ZyXEL Communications Corp. and Subsidiaries Consolidated Financial Statements December 31, 2015 and 2014 (With Independent Auditors Report Thereon)

Transcription

1 ZyXEL Communications Corp. and Subsidiaries Consolidated Financial Statements December 31, 2015 and 2014 (With Independent Auditors Report Thereon)

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3 Consolidated Balance Sheets December 31, 2015 and 2014 (In thousands of New Taiwan dollars) December 31 Assets Amount % Amount % Current assets: Cash and cash equivalents (note 4) $ 2,478, ,428, Financial assets measured at fair value through profit or loss current (notes 5 and 16) 5,260-24,717 - Notes and accounts receivable, net (note 6) 2,912, ,556, Accounts receivable related parties (note 17) 4, Other receivables related parties (note 17) 251, ,798 3 Other financial assets current 20,395-41,622 - Inventories (note 7) 1,848, ,080, Other current assets (note 17) 224, ,337 1 Deferred income tax assets current (note 14) 118, , ,863, ,667, Investments: Available-for-sale financial assets non-current (note 5) 124, ,164 3 Financial assets carried at cost non-current (note 5) 30,373-90,252 1 Investments accounted for using equity method (note 8) 33,105-24, , ,776 4 Property, plant and equipment (note 18): Cost: Land 37,434-36,094 - Buildings and improvements 407, ,663 4 Machinery and equipment 3,896-82,373 1 Research and development equipment 46, ,469 1 Office and other equipment 224, , , ,824 8 Less: accumulated depreciation (282,098) (3) (386,540) (4) Prepayment for equipment 14,883-6, , ,524 4 Intangible Assets (note 9) 83, ,822 1 Other assets: Refundable deposits 28,368-40,994 - Deferred expenses 28,061-22,301 - Restricted deposits (note 18) 57, ,737 2 Prepaid pension cost (note 11) 90, , , ,894 3 Total assets $ 8,791, ,661, December 31 Liabilities and Stockholders Equity Amount % Amount % Current liabilities: Short-term borrowings (note 10) $ 205, ,102 2 Financial liabilities measured at fair value through profit or loss current (note 16) 2, Notes and accounts payable 788, , Accounts payable related parties (note 17) 1,120, ,080, Other payable related parties (note 17) 19,092-22,224 - Unearned sales revenue 70, ,946 1 Reserve for after-sales service 135, ,165 1 Accrued expenses and other current liabilities 863, , ,204, ,344, Other liabilities: Deposits received 800-3,086 - Deferred income tax liabilities non-current (note 14) 9,515-3,563-10,315-6,649 - Total liabilities 3,214, ,351, Equity attributable to parent company stockholders (note 12) Common stock 1,449, ,809, Capital surplus: Additional paid-in capital in excess of par value 1,173, ,173, Employee stock options 8,929-8,929-1,182, ,182, Retained earnings: Legal reserve 1,515, ,515, Unappropriated earnings 1,500, ,745, ,015, ,261, Other adjustments to stockholders equity: Cumulative translation adjustment (110,716) (1) (50,270) (1) Unrealized gains on financial instruments 4,043-46,303 1 (106,673) (1) (3,967) - Parent company stockholders equity 5,540, ,249, Minority interest 36,777-60,536 1 Total stockholders equity 5,576, ,309, Commitments and contingencies (notes 17 and 19) Total liabilities and stockholders equity $ 8,791, ,661, See accompanying notes to consolidated financial statements.

4 Consolidated Statements of Operations Years ended December 31, 2015 and 2014 (In thousands of New Taiwan dollars, except for earnings per common share) Amount % Amount % Sales (note 17) $ 13,622, ,502, Less: sales returns and allowances 664, , ,957, ,828, Cost of goods sold (notes 7 and 17) 9,889, ,610, Gross profit 3,068, ,217, Operating expenses (note 17): Selling 1,621, ,807, General and administrative 659, ,258 4 Research and development 699, , ,980, ,995, Operating income 87, ,313 2 Non-operating income and gains: Interest income (note 17) 15,343-14,180 - Dividend income 1,455-2,817 - Gain on disposal of property, plant and equipment Gain on disposal of investment, net (note 5) 1, Rent income 5,139-6,737 - Gain on valuation of financial assets (notes 5 and 16) 6,783-29,802 - Grant revenues - - 5,236 - Other income (note 5) 41,016-36,432-71,039-95,207 - Non-operating expenses and loss: Interest expense 9,032-6,747 - Loss on disposal of property, plant and equipment Investment loss recognized by equity method (note 8) 5, Loss on disposal of investment, net - - 6,153 - Foreign exchange loss, net 205, ,533 1 Loss on valuation of financial liabilities (notes 5 and 16) 2, Loss on impairment of financial assets (note 5) 31,604-3,053 - Other loss 13,516-17, , ,287 1 Income (loss) before income taxes (108,516) (1) 97,233 1 Income tax expenses (note 14) 157, ,070 1 Consolidated net loss $ (266,462) (2) (6,837) - Attributable to: Shareholders of the parent $ (245,501) (2) (10,715) - Minority interest (20,961) - 3,878 - $ (266,462) (2) (6,837) - Before After Before After Earnings per common share (EPS) (in New Taiwan dollars) (note 15) taxes taxes taxes taxes Basic EPS $ (1.27) (1.56) 0.08 (0.06) See accompanying notes to consolidated financial statements.

