You should read the following discussion of our financial condition and results
of operations together with the audited consolidated financial statements and
notes to the financial statements included elsewhere in this Annual Report on
Form 10-K. This discussion contains forward-looking statements that involve
risks and uncertainties. The forward-looking statements are not historical
facts, but rather are based on current expectations, estimates, assumptions and
projections about our industry, business and future financial results. Our
actual results could differ materially from the results contemplated by these
forward-looking statements due to a number of factors, including those discussed
under "Risk Factors" in Part I, Item 1A above.

Business and Executive Overview



Arlo combines an intelligent cloud infrastructure and mobile app with a variety
of smart connected devices that transform the way people experience the
connected lifestyle. Our cloud-based platform provides users with visibility,
insight and a powerful means to help protect and connect in real-time with the
people and things that matter most, from any location with a Wi-Fi or a cellular
connection. Since the launch of our first product in December 2014, we have
shipped over 15.8 million smart connected devices, and, as of December 31, 2019,
our smart platform had approximately 4.02 million cumulative registered accounts
across more than 100 countries around the world.

We conduct business across three geographic regions-the Americas; Europe,
Middle-East and Africa ("EMEA"); and Asia Pacific ("APAC") and we primarily
generate revenue by selling devices through retail, wholesale distribution and
wireless carrier channels and paid subscription services through in-app
purchases. International revenue was 48.6%, 22.6% and 24.6% of our revenue for
the years ended December 31, 2019, 2018 and 2017, respectively.

For the years ended December 31, 2019, 2018 and 2017, we generated revenue of
$370.0 million, $464.9 million and $370.7 million, respectively. Loss from
operations was $85.2 million for the year ended December 31, 2019 compared with
Loss from operations of $74.8 million for the year ended December 31, 2018 and
Income from operations of $5.7 million for the year ended December 31, 2017.
Income (loss) from operations for the year ended December 31, 2019, 2018 and
2017 included separation expense of $1.9 million, $27.3 million, and
$1.4 million, respectively.

Our goal is to continue to develop innovative, world-class connected lifestyle
solutions to expand and further monetize our current and future user and
subscriber bases. We believe that the growth of our business is dependent on
many factors, including our ability to innovate and launch successful new
products on a timely basis and grow our installed base, to increase
subscription-based recurring revenue, to invest in brand awareness and channel
partnerships and to continue our global expansion. We expect to maintain our
investment in research and development going forward as we continue to introduce
new and innovative products and services to enhance the Arlo platform.

Key Business Metrics



In addition to the measures presented in our consolidated financial statements,
we use the following key metrics to evaluate our business, measure our
performance, develop financial forecasts and make strategic decisions. In
addition, management's incentive compensation is partially determined using
certain of these key business metrics. We believe these key business metrics
provide useful information by offering the ability to make more meaningful
period-to-period comparisons of our on-going operating results and a better
understanding of how management plans and measures our underlying business. Our
key business metrics may be calculated in a manner different from the same key
business metrics used by other companies. We regularly review our processes for
calculating these metrics, and from time to time we may discover inaccuracies in
our metrics or make adjustments to better reflect our business or to improve
their accuracy, including adjustments that may result in the recalculation of
our historical metrics. We believe that any such inaccuracies or adjustments are
immaterial unless otherwise stated.

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                                          As of and for the Year Ended December 31, (1)
                                    2019       % Change        2018       % Change       2017
                                             (In thousands, except percentage data)
Cumulative registered accounts      4,015         40.9  %      2,850         70.7 %      1,670
Cumulative paid accounts              230         59.7  %        144         84.6 %         78
Devices shipped for the period      4,060        (20.2 )%      5,086        

34.9 % 3,770

_________________________


(1) Starting with this Annual Report Form 10-K, Service Revenue is included as a
line item in the consolidated statement of operations in Item 8 of Part II of
this Annual Report on Form 10-K.

Cumulative Registered Accounts. We believe that our ability to increase our user
base is an indicator of our market penetration and growth of our business as we
continue to expand and innovate our Arlo platform. We define our registered
accounts at the end of a particular period as the number of unique registered
accounts on the Arlo platform as of the end of such particular period. The
number of registered accounts does not necessarily reflect the number of
end-users on the Arlo platform, as one registered account may be used by
multiple people. We have changed our definition from registered users to
registered accounts due to the Verisure transaction, Verisure will own the
registered accounts but we will continue to provide services to these European
customers under the Verisure Agreements.

Paid Accounts. Paid accounts worldwide measured as any account where a
subscription to a paid service is being collected (either by the Company or by
the Company's customers or channel partners), plus paid service plans of a
duration of more than 3 months bundled with products (such bundles being counted
as a paid account after 90 days have elapsed from the date of registration).
During the second quarter of 2019, we factored in an adjustment to the first
quarter of 2019 paid account number and have subsequently revised the first
quarter of 2019 paid accounts total to 162,000. We have redefined paid
subscribers as paid accounts to include customers that were transferred to
Verisure as part of the disposal of our commercial operations in Europe because
we will continue to provide services to these European customers and receive
payments under the Verisure Agreements.

Devices Shipped. Devices shipped represents the number of Arlo cameras, lights,
and doorbells that are shipped to our customers during a period. Devices shipped
does not include shipments of Arlo accessories and Arlo base stations, nor does
it take into account returns of Arlo cameras, lights, and doorbells. The growth
rate of our revenue is not necessarily correlated with our growth rate of
devices shipped, as our revenue is affected by a number of other variables,
including but not limited to returns from customers, end-user customer rebates
and other channel sales incentives deemed to be a reduction of revenue per the
authoritative guidance for revenue recognition, sales of accessories, and
premium services, the types of Arlo products sold during the relevant period and
the introduction of new product offerings that have different U.S.
manufacturer's suggested retail prices.

Comparability of Historical Results



The operating results of Arlo have historically been disclosed as a reportable
segment within the consolidated financial statements of NETGEAR, enabling the
identification of directly attributable transactional information, functional
departments, and headcount. Through July 1, 2018, Revenue and Cost of revenue,
with the exception of channel sales incentives, were derived from transactional
information specific to Arlo products and services. Directly attributable
operating expenses were derived from activities relating to Arlo functional
departments and headcount. Arlo employees also historically participated in
NETGEAR's stock-based incentive plans, in the form of restricted stock units
("RSUs"), stock options, and purchase rights issued pursuant to NETGEAR's
employee stock purchase plan. Stock-based compensation expense has been either
directly reported by or allocated to Arlo based on the awards and terms
previously granted to NETGEAR's employees.

The consolidated statements of operations of the Company as presented reflect
the directly attributable transactional information specific to Arlo and certain
additional allocated costs through July 1, 2018. The allocated costs for
corporate functions included, but were not limited to, allocations of general
corporate expenses from NETGEAR including expenses related to corporate
services, such as executive management, information technology, legal, finance
and accounting,

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human resources, tax, treasury, research and development, sales and marketing,
shared facilities and other shared services. These costs were allocated based on
revenue, headcount, or other measures the Company has determined as reasonable.
Following July 1, 2018, the consolidated financial statements include the
accounts of the Company and its wholly-owned subsidiaries.

The amount of these allocations from NETGEAR reflected within operating expenses
in the consolidated statements of operations was $30.6 million from January 1,
2018 to the date of the completion of the IPO, which included $9.4 million for
research and development, $10.0 million for sales and marketing, and $11.2
million for general and administrative expense. For the year ended December 31,
2017, allocations amounted to $40.0 million, which included $11.8 million for
research and development, $13.1 million for sales and marketing and $15.1
million for general and administrative expense.

