ZyXEL Communications Corp. and Subsidiaries Consolidated ... Q4 ZyXEL Audited... · ZyXEL Communications Corp. and Subsidiaries Consolidated Balance Sheets December 31, 2015 and 2014

ZyXEL Communications Corp. and Subsidiaries

Consolidated Financial Statements

December 31, 2015 and 2014 (With Independent Auditors’ Report Thereon)

ZyXEL Communications Corp. and Subsidiaries Consolidated Balance Sheets December 31, 2015 and 2014

(In thousands of New Taiwan dollars)

See accompanying notes to consolidated financial statements.

December 31 2015 2014 Assets Amount % Amount % Current assets:

Cash and cash equivalents (note 4) $ 2,478,100 28 2,428,198 25 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) 2,912,478 33 3,556,787 37 Accounts receivable – related parties (note 17) 4,649 - - - Other receivables – related parties (note 17) 251,024 3 275,798 3 Other financial assets – current 20,395 - 41,622 - Inventories (note 7) 1,848,579 21 2,080,063 21 Other current assets (note 17) 224,567 3 132,337 1 Deferred income tax assets – current (note 14) 118,556 1 127,604 1 7,863,608 89 8,667,126 88

Investments: Available-for-sale financial assets – non-current (note 5) 124,904 2 167,164 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 - 24,360 -

188,382 2 281,776 4 Property, plant and equipment (note 18):

Cost: Land 37,434 - 36,094 - Buildings and improvements 407,527 5 418,663 4 Machinery and equipment 3,896 - 82,373 1 Research and development equipment 46,534 1 93,469 1 Office and other equipment 224,602 3 187,225 2

719,993 9 817,824 8 Less: accumulated depreciation (282,098) (3) (386,540) (4) Prepayment for equipment 14,883 - 6,240 -

452,778 6 437,524 4 Intangible Assets (note 9) 83,229 1 54,822 1 Other assets:

Refundable deposits 28,368 - 40,994 - Deferred expenses 28,061 - 22,301 - Restricted deposits (note 18) 57,189 1 65,737 2 Prepaid pension cost (note 11) 90,076 1 90,862 1

203,694 2 219,894 3 Total assets $ 8,791,691 100 9,661,142 100

December 31 2015 2014

Liabilities and Stockholders’ Equity Amount % Amount % Current liabilities:

Short-term borrowings (note 10) $ 205,243 2 174,102 2 Financial liabilities measured at fair value through profit or

loss – current (note 16) 2,101 - 552 - Notes and accounts payable 788,113 9 999,254 10 Accounts payable – related parties (note 17) 1,120,583 13 1,080,804 11 Other payable – related parties (note 17) 19,092 - 22,224 - Unearned sales revenue 70,235 1 48,946 1 Reserve for after-sales service 135,925 2 115,165 1 Accrued expenses and other current liabilities 863,113 10 903,840 9

3,204,405 37 3,344,887 34 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 3,214,720 37 3,351,536 34

Equity attributable to parent company stockholders (note 12) Common stock 1,449,000 17 1,809,669 19 Capital surplus:

Additional paid-in capital in excess of par value 1,173,093 13 1,173,093 12 Employee stock options 8,929 - 8,929 -

1,182,022 13 1,182,022 12 Retained earnings:

Legal reserve 1,515,430 17 1,515,430 16 Unappropriated earnings 1,500,415 17 1,745,916 18 3,015,845 34 3,261,346 34

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 5,540,194 63 6,249,070 65

Minority interest 36,777 - 60,536 1 Total stockholders’ equity 5,576,971 63 6,309,606 66

Commitments and contingencies (notes 17 and 19)

Total liabilities and stockholders’ equity $ 8,791,691 100 9,661,142 100



Consolidated Statements of Operations

Years ended December 31, 2015 and 2014 (In thousands of New Taiwan dollars, except for earnings per common share)

2015 2014 Amount % Amount % Sales (note 17) $ 13,622,064 105 15,502,892 105Less: sales returns and allowances 664,522 5 674,453 5 12,957,542 100 14,828,439 100Cost of goods sold (notes 7 and 17) 9,889,037 76 11,610,584 78

Gross profit 3,068,505 24 3,217,855 22Operating expenses (note 17):

Selling 1,621,909 13 1,807,061 12General and administrative 659,267 5 524,258 4Research and development 699,761 5 664,223 4

2,980,937 23 2,995,542 20Operating income 87,568 1 222,313 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 203 - 3 -Gain on disposal of investment, net (note 5) 1,100 - - -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 124 - 83 -Investment loss recognized by equity method (note 8) 5,214 - 640 -Loss on disposal of investment, net - - 6,153 -Foreign exchange loss, net 205,275 2 185,533 1Loss on valuation of financial liabilities (notes 5 and 16) 2,358 - 552 -Loss on impairment of financial assets (note 5) 31,604 - 3,053 -Other loss 13,516 - 17,526 - 267,123 2 220,287 1

Income (loss) before income taxes (108,516) (1) 97,233 1Income tax expenses (note 14) 157,946 1 104,070 1Consolidated 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) -

Earnings per common share (EPS) (in New Taiwan dollars) (note 15)Before

taxes After taxes

Before taxes

After taxes

Basic EPS $ (1.27) (1.56) 0.08 (0.06)



