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ZHNE > SEC Filings for ZHNE > Form 10-K on 5-Mar-2014All Recent SEC Filings

Show all filings for ZHONE TECHNOLOGIES INC



Annual Report

We believe that we are the first company dedicated solely to developing the full spectrum of next-generation access network solutions to cost-effectively deliver high bandwidth services while simultaneously preserving the investment in today's networks. Our next-generation solutions are based upon our SLMS architecture. From its inception, this SLMS architecture was specifically designed for the delivery of multiple classes of subscriber services (such as voice, data and video distribution), rather than being based on a particular protocol or media. In other words, our SLMS products are built to support the migration from legacy circuit to packet technologies and from copper to fiber technologies. This flexibility and versatility allows our products to adapt to future technologies while allowing service providers to focus on the delivery of additional high bandwidth services. Because this SLMS architecture is designed to interoperate with existing legacy equipment, service providers can leverage their existing networks to deliver a combination of voice, data and video services today, while they migrate, either simultaneously or at a future date, from legacy equipment to next-generation equipment with minimal interruption. We believe that our SLMS solution provides an evolutionary path for service providers from their existing infrastructures, as well as gives newer service providers the capability to deploy cost-effective, multi-service networks that can support voice, data and video.
Our global customer base includes regional, national and international telecommunications carriers. To date, our products are deployed by over 750 network service providers on six continents worldwide. We believe that we have assembled the employee base, technological breadth and market presence to provide a simple yet comprehensive set of next-generation solutions to the bandwidth bottleneck in the access network and the other problems encountered by network service providers when delivering communications services to subscribers.
Although we generated net income of $4.3 million for the year ended December 31, 2013, we incurred net losses for the years ended December 31, 2012, 2011 and 2010 and there can be no assurance that we will continue to generate net income or have positive cash flows from operations in any future period. We had an accumulated deficit of $1,036.8 million as of December 31, 2013. If we are unable to access or raise the capital needed to meet liquidity needs and finance capital expenditures and working capital, or if the economic, market and geopolitical conditions in the United States and the rest of the world deteriorate, we may experience material adverse impacts on our business, operating results and financial condition. During the past four years, we have continued our focus on cost control and operating efficiency along with restrictions on discretionary spending. In September 2012, we closed our development center in Portsmouth, New Hampshire to reduce occupancy and personnel-related expenses.
Going forward, our key financial objectives include the following:
Increasing revenue while continuing to carefully control costs;

          Continued investments in strategic research and product development
           activities that will provide the maximum potential return on
           investment; and

Minimizing consumption of our cash and cash equivalents.

Critical Accounting Policies and Estimates Management's discussion and analysis of financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with generally accepted accounting principles in the United States of America. The preparation of these consolidated financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses, and related disclosure of contingent