The management of Arlo believes the assumptions underlying the consolidated financial statements, including the assumptions regarding the allocated expenses, reasonably reflect the utilization of services provided, or the benefit received by Arlo during the periods presented. Nevertheless, the consolidated financial statements may not be indicative of Arlo's future performance and do not necessarily reflect Arlo's results of operations, financial position, and cash flows had Arlo been a standalone company during the periods presented.



Our Relationship with NETGEAR

On August 2, 2018, in connection with the IPO, the Company entered into a master
separation agreement, a transition services agreement, an intellectual property
rights cross-license agreement, a tax matters agreement, an employee matters
agreement, and a registration rights agreement, in each case with NETGEAR, which
effect the Separation, provide a framework for the Company's relationship with
NETGEAR after the Separation and provide for the allocation between NETGEAR and
the Company of NETGEAR's assets, employees, liabilities and obligations
(including its investments, property and employee benefits assets and
liabilities) attributable to periods prior to, at and after the Separation.

NETGEAR has provided certain of the services on a transitional basis following
the Distribution pursuant to the Transition Services Agreement ("NETGEAR TSA").
Under the NETGEAR TSA, NETGEAR charges a fee that is consistent with our
historical allocation for such services. During the year ended December 31,
2018, we incurred $6.3 million in NETGEAR TSA related costs, which included $0.4
million for research and development, $1.6 million for sales and marketing, and
$4.3 million for general and administrative expense. During the year ended
December 31, 2019, we incurred $0.7 million in NETGEAR TSA related costs, which
included $0.1 million for cost of revenue, $0.3 million for research and
development, $0.1 million for sales and marketing, and $0.2 million for general
and administrative expense. We do not expect to incur any NETGEAR TSA related
costs during fiscal year 2020.

In addition, to operate as a standalone company, we incurred costs to replace
certain services that were previously provided by NETGEAR, which were higher
than those reflected in our historical combined financial statements. The most
significant component of these costs was IT-related costs, including capital
expenditures, to implement certain new systems, including infrastructure and an
enterprise resource planning system. As of December 31, 2018, we have fully
completed the implementation of these new systems.

We are subject to the reporting requirements of the Exchange Act, and we are
required to establish procedures and practices as a standalone public company in
order to comply with our obligations under the Exchange Act and related rules
and regulations, as well as rules of the New York Stock Exchange. As a result,
we will continue to incur additional costs, including internal audit, investor
relations, stock administration, and regulatory compliance costs. These
additional costs may differ from the costs that were historically allocated to
us by NETGEAR.

Components of Our Operating Results

Revenue


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Our gross revenue consists primarily of sales of devices and prepaid and paid
subscription service revenue. We generally recognize revenue from product sales
at the time the product is shipped and transfer of control from us to the
customer occurs. Our prepaid services primarily pertain to devices which are
sold with our Arlo prepaid services offering, providing users with the ability
to store and access data for up to five cameras for a rolling seven-day period,
one-year free subscription for basic services. Prepaid services also include one
year of Arlo Smart bundled with our for our Arlo Ultra products launched in
early 2019, and three-month free subscription for Arlo Smart services for our
Arlo Pro 3 products launched in late September 2019 and Arlo Video Doorbell
launched in late November 2019. Upon device shipment, we attribute a portion of
the sales price to the prepaid service, deferring this revenue at the outset and
subsequently recognizing it ratably over the estimated useful life of the device
or free trial period, as applicable. Our paid subscription services relate to
sales of subscription plans to our registered accounts.

Our revenue consists of gross revenue, less end-user customer rebates and other
channel sales incentives deemed to be a reduction of revenue per the
authoritative guidance for revenue recognition, allowances for estimated sales
returns, price protection, and net changes in deferred revenue. A significant
portion of our marketing expenditure is with customers and is deemed to be a
reduction of revenue under authoritative guidance for revenue recognition.

Under the Supply Agreement, Verisure became the exclusive distributor of our
products in Europe for all channels, and will non-exclusively distribute our
products through its direct channels globally. Revenue associated with the NRE
arrangement under the Supply Contract is not significant for the year ended
December 31, 2019. We expect that our revenue and profitability in Europe will
improve over the life of the Supply Agreement.

We expect that our revenue and gross margin for the first half of 2020 will be
negatively impacted by delayed delivery of components from suppliers located in
regions affected by COVID-19 and other potential impacts of COVID-19 on our
operations.

Cost of Revenue



Cost of revenue consists of both product costs and costs of service. Product
costs primarily consist of: the cost of finished products from our third-party
manufacturers; overhead costs, including purchasing, product planning, inventory
control, warehousing and distribution logistics, third-party software licensing
fees, inbound freight, warranty costs associated with returned goods,
write-downs for excess and obsolete inventory, royalties to third parties; and
amortization expense of certain acquired intangibles. Cost of service consists
of costs attributable to the provision and maintenance of our cloud-based
platform, including personnel, storage, security, and computing.

Our cost of revenue as a percentage of revenue can vary based upon a number of
factors, including those that may affect our revenue set forth above and factors
that may affect our cost of revenue, including, without limitation: product mix,
sales channel mix, registered user acceptance of paid subscription service
offerings, fluctuation in foreign exchange rates and changes in our cost of
goods sold due to fluctuations in prices paid for components, net of vendor
rebates, cloud platform costs, warranty and overhead costs, inbound freight and
duty product conversion costs, charges for excess or obsolete inventory, and
amortization of acquired intangibles. We outsource our manufacturing,
warehousing, and distribution logistics. We also outsource certain components of
the required infrastructure to support our cloud-based back-end IT
infrastructure. We believe this outsourcing strategy allows us to better manage
our product and services costs and gross margin.


Research and Development



Research and development expense consists primarily of personnel-related
expense, safety, security, regulatory services and testing, other research and
development consulting fees, and corporate IT and facilities overhead. We
recognize research and development expense as it is incurred. We have invested
in and expanded our research and development organization to enhance our ability
to introduce innovative products and services. We believe that innovation and
technological leadership are critical to our future success, and we are
committed to continuing a significant level of research and development to
develop new technologies, products, and services, including our hardware
devices, cloud-based software,

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AI-based algorithms, and machine learning capabilities. We expect research and
development expense to stay relatively flat in absolute dollars as we manage our
expenses while continuing to develop new product and service offerings to
support the connected lifestyle market. We expect research and development
expense to fluctuate depending on the timing and number of development
activities in any given period, and such expense could vary significantly as a
percentage of revenue, depending on actual revenue achieved in any given period.

Sales and Marketing



Sales and marketing expense consists primarily of personnel expense for sales
and marketing staff; technical support expense; advertising; trade shows;
corporate communications and other marketing expense; product marketing expense;
IT and facilities overhead; outbound freight costs; and amortization of certain
intangibles. We expect our sales and marketing expense to fluctuate based on the
seasonality of our business for the foreseeable future.

General and Administrative



General and administrative expense consists primarily of personnel-related
expense for certain executives, finance and accounting, investor relations,
human resources, legal, information technology, professional fees, corporate IT
and facilities overhead, strategic initiative expense, and other general
corporate expense. We expect our general and administrative expense to
moderately decrease in absolute dollars. However, we also expect our general and
administrative expense to fluctuate as a percentage of our revenue in future
periods based on fluctuations in our revenue and the timing of such expense.

Separation Expense



Separation expense consists primarily of costs associated with our separation
from NETGEAR, including third-party advisory, consulting, legal and professional
services for separation matters including IPO-related litigation, IT-related
expenses directly related to our separation from NETGEAR, and other items that
are incremental and one-time in nature. To operate as a standalone company, we
have incurred separation costs of $27.3 million and $1.9 million during the
years ended December 31, 2018 and 2019, respectively, to replicate certain
services previously provided by NETGEAR. The significant reduction during the
year ended December 31, 2019 was as a result of the substantial completion of
our Separation from NETGEAR on December 31, 2018.

