10-Q 1 ntgr20150927-10q.htm FORM 10-Q 10-Q
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 September 27, 2015.
¨ 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 31,509,309 as of October 23, 2015.

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)
 
 
September 27,
2015
 
December 31,
2014
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
202,429

 
$
141,234

Short-term investments
61,419

 
115,895

Accounts receivable, net
274,173

 
275,689

Inventories
170,013

 
222,883

Deferred income taxes
29,430

 
29,039

Prepaid expenses and other current assets
31,019

 
38,225

Total current assets
768,483

 
822,965

Property and equipment, net
23,951

 
29,694

Intangibles, net
53,191

 
66,230

Goodwill
81,721

 
81,721

Other non-current assets
47,405

 
48,077

Total assets
$
974,751

 
$
1,048,687

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
98,171

 
$
106,357

Accrued employee compensation
21,414

 
21,588

Other accrued liabilities
132,911

 
143,742

Deferred revenue
30,722

 
30,023

Income taxes payable
5,258

 
2,406

Total current liabilities
288,476

 
304,116

Non-current income taxes payable
14,402

 
15,252

Other non-current liabilities
10,412

 
7,754

Total liabilities
313,290

 
327,122

Commitments and contingencies (Note 7)


 


Stockholders’ equity:
 
 
 
Common stock
32

 
35

Additional paid-in capital
474,875

 
454,144

Accumulated other comprehensive income (loss)
(43
)
 
38

Retained earnings
186,597

 
267,348

Total stockholders’ equity
661,461

 
721,565

Total liabilities and stockholders’ equity
$
974,751

 
$
1,048,687

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
 
Nine Months Ended
 
September 27,
2015
 
September 28,
2014
 
September 27,
2015
 
September 28,
2014
Net revenue
$
341,893

 
$
353,338

 
$
939,832

 
$
1,040,333

Cost of revenue
245,566

 
251,005

 
677,569

 
742,889

Gross profit
96,327

 
102,333

 
262,263

 
297,444

Operating expenses:
 
 
 
 
 
 
 
Research and development
21,572

 
23,337

 
63,126

 
67,994

Sales and marketing
35,923

 
39,283

 
107,538

 
117,373

General and administrative
11,803

 
11,726

 
33,192

 
34,995

Restructuring and other charges
1,016

 
1,360

 
6,384

 
2,190

Litigation reserves, net

 
69

 
(2,690
)
 
254

Total operating expenses
70,314

 
75,775

 
207,550

 
222,806

Income from operations
26,013

 
26,558

 
54,713

 
74,638

Interest income
65

 
68

 
184

 
174

Other income (expense), net
(199
)
 
2,246

 
(67
)
 
1,911

Income before income taxes
25,879

 
28,872

 
54,830

 
76,723

Provision for income taxes
10,780

 
8,847

 
28,053

 
27,582

Net income
$
15,099

 
$
20,025

 
$
26,777

 
$
49,141

Net income per share:
 
 
 
 
 
 
 
Basic
$
0.47

 
$
0.56

 
$
0.80

 
$
1.36

Diluted
$
0.47

 
$
0.55

 
$
0.79

 
$
1.34

Weighted average shares used to compute net income per share:
 
 
 
 
 
 
 
Basic
31,979

 
35,643

 
33,473

 
36,133

Diluted
32,335

 
36,250

 
34,002

 
36,806

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
 
Nine Months Ended
 
September 27,
2015
 
September 28,
2014
 
September 27,
2015
 
September 28,
2014
Net income
$
15,099

 
$
20,025

 
$
26,777

 
$
49,141

Other comprehensive income (loss), before tax:
 
 
 
 
 
 
 
Unrealized gain (loss) on derivative instruments
10

 
139

 
(102
)
 
66

Unrealized gain on available-for-sale securities
6

 
2

 
34

 
25

Other comprehensive income (loss), before tax
16

 
141

 
(68
)
 
91

Tax expense related to items of other comprehensive income
(2
)
 
(1
)
 
(13
)
 
(10
)
Other comprehensive income (loss), net of tax
14

 
140

 
(81
)
 
81

Comprehensive income
$
15,113

 
$
20,165

 
$
26,696

 
$
49,222

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)
 
 
Nine Months Ended
 
September 27,
2015
 
September 28,
2014
Cash flows from operating activities:
 
 
 
Net income
$
26,777

 
$
49,141

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Depreciation and amortization
27,336

 
26,398

Purchase premium amortization/discount accretion on investments, net
(73
)
 
42

Non-cash stock-based compensation
12,517

 
15,226

Income tax impact associated with stock option exercises
(1,049
)
 
(394
)
Excess tax benefit from stock-based compensation
(252
)
 
(340
)
Deferred income taxes
(149
)
 
(2,133
)
Changes in assets and liabilities:
 
 
 
Accounts receivable
1,516

 
(12,084
)
Inventories
52,870

 
17,963

Prepaid expenses and other assets
7,332

 
(9,846
)
Accounts payable
(7,696
)
 
(22,439
)
Accrued employee compensation
(174
)
 
4,021

Other accrued liabilities
(4,405
)
 
(9,196
)
Deferred revenue
(899
)
 
9,221

Income taxes payable
2,002

 
1,974

Net cash provided by operating activities
115,653

 
67,554

Cash flows from investing activities:
 
 
 
Purchases of short-term investments
(50,301
)
 
(105,076
)
Proceeds from sales and maturities of short-term investments
105,142

 
109,669

Purchase of property and equipment
(11,142
)
 
(13,421
)
Payments made in connection with business acquisitions

 
(1,050
)
Net cash provided by (used in) investing activities
43,699

 
(9,878
)
Cash flows from financing activities:
 
 
 
Purchase and retirement of common stock
(107,531
)
 
(68,006
)
Proceeds from exercise of stock options
6,137

 
6,039

Proceeds from issuance of common stock under employee stock purchase plan
2,985

 
2,762

Excess tax benefit from stock-based compensation
252

 
340

Net cash used in financing activities
(98,157
)
 
(58,865
)
Net increase (decrease) in cash and cash equivalents
61,195

 
(1,189
)
Cash and cash equivalents, at beginning of period
141,234

 
143,009

Cash and cash equivalents, at end of period
$
202,429

 
$
141,820

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. The Company's products are built on a variety of proven technologies such as wireless (WiFi and LTE), Ethernet and powerline, with a focus on reliability and ease-of-use. The product line consists of wired and wireless devices that enable networking, broadband access and network connectivity. These products are available in multiple configurations to address the needs of the end-users in each geographic region in which the Company's products are sold.
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, 2014 has been derived from audited financial statements at such date. Accordingly, these condensed consolidated financial statements do not include all of the information and footnotes typically found in the audited consolidated financial statements and footnotes thereto included in the Annual Report on Form 10-K. 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, 2014.
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 net revenue and expenses during the reported period. Actual results could differ materially from those estimates and operating results for the three and nine months ended September 27, 2015 are not necessarily indicative of the results that may be expected for the year ending December 31, 2015 or any future period.

Note 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, 2014. The Company’s significant accounting policies have not materially changed during the nine months ended September 27, 2015.

