10-Q 1 ntgr20130630-10q.htm 10-Q NTGR 2013.06.30 - 10Q
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
 
x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.
For the quarterly period ended June 30, 2013.
¨ 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
 
77-0419172
(State or other jurisdiction of
incorporation or organization)
 
(IRS Employer
Identification No.)
 
 
 
350 East Plumeria Drive,
San Jose, California
 
95134
(Address of principal executive offices)
 
(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  x    No  ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer, or a smaller reporting company. See definition of “accelerated filer,” “large accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
 
Large Accelerated filer
 
x
 
Accelerated filer
 
¨
Non-Accelerated filer
 
¨
 
Smaller reporting company
 
¨
Indicate by check mark whether the registrant is a shell company (as defined in Exchange Act Rule 12b-2).    Yes  o    No  x
The number of outstanding shares of the registrant’s Common Stock, $0.001 par value, was 38,668,382 as of July 30, 2013.

1


TABLE OF CONTENTS
 
Item 1.
 
 
 
 
 
Item 2.
Item 3.
Item 4.
Item 1.
Item 1A.
Item 2.
Item 3.
Item 4.
Item 5.
Item 6.
 

2


PART I: FINANCIAL INFORMATION
Item 1.
Financial Statements
NETGEAR, INC.
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands)
 
 
June 30,
2013
 
December 31,
2012
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
146,934

 
$
149,032

Short-term investments
141,169

 
227,845

Accounts receivable, net
288,483

 
256,014

Inventories
185,383

 
174,903

Deferred income taxes
25,228

 
22,691

Prepaid expenses and other current assets
41,708

 
33,724

Total current assets
828,905

 
864,209

Property and equipment, net
26,397

 
19,025

Intangibles, net
95,149

 
27,621

Goodwill
155,405

 
100,880

Other non-current assets
22,884

 
22,834

Total assets
$
1,128,740

 
$
1,034,569

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
129,535

 
$
87,310

Accrued employee compensation
16,275

 
18,338

Other accrued liabilities
134,884

 
126,255

Deferred revenue
31,838

 
27,645

Income taxes payable

 
1,382

Total current liabilities
312,532

 
260,930

Non-current income taxes payable
12,972

 
13,735

Other non-current liabilities
6,657

 
5,293

Total liabilities
332,161

 
279,958

Commitments and contingencies (Note 9)


 


Stockholders’ equity:
 
 
 
Common stock
39

 
38

Additional paid-in capital
407,505

 
394,427

Cumulative other comprehensive income
48

 
4

Retained earnings
388,987

 
360,142

Total stockholders’ equity
796,579

 
754,611

Total liabilities and stockholders’ equity
$
1,128,740

 
$
1,034,569

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

3


NETGEAR, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
 
 
Three Months Ended
 
Six Months Ended
 
June 30,
2013
 
July 1,
2012
 
June 30,
2013
 
July 1,
2012
Net revenue
$
357,719

 
$
320,655

 
$
651,118

 
$
646,275

Cost of revenue
254,289

 
226,017

 
459,951

 
451,788

Gross profit
103,430

 
94,638

 
191,167

 
194,487

Operating expenses:
 
 
 
 
 
 
 
Research and development
23,981

 
14,757

 
39,319

 
28,878

Sales and marketing
40,406

 
37,677

 
76,795

 
76,647

General and administrative
12,319

 
11,219

 
24,646

 
21,632

Restructuring and other charges
1,587

 

 
1,557

 

Litigation reserves, net
3,555

 

 
3,603

 
151

Total operating expenses
81,848

 
63,653

 
145,920

 
127,308

Income from operations
21,582

 
30,985

 
45,247

 
67,179

Interest income
95

 
116

 
244

 
235

Other income (expense), net
(548
)
 
354

 
(474
)
 
(247
)
Income before income taxes
21,129

 
31,455

 
45,017

 
67,167

Provision for income taxes
7,144

 
9,933

 
15,689

 
20,498

Net income
$
13,985

 
$
21,522

 
$
29,328

 
$
46,669

Net income per share:
 
 
 
 
 
 
 
Basic
$
0.36

 
$
0.57

 
$
0.76

 
$
1.23

Diluted
$
0.36

 
$
0.56

 
$
0.75

 
$
1.21

Weighted average shares outstanding used to compute net income per share:
 
 
 
 
 
 
 
Basic
38,539

 
37,978

 
38,493

 
37,886

Diluted
39,074

 
38,595

 
39,077

 
38,612

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

4



NETGEAR, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(In thousands)

 
Three Months Ended
 
Six Months Ended
 
June 30,
2013
 
July 1,
2012
 
June 30,
2013
 
July 1,
2012
Net income
$
13,985

 
$
21,522

 
$
29,328

 
$
46,669

Other comprehensive (loss) income, before tax:
 
 
 
 
 
 
 
Unrealized (loss) gain on derivative instruments
(82
)
 
172

 
69

 
116

Unrealized loss on available-for-sale securities
(15
)
 
(1
)
 
(41
)
 
(35
)
Other comprehensive (loss) income, before tax
(97
)
 
171

 
28

 
81

Tax benefit related to items of other comprehensive income
6

 

 
16

 
12

Other comprehensive (loss) income, net of tax
(91
)
 
171

 
44

 
93

Comprehensive income
$
13,894

 
$
21,693

 
$
29,372

 
$
46,762

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


5


NETGEAR, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
 
 
Six Months Ended
 
June 30,
2013
 
July 1,
2012
Cash flows from operating activities:
 
 
 
Net income
$
29,328

 
$
46,669

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Depreciation and amortization
14,329

 
7,493

Purchase premium amortization on investments
621

 
1,468

Non-cash stock-based compensation
7,981

 
6,787

Income tax benefit associated with stock option exercises
514

 
808

Excess tax benefit from stock-based compensation
(569
)
 
(1,093
)
Deferred income taxes
(2,178
)
 
(176
)
Changes in assets and liabilities, net of effect of acquisitions:
 
 
 
Accounts receivable
(32,469
)
 
(10,462
)
Inventories
(7,095
)
 
10,904

Prepaid expenses and other assets
(12,240
)
 
(3,681
)
Accounts payable
51,255

 
(16,110
)
Accrued employee compensation
(2,063
)
 
(7,739
)
Other accrued liabilities
4,823

 
428

Deferred revenue
6,072

 
(14,614
)
Income taxes payable
(2,146
)
 
(6,046
)
Net cash provided by operating activities
56,163

 
14,636

Cash flows from investing activities:
 
 
 
Purchases of short-term investments
(98,327
)
 
(153,862
)
Proceeds from sales and maturities of short-term investments
184,341

 
93,883

Purchase of property and equipment
(7,759
)
 
(6,864
)
Payments for patents
(275
)
 

Proceeds from sale of cost method investment
3,890

 

Payments made in connection with business acquisitions
(144,815
)
 
(7,100
)
Net cash used in investing activities
(62,945
)
 
(73,943
)
Cash flows from financing activities:
 
 
 
Purchase and retirement of treasury stock
(483
)
 
(815
)
Proceeds from exercise of stock options
3,545

 
6,331

Proceeds from issuance of common stock under employee stock purchase plan
1,053

 
955

Excess tax benefit from stock-based compensation
569

 
1,093

Net cash provided by financing activities
4,684

 
7,564

Net decrease in cash and cash equivalents
(2,098
)
 
(51,743
)
Cash and cash equivalents, at beginning of period
149,032

 
208,898

Cash and cash equivalents, at end of period
$
146,934

 
$
157,155

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


6

NETGEAR, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


 
Note 1.
The Company and Basis of Presentation
NETGEAR, Inc. (“NETGEAR” or the “Company”) was incorporated in Delaware in January 1996. The Company is a global networking company that delivers innovative products to consumers, businesses and service providers. For consumers, the Company makes high performance, dependable and easy-to-use home networking, storage and digital media products to connect people with the Internet and their content and devices. For businesses, the Company provides networking, storage and security solutions without the cost and complexity of Big IT. The Company also supplies leading service providers with made-to-order and retail proven, whole home networking solutions for sale to their customers. The Company’s products are built on a variety of proven technologies such as wireless, Ethernet and powerline, with a focus on reliability and ease-of-use. The Company sells products primarily through a global sales channel network, which includes traditional retailers, online retailers, wholesale distributors, direct market resellers ("DMRs"), value added resellers ("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 dated December 31, 2012 has been derived from audited financial statements at such date. In the opinion of management, the unaudited condensed 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, comprehensive income 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, 2012.
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 (i) the reported amounts of assets and liabilities, (ii) the disclosure of contingent assets and liabilities at the date of the financial statements, and (iii) the reported amounts of revenues and expenses during the reported period. Actual results could differ materially from those estimates and operating results for the three and six months ended June 30, 2013 are not necessarily indicative of the results that may be expected for the year ending December 31, 2013.

2.
Summary of Significant Accounting Policies
The Company’s significant accounting policies are disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2012. The Company’s significant accounting policies have not materially changed during the six months ended June 30, 2013.

Recent Accounting Pronouncements

In February 2013, The Financial Accounting Standards Board (the "FASB") issued Accounting Standards Update ("ASU") 2013-04 ("ASU 2013-04"), “Liabilities,” which provides guidance for the recognition, measurement, and disclosure of obligations resulting from joint and several liability arrangements for which the total amount of the obligation is fixed at the reporting date, with the exception of obligations already addressed within existing US GAAP guidance. ASU 2013-04 is effective for reporting periods beginning after December 15, 2013. The Company will adopt this standard in the first quarter of 2014 and it does not expect the adoption to have a significant impact on its financial position, results of operations or cash flows.

In March 2013, the FASB issued ASU 2013-05, "Foreign Currency Matters," which provides the standards for parent's accounting for the cumulative translation adjustment upon derecognition of certain subsidiaries or groups of assets within a foreign entity or of an investment in a foreign entity. ASU 2013-05 is effective for reporting periods beginning after December 15, 2013. The Company will adopt this standard in the first quarter of 2014 and it does not expect the adoption to have a significant impact on its financial position, results of operations or cash flows.


7

NETGEAR, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

3.
Business Acquisitions
Arada Systems, Inc.
On June 21, 2013, the Company acquired certain assets and operations of Arada Systems, Inc. (“Arada”), a privately-held company that develops, licenses, and provides solutions for the next generation of uses of Wi-Fi, for a total purchase consideration of $5.3 million in cash. The Company believes the acquisition will bolster its wireless product offerings in its commercial business unit and strengthen its market position in the small to medium size campus wireless LAN market. The Company paid $4.2 million of the aggregate purchase price in the second quarter of 2013, and expects to pay the remaining $1.1 million, less amounts used to satisfy certain claims, twelve months after the closing of the acquisition.
The acquisition qualified as a business combination and was accounted for using the acquisition method of accounting. The results of Arada have been included in the consolidated financial statements since the date of acquisition. Pro forma results of operations for the acquisition are not presented as the financial impact to the Company's consolidated results of operations is not material.
The allocation of the purchase price was as follows (in thousands):
Fixed Assets
$
15

Intangible assets, net
4,040

Goodwill
1,195

Total consideration
$
5,250

The fair values for tangible and intangible assets acquired and liabilities assumed were based on estimates of their fair values as of the acquisition date. These estimates are subject to revision, which may result in adjustments to the values presented above. We expect to finalize these amounts within 12 months from the acquisition date.
Of the $1.2 million of goodwill recorded on the acquisition of Arada, approximately $0.7 million and $1.2 million is deductible for U.S. federal and state income tax purposes, respectively. The goodwill recognized, which was assigned to the Company's commercial business unit, is primarily attributable to expected synergies resulting from the acquisition.
The Company designated $4.0 million of the acquired intangible assets as technology. The value was calculated based on the present value of the future estimated cash flows derived from estimated savings attributable to the existing technology and discounted at 21.5%. The acquired existing technology is being amortized over its estimated useful life of five years.

AirCard Division of Sierra Wireless, Inc.
On April 2, 2013, the Company completed the acquisition of select assets and operations of the Sierra Wireless, Inc. AirCard business ("AirCard"), including customer relationships, a world-class LTE engineering team, certain intellectual property, inventory and fixed assets. The Company believes this acquisition will accelerate the mobile initiative of the service provider business unit to become a global leader in providing the latest in LTE data networking access devices.
The Company paid $140.0 million of the aggregate purchase price in the second quarter of 2013. The acquisition qualified as a business combination and was accounted for using the acquisition method of accounting. The results of AirCard have been included in the consolidated financial statements since the date of acquisition. Revenue and earnings for AirCard as of the acquisition date are not presented as the business was fully integrated into the service provider business unit subsequent to the acquisition and therefore impracticable for the Company to quantify.