Gain on sale of business

Gain on sale of business represents the gain on sale of the Company's commercial operations in Europe in the fourth quarter of 2019.

Interest Income

Interest income represents interest earned on our cash, cash equivalents and short-term investments.



Other Income (Expense), Net

Other income (expense), net primarily represents gains and losses on
transactions denominated in foreign currencies, foreign currency contract gain
(loss), net, and other miscellaneous income and expense. We have also included
any reimbursement for the Verisure TSA in Other income.

Income Taxes



We record our provision for income taxes in our consolidated financial
statements using the asset and liability method. Under this method, we recognize
income tax liabilities or receivable for the current year. We also recognize
deferred tax assets and liabilities for the expected future tax consequences of
temporary differences between the financial reporting

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and tax basis of assets and liabilities, as well as for operating loss and tax
credit carryforwards. Deferred tax assets and liabilities are measured using the
tax rates that are expected to apply to taxable income for the years in which
those tax assets and liabilities are expected to be realized or settled. We
record a valuation allowance to reduce our deferred tax assets to the net amount
that we believe is more likely than not to be realized. Our assessment considers
the recognition of deferred tax assets on a jurisdictional basis. Accordingly,
in assessing our future taxable income on a jurisdictional basis, we consider
the effect of its transfer pricing policies on that income. We have placed a
valuation allowance against U.S. federal and state deferred tax assets and
certain foreign tax attribute carryforwards since we do not anticipate to
realize the benefits of deferred tax assets.

We recognize tax benefits from uncertain tax positions only if we believe that
it is more likely than not that the tax position will be sustained on
examination by the taxing authorities based on the technical merits of the
position. As we expand internationally, we will face increased complexity in
determining the appropriate tax jurisdictions for revenue and expense items. Our
policy is to adjust these reserves when facts and circumstances change, such as
the closing of a tax audit or refinement of an estimate. To the extent that the
final tax outcome of these matters is different than the amounts recorded, such
differences will affect the provision for income taxes in the period in which
such determination is made and could have a material impact on our financial
condition and operating results. The provision for income taxes includes the
effects of any accruals that we believe are appropriate, as well as the related
net interest and penalties.

The Tax Cuts and Jobs Act of 2017 ("Tax Act") introduced the global intangible
low-taxed income ("GILTI") provisions effective in 2018, which generally impose
a tax on the net income earned by foreign subsidiaries of U.S company in excess
of a deemed return on their tangible assets. We recognize the tax on GILTI as a
period cost when the tax is incurred.


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Results of Operations



We operate as one operating and reportable segment. The following table sets
forth, for the periods presented, the consolidated statements of operations
data, which we derived from the accompanying consolidated financial statements:

                                                            Year Ended December 31,
                                           2019                      2018                      2017
                                                    (In thousands, except percentage data)
Revenue:
Products                          $ 323,242       87.4  %   $ 427,113       91.9  %   $ 341,581       92.2  %
Services                             46,765       12.6  %      37,805        8.1  %      29,077        7.8  %
Total revenue                       370,007      100.0  %     464,918      100.0  %     370,658      100.0  %
Cost of revenue:
Products                            307,348       83.1  %     354,023       76.1  %     270,382       72.9  %
Services                             26,855        7.3  %      18,820        4.0  %       9,042        2.4  %
Total cost of revenue               334,203       90.3  %     372,843       80.2  %     279,424       75.4  %
Gross profit                         35,804        9.7  %      92,075       19.8  %      91,234       24.6  %
Operating expenses:
Research and development             69,384       18.8  %      58,794       12.6  %      34,683        9.4  %
Sales and marketing                  56,985       15.4  %      52,593       11.3  %      34,340        9.3  %
General and administrative           47,624       12.9  %      28,209        6.1  %      15,096        4.1  %
Separation expense                    1,913        0.5  %      27,252        5.9  %       1,384        0.4  %
Gain on sale of business            (54,881 )    (14.8 )%           -          -  %           -          -  %
Total operating expenses            121,025       32.7  %     166,848       35.9  %      85,503       23.1  %
Income (loss) from operations       (85,221 )    (23.0 )%     (74,773 )    (16.1 )%       5,731        1.5  %
Interest income                       2,737        0.7  %       1,239        0.3  %           -          -  %
Other income (expense), net             913        0.3  %      (1,177 )     (0.3 )%       1,946        0.5  %
Income (loss) before income taxes   (81,571 )    (22.0 )%     (74,711 )    (16.1 )%       7,677        2.1  %
Provision for income taxes            4,380        1.2  %         772        0.1  %       1,128        0.3  %
Net income (loss)                 $ (85,951 )    (23.2 )%   $ (75,483 )    (16.2 )%   $   6,549        1.8  %




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Revenue



We conduct business across three geographic regions: Americas, EMEA, and APAC.
We generally base revenue by geography on the ship-to location of the customer
for device sales and device location for service sales.
                                          Year Ended December 31,
                         2019       % Change       2018       % Change       2017
                                  (In thousands, except percentage data)
Americas              $ 289,160      (23.3 )%   $ 376,805        28.7 %   $ 292,671
Percentage of revenue      78.1 %                    81.0 %                    79.0 %
EMEA                  $  57,232      (12.6 )%   $  65,462        11.3 %   $ 

58,795


Percentage of revenue      15.5 %                    14.1 %                    15.9 %
APAC                  $  23,615        4.3  %   $  22,651        18.0 %   $ 

19,192


Percentage of revenue       6.4 %                     4.8 %                     5.1 %
Total revenue         $ 370,007      (20.4 )%   $ 464,918        25.4 %   $ 370,658



Revenue decreased 20.4% across all geographic regions for the year ended
December 31, 2019 compared to the prior year. The decrease was primarily driven
by a slowdown in our customer demand for connected cameras, increased
competition, higher marketing expenditures deemed to be a reduction of revenues,
increased in provisions for price protection that are deemed to be a reduction
of revenue, offset by higher service revenue. We launched Arlo Ultra, with 4K
video resolution capability, in the first fiscal quarter of 2019, Arlo Pro 3,
with 2K video resolution capability, in the third fiscal quarter of 2019 and
Arlo Video Doorbell with 180 degree viewing angle, in the fourth quarter of
2019. Service revenue increased by $9.0 million, or 23.7%, for the year ended
December 31, 2019 compared to the prior year, as our paid subscribers increased
compared to the prior year.

Revenue increased 25.4% across all geographic regions for the year ended
December 31, 2018 compared to the prior year. The increase was primarily driven
by continued rollout of our Arlo Pro 2 camera, which launched in the fourth
quarter of fiscal 2017. Additionally, service revenue increased by $8.7 million,
or 30.0%, for the year ended December 31, 2018 compared to the prior year. We
experienced a slowdown in end user demand for our cameras in the fourth quarter
of 2018.

