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~~June 30, ~~2017~~2018



¨	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to

000-32743

(Commission File Number)

DASAN ZHONE SOLUTIONS, INC.

(Exact name of registrant as specified in its charter)



Delaware		22-3509099
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification Number)

7195 Oakport Street Oakland, California		94621
(Address of principal executive offices)		(Zip code)

(510) 777-7000

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, 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 (Check one~~):Act.

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Large accelerated filer	¨	Accelerated filer	¨
Non-accelerated filer	¨ (Do not check if a smaller reporting company)	Smaller reporting company	x
		Emerging growth company	¨

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

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x

As of ~~November 8, 2017,~~August 6, 2018, there were ~~approximately 16,386,955~~16,497,948 shares of the registrant’s common stock outstanding.

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TABLE OF CONTENTS



		Page
PART I. FINANCIAL INFORMATION

Item 1.	Financial Statements	4
	Unaudited Condensed Consolidated Balance Sheets	5
	Unaudited Condensed Consolidated Statements of Comprehensive ~~Loss~~Income (Loss)	6
	Unaudited Condensed Consolidated Statements of Cash Flows	7
	Notes to Unaudited Condensed Consolidated Financial Statements	8
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	2425
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	3435
Item 4.	Controls and Procedures	3536

PART II. OTHER INFORMATION

Item 1.	Legal Proceedings	3738
Item 1A.	Risk Factors	3738
Item 2.6.	Exhibits	3739
	Signatures	3840

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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, 2017			December 31, 2016			June 30, 2018			December 31, 2017
Assets
Current assets:
Cash and cash equivalents	$	10,145		$	17,893		$	27,308		$	17,475
Restricted cash	13,058			6,650			10,426			12,425
Short-term investments	—			993
Accounts receivable, net of allowances for sales returns and doubtful accounts of $2,095 as of September 30, 2017 and $1,143 as of December 31, 2016:
Trade receivables	43,478			38,324
Accounts receivable, net
Trade							65,939			48,257
Related parties	12,941			13,311			1,224			13,498
Other receivables:
Other receivables
Others	13,851			12,068			25,192			12,494
Related parties	22			171			65			164
Inventories	31,966			31,032			38,187			25,344
Prepaid expenses and other current assets	3,198			4,131			4,137			3,652
Total current assets	128,659			124,573			172,478			133,309
Property and equipment, net	5,812			6,288			5,432			5,873
Goodwill	3,977			3,977			3,977			3,977
Intangible assets, net	7,174			8,767			6,217			6,785
Non-current deferred taxes							2,925			2,954
Long-term restricted cash							1,136			1,512
Other assets	1,536			1,842			4,751			4,717
Total assets	$	147,158		$	145,447		$	196,916		$	159,127
Liabilities, Stockholders’ Equity and Non-controlling Interest
Current liabilities:
Accounts payable:
Accounts payable
Trade							$	49,414		$	31,441
Related parties							1,385			1,351
Short-term debts
Bank and trade facilities							39,874			19,790
Related parties							5,795			—
Other payables
Others	$	35,224		$	30,681		1,426			2,032
Related parties	106			430			1,449			1,956
Short-term debt:
Others	18,382			17,599
Related parties	3,544			—
Other payables:
Others	1,691			2,040
Related parties	210			6,940
Deferred revenue	2,073			1,901
Contract liabilities - current							2,600			3,279
Accrued and other liabilities	10,108			8,163			9,431			11,174
Total current liabilities	71,338			67,754			111,374			71,023
Long-term debt - related parties	5,000			6,800
Deferred revenue	1,875			1,674
Long-term debts
Bank and trade facilities							—			2,987
Related parties							6,800			6,800
Contract liabilities - non-current							1,773			1,883
Other long-term liabilities	2,581			2,351			2,699			2,667
Total liabilities	80,794			78,579			122,646			85,360
Commitments and contingencies (Note 11)
Stockholders’ equity and non-controlling interest:
Common stock, authorized 36,000 shares, 16,387 shares and 16,375 shares outstanding as of September 30, 2017 and December 31, 2016 at $0.001 par value	16			16
Common stock, authorized 36,000 shares, 16,450 shares and 16,410 shares outstanding as of June 30, 2018 and December 31, 2017 at $0.001 par value							16			16
Additional paid-in capital	89,873			89,174			91,126			90,198
Other comprehensive income (loss)	(1,052		)	(2,815		)
Accumulated other comprehensive income (loss)							(399		)	1,871
Accumulated deficit	(23,080		)	(19,923		)	(16,988		)	(18,852		)
Total stockholders’ equity	65,757			66,452			73,755			73,233
Non-controlling interest	607			416			515			534
Total stockholders’ equity and non-controlling interest	66,364			66,868			74,270			73,767
Total liabilities, stockholders’ equity and non-controlling interest	$	147,158		$	145,447		$	196,916		$	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 ~~Loss~~Income (Loss)

(In thousands, except per share ~~data)~~data)


	Three Months Ended						Nine Months Ended						Three Months Ended						Six Months Ended
	September 30,						September 30,						June 30,						June 30,
	2017			2016			2017			2016			2018			2017			2018			2017
Net revenue:
Net revenue	$	60,513		$	24,772		$	150,834		$	68,424
Net revenue - related parties	5,925			6,468			27,657			22,408
Third parties													$	75,187		$	49,080		$	133,093		$	90,321
Related parties													1,070			10,861			2,668			21,732
Total net revenue	66,438			31,240			178,491			90,832			76,257			59,941			135,761			112,053
Cost of revenue:
Products and services	38,643			16,483			96,127			48,750
Products and services - third parties													51,844			31,781			87,697			56,802
Products and services - related parties	5,569			5,406			22,851			19,118			1,095			8,574			2,858			17,282
Amortization of intangible assets	153			51			459			51			153			153			306			306
Total cost of revenue	44,365			21,940			119,437			67,919			53,092			40,508			90,861			74,390
Gross profit	22,073			9,300			59,054			22,913			23,165			19,433			44,900			37,663
Operating expenses:
Research and product development	8,804			5,885			27,028			15,583			8,714			9,141			17,691			18,523
Selling, marketing, general and administrative	11,454			8,278			32,506			16,691			11,712			10,551			24,106			21,435
Amortization of intangible assets	154			251			1,191			259			131			544			262			1,037
Total operating expenses	20,412			14,414			60,725			32,533			20,557			20,236			42,059			40,995
Operating income (loss)	1,661			(5,114		)	(1,671		)	(9,620		)	2,608			(803		)	2,841			(3,332		)
Interest income	36			31			82			137			75			20			161			46
Interest expense	(263		)	(204		)	(793		)	(600		)	(560		)	(256		)	(883		)	(530		)
Other income (loss), net	60			(112		)	43			(41		)	(427		)	264			(287		)	(17		)
Income (loss) before income taxes	1,494			(5,399		)	(2,339		)	(10,124		)	1,696			(775		)	1,832			(3,833		)
Income tax expense (benefit)	107			(610		)	646			(1,041		)
Income tax expense													341			99			336			539
Net income (loss)	1,387			(4,789		)	(2,985		)	(9,083		)	1,355			(874		)	1,496			(4,372		)
Net income (loss) attributable to non-controlling interest	(12		)	(56		)	172			(17		)	(61		)	(65		)	(27		)	184
Net income (loss) attributable to DASAN Zhone Solutions, Inc.	$	1,399		$	(4,733	)	$	(3,157	)	$	(9,066	)	$	1,416		$	(809	)	$	1,523		$	(4,556	)

Foreign currency translation adjustments	(284		)	2,291			1,782			2,690			(2,548		)	(824		)	(2,230		)	2,066
Comprehensive income (loss)	1,103			(2,498		)	(1,203		)	(6,393		)
Comprehensive income (loss) attributable to non-controlling interest	(14		)	(54		)	191			48
Comprehensive income (loss) attributable to DASAN Zhone Solutions, Inc.	$	1,117		$	(2,444	)	$	(1,394	)	$	(6,441	)
Comprehensive loss													(1,193		)	(1,698		)	(734		)	(2,306		)
Comprehensive loss attributable to non-controlling interest													(83		)	(64		)	(19		)	205
Comprehensive loss attributable to DASAN Zhone Solutions, Inc.													$	(1,110	)	$	(1,634	)	$	(715	)	$	(2,511	)

Basic and diluted net income (loss) per share attributable to DASAN Zhone Solutions, Inc.	$	0.09		$	(0.42	)	$	(0.19	)	$	(0.90	)
Weighted average shares outstanding used to compute basic and diluted net income (loss) per share	16,382			11,139			16,380			10,046
Net income (loss) per share attributable to DASAN Zhone Solutions, Inc.
Basic													$	0.09		$	(0.05	)	$	0.09		$	(0.28	)
Diluted													$	0.08		$	(0.05	)	$	0.09		$	(0.28	)

Weighted average shares outstanding used to compute basic net income (loss) per share													16,438			16,380			16,425			16,380
Weighted average shares outstanding used to compute diluted net income (loss) per share													16,672			16,380			16,645			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						Six Months Ended
	September 30,						June 30,
	2017			2016			2018			2017
Cash flows from operating activities:
Net loss	$	(2,985	)	$	(9,083	)
Adjustments to reconcile net loss to net cash provided by (used in) operating activities:
Net income (loss)							$	1,496		$	(4,372	)
Adjustments to reconcile net income (loss) to net cash used in operating activities:
Depreciation and amortization	3,105			1,164			1,381			2,353
Stock-based compensation	670			128			740			475
Unrealized gain (loss) on foreign currency transactions	(185		)	1,655
Valuation allowance on inventories							411			626
Unrealized (gain) loss on foreign currency transactions							(141		)	240
Deferred taxes	—			(1,069		)	(82		)	—
Changes in operating assets and liabilities:				—
Accounts receivable	(2,948		)	14,450			(18,843		)	(8,659		)
Inventories	(578		)	(4,107		)	(14,641		)	(4,346		)
Prepaid expenses and other assets	(101		)	2,320			219			(936		)
Accounts payable	6,713			(5,814		)	18,498			3,689
Accrued expenses	(4,314		)	13,598
Net cash provided by (used in) operating activities	(623		)	13,242
Accrued and other liabilities							(4,448		)	4,118
Net cash used in operating activities							(15,410		)	(6,812		)
Cash flows from investing activities:
Cash increase through Merger	—			7,013
Increase in restricted cash	(6,061		)	(947		)
Decrease in short-term and long-term loans to others	—			1,891
Increase in short-term and long-term loans to others	—			(1,386		)
Proceeds from sale of short-term investments	1,463			—			—			1,463
Purchase of short-term investments	(430		)	—			—			(430		)
Proceeds from disposal of property and equipment and other assets	6			98			1			6
Purchase of property and equipment	(840		)	(370		)	(415		)	(663		)
Purchase of intangible asset	(72		)	(92		)	—			(31		)
Net cash provided by (used in) investing activities	(5,934		)	6,207
Net cash (used in) provided by investing activities							(414		)	345
Cash flows from financing activities:
Proceeds from short-term borrowings from bank and trade facilities							44,368			8,679
Proceeds from long-term borrowings from related party							6,064			—
Repayments of borrowings	(15,627		)	(23,088		)	(26,455		)	(9,581		)
Proceeds from short-term borrowings	13,778			19,769
Proceeds from long-term borrowings	—			6,800
Proceeds from issuance of common stock	28			—			188			1
Net cash provided by (used in) financing activities	(1,821		)	3,481			24,165			(901		)
Effect of exchange rate changes on cash	630			1,538
Effect of exchange rate changes on cash and restricted cash							(883		)	1,067
Net increase (decrease) in cash and cash equivalents	(7,748		)	24,468			7,458			(6,301		)
Cash and cash equivalents at beginning of period	17,893			9,095
Cash and cash equivalents at end of period	$	10,145		$	33,563
Cash, cash equivalents and restricted cash at beginning of period							31,412			24,543
Cash, cash equivalents and restricted cash at end of period							$	38,870		$	18,242
Reconciliation of cash, cash equivalents and restricted cash to statement of financial position
Cash and equivalents							$	27,308		$	9,902
Restricted cash							10,426			8,340
Long-term restricted cash							1,136			—
Cash, cash equivalents and restricted cash in statement of financial position							$	38,870		$	18,242

See accompanying notes to unaudited condensed consolidated financial statements.

Notes to Unaudited Condensed Consolidated Financial Statements


(1)	Organization and Summary of Significant Accounting Policies


(a)	Description of Business

DASAN Zhone Solutions, Inc. ~~(formerly known as Zhone Technologies, Inc. and referred~~(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.~~1999, under the name Zhone Technologies, Inc. On September 9, 2016, the Company acquired Dasan Network Solutions, Inc. ("DNS"), a California corporation through the merger of a wholly owned subsidiary of the Company with and into DNS, with DNS surviving as a wholly owned subsidiary of the Company (the "Merger"). At the effective time of the Merger, all issued and outstanding shares of capital stock of DNS held by DASAN Networks, Inc. ("DNI") were canceled and converted into the right to receive shares of the Company's common stock in an amount equal to ~~58%~~57.7% of the issued and outstanding shares of the Company's common stock immediately following the Merger. In connection with the Merger, the Company changed its name from Zhone Technologies, Inc. to DASAN Zhone Solutions, Inc. For periods through September 8, 2016, Zhone Technologies, Inc. is referred to as "Legacy Zhone." The Company’s common stock continues to be traded on the Nasdaq Capital Market, and the Company’s ticker symbol was changed from "ZHNE" to "DZSI" effective September 12, 2016.

The Company is headquartered in Oakland, ~~California.~~

California and has flexible in-house production facilities in Seminole, Florida and with 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)	~~Going Concern~~Risks and Uncertainties

Liquidity

The accompanying ~~unaudited condensed~~ consolidated financial statements have been prepared in conformity with generally accepted accounting principles in the United States ("U.S. GAAP"), assuming the Company will continue as a going concern, which contemplates the realization of assets and satisfaction of liabilities in the normal course of business. Accordingly, the unaudited condensed consolidated financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that may result from the possible inability of theconcern.

The Company ~~to continue as a going concern.~~

~~Although the Company generated $1.4 million of~~had net income ~~for the quarter ended September 30, 2017, the Company has incurred significant losses to date and losses from operations may continue. The Company incurred net losses~~ of ~~$3.0 million and $15.3~~$1.5 million for the ~~nine~~six months ended ~~September~~June 30, ~~2017~~2018 and $1.2 million for the year ended December 31, ~~2016, respectively. The~~2017. As of June 30, 2018, the Company had an accumulated deficit of ~~$23.1~~$17.0 million and working capital of ~~$57.3 million as of September 30, 2017. As of September 30, 2017,~~$61.1 million. In addition, the Company had ~~approximately $10.1~~a net cash outflow from operations of $15.4 million for the six months ended June 30, 2018. As of June 30, 2018, the Company had $27.3 million in cash and cash equivalents, which included ~~$3.4~~$12.5 million in cash balances held by ~~the Company's~~its Korean subsidiary, and ~~$26.9~~$52.5 million in aggregate principal ~~amount~~debt of ~~outstanding borrowings under the Company's short-term debt obligations and the Company's loans from DNI and its affiliates. In addition,~~which $45.7 million was in current liabilities. Also, as of June 30, 2018, the Company had ~~$7.6 million in aggregate borrowing availability under its revolving credit facilities as of September 30, 2017. The Company had $8.5~~$3.2 million committed as security for letters of credit under ~~these~~its revolving credit facilities, and $8.0 million outstanding indebtedness under those facilities, leaving $5.6 million in aggregate financing availability under the facilities. On July 6, 2018, the Company repaid the $8.0 million borrowings under its Wells Fargo Bank ("WFB") Facility. 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; and

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 ~~September 30, 2017. Due~~business for a period of 12 months from the date of this interim report on Form 10-Q.

The Company’s ability to meet its obligations as they become due in the ~~amount~~ordinary course of ~~short-term debt obligations maturing within~~business for the next 12 months and the Company's recurring operating losses, the Company's cash resources may not be sufficient to settle these short-term debt obligations. The Company's ability to continue as a “going concern” is dependentwill depend on ~~many factors, including, among other things,~~ its ability to ~~comply with the covenants in its existing debt agreements, its ability to cure any defaults that occur under its debt agreements or to obtain waivers or forbearances with respect to any such defaults,~~achieve forecasted results and its ability to pay, retire, amend, replace or refinance its indebtedness as defaults occur or as interest and principal payments come due. Although the process of amending, replacing or refinancing the Company’s short-term debt obligations is ongoing andaccess funds approved under existing facilities. Management’s belief that it will achieve these results assumes that, among other things, the Company iswill continue to be successful in ~~active discussions with multiple parties,~~implementing its business strategy and that there iswill be no ~~guarantee that they will result~~material adverse development in ~~transactions that are sufficient to provide~~its business, liquidity or capital requirements. If one or more of these factors do not occur as expected, it could cause the Company ~~with the required liquidity~~ to ~~remove the substantial doubt as to its ability to continue as a going concern. If the Company is unable to amend, replace or refinance its short-term debt obligations or raise the capital needed~~fail to meet ~~liquidity needs and finance capital expenditures and working capital, the Company may experience material adverse impacts on~~ its ~~business, operating results and financial condition.~~obligations as they come due.

