DZS INC. - Quarter Report: 2021 September (Form 10-Q)

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, 2021

☐

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 31, 2021, there were 27,238,570 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	22
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	30
Item 4.	Controls and Procedures	30

PART II. OTHER INFORMATION

Item 1.	Legal Proceedings	31
Item 5.	Other Information	31
Item 6.	Exhibits	31
	Signatures	33

PART I. FINANCIAL INFORMATION

Item 1.

Financial Statements

DZS INC. AND SUBSIDIARIES

Unaudited Condensed Consolidated Balance Sheets

(In thousands, except par value)

	September 30, 2021			December 31, 2020
Assets
Current assets:
Cash and cash equivalents	$	45,505		$	45,219
Restricted cash		6,884			9,200
Accounts receivable - trade, net of allowance for doubtful accounts of $18,170 as of September 30, 2021 and $4,000 as of December 31, 2020		84,730			97,253
Other receivables		12,477			9,165
Inventories		58,270			39,572
Contract assets		3,466			6,182
Prepaid expenses and other current assets		8,906			5,332
Total current assets		220,238			211,923
Property, plant and equipment, net		9,256			7,146
Right-of-use assets from operating leases		12,932			18,483
Goodwill		6,145			3,977
Intangible assets, net		5,409			3,377
Deferred tax assets		1,156			1,405
Other assets		8,826			5,919
Total assets	$	263,962		$	252,230
Liabilities and Stockholders’ Equity
Current liabilities:
Accounts payable - trade	$	67,953		$	49,250
Short-term debt - bank, trade facilities and secured borrowings		-			13,787
Contract liabilities		4,585			4,400
Operating lease liabilities		4,118			4,494
Accrued and other liabilities		21,802			16,707
Total current liabilities		98,458			88,638
Long-term debt - related party		-			29,754
Contract liabilities - non-current		2,951			2,471
Operating lease liabilities - non-current		12,694			15,959
Pension liabilities		18,685			20,052
Other long-term liabilities		3,426			1,777
Total liabilities		136,214			158,651
Commitments and contingencies (Note 14)
Stockholders’ equity:
Common stock, 36,000 shares authorized, 27,207 and 21,958 shares issued and outstanding as of September 30, 2021 and December 31, 2020, respectively, at $0.001 par value		27			22
Additional paid-in capital		218,596			147,997
Accumulated other comprehensive loss		(6,159	)		(2,124	)
Accumulated deficit		(84,716	)		(52,316	)
Total stockholders’ equity		127,748			93,579
Total liabilities and stockholders’ equity	$	263,962		$	252,230

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,
	2021		2020		2021		2020
Net revenue	$	88,412	$	93,947	$	252,143	$	211,959

Cost of revenue	56,213			65,755			164,771			144,004
Gross profit	32,199			28,192			87,372			67,955
Operating expenses:
Research and product development	11,707			9,033			34,788			27,238
Selling, marketing, general and administrative	19,539			16,795			69,619			43,472
Restructuring and other charges	6,754			-			12,098			-
Impairment of long-lived assets	-			-			1,735			-
Amortization of intangible assets	312			387			888			1,130
Total operating expenses	38,312			26,215			119,128			71,840
Operating income (loss)	(6,113	)		1,977			(31,756	)		(3,885	)
Interest income	20			14			81			98
Interest expense	(49	)		(446	)		(326	)		(1,503	)
Loss on extinguishment of debt	-			—			-			(1,369	)
Other income (expense), net	922			(41	)		1,633			69
Income (loss) before income taxes	(5,220	)		1,504			(30,368	)		(6,590	)
Income tax provision (benefit)	676			1,619			2,032			2,452
Net income (loss)	(5,896	)		(115	)		(32,400	)		(9,042	)
							-
Foreign currency translation adjustments	(2,036	)		1,112			(4,090	)		(1,519	)
Actuarial gain (loss)	—			—			55			285
Comprehensive income (loss)	(7,932	)	$	997		$	(36,435	)	$	(10,276	)
Net income (loss) per share
Basic	(0.22	)	$	(0.01	)	$	(1.22	)	$	(0.42	)
Diluted	(0.22	)	$	(0.01	)	$	(1.22	)	$	(0.42	)
Weighted average shares outstanding used to compute basic net income (loss) per share	27,201			21,592			26,484			21,532
Weighted average shares outstanding used to compute diluted net income (loss) per share	27,201			21,592			26,484			21,532

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
For the Nine-Month Period 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



For the Nine-Month Period Ended September 30, 2020:
Balance as of December 31, 2019		21,419	$	21	$	139,700	$	(3,939	)	$	(29,234	)	$	106,548
Exercise of stock awards and employee stock plan purchases		94		—		709		—			—			709
Stock-based compensation		—		—		782		—			—			782
Net income (loss)		—		—		—		—			(8,771	)		(8,771	)
Other comprehensive loss		—		—		—		(1,979	)		—			(1,979	)
Balance as of March 31, 2020		21,513	$	21	$	141,191	$	(5,918	)	$	(38,005	)	$	97,289
Exercise of stock awards and employee stock plan purchases		46		—		284		—			—			284
Stock-based compensation		—		—		868		—			—			868
Net income (loss)		—		—		—		—			(156	)		(156	)
Other comprehensive loss		—		—		—		(367	)		—			(367	)
Balance as of June 30, 2020		21,559	$	21	$	142,343	$	(6,285	)	$	(38,161	)	$	97,918
Exercise of stock awards and employee stock plan purchases		63		1		269		—			—			270
Stock-based compensation		—		—		1,660		—			—			1,660
Net income (loss)		—		—		—		—			(115	)		(115	)
Other comprehensive loss		—		—		—		1,112			—			1,112
Balance as of September 30, 2020		21,622	$	22	$	144,272	$	(5,173	)	$	(38,276	)	$	100,845

