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

	Three Months Ended
	March 31,
	2019			2018
Net revenue:
Third parties	$	73,234		$	57,906
Related parties		855			1,598
Total net revenue		74,089			59,504
Cost of revenue:
Products and services - third parties		48,172			36,206
Products and services - related parties		639			1,410
Amortization of intangible assets		408			153
Total cost of revenue		49,219			37,769
Gross profit		24,870			21,735
Operating expenses:
Research and product development		10,184			8,977
Selling, marketing, general and administrative		15,039			12,394
Amortization of intangible assets		472			131
Total operating expenses		25,695			21,502
Operating income (loss)		(825	)		233
Interest income		88			86
Interest expense		(871	)		(323	)
Other income (loss), net		228			140
Income (loss) before income taxes		(1,380	)		136
Income tax (benefit) provision		77			(5	)
Net income (loss)		(1,457	)		141
Net income attributable to non-controlling interest		181			34
Net income (loss) attributable to DASAN Zhone Solutions, Inc.	$	(1,638	)	$	107

Foreign currency translation adjustments		(1,124	)		318
Comprehensive income (loss)		(2,581	)		459
Comprehensive income attributable to non-controlling interest		180			64
Comprehensive income (loss) attributable to DASAN Zhone Solutions, Inc.	$	(2,761	)	$	395

Basic and diluted net income (loss) per share attributable to DASAN Zhone Solutions, Inc.	$	(0.10	)	$	0.01
Weighted average shares outstanding used to compute basic net income (loss) per share		16,593			16,416
Weighted average shares outstanding used to compute diluted net income (loss) per share		16,593			16,626

Three Months Ended Nine Months Ended
September 30, September 30,
2018 2017 2018 2017
Net revenue:
Third parties $ 70,227
$ 60,513
$ 203,317
$ 150,834
Related parties 1,687
5,925
4,358
27,657
Total net revenue 71,914
66,438
207,675
178,491
Cost of revenue:
Products and services - third parties 46,565
38,301
134,234
95,103
Products and services - related parties 1,765
5,569
4,651
22,851
Amortization of intangible assets 153
153
459
459
Total cost of revenue 48,483
44,023
139,344
118,413
Gross profit 23,431
22,415
68,331
60,078
Operating expenses:
Research and product development 8,655
8,939
26,346
27,462
Selling, marketing, general and administrative 11,106
11,661
35,212
33,096
Amortization of intangible assets 131
154
393
1,191
Total operating expenses 19,892
20,754
61,951
61,749
Operating income (loss) 3,539
1,661
6,380
(1,671 )
Interest income 42
36
203
82
Interest expense (447 ) (263 ) (1,330 ) (793 )
Other income (expense), net (572 ) 60
(859 ) 43
Income (loss) before income taxes 2,562
1,494
4,394
(2,339 )
Income tax expense 735
107
1,071
646
Net income (loss) 1,827
1,387
3,323
(2,985 )
Net income (loss) attributable to non-controlling interest 29
(12 ) 2
172
Net income (loss) attributable to DASAN Zhone Solutions, Inc. $ 1,798
$ 1,399
$ 3,321
$ (3,157 )

Foreign currency translation adjustments 391
(284 ) (1,839 ) 1,782
Comprehensive income (loss) 2,218
1,103
1,484
(1,203 )
Comprehensive income (loss) attributable to non-controlling interest 16
(14 ) (3 ) 191
Comprehensive income (loss) attributable to DASAN Zhone Solutions, Inc. $ 2,202
$ 1,117
$ 1,487
$ (1,394 )

Net income (loss) per share attributable to DASAN Zhone Solutions, Inc.
Basic $ 0.11
$ 0.09
$ 0.20
$ (0.19 )
Diluted $ 0.11
$ 0.09
$ 0.20
$ (0.19 )

Weighted average shares outstanding used to compute basic net income (loss) per share 16,683
16,382
16,425
16,380
Weighted average shares outstanding used to compute diluted net income (loss) per share 16,891
16,382
16,640
16,380

See accompanying notes to unaudited condensed consolidated financial statements.

~~Table of Contents~~

DASAN ZHONE SOLUTIONS, INC. AND SUBSIDIARIES

Unaudited Condensed Consolidated Statements of ~~Cash Flows~~

Stockholders' Equity and Non-Controlling Interest

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

	Common stock				Additional paid-in		Accumulated other comprehensive			Accumulated			Total stockholders			Non- controlling			Total stockholders' equity and non-controlling
	Shares		Amount		capital		income (loss)			deficit			equity			interest			interest
For the Three-Month Period Ended March 31, 2019:												��
Balance as of December 31, 2018		16,587	$	16	$	93,192	$	(192	)	$	(15,777	)	$	77,239		$	615		$	77,854
Exercise of stock options and restricted stock grant		9		—		97		—			—			97			—			97
Stock-based compensation		—		—		728		—			—			728			—			728
Net loss		—		—		—		—			(1,638	)		(1,638	)		181			(1,457	)
Other comprehensive loss		—		—		—		(1,124	)		—			(1,124	)		(1	)		(1,125	)
Balance as of March 31, 2019		16,596	$	16	$	94,017	$	(1,316	)	$	(17,415	)	$	75,302		$	795		$	76,097

For the Three-Month Period Ended March 31, 2018:
Balance as of December 31, 2017		16,410	$	16	$	90,198	$	1,871		$	(18,852	)	$	73,233		$	534		$	73,767
ASC 606 opening balance adjustment		—		—		—		—			342			342			—			342
Exercise of stock options and restricted stock grant		21		—		111		—			—			111			—			111
Stock-based compensation		—		—		363		—			—			363			—			363
Net income		—		—		—		—			107			107			34			141
Other comprehensive loss		—		—		—		257			—			257			30			287
Balance as of March 31, 2018		16,431	$	16	$	90,672	$	2,128		$	(18,403	)	$	74,413		$	598		$	75,011

Nine Months Ended
September 30,
2018 2017
Cash flows from operating activities:
Net income (loss) $ 3,323
$ (2,985 )
Adjustments to reconcile net income (loss) to net cash used in operating activities:

Depreciation and amortization 2,033
3,105
Stock-based compensation 1,357
670
Valuation allowance on inventories 753
1,003
Unrealized loss (gain) on foreign currency transactions 226
(185 )
Deferred taxes (56 ) —
Changes in operating assets and liabilities:

Accounts receivable (14,536 ) (2,948 )
Inventories (21,967 ) (1,581 )
Prepaid expenses and other assets (7,942 ) (101 )
Accounts payable 24,790
6,713
Accrued and other liabilities (3,695 ) (4,314 )
Net cash used in operating activities (15,714 ) (623 )
Cash flows from investing activities:

Proceeds from sale of short-term investments —
1,463
Purchase of short-term investments —
(430 )
Proceeds from disposal of property and equipment and other assets 1
6
Purchase of property and equipment (753 ) (840 )
Purchase of intangible asset —
(72 )
Net cash (used in) provided by investing activities (752 ) 127
Cash flows from financing activities:

Proceeds from short-term borrowings from bank and trade facilities 61,419
13,778
Proceeds from short-term borrowings from related party 6,098
—
Repayments of borrowings from bank and trade facilities (48,739 ) (15,627 )
Repayments of borrowings related party (4,460 ) —
Proceeds from issuance of common stock 853
28
Net cash provided by (used in) financing activities 15,171
(1,821 )
Effect of exchange rate changes on cash and restricted cash (1,417 ) 977
Net decrease in cash and cash equivalents (2,712 ) (1,340 )
Cash, cash equivalents and restricted cash at beginning of period 31,412
24,543
Cash, cash equivalents and restricted cash at end of period $ 28,700
$ 23,203
Reconciliation of cash, cash equivalents and restricted cash to statement of financial position
      Cash and equivalents $ 20,028
$ 10,145
      Restricted cash 7,825
13,058
      Long-term restricted cash 847
—
      Cash, cash equivalents and restricted cash in statement of financial position $ 28,700
$ 23,203

See accompanying notes to unaudited condensed consolidated financial statements.