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assets and liabilities. The policies discussed below are considered by management to be critical because changes in such estimates can materially affect the amount of our reported net income or loss. For all of these policies, management cautions that actual results may differ materially from these estimates under different assumptions or conditions. Revenue Recognition
We recognize revenue when the earnings process is complete. We recognize product revenue upon shipment of product under contractual terms which transfer title to customers upon shipment, under normal credit terms, net of estimated sales returns and allowances at the time of shipment. Revenue is deferred if there are significant post-delivery obligations or if the fees are not fixed or determinable. When significant post-delivery obligations exist, revenue is deferred until such obligations are fulfilled. Our arrangements generally do not have any significant post-delivery obligations. If our arrangements include customer acceptance provisions, revenue is recognized upon obtaining the signed acceptance certificate from the customer, unless we can objectively demonstrate that the delivered products or services meet all the acceptance criteria specified in the arrangement prior to obtaining the signed acceptance. In those instances where revenue is recognized prior to obtaining the signed acceptance certificate, we use successful completion of customer testing as the basis to objectively demonstrate that the delivered products or services meet all the acceptance criteria specified in the arrangement. We also consider historical acceptance experience with the customer, as well as the payment terms specified in the arrangement, when revenue is recognized prior to obtaining the signed acceptance certificate. When collectability is not reasonably assured, revenue is recognized when cash is collected.
We make certain sales to product distributors. These customers are given certain privileges to return a portion of inventory. Return privileges generally allow distributors to return inventory based on a percent of purchases made within a specific period of time. We recognize revenue on sales to distributors that have contractual return rights when the products have been sold by the distributors, unless there is sufficient customer specific sales and sales returns history to support revenue recognition upon shipment. In those instances when revenue is recognized upon shipment to distributors, we use historical rates of return from the distributors to provide for estimated product returns. We accrue for warranty costs, sales returns and other allowances at the time of shipment based on historical experience and expected future costs.
We derive revenue primarily from stand-alone sales of our products. In certain cases, our products are sold along with services, which include education, training, installation, and/or extended warranty services. As such, some of our sales have multiple deliverables. Our products and services qualify as separate units of accounting and are deemed to be non-contingent deliverables as our arrangements typically do not have any significant performance, cancellation, termination and refund type provisions. Products are typically considered delivered upon shipment. Revenue from services is recognized ratably over the period during which the services are to be performed.
For multiple deliverable revenue arrangements, we allocate revenue to products and services using the relative selling price method to recognize revenue when the revenue recognition criteria for each deliverable are met. The selling price of a deliverable is based on a hierarchy and if we are unable to establish vendor-specific objective evidence of selling price (VSOE) we look to third-party evidence of selling price (TPE) and if no such data is available, we use a best estimated selling price (BSP). In most instances, particularly as it relates to products, we are not able to establish VSOE for all deliverables in an arrangement with multiple elements. This may be due to infrequently selling each element separately, not pricing products within a narrow range, or only having a limited sales history. When VSOE cannot be established, we attempt to establish the selling price of each element based on TPE. Generally, our marketing strategy differs from that of our peers and our offerings contain a significant level of customization and differentiation such that the comparable pricing of products with similar functionality cannot be obtained. Furthermore, we are unable to reliably determine what similar competitor products' selling prices are on a stand-alone basis. Therefore, we are typically not able to determine TPE for our products.

When we are unable to establish selling price using VSOE or TPE, we use BSP. The objective of BSP is to determine the price at which we would transact a sale if the product or service were sold on a stand-alone basis. The BSP of each deliverable is determined using average discounts from list price from historical sales transactions or cost plus margin approaches based on the factors, including but not limited to our gross margin objectives and pricing practices plus customer and market specific considerations.
We have established TPE for our training, education and installation services. These service arrangements are typically short term in nature and are largely completed shortly after delivery of the product. TPE is determined based on competitor prices for similar deliverables when sold separately. Training and education services are based on a daily rate per person and vary according to the type of class offered. Installation services are based on daily rate per person and vary according to the complexity of the products being installed.

