SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
|x||QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934|
For the quarterly period ended March 31, 2023
|o||TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934|
For the transition period from ______ to
(Commission File Number)
(Exact name of registrant as specified in its charter)
|(State or other jurisdiction of|
incorporation or organization)
5700 Tennyson Parkway, Suite 400
|(Address of principal executive offices)||(Zip code)|
(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
|Title of each class||Trading Symbol(s)||Name of each exchange on which registered|
|Common stock, $0.001 par value||DZSI||The Nasdaq Stock Market LLC|
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes x No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in rule 12b-2 of the Exchange Act.
|Large accelerated filer||o||Accelerated filer||x|
|Non-accelerated filer||o||Smaller reporting company||o|
|Emerging growth company||o|
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x
As of May 1, 2023, there were 31,159,778 shares outstanding of the registrant’s common stock, $0.001 par value.
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
DZS INC. AND SUBSIDIARIES
Unaudited Condensed Consolidated Balance Sheets
(In thousands, except par value)
|Cash and cash equivalents||$||28,892 ||$||34,347 |
|Restricted cash||1,975 ||3,969 |
Accounts receivable - trade, net of allowance for doubtful accounts of $16,087 as of March 31, 2023 and $16,184 as of December 31, 2022
|141,029 ||153,780 |
|Other receivables||21,518 ||16,144 |
|Inventories||69,722 ||78,513 |
|Contract assets||605 ||576 |
|Prepaid expenses and other current assets||10,689 ||8,371 |
|Total current assets||274,430 ||295,700 |
|Property, plant and equipment, net||7,135 ||9,478 |
|Right-of-use assets from operating leases||11,971 ||12,606 |
|Goodwill||19,952 ||19,952 |
|Intangible assets, net||30,422 ||31,742 |
|Other assets||17,013 ||15,536 |
|Total assets||$||360,923 ||$||385,014 |
|Liabilities and Stockholders’ Equity|
|Accounts payable - trade||$||107,904 ||$||121,225 |
|Short-term debt – bank, trade facilities and secured borrowings||16,746 ||9,706 |
|Current portion of long-term debt||23,660 ||24,073 |
|Contract liabilities||19,476 ||21,777 |
|Operating lease liabilities||4,859 ||4,834 |
|Accrued and other liabilities||29,615 ||27,559 |
|Total current liabilities||202,260 ||209,174 |
|Long-term debt||— ||— |
|Contract liabilities - non-current||6,636 ||7,864 |
|Operating lease liabilities - non-current||10,499 ||11,417 |
|Pension liabilities||11,060 ||11,021 |
|Other long-term liabilities||2,583 ||2,806 |
|Total liabilities||233,038 ||242,282 |
|Commitments and contingencies (Note 13)|
Common stock, 36,000 shares authorized, 31,102 and 30,968 shares issued and outstanding as of March 31, 2023 and December 31, 2022, respectively, at $0.001 par value
|31 ||30 |
|Additional paid-in capital||276,282 ||271,884 |
|Accumulated other comprehensive loss||(6,462)||(4,351)|
|Total stockholders’ equity||127,885 ||142,732 |
|Total liabilities and stockholders’ equity||$||360,923 ||$||385,014 |
See accompanying notes to unaudited condensed consolidated financial statements.
DZS INC. AND SUBSIDIARIES
Unaudited Condensed Consolidated Statements of Comprehensive Income (Loss)
(In thousands, except per share data)
|Three Months Ended|
|Net revenue||$||90,812 ||$||77,040 |
|Cost of revenue||60,985 ||50,215 |
|Gross profit||29,827 ||26,825 |
|Research and product development||14,851 ||11,844 |
|Selling, marketing, general and administrative||24,781 ||17,742 |
|Restructuring and other charges||4,152 ||436 |
|Amortization of intangible assets||1,271 ||294 |
|Total operating expenses||45,055 ||30,316 |
|Interest expense, net||(792)||(90)|
|Other income (expense), net||728 ||(800)|
|Loss before income taxes||(15,292)||(4,381)|
|Income tax provision (benefit)||1,843 ||(1,333)|
|Foreign currency translation adjustments (a)||(2,051)||(268)|
|Actuarial loss||(60)||— |
|Net loss per share|
|Weighted average shares outstanding|
(a)Includes net gain of $0.2 million and net loss of $0.4 million on intra-entity foreign currency transactions that are of a long-term investment nature for three months ended March 31, 2023 and 2022.
See accompanying notes to unaudited condensed consolidated financial statements.
DZS INC. AND SUBSIDIARIES
Unaudited Condensed Consolidated Statements of Stockholders' Equity
|Three months ended March 31, 2023:|
|Balance as of December 31, 2022||30,968||$||30 ||$||271,884 ||$||(4,351)||$||(124,831)||$||142,732 |
|Issuance of common stock upon vesting of restricted stock units, exercise of stock options and employee stock plan purchases, net of shares withheld for taxes||134||1 ||(88)||— ||— ||(87)|
|Stock-based compensation||—||— ||4,486 ||— ||— ||4,486 |
|Net income (loss)||—||— ||— ||— ||(17,135)||(17,135)|
|Other comprehensive loss||—||— ||— ||(2,111)||— ||(2,111)|
|Balance as of March 31, 2023||31,102||$||31 ||$||276,282 ||$||(6,462)||$||(141,966)||$||127,885 |
|Three months ended March 31, 2022:|
|Balance as of December 31, 2021||27,505||$||27 ||$||223,336 ||$||(4,457)||$||(86,999)||$||131,907 |
|—||— ||— ||— ||(401)||(401)|
|Issuance of common stock upon vesting of restricted stock units, exercise of stock options and employee stock plan purchases, net of shares withheld for taxes||98||— ||156 ||— ||— ||156 |
|Stock-based compensation||—||— ||2,671 ||— ||— ||2,671 |
|Net income (loss)||—||— ||— ||— ||(3,048)||(3,048)|
|Subsidiary dissolution||—||— ||— ||(68)||— ||(68)|
|Other comprehensive loss||—||— ||— ||(268)||— ||(268)|
|Balance as of March 31, 2022||27,603||$||27 ||$||226,163 ||$||(4,793)||$||(90,448)||$||130,949 |
See accompanying notes to unaudited condensed consolidated financial statements.