8

NETGEAR, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

The allocation of the purchase price was as follows (in thousands):
Inventories
$
3,385

Prepaid expenses
9,030

Other assets
3,226

Property and equipment, net
7,455

Intangible assets, net
69,700

Goodwill
53,330

Liabilities Assumed
(6,096
)
Total purchase price
$
140,030

The fair values for tangible and intangible assets acquired and liabilities assumed were based on estimates of their fair values as of the acquisition date. These estimates are subject to revision, which may result in adjustments to the values presented above. We expect to finalize these amounts within 12 months from the acquisition date.
Of the $53.3 million of goodwill recorded on the acquisition of AirCard, approximately $36.2 million, 2.3 million and $53.3 million is deductible for U.S. federal, Canadian, and U.S. state income tax purposes, respectively. The goodwill recognized, which was assigned to the Company's service provider business unit, is primarily attributable to expected synergies resulting from the acquisition.
The Company designated $16.3 million of the acquired intangible assets as technology. The value was calculated based on the present value of the future estimated cash flows derived from estimated savings attributable to the existing technology and discounted at 10.0%. The acquired technology is being amortized over its estimated useful life of four years.
The Company designated $40.5 million of the acquired intangible assets as customer relationships. The value was calculated based on the present value of the future estimated cash flows derived from projections of future operations attributable to existing customer relationships and discounted at 12.0%. The acquired customer relationships are being amortized over an estimated useful life of eight years.
The Company designated $2.3 million of the acquired intangible assets as non-compete agreements. The value was calculated based on the present value of the future estimated cash flows derived from projections of future operations attributable to the non-compete agreements and discounted at 12.0%. The acquired agreements are being amortized over an estimated useful life of five years.
The Company designated $1.1 million of the acquired intangible assets as backlog. The value was calculated based on the present value of the future contractual revenue and discounted at 10.0%. The acquired backlog was fully amortized in the second quarter of 2013.
The Company acquired $9.5 million in in-process research and development (“IPR&D”) projects. The value was calculated based on the present value of future estimated cash flows discounted at 13.0%, derived from projections of future revenues attributable to the assets, expected economic life of the assets, and royalty rates. The IPR&D acquired is considered indefinite lived intangible assets until research and development efforts associated with the projects are completed or abandoned. The most significant of the acquired IPR&D projects relate to multimode LTE technologies, Mobile Hot Spot, USB dongle, and Module form factors. Estimated future cost to complete these IPR&D projects is $7.4 million. As of June 30, 2013, $2.0 million of the acquired IPR&D has reached technical feasibility and was reclassified to definite intangibles and with an estimated useful life of four years. The Company expects approximately 70% of the acquired IPR&D to be completed by the fourth quarter of 2013 and approximately 30% to be completed by the second quarter of 2014.
Pro forma financial information
The unaudited pro forma financial information in the table below summarizes the combined results of our operations and those of AirCard for the periods shown as though the acquisition of AirCard occurred as of the beginning of the fiscal year 2012. The pro forma financial information for the periods presented includes the accounting effects of the business combination, including adjustments to the amortization of intangible assets, fair value of acquired inventory, acquisition-related costs, integration expenses and related tax effects of these adjustments, where applicable. This information is for informational purposes only, is subject to a

9

NETGEAR, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

number of estimates, assumptions and other uncertainties, and may not be indicative of the results of operations that would have been achieved if the acquisition had taken place at January 1, 2012.
The unaudited pro forma financial information is as follows (in thousands):
 
Three Months Ended
 
Six Months Ended
 
June 30,
2013
 
July 1,
2012
 
June 30,
2013
 
July 1,
2012
 
(in millions)
Revenue
$
357.7

 
$
392.7

 
$
696.1

 
$
776.2

Net Income
$
16.2

 
$
25.9

 
$
31.1

 
$
49.4

AVAAK, Inc.
On July 2, 2012, the Company acquired 100% of the voting equity interests of AVAAK, Inc. (“AVAAK”), a privately-held company that developed wire-free video networking products for a total purchase consideration of $24.0 million in cash. The Company believes the acquisition will bolster its retail business unit product offerings and expand its presence into the smart home market. The Company paid $21.6 million of the aggregate purchase price in the third quarter of 2012, and expects to pay the remaining $2.4 million, less amounts used to satisfy certain claims, twelve months after the closing of the acquisition.
The acquisition qualified as a business combination and was accounted for using the acquisition method of accounting. The results of AVAAK have been included in the consolidated financial statements since the date of acquisition. Pro forma results of operations for the acquisition are not presented as the financial impact to the Company's consolidated results of operations is not material.
The allocation of the purchase price was as follows (in thousands):
Net tangible assets acquired (liabilities assumed)
$
172

Deferred tax assets, net
5,937

Intangible assets, net
6,000

Goodwill
11,895

Total purchase price
$
24,004

None of the goodwill recognized related to AVAAK is deductible for income tax purposes. The goodwill recognized, which was assigned to the Company's retail business unit, is primarily attributable to expected synergies resulting from the acquisition.
In connection with the acquisition, the Company recorded $5.9 million of deferred tax assets net of deferred tax liabilities. The deferred tax assets arise from the tax benefit of the estimated net operating losses as of the date of the acquisition after consideration of limitations on the use under U.S. Internal Revenue Code section 382. The deferred tax assets are reduced by deferred tax liabilities recorded for the book basis in intangible assets and IPR&D for which the Company has no tax basis.
The Company designated $2.3 million of the acquired intangible assets as technology. The value was calculated based on the present value of the future estimated cash flows derived from estimated savings attributable to the existing technology and discounted at 14.0%. The acquired existing technology is being amortized over its estimated useful life of five years.
The Company designated $0.3 million of the acquired intangible assets as customer relationships. The value was calculated based on the present value of the future estimated cash flows derived from projections of future operations attributable to existing customer relationships and discounted at 14.0%. The acquired customer relationships are being amortized over an estimated useful life of five years.
The Company designated $1.4 million of the acquired intangible assets as trade name and trademarks. The value was calculated based on the present value of the future estimated cash flows derived from projections of future operations attributable to existing trade name and trademarks and discounted at 16.0%. The acquired trade name and trademarks are being amortized over an estimated useful life of five years.
In addition, $2.0 million of the consideration paid represents the fair value of acquired IPR&D projects. The IPR&D acquired is considered indefinite lived intangible assets until research and development efforts associated with the projects are completed

10

NETGEAR, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

or abandoned. The most significant of the acquired IPR&D projects related to camera technology and applications. As of the first fiscal quarter of 2013, all of the acquired IPR&D had reached technical feasibility and was reclassified to definite intangibles with an estimated useful life of four years.
Firetide, Inc.
On June 4, 2012, the Company acquired certain intellectual property of Firetide, Inc. (“Firetide”) for an aggregate purchase price of $7.2 million in cash. The acquisition included intangible assets that existed at the closing date, including IP contracts, technology assets, business technology, and goodwill. The Company believes the acquisition will bolster its wireless product offerings in its commercial business unit and strengthen its market position in the small to medium size campus wireless LAN market. The acquisition qualified as a business combination and was accounted for using the acquisition method of accounting.
The Company paid $6.6 million of the aggregate purchase price in the second quarter of 2012, and the remaining $0.6 million was paid in the second fiscal quarter of 2013. The ongoing costs of developing these assets subsequent to the date of acquisition have been included in the consolidated financial statements since the date of acquisition. The historical results of operations related to the acquired assets prior to the acquisition were not material to the Company’s results of operations.
The allocation of the purchase price was as follows (in thousands):
 
Intangible assets, net
$
4,159

Goodwill
3,041

Total purchase price
$
7,200


Of the $3.0 million of goodwill recorded on the acquisition of Firetide, approximately $1.6 million and $3.0 million is deductible for U.S. federal and state income tax purposes, respectively. The goodwill recognized, which was assigned to the Company's commercial business unit, is primarily attributable to expected synergies and the assembled workforce of Firetide.
The Company designated the $4.2 million in acquired intangible assets as technology. The value was calculated based on the present value of the future estimated cash flows derived from estimated savings attributable to the existing technology and discounted at 22.0%. The acquired existing technology is being amortized over its estimated useful life of five years.

4.
Balance Sheet Components (in thousands)

Short-Term Investments

 
As of
 
June 30, 2013
 
December 31, 2012
 
Cost
 
Unrealized Gain
 
Unrealized Loss
 
Estimated Fair Value
 
 Cost
 
Unrealized Gain
 
Unrealized Loss
 
Estimated Fair Value
U.S. Treasuries
$
141,001

 
$
12

 
$
(7
)
 
$
141,006

 
$
225,016

 
$
48

 
$
(2
)
 
$
225,062

Certificates of Deposits
163

 

 

 
163

 
2,783

 

 

 
2,783

Total
$
141,164

 
$
12

 
$
(7
)
 
$
141,169

 
$
227,799

 
$
48

 
$
(2
)
 
$
227,845


All of the Company’s marketable securities are classified as available-for-sale and consist of government securities with an original maturity or remaining maturity at the time of purchase of greater than three months and no more than 12 months. Accordingly, none of the short-term investments have unrealized losses greater than 12 months.

Cost Method Investments

As of June 30, 2013 and December 31, 2012, the carrying value of the Company's cost method investments was $1.3 million. These investments are included in other non-current assets in the consolidated balance sheets and are carried at cost, adjusted for any impairment, because the Company does not have a controlling interest and does not have the ability to exercise significant influence over these companies. The Company monitors these investments for impairment on a quarterly basis, and adjusts carrying value for any impairment charges recognized. There were no impairments recognized in the three and six months ended June 30,

11

NETGEAR, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

2013 and July 1, 2012. Realized gains and losses on these investments are reported in other income (expense), net in the consolidated statements of operations.

Accounts receivable, net
 
 
As of
 
June 30,
2013
 
December 31,
2012
Gross accounts receivable
$
307,591

 
$
276,084

Allowance for doubtful accounts
(1,256
)
 
(1,256
)
Allowance for sales returns
(16,122
)
 
(17,031
)
Allowance for price protection
(1,730
)
 
(1,783
)
Total allowances
(19,108
)
 
(20,070
)
Total accounts receivable, net
$
288,483

 
$
256,014


Inventories
 
 
As of
 
June 30,
2013
 
December 31,
2012
Raw materials
$
6,072

 
$
4,447

Work in process
5,098

5,098,000


Finished goods
174,213

 
170,456

Total inventories
$
185,383

 
$
174,903


The Company records provisions for excess and obsolete inventory based on forecasts of future demand. While management believes the estimates and assumptions underlying its current forecasts are reasonable, there is risk that additional charges may be necessary if current forecasts are greater than actual demand.

Property and equipment, net
 
 
As of
 
June 30,
2013
 
December 31,
2012
Computer equipment
$
7,699

 
$
7,290

Furniture, fixtures and leasehold improvements
13,125

 
12,761

Software
23,790

 
21,521

Machinery and equipment
43,366

 
31,694

Construction in progress
794

 
385

Total property and equipment, gross
88,774

 
73,651

Accumulated depreciation and amortization
(62,377
)
 
(54,626
)
Total property and equipment, net
$
26,397

 
$
19,025


Depreciation expense was $4.4 million and $7.8 million for the three and six months ended June 30, 2013, respectively, and $2.9 million and $5.5 million for the three and six months ended July 1, 2012, respectively.


12

NETGEAR, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

Intangibles, net
 
The following tables present details of the Company’s purchased intangible assets:

 
Gross
 
Accumulated Amortization
 
Net
June 30, 2013
 
 
 
 
 
Technology
$
55,599

 
$
(24,899
)
 
$
30,700

Customer contracts and relationships
56,500

 
(5,325
)
 
51,175

Other
10,545

 
(4,771
)
 
5,774

Finite-lived intangibles, net
122,644

 
(34,995
)
 
87,649

Indefinite-lived intangible assets
7,500

 

 
7,500

Total purchased intangible assets, net
$
130,144

 
$
(34,995
)
 
$
95,149


 
Gross
 
Accumulated Amortization
 
Net
December 31, 2012
 
 
 
 
 
Technology
$
32,259

 
$
(22,065
)
 
$
10,194

Customer contracts and relationships
16,000

 
(3,301
)
 
12,699

Other
6,870

 
(3,142
)
 
3,728

Finite-lived intangibles, net
55,129

 
(28,508
)
 
26,621

Indefinite-lived intangible assets
1,000

 

 
1,000

Total purchased intangible assets, net
$
56,129

 
$
(28,508
)
 
$
27,621


The Company purchased finite-lived intangible assets of $64.2 million and indefinite-lived assets of $9.5 million, as a result of its acquisition of AirCard and Arada during the second quarter of 2013. For further discussion regarding the AirCard and Arada acquisitions, see Note 3, Business Acquisitions. In addition, the Company purchased $0.3 million in patents during the second quarter of 2013.

As of June 30, 2013, the Company had $7.5 million in unamortized intangible assets related to IPR&D. All of the IPR&D assets were acquired in connection with the Company's acquisition of AirCard. IPR&D assets represent IPR&D projects that have not reached technical feasibility and are required to be classified as indefinite-lived assets until the successful completion or abandonment of the associated research and development efforts. Accordingly, during the development period after the date of acquisition, these assets will not be amortized. When the asset reaches technical feasibility, the Company will determine the useful life of the asset, reclassify the asset out of IPR&D, and begin amortization. Development costs incurred after acquisition on acquired IPR&D projects are expensed as incurred. Estimated future cost to complete these IPR&D projects is $7.4 million. As of June 30, 2013, $2.0 million of the IPR&D had reached technical feasibility and as a result, was reclassified from IPR&D to technology.

