10-Q 1 dzsi-9302018x10q.htm FORM 10-Q THIRD QUARTER Document
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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, 2018
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 every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).     Yes   x    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer
¨
 
Accelerated filer
¨
Non-accelerated filer
¨ 
 
Smaller reporting company
x
 
 
 
Emerging growth company
¨


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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 5, 2018, there were 16,575,229 shares of the registrant’s common stock outstanding.
 
 
 
    


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TABLE OF CONTENTS
 

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PART I. FINANCIAL INFORMATION

Item 1.    Financial Statements

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DASAN ZHONE SOLUTIONS, INC. AND SUBSIDIARIES
Unaudited Condensed Consolidated Balance Sheets
(In thousands, except par value)
 
September 30,
2018
 
December 31,
2017
Assets
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
20,028

 
$
17,475

Restricted cash
7,825

 
12,425

Accounts receivable - trade, net
 
 
 
Third parties
58,880

 
48,257

Related parties
2,139

 
13,498

Other receivables


 
 
Suppliers and others
28,097

 
12,494

Related parties
91

 
164

Inventories
45,457

 
25,344

Prepaid expenses and other current assets
12,256

 
3,652

Total current assets
174,773

 
133,309

Property and equipment, net
5,374

 
5,873

Goodwill
3,977

 
3,977

Intangible assets, net
5,933

 
6,785

Non-current deferred taxes
2,895

 
2,954

Long-term restricted cash
847

 
1,512

Other assets
1,400

 
4,717

Total assets
$
195,199

 
$
159,127

Liabilities, Stockholders’ Equity and Non-controlling Interest
 
 

Current liabilities:
 
 
 
Accounts payable - trade
 
 
 
Third parties
$
52,943

 
$
31,441

Related parties
1,302

 
1,351

Short-term debts


 


Bank and trade facilities
34,171

 
19,790

Related party
3,148

 

Other payables
 
 
 
Third parties
1,769

 
2,032

Related parties
1,859

 
1,956

Contract liabilities - current
2,394

 
3,279

Accrued and other liabilities
10,315

 
11,174

Total current liabilities
107,901

 
71,023

Long-term debts
 
 
 
Bank and trade facilities

 
2,987

Related parties
5,000

 
6,800

Contract liabilities - non-current
1,851

 
1,883

Other long-term liabilities
2,677

 
2,667

Total liabilities
117,429

 
85,360

Commitments and contingencies (Note 11)

 

Stockholders’ equity and non-controlling interest:
 
 
 
Common stock, authorized 36,000 shares, 16,566 shares and 16,410 shares outstanding as of September 30, 2018 and December 31, 2017 at $0.001 par value
16

 
16

Additional paid-in capital
92,408

 
90,198

Accumulated other comprehensive income
5

 
1,871

Accumulated deficit
(15,190
)
 
(18,852
)
Total stockholders’ equity
77,239

 
73,233

Non-controlling interest
531

 
534

Total stockholders’ equity and non-controlling interest
77,770

 
73,767

Total liabilities, stockholders’ equity and non-controlling interest
$
195,199

 
$
159,127


See accompanying notes to unaudited condensed consolidated financial statements.
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DASAN ZHONE SOLUTIONS, INC. AND SUBSIDIARIES
Unaudited Condensed Consolidated Statements of Comprehensive Income (Loss)
(In thousands, except per share data)
 
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2018
 
2017
 
2018
 
2017
Net revenue:
 
 
 
Third parties
$
70,227

 
$
60,513

 
$
203,317

 
$
150,834

Related parties
1,687

 
5,925

 
4,358

 
27,657

Total net revenue
71,914

 
66,438

 
207,675

 
178,491

Cost of revenue:
 
 
 
 
 
 
 
Products and services - third parties
46,565

 
38,301

 
134,234

 
95,103

Products and services - related parties
1,765

 
5,569

 
4,651

 
22,851

Amortization of intangible assets
153

 
153

 
459

 
459

Total cost of revenue
48,483

 
44,023

 
139,344

 
118,413

Gross profit
23,431

 
22,415

 
68,331

 
60,078

Operating expenses:
 
 
 
 
 
 
 
Research and product development
8,655

 
8,939

 
26,346

 
27,462

Selling, marketing, general and administrative
11,106

 
11,661

 
35,212

 
33,096

Amortization of intangible assets
131

 
154

 
393

 
1,191

Total operating expenses
19,892

 
20,754

 
61,951

 
61,749

Operating income (loss)
3,539

 
1,661

 
6,380

 
(1,671
)
Interest income
42

 
36

 
203

 
82

Interest expense
(447
)
 
(263
)
 
(1,330
)
 
(793
)
Other income (expense), net
(572
)
 
60

 
(859
)
 
43

Income (loss) before income taxes
2,562

 
1,494

 
4,394

 
(2,339
)
Income tax expense
735

 
107

 
1,071

 
646

Net income (loss)
1,827

 
1,387

 
3,323

 
(2,985
)
Net income (loss) attributable to non-controlling interest
29

 
(12
)
 
2

 
172

Net income (loss) attributable to DASAN Zhone Solutions, Inc.
$
1,798

 
$
1,399

 
$
3,321

 
$
(3,157
)
 
 
 
 
 
 
 
 
Foreign currency translation adjustments
391

 
(284
)
 
(1,839
)
 
1,782

Comprehensive income (loss)
2,218

 
1,103

 
1,484

 
(1,203
)
Comprehensive income (loss) attributable to non-controlling interest
16

 
(14
)
 
(3
)
 
191

Comprehensive income (loss) attributable to DASAN Zhone Solutions, Inc.
$
2,202

 
$
1,117

 
$
1,487

 
$
(1,394
)
 
 
 
 
 
 
 
 
Net income (loss) per share attributable to DASAN Zhone Solutions, Inc.
 
 
 
 
 
 
 
     Basic
$
0.11

 
$
0.09

 
$
0.20

 
$
(0.19
)
     Diluted
$
0.11

 
$
0.09

 
$
0.20

 
$
(0.19
)
 
 
 
 
 
 
 
 
Weighted average shares outstanding used to compute basic net income (loss) per share
16,683

 
16,382

 
16,425

 
16,380

Weighted average shares outstanding used to compute diluted net income (loss) per share
16,891

 
16,382

 
16,640

 
16,380

See accompanying notes to unaudited condensed consolidated financial statements.