DASAN ZHONE SOLUTIONS, INC. AND SUBSIDIARIES

Unaudited Condensed Consolidated Statements of Cash Flows

(In thousands)

	Three Months Ended
	March 31,
	2019			2018
Cash flows from operating activities:
Net income (loss)	$	(1,457	)	$	141
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
Depreciation and amortization		1,417			699
Amortization of deferred financing costs		73			—
Bargain purchase gain on acquisition		(334	)		—
Stock-based compensation		825			363
Provision for inventory write-down		14			434
Allowance for doubtful accounts		223			(130	)
Provision for sales returns	218			185
Unrealized loss (gain) on foreign currency transactions		(95	)		20
Deferred taxes		19			(183	)
Changes in operating assets and liabilities:
Accounts receivable		7,930			(9,184	)
Inventories		3,828			(7,781	)
Contract assets		(6,967	)		—
Prepaid expenses and other assets		(207	)		(1,918	)
Accounts payable		(3,966	)		6,013
Accrued and other liabilities		(1,331	)		(1,484	)
Contract liabilities		(5,166	)		(703	)
Net cash used in operating activities		(4,976	)		(13,528	)
Cash flows from investing activities:
Proceeds from disposal of property, plant and equipment and other assets		—			1
Purchases of property, plant and equipment		(109	)		(86	)
Acquisition of business, net of cash acquired		(4,697	)		—
Net cash used in investing activities		(4,806	)		(85	)
Cash flows from financing activities:
Repayments of short-term borrowings		(17,052	)		(8,250	)
Repayments of related party term loan		(5,000	)		—
Proceeds from short-term borrowings and line of credit		4,324			18,849
Proceeds from long-term borrowings		25,000			—
Proceeds from related party term loan		—			6,064
Deferred financing costs		(2,184	)		—
Proceeds from issuance of common stock		—			111
Net cash provided by financing activities		5,088			16,774
Effect of exchange rate changes on cash, cash equivalents, and restricted cash		(306	)		110
Net increase (decrease) in cash and cash equivalents and restricted cash		(5,000	)		3,271
Cash and cash equivalents and restricted cash at beginning of period		35,648			31,412
Cash and cash equivalents and restricted cash at end of period	$	30,648		$	34,683
Reconciliation of cash, cash equivalents and restricted cash to statement of financial position
Cash and equivalents	$	20,872		$	23,158
Restricted cash		9,165			10,118
Long-term restricted cash		611			1,407
	$	30,648		$	34,683

See accompanying notes to unaudited condensed consolidated financial statements.

Notes to Unaudited Condensed ~~Consolidated~~Consolidated Financial Statements

(1)
~~(1)~~	Organization and Summary of Significant Accounting Policies


(a)	Description of Business

DASAN Zhone Solutions, Inc. (referred to, collectively with its subsidiaries, as ~~"DZS"~~“DZS” or the ~~"Company"~~“Company”) is a global provider of ultra-broadband network access solutions and communications ~~equipment for~~platforms deployed by advanced Tier 1, 2 and 3 service ~~provider~~providers and enterprise ~~networks.~~customers. 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~~900 customers in more than 5080 countries worldwide.

DZS was incorporated under the laws of the state of Delaware in June 1999, under the name Zhone Technologies, Inc. On September 9, 2016, the Company acquired Dasan Network Solutions, Inc., a California corporation ~~("DNS"~~(“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"~~“Merger”). At the effective time of the Merger, all issued and outstanding shares of capital stock of DNS held by DASAN Networks, Inc. ~~("DNI"~~(“DNI”) were canceled and converted into the right to receive shares of the Company's common stock in an amount equal to ~~57.3%~~58% of the issued and outstanding shares of the Company's common stock immediately following the Merger. In connection with the Merger, the Company changed its name from Zhone Technologies, Inc. to DASAN Zhone Solutions, Inc.

The Company is headquartered in Oakland, California with flexible in-house production facilities in Seminole, Florida and Hanover, Germany (acquired as part of the Keymile Acquisition in January 2019), and contract manufacturers located in China, India, Korea and Vietnam. The Company also maintains offices to provide sales and customer support at ~~various domestic and international~~global locations.


(b)	Risks and Uncertainties

~~Liquidity~~

The accompanying consolidated financial statements have been prepared in conformity with generally accepted accounting principles in the United States ("(“U.S. ~~GAAP"~~GAAP”), assuming the Company will continue as a going concern.

~~The~~

Although the Company had net income of ~~$3.3~~$2.8 million ~~for the nine months ended September 30, 2018,~~ and $1.2 million for the ~~year~~years ended December 31, ~~2017.~~2018 and 2017, the Company had a net loss of $1.5 million for the quarter ended March 31, 2019 and has incurred significant losses in prior years. As of ~~September 30, 2018,~~March 31, 2019, the Company had an accumulated deficit of ~~$15.2~~$17.4 million and working capital of ~~$66.9~~$86.5 million. ~~In addition,~~As of March 31, 2019, the Company had ~~a net cash outflow from operations of $15.7 million for the nine months ended September 30, 2018. As of September 30, 2018, the Company had $20.0~~$20.9 million in cash and cash equivalents, which included ~~$6.0~~$12.2 million in cash balances held by its international subsidiaries, and ~~$42.3~~$57.5 million in aggregate principal amount of short-term debt ~~of which $37.3 million was in current liabilities. Also,~~obligations, other long-term debt and long-term related-party borrowings. In addition, as of ~~September 30, 2018,~~March 31, 2019, the Company had ~~$6.4~~$12.3 million committed as ~~cash collateral~~security for letters of credit under its revolving credit facilities, ~~and $12.9 million outstanding indebtedness under those facilities,~~ leaving ~~$21.3~~$21.7 million in aggregate ~~financing~~borrowing availability under ~~the~~these facilities. Subsequent to the end of the quarter, the Company repaid $6.0 million in borrowings to Wells Fargo Bank ("WFB"), which constituted all of the outstanding balance under its Wells Fargo Bank Facility (the “WFB Facility”). On July 12, 2018, the Company amended the WFB Facility by entering into an Amended and Restated Credit and Security Agreement (the “A&R Domestic Credit Agreement”) and an Amended and Restated Credit and Security Agreement (the “A&R Ex-Im Credit Agreement”) with WFB which amended and replaced the Company’s existing senior secured revolving line of credit and letter of credit facilities with WFB and revised certain reporting and compliance provisions. The A&R Domestic Credit Agreement and the A&R Ex-Im Credit Agreement (together, the “Amended WFB Facility") is described more fully in Note 7 to the unaudited condensed consolidated financial statements. On October 22, 2018, the Company borrowed $3.0 million under the Amended WFB Facility. On October 31, 2018, the Company repaid the $3.0 million in full.

The Company’s current lack of liquidity could harm itthe Company by:

~~increasing~~

Increasing its vulnerability to adverse economic conditions in its industry or the economy in general;

~~requiring~~

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

~~limiting~~

Limiting its ability to plan for, or react to, changes in its business and industry; and

~~limiting its ability to complete the Keymile acquisition; and~~

~~Table of Contents~~

~~influencing~~

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

These factors indicate that cash flows might not be sufficient for the Company to meet its obligations as they come due in the ordinary course of business for a period of 12 months from the date of this Quarterly Report on Form 10-Q.

The Company’s ability to meet its obligations as they become due in the ordinary course of business for the next 12twelve (12) months will depend on its ability to (i) to achieve forecasted results, (ii) access ~~funds approved~~capital under its existing or new credit facilities and/or raise additional capital through ~~sales of the Company’s common stock to the~~debt or equity financing from public and/or private capital markets and (iii) effectively manage inventory procurement. If the Company cannot access or raise additional ~~funds~~capital when ~~it needs or wants them,~~needed, its operations and prospects could be negatively affected. Management’s belief that itthe Company will be able to achieve forecasted results assumes that, among other things, the Company will continue to be successful in implementing its business strategy and that there will be no material adverse development in its business, liquidity or capital requirements. If one or more of these factors do not occur as expected, it could cause the Company to fail to meet its obligations as they come due.

The Company plans to focus on capital raising, cost management, operating efficiency and restrictions on discretionary spending. In addition, if necessary, the Company may sell assets, issue or enter into amendments of its debt or equity securities, or purchase credit insurance. The Company may also reduce the scope of its planned product development, reduce sales and marketing efforts and reduce its operations in low margin regions, including reductions in headcount.

Based on the Company's current plans and current business conditions, the Company believes that ~~these measures along with~~ its existing cash, cash equivalents and available credit facilities will be sufficient to satisfy its anticipated cash requirements for at least the next ~~12 months from the date of this Quarterly Report on Form 10-Q.~~twelve (12) months.