Amortization of purchased intangible assets was $5.0 million and $6.5 million for the three and six months ended June 30, 2013, respectively, and $1.0 million and $2.0 million for the three and six months ended July 1, 2012, respectively. No impairment charges were recorded in the three and six months ended June 30, 2013, and July 1, 2012.


13

NETGEAR, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

Estimated amortization expense related to intangibles for each of the next five years and thereafter is as follows:

Year Ending December 31
Amount
2013 (remaining six months)
$
8,111

2014
16,013

2015
14,663

2016
14,033

2017
9,392

Thereafter
25,437

Total expected amortization expense
$
87,649


Goodwill
 
The changes in the carrying amount of goodwill during the six months ended June 30, 2013 are as follows:

 
Retail
 
Commercial
 
Service Provider
 
Total
Goodwill at December 31, 2012
$
45,441

 
$
35,084

 
$
20,355

 
$
100,880

      Goodwill acquired during the period

 
1,195

 
53,330

 
54,525

Goodwill at June 30, 2013
$
45,441

 
$
36,279

 
$
73,685

 
$
155,405


During the six months ended June 30, 2013, the Company recorded goodwill of $54.5 million, related to its acquisitions of AirCard and Arada. For further discussion, see Note 3, Business Acquisitions. There were no impairments to goodwill during the three and six months ended June 30, 2013 and July 1, 2012.

Other non-current assets

 
As of
 
June 30,
2013
 
December 31, 2012
Non-current deferred income taxes
$
16,498

 
$
16,856

Cost method investment
1,322

 
1,322

Other
5,064

 
4,656

Total other non-current assets
$
22,884

 
$
22,834


Other accrued liabilities
 
 
As of
 
June 30,
2013
 
December 31,
2012
Sales and marketing programs
$
43,913

 
$
43,652

Warranty obligation
46,175

 
46,659

Freight
6,491

 
4,457

Other
38,305

 
31,487

Total other accrued liabilities
$
134,884

 
$
126,255



14

NETGEAR, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

5.
Product Warranties
The Company provides for estimated future warranty obligations at the time revenue is recognized. The Company’s standard warranty obligation to its direct customers generally provides for a right of return of any product for a full refund in the event that such product is not merchantable or is found to be damaged or defective. At the time revenue is recognized, an estimate of future warranty returns is recorded to reduce revenue in the amount of the expected credit or refund to be provided to its direct customers. At the time the Company records the reduction to revenue related to warranty returns, the Company includes within cost of revenue a write-down to reduce the carrying value of such products to net realizable value.
The Company’s standard warranty obligation to its end-users provides for replacement of a defective product for one or more years. Factors that affect the warranty obligation include product failure rates, material usage and service delivery costs incurred in correcting product failures. The estimated cost associated with fulfilling the Company’s warranty obligation to end-users is recorded in cost of revenue. Because the Company’s products are manufactured by third party manufacturers, in certain cases the Company has recourse to the third party manufacturer for replacement or credit for the defective products. The Company gives consideration to amounts recoverable from its third party manufacturers in determining its warranty liability.
Changes in the Company’s warranty liability, which is included in other accrued liabilities in the unaudited condensed consolidated balance sheets, are as follows (in thousands):
 
 
Six Months Ended
 
June 30,
2013
 
July 1,
2012
Balance as of beginning of the period
$
46,659

 
$
44,846

Provision for warranty liability made during the period
33,586

 
28,282

Settlements made during the period
(34,070
)
 
(30,416
)
Balance at end of period
$
46,175

 
$
42,712


6.
Derivative Financial Instruments

The Company’s subsidiaries have had, and will continue to have material future cash flows, including revenue and expenses, which are denominated in currencies other than the Company’s functional currency. The Company and all its subsidiaries designate the U.S. dollar as the functional currency. Changes in exchange rates between the Company’s functional currency and other currencies in which the Company transacts business will cause fluctuations in cash flow expectations and cash flow realized or settled. Accordingly, the Company uses derivatives to mitigate its business exposure to foreign exchange risk. The Company enters into foreign currency forward contracts in Australian dollars, British pounds, Euros, and Japanese yen to manage the exposures to foreign exchange risk related to expected future cash flows on certain forecasted revenue, costs of revenue, operating expenses and existing assets and liabilities. The Company does not enter into derivatives transactions for trading or speculative purposes.

The Company’s foreign currency forward contracts do not contain any credit-risk-related contingent features. The Company is exposed to credit losses in the event of nonperformance by the counter-parties of its forward contracts. The Company enters into derivative contracts with high-quality financial institutions and limits the amount of credit exposure to any one counter-party. In addition, the derivative contracts typically mature in less than six months and the Company continuously evaluates the credit standing of its counter-party financial institutions. The counter-parties to these arrangements are large highly rated financial institutions and the Company does not consider non-performance a material risk.

The Company may choose not to hedge certain foreign exchange exposures for a variety of reasons, including, but not limited to, immateriality, accounting considerations and the prohibitive economic cost of hedging particular exposures. There can be no assurance the hedges will offset more than a portion of the financial impact resulting from movements in foreign exchange rates. The Company’s accounting policies for these instruments are based on whether the instruments are designated as hedge or non-hedge instruments in accordance with the authoritative guidance for derivatives and hedging. The Company records all derivatives on the balance sheet at fair value. The effective portions of cash flow hedges are recorded in other comprehensive income until the hedged item is recognized in earnings. Derivatives that are not designated as hedging instruments and the ineffective portions of its designated hedges are adjusted to fair value through earnings in other income (expense), net in the unaudited condensed consolidated statement of operations.


15

NETGEAR, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

The fair values of the Company’s derivative instruments and the line items on the unaudited condensed consolidated balance sheet to which they were recorded as of June 30, 2013, and December 31, 2012, are summarized as follows (in thousands):
Derivative Assets
 
Balance Sheet
Location
 
Fair Value at
June 30, 2013

 
Balance Sheet
Location
 
Fair Value at
December 31, 2012

Derivative assets not designated as hedging instruments
 
Prepaid expenses and other current assets
 
$
1,193

 
Prepaid expenses and other current assets
 
$
1,142

Derivative assets designated as hedging
instruments
 
Prepaid expenses and other current assets
 

 
Prepaid expenses and other current assets
 
2

Total
 
 
 
$
1,193

 
 
 
$
1,144


 
Derivative Liabilities
 
Balance Sheet
Location
 
Fair Value at
June 30, 2013

 
Balance Sheet
Location
 
Fair Value at
December 31, 2012

Derivative liabilities not designated as hedging instruments
 
Other accrued liabilities
 
$
(179
)
 
Other accrued liabilities
 
$
(1,616
)
Derivative liabilities designated as hedging instruments
 
Other accrued liabilities
 
(3
)
 
Other accrued liabilities
 
(3
)
Total
 
 
 
$
(182
)
 
 
 
$
(1,619
)

For details of the Company’s fair value measurements, see Note 13, Fair Value of Financial Instruments.

Offsetting Derivative Assets and Liabilities

The Company has entered into master netting arrangements which allow net settlements under certain conditions. Although netting is permitted, it is currently the Company's policy and practice to record all derivative assets and liabilities on a gross basis in the condensed consolidated balance sheets.

The following tables set forth the offsetting of derivative assets as of June 30, 2013 and December 31, 2012 (in thousands):

As of June 30, 2013
 
 
 
 
 
 
 
Gross Amounts Not Offset in the Condensed Consolidated Balance Sheets
 
 
 
Gross Amounts of Recognized Assets
 
Gross Amounts Offset in the Condensed Consolidated Balance Sheets
 
Net Amounts Of Assets Presented in the Condensed Consolidated Balance Sheets
 
Financial Instruments
 
Cash Collateral Pledged
 
Net Amount
Barclays        
 
$
1,192

 
$

 
$
1,192

 
$
(175
)
 
$

 
$
1,017

Wells Fargo Bank
 
1

 

 
1

 
(1
)
 

 

Total
 
$
1,193

 
$

 
$
1,193

 
$
(176
)
 
$

 
$
1,017


As of December 31, 2012
 
 
 
 
 
 
 
Gross Amounts Not Offset in the Condensed Consolidated Balance Sheets
 
 
 
Gross Amounts of Recognized Assets
 
Gross Amounts Offset in the Condensed Consolidated Balance Sheets
 
Net Amounts Of Assets Presented in the Condensed Consolidated Balance Sheets
 
Financial Instruments
 
Cash Collateral Pledged
 
Net Amount
Barclays        
 
$
1,107

 
$

 
$
1,107

 
$
(1,107
)
 
$

 
$

Wells Fargo Bank
 
37

 

 
37

 
(37
)
 

 

Total
 
$
1,144

 
$

 
$
1,144

 
$
(1,144
)
 
$

 
$



16

NETGEAR, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

The following tables set forth the offsetting of derivative liabilities as of June 30, 2013 and December 31, 2012 (in thousands):

As of June 30, 2013
 
 
 
 
 
 
 
Gross Amounts Not Offset in the Condensed Consolidated Balance Sheets
 
 
 
Gross Amounts of Recognized Liabilities
 
Gross Amounts Offset in the Condensed Consolidated Balance Sheets
 
Net Amounts Of Liabilities Presented in the Condensed Consolidated Balance Sheets
 
Financial Instruments
 
Cash Collateral Pledged
 
Net Amount
Barclays        
 
$
175

 
$

 
$
175

 
$
(175
)
 
$

 
$

Wells Fargo Bank
 
7

 

 
7

 
(1
)
 

 
6

Total
 
$
182

 
$

 
$
182

 
$
(176
)
 
$

 
$
6


As of December 31, 2012
 
 
 
 
 
 
 
Gross Amounts Not Offset in the Condensed Consolidated Balance Sheets
 
 
 
Gross Amounts of Recognized Liabilities
 
Gross Amounts Offset in the Condensed Consolidated Balance Sheets
 
Net Amounts Of Liabilities Presented in the Condensed Consolidated Balance Sheets
 
Financial Instruments
 
Cash Collateral Pledged
 
Net Amount
Barclays        
 
$
1,401

 
$

 
$
1,401

 
$
(1,107
)
 
$

 
$
294

Wells Fargo Bank
 
218

 

 
218

 
(37
)
 

 
181

Total
 
$
1,619

 
$

 
$
1,619

 
$
(1,144
)
 
$

 
$
475


Cash flow hedges

To help manage the exposure of operating margins to fluctuations in foreign currency exchange rates, the Company hedges a portion of its anticipated foreign currency revenue, costs of revenue and certain operating expenses. These hedges are designated at the inception of the hedge relationship as cash flow hedges under the authoritative guidance for derivatives and hedging. Effectiveness is tested at least quarterly both prospectively and retrospectively using regression analysis to ensure that the hedge relationship has been effective and is likely to remain effective in the future. The Company typically hedges portions of its anticipated foreign currency exposure for three to five months. The Company enters into about five forward contracts per quarter with an average size of about $7 million USD equivalent related to its cash flow hedging program.

The Company expects to reclassify to earnings all of the amounts recorded in other comprehensive income ("OCI") associated with its cash flow hedges over the next 12 months. OCI associated with cash flow hedges of foreign currency revenue is recognized as a component of net revenue in the same period as the related revenue is recognized. OCI associated with cash flow hedges of foreign currency costs of revenue and operating expenses are recognized as a component of cost of revenue and operating expense in the same period as the related costs of revenue and operating expenses are recognized.

Derivative instruments designated as cash flow hedges must be de-designated as hedges when it is probable the forecasted hedged transaction will not occur within the designated hedge period or if not recognized within 60 days following the end of the hedge period. Deferred gains and losses in other comprehensive income associated with such derivative instruments are reclassified immediately into earnings through other income and expense. Any subsequent changes in fair value of such derivative instruments also are reflected in current earnings unless they are re-designated as hedges of other transactions. The Company did not recognize any material net gains or losses related to the loss of hedge designation on discontinued cash flow hedges during the three and six months ended June 30, 2013, and July 1, 2012.


