10-Q 1 ntgr20190331-10q.htm FORM 10-Q Document

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 March 31, 2019.

¨ 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 every Interactive Data File required to be submitted 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 such files).    Yes  x    No  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See definition of “large accelerated filer,” “accelerated filer,” “smaller reporting company”, and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large Accelerated filer
 
x
 
Accelerated filer
 
¨
Non-Accelerated filer
 
¨
 
Smaller reporting company
 
¨
 
 
 
 
Emerging growth company
 
¨
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.
 
¨


Indicate by check mark whether the registrant is a shell company (as defined in Exchange Act Rule 12b-2).    Yes  o    No  x
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
 
Trading symbol(s):
 
Name of each exchange on which registered
Common Stock, $0.001 par value
 
NTGR
 
The Nasdaq Stock Market LLC

The number of outstanding shares of the registrant’s Common Stock, $0.001 par value, was 31,491,699 as of April 26, 2019.

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)
 
 
As of
 
March 31,
2019
 
December 31,
2018
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
185,680

 
$
201,047

Short-term investments
26,972

 
73,317

Accounts receivable, net of allowance for doubtful accounts of $1,255 and $1,254 as of March 31, 2019 and December 31, 2018, respectively
262,531

 
303,667

Inventories
236,123

 
243,871

Prepaid expenses and other current assets
34,791

 
35,997

Total current assets
746,097

 
857,899

Property and equipment, net
20,645

 
20,177

Operating lease right-of-use assets, net
36,613

 

Intangibles, net
15,058

 
17,146

Goodwill
80,721

 
80,721

Other non-current assets
71,241

 
67,433

Total assets
$
970,375

 
$
1,043,376

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
69,279

 
$
139,748

Accrued employee compensation
18,452

 
31,666

Other accrued liabilities
177,635

 
199,472

Deferred revenue
11,750

 
11,086

Income taxes payable
2,895

 
2,020

Total current liabilities
280,011

 
383,992

Non-current income taxes payable
18,142

 
19,600

Non-current operating lease liabilities
31,514

 

Other non-current liabilities
7,800

 
12,232

Total liabilities
337,467

 
415,824

Commitments and contingencies (Note 10)


 


Stockholders’ equity:
 
 
 
Common stock
32

 
32

Additional paid-in capital
804,413

 
793,585

Accumulated other comprehensive income (loss)
14

 
(15
)
Accumulated deficit
(171,551
)
 
(166,050
)
Total stockholders’ equity
632,908

 
627,552

Total liabilities and stockholders’ equity
$
970,375

 
$
1,043,376

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
 
March 31,
2019
 
April 1,
2018
Net revenue
$
249,082

 
$
245,201

Cost of revenue
167,074

 
168,882

Gross profit
82,008

 
76,319

Operating expenses:
 
 
 
Research and development
18,832

 
21,191

Sales and marketing
35,855

 
37,874

General and administrative
13,117

 
15,761

Separation expense
264

 

Restructuring and other charges
(68
)
 
(9
)
Total operating expenses
68,000

 
74,817

Income from operations
14,008

 
1,502

Interest income
701

 
748

Other income (expense), net
341

 
(1,318
)
Income before income taxes
15,050

 
932

Provision (benefit) for income taxes
2,207

 
(86
)
Net income from continuing operations
12,843

 
1,018

Net income from discontinued operations, net of tax

 
4,572

Net income
$
12,843

 
$
5,590

 
 
 
 
Net income per share - basic:
 
 
 
Income from continuing operations
$
0.41

 
$
0.03

Income from discontinued operations

 
0.15

Net income
$
0.41

 
$
0.18

 
 
 
 
Net income per share - diluted:
 
 
 
Income from continuing operations
$
0.39

 
$
0.03

Income from discontinued operations

 
0.14

Net income
$
0.39

 
$
0.17

 
 
 
 
Weighted average shares used to compute net income per share:
 
 
 
Basic
31,483

 
31,427

Diluted
32,874

 
32,660

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
 
March 31,
2019
 
April 1,
2018
Net income
$
12,843

 
$
5,590

Other comprehensive income, before tax:
 
 
 
Unrealized gains on derivative instruments
23

 
692

Unrealized gains (losses) on available-for-sale securities
15

 
(38
)
Other comprehensive income, before tax
38

 
654

Tax provision related to derivative instruments
(6
)
 
(61
)
Tax provision related to available-for-sale securities
(3
)
 
(11
)
Other comprehensive income, net of tax
29

 
582

Comprehensive income
$
12,872

 
$
6,172

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


5


NETGEAR, INC.

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(In thousands)

 
Common Stock
 
 
 
 
 
 
 
 
 
Shares
 
Amount
 
 Additional Paid-In Capital
 
Accumulated Other Comprehensive Income (Loss)
 
Accumulated deficit
 
Total Stockholder's Equity
Balance as of December 31, 2018
31,562

 
$
32

 
$
793,585

 
$
(15
)
 
$
(166,050
)
 
$
627,552

Change in unrealized gains and losses on available-for-sale securities, net of tax

 

 

 
12

 

 
12

Change in unrealized gains and losses on derivatives, net of tax

 

 

 
17

 

 
17

Net income

 

 

 

 
12,843

 
12,843

Stock-based compensation

 

 
6,457

 

 

 
6,457

Repurchase of common stock
(436
)
 

 

 

 
(15,000
)
 
(15,000
)
Restricted stock unit withholdings
(89
)
 

 

 

 
(3,344
)
 
(3,344
)
Issuance of common stock under stock-based compensation plans
430

 

 
4,371

 

 

 
4,371

Balance as of March 31, 2019
31,467

 
$
32

 
$
804,413

 
$
14

 
$
(171,551
)
 
$
632,908


 
Common Stock
 
 
 
 
 
 
 
 
 
Shares
 
Amount
 
 Additional Paid-In Capital
 
Accumulated Other Comprehensive Income (Loss)
 
Retained Earnings
 
Total Stockholder's Equity
Balance as of December 31, 2017
31,320

 
$
31

 
$
603,137

 
$
(851
)
 
$
128,168

 
$
730,485

Adoptions of ASU 2014-09 (ASC 606 Rev Rec), ASU 2016-16, and ASU 2018-02, net of tax

 

 

 

 
8,593

 
8,593

Change in unrealized gains and losses on available-for-sale securities, net of tax

 

 

 
(49
)
 

 
(49
)
Change in unrealized gains and losses on derivatives, net of tax

 

 

 
631

 

 
631

Net income

 

 

 

 
5,590

 
5,590

Stock-based compensation

 

 
8,150

 

 

 
8,150

Restricted stock unit withholdings
(38
)
 

 

 

 
(2,271
)
 
(2,271
)
Issuance of common stock under stock-based compensation plans
252

 
1

 
4,589

 

 

 
4,590

Balance as of April 1, 2018
31,534

 
$
32

 
$
615,876

 
$
(269
)
 
$
140,080

 
$
755,719

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


6


NETGEAR, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
 
Three Months Ended
 
March 31, 2019
 
April 1, 2018
Cash flows from operating activities:
 
 
 
Net income
$
12,843

 
$
5,590

Net income from discontinued operations

 
(4,572
)
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
 
 
 
Depreciation and amortization
5,028

 
5,040

Purchase premium amortization/discount accretion on investments, net
(141
)
 
(107
)
Stock-based compensation
6,458

 
6,864

(Gains)/charges related to long-term investments, net

 
1,400

Deferred income taxes
1,148

 
870

Changes in assets and liabilities
 
 
 
Accounts receivable
41,136

 
45,561

Inventories
7,748

 
(1,546
)
Prepaid expenses and other assets
453

 
(2,620
)
Accounts payable
(68,431
)
 
(15,029
)
Accrued employee compensation
(13,214
)
 