5 Consolidated Statements of Changes in Stockholders Equity Years ended December 31, 2015 and 2014 (In thousands of New Taiwan dollars) Common stock Capital surplus Retained Earnings Unrealized Unappropriated Cumulative Net loss not gain and loss Legal translation recognized as on financial reserve earnings adjustment pension costs instruments Minority interest Total stockholders equity Balance at January 1, 2014 $ 1,809,669 1,181,634 1,494,092 1,922,743 (28,689) (2,338) 54,755 53,884 6,485,750 Appropriations and distribution of retained earnings: Legal reserve ,338 (21,338) Cash dividends (144,774) (144,774) Unrealized loss on available-for sale financial assets from subsidiaries (8,452) - (8,452) Net change in unrecognized pension costs from subsidiaries , ,338 Cost of stock options awarded by parent company to employees of subsidiaries Foreign currency translation adjustments (21,581) - - 2,774 (18,807) Net loss for (10,715) ,878 (6,837) Balance at December 31, ,809,669 1,182,022 1,515,430 1,745,916 (50,270) - 46,303 60,536 6,309,606 Cash refund from capital reduction (360,669) (360,669) Unrealized loss on available-for sale financial assets from subsidiaries (42,260) - (42,260) Foreign currency translation adjustments (60,446) - - (2,798) (63,244) Net loss for (245,501) (20,961) (266,462) Balance at December 31, 2015 $ 1,449,000 1,182,022 1,515,430 1,500,415 (110,716) - 4,043 36,777 5,576,971 See accompanying notes to consolidated financial statements.

6 Consolidated Statements of Cash Flows Years ended December 31, 2015 and 2014 (in thousands of New Taiwan dollars) Cash flows from operating activities: Consolidated net loss $ (266,462) (6,837) Adjustments: Depreciation 57,072 57,778 Amortization 27,353 27,425 Provision of allowance for doubtful accounts 9, ,809 Compensation cost arising from the parent company s stock transferred to employees Provision for inventory obsolescence 102,851 72,295 Loss (gain) on disposal of property, plant and equipment (79) 80 Investment loss recognized by equity method 5, Loss (gain) on valuation of financial assets and liabilities measured at 6,295 (34,250) fair value Loss on impairment of financial assets 31,604 3,053 Gain on disposal of investment (1,100) - Contribution of the assets and liabilities to subsidiaries 98,596 - Net changes in operating assets and liabilities: Financial assets measured at fair value through profit or loss current 14,711 (4,451) Notes and accounts receivable 635,060 (1,150,596) Accounts receivable related parties (4,649) - Other receivables related parties 24,774 17,168 Inventories 79,251 (930,471) Other financial assets 21,218 (20,260) Other current assets (93,813) 79,780 Deferred income tax assets 27,381 22,371 Notes and accounts payable (including related parties) (169,841) 860,394 Other payables related parties (956) 22,224 Unearned sales revenue, accrued expenses and other current liabilities 36, ,829 Prepaid pension cost 786 (1,298) Cash provided by (used in) operating activities 641,171 (634,929) Cash flows from investing activities: Disposal of available-for-sale financial assets - 40,821 Acquisition of financial assets carried at cost (3,108) (15,145) Return of capital from financial assets carried at cost 29,522 5,478 Acquisition of long-term investment at equity (11,000) (25,000) Net cash outflow to losing control over subsidiaries (37,705) - Acquisition of property, plant and equipment (92,885) (65,584) Disposal of property, plant and equipment 1, Decrease (increase) in refundable deposits 11,531 (7,644) Acquisition of deferred expenses (14,010) (6,062) Decrease (increase) in restricted deposits (17,501) 289,509 Acquisition of intangible assets (50,888) - Cash provided by (used in) investing activities (184,550) 216,389 See accompanying notes to consolidated financial statements.

7 Consolidated Statements of Cash Flows Years ended December 31, 2015 and 2014 (in thousands of New Taiwan dollars) Cash flows from financing activities: Increase in short-term borrowings 31, ,160 Increase (decrease) in deposits received (2,286) 35 Cash refund from capital reduction (360,669) - Cash dividends - (144,774) Cash used in financing activities (331,814) (579) Effect of exchange rate changes on cash (74,905) (18,339) Net increase (decrease) in cash and cash equivalents 49,902 (437,458) Cash and cash equivalents at beginning of year 2,428,198 2,865,656 Cash and cash equivalents at end of year $ 2,478,100 2,428,198 Supplemental disclosures of cash flow information: Cash payments of interest $ 9,032 6,747 Cash payments of income taxes $ 113,856 59,592 Cash from disposal of available-for-sale financial assets: Decrease in accounts receivable on disposal of available-for-sale financial $ - 40,821 assets Cash received $ - 40,821 Changes in disclosure of cash flows due to the changes in consolidated structures, the details of assets and liabilities are as follows: Inventories $ 53,650 - Property, plant and equipment 15,245 - Other current assets 32,546 - Liabilities (40,550) - Net carrying amount of non-cash assets 60,891 - Contribution expense (98,596) - Net cash outflow from contribution of subsidiaries $ (37,705) - See accompanying notes to consolidated financial statements.