DZS INC. AND SUBSIDIARIES
Unaudited Condensed Consolidated Statements of Cash Flows
|Three months ended|
|Cash flows from operating activities:|
|Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:|
|Depreciation and amortization||2,465 ||1,081 |
|Amortization of deferred financing costs||60 ||— |
|Stock-based compensation||4,486 ||2,671 |
|Provision for inventory write-down||1,086 ||705 |
|Bad debt expense, net of recoveries||(184)||(752)|
|Provision for sales returns||541 ||1,448 |
|Provision for warranty||70 ||121 |
|Unrealized loss (gain) on foreign currency transactions||1,396 ||874 |
|Subsidiary dissolution||— ||(68)|
|Loss on disposal of property, plant and equipment||40 ||— |
|Changes in operating assets and liabilities:|
|Accounts receivable||11,033 ||2,761 |
|Other receivable||(5,511)||126 |
|Contract assets||(29)||1,261 |
|Prepaid expenses and other assets||(3,138)||(7,577)|
|Accounts payable||(13,875)||1,586 |
|Accrued and other liabilities||131 ||456 |
|Net cash used in operating activities||(15,006)||(10,732)|
|Cash flows from investing activities:|
|Proceeds from disposal of property, plant and equipment and other assets||1,790 ||— |
|Purchases of property, plant and equipment||(775)||(1,317)|
|Net cash provided by (used in) investing activities||1,015 ||(1,317)|
|Cash flows from financing activities:|
|Repayments of long-term borrowings||(313)||— |
|Proceeds from short-term borrowings and line of credit, net||8,918 ||— |
|Proceeds from related party term loan||4,059 ||— |
|Repayments of related party term loan||(5,845)||— |
|Payments for debt issue costs||(122)||(178)|
|Proceeds from exercise of stock awards and employee stock plan purchases||(87)||156 |
|Net cash provided by (used in) financing activities||6,610 ||(22)|
|Effect of exchange rate changes on cash, cash equivalents and restricted cash||(67)||(903)|
|Net change in cash, cash equivalents and restricted cash||(7,448)||(12,974)|
|Cash, cash equivalents and restricted cash at beginning of period||38,464 ||53,639 |
|Cash, cash equivalents and restricted cash at end of period||$||31,016 ||$||40,665 |
|Reconciliation of cash, cash equivalents and restricted cash to statement of financial position|
|Cash and cash equivalents||$||28,892 ||$||34,160 |
|Restricted cash||1,975 ||6,343 |
|Long-term restricted cash||149 ||162 |
|$||31,016 ||$||40,665 |
|Supplemental disclosure of cash flow information:|
|Cash paid during the period for:|
|Interest - bank and trade facilities||$||660 ||$||36 |
|Interest - related party||$||64 ||$||— |
|Income taxes||$||480 ||$||283 |
See accompanying notes to unaudited condensed consolidated financial statements.
Notes to Unaudited Condensed Consolidated Financial Statements
(1) Organization and Summary of Significant Accounting Policies
(a) Description of Business
DZS Inc. (referred to, collectively with its subsidiaries, as “DZS” or the “Company”) is global provider of access and optical networking infrastructure and cloud software solutions that enable the emerging hyper-connected, hyper-broadband world and broadband experiences. The Company provides a wide array of reliable, cost-effective networking technologies and software to a diverse customer base.
DZS was incorporated under the laws of the state of Delaware in June 1999. The Company is headquartered in Plano, Texas with contract manufacturers and original design manufacturers located in the U.S, India, Korea, China, Taiwan, and Vietnam. The Company also maintains offices to provide sales and customer support at global locations. Through 2022, we also utilized our in-house manufacturing facility in Seminole, Florida. In October 2022, we announced an agreement with Fabrinet, a third-party provider of electro-mechanical and electronic manufacturing and distribution services, to transition the sourcing, procurement, order-fulfillment, manufacturing and return merchandise authorization activities in the Company's Seminole facility to Fabrinet. The transition began in October 2022 and substantially completed in the beginning of 2023, whereupon the Company no longer manufactures its products.
(b) Basis of Presentation
The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with U.S. GAAP for interim financial information and with the instructions to Form 10-Q and Article 3 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by U.S. GAAP for complete financial statements. These financial statements include the accounts of the Company and its wholly owned subsidiaries. These unaudited condensed consolidated financial statements should be read in conjunction with the consolidated financial statements of the Company and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2022 filed with the Securities and Exchange Commission (“SEC”) on March 10, 2023. For a complete description of what the Company believes to be the critical accounting policies and estimates used in the preparation of its unaudited condensed consolidated financial statements, refer to the Company’s Annual Report on Form 10-K for the year ended December 31, 2022.
All intercompany transactions and balances have been eliminated in consolidation. Certain prior-year amounts have been reclassified to conform to the current-quarter presentation. The unaudited condensed consolidated financial statements reflect all adjustments (consisting only of normal recurring adjustments) that, in the opinion of management, are necessary for a fair presentation of the results for the interim periods presented. The results of operations for the current interim period are not necessarily indicative of results to be expected for the current year or any other period.
(c) Risks and Uncertainties
The accompanying unaudited condensed consolidated financial statements have been prepared in conformity with U.S. GAAP, assuming the Company will continue as a going concern.
We continue to be exposed to macroeconomic pressures in the post-COVID-19 environment, including concerns about energy costs, geopolitical issues, inflation, the availability and cost of credit, business and consumer confidence, and unemployment. We have seen improvement in our supply chain in 2023 as supply chain pricing, freight and logistics costs, product and component availability, and extended lead-times which were a challenge in 2021 and 2022 begin to alleviate in 2023 as the world economy recovers from the COVID-19 pandemic. We expect elevated costs for components and expedite fees to further improve throughout 2023.
We conduct significant business in South Korea, Japan, Vietnam, India, Spain, and Canada, as well as in other countries in Europe, Asia-Pacific, Middle East and Latin America, all of which subject us to foreign currency exchange rate risk. The local currencies of our significant foreign subsidiaries are the South Korean Won ("KRW"), Japanese Yen ("JPY"), Euro ("EUR), and Pound Sterling ("GBP"). Revenues and operating expenses are typically denominated in the local currency of each country and result from transactions by our operations in these countries. However, a significant portion of our international cost of sales is denominated in the U.S. Dollar (“USD”). During 2022, the USD appreciated significantly against the KRW, JPY, EUR and GBP which reduced the translated revenues, cost of sales and operating expenses transacted in local currencies, but not the USD based cost of sales, resulting in compressed margins and lower profitability. Late in 2022, exchange rates for these currencies abated somewhat, but the exchange rates for the KRW and JPY remain elevated compared to historical rates.
As of March 31, 2023, the Company's debt obligation under the Term Loan was $23.7 million, net of unamortized issuance cost of $0.4 million, of which $1.3 million is scheduled for payment in the next 12 months. Due to the ongoing risk of non-compliance in the next 12 months we continue to classify the entire amount as a current liability. We are currently in discussion with the lenders to amend the debt agreement to mitigate the risk of non-compliance.
In addition to negotiating for revised financial covenants, we continue to focus on cost management, operating efficiency and efficient discretionary spending. Management is actively taking measures to enhance profitability and liquidity, including reducing the Company’s cost structure and cash outflows, including its investment in inventory, and managing receivable balances through aggressive collection efforts and tighter customers payment terms.These plans are not completely within the Company’s control, as some actions are dependent on the Company’s lenders, vendors and customers. However, the Company believes that it will maintain liquidity in the next 12 months to support its operations.
(d) Use of Estimates
The preparation of the unaudited condensed consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the unaudited condensed consolidated financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ materially from those estimates.
(e) Disaggregation of Revenue
The following table presents revenues by product technology (in thousands):
|Three Months Ended March 31,|
|Access Networking Infrastructure||$||79,459 ||$||72,462 |
|Cloud Software & Services||11,353 ||4,578 |
|Total||$||90,812 ||$||77,040 |
The following table present revenues by geographical concentration (in thousands):
|Three Months Ended March 31,|
|Americas||$||24,855 ||$||23,061 |
|Europe, Middle East, Africa||19,182 ||18,649 |
|Asia||46,775 ||35,330 |
|Total||$||90,812 ||$||77,040 |
(f) Concentration of Risk
Financial instruments that potentially subject the Company to concentrations of credit risk consist primarily of cash, cash equivalents and restricted cash, accounts receivables, and contract assets. Cash, cash equivalents and restricted cash consist of financial deposits and money market accounts that are principally held with various domestic and international financial institutions with high credit standing.