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DASAN ZHONE SOLUTIONS, INC. AND SUBSIDIARIES
Unaudited Condensed Consolidated Statements of Cash Flows
(In thousands)
 
Nine Months Ended
 
September 30,
 
2018
 
2017
Cash flows from operating activities:
 
 
 
Net income (loss)
$
3,323

 
$
(2,985
)
Adjustments to reconcile net income (loss) to net cash used in operating activities:

 

Depreciation and amortization
2,033

 
3,105

Stock-based compensation
1,357

 
670

Valuation allowance on inventories
753

 
1,003

Unrealized loss (gain) on foreign currency transactions
226

 
(185
)
Deferred taxes
(56
)
 

Changes in operating assets and liabilities:

 

Accounts receivable
(14,536
)
 
(2,948
)
Inventories
(21,967
)
 
(1,581
)
Prepaid expenses and other assets
(7,942
)
 
(101
)
Accounts payable
24,790

 
6,713

Accrued and other liabilities
(3,695
)
 
(4,314
)
Net cash used in operating activities
(15,714
)
 
(623
)
Cash flows from investing activities:

 

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
1

 
6

Purchase of property and equipment
(753
)
 
(840
)
Purchase of intangible asset

 
(72
)
Net cash (used in) provided by investing activities
(752
)
 
127

Cash flows from financing activities:

 

Proceeds from short-term borrowings from bank and trade facilities
61,419

 
13,778

Proceeds from short-term borrowings from related party
6,098

 

Repayments of borrowings from bank and trade facilities
(48,739
)
 
(15,627
)
Repayments of borrowings related party
(4,460
)
 

Proceeds from issuance of common stock
853

 
28

Net cash provided by (used in) financing activities
15,171

 
(1,821
)
Effect of exchange rate changes on cash and restricted cash
(1,417
)
 
977

Net decrease in cash and cash equivalents
(2,712
)
 
(1,340
)
Cash, cash equivalents and restricted cash at beginning of period
31,412

 
24,543

Cash, cash equivalents and restricted cash at end of period
$
28,700

 
$
23,203

Reconciliation of cash, cash equivalents and restricted cash to statement of financial position
 
 
 
      Cash and equivalents
$
20,028

 
$
10,145

      Restricted cash
7,825

 
13,058

      Long-term restricted cash
847

 

      Cash, cash equivalents and restricted cash in statement of financial position
$
28,700

 
$
23,203

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. (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, under the name Zhone Technologies, Inc. On September 9, 2016, the Company acquired Dasan Network Solutions, Inc., a California corporation ("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 57.3% 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.
The Company is headquartered in Oakland, California 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 various domestic and international locations.
(b)
Risks and Uncertainties
Liquidity
The accompanying 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.
The Company had net income of $3.3 million for the nine months ended September 30, 2018, and $1.2 million for the year ended December 31, 2017. As of September 30, 2018, the Company had an accumulated deficit of $15.2 million and working capital of $66.9 million. In addition, the Company had a net cash outflow from operations of $15.7 million for the nine months ended September 30, 2018. As of September 30, 2018, the Company had $20.0 million in cash and cash equivalents, which included $6.0 million in cash balances held by its international subsidiaries, and $42.3 million in aggregate principal debt of which $37.3 million was in current liabilities. Also, as of September 30, 2018, the Company had $6.4 million committed as cash collateral for letters of credit under its revolving credit facilities, and $12.9 million outstanding indebtedness under those facilities, leaving $21.3 million in aggregate financing availability under the facilities. Subsequent to the end of the quarter, the Company repaid $6.0 million in borrowings to Wells Fargo Bank ("WFB"), which constituted all of the outstanding balance under its Wells Fargo Bank Facility (the “WFB Facility”). On July 12, 2018, the Company amended the WFB Facility by entering into an Amended and Restated Credit and Security Agreement (the “A&R Domestic Credit Agreement”) and an Amended and Restated Credit and Security Agreement (the “A&R Ex-Im Credit Agreement”) with WFB which amended and replaced the Company’s existing senior secured revolving line of credit and letter of credit facilities with WFB and revised certain reporting and compliance provisions. The A&R Domestic Credit Agreement and the A&R Ex-Im Credit Agreement (together, the “Amended WFB Facility") is described more fully in Note 7 to the unaudited condensed consolidated financial statements. On October 22, 2018, the Company borrowed $3.0 million under the Amended WFB Facility. On October 31, 2018, the Company repaid the $3.0 million in full.
The Company’s current lack of liquidity could harm it by:
increasing its vulnerability to adverse economic conditions in its industry or the economy in general;
requiring substantial amounts of cash to be used for debt servicing, rather than other purposes, including operations;
limiting its ability to plan for, or react to, changes in its business and industry;
limiting its ability to complete the Keymile acquisition; and

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influencing investor and customer perceptions about its financial stability and limiting its ability to obtain financing or acquire customers.
These factors indicate that cash flows might not be sufficient for the Company to meet its obligations as they come due in the ordinary course of business for a period of 12 months from the date of this Quarterly Report on Form 10-Q.
The Company’s ability to meet its obligations as they become due in the ordinary course of business for the next 12 months will depend on its ability (i) to achieve forecasted results, (ii) access funds approved under existing or new credit facilities and/or raise additional capital through sales of the Company’s common stock to the public and (iii) effectively manage inventory procurement. If the Company cannot raise additional funds when it needs or wants them, its operations and prospects could be negatively affected. Management’s belief that it will achieve forecasted results assumes that, among other things, the Company will continue to be successful in implementing its business strategy and that there will be no material adverse development in its business, liquidity or capital requirements. If one or more of these factors do not occur as expected, it could cause the Company to fail to meet its obligations as they come due.
The Company plans to focus on capital raising, cost management, operating efficiency and restrictions on discretionary spending. In addition, if necessary, the Company may sell assets, issue or enter into amendments of its debt or equity securities, or purchase credit insurance. The Company may also 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 current business conditions, the Company believes that these measures 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 from the date of this Quarterly Report on Form 10-Q.
Other Uncertainties
DNI owned approximately 57.3% of the outstanding shares of the Company's common stock as of September 30, 2018. 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 provisions of the Company's bylaws and applicable requirements under Nasdaq listing rules and applicable laws. 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 the Company's indebtedness do not view as beneficial. See Notes 9 and 11 to the unaudited condensed consolidated financial statements for additional information.
(c)
Reclassifications
For the three months ended September 30, 2017, certain statement of comprehensive income (loss) items have been reclassified to correctly reflect research and product development expenses and selling, marketing, general and administrative expenses of $0.1 million and $0.2 million, respectively, which were previously incorrectly classified as cost of revenue-products and services. For the nine months ended September 30, 2017 certain prior period statement of comprehensive loss items have been reclassified to correctly reflect research and product development expenses and selling, marketing, general and administrative expenses of $0.4 million and $0.6 million, respectively, which were incorrectly classified as cost of revenue-products and services.
(d)
Basis of Presentation
For a description of what the Company believes to be the critical accounting policies and estimates used in the preparation of the Company's unaudited condensed consolidated financial statements, refer to the Company's Annual Report on Form 10-K for the year ended December 31, 2017.
The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with U.S. GAAP for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, the Company does not include all of the information and footnotes required by U.S. GAAP for complete financial statements.

