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EX-32.1 - EXHIBIT 32.1 - DASAN ZHONE SOLUTIONS INCexhibit3219302017.htm
EX-31.1 - EXHIBIT 31.1 - DASAN ZHONE SOLUTIONS INCexhibit3119302017.htm
EX-10.3 - EXHIBIT 10.3 - DASAN ZHONE SOLUTIONS INCexhibit10393017.htm
EX-10.2 - EXHIBIT 10.2 - DASAN ZHONE SOLUTIONS INCexhibit10293017.htm

 
 
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
 
 
FORM 10-Q 
 
 
 
(Mark One)
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2017
OR
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from              to             
000-32743
(Commission File Number)
 
 
 
DASAN ZHONE SOLUTIONS, INC.
(Exact name of registrant as specified in its charter)
 
 
 
Delaware
 
22-3509099
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification Number)
 
 
 
7195 Oakport Street
Oakland, California
 
94621
(Address of principal executive offices)
 
(Zip code)
(510) 777-7000
(Registrant’s telephone number, including area code) 
 
 
 
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  ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted 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 and post such files).    Yes   x    No  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act (Check one):
Large accelerated filer
¨
 
Accelerated filer
¨
Non-accelerated filer
¨ (Do not check if a smaller reporting company)
 
Smaller reporting company
x
 
 
 
Emerging growth company
¨

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



Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x
As of November 8, 2017, there were approximately 16,386,955 shares of the registrant’s common stock outstanding.
 
 
 



TABLE OF CONTENTS
 

3


PART I. FINANCIAL INFORMATION

Item 1.    Financial Statements


4


DASAN ZHONE SOLUTIONS, INC. AND SUBSIDIARIES
Unaudited Condensed Consolidated Balance Sheets
(In thousands, except par value)
 
September 30,
2017
 
December 31,
2016
Assets
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
10,145

 
$
17,893

Restricted cash
13,058

 
6,650

Short-term investments

 
993

Accounts receivable, net of allowances for sales returns and doubtful accounts of $2,095 as of September 30, 2017 and $1,143 as of December 31, 2016:
 
 
 
Trade receivables
43,478

 
38,324

Related parties
12,941

 
13,311

Other receivables:
 
 
 
Others
13,851

 
12,068

Related parties
22

 
171

Inventories
31,966

 
31,032

Prepaid expenses and other current assets
3,198

 
4,131

Total current assets
128,659

 
124,573

Property and equipment, net
5,812

 
6,288

Goodwill
3,977

 
3,977

Intangible assets, net
7,174

 
8,767

Other assets
1,536

 
1,842

Total assets
$
147,158

 
$
145,447

Liabilities, Stockholders’ Equity and Non-controlling Interest

 

Current liabilities:
 
 
 
Accounts payable:
 
 
 
Others
$
35,224

 
$
30,681

Related parties
106

 
430

Short-term debt:
 
 
 
Others
18,382

 
17,599

Related parties
3,544

 

Other payables:
 
 
 
Others
1,691

 
2,040

Related parties
210

 
6,940

Deferred revenue
2,073

 
1,901

Accrued and other liabilities
10,108

 
8,163

Total current liabilities
71,338

 
67,754

Long-term debt - related parties
5,000

 
6,800

Deferred revenue
1,875

 
1,674

Other long-term liabilities
2,581

 
2,351

Total liabilities
80,794

 
78,579

Commitments and contingencies (Note 11)

 

Stockholders’ equity and non-controlling interest:
 
 
 
Common stock, authorized 36,000 shares, 16,387 shares and 16,375 shares outstanding as of September 30, 2017 and December 31, 2016 at $0.001 par value
16

 
16

Additional paid-in capital
89,873

 
89,174

Other comprehensive income (loss)
(1,052
)
 
(2,815
)
Accumulated deficit
(23,080
)
 
(19,923
)
Total stockholders’ equity
65,757

 
66,452

Non-controlling interest
607

 
416

Total stockholders’ equity and non-controlling interest
66,364

 
66,868

Total liabilities, stockholders’ equity and non-controlling interest
$
147,158

 
$
145,447

See accompanying notes to unaudited condensed consolidated financial statements.

5


DASAN ZHONE SOLUTIONS, INC. AND SUBSIDIARIES
Unaudited Condensed Consolidated Statements of Comprehensive Loss
(In thousands, except per share data)
 
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2017
 
2016
 
2017
 
2016
Net revenue:
 
 
 
 
 
Net revenue
$
60,513

 
$
24,772

 
$
150,834

 
$
68,424

Net revenue - related parties
5,925

 
6,468

 
27,657

 
22,408

Total net revenue
66,438

 
31,240

 
178,491

 
90,832

Cost of revenue:
 
 
 
 
 
 
 
Products and services
38,643

 
16,483

 
96,127

 
48,750

Products and services - related parties
5,569

 
5,406

 
22,851

 
19,118

Amortization of intangible assets
153

 
51

 
459

 
51

Total cost of revenue
44,365

 
21,940

 
119,437

 
67,919

Gross profit
22,073

 
9,300

 
59,054

 
22,913

Operating expenses:
 
 
 
 
 
 
 
Research and product development
8,804

 
5,885

 
27,028

 
15,583

Selling, marketing, general and administrative
11,454

 
8,278

 
32,506

 
16,691

Amortization of intangible assets
154

 
251

 
1,191

 
259

Total operating expenses
20,412

 
14,414

 
60,725

 
32,533

Operating income (loss)
1,661

 
(5,114
)
 
(1,671
)
 
(9,620
)
Interest income
36

 
31

 
82

 
137

Interest expense
(263
)
 
(204
)
 
(793
)
 
(600
)
Other income (loss), net
60

 
(112
)
 
43

 
(41
)
Income (loss) before income taxes
1,494

 
(5,399
)
 
(2,339
)
 
(10,124
)
Income tax expense (benefit)
107

 
(610
)
 
646

 
(1,041
)
Net income (loss)
1,387

 
(4,789
)
 
(2,985
)
 
(9,083
)
Net income (loss) attributable to non-controlling interest
(12
)
 
(56
)
 
172

 
(17
)
Net income (loss) attributable to DASAN Zhone Solutions, Inc.
$
1,399

 
$
(4,733
)
 
$
(3,157
)
 
$
(9,066
)
 
 
 
 
 
 
 
 
Foreign currency translation adjustments
(284
)
 
2,291

 
1,782

 
2,690

Comprehensive income (loss)
1,103

 
(2,498
)
 
(1,203
)
 
(6,393
)
Comprehensive income (loss) attributable to non-controlling interest
(14
)
 
(54
)
 
191

 
48

Comprehensive income (loss) attributable to DASAN Zhone Solutions, Inc.
$
1,117

 
$
(2,444
)
 
$
(1,394
)
 
$
(6,441
)
 
 
 
 
 
 
 
 
Basic and diluted net income (loss) per share attributable to DASAN Zhone Solutions, Inc.
$
0.09

 
$
(0.42
)
 
$
(0.19
)
 
$
(0.90
)
Weighted average shares outstanding used to compute basic and diluted net income (loss) per share
16,382

 
11,139

 
16,380

 
10,046

 
 
 
 
 
 
 
 

See accompanying notes to unaudited condensed consolidated financial statements.