Consolidated Statements of Changes in Stockholders’ Equity

Years ended December 31, 2015 and 2014 (In thousands of New Taiwan dollars)

Retained Earnings Unrealized

Common stock

Capital surplus

Legal reserve

Unappro- priated earnings

Cumulative translation adjustment

Net loss not recognized as pension costs

gain and loss on financial 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 - - 21,338 (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 - - - - - 2,338 - - 2,338 Cost of stock options awarded by parent company to employees of

subsidiaries - 388 - - - - - - 388 Foreign currency translation adjustments - - - - (21,581) - - 2,774 (18,807) Net loss for 2014 - - - (10,715) - - - 3,878 (6,837)

Balance at December 31, 2014 1,809,669 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 2015 - - - (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



Consolidated Statements of Cash Flows

Years ended December 31, 2015 and 2014

(in thousands of New Taiwan dollars)

2015 2014 Cash flows from operating activities:

Consolidated net loss $ (266,462) (6,837)Adjustments:

Depreciation 57,072 57,778Amortization 27,353 27,425Provision of allowance for doubtful accounts 9,562 118,809Compensation cost arising from the parent company’s stock transferred

to employees - 388

Provision for inventory obsolescence 102,851 72,295Loss (gain) on disposal of property, plant and equipment (79) 80Investment loss recognized by equity method 5,214 640Loss (gain) on valuation of financial assets and liabilities measured at

fair value 6,295 (34,250)

Loss on impairment of financial assets 31,604 3,053Gain 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 17,168Inventories 79,251 (930,471)Other financial assets 21,218 (20,260)Other current assets (93,813) 79,780Deferred income tax assets 27,381 22,371Notes and accounts payable (including related parties) (169,841) 860,394Other payables – related parties (956) 22,224Unearned sales revenue, accrued expenses and other current liabilities 36,343 230,829Prepaid 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 - 40,821Acquisition of financial assets carried at cost (3,108) (15,145)Return of capital from financial assets carried at cost 29,522 5,478Acquisition 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 1,494 16Decrease (increase) in refundable deposits 11,531 (7,644)Acquisition of deferred expenses (14,010) (6,062)Decrease (increase) in restricted deposits (17,501) 289,509Acquisition of intangible assets (50,888) -

Cash provided by (used in) investing activities (184,550) 216,389 (Continued)



Consolidated Statements of Cash Flows (Continued)

Years ended December 31, 2015 and 2014

(in thousands of New Taiwan dollars)

2015 2014 Cash flows from financing activities:

Increase in short-term borrowings 31,141 144,160 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

assets $ - 40,821

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) -

(Continued)


Notes to Consolidated Financial Statements

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, 1999. 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, 2010. Unizyx began operations on August 16, 2010. 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, 2010. 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, 2011. 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:

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(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 2015 2014

ZyXEL ZyChamp Investment Co., Ltd. (ZyChamp)

Investment 100% 100%

ZyXEL ZyXEL Communications Inc. Machining, assembly, development and sales of network products

100% 100%

ZyXEL ZyXEL Communications A/S (ZyXEL Denmark)

Sales and Marketing 100% 100%

ZyXEL ZyXEL Singapore Private Limited


ZyXEL ZyFLEX Communications Inc. Manufactures, development and sales of communication and network products

- 100%

ZyXEL Victor Blue Ltd. (Victor) Investment 100% 100%

ZyXEL ZyTPE Communications Corporation

Manufactures, development and sales of communication and network products

100% 100%

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 Iletisim Teknolojileri A.S.


ZyXEL ZyXEL Communications Do Brasil Ltda.

Sales and Marketing 100% -

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Percentage of the ownership at December 31,

Investor Investee Nature of Business 2015 2014

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 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 Communications Czech s.r.o.


ZyXEL Denmark

ZyXEL Communications B.V. Sales and Marketing 100% 100%

ZyXEL Denmark

ZyXEL Communications Iberia S.L


ZyXEL Denmark

ZyXEL Communications Italy S.r.l

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.

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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 2014. 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 2014. 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 2015. 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 2015. 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 2015. 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-currency-denominated monetary assets or liabilities are reflected as non-operating gains or losses in the accompanying consolidated statements of operations.

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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 non-monetary 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.

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(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.

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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.

(9) Inventories

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.

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(Continued)

(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.

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(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 2016.

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.

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(Continued)

(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.

11



(Continued)

(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 2011. 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.

12



(Continued)

(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, 2015 2014 Petty cash, checking accounts and demand deposits $ 1,113,712 1,880,111 Time deposits 1,229,388 548,087 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, 2016.

5. Financial Assets

(1) Financial assets measured at fair value through profit or loss – current:

December 31, 2015 2014 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.