Cost of Revenue and Gross Margin



The following table presents cost of revenue and gross margin for the periods
indicated:
                                          Year Ended December 31,
                         2019       % Change       2018       % Change       2017
                                  (In thousands, except percentage data)
Cost of revenue:
Products              $ 307,348      (13.2 )%   $ 354,023        30.9 %   $ 270,382
Services                 26,855       42.7  %      18,820       108.1 %       9,042
Total cost of revenue $ 334,203      (10.4 )%   $ 372,843        33.4 %   $ 279,424
Gross margin                9.7 %                    19.8 %                    24.6 %



Cost of revenue decreased for the year ended December 31, 2019, due primarily to
a decline in product revenue compared to the prior year. Service cost of revenue
increased for the year ended December 31, 2019, in line with the service revenue
growth and due to our continued investment in our cloud service offerings to
improve our customer experience and to enhance our security profile. Gross
margin decreased significantly for the year ended December 31, 2019 compared to
the prior year, due to a combination of both product and service margin
declines. The product margin decline is primarily due to increased marketing
expenditures deemed to be a reduction of revenues, increased provisions for
price

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protection that are deemed to be reductions of revenue, increased warranty
costs, product overhead and freight-related costs, offset by less charges for
excess or obsolete inventory. Service margin decreased for the year ended
December 31, 2019 compared to the prior year, primarily due to higher service
cost growth which included the cost of the free 3-month and 12-month trials of
Arlo Smart included in our new product offerings in fiscal 2019.

Cost of revenue increased for the year ended December 31, 2018, due primarily to
revenue growth compared to the prior year. Gross margin decreased for the year
ended December 31, 2018 compared to the prior year due primarily to higher
channel marketing promotion activities deemed to be a reduction of revenue and
due to an increase in inventory reserves for excess and obsolete products as
well as excess materials from our original design manufacturers ("ODMs"). The
decrease was partially offset by higher revenue and product margin, mainly from
the continued rollout of our Arlo Pro 2 camera. During the fourth quarter of
2018, we experienced a decline in our gross margin mainly from increased
marketing expenditures that are deemed to be a reduction in revenue.

Operating Expenses



For the year ended December 31, 2019, our operating expenses, which reflect a
full year as a standalone public company, were expected to increase compared to
historical periods. The full year of 2017 and first and second quarters of 2018,
are based on carve-out financials and reflect the transactions which are
directly attributable to Arlo and certain allocated costs, whereas third quarter
and fourth quarter of 2018 and 2019 are based on our actual results for the
periods as a standalone public company.

Research and Development



The following table presents research and development expense for the periods
indicated:
                                                  Year Ended December 31,
                                   2019      % Change      2018      % Change      2017
                                          (In thousands, except percentage data)

Research and development expense $ 69,384 18.0 % $ 58,794 69.5 % $ 34,683





Research and development expense increased for the year ended December 31, 2019
compared to the prior year due to increases of $2.5 million in personnel-related
expenses and $8.3 million in corporate IT and facilities overhead. The increased
expenditures on personnel-related expense and engineering projects were due to
continuous investment in strategic focus areas, principally the expansion of our
Arlo product and service offerings and the growth of our cloud platform
capabilities. The increase in corporate IT and facilities overhead is due to the
fact that starting in late 2018 Arlo moved to separate facilities globally and
for the whole of 2019 Arlo maintained its own facilities and IT infrastructures
and systems globally as a standalone public company.

Research and development expense increased for the year ended December 31, 2018
compared to the prior year due to increases of $11.6 million in
personnel-related expenses, $9.2 million in corporate IT and facilities
overhead, $2.5 million in engineering projects and outside professional
services, and $0.4 million in NETGEAR TSA related expense. The increased
expenditures on personnel-related expense, engineering projects and outside
professional services were due to continuous investment in strategic focus
areas, principally the expansion of our Arlo product and service offerings and
the growth of our cloud platform capabilities.


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Sales and Marketing



The following table presents sales and marketing expense for the periods
indicated:
                                             Year Ended December 31,
                              2019      % Change      2018      % Change      2017
                                     (In thousands, except percentage data)

Sales and marketing expense $ 56,985 8.4 % $ 52,593 53.2 % $ 34,340





Sales and marketing expense increased for the year ended December 31, 2019
compared to the prior year, primarily due to an increase in outside professional
services of $2.0 million, corporate IT and facilities overhead of $2.7 million,
and personnel-related expenses of $1.2 million. The increases were partially
offset by a decrease NETGEAR TSA related expenses of $1.5 million. The increased
in corporate IT and facilities overhead is due to the fact that starting in late
2018 Arlo moved to separate facilities globally and for the whole of 2019 Arlo
maintained its own facilities and IT infrastructures and systems globally as a
standalone public company.

Sales and marketing expense increased for the year ended December 31, 2018
compared to the prior year, primarily due to an increase in personnel-related
expenses of $7.7 million, digital advertising, media and other costs of $7.1
million, IT and facilities overhead of $2.3 million, NETGEAR TSA related expense
of $1.6 million, and sales freight out expenses of $0.7 million. The increase
was partially offset by a decrease in marketing expenditures of $1.1 million
further to the launch of our Arlo Pro 2 camera in fiscal 2017.

General and Administrative



The following table presents general and administrative expense for the periods
indicated:
                                                    Year Ended December 31,
                                     2019      % Change      2018      % Change      2017
                                            (In thousands, except

percentage data) General and administrative expense $ 47,624 68.8 % $ 28,209 86.9 % $ 15,096





General and administrative expense increased for the year ended December 31,
2019 compared to the prior year, primarily due to higher corporate IT and
facilities overhead of $9.7 million, higher personnel-related expenditures of
$6.0 million, higher legal and professional services of $5.3 million, and
transaction costs of $1.9 million related to the disposal of our commercial
operations in Europe, partially offset by $4.2 million decrease in NETGEAR TSA
related expenses. The increase in general and administrative expense was driven
by the increase in related corporate IT and facilities overhead due to the fact
that starting in late 2018 Arlo moved to separate facilities globally and for
the whole of 2019 Arlo maintained its own facilities and IT infrastructures and
systems globally, increased customary public company costs, including outside
legal and audit fees, insurance and other costs as our company became a
standalone public company since August 2018.

General and administrative expense increased for the year ended December 31,
2018 compared to the prior year, primarily due to higher personnel-related
expenditures of $7.0 million, NETGEAR TSA related expense of $4.3 million, and
higher legal and professional services of $1.8 million. Refer to Overview for
further detail about the NETGEAR TSA.


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Separation Expense

The following table presents separation expense for the periods indicated:


                                  Year Ended December 31,
                     2019     % Change      2018      % Change     2017
                           (In thousands, except percentage data)

Separation expense $ 1,913 (93.0 )% $ 27,252 ** $ 1,384




**Percentage change not meaningful.
Separation expense consists primarily of charges for third-party advisory,
consulting, legal and professional services, IT-related expenses, and other
items that are incremental and one-time in nature related to our separation from
NETGEAR. There was a significant reduction in our separation expense in the
fiscal year ended December 31, 2019 as we completed our Separation from NETGEAR
on December 31, 2018.

Gain on sale of business


                                       Year Ended December 31,
                             2019       % Change    2018    % Change    

2017


                                (In thousands, except percentage data)

Gain on sale of business $ (54,881 ) ** $ - ** $ -

**Percentage change not meaningful.



Our disposal of our commercial operations in Europe generated a gain on sale of
business for the year ended December 31, 2019 of $54.9 million in the fourth
quarter of 2019. There was no gain or loss for the year ended December 31, 2018.
Refer to Note 4, Disposal of business, in Notes to Consolidated Financial
Statements in Item 8 of Part II of this Annual Report on Form 10-K for a
complete discussion of this disposal.

Interest Income and Other Income (Expense), Net
The following table presents other income (expense), net for the periods
indicated:
                                         Year Ended December 31,
                             2019     % Change     2018     % Change    2017
                                 (In thousands, except percentage data)
Interest income              2,737          **    1,239           **       -
Other income (expense), net    913          **   (1,177 )         **   1,946


**Percentage change not meaningful.



During the year ended December 31, 2019, we earned interest income of
$2.7 million from our cash equivalents and short-term investments. Other income
(expense), net increased for the year ended December 31, 2019 compared to the
prior year, due primarily to Verisure TSA related income of $798 thousand and
higher foreign currency transaction gains, mainly as a result of the U.S. dollar
strengthening against transaction currencies.