17

NETGEAR, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

The effects of the Company’s derivative instruments on OCI and the unaudited condensed consolidated statement of operations for the three and six months ended June 30, 2013, and July 1, 2012, are summarized as follows (in thousands):

Derivatives Designated as Hedging Instruments
 
Three Months Ended June 30, 2013
 
Gain or (Loss)
Recognized in
OCI -
Effective
Portion (a)
 
Location of
Gain or (Loss)
Reclassified from OCI
into Income - Effective
Portion
 
Gain or (Loss)
Reclassified
from
OCI into
Income -
Effective
Portion (a)
 
Location of
Gain or (Loss)
Recognized in
Income and
Excluded from
Effectiveness  Testing
 
Amount of Gain or (Loss) Recognized in
Income and
Excluded from
Effectiveness  Testing
Cash flow hedges:
 
 
 
 
 
 
 
 
 
 
Foreign currency forward contracts
 
$
314

 
Net revenue
 
$
445

 
Other income (expense), net
 
$
(26
)
Foreign currency forward contracts
 

 
Cost of revenue
 
(1
)
 
Other income (expense), net
 

Foreign currency forward contracts
 

 
Operating expenses
 
(48
)
 
Other income (expense), net
 

Total
 
$
314

 
 
 
$
396

 
 
 
$
(26
)
 
Derivatives Designated as Hedging Instruments
 
Six Months Ended June 30, 2013
 
Gain or (Loss)
Recognized in
OCI -
Effective
Portion (a)
 
Location of
Gain or (Loss)
Reclassified from OCI
into Income - Effective
Portion
 
Gain or (Loss)
Reclassified
from
OCI into
Income -
Effective
Portion (a)
 
Location of
Gain or (Loss)
Recognized in
Income and
Excluded from
Effectiveness  Testing
 
Amount of Gain or (Loss) Recognized in
Income and
Excluded from
Effectiveness  Testing
Cash flow hedges:
 
 
 
 
 
 
 
 
 
 
Foreign currency forward contracts
 
$
492

 
Net revenue
 
$
520

 
Other income (expense), net
 
$
(48
)
Foreign currency forward contracts
 

 
Cost of revenue
 
(3
)
 
Other income (expense), net
 

Foreign currency forward contracts
 

 
Operating expenses
 
(94
)
 
Other income (expense), net
 

Total
 
$
492

 
 
 
$
423

 
 
 
$
(48
)

Derivatives Designated as
Hedging Instruments
 
Three Months Ended July 1, 2012
 
Gain or (Loss)
Recognized in
OCI -
Effective
Portion (a)
 
Location of
Gain or (Loss)
Reclassified from OCI
into Income - Effective
Portion
 
Gain or (Loss)
Reclassified
from
OCI into
Income -
Effective
Portion (a)
 
Location of
Gain or (Loss)
Recognized in
Income and
Excluded from
Effectiveness  Testing
 
Amount of Gain  or (Loss)  Recognized in
Income and
Excluded from
Effectiveness  Testing
Cash flow hedges:
 
 
 
 
 
 
 
 
 
 
Foreign currency forward contracts
 
659

 
Net revenue
 
682

 
Other income (expense), net
 
(63
)
Foreign currency forward contracts
 

 
Cost of revenue
 
(5
)
 
Other income (expense), net
 

Foreign currency forward contracts
 

 
Operating expenses
 
(190
)
 
Other income (expense), net
 

Total
 
659

 
 
 
487

 
 
 
(63
)


18

NETGEAR, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

Derivatives Designated as
Hedging Instruments
 
Six Months Ended July 1, 2012
 
Gain or (Loss)
Recognized in
OCI -
Effective
Portion (a)
 
Location of
Gain or (Loss)
Reclassified from OCI
into Income - Effective
Portion
 
Gain or (Loss)
Reclassified
from
OCI into
Income -
Effective
Portion (a)
 
Location of
Gain or (Loss)
Recognized in
Income and
Excluded from
Effectiveness  Testing
 
Amount of Gain  or (Loss)  Recognized in
Income and
Excluded from
Effectiveness  Testing
Cash flow hedges:
 
 
 
 
 
 
 
 
 
 
Foreign currency forward contracts
 
$
553

 
Net revenue
 
$
684

 
Other income (expense), net
 
$
(108
)
Foreign currency forward contracts
 

 
Cost of revenue
 
(7
)
 
Other income (expense), net
 

Foreign currency forward contracts
 

 
Operating expenses
 
(240
)
 
Other income (expense), net
 

Total
 
$
553

 
 
 
$
437

 
 
 
$
(108
)

(a)
Refer to Note 10, Stockholders' Equity, which summarizes the cumulative other comprehensive income activity related to derivatives.

The Company did not recognize any net gain or loss related to the ineffective portion of cash flow hedges during the three and six months ended June 30, 2013, and July 1, 2012.

Non-designated hedges

The Company enters into non-designated hedges under the authoritative guidance for derivatives and hedging to manage the exposure of non-functional currency monetary assets and liabilities held on its financial statements to fluctuations in foreign currency exchange rates, as well as to reduce volatility in other income and expense. The non-designated hedges are generally expected to offset the changes in value of its net non-functional currency asset and liability position resulting from foreign exchange rate fluctuations. Foreign currency denominated accounts receivable and payable are hedged with non-designated hedges when the related anticipated foreign revenue and expenses are recognized in the Company’s financial statements. The Company also hedges certain non-functional currency monetary assets and liabilities that may not be incorporated into the cash flow hedge program. The Company adjusts its non-designated hedges monthly and enters into about 13 non-designated derivatives per quarter. The average size of its non-designated hedges is about $2 million USD equivalent and these hedges range from one to five months in duration.

The effects of the Company’s derivatives not designated as hedging instruments in other income (expense), net in the unaudited condensed consolidated statements of operations for the three and six months ended June 30, 2013 and July 1, 2012, are as follows (in thousands):
 
Derivatives Not Designated as Hedging Instruments
 
Location of Gains or (Losses)
Recognized in Income on  Derivative
 
Amount of Gains or (Losses)
Recognized in Income on Derivative
 
Three Months  Ended
June 30, 2013

 
Six Months  Ended
June 30, 2013

Foreign currency forward contracts
 
Other income (expense), net
 
$
1,617

 
$
1,885


Derivatives Not Designated as Hedging Instruments
 
Location of Gains or (Losses)
Recognized in Income on  Derivative
 
Amount of Gains or (Losses)
Recognized in Income on Derivative
 
Three Months  Ended
July 1, 2012

 
Six Months  Ended
July 1, 2012

Foreign currency forward contracts
 
Other income (expense), net
 
$
793

 
$
49

 
7.
Net Income Per Share
Basic net income per share is computed by dividing the net income for the period by the weighted average number of common shares outstanding during the period. Diluted net income per share is computed by dividing the net income for the period by the weighted average number of shares of common stock and potentially dilutive common stock outstanding during the period. Potentially dilutive common shares include outstanding stock options and unvested restricted stock awards, which are reflected in diluted net income per share by application of the treasury stock method. Under the treasury stock method, the amount that the employee must pay for exercising stock options, the amount of stock-based compensation cost for future services that the Company

19

NETGEAR, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

has not yet recognized, and the estimated tax benefit that would be recorded in additional paid-in capital upon exercise are assumed to be used to repurchase shares.
Net income per share for the three and six months ended June 30, 2013, and July 1, 2012, are as follows (in thousands, except per share data):
 
 
Three Months Ended
 
Six Months Ended
 
June 30,
2013
 
July 1,
2012
 
June 30,
2013
 
July 1,
2012
Net income
$
13,985

 
$
21,522

 
$
29,328

 
$
46,669

Weighted average shares outstanding:
 
 
 
 
 
 
 
Basic
38,539

 
37,978

 
38,493

 
37,886

Dilutive potential common shares
535

 
617

 
584

 
726

Total diluted
39,074

 
38,595

 
39,077

 
38,612

 
 
 
 
 
 
 
 
Basic net income per share
$
0.36

 
$
0.57

 
$
0.76

 
$
1.23

Diluted net income per share
$
0.36

 
$
0.56

 
$
0.75

 
$
1.21


Weighted average stock options and unvested restricted stock awards to purchase 2.9 million shares and 2.7 million shares of the Company’s stock for the three months ended June 30, 2013, and July 1, 2012, respectively, and 2.8 million and 2.5 million shares for the six months ended June 30, 2013, and July 1, 2012, respectively, were excluded from the computation of diluted net income per share because their effect would have been anti-dilutive.

8.
Income Taxes

The income tax provision for the three and six months ended June 30, 2013 was $7.1 million or an effective tax rate of 33.8% and $15.7 million or an effective tax rate of 34.9%, respectively. The income tax provision for the three and six months ended July 1, 2012 was $9.9 million or an effective tax rate of 31.6% and $20.5 million or an effective tax rate of 30.5%, respectively. The decrease in income tax expense for the three and six month periods ended June 30, 2013, compared to the same period in the prior year was predominantly due to lower pre-tax earnings for the three and six months ended June 30, 2013. The increase in the effective tax rate for the three and six month periods ended June 30, 2013, compared to the same period in the prior year was primarily caused by a loss incurred during the three and six month period ended June 30, 2013 in a jurisdiction where no tax benefit could be recorded. Because the tax benefit could not be recorded, the forecasted earnings from this jurisdiction were excluded from the determination of the effective tax rate which results in an increase to the tax rate from foreign earnings. The increase for the three and six month periods was partially offset by the release of tax reserves resulting from the resolution of certain state tax issues. Additionally, for the six months ended June 30, 2013 there was an offset for the recognition of the tax benefit for the 2012 U.S. federal research credit. On January 2, 2013 the American Taxpayer Relief Act of 2012 reinstated the research credit, retroactive to January 1, 2012. Accordingly, the entire benefit for the 2012 research credit of approximately $734,000 was recognized in the first fiscal quarter of 2013.

The Company files income tax returns in the U.S. federal jurisdiction as well as various state, local, and foreign jurisdictions. Due to the uncertain nature of ongoing tax audits, the Company has recorded its liability for uncertain tax positions as part of its long-term liability as payments cannot be anticipated over the next 12 months. The existing tax positions of the Company continue to generate an increase in the liability for uncertain tax positions. The liability for uncertain tax positions may be reduced for liabilities that are settled with taxing authorities or on which the statute of limitations could expire without assessment from tax authorities. The possible reduction in liabilities for uncertain tax positions resulting from the expiration of statutes of limitation in multiple jurisdictions in the next 12 months is approximately $2.2 million, excluding the interest, penalties and the effect of any related deferred tax assets or liabilities.

9.
Commitments and Contingencies

Leases

The Company leases office space, cars and equipment under operating leases, some of which are non-cancelable, with various expiration dates through December 2026. The terms of some of the Company’s office leases provide for rental payments on a

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graduated scale. The Company recognizes rent expense on a straight-line basis over the lease period, and has accrued for rent expense incurred but not paid.

Purchase Obligations

The Company has entered into various inventory-related purchase agreements with suppliers. Generally, under these agreements, 50% of orders are cancelable by giving notice 46 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 June 30, 2013, the Company had approximately $217 million in non-cancelable purchase commitments with suppliers. The Company establishes a loss liability for all products it does not expect to sell for which it has committed purchases from suppliers. Such losses have not been material to date.

Guarantees and Indemnifications

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 or director is or was serving at the Company’s request in such capacity. The term of the indemnification period is for the officer’s or director’s lifetime. The maximum amount of potential future indemnification is unlimited; however, the Company has a Director and Officer Insurance Policy that enables it to recover a portion of any future amounts paid. As a result of its insurance policy coverage, the Company believes the fair value of these indemnification agreements is minimal. Accordingly, the Company has no liabilities recorded for these agreements as of June 30, 2013.

In its sales agreements, the Company typically agrees to indemnify its direct customers, distributors and resellers for any expenses or liability resulting from claimed infringements by the Company's products of patents, trademarks or copyrights of third parties, subject to customary carve outs. The terms of these indemnification agreements are generally perpetual any time after execution date of the respective agreement. The maximum amount of potential future infringement indemnification is generally unlimited. The Company believes the estimated fair value of these agreements is minimal. Accordingly, the Company has no liabilities recorded for these agreements as of June 30, 2013.

Employment Agreements

The Company has signed various employment agreements with key executives pursuant to which, if their employment is terminated without cause, such employees are entitled to receive their base salary (and commission or bonus, as applicable) for 52 weeks (for the Chief Executive Officer), 39 weeks (for the Senior Vice President of Worldwide Operations and Support) and up to 26 weeks (for other key executives). Such employees will also continue to have stock options vest for up to a one-year period following such termination without cause. If a termination without cause or resignation for good reason occurs within one year of a change in control, such employees are entitled to full acceleration (for the Chief Executive Officer) and up to two years acceleration (for other key executives) of any unvested portion of his or her stock options.

Litigation and Other Legal Matters

The Company is involved in disputes, litigation, and other legal actions, including, but not limited to, the matters described below. In all cases, at each reporting period, the Company evaluates whether or not a potential loss amount or a potential range of loss is probable and reasonably estimable under the provisions of the authoritative guidance that addresses accounting for contingencies. In such cases, the Company accrues for the amount, or if a range, the Company accrues the low end of the range as a component of legal expense in litigation reserves. The Company monitors developments in these legal matters that could affect the estimate the Company had previously accrued. In relation to such matters, the Company currently believes that there are no existing claims or proceedings that are likely to have a material adverse effect on its financial position within the next 12 months, or the outcome of these matters is currently not determinable. There are many uncertainties associated with any litigation, and these actions or other third-party claims against the Company may cause the Company to incur costly litigation and/or substantial settlement charges. In addition, the resolution of any intellectual property litigation may require the Company to make royalty payments, which could have an adverse effect in future periods. If any of those events were to occur, the Company's business, financial condition, results of operations, and cash flows could be adversely affected. The actual liability in any such matters may be materially different from the Company's estimates, which could result in the need to adjust the liability and record additional expenses.