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,
	2021			2020
Cash flows from operating activities:
Net income (loss)	$	(32,400	)	$	(9,042	)
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
Depreciation and amortization		3,555			3,935
Impairment of long-lived assets and non-cash restructuring		4,475			—
Gain on Lease termination		(908	)		—
Loss on extinguishment of debt		—			1,343
Amortization of deferred financing costs		12			147
Stock-based compensation		6,450			3,310
Provision for inventory write-down		2,928			4,079
Bad debt expense		14,579			446
Provision for sales returns		873			556
Provision for warranty		636			341
Unrealized gain on foreign currency transactions		47			(405	)
Deferred taxes		139			(224	)
Changes in operating assets and liabilities:
Accounts receivable		(3,945	)		(16,582	)
Other receivable		(7,648	)		(1,153	)
Inventories		(24,256	)		(11,984	)
Contract assets		2,557			11,609
Prepaid expenses and other assets		(7,063	)		(805	)
Accounts payable		21,991			2,217
Contract liabilities		631			(131	)
Accrued and other liabilities		2,282			1,348
Net cash provided by (used in) operating activities		(15,065	)		(10,995	)
Cash flows from investing activities:
Purchases of property, plant and equipment		(4,158	)		(1,947	)
Acquisition of business, net of cash acquired		(4,459	)		—
Net cash used in investing activities		(8,617	)		(1,947	)
Cash flows from financing activities:
Proceeds from issuance of common stock in public offerings, net of issuance costs		59,525			—
Proceeds from short-term borrowings and line of credit		—			13,774
Repayments of short-term borrowings and line of credit		(13,278	)		(12,077	)
Repayments of long-term borrowings		—			(13,125	)
Proceeds from related party term loan		—			18,361
Repayments of related party term loan		(29,298	)		—
Proceeds from factored accounts receivable		—			11,645
Deferred financing costs		—			(20	)
Proceeds from exercise of stock awards and employee stock plan purchases		4,629			1,262
Net cash provided by financing activities		21,578			19,820
Effect of exchange rate changes on cash, cash equivalents and restricted cash		71			47
Net increase in cash, cash equivalents and restricted cash		(2,033	)		6,925
Cash, cash equivalents and restricted cash at beginning of period		54,587			33,635
Cash, cash equivalents and restricted cash at end of period	$	52,554		$	40,560

Reconciliation of cash, cash equivalents and restricted cash to statement of financial position
Cash and cash equivalents	$	45,505		$	31,307
Restricted cash		6,884			9,087
Long-term restricted cash		165			166
	$	52,554		$	40,560

Supplemental disclosure of cash flow information:
Cash paid during the period for:
Interest - bank and trade facilities	$	83		$	616
Interest - related party	$	108		$	888
Income taxes	$	3,029		$	2,587

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 provider of optical and packet-based mobile transport, broadband connectivity, and software defined networking solutions deployed by advanced Tier 1, national and regional service providers and enterprise customers. The Company provides a wide array of reliable, cost-effective networking technologies, including broadband access, Ethernet switching, mobile backhaul, Passive Optical LAN and software-defined networks, 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 8 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, 2020 filed with the Securities and Exchange Commission (“SEC”) on March 11, 2021. 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, 2020.

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.

In December 2019, a strain of coronavirus, now known to cause COVID-19, was reported to have surfaced in Wuhan, China. Since that time, the widespread and sustained transmission of the virus has reached global pandemic status. In response to the pandemic, many national and international health agencies have recommended, and many countries and state, provincial and local governments have implemented, various measures, including travel bans and restrictions, limitations on public and private gatherings, business 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 the worldwide response related thereto, it is difficult to predict the full impact of the COVID-19 pandemic on our business. Due to the uncertainty around the future economic impact of the pandemic, the fair value measurements used in the Company’s impairment assessments could be negatively impacted and could result in future impairments of goodwill, intangibles and other long-lived assets. During the nine months ended September 30, 2021, the Company’s revenues increased by 19.0%, compared to the nine months ended September 30, 2020, however, the impact of a continued COVID-19 pandemic or sustained measures taken to limit or contain the outbreak could have a material and adverse effect on our business, financial condition, results of operations, and cash flows.

(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,
	2021		2020		2021		2020
Revenue by source:
Products	$	82,911	$	88,910	$	237,083	$	197,832
Services and other		5,501		5,037		15,060		14,127
Total	$	88,412	$	93,947	$	252,143	$	211,959

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

	Three Months Ended September 30,				Nine Months Ended September 30,
	2021		2020		2021		2020
Revenue by geography:
Americas	$	27,302	$	16,904	$	73,984	$	43,741
Europe, Middle East, Africa		20,380		19,964		54,999		47,740
Asia		40,730		57,079		123,160		120,478
Total	$	88,412	$	93,947	$	252,143	$	211,959

(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. The Company bases its allowance on periodic assessments of its customers’ liquidity and financial condition through analysis of information obtained from credit rating agencies, financial statement review and historical and current collection trends, as well as on specific balances where collectability may be uncertain.

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. For the three months ended September 30, 2020, two customers accounted for 23% and 12% of net revenue, respectively. For the nine months ended September 30, 2020, one customer accounted for 16% of net revenue.

As of September 30, 2021, two customers represented 18% and 15% of net accounts receivable, respectively. As of December 31, 2020, two customers represented 17% and 16% of net accounts receivable, respectively.

As of September 30, 2021, and December 31, 2020, net accounts receivables from customers in countries other than the United States represented 80% and 89%, 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 billed the customer, which is a state government sponsored entity, approximately $59.0 million and collected payments of approximately $41.7 million, leaving a balance of approximately $17.3 million as of December 31, 2020. The Company substantially completed its obligations under the agreement in 2018, and all amounts due were billed under the terms of the agreement by December 31, 2020. The remaining $17.3 million is substantially beyond the customers contractual payment terms, and the Company has been actively working with the customer and third parties in India to arrange payment of the entire remaining balance of $17.3 million. The Company recorded an allowance for doubtful accounts of $3.1 million on December 31, 2020, for a partial payment promised but not received. In late March 2021, the customer’s state government parent experienced difficulty passing a budget further impacting the ability of the customer to make agreed-upon partial payments to us. In light of this development, the Company recognized an additional allowance of $14.2 million during the three months ended March 31, 2021, to bring the total allowance for the customer to $17.3 million, which is the total balance as of September 30, 2021. 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). Refer to Note 9 Restructuring and Other Charges for further information.

(i) Recent Accounting Pronouncements

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 expects to adopt the updated guidance on January 1, 2022, utilizing the modified retrospective transition method through a cumulative-effect adjustment to retained earnings. The ASU is not expected to have a material impact on our consolidated financial statements.

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 (the “Optelian Acquisition”). Following the closing of the Optelian Acquisition, 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 100 gigabits per second (Gig) and above capability, expanding DZS product portfolios 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 (in thousands):

Purchase consideration
Retirement of Optelian debt	$	4,929
Payment to shareholders and option holders		664
Contingent payment to shareholders		1,897
Total purchase consideration	$	7,490

The payment to shareholders and option holders includes a $0.3 million holdback and $1.9 million contingent consideration based on a certain percentage of future revenue of certain Optelian products through the end of 2023.

Allocation of purchase consideration

The acquisition was recorded as a business combination with valuations of the assets acquired and liabilities assumed at their acquisition date fair value 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 valuing the consideration paid and the purchase price allocation, and the timing of these activities, certain amounts included in the unaudited condensed consolidated financial statements, including long-lived 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 2021, we recorded a measurement-period adjustment of $0.5 million to reduce the value of intangible assets acquired with a corresponding offset to goodwill. The adjustment did not have a material impact on the amortization expense recorded in the previous quarters.