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The Company ~~has continued its~~plans to focus on cost ~~control and~~management, operating efficiency ~~along with~~and restrictions on discretionary ~~spending, however in order to meet the Company's liquidity needs and finance its capital expenditures and working capital needs for its business,~~spending. In addition, if necessary, the Company may ~~be required to~~ sell assets, issue or enter into amendments of its debt or equity securities, or purchase credit ~~insurance or borrow on potentially unfavorable terms. In addition, the~~insurance. The Company may ~~be required to~~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. In fact, subsequent to the end of the quarter, on July 12, 2018, the Company entered into an Amended and Restated Credit and Security Agreement (the “A&R Domestic Credit Agreement”) and an Amended and Restated Credit and Security Agreement ("Ex-Im Subfacility") (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, as described more fully in Note 7 to the unaudited condensed consolidated financial statements.

Based on the Company's current plans and current business conditions, the Company believes that ~~its focused operating expense discipline~~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 however the factors discussed above raise substantial doubt about the Company's ability to continue as a going concern. The accompanying unaudited condensed consolidated financial statements do not include any adjustments that may result from the ~~outcome~~date of ~~the uncertainties set forth above.~~this Quarterly Report on Form 10-Q.

Other Uncertainties


~~(c)~~	~~Risks and Uncertainties~~

DNI owned approximately ~~58%~~57.7% of the outstanding shares of the Company's common stock as of ~~September~~June 30, ~~2017.~~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~~subject to the ~~restrictions in~~provisions of the Company's ~~bylaws).~~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 ~~our~~the Company's indebtedness do not view as beneficial. See ~~Note 2, Note~~Notes 9 and ~~Note~~ 11 to the unaudited condensed consolidated financial statements for additional information.


(c)	Reclassifications

~~As discussed above in Note 1(b), there is also substantial doubt about~~For the ~~Company's ability~~three months ended June 30, 2017, certain prior period statement of comprehensive income (loss) items have been reclassified to ~~continue~~correctly reflect research and product development expenses and selling, marketing, general and administrative expenses of $0.1 million and $0.1 million, respectively, which were previously incorrectly classified as ~~a going concern. The accompanying unaudited consolidated financial statements do not include any adjustments that might be necessary if~~cost of revenue-products and services. For the ~~Company is unable~~six months ended June 30, 2017 certain prior period statement of comprehensive loss items have been reclassified to ~~continue~~correctly reflect research and product development expenses and selling, marketing, general and administrative expenses of $0.3 million and $0.4 million, respectively, which were previously incorrectly classified as ~~a going concern.~~

cost of revenue-products and services.


(d)	~~Correction of errors~~

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


~~(e)~~	Basis of Presentation

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 ~~generally accepted accounting principles~~the U.S. GAAP for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, ~~they do~~the Company does not include all of the information and footnotes required by ~~generally accepted accounting principles~~U.S. GAAP for complete financial statements.

The unaudited condensed consolidated financial statements reflect all adjustments (consisting only of normal recurring adjustments) that, in the opinion of management, are necessary for a fair ~~presentation~~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 ~~unaudited condensed~~ consolidated financial statements of the Company and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, ~~2016~~2017 filed with the Securities and Exchange Commission.

~~As discussed more fully in Note 2, the Merger is treated as a reverse acquisition for accounting purposes, with DNS as the acquirer~~

Table of the Company. As such, the consolidated financial results of the Company for the three and nine months ended September 30, 2017 are compared to the financial results for DNS and its consolidated subsidiaries for the prior year period through September 8, 2016 and the financial results of DZS and its consolidated subsidiaries for the period from September 9, 2016 through September 30, 2016. The balance sheet of the Company reflects the fair value of the assets and liabilities of Legacy Zhone as of the effective date of the Merger. Those assets include the fair value of acquired intangible assets and goodwill. Due to the foregoing, the Company’s financial results for the three and nine months ended September 30, 2017 are not comparable to its financial results for the three and nine months ended September 30, 2016.Contents

Except as otherwise specifically noted herein, all references to the "Company" refer to (i) DNS and its consolidated subsidiaries for periods through September 8, 2016 and (ii) the Company and its consolidated subsidiaries for periods on or after September 9, 2016.


~~(f)~~(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.


~~(g)~~(f)	Concentration of Risk

The Company’s customers include competitive and incumbent local exchange carriers, competitive access providers, ~~Internet~~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 six months ended ~~September~~June 30, ~~2017, two customers represented, 10%~~2018, one customer accounted for 22% and 9%15% of net revenue, respectively. For the three months ended ~~September~~June 30, ~~2016, three~~2017, two customers represented ~~18%, 16%~~11% and 14% (a ~~related-party) and 12%~~related party) of net revenue, respectively. For the ~~nine~~six months ended ~~September~~June 30, 2017, ~~two customers each~~one customer represented 9%12% (a related party) of net ~~revenue (one of which was a related-party). For the nine months ended September 30, 2016, three customers represented 23%, 21% (a related-party) and 12% of net revenue, respectively.~~revenue.

As of ~~September~~June 30, ~~2017, three~~2018, two customers represented ~~16% (a related-party),~~23% and 11% ~~and 10%~~ of net accounts receivable, respectively. As of December 31, ~~2016,~~2017, two customers represented ~~13%~~20% (a ~~related-party)~~related party) and ~~10%~~11% of net accounts receivable, respectively.

As of ~~September~~June 30, ~~2017~~2018 and December 31, ~~2016,~~2017, receivables from customers in countries other than the United States represented ~~84%~~80% and ~~87%~~84%, respectively, of net accounts receivable.


(g)	Recent Accounting Pronouncements

~~(h)~~ Recent Accounting Pronouncements Adopted

OnIn May ~~28,~~ 2014, the ~~Financial Accounting Standards Board ("FASB")~~FASB issued ~~Accounting Standards Update ("ASU")~~ASU No. 2014-09 “Revenue from Contracts with ~~Customers,~~Customers” (“Topic 606”), which ~~requires an entity~~provides a single comprehensive model for entities to ~~recognize the amount of~~use in accounting for revenue ~~to which it expects to be entitled for the transfer of promised goods or services to~~arising from contracts with customers. ~~The ASU will replace~~Topic 606 replaced most existing revenue recognition ~~guidance in~~standards under U.S. GAAP, ~~when it becomes effective.~~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 ~~standard permits~~Company recognized the ~~use of either the retrospective or~~ cumulative effect ~~transition method.~~ 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 between deliverables (performance obligations) 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 provides 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 is transferred to customer, which is typically upon shipment or delivery dependent upon the terms of the underlying contract.

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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	2,866			(413		)	⁽²⁾	3,279
Accrued and other liabilities	11,518			344			⁽¹⁾	11,174
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 at June 30, 2018 (in thousands):



	As of June 30, 2018
	As reported			Adjustments				Balance without adoption of ASC 606
Assets
Accounts receivable, net	$	67,163		$	512		⁽¹⁾	$	66,651
Inventories	38,187			66			⁽²⁾	38,121
Liabilities
Contract liabilities - current	2,600			347			⁽²⁾	2,253
Accrued and other liabilities	9,431			512			⁽¹⁾	8,919
Stockholders’ equity
Accumulated deficit	(16,988		)	(281		)		(16,707		)

⁽²⁾ Represents the impact of allocation of transaction price to separate performance obligations in open contracts as of June 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.

The following table summarizes the effects of Topic 606 on the Company’s unaudited condensed consolidated statement of operations for the three and six months ended June 30, 2018 (in thousands):



	Three Months Ended June 30, 2018
	As reported			Adjustments			Balance without adoption of ASC 606
Net revenue	$	76,257		$	(152	)	$	76,409
Cost of revenue - products and services	53,092			(5		)	53,097
Gross profit	23,165			(147		)	23,312
Provision for income taxes	(341		)	—			(341		)
Net income	1,355			(147		)	1,502

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	Six Months Ended June 30, 2018
	As reported			Adjustments			Balance without adoption of ASC 606
Net revenue	$	135,761		$	(347	)	$	136,108
Cost of revenue - products and services	90,861			(66		)	90,927
Gross profit	44,900			(281		)	45,181
Provision for income taxes	(336		)	—			(336		)
Net income	1,496			(281		)	1,777

During the three and six months ended June 30, 2018, $0.3 million and $0.6 million respectively, was recognized as revenue from the opening contract liabilities balance.

There was no impact on net revenue from related parties as a result of Topic 606.

In August ~~2015, the~~2016, FASB issued ASU ~~2015-14,~~2016-15, Statement of Cash Flows, Classification of Certain Cash Receipts and Cash Payments, which ~~defers~~addresses eight specific cash flow issues with the ~~effective date~~objective of reducing the existing diversity in practice. The updated guidance ~~in ASU No. 2014-09, Revenue from Contracts with Customer, for all entities by one year. With the deferral, the new standard is~~became effective for the Company on January 1, 2018. Early adoption is permitted, but not before the original effective date of January 1, 2017. In May 2016, the FASB issued ASU 2016-12, Revenue from Contracts with Customers, Narrow-Scope Improvements2018 and Practical Expedients, which provides clarification on how to assess collectibility, present sales tax, treat noncash consideration, and account for completed and modified contracts at the time of transition of ASU 2014-09. The effective date of this updated guidance for the Company is the same as the effective date of ASU 2014-09, which is January 1, 2018. The Company does not plan to early adopt this guidance. The Company is currently assessing the

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

In July 2015, the FASB issued ASU No. 2015-11, Simplifying the Measurement of Inventory, which requires an entity to measure inventory at the lower of cost and net realizable value. The guidance does not apply to inventory that is measured using last-in, first-out ("LIFO") or the retail inventory method. The guidance applies to all other inventory, which includes inventory that is measured using first-in, first-out ("FIFO") or average cost. The guidance is effective for the Company on January 1, 2017, and will bewas adopted accordingly. ~~ASU No. 2015-11 should be applied prospectively with earlier application permitted as of the beginning of an interim or annual reporting period.~~ The adoption of this standard ~~will~~did not have ~~no impact~~any effect on the Company's ~~unaudited~~ condensed consolidated ~~financial statements.~~statement of cash flows for the three and six months ended June 31, 2018 or 2017.

In November ~~2015, the~~2016, FASB issued ASU ~~2015-17, Income Taxes, Balance Sheet Classification~~2016-18, Statement of ~~Deferred Taxes,~~Cash Flows, Restricted Cash, which ~~simplifies~~requires that a statement of cash flows to explain the ~~classification of deferred tax assets and liabilities as non-current~~change during the period in the ~~balance sheet.~~total of cash, cash equivalents and amounts generally described as restricted cash and restricted cash equivalents. The updated guidance isbecame effective for the Company beginning on January 1, ~~2017,~~2018 and ~~will be~~was adopted ~~accordingly.~~

~~The adoption of this standard will not have~~accordingly, using the retrospective approach. As a ~~material impact on~~result, the ~~Company's unaudited~~Company no longer presents transfers between cash and cash equivalents and restricted cash in the consolidated cash flow statements. The condensed consolidated ~~financial statements.~~statement of cash flows for the six months ended June 30, 2017 was revised to exclude the $1.3 million change in restricted cash from net cash used in investing activities and to include $6.7 million and $8.3 million in cash, cash equivalents and restricted cash, beginning of period and cash, cash equivalents and restricted cash, end of period, respectively.

Other Recent Accounting Pronouncements

In February 2016, the FASB issued ASU 2016-02, ~~Leases.~~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 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 ~~unaudited condensed~~ consolidated financial statements. The Company is not able to quantify or cannot reasonably estimate quantitative information related to the impact of the new standard on its unaudited condensed consolidated financial statements at this time.

In March 2016, the FASB issued ASU 2016-09, Improvements to Employee Share-Based Payment Accounting, which requires entities to simplify several aspects of the accounting for share-based payment transactions, including income tax consequences, classification of awards as either equity or liabilities, and classification on statements of cash flows. The guidance is effective for the Company on January 1, 2017, and has been adopted in the first quarter of 2017. The adoption of this standard had no material impact on the Company's unaudited condensed consolidated financial statements.

In August 2016, FASB issued ASU 2016-15, Statement of Cash Flows, Classification of Certain Cash Receipts and Cash Payments, which addresses eight specific cash flow issues with the objective of reducing the existing diversity in practice. The updated guidance is effective for the Company on January 1, 2018. Early adoption is permitted. The Company continues to assess all the potential impacts of the new standard and anticipates this standard may have a material impact on its unaudited condensed consolidated financial statements. The Company is not able to quantify or cannot reasonably estimate quantitative information related to the impact of the new standard on its unaudited condensed consolidated financial statements at this time.

In November 2016, FASB issued ASU 2016-18, Statement of Cash Flows, Restricted Cash, which require that a statement of cash flows to explain the change during the period in the total of cash, cash equivalents and amounts generally described as restricted cash and restricted cash equivalents. The updated guidance is effective for the Company beginning on January 1, 2018. Early adoption is permitted. Adoption of this ASU is applied using a retrospective approach. As a result, the Company will no longer present transfers between cash and cash equivalents and restricted cash in the consolidated cash flow statements.

In January 2017, FASB issued ASU 2017-04, Simplifying the Test for Goodwill Impairment, which simplifies the accounting for goodwill impairment. The updated guidance is effective for the Company on January 1, 2020, and will be adopted accordingly. Early adoption is permitted. The Company is currently assessing the potential impact of adopting this new guidance on its ~~unaudited condensed~~ consolidated financial statements.

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 is not able to quantify or cannot reasonably estimate quantitative information related to the impact of the new standard on its ~~unaudited condensed~~ consolidated financial statements at this time.

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In ~~May 2017,~~March 2018, the FASB issued ASU No. ~~2017-09, Compensation—Stock Compensation~~2018-05, Income Taxes (Topic ~~718): Scope~~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 ~~modification accounting. The purpose~~SEC Accounting Bulletin No. 118, Income Tax Accounting Implications of the ~~amendment is~~Tax Cuts and Jobs Act (“Act”) (“SAB 118”). The SEC issued SAB 118 to ~~clarify which changes~~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 ~~terms or conditions of a share-based payment award require an entity to apply modification accounting. The updated guidance is effective~~

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


(2)	~~Merger~~Fair Value Measurement

On September 9, 2016, the Company acquired DNS through the Merger of a wholly owned subsidiary of the Company with and into DNS, with DNS surviving as a wholly owned subsidiary of the Company. The Merger combines leading technology platforms with a broadened customer base.

At the effective time of the Merger, all issued and outstanding shares of capital stock of DNS held by DNI were canceled and converted into the right to receive shares of the Company's common stock in an amount equal to 58% of the issued and outstanding shares of the Company's common stock immediately following the Merger. Accordingly, at the effective time of the Merger, the Company issued 9,493,016 shares (post reverse stock split) of the Company’s common stock to DNI as consideration in the Merger, of which 949,302 shares (post reverse stock split) are being held in escrow as security for claims for indemnifiable losses in accordance with the merger agreement relating to the Merger. As a result, immediately following the effective time of the Merger, DNI held 58% of the outstanding shares of the Company's common stock and the holders of the Company's common stock immediately prior to the Merger retained, in the aggregate, 42% of the outstanding shares of the Company's common stock.

The Company accounted for the Merger as a reverse acquisition under the acquisition method of accounting in accordance with ASC 805, "Business Combination." Consequently, for the purpose of the purchase price allocation, DNS' assets and liabilities have been retained at their carrying values and Legacy Zhone's assets acquired, and liabilities assumed, by DNS (as the accounting acquirer in the Merger) have been recorded at their fair value measured as of September 9, 2016.

The total purchase consideration in the Merger was based on the number of shares of Legacy Zhone common stock and Legacy Zhone stock options vested and outstanding immediately prior to the closing of the Merger, and was determined based on the closing price of $5.95 per share (post reverse stock split) of the Company's common stock on the September 9, 2016. The estimated total purchase consideration is calculated as follows (in thousands):

Shares Estimated Fair Value
Shares of Legacy Zhone stock as of September 8, 2016 6,874
$ 40,902
Legacy Zhone stock options 198
540
Total Purchase Consideration $ 41,442

~~The following table summarizes the allocation of the fair value consideration transferred as of the acquisition date (in thousands):~~

Cash and cash equivalents $ 7,013
Accounts receivable 18,510
Inventory 16,456
Prepaid expenses and other current assets 2,191
Property and equipment 4,339
Other assets 125
Identifiable intangible assets 10,479
Goodwill 3,284
Accounts payable (11,021 )
Accrued and other liabilities (7,089 )
Other long-term liabilities (2,845 )
Total Indicated Fair Value of Assets $ 41,442

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

The Company considered the deferred tax liabilities caused by the Merger to be a source of income to support recoverability of acquired deferred tax assets, before considering the recoverability of the acquirer's existing deferred tax assets. Accordingly, the valuation allowance on the acquiree's deferred tax assets was reduced by the deferred tax liabilities caused by the Merger and accounted for as part of the purchase price allocation.