(c)

DNI Ownership

~~Other Uncertainties~~

DNI owned approximately ~~57.3%~~57.2% of the outstanding shares of the Company's common stock as of ~~September 30, 2018. For so~~March 31, 2019. As long as DNI and its affiliates hold shares of the Company's common stock representing at least a majority of the votes, DNI will be able to freely nominate and elect all the members of the Company's board of directors, subject to ~~the provisions of the Company's bylaws and~~ applicable requirements under Nasdaq listing rules and applicable laws. The directors elected by DNI will have the authority to make decisions affecting the Company's capital structure, including the issuance of additional capital stock or options, the incurrence of additional indebtedness, the implementation of stock repurchase programs, and the declaration of dividends. The interests of DNI may not coincide with the interests of the Company's other stockholders or with holders of the Company's indebtedness. DNI’s ability to control all matters submitted to the Company's stockholders for approval limits the ability of other stockholders to influence corporate matters and, as a result, the Company may take actions that the Company's other stockholders or holders of the Company's indebtedness do not view as beneficial. See ~~Notes 9~~Note 11 and 11Note 14 to the unaudited condensed consolidated financial statements for additional information.


~~(c)~~ (d)	~~Reclassifications~~

For the three months ended September 30, 2017, certain statement of comprehensive income (loss) items have been reclassified to correctly reflect research and product development expenses and selling, marketing, general and administrative expenses of $0.1 million and $0.2 million, respectively, which were previously incorrectly classified as cost of revenue-products and services. For the nine months ended September 30, 2017 certain prior period statement of comprehensive loss items have been reclassified to correctly reflect research and product development expenses and selling, marketing, general and administrative expenses of $0.4 million and $0.6 million, respectively, which were incorrectly classified as cost of revenue-products and services.


~~(d)~~	Basis of Presentation

For a complete description of what the Company believes to be the critical accounting policies and estimates used in the preparation of ~~the Company's~~its unaudited condensed consolidated financial statements, refer to the ~~Company's~~Company’s Annual Report on Form 10-K for the year ended December 31, ~~2017.~~

2018.

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with U.S. GAAP for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, ~~the Company does~~they do not include all of the information and footnotes required by U.S. GAAP for complete financial statements.

~~Table of Contents~~

The unaudited condensed consolidated financial statements reflect all adjustments (consisting only of normal recurring adjustments) that, in the opinion of management, are necessary for a fair ~~statement~~presentation of the results for the interim periods presented. All intercompany transactions and balances have been eliminated in consolidation. The results of operations for the current interim period are not necessarily indicative of results to be expected for the current year or any other period. These unaudited condensed consolidated financial statements should be read in conjunction with the consolidated financial statements of the Company and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, ~~2017~~2018 filed with the Securities and Exchange ~~Commission ("SEC").~~

Commission.


(e)	~~Reverse Stock Split~~ Use of Estimates

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

~~On February 28, 2017,~~

(f)

Revenue Recognition

The following table presents the revenues by source (in thousand):

	Three Months Ended
	March 31,
	2019		2018
Revenue by products and services:
Products	$	69,582	$	56,726
Services		4,507		2,778
Total	$	74,089	$	59,504

The following summarizes required disclosures about geographical concentrations and revenue by products and services (in thousands):

	Three Months Ended
	March 31,
	2019		2018
Revenue by geography:
United States	$	9,578	$	16,551
Canada		923		971
Total North America		10,501		17,522
Latin America		6,585		7,958
Europe, Middle East, Africa		18,414		7,486
Korea		15,851		12,124
Other Asia Pacific		22,738		14,414
Total International		63,588		41,982
Total	$	74,089	$	59,504

(g)

Concentration of Risk

Financial instruments, which potentially subject the Company ~~filed a Certificate~~to concentrations of ~~Amendment with the Delaware Secretary~~credit risk, consist primarily of ~~State to amend the Company's Restated Certificate of Incorporation,~~cash and cash equivalents 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~~totaled $20.9 million ~~to 36 million. As a result of the reverse stock split, the number of shares of~~at March 31, 2019, as well as the Company’s ~~common stock then issued~~PNC Facility (defined below), under which the Company had aggregate borrowing availability of $15.0 million as of March 31, 2019. Cash and ~~outstanding was reduced from approximately 81.9 million to approximately 16.4 million. References to shares~~cash equivalents consist principally of ~~the Company's common stock, stock options (and associated exercise price)~~financial deposits and ~~restricted stock units in this Quarterly Report on Form 10-Q~~money market accounts. Cash and cash equivalents are ~~provided on a post-reverse stock split basis.~~


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

principally held with various domestic and international financial institutions with high credit standing.

The Company’s customers include competitive and incumbent local exchange carriers, competitive access providers, internet service providers, wireless carriers and resellers serving these markets. The Company performs ongoing credit evaluations of its customers and generally does not require collateral. Allowances are maintained for potential doubtful accounts.

~~For the three and nine months ended September 30, 2018, one customer each accounted for 11% of net revenue, respectively.~~

For the three months ended ~~September 30, 2017, two customers~~March 31, 2019 and 2018, no single customer accounted for 10% or more of net revenue.

As of March 31, 2019, no single customer represented 10% ~~and 9% (a related party) of net revenue, respectively. For the nine months ended September 30, 2017, two customers each represented 9% of net revenue (one of which was a related party).~~

~~As of September 30, 2018, one customer represented 12%~~or more of net accounts receivable. As of December 31, ~~2017,~~2018, two (2) customers represented ~~20% (a related party)~~11% and ~~11%~~10% of net accounts receivable, respectively.

As of ~~September 30, 2018~~March 31, 2019 and December 31, ~~2017,~~2018, receivables from customers in countries other than the United States represented ~~89%~~92% and ~~84%~~88%, respectively, of net accounts ~~receivable, respectively.~~

receivable.


~~(g)~~ (h)	~~Recent Accounting Pronouncements~~ Business Combination

The Company allocates the fair value of purchase consideration to the tangible assets acquired, liabilities assumed and intangible assets acquired based on their estimated fair values. The excess of the fair value of purchase consideration over the fair values of these identifiable assets and liabilities is recorded as goodwill. When determining the fair values of assets acquired and liabilities assumed, management makes significant estimates and assumptions, especially with respect to intangible assets and certain tangible assets such as inventory.

Critical estimates in valuing certain tangible and intangible assets include but are not limited to future expected cash flows from the underlying assets and discount rates. Management’s estimates of fair value are based upon assumptions believed to be reasonable, but which are inherently uncertain and unpredictable and, as a result, actual results may differ from estimates.

~~Recent Accounting Pronouncements Adopted~~

~~In May 2014,~~

(i)

Defined Benefit Plans and Plan Assumptions

The Company provides certain defined benefit pension plans to employees in Germany. Pension accounting is intended to reflect the ~~FASB issued ASU No. 2014-09~~ ~~“Revenue from Contracts with Customers”~~ ~~(“Topic 606”), which provides a single comprehensive model for entities~~recognition of future benefit costs over the employees' average expected future service to ~~use in accounting for revenue arising from contracts with customers. Topic 606 replaced most existing revenue recognition standards under U.S. GAAP, including ASC 605,~~ ~~Revenue Recognition~~ ~~("Topic 605").~~

~~On January 1, 2018,~~ the Company adopted Topic 606 and applied this guidance to all open contracts at the date of adoption using the modified retrospective method. The Company recognized the cumulative effect of initially applying Topic 606 as an adjustment to the balance of accumulated deficit at January 1, 2018. The comparative information has not been restated and continues to be reported under Topic 605.

~~The Company’s adoption of Topic 606 primarily impacted the following:~~

~~Topic 606 requires an allocation of revenue to performance obligations identified within an arrangement. Topic 605 restricted the allocation of revenue that is contingent~~based on future deliverables to current deliverables, however, Topic 606 removes this restriction, to the extent that the future deliverables represent performance obligations that are distinct. Under Topic 606, the nature of the performance obligations identified within a contract impacts the allocation of the transaction price between deliverables.