During the year ended December 31, 2018, we earned interest income of $1.2
million from our cash proceeds from the IPO and from our cash equivalents and
short-term investments. Other income (expense), net decreased for the year ended
December 31, 2018 compared to the prior year, due primarily to higher foreign
currency transaction losses, mainly as a result of the U.S. dollar strengthening
against transaction currencies. We entered into a foreign currency hedging
program during the third quarter of fiscal 2018, which effectively reduced
volatility associated with hedged currency exchange rate movements. For a
detailed discussion of our hedging program and related foreign currency

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contracts, refer to Note 7, Derivative Financial Instruments, in Notes to Consolidated Financial Statements in Item 8 of Part II of this Annual Report on Form 10-K.



Provision for Income Taxes

Provision for income taxes and effective tax rate consisted of the following:
                                            Year Ended December 31,
                              2019      % Change      2018     % Change      2017
                                    (In thousands, except percentage data)

Provision for income taxes $ 4,380 467.4 % $ 772 (31.6 )% $ 1,128 Effective tax rate

            (5.4 )%                (1.0 )%                  14.7 %



The increase in provision for income taxes for the year ended December 31, 2019
compared to 2018 was primarily due to higher foreign earnings in 2019 and gain
on sale of certain assets related to the Company's commercial operations in
Europe during the fourth quarter of 2019. Losses incurred predominantly in the
U.S continue to be subject to a full valuation allowance.

The decrease in provision for income taxes for the year ended December 31, 2018
compared to 2017 was primarily caused by the deemed repatriation of foreign
earnings in 2017 following the 2017 U.S. Tax Act. The negative 1.0% effective
tax rate was a result of losses in the U.S for which the Company was not
recognizing a tax benefit due to its full U.S federal and state valuation
allowance.

Liquidity and Capital Resources

Following the completion of the IPO, our capital structure and sources of liquidity changed significantly from our historical capital structure as we became a standalone public company. We are no longer participating in cash management and funding arrangements managed by NETGEAR. Arlo maintained a separate cash management and financing function for our operations.



We have a history of losses and may continue to incur operating and net losses
for the foreseeable future. As of December 31, 2019, our accumulated deficit was
$131.5 million.

Our principal sources of liquidity are cash, cash equivalents and short-term
investments. Short-term investments are marketable government securities with an
original maturity or a remaining maturity at the time of purchase of greater
than three months and no more than 12 months. The marketable securities are held
in our company's name with a high quality financial institution, which acts as
our custodian and investment manager. As of December 31, 2019, we had cash, cash
equivalents and short-term investments totaling $256.7 million.

In November 2019, we entered into a business financing agreement with Western
Alliance Bank providing for a credit facility to up to $40.0 million and as of
December 31, 2019, we have not borrowed against this credit facility. Refer to
Note 10. Debt in the Notes to Consolidated Financial Statements in Item 8 of
Part II of this Annual Report on Form 10-K for further details on such business
financing agreement.

In December 2019, we received a total of $75.2 million from Verisure for the
disposal of our commercial operations in Europe, including a $20.0 million
prepayment for product purchases and a $2.5 million installment payment for the
NRE Services under the Supply Agreement.

As of December 31, 2019, 25.2% of our cash and cash equivalents were held outside of the U.S. Starting in 2018, as a result of the Tax Cuts and the Jumpstart Our Business Startups Act of 2017 (the "Tax Act"), due to the one-time transition tax on un-repatriated earnings, the tax impact is generally immaterial should we repatriate our cash from foreign


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earnings. The cash and cash equivalents balance outside of the U.S is subject to fluctuation based on the settlement of intercompany balances.



Based on our current plans, business financing agreement with Western Alliance
Bank, and market conditions, we believe that such sources of liquidity will be
sufficient to satisfy our anticipated cash requirements for at least the next 12
months. However, in the future, including sooner as may be anticipated, we may
require or desire additional funds to support our operating expenses and capital
requirements or for other purposes, such as acquisitions, and may seek to raise
such additional funds through public or private equity or debt financings or
collaborative agreements or from other sources. To preserve the tax-free
treatment of our separation from NETGEAR, we have agreed in the tax matters
agreement with NETGEAR to certain restrictions on our business, which generally
will be effective during the two-year period following the Distribution that
could limit our ability to pursue certain transactions including equity
issuances.

We have no commitments to obtain such additional financing and cannot assure you
that additional financing will be available at all or, if available, that such
financing would be obtainable on terms favorable to us and would not be
dilutive. Our future liquidity and cash requirements will depend on numerous
factors, including the introduction of new products, the growth in our service
revenue, as well as the ability to increase our gross margin dollars and
continue to maintain controls over our operating expenditures.

Cash Flow

The following table presents our cash flows for the periods presented.


                                                              Year Ended December 31,
                                                          2019         2018          2017
                                                                   (In thousands)
Net cash provided by (used in) operating activities    $  9,171     $ (17,686 )   $ (38,985 )
Net cash provided by (used in) investing activities      76,262       (71,285 )      (4,315 )
Net cash provided by (used in) financing activities         (38 )     244,287        43,188
Net increase (decrease) in cash and cash equivalents
and restricted cash                                    $ 85,395     $ 155,316     $    (112 )



Operating activities

Net cash provided by operating activities increased by $26.9 million for the
year ended December 31, 2019 compared to the prior year, due primarily to
improved working capital management, offset by a $55.0 million year over year
decrease in the adjusted net loss from operations. Our cash inflow from changes
in assets and liabilities increased by $81.9 million year over year as a result
of increased accounts receivable collections, prepayments from Verisure product
purchases and NRE services under the Supply Agreement and lower inventory
balance.

Net cash used in operating activities decreased by $21.3 million for the year
ended December 31, 2018 compared to the prior year, due primarily to the
favorable net working capital changes offset by the net loss incurred. Changes
in operating activities also reflected the movements of the balances for
Statements of Cash Flows purposes since the balances contributed by NETGEAR on
or before the initial public offering reflects the contributed balances to us as
per the master separation agreement between Arlo and NETGEAR and related
documents governing the Contribution.

Our days sales outstanding ("DSO") decreased to 97 days as of December 31, 2019
as compared to 125 days as of December 31, 2018. Inventory decreased to $68.6
million as of December 31, 2019 from $124.8 million as of December 31, 2018,
primarily due to better inventory management. As a result, ending inventory
turns were 5.9x in the three months ended December 31, 2019 down from 3.6x turns
in the three months ended December 31, 2018. Our accounts payable increased to
$111.7 million as of December 31, 2019 from $82.5 million as of December 31,
2018, primarily as a result of extended payment terms with our suppliers.


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Investing activities



Net cash provided by investing activities increased by $147.5 million for the
year ended December 31, 2019 compared to the prior year, primarily due to the
more maturity of short-term investments in the amount of $55.0 million, less
purchases of short-term investments of $24.9 million, less purchases of property
equipment of $15.0 million, and proceeds from sale of our commercial operations
in Europe in the amount of $52.7 million.

Net cash used in investing activities increased by $67.0 million for the year
ended December 31, 2018 compared to the prior year, primarily due to the
purchase of short-term investments of $54.6 million and the increased capital
expenditures as we implement certain new systems, including infrastructure and
an enterprise resource planning system. In the year ended December 31, 2017, we
made a $0.7 million payment in connection with our Placemeter acquisition.

