e10vq

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-Q


þ		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.

For the quarterly period ended October 2, 2005.


o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.

For the transition period from to

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 (IRS Employer Identification No.)

4500 Great America Parkway, Santa Clara, California (Address of principal executive offices)		95054 (Zip Code)

(408) 907-8000
(Registrant’s telephone number including area code)

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 þ No o

Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). Yes þ No o

Indicate by check mark whether the registrant is a shell company (as defined in Exchange Act Rule 12b-2). Yes o No þ

The number of outstanding shares of the registrant’s Common Stock, $0.001 par value, was 32,941,412 as of November 4, 2005.

PART I: FINANCIAL INFORMATION

Item 1. Financial Statements

NETGEAR, INC.

UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands)


	October 2,			December 31,
	2005			2004
ASSETS
Current assets:
Cash and cash equivalents	$	69,238		$	65,052
Short-term investments		83,346			76,663
Accounts receivable, net		89,531			82,203
Inventories		46,872			53,557
Deferred income taxes		12,113			11,475
Prepaid expenses and other current assets		9,885			7,151

Total current assets		310,985			296,101
Property and equipment, net		4,655			3,579
Goodwill		558			558

Total assets	$	316,198		$	300,238

LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	24,297		$	52,742
Accrued employee compensation		7,672			5,534
Other accrued liabilities		52,778			50,966
Deferred revenue		4,740			2,143
Income taxes payable		298			3,659

Total current liabilities		89,785			115,044

Commitments and contingencies (Note 9)
Stockholders’ equity:
Common stock		33			31
Additional paid-in capital		204,213			188,900
Deferred stock-based compensation		(645	)		(1,882	)
Cumulative other comprehensive loss		(95	)		(7	)
Retained earnings (accumulated deficit)		22,907			(1,848	)

Total stockholders’ equity		226,413			185,194

Total liabilities and stockholders’ equity	$	316,198		$	300,238

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

NETGEAR INC.

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)


	Three Months Ended						Nine Months Ended
	October 2,			October 3,			October 2,			October 3,
	2005			2004			2005			2004
Net revenue	$	111,317		$	101,236		$	327,845		$	278,033

Cost of revenue:
Cost of revenue		72,181			68,704			214,151			189,578
Amortization of deferred stock-based compensation		37			41			113			123

Total cost of revenue		72,218			68,745			214,264			189,701

Gross profit		39,099			32,491			113,581			88,332

Operating expenses:
Research and development		3,342			2,730			9,386			7,350
Sales and marketing		18,142			15,427			53,245			45,243
General and administrative		3,534			4,411			10,921			10,806
Litigation reserves		600			—			600			—
Amortization of deferred stock-based compensation:
Research and development		72			85			225			322
Sales and marketing		57			222			330			599
General and administrative		45			104			228			298

Total operating expenses		25,792			22,979			74,935			64,618

Income from operations		13,307			9,512			38,646			23,714
Interest income		1,093			439			2,761			983
Other expense		(314	)		(357	)		(1,148	)		(254	)

Income before income taxes		14,086			9,594			40,259			24,443
Provision for income taxes		5,492			3,718			15,504			9,542

Net income	$	8,594		$	5,876		$	24,755		$	14,901

Net income per share:
Basic	$	0.26		$	0.19		$	0.77		$	0.49

Diluted	$	0.25		$	0.18		$	0.73		$	0.46

Weighted average shares outstanding used to compute net income per share:
Basic		32,697			30,689			32,160			30,212

Diluted		34,314			32,269			33,805			32,378

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

NETGEAR, INC.

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)


	Nine Months Ended
	October 2,			October 3,
	2005			2004
Cash flows from operating activities:
Net income	$	24,755		$	14,901
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		2,324			1,852
Amortization of deferred stock-based compensation		896			1,342
Tax benefit from exercise of stock options		6,785			9,079
Deferred income taxes		(638	)		—
Changes in assets and liabilities:
Accounts receivable		(7,329	)		1,826
Inventories		6,685			(1,240	)
Prepaid expenses and other current assets		(2,735	)		(693	)
Accounts payable		(28,445	)		(3,658	)
Accrued employee compensation		2,138			1,466
Other accrued liabilities		1,812			14,071
Deferred revenue		2,597			(646	)
Income taxes payable		(3,361	)		(1,765	)

Net cash provided by operating activities		5,484			36,535

Cash flows from investing activities:
Proceeds from sale of short-term investments		81,611			324,529
Purchases of short-term investments		(88,381	)		(367,507	)
Purchase of property and equipment		(3,400	)		(1,599	)

Net cash used in investing activities		(10,170	)		(44,577	)

Cash flows from financing activities:
Proceeds from exercise of stock options		7,836			9,680
Proceeds from issuance of common stock under employee stock purchase plan		1,036			381

Net cash provided by financing activities		8,872			10,061

Net increase in cash and cash equivalents		4,186			2,019
Cash and cash equivalents, at beginning of period		65,052			27,715

Cash and cash equivalents, at end of period	$	69,238		$	29,734

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

NETGEAR, Inc.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Note 1. Organization and Basis of Presentation

NETGEAR, Inc. was incorporated in Delaware in January 1996. NETGEAR, Inc. together with its subsidiaries (collectively, “NETGEAR” or the “Company”) designs, develops and markets networking products that address the specific needs of small businesses and homes, enabling customers to share Internet access, peripherals, files and digital content and applications among multiple personal computers. The Company’s products include Ethernet networking products, broadband products, and wireless networking products that are sold worldwide through distributors, traditional retailers, on-line retailers, direct marketing resellers, or DMRs, value added resellers, or VARs, and broadband service providers.

The accompanying unaudited condensed consolidated financial statements include the accounts of NETGEAR, Inc., and its wholly owned subsidiaries. They have been prepared in accordance with established guidelines for interim financial reporting and with the instructions of Form 10-Q and Article 10 of regulation S-X. All significant intercompany balances and transactions have been eliminated in consolidation. The balance sheet at December 31, 2004 has been derived from audited financial statements at such date. In the opinion of management, the consolidated financial statements reflect all adjustments considered necessary (consisting only of normal recurring adjustments) to fairly state the Company’s financial position, results of operations and cash flows for the periods indicated. These unaudited condensed consolidated financial statements should be read in conjunction with the notes to the consolidated financial statements included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2004.