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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 statement 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 the current year or any other period. 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, 2017 filed with the Securities and Exchange Commission ("SEC").
(e)
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.
(f)
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 and nine months ended September 30, 2018, one customer each accounted for 11% of net revenue, respectively. For the three months ended September 30, 2017, two customers represented 10% and 9% (a related party) 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).
As of September 30, 2018, one customer represented 12% of net accounts receivable. As of December 31, 2017, two customers represented 20% (a related party) and 11% of net accounts receivable, respectively.
As of September 30, 2018 and December 31, 2017, receivables from customers in countries other than the United States represented 89% and 84%, of net accounts receivable, respectively.
(g)
Recent Accounting Pronouncements
Recent Accounting Pronouncements Adopted
In May 2014, the FASB issued ASU No. 2014-09 “Revenue from Contracts with Customers” (“Topic 606”), which provides a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers. Topic 606 replaced most existing revenue recognition standards under U.S. GAAP, including ASC 605, Revenue Recognition ("Topic 605").
On January 1, 2018, the Company adopted Topic 606 and applied this guidance to all open contracts at the date of adoption using the modified retrospective method. The Company recognized the cumulative effect of initially applying Topic 606 as an adjustment to the balance of accumulated deficit at January 1, 2018. The comparative information has not been restated and continues to be reported under Topic 605.
The Company’s adoption of Topic 606 primarily impacted the following:
Topic 606 requires an allocation of revenue to performance obligations identified within an arrangement. Topic 605 restricted the allocation of revenue that is contingent on future deliverables to current deliverables, however, Topic 606 removes this restriction, to the extent that the future deliverables represent performance obligations that are distinct. Under Topic 606, the nature of the performance obligations identified within a contract impacts the allocation of the transaction price between deliverables.
Some of the Company’s contracts include customer acceptance terms, which provide protection to the customer by allowing it to either cancel a contract or force the Company to take corrective actions if products or services do not meet the requirements in the contract. Under Topic 606, customer acceptance that is considered a “formality”, would result in revenue recognized when control of the product or service

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is transferred to customer, which is typically upon shipment or delivery dependent upon the terms of the underlying contract.
The following table summarizes the effects of Topic 606 on the Company’s unaudited condensed consolidated balance sheet at January 1, 2018 (in thousands):
 
As of January 1, 2018
 
 Balance after adoption of ASC 606
 
 Adjustments
 
 Balance without adoption of ASC 606
 Assets
 
 
 
 
 
 Accounts receivable, net
$
62,099

 
$
344

(1) 
$
61,755

 Inventories
25,239

 
(105
)
(2) 
25,344

 Liabilities
 
 
 
 


 Contract liabilities - current
3,038

 
(241
)
(2) 
3,279

 Accrued and other liabilities
11,518

 
344

(1) 
11,174

 Contract liabilities - non-current
1,711

 
(172
)
(2) 
1,883

 Stockholders’ equity
 
 
 
 
 
 Accumulated deficit
(18,544
)
 
308

 
(18,852
)

(1) Allowance for sales returns was historically presented as a contra-asset within accounts receivable on the Company's consolidated balance sheets. Upon the adoption of Topic 606, the Company presents the allowance for sales returns in Accrued and other liabilities (current).
(2) Represents the impact of allocation of transaction price to separate performance obligations in open contracts as of the adoption date on a relative standalone selling price basis and acceleration of revenue (and related costs) for contracts for which acceptance clauses are a formality.
The following table summarizes the effects of Topic 606 on the Company’s unaudited condensed consolidated balance sheet as of September 30, 2018 (in thousands): 
 
As of September 30, 2018
 
 As reported
 
 Adjustments
 
 
 Balance without adoption of ASC 606
 Assets
 
 
 
 
 
 
 Accounts receivable, net
$
61,019

 
$
(5,356
)
(1) 
(3) 
$
66,375

 Inventories
45,457

 
62

(2) 
 
45,395

 Prepaid expenses and other current assets
12,256

 
5,984

(3) 
 
6,272

 Liabilities
 
 
 
 
 
 
 Contract liabilities - current
2,394

 
(75
)
(2) 
 
2,469

 Accrued and other liabilities
10,315

 
628

(1) 
 
9,687

 Contract liabilities - non-current
1,851

 
36

(2) 
 
1,815

 Stockholders’ equity
 
 
 
 
 
 
 Accumulated deficit
(15,190
)
 
101

 
 
(15,291
)
 
(1) Allowance for sales returns was historically presented as a contra-asset within accounts receivable on the Company's consolidated balance sheets. Upon the adoption of Topic 606, the Company presents the allowance for sales returns in Accrued and other liabilities (current).
(2) Represents the impact of allocation of transaction price to separate performance obligations in open contracts as of September 30, 2018 on a relative standalone selling price basis and acceleration of revenue (and related costs) for contracts for which acceptance clauses are a formality.
(3) Represents conditional rights to consideration as of September 30, 2018.


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The following table summarizes the effects of Topic 606 on the Company’s unaudited condensed consolidated statement of operations for the three and nine months ended September 30, 2018 (in thousands):
 
Three Months Ended September 30, 2018
 
As reported
 
Adjustments
 
Balance without adoption of ASC 606
Net revenue
$
71,914

 
$
386

 
$
71,528

Cost of revenue - products and services
48,483

 
5

 
48,478

Gross profit
23,431

 
381

 
23,050

Income tax expense
(735
)
 

 
(735
)
Net income
1,827

 
381

 
1,446

 
Nine Months Ended September 30, 2018
 
As reported
 
Adjustments
 
Balance without adoption of ASC 606
Net revenue
$
207,675

 
$
39

 
$
207,636

Cost of revenue - products and services
139,344

 
(62
)
 
139,406

Gross profit
68,331

 
101

 
68,230

Income tax expense
(1,071
)
 

 
(1,071
)
Net income
3,323

 
101

 
3,222

There was no impact on net revenue from related parties as a result of Topic 606.
Revenue Recognition Accounting Policy
Revenue Recognition
Revenue from contracts with customers is recognized when control of the promised goods or services is transferred to the customers, in an amount that reflects the consideration the Company expects to be entitled to in exchange for those goods or services.
The Company generates revenue primarily from sales of products and services, including, extended warranty service and customer support. Revenue from product sales is recognized at a point in time when control of the goods is transferred to the customer, generally occurring upon shipment or delivery dependent upon the terms of the underlying contract. Revenue from services is generally recognized over time on a ratable basis over the contract term, using an output measure of progress, as the contracts usually provide the customer equal benefit throughout the contract period. The Company typically invoices customers for support contracts in advance, for periods ranging from one to five years.
Revenue from all sales types is recognized at the transaction price, which is the amount the Company expects to be entitled to in exchange for transferring goods and/or providing services. Transaction price is calculated as selling price net of variable consideration. Sales to certain distributors are made under arrangements which provide the distributors with volume discounts, price adjustments, and other allowances under certain circumstances. These adjustments and allowances are accounted for as variable consideration. To estimate variable consideration, the Company analyzes historical data, channel inventory levels, current economic trends and changes in customer demand for the Company's products, among other factors. Historically, variable consideration has not been a significant component of the Company’s contracts with customers. As of September 30, 2018, the total estimate of variable consideration was not significant.
Contracts with Multiple Performance Obligations
Some of the Company's contracts with customers contain multiple promised goods or services. For these contracts, the Company accounts for the promises separately as individual performance obligations if they are distinct. In determining whether performance obligations meet the criteria for being distinct, the Company considers a number of factors, including the degree of interrelation and interdependence between obligations and whether or not the good or service significantly modifies or transforms another good or service in the contract. After identifying the separate performance obligations, the transaction price is allocated to the separate performance obligations on a relative standalone selling price basis. Standalone selling prices for