~~The following table presents the fair values of the acquired intangible assets at the effective date of the Merger (in thousands, except years):~~

Useful life
(in Years)
Fair Value
Developed technology 5 $ 3,060
Customer relationships 10 5,240
Backlog 1 2,179
$ 10,479

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

September 30, 2016
(in thousands) Three
Months
Ended Nine
Months
Ended
Pro forma total net revenue $ 39,740
$ 142,530
Pro forma net loss (15,569 ) (25,504 )

~~(3) Fair Value Measurement~~

The Company utilizes a fair value hierarchy that is intended to increase consistency and comparability in fair value measurements and related disclosures. The fair value hierarchy is based on inputs to valuation techniques that are used to measure fair value that are either observable or unobservable. Observable inputs reflect assumptions market participants would use in pricing an asset or liability based on market data obtained from independent sources while unobservable inputs reflect a reporting entity’s pricing based upon their own market assumptions. The fair value hierarchy consists of the following three levels:



Level 1 –	Inputs are quoted prices in active markets for identical assets or liabilities.
Level 2 –	Inputs are quoted prices for similar assets or liabilities in an active market, quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable and market-corroborated inputs which are derived principally from or corroborated by observable market data.
Level 3 –	Inputs are derived from valuation techniques in which one or more significant inputs or value drivers are unobservable.

The following financial instruments are not measured at fair value on the Company’s condensed consolidated balance sheet as of ~~September~~June 30, ~~2017~~2018 and the consolidated balance sheet as of December 31, ~~2016,~~2017, but require disclosure of their fair values: cash and cash equivalents, short-term investments, accounts receivable, accounts payable and debt. The carrying values of financial instruments such as cash and cash equivalents, ~~short-term investments,~~ accounts receivable and accounts payable approximate their fair values based on their short-term nature. The carrying value of the Company's debt approximates their fair values based on the current rates available to the Company for debt of similar terms and ~~maturities.~~maturities

To manage certain exposures to currency fluctuations, the Company started a limited hedging program during the three months ended June 30, 2018 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".

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.

As of June 30, 2018, the Company had derivative contracts with total notional values of $20.1 million. 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. The fair values of these outstanding derivative contracts as of June 30, 2018 was a $1.0 million liability, included in accounts payable - trade.

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(3)	Cash, Cash Equivalents and Restricted Cash

As of June 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 $11.6 million at June 30, 2018 and $13.9 million at December 31, 2017.


(4)	~~Inventories~~Balance Sheet Detail

Accounts Receivable

Accounts receivable, net as of June 30, 2018 and December 31, 2017 was as follows (in thousands):



	June 30, 2018				December 31, 2017
Gross accounts receivable	$	67,531			$	63,446
Allowance for doubtful accounts	(368		)		(922		)
Allowance for sales returns	—			⁽¹⁾	(769		)
Total allowances	(368		)		(1,691		)
Accounts receivable, net	$	67,163			$	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.

Inventories

Inventories as of ~~September~~June 30, ~~2017~~2018 and December 31, ~~2016~~2017 were as follows (in thousands):


	September 30, 2017		December 31, 2016		June 30, 2018		December 31, 2017
Raw materials	$	12,812	$	13,547	$	16,730	$	12,671
Work in process	3,004		3,705		2,030		2,150
Finished goods	16,150		13,780		19,427		10,523
Total inventories	$	31,966	$	31,032	$	38,187	$	25,344

Inventories provided as collateral for borrowings from Export-Import Bank of Korea amounted to ~~$18.9~~$23.4 million and ~~$14.4~~$11.4 million as of ~~September~~June 30, ~~2017~~2018 and December 31, ~~2016,~~2017, respectively.

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(5)	Property and Equipment

Property and equipment as of ~~September~~June 30, ~~2017~~2018 and December 31, ~~2016~~2017 were as follows (in thousands):


	September 30, 2017			December 31, 2016			June 30, 2018			December 31, 2017
Furniture and fixtures	$	21,251		$	20,040		$	22,066		$	22,988
Machinery and equipment	4,945			4,530			5,557			5,455
Leasehold improvements	3,386			3,573			3,613			3,647
Computers and software	567			411			682			621
Other	983			922
Others							975			1,007
	31,132			29,476			32,893			33,718
Less accumulated depreciation and amortization	(25,109		)	(22,922		)
Less government grants	(211		)	(266		)
Total property and equipment, net	$	5,812		$	6,288
Less: accumulated depreciation and amortization							(27,260		)	(27,584		)
Less: government grants							(201		)	(261		)
Property and equipment, net							$	5,432		$	5,873

Depreciation ~~and amortization~~ expense associated with property and equipment for the three and ~~nine~~six months ended ~~September~~June 30, 2018 was $0.4 million and $0.8 million respectively. Depreciation expense for the three and six months ended June 30, 2017 was $0.5 million and ~~$1.4 million, respectively. Depreciation and amortization expense associated with property and equipment for the three and nine months ended September 30, 2016 was $0.4 million and $0.9~~$1.0 million, respectively.

The Company receives grants from ~~the~~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~~June 30, ~~2017~~2018 and December 31, ~~2016~~2017 was as follows (in thousands):


	September 30, 2017		December 31, 2016		June 30, 2018		December 31, 2017
Beginning balance	$	3,977	$	693	$	3,977	$	3,977
Addition from Merger	—		3,284
Less: accumulated impairment	—		—		—		—
Ending balance	$	3,977	$	3,977	$	3,977	$	3,977

The Company did not recognize impairment loss on goodwill during the ~~three and nine~~six months ended ~~September~~June 30, ~~2017~~2018 and ~~2016.~~

2017. Intangible assets as of ~~September~~June 30, ~~2017~~2018 and December 31, ~~2016~~2017 were as follows (in thousands):


							June 30, 2018
	September 30, 2017			December 31, 2016			Gross Carrying Amount		Accumulated Amortization			Net
Developed technology	$	3,060		$	3,060		$	3,060	$	(1,122	)	$	1,938
Customer relationships	5,240			5,240			5,240		(961		)	4,279
Backlog	2,179			2,179			2,179		(2,179		)	—
Other	194			105
Less accumulated amortization	(3,499		)	(1,817		)
Intangible assets, net	$	7,174		$	8,767
Total intangible assets							$	10,479	$	(4,262	)	$	6,217

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	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~~six months ended ~~September~~June 30, ~~2017~~2018 was $0.3 million and ~~$1.7~~$0.6 million, respectively. Amortization expense associated with intangible assets for ~~each of~~ the three and ~~nine~~six months ended ~~September~~June 30, ~~2016~~2017 was ~~$0.3 million.~~

$0.7 million and $1.4 million, respectively.


(7)	~~Debt~~Debts

Wells Fargo Bank Facility

As of ~~September~~June 30, ~~2017,~~2018, the Company had a $25.0 million revolving line of credit and letter of credit facility (then and as subsequently amended and replaced) with WFB, (the "WFB Facility"~~) with Wells Fargo Bank ("WFB"~~). Under the WFB Facility, the Company has the option of borrowing funds at agreed upon interest rates. The amount that the Company is able to borrow under the WFB Facility varies based on eligible accounts receivable and inventory, as defined in the ~~agreement,~~WFB Facility, as long as the aggregate amount outstanding does not exceed $25.0 million less the amount committed as security for letters of credit. To maintain availability of funds under the WFB Facility, the Company pays a commitment fee on the unused portion. The commitment fee is 0.25% per annum and is recorded as interest expense.

As of ~~September~~June 30, ~~2017,~~2018, the Company had no$8.0 million in outstanding borrowings under its WFB Facility (included in short-term debts), and ~~$2.5~~$2.1 million was committed as security for letters of credit. ~~The~~Subsequent to the end of the quarter, on July 6, 2018, the Company repaid the $8.0 million borrowings under the WFB Facility. Based on the Company's eligible accounts receivable and inventory, the Company had ~~$6.7~~$2.2 million of ~~borrowing~~financing availability under the WFB Facility as of ~~September~~June 30, ~~2017.~~2018. The interest rate on the WFB Facility was 4.59% at June 30, 2018.

Subsequent to the end of the quarter, on July 12, 2018, the Company entered into an Amended and Restated Credit and Security Agreement (the “A&R Domestic Credit Agreement”) and an Amended and Restated Credit and Security Agreement ("Ex-Im Subfacility") (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 provide 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 security for letters of credit. To maintain availability of funds under the A&R Domestic Credit Agreement and the A&R Ex-Im Credit Agreement, the Company will continue to pay a commitment fee of 0.25% per annum on the unused portion. The amounts borrowed under the amended WFB Facility continue to bear interest, payable monthly, at a floating rate equal to the three-month LIBOR plus a margin based on the Company's average excess availability (as calculated under the WFB Facility). The ~~interest rate on the WFB Facility was 3.8% at September 30, 2017. The~~new maturity date under the WFB Facility is ~~March 31, 2019.~~also extended from July 15, 2019 to July 12, 2021.

The Company’s obligations under the WFB Facility are secured by substantially all of its ~~personal property~~ assets and those of its subsidiaries that guarantee the WFB Facility, including their intellectual property. The WFB Facility contains certain financial covenants, and customary affirmative ~~covenants~~ and negative covenants. If the Company defaults under the WFB Facility due to a covenant breach or otherwise, WFB may be entitled to, among other things, require the immediate repayment of all outstanding amounts and sell the Company’s assets to satisfy the obligations under the WFB Facility. As of ~~September~~June 30, ~~2017,~~2018, the Company was in compliance with the covenants under the WFB Facility.

Bank and Trade Facilities - Foreign Operations

Certain of the Company's foreign subsidiaries have entered into various financing arrangements with foreign banks and other lending institutions consisting primarily of revolving lines of credit, trade facilities, term loans and export development loans. These facilities are renewed ~~on an annual basis~~as they mature and are generally secured by a security interest in certain assets of the applicable foreign ~~subsidiaries.~~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~~June 30, ~~2017~~2018 and December 31, ~~2016,~~2017, the Company had an aggregate outstanding balance of ~~$18.4~~$31.9 million (included in short-term debts) and ~~$17.6~~$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.~~below (amount in thousands).


		As of September 30, 2017				As of June 30, 2018
		Interest rate (%)	Amount			Interest rate (%)	Amount
Industrial Bank of Korea	Credit facility	2.8 - 3.0	$	3,235	Credit facility	3.48-4.02	$	4,515
Industrial Bank of Korea	Trade finance	3.9-5.4	2,287		Trade finance	4.47-5.25	2,427
Shinhan Bank	General loan	5.89	2,791		General loan	6.06	2,853
Shinhan Bank	Trade finance	3.70	1,950		Trade finance	4.16	1,200
NongHyup Bank	Credit facility	1.7 - 3.0	1,841		Credit facility	3.90-4.10	2,569
The Export-Import Bank of Korea	Export development loan	3.1	6,278		Export development loan	3.20-3.28	7,270
LGUPlus					General loan	0	1,782
JECC Factoring					AR Factoring	1.58	6,362
Shinhan Bank (India)					General loan	8.70-8.90	2,896
			$	18,382			$	31,874

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		As of December 31, 2016				As of December 31, 2017
		Interest rate (%)	Amount			Interest rate (%)	Amount
Industrial Bank of Korea	Credit facility	2.16 - 2.76	$	1,106	Credit facility	2.89 - 3.26	$	2,328
Industrial Bank of Korea					Trade Finance	4.47 - 5.97	2,401
Shinhan Bank	General loan	4.08	3,310		General loan	5.91	2,987
Shinhan Bank	Trade finance	3.28 - 3.44	1,752		Trade finance	3.90 - 4.14	3,050
NongHyup Bank	Credit facility	1.92 - 2.66	482
KEB Hana Bank	Comprehensive credit loan	2.79	3,501
NongHyup Bank (Korea)					Credit facility	2.83 - 3.42	860
The Export-Import Bank of Korea	Export development loan	3.10	7,448		Export development loan	3.20 - 3.28	7,570
Mitsubishi Bank (Japan)					AR factoring	1.58	1,872
Shinhan Bank (India)					General loan	8.70 - 8.90	1,709
			$	17,599			$	22,777

As of ~~September~~June 30, ~~2017,~~2018, the Company had ~~$5.0~~$7.1 million in outstanding borrowings and ~~$6.0~~$1.1 million committed as security for letters of credit under the Company's $12.0 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~~six months ended ~~September~~June 30, ~~2017~~2018 and ~~2016~~2017 were as follows (in thousands):


	Nine Months Ended September 30,					Six Months Ended June 30,
	2017		2016			2018			2017
Beginning non-controlling interests	$	416	$	138		$	534		$	416
Acquisition of additional interest in a subsidiary	—		277
Net income (loss) attributable to non-controlling interests	172		(17		)	(27		)	184
Foreign currency translation adjustments (OCI)	19		66
Foreign currency translation adjustments						8			21
Ending non-controlling interests	$	607	$	464		$	515		$	621


(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~~June 30, ~~2017,~~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~~June 30, ~~2017~~2018 under this facility was 4.6% per annum.

~~In addition,~~Also, the Company borrowed $1.8 million from DNI for capital investment in February 2016, which amount was outstanding as of ~~September~~June 30, 2017. This loan matured in March 2017 with an option of renewal by mutual agreement, and bore interest at a rate of 6.9% per annum, payable annually. Effective February 27, 2017, the Company amended the terms of this loan to extend the repayment date from March 2017 to March 2018, and to reduce the interest rate from 6.9% to 4.6% per annum.

~~On June 23, 2017, the Company borrowed $3.5 million from Solueta, an affiliate of DNI. As of September 30, 2017, the aggregate outstanding balance under this loan agreement was $1.7 million.~~2018. This loan matures in ~~November 2017~~July 2019 and bears interest at a rate of 4.6% per annum, payable ~~monthly.~~annually.

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On March 21, 2018, DNS borrowed KRW6.5 billion ($5.8 million) from DNI, which remained outstanding at June 30, 2018. 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~~six months ended ~~September~~June 30, ~~2017~~2018 and ~~2016~~2017 were as follows (in thousands):

Three Months Ended September 30, 2017
Counterparty DNI Ownership Interest Sales Cost of revenue Manufacturing (Cost of revenue) Research and product development
Selling, marketing,
general and administrative
Other Expenses
DNI (Parent Company) N/A $ 3,976
$ 3,604
$ —
$ —
$ 1,291
$ 51
CHASAN Networks Co., Ltd. 100% —
—
257
20
—
—
DASAN FRANCE 100% 662
576
—
—
83
—
DASAN INDIA Private Limited 100% —
—
—
—
30
—
D-Mobile 100% 1,233
1,077
—
—
122
—
HANDYSOFT, Inc. 17.64% 54
12
—
—
6
4
Tomato Soft Ltd. 100% —
—
43
108
—
—
Tomato Soft (Xi'an) Ltd. 100% —
—
—
144
—
—
$ 5,925
$ 5,269
$ 300
$ 272
$ 1,532
$ 55



		Three Months Ended June 30, 2018
Counterparty	DNI ownership Interest	Sales		Cost of revenue		Manufacturing (cost of revenue)		Research and product development		Selling, marketing, general and administrative		Interest expense		Other expenses
DNI (Parent Company)	N/A	$	962	$	750	$	—	$	—	$	1,144	$	69	$	79
Tomato Soft Ltd.	100%	—		—		38		—		—		—		—
Tomato Soft (Xi'an) Ltd.	100%	—		—		—		123		—		—		—
Chasan Networks Co., Ltd.	100%	—		—		268		18		—		—		—
Dasan France	100%	—		—		—		—		—		—		—
Handysoft, Inc.	17.63%	108		39		—		—		2		—		—
		$	1,070	$	789	$	306	$	141	$	1,146	$	69	$	79

Three Months Ended September 30, 2016 (As Revised)
Counterparty DNI Ownership Interest Sales Cost of revenue Manufacturing (Cost of revenue) Research and product development Selling, marketing,
general and administrative Other Expenses
DNI (Parent Company) N/A $ 5,112
$ 4,390
$ —
$ —
$ 946
$ 89
CHASAN Networks Co., Ltd. 100% —
—
130
38
—
—
DASAN FRANCE 100% 3
3
—
—
—
—
D-Mobile 100% 1,267
789
—
—
125
—
HANDYSOFT, Inc. 17.64% 68
58
—
—
—
—
J-Mobile Corporation 90.47% 18
—
—
—
—
—
Tomato Soft Ltd. 100% —
—
36
—
—
—
Tomato Soft (Xi'an) Ltd. 100% —
—
—
181
—
—
$ 6,468
$ 5,240
$ 166
$ 219
$ 1,071
$ 89