Recent Accounting Pronouncements

In May 2014, the FASB issued ASU 2014-09, "Revenue from Contracts with Customer" (Topic 606). The guidance in this update supersedes the revenue recognition requirements in Topic 605, Revenue Recognition. Under the new guidance, an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The guidance also specifies the accounting for some costs to obtain or fulfill a contract with a customer. An entity should apply the amendments in the update either retrospectively to each prior reporting period presented or retrospectively with the cumulative effect of initially applying this update recognized at the date of initial application. On July 9, 2015, the FASB concluded to delay the effective date of the new revenue standard by one year. ASU 2014-09 is effective for the Company beginning in the first quarter fiscal 2018. Early adoption is permitted but may not occur earlier than January 1, 2017, the original effective date of the standard for the Company. The Company is in the process of evaluating the available transition methods and the impact of this standard on its financial position, results of operations or cash flows.

In July 2015, the FASB issued ASU 2015-11, "Simplifying the Measurement of Inventory" (Topic 330). Under the current guidance, inventory is measured at the lower of cost or market, with market value represented by replacement cost, net realizable value or net realizable value less a normal profit margin. Under the new guidance, inventory is required to be measured at the lower of cost or net realizable value. ASU 2015-11 should be applied on a prospective basis and is effective for the Company

7

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

beginning in the first fiscal quarter of 2017. Early adoption is permitted. The Company does not expect the adoption of this guidance to have a material impact on its financial position, results of operations or cash flows.


8

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

Note 3.
Balance Sheet Components

Available-for-sale short-term investments (in thousands)

 
As of
 
September 27, 2015
 
December 31, 2014
 
Cost
 
Unrealized Gain
 
Unrealized Loss
 
Estimated Fair Value
 
 Cost
 
Unrealized Gain
 
Unrealized Loss
 
Estimated Fair Value
U.S. treasuries
$
60,067

 
$
26

 
$

 
$
60,093

 
$
114,944

 
$
6

 
$
(15
)
 
$
114,935

Certificates of deposit
269

 

 

 
269

 
158

 

 

 
158

Total
$
60,336

 
$
26

 
$

 
$
60,362

 
$
115,102

 
$
6

 
$
(15
)
 
$
115,093


The Company’s short-term investments are primarily comprised of marketable securities that 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 available-for-sale securities have unrealized losses greater than 12 months.

Accounts receivable, net (in thousands)
 
As of
 
September 27,
2015
 
December 31,
2014
Gross accounts receivable
$
291,345

 
$
296,239

Allowance for doubtful accounts
(1,255
)
 
(1,255
)
Allowance for sales returns
(14,394
)
 
(17,489
)
Allowance for price protection
(1,523
)
 
(1,806
)
Total allowances
(17,172
)
 
(20,550
)
Total accounts receivable, net
$
274,173

 
$
275,689


Inventories (in thousands)
 
As of
 
September 27,
2015
 
December 31,
2014
Raw materials
$
2,382

 
$
3,625

Work in process
1


8

Finished goods
167,630

 
219,250

Total inventories
$
170,013

 
$
222,883


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.


9

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

Property and equipment, net (in thousands)
 
 
As of
 
September 27,
2015
 
December 31,
2014
Computer equipment
$
10,399

 
$
9,779

Furniture, fixtures and leasehold improvements
18,202

 
19,379

Software
30,140

 
29,294

Machinery and equipment
65,094

 
60,135

Total property and equipment, gross
123,835

 
118,587

Accumulated depreciation and amortization
(99,884
)
 
(88,893
)
Total property and equipment, net
$
23,951

 
$
29,694


Depreciation and amortization expense pertaining to property and equipment was $4.4 million and $13.8 million for the three and nine months ended September 27, 2015, respectively, and $4.6 million and $13.1 million for the three and nine months ended September 28, 2014, respectively.

Intangibles, net (in thousands)
 
Gross
 
Accumulated Amortization
 
Net
September 27, 2015
 
 
 
 
 
Technology
$
61,099

 
$
(46,275
)
 
$
14,824

Customer contracts and relationships
56,500

 
(21,519
)
 
34,981

Other
10,545

 
(7,159
)
 
3,386

Total intangibles, net
$
128,144

 
$
(74,953
)
 
$
53,191


 
Gross
 
Accumulated Amortization
 
Net
December 31, 2014
 
 
 
 
 
Technology
$
61,099

 
$
(39,341
)
 
$
21,758

Customer contracts and relationships
56,500

 
(16,205
)
 
40,295

Other
10,545

 
(6,368
)
 
4,177

Total intangibles, net
$
128,144

 
$
(61,914
)
 
$
66,230


Amortization of intangibles was $4.2 million and $13.0 million for the three and nine months ended September 27, 2015, respectively, and $4.5 million and $13.4 million for the three and nine months ended September 28, 2014, respectively.
.

10

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 (in thousands):
Year Ending December 31
Amount
2015 (remaining three months)
$
4,244

2016
16,921

2017
11,386

2018
7,871

2019
6,028

Thereafter
6,741

Total estimated amortization expense
$
53,191


Other non-current assets (in thousands)
 
As of
 
September 27,
2015
 
December 31, 2014
Non-current deferred income taxes
$
38,805

 
$
38,696

Cost method investment
1,322

 
1,322

Other
7,278

 
8,059

Total other non-current assets
$
47,405

 
$
48,077


Other accrued liabilities (in thousands)
 
As of
 
September 27,
2015
 
December 31,
2014
Sales and marketing programs
$
52,130

 
$
54,582

Warranty obligation
47,928

 
44,888

Freight
6,550

 
6,827

Other
26,303

 
37,445

Total other accrued liabilities
$
132,911

 
$
143,742

 
Note 4.
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, materiality, accounting considerations and the prohibitive economic cost of hedging particular exposures. There can be no

11

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

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 ("OCI") 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.

The fair values of the Company’s derivative instruments and the line items on the unaudited condensed consolidated balance sheets to which they were recorded as of September 27, 2015 and December 31, 2014 are summarized as follows (in thousands):
Derivative Assets
 
Balance Sheet
Location
 
Fair Value at
September 27, 2015
 
Balance Sheet
Location
 
Fair Value at
December 31, 2014
Derivative assets not designated as hedging instruments
 
Prepaid expenses and other current assets
 
$
505

 
Prepaid expenses and other current assets
 
$
2,416

Derivative assets designated as hedging
instruments
 
Prepaid expenses and other current assets
 
32

 
Prepaid expenses and other current assets
 

Total
 
 
 
$
537

 
 
 
$
2,416


 
Derivative Liabilities
 
Balance Sheet
Location
 
Fair Value at
September 27, 2015
 
Balance Sheet
Location
 
Fair Value at
December 31, 2014
Derivative liabilities not designated as hedging instruments
 
Other accrued liabilities
 
$
641

 
Other accrued liabilities
 
$
409

Derivative liabilities designated as hedging instruments
 
Other accrued liabilities
 
37

 
Other accrued liabilities
 
38

Total
 
 
 
$
678

 
 
 
$
447


For details of the Company’s fair value measurements, see Note 11, Fair Value Measurements.