(2,720
)
Other accrued liabilities
(31,371
)
 
(19,214
)
Deferred revenue
1,733

 
(31
)
Income taxes payable
(583
)
 
3,397

Net cash provided by (used in) continuing operating activities
(37,193
)
 
22,883

Net cash provided by discontinued operating activities

 
34,113

Net cash provided by (used in) operating activities
(37,193
)
 
56,996

Cash flows from investing activities:
 
 

Purchases of short-term investments
(146
)
 
(35,167
)
Proceeds from maturities of short-term investments
47,145

 
34,907

Purchases of property and equipment
(5,958
)
 
(2,774
)
Purchases of long-term investments
(5,200
)
 

Net cash provided by (used in) continuing investing activities
35,841

 
(3,034
)
Net cash used in discontinued investing activities

 
(410
)
Net cash provided by (used in) investing activities
35,841

 
(3,444
)
Cash flows from financing activities:
 
 
 
Repurchases of common stock
(15,000
)
 

Restricted stock unit withholdings
(3,344
)
 
(2,271
)
Proceeds from exercise of stock options
2,026

 
1,912

Proceeds from issuance of common stock under employee stock purchase plan
2,303

 
2,732

Net cash provided by (used in)continuing financing activities
(14,015
)
 
2,373

Net cash provided by (used in) discontinued financing activities

 

Net cash provided by (used in) in financing activities
(14,015
)
 
2,373

Net increase (decrease) in cash and cash equivalents
(15,367
)
 
55,925

Cash and cash equivalents, at beginning of period
201,047

 
202,870

Cash and cash equivalents, at end of period
$
185,680

 
$
258,795

Non-cash investing and financing activities:
 
 
 
Additions to property and equipment included in accounts payable and other accrued liabilities
$
2,550

 
$
598

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

7

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 company that delivers innovative networking and Internet connected products to consumers and businesses. The Company's products are built on a variety of proven technologies such as wireless (WiFi and 4G/5G mobile), Ethernet and powerline, with a focus on reliability and ease-of-use. The product line consists of devices that create and extend wired and wireless networks as well as devices that provide a special function and attach to the network, such as smart digital canvasses and services. These products are available in multiple configurations to address the changing needs of our customers 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, 2018 has been derived from audited financial statements at such date. Accordingly, these unaudited 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, stockholder's equity and cash flows for the periods indicated. These unaudited condensed consolidated financial statements should be read in conjunction with the notes to the audited consolidated financial statements included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2018.

On December 31, 2018, the Company completed the Spin-Off of Arlo Technologies, Inc. (“Arlo”), a majority owned subsidiary and reporting segment of NETGEAR. Arlo’s historical financial results for periods prior to the Spin-Off are reflected in the unaudited condensed consolidated financial statements as discontinued operations. For further detail, refer to Note 4. Discontinued Operations.
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 March 31, 2019 are not necessarily indicative of the results that may be expected for the year ending December 31, 2019 or any future period.


 

8

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

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 fiscal year ended December 31, 2018. Refer to Note 15. Leases, for the updated accounting policy on leases upon adoption of ASU 2016-02, "Leases" as of January 1, 2019.

Recent accounting pronouncements

Accounting Pronouncements Recently Adopted

ASU 2016-02

In February 2016, FASB issued ASU 2016-02, "Leases" (Topic 842), which requires a lessee to recognize on the balance sheets a right-of-use asset, representing its right to use the underlying asset for the lease term, and a corresponding lease liability. The liability is equal to the present value of lease payments while the right-of-use asset is based on the liability, subject to adjustment, such as for initial direct costs. In addition, ASU 2016-02 expands the disclosure requirements for lessees.

The Company adopted the new standard effective January 1, 2019 and was required to record a lease asset and lease liability related to its operating leases. The Company elected to utilize the alternative modified transaction method, under which the cumulative-effect adjustment to the opening balance is recognized on the date of adoption while comparative prior periods continue to be reported under the guidance in effect prior to January 1, 2019. Accordingly, the Company did not restate or make related disclosures under the new standard for comparative prior periods in the period of adoption, and the Company applied the new lease standard prospectively to leases existing or commencing on or after January 1, 2019. The Company elected the package of practical expedients permitted under the transition guidance within the standard to not (1) reassess whether any expired or existing contracts are considered or contain leases; (2) reassess the lease classification for any expired or existing leases; and (3) reassess the initial direct costs for any existing leases. The Company made an accounting policy election to treat the lease and non-lease components in its office lease contracts as a single performance obligation to the extent that the timing and pattern of transfer are similar for the lease and non-lease components and the lease component qualifies as an operating lease. The Company also made an accounting policy election not to recognize lease liabilities and right-of-use assets for leases with a term of 12 months or less. The Company will recognize these lease payments on a straight-line basis over the lease term.



9

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

The following table summarizes the impact of adopting ASU 2016-02 on the Company’s unaudited condensed consolidated balance sheets for the fiscal year beginning January 1, 2019 as an adjustment to the opening balances:
 
As of
 
Adjustments
 
As of
 
December 31,
2018
 
 
January 1,
2019
 
(In thousands)
Assets:
 
 
 
 
 
Prepaid expenses and other current assets
$
35,997

 
$
(543
)
 
$
35,454

Total current assets
$
857,899

 
$
(543
)
 
$
857,356

Operating lease right-of-use assets, net
$

 
$
39,110

 
$
39,110

Total assets
$
1,043,376

 
$
38,567

 
$
1,081,943

Liabilities:
 
 
 
 
 
Other accrued liabilities
$
199,472

 
$
10,909

 
$
210,381

Total current liabilities
$
383,992

 
$
10,909

 
$
394,901

Non-current operating lease liabilities
$

 
$
33,823

 
$
33,823

Other non-current liabilities
$
12,232

 
$
(6,165
)
 
$
6,067

Total liabilities
$
415,824

 
$
38,567

 
$
454,391

Total liabilities and stockholders’ equity
$
1,043,376

 
$
38,567

 
$
1,081,943


The standard did not impact our statements of operations and had no impact on our cash flows.

Accounting Pronouncements Not Yet Effective

In June 2016, the FASB issued ASU 2016-13, "Measurement of Credit Losses on Financial Instruments" (Topic 326), which replaces the incurred-loss impairment methodology and requires immediate recognition of estimated credit losses expected to occur for most financial assets, including trade receivables. Credit losses on available-for-sale debt securities with unrealized losses will be recognized as allowances for credit losses limited to the amount by which fair value is below amortized cost. ASU 2016-13 is effective for the Company beginning in the first fiscal quarter of 2020 and early adoption is permitted. The Company continues to assess the potential impact of the new guidance and related codification improvements on its financial position, results of operations and cash flows, including accounting policies, processes, and systems.

With the exception of the new standards discussed above, there have been no other new accounting pronouncements that have significance, or potential significance, to the Company's financial position, results of operations and cash flows.

Note 3.
Revenue

Revenue from contracts with customers is recognized when control of the promised goods or services is transferred to the customers, in an amount that reflects the consideration the Company expects to be entitled to in exchange for those goods or services.


10

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

Transaction Price Allocated to the Remaining Performance Obligations

Remaining performance obligations represent the transaction price allocated to performance obligations that are unsatisfied or partially unsatisfied as of the end of the reporting period. Unsatisfied and partially unsatisfied performance obligations consist of contract liabilities, in-transit orders with destination terms, and non-cancellable backlog. Non-cancellable backlog includes goods and services for which customer purchase orders have been accepted that are scheduled or in the process of being scheduled for shipment.

