DZS INC. - Annual Report: 2014 (Form 10-K)
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
x | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the fiscal year ended December 31, 2014
OR
¨ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to
Commission File Number: 000-32743
ZHONE TECHNOLOGIES, INC.
(Exact name of registrant as specified in its charter)
Delaware | 22-3509099 |
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) |
7195 Oakport Street
Oakland, California 94621
(Address of principal executive office)
Registrant’s telephone number, including area code: (510) 777-7000
Securities registered pursuant to Section 12(b) of the Act:
Common Stock, $0.001 Par Value | The Nasdaq Stock Market LLC |
(Title of class) | (Name of each exchange on which registered) |
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ¨ No x
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act. Yes ¨ No x
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be filed to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “accelerated filer,” “large accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act (Check one):
Large accelerated filer | ¨ | Accelerated filer | x |
Non-accelerated filer | ¨ (Do not check if a smaller reporting company) | Smaller reporting company | ¨ |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
As of February 27, 2015, there were 32,620,866 shares outstanding of the registrant’s common stock, $0.001 par value. As of June 30, 2014 (the last business day of the registrant’s most recently completed second fiscal quarter), the aggregate market value of common stock held by non-affiliates of the registrant was approximately $80,089,325.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant’s definitive Proxy Statement for the 2015 Annual Meeting of Stockholders are incorporated by reference into Part III of this Form 10-K where indicated.
TABLE OF CONTENTS
Page | ||
PART I | ||
Item 1. | ||
Item 1A. | ||
Item 1B. | ||
Item 2. | ||
Item 3. | ||
Item 4. | ||
PART II | ||
Item 5. | ||
Item 6. | ||
Item 7. | ||
Item 7A. | ||
Item 8. | ||
Item 9. | ||
Item 9A. | ||
Item 9B. | ||
PART III | ||
Item 10. | ||
Item 11. | ||
Item 12. | ||
Item 13. | ||
Item 14. | ||
PART IV | ||
Item 15. | ||
Forward-looking Statements
This Annual Report on Form 10-K, including “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” contains forward-looking statements regarding future events and our future results that are subject to the safe harbors created under the Securities Act of 1933 and the Securities Exchange Act of 1934. These statements are based on current expectations, estimates, forecasts, and projections about the industries in which we operate and the beliefs and assumptions of our management. We use words such as “anticipate,” “believe,” “continue,” “could,” “estimate,” “expect,” “goal,” “intend,” “may,” “plan,” “project,” “seek,” “should,” “target,” “will,” “would,” variations of such words, and similar expressions to identify forward-looking statements. In addition, statements that refer to projections of earnings, revenue, costs or other financial items; anticipated growth and trends in our business or key markets; future growth and revenues from our Single Line Multi-Service (SLMS) products; our ability to refinance or repay our existing indebtedness prior to the applicable maturity date; future economic conditions and performance; anticipated performance of products or services; plans, objectives and strategies for future operations; and other characterizations of future events or circumstances, are forward-looking statements. Readers are cautioned that these forward-looking statements are only predictions and are subject to risks, uncertainties and assumptions that are difficult to predict, including those identified under the heading “Risk Factors” in Item 1A, elsewhere in this report and our other filings with the Securities and Exchange Commission (the SEC). Therefore, actual results may differ materially and adversely from those expressed in any forward-looking statements. Factors that might cause such a difference include, but are not limited to, the ability to generate sufficient revenue to achieve or sustain profitability, the ability to raise additional capital to fund existing and future operations or to refinance or repay our existing indebtedness, defects or other performance problems in our products, the economic slowdown in the telecommunications industry that has restricted the ability of our customers to purchase our products, commercial acceptance of our SLMS products in our core and FiberLAN businesses, intense competition in the communications equipment market from large equipment companies as well as private companies with products that address the same networks needs as our products, higher than anticipated expenses that we may incur, and other factors identified elsewhere in this report. We undertake no obligation to revise or update any forward-looking statements for any reason.
PART I
ITEM 1. BUSINESS
Company Overview
We design, develop and manufacture communications network equipment for telecommunications operators and enterprises worldwide. Our products provide enterprise solutions that enable both network service providers and enterprises to deliver high speed fiber access, while transporting voice, video and data to the end user.
Our core business provides access products to carriers and service providers worldwide. We believe that carriers and service providers can increase their revenues and lower their operating costs by using our products to deliver high quality video and interactive entertainment and Internet Protocol (IP) enabled next generation voice services in addition to their existing voice and data service offerings, all on a platform that permits a seamless migration from legacy technologies to a converged packet-based architecture.
In addition to our established product offerings in our core business, we launched our FiberLAN Passive Optical LAN in 2012, which provides an alternative to switched copper-based LANs. Target customers of our FiberLAN business include hospitality, government, education, manufacturing and business enterprises. We believe FiberLAN Passive Optical LAN is one of the most cost-effective, efficient and environmentally friendly alternatives to existing copper-based Ethernet LAN infrastructure.
Our established SLMS architecture provides cost-efficiency and feature flexibility with support for voice over internet protocol (VoIP) and IP entertainment (IPTV). Within this versatile SLMS architecture, our products allow service providers to deliver all of these and other next generation converged packet services over their existing copper lines while providing support for fiber or Fiber to the home or business (FTTx) build-out. With our products and solutions, network service providers can seamlessly migrate from traditional circuit-based networks to packet-based networks and from copper-based access lines to fiber-based access lines without abandoning the investments they have made in their existing infrastructures.
Zhone launched our flagship MXK IP Multi-service Terabit Access Concentrator (MXK) and multiple new Optical Line Terminal (OLT) and outdoor units in late 2009. Our MXK product is a converged multi-services access platform that can be configured as a Gigabit Passive Optical Network (GPON) or Active Ethernet OLT. The MXK GPON line module is ITU-T G.984 compliant, delivering data throughputs of up to 2.5 Gbps downstream and 1.25 Gbps upstream. Each line card is designed for up to 64 passive splits per fiber. Active Ethernet delivers up to 1 Gbps point-to-point from a 20-port card. MXK continues to be widely deployed by service providers around the world, with over 7,300 total MXK units deployed as of December 31, 2014 at over 150 service providers in more than 40 countries.
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Zhone’s MXK product supports high-performance business and residential FTTx services. Unlike most competing products, MXK has the ability to support both Passive Optical Network (PON) and Active Ethernet fiber technologies to the node, curb or premises as well as a host of copper line interfaces. With our MXK product, service providers can offer digital or Ratio Frequency (RF) video, high-bandwidth Internet access, VoIP and digital subscriber line (DSL) from a single platform. Additionally, our MXK product can support up to 9,216 GPON subscribers in a single MXK chassis. In 2014, Zhone's MXK GPON solution was one of the first to receive Metro Ethernet Forum's Certification for Carrier Ethernet (CE) 2.0.
Our FiberLAN Passive Optical LAN is comprised of our MXK OLT and zNID Optical Network Terminals (ONT), and delivers GPON and Active Ethernet-based LAN services to enterprises. Both our core business and FiberLAN business leverage the same R&D efficiencies. In 2013, the Association for Passive Optical LAN was established, which includes as founding members IBM, 3M, Corning and Zhone. In addition, our FiberLAN solution (including FiberLAN OLT and ONT PON) was granted JITC (Joint Interoperability Test Command) certification by the Defense Information Systems Agency. This certification provides new sales opportunities in military and government markets, while helping to demonstrate the capabilities and security aspects of our FiberLAN solution. In 2014, Zhone announced a marketing relationship with Corning for their ONE DAS (Distributed Antenna System), which will assist in university and hospitality deployments.
The flexibility of our MXK product enables service provider and enterprise customers alike to choose the best technology for both services and network architecture. Active Ethernet provides dedicated high symmetric bandwidth to the end customers and makes it an excellent technology for deployment of business services. GPON provides a cost-effective way to deliver high bandwidth to the residence for a robust triple play offering while enabling a host of high speed data and video options for the businesses. In addition to Active Ethernet and dense GPON support, the MXK provides a wide array of multi-service functionality supporting well defined access standards enabling the convergence of voice, data and entertainment over any access medium delivering high-performance all IP solutions designed for either our core business or FiberLAN customers.
In 2014, we observed a growing demand for an ultra high density fiber-only GPON and Active Ethernet solution. To address this need, we developed the MXK-F platform. MXK-F is the fiber-only evolution of our MXK product line, offering ten times the switching capacity and two times the port capacity, while giving our customers a path to migrate to new high speed fiber services and access to network functions such as software defined networks, deep packet inspection and other network virtualization functions. The MXK-F is based on the SLMS architecture and leverages our 15 years of development and maturity of the SLMS code base in a new higher density platform.
We will continue to support and enhance our MXK platforms for copper and fiber access deployments but the MXK-F rounds out our portfolio and gives our carrier customers another tool to offer to their end user customers.
Corporate Information
We were incorporated in Delaware under the name Zhone Technologies, Inc. in June 1999, and in November 2003, we consummated our merger with Tellium, Inc. (Tellium). Although Tellium acted as the legal acquirer, due to various factors, including the relative voting rights, board control and senior management composition of the combined company, Zhone was treated as the “acquirer” for accounting purposes. Following the merger, the combined company was renamed Zhone Technologies, Inc. and retained substantially all of Zhone’s previous management and operating structure. The mailing address of our worldwide headquarters is 7195 Oakport Street, Oakland, California 94621, and our telephone number at that location is (510) 777-7000. Our website address is www.zhone.com. The information on our website does not constitute part of this report. Through a link on the Investor Relations section of our website, we make available the following filings as soon as reasonably practicable after they are electronically filed with or furnished to the SEC: our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and any amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934. All such filings are available free of charge.
Industry Background
Over the past decade, the communications network industry has experienced rapid expansion as the internet and the proliferation of bandwidth intensive applications and services have led to an increased demand for high bandwidth communications networks. The broad adoption of new technologies such as smartphones, digital cameras and high definition televisions allow music, pictures, user-generated content (as found on the many video-sharing sites) and high definition video to be a growing part of consumers’ regular exchange of information. In recent years, the growth of social communications and social networking has continued to place demands on existing copper based access infrastructure and new consumer demands are challenging even the newest and most advanced infrastructures. All of these new technologies share a common dependency on high bandwidth communication networks and sophisticated traffic management tools. However, network service providers have struggled to meet the increased demand for high speed broadband access due to the constraints of the existing communications network infrastructure. This infrastructure consists of two interconnected networks:
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• | the “core” network, which interconnects service providers with each other; and |
• | the “access” network, which connects end-users to a service provider’s closest facility. |
To address the increased demand for higher transmission speeds via greater bandwidth, service providers have expended significant capital over the past decade to upgrade the core network by replacing much of their copper infrastructure with high-speed optical infrastructure. While the use of fiber optic equipment in the core network has relieved the bandwidth capacity constraints in the core network between service providers, the access network continues to be a “bottleneck” that severely limits the transmission speed between service providers and end-users. As a result, communications in the core network can travel at up to 10 gigabits per second, while in stark contrast, many communications over the access network throughout the world still occur at a mere 56 kilobits per second, a speed that is 175,000 times slower. At 56 kilobits per second, it may take several minutes to access even a modestly media laden website and several hours to download large files. Fiber access lines have the potential to remedy this disparity, but re-wiring every home or business with fiber optic cable is both cost prohibitive and extremely time consuming. Consequently, solving the access network bottleneck has typically required more efficient use of the existing copper wire infrastructure and support for the gradual migration from copper to fiber.
In an attempt to deliver high bandwidth services over existing copper wire in the access network, service providers began deploying DSL technology over a decade ago. However, this early DSL technology has practical limitations. Copper is a distance sensitive medium in that the amount of bandwidth available over a copper wire is inversely proportional to the length of the copper wire. In other words, the greater the distance between the service provider’s equipment and the customer’s premises, the lower the bandwidth. Unfortunately, most DSL services available today are provided by first generation DSL access multiplexer (DSLAM) equipment. These large unwieldy devices require conditioned power and a climate controlled environment typically found only in a telephone company’s central office, which is often at great distance from the customer. While adequate for basic data services, these first generation DSLAMs were not designed to meet the needs of today’s high bandwidth applications. The modest bandwidth provided by existing DSLAM equipment is often incapable of delivering even a single channel of standard definition video, much less multiple channels of standard definition video or high definition video.
Over the past decade, regulatory changes have introduced new competitors in the telecommunication services industry. Cable operators, with extensive networks designed originally to provide only video programming, have collaborated to adopt new packet technologies that leverage their hybrid fiber/coaxial cable infrastructure. Using more recent technologies, cable operators have begun to cost-effectively deliver new service bundles. The new service offerings provide not only enhanced features and capabilities, but also allow the cable operators to deliver these services over a common network. The resulting cost-efficiencies realized by cable operators are difficult for incumbent telephone companies to match. Even with the telephone companies’ legacy voice switches fully paid for, maintaining separate networks for their circuit-based voice and packet-based video and data networks is operationally non-competitive. Perhaps even more important than economic efficiencies, by integrating these services over a common packet infrastructure, cable operators will realize levels of integration between applications and new features that will be difficult to achieve from a multi-platform solution. Despite these benefits, coaxial cable has its own share of limitations. Unlike DSL, coaxial cable shares its bandwidth among all customers connected to it. Consequently, as new customers are added to coaxial cable networks, performance decreases. As a shared medium, large numbers of subscribers who simultaneously access the same segment of the coaxial cable network can potentially compromise performance and security. This represents a source of strategic advantage for telecom operators who employ technology designed to maximize their service capabilities on the point-to-point (i.e. not shared) architecture of their copper infrastructure. In addition, the introduction of 3G and 4G wireless technologies and improved satellite technologies have enabled wireless and satellite service providers to provide competitive broadband offerings as alternatives to traditional landline access. This increased competition has placed significant pressure on all network service providers. With significant service revenues at risk, these service providers have sought to upgrade and modernize their networks and broaden their service offerings to enable delivery of additional high bandwidth, high margin services, and to lower the cost of delivering these services.
The Zhone Solution
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 legacy 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 using their existing infrastructures, as well as
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giving newer service providers the capability to deploy cost-effective, multi-service networks that can support voice, data and video.
Triple Play Services with Converged Voice, Data and Video – SLMS simplifies the access network by consolidating new and existing services onto a single line. This convergence of services and networks simplifies provisioning and operations, ensures quality of service and reliability, and reduces the time required to provide services. SLMS integrates access, transport, customer premises equipment, and management functions in a standards-based system that provides scalability, interoperability and functionality for voice, data and video services.
Packet Migration – SLMS is a flexible multi-service architecture that provides current services while simultaneously supporting migration to a pure packet network. This flexibility allows service providers to cost-effectively provide carrier class performance, and functionality for current and future services without interrupting existing services or abandoning existing subscribers. SLMS also protects the value of the investments made by residential and commercial subscribers in equipment, inside wiring and applications, thereby minimizing transition impact and subscriber attrition.
Fiber to the Home, Premise, Node, or Curb (FTTx) – We provide support for the full range of fiber-based access network architectures that are seeing increased use by carriers. In many markets worldwide, both business and residential demand for bandwidth is growing to the point where the deployment of fiber in the access network is increasingly desirable. Where copper loops are plentiful and where civil restrictions make fiber deployment all the way to the customer premises prohibitively expensive, if not impossible, many operators are choosing to deploy fiber from central offices to neighborhoods and then using VDSL2 over copper to deliver broadband connectivity over the last hundred meters or so. In other circumstances operators choose to deploy passive optical networks (PON) all the way to the customer premises, where a single fiber’s bandwidth is shared through splitters with up to 64 subscribers. Some circumstances demand so-called “home run” fiber networks (with dedicated fiber resources linking every customer directly to the central office) to maximize bandwidth or service segmentation. By supporting all these architectures within a common SLMS-based platform, we provide carriers maximum flexibility to build the network that best suits their needs.
Ethernet Service Delivery – We offer a complete array of equipment that allows carriers to deliver ethernet services over copper or fiber. For business subscribers, our ethernet over copper product family allows carriers to quickly deliver ethernet services over existing copper SHDSL or T1/E1 circuits. Multiple circuits can be bonded to provide over 70 Megabits per second, enough to deliver ample ethernet bandwidth to satisfy business subscribers’ growing service requirements. This copper-based solution provides a compelling alternative to burying fiber and dedicating valuable fiber strands to long-haul ethernet services to small and medium enterprises.
FiberLAN Passive Optical LAN - Passive Optical LAN is a next generation passive optical network architecture built using industry leading IT standards. This fully converged solution is scalable for a single building or large campus environments where customers are installing new facilities or upgrading their current LAN infrastructures. The solution provides a future-resistant LAN with environmentally friendly benefits, and high bandwidth capabilities to handle large sharing, file transfers, imaging, streaming video or real-time workgroup collaboration. Optical LAN Solutions are engineered to help improve network efficiencies, reduce capital costs, reduce space requirements, and conserve energy.
The Zhone Strategy
Our strategy has been to combine internal development with acquisitions of established access equipment vendors to achieve the critical mass required of telecommunications equipment providers. We expect that our future growth will focus primarily on organic growth in emerging technology markets. Going forward, the key elements of our strategy include:
• | Expanding Our Infrastructure to Meet Service Provider Needs. Network service providers require extensive support and integration with manufacturers to deliver reliable, innovative and cost-effective services. By combining advanced, computer-aided design, test and manufacturing systems with experienced, customer-focused management and technical staff, we believe that we have established the critical mass required to fully support global service provider requirements. We continue to expand our infrastructure through ongoing development and strategic relationships, continuously improving quality, reducing costs and accelerating delivery of advanced solutions. |
• | Continuing the Development and Enhancement of Our SLMS Products. Our SLMS architecture is the cornerstone of our product development strategy. The design criteria for SLMS products include carrier-class reliability, multi-protocol and multi-service support, and ease of provisioning. We intend to continue to introduce SLMS products that offer the configurations and feature sets that our customers require. In addition, we have introduced products that adhere to the standards, protocols and interfaces dictated by international standards bodies and service providers. In 2009, we introduced our MXK product, an SLMS-based product that |
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provides a converged multi-services access platform. In 2012, we launched our FiberLAN OLS, a cost-effective, efficient and environmentally friendly alternative to existing copper-based ethernet LAN infrastructure. In 2014, we developed our MXK-F fiber-only platform to meet the growing needs of fiber-only carriers. To facilitate the rapid development of our existing and new SLMS architecture and products, we have established engineering teams responsible for each critical aspect of the architecture and products. We intend to continue to leverage our expertise in voice, data and video technologies to enhance our SLMS architecture, supporting new services, protocols and technologies as they emerge. To further this objective, we intend to continue investing in research and development efforts to extend the SLMS architecture and introduce new SLMS products.
• | Delivering Full Customer Solutions. In addition to delivering hardware and software product solutions, we provide customers with pre-sales and post-sales support, education and professional services to enable our customers to more efficiently deploy and manage their networks. We provide customers with application notes, business planning information, web-based and phone-based troubleshooting assistance and installation guides. Our support programs provide a comprehensive portfolio of support tools and resources that enable our customers to effectively sell to, support and expand their subscriber base using our products and solutions. |
Product Portfolio
Our products provide the framework around which we are designing and developing high speed communications software and equipment for the access network. All of the products listed below are currently available and being shipped to customers. Our products span two distinct categories:
SLMS Products
Our SLMS products address four areas of customer requirements. Our Broadband Aggregation and Service products aggregate, concentrate and optimize communications traffic from copper and fiber networks. These products are deployed in central offices, remote offices, points of presence, curbsides, data and co-location centers, and large enterprises. Our Customer Premise Equipment, or CPE, products offer a cost-effective solution for combining analog voice and data services to the subscriber’s premises over a single platform. The Zhone Management System, or ZMS, product provides optional software tools to help manage aggregation and customer premises network hardware. These products deliver voice, data and video interface connectivity for broadcast and subscription television, internet routers and traditional telephony equipment. The FiberLAN Passive Optical LAN product is a cost-effective alternative to existing copper-based ethernet LAN, which is scalable for a single building or large campus environments.
Our SLMS products include:
Category | Product | Function |
Broadband Aggregation and Service | MXK-F | Fiber-only Multi Terabit Access OLT |
MXK | Multi-Service Terabit Access Concentrator | |
MALC | Multi-Access Line Concentrator | |
MXP/MX | Scalable 1U SLMS VDSL2/Active Ethernet | |
MALC-OLT | FTTx Optical Line Terminal | |
8000 /12000 | DSLAMs | |
Customer Premise Equipment (CPE) | EtherXtend | Ethernet Over Copper |
15xx, 67xx, 65xx | Wireline/Wireless DSL Modems | |
17xx, 6xxx | Wireline/Wireless DSL Modems | |
zNID | Optical Network Terminals | |
Zhone Management System | ZMS | Network and Subscriber Management |
FiberLAN Passive Optical LAN | MXK | Multi-Service Terabit Access Concentrator |
zNID | Optical Network Terminals | |
Legacy, Service and Other Products
Our legacy products support a variety of voice and data services, and are broadly deployed by service providers worldwide. Our main legacy product during 2014 and 2013 was our IMACS product which functions as a multi-access multiplexer.