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 unaudited condensed consolidated balance sheets.

The following tables set forth the offsetting of derivative assets as of September 27, 2015 and December 31, 2014 (in thousands):
As of September 27, 2015
 
 
 
 
 
 
 
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        
 
$
73

 
$

 
$
73

 
$
(73
)
 
$

 
$

Wells Fargo
 
464

 

 
464

 
(283
)
 

 
181

Total
 
$
537

 
$

 
$
537

 
$
(356
)
 
$

 
$
181



12

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

As of December 31, 2014
 
 
 
 
 
 
 
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        
 
$
319

 
$

 
$
319

 
$
(16
)
 
$

 
$
303

Wells Fargo
 
2,097

 

 
2,097

 
(431
)
 

 
1,666

Total
 
$
2,416

 
$

 
$
2,416

 
$
(447
)
 
$

 
$
1,969


The following tables set forth the offsetting of derivative liabilities as of September 27, 2015 and December 31, 2014 (in thousands):
As of September 27, 2015
 
 
 
 
 
 
 
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        
 
$
372

 
$

 
$
372

 
$
(73
)
 
$

 
$
299

JP Morgan Chase
 
23

 

 
23

 

 

 
23

Wells Fargo
 
283

 

 
283

 
(283
)
 

 

Total
 
$
678

 
$

 
$
678

 
$
(356
)
 
$

 
$
322


As of December 31, 2014
 
 
 
 
 
 
 
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        
 
$
16

 
$

 
$
16

 
$
(16
)
 
$

 
$

Wells Fargo
 
431

 

 
431

 
(431
)
 

 

Total
 
$
447

 
$

 
$
447

 
$
(447
)
 
$

 
$


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 approximately $7.0 million USD equivalent related to its cash flow hedging program.

The Company expects to reclassify to earnings all of the amounts recorded in OCI associated with its cash flow hedges over the next twelve 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 OCI 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

13

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

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 as there were no discontinued cash flow hedges during the three and nine months ended September 27, 2015 and September 28, 2014.

The effects of the Company’s derivative instruments on OCI and the unaudited condensed consolidated statement of operations for the three and nine months ended September 27, 2015 and September 28, 2014 are summarized as follows (in thousands):
Derivatives Designated as Hedging Instruments
 
Three Months Ended September 27, 2015
 
Gain (Loss)
Recognized in
OCI -
Effective
Portion (a)
 
Location of
Gain (Loss)
Reclassified from OCI
into Income - Effective
Portion
 
Gain (Loss)
Reclassified
from
OCI into
Income -
Effective
Portion (a)
 
Location of
Gain (Loss)
Recognized in
Income and
Excluded from
Effectiveness  Testing
 
Amount of Gain (Loss) Recognized in
Income and
Excluded from
Effectiveness Testing
Cash flow hedges:
 
 
 
 
 
 
 
 
 
 
Foreign currency forward contracts
 
$
(416
)
 
Net revenue
 
$
(552
)
 
Other income (expense), net
 
$
(9
)
Foreign currency forward contracts
 

 
Cost of revenue
 
3

 
Other income (expense), net
 

Foreign currency forward contracts
 

 
Operating expenses
 
123

 
Other income (expense), net
 

Total
 
$
(416
)
 
 
 
$
(426
)
 
 
 
$
(9
)
(a)
Refer to Note 8, Stockholders' Equity, which summarizes the accumulated other comprehensive income activity related to derivatives.

 
Derivatives Designated as Hedging Instruments
 
Nine Months Ended September 27, 2015
 
Gain (Loss)
Recognized in
OCI -
Effective
Portion (a)
 
Location of
Gain (Loss)
Reclassified from OCI
into Income - Effective
Portion
 
Gain (Loss)
Reclassified
from
OCI into
Income -
Effective
Portion (a)
 
Location of
Gain (Loss)
Recognized in
Income and
Excluded from
Effectiveness  Testing
 
Amount of Gain (Loss) Recognized in
Income and
Excluded from
Effectiveness Testing
Cash flow hedges:
 
 
 
 
 
 
 
 
 
 
Foreign currency forward contracts
 
$
(1,299
)
 
Net revenue
 
$
(1,474
)
 
Other income (expense), net
 
$
(43
)
Foreign currency forward contracts
 

 
Cost of revenue
 
7

 
Other income (expense), net
 

Foreign currency forward contracts
 

 
Operating expenses
 
270

 
Other income (expense), net
 

Total
 
$
(1,299
)
 
 
 
$
(1,197
)
 
 
 
$
(43
)
(a)
Refer to Note 8, Stockholders' Equity, which summarizes the accumulated other comprehensive income activity related to derivatives.


14

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

Derivatives Designated as Hedging Instruments
 
Three Months Ended September 28, 2014
 
Gain (Loss)
Recognized in
OCI -
Effective
Portion (a)
 
Location of
Gain (Loss)
Reclassified from OCI
into Income - Effective
Portion
 
Gain (Loss)
Reclassified
from
OCI into
Income -
Effective
Portion (a)
 
Location of
Gain (Loss)
Recognized in
Income and
Excluded from
Effectiveness Testing
 
Amount of Gain (Loss) Recognized in
Income and
Excluded from
Effectiveness Testing
Cash flow hedges:
 
 
 
 
 
 
 
 
 
 
Foreign currency forward contracts
 
$
401

 
Net revenue
 
$
320

 
Other income (expense), net
 
$
(41
)
Foreign currency forward contracts
 

 
Cost of revenue
 

 
Other income (expense), net
 

Foreign currency forward contracts
 

 
Operating expenses
 
(58
)
 
Other income (expense), net
 

Total
 
$
401

 
 
 
$
262

 
 
 
$
(41
)
(a)
Refer to Note 8, Stockholders' Equity, which summarizes the accumulated other comprehensive income activity related to derivatives.

Derivatives Designated as Hedging Instruments
 
Nine Months Ended September 28, 2014
 
Gain (Loss)
Recognized in
OCI -
Effective
Portion (a)
 
Location of
Gain (Loss)
Reclassified from OCI
into Income - Effective
Portion
 
Gain (Loss)
Reclassified
from
OCI into
Income -
Effective
Portion (a)
 
Location of
Gain (Loss)
Recognized in
Income and
Excluded from
Effectiveness Testing
 
Amount of Gain (Loss) Recognized in
Income and
Excluded from
Effectiveness Testing
Cash flow hedges:
 
 
 
 
 
 
 
 
 
 
Foreign currency forward contracts
 
$
(170
)
 
Net revenue
 
$
(221
)
 
Other income (expense), net
 
$
(107
)
Foreign currency forward contracts
 

 
Cost of revenue
 
8

 
Other income (expense), net
 

Foreign currency forward contracts
 

 
Operating expenses
 
(23
)
 
Other income (expense), net
 

Total
 
$
(170
)
 
 
 
$
(236
)
 
 
 
$
(107
)
(a)
Refer to Note 8, Stockholders' Equity, which summarizes the accumulated other comprehensive income activity related to derivatives.

