10-Q 1 ntgr20160403-10q.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 April 3, 2016.
¨ 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
 
¨
 
Accelerated filer
 
x
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 32,565,171 as of April 29, 2016.

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)
 
 
April 3,
2016
 
December 31,
2015
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
226,858

 
$
181,945

Short-term investments
106,446

 
96,321

Accounts receivable, net
218,421

 
290,642

Inventories
215,307

 
213,118

Prepaid expenses and other current assets
35,431

 
39,117

Total current assets
802,463

 
821,143

Property and equipment, net
20,687

 
22,384

Intangibles, net
44,703

 
48,947

Goodwill
81,721

 
81,721

Other non-current assets
75,677

 
76,374

Total assets
$
1,025,251

 
$
1,050,569

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
75,134

 
$
90,546

Accrued employee compensation
21,571

 
27,868

Other accrued liabilities
148,018

 
166,282

Deferred revenue
26,399

 
29,125

Income taxes payable
3,631

 
1,951

Total current liabilities
274,753

 
315,772

Non-current income taxes payable
14,694

 
14,444

Other non-current liabilities
11,439

 
11,643

Total liabilities
300,886

 
341,859

Commitments and contingencies (Note 7)


 


Stockholders’ equity:
 
 
 
Common stock
33

 
33

Additional paid-in capital
522,953

 
513,047

Accumulated other comprehensive income (loss)
(481
)
 
3

Retained earnings
201,860

 
195,627

Total stockholders’ equity
724,365

 
708,710

Total liabilities and stockholders’ equity
$
1,025,251

 
$
1,050,569

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
 
April 3,
2016
 
March 29,
2015
Net revenue
$
310,256

 
$
309,157

Cost of revenue
209,691

 
220,877

Gross profit
100,565

 
88,280

Operating expenses:
 
 
 
Research and development
22,137

 
20,452

Sales and marketing
37,277

 
37,602

General and administrative
12,849

 
11,023

Restructuring and other charges
2,678

 
4,394

Litigation reserves, net
10

 
(2,690
)
Total operating expenses
74,951

 
70,781

Income from operations
25,614

 
17,499

Interest income
234

 
52

Other income (expense), net
(366
)
 
475

Income before income taxes
25,482

 
18,026

Provision for income taxes
8,893

 
10,015

Net income
$
16,589

 
$
8,011

Net income per share:
 
 
 
Basic
$
0.51

 
$
0.23

Diluted
$
0.50

 
$
0.23

Weighted average shares used to compute net income per share:
 
 
 
Basic
32,519

 
34,678

Diluted
33,269

 
35,285

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
 
April 3,
2016
 
March 29,
2015
Net income
$
16,589

 
$
8,011

Other comprehensive loss, before tax:
 
 
 
Unrealized loss on derivative instruments
(547
)
 
(24
)
Unrealized gain on available-for-sale securities
101

 
10

Other comprehensive loss, before tax
(446
)
 
(14
)
Tax expense related to items of other comprehensive income
(38
)
 
(4
)
Other comprehensive loss, net of tax
(484
)
 
(18
)
Comprehensive income
$
16,105

 
$
7,993

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)
 
 
Three Months Ended
 
April 3,
2016
 
March 29,
2015
Cash flows from operating activities:
 
 
 
Net income
$
16,589

 
$
8,011

Adjustments to reconcile net income to net cash provided by (used in) operating activities:
 
 
 
Depreciation and amortization
8,508

 
9,215

Purchase premium amortization/discount accretion on investments, net
20

 
(30
)
Non-cash stock-based compensation
4,411

 
4,348

Income tax impact associated with stock option exercises
(24
)
 
(262
)
Excess tax benefit from stock-based compensation
(165
)
 
(88
)
Deferred income taxes
489

 
(386
)
Changes in assets and liabilities:
 
 
 
Accounts receivable
72,221

 
20,945

Inventories
(2,189
)
 
21,934

Prepaid expenses and other assets
3,784

 
120

Accounts payable
(16,101
)
 
(38,939
)
Accrued employee compensation
(6,297
)
 
(1,680
)
Other accrued liabilities
(18,591
)
 
(19,860
)
Deferred revenue
(2,726
)
 
(5,819
)
Income taxes payable
1,930

 
2,126

Net cash provided by (used in) operating activities
61,859

 
(365
)
Cash flows from investing activities:
 
 
 
Purchases of short-term investments
(30,148
)
 
(24,961
)
Proceeds from sales and maturities of short-term investments
20,143

 
40,000

Purchase of property and equipment
(2,056
)
 
(5,633
)
Net cash provided by (used in) investing activities
(12,061
)
 
9,406

Cash flows from financing activities:
 
 
 
Purchase and retirement of common stock
(10,356
)
 
(8,572
)
Proceeds from exercise of stock options
3,661

 
3,108

Proceeds from issuance of common stock under employee stock purchase plan
1,645

 
1,502

Excess tax benefit from stock-based compensation
165

 
88

Net cash used in financing activities
(4,885
)
 
(3,874
)
Net increase in cash and cash equivalents
44,913

 
5,167

Cash and cash equivalents, at beginning of period
181,945

 
141,234

Cash and cash equivalents, at end of period
$
226,858

 
$
146,401

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, 2015 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, 2015.
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 months ended April 3, 2016 are not necessarily indicative of the results that may be expected for the year ending December 31, 2016 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, 2015. The Company’s significant accounting policies have not materially changed during the three months ended April 3, 2016.

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). The new guidance changes the subsequent measurement of inventory from lower of cost or market to lower of cost and net realizable value. ASU 2015-11 should be applied on a prospective basis and is effective for the Company 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.

7

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


In November 2015, the FASB issued ASU 2015-17, "Balance Sheet Classification of Deferred Taxes" (Topic 740), which simplifies the presentation of deferred income taxes. This ASU requires that deferred tax assets and liabilities be classified as non-current in a statement of financial position. ASU 2015-17 may be adopted either prospectively or retrospectively and is effective for reporting periods beginning after December 15, 2016, with early adoption permitted. The Company elected early adoption ASU 2015-17 effective December 31, 2015 on a prospective basis. Adoption of this ASU resulted in a reclassification of the Company's net current deferred tax asset to the net non-current deferred tax asset in its Consolidated Balance Sheet as of December 31, 2015. No prior periods were retrospectively adjusted.

In January 2016, the FASB issued ASU 2016-01, “Recognition and Measurement of Financial Assets and Financial Liabilities (Subtopic 825-10). The changes to the current US GAAP financial instruments model primarily affect the accounting for equity investments, financial liabilities under the fair value option, and the presentation and disclosure requirements for financial instruments. The Company is currently evaluating what impact, if any, the adoption of this standard will have on its financial position, results of operations or cash flows.

In February 2016, FASB issued ASU No. 2016-02, "Leases" (Topic 842), which requires lessees to recognize on the balance sheet a right-of-use asset, representing its right to use the underlying asset for the lease term, and a corresponding lease liability for all leases with terms greater than twelve months. This ASU becomes effective for the Company in the first quarter fiscal 2019 and early adoption is permitted. This ASU is required to be applied with a modified retrospective approach and requires application of the new standard at the beginning of the earliest comparative period presented. The Company is currently evaluating what impact the adoption of this standard will have on its financial position, results of operations or cash flows.

