DZS 10Q 2022 Q3 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)


☒		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2022


☐		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to

000-32743

(Commission File Number)

DZS INC.

(Exact name of registrant as specified in its charter)


Delaware		22-3509099
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification Number)

5700 Tennyson Parkway, Suite 400 Plano, Texas		75024
(Address of principal executive offices)		(Zip code)

(469) 327-1531

(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:


Title of each class	Trading Symbol(s)	Name of each exchange on which registered

Common stock, $0.001 par value	DZSI	The Nasdaq Stock Market LLC

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No 

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in rule 12b-2 of the Exchange Act.


Large accelerated filer	☐	Accelerated filer	☒
Non-accelerated filer	☐	Smaller reporting company	☐
		Emerging growth company	☐

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes☐ No ☒

As of October 25, 2022, there were 27,953,050 shares outstanding of the registrant’s common stock, $0.001 par value.

TABLE OF CONTENTS


		Page
PART I. FINANCIAL INFORMATION

Item 1.	Financial Statements	3
	Unaudited Condensed Consolidated Balance Sheets	3
	Unaudited Condensed Consolidated Statements of Comprehensive Income (Loss)	4
	Unaudited Condensed Consolidated Statements of Stockholders' Equity	5
	Unaudited Condensed Consolidated Statements of Cash Flows	6
	Notes to Unaudited Condensed Consolidated Financial Statements	7
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	21
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	30
Item 4.	Controls and Procedures	30

PART II. OTHER INFORMATION

Item 1.	Legal Proceedings	32
Item 1A.	Risk Factors	32
Item 5.	Other Information	32
Item 6.	Exhibits	32
	Signatures	34

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

DZS INC. AND SUBSIDIARIES

Unaudited Condensed Consolidated Balance Sheets

(In thousands, except par value)


	September 30, 2022			December 31, 2021
Assets
Current assets:
Cash and cash equivalents	$	17,861		$	46,666
Restricted cash		2,942			6,808
Accounts receivable - trade, net of allowance for doubtful accounts of $16,091 as of September 30, 2022 and $17,735 as of December 31, 2021		125,909			86,114
Other receivables		19,441			10,621
Inventories		84,654			56,893
Contract assets		573			2,184
Prepaid expenses and other current assets		8,688			5,690
Total current assets		260,068			214,976
Property, plant and equipment, net		9,246			9,842
Right-of-use assets from operating leases		12,208			12,640
Goodwill		26,778			6,145
Intangible assets, net		25,365			5,115
Other assets		12,402			8,950
Total assets	$	346,067		$	257,668
Liabilities and Stockholders’ Equity
Current liabilities:
Accounts payable - trade	$	116,317		$	64,258
Revolving credit facility		7,000			—
Current portion of long-term debt		1,250			—
Contract liabilities		23,448			6,091
Operating lease liabilities		4,187			4,097
Accrued and other liabilities		24,032			16,032
Total current liabilities		176,234			90,478
Long-term debt		23,118			—
Contract liabilities - non-current		7,765			3,044
Operating lease liabilities - non-current		11,777			12,103
Pension liabilities		14,034			16,527
Other long-term liabilities		2,858			3,609
Total liabilities		235,786			125,761
Commitments and contingencies (Note 13)
Stockholders’ equity:
Common stock, 36,000 shares authorized, 27,925 and 27,505 shares issued and outstanding as of September 30, 2022 and December 31, 2021, respectively, at $0.001 par value		27			27
Additional paid-in capital		234,383			223,336
Accumulated other comprehensive loss		(13,857	)		(4,457	)
Accumulated deficit		(110,272	)		(86,999	)
Total stockholders’ equity		110,281			131,907
Total liabilities and stockholders’ equity	$	346,067		$	257,668

See accompanying notes to unaudited condensed consolidated financial statements.

DZS INC. AND SUBSIDIARIES

Unaudited Condensed Consolidated Statements of Comprehensive Income (Loss)

(In thousands, except per share data)


	Three Months Ended						Nine Months Ended
	September 30,						September 30,
	2022			2021			2022			2021
Net revenue	$	107,394		$	88,412		$	275,514		$	252,143
Cost of revenue		70,864			56,213			187,216			164,771
Gross profit		36,530			32,199			88,298			87,372
Operating expenses:
Research and product development		15,499			11,707			39,691			34,788
Selling, marketing, general and administrative		23,698			19,539			61,953			69,619
Restructuring and other charges		601			6,754			1,393			12,098
Impairment of long-lived assets		827			—			827			1,735
Amortization of intangible assets		1,190			312			1,948			888
Total operating expenses		41,815			38,312			105,812			119,128
Operating loss		(5,285	)		(6,113	)		(17,514	)		(31,756	)
Interest income		47			20			120			81
Interest expense		(446	)		(49	)		(773	)		(326	)
Other income (expense), net		(1,984	)		922			(2,847	)		1,633
Loss before income taxes		(7,668	)		(5,220	)		(21,014	)		(30,368	)
Income tax provision (benefit)		6,128			676			1,858			2,032
Net loss		(13,796	)		(5,896	)		(22,872	)		(32,400	)

Foreign currency translation adjustments (a)		(4,425	)		(2,036	)		(9,332	)		(4,090	)
Actuarial loss		—			—			—			55
Comprehensive loss	$	(18,221	)	$	(7,932	)	$	(32,204	)	$	(36,435	)
Net loss per share
Basic	$	(0.49	)		(0.22	)	$	(0.83	)	$	(1.22	)
Diluted	$	(0.49	)		(0.22	)	$	(0.83	)	$	(1.22	)
Weighted average shares outstanding
Basic		27,902			27,201			27,696			26,484
Diluted		27,902			27,201			27,696			26,484

(a) Includes net loss on intra-entity foreign currency transactions that are of a long-term investment nature of $0.9 million and $2.0 million for three and nine months ended September 30, 2022 and $0.4 million and $0.9 million for three and nine months ended September 30, 2021.

See accompanying notes to unaudited condensed consolidated financial statements.

DZS INC. AND SUBSIDIARIES

Unaudited Condensed Consolidated Statements of Stockholders' Equity

(In thousands)


	Common stock				Additional paid-in			Accumulated other comprehensive			Accumulated			Total stockholders'
	Shares		Amount		capital			loss			deficit			equity
Nine-months ended September 30, 2022:
Balance as of December 31, 2021		27,505	$	27	$	223,336		$	(4,457	)	$	(86,999	)	$	131,907
Cumulative effect of ASC 326 adoption		—		—		—			—			(401	)		(401	)
Exercise of stock awards and employee stock plan purchases		98		—		156			—			—			156
Stock-based compensation		—		—		2,671			—			—			2,671
Net income (loss)		—		—		—			—			(3,048	)		(3,048	)
Subsidiary dissolution		—		—		—			(68	)		—			(68	)
Other comprehensive loss		—		—		—			(268	)		—			(268	)
Balance as of March 31, 2022		27,603	$	27	$	226,163		$	(4,793	)	$	(90,448	)	$	130,949
Exercise of stock awards and employee stock plan purchases		181		—		938			—			—			938
Stock-based compensation		—		—		2,868			—			—			2,868
Net income (loss)		—		—		—			—			(6,028	)		(6,028	)
Other comprehensive loss		—		—		—			(4,639	)		—			(4,639	)
Balance as of June 30, 2022		27,784	$	27	$	229,969		$	(9,432	)	$	(96,476	)	$	124,088
Exercise of stock awards and employee stock plan purchases		141		—		(609	)		—			—			(609	)
Stock-based compensation		—		—		5,023			—			—			5,023
Net income (loss)		—		—		—			—			(13,796	)		(13,796	)
Other comprehensive loss		—		—		—			(4,425	)		—			(4,425	)
Balance as of September 30, 2022		27,925	$	27	$	234,383		$	(13,857	)	$	(110,272	)	$	110,281

Nine-months ended September 30, 2021:
Balance as of December 31, 2020		21,958	$	22	$	147,997		$	(2,124	)	$	(52,316	)	$	93,579
Issuance of common stock in public offering, net of issuance costs		4,600		5		59,520									59,525
Exercise of stock awards and employee stock plan purchases		325		—		2,569			—			—			2,569
Stock-based compensation		—		—		1,352			—			—			1,352
Net income (loss)		—		—		—			—			(23,225	)		(23,225	)
Other comprehensive (loss)		—		—		—			(2,298	)		—			(2,298	)
Balance as of March 31, 2021		26,883	$	27	$	211,438		$	(4,422	)	$	(75,541	)	$	131,502
Exercise of stock awards and employee stock plan purchases		309		—		1,967			—			—			1,967
Stock-based compensation		—		—		1,994			—			—			1,994
Net income (loss)		—		—		—			—			(3,279	)		(3,279	)
Other comprehensive loss		—		—		—			299			—			299
Balance as of June 30, 2021		27,192	$	27	$	215,399		$	(4,123	)	$	(78,820	)	$	132,483
Exercise of stock awards and employee stock plan purchases		15		—		93			—			—			93
Stock-based compensation		—		—		3,104			—			—			3,104
Net income (loss)		—		—		—			—			(5,896	)		(5,896	)
Other comprehensive loss		—		—		—			(2,036	)		—			(2,036	)
Balance as of September 30, 2021		27,207	$	27	$	218,596		$	(6,159	)	$	(84,716	)	$	127,748

See accompanying notes to unaudited condensed consolidated financial statements.

DZS INC. AND SUBSIDIARIES

Unaudited Condensed Consolidated Statements of Cash Flows

(In thousands)


	Nine months ended
	September 30,
	2022			2021
Cash flows from operating activities:
Net loss	$	(22,872	)	$	(32,400	)
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
Depreciation and amortization		4,551			3,555
Impairment of long-lived assets and non-cash restructuring		827			4,475
Gain on Lease termination		—			(908	)
Amortization of deferred financing costs		121			12
Stock-based compensation		10,562			6,450
Provision for inventory write-down		3,498			2,928
Bad debt expense, net of recoveries		(482	)		14,579
Provision for sales returns		2,307			873
Provision for warranty		323			636
Unrealized loss (gain) on foreign currency transactions		1,318			47
Subsidiary dissolution		(68	)		—
Gain on disposal of property, plant and equipment		(68	)		—
Deferred taxes		—			139
Changes in operating assets and liabilities:
Accounts receivable		(45,170	)		(3,945	)
Other receivable		(11,577	)		(7,648	)
Inventories		(37,926	)		(24,256	)
Contract assets		1,515			2,557
Prepaid expenses and other assets		(5,319	)		(7,063	)
Accounts payable		58,202			21,991
Contract liabilities		2,851			631
Accrued and other liabilities		(231	)		2,282
Net cash used in operating activities		(37,638	)		(15,065	)
Cash flows from investing activities:
Proceeds from disposal of property, plant and equipment and other assets		65			—
Purchases of property, plant and equipment		(2,310	)		(4,158	)
Acquisition of business, net of cash acquired		(22,297	)		(4,459	)
Net cash used in investing activities		(24,542	)		(8,617	)
Cash flows from financing activities:
Proceeds from issuance of common stock in public offerings, net of issuance costs		—			59,525
Proceeds from long-term borrowings		25,000			—
Repayments of long-term borrowings		(313	)		—
Proceeds from short-term borrowings and line of credit, net		7,000			—
Repayments of short-term borrowings and line of credit		—			(13,278	)
Repayments of related party term loan		—			(29,298	)
Payments for debt issue costs		(776	)		—
Payments of contingent consideration		(558	)		—
Proceeds from exercise of stock awards and employee stock plan purchases		485			4,629
Net cash provided by financing activities		30,838			21,578
Effect of exchange rate changes on cash, cash equivalents and restricted cash		(1,344	)		71
Net change in cash, cash equivalents and restricted cash		(32,686	)		(2,033	)
Cash, cash equivalents and restricted cash at beginning of period		53,639			54,587
Cash, cash equivalents and restricted cash at end of period	$	20,953		$	52,554

Reconciliation of cash, cash equivalents and restricted cash to statement of financial position
Cash and cash equivalents	$	17,861		$	45,505
Restricted cash		2,942			6,884
Long-term restricted cash		150			165
	$	20,953		$	52,554

Supplemental disclosure of cash flow information:
Cash paid during the period for:
Interest - bank and trade facilities	$	425		$	83
Interest - related party	$	—		$	108
Income taxes	$	986		$	3,029

See accompanying notes to unaudited condensed consolidated financial statements.