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Global Service & Support
In addition to our product offerings, we provide a broad range of service offerings through our Global Service & Support organization. We supplement our standard and extended product warranties with programs that offer technical support, product repair, education services and enhanced support services. These services enable our customers to protect their network investments, manage their networks more efficiently and minimize downtime for mission-critical systems. Technical support services are designed to help ensure that our products operate efficiently, remain highly available, and benefit from recent software releases. Through our education services program, we offer in-depth training courses covering network design, installation, configuration, operation, trouble-shooting and maintenance. Our professional services offering is a comprehensive program that provides network engineering, configuration, integration, project management, installation, and other consultative support to maximize the results of our customers during the design, deployment and operational phases. As part of our commitment to ensure around-the-clock support, we maintain a technical assistance center and a world wide staff of qualified network support engineers to provide customers with 24-hour service, seven days a week.
Technology
We believe that our future success is built upon our investment in the development of advanced technologies. SLMS is based on a number of technologies that provide sustainable advantages, including the following:
• | Services-Centric Architecture. SLMS has been designed from inception for the delivery of multiple classes of subscriber services (such as voice, data or video distribution), rather than being based on a particular protocol or media. Our SLMS products are built to interoperate in networks supporting packet, cell and circuit technologies. This independence between services and the underlying transportation is designed to position our products to be able to adapt to future transportation technologies within established architectures and to allow our customers to focus on service delivery. |
• | Common Code Base. Our SLMS products share a common base of software code, which is designed to accelerate development, improve software quality, enable rapid deployment, and minimize training and operations costs, in conjunction with network management software. |
• | Network Management and Operations. Our ZMS product provides management capabilities that enable rapid, cost-effective, and secure control of the network; standards-based interfaces for seamless integration with supporting systems; hierarchical service and subscriber profiles to allow rapid service definition and provisioning, and to enable wholesaling of services; automated and intelligent CPE provisioning to provide the best end-user experience and accelerate service turn-up; load-balancing for scalability; and full security features to ensure reliability and controlled access to systems and data. |
• | Test Methodologies. Our SLMS architecture provides for interoperability with a variety of products that reside in networks in which we will deploy our products. To ensure interoperability, we have built a testing facility to conduct extensive multi-vendor trials and to ensure full performance under valid network conditions. Testing has included participation with partners’ certification and accreditation programs for a wide range of interoperable products, including soft switches, SAN equipment and management software. The successful completion of these processes is required by our largest customers to ensure interoperability with their existing software and systems. |
• | Acquired Technologies. Since our inception, we have completed twelve acquisitions pursuant to which we acquired products, technology and additional technical expertise. |
Customers
For our core business, we sell our products and services to network service providers that offer voice, data and video services to businesses, governments, utilities and residential consumers. 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. Baud Telecom Company represented 14% and 13% of net revenue in 2014 and 2013, respectively. Emirates Telecommunications Corporation (Etisalat) accounted for 11% and 9% of net revenue in 2014 and 2013, respectively. Axtel SAB DE CV (Axtel) accounted for 4% and 10% of net revenue in 2014 and 2013, respectively. No other customers accounted for 10% or more of net revenue during either period.
For our FiberLAN business, we sell our FiberLAN solutions directly and through partners and distributors to hospitality, education, manufacturing and business enterprises as well as to the government and military. Our global FiberLAN customer base includes hotels, universities, military bases, government institutions, manufacturing facilities and businesses. To date, our enterprise products and solutions are deployed in each of our served markets around the globe.
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Research and Development
The industry in which we compete is subject to rapid technological developments, evolving industry standards, changes in customer requirements, and continuing developments in communications service offerings. Our continuing ability to adapt to these changes, and to develop new and enhanced products, is a significant factor in maintaining or improving our competitive position and our prospects for growth. Therefore, we continue to make significant investments in product development.
We conduct the majority of our research and product development activities at our headquarters in Oakland, California. In Oakland, we have built an extensive communications laboratory with hundreds of access infrastructure products from multiple vendors that serve as an interoperability and test facility. This facility allows us to emulate a communications network with serving capacity equivalent to that supporting a city of 350,000 residents. We also have focused engineering staff and activities at additional development centers located in Alpharetta, Georgia; Largo, Florida; and Westlake Village, California.
Our product development activities focus on products to support both existing and emerging technologies in the segments of the communications industry that we consider viable revenue opportunities. We are actively engaged in continuing to refine our SLMS architecture, introducing new products under our SLMS architecture, and creating additional interfaces and protocols for both domestic and international markets.
We continue our commitment to invest in leading edge technology research and development. Our research and product development expenditures were $17.3 million, $15.3 million, and $18.5 million in 2014, 2013 and 2012, respectively. All of our expenditures for research and product development costs, as well as stock-based compensation expense relating to research and product development, have been expensed as incurred. Stock-based compensation expense in 2014 and 2013 related to research and product development was immaterial. For 2012, our research and product development costs included stock-based compensation of $0.3 million. We plan to continue to support the development of new products and features, while seeking to carefully manage associated costs through expense controls.
Intellectual Property
We seek to establish and maintain our proprietary rights in our technology and products through the use of patents, copyrights, trademarks and trade secret laws. We also seek to maintain our trade secrets and confidential information by nondisclosure policies and through the use of appropriate confidentiality agreements. We have obtained a number of patents and trademarks in the United States and in other countries. There can be no assurance, however, that these rights can be successfully enforced against competitive products in every jurisdiction. Although we believe the protection afforded by our patents, copyrights, trademarks and trade secrets has value, the rapidly changing technology in the networking industry and uncertainties in the legal process make our future success dependent primarily on the innovative skills, technological expertise, and management abilities of our employees rather than on the protection afforded by patent, copyright, trademark, and trade secret laws.
Many of our products are designed to include software or other intellectual property licensed from third parties. While it may be necessary in the future to seek or renew licenses relating to various aspects of our products, we believe, based upon past experience and standard industry practice, that such licenses generally could be obtained on commercially reasonable terms. Nonetheless, there can be no assurance that the necessary licenses would be available on acceptable terms, if at all. Our inability to obtain certain licenses or other rights or to obtain such licenses or rights on favorable terms, or the need to engage in litigation regarding these matters, could have a material adverse effect on our business, operating results and financial condition.
The communications industry is characterized by rapidly changing technology, a large number of patents, and frequent claims and related litigation regarding patent and other intellectual property rights. We cannot assure you that our patents and other proprietary rights will not be challenged, invalidated or circumvented, that others will not assert intellectual property rights to technologies that are relevant to us, or that our rights will give us a competitive advantage. In addition, the laws of some foreign countries may not protect our proprietary rights to the same extent as the laws of the United States.
Sales and Marketing
We have a sales presence in various domestic and foreign locations, and we sell our products and services both directly and indirectly through channel partners with support from our sales force. Channel partners include distributors, resellers, system integrators and service providers. These partners sell directly to end customers and often provide system installation, technical support, professional services and support services in addition to the network equipment sale. Our sales efforts are generally organized according to geographical regions:
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• | U.S. Sales. Our U.S. Sales organization establishes and maintains direct relationships with domestic customers, which include communication service providers, cable operators, independent operating companies, or IOCs, as well as competitive carriers, developers and utilities. In addition, this organization is responsible for managing our distribution and original equipment manufacturer, or OEM, partnerships. |
• | International Sales. Our International Sales organization targets foreign based service providers and is staffed with individuals with specific experience dealing with service providers in their designated international territories. |
Our marketing team works closely with our sales, research and product development organizations, and our customers by providing communications that keep the market current on our products and features. Marketing also identifies and sizes new target markets for our products, creates awareness of our company and products, generates contacts and leads within these targeted markets and performs outbound education and public relations.
Backlog
Our backlog consists of purchase orders for products and services that we expect to ship or perform within the next year. Our backlog may fluctuate based on the timing of when purchase orders are received. At December 31, 2014, our backlog was $4.8 million, as compared to $3.7 million at December 31, 2013. We consider backlog to be an indicator, but not the sole predictor, of future sales because our customers may cancel or defer orders without penalty.
Competition
We compete in the communications equipment market, providing products and services for the delivery of voice, data and video services. This market is characterized by rapid change, converging technologies and a migration to solutions that offer superior advantages. These market factors represent both an opportunity and a competitive threat to us. We compete with numerous vendors in our core business, including Alcatel-Lucent, Calix, Adtran, Huawei, and ZTE, among others. In our FiberLAN business, our competitors include Tellabs and Cisco, among others. In addition, a number of companies have introduced products that address the same network needs that our products address, both domestically and abroad. The overall number of our competitors may increase, and the identity and composition of competitors may change. As we continue to expand our sales globally, we may see new competition in different geographic regions. Barriers to entry are relatively low, and new ventures to create products that do or could compete with our products are regularly formed. Many of our competitors have greater financial, technical, sales and marketing resources than we do.
The principal competitive factors in the markets in which we presently compete and may compete in the future include:
• | product performance; |
• | interoperability with existing products; |
• | scalability and upgradeability; |
• | conformance to standards; |
• | breadth of services; |
• | reliability; |
• | ease of installation and use; |
• | geographic footprints for products; |
• | ability to provide customer financing; |
• | price; |
• | technical support and customer service; and |
• | brand recognition. |
While we believe that we compete successfully with respect to each of these factors, we expect to face intense competition in our market. In addition, the inherent nature of communications networking requires interoperability. As such, we must cooperate and at the same time compete with many companies.
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Manufacturing
We manufacture our products using a strategic combination of procurement from qualified suppliers, in-house manufacturing at our facility in Florida, and the use of original design manufacturers (ODM) located in the Far East. We manufacture a significant majority of our more complex products at our manufacturing facility in Florida.
Our parts and components are procured from a variety of qualified suppliers in the U.S., Far East, Mexico, and other countries around the world per our approved supplier list and detailed engineering specifications. Some completed products are procured to our specifications and shipped directly to our customers. We also acquire completed products from certain suppliers and configure and ship from our facility. Some of these purchases are significant. We purchase both standard off-the-shelf parts and components, which are generally available from more than one supplier, and single-source parts and components. We have generally been able to obtain adequate supplies to meet customer demand in a timely manner from our current vendors, or, when necessary, from alternate vendors. We believe that alternate vendors can be identified if current vendors are unable to fulfill our needs, or design changes can be made to employ alternate parts.
We design, specify, and monitor all of the tests that are required to meet our quality standards. Our manufacturing and test engineers work closely with our design engineers to ensure manufacturability and testability of our products, and to ensure that manufacturing and testing processes evolve as our technologies evolve. Our manufacturing engineers specify, build, or procure our test stations, establish quality standards and protocols, and develop comprehensive test procedures and processes to assure the reliability and quality of our products. Products that are procured complete or partially complete are inspected, tested, or audited for quality control.
Our manufacturing quality system is ISO-9001:2008 and is certified to ISO-9001:2008 by our external registrar. ISO-9001:2008 ensures our processes are documented, followed, and continuously improved. Internal audits are conducted on a regular schedule by our quality assurance personnel, and external audits are conducted by our external registrar every year. Our quality system is based upon our model for quality assurance in design, development, production, installation, and service to ensure our products meet rigorous quality standards.
We believe that we have sufficient production capacity to meet current and future demand for our product offerings through a combination of existing and added capacity, additional employees, or the outsourcing of products or components.
Compliance with Regulatory and Industry Standards
Our products must comply with a significant number of voice and data regulations and standards which vary between the U.S. and international markets, and which vary between specific international markets. Standards for new services continue to evolve, and we may need to modify our products or develop new versions to meet these standards. Standards setting and compliance verification in the U.S. are determined by the Federal Communications Commission, or FCC, Underwriters Laboratories, Quality Management Institute, Telcordia Technologies, Inc., and other communications companies. In international markets, our products must comply with standards issued by the European Telecommunications Standards Institute, or ETSI, and implemented and enforced by the telecommunications regulatory authorities of each nation.
Environmental Matters
Our operations and manufacturing processes are subject to federal, state, local and foreign environmental protection laws and regulations. These laws and regulations relate to the use, handling, storage, discharge and disposal of certain hazardous materials and wastes, the pre-treatment and discharge of process waste waters and the control of process air pollutants.
We believe that our operations and manufacturing processes currently comply in all material respects with applicable environmental protection laws and regulations. If we fail to comply with any present and future regulations, we could be subject to future liabilities, the suspension of production or a prohibition on the sale of our products. In addition, such regulations could require us to incur other significant expenses to comply with environmental regulations, including expenses associated with the redesign of any non-compliant product. From time to time new regulations are enacted, and it is difficult to anticipate how such regulations will be implemented and enforced. For example, in 2003 the European Union enacted the Restriction on the Use of Certain Hazardous Substances in Electrical and Electronic Equipment Directive (RoHS) and the Waste Electrical and Electronic Equipment Directive (WEEE), for implementation in European Union member states. We are
aware of similar legislation that is currently in force or is being considered in the United States, as well as other countries, such as Japan and China. Our failure to comply with any of such regulatory requirements or contractual obligations could result in our being liable for costs, fines, penalties and third-party claims, and could jeopardize our ability to conduct business in countries in the jurisdictions where these regulations apply.
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Employees
As of December 31, 2014, we employed 277 individuals worldwide. We consider the relationships with our employees to be positive. Competition for technical personnel in our industry is intense. We believe that our future success depends in part on our continued ability to hire, assimilate and retain qualified personnel. To date, we believe that we have been successful in recruiting qualified employees, but there is no assurance that we will continue to be successful in the future.
Executive Officers
Set forth below is information concerning our executive officers and their ages as of December 31, 2014.
Name | Age | Position |
Morteza Ejabat | 64 | Executive Chairman of the Board of Directors |
James Norrod | 66 | Chief Executive Officer and President |
Kirk Misaka | 56 | Chief Financial Officer, Corporate Treasurer and Secretary |
Morteza Ejabat is a co-founder of Zhone and has served as Executive Chairman of the Board of Directors since July 2014. From June 1999 to July 2014, Mr. Ejabat served as Zhone's President, Chief Executive Officer and Chairman of the Board. Prior to co-founding Zhone, from June 1995 to June 1999, Mr. Ejabat was President and Chief Executive Officer of Ascend Communications, Inc., a provider of telecommunications equipment which was acquired by Lucent Technologies, Inc. in June 1999. Previously, Mr. Ejabat held various senior management positions with Ascend from September 1990 to June 1995, most recently as Executive Vice President and Vice President, Operations. Mr. Ejabat holds a B.S. in Industrial Engineering and an M.S. in Systems Engineering from California State University at Northridge, and an M.B.A. from Pepperdine University.
James Norrod became Zhone's President, Chief Executive Officer, and Zhone director in July 2014. With 25 years of experience as a chairman and chief executive officer, Mr. Norrod's relevant expertise includes development of domestic and international operations, establishment of new sales distribution channels, hiring and developing world class management teams while developing and implementing business strategies. Mr. Norrod's extensive chief executive officer experience includes leading companies such as Infinite Power Solutions, Segway, ZAN3D, CGX, Octocom, Telebit and ITK. Mr. Norrod earned an MBA at University of Detroit and a B.S. at Oakland University.
Kirk Misaka has served as Zhone’s Corporate Treasurer since November 2000 and as Chief Financial Officer and Secretary since July 2003. Prior to joining Zhone, Mr. Misaka was a Certified Public Accountant with KPMG LLP from 1980 to 2000, becoming a partner in 1989. Mr. Misaka earned a B.S. and an M.S. in Accounting from the University of Utah, and an M.S. in Tax from Golden Gate University.
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ITEM 1A. RISK FACTORS
Set forth below and elsewhere in this report and in other documents we file with the SEC are risks and uncertainties that could cause actual results to differ materially from the results contemplated by the forward-looking statements contained in this report.
Our future operating results are difficult to predict and our stock price may continue to be volatile.
As a result of a variety of factors discussed in this report, our revenues for a particular quarter are difficult to predict. Our revenue and operating results may vary significantly from quarter to quarter due to a number of factors, many of which are outside of our control. The primary factors that may affect our results of operations include the following:
• | commercial acceptance of our SLMS and other products and services; |
• | fluctuations in demand for network access products; |
• | the timing and size of orders from customers; |
• | the ability of our customers to finance their purchase of our products as well as their own operations; |
• | new product introductions, enhancements or announcements by our competitors; |
• | our ability to develop, introduce and ship new products and product enhancements that meet customer requirements in a timely manner; |
• | changes in our pricing policies or the pricing policies of our competitors; |
• | the ability of our company and our contract manufacturers to attain and maintain production volumes and quality levels for our products; |
• | our ability to obtain sufficient supplies of sole or limited source components; |
• | increases in the prices of the components we purchase, or quality problems associated with these components; |
• | unanticipated changes in regulatory requirements which may require us to redesign portions of our products; |
• | changes in accounting rules, such as recording expenses for employee stock option grants; |
• | integrating and operating any acquired businesses; |
• | our ability to achieve targeted cost reductions; |
• | how well we execute on our strategy and operating plans; and |
• | general economic conditions as well as those specific to the communications, internet and related industries. |
Any of the foregoing factors, or any other factors discussed elsewhere herein, could have a material adverse effect on our business, results of operations, and financial condition that could adversely affect our stock price. During recent years our stock price has been volatile, ranging from a low of $0.40 to a high of $6.62 since December 31, 2011, and we anticipate that our stock price and trading volume may continue to be volatile in the future, whether due to the factors described above, volatility in public stock markets generally (particularly in the technology sector) or otherwise.
Between October 2011 and July 2013, the bid price for our common stock traded below the $1.00 minimum per share bid price required for continued inclusion on the Nasdaq Capital Market under Marketplace Rule 5550(a)(2), and we received letters from The Nasdaq Stock Market, or Nasdaq, requiring us to regain compliance within a specified period. A failure to regain compliance could result in our stock being delisted, subject to a right of appeal. In August 2013, we received written notification from Nasdaq advising us that we had regained compliance with the minimum bid price rule as the closing bid price of our common stock had been $1.00 per share or greater for ten consecutive business days. There can be no assurance that our stock price will remain above the minimum bid price or that we will be able to regain compliance if our stock price falls below the minimum bid price again in the future. In addition, if our average market capitalization falls below the carrying value of our assets for an extended period of time as it has done during recent years, this may indicate that the fair value of our net assets is below their carrying value, and may result in recording impairment charges.
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We have experienced significant losses and we may incur losses in the future. If we fail to generate sufficient revenue to sustain our profitability, our stock price could decline.
We have incurred significant losses to date and expect that our operating losses and negative cash flows from operations may continue. Our net loss was $4.1 million for the year ended December 31, 2014 and we had an accumulated deficit of $1,041.0 million at December 31, 2014. We have significant fixed expenses and expect that we will continue to incur substantial manufacturing, research and product development, sales and marketing, customer support, administrative and other expenses in connection with the ongoing development of our business. In addition, we may be required to spend more on research and product development than originally budgeted to respond to industry trends. We may also incur significant new costs related to acquisitions and the integration of new technologies and other acquisitions that may occur in the future. We may not be able to adequately control costs and expenses or achieve or maintain adequate operating margins. As a result, our ability to sustain profitability in future periods will depend on our ability to generate and sustain higher revenue while maintaining reasonable cost and expense levels. If we fail to generate sufficient revenue to sustain profitability in future periods, we may continue to incur operating losses, which could be substantial, and our stock price could decline.
We have significant debt obligations, which could adversely affect our business, operating results and financial condition.
As of December 31, 2014, we had approximately $10.0 million of total debt outstanding under our $25.0 million revolving line of credit and letter of credit facility (the WFB Facility) with Wells Fargo Bank (WFB), of which all was current. In addition, as of December 31, 2014, $3.0 million was committed as security for various letters of credit under the WFB Facility. We expect to make borrowings from time to time under the WFB Facility. The WFB Facility includes covenants, restrictions and financial ratios that may restrict our ability to operate our business. Our debt obligations could materially and adversely affect us in a number of ways, including:
• | limiting our ability to obtain additional financing in the future for working capital, capital expenditures, acquisitions or general corporate purposes; |
• | limiting our flexibility to plan for, or react to, changes in our business or market conditions; |
• | requiring us to use a significant portion of any future cash flow from operations to repay or service the debt, thereby reducing the amount of cash available for other purposes; |
• | making us more highly leveraged than some of our competitors, which may place us at a competitive disadvantage; and |
• | making us more vulnerable to the impact of adverse economic and industry conditions and increases in interest rates. |
We cannot assure you that we will be able to generate sufficient cash flow in amounts sufficient to enable us to service our debt or to meet our working capital and capital expenditure requirements. If we are unable to generate sufficient cash flow from operations or to borrow sufficient funds to service our debt, due to borrowing base restrictions or otherwise, we may be required to sell assets, reduce capital expenditures or obtain additional financing. We cannot assure you that we will be able to engage in any of these actions on reasonable terms, if at all.