		Three Months Ended June 30, 2017
Counterparty	DNI ownership Interest	Sales		Cost of revenue		Manufacturing (cost of revenue)		Research and product development		Selling, marketing, general and administrative		Other expenses
DNI (Parent Company)	N/A	$	8,480	$	7,095	$	—	$	—	$	1,326	$	57
Chasan Networks Co., Ltd.	100%	—		—		187		32		—		—
Dasan France	100%	556		549		—		—		300		—
D-Mobile	100%	1,811		741		—		—		94		—
Fine Solution	100%	—		—		—		—		1		—
HandySoft, Inc.	17.64%	14		2		—		—		—		—
Tomato Soft (Xi'an) Ltd.	100%	—		—		—		133		37		—
Solueta	27.21%	—		—		—		—		—		3
		$	10,861	$	8,387	$	187	$	165	$	1,758	$	60



		Six Months Ended June 30, 2018
Counterparty	DNI ownership Interest	Sales		Cost of revenue		Manufacturing (cost of revenue)		Research and product development		Selling, marketing, general and administrative		Interest expense		Other expenses
DNI (Parent Company)	N/A	$	2,210	$	1,873	$	—	$	—	$	2,166	$	71	$	145
Tomato Soft Ltd.	100%	—		—		57		—		—		—		—
Tomato Soft (Xi'an) Ltd.	100%	—		—		10		2,777		—		—		—
Chasan Networks Co., Ltd.	100%	—		—		592		36		—		—		—
Dasan France	100%	202		177		—		—		—		—		—
HandySoft, Inc.	17.63%	256		149		—		—		2		—		—
		$	2,668	$	2,199	$	659	$	2,813	$	2,168	$	71	$	145

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		Nine Months Ended September 30, 2017														Six Months Ended June 30, 2017
Counterparty	DNI Ownership Interest	Sales		Cost of revenue		Manufacturing (Cost of revenue)		Research and product development		Selling, marketing, general and administrative		Other Expenses		DNI ownership Interest		Sales		Cost of revenue		Manufacturing (cost of revenue)		Research and product development		Selling, marketing, general and administrative		Other expenses
DNI (Parent Company)	N/A	$	16,608	$	14,020	$	—	$	—	$	3,491	$	171	N/A		$	12,631	$	10,416	$	—	$	—	$	2,200	$	120
CHASAN Networks Co., Ltd.	100%	—		—		578		79		—		—
DASAN FRANCE	100%	1,612		1,512		—		—		383		—
DASAN INDIA Private Limited	100%	6,287		4,783		—		—		30		—
Chasan Networks Co., Ltd.														100	%	—		—		382		59		—		—
Dasan France														100	%	950		936		—		—		300		—
Dasan India Private Limited⁽¹⁾														100	%	6,287		4,783		—		—		—		—
D-Mobile(1)	100%	3,054		1,831		—		—		318		—		100	%	1,822		754		—		—		196		—
Fine Solution	100%	—		—		—		—		4		—		100	%	—		—		—		—		4		—
HANDYSOFT, Inc.	17.64%	88		23		—		—		6		4
HandySoft, Inc.														17.64	%	34		11		—		—		—		—
J-Mobile Corporation	90.47%	8		—		—		—		132		—		68.56	%	8		—		—		—		132		—
Tomato Soft Ltd.	100%	—		—		104		108		—		—
Tomato Soft (Xi'an) Ltd.	100%	—		—		—		448		37		—		100	%	—		—		—		304		37		—
Solueta	27.21%	—		—		—		—		—		3		27.21	%	—		—		—		—		—		3
		$	27,657	$	22,169	$	682	$	635	$	4,401	$	178			$	21,732	$	16,900	$	382	$	363	$	2,869	$	123

Nine Months Ended September 30, 2016 (As Revised)
Counterparty DNI Ownership Interest Sales Cost of revenue Manufacturing (Cost of revenue) Research and product development Selling, marketing,
general and administrative Other Expenses
DNI (Parent Company) N/A $ 19,080
$ 16,219
$ —
$ —
$ 4,255
$ 309
CHASAN Networks Co., Ltd. 100% —
—
436
106
—
—
DASAN FRANCE 100% 3
3
—
—
—
—
DASAN INDIA Private Limited 100% —
—
—
—
—
—
D-Mobile 100% 3,135
2,231
—
—
318
—
DMC, Inc. 27.21% 1
1
—
—
—
—
HANDYSOFT, Inc. 17.64% 150
130
—
—
—
—
J-Mobile Corporation 90.47% 39
—
—
—
634
—
PANDA Media, Inc. 100% —
—
—
—
2
—
Tomato Soft Ltd. 100% —
—
98
—
—
—
Tomato Soft (Xi'an) Ltd. 100% —
—
—
560
—
—
$ 22,408
$ 18,584
$ 534
$ 666
$ 5,209
$ 309
_{(1) As discussed above, on December 31, 2017 DNS acquired DASAN India and D-Mobile from DNI.}

The Company has entered into ~~certain~~ 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 and second quarters of 2017, DASAN ~~INDIA Private Limited,~~India and ~~D-Mobile~~D-Mobile) represent finished goods produced by the Company that are sold to these related parties who sell the Company's products in Korea, France, India and Taiwan, respectively.

The Company has entered into ~~agreements~~an agreement with ~~Tomato Soft Ltd. and CHASAN~~Chasan Networks Co., Ltd. to provide manufacturing and research and development services for the Company. Under the agreement with ~~Tomato Soft Ltd. and CHASAN~~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. ~~Selling, marketing, general and administrative expense~~Sales to DNI ~~includes a fee~~necessary for DNI to fulfill agreements with its customers are recorded net of ~~3% of total sales to DNI for sales to these customers.~~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 ~~shared~~ office

space and ~~shared~~ administrative services. Expenses related to ~~rent~~leases and administrative services are allocated and billed to the Company based on square footage occupied and headcount, respectively.

The Company has entered into sales agreement with Handysoft, Inc., provider of software and system integration solutions in Korea, to supply networks equipment, research and development and logistics services through DASAN Networks, Inc.

~~The Company has entered into sales agreement with J-Mobile Corporation to supply networks equipment in Japan. J-Mobile Corporation also provides marketing services in Japan.~~

Other expenses to related parties represent ~~expenses~~payment to DNI for its ~~payment~~ guarantees relating to the Company's borrowings. The Company pays DNI a guarantee fee which is calculated as 0.9% of the guaranteed amount.

Balances of Receivables and Payables with Related Parties

Balances of receivables and payables arising from sales and purchases of goods and services with related parties as of ~~September~~June 30, ~~2017~~2018 and December 31, ~~2016~~2017 were as follows (in thousands):

Table of Contents

As of September 30, 2017
Counterparty DNI Ownership Interest Account receivables Other receivables Deposits for lease* Accounts payable Other payables Loans
DNI (Parent Company) N/A $ 9,196
$ —
$ 727
$ —
$ 125
$ 6,800
ABLE 61.99% 56
—
—
—
—
—
CHASAN Networks Co., Ltd. 100% —
—
—
100
—
—
DASAN France 100% 662
4
—
—
—
—
D-Mobile 100% 3,001
16
—
—
—
—
HANDYSOFT, Inc. 17.64% 26
—
—
6
1
—
Solueta 27.21% —
2
—
—
2
1,744
Tomato Soft Ltd. 100% —
—
—
—
25
—
Tomato Soft (Xi'an) Ltd. 100% —
—
—
—
57
—
$ 12,941
$ 22
$ 727
$ 106
$ 210
$ 8,544

As of December 31, 2016
Counterparty DNI Ownership Interest Account receivables Other receivables Deposits for lease* Accounts payable Other payables Loans
DNI (Parent Company) N/A $ 6,679
$ 171
$ 690
$ 360
$ 6,861
$ 6,800
ABLE 61.99% 53
—
9
—
—
—
CHASAN Networks Co., Ltd. 100% —
—
—
70
—
—
DASAN France 100% 23
—
—
—
—
—
DASAN INDIA Private Limited 100% 2,606
—
—
—
—
—
D-Mobile 100% 3,943
—
—
—
—
—
HANDYSOFT, Inc. 17.64% 2
—
—
—
—
—
J-Mobile Corporation 68.56% 5
—
—
—
—
—
Tomato Soft Ltd. 100% —
—
—
—
16
—
Tomato Soft (Xi'an) Ltd. 100% —
—
—
—
63
—
$ 13,311
$ 171
$ 699
$ 430
$ 6,940
$ 6,800



		As of June 30, 2018
Counterparty	DNI ownership Interest	Account receivables		Other receivables		Deposits for lease *		Short-term debt		Long-term debt		Accounts payable		Other Payables
DNI (parent company)	N/A	$	565	$	—	$	751	$	5,795	$	6,800	$	1,253	$	1,399
Tomato Soft Ltd.	100%	—		—		—		—		—		—		9
Tomato Soft (Xi'an) Ltd.	100%	—		—		—		—		—		—		41
Dasan France	100%	461		65		—		—		—		—		—
HandySoft, Inc.	17.63%	198		—		—		—		—		28		—
Chasan Networks Co., Ltd.	100%	—		—		—		—		—		104		—
		$	1,224	$	65	$	751	$	5,795	$	6,800	$	1,385	$	1,449



		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 related to deposits for lease in the condensed consolidated balance sheetsheets as of September}_{June 30, 20172018}_{and December 31, 2017.}

_{**Included in accrued and other liabilities in the condensed consolidated balance sheetsheets as of June 30, 2018 and December 31, 2016.2017.}

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(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.

Basic net income (loss) per share is the same as diluted net income (loss) per share for the three and nine months ended September 30, 2016 because DNS did not issue the potentially dilutive common stock. Basic net income (loss) per share is the same as diluted net income (loss) per share for the three and nine months ended September 30, 2017 because the effects of stock options and restricted stock units would have been anti-dilutive.

The following table is a reconciliation of the numerator and denominator in the basic and diluted net income (loss) per share calculation (in thousands, except per share data):



	Three Months Ended June 30,					Six Months Ended June 30,
	2018		2017			2018		2017
Net income (loss) attributable to DASAN Zhone Solutions, Inc.	$	1,416	$	(809	)	$	1,523	$	(4,556	)
Weighted average number of shares outstanding:
Basic	16,438		16,380			16,425		16,380
Effect of dilutive securities:
Stock options, restricted stock units and share awards	234		—			220		—
Diluted	16,672		16,380			16,645		16,380
Net income (loss) per share attributable to DASAN Zhone Solutions, Inc.:
Basic	$	0.09	$	(0.05	)	$	0.09	$	(0.28	)
Diluted	$	0.08	$	(0.05	)	$	0.09	$	(0.28	)

Three Months Ended September 30, Nine Months Ended September 30,
2017 2016 2017 2016
(As Revised) (As Revised)
Net income (loss) attributable to DASAN Zhone Solutions, Inc. $ 1,399
$ (4,733 ) $ (3,157 ) $ (9,066 )
Weighted average number of shares outstanding:
Basic 16,382
11,139
16,380
10,046
Effect of dilutive securities:
Stock options, restricted stock units and share awards —
—
—
—
Diluted 16,382
11,139
16,380
10,046
Net income (loss) per share attributable to DASAN Zhone Solutions, Inc.:
Basic $ 0.09
$ (0.42 ) $ (0.19 ) $ (0.90 )
Diluted $ 0.09
$ (0.42 ) $ (0.19 ) $ (0.90 )

During the three and six months ended June 30, 2018, the Company excluded 285 thousand, and 436 thousand stock options at a weighted average exercise price of $14.02, and $12.35, respectively, from diluted net income per share because their effect would have been antidilutive.

~~The outstanding common equivalent shares excluded from~~Basic net income (loss) per share is the ~~computation of the~~same as diluted net income (loss) per share ~~attributable to DASAN Zhone Solutions, Inc.~~ for the ~~periods presented~~three and six months ended June 30, 2017 because ~~including them~~the effects of stock options and restricted stock units would have been ~~antidilutive are as follows (in thousands):~~ anti-dilutive.

Three and Nine Months Ended September 30,
2017 2016
(As Revised)
Stock options 915
795
Restricted stock units 2
9
917
804


(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		Operating Leases
Year ending December 31:
2017 (remainder of the year)	$	967
2018	3,359
2018 (remainder of the year)			$	2,043
2019	2,496		3,993
2020	2,358		2,998
2021	2,264		2,590
2022			2,664
Thereafter	8,722		8,423
Total minimum lease payments	$	20,166	$	22,711

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Warranties

The Company accrues ~~for~~ warranty costs based on historical trends for the expected material and labor costs to provide warranty services. Warranty periods are generally ~~two~~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~~six months ended ~~September~~June 30, ~~2017~~2018 and ~~2016~~2017 (in thousands):


	Nine Months Ended September 30,						Six Months Ended June 30,
	2017			2016			2018			2017
Beginning balance	$	878		$	441		$	931		$	878
Charged to cost of revenue	126			227			728			239
Claims and settlements	(195		)	(389		)	(421		)	(381		)
Foreign exchange impact	14			78			9			15
Ending balance	$	823		$	357		$	1,247		$	751

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~~June 30, ~~2017,~~2018, the Company had ~~$1.0~~$2.9 million of ~~performance bonds and $0.4 million of warranty~~surety bonds guaranteed by third parties.

In addition, the Company has entered into a sales agreement with DNI, that distributes Company's products to a certain customer in Vietnam. Under the agreement with the customer, DNI is required to provides various types of surety bonds which are guaranteed by the bank. As of September 30, 2017, the Company had restricted cash of $1.2 million, $2.1 million and $2.0 million as a collateral for the advance payment bonds, performance bonds and warranty bonds, respectively, issued by DNI.

Purchase Commitments

The Company has agreements with various contract manufacturers which include non-cancellable inventory purchase commitments. The Company’s inventory purchase commitments typically allow for cancellation of orders 30 days in advance of the required inventory availability date as set by the Company at time of order. The amount of non-cancellable purchase commitments outstanding, net of reserve, was ~~$3.0~~$4.3 million as of ~~September~~June 30, ~~2017~~2018.

Payment Guarantees provided by Third Parties and DNI

The following table sets forth ~~third parties that have provided~~ payment guarantees of the Company's indebtedness and other obligations as of ~~September~~June 30, ~~2017~~2018 (in thousands): that have been provided by third parties and DNI. DNI owns approximately 57.7% of the outstanding shares of the Company's common stock:



Guarantor	Amount Guaranteed (in thousands)		Description of Obligations Guaranteed
DNI	$	3,423	Borrowings from Shinhan Bank
DNI	1,712		Purchasing card from Shinhan Bank
DNI	12,355		Letter of credit from Industrial Bank of Korea
DNI	2,140		Purchasing Card from Industrial Bank of Korea
DNI	6,000		Letter of credit from NongHyup Bank
DNI	535		Purchasing card from NongHyup Bank
DNI	6,128		Borrowings from Export-Import Bank of Korea
DNI	6,000		Letter of credit from KookMin Bank
Industrial Bank of Korea	8,232		Letter of credit
NongHyup Bank	3,685		Letter of credit
Kookmin Bank	4,999		Letter of credit
Shinhan Bank	242		Purchasing card
Industrial Bank of Korea	1,556		Performance bonds
Industrial Bank of Korea	810		Purchasing Card
State Bank of India	38		Performance bonds
Seoul Guarantee Insurance Co.	3,961		Performance payment guarantee*
	$	61,816

_{*The Company is responsible for the warranty liabilities generally for the period of}_two_{years regarding major product sales and has contracted surety insurance over part of the warranty liabilities.}

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Guarantor Amount Guaranteed Description of Obligations Guaranteed
DNI (Parent Company) $ 3,349
Borrowings from Shinhan Bank
DNI (Parent Company) 1,884
Purchasing card from Shinhan Bank
DNI (Parent Company) 10,493
Credit facility & purchasing card from Industrial Bank of Korea
DNI (Parent Company) 6,000
Credit facility from NongHyup Bank
DNI (Parent Company) 523
Purchasing card from NongHyup Bank
Industrial Bank of Korea 6,512
Credit facility
Industrial Bank of Korea 864
Performance bonds
NongHyup Bank 4,567
Credit facility
Shinhan Bank 191
Purchasing card
KEB Hana Bank 33
Performance bonds
State Bank of India 38
Performance bonds
Seoul Guarantee Insurance Co. 54
Performance bonds
Seoul Guarantee Insurance Co. 373
Warranty bonds
$ 34,881

Royalties

The Company has certain royalty commitments associated with the shipment and licensing of certain products. Royalty expense is generally based on a dollar amount per unit shipped or a percentage of the underlying revenue and is recorded in cost of revenue.