The following table includes estimated revenue expected to be recognized in the future related to performance obligations that are unsatisfied (or partially unsatisfied) as of March 31, 2019:
 
 
1 year
 
2 years
 
Greater than 2 years
 
Total
Performance obligations
 
$
49,895

 
$
1,012

 
$
965

 
$
51,872


Contract Balances

The Company records accounts receivable when it has an unconditional right to consideration. Contract liabilities are recorded when cash payments are received or due in advance of performance. Contract liabilities consist of advance payments and deferred revenue, where the Company has unsatisfied performance obligations. Contract liabilities are classified as Deferred revenue on the unaudited condensed consolidated balance sheets.

Payment terms vary by customer. The time between invoicing and when payment is due is not significant. For certain products or services and customer types, payment is required before the products or services are delivered to the customer.

The following table reflects the changes in contract balances for the three months ended March 31, 2019:
 
Balance Sheet Location
March 31, 2019
December 31, 2018
$ change
% change
 
 
(In thousands)
 
Accounts Receivable, net
Accounts receivable, net
$
262,531

$
303,667

$
(41,136
)
(13.5
)%
Contract liabilities - current
Deferred revenue
$
11,750

$
11,086

$
664

6.0
 %
Contract liabilities - non-current
Other non-current liabilities
$
1,847

$
779

$
1,068

137.1
 %

The difference in the balances of the Company’s contract assets and liabilities as of March 31, 2019 and December 31, 2018 primarily results from the timing difference between the Company’s performance and the customer’s payment.

During the three months ended March 31, 2019, $3.7 million of revenue was deferred due to unsatisfied performance obligations, primarily relating to over time revenue. During the three months, $2.0 million of revenue was recognized for the satisfaction of performance obligations over time. $1.7 million of this recognized revenue was included in the contract liability balance at the beginning of the period.

There were no significant changes in estimates during the period that would affect the contract balances.


11

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

Disaggregation of Revenue

In the following table, net revenue is disaggregated by geographic region and sales channel. The Company conducts business across three geographic regions: Americas; Europe, Middle-East and Africa (“EMEA”); and Asia Pacific ("APAC"). The table also includes a reconciliation of the disaggregated revenue by reportable segment. The Company operates and reports in two segments: Connected Home, and Small and Medium Business ("SMB"). Sales and usage-based taxes are excluded from net revenue.

 
Three Months Ended
 
March 31,
2019
 
April 1,
2018
 
Connected Home
 
SMB
 
Total
 
Connected Home
 
SMB
 
Total
 
 
Geographic regions:
 
 
 
 
 
 
 
 
 
 
 
Americas
$
113,687

 
$
34,342

 
$
148,029

 
$
129,038

 
$
30,974

 
$
160,012

EMEA
25,690

 
31,273

 
56,963

 
21,010

 
26,424

 
47,434

APAC
29,988

 
14,102

 
44,090

 
24,267

 
13,488

 
37,755

Total net revenue
$
169,365

 
$
79,717

 
$
249,082

 
$
174,315

 
$
70,886

 
$
245,201

Sales channels:
 
 


 


 


 


 


Service provider
$
36,818

 
$
1,476

 
$
38,294

 
$
41,797

 
$
1,063

 
$
42,860

Non-service provider
132,547

 
78,241

 
210,788

 
132,518

 
69,823

 
202,341

Total net revenue
$
169,365

 
$
79,717

 
$
249,082

 
$
174,315

 
$
70,886

 
$
245,201



Note 4. Discontinued Operations

On February 6, 2018, the Company announced that its Board of Directors had unanimously approved the pursuit of a separation of its smart camera business “Arlo” from NETGEAR (the “Separation”) to be effected by way of initial public offering (“IPO”) and spin-off. In August 2018, Arlo Technologies, Inc. (“Arlo”) was listed on the New York Stock Exchange under the symbol "ARLO" and completed the IPO. Upon completion of the IPO, NETGEAR held approximately 84.2% of the outstanding shares of Arlo common stock, or 62,500,000 shares. On December 31, 2018, NETGEAR completed the distribution of these 62,500,000 shares of common stock of Arlo (the “Distribution”) and no longer owns any shares of Arlo common stock. The Distribution took place by way of a pro rata common stock dividend to each NETGEAR stockholder of record on the record date of the Distribution, December 17, 2018, and NETGEAR stockholders received 1.980295 shares of Arlo common stock for every share of NETGEAR common stock held as of the record date.

Upon completion of the Distribution, the Company ceased to own a controlling financial interest in Arlo and Arlo's assets, liabilities, operating results and cash flows for all periods presented have been classified as discontinued operations within the unaudited condensed Consolidated Financial Statements.


12

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

The financial results of Arlo through the Distribution date are presented as income from discontinued operations, net of tax, in the unaudited condensed consolidated statement of operations. The following table presents financial results of Arlo for the three months ended April 1, 2018:
 
Three Months Ended
 
April 1, 2018
 
(In thousands)
Net revenues
$
99,772

Cost of revenue
71,586

Gross profit
28,186

Operating expenses:
 
Research and development
7,757

Sales and marketing
5,784

General and administrative
876

Separation expense
6,784

Total operating expenses
21,201

Income from operations of discontinued operations
6,985

Other income (expense), net
66

Income from discontinued operations before income taxes
7,051

Provision for income taxes
2,479

Income from discontinued operations, net of tax
$
4,572


Note 5.
Business Acquisition
Meural Inc.
On August 6, 2018, the Company acquired Meural Inc. ("Meural"), a New York based startup focused on producing and developing hardware and cloud platform capabilities for the digital distribution of curated artwork. Meural aims to provide a premium product to customers and to complement sales of digital canvasses with subscription services by offering customers the ability to subscribe to a large library of curated artworks. The Company believes that the acquisition enables it to enter a new and growing product category focused on consumer lifestyle and enhance its portfolio of hardware and service offerings.
Prior to the business acquisition, the Company had an investment in Meural since 2017. The total purchase consideration was $22.2 million, which consisted of $14.4 million of cash, which was paid in the third quarter of 2018, $1.5 million due to the Company's settlement in its prior equity interest in Meural, and the acquisition date fair value of contingent consideration of $6.3 million.

13

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

The merger agreement provides for the payment of contingent consideration to each selling shareholder of Meural based on the achievement of certain technical and service revenue milestones through August 6, 2023, with a maximum payout of $3.5 million on each of two milestones. The valuation of the contingent consideration was derived using estimates of the probability of achievement within specified time periods, in a scenario based model for the technical milestone; and using an option pricing model in a risk neutral framework using a Monte Carlo simulation, based on projections of future service revenues for the service revenue milestone. The fair value of such contingent consideration payable to Meural’s external shareholders is determined to be $5.9 million and is included in Other non-current liabilities on the unaudited condensed consolidated balance sheets. As of March 31, 2019, there were no significant changes in the range of expected outcomes for the contingent consideration from the acquisition date. The acquisition qualified as a business combination and was accounted for using the acquisition method of accounting. The results of Meural have been included in the unaudited condensed consolidated financial statements since the date of acquisition. Pro forma results of operations for the acquisition are not presented as the financial impact to the Company's consolidated results of operations is not material.
The purchase price allocation was as follows (in thousands):
Cash and cash equivalents
$
20

Accounts receivable
209

Inventories
760

Prepaid expenses and other current assets
500

Property and equipment
16

Intangibles
4,800

Non-current deferred income taxes
815

Goodwill
16,407

Accounts payable
(1,317
)
Other accrued liabilities
(35
)
Total purchase price
$
22,175


The $16.4 million of goodwill recorded on the acquisition of Meural is not deductible for U.S. federal or U.S. state income tax purposes. The goodwill was generated as a result of the anticipated synergies, expected to be derived through selling Meural’s products and services through NETGEAR’s established worldwide sales channel and customer base. The goodwill was assigned to the Company's Connected Home segment.
In connection with the acquisition, the Company recorded $0.8 million of deferred tax assets net of deferred tax liabilities. The deferred tax assets were recorded for the tax benefit of the net operating losses as of the date of the acquisition after consideration of limitations on their use under U.S. Internal Revenue Code section 382. The deferred tax assets were reduced by deferred tax liabilities for the book basis of intangible assets for which the Company has no tax basis.
The Company designated $3.0 million of the acquired intangibles as developed technology. The valuation was derived using an income approach, based on the present value of the estimated future cash flows derived from projections of future operations attributable to the developed technology, discounted at a rate of 16.0% and are being amortized over an estimated useful life of seven years.