If we default under the WFB Facility because of a covenant breach or otherwise, WFB may be entitled to, among other things, require the immediate repayment of all outstanding amounts and sell our assets to satisfy the obligations under the WFB Facility. We were in compliance with our covenants under our WFB Facility as of December 31, 2014. In 2010, we failed to satisfy a financial covenant under our former revolving line of credit and letter of credit facility. Although we were able to obtain a waiver with respect to that default, we cannot give assurances that we will be able to obtain a waiver should a default occur under our WFB Facility in the future. Any acceleration of amounts due could have a material adverse effect on our liquidity and financial condition.
If we are unable to obtain additional capital to fund our existing and future operations, we may be required to reduce the scope of our planned product development, and marketing and sales efforts, which would harm our business, financial condition and results of operations.
The development and marketing of new products, and the expansion of our direct sales operations and associated support personnel requires a significant commitment of resources. We may incur significant losses or expend significant amounts of capital if:
• | the market for our products develops more slowly than anticipated; |
• | we fail to establish market share or generate revenue at anticipated levels; |
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• | our capital expenditure forecasts change or prove inaccurate; or |
• | we fail to respond to unforeseen challenges or take advantage of unanticipated opportunities. |
As a result, we may need to raise substantial additional capital. Additional capital, if required, may not be available on acceptable terms, or at all. If additional capital is raised through the issuance of debt securities or other debt financing, the terms of such debt may include covenants, restrictions and financial ratios that may restrict our ability to operate our business. In addition, volatility in our stock price may make it more difficult or costly for us to raise capital through the issuance of common stock, preferred stock or other equity securities. If we elect to raise equity capital, this may be dilutive to existing stockholders and could reduce the trading price of our common stock. If we are unable to obtain additional capital or are required to obtain additional capital on terms that are not favorable to us, we may be required to reduce the scope of our planned product development and sales and marketing efforts beyond the reductions that we have previously taken, which could have a material adverse effect on our business, financial condition and results of operations.
Our lack of liquid funds and other sources of financing may limit our ability to maintain our existing operations, grow our business and compete effectively.
As of December 31, 2014, we had approximately $11.5 million in cash and cash equivalents and $10.0 million outstanding under our bank lending facility. Our current lack of liquidity could harm us by:
• | increasing our vulnerability to adverse economic conditions in our industry or the economy in general; |
• | requiring substantial amounts of cash to be used for debt servicing, rather than other purposes, including operations; |
• | limiting our ability to plan for, or react to, changes in our business and industry; and |
• | influencing investor and customer perceptions about our financial stability and limiting our ability to obtain financing or acquire customers. |
In order to meet our liquidity needs and finance our capital expenditures and working capital needs for our business, we may be required to sell assets, issue debt or equity securities, or borrow on potentially unfavorable terms. In addition, we may be required to reduce our operations in low margin regions, including reductions in headcount. We may be unable to sell assets, access additional indebtedness or undertake other actions to meet these needs. As a result, we may become unable to pay our ordinary expenses, including our debt service, on a timely basis. If additional capital is raised through the issuance of debt securities or other debt financing, the terms of such debt may include covenants, restrictions and financial ratios that may restrict our ability to operate our business. Likewise, any equity financing could result in additional dilution of our stockholders. If we are unable to sell assets, issue securities or access additional indebtedness to meet these needs on favorable terms, or at all, we may become unable to pay our ordinary expenses, including our debt service, on a timely basis and may be required to reduce the scope of our planned product development and sales and marketing efforts beyond the reductions we have previously taken. In addition, we may be required to reduce our operations in low margin regions, including reductions in headcount. In addition, we may not be able to fund our business expansion, take advantage of future opportunities, or respond to competitive pressures or unanticipated capital requirements, any of which could have a material adverse effect on our business, financial condition and results of operations.
Our business and future operating results are subject to global economic and market conditions.
Market turbulence and weak economic conditions, as well as concerns about energy costs, geopolitical issues, the availability and cost of credit, business and consumer confidence, and unemployment could impact our business in a number of ways, including:
Potential deferment of purchases and orders by customers: Uncertainty about global economic conditions may cause consumers, businesses and governments to defer purchases in response to flat revenue budgets, tighter credit, decreased cash availability and weak consumer confidence. Accordingly, future demand for our products could differ materially from our current expectations.
Customers’ inability to obtain financing to make purchases from Zhone and/or maintain their business: Some of our customers require substantial financing in order to finance their business operations, including capital expenditures on new equipment and equipment upgrades, and make purchases from Zhone. The potential inability of these customers to access the capital needed to finance purchases of our products and meet their payment obligations to us could adversely impact our financial condition and results of operations. To sell to some of these customers, we may be required to assume incremental risks of uncollectible accounts or to extend credit or credit support. While we monitor these situations carefully and attempt to take appropriate
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measures to protect ourselves, including factoring credit arrangements to financial institutions, it is possible that we may have to defer revenue until cash is collected or write-down or write-off uncollectible accounts. Such write-downs or write-offs, if large, could have a material adverse effect on our results of operations and financial condition. If our customers become insolvent due to market and economic conditions or otherwise, it could have a material adverse impact on our business, financial condition and results of operations.
Negative impact from increased financial pressures on third-party dealers, distributors and retailers: We make sales in certain regions through third-party dealers, distributors and retailers. These third parties may be impacted, among other things, by a significant decrease in available credit. If credit pressures or other financial difficulties result in insolvency for these third parties and we are unable to successfully transition end customers to purchase our products from other third parties, or from us directly, it could adversely impact our financial condition and results of operations.
Negative impact from increased financial pressures on key suppliers: Our ability to meet customers’ demands depends, in part, on our ability to obtain timely and adequate delivery of quality materials, parts and components from our suppliers. Certain of our components are available only from a single source or limited sources. If certain key suppliers were to become capacity constrained or insolvent, it could result in a reduction or interruption in supplies or a significant increase in the price of supplies and adversely impact our financial condition and results of operations. In addition, credit constraints of key suppliers could result in accelerated payment of accounts payable by Zhone, impacting our cash flow.
We may experience material adverse impacts on our business, operating results and financial condition as a result of weak or recessionary economic or market conditions in the United States or the rest of the world.
If demand for our SLMS products in our core or our FiberLAN business does not develop as we anticipate, then our results of operations and financial condition will be adversely affected.
Our future revenue depends significantly on our ability to successfully develop, enhance and market our SLMS products to the network service provider market in our core business. Most network service providers have made substantial investments in their current infrastructure, and they may elect to remain with their current architectures or to adopt new architectures, such as SLMS, in limited stages or over extended periods of time. A decision by a customer to purchase our SLMS products will involve a significant capital investment. We must convince our service provider customers that they will achieve substantial benefits by deploying our products for future upgrades or expansions.
We commenced our FiberLAN business in 2012 with the launch of our FiberLAN Passive Optical LAN product, which provides an alternative to switched copper-based LANs. The success of our FiberLAN business depends on our ability to market and sell our FiberLAN Passive Optical LAN product to the enterprise market, including hospitality, government, education, manufacturing and business enterprises. We may be unsuccessful in implementing our business plan for our FiberLAN business, or we may not be able to achieve the revenue that we expect from our FiberLAN business. We may experience difficulties with product reliability, partnering, and sales and marketing efforts that could adversely affect our FiberLAN business and divert management attention and resources from our core business.
We do not know whether a viable market for our SLMS products will develop or be sustainable in our core and FiberLAN businesses. If these markets do not develop or develop more slowly than we expect, our business, financial condition and results of operations will be seriously harmed.
We depend upon the development of new products and enhancements to existing products, and if we fail to predict and respond to emerging technological trends and customers’ changing needs, our operating results and market share may suffer.
The markets for our products are characterized by rapidly changing technology, evolving industry standards, changes in end-user requirements, frequent new product introductions and changes in communications offerings from network service provider customers. Our future success depends on our ability to anticipate or adapt to such changes and to offer, on a timely and cost-effective basis, products that meet changing customer demands and industry standards. We may not have sufficient resources to successfully and accurately anticipate customers’ changing needs and technological trends, manage long development cycles or develop, introduce and market new products and enhancements. The process of developing new technology is complex and uncertain, and if we fail to develop new products or enhancements to existing products on a timely and cost-effective basis, or if our new products or enhancements fail to achieve market acceptance, our business, financial condition and results of operations would be materially adversely affected.
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Because our products are complex and are deployed in complex environments, our products may have defects that we discover only after full deployment by our customers, which could seriously harm our business.
We produce highly complex products that incorporate leading-edge technology, including both hardware and software. Software typically contains defects or programming flaws that can unexpectedly interfere with expected operations. In addition, our products are complex and are designed to be deployed in large quantities across complex networks. Because of the nature of these products, they can only be fully tested when completely deployed in large networks with high amounts of traffic, and there is no assurance that our pre-shipment testing programs will be adequate to detect all defects. As a result, our customers may discover errors or defects in our hardware or software, or our products may not operate as expected, after they have been fully deployed by our customers. If we are unable to cure a product defect, we could experience damage to our reputation, reduced customer satisfaction, loss of existing customers and failure to attract new customers, failure to achieve market acceptance, reduced sales opportunities, loss of revenue and market share, increased service and warranty costs, diversion of development resources, legal actions by our customers, and increased insurance costs. Defects, integration issues or other performance problems in our products could also result in financial or other damages to our customers. Our customers could seek damages for related losses from us, which could seriously harm our business, financial condition and results of operations. A product liability claim brought against us, even if unsuccessful, would likely be time consuming and costly. The occurrence of any of these problems would seriously harm our business, financial condition and results of operations.
A shortage of adequate component supply or manufacturing capacity could increase our costs or cause a delay in our ability to fulfill orders, and our failure to estimate customer demand properly may result in excess or obsolete component inventories that could adversely affect our gross margins.
Occasionally, we may experience a supply shortage, or a delay in receiving, certain component parts as a result of strong demand for the component parts and/or capacity constraints or other problems experienced by suppliers. If shortages or delays persist, the price of these components may increase, or the components may not be available at all, and we may also encounter shortages if we do not accurately anticipate our needs. Conversely, we may not be able to secure enough components at reasonable prices or of acceptable quality to build new products in a timely manner in the quantities or configurations needed. Accordingly, our revenue and gross margins could suffer until other sources can be developed. Our operating results would also be adversely affected if, anticipating greater demand than actually develops, we commit to the purchase of more components than we need. Furthermore, as a result of binding price or purchase commitments with suppliers, we may be obligated to purchase components at prices that are higher than those available in the current market. In the event that we become committed to purchase components at prices in excess of the current market price when the components are actually used, our gross margins could decrease. In the past we experienced component shortages that adversely affected our financial results and in the future may continue to experience component shortages.
We rely on contract manufacturers for a portion of our manufacturing requirements.
We rely on contract manufacturers to perform a portion of the manufacturing operations for our products. These contract manufacturers build product for other companies, including our competitors. In addition, we do not have contracts in place with some of these providers and may not be able to effectively manage those relationships. We cannot be certain that our contract manufacturers will be able to fill our orders in a timely manner. We face a number of risks associated with this dependence on contract manufacturers including reduced control over delivery schedules, the potential lack of adequate capacity during periods of excess demand, poor manufacturing yields and high costs, quality assurance, increases in prices, and the potential misappropriation of our intellectual property. We have experienced in the past, and may experience in the future, problems with our contract manufacturers, such as inferior quality, insufficient quantities and late delivery of products.
We depend on a limited source of suppliers for several key components. If we are unable to obtain these components on a timely basis, we will be unable to meet our customers’ product delivery requirements, which would harm our business.
We currently purchase several key components from a limited number of suppliers. If any of our limited source of suppliers become insolvent, cease business or experience capacity constraints, work stoppages or any other reduction or disruption in output, they may be unable to meet our delivery schedules. Our suppliers may enter into exclusive arrangements with our competitors, be acquired by our competitors, stop selling their products or components to us at commercially reasonable prices, refuse to sell their products or components to us at any price or be unable to obtain or have difficulty obtaining components for their products from their suppliers. If we do not receive critical components from our limited source of suppliers in a timely manner, we will be unable to meet our customers’ product delivery requirements. Any failure to meet a customer’s delivery requirements could materially adversely affect our business, operating results and financial condition and could materially damage customer relationships.
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Our target customer base is concentrated, and the loss of one or more of our customers could harm our business.
The target customers for our products are network service providers that operate voice, data and video communications networks. There are a limited number of potential customers in our target market. For the years ended December 31, 2014 and 2013, three customers represented 31% and 33% of net revenue, respectively. We expect that a significant portion of our future revenue will depend on sales of our products to a limited number of customers. As a result, our revenue for any quarter may be subject to significant volatility based on changes in orders from one or a small number of key customers. Any failure of one or more customers to purchase products from us for any reason, including any downturn in their businesses, would seriously harm our business, financial condition and results of operations.
Due to the international nature of our business, political or economic changes or other factors in a specific country or region could harm our future revenue, costs and expenses and financial condition.
We currently have international operations consisting of sales and technical support teams in various locations around the world. We expect to continue expanding our international operations in the future. The successful management and expansion of our international operations requires significant human effort and the commitment of substantial financial resources. Further, our international operations may be subject to certain risks and challenges that could harm our operating results, including:
• | trade protection measures and other regulatory requirements which may affect our ability to import or export our products into or from various countries; |
• | political considerations that affect service provider and government spending patterns; |
• | differing technology standards or customer requirements; |
• | developing and customizing our products for foreign countries; |
• | fluctuations in currency exchange rates; |
• | longer accounts receivable collection cycles and financial instability of customers; |
• | difficulties and excessive costs for staffing and managing foreign operations; |
• | potentially adverse tax consequences; and |
• | changes in a country’s or region’s political and economic conditions. |
Any of these factors could harm our existing international operations and business or impair our ability to continue expanding into international markets.
Industry consolidation may lead to increased competition and may harm our operating results.
There has been a trend toward industry consolidation in the communications equipment market for several years. We expect this trend to continue as companies attempt to strengthen or hold their market positions in an evolving industry and as companies are acquired or are unable to continue operations. We believe that industry consolidation may result in stronger competitors that are better able to compete as sole-source vendors for customers. This could have a material adverse effect on our business, financial condition and results of operations. Furthermore, rapid consolidation could result in a decrease in the number of customers we serve. Loss of a major customer could have a material adverse effect on our business, financial condition and results of operations.
The market we serve is highly competitive and we may not be able to compete successfully.
Competition in the communications equipment market is intense. This market is characterized by rapid change, converging technologies and a migration to networking solutions that offer superior advantages. We are aware of many companies in related markets that address particular aspects of the features and functions that our products provide. Currently, our primary competitors in our core business include Alcatel-Lucent, Calix, Adtran, Huawei, and ZTE, among others. In our FiberLAN business, our competitors include Tellabs and Cisco. We also may face competition from other large communications equipment companies or other companies that may enter our market in the future. In addition, a number of companies have introduced products that address the same network needs that our products address, both domestically and abroad. Many of our competitors have longer operating histories, greater name recognition, larger customer bases and greater financial, technical, sales and marketing resources than we do and may be able to undertake more extensive marketing efforts, adopt more aggressive pricing policies and provide more customer financing than we can. In particular, we are encountering price-focused competitors from Asia, especially China, which places pressure on us to reduce our prices. If we are forced to reduce prices in order to secure customers, we may be unable to sustain gross margins at desired levels or achieve profitability. Competitive pressures could result in increased pricing pressure, reduced profit margins, increased sales and marketing
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expenses and failure to increase, or the loss of, market share, any of which could reduce our revenue and adversely affect our financial results. Moreover, our competitors may foresee the course of market developments more accurately than we do and could develop new technologies that render our products less valuable or obsolete.
In our markets, principal competitive factors include:
• | product performance; |
• | interoperability with existing products; |
• | scalability and upgradeability; |
• | conformance to standards; |
• | breadth of services; |
• | reliability; |
• | ease of installation and use; |
• | geographic footprints for products; |
• | ability to provide customer financing; |
• | price; |
• | technical support and customer service; and |
• | brand recognition. |
If we are unable to compete successfully against our current and future competitors, we may have difficulty obtaining or retaining customers, and we could experience price reductions, order cancellations, increased expenses and reduced gross margins, any of which could have a material adverse effect on our business, financial condition and results of operations.
Our success largely depends on our ability to retain and recruit key personnel, and any failure to do so would harm our ability to meet key objectives.
Our future success depends upon the continued services of James Norrod, our President and Chief Executive Officer
and our other executive officers, as well as the continued chairmanship of our Board by Morteza Ejabat (our co-founder), our ability to identify, attract and retain highly skilled technical, managerial, sales and marketing personnel who have critical industry experience and relationships that we rely on to build our business. The loss of the services of any of our key employees, including our Chief Executive Officer and our Chief Financial Officer, or the loss of Mr. Ejabat as our Executive Chairman, could delay the development and production of our products and negatively impact our ability to maintain customer relationships, which would harm our business, financial condition and results of operations.
Any strategic acquisitions or investments we make could disrupt our operations and harm our operating results.
As of December 31, 2014, we had acquired twelve companies or product lines since we were founded in 1999. Further, we may acquire additional businesses, products or technologies in the future. On an ongoing basis, we may evaluate acquisitions of, or investments in, complementary companies, products or technologies to supplement our internal growth. Also, in the future, we may encounter difficulties identifying and acquiring suitable acquisition candidates on reasonable terms.
If we do complete future acquisitions, we could:
• | issue stock that would dilute our current stockholders’ percentage ownership; |
• | consume a substantial portion of our cash resources; |
• | incur substantial debt; |
• | assume liabilities; |
• | increase our ongoing operating expenses and level of fixed costs; |
• | record goodwill and non-amortizable intangible assets that will be subject to impairment testing and potential periodic impairment charges; |
• | incur amortization expenses related to certain intangible assets; |
• | incur large and immediate write-offs; and |
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• | become subject to litigation. |
Any acquisitions or investments that we make in the future will involve numerous risks, including:
• | difficulties in integrating the operations, technologies, products and personnel of the acquired companies; |
• | unanticipated costs; |
• | diversion of management’s time and attention away from normal daily operations of the business and the challenges of managing larger and more widespread operations resulting from acquisitions; |
• | difficulties in entering markets in which we have no or limited prior experience; |
• | insufficient revenues to offset increased expenses associated with acquisitions and where competitors in such markets have stronger market positions; and |
• | potential loss of key employees, customers, distributors, vendors and other business partners of the companies we acquire following and continuing after announcement of acquisition plans. |
Mergers and acquisitions of high-technology companies are inherently risky and subject to many factors outside of our control, and we cannot be certain that our previous or future acquisitions will be successful and will not materially adversely affect our business, operating results or financial condition. We do not know whether we will be able to successfully integrate the businesses, products, technologies or personnel that we might acquire in the future or that any strategic investments we make will meet our financial or other investment objectives. Any failure to do so could seriously harm our business, financial condition and results of operations.
Sales to communications service providers are especially volatile, and weakness in sales orders from this industry may harm our operating results and financial condition.
Sales activity in the service provider industry depends upon the stage of completion of expanding network infrastructures, the availability of funding, and the extent to which service providers are affected by regulatory, economic and business conditions in the country of operations. Although some service providers may be increasing capital expenditures over the depressed levels that have prevailed over the last few years, weakness in orders from this industry could have a material adverse effect on our business, operating results and financial condition. Slowdowns in the general economy, overcapacity, changes in the service provider market, regulatory developments and constraints on capital availability have had a material adverse effect on many of our service provider customers, with many of these customers going out of business or substantially reducing their expansion plans. These conditions have materially harmed our business and operating results, and we expect that some or all of these conditions may continue for the foreseeable future. Finally, service provider customers typically have longer implementation cycles; require a broader range of service including design services; demand that vendors take on a larger share of risks; often require acceptance provisions, which can lead to a delay in revenue recognition; and expect financing from vendors. All these factors can add further risk to business conducted with service providers.
Compliance or the failure to comply with current and future environmental regulations could cause us significant expense.