Certain reclassifications have been made to prior period reported amounts to conform to current year presentation, including reclassification of investments in auction rate securities from cash and cash equivalents to short-term investments. Previously, such investments were classified as cash and cash equivalents. Accordingly, the Company has revised its presentation to exclude from cash and cash equivalents $82.7 million of auction rate securities at October 3, 2004 and to include such amounts as short-term investments. In addition, the Company has made corresponding adjustments to the accompanying statement of cash flows to reflect the gross purchases and sales of these securities as investing activities. This adjustment resulted in a net increase in cash used for investing activities by $49.2 million for the nine months ended October 3, 2004. This reclassification had no impact on previously reported results of operations, operating cash flows or working capital of the Company.

The Company’s fiscal year begins on January 1 of the year stated and ends on December 31 of the same year. The Company reports its interim results on a fiscal quarter basis rather than on a calendar quarter basis. Under the fiscal quarter basis, each of the first three fiscal quarters ends on the Sunday closest to the calendar quarter end, with the fourth quarter ending on December 31.

The preparation of financial statements in conformity with accounting principles generally accepted in the United States 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 statements and the reported amounts of revenues and expenses during the reported period. Actual results could differ from those estimates and operating results for the three and nine months ended October 2, 2005 are not necessarily indicative of the results that may be expected for the year ending December 31, 2005.

The Company’s significant accounting policies are disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2004. The Company’s significant accounting policies have not materially changed during the nine months ended October 2, 2005.

2. Recent Accounting Pronouncements

In December 2004, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards No. 123R, “Share-Based Payment” (“FAS 123R”), an amendment of FAS No. 123, “Accounting for Stock-Based Compensation.” FAS 123R eliminates the ability to account for share-based payments using Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” and instead requires companies to recognize compensation expense using a fair-value based method for costs related to share-based payments including stock options and employee stock purchase plans. The expense will be measured as the fair value of the award at its grant date based on the estimated number of awards that are expected to vest, and recorded over the applicable service period. In the absence of an observable market price for a share-based award, the fair value would be based upon a valuation methodology that takes into consideration various factors, including the exercise price of the award, the expected term of the

award, the current price of the underlying shares, the expected volatility of the underlying share price, the expected dividends on the underlying shares and the risk-free interest rate. The requirements of FAS 123R are effective for the Company’s fiscal year beginning January 1, 2006 and apply to all awards granted, modified or cancelled after that date as well as unvested awards on that date. Prior to the effective date of FAS 123R, the Company will continue to provide the pro-forma disclosures for past award grants as required under FAS 123. The Company believes the adoption of FAS 123R will likely result in charges being taken similar to those currently shown in the pro forma disclosure, as required under FAS 123, found in Note 3.

In March 2005, the SEC staff issued guidance on FAS 123R. Staff Accounting Bulletin No. 107 (“SAB 107”) was issued to assist preparers by simplifying some of the implementation challenges of FAS 123R while enhancing the information that investors receive. SAB 107 creates a framework that is premised on two overarching themes: (a) considerable judgment will be required by preparers to successfully implement FAS 123R, specifically when valuing employee stock options; and (b) reasonable individuals, acting in good faith, may conclude differently on the fair value of employee stock options. Key topics covered by SAB 107 include: (a) valuation models — SAB 107 reinforces the flexibility allowed by FAS 123R to choose an option-pricing model that meets the standard’s fair value measurement objective; (b) expected volatility — SAB 107 provides guidance on when it would be appropriate to rely exclusively on either historical or implied volatility in estimating expected volatility; and (c) expected term — the new guidance includes examples and some simplified approaches to determining the expected term under certain circumstances. The Company will apply the principles of SAB 107 in conjunction with its adoption of FAS 123R.

In June 2005, the FASB issued Statement No. 154, “Accounting Changes and Error Corrections”, (SFAS 154) a replacement of APB Opinion No. 20, “Accounting Changes”, and Statement No. 3, “Reporting Accounting Changes in Interim Financial Statements.” SFAS 154 changes the requirements for the accounting for and the reporting of a change in accounting principle. Previously, most voluntary changes in accounting principles required recognition by recording a cumulative effect adjustment within net income in the period of change. SFAS 154 requires retrospective application to prior periods’ financial statements, unless it is impracticable to determine either the specific period effects or the cumulative effect of the change. SFAS 154 is effective for accounting changes made in fiscal years beginning after December 15, 2005. The Company’s results of operations and financial condition will only be impacted following the adoption of SFAS No. 154 if it implements changes in accounting principles that are addressed by this statement or corrects accounting errors in future periods.

3. Stock-based Compensation

Pursuant to SFAS No. 123, “Accounting for Stock-Based Compensation,” the Company accounts for employee stock options under APB Opinion No. 25, “Accounting for Stock Issued to Employees,” and follows the disclosure-only provisions of SFAS No. 123 and SFAS No. 148. Under APB Opinion No. 25, compensation expense is based on the difference, if any, on the date of grant, between the fair value of the Company’s common stock and the option’s exercise price to purchase that stock. For purposes of estimating the compensation cost of the Company’s option grants in accordance with SFAS No. 123, the fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model. Had compensation cost for the Company’s stock-based compensation plans 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 income would have been changed to the adjusted amounts indicated (in thousands, except per share data):


	Three Months Ended						Nine Months Ended
	October 2,			October 3,			October 2,			October 3,
	2005			2004			2005			2004
Net income, as reported	$	8,594		$	5,876		$	24,755		$	14,901
Add:
Employee stock-based compensation included in reported net income		211			452			896			1,342
Less:
Total employee stock-based compensation determined under fair value method, net of taxes		(1,222	)		(1,219	)		(6,302	)		(3,375	)