6


DASAN ZHONE SOLUTIONS, INC. AND SUBSIDIARIES
Unaudited Condensed Consolidated Statements of Cash Flows
(In thousands)
 
 
Nine Months Ended
 
September 30,
 
2017
 
2016
Cash flows from operating activities:
 
 
 
Net loss
$
(2,985
)
 
$
(9,083
)
Adjustments to reconcile net loss to net cash provided by (used in) operating activities:

 

Depreciation and amortization
3,105

 
1,164

Stock-based compensation
670

 
128

Unrealized gain (loss) on foreign currency transactions
(185
)
 
1,655

Deferred taxes

 
(1,069
)
Changes in operating assets and liabilities:

 

Accounts receivable
(2,948
)
 
14,450

Inventories
(578
)
 
(4,107
)
Prepaid expenses and other assets
(101
)
 
2,320

Accounts payable
6,713

 
(5,814
)
Accrued expenses
(4,314
)
 
13,598

Net cash provided by (used in) operating activities
(623
)
 
13,242

Cash flows from investing activities:

 

Cash increase through Merger

 
7,013

Increase in restricted cash
(6,061
)
 
(947
)
Decrease in short-term and long-term loans to others

 
1,891

Increase in short-term and long-term loans to others

 
(1,386
)
Proceeds from sale of short-term investments
1,463

 

Purchase of short-term investments
(430
)
 

Proceeds from disposal of property and equipment and other assets
6

 
98

Purchase of property and equipment
(840
)
 
(370
)
Purchase of intangible asset
(72
)
 
(92
)
Net cash provided by (used in) investing activities
(5,934
)
 
6,207

Cash flows from financing activities:

 

Repayments of borrowings
(15,627
)
 
(23,088
)
Proceeds from short-term borrowings
13,778

 
19,769

Proceeds from long-term borrowings

 
6,800

Proceeds from issuance of common stock
28

 

Net cash provided by (used in) financing activities
(1,821
)
 
3,481

Effect of exchange rate changes on cash
630

 
1,538

Net increase (decrease) in cash and cash equivalents
(7,748
)
 
24,468

Cash and cash equivalents at beginning of period
17,893

 
9,095

Cash and cash equivalents at end of period
$
10,145

 
$
33,563


See accompanying notes to unaudited condensed consolidated financial statements.



7


Notes to Unaudited Condensed Consolidated Financial Statements
 
(1)
Organization and Summary of Significant Accounting Policies

(a)
Description of Business
DASAN Zhone Solutions, Inc. (formerly known as Zhone Technologies, Inc. and referred to, collectively with its subsidiaries, as "DZS" or the "Company") is a global provider of network access solutions and communications equipment for service provider and enterprise networks. The Company provides a wide array of reliable, cost-effective networking technologies, including broadband access, Ethernet switching, mobile backhaul, Passive Optical LAN and software-defined networks, to a diverse customer base that includes more than 1,000 customers in more than 50 countries worldwide.
DZS was incorporated under the laws of the state of Delaware in June 1999. On September 9, 2016, the Company acquired Dasan Network Solutions, Inc. ("DNS") through the merger of a wholly owned subsidiary of the Company with and into DNS, with DNS surviving as a wholly owned subsidiary of the Company (the "Merger"). At the effective time of the Merger, all issued and outstanding shares of capital stock of DNS held by DASAN Networks, Inc. ("DNI") were canceled and converted into the right to receive shares of the Company's common stock in an amount equal to 58% of the issued and outstanding shares of the Company's common stock immediately following the Merger. In connection with the Merger, the Company changed its name from Zhone Technologies, Inc. to DASAN Zhone Solutions, Inc. For periods through September 8, 2016, Zhone Technologies, Inc. is referred to as "Legacy Zhone." The Company’s common stock continues to be traded on the Nasdaq Capital Market, and the Company’s ticker symbol was changed from "ZHNE" to "DZSI" effective September 12, 2016. The Company is headquartered in Oakland, California.

(b)
Going Concern
The accompanying unaudited condensed consolidated financial statements have been prepared in conformity with generally accepted accounting principles in the United States ("U.S. GAAP"), assuming the Company will continue as a going concern, which contemplates the realization of assets and satisfaction of liabilities in the normal course of business. Accordingly, the unaudited condensed consolidated financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that may result from the possible inability of the Company to continue as a going concern.
Although the Company generated $1.4 million of net income for the quarter ended September 30, 2017, the Company has incurred significant losses to date and losses from operations may continue. The Company incurred net losses of $3.0 million and $15.3 million for the nine months ended September 30, 2017 and for the year ended December 31, 2016, respectively. The Company had accumulated deficit of $23.1 million and working capital of $57.3 million as of September 30, 2017. As of September 30, 2017, the Company had approximately $10.1 million in cash and cash equivalents, which included $3.4 million in cash balances held by the Company's Korean subsidiary, and $26.9 million in aggregate principal amount of outstanding borrowings under the Company's short-term debt obligations and the Company's loans from DNI and its affiliates. In addition, the Company had $7.6 million in aggregate borrowing availability under its revolving credit facilities as of September 30, 2017. The Company had $8.5 million committed as security for letters of credit under these facilities as of September 30, 2017. Due to the amount of short-term debt obligations maturing within the next 12 months and the Company's recurring operating losses, the Company's cash resources may not be sufficient to settle these short-term debt obligations. The Company's ability to continue as a “going concern” is dependent on many factors, including, among other things, its ability to comply with the covenants in its existing debt agreements, its ability to cure any defaults that occur under its debt agreements or to obtain waivers or forbearances with respect to any such defaults, and its ability to pay, retire, amend, replace or refinance its indebtedness as defaults occur or as interest and principal payments come due. Although the process of amending, replacing or refinancing the Company’s short-term debt obligations is ongoing and the Company is in active discussions with multiple parties, there is no guarantee that they will result in transactions that are sufficient to provide the Company with the required liquidity to remove the substantial doubt as to its ability to continue as a going concern. If the Company is unable to amend, replace or refinance its short-term debt obligations or raise the capital needed to meet liquidity needs and finance capital expenditures and working capital, the Company may experience material adverse impacts on its business, operating results and financial condition.

8


The Company has continued its focus on cost control and operating efficiency along with restrictions on discretionary spending, however in order to meet the Company's liquidity needs and finance its capital expenditures and working capital needs for its business, the Company may be required to sell assets, issue debt or equity securities, purchase credit insurance or borrow on potentially unfavorable terms. In addition, the Company may be required to reduce the scope of its planned product development, reduce sales and marketing efforts and reduce its operations in low margin regions, including reductions in headcount. Based on the Company's current plans and business conditions, the Company believes that its focused operating expense discipline along with its existing cash, cash equivalents and available credit facilities will be sufficient to satisfy its anticipated cash requirements for at least the next 12 months, however the factors discussed above raise substantial doubt about the Company's ability to continue as a going concern. The accompanying unaudited condensed consolidated financial statements do not include any adjustments that may result from the outcome of the uncertainties set forth above.

(c)
Risks and Uncertainties
DNI owned approximately 58% of the outstanding shares of the Company's common stock as of September 30, 2017. For so long as DNI and its affiliates hold shares of the Company's common stock representing at least a majority of the votes, DNI will be able to freely nominate and elect all the members of the Company's board of directors (subject to the restrictions in the Company's bylaws). The directors elected by DNI will have the authority to make decisions affecting the Company's capital structure, including the issuance of additional capital stock or options, the incurrence of additional indebtedness, the implementation of stock repurchase programs, and the declaration of dividends. The interests of DNI may not coincide with the interests of the Company's other stockholders or with holders of the Company's indebtedness. DNI’s ability to control all matters submitted to the Company's stockholders for approval limits the ability of other stockholders to influence corporate matters and, as a result, the Company may take actions that the Company's other stockholders or holders of our indebtedness do not view as beneficial. See Note 2, Note 9 and Note 11 to the unaudited condensed consolidated financial statements for additional information.
As discussed above in Note 1(b), there is also substantial doubt about the Company's ability to continue as a going concern. The accompanying unaudited consolidated financial statements do not include any adjustments that might be necessary if the Company is unable to continue as a going concern.

(d)
Correction of errors

In this Quarterly Report on Form 10-Q, certain prior quarter financial information has been revised due to correction of certain errors.  The Company identified errors related to the timing of revenue recognition in the consolidated financial statements for the quarter ended September 30, 2016.  Correction of this error resulted in a decrease in total net revenue of $0.8 million, an increase in net loss of $0.1 million for the quarter ended September 30, 2016 as well as a decrease in net revenue of $1.8 million, an increase in net loss of $0.5 million and an increase in basic and diluted net loss per share attributable to DZS of $0.05 for the nine months ended September 30, 2016. The prior quarter financial information has also been revised for the classification of certain related party revenue, related party cost of revenue, and related royalty fees.  This correction resulted in the Company reclassifying revenues of $0.2 million to related party revenues and costs of $0.1 million to related party cost of revenue for the quarter ended September 30, 2016. This further resulted in the Company reclassifying revenues of $9.6 million to related party revenues and costs of $7.6 million to related party cost of revenue for the nine months ended September 30, 2016. Finally, an understatement of the cash flows used in investing activities of $1.0 million was corrected in the statement of cash flows for the nine months ended September 30, 2016. The overall impact of these errors on the Company's condensed consolidated financial position and results of operations is not material and as such, previously filed quarterly financial information filed with the SEC on March 10, 2017 affected by the errors has not been amended.