The Company’s customers include competitive and incumbent local exchange carriers, competitive access providers, internet service providers, wireless carriers and resellers serving these markets. The Company performs ongoing credit evaluations of its customers and generally does not require collateral. Allowances are maintained for potential doubtful accounts based upon the expected collectability of accounts receivable using historical loss rates adjusted for customer-specific factors and current economic conditions. The Company determines historical loss rates on a rational and systematic basis. The Company performs periodic assessments of its customers’ liquidity and financial condition through analysis of information obtained from credit rating agencies, financial statement review and historical and current collection trends.
Activity under the Company’s allowance for doubtful accounts consists of the following (in thousands):
|Three Months Ended March 31,|
|Balance at beginning of period||$||16,184 ||$||17,735 |
|Charged to expense, net of recoveries||(184)||(752)|
|Utilization and write off||— ||— |
|Cumulative effect of ASC 326 adoption||— ||401 |
|Foreign exchange impact||87 ||(326)|
|Balance at end of period||$||16,087 ||$||17,058 |
For the three months ended March 31, 2023, two customers each accounted for 13% of net revenue. For the three months ended March 31, 2022, two customers accounted for 13% and 12% of net revenue, respectively.
As of March 31, 2023 and December 31, 2022, no customers represented more than 10% of net accounts receivable.
As of March 31, 2023 and December 31, 2022, net accounts receivables from customers in countries other than the United States represented 86%.
In 2017, the Company entered into an agreement with a customer in India to supply product for a state sponsored broadband project. The Company substantially completed its obligations under the agreement in 2018. The Company billed the customer, which is a state government sponsored entity, approximately $59.0 million and collected payments of approximately $41.7 million by December 31, 2020. In late March 2021, the customer’s state government parent experienced difficulty passing a budget impacting the ability of the customer to make remaining agreed-upon payments to us. In light of this development, the Company recorded an allowance that covered the entire balance unpaid by the customer. Subsequent to March 2021, the Company recovered approximately $2.5 million of accounts receivable related to the customer. As of March 31, 2023 the Company has a recorded allowance for doubtful accounts of $13.1 million related to this receivable. The Company will continue to pursue collection of the entire outstanding balance and any amounts collected will be recognized in the period which they are received. In the event the Company’s efforts to collect from this customer prove unsuccessful, DZS may seek payment through other means, including through legal action.
(g) Business Combinations
The Company allocates the fair value of purchase consideration to the tangible and identifiable intangible assets acquired and liabilities assumed based on their estimated fair values. The excess of the fair value of purchase consideration over the fair values of these identifiable assets and liabilities is recorded as goodwill. When determining the fair values of assets acquired and liabilities assumed, management makes significant estimates and assumptions, especially with respect to intangible assets and certain tangible assets such as inventory.
Critical estimates in valuing certain tangible and intangible assets include but are not limited to future expected cash flows from the underlying assets and discount rates. Management’s estimates of fair value are based upon assumptions believed to be reasonable, but which are inherently uncertain and unpredictable and, as a result, actual results may differ from estimates.
Assets acquired and liabilities assumed are generally measured at their acquisition-date fair values. If the initial accounting for a business combination is incomplete by the end of the reporting period in which the combination occurs, the Company reports provisional amounts for the items for which the accounting is incomplete. Those provisional amounts are adjusted during the measurement period (which cannot exceed one year from the acquisition date), or additional assets or liabilities are recognized, to reflect new information obtained about facts and circumstances that existed as of the acquisition date that, if known, would have affected the amounts recognized as of that date.
When the consideration transferred by the Company in a business combination includes a contingent consideration arrangement, the contingent consideration is measured at its acquisition-date fair value and included as part of the total consideration transferred in a business combination. Changes in fair value of the contingent consideration that qualify as measurement period adjustments are made retrospectively, with corresponding adjustments against goodwill. Changes in the fair value of the contingent consideration that do not qualify as measurement period adjustments are made in the current period, with corresponding adjustments recognized in earnings.
(h) Restructuring and Other Charges
From time to time, the Company takes actions to align its workforce, facilities and operating costs with perceived market opportunities, business strategies and changes in market and business conditions. The Company recognizes a liability for the cost associated with an exit or disposal activity in the period in which the liability is incurred, except for one-time employee termination benefits, which are measured at the communication date and recognized ratably over the required service period, if any.
(i) Recent Accounting Pronouncements
In October 2021, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2021-08, Business Combinations (Topic 805): Accounting for Contract Assets and Contract Liabilities from Contracts with Customers, which requires the Company to apply ASC 606, Revenue from Contracts with Customers, to recognize and measure contract assets and contract liabilities from contracts with customers acquired in a business combination. Before the update such balances were measured and recognized at fair value on the acquisition date. The ASU is effective for fiscal years beginning after December 15, 2022, including interim periods within those fiscal years. Early adoption is permitted, including in interim periods. The Company adopted these requirements prospectively, effective on the first day of the second quarter of year 2022. There was no material impact on our consolidated financial statements on the adoption date.
In June 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, which requires the Company to measure and recognize expected credit losses for financial assets held and not accounted for at fair value through net income. In November 2018, April 2019 and May 2019, the FASB issued ASU No. 2018-19, Codification Improvements to Topic 326, Financial Instruments - Credit Losses, ASU No. 2019-04, Codification Improvements to Topic 326, Financial Instruments - Credit Losses, and ASU No. 2019-05, Financial Instruments - Credit Losses (Topic 326): Targeted Transition Relief, which provided additional implementation guidance on the previously issued ASU. The Company adopted the updated guidance on January 1, 2022, utilizing the modified retrospective transition method and recorded a cumulative-effect adjustment of $0.4 million to retained earnings.
(2) Business Combinations
On May 27, 2022, the Company acquired certain assets and liabilities of Adaptive Spectrum and Signal Alignment, Incorporated (“ASSIA”), an industry pioneer of broadband access quality-of-experience and service assurance software solutions (the “ASSIA Acquisition”). The core assets acquired include the CloudCheck® Wi-Fi experience management and Expresse® access network optimization software solutions. These software solutions add powerful data analytics and network intelligence capabilities to DZS Cloud, including cloud-managed WiFi solutions, access network optimization and intelligent automation tools. The CloudCheck® and Expresse® solutions are currently deployed in over 125 million connected homes globally, and many of these connections now represent recurring software revenue opportunities for DZS.
The initial purchase consideration was $25.0 million, including a $2.5 million holdback that will be released in 13 months following the transaction close date. In October 2022, the Company agreed to pay an additional $1.35 million of purchase consideration to settle certain unresolved matters related to the ASSIA Acquisition.
The acquisition was recorded as a business combination with valuation of the assets acquired and liabilities assumed recorded at their acquisition date fair value determined using level three inputs, defined as unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. We completed the purchase price allocation for ASSIA Acquisition in the first quarter of 2023.
The following summarizes the final fair values of the assets acquired and liabilities assumed at the date of the ASSIA Acquisition (in thousands):
|Allocation of purchase consideration|
|Cash and cash equivalents||$||203 |
|Accounts receivable||2,322 |
|Other assets||407 |
|Right-of-use assets||2,172 |
|Property, plant and equipment||232 |
|Intangible assets||30,200 |
|Operating lease liabilities||(2,612)|
|Accrued and other liabilities||(756)|
|Total purchase consideration||$||26,350 |
The purchase price allocation resulted in the recognition of goodwill of approximately $13.8 million, which included the experienced workforce and the expected synergies from combining operations. The Company expects no goodwill to be deductible for tax purposes.