In March 2016, the FASB issued ASU 2016-09, "Improvements to Employee Share-Based Payment Accounting" (Topic 718), which simplifies the accounting for share-based payment transactions, including the income tax consequences, forfeitures, and statutory tax withholding requirements, as well as classification on the statement of cash flows. ASU 2016-09 is effective for the Company beginning in the first quarter fiscal 2017, with early adoption permitted (an entity that elects early adoption must adopt all of the amendments in the same period). The Company is currently evaluating what impact the adoption of this standard will have 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
 
April 3, 2016
 
December 31, 2015
 
Cost
 
Unrealized Gain
 
Unrealized Loss
 
Estimated Fair Value
 
 Cost
 
Unrealized Gain
 
Unrealized Loss
 
Estimated Fair Value
U.S. treasuries
$
105,033

 
$
39

 
$
(2
)
 
$
105,070

 
$
95,057

 
$
1

 
$
(65
)
 
$
94,993

Certificates of deposit
155

 

 

 
155

 
147

 

 

 
147

Total
$
105,188

 
$
39

 
$
(2
)
 
$
105,225

 
$
95,204

 
$
1

 
$
(65
)
 
$
95,140


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
 
April 3,
2016
 
December 31,
2015
Gross accounts receivable
$
237,022

 
$
309,926

Allowance for doubtful accounts
(1,255
)
 
(1,255
)
Allowance for sales returns
(15,578
)
 
(15,904
)
Allowance for price protection
(1,768
)
 
(2,125
)
Total allowances
(18,601
)
 
(19,284
)
Total accounts receivable, net
$
218,421

 
$
290,642


Inventories (in thousands)
 
As of
 
April 3,
2016
 
December 31,
2015
Raw materials
$
6,155

 
$
4,292

Work in process
1


2

Finished goods
209,151

 
208,824

Total inventories
$
215,307

 
$
213,118


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
 
April 3,
2016
 
December 31,
2015
Computer equipment
$
11,502

 
$
11,161

Furniture, fixtures and leasehold improvements
18,427

 
18,317

Software
30,957

 
30,396

Machinery and equipment
67,560

 
66,662

Total property and equipment, gross
128,446

 
126,536

Accumulated depreciation and amortization
(107,759
)
 
(104,152
)
Total property and equipment, net
$
20,687

 
$
22,384


Depreciation and amortization expense pertaining to property and equipment was $3.9 million and $4.8 million for the three months ended April 3, 2016, and March 29, 2015, respectively.

Intangibles, net (in thousands)
 
Gross
 
Accumulated Amortization
 
Net
April 3, 2016
 
 
 
 
 
Technology
$
61,099

 
$
(50,694
)
 
$
10,405

Customer contracts and relationships
56,500

 
(25,061
)
 
31,439

Other
10,545

 
(7,686
)
 
2,859

Total intangibles, net
$
128,144

 
$
(83,441
)
 
$
44,703


 
Gross
 
Accumulated Amortization
 
Net
December 31, 2015
 
 
 
 
 
Technology
$
61,099

 
$
(48,485
)
 
$
12,614

Customer contracts and relationships
56,500

 
(23,290
)
 
33,210

Other
10,545

 
(7,422
)
 
3,123

Total intangibles, net
$
128,144

 
$
(79,197
)
 
$
48,947


Amortization of intangibles was $4.2 million and $4.5 million for the three months ended April 3, 2016 and March 29, 2015, respectively.

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
2016 (remaining nine months)
$
12,677

2017
11,386

2018
7,871

2019
6,028

2020
5,316

Thereafter
1,425

Total estimated amortization expense
$
44,703



10

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

Other non-current assets (in thousands)
 
As of
 
April 3,
2016
 
December 31, 2015
Non-current deferred income taxes
$
67,955

 
$
68,445

Cost method investment
105

 
105

Other
7,617

 
7,824

Total other non-current assets
$
75,677

 
$
76,374


Other accrued liabilities (in thousands)
 
As of
 
April 3,
2016
 
December 31,
2015
Sales and marketing programs
$
62,802

 
$
69,693

Warranty obligation
49,908

 
56,706

Freight
6,882

 
5,748

Other
28,426

 
34,135

Total other accrued liabilities
$
148,018

 
$
166,282

 
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, Canadian dollars, 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 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.


11

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 sheets to which they were recorded as of April 3, 2016 and December 31, 2015 are summarized as follows (in thousands):
Derivative Assets
 
Balance Sheet
Location
 
Fair Value at
April 3, 2016
 
Balance Sheet
Location
 
Fair Value at
December 31, 2015
Derivative assets not designated as hedging instruments
 
Prepaid expenses and other current assets
 
$
463

 
Prepaid expenses and other current assets
 
$
3,203

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

 
Prepaid expenses and other current assets
 
2

Total
 
 
 
$
463

 
 
 
$
3,205


 
Derivative Liabilities
 
Balance Sheet
Location
 
Fair Value at
April 3, 2016
 
Balance Sheet
Location
 
Fair Value at
December 31, 2015
Derivative liabilities not designated as hedging instruments
 
Other accrued liabilities
 
$
3,106

 
Other accrued liabilities
 
$
447

Derivative liabilities designated as hedging instruments
 
Other accrued liabilities
 
443

 
Other accrued liabilities
 
4

Total
 
 
 
$
3,549

 
 
 
$
451


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 April 3, 2016 and December 31, 2015 (in thousands):
As of April 3, 2016
 
 
 
 
 
 
 
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
Wells Fargo
 
$
463

 
$

 
$
463

 
$
(463
)
 
$

 
$

Total
 
$
463

 
$

 
$
463

 
$
(463
)
 
$

 
$


As of December 31, 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        
 
$
577

 
$

 
$
577

 
$
(56
)
 
$

 
$
521

Wells Fargo
 
2,628

 

 
2,628

 
(395
)
 

 
2,233

Total
 
$
3,205

 
$

 
$
3,205

 
$
(451
)
 
$

 
$
2,754



12

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

The following tables set forth the offsetting of derivative liabilities as of April 3, 2016 and December 31, 2015 (in thousands):
As of April 3, 2016
 
 
 
 
 
 
 
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
JP Morgan Chase
 
$
28

 
$

 
$
28

 
$

 
$

 
$
28

Wells Fargo
 
3,521

 

 
3,521

 
(463
)
 

 
3,058

Total
 
$
3,549

 
$

 
$
3,549

 
$
(463
)
 
$

 
$
3,086


As of December 31, 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        
 
$
56

 
$

 
$
56

 
$
(56
)
 
$

 
$

Wells Fargo
 
395

 

 
395

 
(395
)
 

 

Total
 
$
451

 
$

 
$
451

 
$
(451
)
 
$

 
$


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 six 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 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 months ended April 3, 2016 and March 29, 2015.


