Organization and Summary of Significant Accounting Policies

3 Months Ended

Mar. 31, 2022

Organization Consolidation And Presentation Of Financial Statements [Abstract]

Organization and Summary of Significant Accounting Policies

(1) Organization and Summary of Significant Accounting Policies

(a) Description of Business

DZS Inc. (referred to, collectively with its subsidiaries, as “DZS” or the “Company”) is a global provider of leading-edge access, 5G transport, and enterprise communications platforms that enable the emerging hyper-connected, hyper-broadband world. 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.

DZS was incorporated under the laws of the state of Delaware in June 1999. The Company is headquartered in Plano, Texas with flexible in-house production facilities in Seminole, Florida, and contract manufacturers located in China, India, Korea and Vietnam. The Company also maintains offices to provide sales and customer support at global locations.

(b) Basis of Presentation

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (U.S. GAAP) for interim financial information and with the instructions to Form 10-Q/A and Article 3 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by U.S. GAAP for complete financial statements. These financial statements include the accounts of the Company and its wholly owned subsidiaries. These unaudited condensed consolidated financial statements should be read in conjunction with the consolidated financial statements of the Company and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2021 filed with the Securities and Exchange Commission (“SEC”) on March 9, 2022. For a complete description of what the Company believes to be the critical accounting policies and estimates used in the preparation of its unaudited condensed consolidated financial statements, refer to the Company’s Annual Report on Form 10-K for the year ended December 31, 2021.

All intercompany transactions and balances have been eliminated in consolidation. Certain prior-year amounts have been reclassified to conform to the current-quarter presentation. The unaudited condensed consolidated financial statements reflect all adjustments (consisting only of normal recurring adjustments) that, in the opinion of management, are necessary for a fair presentation of the results for the interim periods presented. The results of operations for the current interim period are not necessarily indicative of results to be expected for the current year or any other period.

(c) Risks and Uncertainties

The accompanying unaudited condensed consolidated financial statements have been prepared in conformity with U.S. GAAP, assuming the Company will continue as a going concern.

The COVID-19 pandemic continued to adversely affect significant portions of our business and our financial condition and results of operations in the first quarter of 2022. The emergence of the Omicron variant in late 2021 with a resulting increase in COVID cases in early 2022 resulted in re-implementation of 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 will likely continue to impact the Company’s financial condition, results of operations and cash flows. Given the ongoing and dynamic nature of the virus and its variants, and the worldwide response related thereto, it is difficult to predict the full impact of the COVID-19 pandemic on our business.

We have experienced and continue to experience disruptions in our supply chain due to the pandemic, which has also impacted and may adversely impact our operations (including, without limitation, logistical and other operational costs) and the operations of some of our key suppliers. Supply chain pricing, freight and logistics costs, product and component availability, and extended lead-times became a challenge in 2021 and continue into 2022 as the world economy recovers from the COVID-19 pandemic. As we continue to incur elevated costs for components and expedite fees, our supply chain and operations teams continue to focus on managing through a constrained environment, thereby enabling DZS to maximize shipments despite elongated lead times. We remain cautious about continued supply chain headwinds that challenge the industry and anticipate a constrained supply chain environment to persist throughout 2022.

For additional risks to the corporation related to the COVID-19 pandemic, see Item 1A, Risk Factors of our 2021 Form 10-K.

(d) Use of Estimates

The preparation of the unaudited condensed consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the unaudited condensed consolidated financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ materially from those estimates.

(e) Restatement

Subsequent to the issuance of the unaudited condensed consolidated financial statements as of March 31, 2023 and as previously disclosed on June 1, 2023, Management determined that the Company’s previously issued unaudited condensed consolidated financial statements as of and for the three months ended March 31, 2023 (the “Q1 2023 Financial Statements”) contained an accounting error relating to the timing of revenue recognition with respect to certain customer projects. As a result of this error, the Audit Committee determined that the Company’s Q1 2023 Financial Statements should no longer be relied upon and should be restated. In addition, as a result of the error, the Audit Committee initiated a review of the Company’s accounting for revenue recognition and the extent to which these matters affect the Company’s internal controls over financial reporting (the “Review”).

On November 9, 2023, the Company disclosed that although the Review was still ongoing, based on preliminary findings, management had determined that the Company’s previously issued audited condensed consolidated financial statements as of and for the year ended December 31, 2022 (the “2022 Annual Financial Statements”), as well as the Company’s previously issued unaudited condensed consolidated financial statements as of and for each of the three months ended March 31, 2022, the three and six months ended June 30, 2022 and the three and nine months ended September 30, 2022 (collectively, the “2022 Interim Financial Statements” and, together with the 2022 Annual Financial Statements, the “2022 Financial Statements” and, together with the Q1 2023 Financial Statements, the “Affected Financial Statements”), should no longer be relied upon and should be restated due to accounting errors in each of the 2022 Financial Statements relating to revenue recognition.