Notes to Unaudited Condensed Consolidated Financial Statements

(1) Organization and Summary of Significant Accounting Policies

(a) Description of Business

DZS Inc. (referred to, collectively with its subsidiaries, as “DZS” or the “Company”) is a global leader in access and optical networking infrastructure and cloud software solutions that enable the emerging hyper-connected, hyper-broadband world and broadband experiences. The Company provides a wide array of reliable, cost-effective networking technologies and software to a diverse customer base.

DZS was incorporated under the laws of the state of Delaware in June 1999. The Company is headquartered in Plano, Texas with flexible in-house production facilities in Seminole, Florida, and contract manufacturers located in China, India, Korea and Vietnam. The Company also maintains offices to provide sales and customer support at global locations.

(b) Basis of Presentation

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with U.S. GAAP for interim financial information and with the instructions to Form 10-Q and Article 3 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by U.S. GAAP for complete financial statements. These financial statements include the accounts of the Company and its wholly owned subsidiaries. These unaudited condensed consolidated financial statements should be read in conjunction with the consolidated financial statements of the Company and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2021 filed with the Securities and Exchange Commission (“SEC”) on March 9, 2022. For a complete description of what the Company believes to be the critical accounting policies and estimates used in the preparation of its unaudited condensed consolidated financial statements, refer to the Company’s Annual Report on Form 10-K for the year ended December 31, 2021.

All intercompany transactions and balances have been eliminated in consolidation. Certain prior-year amounts have been reclassified to conform to the current-quarter presentation. The unaudited condensed consolidated financial statements reflect all adjustments (consisting only of normal recurring adjustments) that, in the opinion of management, are necessary for a fair presentation of the results for the interim periods presented. The results of operations for the current interim period are not necessarily indicative of results to be expected for the current year or any other period.

The accompanying unaudited condensed consolidated financial statements have been prepared in conformity with U.S. GAAP, assuming the Company will continue as a going concern.

The COVID-19 pandemic continued to adversely affect significant portions of our business and our financial condition and results of operations in the first three quarters of 2022. The emergence of the Omicron variant in late 2021 with a resulting increase in COVID cases in 2022 resulted in re-implementation of various measures, including travel bans and restrictions, limitations on public and private gatherings, business and port closures or operating restrictions, social distancing, and shelter-in-place orders. The health effects of the pandemic and the above measures taken in response thereto have had an effect on the global economy in general and have materially impacted and will likely continue to impact the Company’s financial condition, results of operations and cash flows. Given the ongoing and dynamic nature of the virus and its variants, and the worldwide response related thereto, it is difficult to predict the full impact of the COVID-19 pandemic on our business.

We have experienced and continue to experience disruptions in our supply chain due to the pandemic, which has also impacted and may adversely impact our operations (including, without limitation, logistical and other operational costs) and the operations of some of our key suppliers. Supply chain pricing, freight and logistics costs, product and component availability, and extended lead-times became a challenge in 2021 and continue into 2022 as the world economy recovers from the COVID-19 pandemic. As we continue to incur elevated costs for components and expedite fees, our supply chain and operations teams continue to focus on managing through a constrained environment, thereby enabling DZS to maximize shipments despite elongated lead times. We remain cautious about continued supply chain headwinds that challenge the industry and anticipate a constrained supply chain environment to persist throughout 2022.

For additional risks to the corporation related to the COVID-19 pandemic, see Item 1A, Risk Factors of our 2021 Form 10-K.

(d) Use of Estimates

The preparation of the unaudited condensed consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the unaudited condensed consolidated financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ materially from those estimates.

(e) Disaggregation of Revenue

The following table presents revenues by source (in thousands):


	Three Months Ended September 30,				Nine Months Ended September 30,
	2022		2021		2022		2021
Products	$	91,703	$	82,911	$	247,500	$	237,083
Services and software		15,691		5,501		28,014		15,060
Total	$	107,394	$	88,412	$	275,514	$	252,143

The following table present revenues by geographical concentration (in thousands):


	Three Months Ended September 30,				Nine Months Ended September 30,
	2022		2021		2022		2021
Americas	$	27,609	$	27,302	$	78,950	$	73,984
Europe, Middle East, Africa		26,595		20,380		58,397		54,999
Asia		53,190		40,730		138,167		123,160
Total	$	107,394	$	88,412	$	275,514	$	252,143

(f) Concentration of Risk

Financial instruments that potentially subject the Company to concentrations of credit risk consist primarily of cash, cash equivalents and restricted cash, accounts receivables, and contract assets. Cash, cash equivalents and restricted cash consist of financial deposits and money market accounts that are principally held with various domestic and international financial institutions with high credit standing.

The Company’s customers include competitive and incumbent local exchange carriers, competitive access providers, internet service providers, wireless carriers and resellers serving these markets. The Company performs ongoing credit evaluations of its customers and generally does not require collateral. Allowances are maintained for potential doubtful accounts based upon the expected collectability of accounts receivable using historical loss rates adjusted for customer-specific factors and current economic conditions. The Company determines historical loss rates on a rational and systematic basis. The Company performs periodic assessments of its customers’ liquidity and financial condition through analysis of information obtained from credit rating agencies, financial statement review and historical and current collection trends.

Activity under the Company’s allowance for doubtful accounts consists of the following (in thousands):


	Nine Months Ended September 30,
	2022			2021
Balance at beginning of period	$	17,735		$	3,954
Charged to expense, net of recoveries		(482	)		14,579
Utilization and write off		(117	)		(118	)
Cumulative effect of ASC 326 adoption		401			—
Foreign exchange impact		(1,446	)		(247	)
Balance at end of period	$	16,091		$	18,168

For the three and nine months ended September 30, 2022, one customer accounted for 12% of net revenue. For the three months ended September 30, 2021, two customers accounted for 15% and 11% of net revenue, respectively. For the nine months ended September 30, 2021, two customers accounted for 18% and 12% of net revenue, respectively.

As of September 30, 2022, one customer represented 10% of net accounts receivable. As of December 31, 2021, two customers represented 26% and 10% of net accounts receivable, respectively.

As of September 30, 2022, and December 31, 2021, net accounts receivables from customers in countries other than the United States represented 83% and 79%, respectively.

In 2017, the Company entered into an agreement with a customer in India to supply product for a state sponsored broadband project. The Company substantially completed its obligations under the agreement in 2018. The Company billed the customer, which is a state government sponsored entity, approximately $59.0 million and collected payments of approximately $41.7 million by December 31, 2020. In late March 2021, the customer’s state government parent experienced difficulty passing a budget impacting the ability of the customer to make remaining agreed-upon payments to us. In light of this development, the Company recorded an allowance that covered the entire balance unpaid by the customer. Subsequent to March 2021, the Company recovered approximately $2.1 million of accounts receivable related to the customer. As of September 30, 2022 the Company has a recorded allowance for doubtful accounts of $13.5 million related to this receivable. The Company will continue to pursue collection of the entire outstanding balance and any amounts collected will be recognized in the period

which they are received. In the event the Company’s efforts to collect from this customer prove unsuccessful, DZS may seek payment through other means, including through legal action.

(g) Business Combinations

The Company allocates the fair value of purchase consideration to the tangible and identifiable intangible assets acquired and liabilities assumed based on their estimated fair values. The excess of the fair value of purchase consideration over the fair values of these identifiable assets and liabilities is recorded as goodwill. When determining the fair values of assets acquired and liabilities assumed, management makes significant estimates and assumptions, especially with respect to intangible assets and certain tangible assets such as inventory.

Critical estimates in valuing certain tangible and intangible assets include but are not limited to future expected cash flows from the underlying assets and discount rates. Management’s estimates of fair value are based upon assumptions believed to be reasonable, but which are inherently uncertain and unpredictable and, as a result, actual results may differ from estimates.

Assets acquired and liabilities assumed are generally measured at their acquisition-date fair values. If the initial accounting for a business combination is incomplete by the end of the reporting period in which the combination occurs, the Company reports provisional amounts for the items for which the accounting is incomplete. Those provisional amounts are adjusted during the measurement period (which cannot exceed one year from the acquisition date), or additional assets or liabilities are recognized, to reflect new information obtained about facts and circumstances that existed as of the acquisition date that, if known, would have affected the amounts recognized as of that date.

When the consideration transferred by the Company in a business combination includes a contingent consideration arrangement, the contingent consideration is measured at its acquisition-date fair value and included as part of the total consideration transferred in a business combination. Changes in fair value of the contingent consideration that qualify as measurement period adjustments are made retrospectively, with corresponding adjustments against goodwill. Changes in the fair value of the contingent consideration that do not qualify as measurement period adjustments are made in the current period, with corresponding adjustments recognized in earnings.

(h) Restructuring and Other Charges

Restructuring and other charges primarily consists of severance and other termination benefits and non-cash impairment charges related to right-of-use assets from operating leases related to the restructuring activities in Hanover, Germany and Ottawa, Canada. The Company recognizes contractual termination benefits when it is probable that employees will be entitled to benefits and the amount can be reasonably estimated. The Company recognizes one-time employee termination benefits when (i) management commits to a plan of termination, (ii) the plan identifies the number of employees to be terminated, their job classifications or functions and their locations, and the expected completion date, (iii) the plan establishes the terms of the benefit arrangement in sufficient detail to enable employees to determine the type and amount of benefits they will receive, and (iv) actions required to complete the plan indicate that it is unlikely that significant changes to the plan will be made or that the plan will be withdrawn. These charges are included in restructuring and other charges in the unaudited condensed consolidated statement of comprehensive income (loss).

(i) Recent Accounting Pronouncements

In October 2021, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2021-08, Business Combinations (Topic 805): Accounting for Contract Assets and Contract Liabilities from Contracts with Customers, which requires the Company to apply ASC 606, Revenue from Contracts with Customers, to recognize and measure contract assets and contract liabilities from contracts with customers acquired in a business combination. Before the update such balances were measured and recognized at fair value on the acquisition date. The ASU is effective for fiscal years beginning after December 15, 2022, including interim periods within those fiscal years. Early adoption is permitted, including in interim periods. The Company adopted these requirements prospectively, effective on the first day of the second quarter of year 2022. There was no material impact on our consolidated financial statements on the adoption date.

In June 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, which requires the Company to measure and recognize expected credit losses for financial assets held and not accounted for at fair value through net income. In November 2018, April 2019 and May 2019, the FASB issued ASU No. 2018-19, Codification Improvements to Topic 326, Financial Instruments - Credit Losses, ASU No. 2019-04, Codification Improvements to Topic 326, Financial Instruments - Credit Losses, and ASU No. 2019-05, Financial Instruments - Credit Losses (Topic 326): Targeted Transition Relief, which provided additional implementation guidance on the previously issued ASU. The Company adopted the updated guidance on January 1, 2022, utilizing the modified retrospective transition method and recorded a cumulative-effect adjustment of $0.4 million to retained earnings.

In March 2020, the FASB issued ASU No. 2020-04 (Topic 848), Reference Rate Reform - Facilitation of the Effects of Reference Rate Reform on Financial Reporting, which provides temporary optional expedients and exceptions to the existing guidance on contract modifications and hedge accounting to ease the financial reporting burdens related to the expected market transition from the London Interbank Offered Rate (LIBOR) and other interbank offered rates to alternative reference rates, such as the Secured Overnight Financing Rate. The standard was effective upon issuance and may generally be applied through December 31, 2022, to any new or amended contracts, hedging relationships, and other transactions that reference LIBOR. The ASU is not expected to have a material impact on our consolidated financial statements.