13

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 months ended April 3, 2016 and March 29, 2015 are summarized as follows (in thousands):
Derivatives Designated as Hedging Instruments
 
Three Months Ended April 3, 2016
 
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
 
$
(787
)
 
Net revenue
 
$
(312
)
 
Other income (expense), net
 
$
35

Foreign currency forward contracts
 

 
Cost of revenue
 
2

 
Other income (expense), net
 

Foreign currency forward contracts
 

 
Operating expenses
 
70

 
Other income (expense), net
 

Total
 
$
(787
)
 
 
 
$
(240
)
 
 
 
$
35

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

 
Derivatives Designated as Hedging Instruments
 
Three Months Ended March 29, 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
 
$
(195
)
 
Net revenue
 
$
(147
)
 
Other income (expense), net
 
$
(19
)
Foreign currency forward contracts
 

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

Foreign currency forward contracts
 

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

Total
 
$
(195
)
 
 
 
$
(171
)
 
 
 
$
(19
)
(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.


14

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

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 months ended April 3, 2016 and March 29, 2015 are as follows (in thousands):
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
 
April 3, 2016
 
March 29, 2015
Foreign currency forward contracts
 
Other income (expense), net
 
$
(1,944
)
 
$
3,843


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 months ended April 3, 2016 and March 29, 2015 are as follows (in thousands, except per share data):
 
Three Months Ended
 
April 3,
2016
 
March 29,
2015
Numerator:
 
 
 
Net income
$
16,589

 
$
8,011

 
 
 
 
Denominator:
 
 
 
Weighted average common shares - basic
32,519

 
34,678

Potentially dilutive common share equivalent
750

 
607

Weighted average common shares - dilutive
33,269

 
35,285

 
 
 
 
Basic net income per share
$
0.51

 
$
0.23

Diluted net income per share
$
0.50

 
$
0.23

 
 
 
 
Anti-dilutive employee stock-based awards, excluded
486

 
2,368


Note 6.
Income Taxes

The income tax provision was $8.9 million, or an effective tax rate of 34.9%, and $10.0 million, or an effective tax rate of 55.6% for the three months ended April 3, 2016 and March 29, 2015 respectively. The effective tax rate for the three months ended April 3, 2016 compared to the three months ended March 29, 2015 decreased primarily due to changes in earnings incurred in a jurisdiction where a loss was not tax benefited for the three months ended March 29, 2015. For the three months ended March 29, 2015, the forecasted loss from this jurisdiction was excluded from the determination of tax expense. For the three months ended April 3, 2016, the Company did not exclude any jurisdictions from the determination of tax expense. The Company is subject to income taxes in the U.S. and numerous foreign jurisdictions. The future foreign tax rate could be affected by changes in the composition in earnings in countries with tax rates differing from the U.S. federal rate. The Company is under examination in various U.S. and foreign jurisdictions.
 
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

15

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

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 twelve months is approximately $0.6 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 April 3, 2016, the Company had approximately $128 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
 
April 3,
2016
 
March 29,
2015
Balance as of beginning of the period
$
56,706

 
$
44,888

Provision for warranty obligation made during the period
16,216

 
16,255

Settlements made during the period
(23,014
)
 
(18,266
)
Balance at end of period
$
49,908

 
$
42,877


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 April 3, 2016.

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 April 3, 2016.

16

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 April 3, 2016.

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 alleged 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 June 8, 2011, Ericsson filed an amended complaint that added Dell, Toshiba and Belkin as defendants. At the status conference held on June 9, 2011, the Court set a Markman (claim construction) hearing for June 28, 2012 and trial for June 3, 2013. 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. 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.

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 equated to 15 cents per unit for each accused 802.11 device sold by each defendant (5 cent per patent).

17

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


On December 16, 2013, the Company and 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.

In 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.

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.

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, August 2015, and December 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, the 2008 through 2010 tax years, and the 2011 through 2012 tax years, respectively.

In May 2014, the Company filed with the Provincial Tax Court of Milan an appeal brief, including 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 December 19, 2014. The Tax Court decided 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. On February 26, 2016 the Regional Tax Court conducted the appeals hearing for the 2004 year, ruling in favor of the Company. The Inland Revenue Agency has until June 8, 2016 to appeal the decision to the Supreme Court.

In June, 2015, the Company filed with the Provincial Tax Court of Milan an appeal brief including a Request for Hearing in Open Court and Request for Suspension of the Tax Assessment for the 2005 through 2007 tax years. The hearing for suspension was held and the Request for Suspension of payment was granted. The hearing for the validity of the tax assessment for 2005 and 2006 was held in December 2015 with the Provincial Tax Court issuing its decision in favor of the Company. The Inland Revenue Agency has until July 12, 2016 to file its appeal with the Regional Tax Court.


18

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

The hearing for the validity of the tax assessment for 2007 was held on March 10, 2016 with the Provincial Tax Court who issued its decision in favor of the Company on April 7, 2016. The Inland Revenue Agency has until November 7, 2016 to file for an appeal to the Regional Tax Court with regard to the 2007 tax year.

With respect to 2008 through 2010, the Company filed its briefs with the Tax Court in October 2015 and the hearing for the validity of the tax assessments was held on April 21, 2016. The decision has not yet been issued.

With respect to 2011 through 2012, the Company has filed its appeal brief on February 26, 2016 the Provincial Tax Court to contest this assessment.

With regard to all tax years, 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 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. On July 30, 2015 the Court granted the Company’s motion to transfer venue to the Northern District of California. In addition, the Company learned that Amazon and Blizzard filed petitions for the inter partes reviews (“IPRs”) for the patents in suit. On October 30, 2015, the Company and Via Vadis filed a joint stipulation requesting that the Court vacate all deadlines and enter a stay of all proceedings in the case pending the Patent Trial and Appeal Board’s final non-appealable decision on the IPRs initiated by Amazon and Blizzard. On November 2, 2015 the Court granted the requested stay. On March 8, 2016, the Patent Trial and Appeal Board issued written decisions instituting the IPRs jointly filed by Amazon and Blizzard.

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. In November 2015, Wetro Lan filed a notice requesting a scheduling conference from which deadlines in the case arise. On January 29, 2016, the Court issued

19

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

an order consolidating twenty Wetro Lan cases, including the case against the Company for all pretrial issues, except for venue. In the lead case, Wetro Lan v. ADTRAN (No. 2:15-cv-00041), the Court has not yet issued any docket control order or set any scheduling conference. The Court also has not yet ruled on the Company’s transfer motion.

Without admitting any wrongdoing or violation of law and to avoid the distraction and expense of continued litigation and the uncertainty of a jury verdict on the merits, on April 19, 2016, the Company and Wetro Lan settled the lawsuit for a one-time payment from the Company to Wetro Lan in return for a perpetual and worldwide covenant not to sue and release from Wetro Lan to the Company on the ‘918 patent and any of its related patents and foreign counterparts. The Court dismissed the case with prejudice on April 20, 2016. The settlement did not have a material financial impact to the Company.

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 CMS 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 answered the complaint on September 15, 2015. On November 24, 2015, CMS served its infringement contentions on the Company, and CMS is generally attempting to assert that the patents in suit cover the Power over Ethernet standard (802.3af and 802.3at) used by certain of NETGEAR’s products.