Some of the Company’s contracts include customer acceptance terms, which provide protection to the customer by allowing it to either cancel a contract or force the Company to take corrective actions if products or services do not meet the requirements in the contract. Under Topic 606, customer acceptance that is considered a “formality”, would result in revenue recognized when control of the product or service

~~Table of Contents~~

~~is transferred to customer, which is typically upon shipment or delivery dependent upon~~ the terms of the ~~underlying contract.~~

~~The following table summarizes the effects of Topic 606 on the Company’s unaudited condensed consolidated balance sheet at January 1, 2018 (in thousands):~~

As of January 1, 2018
Balance after adoption of ASC 606 Adjustments Balance without adoption of ASC 606
Assets
Accounts receivable, net $ 62,099
$ 344
⁽¹⁾
$ 61,755
Inventories 25,239
(105 )
⁽²⁾
25,344
Liabilities

Contract liabilities - current 3,038
(241 )
⁽²⁾
3,279
Accrued and other liabilities 11,518
344
⁽¹⁾
11,174
Contract liabilities - non-current 1,711
(172 )
⁽²⁾
1,883
Stockholders’ equity
Accumulated deficit (18,544 ) 308
(18,852 )

⁽¹⁾Allowance for sales returns was historically presented as a contra-asset within accounts receivable on the Company's consolidated balance sheets. Upon the adoption of Topic 606, the Company presents the allowance for sales returns in Accruedplans and ~~other liabilities (current).~~

⁽²⁾ ~~Represents~~investment and funding decisions. To estimate 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~~these future payments and ~~acceleration of revenue (and related costs) for contracts for which acceptance clauses are a formality.~~

~~The following table summarizes the effects of Topic 606 on~~ the Company’s ~~unaudited condensed consolidated balance sheet as~~decisions concerning funding of ~~September 30, 2018 (in thousands):~~

As of September 30, 2018
As reported Adjustments Balance without adoption of ASC 606
Assets
Accounts receivable, net $ 61,019
$ (5,356 )
⁽¹⁾
⁽³⁾
$ 66,375
Inventories 45,457
62
⁽²⁾
45,395
Prepaid expenses and other current assets 12,256
5,984
⁽³⁾
6,272
Liabilities
Contract liabilities - current 2,394
(75 )
⁽²⁾
2,469
Accrued and other liabilities 10,315
628
⁽¹⁾
9,687
Contract liabilities - non-current 1,851
36
⁽²⁾
1,815
Stockholders’ equity
Accumulated deficit (15,190 ) 101
(15,291 )

⁽¹⁾~~Allowance for sales returns was historically presented as a contra-asset within accounts receivable on the Company's consolidated balance sheets. Upon the adoption of Topic 606,~~these obligations, the Company ~~presents~~is required to make assumptions using actuarial concepts within the ~~allowance for sales returns in Accrued~~framework of U.S. GAAP. Two critical assumptions are the discount rate and ~~other liabilities (current).~~

⁽²⁾ ~~Represents~~ the ~~impact of allocation of transaction price~~expected long-term return on plan assets. Other important assumptions include expected future salary increases, expected future increases to ~~separate performance obligations in open contracts as of September 30, 2018 on a relative standalone selling price basis~~benefit payments, expected retirement dates, employee turnover, retiree mortality rates and ~~acceleration of revenue (and related costs) for contracts for which acceptance clauses are a formality.~~

⁽³⁾ ~~Represents conditional rights to consideration as of September 30, 2018.~~

~~Table of Contents~~

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

Three Months Ended September 30, 2018
As reported Adjustments Balance without adoption of ASC 606
Net revenue $ 71,914
$ 386
$ 71,528
Cost of revenue - products and services 48,483
5
48,478
Gross profit 23,431
381
23,050
Income tax expense (735 ) —
(735 )
Net income 1,827
381
1,446

Nine Months Ended September 30, 2018
As reported Adjustments Balance without adoption of ASC 606
Net revenue $ 207,675
$ 39
$ 207,636
Cost of revenue - products and services 139,344
(62 ) 139,406
Gross profit 68,331
101
68,230
Income tax expense (1,071 ) —
(1,071 )
Net income 3,323
101
3,222

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

~~Revenue Recognition Accounting Policy~~

~~Revenue Recognition~~

Revenue from contracts with customers is recognized when control of the promised goods or services is transferred to the customers, in an amount that reflects the consideration the Company expects to be entitled to in exchange for those goods or services.

portfolio composition. The Company ~~generates revenue primarily from sales of products and services, including, extended warranty service and customer support. Revenue from product sales is recognized~~evaluates these assumptions at a point in time when control of the goods is transferred to the customer, generally occurring upon shipment or delivery dependent upon the terms of the underlying contract. Revenue from services is generally recognized over time on a ratable basis over the contract term, using an output measure of progress, as the contracts usually provide the customer equal benefit throughout the contract period. The Company typically invoices customers for support contracts in advance, for periods ranging from one to five years.least annually.

(j)

Recent Accounting Pronouncements

Revenue from all sales types is recognized at the transaction price, which is the amount the Company expects to be entitled to in exchange for transferring goods and/or providing services. Transaction price is calculated as selling price net of variable consideration. Sales to certain distributors are made under arrangements which provide the distributors with volume discounts, price adjustments, and other allowances under certain circumstances. These adjustments and allowances are accounted for as variable consideration. To estimate variable consideration, the Company analyzes historical data, channel inventory levels, current economic trends and changes in customer demand for the Company's products, among other factors. Historically, variable consideration has not been a significant component of the Company’s contracts with customers. As of September 30, 2018, the total estimate of variable consideration was not significant.

~~Contracts with Multiple Performance Obligations~~

Some of the Company's contracts with customers contain multiple promised goods or services. For these contracts, the Company accounts for the promises separately as individual performance obligations if they are distinct. In determining whether performance obligations meet the criteria for being distinct, the Company considers a number of factors, including the degree of interrelation and interdependence between obligations and whether or not the good or service significantly modifies or transforms another good or service in the contract. After identifying the separate performance obligations, the transaction price is allocated to the separate performance obligations on a relative standalone selling price basis. Standalone selling prices for

~~Table of Contents~~

~~products are determined using either an adjusted market assessment or~~ ~~expected cost-plus margin~~. For customer support and extended warranty services, standalone selling price is primarily based on the prices charged to customers. Remaining performance obligations represent the transaction price allocated to performance obligations that are unsatisfied or partially unsatisfied as of the end of the reporting period. Unsatisfied and partially unsatisfied performance obligations primarily consist of backlog, which are products and services for which customer purchase orders have been accepted and that are in the process of being delivered.

~~Contract Balances~~

~~Topic~~ ~~606 distinguishes between contract assets and accounts receivable based on whether receipt of the consideration is conditional on something other than the passage of time.~~ The Company records contract assets when it has a right to consideration and records accounts receivable when it has an “unconditional” right to consideration. Contract liabilities consist of cash payments received (or unconditional rights to receive cash) in advance of fulfilling performance obligations.

~~The following table reflects the changes in contract balances for the nine months ended September 30, 2018 (in thousands):~~

Item Balance Sheet Location September 30,
2018 January 1,
2018 $ change % change
Contract assets Prepaid expenses and other current assets $ 5,984
$ —
$ 5,984
—
Contract liabilities - current Contract liabilities - current 2,394
3,038
(644 ) (21 )%
Contract liabilities - non-current Contract liabilities - non-current 1,851
1,711
140
8 %

During the nine months ended September 30, 2018, contract liabilities - non-current increased and contract liabilities - current decreased primarily as a result of changes in open contracts containing multiple performance obligations. As of September 30, 2018, contract assets increased as a result of the timing of certain events for the right to consideration to become unconditional. There were no significant changes in estimates during the nine months ended September 30, 2018 that would affect the contract assets and liabilities balances.

~~During the three and nine months ended September 30, 2018, $0.4 million and $2.7 million, respectively, was recognized as revenue from the opening contract liabilities balance.~~

~~Warranties~~

Products sold to customers include standard warranties, covering bug fixes, minor updates such that the product continues to function according to published technical specifications. These standard warranties are assurance type warranties and do not offer any services in addition to the assurance that the product will continue working as specified. Therefore, standard warranties are not considered separate performance obligations in the arrangement. Instead, the expected cost of warranty is accrued as expense in accordance with applicable guidance. Extended warranties are sold with certain products and include additional support services. The transaction price for extended warranties is accounted for as service revenue and recognized ratably over the life of the contract.