8 December 31, 2015 and 2014 (Amounts expressed in thousands of New Taiwan dollars, Except for per share information and unless otherwise noted) 1. Organization and Principal Activities ZyXEL Communications Corp. ( ZyXEL ) was incorporated on August 16, 1989 at the Hsinchu Science-based Industrial Park. The shares of ZyXEL have been traded on the Taiwan Stock Exchange (TSE) since August 12, ZyXEL s main activities include the research, development, production and sale of high-speed multi-mode modems and application-specific chipsets (ASICs), secure telephones, network modems, digital video coders and decoders, wide area networks (WANs), local area networks (LANs), and integrated service digital network (ISDN) equipment. In addition, it provides related consulting and design services and imports and exports related products. In order to increase operating efficiency, implement the policies on holding companies and separation of functions, and enhance market competitiveness, the board of directors of ZyXEL resolved on March 23, 2010, to form a new holding company Unizyx Holding Co., Ltd. (Unizyx). The resolution was approved by the shareholders meeting on June 17, Unizyx began operations on August 16, As Unizyx was set up to hold ZyXEL's group of communications businesses, ZyXEL became a 100%-held subsidiary of Unizyx through a share swap. In compliance with the Business Mergers and Acquisitions Act, ZyXEL exchanged one share of its common stock for each share of Unizyx for the shareholders of ZyXEL. Unizyx became the surviving listed company on the TSE, replacing ZyXEL. The effective date for the stock swap was August 16, 2010, and it was registered with the Securities and Futures Bureau (SFB) and TSE on July 21, The stock of ZyXEL stopped being publicly traded on September 2, 2010, as approved by the SFB. As approved by the board of directors meeting on October 15, 2010, MitraStar Technology Corporation (MitraStar), an OEM/ODM Business Unit of ZyXEL, was spun off from ZyXEL and became a 100%-held subsidiary of Unizyx on January 1, ZyXEL and MitraStar will focus and optimize their operations in different areas of the communication product value chain, with one focusing on ZyXEL brand communication product marketing and sales, and the other concentrating on communication technology development and product manufacturing. The focused and optimized operation of each subsidiary is expected to increase the overall efficiency of the ZyXEL group. 2. Summary of Significant Accounting Policies The accompanying consolidated financial statements are prepared in accordance with the Business Entity Accounting Act, the Regulation on Business Entity Accounting Handing, and the Financial Accounting Standards and Interpretations announced by Accounting Research and Development Foundation. The major accounting policies and measurement bases adopted in preparing the accompanying consolidated financial statements are summarized as follows:

9 2 (1) Spin-off Unizyx spun off a product segment to form MitraStar, and owned all shares of MitraStar. The cost of investment in MitraStar is recognized as the net assets (less any asset impairment) minus liabilities of MitraStar. No exchange gain or loss is recognized. (2) Overview of consolidated entities (a) The consolidated subsidiaries of ZyXEL are summarized below: Percentage of the ownership at December 31, Investor Investee Nature of Business ZyXEL ZyChamp Investment Co., Ltd. Investment 100% 100% (ZyChamp) ZyXEL ZyXEL Communications Inc. Machining, assembly, 100% 100% development and sales of network products ZyXEL ZyXEL Communications A/S Sales and Marketing 100% 100% (ZyXEL Denmark) ZyXEL ZyXEL Singapore Private Sales and Marketing 100% 100% Limited ZyXEL ZyFLEX Communications Inc. Manufactures, - 100% development and sales of communication and network products ZyXEL Victor Blue Ltd. (Victor) Investment 100% 100% ZyXEL ZyTPE Communications Manufactures, 100% 100% Corporation development and sales of communication and network products ZyXEL ZyXEL Korea Co., Ltd. Sales and Marketing 65% 65% ZyXEL Sphairon GmbH (a ZyXEL company) Development of communication and network products 100% 100% ZyXEL ZyXEL ZyXEL Iletisim Teknolojileri A.S. ZyXEL Communications Do Brasil Ltda. Sales and Marketing 100% 100% Sales and Marketing 100% -

10 3 Percentage of the ownership at December 31, Investor Investee Nature of Business Victor Tianjin Huagin Communications Equipment Co., Ltd. Manufactures and sales of communication and network products 95% 95% Victor ZyXEL Malaysia SDN BHD Sales and Marketing 100% 100% Victor ZyXEL Thailand Co., Ltd. Sales and Marketing 51% 51% Victor ZyXEL Communications (Shanghai) Corp. Sales of communication and network products 100% 100% Victor ZyXEL Technology India Pvt Sales and Marketing 100% 100% Ltd. Victor ZyXEL Middle East FZE Sales and Marketing 100% 100% ZyXEL Denmark ZyXEL Deutschland GmbH Sales and Marketing 100% 100% ZyXEL Denmark ZyXEL Communcations UK Ltd. Sales and Marketing 100% 100% ZyXEL Denmark ZyXEL Denmark ZyXEL Denmark ZyXEL Denmark ZyXEL Communications Czech s.r.o. Sales and Marketing 100% 100% ZyXEL Communications B.V. Sales and Marketing 100% 100% ZyXEL Communications Iberia S.L ZyXEL Communications Italy S.r.l Sales and Marketing 100% 100% Sales and Marketing 100% - Employees of ZyXEL and the subsidiaries stated above as of December 31, 2015 and 2014 numbered 1,309 and 1,151, respectively. (b) Change in subsidiaries included in the consolidated financial statements: For the purpose of expanding the European market, ZyXEL acquired Iberia branch, which belong to ZyXEL Denmark and became its 100% owned subsidiary, ZyXEL Communications Iberia S.L, in January 2014 and it was included in the consolidated financial statements since its inception.

