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May 10, 2021, 4:51 p.m. EDT

10-Q: DZS INC.

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(EDGAR Online via COMTEX) -- Item 2.Management's Discussion and Analysis of Financial Condition and Results of Operations

As used in this Quarterly Report on Form 10-Q, unless the context suggests otherwise, the terms "DZS," the "Company" "we," "our" and "us" refer to DZS Inc. and its subsidiaries.

Forward-Looking Statements

This Quarterly Report on Form 10-Q, including "Management's Discussion and Analysis of Financial Condition and Results of Operations," contains forward-looking statements regarding future events and our future results that are subject to the safe harbors created under the Securities Act of 1933 (the "Securities Act") and the Securities Exchange Act of 1934 (the "Exchange Act"). These statements are based on current expectations, estimates, forecasts, and projections about the industries in which we operate, and reflect the beliefs and assumptions of our management as of the date hereof.

We use words such as "anticipate," "believe," "continue," "could," "estimate," "expect," "forecast," "goal," "intend," "may," "plan," "project," "seek," "should," "target," "will," "would," variations of such words, the negative of such words, and similar expressions to identify forward-looking statements. In addition, statements that refer to projections of earnings, revenue, costs or other financial items in future periods; our ability to satisfy our short- and long-term cash requirements; anticipated growth and trends in our business, industry or key markets; future growth and revenues from our products; our plans and our ability to refinance or repay our existing indebtedness prior to the applicable maturity dates; our ability to access other capital to fund our future operations; future economic conditions and performance; the impact of the global outbreak of COVID-19; the impact of interest rate and foreign currency fluctuations; the impact of the completed relocation of our corporate headquarters to Texas; anticipated performance of products or services; competition; plans, objectives and strategies for future operations, including our pursuit or strategic acquisitions and our continued investment in research and development; other characterizations of future events or circumstances; and all other statements that are not statements of historical fact, are forward-looking statements within the meaning of the Securities Act and the Exchange Act. Although we believe that the assumptions underlying the forward-looking statements are reasonable, we can give no assurance that our expectations will be attained. Factors which could have a material adverse effect on our operations and future prospects or which could cause actual results to differ materially from our expectations include, but are not limited to:

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

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

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

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

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

defects or other performance problems in our products;

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

commercial acceptance of our products;

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

higher than anticipated expenses that we may incur;

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

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

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

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

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

OVERVIEW

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

We research, develop, test, sell, manufacture and support platforms in the areas of mobile transport and fixed broadband access, as discussed below. We have extensive regional development and support centers around the world to support our customer needs.

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

DZS Cronos portfolio - Mobile Transport. Our mobile transport products provide a robust, manageable and scalable solution for mobile operators that enable them to upgrade their mobile fronthaul/midhaul/backhaul ("xHaul") systems and migrate to fifth generation wireless technologies ("5G") and beyond. Our mobile xHaul products may be collocated at the radio access node base station and can aggregate multiple radio access node base stations into a single backhaul for delivery of mobile traffic to the radio access node network controller. Our products support pure Ethernet switching as well as layer 3 IP and Multiprotocol Label Switching ("MPLS"), and we interoperate with other vendors in these networks.

DZS Velocity portfolio - Fixed Broadband Access. Our fixed broadband access products offer a variety of solutions for carriers and service providers to connect residential and business customers, either using high-speed fiber or leveraging their existing deployed copper networks to offer broadband services to customer premises. Once our broadband access products are deployed, the service provider can offer voice, high-definition and ultra-high-definition video, highspeed internet access and business class services to their customers. In addition, the switching and routing products we provide in this space offer a high-performance and manageable solution that bridges the gap from carrier access technologies to the core network. Connected premises products are designed for high bandwidth services being deployed to the home or business. Our connected premises portfolio consists of indoor/outdoor ONT gateways delivering best-in-class data throughout to support the most demanding FTTx applications. The product feature set gives service providers an elegant migration path from legacy to softswitch architectures without replacing optical network terminals ("ONTs").