(e)
Basis of Presentation
The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements.
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. All intercompany transactions and balances have been eliminated in consolidation. The results of operations for the current interim period are not necessarily indicative of results to be expected for

9


the current year or any other period. These unaudited condensed consolidated financial statements should be read in conjunction with the unaudited condensed 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, 2016 filed with the Securities and Exchange Commission.
As discussed more fully in Note 2, the Merger is treated as a reverse acquisition for accounting purposes, with DNS as the acquirer of the Company. As such, the consolidated financial results of the Company for the three and nine months ended September 30, 2017 are compared to the financial results for DNS and its consolidated subsidiaries for the prior year period through September 8, 2016 and the financial results of DZS and its consolidated subsidiaries for the period from September 9, 2016 through September 30, 2016. The balance sheet of the Company reflects the fair value of the assets and liabilities of Legacy Zhone as of the effective date of the Merger. Those assets include the fair value of acquired intangible assets and goodwill. Due to the foregoing, the Company’s financial results for the three and nine months ended September 30, 2017 are not comparable to its financial results for the three and nine months ended September 30, 2016.
Except as otherwise specifically noted herein, all references to the "Company" refer to (i) DNS and its consolidated subsidiaries for periods through September 8, 2016 and (ii) the Company and its consolidated subsidiaries for periods on or after September 9, 2016.

(f)
Reverse Stock Split
On February 28, 2017, the Company filed a Certificate of Amendment with the Delaware Secretary of State to amend the Company's Restated Certificate of Incorporation, which amendment effected a one-for-five reverse stock split of the Company's common stock and reduced the authorized shares of the Company's common stock from 180 million to 36 million. As a result of the reverse stock split, the number of shares of the Company’s common stock then issued and outstanding was reduced from approximately 81.9 million to approximately 16.4 million. References to shares of the Company's common stock, stock options (and associated exercise price) and restricted stock units in this Quarterly Report on Form 10-Q are provided on a post-reverse stock split basis.

(g)
Concentration of Risk
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. For the three months ended September 30, 2017, two customers represented, 10% and 9% of net revenue, respectively. For the three months ended September 30, 2016, three customers represented 18%, 16% (a related-party) and 12% of net revenue, respectively. For the nine months ended September 30, 2017, two customers each represented 9% of net revenue (one of which was a related-party). For the nine months ended September 30, 2016, three customers represented 23%, 21% (a related-party) and 12% of net revenue, respectively.
As of September 30, 2017, three customers represented 16% (a related-party), 11% and 10% of net accounts receivable, respectively. As of December 31, 2016, two customers represented 13% (a related-party) and 10% of net accounts receivable, respectively.
As of September 30, 2017 and December 31, 2016, receivables from customers in countries other than the United States represented 84% and 87%, respectively, of net accounts receivable.

(h) Recent Accounting Pronouncements
On May 28, 2014, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") No. 2014-09, Revenue from Contracts with Customers, which requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. The ASU will replace most existing revenue recognition guidance in U.S. GAAP when it becomes effective. The standard permits the use of either the retrospective or cumulative effect transition method. In August 2015, the FASB issued ASU 2015-14, which defers the effective date of the guidance in ASU No. 2014-09, Revenue from Contracts with Customer, for all entities by one year. With the deferral, the new standard is effective for the Company on January 1, 2018. Early adoption is permitted, but not before the original effective date of January 1, 2017. In May 2016, the FASB issued ASU 2016-12, Revenue from Contracts with Customers, Narrow-Scope Improvements and Practical Expedients, which provides clarification on how to assess collectibility, present sales tax, treat noncash consideration, and account for completed and modified contracts at the time of transition of ASU 2014-09. The effective date of this updated guidance for the Company is the same as the effective date of ASU 2014-09, which is January 1, 2018. The Company does not plan to early adopt this guidance. The Company is currently assessing the

10


potential impact of adopting this new guidance on its unaudited condensed consolidated financial statements. The Company is not able to quantify or cannot reasonably estimate quantitative information related to the impact of the new standard on its unaudited condensed consolidated financial statements at this time.
In July 2015, the FASB issued ASU No. 2015-11, Simplifying the Measurement of Inventory, which requires an entity to measure inventory at the lower of cost and net realizable value. The guidance does not apply to inventory that is measured using last-in, first-out ("LIFO") or the retail inventory method. The guidance applies to all other inventory, which includes inventory that is measured using first-in, first-out ("FIFO") or average cost. The guidance is effective for the Company on January 1, 2017, and will be adopted accordingly. ASU No. 2015-11 should be applied prospectively with earlier application permitted as of the beginning of an interim or annual reporting period. The adoption of this standard will have no impact on the Company's unaudited condensed consolidated financial statements.
In November 2015, the FASB issued ASU 2015-17, Income Taxes, Balance Sheet Classification of Deferred Taxes, which simplifies the classification of deferred tax assets and liabilities as non-current in the balance sheet. The updated guidance is effective for the Company on January 1, 2017, and will be adopted accordingly.
The adoption of this standard will not have a material impact on the Company's unaudited condensed consolidated financial statements.
In February 2016, the FASB issued ASU 2016-02, Leases. ASU 2016-02 requires that lease arrangements longer than 12 months result in an entity recognizing an asset and liability. The updated guidance is effective for the Company on January 1, 2019, and early adoption is permitted. The Company does not plan to early adopt this guidance. The Company expects its assets and liabilities to increase as a result of the adoption of this standard. The Company is currently assessing the potential impact of adopting this new guidance on its unaudited condensed consolidated financial statements. The Company is not able to quantify or cannot reasonably estimate quantitative information related to the impact of the new standard on its unaudited condensed consolidated financial statements at this time.
In March 2016, the FASB issued ASU 2016-09, Improvements to Employee Share-Based Payment Accounting, which requires entities to simplify several aspects of the accounting for share-based payment transactions, including income tax consequences, classification of awards as either equity or liabilities, and classification on statements of cash flows. The guidance is effective for the Company on January 1, 2017, and has been adopted in the first quarter of 2017. The adoption of this standard had no material impact on the Company's unaudited condensed consolidated financial statements.
In August 2016, FASB issued ASU 2016-15, Statement of Cash Flows, Classification of Certain Cash Receipts and Cash Payments, which addresses eight specific cash flow issues with the objective of reducing the existing diversity in practice. The updated guidance is effective for the Company on January 1, 2018. Early adoption is permitted. The Company continues to assess all the potential impacts of the new standard and anticipates this standard may have a material impact on its unaudited condensed consolidated financial statements. The Company is not able to quantify or cannot reasonably estimate quantitative information related to the impact of the new standard on its unaudited condensed consolidated financial statements at this time.
In November 2016, FASB issued ASU 2016-18, Statement of Cash Flows, Restricted Cash, which require that a statement of cash flows to explain the change during the period in the total of cash, cash equivalents and amounts generally described as restricted cash and restricted cash equivalents. The updated guidance is effective for the Company beginning on January 1, 2018. Early adoption is permitted. Adoption of this ASU is applied using a retrospective approach. As a result, the Company will no longer present transfers between cash and cash equivalents and restricted cash in the consolidated cash flow statements.
In January 2017, FASB issued ASU 2017-04, Simplifying the Test for Goodwill Impairment, which simplifies the accounting for goodwill impairment. The updated guidance is effective for the Company on January 1, 2020, and will be adopted accordingly. Early adoption is permitted. The Company is currently assessing the potential impact of adopting this new guidance on its unaudited condensed consolidated financial statements. The Company is not able to quantify or cannot reasonably estimate quantitative information related to the impact of the new standard on its unaudited condensed consolidated financial statements at this time.
In May 2017, the FASB issued ASU No. 2017-09, Compensation—Stock Compensation (Topic 718): Scope of modification accounting. The purpose of the amendment is to clarify which changes to the terms or conditions of a share-based payment award require an entity to apply modification accounting. The updated guidance is effective

11


for the Company beginning on January 1, 2018. The Company is currently assessing the potential impact of adopting this new guidance on its unaudited condensed consolidated financial statements. The Company is not able to quantify or cannot reasonably estimate quantitative information related to the impact of the new standard on its unaudited condensed consolidated financial statements at this time.