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products are determined using either an adjusted market assessment or expected cost-plus margin. For customer support and extended warranty services, standalone selling price is primarily based on the prices charged to customers. Remaining performance obligations represent the transaction price allocated to performance obligations that are unsatisfied or partially unsatisfied as of the end of the reporting period. Unsatisfied and partially unsatisfied performance obligations primarily consist of backlog, which are products and services for which customer purchase orders have been accepted and that are in the process of being delivered.
Contract Balances
Topic 606 distinguishes between contract assets and accounts receivable based on whether receipt of the consideration is conditional on something other than the passage of time. The Company records contract assets when it has a right to consideration and records accounts receivable when it has an “unconditional” right to consideration. Contract liabilities consist of cash payments received (or unconditional rights to receive cash) in advance of fulfilling performance obligations.
The following table reflects the changes in contract balances for the nine months ended September 30, 2018 (in thousands):
Item
 
Balance Sheet Location
 
September 30,
2018
 
January 1,
2018
 
$ change
 
% change
Contract assets
 
Prepaid expenses and other current assets
 
$
5,984

 
$

 
$
5,984

 

Contract liabilities - current
 
Contract liabilities - current
 
2,394

 
3,038

 
(644
)
 
(21
)%
Contract liabilities - non-current
 
Contract liabilities - non-current
 
1,851

 
1,711

 
140

 
8
 %
During the nine months ended September 30, 2018, contract liabilities - non-current increased and contract liabilities - current decreased primarily as a result of changes in open contracts containing multiple performance obligations. As of September 30, 2018, contract assets increased as a result of the timing of certain events for the right to consideration to become unconditional. There were no significant changes in estimates during the nine months ended September 30, 2018 that would affect the contract assets and liabilities balances.
During the three and nine months ended September 30, 2018, $0.4 million and $2.7 million, respectively, was recognized as revenue from the opening contract liabilities balance.
Warranties
Products sold to customers include standard warranties, covering bug fixes, minor updates such that the product continues to function according to published technical specifications. These standard warranties are assurance type warranties and do not offer any services in addition to the assurance that the product will continue working as specified. Therefore, standard warranties are not considered separate performance obligations in the arrangement. Instead, the expected cost of warranty is accrued as expense in accordance with applicable guidance. Extended warranties are sold with certain products and include additional support services. The transaction price for extended warranties is accounted for as service revenue and recognized ratably over the life of the contract.
Contract Costs
Applying a practical expedient, the Company recognizes the incremental costs of obtaining contracts, which primarily consist of sales commissions, as an expense when incurred if the amortization period of the assets that otherwise would have been recognized is one year or less. These costs are included in sales and marketing expenses. If the incremental direct costs of obtaining a contract relate to a service recognized over a period longer than one year, such costs are capitalized and amortized in line with the related services over the period of benefit. As of September 30, 2018, such capitalizable costs were not significant.

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Financing
The Company's contracts do not include a significant financing component. The Company applies the practical expedient not to adjust the promised amount of consideration for the effects of a financing component if the Company expects, at contract inception, that the period between when the Company transfers a good or service to the customer and when the customer pays for the good or service will be one year or less.
Shipping and Handling
The Company has elected to account for shipping and handling activities that occur after the customer has obtained control of a good as a fulfillment cost rather than as an additional promised service. As a result, the Company accrues the costs of shipping and handling when the related revenue is recognized.
Unsatisfied performance obligations
The Company does not disclose the value of unsatisfied performance obligations for (i) contracts with an original expected length of one year or less and (ii) contracts for which the Company recognizes revenue at the amount to which the Company has the right to invoice for the services performed. The majority of the Company's performance obligations in its contracts with customers relate to contracts with duration of less than one year and therefore transaction price allocated to unsatisfied performance obligations included in contracts with duration of more than 12 months was not material.
Disaggregation of Revenue
The disaggregation of revenue by geographical regions for the three and nine months ended September 30, 2018 is disclosed in Note 12.

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 became effective for the Company on January 1, 2018 and was adopted accordingly. The adoption of this standard did not have any effect on the Company's condensed consolidated statement of cash flows for the three and nine months ended September 30, 2018 or 2017.
In November 2016, FASB issued ASU 2016-18, Statement of Cash Flows, Restricted Cash, which requires 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 became effective for the Company beginning on January 1, 2018 and was adopted accordingly, using the retrospective approach. As a result, the Company no longer presents transfers between cash and cash equivalents and restricted cash in the consolidated cash flow statements. The condensed consolidated statement of cash flows for the nine months ended September 30, 2017 was revised to exclude the $6.1 million change in restricted cash from net cash used in investing activities and to include $6.7 million in cash, cash equivalents and restricted cash, beginning of period and $13.1 million in cash, cash equivalents and restricted cash, end of period.  
Other Recent Accounting Pronouncements
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. In July 2018, the FASB issued ASU 2018-18-11, Leases (Topic 842): Targeted Improvements, ASU 2018-11 states that, separating components of a contract affect the amendments in Update 2016-02, which are not yet effective but can be early adopted. All entities, including early adopters that elect the practical expedient related to separating components of a contract in this Update 2016-02 must apply the expedient, by class of underlying asset, to all existing lease transactions that qualify for the expedient at the date elected. The Company is currently assessing the potential impact of adopting this new guidance on its consolidated financial 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 consolidated financial statements.

