Netgear 2006 Annual Report Download

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FORM 10-K
NETGEAR, INC
(Annual Report)
Filed 3/1/2007 For Period Ending 12/31/2006
Address 4500 GREAT AMERICAN PARKWAY
SANTA CLARA, California 95054
Telephone 408-907-8000
CIK 0001122904
Industry Communications Equipment
Sector Technology
Fiscal Year 12/31

Table of contents

  • Page 1
    NETGEAR, INC FORM 10-K (Annual Report) Filed 3/1/2007 For Period Ending 12/31/2006 Address Telephone CIK Industry Sector Fiscal Year 4500 GREAT AMERICAN PARKWAY SANTA CLARA, California 95054 408-907-8000 0001122904 Communications Equipment Technology 12/31

  • Page 2

  • Page 3
    ... by reference to the closing price of the common stock as reported on the Nasdaq National Market on June 30, 2006 (the last business day of the Registrant's most recently completed fiscal second quarter). The number of outstanding shares of the registrant's Common Stock, $0.001 par value, was...

  • Page 4
    in Part III of this Form 10-K.

  • Page 5
    ... Item 14. PART I Business. Risk Factors Unresolved Staff Comments Properties Legal Proceedings Submission of Matters to a Vote of Security Holders PART II Market for Registrant's Common Stock, Related Stockholder Matters and Issuer Purchases of Equity Securities Selected Consolidated Financial Data...

  • Page 6
    ... product 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. We sell our products...

  • Page 7
    ... Partner program. Our DMRs and VARs generally purchase our products through our wholesale distributors, primarily Ingram Micro, Inc. and Tech Data Corporation. Broadband Service Providers. We also supply our products directly to broadband service providers in the United States and internationally...

  • Page 8
    ...connecting devices in today's home and small-office networks. Products that enable Ethernet networking include: • 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...

  • Page 9
    ... 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...

  • Page 10
    ...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...

  • Page 11
    ...-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...

  • Page 12
    ..., ProSafe, RangeMax and Smart Wizard, in the United States and 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...

  • Page 13
    ...-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, including as the Asia/Pacific marketing director for Unix servers. Mr...

  • Page 14
    ... and annual operating results include those listed in this risk factors section of this Form 10-K and others such as: • changes in the pricing policies of or the introduction of new products by us or our competitors; • changes in the terms of our contracts with customers or suppliers that cause...

  • Page 15
    ..., 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...

  • Page 16
    ... 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, consumer class-action lawsuits related to the marketing and performance of our home networking products...

  • Page 17
    ... 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...

  • Page 18
    ...longer sales cycle, more stringent product testing and 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...

  • Page 19
    ...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...

  • Page 20
    ... 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...

  • Page 21
    ... 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 generally packaged by a limited number of original design manufacturers, or ODMs, and original equipment manufacturers, or OEMs. We rely on...

  • Page 22
    ... 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...

  • Page 23
    ...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...

  • Page 24
    ...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...

  • Page 25
    ... Purchases of Equity Securities Our common stock has been quoted under the symbol "NTGR" on the Nasdaq National Market from July 31, 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...

  • Page 26
    ... $ $ 148.39 131.51 139.21 Dividend Policy We have never declared or paid cash dividends on our capital stock. 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. 22

  • Page 27
    ...security holders(1) Equity compensation plans not approved by security holder 4,048,457 - $ 14.37 - 1,911,861 - (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

  • Page 28
    ...included in this Form 10-K. 2002 Year Ended December 31, 2003 2004 2005 (In thousands, except per share data) 2006 Consolidated Statement of Operations Data: Net revenue Cost of revenue(2) Gross profit Operating expenses: Research and development(2) Sales and marketing(2) General and administrative...

  • Page 29
    ... retailers, online retailers, wholesale distributors, DMRs, 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, Argos (U.K.), Dixons...

  • Page 30
    ... 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...

  • Page 31
    ... and estimates. Allowances for Product Warranties, Returns due to 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...

  • Page 32
    ...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...

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    ... Gross profit Operating expenses: Research and development Sales and marketing General and administrative In-process research and development Litigation reserves Total operating expenses Income from operations Interest income Other income (expense), net Income before income taxes Provision for...