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 15 non-designated derivatives per quarter. The average size of its non-designated hedges is approximately $2.0 million USD equivalent and these hedges range from one to five months in duration.

The effects of the Company’s non-designated hedged included in other income (expense), net in the unaudited condensed consolidated statements of operations for the three and nine months ended September 27, 2015 and September 28, 2014 are as follows (in thousands):

15

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

Derivatives Not Designated as Hedging Instruments
 
Location of Gains (Losses)
Recognized in Income on Derivative
 
Amount of Gains (Losses)
Recognized in Income
 
Three Months Ended
 
Nine Months Ended
 
September 27, 2015
 
September 28, 2014
 
September 27, 2015
 
September 28, 2014
Foreign currency forward contracts
 
Other income (expense), net
 
$
1,267

 
$
3,567

 
$
3,278

 
$
1,629


Note 5.
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 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 nine months ended September 27, 2015 and September 28, 2014 are as follows (in thousands, except per share data):
 
Three Months Ended
 
Nine Months Ended
 
September 27,
2015
 
September 28,
2014
 
September 27,
2015
 
September 28,
2014
Numerator:
 
 
 
 
 
 
 
Net income
$
15,099

 
$
20,025

 
$
26,777

 
$
49,141

 
 
 
 
 
 
 
 
Denominator:
 
 
 
 
 
 
 
Weighted average common shares - basic
31,979

 
35,643

 
33,473

 
36,133

Potentially dilutive common share equivalent
356

 
607

 
529

 
673

Weighted average common shares - dilutive
32,335

 
36,250

 
34,002

 
36,806

 
 
 
 
 
 
 
 
Basic net income per share
$
0.47

 
$
0.56

 
$
0.80

 
$
1.36

Diluted net income per share
$
0.47

 
$
0.55

 
$
0.79

 
$
1.34

 
 
 
 
 
 
 
 
Anti-dilutive employee stock-based awards, excluded
2,768

 
2,774

 
$
2,486

 
$
2,608


Note 6.
Income Taxes

The income tax provision for the three and nine months ended September 27, 2015 was $10.8 million, or an effective tax rate of 41.7%, and $28.1 million, or an effective tax rate of 51.2%, respectively. The income tax provision for the three and nine months ended September 28, 2014 was $8.8 million, or an effective tax rate of 30.6%, and $27.6 million, or an effective tax rate of 36.0%, respectively. During the three and nine months ended September 27, 2015 and September 28, 2014, the Company incurred losses in a jurisdiction where no tax benefit could be recorded. As a result, the forecasted losses from this jurisdiction were excluded from the determination of tax expense for the respective periods. The increase in the effective tax rate for the three and nine month period ended September 27, 2015 compared to the same period in the prior year was primarily caused by an increase in losses incurred in a jurisdiction where no tax benefit could be recorded as well as a shift in the distribution of earnings to jurisdictions with relatively higher tax rates.

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 twelve 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

16

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

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 twelve months is approximately $0.7 million, excluding the interest, penalties and the effect of any related deferred tax assets or liabilities.

Note 7.
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 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 September 27, 2015, the Company had approximately $158 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. From time to time the Company’s suppliers procure unique complex components on the Company's behalf. If these components do not meet specified technical criteria or are defective, the Company should not be obligated to purchase the materials. However, disputes may arise as a result and significant resources may be spent resolving such disputes.

Warranty Obligation
Changes in the Company’s warranty obligation, which is included in other accrued liabilities in the unaudited condensed consolidated balance sheets, are as follows (in thousands):
 
 
Three Months Ended
 
Nine Months Ended
 
September 27,
2015
 
September 28,
2014
 
September 27,
2015
 
September 28,
2014
Balance as of beginning of the period
$
40,967

 
$
41,934

 
$
44,888

 
$
48,754

Provision for warranty obligation made during the period
22,625

 
17,175

 
53,862

 
44,630

Settlements made during the period
(15,664
)
 
(16,357
)
 
(50,822
)
 
(50,632
)
Balance at end of period
$
47,928

 
$
42,752

 
$
47,928

 
$
42,752


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 each indemnification agreement is minimal. Accordingly, the Company has no liabilities recorded for these agreements as of September 27, 2015.

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 September 27, 2015.


17

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

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 equity awards. The Company has no liabilities recorded for these agreements as of September 27, 2015.

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, only if there is not a better estimate than any other amount within the range, as a component of legal expense within litigation reserves, net. 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 twelve 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.

Ericsson v. NETGEAR, Inc.

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 (the “'516 Patent”); 6,330,435 (the “'435 Patent”); 6,424,625 (the “'625 Patent”); 6,519,223 (the “'223 Patent”); 6,772,215 (the “'215 Patent”); 5,987,019 (the “'019 Patent”); 6,466,568 (the “'568 Patent”); 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 (claim construction) 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 became an official defendant in the Ericsson case. The parties thereafter completed fact discovery and exchanged 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 were all only asserted against 802.11-compliant products.

18

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


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 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).

The Company and other defendants submitted various post-trial motions and briefs to the Court for its consideration, including motions and briefs for judgment as 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. On August 6, 2013, the Court issued its orders on the various JMOL's (“Judgment as a Matter of Law”) and other post-trial motions. The Court denied all the defendants’ motions and set the reasonable and nondiscriminatory (RAND) royalty rate for the infringed patents equivalent to the jury verdict of 15 cents per unit.

After negotiations, Ericsson and the Company agreed to the following as collateral while the appeal of the verdict, Court’s rulings, and the RAND royalty rate are pending. Ericsson will forego collecting the $3,555,000 verdict plus various fees (Prejudgment interest of $224,141; Post-judgment interest of $336 per day; Costs of $41,667) assigned to the Company pending appeal, so long as a Company representative declares and provides Ericsson with adequate quarterly assurances that the judgment can still be paid. For the ongoing royalties of 15 cents per 802.11n or 802.11ac device sold by the company that the jury and Court awarded, the Company will place the ongoing royalty amount into the Court’s registry (escrow account) and will give Ericsson a corresponding royalty report until the Company’s appeals of the jury verdict, the Court’s orders, and the RAND royalty rate are exhausted.

On December 16, 2013, the defendants submitted their appeal brief to the Federal Circuit. Ericsson filed its response brief on February 20, 2014, and the defendants filed their reply brief before on March 24, 2014. The oral arguments before the Federal Circuit took place on June 5, 2014.

On December 4, 2014, the Federal Circuit issued its opinion and order in the Company’s Ericsson appeal. The Federal Circuit vacated the entirety of the $3.6 million jury verdict against the Company and the ongoing 15 cent per unit royalty verdict, and also vacated the entirety of the verdict against the other defendants and their ongoing royalties, finding that the District Court hadn’t properly instructed the jury on royalty rates and Ericsson’s licensing promises. The Federal Circuit held that the lower court had failed to adequately instruct the jury about Ericsson’s actual commitments to license the infringed patents on reasonable and nondiscriminatory (“RAND”) terms. Further, the Federal Circuit stated that the lower court had neglected to inform the jury that a royalty for a patented technology must be removed from the value of the entire standard, and that a RAND royalty rate should be based on the invention’s value, rather than any added value from standardization. The jury’s damages awards were therefore completely vacated, and the case was remanded for further proceedings. As of the end of the fourth quarter of 2014, based on the Federal Circuit’s opinion and order, the Company made adjustments to decrease the accrual related to this case.