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Ruckus Wireless v. NETGEAR

On May 5, 2008, a lawsuit was filed against the Company by Ruckus Wireless (“Ruckus”), a developer of Wi-Fi technology, in the U.S. District Court, Northern District of California (case number C08-2310-PJH (“NETGEAR I”)). Ruckus alleges that the Company infringes U.S. Patent Nos. 7,358,912 ("the '912 Patent") and 7,193,562 ("the '562 Patent") in the course of deploying Wi-Fi antenna array technology in its WPN824 RangeMax wireless router. Ruckus also sued Rayspan Corporation alleging similar claims of patent infringement. The Company filed its answer to the lawsuit in the third quarter of 2008. The Company and Rayspan Corporation jointly filed a request for inter partes reexamination of the Ruckus patents with the USPTO on September 4, 2008. The Court issued a stay of the litigation while the reexaminations proceeded in the USPTO. On November 28, 2008, a reexamination was ordered with respect to claims 11-17 of the '562 Patent, but denied with respect to claims 1-10 and 18-36. On December 17, 2008, the defendants jointly filed a petition to challenge the denial of reexamination of claims 1-10 and 18-36 of the '562 Patent. In July 2009, the petition was denied, and the remaining claims 11-17 were confirmed by the USPTO. On December 2, 2008, reexamination was granted with regard to the '912 Patent. In early October 2009, the Company received an Action Closing Prosecution in the reexamination of the '912 Patent. All the claims of the '912 Patent, with the exception of the unchallenged claims 7 and 8, were finally rejected by the USPTO. On October 30, 2009, Ruckus submitted an “after-final” amendment in the '912 Patent reexamination proceeding. The Company's comments to Ruckus' “after-final” amendment were submitted on November 30, 2009. On December 1, 2009, the Court found that bifurcating the '562 Patent from the '912 Patent and commencing litigation on the '562 Patent while the USPTO reexamination process and appeals are still pending would be an inefficient use of the Court's resources. Accordingly, the Court ruled that the litigation stay should remain in effect. On September 12, 2010, the Company filed the rebuttal brief in its appeals of the USPTO's rulings during the reexamination of the '562 Patent, and the Company requested an oral hearing with the Board of Appeals at the USPTO to discuss this brief. On September 13, 2010, Ruckus filed a notice of appeal of the '912 Patent to appeal the adverse rulings it received from the USPTO in the reexamination of this patent. The Company filed a respondent's brief in the '912 Patent case on January 24, 2011. An oral hearing in the '562 case was set for February 1, 2011, but the Company decided to cancel it and let the USPTO decide the '562 case based solely on the previously submitted papers. On May 13, 2011, the USPTO indicated that the Company was successful in its appeal of the examiner's previous decision to allow claims 11-17 in the '562 reexamination, and the USPTO Board of Appeals reversed the examiner's decision and declared those claims invalid. On June 13, 2011, Ruckus submitted a request for rehearing by the Board of Appeals of its decision to reject claims 11-17 of the '562 Patent. On September 28, 2011, the Board of Patent Appeals and Interferences denied Ruckus's request for a rehearing in the '562 Patent reexamination case. Ruckus did not timely file a notice of appeal to the Court of Appeals for the Federal Circuit appealing the USPTO's cancellation of claims 11-17 of the '562 patent. Therefore, a reexamination certificate will issue with claims 11-17 cancelled and claims 1-10 and 18-36 confirmed.

On November 4, 2009, Ruckus filed a complaint in the U.S. District Court, Northern District of California (case number C09-5271-PJH (“NETGEAR II”)), alleging the Company and Rayspan Corporation infringe a patent that is related to the patents previously asserted against the Company and Rayspan Corporation by Ruckus, as discussed above. This asserted patent in this second case is U.S. Patent No. 7,525,486 entitled “Increased wireless coverage patterns.” As with the previous Ruckus action, the WPN824 RangeMax wireless router is the alleged infringing device. The Company challenged the sufficiency of Ruckus's complaint in this new action and moved to dismiss the complaint. Ruckus opposed this motion. The Court partially agreed with the Company's motion and ordered Ruckus to submit a new complaint, which Ruckus did. The initial case management conference occurred on February 11, 2010. On March 25, 2010, the Court ordered a stay until the completion of the reexamination proceedings instigated on the patents in NETGEAR I.

Ruckus and the Company in December of 2012 requested that the stay of the California actions be lifted. This request to lift the stay was predicated on Ruckus's Withdrawal of Appeal and Cancellation of Claims ("Withdrawal") of the '912 Patent that was on appeal in re-examination at the USPTO and that was asserted by Ruckus in NETGEAR I. Through the filing of the Withdrawal, Ruckus announced its intent to withdraw and its actual withdrawal of its appeal of claims 1, 4-9-14, 18, 19, and 22-29 in re-examination (the "Appealed Claims"), and Ruckus further announced its intent to cancel and its actual cancellation of claims 30-31 in re-examination (the "Cancelled Claims"). Claims 2, 3, 15-17, 20, and 21 had previously been cancelled during re-examination (the "Previously Cancelled Claims"). Because the Appealed Claims and the Cancelled Claims represented the entirety of the claims remaining for consideration in re-examination, and the Previously Cancelled Claims are no longer of record in the offensive case by Ruckus against the Company, there are no remaining claims for re-examination in the '912 Patent and the '912 Patent cannot be asserted against the Company. Thus, the Company and Ruckus requested that the Court lift the stay of this litigation and calendar a case management conference. The case management conference occurred on January 3, 2013. At that time, the Court scheduled a claim construction hearing for August of 2013. The parties to the lawsuit - the Company, Rayspan, and Ruckus - also agreed that Ruckus's two offensive cases against the Company and Rayspan should be consolidated because the cases involve similar complaints and common questions of law and fact and doing so will advance the interests of judicial economy.


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Ruckus served its infringement contentions on the Company on January 17, 2013, and the Company's invalidity contentions were served on Ruckus on March 4, 2013. On March 5, 2013, Ruckus and Rayspan filed a stipulation with proposed order dismissing Rayspan from the case, and, on March 6, 2013, the Court dismissed with prejudice Rayspan. On March 14, 2013, Ruckus filed its Second Amended Complaint, as ordered by the Court. Ruckus did not add any patents, but attempted to add claims of breach of contract and misappropriation of trade secrets by the Company. The Company believes that Ruckus contravened the Court's order that there should not be a “substantial change” in the Second Amended Complaint by adding the breach of contract and misappropriation of trade secrets claims to the lawsuit. Consequently, the Company filed a Motion to Strike the newly added claims. On May 22, 2013, the Court granted the Company's motion to strike the state law claims of trade secret misappropriation and breach of contract from the Second Amended Complaint. On June 10, 2013, Ruckus filed its Motion for Leave to Amend and File its Third Amended Complaint, adding back the trade secret misappropriation and breach of contract claim. The Company responded on June 24, 2013, and the parties orally argued the motion and response on July 24, 2013. On July 29, 2013, the Court denied Ruckus's Motion for Leave to Amend and File its Third Amended Complaint, meaning the Court will not allow Ruckus to bring its breach of contract claims or trade secret misappropriation claims because they are time barred.

In May 2013, the parties filed their Joint Claim Construction Statement where the parties indicate to the Court the disputed claim language, the parties's competing constructions, and the evidence in support of the parties' positions. Ruckus then filed its opening claim construction brief on June 18, 2013 and the Company filed its reply on July 1, 2013. The parties are scheduled to give a claim construction tutorial to the Court on August 16, 2013, and the claim construction arguments by the parties to the Court will occur on August 28, 2013. Discovery is ongoing.

On November 19, 2010, the Company filed suit against Ruckus in the U.S. District Court, District of Delaware for infringement of four of the Company's patents. The Company alleges that Ruckus's manufacture, use, sale or offers for sale within the United States or importation into the United States of products, including wireless communication products, infringe United States Patent Nos. 5,812,531, 6,621,454, 7,263,143, and 5,507,035, all owned by the Company. The Company granted Ruckus an extension to file its answer to the Company's suit, and on January 11, 2011, Ruckus filed a motion to dismiss the Company's suit based on insufficient pleadings. The Company filed its response to Ruckus's motion on January 31, 2011. In addition, on May 6, 2011, Ruckus filed a motion to transfer venue to the Northern District of California. The Court denied Ruckus' motion to transfer the case to the Northern District of California and granted the Company leave to file an amended complaint rather than address the Ruckus motion to dismiss based on insufficient pleadings. The Company filed the proposed amended complaint. Nevertheless, Ruckus filed a second motion to dismiss based on insufficient pleadings by the Company. On March 28, 2012, the Delaware District Court in a memorandum opinion and order denied Ruckus's second motion to dismiss. A scheduling conference occurred April 18, 2012, and the Company submitted its initial disclosures in the case on May 15, 2012. On May 31, 2012, Ruckus filed its third motion to dismiss, asserting that the Company cannot sustain its indirect infringement and willfulness allegations without pleading pre-suit knowledge of the patents. The Company responded to Ruckus's motion to dismiss on June 18, 2012. The Court released the schedule for the case on June 8, 2012 with Claim Construction and Summary Judgment Hearings scheduled for August 9, 2013 and a ten day jury trial scheduled for October 21, 2013. On July 13, 2012, the Company added to its complaint against Ruckus an allegation of infringement of patent number 6,512,480 (“System and method for narrow beam antenna diversity in an RF data transmission system”) by Ruckus's ZoneFlex and MediaFlex products. The Company and Ruckus participated in a court-ordered mediation on September 13, 2012 in Delaware, and the parties did not come to an agreement to settle the litigation pending between the parties. Fact discovery closed on December 14, 2012 and expert discovery is also closed. In addition, all claim construction and summary judgment briefing is finished, and on August 9, 2013 the parties will argue their claim construction and summary judgment briefing before the Court.

On June 19, 2013, Ruckus filed a complaint in Delaware accusing NETGEAR of infringing United States Patent No. 8,031,129 (“the '129 Patent”) and United States Patent No. 8,150,470 (“the '470 Patent”). Ruckus has accused the Company of infringing the '129 Patent by making, using, offering to sell, selling, and/or importing products, such as the Company's N600 Wireless Dual Band Routers (WNDR3400). Ruckus has also accused the Company of knowingly and actively inducing infringement of the '129 Patent. Ruckus has accused the Company of infringing the '470 Patent by making, using, offering to sell, selling, and/or importing products, such as NETGEAR's N600 Wireless Dual Band Gigabit Routers (WNDR3800). Ruckus has also accused the Company of knowingly and actively inducing infringement of the '470 Patent.

The Company is continuing to evaluate the claims and its options in this newly filed Delaware case, and the parties stipulated that the Company shall have until August 12, 2013 to answer the complaint.

It is too early to reasonably estimate the financial impact to the Company as a result of the Ruckus litigation matters.


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Northpeak Wireless, LLC v. NETGEAR

In October 2008, a lawsuit was filed against the Company and 30 other companies by Northpeak Wireless, LLC (“Northpeak”) in the U.S. District Court, Northern District of Alabama. Northpeak alleges that the Company's 802.11b compatible products infringe certain claims of U.S. Patent Nos. 4,977,577 ("the '577 Patent") and 5,987,058 ("the '058 Patent"). The Company filed its answer to the lawsuit in the fourth quarter of 2008. On January 21, 2009, the District Court granted a motion to transfer the case to the U.S. District Court, Northern District of California. In August 2009, the parties stipulated to a litigation stay pending a reexamination request to the USPTO on the asserted patents. The reexaminations of the patents are proceeding. In March 2011, the USPTO confirmed the validity of the asserted claims of the '577 Patent over certain prior art references. In April 2011, the USPTO issued a final office action rejecting both asserted claims of the '058 Patent as being obvious in light of the prior art. In March of 2013, the Board of Patent Appeals and Interferences of the USPTO affirmed the rejection of both asserted claims of the '058 Patent. The case remains stayed by stipulation, and no trial date has been set. The Company does not expect there to be a material financial impact to the Company because of this litigation matter.