The Company designated $0.6 million of the acquired intangibles as trade name, $0.6 million of the acquired intangibles as customer relationship and $0.6 million of the acquired intangibles as playlist database. The valuations of these intangibles were derived using variations of the income approach for the trade name and customer relationships, and replacement cost method for the playlist database. The valuations were based on certain key assumptions like the royalty rate, revenue and cash flows derived from projections of future operations and discount rates ranging from 16.0% to 19.0%. The intangible assets are being amortized over estimated useful lives of three years, two years and seven years for trade name, customer relationships and playlist database, respectively.


14

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

Note 6.
Balance Sheet Components

Available-for-sale short-term investments
 
As of
 
March 31, 2019
 
December 31, 2018
 
Cost
 
Unrealized Gains
 
Unrealized Losses
 
Estimated Fair Value
 
 Cost
 
Unrealized Gains
 
Unrealized Losses
 
Estimated Fair Value
 
(In thousands)
U.S. treasuries
$
23,471

 
$

 
$
(1
)
 
$
23,470

 
$
70,330

 
$
1

 
$
(17
)
 
$
70,314

Certificates of deposit
151

 

 

 
151

 
149

 

 

 
149

Total
$
23,622

 
$

 
$
(1
)
 
$
23,621

 
$
70,479

 
$
1

 
$
(17
)
 
$
70,463


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 twelve months. Accordingly, none of the available-for-sale securities have unrealized losses greater than twelve months.

Inventories
 
As of
 
March 31,
2019
 
December 31,
2018
 
(In thousands)
Raw materials
$
5,650

 
$
3,427

Finished goods
230,473

 
240,444

Total inventories
$
236,123

 
$
243,871


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

Property and equipment, net  
 
As of

March 31,
2019
 
December 31,
2018
 
(In thousands)
Computer equipment
$
9,814

 
$
9,205

Furniture, fixtures and leasehold improvements
18,477

 
18,286

Software
28,848

 
28,065

Machinery and equipment
62,249

 
60,552

Total property and equipment, gross
119,388

 
116,108

Accumulated depreciation and amortization
(98,743
)
 
(95,931
)
Total property and equipment, net
$
20,645

 
$
20,177


Depreciation and amortization expense pertaining to property and equipment was $2.9 million for the three months ended March 31, 2019 and April 1, 2018, respectively.


15

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

Intangibles, net
 
As of March 31, 2019
 
As of December 31, 2018
 
Gross
 
Accumulated Amortization
 
Net
 
Gross
 
Accumulated Amortization
 
Net
 
(In thousands)
Technology
$
59,799

 
$
(57,085
)
 
$
2,714

 
$
59,799

 
$
(56,978
)
 
$
2,821

Customer contracts and relationships
56,800

 
(46,111
)
 
10,689

 
56,800

 
(44,280
)
 
12,520

Other
10,345

 
(8,690
)
 
1,655

 
10,345

 
(8,540
)
 
1,805

Total intangibles, net
$
126,944

 
$
(111,886
)
 
$
15,058

 
$
126,944

 
$
(109,798
)
 
$
17,146


Amortization of intangibles was $2.1 million for the three months ended March 31, 2019 and $2.2 million for the three months ended April 1, 2018.

As of March 31, 2019, estimated amortization expense related to finite-lived intangibles for the remaining years is as follows (in thousands):
2019 (remaining nine months)
$
4,954

2020
6,205

2021
2,044

2022
527

2023
514

Thereafter
814

Total estimated amortization expense
$
15,058


Other non-current assets
 
As of
 
March 31,
2019
 
December 31, 2018
 
(In thousands)
Non-current deferred income taxes
$
56,402

 
$
57,557

Long-term investments
8,086

 
2,886

Other
6,753

 
6,990

Total other non-current assets
$
71,241

 
$
67,433


Other accrued liabilities
 
As of
 
March 31,
2019
 
December 31,
2018
 
(In thousands)
Current operating lease liabilities
$
10,599

 
$

Sales and marketing
74,659

 
91,548

Warranty obligations
12,531

 
14,412

Sales returns
42,202

 
46,318

Freight and duty
5,268

 
10,586

Other
32,376

 
36,608

Total other accrued liabilities
$
177,635

 
$
199,472



16

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

Note 7.
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 dollar, 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 or 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 sheets at fair value. Cash flow hedge gains and losses are recorded in other comprehensive income ("OCI") until the hedged item is recognized in earnings. Derivatives that are not designated as hedging instruments are adjusted to fair value through earnings in Other income (expense), net in the unaudited condensed consolidated statements of operations.

The fair values of the Company’s derivative instruments and the line items on the unaudited condensed consolidated balance sheets to which they were recorded as of March 31, 2019 and December 31, 2018 are summarized as follows:
Derivative Assets
 
Balance Sheet
Location
 
March 31,
2019
 
December 31,
2018
 
Balance Sheet
Location
 
March 31,
2019
 
December 31,
2018
 
 
 
 
(In thousands)
 
 
 
(In thousands)
Derivative assets not designated as hedging instruments
 
Prepaid expenses and other current assets
 
$
841

 
$
784

 
Other accrued liabilities
 
$
140

 
$
331

Derivative assets designated as hedging instruments
 
Prepaid expenses and other current assets
 
18

 
2

 
Other accrued liabilities
 
25

 
37

Total
 
 
 
$
859

 
$
786

 
 
 
$
165

 
$
368


Refer to Note 14. Fair Value Measurements, in Notes to Unaudited Condensed Consolidated Financial Statements for detailed disclosures regarding fair value measurements in accordance with the authoritative guidance for fair value measurements and disclosures.

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 on the unaudited condensed consolidated balance sheets.


17

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

The following tables set forth the offsetting of derivative assets as of March 31, 2019 and December 31, 2018:
As of March 31, 2019
 
 
 
 
 
 
 
Gross Amounts Not Offset on the Condensed Consolidated Balance Sheets
 
 
 
Gross Amounts of Recognized Assets
 
Gross Amounts Offset on the Condensed Consolidated Balance Sheets
 
Net Amounts Of Assets Presented on the Condensed Consolidated Balance Sheets
 
Financial Instruments
 
Cash Collateral Pledged
 
Net Amount
 
 
(In thousands)
J.P. Morgan Chase
 
$
429

 
$

 
$
429

 
$
(110
)
 
$

 
$
319

Bank of America
 
156

 

 
156

 

 

 
156

Wells Fargo
 
274

 

 
274

 
(55
)
 

 
219

Total
 
$
859

 
$

 
$
859

 
$
(165
)
 
$

 
$
694


As of December 31, 2018
 
 
 
 
 
 
 
Gross Amounts Not Offset on the Condensed Consolidated Balance Sheets
 
 
 
Gross Amounts of Recognized Assets
 
Gross Amounts Offset on the Condensed Consolidated Balance Sheets
 
Net Amounts Of Assets Presented on the Condensed Consolidated Balance Sheets
 
Financial Instruments
 
Cash Collateral Pledged
 
Net Amount
 
 
(In thousands)
Bank of America
 
$
323

 
$

 
$
323

 
$
(64
)
 
$

 
$
259

Wells Fargo
 
463

 

 
463

 
(298
)
 

 
165

Total
 
$
786

 
$

 
$
786

 
$
(362
)
 