On December 3, 2015, the Company filed with the Court a motion to transfer venue to the District Court for the Northern District of California and their memorandum of law in support thereof. On December 23, 2015, CMS filed its response to the Company’s motion to transfer, and, on January 8, 2016, the Company filed its reply brief in support of its motion to transfer venue. On January 15, 2016, the Court granted the Company’s motion to transfer venue to the District Court for the Northern District of California. The initial case management conference in the Northern District of California has been scheduled for May 13, 2016.

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

Wi3, INC. v. NETGEAR, Inc.

On November 12, 2015, a lawsuit was filed against the Company by a company called Wi3, INC. (“Wi3”) in the United States District Court, Western District of New York. The patent No. 6,108,331 (the “'331 Patent”) is entitled “Single Medium Wiring Scheme for Multiple Signal Distribution in Building and Access Port Therefor,” and was filed in 1998, and should expire in July 2018. The complaint alleges direct and indirect infringement, and accuses NETGEAR’s MoCA Network Adapters and/or Network Extenders (including at least model MCA1001 v2) of infringing at least claims 26, 27, 29, and 30. The complaint alleges no pre-suit knowledge of the patent, but seeks enhanced damages. The patent has been asserted in three prior cases, and all three cases were resolved in the early stages.

The Company filed its answer to the Wi3 complaint on March 11, 2016. In the answer, the Company denied the infringement allegations and put forth several counterclaims. Subsequent to the Company’s answer, the parties participated in some motion practice resulting in an amended answer and counterclaims being filed by the Company on April 1, 2016. Wi3 answered the Company’s amended answer and counterclaims on April 13, 2016. No scheduling conference has been set by the Court, and discovery has not commenced.

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


20

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 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 three months ended April 3, 2016 and March 29, 2015 are discussed below. As of April 3, 2016, 1.9 million shares remained authorized for repurchase under the repurchase program approved by the Board in July 2015. There were no remaining shares authorized under any previously approved programs.
The Company repurchased, reported based on trade date, 0.3 million shares of common stock at a cost of $10.0 million during the three months ended April 3, 2016. The Company repurchased, reported based on trade date, 0.3 million shares of common stock at a cost of $8.3 million under the repurchase authorization during the three months ended March 29, 2015.
The Company repurchased, as reported based on trade date, approximately 9,000 shares of common stock at a cost of $0.4 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 three months ended April 3, 2016. Similarly, during the three months ended March 29, 2015, the Company repurchased approximately 7,000 shares of common stock at a cost of $0.2 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.

21

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 three months ended April 3, 2016 (in thousands):

 
Gains and losses on available-for-sale securities
 
Gains and losses on derivatives
 
Total
Beginning balance as of December 31, 2015
$
(40
)
 
$
43

 
$
3

Other comprehensive income (loss) before reclassifications
63

 
(787
)
 
(724
)
Amounts reclassified from accumulated other comprehensive income

 
240

 
240

Net current period other comprehensive income (loss)
63

 
(547
)
 
(484
)
Ending balance as of April 3, 2016
$
23

 
$
(504
)
 
$
(481
)

The following tables provide details about significant amounts reclassified out of each component of AOCI for the three months ended April 3, 2016 and March 29, 2015 (in thousands):
Details about Accumulated Other Comprehensive Income Components
 
Three Months Ended April 3, 2016
 
Three Months Ended March 29, 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
 
$
(312
)
 
Net revenue
 
$
(147
)
 
Net revenue
Foreign currency forward contracts
 
2

 
Cost of revenue
 
(1
)
 
Cost of revenue
Foreign currency forward contracts
 
70

 
Operating expenses
 
(23
)
 
Operating expenses
 
 
(240
)
 
Total before tax
 
(171
)
 
Total before tax
 
 

 
Tax expense (1)
 

 
Tax expense (1)
 
 
$
(240
)
 
Total, net of tax
 
$
(171
)
 
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 April 3, 2016, approximately 0.7 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. Prior to February 16, 2016, employees could purchase stock semi-annually at a price equal to 85% of the fair market value on the purchase date. As the price of the shares was determined at the purchase date, the Company recognized expense based on the 15% discount at purchase. Beginning February 16, 2016, the terms of the plan include a look-back feature that enables employees to purchase stock semi-annually at a price equal to 85% of the lesser of the fair market value at the beginning of the offering period or the purchase date. The duration of each offering period is generally six-months. The fair value of the shares offered under the ESPP is estimated at grant using a Black-Scholes option valuation model. As of April 3, 2016, approximately 47,000 shares were reserved under the ESPP.

22

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

Option Activity
Stock option activity during the three months ended April 3, 2016 was as follows:
 
 
Number of shares
 
Weighted Average Exercise Price Per Share
 
(in thousands)
 
(in dollars)
Outstanding at December 31, 2015
2,461

 
$
30.08

Granted
328

 
39.53

Exercised
(128
)
 
28.54

Cancelled
(12
)
 
33.75

Expired
(1
)
 
33.79

Outstanding at April 3, 2016
2,648

 
$
31.31


RSU Activity

RSU activity during the three months ended April 3, 2016 was as follows:
 
Number of shares
 
Weighted Average Grant Date Fair Value Per Share
 
(in thousands)
 
(in dollars)
Outstanding at December 31, 2015
964

 
$
31.63

RSUs granted
362

 
39.23

RSUs vested
(25
)
 
30.77

RSUs cancelled
(50
)
 
30.19

Outstanding at April 3, 2016
1,251

 
$
33.91


Valuation and Expense Information
The fair value of each option award and share granted under the ESPP commencing February 16, 2016 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 for options and ESPP shares 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 for options and ESPP shares 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 and purchase rights granted under the ESPP commencing February 16, 2016 during the three months ended April 3, 2016 and March 29, 2015.
 
 
ESPP
 
Stock Options
 
Three Months Ended
 
Three Months Ended
 
April 3,
2016
 
March 29,
2015
 
April 3,
2016
 
March 29,
2015
Expected life (in years)
0.5
 
N/A
 
4.4
 
4.4
Risk-free interest rate
0.42%
 
N/A
 
1.28%
 
1.06%
Expected volatility
44.7%
 
N/A
 
35.4%
 
39.9%
Dividend yield
 
N/A
 
 

23

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
 
April 3,
2016
 
March 29,
2015
Cost of revenue
$
439

 
$
496

Research and development
866

 
845

Sales and marketing
1,197

 
1,393

General and administrative
1,909

 
1,614

Total stock-based compensation
$
4,411

 
$
4,348


As of April 3, 2016, $8.4 million of unrecognized compensation cost related to stock options, adjusted for estimated forfeitures, is expected to be recognized over a weighted-average period of 2.9 years. $27.3 million of unrecognized compensation cost related to unvested RSUs, adjusted for estimated forfeitures, is expected to be recognized over a weighted-average period of 2.7 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 has identified its CEO as the CODM and 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 video security, storage and digital media 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. Each business unit contains leadership focused on the product development efforts, both from a product marketing and engineering standpoint, to service the unique needs of these customer segments. 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 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.


