Zhone Technologies Annual Report 2004

2002 and no longer amortizes goodwill. The Company evaluates goodwill, at a minimum, on an annual
basis and whenever events and changes in circumstances suggest that the carrying amount may not be
recoverable. Impairment of goodwill is tested at the reporting unit level by comparing the reporting unit’s
carrying amount, including goodwill, to the fair value of the reporting unit. The Company has determined
that it operates in a single segment with one operating unit. In 2002, the fair value of the reporting unit was
estimated using a combination of the income, or discounted cash flows, approach and the market approach,
which utilized comparable companies’ data. Effective November 2003, the Company performs the annual
goodwill impairment test using the market approach, reflecting the fact that the Company’s stock was
publicly traded following the consummation of the Tellium merger. If the carrying amount of the reporting
unit exceeds its fair value, goodwill is considered impaired and a second step is performed to measure the
amount of impairment loss, if any.
(m) Purchased Intangibles and Other Long-Lived Assets
In accordance with SFAS No. 144, long-lived assets, such as property, plant and equipment, and
purchased intangibles subject to amortization, are reviewed for impairment whenever events or changes in
circumstances indicate that the carrying amount of an asset may not be fully recoverable. Recoverability of
assets to be held and used is measured by a comparison of the carrying amount of an asset to future net
undiscounted cash flows expected to be generated by the asset. If the carrying amount of an asset exceeds its
estimated future cash flows, an impairment charge is recognized by the amount by which the carrying
amount of the asset exceeds the fair value of the asset. During the year ended December 31, 2002, the
Company recorded an impairment loss on long-lived assets of $50.8 million. Any assets to be disposed of
would be separately presented in the balance sheet and reported at the lower of the carrying amount or fair
value less costs to sell, and would no longer be depreciated. The assets and liabilities of a disposed group
classified as held for sale would be presented separately in the appropriate asset and liability sections of the
balance sheet.
Goodwill and other acquisition-related intangible assets not subject to amortization are tested annually
for impairment, and are tested for impairment more frequently if events and circumstances indicate that the
asset might be impaired. An impairment loss is recognized to the extent that the carrying amount exceeds
the asset’s fair value. During the year ended December 31, 2004, the Company recorded a charge of $0.2
million related to impairment of the acquired workforce from Gluon.
(n) Research and Product Development Expenditures
Costs related to research, design, and development of products are charged to research and product
development expense as incurred. Costs for the development of new software and substantial enhancements
to existing software are expensed as incurred until technological feasibility has been established, at which
time any additional development costs would be capitalized. The Company’s current process for developing
software is essentially completed concurrently with the establishment of technological feasibility;
accordingly, no costs have been capitalized to date.
(o) Accounting for Stock-Based Compensation
The Company has elected to account for employee stock options using the intrinsic-value method in
accordance with Accounting Principles Board Opinion No. 25 (“APB 25”) and related interpretations.
Under this method, compensation expense is recorded on the date of grant only if the current fair value
exceeds the exercise price. SFAS No. 123, Accounting for Stock-Based Compensation, established
accounting and disclosure requirements using a fair value-based method of accounting for stock-based
employee compensation plans. As allowed by SFAS No. 123, the Company has elected to continue to apply
the intrinsic value-based method of accounting described above, and has adopted the disclosure
requirements of SFAS No. 123, as amended.
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