13



(Continued)

(2) Available-for-sale financial assets – non-current:

December 31, 2015 2014 Unizyx $ 124,904 167,164

ZyChamp held 4,630 thousand shares of ZyXEL amounting to $120,861 before the revision of Company Law on November 12, 2001. 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:

December 31, 2015 2014

Investee Amount

Percentage of ownership Amount

Percentage of ownership

Global Channel Resource Pte. Ltd. $ 15,293 15 15,145 19 Homeyen Networks Inc. 11,985 17 11,985 17 Handlink Technology, Inc. 2,035 3 2,035 4 Essence Technology, Inc. 911 3 911 3 ZOWIE Technology Corporation 149 - 772 - Hong Pang Venture Capital Corp. - - 30,830 10 Chien Pang Venture Capital Corp. - - 28,426 10 L7 Networks Inc. - 1 148 1 AccFast Technologies Corp. - 5 - 5 Aetas Technology Inc. - 1 - 1 $ 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 2015. 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, 2015. Meanwhile, the Company recognized the investment loss of $2,960 as an investment accounted for using the equity method.

14



(Continued)

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, 2015. 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 2015. Trend Micro Co., Ltd., therefore followed the contract, the rest value of the acquisition value is decreased by 0.6034 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.

15



(Continued)

6. Notes and Accounts Receivable, Net

December 31, 2015 2014 Notes receivable $ 2,001 626 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 2014. 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.

7. Inventories

December 31, 2015 2014 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 93,991 121,005 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.

16



(Continued)

8. Investments Accounted for Using Equity Method

December 31 2015 2014

Investee Amount

Percentage of ownership Amount

Percentage of ownership

Ecowork Inc. $ 22,105 40 24,360 40 ShareTech Information Co., Ltd. 11,000 40 - - $ 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 2014. 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 2015. 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:

2015 2014 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.

17



(Continued)

10. Short-term Borrowings

December 31, 2015 2014 Unsecured borrowings $ 205,243 75,417 Secured loans - 98,685 $ 205,243 174,102

Interest rate 2.75%~

3.50% 2.65%~

2.85% Building and improvement are pledged for the above loan. Please refer to note 18.

11. Retirement Plans

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, 2015 2014 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:

2015 2014 Defined benefit plan:

Service cost $ 521 420 Interest expenses 1,224 1,249 Actual returns on pension fund (3,635) (3,313) Amortization 1,140 691 Net pension cost $ (750) (953)

Defined contribution plan $ 58,363 56,176

18



(Continued)

Actuarial assumptions are summarized as follows:

December 31, 2015 2014 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 2010. 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 DateIssued 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, 2010 15,000 Dec. 9, 2012~ Dec. 8, 2014

29 25.9

19



(Continued)

Unizyx adopted ROC SFAS No. 39 and used the fair value method to recognize compensation costs. The estimated fair value of the options granted was $1.3~$2.0 (TWD) at the date of grant using the Black-Scholes option pricing model. As of December 31, 2015, the number of options which Unizyx had granted to employees of ZyXEL was 5,102 thousand units. For the years ended December 31, 2015 and 2014, ZyXEL recognized compensation cost of $0 and $388, respectively, with the following weighted-average assumptions:

Expected dividend yield 2.55% Expected volatility 14.19% Risk-free interest rate 0.45%~0.90% Expected life 1~3 years

Information related to employee stock options that Unizyx granted to ZyXEL’s employees is as follows:

2015 2014

Employee stock options Options

(thousands)

Weighted-average exercise

price (TWD) Options

(thousands)

Weighted-average exercise

price (TWD)

Outstanding at beginning of year 5,102 $ 25.90 5,102 25.90 Granted - - - - Exercised - - - - Forfeited (5,102) 25.90 - - Outstanding at end of year - $ - 5,102 25.90 Outstanding exercisable employee

stock options - 5,102 As of December 31, 2015 and 2014, the weighted-average remaining contractual life of outstanding options was 0 year and 0.94 years, respectively.

(3) Capital surplus

According to the ROC Company Act, capital surplus should be used to offset a deficit first, and then the realized capital surplus can be converted into capital and distributed as stock dividends or distributed as cash dividends. The aforementioned realized capital surplus that was generated from the excess of the issuance price over the par value of the capital stock and donations received. However, capital surplus that originated from long-term equity investments accounted for by the equity method cannot be used to increase share capital or to offset a deficit.

20



(Continued)

(4) Legal reserve According to the ROC Company Act stipulates that companies must retain 10% of their annual net earnings, as defined in the Act, until such retention equals the amount of the issued share capital. When a company incurs no loss, it may, pursuant to a resolution to be adopted by the shareholders’ meeting as required, distribute its legal reserve to shareholders by issuing new shares or distributing cash. Only the portion of the legal reserve which exceeds 25% of the paid-in capital may be distributed.

(5) Distribution of earnings and dividend policy

According to ZyXEL’s articles of incorporation, in years of earnings, ZyXEL has to offset any accumulated deficit, pay income tax, and appropriate 10% of the balance as a legal reserve before distribution of earnings. The balance of the earnings may be distributed in the following order: no more than 2% should be distributed as the remuneration of the board of directors and supervisors, and the remaining earnings together with prior years’ unappropriated earnings could be retained in accordance with a resolution of the shareholders’ meeting or distributed as below after retaining part of the earnings: (a) No less than 0.01% should be distributed as employee bonuses, and the bonuses could be

either cash or stock. However, ZyXEL may issue stock to employees of subsidiaries for profit sharing.