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

Provisional allocation of purchase consideration
Cash and cash equivalents	$	1,236
Accounts receivable - trade		460
Other receivables		153
Inventories		448
Prepaid expenses and other current assets		49
Property, plant and equipment		718
Intangible assets		3,160
Accounts payable - trade		(390	)
Contract liabilities		(169	)
Accrued and other liabilities		(123	)
Goodwill		1,948
Total purchase consideration	$	7,490

The provisional purchase price allocation resulted in the recognition of goodwill of approximately $1.9 million. 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
Developed technology	$	1,780	5 years
Customer relationships		490	5 years
In-process research and development		890	5 years
Total intangible assets	$	3,160

There were no material differences between total revenue and net loss reported and pro forma total revenues and pro forma net loss that would have been reported for the financial periods presented.

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 RIFTIO 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. 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. The Company allocated the purchase price to $0.1 million in net tangible assets, $0.2 million in developed technologies, and $0.2 million in goodwill. As a result of the acquisition, RIFTIO India Private Limited became a wholly owned subsidiary of the Company.

(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 Company classifies its contingent liability 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. Refer to Note 2 Business Combinations for further information.

The following tables present information about the Company’s assets and liabilities that are measured at fair value on a recurring basis using the above input categories (in thousands):

	September 30, 2021
	Level 1		Level 2		Level 3		Total
Cash and cash equivalents	$	45,505		-		-	$	45,505
Restricted cash		6,884		-		-		6,884
Contingent liability		-		-		2,116		2,116
Total	$	52,389	$	-	$	2,116	$	54,505

	December 31, 2020
	Level 1		Level 2		Level 3		Total
Cash and cash equivalents	$	45,219		-		-	$	45,219
Restricted cash		9,200		-		-		9,200
Total	$	54,419	$	-	$	-	$	54,419

The change in fair value of the Company’s contingent liability 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, 2021
Balance at the beginning of the period	$	-
Initial fair value of contingent liability		1,897
Net change in fair value		219
Balance at the end of the period	$	2,116

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

In conjunction with the restructuring in Hanover, Germany and the headquarters relocation to Plano, Texas, we wrote down certain long-lived assets held and used to their fair value of $0.2 million, resulting in an impairment charge of $4.5 million, which was included in earnings for the period. The impaired long-lived assets primarily consisted of right-of-use assets, and we used estimated sub-lease payment data to fair value the respective assets. We concluded that this fair value measurement should be categorized within Level 2.

(4) Cash, Cash Equivalents and Restricted Cash

As of September 30, 2021 and December 31, 2020, the Company's cash, cash equivalents and restricted cash consisted of financial deposits. 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 $22.3 million and $32.2 million as of September 30, 2021 and December 31, 2020, respectively. Restricted cash consisted primarily of cash restricted for performance bonds, warranty bonds and collateral for borrowings. Long-term restricted cash was $0.2 million as of September 30, 2021 and December 31, 2020 and is included in other assets on the unaudited condensed consolidated balance sheets.

(5) Balance Sheet Details

Balance sheet detail as of September 30, 2021 and December 31, 2020 is as follows (in thousands):

Inventories

	September 30, 2021		December 31, 2020
Raw materials	$	33,012	$	16,962
Work in process		832		1,486
Finished goods		24,426		21,124
Total inventories	$	58,270	$	39,572

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. The Company had no inventories provided as collateral for borrowings from Export-Import Bank of Korea as of September 30, 2021 compared to $9.6 million as of December 31, 2020.

Property, plant and equipment

	September 30, 2021			December 31, 2020
Property, plant and equipment, net:
Machinery and equipment	$	13,866		$	13,656
Leasehold improvements		5,202			4,633
Computers and software		3,133			2,829
Furniture and fixtures		1,685			1,123
Construction in progress and other		2,386			716
		26,272			22,957
Less: accumulated depreciation and amortization		(16,794	)		(15,445	)
Less: government grants		(222	)		(366	)
Total property, plant and equipment, net	$	9,256		$	7,146

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. Depreciation expense associated with property, plant and equipment for the three and nine months ended September 30, 2020 was $0.6 million and $1.6 million, respectively.

The Company receives grants from certain foreign government entities mainly to support capital expenditures in the region. Such grants are deferred and are generally refundable to the extent the Company does not utilize the funds for qualifying

expenditures. Once earned, the Company records the grants as a contra amount to the assets and amortizes such amount over the useful lives of the related assets as a reduction to depreciation expense.

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,
	2021			2020
Balance at the beginning of the period	$	1,522		$	1,610
Charged to cost of revenue		636			341
Claims and settlements		(745	)		(1,026	)
Foreign exchange impact		68			(15	)
Balance at the end of the period	$	1,481		$	910

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, 2020	$	6,182		$	6,871
September 30, 2021		3,466			7,536
Increase (decrease)	$	(2,716	)	$	665

The decrease in contract assets during the nine months ended September 30, 2021 was primarily due to invoicing that occurred in 2021 from unbilled balances reflected as contract assets as of December 31, 2020.

The increase in contract liabilities during the nine months ended September 30, 2021 was primarily due to amounts being invoiced for certain customers that did not yet meet the revenue recognition criteria. The amount of revenue recognized in the nine months ended September 30, 2021 that was included in the prior period contract liability balance was $3.6 million. This revenue consists of services provided to customers who had been invoiced prior to the current year. We expect to recognize approximately 61% 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, 2021 and December 31, 2020 was $0.5 million, respectively. During the nine months ended September 30, 2021, the Company recorded $0.4 million in amortization related to contract cost deferred as of December 31, 2020.

(6) Goodwill and Intangible Assets

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

	September 30,
		2021			2020
Balance at the beginning of the period, gross	$	4,980		$	4,980
Accumulated impairment at the beginning of the period		(1,003	)		(1,003	)
Goodwill from acquisitions		2,168			-
Balance at the end of the period	$	6,145		$	3,977

During the nine months ended September 30, 2021, the Company recorded goodwill of $1.9 million related to the acquisition of Optelian and $0.2 million related to the acquisition of RIFT, which was allocated to the Americas reporting unit. Refer to Note 2 Business Combinations for further information. The accumulated impairment of goodwill was $1.0 million as of both September 30, 2021 and 2020.