~~Contract Costs~~

Applying a practical expedient, the Company recognizes the incremental costs of obtaining contracts, which primarily consist of sales commissions, as an expense when incurred if the amortization period of the assets that otherwise would have been recognized is one year or less. These costs are included in sales and marketing expenses. If the incremental direct costs of obtaining a contract relate to a service recognized over a period longer than one year, such costs are capitalized and amortized in line with the related services over the period of benefit. As of September 30, 2018, such capitalizable costs were not significant.

~~Table of Contents~~

~~Financing~~

The Company's contracts do not include a significant financing component. The Company applies the practical expedient not to adjust the promised amount of consideration for the effects of a financing component if the Company expects, at contract inception, that the period between when the Company transfers a good or service to the customer and when the customer pays for the good or service will be one year or less.

~~Shipping and Handling~~

The Company has elected to account for shipping and handling activities that occur after the customer has obtained control of a good as a fulfillment cost rather than as an additional promised service. As a result, the Company accrues ~~the costs of shipping and handling when the related revenue is recognized~~.

~~Unsatisfied performance obligations~~

The Company does not disclose the value of unsatisfied performance obligations for (i) contracts with an original expected length of one year or less and (ii) contracts for which the Company recognizes revenue at the amount to which the Company has the right to invoice for the services performed. The majority of the Company's performance obligations in its contracts with customers relate to contracts with duration of less than one year and therefore transaction price allocated to unsatisfied performance obligations included in contracts with duration of more than 12 months was not material.

~~Disaggregation of Revenue~~

~~The disaggregation of revenue by geographical regions for the three and nine months ended September 30, 2018 is disclosed in Note 12.~~

~~In August 2016, FASB issued ASU 2016-15,~~ ~~Statement of Cash Flows, Classification of Certain Cash Receipts and Cash Payments~~, which addresses eight specific cash flow issues with the objective of reducing the existing diversity in practice. The updated guidance became effective for the Company on January 1, 2018 and was adopted accordingly. The adoption of this standard did not have any effect on the Company's condensed consolidated statement of cash flows for the three and nine months ended September 30, 2018 or 2017.

~~In November 2016, FASB issued ASU 2016-18,~~ ~~Statement of Cash Flows, Restricted Cash~~, which requires that a statement of cash flows to explain the change during the period in the total of cash, cash equivalents and amounts generally described as restricted cash and restricted cash equivalents. The updated guidance became effective for the Company beginning on January 1, 2018 and was adopted accordingly, using the retrospective approach. As a result, the Company no longer presents transfers between cash and cash equivalents and restricted cash in the consolidated cash flow statements. The condensed consolidated statement of cash flows for the nine months ended September 30, 2017 was revised to exclude the $6.1 million change in restricted cash from net cash used in investing activities and to include $6.7 million in cash, cash equivalents and restricted cash, beginning of period and $13.1 million in cash, cash equivalents and restricted cash, end of period.

~~Other~~

Recent Accounting Pronouncements

Adopted

Leases

In February 2016, the ~~FASB~~Financial Accounting Standards Board (“FASB”) issued ~~ASU~~Accounting Standards Update (“ASU”) 2016-02, Leases. as modified subsequently by ASUs 2018-01, 2018-10, 2018-11, 2018-20 and 2019-01 (“ASC 842”), which introduces the recognition of lease assets and lease liabilities by lessees for those leases classified as operating leases under previous guidance. ASU 2016-02 requires that lease arrangements longer than 12 ~~months~~months’ result in an entity recognizing an asset and ~~liability.~~ liability, among other changes.

The ~~updated guidance is effective for~~Company adopted the ~~Company~~new standard on January 1, 2019, the first day of fiscal 2019 using the modified retrospective approach whereby the cumulative effect of adoption was recognized on the adoption date and ~~early adoption is permitted. The Company does~~prior periods were not ~~plan~~restated. There was no net cumulative effect adjustment to ~~early adopt this guidance. The Company expects its assets and liabilities to increase~~retained earnings as of January 1, 2019 as a result of this adoption. ASC 842 sets out the ~~adoption~~principles for the recognition, measurement, presentation and disclosure of ~~this standard.~~ leases.

The Company has elected a certain package of practical expedients permitted under the transition guidance within ASC 842. Those practical expedients are as follows:

The Company did not reassess (i) whether expired or existing contracts contain leases under the new definition of a lease; (ii) lease classification for expired or existing leases; and (iii) whether previously capitalized initial direct costs would qualify for capitalization under ASC 842.

The Company did not reassess a lease whose term is 12 months or less and does not include a purchase option that the lessee is reasonably certain to exercise.

The Company did not elect to use hindsight for transition when considering judgments and estimates such as assessments of lessee options to extend or terminate a lease or purchase the underlying asset.

For all asset classes, the Company elected to not recognize a right-of-use asset and lease liability for leases with a term of 12 months or less.

For all asset classes, the Company elected to not separate non-lease components from lease components to which they relate and have accounted for the combined lease and non-lease components as a single lease component.

The Company applies significant judgment in considering all relevant factors that create an economic benefit (e.g., contract-based, asset-based, entity-based, and market-based, among others) as of the commencement date in determining the initial lease term and future lease payments. For example, the Company exercises judgment in determining whether renewal periods will be exercised during the initial measurement process. If the Company believes it will exercise the renewal option, and the lease payments associated with the renewal periods are known or calculable, such renewal lease payments would be included in the initial measurement of the lease liability. Otherwise, even if the Company believes that it will exercise the renewal period, if the renewal payments are unknown or not calculable, they would not be included until they become known or calculable at which time the Company would remeasure the remaining lease payments similar to a lease modification.

Adoption of the standard resulted in the balance sheet recognition of right of use assets and lease liabilities of approximately $21.2 million and $22.4 million, respectively as of January 1, 2019. Adoption of the standard did not materially impact the Company’s unaudited condensed consolidated statements of comprehensive income (loss) and cash flows. See Note 13 in the notes to unaudited condensed consolidated financial statements.

Income Tax Effects within Accumulated Other Comprehensive Income

In ~~July~~February 2018, the FASB issued ASU ~~2018-18-11,~~ 2018-02, Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income~~Leases(Topic 842): Targeted Improvements~~,. 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”). The adoption of this standard on January 1, 2019 did not have a material impact on the Company’s condensed consolidated financial statements, since the Company did not elect to reclassify the income tax effects of 2017 Tax Act from accumulated other comprehensive income to retained earnings.

Improving the Presentation of Net Periodic Pension Cost and Net Periodic Post-Retirement Benefit Cost

In March 2017, the FASB issued ASU ~~2018-11 states that, separating~~2017-07, Improving the Presentation of Net Periodic Pension Cost and Net Periodic Post-Retirement Benefit Cost. The ASU requires the Company to disaggregate the service cost component from the other components of ~~a contract affect~~net periodic benefit costs and requires the ~~amendments in Update 2016-02, which are not yet effective but can be early adopted. All entities, including early adopters that elect~~Company to present the ~~practical expedient related to separating~~other components of ~~a contract~~net periodic benefit cost in ~~this Update 2016-02 must apply the expedient, by class of underlying asset, to all existing lease transactions that qualify~~other income, net. The standard is effective for ~~the expedient at the date elected.~~annual and interim periods beginning after December 31, 2017, and retrospective application is required. The Company adopted this guidance during the first quarter of 2019 without any retrospective adjustments since the underlying pension obligations were acquired through Keymile Acquisition in 2019. The interest cost, which is ~~currently assessing~~ the ~~potential impact~~only component of ~~adopting this new guidance on its~~net period post-retirement cost, is recognized in Other income (loss), net in the condensed consolidated ~~financial statements.~~

statement of comprehensive income (loss).

Other Recent Accounting Pronouncements Not Yet Adopted

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

~~Table of Contents~~

~~In February 2018, the FASB issued ASU 2018-02,~~ ~~Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income~~. The amendments in this update allow a reclassification from accumulated other comprehensive income to retained earnings for stranded tax effects resulting from the Tax Cuts and Jobs Act (the "Tax Act"). Consequently, the amendments eliminate the stranded tax effects resulting from the Tax Act. Because the amendments only relate to the reclassification of the income rate tax effect of the Tax Act, the underlying guidance that requires that the effect of a change in tax laws or rates be included in income from continuing operations is not affected. The amendments in this update are effective for all entities for fiscal years beginning after December 15, 2018 and interim periods in those years. The Company does not expect the impact of the new standard to have a material impact on its consolidated financial statements.