The following table represents the final estimated fair value and useful lives of identifiable intangible assets acquired (estimated fair value in thousands):
|Intangible assets acquired|
|Customer relationships||$||18,600 ||15 years|
|Customer backlog||5,100 ||10 years|
|Developed technology||6,200 |
5 - 7 years
|Tradenames||300 ||10 years|
|Total intangible assets||$||30,200 || |
On February 5, 2021, the Company acquired Optelian Access Networks Corporation (“Optelian”), a corporation incorporated under the laws of Canada and registered extra-provincially in the Province of Ontario, pursuant to an acquisition agreement whereby the Company purchased all the outstanding shares of Optelian. Following the closing of the transaction, Optelian became the Company’s wholly owned subsidiary.
Optelian was a leading optical networking solution provider. This acquisition introduced the “O-Series” to the DZS portfolio of carrier grade optical networking products with up to 400 gigabits per second (Gig) and above capability, expanding the DZS product portfolio by providing environmentally hardened, high capacity, and flexible solutions at the network edge.
The purchase price of $7.5 million included cash paid to the shareholders and option holders of Optelian, cash paid to retire Optelian's outstanding debt on the date of acquisition, and contingent payments to shareholders.
The payment to shareholders and option holders included a $0.3 million holdback, which was released during the third quarter of 2022, and $1.9 million contingent consideration based on a certain percentage of future revenue of certain Optelian products through the end of 2023. We completed the purchase price allocation for Optelian acquisition in 2021. The purchase price allocation resulted in the recognition of goodwill of approximately $1.9 million, which primarily related to the expected synergies from combining operations.
On March 3, 2021, the Company acquired substantially all of the assets of RIFT, Inc., a network automation solutions company, and all the outstanding shares of RIFT.IO India Private Limited, a wholly owned subsidiary of RIFT, Inc. (collectively “RIFT”). RIFT developed a carrier-grade RIFT.ware software platform that simplifies the deployment of any slice, service, or application on any cloud. This acquisition introduced DZS Xtreme, a solution within the DZS Cloud portfolio, to the overall portfolio of DZS systems and software solutions. The total purchase consideration was $0.5 million, including a $0.2 million holdback that was released in April of 2021 following the fulfillment of certain requirements in the purchase agreement. We completed the purchase price allocation for RIFT acquisition in 2021. The purchase price allocation resulted in the recognition of goodwill of approximately $0.2 million, which primarily related to the expected synergies from combining operations.
(3) Fair Value Measurement
The Company utilizes a fair value hierarchy that is intended to increase consistency and comparability in fair value measurements and related disclosures. The fair value hierarchy is based on inputs to valuation techniques that are used to measure fair value that are either observable or unobservable. Observable inputs reflect assumptions market participants would use in pricing an asset or liability based on market data obtained from independent sources while unobservable inputs reflect a reporting entity’s pricing based upon their own market assumptions. The fair value hierarchy consists of the following three levels:
Level 1 Inputs are quoted prices in active markets for identical assets or liabilities.
Level 2 Inputs are quoted prices for similar assets or liabilities in an active market, quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable and market-corroborated inputs which are derived principally from or corroborated by observable market data.
Level 3 Inputs are derived from valuation techniques in which one or more significant inputs or value drivers are unobservable
Assets and Liabilities Measured at Fair Value on a Recurring Basis:
The carrying values of financial instruments such as cash and cash equivalents, restricted cash, accounts and other receivables, accounts payable and accrued liabilities approximate their fair values based on their short-term nature. The carrying value of the Company's debt approximates its fair values based on the current rates available to the Company for debt of similar terms and maturities.
The Company classifies its contingent liability from Optelian acquisition within Level 3 as it includes inputs not observable in the market. The Company estimates the fair value of contingent consideration as the present value of the expected contingent payments, determined using the revenue forecast for certain Optelian products through the end of 2023. The fair value of contingent liability is generally sensitive to changes in the revenue forecast during the payout period. The change in the respective fair value is included in selling, marketing, general and administrative expenses on the unaudited condensed consolidated statement of comprehensive income (loss).
The following table reconciles the beginning and ending balances of the Company’s Level 3 contingent liability (in thousands):
|Three Months Ended March 31,|
|Balance at beginning of period||$||1,156 ||$||2,121 |
|Cash payments||— ||— |
|Net change in fair value||27 ||51 |
|Balance at end of period||$||1,183 ||$||2,172 |
(4) Cash, Cash Equivalents and Restricted Cash
As of March 31, 2023 and December 31, 2022, the Company's cash, cash equivalents and restricted cash consisted of financial deposits. Cash, cash equivalents and restricted cash held within the U.S. totaled $16.8 million and $24.9 million as of March 31, 2023 and December 31, 2022, respectively. Cash, cash equivalents and restricted cash held within the U.S. are held at FDIC insured depository institutions. Cash, cash equivalents and restricted cash held outside the U.S. totaled $14.1 million and $13.6 million as of March 31, 2023 and December 31, 2022, respectively. Restricted cash consisted primarily of cash collateral for performance bonds and warranty bonds. Long-term restricted cash was $0.1 million and $0.2 million as of March 31, 2023 and December 31, 2022, respectively, and is included in other assets on the unaudited condensed consolidated balance sheets.
(5) Balance Sheet Details
Balance sheet detail as of March 31, 2023 and December 31, 2022 is as follows (in thousands):
|March 31, 2023||December 31, 2022|
|Raw materials||$||35,870 ||$||37,354 |
|Work in process||699 ||1,050 |
|Finished goods||33,153 ||40,109 |
|Total inventories||$||69,722 ||$||78,513 |
Inventories are stated at the lower of cost or net realizable value, with cost being computed based on an adjusted standard basis, which approximates actual cost on an average or first-in, first-out basis.
Property, plant and equipment
|March 31, 2023||December 31, 2022|
|Property, plant and equipment, net:|
|Machinery and equipment||$||12,971 ||$||17,214 |
|Leasehold improvements||2,440 ||5,683 |
|Computers and software||4,608 ||4,713 |
|Furniture and fixtures||2,108 ||1,748 |
|Construction in progress and other||1,358 ||1,264 |
|23,485 ||30,622 |
|Less: accumulated depreciation and amortization||(16,285)||(21,062)|
|Less: government grants||(65)||(82)|
|Total property, plant and equipment, net||$||7,135 ||$||9,478 |
Depreciation expense associated with property, plant and equipment for the three months ended March 31, 2023 and March 31, 2022 was $1.2 million and $0.8 million, respectively.
The Company accrues warranty costs based on historical trends for the expected material and labor costs to provide warranty services. The Company's standard warranty period is one year from the date of shipment with the ability for customers to purchase an extended warranty of up to five years from the date of shipment. The following table summarizes the activity related to the product warranty liability:
|Three Months Ended March 31,|
|Balance at beginning of period||$||1,896 ||$||1,981 |
|Charged to cost of revenue||70 ||121 |
|Claims and settlements||(113)||(149)|
|Foreign exchange impact||21 ||(17)|
|Balance at end of period||$||1,874 ||$||1,936 |
The Company records contract assets when it has a right to consideration and records accounts receivable when it has an unconditional right to consideration. Contract liabilities consist of cash payments received (or unconditional rights to receive cash) in advance of fulfilling performance obligations. The majority of the Company's performance obligations in its contracts with customers relate to contracts with duration of less than one year.
