Netgear 2006 Annual Report Download - page 31

Table of Contents
customer. The amount and timing of our revenue for any period could be materially different if our management
made different judgments 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 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 current 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 financial position and results of operations.
Sales incentives provided to customers are accounted for in accordance with Emerging Issues Task Force
(“EITF”) Issue No. 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 can reasonably estimate the fair value of the 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
classification of the sales 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 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 value our inventory at the lower of cost or market, cost being determined using the first-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 to
determine what inventory, if any, are not saleable. Our analysis is based on the demand forecast but takes into
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