(2) Business Combinations

Optelian Acquisition

On February 5, 2021, the Company acquired Optelian Access Networks Corporation (“Optelian”), a corporation incorporated under the laws of Canada and registered extra-provincially in the Province of Ontario, pursuant to an acquisition agreement whereby the Company purchased all the outstanding shares of Optelian. Following the closing of the transaction, Optelian became the Company’s wholly owned subsidiary.

Optelian was a leading optical networking solution provider. This acquisition introduced the “O-Series” to the DZS portfolio of carrier grade optical networking products with up to 400 gigabits per second (Gig) and above capability, expanding the DZS product portfolio by providing environmentally hardened, high capacity, and flexible solutions at the network edge.

The purchase price of $7.5 million included cash paid to the shareholders and option holders of Optelian, cash paid to retire Optelian's outstanding debt on the date of acquisition, and contingent payments to shareholders.

The payment to shareholders and option holders included a $0.3 million holdback, which was released during the third quarter of 2022, and $1.9 million contingent consideration based on a certain percentage of future revenue of certain Optelian products through the end of 2023. We completed the purchase price allocation for Optelian acquisition in 2021. The purchase price allocation resulted in the recognition of goodwill of approximately $1.9 million, which primarily related to the expected synergies from combining operations.

RIFT Acquisition

On March 3, 2021, the Company acquired substantially all of the assets of RIFT, Inc., a network automation solutions company, and all the outstanding shares of RIFT.IO India Private Limited, a wholly owned subsidiary of RIFT, Inc. (collectively “RIFT”). RIFT developed a carrier-grade RIFT.ware software platform that simplifies the deployment of any slice, service, or application on any cloud. This acquisition introduced DZS Xtreme, a solution within the DZS Cloud portfolio, to the overall portfolio of DZS systems and software solutions. The total purchase consideration was $0.5 million, including a $0.2 million holdback that was released in April of 2021 following the fulfillment of certain requirements in the purchase agreement. We completed the purchase price allocation for RIFT acquisition in 2021. The purchase price allocation resulted in the recognition of goodwill of approximately $0.2 million, which primarily related to the expected synergies from combining operations.

ASSIA Acquisition

On May 27, 2022, the Company acquired certain assets and liabilities of Adaptive Spectrum and Signal Alignment, Incorporated (“ASSIA”), an industry pioneer of broadband access quality-of-experience and service assurance software solutions (the “ASSIA Acquisition”). The core assets acquired include the CloudCheck® Wi-Fi experience management and Expresse® access network optimization software solutions. These software solutions add powerful data analytics and network intelligence capabilities to DZS Cloud, including cloud-managed WiFi solutions, access network optimization and intelligent automation tools. The CloudCheck® and Expresse® solutions are currently deployed in over 125 million connected homes globally, and many of these connections now represent recurring software revenue opportunities for DZS.

The total purchase consideration was $25.0 million, including a $2.5 million holdback that will be released in 13 months following the transaction close date. In October 2022, the Company agreed to pay an additional $1.35 million of purchase consideration to settle certain unresolved matters related to the ASSIA acquisition. This additional purchase consideration will be reflected in subsequent financial statements of the Company.

The acquisition was recorded as a business combination with valuation of the assets acquired and liabilities assumed recorded at their acquisition date fair value determined using level three inputs, defined as unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. Due to the complexity of the valuation of the assets acquired and the liabilities assumed, and the timing of these activities, certain amounts included in the unaudited condensed consolidated financial statements, including working capital, long-lived assets, intangible assets, deferred taxes and goodwill, are provisional and subject to additional adjustments within the measurement period as permitted by Topic 805. In the third quarter of 2022, we recorded measurement-period adjustments related to working capital and intangible assets

acquired. These adjustments resulted into $2.2 million reduction of goodwill. The adjustments did not have a material impact on the amortization expense recorded in the previous quarter for intangible assets acquired.

The following summarizes the provisional estimated fair values of the assets acquired and liabilities assumed at the date of the ASSIA Acquisition (in thousands):


Provisional allocation of purchase consideration
Cash and cash equivalents	$	203
Accounts receivable		2,322
Other assets		407
Right-of-use assets		2,172
Property, plant and equipment		232
Intangible assets		22,200
Accounts payable		(91	)
Contract liabilities		(19,550	)
Operating lease liabilities		(2,612	)
Accrued and other liabilities		(909	)
Goodwill		20,626
Total purchase consideration	$	25,000

The provisional purchase price allocation resulted in the recognition of goodwill of approximately $20.6 million, which included the experienced workforce and the expected synergies from combining operations. The Company expects that the goodwill recognized will be deductible for tax purposes.

The following table represents the preliminary estimated fair value and useful lives of identifiable intangible assets acquired (estimated fair value in thousands):


	Estimated		Estimated
	fair value		useful life
Intangible assets acquired
Customer relationships	$	11,000	15 years
Customer backlog		4,900	10 years
Developed technology		6,100	5 - 7 years
Tradenames		200	10 years
Total intangible assets	$	22,200

(3) Fair Value Measurement

The Company utilizes a fair value hierarchy that is intended to increase consistency and comparability in fair value measurements and related disclosures. The fair value hierarchy is based on inputs to valuation techniques that are used to measure fair value that are either observable or unobservable. Observable inputs reflect assumptions market participants would use in pricing an asset or liability based on market data obtained from independent sources while unobservable inputs reflect a reporting entity’s pricing based upon their own market assumptions. The fair value hierarchy consists of the following three levels:


Level 1		Inputs are quoted prices in active markets for identical assets or liabilities.

Level 2		Inputs are quoted prices for similar assets or liabilities in an active market, quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable and market-corroborated inputs which are derived principally from or corroborated by observable market data.

Level 3		Inputs are derived from valuation techniques in which one or more significant inputs or value drivers are unobservable

Assets and Liabilities Measured at Fair Value on a Recurring Basis:

The carrying values of financial instruments such as cash and cash equivalents, restricted cash, accounts and other receivables, accounts payable and accrued liabilities approximate their fair values based on their short-term nature. The carrying value of the Company's debt approximates its fair values based on the current rates available to the Company for debt of similar terms and maturities.

The Company classifies its contingent liability from Optelian acquisition within Level 3 as it includes inputs not observable in the market. The Company estimates the fair value of contingent consideration as the present value of the expected contingent

payments, determined using the revenue forecast for certain Optelian products through the end of 2023. The fair value of contingent liability is generally sensitive to changes in the revenue forecast during the payout period. The change in the respective fair value is included in selling, marketing, general and administrative expenses on the unaudited condensed consolidated statement of comprehensive income (loss).

The following table reconciles the beginning and ending balances of the Company’s Level 3 contingent liability (in thousands):


	Nine Months Ended September 30,
	2022			2021
Balance at beginning of period	$	2,121		$	—
Initial fair value of contingent liability		—			1,897
Cash payments		(558	)		—
Net change in fair value		(516	)		219
Balance at end of period	$	1,047		$	2,116

(4) Cash, Cash Equivalents and Restricted Cash

As of September 30, 2022 and December 31, 2021, the Company's cash, cash equivalents and restricted cash consisted of financial deposits. Cash, cash equivalents and restricted cash held within the U.S. totaled $10.5 million and $22.3 million as of September 30, 2022 and December 31, 2021, respectively. Cash, cash equivalents and restricted cash held within the U.S. are held at FDIC insured depository institutions. Cash, cash equivalents and restricted cash held outside the U.S. totaled $10.5 million and $31.3 million as of September 30, 2022 and December 31, 2021, respectively. Restricted cash consisted primarily of cash collateral for performance bonds and warranty bonds. Long-term restricted cash was $0.2 million as of September 30, 2022 and December 31, 2021 and is included in other assets on the unaudited condensed consolidated balance sheets.

(5) Balance Sheet Details

Balance sheet detail as of September 30, 2022 and December 31, 2021 is as follows (in thousands):

Inventories


	September 30, 2022		December 31, 2021
Raw materials	$	41,793	$	34,512
Work in process		1,065		1,427
Finished goods		41,796		20,954
Total inventories	$	84,654	$	56,893

Inventories are stated at the lower of cost or net realizable value, with cost being computed based on an adjusted standard basis, which approximates actual cost on an average or first-in, first-out basis.

Property, plant and equipment


	September 30, 2022			December 31, 2021
Property, plant and equipment, net:
Machinery and equipment	$	15,944		$	14,278
Leasehold improvements		5,182			5,219
Computers and software		3,258			3,217
Furniture and fixtures		1,581			1,771
Construction in progress and other		1,077			2,937
		27,042			27,422
Less: accumulated depreciation and amortization		(17,723	)		(17,394	)
Less: government grants		(73	)		(186	)
Total property, plant and equipment, net	$	9,246		$	9,842

Depreciation expense associated with property, plant and equipment for the three and nine months ended September 30, 2022 was $0.9 million and $2.6 million, respectively. Depreciation expense associated with property, plant and equipment for the three and nine months ended September 30, 2021 was $0.7 million and $2.3 million, respectively.

Warranties

The Company accrues warranty costs based on historical trends for the expected material and labor costs to provide warranty services. The Company's standard warranty period is one year from the date of shipment with the ability for customers to

purchase an extended warranty of up to five years from the date of shipment. The following table summarizes the activity related to the product warranty liability:


	Nine Months Ended September 30,
	2022			2021
Balance at beginning of period	$	1,980		$	1,522
Charged to cost of revenue		323			636
Claims and settlements		(434	)		(745	)
Foreign exchange impact		(110	)		68
Balance at end of period	$	1,759		$	1,481

Contract Balances

The Company records contract assets when it has a right to consideration and records accounts receivable when it has an unconditional right to consideration. Contract liabilities consist of cash payments received (or unconditional rights to receive cash) in advance of fulfilling performance obligations. The majority of the Company's performance obligations in its contracts with customers relate to contracts with duration of less than one year.

The opening and closing balances of current and long-term contract assets and contract liabilities related to contracts with customers are as follows:


	Contract assets			Contract liabilities
December 31, 2021	$	2,184		$	9,135
September 30, 2022		573			31,213
Increase (decrease)	$	(1,611	)	$	22,078

The decrease in contract assets during the nine months ended September 30, 2022 was primarily due to invoicing that occurred in 2022 from unbilled balances reflected as contract assets as of December 31, 2021.

The increase in contract liabilities during the nine months ended September 30, 2022 was primarily due to the assumption of ASSIA contract liabilities in conjunction with the ASSIA Acquisition. Refer to Note 2 Business Combinations for further information. The amount of revenue recognized in the nine months ended September 30, 2022 that was included in the prior period contract liability balance was $5.4 million. This revenue consists of services provided to customers who had been invoiced prior to the current year. We expect to recognize approximately 75% of outstanding contract liabilities as revenue over the next 12 months and the remainder thereafter.

The balance of contract cost deferred as of September 30, 2022 and December 31, 2021 was $0.6 million and $0.8 million, respectively. During the nine months ended September 30, 2022, the Company recorded $0.6 million in amortization related to contract cost deferred as of December 31, 2021.

(6) Goodwill and Intangible Assets

The following table summarizes the activity related to goodwill (in thousands):


	September 30,
	2022			2021
Balance at beginning of period, gross	$	7,148		$	4,980
Accumulated impairment at beginning of period		(1,003	)		(1,003	)
Goodwill from acquisitions		20,626			2,168
Foreign exchange impact		7			—
Balance at end of period	$	26,778		$	6,145

During the nine months ended September 30, 2022, the Company recorded goodwill of $20.6 million related to the ASSIA Acquisition, which was allocated to the Americas reporting unit. Refer to Note 2 Business Combinations for further information.