~~In March 2018, the FASB issued ASU No. 2018-05,~~ ~~Income Taxes (Topic 740), Amendments to SEC Paragraphs Pursuant to SEC Staff Accounting Bulletin No. 118~~. The amendments add various Securities and Exchange Commission (“SEC) paragraphs pursuant to the issuance of SEC Accounting Bulletin No. 118, Income Tax Accounting Implications of the Tax Cuts and Jobs Act (“Act”) (“SAB 118”). The SEC issued SAB 118 to address concerns about reporting entities’ ability to timely comply with the accounting requirements to recognize all of the effects of the Act in the period of enactment. SAB 118 allows disclosure that timely determination of some or all of the income tax effects from the Act are incomplete by the due date of the financial statements and if possible to provide a reasonable estimate. The Company has provided a reasonable estimate of the tax reform in the notes to the consolidated financial statements.

~~On July 30, 2018, the FASB issued ASU No. 2018-11,~~ ~~Leases (Topic 842),~~ to provide entities with relief from the costs of implementing certain aspects of the new leasing standard, ASU 2016-0210 (codified as ASC 842). Specifically, under the amendments in ASU 2018-11, entities may elect not to recast the comparative periods presented when transitioning to ASC 842, and lessors may elect not to separate lease and nonlease components when certain conditions are met. The Company is currently assessing the potential impact of adopting this new guidance on its consolidated financial statements.

On August 28, 2018, the FASB issued ASU ~~No.~~ 2018-13, Fair Value Measurement (Topic 820), which removes, modifies, and adds certain disclosure requirements related to fair value measurements in ASC 820. The Company is currently assessing the potential impact of adopting this new guidance on its consolidated financial statements.

In August 2018, the FASB issued ASU 2018-14, Disclosure Framework-Changes to the Disclosure Requirements for Defined Benefit Plans

, which amends ASC 715 to add, remove, and clarify disclosure requirements related to defined benefit pension and other postretirement plans. The updated guidance is effective for the Company on January 1, 2021, with early adoption permitted. The Company is currently assessing the potential impact of adopting this new guidance on its consolidated financial statements.

(2)	Business Combination

Keymile Acquisition

On January 3, 2019, ZTI Merger Subsidiary III Inc., a Delaware corporation and a wholly owned subsidiary of the Company (“ZTI”), acquired all of the outstanding shares of Keymile GmbH (“Keymile”), a limited liability company organized under the laws of Germany, from Riverside KM Beteiligung GmbH (“Riverside”), a limited liability company organized under the laws of Germany, pursuant to a share purchase agreement (the “Keymile Acquisition”).

The allocation of the purchase price was based upon a preliminary valuation, and the Company’s estimates and assumptions are subject to refinement, within the measurement period (up to one year from the Acquisition Date). Measurement period adjustments, with the corresponding adjustment to the bargain purchase, will be recorded in the reporting period in which the adjustment to the provisional amounts are determined.

The aggregate cash purchase price paid for all of the shares of Keymile and certain of its subsidiaries, was €10,250,000 (approximately $11.8 million). The Company also assumed pension obligations of approximately $12.7 million, net of pension assets of $3.5 million. Following the closing of the Keymile Acquisition, Keymile became the Company’s wholly owned subsidiary. The Keymile Acquisition agreement also provides for a lockbox mechanism such that normal operations are observed by Keymile management and any excess cash flows generated from operating activities for the period from October 1, 2018 to December 31, 2018 remains with Keymile, with the Company as the beneficiary, as the purchaser of Keymile. At December 31, 2018, cash received from the lockbox mechanism amounted to $2.5 million.

On October 1, 2018, as a condition for the Keymile Acquisition, Riverside extended a €4.0 million ($4.6 million, which represents the cash and cash equivalents and short-term debt, in the table below) as working capital loan to Keymile. The working capital loan bears interest at a rate of 3.5% per annum and is scheduled for repayment in two equal installments in April and November 2019.

Keymile is a leading solution provider and manufacturer of telecommunication systems for broadband access. The Company believes Keymile strengthens its portfolio of broadband access solutions, which now includes a series of multi-service access platforms for FTTx network architectures, including ultra-fast broadband copper access based on VDSL/Vectoring and G. Fast technology.

A summary of the preliminary estimated purchase price allocation to the fair value of assets acquired and liabilities assumed is as follows (in thousands):

Purchase consideration
Cash consideration	$	11,776
Working capital adjustment: cash received from lockbox mechanism		(2,497	)
Adjusted purchase consideration	$	9,279

The following summarizes the preliminary estimated fair values of the assets acquired and liabilities assumed at the date of acquisition for the acquisition consummated during the three-month period ended March 31, 2019 (in thousands):

Allocation of purchase consideration
Current assets
Cash and cash equivalents	$	4,582
Accounts receivable - trade, net		6,820
Other receivables		798
Inventories		9,943
Property, plant and equipment		983
Other assets		163
Intangible assets		12,030
Accounts payable - trade		(3,303	)
Short-term debt		(4,582	)
Contract liabilities		(364	)
Accrued liabilities		(3,614	)
Deferred tax liabilities		(1,071	)
Pension obligations		(12,656	)
Other long term liabilities		(116	)
Bargain purchase gain		(334	)
Total purchase consideration	$	9,279

The purchase price allocation resulted in the recognition of a gain on bargain purchase of approximately $0.3 million, which was included in the unaudited condensed consolidated statements of comprehensive income (loss) for the quarter ended March 31, 2019. The gain on bargain purchase was the result of the fair value of the identifiable net assets acquired exceeding the purchase price paid for the Keymile Acquisition which was reduced by the lockbox mechanism.

The estimated weighted average useful lives of the acquired property, plant and equipment is 5 years. Depreciation is calculated using straight-line method.

The following table represents the preliminary estimated fair value and useful lives of identifiable intangible assets acquired:

	Estimated Fair Value (in thousands)		Estimated Useful Life
Intangible assets acquired
Customer relationship	$	3,667	5 years
Trade name		3,208	5 years
Technology - developed core		5,155	5 years
Total intangible assets	$	12,030

The Company valued the customer relationships using the Income Approach, specifically the Multi-Period Excess Earnings Method (“MPEEM”). As of the valuation date, there was value attributable to Keymile’s existing customer relationships. Keymile’s key customer base is made up of independent telecommunication service providers and network operators, a base of customers that have seen growth since 2012. Keymile is seen as a market leader and historically has had low customer attrition. In addition, switching costs are considered to be high due to the disruption of switching platforms as well as the additional training necessary.

The Company utilized the Relief from Royalty Method (“RFRM”) to value the tradename and developed technology. The RFRM assumes that the value of the asset equals the amount a third party would pay to use the asset and capitalize on the related benefits of the asset. Therefore, a revenue stream for the asset is estimated, and then an appropriate royalty rate is applied to the forecasted revenue to estimate the pre-tax income associated with the asset. The pre-tax income is then tax-effected to estimate the after-tax net income associated with the asset. Finally, the after tax net income is discounted to the present value using an appropriate rate of return that considers both the risk of the asset and the associated cash flow estimates.

Pro Forma Financial Information

The unaudited pro forma information for the periods set forth below gives effect to the Keymile Acquisition as if it had occurred as of January 1, 2018. The unaudited pro forma financial information has been prepared by management for illustrative purposes only and does not purport to represent what the results of operations, financial condition or other financial information of the Company would have been if the Keymile Acquisition had occurred on January 1, 2018 or what such results or financial condition will be for any future periods. The unaudited pro forma financial information is based on estimates and assumptions and on the information available at the time of the preparation thereof. These estimates and assumptions may change, be revised or prove to be materially different, and the estimates and assumptions may not be representative of facts existing at the time of the Keymile Acquisition. The pro forma adjustments primarily relate to acquisition related costs, amortization of acquired intangibles and interest expense related to financing arrangements. Below is the pro forma financial information (in thousands):

	Pro Forma Three Months Ended March 31,
	2019			2018
Pro forma net revenues	$	74,089		$	69,835
Pro forma net income (loss) attributable to DASAN Zhone Solutions, Inc.		(1,301	)		121

~~(2)~~

(3)

Fair Value Measurement

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



Level 1 –	Inputs are quoted prices in active markets for identical assets or liabilities.