Intangible assets consisted of the following (in thousands):

	September 30, 2021
	Gross Carrying Amount		Accumulated Amortization			Net
Developed technology	$	5,007	$	(3,371	)	$	1,636
Customer relationships		5,730		(2,730	)	$	3,000
In-process research and development		890		(118	)	$	772
Total intangible assets, net	$	11,627	$	(6,218	)	$	5,409

	December 31, 2020
	Gross Carrying Amount		Accumulated Amortization			Net
Developed technology	$	3,060	$	(2,652	)	$	408
Customer relationships		5,240		(2,271	)	$	2,969
Total intangible assets, net	$	8,300	$	(4,923	)	$	3,377

During the nine months ended September 30, 2021, the Company recorded $1.9 million, $0.5 million and $0.9 million in developed technology, customer relationships and in-process research and development, respectively, related to the acquisitions of Optelian and RIFT. Refer to Note 2 Business Combinations for further information.

The following table summarizes the activity related to intangible assets, net (in thousands):

	September 30, 2021
	2021			2020
Balance at the beginning of the period	$	3,377		$	12,381
Intangible assets from acquisitions		3,327			-
Less: amortization expense		(1,295	)		(2,331	)
Foreign exchange impact		-			294
Balance at the end of the period	$	5,409		$	10,344

Amortization expense associated with intangible assets for the nine months ended September 30, 2021 and 2020 was $1.3 million and $2.3 million, respectively.

The following table presents the future amortization expense of the Company’s intangible assets as of September 30, 2021 (in thousands):

Remainder of 2021	$	294
2022		1,177
2023		1,177
2024		1,177
2025		1,177
Thereafter		407
Total	$	5,409

(7) Debt

As of September 30, 2021, the Company had no debt obligations. During the first half of 2021, the Company paid off the outstanding balance of debt with related parties, foreign banks and other lending institutions. The Company has no contractual principal payments due in the next five years.

The following tables summarize the Company’s debt as of the beginning of the period (in thousands):

	December 31, 2020
	Short-term		Long-term			Total
Bank and Trade Facilities - Foreign Operations	$	13,787	$	—		$	13,787
Related Party		—		29,766			29,766
		13,787		29,766			43,553
Less: unamortized deferred financing costs		—		(12	)		(12	)
	$	13,787	$	29,754		$	43,541

Bank and Trade Facilities - Foreign Operations

During prior periods, certain of the Company's foreign subsidiaries entered into financing arrangements with foreign banks and other lending institutions consisting primarily of revolving lines of credit, trade facilities, term loans and export development loans. As of December 31, 2020, the Company had an aggregate outstanding balance of $13.8 million under such financing arrangements. The weighted average borrowing rates as of December 31, 2020 was 1.8%. During the first two quarters of 2021, the Company paid the entire outstanding balance under such financing arrangements. As of September 30, 2021, the Company had no borrowings outstanding from banks and other lending institutions.

As of December 31, 2020, the Company had $19.0 million available to draw under its letter of credit facilities with NongHyup Bank and Korea Development Bank. These letter of credit facilities expired in the third quarter of 2021.

Related Party Debt

During prior periods, certain of the Company's subsidiaries entered into term loan arrangements with DASAN Networks, Inc. (“DNI”). As of December 31, 2020, the Company had an aggregate outstanding balance of $29.8 million under such financing arrangements. In the first quarter of 2021, the entire outstanding balance on these term loans was repaid.

Interest expense on related party borrowings was $0.1 million and $0.8 million for the nine months ended September 30, 2021 and 2020, respectively. As of September 30, 2021, the Company had no borrowings outstanding from related parties.

PNC Credit Facilities

On February 27, 2019, the Company entered into a Revolving Credit, Term Loan, Guaranty and Security Agreement with PNC Bank, National Association (“PNC”) and Citibank, N.A. as lenders, and PNC as agent for the lenders (the “PNC Credit Facilities”).

On March 26, 2020, the Company paid the outstanding term loan borrowings in full and terminated the PNC Credit Facilities. In association with this debt repayment, the Company recorded a loss on extinguishment of debt of $1.4 million during the three months ended March 31, 2020.

(8) Employee Benefit Plans

Defined Contribution Plans

In the U.S., the Company maintains a 401(k) plan for its employees whereby eligible employees may contribute up to a specified percentage of their earnings, on a pretax basis, subject to the maximum amount permitted by the Internal Revenue Code. Under the 401(k) plan, the Company made discretionary contributions to the plan in 2021. For the three and nine months ended September 30, 2021, the Company recorded an expense of $0.1 million and $0.4 million, respectively, compared to no expense for the three and nine months ended September 30, 2020.

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 months ended September 30, 2021 and September 30, 2020, the Company recorded an expense of $0.3 million and $0.4 million, respectively. For the nine months ended September 30, 2021 and September 30, 2020, the Company recorded an expense of $0.9 million and $1.0 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, 2021 and December 31, 2020, respectively, as a long-term liability on the unaudited condensed consolidated balance sheets. The accumulated benefit obligation for the plans in Germany and Japan was $18.7 million and $20.1 million as of September 30, 2021 and December 31, 2020, respectively. Periodic benefit costs for the three months ended September 30, 2021 and 2020 were $0.1 million, respectively. Periodic benefit costs for the nine months ended September 30, 2021 and 2020 were $0.2 million, respectively.

The Company holds life insurance contracts, with the Company as beneficiary, in the amount of $3.3 million as of September 30, 2021 and $3.5 million as of December 31, 2020, respectively, related to individuals under the pension plans. 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.

(9) Restructuring and Other Charges

For the nine months ended September 30, 2021, the Company incurred restructuring and other charges of approximately $12.1 million mainly related to DZS GmbH. The restructuring and other charges consisting of termination-related benefits of $8.5 million, an impairment of long-lived assets charge of $2.7 million mainly related to right-of-use assets from operating leases, professional services of $0.8 million, and $0.1 million of other charges. The termination-related benefits are comprised of statutory benefits of $2.0 million and one-time severance obligations of $6.5 million.

On March 8, 2021, the Company made the strategic decision to transition DZS GmbH to a sales and research and development center by the end of 2021. On July 15, 2021, the Company came to an agreement with the works council and entered into a social plan that covers statutory benefits and one-time severance obligations. The Company accounted for the statutory benefit obligations in accordance with ASC 712, Nonretirement Postemployment Benefits, and recognized an expense when probable and estimable. The Company accounted for the one-time severance in accordance with ASC 420, Exit or Disposal Cost Obligations, and recognized the expense when the final terms of the benefit arrangement were communicated to the affected employees. The Company incurred restructuring and other charges of approximately $6.6 million and $11.8 million for the three and nine months ended September 30, 2021, respectively, consisting primarily of termination-related benefits.

In May 2021, the Company made the strategic decision to relocate manufacturing function of Optelian to Seminole, Florida and eliminate redundant workforces. The Company incurred restructuring and other charges of approximately $0.3 million for the nine months ended September 30, 2021, consisting primarily of termination-related benefits. No such costs were incurred during the three months ended September 30, 2021.

