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MarketScreener Homepage  >  Equities  >  Nasdaq  >  DZS Inc.    DZSI

DZS INC.

(DZSI)
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DZS : Management's Discussion and Analysis of Financial Condition and Results of Operations (form 10-Q)

11/06/2020 | 04:33pm EST

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; cost synergies, growth opportunities and other
potential financial and operating benefits of the Merger and the acquisition of
Keymile; 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; the
impact of the completed relocation of our corporate headquarters to Texas;
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, disruption of our supply

      chain and softening of demands for our products;




   •  our ability to realize the anticipated cost savings, synergies and other

benefits of the Merger and the acquisition of Keymile and any integration

      risks relating to the acquisition of Keymile;




   •  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 existing 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;




   •  material weaknesses or other deficiencies in our internal control over
      financial reporting; and



• additional factors discussed in our Annual Report on Form 10-K for the year

ended December 31, 2019 and from time to time in our other reports filed

      with the SEC.




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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 ultra-broadband network access solutions and
communications platforms deployed by advanced Tier 1, 2 and 3 service providers
and enterprise customers. We operate in a single reporting segment. We research,
develop, test, sell, manufacture and support communications equipment in five
major areas: mobile transport, broadband access, switching and routing,
connected premises and SDN ("Software Defined Networking") Orchestration
solutions:

• Our mobile transport products provide a robust, manageable and scalable

solution for mobile operators that enable them to upgrade their mobile

fronthaul/backhaul systems and migrate to 5G and beyond. Our mobile backhaul

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.

We provide standard Ethernet/IP or Multiprotocol Label Switching ("MPLS")

interfaces and interoperate with other vendors in these networks.

• Our broadband access products offer 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, high-speed internet access and business

class services to their customers.

• Our switching and routing products provide a high-performance and manageable

solution that bridges the gap from carrier access technologies to the core

network. Our products support pure Ethernet switching as well as layer 3 IP

and MPLS and are currently being developed for deployment as part of SDNs.

• Our connected premises products 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.

• Our SDN Orchestration strategy is to develop tools and building blocks that

will allow service providers to migrate their networks' full complement of

legacy control plane and data plane devices to a centralized intelligent

controller that can reconfigure the services of the hundreds of network

elements in real time for more controlled and efficient provision of

bandwidth and latency across the network. The migration move to SDN/Network

Function Virtualization ("NFV") will provide better service for end

customers and a more efficient and cost-effective use of hardware resources

for service providers.

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.



As of September 30, 2020, we employed over 750 personnel worldwide. We consider
the relationships with our employees to be positive. Competition for technical
personnel in our industry is intense. We believe that our future success depends
in part on our continued ability to hire, assimilate and retain qualified
personnel. To date, we believe that we have been successful in recruiting
qualified employees, but there is no assurance that we will continue to be
successful in the future.

RECENT DEVELOPMENTS



On August 24, 2020, our board approved an amendment to our Certificate of
Incorporation to change our name from Dasan Zhone Solutions, Inc. to "DZS
Inc.". On August 26, 2020, we filed a Certificate of Amendment to our Restated
Certificate of Incorporation with the Delaware Secretary of State reflecting the
above action. The name change took effect upon filing. The Company's trading
symbol "DZSI" did not change.



Effective August 1, 2020, Charlie Vogt was appointed as the President and Chief
Executive Officer of the DZS, Inc.. In addition, Mr. Vogt was elected as a new
member of the Board, also effective August 1, 2020. In connection with Mr.
Vogt's appointment, Il Yung Kim ceased to serve as President and Chief Executive
Officer of DZS, Inc. and as a member of the Board

                                       27

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effective July 31, 2020. Prior to joining the Company, Mr. Vogt was most
recently President and Chief Executive Officer of ATX Networks, a leader in
broadband access and media distribution, where he led the company through
extensive transformation and growth since February 2018 and will remain a member
of the board. From July 2013 to January 2018, Mr. Vogt served as President and
Chief Executive Officer of Imagine Communications, where he directed the company
through change as it evolved its core technology, including large-scale
restructuring and rebranding and multiple technology acquisitions as he
implemented a vision and growth strategy. Before joining Imagine Communications,
Mr. Vogt was President and Chief Executive Officer of GENBAND (today known as
Ribbon Communications), where he transformed the company from a startup to a
global leader in voice over IP and real-time IP communications solutions. His
professional career has also included leadership roles at Taqua (Tekelec),
Lucent Technology (Nokia), Ascend Communications (Lucent), ADTRAN, Motorola and
IBM.