11 4 Due to the adjustment of its group investment structure, ZyXEL acquired 100% share of ZyXEL Iletisim Teknolojileri A.S. from its subsidiary Victor, by book value in November This adjustment did not affect the preparation of the consolidated financial statements. ZyXEL Costa Rica, S.A. and ZyXEL Pakistan (Pvt.) Ltd. had completed the liquidation in April and December of The Company has discontinued recognizing these companies share on its consolidated financial statements on the date these companies completed the liquidation. For the purpose of expanding the South American market, ZyXEL set up a new 100% owned sub-subsidiary, ZyXEL Communications Do Brasil Ltda., in January It was included in its consolidated financial statements since the investment date. For the purpose of expanding the European market, ZyXEL set up a new 100% indirectly owned subsidiary, ZyXEL Communications Italy s.r.l, in May It was included in its consolidated financial statements since its inception. For the purpose of operations for the long-term support of ZyXEL Foundation, ZyXEL contributes 100% shares of ZyFLEX Technology Inc. to ZyXEL Foundation in November ZyXEL discontinued recognizing the shares of ZyFLEX Technology Inc. in its consolidated financial statement on the date of contribution. (3) Basis of consolidation The consolidated financial statements include the accounts of ZyXEL and its subsidiaries in which ZyXEL directly or indirectly owns over 50% of the voting shares and is able to exercise control over the subsidiaries operations and financial policies. ZyXEL and such subsidiaries are referred to individually or collectively as the Company. All significant inter-company transactions and balances are eliminated in consolidation. (4) Use of estimates The preparation of the accompanying consolidated financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, and disclosures of contingent liabilities. Actual results could differ from these estimates. (5) Foreign currency transactions and translation Non-derivative foreign currency transactions are recorded at the exchange rates prevailing on the transaction date. At the balance sheet date, monetary assets and liabilities denominated in foreign currencies are translated using the exchange rates on that date. The resulting exchange gains or losses from settlement of such transactions or translation of foreign-currencydenominated monetary assets or liabilities are reflected as non-operating gains or losses in the accompanying consolidated statements of operations.

12 5 Non-monetary assets and liabilities that are measured in terms of historical cost in a foreign currency are translated using the exchange rates at the date of the transaction. Non-monetary assets and liabilities denominated in foreign currencies that are stated at fair value are translated into New Taiwan dollars (TWD) at the rates ruling at the balance sheet date. If the nonmonetary assets or liabilities are measured at fair value through profit or loss, the resulting unrealized exchange gains or losses from such translations are recorded in current profit or loss. If the non-monetary assets or liabilities are measured at fair value through stockholders equity, then the resulting unrealized exchange gains or losses from such translations are recorded as a separate component of stockholders equity. Entities included in the consolidated financial statements record transactions in their respective local currencies which are their functional currencies. Remeasurement of the foreign financial statements into the functional currency is performed first, and the remeasuring differences are accounted for as exchange gains or losses in the statements of operations. The financial statements of foreign subsidiaries are translated into New Taiwan dollars at the exchange rates prevailing on the balance sheet date, with the exception of stockholders equity, which is translated at historical cost rates, and revenue, costs, and expenses, which are translated at the weighted-average exchange rates during the reporting period. Translation adjustments resulting from the translation of foreign currency financial statements into the Company s reporting currency are accounted for as translation adjustment, a separate component of stockholders equity. (6) Principles of classifying assets and liabilities as current and noncurrent Cash, assets held for the purpose of trading, and assets that will be held for a short time period and are expected to be converted to cash within 12 months from the balance sheet date are presented as current assets; all other assets are presented as noncurrent assets. Liabilities that are incurred for the purpose of trading or are expected to be liquidated within 12 months after the balance sheet date are reflected as current liabilities; all other liabilities are reflected as noncurrent liabilities. (7) Asset impairment The Company assesses at each balance sheet date whether there is any indication that an asset (excluded goodwill, including individual asset or cash-generating unit) may have been impaired. If any such indication exists, the Company estimates the recoverable amount of the asset. The Company recognizes impairment loss for an asset whose carrying value is higher than the recoverable amount. The Company reverses an impairment loss recognized in prior periods for assets other than goodwill if there is any indication that the impairment loss recognized no longer exists or has decreased. The carrying value after the reversal should not exceed the recoverable amount or the depreciated or amortized balance of the assets assuming no impairment loss was recognized in prior periods.

13 6 (8) Financial assets and liabilities (a) Financial assets and liabilities measured at fair value: Financial assets and liabilities measured at fair value are held with the intention of buying and selling them in a short period of time. Except for those that the Company holds for hedging purposes and are considered to be effective hedging instruments, financial derivatives are classified into this account. (b) Financial assets carried at cost: Financial instruments whose fair values could not be measured with reasonable certainty are measured at their initial cost. However, if there is any objective evidence of impairment, a loss should be recognized thereon. Thereafter, the loss could not be reversed. (c) Available-for-sale financial assets: These are measured at fair value, and any changes, excluding impairment loss and unrealized foreign currency exchange gain or loss, are reported as a separate component of stockholders equity before gain or loss on financial instruments is realized. Realized gain or loss on financial instruments is charged to current operations. If there is objective evidence of impairment, an impairment loss is recognized in profit or loss. If, in a subsequent period, events or changes in circumstances indicate that the amount of impairment loss has decreased, the previously recognized impairment loss for equity securities is reversed to the extent of the decrease and recorded as an adjustment to equity, while for debt securities, the reversal is allowed through profit or loss provided that the decrease is clearly attributable to an event which occurs after the impairment loss is recognized. (d) Notes, accounts receivable and other receivables: Notes and accounts receivable are the creditor rights from selling goods or rendering services. Other receivables are created from non-operating activities. Concerning financial assets, the Company first assesses whether objective evidence of impairment exists individually for financial assets that are individually significant, and individually or collectively for financial assets that are not individually significant. Assets that are individually assessed for impairment and for which an impairment loss is or continues to be recognized are not included in a collective assessment of impairment. Impairment loss is recognized and measured as the difference between the asset s carrying amount and the present value of estimated future cash flows discounted at the financial asset s original effective interest rate. The carrying amount of the asset is reduced through the use of an allowance account. The impairment loss is recognized in profit or loss. The present value of estimated future cash flows includes the recoverable amount of collateral and insurance.