Adjusted net income	$	7,583		$	5,109		$	19,349		$	12,868

Basic net income per share:
As reported	$	0.26		$	0.19		$	0.77		$	0.49

Pro forma	$	0.23		$	0.17		$	0.60		$	0.43

Diluted net income per share:
As reported	$	0.25		$	0.18		$	0.73		$	0.46

Pro forma	$	0.22		$	0.16		$	0.57		$	0.40

The fair value of options granted in the three and nine months ended October 2, 2005 and October 3, 2004, were estimated at the date of grant using the Black-Scholes valuation model with the following weighted average assumptions:


	Three Months Ended						Nine Months Ended
	October 2,			October 3,			October 2,			October 3,
	2005			2004			2005			2004
Expected life (in years)		4			4			4			4
Risk-free interest rate		3.96	%		2.93	%		3.68	%		2.90	%
Expected volatility		54	%		52	%		56	%		52	%
Dividend yield		—			—			—			—

4. Product Warranties

The Company provides for estimated future warranty obligations upon product delivery based on historical experience and the Company’s judgment regarding anticipated rates of warranty claims. Changes in the Company’s warranty liability, which is included as a component of “Other accrued liabilities” in the condensed consolidated balance sheets, are as follows (in thousands):


	Nine Months Ended
	October 2,			October 3,
	2005			2004
Balance as of beginning of the period	$	10,766		$	11,959
Provision for warranty liability for sales made during the period		16,220			12,690
Settlements made during the period		(17,350	)		(14,216	)

Balance at end of period	$	9,636		$	10,433

5. Shipping and Handling Fees and Costs

The Company includes shipping and handling fees billed to customers in net revenue. Shipping and handling costs associated with inbound freight are included in cost of revenue. Shipping and handling costs associated with outbound freight are included in sales and marketing expenses and totaled $2.1 million for the three months ended October 2, 2005, $1.5 million for the three months ended October 3, 2004, $5.3 million for the nine months ended October 2, 2005 and $4.6 million for the nine months ended October 3, 2004.

6. Balance Sheet Components

Accounts receivable, net:


	October 2,			December 31,
	2005			2004
	(In thousands)
Gross accounts receivable	$	99,891		$	94,768

Less: Allowance for doubtful accounts		(1,324	)		(1,509	)
Allowance for sales returns		(6,355	)		(6,407	)
Allowance for price protection		(2,681	)		(4,649	)

Total allowances		(10,360	)		(12,565	)

Accounts receivable, net	$	89,531		$	82,203

Inventories:


	October 2,		December 31,
	2005		2004
	(In thousands)
Finished goods	$	46,872	$	53,557

Other accrued liabilities:


	October 2,		December 31,
	2005		2004
	(In thousands)
Sales and marketing programs	$	31,829	$	29,277
Warranty obligation		9,636		10,766
Outsourced engineering costs		1,797		1,878
Freight		3,470		3,354
Other		6,046		5,691

Other accrued liabilities	$	52,778	$	50,966

7. 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 stock options. Diluted EPS gives effect to all dilutive potential common shares outstanding during a 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.

Net income per share for the three and nine months ended October 2, 2005 and October 3, 2004 are as follows (in thousands, except per share data):


	Three Months Ended				Nine Months Ended
	October 2,		October 3,		October 2,		October 3,
	2005		2004		2005		2004
Net income (numerator)	$	8,594	$	5,876	$	24,755	$	14,901

Weighted average shares outstanding:
Basic		32,697		30,689		32,160		30,212
Options		1,617		1,580		1,645		2,166

Total diluted		34,314		32,269		33,805		32,378

Basic net income per share	$	0.26	$	0.19	$	0.77	$	0.49

Diluted net income per share	$	0.25	$	0.18	$	0.73	$	0.46

Anti-dilutive outstanding common stock options amounting to none and 563,046 were excluded from the weighted average shares outstanding for the three months ended October 2, 2005 and October 3, 2004, respectively, and 78,777 and 424,267 were excluded from the weighted average shares outstanding for the diluted per share calculation for the nine months ended October 2, 2005 and October 3, 2004, respectively.

8. Segment Information, Operations by Geographic Area and Significant Customers

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 organization, in order to determine operating and resource allocation decisions. The Company primarily operates in one business segment, which is the development, marketing and sale of networking products for the small business and home markets. NETGEAR’s headquarters and most of its operations are located in the United States. The Company also conducts sales, marketing and customer service activities through sales offices in Europe, Middle-East and Africa, or EMEA, and Asia Pacific. Geographic revenue information is based on the location of the reseller or distributor. Long-lived assets, primarily fixed assets, are reported below based on the location of the asset.

Net revenue consists of (in thousands):


	Three Months Ended				Nine Months Ended
	October 2,		October 3,		October 2,		October 3,
	2005		2004		2005		2004
United States	$	59,005	$	57,075	$	165,278	$	151,927
United Kingdom		16,640		14,909		52,276		38,452
Germany		11,208		11,892		34,955		33,287
EMEA (excluding UK and Germany)		13,714		9,372		41,733		28,679
Asia Pacific and rest of the world		10,750		7,988		33,603		25,688

	$	111,317	$	101,236	$	327,845	$	278,033

Long-lived assets consist of (in thousands):


	Nine Months Ended
	October 2,		October 3,
	2005		2004
United States	$	4,309	$	3,015
EMEA		49		43
Asia Pacific and rest of the world		297		315

	$	4,655	$	3,373

Significant customers (as a percentage of net revenue):


	Three Months Ended						Nine Months Ended
	October 2,			October 3,			October 2,			October 3,
	2005			2004			2005			2004
Ingram Micro, Inc.		24	%		31	%		27	%		27	%
Tech Data Corporation		17	%		17	%		17	%		18	%
Best Buy		10	%		8	%		8	%		9	%

All others individually less than 10% of net revenue		49	%		44	%		48	%		46	%

		100	%		100	%		100	%		100	%

9. Commitments and Contingencies

Guarantees and Purchase Commitments

We enter into various inventory-related purchase agreements with suppliers. Generally, under these agreements, 50% of the 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 non-cancelable within 30 days prior to the expected shipment date. At October 2, 2005, we had approximately $43.8 million in non-cancelable purchase commitments with suppliers.

Indemnification

The Company, 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 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 Director and Officer insurance that limits its exposure and enables it to recover a portion of any future amounts paid. To date the Company has not received any claims. As a result, the Company believes the fair value of these indemnification agreements is minimal. Accordingly, the Company has no liabilities recorded for these agreements as of October 2, 2005.