During the course of the Review, and during the Company's subsequent assessment of its accounting practices, accounting and financial reporting errors were identified. Specifically, errors in timing of revenue recognition relating to incorrect shipping dates, incorrect or unapproved shipping terms, incorrect timing of the transfer of control, and incorrect evaluation of the existence of contracts. As a result, revenue, accounts receivable, contract assets and liabilities, and inventory and cost of sales contained errors which resulted in corrections in accounting under U.S. GAAP related to the timing of revenue recognition under certain customer projects. Accordingly, the Company is restating its unaudited condensed consolidated financial statements for the three months ended March 31, 2022, to correct these errors which are described below.

The amounts in the "As Previously Reported" columns are amounts derived from the Company's previously filed financial statements in its Quarterly Report on Form 10-Q, originally filed with the Securities and Exchange Commission on May 3, 2022. The amounts in the "Adjustments" columns present the impact of the accounting error corrections relating to the timing of revenue recognition with respect to certain customer projects along with other corrections to the Company's previously filed financial statements. The description of the corrections is referenced by (a) through (b) in the tables below. The amounts in the "As Restated" columns are the updated amounts including the impacts from the adjustments.

The following table presents the effect of the restatement on the Company's previously reported unaudited condensed consolidated balance sheet as of March 31, 2022 (in thousands, except par value).

	March 31, 2022
	As Previously Reported			Adjustments				As Restated
Assets
Current assets:
Cash and cash equivalents	$	34,160		$	—			$	34,160
Restricted cash		6,343			—				6,343
Accounts receivable - trade, net		82,607			(3,657	)	(a)		78,950
Other receivables		9,898			—				9,898
Inventories		66,459			3,626		(a)		70,085
Contract assets		902			—				902
Prepaid expenses and other current assets		13,039			(3,020	)	(b)		10,019
Total current assets		213,408			(3,051	)			210,357
Property, plant and equipment, net		10,277			—				10,277
Right-of-use assets from operating leases		11,751			—				11,751
Goodwill		6,145			—				6,145
Intangible assets, net		4,820			—				4,820
Other assets		9,904			—				9,904
Total assets	$	256,305		$	(3,051	)		$	253,254
Liabilities and Stockholders’ Equity
Current liabilities:
Accounts payable - trade	$	63,774		$	—			$	63,774
Contract liabilities		7,103			1,403		(a)		8,506
Operating lease liabilities		3,927			—				3,927
Accrued and other liabilities		16,832			84		(b)		16,916
Total current liabilities		91,636			1,487				93,123
Contract liabilities - non-current		2,881			—				2,881
Operating lease liabilities - non-current		11,029			—				11,029
Pension liabilities		16,106			—				16,106
Other long-term liabilities		3,704			—				3,704
Total liabilities		125,356			1,487				126,843
Stockholders’ equity:
Common stock		27			—				27
Additional paid-in capital		226,163			—				226,163
Accumulated other comprehensive loss		(4,793	)		—				(4,793	)
Accumulated deficit		(90,448	)		(4,538	)			(94,986	)
Total stockholders’ equity		130,949			(4,538	)	(a)		126,411
Total liabilities and stockholders’ equity	$	256,305		$	(3,051	)		$	253,254

The impact of each error for the corresponding period in the above table is described below:

(a) Error corrections relating to the timing of revenue recognition with respect to certain customer projects.

(b) Tax impact on the error corrections relating to the timing of revenue recognition with respect to certain customer projects.

The following table presents the effect of the restatement on the Company's previously reported unaudited condensed consolidated statement of comprehensive income (loss) for the three months ended March 31, 2022 (in thousands, except per share data).

	Three Months Ended March 31, 2022
	As Previously Reported			Adjustments				As Restated
Net revenue	$	77,040		$	(5,050	)	(a)	$	71,990
Cost of revenue		50,215			(3,616	)	(a)		46,599
Gross profit		26,825			(1,434	)			25,391
Operating expenses:
Research and product development		11,844			—				11,844
Selling, marketing, general and administrative		17,742			—				17,742
Restructuring and other charges		436			—				436
Amortization of intangible assets		294			—				294
Total operating expenses		30,316			—				30,316
Operating loss		(3,491	)		(1,434	)			(4,925	)
Interest income		37			—				37
Interest expense		(127	)		—				(127	)
Other expense, net		(800	)		—				(800	)
Loss before income taxes		(4,381	)		(1,434	)			(5,815	)
Income tax provision (benefit)		(1,333	)		3,104		(b)		1,771
Net loss		(3,048	)		(4,538	)			(7,586	)
									-
Foreign currency translation adjustments		(268	)		—				(268	)
Comprehensive loss	$	(3,316	)	$	(4,538	)		$	(7,854	)
Net loss per share									-
Basic	$	(0.11	)	$	(0.17	)		$	(0.28	)
Diluted	$	(0.11	)	$	(0.17	)		$	(0.28	)
Weighted average shares outstanding
Basic		27,530							27,530
Diluted		27,530							27,530

The impact of each error for the corresponding period in the above table is described below:

(a) Error corrections relating to the timing of revenue recognition with respect to certain customer projects.