As of September 30, 2021, the Company had $7.4 million of accrued liabilities related to the restructuring costs.

(10) Related Party Transactions

Related Party Debt and Guarantees

As of September 30, 2021, the Company had no outstanding borrowings from related parties compared to $29.8 million as of December 31, 2020. See Note 7 Debt for further information about the Company’s related party debt.

The following table sets forth payment guarantees of the Company's obligations as of September 30, 2021 that have been provided by DNI. DNI owns approximately 37.1% 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
DNI		6,077	Payment guarantee to Industrial Bank of Korea
DNI		1,621	Payment guarantee to Shinhan Bank
	$	7,698

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, 2021 and 2020:

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

	Three Months Ended September 30, 2020
Counterparty	Sales		Cost of revenue		Research and product development		Selling, marketing, general and administrative		Interest expense		Other expenses
DNI	$	552	$	485	$	306	$	523	$	324	$	93
	$	552	$	485	$	306	$	523	$	324	$	93

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

	Nine Months Ended September 30, 2020
Counterparty	Sales		Cost of revenue		Research and product development		Selling, marketing, general and administrative		Interest expense		Other expenses
DNI	$	2,077	$	1,887	$	690	$	1,183	$	763	$	263
Dasan Invest*		—		20		81		55		—		—
	$	2,077	$	1,907	$	771	$	1,238	$	763	$	263

* Dasan Invest indirectly holds 3.4% of DNI’s shares.

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 California shares human resources, treasury and other administrative support with DNI. As such, the Company entered into certain service sharing agreements with DNI and certain of its subsidiaries for the shared office space and shared administrative services.

DNS Korea has two separate lease agreements with DNI related to the lease of office space and warehouse facilities. Operating lease cost related to these leases totaled $0.4 million for three months ended September 30, 2021 and 2020, respectively. Operating lease cost related to these leases totaled $1.3 million for the nine months ended September 30, 2021 and 2020, 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). As of September 30, 2021, the right-of-use asset and operating lease liability related to these leases were $6.7 million. As of December 31, 2020, the right-of-use asset and operating lease liability related to these leases were $8.6 million.

The Company has an agreement with Dasan Invest to provide IT services for the Company. The respective 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).

Interest expense represents interest paid to DNI for the related party debt. Refer to Note 7 Debt for further information.

Other expenses represent expenses to 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, 2021 and December 31, 2020 were included in the following balance sheet captions on the unaudited condensed consolidated balance sheets, as follows (in thousands):

	As of September 30, 2021
Counterparty	Account receivables		Other receivables		Other assets		Loans Payable		Accounts payable
DNI	$	106	$	215	$	693	$	—	$	564
Dasan Invest*		—		—		—		—		26
	$	106	$	215	$	693	$	—	$	590

	As of December 31, 2020
Counterparty	Account receivables		Other receivables		Other assets		Loans Payable		Accounts payable
DNI	$	2,278	$	247	$	755	$	29,754	$	1,552
Dasan Invest*		—		—		—		—		32
	$	2,278	$	247	$	755	$	29,754	$	1,584

* Dasan Invest indirectly holds 3.4% of DNI’s shares.

(11) Common Stock

On January 26, 2021, the Company sold 4.6 million shares of common stock (including 0.6 million shares issued pursuant to the underwriters’ option to purchase additional shares) at a price of $14.00 per share in an underwritten public offering. The equity offering closed on January 29, 2021 and resulted in gross proceeds to the Company of approximately $64.4 million and net proceeds to the Company, after deducting underwriting discounts and commissions and offering expenses, of approximately $59.5 million. The Company used a portion of the net proceeds from the equity offering to pay off the remaining outstanding balance of debt with related parties.

(12) 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, 2021 and 2020:

	Three months ended September 30,						Nine months ended September 30,
	2021			2020			2021			2020
Net income (loss)	$	(5,896	)	$	(115	)	$	(32,400	)	$	(9,042	)
Weighted average number of shares outstanding:
Basic		27,201			21,592			26,484			21,532
Effect of dilutive securities:
Stock options, restricted stock units and share awards		—			—			—			—
Diluted		27,201			21,592			26,484			21,532
Net income (loss) per share:
Basic	$	(0.22	)	$	(0.01	)	$	(1.22	)	$	(0.42	)
Diluted	$	(0.22	)	$	(0.01	)	$	(1.22	)	$	(0.42	)

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,
	2021		2020		2021		2020
Outstanding stock options		389		148		651		286
Unvested restricted stock units		312		12		232		16

(13) 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.

In August 2020, the Company completed its relocation of its corporate headquarters from Alameda, California to Plano, Texas and established a new U.S.-based Engineering Center of Excellence in Plano. In September 2020, the Company entered into a lease agreement for additional office space at its headquarters in Plano, Texas. On the commencement date of this lease in March 2021, the Company recognized an aggregate of approximately $1.7 million in right-of-use assets and operating lease liabilities in connection with these leases.

During the nine months ended September 30, 2021, the Company recorded $4.2 million in impairment charges on the right-of-use assets, including $2.5 million related to the restructuring in Hanover, Germany and $1.7 million related to the headquarters relocation to Plano, Texas. See Note 9 Restructuring and Other Charges for further information about the Company's restructuring activities in Hanover, Germany.

The components of lease expense were as follows (in thousands):

	Three months ended September 30,				Nine months ended September 30,
	2021		2020		2021		2020
Operating lease cost	$	952	$	1,335	$	3,301	$	4,024
Short-term lease cost		382		252		1,146		752
Total net lease cost	$	1,334	$	1,587	$	4,447	$	4,776

Variable lease cost was not significant for the three and nine months ended September 30, 2021 and 2020.

Supplemental cash flow information related to the Company’s operating leases was as follows (in thousands):

	Three months ended September 30,				Nine months ended September 30,
	2021		2020		2021		2020
Operating cash outflows from operating leases	$	1,923	$	1,357	$	4,690	$	3,903
Right-of-use assets obtained in exchange for operating lease obligations		409		—		2,283		1,364

The following table presents the weighted average remaining lease term and weighted average discount rates related to the Company’s operating leases as of September 30, 2021 and December 31, 2020, respectively (in thousands, excluding years and percentages):

	September 30, 2021			December 31, 2020
Lease Assets and Liabilities
Assets:
Right-of-use assets from operating leases	$	12,932		$	18,483

Liabilities:
Operating lease liabilities - current	$	4,118		$	4,494
Operating lease liabilities - non-current		12,694			15,959
Total operating lease liabilities	$	16,812		$	20,453
Weighted average remaining lease term	4.4 years			4.6 years
Weighted average discount rate		5.5	%		5.7	%

The following table presents the maturity of the Company’s operating lease liabilities as of September 30, 2021 (in thousands):

Remainder of 2021	$	1,701
2022		4,877
2023		4,442
2024		3,866
2025		2,531
Thereafter		2,457
Total operating lease payments		19,874
Less: imputed interest		(3,062	)
Total operating lease liabilities	$	16,812

(14) Commitments and Contingencies

Performance Bonds

In the normal course of operations, from time to time, the Company arranges for the issuance of various types of performance bonds, such as performance, warranty, and bid bonds, in the form of bank guarantees 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, 2021, the Company had $7.6 million of performance bonds in the form of bank guarantees or surety bonds guaranteed by third parties.