While the Federal Circuit found the district court had inadequate jury instructions, it held that there was enough evidence for the jury to find infringement of two claims of U.S. Patent Number 6,466,568 and two claims of U.S. Patent Number 6,772,215, but reversed the lower court’s decision not to grant a noninfringement judgment as a matter of law regarding the third patent, U.S. Patent Number 6,424,625, finding that no reasonable jury could find that the '625 Patent was infringed by the defendants.

Neither Ericsson nor the defendants appealed the Federal Circuit’s decision, and the Federal Circuit issued its mandate and sent the case back to the U.S. District Court in the Eastern District of Texas for a new damages trial. No proceedings have yet taken place in the U.S. District Court in the Eastern District of Texas following the Federal Circuit’s mandate.


19

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

In September of 2013, Broadcom filed petitions in the USPTO at the Patent Trial and Appeal Board (PTAB) seeking inter partes review (“IPR”) of Ericsson’s three patents that the jury found were infringed by the Company and other defendants. On March 6, 2015, the PTAB invalidated all the claims of these three patents that were asserted against the Company and other defendants at trial -- claim 1 of the '625 Patent, claims 1 and 5 of the '568 Patent, and claims 1 and 2 of the '215 Patent -- ruling these claims were anticipated or obvious in light of prior art. The PTAB also rejected two motions to amend by Ericsson, which sought to substitute certain proposed claims in the '625 and '568 patents, should they be found unpatentable by the PTAB. This PTAB decision comes on top of the Federal Circuit decision (a) vacating the jury verdict after finding that the district court had not properly instructed the jury on royalty rates and Ericsson’s licensing promises, and (b) ruling that no reasonable jury could have found the ‘625 Patent infringed. Ericsson appealed the PTAB decision to the Federal Circuit and also requested that the PTAB reconsider its decision, but the PTAB denied Ericsson’s request for reconsideration. While Ericsson appeals the PTAB decision the present status of the case is that the Company does not infringe on any valid Ericsson patent, and accordingly the Company reversed the accruals related to this case in the first fiscal quarter of 2015.

Agenzia Entrate Provincial Revenue Office 1 of Milan v. NETGEAR International, Inc.

In November 2012, the Italian Tax Police began a comprehensive tax audit of NETGEAR International, Inc.’s Italian Branch. The scope of the audit initially was from 2004 through 2011 and was subsequently expanded to include 2012. The tax audit encompasses Corporate Income Tax (IRES), Regional Business Tax (IRAP) and Value-Added Tax (VAT). In December 2013, December 2014, and August 2015, an assessment was issued by Inland Revenue Agency, Provincial Head Office No. 1 of Milan-Auditing Department (Milan Tax Office) for the 2004 tax year, the 2005 through 2007 tax years, and the 2008 through 2010 tax years, respectively. All other years remain under audit. In May 2014, the Company filed with the Provincial Tax Court of Milan (Tax Court) a Request for Hearing in Open Court and Request for Suspension of the Tax Assessment for the 2004 year. The hearing was held and decision was issued on November 7, 2014. The Tax Court found in favor of the Company and nullified the assessment by the Inland Revenue Agency for 2004. The Inland Revenue Agency appealed the decision of the Tax Court on June 12, 2015. The Company filed its counter appeal with respect to the 2004 year during September 2015. With respect to 2005 through 2007, the Company filed its briefs with the Tax Court in mid-February. In June, 2015, the Company filed with the Provincial Tax Court of Milan (Tax Court) a Request for Hearing in Open Court and Request for Suspension of the Tax Assessment for the 2005 through 2007 tax years. The hearing was held and the Request for Suspension of payment was granted. With respect to 2008 through 2010, the Company filed its briefs with the Tax Court in October 2015. It is too early to reasonably estimate any financial impact to the Company resulting from this litigation matter.

Via Vadis v. NETGEAR, Inc.

On August 22, 2014, the Company was sued by Via Vadis, LLC and AC Technologies, S.A. (“Via Vadis”), in the Western District of Texas. The complaint alleges that the Company’s ReadyNAS and Stora products “with built-in BitTorrent software" allegedly infringe three related patents of Via Vadis (U.S. Patent Nos. 7,904,680, RE40,521, and 8,656,125). Via Vadis filed similar complaints against Belkin, Buffalo, Blizzard, D-Link, and Amazon.

By referring to “built-in BitTorrent software,” the Company believes that the complaint is referring to the BitTorrent Sync application, which was released by BitTorrent Inc. in spring of 2014. At a high-level, the application allows file synchronization across multiple devices by storing the underlying files on multiple local devices, rather than on a centralized server. The Company’s ReadyNAS products do not include BitTorrent software when sold. The BitTorrent application is provided as one of a multitude of potential download options, but the software itself is not included on the Company’s devices when shipped. Therefore, the only viable allegation at this point is an indirect infringement allegation.

On November 10, 2014, the Company answered the complaint denying that it infringes the patents in suit and also asserting the affirmative defenses that the patents in suit are invalid and barred by the equitable doctrines of laches, waiver, and/or estoppel.

On February 5, 2015, the Court set the claim construction hearing for December 4, 2015 and allowed discovery for claim construction purposes to commence. On February 6, 2015, the Company filed its motion to transfer venue from the Western District of Texas to the Northern District of California with the Court; on February 13, 2015, Via Vadis filed its opposition to the Company’s motion to transfer; and on February 20, 2015, the Company filed its reply brief on its motion to transfer. In early April 2015, the Company received the plaintiff’s infringement contentions, and on June 12, 2015, the defendants served invalidity contentions. Discovery in the case was stayed until the Court issues its claim construction order. On July 30, 2015 the Court granted the Company’s motion to transfer venue to the Northern District of California. In addition, the Company recently learned that Amazon and Blizzard filed petitions for the inter partes reviews (“IPRs”) for the patents in suit. On October 15, 2015, the Company and

20

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

Via Vadis came to an agreement in principle to petition the California Court to stay the case pending resolution of the IPR proceedings filed by Amazon and Blizzard. No Scheduling Order has been issued by the California Court.

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

Wetro Lan v. NETGEAR, Inc.

On January 30, 2015, the Company was sued by a non-practicing entity called Wetro Lan LLC (“Wetro Lan”) in United States District Court, Eastern District of Texas, Marshall Division. Wetro Lan alleges direct infringement by the Company of United States Patent No. 6,795,918 (the “'918 Patent”) entitled “Service Level Computer Security” based on the Company’s manufacture and selling of the “NETGEAR WGR614v9 Wireless Router and similarly situated NETGEAR, Inc. Wireless Routers.” On April 13, 2015 the Company answered the complaint. The Company denied that it infringed the patent and asserted several affirmative defenses (counterclaims), including noninfringement, invalidity, limitation of damages, laches, waiver, estoppel, and other equitable defenses, and on May 4, 2015 Wetro Lan answered the Company’s counterclaims.