24

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
 
April 3,
2016
 
March 29,
2015
Net revenue:
 
 
 
Retail
$
157,543

 
$
120,957

Commercial
68,432

 
72,731

Service provider
84,281

 
115,469

Total net revenue
310,256

 
309,157

Contribution income:
 
 
 
Retail
$
24,299

 
$
16,319

Retail contribution margin
15.4
%
 
13.5
%
Commercial
14,837

 
16,243

Commercial contribution margin
21.7
%
 
22.3
%
Service Provider
14,458

 
8,758

Service Provider contribution margin
17.2
%
 
7.6
%
Total segment contribution income
53,594

 
41,320

Corporate and unallocated costs
(16,716
)
 
(12,966
)
Amortization of intangibles (1)
(4,165
)
 
(4,396
)
Stock-based compensation expense
(4,411
)
 
(4,348
)
Restructuring and other charges
(2,678
)
 
(4,394
)
Losses on inventory commitments due to restructuring

 
(407
)
Litigation reserves, net
(10
)
 
2,690

Interest income
234

 
52

Other income (expense), net
(366
)
 
475

Income before income taxes
$
25,482

 
$
18,026

________________________________
(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
 
April 3,
2016
 
March 29,
2015
United States (U.S.)
$
189,366

 
$
170,592

Americas (excluding U.S.)
4,484

 
3,194

United Kingdom (U.K.)
11,540

 
31,365

EMEA (excluding U.K.)
52,965

 
57,744

Australia
31,134

 
29,653

APAC (excluding Australia)
20,767

 
16,609

Total net revenue
$
310,256

 
$
309,157



25

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

Property and equipment, net, by geographic location are as follows (in thousands):
 
As of
 
April 3,
2016
 
December 31,
2015
United States
$
9,193

 
$
9,832

Canada
3,169

 
3,586

EMEA
367

 
468

China
5,851

 
6,562

APAC (excluding China)
2,107

 
1,936

 
$
20,687

 
$
22,384


Note 11.
Fair Value Measurements (in thousands)
The following tables summarize assets and liabilities measured at fair value on a recurring basis as of April 3, 2016:
 
 
As of April 3, 2016
 
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
$
705

 
$
705

 
$

 
$

Available-for-sale securities—U.S. treasuries (1)
105,070

 
105,070

 

 

Available-for-sale securities—certificates of deposit (1)
155

 
155

 

 

Trading securities—mutual funds (1)
1,221

 
1,221

 

 

Foreign currency forward contracts (2)
463

 

 
463

 

Total assets measured at fair value
$
107,614

 
$
107,151

 
$
463

 
$

 
(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 April 3, 2016
 
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)
$
3,549

 
$

 
$
3,549

 
$

Total liabilities measured at fair value
$
3,549

 
$

 
$
3,549

 
$

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

26

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, 2015:
 
 
As of December 31, 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
$
10,976

 
$
10,976

 
$

 
$

Available-for-sale securities—U.S. treasuries (1)
94,993

 
94,993

 

 

Available-for-sale securities—certificates of deposit (1)
147

 
147

 

 

Trading securities—mutual funds (1)
1,181

 
1,181

 

 

Foreign currency forward contracts (2)
3,205

 

 
3,205

 

Total assets measured at fair value
$
110,502

 
$
107,297

 
$
3,205

 
$

 
(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, 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)
$
451

 
$

 
$
451

 
$

Total liabilities measured at fair value
$
451

 
$

 
$
451

 
$


(3)
Included in other accrued liabilities on the Company’s unaudited condensed consolidated balance sheet.
The Company’s investments in cash equivalents and available-for-sale securities are classified within Level 1 of the fair value hierarchy because they are valued based on quoted market prices in active markets. The Company enters into foreign currency forward contracts with only those counterparties that have long-term credit ratings of A-/A3 or higher. The Company’s foreign currency forward contracts are classified within Level 2 of the fair value hierarchy as they are valued using pricing models that take into account the contract terms as well as currency rates and counterparty credit rates. The Company verifies the reasonableness of these pricing models using observable market data for related inputs into such models. Additionally, the Company includes an adjustment for non-performance risk in the recognized measure of fair value of derivative instruments. At April 3, 2016 and December 31, 2015, the adjustment for non-performance risk did not have a material impact on the fair value of the Company’s foreign currency forward contracts. The carrying value of non-financial assets and liabilities measured at fair value in the financial statements on a recurring basis, including accounts receivable and accounts payable, approximate fair value due to their short maturities.

Note 12.
Shipping and Handling Fees and Costs

The Company includes shipping and handling fees billed to customers in net revenue. Shipping and handling costs associated with inbound freight are included in cost of revenue and ending inventory. Shipping and handling costs associated with outbound freight are included in sales and marketing expenses and totaled $2.1 million and $3.2 million for the three months ended April 3, 2016 and March 29, 2015, respectively.

Note 13.
Restructuring and Other Charges

The Company incurred restructuring and other charges of $2.7 million and $4.4 million during the three months ended April 3, 2016 and March 29, 2015, respectively. Restructuring and other charges recognized in the three months ended April 3, 2016 are primarily related to severance, other one-time termination benefits and other associated costs attributable to the restructuring actions announced in January 2016. Restructuring and other charges incurred in the three months ended March 29, 2015 were

27

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

primarily attributable to employee termination charges recognized associated with actions taken to reduce the cost structure of the service provider business unit and supporting functions announced in February 2015. 

Accrued restructuring and other charges are classified within other accrued liabilities in the unaudited condensed consolidated balance sheets. Amounts attributable to lease contract termination charges will be paid over the remaining lease term until January 2022.

The following table provides a summary of the activity related to accrued restructuring and other charges for the three months ended April 3, 2016 (in thousands):
 
Accrued Restructuring and Other Charges at December 31, 2015
 
Additions (a)
 
Cash Payments
 
Accrued Restructuring and Other Charges at April 3, 2016
Restructuring
 
 
 
 
 
 
 
Employee termination charges
$
13

 
$
1,918

 
$
(1,878
)
 
$
53

Lease contract termination and other charges
1,253

 
441

 
(188
)
 
1,506

Total Restructuring and other charges
$
1,266

 
$
2,359

 
$
(2,066
)
 
$
1,559

(a) Total restructuring and other charges recognized in the Company's unaudited condensed consolidated statement of operations for the three months ended April 3, 2016 includes non-cash charges and adjustments, net of $0.3 million. These amounts have been excluded from the table above.
 
In the first quarter of 2016, the Company completed the further steps necessary to reduce the cost structure of the service provider business unit and supporting functions, to match the reduced revenue outlook and concentrate resources on long-term and profitable accounts. Management does not expect to incur any material incremental charges associated with the restructuring actions announced in January 2016.

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

Forward-looking Statements

This report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Such statements are based upon current expectations that involve risks and uncertainties. Any statements contained herein that are not statements of historical fact may be deemed to be forward-looking statements. For example, the words “believes,” “anticipates,” “plans,” “expects,” “intends,” “could,” “may,” “will,” and similar expressions are intended to identify forward-looking statements. Our actual results and the timing of certain events may differ significantly from the results discussed in the forward-looking statements. Factors that might cause such a discrepancy include, but are not limited to, those discussed in “Part II—Item 1A—Risk Factors” and “Liquidity and Capital Resources” below. All forward-looking statements in this document are based on information available to us as of the date hereof and we assume no obligation to update any such forward-looking statements. The following discussion should be read in conjunction with our unaudited condensed consolidated financial statements and the accompanying notes contained in this quarterly report. Unless expressly stated or the context otherwise requires, the terms “we,” “our,” “us” and “NETGEAR” refer to NETGEAR, Inc. and our subsidiaries.