On August 1, 2020, the Company completed the relocation of its corporate
headquarters from California to Plano, Texas. In connection with the relocation,
the Company entered into sublease agreements with Huawei Technologies, Inc. and
Futurewei Technologies, Inc. to sublease an aggregate of approximately 16,300
square feet located at 5700 Tennyson Parkway, Plano, Texas. In September 2020,
the Company entered into a lease agreement for approximately 10,300 square feet
of additional office space at its headquarters in Plano, TX.

On June 1, 2020, DZS Japan, Inc. ("DZS Japan") entered into an assignment
agreement with JECC Corporation to factor 1,258,822,828 YEN (approximately $11.6
million) of accounts receivables from one of its customers. JECC assessed a
discount equivalent to 5,964,328 YEN (approximately $0.05 million) (or
approximately 0.474% of the amount factored, with a stated factoring rate of
1.575% based on the days remaining from factoring to expected receivable
collection). DZS Japan received 1,252,588,500 YEN (approximately $11.65 million)
on June 19, 2020. As of September 30, 2020, the secured borrowing balance was
$5.9 million.

On March 5, 2020, Dasan Network Solutions, Inc. ("DNS Korea") entered into a
Loan Agreement with DNI, pursuant to which DNS Korea borrowed KRW 22.4 billion
($18.5 million) from DNI. DNS Korea subsequently loaned all of such borrowed
funds to the Company, a portion of which were used to repay and terminate the
PNC Credit Facilities.



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RESULTS OF OPERATIONS


We list in the table below the historical condensed consolidated statement of
comprehensive (loss) income as a percentage of total net revenue for the periods
indicated.





                                               Three Months Ended                Nine Months Ended
                                                  September 30,                    September 30,
                                              2020             2019            2020              2019
Net revenue:
Third parties                                      99 %            100 %            99 %              99 %
Related parties                                     1 %              -               1 %               1 %
Total net revenue                                 100 %            100 %           100 %             100 %
Cost of revenue:
Products and services - third parties              69 %             68 %            67 %              66 %
Products and services - related parties             -                -               1 %               1 %
Amortization of intangible assets                   1 %              1 %             -                 1 %
Total cost of revenue                              70 %             69 %            68 %              68 %
Gross profit                                       30 %             31 %            32 %              32 %
Operating expenses:
Research and product development                   10 %             14 %            13 %              13 %
Selling, marketing, general and
administrative                                     18 %             22 %            21 %              20 %
Amortization of intangible assets                   -                1 %             -                 1 %
Total operating expenses                           28 %             37 %            34 %              34 %
Operating income (loss)                             2 %             (6 )%           (2 )%             (2 )%
Interest income                                     -                1 %             0 %               -
Interest expense                                    -               (2 )%           (1 )%             (1 )%
Loss on extinguishment of debt                      -                -               -                 -
Other income (expense), net                         -                1 %             -                 1 %
Income (loss) before income taxes                   2 %             (6 )%           (3 )%             (2 )%
Income tax provision                                2 %              -               1 %              (1 )%
Net income (loss)                                   -               (6 )%           (4 )%             (1 )%
Net income (loss) attributable to
non-controlling interest                            -                -               -                 -
Net income (loss) attributable to DZS
Inc.                                                -               (6 )%           (4 )%             (1 )%








Net Revenue


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



                                Three Months Ended September 30,                               Nine Months Ended September 30,
                                                   Increase/                                                    Increase/
                      2020            2019        (Decrease)       % change         2020           2019         (Decrease)        % change
Products            $    88.9$    66.4$      22.5             34 %    $   197.8$ 214.9$        (17.1 )           (8 )%
Services                  5.0             5.1            (0.1 )           (2 )%        14.1          14.4               (0.3 )           (2 )%
Total               $    93.9$    71.5$      22.4             31 %    $   211.9$ 229.3$        (17.4 )           (8 )%




For the three months ended September 30, 2020, product revenue increased by 34%
or $22.5 million to $88.9 million from $66.4 million in the same period last
year. The increase in product revenue during the period was primarily
attributable to increased demand in broadband and mobile transport products. For
the three months ended September 30, 2020, service revenue decreased by 2% or
$0.1 million to $5.0 million from $5.1 million in the same period last year.



