DZS INC. 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
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 toTexas ; 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 otherbenefits 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
with the SEC .
26
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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
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 ofSeptember 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 OnAugust 24, 2020 , our board approved an amendment to our Certificate of Incorporation to change our name fromDasan Zhone Solutions, Inc. to "DZS Inc. ". OnAugust 26, 2020 , we filed a Certificate of Amendment to our Restated Certificate of Incorporation with theDelaware Secretary of State reflecting the above action. The name change took effect upon filing. The Company's trading symbol "DZSI" did not change. EffectiveAugust 1, 2020 ,Charlie Vogt was appointed as the President and Chief Executive Officer of theDZS, Inc. . In addition,Mr. Vogt was elected as a new member of the Board, also effectiveAugust 1, 2020 . In connection withMr. Vogt's appointment,Il Yung Kim ceased to serve as President and Chief Executive Officer ofDZS, Inc. and as a member of the Board 27 -------------------------------------------------------------------------------- effectiveJuly 31, 2020 . Prior to joining the Company,Mr. Vogt was most recently President and Chief Executive Officer ofATX Networks , a leader in broadband access and media distribution, where he led the company through extensive transformation and growth sinceFebruary 2018 and will remain a member of the board. FromJuly 2013 toJanuary 2018 ,Mr. Vogt served as President and Chief Executive Officer ofImagine 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 joiningImagine 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. OnAugust 1, 2020 , the Company completed the relocation of its corporate headquarters fromCalifornia toPlano, Texas . In connection with the relocation, the Company entered into sublease agreements withHuawei Technologies, Inc. andFuturewei Technologies, Inc. to sublease an aggregate of approximately 16,300 square feet located at5700 Tennyson Parkway ,Plano, Texas . InSeptember 2020 , the Company entered into a lease agreement for approximately 10,300 square feet of additional office space at its headquarters inPlano, TX. OnJune 1, 2020 ,DZS Japan, Inc. ("DZS Japan") entered into an assignment agreement withJECC Corporation to factor1,258,822,828 YEN (approximately$11.6 million ) of accounts receivables from one of its customers. JECC assessed a discount equivalent to5,964,328 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 received1,252,588,500 YEN (approximately$11.65 million ) onJune 19, 2020 . As ofSeptember 30, 2020 , the secured borrowing balance was$5.9 million . OnMarch 5, 2020 ,Dasan Network Solutions, Inc. ("DNS Korea") entered into a Loan Agreement with DNI, pursuant to which DNS Korea borrowedKRW 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. 28
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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.
29
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Information about our net revenue for
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 endedSeptember 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 endedSeptember 30, 2020 andSeptember 30, 2019 , respectively. Total cost of revenue decreased 7% or$10.4 million to$144.0 million for the nine months endedSeptember 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 endedSeptember 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 endedSeptember 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 endedSeptember 30, 2020 and 2019, respectively. Research and product development expenses decreased 9% or$2.6 million to$26.9 million for the nine months endedSeptember 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 -------------------------------------------------------------------------------- nine months endedSeptember 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 endedSeptember 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 endedSeptember 30, 2020 and 2019, respectively. The increase in selling, general and administrative expenses for the three months endedSeptember 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 endedSeptember 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 endedSeptember 30, 2020 and 2019, respectively. The decrease in selling, general and administrative expenses for the nine months endedSeptember 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 endedSeptember 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 endedSeptember 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 endedSeptember 30, 2020 , the effective income tax rate varied fromthe United States statutory income tax rate primarily due to valuation allowances inthe United States and the mix of earnings generated by our wholly-owned foreign subsidiaries, including higher pre-tax income inJapan during the nine month endedSeptember 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 ourU.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. 31 --------------------------------------------------------------------------------
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 withU.S. GAAP or as a measure of liquidity. Management understands these limitations and compensates for these limitations by relying primarily on ourU.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
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 endedDecember 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
32
-------------------------------------------------------------------------------- The Company had a net loss of$9.0 million for the nine months endedSeptember 30, 2020 and a net loss of$13.3 million for the year endedDecember 31, 2019 . Additionally, the Company incurred significant losses in years prior to 2019. As ofSeptember 30, 2020 , the Company had an accumulated deficit of$38.3 million and working capital of$120.7 million . InMarch 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 withPNC Bank . InJune 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
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.