In addition, we have our DZS Cloud portfolio and our DZS Helix portfolio. DZS Cloud accelerates our software capabilities specifically in the areas of network orchestration, application slicing, automation, analytics, and service assurance. Communications service providers are implementing software defined networking ("SDN") and network functions virtualization ("NFV") architectures to reduce reliance on proprietary systems and hardware, which increase service agility, flexibility, and deployment of new network services while lowering costs. DZS Helix is our connected premises product portfolio, offering a large collection of smart gateway platforms for any FTTx deployment.

Going forward, our key financial objectives include the following:

Increasing revenue while continuing to carefully control costs;

Continuing investments in strategic research and product development activities that will provide the maximum potential return on investment; and

Minimizing consumption of our cash and cash equivalents.

RECENT DEVELOPMENTS

On March 8, 2021, we made the strategic decision, subject to the proper involvement of the employee representatives, to transition DZS GmbH to a sales and research and development center. Negotiations are being held with the works council in Germany on a reconciliation of interests and a social plan. DZS GmbH is expecting to reduce headcount by approximately 100 employees.

On March 3, 2021, we acquired substantially all of the assets of RIFT, Inc., a software defined orchestration, automation and network slicing provider.

On February 5, 2021, we acquired Optelian Access Networks Corporation, a leading optical networking solution provider based in Ottawa, Ontario, Canada, and its portfolio of optical transport solutions.

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







        RESULTS OF OPERATIONS
        We list in the table below the unaudited condensed consolidated statement of
        comprehensive (loss) income as a percentage of total net revenue for the periods
        indicated.
                                                                      Three Months Ended March 31,
                                                                     2021                      2020
        Net revenue                                                        100 %                     100 %
        Cost of revenue                                                     65 %                      66 %
        Gross profit                                                        35 %                      34 %
        Operating expenses:
        Research and product development                                    14 %                      21 %
        Selling, marketing, general and administrative                      39 %                      28 %
        Restructuring and other charges                                      8 %                       -
        Impairment of long-lived assets                                      2 %                       -
        Amortization of intangible assets                                    1 %                       1 %
        Total operating expenses                                            64 %                      50 %
        Operating income (loss)                                            (29 )%                    (16 )%
        Interest income                                                      -                         -
        Interest expense                                                     -                        (1 )%
        Loss on extinguishment of debt                                       -                        (3 )%
        Other income (expense), net                                          1 %                       2 %
        Income (loss) before income taxes                                  (28 )%                    (18 )%
        Income tax provision (benefit)                                       1 %                       -
        Net income (loss)                                                  (29 )%                    (18 )%
        








        Net Revenue
        The following table presents our revenues by source (in millions):
                              Three Months Ended March 31,
                                            Increase/
                     2021        2020      (Decrease)       % change
        Products   $   76.2     $ 42.7     $      33.5           78.5 %
        Services        4.8        4.8               -            0.4 %
        Total      $   81.0     $ 47.5     $      33.5           70.7 %
        


For the three months ended March 31, 2021, product revenue increased by 78.5% or $33.5 million to $76.2 million from $42.7 million in the same period last year. The increase in product revenue during the period was primarily attributable to increased sales of our mobile transport and fixed broadband projects and partly as a result of recovering from the impacts of the early onset of the COVID-19 pandemic in the first quarter of 2020. For the three months ended March 31, 2021, service revenue of $4.8 million was consistent with the same period last year.

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







                                                 Three Months Ended March 31,
                                                               Increase/
                                        2021        2020      (Decrease)       % change
        Revenue by geography:
        Americas                      $   20.2     $ 11.7     $       8.5           72.4 %
        Europe, Middle East, Africa       17.9       11.3             6.6           58.0 %
        Asia                              42.9       24.5            18.4           75.0 %
        Total                         $   81.0     $ 47.5     $      33.5           70.7 %
        


From a geographical perspective, the increase in net revenue for the three months ended March 31, 2021 was attributable to increased revenue in all regions and was partly attributed to impacts from the worldwide COVID-19 pandemic in the first quarter of 2020. In addition, the increase in Asia was also attributable to increased revenue related to next generation mobile edge access transport and fixed broadband access solutions.

For the three months ended March 31, 2021, two customers accounted for 18% and 10% of net revenue, respectively. For the three months ended March 31, 2020, two customers accounted for 14% and 10% of net revenue, respectively.

We anticipate that our results of operations in any given period may depend to a large extent on sales to a small number of large customers. As a result, our revenue for any quarter may be subject to significant volatility based upon changes in orders from one or a small number of key customers.