We are subject to a variety of federal, state, local and foreign environmental regulations. If we fail to comply with any present and future regulations, we could be subject to future liabilities, the suspension of production or a prohibition on the sale of our products. In addition, such regulations could require us to incur other significant expenses to comply with environmental regulations, including expenses associated with the redesign of any non-compliant product. From time to time new regulations are enacted, and it is difficult to anticipate how such regulations will be implemented and enforced. For example, in 2003 the European Union enacted the Restriction on the Use of Certain Hazardous Substances in Electrical and Electronic Equipment Directive (RoHS) and the Waste Electrical and Electronic Equipment Directive (WEEE), for implementation in European Union member states. We are aware of similar legislation that is currently in force or is being considered in the United States, as well as other countries, such as Japan and China. Our failure to comply with any of such regulatory requirements or contractual obligations could result in our being liable for costs, fines, penalties and third-party claims, and could jeopardize our ability to conduct business in countries in the jurisdictions where these regulations apply.
Adverse resolution of litigation may harm our operating results or financial condition.
We are a party to various lawsuits and claims in the normal course of our business. Litigation can be expensive, lengthy, and disruptive to normal business operations. Moreover, the results of complex legal proceedings are difficult to predict. An unfavorable resolution of a particular lawsuit could have a material adverse effect on our business, operating results and financial condition.
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Our intellectual property rights may prove difficult to protect and enforce.
We generally rely on a combination of copyrights, patents, trademarks and trade secret laws and restrictions on disclosure to protect our intellectual property rights. We also enter into confidentiality or license agreements with our employees, consultants and corporate partners, and control access to and distribution of our proprietary information. Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to copy or otherwise obtain and use our products or technology. Monitoring unauthorized use of our technology is difficult, and we do not know whether the steps we have taken will prevent unauthorized use of our technology, particularly in foreign countries where the laws may not protect our proprietary rights as extensively as in the United States. We cannot assure you that our pending, or any future, patent applications will be granted, that any existing or future patents will not be challenged, invalidated, or circumvented, or that any existing or future patents will be enforceable. While we are not dependent on any individual patents, if we are unable to protect our proprietary rights, we may find ourselves at a competitive disadvantage to others who need not incur the substantial expense, time and effort required to create the innovative products.
We may be subject to intellectual property infringement claims that are costly and time consuming to defend and could limit our ability to use some technologies in the future.
Third parties have in the past and may in the future assert claims or initiate litigation related to patent, copyright, trademark and other intellectual property rights to technologies and related standards that are relevant to us. The asserted claims or initiated litigation can include claims against us or our manufacturers, suppliers or customers alleging infringement of their proprietary rights with respect to our existing or future products, or components of those products. We have received correspondence from companies claiming that many of our products are using technology covered by or related to the intellectual property rights of these companies and inviting us to discuss licensing arrangements for the use of the technology. Regardless of the merit of these claims, intellectual property litigation can be time consuming and costly, and result in the diversion of technical and management personnel. Any such litigation could force us to stop selling, incorporating or using our products that include the challenged intellectual property, or redesign those products that use the technology. In
addition, if a party accuses us of infringing upon its proprietary rights, we may have to enter into royalty or licensing agreements, which may not be available on terms acceptable to us, if at all. If we are unsuccessful in any such litigation, we could be subject to significant liability for damages and loss of our proprietary rights. Any of these results could have a material adverse effect on our business, financial condition and results of operations.
We rely on the availability of third party licenses.
Many of our products are designed to include software or other intellectual property licensed from third parties. It may be necessary in the future to seek or renew licenses relating to various elements of the technology used to develop these products. We cannot assure you that our existing and future third-party licenses will be available to us on commercially reasonable terms, if at all. Our inability to maintain or obtain any third-party license required to sell or develop our products and product enhancements could require us to obtain substitute technology of lower quality or performance standards, or at greater cost.
The long and variable sales cycles for our products may cause revenue and operating results to vary significantly from quarter to quarter.
The target customers for our products have substantial and complex networks that they traditionally expand in large increments on a periodic basis. Accordingly, our marketing efforts are focused primarily on prospective customers that may purchase our products as part of a large-scale network deployment. Our target customers typically require a lengthy evaluation, testing and product qualification process. Throughout this process, we are often required to spend considerable time and incur significant expense educating and providing information to prospective customers about the uses and features of our products. Even after a company makes the final decision to purchase our products, it may deploy our products over extended periods of time. The timing of deployment of our products varies widely, and depends on a number of factors, including our customers’ skill sets, geographic density of potential subscribers, the degree of configuration and integration required to deploy our products, and our customers’ ability to finance their purchase of our products as well as their operations. As a result of any of these factors, our revenue and operating results may vary significantly from quarter to quarter.
Decreased effectiveness of share-based compensation could adversely affect our ability to attract and retain employees.
We have historically used stock options as a key component of our employee compensation program in order to align the interests of our employees with the interests of our stockholders, encourage employee retention and provide competitive compensation and benefit packages. If the trading price of our common stock declines, this would reduce the value of our share-based compensation to our present employees and could affect our ability to retain existing or attract prospective
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employees. Difficulties relating to obtaining stockholder approval of equity compensation plans could also make it harder or more expensive for us to grant share-based payments to employees in the future.
Our industry is subject to government regulations, which could harm our business.
Our operations are subject to various laws and regulations, including those regulations promulgated by the FCC. The FCC has jurisdiction over the entire communications industry in the United States and, as a result, our existing and future products and our customers’ products are subject to FCC rules and regulations. Changes to current FCC rules and regulations and future FCC rules and regulations could negatively affect our business. The uncertainty associated with future FCC decisions may cause network service providers to delay decisions regarding their capital expenditures for equipment for broadband services. In addition, international regulatory bodies establish standards that may govern our products in foreign markets. The SEC has adopted disclosure rules regarding the use of “conflict minerals” mined from the Democratic Republic of Congo and adjoining countries (DRC) and procedures regarding a manufacturer’s efforts to prevent the sourcing of such conflict minerals. These rules may have the effect of reducing the pool of suppliers who can supply DRC “conflict free” components and parts, and we may not be able to obtain DRC conflict free products or supplies in sufficient quantities for our operations. Also, we may face reputational challenges with our customers, stockholders and other stakeholders if we are unable to sufficiently verify the origins for the conflict minerals used in our products. We are unable to predict the scope, pace or financial impact of government regulations and other policy changes that could be adopted in the future, any of which could negatively impact our operations and costs of doing business. Because of our smaller size, legislation or governmental regulations can significantly increase our costs and affect our competitive position. Changes to or future domestic and international regulatory requirements could result in postponements or cancellations of customer orders for our products and services, which would harm our business, financial condition and results of operations. Further, we cannot be certain that we will be successful in obtaining or maintaining regulatory approvals that may, in the future, be required to operate our business.
The ability of unaffiliated stockholders to influence key transactions, including changes of control, may be limited by significant insider ownership, provisions of our charter documents and provisions of Delaware law.
At December 31, 2014, our executive officers, directors and entities affiliated with them beneficially owned, in the aggregate, approximately 30% of our outstanding common stock. These stockholders, if acting together, will be able to influence substantially all matters requiring approval by our stockholders, including the election of directors and the approval of mergers or other business combination transactions. Circumstances may arise in which the interests of these stockholders could conflict with the interests of our other stockholders. These stockholders could delay or prevent a change in control of our company even if such a transaction would be beneficial to our other stockholders. In addition, provisions of our certificate of incorporation, bylaws and Delaware law could make it more difficult for a third party to acquire us, even if doing so would be beneficial to certain stockholders.
Our business and operations are especially subject to the risks of earthquakes and other natural catastrophic events.
Our corporate headquarters, including a significant portion of our research and development operations, are located in Northern California, a region known for seismic activity. Additionally, some of our facilities, including our manufacturing facilities, are located near geographic areas that have experienced hurricanes in the past. A significant natural disaster, such as an earthquake, hurricane, fire, flood or other catastrophic event, could severely affect our ability to conduct normal business operations, and as a result, our future operating results could be materially and adversely affected.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
ITEM 2. PROPERTIES
Our worldwide headquarters are located in Oakland, California. We also lease facilities for manufacturing, research and development purposes at locations including Largo, Florida; Alpharetta, Georgia; and Westlake Village, California. We maintain smaller offices to provide sales and customer support at various domestic and international locations. We believe that our existing facilities are suitable and adequate for our present purposes.
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ITEM 3. LEGAL PROCEEDINGS
We are subject to various legal proceedings, claims and litigation arising in the ordinary course of business. While the outcome of these matters is currently not determinable, we do not expect that the ultimate costs to resolve these matters will have a material adverse effect on our consolidated financial position or results of operations. However, litigation is subject to inherent uncertainties, and unfavorable rulings could occur. If an unfavorable ruling were to occur, there exists the possibility of a material adverse impact on the results of operations of the period in which the ruling occurs, or future periods.
ITEM 4. MINE SAFETY DISCLOSURES
Not applicable.
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PART II
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Price Range of Common Stock
Our common stock is listed on the Nasdaq Capital Market under the symbol “ZHNE.” The following table sets forth, for the periods indicated, the high and low per share sales prices of our common stock as reported on Nasdaq.
2014: | |||||||
High | Low | ||||||
Fourth Quarter ended December 31, 2014 | $ | 2.73 | $ | 1.70 | |||
Third Quarter ended September 30, 2014 | 3.85 | 2.64 | |||||
Second Quarter ended June 30, 2014 | 4.45 | 2.08 | |||||
First Quarter ended March 31, 2014 | 6.62 | 3.62 | |||||
2013: | |||||||
High | Low | ||||||
Fourth Quarter ended December 31, 2013 | $ | 6.62 | $ | 2.75 | |||
Third Quarter ended September 30, 2013 | 3.89 | 0.80 | |||||
Second Quarter ended June 30, 2013 | 1.15 | 0.72 | |||||
First Quarter ended March 31, 2013 | 1.24 | 0.43 | |||||
As of February 27, 2015, there were 850 registered stockholders of record. A substantially greater number of holders of Zhone common stock are “street name” or beneficial holders, whose shares are held of record by banks, brokers and other financial institutions.
Dividend Policy
We have never paid or declared any cash dividends on our common stock or other securities and do not anticipate paying cash dividends in the foreseeable future. Any future determination to pay cash dividends will be at the discretion of the Board of Directors, subject to any applicable restrictions under our debt and credit agreements, and will be dependent upon our financial condition, results of operations, capital requirements, general business condition and such other factors as the Board of Directors may deem relevant.
Recent Sales of Unregistered Securities
There were no unregistered sales of equity securities during 2014.
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ITEM 6. SELECTED FINANCIAL DATA
The following selected financial data has been derived from our consolidated financial statements and should be read in conjunction with the consolidated financial statements and notes thereto, and with “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”
Year Ended December 31, | |||||||||||||||||||
2014 | 2013 | 2012 | 2011 | 2010 | |||||||||||||||
(in thousands, except per share data) | |||||||||||||||||||
Statement of Comprehensive Income (Loss) Data: | |||||||||||||||||||
Net revenue | $ | 120,582 | $ | 122,248 | $ | 115,385 | $ | 124,502 | $ | 129,036 | |||||||||
Cost of revenue (1) | 78,748 | 76,116 | 79,101 | 80,541 | 79,864 | ||||||||||||||
Gross profit | 41,834 | 46,132 | 36,284 | 43,961 | 49,172 | ||||||||||||||
Operating expenses: | |||||||||||||||||||
Research and product development (1) | 17,340 | 15,326 | 18,542 | 21,380 | 21,188 | ||||||||||||||
Sales and marketing (1) | 19,079 | 20,159 | 19,304 | 22,297 | 23,982 | ||||||||||||||
General and administrative (1) | 9,409 | 6,199 | 7,157 | 7,784 | 9,855 | ||||||||||||||
Gain on sale of fixed assets | — | — | — | — | (1,959 | ) | |||||||||||||
Impairment of fixed assets | — | — | 61 | 4,236 | — | ||||||||||||||
Total operating expenses | 45,828 | 41,684 | 45,064 | 55,697 | 53,066 | ||||||||||||||
Operating income (loss) | (3,994 | ) | 4,448 | (8,780 | ) | (11,736 | ) | (3,894 | ) | ||||||||||
Interest expense, net | (68 | ) | (85 | ) | (102 | ) | (41 | ) | (989 | ) | |||||||||
Other income (expense), net | (1 | ) | (7 | ) | (9 | ) | 111 | 1 | |||||||||||
Income (loss) before income taxes | (4,063 | ) | 4,356 | (8,891 | ) | (11,666 | ) | (4,882 | ) | ||||||||||
Income tax provision (benefit) | 68 | 42 | 124 | 60 | (101 | ) | |||||||||||||
Net income (loss) | $ | (4,131 | ) | $ | 4,314 | $ | (9,015 | ) | $ | (11,726 | ) | $ | (4,781 | ) | |||||
Other comprehensive loss | (100 | ) | (151 | ) | (21 | ) | (40 | ) | (16 | ) | |||||||||
Comprehensive income (loss) | $ | (4,231 | ) | $ | 4,163 | $ | (9,036 | ) | $ | (11,766 | ) | $ | (4,797 | ) | |||||
Basic net income (loss) per share | $ | (0.13 | ) | $ | 0.14 | $ | (0.29 | ) | $ | (0.38 | ) | $ | (0.16 | ) | |||||
Diluted net income (loss) per share | $ | (0.13 | ) | $ | 0.13 | $ | (0.29 | ) | $ | (0.38 | ) | $ | (0.16 | ) | |||||
Shares used in per-share calculation | |||||||||||||||||||
Basic | 32,380 | 31,429 | 31,010 | 30,671 | 30,393 | ||||||||||||||
Diluted | 32,380 | 33,021 | 31,010 | 30,671 | 30,393 | ||||||||||||||
(1) Amounts include stock-based compensation cost as follows: | |||||||||||||||||||
Cost of revenue | $ | 7 | $ | — | $ | 63 | $ | 61 | $ | 94 | |||||||||
Research and product development | 11 | 2 | 297 | 244 | 362 | ||||||||||||||
Sales and marketing | 29 | 2 | 250 | 350 | 421 | ||||||||||||||
General and administrative | 739 | 420 | 704 | 1,015 | 1,388 | ||||||||||||||
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As of December 31, | |||||||||||||||||||
2014 | 2013 | 2012 | 2011 | 2010 | |||||||||||||||
(in thousands) | |||||||||||||||||||
Balance Sheet Data: | |||||||||||||||||||
Cash, cash equivalents and short-term investments | $ | 11,528 | $ | 15,686 | $ | 11,119 | $ | 18,190 | $ | 21,174 | |||||||||
Working capital | 34,904 | 39,291 | 34,868 | 43,027 | 49,402 | ||||||||||||||
Total assets | 65,712 | 71,817 | 61,724 | 80,732 | 90,111 | ||||||||||||||
Long-term debt, including current portion | — | — | — | — | — | ||||||||||||||
Stockholders’ equity | $ | 34,343 | $ | 37,559 | $ | 31,940 | $ | 39,527 | $ | 49,415 | |||||||||
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Overview
We design, develop and manufacture communications network equipment for enterprises and telecommunications operators worldwide. Our products enable both enterprises and network service providers to deliver high speed fiber access, while transporting voice, video and data to the end user. 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. In addition to our established product offerings in our core business, our FiberLAN Passive Optical LAN product provides an alternative to switched copper-based ethernet LANs.
Our global customer base in our core business includes regional, national and international telecommunications carriers. To date, our products are deployed by over 750 network service providers on six continents worldwide. Our global FiberLAN customer base includes hotels, universities, military bases, government institutions, manufacturing facilities and businesses. 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.
We have incurred significant losses to date and expect that our operating losses and negative cash flows from operations may continue. Our net loss was $4.1 million for the year ended December 31, 2014 and we had an accumulated deficit of $1,041.0 million at December 31, 2014. 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 five 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
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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 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.
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.
On July 17, 2014, the Compensation Committee of our Board of Directors approved the grant of an inducement award to Mr. Norrod in connection with his appointment as Zhone's President and Chief Executive Officer and as a member of the Board. The award consisted of a stock option to purchase 1,250,000 shares of Zhone's common stock at an exercise price equal to the closing price of Zhone's common stock on the grant date, which stock option was granted on July 21, 2014. The estimated fair value of the stock option award at the grant date was $2.8 million and will be amortized to expense over the service period of four years.
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, 2014, we did not record any impairment charges related to the impairment of long-lived assets.
RESULTS OF OPERATIONS
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, | ||||||||
2014 | 2013 | 2012 | ||||||
Net revenue | 100 | % | 100 | % | 100 | % | ||
Cost of revenue | 65 | % | 62 | % | 69 | % | ||
Gross profit | 35 | % | 38 | % | 31 | % | ||
Operating expenses: | ||||||||
Research and product development | 14 | % | 13 | % | 16 | % | ||
Sales and marketing | 16 | % | 16 | % | 17 | % | ||
General and administrative | 8 | % | 5 | % | 6 | % | ||
Impairment of fixed assets | 0 | % | 0 | % | — | % | ||
Total operating expenses | 38 | % | 34 | % | 39 | % | ||
Operating income (loss) | (3 | )% | 4 | % | (8 | )% | ||
Interest expense, net | 0 | % | 0 | % | 0 | % | ||
Other income (expense), net | 0 | % | 0 | % | 0 | % | ||
Income (loss) before income taxes | (3 | )% | 4 | % | (8 | )% | ||
Income tax provision | 0 | % | 0 | % | 0 | % | ||
Net income (loss) | (3 | )% | 4 | % | (8 | )% | ||
Other comprehensive income (loss) | 0 | % | 0 | % | 0 | % | ||
Comprehensive income (loss) | (3 | )% | 4 | % | (8 | )% | ||
2014 COMPARED WITH 2013
Net Revenue
Information about our net revenue for products and services for 2014 and 2013 is summarized below (in millions):
2014 | 2013 | Decrease | % change | |||||||||||
Products | $ | 114.0 | $ | 114.0 | $ | — | — | % | ||||||
Services | 6.6 | 8.2 | (1.6 | ) | (20 | )% | ||||||||
$ | 120.6 | $ | 122.2 | $ | (1.6 | ) | (1 | )% | ||||||
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Information about our net revenue for North America and international markets for 2014 and 2013 is summarized below (in millions):
2014 | 2013 | Increase (Decrease) | % change | |||||||||||
Revenue by geography: | ||||||||||||||
United States | $ | 36.2 | $ | 38.2 | $ | (2.0 | ) | (5 | )% | |||||
Canada | 2.9 | 3.4 | (0.5 | ) | (15 | )% | ||||||||
Total North America | 39.1 | 41.6 | (2.5 | ) | (6 | )% | ||||||||
Latin America | 20.0 | 27.2 | (7.2 | ) | (26 | )% | ||||||||
Europe, Middle East, Africa | 58.1 | 49.6 | 8.5 | 17 | % | |||||||||
Asia Pacific | 3.4 | 3.8 | (0.4 | ) | (11 | )% | ||||||||
Total International | 81.5 | 80.6 | 0.9 | 1 | % | |||||||||
Total | $ | 120.6 | $ | 122.2 | $ | (1.6 | ) | (1 | )% | |||||
Net revenue decreased 1% or $1.6 million to $120.6 million for 2014 compared to $122.2 million for 2013. The decrease in net revenue was attributable to the decrease in service revenue. Product revenue for 2014 remained flat. Service revenue decreased 20% or $1.6 million in 2014. Service revenue represents revenue from maintenance and other services associated with product shipments. The decrease in service revenue was primarily due to decreased sales of installation services.
International net revenue increased 1% or $0.9 million to $81.5 million in 2014 and represented 68% of total net revenue compared with 66% in 2013. The increase in international net revenue was primarily due to increased sales in Europe and the Middle East as a result of recent growth in demand for our products in these regions, which was partially offset by lower revenue from Latin America and Asia. Domestic net revenue decreased 6% or $2.5 million to $39.1 million in 2014 compared to $41.6 million in 2013. The decrease was primarily due to fewer broadband development projects in connection with federal stimulus funding.
For the years ended December 31, 2014 and 2013, three customers represented 31% and 33% 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, increased $2.6 million or 4% to $78.7 million for 2014, compared to $76.1 million for 2013. The increase in cost of revenue for 2014 was primarily due to changes in product mix and higher personnel-related expenses. Total cost of revenue was 65% of net revenue for 2014, compared to 62% of net revenue for 2013, which resulted in a decrease in gross profit percentage from 38% in 2013 to 35% in 2014. The year-over-year decrease in gross margin was primarily due to greater sales of products with lower gross margin, such as zNID products, and decreased 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 increased 13% or $2.0 million to $17.3 million for 2014 compared to $15.3 million for 2013. The increase was primarily due to higher personnel-related expenses of $0.7 million resulting from a higher average headcount in 2014 as compared with 2013. The increase was also due to higher expensed inventory costs and tooling expenses of $0.5 million as well as higher consultant fees of $0.4 million and an increase of $0.1 million in allocated facilities costs. 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.