(b) Tax impact on the error corrections relating to the timing of revenue recognition with respect to certain customer projects.

The following table presents the effect of the restatement on the Company's previously reported unaudited condensed consolidated statement of cash flows for the three months ended March 31, 2022 (in thousands).

	Three Months Ended March 31, 2022
	As Previously Reported			Adjustments				As Restated
Cash flows from operating activities:
Net loss	$	(3,048	)	$	(4,538	)	(a)(b)	$	(7,586	)
Adjustments to reconcile net loss to net cash   provided by (used in) operating activities:
Depreciation and amortization		1,081			—				1,081
Stock-based compensation		2,671			—				2,671
Provision for inventory write-down		705			—				705
Provision for credit losses, net of recoveries		(752	)		—				(752	)
Provision for sales returns		1,448			—				1,448
Provision for warranty expense		121			—				121
Unrealized loss (gain) on foreign currency transactions		874			—				874
Subsidiary dissolution		(68	)		—				(68	)
Changes in operating assets and liabilities excluding effects of acquisition:
Accounts receivable		2,761			3,657		(a)		6,418
Other receivable		126			—				126
Inventories		(10,931	)		(3,626	)	(a)		(14,557	)
Contract assets		1,261			—				1,261
Prepaid expenses and other assets		(7,577	)		3,020		(b)		(4,557	)
Accounts payable		1,586			—				1,586
Contract liabilities		(1,446	)		1,403		(a)		(43	)
Accrued and other liabilities		456			84		(b)		540
Net cash used in operating activities		(10,732	)		—				(10,732	)
Cash flows from investing activities:
Purchases of property, plant and equipment		(1,317	)		—				(1,317	)
Acquisition of business, net of cash acquired		—			—				—
Net cash used in investing activities		(1,317	)		—				(1,317	)
Cash flows from financing activities:
Payments for debt issue costs		(178	)		—				(178	)
Proceeds from exercise of stock awards and employee stock plan purchases		156			—				156
Net cash provided by (used in) financing activities		(22	)		—				(22	)
Effect of exchange rate changes on cash, cash equivalents and restricted cash		(903	)		—				(903	)
Net increase in cash, cash equivalents and restricted cash		(12,974	)		—				(12,974	)
Cash, cash equivalents and restricted cash at beginning of period		53,639			—				53,639
Cash, cash equivalents and restricted cash at end of period	$	40,665		$	—			$	40,665

The impact of each error for the corresponding period in the above table is described below:

(a) Error corrections relating to the timing of revenue recognition with respect to certain customer projects.

(b) Tax impact on the error corrections relating to the timing of revenue recognition with respect to certain customer projects.

(f) Disaggregation of Revenue

The following table presents revenues by source (in thousands):

	Three Months Ended March 31,
	2022 (As Restated)		2021
Products	$	67,412	$	76,252
Services and other		4,578		4,779
Total	$	71,990	$	81,031

The following table present revenues by geographical concentration (in thousands):

	Three Months Ended March 31,
	2022 (As Restated)		2021
Americas	$	22,924	$	20,169
Europe, Middle East, Africa		16,393		17,918
Asia		32,673		42,944
Total	$	71,990	$	81,031

(g) Concentration of Risk

Financial instruments that potentially subject the Company to concentrations of credit risk consist primarily of cash, cash equivalents and restricted cash, accounts receivables, and contract assets. Cash, cash equivalents and restricted cash consist of financial deposits and money market accounts that are principally held with various domestic and international financial institutions with high credit standing. As of March 31, 2022, the Company had cash accounts in excess of Federal Deposit Insurance Corporation ("FDIC") insured limits.

The Company’s customers include competitive and incumbent local exchange carriers, competitive access providers, internet service providers, wireless carriers and resellers serving these markets. The Company performs ongoing credit evaluations of its customers and generally does not require collateral. Allowances are maintained for potential doubtful accounts based upon the expected collectability of accounts receivable using historical loss rates adjusted for customer-specific factors and current economic conditions. The Company determines historical loss rates on a rational and systematic basis. The Company performs periodic assessments of its customers’ liquidity and financial condition through analysis of information obtained from credit rating agencies, financial statement review and historical and current collection trends.