Financing activities

Net cash used in financing activities was $38 thousand in the year ended December 31, 2019 represented by proceeds from ESPP contributions of $1.8 million, partially offset by $1.9 million in tax withholdings from restricted stock unit releases.



Net cash provided by financing activities was $244.3 million in the year ended
December 31, 2018, primarily due to net proceeds from IPO of $173.4 million and
net investment from parent of $70.9 million. Prior to the completion of the IPO,
because cash and cash equivalents were held by NETGEAR at the corporate level
and were not attributable to Arlo, cash flows related to financing activities
primarily reflect changes in Net parent investment.

Backlog



Our backlog consists of products for which customer purchase orders have been
received and that are scheduled or in the process of being scheduled for
shipment. As of December 31, 2019, we had a backlog of $5.4 million, compared to
$18.9 million as of December 31, 2018 and $15.6 million as of December 31, 2017.
As we typically fulfill orders received within a relatively short period (e.g.,
within one week for our top three customers) after receipt, our revenue in any
fiscal year depends primarily upon orders booked and the availability of supply
of our products in that year. In addition, most of our backlog is subject to
rescheduling or cancellation with minimal penalties. As a result, our backlog as
of any particular date may not be an indicator of revenue for any succeeding
period. Similarly, there is a lack of meaningful correlation between
year-over-year changes in backlog as compared with year-over-year changes in
revenue. Accordingly, we do not believe that backlog information is material to
an understanding of our overall business, and backlog as of any particular date
should not be considered a reliable indicator of our ability to achieve any
particular level of revenue or financial performance.

Contractual Obligations

The following table summarizes our non-cancelable operating lease commitments and purchase obligations as of December 31, 2019:


                                         Payments due by period
                                  Less Than        1-3        3-5       More Than
                       Total        1 Year        Years      Years       5 Years
                                             (In thousands)

Operating leases $ 41,011 $ 5,660 $ 11,324 $ 9,358 $ 14,669 Purchase obligations 29,615 29,615

           -          -              -
                     $ 70,626    $    35,275    $ 11,324    $ 9,358    $    14,669




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Operating leases



We entered into several office lease agreements under non-cancelable operating
leases with various expiration dates through June 2029. The terms of certain of
our facility leases provide for rental payments on a graduated scale. We
recognize rent expense on a straight-line basis over the lease period and have
accrued for rent expense incurred but not paid. The amounts presented are
consistent with contractual terms and are not expected to differ significantly,
unless a substantial change in our headcount requires us to exit an office
facility early or expand our occupied space. For the year ended December 31,
2019, rent expense was $7 million. For the year ended December 31, 2017 and six
months ended July 1, 2018, rent expense reflected allocations from NETGEAR and
may not be indicative of our results. Rent expense was $1.4 million after the
Separation through December 31, 2018.

Letters of Credit



In connection with the lease agreement for the headquarters located in San Jose,
California, we executed a letter of credit with the landlord as the beneficiary.
As of December 31, 2019, we had approximately $3.6 million of unused letters of
credit outstanding, of which $3.1 million pertains to the lease arrangement.

Purchase obligations



We enter into various inventory-related purchase agreements with suppliers.
Generally, under these agreements, 50% of the orders are cancelable by giving
notice of 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 not cancelable within 30 days prior to the expected shipment
date. As of December 31, 2019, we had $29.6 million in non-cancelable purchase
commitments with suppliers. We expect to sell all products for which we have
committed purchases from suppliers.

Uncertain tax position



As of December 31, 2019, the total gross unrecognized tax benefits and related
interest and penalties was $0.7 million. The timing of any payments that could
result from these unrecognized tax benefits will depend upon a number of
factors. The unrecognized tax benefits have been excluded from the contractual
obligations table because reasonable estimates cannot be made of whether, or
when, any cash payments for such items might occur. We do not expect to reduce
our liabilities for uncertain tax positions in any jurisdiction, where the
impact would affect the statement of operations, in the next 12 months. We do
not estimate any long-term liability related to a one-time transaction tax that
resulted from the passage of the Tax Act.

Off-Balance Sheet Arrangements
As of December 31, 2019, we did not have any off-balance sheet arrangements as
defined in Item 303(a)(4)(ii) of SEC Regulation S-K.

Critical Accounting Policies and Estimates



Our consolidated financial statements have been prepared in accordance with
accounting principles generally accepted in the United States of America and
pursuant to the regulations of the SEC. The preparation of the consolidated
financial statements requires management to make assumptions, judgments and
estimates that can have a significant impact on the reported amounts of assets,
liabilities, revenue and expenses. We base our estimates on historical
experience and on various other assumptions believed to be applicable and
reasonable under the circumstances. Actual results could differ significantly
from these estimates. These estimates may change as new events occur, as
additional information is obtained and as our operating environment changes. On
a regular basis, we evaluate our assumptions, judgments and estimates and make
changes accordingly. We also discuss our critical accounting estimates with the
Audit Committee of the Board of Directors. Note 2, Summary of Significant
Accounting Policies, in Notes to Consolidated Financial Statements in Item 8 of
Part II of this Annual Report on Form 10-K describes the significant accounting
policies used in the preparation of the

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consolidated financial statements. We have listed below our critical accounting policies that we believe to have the greatest potential impact on our consolidated financial statements.

Revenue Recognition



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 we expect to be entitled to in exchange for those goods or
services.

The majority of revenue comes from sales of hardware products to customers
(retailers, distributors, and service providers). Revenue is recognized at a
point in time when control of the goods is transferred to the customer,
generally occurring upon shipment or delivery dependent upon the terms of the
underlying contract. The amount recognized reflects the consideration we expect
to be entitled to in exchange for the transferred goods.

We sell paid subscription services to our end user customers where we provide
customers access to our cloud services. Revenue for subscription sales is
generally recognized on a ratable basis over the contract term, beginning on the
date that the service is made available to the customers at the time of
registration. The subscription contracts are generally 30 days or 12 months in
length, billed in advance. All such service or support sales are typically
recognized using an output measure of progress by looking at the time elapsed as
the contracts generally provide the customer equal benefit throughout the
contract period. In addition to selling paid subscriptions, we also sell
services bundled with hardware products and accounts for these sales in line
with the multiple performance obligations guidance.

Revenue from all sales types is recognized at transaction price, the amount we
expect to be entitled to in exchange for transferring goods or providing
services. Transaction price is calculated as selling price net of variable
consideration which may include estimates for future returns, sales incentives,
and price protection related to current period product revenue. Our standard
obligation to our direct customers generally provides for a full refund in the
event that such product is not merchantable or is found to be damaged or
defective. In determining estimates for future returns, management analyzes
historical sales and returns data, channel inventory levels, current economic
trends, and changes in customer demand for our products. Sales incentives and
price protection are determined based on a combination of the actual amounts
committed and estimated future expenditure based upon historical customary
business practice. Typically variable consideration does not need to be
constrained as estimates are based on predictive historical data or future
commitments that we plan and control. However, we continue to assess variable
consideration estimates such that it is probable that a significant reversal of
revenue will not occur.

Contracts with Multiple Performance Obligations



Some of our contracts with customers contain multiple promised goods or
services. Such contracts include hardware products with bundled services,
various subscription services, and support. For these contracts, we account for
the promises separately as individual performance obligations if they are
distinct. Performance obligations are determined to be considered distinct if
they are both capable of being distinct and distinct within the context of the
contract. In determining whether performance obligations meet the criteria for
being distinct, we consider a number of factors, such as the degree of
interrelation and interdependence between obligations, and whether or not the
good or service significantly modifies or transforms another good or service in
the contract. The embedded software in most of the hardware products is not
considered distinct and therefore the combined hardware and incidental software
are treated as one performance obligation and recognized at the point in time
when control of product transfers to the customer. Services that are included
with certain hardware products are considered distinct and therefore the
hardware and service are treated as separate performance obligations.