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. The Company believes that it has recourse to its suppliers and vendors in the event amounts are required to be paid to settle 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 October 2, 2005.

Litigation

In June 2004, a lawsuit, entitled Zilberman v. NETGEAR, Civil Action CV021230, was filed against the Company in the Superior Court of California, County of Santa Clara. The complaint purports 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 for resale. Plaintiff alleges that the Company made false representations concerning the data transfer speeds of the Company’s wireless products when used in typical operating circumstances, and is requesting injunctive relief, payment of restitution and reasonable attorney fees. Similar lawsuits have been filed against other companies within our industry. The Company has filed an answer to the complaint denying the allegations. The Company and the Plaintiff are engaged in settlement discussions. Any settlement would be subject to final court approval.

In February 2005, a lawsuit, entitled McGrew v. NETGEAR, Civil Action CV035191, was filed against the Company in the Superior Court of California, County of Santa Clara. The complaint makes the same allegations and purports to represent the same class of persons and entities as the Zilberman suit. In August, 2005, the Plaintiff voluntarily dismissed the matter against us.

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 the United States District Court, Northern District of California. 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 products implementing the IEEE 802.11a and 802.11g wireless LAN standards infringe its patent. 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 becomes probable.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Forward-looking Statements

This report contains 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. Such statements are based upon current expectations that involve risks and uncertainties. Any statements contained herein that are not statements of historical fact may be deemed to be forward-looking statements. For example, the words “believes,” “anticipates,” “plans,” “expects,” “intends” and similar expressions are intended to identify forward-looking statements. Our actual results and the timing of certain events may differ significantly from the results discussed in the forward-looking statements. Factors that might cause such a discrepancy include, but are not limited to, those discussed in “Risk Factors Affecting Future Results” and “Liquidity and Capital Resources” below. All forward-looking statements in this document 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 unaudited condensed consolidated financial statements and the accompanying notes contained in this quarterly report. Unless expressly stated or the context otherwise requires, the terms “we,” “our,” “us” and “NETGEAR” refer to NETGEAR, Inc. and its subsidiaries.

Overview

We design, develop and market technologically advanced, branded networking products that address the specific needs of small business and home users. We supply innovative networking products, both domestically and worldwide, that meet 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 primarily to research and development, developing relationships with outsourced design, manufacturing 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 2004, our net revenue was $383.1 million and our net income was $23.5 million.

Our products are grouped into three major product lines within the small business and home markets: Ethernet 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. 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 products are sold through multiple sales channels worldwide, including traditional retailers, online retailers, direct market resellers, or 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, Staples, 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 resellers include CDW Corporation, Insight Corporation and PC Connection in domestic markets and Misco throughout Europe. In addition, we also sell our products through broadband service providers, such as Comcast, Charter Communications and Time-Warner Cable, in domestic markets and Tiscali (Germany), AOL (UK), Telewest (UK), Tele Denmark, and Telstra (Australia) internationally. Some of these retailers and resellers purchase directly from us while most are fulfilled through 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 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.

Results of Operations

The following table sets forth the consolidated statements of operations and the percentage change for the three and nine months ended October 2, 2005, with the comparable reporting period in the preceding year.


	Three Months Ended									Nine Months Ended
	October 2,			Percentage			October 3,			October 2,			Percentage			October 3,
	2005			Change			2004			2005			Change			2004
Net revenue	$	111,317			10.0	%	$	101,236		$	327,845			17.9	%	$	278,033

Cost of revenue:
Cost of revenue		72,181			5.1			68,704			214,151			13.0			189,578
Amortization of deferred stock-based compensation		37			(9.8	)		41			113			(8.1	)		123

Total cost of revenue		72,218			5.1			68,745			214,264			12.9			189,701

Gross profit		39,099			20.3			32,491			113,581			28.6			88,332

Operating expenses:
Research and development		3,342			22.4			2,730			9,386			27.7			7,350
Sales and marketing		18,142			17.6			15,427			53,245			17.7			45,243
General and administrative		3,534			(19.9	)		4,411			10,921			1.1			10,806
Litigation reserves		600			**			—			600			**			—
Amortization of deferred stock-based compensation:
Research and development		72			(15.3	)		85			225			(30.1	)		322
Sales and marketing		57			(74.3	)		222			330			(44.9	)		599
General and administrative		45			(56.7	)		104			228			(23.5	)		298

Total operating expenses		25,792			12.2			22,979			74,935			16.0			64,618

Income from operations		13,307			39.9			9,512			38,646			63.0			23,714
Interest income		1,093			149.0			439			2,761			180.9			983
Other expense		(314	)		(12.0	)		(357	)		(1,148	)		352.0			(254	)

Income before income taxes		14,086			46.8			9,594			40,259			64.7			24,443
Provision for income taxes		5,492			47.7			3,718			15,504			62.5			9,542

Net income	$	8,594			46.3	%	$	5,876		$	24,755			66.1	%	$	14,901


**		Percentage change not meaningful as prior year basis is zero.

The following table sets forth the condensed consolidated statements of operations, expressed as a percentage of net revenue, for the periods indicated:


	Three Months Ended						Nine Months Ended
	October 2,			October 3,			October 2,			October 3,
	2005			2004			2005			2004
Net revenue		100	%		100	%		100	%		100	%

Cost of revenue		64.9			67.9			65.4			68.2

Gross Margin		35.1			32.1			34.6			31.8

Operating expenses:
Research and development		3.0			2.7			2.9			2.6
Sales and marketing		16.3			15.2			16.2			16.3
General and administrative		3.2			4.4			3.3			3.9
Litigation reserves		0.5			—			0.2			—
Amortization of deferred stock-based compensation:
Research and development		0.1			0.1			0.1			0.2
Sales and marketing		0.1			0.2			0.1			0.2
General and administrative		0.0			0.1			0.1			0.1

Total operating expenses		23.2			22.7			22.9			23.3

Income from operations		11.9			9.4			11.7			8.5
Interest income		1.0			0.4			0.9			0.4
Other expense		(0.3	)		(0.3	)		(0.3	)		(0.1	)

Income before income taxes		12.6			9.5			12.3			8.8
Provision for income taxes		4.9			3.7			4.7			3.4

Net income		7.7	%		5.8	%		7.6	%		5.4	%

Quarter Ended October 2, 2005 Compared to Quarter Ended October 3, 2004

Net Revenue

Net revenue increased $10.1 million, or 10.0%, to $111.3 million for the quarter ended October 2, 2005, from $101.2 million for the quarter ended October 3, 2004. The increase in net revenue was attributable to increased gross shipments of our products in our broadband, wireless and Ethernet LAN product categories driven in part by the introduction of new products, partially offset by provisions made for rebates and cooperative marketing programs associated with increased retail product sales.