The opening and closing balances of current and long-term contract assets and contract liabilities related to contracts with customers are as follows:
|December 31, 2022||$||576 ||$||29,641 |
|March 31, 2023||$||605 ||$||29,225 |
The decrease in contract liabilities during the three months ended March 31, 2023 was primarily due to the revenue recognition criteria being met for previously deferred revenue, partially offset by invoiced amounts that did not yet meet the revenue recognition criteria. The amount of revenue recognized in the three months ended March 31, 2023 that was included in the prior period contract liability balance was $7.4 million. This revenue consists of services provided to customers who had been invoiced prior to the current year. We expect to recognize approximately 75% of outstanding contract liabilities as revenue over the next 12 months and the remainder thereafter.
The balance of contract cost deferred as of March 31, 2023 and December 31, 2022 was $0.5 million and $1.0 million, respectively. During the three months ended March 31, 2023, the Company recorded $0.5 million in amortization related to contract cost deferred as of December 31, 2022.
(6) Goodwill and Intangible Assets
The following table summarizes the activity related to goodwill (in thousands):
|Balance at beginning of period, gross||$||20,955 ||$||7,148 |
|Accumulated impairment at beginning of period||(1,003)||(1,003)|
|Goodwill from acquisitions||— ||— |
|Foreign exchange impact||— ||— |
|Balance at end of period||$||19,952 ||$||6,145 |
Intangible assets consisted of the following (in thousands):
|March 31, 2023|
|Customer relationships||$||24,331 ||$||(5,451)||$||18,880 |
|Customer backlog||5,100 ||(723)||4,377 |
|Developed technology||11,207 ||(4,822)||6,385 |
|In-process research and development||890 ||(385)||505 |
|Tradenames||300 ||(25)||275 |
|Total intangible assets, net||$||41,828 ||$||(11,406)||$||30,422 |
|December 31, 2022|
|Customer relationships||$||24,330 ||$||(4,759)||$||19,571 |
|Customer backlog||5,100 ||(506)||4,594 |
|Developed technology||11,207 ||(4,463)||6,744 |
|In-process research and development||890 ||(340)||550 |
|Tradenames||300 ||(17)||283 |
|Total intangible assets, net||$||41,827 ||$||(10,085)||$||31,742 |
Amortization expense associated with intangible assets for the three months ended March 31, 2023 and March 31, 2022 was $1.3 million and $0.3 million, respectively.
The following table presents the future amortization expense of the Company’s intangible assets as of March 31, 2023 (in thousands):
|Remainder of 2023||$||3,962 |
The following table summarizes the Company’s debt (in thousands):
|March 31, 2023||December 31, 2022|
|JPMorgan Term Loan, long-term||$||— ||$||— |
|JPMorgan Term Loan, current portion||24,063 ||24,375 |
|Unamortized debt issuance costs||(403)||(302)|
|Long-term debt, including current portion||$||23,660 ||$||24,073 |
|JPMorgan Revolving Credit Facility||$||12,000 ||$||4,000 |
|Industrial Bank of Korea Loan||919 ||— |
|DNI Related Party Loan||3,827 ||5,706 |
|Short-term debt and credit facilities||$||16,746 ||$||9,706 |
|Total Debt||$||40,406 ||$||33,779 |
JPMorgan Credit Agreement
On February 9, 2022, the Company entered into a Credit Agreement (the “Credit Agreement”) by and between the Company, as borrower, certain subsidiaries of the Company, as guarantors, the lenders party thereto and JPMorgan Chase Bank, N.A., as administrative agent. The Credit Agreement originally provided for revolving loans (the "Revolving Credit Facility") in an aggregate principal amount of up to $30.0 million, up to $15.0 million of which is available for letters of credit, and was scheduled to mature on February 9, 2024. The maximum amount that the Company can borrow under the Credit Agreement is subject to a borrowing base, which is based on a percentage of eligible accounts receivable and eligible inventory, subject to reserves and other adjustments, plus $10.0 million.
On May 27, 2022, the Company entered into a First Amendment to Credit Agreement (the “Amendment”), which amends the Credit Agreement dated February 9, 2022 with the Company, as borrower, certain subsidiaries of the Company, as guarantors, the lenders party thereto and JPMorgan Chase Bank, N.A., as administrative agent.
The Amendment, among other things, (1) provides for a term loan (the “Term Loan”) in an aggregate principal amount of $25.0 million with a maturity date of May 27, 2027, (2) extends the maturity date of the $30.0 million Revolving Credit Facility to May 27, 2025, (3) permits the ASSIA Acquisition, (4) modifies the applicable margin for borrowings under the Credit Agreement to be, at the Company’s option, either (i) the adjusted term SOFR rate plus a margin ranging from 3.0% to 3.5% per year or (ii) the prime rate plus a margin ranging from 2.0% to 2.5% per year, in each case depending on the Company’s leverage ratio, (5) modifies the letter of credit fee such that it ranges from 3.0% to 3.5%, depending on the Company’s leverage ratio, (6) modifies the commitment fee on the unused portion of the Revolving Credit Facility to range from 0.25% to 0.35% per year, depending on the Company’s leverage ratio, (7) modifies the method of calculating the leverage ratio, and (8) modifies the financial covenants to (i) increase the maximum permitted leverage ratio to 3.00 to 1.00 through September 30, 2022, 2.50 to 1.00 thereafter through September 30, 2023, and 2.00 to 1.00 thereafter and (ii) replace the minimum liquidity requirement with a minimum permitted fixed charge coverage ratio of 1.25 to 1.00.
On May 27, 2022, the Company borrowed the full amount of the Term Loan to finance the ASSIA Acquisition.
On February 15, 2023, the Company entered into a Second Amendment to Credit Agreement (the "Second Amendment"), which amends the Credit Agreement dated February 9, 2022 (as previously amended on May 27, 2022). The Second Amendment, among other things, (1) modifies the financial covenants to (i) suspend the maximum leverage ratio requirement of 2.50 to 1.00 until the fiscal quarter ending September 30, 2023 and (ii) suspend the minimum fixed charge coverage ratio requirement of 1.25 to 1.00 until the fiscal quarter ending December 31, 2023, (2) adds new financial covenants to require (i) minimum liquidity of $30.0 million for the fiscal quarter ending March 31, 2023, $35.0 million for the fiscal quarters ending June 30, 2023 and September 30, 2023, and $20.0 million at any time until September 30, 2023, and (ii) minimum EBITDA (as defined in the Credit Facility) of ($1 million) for the fiscal quarter ending March 31, 2023 and $1 for the fiscal quarter ending June 30, 2023, (3) increases the applicable margin for adjusted term SOFR borrowings and prime rate borrowings to 4.0% and 3.0%, respectively, when the Company’s leverage ratio exceeds 2.50 to 1.00, (4) increases the commitment fee on the unused portion of the revolving commitment to 0.40% per year when the Company’s leverage ratio exceeds 2.50 to 1.00, and (5) prohibits dividends and other distributions and tightens certain covenants.
On May 8, 2023, the Company entered into a Third Amendment to the Credit Agreement (the "Third Amendment"), which amends the Credit Agreement dated February 9, 2022 (as previously amended on May 27, 2022 and February 15, 2023). The Third Amendment, among other things, (1) modifies the financial covenants to eliminate the minimum EBITDA (as defined in the Credit Facility) of ($1 million) for the fiscal quarter ending March 31, 2023, (2) decreases the calculation of the borrowing base by $5 million through June 30, 2023 and an additional $5 million thereafter, (3) reduces the amount of the Revolving Credit Facility commitment to $25 million effective June 15, 2023, and (4) increases the applicable margin for adjusted term SOFR borrowings and prime rate borrowings to 4.5% and 3.5%, respectively, when the Company’s leverage ratio exceeds 2.50 to 1.00.