For the nine months ended September 30, 2020, product revenue decreased by 8% or
$17.1 million to $197.8 million from $214.9 million in the same period last
year. The decrease in product revenue during the period was primarily
attributable to impacts from the worldwide COVID-19 pandemic, which resulted in
disruptions to our supply chain, as well as decreased business operations by
certain of our customers earlier in 2020. For the nine months ended September
30, 2020, service revenue decreased by 2% or $0.3 million to $14.1 million from
$14.4 million in the same period last year.



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Information about our net revenue for North America and international markets is summarized below (in millions):




                                   Three Months Ended September 30,                             Nine Months Ended September 30,
                                                       Increase/                                                 Increase/
                          2020            2019        (decrease)      % change         2020          2019        (decrease)      % change
Revenue by geography:
United States           $    10.6$     9.7$       0.9             9 %    $    27.5$  29.0$       (1.5 )          (5 )%
Canada                        1.3             1.1             0.2            24 %          4.4          3.0              1.4            49 %
Total North America          11.9            10.8             1.1            11 %         31.9         32.0             (0.1 )           0 %
Latin America                 5.1             6.3            (1.2 )         (19 )%        12.1         18.8             (6.7 )         (36 )%
Europe, Middle East,
  Africa                     19.9            15.8             4.1            26 %         47.5         59.4            (11.9 )         (20 )%
Korea                        15.4            20.9            (5.5 )         (26 )%        39.1         55.7            (16.6 )         (30 )%
Japan                        33.0             9.3            23.7           254 %         66.3         28.7             37.6           131 %
Other Asia Pacific            8.6             8.4             0.2             2 %         15.1         34.7            (19.6 )         (57 )%
Total International          82.0            60.7            21.3            35 %        180.1        197.3            (17.2 )          (9 )%
Total                   $    93.9$    71.5$      22.4            31 %    $   212.0$ 229.3$      (17.3 )          (8 )%




From a geographical perspective, the increase in net revenue for the three
months ended September 30, 2020, was primarily attributable to increased demand
in most regions, most notably Japan, and was largely attributed to increased
demand in broadband and mobile transport products. From a geographical
perspective, the decrease in revenue for the nine months ended September 30,
2020, by geography was mainly attributable to a decrease in almost all markets
and was largely attributed to the impacts from the worldwide COVID-19 pandemic
earlier in 2020.



International net revenue for the three months ended September 30, 2020
increased 35% or $21.3 million to $82.0 million from $60.7 million from the same
period last year and represented 87% of total net revenue compared with 85%
during the same period of 2019.  International net revenue for the nine months
ended September 30, 2020 decreased 9% or $17.2 million to $180.1 million from
$197.3 million for the same period last year and represented 85% of total net
revenue compared with 86% during the same period of 2019.



For the three months ended September 30, 2020, two customers accounted for 35%
of net revenue in the aggregate. For the nine months ended September 30, 2020,
one customer accounted for 16% of net revenue. For the three months ended
September 30, 2019, one customer accounted for 11% of net revenue. For the nine
months ended September 30, 2019, no single customer accounted for 10% or more of
net revenue.

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 increased 33% or $16.5 million to $65.8 million for the
three months ended September 30, 2020, compared to $49.3 million for the same
period in 2019. Total cost of revenue was 70% and 69% of net revenue for the
three months ended September 30, 2020 and September 30, 2019, respectively.
Total cost of revenue decreased 7% or $10.4 million to $144.0 million for the
nine months ended September 30, 2020, compared to $154.4 million for the same
period in 2019. Total cost of revenue was 68% of net revenue for the nine months
ended September 30, 2020 and 2019, respectively.

