include third parties who claim to own patents or other intellectual property that cover industry standards that our products comply with. From time to time we are contacted by third parties that allege we are wrongfully using their intellectual property. For example, we have been contacted by Cactus Services, Inc., CSIRO, ipValue, Motorola, Network-1 Security Solutions and Vertical Networks, each of which is seeking royalties or compensation from us for alleged intellectual property infringement. Several of the parties claim that we need to acquire a license because our products allegedly infringe on their intellectual property by virtue of the fact that our products comply with various industry-wide standards. If we are unable to resolve these matters or obtain licenses on acceptable or commercially reasonable terms, we could be sued. The cost of any necessary licenses could significantly harm our business, operating results and financial condition. Also, at any time, any of these companies, or any other third-party could initiate litigation against us, which could divert management attention, be costly to defend, prevent us from using or selling the challenged technology, require us to design around the challenged technology and cause the price of our stock to decline. In addition, third parties, some of which are potential competitors, may initiate litigation against our manufacturers, suppliers or members of our sales channel, alleging infringement of their proprietary rights with respect to existing or future products. In the event successful claims of infringement are brought by third parties, and if we are unable to obtain licenses or to independently develop alternative technology on a timely basis, we may be subject to an indemnification obligation or unable to offer competitive products, and be subject to increased expenses. As a result, our business, operating results and financial condition could be significantly harmed.
If our products contain defects or errors, we could incur significant unexpected expenses, experience product returns and lost sales, suffer damage to our brand and reputation, and be subject to product liability or other claims.
Our products are complex and may contain defects, errors or failures, particularly when first introduced or when new versions are released. For example, in the quarter ended September 29, 2002, we recalled some of our 48 port 10/100 Mbps Ethernet switches due to an intermittent connectivity issue with a connector. Some
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errors and defects may be discovered only after a product has been installed and used by the end user. If our products contain defects or errors, we could experience decreased sales and increased product returns, loss of customers and market share, and increased service, warranty and insurance costs. In addition, our reputation and brand could be damaged, and we could face legal claims regarding our products. A successful product liability or other claim could result in negative publicity and further harm our reputation, result in unexpected expenses and adversely impact our operating results.
We intend to implement an international restructuring, which may strain our resources and increase our operating expenses.
By the end of 2004, we plan to reorganize our foreign subsidiaries and entities to manage and optimize our international operations. Our implementation of this project will require substantial efforts by our staff and could result in increased staffing requirements and related expenses. Failure to successfully execute the restructuring or other factors outside of our control could negatively impact the timing and extent of any benefit we receive from the restructuring. The restructuring will also require us to amend a number of our customer and supplier agreements, which will require the consent of our third-party customers and suppliers. In addition, there could be unanticipated interruptions in our business operations as a result of implementing these changes that could result in loss or delay in revenue causing an adverse effect on our financial results.
We intend to expand our operations and infrastructure, which may strain our operations and increase our operating expenses.
We intend to expand our operations and pursue market opportunities domestically and internationally to grow our sales. For example, we are intensifying our efforts to sell our products in China. We expect that this expansion will strain our existing management information systems, and operational and financial controls. In addition, as we continue to grow, our expenditures will likely be significantly higher than our historical costs. We may not be able to install adequate controls in an efficient and timely manner as our business grows, and our current systems may not be adequate to support our future operations. The difficulties associated with installing and implementing these new systems, procedures and controls may place a significant burden on our management, operational and financial resources. In addition, as we grow internationally, we will have to expand and enhance our communications infrastructure. If we fail to continue to improve our management information systems, procedures and financial controls or encounter unexpected difficulties during expansion, our business could be harmed.
Our sales and operations in international markets expose us to operational, financial and regulatory risks.
International sales comprise a significant amount of our overall net revenue. International sales were 37% in each of 2001 and 2002 and 42% in 2003. We anticipate that international sales may grow as a percentage of net revenue. We have committed resources to expanding our international operations and sales channels and these efforts may not be successful. International sales are subject to a number of risks. For example, we recognize revenue from our international sales when our products reach the country of destination. As a result, if these products are delayed in transit, we are unable to recognize revenue.
International operations are subject to a number of other risks, including:
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| • | political and economic instability, international terrorism and anti-American sentiment, particularly in emerging markets; |
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| • | preference for locally branded products, and laws and business practices favoring local competition; |
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| • | exchange rate fluctuations; |
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| • | increased difficulty in managing inventory; |
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| • | delayed revenue recognition; |
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| • | less effective protection of intellectual property; and |
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| • | difficulties and costs of staffing and managing foreign operations. |
We currently do not engage in any currency hedging transactions. Except for sales to Japan and Singapore, our international sales are currently invoiced in United States dollars. Nonetheless, as we expand our international operations, we are exploring the option of allowing both invoicing and payment in additional foreign currencies and our exposure to losses in foreign currency transactions may increase. Moreover, the costs of doing business abroad may increase as a result of adverse exchange rate fluctuations. For example, if the United States dollar declined in value relative to a local currency, we could be required to pay more for our expenditures in that market, including salaries, commissions, local operations and marketing expenses, each of which is paid in local currency. In addition, we may lose customers if exchange rate fluctuations, currency devaluations or economic crises increase the local currency price of our products or reduce our customers’ ability to purchase products.
If we lose the services of our Chairman and Chief Executive Officer, Patrick C.S. Lo, or our other key personnel, we may not be able to execute our business strategy effectively.
Our future success depends in large part upon the continued services of our key technical, sales, marketing and senior management personnel. In particular, the services of Patrick C.S. Lo, our Chairman and Chief Executive Officer, who has led our company since its inception, are very important to our business. All of our executive officers or key employees are at will employees, and we do not maintain any key person life insurance policies. The loss of any of our senior management or other key research, development, sales or marketing personnel, particularly if lost to competitors, could harm our ability to implement our business strategy and respond to the rapidly changing needs of the small business and home markets.
Natural disasters, mischievous actions or terrorist attacks could delay our ability to receive or ship our products, or otherwise disrupt our business.
Our corporate headquarters are located in Northern California and one of our warehouses is located in Southern California, regions known for seismic activity. In addition, substantially all of our manufacturing occurs in a geographically concentrated area in mainland China, where disruptions from natural disasters, health epidemics and political, social and economic instability may affect the region. If our manufacturers or warehousing facilities are disrupted or destroyed, we would be unable to distribute our products on a timely basis, which could harm our business. Moreover, if our computer information systems or communication systems, or those of our vendors or customers, are subject to disruptive hacker attacks or other disruptions, our business could suffer. We have not established a formal disaster recovery plan. Our back-up operations may be inadequate and our business interruption insurance may not be enough to compensate us for any losses that may occur. A significant business interruption could result in losses or damages and harm our business. For example, much of our order fulfillment process is automated and the order information is stored on our servers. If our computer systems and servers go down even for a short period at the end of a fiscal quarter, our ability to recognize revenue would be delayed until we were again able to process and ship our orders, which could cause our stock price to decline significantly.
Our stock price may be volatile and your investment in our common stock could suffer a decline in value.
With the current uncertainty about economic conditions in the United States, there has been significant volatility in the market price and trading volume of securities of technology and other companies, which may be unrelated to the financial performance of these companies. These broad market fluctuations may negatively affect the market price of our common stock.
Some specific factors that may have a significant effect on our common stock market price include:
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| • | actual or anticipated fluctuations in our operating results or our competitors’ operating results; |
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| • | actual or anticipated changes in our growth rates or our competitors’ growth rates; |
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| • | conditions in the financial markets in general or changes in general economic conditions; |
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| • | our ability to raise additional capital; and |
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| • | changes in stock market analyst recommendations regarding our common stock, other comparable companies or our industry generally. |
The large number of shares eligible for public sale could cause our stock price to decline.
A small number of stockholders own a substantial number of shares of our stock. Many of our largest holders will have rights, subject to some conditions, to require us to file registration statements covering their shares or to include their shares in registration statements that we may file for ourselves or other stockholders. Moreover, substantially all of the common stock issued upon exercise of options under our stock option plans and employee stock purchase plan can be freely sold in the public market. If any of these holders cause a large number of securities to be sold in the public market, the sales could reduce the trading price of our common stock. These sales also could impede our ability to raise future capital.
Concentration of ownership among our existing executive officers, directors and principal stockholders may prevent new investors from influencing significant corporate decisions and may result in a lower trading price for our stock than if ownership of our stock was less concentrated.
Our executive officers, directors and principal stockholders beneficially own, in total, approximately 63.3% of our outstanding common stock. As a result, these stockholders, acting together, could have the ability to exert substantial influence over all matters requiring approval by our stockholders, including the election and removal of directors and any proposed merger, consolidation or sale of all or substantially all of our assets and other corporate transactions. This concentration of control could be disadvantageous to other stockholders with interests different from those of our officers, directors and principal stockholders. For example, our officers, directors and principal stockholders could delay or prevent an acquisition or merger even if the transaction would benefit other stockholders. In addition, this significant concentration of share ownership may adversely affect the trading price for our common stock because investors often perceive disadvantages in owning stock in companies with controlling stockholders.
Some provisions of our charter and by-laws may delay or prevent transactions that many stockholders may favor, and may have the effect of entrenching management.
Some provisions of our certificate of incorporation and by-laws may discourage, delay or prevent a merger or acquisition that our stockholders may consider favorable, including transactions in which stockholders might otherwise receive a premium for their shares. These provisions include:
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| • | authorization of the issuance of “blank check” preferred stock without the need for stockholder approval; |
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| • | elimination of the ability of stockholders to call special meetings of stockholders or act by written consent; and |
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| • | advance notice requirements for proposing matters that can be acted on by stockholders at stockholder meetings. |
In addition, some provisions of Delaware law may also discourage, delay or prevent someone from acquiring us or merging with us. Such provisions of Delaware law and the provisions of our certificate of incorporation may have the effect of entrenching management by making it more difficult to remove directors.
| |
Item 7A. | Quantitative and Qualitative Disclosures About Market Risk |
We do not use derivative financial instruments in our investment portfolio. We have an investment portfolio of fixed income securities that are classified as
“available-for-sale“available-for-sale securities.” These securities, like all fixed income instruments, are subject to interest rate risk and will fall in value if market interest rates increase. We attempt to limit this exposure by investing primarily in short-term securities. Due to the short
43
duration and conservative nature of our investment portfolio, a movement of 10% by market interest rates would not have a material impact on our operating results and the total value of the portfolio over the next fiscal year.
We are exposed to risks associated with foreign exchange rate fluctuations due to our international manufacturing and sales activities. We generally have not hedged currency exposures. These exposures may change over time as business practices evolve and could negatively impact our operating results and financial condition. AllIn the second quarter of 2005 we began to invoice some of our salesinternational customers in foreign currencies including, but not limited to, the Euro, Great Britain Pound, Japanese Yen and the Australian dollar. As the customers that are denominatedcurrently invoiced in local currency become a larger percentage of our business, or to the extent we begin to bill additional customers in foreign currencies, the impact of fluctuations in foreign exchange rates could have a more significant impact on our results of operations. For those customers in our international markets that we continue to sell to in U.S. dollars. Andollars, an increase in the value of the U.S. dollar relative to foreign currencies could make our products more expensive and therefore reduce the demand for our products. Such a decline in the demand could reduce sales and/orand negatively impact our operating results. Certain operating expenses of our foreign operations require payment in the local currencies. As of December 31, 2006, we had net assets in various local currencies. A hypothetical 10% movement in foreign exchange rates would result in operating losses.an after tax positive or negative impact of $2.6 million to net income at December 31, 2006.
38
44
| |
| Item 8. | Consolidated Financial Statements and Supplementary Data |
Management’s Report on Internal Control Over Financial Reporting
Management of NETGEAR, Inc. is responsible for establishing and maintaining adequate internal control over financial reporting, as defined inRules 13a-15(f) and 15(d)-15(f) under the Securities Exchange Act of 1934. The Company’s internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Under the supervision and with the participation of management, including its principal executive officer and principal financial officer, the Company assessed the effectiveness of its internal control over financial reporting as of December 31, 2006. In conducting its evaluation, the Company used the criteria set forth in theInternal Control-Integrated Frameworkissued by the Committee of Sponsoring Organizations of the Treadway Commission.
Based on its evaluation and those criteria, management concluded that the Company maintained effective internal control over financial reporting as of December 31, 2006. The Company’s independent registered public accounting firm, PricewaterhouseCoopers LLP, has audited management’s assessment of the Company’s internal control over financial reporting as of December 31, 2006 as stated in their report which appears herein.
39
REPORT OF INDEPENDENT AUDITORSReport of Independent Registered Public Accounting FirmTo the Board of Directors and Stockholders
of NETGEAR, Inc.:
We have completed integrated audits of NETGEAR, Inc.’s consolidated financial statements and of its internal control over financial reporting as of December 31, 2006 in accordance with the standards of the Public Company Accounting Oversight Board (United States). Our opinions, based on our audits, are presented below.
Consolidated financial statements and financial statement schedule
In our opinion, the
consolidated financial statements listed in the accompanying
consolidated balance sheets and related consolidated statements of operations, of stockholders’ equity (deficit) and of cash flowsindex appearing under Item 15 (a)(1) present fairly, in all material respects, the financial position of NETGEAR, Inc. and its subsidiaries at December 31,
20022006 and
2003,December 31, 2005, and the results of their operations and their cash flows for each of the three years in the period ended December 31,
2003,2006 in conformity with accounting principles generally accepted in the United States of America.
In addition, in our opinion, the financial statement schedule appearing under Item 15 (a)(2) presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. These financial statements
and financial statement schedule are the responsibility of the Company’s
management; ourmanagement. Our responsibility is to express an opinion on these financial statements
and financial statement schedule based on our audits. We conducted our audits of these statements in accordance with
auditingthe standards
generally accepted inof the
United States of America, whichPublic Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit
of financial statements includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
As discussed in Note 27 of the Notes to Consolidated Financial Statements, in accordance with the adoption of SFAS 123R, the Company changed the manner in which it accounts for share-based compensation in the year ended December 31, 2006.
Internal control over financial reporting
Also, in our opinion, management’s assessment, included in Management’s Report on Internal Control Over Financial Reporting appearing under Item 8, that the Company maintained effective internal control over financial reporting as of December 31, 2006 based on criteria established inInternal Control — Integrated Frameworkissued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), is fairly stated, in all material respects, based on those criteria. Furthermore, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2006, based on criteria established inInternal Control — Integrated Frameworkissued by the COSO. The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express opinions on management’s assessment and on the effectiveness of the Company’s internal control over financial reporting based on our audit. We conducted our audit of internal control over financial reporting in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. An audit of internal control over financial reporting includes obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we consider necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinions.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the accompanying consolidatedmaintenance of records that, in reasonable detail,
40
accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in 2002 NETGEAR, Inc. changedaccordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its
methodinherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of
accounting for goodwill. | |
| /S/ PRICEWATERHOUSECOOPERS LLP |
any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
/s/ PRICEWATERHOUSECOOPERS LLP
San Jose, California
February 23, 2004March 1, 2007
41
45
CONSOLIDATED BALANCE SHEETS
(In Thousands, Except Share and Per Share Data)
| | | | | | | | | | | | |
| | |
| | December 31, |
| |
|
| | 2002 | | 2003 |
| |
| |
|
| ASSETS |
| Current Assets: | | | | | | | | |
| | Cash and cash equivalents | | $ | 19,880 | | | $ | 61,215 | |
| | Short-term investments | | | — | | | | 12,390 | |
| | Accounts receivable, net | | | 42,492 | | | | 74,866 | |
| | Inventories | | | 24,774 | | | | 39,266 | |
| | Deferred income taxes | | | — | | | | 9,056 | |
| | Prepaid expenses and other current assets | | | 3,003 | | | | 4,169 | |
| | | |
| | | |
| |
| | | Total current assets | | | 90,149 | | | | 200,962 | |
| Property and equipment, net | | | 3,144 | | | | 3,626 | |
| Goodwill | | | 558 | | | | 558 | |
| | | |
| | | |
| |
| | | Total assets | | $ | 93,851 | | | $ | 205,146 | |
| | | |
| | | |
| |
LIABILITIES, REDEEMABLE CONVERTIBLE PREFERRED
STOCK AND STOCKHOLDERS’ EQUITY (DEFICIT) |
| Current Liabilities: | | | | | | | | |
| | Accounts payable | | $ | 10,628 | | | $ | 24,480 | |
| | Payable to related parties | | | 13,687 | | | | 6,412 | |
| | Accrued employee compensation | | | 3,375 | | | | 3,871 | |
| | Other accrued liabilities | | | 29,419 | | | | 31,299 | |
| | Deferred revenue | | | 5,059 | | | | 2,380 | |
| | Income taxes payable | | | 934 | | | | 1,765 | |
| | Note payable to Nortel Networks | | | 13,294 | | | | — | |
| | | |
| | | |
| |
| | | Total current liabilities | | | 76,396 | | | | 70,207 | |
| | | |
| | | |
| |
| Commitments (Note 7) | | | | | | | | |
| Redeemable convertible preferred stock: $0.001 par value; shares authorized, 40,508,038 in 2002 and none in 2003 | | | | | | | | |
| | Series A, shares designated: 26,250,000 in 2002, none in 2003; shares issued and outstanding: 5,976,082 in 2002 and none in 2003 | | | 6,630 | | | | — | |
| | Series B, shares designated: 3,320,538 in 2002, none in 2003; shares issued and outstanding: 3,320,537 in 2002 and none in 2003 | | | 14,955 | | | | — | |
| | Series C, shares designated: 10,937,500 in 2002, none in 2003; shares issued and outstanding: 10,937,406 in 2002 and none in 2003 | | | 26,467 | | | | — | |
| | | |
| | | |
| |
| | | | 48,052 | | | | — | |
| | | |
| | | |
| |
| Stockholders’ equity (deficit): | | | | | | | | |
| | Preferred Stock: $0.001 par value; shares authorized, none in 2002 and 5,000,000 in 2003; none in 2002; none outstanding in 2002 or 2003 | | | — | | | | — | |
| | Common stock: $0.001 par value; shares authorized, 63,656,250 in 2002, and 200,000,000 in 2003; | | | | | | | | |
| | | Shares issued and outstanding: none in 2002 and 28,618,969 in 2003 | | | — | | | | 28 | |
| | Additional paid-in capital | | | 12,810 | | | | 164,459 | |
| | Deferred stock-based compensation | | | (4,997 | ) | | | (4,248 | ) |
| | Cumulative other comprehensive income | | | — | | | | 13 | |
| | Accumulated deficit | | | (38,410 | ) | | | (25,313 | ) |
| | | |
| | | |
| |
| | | | Total stockholders’ equity (deficit) | | | (30,597 | ) | | | 134,939 | |
| | | |
| | | |
| |
| | | | Total liabilities, redeemable convertible preferred stock and stockholders’ equity (deficit) | | $ | 93,851 | | | $ | 205,146 | |
| | | |
| | | |
| |
| | | | | | | | | |
| | | December 31, | |
| | | 2005 | | | 2006 | |
| | | (In thousands, except share and per share data) | |
| |
ASSETS |
| Current assets: | | | | | | | | |
| Cash and cash equivalents | | $ | 90,002 | | | $ | 87,736 | |
| Short-term investments | | | 83,654 | | | | 109,729 | |
| Accounts receivable, net | | | 104,269 | | | | 119,601 | |
| Inventories | | | 51,873 | | | | 77,932 | |
| Deferred income taxes | | | 11,503 | | | | 13,415 | |
| Prepaid expenses and other current assets | | | 9,408 | | | | 15,946 | |
| | | | | | | | | |
| Total current assets | | | 350,709 | | | | 424,359 | |
| Property and equipment, net | | | 4,702 | | | | 6,568 | |
| Intangibles, net | | | — | | | | 975 | |
| Goodwill | | | 558 | | | | 3,800 | |
| Other non-current assets | | | 328 | | | | 2,202 | |
| | | | | | | | | |
| Total assets | | $ | 356,297 | | | $ | 437,904 | |
| | | | | | | | | |
| |
LIABILITIES AND STOCKHOLDERS’ EQUITY |
| Current liabilities: | | | | | | | | |
| Accounts payable | | $ | 38,912 | | | $ | 39,818 | |
| Accrued employee compensation | | | 7,743 | | | | 11,803 | |
| Other accrued liabilities | | | 66,279 | | | | 75,909 | |
| Deferred revenue | | | 4,304 | | | | 8,215 | |
| Income taxes payable | | | 3,055 | | | | 7,737 | |
| | | | | | | | | |
| Total current liabilities | | | 120,293 | | | | 143,482 | |
| Commitments and contingencies (Note 6) | | | | | | | | |
| Stockholders’ equity: | | | | | | | | |
| Preferred stock: $0.001 par value; 5,000,000 shares authorized in 2005 and 2006; none outstanding in 2005 or 2006 | | | — | | | | — | |
| Common stock: $0.001 par value; 200,000,000 shares authorized in 2005 and 2006; shares issued and outstanding: 32,963,596 in 2005 and 33,960,506 in 2006 | | | 33 | | | | 33 | |
| Additional paid-in capital | | | 204,754 | | | | 221,487 | |
| Deferred stock-based compensation | | | (468 | ) | | | — | |
| Cumulative other comprehensive loss | | | (90 | ) | | | (5 | ) |
| Retained earnings | | | 31,775 | | | | 72,907 | |
| | | | | | | | | |
| Total stockholders’ equity | | | 236,004 | | | | 294,422 | |
| | | | | | | | | |
| Total liabilities and stockholders’ equity | | $ | 356,297 | | | $ | 437,904 | |
| | | | | | | | | |
The accompanying notes are an integral part of these consolidated financial statements.