Ericsson v. NETGEAR

On September 14, 2010, Ericsson Inc. and Telefonaktiebolaget LM Ericsson (collectively “Ericsson”) filed a patent infringement lawsuit against the Company and defendants D-Link Corporation, D-Link Systems, Inc., Acer, Inc., Acer America Corporation, and Gateway, Inc. in the U.S. District Court, Eastern District of Texas alleging that the defendants infringe certain Ericsson patents. The Company has been accused of infringing eight U.S. patents: 5,790,516; 6,330,435; 6,424,625; 6,519,223; 6,772,215; 5,987,019; 6,466,568; and 5,771,468 ("the '468 Patent"). Ericsson generally alleges that the Company and the other defendants have infringed and continue to infringe the Ericsson patents through the defendants' IEEE 802.11-compliant products. In addition, Ericsson alleged that the Company infringed the claimed methods and apparatuses of the '468 Patent through the Company's PCMCIA routers. The Company filed its answer to the Ericsson complaint on December 17, 2010 where it asserted the affirmative defenses of noninfringement and invalidity of the asserted patents. On March 1, 2011, the defendants filed a motion to transfer venue to the District Court for the Northern District of California and their memorandum of law in support thereof. On March 21, 2011, Ericsson filed its opposition to the motion, and on April 1, 2011, defendants filed their reply to Ericsson's opposition to the motion to transfer. On June 8, 2011, Ericsson filed an amended complaint that added Dell, Toshiba and Belkin as defendants. At the status conference held on Jun 9, 2011, the Court set a Markman hearing for June 28, 2012 and trial for June 3, 2013. On June 14, 2011, Ericsson submitted its infringement contentions against the Company. On September 29, 2011, the Court denied the defendants motion to transfer venue to the Northern District of California. In advance of the Markman hearing, the parties on March 9, 2012 exchanged proposed constructions of claim terms and on April 9, 2012 filed the Joint Claim Construction Statement with the District Court. On May 8, 2012, Ericsson submitted its opening Markman brief and on June 1, 2012 the defendants submitted their responsive Markman brief. Ericsson's Reply Markman brief was submitted June 15, 2012, and on June 28, 2012 the Markman hearing was held in the Eastern District of Texas. On June 21, 2012, Ericsson dismissed the '468 Patent (“Multi-purpose base station”) with prejudice and gave the Company a covenant not to sue as to products in the marketplace now or in the past. On June 22, 2012, Intel filed its Complaint in Intervention, meaning that Intel is now an official defendant in the Ericsson case. The parties recently completed fact discovery and are exchanging expert reports. During the exchange of the expert reports, Ericsson dropped the '516 patent (the OFDM “pulse shaping” patent). In addition, Ericsson dropped the '223 Patent (packet discard patent) against all the defendants' products, except for those products that use Intel chips. Thus, Ericsson has now dropped the '468 Patent (wireless base station), the '516 Patent (OFDM pulse shaping), and the '223 Patent (packet discard patent) for all non-Intel products. The five remaining patents are all only asserted against 802.11-compliant products.

At a Court ordered mediation in Dallas on January 15, 2013, the parties did not come to an agreement to settle the litigation. On March 8, 2013, the parties received the Markman (claim construction) Order in response to the claim construction briefing and claim construction hearing.

A jury trial in the Ericsson case occurred in the Eastern District of Texas from June 3 through June 13, 2013. After hearing the evidence, the jury found no infringement of the '435 and '223 patents, and the jury found infringement of claim 1 of the '625 patent, claims 1 and 5 of the '568 patent, and claims 1 and 2 of the '215 patent. The jury also found that there was no willful infringement by any defendant. Additionally, the jury found no invalidity of the asserted claims of the '435 and '625 patents. The jury assessed the following damages against the defendants: D-Link: $435,000; NETGEAR: $3,555,000; Acer/Gateway: $1,170,000; Dell: $1,920,000; Toshiba: $2,445,000; Belkin: $600,000. The damages awards equate to 15 cents per unit for each accused 802.11 device sold by each defendant. Thus, unless the defendants' various appeals are successful, the Company will likely have a 15 cent per unit obligation on its 802.11 devices until 2016 (when one infringed patent in suit expires), 10 cent per unit obligation from 2016 through 2018 (when a second infringed patent in suit expires), and a 5 cent per unit obligation from 2018 through 2020 (when the third and last infringed patent in suit expires).

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The Company and other defendants have submitted various post-trial motions and briefs to the Court for its consideration, including motions and briefs for judgment of a matter of law in favor of defendants on non-infringement and invalidity of the patents in suit and for a reduction in damages, and the defendants have also moved for a new trial. These motions were argued before the Court on July 16, 2013. The defendants likely will bring various appeals of the verdicts to the Court of Appeals for the Federal Circuit, and this process will take about 18 months to run its course. The Company accrued and expensed the $3,555,000 in damages during the second quarter of 2013.

Fujitsu v. NETGEAR

On September 3, 2010, Fujitsu filed a complaint against the Company, Belkin International, Inc., Belkin, Inc., D−Link Corporation, D−Link Systems, Inc., ZyXEL Communications Corporation, and ZyXEL Communications, Inc. in the U.S. District Court, Northern District of California alleging that certain of the Company's products infringe upon Fujitsu's U.S. patent Re. 36,769 patent ("the '769 Patent") through various cards and interface devices within the Company's products. The Company answered the complaint denying the allegations of infringement and claiming that the asserted patent is invalid. In addition, the Company filed a motion to disqualify counsel for Fujitsu. The Company's disqualification motion was argued before the Court on December 16, 2010, and on December 22, 2010, the Court granted the Company's motion and disqualified counsel for Fujitsu. In response, Fujitsu requested a stipulation from all parties to reset the case management conference and scheduled hearing dates for the motions to dismiss. The initial case management conference was held on March 18, 2011. A claim construction hearing was held on October 14, 2011. On February 3, 2012, the Court issued its claim construction order based on the claim construction hearing. On March 3, 2012, the Fujitsu patent emerged from the latest ex-parte reexamination in the USPTO that was initiated by Belkin, Inc. The USPTO examiner rejected five of the “wired” claims in the patent, but found that the majority of claims of the patent were valid. Expert discovery opened May 4, 2012 with the exchange of initial expert reports. Rebuttal expert reports were exchanged on May 25, 2012, and expert discovery closed on June 8, 2012. A further case management conference was held on May 9, 2012 where the Court ordered that by June 12, 2012 Fujitsu must file a status report narrowing its asserted claims to no more than 10 claims, and narrowing the accused products accordingly, and Fujitsu filed the status report on the due date. By July 3, 2012, the Court ordered the Defendants to file a status report reducing its number of prior art references and obviousness combinations, and Defendants filed the status report on the due date. The Court also limited Fujitsu to one motion for summary judgment and allowed Defendants to jointly file two summary judgment motions. The Court further implemented the following dates: last day to file disposition motions of July 26, 2012; hearing on dispositive motions on September 6, 2012; final pretrial conference on November 1, 2012; and jury trial beginning November 26, 2012. The Court ordered the length of the trial to be 10 days. The Court also set a further case management conference for September 6, 2012, immediately following the hearing on any dispositive motions filed. The parties submitted their summary judgment motions on July 26, 2012. Fujitsu submitted a summary judgment motion arguing that the defendants infringe the '769 Patent. The defendants submitted two summary judgment motions. The first argued that any infringement by the defendants was not willful, and the second argued that the '769 Patent is invalid.
 
On September 28, 2012, the Court issued its summary judgment ruling. The Court did not invalidate the '769 Patent and ruled that some of the Company's cards infringed the '769 Patent.

In addition, the Court rejected Fujitsu's narrowing arguments for the terms “card” and “slot” that are contained in the claims of the patent in suit, expressly holding that “card” should be given its plain and ordinary meaning and agreeing with Defendants that “slot” was a broad term meaning “an opening.”

After a 10-day trial in November and December of 2012, the eight-member jury sided with the remaining defendants - NETGEAR, Belkin, and D-Link - and found Fujitsu's claims under the '769 patent for a "card type input/output interface device" to be invalid. The jury also found the defendants had not caused infringement by selling routers and access points that were compatible with wireless interface cards. The parties then entered into a final settlement agreement ending the case on March 7, 2013. There was no material financial impact to the Company because of this settlement agreement.
 
NETGEAR v. Innovatio IP Ventures LLC.

On November 16, 2011, the Company filed a declaratory judgment action in the District of Delaware for non-infringement and invalidity of 17 WiFi-related patents brought in the approximately 15 actions throughout the United States by Innovatio IP Ventures LLC (“Innovatio”) against end user customers of the Company and other companies. Shortly after filing the declaratory judgment action, the Company filed a response supporting Cisco Systems, Inc.'s ("Cisco") and Motorola Solutions, Inc.'s ("Motorola") Motion to Transfer for Coordinated Pretrial Proceedings Pursuant to 28 U.S.C. § 1407 that was before the United States Judicial Panel on Multidistrict Litigation (“JPML”). The pending motion to transfer would serve to consolidate all of the

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Innovatio lawsuits - including the Company's pending declaratory judgment action in Delaware-and transfer them to a single court for coordinated pretrial proceedings. On December 28, 2011, the JPML issued an order transferring the Innovatio actions throughout the United States, including the Company's declaratory judgment action, to the United States District Court for the Northern District of Illinois. Thus, the Company's declaratory judgment action and approximately 15 other similar cases will now proceed in the Northern District of Illinois in a consolidated fashion. The status conference originally scheduled for March 27, 2012 was postponed by the District Court until April 10, 2012. At the conference, the District Court discussed two primary issues (1) case phasing (i.e., which subset of defendants should proceed after Markman Hearing through the remaining proceedings) and (2) the defendants' proposal on damages contentions. The District Court stated that it tentatively felt that the case should proceed with one or more WiFi hardware suppliers after the Markman Hearing, but was going to reserve a final ruling on the issue. The District Court also ordered that the parties prepare a joint pretrial order reflecting the court's decisions and the schedule for the case. On July 10, 2012, Innovatio answered the Declaratory Judgment Complaint filed by the Company with various counterclaims, cross claims, and affirmative defenses. In its answer, Innovatio accused the Company of infringing six WiFi-related patents in addition to the 17 WiFi-related patents on which the Company brought its declaratory judgment action of non-infringement and invalidity. The Company filed its answer to Innovatio's various counterclaims, cross claims, and affirmative defenses on August 3, 2012. In addition, on October 1, 2012, Cisco, Motorola and the Company filed an amended complaint alleging racketeering, fraud, interference with contract, unfair business practices, and conspiracy, among other things, against Innovatio. On February 4, 2013, the Court dismissed the offensive claims of Cisco, Motorola, and the Company that alleged Innovatio was engaging in racketeering, fraud, and unfair business practices by demanding licensing fees from hotels, cafes and other businesses but left intact claims against Innovatio that allege breach of contract with respect to Innovatio's fair, reasonable, and nondiscriminatory (FRAND) royalty obligations. The parties have already exchanged their Final Infringement, Unenforceability and Invalidity Contentions and Damages contentions.

The Court has implemented special damages-focused proceedings prior to proceeding to the liability or infringement phase of the case. Accordingly, the parties on July 18 and July 19, 2013 participated in a bench trial on essentiality. Because the plaintiff and defendants disagree as to whether approximately 230 patent claims asserted by Innovatio are essential to practicing the 802.11 standard, this bench trial was held to determine whether those claims are essential. Essential claims are subject to FRAND royalty obligations, and such royalty obligations are generally subject to lower rates than Innovatio is currently demanding from the parties it is accusing of infringing its patents. On July 26, 2013, the Court issued an order deeming all claim essential. The Court reviewed various arguments on the IEEE's definition of “Essential Patent Claims” and found that essential patent claims are those which are necessary to implement mandatory or optional features but also can cover items not explicitly required by the standard -- either “enabling” technologies or items that are technically and commercially necessary to implement the standard. The Court confirmed its previous holding that the prospective licensee has the burden of proving essentiality, and that the analysis should be performed on a claim by claim basis, as opposed to a patent by patent basis. The Court also set September 9-12, 2013 for a bench trial on what the FRAND royalty rate would be on those patents and claims found to be essential, and the liability trial date has not been set. It is too early to reasonably estimate any financial impact to the Company because of this litigation matter.

U.S. Ethernet Innovation, LLC v. NETGEAR

On June 22, 2012, U.S. Ethernet Innovations, LLC (“USEI”) sued the Company in the District Court for the Eastern District of Texas, alleging infringement of certain of its Ethernet-related patents: U.S. Patent Numbers 5,732,094 (“Method for automatic initiation of data transmission”); 5,434,872 (“Apparatus for automatic initiation of data transmission”); 5,299,313 (“Network interface with host independent buffer management”) and 5,530,874 (“Network adapter with an indication signal mask and an interrupt signal mask”). USEI is a patent holding entity with a nominal office in the Eastern District of Texas. The accused products include products such as the “Netgear RT311 Internet Gateway Router.” The Company received an extension until August 17, 2012 to answer the complaint. USEI has sued, in addition to the Company, the following companies on the same and other of its Ethernet-related patents: Ricoh Americas Corporation, TRENDnet, Inc., Xerox Corporation, Konica Minolta Business Solutions U.S.A., Inc., Freescale Semiconductor, Inc., Sharp Electronics Corporation, Digi International Inc., NetSilicon, Inc., Epson America, Inc., Cirrus Logic, Inc., Yamaha Corporation of America, Control4 Corporation, Samsung Electronics Co., Ltd., Samsung Electronics America, Inc., Samsung Telecommunications America, LLC, Samsung Austin Semiconductor, LLC, Oki Data Americas, Inc., STMicroelectronics N.V., and STMicroelectronics, Inc. (collectively, “Defendants”).

The Company received a further extension to answer the complaint and answered on September 4, 2012 via a 12(b)(6) motion to dismiss the complaint for various reasons, including a lack of pleading specificity. USEI responded to the Company's motion to dismiss under Rule 12(b)(6) on September 21, 2012. The Company submitted its Reply in Support of its Motion to Dismiss on October 1, 2012.

USEI served its infringement contentions on the Company on October 10, 2012. The Company filed its transfer motion for

26

NETGEAR, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

a transfer to the Northern District of California and supporting declarations on November 16, 2012. On December 3, 2012, Defendants filed their joint invalidity contentions.