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Sales and Marketing Expenses
Sales and marketing expenses decreased 5% or $1.1 million to $19.1 million for 2014 compared to $20.2 million for 2013. The decrease in sales expenses was primarily attributable to decreased consulting costs of $0.9 million and commissions of $0.2 million.
General and Administrative Expenses
General and administrative expenses increased 52% or $3.2 million to $9.4 million for 2014 compared to $6.2 million for 2013. The increase was mainly attributable to restructuring costs of $1.7 million in connection with the Chief Executive Officer transition, offset by a decrease in bonus expense of $0.3 million. In addition, the year-over-year increase in general and administrative expenses was also due to higher personnel-related expenses of $0.6 million resulting from a higher headcount in 2014 as compared with 2013, increased accounting and legal costs of $0.5 million, higher stock-based compensation expenses of $0.3 million, and higher bad debt expenses of $0.1 million.
Impairment of Fixed Assets
Impairment of fixed assets was zero for both 2014 and 2013 and $0.1 million for 2012.
Interest Expense
Interest expense for 2014 remained flat at $0.1 million. Our outstanding debt balances remained constant and interest rates remained low during 2014.
Other Income (Expense)
Other income (expense) for 2014 and 2013 remained flat and was immaterial.
Income Tax Provision
We recorded an income tax provision of $0.07 million and $0.04 million related to foreign and state taxes for the years ended December 31, 2014 and 2013, respectively. No material provision or benefit for income taxes was recorded in 2014 and 2013, 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.
2013 COMPARED WITH 2012
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 | % | |||||||
Information about our net revenue for North America and international markets for 2013 and 2012 is summarized below (in millions):
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2013 | 2012 | Increase (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 years ended December 31, 2013 and 2012, three customers represented 33% and 25% of net revenue, respectively.
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.
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.
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.
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.
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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 and $0.1 million for 2013 and 2012, respectively.
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.
OTHER PERFORMANCE MEASURES
In managing our business and assessing our financial performance, we supplement the information provided by our GAAP results with adjusted earnings before stock-based compensation, interest, taxes, and depreciation, or Adjusted EBITDA, a non-GAAP financial measure. We define Adjusted EBITDA as net income (loss) plus (i) interest expense, (ii) provision (benefit) for taxes, (iii) depreciation and amortization, (iv) non-cash equity-based compensation expense, and (v) material non-recurring non-cash transactions, such as a gain (loss) on sale of assets or impairment of fixed assets. We believe that the presentation of Adjusted EBITDA enhances the usefulness of our financial information by presenting a measure that management uses internally to monitor and evaluate our operating performance and to evaluate the effectiveness of our business strategies. We believe Adjusted EBITDA also assists investors and analysts in comparing our performance across reporting periods on a consistent basis because it excludes the impact of items that we do not believe reflect our core operating performance.
Adjusted EBITDA has limitations as an analytical tool. Some of these limitations are:
• | Adjusted EBITDA does not reflect our cash expenditures, or future requirements for capital expenditures or contractual requirements; |
• | Adjusted EBITDA does not reflect changes in, or cash requirements for, our working capital needs; |
• | Adjusted EBITDA does not reflect the interest expense, or the cash requirements necessary to service interest or principal payments, on our debts; |
• | although depreciation and amortization are non-cash charges, the assets being depreciated and amortized will often have to be replaced in the future, and Adjusted EBITDA does not reflect any cash requirements for such replacements; |
• | non-cash compensation is and will remain a key element of our overall long-term incentive compensation package, although we exclude it as an expense when evaluating our ongoing operating performance for a particular period; and |
• | other companies in our industry may calculate Adjusted EBITDA and similar measures differently than we do, limiting its usefulness as a comparative measure. |
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Because of these limitations, Adjusted EBITDA should not be considered in isolation or as a substitute for net income (loss) or any other performance measures calculated in accordance with GAAP or as a measure of liquidity. Management understands these limitations and compensates for these limitations by relying primarily on our GAAP results and using Adjusted EBITDA only supplementally.
Set forth below is a reconciliation of net income (loss) to Adjusted EBITDA, which we consider to be the most directly comparable GAAP financial measure to Adjusted EBITDA:
Year Ended December 31, | |||||||||||
2014 | 2013 | 2012 | |||||||||
(in thousands) | |||||||||||
Net income (loss) | $ | (4,131 | ) | $ | 4,314 | $ | (9,015 | ) | |||
Add: | |||||||||||
Interest expense | 68 | 85 | 102 | ||||||||
Income tax provision | 68 | 42 | 124 | ||||||||
Depreciation and amortization | 403 | 367 | 316 | ||||||||
Non-cash equity-based compensation expense | 786 | 424 | 1,314 | ||||||||
Adjusted EBITDA | $ | (2,806 | ) | $ | 5,232 | $ | (7,159 | ) | |||
LIQUIDITY AND CAPITAL RESOURCES
Our operations are financed through a combination of our existing cash, cash equivalents, available credit facilities, and sales of equity and debt instruments, based on our operating requirements and market conditions.
At December 31, 2014, cash and cash equivalents were $11.5 million compared to $15.7 million at December 31, 2013. The decrease in cash and cash equivalents of $4.2 million was attributable to net cash used in operating activities and investing activities of $3.4 million and $0.9 million, respectively, in addition to a foreign currency translation adjustment of $0.1 million. These decreases were offset by cash provided by financing activities of $0.2 million.
Operating Activities
For fiscal year 2014, net cash used in operating activities consisted of a net loss of $4.1 million, adjusted for non-cash charges totaling $0.8 million and a decrease in operating assets totaling $0.1 million. The most significant components of the changes in net operating assets were a decrease in accounts receivable of $3.8 million partially offset by a decrease in accrued and other liabilities of $1.9 million and a decrease in accounts payable of $1.0 million. The decrease in accounts receivable was related to the timing of cash collections and decreased sales. The decrease in accounts payable was primarily due to timing of payments. The decrease in accrued and other liabilities was due to a non-cash decrease of $0.3 million due to the continued amortization of our deferred gain and leasehold improvement liabilities in connection with our Oakland campus as well as a lower warranty reserve of $0.3 million. In addition, unearned revenue decreased by $0.3 million and $0.2 million legal accrual was released due to lapsing of the statute of limitations.
For fiscal year 2013, net cash provided by operating activities consisted of net income of $4.3 million, adjusted for non-cash charges totaling $0.6 million and an increase in operating assets totaling $0.5 million. The most significant components of the changes in net operating assets were an increase in accounts receivable of $6.1 million and an increase in accounts payable of $5.5 million, partially offset by decreases in inventories of $1.8 million and accrued and other liabilities of $1.0 million. The increase in accounts receivable was related to the timing of cash collections and increased sales. The increase in accounts payable was primarily due to timing of payments. The main driver for the decrease in accrued and other liabilities related to a non-cash decrease of $0.8 million due to the continued amortization of our deferred gain and leasehold improvement liabilities in connection with our Oakland campus. Lastly, the decrease in inventories was primarily due to better inventory management and a buildup of inventory in prior periods.
Investing Activities
For fiscal year 2014, net cash used in investing activities consisted of purchases of property and equipment of $0.9 million related mainly to the continued build-out of our Oakland campus lab facilities and software upgrades.
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For fiscal year 2013, net cash used in investing activities consisted of purchases of property and equipment of $0.5 million related mainly to the continued build-out of our Oakland campus lab facilities.
Financing Activities
For fiscal year 2014 and 2013, net cash provided by financing activities consisted of proceeds related to exercise of stock options of $0.2 million and $1.0 million, respectively.
Cash Management
Our primary source of liquidity comes from our cash and cash equivalents, which totaled $11.5 million at December 31, 2014, and our $25.0 million WFB Facility. Our cash and cash equivalents are held in accounts managed by third party financial institutions and consist of invested cash and cash in our operating accounts.
We had $10.0 million outstanding at December 31, 2014 under our WFB Facility. In addition, $3.0 million was committed as security for letters of credit. We had $6.5 million of borrowing availability under our WFB Facility as of December 31, 2014. Amounts borrowed under the WFB Facility bear interest, payable monthly, at a floating rate equal to the three-month LIBOR plus a margin of 3.0%. The interest rate on the WFB Facility was 3.26% at December 31, 2014. The amount that we are able to borrow under the WFB Facility varies based on eligible accounts receivable and inventory, as defined in the agreement, as long as the aggregate principal amount outstanding does not exceed $25.0 million less the amount committed as security for letters of credit. In addition, under the WFB Facility, we are able to utilize the facility as security for letters of credit. To maintain availability of funds under the WFB Facility, we pay a commitment fee on the unused portion. The commitment fee is 0.25% and is recorded as interest expense.
Our obligations under the WFB Facility are secured by substantially all of our personal property assets and those of our subsidiaries that guarantee the WFB Facility, including our intellectual property. The WFB Facility contained certain financial covenants, and customary affirmative covenants and negative covenants. If we default under the WFB Facility due to a covenant breach or otherwise, WFB may be entitled to, among other things, require the immediate repayment of all outstanding amounts and sell our assets to satisfy the obligations under the WFB Facility. As of December 31, 2014, we were in compliance with these covenants. We make no assurances that we will be in compliance with these covenants in the future.
Future Requirements and Funding Sources
Our fixed commitments for cash expenditures consist primarily of payments under operating leases, inventory purchase commitments, and payments of principal and interest for debt obligations. Our operating lease commitments include $1.1 million of future minimum lease payments spread over the three-year lease term under the lease agreement we entered into in July 2013 for our manufacturing facility in Largo, Florida. In addition, we have $0.5 million of future minimum lease payments spread over the five-year lease term under the lease agreement we entered into in September 2010 with respect to our Oakland, California campus following the sale of our campus in a sale-leaseback transaction.
From time to time, we may provide or commit to extend credit or credit support to our customers. This financing may include extending the terms for product payments to customers. Any extension of financing to our customers will limit the capital that we have available for other uses.
Our accounts receivable, while not considered a primary source of liquidity, represent a concentration of credit risk because a significant portion of the accounts receivable balance at any point in time typically consists of a relatively small number of customer account balances. As of December 31, 2014, three customers accounted for 53% of net accounts receivable. Receivables from customers in countries other than the United States of America represented 86% of net accounts receivable at December 31, 2014. We do not currently have any material commitments for capital expenditures, or any other material commitments aside from operating leases for our facilities, inventory purchase commitments and debt.
We have incurred significant losses to date and expect that our operating losses and negative cash flows from operations may continue. Our net loss was $4.1 million for the year ended December 31, 2014 and we had an accumulated deficit of $1,041.0 million at December 31, 2014. In order to meet our liquidity needs and finance our capital expenditures and working capital needs for our business, we may be required to sell assets, issue debt or equity securities or borrow on potentially unfavorable terms. In addition, we may be required to reduce our operations in low margin regions, including reductions in headcount. We may be unable to sell assets, issue securities or access additional indebtedness to meet these needs on favorable terms, or at all. If additional capital is raised through the issuance of debt securities or other debt financing, the terms of such debt may include covenants, restrictions and financial ratios that may restrict our ability to operate our business. Likewise, any equity financing could result in additional dilution of our stockholders. If we are unable to obtain additional capital or are required to obtain additional capital on terms that are not favorable to us, we may be required to reduce the scope
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of our planned product development and sales and marketing efforts beyond the reductions we have previously taken. In addition, we may be required to reduce our operations in low margin regions, including reductions in headcount. Based on our current plans and business conditions, we believe that our existing cash, cash equivalents and available credit facilities will be sufficient to satisfy our anticipated cash requirements for at least the next twelve months.
Contractual Commitments and Off-Balance Sheet Arrangements
At December 31, 2014, our future contractual commitments by fiscal year were as follows (in thousands):
Total | Payments due by period | ||||||||||||||||||||||
2015 | 2016 | 2017 | 2018 | 2019 and thereafter | |||||||||||||||||||
Operating leases | $ | 2,123 | $ | 1,499 | $ | 541 | $ | 83 | $ | — | $ | — | |||||||||||
Purchase commitments | 6,199 | 6,199 | — | — | — | — | |||||||||||||||||
Line of credit | 10,000 | 10,000 | — | — | — | — | |||||||||||||||||
Total future contractual commitments | $ | 18,322 | $ | 17,698 | $ | 541 | $ | 83 | $ | — | $ | — | |||||||||||
Operating Leases
The operating lease amounts shown above represent primarily off-balance sheet arrangements. For operating lease commitments, a liability is generally not recorded on our balance sheet unless the facility represents an excess facility for which an estimate of the facility exit costs has been recorded on our balance sheet, net of estimated sublease income. For operating leases that include contractual commitments for operating expenses and maintenance, estimates of such amounts are included based on current rates. Payments made under operating leases will be treated as rent expense for the facilities currently being utilized.
Purchase Commitments
The purchase commitments shown above represent non-cancellable inventory purchase commitments as of December 31, 2014. The inventory purchase commitments typically allow for cancellation of orders 30 days in advance of the required inventory availability date as set by us at time of order.
Line of Credit
The line of credit obligation has been recorded as a liability on our balance sheet. The line of credit obligation amount shown above represents the scheduled principal repayment, but not the associated interest payments which may vary based on changes in market interest rates. At December 31, 2014, the interest rate under our WFB Facility was 3.26%. See above under “Cash Management” for further information about the WFB Facility.
As of December 31, 2014, we had $10.0 million outstanding under our line of credit under the WFB Facility and an additional $3.0 million committed as security for letters of credit, as discussed in Note 4 to the consolidated financial statements.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Cash and Cash Equivalents
We consider all cash and highly liquid investments purchased with an original maturity of less than three months to be cash equivalents.
Concentration of Credit Risk
Financial instruments which potentially subject us to concentrations of credit risk consist primarily of cash and cash equivalents, and accounts receivable. Cash and cash equivalents consist principally of demand deposit and money market accounts. Cash and cash equivalents are principally held with various domestic financial institutions with high credit standing. We perform ongoing credit evaluations of our customers and generally do not require collateral. Allowances are maintained for potential doubtful accounts.
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.
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For the years ended December 31, 2014 and 2013, three customers represented 31% and 33% of net revenue, respectively. As of December 31, 2014 and 2013, three customers accounted for 53% and 56% of net accounts receivable, respectively. As of December 31, 2014 and 2013, receivables from customers in countries other than the United States represented 86% and 82%, respectively, of net accounts receivable.
Interest Rate Risk
Our exposure to market risk for changes in interest rates relates primarily to our outstanding debt. As of December 31, 2014, our outstanding debt balance under our WFB Facility was $10.0 million. Amounts borrowed under the WFB Facility bear interest, payable monthly, at a floating rate equal to the three-month LIBOR plus a margin of 3.0%. As of December 31, 2014, the interest rate on the WFB Facility was 3.26%. Assuming the outstanding balance on our variable rate debt remains constant over a year, a 2% increase in the interest rate would decrease pre-tax income and cash flow by approximately $0.2 million.
Foreign Currency Risk
We transact business in various foreign countries. Substantially all of our assets are located in the United States. We have sales operations throughout Europe, Asia, the Middle East and Latin America. We are exposed to foreign currency exchange rate risk associated with foreign currency denominated assets and liabilities, primarily intercompany receivables and payables. Accordingly, our operating results are exposed to changes in exchange rates between the U.S. dollar and those currencies. During 2014 and 2013, we did not hedge any of our foreign currency exposure. During 2014 and 2013, we recorded zero foreign exchange loss in other income (expense) on our statements of comprehensive income (loss).
We have performed sensitivity analyses as of December 31, 2014 and 2013, using a modeling technique that measures the impact arising from a hypothetical 10% adverse movement in the levels of foreign currency exchange rates relative to the U.S. dollar, with all other variables held constant. The sensitivity analyses indicated that a hypothetical 10% adverse movement in foreign currency exchange rates would result in a foreign exchange loss of $0.4 million for 2014 and 2013, respectively. This sensitivity analysis assumes a parallel adverse shift in foreign currency exchange rates, which do not always move in the same direction. Actual results may differ materially.
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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
ZHONE TECHNOLOGIES, INC. AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and Stockholders
Zhone Technologies, Inc.:
We have audited the accompanying consolidated balance sheets of Zhone Technologies, Inc. and subsidiaries (“the Company”) as of December 31, 2014 and 2013, and the related consolidated statements of comprehensive income (loss), stockholders’ equity and cash flows for each of the years in the three-year period ended December 31, 2014. We also have audited Zhone Technologies, Inc.’s internal control over financial reporting as of December 31, 2014, based on criteria established in Internal Control - Integrated Framework (1992) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Zhone Technologies, Inc.’s management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Controls over Financial Reporting at Item 9A. Our responsibility is to express an opinion on these consolidated financial statements and an opinion on the Company’s internal control over financial reporting based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the consolidated financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Zhone Technologies, Inc. and subsidiaries as of December 31, 2014 and 2013, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2014, in conformity with U.S. generally accepted accounting principles. Also in our opinion, Zhone Technologies, Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2014, based on criteria established in Internal Control - Integrated Framework (1992) issued by COSO.
/s/ KPMG LLP
San Francisco, California
March 6, 2015
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ZHONE TECHNOLOGIES, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
December 31, 2014 and 2013
(In thousands, except par value)
2014 | 2013 | ||||||
Assets | |||||||
Current assets: | |||||||
Cash and cash equivalents | $ | 11,528 | $ | 15,686 | |||
Accounts receivable, net of allowances for sales returns and doubtful accounts of $1,095 in 2014 and $1,452 in 2013 | 29,916 | 33,328 | |||||
Inventories | 19,985 | 19,562 | |||||
Prepaid expenses and other current assets | 2,863 | 2,269 | |||||
Total current assets | 64,292 | 70,845 | |||||
Property and equipment, net | 1,165 | 718 | |||||
Other assets | 255 | 254 | |||||
Total assets | $ | 65,712 | $ | 71,817 | |||
Liabilities and Stockholders’ Equity | |||||||
Current liabilities: | |||||||
Accounts payable | $ | 11,719 | $ | 12,689 | |||
Line of credit | 10,000 | 10,000 | |||||
Accrued and other liabilities | 7,669 | 8,865 | |||||
Total current liabilities | 29,388 | 31,554 | |||||
Other long-term liabilities | 1,981 | 2,704 | |||||
Total liabilities | 31,369 | 34,258 | |||||
Stockholders’ equity: | |||||||
Common stock, $0.001 par value. Authorized 180,000 shares; issued and outstanding 32,506 and 32,249 shares as of December 31, 2014 and 2013, respectively | 32 | 32 | |||||
Additional paid-in capital | 1,075,309 | 1,074,294 | |||||
Other comprehensive (loss) income | (35 | ) | 65 | ||||
Accumulated deficit | (1,040,963 | ) | (1,036,832 | ) | |||
Total stockholders’ equity | 34,343 | 37,559 | |||||
Total liabilities and stockholders’ equity | $ | 65,712 | $ | 71,817 | |||
See accompanying notes to consolidated financial statements.
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ZHONE TECHNOLOGIES, INC. AND SUBSIDIARIES
Consolidated Statements of Comprehensive Income (Loss)
Years ended December 31, 2014, 2013 and 2012
(In thousands, except per share data)
2014 | 2013 | 2012 | |||||||||
Net revenue | $ | 120,582 | $ | 122,248 | $ | 115,385 | |||||
Cost of revenue (1) | 78,748 | 76,116 | 79,101 | ||||||||
Gross profit | 41,834 | 46,132 | 36,284 | ||||||||
Operating expenses: | |||||||||||
Research and product development (1) | 17,340 | 15,326 | 18,542 | ||||||||
Sales and marketing (1) | 19,079 | 20,159 | 19,304 | ||||||||
General and administrative (1) | 9,409 | 6,199 | 7,157 | ||||||||
Impairment of fixed assets | — | — | 61 | ||||||||
Total operating expenses | 45,828 | 41,684 | 45,064 | ||||||||
Operating income (loss) | (3,994 | ) | 4,448 | (8,780 | ) | ||||||
Interest expense, net | (68 | ) | (85 | ) | (102 | ) | |||||
Other expense, net | (1 | ) | (7 | ) | (9 | ) | |||||
Income (loss) before income taxes | (4,063 | ) | 4,356 | (8,891 | ) | ||||||
Income tax provision | 68 | 42 | 124 | ||||||||
Net income (loss) | $ | (4,131 | ) | $ | 4,314 | $ | (9,015 | ) | |||
Other comprehensive loss—foreign currency translation adjustments | (100 | ) | (151 | ) | (21 | ) | |||||
Comprehensive income (loss) | $ | (4,231 | ) | $ | 4,163 | $ | (9,036 | ) | |||
Earnings per common share | |||||||||||
Basic | $ | (0.13 | ) | $ | 0.14 | $ | (0.29 | ) | |||
Diluted | $ | (0.13 | ) | $ | 0.13 | $ | (0.29 | ) | |||
Weighted average shares outstanding used to compute earnings per common share | |||||||||||
Basic | 32,380 | 31,429 | 31,010 | ||||||||
Diluted | 32,380 | 33,021 | 31,010 | ||||||||
(1) Amounts include stock-based compensation costs as follows: | ||||||||
Cost of revenue | 7 | — | 63 | |||||
Research and product development | 11 | 2 | 297 | |||||
Sales and marketing | 29 | 2 | 250 | |||||
General and administrative | 739 | 420 | 704 | |||||
See accompanying notes to consolidated financial statements.