42
46
CONSOLIDATED STATEMENTS OF OPERATIONS
(In Thousands, Except Per Share Data)
| | | | | | | | | | | | | | | | |
| | |
| | Year Ended December 31, |
| |
|
| | 2001 | | 2002 | | 2003 |
| |
| |
| |
|
| Net revenue | | $ | 192,440 | | | $ | 237,331 | | | $ | 299,302 | |
| | | |
| | | |
| | | |
| |
| Cost of revenue: | | | | | | | | | | | | |
| | Cost of revenue | | | 172,795 | | | | 176,972 | | | | 215,332 | |
| | Amortization of deferred stock-based compensation | | | — | | | | 144 | | | | 128 | |
| | | |
| | | |
| | | |
| |
| | Total cost of revenue | | | 172,795 | | | | 177,116 | | | | 215,460 | |
| | | |
| | | |
| | | |
| |
| Gross profit | | | 19,645 | | | | 60,215 | | | | 83,842 | |
| | | |
| | | |
| | | |
| |
| Operating expenses: | | | | | | | | | | | | |
| | Research and development | | | 4,432 | | | | 7,359 | | | | 8,220 | |
| | Sales and marketing | | | 24,267 | | | | 32,622 | | | | 48,963 | |
| | General and administrative | | | 5,914 | | | | 8,103 | | | | 8,977 | |
| | Goodwill amortization | | | 335 | | | | — | | | | — | |
| | Amortization of deferred stock-based compensation: | | | | | | | | | | | | |
| | | Research and development | | | — | | | | 306 | | | | 454 | |
| | | Sales and marketing | | | — | | | | 346 | | | | 715 | |
| | | General and administrative | | | — | | | | 867 | | | | 476 | |
| | | |
| | | |
| | | |
| |
| | | | Total operating expenses | | | 34,948 | | | | 49,603 | | | | 67,805 | |
| | | |
| | | |
| | | |
| |
| Income (loss) from operations | | | (15,303 | ) | | | 10,612 | | | | 16,037 | |
| Interest income | | | 308 | | | | 119 | | | | 364 | |
| Interest expense | | | (939 | ) | | | (1,240 | ) | | | (901 | ) |
| Extinguishment of debt | | | — | | | | — | | | | (5,868 | ) |
| Other expenses, net | | | (478 | ) | | | (19 | ) | | | (59 | ) |
| | | |
| | | |
| | | |
| |
| Income (loss) before taxes | | | (16,412 | ) | | | 9,472 | | | | 9,573 | |
| Provision for (benefit from) income taxes | | | 3,072 | | | | 1,333 | | | | (3,524 | ) |
| | | |
| | | |
| | | |
| |
| Net income (loss) | | | (19,484 | ) | | | 8,139 | | | | 13,097 | |
| Deemed dividend on Preferred Stock | | | — | | | | (17,881 | ) | | | — | |
| | | |
| | | |
| | | |
| |
| Net income (loss) attributable to common stockholders | | $ | (19,484 | ) | | $ | (9,742 | ) | | $ | 13,097 | |
| | | |
| | | |
| | | |
| |
| Net income (loss) per share attributable to common stockholders (Note 4): | | | | | | | | | | | | |
| | Basic | | $ | (0.66 | ) | | $ | (0.46 | ) | | $ | 0.55 | |
| | | |
| | | |
| | | |
| |
| | Diluted | | $ | (0.66 | ) | | $ | (0.46 | ) | | $ | 0.49 | |
| | | |
| | | |
| | | |
| |
| |
| Weighted average shares outstanding | | | | | | | | | | | | |
| Used to compute net income (loss) per share: | | | | | | | | | | | | |
| Basic | | | 29,571 | | | | 21,181 | | | | 23,653 | |
| | | |
| | | |
| | | |
| |
| Diluted | | | 29,571 | | | | 21,181 | | | | 26,800 | |
| | | |
| | | |
| | | |
| |
| | | | | | | | | | | | | |
| | | Year Ended December 31, | |
| | | 2004 | | | 2005 | | | 2006 | |
| | | (In thousands, except per share data) | |
| |
| Net revenue | | $ | 383,139 | | | $ | 449,610 | | | $ | 573,570 | |
| Cost of revenue(1) | | | 260,318 | | | | 297,911 | | | | 379,911 | |
| | | | | | | | | | | | | |
| Gross profit | | | 122,821 | | | | 151,699 | | | | 193,659 | |
| | | | | | | | | | | | | |
| Operating expenses: | | | | | | | | | | | | |
| Research and development(1) | | | 10,316 | | | | 12,837 | | | | 18,443 | |
| Sales and marketing(1) | | | 62,247 | | | | 71,345 | | | | 91,881 | |
| General and administrative(1) | | | 14,905 | | | | 14,559 | | | | 20,905 | |
| In-process research and development | | | — | | | | — | | | | 2,900 | |
| Litigation reserves | | | — | | | | 802 | | | | — | |
| | | | | | | | | | | | | |
| Total operating expenses | | | 87,468 | | | | 99,543 | | | | 134,129 | |
| | | | | | | | | | | | | |
| Income from operations | | | 35,353 | | | | 52,156 | | | | 59,530 | |
| Interest income | | | 1,593 | | | | 4,104 | | | | 6,974 | |
| Other income (expense), net | | | (560 | ) | | | (1,770 | ) | | | 2,495 | |
| | | | | | | | | | | | | |
| Income before income taxes | | | 36,386 | | | | 54,490 | | | | 68,999 | |
| Provision for income taxes | | | 12,921 | | | | 20,867 | | | | 27,867 | |
| | | | | | | | | | | | | |
| Net income | | $ | 23,465 | | | $ | 33,623 | | | $ | 41,132 | |
| | | | | | | | | | | | | |
| Net income per share: | | | | | | | | | | | | |
| Basic | | $ | 0.77 | | | $ | 1.04 | | | $ | 1.23 | |
| | | | | | | | | | | | | |
| Diluted | | $ | 0.72 | | | $ | 0.99 | | | $ | 1.19 | |
| | | | | | | | | | | | | |
| Weighted average shares outstanding used to compute net income per share: | | | | | | | | | | | | |
| Basic | | | 30,441 | | | | 32,351 | | | | 33,381 | |
| | | | | | | | | | | | | |
| Diluted | | | 32,626 | | | | 33,939 | | | | 34,553 | |
| | | | | | | | | | | | | |
| (1) Stock-based compensation expense was allocated as follows: | | | | | | | | | | | | |
| Cost of revenue | | $ | 163 | | | $ | 147 | | | $ | 430 | |
| Research and development | | | 400 | | | | 293 | | | | 1,119 | |
| Sales and marketing | | | 733 | | | | 375 | | | | 1,405 | |
| General and administrative | | | 391 | | | | 249 | | | | 1,551 | |
The accompanying notes are an integral part of these consolidated financial statements.
43
47
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (DEFICIT)
Years Ended December 31, 2001, 20022004, 2005 and 20032006
(In thousands, except share data)
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | Cumulative | | | | Total | | |
| | Common Stock | | Additional | | Deferred | | Other | | | | Stockholders’ | | |
| |
| | Paid-In | | Stock-based | | Comprehensive | | Accumulated | | Equity | | Comprehensive |
| | Shares | | Amount | | Capital | | Compensation | | Income | | Deficit | | (Deficit) | | Income (loss) |
| |
| |
| |
| |
| |
| |
| |
| |
|
| Balance at January 1, 2001 | | | — | | | $ | — | | | $ | 2,601 | | | $ | — | | | $ | — | | | $ | (9,184 | ) | | $ | (6,583 | ) | | $ | (9,184 | ) |
| Net loss | | | — | | | | — | | | | — | | | | — | | | | — | | | | (19,484 | ) | | | (19,484 | ) | | | (19,484 | ) |
| | | |
| | | |
| | | |
| | | |
| | | |
| | | |
| | | |
| | | |
| |
| Balance at December 31, 2001 | | | — | | | | — | | | | 2,601 | | | | — | | | | — | | | | (28,668 | ) | | | (26,067 | ) | | | (28,668 | ) |
| Forgiveness of payable by Nortel Networks | | | — | | | | — | | | | 2,927 | | | | — | | | | — | | | | — | | | | 2,927 | | | | — | |
| Deferred stock-based compensation | | | — | | | | — | | | | 6,660 | | | | (6,660 | ) | | | — | | | | — | | | | — | | | | — | |
| Amortization of deferred stock-based compensation | | | | | | | — | | | | — | | | | 1,663 | | | | — | | | | — | | | | 1,663 | | | | — | |
| Deemed dividend related to repurchase of Series A Preferred Stock and issuance of Series C Preferred Stock | | | — | | | | — | | | | — | | | | — | | | | — | | | | (17,881 | ) | | | (17,881 | ) | | | (17,881 | ) |
| Issuance of common stock warrant in connection with issuance of Series C Preferred Stock | | | — | | | | — | | | | 622 | | | | — | | | | — | | | | — | | | | 622 | | | | — | |
| Net income | | | — | | | | — | | | | — | | | | — | | | | — | | | | 8,139 | | | | 8,139 | | | | 8,139 | |
| | | |
| | | |
| | | |
| | | |
| | | |
| | | |
| | | |
| | | |
| |
| Balance at December 31, 2002 | | | — | | | | — | | | | 12,810 | | | | (4,997 | ) | | | — | | | | (38,410 | ) | | | (30,597 | ) | | | (38,410 | ) |
| Deferred stock-based compensation | | | — | | | | — | | | | 1,024 | | | | (1,024 | ) | | | — | | | | — | | | | — | | | | — | |
| Amortization of deferred stock-based compensation | | | — | | | | — | | | | — | | | | 1,773 | | | | — | | | | — | | | | 1,773 | | | | — | |
| Conversion of Preferred Stock into common stock | | | 20,228,480 | | | | 20 | | | | 48,019 | | | | — | | | | — | | | | — | | | | 48,039 | | | | — | |
| Issuance of common stock in IPO (net of issuance costs of $2,999) | | | 8,050,000 | | | | 8 | | | | 101,801 | | | | — | | | | — | | | | — | | | | 101,809 | | | | — | |
| Exercise of common stock warrants | | | 218,750 | | | | — | | | | 283 | | | | — | | | | — | | | | — | | | | 283 | | | | — | |
| Repurchase of common stock | | | (20,157 | ) | | | — | | | | (283 | ) | | | — | | | | — | | | | — | | | | (283 | ) | | | — | |
| Exercise of common stock options | | | 141,896 | | | | — | | | | 805 | | | | — | | | | — | | | | — | | | | 805 | | | | — | |
| Unrealized gain on short-term investments | | | — | | | | — | | | | — | | | | — | | | | 13 | | | | — | | | | 13 | | | | 13 | |
| Net income | | | — | | | | — | | | | — | | | | — | | | | — | | | | 13,097 | | | | 13,097 | | | | 13,097 | |
| | | |
| | | |
| | | |
| | | |
| | | |
| | | |
| | | |
| | | |
| |
| Balance at December 31, 2003 | | | 28,618,969 | | | $ | 28 | | | $ | 164,459 | | | $ | (4,248 | ) | | $ | 13 | | | $ | (25,313 | ) | | $ | 134,939 | | | $ | (25,300 | ) |
| | | |
| | | |
| | | |
| | | |
| | | |
| | | |
| | | |
| | | |
| |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | Cumulative
| | | Retained
| | | | |
| | | | | | | | | Additional
| | | Deferred
| | | Other
| | | Earnings
| | | | |
| | | Common Stock | | | Paid-in
| | | Stock-Based
| | | Comprehensive
| | | (Accumulated
| | | | |
| | | Shares | | | Amount | | | Capital | | | Compensation | | | Income (Loss) | | | Deficit) | | | Total | |
| | | (In thousands, except share data) | |
| |
| Balance at December 31, 2003 | | | 28,618,969 | | | | 28 | | | | 164,459 | | | | (4,248 | ) | | | 13 | | | | (25,313 | ) | | | 134,939 | |
| Comprehensive income: | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Unrealized loss on short-term investments | | | — | | | | — | | | | — | | | | — | | | | (20 | ) | | | — | | | | (20 | ) |
| Net income | | | — | | | | — | | | | — | | | | — | | | | — | | | | 23,465 | | | | 23,465 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Total comprehensive income | | | — | | | | — | | | | — | | | | — | | | | — | | | | — | | | | 23,445 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Reversal of deferred stock-based compensation | | | — | | | | — | | | | (678 | ) | | | 678 | | | | — | | | | — | | | | — | |
| Amortization of deferred stock-based compensation | | | — | | | | — | | | | — | | | | 1,688 | | | | — | | | | — | | | | 1,688 | |
| Exercise of common stock options | | | 2,796,428 | | | | 3 | | | | 12,965 | | | | — | | | | — | | | | — | | | | 12,968 | |
| Issuance of common stock under employee stock purchase plan | | | 39,217 | | | | — | | | | 381 | | | | — | | | | — | | | | — | | | | 381 | |
| Tax benefit from exercise of stock options | | | — | | | | — | | | | 11,773 | | | | — | | | | — | | | | — | | | | 11,773 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Balance at December 31, 2004 | | | 31,454,614 | | | | 31 | | | | 188,900 | | | | (1,882 | ) | | | (7 | ) | | | (1,848 | ) | | | 185,194 | |
| Comprehensive income: | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Unrealized loss on short-term investments | | | — | | | | — | | | | — | | | | — | | | | (83 | ) | | | — | | | | (83 | ) |
| Net income | | | — | | | | — | | | | — | | | | — | | | | — | | | | 33,623 | | | | 33,623 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Total comprehensive income | | | — | | | | — | | | | — | | | | — | | | | — | | | | — | | | | 33,540 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Reversal of deferred stock-based compensation | | | — | | | | — | | | | (350 | ) | | | 350 | | | | — | | | | — | | | | — | |
| Amortization of deferred stock-based compensation | | | — | | | | — | | | | — | | | | 1,064 | | | | — | | | | — | | | | 1,064 | |
| Exercise of common stock options | | | 1,422,123 | | | | 2 | | | | 8,101 | | | | — | | | | — | | | | — | | | | 8,103 | |
| Issuance of common stock under employee stock purchase plan | | | 86,859 | | | | — | | | | 1,002 | | | | — | | | | — | | | | — | | | | 1,002 | |
| Tax benefit from exercise of stock options | | | — | | | | — | | | | 7,101 | | | | — | | | | — | | | | — | | | | 7,101 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Balance at December 31, 2005 | | | 32,963,596 | | | | 33 | | | | 204,754 | | | | (468 | ) | | | (90 | ) | | | 31,775 | | | | 236,004 | |
| Comprehensive income: | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Unrealized gain on short-term investments | | | — | | | | — | | | | — | | | | — | | | | 85 | | | | — | | | | 85 | |
| Net income | | | — | | | | — | | | | — | | | | — | | | | — | | | | 41,132 | | | | 41,132 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Total comprehensive income | | | — | | | | — | | | | — | | | | — | | | | — | | | | — | | | | 41,217 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Reversal of deferred stock-based compensation | | | — | | | | — | | | | (468 | ) | | | 468 | | | | — | | | | — | | | | — | |
| Stock-based compensation expense | | | — | | | | — | | | | 4,505 | | | | — | | | | — | | | | — | | | | 4,505 | |
| Exercise of common stock options | | | 932,928 | | | | — | | | | 7,433 | | | | — | | | | — | | | | — | | | | 7,433 | |
| Issuance of common stock under employee stock purchase plan | | | 63,982 | | | | — | | | | 1,100 | | | | — | | | | — | | | | — | | | | 1,100 | |
| Tax benefit from exercise of stock options | | | — | | | | — | | | | 4,163 | | | | — | | | | — | | | | — | | | | 4,163 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Balance at December 31, 2006 | | | 33,960,506 | | | $ | 33 | | | $ | 221,487 | | | $ | — | | | $ | (5 | ) | | $ | 72,907 | | | $ | 294,422 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
The accompanying notes are an integral part of these consolidated financial statements.
44
48
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
| | | | | | | | | | | | | | | | | |
| | |
| | Year Ended December 31, |
| |
|
| | 2001 | | 2002 | | 2003 |
| |
| |
| |
|
Cash flows from operating activities: | | | | | | | | | | | | |
| | Net income (loss) | | $ | (19,484 | ) | | $ | 8,139 | | | $ | 13,097 | |
| | Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: | | | | | | | | | | | | |
| | | Depreciation and amortization | | | 898 | | | | 1,354 | | | | 2,007 | |
| | | Goodwill amortization | | | 335 | | | | — | | | | — | |
| | | Amortization of deferred stock-based compensation | | | — | | | | 1,663 | | | | 1,773 | |
| | | Deferred income taxes | | | 3,472 | | | | — | | | | (9,056 | ) |
| | | Accretion of note payable to Nortel Networks | | | — | | | | 1,220 | | | | 838 | |
| | | Extinguishment of debt charge | | | — | | | | — | | | | 5,868 | |
| | | Changes in assets and liabilities: | | | | | | | | | | | | |
| | | | Accounts receivable | | | 14,400 | | | | (23,740 | ) | | | (32,374 | ) |
| | | | Inventories | | | 31,259 | | | | 6,482 | | | | (14,492 | ) |
| | | | Prepaid expenses and other current assets | | | (459 | ) | | | (1,093 | ) | | | (1,166 | ) |
| | | | Accounts payable | | | (7,402 | ) | | | (1,301 | ) | | | 13,852 | |
| | | | Payable to related parties | | | 2,362 | | | | 1,109 | | | | (7,275 | ) |
| | | | Accrued employee compensation | | | (463 | ) | | | 2,404 | | | | 496 | |
| | | | Other accrued liabilities | | | 7,302 | | | | 14,674 | | | | 1,880 | |
| | | | Deferred revenue | | | (27,286 | ) | | | 4,693 | | | | (2,679 | ) |
| | | | Income tax payable | | | (1,107 | ) | | | (441 | ) | | | 831 | |
| | | |
| | | |
| | | |
| |
| | | | | Net cash provided by (used in) operating activities | | | 3,827 | | | | 15,163 | | | | (26,400 | ) |
| | | |
| | | |
| | | |
| |
Cash flows from investing activities: | | | | | | | | | | | | |
| | Purchase of short-term investments | | | — | | | | — | | | | (12,377 | ) |
| | Purchase of property and equipment | | | (1,122 | ) | | | (3,224 | ) | | | (2,489 | ) |
| | | |
| | | |
| | | |
| |
| | | | | Net cash used in investing activities | | | (1,122 | ) | | | (3,224 | ) | | | (14,866 | ) |
| | | |
| | | |
| | | |
| |
Cash flows from financing activities: | | | | | | | | | | | | |
| | Borrowing under line of credit | | | 12,042 | | | | 47,473 | | | | 17,000 | |
| | Repayments under line of credit | | | (12,042 | ) | | | (47,473 | ) | | | (17,000 | ) |
| | Repayment of note payable to Nortel Networks | | | — | | | | — | | | | (20,000 | ) |
| | Issuance of common stock in IPO | | | — | | | | — | | | | 101,809 | |
| | Proceeds from issuance of Series C Preferred Stock | | | — | | | | 4,700 | | | | — | |
| | Series C Preferred Stock issuance costs | | | — | | | | (1,211 | ) | | | — | |
| | Repurchase of Series A Preferred Stock | | | — | | | | (4,700 | ) | | | (13 | ) |
| | Proceeds from exercise of stock options | | | — | | | | — | | | | 805 | |
| | | |
| | | |
| | | |
| |
| | | | | Net cash provided by (used in) financing activities | | | — | | | | (1,211 | ) | | | 82,601 | |
| | | |
| | | |
| | | |
| |
| Net increase in cash and cash equivalents | | | 2,705 | | | | 10,728 | | | | 41,335 | |
| Cash and cash equivalents at beginning of year | | | 6,447 | | | | 9,152 | | | | 19,880 | |
| | | |
| | | |
| | | |
| |
| Cash and cash equivalents at end of year | | $ | 9,152 | | | $ | 19,880 | | | $ | 61,215 | |
| | | |
| | | |
| | | |
| |
Supplemental cash flow information: | | | | | | | | | | | | |
| | Cash paid for income taxes | | $ | 425 | | | $ | 1,903 | | | $ | 4,840 | |
| | | |
| | | |
| | | |
| |
| | Cash paid for interest | | $ | 939 | | | $ | 18 | | | $ | 67 | |
| | | |
| | | |
| | | |
| |
Supplemental schedule of noncash investing and financing: | | | | | | | | | | | | |
| | Conversion of Preferred Stock to common stock | | $ | — | | | $ | — | | | $ | 48,039 | |
| | | |
| | | |
| | | |
| |
| | Cashless exercise of warrants and net common stock issued | | $ | — | | | $ | — | | | $ | 283 | |
| | | |
| | | |
| | | |
| |
| | | | | | | | | | | | | |
| | | Year Ended December 31, | |
| | | 2004 | | | 2005 | | | 2006 | |
| | | (In thousands) | |
| |
Cash flows from operating activities: | | | | | | | | | | | | |
| Net income | | $ | 23,465 | | | $ | 33,623 | | | $ | 41,132 | |
| Adjustments to reconcile net income to net cash provided by operating activities: | | | | | | | | | | | | |
| Depreciation and amortization | | | 2,593 | | | | 3,069 | | | | 7,078 | |
| Amortization (accretion) of investment purchase premiums (discounts) | | | 210 | | | | (1,373 | ) | | | (1,835 | ) |
| Non-cash stock-based compensation | | | 1,688 | | | | 1,064 | | | | 4,505 | |
| Income tax benefit associated with stock option exercises | | | 11,773 | | | | 7,101 | | | | 4,163 | |
| Excess tax benefit from stock-based compensation | | | — | | | | — | | | | (3,806 | ) |
| Deferred income taxes | | | (2,419 | ) | | | (356 | ) | | | (3,252 | ) |
| Changes in assets and liabilities, net of effect of acquisition: | | | | | | | | | | | | |
| Accounts receivable | | | (8,037 | ) | | | (22,066 | ) | | | (15,332 | ) |
| Inventories | | | (14,291 | ) | | | 1,684 | | | | (26,059 | ) |
| Prepaid expenses and other current assets | | | (2,492 | ) | | | (1,358 | ) | | | (6,582 | ) |
| Accounts payable | | | 21,850 | | | | (13,830 | ) | | | 906 | |
| Accrued employee compensation | | | 1,663 | | | | 2,209 | | | | 4,060 | |
| Other accrued liabilities | | | 19,667 | | | | 15,313 | | | | 9,497 | |
| Deferred revenue | | | (237 | ) | | | 2,160 | | | | 3,911 | |
| Income taxes payable | | | 1,894 | | | | (604 | ) | | | 4,682 | |
| | | | | | | | | | | | | |
| Net cash provided by operating activities | | | 57,327 | | | | 26,636 | | | | 23,068 | |
| | | | | | | | | | | | | |
Cash flows from investing activities: | | | | | | | | | | | | |
| Purchases of short-term investments | | | (451,287 | ) | | | (124,471 | ) | | | (173,191 | ) |
| Proceeds from maturities of short-term investments | | | 420,494 | | | | 117,873 | | | | 149,036 | |
| Purchase of property and equipment | | | (2,546 | ) | | | (4,193 | ) | | | (5,918 | ) |
| Payments made in connection with business acquisition | | | — | | | | — | | | | (7,600 | ) |
| | | | | | | | | | | | | |
| Net cash used in investing activities | | | (33,339 | ) | | | (10,791 | ) | | | (37,673 | ) |
| | | | | | | | | | | | | |
Cash flows from financing activities: | | | | | | | | | | | | |
| Proceeds from exercise of stock options | | | 12,968 | | | | 8,103 | | | | 7,433 | |
| Proceeds from issuance of common stock under employee stock purchase plan | | | 381 | | | | 1,002 | | | | 1,100 | |
| Excess tax benefit from stock-based compensation | | | — | | | | — | | | | 3,806 | |
| | | | | | | | | | | | | |
| Net cash provided by financing activities | | | 13,349 | | | | 9,105 | | | | 12,339 | |
| | | | | | | | | | | | | |
| Net increase (decrease) in cash and cash equivalents | | | 37,337 | | | | 24,950 | | | | (2,266 | ) |
| Cash and cash equivalents, at beginning of period | | | 27,715 | | | | 65,052 | | | | 90,002 | |
| | | | | | | | | | | | | |
| Cash and cash equivalents, at end of period | | $ | 65,052 | | | $ | 90,002 | | | $ | 87,736 | |
| | | | | | | | | | | | | |
Supplemental cash flow information: | | | | | | | | | | | | |
| Cash paid for income taxes | | $ | 3,297 | | | $ | 14,728 | | | $ | 22,284 | |
| | | | | | | | | | | | | |
The accompanying notes are an integral part of these consolidated financial statements.