Legal Proceedings

The Company is subject to various legal proceedings, claims and litigation arising in the ordinary course of business. While the outcome of these matters is currently not determinable, the Company records an accrual for legal contingencies that it has determined to be probable to the extent the amount of the loss can be reasonably estimated. The Company does not expect that the ultimate costs to resolve these matters will have a material adverse effect on its consolidated financial position or results of operations. However, litigation is subject to inherent uncertainties, and unfavorable rulings could occur. If an unfavorable ruling were to occur, there exists the possibility of a material adverse impact on the results of operations of the period in which the ruling occurs, or future periods.


(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 (1) 1% of the shares outstanding on the last day of the immediately preceding calendar year and (2) 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.

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~~(12)~~(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 ~~makers are~~maker is the Company’s ~~Co-Chief~~Chief Executive ~~Officers,~~Officer, who ~~review~~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 ~~countries based on location shipped.~~bill to countries. The following summarizes required disclosures about ~~geographic~~geographical concentrations and revenue by products and services (in thousands):



	Three Months Ended				Six months ended
	June 30,				June 30,
	2018		2017		2018		2017
Revenue by geography:
United States	$	13,630	$	11,961	$	30,179	$	24,108
Canada	1,321		1,422		2,293		2,614
Total North America	14,951		13,383		32,472		26,722
Latin America	7,312		7,075		15,269		11,945
Europe, Middle East, Africa	9,475		6,253		16,963		11,756
Korea	19,111		32,197		31,235		48,513
Other Asia Pacific	25,408		1,033		39,822		13,117
Total International	61,306		46,558		103,289		85,331
Total	$	76,257	$	59,941	$	135,761	$	112,053



	Three Months Ended				Six months ended
	June 30,				June 30,
	2018		2017		2018		2017
Revenue by classification:
Products	$	73,317	$	57,278	$	130,043	$	107,003
Services	2,940		2,663		5,718		5,050
Total	$	76,257	$	59,941	$	135,761	$	112,053

Three Months Ended Nine Months Ended
September 30, September 30,
2017 2016 2017 2016
(As Revised) (As Revised)
Revenue by geography:
United States $ 13,068
$ 3,408
$ 37,176
$ 7,432
Canada 1,498
254
4,112
254
Total North America 14,566
3,662
41,288
7,686
Latin America 7,480
1,877
19,425
2,912
Europe, Middle East, Africa 7,378
2,232
19,134
5,209
Korea 20,520
18,372
69,032
60,144
Other Asia Pacific 16,494
5,097
29,612
14,881
Total International 51,872
27,578
137,203
83,146
Total $ 66,438
$ 31,240
$ 178,491
$ 90,832

Three Months Ended Nine Months Ended
September 30, September 30,
2017 2016 2017 2016
(As Revised) (As Revised)
Revenue by products and services:
Products $ 63,257
$ 28,891
$ 169,831
$ 84,666
Services 3,181
2,349
8,660
6,166
Total $ 66,438
$ 31,240
$ 178,491
$ 90,832

The Company's property and equipment, net of accumulated depreciation, were located in the following geographical areas as of ~~September~~June 30, ~~2017~~2018 and December 31, ~~2016~~2017 (in thousands):


	September 30, 2017		December 31, 2016		As of June 30, 2018		As of December 31, 2017
United States	$	3,611	$	4,094	$	3,238	$	3,393
Korea	1,449		1,455		1,382		1,633
Japan and Vietnam	752		739
Other Asia Pacific					812		847
	$	5,812	$	6,288	$	5,432	$	5,873


~~(13)~~(14)	Income Taxes

Income tax expense for the three and ~~nine~~six months ended ~~September~~June 30, ~~2017~~2018 was ~~$0.1~~$0.3 million ~~and $0.6 million, respectively,~~for each period, on pre-tax income ~~(losses)~~ of ~~$1.5~~$1.7 million and ~~$(2.3)~~$1.8 million, respectively. For the three and ~~nine~~six months ended ~~September~~June 30, ~~2016, the Company recognized~~2017, income tax ~~benefit of $0.6~~expense was $0.1 million and ~~$1.0~~$0.5 million, respectively, on pre-tax losses of ~~$5.4~~$0.8 million and ~~$10.1~~$3.8 million, respectively.

As of ~~September~~June 30, ~~2017,~~2018, the income tax rate varied from the United States statutory income tax rate primarily due to valuation allowances in the United States, income attributable to foreign jurisdictions taxed at rates different from the United States federal statutory rate, and ~~taxable income generated by the Company’s wholly-owned foreign subsidiaries.~~tax credits.

~~Management periodically evaluates the realizability~~

Table of the Company's net deferred tax assets based on all available evidence, both positive and negative. The Company evaluates on a jurisdictional basis and certain jurisdictions could result in a realization of net deferred tax assets sooner than others. The realization of net deferred tax assets is dependent on the Company's ability to generate sufficient future taxable income, on a jurisdictional basis, during periods prior to the expiration of tax attributes to fully utilize these assets. The Company weighed both positive and negative evidence and determined that there is a continued need for a full valuation allowance on its deferred tax assets in certain jurisdictions as of September 30, 2017. The Company currently believes there is not sufficient positive evidence of future profitability to change its judgment regarding the need for a full valuation allowance on its deferred tax assets in these jurisdictions. The continued improvement in the Company's operating results, conditioned on successfully commercializing new business arrangements and managing costs would provide additional positive evidence in determining the need for a valuation allowance in certain jurisdictions and could lead to reversal of substantially all of the Company's valuation allowance on its deferred tax assets. Until such time, consumption of tax attributes to offset profits will reduce the overall level of deferred tax assets subject to valuation allowance. Should the Company determine that it would be able to realize its remaining deferred tax assets in the foreseeable future, on a jurisdictional basis, an adjustment to its remaining deferred tax assets would cause a material increase to income in the period such determination is made.Contents

The total amount of unrecognized tax benefits, including interest and penalties, at ~~September~~June 30, ~~2017~~2018 was ~~not material.~~$0.5 million. The amount of tax benefits that would impact the effective income tax rate, if recognized, is ~~not expected to be material.~~$0.1 million. There were no significant changes to unrecognized tax benefits during the quarters ended ~~September~~June 30, 2017 and ~~2016.~~June 30, 2018. The Company does not anticipate any significant changes with respect to unrecognized tax benefits within the next 12 months.

The Company ~~or one of its subsidiaries files income~~has recognized the provisional tax ~~returns~~impacts related to the Tax Act in the ~~U.S. federal jurisdiction, and various state and foreign jurisdictions. The open tax years~~Company’s consolidated financial statements for the ~~major jurisdictions are as follows:~~



~~• Federal~~	~~2013 - 2016~~
~~• California and Canada~~	~~2012 - 2016~~
~~• Brazil~~	~~2011 - 2016~~
~~• Germany~~	~~2012 - 2016~~
~~• Japan~~	~~2011 - 2016~~
~~• Korea~~	~~2015 - 2016~~
~~• United Kingdom~~	~~2014 - 2016~~
~~• Vietnam~~	~~2016~~

~~However,~~year ended December 31, 2017. The ultimate impact may differ from provisional amounts, possibly materially, due to, ~~the fact the Company had net operating losses~~among other things, additional analysis, changes in interpretations and credits carried forward in most jurisdictions, certain items attributable to closed years are still subject to adjustment by the relevant taxing authority through an adjustment to tax attributes carried forward to open years.

The Company estimates that its foreign income will generally be subject to taxation in the United States on a current basis and that its foreign subsidiaries and representative offices will therefore not have any material untaxed earnings subject to deferred taxes. In addition, to the extent the Company is deemed to have sufficient connection to a particular taxing jurisdiction to enable that jurisdiction to tax the Company butassumptions the Company has made, additional regulatory guidance that may be issued, and actions the Company may take as a result of the Tax Act. The Company has not ~~filed~~yet determined its policy election with respect to whether to record deferred taxes for basis differences expected to reverse as a result of the global intangible low-taxed income (“GILTI”) provisions in future periods or use the period cost method. The Company has, however, included an estimate of the current GILTI impact in its tax provision for 2018. The Company continues to evaluate the impact of the tax reform and the accounting is expected to be completed when the Company's 2017 U.S. corporate income tax return is filed in ~~that jurisdiction for the year(s) at issue, the jurisdiction would typically be able to assert a tax liability for such years without limitation on the number of years it may examine.~~

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

2018.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

As used in this report, unless the context suggests otherwise, the terms "we", "us", or "our" refer to (i) Dasan Network Solutions, Inc. (DNS) and its consolidated subsidiaries for periods through September 8, 2016 and (ii) DASAN Zhone Solutions, Inc. and its consolidated subsidiaries (collectively, DZS) for periods on or after September 9, 2016, the effective date of the Merger (as defined below). In connection with the Merger, Zhone Technologies, Inc. changed its name to DASAN Zhone Solutions, Inc. For periods through September 8, 2016, Zhone Technologies, Inc. is referred to as "Legacy Zhone."

Forward-Looking Statements

This report, including “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” contains forward-looking statements regarding future events and our future results that are subject to the safe harbors created under the Securities Act of 1933 and the Securities Exchange Act of 1934. These statements are based on current expectations, estimates, forecasts, and projections about the industries in which we operate and the beliefs and assumptions of our management. We use words such as “anticipate,” “believe,” “continue,” “could,” “estimate,” “expect,” “goal,” “intend,” “may,” “plan,” “project,” “seek,” “should,” “target,” “will,” “would,” variations of such words, and similar expressions to identify forward-looking statements. In addition, statements that refer to projections of earnings, revenue, costs or other financial ~~items;~~items as to future periods; anticipated

growth and trends in our business or key markets; cost synergies, growth opportunities and other financial and operating benefits of the Merger; future growth and revenues from our products; our ability to refinance or repay our existing indebtedness prior to the applicable maturity date; future economic conditions and performance; anticipated performance of products or services; plans, objectives and strategies for future operations; and other characterizations of future events or circumstances, are forward-looking statements. Readers are cautioned that these forward-looking statements are only predictions and that they are subject to risks, uncertainties and assumptions that are difficult to predict, including those identified or referenced under the heading “Risk Factors” in Part II, Item 1A, elsewhere in this report and in our other filings with the Securities and Exchange Commission (the SEC). ~~Therefore, actual~~Actual results may differ materially and adversely from those expressed in any forward-looking statements. Factors that might cause such a difference include, but are not limited to, our ability to realize the anticipated cost savings, synergies and other benefits of the Merger and any integration risks relating to the Merger, the ability to generate sufficient revenue to achieve or sustain profitability, the ability to raise additional capital to fund existing and future operations or to refinance or repay our existing indebtedness, defects or other performance problems in our products, any economic slowdown in the telecommunications industry that restricts the ability of our customers to purchase our products, commercial acceptance of our products, intense competition in the communications equipment market from large equipment companies as well as private companies with products that address the same networks needs as our products, higher than anticipated expenses that we may incur, any failure to comply with the periodic filing and other requirements of The Nasdaq Stock Market for continued listing, material weaknesses or other deficiencies in our internal control over financial reporting, the initiation of any civil litigation, regulatory proceedings, government enforcement actions or other adverse effects relating to the Audit Committee investigation or errors in the consolidated financial statements of ~~Legacy~~ Zhone Technologies, Inc., and other factors identified elsewhere in this report and in our most recent reports on Forms 10-K, 10-Q and 8-K. We undertake no obligation to revise or update any forward-looking statements for any reason.

OVERVIEW

We are a global provider of network access solutions and communications equipment for service provider and enterprise networks. We research, develop, test, sell, manufacture and support communications equipment in five major areas: broadband access, Ethernet switching, mobile backhaul, passive optical LAN (POLAN) and software defined networks (SDN).

~~As discussed under "Liquidity and Capital Resources" below, the maturing~~

Table of ~~short-term debt obligations and our recurring losses from operations raise substantial doubt on whether we will be able to continue as a going concern.~~

~~As of September 30, 2017, the total outstanding principal amount of our debt obligations was $26.9 million, consisting of the following:~~

~~$18.4 million in short-term debt obligations to other non-related parties;~~

~~$3.5 million in short-term debt obligations to related parties; and~~

~~$5.0 million in long-term debt obligations to related parties.~~

Our ability to continue as a “going concern” is dependent on many factors, including, among other things, our ability to comply with the covenants in our existing debt agreements, our ability to cure any defaults that occur under our debt agreements or to obtain waivers or forbearances with respect to any such defaults, and our ability to pay, retire, amend, replace or refinance our indebtedness as defaults occur or as interest and principal payments come due.

~~Going forward, our key financial objectives include the following:~~

~~Increasing revenue while continuing to carefully control costs;~~

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

~~Minimizing consumption of our cash and cash equivalents.~~Contents

~~Merger~~

On September 9, 2016, we acquired DNS through the merger of a wholly owned subsidiary of Zhone Technologies, Inc. with and into DNS, with DNS surviving as our wholly owned subsidiary (the Merger). In connection with the Merger, Zhone Technologies, Inc. changed its name to DASAN Zhone Solutions, Inc. Our common stock continues to be traded on the Nasdaq Capital Market, and our ticker symbol was changed from "ZHNE" to "DZSI" effective September 12, 2016.

At the effective time of the Merger, all issued and outstanding shares of capital stock of DNS held by its sole shareholder, DASAN Networks, Inc. (DNI), were canceled and converted into the right to receive shares of our common stock in an amount equal to 58% of the issued and outstanding shares of our common stock immediately following the Merger. Accordingly, at the effective time of the Merger, we issued 9,493,016 shares (post reverse stock split) of our common stock to DNI as consideration in the Merger, of which 949,302 shares (post reverse stock split) are being held in escrow as security for claims for indemnifiable losses in accordance with the merger agreement relating to the Merger. As a result, immediately following the effective time of the Merger, DNI held 58% of the outstanding shares of our common stock and the holders of our common stock immediately prior to the Merger retained, in the aggregate, 42% of the outstanding shares of our common stock.

~~See Note 2 to the unaudited condensed consolidated financial statements set forth in Part I, Item 1 of this report for additional information regarding the Merger.~~

~~ITEMS AFFECTING COMPARABILITY OF OUR FINANCIAL RESULTS~~

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

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

~~There~~Management’s discussion and analysis of financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with generally accepted accounting principles in the United States of America. The preparation of these consolidated financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses, and related disclosure of contingent assets and liabilities.

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

2017. The policies discussed below are considered by management to be critical because changes in such estimates can materially affect the amount of our reported net income or loss. For all of these policies, management cautions that actual results may differ materially from these estimates under different assumptions or conditions.

For a description of what we believe to be the critical accounting policies and estimates used in the preparation of our unaudited condensed consolidated financial statements, refer to our Annual Report on Form 10-K for the year ended December 31, 2017.

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 we expect to be entitled to in exchange for those goods or services.

We generate 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 good 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. We typically invoice customers for support contracts in advance, for periods ranging from one to five years.

Revenue from all sales types is recognized at transaction price, which is the amount we expect 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, we analyze historical data, channel inventory levels, current economic trends and changes in customer demand for our products, among other factors. Historically, variable consideration has not been a significant component of our contracts with customers. As of June 30, 2018, the total estimate of variable consideration was not significant.

Contracts with Multiple Performance Obligations

Some of our contracts with customers contain multiple promised goods or services. For these contracts, we account for the promises separately as individual performance obligations if they are distinct. In determining whether performance obligations meet the criteria for being distinct, we consider 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 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.

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Contract Balances

Topic 606 distinguishes between a contract asset and accounts receivable based on whether receipt of the consideration is conditional on something other than passage of time. We record contract assets when we have a right to consideration and records accounts receivable when we have an “unconditional” right to consideration. Contract liabilities consist of cash payments received in advance of performance or where we have a right to consideration that is unconditional, before we transfer a good or service to a customer.

Warranties

Products sold to customers include standard warranties, covering bug fixes, such as 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 over the life of the contract.

Contract Costs

Applying a practical expedient, we recognize 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 June 30, 2018, such capitalizable costs were not significant.

Financing

Our contracts do not include a significant financing component. We apply the practical expedient not to adjust the promised amount of consideration for the effects of a financing component if we expect, at contract inception, that the period between when we transfer 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

We have 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, we accrue the costs of shipping and handling when the related revenue is recognized.

Unsatisfied performance obligations

We do 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 we recognize revenue at the amount to which we have the right to invoice for the services performed. The majority of our performance obligations in our contracts with customers relate to contracts with a duration of less than one year and therefore transaction price allocated to unsatisfied performance obligations included in contracts with a duration of more than 12 months was not material.

Disaggregation of Revenue

The disaggregation of revenue by geographical regions for the three months and six months ended June 30, 2018 is disclosed in Note 13.

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RESULTS OF OPERATIONS

We list in the table below the historical condensed consolidated statement of comprehensive ~~loss data~~income (loss) as a percentage of total net revenue for the periods indicated.