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Extended warranty services are priced based on the type of product and are sold in one to five year durations. Extended warranty services include the right to warranty coverage beyond the standard warranty period. In substantially all of the arrangements with multiple deliverables pertaining to arrangements with these services, we have used and intend to continue using VSOE to determine the selling price for the services. We determine VSOE based on our normal pricing practices for these specific services when sold separately. Allowances for Sales Returns and Doubtful Accounts We record an allowance for sales returns for estimated future product returns related to current period product revenue. The allowance for sales returns is recorded as a reduction of revenue and an allowance against our accounts receivable. We base our allowance for sales returns on periodic assessments of historical trends in product return rates and current approved returned products. If the actual future returns were to deviate from the historical data on which the reserve had been established, our future revenue could be adversely affected. We record an allowance for doubtful accounts for estimated losses resulting from the inability of customers to make payments for amounts owed to us. The allowance for doubtful accounts is recorded as a charge to general and administrative expenses. We base our allowance on periodic assessments of our customers' liquidity and financial condition through analysis of information obtained from credit rating agencies, financial statement reviews and historical collection trends. Additional allowances may be required in the future if the liquidity or financial condition of our customers deteriorates, resulting in impairment in their ability to make payments. Stock-Based Compensation
We estimate the fair value of stock-based payment awards on the date of grant using the Black Scholes pricing model, which is affected by our stock price as well as assumptions regarding a number of complex and subjective variables. These variables include our expected stock price volatility over the term of the awards, actual and projected employee option exercise behaviors, risk free interest rate and expected dividends. The expected stock price volatility is based on the weighted average of the historical volatility of our common stock over the most recent period commensurate with the estimated expected life of our stock options. We base our expected life assumption on our historical experience and on the terms and conditions of the stock awards we grant to employees. Risk free interest rates reflect the yield on zero-coupon U.S. Treasury securities. We do not anticipate paying any cash dividends in the foreseeable future and therefore use an expected dividend yield of zero.
If factors change, and we employ different assumptions for estimating stock-based compensation expense in future periods, or if we decide to use a different valuation model, the future periods may differ significantly from what we have recorded in the current period and could materially affect our operating income, net income (loss) and net income (loss) per share. We are also required to estimate forfeitures at the time of grant and revise those estimates in subsequent periods if actual forfeitures differ from those estimates. In 2011, our board of directors approved the acceleration of vesting of all unvested options to purchase shares of Zhone common stock that were held by members of our senior management as of that date. The acceleration was effective as of September 30, 2011. Options to purchase an aggregate of approximately 0.6 million shares of Zhone common stock were subject to the acceleration and resulted in a compensation charge of $0.7 million which was fully expensed in the three-month period ended September 30, 2011. The acceleration of these options was undertaken to partially offset previous reductions in cash compensation and other benefits by our senior management.
On August 9, 2012, our board of directors approved the acceleration of vesting of all unvested options to purchase shares of Zhone common stock that were held by our senior management and employees as of that date. The acceleration for shares held by senior management was effective as of August 9, 2012 and the acceleration of shares held by all other employees was effective as of September 30, 2012. Options to purchase an aggregate of approximately 0.6 million shares of Zhone common stock were subject to the acceleration and resulted in a compensation charge of $0.7 million which was fully expensed in the three month period ended September 30, 2012. The acceleration of these options was undertaken to partially offset previous reductions in cash compensation and other benefits by our senior management and employees. Inventories
Inventories are stated at the lower of cost or market, with cost being determined using the first-in, first-out (FIFO) method. In assessing the net realizable value of inventories, we are required to make judgments as to future demand requirements and compare these with the current or committed inventory levels. Once inventory has been written down to its estimated net realizable value, its carrying value cannot be increased due to subsequent changes in demand forecasts. To the extent that a severe decline in forecasted demand occurs, or we experience a higher incidence of inventory obsolescence due to rapidly changing technology and customer requirements, we may incur significant charges for excess inventory.

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Accounting for Impairment of Long-Lived Assets Long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying value of an asset may not be fully recoverable based on expected undiscounted cash flows attributable to that asset. Recoverability of assets to be held and used is measured by comparing the carrying amount of an asset to the future net undiscounted cash flows expected to be generated by the asset. If the carrying amount of an asset exceeds its estimated future net undiscounted cash flows, an impairment charge is recognized in the amount by which the carrying amount of the asset exceeds the fair value of the asset. Any assets to be disposed of would be separately presented in the balance sheet and reported at the lower of the carrying amount or fair value less costs to sell, and would no longer be depreciated. The assets and liabilities of a disposed group classified as held for sale would be presented separately in the appropriate asset and liability sections of the balance sheet.

During the year ended December 31, 2013, we did not record any impairment charges related to the impairment of long-lived assets.

We list in the table below the historical consolidated statement of comprehensive income (loss) as a percentage of net revenue for the periods indicated.