45
49
Note 1 — The Company and Summary of Significant Accounting Policies:
The Company
NETGEAR, Inc. (“NETGEAR” or the “Company”) was incorporated in Delaware in January 1996. The Company designs, develops and markets networking products
that addressfor small business, which the
specific needsCompany defines as a business with fewer than 250 employees, and home users. The Company focuses on satisfying theease-of-use, quality, reliability, performance and affordability requirements of
small businesses and homes, enabling customersthese users. The Company’s product offerings enable users to share Internet access, peripherals, files,
and digital
multimedia content and applications among multiple personal
computers.computers, or PCs, and other Internet-enabled devices. The
Company’sCompany sells products
include Ethernet networking products, broadband products and wireless networking products that are soldprimarily through
a global sales channel network, which includes traditional retailers,
on-lineonline retailers, direct
marketingmarket resellers, or DMRs, value added resellers, or VARs, and broadband service providers.
The Company was a wholly owned subsidiary
Basis of Nortel Networks NA Inc. (“Nortel Networks”) until March 2000. In March 2000, the Company sold Series B redeemable convertible preferred stock (“Preferred Stock”) to a third-party investor, thereby diluting Nortel Networks’ ownership in the Company. In September 2000, Nortel Networks sold a portion of its ownership in the Company to additional third-party investors, further diluting its ownership interest in the Company. In February 2002, the Company sold Series C Preferred Stock to third-party investors, and Nortel Networks sold to the Company its remaining ownership interest in the Company. See Note 8 for description of the change in capital structure of the Company. On July 31, 2003, the Company completed its initial public offering, selling 8,050,000 shares of common stock (which included an underwriters’ overallotment of 1,050,000 shares) resulting in net proceeds to the Company of $101.8 million (after underwriters’ discount of $7.9 million and related offering expenses of $3.0 million). During the third quarter of 2003 the Company used $20.0 million of the proceeds to repay debt to Nortel Networks that had a carrying value of $14.1 million. The repayment of debt resulted in the recognition of an extinguishment of debt charge of $5.9 million in the third quarter of 2003 due to the acceleration of interest expense equal to the unamortized discount balance at the date of repayment. The Company also used an additional $17.0 million of the proceeds to repay debt on amounts drawn on its bank line of credit.
Immediately prior to its initial public offering, the Company effected a split of its outstanding common stock of 1.75 shares for each share outstanding. All shares and per share calculations included in the accompanying consolidated financial statements of NETGEAR have been adjusted to reflect this split.presentation
The accompanying consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All inter-company accounts and transactions have been eliminated in the consolidation of these subsidiaries. Certain reclassifications have been made to prior period reported amounts to conform to current year presentation.
Fiscal periods
The Company’s fiscal year begins on January 1 of the year stated and ends on December 31 of the same year. Effective January 1, 2002, theThe Company began reportingreports its results on a fiscal quarter basis rather than on a calendar quarter basis. Under the fiscal quarter basis, each of the first three fiscal quarterquarters ends on the Sunday closest to the calendar quarter end, with the fourth quarter ending on December 31.
Use of estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial
50
NETGEAR, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
statements and the reported amounts of revenues and expenses during the reportingreported period. Actual results could differ from those estimates.
| |
| Cash and cash equivalents
|
Cash and cash equivalents
The Company considers all highly liquid investments with an original maturity, or a remaining maturity at the time of purchase of three months or less to be cash equivalents. The Company deposits cash and cash equivalents with high credit quality financial institutions.
Short-term investments
Short-term investments comprise of marketable securities that consist of government securities with an original maturity or a remaining maturity at the time of purchase, of greater than three months and less than twelve months. All marketable securities are held in the Company’s name and are held primarily with onetwo high quality banking institution. Thefinancial institutions, who act as the Company’s policy is to protect the value of itscustodians and investment portfolio and minimize principal risk by earning returns based on current interest rates.managers. All of the Company’s marketable securities are classified asavailable-for-sale securities in accordance with the provisions of Statement of Financial Accounting Standards (“SFAS”) No. 115, “Accounting For Certain Investments in Debt and Equity Securities” and are carried at fair value with unrealized gains and losses net of taxes, reported as a separate component of stockholders’ equity.
46
| |
| Certain risks and uncertainties |
NETGEAR, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Certain risks and uncertainties
The Company’s products
and services are concentrated
in a single segment in the networking industry, which is characterized by rapid technological advances, changes in customer requirements and evolving regulatory requirements and industry standards. The success of the Company depends on management’s ability to anticipate
and/or to respond quickly and adequately to technological developments in its industry, changes in customer requirements, or changes in regulatory requirements or industry standards. Any significant delays in the development or introduction of products
or services could have a material adverse effect on the Company’s business and operating results.
The Company relies on a limited number of third parties to manufacture all of its products. If any of the Company’s third party manufacturers cannot or will not manufacture its products in required volumes, on a cost-effective basis, in a timely manner, or at all, the Company will have to secure additional manufacturing capacity. Any interruption or delay in manufacturing could have a material adverse effect on the Company’s business and operating results.
| |
| Concentration of credit risk |
Concentration of credit risk
Financial instruments that potentially subject the Company to a concentration of credit risk consist of cash and cash equivalents, short-term investments and accounts receivable. The Company believes that there is minimal credit risk associated with the investment of its cash and cash equivalents and short-term
investment,investments, due to the high quality
bankingfinancial institutions
in which
itsmanage the Company’s investments,
are deposited and the restrictions placed on the type of investment that can be entered into under the Company’s investment policy.
The Company’s accounts receivable are derived from revenue earned from customers located in the United States, and at numerous international locations around the world.
The Company’s customers are primarily distributors
as well as retailers and broadband service providers who sell the
productproducts to a large group of
end users.end-users. The Company
maintains an allowance for doubtful accounts for estimated losses resulting from the inability of the Company’s customers to make required payments. The Company regularly performs
ongoing credit evaluations of
itsthe Company’s customers’ financial condition
and considers factors such as historical experience, credit quality, age of the accounts receivable balances, and geographic or country-specific risks and economic conditions that may affect customers’ ability to pay, and, generally, requires no collateral from its customers.
The Company maintains an allowance for doubtful accounts receivable based upon the estimated rates for failure to pay by customers.51
NETGEAR, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
The following table summarizes the
percentage of the Company’s total accounts receivable represented by customers with balances
from customers in excess of 10% of
theits total accounts receivable as of December 31,
20022005 and
2003.| | | | | | | | | |
| | |
| | December 31, |
| |
|
| | 2002 | | 2003 |
| |
| |
|
| Company A | | | 30 | % | | | 40% | |
| Company B | | | 16 | % | | | 10% | |
| Company C | | | — | | | | 15% | |
| |
| | | | | | | | | | | | | | December 31, | | | | | 2005 | | | 2006 | | | | | Ingram Micro, Inc. | | | 21 | % | | | 12 | % | | Tech Data Corporation | | | 15 | % | | | 12 | % | | Best Buy Co., Inc. | | | 17 | % | | | 15 | % |
Fair value of financial instruments
|
Fair value of financial instruments
The carrying amounts of the Company’s financial instruments, including cash and cash equivalents, accounts receivable, prepaid expenses, accounts payable, accrued employee compensation and other accrued liabilities approximate their fair values due to their short maturities. See Note 23 for disclosures regarding the fair value of the Company’s short-term investments.
Inventories
Inventories consist primarily of finished goods which are valued at the lower of cost or market, with cost being determined using thefirst-in, first-out method. The Company writes down its inventories based on estimated excess and obsolete inventories determined primarily by future demand forecasts. At the point of loss recognition, a new,
47
NETGEAR, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
lower cost basis for that inventory is established, and subsequent changes in facts and circumstances do not result in the restoration or increase in that newly established cost basis.
Property and equipment
Property and equipment are stated at historical cost, less accumulated depreciation. Depreciation is computed using the straight-line method over the estimated useful lives of the assets as follows:
| | | | |
| Computer equipment | | 2-3 | 2 years | |
| Furniture and fixtures | | | 5 years | |
| Software | | | 2-5 years | |
| Machinery and equipment | | | 1-3 years | |
| Leasehold improvements | | | Shorter of the lease term or 5 years | |
The Company accounts for impairment of property and equipment in accordance with SFAS No. 144 “Accounting for the Impairment ofor Disposal of Long-Lived Assets.” Recoverability of assets to be held and used is measured by comparing the carrying amount of an asset to the estimated undiscounted future cash flows expected to be generated by the asset. If the carrying amount of the asset exceeds its estimated undiscounted future net cash flows, an impairment charge is recognized by the amount by which the carrying amount of the asset exceeds the fair value of the assets.asset. The carrying value of the asset is reviewed on a regular basis for the existence of facts, both internallyinternal and externally,external, that may suggest impairment. The Company did not recognize impairment charges in any of the periods presented.
In 2002, the
Goodwill and intangibles
The Company adoptedapplies SFAS No. 142, “Goodwill and Other Intangible Assets.” SFAS No. 142 requires, among other things, the discontinuance of goodwill amortizationAssets” and the performance ofperforms an annual goodwill impairment test. As a result, a total of approximately $558,000 of goodwill will no longer be amortized. The standard also requires that goodwill be allocated to a company’s reporting units forFor purposes of impairment testing. Thetesting, the Company has determined that it has only one reporting unit. In lieu of amortization, the Company regularly reviews the goodwill balance for potential impairment. The identification and measurement of goodwill impairment involves the estimation of the fair value of the Company. The estimates of fair value of the Company are based on the best information available as of the date of the assessment, which primarily includes the Company’s market capitalization and incorporates management assumptions about expected future cash flows. Although
Purchased intangible assets with finite lives are amortized using the straight-line method over the estimated economic lives of the assets, which range from two to four years. Purchased intangible assets determined to have indefinite useful lives are not amortized. Determination of recoverability is based on an estimate of undiscounted future cash flows resulting from the use of the asset and its eventual disposition. Measurement of an impairment loss for long-lived assets that management expects to hold and use is based on the fair value of the asset. Long-lived assets to be disposed of are reported at the lower of carrying amount or fair value less costs to sell. The carrying value of the asset is reviewed on a regular basis for the existence of facts, both internal and external, that may suggest impairment.
Product warranties
The Company provides for estimated future warranty obligations at the time revenue is recognized. The Company’s standard warranty obligation to its direct customers generally provides for a right of return of any product for a full refund in the event that such product is not merchantable or is found to be damaged or defective. At the time revenue is recognized, an estimate of future warranty returns is recorded to reduce revenue in the amount of the expected credit or refund to be provided to its direct customers. At the time the Company records the reduction to revenue related to warranty returns, the Company includes within cost of revenue a write-down to reduce the carrying value of such products to net realizable value. The Company’s standard warranty obligation to its end-users provides for repair or replacement of a defective product for one or more years. Factors that affect the warranty obligation include product failure rates, material usage, and service delivery costs incurred in correcting product
52
48
NETGEAR, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
no goodwill impairment has beenfailures. The estimated cost associated with fulfilling the Company’s warranty obligation to end-users is recorded
to date, there can be no assurances that future goodwill impairment will not occur.The Company provides for future warranty obligations upon product delivery. The warranties are generally for one year from the datein cost of purchase by the end user. The Company’s liability under these warranties is to provide a replacement product or issue a credit to the customer.revenue. Because the Company’s products are manufactured by a contract manufacturer,manufacturers, in mostcertain cases the Company has recourse to the contract manufacturer for replacement or credit for the defective products. The Company accounts for warranty returns similargives consideration to stock rotation returns. That is, revenue on shipments is reduced for estimated returns for product under warranty. Factors that affect the Company’s warranty liability include the number of installed units, historical experience and management’s judgment regarding anticipated rates of warranty claims. The Company assesses the adequacy ofamounts recoverable from its contract manufacturers in determining its warranty liability every quarter and makes adjustments to the liability if necessary.liability. Changes in the Company’s warranty liability, which is included as a component of “Other accrued liabilities” onin the Consolidated Balance Sheet, during the periodsconsolidated balance sheets, are as follows (in thousands):
| | | | | | | | | |
| | |
| | Year Ended December 31, |
| |
|
| | 2002 | | 2003 |
| |
| |
|
| Balance as of the beginning of the period | | $ | 4,720 | | | $ | 8,941 | |
| Provision for warranty liability for sales made during the period | | | 12,587 | | | | 16,237 | |
| Settlements made during the period | | | (8,366 | ) | | | (13,219 | ) |
| | | |
| | | |
| |
| Balance as of the end of period | | $ | 8,941 | | | $ | 11,959 | |
| | | |
| | | |
| |
| | | | | | | | | |
| | | Year Ended December 31, | |
| | | 2005 | | | 2006 | |
| |
| Balance as of beginning of year | | $ | 10,766 | | | $ | 11,845 | |
| Provision for warranty liability made during the year | | | 25,087 | | | | 45,459 | |
| Settlements made during the year | | | (24,008 | ) | | | (36,005 | ) |
| | | | | | | | | |
| Balance at end of year | | $ | 11,845 | | | $ | 21,299 | |
| | | | | | | | | |
Revenue recognition
Revenue from product sales is
generally recognized at the time the product is shipped provided that persuasive evidence of an arrangement exists, title and risk of loss has transferred to the customer, the selling price is fixed or determinable and
the collection of the related receivable is reasonably assured. Currently, for
internationalsome of the Company’s customers, title passes to the customer upon delivery to the port
or country of destination,
and for our selected retailers in the United States to whom the Company sells directly; title passes to the customer upon their receipt of
the product, or upon the customer’s resale of the product. At the end of each fiscal quarter, the Company estimates and defers revenue related to
the product
that is in-transit to international customers and selected retail customers in the United States that purchase direct from the Company.where title has not transferred. The revenue continues to be deferred until such time that title passes to the customer.
In addition to warranty-related returns, certain distributors and retailers generally have the right to return product for stock rotation purposes. Every quarter, stock rotation rights are
generally limited to 10% of invoiced sales to the distributor or retailer in the prior quarter. Upon shipment of the product, the Company reduces revenue for an estimate of potential future product warranty and stock rotation returns related to
the current period product revenue. Management analyzes historical returns, channel inventory levels, current economic trends and changes in customer demand
and acceptance offor the Company’s products when evaluating the adequacy of the allowance for sales returns, namely warranty and stock
rotationsrotation returns. Revenue on shipments is also reduced for estimated price protection
programs and
cooperative marketing expensessales incentives deemed to be
sales incentivescontra-revenue under Emerging Issues Task Force (“EITF”) Issue
No. 01-9.53
NETGEAR, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
The Company followsSales incentives
Sales incentives provided to customers are accounted for in accordance with EITF IssueNo. 01-9, “Accounting for Consideration Given by a Vendor to a Customer or a Reseller of the Vendor’s Products.”Products”. Under these guidelines, the Company accrues for sales incentives as a marketing expense if it receives an identifiable benefit in exchange and can reasonably estimate the fair value of the identifiable benefit received; otherwise, it is recorded as a reduction to revenues. As a consequence, the Company records a substantial portion of its channel marketing costs as a reduction of net revenue.
| |
| The Company records estimated reductions to revenues for sales incentives at the later of when the related revenue is recognized or when the program is offered to the customer or end consumer. Shipping and handling fees and costs
|
Shipping and handling fees and costs
In September 2000, the EITF issued EITF IssueNo. 00-10, “Accounting for Shipping and Handling Fees and Costs.” EITF IssueNo. 00-10 requires shipping and handling fees billed to customers to be classified as revenue and shipping and handling costs to be either classified as cost of revenue or disclosed in the notes to the consolidated financial statements. The Company includes shipping and handling fees billed to customers in net revenue.
49
NETGEAR, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Shipping and handling costs associated with inbound freight are included in cost of revenue. In cases where the Company gives a freight allowance to the customer for their own inbound freight costs, such costs are appropriately recorded as a reduction in net revenue. Shipping and handling costs associated with outbound freight are included in sales and marketing expenses and totaled $2.6$6.4 million, $2.7$6.7 million and $4.2$8.3 million in the years ended December 31, 2001, 20022004, 2005 and 2003,2006 respectively.
Research and development
Costs incurred in the research and development of new products and enhancements to existing products are charged to expense as incurred.
Advertising costs
Advertising costs are expensed as incurred. Total advertising and promotional expenses were $4.9$11.9 million, $7.1$14.5 million and $12.8$15.3 million in the years ended December 31, 2001, 20022004, 2005 and 2003,2006, respectively.
Income taxes
The Company accounts for income taxes under an asset and liability approach. Under this method, income tax expense is recognized for the liability method, which recognizesamount of taxes payable or refundable for the current year. In addition, deferred tax assets and liabilities determined based onare recognized for the difference between the financial statementexpected future tax consequences of temporary differences resulting from different treatments for tax versus accounting of certain items, such as accruals and allowances not currently deductible for tax basis ofpurposes. These differences result in deferred tax assets and liabilities, using enacted tax rates in effect forwhich are included within the year in whichconsolidated balance sheet. The Company must then assess the differences are expected to affect taxable income. Valuation allowances are established to reducelikelihood that the Company’s deferred tax assets when, based on available objective evidence, itwill be recovered from future taxable income and to the extent the Company believes that recovery is not more likely than not, the Company must establish a valuation allowance.
The Company assesses the probability of adverse outcomes from tax examinations regularly to determine the adequacy of the Company’s income tax liability. If the Company ultimately determines that payment of these amounts is unnecessary, the Company reverses the liability and recognizes a tax benefit during the period in which the Company determines that the benefitliability is no longer necessary. The Company records an additional charge in the Company’s provision for taxes in the period in which the Company determines that the recorded tax liability is less than the Company expects the ultimate assessment to be.