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ZHONE TECHNOLOGIES, INC. AND SUBSIDIARIES
Consolidated Statements of Stockholders’ Equity
Years ended December 31, 2014, 2013 and 2012 (In thousands)
Common stock | Additional paid-in capital | Other comprehensive income | Accumulated deficit | Total stockholders’ equity | ||||||||||||||||||
Shares | Amount | |||||||||||||||||||||
Balances as of December 31, 2011 | 30,820 | $ | 31 | $ | 1,071,390 | $ | 237 | $ | (1,032,131 | ) | $ | 39,527 | ||||||||||
Exercise of stock options for cash | 95 | — | 49 | — | — | 49 | ||||||||||||||||
Stock-based compensation: | ||||||||||||||||||||||
Employee stock-based compensation | — | — | 1,214 | — | — | 1,214 | ||||||||||||||||
Issuance of common stock for executive services | 117 | — | 86 | — | — | 86 | ||||||||||||||||
Issuance of common stock for director services | 84 | — | 100 | — | — | 100 | ||||||||||||||||
Net loss | — | — | — | — | (9,015 | ) | (9,015 | ) | ||||||||||||||
Foreign currency translation adjustment | — | — | — | (21 | ) | — | (21 | ) | ||||||||||||||
Balances as of December 31, 2012 | 31,116 | 31 | 1,072,839 | 216 | (1,041,146 | ) | 31,940 | |||||||||||||||
Exercise of stock options for cash | 930 | 1 | 1,031 | — | — | 1,032 | ||||||||||||||||
Stock-based compensation: | ||||||||||||||||||||||
Employee stock-based compensation | — | — | 213 | — | — | 213 | ||||||||||||||||
Issuance of common stock for executive services | 138 | — | 132 | — | — | 132 | ||||||||||||||||
Issuance of common stock for director services | 65 | — | 79 | — | — | 79 | ||||||||||||||||
Net income | — | — | — | — | 4,314 | 4,314 | ||||||||||||||||
Foreign currency translation adjustment | — | — | — | (151 | ) | — | (151 | ) | ||||||||||||||
Balances as of December 31, 2013 | 32,249 | 32 | 1,074,294 | 65 | (1,036,832 | ) | 37,559 | |||||||||||||||
Exercise of stock options for cash | 223 | — | 229 | — | — | 229 | ||||||||||||||||
Stock-based compensation: | ||||||||||||||||||||||
Employee stock-based compensation | — | — | 725 | — | — | 725 | ||||||||||||||||
Issuance of common stock for director services | 34 | — | 61 | — | — | 61 | ||||||||||||||||
Net loss | — | — | — | — | (4,131 | ) | (4,131 | ) | ||||||||||||||
Foreign currency translation adjustment | — | — | — | (100 | ) | — | (100 | ) | ||||||||||||||
Balances as of December 31, 2014 | 32,506 | $ | 32 | $ | 1,075,309 | $ | (35 | ) | $ | (1,040,963 | ) | $ | 34,343 | |||||||||
See accompanying notes to consolidated financial statements.
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ZHONE TECHNOLOGIES, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
Years ended December 31, 2014, 2013 and 2012
(In thousands)
2014 | 2013 | 2012 | |||||||||
Cash flows from operating activities: | |||||||||||
Net income (loss) | $ | (4,131 | ) | $ | 4,314 | $ | (9,015 | ) | |||
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: | |||||||||||
Depreciation and amortization | 403 | 367 | 316 | ||||||||
Stock-based compensation | 786 | 424 | 1,314 | ||||||||
Loss on disposal of fixed assets | — | — | 7 | ||||||||
Impairment of fixed assets | — | — | 61 | ||||||||
Provision for (recovery of) sales returns and doubtful accounts | (357 | ) | (1,426 | ) | 2,594 | ||||||
Changes in operating assets and liabilities: | |||||||||||
Accounts receivable | 3,769 | (6,082 | ) | 3,184 | |||||||
Inventories | (423 | ) | 1,842 | 5,989 | |||||||
Prepaid expenses and other current assets | (594 | ) | 321 | 82 | |||||||
Other assets | (1 | ) | (46 | ) | 5 | ||||||
Accounts payable | (970 | ) | 5,460 | (4,568 | ) | ||||||
Accrued and other liabilities | (1,919 | ) | (986 | ) | (1,853 | ) | |||||
Net cash provided by (used in) operating activities | (3,437 | ) | 4,188 | (1,884 | ) | ||||||
Cash flows from investing activities: | |||||||||||
Purchases of property and equipment | (850 | ) | (502 | ) | (359 | ) | |||||
Changes in restricted cash | — | — | 58 | ||||||||
Net cash used in investing activities | (850 | ) | (502 | ) | (301 | ) | |||||
Cash flows from financing activities: | |||||||||||
Proceeds from exercise of stock options and purchases under the ESPP plan | 229 | 1,032 | 135 | ||||||||
Net advances (repayment) under credit facilities | — | — | (5,000 | ) | |||||||
Net cash provided by (used in) financing activities | 229 | 1,032 | (4,865 | ) | |||||||
Effect of exchange rate changes on cash | (100 | ) | (151 | ) | (21 | ) | |||||
Net increase (decrease) in cash and cash equivalents | (4,158 | ) | 4,567 | (7,071 | ) | ||||||
Cash and cash equivalents at beginning of year | 15,686 | 11,119 | 18,190 | ||||||||
Cash and cash equivalents at end of year | $ | 11,528 | $ | 15,686 | $ | 11,119 | |||||
Supplemental disclosures of cash flow information: | |||||||||||
Cash paid during period for: | |||||||||||
Taxes | $ | 68 | $ | 42 | $ | 124 | |||||
Interest | 68 | 85 | 102 | ||||||||
See accompanying notes to consolidated financial statements.
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ZHONE TECHNOLOGIES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(1) Organization and Summary of Significant Accounting Policies
(a) Description of Business
Zhone Technologies, Inc. (sometimes referred to, collectively with its subsidiaries, as “Zhone” or the “Company”) designs, develops and manufactures communications network equipment for telecommunications operators and enterprises worldwide. The Company’s products provide enterprise solutions that enable both network service providers and enterprises to deliver high speed fiber access, while transporting voice, video and data to the end user. The Company was incorporated under the laws of the state of Delaware in June 1999. The Company began operations in September 1999 and is headquartered in Oakland, California.
(b) Basis of Presentation
The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All significant inter-company transactions and balances have been eliminated in consolidation. In the quarter ended March 31, 2013, the Company recorded a $0.6 million credit to the statement of comprehensive income as a result of a vendor refund received in 2013 which related to overpayments made in 2012.
(c) Risks and Uncertainties
The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. The Company incurred a net loss of $4.1 million for the year ended December 31, 2014 which reduced cash and cash equivalents in 2014. As of December 31, 2014, the Company had approximately $11.5 million in cash and cash equivalents and $10.0 million in current debt outstanding under its revolving line of credit and letter of credit facility (the “WFB Facility”) with Wells Fargo Bank (“WFB”). The Company currently expects to repay the WFB Facility within the next twelve months. The Company entered into its WFB Facility to provide liquidity and working capital through March 31, 2016, as discussed in Note 4.
The Company’s current lack of liquidity could harm it by:
• | increasing its vulnerability to adverse economic conditions in its industry or the economy in general; |
• | requiring substantial amounts of cash to be used for debt servicing, rather than other purposes, including operations; |
• | limiting its ability to plan for, or react to, changes in its business and industry; and |
• | influencing investor and customer perceptions about its financial stability and limiting its ability to obtain financing or acquire customers. |
In order to meet the Company’s liquidity needs and finance its capital expenditures and working capital needs for the business, the Company may be required to sell assets, issue debt or equity securities or borrow on unfavorable terms. If additional capital is raised through the issuance of debt securities or other debt financing, the terms of such debt may include covenants, restrictions and financial ratios that may restrict the Company’s ability to operate its business. Likewise, any equity financing could result in additional dilution of the Company’s stockholders. If the Company is unable to sell assets, issue securities or access additional indebtedness to meet these needs on favorable terms, or at all, the Company may become unable to pay its ordinary expenses, including its debt service, on a timely basis and may be required to reduce the scope of its planned product development and sales and marketing efforts beyond the reductions it has previously taken. In addition, the Company may be required to reduce its operations in low margin regions, including reductions in headcount. Based on the Company’s current plans and business conditions, it believes that its existing cash, cash equivalents and available credit facilities will be sufficient to satisfy its anticipated cash requirements for at least the next twelve months.
The Company’s financial condition and results of operations could be materially and adversely affected by various factors, including:
• | Potential deferment of purchases and orders by customers; |
• | Customers’ inability to obtain financing to make purchases from the Company and/or maintain their business; |
• | Negative impact from increased financial pressures on third-party dealers, distributors and retailers; |
• | Intense competition in the communication equipment market; |
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• | Commercial acceptance of the Company’s Single Line Multi-Service ("SLMS") products in its core and FiberLAN business; and |
• | Negative impact from increased financial pressures on key suppliers. |
The Company may experience material adverse impacts on its business, operating results and financial condition as a result of weak or recessionary economic or market conditions in the United States or the rest of the world.
(d) Use of Estimates
The preparation of the consolidated financial statements in conformity with generally accepted accounting principles in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ materially from those estimates.
(e) Revenue Recognition
The Company recognizes revenue when the earnings process is complete. The Company recognizes 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. The Company’s arrangements generally do not have any significant post-delivery obligations. If the Company’s arrangements include customer acceptance provisions, revenue is recognized upon obtaining the signed acceptance certificate from the customer, unless the Company 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, the Company uses 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. The Company also considers 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.
The Company makes 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. The Company recognizes 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, the Company uses historical rates of return from the distributors to provide for estimated product returns.
The Company derives revenue primarily from stand-alone sales of its products. In certain cases, the Company’s products are sold along with services, which include education, training, installation, and/or extended warranty services. As such, some of the Company’s sales have multiple deliverables. The Company’s products and services qualify as separate units of accounting and are deemed to be non-contingent deliverables as the Company’s 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, the Company allocates 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 the Company is unable to establish vendor-specific objective evidence of selling price (“VSOE”) it uses third-party evidence of selling price (“TPE”), and if no such data is available, it uses a best estimated selling price (“BSP”). In most instances, particularly as it relates to products, the Company is 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, the Company attempts to establish the selling price of each element based on TPE. Generally, the Company’s marketing strategy differs from that of the Company’s peers and the Company’s offerings contain a significant level of customization and differentiation such that the comparable pricing of products with similar functionality cannot be obtained. Furthermore, the Company is unable to reliably determine what similar competitor products’ selling prices are on a stand-alone basis. Therefore, the Company is typically not able to determine TPE for the Company’s products.
When the Company is unable to establish selling price using VSOE or TPE, the Company uses BSP. The objective of BSP is to determine the price at which the Company 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
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or cost plus margin approaches based on the factors, including but not limited to, the Company’s gross margin objectives and pricing practices plus customer and market specific considerations.
The Company has established TPE for its training, education and installation services. TPE is determined based on competitor prices for similar deliverables when sold separately. These service arrangements are typically short term in nature and are largely completed shortly after delivery of the product. 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.
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, the Company has used and intends to continue using VSOE to determine the selling price for the services. The Company determines VSOE based on its normal pricing practices for these specific services when sold separately.
(f) Allowances for Sales Returns and Doubtful Accounts
The Company records 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 accounts receivable. The Company bases its 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, the Company’s future revenue could be adversely affected.
The Company records an allowance for doubtful accounts for estimated losses resulting from the inability of customers to make payments for amounts owed to the Company. The allowance for doubtful accounts is recorded as a charge to general and administrative expenses. The Company bases its allowance on periodic assessments of its customers’ liquidity and financial condition through analysis of information obtained from credit rating agencies, financial statement review and historical collection trends. Additional allowances may be required in the future if the liquidity or financial conditions of its customers deteriorate, resulting in impairment in their ability to make payments.
Activity under the Company’s allowance for sales returns and doubtful accounts was comprised as follows (in thousands):
Year ended December 31, | |||||||||||
2014 | 2013 | 2012 | |||||||||
Balance at beginning of year | $ | 1,452 | $ | 2,878 | $ | 2,024 | |||||
Charged to revenue | 884 | 776 | 2,190 | ||||||||
Charged to (reversal of) expense | (91 | ) | (180 | ) | 404 | ||||||
Utilization | (1,150 | ) | (2,022 | ) | (1,740 | ) | |||||
Balance at end of year | $ | 1,095 | $ | 1,452 | $ | 2,878 | |||||
The allowance for doubtful accounts was $0.6 million and $0.7 million as of December 31, 2014 and 2013, respectively.
(g) 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, the Company is 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 the Company experiences a higher incidence of inventory obsolescence due to rapidly changing technology and customer requirements, the Company may incur significant charges for excess inventory.
(h) Foreign Currency Translation
For operations outside the United States, the Company translates assets and liabilities of foreign subsidiaries, whose functional currency is the local currency, at end of period exchange rates. Revenues and expenses are translated at monthly average rates of exchange prevailing during the year. The adjustment resulting from translating the financial statements of such foreign subsidiaries, is included in accumulated other comprehensive income (loss), which is reflected as a separate component of stockholders’ equity. Realized gains and losses on foreign currency transactions are included in other
44
income (expense) in the accompanying consolidated statement of comprehensive income (loss). During 2014, 2013 and 2012, the Company recorded no realized foreign exchange gain or loss on its statements of comprehensive income (loss).
(i) Comprehensive Income (Loss)
There have been no items reclassified out of accumulated other comprehensive income (loss) and into net income (loss). The Company’s other comprehensive loss for the years ended December 31, 2014, 2013, and 2012 is comprised of only foreign exchange translations.
(j) Concentration of Risk
Financial instruments which potentially subject the Company to concentrations of credit risk consist primarily of cash and cash equivalents and accounts receivable. Cash and cash equivalents consist principally of demand deposit and money market accounts. Cash and cash equivalents are principally held with various domestic financial institutions with high credit standing.
The Company’s customers include competitive and incumbent local exchange carriers, competitive access providers, Internet service providers, wireless carriers and resellers serving these markets. The Company performs ongoing credit evaluations of its customers and generally does not require collateral. Allowances are maintained for potential doubtful accounts.
For the year ended December 31, 2014 and 2013, three customers represented 31% and 33% of net revenue, respectively. The target customers for the Company’s products are network service providers that operate voice, data and video communications networks. There are a limited number of potential customers in this target market. The Company expects that a significant portion of the Company’s future revenue will depend on sales of its products to a limited number of customers. Any failure of one or more customers to purchase products from the Company for any reason, including any downturn in their businesses, would seriously harm the Company’s business, financial condition and results of operations.
As of December 31, 2014 and December 31, 2013, three customers accounted for 53% and 56% of net accounts receivable, respectively. As of December 31, 2014 and December 31, 2013, receivables from customers in countries other than the United States represented 86% and 82%, respectively, of net accounts receivable.
From time to time, the Company may provide or commit to extend credit or credit support to its customers. As of December 31, 2014, the Company did not have any significant customer financing commitments or guarantees.
The Company’s products are concentrated in the communications equipment market, which is highly competitive and subject to rapid change. Significant technological changes in the industry could adversely affect operating results. The Company’s inventories include components that may be specialized in nature, and subject to rapid technological obsolescence. The Company actively manages inventory levels, and the Company considers technological obsolescence and potential changes in product demand based on macroeconomic conditions when estimating required allowances to reduce recorded inventory amounts to market value. Such estimates could change in the future.
The Company’s growth and ability to meet customer demands are also dependent on its ability to obtain timely deliveries of components from suppliers and contract manufacturers. The Company depends on contract manufacturers and sole or limited source suppliers for several key components. If the Company were unable to obtain these components on a timely basis, the Company would be unable to meet its customers’ product delivery requirements which could adversely impact operating results. While the Company is not solely dependent on one contract manufacturer, it expects to continue to rely on contract manufacturers to fulfill a portion of its product manufacturing requirements.
(k) Property and Equipment
Property and equipment are stated at cost and depreciated using the straight-line method over their estimated useful lives. Useful lives of all property and equipment range from 3 to 5 years. Leasehold improvements are generally amortized over the shorter of their useful lives or the remaining lease term.
(l) Long-Lived Assets
The Company reviews long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying value of an asset or asset group may not be recoverable based on expected undiscounted cash flows attributable to that asset or asset group. 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
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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.
The Company estimates the fair value of its long-lived assets based on a combination of market information primarily obtained from third-party quotes and online markets. In the application of the impairment testing, the Company is required to make estimates of future operating trends and resulting cash flows and judgments on discount rates and other variables. Actual future results and other assumed variables could differ from these estimates. During the years ended December 31, 2014 and 2013, the Company recorded no impairment charges related to the impairment of long-lived assets. During the year ended December 31, 2012, the Company recorded a charge of $0.1 million related to the impairment of long-lived assets. The Company’s long-lived assets as of December 31, 2014, 2013, and 2012 consisted of net fixed assets totaling $1.2 million, $0.7 million, and $0.6 million, respectively.
(m) Accounting for Stock-Based Compensation
The Company uses the Black Scholes model to estimate the fair value of options. The value of the portion of the award that is ultimately expected to vest is recognized as expense over the requisite service periods in the Company’s consolidated statement of comprehensive income (loss).
Awards of stock options granted to non-employees under the Company’s share-based compensation plans are accounted for at fair value determined by using the Black Scholes option pricing model. These options are generally immediately exercisable and expire seven to ten years from the date of grant. Non-employee options subject to vesting are re-valued as they become vested.
The Company attributes the values of the stock-based compensation to expense using the straight line method.
(n) Income Taxes
The Company uses the asset and liability method to account for income taxes. Under this method, deferred tax assets and liabilities are determined based on differences between the financial reporting and the income tax bases of assets and liabilities. Deferred tax assets and liabilities are measured using enacted tax rates and laws that will be in effect when the differences are expected to reverse. Valuation allowances are established, when necessary, to reduce deferred tax assets to the amount expected to be realized. The Company has recorded a full valuation allowance against its net deferred tax assets at December 31, 2014 and 2013 due to the significant uncertainty regarding whether the deferred tax assets will be realized.
(o) Net Income (Loss) per Common Share
Basic net income (loss) per share is computed by dividing the net income (loss) applicable to holders of common stock for the period by the weighted average number of shares of common stock outstanding during the period. The calculation of diluted net income (loss) per share gives effect to common stock equivalents; however, potential common equivalent shares are excluded if their effect is antidilutive. Potential common equivalent shares are composed of incremental shares of common equivalent shares issuable upon the exercise of stock options and warrants.
(p) Recent Accounting Pronouncements
On May 28, 2014, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") No. 2014-09, Revenue from Contracts with Customers, which requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. The ASU will replace most existing revenue recognition guidance in U.S. GAAP when it becomes effective. The new standard is effective for the Company on January 1, 2017. Early application is not permitted. The standard permits the use of either the retrospective or cumulative effect transition method. The Company is evaluating the effect that ASU 2014-09 will have on its consolidated financial statements and related disclosures. The Company has not yet selected a transition method nor has it determined the effect of the standard on its ongoing financial reporting.
In August 2014, the FASB issued ASU No. 2014-15, Disclosure of Uncertainties about an Entity's Ability to Continue as a Going Concern, which describes how an entity should assess its ability to meet obligations and sets
rules for how this information should be disclosed in financial statements. The new standard is effective for the Company on January 1, 2017. Early application is permitted. The Company is evaluating the effect that ASU 2014-15 will have on its consolidated financial statements and related disclosures.