$

 
$
424


The following tables set forth the offsetting of derivative liabilities as of March 31, 2019 and December 31, 2018:
As of March 31, 2019
 
 
 
 
 
 
 
Gross Amounts Not Offset on the Condensed Consolidated Balance Sheets
 
 
 
Gross Amounts of Recognized Liabilities
 
Gross Amounts Offset on the Condensed Consolidated Balance Sheets
 
Net Amounts Of Liabilities Presented on the Condensed Consolidated Balance Sheets
 
Financial Instruments
 
Cash Collateral Pledged
 
Net Amount

 
(In thousands)
J.P. Morgan Chase
 
$
110

 
$

 
$
110

 
$
(110
)
 
$

 
$

Wells Fargo
 
55

 

 
55

 
(55
)
 

 

Total
 
$
165

 
$

 
$
165

 
$
(165
)
 
$

 
$



18

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

As of December 31, 2018
 
 
 
 
 
 
 
Gross Amounts Not Offset on the Condensed Consolidated Balance Sheets
 
 
 
Gross Amounts of Recognized Liabilities
 
Gross Amounts Offset on the Condensed Consolidated Balance Sheets
 
Net Amounts Of Liabilities Presented on the Condensed Consolidated Balance Sheets
 
Financial Instruments
 
Cash Collateral Pledged
 
Net Amount
 
 
(In thousands)
J.P. Morgan Chase
 
$
6

 
$

 
$
6

 
$

 
$

 
$
6

Bank of America
 
64

 

 
64

 
(64
)
 

 

Wells Fargo
 
298

 

 
298

 
(298
)
 

 

Total
 
$
368

 
$

 
$
368

 
$
(362
)
 
$

 
$
6


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 less than six months. The Company enters into about ten forward contracts per quarter with an average size of approximately $7.0 million USD equivalent related to its cash flow hedging program.

The effects of the Company's cash flow hedges on the unaudited condensed statements of operations for the three months ended March 31, 2019 and April 1, 2018 are summarized as follows:
 
 
Location and Amount of Gains (Losses) Recognized in Income on Cash Flow Hedges
 
 
Three Months Ended March 31, 2019
 
Net revenue
 
Cost of revenue
 
Research and development
 
Sales and marketing
 
General and administrative
 
 
(In thousands)
Statements of operations
 
$
249,082

 
$
167,074

 
$
18,832

 
$
35,855

 
$
13,117

Gains (losses) on cash flow hedge
 
$
414

 
$
(2
)
 
$
(26
)
 
$
(69
)
 
$
(11
)

 
 
Location and Amount of Gains (Losses) Recognized in Income on Cash Flow Hedges
 
 
Three Months Ended April 1, 2018
 
Net revenue
 
Cost of revenue
 
Research and development
 
Sales and marketing
 
General and administrative
 
 
(In thousands)
Statements of operations
 
$
245,201

 
$
168,882

 
$
21,191

 
$
37,874

 
$
15,761

Gains (losses) on cash flow hedge
 
$
(1,702
)
 
$
6

 
$
99

 
$
230

 
$
41

 
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 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 expenses in the same period and in the same statements of operations line item 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 (expense), net. Any subsequent changes in fair value of such derivative instruments also are reflected in

19

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

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 March 31, 2019 and April 1, 2018.

The pre-tax effects of the Company’s derivative instruments in OCI and the unaudited condensed consolidated statement of operations for the three months ended March 31, 2019 and April 1, 2018 are summarized as follows:
Derivatives Designated as Hedging Instruments
 
Three Months Ended March 31, 2019
 
Gains (Losses)
Recognized in
OCI -
Effective
Portion
 
Location of
Gains (Losses)
Reclassified from OCI
into Income - Effective
Portion
 
Gains (Losses)
Reclassified
from
OCI into
Income -
Effective
Portion (1)
 
 
(In thousands)
Cash flow hedges:
 
 
 
 
 
 
Foreign currency forward contracts
 
$
329

 
Net revenue
 
$
414

Foreign currency forward contracts
 

 
Cost of revenue
 
(2
)
Foreign currency forward contracts
 

 
Research and development

 
(26
)
Foreign currency forward contracts
 

 
Sales and marketing

 
(69
)
Foreign currency forward contracts
 

 
General and administrative

 
(11
)
Total
 
$
329

 
 
 
$
306

_________________________
(1) Refer to Note 11. Stockholders' Equity, which summarizes the accumulated other comprehensive income activity related to derivatives.

Derivatives Designated as Hedging Instruments
 
Three Months Ended April 1, 2018
 
Gains (Losses)
Recognized in
OCI -
Effective
Portion
 
Location of
Gains (Losses)
Reclassified from OCI
into Income - Effective
Portion
 
Gains (Losses)
Reclassified
from
OCI into
Income -
Effective
Portion (1)
 
 
(In thousands)
Cash flow hedges:
 
 
 
 
 
 
Foreign currency forward contracts
 
$
(634
)
 
Net revenue
 
$
(1,702
)
Foreign currency forward contracts
 

 
Cost of revenue
 
6

Foreign currency forward contracts
 

 
Research and development

 
99

Foreign currency forward contracts
 

 
Sales and marketing

 
230

Foreign currency forward contracts
 

 
General and administrative

 
41

Total
 
$
(634
)
 
 
 
$
(1,326
)
_______________________
(1) Refer to Note 11. 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 ten 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 three months in duration.

20

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


The effects of the Company’s non-designated hedge included in Other income (expense), net in the unaudited condensed consolidated statements of operations for the three months ended March 31, 2019 and April 1, 2018 are as follows:

Derivatives Not Designated as Hedging Instruments
 
Location of Gains (Losses)
Recognized in Income on Derivative
 
Three Months Ended
 
March 31, 2019
 
April 1, 2018
 
 
 
 
(In thousands)
Foreign currency forward contracts
 
Other income (expense), net
 
$
602

 
$
(1,855
)

Note 8.
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 common shares issuable upon exercise of stock options, vesting of restricted stock awards, and issuances of shares under the Employee Stock Purchase Plan (the "ESPP"), which are reflected in diluted net income per share by application of the treasury stock method. Potentially dilutive common shares are excluded from the computation of diluted net income per share when their effect is anti-dilutive.
Net income per share for the three months ended March 31, 2019 and April 1, 2018 are as follows:
 
Three Months Ended
 
March 31,
2019
 
April 1,
2018
 
(In thousands, except per share data)
Numerator:
 
 
 
Net income from continuing operations
$
12,843

 
$
1,018

Net income from discontinued operations

 
4,572

Net income
$
12,843

 
$
5,590

 
 
 
 
Denominator:
 
 
 
Weighted average common shares - basic
31,483

 
31,427

Potentially dilutive common share equivalent
1,391

 
1,233

Weighted average common shares - dilutive
32,874

 
32,660

 
 
 
 
Basic net income per share
 
 
 
Net income from continuing operations
$
0.41

 
$
0.03

Net income from discontinued operations

 
0.15

Net income
$
0.41

 
$
0.18

 
 
 
 
Diluted net income per share


 


Net income from continuing operations
$
0.39

 
$
0.03

Net income from discontinued operations

 
0.14

Net income
$
0.39

 
$
0.17

 
 
 
 
Anti-dilutive employee stock-based awards, excluded
507

 
773




21

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

Note 9.
Income Taxes

The income tax provision (benefit) for the three months ended March 31, 2019 and April 1, 2018, was $2.2 million, or an effective tax rate of 14.7%, and $(86) thousand, or an effective tax rate of (9.2)%, respectively. The increase in the effective tax rate for the three months ended March 31, 2019, compared to the three months ended April 1, 2018, resulted primarily from higher pre-tax earnings compared to the three months ended April 1, 2018. The effective tax rate for the period ended March 31, 2019 included a one-time benefit related to the closing of the French tax audit whereas the period ended April 1, 2018 included  benefits from stock based compensation transactions accounted for as discrete benefits during the period.
  