Business and Executive Overview

We are a global networking company that delivers innovative products to consumers, businesses and service providers. Our 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. Our 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 our end-users in each geographic region in which our products are sold.

We operate in three specific business segments: retail, commercial, and service provider. We believe this structure enables us to better focus our efforts on our core customer segments and allows us to be more nimble and opportunistic as a company overall. Each business unit contains leadership focused on the product development efforts, both from a product marketing and engineering standpoint, to service the unique needs of these customer segments. The retail business unit is focused on individual consumers and consists of high performance, dependable and easy-to-use home networking, home video security, storage and

28


digital media products. The commercial business unit is focused on small and medium-sized businesses and consists of business networking, storage and security solutions that bring enterprise class functionality at an affordable price. The service provider business unit is focused on the service provider market and 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. We conduct business across three geographic regions: Americas; Europe, Middle-East and Africa (“EMEA”) and Asia Pacific (“APAC”).

The retail, commercial business, and service provider markets are intensely competitive and subject to rapid technological change. We believe that the principal competitive factors in the retail, commercial, and service provider markets for networking products include product breadth, size and scope of the sales channel, brand name, timeliness of new product introductions, product availability, performance, features, functionality and reliability, ease-of-installation, maintenance and use, and customer service and support. To remain competitive, we believe we must continue to aggressively invest resources in developing new products and enhancing our current products while continuing to expand our channels and maintaining customer satisfaction worldwide.

We sell our networking products through multiple sales channels worldwide, including traditional retailers, online retailers, wholesale distributors, direct market resellers (“DMRs”), value-added resellers (“VARs”), and broadband service providers. Our retail channel includes traditional retail locations domestically and internationally, such as Best Buy, Costco, Fry’s Electronics, Staples, Target, Wal-Mart, Argos (U.K.), Dixons (U.K.), PC World (U.K.), MediaMarkt (Europe), Darty (France), JB HiFi (Australia), Elkjop (Norway) and Sunning and Guomei (China). Online retailers include Amazon.com worldwide, Newegg.com (US), JD.com and Alibaba (China), as well as NBB.com (Germany) and Coolblue.com (Netherlands). Our DMRs include CDW Corporation, Insight Corporation and PC Connection in domestic markets and Misco throughout Europe. In addition, we also sell our products through broadband service providers, such as multiple system operators (“MSOs”), xDSL, and other broadband technology operators domestically and internationally. Some of these retailers and broadband service providers purchase directly from us, while others are fulfilled through wholesale distributors around the world. A substantial portion of our net revenue to date has been derived from a limited number of wholesale distributors and retailers. We expect that these wholesale distributors and retailers will continue to contribute a significant percentage of our net revenue for the foreseeable future.

During the first quarter of 2016, we experienced a 0.4% increase in net revenue compared to the first quarter of 2015, driven primarily by an increase in retail net revenue, partially offset by decreases in service provider net revenue and, to a lesser extent, commercial business unit net revenue. Retail net revenue increased 30% compared to the prior year period due to an increase in gross shipments of home wireless products, broadband gateways, and home security camera products. Additionally, the increase in retail net revenue was due to a continued focus to increase average selling prices by offering premium differentiated products. We continue to see strong demand for our retail products, including the Nighthawk family and Arlo Smart Home cameras. Service provider net revenue decreased compared to the prior year period due primarily to a reduction in gross shipments of broadband gateways and mobile products. As previously announced, in 2015 we began to execute on our plans to resize our service provider business for higher profitability by focusing on higher margin products and accounts while reducing the cost structure of this business unit. In line with this objective, we made further restructuring efforts in the first quarter of 2016. Commercial net revenue decreased compared to the prior year period due to a reduction in gross shipments of network storage products and switches. On a geographic basis, net revenue increased in the Americas and APAC, offset by a decline in EMEA. The increase in Americas was driven primarily by an increase in gross shipments of our broadband gateways, home security camera and home wireless products, partially offset by a decrease in gross shipments of our mobile products and switches. The increase in APAC was driven by an increase in gross shipments of broadband gateways, home wireless products and switches, partially offset by a reduction in gross shipments of our mobile products. The decrease in EMEA was driven primarily by a reduction in gross shipments of broadband gateways, partially offset by an increase in gross shipments of home security camera products.

Looking forward, we expect growth in our retail business unit mainly driven by gaining additional market share for cable products sold in retail, WiFi high end router and extender products, and home security camera products. We expect growth in our commercial business unit driven by the sales of our 11 ac WLAN products and web-managed PoE and 10Gig switches. We also expect approximately $75 million per quarter revenue run rate for the service provider business unit for the remainder of 2016 as we continue to remain focused on improving profitability.


29


Results of Operations
The following table sets forth the unaudited condensed consolidated statements of operations for the three months ended April 3, 2016, with the comparable reporting period in the preceding year.
 
 
Three Months Ended
 
April 3,
2016
 
March 29,
2015
 
(In thousands, except percentage data)
Net revenue
$
310,256

 
100.0
 %
 
$
309,157

 
100.0
 %
Cost of revenue
209,691

 
67.6
 %
 
220,877

 
71.4
 %
Gross profit
100,565

 
32.4
 %
 
88,280

 
28.6
 %
Operating expenses:
 
 
 
 
 
 
 
Research and development
22,137

 
7.1
 %
 
20,452

 
6.6
 %
Sales and marketing
37,277

 
12.0
 %
 
37,602

 
12.2
 %
General and administrative
12,849

 
4.1
 %
 
11,023

 
3.6
 %
Restructuring and other charges
2,678

 
0.9
 %
 
4,394

 
1.4
 %
Litigation reserves, net
10

 
0.0
 %
 
(2,690
)
 
(0.9
)%
Total operating expenses
74,951

 
24.1
 %
 
70,781

 
22.9
 %
Income from operations
25,614

 
8.3
 %
 
17,499

 
5.7
 %
Interest income
234

 
0.0
 %
 
52

 
(0.1
)%
Other income (expense), net
(366
)
 
(0.1
)%
 
475

 
0.2
 %
Income before income taxes
25,482

 
8.2
 %
 
18,026

 
5.8
 %
Provision for income taxes
8,893

 
2.9
 %
 
10,015

 
3.2
 %
Net income
$
16,589

 
5.3
 %
 
$
8,011

 
2.6
 %


Net Revenue by Geographic Segment

Our net revenue consists of gross product shipments, less allowances for estimated returns for stock rotation and warranty, price protection, end-user customer rebates and other sales incentives deemed to be a reduction of net revenue per the authoritative guidance for revenue recognition, and net changes in deferred revenue.

We conduct business across three geographic regions: Americas, EMEA and APAC. For reporting purposes revenue is attributed to each geographic region based upon the location of the customer.
 