14 7 (9) Inventories If, in a subsequent period, the impairment loss decreases and the decrease can be related objectively to an event occurring after the impairment was recognized, the reversal shall not result in a carrying amount of the financial asset that exceeds what the amortized cost would have been had the impairment not been recognized at the date the impairment is reversed. The amount of the reversal shall be recognized in profit or loss. The cost of inventories shall comprise all costs of purchase, costs of conversion, and other costs incurred in bringing the inventories to their present location and condition. The allocation of fixed production overheads to the finished goods and work in progress is based on the normal capacity of the production facilities. Variable production overheads are allocated to each unit of production on the basis of the actual use of the production facilities. Inventories are measured at the lower of cost or net realizable value on an individual item basis. The cost of inventories is based on the weighted-average-cost principle. Net realizable value is the estimated selling price in the ordinary course of business, less the estimated costs of completion and selling expenses at the balance sheet date. (10) Investments accounted for using equity method Long-term investments in which the Company owns more than 20% of the investee companies voting shares or owns less than 20% but has a significant influence on the investee companies are accounted for by using the equity method. (11) Property, plant and equipment Property, plant and equipment are stated at cost. Interest expenses which are incurred for the construction of equipment before its usable condition are capitalized and added to the cost. Costs associated with significant additions, improvements, and replacements to property, plant and equipment are capitalized. Repairs and maintenance are charged to expenses as incurred. In addition, gains or losses on the disposal of property, plant and equipment are accounted for as non-operating income or losses in the consolidated statement of operations. Depreciation of property, plant and equipment of the Company is provided for by using the straight-line method over the estimated useful lives of the respective assets. At the end of each fiscal year, any changes in the remaining useful life, depreciation method, or salvage value are regarded as changes in accounting estimates. The useful lives of the main property, plant and equipment are as follows: (a) Buildings: 30~40 years. (b) Building improvements: 5~10 years. (c) Machinery, and research and development equipment: 3~7 years. (d) Office equipment and others: 3~10 years.

15 8 (12) Intangible assets Expenditure on research is recognized as an expense when it is incurred, except for the recognition of goodwill or intangible assets in a business combination. An intangible asset arising from technology development is recognized if, and only if, the Company can demonstrate all of the following: (a) The technical feasibility of completing the intangible asset so that it will be available for use or sale. (b) Its intention to complete the intangible asset and use or sell it. (c) Its ability to use or sell the intangible asset. (d) How the intangible asset will generate probable future economic benefits. Among other things, the Company can demonstrate the existence of a market for the output of the intangible asset or the intangible asset itself or, if it is to be used internally, the usefulness of the intangible asset. (e) The availability of adequate technical, financial and other resources to complete the development and to use or sell the intangible asset. (f) Its ability to measure reliably the expenditure attributable to the intangible asset during its development. The amount of intangible assets not generated from internal is originally measured by cost. Continued after, it is measured at cost less accumulated amortization and accumulated impairment losses. The amortized amount is measured at cost less residual value. Amortization is recognized as an expense on a straight-line basis over the estimated useful lives (5 years) of intangible assets of the Company from the date that they are made available for use. The Company has to revaluate residual value, and the amortization method and period at the end of each fiscal year, at least. Any changes in residual value, amortization method, or amortization period are regarded as changes in accounting estimates. (13) Deferred expenses The costs of computer software are presented under deferred expenses, and are amortized over periods ranging from five to ten years on a straight-line basis.