On July 16, 2015, the Company filed with the Court a motion to transfer venue from the Eastern District of Texas to the Northern District of California. On August 17, 2015, Wetro Lan filed with the Court its opposition to the Company’s motion to transfer venue, and on August 24, 2015 the Company filed its Reply in Support of Transfer as filed. The Court has not yet ruled on the Company’s transfer motion. It is too early to reasonably estimate any financial impact to the Company resulting from this litigation matter.

Frequency Systems LLC v NETGEAR, Inc.

On May 8, 2015, the Company was sued by a non-practicing entity named Frequency Systems LLC (“Frequency Systems”) in the United States District Court, Eastern District of Texas. Frequency Systems alleges direct or indirect infringement by the Company of a single patent, U.S. Pat. No. 8,417,205 (the “'205 Patent”), entitled “Antenna selection scheme for multiple antennae.” Frequency Systems alleges infringement generically by the Company’s “wireless routers and access points product families” without specifying any models.

Frequency Systems also simultaneously sued ADTRAN, TCL Communications, Amped Wireless, ASUS, Belkin, Buffalo, Cisco, D-Link, EnGenius Technologies, Extreme Networks, HP, HTC, Huawei, ATEN Technology, IOGear, Kyocera, LG, Linksys, Motorola Mobility, Novatel Wireless, Sharp, TP-Link, TRENDnet, Western Digital, ZTE, and ZyXEL.

The Company answered the complaint on July 23, 2015 asserting various defenses, including noninfrigement and invalidity of the patent in suit.

Recently, it appears that Frequency Systems granted RPX Corporation a license. This is significant because the Company’s products that use WiFi chipsets of licensed companies (i.e. companies that are RPX members) likely will be licensed. The licensed RPX members include Broadcom and QualComm-Atheros.

On September 24, 2015, Frequency Systems served preliminary infringement contentions. Frequency Systems alleges that the Company infringes claims 1, 2 and 4 of the '205 Patent by the sale of products that are compliant with the 802.11n wireless standard, and identifies the following Company models as exemplars: R8000, R7500, R7000, R6400, R6300, R6250, AC1450, R6220, R6200, R6100, R6050, WNDR4700, WNDR4720, WNDR4500, WNDR4300, WNDR3700, WNDR3400, WNR2500, JNR3210, WNR2020, R7900, R6700, D7800, D7000, D6400, D6200, DGND4000, DGND3700, C7000, C6300, C3700, MBR1515, MBR1515A, MVBR1517, MVBR1210C, WNDAP660, EX7000, EX6200, EX6150, EX6100, X3920, EX3700, WN2500RP, WN3000RP, EX2700, A6210, LG2200D, LG6100D, WNDAP620, WND930, WNDAP360, WNDAP350, WN203, WN802T, and D2200D.

The Court held its initial scheduling conference on September 30, 2015. The Company’s invalidity contentions are due on November 25, 2015.

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




21

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

Verifire Network Solutions v NETGEAR, Inc.

On June 3, 2015, the Company was sued by a non-practicing entity named Verifire Network Solutions, LLC. (“Verifire”) in the United States District Court, Eastern District of Texas. Verifire alleges direct infringement by the Company of a single patent, US Patent No. 8,463,727 (the “'727 Patent”), entitled “Communication management system and communication management method,” and the complaint targets Netgear’s ProSAFE® business-class VPN Firewall and ProSECURE® UTM Firewall product families. Verifire recently has sued several other companies in the same Court on the same patent, including Fortinet, WatchGuard, Check Point, and Hewlett Packard.

The Company received an extension to answer the complaint and filed its Answer to the on August 26, 2015. On September 22, 2015, Verifire produced its preliminary infringement contentions. Verifire asserted that claims 1 and 3 of the '727 Patent cover all network security equipment, including firewalls such as the ProSAFE and ProSECURE lines manufactured by the Company.

Recently, many defendants settled, as RPX Corporation appears to have signed a settlement agreement with Verifire to settle out RPX members. The remaining defendants are: ADTRAN, Panda Distribution, Inc., and the Company. The Court held its initial scheduling conference on September 30, 2015. The Company’s invalidity contentions are due on November 25, 2015.

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

Chrimar Systems, Inc. v NETGEAR, Inc.

On July 1, 2015, the Company was sued by a non-practicing entity named Chrimar Systems, Inc., doing business as CMS Technologies and Chrimar Holding Company, LLC (collectively, “CMS”), in the Eastern District of Texas for allegedly infringing four patents-U.S. Patent Nos. 8,155,012 (the “'012 Patent”), entitled “System and method for adapting a piece of terminal equipment”; 8,942,107 (the “'107 Patent”), entitled “Piece of ethernet terminal equipment”; 8,902,760 (the “'760 Patent”), entitled “Network system and optional tethers”; and 9,019,838 (the “'838 Patent”), entitled “Central piece of network equipment” (collectively “patents-in-suit”). 

The patents-in-suit relate to using or embedding an electrical DC current or signal into an existing Ethernet communication link in order to transmit additional data about the devices on the communication link, and the specifications for the patents are identical. It appears that Chrimar has approximately 40 active cases in the Eastern District of Texas, as well as some cases in the Northern District of California on the patents-in-suit and the parent patent to the patents-in-suit.

The Company received an extension until September 15, 2015 to answer the complaint. The Company answered the complaint with a Motion to Dismiss Chrimar’s indirect infringement claims. Chrimar subsequently filed a response to the Company’s motion to dismiss and Chrimar’s First Amended Complaint. Chrimar responded to the Motion to Dismiss by dropping its induced infringement claims and providing supplemental allegations in support of its contributory infringement claims with respect to the '760 Patent. For the '012, '107 and '838 Patents, Chrimar now only alleges direct infringement. Chrimar originally asserted direct and indirect infringement for all four patents-in-suit.

Subsequently, on October 5, 2015, the Company filed a Motion to Dismiss the Direct Infringement Claims Relating to the '760 Patent. Chrimar filed its response to this motion to dismiss on October 15, 2015, and the Company filed its Reply on October 26, 2015.

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

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.


22

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

Environmental Regulation

The Company is required to comply and is currently in compliance with the European Union ("EU") and other Directives on the Restrictions of the use of Certain Hazardous Substances in Electrical and Electronic Equipment (“RoHS”), Waste Electrical and Electronic Equipment ("WEEE") requirements, Energy Using Product (“EuP”) requirements, the REACH Regulation, Packaging Directive and the Battery Directive.

The Company is subject to various federal, state, local, and foreign environmental laws and regulations, including those governing the use, discharge, and disposal of hazardous substances in the ordinary course of our manufacturing process. The Company believes that its current manufacturing and other operations comply in all material respects with applicable environmental laws and regulations; however, it is possible that future environmental legislation may be enacted or current environmental legislation may be interpreted to create an environmental liability with respect to its facilities, operations, or products. See further discussion of the business risks associated with environmental legislation under the risk titled, "We are subject to, and must remain in compliance with, numerous laws and governmental regulations concerning the manufacturing, use, distribution and sale of our products, as well as any such future laws and regulations. Some of our customers also require that we comply with their own unique requirements relating to these matters. Any failure to comply with such laws, regulations and requirements, and any associated unanticipated costs, may adversely affect our business, financial condition and results of operations." within Item 1A Risk Factors of this Form 10-Q.

