Netgear 2007 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
    ... Commission file number 000-50350 NETGEAR, Inc. (Exact name of registrant as specified in its charter) Delaware (State or other jurisdiction of incorporation or organization) 77-0419172 (I.R.S. Employer Identification No.) 4500 Great America Parkway, Santa Clara, California (Address of principal...

  • 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
    ... among multiple personal computers, or PCs, and other Internet-enabled devices. We sell our products primarily through a global sales channel network, which includes traditional retailers, online retailers, direct market resellers, or DMRs, value added resellers, or VARs, and broadband service...

  • Page 7
    ... Data Corporation. We work directly with our retail channels on market development activities, such as coadvertising, 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...

  • Page 8
    ... Data Corporation Product Offerings 27% 18% 25% 17% 19% 16% 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...

  • Page 9
    ... 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...

  • Page 10
    ...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...

  • Page 11
    ... 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...

  • Page 12
    ... our products, including NETGEAR, the NETGEAR logo, the NETGEAR Digital Entertainer logo, the Gear Guy logo, Connect with Innovation, Everybody's connecting, IntelliFi, ProSafe, RangeMax and Smart Wizard, in the United States and internationally. We have registered several Internet domain names that...

  • Page 13
    ..., 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. Lo received...

  • Page 14
    ... markets, as well as decreased demand for Internet access; • changes in or consolidation of our sales channels and wholesale distributor relationships or failure to manage our sales channel inventory and warehousing requirements; • delay or failure to fulfill orders for our products on a timely...

  • 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
    ... 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...

  • Page 17
    ... 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...

  • Page 18
    ... 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...

  • Page 19
    ... 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...

  • Page 20
    ... 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...

  • 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
    ... Our principal administrative, sales, marketing and research and development facilities occupy approximately 74,000 square feet in an office complex in Santa Clara, California, under a lease that expires in December 2007, with a three-year renewal option. Our international headquarters occupy...

  • Page 25
    ...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 forth for the indicated periods the high and low sales prices for...

  • Page 26
    ... 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...

  • 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
    ... traditional 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...

  • 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
    ...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...

  • 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...

  • Page 33
    ... 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...

  • Page 34
    ... returns for stock rotation and warranty, price protection and sales incentives deemed to be a reduction of net revenue per EITF Issue No. 01-9 and net changes in deferred revenue. Sales incentives include advertising, cooperative marketing programs, end-caps, instant rebates and mail-in rebates...

  • Page 35
    ... 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...

  • 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
    ... 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...

  • Page 40
    ... short-term investments, which represent the investment of funds available for current operations,...stock 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...

  • Page 41
    ... 5 Years Total Operating leases Purchase obligations $ 2,371 $ 55,227 $ 57,598 $ 2,016 $ - $ 2,016 $ 1,053 $ - $ 1,053 $ $ $ 3,214 - 3,214 $ 8,654 $55,227 $63,881 We lease office space, cars and equipment under non-cancelable operating leases with various expiration dates through December...

  • Page 42
    ...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...

  • 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
    ... 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...

  • Page 45
    ... 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 prevention or timely detection of...

  • Page 46
    ... (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 assets Property and equipment, net Intangibles, net Goodwill...

  • Page 47
    ... taxes Provision for income taxes Net income Net income per share: Basic Diluted Weighted average shares outstanding used to compute net income per share: Basic Diluted (1) Stock-based compensation expense was allocated as follows: Cost of revenue Research and development Sales and marketing General...

  • 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 at...

  • Page 49
    ...) of investment purchase premiums (discounts) Non-cash stock-based compensation Income tax benefit associated with stock option exercises Excess tax benefit from stock-based compensation Deferred income taxes Changes in assets and liabilities, net of effect of acquisition: Accounts receivable...

  • 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
    ... be entered into under the Company's investment policy. The Company's customers are primarily distributors as well 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...

  • Page 52
    ...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...

  • 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
    .... 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...

  • 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
    ... 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...

  • Page 57
    ... 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...

  • Page 58
    ... for sales returns Allowance for price protection Total allowances Accounts receivable, net Inventories consist of the following: $113,005 (1,295) (5,985) (1,456) (8,736) $104,269 $132,651 (1,727) (8,129) (3,194) (13,050) $119,601 December 31, 2005 2006 Finished goods Property and equipment, net...

  • Page 59
    ... 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 the amount of tax benefit...

  • 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
    ... Zilberman v. NETGEAR, Civil Action CV021230, was filed against the Company in the Superior Court of California, County of Santa Clara. The complaint purported to be a class action on behalf of all persons or entities in the United States who purchased the Company's wireless products other than...

  • 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
    ... 31, 2007 2008 2009 2010 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...

  • 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
    ...of the shares on the date of grant. To date, options granted generally vest over four years. 2003 Stock Plan In April 2003, the Company adopted the 2003 Stock Plan (the "2003 Plan"). The 2003 Plan provides for the granting of stock options to employees and consultants of the Company. Options granted...

  • 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
    ... 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...

  • Page 68
    ... 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 received by the...

  • Page 69
    ... 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 certain...

  • Page 70
    ... 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 Issue No. 01-9, sales returns and price...

  • Page 71
    ...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 income Net income per share - basic Net income per share - diluted $ 127,259 $ 44,548 $ 6,714...

  • Page 72
    ... of the Registrant" included under 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...

  • Page 73
    ...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...

  • Page 74
    ... are filed 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...

  • Page 75
    ...Allowance for doubtful 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 protection: Year ended...

  • 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
    ... registrant(1) Bylaws of the registrant(1) Form of registrant's common stock certificate(1) Form of Indemnification Agreement for directors and officers(1) 2000 Stock Option Plan and forms of agreements thereunder(1) 2003 Stock Plan and forms of agreements thereunder(1) 2003 Employee Stock Purchase...

  • 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

  • Page 80
    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, ...

  • Page 83

  • Page 84
    ... 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 /s/ PATRICK C.S. LO Patrick C.S. Lo Chairman and Chief Executive Officer NETGEAR, Inc.

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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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  • Page 88
    ... with the Annual Report of NETGEAR, Inc. (the "Company") on Form 10-K for the year ended December 31, 2006, as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Patrick C.S. Lo, Chairman and Chief Executive Officer of the Company, certify, pursuant to 18...

  • Page 89

  • Page 90
    ... In connection with the Annual Report of NETGEAR, Inc. (the "Company") on Form 10-K for the year ended December 31, 2006, as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Christine M. Gorjanc, Chief Accounting Officer of the Company, certify, pursuant to 18...