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In February 2018, the FASB issued ASU 2018-02, Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income. The amendments in this update allow a reclassification from accumulated other comprehensive income to retained earnings for stranded tax effects resulting from the Tax Cuts and Jobs Act (the "Tax Act"). Consequently, the amendments eliminate the stranded tax effects resulting from the Tax Act. Because the amendments only relate to the reclassification of the income rate tax effect of the Tax Act, the underlying guidance that requires that the effect of a change in tax laws or rates be included in income from continuing operations is not affected. The amendments in this update are effective for all entities for fiscal years beginning after December 15, 2018 and interim periods in those years. The Company does not expect the impact of the new standard to have a material impact on its consolidated financial statements.
In March 2018, the FASB issued ASU No. 2018-05, Income Taxes (Topic 740), Amendments to SEC Paragraphs Pursuant to SEC Staff Accounting Bulletin No. 118. The amendments add various Securities and Exchange Commission (“SEC) paragraphs pursuant to the issuance of SEC Accounting Bulletin No. 118, Income Tax Accounting Implications of the Tax Cuts and Jobs Act (“Act”) (“SAB 118”). The SEC issued SAB 118 to address concerns about reporting entities’ ability to timely comply with the accounting requirements to recognize all of the effects of the Act in the period of enactment. SAB 118 allows disclosure that timely determination of some or all of the income tax effects from the Act are incomplete by the due date of the financial statements and if possible to provide a reasonable estimate. The Company has provided a reasonable estimate of the tax reform in the notes to the consolidated financial statements.
On July 30, 2018, the FASB issued ASU No. 2018-11, Leases (Topic 842), to provide entities with relief from the costs of implementing certain aspects of the new leasing standard, ASU 2016-0210 (codified as ASC 842). Specifically, under the amendments in ASU 2018-11, entities may elect not to recast the comparative periods presented when transitioning to ASC 842, and lessors may elect not to separate lease and nonlease components when certain conditions are met. The Company is currently assessing the potential impact of adopting this new guidance on its consolidated financial statements.
On August 28, 2018, the FASB issued ASU No. 2018-13, Fair Value Measurement (Topic 820), which removes, modifies, and adds certain disclosure requirements related to fair value measurements in ASC 820. The Company is currently assessing the potential impact of adopting this new guidance on its consolidated financial statements.
(2)
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, 2018 and the consolidated balance sheet as of December 31, 2017, but require disclosure of their fair values: cash and cash equivalents, accounts receivable, accounts payable and debt. The carrying values of financial instruments such as cash and cash equivalents, 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.
To manage certain exposures to currency fluctuations, the Company started a limited hedging program by entering into foreign currency forward contracts with maturities of one month to hedge a portion of its net outstanding foreign currency monetary assets and liabilities. These derivatives are recorded at fair value on the condensed consolidated balance sheet under "Other Current Assets" or "Accounts Payable - Trade" with changes in the fair value being recorded in "Other income (loss), net".

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These derivative contracts are entered into with a single counterparty, and are not designated as hedging instruments under applicable accounting guidance. As such, all changes in the fair value of these derivative contracts are recorded in other income (loss), net on the condensed consolidated statements of comprehensive income (loss). These derivative contracts are intended to offset the foreign currency gains or losses associated with the underlying monetary assets and liabilities, and changes in the related derivative assets and liabilities balances are classified outside of operating income (loss), consistent with the related underlying foreign currency gain or loss. 
These derivative contracts expose the Company to credit risk to the extent that the counterparty may be unable to meet the terms of the arrangement. The Company mitigates this credit risk by transacting with reputable financial institutions and entering into master netting arrangements, which permit net settlement of transactions with the same counterparty. While the contract or notional amount is often used to express the volume of foreign currency derivative contracts, the amounts potentially subject to credit risk are generally limited to the amounts, if any, by which the counterparties’ obligations under the agreements exceed the obligations of the Company to the counterparties. The Company is not required to pledge, and is not entitled to receive, cash collateral related to these derivative instruments. The Company does not enter into derivative contracts for trading or speculative purposes. The Company's foreign currency contracts are classified within Level 2 because the valuation inputs are based on quoted prices and market observable data of similar instruments in active markets, such as currency spot and forward rates.
As of September 30, 2018, the Company had no derivative contracts, and no liability was included in accounts payable - trade.
(3)
Cash, Cash Equivalents and Restricted Cash
As of September 30, 2018 and December 31, 2017, the Company's cash and cash equivalents comprised financial deposits. Restricted cash consisted primarily of cash restricted for performance bonds, warranty bonds and collateral for borrowings. Current and long-term restricted cash was $8.7 million at September 30, 2018 and $13.9 million at December 31, 2017.
Reconciliation of cash, cash equivalents and restricted cash to statement of financial position as of September 30, 2018 and December 31, 2017 were as follows (in thousands):
 
September 30,
2018
 
December 31,
2017
Cash and cash equivalents
$
20,028

 
$
17,475

Restricted cash
7,825

 
12,425

Long-term restricted cash
847

 
1,512

Cash, cash equivalents and restricted cash
$
28,700

 
$
31,412


(4)
Balance Sheet Detail
Accounts Receivable - Trade
Accounts receivable - trade, net as of September 30, 2018 and December 31, 2017 was as follows (in thousands):
 
September 30,
2018
 
December 31,
2017
Gross accounts receivable
$
61,324

 
$
63,446

Allowance for doubtful accounts
(305
)
 
(922
)
Allowance for sales returns

(1) 
(769
)
Total allowances
(305
)
 
(1,691
)
Accounts receivable - trade, net
$
61,019

 
$
61,755

(1) Upon adoption of ASC 606, allowances for sales returns were reclassified to accrued and other liabilities as these reserve balances are considered estimated refund liabilities. Refer to footnote 1(g) for additional information about the adoption impact.

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Inventories
Inventories as of September 30, 2018 and December 31, 2017 were as follows (in thousands): 
 
September 30,
2018
 
December 31,
2017
Raw materials
$
19,227

 
$
12,671

Work in process
3,474

 
2,150

Finished goods
22,756

 
10,523

Total inventories
$
45,457

 
$
25,344

Inventories provided as collateral for borrowings from Export-Import Bank of Korea amounted to $9.5 million and $11.4 million as of September 30, 2018 and December 31, 2017, respectively.
(5)
Property and Equipment
Property and equipment as of September 30, 2018 and December 31, 2017 were as follows (in thousands): 
 
September 30,
2018
 
December 31,
2017
Furniture and fixtures
$
22,495

 
$
22,988

Machinery and equipment
5,577

 
5,455

Leasehold improvements
3,619

 
3,647

Computers and software
728

 
621

Others
1,034

 
1,007

 
33,453

 
33,718

Less: accumulated depreciation and amortization
(27,872
)
 
(27,584
)
Less: government grants
(207
)
 
(261
)
Property and equipment, net
$
5,374

 
$
5,873

Depreciation expense associated with property and equipment for the three and nine months ended September 30, 2018 was $0.4 million and $1.2 million respectively. Depreciation expense for the three and nine months ended September 30, 2017 was $0.5 million and $1.4 million, respectively.
The Company receives grants from various government entities, 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, 2018 and December 31, 2017 was as follows (in thousands):
 
September 30,
2018
 
December 31,
2017
Beginning balance
$
3,977

 
$
3,977

Less: accumulated impairment

 

Ending balance
$
3,977

 
$
3,977

The Company did not recognize impairment loss on goodwill during the nine months ended September 30, 2018 and 2017.