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    ...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...

  • Page 35
    ... 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...

  • Page 36
    ... 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...

  • Page 37
    ... 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...

  • Page 38
    ... 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...

  • Page 39
    ...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...Zilberman v. NETGEAR lawsuit. The lawsuit was ...

  • Page 40
    ... upon exercise of stock options and our employee stock purchase program. Our days sales outstanding decreased from 77 days as of December 31, 2005 to 66 days as of December 31, 2006. Our accounts payable increased from $38.9 million at December 31, 2005 to $39.8 million at December 31, 2006. 36

  • Page 41
    ... terms, which could have a negative effect on our business and results of operations. Backlog As of December 31, 2006, we had a backlog of approximately $42.7 million compared to approximately $15.7 million as of December 31, 2005. Our backlog consists of products for which customer purchase orders...

  • Page 42
    ... 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...

  • Page 43
    ... 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...

  • Page 44
    ... 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...

  • Page 45
    ...permit preparation of financial statements in accordance 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...

  • Page 46
    ...NETGEAR, INC. CONSOLIDATED BALANCE SHEETS December 31, 2005 2006 (In thousands, except share and per share data) ASSETS Current assets: Cash and cash equivalents Short-term investments Accounts receivable, net Inventories Deferred income taxes Prepaid expenses and other current assets Total current...

  • Page 47
    Table of Contents NETGEAR, INC. CONSOLIDATED STATEMENTS OF OPERATIONS Year Ended December 31, 2004 2005 2006 (In thousands, except per share data) Net revenue Cost of revenue(1) Gross profit Operating expenses: Research and development(1) Sales and marketing(1) General and administrative(1) In-...

  • Page 48
    ... gain on short-term investments Net income Total comprehensive income Reversal of deferred stock-based compensation Stock-based compensation expense Exercise of common stock options Issuance of common stock under employee stock purchase plan Tax benefit from exercise of stock options Balance...

  • Page 49
    ... other current assets Accounts payable Accrued employee compensation Other accrued liabilities Deferred revenue Income taxes payable Net cash provided by operating activities Cash flows from investing activities: Purchases of short-term investments Proceeds from maturities of short-term investments...

  • Page 50
    ... users. The Company's product offerings enable users to share Internet access, peripherals, files, digital multimedia content and applications among multiple personal computers, or PCs, and other Internet-enabled devices. The Company sells products primarily through a global sales channel network...

  • Page 51
    ... as retailers and broadband service providers who sell the products to a large group of 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 credit...

  • Page 52
    ...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...

  • Page 53
    ..., channel inventory levels, current economic trends and changes in customer demand for the Company's products when evaluating the adequacy of the allowance for sales returns, namely warranty and stock rotation returns. Revenue on shipments is also reduced for estimated price protection and sales...

  • Page 54
    ...31, 2004, 2005 and 2006 respectively. Research and development Costs incurred in the research and development of new products are charged to expense as incurred. Advertising costs Advertising costs are expensed as incurred. Total advertising and promotional expenses were $11.9 million, $14.5 million...

  • Page 55
    ..., "Accounting for Stock Issued to Employees" ("APB 25"). In March 2005, the Securities and Exchange Commission (the "SEC") issued Staff Accounting Bulletin No. 107 ("SAB 107") regarding the SEC's interpretation of SFAS 123R and the valuation of share-based payments for public companies. The Company...

  • Page 56
    ...Prepaid expenses and other current assets Intangibles Goodwill Non-current deferred income taxes Total purchase price allocation $ $ 6 4,000 3,243 484 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...

  • Page 57
    ...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...

  • Page 58
    ... of Contents NETGEAR, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) Accounts receivable and related allowances consist of the following: December 31, 2005 2006 Gross accounts receivable Less: Allowance for doubtful accounts Allowance for sales returns Allowance for price protection...

  • Page 59
    ... are reflected in diluted earnings per share by application of the treasury 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...

  • Page 60
    ...: Accruals and allowances Net operating loss carryforwards Depreciation Stock-based compensation Other Deferred Tax Liabilities: Acquired intangible assets Unremitted earnings of foreign subsidiaries Net deferred tax assets Current portion Non-current portion Net deferred tax assets $11,503 - 328...