Intangible assets consisted of the following (in thousands):


	September 30, 2022
	Gross Carrying Amount		Accumulated Amortization			Net
Customer relationships	$	16,730	$	(3,782	)	$	12,948
Customer backlog		4,900		(282	)		4,618
Developed technology		11,107		(4,095	)		7,012
In-process research and development		890		(296	)		594
Tradenames		200		(7	)		193
Total intangible assets, net	$	33,827	$	(8,462	)	$	25,365


	December 31, 2021
	Gross Carrying Amount		Accumulated Amortization			Net
Customer relationships	$	5,730	$	(2,886	)	$	2,844
Developed technology		5,007		(3,464	)		1,543
In-process research and development		890		(162	)		728
Total intangible assets, net	$	11,627	$	(6,512	)	$	5,115

During the nine months ended September 30, 2022, the Company recorded $11.0 million, $4.9 million, $6.1 million and $0.2 million in customer relationships, orders backlog, developed technology, and tradenames, respectively, related to the ASSIA Acquisition. Refer to Note 2 Business Combinations for further information.

Amortization expense associated with intangible assets for the three and nine months ended September 30, 2022 was $1.2 million and $1.9 million, respectively. Amortization expense associated with intangible assets for the three and nine months ended September 30, 2021 was $0.4 million and $1.3 million, respectively.

The following table presents the future amortization expense of the Company’s intangible assets as of September 30, 2022 (in thousands):


Remainder of 2022	$	1,095
2023		4,378
2024		4,378
2025		4,367
2026		3,192
Thereafter		7,955
Total	$	25,365

(7) Debt

JPMorgan Credit Agreement

On February 9, 2022, the Company entered into a Credit Agreement (the “Credit Agreement”) with the Company, as borrower, certain subsidiaries of the Company, as guarantors, the lenders party thereto and JPMorgan Chase Bank, N.A., as administrative agent. The Credit Agreement originally provided for revolving loans (the "Revolving Credit Facility") in an aggregate principal amount of up to $30.0 million, up to $15.0 million of which is available for letters of credit, and was scheduled to mature on February 9, 2024. The maximum amount that the Company can borrow under the Credit Agreement is subject to a borrowing base, which is based on a percentage of eligible accounts receivable and eligible inventory, subject to reserves and other adjustments, plus $10.0 million.

On May 27, 2022, the Company entered into a First Amendment to Credit Agreement (the “Amendment”), which amends the Credit Agreement dated February 9, 2022 with the Company, as borrower, certain subsidiaries of the Company, as guarantors, the lenders party thereto and JPMorgan Chase Bank, N.A., as administrative agent.

The Amendment, among other things, (1) provides for a term loan (the “Term Loan”) in an aggregate principal amount of $25.0 million with a maturity date of May 27, 2027, (2) extends the maturity date of the $30.0 million Revolving Credit Facility to May 27, 2025, (3) permits the ASSIA Acquisition, (4) modifies the applicable margin for borrowings under the Credit Agreement to be, at the Company’s option, either (i) the adjusted term SOFR rate plus a margin ranging from 3.0% to 3.5% per year or (ii) the prime rate plus a margin ranging from 2.0% to 2.5% per year, in each case depending on the Company’s leverage ratio, (5) modifies the letter of credit fee such that it ranges from 3.0% to 3.5%, depending on the Company’s leverage ratio, (6) modifies the commitment fee on the unused portion of the Revolving Credit Facility to range from 0.25% to 0.35% per year, depending on the Company’s leverage ratio, (7) modifies the method of calculating the leverage ratio, and (8) modifies the financial

covenants to (i) increase the maximum permitted leverage ratio to 3.00 to 1.00 through September 30, 2022, 2.50 to 1.00 thereafter through September 30, 2023, and 2.00 to 1.00 thereafter and (ii) replace the minimum liquidity requirement with a minimum permitted fixed charge coverage ratio of 1.25 to 1.00.

On May 27, 2022, the Company borrowed the full amount of the Term Loan to finance the ASSIA Acquisition. The Company capitalized $0.4 million of debt issuance cost related to execution of the Credit Agreement. Such cost is presented within other assets on the Company’s unaudited condensed consolidated balance sheet. The Company capitalized $0.3 million of debt issuance cost related to execution of the Amendment. Such cost is presented as a direct deduction from the long-term debt obligation on the Company’s unaudited condensed consolidated balance sheet. As of September 30, 2022, the Company's long-term debt obligation was $23.1 million, net of the current portion of $1.3 million, and unamortized issuance cost of $0.3 million. The Company had $7.0 million outstanding debt and $1.5 million in letters of credit issued under the $30.0 million Revolving Credit Facility as of September 30, 2022, and $21.5 million was available to the Company for additional borrowing. The Company had no debt obligation as of December 31, 2021.

The future principal maturities of the Term Loan for each of the next five years are as follows (in thousands):


Remainder of 2022	$	313
2023		1,250
2024		1,563
2025		1,875
2026		2,188
Thereafter		17,499
Total	$	24,688

The Company was in compliance with all debt covenants as of September 30, 2022.

(8) Employee Benefit Plans

Defined Contribution Plans

The Company maintains a 401(k) plan for its employees in the US whereby eligible employees may contribute up to a specified percentage of their earnings, on a pretax basis, subject to the maximum amount permitted by the Internal Revenue Code. Under the 401(k) plan, the Company made discretionary contributions to the plan in 2021. For the three and nine months ended September 30, 2022, the Company recorded an expense of $0.3 million and $0.7 million, respectively. For the three and nine months ended September 30, 2021, the Company recorded an expense of $0.1 million and $0.4 million, respectively.

The Company maintains a defined contribution plan for its employees in Korea. Under the defined contribution plan, the Company contributes the equivalent of 8.3% of an employee's gross salary into the plan. For the three and nine months ended September 30, 2022, the Company recorded an expense of $0.3 million and $0.9 million, respectively. For the three and nine months ended September 30, 2021, the Company recorded an expense of $0.3 million and $0.9 million, respectively.

Defined Benefit Plans

The Company sponsors defined benefit plans for its employees in Germany and Japan. Defined benefit plans provide pension benefits based on compensation and years of service. The Germany plans were frozen as of September 30, 2003 and have not been offered to new employees after that date. The Company has recorded the underfunded status as of September 30, 2022 and December 31, 2021 as a long-term liability on the unaudited condensed consolidated balance sheets. The accumulated benefit obligation for the plans in Germany and Japan was $14.0 million and $16.5 million as of September 30, 2022 and December 31, 2021, respectively. Periodic benefit costs for the three and nine months ended September 30, 2022 were $0.1 million and $0.2 million, respectively. Periodic benefit costs for the three and nine months ended September 30, 2021 were $0.1 million and $0.2 million, respectively.

The Company holds life insurance contracts, with the Company as beneficiary, in the amount of $2.2 million as of September 30, 2022 and $2.9 million as of December 31, 2021, respectively, related to individuals under the pension plans. The Company records these insurance contracts based on their cash surrender value at the balance sheet dates. These insurance contracts are classified as other assets on the Company’s unaudited condensed consolidated balance sheet. The Company intends to use any proceeds from these policies to fund the pension plans. However, since the Company is the beneficiary on these policies, these assets have not been designated pension plan assets.

Stock Incentive Plans

The Company’s DASAN Zhone Solutions, Inc. 2017 Incentive Award Plan (“2017 Plan”) authorizes the issuance of stock options, restricted stock, restricted stock units, dividend equivalents, stock payment awards, stock appreciation rights, performance bonus awards and other incentive awards. The 2017 Plan authorizes the grant of awards to employees, non-employee directors and consultants of the Company and its subsidiaries.

In the third quarter of 2022, certain employees were provided a limited opportunity to exchange two stock options granted under 2017 Plan for one restricted stock unit with the vesting period equal the remaining vesting period for options as of the exchange date. The Company accounted for the exchange as a modification of share-based payments. No incremental expense was recorded in conjunction with the modification.

(9) Restructuring and Other Charges

In 2021, the Company made the strategic decision to relocate manufacturing functions of DZS GmbH and Optelian to Seminole, Florida and to transition the above subsidiaries to sales and research and development centers. The Company incurred approximately $13.1 million of restructuring and other charges since the beginning of its restructuring activities in the first quarter of 2021. For the three and nine months ended September 30, 2022, the Company recorded zero and $0.8 million of restructuring related costs, respectively, consisting primarily of logistics costs and professional services related to legal and accounting support. For the three and nine months ended September 30, 2021, the Company recorded $6.8 million and $12.1 million of restructuring related costs, respectively, consisting primarily of severance and other termination related benefits, an impairment of long-lived assets charge primarily related to right-of-use assets from operating leases, logistics costs and professional services. The Company paid in full its liability related to termination benefits as of September 30, 2022.

On September 17, 2022, DZS signed an agreement with Fabrinet, a third-party provider of electro-mechanical and electronic manufacturing and distribution services, to transition the sourcing, procurement, order-fulfillment, manufacturing and return merchandise authorization activities in the Company's Seminole, Florida facility to Fabrinet. The agreement was announced on October 4, 2022 and the transition to Fabrinet began in October 2022 with the goal of being fully operational by the beginning of 2023. Post transition, the DZS Seminole, Florida-based operations, supply chain and manufacturing workforce will be reduced by approximately two-thirds and the remaining team will be relocated to an appropriately sized facility. For the three and nine months ended September 30, 2022, the Company recorded a $0.4 million loss on inventory to be sold to Fabrinet, which was included in restructuring and other charges in the unaudited condensed consolidated statement of comprehensive income (loss). The Company also recorded $0.2 million of restructuring for personnel related costs. No other restructuring charges were recorded by the Company during the period. The Company will account for the one-time employee termination benefits in accordance with ASC 420, Exit or Disposal Cost Obligations, and will recognize the respective liability when the final terms of the benefit arrangement are communicated to the affected employees.

(10) Related Party Transactions

Related Party Guarantees

The following table sets forth payment guarantees of the Company's obligations as of September 30, 2022 that have been provided by Dasan Networks, Inc. ("DNI"). DNI owns approximately 36.1% of the outstanding shares of the Company's common stock. The amount guaranteed exceeds the principal amounts of outstanding obligations due to collateral requirements by the banks.


Guarantor	Amount Guaranteed (in thousands)		Description of Obligations Guaranteed
Dasan Networks, Inc.	$	4,952	Payment guarantee to Industrial Bank of Korea
Dasan Networks, Inc.		1,312	Payment guarantee to Shinhan Bank
	$	6,264

Other Related Party Transactions

Sales, cost of revenue, research and product development, selling, marketing, general and administrative, interest expense and other expenses to and from related parties were as follows (in thousands) for the three and nine months ended September 30, 2022 and 2021:


	Three Months Ended September 30, 2022
Counterparty	Sales		Cost of revenue		Research and product development		Selling, marketing, general and administrative		Interest expense		Other expenses
Dasan Networks, Inc.	$	98	$	67	$	—	$	167	$	—	$	15
DS Commerce, Inc.		—		4		—		10		—		—
	$	98	$	71	$	—	$	177	$	—	$	15

	Three Months Ended September 30, 2021
Counterparty	Sales		Cost of revenue		Research and product development		Selling, marketing, general and administrative		Interest expense		Other expenses
Dasan Networks, Inc.	$	54	$	45	$	253	$	394	$	—	$	42
Dasan Invest Co., Ltd.		—		10		43		19		—		—
	$	54	$	55	$	296	$	413	$	—	$	42


	Nine Months Ended September 30, 2022
Counterparty	Sales		Cost of revenue		Research and product development		Selling, marketing, general and administrative		Interest expense		Other expenses
Dasan Networks, Inc.	$	1,014	$	873	$	90	$	800	$	—	$	48
DS Commerce, Inc.		—		26		3		29		—		—
	$	1,014	$	899	$	93	$	829	$	—	$	48

	Nine Months Ended September 30, 2021
Counterparty	Sales		Cost of revenue		Research and product development		Selling, marketing, general and administrative		Interest expense		Other expenses
Dasan Networks, Inc.	$	1,965	$	1,791	$	776	$	1,185	$	132	$	180
Dasan Invest Co., Ltd.		—		30		134		57		—		—
	$	1,965	$	1,821	$	910	$	1,242	$	132	$	180

The Company has entered into sales agreements with DNI to sell certain services and finished goods produced by the Company. The Company also has an agreement with DNI in which DNI acts as a sales channel to third party customers. The above transactions are included in sales and cost of revenue on the unaudited condensed consolidated statement of comprehensive income (loss). Sales to DNI are recorded net of royalty fees for a sales channel arrangement.