33
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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 endedSeptember 30, 2020 from net cash used in operating activities of$21.9 million for the nine months endedSeptember 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 endedSeptember 30, 2020 from$6.2 million for the nine months endedSeptember 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 endedSeptember 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 endedSeptember 30, 2019 and consisted primarily of proceeds from a public stock offering inMay 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 atSeptember 30, 2020 . Our cash, cash equivalents and restricted cash as ofSeptember 30, 2020 included$17.8 million held by our international subsidiaries. 34 --------------------------------------------------------------------------------
Debt Facilities
Bank, Trade Facilities and Secured Borrowings - Foreign Operations
OnJune 1, 2020 , DZS Japan entered into an assignment agreement withJECC Corporation to factor1,258,822,828 YEN (approximately$11.6 million USD ) of accounts receivables from a customer. JECC assessed a discount equivalent to5,964,328 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 received1,252,858,500 YEN (approximately$11.65 million USD ) onJune 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 ofSeptember 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 ofSeptember 30, 2020 andDecember 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 ofSeptember 30, 2020 .
Related Party Debt
InFebruary 2016 , DNS California borrowed$1.8 million from DNI for capital investment with an interest rate of 4.6% per annum. OnFebruary 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 toMay 27, 2022 . As ofSeptember 30, 2020 , the$1.8 million was outstanding. InSeptember 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 inSeptember 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. InFebruary 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. InMarch 2018 , DNS Korea borrowed$5.8 million from DNI, of which$4.5 million was repaid onAugust 8, 2018 . The loan bears interest at a rate of 4.6%. OnFebruary 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 toMay 27, 2022 . As ofSeptember 30, 2020 ,$1.2 million was outstanding. InDecember 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. OnFebruary 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 toMay 27, 2022 and to terminate any security granted to DNI with respect to such term loan. As ofSeptember 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. OnMarch 5, 2020 , DNS Korea, the Company's wholly-owned, indirect subsidiary entered into a Loan Agreement with DNI (the "March 2020 DNI Loan"). TheMarch 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. TheMarch 2020 DNI Loan consists of a term loan in the amount ofKRW 22.4 billion ($18.5 million USD ) with interest payable semi-annually at an annual rate of 4.6% and maturing onMarch 11, 2022 . No principal payments are due on theMarch 2020 DNI Loan until the maturity date, but DNS Korea may prepay the loan, or a portion thereof, without penalty. As ofSeptember 30, 2020 ,$19.1 million was outstanding. As security for theMarch 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. TheMarch 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 thanKRW 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 --------------------------------------------------------------------------------
including requiring the immediate repayment of all outstanding amounts under the
DNS Korea loaned the funds borrowed under the
As ofSeptember 30, 2020 , the Company had borrowings of$28.2 million outstanding from related parties. The outstanding balance atSeptember 30, 2020 consisted of theMarch 2020 DNI Loan ofKRW 22.4 billion (approximately$19.1 million ), a$6.0 million unsecured subordinated term loan facility which matures inMarch 2022 , a$1.8 million loan for capital investment which matures inMay 2022 , andKRW 1.5 billion (approximately$1.3 million ) outstanding under a secured loan from DNS Korea which matures inMay 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 endedSeptember 30, 2020 , respectively. Interest expense on these related party borrowings was$0.1 million and$0.3 million for the three and nine months endedSeptember 30, 2019 , respectively.
Future Requirements and Funding Sources
Our fixed commitments for cash expenditures consist primarily of payments under operating leases, inventory purchase commitments, and payments of principal and interest for debt obligations. From time to time, we may provide or commit to extend credit or credit support to our customers. This financing may include extending the terms for product payments to customers. Any extension of financing to our customers will limit the capital that we have available for other uses. Our accounts receivable, while not considered a primary source of liquidity, represent a concentration of credit risk because a significant portion of the accounts receivable balance at any point in time typically consists of a relatively small number of customer account balances. As ofSeptember 30, 2020 , three customers each represented 17%, 16% and 16% of net accounts receivable, respectively, and receivables from customers in countries other thanthe United States represented 93% of net accounts receivable. We do not currently have any material commitments for capital expenditures, or any other material commitments aside from operating leases for our facilities, inventory purchase commitments and debt. Contractual Commitments AtSeptember 30, 2020 , our future contractual commitments by fiscal year were as follows (in thousands): Payments due by period Total 2020 2021 2022 2023 2024 Thereafter Operating lease payments$ 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
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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.
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