Computation of such assets will not be realized.net income per share
Pursuant
Basic net income per share is computed by dividing net income by the weighted average number of common shares outstanding for the period. Diluted net income per share reflects the additional dilution from potential issuances of common stock, such as stock issuable pursuant to the exercise of stock options and awards. Potentially dilutive shares are excluded from the computation of diluted net income per share when their effect is anti-dilutive.
Stock-based compensation
Effective January 1, 2006, the Company adopted the fair value recognition provisions of SFAS No. 123 (revised 2004), “Share-Based Payment” (“SFAS 123R”), using the modified prospective transition method and therefore has not restated results for prior periods. Under this transition method, stock-based compensation expense for the year ended December 31, 2006 includes compensation expense for all stock-based compensation awards granted prior to, but not yet vested as of January 1, 2006, based on the grant date fair value estimated in accordance with the original provisions of SFAS No. 123, “Accounting for Stock-Based Compensation,” the Company accountsCompensation” (“SFAS 123”). Stock-based compensation expense for employee stock options under Accounting Principles Board Opinion (“APB”) No. 25, “Accounting for Stock Issued to Employees,” and follows the disclosure-only provisions of SFAS No. 123. Under APB No. 25,all stock-based compensation expenseawards granted on or after January 1, 2006 is based on the difference, if any, on the date of the grant, between the estimatedgrant-date fair value of the Company’s common stock and the exercise price of options to purchase that stock. For purposes of estimating the compensation cost of the Company’s option grantsestimated in accordance with the provisions of SFAS No. 123,123R. The valuation provisions of SFAS 123R also apply to grants that are modified after January 1, 2006. The Company recognizes these compensation costs on a straight-line basis over the fair valuerequisite service period of each option grantthe award, which is estimated on the date of grant using the Black-Scholes option-pricing model.generally
Had compensation cost for the Company’s stock-based compensation plan been determined based on the fair value at the grant dates for the awards under a method prescribed by SFAS No. 123, the Company’s net
50
54
NETGEAR, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
income (loss) would have been adjustedthe option vesting term of four years. Prior to the
amounts indicated below (in thousands, except per share data):| | | | | | | | | | | | | | |
| | |
| | Year Ended December 31, |
| |
|
| | 2001 | | 2002 | | 2003 |
| |
| |
| |
|
| Net income (loss) attributable to common stockholders, as reported | | $ | (19,484 | ) | | $ | (9,742 | ) | | $ | 13,097 | |
| Add: Employee stock-based compensation included in reported net income (loss) | | | — | | | | 1,581 | | | | 1,773 | |
| Less: Total employee stock-based compensation determined under fair value method | | | (5,723 | ) | | | (5,558 | ) | | | (5,846 | ) |
| | | |
| | | |
| | | |
| |
| Adjusted net loss attributable to common stockholders | | $ | (25,207 | ) | | $ | (13,719 | ) | | $ | 9,024 | |
| | | |
| | | |
| | | |
| |
| Basic net income (loss) per share attributable to common stockholders: | | | | | | | | | | | | |
| | As reported | | $ | (0.66 | ) | | $ | (0.46 | ) | | $ | 0.55 | |
| | | |
| | | |
| | | |
| |
| | Adjusted | | $ | (0.85 | ) | | $ | (0.65 | ) | | $ | 0.38 | |
| | | |
| | | |
| | | |
| |
| Diluted net income (loss) per share attributable to common stockholders: | | | | | | | | | | | | |
| | As reported | | $ | (0.66 | ) | | $ | (0.46 | ) | | $ | 0.49 | |
| | | |
| | | |
| | | |
| |
| | Adjusted | | $ | (0.85 | ) | | $ | (0.65 | ) | | $ | 0.34 | |
| | | |
| | | |
| | | |
| |
Comprehensive income
Under SFAS 130, “Reporting Comprehensive Income,” the Company is required to display comprehensive income and its components as part of the financial statements. The Company has displayed its comprehensive income as part of the consolidated statementsConsolidated Statements of stockholders equity (deficit). Other comprehensive income for the year ended December 31, 2003 was a $13,000 unrealized gain on available-for-sale securities. There were no items of other comprehensive income in the years ended December 31, 2001 or 2002.Stockholders’ Equity.
| |
| Foreign currency translation
|
Foreign currency translation
The Company usesCompany’s functional currency is the U.S. dollar as its functional currency for all of its international subsidiaries. Foreign currency assets and liabilitiestransactions of international subsidiaries are translatedremeasured into U.S. dollars at theend-of-period exchange rates except for fixedmonetary assets which are translated atand liabilities, and historical exchange rates.rates for nonmonetary assets. Expenses are translatedremeasured at average exchange rates in effect during each period, except for those expenses related to balance sheet amounts,non-monetary assets, which are translatedremeasured at historical exchange rates. Revenue is remeasured at the daily rate in effect as of the date the order ships. Gains orand losses arising from foreign currency transactions are included in net income (loss) and were immaterialnet losses of $560,000 and $1.8 million for allthe years ended December 31, 2004 and 2005, respectively, and a net gain of $2.5 million for the year ended December 31, 2006.
Recent accounting pronouncements
In June 2006, the Financial Accounting Standards Board (“FASB”) issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes — an interpretation of FASB Statement No. 109” (“FIN 48”), which clarifies the accounting for uncertainty in income tax positions. FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken, or expected to be taken, on a tax return. This Interpretation also provides guidance on derecognition, classification, interest, penalties, accounting in interim periods, being reported.disclosure and transition. The evaluation of a tax position in accordance with this Interpretation is a two-step process. The first step will determine if it is more likely than not that a tax position will be sustained upon examination and should therefore be recognized. The second step will measure a tax position that meets the more likely than not recognition threshold to determine the amount of benefit to recognize in the financial statements. FIN 48 is effective for fiscal years beginning after December 15, 2006. The Company is currently evaluating the impact of adopting FIN 48 on the consolidated financial statements.
| |
| Recent accounting pronouncements |
In November 2002,June 2006, the EITF reached a consensus on Issue 00-21, “Revenue Arrangements with Multiple Deliverables.” EITF Issue 00-21No. 06-3, “How Taxes Collected from Customers and Remitted to Governmental Authorities Should Be Presented in the Income Statement (That Is, Gross versus Net Presentation)”. EITF IssueNo. 06-3 provides guidancethat the presentation of taxes assessed by a governmental authority that is directly imposed on how to accounta revenue-producing transaction between a seller and a customer on either a gross basis (included in revenues and costs) or on a net basis (excluded from revenues) is an accounting policy decision that should be disclosed. EITF IssueNo. 06-3 is effective for arrangements that involve the delivery or performance of multiple products, services and/or rights to use assets. The provisions of EITF Issue 00-21 applies to revenue arrangements entered into in reporting periodsfiscal years beginning after JuneDecember 15, 2003.2006. The adoptionCompany is currently evaluating the impact of adopting EITF Issue 00-21No. 06-3 on the consolidated financial statements.
In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements” (“SFAS 157”), which defines fair value, establishes guidelines for measuring fair value, and expands disclosures regarding fair value measurements. SFAS 157 does not require any new fair value measurements but rather eliminates inconsistencies in guidance found in various prior accounting pronouncements. SFAS 157 is effective for fiscal years beginning after
51
NETGEAR, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
November 15, 2007. The Company is currently evaluating the impact of adopting SFAS 157 on the consolidated financial statements.
In September 2006, the SEC issued Staff Accounting Bulletin No. 108, “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements” (“SAB 108”). SAB 108 requires that registrants quantify errors using both a balance sheet and income statement approach and evaluate whether either approach results in a misstated amount that, when all relevant quantitative and qualitative factors are considered, is material. SAB 108 is effective for fiscal years ending after November 15, 2006, and did not have a material impact on the Company’s consolidated financial position,statements.
In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities” (“SFAS 159”). SFAS 159 permits entities to choose to measure many financial assets and financial liabilities at fair value. Unrealized gains and losses on items for which the fair value option has been elected are reported in earnings. SFAS 159 is effective for fiscal years beginning after November 15, 2007. The Company is currently assessing the impact of SFAS 159 on the consolidated financial statements.
Note 2 — Business Acquisition:
On August 1, 2006, the Company completed the acquisition of SkipJam Corp. (“SkipJam”), a developer of networkable media devices for home entertainment and control. The Company believes the acquisition enhances its strategically important digital home entertainment and control business by strengthening the Company’s ability to expand its multimedia product portfolio. The aggregate purchase price was $7.6 million, paid in cash.
The results of SkipJam’s operations orhave been included in the consolidated financial statements since the date of acquisition. The historical results of SkipJam prior to the acquisition were not material to the Company’s results of operations.
The accompanying consolidated financial statements reflect total consideration of approximately $7.7 million, consisting of cash, flowsand other costs directly related to the acquisition as follows (in thousands):
| | | | | |
| Purchase price | | $ | 7,600 | |
| Direct acquisition costs | | | 133 | |
| | | | | |
| Total consideration | | $ | 7,733 | |
| | | | | |
In accordance with the purchase method of accounting, the Company allocated the total purchase price to tangible assets, liabilities and identifiable intangible assets based on their estimated fair values. The excess of purchase price over the aggregate fair values was recorded as goodwill. The fair values assigned to identifiable intangible assets acquired were estimated with the assistance of an independent valuation firm. Purchased intangibles are amortized on a straight-line basis over their respective useful lives. The total allocation of the Company.purchase price is as follows (in thousands):
| | | | | |
| | | Fair Value on
| |
| | | August 1, 2006 | |
| |
| Prepaid expenses and other current assets | | $ | 6 | |
| Intangibles | | | 4,000 | |
| Goodwill | | | 3,243 | |
| Non-current deferred income taxes | | | 484 | |
| | | | | |
| Total purchase price allocation | | $ | 7,733 | |
| | | | | |
$2.9 million of the $4.0 million in acquired intangible assets was designated as in-process research and development (“in-process R&D”). In-process R&D is expensed upon an acquisition because technological feasibility has not been established and no future alternative uses exist. The Company acquired only onein-process
55
52
NETGEAR, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
In December 2003,
R&D project, which is related to the Financial Accounting Standards Board (“FASB”) issued a revision to Interpretation number 46, “Consolidation of variable interest entities, and interpretation of ARB Opinion No. 51 (FIN 46R).” FIN 46R clarifies the application of ARB 51 “Consolidated Financial Statements,” to certain entities in which equity investors do not have the characteristicsdevelopment of a controlling financial interestmultimedia product that had not reached technological feasibility and had no alternative use.
The fair value assigned to in-process R&D was determined using the income approach, under which the Company considered the importance of products under development to the Company’s overall development plans, estimated the costs to develop the purchased in-process R&D into commercially viable products, estimated the resulting net cash flows from the products when completed and discounted the net cash flows to their present values. The Company used a discount rate of 35% in the present value calculations, which was derived from a weighted-average cost of capital analysis, adjusted to reflect additional risks related to the products’ development and success as well as the products’ stage of completion. The estimates used in valuing in-process R&D were based upon assumptions believed to be reasonable but which are inherently uncertain and unpredictable. These assumptions may be incomplete or do not have sufficient equity at riskinaccurate, and unanticipated events and circumstances may occur. Accordingly, actual results may vary from the projected results. The Company incurred costs of approximately $725,000 to complete the project, of which approximately $575,000 was incurred through December 31, 2006. The Company completed the project in February 2007.
$1.0 million of the $4.0 million in acquired intangible assets was designated as core technology. The value was calculated based on the present value of the future estimated cash flows derived from estimated royalty savings attributable to the core technology. This $1.0 million will be amortized over its four year useful life.
The remaining acquired intangible assets consist of non-competition agreements of $100,000, with a two year useful life. None of the goodwill recorded as part of the SkipJam acquisition will be deductible for income tax purposes.
Of the entity$1.1 million in total intangibles subject to finance its activities without additional subordinated financial support provided by any parties, including the equity holders. FIN 46R requires the consolidation of these entities, known as variable interest entities (“VIE’s”),amortization, $125,000 was expensed by the primary beneficiaryCompany in the year ended December 31, 2006.
As part of the
entity. The primary beneficiary isacquisition, the
entity, if any, that will absorb a majority of the entity’s expected losses, receive a majority of the entity’s expected residual returns, or both. Among other changes, the revisions of FIN 46R (a) clarified some requirements of the original FIN 46, which had been issuedCompany has also agreed to pay up to $1.4 million in January 2003, (b) eased some implementation problems, and (c) added new scope exceptions. FIN 46R deferred the effective date of the interpretation for public companies to the end of the first reporting period ending after March 15, 2004, except that all public companies must at a minimum apply the unmodified provisions of the interpretation to entities that were previously considered “special-purpose entities” in practice and under the FASB literature prior to the issuance of FIN 46R by the end of the first reporting period ending after December 15, 2003.
Among the scope exceptions, companies are not required to apply FIN 46R to an entity that meets the criteria to be considered a “business” as defined in the interpretation unless one or more of four named conditions exist. FIN 46R applies immediately to a VIE created or acquired after January 31, 2003. The company does not have any interests in VIE’s, and the adoption of FIN 46R is not expected to have a material impactcash contingent on the Company’s financial position, resultscontinued employment of operations or cash flows.
certain SkipJam employees with the Company. These payments will be recorded as compensation expense over a two-year period. During the year ended December 31, 2006, the Company recorded $486,000 of additional compensation expense pursuant to this agreement.
Note 23 — Balance Sheet Components (In(in thousands): Available-for-sale short-term investments consist of the following:| | | | | | | | | | | | | | | | | | | | | | | | | |
| | |
| | December 31, |
| |
|
| | | | |
| | 2002 | | 2003 |
| |
| |
|
| | | | Unrealized | | Estimated | | | | Unrealized | | Estimated |
| | Cost | | Gains/(Losses) | | Fair Value | | Cost | | Gains/(Losses) | | Fair Value |
| |
| |
| |
| |
| |
| |
|
| Government Securities | | | — | | | | — | | | | — | | | $ | 12,377 | | | $ | 13 | | | $ | 12,390 | |
| | | |
| | | |
| | | |
| | | |
| | | |
| | | |
| |
| Totals | | | — | | | | — | | | | — | | | $ | 12,377 | | | $ | 13 | | | $ | 12,390 | |
| | | |
| | | |
| | | |
| | | |
| | | |
| | | |
| |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| | | December 31, |
| | | 2005 | | 2006 |
| | | | | Unrealized
| | Estimated
| | | | Unrealized
| | Estimated
|
| | | Cost | | Loss | | Fair Value | | Cost | | Loss | | Fair Value |
| |
| Government Securities | | $ | 83,744 | | | $ | (90 | ) | | $ | 83,654 | | | $ | 109,734 | | | $ | (5 | ) | | $ | 109,729 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
53
NETGEAR, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Accounts receivable and related allowances consist of the following:| | | | | | | | | | |
| | |
| | December 31, |
| |
|
| | 2002 | | 2003 |
| |
| |
|
| Gross accounts receivable | | $ | 49,780 | | | $ | 83,639 | |
| | | |
| | | |
| |
| Less: Allowance for doubtful accounts | | | (873 | ) | | | (1,322 | ) |
| | Allowance for sales returns | | | (3,363 | ) | | | (4,845 | ) |
| | Allowance for price protection | | | (3,052 | ) | | | (2,606 | ) |
| | | |
| | | |
| |
| | Total allowances | | | (7,288 | ) | | | (8,773 | ) |
| | | |
| | | |
| |
| Accounts receivable, net | | $ | 42,492 | | | $ | 74,866 | |
| | | |
| | | |
| |
| | | | | | | | | |
| | | December 31, | |
| | | 2005 | | | 2006 | |
| |
| Gross accounts receivable | | $ | 113,005 | | | $ | 132,651 | |
| | | | | | | | | |
| Less: Allowance for doubtful accounts | | | (1,295 | ) | | | (1,727 | ) |
| Allowance for sales returns | | | (5,985 | ) | | | (8,129 | ) |
| Allowance for price protection | | | (1,456 | ) | | | (3,194 | ) |
| | | | | | | | | |
| Total allowances | | | (8,736 | ) | | | (13,050 | ) |
| | | | | | | | | |
| Accounts receivable, net | | $ | 104,269 | | | $ | 119,601 | |
| | | | | | | | | |
Inventories consist of the following:
| | | | | | | | | |
| | | December 31, | |
| | | 2005 | | | 2006 | |
| |
| Finished goods | | $ | 51,873 | | | $ | 77,932 | |
| | | | | | | | | |
Property and equipment, net, consists of the following:
| | | | | | | | | |
| | | December 31, |
| | | 2005 | | 2006 |
| |
| Computer equipment | | $ | 4,514 | | | $ | 6,101 | |
| Furniture, fixtures and leasehold improvements | | | 1,407 | | | | 2,150 | |
| Software | | | 4,523 | | | | 6,805 | |
| Machinery | | | 4,174 | | | | 5,646 | |
| Construction in progress | | | 1,090 | | | | 554 | |
| | | | | | | | | |
| | | | 15,708 | | | | 21,256 | |
| Less: Accumulated depreciation and amortization | | | (11,006 | ) | | | (14,688 | ) |
| | | | | | | | | |
| | | $ | 4,702 | | | $ | 6,568 | |
| | | | | | | | | |
Depreciation and amortization expense pertaining to property and equipment in 2004, 2005 and 2006 was $2.6 million, $3.1 million and $4.0 million, respectively.
Other accrued liabilities consist of the following:
| | | | | | | | | |
| | | December 31, | |
| | | 2005 | | | 2006 | |
| |
| Sales and marketing programs | | $ | 39,126 | | | $ | 38,058 | |
| Warranty obligation | | | 11,845 | | | | 21,299 | |
| Freight | | | 5,814 | | | | 4,073 | |
| Other | | | 9,494 | | | | 12,479 | |
| | | | | | | | | |
| Other accrued liabilities | | $ | 66,279 | | | $ | 75,909 | |
| | | | | | | | | |
Note 4 — Net Income Per Share:
Basic Earnings Per Share (“EPS”) is computed by dividing net income (numerator) by the weighted average number of common shares outstanding (denominator) during the period. Basic EPS excludes the dilutive effect of
56
54
NETGEAR, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Inventories consiststock options. Diluted EPS gives effect to all dilutive potential common shares outstanding during the period. In computing diluted EPS, the average stock price for the period is used in determining the number of shares assumed to be purchased using the proceeds from the assumed exercise of stock options.
Potentially dilutive common shares include outstanding stock options and unvested restricted stock awards, which are reflected in diluted earnings per share by application of the
following:| | | | | | | | | |
| | |
| | December 31, |
| |
|
| | 2002 | | 2003 |
| |
| |
|
| Finished goods | | $ | 24,774 | | | $ | 39,266 | |
| | | |
| | | |
| |
Propertytreasury stock method. Under the treasury stock method, the amount that the employee must pay for exercising stock options, the amount of stock-based compensation cost for future services that the Company has not yet recognized, and equipment, netthe amount of tax benefit that would be recorded in additional paid-in capital upon exercise are assumed to be used to repurchase shares.
Net income per share for the years ended December 31, 2004, 2005 and 2006 are as follows (in thousands, except per share data):
| | | | | | | | | | | | | |
| | | Year Ended December 31, | |
| | | 2004 | | | 2005 | | | 2006 | |
| |
| Net income | | $ | 23,465 | | | $ | 33,623 | | | $ | 41,132 | |
| | | | | | | | | | | | | |
| Weighted average shares outstanding: | | | | | | | | | | | | |
| Basic | | | 30,441 | | | | 32,351 | | | | 33,381 | |
| Options and awards | | | 2,185 | | | | 1,588 | | | | 1,172 | |
| | | | | | | | | | | | | |
| Total diluted | | | 32,626 | | | | 33,939 | | | | 34,553 | |
| | | | | | | | | | | | | |
| Basic net income per share | | $ | 0.77 | | | $ | 1.04 | | | $ | 1.23 | |
| | | | | | | | | | | | | |
| Diluted net income per share | | $ | 0.72 | | | $ | 0.99 | | | $ | 1.19 | |
| | | | | | | | | | | | | |
Anti-dilutive common stock options totalling 416,280, 131,560 and 675,953 were excluded from the weighted average shares outstanding for the diluted per share calculation for 2004, 2005 and 2006, respectively.
Note 5 — Income Taxes:
Income before income taxes consists of the following
:| | | | | | | | | |
| | |
| | December 31, |
| |
|
| | 2002 | | 2003 |
| |
| |
|
| Computer equipment | | $ | 2,129 | | | $ | 2,722 | |
| Furniture, fixtures and leasehold improvements | | | 399 | | | | 794 | |
| Software | | | 2,878 | | | | 3,236 | |
| Machinery | | | 1,032 | | | | 2,216 | |
| Construction in progress | | | 41 | | | | — | |
| | | |
| | | |
| |
| | | | 6,479 | | | | 8,968 | |
| Less: Accumulated depreciation and amortization | | | (3,335 | ) | | | (5,342 | ) |
| | | |
| | | |
| |
| | | $ | 3,144 | | | $ | 3,626 | |
| | | |
| | | |
| |
Depreciation expense in 2001, 2002 and 2003 was $950,000, $1.4 million and $2.0 million, respectively.
In accordance with SFAS No. 142, “Goodwill and Other Intangible Assets,” goodwill amortization was discontinued as of January 1, 2002. The carrying value of goodwill at December 31, 2002 and 2003 was $558,000, net of $1.1 million of accumulated amortization. Management has determined that the net book value of the goodwill has not been impaired.