Cost of Revenue and Gross Profit

Total cost of revenue increased 68.1% to $52.9 million for the three months ended March 31, 2021, compared to $31.5 million for March 31, 2020. Total cost of revenue was 65.3% of net revenue for the three months ended March 31, 2021, compared to 66.3% of net revenue for the three months ended March 31, 2020, which resulted in an increase in gross profit percentage to 34.7% for the three months ended March 31, 2021 from 33.7% for the three months ended March 31, 2020. The increase in total cost of revenue was primarily due to the increase in number and mix of products sold, including the geographic mix of those sales.

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

Research and Product Development Expenses

Research and product development expenses include personnel costs, outside contractor and consulting services, depreciation on lab equipment, costs of prototypes and overhead allocations. Research and product development expenses increased by 14.5% to $11.1 million for the three months ended March 31, 2021 compared to $9.7 million for the three months ended March 31, 2020, mainly due to strategic hiring decisions in research, development, and product line management in the second half of 2020 and into the first quarter of 2021 with the intent to accelerate growth and capture market share.

We intend to continue to invest in research and product development to attain our strategic product development objectives, while seeking to manage the associated costs through expense controls.

Selling, Marketing, General and Administrative Expenses

Selling, marketing, general and administrative expenses include personnel costs for sales, marketing, administration, finance, information technology, human resources and general management as well as legal and accounting expenses, rent, utilities, trade show expenses and related travel costs.

Selling, marketing, general and administrative expenses increased $18.3 million or 135.6% to $31.8 million for the three months ended March 31, 2021 compared to $13.5 million for the three months ended March 31, 2020. The increase in selling, marketing, general and administrative expenses was primarily due to the increase in allowance for doubtful accounts for one customer in India by $14.2 million. Refer to Note 1 in the Notes to Unaudited Condensed Consolidated Financial Statements, for further information on the bad debt expense. The increase was also partially due to strategic hiring decisions across sales and administration in the second half of 2020 and into the first quarter of 2021 with the intent to accelerate growth and capture market share.

Restructuring and Other Charges

Restructuring and other charges for the three months ended March 31, 2021 was $6.3 million, and relate to the restructuring activities related to Hanover, Germany. See Note 9 Restructuring and Other Charges of the Notes to Unaudited Condensed Consolidated Financial Statements included in this Quarterly Report on Form 10-Q for further information.

Impairment of Long-lived Assets

Impairment of long-lived assets for the three months ended March 31, 2021 was $1.7 million, and relates to the consolidation of office space in the United States. See Note 13 Leases of the Notes to Unaudited Condensed Consolidated Financial Statements included in this Quarterly Report on Form 10-Q for further information.

Income Tax Provision

Income tax expense for the three months ended March 31, 2021 was $0.9 million, on pre-tax loss of $22.3 million. There was no income tax expense for the three months ended March 31, 2020 on pre-tax loss of $8.8 million. For the three months ended March 31, 2021, the effective income tax rate varied from the United States statutory income tax rate primarily due to valuation allowances in North America and EMEA and the mix of earnings generated by our wholly owned foreign subsidiaries in Asia.

OTHER PERFORMANCE MEASURES

In managing our business and assessing our financial performance, we supplement the information provided by our U.S. GAAP results with adjusted earnings before stock-based compensation, interest, taxes, and depreciation, or Adjusted EBITDA, a non-U.S. GAAP financial measure. We define Adjusted EBITDA as net income

Adjusted EBITDA has limitations as an analytical tool. Some of these limitations are:

Adjusted EBITDA does not reflect our cash expenditures, or future requirements, for capital expenditures or contractual requirements;

Adjusted EBITDA does not reflect changes in, or cash requirements for, our working capital needs;

Adjusted EBITDA does not reflect the interest expense, or the cash requirements necessary to service interest or principal payments, on our debts;

Although depreciation and amortization are non-cash expenses, the assets being depreciated and amortized will often have to be replaced in the future, and Adjusted EBITDA does not reflect any cash requirements for such replacements;

Non-cash compensation is and will remain a key element of our overall long-term incentive compensation package, although we exclude it as an expense when evaluating our ongoing operating performance for a particular period; and

Other companies in our industry may calculate Adjusted EBITDA and similar measures differently than we do, limiting its usefulness as a comparative measure.