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(2) Fair Value Measurement
The Company utilizes a fair value hierarchy that is intended to increase consistency and comparability in fair value measurements and related disclosures. The fair value hierarchy is based on inputs to valuation techniques that are used to measure fair value that are either observable or unobservable. Observable inputs reflect assumptions market participants would use in pricing an asset or liability based on market data obtained from independent sources while unobservable inputs reflect a reporting entity’s pricing based upon their own market assumptions. The fair value hierarchy consists of the following three levels:
Level 1 – | Inputs are quoted prices in active markets for identical assets or liabilities. |
Level 2 – | Inputs are quoted prices for similar assets or liabilities in an active market, quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable and market-corroborated inputs which are derived principally from or corroborated by observable market data. |
Level 3 – | Inputs are derived from valuation techniques in which one or more significant inputs or value drivers are unobservable. |
The following financial instruments are not measured at fair value on the Company’s consolidated balance sheet as of December 31, 2014 and 2013, but require disclosure of their fair values: cash and cash equivalents, accounts receivable, accounts payable, accrued liabilities, and debt. The estimated fair value of such instruments at December 31, 2014 and 2013 approximated their carrying value as reported on the consolidated balance sheet. The fair value of such financial instruments is determined using the income approach based on the present value of estimated future cash flows. The fair value of these instruments would be categorized as Level 2 in the fair value hierarchy, with the exception of cash and cash equivalents, which would be categorized as Level 1.
The Company had no financial assets and liabilities as of December 31, 2014 and 2013 recorded at fair value.
(3) Balance Sheet Detail
Balance sheet detail as of December 31, 2014 and 2013 is as follows (in thousands):
2014 | 2013 | ||||||
Inventories: | |||||||
Raw materials | $ | 12,794 | $ | 11,722 | |||
Work in process | 2,217 | 1,724 | |||||
Finished goods | 4,974 | 6,116 | |||||
$ | 19,985 | $ | 19,562 | ||||
Property and equipment, net: | |||||||
Machinery and equipment | 10,120 | 9,610 | |||||
Computers and acquired software | 4,155 | 3,830 | |||||
Furniture and fixtures | 262 | 247 | |||||
Leasehold improvements | 2,066 | 2,066 | |||||
16,603 | 15,753 | ||||||
Less accumulated depreciation and amortization | (15,438 | ) | (15,035 | ) | |||
$ | 1,165 | $ | 718 | ||||
Depreciation and amortization expense associated with property and equipment amounted to $0.4 million, $0.4 million and $0.3 million for the years ended December 31, 2014, 2013 and 2012, respectively.
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2014 | 2013 | ||||||
Accrued and other liabilities (in thousands): | |||||||
Accrued warranty | $ | 952 | $ | 1,265 | |||
Accrued compensation | 2,296 | 2,191 | |||||
Deferred revenue | 809 | 1,141 | |||||
Other | 3,612 | 4,268 | |||||
$ | 7,669 | $ | 8,865 | ||||
The Company accrues for warranty costs based on historical trends for the expected material and labor costs to provide warranty services. Warranty periods are generally one year from the date of shipment. The following table summarizes the activity related to the product warranty liability during the years ended December 31, 2014 and 2013 (in thousands):
Balance at December 31, 2012 | $ | 1,499 | |
Charged to cost of revenue | 696 | ||
Claims and settlements | (930 | ) | |
Balance at December 31, 2013 | $ | 1,265 | |
Charged to cost of revenue | 358 | ||
Claims and settlements | (671 | ) | |
Balance at December 31, 2014 | $ | 952 | |
(4) Debt
As of December 31, 2014, the Company had a $25.0 million revolving line of credit and letter of credit facility with WFB to provide liquidity and working capital through March 31, 2016.
Under the WFB Facility, the Company has the option of borrowing funds at agreed upon interest rates. The amount that the Company is able to borrow under the WFB Facility varies based on eligible accounts receivable and inventory, as defined in the agreement, as long as the aggregate amount outstanding does not exceed $25.0 million less the amount committed as security for letters of credit, which at December 31, 2014 was $3.0 million. To maintain availability of funds under the WFB Facility, the Company pays a commitment fee on the unused portion. The commitment fee is 0.25% per annum and is recorded as interest expense.
The Company had $10.0 million outstanding at December 31, 2014 under its WFB Facility. In addition, $3.0 million was committed as security for letters of credit. The Company had $6.5 million of borrowing availability under the WFB Facility as of December 31, 2014. The amounts borrowed under the WFB Facility bear interest, payable monthly, at a floating rate equal to the three-month LIBOR plus a margin of 3.0%. The interest rate on the WFB Facility was 3.26% at December 31, 2014.
The Company’s obligations under the WFB Facility are secured by substantially all of its personal property assets and those of its subsidiaries that guarantee the WFB Facility, including their intellectual property. The WFB Facility contains certain financial covenants, and customary affirmative covenants and negative covenants. If the Company defaults under the WFB Facility due to a covenant breach or otherwise, WFB may be entitled to, among other things, require the immediate repayment of all outstanding amounts and sell the Company’s assets to satisfy the obligations under the WFB Facility. As of December 31, 2014, the Company was in compliance with these covenants.
(5) Executive Compensation
On July 17, 2014, Morteza Ejabat, the Company's then President, Chief Executive Officer and Chairman of Zhone's Board of Directors, resigned from his position as President and Chief Executive Officer and was appointed by the Board of Directors to serve as Executive Chairman. Effective July 17, 2014, the Board appointed James Norrod as the Company’ s President and Chief Executive Officer and as a member of the Board of Directors.
In connection with this transition, the Company paid Mr . Ejabat a one-time performance bonus in the amount of $1.7 million on July 17, 2014 in recognition of his services as Chief Executive Officer since 1999. The performance bonus was expensed during the three month period ended September 30, 2014. In addition, the Compensation Committee of the Board of Directors
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approved the grant of an inducement award to Mr. Norrod consisting of a stock option to purchase 1,250,000 shares of the Company’ s common stock at an exercise price equal to the closing price of the Company’ s common stock on the grant date, which stock option was granted on July 21, 2014. The estimated fair value of the stock option award at the grant date was $2.8 million and will be amortized to expense over the service period of four years.
(6) Stockholders’ Equity
(a) Overview
As of December 31, 2014 and 2013, the Company’s equity capitalization consisted of 180 million authorized shares of common stock, of which 32.5 million and 32.2 million, respectively, were outstanding.
(b) Warrants
At December 31, 2014, the Company had no warrants to purchase common stock outstanding. None of the Company's former warrants were exercised in 2014, 2013, or 2012.
(c) Stock-Based Compensation
As of December 31, 2014, the Company had two types of share-based compensation plans related to stock options and employee stock purchases. The compensation cost that has been charged as an expense in the statement of comprehensive income (loss) for those plans was $0.8 million, $0.4 million and $1.3 million for the years ended December 31, 2014, 2013 and 2012, respectively.
The following table summarizes stock-based compensation expense for the years ended December 31, 2014, 2013 and 2012 (in thousands):
Year ended December 31, | |||||||||||
2014 | 2013 | 2012 | |||||||||
Compensation expense relating to employee stock options | $ | 786 | $ | 424 | $ | 1,283 | |||||
Compensation expense relating to Employee Stock Purchase Plan | — | — | 31 | ||||||||
Stock-based compensation expense | $ | 786 | $ | 424 | $ | 1,314 | |||||
Stock Options
The Company’s stock-based compensation plans are designed to attract, motivate, retain and reward talented employees, directors and consultants and align stockholder and employee interests. The Company has two active stock option plans, the Amended and Restated Special 2001 Stock Incentive Plan and the Amended and Restated 2001 Stock Incentive Plan. Stock options are primarily issued from the Amended and Restated 2001 Stock Incentive Plan. This plan provides for the grant of incentive stock options, non-statutory stock options, restricted stock awards and other stock-based awards to officers, employees, directors and consultants of the Company. Options may be granted at an exercise price less than, equal to or greater than the fair market value on the date of grant, except that any options granted to a 10% stockholder must have an exercise price equal to at least 110% of the fair market value of the Company’s common stock on the date of grant. The Board of Directors determines the term of each option, the option exercise price and the vesting terms. Stock options are generally granted at an exercise price equal to the fair market value on the date of grant, expiring seven to ten years from the date of grant and vesting over a period of four years. On January 1 of each year, if the number of shares available for grant under the Amended and Restated 2001 Stock Incentive Plan is less than 5% of the total number of shares of common stock outstanding as of that date, the shares available for grant under the plan are automatically increased by the amount necessary to make the total number of shares available for grant equal to 5% of the total number of shares of common stock outstanding, or by a lesser amount as determined by the Board of Directors. As of December 31, 2014, 0.1 million shares were available for grant under these plans.
The Company has estimated the fair value of stock-based payment awards on the date of grant using the Black Scholes pricing model, which is affected by the Company’s stock price as well as assumptions regarding a number of complex and subjective variables. These variables include the Company’s 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 estimated expected term of options granted was determined based on historical option exercise trends. Estimated volatility was based on historical volatility and the risk free interest rate was based on U.S. Treasury yield in effect at the time of grant for the expected life of the options. The Company does not anticipate paying any cash dividends in the foreseeable future and therefore used an expected dividend yield of zero in the option valuation model. The Company is also required to estimate forfeitures at the time of grant
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and revise those estimates in subsequent periods if actual forfeitures differ from those estimates. Historical data was used to estimate pre-vesting forfeitures and record stock-based compensation expense only for those awards that are expected to vest.
The assumptions used to value option grants for the years ended December 31, 2014, 2013 and 2012 are as follows:
Year ended December 31, | ||||||||
2014 | 2013 | 2012 | ||||||
Expected term | 4.0 - 5.2 years | 4.7 years | 4.7 years | |||||
Expected volatility | 81% - 110% | 94 | % | 96 | % | |||
Risk free interest rate | 1.72 | % | 1.42 | % | 0.74 | % | ||
The weighted average grant date fair value of options granted during the years ended December 31, 2014, 2013 and 2012 was $1.83, $1.17 and $0.95 per share, respectively. The intrinsic value of options exercised for the years ended December 31, 2014, 2013 and 2012 was $0.5 million, $3.9 million and zero, respectively. The Company received $0.2 million, $1.0 million, and $49 thousand in proceeds from stock option exercises for the years ended December 31, 2014, 2013 and 2012, respectively.
The following table sets forth the summary of option activity under the stock option program for the year ended December 31, 2014 (in thousands, except per share data):
Options Outstanding | Weighted Average Exercise Price | Weighted Average Remaining Contractual Term | Aggregate Intrinsic Value | |||||||||
Outstanding as of December 31, 2013 | 4,278 | $ | 1.36 | 3.02 | $ | 17,828 | ||||||
Granted | 2,206 | $ | 3.14 | |||||||||
Canceled/Forfeited | (177 | ) | $ | 5.86 | ||||||||
Exercised | (222 | ) | $ | 1.03 | ||||||||
Outstanding as of December 31, 2014 | 6,085 | $ | 1.89 | 3.60 | $ | 2,758 | ||||||
Vested and expected to vest at December 31, 2014 | 5,034 | $ | 1.67 | 3.00 | $ | 2,732 | ||||||
Vested and exercisable at December 31, 2014 | 3,779 | $ | 1.22 | 1.84 | $ | 2,618 | ||||||
The aggregate intrinsic value represents the total pretax intrinsic value, based on the Company’s closing stock price as of December 31, 2014 of $1.77, which would have been received by the option holders had the option holders exercised their options as of that date.
As of December 31, 2014, there was $4.1 million of unrecognized compensation costs, adjusted for estimated forfeitures related to unvested stock-based payments granted which are expected to be recognized over a weighted average period of 3.2 years.
On August 9, 2012, the Company’s Board of Directors approved the acceleration of vesting of all unvested options to purchase shares of Zhone common stock that were held by the Company’s 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 the Company’s senior management and employees.
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Employee Stock Purchase Plan
The Company’s 2002 Employee Stock Purchase Plan (“ESPP”) allows eligible employee participants to purchase shares of the Company’s common stock at a price equal to 85% of the lower of the fair market value of the common stock at the beginning or the end of each three-month offering period. Participation is limited to 10% of an employee’s eligible compensation, not to exceed amounts allowed by the Internal Revenue Code. The program was suspended by the Company in June 2012 and there was no activity during the years ended December 31, 2014 and 2013. The following table summarizes shares purchased, weighted average purchase price, cash received and the aggregate intrinsic value for ESPP purchases during the year ended December 31, 2012 (in thousands, except per share data):
Year ended December 31, | ||||
2012 | ||||
Shares purchased | 117 | |||
Weighted average purchase price | $ | 0.73 | ||
Cash received | $ | 86 | ||
Aggregate intrinsic value | $ | 40 | ||
The assumptions used to value stock purchases under the Company’s ESPP for the year ended December 31, 2012:
Year ended December 31, | ||||
2012 | ||||
Expected term | 3 months | |||
Volatility | 77 | % | ||
Risk free interest rate | 0.01 | % | ||
Weighted average fair value per share | $ | 0.33 | ||
(7) Net Income (Loss) Per Share
The following table sets forth the computation of basic and diluted net income (loss) per share (in thousands, except per share data):
Year ended December 31, | |||||||||||
2014 | 2013 | 2012 | |||||||||
Numerator: | |||||||||||
Net income (loss) | $ | (4,131 | ) | $ | 4,314 | $ | (9,015 | ) | |||
Denominator: | |||||||||||
Weighted average number of shares outstanding: | |||||||||||
Basic | 32,380 | 31,429 | 31,010 | ||||||||
Effect of dilutive securities: | |||||||||||
Stock options and share awards | — | 1,592 | — | ||||||||
Diluted | 32,380 | 33,021 | 31,010 | ||||||||
Net income (loss) per share: | |||||||||||
Basic | $ | (0.13 | ) | $ | 0.14 | $ | (0.29 | ) | |||
Diluted | $ | (0.13 | ) | $ | 0.13 | $ | (0.29 | ) | |||
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The following tables set forth potential common stock that is not included in the diluted net income (loss) per share calculation above because their effect would be anti-dilutive for the periods indicated (in thousands, except exercise price per share data):
2014 | Weighted average exercise price | |||||
Outstanding stock options and unvested restricted shares | 6,167 | $ | 1.87 | |||
2013 | Weighted average exercise price | |||||
Warrants | 3 | $ | 32.45 | |||
Outstanding stock options and unvested restricted shares | 40 | $ | 1.34 | |||
43 | ||||||
2012 | Weighted average exercise price | |||||
Warrants | 7 | $ | 116.55 | |||
Outstanding stock options and unvested restricted shares | 5,376 | $ | 2.05 | |||
5,383 | ||||||
As of December 31, 2014, 2012 and 2011, there were zero shares of issued common stock subject to repurchase.
(8) Income Taxes
The following is a summary of the components of income tax expense applicable to loss before income taxes (in thousands):
Year ended December 31, | |||||||||||
2014 | 2013 | 2012 | |||||||||
Current: | |||||||||||
Federal | — | — | — | ||||||||
State | 4 | 21 | 26 | ||||||||
Foreign | 64 | 21 | 98 | ||||||||
Total current tax expense | $ | 68 | $ | 42 | $ | 124 | |||||
Deferred: | |||||||||||
Federal | — | — | — | ||||||||
State | — | — | — | ||||||||
Foreign | — | — | — | ||||||||
Total deferred tax expense | $ | — | $ | — | $ | — | |||||
Total tax expense | $ | 68 | $ | 42 | $ | 124 | |||||
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A reconciliation of the expected tax expense (benefit) to the actual tax expense is as follows (in thousands):
Year ended December 31, | |||||||||||
2014 | 2013 | 2012 | |||||||||
Expected tax expense (benefit) at statutory rate (35%) | $ | (1,446 | ) | $ | 1,510 | $ | (3,155 | ) | |||
State taxes, net of Federal effect | 3 | 13 | 17 | ||||||||
Foreign rate differential | 166 | (5,465 | ) | (2,416 | ) | ||||||
Valuation allowance | 985 | 3,962 | 5,362 | ||||||||
Stock-based compensation | 275 | 136 | 402 | ||||||||
Other | 85 | (114 | ) | (86 | ) | ||||||
Total tax expense | $ | 68 | $ | 42 | $ | 124 | |||||
Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting and income tax purposes. Significant components of the Company’s deferred tax assets and liabilities as of December 31, 2014 and 2013 are as follows (in thousands):
2014 | 2013 | ||||||
Deferred tax assets: | |||||||
Net operating loss, capital loss, and tax credit carryforwards | $ | 518,667 | $ | 552,010 | |||
Fixed assets and intangible assets | 11,918 | 14,260 | |||||
Inventory and other reserves | 2,874 | 4,088 | |||||
Other | 83 | 131 | |||||
Gross deferred tax assets | 533,542 | 570,489 | |||||
Less valuation allowance | (533,542 | ) | (570,489 | ) | |||
Total net deferred tax assets | $ | — | $ | — | |||
For the years ended December 31, 2014 and 2013, the net changes in the valuation allowance were a decrease of $36.9 million and an increase of $18.0 million, respectively. The Company recorded a full valuation allowance against the net deferred tax assets at December 31, 2014 and 2013 since it is more likely than not that the net deferred tax assets will not be realized due to the lack of previously paid taxes and anticipated taxable income.
As of December 31, 2014, the Company had net operating loss carryforwards for federal and California income tax purposes of approximately $1,356.7 million and $434.5 million, respectively, which are available to offset future taxable income, if any, in years through 2034. These losses begin to expire in 2015. In 2014, the Company recorded an adjustment to reduce its federal net operating loss carry forwards by $73.6 million to reflect allocations of losses to its foreign affiliate. Approximately $3.6 million federal and $2.5 million California net operating loss carryforwards stated here are attributable to employee stock option deductions, the benefit from which will be allocated to paid-in-capital rather than current income when subsequently recognized. Federal and state laws impose substantial restrictions on the utilization of net operating loss and tax credit carryforwards in the event of an ownership change for tax purposes, as defined in Section 382 of the Internal Revenue Code. As a result of such ownership changes, the Company’s ability to realize the potential future benefit of tax losses and tax credits that existed at the time of the ownership change will be significantly reduced. The Company’s deferred tax asset and related valuation allowance would be reduced as a result. The Company has not yet performed a Section 382 study to determine the amount of reduction, if any.
As of December 31, 2014, the Company also had research credit carryforwards for federal and state income tax purposes of approximately $22.7 million and $7.9 million, respectively, which are available to reduce future income taxes, if any, in years through 2034 and over an indefinite period, respectively. The federal credits begin to expire in 2015 and the California credits carryover indefinitely. Additionally, the Company had alternative minimum tax credit carryforwards for federal income tax purposes of approximately $0.1 million which are available to reduce future income taxes, if any, over an indefinite period. The Company also had enterprise zone credit carryforwards for state income tax purposes of approximately $0.2 million which are available to reduce future state income taxes, if any, over an indefinite period.
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The Company may have unrecognized tax benefits included in its deferred tax assets which are subject to a full valuation allowance as of December 31, 2014 and 2013. However, the Company has not yet performed a study to determine the amount of such unrecognized tax benefits.
Interest and penalties, to the extent accrued on unrecognized tax benefits in the future, will be included in tax expense.
The Company or one of its subsidiaries files income tax returns in the U.S. federal jurisdiction, and various state and foreign jurisdictions. The open tax years for the major jurisdictions are as follows:
• Federal | 2011 – 2014 |
• California and Canada | 2010 – 2014 |
• Brazil | 2009 – 2014 |
• Germany | 2007 – 2014 |
• United Kingdom | 2010 – 2014 |
However, due to the fact the Company had net operating losses and credits carried forward in most jurisdictions, certain items attributable to technically closed years are still subject to adjustment by the relevant taxing authority through an adjustment to tax attributes carried forward to open years.
The Company estimates that its foreign income will generally be subject to taxation in the United States on a current basis and that its foreign subsidiaries and representative offices will therefore not have any material untaxed earnings subject to deferred taxes. In addition, to the extent the Company is deemed to have a sufficient connection to a particular taxing jurisdiction to enable that jurisdiction to tax the Company but the Company has not filed an income tax return in that jurisdiction for the year(s) at issue, the jurisdiction would typically be able to assert a tax liability for such years without limitation on the number of years it may examine.
The Company is not currently under examination for income taxes in any material jurisdiction.
(9) Related-Party Transactions
In the ordinary course of business, the Company’s executive officers and non-employee directors are reimbursed for travel related expenses when incurred for business purposes. The Company reimburses its Chairman, Morteza Ejabat, for the direct operating expenses incurred in the use of his private aircraft when used for business purposes. The amount reimbursed for these expenses was zero, $0.1 million, and $0.3 million during the years ended December 31, 2014, 2013 and 2012, respectively.
(10) Commitments and Contingencies
Operating Leases
The Company has entered into operating leases for certain office space and equipment, some of which contain renewal options.