Contingent Consideration

The Company has, as part of the Optelian purchase agreement, a contingent liability payable to the sellers. The contingent consideration is payable based on the achievement of certain future performance targets during the three-year period following the acquisition date. The Company records changes in the fair value of contingent consideration liabilities within operating expenses in the unaudited condensed consolidated statement of operations during the period in which a change in the estimate of fair value is made. Refer to Note 2 Business Combinations for further information.

Litigation

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.

(15) Income Taxes

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 loss of $5.2 million and pre-tax loss of $30.4 million, respectively. Income tax expense for the three and nine months ended September 30, 2020 was approximately $1.6 million and $2.5 million respectively, on pre-tax income of $1.5 million and pre-tax loss $6.6 million, respectively.

As of September 30, 2021, the income tax rate varied from the United States statutory income tax rate primarily due to valuation allowances in North America and EMEA and taxable income generated by the Company’s wholly owned foreign subsidiaries in Asia.

The total amount of unrecognized tax benefits, including interest and penalties, at September 30, 2021 was $1.3 million. There were no significant changes to unrecognized tax benefits during the nine months ended September 30, 2021. The Company does not anticipate any significant changes with respect to unrecognized tax benefits within the next twelve months.

(16) 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, 2021 and December 31, 2020:

	September 30, 2021		December 31, 2020
United States	$	5,406	$	2,878
Korea		2,172		2,472
Japan		844		952
Canada		400		—
Germany		337		761
Other		97		83
	$	9,256	$	7,146

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, the negative 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; our ability to satisfy our short- and long-term cash requirements; anticipated growth and trends in our business, industry or key markets; 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 other capital to fund our future operations; future economic conditions and performance; the impact of the global outbreak of COVID-19; 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. 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, but are not limited to:

•

the impact of the global COVID-19 pandemic on the Company’s business and operations, including as a result of travel bans related thereto, the health and wellbeing of our employees in affected areas and disruption of our supply chain;

•

our ability to realize the anticipated cost savings, synergies and other benefits of the Company’s acquisitions and any integration risks relating to the Company’s acquisitions;

•

our ability to generate sufficient revenue to achieve or sustain profitability;

•

our ability to raise additional capital to fund existing and future operations or to refinance or repay our future indebtedness;

•

our ability to hire and retain key management and other personnel;

•

defects or other performance problems in our products;

•

any economic slowdown in the telecommunications industry that restricts or delays the purchase of our products by our customers, or delays in payments of accounts receivable by our customers;

•

commercial acceptance of our products;

•

intense competition in the communications equipment market from large equipment companies as well as private companies with products that address the same network needs as our products;

•

higher than anticipated expenses that we may incur;

•

any failure to comply with the periodic report filing and other requirements of The Nasdaq Stock Market for continued listing;

•

our ability to meet future customer demands, by utilizing outsourced manufacturers and based on the availability of raw material component parts; and

•

additional factors discussed in our Annual Report on Form 10-K for the year ended December 31, 2020 and from time to time in our other reports filed with the SEC.

You are urged to consider these factors carefully in evaluating the forward-looking statements herein and are cautioned not to place undue reliance on such forward-looking statements, which are qualified in their entirety by this cautionary statement.

OVERVIEW

We are a global provider of packet-based mobile transport, broadband access, network orchestration and cloud-native automation solutions deployed by advanced Tier I, national and regional service providers and enterprise customers. Our solutions are deployed worldwide. Our intelligent-edge solutions are focused on creating significant value for our customers by delivering innovative solutions that empower global communication advancement by shaping the internet connection experience.

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 network access solutions and communications platforms include products in Mobile Transport and Fixed Broadband Access, which includes broadband access and connected premises.

•

Mobile Transport. Our DZS Chronos portfolio provides a robust, manageable and scalable solution for mobile operators that enable them to upgrade their mobile fronthaul/midhaul/backhaul (“xHaul”) systems and migrate to fifth generation wireless technologies (“5G”) and beyond. DZS Chronos provides a full range of 5G-ready xHaul solutions that are open, software-defined, and field proven. Our mobile xHaul 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. 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.

•

Fixed Broadband Access. 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 GPON to 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.

•

Network Orchestration. Our DZS Cloud solution accelerates our software capabilities specifically in the areas of network orchestration, application slicing, automation, analytics, and service assurance. We offer a commercial, carrier-grade network-slicing enabled orchestration platform complementing our position with physical network devices supporting O-RAN and 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.

•

Connected Premises. Our DZS Helix connected premises product portfolio offer a large collection of smart gateway platforms for any FTTx deployment. DZS Smart Gateway platforms are designed for high bandwidth services being deployed to the home or business. Our connected premises portfolio consists of indoor/outdoor optical network terminal (“ONT”) gateways delivering best-in-class data throughout to support the most demanding fiber to the “x” (“FTTx”) applications. The product feature set gives service providers an elegant migration path from legacy to softswitch architectures without replacing ONTs.

Going forward, 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; and

•

Minimizing consumption of our cash and cash equivalents.