Note 8.
Stockholders' Equity

Common Stock Repurchase Program

From time to time, the Company’s Board of Directors has authorized programs under which the Company may repurchase shares of its common stock, depending on market conditions, in the open market or through privately negotiated transactions. Under the authorizations, 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. Repurchases made by the Company pursuant to Board-authorized programs during the nine months ended September 27, 2015 and September 28, 2014 are discussed below. As of September 27, 2015, 2.6 million shares remained authorized for repurchase under the repurchase program approved by the Board on July 21, 2015. There were no remaining shares authorized under any previously approved programs.
The Company repurchased, reported based on trade date, 3.4 million shares of common stock at a cost of $105.2 million during the nine months ended September 27, 2015. The Company repurchased, reported based on trade date, 2.1 million shares of common stock at a cost of $68.6 million under the repurchase authorization during the nine months ended September 28, 2014.
The Company repurchased, as reported based on trade date, approximately 77,000 shares of common stock at a cost of $2.4 million under a repurchase program to help administratively facilitate the withholding and subsequent remittance of personal income and payroll taxes for individuals receiving restricted stock units ("RSUs") during the nine months ended September 27, 2015. Similarly, during the nine months ended September 28, 2014, the Company repurchased approximately 50,000 shares of common stock at a cost of $1.6 million under the same program to help facilitate tax withholding for RSUs.
These shares were retired upon repurchase. The purchase price for the shares of the Company’s stock repurchased is reflected as a reduction to stockholders’ equity. 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.

23

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

Accumulated Other Comprehensive Income, Net

The following table sets forth the changes in accumulated other comprehensive income ("AOCI") by component, net of tax, for the nine months ended September 27, 2015 (in thousands):

 
Gains and losses on available for sale securities
 
Gains and losses on derivatives
 
Total
Beginning balance as of December 31, 2014
$
(5
)
 
$
43

 
$
38

Other comprehensive income (loss) before reclassifications
21

 
(1,299
)
 
(1,278
)
Amounts reclassified from accumulated other comprehensive income

 
1,197

 
1,197

Net current period other comprehensive income (loss)
21

 
(102
)
 
(81
)
Ending balance as of September 27, 2015
$
16

 
$
(59
)
 
$
(43
)

The following tables provide details about significant amounts reclassified out of each component of AOCI for the three and nine months ended September 27, 2015 and September 28, 2014 (in thousands):
Details about Accumulated Other Comprehensive Income Components
 
Three Months Ended September 27, 2015
 
Nine Months Ended September 27, 2015
 
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
 
$
(552
)
 
Net revenue
 
$
(1,474
)
 
Net revenue
Foreign currency forward contracts
 
3

 
Cost of revenue
 
7

 
Cost of revenue
Foreign currency forward contracts
 
123

 
Operating expenses
 
270

 
Operating expenses
 
 
(426
)
 
Total before tax
 
(1,197
)
 
Total before tax
 
 

 
Tax expense (1)
 

 
Tax expense (1)
 
 
$
(426
)
 
Total, net of tax
 
$
(1,197
)
 
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 September 28, 2014
 
Nine Months Ended September 28, 2014
 
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
 
$
320

 
Net revenue
 
$
(221
)
 
Net revenue
Foreign currency forward contracts
 

 
Cost of revenue
 
8

 
Cost of revenue
Foreign currency forward contracts
 
(58
)
 
Operating expenses
 
(23
)
 
Operating expenses
 
 
262

 
Total before tax
 
(236
)
 
Total before tax
 
 

 
Tax expense (1)
 

 
Tax expense (1)
 
 
$
262

 
Total, net of tax
 
$
(236
)
 
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.

Note 9.
Employee Benefit Plans
The Company grants options and RSUs 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 September 27, 2015, approximately 1.5 million shares from this plan were reserved for future grants.
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 September 27, 2015, approximately 0.1 million shares were reserved under the ESPP.

24

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

Option Activity
Stock option activity during the nine months ended September 27, 2015 was as follows:
 
 
Number of shares
 
Weighted Average Exercise Price Per Share
 
(in thousands)
 
(in dollars)
Outstanding at December 31, 2014
3,939

 
$
30.58

Granted
296

 
31.34

Exercised
(262
)
 
23.44

Cancelled
(128
)
 
33.23

Expired
(246
)
 
34.82

Outstanding at September 27, 2015
3,599

 
$
30.78


RSU Activity

RSU activity during the nine months ended September 27, 2015 was as follows:
 
Number of shares
 
Weighted Average Grant Date Fair Value Per Share
 
(in thousands)
 
(in dollars)
Outstanding at December 31, 2014
858

 
$
30.68

RSUs granted
468

 
32.13

RSUs vested
(259
)
 
31.04

RSUs cancelled
(108
)
 
31.44

Outstanding at September 27, 2015
959

 
$
31.59


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.
The table below sets forth the weighted average assumptions used to estimate the fair value of option grants during the three and nine months ended September 27, 2015 and September 28, 2014.
 
 
Three Months Ended
 
Nine Months Ended
 
September 27,
2015
 
September 28,
2014
 
September 27,
2015
 
September 28,
2014
Expected life (in years)
N/A
 
N/A
 
4.5
 
4.5
Risk-free interest rate
N/A
 
N/A
 
1.44%
 
1.44%
Expected volatility
N/A
 
N/A
 
39.3%
 
42.6%
Dividend yield
N/A
 
N/A
 
 

25

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

The following table sets forth the 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
 
Nine Months Ended
 
September 27,
2015
 
September 28,
2014
 
September 27,
2015
 
September 28,
2014
Cost of revenue
$
358

 
$
573

 
$
1,190

 
$
1,533

Research and development
877

 
1,255

 
2,495

 
3,878

Sales and marketing
1,173

 
1,409

 
3,838

 
4,759

General and administrative
1,703

 
1,925

 
4,994

 
5,056

Total stock-based compensation
$
4,111

 
$
5,162

 
$
12,517

 
$
15,226


As of September 27, 2015, $7.9 million of unrecognized compensation cost related to stock options, adjusted for estimated forfeitures, is expected to be recognized over a weighted-average period of 2.53 years. Additionally, $21.0 million of unrecognized compensation cost related to unvested RSUs, adjusted for estimated forfeitures, is expected to be recognized over a weighted-average period of 2.66 years.

Note 10.
Segment Information and Operations by Geographic Area

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, home security automation and storage products. The commercial business unit consists of business networking, storage and security solutions that bring enterprise class functionality down to the small and medium-sized business at an affordable price. The service provider business unit consists of made-to-order and retail proven, whole home networking hardware and software solutions as well as 4G LTE hotspots sold to service providers for sale to their subscribers. 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.