                                     Year ended December 31,
                                    2013        2012       2011
Net revenue                         100 %       100  %    100  %
Cost of revenue                      62 %        69  %     65  %
Gross profit                         38 %        31  %     35  %
Operating expenses:
Research and product development     13 %        16  %     17  %
Sales and marketing                  16 %        17  %     18  %
General and administrative            5 %         6  %      6  %
Impairment of fixed assets            0 %         0  %      3  %
Total operating expenses             34 %        39  %     44  %
Operating income (loss)               4 %        (8 )%     (9 )%
Interest expense, net                 0 %         0  %      0  %
Other income (expense), net           0 %         0  %      0  %
Income (loss) before income taxes     4 %        (8 )%     (9 )%
Income tax provision                  0 %         0  %      0  %
Net income (loss)                     4 %        (8 )%     (9 )%
Other comprehensive income (loss)     0 %         0  %      0  %
Comprehensive income (loss)           4 %        (8 )%     (9 )%

Net Revenue
Information about our net revenue for products and services for 2013 and 2012 is
summarized below (in millions):

           2013       2012      Increase    change
Products $ 114.0    $ 110.3    $     3.7       3 %
Services     8.2        5.1    $     3.1      61 %
         $ 122.2    $ 115.4    $     6.8       6 %

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Information about our net revenue for North America and international markets for 2013 and 2012 is summarized below (in millions):

                                                    Increase        %
                              2013       2012      (Decrease)    change
Revenue by geography:
United States               $  38.2    $  47.1    $     (8.9 )    (19 )%
Canada                          3.4        3.8          (0.4 )    (11 )%
Total North America            41.6       50.9          (9.3 )    (18 )%
Latin America                  27.2       27.9          (0.7 )     (3 )%
Europe, Middle East, Africa    49.6       34.2          15.4       45  %
Asia Pacific                    3.8        2.4           1.4       58  %
Total International            80.6       64.5          16.1       25  %
Total                       $ 122.2    $ 115.4    $      6.8        6  %

Net revenue increased 6% or $6.8 million to $122.2 million for 2013 compared to $115.4 million for 2012. The increase in net revenue was attributable to increases in product and service revenue. Product revenue increased 3% or $3.7 million from 2012 primarily due to increased sales of our ONT products. Service revenue increased 61% or $3.1 million in 2013. Service revenue represents revenue from maintenance and other services associated with product shipments. The increase in service revenue was primarily due to new service contracts, increased sales of installation services, and recognition of previously deferred revenue associated with extended warranties.
International net revenue increased 25% or $16.1 million to $80.6 million in 2013 and represented 66% of total net revenue compared with 56% in 2012. The increase in international net revenue was primarily due to increased sales in Europe, Middle East, and Asia, as a result of recent growth in demand for our products in these regions, which was partially offset by lower revenue from Latin America. Domestic net revenue decreased 18% or $9.3 million to $41.6 million in 2013 compared to $50.9 million in 2012. The decrease was primarily due to fewer broadband development projects in connection with federal stimulus funding.
For the year ended December 31, 2013 and 2012, three customers represented 33% and 25% of net revenue, respectively. We anticipate that our results of operations in any given period may depend to a large extent on sales to a small number of large accounts. As a result, our revenue for any quarter may be subject to significant volatility based upon changes in orders from one or a small number of key customers.
Cost of Revenue and Gross Profit
Total cost of revenue, including stock-based compensation, decreased $3.0 million or 4% to $76.1 million for 2013, compared to $79.1 million for 2012. The decrease in cost of revenue for 2013 was primarily due to changes in product mix and an improved pricing environment resulting in lower costs. Total cost of revenue was 62% of net revenue for 2013, compared to 69% of net revenue for 2012, which resulted in an increase in gross profit percentage from 31% in 2012 to 38% in 2013. The year-over-year increase in gross margin was primarily due to greater sales of products with higher gross margin, such as MXK products, and increased service revenue.
We expect that in the future, our cost of revenue as a percentage of net revenue will vary depending on the mix and average selling prices of products sold in the future. In addition, continued competitive and economic pressures could cause us to reduce our prices, adjust the carrying values of our inventory, or record inventory charges relating to discontinued products and excess or obsolete inventory.
Research and Product Development Expenses Research and product development expenses decreased 17% or $3.2 million to $15.3 million for 2013 compared to $18.5 million for 2012. The decrease was primarily due to lower personnel-related expenses of $1.3 million resulting from a lower headcount in 2013 as compared with 2012. In addition, we recorded a $0.6 million credit to our statement of comprehensive income in the year ended December 31, 2013 as a result of a vendor refund received in 2013 which related to overpayments for health benefits made in 2012. A portion of the credit was allocated to research and product development expenses.