As of March 31, 2023, the Company's debt obligation under the Term Loan was $23.7 million, net of unamortized issuance cost of $0.4 million, and of which $1.3 million is scheduled for payment in the next 12 months. The Company had $12.0 million outstanding debt and $1.2 million in letters of credit issued under the $30.0 million Revolving Credit Facility as of March 31, 2023, and, after entering into the Third Amendment, $16.8 million was available to the Company for additional borrowing under the Revolving Credit Facility.
Due to the ongoing risk of non-compliance with certain financial covenants in the next 12 months, we presented our contractual long-term debt obligation of $22.8 million and $23.1 million as of March 31, 2023 and December 31, 2022, respectively, within the current portion of long-term debt on the unaudited condensed consolidated balance sheets. We are currently in discussion with the lenders to amend the debt agreement to mitigate the risk of non-compliance. While the borrowings under the term loan are currently classified as a current liability, the Company believes that it will maintain liquidity in the next 12 months to support its operations.
The future principal maturities of the Term Loan for each of the next five years are as follows (in thousands):
|Remainder of 2023||$||938 |
Related Party Debt
On October 31, 2022, DNS Korea, the Company’s wholly-owned subsidiary, entered into a Loan Agreement with DNI (the “November 2022 DNI Loan”). The November 2022 DNI Loan was negotiated and approved on behalf of the Company and its subsidiaries by the audit committee of the Board of Directors of the Company which consists of directors determined to be independent from DNI. The November 2022 DNI Loan consisted of a term loan in the amount of KRW 7.2 billion ($5.0 million USD), with interest payable monthly at an annual rate of 6.0%.
In the first quarter of 2023, the entire outstanding balance on the November 2022 DNI Loan was repaid and DNS Korea entered into a new short-term loan arrangement with DNI (the “February 2023 DNI Loan”) and borrowed KRW 5.0 billion ($4.1 million USD), with interest payable monthly at an annual rate of 7.0%. The Company's debt obligation under the February 2023 DNI Loan was KRW 5.0 billion ($3.8 million USD) as of March 31, 2023. The entire outstanding balance on the February 2023 DNI Loan was repaid in the second quarter of 2023.
As security for the February 2023 DNI Loan, DNS Korea granted a security interest to DNI in inventory of KRW 35.0 billion ($26.8 million USD) in its Janghowon warehouse, which should be maintained at a minimum of KRW 10.0 billion ($7.7 million USD), and account receivable for two certain customers in the amount to KRW 16.2 billion ($12.4 million USD).
Industrial Bank of Korea Loan
On March 30, 2023, DNS Korea entered into a Loan Agreement with Industrial Bank of Korea (the “IBK Loan”). The IBK Loan consisted of a short-term loan in the amount of KRW 1.2 billion ($0.9 million USD) with interest payable monthly at an annual rate of 6.3%. The entire outstanding balance on the IBK Loan was repaid in the second quarter of 2023.
(8) Employee Benefit Plans
Defined Contribution Plans
The Company maintains a 401(k) plan for its employees in the US whereby eligible employees may contribute up to a specified percentage of their earnings, on a pretax basis, subject to the maximum amount permitted by the Internal Revenue Code. Under the 401(k) plan, the Company made discretionary contributions to the plan in 2022. For the three months ended March 31, 2023, the Company recorded an expense of $0.3 million. For the three months ended March 31, 2022, the Company recorded an expense of $0.2 million.
The Company maintains a defined contribution plan for its employees in Korea. Under the defined contribution plan, the Company contributes the equivalent of 8.3% of an employee's gross salary into the plan. For each of the three months ended March 31, 2023 and March 31, 2022 the Company recorded an expense of $0.3 million.
Defined Benefit Plans
The Company sponsors defined benefit plans for its employees in Germany and Japan. Defined benefit plans provide pension benefits based on compensation and years of service. The Germany plans were frozen as of September 30, 2003 and have not been offered to new employees after that date. The Company has recorded the underfunded status as of March 31, 2023 and December 31, 2022 as a long-term liability on the unaudited condensed consolidated balance sheets. The accumulated benefit obligation for the plans in Germany and Japan was $11.1 million and $11.0 million as of March 31, 2023 and December 31, 2022, respectively. Periodic benefit costs for each of the three months ended March 31, 2023 and March 31, 2022 were $0.1 million.
The Company holds pension insurance contracts, with the Company as beneficiary, in the amount of $2.5 million as of March 31, 2023 and December 31, 2022 related to individuals under the pension plans. The Company records these insurance contracts based on their cash surrender value at the balance sheet dates. These insurance contracts are classified as other assets on the Company’s unaudited condensed consolidated balance sheet. The Company intends to use any proceeds from these policies to fund the pension plans. However, since the Company is the beneficiary on these policies, these assets have not been designated pension plan assets.
(9) Restructuring and Other Charges
In 2021, the Company made the strategic decision to relocate manufacturing functions of DZS GmbH and Optelian to Seminole, Florida and to transition the above subsidiaries to sales and research and development centers. For the three months ended March 31, 2022, the Company recorded $0.4 million of related restructuring costs. The restructuring of DZS GmbH and Optelian was completed in 2022 and no related restructuring costs were recorded for the three months ended March 31, 2023.
On September 17, 2022, DZS signed an agreement with Fabrinet, a third-party provider of electro-mechanical and electronic manufacturing and distribution services, to transition the sourcing, procurement, order-fulfillment, manufacturing and return merchandise authorization activities in the Company's Seminole, Florida facility to Fabrinet. The transition to Fabrinet began in October 2022 and substantially completed in the beginning of 2023. Post transition, the DZS Seminole, Florida-based operations, supply chain and manufacturing workforce will be reduced by approximately two-thirds and the remaining team is expected to be relocated to an appropriately sized facility. For the three months ended March 31, 2023, the Company recorded $3.5 million of restructuring related costs, consisting of freight and expedite fees of $1.0 million, facility and labor costs of $0.8 million, accelerated depreciation of manufacturing related assets of $0.4 million, termination-related benefits of $0.3 million, inventory write-off of $0.5 million, and other costs of $0.5 million. The Company accounted for the one-time employee termination benefits in accordance with ASC 420, Exit or Disposal Cost Obligations, and recognized the respective liability when the final terms of the benefit arrangement were communicated to the affected employees. As of March 31, 2023, the Company had $0.6 million liability related to termination benefits associated with Seminole restructuring.
For the three months ended March 31, 2023, the Company also included in restructuring and other charges approximately $0.3 million of facility costs related to impaired facilities and $0.4 million of non-capitalizable implementation costs related to replacement of the Company’s legacy enterprise resource planning and reporting software.
(10) Related Party Transactions
Related Party Debt
As of March 31, 2023, the Company had KRW 5.0 billion ($3.8 million USD) outstanding of the related party borrowing from DNI. See Note 7 Debt for additional information about the Company’s related party debt.