Activity under the Company’s allowance for credit losses is comprised as follows (in thousands):

	Three Months Ended March 31,
	2022			2021
Balance at beginning of period	$	17,735		$	3,954
Charged to expense, net of recoveries		(752	)		14,228
Utilization/write offs/exchange rate differences		—			(94	)
Cumulative effect of ASC 326 adoption		401			—
Foreign exchange impact		(326	)		(148	)
Balance at end of period	$	17,058		$	17,940

For the three months ended March 31, 2022, three customers accounted for 15%, 14% and 13% of net revenue, respectively. For the three months ended March 31, 2021, two customers accounted for 18% and 10% of net revenue, respectively.

As of March 31, 2022, no customers represented more than 10% of net accounts receivable. As of December 31, 2021, two customers represented 26% and 10% of net accounts receivable, respectively.

As of March 31, 2022, and December 31, 2021, net accounts receivables from customers in countries other than the United States represented 76% and 79%, respectively.

In 2017, the Company entered into an agreement with a customer in India to supply product for a state sponsored broadband project. The Company substantially completed its obligations under the agreement in 2018. The Company billed the customer, which is a state government sponsored entity, approximately $59.0 million and collected payments of approximately $41.7 million by December 31, 2020. In late March 2021, the customer’s state government parent experienced difficulty passing a budget impacting the ability of the customer to make remaining agreed-upon payments to us. In light of this development, the Company recorded an allowance that covered the entire balance unpaid by the customer. Subsequent to March 2021, the Company recovered approximately $1.9 million of accounts receivable related to the customer. As of March 31, 2022 the Company has a recorded allowance for doubtful accounts of $14.8 million related to this receivable. The Company will

continue to pursue collection of the entire outstanding balance and any amounts collected will be recognized in the period which they are received. In the event the Company’s efforts to collect from this customer prove unsuccessful, DZS may seek payment through other means, including through legal action.

(h) Business Combinations

We account for business combinations using the acquisition method, which requires the identification of the acquirer, the determination of the acquisition date and the allocation of the purchase price paid by the acquirer to the identifiable tangible and intangible assets acquired, the liabilities assumed, including any contingent consideration and any noncontrolling interest in the acquiree at their acquisition date fair values. Goodwill represents the excess of the purchase price over the fair value of net assets acquired, including the amount assigned to identifiable intangible assets. Identifiable intangible assets with finite lives are amortized over their expected useful lives. Acquisition-related costs are expensed in the periods in which the costs are incurred. The results of operations of acquired businesses are included in our consolidated financial statements from the acquisition date.

(i) Restructuring and Other Charges

Restructuring and other charges primarily consists of severance and other termination benefits and non-cash impairment charges related to right-of-use assets from operating leases related to the restructuring activities in Hanover, Germany and Ottawa, Canada. The Company recognizes contractual termination benefits when it is probable that employees will be entitled to benefits and the amount can be reasonably estimated. The Company recognizes one-time employee termination benefits when (i) management commits to a plan of termination, (ii) the plan identifies the number of employees to be terminated, their job classifications or functions and their locations, and the expected completion date, (iii) the plan establishes the terms of the benefit arrangement in sufficient detail to enable employees to determine the type and amount of benefits they will receive, and (iv) actions required to complete the plan indicate that it is unlikely that significant changes to the plan will be made or that the plan will be withdrawn. These charges are included in restructuring and other charges in the unaudited condensed consolidated statement of comprehensive income (loss).

(j) Recent Accounting Pronouncements

In June 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, which requires the Company to measure and recognize expected credit losses for financial assets held and not accounted for at fair value through net income. In November 2018, April 2019 and May 2019, the FASB issued ASU No. 2018-19, Codification Improvements to Topic 326, Financial Instruments - Credit Losses, ASU No. 2019-04, Codification Improvements to Topic 326, Financial Instruments - Credit Losses, and ASU No. 2019-05, Financial Instruments - Credit Losses (Topic 326): Targeted Transition Relief, which provided additional implementation guidance on the previously issued ASU. The Company adopted the updated guidance on January 1, 2022, utilizing the modified retrospective transition method and recorded a cumulative-effect adjustment of $0.4 million to accumulated deficit.

In March 2020, the FASB issued ASU No. 2020-04 (Topic 848), Reference Rate Reform - Facilitation of the Effects of Reference Rate Reform on Financial Reporting, which provides temporary optional expedients and exceptions to the existing guidance on contract modifications and hedge accounting to ease the financial reporting burdens related to the expected market transition from the London Interbank Offered Rate (LIBOR) and other interbank offered rates to alternative reference rates, such as the Secured Overnight Financing Rate. The standard was effective upon issuance and may generally be applied through December 31, 2022, to any new or amended contracts, hedging relationships, and other transactions that reference LIBOR. The ASU is not expected to have a material impact on our consolidated financial statements.