  • Page 61
    ... for a proposed settlement. Under the terms of the 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...

  • Page 62
    ...'s switches, routers, modems, adapters, powerline products, and wireless access points of infringement. In July 2006, the court granted the Company's motion to transfer the action to the Northern District of California. This action is in the preliminary motion stages and no trial date has been set...

  • Page 63
    ... 2011 2012 and thereafter Total minimum lease payments Guarantees and Indemnifications 2,371 1,298 718 544 509 3,214 $8,654 The Company has entered into various inventory related purchase agreements with suppliers. Generally, under these agreements, 50% of orders are cancelable by giving notice 46...

  • Page 64
    ... 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...

  • Page 65
    ... 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. 7,350,000 shares of Common Stock have been reserved for issuance under the 2000 Plan...

  • Page 66
    ... 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 by the closing sales price for such stock as quoted on any established stock exchange or...

  • Page 67
    ... 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...

  • Page 68
    ... 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 the in-the-money options) that would have been...

  • Page 69
    ... comprises the development, marketing and sale of networking products for the small business and home markets. The Company's primary headquarters and a significant portion of its operations are located in the United States. The Company also conducts sales, marketing, customer service activities and...

  • Page 70
    Table of Contents 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...

  • Page 71
    ...in this Form 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 Gross profit Provision for income taxes Net...

  • Page 72
    ...Part I, Item 1 of this report. 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...

  • Page 73
    ... Interlocks and Insider Participation," and "Compensation Committee Report." Item 12. Security Ownership of Certain Beneficial Owners... 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...

  • Page 74
    ... as part of this report: (1) Financial Statements. Page Management's Report on Internal Control Over Financial Reporting Report of Independent Registered Public Accounting Firm Consolidated Balance Sheets as of December 31, 2005 and 2006 Consolidated Statements of Operations for the three years...

  • Page 75
    ...accounts: Year ended December 31, 2004 Year ended December 31, 2005 Year ended December 31, 2006 Allowance for sales returns and product warranty:... Year ended December 31, 2004 Year ended December 31, 2005 Year ended December 31, 2006 Allowance for price ...

  • Page 76
    ... 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 1st day of March 2007. NETGEAR, INC . Registrant /s/ PATRICK C.S. LO Patrick...

  • Page 77
    ... and Charles T. Olson(1) Employment Agreement, dated October 18, 2004, between the registrant and Albert Y. Liu(2) Employment Agreement, dated November 16, 2005, between the registrant and Christine M. Gorjanc(3) Standard Office Lease, dated December 3, 2001, between the registrant and Dell...

  • Page 78
    ...10) Incorporated by reference to Exhibit 99.2 of the Registrant's Current Report on Form 8-K filed on April 26, 2006 with the Securities and Exchange Commission. (11) Incorporated by reference to Exhibit 99.1 of the Company's Current Report on Form 8-K filed on September 11, 2006 with the Securities...

  • Page 79

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    Exhibit 21.1 Subsidiaries of the Registrant Entity Name Jurisdiction Netgear International, Inc. SkipJam Corp. Delaware Delaware

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    Exhibit 23.1 CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM We hereby consent to the incorporation by reference in the Registration Statements on Form S-8 (No. 333-107718, 333-136892, 333-136895) of NETGEAR, Inc. of our report dated March 1, 2007 relating to the financial statements, ...

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    ... and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the Registrant's ability to record, process, summarize and report financial information; and b. Any fraud, whether or not material, that involves...

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  • Page 86
    ...information; and b. Any fraud, whether or not material, that involves management or other employees who have a significant role in the Registrant's internal control over financial reporting. Date: March 1, 2007 By: /s/ CHRISTINE M. GORJANC Christine M. Gorjanc Chief Accounting Officer NETGEAR, Inc.

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    ... information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. Date: March 1, 2007 By: /s/ PATRICK C.S. LO Patrick C.S. Lo Chairman and Chief Executive Officer NETGEAR, Inc. A signed original of this written statement...

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    ... information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. Date: March 1, 2007 By: /s/ CHRISTINE M. GORJANC Christine M. Gorjanc Chief Accounting Officer NETGEAR, Inc. A signed original of this written statement...