The following table reflects consolidated results of operations adjusted as though the adoption of SFAS No. 142 occurred as of January 1, 2001 (in thousands):
| | | | | |
| | Year Ended |
| | December 31, |
| |
|
| | 2001 |
| |
|
| Reported net income (loss) attributable to common stockholders | | $ | (19,484 | ) |
| Goodwill amortization | | | 335 | |
| | | |
| |
| Adjusted net income (loss) attributable to common stockholders | | $ | (19,149 | ) |
| | | |
| |
| Basic net income (loss) per share attributable to common stockholders | | $ | (0.66 | ) |
| Goodwill amortization | | | 0.01 | |
| | | |
| |
| Adjusted basic net income (loss) per share attributable to common stockholders | | $ | (0.65 | ) |
| | | |
| |
| Diluted net income (loss) per share attributable to common stockholders | | $ | (0.66 | ) |
| Goodwill amortization | | | 0.01 | |
| | | |
| |
| Adjusted diluted net income (loss) per share attributable to common stockholders | | $ | (0.65 | ) |
| | | |
| |
| | | | | | | | | | | | | |
| | | Year Ended December 31, | |
| | | 2004 | | | 2005 | | | 2006 | |
| |
| United States | | $ | 32,743 | | | $ | 50,127 | | | $ | 52,501 | |
| International | | | 3,643 | | | | 4,363 | | | | 16,498 | |
| | | | | | | | | | | | | |
| Total | | $ | 36,386 | | | $ | 54,490 | | | $ | 68,999 | |
| | | | | | | | | | | | | |
57
55
NETGEAR, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)Other accrued liabilities consist of the following;
| | | | | | | | | |
| | |
| | December 31, |
| |
|
| | 2002 | | 2003 |
| |
| |
|
| Sales and marketing programs | | $ | 13,855 | | | $ | 14,207 | |
| Warranty obligation | | | 8,941 | | | | 11,959 | |
| Outsourced engineering costs | | | 1,588 | | | | 1,604 | |
| Freight | | | 2,593 | | | | 937 | |
| Other | | | 2,442 | | | | 2,592 | |
| | | |
| | | |
| |
| | | $ | 29,419 | | | $ | 31,299 | |
| | | |
| | | |
| |
Note 3 — Related Party Transactions:
| |
| Manufacturing Agreement with Delta Electronics |
Some of the Company’s products are manufactured by Delta Electronics, which is associated with Delta International Holding Ltd., a shareholder in NETGEAR. Product purchases from Delta Electronics amounted to $81.0 million, $121.3 million and $68.6 million during the years ended December 31, 2001, 2002 and 2003, respectively. Payables related to these purchases amounted to $13.0 million and $6.4 million at December 31, 2002 and 2003, respectively, and are included in payables to related parties in the accompanying balance sheets.
| |
| Other Related Party Transactions |
As consideration for services received in relation to the issuance of Series C Preferred Stock (see Note 8), in March 2002 the Company issued a warrant to one of its shareholders to purchase 218,750 shares of common stock. The warrant was fully exercisable on the day of grant. The warrant was due to expire in the event of an initial public offering provided that the aggregate gross proceeds from the offering are not less than $35.0 million and the valuation of the Company is at least $250.0 million, but would otherwise expire on March 13, 2007. Immediately prior to the Company’s initial public offering the warrant was exercised in a cashless exercise involving the simultaneous exercise of the warrant and the surrender of some of the shares of common stock issued as payment for the exercise price. As such a net of 198,593 shares of common stock were issued pursuant to the terms of the warrant. The Company determined the fair value of the warrant using Black-Scholes option pricing model with the following assumptions: exercise price — $1.29 per share, estimated fair value of the common stock — $6.24, volatility — 71%, dividend rate — 0%, risk free interest rate — 4.30%, expected life — 4 years. The fair value of the warrant of $622,000 was recorded against the proceeds of Series C Preferred Stock.
Note 4 — Net Income (Loss) Per Share:
Immediately prior to the effective date of the Company’s initial public offering on July 30, 2003, the Company’s outstanding Preferred Stock was automatically converted into 20,228,480 shares of common stock. Prior to July 30, 2003, the holders of Series A, B and C Preferred Stock were entitled to participate in all dividends paid on common stock, as and when declared by the Board of Directors, on an as-if converted basis. In accordance with EITF Topic D-95, “Effect of Participating Convertible Securities on the Computation of Basic Earnings per Share,” the Company has included the impact of Preferred Stock in the computation of basic earnings per share using the “two class” method. Under this method, an earnings allocation formula is used to determine the amount of net income (loss) attributable to common stockholders to be allocated to each class of stock (the two classes being common stock and Preferred Stock). Basic net income (loss) per share attributable to common stockholders is calculated by dividing the amount of net income (loss)
58
NETGEAR, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
attributable to common shareholders that is apportioned to common stock by the weighted average number of shares of common stock outstanding during the period. Although there were no common shares outstanding during 2001 and 2002, basic net loss per share attributable to common stockholders is presented, as there were potential common shares outstanding (representing Preferred Stock) during the period. This per share data is based on the net loss, which would be attributable to one share of common stock during each period, after apportioning the loss to reflect the participation rights of the preferred stockholders.
Net income (loss) per share applicable to each class of stock (common stock and Preferred Stock) is as follows (in thousands, except per share data):
| | | | | | | | | | |
| | |
| | Year Ended December 31, 2001 |
| |
|
| | Common Stock | | Preferred Stock |
| |
| |
|
| Basic net loss per share: | | | | | | | | |
| | Apportioned net loss | | | | | | $ | (19,484 | ) |
| | | | | | | |
| |
| | Total numerator for basic net loss per share | | | | | | $ | (19,484 | ) |
| | | | | | | |
| |
| | Weighted average basic shares outstanding | | | | | | | 29,571 | |
| | | | | | | |
| |
| Basic net loss per share | | $ | (0.66 | )(A) | | $ | (0.66 | ) |
| | | |
| | | |
| |
| | | | | | | | | | |
| | |
| | Year Ended December 31, 2002 |
| |
|
| | Common Stock | | Preferred Stock |
| |
| |
|
| Basic net income (loss) per share: | | | | | | | | |
| | Apportioned net loss after deemed dividend to Preferred Stock | | | | | | $ | (9,742 | ) |
| | Deemed dividend to Preferred Stock | | | | | | | 17,881 | |
| | | | | | | |
| |
| | Total numerator for basic net income (loss) per share | | | | | | $ | 8,139 | |
| | | | | | | |
| |
| | Weighted average basic shares outstanding | | | | | | | 21,181 | |
| | | | | | | |
| |
| Net income (loss) per share | | $ | (0.46 | )(A) | | $ | 0.38 | |
| | | |
| | | |
| |
| | | | | | | | | | |
| | |
| | Year Ended December 31, 2003 |
| |
|
| | Common Stock | | Preferred Stock |
| |
| |
|
| Basic net income per share: | | | | | | | | |
| | Apportioned net income | | $ | 6,621 | | | $ | 6,476 | |
| | | |
| | | |
| |
| | Total numerator for basic net income per share | | $ | 6,621 | | | $ | 6,476 | |
| | | |
| | | |
| |
| | Weighted average basic shares outstanding | | | 11,958 | | | | 11,695 | |
| | | |
| | | |
| |
| Basic net income per share | | $ | 0.55 | | | $ | 0.55 | |
| | | |
| | | |
| |
59
NETGEAR, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
| | | | | | |
| | December 31, |
| | 2003 |
| |
|
| | Common Stock |
| |
|
| Diluted net income per share: | | | | |
| | Apportioned net income | | $ | 13,097 | |
| | | |
| |
| | Total numerator for diluted net income per share | | $ | 13,097 | |
| | | |
| |
| Weighted average shares outstanding: | | | | |
| | Basic | | | 11,958 | |
| | Conversion of preferred stock | | | 11,695 | |
| | Options and warrants | | | 3,147 | |
| | | |
| |
| | Total diluted | | | 26,800 | |
| | | |
| |
| Diluted net income per share | | $ | 0.49 | |
| | | |
| |
| |
(A): | As described above, these amounts represent the amount of net loss after deemed dividend to Preferred Stock which would be apportioned to one share of common stock. |
Diluted net income (loss) per share attributable to common stockholders for 2001 and 2002 is the same as basic net income (loss) per share attributable to common stockholders because the impact of including common stock equivalents would not be dilutive.
Anti-dilutive common stock options and warrants amounting to 6,695,592, 3,021,893 and 175,000 were excluded from the weighted average shares outstanding from the diluted per share calculation for 2001, 2002 and 2003, respectively.
Note 5 — Income Taxes:
The provision for income taxes consists of the following (in thousands):
| | | | | | | | | | | | | | |
| | |
| | Year Ended December 31, |
| |
|
| | 2001 | | 2002 | | 2003 |
| |
| |
| |
|
Current: | | | | | | | | | | | | |
| | U.S. federal | | $ | (546 | ) | | $ | 378 | | | $ | 4,282 | |
| | State | | | (154 | ) | | | 662 | | | | 513 | |
| | Foreign | | | 300 | | | | 293 | | | | 737 | |
| | | |
| | | |
| | | |
| |
| | | | (400 | ) | | | 1,333 | | | | 5,532 | |
| | | |
| | | |
| | | |
| |
Deferred: | | | | | | | | | | | | |
| | U.S. federal | | | 2,702 | | | | — | | | | (7,908 | ) |
| | State | | | 770 | | | | — | | | | (1,148 | ) |
| | | |
| | | |
| | | |
| |
| | | | 3,472 | | | | — | | | | (9,056 | ) |
| | | |
| | | |
| | | |
| |
| Total | | $ | 3,072 | | | $ | 1,333 | | | $ | (3,524 | ) |
| | | |
| | | |
| | | |
| |
| | | | | | | | | | | | | |
| | | Year Ended December 31, | |
| | | 2004 | | | 2005 | | | 2006 | |
| |
Current: | | | | | | | | | | | | |
| U.S. Federal | | $ | 13,110 | | | $ | 16,766 | | | $ | 21,362 | |
| State | | | 1,197 | | | | 2,799 | | | | 2,965 | |
| Foreign | | | 1,033 | | | | 1,658 | | | | 6,719 | |
| | | | | | | | | | | | | |
| | | | 15,340 | | | | 21,223 | | | | 31,046 | |
| | | | | | | | | | | | | |
Deferred: | | | | | | | | | | | | |
| U.S. Federal | | | (2,427 | ) | | | (860 | ) | | | (780 | ) |
| State | | | 8 | | | | 504 | | | | 100 | |
| Foreign | | | — | | | | — | | | | (2,499 | ) |
| | | | | | | | | | | | | |
| | | | (2,419 | ) | | | (356 | ) | | | (3,179 | ) |
| | | | | | | | | | | | | |
| Total | | $ | 12,921 | | | $ | 20,867 | | | $ | 27,867 | |
| | | | | | | | | | | | | |
Net deferred tax assets consist of the following (in thousands):
| | | | | | | | | |
| | | December 31, | |
| | | 2005 | | | 2006 | |
| |
Deferred Tax Assets: | | | | | | | | |
| Accruals and allowances | | $ | 11,503 | | | $ | 13,302 | |
| Net operating loss carryforwards | | | — | | | | 859 | |
| Depreciation | | | 328 | | | | 801 | |
| Stock-based compensation | | | — | | | | 899 | |
| Other | | | — | | | | 113 | |
| | | | | | | | | |
| | | | 11,831 | | | | 15,974 | |
Deferred Tax Liabilities: | | | | | | | | |
| Acquired intangible assets | | | — | | | | (395 | ) |
| Unremitted earnings of foreign subsidiaries | | | — | | | | (11 | ) |
| | | | | | | | | |
| | | | — | | | | (406 | ) |
| | | | | | | | | |
| Net deferred tax assets | | $ | 11,831 | | | $ | 15,568 | |
| | | | | | | | | |
| Current portion | | $ | 11,503 | | | $ | 13,415 | |
| Non-current portion | | | 328 | | | | 2,153 | |
| | | | | | | | | |
| Net deferred tax assets | | $ | 11,831 | | | $ | 15,568 | |
| | | | | | | | | |
Management’s judgment is required in determining the Company’s provision for income taxes, its deferred tax assets and any valuation allowance recorded against its deferred tax assets. In management’s judgment it is more likely than not that such assets will be realized in the future as of December 31, 2006, and as such no valuation allowance has been recorded against the Company’s deferred tax assets.
60
56
NETGEAR, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Deferred tax assets and liabilities consist of the following (in thousands):
| | | | | | | | | | |
| | |
| | December 31, |
| |
|
| | 2002 | | 2003 |
| |
| |
|
Deferred tax assets: | | | | | | | | |
| | Net operating loss carry-forwards | | $ | 182 | | | $ | 180 | |
| | Accruals and allowances | | | 9,275 | | | | 9,050 | |
| | Other | | | 33 | | | | — | |
| | | |
| | | |
| |
| | | | 9,490 | | | | 9,230 | |
| | | |
| | | |
| |
Deferred tax liabilities: | | | | | | | | |
| | Depreciation and goodwill amortization | | | (317 | ) | | | (174 | ) |
| | | |
| | | |
| |
| | | | (317 | ) | | | (174 | ) |
| | | |
| | | |
| |
| | Gross deferred tax assets | | | 9,173 | | | | 9,056 | |
| | Valuation allowance | | | (9,173 | ) | | | — | |
| | | |
| | | |
| |
| | Net deferred tax assets | | $ | — | | | $ | 9,056 | |
| | | |
| | | |
| |
As of December 31, 2003, the Company had approximately $3.1 million of California State net operating loss carry-forwards available to offset future taxable income. These net-operating losses will begin to expire in 2013.
During the fiscal year ended December 31, 2003, the Company reassessed its ability to realize its deferred tax assets and determined that it is more likely than not that future benefits will be realized. This determination was made principally based on the cumulative profitability of the Company over the past several quarters, plus the projected current and future taxable income expected to be generated by the Company.
Accordingly, the Company fully reversed the valuation allowance of $9,772,000 in the second quarter of the year ended December 31, 2003 to reflect the anticipated net deferred tax asset utilization.
The effective tax rate differs from the applicable U.S. statutory federal income tax rate as follows:
| | | | | | | | | | | | | |
| | |
| | Year Ended December 31, |
| |
|
| | 2001 | | 2002 | | 2003 |
| |
| |
| |
|
| Tax at federal statutory rate | | | (34.0 | )% | | | 34.0 | % | | | 35.0 | % |
| State, net of federal benefit | | | (4.6 | ) | | | 9.6 | | | | 4.3 | |
| Stock-based compensation | | | 0.0 | | | | 2.7 | | | | 7.3 | |
| Non-deductible interest charges | | | 0.0 | | | | 2.2 | | | | 27.1 | |
| Tax credits | | | (0.4 | ) | | | 0.0 | | | | (6.4 | ) |
| Other | | | 1.0 | | | | 6.0 | | | | (2.0 | ) |
| Change in valuation allowance | | | 56.7 | | | | (40.4 | ) | | | (102.1 | ) |
| | | |
| | | |
| | | |
| |
| Provision (Benefit) for taxes | | | 18.7 | % | | | 14.1 | % | | | (36.8 | )% |
| | | |
| | | |
| | | |
| |
| | | | | | | | | | | | | |
| | | Year Ended December 31, | |
| | | 2004 | | | 2005 | | | 2006 | |
| |
| Tax at federal statutory rate | | | 35.0 | % | | | 35.0 | % | | | 35.0 | % |
| State, net of federal benefit | | | 2.3 | | | | 3.5 | | | | 2.8 | |
| Stock-based compensation | | | (2.3 | ) | | | 0.0 | | | | 0.8 | |
| In-process research and development | | | 0.0 | | | | 0.0 | | | | 1.4 | |
| Tax credits | | | (2.3 | ) | | | (0.6 | ) | | | (0.6 | ) |
| Permanent and other items | | | 2.8 | | | | 0.4 | | | | 1.0 | |
| | | | | | | | | | | | | |
| Provision for income taxes | | | 35.5 | % | | | 38.3 | % | | | 40.4 | % |
| | | | | | | | | | | | | |
Income tax benefits in the amount of $11.8 million, $7.1 million and $4.2 million related to the exercise of stock options were credited to additional paid-in capital during the years ended December 31, 2004, 2005 and 2006, respectively.
The Company has $2.5 million of acquired federal net operating losses from its acquisition of SkipJam as of December 31, 2006. Use of these losses is subject to annual limitation under Internal Revenue Code Section 382. These losses expire in different years beginning in fiscal 2023.
Note 6 — Borrowings:Commitments and Contingencies:
On July 25, 2002,
Litigation and Other Legal Matters
In June 2004, a lawsuit, entitled Zilberman v. NETGEAR, Civil Action CV021230, was filed against the Company entered intoin the Superior Court of California, County of Santa Clara. The complaint purported to be a revolving lineclass action on behalf of credit agreement with a bankall persons or entities in the United States who purchased the Company’s wireless products other than for resale. Plaintiff alleged that providesthe Company made false representations concerning the data transfer speeds of its wireless products when used in typical operating circumstances, and requested injunctive relief, payment of restitution and reasonable attorney fees. Similar lawsuits were filed against other companies within the industry. In November 2005, without admitting any wrongdoing or violation of law and to avoid the distraction and expense of continued litigation, the Company and the Plaintiff received preliminary court approval for a maximum lineproposed settlement.
Under the terms of creditthe settlement, the Company (i) issued each eligible class member a promotional code which may be used to purchase a new wireless product from the Company’s online store, www.buynetgear.com, at a 15% discount during the redemption period; (ii) included a disclaimer regarding wireless signal rates on the Company’s wireless products packaging and user’s manuals and in the Company’s press releases and advertising that reference wireless signal rates; (iii) donated $25,000 worth of the Company’s products to a local,not-for-profit charitable organization to be chosen by the Company; and (iv) agreed to pay, subject to court approval, up to $20.0 million including amounts drawn under letters$700,000 in attorneys’ fees and costs.
In March 2006, the Company received final court approval for the proposed settlement. On May 26, 2006, the proposed settlement became final and binding. The Company recorded a charge of credit. Availability under$802,000 relating to this proposed settlement during the lineyear ended December 31, 2005.
NETGEAR v. CSIRO
In May 2005, the Company filed a complaint for declaratory relief against the Commonwealth Scientific and Industrial Research Organization (CSIRO), in the San Jose division of credit is equal to 75%the United States District Court, Northern District of eligible accounts receivable balances as determined inCalifornia. The complaint alleges that the claims of CSIRO’s U.S. Patent No. 5,487,069 are invalid and not infringed by any of the Company’s products. CSIRO had asserted that the Company’s wireless networking
61
57
NETGEAR, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
products implementing the agreement. The annualized interest rateIEEE 802.11a and 802.11g wireless LAN standards infringe its patent. In July 2006, United States Court of Appeals for the bank’s prime rate plus 0.75% is charged onFederal Circuit affirmed the outstanding credit balance, calculated on a daily basis. Substantially allDistrict Court’s decision to deny CSIRO’s motion to dismiss the Company’s assets are collateralizedaction under the lineForeign Sovereign Immunities Act. CSIRO has filed a petition with the Federal Circuit requesting a rehearing en banc. This action is in the preliminary motion stages and no trial date has been set.
SercoNet v. NETGEAR
In May 2006, a lawsuit was filed against the Company by SercoNet, Ltd., a manufacturer of credit. Percomputer networking products organized under the linelaws of credit agreement,Israel, in the bank can issue lettersUnited States District Court for the Southern District of credit of up to an aggregate face amount of $2.0 million. Prior toNew York. SercoNet alleges that the closingCompany infringes U.S. Patents Nos. 5,841,360; 6,480,510; 6,970,538; 7,016,368; and 7,035,280. SercoNet has accused certain of the Company’s initial public offeringswitches, routers, modems, adapters, powerline products, and wireless access points of infringement. In July 2006, the linecourt granted the Company’s motion to transfer the action to the Northern District of credit contained covenants,California. This action is in the preliminary motion stages and no trial date has been set.
These claims against the Company, or filed by the Company, whether meritorious or not, could be time consuming, result in costly litigation, require significant amounts of management time, and result in the diversion of significant operational resources. Were an unfavorable outcome to occur, there exists the possibility it would have a material adverse impact on the Company’s financial position and results of operations for the period in which the unfavorable outcome occurs or becomes probable. In addition, the Company is subject to legal proceedings, claims and litigation arising in the ordinary course of business, including butlitigation related to intellectual property and employment matters.
While the outcome of these matters is currently not limiteddeterminable, the Company does not expect that the ultimate costs to certainresolve these matters will have a material adverse effect on the Company’s consolidated financial covenants based on earnings before interest, taxes, depreciationposition, results of operations or cash flows.