Level 2 –

Inputs are quoted prices for similar assets or liabilities in an active market, quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable and market-corroborated inputs which are derived principally from or corroborated by observable market data.

Level 3 –

Inputs are derived from valuation techniques in which one or more significant inputs or value drivers are unobservable.

The following financial instruments are not measured at fair value on the Company’s condensed consolidated balance sheet as of ~~September 30, 2018~~March 31, 2019 and the consolidated balance sheet as of December 31, ~~2017,~~2018, 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 (Level 3) 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 (Level 3) approximates their fair values based on the current rates available to the Company for debt of similar terms and maturities.

To manage certain exposures to currency fluctuations, the Company started a limited hedging program by entering into foreign currency forward contracts with maturities of one month to hedge a portion of its net outstanding foreign currency monetary assets and liabilities. These derivatives are recorded at fair value on the condensed consolidated balance sheet under "Other Current Assets" or "Accounts Payable - Trade" with changes in the fair value being recorded in "Other income (loss), net".

~~Table of Contents~~

These derivative contracts are entered into with a single counterparty, and are not designated as hedging instruments under applicable accounting guidance. As such, all changes in the fair value of these derivative contracts are recorded in other income (loss), net on the condensed consolidated statements of comprehensive income (loss). These derivative contracts are intended to offset the foreign currency gains or losses associated with the underlying monetary assets and liabilities, and changes in the related derivative assets and liabilities balances are classified outside of operating income (loss), consistent with the related underlying foreign currency gain or loss.

These derivative contracts expose the Company to credit risk to the extent that the counterparty may be unable to meet the terms of the arrangement. The Company mitigates this credit risk by transacting with reputable financial institutions and entering into master netting arrangements, which permit net settlement of transactions with the same counterparty. While the contract or notional amount is often used to express the volume of foreign currency derivative contracts, the amounts potentially subject to credit risk are generally limited to the amounts, if any, by which the counterparties’ obligations under the agreements exceed the obligations of the Company to the counterparties. The Company is not required to pledge, and is not entitled to receive, cash collateral related to these derivative instruments. The Company does not enter into derivative contracts for trading or speculative purposes. The Company's foreign currency contracts are classified within Level 2 because the valuation inputs are based on quoted prices and market observable data of similar instruments in active markets, such as currency spot and forward rates.

~~As of September 30, 2018, the Company had no derivative contracts, and no liability was included in accounts payable - trade.~~

(4)
~~(3)~~	Cash, Cash Equivalents and Restricted Cash

As of ~~September 30, 2018~~March 31, 2019 and December 31, ~~2017,~~2018, the Company's cash and cash equivalents comprised financial deposits. Restricted cash consisted primarily of cash restricted for performance bonds, warranty bonds and collateral for borrowings. ~~Current and long-term restricted cash was $8.7 million at September 30, 2018 and $13.9 million at December 31, 2017.~~

(5)	Balance Sheet Details

~~Reconciliation of cash, cash equivalents and restricted cash to statement of financial position~~

Accounts receivable, net as of ~~September 30, 2018~~March 31, 2019 and December 31, ~~2017~~2018 was as follows (in thousands):

	March 31, 2019			December 31, 2018
Gross accounts receivable	$	70,189		$	71,945
Less: allowance for doubtful accounts		(544	)		(328	)
Total accounts receivable, net	$	69,645		$	71,617

Inventories as of March 31, 2019 and December 31, 2018 were as follows (in thousands):

	March 31, 2019		December 31, 2018
Raw materials	$	17,492	$	15,688
Work in process		3,490		2,429
Finished goods		18,736		15,751
Total inventories	$	39,718	$	33,868

September 30,
2018 December 31,
2017
Cash and cash equivalents $ 20,028
$ 17,475
Restricted cash 7,825
12,425
Long-term restricted cash 847
1,512
Cash, cash equivalents and restricted cash $ 28,700
$ 31,412


~~(4)~~	~~Balance Sheet Detail~~

~~Accounts Receivable - Trade~~

~~Accounts receivable - trade, net as of September 30, 2018 and December 31, 2017 was as follows (in thousands):~~

September 30,
2018 December 31,
2017
Gross accounts receivable $ 61,324
$ 63,446
Allowance for doubtful accounts (305 ) (922 )
Allowance for sales returns —
⁽¹⁾
(769 )
Total allowances (305 ) (1,691 )
Accounts receivable - trade, net $ 61,019
$ 61,755

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

~~Table of Contents~~

~~Inventories~~

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

September 30,
2018 December 31,
2017
Raw materials $ 19,227
$ 12,671
Work in process 3,474
2,150
Finished goods 22,756
10,523
Total inventories $ 45,457
$ 25,344

Inventories provided as collateral for borrowings from Export-Import Bank of Korea amounted to ~~$9.5~~$8.2 million and ~~$11.4~~$9.5 million as of ~~September 30, 2018~~March 31, 2019 and December 31, ~~2017,~~2018, respectively.

(6)
~~(5)~~	Property, Plant and Equipment

Property, plant and equipment as of ~~September 30, 2018~~March 31, 2019 and December 31, ~~2017~~2018 were as follows (in thousands):

	March 31, 2019			December 31, 2018
Furniture and fixtures	$	9,838		$	8,029
Machinery and equipment		2,262			3,553
Leasehold improvements		4,047			3,715
Computers and software		1,203			922
Other		747			982
		18,097			17,201
Less: accumulated depreciation and amortization		(11,611	)		(11,271	)
Less: government grants		(362	)		(412	)
Total property and equipment, net	$	6,124		$	5,518

September 30,
2018 December 31,
2017
Furniture and fixtures $ 22,495
$ 22,988
Machinery and equipment 5,577
5,455
Leasehold improvements 3,619
3,647
Computers and software 728
621
Others 1,034
1,007
33,453
33,718
Less: accumulated depreciation and amortization (27,872 ) (27,584 )
Less: government grants (207 ) (261 )
Property and equipment, net $ 5,374
$ 5,873

Depreciation expense associated with property and equipment for the three ~~and nine~~ months ended ~~September 30,~~March 31, 2019 and March 31, 2018 ~~was $0.4 million and $1.2 million respectively. Depreciation expense for the three and nine months ended September 30, 2017~~ was $0.5 million and ~~$1.4~~$0.4 million, respectively.

The Company receives grants from various government entities mainly to support capital expenditures. Such grants are deferred and are generally refundable to the extent the Company does not utilize the funds for qualifying expenditures. Once earned, the Company records the grants as a contra amount to the assets and amortizes such amount over the useful lives of the related assets as a reduction to depreciation expense.

(7)
~~(6)~~	Goodwill and Intangible Assets

Goodwill as of ~~September 30, 2018~~March 31, 2019 and December 31, ~~2017~~2018 was as follows (in thousands):

	March 31, 2019		December 31, 2018
Beginning balance	$	3,977	$	3,977
Less: accumulated impairment		—		—
Ending balance	$	3,977	$	3,977

September 30,
2018 December 31,
2017
Beginning balance $ 3,977
$ 3,977
Less: accumulated impairment —
—
Ending balance $ 3,977
$ 3,977

The Company did not recognize impairment loss on goodwill during the ~~nine~~three months ended ~~September 30, 2018~~March 31, 2019 and ~~2017.~~

~~Table of Contents~~

2018.

Intangible assets as of ~~September 30, 2018~~March 31, 2019 and December 31, ~~2017~~2018 were as follows (in thousands):

	March 31, 2019
	Gross Carrying Amount		Accumulated Amortization			Net
Developed technology	$	8,109	$	(1,822	)	$	6,287
Customer relationships		8,830		(1,572	)		7,258
Backlog		2,179		(2,179	)		—
Trade name		3,142		(157	)		2,985
Total intangible assets	$	22,260	$	(5,730	)	$	16,530

	December 31, 2018
	Gross Carrying Amount		Accumulated Amortization			Net
Developed Technology	$	3,060	$	(1,428	)	$	1,632
Customer Relationships		5,240		(1,223	)		4,017
Backlog		2,179		(2,179	)		—
Total intangible assets, net	$	10,479	$	(4,830	)	$	5,649

September 30, 2018
Gross Carrying Amount Accumulated Amortization Net
Developed technology $ 3,060
$ (1,276 ) $ 1,784
Customer relationships 5,240
(1,091 ) 4,149
Backlog 2,179
(2,179 ) —
Total intangible assets $ 10,479
$ (4,546 ) $ 5,933

December 31, 2017
Gross Carrying Amount Accumulated Amortization Net
Developed technology $ 3,060
$ (816 ) $ 2,244
Customer relationships 5,240
(699 ) 4,541
Backlog 2,179
(2,179 ) —
Total intangible assets $ 10,479
$ (3,694 ) $ 6,785

Intangible assets as of March 31, 2019 includes the technology acquired through Keymile Acquisition (Note 2).