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 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 $0.8 million, excluding the interest, penalties and the effect of any related deferred tax assets or liabilities.

Note 10.
Commitments and Contingencies

Leases

The Company leases office space, cars, distribution centers 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. Lease expense is recognized on a straight-line basis over the lease term. For further details, refer to Note 15. Leases.
 
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. For those orders not governed by master purchase agreements, the commitments are governed by the commercial terms on the Company's purchase orders subject to acknowledgment from its suppliers. As of March 31, 2019, the Company had approximately $169.8 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.

Non-Trade Commitments

As of March 31, 2019, the Company had long term, non-cancellable purchase commitments of $17.4 million pertaining to non-trade activities.


22

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

Warranty Obligations
Changes in the Company’s warranty obligations, which is included in Other accrued liabilities on the unaudited condensed consolidated balance sheets, are as follows:
 
Three Months Ended
 
March 31,
2019
 
April 1,
2018
 
 
(In thousands)
 
Balance as of beginning of the period
$
14,412

 
$
44,068

 
Reclassified to sales returns upon adoption of ASC 606

 
(29,147
)
*
Provision for warranty obligation made during the period
1,281

 
3,844

 
Settlements made during the period
(3,162
)
 
(3,273
)
 
Balance at end of period
$
12,531

 
$
15,492

 
________________________
* Upon adoption of ASC 606 on January 1, 2018, certain warranty reserve balances totaling $29.1 million were reclassified to sales returns as these liabilities are payable to the Company's customers and settled in cash or by credit on account. Under ASC 606, these amounts are to be accounted for as sales with right of return.

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 March 31, 2019.

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. The Company believes the estimated fair value of these agreements is minimal. Accordingly, the Company has no liabilities recorded for these agreements as of March 31, 2019.


23

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

Employment Agreements

The Company has signed various change in control and severance agreements with key executives. Upon a termination without cause or resignation with good reason, executive officers would be entitled to (1) cash severance equal to the executive officer’s annual base salary, and, for the Chief Executive Officer, an additional amount equal to his target annual bonus, (2) 12 months of health benefits continuation and (3) accelerated vesting of any unvested equity awards that would have vested during the 12 months following the termination date. Upon a termination without cause or resignation with good reason that occurs during the one month prior to or 12 months following a change in control of the Company, executive officers would be entitled to (1) cash severance equal to a multiple (2x for the Chief Executive Officer and 1x for all other executive officers) of the sum of the executive officer’s annual base salary and target annual bonus, (2) a number of months (24 for the Chief Executive Officer and 12 for other executive officers) of health benefits continuation and (3) accelerated vesting of all outstanding, unvested equity awards. Severance will be conditioned upon the execution and non-revocation of a release of claims. The change in control and severance agreements will not provide for any excise tax gross ups. If the merger-related payments or benefits of the executive officer are subject to the 20% excise tax under Section 4999 of the tax code, then the executive officer will either receive all such payments and benefits subject to the excise tax or such payments and benefits will be reduced so that the excise tax does not apply, whichever approach yields the best after-tax outcome for the executive officer. The Company has no liabilities recorded for these agreements as of March 31, 2019.

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.


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 encompassed 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. On June 13, 2016, the Inland Revenue Agency appealed the decision to the Supreme Court. The Company filed a counter appeal on July 23, 2016 and is awaiting scheduling of the hearing.


24

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

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 2006 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 filed its appeal with the Regional Tax Court. The Company filed its counter brief on September 30, 2016 and the hearing was held on March 22, 2017. A decision favorable to the Company was issued by the Court on July 5, 2017. The Italian Tax Authority has appealed the decision to the Supreme Court and the Company has responded with a counter appeal brief on December 3, 2017 and awaits scheduling of the hearing.

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 filed its appeal to the Regional Tax Court and the Company has submitted its counter brief. The hearing was held on November 17, 2017 and the Company received a positive decision on December 11, 2017. On June 11, 2018, the Italian government filed its appeal brief with the Supreme Court, and the Company filed its counter brief on July 12, 2018 and awaits scheduling the hearing.

With respect to 2008 through 2010, the Company filed its appeal briefs with the Provincial Tax Court in October 2015 and the hearing for the validity of the tax assessments was held on April 21, 2016. A decision favorable to the Company was issued on May 12, 2016. The Inland Revenue Agency has filed its appeal to the Regional Tax Court. The Company filed its counter brief on February 5, 2017. The hearing was held on May 21, 2018, and the Company received a favorable decision on June 12, 2018. The decision has yet to be served to the Tax Office. The enactment of recent legislative actions that introduced a tax amnesty program (Law n.136/2018) had the effect of suspending the deadline to appeal the Court decision for nine months. Accordingly, this effectively extended the Tax Office deadline for filing its appeal from January 12, 2019 to November 19, 2019.

With respect to 2011 through 2012, the Company has filed its appeal brief on February 26, 2016 with the Provincial Tax Court to contest the relevant tax assessments. The hearing for suspension was held and the Request for Suspension of payment was granted. On October 13, 2016, the Company filed its final brief with the Provincial Tax Court. The hearing was held on October 24, 2016 and a decision favorable to the Company was issued by the Court. The Inland Revenue Agency appealed the decision before the Regional Tax Court. The Regional Tax Court heard the case on February 26, 2019 for both years and issued a decision favorable to the Company on March 11, 2019. The decision has not yet been served to the Tax Office. Once served, the Tax Office will have until October 14, 2019 to appeal the decision to the Supreme Court..

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,

25

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

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. In early March of 2017, The Patent Trial and Appeal Board (PTAB) issued various decisions regarding Amazon’s and Blizzard’s IPRs of the patents in suit. One of the IPRs of the '125 patent resulted in a finding by the PTAB that Amazon and Blizzard had had failed to show invalidity. The second IPR on the '125 patent, however, resulted in cancellation of all claims asserted in Via Vadis’s suit against the Company. Reissue '521 did not have any claims found invalid by the PTAB, and some dependent claims of the '680 patent survived the IPRs, and some claims of the '680 patent were canceled. Via Vadis has completed its appeal of the PTAB decisions on the IPRs, which were affirmed by the Federal Circuit. Meanwhile, the W.D. Texas Court issued a claim construction order finding the '680 patent indefinite. The parties in the W.D. of Texas case are seeking to lift the stay in their case. The Northern District of California case against the Company remains stayed.

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

Chrimar Systems, Inc. v NETGEAR, Inc.

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

The patents-in-suit relate to using or embedding an electrical DC current or signal into an existing Ethernet communication link in order to transmit additional data about the devices on the communication link, and the specifications for the patents are identical. It appears that 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 the Company'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 occurred on May 13, 2016, and on August 19, 2016, the parties exchanged preliminary claim constructions and extrinsic evidence. On August 26, 2016, the Company and three defendants in other Northern District of California CMS cases (Juniper Networks, Inc., Ruckus Wireless, Inc., and Fortinet, Inc.) submitted motions to stay their cases. The defendants in part argued that stays were appropriate pending the resolution of the currently-pending IPRs of the patents-in-suit before the Patent Trial and Appeal Board (PTAB), including four IPR Petitions filed by Juniper. On September 9, 2016, CMS submitted its opposition to the motions to stay the cases. On September 26, 2016, the Court ordered the cases stayed in their entirety, until the PTAB reaches institution decisions with respect to Juniper’s four pending IPR petitions. Juniper’s four IPR petitions were instituted by the PTAB in January 2017, and the Company subsequently moved to join the IPR petitions as an “understudy” to Juniper, only assuming a more active role in the petitions in the event Juniper settles with CMS. For all four patents in suit against the Company, the PTAB ordered that (a) the Petitioners’ (the Company, Ruckus, and Brocade) Motion for Joinder to the Juniper IPRs is granted; (b) the Petitioners IPRs are instituted on the same grounds as in the Juniper ‘IPRs and Petitioners are joined with the Juniper IPRs; and (c) all further filings by Petitioners in the joined proceedings will be in the Juniper IPRs. On December 21, 2017, the PTAB issued the first of the four Final Written Decisions in the IPRs filed by the Company on the patents in suit, ruling that the claims of the ‘107 Patent asserted by Chrimar were invalid. This was quickly followed by two more Final Written Decisions -- on January 3, 2018, the ’838 patent’s asserted claims were ruled invalid, and on January 23, 2018 the ‘012 patent’s asserted claims were ruled invalid.