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Intangible assets as of September 30, 2018 and December 31, 2017 were as follows (in thousands):
 
September 30, 2018
 
Gross Carrying Amount
 
Accumulated Amortization
 
Net
Developed technology
$
3,060

 
$
(1,276
)
 
$
1,784

Customer relationships
5,240

 
(1,091
)
 
4,149

Backlog
2,179

 
(2,179
)
 

Total intangible assets
$
10,479

 
$
(4,546
)
 
$
5,933

 
December 31, 2017
 
Gross Carrying Amount
 
Accumulated Amortization
 
Net
Developed technology
$
3,060

 
$
(816
)
 
$
2,244

Customer relationships
5,240

 
(699
)
 
4,541

Backlog
2,179

 
(2,179
)
 

Total intangible assets
$
10,479

 
$
(3,694
)
 
$
6,785

Amortization expense associated with intangible assets for the three and nine months ended September 30, 2018 was $0.3 million and $0.9 million, respectively. 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.
(7)
Debts
Wells Fargo Bank Facility
On July 12, 2018, the Company entered into the A&R Domestic Credit Agreement and the A&R Ex-Im Credit Agreement with WFB, which amended and replaced the Company’s existing senior secured revolving line of credit and letter of credit facilities with WFB and revised certain reporting and compliance provisions. The Amended WFB Facility provides for a revolving line of credit of $25.0 million (including up to $5.0 million of letters of credit), with the amount that the Company is able to borrow based on eligible accounts receivable and inventory, less the amount committed as cash collateral for letters of credit. The amounts borrowed under the Amended WFB Facility bears 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). To maintain availability of funds under the Amended 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. The maturity date of the Amended WFB Facility is July 12, 2021.
As of September 30, 2018, the Company had $6.0 million in outstanding borrowings under its Amended WFB Facility (included in short-term debts), and $2.1 million was committed as cash collateral for letters of credit. Subsequent to the end of the quarter, the Company repaid $6.0 million in borrowings under the WFB Facility.
Based on the Company's eligible accounts receivable and inventory, the Company had $6.5 million of financing availability under the Amended WFB Facility as of September 30, 2018. The interest rate on the Amended WFB Facility was 4.4% at September 30, 2018.
The Company’s obligations under the Amended WFB Facility are secured by substantially all of its assets and those of its subsidiaries that guarantee the Amended WFB Facility, including their intellectual property. The Amended WFB Facility contains certain financial covenants, and customary affirmative and negative covenants. If the Company defaults under the Amended WFB Facility due to a covenant breach or otherwise, WFB may, after the lapse of any applicable grace periods, 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 Amended WFB Facility. As of September 30, 2018, the Company was in compliance with the covenants under the WFB Facility. On October 22, 2018, the Company borrowed $3.0 million under the Amended WFB Facility. On October 31, 2018, the Company repaid the $3.0 million in full.

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Table of Contents


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 as they mature and are generally secured by a security interest in certain assets of the applicable foreign subsidiaries and supported by guarantees given by DNI or third parties. Payments under such facilities are made in accordance with the given lender’s amortization schedules.
As of September 30, 2018 and December 31, 2017, the Company had an aggregate outstanding balance of $28.2 million (included in short-term debts) and $22.8 million ($19.8 million included in short-term debts), 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 (amount in thousands).
 
 
 
 
As of September 30, 2018
 
 
 
 
Maturity Date
Denomination
Interest rate (%)
 
Amount
Industrial Bank of Korea
 
Credit facility
 
10/2/2018 - 2/4/2019
USD
3.81~4.03
 
$
4,229

Industrial Bank of Korea
 
Credit facility
 
10/10/2018 - 11/12/2018
USD
3.81~3.84
 
1,834

Industrial Bank of Korea
 
Trade finance
 
10/15/2018
USD
6.82
 
651

Shinhan Bank
 
General loan
 
3/30/2019
KRW
6.06
 
2,876

NongHyup Bank
 
Credit facility
 
11/19/2018 - 3/4/2019
USD
3.95~4.17
 
852

The Export-Import Bank of Korea
 
Export development loan
 
12/29/2018
KRW
3.28
 
6,471

The Export-Import Bank of Korea
 
Import development loan
 
11/14/2018
USD
4.02
 
850

Korea Development Bank
 
General loan
 
8/8/2019
KRW
3.48
 
4,494

LGUPlus
 
General loan
 
6/17/2019
KRW
0
 
1,797

JECC Factoring
 
AR Factoring
 
10/26/2018 - 12/25/2018
JPY
1.58
 
3,236

Shoko Chukin Bank
 
General loan
 
6/28/2019
JPY
1.33
 
881

 
 
 
 
 
 
 
 
$
28,171

 
 
 
 
As of December 31, 2017
 
 
 
 
Maturity Date
Denomination
Interest rate (%)
 
Amount
Industrial Bank of Korea
 
Credit facility
 
1/2/2018 - 5/2/2018
USD
2.89 - 3.26
 
$
2,328

Industrial Bank of Korea
 
Trade Finance
 
1/2/2018 - 5/23/2018
USD
4.47 - 5.97
 
2,401

Shinhan Bank
 
General loan
 
3/30/2019
KRW
5.91
 
2,987

Shinhan Bank
 
Trade finance
 
2/19/2018- 3/26/2018
KRW
3.90 - 4.14
 
3,050

NongHyup Bank (Korea)
 
Credit facility
 
1/8/2018- 6/18/2018
USD
2.83 - 3.42
 
860

The Export-Import Bank of Korea
 
Export development loan
 
2/13/2018 & 6/29/2018
KRW
3.20 - 3.28
 
7,570

Mitsubishi Bank (Japan)
 
AR factoring
 
1/31/2018 - 5/31/2018
JPY
1.58
 
1,872

Shinhan Bank (India)
 
General loan
 
4/24/2018 - 11/12/2018
INR
8.70 - 8.90
 
1,709

 
 
 
 
 
 
 
 
$
22,777


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As of September 30, 2018, the Company had $6.9 million in outstanding borrowings and $4.3 million committed as cash collateral for letters of credit under the Company's $25.9 million credit facility with certain foreign banks. On June 18, 2018, the Company's Korean subsidiary received a mutual cooperation capital loan of $1.8 million from LGUPlus and provided a letter of guarantee of the same amount from Seoul Guarantee Insurance as collateral.
See Note 9 for a discussion of related-party debt.
(8)
Non-Controlling Interests
Non-controlling interests for the nine months ended September 30, 2018 and 2017 were as follows (in thousands):
 
 
Nine Months Ended September 30,
 
 
2018
 
2017
Beginning non-controlling interests
 
$
534

 
$
416

Net income (loss) attributable to non-controlling interests
 
2

 
172

Foreign currency translation adjustments
 
(5
)
 