Environmental Regulation
The European Union (“EU”) has enacted the Waste Electrical and amortization,Electronic Equipment Directive, which makes producers of electrical goods, including home and small business networking products, financially responsible for specified collection, recycling, treatment and disposal of past and future covered products. The deadline for the individual member states of the EU to enact the directive in their respective countries was August 13, 2004 (such legislation, together with the directive, the “WEEE Legislation”). Producers participating in the market are financially responsible for implementing these responsibilities under the WEEE Legislation beginning in August 2005. Similar WEEE Legislation has been or EBITDA,may be enacted in other jurisdictions, including in the United States, Canada, Mexico, China and tangible net worth,Japan. The Company adopted FSPSFAS 143-1, “Accounting for Electronic Equipment Waste Obligations”, in the third quarter of fiscal 2005 and has determined that its effect did not allowhave a material impact on its consolidated results of operations and financial position for declaration of dividends. Subsequent to the Company’s initial public offering, the line of credit no longer contains the aforementioned covenants but rather requires the Company to maintain a ratio of quick assets to current liabilities of at least 1.25 : 1.00, as of the last day of each calendar month.fiscal 2005 and fiscal 2006. The Company is not requiredcontinuing to maintain compensating balances, however, it is required to pay a fee of 0.25% per annum onevaluate the unused portionimpact of the total facilityWEEE Legislation and 1.50% per annum for letters of credit. During the year ended December 31, 2002 and 2003, the Company wassimilar legislation in compliance with all of the covenants.other jurisdictions as individual countries issue their implementation guidance.
As collateral for the Company’s payment obligations to certain third parties who provide inventory warehousing and distribution services, the Company is contingently liable under letters of credit for an aggregate of $756,000 and $360,000 at December 31, 2002 and 2003, respectively. No amount has been drawn under these letters of credit as of December 31, 2002 and 2003.
Note 7 — Commitments:Employments Agreements
The Company has signed various employment agreements with key executives pursuant to which if their employment is terminated without cause, the employees are entitled to receive their base salary (and commission or bonus, as applicable) for 52 weeks (for the Chief Executive Officer), 39 weeks (for the Chief Financial Officer and for the President) andup to 26 weeks (for other key executives), and such employees will continue to have stock options vest for up to a one year period following the termination. If the termination, without cause, occurs within one year of a change in control, the officer is entitled to two years acceleration of any unvested portion of his or her stock options.
58
NETGEAR, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Leases
The Company leases office space,
cars and equipment under non-cancelable operating leases with various expiration dates through
March 2006.December 2026. Rent expense in the years ended, December 31,
2001, 20022004, 2005 and
20032006 was
$1.2$1.3 million,
$959,000$1.5 million, and
$1.1$2.2 million, respectively. The terms of
some of the
facility lease providesCompany’s office leases provide for rental payments on a graduated scale. The Company recognizes rent expense on a straight-line basis over the lease period, and has accrued for rent expense incurred but not paid.
Future minimum lease payments under non-cancelable operating
and capital leases are as follows (in thousands):
| | | | | |
| | Operating |
| Year Ending December 31, | | Leases |
| |
|
| 2004 | | $ | 1,033 | |
| 2005 | | | 153 | |
| 2006 | | | 26 | |
| | | |
| |
| Total minimum lease payments | | $ | 1,212 | |
| | | |
| |
62
NETGEAR, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
| |
| Guarantees, Indemnifications |
| | | | | |
Year Ending December 31, | | | |
| |
| 2007 | | | 2,371 | |
| 2008 | | | 1,298 | |
| 2009 | | | 718 | |
| 2010 | | | 544 | |
| 2011 | | | 509 | |
| 2012 and thereafter | | | 3,214 | |
| | | | | |
| Total minimum lease payments | | $ | 8,654 | |
| | | | | |
Guarantees and Indemnifications
The Company
has entered into various inventory related purchase agreements with suppliers.
UnderGenerally, under these agreements, 50% of orders are cancelable by giving notice 46 to 60 days prior to the expected shipment date
and 25% of orders are cancelable by giving notice 31 to 45 days prior to the expected shipment date. Orders are
noncancelablenon-cancelable within 30 days prior to the expected shipment date. At December 31,
2003,2006, the Company had
$27.5$55.2 million in
noncancelablenon-cancelable purchase commitments with suppliers. The Company expects to sell all products for which it has committed
to purchasepurchases from suppliers.
During 2001, the Company entered into an agreement with a service provider with respect to legal consultative and other services in international jurisdictions. Under the agreement, the Company agreed to indemnify the service provider to the fullest extent permitted by law against claims, suits and legal and other expenses incurred by the service provider in the course of providing such services. The terms of the indemnity agreement remain in effect until modified by the parties to the agreement. The maximum amount of potential future indemnification is unlimited. To date the Company has not received any claims against this agreement and believes the fair value of the indemnification agreement is minimal. Accordingly, the Company has no liabilities recorded for these agreements as at December 31, 2003.
The Company,
also, as permitted under Delaware law and in accordance with its Bylaws, indemnifies its officers and directors for certain events or occurrences, subject to certain limits, while the officer
or director is or was serving at the Company’s request in such capacity. The term of the indemnification period is for the officer’s or director’s lifetime. The maximum amount of potential future indemnification is unlimited; however, the Company has a Director and Officer Insurance Policy that limits its exposure and enables it to recover a portion of any future amounts paid. As a result of its insurance policy coverage, the Company believes the fair value of these indemnification agreements is minimal. Accordingly, the Company has no liabilities recorded for these agreements as
atof December 31,
2003.2006.
In its sales agreements, the Company typically agrees to indemnify its distributors and resellers for any expenses or liability resulting from claimed infringements of patents, trademarks or copyrights of third parties. The terms of these indemnification agreements are generally perpetual any time after execution of the agreement. The maximum amount of potential future indemnification is unlimited. To date the Company has not paid any amounts to settle claims or defend lawsuits. As a result, the Company believes the estimated fair value of these agreements is minimal. Accordingly, the Company has no liabilities recorded for these agreements as of December 31, 2003.2006.
Note 7 — Stock-Based Compensation:
At December 31, 2006, the Company had five stock-based employee compensation plans as described below. The total compensation expense related to these plans was approximately $4.5 million for the year ended December 31, 2006. Prior to January 1, 2006, the Company accounted for those plans under the recognition and measurement provisions of APB 25. Accordingly, the Company generally recognized compensation expense
63
59
NETGEAR, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
only when it granted options with a discounted exercise price. Any resulting compensation expense was recognized ratably over the associated service period, which was generally the option vesting term.
Prior to January 1, 2006, the Company provided pro forma disclosure amounts in accordance with SFAS No. 148, “Accounting for Stock-Based Compensation — Transition and Disclosure” (“SFAS 148”), as if the fair value method defined by SFAS 123 had been applied to its stock-based compensation.
Effective January 1, 2006, the Company adopted the fair value recognition provisions of SFAS 123R, using the modified prospective transition method and therefore has not restated prior periods’ results. Under this transition method, stock-based compensation expense for the year ended December 31, 2006 includes compensation expense for all stock-based compensation awards granted prior to, but not yet vested as of, January 1, 2006, based on the grant date fair value estimated in accordance with the original provisions of SFAS 123. Stock-based compensation expense for the year ended December 31, 2006 also includes stock-based compensation awards granted after January 1, 2006 based on the grant-date fair value estimated in accordance with the provisions of SFAS 123R. The valuation provisions of SFAS 123R also apply to grants that are modified after January 1, 2006.
The Company recognizes these compensation costs net of the estimated forfeitures on a straight-line basis over the requisite service period of the award, which is generally the option vesting term of four years. The Company estimated the forfeiture rate for the year ended December 31, 2006 based on its historical experience.
As a result of adopting SFAS 123R, the Company’s income before income taxes and net income for the year ended December 31, 2006 was $4.0 million and $3.0 million lower, respectively, than if the Company had continued to account for stock-based compensation under APB 25. The impact on both basic and diluted earnings per share for the year ended December 31, 2006 was $0.09. Total stock-based compensation cost capitalized in inventory was less than $0.1 million for the year ended December 31, 2006.
Prior to the adoption of SFAS 123R, the Company presented the excess tax benefit of stock option exercises as operating cash flows. Upon the adoption of SFAS 123R, “as if” windfall tax benefits (the tax deductions in excess of the compensation cost that would increase the pool of windfall tax benefits) are classified as financing cash flows, with the remaining excess tax benefit classified as operating cash flows. This requirement will reduce net operating cash flows and increase net financing cash flows in periods after adoption. Prior period cash flows are not reclassified to reflect this new requirement. In addition, total cash flow is not impacted as a result of this new requirement.
60
Note 8NETGEAR, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — Redeemable Convertible Preferred Stock (“Preferred Stock”):(Continued)
The
followingpro forma table
summarizesbelow reflects net income and basic and diluted net income per share for the
activityyears ended December 31, 2004 and 2005, had the Company applied the fair value recognition provisions of
Preferred StockSFAS 123, as follows (in thousands, except
per share data):
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | |
| | Series A | | Series B | | Series C | | Total |
| |
| |
| |
| |
|
| | Shares | | Amount | | Shares | | Amount | | Shares | | Amount | | Shares | | Amount |
| |
| |
| |
| |
| |
| |
| |
| |
|
| Balances at January 1, 2002 | | | 26,250,000 | | | $ | 29,123 | | | | 3,320,537 | | | $ | 14,955 | | | | — | | | $ | — | | | | 29,570,537 | | | $ | 44,078 | |
| Issuance of Preferred Stock (net of issuance cost $1,833) | | | — | | | | — | | | | — | | | | — | | | | 10,937,406 | | | | 3,368 | | | | 10,937,406 | | | | 3,368 | |
| Repurchase of Preferred Stock | | | (20,273,918 | ) | | | (17,275 | ) | | | — | | | | — | | | | — | | | | — | | | | (20,273,918 | ) | | | (17,275 | ) |
| Deemed Preferred Stock dividend | | | — | | | | (5,218 | ) | | | — | | | | — | | | | — | | | | 23,099 | | | | — | | | | 17,881 | |
| | | |
| | | |
| | | |
| | | |
| | | |
| | | |
| | | |
| | | |
| |
| Balances at December 31, 2002 | | | 5,976,082 | | | $ | 6,630 | | | | 3,320,537 | | | $ | 14,955 | | | | 10,937,406 | | | $ | 26,467 | | | | 20,234,025 | | | $ | 48,052 | |
| Repurchase of Preferred Stock | | | (2,525 | ) | | | (6 | ) | | | — | | | | — | | | | (3,020 | ) | | | (7 | ) | | | (5,545 | ) | | | (13 | ) |
| Conversion of Preferred Stock into common stock | | | (5,973,557 | ) | | | (6,624 | ) | | | (3,320,537 | ) | | | (14,955 | ) | | | (10,934,386 | ) | | | (26,460 | ) | | | (20,228,480 | ) | | | (48,039 | ) |
| | | |
| | | |
| | | |
| | | |
| | | |
| | | |
| | | |
| | | |
| |
| Balances at December 31, 2003 | | | — | | | $ | — | | | | — | | | $ | — | | | | — | | | $ | — | | | | — | | | $ | — | |
| | | |
| | | |
| | | |
| | | |
| | | |
| | | |
| | | |
| | | |
| |
As of December 31, 2003, 5,000,000 shares of Preferred Stock had been authorized, of which no amount was outstanding.
| | | | | | | | | |
| | | Year Ended
| |
| | | December 31, | |
| | | 2004 | | | 2005 | |
| |
| Net income, as reported | | $ | 23,465 | | | $ | 33,623 | |
| Add: | | | | | | | | |
| Employee stock-based compensation included in reported net income | | | 1,687 | | | | 1,064 | |
| Less: | | | | | | | | |
| Total employee stock-based compensation determined under fair value method, net of taxes(1) | | | (4,329 | ) | | | (9,684 | ) |
| | | | | | | | | |
| Pro forma net income | | $ | 20,823 | | | $ | 25,003 | |
| | | | | | | | | |
| Basic net income per share: | | | | | | | | |
| As reported | | $ | 0.77 | | | $ | 1.04 | |
| | | | | | | | | |
| Pro forma | | $ | 0.68 | | | $ | 0.77 | |
| | | | | | | | | |
| Diluted net income per share: | | | | | | | | |
| As reported | | $ | 0.72 | | | $ | 0.99 | |
| | | | | | | | | |
| Pro forma | | $ | 0.64 | | | $ | 0.74 | |
| | | | | | | | | |
The Company’s Certificate of Incorporation, as amended, authorizes the Company to issue 200,000,000 shares of $0.001 par value common stock. There were 28,618,969 shares of common stock outstanding at December 31, 2003.
| |
Note 10 —(1) | Stock Option Plans: | Of the 1,144,050 options granted during the year ended December 31, 2005, 964,100 were sales-restricted options that vested immediately on grant. These options had a fair value of $6.1 million, net of taxes. No such options were granted in 2004. |
As of December 31, 2006, the Company has the following share-based compensation plans:
2000 Stock Option Plan
In April 2000, the Company adopted the 2000 Stock Option Plan (the
“Plan”“2000 Plan”). The
2000 Plan provides for the granting of stock options to employees and consultants of the Company. Options granted under the
2000 Plan may be either incentive stock options or nonqualified stock options. Incentive stock options (“ISO”) may be granted only to Company employees (including officers and directors who are also employees). Nonqualified stock options (“NSO”) may be granted to Company employees,
directors and consultants.
The Company has reserved 7,350,000 shares of Common Stock
have been reserved for issuance under the
2000 Plan.
Options under the
2000 Plan may be granted for periods of up to ten years and at prices no less than the estimated fair value of the shares on the date of grant as determined by the Board of Directors, provided, however, that (i) the exercise price of an ISO and NSO shall not be less than the estimated fair value of the shares on the date of grant
respectively, and (ii) the exercise price of an ISO and NSO granted to a 10% shareholder shall not be less than 110% of the estimated fair value of the shares on the date of
grant, respectively.grant. To date, options granted generally vest over four years.
64
NETGEAR, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
2003 Stock Plan
In April 2003, the Company adopted the 2003 Stock Plan (the “Plan”“2003 Plan”). The 2003 Plan provides for the granting of stock options to employees and consultants of the Company. Options granted under the 2003 Plan may be either incentive stock options or nonqualified stock options. Incentive stock options (“ISO”)ISOs may be granted only to Company employees (including officers and directors who are also employees). Nonqualified stock options (“NSO”)NSOs may be granted to Company employees, directors
61
NETGEAR, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
and consultants. The Company has reserved 750,000 shares of Common Stock plus any shares which were reserved but not issued under the
Company’s 2000
Stock Option Plan as of the date of the approval of the 2003
Stock Plan,Plan. The number of shares which were reserved but not issued under the
Company’s 2000
Stock Option Plan that were transferred to the Company’s 2003
Stock Plan were 615,290, which when combined with the
stock option allocationshares reserved for the Company’s 2003
Stock Plan
give a total
of 1,365,290
shares reserved under the Company’s 2003
Stock Plan as of the date of transfer.
Any options cancelled under either the 2000 Plan or the 2003 Plan are returned to the pool available for grant. As of December 31,
2003, 1,396,4122006, 143,209 shares were reserved for
issuancefuture grants under the Company’s 2003
Stock Plan.
Options under the 2003 Plan may be granted for periods of up to ten years and at prices no less than the estimated fair value of the common stock on the date of grant as determined by the closing sales price for such stock as quoted on any established stock exchange or a national market system, provided, however, that (i) the exercise price of an ISO and NSO shall not be less than the estimated fair value of the shares on the date of grant respectively, and (ii) the exercise price of an ISO and NSO granted to a 10% shareholder shall not be less than 110% of the estimated fair value of the shares on the date of grant, respectively.grant. To date, options granted generally vest over four years, with the first tranche vesting at the end of twelve months and the remaining optionsshares underlying the option vesting monthly over the remaining three years. In fiscal 2005, certain options granted under the 2003 Plan immediately vested and were exercisable on the date of grant, and the shares underlying such options were subject to a resale restriction which expires at a rate of 25% per year.
For financial reporting purposes,
2006 Long Term Incentive Plan
In April 2006, the Company determined thatadopted the 2006 Long Term Incentive Plan (the “2006 Plan”), which was approved by the Company’s stockholders at the 2006 Annual Meeting of Stockholders on May 23, 2006. The 2006 Plan provides for the granting of stock options, stock appreciation rights, restricted stock, performance awards and other stock awards, to eligible directors, employees and consultants of the Company. The Company has reserved 2,500,000 shares of Common Stock for issuance under the 2006 Plan. Any options cancelled under the 2006 Plan are returned to the pool available for grant. As of December 31, 2006, 1,458,710 shares were reserved for future grants under the 2006 Plan.
Options granted under the 2006 Plan may be either incentive stock options or nonqualified stock options. ISOs may be granted only to Company employees (including officers and directors who are also employees). NSOs may be granted to Company employees, directors and consultants. Options may be granted for periods of up to ten years and at prices no less than the estimated fair value of the common stock on the date of grant as determined in anticipation ofby the Company’s initial public offering was in excess ofclosing sales price for such stock as quoted on any established stock exchange or a national market system, provided, however, that (i) the exercise price which was deemedof an ISO and NSO shall not be less than the estimated fair value of the shares on the date of grant and (ii) the exercise price of an ISO and NSO granted to a 10% shareholder shall not be less than 110% of the estimated fair value of the shares on the date of grant. Options granted under the 2006 Plan generally vest over four years, with the first tranche vesting at the end of twelve months and the remaining shares underlying the option vesting monthly over the remaining three years.
Stock appreciation rights may be granted under the 2006 Plan subject to the terms specified by the plan administrator, provided that the term of any such right may not exceed ten (10) years from the date of grant. The exercise price generally cannot be less than the fair market value as of the dates of grant. In connection withCompany’s common stock on the date the stock appreciation right is granted.
Restricted stock awards may be granted under the 2006 Plan subject to the terms specified by the plan administrator. The period over which any restricted award may fully vest is generally no less than three (3) years. Restricted stock awards are nonvested stock awards that may include grants of such options,restricted stock or grants of restricted stock units. Restricted stock awards are independent of option grants and are generally subject to forfeiture if employment terminates prior to the Company recorded deferredrelease of the restrictions. During that period, ownership of the shares cannot be transferred. Restricted stock based compensationhas the same voting rights as other common stock and is considered to be currently issued and outstanding. Restricted stock units do not have the voting rights of $6.7 million incommon stock, and the year ended December 31, 2002 and $1.0 million in the year ended December 31, 2003. For the year ended December 31, 2002 and December 31, 2003, respectively, the amortization of non-cash deferred stock-based compensation was $1.6 million and $1.8 million, respectively.shares
Activity under the combined Company’s 2000 and 2003 Stock Option Plans is set forth as follows:
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| | |
| | Year Ended December 31, |
| |
|
| | | | | | |
| | 2001 | | 2002 | | 2003 |
| |
| |
| |
|
| | | | Average | | | | Average | | | | Average |
| | | | Exercise | | | | Exercise | | | | Exercise |
| | Shares | | Price | | Shares | | Price | | Shares | | Price |
| |
| |
| |
| |
| |
| |
|
| Options outstanding at January 1 | | | 5,134,900 | | | $ | 5.39 | | | | 4,706,349 | | | $ | 5.40 | | | | 6,433,092 | | | $ | 4.68 | |
| | Options granted | | | 514,937 | | | | 8.57 | | | | 2,470,041 | | | | 3.99 | | | | 654,735 | | | | 12.14 | |
| | Options exercised | | | — | | | | — | | | | — | | | | — | | | | (141,896 | ) | | | 5.67 | |
| | Options cancelled | | | (943,488 | ) | | | 7.09 | | | | (743,298 | ) | | | 6.88 | | | | (384,238 | ) | | | 4.93 | |
| | | |
| | | | | | | |
| | | | | | | |
| | | | | |
| Outstanding at end of period | | | 4,706,349 | | | | 5.40 | | | | 6,433,092 | | | | 4.68 | | | | 6,561,693 | | | | 5.39 | |
| | | |
| | | | | | | |
| | | | | | | |
| | | | | |
| Options exercisable at end of period | | | 2,188,058 | | | | 5.17 | | | | 3,256,417 | | | | 4.69 | | | | 4,654,024 | | | | 4.88 | |
| | | |
| | | | | | | |
| | | | | | | |
| | | | | |
65
NETGEAR, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
underlying the restricted stock units are not considered issued and outstanding. The Company expenses the cost of the restricted stock awards, which is determined to be the fair market value of the shares at the date of grant, ratably over the period during which the restrictions lapse.
Performance awards may be in the form of performance shares or performance units. A performance share means an award denominated in shares of Company common stock and a performance unit means an award denominated in units having a dollar value or other currency, as determined by the Committee. The plan administrator will determine the number of performance awards that will be granted and will establish the performance goals and other conditions for payment of such performance awards. The period of measuring the achievement of performance goals will be a minimum of twelve (12) months.
Other stock-based awards may be granted under the 2006 Plan subject to the terms specified by the plan administrator. Other stock-based awards may include dividend equivalents, restricted stock awards, or amounts which are equivalent to all or a portion of any federal, state, local, domestic or foreign taxes relating to an award, and may be payable in shares, cash, other securities or any other form of property as the plan administrator may determine.
In the event of a change in control of the Company, all awards under the 2006 Plan vest in full and all outstanding performance shares and performance units will be paid out upon transfer.
2006 Stand-Alone Stock Option Agreement
In August 2006, the Company reserved for and granted a 300,000 share nonqualified stock option in connection with the hiring of a key executive. In the event of a change in control of the Company, this option vests in full.