RESULTS OF OPERATIONS

We list in the table below 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,
	2021			2020			2021			2020
Net revenue		100	%		100	%		100	%		100	%
Cost of revenue		64	%		70	%		65	%		68	%
Gross profit		36	%		30	%		35	%		32	%
Operating expenses:
Research and product development		13	%		10	%		14	%		13	%
Selling, marketing, general and administrative		22	%		18	%		28	%		21	%
Restructuring and other charges		8	%		—			5	%		—
Impairment of long-lived assets		—			—			1	%		—
Amortization of intangible assets		—			—			—			—
Total operating expenses		43	%		28	%		48	%		34	%
Operating income (loss)		(7	)%		2	%		(13	)%		(2	)%
Interest income		—			—			—			—
Interest expense		—			—			—			(1	)%
Loss on extinguishment of debt		—			—			—			—
Other income (expense), net		1	%		—			1	%		—
Income (loss) before income taxes		(6	)%		2	%		(12	)%		(3	)%
Income tax provision (benefit)		1	%		2	%		1	%		1	%
Net income (loss)		(7	)%		—			(13	)%		(4	)%

Net Revenue

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

	Three months ended September 30,										Nine months ended September 30,
	2021		2020		Increase/ (Decrease)			% change			2021		2020		Increase/ (Decrease)		% change
Products	$	82.9	$	88.9	$	(6.0	)		(6.7	)%	$	237.1	$	197.8	$	39.3		19.9	%
Services and other	$	5.5	$	5.0		0.5			10.0	%	$	15.1	$	14.1		1.0		7.1	%
Total	$	88.4	$	93.9	$	(5.5	)		(5.9	)%	$	252.2	$	211.9	$	40.3		19.0	%

For the three months ended September 30, 2021, product revenue decreased by 6.7% or $6.0 million to $82.9 million from $88.9 million in the same period last year. The decrease in product revenue during the period was primarily attributable to the very strong prior year results for our mobile transport products. For the three months ended September 30, 2021, service and other revenue of $5.5 million increased by 10.0% partly due to increased product sales.

For the nine months ended September 30, 2021, product revenue increased by 19.9% or $39.3 million to $237.1 million from $197.8 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 in the first half of 2020. For the nine months ended September 30, 2021, service and other revenue of $15.1 million increased by 7.1% partly due to increased product sales.

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

	Three months ended September 30,										Nine months ended September 30,
	2021		2020		Increase/ (Decrease)			% change			2021		2020		Increase/ (decrease)		% change
Revenue by geography:
Americas	$	27.3	$	16.9	$	10.4			61.5	%	$	74.0	$	43.7	$	30.3		69.3	%
Europe, Middle East, Africa	$	20.4	$	20.0		0.4			2.0	%	$	55.0	$	47.7		7.3		15.3	%
Asia	$	40.7	$	57.0		(16.3	)		(28.6	)%	$	123.2	$	120.5		2.7		2.2	%
Total	$	88.4	$	93.9	$	(5.5	)		(5.9	)%	$	252.2	$	211.9	$	40.3		19.0	%

From a geographical perspective, the decrease in net revenue for the three months ended September 30, 2021 was attributable to decreased revenue in Asia primarily attributable to the very strong prior year results. The increase in net revenue for the nine

months ended September 30, 2021 was attributable to increased revenue in all regions driven by our enhanced go-to-market strategy and recovery from the impacts of the early onset of the COVID-19 pandemic in the first quarter of 2020.

We anticipate that our results of operations in any given period may depend to a large extent on sales to a small number of large 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 decreased 14.5% to $56.2 million for the three months ended September 30, 2021, compared to $65.8 million for the three months ended September 30, 2020. Total cost of revenue was 63.6% of net revenue for the three months ended September 30, 2021, compared to 70.0% of net revenue for the three months ended September 30, 2020, which resulted in an increase in gross profit percentage to 36.4% for the three months ended September 30, 2021 from 30.0% for the three months ended September 30, 2020. The decrease in total cost of revenue was primarily due to the change in number and mix of products sold, including the geographic mix of those sales.

Total cost of revenue increased 14.4% to $164.8 million for the nine months ended September 30, 2021, compared to $144.0 million for the nine months ended September 30, 2020. Total cost of revenue was 65.3% of net revenue for the nine months ended September 30, 2021, compared to 67.9% of net revenue for the nine months ended September 30, 2020, which resulted in an increase in gross profit percentage to 34.7% for the nine months ended September 30, 2021 from 32.1% for the nine months ended September 30, 2020. The increase in total cost of revenue was primarily due to the increase in number and mix of products sold, including the geographic mix of those sales.

We expect that in the future our cost of revenue as a percentage of net revenue will vary depending on the geographic and product mix and average selling prices of products sold. In addition, continued competitive and economic pressures could cause us to reduce our prices, adjust the carrying values of our inventory, or recognize inventory expenses relating to discontinued products and excess or obsolete inventory.

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 29.6% to $11.7 million for the three months ended September 30, 2021 compared to $9.0 million for the three months ended September 30, 2020. Research and product development expenses increased by 27.7% to $34.8 million for the nine months ended September 30, 2021 compared to $27.2 million for the nine months ended September 30, 2020. The increase in research and product development expenses was primarily due to strategic hiring decisions in research, development, and product line management in the second half of 2020 and into the first half of 2021 with the intent to accelerate growth and capture market share.

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 16.3% to $19.5 million for the three months ended September 30, 2021 compared to $16.8 million for the three months ended September 30, 2020. The increase was due to strategic hiring decisions across sales and administration in the second half of 2020 and into the first half of 2021 with the intent to accelerate growth and capture market share, along with the full quarter impact of the Optelian and Rift acquisitions.

Selling, marketing, general and administrative expenses increased by 60.1% to $69.6 million for the nine months ended September 30, 2021 compared to $43.5 million for the nine months ended September 30, 2020. The increase in selling, marketing, general and administrative expenses was primarily due to the increase in allowance for doubtful accounts for one customer in India by $14.2 million in the first quarter of 2021. Refer to Note 1 in the Notes to Unaudited Condensed Consolidated Financial Statements, for further information on the bad debt expense. The increase was also partially due to strategic hiring decisions across sales and administration in the second half of 2020 and into the first half of 2021 with the intent to accelerate growth and capture market share, along with the impact of the Optelian and Rift acquisitions.

Restructuring and Other Charges

Restructuring and other charges for the nine months ended September 30, 2021 were $12.1 million and relate primarily to the strategic decision to transition DZS GmbH to a sales and research and development center by the end of 2021. During July 2021, the Company and works council agreed to the terms of and entered into a social plan that included employee termination benefits in conjunction with the restructuring in Germany. The Company accounted for the one-time employee termination benefits when the final terms of the benefit arrangement were communicated to the affected employees in the third quarter of 2021, as reflected in the increase to restructuring and other charges in the statement of operations during the three months ended September 30, 2021 of $6.7 million. See Note 9 Restructuring and Other Charges of the Notes to Unaudited Condensed Consolidated Financial Statements included in this Quarterly Report on Form 10-Q for further information.

Impairment of Long-lived Assets

Impairment of long-lived assets for the nine months ended September 30, 2021 was $1.7 million, and related to the headquarters relocation to Plano, Texas. No impairment was recorded during the three months ended September 30, 2021. See Note 13 Leases of the Notes to Unaudited Condensed Consolidated Financial Statements included in this Quarterly Report on Form 10-Q for further information.