In the quarter ended October 2, 2005, net revenue generated within North America, EMEA and Asia Pacific was 53.0%, 37.3% and 9.7%, respectively, of the Company’s total net revenue. The comparable net revenue for the quarter ended October 3, 2004 was 56.4%, 35.7% and 7.9%, respectively, of the Company’s total net revenue. The increase in net revenue over the prior year comparable quarter for each region was 3.4%, 14.9% and 34.6%, respectively. The increase in all geographies was attributable to increased shipment of broadband and wireless products and Ethernet switches, due in part to the continuous introduction of new products in all channels. Further, the EMEA increase was due to growth in most of the EMEA markets, notably the United Kingdom, France, Sweden and Norway. The Asia Pacific increase was primarily due to growth in the Australia, China and Japan markets from the prior year comparable quarter.

Cost of Revenue and Gross Margin

Cost of revenue increased $3.5 million, or 5.1%, to $72.2 million for the quarter ended October 2, 2005, from $68.7 million for the quarter ended October 3, 2004. In addition, our gross margin improved to 35.1% for the quarter ended October 2, 2005, from 32.1% for the quarter ended October 3, 2004. This 3.0 percent improvement in gross margin was due primarily to (1) a favorable shift in the sales mix to products which carry higher gross margins, (2) relatively lower product costs, and (3) operational efficiency and supply chain management programs that led to a reduction in the provisions needed for returned product under warranty programs through identification of alternative markets of distribution for refurbished product. We also were able to take advantage of rebates and prompt

payment discounts from our suppliers, which contributed to our gross margin improvement. These improvements in gross margin were partially offset by increases in costs associated with freight, product conversions, cooperative marketing costs, end-user rebates and other marketing programs. Cooperative marketing costs and end-user rebates are typically recorded as a reduction in net revenue.

Operating Expenses

Research and Development

Research and development expenses increased $612,000, or 22.4%, to $3.3 million for the quarter ended October 2, 2005, from $2.7 million for the quarter ended October 3, 2004. The increase was primarily due to increased salary and payroll related expenses of $607,000 resulting from research and development related headcount growth. Employee headcount increased by 46% to 54 employees as of October 2, 2005 as compared to 37 employees as of October 3, 2004, including 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.

Sales and Marketing

Sales and marketing expenses increased $2.7 million, or 17.6%, to $18.1 million for the quarter ended October 2, 2005, from $15.4 million for the quarter ended October 3, 2004. Of this increase, $1.2 million was due to product promotion, including 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 $560,000 as a result of sales and marketing related headcount growth, especially due to expansion in EMEA where employee headcount grew 37% accounting for 14 of the 22 incremental employee additions and the staffing of our new India subsidiary in the Asia Pacific region. The increase was also attributable to an increase in freight charges of $660,000 and additional general overhead costs such as allocated facilities and information systems costs.

General and Administrative

General and administrative expenses decreased $877,000, or 19.9%, to $3.5 million for the quarter ended October 2, 2005, from $4.4 million for the quarter ended October 3, 2004. This decrease was due to a decrease in fees for professional services aggregating $1.3 million, consisting primarily of legal fees of approximately $520,000, and costs associated with Sarbanes-Oxley 404 compliance of approximately $655,000, partially offset by an increase in employee related costs of $564,000. The increase in employee related costs resulted from an increase in general and administrative related headcount, particularly in the Finance and Information Systems departments to support an increase in transactional data resulting from increased revenue. We also experienced a decrease of $82,000 in the costs associated with Directors and Officers insurance.

Litigation Reserves

During the quarter ended October 2, 2005, we recorded a reserve of $600,000 for the estimated costs of adjudication or settlement of various asserted and unasserted claims existing as of the balance sheet date. For a detailed discussion of our pending litigation matters, please see “Item 1. Legal Proceedings” under Part II of this report.

Amortization of Deferred Stock-based Compensation

During the quarter ended October 2, 2005, we recorded charges of $37,000 in cost of revenue, $72,000 in research and development expenses, $57,000 in sales and marketing expenses, and $45,000 in general and administrative expenses related to amortization of deferred stock-based compensation. During the quarter ended October 3, 2004, we recorded charges of $41,000 in cost of revenue, $85,000 in research and development expenses, $222,000 in sales and marketing expenses, and $104,000 in general and administrative expenses related to the amortization of deferred stock-based compensation. The remaining deferred stock-based compensation balance of $645,000 will be fully amortized by the end of the third quarter of the year ending December 31, 2007.

Interest Income

Interest income increased $654,000, or 149.0%, to $1.1 million for the quarter ended October 2, 2005, from $439,000 for the quarter ended October 3, 2004. The increase in interest income was a result of an increase in cash, cash equivalents and short-term investments, as well as an increase in the average interest rate earned in the third quarter of 2005 as compared to the third quarter of 2004.

Other Expense

Other expense decreased $43,000, or 12.0%, to $314,000 for the quarter ended October 2, 2005, from $357,000 for the quarter ended October 3, 2004 due to a decrease in foreign exchange losses. The foreign exchange loss of $314,000 experienced in the quarter ending October 2, 2005 was attributable to the strengthening of the U.S. dollar against the Euro, Great British Pound and Australian dollar, combined with us invoicing some of our international customers in foreign currencies, including the Euro, Great British Pound and Australian dollar, during the quarter.