Employee Stock Purchase Plan
The Company sponsors an Employee Stock Purchase Plan (the “ESPP”), pursuant to which eligible employees may contribute up to 10% of compensation, subject to certain income limits, to purchase shares of the Company’s common stock. Prior to January 1, 2006, employees were able to purchase stock semi-annually at a price equal to 85% of the fair market value at certain plan-defined dates. As of January 1, 2006, the Company changed the ESPP such that employees will purchase stock semi-annually at a price equal to 85% of the fair market value on the purchase date. Since the price of the shares is now determined at the purchase date and there is no longer a look-back period, the Company recognizes the expense based on the 15% discount at purchase. For the year ended December 31, 2006, ESPP compensation expense was $206,000.
The fair value of each option award is estimated on the date of grant using the Black-Scholes-Merton option valuation model and the weighted average assumptions in the following table. The expected term of options granted is derived from historical data on employee exercise and post-vesting employment termination behavior. The risk free interest rate is based on the implied yield currently available on U.S. Treasury securities with an equivalent remaining term. Expected volatility is based on a combination of the historical volatility of the Company’s stock as well as the historical volatility of certain of the Company’s industry peers’ stock.
| | | | | | | | | | | | | | | | | | | | | |
| | | Stock Options | | | | |
| | | Year Ended
| | | ESPP | |
| | | December 31, | | | Year Ended December 31, | |
| | | 2004 | | | 2005 | | | 2006 | | | 2004 | | | 2005 | |
| |
| Expected life (in years) | | | 4.0 | | | | 4.0 | | | | 4.9 | | | | 0.5 | | | | 0.5 | |
| Risk-free interest rate | | | 2.81 | % | | | 3.85 | % | | | 4.74 | % | | | 1.39 | % | | | 2.93 | % |
| Expected volatility | | | 52 | % | | | 56 | % | | | 59 | % | | | 52 | % | | | 55 | % |
| Dividend yield | | | — | | | | — | | | | — | | | | — | | | | — | |
| Weighted average fair value of grants | | $ | 5.47 | | | $ | 8.01 | | | $ | 12.05 | | | $ | 4.11 | | | $ | 5.21 | |
63
NETGEAR, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Activity under the Company’s Stock Option Plans is set forth as follows:
| | | | | | | | | | | | | | | | | |
| | | December 31, 2004 | | | December 31, 2005 | |
| | | | | | Weighted
| | | | | | Weighted
| |
| | | | | | Average
| | | | | | Average
| |
| | | | | | Exercise
| | | | | | Exercise
| |
| | | Shares | | | Price | | | Shares | | | Price | |
| |
| Options outstanding at beginning of year | | | 6,561,693 | | | $ | 5.39 | | | | 4,147,089 | | | $ | 7.00 | |
| Options granted | | | 614,602 | | | | 13.60 | | | | 1,147,050 | | | | 17.22 | |
| Options exercised | | | (2,796,428 | ) | | | 4.64 | | | | (1,378,373 | ) | | | 5.77 | |
| Options cancelled | | | (232,778 | ) | | | 7.41 | | | | (242,079 | ) | | | 9.41 | |
| | | | | | | | | | | | | | | | | |
| Outstanding at end of year | | | 4,147,089 | | | | 7.00 | | | | 3,673,687 | | | | 10.49 | |
| | | | | | | | | | | | | | | | | |
| Options exercisable at end of year | | | 2,644,063 | | | | 5.29 | | | | 2,959,255 | | | | 9.82 | |
| | | | | | | | | | | | | | | | | |
Options outstanding under the stock option plans as of December 31, 2005 and changes during the year ended December 31, 2006 were as follows:
| | | | | | | | | | | | | | | | | |
| | | | | | | | | Weighted
| | | | |
| | | | | | Weighted
| | | Average
| | | | |
| | | | | | Average
| | | Remaining
| | | Aggregate
| |
| | | | | | Exercise
| | | Contractual
| | | Intrinsic
| |
| | | Shares | | | Price | | | Term (In Years) | | | Value | |
| | | | | | | | | | | | (In thousands) | |
| |
| Options outstanding at December 31, 2005 | | | 3,673,687 | | | $ | 10.49 | | | | | | | | | |
| Options granted | | | 1,326,490 | | | | 22.06 | | | | | | | | | |
| Options exercised | | | (932,928 | ) | | | 7.97 | | | | | | | | | |
| Options cancelled | | | (132,792 | ) | | | 16.60 | | | | | | | | | |
| | | | | | | | | | | | | | | | | |
| Options outstanding at December 31, 2006 | | | 3,934,457 | | | $ | 14.79 | | | | 7.13 | | | $ | 45,148 | |
| | | | | | | | | | | | | | | | | |
| Options exercisable and expected to vest at December 31, 2006 | | | 3,843,643 | | | $ | 14.64 | | | | 7.08 | | | $ | 44,650 | |
| | | | | | | | | | | | | | | | | |
| Options exercisable at December 31, 2006 | | | 2,386,728 | | | $ | 10.86 | | | | 5.72 | | | $ | 36,732 | |
| | | | | | | | | | | | | | | | | |
The aggregate intrinsic value in the table above represents the total pre-tax intrinsic value (the difference between the Company’s closing stock price on the last trading day of fiscal 2006 and the exercise price, multiplied by the number of shares underlying thein-the-money options) that would have been received by the option holders had all option holders exercised their options on December 31, 2006. This amount changes based on the fair market value of the Company’s stock. Total intrinsic value of options exercised for the year ended December 31, 2004, 2005 and 2006 was $30.9 million, $18.7 million, and $15.1 million, respectively. Total fair value of options expensed for the year ended December 31, 2006 was $3.2 million, net of tax.
The total fair value of options vested during the years ended December 31, 2004, 2005, and 2006 was $1.9 million, $1.1 million, and $2.8 million, respectively.
64
NETGEAR, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Additional information regarding stock options outstanding under the Company’s
2000 Stock Option
Plan and 2003 Stock PlanPlans as of December 31,
20032006 is as follows:
| | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | |
| | Options Outstanding | | | | | | |
| |
| | | | |
| | | | Weighted | | | | Options Exercisable |
| | | | Average | | | |
|
| | | | Remaining | | Weighted | | | | Weighted |
| | | | Contractual | | Average | | | | Average |
| | Number | | Life (in | | Exercise | | Number | | Exercise |
| Range of Exercise Price | | Outstanding | | Years) | | Price | | Outstanding | | Price |
| |
| |
| |
| |
| |
|
| $1.29-$2.99 | | | 740,983 | | | | 8.0 | | | $ | 1.29 | | | | 429,378 | | | $ | 1.29 | |
| $3.00-$5.99 | | | 4,037,668 | | | | 6.7 | | | $ | 4.58 | | | | 3,484,681 | | | $ | 4.55 | |
| $6.00-$8.99 | | | 1,274,431 | | | | 7.7 | | | $ | 7.23 | | | | 637,814 | | | $ | 7.40 | |
| $9.00-$11.99 | | | 273,186 | | | | 9.2 | | | $ | 11.00 | | | | 656 | | | $ | 11.00 | |
| $12.00-$14.99 | | | 60,000 | | | | 9.6 | | | $ | 14.00 | | | | — | | | $ | — | |
| $15.00-$17.99 | | | 175,425 | | | | 9.9 | | | $ | 16.25 | | | | 101,495 | | | $ | 15.34 | |
| | | |
| | | | | | | | | | | |
| | | | | |
| $1.29-$17.99 | | | 6,561,693 | | | | 7.2 | | | $ | 5.39 | | | | 4,654,024 | | | $ | 4.88 | |
| | | |
| | | | | | | | | | | |
| | | | | |
The fair value of each option grant under the Company’s stock option plan is estimated on the date of grant using the fair value method, using the following weighted average assumptions:
| | | | | | | | | | | | | |
| | |
| | Year Ended December 31, |
| |
|
| | 2001 | | 2002 | | 2003 |
| |
| |
| |
|
| Risk free interest rate | | | 4.81 | % | | | 3.14 | % | | | 2.68 | % |
| Expected life (years) | | | 4 | | | | 4 | | | | 4 | |
| Expected dividends | | $ | — | | | $ | — | | | $ | — | |
| Volatility | | | 71 | % | | | 71 | % | | | 71 | % |
The weighted average fair value of options granted during 2001, 2002 and 2003 was $4.86, $4.45 and $8.37, respectively.
Note 11 — Employee Stock Purchase Plans:
In April 2003, the Company adopted the Employee Stock Purchase Plan (the “Purchase Plan”) under which 500,000 shares have been reserved for issuance. The Purchase Plan permits purchases of common stock via payroll deductions. The maximum payroll deduction is 10% of the employee’s cash compensation. Purchases of the common stock will occur on February 1 and August 1 of each year. The price of each share purchased will be 85% of the lower of:
The fair market value per share of common stock on the first trading day of each offering period (which lasts 6 months); or
The fair market value per share of common stock on the first trading day on or subsequent to the last day of the offering period, if it falls on a weekend or Government holiday.
The value of the shares purchased in any calendar year may not exceed $25,000.
| | | | | | | | | | | | | | | | | | | | | |
| | | Options Outstanding | | | Options Exercisable | |
| | | | | | Weighted Average
| | | Weighted
| | | | | | Weighted
| |
| | | | | | Remaining
| | | Average
| | | | | | Average
| |
| | | Number
| | | Contractual Life
| | | Exercise
| | | Number
| | | Exercise
| |
Range of Exercise Prices | | Outstanding | | | (In Years) | | | Price | | | Outstanding | | | Price | |
| |
| $ 1.29 - $ 2.99 | | | 81,888 | | | | 2.6 | | | $ | 1.29 | | | | 81,888 | | | $ | 1.29 | |
| $ 3.00 - $ 5.99 | | | 830,138 | | | | 3.4 | | | $ | 4.53 | | | | 830,138 | | | $ | 4.53 | |
| $ 6.00 - $ 8.99 | | | 205,495 | | | | 4.8 | | | $ | 7.54 | | | | 202,521 | | | $ | 7.53 | |
| $ 9.00 - $11.99 | | | 183,536 | | | | 7.0 | | | $ | 10.12 | | | | 121,156 | | | $ | 10.35 | |
| $12.00 - $14.99 | | | 253,812 | | | | 7.3 | | | $ | 13.86 | | | | 187,127 | | | $ | 13.80 | |
| $15.00 - $17.99 | | | 658,928 | | | | 7.4 | | | $ | 15.69 | | | | 564,417 | | | $ | 15.57 | |
| $18.00 - $20.99 | | | 954,158 | | | | 9.1 | | | $ | 19.42 | | | | 335,519 | | | $ | 19.51 | |
| $21.00 - $23.99 | | | 430,012 | | | | 9.2 | | | $ | 22.44 | | | | 63,962 | | | $ | 21.23 | |
| $24.00 - $26.39 | | | 336,490 | | | | 10.0 | | | $ | 26.39 | | | | 0 | | | | N/A | |
| | | | | | | | | | | | | | | | | | | | | |
| $ 1.29 - $26.39 | | | 3,934,457 | | | | 7.1 | | | $ | 14.79 | | | | 2,386,728 | | | $ | 10.86 | |
| | | | | | | | | | | | | | | | | | | | | |
As of December 31, 2003 there had not been any payroll deductions2006, $15.1 million of total unrecognized compensation cost related to stock options is expected to be recognized over a weighted-average period of 1.72 years.
Cash received from option exercises and no shares had been issuedpurchases under the Purchase Plan.ESPP for the year ended December 31, 2006 was $8.5 million. The actual excess tax benefit recognized for the tax deduction arising from the exercise of stock-based compensation awards for the year ended December 31, 2006 totaled $4.2 million.
| |
Note 12 — | Segment Information, Operations by Geographic Area and Customers Concentration: |
Nonvested restricted stock awards as of December 31, 2006 and changes during the year ended December 31, 2006 were as follows:
| | | | | | | | | |
| | | | | | Weighted
| |
| | | | | | Average
| |
| | | | | | Grant Date
| |
| | | Shares | | | Fair Value | |
| |
| Nonvested outstanding at December 31, 2005 | | | — | | | $ | — | |
| Granted | | | 114,000 | | | | 22.52 | |
| Vested | | | — | | | | — | |
| Forfeited | | | — | | | | — | |
| | | | | | | | | |
| Nonvested outstanding at December 31, 2006 | | | 114,000 | | | $ | 22.52 | |
| | | | | | | | | |
As of December 31, 2006, $1.9 million of total unrecognized compensation cost related to nonvested restricted stock awards is expected to be recognized over a weighted-average period of 1.59 years.
Note 8 — Segment Information, Operations by Geographic Area and Customer Concentration:
Operating segments are components of an enterprise about which separate financial information is available and is regularly evaluated by management, namely the chief operating decision maker of an
66
NETGEAR, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
organization, in order to make operating and resource allocation decisions. By this definition, the Company primarily operates in one business segment, which comprises the development, marketing and sale of networking products for the small business and home markets. NETGEAR’sThe Company’s primary headquarter functionsheadquarters and a significant portion of its operations are located in the United States. The Company also conducts sales, marketing, customer service activities and certain distribution
65
NETGEAR, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
center activities through several small sales offices in Europe, Middle-East and Africa (EMEA) and Asia as well as outsourced distribution centers.
For reporting purposes revenue is attributed to each geography based on the geographic location of the customer. Net revenue by geography comprises gross revenue less such items as sales incentives deemed to be a reduction of net revenue per EITF IssueNo. 01-9, sales returns and price protection, which reduce gross revenue.
Geographic information
Net revenue informationby geographic location is as follows (in thousands):
| | | | | | | | | | | | | |
| | | Year Ended December 31, | |
| | | 2004 | | | 2005 | | | 2006 | |
| |
| United States | | $ | 186,836 | | | $ | 199,208 | | | $ | 220,440 | |
| United Kingdom | | | 60,585 | | | | 76,456 | | | | 151,026 | |
| Germany | | | 51,304 | | | | 52,869 | | | | 55,104 | |
| EMEA (excluding UK and Germany) | | | 47,726 | | | | 70,626 | | | | 92,104 | |
| Asia Pacific and rest of the world | | | 36,688 | | | | 50,451 | | | | 54,896 | |
| | | | | | | | | | | | | |
| | | $ | 383,139 | | | $ | 449,610 | | | $ | 573,570 | |
| | | | | | | | | | | | | |
Long-lived assets, comprising fixed assets, are reported based on the location of the
reseller or distributor.asset. Long-lived assets primarily fixed assets,by geographic location are reported below based on the location of the asset.
Net revenue consist ofas follows (in thousands):
| | | | | | | | | | | | | |
| | |
| | Year Ended December 31, |
| |
|
| | 2001 | | 2002 | | 2003 |
| |
| |
| |
|
| North America | | $ | 121,688 | | | $ | 150,096 | | | $ | 172,885 | |
| United Kingdom | | | 20,701 | | | | 23,919 | | | | 35,415 | |
| Germany | | | 16,156 | | | | 23,963 | | | | 34,422 | |
| EMEA (excluding UK and Germany) | | | 16,120 | | | | 20,124 | | | | 29,585 | |
| Asia Pacific and rest of world | | | 17,775 | | | | 19,229 | | | | 26,995 | |
| | | |
| | | |
| | | |
| |
| | | $ | 192,440 | | | $ | 237,331 | | | $ | 299,302 | |
| | | |
| | | |
| | | |
| |
Long-lived assets consist of (in thousands):
| | | | | | | | | |
| | |
| | December 31, |
| |
|
| | 2002 | | 2003 |
| |
| |
|
| North America | | $ | 3,074 | | | $ | 3,260 | |
| EMEA | | | 12 | | | | 45 | |
| Asia Pacific | | | 58 | | | | 321 | |
| | | |
| | | |
| |
| | | $ | 3,144 | | | $ | 3,626 | |
| | | |
| | | |
| |
| | | | | | | | | |
| | | December 31, | |
| | | 2005 | | | 2006 | |
| |
| United States | | $ | 4,378 | | | $ | 4,878 | |
| EMEA | | | 42 | | | | 592 | |
| Asia Pacific and rest of the world | | | 282 | | | | 1,098 | |
| | | | | | | | | |
| | | $ | 4,702 | | | $ | 6,568 | |
| | | | | | | | | |
Customer
Concentration:concentration (as a percentage of net revenue):
| | | | | | | | | | | | | |
| | |
| | Year Ended |
| | December 31, |
| |
|
| Customer | | 2001 | | 2002 | | 2003 |
| |
| |
| |
|
| A | | | 36% | | | | 32% | | | | 31% | |
| B | | | 23% | | | | 20% | | | | 15% | |
| |
Note 13 — | Employee Benefit Plan: |
| | | | | | | | | | | | | |
| | | Year Ended December 31, |
| | | 2004 | | 2005 | | 2006 |
| |
| Ingram Micro, Inc. | | | 27 | % | | | 25 | % | | | 19 | % |
| Tech Data Corporation | | | 18 | % | | | 17 | % | | | 16 | % |
Note 9 — Employee Benefit Plan:
In April 2000, the Company adopted the NETGEAR 401(k) Plan to which employees couldmay contribute up to 15%100% of salary subject to the legal maximum. The Company contributes an amount equal to 50% of the first 5%employee contributions up to a maximum of the employees’ contribution. The maximum Company contribution is $1,500 per calendar year per employee. The Company contributed and expensed $80,000, $130,000$279,000, $361,000 and $233,000$473,000 related to the NETGEAR 401(k) Plan in the years ended December 31, 2001, 20022004, 2005 and 2003,2006, respectively.
67
66
QUARTERLY FINANCIAL DATA
(In thousands, except per share amounts)
(unaudited)
The following table presents unaudited quarterly financial information for each of the Company’s last eight quarters. This information has been derived from the Company’s unaudited financial statements and has been prepared on the same basis as the audited Consolidated Financial Statements appearing elsewhere in thisForm 10-K. In the opinion of management, all necessary adjustments, consisting only of normal recurring adjustments, have been included to state fairly the quarterly results.
| | | | | | | | | | | | | | | | | |
| | | April 2, 2006 | | | July 2, 2006 | | | October 1, 2006 | | | December 31, 2006 | |
| |
| Net revenue | | $ | 127,259 | | | $ | 130,738 | | | $ | 151,571 | | | $ | 164,002 | |
| Gross profit | | $ | 44,548 | | | $ | 45,377 | | | $ | 50,558 | | | $ | 53,176 | |
| Provision for income taxes | | $ | 6,714 | | | $ | 6,413 | | | $ | 7,080 | | | $ | 7,660 | |
| Net income | | $ | 9,868 | | | $ | 9,835 | | | $ | 7,980 | | | $ | 13,449 | |
| Net income per share — basic | | $ | 0.30 | | | $ | 0.30 | | | $ | 0.24 | | | $ | 0.40 | |
| Net income per share — diluted | | $ | 0.29 | | | $ | 0.29 | | | $ | 0.23 | | | $ | 0.38 | |
| | | | | | | | | | | | | | | | | |
| | | April 3, 2005 | | | July 3, 2005 | | | October 2, 2005 | | | December 31, 2005 | |
| |
| Net revenue | | $ | 108,952 | | | $ | 107,576 | | | $ | 111,317 | | | $ | 121,765 | |
| Gross profit | | $ | 35,881 | | | $ | 38,601 | | | $ | 39,099 | | | $ | 38,118 | |
| Provision for income taxes | | $ | 5,068 | | | $ | 4,944 | | | $ | 5,492 | | | $ | 5,363 | |
| Net income | | $ | 7,860 | | | $ | 8,301 | | | $ | 8,594 | | | $ | 8,868 | |
| Net income per share — basic | | $ | 0.25 | | | $ | 0.26 | | | $ | 0.26 | | | $ | 0.27 | |
| Net income per share — diluted | | $ | 0.24 | | | $ | 0.25 | | | $ | 0.25 | | | $ | 0.26 | |
67
| |
| Item 9. | Changes in and Disagreements With Accountants on Accounting and Financial Disclosure |
None
None.
| |
| Item 9A. | Controls and Procedures |
Evaluation of disclosure controls and procedures.Our management evaluated, with the participation of our chief executive officer and our chief financialaccounting officer, the effectiveness of our disclosure controls and procedures, as defined inRules 13a-15(e) and15d-15(e) under the Securities Exchange Act of 1934, as of the end of the period covered by this report.Annual Report onForm 10-K. Based on this evaluation, our chief executive officer and our chief financialaccounting officer have concluded that our disclosure controls and procedures are effective to ensure that information we are required to disclose in reports that we file or submit under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms.forms, and that such information is accumulated and communicated to management, including the chief executive officer and chief accounting officer, as appropriate to allow timely decisions regarding required disclosures.
Design and evaluation of internal control over financial reporting. Pursuant to Section 404 of the Sarbanes-Oxley Act of 2002, we have included a report of management’s assessment of the design and effectiveness of our internal controls as part of this Annual Report onForm 10-K for the fiscal year ended December 31, 2006. Management’s report is included with our Consolidated Financial Statements under Part II, Item 8 of thisForm 10-K.
Changes in internal control over financial reporting.There was no change in our internal control over financial reporting that occurred during the period covered by this reportmost recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. We are aware that any system of controls, however well designed and operated, can only provide reasonable, and not absolute, assurance that the objectives of the system are met, and that maintenance of disclosure controls and procedures is an ongoing process that may change over time. | |
| Item 9B. | Other Information |
None.