	Three Months Ended September 30,				Nine Months Ended September 30,
	2017		2016		2017		2016		Three Months Ended June 30,				Six Months Ended June 30,
			(As Revised)				(As Revised)		2018		2017		2018		2017
Net revenue:
Net revenue	91	%	79	%	85	%	75	%
Net revenue - related parties	9	%	21	%	15	%	25	%
Third parties									99	%	82	%	98	%	81	%
Related parties									1	%	18	%	2	%	19	%
Total net revenue	100	%	100	%	100	%	100	%	100	%	100	%	100	%	100	%
Cost of revenue:
Products and services	58	%	53	%	54	%	54	%
Products and services - third parties									68	%	53	%	65	%	51	%
Products and services - related parties	8	%	17	%	13	%	21	%	1	%	14	%	2	%	15	%
Amortization of intangible assets	0	%	0	%	0	%	0	%	—	%	—	%	—	%	—	%
Total cost of revenue	67	%	70	%	67	%	75	%	69	%	67	%	67	%	66	%
Gross profit	33	%	30	%	33	%	25	%	31	%	33	%	33	%	34	%
Operating expenses:
Research and product development	14	%	19	%	15	%	17	%	11	%	15	%	13	%	17	%
Selling, marketing, general and administrative	17	%	26	%	18	%	18	%	15	%	18	%	18	%	19	%
Amortization of intangible assets	0	%	1	%	1	%	0	%	—	%	1	%	—	%	1	%
Total operating expenses	31	%	46	%	34	%	35	%	26	%	34	%	31	%	37	%
Operating income (loss)	2	%	(16	)%	(1	)%	(10	)%	5	%	(1	)%	2	%	(3	)%
Interest income	0	%	0	%	0	%	0	%	—	%	—	%	—	%	—	%
Interest expense	0	%	(1	)%	0	%	(1	)%	(1	)%	—	%	(1	)%	—	%
Other income, net	0	%	0	%	0	%	0	%	(1	)%	—	%	—	%	—	%
Income (loss) before income taxes	2	%	(17	)%	(1	)%	(11	)%	3	%	(1	)%	1	%	(3	)%
Income tax provision (benefit)	0	%	(2	)%	1	%	(1	)%
Income tax provision									—	%	—	%	—	%	—	%
Net income (loss)	2	%	(15	)%	(2	)%	(10	)%	3	%	(1	)%	1	%	(3	)%
Net loss attributable to non-controlling interest	0	%	0	%	0	%	0	%	—	%	—	%	—	%	—	%
Net income (loss) attributable to DASAN Zhone Solutions, Inc.	2	%	(15	)%	(2	)%	(10	)%	3	%	(1	)%	1	%	(3	)%
Foreign currency translation adjustments	0	%	7	%	1	%	3	%	(2	)%	(1	)%	(2	)%	2	%
Comprehensive income (loss)	2	%	(8	)%	(1	)%	(7	)%
Comprehensive income attributable to non-controlling interest	0	%	0	%	0	%	0	%
Comprehensive income (loss) attributable to DASAN Zhone Solutions, Inc.	2	%	(8	)%	(1	)%	(7	)%
Comprehensive loss									1	%	(2	)%	(1	)%	(1	)%
Comprehensive loss attributable to non-controlling interest									—	%	—	%	—	%	—	%
Comprehensive loss attributable to DASAN Zhone Solutions, Inc.									1	%	(2	)%	(1	)%	(1	)%

Net Revenue

Information about our net revenue for products and services for the ~~three and~~ ~~nine~~six months ended ~~September~~June 30, ~~2017~~2018 and ~~2016~~2017 is summarized below (in millions):


	Three Months Ended September 30,								Nine Months Ended September 30,
	2017		2016		Increase/(decrease)		% change		2017		2016		Increase/(decrease)		% change		Three Months Ended June 30,								Six Months Ended June 30,
			(As Revised)								(As Revised)						2018		2017		Increase		% change		2018		2017		Increase		% change
Products	$	63.2	$	28.9	$	34.3	119	%	$	169.8	$	84.6	$	85.2	101	%	$	73.4	$	57.3	$	16.1	28	%	$	130.1	$	107.0	$	23.1	22	%
Services	3.2		2.3		0.9		39	%	8.7		6.2		2.5		40	%	2.9		2.7		0.2		7	%	5.7		5.1		0.6		12	%
Total	$	66.4	$	31.2	$	35.2	113	%	$	178.5	$	90.8	$	87.7	97	%	$	76.3	$	60.0	$	16.3	27	%	$	135.8	$	112.1	$	23.7	21	%

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Information about our net revenue for North America and international markets for the three and ~~nine~~six months ended ~~September~~June 30, ~~2017~~2018 and ~~2016~~2017 is summarized below (in millions):


	Three Months Ended September 30,								Nine Months Ended September 30,
	2017		2016		Increase/(decrease)		% change		2017		2016		Increase/(decrease)		% change		Three Months Ended June 30,									Six Months Ended June 30,
			(As Revised)								(As Revised)						2018		2017		Increase/(decrease)			% change		2018		2017		Increase/(decrease)			% change
Revenue by geography:
United States	$	13.1	$	3.4	$	9.7	285	%	$	37.2	$	7.4	$	29.8	403	%	$	13.6	$	12.0	$	1.6		13	%	$	30.2	$	24.1	$	6.1		25	%
Canada	1.5		0.3		1.2		100	%	4.1		0.3		3.8		100	%	1.3		1.4		(0.1		)	(7	)%	2.3		2.6		(0.3		)	(12	)%
Total North America	14.6		3.7		10.9		295	%	41.3		7.7		33.6		436	%	14.9		13.4		1.5			11	%	32.5		26.7		5.8			22	%
Latin America	7.5		1.9		5.6		295	%	19.4		2.9		16.5		569	%	7.3		7.1		0.2			3	%	15.3		12.0		3.3			28	%
Europe, Middle East, Africa	7.4		2.2		5.2		236	%	19.1		5.2		13.9		267	%	9.5		6.3		3.2			51	%	17.0		11.8		5.2			44	%
Korea	20.5		18.4		2.1		11	%	69.0		60.1		8.9		15	%	19.1		32.2		(13.1		)	(41	)%	31.2		48.5		(17.3		)	(36	)%
Asia Pacific	16.4		5.0		11.4		228	%	29.7		14.9		14.8		99	%
Other Asia Pacific																	25.5		1.0		24.5			2,450	%	39.8		13.1		26.7			204	%
Total International	51.8		27.5		24.3		88	%	137.2		83.1		54.1		65	%	61.4		46.6		14.8			32	%	103.3		85.4		17.9			21	%
Total	$	66.4	$	31.2	$	35.2	113	%	$	178.5	$	90.8	$	87.7	97	%	$	76.3	$	60.0	$	16.3		27	%	$	135.8	$	112.1	$	23.7		21	%

For the three months ended ~~September~~June 30, ~~2017,~~2018, net revenue increased ~~113%~~27% or ~~$35.2~~$16.3 million to ~~$66.4~~$76.3 million from ~~$31.2~~$60.0 million for the same period last year. For the ~~nine~~six months ended ~~September~~June 30, ~~2017,~~2018 net revenue increased ~~97%~~21% or ~~$87.7~~$23.7 million to ~~$178.5~~$135.8 million from ~~$90.8~~$112.1 million for the same period of last year. For the three months ended June 30, 2018, product revenue increased 28% or $16.1 million to $73.4 million from $57.3 million for the same period last year. For the ~~three~~six months ended ~~September~~June 30, ~~2017,~~2018 product revenue increased ~~119%~~22% or ~~$34.3~~$23.1 million to ~~$63.2~~$130.1 million ~~compared to the same period last year. For the nine months ended September 30, 2017, product revenue increased 101% or $85.2~~from $107.0 million ~~to $169.8 million compared to~~for the same period last year. The increase in net revenue for both the three and ~~nine months~~six month periods ended ~~September~~June 30, ~~2017~~2018 was primarily ~~related~~due to increased products sales in the United States and Other Asia Pacific, primarily in India, offset by decreased products sales in Korea. We also added customers in late 2017, which contributed to the ~~consummation of~~revenue increase during the ~~Merger in September 2016 (which resulted in the inclusion of net revenue related~~first two quarters this year as compared to the ~~Legacy Zhone business for the entire current year~~same periods ~~compared to only 22 days in the prior year periods).~~last year.

Service revenue represents revenue from maintenance and other services associated with product shipments. For the three months ended ~~September~~June 30, ~~2017,~~2018, service revenue increased ~~39%~~7% or ~~$0.9~~$0.2 million to ~~$3.2~~$2.9 million ~~compared to~~from $2.7 million for the same period last year. For the ~~nine~~six months ended ~~September~~June 30, ~~2017,~~2018 service revenue increased ~~40%~~12% or ~~$2.5~~$0.6 million to ~~$8.7~~$5.7 million ~~compared to~~from $5.1 million for the same period last year. The ~~increases~~increase in service revenue ~~were~~was primarily related to ~~the consummation~~a greater number of ~~the Merger in September 2016 (which resulted in the inclusion of service revenue related to the Legacy Zhone business~~products under contract for ~~the entire current year periods, compared to only 22 days in the prior year periods), as well as an increase in sales of~~ maintenance ~~services.~~and extended warranty.

International net revenue increased ~~88%~~32% or ~~$24.3~~$14.8 million to ~~$51.8~~$61.4 million for the three months ended ~~September~~June 30, ~~2017~~2018 from ~~$27.5~~$46.6 million for the same period last year, and represented ~~78%~~80% of total net revenue compared with ~~88%~~78% during the same period of ~~2016.~~2017. International net revenue increased ~~65%~~21% or ~~$54.1~~$17.9 million to ~~$137.2~~$103.3 million for the ~~nine~~six months ended ~~September~~June 30, ~~2017~~2018 from ~~$83.1~~$85.4 million for the same period last year, and represented ~~77%~~76% of total net revenue compared with ~~92%~~76% during the same period ~~of 2016.~~last year. The increases in international net revenue were primarily related to increased product sales in Other Asia Pacific, primarily in India.

For the ~~consummation~~three and six months ended June 30, 2018, one customer accounted for 22% and 15% of ~~the Merger in September 2016 (which resulted in the inclusion of international~~ net ~~revenue related to the Legacy Zhone business for the entire current year periods, compared to only 22 days in the prior year periods).~~

revenue. For the three months ended ~~September~~June 30, 2017, two customers represented ~~10%~~11% and 9%14% (a related party) of net revenue, respectively. For the ~~nine~~six months ended ~~September~~June 30, 2017, ~~two customers each~~one customer represented 9%12% (a related party) of net revenue (one of which was a related-party). For the three months ended September 30, 2016, three customers represented 18%, 16% (a related-party) and 12% of net revenue, respectively. For the nine months ended September 30, 2016, three customers represented 23%, 21% (a related-party) and 12% of net revenue, respectively. revenue.

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

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Cost of Revenue and Gross ~~Margin~~Profit

Total cost of revenue increased ~~102%~~31% or ~~$22.4~~$12.6 million to ~~$44.4~~$53.1 million for the three months ended ~~September~~June 30, ~~2017,~~2018, compared to ~~$21.9~~$40.5 million for the three months ended ~~September~~June 30, ~~2016.~~2017. Total cost of revenue was 69% of net revenue for the three months ended June 30, 2018, compared to 67% for the three months ended June 30, 2017. Total cost of revenue increased ~~76%~~22% or ~~$51.5~~$16.5 million to ~~$119.4~~$90.9 million for the ~~nine~~six months ended ~~September~~June 30, ~~2017, compared to $67.9~~2018, from $74.4 million for the ~~nine~~six months ended ~~September~~June 30, ~~2016.~~2017. Total cost of revenue was 67% of net revenue for the six months ended June 30, 2018 compared to 66% for the six months ended June 30, 2017. The ~~increases~~increase in total cost of revenue, as a percentage of sales, were primarily due to ~~the consummation of the Merger~~an increase in ~~September 2016 (which resulted~~revenues in the inclusion of cost of revenue related to the Legacy Zhone business for the entire current year periods, compared to only 22 days in the prior year periods) as well as increased sales. Gross margin increased slightly in both the threeUnited States and ~~nine months ended September 30, 2017 compared to the prior year periods due to improved manufacturing efficiencies and product mix.~~certain Other Asia Pacific customers.

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

Research and Product Development Expenses

Research and product development expenses ~~increased 50%~~decreased 5% or ~~$2.9~~$0.4 million to ~~$8.8~~$8.7 million for the three months ended ~~September~~June 30, ~~2017~~2018 compared to ~~$5.9~~$9.1 million for the three months ended ~~September~~June 30, ~~2016.~~2017. As a percentage of sales, research and product development expenses were 11% for the three months ended June 30, 2018, compared to 15% for the three months ended June 30, 2017. Research and product development expenses ~~increased 73%~~decreased 4% or ~~$11.4~~$0.8 million to ~~$27.0~~$17.7 million for the ~~nine~~six months ended ~~September~~June 30, ~~2017~~2018 compared to ~~$15.6~~$18.5 million for the ~~nine~~six months ended ~~September~~June 30, ~~2016.~~2017. As a percentage of sales, research and product development expenses were 13% for the six months ended June 30, 2018, compared to 17% for the six months ended June 30, 2017. The ~~increase~~decrease in research and product development expenses was primarily due to lower personnel-related expenses due to synergies from the consummation of the Merger in September 2016 (which resulted in the inclusion of research and product development expenses related to the Legacy Zhone business for the entire current year periods, compared to only 22 days in the prior year periods).Merger. We intend to continue to invest in research and product development to attain our strategic product development objectives, while seeking to manage the associated costs through expense controls.

Selling, Marketing, General and Administrative Expenses

Selling, marketing, general and administrative expenses increased ~~38%~~11% or ~~$3.2~~$1.2 million to ~~$11.5~~$11.7 million for the three months ended ~~September~~June 30, ~~2017~~2018, compared to ~~$8.3~~$10.6 million for the three months ended ~~September~~June 30, ~~2016.~~2017. As a percentage of sales, selling, marketing, general and administrative expenses was 15% for the three months ended June 30, 2018, compared to 18% for the three months ended June 30, 2017. Selling, marketing, general and administrative expenses increased ~~95%~~12% or ~~$15.8~~$2.7 million to ~~$32.5~~$24.1 million for the ~~nine~~six months ended ~~September~~June 30, ~~2017~~2018, compared to ~~$16.7~~$21.4 million for the ~~nine~~six months ended ~~September~~June 30, ~~2016.~~2017. As a percentage of sales, selling, marketing, general and administrative expenses was 18% for the six months ended June 30, 2018, compared to 19% for the six months ended June 30, 2018. The ~~increases~~increase in selling, marketing, general and administrative expenses ~~were~~was primarily related to higher personnel expenses due to ~~the consummation of the Merger in September 2016 (which resulted in the inclusion of selling, marketing, general~~increased headcount, as well as increased legal and administrative expenses related to Legacy Zhone business for the entire current year periods, compared to only 22 days in the prior year periods), offset by higher commission expenses during the three and nine months ended September 30, 2016.outside service fees.

Income Tax Provision

~~During~~Income tax expense for the three and ~~nine~~six months ended ~~September~~June 30, ~~2017~~2018 was $0.3 million for each period, on pre-tax income of $1.7 million and ~~2016, no material provision or benefit for~~$1.8 million, respectively. For the three and six months ended June 30, 2017, income ~~taxes~~tax expense was ~~recorded,~~$0.1 million and $0.5 million, respectively, on pre-tax losses of $0.8 million and $3.8 million, respectively. As of June 30, 2018, the income tax rate varied from the United States statutory income tax rate primarily due to ~~our recurring operating losses~~valuation allowances in the United States, income attributable to foreign jurisdictions taxed at rates different from the United States federal statutory rate, and ~~the significant uncertainty regarding the realization of our net deferred~~ tax ~~assets, against which we have continued to record a full valuation allowance.~~credits.

OTHER PERFORMANCE MEASURES

In managing our business and assessing our financial performance, we supplement the information provided by our U.S. GAAP results with adjusted earnings before stock-based compensation, interest, taxes, and depreciation, or Adjusted EBITDA, a non-GAAP financial measure. We define Adjusted EBITDA as net income (loss) plus (i) interest expense, net, (ii) provision (benefit) for taxes, (iii) depreciation and amortization, (iv) stock-based compensation expenses, and (v) material non-recurring transactions or events, such as Merger transaction costs or a gain (loss) on sale of assets or impairment of fixed assets. We believe that the presentation of Adjusted EBITDA enhances the usefulness of our financial information by presenting a measure that management uses internally to monitor and evaluate our operating performance and to evaluate the effectiveness of our core operating business strategies. We believe Adjusted EBITDA also assists investors and analysts in comparing our performance across reporting periods on a consistent basis because it excludes the impact of items that we do not believe reflect our core operating performance.