DNS Korea has a lease agreement with DNI related to the lease of a warehouse facility. DNS Korea also had a separate office lease agreement with DNI. In the first quarter of 2022, DNI sold the office building to the unrelated third party, and the respective lease was reassigned to the new landlord. Operating lease cost related to the DNI leases totaled $0.1 million and $0.5 million for the three and nine months ended September 30, 2022, respectively. Operating lease cost related to the DNI leases totaled $0.4 million and $1.3 million for the three and nine months ended September 30, 2021, respectively. Operating lease expense is allocated between cost of revenue, research and product development, and selling, marketing, general and administrative expenses on the unaudited condensed consolidated statement of comprehensive income (loss). Deposits for the DNI office lease were included in other assets on the consolidated balance sheets as of December 31, 2021.

DNS Korea had an agreement with Dasan Invest Co., Ltd. to provide IT services for the Company. The agreement was terminated in the fourth quarter of 2021 and the new agreement was signed with DS Commerce, Inc. Both entities have an affiliation with DZS board members. The expense related to the above IT services is allocated between cost of revenue, research and product development, and selling, marketing, general and administrative expenses on the unaudited condensed consolidated statement of comprehensive income (loss).

Interest expense represents interest paid to DNI for the related party debt. The respective debt was fully repaid in the first quarter of 2021.

Other expenses represent charges from DNI for its payment guarantees relating to the Company's borrowings. The Company pays DNI a guarantee fee which is calculated as 0.9% of the guaranteed amount. Refer to the table above for further information about obligations guaranteed by DNI.

Balances of Receivables and Payables with Related Parties

Balances of receivables and payables arising from sales and purchases of goods and services with related parties as of September 30, 2022 and December 31, 2021 were included in the following balance sheet captions on the unaudited condensed consolidated balance sheets, as follows (in thousands):


	As of September 30, 2022
Counterparty	Account receivables		Other receivables		Other assets		Accounts payable
Dasan Networks, Inc.	$	484	$	98	$	—	$	659
DS Commerce, Inc.		—		—		—		14
	$	484	$	98	$	—	$	673


	As of December 31, 2021
Counterparty	Account receivables		Other receivables		Other assets		Accounts payable
Dasan Networks, Inc.	$	181	$	215	$	691	$	785
DS Commerce, Inc.		—		—		—		46
	$	181	$	215	$	691	$	831

(11) Net Income (Loss) Per Share

Basic net income (loss) per share is computed by dividing the net income (loss) for the period by the weighted average number of shares of common stock outstanding during the period. The calculation of diluted net income (loss) per share gives effect to common stock equivalents; however, potential common stock equivalents are excluded if their effect is antidilutive. Potential common stock equivalents are composed of incremental shares of common stock issuable upon the exercise of stock options and the vesting of restricted stock units. In periods when a net loss is reported, all common stock equivalents are excluded from the calculation because they would have an anti-dilutive effect, meaning the loss per share would be reduced. Therefore, in periods when a loss is reported, basic and dilutive loss per share are the same.

The following table is a reconciliation of the numerator and denominator in the basic and diluted net income (loss) per share calculation (in thousands, except per share data) for the three and nine months ended September 30, 2022, and 2021:


	Three months ended September 30,						Nine months ended September 30,
	2022			2021			2022			2021
Net income (loss)	$	(13,796	)	$	(5,896	)	$	(22,872	)	$	(32,400	)
Weighted average number of shares outstanding:
Basic		27,902			27,201			27,696			26,484
Effect of dilutive securities:
Stock options, restricted stock units and share awards		—			—			—			—
Diluted		27,902			27,201			27,696			26,484
Net income (loss) per share:
Basic	$	(0.49	)	$	(0.22	)	$	(0.83	)	$	(1.22	)
Diluted	$	(0.49	)	$	(0.22	)	$	(0.83	)	$	(1.22	)

The following table sets forth potential common stock that is not included in the diluted net income (loss) per share calculation above because their effect would be anti-dilutive for the periods indicated (in thousands):


	Three months ended September 30,				Nine months ended September 30,
	2022		2021			2022	2021
Outstanding stock options		689		966		854	773
Unvested restricted stock units		415		331		306	238

(12) Leases

The Company leases certain properties and buildings (including manufacturing facilities, warehouses, and office spaces) and equipment under various arrangements which provide the right to use the underlying asset and require lease payments for the lease term. The Company’s lease portfolio consists of operating leases which expire at various dates through 2028.

Assets and liabilities related to operating leases are included in the consolidated balance sheets as right-of-use assets from operating leases, operating lease liabilities - current and operating lease liabilities - non-current. The Company recognizes minimum rental expense on a straight-line basis based on the fixed components of a lease arrangement. The Company amortizes this expense over the term of the lease beginning with the date of initial possession, which is the date the lessor makes an underlying asset available for use. For the three and nine months ended September 30, 2022, the Company recognized lease expense of $1.1 million and $3.2 million, respectively. For the three and nine months ended September 30, 2021, the Company recognized lease expense of $1.3 million and $4.4 million, respectively.

During the nine months ended September 30, 2022, the Company recorded $0.8 million in impairment charges on the right-of-use assets related to the office lease in Redwood City, California, acquired in conjunction with ASSIA Acquisition. Following the acquisition, the Company made a decision to vacate the space in Redwood City and to adopt a remote work policy in the region.

The following table presents the maturity of the Company’s operating lease liabilities as of September 30, 2022 (in thousands):


Remainder of 2022	$	1,574
2023		4,968
2024		4,595
2025		3,346
2026		2,065
Thereafter		1,677
Total operating lease payments		18,225
Less: imputed interest		(2,261	)
Total operating lease liabilities	$	15,964

(13) Commitments and Contingencies

Performance Guarantees

In the normal course of operations, from time to time, the Company arranges for the issuance of various types of performance guarantees, such as standby letters of credit or surety bonds. These instruments are arrangements under which the financial institution or surety provides a financial guarantee that the Company will perform in accordance with contractual or legal obligations. As of September 30, 2022, the Company had $8.4 million of performance guarantees in the form of bank guarantees or surety bonds guaranteed by third parties.

Trade Compliance Matter

During the first quarter of 2022, the Company received a notice letter from the Office of the Commissioner of Customs of the India Department of Revenue (the “Notice”) claiming the Company had mis-declared and wrongly classified certain products imported to India by the Company at the time of clearance of customs. The Notice claims that due to such mis-declaration and wrong classification of the imported products, the Company and its contract manufacturer in India underpaid duties approximating $3.9 million related to such products. The Company intends to vigorously defend itself in this matter. As we have not yet received the full contents of the Notice, we are unable to estimate a potential loss related to this matter, if any, which could range up to the full amount of the unpaid duties, plus penalties and interest.

In addition to the Notice discussed above, from time to time, the Company is subject to various legal proceedings, claims and litigation arising in the ordinary course of business. While the outcome of these matters is currently not determinable, the Company records an accrual for legal contingencies that it has determined to be probable to the extent that the amount of the loss can be reasonably estimated. The Company does not expect that the ultimate costs to resolve these matters will have a material adverse effect on its consolidated financial position, results of operations or cash flows. However, litigation is subject to inherent uncertainties, and unfavorable rulings could occur. If an unfavorable ruling were to occur, there exists the possibility of a material adverse impact on the results of operations and cash flows of the reporting period in which the ruling occurs, or future periods.

(14) Income Taxes

Income tax expense for the three and nine months ended September 30, 2022 was approximately $6.1 million and $1.9 million on pre-tax losses of $7.7 million and $21.0 million, respectively. In the third quarter of 2022, the Company derecognized the tax benefits previously recorded in the first and second quarters of 2022 based on its quarterly realizability assessment of such benefits. Income tax expense for the three and nine months ended September 30, 2021 was approximately $0.7 million and $2.0 million respectively, on pre-tax losses of $5.2 and $30.4 million, respectively.

As of September 30, 2022, the income tax rate varied from the United States statutory income tax rate primarily due to the derecognition of tax benefits previously recognized in the first and second quarters of 2022 as discussed above. Consistent with the prior periods, the Company continued to maintain valuation allowances in North America, EMEA and Asia.

(15) Enterprise-Wide Information

The Company is a global provider of ultra-broadband network access solutions and communications platforms deployed by advanced Tier 1, national and regional service providers and enterprise customers. There are no segment managers who are held accountable for operations, operating results and plans for levels or components below the Company unit level. Accordingly, the Company is considered to be in a single operating segment. The Company’s chief operating decision maker is the Company’s Chief Executive Officer, who reviews financial information presented on a consolidated basis accompanied with disaggregated revenues by geographic region for purposes of making operating decisions and assessing financial performance.

The Company attributes revenue from customers to individual countries based on location shipped. Refer to Note 1(e) Disaggregation of Revenue for the required disclosures on geographical concentrations and revenues by source.

The Company's property, plant and equipment, net of accumulated depreciation, were located in the following geographical areas (in thousands) as of September 30, 2022 and December 31, 2021:


	September 30, 2022		December 31, 2021
United States	$	6,740	$	6,105
Korea		1,511		2,367
Japan		598		799
Canada		181		280
Germany		109		210
Other		107		81
	$	9,246	$	9,842

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

As used in this Quarterly Report on Form 10-Q, unless the context suggests otherwise, the terms “DZS,” the “Company” “we,” “our” and “us” refer to DZS Inc. and its subsidiaries.

Forward-Looking Statements

This Quarterly Report on Form 10-Q, including “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” contains forward-looking statements regarding future events and our future results that are subject to the safe harbors created under the Securities Act of 1933 (the “Securities Act”) and the Securities Exchange Act of 1934 (the “Exchange Act”). These statements are based on current expectations, estimates, forecasts, and projections about the industries in which we operate, and reflect the beliefs and assumptions of our management as of the date hereof.

We use words such as “anticipate,” “believe,” “continue,” “could,” “estimate,” “expect,” “forecast,” “goal,” “intend,” “may,” “plan,” “project,” “seek,” “should,” “target,” “will,” “would,” variations of such words, and similar expressions to identify forward-looking statements. In addition, statements that refer to projections of earnings, revenue, costs or other financial items in future periods; anticipated growth and trends in our business, industry or key markets; cost synergies, growth opportunities and other potential financial and operating benefits of our acquisitions; future growth and revenues from our products; our plans and our ability to refinance or repay our existing indebtedness prior to the applicable maturity dates; our ability to access capital to fund our future operations; future economic conditions and performance; the impact of the global outbreak of COVID-19, also known as the coronavirus; the impact of interest rate and foreign currency fluctuations; anticipated performance of products or services; competition; plans, objectives and strategies for future operations, including our pursuit or strategic acquisitions and our continued investment in research and development; other characterizations of future events or circumstances; and all other statements that are not statements of historical fact, are forward-looking statements within the meaning of the Securities Act and the Exchange Act. Although we believe that the assumptions underlying the forward-looking statements are reasonable, we can give no assurance that our expectations will be attained. Readers are cautioned not to place undue reliance on such forward-looking statements, which are being made as of the date of this Quarterly Report on Form 10-Q. Except as required by law, we undertake no obligation to update any forward-looking statements, whether as a result of new information, future events or otherwise.

Factors which could have a material adverse effect on our operations and future prospects or which could cause actual results to differ materially from our expectations include factors discussed in Part I, Item 1A “Risk Factors” of our Annual Report on Form 10-K, as well as factors described from time to time in our future reports filed with the U.S. Securities and Exchange Commission (the “SEC”).

OVERVIEW

We are a global provider of access and optical networking infrastructure and cloud software solutions that enable the emerging hyper-connected, hyper-broadband world and broadband experiences. The Company provides a wide array of reliable, cost-effective networking technologies and software to a diverse customer base.

We research, develop, test, sell, manufacture and support platforms in the areas of mobile transport and fixed broadband access, as discussed below. We have extensive regional development and support centers around the world to support our customer needs.