(2)
Merger
On September 9, 2016, the Company acquired DNS through the Merger of a wholly owned subsidiary of the Company with and into DNS, with DNS surviving as a wholly owned subsidiary of the Company. The Merger combines leading technology platforms with a broadened customer base.
At the effective time of the Merger, all issued and outstanding shares of capital stock of DNS held by DNI were canceled and converted into the right to receive shares of the Company's common stock in an amount equal to 58% of the issued and outstanding shares of the Company's common stock immediately following the Merger. Accordingly, at the effective time of the Merger, the Company issued 9,493,016 shares (post reverse stock split) of the Company’s common stock to DNI as consideration in the Merger, of which 949,302 shares (post reverse stock split) are being held in escrow as security for claims for indemnifiable losses in accordance with the merger agreement relating to the Merger. As a result, immediately following the effective time of the Merger, DNI held 58% of the outstanding shares of the Company's common stock and the holders of the Company's common stock immediately prior to the Merger retained, in the aggregate, 42% of the outstanding shares of the Company's common stock.
The Company accounted for the Merger as a reverse acquisition under the acquisition method of accounting in accordance with ASC 805, "Business Combination." Consequently, for the purpose of the purchase price allocation, DNS' assets and liabilities have been retained at their carrying values and Legacy Zhone's assets acquired, and liabilities assumed, by DNS (as the accounting acquirer in the Merger) have been recorded at their fair value measured as of September 9, 2016.
The total purchase consideration in the Merger was based on the number of shares of Legacy Zhone common stock and Legacy Zhone stock options vested and outstanding immediately prior to the closing of the Merger, and was determined based on the closing price of $5.95 per share (post reverse stock split) of the Company's common stock on the September 9, 2016. The estimated total purchase consideration is calculated as follows (in thousands):
 
 
Shares
 
Estimated Fair Value
Shares of Legacy Zhone stock as of September 8, 2016
 
6,874

 
$
40,902

Legacy Zhone stock options
 
198

 
540

Total Purchase Consideration
 
 
 
$
41,442


The following table summarizes the allocation of the fair value consideration transferred as of the acquisition date (in thousands):
Cash and cash equivalents
 
$
7,013

Accounts receivable
 
18,510

Inventory
 
16,456

Prepaid expenses and other current assets
 
2,191

Property and equipment
 
4,339

Other assets
 
125

Identifiable intangible assets
 
10,479

Goodwill
 
3,284

Accounts payable
 
(11,021
)
Accrued and other liabilities
 
(7,089
)
Other long-term liabilities
 
(2,845
)
Total Indicated Fair Value of Assets
 
$
41,442


The goodwill was primarily attributed to people, geographic diversification and complementary products. The goodwill arising from the Merger is not tax deductible.

12


The Company considered the deferred tax liabilities caused by the Merger to be a source of income to support recoverability of acquired deferred tax assets, before considering the recoverability of the acquirer's existing deferred tax assets. Accordingly, the valuation allowance on the acquiree's deferred tax assets was reduced by the deferred tax liabilities caused by the Merger and accounted for as part of the purchase price allocation.
The following table presents the fair values of the acquired intangible assets at the effective date of the Merger (in thousands, except years):
 
 
Useful life
(in Years)
 
Fair Value
Developed technology
 
5
 
$
3,060

Customer relationships
 
10
 
5,240

Backlog
 
1
 
2,179

 
 
 
 
$
10,479


The following unaudited pro forma condensed combined financial information for the three and nine months ended September 30, 2016 gives effect to the Merger as if it had occurred at the beginning of 2015. The unaudited pro forma condensed combined financial information has been included for comparative purposes only and is not necessarily indicative of what the combined Company's financial position or results of operations might have been had the Merger been completed as of the date indicated.

 
September 30, 2016
(in thousands)
Three
Months
Ended
 
Nine
Months
Ended
Pro forma total net revenue
$
39,740

 
$
142,530

Pro forma net loss
(15,569
)
 
(25,504
)


(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.
The following financial instruments are not measured at fair value on the Company’s condensed consolidated balance sheet as of September 30, 2017 and December 31, 2016, but require disclosure of their fair values: cash and cash equivalents, short-term investments, accounts receivable, accounts payable and debt. The carrying values of financial instruments such as cash and cash equivalents, short-term investments, accounts receivable and accounts payable approximate their fair values based on their short-term nature. The carrying value of the Company's debt approximates their fair values based on the current rates available to the Company for debt of similar terms and maturities.


13


(4)
Inventories
Inventories as of September 30, 2017 and December 31, 2016 were as follows (in thousands):
 
 
September 30,
2017
 
December 31,
2016
Raw materials
$
12,812

 
$
13,547

Work in process
3,004

 
3,705

Finished goods
16,150

 
13,780

Total inventories
$
31,966

 
$
31,032

Inventories provided as collateral for borrowings from Export-Import Bank of Korea amounted to $18.9 million and $14.4 million as of September 30, 2017 and December 31, 2016, respectively.
 
(5)
Property and Equipment
Property and equipment as of September 30, 2017 and December 31, 2016 were as follows (in thousands):
 
 
September 30,
2017
 
December 31,
2016
Furniture and fixtures
$
21,251

 
$
20,040

Machinery and equipment
4,945

 
4,530

Leasehold improvements
3,386

 
3,573

Computers and software
567

 
411

Other
983

 
922

 
31,132

 
29,476

Less accumulated depreciation and amortization
(25,109
)
 
(22,922
)
Less government grants
(211
)
 
(266
)
Total property and equipment, net
$
5,812

 
$
6,288

Depreciation and amortization expense associated with property and equipment for the three and nine months ended September 30, 2017 was $0.5 million and $1.4 million, respectively. Depreciation and amortization expense associated with property and equipment for the three and nine months ended September 30, 2016 was $0.4 million and $0.9 million, respectively.
The Company receives grants from the government mainly to support capital expenditures. Such grants are deferred and are generally refundable to the extent the Company does not utilize the funds for qualifying expenditures. Once earned, the Company records the grants as a contra amount to the assets and amortizes such amount over the useful lives of the related assets as a reduction to depreciation expense.
 
(6)
Goodwill and Intangible Assets
Goodwill as of September 30, 2017 and December 31, 2016 was as follows (in thousands):
 
September 30,
2017
 
December 31,
2016
Beginning balance
$
3,977

 
$
693

Addition from Merger

 
3,284

Less: accumulated impairment

 

Ending balance
$
3,977

 
$
3,977


14


The Company did not recognize impairment loss on goodwill during the three and nine months ended September 30, 2017 and 2016.
Intangible assets as of September 30, 2017 and December 31, 2016 were as follows (in thousands):
 
September 30,
2017
 
December 31,
2016
Developed technology
$
3,060

 
$
3,060

Customer relationships
5,240

 
5,240

Backlog
2,179

 
2,179

Other
194

 
105

Less accumulated amortization
(3,499
)
 
(1,817
)
Intangible assets, net
$
7,174

 
$
8,767

Amortization expense associated with intangible assets for the three and nine months ended September 30, 2017 was $0.3 million and $1.7 million, respectively. Amortization expense associated with intangible assets for each of the three and nine months ended September 30, 2016 was $0.3 million.

(7)
Debt
Wells Fargo Bank Facility
As of September 30, 2017, the Company had a $25.0 million credit facility (the "WFB Facility") with Wells Fargo Bank ("WFB"). Under the WFB Facility, the Company has the option of borrowing funds at agreed upon interest rates. The amount that the Company is able to borrow under the WFB Facility varies based on eligible accounts receivable and inventory, as defined in the agreement, as long as the aggregate amount outstanding does not exceed $25.0 million less the amount committed as security for letters of credit. To maintain availability of funds under the WFB Facility, the Company pays a commitment fee on the unused portion. The commitment fee is 0.25% per annum and is recorded as interest expense.
As of September 30, 2017, the Company had no outstanding borrowings under its WFB Facility, and $2.5 million was committed as security for letters of credit. The Company had $6.7 million of borrowing availability under the WFB Facility as of September 30, 2017. The amounts borrowed under the WFB Facility bear interest, payable monthly, at a floating rate equal to the three-month LIBOR plus a margin based on the Company's average excess availability (as calculated under the WFB Facility). The interest rate on the WFB Facility was 3.8% at September 30, 2017. The maturity date under the WFB Facility is March 31, 2019.
The Company’s obligations under the WFB Facility are secured by substantially all of its personal property assets and those of its subsidiaries that guarantee the WFB Facility, including their intellectual property. The WFB Facility contains certain financial covenants, and customary affirmative covenants and negative covenants. If the Company defaults under the WFB Facility due to a covenant breach or otherwise, WFB may be entitled to, among other things, require the immediate repayment of all outstanding amounts and sell the Company’s assets to satisfy the obligations under the WFB Facility. As of September 30, 2017, the Company was in compliance with the covenants under the WFB Facility.
Bank and Trade Facilities - Foreign Operations
Certain of the Company's 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. Payments under such facilities are made in accordance with the given lender’s amortization schedules.