16 9 (14) Retirement plan ZyXEL and its ROC subsidiaries established an employee non-contributory defined benefit retirement plan ( the Plan ) covering all regular employees under the ROC Labor Standards Law. In accordance with the Plan, ZyXEL and its ROC subsidiaries employees are eligible for retirement or are required to retire after meeting certain age or service requirements. Payments of retirement benefits are based on the years of service and the average salary for the six-month period before the employee s retirement. Each employee earns two months of salary for the first fifteen years of service, and one month of salary for each year of service thereafter. The maximum retirement benefit is 45 months of salary. In accordance with the requirements of the ROC Labor Standards Law, ZyXEL and its ROC subsidiaries have contributed monthly at the rate of 2% of salaries and wages to a pension fund. However, ZyXEL suspended its contribution of pension fund which has been approved by the Department of Labor, Taipei City Government since September 2015 to August For the Plan, ZyXEL and its ROC subsidiaries carry out an actuarial calculation of their pension obligation at year-end. Based on the actuarial calculation, ZyXEL and its ROC subsidiaries recognize a minimum pension liability and net periodic pension costs covering the service lives of the retirement plan participants, including current service cost, net obligation at transition, prior service cost, and pension gains or losses amortized on a straight-line basis. Beginning July 2005, pursuant to the ROC Labor Pension Act (hereinafter referred to as the New Act ), employees who elected to participate in the New Act or joined ZyXEL and its ROC subsidiaries after July 1, 2005, are covered by a defined contribution plan under the New Act. For these employees, ZyXEL and its ROC subsidiaries are required to make a monthly contribution at a rate no less than 6% of the employee s monthly wages to the employee s individual pension fund account at the ROC Bureau of Labor Insurance. Under the New Act, ZyXEL and its ROC subsidiaries contribute 6% of each employee s monthly wages to the Bureau of Labor Insurance. Pension cost is recognized in the period when the contribution is made. For employees hired by foreign subsidiaries which adopt defined contribution plans, pension costs are recognized in the period when the actual contributions are made. (15) Employee bonuses or payroll and remuneration of directors and supervisors Effective January 1, 2008, and in accordance with Interpretation No.(96) 052, issued by the Accounting Research and Development Foundation ( ARDF ), the Company estimates employee bonuses or payroll and remuneration of directors and supervisors and charges them to current operations, classified under cost of goods sold and operating expense, as appropriate. The difference, if any, between the amount approved by stockholders in the subsequent year and the amount estimated in the current-year financial statements is accounted for as a change in accounting estimate, and charged to profit or loss in the subsequent year.

17 10 (16) Share-based payment The capital increased by cash arising from the exercise of employee stock subscription rights commencing from January 1, 2008, is accounted for in accordance with ARDF Interpretation No. (96) 267. According to this Interpretation, compensation cost is calculated based on the option-pricing model on the grant date and is amortized over the vesting period. If the stock cannot be fairly evaluated before its public offering, the intrinsic value is used to recognize the compensation cost. The grant date is either the ex-rights date or the date of approval by the board of directors if approval from the board of directors is required. According to ROC SFAS No. 39 and ARDF Interpretation No. (96) 267, for the share-based payment granted by a parent company to its subsidiary after January 1, 2008, the compensation cost should be evaluated by the fair value of the share-based instrument and amortized throughout the vesting period as salary expense. (17) Treasury stock ZyXEL adopted ROC SFAS No. 30 Accounting for Treasury Stock for the repurchase of outstanding stock, and recognizes it as treasury stock at cost. If the disposal price is more than the book value of treasury stock, the difference between them will be presented under capital surplus treasury stock transactions. The difference will be offset with capital surplus resulting from transactions of the same sort of treasury stock if the book value is more than the disposal price. The difference will be charged to retained earnings if capital surplus is insufficient. Upon retirement of treasury stock, the capital stock and capital surplus additional paid-in capital are debited on a pro rata basis. If the book value exceeds the sum of the par value of capital stock and the premium on stock issuance, the difference is charged against capital surplus arising from the same class of treasury stock transactions, and the remainder, if any, is charged against retained earnings. If the book value is less than the sum of the par value of capital stock and the premium on stock issuance, the difference is credited to capital surplus arising from the same class of treasury stock transactions. Since January 1, 2008, when treasury stock is transferred to employees as bonus, the Company measures compensation cost at the date of grant using an option pricing model and amortizes the compensation cost over the requisite service period. The grant date is the date when employees accept the grant of stock. If approval from the board of directors is required, the grant date is the date of approval by the board of directors. (18) Revenue recognition Sales revenue is recognized when title to the products and the risks and rewards of ownership are transferred to the customers, which occurs principally at the time of shipment. Shipments of materials for outsourced processing services are not recognized as sales until the processed products are delivered to customers.

18 11 (19) Income taxes Income taxes are accounted for under the asset and liability method. Deferred income taxes are determined based on differences between the financial statements and tax basis of assets and liabilities using the enacted tax rates in effect during the years in which the differences are expected to reverse. The income tax effects resulting from taxable temporary differences are recognized as deferred income tax liabilities. The income tax effects resulting from deductible temporary differences, loss carryforward, and tax credits are recognized as deferred income tax assets. The realization of the deferred income tax assets is evaluated, and if it is considered more likely than not that the deferred income tax assets will not be realized, a valuation allowance is recognized accordingly. When a change in the income tax rate is enacted, any deferred tax liability or asset should be recomputed accordingly in the period of change. The difference between the new amount and the original amount, that is, the effect of changes in the deferred tax liability or assets, should be reported as an adjustment to income tax expense (benefit) for income from continuing operations. Classification of the deferred income tax assets or liabilities as current or noncurrent is based on the classification of the related assets or liabilities. If the deferred income tax asset or liability is not directly related to a specific asset or liability, the classification is based on the expected realization period. The Company s expenditures for research and development and for training entitle the Company to tax credits that are recognized by using the flow-through method. In accordance with the Article 40 of Business Mergers and Acquisitions Act, ZyXEL has adopted its parent company, Unizyx, as the taxpayer to file a combined corporate income tax return and the 10% surtax on undistributed earnings from Unizyx and subsidiaries firstly calculated their respective income tax provision according to SFAS No. 22 Income Taxes and reconciled the difference between the separate income tax returns and the combined final business income return. The differences were allocated to all combined entities on a reasonable, systematic and consistent basis and consequently to current year s income tax expense and deferred income tax expenses. According to the ROC Income Tax Act, ZyXEL s and its ROC subsidiaries earnings are subject to an additional 10% corporate income surtax if not distributed. This surtax is charged to income tax expense in the following year when the shareholders decide not to distribute the earnings.