Provision for Income Taxes

Provision for income taxes increased $1.8 million, to $5.5 million for the quarter ended October 2, 2005, from $3.7 million for the quarter ended October 3, 2004. The effective tax rate for both the quarter ended October 2, 2005 and October 3, 2004 was approximately 39%. The effective tax rate for both periods differed from our statutory rate of approximately 35% due to non-deductible stock-based compensation, state taxes, and other non-deductible expenses, offset by tax credits.

Net Income

Net income increased $2.7 million, or 46.3%, to $8.6 million for the quarter ended October 2, 2005, from $5.9 million for the quarter ended October 3, 2004. This increase was due to an increase in gross profit of $6.6 million, an increase in interest income of $654,000, and a decrease of other expense of $43,000 offset by an increase in operating expenses of $2.8 million and an increase in provision for income taxes of $1.8 million.

Nine Months Ended October 2, 2005 Compared to Nine Months Ended October 3, 2004

Net Revenue

Net revenue increased $49.8 million, or 17.9%, to $327.8 million for the nine months ended October 2, 2005, from $278.0 million for the nine months ended October 3, 2004. The increase in net revenue was attributable to increased gross shipments of our products in our broadband, wireless and Ethernet LAN product categories driven in part by the introduction of new products, partially offset by provisions made for rebates and cooperative marketing programs associated with increased retail product sales.

In the nine months ended October 2, 2005, net revenue generated within North America, EMEA and Asia Pacific was 50.4%, 39.3% and 10.3%, respectively, of the Company’s total net revenue. The comparable net revenue for the nine months ended October 3, 2004 was 54.7%, 36.1% and 9.2%, respectively, of the Company’s total net revenue. The increase in net revenue over the prior year comparable nine month period for each region was 8.8%, 28.4% and 30.8%, respectively. The increase in all geographies was attributable to increased shipment of broadband and wireless products and Ethernet switches, due in part to the continuous introduction of new products in all channels. Further, the EMEA increase was due to growth in all EMEA markets, most notably the United Kingdom, which increased $13.8 million, or 36.0%, as well as the Nordic and Southern European regions. The Asia Pacific increase was due to growth in all Asia Pacific markets from the prior year comparable nine month period.

Cost of Revenue and Gross Margin

Cost of revenue increased $24.6 million, or 12.9%, to $214.3 million for the nine months ended October 2, 2005, from $189.7 million for the nine months ended October 3, 2004. In addition, our gross margin improved to 34.6% for the nine months ended October 2, 2005, from 31.8% for the nine months ended October 3, 2004. This 2.8 percent improvement in gross margin was due primarily to (1) a favorable shift in the sales mix to products which carry higher gross margins, (2) relatively lower product costs, and (3) operational efficiency and supply chain management programs that led to a reduction in the provisions needed for returned product under warranty programs through identification of alternative markets of distribution for refurbished product. We also were able to take advantage of rebates and prompt payment discounts from our suppliers, which contributed to our gross margin improvement. These improvements in gross margin were partially offset by increases in costs associated with freight, product conversions, cooperative marketing costs, end-user rebates and other marketing programs. Cooperative marketing costs and end-user rebates are typically recorded as a reduction in net revenue.

Operating Expenses

Research and Development

Research and development expenses increased $2.0 million, or 27.7%, to $9.4 million for the nine months ended October 2, 2005, from $7.4 million for the nine months ended October 3, 2004. The increase was primarily due to increased salary and payroll related expenses of $1.8 million resulting from research and development related headcount growth. Employee headcount increased by 46% to 54 employees as of October 2, 2005 as compared to 37 employees as of October 3, 2004, including 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.

Sales and Marketing

Sales and marketing expenses increased $8.0 million, or 17.7%, to $53.2 million for the nine months ended October 2, 2005, from $45.2 million for the nine months ended October 3, 2004. Of this increase, $4.1 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 $2.2 million as a result of sales and marketing related headcount growth from 129 employees as of October 3, 2004 to 151 employees as of October 2, 2005, especially due to expansion in EMEA where employee headcount grew 37% accounting for 14 of the 22 incremental employee additions and the staffing of our new India subsidiary in the Asia Pacific region. The increase was also attributable to an increase in freight charges of $633,000 and additional general overhead costs such as facilities and information systems costs amounting to $714,000.

General and Administrative

General and administrative expenses increased $115,000, or 1.1%, to $10.9 million for the nine months ended October 2, 2005, from $10.8 million for the nine months ended October 3, 2004. This increase was primarily due to an increase in employee related costs of $1.6 million, offset by a decrease in fees for professional services aggregating $1.0 million, composed of systems consulting, accounting and legal fees, and costs associated with Sarbanes-Oxley 404 compliance. The increase in employee related costs resulted from an increase in general and administrative related headcount, particularly in the Finance and Information Systems departments to support an increase in transactional data resulting from increased revenue. We also experienced a decrease of $239,000 in the costs associated with Directors and Officers insurance.

Litigation Reserves

Amortization of Deferred Stock-based Compensation

During the nine months ended October 2, 2005, we recorded charges of $113,000 in cost of revenue, $225,000 in research and development expenses, $330,000 in sales and marketing expenses, and $228,000 in general and administrative expenses related to amortization of deferred stock-based compensation. During the nine months ended October 3, 2004, we recorded charges of $123,000 in cost of revenue, $322,000 in research and development expenses, $599,000 in sales and marketing expenses, and $298,000 in general and administrative expenses related to the amortization of deferred stock-based compensation. The remaining deferred stock-based compensation balance of $645,000 will be fully amortized by the end of the third quarter of the year ending December 31, 2007.

Interest Income

Interest income increased $1.8 million, or 180.9%, to $2.8 million for the nine months ended October 2, 2005, from $983,000 for the nine months ended October 3, 2004. The increase in interest income was a result of an increase in cash, cash equivalents and short-term investments, as well as an increase in the average interest rate earned in the first nine months of 2005 as compared to the first nine months of 2004.

Other Expense

Other expense increased $894,000, or 352.0%, to $1.1 million for the nine months ended October 2, 2005, from $254,000 for the nine months ended October 3, 2004. The change was due to a foreign exchange loss of $1.1 million in our European and Asia Pacific markets for the first nine months of 2005, as compared to a foreign exchange loss of $254,000 for the first nine months of 2004. The foreign exchange loss experienced in the nine months ended October 2, 2005 was attributable to the strengthening of the U.S. dollar against the Euro, Great British Pound and Australian dollar,combined with us beginning to invoice some of our international customers in foreign currencies, including the Euro, Great British Pound and Australian dollar, in the first nine months of 2005.