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 record inventory expenses relating to discontinued products and
excess or obsolete inventory.

Research and Product Development Expenses


Research and product development expenses decreased 10% or $1.0 million to $8.9
million for the three months ended September 30, 2020, compared to $9.9 million
for the same period in 2019. Research and product development expenses were 10%
and 14% of net revenue for the three months ended September 30, 2020 and 2019,
respectively. Research and product development expenses decreased 9% or $2.6
million to $26.9 million for the nine months ended September 30, 2020 compared
to $29.5 million for the same period in 2019. Research and product development
expenses were 13% of net revenue for the

                                       30

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nine months ended September 30, 2020 and 2019, respectively. The decrease in
research and development expenses were mainly attributable to the restructuring
activities, and reduction in force, during 2019.

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 8% or $1.2
million to $16.9 million for the three months ended September 30, 2020, compared
to $15.7 million for the same period in 2019. Selling, marketing, general and
administrative expenses were 18% and 22% as a percentage of sales, for the three
months ended September 30, 2020 and 2019, respectively. The increase in selling,
general and administrative expenses for the three months ended September 30,
2020 compared to the same period in 2019 was largely the result of incremental
sales commission compensation in the 2020 period, related to higher revenue, as
well as to certain executive hires, and was offset by the impact of
restructuring activities undertaken during the second half of 2019.

Selling, marketing, general and administrative expenses decreased 4% or $1.9
million to $43.8 million for the nine months ended September 30, 2020, compared
to $45.7 million for the same period in 2019. Selling, marketing, general and
administrative expenses were 21% and 20% of net revenue for the nine months
ended September 30, 2020 and 2019, respectively.  The decrease in selling,
general and administrative expenses for the nine months ended September 30, 2020
compared to the same period in 2019 was largely the result of lower sales
commission expense associated with lower revenues for the 2020 period, as well
as the impact of restructuring activities undertaken during the second half of
2019.

Income Tax Provision

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 $6.5 million, respectively. Income tax expense for the three
and nine months ended September 30, 2019 was $0.3 million and $1.1 million,
respectively, on pre-tax loss of $3.7 million and $2.0 million, respectively.
For the three and nine months ended September 30, 2020, the effective income tax
rate varied from the United States statutory income tax rate primarily due to
valuation allowances in the United States and the mix of earnings generated by
our wholly-owned foreign subsidiaries, including higher pre-tax income in Japan
during the nine month ended September 30, 2020, as a result of increased
revenue.

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 merger and acquisition transaction
costs, inventory valuation step-up amortization, purchase price adjustments,
restructuring and other charges, goodwill impairment, bargain purchase gain,
gain (loss) on sale of assets, impairment of long-lived assets or loss on debt
extinguishment, 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.



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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 Adjusted EBITDA and net income, 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,
                                                2020                  2019              2020                  2019
Net income (loss)                          $          (115 )       $    (3,996 )$        (9,042 )$        (3,069 )
Add (less):
Interest expense, net                                  432                 750               1,405                 2,715
Income tax expense                                   1,619                 289               2,452                 1,098
Depreciation and amortization                        1,386               1,343               3,935                 4,110
Stock-based compensation                             1,660               1,182               3,310                 2,818
Headquarters relocation                                 35                   -                  35                     -
Executive transition                                 1,383                   -               1,383                     -
Acquisition costs                                        -                   -                   -                   337
Inventory step-up valuation amortization                 -                 175                   -                   577
Bargain purchase gain                                    -                   -                   -                  (334 )
Loss on debt extinguishment                              -                   -               1,369                     -
Adjusted EBITDA                            $         6,400         $      (257 )   $         4,847       $         8,252



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, 2019, 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, 2020       December 31, 2019
Cash and cash equivalents   $             31,307     $            28,747
Working capital                          120,653                 114,885


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The Company had a net loss of $9.0 million for the nine months ended September
30, 2020 and a net loss of $13.3 million for the year ended December 31, 2019.
Additionally, the Company incurred significant losses in years prior to 2019. As
of September 30, 2020, the Company had an accumulated deficit of $38.3 million
and working capital of $120.7 million.