19 12 (20) Earnings per common share Earnings per common share are computed based on the weighted-average number of common shares outstanding during the year. Earnings per common share for the prior year are retroactively adjusted to reflect the effects of new shares issued by transferring capital surplus and retained earnings. ZyXEL s employee bonuses, to be settled through the issuance of stock upon the approval of the stockholders, are regarded as potential common stock. Because ZyXEL has a complex capital structure, both basic and diluted earnings per share are disclosed. For diluted earnings per common share, net income, and the weighted-average number of common shares outstanding during the year are adjusted to include the dilutive effects of the potential common shares, assuming that they are outstanding during the entire year. 3. Reasons for and Effect of Changes in Accounting Principles: None 4. Cash and Cash Equivalents December 31, Petty cash, checking accounts and demand deposits $ 1,113,712 1,880,111 Time deposits 1,229, ,087 Cash equivalents repurchase agreement 135,000 - $ 2,478,100 2,428,198 The interest rate on the repurchase agreement is 0.38% on December 31, 2015, and the bonds matured on January 4, Financial Assets (1) Financial assets measured at fair value through profit or loss current: December 31, Financial assets held for trading: Beneficiary certificates open-end fund $ 4,311 19,022 The gain (loss) on valuation at fair value of financial assets held for trading was $(722) and $79 for the years ended December 31, 2015 and 2014, respectively.

20 13 (2) Available-for-sale financial assets non-current: December 31, Unizyx $ 124, ,164 ZyChamp held 4,630 thousand shares of ZyXEL amounting to $120,861 before the revision of Company Law on November 12, On the share swap date (refers to note 1 for stock swap information), ZyChamp held 9,391 thousand shares of ZyXEL amounting to $120,861. The increase of shares is all due to new shares issued by transferring retained earnings. On the share swap date, ZyChamp held shares of Unizyx, accounted for as available-for-sale financial assets non-current at the market value. Unizyx stock held by ZyChamp equaled to $124,904 and $167,164 at fair value as of December 31, 2015 and 2014, respectively. (3) Financial assets carried at cost non-current: Investee December 31, Percentage Percentage of of Amount ownership Amount ownership Global Channel Resource Pte. Ltd. $ 15, , Homeyen Networks Inc. 11, , Handlink Technology, Inc. 2, ,035 4 Essence Technology, Inc ZOWIE Technology Corporation Hong Pang Venture Capital Corp , Chien Pang Venture Capital Corp , L7 Networks Inc AccFast Technologies Corp Aetas Technology Inc $ 30,373 90,252 The above investments did not have quoted prices in an active market, and their fair value could not be reliably measured. Thus, they were classified under financial assets carried at cost. In April 2015, the Company increased its capital of $3,108 in Global Channel Resource Pte. Ltd. which made its ownership of shares raised from 19% to 20%; therefore, Global Channel Resource Pte. Ltd. had been categorized as an investment under equity method since April However, since Global Channel Resource Pte. Ltd. increased its capital in July 2015, the Company s ownership of shares decreased from 20% to 17%; thereafter, the Company recognized it as a financial asset in cost measurement beginning August, Meanwhile, the Company recognized the investment loss of $2,960 as an investment accounted for using the equity method.

21 14 The Company recognized an impairment loss on the ownership of Handlink Technologies, Inc. because this investee decreased its capital in fourth quarter of 2014 amounting to $3,053. Chien Pang Venture Corp. and Hong Pang Venture Corp. reduced their capital and commenced liquidation in March and July 2015, respectively. The Company recognized an impairment loss of $30,833 at book value, which was based on the predicted-post capital reduction. The date of both dissolution was on Oct. 1, The difference between actual and the predicted amount of the impairment was recognized as a gain on the disposal of $1,100. The Company received a $29,522 and $5,478 refund due to the capital reduction of Hong Pang Venture Capital Corp. and Chien Pang Venture Capital Corp. in 2015 and 2014, respectively. The Company recognized an impairment loss on the ownership of Zowie Technology Corp. because this investee decreased its capital in third quarter of 2015 amounting to $623. In June 2015, the Company recognized an impairment loss of $148 due to the decrease in capital of its investee, L7 Networks Inc. The said investee has made a decision to close its operation in the future. The special shareholders meeting of Broad Web Corporation approved the merger on October 29, 2013, Broad Web Corporation was merged with Trend Micro Co., Ltd., and Trend Micro Co., Ltd. is the surviving company. And set November 30, 2013, as the acquisition date, the acquisition price was $34.2 TWD per share. According to the merger contract, Trend Micro Co., Ltd. offered $27.36 TWD per share (80% total of the acquisition price) to the shareholders of Broad Web Corporation. Therefore, the Company received $34,785 and recognized a gain on disposal of investment of $17,078. The rest value of the acquisition price was 6.84 TWD per share (20% of the acquisition price), which was deposited as a guarantee of Broad Web s compliance with the assurances and obligations in the merger contract. If Broad Web Corporation breaches the contract within two years (starting from the acquisition date,) Trend Micro Co., Ltd. can offset the loss from the deposit. Trend Micro Co., Ltd. will pay 10% (less the loss from the contract plus interest) to the shareholders of Broad Web Corporation at the end of the first and second year after the acquisition date. The contingent fee of $8,698 depends on the performance of Broad Web Corporation. Therefore, The Company will not recognize this part of gain on disposal investment under the material uncertainty until the Company receives this amount. Broad Web Corporation breached the merger contract in Trend Micro Co., Ltd., therefore followed the contract, the rest value of the acquisition value is decreased by TWD per share that resulted in decreasing the deposit of $769. The Company received the refund deposit of $3,581 and $4,348 in 2015 and 2014, respectively, and was recorded as other revenue.