(b) The rest of the earnings are shareholders’ dividends. Because ZyXEL incurred a loss for the year ended December 31, 2014, it did not recognize its employee bonuses and remuneration of directors and supervisors in 2014. In accordance with the ROC Company Act as amended in May 2015, profit sharing to employee and remuneration to directors are no longer subject to earnings distribution appropriated from current-year distributable earnings. ZyXEL will amend its articles of incorporation before the deadline specified by the authorities. On March 17, 2015 and March 11, 2014, the board of directors of ZyXEL approved the plan to offset the operating losses for the year 2014 and the distribution of its retained earnings for the year 2013. Information about ZyXEL’s cash dividend, directors’ and supervisors’ remuneration and employee bonuses which were distributed from unappropriated earnings is as follows:

2014 2013 Cash dividend per common share (TWD) $ - 0.80Employee bonuses – cash $ - 21Directors’ and supervisors’ remuneration - - $ - 21

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(Continued)

The above earnings distribution had no difference from that of the resolution made by ZyXEL’s board of directors. The deficit compensation for 2015 had been approved in the meeting of the ZyXEL’s board of directors held on March 17, 2016.

13. Remuneration of employees and directors

Pursuant to the amendment of the ROC Company Act, the amendment of ZyXEL’s articles of incorporation was approved by the board of directors. In accordance with ZyXEL’s articles of incorporation, ZyXEL shall accrue its remuneration to employees and directors based on a certain percentage of the current-year’s profit (profit before income tax excluding remuneration to employees and directors) less, accumulated deficit as follows: no less than 0.01% as employees’ remuneration and no more than 2% as directors’ remuneration. The aforementioned employee bonuses will be distributed in cash or stock dividends to employees who meet certain requirements of ZyXEL and its affiliates. ZyXEL incurred an operating loss and did not estimate its remuneration to employees and directors for the year ended December 31, 2015.

14. Income Taxes

(1) For ZyXEL and its ROC subsidiaries, the statutory income tax rate is 17% in 2015 and 2014,

and they are also subject to the Income Basic Tax Act. Starting 2011, in accordance with the Article 40 of the Business Mergers and Acquisitions Act, ZyXEL has adopted its parent company, Unizyx, as the taxpayer to file a consolidated corporate income tax return and pay the 10% surtax on undistributed earnings. The tax rates for the foreign subsidiaries of ZyXEL are based on the tax law of their local jurisdiction.

The Company’s income tax expense was as follows:

2015 2014 Current $ 130,565 80,682 Deferred 27,381 22,371 Additional 10% surtax on undistributed earnings - 1,017 $ 157,946 104,070

22



(Continued)

(2) The reconciliation of the expected income tax expense at the statutory tax rate and the actual income tax expense was as follows:

2015 2014 Income tax expense (benefit) computed at the statutory tax

rate of 17% $ (18,448) 16,530

Difference due to local tax rates of subsidiaries 31,084 21,798 Gains on recognized long-term equity investments in

foreign subsidiaries 4,074 42,227

Change in valuation allowance of deferred tax assets 98,266 4,158 Approved-supplementary tax payment, prior-year

adjustments and others 42,970 20,841

Tax combination effect - (2,501) Additional 10% surtax on undistributed earnings - 1,017 Income tax expense $ 157,946 104,070

(3) The components of deferred income tax assets (liabilities) are summarized as follows:

December 31, 2015 2014 Deferred tax assets – current:

Loss carryforward $ 19,025 19,064 Unrealized profit on inter-company sales 16,529 20,891 Provision for uncollectible expenses in excess of limit 21,421 24,478 Warranty expense 8,202 7,445 Unrealized decline in value of inventories 51,490 54,125 Unrealized gain on exchange (9,338) (2,377) Allowance for sales discounts and returns 11,222 9,863 Others 19,030 13,179 137,581 146,668 Less: valuation allowance (19,025) (19,064) $ 118,556 127,604

Deferred tax assets – non-current: Loss carryforward $ 114,642 85,414 Loss on recognized long-term equity investments in

foreign subsidiaries 11,343 15,418 Prepaid pension cost (15,313) (15,185) Cumulative translation adjustment 22,677 10,296 Others (1,559) 3,634 131,790 99,577 Less: valuation allowance (141,305) (103,140) $ (9,515) (3,563)

Total deferred tax assets $ 295,581 264,681 Total deferred tax liabilities $ 26,210 18,436 Total valuation allowance $ 160,330 122,204

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(Continued)

(4) Below is the reconciliation of ZyXEL’s calculation of the current income tax expense, deferred

income tax expense, deferred tax assets, income tax receivable and receivables from related parties under the provisions of SFAS No. 22 “Income Taxes” to the related balances computed for filing final corporate income tax returns with Unizyx as the taxpayer:

2015

Current income

tax

Deferred income

tax

Deferred tax assets,

net

Income tax

receivable

Other receivables

-related parties

Amount computed under SFAS No.

22 $ 130,565 27,381 109,041 391 -

Adjustments - - - (391) 391Amounts computed for filing

combined corporate income tax returns

$ 130,565 27,381 109,041 - 391

The estimated income tax receivable of ZyXEL in 2015 was $391, which will be offset by using the operating losses of other affiliated companies through the d filing of their income taxes. Based on the amounts mentioned above, the total receivable due to affiliated companies amounted to $391, which was classified as other receivables-related parties on the accompanying consolidated balance sheet.

2014

Current income

tax

Deferred income

tax

Deferred tax assets,

net

Income tax

receivable

Other receivables

-related parties

Amount computed under SFAS No.