In March 2020, as described below under the header Related Party Debt,
we entered into a Loan Agreement with DNI, and used a portion of such funds to
repay in full and terminate the Company's existing credit facility with PNC
Bank. In June 2020, we entered into an assignment agreement with a third party
to factor accounts receivables from a customer, and we received approximately
$11.6 million from this arrangement.



As of September 30, 2020, the Company had $31.3 million in cash and cash equivalents, which included $13.7 million held by its international subsidiaries; and $51.5 million in aggregate principal debt, of which $23.3 million was reflected in current liabilities.

If our liquidity proves to be insufficient, our business could suffer due to:

• increased vulnerability to adverse economic conditions in our industry or

      the economy in general, including those conditions resulting from the
      ongoing COVID-19 pandemic;

• substantial amounts of cash required to be used for debt servicing, rather

than other purposes, including operations;

• limitations on our ability to plan for, or react to, changes in our business

and industry; and

• investor and customer perceptions about our financial stability and limiting

our ability to obtain financing or acquire customers.



However, we continue to focus on cost management, operating efficiency and
restrictions on discretionary spending. In addition, if necessary, we may sell
assets, issue debt or equity securities or purchase credit insurance. We may
also reduce the scope of our planned product development, reduce sales and
marketing efforts and reduce our operations in low margin regions, including
reductions in headcount. Based on our current plans and current business
conditions, as of the date of this Quarterly Report on Form 10-Q, 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
twelve months from the date of this Quarterly Report on Form 10-Q.

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Our ability to meet our obligations as they become due in the ordinary course of
business for the next twelve (12) months will depend on our ability to (i)
achieve forecasted results of operations, (ii) access funds under new borrowing
arrangements and/or raise additional capital through sale of our common stock to
the public, and (iii) effectively manage working capital requirements. If we
cannot raise additional funds when we need or want them, our operations and
prospects could be negatively affected. While we believe that we are likely to
achieve forecasted results of operations if we are successful in implementing
our business strategies, the impact of the COVID-19 pandemic provides great
uncertainty with respect to our future operations, could result in a material
decline in our operating cash flows and could cause us to fail to meet our
obligations as they come due.

In December 2019, a strain of coronavirus, now known as 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 has 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. During the nine months ended September 30, 2020, the
Company's revenues declined relative to its prior expectations, in part due to
the COVID-19 pandemic. 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. The impact of a continued
COVID-19 pandemic or sustained measures taken to limit or contain the outbreak
could continue to have a material adverse effect on our business, financial
condition, results of operations, and cash flows. We are currently evaluating
the collectability of certain accounts receivable totaling $17.1 million that
are due from a customer located in India that are past due under the original
sales terms. It's difficult to determine when this receivable will be collected
and the ultimate amount to be collected.  We are actively working with the
customer to arrange payment. We are currently unable to determine whether any
loss will ultimately occur in connection with the resolution of this matter and
has not accrued any loss in the accompanying condensed consolidated financial
statements based on its current expectations regarding the collectability of the
receivable.  We will continue to evaluate the collectability of this receivable
as more information becomes available.

Operating Activities


Net cash used in operating activities decreased by $10.9 million to $11.0
million for the nine months ended September 30, 2020 from net cash used in
operating activities of $21.9 million for the nine months ended September 30,
2019. The improvement in cash from changes in operating assets and liabilities
was primarily due to collection of accounts receivables, including amounts
previously reflected in contract assets, partially offset by increases in
inventory.

Investing Activities


Net cash used in investing activities decreased by $4.2 million to $1.9 million
for the nine months ended September 30, 2020 from $6.2 million for the nine
months ended September 30, 2019. This decrease was primarily due to cash used in
the acquisition of Keymile in 2019.

Financing Activities


Net cash provided by financing activities totaled $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. This is in comparison to cash provided by financing
activities of $46.2 million for the nine months ended September 30, 2019 and
consisted primarily of proceeds from a public stock offering in May 2019 in
which we received $42.5 million in net proceeds.