Three Months Ended
 
April 3,
2016
 
% Change
 
March 29,
2015
 
(In thousands, except percentage data)
Americas
$
193,850

 
11.5
 %
 
$
173,786

Percentage of net revenue
62.5
%
 
 
 
56.2
%
EMEA
$
64,505

 
(27.6
)%
 
$
89,109

Percentage of net revenue
20.8
%
 
 
 
28.8
%
APAC
$
51,901

 
12.2
 %
 
$
46,262

Percentage of net revenue
16.7
%
 
 
 
15.0
%
Total net revenue
$
310,256

 
0.4
 %
 
$
309,157


Americas

The increase in Americas net revenue for the three months ended April 3, 2016 compared to the prior year period was driven primarily by an increase in gross shipments of our broadband gateways, home security cameras and home wireless products, partially offset by a decrease in gross shipments of our mobile products and switches. The increase was primarily due to continued growth in the retail business unit driven by strong demand for our products, including the Nighthawk family and Arlo Smart Home cameras. Additionally, the increase was due to a continued focus to increase the average selling prices on our retail products. The

30


increase in Americas net revenue was partially offset by a reduction in service provider and to a lesser extent commercial business unit net revenues. Service provider net revenue fell versus the prior year period as we continue to prioritize profitability with respect to service provider business opportunities.

EMEA

The decrease in EMEA net revenue for the three months ended April 3, 2016 compared to the prior year period was driven primarily by a reduction in gross shipments of broadband gateways, partially offset by an increase in gross shipments of home security camera products. The decrease in gross shipments was driven by a decline in service provider gross shipments as we continue to prioritize profitability with respect to service provider business opportunities. Further, in the period ended June 28, 2015 we recorded a charge of $3.3 million against net revenue relating to an anticipated credit to a customer to resolve a disputed quality issue. We no longer believe there to be a quality issue after obtaining two independent party reports, and consequently the full amount of this charge was reversed in the three months ended April 3, 2016. The impact of this reversal positively benefited EMEA net revenue and in part offset the service provider business unit decline.

APAC

The increase in APAC net revenue for the three months ended April 3, 2016 compared to the prior year period was driven primarily by an increase in gross shipments of broadband gateways, home wireless products and switches, partially offset by a reduction in gross shipments of our mobile products. The increase was due, in part, to improved performance in our service provider business unit.

Cost of Revenue and Gross Margin

Cost of revenue consists primarily of the following: the cost of finished products from our third party contract manufacturers; overhead costs, including purchasing, product planning, inventory control, warehousing and distribution logistics; third-party software licensing fees; inbound freight and duty; warranty costs associated with returned goods; write-downs for excess and obsolete inventory, amortization expense of certain acquired intangibles and restructuring accounting adjustments to inventory.

We outsource our manufacturing, warehousing and distribution logistics. We believe this outsourcing strategy allows us to better manage our product costs and gross margin. Our gross margin can be affected by a number of factors, including fluctuation in foreign exchange rates, sales returns, changes in average selling prices, end-user customer rebates and other sales incentives, changes in our cost of goods sold due to fluctuations in prices paid for components, net of vendor rebates, warranty and overhead costs, inbound freight and duty, conversion costs, charges for excess or obsolete inventory and amortization of acquired intangible assets. The following table presents costs of revenue and gross margin, for the periods indicated:
 
Three Months Ended
 
April 3,
2016
 
% Change
 
March 29,
2015
 
(In thousands, except percentage data)
Cost of revenue
$
209,691

 
(5.1
)%
 
$
220,877

Gross margin percentage
32.4
%
 
 
 
28.6
%

Cost of Revenue
Cost of revenue decreased for the three months ended April 3, 2016 compared to the prior year period mainly due to product costs as a percentage of revenue falling approximately $10.7 million, or 4.4%, as higher average selling prices increased revenue proportionate to product costs.
Gross Margin
Our gross margin increased partially due to our strategy of pursuing higher average selling prices in the retail business unit combined with a focus on prioritizing profitability in the service provider business unit. Additionally, gross margins were positively impacted by the reversal of the $3.3 million charge recorded against net revenue in the period ending June 28, 2015. The charge was related to an anticipated credit to a customer to resolve a disputed quality issue.

We expect gross margin achievement will increase slightly versus the prior year in the near term. Forecasting future gross margin percentages is difficult, and there are a number of risks related to our ability to maintain or improve our current gross margin levels. Our cost of revenues as a percentage of revenues can vary significantly based upon a number of factors such as the

31


following: uncertainties surrounding revenue levels, including future pricing and/or potential discounts as a result of the economy or in response to the strengthening of the U.S. dollar in our international markets, and related production level variances; competition; changes in technology; changes in product mix; variability of stock-based compensation costs; royalties to third parties; fluctuations in freight, duty and repair costs; manufacturing and purchase price variances; changes in prices on commodity components; warranty costs; and the timing of sales, particularly to service providers.
     
Operating Expenses
Research and Development 
Research and development expenses consist primarily of personnel expenses, payments to suppliers for design services, safety and regulatory testing, product certification expenditures to qualify our products for sale into specific markets, prototypes and other consulting fees. Research and development expenses are recognized as they are incurred. We have invested in building our research and development organization to enhance our ability to introduce innovative and easy-to-use products. The following table presents research and development expense, for the periods indicated:

 
Three Months Ended
 
April 3,
2016
 
% Change
 
March 29,
2015
 
(In thousands, except percentage data)
Research and development expense
$
22,137

 
8.2
%
 
$
20,452


Research and development expense increased for the three months ended April 3, 2016 compared to the prior year period due primarily to an increase in variable compensation of $1.4 million.
We believe that innovation and technological leadership is critical to our future success, and we are committed to continuing a significant level of research and development to develop new technologies and products to combat competitive pressures. We continue to invest in research and development to expand our cloud platform capabilities, grow our home security camera and home automation device portfolio, and develop innovative whole home WiFi coverage solutions. In the near future, we expect research and development expenses to remain relatively flat as a percentage of revenue as we are allocating resources in the key areas that we expect will drive future growth and profitability. Research and development expenses will fluctuate depending on the timing and number of development activities in any given quarter and could vary significantly as a percentage of revenue, depending on actual revenues achieved in any given quarter.

Sales and Marketing
 
Sales and marketing expenses consist primarily of advertising, trade shows, corporate communications and other marketing expenses, product marketing expenses, outbound freight costs, amortization expenses, personnel expenses for sales and marketing staff and technical support expenses. The following table presents sales and marketing expense, for the periods indicated:

 
Three Months Ended
 
April 3,
2016
 
% Change
 
March 29,
2015
 
(In thousands, except percentage data)
Sales and marketing expense
$
37,277

 
(0.9
)%
 
$
37,602


Sales and marketing expense decreased slightly for the three months ended April 3, 2016 compared to the prior year period. The decrease was attributable to a reduction in freight out of $1.1 million offset by an increase in variable compensation of $0.6 million.
We expect our sales and marketing expense in the near term to remain relatively flat as a percentage of net revenue while we continue to adjust our sales coverage to better align with our 2016 net revenue outlook. Expenses may fluctuate depending on revenue levels achieved as certain expenses, such as commissions, are determined based upon the revenues achieved. Forecasting sales and marketing expenses as a percentage of revenues is highly dependent on expected revenue levels and could vary significantly depending on actual revenues achieved in any given quarter. Marketing expenses will also fluctuate depending upon the timing, extent and nature of marketing programs as we introduce new products.