22 $ 84,200 22,371 145,481 1,133 -

Adjustments (2,501) - (21,440) (1,133) 25,074Amounts computed for filing

combined corporate income tax returns

$ 81,699 22,371 124,041 - 25,074

ZyXEL estimated its investment tax credits of Statute for Industrial Innovation in 2014 which caused an income tax benefit of $2,501 under the combined filing of income tax. The deferred tax asset of the combined filing of income tax being used was $21,440 due to the loss carryforward of $126,119 and the withholding interest tax of $1,133 in 2014. The above adjustments generated an account of other receivables – related parties amounted to $25,074.

Due to the combined filing of income tax, the estimated income tax receivable is recorded as other receivables – related parties.

24



(Continued)

(5) According to the ROC Income Tax Act amended in January 2009, the previous 10 years’ losses of the Company’s ROC subsidiaries as assessed by the tax authorities can offset the current year’s net income for income tax purposes.

As of December 31, 2015, the unused loss carryforwards and related expiration years of ZyXEL and ZyChamp were as follows:

Year of loss Expiration year Tax effect

2006 2016 $ 22,277 2007 2017 84,811 2011 2021 2,547 2012 2022 59,564 2014 2024 43,708 2015 2025 318,636

$ 531,543 In accordance with the tax law of each region where the subsidiaries of the Company are located, losses on foreign subsidiaries as assessed by the tax authorities can be carried forward to offset the future years’ taxable profits. As of December 31, 2015, the tax effects of the unused loss on carryforwards amounted to $43,305.

(6) As of the December 31, 2015, ZyXEL’s income tax returns had been examined by the tax authority through year 2013.

(7) Information related to the imputation credit account (ICA) of ZyXEL is summarized as follows:

December 31, 2015 2014 Unappropriated earnings:

Earned before December 31, 1997 $ 256,529 256,529 Earned after January 1, 1998 1,243,886 1,489,387 $ 1,500,415 1,745,916

ICA balance $ 255,528 245,128

2015 2014 Creditable ratio for earnings distribution to resident

stockholders 20.54%

(estimated) 16.46% (actual)

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(Continued)

15. Earnings per Common Share

The calculations of basic earnings per share attributable to the stockholders of ZyXEL were as below.

2015 2014 Before

taxes After taxes

Before taxes

After taxes

Basic earnings per common share: Net income (loss) $ (199,671) (245,501) 14,828 (10,715)Weighted-average common shares

outstanding (thousand shares) 157,153 157,153 180,967 180,967 Basic earnings per common share (TWD) $ (1.27) (1.56) 0.08 (0.06)

16. Financial Instruments

(1) The Company uses derivative instruments to hedge certain currency risk the Company is exposed to arising from its operating activities in 2015 and 2014. Because the Company does not qualify SFAS No.34, therefore, the hedge accounting is not used. The forward exchange agreements that were not settled as of December 31, 2015 and 2014 are as follows:

2015.12.31

Notional amount (EUR

thousand) Currency Duration of contract Book value

Sell forward foreign currency

exchange contract 1,000 EUR exchange USD 2015.12.16~

2016.06.20 $ 416

Sell forward foreign currency exchange contract

1,000 EUR exchange USD 2015.12.10~ 2016.06.14

314


300 EUR exchange USD 2015.12.17~ 2016.06.21

131


200 EUR exchange USD 2015.12.17~ 2016.06.21

88

Financial assets measured at fair value – current $ 949

26



(Continued)

2015.12.31

Notional amount (EUR

thousand) Currency Duration of contract Book value


1,000 EUR exchange USD 2015.11.17~ 2016.05.19

(643)


1,000 EUR exchange USD 2015.11.16~ 2016.06.20

(360)


500 EUR exchange USD 2015.11.17~ 2016.05.19

(312)


500 EUR exchange USD 2015.11.17~ 2016.05.19

(308)


500 EUR exchange USD 2015.11.16~ 2016.06.20

(228)


500 EUR exchange USD 2015.11.16~ 2016.06.20

(225)


2,000 EUR exchange USD 2015.12.04~ 2016.06.08

(25)

Financial liabilities measured at fair value – current $ (2,101)

2014.12.31

Notional amount

(JPY thousand) Currency

Duration of contract Book value

Sell forward foreign currency

exchange contract 200,000 JPY exchange USD 2014.11.13~

2015.05.18 1,579


200,000 JPY exchange USD 2014.11.17~ 2015.06.19

1,542


200,000 JPY exchange USD 2014.12.17~ 2015.07.21

1,390


200,000 JPY exchange USD 2014.12.17~ 2015.07.21

1,160


200,000 JPY exchange USD 2014.12.31~ 2015.08.06

24

Financial assets measured at fair value – current $ 5,695 Sell forward foreign currency

exchange contract 200,000 JPY exchange USD 2014.12.30~

2015.08.06 (420)


100,000 JPY exchange USD 2014.12.31~ 2015.08.06

(132)

Financial liabilities measured at fair value – current $ (552)

27



(Continued)

For the years ended December 31, 2015 and 2014, for the sell forward foreign currency exchange contract transactions, unrealized valuation gain (loss) amounted to $(1,152) and $5,143, respectively. For the years ended December 31, 2015 and 2014, for the sell forward foreign currency exchange contract transactions realized as valuation on gain amounted to $6,299 and $24,028, respectively.