26

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

Chrimar has 30 days from each Final Written Decision to seek a rehearing at the PTAB and 63 days from each to file an appeal. On April 26, 2018, the PTAB issued its decision invalidating all of the claims of the ‘760 patent challenged in the IPR. The PTAB’s reasoning was similar to the reasoning set forth in the PTAB’s previous decisions on the 012, 107 and 838 patents. The ‘760 patent claims were, however, amended by Chrimar during the pendency of the ‘760 IPR, and the PTAB did not rule on the validity of the amended claims, as they were not challenged in the original IPR Petitions (they couldn’t have been because the Chrimar amendments had not yet happened). On June 6, 2018, Chrimar's appeals on all 4 written decisions by the USPTO invalidating all challenged claims were consolidated. The parties have completed briefing the matter and are awaiting schedule for oral argument before the Federal Circuit.

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

Vivato v. NETGEAR, Inc.

On April 19, 2017, the Company was sued by XR Communications (d/b/a) Vivato (“Vivato”) in the United States District Court, Central District of California.

Based on its complaint, Vivato purports to be a research and development and product company in the WiFi area, but it appears that Vivato is not currently a manufacturer of commercial products. The three (3) patents that Vivato asserts against the Company are U.S. Patent Nos. 7,062,296, 7,729,728, and 6,611,231. The ’296 and ’728 patents are entitled “Forced Beam Switching in Wireless Communication Systems Having Smart Antennas.” The ’231 patent is entitled “Wireless Packet Switched Communication Systems and Networks Using Adaptively Steered Antenna Arrays.” Vivato also has recently asserted the same patents in the Central District of California against D-Link, Ruckus, and Aruba, among others.

According to the complaint, the accused products include WiFi access points and routers supporting MU-MIMO, including without limitation access points and routers utilizing the IEEE 802.11ac-2013 standard. The accused technology is standards-based, and more specifically, based on the transmit beamforming technology in the 802.11ac WiFi standard.

The Company answered an amended complaint on July 7, 2017. In its answer, the Company objected to venue and recited that objection as a specific affirmative defense, so as to expressly reserve the same. The Company also raised several other affirmative defenses in its answer.

On August 28, 2017, the Company submitted its initial disclosures to the plaintiff. The initial scheduling conference was on October 2, 2017, and the Court set five day jury trial for March 19, 2019 for the leading Vivato/D-Link case, meaning the Company’s trial date will be at some point after March 19, 2019.

On March 20, 2018, the Company and other defendants in the various Vivato cases moved the Court to stay the case pending various IPRs filed on all of the patents in suit. Every asserted claim of all three patents-in-suit is now subject to challenge in IPRs that are pending before the U.S. Patent and Trial Appeal Board (“PTAB”). In particular, the Company, Belkin, and Ruckus are filing one set of IPRs on the three patents in suit; Cisco is filing another set of independent IPRs on the three patents in suit; and Aruba is filing yet another set of independent IPRs on the three patents in suit. On April 11, 2018, the Court granted the motion to stay pending filing of the IPRs. On May 3, 2018, the Company and other defendants filed their IPRs. The PTAB instituted the IPRs for the ’296 and ’728 patents, but not the ’231 patent from the Ruckus and Belkin set of petitions. However, the Cisco IPR for the ’231 patent was instituted. Vivato has proposed amendments to its claims and the parties are currently briefing the matter before the PTAB. The District Count case remains stayed.

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

27

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


Hera Wireless v. NETGEAR, Inc.

On July 14, 2017, the Company was sued by Sisvel (via Hera Wireless) in the District of Delaware on three related patents allegedly covering the 802.11n standard. Similar complaints were filed against Amazon, ARRIS, Belkin, Buffalo, and Roku. On December 12, 2017, the Company answered the complaint, denying why each claim limitation of the patents in suit were allegedly met and asserting various affirmative defenses, including invalidity and noninfringement. A proposed joint Scheduling Order was submitted to the Court on January 24, 2018 with trial proposed for March of 2020.
 
On February 27, 2018, Hera Wireless identified the accused products and the asserted claims, alleging that any 802.11n compliant product infringes, and identified only the Company’s Orbi and WND930 products with particularity. Hera Wireless’ infringement contentions were submitted on April 28, 2018. Discovery is ongoing.

On June 28, 2018, the Company and other defendants submitted invalidity contentions. The Company along with other defendants jointly filed IPRs challenging 3 of the patents in suit on July 18, 2018. On September 14, 2018, the Company and other defendants jointly filed a second set of IPRs with the USPTO challenging the remaining 6 patents asserted in the Amended Complaint. The USPTO has instituted IPRs on five of the patents-in-suit and the Company is awaiting institution decisions on the other four patents. The District Court case has been stayed pending outcome of the IPRs.

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

Fischer v. NETGEAR, Inc.

On June 4, 2018, Plaintiff Rob Fischer filed a purported class-action complaint in the Circuit Court of Cook County, Ill, alleging the Company’s Range Extender does not extend the range of a consumer’s WiFi network as shown in a diagram in a data sheet. On August 3, 2018, the Company filed a motion to dismiss the case and a hearing was held on November 29, 2018, where the motion was denied. The Company filed its Answer on December 27, 2018. The parties are conducting routine discovery.

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

Modern Telecom Systems (MTS) v. NETGEAR, Inc.

On August 3, 2018, Plaintiff MTS filed a patent infringement lawsuit against NETGEAR in the District of Delaware. MTS accuses all of NETGEAR’s routers that are compliant with those 802.11 standards of infringing U.S. Patent No. 6,504,886 (“the ’886 Patent”), and specifically identifies NETGEAR’s Nighthawk X10 Smart WiFi Router. The Company filed its Answer on January 4, 2019.

The Company’s case was consolidated with ARRIS / Ruckus and Brother. In March 2019, the Company joined a motion for judgment on the pleadings that the patent-in-suit is invalid under Section 101 led by Arris.

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

Mentone Solutions v. NETGEAR, Inc.

On October 31, 2018, Mentone Solutions LLC filed a patent infringement suit against the Company in the District of Delaware, alleging infringement of U.S. Patent No. 6,952,413 (the ’413 patent). Mentone alleges NETGEAR’s LTE Modem LB2120 device, and in particular the device’s dual carrier HSPA+ (“DC-HSPA+”) capability infringes the ’413 patent. The Company filed its Answer on February 21, 2019.

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


28

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

John Pham v. Arlo Technologies, Inc., NETGEAR Inc., et al., and other related actions

On January 9, 2019 and January 10, 2019, February 1, 2019 and February 8, 2019, the Company was sued in four separate securities class action suits in Superior Court of California, County of Santa Clara, along with Arlo Technologies, individuals, and underwriters involved in the spin-off of Arlo. Two more similar state actions have been filed against Arlo Technologies Inc. et al.. In total, six putative class action complaints have now been filed in California state court in Santa Clara County.  The Company is named as a defendant in five of the six lawsuits.  The complaints generally allege that Arlo’s IPO materials contained false and misleading statements, hiding problems with Arlo’s Ultra product.  These claims are styled as violations of Sections 11, 12(a), and 15 of the Securities Act of 1933.