Our solutions and platforms portfolio include products in the Access Edge, Subscriber Edge, Optical Edge, and Cloud Software.

•

Access Edge. Our DZS Velocity portfolio offers a variety of solutions for carriers and service providers to connect residential and business customers, either using high-speed fiber or leveraging their existing deployed copper networks to offer broadband services to customer premises. Once our broadband access products are deployed, the service provider can offer voice, high-definition and ultra-high-definition video, highspeed internet access and business class services to their customers. In addition, the switching and routing products we provide in this space offer a high-performance and manageable solution that bridges the gap from carrier access technologies to the core network. XCelerate by DZS increases the velocity with which service providers can leap to multi-gigabit services at scale by enabling rapid transition from Gigabit Ethernet Passive Optical Network (“GPON”) to 10 Gigabit Symmetrical Passive Optical Network (“XGS-PON”) and Gigabit Ethernet to 10 Gigabit Ethernet via any service port across a range of existing DZS Velocity chassis and 10 gig optimized stackable fixed form factor units.

•

Subscriber Edge. Our DZS Helix connected premises product portfolio offers a large collection of optical network terminals (“ONTs”) and smart gateway solutions for any fiber to the “x” (“FTTx”) deployment. DZS ONTs and Smart Gateway platforms are designed for high bandwidth services being deployed to the home or business. Our connected premises portfolio consists of indoor/outdoor ONTs and gateways delivering best-in-class data and WiFi

throughout the premises to support the most demanding FTTx applications. The product feature set gives service providers an elegant migration path from legacy to soft switch architectures without replacing ONTs.

•

Optical Edge. Our DZS Chronos portfolio provides a robust, manageable and scalable solution for mobile operators and service providers that enable them to upgrade their mobile fronthaul/midhaul/backhaul (“xHaul”) systems and migrate to fifth generation wireless technologies (“5G”) and beyond as well as deliver robust edge transport. DZS Chronos provides a full range of 5G-ready xHaul and coherent optical capable solutions that are open, software-defined, and field proven. Our mobile xHaul and edge transport products may be collocated at the radio access node base station and can aggregate multiple radio access node base stations into a single backhaul for delivery of mobile traffic to the radio access node network controller or be leveraged as transport vehicles for FTTx deployments. Our products support pure Ethernet switching as well as layer 3 IP and Multiprotocol Label Switching (“MPLS”), and we interoperate with other vendors in these networks.

•

Cloud Software. Our DZS Cloud platform provides software capabilities specifically in the areas of network orchestration, application slicing, automation, analytics, service assurance, and consumer broadband experience. Via our DZS Xtreme solutions we offer a commercial, carrier-grade network-slicing enabled orchestration platform complementing our position with physical network devices supporting Open RAN (“O-RAN”) and 4G/5G networks. Communications service providers are implementing software defined networking (“SDN”) and network functions virtualization (“NFV”) architectures to reduce reliance on proprietary systems and hardware, which increase service agility, flexibility, and deployment of new network services while lowering costs. Via our DZS Xperience solutions, we enable advanced WiFi experience management and analytics solutions. Communications service providers are implementing experience and service assurance solutions to reduce support costs, including specifically the costs of WiFi troubleshooting and truck rolls, improve service performance and customer satisfaction, and ultimately reduce subscriber churn and increase average revenue per user (ARPU).

Our key financial objectives include the following:

•

Increasing revenue while continuing to carefully control costs;

•

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

•

Minimizing consumption of our cash and cash equivalents; and

•

Improving gross margin through a wide range of initiatives, including an increase in the mix of recurring software revenue.

RECENT DEVELOPMENTS

On February 9, 2022, the Company entered into a Credit Agreement with the Company, as borrower, certain subsidiaries of the Company, as guarantors, the lenders party thereto and JPMorgan Chase Bank, N.A., as administrative agent. The Credit Agreement originally provided for revolving loans in an aggregate principal amount of up to $30.0 million, up to $15.0 million of which is available for letters of credit, and was scheduled to mature on February 9, 2024. On May 27, 2022, the Company entered into a First Amendment to Credit Agreement, which amends the Credit Agreement dated February 9, 2022. The Amendment, among other things, provides for a Term Loan in an aggregate principal amount of $25.0 million with a maturity date of May 27, 2027 and extends the maturity date of the $30.0 million Revolving Credit Facility to May 27, 2025. On May 27, 2022, the Company borrowed the full amount of the Term Loan to finance the ASSIA Acquisition discussed below. During the third quarter of 2022, the Company borrowed $9.0 million and repaid $2.0 million under the revolving facility.

On May 27, 2022, the Company acquired certain assets and liabilities of ASSIA, an industry pioneer of broadband access quality-of-experience software solutions. The core assets acquired include the CloudCheck® Wi-Fi experience management and Expresse® access network optimization software solutions. These software solutions add powerful data analytics and network intelligence capabilities to DZS Cloud, including cloud-managed WiFi solutions, access network optimization and intelligent automation tools. The total purchase consideration was $25.0 million, including a $2.5 million holdback that will be released 13 months following the transaction close date. In October 2022, the Company agreed to pay an additional $1.35 million of purchase consideration to settle certain unresolved matters related to the ASSIA acquisition.

RESULTS OF OPERATIONS

The table below presents the unaudited condensed consolidated statement of (loss) income with year-over-year changes (in thousands except percent change).


	Three months ended September 30,									Nine months ended September 30,
	2022			2021			% change			2022			2021			% change

Net revenue	$	107,394		$	88,412			21.5	%	$	275,514		$	252,143			9.3	%
Cost of revenue		70,864			56,213			26.1	%		187,216			164,771			13.6	%
Gross profit		36,530			32,199			13.5	%		88,298			87,372			1.1	%
Operating expenses:
Research and product development		15,499			11,707			32.4	%		39,691			34,788			14.1	%
Selling, marketing, general and administrative		23,698			19,539			21.3	%		61,953			69,619			-11.0	%
Restructuring and other charges		601			6,754			-91.1	%		1,393			12,098			-88.5	%
Impairment of long-lived assets		827			—			100.0	%		827			1,735			-52.3	%
Amortization of intangible assets		1,190			312			281.4	%		1,948			888			119.4	%
Total operating expenses		41,815			38,312			9.1	%		105,812			119,128			-11.2	%
Operating loss		(5,285	)		(6,113	)		-13.5	%		(17,514	)		(31,756	)		-44.8	%
Interest income		47			20			135.0	%		120			81			48.1	%
Interest expense		(446	)		(49	)		810.2	%		(773	)		(326	)		137.1	%
Other income (expense), net		(1,984	)		922			-315.2	%		(2,847	)		1,633			-274.3	%
Loss before income taxes		(7,668	)		(5,220	)		46.9	%		(21,014	)		(30,368	)		-30.8	%
Income tax provision (benefit)		6,128			676			806.5	%		1,858			2,032			-8.6	%
Net loss	$	(13,796	)	$	(5,896	)		134.0	%	$	(22,872	)	$	(32,400	)		-29.4	%

The table below presents the unaudited condensed consolidated statement of (loss) income as a percentage of total net revenue for the periods indicated.


	Three months ended September 30,						Nine months ended September 30,
	2022			2021			2022			2021
Net revenue		100	%		100	%		100	%		100	%
Cost of revenue		66	%		64	%		68	%		65	%
Gross profit		34	%		36	%		32	%		35	%
Operating expenses:
Research and product development		14	%		13	%		14	%		14	%
Selling, marketing, general and administrative		22	%		22	%		22	%		28	%
Restructuring and other charges		1	%		8	%		1	%		5	%
Impairment of long-lived assets		1	%		—			—			1	%
Amortization of intangible assets		1	%		—			1	%		—
Total operating expenses		39	%		43	%		38	%		48	%
Operating income (loss)		(5	)%		(7	)%		(6	)%		(13	)%
Interest income		—			—			—			—
Interest expense		—			—			—			—
Other income (expense), net		(2	)%		1	%		(1	)%		1	%
Income (loss) before income taxes		(7	)%		(6	)%		(7	)%		(12	)%
Income tax provision (benefit)		6	%		1	%		1	%		1	%
Net income (loss)		(13	)%		(7	)%		(8	)%		(13	)%

Net Revenue

The following table presents our revenues by source (in millions):


	Three months ended September 30,							Nine months ended September 30,
	2022		2021		% change			2022		2021		% change
Products	$	91.7	$	82.9		10.6	%	$	247.5	$	237.1		4.4	%
Services and software		15.7		5.5		185.5	%		28.0		15.1		85.4	%
Total	$	107.4	$	88.4		21.5	%	$	275.5	$	252.2		9.2	%

For the three months ended September 30, 2022, product revenue increased by 10.6% or $8.8 million to $91.7 million from $82.9 million in the same period last year. The increase in product revenue during the period was primarily attributable to higher spending levels from our major customers in Asia, partially offset by the impact of unfavorable foreign exchange rate fluctuations. Service and software revenue represents revenue from maintenance and other services associated with product shipments as well as ASSIA related software revenue. The increase in service and software revenue was primarily due to the increased product and software sales, including revenue related to ASSIA.

For the nine months ended September 30, 2022, product revenue increased by 4.4% or $10.4 million to $247.5 million from $237.1 million in the same period last year. The increase in product revenue during the period was primarily attributable to increased sales of our mobile transport and fixed broadband connectivity products and partly as a result of recovering from the impacts of the COVID-19 pandemic. The increase in service and software revenue was primarily due to the increased product and software sales and revenue related to the ASSIA Acquisition.

The following table presents our revenues by geographical concentration (in millions):


	Three months ended September 30,							Nine months ended September 30,
	2022		2021		% change			2022		2021		% change
Americas	$	27.6	$	27.3		1.1	%	$	78.9	$	74.0		6.6	%
Europe, Middle East, Africa		26.6		20.4		30.4	%		58.4		55.0		6.2	%
Asia		53.2		40.7		30.7	%		138.2		123.2		12.2	%
Total	$	107.4	$	88.4		21.5	%	$	275.5	$	252.2		9.2	%

Our geographic diversification reflects the combination of market demand, a strategic focus on capturing market share through new customer wins and new product introductions.

From a geographical perspective, the increase in net revenue for the three and nine months ended September 30, 2022 was attributable to increased revenue in all regions driven by increased spending levels from our major customers and revenue related to the ASSIA Acquisition.

We anticipate that our results of operations in any given period may depend to a significant extent on sales to a small number of large customers. As a result, our revenue for any quarter may be subject to significant volatility based upon changes in orders from one or a small number of key customers.

Cost of Revenue and Gross Profit

Total cost of revenue increased by 26.1% to $70.9 million for the three months ended September 30, 2022, compared to $56.2 million for the three months ended September 30, 2021. Total cost of revenue was 66.0% of net revenue for the three months ended September 30, 2022, compared to 63.6% of net revenue for the three months ended September 30, 2021, which resulted in an decrease in gross profit percentage to 34.0% for the three months ended September 30, 2022 from 36.4% for the three months ended September 30, 2021. The increase in total cost of revenue was primarily due to an increase in revenue combined with fees paid to expedite certain product components, while the decrease in gross profit percentage was primarily due to the change in number and mix of products sold, including the geographic mix of those sales, negative exchange rate impacts on revenues and such expedite fees.

Total cost of revenue increased by 13.6% to $187.2 million for the nine months ended September 30, 2022, compared to $164.8 million for the nine months ended September 30, 2021. Total cost of revenue was 68.0% of net revenue for the nine months ended September 30, 2022, compared to 65.3% of net revenue for the nine months ended September 30, 2021, which resulted in an decrease in gross profit percentage to 32.0% for the nine months ended September 30, 2022 from 34.7% for the nine months ended September 30, 2021. The increase in total cost of revenue was primarily due to an increase in revenue combined with fees paid to expedite certain product components, while the decrease in gross profit percentage was primarily due to the change in number and mix of products sold, including the geographic mix of those sales, negative exchange rate impacts on revenues and such expedite fees.