After identifying the separate performance obligations, the transaction price is
allocated to the separate performance obligations on a relative standalone
selling price basis. Standalone selling prices are generally determined based on
the prices charged to customers or using an adjusted market assessment.
Standalone selling price of the hardware

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is directly observable from add-on camera and base station sales. Standalone
selling price of the premium services are directly observable from direct sales
to end users, while the service is estimated using an adjusted market approach.

Revenue is then recognized for each distinct performance obligation as control
is transferred to the customer. Revenue attributable to hardware is recognized
at the time control of the product transfers to the customer. The transaction
price allocated to the service is recognized over the specified service period
or over the estimated useful life of the hardware, beginning when the customer
is expected to activate their account. Useful life of the hardware is determined
by industry norms, technical and financial relevance, frequency of new model
releases, and user history.

Long-term Supply Arrangement - Verisure



We have entered into a Supply Agreement as part of the disposal of our
commercial operations in Europe where Verisure prepays future product purchases
with a minimum product purchase commitment also required. The Supply Agreement
includes product purchases, paid subscription services, basic services, and an
option for Verisure to acquire development services by submitting a statement of
work ("SOW"). Products sold come with a standard twelve month warranty. Verisure
assumes responsibilities for all warranty claims, returns on products and
certain technical support to the end users. We provide technical support for
paid subscription services where Verisure can not resolve the issue. Verisure is
responsible for any marketing and promotion of our products and services sold in
Europe.

Products are priced at a cost plus markup based on markups specified in the
agreement and that price varies based on the cost of the product. The paid
subscription services and basic services pricing is based on the number of users
monthly and is priced at a cost plus markup specified in the Supply Agreement
that varies based on the user and service type. The transaction price for
products and paid subscription services is entirely variable because the
consideration is dependent on the actual costs. We allocate variable
consideration specified for products entirely to products, and variable
consideration specified for the paid subscription services entirely to the paid
subscription services. For development services, no contract exists until an SOW
is submitted and approved by both parties. For products, since quantity and
product types are not specified in the agreement, contracts are not deemed to
exist until we receive and accept the customer purchase order (PO). Each product
with a valid PO is a single performance obligation.

We recognize variable consideration for products upon delivery and for services
when the monthly service is rendered for paid subscription services and basic
services. The non-refundable prepayment does not relate to future goods or
services, as such no further assessment of material rights is required. Further,
as the transfer of products is at the discretion of the customer (i.e. when
Verisure issues a PO), a significant financing component does not exist as it
relates to the prepayment. We also expect that prepayment will be fully utilized
by Verisure within one year, hence, no additional accounting consideration is
necessary for breakage. We also concluded that we are acting as the principal in
the Supply Agreement and determined that revenue should be presented gross.

Non-recurring Engineering ("NRE") Arrangement - Verisure



The Supply Agreement also provides for certain development services under an SOW
to Verisure ("NRE arrangement") as part of the disposal of our commercial
operations in Europe. In the NRE arrangement, Verisure pays non-refundable
installments upon the commencement of agreed-upon milestones. There is a single
performance obligation as the distinct goods and services promised under the SOW
are highly interdependent or interrelated inputs that produce a single combined
output given the nature of such arrangement. The output (or work-in-progress of
such output) typically has no alternative use to us given the customized nature
of the arrangement and we have enforceable rights given that the non-refundable
milestone payments are prepayments in nature; control for NRE development
services therefore transfers over time.

We determined that the most appropriate measure of progress for revenue
recognition is the input method based on cost because we can reasonably estimate
the total costs for the NRE, and the costs incurred reasonably reflects our
efforts to satisfy the performance obligation. The NRE costs include labor,
material, overhead as well as the use of outside services. The total estimated
NRE costs are based on a combination of historical costs together with quotes
from vendors

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for supplying parts or services towards the completion. Adjustments to cost and
profit estimates are made periodically due to changes in scope of work, hours to
complete and estimated profitability, including those arising from final
contract settlements. These changes may result in revisions to revenue and costs
and are recognized in the period in which the revisions are determined. Any
losses expected to be incurred on contracts in progress are charged to
operations in the period such losses are determined. If total NRE costs
calculated upon completion in the current period are more than the estimated
total costs at completion used to calculate revenue in a prior period, then the
profits in the current period will be lower than if the estimated costs used in
the prior period calculation were equal to the actual total costs upon
completion.

Allowances for Warranty Obligations and Returns due to Stock Rotation



Our standard warranty obligation to our direct customers generally provides for
a right of return of any product for a full refund in the event that such
product is not merchantable or is found to be damaged or defective. At the time
we recognize revenue, we record an estimate of future warranty returns to reduce
revenue in the amount of the expected credit or refund to be provided to our
direct customers. At the time we record the reduction to revenue related to
warranty returns, we include within cost of revenue a write-down to reduce the
carrying value of such products to net realizable value. Our standard warranty
obligation to end-users provides for replacement of a defective product for one
or more years. Factors that affect the warranty obligation include product
failure rates, material usage and service delivery costs incurred in correcting
product failures. We record the estimated cost associated with fulfilling the
warranty obligation to end-users in cost of revenue. Because our products are
manufactured by third-party manufacturers, in certain cases we have recourse to
the third-party manufacturer for replacement or credit for the defective
products. We give consideration to amounts recoverable from our third-party
manufacturers in determining our warranty liability. Our estimated allowances
for product warranties can vary from actual results, and we may have to record
additional revenue reductions or charges to cost of revenue, which could
materially impact our financial position and results of operations.

In addition to warranty-related returns, certain distributors and retailers
generally have the right to return products for stock rotation purposes. Upon
shipment of the product, we reduce revenue by an estimate of potential future
stock rotation returns related to the current period product revenue. We analyze
historical returns, channel inventory levels, current economic trends and
changes in customer demand for our products when evaluating the adequacy of the
allowance for stock rotation returns. Our estimated allowances for returns due
to stock rotation can vary from actual results, and we may have to record
additional revenue reductions, which could materially impact our financial
position and results of operations.

Sales Incentives



We accrue for sales incentives as a marketing expense if we receive an
identifiable benefit in exchange and can reasonably estimate the fair value of
the identifiable benefit received; otherwise, it is recorded as a reduction to
revenue. As a consequence, we record a substantial portion of our channel
marketing costs as a reduction of revenue. We record estimated reductions to
revenue for sales incentives when the related revenue is recognized or ahead of
customer or end customer commitment if customary business practice creates an
implied expectation that such activities will occur in the future.

Valuation of Inventory



We value our inventory at the lower of cost or net realizable value, cost being
determined using the first-in, first-out method. We continually assess the value
of our inventory and will periodically write down its value to account for
estimated excess and obsolete inventory based upon assumptions about future
demand and market conditions. On a quarterly basis, we review inventory
quantities on hand and on order under non-cancelable purchase commitments and
compare those quantities to our estimated forecast of product demand for the
next nine months to determine what inventory, if any, is not saleable. We base
our analysis on the product demand forecast but take into account market
conditions, product development plans, product life expectancy and other
factors. Based on this analysis, we write down the carrying value of the
affected inventory to account for estimated excess and obsolete amounts. At the
point of loss recognition, a new, lower cost basis for that inventory is
established, and subsequent changes in facts and circumstances do

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not result in the restoration or increase in that newly established cost basis.
As demonstrated during prior years, demand for our products can fluctuate
significantly. If actual demand is lower than our forecasted demand and we fail
to reduce our manufacturing accordingly, we could be required to write down the
value of additional inventory, which would have a negative effect on our gross
profit.