Cash Management


Our primary source of liquidity comes from our cash, cash equivalents and
restricted cash, which totaled $40.6 million at September 30, 2020. Our cash,
cash equivalents and restricted cash as of September 30, 2020 included $17.8
million held by our international subsidiaries.

                                       34

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Debt Facilities


Bank, Trade Facilities and Secured Borrowings - Foreign Operations


On June 1, 2020, DZS Japan entered into an assignment agreement with JECC
Corporation to factor 1,258,822,828 YEN (approximately $11.6 million USD) of
accounts receivables from a customer. JECC assessed a discount equivalent to
5,964,328 YEN (approximately $0.05 million USD) (or approximately 0.474% of the
amount factored, with a stated factoring rate of 1.575% based on the days
remaining from factoring to expected receivable collection). DZS Japan received
1,252,858,500 YEN (approximately $11.65 million USD) on June 19, 2020. In
accordance with ASC 860, Transfers and Servicing of Financial Assets, this
agreement is accounted for as a secured borrowing. The expected collection of
the underlying accounts receivable is before the end of 2020. As of September
30, 2020, the secured borrowing balance was $5.9 million.

Certain of our foreign subsidiaries have entered into various financing
arrangements with foreign banks and other lending institutions consisting
primarily of revolving lines of credit, trade facilities, term loans and export
development loans. These facilities are renewed on an annual basis and are
generally secured by a security interest in certain assets of the applicable
foreign subsidiaries and supported by guarantees given by DNI or third parties.
Payments under such facilities are made in accordance with the given lender's
amortization schedules.

As of September 30, 2020 and December 31, 2019, we had an aggregate outstanding
balance of $23.3 million and $15.8 million, respectively, under such financing
arrangements, and the interest rate per annum applicable to outstanding
borrowings under these financing arrangements ranged from 0% to 3.30% as of
September 30, 2020.

Related Party Debt


In February 2016, DNS California borrowed $1.8 million from DNI for capital
investment with an interest rate of 4.6% per annum. On February 27, 2019, in
connection with the entry into the PNC Credit Facilities, the Company amended
the terms of this loan to extend the repayment date to May 27, 2022. As of
September 30, 2020, the $1.8 million was outstanding.

In September 2016, the Company entered into a loan agreement with DNI for a $5.0
million unsecured subordinated term loan facility. The term loan was scheduled
to mature in September 2021 and was pre-payable at any time by the Company
without premium or penalty. The interest rate under this facility was 4.6% per
annum. In February 2019, the Company repaid the term loan in full plus accrued
interest in connection with the entry into the PNC Credit Facilities, thereby
terminating the loan agreement.

In March 2018, DNS Korea borrowed $5.8 million from DNI, of which $4.5 million
was repaid on August 8, 2018. The loan bears interest at a rate of 4.6%. On
February 27, 2019, in connection with the entry into the PNC Credit Facilities,
the Company amended the terms of this loan to extend the repayment date to May
27, 2022. As of September 30, 2020, $1.2 million was outstanding.

In December 2018, the Company entered into a loan agreement with DNI, for a $6.0
million term loan with an interest rate of 4.6% per annum. On February 27, 2019,
in connection with the entry into the PNC Credit Facilities, the Company amended
the terms of the term loan to extend the repayment date to May 27, 2022 and to
terminate any security granted to DNI with respect to such term loan. As of
September 30, 2020, the $6.0 million was outstanding.

The modifications resulting from the amendments described in the four preceding
paragraphs were limited to the extension of the maturity dates and removal of
the collateral on the outstanding term loans with DNI. There were no fees paid
to DNI or external costs otherwise incurred in connection with these
modifications.



On March 5, 2020, DNS Korea, the Company's wholly-owned, indirect subsidiary
entered into a Loan Agreement with DNI (the "March 2020 DNI Loan"). The March
2020 DNI Loan was negotiated and approved on behalf of the Company and its
subsidiaries by a special committee of the Board of Directors of the Company
(the "Special Committee") consisting of directors determined to be independent
from DNI. The March 2020 DNI Loan consists of a term loan in the amount of KRW
22.4 billion ($18.5 million USD) with interest payable semi-annually at an
annual rate of 4.6% and maturing on March 11, 2022. No principal payments are
due on the March 2020 DNI Loan until the maturity date, but DNS Korea may prepay
the loan, or a portion thereof, without penalty. As of September 30, 2020, $19.1
million was outstanding.