The following table sets forth payment guarantees of the Company's obligations as of March 31, 2023 that have been provided by Dasan Networks, Inc. ("DNI"). DNI owns approximately 29.2% of the outstanding shares of the Company's common stock. The amount guaranteed exceeds the principal amounts of outstanding obligations due to collateral requirements by the banks.
|Description of Obligations Guaranteed|
|Dasan Networks, Inc.||$||4,422 ||Payment guarantee to Industrial Bank of Korea|
|Dasan Networks, Inc.||3,068 ||Payment guarantee to Shinhan Bank|
Other Related Party Transactions
Sales, cost of revenue, operating expense, interest expense and other expenses to and from related parties were as follows (in thousands) for the three months ended March 31, 2023 and 2022:
|Three Months Ended March 31, 2023|
|Dasan Networks, Inc.||$||153 ||$||128 ||$||294 ||$||79 ||$||16 |
|Three Months Ended March 31, 2022|
|Dasan Networks, Inc.||$||198 ||$||177 ||$||407 ||$||— ||$||17 |
The Company has entered into sales agreements with DNI to sell certain services and finished goods produced by the Company. The Company also has an agreement with DNI in which DNI acts as a sales channel to third party customers. The above transactions are included in sales and cost of revenue on the unaudited condensed consolidated statement of comprehensive income (loss). Sales to DNI are recorded net of royalty fees for a sales channel arrangement.
DNS Korea has a lease agreement with DNI related to the lease of a warehouse facility. Operating lease cost related to the DNI lease totaled $0.1 million for the three months ended March 31, 2023. Operating lease cost related to the DNI leases totaled $0.2 million for the three months ended March 31, 2022. Operating lease expense is allocated between cost of revenue, research and product development, and selling, marketing, general and administrative expenses on the unaudited condensed consolidated statement of comprehensive income (loss). As of March 31, 2023, the right-of-use asset and operating lease liability related to DNI leases were $1.6 million. As of December 31, 2022, the right-of-use asset and operating lease liability related to DNI leases were $1.7 million.
The Company also pays a license fee under the Trademark License Agreement with DNI. The license fee is calculated as 0.4% of DNS Korea annual sales. For the three months ended March 31, 2023, license related expense were $0.2 million. For the three months ended March 31, 2022, license related expense were $0.1 million. License related expense are included in selling, marketing, general and administrative expenses on the consolidated statements of comprehensive income (loss).
Interest expense represents interest paid to DNI for the related party debt. Interest due to DNI was included in accrued and other liabilities on the unaudited condensed consolidated balance sheets as of March 31, 2022 and December 31, 2022. See Note 7 Debt for additional information about the Company’s related party debt.
Other expenses represent charges from DNI for its payment guarantees relating to the Company's obligations. The Company pays DNI a guarantee fee which is calculated as 0.9% per annum of the guaranteed amount. Refer to the table above for further information about obligations guaranteed by DNI.
Balances of Receivables and Payables with Related Parties
Balances of receivables and payables arising from sales and purchases of goods and services with related parties as of March 31, 2023 and December 31, 2022 were included in the following balance sheet captions on the unaudited condensed consolidated balance sheets, as follows (in thousands):
|As of March 31, 2023|
|Accrued and other liabilities|
|Dasan Networks, Inc.||$||224 ||$||— ||$||3,827 ||$||895 ||$||212 |
|As of December 31, 2022|
|Accrued and other liabilities|
|Dasan Networks, Inc.||$||943 ||$||123 ||$||5,706 ||$||1,019 ||$||483 |
(11) Net Income (Loss) Per Share
Basic net income (loss) per share is computed by dividing the net income (loss) for the period by the weighted average number of shares of common stock outstanding during the period. The calculation of diluted net income (loss) per share gives effect to common stock equivalents; however, potential common stock equivalents are excluded if their effect is antidilutive. Potential common stock equivalents are composed of incremental shares of common stock issuable upon the exercise of stock options and the vesting of restricted stock units. In periods when a net loss is reported, all common stock equivalents are excluded from the calculation because they would have an anti-dilutive effect, meaning the loss per share would be reduced. Therefore, in periods when a loss is reported, basic and dilutive loss per share are the same.
The following table is a reconciliation of the numerator and denominator in the basic and diluted net income (loss) per share calculation (in thousands, except per share data) for the three months ended March 31, 2023, and 2022:
|Three months ended March 31,|
|Net income (loss)||$||(17,135)||$||(3,048)|
|Weighted average number of shares outstanding:|
|Effect of dilutive securities:|
|Stock options, restricted stock units and share awards||—||—|
|Net income (loss) per share:|
The following table sets forth potential common stock that is not included in the diluted net income (loss) per share calculation above because their effect would be anti-dilutive for the periods indicated (in thousands):
|Three months ended March 31,|
|Outstanding stock options||563 ||939 |
|Unvested restricted stock units||500 ||278 |
The Company leases certain properties and buildings (including manufacturing facilities, warehouses, and office spaces) and equipment under various arrangements which provide the right to use the underlying asset and require lease payments for the lease term. The Company’s lease portfolio consists of operating leases which expire at various dates through 2028.
Assets and liabilities related to operating leases are included in the consolidated balance sheets as right-of-use assets from operating leases, operating lease liabilities - current and operating lease liabilities - non-current. The Company recognizes minimum rental expense on a straight-line basis based on the fixed components of a lease arrangement. The Company amortizes this expense over the term of the lease beginning with the date of initial possession, which is the date the lessor makes an underlying asset available for use. For the three months ended March 31, 2023, the Company recognized lease expense of $1.0 million. For the three months ended March 31, 2022, the Company recognized lease expense of $1.2 million.
The following table presents the maturity of the Company’s operating lease liabilities as of March 31, 2023 (in thousands):
|Remainder of 2023||$||4,209 |
|Total operating lease payments||16,961 |
|Less: imputed interest||(1,603)|
|Total operating lease liabilities||$||15,358 |
(13) Commitments and Contingencies
In the normal course of operations, from time to time, the Company arranges for the issuance of various types of performance guarantees, such as standby letters of credit or surety bonds. These instruments are arrangements under which the financial institution or surety provides a financial guarantee that the Company will perform in accordance with contractual or legal obligations. As of March 31, 2023, the Company had $15.6 million of performance guarantees in the form of bank guarantees or surety bonds guaranteed by third parties.
Trade Compliance Matter
During the first quarter of 2022, the Company received a notice letter from the Office of the Commissioner of Customs, Chennai II of the India Department of Revenue (the “Notice”) claiming the Company had allegedly mis-declared and incorrectly classified certain products imported to India by the Company at the time of clearance of customs. The Notice claims that due to such mis-declaration and incorrect classification of the imported products, the Company and its contract manufacturer in India underpaid duties approximating INR 299.6 million ($3.6 million USD based on exchange rates as of March 31, 2023) related to such products. The documents relied upon in the Notice were requested by the Company, however they are yet to be received. In the second quarter of 2023, the Company received a second notice letter issued by the Office of the Principal Commissioner of Customs (Air Cargo) Complex, Chennai VII Commissionerate claiming the alleged underpaid duties approximated INR 389.3 million ($4.7 million based on exchange rates as of March 31, 2023). The two notice letters cover substantially the same shipments and overlap in scope. The Company intends to vigorously defend itself in this matter. As we have not yet received the full contents of the Notice, we are unable to estimate a potential loss related to this matter, if any, which could range up to the full amount of the alleged unpaid duties, plus penalties and interest.
In addition to the Notice discussed above, from time to time, the Company is subject to various legal proceedings, claims and litigation arising in the ordinary course of business. While the outcome of these matters is currently not determinable, the Company records an accrual for legal contingencies that it has determined to be probable to the extent that the amount of the loss can be reasonably estimated. The Company does not expect that the ultimate costs to resolve these matters will have a material adverse effect on its consolidated financial position, results of operations or cash flows. However, litigation is subject to inherent uncertainties, and unfavorable rulings could occur. If an unfavorable ruling were to occur, there exists the possibility of a material adverse impact on the results of operations and cash flows of the reporting period in which the ruling occurs, or future periods.