Because the Eastern District of Texas's preferred time for deciding motions to transfer is after the Markman Hearing, the defendants filed a motion to stay the litigation pending the result of the Eastern District of Texas's decisions on the motion to transfer on January 29, 2013.

The Court has consolidated for discovery purposes USEI's cases against the aforementioned defendants and scheduled a consolidated Markman hearing for April 4, 2013 for the asserted patents. The Court also indicated that the court would consider any of Defendants' transfer motions as soon as possible.

On March 27, 2013, the Court issued a Memorandum Opinion and Order granting the Company's motion to transfer to the United States District Court for the Northern District of California, effective on April 16, 2013. In response, on April, 12, 2013, USEI filed a motion for clarification and/or reconsideration of the venue order. Specifically, USEI seeks to delay the transfer until the Markman order in the Eastern District of Texas case becomes final under the guise that it is more efficient to allow the Texas court to construe the terms. The Company opposed USEI's motion. The mediation in this case that was scheduled for May 15, 2013 was cancelled.

On May 16, 2013, the Court in the Eastern District of Texas denied USEI's motion to reconsider the timing of transfer. Also, the Court sent notice that the Eastern District of Texas case is closed, and instructed the clerk to transfer the case immediately.

On June 28, 2013, the new Court in the case of USEI against the Company (the District Court for the Northern District of California), held a combined Case Management Conference for the Company's newly transferred case and the case USEI has previously instigated against several other defendants, including several Ethernet chip manufacturers. At this Case Management Conference, the Court commented that the chip manufacturers should go to trial first. The Court also ruled that the Company is going to join on the same schedule as the other defendants and allowed the Company to file a new motion to dismiss with the citation of supplemental Northern District of California authority.

One additional patent is asserted against the Company that is not asserted against the other Northern District of California defendants (the '874 Patent). The Court agreed that, if USEI and the Company cannot resolve '874 Patent claim construction issues, the Court will build in dates to the litigation schedule for doing so (i.e. a limited claim construction hearing on terms of the '874 Patent).

It is too early to reasonably estimate any financial impact to the Company because of this litigation matter.

ReefEdge Networks, LLC v. NETGEAR, Inc.

On September 17, 2012, the Company was sued by ReefEdge Networks, LLC, a non-practicing entity. The Company received an extension from the plaintiff until November 8, 2012 to answer the complaint and answered the complaint on that date.

The complaint alleges that NETGEAR infringes three related patents: 6,633,761 B1; 6,975,864 B2; 7,197,308 B2. In general terms, these asserted patents involve seamlessly handing-off portable wireless devices from one access point to another so as to provide roaming within a wireless network.

The complaint specifically accuses the Company's ProSafe wireless controller of infringing these three patents. On August 15, 2012, ReefEdge filed complaints in Delaware against Aruba Networks Inc., Cisco Systems Inc., Meru Networks Inc., and Ruckus Wireless Inc. alleging infringement of the same three patents. In the second tranche of lawsuits, ReefEdge sued--in addition to the Company-Brocade Communications Systems, Inc., Extreme Networks Inc., ADTRAN, Inc., Alcatel-Lucent Inc., D-Link Systems, Inc., Enterasys Networks, Inc., Motorola Solutions Inc., CDW Corporation, Avaya Inc., and ZyXEL Communications Corporation. The Company has hired defense counsel and is evaluating ReefEdge's allegations. It is too early to reasonably estimate any financial impact to the Company because of this litigation matter.


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NETGEAR, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

Pragmatus Telecom, LLC v. NETGEAR, Inc.

On December 6, 2012, Pragmatus Telecom, LLC (“Pragmatus”), filed a lawsuit against the Company asserting that the Company's use of a system “to provide live chat service over the Internet” infringes U.S. Patent Nos. 6,311,231, 6,668,286, and 7,159,043 ("'231 patent", "'286 patent", and "'043 patent", respectively).

The '231 patent is entitled "Method and System for Coordinating Data and Voice Communications via Customer Contact,” the '286 patent is entitled "Method and System for Coordinating Data and Voice Communications via Customer Contact Channel Changing System Over IP," and the '043 patent is entitled "Method and System for Coordinating Data and Voice Communications via Contact Channel Changing System," The patents very generally allegedly relate to “live chat" services of companies, which can give customers the ability to exchange text messages with a virtual or real customer support person. It appears that most companies named in the various lawsuits by Pragmatus license the “live chat” technology and software from a third-party supplier. A few of these third-party suppliers have been named in some of the over 100 lawsuits filed by Pragmatus in California, Delaware, and the Eastern District of Texas, and two third-party suppliers of text-chat (LivePerson and LogMeIn) have filed declaratory judgment actions on the patents in suit in Delaware. There is a pending reexamination on one of the three asserted patents.

Pragmatus and the Company agreed to extend the deadline for the Company to answer or otherwise respond to Pragmatus's complaint until February 11, 2013. The Company answered the complaint on that day by denying Pragmatus's infringement allegations and requesting a declaratory judgment by the Court that the patents in suit are not infringed and invalid. On February 20, 2013, the Company filed a motion to stay the case, and, on March 6, 2013, Pragmatus filed its opposition to the Company's motion to stay the case. The Company filed its reply on March 13, 2013. On May 14, 2013, the Court granted the Company's motion to stay “pending final exhaustion of all pending reexamination proceedings.” On June 22, 2013, both the '231 and '286 patents, which were the two asserted patents against the Company that were put into reexam by the defendants in a parallel Delaware action and the basis of the stay in the Pragmatus' case against the Company, emerged from reexam. In addition, the Delaware court lifted the stay in the Pragmatus cases pending in Delaware, and the parties are negotiating whether the stay should be lifted in Pragmatus's California lawsuit against the Company.

It is too early to reasonably estimate any financial impact to the Company because of this litigation matter.

Freeny v. NETGEAR, Inc.

On April 29, 2013, the Company and several other companies, including Apple, ASUSTek, Belkin, Buffalo, D-Link, IC Intracom, Ruckus, TP-Link, Vizio, and Western Digital, were sued in separate actions in the Eastern District of Texas by Charles C. Freeny III, Bryan E. Freeny, and James P. Freeny. The complaint alleges that dual-band wireless routers infringe U.S. Patent No. 7,110,744. The patent lists Charles Freeny as the inventor. Mr. Freeny's sons, Charles III and Bryan, now own the '744 patent, as Mr. Freeny is deceased. On June 21, 2013, the Company's answer and counterclaims were timely filed with the Court. The Court has not yet set a litigation schedule, and discovery has not commenced.
  
Concinnitas v. NETGEAR, Inc.

On May 2, 2013, the Company was added to an existing case against Sierra Wireless America, Inc. and Sierra Wireless S.A. that was brought by Concinnitas, LLC and George W. Hindman in the Eastern District of Texas. The accused products will be the Company's Aircard products that it acquired from Sierra Wireless. On July 20, 2013, the Company's answer and counterclaims were timely filed with the Court. The Court has not yet set a litigation schedule, and discovery has not commenced.

Voice Integration Technologies, LLC v. NETGEAR, Inc.

On December 28, 2012, Voice Integration Technologies, LLC (“VIT”) sued the Company alleging direct, indirect, and willful infringement of U.S. Patent No. 7,127,048 (the "'048 Patent"), entitled "Systems and Methods for Integrating Analog Voice Service and Derived POTS Voice Service in a Digital Subscriber Line Environment." The '048 Accused Products include integrated access device ("IAD") products that allow users to place and receive both telephone and VoIP calls over the same telephone line, and VIT specifically named the Company's DG 834GV Integrated ADSL2+ Modem and Wireless Router with Voice in the complaint.

The Company was served with the complaint on February 6, 2013, and on February 25, 2013 received an extension to answer the complaint until April 12, 2013. In parallel, the Company reached out to VIT requesting that the case against the Company be voluntarily dismissed by VIT since the Company has sold no products in the U.S. that could in good faith be argued to infringe the '048 Patent. Accordingly, VIT agreed to dismiss its suit without prejudice, and, on March 13, 2013, VIT filed with the Court

28

NETGEAR, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

its Notice of Voluntary Dismissal as to the Company. There was no financial impact to the Company because of this litigation matter.

NETGEAR v. ASUS

On July 22, 2013, the Company filed a complaint against ASUSTEK COMPUTER, INC. and ASUS COMPUTER INTERNATIONAL, INC. (collectively “ASUS”) seeking permanent injunctive relief, damages and declaratory relief for false advertising in violation of the Lanham Act, damages for tortious interference with the Company's prospective business relations, injunctive relief for unfair competition in violation of California Business and Professions Code, injunctive relief for false advertising pursuant to California Business and Professions Code, damages and injunctive relief pursuant the Sherman Antitrust Act, and various forms of declaratory relief.

The Company has asserted that contrary to ASUS's representations to the Federal Communications Commission (“FCC”), ASUS's wireless routers, including without limitation models RT-N65U and RT-AC66U, produce power outputs far in excess of those represented to the FCC, produce power outputs that exceed FCC maximum output levels, unlawfully cause interference with adjacent bandwidths (potentially including critically important navigation, communications, and safety devices), and operate in a manner that has never been accurately reported to the FCC. The Company contends that ASUS's representations that its RT-N65U and RT-AC66U wireless routers are FCC compliant are false, and are made with the intent to deceive potential consumers. The Company further contends that ASUS's misrepresentations regarding compliance of its wireless routers with the FCC regulations constitute unfair competition and false advertising, tortuously interfere with the Company's prospective business advantage, and have harmed the Company because the Company has lost expected sales due to such wrongful conduct and misrepresentations by ASUS. ASUS has not yet responded to the Company's complaint, and discovery in this case has not commenced.

Spansion LLC v. NETGEAR, Inc.

On August 1, 2013, Spansion LLC (“Spansion”) filed a section 337 complaint with the U.S. International Trade Commission (“ITC”) naming: the Company; Belkin International, Inc. (“Belkin”); ASUSTek Computer Inc. and Asus Computer International (collectively, “Asus”); D-Link Corporation and D-Link System, Inc. (collectively, “D-Link”); Nintendo Co., Ltd. and Nintendo of America, Inc. (collectively, “Nintendo”); and Macronix America, Inc., Macronix Asia Limited, and Macronix (Hong Kong) Co., Ltd. (collectively “Macronix”), as proposed respondents. The Complaint is styled Certain Flash Memory Chips and Products Containing the Same. Spansion is seeking a general exclusion order, or in the alternative a limited exclusion order, as well as a cease and desist order.

Spansion has asserted six patents related to the manufacture, structure, and operation of flash memory cells, as well as security protection systems for flash memory devices:

US Patent No. 6,369,416 “Semiconductor Device with Contacts Having a Sloped Profile
US Patent No. 6,459,625 “Three Metal Process for Optimizing Layout Density”
US Patent No. 6,731,536 “Password and Dynamic Protection of Flash Memory Data”
US Patent No. 6,900,124 “Patterning for Elliptical Vss Contact on Flash Memory
US Patent No. 7,018,922 “Patterning for Elongated Vss Contact on Flash Memory
US Patent No. 7,151,027 “Method and Device for Reducing Interface Area of a Memory Device”

Four of the asserted patents, the '416, '625, '124, and '922 patents, were previously asserted by Spansion in the 337-TA-735 Investigation against Samsung, Apple, Nokia, PNY, RIM, and Transcend. ITC records indicate the 735 Investigation terminated based on settlement agreements prior to the hearing on the merits.

The accused products are identified as flash memory chips manufactured and sold by Macronix, as well as downstream products which contain the accused Macronix flash memory chips. The Complaint specifically identifies the Company WNR1000 wireless router, as an exemplary accused product, but makes clear that Spansion intends to expand the scope of accused products to include additional products, if any, which contain the accused Macronix flash memory chips.

In addition, on August 1, 2013, Spansion filed a parallel similar complaint against the same parties in the Northern District of California.




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NETGEAR, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

IP Indemnification Claims

In its sales agreements, the Company typically agrees to indemnify its direct customers, distributors and resellers (the “Indemnified Parties”) for any expenses or liability resulting from claimed infringements by the Company's products of patents, trademarks or copyrights of third parties that are asserted against the Indemnified Parties, subject to customary carve outs. The terms of these indemnification agreements are generally perpetual after execution of the agreement. The maximum amount of potential future indemnification is generally unlimited. From time to time, the Company receives requests for indemnity and may choose to assume the defense of such litigation asserted against the Indemnified Parties.