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In addition, there was lower software maintenance expenses and expensed inventory costs of $0.6 million, decreased stock-based compensation expense of $0.3 million, and lower allocated facilities costs of $0.3 million. We intend to continue to invest in research and product development to attain our strategic product development objectives while seeking to manage the associated costs through expense controls.
Sales and Marketing Expenses
Sales and marketing expenses increased 4% or $0.9 million to $20.2 million for 2013 compared to $19.3 million for 2012. The overall increase was due to increased sales expenses while marketing and customer service expenses remained flat. The increase in sales expenses was primarily attributable to increased consulting costs of $1.2 million and commissions of $0.6 million. These increases were offset by lower personnel-related expenses of $0.8 million resulting from a lower headcount in 2013 as compared with 2012 as well as continued reductions in travel of $0.1 million. General and Administrative Expenses
General and administrative expenses decreased 13% or $1.0 million to $6.2 million for 2013 compared to $7.2 million for 2012. The decrease was mainly attributable to lower personnel-related expenses of $0.7 million, as our Chief Executive Officer continued to forego his annual base cash compensation, which was partially offset by an increase in bonuses. The decrease in general and administrative expenses was also due to lower bad debt expenses of $0.6 million, lower stock-based compensation expenses of $0.3 million, and decreased transportation costs of $0.3 million. These decreases were partially offset by a $1.0 million gain recorded in 2012 as a result of patent sales. There was no similar gain in 2013.
Impairment of Fixed Assets
Impairment of fixed assets was zero, $0.1 million, and $4.2 million for 2013, 2012, and 2011, respectively. In 2011, our continued negative cash flows and operating losses as well as the significant decrease in the market price of our stock indicated that the book value of our fixed assets could be impaired. After determining there were indicators of impairment, we proceeded to test for impairment on an annual basis. We concluded that an impairment charge was required in both 2012 and 2011 to write down the value of our fixed assets to fair value, as discussed in Note 3 of the consolidated financial statements. Interest Expense
Interest expense for 2013 remained flat at $0.1 million. Our outstanding debt balances remained constant and interest rates remained low during 2013. Other Income (Expense)
Other income (expense) for 2013 and 2012 remained flat and was immaterial. Income Tax Provision
During the year ended December 31, 2013, the income tax provision we recorded was an immaterial balance. During the year ended December 31, 2012, we recorded income tax provision of $0.1 million related to foreign and state taxes. No material provision or benefit for income taxes was recorded in 2013 and 2012, due to our recurring operating losses and the significant uncertainty regarding the realization of our net deferred tax assets, against which we have continued to record a full valuation allowance.

Net Revenue
Information about our net revenue for products and services for 2012 and 2011 is
summarized below (in millions):

                                 Increase        %
           2012       2011      (Decrease)    change
Products $ 110.3    $ 119.4    $     (9.1 )    (8 )%
Services     5.1        5.1             -       -  %
         $ 115.4    $ 124.5    $     (9.1 )    (7 )%

Information about our net revenue for North America and international markets for 2012 and 2011 is summarized below (in millions):

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                                                    Increase        %
                              2012       2011      (Decrease)    change
Revenue by geography:
United States               $  47.1    $  48.6    $     (1.5 )     (3 )%
Canada                          3.8        4.2          (0.4 )    (10 )%
Total North America            50.9       52.8          (1.9 )     (4 )%
Latin America                  27.9       32.1          (4.2 )    (13 )%
Europe, Middle East, Africa    34.2       38.5          (4.3 )    (11 )%
Asia Pacific                    2.4        1.1           1.3      118  %
Total International            64.5       71.7          (7.2 )    (10 )%
Total                       $ 115.4    $ 124.5    $     (9.1 )     (7 )%

Net revenue decreased 7% or $9.1 million to $115.4 million for 2012 compared to $124.5 million for 2011. The decrease in net revenue was primarily attributable to a decrease in product revenue, which in 2012 decreased 8% or $9.1 million . . .

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