There is also a putative class action pending in federal court in the Northern District of California, on behalf of the same class of plaintiffs, making very similar claims.  The Company is not presently named in the federal action. Defendants are planning to file motions to stay the state court actions in deference to the federal court action.  There will be a hearing in state court on April 26, 2019, where the court will consider whether to consolidate the six lawsuits and appoint a “lead plaintiff.”  The Company is opposing the appointment of a lead plaintiff in the state court actions.  There will be another hearing on May 31, 2019 to consider defendants’ motions to stay the state court cases.

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

Note 11.
Stockholders' Equity

Stock Repurchases

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. As of March 31, 2019, 1.0 million shares remained authorized for repurchase under the repurchase program. The Company repurchased, reported based on trade date, 0.4 million shares of common stock at a cost of $15.0 million under the repurchase authorization during the three months ended March 31, 2019. The Company did not repurchase any shares of common stock under the authorizations during the three months ended April 1, 2018.

The Company repurchased, as reported based on trade date, approximately 89,000 shares of common stock at a cost of $3.3 million to administratively facilitate the withholding and subsequent remittance of personal income and payroll taxes for individuals receiving RSUs during the three months ended March 31, 2019. Similarly, during the three months ended April 1, 2018, the Company repurchased, as reported based on trade date, approximately 38,000 shares of common stock at a cost of $2.3 million to facilitate tax withholding for RSUs.

These shares were retired upon repurchase. The Company’s policy related to repurchases of its common stock is to charge the excess of cost over par value to retained earnings. All repurchases were made in compliance with Rule 10b-18 under the Securities Exchange Act of 1934, as amended.


29

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

Accumulated Other Comprehensive Income (Loss)

The following table sets forth the changes in accumulated other comprehensive income ("AOCI") by component for the three months ended March 31, 2019 and April 1, 2018:

 
Unrealized gains (losses) on available-for-sale securities
 
Unrealized gains (losses) on derivatives
 
Estimated tax benefit (provision)
 
Total
 
(In thousands)
Balance as of December 31, 2018
$
(18
)
 
$
(8
)
 
$
11

 
$
(15
)
Other comprehensive income (loss) before reclassifications
15

 
329

 
(73
)
 
271

Less: Amount reclassified from accumulated other comprehensive income

 
306

 
(64
)
 
242

Net current period other comprehensive income (loss)
15

 
23

 
(9
)
 
29

Balance as of March 31, 2019
$
(3
)
 
$
15

 
$
2

 
$
14



 
Unrealized gains (losses) on available-for-sale securities
 
Unrealized gains (losses) on derivatives
 
Estimated tax benefit (provision)
 
Total
 
(In thousands)
Balance as of December 31, 2017
$
(146
)
 
$
(838
)
 
$
133

 
$
(851
)
Other comprehensive loss before reclassifications
(38
)
 
(1,500
)
 
388

 
(1,150
)
Less: Amount reclassified from accumulated other comprehensive income

 
(2,192
)
 
460

 
(1,732
)
Net current period other comprehensive income (loss)
(38
)
 
692

 
(72
)
 
582

Balance as of April 1, 2018
$
(184
)
 
$
(146
)
 
$
61

 
$
(269
)

30

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


The following tables provide details about significant amounts reclassified out of each component of AOCI for the three months ended March 31, 2019 and April 1, 2018:

Details about Accumulated Other Comprehensive Income Components
 
Three Months Ended March 31, 2019
 
Amount Reclassified from AOCI
 
Affected Line Item in the Statements of Operations
 
 
(In thousands)
 
 
Gains (losses) on cash flow hedge:
 
 
 
 
Foreign currency forward contracts
 
$
414

 
Net revenue
Foreign currency forward contracts
 
(2
)
 
Cost of revenue
Foreign currency forward contracts
 
(26
)
 
Research and development
Foreign currency forward contracts
 
(69
)
 
Sales and marketing
Foreign currency forward contracts
 
(11
)
 
General and administrative
 
 
306

 
Total from continuing operations before tax
 
 
(64
)
 
Tax impact from continuing operations
 
 
242

 
Total, from continuing operations net of tax
 
 

 
Total, from discontinued operations net of tax
 
 
$
242

 
Total, net of tax


Details about Accumulated Other Comprehensive Income Components
 
Three Months Ended April 1, 2018
 
Amount Reclassified from AOCI
 
Affected Line Item in the Statements of Operations
 
 
(In thousands)
 
 
Gains (losses) on cash flow hedge:
 
 
 
 
Foreign currency forward contracts
 
$
(1,702
)
 
Net revenue
Foreign currency forward contracts
 
6

 
Cost of revenue
Foreign currency forward contracts
 
99

 
Research and development
Foreign currency forward contracts
 
230

 
Sales and marketing
Foreign currency forward contracts
 
41

 
General and administrative
 
 
(1,326
)
 
Total from continuing operations before tax
 
 
278

 
Tax impact from continuing operations
 
 
(1,048
)
 
Total, from continuing operations net of tax
 
 
(684
)
 
Total, from discontinued operations net of tax
 
 
$
(1,732
)
 
Total, net of tax

Note 12.
Employee Benefit Plans

The Company grants options and RSUs under the 2016 Incentive Plan (the "2016 Plan"), under which awards may be granted to all employees. Award vesting periods for this plan are generally four years. In January 2019, the Company received the approval from its Compensation Committee to increase the number of shares that the Company may issue under the 2016 plan to a new total of 3.1 million shares, pursuant to the adjustment provisions of the 2016 Plan as a result of the Distribution. As of March 31, 2019, approximately 3.0 million shares were reserved for future grants under the 2016 Plan.

Additionally, the Company sponsors an Employee Stock Purchase Plan (the “ESPP”), pursuant to which eligible employees may contribute up to 10% of compensation, subject to certain income limits, to purchase shares of the Company’s common stock. 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

31

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

offering period is generally six-months. As of March 31, 2019, approximately 0.7 million shares were available for issuance under the ESPP.

Option Activity

Stock option activity during the three months ended March 31, 2019 was as follows:
 
Number of shares
 
Weighted Average Exercise Price Per Share
 
(In thousands)
 
(In dollars)
Outstanding as of December 31, 2018
1,969

 
$
25.30

Exercised
(100
)
 
$
20.76

Outstanding as of March 31, 2019
1,869

 
$
25.54


RSU Activity

RSU activity during the three months ended March 31, 2019 was as follows:
 
Number of shares
 
Weighted Average Grant Date Fair Value Per Share
 
(In thousands)
 
(In dollars)
Outstanding as of December 31, 2018
1,627

 
$
34.31

Granted
25

 
$
39.36

Vested
(255
)
 
$
34.65

Cancelled
(12
)
 
$
34.77

Outstanding as of March 31, 2019
1,385

 
$
34.33


Valuation and Expense Information
The Company measures stock-based compensation at the grant date based on the estimated fair value of the award. Estimated compensation cost relating to RSUs is based on the closing fair market value of the Company’s common stock on the date of grant. The fair value of options granted and the purchase rights granted under the ESPP 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 of options granted and the purchase rights granted under the ESPP 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 of options granted and the purchase rights granted under the ESPP is based on historical volatility over the most recent period commensurate with the estimated expected term.

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

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 during the three months ended March 31, 2019 and April 1, 2018.
 
Three Months Ended
 
Stock Options
 
ESPP
 
March 31,
2019
 
April 1,
2018
 
March 31,
2019
 
April 1,
2018
Expected life (in years)
N/A
 
4.4

 
0.5

 
0.5

Risk-free interest rate
N/A
 
2.32
%
 
2.49
%
 
1.81
%
Expected volatility
N/A
 
30.9
%
 
42.6
%
 
37.1
%