Because of these limitations, Adjusted EBITDA should not be considered in isolation or as a substitute for net income (loss) or any other performance measures calculated in accordance with U.S. GAAP or as a measure of liquidity. Management understands these limitations and compensates for these limitations by relying primarily on our U.S. GAAP results and using Adjusted EBITDA only as a supplemental measure.

Set forth below is a reconciliation of net income (loss) to Adjusted EBITDA, which we consider to be the most directly comparable U.S. GAAP financial measure to Adjusted EBITDA (in thousands):







                                             Three Months Ended March 31,
                                               2021                 2020
        Net income (loss)                 $       (23,225 )     $      (8,771 )
        Add (deduct):
        Interest expense, net                         207                 573
        Income tax provision (benefit)                893                  (5 )
        Depreciation and amortization               1,265               1,256
        Stock-based compensation                    1,352                 782
        Headquarters relocation                     1,920                   -
        Restructuring and other charges             6,252                   -
        Acquisition costs                             643                   -
        Executive transition                           71                   -
        Bad debt expense*                          14,206                   -
        Loss on debt extinguishment                     -               1,369
        Adjusted EBITDA                   $         3,584       $      (4,796 )
        


* See Note 1 of the Notes to Unaudited Condensed Consolidated Financial Statements included in this Quarterly Report on Form 10-Q for further information.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

For a complete description of what we believe to be the critical accounting policies and estimates used in the preparation of our unaudited condensed consolidated financial statements, refer to Note 1 Organization and Summary of Significant Accounting Policies in the notes to our audited consolidated financial statements in our Annual Report on Form 10-K for the year ended December 31, 2020, as supplemented by Note 1 Organization and Summary of Significant Accounting Policies in the notes to our unaudited condensed consolidated financial statements in Part I, Item 1 of this Quarterly Report on Form 10-Q.







        LIQUIDITY AND CAPITAL RESOURCES
        Our operations are financed through a combination of our existing cash, cash
        equivalents, available credit facilities, and sales of equity and debt
        instruments, based on our operating requirements and market conditions.
        The following table summarizes the information regarding our cash and cash
        equivalents and working capital (in thousands):
                                     March 31, 2021       December 31, 2020
        Cash and cash equivalents   $         56,818     $            45,219
        Working capital                      130,713                 123,285
        


We had a net loss of $23.2 million for the three months ended March 31, 2021 and a net loss of $8.8 million for the three months ended March 31, 2020.

As of March 31, 2021, we had an accumulated deficit of $75.5 million and working capital of $130.7 million. As of March 31, 2021, we had $56.8 million in cash and cash equivalents, which included $26.3 million in cash balances held by our international subsidiaries, and $1.8 million in aggregate principal debt.

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

We continue to focus on cost management, operating efficiency and efficient discretionary spending. In addition, if necessary, we may sell assets, issue debt or equity securities or purchase credit insurance. We may also rationalize the number of products we sell, adjust our manufacturing footprint, and reduce our operations in low margin regions, including reductions in headcount. Based on our current plans and current business conditions, we believe that these measures along with our existing cash and cash equivalents will be sufficient to satisfy our anticipated cash requirements for at least the next 12 months from the date of this Quarterly Report on Form 10-Q.

In December 2019, a strain of coronavirus, now known as COVID-19, was reported to have surfaced in Wuhan, China. Since that time, the widespread and sustained transmission of the virus has reached global pandemic status. In response to the pandemic, many national and international health agencies have recommended, and many countries and state, provincial and local governments have implemented, various measures, including travel bans and restrictions, limitations on public and private gatherings, business closures or operating restrictions, social distancing, and shelter-in-place orders. The health effects of the

pandemic and the above measures taken in response thereto have had an effect on the global economy in general and have materially impacted and may continue to impact on our financial condition, results of operations and cash flows. Given the ongoing and dynamic nature of the virus and the worldwide response related thereto, it is difficult to predict the full impact of the COVID-19 pandemic on our business. Due to the uncertainty around the future economic impact of the . . .

May 10, 2021

COMTEX_386291059/2041/2021-05-10T16:50:58

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