22 15 6. Notes and Accounts Receivable, Net 7. Inventories December 31, Notes receivable $ 2, Accounts receivable 3,131,261 2,803,568 Letters of credit receivable 41,094 1,009,377 3,174,356 3,813,571 Less: Allowance for doubtful accounts (Note) (189,148) (181,038) Allowance for sales discounts and returns (72,730) (75,746) $ 2,912,478 3,556,787 Note: With the individual provision for impairment, the amount of $87,105 related to a receivable from a customer who has significant uncertainty to pay due to the supplier s chipsets quality problem in second quarter of Hence, the supplier provided free use of other chipsets products at the amount of $64,645 as compensation, which was recognized as a deduction for the cost of goods sold. December 31, Finished goods $ 2,069,823 2,214,906 Less: Provision for devaluation (308,409) (243,451) 1,761,414 1,971,455 Work in process and semi-finished goods 42,963 38,187 Less: Provision for devaluation (2,656) (4,155) 40,307 34,032 Raw materials 93, ,005 Less: Provision for devaluation (47,133) (46,429) 46,858 74,576 $ 1,848,579 2,080,063 For the years ended December 31, 2015 and 2014, the Company recognized operating cost of $102,851 and $72,295, respectively, from the write-down of inventory costs to net realizable value.

23 16 8. Investments Accounted for Using Equity Method Investee Amount December 31 Percentage Percentage of of ownership Amount ownership Ecowork Inc. $ 22, , ShareTech Information Co., Ltd. 11, $ 33,105 24,360 On the purpose of developing and designing cloud calculating, applications, database and server virtualization, the Company obtained 40% of shares of Ecoworks with an investment of $25,000 in May In addition, on the purpose of developing the business of Mail Server and Internet Security, the Company acquired 40% of shares of Share Tech Information Co., Ltd. with an investment of $11,000 in December For the years ended December 31, 2015 and 2014, the investment loss recognized by equity method amounted to $5,214 and $640, respectively. 9. Intangible Assets The costs of trade rights are presented under intangible assets, the cost and amortization in 2015 and 2014 are as follows: Costs: Balance at January 1 $ 73,353 80,834 Additions 50,888 - Translation adjustment (4,056) (7,481) Balance at December 31 $ 120,185 73,353 Accumulated amortization: Balance at January 1 $ 18,531 2,485 Amortization for the year 19,336 19,403 Translation adjustment (911) (3,357) Balance at December 31 $ 36,956 18,531 Book value: Balance at December 31 $ 83,229 54,822 As of December 31, 2015 and 2014, there is no intangible asset pledged.

24 Short-term Borrowings December 31, Unsecured borrowings $ 205,243 75,417 Secured loans - 98,685 $ 205, ,102 Interest rate 2.75%~ 3.50% Building and improvement are pledged for the above loan. Please refer to note Retirement Plans 2.65%~ 2.85% The Company assesses their defined benefit retirement plans using the balance sheet date as the measurement date. The following table sets forth the benefit obligation and accrued pension liabilities for the defined benefit plans: December 31, Benefit obligation: Vested benefit obligation $ 13,555 12,421 Nonvested benefit obligation 33,994 32,753 Accumulated benefit obligation 47,549 45,174 Projected future salary increase 23,467 23,613 Projected benefit obligation 71,016 68,787 Fair value of plan assets (137,756) (139,389) Funded status (66,740) (70,602) Unrecognized net loss - 26 Unamortized pension loss (23,336) (20,286) Prepaid pension cost $ (90,076) (90,862) The components of net periodic pension cost are summarized as follows: Defined benefit plan: Service cost $ Interest expenses 1,224 1,249 Actual returns on pension fund (3,635) (3,313) Amortization 1, Net pension cost $ (750) (953) Defined contribution plan $ 58,363 56,176

25 18 Actuarial assumptions are summarized as follows: December 31, Discount rate 1.875% 2.00% Rate of increase in future compensation levels 3.000% 2.50%~ 3.00% Expected long-term rate of return on plan assets 1.875% 2.00% As of December 31, 2015 and 2014, the vested benefit of employees meeting retirement requirements was $14,539 and $13,763, respectively. 12. Stockholders Equity (1) Common stock As of December 31, 2015 and 2014, ZyXEL s authorized common stock both amounted to $6,000,000, of which $260,000 was for use as employee stock options, convertible preferred stock, or convertible corporate bonds. The issued common stock with par value of $10 TWD per share amounted to $1,449,000 and $1,809,669, respectively. As approved by the board of directors on April, 28, 2015, ZyXEL set May 4, 2015 as the record date for capital reduction and wrote off 36,067 thousand shares which had a value of $360,669. This capital reduction was registered through legal procedures. (2) Employee stock options (a) Unizyx registered and issued 15,000,000 units of employee stock options in November Each unit can purchase one share of Unizyx. The duration of the plan is 5 years, and the plan was certified by the SFB. As of December 31, 2015, the information related to the employee stock option rights which had expired was as follows: Classification Certified Date Issuance Date Issued Units (in thousands) Grant period Exercise price per share (TWD) Adjusted exercise price per share (TWD) Employee stock options in 2010 Nov. 26, 2010 Dec. 9, ,000 Dec. 9, 2012~ Dec. 8,