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

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

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

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

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

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

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

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

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


	Three Months Ended September 30,					Nine Months Ended September 30,
	2017		2016			2017			2016			Three Months Ended June 30,					Six Months Ended June 30,
			(As Revised)						(As Revised)			2018		2017			2018		2017
Net income (loss)	$	1,387	$	(4,789	)	$	(2,985	)	$	(9,083	)	$	1,355	$	(874	)	$	1,496	$	(4,372	)
Add:
Interest expense, net	227		173			711			463			485		236			722		484
Income tax provision (benefit)	107		(610		)	646			(1,041		)
Income tax expense												341		99			336		539
Depreciation and amortization	752		628			3,105			1,165			682		1,172			1,381		2,353
Stock-based compensation	195		128			670			128			377		220			740		475
Merger-related costs	—		3,536			—			3,536
Adjusted EBITDA	$	2,668	$	(934	)	$	2,147		$	(4,832	)	$	3,240	$	853		$	4,675	$	(521	)

LIQUIDITY AND CAPITAL RESOURCES

Our operations are financed through a combination of our existing cash, cash equivalents, available credit facilities, and sales of equity and debt instruments, based on our operating requirements and market conditions.

~~As of~~ ~~September 30, 2017, our cash and cash equivalents were~~ ~~$10.1 million~~ compared to $17.9 million at December 31, 2016. Our cash and cash equivalents as of September 30, 2017 included $3.4 million in cash balances held by our Korean subsidiary. The $7.7 million decrease in cash and cash equivalents was attributable to net cash used in operating, investing and financing activities of $0.6 million, $5.9 million and $1.8 million, respectively, partially offset by the effect of exchange rate changes on cash of $0.6 million.

~~Ability to Continue as~~We had a ~~Going Concern~~

The accompanying unaudited condensed consolidated financial statements have been prepared in conformity with GAAP, assuming we will continue as a going concern, which contemplates the realization of assets and satisfaction of liabilities in the normal course of business. Accordingly, the unaudited condensed consolidated financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that may result from the possible inability of DZS to continue as a going concern.

~~Although we generated $1.4 million of~~ net income ~~for the quarter ended September 30, 2017, we have incurred significant losses to date and our losses from operations may continue. We incurred net losses~~ of ~~$3.0 million and $15.3~~$1.5 million for the ~~nine~~six months ended ~~September~~June 30, ~~2017~~2018, and $1.2 million for the year ended December 31, ~~2016, respectively. We~~2017. As of June 30, 2018, we had an accumulated deficit of ~~$23.1~~$17.0 million and working capital of ~~$57.3~~$61.1 million. In addition, the Company had a net cash outflow from operations of $15.4 million ~~as of September~~for the six months ended June 30, ~~2017.~~2018. As of ~~September~~June 30, ~~2017,~~2018, we had ~~approximately $10.1~~$27.3 million in cash and cash equivalents, which included ~~$3.4~~$12.5 million in cash balances held by our Korean subsidiary and ~~$26.9~~$52.5 million in aggregate principal ~~amount~~debt of ~~outstanding borrowings under our short-term debt obligations and our loans from DNI and its affiliates.~~which $45.7 million was in current liabilities. In addition, as of June 30, 2018 we had ~~$7.6 million in aggregate borrowing availability under our credit facilities as of~~

~~September 30, 2017. We had $8.5~~$3.2 million committed as security for letters of credit under our revolving credit facilities, leaving $5.6 million in aggregate financing availability under these ~~facilities~~facilities. Our current lack of liquidity could harm us by:

increasing our vulnerability to adverse economic conditions in our industry or the economy in general;

requiring substantial amounts of cash to be used for debt servicing, rather than other purposes, including operations;

limiting our ability to plan for, or react to, changes in our business and industry; and

influencing investor and customer perceptions about our financial stability and limiting our ability to obtain financing or acquire customers.

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These factors indicate that cash flows might not be sufficient for us to meet our obligations as they come due in the ordinary course of ~~September 30, 2017. Due~~business for a period of 12 months from the date of this interim report on Form 10-Q.

Our ability to meet our obligations as they become due in the ~~amount~~ordinary course of ~~short-term debt obligations maturing within~~business for the next 12 months ~~and our recurring operating losses, our cash resources may not be sufficient to settle these short-term debt obligations. Our ability to continue as a "going concern" is dependent~~will depend on ~~many factors, including, among other things,~~ our ability to ~~comply with the covenants in our existing debt agreements, our ability to cure any defaults that occur under our debt agreements or to obtain waivers or forbearances with respect to any such defaults,~~achieve forecasted results and our ability to ~~pay, retire, amend, replace~~access funds approved under existing facilities. Management’s belief that we will achieve these results assumes that, among other things, we will continue to be successful in implementing our business strategy and that there will be no material adverse development in our business, liquidity or ~~refinance our indebtedness~~capital requirements. If one or more of these factors do not occur as defaults occur or as interest and principal payments come due. Although the process of amending, replacing or refinancing our short-term debt obligations is ongoing and we are in active discussions with multiple parties, there is no guarantee that they will result in transactions that are sufficientexpected, it could cause us to provide us with the required liquidity to remove the substantial doubt as to our ability to continue as a going concern. If we are unable to amend, replace, refinance our short-term debt obligations or raise the capital neededfail to meet ~~liquidity needs and finance capital expenditures and working capital, we may experience material adverse impacts on~~ our ~~business, operating results and financial condition.~~obligations as they come due.

We ~~have continued our~~plan to focus on cost ~~control and~~management, operating efficiency ~~along with~~and restrictions on discretionary spending. In ~~order to meet our liquidity needs and finance our capital expenditures and working capital needs for our business,~~addition, if necessary, we may ~~be required to~~ sell assets, issue or enter into amendments of our debt or equity securities, or purchase credit ~~insurance or borrow on potentially unfavorable terms. In addition, we~~insurance. We may ~~be required to~~also reduce the scope of our planned product development, reduce sales and marketing efforts and reduce our operations in low margin regions, including reductions in headcount. In fact, subsequent to the end of the quarter, on July 12, 2018, we entered into an Amended and Restated Credit and Security Agreement (the “A&R Domestic Credit Agreement”) and an Amended and Restated Credit and Security Agreement ("Ex-Im Subfacility") (the “A&R Ex-Im Credit Agreement”) with WFB, which amended and replaced our existing senior secured revolving line of credit and letter of credit facilities with WFB and revised certain reporting and compliance provisions, as described more fully in Note 7 to the unaudited condensed consolidated financial statements.

Based on our current plans and current business conditions, we believe that ~~our focused operating expense discipline~~these measures along with our existing cash, cash equivalents and available credit facilities will be sufficient to satisfy our anticipated cash requirements for at least the next 12 months ~~however~~from the ~~factors discussed above raise substantial doubt about our ability to continue as a going concern.~~date of this Quarterly Report on Form 10-Q.

Operating Activities

Net cash used in operating activities was $15.4 million for the ~~nine~~six months ended ~~September~~June 30, ~~2017 consisted~~2018, compared with net cash used of ~~a net loss of $3.0~~$6.8 million adjusted for non-cash charges totaling $3.6 million and a decrease in net operating assets totaling $1.2 million. The most significant components of the changes in net operating assets were an increase in accounts receivable of $2.9 million, an increase in inventory of $0.6 million and a decrease in accrued expenses of $4.3 million offset by an increase in accounts payable of $6.7 million. The increase in accounts receivable was primarily the result of the timing of receivables collections during the current year period. The increase in inventory was due to slower utilization of inventory in the current year period. The decrease in accounts payable was mainly due to reclassification of certain balances to short-term debt.

~~Net cash provided by operating activities~~ for the ~~nine~~six months ended ~~September~~June 30, ~~2016 consisted of a net loss of $9.1 million, adjusted for non-cash charges totaling $1.9 million and an~~2017. This increase in net operating assets totaling $20.4 million. The most significant components of the changes were a decrease in accounts receivables of $14 million and an increase in accrued expenses of $13.6 million offset by a decrease in accounts payable of $5.8 million. The increase in accounts receivable was primarily due to changes in operating assets and liabilities, resulting in using $19.2 million of cash for the ~~timing~~six months ended June 30, 2018, compared to providing $6.1 million of ~~receivables collections during~~cash for the ~~current year period. The decrease in accounts payable was primarily due to timing of payments.~~six months ended June 30, 2017.

Investing Activities

Net cash used in investing activities was $0.4 million for the ~~nine~~six months ended ~~September~~June 30, ~~2017~~2018 ~~consisted~~compared to net cash provided by investing activities of ~~an increase in restricted cash of $6.1~~$0.3 million ~~and purchase of property of equipment of $0.8 million, offset by proceeds from sale of short-term investments of $1.5 million. The increase in restricted cash was to provide collateral~~ for the ~~various surety bonds issued by DNI to a certain customer in Vietnam.~~

~~Net cash used in investing activities for the nine~~six months ended ~~September~~June 30, 2016 consisted of an increase in short-term and long-term loans to others of $1.4 million and an increase in restricted cash of $0.9 million, offset by a decrease in short-term and long-term loans of $1.9 million.

2017.

Financing Activities

Net cash provided by financing activities was $24.2 million for the six months ended June 30, 2018 compared to net cash used in financing activities of $0.9 million for the ~~nine~~six months ended ~~September~~June 30, ~~2017~~ ~~consisted~~2017. This change was primarily due to the borrowing of ~~cash used in repayments of borrowings of $15.6~~$6.3 million ~~offset by proceeds~~under the WFB Facility (as defined below) and KRW6.5 billion ($5.8 million) from ~~short-term borrowings of $13.8 million.~~

~~Net cash provided by financing activities~~DNI for the ~~nine~~six months ended ~~September~~June 30, ~~2016 consisted of proceeds from short-term borrowings and proceeds from long-term borrowings of $19.8 million and $6.8 million, respectively, offset by repayments of borrowings of $23.1 million.~~2018.

Cash Management

Our primary source of liquidity comes from our cash and cash equivalents, which totaled ~~$10.1~~$27.3 million at ~~September~~June 30, ~~2017~~2018, as well as our credit facilities, under which we had aggregate ~~borrowing~~financing availability of ~~$7.6~~$5.6 million as of ~~September~~June 30, ~~2017,~~2018, and under which ~~$8.5~~$3.2 million was committed as security for letters of credit as of ~~September~~June 30, ~~2017.~~2018. Our cash and cash equivalents as of ~~September~~June 30, ~~2017~~2018 included ~~$3.4~~$12.5 million in cash balances held by our Korean subsidiary.

WFB Facility

Wells Fargo Bank Facility

As of ~~September~~June 30, ~~2017,~~2018, we had a $25.0 million revolving line of credit and letter of credit facility (then and as subsequently amended and replaced) with WFB, (the ~~WFB Facility) with Wells Fargo Bank (WFB)~~"WFB Facility"). Under the WFB Facility, we ~~have~~had the option of borrowing funds at agreed upon interest rates. The amount that we are able to borrow under the WFB Facility varies based on eligible accounts receivable and inventory, as defined in the WFB Facility, as long as the aggregate amount outstanding does not exceed $25.0 million less the amount committed as security for letters of credit. To maintain availability of funds under the WFB Facility, we pay a commitment fee on the unused portion. The commitment fee is 0.25% per annum and is recorded as interest expense.

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As of ~~September~~June 30, ~~2017,~~2018, we had no$8.0 million in outstanding borrowings under ~~the~~its WFB Facility, and ~~$2.5~~$2.1 million was committed as security for letters of credit. WeSubsequent to the end of the quarter, on July 6, 2018, we repaid the $8.0 million borrowings under the WFB Facility. Based on our eligible accounts receivable and inventory, we had ~~$6.7~~$2.2 million of ~~borrowing~~financing availability under the WFB Facility as of ~~September~~June 30, ~~2017.~~2018. The interest rate on the WFB Facility was 4.59% at June 30, 2018.

Subsequent to the end of the quarter, on July 12, 2018, we entered into an Amended and Restated Credit and Security Agreement (the “A&R Domestic Credit Agreement”) and an Amended and Restated Credit and Security Agreement ("Ex-Im Subfacility") (the “A&R Ex-Im Credit Agreement”) with WFB, which amended and replaced our 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 provide for a revolving line of credit of $25.0 million (including up to $5.0 million of letters of credit), with the amount that we are able to borrow based on eligible accounts receivable and inventory, less the amount committed as security for letters of credit. To maintain availability of funds under the A&R Domestic Credit Agreement and the A&R Ex-Im Credit Agreement, we will continue to pay commitment fee of 0.25% per annum on the unused portion. The amounts borrowed under the amended WFB Facility continue to bear interest, payable monthly, at a floating rate equal to the three-month LIBOR plus a margin based on our average excess availability (as calculated under the WFB Facility). The ~~interest rate on the WFB Facility was 3.8% at September 30, 2017. The~~new maturity date under the WFB Facility ~~is March 31, 2019.~~was also extended from July 15, 2019 to July 12, 2021.

Our obligations under the WFB Facility are secured by substantially all of our ~~personal property~~ assets and those of our subsidiaries that guarantee the WFB Facility, including ~~our~~their intellectual property. The WFB Facility contains certain financial covenants, and customary affirmative ~~covenants~~ and negative covenants. If we default under the WFB Facility due to a covenant breach or otherwise, WFB may be entitled to, among other things, require the immediate repayment of all outstanding amounts and sell our assets to satisfy the obligations under the WFB Facility. ~~In the past we have violated the covenants in our former credit facility and received waivers for these violations.~~ As of ~~September~~June 30, ~~2017,~~2018, we were in compliance with the covenants under the WFB Facility. ~~We make no assurances that we will be in compliance with these covenants in the future.~~

Bank and Trade Facilities - Foreign Operations

Certain of our foreign subsidiaries have entered into various financing arrangements with foreign banks and other lending institutions consisting primarily of revolving lines of credit, trade facilities, term loans and export development loans. These facilities are renewed on an annual basis and are generally secured by a security interest in certain assets of the applicable foreign ~~subsidiaries.~~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~~June 30, ~~2017~~2018 and December 31, ~~2016,~~2017, we had an aggregate outstanding balance of ~~$18.4~~$31.9 million and ~~$17.6~~$22.8 million, respectively, under such financing arrangements, and the interest rate per annum applicable to outstanding borrowings under these financing arrangements ranged from 1.58% to 8.90% as of ~~September~~both June 30, ~~2017~~2018 and December 31, ~~2016 ranged from 2.3% to 5.9% and 1.9% to 4.1%, respectively.~~

2017.

Related-Party Debt

In connection with the Merger, on September 9, 2016, we entered into a loan agreement with DNI for a $5.0 million unsecured subordinated term loan facility. Under the loan agreement, we were permitted to request drawdowns of one or more term loans in an aggregate principal amount not to exceed $5.0 million. As of ~~September~~June 30, ~~2017,~~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 us without premium or penalty. The interest rate as of ~~September~~June 30, ~~2017~~2018 under this facility was 4.6% per annum.

~~In addition,~~Also, we borrowed $1.8 million from DNI for capital investment in February 2016, which amount was outstanding as of ~~September~~June 30, 2017. This loan matured in March 2017 with an option of renewal by mutual agreement, and bore interest at a rate of 6.9% per annum, payable annually. Effective February 27, 2017, we amended the terms of this loan to extend the repayment date from March 2017 to March 2018 and to reduce the interest rate from 6.9% to 4.6% per annum.

~~On June 23, 2017, we borrowed $3.5 million from Solueta, an affiliate of DNI. As of September 30, 2017, the aggregate outstanding balance under this loan agreement was $1.7 million.~~2018. This loan matures in ~~November 2017~~July 2019 and bears interest at a rate of 4.6% per annum, payable ~~monthly.~~annually.

Interest expense on these related-party borrowings was $0.1 million in the three and six months ended June 30, 2018 and 2017 respectively.

Future Requirements and Funding Sources

Our fixed commitments for cash expenditures consist primarily of payments under operating leases, inventory purchase commitments, and payments of principal and interest for debt obligations.

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From time to time, we may provide or commit to extend credit or credit support to our customers. This financing may include extending the terms for product payments to customers. Any extension of financing to our customers will limit the capital that we have available for other uses.

Our accounts receivable, while not considered a primary source of liquidity, represent a concentration of credit risk because a significant portion of the accounts receivable balance at any point in time typically consists of a relatively small number of customer account balances. As of ~~September~~June 30, ~~2017, three~~2018, two customers ~~accounted for 16% (a related-party),~~represented 23% and 11% ~~and 10%~~ of net accounts ~~receivables,~~receivable, respectively, and receivables from customers in countries other than the United States represented ~~84%~~80% of net accounts receivable. Additionally, Dasan Networks Japan has factoring arrangements in relation to certain accounts receivable with certain financial institutions as of June 30, 2018. We do not currently have any material commitments for capital expenditures, or any other material commitments aside from operating leases for our facilities, inventory purchase commitments and debt.

As discussed above in "Ability to Continue as a Going Concern", there is substantial doubt about our ability to continue as a going concern. The accompanying unaudited condensed consolidated financial statements do not include any adjustments that might be necessary if we are unable to continue as a going concern.