The Company's CEO began temporarily serving as interim general manager of the retail business unit in March 2014 and as interim general manager of the service provider business unit in February 2015, due to the previous general managers' departures from the Company. As of September 27, 2015, the CEO continued to serve as interim general manager of both business units and will do so until replacements for the positions are appointed.

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, corporate marketing expense and general and administrative costs, amortization of intangibles, stock-based compensation expense, restructuring and other charges, acquisition-related expense, losses on inventory commitments due to restructuring, litigation reserves, net, and interest and other income (expense), net. The Company does not evaluate operating segments using discrete asset information.


26

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

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
 
Nine Months Ended
 
September 27,
2015
 
September 28,
2014
 
September 27,
2015
 
September 28,
2014
Net revenue:
 
 
 
 
 
 
 
Retail
$
164,081

 
$
131,341

 
$
416,847

 
$
360,236

Commercial
65,187

 
71,974

 
200,935

 
226,284

Service provider
112,625

 
150,023

 
322,050

 
453,813

Total net revenue
341,893

 
353,338

 
939,832

 
1,040,333

Contribution income:
 
 
 
 
 
 
 
Retail
$
21,149

 
$
21,813

 
$
53,715

 
$
51,222

Retail contribution margin
12.9
%
 
16.6
%
 
12.9
%
 
14.2
%
Commercial
13,700

 
15,112

 
42,507

 
51,781

Commercial contribution margin
21.0
%
 
21.0
%
 
21.2
%
 
22.9
%
Service Provider
14,819

 
14,164

 
27,472

 
42,918

Service Provider contribution margin
13.2
%
 
9.4
%
 
8.5
%
 
9.5
%
Total segment contribution income
49,668

 
51,089

 
123,694

 
145,921

Corporate and unallocated costs
(14,363
)
 
(13,544
)
 
(39,559
)
 
(40,428
)
Amortization of intangibles (1)
(4,165
)
 
(4,396
)
 
(12,804
)
 
(13,177
)
Stock-based compensation expense
(4,111
)
 
(5,162
)
 
(12,517
)
 
(15,226
)
Restructuring and other charges
(1,016
)
 
(1,360
)
 
(6,384
)
 
(2,190
)
Acquisition-related expense

 

 

 
(8
)
Losses on inventory commitments due to restructuring

 

 
(407
)
 

Litigation reserves, net

 
(69
)
 
2,690

 
(254
)
Interest income
65

 
68

 
184

 
174

Other income (expense), net
(199
)
 
2,246

 
(67
)
 
1,911

Income before income taxes
$
25,879

 
$
28,872

 
$
54,830

 
$
76,723

________________________________
(1)
Amount excludes amortization expense related to patents included in cost of revenue.

The Company conducts business across three geographic regions: Americas, Europe, Middle-East and Africa (“EMEA”) and Asia Pacific ("APAC"). Net revenue by geography comprises gross revenue less such items as end-user customer rebates and other sales incentives deemed to be a reduction of net revenue per the authoritative guidance for revenue recognition, sales returns and price protection. For reporting purposes revenue is attributed to each geographic region based on the location of the customer. The following table shows net revenue by geography for the periods indicated (in thousands):
 
 
Three Months Ended
 
Nine Months Ended
 
September 27,
2015
 
September 28,
2014
 
September 27,
2015
 
September 28,
2014
United States (U.S.)
$
213,913

 
$
188,569

 
$
552,787

 
$
561,067

Americas (excluding U.S.)
5,823

 
5,335

 
13,194

 
15,150

United Kingdom (U.K.)
27,850

 
38,933

 
80,965

 
122,707

EMEA (excluding U.K.)
49,875

 
69,488

 
153,862

 
192,943

APAC
$
44,432

 
$
51,013

 
$
139,024

 
$
148,466

Total net revenue
$
341,893

 
$
353,338

 
$
939,832

 
$
1,040,333



27

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

Property and equipment, net, by geographic location are as follows (in thousands):
 
As of
 
September 27,
2015
 
December 31,
2014
United States
$
10,200

 
$
12,453

Canada
3,982

 
4,375

EMEA
506

 
657

China
7,723

 
10,786

APAC (excluding China)
1,540

 
1,423

 
$
23,951

 
$
29,694


Note 11.
Fair Value Measurements (in thousands)
The following tables summarize assets and liabilities measured at fair value on a recurring basis as of September 27, 2015:
 
 
As of September 27, 2015
 
Total
 
Quoted market
prices in active
markets
(Level 1)
 
Significant
other
observable
inputs
(Level 2)
 
Significant
unobservable
inputs
(Level 3)
Cash equivalents—money-market funds
$
45,904

 
$
45,904

 
$

 
$

Available-for-sale securities—U.S. treasuries (1)
60,093

 
60,093

 

 

Available-for-sale securities—certificates of deposit (1)
269

 
269

 

 

Trading securities—mutual funds (1)
1,057

 
1,057

 

 

Foreign currency forward contracts (2)
537

 

 
537

 

Total assets measured at fair value
$
107,860

 
$
107,323

 
$
537

 
$

 
(1)
Included in short-term investments on the Company’s unaudited condensed consolidated balance sheet.
(2)
Included in prepaid expenses and other current assets on the Company’s unaudited condensed consolidated balance sheet.
 
As of September 27, 2015
 
Total    
 
Quoted market
prices in active
markets
(Level 1)
 
Significant
other
observable
inputs
(Level 2)
 
Significant
unobservable
inputs
(Level 3)
Foreign currency forward contracts (3)
$
678

 
$

 
$
678

 
$

Total liabilities measured at fair value
$
678

 
$

 
$
678

 
$

 
(3)
Included in other accrued liabilities on the Company’s unaudited condensed consolidated balance sheet.

28

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

The following tables summarize assets and liabilities measured at fair value on a recurring basis as of December 31, 2014:
 
 
As of December 31, 2014
 
Total
 
Quoted market
prices in active
markets
(Level 1)
 
Significant
other
observable
inputs
(Level 2)
 
Significant
unobservable
inputs
(Level 3)
Cash equivalents—money-market funds
$
4,408

 
$
4,408

 
$

 
$

Available-for-sale securities—U.S. treasuries (1)
114,935

 
114,935

 

 

Available-for-sale securities—certificates of deposit (1)
158

 
158

 

 

Trading securities—mutual funds (1)
802

 
802

 

 

Foreign currency forward contracts (2)
2,416

 

 
2,416

 

Total assets measured at fair value
$
122,719

 
$
120,303

 
$
2,416

 
$

 
(1)
Included in short-term investments on the Company’s unaudited condensed consolidated balance sheet.
(2)
Included in prepaid expenses and other current assets on the Company’s unaudited condensed consolidated balance sheet.

 
As of December 31, 2014
 
Total
 
Quoted market
prices in active
markets
(Level 1)
 
Significant
other
observable
inputs
(Level 2)
 
Significant
unobservable
inputs
(Level 3)
Foreign currency forward contracts (3)
$
447

 
$

 
$
447

 
$

Total liabilities measured at fair value
$
447