15


As of September 30, 2017 and December 31, 2016, the Company had an aggregate outstanding balance of $18.4 million and $17.6 million, respectively, under such financing arrangements, and the interest rates per annum applicable to outstanding borrowings under these financing arrangements were as listed in the tables below.
 
 
 
 
As of September 30, 2017
 
 
 
 
Interest rate (%)
 
Amount
Industrial Bank of Korea
 
Credit facility
 
2.8 - 3.0
 
$
3,235

Industrial Bank of Korea
 
Trade finance
 
3.9-5.4
 
2,287

Shinhan Bank
 
General loan
 
5.89
 
2,791

Shinhan Bank
 
Trade finance
 
3.70
 
1,950

NongHyup Bank
 
Credit facility
 
1.7 - 3.0
 
1,841

The Export-Import Bank of Korea
 
Export development loan
 
3.1
 
6,278

 
 
 
 
 
 
$
18,382

 
 
 
 
As of December 31, 2016
 
 
 
 
Interest rate (%)
 
Amount
Industrial Bank of Korea
 
Credit facility
 
2.16 - 2.76
 
$
1,106

Shinhan Bank
 
General loan
 
4.08
 
3,310

Shinhan Bank
 
Trade finance
 
3.28 - 3.44
 
1,752

NongHyup Bank
 
Credit facility
 
1.92 - 2.66
 
482

KEB Hana Bank
 
Comprehensive credit loan
 
2.79
 
3,501

The Export-Import Bank of Korea
 
Export development loan
 
3.10
 
7,448

 
 
 
 
 
 
$
17,599

As of September 30, 2017, the Company had $5.0 million in outstanding borrowings and $6.0 million committed as security for letters of credit under the Company's $12.0 million credit facility with certain foreign banks.

(8)
Non-Controlling Interests

Non-controlling interests for the nine months ended September 30, 2017 and 2016 were as follows (in thousands):
 
 
Nine Months Ended September 30,
 
 
2017
 
2016
Beginning non-controlling interests
 
$
416

 
$
138

Acquisition of additional interest in a subsidiary
 

 
277

Net income (loss) attributable to non-controlling interests
 
172

 
(17
)
Foreign currency translation adjustments (OCI)
 
19

 
66

 Ending non-controlling interests
 
$
607

 
$
464



(9)
Related-Party Transactions

Related-Party Debt
In connection with the Merger, on September 9, 2016, the Company entered into a loan agreement with DNI for a $5.0 million unsecured subordinated term loan facility. Under the loan agreement, the Company was permitted to request drawdowns of one or more term loans in an aggregate principal amount not to exceed $5.0 million. As of September 30, 2017, $5.0 million in term loans was outstanding under the facility. Such term loans mature in September 2021 and are pre-payable at any time by the Company without premium or penalty. The interest rate as of September 30, 2017 under this facility was 4.6% per annum.

16


In addition, the Company borrowed $1.8 million from DNI for capital investment in February 2016, which amount was outstanding as of September 30, 2017. This loan matured in March 2017 with an option of renewal by mutual agreement, and bore interest at a rate of 6.9% per annum, payable annually. Effective February 27, 2017, the Company amended the terms of this loan to extend the repayment date from March 2017 to March 2018, and to reduce the interest rate from 6.9% to 4.6% per annum.
On June 23, 2017, the Company borrowed $3.5 million from Solueta, an affiliate of DNI. As of September 30, 2017, the aggregate outstanding balance under this loan agreement was $1.7 million. This loan matures in November 2017 and bears interest at a rate of 4.6% per annum, payable monthly.

Other Related-Party Transactions
Sales and purchases, cost of revenue, research and product development, selling, marketing, general and administrative and other expenses to and from related parties for the three and nine months ended September 30, 2017 and 2016 were as follows (in thousands):
 
 
 
 
Three Months Ended September 30, 2017
Counterparty
 
DNI Ownership Interest
 
Sales
 
Cost of revenue
 
Manufacturing (Cost of revenue)
 
Research and product development
 
Selling, marketing,
general and administrative
 
Other Expenses
DNI (Parent Company)
 
N/A
 
$
3,976

 
$
3,604

 
$

 
$

 
$
1,291

 
$
51

CHASAN Networks Co., Ltd.
 
100%
 

 

 
257

 
20

 

 

DASAN FRANCE
 
100%
 
662

 
576

 

 

 
83

 

DASAN INDIA Private Limited
 
100%
 

 

 

 

 
30

 

D-Mobile
 
100%
 
1,233

 
1,077

 

 

 
122

 

HANDYSOFT, Inc.
 
17.64%
 
54

 
12

 

 

 
6

 
4

Tomato Soft Ltd.
 
100%
 

 

 
43

 
108

 

 

Tomato Soft (Xi'an) Ltd.
 
100%
 

 

 

 
144

 

 

 
 
 
 
$
5,925

 
$
5,269

 
$
300

 
$
272

 
$
1,532

 
$
55

 
 
 
 
Three Months Ended September 30, 2016 (As Revised)
Counterparty
 
DNI Ownership Interest
 
Sales
 
Cost of revenue
 
Manufacturing (Cost of revenue)
 
Research and product development
 
Selling, marketing,
general and administrative
 
Other Expenses
DNI (Parent Company)
 
N/A
 
$
5,112

 
$
4,390

 
$

 
$

 
$
946

 
$
89

CHASAN Networks Co., Ltd.
 
100%
 

 

 
130

 
38

 

 

DASAN FRANCE
 
100%
 
3

 
3

 

 

 

 

D-Mobile
 
100%
 
1,267

 
789

 

 

 
125

 

HANDYSOFT, Inc.
 
17.64%
 
68

 
58

 

 

 

 

J-Mobile Corporation
 
90.47%
 
18

 

 

 

 

 

Tomato Soft Ltd.
 
100%
 

 

 
36

 

 

 

Tomato Soft (Xi'an) Ltd.
 
100%
 

 

 

 
181

 

 

 
 
 
 
$
6,468

 
$
5,240

 
$
166

 
$
219

 
$
1,071

 
$
89



17


 
 
 
 
Nine Months Ended September 30, 2017
Counterparty
 
DNI Ownership Interest
 
Sales
 
Cost of revenue
 
Manufacturing (Cost of revenue)
 
Research and product development
 
Selling, marketing,
general and administrative
 
Other Expenses
DNI (Parent Company)
 
N/A
 
$
16,608

 
$
14,020

 
$

 
$

 
$
3,491

 
$
171

CHASAN Networks Co., Ltd.
 
100%
 

 

 
578

 
79

 

 

DASAN FRANCE
 
100%
 
1,612

 
1,512

 

 

 
383

 

DASAN INDIA Private Limited
 
100%
 
6,287

 
4,783

 

 

 
30

 

D-Mobile
 
100%
 
3,054

 
1,831

 

 

 
318

 

Fine Solution
 
100%
 

 

 

 

 
4

 

HANDYSOFT, Inc.
 
17.64%
 
88

 
23

 

 

 
6

 
4

J-Mobile Corporation
 
90.47%
 
8

 

 

 

 
132

 

Tomato Soft Ltd.
 
100%
 

 

 
104

 
108

 

 

Tomato Soft (Xi'an) Ltd.
 