(2) The Company’s non-derivative financial instruments’ fair values, including notes/accounts receivable, other relievable – related parties, other financial assets – current, short-term borrowings, notes/accounts payable (including related parties), and other payables – related parties were determined based on their carrying values because of the short maturities of the instruments. The carrying amounts and estimated fair values of all other financial instruments were as follows:

December 31, 2015 2014 Book value Fair value Book value Fair value

Financial assets: Financial assets measured at fair

value through profit or loss–current $ 5,260 5,260 24,717 24,717 Available-for-sale financial assets–

non-current

124,904 124,904 167,164 167,164 Financial assets carried at cost 30,373 (3)(iii) below 90,252 (3)(iii) belowRefundable deposits 28,368 28,196 40,994 40,744 Restricted deposits 57,189 57,189 65,737 65,737

Financial liabilities:

Financial liabilities measured at fair value through profit or loss–current

2,101 2,101 552 552

Deposits received 800 800 3,086 3,086

(3) The following methods and assumptions were used to estimate the fair value of each class of financial instruments:

(i) The carrying amounts of notes and accounts receivable (including related parties), other

receivables – related parties, other financial assets – current, short-term borrowings, notes and accounts payable (including related parties), and other payables – related parties approximate their fair value due to the short-term nature of these items.

(ii) The fair value of financial instruments is the active market quoted price if it is available. If the market price is unavailable, the Company will determine the fair value based on an evaluation method, and the estimates and assumptions incorporated in such evaluation are consistent with those used by market participants in their pricing of financial instruments. The above information is accessible to the Company.

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(Continued)

(iii) It is not practicable to determine the fair values of financial assets carried at cost when these investments are not publicly traded. Refer to note 5 for details.

(iv) On December 31, 2015 and 2014, the discount rates used to estimate the fair value of

refundable deposits were the average interest rates on time deposits both 0.610%.

(v) The interest rates on restricted deposits are substantially the market interest rates. Therefore, the amounts of the deposits are treated as the fair value.

(4) The details of quoted market prices and estimated fair values of financial instruments were as

follows: December 31, 2015 2014 Quoted

market price

Estimated fair value

Quoted market price

Estimated fair value

Financial assets: Cash and cash equivalents $ 2,478,100 - 2,428,198 - Financial assets measured at fair value

through profit or loss – current 4,311 949 19,022 5,695 Notes and accounts receivable

(including related parties) - 2,917,127 - 3,556,787 Other receivables – related parties - 251,024 - 275,798 Other financial assets – current - 20,395 - 41,622 Available-for-sale financial assets –

non-current 124,904 - 167,164 - Refundable deposits - 28,196 - 40,744 Restricted deposits 57,189 - 65,737 -

Financial liabilities: Short-term borrowings - 205,243 - 174,102 Financial liabilities measured at fair

value through profit or loss – current - 2,101 - 552 Notes and accounts payable (including

related parties) - 1,908,696 - 2,080,058 Other payables-related parties - 19,092 - 22,224 Deposits received - 800 - 3,086

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(Continued)

(5) Financial risk information

(i) Market risk

The Company’s purchases and sales are mainly denominated in foreign currency. As a result, current and future cash flows of foreign currency assets and liabilities are exposed to the risk of foreign currency exchange rate volatility. Therefore, the Company engaged in derivative financial instrument transactions as economic hedges against potential changes in assets or liabilities held in foreign currencies. Gains and losses arising from changes in exchange rates are offset by those of the hedged item. As a result, the market risk is low. Beneficiary certificates and listed stock held by the Company are presented under financial assets measured at fair value or available-for-sale financial assets. Such assets are measured at fair value, and the Company is exposed to market price volatility.

(ii) Credit risk

The Company’s potential credit risk is derived primarily from deposits with banks, financial assets measured at fair value – current, available-for-sale financial assets, and accounts receivable. The Company maintains its cash in various creditworthy financial institutions and purchases funds and stocks issued by companies with good credit ratings. Credit risk exposure to each financial institution is controlled by the Company. As a result, the Company believes that there is no concentration of credit risk of cash and financial assets. The main customers of the Company are multinational companies or companies with good credit ratings. From time to time, the Company monitors customers’ credit condition, and hence has not encountered any significant loss due to credit risk. Although, there is a potential for concentration of credit risk, the Company continually assesses the collectability of accounts receivable and makes a corresponding allowance for doubtful accounts. The Company’s management does not foresee any significant credit risk loss for the Company.

(iii) Liquidity risk

There is no liquidity risk of being unable to raise capital to settle contract obligations since the Company has sufficient capital and working capital to fulfill contract obligations. As there is no open market for the financial assets carried at cost, they are subject to liquidity risk.

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(Continued)

(iv) Cash flow risk resulting from change in interest rates

The financial assets of the Company with cash flow risk resulting from a change in interest rates were $1,102,560 and $1,877,138 as of December 31, 2015 and 2014, respectively. The financial liabilities of the Company with cash flow risk resulting from a change in interest rates were $205,243 and $174,102 as of December 31, 2015 and 2014, respectively.