(14) Income Taxes
Income tax expense for the three months ended March 31, 2023 was approximately $1.8 million on pre-tax loss of $15.3 million. Income tax benefit for the three months ended March 31, 2022 was approximately $1.3 million on pre-tax loss of $4.4 million.
As of March 31, 2023, the income tax rate varied from the United States statutory income tax rate primarily due to valuation allowances in North America, EMEA and Asia, mandatory R&D expense capitalization in the U.S., and foreign and state income tax rate differentials. Consistent with the prior periods, the Company continued to maintain valuation allowances in North America, EMEA and Asia.
(15) Enterprise-Wide Information
The Company is a global provider of ultra-broadband network access solutions and communications platforms deployed by advanced Tier 1, national and regional service providers and enterprise customers. There are no segment managers who are held accountable for operations, operating results and plans for levels or components below the Company unit level. Accordingly, the Company is considered to be in a single operating segment. The Company’s chief operating decision maker is the Company’s Chief Executive Officer, who reviews financial information presented on a consolidated basis accompanied with disaggregated revenues by geographic region for purposes of making operating decisions and assessing financial performance.
The Company attributes revenue from customers to individual countries based on location shipped. Refer to Note 1(e) Disaggregation of Revenue for the required disclosures on geographical concentrations and revenues by source.
The Company's property, plant and equipment, net of accumulated depreciation, were located in the following geographical areas (in thousands) as of March 31, 2023 and December 31, 2022:
|March 31, 2023||December 31, 2022|
|United States||$||3,870 ||$||5,725 |
|Korea||2,440 ||2,706 |
|Japan||619 ||644 |
|Canada||— ||157 |
|Germany||88 ||110 |
|Other||118 ||136 |
|$||7,135 ||$||9,478 |
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
As used in this Quarterly Report on Form 10-Q, unless the context suggests otherwise, the terms “DZS,” the “Company” “we,” “our” and “us” refer to DZS Inc. and its subsidiaries.
This Quarterly Report on Form 10-Q, including “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” contains forward-looking statements regarding future events and our future results that are subject to the safe harbors created under the Securities Act of 1933 (the “Securities Act”) and the Securities Exchange Act of 1934 (the “Exchange Act”). These statements are based on current expectations, estimates, forecasts, and projections about the industries in which we operate, and reflect the beliefs and assumptions of our management as of the date hereof.
We use words such as “anticipate,” “believe,” “continue,” “could,” “estimate,” “expect,” “forecast,” “goal,” “intend,” “may,” “plan,” “project,” “seek,” “should,” “target,” “will,” “would,” variations of such words, and similar expressions to identify forward-looking statements. In addition, statements that refer to projections of earnings, revenue, costs or other financial items in future periods; anticipated growth and trends in our business, industry or key markets; cost synergies, growth opportunities and other potential financial and operating benefits of our acquisitions; future growth and revenues from our products; our plans and our ability to refinance or repay our existing indebtedness prior to the applicable maturity dates; our ability to access capital to fund our future operations; future economic conditions and performance; the impact of the global outbreak of COVID-19, also known as the coronavirus; the impact of inflation, interest rate and foreign currency fluctuations; anticipated performance of products or services; competition; plans, objectives and strategies for future operations, including our pursuit or strategic acquisitions and our continued investment in research and development; other characterizations of future events or circumstances; and all other statements that are not statements of historical fact, are forward-looking statements within the meaning of the Securities Act and the Exchange Act. Although we believe that the assumptions underlying the forward-looking statements are reasonable, we can give no assurance that our expectations will be attained. Readers are cautioned not to place undue reliance on such forward-looking statements, which are being made as of the date of this Quarterly Report on Form 10-Q. Except as required by law, we undertake no obligation to update any forward-looking statements, whether as a result of new information, future events or otherwise.
Factors which could have a material adverse effect on our operations and future prospects or which could cause actual results to differ materially from our expectations include factors discussed in Part I, Item 1A “Risk Factors” of our Annual Report on Form 10-K, as well as factors described from time to time in our future reports filed with the U.S. Securities and Exchange Commission (the “SEC”).
We are a global provider of access and optical networking infrastructure and cloud software solutions that enable the emerging hyper-connected, hyper-broadband world and broadband experiences. The Company provides a wide array of reliable, cost-effective networking technologies and software to a diverse customer base.
We research, develop, test, sell, manufacture and support platforms in the areas of mobile transport and fixed broadband access, as discussed below. We have extensive regional development and support centers around the world to support our customer needs.
Our solutions and platforms portfolio include products in Access Edge, Subscriber Edge, Optical Edge, and Cloud Software.
•Access Edge. Our DZS Velocity portfolio offers a variety of solutions for carriers and service providers to connect residential and business customers, either using high-speed fiber or leveraging their existing deployed copper networks to offer broadband services to customer premises. Once our broadband access products are deployed, the service provider can offer voice, high-definition and ultra-high-definition video, high speed internet access and business class services to their customers. In addition, the switching and routing products we provide in this space offer a high-performance and manageable solution that bridges the gap from carrier access technologies to the core network. XCelerate by DZS increases the velocity with which service providers can leap to multi-gigabit services at scale by enabling rapid transition from Gigabit Ethernet Passive Optical Network (“GPON”) to 10 Gigabit Symmetrical Passive Optical Network (“XGS-PON”) and Gigabit Ethernet to 10 Gigabit Ethernet via any service port across a range of existing DZS Velocity chassis and 10 gigabit optimized stackable fixed form factor units.
•Subscriber Edge. Our DZS Helix connected premises product portfolio offers a large collection of optical network terminals (“ONTs”) and smart gateway solutions for any fiber to the “x” (“FTTx”) deployment. DZS ONTs and Smart Gateway platforms are designed for high bandwidth services being deployed to the home or business. Our connected premises portfolio consists of indoor/outdoor ONTs and gateways delivering best-in-class data and WiFi throughout the premises to support FTTx applications. The product feature set gives service providers an elegant migration path from legacy to soft switch architectures without replacing ONTs.
•Optical Edge. Our DZS Chronos and DZS Saber portfolios provide robust, manageable and scalable solution for mobile operators and service providers that enable them to upgrade their mobile fronthaul/midhaul/backhaul (“xHaul”) systems and migrate to fifth generation wireless technologies (“5G”) and beyond as well as deliver robust edge transport. DZS Chronos provides a full range of 5G-ready xHaul and coherent optical capable solutions that are open, software-defined, and field proven. Our mobile xHaul and edge transport products may be collocated at the radio access node base station and can aggregate multiple radio access node base stations into a single backhaul for delivery of mobile traffic to the radio access node network controller or be leveraged as transport vehicles for FTTx deployments. Our products support pure Ethernet switching as well as layer 3 IP and Multiprotocol Label Switching (“MPLS”), and we interoperate with other vendors in these networks. Our DZS Saber portfolio provides high bandwidth optical transport and services, enabling service providers to push high bandwidth transport closer to their subscribers near the edge of their networks. Complementary to the growth of high bandwidth technologies like XGS-PON and 5G mobile at the access edge, DZS Saber products leverage environmentally hardened dense wavelength-division multiplexing (DWDM) coherent optics to deliver transport bandwidth speeds from 100 gigabits per second (Gbps) to 400 Gbps over long distances that can be necessary to support advanced access and mobile technologies. Some DZS Saber platforms also provide additional feature such as multi-degree colorless directionless contentionless (CDC) FlexGrid reconfigurable optical add-drop multiplexer (ROADM) functionality, which allows service pr