100%
 

 

 

 
448

 
37

 

Solueta
 
27.21%
 

 

 

 

 

 
3

 
 
 
 
$
27,657

 
$
22,169

 
$
682

 
$
635

 
$
4,401

 
$
178

 
 
 
 
Nine Months Ended September 30, 2016 (As Revised)
Counterparty
 
DNI Ownership Interest
 
Sales
 
Cost of revenue
 
Manufacturing (Cost of revenue)
 
Research and product development
 
Selling, marketing,
general and administrative
 
Other Expenses
DNI (Parent Company)
 
N/A
 
$
19,080

 
$
16,219

 
$

 
$

 
$
4,255

 
$
309

CHASAN Networks Co., Ltd.
 
100%
 

 

 
436

 
106

 

 

DASAN FRANCE
 
100%
 
3

 
3

 

 

 

 

DASAN INDIA Private Limited
 
100%
 

 

 

 

 

 

D-Mobile
 
100%
 
3,135

 
2,231

 

 

 
318

 

DMC, Inc.
 
27.21%
 
1

 
1

 

 

 

 

HANDYSOFT, Inc.
 
17.64%
 
150

 
130

 

 

 

 

J-Mobile Corporation
 
90.47%
 
39

 

 

 

 
634

 

PANDA Media, Inc.
 
100%
 

 

 

 

 
2

 

Tomato Soft Ltd.
 
100%
 

 

 
98

 

 

 

Tomato Soft (Xi'an) Ltd.
 
100%
 

 

 

 
560

 

 

 
 
 
 
$
22,408

 
$
18,584

 
$
534

 
$
666

 
$
5,209

 
$
309

The Company has entered into certain sales agreements with DNI and certain of its subsidiaries. Sales and cost of revenue to DNI, DASAN France, DASAN INDIA Private Limited, and D-Mobile represent finished goods produced by the Company that are sold to these related parties who sell the Company's products in Korea, France, India and Taiwan, respectively.
The Company has entered into agreements with Tomato Soft Ltd. and CHASAN Networks Co., Ltd. to provide manufacturing and research and development services for the Company. Under the agreement with Tomato Soft Ltd. and CHASAN Networks., Ltd., the Company is charged a cost plus 7% fee for the manufacturing and development of certain deliverables.
The Company has entered into an agreement with Tomato Soft (Xi'an) Ltd. to provide research and development services for the Company. Under the agreement with Tomato Soft (Xi'an) Ltd., the Company is charged an expected annual fee of $0.8 million for the development of certain deliverables.
Prior to the Merger, as DNS was then a wholly owned subsidiary of DNI, DNI had sales agreements with certain customers on DNS' behalf. Since the Merger, due to these prior sales agreements, the Company has entered into an agreement with DNI in which DNI acts as a sales channel to these customers. Selling, marketing, general and administrative expense to DNI includes a fee of 3% of total sales to DNI for sales to these customers.
The Company shares office space with DNI and certain of DNI's subsidiaries. Prior to the Merger, DNS, then a wholly owned subsidiary of DNI, shared human resources, treasury and other administrative support with DNI. As such, the Company entered into certain service sharing agreements with DNI and certain of its subsidiaries for the shared office

18


space and shared administrative services. Expenses related to rent and administrative services are allocated to the Company based on square footage occupied and headcount, respectively.
The Company has entered into sales agreement with Handysoft, Inc., provider of software and system integration solutions in Korea, to supply networks equipment, research and development and logistics services through DASAN Networks, Inc.
The Company has entered into sales agreement with J-Mobile Corporation to supply networks equipment in Japan. J-Mobile Corporation also provides marketing services in Japan.
Other expenses to related parties represent expenses to DNI for its payment guarantees relating to the Company's borrowings. The Company pays DNI a guarantee fee which is calculated as 0.9% of the guaranteed amount.

Balances of Receivables and Payables with Related Parties
Balances of receivables and payables arising from sales and purchases of goods and services with related parties as of September 30, 2017 and December 31, 2016 were as follows (in thousands):
 
 
 
 
As of September 30, 2017
Counterparty
 
DNI Ownership Interest
 
Account receivables
 
Other receivables
 
Deposits for lease*
 
Accounts payable
 
Other payables
 
Loans
DNI (Parent Company)
 
N/A
 
$
9,196

 
$

 
$
727

 
$

 
$
125

 
$
6,800

ABLE
 
61.99%
 
56

 

 

 

 

 

CHASAN Networks Co., Ltd.
 
100%
 

 

 

 
100

 

 

DASAN France
 
100%
 
662

 
4

 

 

 

 

D-Mobile
 
100%
 
3,001

 
16

 

 

 

 

HANDYSOFT, Inc.
 
17.64%
 
26

 

 

 
6

 
1

 

Solueta
 
27.21%
 

 
2

 

 

 
2

 
1,744

Tomato Soft Ltd.
 
100%
 

 

 

 

 
25

 

Tomato Soft (Xi'an) Ltd.
 
100%
 

 

 

 

 
57

 

 
 
 
 
$
12,941

 
$
22

 
$
727

 
$
106

 
$
210

 
$
8,544


 
 
 
 
As of December 31, 2016
Counterparty
 
DNI Ownership Interest
 
Account receivables
 
Other receivables
 
Deposits for lease*
 
Accounts payable
 
Other payables
 
Loans
DNI (Parent Company)
 
N/A
 
$
6,679

 
$
171

 
$
690

 
$
360

 
$
6,861

 
$
6,800

ABLE
 
61.99%
 
53

 

 
9

 

 

 

CHASAN Networks Co., Ltd.
 
100%
 

 

 

 
70

 

 

DASAN France
 
100%
 
23

 

 

 

 

 

DASAN INDIA Private Limited
 
100%
 
2,606

 

 

 

 

 

D-Mobile
 
100%
 
3,943

 

 

 

 

 

HANDYSOFT, Inc.
 
17.64%
 
2

 

 

 

 

 

J-Mobile Corporation
 
68.56%
 
5

 

 

 

 

 

Tomato Soft Ltd.
 
100%
 

 

 

 

 
16

 

Tomato Soft (Xi'an) Ltd.
 
100%
 

 

 

 

 
63

 

 
 
 
 
$
13,311

 
$
171

 
$
699

 
$
430

 
$
6,940

 
$
6,800


* Included in other assets related to deposits for lease in the condensed consolidated balance sheet as of September 30, 2017 and the consolidated balance sheet as of December 31, 2016.

(10)
Net Income (Loss) Per Share Attributable to DASAN Zhone Solutions, Inc.
Basic net income (loss) per share attributable to DASAN Zhone Solutions, Inc. is computed by dividing the net income (loss) attributable to DASAN Zhone Solutions, Inc. for the period by the weighted average number of shares of common

19


stock outstanding during the period. The calculation of diluted net income (loss) per share attributable to DASAN Zhone Solutions, Inc. gives effect to common stock equivalents; however, potential common equivalent shares are excluded if their effect is antidilutive. Potential common equivalent shares are composed of incremental shares of common equivalent shares issuable upon the exercise of stock options and the vesting of restricted stock units.
Basic net income (loss) per share is the same as diluted net income (loss) per share for the three and nine months ended September 30, 2016 because DNS did not issue the potentially dilutive common stock. Basic net income (loss) per share is the same as diluted net income (loss) per share for the three and nine months ended September 30, 2017 because the effects of stock options and restricted stock units would have been anti-dilutive.
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):
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
2017
 
2016
 
2017
 
2016
 
 
 
 
(As Revised)
 
 
 
(As Revised)
Net income (loss) attributable to DASAN Zhone Solutions, Inc.
 