32


General and Administrative

General and administrative expenses consist of salaries and related expenses for executives, finance and accounting, human resources, information technology, professional fees, including legal costs associated with defending claims against us, allowance for doubtful accounts and other general corporate expenses. The following table presents general and administrative expense, for the periods indicated:
 
Three Months Ended
 
April 3,
2016
 
% Change
 
March 29,
2015
 
(In thousands, except percentage data)
General and administrative expense
$
12,849

 
16.6
%
 
$
11,023


General and administrative expense increased for the three months ended April 3, 2016 compared to the prior year period mainly due to increases in variable compensation costs of $1.4 million, personnel-related expense of $0.8 million and outside professional service fee of $0.5 million relating to software maintenance, partially offset by a reduction in facility, allocation and other expenses of $1.0 million.
We expect our general and administrative expenses to remain flat in absolute dollar value in the near term but they could fluctuate depending on a number of factors, including the level and timing of expenditures associated with litigation defense costs in connection with the litigation described in Note 7, Commitments and Contingencies, in the notes to unaudited condensed consolidated financial statements. Future general and administrative expense increases or decreases in absolute dollars are difficult to predict due to the lack of visibility of certain costs, including legal costs associated with defending claims against us, as well as legal costs associated with asserting and enforcing our intellectual property portfolio and other factors.

Restructuring and Other Charges
 
Three Months Ended
 
April 3,
2016
 
% Change
 
March 29,
2015
 
(In thousands, except percentage data)
Restructuring and other charges
$
2,678

 
(39.1
)%
 
$
4,394



Restructuring and other charges decreased for the three months ended April 3, 2016 compared to the prior year period. Charges recognized in the first quarter of 2016 were primarily related to severance, other one-time termination benefits and other associated costs attributable to the restructuring actions announced in January 2016. Expenses incurred during the first quarter of 2015 were associated with actions taken to reduce the cost structure of the service provider business unit and supporting functions announced in February 2015.

In the first quarter of 2016 we completed the steps necessary to further reduce the cost structure of the service provider business unit and supporting functions to match the reduced revenue outlook and to concentrate resources on LTE and long-term and profitable accounts. Management does not expect to incur any additional material charges associated with the restructuring actions announced in January 2016. Restructuring actions are subject to significant risks, including delays in implementing expense control programs or workforce reductions and the failure to meet operational targets due to the loss of employees, all of which would impair our ability to achieve anticipated cost reductions. If we do not achieve anticipated cost reductions, our financial results could be negatively impacted.

For further discussion of restructuring and other charges, refer to Note 13, Restructuring and Other Charges, of the notes to unaudited condensed consolidated financial statements.

Litigation Reserves, Net
 
Three Months Ended
 
April 3,
2016
 
% Change
 
March 29,
2015
 
(In thousands, except percentage data)
Litigation reserves, net
$
10

 
**
 
$
(2,690
)
**Percentage change not meaningful.

33



No significant litigation reserves or benefits were recognized during the three months ended April 3, 2016. By contrast, we recognized a benefit of $2.7 million during the three months ended March 29, 2015 resulting from adjustments recorded to release accrued litigation reserves associated with the Ericsson patent litigation matter.

For a detailed discussion of our litigation matters, refer to Note 7, Commitments and Contingencies, in the notes to unaudited condensed consolidated financial statements.

Interest Income and Other Income (Expense), Net
Interest income represents amounts earned on our cash, cash equivalents and short-term investments. Other income (expense), net primarily represents gains and losses on transactions denominated in foreign currencies and other miscellaneous income and expenses. The following table presents interest income and other income (expense), net, for the periods indicated:
 
 
Three Months Ended
 
April 3,
2016
 
% Change
 
March 29,
2015
 
(In thousands, except percentage data)
Interest income
$
234

 
**
 
$
52

Other income (expense), net
(366
)
 
**
 
475

Total interest income and other income (expense), net
$
(132
)
 
**
 
$
527

**Percentage change not meaningful.

Interest income increased slightly for the three months ended April 3, 2016 compared to the prior year period due primarily to the increase in our short term investment average balance in the quarter, resulting from the timing of purchase and sale transactions.

Other income (expense), net, decreased for the three months ended April 3, 2016 compared to the prior year period due primarily to losses recognized relating to foreign currency forward contracts, partially offset by foreign exchange gains. Our foreign currency hedging program effectively reduced volatility associated with hedged currency exchange rate movements during the three months ended April 3, 2016. For a detailed discussion of our hedging program and related foreign currency contracts, refer to Note 4, Derivative Financial Instruments, in the notes to unaudited condensed consolidated financial statements.

Provision for Income Taxes
 
Three Months Ended
 
April 3,
2016
 
% Change
 
March 29,
2015
 
(In thousands, except percentage data)
Provision for income taxes
$
8,893

 
(11.2
)%
 
$
10,015

Effective tax rate
34.9
%
 
 
 
55.6
%

The decrease in the effective tax rate for the three months ended April 3, 2016 compared to the three months ended March 29, 2015 was due primarily to changes in earnings incurred in a jurisdiction where a loss was not tax benefited for the three months ended March 29, 2015. For the three months ended March 29, 2015, the forecasted loss from this jurisdiction was excluded from the determination of tax expense. For the three months ended April 3, 2016, we did not exclude any jurisdictions from the determination of tax expense. We are subject to income taxes in the U.S. and numerous foreign jurisdictions. Our future foreign tax rate could be affected by changes in the composition in earnings in countries with tax rates differing from the U.S. federal rate. We are under examination in various U.S. and foreign jurisdictions.


Segment Information
A description of our products and services, as well as segment financial data, for each segment and a reconciliation of segment contribution income to income before income taxes can be found in Note 10, Segment Information and Operations by Geographic Area, in the Notes to Unaudited Condensed Consolidated Financial Statements in Item 1 of Part I of this Quarterly Report on Form 10-Q.

34


Retail
 
 
Three Months Ended
  
April 3,
2016
 
% Change
 
March 29,
2015
 
(in thousands, except percentage data)
Net revenue
$
157,543

 
30.2
%
 
$
120,957

Percentage of net revenue
50.7
%
 
 
 
39.2
%
Contribution income
$
24,299

 
48.9
%
 
$
16,319

Contribution margin
15.4
%
 
 
 
13.5
%

Retail net revenue increased for the three months ended April 3, 2016 compared to the prior year period due primarily to an increase in gross shipments of home wireless products, broadband gateways, and home security camera products. Additionally, the increase in retail net revenue was due to a continued focus to increase average selling prices on our retail products. Geographically, we experienced growth in the Americas and, to a lesser extent, EMEA, while net revenue in APAC slightly declined. We continue to see strong end-user demand for our recently introduced retail products, including the Nighthawk series and Arlo Smart Home cameras. 

Contribution income increased for the three months ended April 3, 2016 compared to the prior year period as our strategy of pursuing higher average selling prices resulted in higher gross margins and profitability for the retail business unit.
Commercial
 
Three Months Ended
  
April 3,
2016
 
% Change
 
March 29,
2015
 
(in thousands, except percentage data)
Net revenue
$
68,432

 
(5.9
)%
 
$
72,731

Percentage of net revenue
22.1
%