19

 Ending non-controlling interests
 
$
531

 
$
607

(9)
Related-Party Transactions
Related-Party Acquisitions
On December 31, 2017, DNS acquired 100% and 99.99% of the common stock of D-Mobile Limited (“D-Mobile”) and DASAN India Private Limited ("DASAN India"), respectively, from DNI. D-Mobile and DASAN India are resellers of the Company's products in Taiwan and India, respectively. The consideration payable by the Company to DNI for the common stock of the two subsidiaries is the net book value of D-Mobile and DASAN India at December 31, 2017, subject to final adjustments. The net book value of D-Mobile and DASAN India was an aggregate of $0.8 million. These transactions were accounted for by the Company as common control transactions, with the net assets transferred recorded at historical cost. The transactions did not result in a change in reporting entity and hence were accounted for prospectively.
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, 2018, $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, 2018 under this facility was 4.6% per annum.
In February 2016, the Company borrowed $1.8 million from DNI for capital investment, which was outstanding as of September 30, 2018. This loan matures in July 2019 and bears interest at a rate of 4.6% per annum, payable annually.
On March 21, 2018, DNS borrowed $5.8 million from DNI, of which $4.5 million was repaid on August 8, 2018. As of September 30, 2018, $1.3 million remained outstanding. The loan bears interest at a rate of 4.6% and matures on June 27, 2019, and is secured by certain accounts receivable of DNS Korea.
Other Related-Party Transactions
Sales and purchases, cost of revenue, research and product development, selling, marketing, general and administrative, interest expense and other expenses to and from related parties for the three and nine months ended September 30, 2018 and 2017 were as follows (in thousands):

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Table of Contents


 
 
 
 
Three Months Ended September 30, 2018
Counterparty
 
DNI ownership Interest
 
Sales
 
Cost of revenue
 
Research and product development
 
Selling, marketing,
general and administrative
 
Interest expense
 
Other expenses
DNI (Parent Company)
 
N/A
 
$
1,472

 
$
1,270

 
$

 
$
784

 
$
112

 
$
89

Tomato Soft Ltd.
 
100%
 

 
27

 

 

 

 

Tomato Soft (Xi'an) Ltd.
 
100%
 

 

 
119

 

 

 

Chasan Networks Co., Ltd.
 
100%
 

 
260

 
21

 

 

 

Handysoft, Inc.
 
17.63%
 
215

 
208

 

 
2

 

 

 
 
 
 
$
1,687

 
$
1,765

 
$
140

 
$
786

 
$
112

 
$
89

 
 
 
 
Three Months Ended September 30, 2017
Counterparty
 
DNI ownership Interest
 
Sales
 
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

 
$
5,569

 
$
272

 
$
1,532

 
$
55

    
 
 
 
 
Nine Months Ended September 30, 2018
Counterparty
 
DNI ownership Interest
 
Sales
 
Cost of revenue
 
Research and product development
 
Selling, marketing,
general and administrative
 
Interest expense
 
Other expenses
DNI (Parent Company)
 
N/A
 
$
3,683

 
$
3,143

 
$

 
$
2,950

 
$
338

 
$
234

Tomato Soft Ltd.
 
100%
 

 
84

 

 

 

 

Tomato Soft (Xi'an) Ltd.
 
100%
 

 
10

 
396

 

 

 

Chasan Networks Co., Ltd.
 
100%
 

 
880

 
57

 

 

 

Dasan France
 
100%
 
202

 
177

 

 

 

 

HandySoft, Inc.
 
17.63%
 
473

 
357

 

 
4

 

 

 
 
 
 
$
4,358

 
$
4,651

 
$
453

 
$
2,954

 
$
338

 
$
234


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Table of Contents


 
 
 
 
Nine Months Ended September 30, 2017
Counterparty
 
DNI ownership Interest
 
Sales
 
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(1)
 
100%
 
6,287

 
4,783

 

 
30

 

D-Mobile(1)
 
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

 
$
22,851

 
$
635

 
$
4,401

 
$
178

(1) As discussed above, on December 31, 2017 DNS acquired DASAN India and D-Mobile from DNI.            
The Company has entered into sales agreements with DNI and certain of its subsidiaries. Sales and cost of revenue to DNI and DASAN France (and with respect to the first three quarters of 2017, DASAN India 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 an agreement with Chasan Networks Co., Ltd. to provide manufacturing and research and development services for the Company. Under the agreement with 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 Ltd., a wholly owned subsidiary of DNI, to provide manufacturing and research and development services for the Company.
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. Sales to DNI necessary for DNI to fulfill agreements with its customers are recorded net of royalty fees in related-party revenue.
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 office space and administrative services. Expenses related to leases and administrative services are allocated and billed to the Company based on square footage occupied and headcount, respectively.
Other expenses to related parties represent payment to DNI for its 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, 2018 and December 31, 2017 were as follows (in thousands):

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As of September 30, 2018
 
 
 
Counterparty
 
DNI ownership Interest
 
Account receivables
 
Other receivables
 
Deposits for lease *
 
Loans Payable
 
Accounts payable
 
Other Payables
Accrued and other liabilities**
DNI (parent company)
 
N/A
 
$
1,679

 
$
26

 
$
738

 
$
8,148

 
$
1,000

 
$
1,810

$
157

Tomato Soft Ltd.
 
100%
 

 

 

 

 

 
9


Tomato Soft (Xi'an) Ltd.
 
100%
 

 

 

 

 

 
40


Dasan France
 
100%
 
285

 
65

 

 

 

 


HandySoft, Inc.
 
17.63%
 
175

 

 

 

 
216

 


Chasan Networks Co., Ltd.
 
100%
 

 

 

 

 
86

 


 
 
 
 
$
2,139

 
$
91

 
$
738

 
$
8,148

 
$
1,302

 
$
1,859

$
157

 
 
 
 
As of December 31, 2017
 
 
 
 
Counterparty
 
DNI Ownership Interest
 
Account receivables
 
Other receivables
 
Deposits for lease *
 
Long-term debt
 
Accounts payable
 
Other Payables
 
Accrued and other liabilities**
DNI (parent company)
 
N/A
 
$
12,576

 
$
93

 
$
786

 
$
6,800

 
$
1,264

 
$
1,859

 
$
59

Tomato Soft Ltd.
 
100%
 

 

 

 

 

 
18

 

Tomato Soft (Xi'an) Ltd.
 
100%
 

 

 

 

 

 
54

 

Dasan France
 
100%
 
870

 
71

 

 

 

 

 

HandySoft, Inc.
 
17.63%
 
52

 

 

 

 

 

 

Chasan Networks Co., Ltd.
 
100%
 

 

 

 

 
87

 

 

Solueta
 
100%
 

 

 

 

 

 
25

 

 
 
 
 
$
13,498

 
$
164

 
$
786

 
$
6,800

 
$
1,351

 
$
1,956

 
$
59

* Included in other assets in the condensed consolidated balance sheets as of September 30, 2018 and December 31, 2017. 
**Included in accrued and other liabilities in the condensed consolidated balance sheet as of September 30, 2018 and December 31, 2017. 


23

Table of Contents


(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 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.