Operating Expenses

Research and Product Development Expenses: Research and product development expenses include personnel costs, outside contractor and consulting services, depreciation on lab equipment, costs of prototypes and overhead allocations.

Research and product development expenses increased by 32.4% to $15.5 million for the three months ended September 30, 2022 compared to $11.7 million for the three months ended September 30, 2021. Research and product development expenses increased by 14.1% to $39.7 million for the nine months ended September 30, 2022 compared to $34.8 million for the nine

months ended September 30, 2021. The increase in research and product development expenses was primarily due to strategic hiring decisions in research, development, and product line management with the intent to accelerate growth and capture market share and the ASSIA Acquisition.

We intend to continue to invest in research and product development to attain our strategic product development objectives, while seeking to manage the associated costs through expense controls.

Selling, Marketing, General and Administrative Expenses: Selling, marketing, general and administrative expenses include personnel costs for sales, marketing, administration, finance, information technology, human resources and general management as well as legal and accounting expenses, rent, utilities, trade show expenses and related travel costs.

Selling, marketing, general and administrative expenses increased by 21.3% to $23.7 million for the three months ended September 30, 2022 compared to $19.5 million for the three months ended September 30, 2021. The increase was primarily due to higher stock-based compensation and strategic hiring decisions across sales and administration with the intent to accelerate growth and capture market share.

Selling, marketing, general and administrative expenses decreased by 11.0% to $62.0 million for the nine months ended September 30, 2022 compared to $69.6 million for the nine months ended September 30, 2021. The decrease was primarily due to $14.2 million of bad debt expense recorded in the first quarter of 2021 for one customer in India. Refer to Note 1 in the Notes to Unaudited Condensed Consolidated Financial Statements for further information on the bad debt expense. The above impact was partially offset by higher stock-based compensation and strategic hiring decisions across sales and administration with the intent to accelerate growth and capture market share.

Restructuring and Other Charges: Restructuring and other charges for the nine months ended September 30, 2022 and 2021 related primarily to the strategic decisions in the third quarter of 2022 to outsource manufacturing from the Company's Seminole, Florida facility to Fabrinet, and in 2021, to transition DZS GmbH and Optelian to sales and research and development centers. For the three months ended September 30, 2022, the Company recorded $0.6 million, consisting of $0.2 million of personnel costs and $0.4 million of inventory valuation adjustments related to the Seminole transition and for the nine months ended September 30, 2022, the Company recorded $1.4 million, consisting of $0.6 million related to the Seminole transition and $0.8 million of logistics costs and professional services related to legal and accounting support for the DZS GmbH transition. See Note 9 Restructuring and Other Charges of the Notes to Unaudited Condensed Consolidated Financial Statements, for further information.

Impairment of Long-lived Assets: Impairment of long-lived assets for the three and nine months ended September 30, 2022 was $0.8 million for the right-of use assets from operating leases in connection with vacating the office space in Redwood City, California. Refer to Note 12 in the Notes to Unaudited Condensed Consolidated Financial Statements for further information. Impairment of long-lived assets for the nine months ended September 30, 2021 was $1.7 million for the right-of use assets from operating leases in connection with the relocation of the headquarters to Plano, Texas.

Interest Income (Expense), net: Interest income (expense) relates mainly to earnings from our cash and cash equivalents, interest expense associated with the credit facilities and amortization of debt issuance costs associated with obtaining such credit facilities. For the three and nine months ended September 30, 2022, the Company recorded $0.4 million and $0.6 million of interest expense, net, respectively. For the three and nine months ended September 30, 2021, the Company recorded $0.1 million and $0.2 million of interest expense, net, respectively.

Other Income (Expense), net: Other income (expense) relates mainly to realized and unrealized foreign exchange gains and losses. For the three and nine months ended September 30, 2022, the Company recorded $2.0 million and $2.8 million of other expense, net, respectively. For the three and nine months ended September 30, 2021, the Company recorded $0.9 million and $1.6 million of other income, net, respectively. The change in other income (expense), net was primarily due to foreign currency exchange rates fluctuation during the above periods.

Income Tax Provision: Income tax expense for the three and nine months ended September 30, 2022 was $6.1 million and $1.9 million on pre-tax losses of $7.7 million and $21.0 million, respectively. In the third quarter of 2022, the Company derecognized the tax benefits previously recorded in the first and second quarters of 2022 based on its quarterly realizability assessment of such benefits. Income tax expense for the three and nine months ended September 30, 2021 was approximately $0.7 million and $2.0 million respectively, on pre-tax losses of $5.2 and $30.4 million, respectively. As of September 30, 2022, the income tax rate varied from the United States statutory income tax rate primarily due to the derecognition of tax benefits previously recognized in the first and second quarters of 2022 as discussed above. Consistent with the prior periods, the Company continued to maintain valuation allowances in North America, EMEA and Asia.

NON-GAAP FINANCIAL MEASURES

In managing our business and assessing our financial performance, we supplement the information provided by our U.S. GAAP results with adjusted earnings before stock-based compensation, interest, taxes, and depreciation, or Adjusted EBITDA, a

non-U.S. GAAP financial measure. We define Adjusted EBITDA as net income (loss) plus (i) interest expense, net, (ii) other income and expense, (iii) provision (benefit) for taxes, (iv) depreciation and amortization, (v) stock-based compensation, and (vi) the impact of material transactions or events that we believe are not indicative of our core operating performance, such as acquisition costs, impairment of goodwill, intangibles or long-lived assets, loss on debt extinguishment, restructuring and other charges, including termination related benefits, headquarters and facilities relocation, executive transition, and bad debt expense primarily related to a large customer in India, any of which may or may not be recurring in nature. We believe that the presentation of Adjusted EBITDA enhances the usefulness of our financial information by presenting a measure that management uses internally to monitor and evaluate our operating performance and to evaluate the effectiveness of our business strategies. We believe Adjusted EBITDA also assists investors and analysts in comparing our performance across reporting periods on a consistent basis because it excludes the impact of items that we do not believe reflect our core operating performance.

Adjusted EBITDA has limitations as an analytical tool. Some of these limitations are:

•

Adjusted EBITDA does not reflect our cash expenditures, or future requirements, for capital expenditures or contractual requirements;

•

Adjusted EBITDA does not reflect changes in, or cash requirements for, our working capital needs;

•

Adjusted EBITDA does not reflect the interest expense, or the cash requirements necessary to service interest or principal payments, on our debts;

•

Although depreciation and amortization are non-cash expenses, the assets being depreciated and amortized will often have to be replaced in the future, and Adjusted EBITDA does not reflect any cash requirements for such replacements;

•

Non-cash compensation is and will remain a key element of our overall long-term incentive compensation package, although we exclude it as an expense when evaluating our ongoing operating performance for a particular period; and

•

Other companies in our industry may calculate Adjusted EBITDA and similar measures differently than we do, limiting its usefulness as a comparative measure.

Because of these limitations, Adjusted EBITDA should not be considered in isolation or as a substitute for net income (loss) or any other performance measures calculated in accordance with U.S. GAAP or as a measure of liquidity. Management understands these limitations and compensates for these limitations by relying primarily on our U.S. GAAP results and using Adjusted EBITDA only as a supplemental measure.

Beginning in the third quarter of 2022, the Company updated its presentation of non-GAAP financial measures to exclude the impact of Other Income/Other Expense in its reported Adjusted EBITDA. The change to Adjusted EBITDA reflects exclusion of transactions that we believe are not indicative of our core operating performance. All prior periods presented have been restated to reflect this change.

Set forth below is a reconciliation of net income (loss) to Adjusted EBITDA, which we consider to be the most directly comparable U.S. GAAP financial measure to Adjusted EBITDA (in thousands):


	Three months ended September 30,						Nine months ended September 30,
	2022			2021			2022			2021
Net income (loss)	$	(13,796	)	$	(5,896	)	$	(22,872	)	$	(32,400	)
Add (deduct):
Interest expense, net		399			29			653			245
Other expense (income)*		1,984			(14	)		2,847			(725	)
Income tax provision (benefit)		6,128			676			1,858			2,032
Depreciation and amortization		2,109			1,112			4,551			3,555
Stock-based compensation		5,023			3,104			10,562			6,450
Headquarters and facilities relocation		827			(908	)		827			1,012
Restructuring and other charges		601			6,754			1,393			12,098
Acquisition costs		111			9			733			689
Executive transition		464			200			802			372
Bad debt expense, net of recoveries**		(120	)		—			(1,030	)		14,206
Adjusted EBITDA	$	3,730		$	5,066		$	324		$	7,534

* For the three and nine months of 2021, previously reported Adjusted EBITDA excluded a component of Other Income related to the lease termination in Alameda. The related amount is included in the Headquarters and facilities relocation line on the net income (loss) to Adjusted EBITDA reconciliation table and is not included in Other expense (income) here.

** See Note 1 of the Notes to Unaudited Condensed Consolidated Financial Statements for further information.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

For a complete description of what we believe to be the critical accounting policies and estimates used in the preparation of our unaudited condensed consolidated financial statements, refer to Note 1 Organization and Summary of Significant Accounting Policies in the Notes to our Audited Consolidated Financial Statements in our Annual Report on Form 10-K for the year ended December 31, 2021, as supplemented by Note 1 Organization and Summary of Significant Accounting Policies of the Notes to Unaudited Condensed Consolidated Financial Statements in Part I, Item 1 of this Quarterly Report on Form 10-Q.

LIQUIDITY AND CAPITAL RESOURCES

Our operations are financed through a combination of our existing cash, cash equivalents, available credit facilities, and issuance of equity or debt instruments, based on our operating requirements and market conditions.

The following table summarizes the information regarding our cash and cash equivalents and working capital (in thousands):


	September 30, 2022		December 31, 2021
Cash and cash equivalents	$	17,861	$	46,666
Working capital		83,834		124,498

The Company had a net loss of $13.8 million and $22.9 million for the three and nine months ended September 30, 2022, respectively. The Company had a net loss of $5.9 million and $32.4 million for the three months and nine months ended September 30, 2021, respectively.

As of September 30, 2022, we had working capital of $83.8 million. As of September 30, 2022, we had $17.9 million in unrestricted cash and cash equivalents, which included $9.5 million in cash balances held by our international subsidiaries.

As of September 30, 2022, we had $7.0 million outstanding debt and $1.5 million in letters of credit issued under the $30.0 million Revolving Credit Facility, and $21.5 million was available to the Company for additional borrowings.

We continue to focus on cost management, operating efficiency and efficient discretionary spending. In addition, if necessary, we may leverage our Revolving Credit Facility or issue debt or equity securities. We may also rationalize the number of products we sell, adjust our manufacturing footprint, and reduce our operations in low margin regions, including reductions in headcount. Based on our current plans and current business conditions, we believe that these measures along with our existing cash and cash equivalents will be sufficient to satisfy our anticipated cash requirements for at least the next 12 months from the date of this Quarterly Report on Form 10-Q.

The following table presents a summary of our cash flow activity for the periods set forth below (in thousands):


	Nine months ended September 30,
	2022			2021
Consolidated Statements of Cash Flows Data
Net cash used in operating activities	$	(37,638	)	$	(15,065	)
Net cash used in investing activities		(24,542	)		(8,617	)
Net cash provided by financing activities		30,838			21,578
Effect of exchange rate changes on cash, cash equivalents and restricted cash		(1,344	)		71
Net change in cash, cash equivalents and restricted cash		(32,686	)		(2,033	)
Cash, cash equivalents and restricted cash at beginning of period		53,639			54,587
Cash, cash equivalents and restricted cash at end of period	$	20,953		$	52,554

Operating Activities

Net cash used in operating activities increased by $22.6 million to $37.6 million for the nine months ended September 30, 2022 from net cash used in operating activities of $15.1 million for the nine months ended September 30, 2021. The increase in cash used in operating activities was primarily due to an increase in accounts receivable as shipments were heavily weighted toward the last month of the third quarter 2022 due to component availability, and an increase in inventory purchases in anticipation of increased shipments later in the year and as a mitigation against long lead times.