Contractual Commitments and Off-Balance Sheet Arrangements

At ~~September~~June 30, ~~2017,~~2018, our future contractual commitments by fiscal year were as follows (in thousands):


			Payments due by period														Payments due by period
	Total		2017		2018		2019		2020		2021		Thereafter		Total		2018		2019		2020		2021		2022		Thereafter
Operating leases	$	20,166	$	967	$	3,359	$	2,496	$	2,358	$	2,264	$	8,722	$	22,711	$	2,043	$	3,993	$	2,998	$	2,590	$	2,664	$	8,423
Purchase commitments	2,966		2,966		—		—		—		—		—		4,272		4,272		—		—		—		—		—
Short-term debt	18,382		18,382		—		—		—		—		—
Related-party debt	8,544		1,744		1,800		—		—		5,000		—
Short-term debt - bank and trade facilities															39,874		39,874		—		—		—		—		—
Short-term debt - related party															5,795		5,795		—		—		—		—		—
Long-term debt -related party															6,800		—		1,800		—		5,000		—		—
Other payable - related party															1,449		1,449		—		—		—		—		—
Royalty obligations															500		500		—		—		—		—		—
Total future contractual commitments	$	50,058	$	24,059	$	5,159	$	2,496	$	2,358	$	7,264	$	8,722	$	81,401	$	53,933	$	5,793	$	2,998	$	7,590	$	2,664	$	8,423

Operating Leases

The operating lease amounts shown above represent primarily off-balance sheet arrangements. For operating lease commitments, a liability is generally not recorded on our balance sheet unless the facility represents an excess facility for which an estimate of the facility exit costs has been recorded on our balance sheet, net of estimated sublease income. For operating leases that include contractual commitments for operating expenses and maintenance, estimates of such amounts are included based on current rates. Payments made under operating leases ~~will be~~are treated as rent expense for the facilities currently being utilized.

Purchase Commitments

The purchase commitments shown above represent non-cancellable inventory purchase commitments as of ~~September~~June 30, ~~2017.~~2018.

Short-term Debt

Our short-term debt obligations have been recorded as liabilities on our balance sheet, and are comprised ~~$18.4~~of $31.9 million in outstanding borrowings under the credit facilities of our foreign subsidiaries and $8.0 million in outstanding borrowings under the WFB Facility as of ~~September~~June 30, ~~2017.~~2018. The amount shown above represents scheduled principal repayments under the facilities, but not the associated interest payments which may vary based on changes in market interest rates. Subsequent to the end of the quarter, on July 6, 2018, we repaid the $8.0 million borrowings under our WFB Facility. At ~~September~~June 30, ~~2017,~~2018, the interest rate per annum applicable to outstanding borrowings under the trade facilities of our foreign subsidiaries ranged from ~~2.3%~~1.58% to ~~5.9%. The amount shown above excludes $3.5 million in short-term debt obligations to related parties, which is included in~~8.90% and was 4.59% under the ~~table as related-party debt (as discussed further below).~~

WFB Facility. See above under ~~“Cash Management”~~"Cash Management" for further information about these facilities.

Related-Party Debt

As of ~~September~~June 30, ~~2017,~~2018, we had borrowed an aggregate of ~~$8.5 million from related parties, which included~~ $6.8 million from DNI, which consisted of ~~which~~a $5.0 million ~~and $1.8 million mature~~unsecured subordinated term loan facility which matures in September 2021 and ~~March 2018, respectively, and $1.7~~a $1.8 million ~~from Solueta, an affiliate of DNI,~~loan for capital investment which matures in ~~November 2017. The~~July 2019. In addition, DNS Korea has a secured loan outstanding of KRW 6.5 billion ($5.8 million) which matures in June 2019. All three loans bear interest at a rate of 4.6% per ~~annum applicable to these borrowings was 4.6%.~~annum.

See above under “Cash Management” for further information about our related-party debt.

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RECENT ACCOUNTING PRONOUNCEMENTS

Please refer to “~~Part I,~~Note 1(g) to the unaudited condensed consolidated financial statements included in part 1, Item ~~1. Financial Statements” and “Notes to Condensed Consolidated Financial Statements, Note~~ 1 ~~(h) – Recent Accounting Pronouncements~~.”of this report.

Item 3. Quantitative and Qualitative Disclosures about Market Risk

Concentration of Credit Risk

Financial instruments which potentially subject us to concentrations of credit risk consist primarily of cash and cash equivalents, and accounts receivable. Cash and cash equivalents consist principally of ~~demand~~financial deposit and money market accounts. Cash and cash equivalents are principally held with various domestic financial institutions with high credit standing. We perform ongoing credit evaluations of our customers and generally do not require collateral. Allowances are maintained for potential doubtful accounts.

For the three and six months ended ~~September~~June 30, 2018, one customer accounted for 22% and 15% of net revenue. For the three months ended June 30, 2017, two customers represented ~~10%~~11% and 9%14% of net revenue, respectively. For the ~~nine~~six months ended ~~September~~June 30, 2017, ~~two customers each~~one customer represented 9%11% (a related-party) of net revenue (one of which was a related-party). For the three months ended September 30, 2016, three customers represented 18%, 16% (a related-party) and 12% of net revenue, respectively. For the nine months ended September 30, 2016, three customers represented 23%, 21% (a related-party) and 12% of net revenue, respectively.revenue.

Interest Rate Risk

Our exposure to market risk for changes in interest rates relates primarily to our variable rate outstanding debt. As of ~~September~~June 30, ~~2017~~,2018, our outstanding short-term debt balance was ~~$26.9~~$45.7 million, which ~~comprised $18.4 million in aggregate~~consisted of principal amount of borrowings under ~~our~~the short-term credit facilities ~~and $8.5 million in loans from~~of our foreign subsidiaries, DNI and ~~its affiliates (which~~the WFB Facility (all of which bear interest at a ~~fixed~~variable rate). Amounts borrowed under our short-term credit facilities bore interest ranging from ~~2.3%~~1.58% to ~~5.9%~~8.90% as of ~~September~~June 30, ~~2017~~2018 and amounts borrowed under the WFB Facility bore interest at 4.59%. Assuming the outstanding balance on our variable rate debt remains constant over a year, a 2%1% increase in the interest rate would decrease pre-tax income and cash flow by approximately ~~$0.5~~$0.3 million. As of June 30, 2018, our outstanding long-term debt balance was $6.8 million and consisted of loans from DNI and its affiliates (which bear interest at fixed rates).

Foreign Currency Risk

We transact business in various foreign countries, and a significant portion of our assets is located in Korea. We have sales operations throughout Asia, Europe ~~Asia,~~ the Middle East and Latin America. We are exposed to foreign currency exchange rate risk associated with foreign currency denominated assets and liabilities, primarily intercompany receivables and payables. Accordingly, our operating results are exposed to changes in exchange rates between the U.S. dollar and those currencies. ~~During the first nine months of 2017 and during fiscal year 2016, we did not hedge any of our foreign currency exposure.~~

We have performed a sensitivity analysis as of ~~September~~June 30, ~~2017~~2018 using a modeling technique that measures the impact on the balance sheet arising from a hypothetical 10% adverse movement in the levels of foreign currency exchange rates relative to the U.S. dollar, with all other variables held constant. The sensitivity analysis indicated that a hypothetical 10% adverse movement in foreign currency exchange rates would result in a foreign exchange loss of ~~$2.3~~approximately $2.8 million at ~~September~~June 30, ~~2017~~2018. This sensitivity analysis assumes a parallel adverse shift in foreign currency exchange rates, which do not always move in the same direction. Actual results may differ materially.

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Item 4. Controls and Procedures

Disclosure Controls and Procedures

We maintain disclosure controls and procedures designed to provide reasonable assurance of achieving the objective that information required to be disclosed in our reports filed or submitted pursuant to the Securities Exchange Act of 1934 (the Exchange Act) is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and that such information is accumulated and communicated to our management, including our ~~Co-Chief~~Chief Executive ~~Officers~~Officer and Chief Financial Officer, as appropriate to allow for timely decisions regarding required disclosures. In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures.

As required by ~~SEC~~ Rule 13a-15(b), under the Exchange Act, we conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures as of ~~September~~June 30, ~~2017,~~2018, the end of the period covered by this report. The evaluation was done under the supervision and with the participation of management, including our ~~Co-Chief~~Chief Executive ~~Officers~~Officer and our Chief Financial Officer. Based upon this evaluation, our ~~Co-Chief~~Chief Executive ~~Officers~~Officer and Chief Financial Officer concluded that, because of the material weaknesses in our internal control over financial reporting that existed as of December 31, ~~2016~~2017 and that have not yet been remediated, as described below, our disclosure controls and procedures were not effective as of ~~September~~June 30, ~~2017.~~2018.

A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting such that there is a reasonable possibility that a material misstatement of the registrant’s annual or interim financial statements will not be prevented or detected on a timely basis. ~~The~~Based on the results of the independent investigation and due to the incorrect application of generally accepted accounting principles that resulted in material misstatements and a restatement of our unaudited condensed consolidated financial statements for the three and nine months ended September 30, 2016, management identified material weaknesses ~~that management previously identified~~ in ~~connection with its evaluation of~~ our internal control over financial reporting as of December 31, 2016 ~~were as follows:~~which continued to exist at December 31, 2017. Specifically, we did not maintain an effective control environment as there was an insufficient complement of personnel with appropriate accounting knowledge, experience and competence, resulting in incorrect application of generally accepted accounting principles. This material weakness contributed to the following material weaknesses. We did not maintain effective controls over our financial close process. Also, we did not design and maintain effective controls over the review of supporting information to determine the completeness and accuracy of the accounting for complex transactions, specifically related to the business combination that occurred on September 9, 2016, which resulted in an incorrect application of generally accepted accounting principles that resulted in material misstatements and a restatement of our unaudited condensed consolidated financial statements for the three and nine months period ended September 30, 2016. Additionally, these material weaknesses could result in a misstatement in the financial statements that would result in a material misstatement in the annual or interim consolidated financial statements that would not be prevented or detected.

In light of the material weakness described above, and based on the criteria set forth in Internal Control —Integrated Framework (2013) issued by the Committee Sponsoring Organizations of the Treadway Commission (COSO), our management concluded that our internal control over financial reporting was not effective as of December 31, ~~2016.~~2017.

As of the date of this report, we are re-assessing the design of our controls and modifying processes related to the accounting for significant and unusual transactions as well as enhancing monitoring and oversight controls in the application of applicable accounting guidance related to such transactions. In connection therewith, we have hired and we anticipate that we will hire additional accounting personnel with relevant skills, training and experience, and conduct further training of accounting and finance personnel.

Changes in Internal Control over Financial Reporting

Except as described above, there were no changes in our internal control over financial reporting that occurred during our last fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. Merger-related integration activities may lead us to modify certain internal controls in future periods.

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Inherent Limitations on Effectiveness of Controls

Our management, including our ~~Co-Chief~~Chief Executive ~~Officers~~Officer and Chief Financial Officer, does not expect that our disclosure controls and procedures or our internal control over financial reporting will prevent or detect all ~~error~~errors and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system’s objectives will be met. The design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Further, because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that misstatements due to error or fraud will not occur or that all control issues and instances of fraud, if any, within the company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns can occur because of simple error or mistake. Controls can also be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. The design of any system of controls is based in part on certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Projections of any evaluation of controls effectiveness to future periods are subject to risks. Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies or procedures.

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PART II. OTHER INFORMATION

Item 1. Legal Proceedings

We are 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, we do not expect that the ultimate costs to resolve these matters will have a material adverse effect on our 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.

Item 1A. Risk Factors

In addition to the other information set forth in this report, you should carefully consider the factors discussed in Part I, "Item 1A, Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, ~~2016,~~2017, which could materially affect our business, financial condition or future results. ~~There have been no material changes to the risk factors described in the "Risk Factors" section in our Annual Report on Form 10-K for the year ended December 31, 2016.~~ The risks described in our Annual Report on Form 10-K are not the only risks facing our company. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition and/or operating results.

Item 2.6. Exhibits

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EXHIBIT INDEX



Exhibit Number	Description


10.1	~~Letter agreement,~~Amended and Restated Credit and Security Agreement, dated as of July ~~3, 2017,~~12, 2018, by and among DASAN Zhone Solutions, Inc., ZTI Merger Subsidiary III, Inc., Premisys Communications, Inc., Zhone Technologies International, Inc., Paradyne Networks, Inc., Paradyne Corporation, ~~Dasan~~DASAN Network Solutions, Inc. and Wells Fargo Bank, National Association ~~(incorporated by reference to Exhibit 10.1 of registrant's Current Report on Form 8-K dated July 3, 2017)~~
10.2	~~General Release of Claims,~~Amended and Restated Credit and Security Agreement (Ex-Im Subfacility), dated as of ~~September 11, 2017,~~July 12, 2018, by and ~~between~~among DASAN Zhone Solutions, Inc. ~~and James Norrod~~
~~10.3~~	~~General Release of Claims, dated as of September 11, 2017, by and between~~, ZTI Merger Subsidiary III, Inc., Premisys Communications, Inc., Zhone Technologies International, Inc., Paradyne Networks, Inc., Paradyne Corporation, DASAN ~~Zhone~~Network Solutions, Inc. and ~~Kirk Misaka~~Wells Fargo Bank, National Association
31.1	Certification of Chief Executive Officer ~~and Acting~~Pursuant to Securities Exchange Rules 13a-14(a)/15d-14(a), as Adopted, Pursuant to Section 302 of the Sarbanes Oxley Act of 2002
31.2	Certification of Chief Financial Officer Pursuant to ~~Rule~~Securities Exchange Rules 13a-14(a)/15d-14(a), as Adopted, Pursuant to Section 302 of the Sarbanes Oxley Act of 2002
32.1	Section 1350 Certification of Chief Executive Officer and ~~Acting~~ Chief Financial Officer
101.INS	XBRL Instance Document
101.SCH	XBRL Taxonomy Extension Schema
101.CAL	XBRL Taxonomy Extension Calculation Linkbase
101.DEF	XBRL Taxonomy Extension Definition Linkbase
101.LAB	XBRL Taxonomy Extension Labels Linkbase
101.PRE	XBRL Taxonomy Extension Presentation Linkbase

Table of Contents

SIGNATURES

Pursuant to the retirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.



	DASAN ZHONE SOLUTIONS, INC.

Date: ~~November 14, 2017~~August 10, 2018
	By:	/s/ IL YUNG KIM
	Name:	Il Yung Kim
	Title:	President and Chief Executive Officer ~~and Acting~~


	By:	/s/ MICHAEL GOLOMB
	Name:	Michael Golomb
	Title:	Chief Financial Officer, Corporate Treasurer and Secretary

3940



	Shares	Estimated Fair Value
Shares of Legacy Zhone stock as of September 8, 2016	6,874	$	40,902
Legacy Zhone stock options	198	540
Total Purchase Consideration		$	41,442



	Useful life (in Years)	Fair Value
Developed technology	5	$	3,060
Customer relationships	10	5,240
Backlog	1	2,179
		$	10,479



	September 30, 2016
(in thousands)	Three Months Ended			Nine Months Ended
Pro forma total net revenue	$	39,740		$	142,530
Pro forma net loss	(15,569		)	(25,504		)



		Three Months Ended September 30, 2017
Counterparty	DNI Ownership Interest	Sales		Cost of revenue		Manufacturing (Cost of revenue)		Research and product development		Selling, marketing, general and administrative		Other Expenses
DNI (Parent Company)	N/A	$	3,976	$	3,604	$	—	$	—	$	1,291	$	51
CHASAN Networks Co., Ltd.	100%	—		—		257		20		—		—
DASAN FRANCE	100%	662		576		—		—		83		—
DASAN INDIA Private Limited	100%	—		—		—		—		30		—
D-Mobile	100%	1,233		1,077		—		—		122		—
HANDYSOFT, Inc.	17.64%	54		12		—		—		6		4
Tomato Soft Ltd.	100%	—		—		43		108		—		—
Tomato Soft (Xi'an) Ltd.	100%	—		—		—		144		—		—
		$	5,925	$	5,269	$	300	$	272	$	1,532	$	55



Guarantor	Amount Guaranteed		Description of Obligations Guaranteed
DNI (Parent Company)	$	3,349	Borrowings from Shinhan Bank
DNI (Parent Company)	1,884		Purchasing card from Shinhan Bank
DNI (Parent Company)	10,493		Credit facility & purchasing card from Industrial Bank of Korea
DNI (Parent Company)	6,000		Credit facility from NongHyup Bank
DNI (Parent Company)	523		Purchasing card from NongHyup Bank
Industrial Bank of Korea	6,512		Credit facility
Industrial Bank of Korea	864		Performance bonds
NongHyup Bank	4,567		Credit facility
Shinhan Bank	191		Purchasing card
KEB Hana Bank	33		Performance bonds
State Bank of India	38		Performance bonds
Seoul Guarantee Insurance Co.	54		Performance bonds
Seoul Guarantee Insurance Co.	373		Warranty bonds
	$	34,881