17. Related-parties Transactions

(1) The name and relationship of the related parties with which the Company had significant transactions are shown below:

Name Relationship

Unizyx Holding Corporation (Unizyx) Parent company owning 100% of ZyXEL

MitraStar Technology Corporation (MitraStar) 100% owned by Unizyx

ZyFLEX Communications Inc. (ZyFLEX) 100% owned by ZyXEL, however, ZyFLEX was contributed to ZyXEL Foundation on November 1, 2015 and its chairman is a board of director of Unizyx.

Ecowork Inc. Equity-method investee of ZyXEL

ZyXEL Foundation Having the same board chairman with ZyXEL

(2) Significant transactions with related parties are summarized below:

(a) Sales

2015 2014

Amount Percentage of net sales

Amount

Percentage of net sales

MitraStar $ 15,662 - 390 - ZyFLEX 111 - - - $ 15,773 - 390 -

The selling prices of related-party transactions are based on market information. The terms of payment are 60 to 180 days after delivery. As of December 31, 2015 and 2014, the abovementioned transaction generated account receivables – related parties of $4,649 and $0, respectively.

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(Continued)

(b) Purchases

2015 2014

Amount

Percentage to net purchases

Amount

Percentage to net purchases

MitraStar $ 6,049,447 64 7,451,718 61

The terms of payment for purchases from a related party are 60 days after the purchase. The terms of payment for purchases from third parties were 60 to 90 days. The accounts payable for purchases from the above related party were as follows:

2015 2014 MitraStar $ 1,120,583 1,080,804

(c) ZyXEL paid consulting fees to Unizyx amounting to $51,408 and $69,826, and they were

recorded as operating expenses for the years ended December 31, 2015 and 2014, respectively. As of December 31, 2015 and 2014, all other payables – related parties generated by the abovementioned transaction had been paid. As of December 31, 2015 prepaid consulting fees generated other current assets of $ 25,052. The expenditures on developing products related to information service, cloud platform and programming with related parties were as follows:

2015 2014 Ecowork Inc. $ 23,181 13,718 ZyFLEX 13,810 - $ 36,991 13,718

As of December 31, 2015 and 2014, the abovementioned expenses were generated from other payables – related parties amounting to $7,771 and $10,573, respectively. As of December 31, 2015 and 2014, the prepaid services expense generated from other current assets amounted to $ 78,690 and $400, respectively.

(d) Donation The Company donated 100% shares of ZyFLEX with the carrying amount of $98,596 to ZyXEL Foundation in November 2015.

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(Continued)

(e) Miscellaneous expenses ZyXEL paid R&D and manufacturing fee for buying supplies and outsourced manufacturing service were derived from MitraStar amounting to $19,282 and $16,582 for the years ended December 31, 2015 and 2014, respectively. As of December 2015 and 2014, the abovementioned expenses generated other payable – related parties of $11,321 and $11,651, respectively.

(f) Advances

Uncleared mutual advances between related parties are recorded as other receivables – related parties. They were as follows:

December 31, 2015 2014 Other receivables – related parties

MitraStar $ - 285 Unizyx 633 - $ 633 285

(g) Loans

The Company makes loans to its related parties and records them as other receivables – related parties. They were as follows: 2015 2014

Related Party

Highest Balance

Ending Balance

Interest Rate Range

Interest Revenue

Highest Balance

Ending Balance

Interest Rate Range

Interest Revenue

MitraStar $ 250,000 250,000 1% 2,281 500,000 250,000 1% 2,445

Note: The highest balance and ending balance represent the amounts approved by the board

of directors. As of December 31, 2015 and 2014, the unreceived interest revenue amounted to $0 and $439, and they were recorded as other receivables – related parties.

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(Continued)

(h) Tax combination Started from 2011, ZyXEL and its parent company, Unizyx, file their corporate income tax on a combination basis. As of December 31, 2015 and 2014, the estimated receivables from Unizyx and MitraStar of tax combination are summarized as follows:

December 31, 2015 2014 Other receivables – related parties

Unizyx $ 391 8,457 MitraStar - 16,617 $ 391 25,074

18. Pledged Assets

Assets pledged as collateral are summarized as follows:

December 31, Pledged assets Pledged to secure 2015 2014 Restricted deposits Contact fulfillment and warranty for

Ministry of National Defense etc. $ 38,333 32,711

Time deposit (recorded as restricted deposits)

Contract fulfillment and warranty guarantee

10,341 24,827

Restricted deposits Warranty fund for letter of credit 8,515 8,199

Buildings and Structures Short-term borrowings - 34,710

$ 57,189 100,447

19. Commitments and Contingencies

(1) Significant Commitments

(a) The Company entered into 20 years renewable operating lease agreements for land and operating facilities with the Science-based Industrial Park Administration (“SIPA“) expiring on December 31, 2025, with an annual rental subject to SIPA adjustments. In addition, certain subsidiaries leased their offices. Minimum payments in future years under current operating lease agreements are listed below:

Year Amount 2016 $ 60,837 2017 to 2020 76,648 2021 and thereafter 35,632

$ 173,117

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(Continued)

As of December 31, 2015 and 2014, the Company rented a piece of land from the SIPA, and both the bank had issued a guarantee of $7,160.