As security for the March 2020 DNI Loan (and other existing loans between DNI
and DNS Korea and/or DNS California), (i) DNS California, a wholly-owned, direct
subsidiary of the Company and the sole stockholder of DNS Korea, agreed to
pledge the outstanding shares of DNS Korea to DNI and (ii) DNS Korea granted a
security interest in its personal property assets, accounts receivable and
intellectual property assets to DNI. The March 2020 DNI Loan includes certain
covenants consisting of financial reporting obligations, a maintenance covenant
whereby DNS Korea agreed to maintain a minimum stockholders' equity value in an
amount equal to or greater than KRW 43.3 billion ($35.8 million), and customary
events of default. If an event of default occurs and is not remedied within the
applicable cure period, DNI will be entitled to take various actions,

                                       35

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including requiring the immediate repayment of all outstanding amounts under the March 2020 DNI Loan and selling the shares or assets of DNS Korea.

DNS Korea loaned the funds borrowed under the March 2020 DNI Loan to the Company, and the Company used a portion of such funds to repay in full and terminate the PNC Credit Facilities, described above.


As of September 30, 2020, the Company had borrowings of $28.2 million
outstanding from related parties. The outstanding balance at September 30, 2020
consisted of the March 2020 DNI Loan of KRW 22.4 billion (approximately $19.1
million), a $6.0 million unsecured subordinated term loan facility which matures
in March 2022, a $1.8 million loan for capital investment which matures in May
2022, and KRW 1.5 billion (approximately $1.3 million) outstanding under a
secured loan from DNS Korea which matures in May 2022. All four loans bear
interest at a rate of 4.6% per annum.

Interest expense on these related party borrowings was $0.3 million and $0.8
million for the three and nine months ended September 30, 2020,
respectively. Interest expense on these related party borrowings was $0.1
million and $0.3 million for the three and nine months ended September 30, 2019,
respectively.

Future Requirements and Funding Sources


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

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

Our accounts receivable, while not considered a primary source of liquidity,
represent a concentration of credit risk because a significant portion of the
accounts receivable balance at any point in time typically consists of a
relatively small number of customer account balances. As of September 30, 2020,
three customers each represented 17%, 16% and 16% of net accounts receivable,
respectively, and receivables from customers in countries other than the United
States represented 93% of net accounts receivable. We do not currently have any
material commitments for capital expenditures, or any other material commitments
aside from operating leases for our facilities, inventory purchase commitments
and debt.

Contractual Commitments

At September 30, 2020, our future contractual commitments by fiscal year were as
follows (in thousands):



                                                              Payments due by period
                       Total         2020         2021         2022         2023         2024        Thereafter
Operating lease
payments              $ 23,845$  1,601$  5,283$  4,859$  4,424$  3,958$      3,720
Short-term debt         23,341        5,940       17,401                         -            -                -
Purchase
commitments              4,663        4,663            -            -            -            -                -
Long-term debt -
related party           28,167            -            -       28,167            -            -                -
Total future
contractual
  commitments         $ 80,016$ 12,204$ 22,684$ 33,026$  4,424$  3,958$      3,720




Operating Leases

Future minimum operating lease obligations in the table above include primarily
payments for our office locations and manufacturing, research and development
locations, which expire at various dates through 2027. See Note 13 "Leases" of
the Notes to Unaudited Condensed Consolidated Financial Statements included in
this Quarterly Report on Form 10-Q for further discussion regarding our
operating leases.

Purchase Commitments

The purchase commitments shown above represent non-cancellable inventory purchase commitments as of September 30, 2020.

                                       36

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Short-term and Long-term Debt


The debt obligation amount shown above represents scheduled principal
repayments, but not the associated interest payments which may vary based on
changes in market interest rates. See Note 7 "Debt" of the Notes to Unaudited
Condensed Consolidated Financial Statements included in this Quarterly Report on
Form 10-Q for further discussion regarding our debt agreements.

                                       37

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