Goodwill

Goodwill pertains to the acquisitions of Avaak, Inc. ("Avaak") and Placemeter,
Inc. ("Placemeter"). Goodwill represents the purchase price exceeds the
estimated fair value of net assets of businesses acquired in a business
combination. We perform an annual impairment assessment of goodwill at the
reporting unit level on the first day of the fourth fiscal quarter. The analysis
may include both qualitative and quantitative factors to assess the likelihood
of an impairment. Should certain events or indicators of impairment occur
between annual impairment tests, we will perform the impairment test as those
events or indicators occur. Examples of such events or circumstances include: a
significant decline in our expected future cash flows, a sustained, significant
decline in our stock price and market capitalization, a significant adverse
change in the business climate and slower growth rates.

We test goodwill for impairment at the reporting unit level by first performing
a qualitative assessment to determine whether it is more likely than not (that
is, a likelihood of more than 50%) that the fair value of the reporting unit is
less than its carrying amount. The qualitative assessment considers:
macroeconomic conditions, industry and market considerations, cost factors,
overall company financial performance, events affecting the reporting units and
changes in our stock price. If the reporting unit does not pass the qualitative
assessment, we estimate its fair value and compare the fair value with the
carrying amount of the reporting unit, including goodwill. If the fair value is
greater than the carrying amount of the reporting unit, we do not record an
impairment.

We also test goodwill for impairment by performing a quantitative assessment,
which is used to identify both the existence of impairment and the amount of
impairment loss. The quantitative assessment compares the fair value of a
reporting unit with its carrying amount, including goodwill. If the fair value
is less than the carrying amount, an impairment loss shall be recognized in an
amount equal to that excess, limited to the total amount of goodwill allocated
to that reporting unit. We would record any impairment charge within earnings in
the consolidated statements of operations.

A quantitative assessment of goodwill was performed on the first day of the
fourth quarter of fiscal 2019. We identified that we had one reporting unit for
the purpose of goodwill impairment testing and the reporting unit is at the same
level as the operating segment and reportable segment. We utilized our market
capitalization as a proxy for fair value of the business and compared it to the
carrying amount as of October 1, 2019. Based on the results of the quantitative
assessment, the respective fair value was substantially in excess of the
carrying amount by $68.0 million, or 38%. We updated our quantitative test as of
December 31, 2019 at which time the fair value of the business was substantially
in excess of the carrying amount by $115.7 million, or 57%.

No goodwill impairment was recognized for the years ended December 31, 2019 and
2018. However, included in our accounting for the disposal of our commercial
operations in Europe was a derecognition of $4.6 million of goodwill associated
with the disposal of our commercial operations in Europe.

We do not believe it is likely that there will be a material change in the estimates or assumptions we use to test for impairment loss on goodwill. However, if the actual result is not consistent with our estimates or assumptions, we may be exposed to an impairment charge that could be material.

Stock-based compensation



Our employees have historically participated in NETGEAR's stock-based
compensation plans. Stock-based compensation expense has been allocated to us
based on the awards and terms previously granted to our employees as well as an
allocation of NETGEAR's corporate and shared functional employee expenses. We
measure stock-based compensation at the grant date based on the fair value of
the award. The fair value of stock options and the shares offered

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under the employee stock purchase plan is estimated using the Black-Scholes
option pricing model. Estimated compensation cost relating to restricted stock
units ("RSUs") is based on the closing fair market value of NETGEAR's common
stock on the date of grant.

Equity awards granted under our own stock-based compensation plans on or after
the completion of the IPO are comprised of performance-based stock options (the
"PSOs"), stock options, and RSUs. We use the fair value method of accounting for
its equity awards granted to employees and measures the cost of employee
services received in exchange for the stock-based awards. We recognize these
compensation expenses generally on a straight-line basis over the requisite
service period of the award. The fair value of stock options and PSOs is
estimated on the grant or offering date using the Black-Scholes option pricing
model and the forfeitures recorded as they occur. The fair value of RSUs is
measured on the grant date based on the closing fair market value of our common
stock.

The stock-based compensation cost is recognized ratably over the period during
which an employee is required to provide service in exchange for the awards,
usually the vesting period, which is generally four years for stock options and
three to four years for RSUs. For PSOs, stock-based compensation expense of
individual performance milestone is recognized over the expected performance
achievement period when the achievement becomes probable.

Our 2018 Employee Stock Purchase Plan ("ESPP") is intended to provide employees
with the opportunity to purchase our common stock through accumulated payroll
deductions at the end of specified purchase period. Eligible employees may
contribute up to 15% of compensation, subject to certain income limits, to
purchase shares of our 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 purchasing period is generally
six months. We determine the fair value using the Black-Scholes Model using
various inputs, including our estimate of expected volatility, term, dividend
yield and risk-free interest rate. We recognize compensation costs for the ESPP
on a straight-line basis over the requisite service period of the award.

Income Taxes



We record our provision for income taxes in our consolidated financial
statements using the asset and liability method. Under this method, we recognize
income tax liabilities or receivable for the current year. We also recognize
deferred tax assets and liabilities for the expected future tax consequences of
temporary differences between the financial reporting and tax basis of assets
and liabilities, as well as for operating loss and tax credit carryforwards.
Deferred tax assets and liabilities are measured using the tax rates that are
expected to apply to taxable income for the years in which those tax assets and
liabilities are expected to be realized or settled. We record a valuation
allowance to reduce our deferred tax assets to the net amount that we believe is
more likely than not to be realized. Our assessment considers the recognition of
deferred tax assets on a jurisdictional basis. Accordingly, in assessing our
future taxable income on a jurisdictional basis, we consider the effect of its
transfer pricing policies on that income. We have placed a valuation allowance
against U.S. federal and state deferred tax assets and certain foreign tax
attribute carryforwards since we do not anticipate to realize the benefits of
deferred tax assets.

We recognize tax benefits from uncertain tax positions only if we believe that
it is more likely than not that the tax position will be sustained on
examination by the taxing authorities based on the technical merits of the
position. As we expand internationally, we will face increased complexity in
determining the appropriate tax jurisdictions for revenue and expense items. Our
policy is to adjust these reserves when facts and circumstances change, such as
the closing of a tax audit or refinement of an estimate. To the extent that the
final tax outcome of these matters is different than the amounts recorded, such
differences will affect the provision for income taxes in the period in which
such determination is made and could have a material impact on our financial
condition and operating results. The provision for income taxes includes the
effects of any accruals that we believe are appropriate, as well as the related
net interest and penalties.

The Tax Act introduced the global intangible low-taxed income ("GILTI")
provisions effective in 2018, which generally impose a tax on the net income
earned by foreign subsidiaries of U.S company in excess of a deemed return on
their tangible assets. We recognize the tax on GILTI as a period cost when the
tax is incurred.

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Recent Accounting Pronouncements



For a complete description of recent accounting pronouncements, including the
expected dates of adoption and estimated effects on financial condition and
results of operations, refer to Note 2, Summary of Significant Accounting
Policies, in Notes to Consolidated Financial Statements in Item 8 of Part II of
this Annual Report on Form 10-K.

Emerging Growth Company Status



As an emerging growth company ("EGC"), under the Jumpstart Our Business Startups
Act ("JOBS Act"), we are allowed to delay adoption of new or revised accounting
pronouncements applicable to public companies until such pronouncements are made
applicable to private companies, unless we otherwise irrevocably elect not to
avail ourselves of this exemption. While we have not made such an irrevocable
election, we have not delayed the adoption of any applicable accounting
standards.


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