$
1,399

 
$
(4,733
)
 
$
(3,157
)
 
$
(9,066
)
Weighted average number of shares outstanding:
 
 
 
 
 
 
 
 
Basic
 
16,382

 
11,139

 
16,380

 
10,046

Effect of dilutive securities:
 
 
 
 
 
 
 
 
Stock options, restricted stock units and share awards
 

 

 

 

Diluted
 
16,382

 
11,139

 
16,380

 
10,046

Net income (loss) per share attributable to DASAN Zhone Solutions, Inc.:
 
 
 
 
 
 
 
 
Basic
 
$
0.09

 
$
(0.42
)
 
$
(0.19
)
 
$
(0.90
)
Diluted
 
$
0.09

 
$
(0.42
)
 
$
(0.19
)
 
$
(0.90
)


The outstanding common equivalent shares excluded from the computation of the diluted net income (loss) per share attributable to DASAN Zhone Solutions, Inc. for the periods presented because including them would have been antidilutive are as follows (in thousands):            
 
 
Three and Nine Months Ended September 30,
 
 
2017
 
2016
 
 
 
 
(As Revised)
Stock options
 
915

 
795

Restricted stock units
 
2

 
9

 
 
917

 
804

     


20


(11)
Commitments and Contingencies
Operating Leases
The Company has entered into operating leases for certain office space and equipment, some of which contain renewal options and escalation clauses. Estimated future lease payments under all non-cancellable operating leases with terms in excess of one year, including taxes and service fees, are as follows (in thousands):
 
Operating Leases
Year ending December 31:
 
2017 (remainder of the year)
$
967

2018
3,359

2019
2,496

2020
2,358

2021
2,264

Thereafter
8,722

Total minimum lease payments
$
20,166

Warranties
The Company accrues for warranty costs based on historical trends for the expected material and labor costs to provide warranty services. Warranty periods are generally two to five years from the date of shipment. The following table reconciles changes in the Company’s accrued warranties and related costs for the nine months ended September 30, 2017 and 2016 (in thousands):  
 
Nine Months Ended September 30,
 
2017
 
2016
Beginning balance
$
878

 
$
441

Charged to cost of revenue
126

 
227

Claims and settlements
(195
)
 
(389
)
Foreign exchange impact
14

 
78

Ending balance
$
823

 
$
357

Performance Bonds
In the normal course of operations, from time to time, the Company arranges for the issuance of various types of surety bonds, such as bid and performance bonds, which are agreements under which the surety company guarantees that the Company will perform in accordance with contractual or legal obligations. As of September 30, 2017, the Company had $1.0 million of performance bonds and $0.4 million of warranty bonds guaranteed by third parties.
In addition, the Company has entered into a sales agreement with DNI, that distributes Company's products to a certain customer in Vietnam. Under the agreement with the customer, DNI is required to provides various types of surety bonds which are guaranteed by the bank. As of September 30, 2017, the Company had restricted cash of $1.2 million, $2.1 million and $2.0 million as a collateral for the advance payment bonds, performance bonds and warranty bonds, respectively, issued by DNI.
Purchase Commitments
The Company has agreements with various contract manufacturers which include non-cancellable inventory purchase commitments. The Company’s inventory purchase commitments typically allow for cancellation of orders 30 days in advance of the required inventory availability date as set by the Company at time of order. The amount of non-cancellable purchase commitments outstanding, net of reserve, was $3.0 million as of September 30, 2017.




21


Payment Guarantees
The following table sets forth third parties that have provided payment guarantees of the Company's indebtedness and other obligations as of September 30, 2017 (in thousands):
Guarantor
 
Amount Guaranteed
 
Description of Obligations Guaranteed
DNI (Parent Company)
 
$
3,349

 
Borrowings from Shinhan Bank
DNI (Parent Company)
 
1,884

 
Purchasing card from Shinhan Bank
DNI (Parent Company)
 
10,493

 
Credit facility & purchasing card from Industrial Bank of Korea
DNI (Parent Company)
 
6,000

 
Credit facility from NongHyup Bank
DNI (Parent Company)
 
523

 
Purchasing card from NongHyup Bank
Industrial Bank of Korea
 
6,512

 
Credit facility
Industrial Bank of Korea
 
864

 
Performance bonds
NongHyup Bank
 
4,567

 
Credit facility
Shinhan Bank
 
191

 
Purchasing card
KEB Hana Bank
 
33

 
Performance bonds
State Bank of India
 
38

 
Performance bonds
Seoul Guarantee Insurance Co.
 
54

 
Performance bonds
Seoul Guarantee Insurance Co.
 
373

 
Warranty bonds
 
 
$
34,881

 
 
Royalties
The Company has certain royalty commitments associated with the shipment and licensing of certain products. Royalty expense is generally based on a dollar amount per unit shipped or a percentage of the underlying revenue and is recorded in cost of revenue.
Legal Proceedings
The Company is subject to various legal proceedings, claims and litigation arising in the ordinary course of business. While the outcome of these matters is currently not determinable, the Company records an accrual for legal contingencies that it has determined to be probable to the extent 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 or results of operations. However, litigation is subject to inherent uncertainties, and unfavorable rulings could occur. If an unfavorable ruling were to occur, there exists the possibility of a material adverse impact on the results of operations of the period in which the ruling occurs, or future periods.


22


(12)
Enterprise-Wide Information
The Company is a global provider of network access solutions and communications equipment for service provider and enterprise networks. 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 reporting segment and operating unit structure. The Company’s chief operating decision makers are the Company’s Co-Chief Executive Officers, who review financial information presented on a consolidated basis accompanied by disaggregated information about 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. The following summarizes required disclosures about geographic concentrations and revenue by products and services (in thousands):
 
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2017
 
2016
 
2017
 
2016
 
 
 
(As Revised)
 
 
 
(As Revised)
Revenue by geography:
 
 
 
 
 
 
 
United States
$
13,068

 
$
3,408

 
$
37,176

 
$
7,432

Canada
1,498

 
254

 
4,112

 
254

Total North America
14,566

 
3,662

 
41,288

 
7,686

Latin America
7,480

 
1,877

 
19,425

 
2,912

Europe, Middle East, Africa
7,378

 
2,232

 
19,134

 
5,209

Korea
20,520

 
18,372

 
69,032

 
60,144

Other Asia Pacific
16,494

 
5,097

 
29,612

 
14,881

Total International
51,872

 
27,578

 
137,203

 
83,146

Total
$
66,438

 
$
31,240

 
$
178,491

 
$
90,832



 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2017
 
2016
 
2017
 
2016
 
 
 
(As Revised)
 
 
 
(As Revised)
Revenue by products and services:
 
 
 
 
 
 
 
Products
$
63,257

 
$
28,891

 
$
169,831

 
$
84,666

Services
3,181

 
2,349

 
8,660

 
6,166

Total
$
66,438

 
$
31,240

 
$
178,491

 
$
90,832



The Company's property and equipment, net of accumulated depreciation, were located in the following geographical areas as of September 30, 2017 and December 31, 2016 (in thousands):

 
September 30,
2017
 
December 31,
2016
United States
$
3,611

 
$
4,094

Korea
1,449

 
1,455

Japan and Vietnam
752

 
739

 
$
5,812

 
$
6,288




23


(13)
Income Taxes
Income tax expense for the three and nine months ended September 30, 2017 was $0.1 million and $0.6 million, respectively, on pre-tax income (losses) of $1.5 million and $(2.3) million, respectively. For the three and nine months ended September 30, 2016, the Company recognized income tax benefit of $0.6 million and $1.0 million, respectively, on pre-tax losses of $5.4 million and $10.1 million, respectively. As of September 30, 2017, the income tax rate varied from the United States statutory income tax rate primarily due to valuation allowances in the United States and taxable income generated by the Company’s wholly-owned foreign subsidiaries.
Management periodically evaluates the realizability of the Company's net deferred tax assets based on all available evidence, both positive and negative. The Company evaluates on a jurisdictional basis and certain jurisdictions could result in a realization of net deferred tax assets sooner than others. The realization of net deferred tax assets is dependent on the Company's ability to generate sufficient future taxable income, on a jurisdictional basis, during periods prior to the expiration of tax attributes to fully utilize these assets. The Company weighed both positive and negative evidence and determined that there is a continued need for a full valuation allowance on its deferred tax assets in certain jurisdictions as of September 30, 2017. The Company currently believes there is not sufficient positive evidence of future profitability to change its judgment regarding the need for a full valuation allowance on its deferred tax assets in these jurisdictions. The continued improvement in the Company's operating results, conditioned on successfully commercializing new business arrangements and managing costs would provide additional positive evidence in determining the need for a valuation allowance in certain jurisdictions and could lead to reversal of substantially all of the Company's valuation allowance on its deferred tax assets. Until such time, consumption of tax attributes to offset profits will reduce the overall level of deferred tax assets subject to valuation allowance. Should the Company determine that it would be able to realize its remaining deferred tax assets in the foreseeable future, on a jurisdictional basis, an adjustment to its remaining deferred tax assets would cause a material increase to income in the period such determination is made.
The total amount of unrecognized tax benefits, including interest and penalties, at September 30, 2017 was not material. The amount of tax benefits that would impact the effective income tax rate, if recognized, is not expected to be material. There were no significant changes to unrecognized tax benefits during the quarters ended September 30, 2017 and 2016. The Company does not anticipate any significant changes with respect to unrecognized tax benefits within the next 12 months.
The Company or one of its subsidiaries files income tax returns in the U.S. federal jurisdiction, and various state and foreign jurisdictions. The open tax years for the major jurisdictions are as follows:
•    Federal
2013 - 2016
•    California and Canada
2012 - 2016
•    Brazil
2011 - 2016
•    Germany
2012 - 2016
•    Japan
2011 - 2016
•    Korea
2015 - 2016
•    United Kingdom
2014 - 2016
•    Vietnam
2016

However, due to the fact the Company had net operating losses and credits carried forward in most jurisdictions, certain items attributable to closed years are still subject to adjustment by the relevant taxing authority through an adjustment to tax attributes carried forward to open years.