Provision for Income Taxes

Provision for income taxes increased $6.0 million, to $15.5 million for the nine months ended October 2, 2005, from $9.5 million for the nine months ended October 3, 2004. The effective tax rate for the nine months ended October 2, 2005 was 38.5%, as compared to 39% for the nine months ended October 3, 2004. The effective tax rate for both periods differed from our statutory rate of approximately 35% due to non-deductible stock-based compensation, state taxes, and other non-deductible expenses, offset by tax credits.

Net Income

Net income increased $9.9 million, or 66.1%, to $24.8 million for the nine months ended October 2, 2005, from $14.9 million for the nine months ended October 3, 2004. This increase was due to an increase in gross profit of $25.2 million and an increase in interest income of $1.8 million, offset by an increase in operating expenses of $10.3 million, an increase in other expense of $894,000 and an increase in provision for income taxes of $6.0 million.

Liquidity and Capital Resources

As of October 2, 2005, we had cash, cash equivalents and short-term investments totaling $152.6 million. Short-term investments accounted for $83.3 million of this balance.

Our cash and cash equivalents balance increased from $65.1 million as of December 31, 2004 to $69.2 million as of October 2, 2005. Operating activities during the nine months ended October 2, 2005 provided cash of $5.5 million. Investing activities during the nine months ended October 2, 2005 used $10.2 million primarily for the net purchase of short-term investments of $6.8 million, and purchases of property and equipment amounting to $3.4 million. During the nine months ended October 2, 2005, financing activities provided $8.9 million, resulting from the issuance of common stock related to stock option exercises and our employee stock purchase program.

Our days sales outstanding increased from 70 days as of December 31, 2004 to 73 days as of October 2, 2005.

Our accounts payable decreased from $52.7 million at December 31, 2004 to $24.3 million at October 2, 2005. The decrease of $28.4 million is due to the timing of purchases and the Company’s decision to take advantage of favorable discounts upon prompt payment.

Inventory decreased by $6.7 million from $53.6 million at December 31, 2004 to $46.9 million at October 2, 2005. In the quarter ended October 2, 2005 we experienced annual inventory turns of approximately 6.2, up from approximately 5.3 in the quarter ended December 31, 2004.

We lease office space and equipment under non-cancelable operating leases with various expiration dates through January 2009. The terms of certain of our facility 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.

Contractual Obligations and Off-Balance Sheet Arrangements

The following table describes our commitments to settle contractual obligations and off-balance sheet arrangements in cash as of October 2, 2005 (in thousands):


	Less than		1 - 3		3 - 5
Contractual Obligations	1 Year		Years		Years		Total
Operating leases	$	1,124	$	1,047	$	15	$	2,186
Purchase obligations		43,752		—		—		43,752

	$	44,876	$	1,047	$	15	$	45,938

Based on our current plans and market conditions, we believe that our existing cash, cash equivalents and short-term investments will be sufficient to satisfy our anticipated cash requirements for at least the next twelve months. However, we may require or desire additional funds to support our operating expenses and capital requirements or for other purposes, such as acquisitions, and may seek to raise such additional funds through public or private equity financing or from other sources. We cannot assure you that additional financing will be available at all or that, if available, such financing will be obtainable on terms favorable to us and would not be dilutive. Our future liquidity and cash requirements will depend on numerous factors, including the introduction of new products and potential acquisitions of related businesses or technology.

Critical Accounting Policies and Estimates

For a description of what we believe to be the critical accounting policies that affect our more significant judgments and estimates used in the preparation of our condensed consolidated financial statements, refer to our Annual Report on Form 10-K for the year ended December 31, 2004. There have been no changes in our critical accounting policies since December 31, 2004.

Risk Factors Affecting Future Results

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 complete loss of your investment.

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-Q 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;

	•		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;

	•		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 basis;

	•		our inability to accurately forecast our contract manufacturing needs;

	•		delays in the introduction of new products by us or market acceptance of these products;

	•		an increase in price protection claims, redemptions of marketing rebates, product warranty returns or allowance for doubtful accounts;

	•		operational disruptions, such as transportation delays or failure of our order processing system, particularly if they occur at the end of a fiscal quarter;

	•		seasonal patterns of higher sales during the second half of our fiscal year, particularly retail-related sales in our fourth quarter;

	•		foreign currency exchange rate fluctuations in the jurisdictions where we transact in local currency; and

	•		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. Other current and potential competitors include numerous local vendors such as Siemens Corporation 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.

Many of our existing and potential competitors have longer operating histories, greater name recognition and substantially greater financial, technical, sales, marketing and other resources. 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 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.

Unfavorable economic conditions, particularly in Western Europe, and recent 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. Recent turmoil in the global geopolitical environment, including terrorist activities in the United Kingdom and the ongoing tensions in Iraq and the Middle East, have pressured and continue to pressure global economies. If the global economic climate does not improve, our business and operating results will be harmed.

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 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 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.

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, 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. Finally, consumer class-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 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 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 unanticipated delays in product introductions beyond announced release dates. Any future delays in product development and introduction could result in:

•

loss of or delay in revenue and loss of market share;

•

negative publicity and damage to our reputation and brand;

•

decline in the average selling price of our products; and

•

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 broadband service 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 generally 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 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, our business could be harmed.

If we fail to successfully overcome the challenges associated with 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 market that differ from what we have traditionally faced with the retail market. These challenges include a 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 margins, and our general inexperience in selling to carriers. Any slowdown in the 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 carrier sales channel and our growth will be slowed.

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 the majority 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 local foreign currencies. Recently, we have experienced currency exchange losses, and our exposure to losses in foreign currency transactions 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 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 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. For example, in the second half of 2004, ports on the West Coast have experienced and continue to experience higher than usual shipping traffic, resulting in congestion and delays in our product shipment schedules. 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 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 the fiscal quarter ended October 2, 2005, sales to Ingram Micro and its affiliates accounted for 24% of our net revenue and sales to Tech Data and its affiliates accounted for 17% 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 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. 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, 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.