PART III
Certain information required by Part III is
omittedincorporated herein by reference from
this report in that we will file a definitive proxy statement pursuant to Regulation 14A, or theour Proxy Statement
notrelated to our 2007 Annual Meeting of Stockholders, which we intend to file no later than 120 days after the end of the fiscal year covered by this
report, and certain information included therein is incorporated herein by reference.report.
| |
| Item 10. | Directors, and Executive Officers of the Registrantand Corporate Governance |
Directors
The information required by this Item
regardingconcerning our directors
and executive officers is incorporated by reference to the
information contained insections of our Proxy Statement under the
section captionedheadings “Election of
Directors” in our Proxy Statement.Executive Officers
The information required by this Item regarding our executive officers is incorporated by referenceDirectors,” “Board and Committees Meetings,” and “Section 16(a) Beneficial Ownership Reporting Compliance,” and to the information contained in the section captioned “Executive Officers of the Registrant” included under Part I, Item 1 of this report.
Audit Committee
The information required by this Item regarding our Audit Committee and Audit Committee Financial Expert(s) is incorporated by reference to the information contained in our Proxy Statement.
Section 16(a) Beneficial Ownership Reporting Compliance
The information required by this Item regarding Section 16(a) beneficial ownership reporting compliance is incorporated by reference to the information contained in the section captioned “Section 16(a) Beneficial Ownership Reporting Compliance” in our Proxy Statement.
Code of Ethics
We have adopted a Code of Ethics that applies to our chief executive officer and senior financial officers, as required by the SEC. The current version of our Code of Ethics can be found on our Internet site at
http://www.netgear.com. Additional information required by this Item regarding our Code of Ethics is
68
incorporated by reference to the information contained in the section captioned “Code of Ethics” in our Proxy Statement.
We intend to satisfy the disclosure requirement under Item 10 ofForm 8-K regarding an amendment to, or waiver from, a provision of this code of ethics by posting such information on our website at the address specified above.
68
| |
| Item 11. | Executive Compensation |
The information required by this Item is incorporated by reference to the
information contained in the section captioned “Executive Compensation” insections of our Proxy
Statement.Statement under the headings “Compensation Discussion and Analysis,” “Executive Compensation,” “Compensation Committee Interlocks and Insider Participation,” and “Compensation Committee Report.”
| |
| Item 12. | Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters |
The information required by this Item is incorporated by reference to the information contained in the section captioned “Security Ownership of Certain Beneficial Owners and Management” in our Proxy Statement. The information required by this Item regarding Equity Compensation Plan information is included in Part II, Item 5 of this report.
| |
| Item 13. | Certain Relationships and Related Transactions, and Director Independence |
The information required by this Item is incorporated by reference to the information contained in the section captioned “Election of Directors” in our Proxy Statement.
| |
| Item 14. | Principal Accountant Fees and Services |
The information required by this Item related to audit fees and services is incorporated by reference to the information appearing in our Proxy Statement.
69
PART IV
| |
| Item 15. | Exhibits and Financial Statement Schedule |
Item 15. Exhibits, Financial Statement Schedule and Reports on Form 8-K
(a) The following documents are filed as part of this report:
| |
| (1) Financial Statements. |
(1) Financial Statements.
| | | | | |
| | Page | |
| |
|
| | | 39 | |
| | | 40 | |
| | | 42 | |
| | | 43 | |
| | | 44 | |
| | | 45 | |
| | | 46 | |
Consolidated Statements of Operations for each of the three years ended December 31, 2003, 2002 and 2001 | | | 47 | |
Consolidated Statements of Stockholders’ Equity (Deficit) for each of the three years ended December 31, 2003, 2002 and 2001 | | | 48 | |
Consolidated Statements of Cash Flows for each of the three years ended December 31, 2003, 2002 and 2001 | | | 49 | |
Notes to Consolidated Financial Statements | | | 5067 | |
| |
| (2)Financial Statement Schedule. |
|
| (3) Exhibits.The exhibits listed in the accompanying Index to Exhibits are filed or incorporated by reference as part of this report. |
(b) Reports on Form 8-KFinancial Statement Schedule.
Report on Form 8-K furnished on September 12, 2003 under Item 12 (Results
The following financial statement schedule of
Operations and Financial Condition), regarding our financial resultsNETGEAR, Inc. for the fiscal
quarteryears ended
June 29, 2003. Report on December 31, 2004, 2005 and 2006 is filed as part of thisForm 8-K furnished on October 28, 2003 under Item 12 (Results10-K and should be read in conjunction with the Consolidated Financial Statements of Operations and Financial Condition), regarding our financial results for the fiscal quarter ended September 28, 2003.NETGEAR, Inc.
70
69
Schedule II — Valuation and Qualifying Accounts
| | | | | | | | | | | | | | | | | |
| | | Balance at
| | | | | | | | | Balance at
| |
| | | Beginning of Year | | | Additions | | | Deductions | | | End of Year | |
| | | (In thousands) | |
| |
| Allowance for doubtful accounts: | | | | | | | | | | | | | | | | |
| Year ended December 31, 2004 | | | 1,322 | | | | 371 | | | | (184 | ) | | | 1,509 | |
| Year ended December 31, 2005 | | | 1,509 | | | | (4 | ) | | | (210 | ) | | | 1,295 | |
| Year ended December 31, 2006 | | | 1,295 | | | | 648 | | | | (216 | ) | | | 1,727 | |
| Allowance for sales returns and product warranty: | | | | | | | | | | | | | | | | |
| Year ended December 31, 2004 | | | 16,804 | | | | 30,863 | | | | (30,494 | ) | | | 17,173 | |
| Year ended December 31, 2005 | | | 17,173 | | | | 37,533 | | | | (36,876 | ) | | | 17,830 | |
| Year ended December 31, 2006 | | | 17,830 | | | | 61,558 | | | | (49,960 | ) | | | 29,428 | |
| Allowance for price protection: | | | | | | | | | | | | | | | | |
| Year ended December 31, 2004 | | | 2,607 | | | | 14,939 | | | | (12,897 | ) | | | 4,649 | |
| Year ended December 31, 2005 | | | 4,649 | | | | 11,828 | | | | (15,021 | ) | | | 1,456 | |
| Year ended December 31, 2006 | | | 1,456 | | | | 9,517 | | | | (7,779 | ) | | | 3,194 | |
(3) Exhibits. The exhibits listed in the accompanying Index to Exhibits are filed or incorporated by reference as part of this report.
71
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Annual Report to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Santa Clara, State of California, on the
5th1st day of March
2004.2007.
NETGEAR, INC.
Registrant
| | |
| | NETGEAR, INC. |
| Registrant |
|
| /s/ | PATRICK C.S. LO |
|
|
| Patrick C.S. Lo |
| Chairman of the Board and Chief Executive Officer (Principal Executive Officer) |
Patrick C.S. Lo
Chairman of the Board and Chief Executive Officer
(Principal Executive Officer)
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Patrick C.S. Lo and
Jonathan Mather,Christine M. Gorjanc, and each of them, his
attorneys-in-fact, each with the power of substitution, for him in any and all capacities, to sign any and all amendments to this Report on
Form 10-K and to file the same, with exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, hereby ratifying and confirming all that each of said
attorneys-in-fact, or his substitute or substitutes, may do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated:
| | | | | | | |
Signature | | Title | | |
SignatureDate
| | Title | | Date |
| |
| |
|
| |
/s/ PATRICK C.S. LO
Patrick C.S. Lo | | Chairman of the Board and
Chief Executive Officer
(Principal Executive Officer) | | March 5, 20041, 2007 |
| | | | | |
/s/ JONATHAN MATHERCHRISTINE M. GORJANC
Jonathan MatherChristine M. Gorjanc | | Executive Vice President and
Chief FinancialAccounting Officer
(Principal Financial and
Accounting Officer) | | March 5, 20041, 2007 |
| | | | | |
/s/ RALPH E. FAISON
Ralph E. Faison | | Director | | March 5, 20041, 2007 |
| | | | | |
/s/ A. TIMOTHY GODWIN
A. Timothy Godwin | | Director | | March 5, 20041, 2007 |
| | | | | |
/s/ JEF GRAHAM
Jef Graham | | Director | | March 1, 2007 |
| | | | |
/s/ LINWOOD A. LACY, JR.
Linwood A. Lacy, Jr. | | Director | | March 5, 20041, 2007 |
| | | | | |
/s/ GERALD A. POCHGEORGE G. C. PARKER
Gerald A. PochGeorge G. C. Parker | | Director | | March 5, 20041, 2007 |
| | | | | |
/s/ GREGORY J. ROSSMANN
Gregory J. Rossmann | | Director | | March 5, 2004 |
|
/s/ STEPHEN D. ROYER
Stephen D. Royer | | Director | | March 5, 20041, 2007 |
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INDEX TO EXHIBITS| | | | | |
| Exhibit | | |
| Number | | Description |
| |
|
| | 3 | .3 | | Amended and Restated Certificate of Incorporation of the registrant (1) |
| | 3 | .5 | | Bylaws of the registrant (1) |
| | 4 | .1 | | Form of registrant’s common stock certificate (1) |
| | 4 | .2 | | Amended and Restated Investor Rights Agreement, dated February 7, 2002, by and between the registrant and the individuals and entities listed therein (1) |
| | 10 | .1 | | Form of Indemnification Agreement for directors and officers (1) |
| | 10 | .2 | | 2000 Stock Option Plan and forms of agreements thereunder (1) |
| | 10 | .3 | | 2003 Stock Plan and forms of agreements thereunder (1) |
| | 10 | .4 | | 2003 Employee Stock Purchase Plan (1) |
| | 10 | .5 | | Employment Agreement, dated December 3, 1999, between the registrant and Patrick C.S. Lo (1) |
| | 10 | .6 | | Employment Agreement, dated August 10, 2001, between the registrant and Ray Robidoux (1) |
| | 10 | .7 | | Employment Agreement, dated August 10, 2001, between the registrant and Jonathan R. Mather (1) |
| | 10 | .8 | | Employment Agreement, dated December 9, 1999, between the registrant and Mark G. Merrill (1) |
| | 10 | .9 | | Employment Agreement, dated November 4, 2002, between the registrant and Michael F. Falcon (1) |
| | 10 | .10 | | Employment Agreement, dated January 6, 2003, between the registrant and Charles T. Olson (1) |
| | 10 | .11 | | Employment Agreement, dated November 3, 2003, between the registrant and Michael Werdann |
| | 10 | .12 | | Loan and Security Agreement, dated July 25, 2002, between the registrant and Comerica Bank-California (1) |
| | 10 | .13 | | Standard Office Lease, dated December 3, 2001, between the registrant and Dell Associates II-A, and First Amendment to Standard Office Lease, dated March 21, 2002 (1) |
| | 10 | .14* | | Distributor Agreement, dated March 1, 1997, between the registrant and Tech Data Product Management, Inc. (1) |
| | 10 | .15* | | Distributor Agreement, dated March 1, 1996, between the registrant and Ingram Micro Inc., as amended by Amendment dated October 1, 1996 and Amendment No. 2 dated July 15, 1998 (1) |
| | 10 | .16* | | Non-exclusive Distributor Agreement, dated September 25, 1995, between registrant and Computer 1000 AG, as amended by Amendment dated September 30, 1996 (1) |
| | 10 | .17* | | Master Purchase Agreement, dated February 11, 2003, between the registrant and Lite-On Technology Corporation (1) |
| | 10 | .18* | | Master Purchase Agreement, dated March 31, 2003, between the registrant and Delta Networks, Inc., as signed by the registrant on April 24, 2003 (1) |
| | 10 | .19* | | Vendor Agreement, dated September 24, 2001, between the registrant and BestBuy Co., Inc. (1) |
| | 10 | .20* | | Product Service Addendum to the Vendor Agreement, dated September 21, 2001, between the registrant and Best Buy Co. Inc., and Addendum Consignment Agreement to the Vendor Agreement, dated January 1, 2002 (1) |
| | 10 | .21* | | Master Purchase Agreement, dated April 25, 2003, between the registrant and SerComm Corporation, as signed by the registrant on May 8, 2003 (1) |
| | 10 | .22* | | Vendor Agreement, dated March 26, 1998, between the registrant and Fry’s Electronics, Inc. (1) |
| | 10 | .23* | | Retail Outlet Retailer Agreement, dated April 1, 1998, between the registrant and Circuit City Stores, Inc. (1) |
| | 10 | .24* | | Warehousing Agreement, dated July 5, 2001, between the registrant and API, Logistics Americas, Ltd. (1) |
| | | | | |
Exhibit
| | |
Number | | Description |
| |
| | 3 | .3 | | Amended and Restated Certificate of Incorporation of the registrant(1) |
| | 3 | .5 | | Bylaws of the registrant(1) |
| | 4 | .1 | | Form of registrant’s common stock certificate(1) |
| | 10 | .1 | | Form of Indemnification Agreement for directors and officers(1) |
| | 10 | .2 | | 2000 Stock Option Plan and forms of agreements thereunder(1) |
| | 10 | .3 | | 2003 Stock Plan and forms of agreements thereunder(1) |
| | 10 | .4 | | 2003 Employee Stock Purchase Plan(1) |
| | 10 | .5 | | Employment Agreement, dated December 3, 1999, between the registrant and Patrick C.S. Lo(1) |
| | 10 | .7 | | Employment Agreement, dated August 10, 2001, between the registrant and Jonathan R. Mather(1) |
| | 10 | .8 | | Employment Agreement, dated December 9, 1999, between the registrant and Mark G. Merrill(1) |
| | 10 | .9 | | Employment Agreement, dated November 4, 2002, between the registrant and Michael F. Falcon(1) |
| | 10 | .10 | | Employment Agreement, dated January 6, 2003, between the registrant and Charles T. Olson(1) |
| | 10 | .11 | | Employment Agreement, dated October 18, 2004, between the registrant and Albert Y. Liu(2) |
| | 10 | .12 | | Employment Agreement, dated November 16, 2005, between the registrant and Christine M. Gorjanc(3) |
| | 10 | .13 | | Standard Office Lease, dated December 3, 2001, between the registrant and Dell Associates II-A, and First Amendment to Standard Office Lease, dated March 21, 2002(1) |
| | 10 | .13.1 | | Second Amendment to Lease, dated June 30, 2004, between the registrant and Dell Associates II-A(4) |
| | 10 | .14* | | Distributor Agreement, dated March 1, 1997, between the registrant and Tech Data Product Management, Inc.(1) |
| | 10 | .15* | | Distributor Agreement, dated March 1, 1996, between the registrant and Ingram Micro Inc., as amended by Amendment dated October 1, 1996 and Amendment No. 2 dated July 15, 1998(1) |
| | 10 | .24* | | Warehousing Agreement, dated July 5, 2001, between the registrant and APL, Logistics Americas, Ltd.(1) |
| | 10 | .25* | | Distribution Operation Agreement, dated April 27, 2001, between the registrant and Furness Logistics BV(1) |
| | 10 | .26* | | Distribution Operation Agreement, dated December 1, 2001, between the registrant and Kerry Logistics (Hong Kong) Limited(1) |
| | 10 | .30 | | Employment Agreement, dated November 3, 2003, between the registrant and Michael Werdann(5) |
| | 10 | .31 | | Severance Agreement and Release, effective as of November 12, 2004, between the registrant and Christopher Marshall(6) |
| | 10 | .32 | | Settlement Agreement and Release for Zilberman v. NETGEAR, Civil Action CV021230, effective as of November 22, 2005(7) |
| | 10 | .33 | | 2006 Long Term Incentive Plan and forms of agreements thereunder(8) |
| | 10 | .34 | | Agreement and Plan of Merger, dated as of July 26, 2006, by and among NETGEAR, Inc., SKJM Holdings Corporation, SkipJam Corp., Michael Spilo, Jonathan Daub, Francis Refol, Dennis Aldover and Zhicheng Qiu(9) |
| | 10 | .35 | | Separation Agreement and Release, dated as of April 26, 2006, by and between NETGEAR, Inc. and Jonathan R. Mather(10) |
| | 10 | .36 | | Employment Agreement, dated September 5, 2006, between the registrant and Deborah A. Williams(11) |
| | 10 | .38 | | Relocation Agreement, dated September 5, 2006, between the registrant and Deborah A. Williams(12) |
| | 10 | .39 | | Employment Agreement, dated September 7, 2006, between the registrant and Thomas Holt(13) |
| | 10 | .40 | | Relocation Agreement, dated September 7, 2006, between the registrant and Thomas Holt(14) |
| | 21 | .1 | | List of subsidiaries |
| | 23 | .1 | | Consent of PricewaterhouseCoopers LLP, Independent Registered Public Accounting Firm |
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| | | | | |
| Exhibit | | |
| Number | | Description |
| |
|
| | 10 | .25* | | Distribution Operation Agreement, dated April 27, 2001, between the registrant and Furness Logistics BV (1) |
| | 10 | .26* | | Distribution Operation Agreement, dated December 1, 2001, between the registrant and Kerry Logistics (Hong Kong) Limited (1) |
| | 10 | .27 | | Services Agreement, dated March 11, 2000, between the registrant and TRINET Employer Group, Inc. (1) |
| | 10 | .28* | | Wholesale Vendor Agreement, dated August 28, 2002, between the registrant and Costco Wholesale Corporation and The Price Company (1) |
| | 10 | .29* | | Master Purchase Agreement, dated March 27, 2003, between the registrant and Cameo Communications Corporation (1) |
| | 10 | .30* | | Master Purchase Agreement, dated April 18, 2003, between the registrant and Z-Com, Inc., as signed by the registrant on April 23, 2003 (1) |
| | 10 | .31 | | Employment Agreement, dated November 14, 2003, between the registrant and Christopher Marshall |
| | 10 | .32 | | Severance Agreement and Release, dated December 14, 2003, between the registrant and Leslie Adams |
| | 21 | .1 | | List of subsidiaries (1) |
| | 23 | .1 | | Consent of PricewaterhouseCoopers LLP, Independent Accountants |
| | 23 | .2 | | Report of PricewaterhouseCoopers LLP, Independent Auditors, on Financial Statement Schedule |
| | 31 | .1 | | Certification of Chief Executive Officer pursuant to Securities Exchange Act Rules 13a-15(c) and 15d-15(e), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 |
| | 31 | .2 | | Certification of Chief Financial Officer pursuant to Securities Exchange Act Rules 13a-15(c) and 15d-15(e), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 |
| | 32 | .1 | | Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |
| | 99 | .1 | | Schedule II — Valuation and Qualifying Accounts |
| | | | | |
Exhibit
| | |
Number | | Description |
| |
| | 31 | .1 | | Certification of Chief Executive Officer pursuant to Securities Exchange ActRules 13a-15(c) and15d-15(e), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 |
| | 31 | .2 | | Certification of Chief Accounting Officer pursuant to Securities Exchange ActRules 13a-15(c) and15d-15(e), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 |
| | 32 | .1 | | Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |
| | 32 | .2 | | Certification of Chief Accounting Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |
| | |
| * | | Confidential treatment has been granted as to certain portions of this Exhibit. |
| |
| (1) | | Incorporated by reference to the exhibit bearing the same number filed with the Registrant’s Registration Statement onForm S-1 (RegistrationStatement 333-104419), which the Securities and Exchange Commission declared effective on July 30, 2003. |
|
| (2) | | Incorporated by reference to Exhibit 10.3 of the Registrant’s Quarterly Report onForm 10-Q filed on November 17, 2004 with the Securities and Exchange Commission. |
|
| (3) | | Incorporated by reference to Exhibit 10.32 of the Registrant’s Current Report onForm 8-K filed on November 22, 2005 with the Securities and Exchange Commission. |
|
| (4) | | Incorporated by reference to Exhibit 10.2 of the Registrant’s Quarterly Report onForm 10-Q filed on November 17, 2004 with the Securities and Exchange Commission. |
|
| (5) | | Incorporated by reference to Exhibit 10.11 of the Registrant’s Annual Report onForm 10-K filed on March 5, 2004 with the Securities and Exchange Commission. |
|
| (6) | | Incorporated by reference to Exhibit 10.4 of the Registrant’s Quarterly Report onForm 10-Q filed on November 17, 2004 with the Securities and Exchange Commission. |
|
| (7) | | Incorporated by reference to Exhibit 10.33 of the Registrant’s Current Report onForm 8-K filed on November 25, 2005 with the Securities and Exchange Commission. |
|
| (8) | | Incorporated by reference to the copy included in the Registrant’s Proxy Statement for the 2006 Annual Meeting of Stockholders filed on April 21, 2006 with the Securities and Exchange Commission. |
|
| (9) | | Incorporated by reference to Exhibit 2.1 of the Registrant’s Current Report onForm 8-K filed on July 27, 2006 with the Securities and Exchange Commission. |
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| (10) | | Incorporated by reference to Exhibit 99.2 of the Registrant’s Current Report onForm 8-K filed on April 26, 2006 with the Securities and Exchange Commission. |
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| (11) | | Incorporated by reference to Exhibit 99.1 of the Company’s Current Report onForm 8-K filed on September 11, 2006 with the Securities and Exchange Commission. |
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| (12) | | Incorporated by reference to Exhibit 99.2 of the Company’s Current Report onForm 8-K filed on September 11, 2006 with the Securities and Exchange Commission. |
|
| (13) | | Incorporated by reference to Exhibit 99.3 of the Company’s Current Report onForm 8-K filed on September 11, 2006 with the Securities and Exchange Commission. |
|
| (14) | | Incorporated by reference to Exhibit 99.4 of the Company’s Current Report onForm 8-K filed on September 11, 2006 with the Securities and Exchange Commission. |
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