Estimated future lease payments under all non-cancelable operating leases with terms in excess of one year, including taxes and service fees, are as follows (in thousands):
Operating leases | |||
Year ending December 31: | |||
2015 | $ | 1,499 | |
2016 | 541 | ||
2017 and thereafter | 83 | ||
Total minimum lease payments | $ | 2,123 | |
The above amounts include $1.1 million and $0.5 million of future minimum lease payments with respect to the Company’s manufacturing facility in Largo, Florida and headquarters in Oakland, California, respectively. For operating leases that include contractual commitments for operating expenses and maintenance, estimates of such amounts are included based
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on current rates. Rent expense under operating leases, excluding rent relating to excess facilities previously accrued, totaled $2.3 million, $2.0 million and $2.5 million for the years ended December 31, 2014, 2013 and 2012, respectively. Sublease rental income was immaterial for the years ended December 31, 2014 and 2013. Sublease rental income totaled $0.4 million for the year ended December 31, 2012.
Performance Bonds
In the normal course of operations, from time to time, the Company arranges for the issuance of various types of surety bonds, such as bid and performance bonds, which are agreements under which the surety company guarantees that the Company will perform in accordance with contractual or legal obligations. If the Company fails to perform under its obligations, the maximum potential payment under these surety bonds would have been $0.2 million as of December 31, 2014.
Purchase Commitments
The Company has agreements with various contract manufacturers which include non-cancellable inventory purchase commitments. The Company’s inventory purchase commitments typically allow for cancellation of orders 30 days in advance of the required inventory availability date as set by the Company at time of order. The amount of non-cancellable purchase commitments outstanding was $6.2 million as of December 31, 2014.
Royalties
The Company has certain royalty commitments associated with the shipment and licensing of certain products. Royalty expense is generally based on a dollar amount per unit shipped or a percentage of the underlying revenue and is recorded in cost of revenue.
Gain Contingencies
As part of a patent sale agreement entered into in 2011, the Company is entitled to a portion of proceeds arising from sales of assigned patents. During the years ended December 31, 2014, 2013, and 2012, the Company recorded a gain on patent sales in general and administrative expenses of zero, zero, and $1.0 million, respectively. Future patent sales could result in additional gains. The Company recognizes the gain based upon cash receipts.
(11) Litigation
The Company is subject to various legal proceedings, claims and litigation arising in the ordinary course of business. While the outcome of these matters is currently not determinable, the Company does not expect that the ultimate costs to resolve these matters will have a material adverse effect on its consolidated financial position or results of operations. However, litigation is subject to inherent uncertainties, and unfavorable rulings could occur. If an unfavorable ruling were to occur, there exists the possibility of a material adverse impact on the results of operations of the period in which the ruling occurs, or future periods.
(12) Employee Benefit Plan
The Company maintains a 401(k) plan for its employees whereby eligible employees may contribute up to a specified percentage of their earnings, on a pretax basis, subject to the maximum amount permitted by the Internal Revenue Code. Under the 401(k) plan, the Company may make discretionary contributions. The Company made no discretionary contributions to the plan in 2014, 2013, and 2012.
(13) Enterprise Wide Information
The Company designs, develops and manufactures communications products for network service providers. The Company derives substantially all of its revenues from the sales of the Zhone product family. The Company’s chief operating decision maker is the Company’s Chief Executive Officer. The Chief Executive Officer reviews financial information presented on a consolidated basis accompanied by disaggregated information about revenues by geographic region for purposes of making operating decisions and assessing financial performance. The Company has determined that it has operated within one discrete reportable business segment since inception. The following summarizes required disclosures about geographic concentrations and revenue by products and services (in thousands):
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Year ended December 31, | |||||||||||
2014 | 2013 | 2012 | |||||||||
Revenue by Geography: | |||||||||||
United States | $ | 36,193 | $ | 38,208 | $ | 47,131 | |||||
Canada | 2,904 | 3,398 | 3,763 | ||||||||
Total North America | 39,097 | 41,606 | 50,894 | ||||||||
Latin America | 19,979 | 27,253 | 27,890 | ||||||||
Europe, Middle East, Africa | 58,067 | 49,592 | 34,215 | ||||||||
Asia Pacific | 3,439 | 3,797 | 2,386 | ||||||||
Total International | 81,485 | 80,642 | 64,491 | ||||||||
$ | 120,582 | $ | 122,248 | $ | 115,385 | ||||||
Year ended December 31, | |||||||||||
2014 | 2013 | 2012 | |||||||||
Revenue by products and services: | |||||||||||
Products | $ | 113,986 | $ | 113,979 | $ | 110,267 | |||||
Services | 6,596 | 8,269 | 5,118 | ||||||||
$ | 120,582 | $ | 122,248 | $ | 115,385 | ||||||
(14) Quarterly Information (unaudited)
Year ended December 31, 2014 | |||||||||||||||
Q1 | Q2 | Q3 | Q4 | ||||||||||||
(in thousands, except per share data) | |||||||||||||||
Net revenue | $ | 28,609 | $ | 32,422 | $ | 29,436 | $ | 30,115 | |||||||
Gross profit | 10,865 | 11,014 | 10,754 | 9,201 | |||||||||||
Operating income (loss) | 355 | 399 | (2,656 | ) | (2,092 | ) | |||||||||
Net income (loss) | 302 | 369 | (2,705 | ) | (2,097 | ) | |||||||||
Net income (loss) per share | |||||||||||||||
Basic | $ | 0.01 | $ | 0.01 | $ | (0.08 | ) | $ | (0.06 | ) | |||||
Diluted | 0.01 | 0.01 | (0.08 | ) | (0.06 | ) | |||||||||
Weighted-average shares outstanding | |||||||||||||||
Basic | 32,299 | 32,354 | 32,384 | 32,484 | |||||||||||
Diluted | 34,826 | 34,441 | 32,384 | 32,484 | |||||||||||
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Year ended December 31, 2013 | |||||||||||||||
Q1 (1) | Q2 | Q3 | Q4 | ||||||||||||
(in thousands, except per share data) | |||||||||||||||
Net revenue | $ | 28,379 | $ | 30,048 | $ | 31,515 | $ | 32,306 | |||||||
Gross profit | 10,504 | 11,612 | 11,907 | 12,109 | |||||||||||
Operating income | 333 | 1,094 | 1,627 | 1,394 | |||||||||||
Net income | 230 | 1,056 | 1,596 | 1,432 | |||||||||||
Net income per share | |||||||||||||||
Basic | $ | 0.01 | $ | 0.03 | $ | 0.05 | $ | 0.04 | |||||||
Diluted | 0.01 | 0.03 | 0.05 | 0.04 | |||||||||||
Weighted-average shares outstanding | |||||||||||||||
Basic | 31,118 | 31,222 | 31,480 | 31,896 | |||||||||||
Diluted | 31,758 | 32,696 | 33,344 | 34,287 | |||||||||||
(1) | Includes a $0.6 million credit as a result of a vendor refund received in 2013 which related to overpayments made in 2012. |
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ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
ITEM 9A. CONTROLS AND PROCEDURES
Disclosure Controls and Procedures
We conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the period covered by this report. The controls evaluation was done under the supervision and with the participation of management, including our Chief Executive Officer and our Chief Financial Officer. Based upon this evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that, subject to the limitations noted in this Part II, Item 9A, as of the end of the period covered by this report, our disclosure controls and procedures were effective to provide reasonable assurance that information required to be disclosed in our reports under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified by the SEC, and that material information relating to Zhone and its consolidated subsidiaries is made known to management, including our Chief Executive Officer and Chief Financial Officer, particularly during the period when our periodic reports are being prepared.
Management’s Annual Report on Internal Control Over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting to provide reasonable assurance regarding the reliability of our financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. Management assessed the effectiveness of our internal control over financial reporting as of December 31, 2014, the end of our fiscal year. In making this assessment, management used the criteria in the 1992 Framework established by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in the report entitled “Internal Control-Integrated Framework.” Based on our assessment of internal control over financial reporting, management has concluded that, as of December 31, 2014, our internal control over financial reporting was effective to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external reporting purposes in accordance with generally accepted accounting principles. The effectiveness of our internal control over financial reporting as of December 31, 2014, has been audited by KPMG LLP, an independent registered public accounting firm and their report is included in Item 8 of this report.
Changes in Internal Control Over Financial Reporting
There were no changes in our internal control over financial reporting that occurred during our last fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Inherent Limitations on Effectiveness of Controls
Our management, including our Chief Executive Officer and Chief Financial Officer, does not expect that our disclosure controls and procedures or our internal control over financial reporting will prevent or detect all error and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system’s objectives will be met. The design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Further, because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that misstatements due to error or fraud will not occur or that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns can occur because of simple error or mistake. Controls can also be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. The design of any system of controls is based in part on certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Projections of any evaluation of controls effectiveness to future periods are subject to risks. Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies or procedures.
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ITEM 9B. OTHER INFORMATION
Amendment of WFB Facility
On March 6, 2015, we entered into an amendment of the WFB Facility with Wells Fargo Bank, National Association, to establish the financial covenant requirements for minimum EBITDA and maximum capital expenditures for 2015. No other changes were made to the covenants under the WFB Facility. The foregoing description does not purport to be complete and is qualified in its entirety by reference to the Fourth Amendment to Credit and Security Agreements, which is filed with this report as Exhibit 10.14.4 and incorporated herein by reference.
Chief Operating Officer
On August 6, 2014, Robert Smith, 50, was appointed as the Chief Operating Officer of Zhone. Prior to joining Zhone, Mr. Smith had over 29 years of experience in operations, including as chief operating officer at Infinite Power Solutions. Mr. Smith was terminated from this position on January 23, 2015.
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PART III
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
The information required by this item relating to our corporate governance, directors and nominees, and compliance with Section 16(a) of the Securities Exchange Act of 1934 is included under the captions “Corporate Governance Principles and Board Matters,” “Ownership of Securities” and “Proposal 1: Election of Directors” in our definitive Proxy Statement for the 2015 Annual Meeting of Stockholders and is incorporated herein by reference.
The information required by this item relating to our executive officers is included under the caption “Executive Officers” in Part I of this Form 10-K and is incorporated by reference into this section.
We have adopted a Code of Conduct and Ethics applicable to all of our employees, directors and officers (including our principal executive officer, principal financial officer, principal accounting officer and controller). The Code of Conduct and Ethics is designed to deter wrongdoing and to promote honest and ethical conduct and compliance with applicable laws and regulations. The full text of our Code of Conduct and Ethics is published on our website at www.zhone.com. We intend to disclose future amendments to certain provisions of our Code of Conduct and Ethics, or waivers of such provisions granted to executive officers and directors, on our website within four business days following the date of such amendment or waiver.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this item is included under the captions “Executive Compensation” and “Compensation Committee Report” in our definitive Proxy Statement for the 2015 Annual Meeting of Stockholders and is incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The information required by this item relating to security ownership of certain beneficial owners and management, and securities authorized for issuance under equity compensation plans is included under the captions “Ownership of Securities” and “Executive Compensation” in our definitive Proxy Statement for the 2015 Annual Meeting of Stockholders and is incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
The information required by this item is included under the captions “Certain Relationships and Related Transactions” and “Corporate Governance Principles and Board Matters” in our definitive Proxy Statement for the 2015 Annual Meeting of Stockholders and is incorporated herein by reference.
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
The information required by this item is included under the caption “Proposal 2: Ratification of Appointment of Independent Registered Public Accounting Firm” in our definitive Proxy Statement for the 2015 Annual Meeting of Stockholders and is incorporated herein by reference.
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PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
1. | Financial Statements |
The Index to Consolidated Financial Statements on page 36 is incorporated herein by reference as the list of financial statements required as part of this report.
2. | Exhibits |
The Exhibit Index on page 63 is incorporated herein by reference as the list of exhibits required as part of this report.
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SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
ZHONE TECHNOLOGIES, INC. | ||||
Date: March 6, 2015 | By: | /S/ JAMES NORROD | ||
James Norrod | ||||
Chief Executive Officer | ||||
Know all persons by these presents, that each person whose signature appears below constitutes and appoints James Norrod and Kirk Misaka, jointly and severally, his attorneys-in-fact, each with the full power of substitution, for him in any and all capacities, to sign any amendments to this Annual Report on Form 10-K, and to file the same, with all exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, hereby ratifying and confirming all that each of said attorneys-in-fact, or his substitute or substitutes, may do or cause to be done by virtue hereof. Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
Signature | Title | Date | ||
/S/ JAMES NORROD | President, | March 6, 2015 | ||
James Norrod | Chief Executive Officer and Director (Principal Executive Officer) | |||
/S/ KIRK MISAKA | Chief Financial Officer, | March 6, 2015 | ||
Kirk Misaka | Treasurer and Secretary (Principal Financial and Accounting Officer) | |||
/S/ MORTEZA EJABAT | Executive Chairman of the Board of Directors | March 6, 2015 | ||
Morteza Ejabat | ||||
/S/ MICHAEL CONNORS | Director | March 6, 2015 | ||
Michael Connors | ||||
/S/ ROBERT DAHL | Director | March 6, 2015 | ||
Robert Dahl | ||||
/S/ NANCY PIERCE | Director | March 6, 2015 | ||
Nancy Pierce | ||||
Director | March 6, 2015 | |||
C. Richard Kramlich | ||||
/S/ JAMES TIMMINS | Director | March 6, 2015 | ||
James Timmins | ||||
/S/ MAHVASH YAZDI | Director | March 6, 2015 | ||
Mahvash Yazdi | ||||
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EXHIBIT INDEX
Exhibit Number | Exhibit Description | Incorporated by Reference | Filed Herewith | ||||||||
Form | File Number | Exhibit | Filing Date | ||||||||
3.1 | Restated Certificate of Incorporation dated February 16, 2005 | 10-K | 000-32743 | 3.10 | March 16, 2005 | ||||||
3.2 | Certificate of Amendment of Restated Certificate of Incorporation dated March 11, 2010 | 10-K | 000-32743 | 3.20 | March 16, 2010 | ||||||
3.3 | Amended and Restated Bylaws | 10-K | 000-32743 | 3.30 | March 16, 2005 | ||||||
4.1 | Form of Second Restated Rights Agreement dated November 13, 2003 | 10-Q | 000-32743 | 4.10 | May 14, 2004 | ||||||
10.1# | Zhone Technologies, Inc. 1999 Stock Option Plan | 10 | 000-50263 | 10.20 | April 30, 2003 | ||||||
10.2# | Zhone Technologies, Inc. Amended and Restated 2001 Stock Incentive Plan | 8-K | 000-32743 | 10.10 | May 17, 2007 | ||||||
10.3# | Form of Stock Option Agreement for the Zhone Technologies, Inc. Amended and Restated 2001 Stock Incentive Plan | 8-K | 000-32743 | 10.10 | September 1, 2006 | ||||||
10.4# | Zhone Technologies, Inc. Amended and Restated Special 2001 Stock Incentive Plan | 10-Q | 000-32743 | 10.28 | August 15, 2002 | ||||||
10.5# | Form of Restricted Stock Award Agreement for the Zhone Technologies, Inc. Amended and Restated 2001 Stock Incentive Plan | 8-K | 000-32743 | 10.20 | May 17, 2007 | ||||||
10.6# | Zhone Technologies, Inc. 2002 Employee Stock Purchase Plan | 8-K | 000-32743 | 10.10 | May 17, 2006 | ||||||
10.7# | Incentive Awards Program Summary | 8-K | 000-32743 | 10.20 | March 15, 2006 | ||||||
10.8# | Form of Indemnity Agreement between Zhone Technologies, Inc. and its directors and officers | 10-Q | 000-32743 | 10.20 | May 14, 2004 | ||||||
10.9# | Form of Change of Control Severance Agreement | 10-Q | 000-32743 | 10.10 | August 9, 2012 | ||||||
10.10 | Letter Agreement dated November 13, 2003 between Zhone Technologies, Inc. and New Enterprise Associates VIII, Limited Partnership | Schedule 13D | 005-61973 | 5.00 | November 24, 2003 | ||||||
10.11# | Third Amended and Restated Employment Agreement dated as of July 17, 2014 by and between Zhone Technologies, Inc. and Morteza Ejabat | 8-K | 000-32743 | 10.1 | July 17, 2014 | ||||||
10.12# | Employment Agreement dated as of July 17, 2014 by and between Zhone Technologies, Inc. and James Norrod | 8-K | 000-32743 | 10.2 | July 17, 2014 | ||||||
10.13# | Zhone Technologies, Inc. Incentive Bonus Plan | 10-Q | 000-32743 | 10.10 | November 8, 2013 | ||||||
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Exhibit Number | Exhibit Description | Incorporated by Reference | Filed Herewith | ||||||||
Form | File Number | Exhibit | Filing Date | ||||||||
10.14 | Credit and Security Agreement, dated as of March 13, 2012, by and among Zhone Technologies, Inc., ZTI Merger Subsidiary III, Inc., Premisys Communications, Inc., Zhone Technologies International, Inc., Paradyne Networks, Inc., Paradyne Corporation and Wells Fargo Bank, National Association | 10-K | 000-32743 | 10.16 | March 15, 2012 | ||||||
10.14.1 | First Amendment to Credit and Security Agreements, dated as of March 12, 2013, by and among Zhone Technologies, Inc., ZTI Merger Subsidiary III, Inc., Premisys Communications, Inc., Zhone Technologies International, Inc., Paradyne Networks, Inc., Paradyne Corporation and Wells Fargo Bank, National Association | 10-K | 000-32743 | 10.12.1 | March 15, 2013 | ||||||
10.14.2 | Second Amendment to Credit and Security Agreements, dated as of September 30, 2013, by and among Zhone Technologies, Inc., ZTI Merger Subsidiary III, Inc., Premisys Communications, Inc., Zhone Technologies International, Inc., Paradyne Networks, Inc., Paradyne Corporation and Wells Fargo Bank, National Association | 8-K | 000-32743 | 10.20 | October 1, 2013 | ||||||
10.14.3 | Third Amendment to Credit and Security Agreements, dated as of March 5, 2014, by and among Zhone Technologies, Inc., ZTI Merger Subsidiary III, Inc., Premisys Communications, Inc., Zhone Technologies International, Inc., Paradyne Networks, Inc., Paradyne Corporation and Wells Fargo Bank, National Association | 10-K | 000-32743 | 10.13.3 | March 5, 2014 | ||||||
10.14.4 | Fourth Amendment to Credit and Security Agreements, dated as of March 6, 2015, by and among Zhone Technologies, Inc., ZTI Merger Subsidiary III, Inc., Premisys Communications, Inc., Zhone Technologies International, Inc., Paradyne Networks, Inc., Paradyne Corporation and Wells Fargo Bank, National Association | X | |||||||||
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Exhibit Number | Exhibit Description | Incorporated by Reference | Filed Herewith | ||||||||
Form | File Number | Exhibit | Filing Date | ||||||||
10.15 | Credit and Security Agreement (Ex-Im Subfacility), dated as of March 13, 2012, by and among Zhone Technologies, Inc., ZTI Merger Subsidiary III, Inc., Premisys Communications, Inc., Zhone Technologies International, Inc., Paradyne Networks, Inc., Paradyne Corporation and Wells Fargo Bank, National Association | 10-K | 000-32743 | 10.17 | March 15, 2012 | ||||||
10.16 | Multi-Tenant Commercial/Industrial Lease Agreement between Zhone Technologies, Inc. and LBA Realty, LLC | 8-K | 000-32743 | 10.2 | September 22, 2010 | ||||||
21.2 | List of Subsidiaries | 10-K | 000-32743 | 10.22 | March 15, 2011 | ||||||
23.1 | Consent of Independent Registered Public Accounting Firm | X | |||||||||
24.1 | Power of Attorney (see signature page) | X | |||||||||
31.1 | Certification of Chief Executive Officer Pursuant to Rule 13a-14(a)/15d-14(a) | X | |||||||||
31.2 | Certification of Chief Financial Officer Pursuant to Rule 13a-14(a)/15d-14(a) | X | |||||||||
32.1 | Section 1350 Certification of Chief Executive Officer and Chief Financial Officer | X | |||||||||
101.INS | XBRL Instance Document | X | |||||||||
101.SCH | XBRL Taxonomy Extension Schema | X | |||||||||
101.CAL | XBRL Taxonomy Extension Calculation Linkbase | X | |||||||||
101.DEF | XBRL Taxonomy Extension Definition Linkbase | X | |||||||||
101.LAB | XBRL Taxonomy Extension Labels Linkbase | X | |||||||||
101.PRE | XBRL Taxonomy Extension Presentation Linkbase | X | |||||||||
# | Management contract or compensatory plan or arrangement in which one or more executive officers or directors participates. |
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