(b) As of December 31, 2015 and 2014, the amounts of notes pledged at the bank for financing

purposes were $1,611,075 and $1,348,150, respectively.

(c) As of December 31, 2015 and 2014, ZyXEL had outstanding letters of credit amounting to US$0 thousand and USD$324 thousand, respectively. The outstanding letters of credit facilitate ZyXEL’s purchase of materials from suppliers.

(d) In order to bid on the projects, ZyXEL submitted a performance guarantee letter amounting to USD$411 thousand as of December 31, 2015.

(e) In order to bid on the projects, ZyTPE Communications Corporation submitted a performance guarantee letter amounting to $16,221 and $31,066 as of December 31, 2015 and 2014, respectively.

(f) In order to bid on the projects of Bank of Taiwan, Chunghwa Telecom Co., Ltd., and others, ZyFLEX Communications Inc. requested a bank to sub mit a performance guarantee letter and a warranty guarantee letter to its counterparties amounted to $14,043 as of December 31, 2014.

(g) As of December 31, 2015 and 2014, in order to obtain the bid of TTNET A.S., ZyXEL Iletisim Teknolojileri A.S. requested a bank to issue a guarantee amounting to USD $3,218 thousand and USD $3,091 thousand, respectively.

(h) The Company signed technology licensing agreements with certain companies and was required to pay licensing fees in proportion to sales revenue of the licensed products under the agreements.

(i) The Company signed agency service agreements with certain companies and was required to pay commission fees in proportion to commissioned sales under the agreements.

(2) Contingencies liabilities

(a) In 2013, TQDelta, L.L.C. asserted that ZyXEL sold products that infringed certain patents of TQDelta, L.L.C. and brought suit against ZyXEL and ZyXEL’s subsidiary ZyXEL Communications Inc., ZyXEL is defending the lawsuit with a lawyer. However, ZyXEL believes that the abovementioned event will not have a significant effect on current operations.

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(Continued)

(b) In 2014, Charles C. Freeny III, Bryan E. Freeny, and James P. Freeny asserted that ZyXEL sold products that infringed certain patents of Charles C. Freeny III, Bryan E. Freeny, and James P. Freeny and brought suit against ZyXEL’s subsidiary, ZyXEL Communications Inc; ZyXEL reached a settlement with these companies in March 2015.

(c) In 2013, Innovative Wireless Solution, L.L.C. asserted that ZyXEL sold products that

infringed certain patents of Innovative Wireless Solution, L.L.C. and brought suit against ZyXEL’s subsidiary, ZyXEL Communications Inc.; Innovative Wireless Solution L.L.C. withdrew the lawsuit in March 2015.

(d) In 2008, Northpeak Wireless, L.L.C. (“Northpeak”) asserted that ZyXEL sold products that

infringed certain Northpeak patents and brought suit against ZyXEL subsidiary, ZyXEL Communications Inc.; Northpeak withdrew the lawsuit in December 2015.

(e) In 2015, IO dapt, L.L.C. asserted that ZyXEL sold products that infringed certain IO dapt,

L.L.C. patents and brought suit against ZyXEL subsidiary, ZyXEL Communications Inc.; IO dapt, L.L.C. withdrew the lawsuit on December 15, 2015.

(f) In 2015, Frequency systems, L.L.C. asserted that ZyXEL sold products that infringed

certain Frequency systems, L.L.C. patents and brought suit against ZyXEL subsidiary, ZyXEL Communications Inc.; ZyXEL reached a settlement with Frequency systems, L.L.C. in January 2016.

(g) In 2015, Wetro Lan L.L.C asserted that ZyXEL sold products that infringed certain Wetro Lan L.L.C patents and brought suit against ZyXEL subsidiary, ZyXEL Communications Inc.; ZyXEL reached a settlement with Wetro Lan L.L.C in February 2016.

20. Significant disaster: None

21. Subsequent Events: None

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22. Other Information

(1) The Company’s personnel, depreciation, and amortization expenses, by function, are summarized as follows:

Account 2015 2014

Cost of goods sold

Operatingexpenses

Total Cost of

goods sold Operating expenses

Total

Personnel expenses:

Salaries 20,993 1,440,953 1,461,946 26,740 1,385,450 1,412,190Labor and health

insurance 1,942 125,452 127,394 3,316 108,318 111,634

Pension 1,115 56,498 57,613 817 54,406 55,223Others 1,777 53,184 54,961 1,537 55,713 57,250

Depreciation 336 56,736 57,072 964 56,814 57,778Amortization - 27,353 27,353 - 27,425 27,425

(2) The significant financial assets and liabilities in foreign currency were as follows (in thousands):

December 31, 2015 2014 Foreign

currency Exchange rate TWD

Foreign currency

Exchange rate TWD

Financial assets Monetary Items US Dollar 31,574 32.825 1,036,417 22,891 31.650 724,493 EURO 461 35.880 16,541 40,286 38.470 1,549,792 JPY 43 0.2727 12 394,675 0.2646 104,431 Financial liabilities Monetary Items US Dollar 25,926 32.825 851,021 37,472 31.650 1,185,995

Documents

ZyXEL Communications Corp. and Subsidiaries Consolidated ... Q4 ZyXEL Audited... · ZyXEL Communications Corp. and Subsidiaries Consolidated Balance Sheets December 31, 2015 and 2014