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, our net revenue and gross margin will be negatively affected.

Recently enacted and proposed changes in securities laws and related regulations are resulting in increased costs to us.

Recently enacted and proposed changes in the laws and regulations affecting public companies, including the provisions of the Sarbanes-Oxley Act of 2002 and recent rules enacted and proposed by the SEC and the NASDAQ National Market, are resulting in increased costs to us as we respond to their requirements. In particular, complying with the internal control audit requirements of Sarbanes-Oxley Section 404 is resulting in increased internal efforts and higher fees from our independent registered public accounting firm and compliance consultant. The new rules could make it more difficult for us to obtain certain types of insurance, including director and officer liability insurance, and we may be forced to accept reduced policy limits and coverage and/or incur substantially higher costs to obtain the same or similar coverage. The impact of these events could also make it more difficult for us to attract and retain qualified persons to serve on our Board of Directors, on committees of our Board of Directors, or as executive officers.

We are required to evaluate our internal control under Section 404 of the Sarbanes-Oxley Act of 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 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 attestation report on management’s assessment of such internal controls. Public Company Accounting Oversight Board Auditing Standard No. 2 provides the professional standards and related performance guidance for independent registered public accounting firms to attest to, and report on, management’s assessment of the effectiveness of internal control over financial reporting under Section 404.

We will continue to perform the system 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 controls, we could lose investor confidence in the accuracy and completeness of our financial reports, which may have an adverse effect on our stock price.

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 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:

	•		unexpected increases in manufacturing and repair costs;

	•		inability to control the quality of finished products;

	•		inability to control delivery schedules; and

	•		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 wireless local area network chipsets, 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.

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, 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 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 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, or if any of these providers unilaterally decide not to do business with us for any reason, 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 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 47% of overall net revenue in the third quarter of 2005. 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 and anti-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.

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 systems, 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 intend to implement an international reorganization, which may strain our resources and increase our operating expenses.

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 reorganization or other factors outside of our control could negatively impact the timing and extent of any benefit we receive from the reorganization. The reorganization 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.

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:

	•		actual or anticipated fluctuations in our operating results or our competitors’ operating results;

	•		actual or anticipated changes in our growth rates or our competitors’ growth rates;

	•		conditions in the financial markets in general or changes in general economic conditions;

	•		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 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.

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.

Item 3. 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 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 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. We have now begun to invoice some of our international customers in foreign currencies including but not limited to, the Euro, Great British Pound and the Australian dollar. As the customers that are currently 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. 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. Certain operating expenses of our foreign operations require payment in the local currencies. As of October 2, 2005, we had net receivables in various local currencies. However, based on the total amount of these receivables due in foreign currencies as of October 2, 2005, a movement of 10% in foreign currency exchange rates would not have a material impact on our operating results.

Item 4. Controls and Procedures

Evaluation of disclosure controls and procedures. Our management evaluated, with the participation of our chief executive officer and our chief financial officer, the effectiveness of our disclosure controls and procedures as of the end of the period covered by this Quarterly Report on Form 10-Q. Based on this evaluation, our chief executive officer and our chief financial 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 is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms.

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 Quarterly Report on Form 10-Q 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.

PART II: OTHER INFORMATION

Item 1. Legal Proceedings

In June 2004, a lawsuit, entitled Zilberman v. NETGEAR, Civil Action CV021230, was filed against us in the Superior Court of California, County of Santa Clara. The complaint purports to be a class action on behalf of all persons or entities in the United States who purchased our wireless products other than for resale. Plaintiff alleges that we made false representations concerning the data transfer speeds of our wireless products when used in typical operating circumstances, and is requesting injunctive relief, payment of restitution and reasonable attorney fees. Similar lawsuits have been filed against other companies within our industry. We have filed an answer to the complaint denying the allegations. We and the Plaintiff are engaged in settlement discussions. Any settlement would be subject to final court approval.

In February 2005, a lawsuit, entitled McGrew v. NETGEAR, Civil Action CV035191, was filed against us in the Superior Court of California, County of Santa Clara. The complaint makes the same allegations and purports to represent the same class of persons and entities as the Zilberman suit. In August, 2005, the Plaintiff voluntarily dismissed the matter against us.

In May 2005, we filed a complaint for declaratory relief against the Commonwealth Scientific and Industrial Research Organization (CSIRO), in the San Jose division of the United States District Court, Northern District of California. The complaint alleges that the claims of CSIRO’s U.S. Patent No. 5,487,069 are invalid and not infringed by any of our products. CSIRO had asserted that our wireless networking products implementing the IEEE 802.11a and 802.11g wireless LAN standards infringe its patent. No trial date has been set.

These claims against us or filed by us, 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 our financial position and results of operations for the period in which the unfavorable outcome becomes probable.

Item 6. Exhibits.

Exhibits.


Exhibit
Number		Description
31.1		Rule 13a-14(a)/15d-14(a) Certification of Principal Executive Officer

31.2		Rule 13a-14(a)/15d-14(a) Certification of Principal Financial Officer

32.1		Section 1350 Certification of Principal Executive Officer

32.2		Section 1350 Certification of Principal Financial Officer


				NETGEAR, INC.
				Registrant

				/s/ JONATHAN R. MATHER

				Jonathan R. Mather
				Executive Vice President and Chief Financial Officer
				(Principal Financial and Accounting Officer)

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	PART I: FINANCIAL INFORMATION
Item 1.	Financial Statements	3
	Unaudited Condensed Consolidated Balance Sheets	3
	Unaudited Condensed Consolidated Statements of Operations	4
	Unaudited Condensed Consolidated Statements of Cash Flows	5
	Notes to Unaudited Condensed Consolidated Financial Statements	6
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	12
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	28
Item 4.	Controls and Procedures	28
	PART II: OTHER INFORMATION
Item 1.	Legal Proceedings	29
Item 6.	Exhibits	29
Signatures		30
EXHIBIT 31.1
EXHIBIT 31.2
EXHIBIT 32.1
EXHIBIT 32.2