Income Tax Provision

Income tax expense for the three and nine months ended September 30, 2021 was $0.7 million and $2.0 million, respectively, on pre-tax loss of $5.2 million and $30.4 million, respectively. Income tax expense for the three and nine months ended September 30, 2020 was $1.6 million and $2.5 million, respectively, on pre-tax income of $1.5 million and pre-tax loss of $6.6 million, respectively. For the three and nine months ended September 30, 2021, the effective income tax rate varied from the United States statutory income tax rate primarily due to valuation allowances in North America and EMEA and the mix of earnings generated by our wholly owned foreign subsidiaries in Asia.

OTHER PERFORMANCE 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) provision (benefit) for taxes, (iii) depreciation and amortization, (iv) stock-based compensation, and (v) the impact of material transactions or events that we believe are not indicative of our core operating performance, such as acquisition costs, goodwill impairment, impairment of long-lived assets, loss on debt extinguishment, restructuring and other charges, headquarters relocation, executive transition, and bad debt expense 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.

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,
	2021			2020			2021			2020
Net income (loss)	$	(5,896	)	$	(115	)	$	(32,400	)	$	(9,042	)
Add (deduct):
Interest expense, net		29			432			245			1,405
Income tax provision (benefit)		676			1,619			2,032			2,452
Depreciation and amortization		1,112			1,386			3,555			3,935
Stock-based compensation		3,104			1,660			6,450			3,310
Headquarters and facilities relocation		(908	)		35			1,012			35
Restructuring and other charges		6,754			—			12,098			—
Acquisition costs		9			—			689			—
Executive transition		200			1,383			372			1,383
Bad debt expense*		—			—			14,206			-
Loss on debt extinguishment		—			—			—			1,369
Adjusted EBITDA	$	5,080		$	6,400		$	8,259		$	4,847

* See Note 1 of the Notes to Unaudited Condensed Consolidated Financial Statements included in this Quarterly Report on Form 10-Q 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, 2020, as supplemented by Note 1 Organization and Summary of Significant Accounting Policies in the notes to our 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 sales of equity and 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, 2021		December 31, 2020
Cash and cash equivalents	$	45,505	$	45,219
Working capital		121,780		123,285

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. The Company had a net loss of $0.1 million and $9.0 million for the three months and nine months ended September 30, 2020, respectively.

As of September 30, 2021, we had working capital of $121.8 million. As of September 30, 2021, we had $45.5 million in cash and cash equivalents, which included $22.3 million in cash balances held by our international subsidiaries.

On January 29, 2021, we closed an equity offering which resulted in gross proceeds of approximately $64.4 million and net proceeds, after deducting underwriting discounts and commissions and offering expenses, of approximately $59.5 million. We used a portion of the net proceeds from the equity offering to pay off the outstanding balance of debt with financial institutions and related parties.

We continue to focus on cost management, operating efficiency and efficient discretionary spending. In addition, if necessary, we may sell assets, issue debt or equity securities or purchase credit insurance. 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.

gatherings, business 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 may continue to impact on our financial condition, results of operations and cash flows. Given the ongoing and dynamic nature of the virus and the worldwide response related thereto, it is difficult to predict the full impact of the COVID-19 pandemic on our business. Due to the uncertainty around the future economic impact of the pandemic, the fair value measurements used in our impairment assessments could be negatively impacted and could result in future impairments of goodwill, intangibles and other long-lived assets. During the nine months ended September 30, 2021, our revenues increased by 19.0%, compared to the nine months ended September 30, 2020, however the impact of a continued COVID-19 pandemic or sustained measures taken to limit or contain the outbreak could have a material and adverse effect on our business, financial condition, results of operations, and cash flows.

Operating Activities

Net cash used in operating activities increased by $4.1 million to $15.1 million for the nine months ended September 30, 2021 from net cash used in operating activities of $11.0 million for the nine months ended September 30, 2020. The increase in cash used in operating activities was primarily due to restructuring activities related to our Hanover location, an increase in research and development expenses, along with an increase in selling, general and administrative expenses, partially offset by an increase in gross margin. The increase in research and product development expenses was primarily due to strategic hiring decisions in research, development, and product line management in the second half of 2020 and into the first half of 2021 with the intent to accelerate growth and capture market share. The increase in selling, general and administrative expenses was due to strategic hiring decisions across sales and administration in the second half of 2020 and into the first half of 2021 with the intent to accelerate growth and capture market share, along with the impact of the Optelian and Rift acquisitions.

Investing Activities

Net cash used in investing activities increased by $6.7 million to $8.6 million for the nine months ended September 30, 2021 from $1.9 million for the nine months ended September 30, 2020. This increase was primarily due to cash used in the Optelian and RIFT acquisitions.

Financing Activities

Net cash provided by financing activities totaled $21.6 million for the nine months ended September 30, 2021 and consisted primarily of proceeds from the equity offering of $59.5 million, partially offset by repayments of our short-term borrowings and related party term loan. This is in comparison to cash provided by financing activities of $19.8 million for the nine months ended September 30, 2020 and consisted primarily of proceeds from a related party loan, factored accounts receivable accounted for as a secured borrowing, and proceeds from short-term borrowings, partially offset by a net outflow associated with the repayment of the PNC Credit Facilities and other short-term borrowings.

Cash Management

Our primary source of liquidity comes from our cash, cash equivalents and restricted cash, which totaled $52.4 million at September 30, 2021. Our cash, cash equivalents and restricted cash as of September 30, 2021 included $22.3 million held by our international subsidiaries.

Debt Facilities

Bank and Trade Facilities - Foreign Operations

As of September 30, 2021, we had no outstanding balances with banks and other lending institutions. As of December 31, 2020, we had an aggregate outstanding balance of $13.8 million under financing arrangements with foreign banks and other lending institutions. During the first half of 2021, we paid off the outstanding balance of debt under such financing arrangements.

Related Party Debt

As of September 30, 2021, we had no related party debt outstanding. As of December 31, 2020, we had an aggregate outstanding balance of $29.8 million of related party debt with DNI. In January and February 2021, we paid off the outstanding balance of debt with related parties with proceeds from the issuance of shares of our common stock during January 2021.

Future Cash Requirements and Funding Sources

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

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, 2021, two customers represented 18% and 15% of net accounts receivable, respectively, and net receivables from customers in countries other than the United States represented 80%. We do not currently have any material commitments for capital expenditures, or any other material commitments aside from operating leases for our facilities, and inventory purchase commitments.

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 13 Leases of the Notes to Unaudited Condensed Consolidated Financial Statements included in this Quarterly Report on Form 10-Q 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.

Item 3.

Quantitative and Qualitative Disclosures about Market Risk

Not required.

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, 2021, 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, 2021.

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

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 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+		Employment Agreement effective August 2, 2021 by and between DZS Inc. and Misty D. Kawecki (incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed with the SEC on August 2, 2021).

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 3, 2021
	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)