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,
 
 
2018
 
2017
 
2018
 
2017
Net income (loss) attributable to DASAN Zhone Solutions, Inc.
 
$
1,798

 
$
1,399

 
$
3,321

 
$
(3,157
)
Weighted average number of shares outstanding:
 
 
 
 
 
 
 
 
Basic
 
16,683

 
16,382

 
16,425

 
16,380

Effect of dilutive securities:
 
 
 
 
 
 
 
 
Stock options, restricted stock units and share awards
 
208

 

 
215

 

Diluted
 
16,891

 
16,382

 
16,640

 
16,380

Net income (loss) per share attributable to DASAN Zhone Solutions, Inc.:
 
 
 
 
 
 
 
 
Basic
 
$
0.11

 
$
0.09

 
$
0.20

 
$
(0.19
)
Diluted
 
$
0.11

 
$
0.09

 
$
0.20

 
$
(0.19
)
 

During the three and nine months ended September 30, 2018, the Company excluded 1.0 million, and 26 thousand stock options at a weighted average exercise price of $10.89, and $14.73, respectively, from diluted net income per share because their effect would have been antidilutive. 

Basic net income (loss) per share is the same as diluted net income (loss) per share for the nine months ended September 30, 2017 because the effects of stock options and restricted stock units would have been anti-dilutive.

(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:
 
2018 (remainder of the year)
$
1,053

2019
4,088

2020
2,998

2021
2,590

2022
2,664

Thereafter
8,423

Total minimum lease payments
$
21,816


24

Table of Contents


Warranties
The Company accrues warranty costs based on historical trends for the expected material and labor costs to provide warranty services. Warranty periods are generally one 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, 2018 and 2017 (in thousands):  
 
Nine Months Ended September 30,
 
2018
 
2017
Beginning balance
$
931

 
$
878

Charged to cost of revenue
1,022

 
126

Claims and settlements
(598
)
 
(195
)
Foreign exchange impact
6

 
14

Ending balance
$
1,361

 
$
823

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, 2018, and 2017, the Company had $2.9 million and $1.0 million of surety bonds guaranteed by third parties, respectively.
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 $2.4 million as of September 30, 2018.
Payment Guarantees provided by Third Parties and DNI
The following table sets forth payment guarantees of the Company's indebtedness and other obligations as of September 30, 2018 (in thousands) that have been provided by third parties and DNI. DNI owns approximately 57.3% of the outstanding shares of the Company's common stock:
Guarantor
 
Amount Guaranteed (in thousands)
 
Description of Obligations Guaranteed
DNI
 
$
3,451

 
Borrowings from Shinhan Bank
DNI
 
1,726

 
Purchasing Card from Shinhan Bank
DNI
 
10,730

 
LC from Industrial Bank of Korea
DNI
 
2,157

 
Purchasing Card from Industrial Bank of Korea
DNI
 
6,000

 
LC from NongHyup Bank
DNI
 
6,170

 
Borrowings from Export-Import Bank of Korea
DNI
 
6,000

 
LC from KookMin Bank
DNI
 
5,392

 
Borrowings from Korea Development Bank
DNI

8,400


LC from Korea Development Bank
Industrial Bank of Korea
 
6,486

 
Borrowings and letter of credit
NongHyup Bank
 
3,497

 
Borrowings and letter of credit
Kookmin Bank
 
304

 
Letter of credit
Korea Development Bank
 
894

 
Letter of credit
Shinhan Bank
 
933

 
Purchasing Card
Industrial Bank of Korea
 
4,075

 
Performance bonds
State Bank of India
 
34

 
Performance bonds
Seoul Guarantee Insurance Co.
 
4,232

 
Performance payment guarantee*
 
 
$
70,481

 
 
*The Company is responsible for the warranty liabilities generally for the period of two years on major product sales and has contracted surety insurance to cover part of the warranty liabilities. 

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Table of Contents


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.
(12)
Stock Option and Other Benefit Plans
2018 Employee Stock Purchase Plan 
On May 22, 2018, the stockholders of the Company approved the adoption of the DASAN Zhone Solutions, Inc. 2018 Employee Stock Purchase Plan (the “ESPP”). The ESPP became effective upon stockholder approval and replaced the Company’s existing DASAN Zhone Solutions, Inc. 2002 Employee Stock Purchase Plan.
The ESPP authorizes the issuance of up to 250,000 shares of the Company’s common stock. In addition, the ESPP provides for an annual increase on the first day of each calendar year beginning on January 1, 2019 and ending on and including January 1, 2028 equal to the lesser of (i) 1% of the shares outstanding on the last day of the immediately preceding calendar year and (ii) such smaller number of shares as may be determined by the Board in its sole discretion. Notwithstanding the foregoing, the number of shares of stock that may be issued or transferred pursuant to awards under the ESPP may not exceed an aggregate of 2,000,000 shares. These 2,000,000 shares have been registered pursuant to a registration statement on Form S-8 filed with the SEC on November 8, 2018.

26

Table of Contents



(13)
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 maker is the Company’s Chief Executive Officer, who reviews 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 bill to countries. The following summarizes required disclosures about geographical concentrations and revenue by products and services (in thousands):
 
Three Months Ended
 
Nine months ended
 
September 30,
 
September 30,
 
2018
 
2017
 
2018
 
2017
Revenue by geography:
 
 
 
 
 
 
 
United States
$
11,125

 
$
13,068

 
$
41,373

 
$
37,176

Canada
1,131

 
1,498

 
3,344

 
4,112

Total North America
12,256

 
14,566

 
44,717

 
41,288

Latin America
6,841

 
7,480

 
21,713

 
19,425

Europe, Middle East, Africa
10,425

 
7,378

 
27,264

 
19,134

Korea
19,609

 
20,520

 
50,844

 
69,032

Other Asia Pacific
22,783

 
16,494

 
63,137

 
29,612

Total International
59,658

 
51,872

 
162,958

 
137,203

Total
$
71,914

 
$
66,438

 
$
207,675

 
$
178,491

 
 
 
 
 

 

 
Three Months Ended
 
Nine months ended
 
September 30,
 
September 30,
 
2018
 
2017
 
2018
 
2017
Revenue by classification:
 
 
 
 
 
 
 
Products
$
68,787

 
$
63,257

 
$
198,830

 
$
169,831

Services
3,127

 
3,181

 
8,845

 
8,660

Total
$
71,914

 
$
66,438

 
$
207,675

 
$
178,491

    
The Company's property and equipment, net of accumulated depreciation, were located in the following geographical areas as of September 30, 2018 and December 31, 2017 (in thousands):
 
As of September 30,
2018
 
As of December 31,
2017
United States
$
3,131

 
$
3,393

Korea
1,441

 
1,633

Other Asia Pacific
802

 
847

 
$
5,374

 
$
5,873

(14)
Income Taxes
Income tax expense for the three and nine months ended September 30, 2018 was $0.7 million and $1.1 million, respectively, on pre-tax income of $2.6 million and $4.4 million, respectively. For the three and nine months ended September 30, 2017, income tax expense was $0.1 million and $0.6 million, respectively, on pre-tax income (loss) of $1.5 million and $(2.3) million, respectively.
As of