Investing Activities

Net cash used in investing activities increased by $15.9 million to $24.5 million for the nine months ended September 30, 2022 from $8.6 million for the nine months ended September 30, 2021. This increase was primarily due to cash used in the ASSIA Acquisition in the second quarter of 2022.

Financing Activities

Net cash provided by financing activities totaled $30.8 million for the nine months ended September 30, 2022 and consisted primarily of borrowing under the term loan to fund the ASSIA Acquisition, net drawings on Revolving Credit Facility, and proceeds from exercise of stock awards, partially offset by payments of debt issuance cost and contingent consideration for the Optelian Acquisition. This is in comparison to cash provided by financing activities of $21.6 million for the nine months ended September 30, 2021 which consisted primarily of proceeds from the equity offering and exercise of stock awards offset by repayments of our short-term borrowings and related party term loan.

Cash Management

Our primary source of liquidity comes from our cash, cash equivalents and restricted cash, which totaled $20.9 million at September 30, 2022. Our cash, cash equivalents and restricted cash as of September 30, 2022 included $10.5 million held by our international subsidiaries.

Debt Facilities

On May 27, 2022, the Company entered into a First Amendment to Credit Agreement, which amends the Credit Agreement dated February 9, 2022. The Amendment, among other things, provides for the Term Loan in an aggregate principal amount of $25.0 million with a maturity date of May 27, 2027 and extends the maturity date of the $30.0 million Revolving Credit Facility to May 27, 2025. On May 27, 2022, the Company borrowed the full amount of the Term Loan to finance the ASSIA Acquisition.

As of September 30, 2022, the Company's long-term debt obligation was $23.1 million, net of the current portion of $1.3 million, and unamortized issuance costs of $0.3 million. As of September 30, 2022, the Company had $7.0 million outstanding debt and $1.5 million in letters of credit issued under the $30.0 million Revolving Credit Facility, and $21.5 million was available to the Company for additional borrowing. The Company was in compliance with all debt covenants as of September 30, 2022.

Future Cash Requirements and Funding Sources

Our fixed commitments for cash expenditures consist primarily of payments under operating leases, inventory purchase commitments, and payments of principal and interest for debt obligations.

From time to time, we may provide or commit to extend credit or credit support to our customers. This financing may include extending the terms for product payments to customers. Any extension of financing to our customers will limit the capital that we have available for other uses.

Our accounts receivable, while not considered a primary source of liquidity, represent a concentration of credit risk because a significant portion of the accounts receivable balance at any point in time typically consists of a relatively small number of customer account balances. As of September 30, 2022, one customer represented 10% of net accounts receivable. Net receivables from customers in countries other than the United States represented 83%. We do not currently have any material commitments for capital expenditures, or any other material commitments aside from operating leases for our facilities, inventory purchase commitments and debt obligations.

Operating Leases

Future minimum operating lease obligations include primarily payments for our office locations and manufacturing, research and development locations, which expire at various dates through 2028. See Note 12 Leases of the Notes to Unaudited Condensed Consolidated Financial Statements for further information regarding our operating leases.

Purchase Commitments

We may have short-term purchase commitments related to the purchase orders for products and services, within the normal course of business. These arrangements typically have cancellation provisions that allow us to cancel with little to no penalty.

Debt obligations

Future debt obligations include scheduled principal repayments, and associated interest payments which may vary based on changes in market interest rates. See Note 7 Debt to Unaudited Condensed Consolidated Financial Statements for further information regarding our debt obligations.

U.S. Income Tax Changes

Effective January 1, 2022, the Tax Cuts and Jobs Act (TCJA) eliminates the option to immediately deduct research and development expenditures and requires taxpayers to capitalize and amortize these costs pursuant to IRC Section 174. Although Congress is considering legislation that would defer or repeal this provision, we have no assurance this will be enacted. If this provision of the TCJA is not repealed or otherwise modified, it is expected to negatively impact our operating cash flows in 2022 and future years.

Item 3. Quantitative and Qualitative Disclosures about Market Risk

Market risk represents the risk of loss that may impact our financial position due to adverse changes in financial market prices and rates. Our market risk exposure is primarily a result of fluctuations in interest rates and foreign currency exchange risks. We do not hold or issue financial instruments for trading purposes.

Interest Rate Risk

We had unrestricted cash and cash equivalents of $17.9 million and $46.7 million at September 30, 2022 and December 31, 2021, respectively. We do not have material exposure to market risk with respect to investments, as our investments consist primarily of highly liquid investments purchased with original maturities of three months or less.

Our exposure to interest rate risk includes the amount of interest we must pay on our borrowings under our JPMorgan Credit Agreement. At the Company’s option, amounts borrowed under the Credit Agreement, as amended, accrue interest at a per annum rate equal to either (i) the adjusted term SOFR rate plus a margin ranging from 3.0% to 3.5% per year or (ii) the prime rate plus a margin ranging from 2.0% to 2.5% per year, in each case depending on the Company’s leverage ratio.

As of September 30, 2022, the Company's contractual debt obligation under the Term Loan was $24.7 million. If the applicable variable interest rates changed by 200 basis points, our interest expense for the first nine months of 2022 would have decreased or increased by less than $0.2 million.

Foreign Currency Exchange Risk

We have foreign currency risks related to certain of our foreign subsidiaries, primarily in Korea, Japan, Germany, and the UK. International net revenues and operating expense are typically denominated in the local currency of each country and result from transactions by our operations in these countries. The local currencies of these foreign subsidiaries are the South Korean Won ("KRW"), Japanese Yen ("JPY"), Euro ("EUR), and Pound Sterling ("GBP"), respectively. Fluctuations in foreign currencies create volatility in our reported results of operations. If the U.S. Dollar ("USD") had appreciated or depreciated by 10% relative to KRW, JPY, EUR and GBP our operating income for the first nine months of 2022 would have decreased or increased by approximately $1.5 million, respectively.

Foreign exchange rate fluctuations may also adversely impact our financial position as the assets and liabilities of our foreign operations are translated into USD in preparing our unaudited condensed consolidated balance sheets. The effect of foreign exchange rate fluctuations on our consolidated financial position for the nine months ended September 30, 2022 was a net translation loss of $9.3 million. This loss is recognized as an adjustment to stockholders’ equity through accumulated other comprehensive loss. If USD had appreciated or depreciated by 10% relative to KRW, JPY, EUR, and GBP, our net assets as of September 30, 2022 would have decreased or increased by approximately $1.8 million, respectively.

We have certain assets and liabilities, primarily inter-company loans, that are denominated in currencies other than the relevant entity’s functional currency. Our intercompany loans are primarily denominated in USD and EUR. Changes in the functional currency value of these balances create fluctuations in our reported consolidated financial position, cash flows and results of operations. Transaction gains and losses on these foreign currency denominated assets and liabilities are recognized each period within “Other income (expense), net” in our unaudited condensed consolidated statement of comprehensive income (loss). During the nine months ended September 30, 2022, we recognized approximately $3.0 million of expense related to the intercompany loans denominated in foreign currencies. If USD had appreciated or depreciated by 10% relative to EUR, our net income for the first nine months of 2022 would have decreased or increased by approximately $2.0 million, respectively.

Item 4. Controls and Procedures

Disclosure Controls and Procedures

We are required to maintain disclosure controls and procedures designed to provide reasonable assurance of achieving the objective that information required to be disclosed in our reports filed or submitted pursuant to the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and that such information is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate to allow for timely decisions regarding required disclosures. Our disclosure controls and procedures include those components of our internal control over financial reporting intended to provide reasonable assurance that transactions are recorded as necessary to permit preparation of financials in accordance with U.S. GAAP. In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures.

As required by Rule 13a-15(b) under the Exchange Act, we conducted an evaluation of the effectiveness of our disclosure controls and procedures as of September 30, 2022, the end of the period covered by this Quarterly Report on Form 10-Q. The

evaluation was done under the supervision and with the participation of management, including our principal executive officer and principal financial officer. In the course of the evaluation of our disclosure controls and procedures, our principal executive officer and principal financial officer concluded our disclosure controls and procedures were effective as of September 30, 2022.

Changes in Internal Control over Financial Reporting

There were no changes in our internal control over financial reporting that occurred during our last fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II. OTHER INFORMATION

Item 1. Legal Proceedings

In addition to the Notice discussed in Note 13 of the Notes to Unaudited Condensed Consolidated Financial Statements, from time to time, the Company is subject to various legal proceedings, claims and litigation arising in the ordinary course of business. While the outcome of these matters is currently not determinable, the Company does not expect that the ultimate costs to resolve these matters will have a material adverse effect on the unaudited condensed consolidated financial position or results of operations. However, litigation is subject to inherent uncertainties, and unfavorable rulings could occur. If an unfavorable ruling were to occur, there exists the possibility of a material adverse impact on the financial position, results of operations and cash flows of the period in which the ruling occurs, or future periods.

Item 1A. Risk Factors

A list of factors that could materially affect our business, financial condition or operating results is described in Part I, Item 1A, “Risk Factors” in the 2021 Form 10-K. There have been no material changes to our risk factors from those disclosed in Part I, Item 1A, “Risk Factors” in the 2021 Form 10-K.

Item 5. Other Information

None.

Item 6. Exhibits

The exhibits required to be filed with this quarterly report on Form 10-Q are listed in the Exhibit Index attached hereto and are incorporated herein by reference.

EXHIBIT INDEX


Exhibit Number		Description

3.1		Restated Certificate of Incorporation of DASAN Zhone Solutions, Inc. (incorporated by reference to Exhibit 3.1 to the Company’s Annual Report on Form 10-K filed with the SEC on September 27, 2017).

3.2		Certificate of Amendment to the Restated Certificate of Incorporation of DZS Inc. (incorporated by reference to Exhibit 3.1 to the Company’s Current Report on Form 8-K filed with the SEC on August 27, 2020).

3.3		Amended and Restated Bylaws of DZS Inc. (incorporated by reference to Exhibit 3.2 to the Company’s Annual Report on Form 10-K filed with the SEC on March 11, 2021).

10.1		Credit Agreement, dated as of February 9, 2022, among DZS Inc., as Borrower, the other Loan Parties party thereto, the Lenders from time to time parties thereto and JPMorgan Chase Bank, N.A., as Administrative Agent (incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed with the SEC on February 10, 2022).

10.2		First Amendment to Credit Agreement, dated as of May 27, 2022, among DZS Inc., as Borrower, the other Loan Parties party thereto, the Lenders party thereto and JPMorgan Chase Bank, N.A., as Administrative Agent (incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed with the SEC on June 1, 2022).

31.1*		Certification of Chief Executive Officer Pursuant to Rule 13a-14(a)/15d-14(a)

31.2*		Certification of Chief Financial Officer Pursuant to Rule 13a-14(a)/15d-14(a)

32.1*		Section 1350 Certification of Chief Executive Officer and Chief Financial Officer

101.INS		Inline XBRL Instance Document – the instance document does not appear in the Interactive Data File because XBRL tags are embedded within the Inline XBRL document

101.SCH		Inline XBRL Taxonomy Extension Schema

101.CAL		Inline XBRL Taxonomy Extension Calculation Linkbase

101.DEF		Inline XBRL Taxonomy Extension Definition Linkbase

101.LAB		Inline XBRL Taxonomy Extension Labels Linkbase

101.PRE		Inline XBRL Taxonomy Extension Presentation Linkbase

104		Cover Page Interactive Data File (embedded within the Inline XBRL document and included in Exhibit 101)

*		Filed herewith.
+		Indicates management contract or compensatory plan, contract or arrangement.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.


	DZS INC.

Date: November 1, 2022
	By:	/s/ Charles Daniel Vogt
	Name:	Charles Daniel Vogt
	Title:	President and Chief Executive Officer

	By:	/s/ Misty Kawecki
	Name:	Misty Kawecki
	Title:	Chief Financial Officer
		(Principal Financial and
		Accounting Officer)

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DZS (DZSI) 10-Q2022 Q3 Quarterly report

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