The Company estimates that its foreign income will generally be subject to taxation in the United States on a current basis and that its foreign subsidiaries and representative offices will therefore not have any material untaxed earnings subject to deferred taxes. In addition, to the extent the Company is deemed to have sufficient connection to a particular taxing jurisdiction to enable that jurisdiction to tax the Company but the Company has not filed an income tax return in that jurisdiction for the year(s) at issue, the jurisdiction would typically be able to assert a tax liability for such years without limitation on the number of years it may examine.

The Company is not currently under examination for income taxes in any material jurisdiction.



Item 2.    Management’s Discussion and Analysis of Financial Condition and Results of Operations
As used in this report, unless the context suggests otherwise, the terms "we", "us", or "our" refer to (i) Dasan Network Solutions, Inc. (DNS) and its consolidated subsidiaries for periods through September 8, 2016 and (ii) DASAN Zhone Solutions, Inc. and its consolidated subsidiaries (collectively, DZS) for periods on or after September 9, 2016, the effective date of the Merger (as defined below). In connection with the Merger, Zhone Technologies, Inc. changed its name to DASAN Zhone Solutions, Inc. For periods through September 8, 2016, Zhone Technologies, Inc. is referred to as "Legacy Zhone."
Forward-Looking Statements
This report, 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 and the Securities Exchange Act of 1934. These statements are based on current expectations, estimates, forecasts, and projections about the industries in which we operate and the beliefs and assumptions of our management. We use words such as “anticipate,” “believe,” “continue,” “could,” “estimate,” “expect,” “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; anticipated

24


growth and trends in our business or key markets; cost synergies, growth opportunities and other financial and operating benefits of the Merger; future growth and revenues from our products; our ability to refinance or repay our existing indebtedness prior to the applicable maturity date; future economic conditions and performance; anticipated performance of products or services; plans, objectives and strategies for future operations; and other characterizations of future events or circumstances, are forward-looking statements. Readers are cautioned that these forward-looking statements are only predictions and are subject to risks, uncertainties and assumptions that are difficult to predict, including those identified under the heading “Risk Factors” in Part II, Item 1A, elsewhere in this report and our other filings with the Securities and Exchange Commission (the SEC). Therefore, actual results may differ materially and adversely from those expressed in any forward-looking statements. Factors that might cause such a difference include, but are not limited to, our ability to realize the anticipated cost savings, synergies and other benefits of the Merger and any integration risks relating to the Merger, the ability to generate sufficient revenue to achieve or sustain profitability, the ability to raise additional capital to fund existing and future operations or to refinance or repay our existing indebtedness, defects or other performance problems in our products, any economic slowdown in the telecommunications industry that restricts the ability of our customers to purchase our products, 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 networks needs as our products, higher than anticipated expenses that we may incur, any failure to comply with the periodic filing and other requirements of The Nasdaq Stock Market for continued listing, material weaknesses or other deficiencies in our internal control over financial reporting, the initiation of any civil litigation, regulatory proceedings, government enforcement actions or other adverse effects relating to the Audit Committee investigation or errors in the consolidated financial statements of Legacy Zhone and other factors identified elsewhere in this report and in our most recent reports on Forms 10-K, 10-Q and 8-K. We undertake no obligation to revise or update any forward-looking statements for any reason.
OVERVIEW
We are a global provider of network access solutions and communications equipment for service provider and enterprise networks. We research, develop, test, sell, manufacture and support communications equipment in five major areas: broadband access, Ethernet switching, mobile backhaul, passive optical LAN (POLAN) and software defined networks (SDN).
As discussed under "Liquidity and Capital Resources" below, the maturing of short-term debt obligations and our recurring losses from operations raise substantial doubt on whether we will be able to continue as a going concern.
As of September 30, 2017, the total outstanding principal amount of our debt obligations was $26.9 million, consisting of the following:
$18.4 million in short-term debt obligations to other non-related parties;
$3.5 million in short-term debt obligations to related parties; and
$5.0 million in long-term debt obligations to related parties.
Our ability to continue as a “going concern” is dependent on many factors, including, among other things, our ability to comply with the covenants in our existing debt agreements, our ability to cure any defaults that occur under our debt agreements or to obtain waivers or forbearances with respect to any such defaults, and our ability to pay, retire, amend, replace or refinance our indebtedness as defaults occur or as interest and principal payments come due.
Going forward, our key financial objectives include the following:
Increasing revenue while continuing to carefully control costs;
Continued 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.

25


Merger
On September 9, 2016, we acquired DNS through the merger of a wholly owned subsidiary of Zhone Technologies, Inc. with and into DNS, with DNS surviving as our wholly owned subsidiary (the Merger). In connection with the Merger, Zhone Technologies, Inc. changed its name to DASAN Zhone Solutions, Inc. Our common stock continues to be traded on the Nasdaq Capital Market, and our ticker symbol was changed from "ZHNE" to "DZSI" effective September 12, 2016.
At the effective time of the Merger, all issued and outstanding shares of capital stock of DNS held by its sole shareholder, DASAN Networks, Inc. (DNI), were canceled and converted into the right to receive shares of our common stock in an amount equal to 58% of the issued and outstanding shares of our common stock immediately following the Merger. Accordingly, at the effective time of the Merger, we issued 9,493,016 shares (post reverse stock split) of our common stock to DNI as consideration in the Merger, of which 949,302 shares (post reverse stock split) are being held in escrow as security for claims for indemnifiable losses in accordance with the merger agreement relating to the Merger. As a result, immediately following the effective time of the Merger, DNI held 58% of the outstanding shares of our common stock and the holders of our common stock immediately prior to the Merger retained, in the aggregate, 42% of the outstanding shares of our common stock.
See Note 2 to the unaudited condensed consolidated financial statements set forth in Part I, Item 1 of this report for additional information regarding the Merger.

ITEMS AFFECTING COMPARABILITY OF OUR FINANCIAL RESULTS
As discussed in Note 1(e) to the unaudited condensed consolidated financial statements set forth in Part I, Item 1 of this report, the Merger has been accounted for as a reverse acquisition under which DNS was considered the accounting acquirer of Legacy Zhone. As such, our financial results for the three and nine months ended September 30, 2017 presented in this report are compared to the financial results of DNS and its consolidated subsidiaries for the prior year period through September 8, 2016 and the financial results of DZS and its consolidated subsidiaries for the period from September 9, 2016 through September 30, 2016. Our balance sheet includes the fair value of the assets and liabilities of Legacy Zhone as of the effective date of the Merger. Those assets include the fair value of acquired intangible assets and goodwill. Due to the foregoing, our financial results for the three and nine months ended September 30, 2017 are not comparable to our financial results for the three and nine months ended September 30, 2016.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES

There have been no material changes to our critical accounting policies and estimates from the information provided in Part II, “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations – Critical Accounting Policies and Estimates” included in our Annual Report on Form 10-K for the year ended December 31, 2016.




26


RESULTS OF OPERATIONS
We list in the table below the historical condensed consolidated statement of comprehensive loss data as a percentage of net revenue for the periods indicated.
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2017
 
2016
 
2017
 
2016
 
 
 
(As Revised)
 
 
 
(As Revised)
Net revenue:
 
 
 
 
 
 
 
Net revenue
91
 %
 
79
 %
 
85
 %
 
75
 %
Net revenue - related parties
9
 %
 
21
 %
 
15
 %
 
25
 %
Total net revenue
100
 %
 
100
 %
 
100
&