Environmental Regulation

The European Union (“EU”) enacted the Waste Electrical and Electronic Equipment Directive, which makes producers of electrical goods, including home and commercial business networking products, financially responsible for specified collection, recycling, treatment and disposal of past and future covered products. The deadline for the individual member states of the EU to transpose the directive into law in their respective countries was August 13, 2004 (such legislation, together with the directive, the “WEEE Legislation”). Producers participating in the market were financially responsible for implementing these responsibilities under the WEEE Legislation beginning in August 13, 2005. The Company adopted the authoritative guidance for asset retirement and environmental obligations in the third quarter of fiscal 2005 and has determined that its effect did not have a material impact on the Company's consolidated results of operations and financial position for the three and six months ended June 30, 2013 and July 1, 2012. The WEEE Directive was recast on July 24, 2012, published on August 13, 2012, and will be implemented by all member states on February 14, 2014. The Company expects no material impact on its consolidated results of operations and financial positions due to this recasting. Similar WEEE Legislation has been or may be enacted in other jurisdictions, including in the United States, Canada, Mexico, China, India, Australia and Japan. The Company continues to monitor WEEE Legislation and similar legislation in other jurisdictions as individual countries issue their implementation guidance. The Company believes it has met the applicable requirements of current WEEE Legislation and similar legislation in other jurisdictions, to the extent implementation requirements has been published.

Additionally, the EU enacted the Restriction of Hazardous Substances Directive (“RoHS Legislation”), the REACH Regulation, Packaging Directive and the Battery Directive. EU RoHS Legislation, along with similar legislation in China, requires manufacturers to ensure certain substances, including polybrominated biphenyls (“PBD”), polybrominated diphenyl ethers (“PBDE”), mercury, cadmium, hexavalent chromium and lead (except for allowed exempted materials and applications), are below specified maximum concentration values in certain products put on the market after July 1, 2006. The RoHS Directive was recast on July 21, 2011 and went into force on January 3, 2013. The Company expects no material impact on its consolidated results of operations and financial positions due to this recasting. The REACH Regulation requires manufacturers to ensure the published lists of substances of very high concern in certain products are below specified maximum concentration values. The Battery Directive controls use of certain types of battery technology in certain products and requires mandatory marking. The Company believes it has met the requirements of the RoHS Directive Legislation, the REACH Regulation and the Battery Directive Legislation.

Additionally, the EU enacted the Energy Using Product (“EuP”) Directive, which came into force in August of 2007. The EuP Directive required manufacturers of certain products to meet minimum energy efficiency performance requirements. These requirements were documented in EuP implementing measures issued for specific product categories. The implementing measures affecting the Company's products are minimum power supply efficiencies and may include required equipment standby modes, which also reduce energy consumption. The EuP Directive was repealed in November of 2009 and replaced by the Energy Related Products ("ErP") Directive, which includes the same implementing measures of the former EuP Directive and new implementing measures applicable to the Company's products. The Company is in compliance with applicable implementing measures of the ErP Directives since it came into force.

10.
Stockholders' Equity

Common Stock Repurchase Program

On October 21, 2008, the Company’s Board of Directors authorized management to repurchase up to 6,000,000 shares of the Company’s outstanding common stock. Under this authorization, the timing and actual number of shares subject to repurchase are at the discretion of management and are contingent on a number of factors, such as levels of cash generation from operations, cash requirements for acquisitions and the price of the Company’s common stock. The Company did not repurchase any shares under this authorization during the three and six months ended June 30, 2013, and July 1, 2012.

30

NETGEAR, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

The Company repurchased approximately 13,000 shares, or $0.5 million of common stock under a repurchase program to help administratively facilitate the withholding and subsequent remittance of personal income and payroll taxes for individuals receiving RSUs during the six months ended June 30, 2013. Similarly, during the six months ended July 1, 2012, the Company repurchased approximately 22,000 shares, or $0.8 million of common stock, under the same program to help facilitate tax withholding for RSUs.
These shares were retired upon repurchase. The Company’s policy related to repurchases of its common stock is to charge the excess of cost over par value to retained earnings. All repurchases were made in compliance with Rule 10b-18 under the Securities Exchange Act of 1934, as amended.
Cumulative Other Comprehensive Income, Net

The following table sets forth the changes in accumulated other comprehensive income by component, net of tax, as of June 30, 2013 and December 31, 2012 (in thousands):

 
Gains and losses on available for sale securities
 
Gains and losses on derivatives
 
Total
Beginning balance as of December 31, 2012
$
28

 
$
(24
)
 
$
4

Other comprehensive income (loss) before reclassifications
(25
)
 
492

 
467

Amounts reclassified from accumulated other comprehensive income

 
(423
)
 
(423
)
Net current period other comprehensive income
(25
)
 
69

 
44

Ending balance as of June 30, 2013
$
3

 
$
45

 
$
48


The following tables provide details about significant amounts reclassified out of each component of accumulated other comprehensive income for the three and six months ended June 30, 2013, and July 1, 2012 (in thousands):

Details about Accumulated Other Comprehensive Income Components
 
Three Months Ended June 30, 2013
 
Six Months Ended June 30, 2013
 
Amount Reclassified from AOCI
 
Affected Line Item in the Statement of Operations
 
Amount Reclassified from AOCI
 
Affected Line Item in the Statement of Operations
Gains and losses on cash flow hedge:
 
 
 
 
 
 
 
 
Foreign currency forward contracts
 
$
445

 
Net revenue
 
$
520

 
Net revenue
Foreign currency forward contracts
 
(1
)
 
Cost of revenue
 
(3
)
 
Cost of revenue
Foreign currency forward contracts
 
(48
)
 
Operating expenses
 
(94
)
 
Operating expenses
 
 
396

 
Total before tax
 
423

 
Total before tax
 
 

 
Tax expense (1)
 

 
Tax expense (1)
 
 
$
396

 
Total, net of tax
 
$
423

 
Total, net of tax
(1)
Under our tax structure all hedging gains and losses from derivative contracts are ultimately borne by a legal entity in a jurisdiction with no income tax.

Details about Accumulated Other Comprehensive Income Components
 
Three Months Ended July 1, 2012
 
Six Months Ended July 1, 2012
 
Amount Reclassified from AOCI
 
Affected Line Item in the Statement of Operations
 
Amount Reclassified from AOCI
 
Affected Line Item in the Statement of Operations
Gains and losses on cash flow hedge:
 
 
 
 
 
 
 
 
Foreign currency forward contracts
 
$
682

 
Net revenue
 
$
684

 
Net revenue
Foreign currency forward contracts
 
(5
)
 
Cost of revenue
 
(7
)
 
Cost of revenue
Foreign currency forward contracts
 
(190
)
 
Operating expenses
 
(240
)
 
Operating expenses
 
 
487

 
Total before tax
 
437

 
Total before tax
 
 

 
Tax expense (1)
 

 
Tax expense (1)
 
 
$
487

 
Total, net of tax
 
$
437

 
Total, net of tax
(1)
Under our tax structure all hedging gains and losses from derivative contracts are ultimately borne by a legal entity in a jurisdiction with no income tax.

11.
Employee Benefit Plans

31

NETGEAR, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

The Company grants options and restricted stock units from the Amended and Restated 2006 Long-Term Incentive Plan, under which awards may be granted to all employees. Award vesting periods for this plan is generally four years. As of June 30, 2013, a total of 1,447,009 shares from 2006 plan were reserved for future grants under the plan. During the second quarter of 2013, the Company's 2003 Stock Plan expired and the remaining unissued 62,791 reserved shares were retired accordingly.
Additionally, the Company sponsors an Employee Stock Purchase Plan (the “ESPP”), pursuant to which eligible employees may contribute up to 10% of base compensation, subject to certain income limits, to purchase shares of the Company’s common stock. Employees may purchase stock semi-annually at a price equal to 85% of the fair market value on the purchase date. As of June 30, 2013, a total of 350,274 shares were reserved for future grants under the ESPP.
Option Activity
Stock options activity during the six months ended June 30, 2013, was as follows:
 
 
Options Outstanding
 
Number of shares
 
Weighted Average Exercise Price Per Share
 
(in thousands)
 
(in dollars)
December 31, 2012
4,324

 
$
29.29

Granted
469

 
33.48

Exercised
(168
)
 
21.12

Cancelled and expired
(122
)
 
33.70

June 30, 2013
4,503

 
$
29.92


RSU Activity

RSU activity during the six months ended June 30, 2013, was as follows:

 
RSUs Outstanding
 
Number of shares
 
Weighted Average Grant Date Fair Value Per Share
 
(in thousands)
 
(in dollars)
December 31, 2012
112

 
$
28.36

RSUs granted
569

 
28.91

RSUs vested
(82
)
 
26.69

RSUs cancelled
(3
)
 
28.59

June 30, 2013
596

 
$
29.11


Valuation and Expense Information
The fair value of each option award is estimated on the date of grant using a Black-Scholes-Merton option valuation model that uses the assumptions noted in the following table. The estimated expected term of options granted is derived from historical data on employee exercise and post-vesting employment termination behavior. The risk free interest rate is based on the implied yield currently available on U.S. Treasury securities with a remaining term commensurate with the estimated expected term. Expected volatility is based on historical volatility over the most recent period commensurate with the estimated expected term.

32

NETGEAR, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

The following table sets forth the weighted average assumptions used to fair value option grants during the three and six months ended June 30, 2013 and July 1, 2012:
 
 
Three Months Ended
 
Six Months Ended
 
June 30,
2013
 
July 1,
2012
 
June 30,
2013
 
July 1,
2012
Expected life (in years)
4.5

 
4.4

 
4.4

 
4.4

Risk-free interest rate
0.67
%
 
0.68
%
 
0.69
%
 
0.67
%
Expected volatility
47.3
%
 
52.1
%
 
48.2
%
 
52.1
%
Dividend yield

 

 

 


The following table sets forth the total stock-based compensation expense resulting from stock options, RSUs and the ESPP included in the Company’s unaudited condensed consolidated statements of operations (in thousands):
 
 
Three Months Ended
 
Six Months Ended
 
June 30,
2013
 
July 1,
2012
 
June 30,
2013
 
July 1,
2012
Cost of revenue
$
406

 
$
278

 
$
595

 
$
548

Research and development
1,135

 
677

 
1,807

 
1,288

Sales and marketing
1,310

 
1,191

 
2,540

 
2,385

General and administrative
1,540

 
1,249

 
3,039

 
2,566

Total stock-based compensation
$
4,391

 
$
3,395

 
$
7,981

 
$
6,787


As of June 30, 2013, $22.9 million of total unrecognized compensation cost related to stock options, adjusted for estimated forfeitures, is expected to be recognized over a weighted-average period of 2.61 years. Additionally, $13.1 million of total unrecognized compensation cost related to non-vested RSUs, adjusted for estimated forfeitures, is expected to be recognized over a weighted-average period of 3.47 years.

12.
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 (“CODM”) of an organization, in order to determine operating and resource allocation decisions. By this definition, the Company operates in three specific business units: retail, commercial, and service provider. The retail business unit consists of high performance, dependable and easy-to-use home networking, storage and digital media products to connect people with the Internet and their content and devices. The commercial business unit consists of business networking, storage and security solutions without the cost and complexity of Big IT. The service provider business unit consists of made-to-order and retail proven, whole home networking solutions sold to service providers for sale to their customers. Each business unit is managed by a Senior Vice President/General Manager. The Company believes this structure enables it to better focus its efforts on the Company’s core customer segments and allows it to be more nimble and opportunistic as a company overall.

In the second quarter of 2012, the CEO began temporarily serving as interim General Manager of the commercial business unit due to the previous general manager's departure from the Company. The CEO continued serving as interim general manager until a replacement was established in July 2013.

The results of the reportable segments are derived directly from the Company’s management reporting system. The results are based on the Company’s method of internal reporting and are not necessarily in conformity with accounting principles generally accepted in the United States. Management measures the performance of each segment based on several metrics, including contribution income. Segment contribution income includes all product line segment revenues less the related cost of sales, research and development and sales and marketing costs. Contribution income is used, in part, to evaluate the performance of, and allocate resources to, each of the segments. Certain operating expenses are not allocated to segments because they are separately managed at the corporate level. These unallocated indirect costs include corporate costs, such as corporate research and development, general and administrative costs, stock-based compensation expenses, amortization of intangibles, acquisition-related integration costs,

33

NETGEAR, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

restructuring costs, litigation reserves and interest and other income (expense), net. The Company does not evaluate operating segments using discrete asset information.

Financial information for each reportable segment and a reconciliation of segment contribution income to income before income taxes is as follows (in thousands, except percentage data):

 
Three Months Ended
 
Six Months Ended
 
June 30,
2013
 
July 1,
2012
 
June 30,
2013
 
July 1,
2012
Net revenues:
 
 
 
 
 
 
 
Retail
$
117,395

 
$
113,824

 
$
243,717

 
$
242,801

Commercial
88,446

 
80,626

 
159,297

 
155,258

Service provider
151,878

 
126,205

 
248,104

 
248,216

Total net revenues
357,719

 
320,655

 
651,118

 
646,275

Contribution income:
 
 
 
 
 
 
 
Retail
$
15,761

 
$
18,559

 
$
34,379

 
$
44,831

Retail contribution margin
13.4
%
 
16.3
%
 
14.1
%
 
18.5
%
Commercial
20,476

 
19,429

 
34,287

 
32,274

Commercial contribution margin
23.2
%
 
24.1
%
 
21.5
%
 
20.8
%
Service Provider
14,090

 
9,609

 
23,581

 
22,539

Service Provider contribution margin
9.3
%
 
7.6
%
 
9.5
%
 
9.1
%
Total segment contribution income
50,327