Amortization expense associated with intangible assets for the three ~~and nine~~ months ended ~~September 30,~~March 31, 2019 and 2018 was $0.9 million and $0.3 million, respectively.

(8)

Debt

The following tables summarize the Company’s debt as of March 31, 2019 and ~~$0.9 million, respectively. Amortization expense associated~~December 31, 2018 (in thousands):

	As of March 31, 2019
	Short-term			Long-term			Total
PNC Bank Facility	$	2,500		$	22,500		$	25,000
Working Capital Loan		4,488			—			4,488
Bank and Trade Facilities - Foreign Operations		18,905			—			18,905
Related Party		—			9,118			9,118
	$	25,893		$	31,618		$	57,511
Less: unamortized deferred financing costs on the PNC Bank Facility		(812	)		(1,299	)		(2,111	)
	$	25,081		$	30,319		$	55,400

	As of December 31, 2018
	Short-term		Long-term		Total
Wells Fargo Bank Facility	$	7,000		—	$	7,000
Bank and Trade Facilities - Foreign Operations		24,762		—		24,762
Related Party		—		14,142		14,142
	$	31,762	$	14,142	$	45,904

PNC Bank Facility

On February 27, 2019, the Company and ZTI (collectively, the “Borrowers”), and certain direct and indirect subsidiaries of the Borrowers, as guarantors, entered into that certain Revolving Credit, Term Loan, Guaranty and Security Agreement (the “Domestic Credit Agreement”) and that certain Export-Import Revolving Credit, Guaranty and Security Agreement (the “Ex-Im Credit Agreement,” and together with ~~intangible assets~~the Domestic Credit Agreement, the “Credit Agreements”), in each case with PNC Bank, National Association (“PNC”) and Citibank, N.A. as lenders, and PNC as agent for the ~~three and nine months ended September 30, 2017 was $0.3 million and $1.7 million, respectively.~~


~~(7)~~	~~Debts~~

lenders (the “PNC Facility”), which replaced the Company’s former senior secured credit facilities with Wells Fargo Bank ~~Facility~~

~~On July 12, 2018, the Company entered into the A&R Domestic~~(the “Former WFB Facility”).

The Credit ~~Agreement~~Agreements provide for a $25.0 million term loan and ~~the A&R Ex-Im Credit Agreement with WFB, which amended and replaced the Company’s existing senior secured~~a $15.0 million revolving line of credit ~~and letter~~(including subfacilities for Ex-Im transactions, letters of credit ~~facilities with WFB~~ and ~~revised certain reporting and compliance provisions.~~swing loans). The ~~Amended WFB Facility provides for a revolving line of credit of $25.0 million (including up to $5.0 million of letters of credit), with the~~ amount ~~that~~ the Company is able to borrow on the revolving line of credit at any time is based on eligible accounts receivable and ~~inventory,~~other conditions, less ~~the amount committed as cash collateral for letters of credit. The amounts borrowed~~certain reserves. Borrowings under the ~~Amended WFB~~PNC Facility ~~bears~~bear interest ~~payable monthly,~~ at the Company’s option, at either (i) a ~~floating~~base rate equal to the ~~three-month~~highest of the federal funds rate plus 0.50%, PNC’s prime rate, or the daily LIBOR rate plus 1.00%, or (ii) the LIBOR rate for the applicable interest period, subject to a floor of 1.00% (with respect to the term loans only), plus in each case, an applicable margin. The applicable margin ~~based on~~for term loans is 5.00% for base rate loans and 6.00% for LIBOR rate loans, and the ~~Company's average excess availability (as calculated~~applicable margin for borrowings under the ~~WFB Facility). To maintain availability~~revolving line of credit is 1.50% for base rate loans and 2.50% for LIBOR rate loans.

The Company used a portion of the funds borrowed from the term loan under the ~~Amended WFB Facility, the Company pays a commitment fee on the unused portion. The commitment fee is 0.25% per annum and is recorded as~~Credit Agreements to (i) repay $5.0 million in principal amount of existing related-party indebtedness with DNI plus accrued interest, ~~expense. The maturity date of the Amended WFB Facility is July 12, 2021.~~

~~As of September 30, 2018, the Company had $6.0~~(ii) repay $1.5 million in outstanding borrowings under ~~its Amended~~the Company’s former revolving line of credit plus accrued interest and fees and cash collateralize $3.6 million in outstanding letters of credit under the Former WFB Facility, ~~(included~~and (iii) repay $5.6 million short-term debt in ~~short-term debts),~~Korea and ~~$2.1 million was committed as cash collateral~~Japan. The Company intends to use the remaining funds for ~~letters of credit. Subsequent to the end of the quarter, the Company repaid $6.0 million in borrowings~~ongoing working capital needs. Obligations under the ~~WFB Facility.~~

Based on the Company's eligible accounts receivable and inventory, the Company had $6.5 million of financing availability under the Amended WFB Facility as of September 30, 2018. The interest rate on the Amended WFB Facility was 4.4% at September 30, 2018.

~~The Company’s obligations under the Amended WFB Facility~~Credit Agreements are secured by substantially all of ~~its~~the personal property assets of the Borrowers and ~~those of its~~the subsidiaries that guarantee the ~~Amended WFB Facility,~~Credit Agreements, including their intellectual property.

The ~~Amended WFB Facility contains~~maturity date under the Credit Agreements is February 27, 2022. The term loan under the Credit Agreements is repayable in eight quarterly installments of $625,000 beginning June 30, 2019, followed by quarterly installments of $937,500 beginning on June 30, 2021, with all remaining unpaid principal and accrued interest due on the maturity date.

The Credit Agreements contain certain covenants, limitations, and conditions with respect to the Borrowers and their subsidiaries, including a maximum leverage ratio, a minimum fixed charge coverage ratio, and a minimum liquidity covenant, as well as financial ~~covenants,~~reporting obligations, and customary ~~affirmative~~events of default. If an event of default occurs, the agent and ~~negative covenants. If the Company defaults under the Amended WFB Facility due to a covenant breach or otherwise, WFB may, after the lapse of any applicable grace periods,~~lenders will be entitled to ~~among other things, require~~take various actions, including requiring the immediate repayment of all outstanding amounts under the Credit Agreements, terminating commitments to make additional advances and ~~sell~~selling the ~~Company’s~~ assets of the Borrowers and their subsidiary guarantors to satisfy the obligations under the ~~Amended WFB Facility. As of September 30, 2018, the~~Credit Agreements. The Company was in compliance with the covenants under the Credit Agreements as of March 31, 2019.

As of March 31, 2019, the Company had $25.0 million in outstanding term loan borrowings under its PNC Facility, and no outstanding borrowings under the revolving line of credit. The interest rate on the PNC Facility was 8.63% at March 31, 2019. Deferred financing cost of $2.1 million as of March 29, 2019 has been netted against the aggregate principal amount of the PNC term loan in the unaudited condensed consolidated balance sheet as of March 31, 2019.

Former Wells Fargo Bank Facility

On February 27, 2019, in connection with the entry into the PNC Facility, the Company repaid $1.5 million in principal amount of outstanding borrowings plus accrued interest and fees under the Former WFB Facility, cash collateralized $3.6 million outstanding letters of credit under the Former WFB Facility. On ~~October 22, 2018,~~February 27, 2019, the Company ~~borrowed $3.0 million under~~also terminated the ~~Amended~~Former WFB Facility. There was no outstanding balance as of March 31, 2019.

Working Capital Loan

On October 1, 2018, as a condition for the Keymile Acquisition, Riverside, the former stockholder of Keymile extended a €4.0 million ($4.5 million as of March 31, ~~2018,~~2019) working capital loan to Keymile. The working capital loan bears interest at a rate of 3.5% per annum and is scheduled for repayment in two equal installments. The first payment of $2.2 million was made in April 2019 and the ~~Company repaid the $3.0 million~~balance is due in ~~full.~~

~~Table of Contents~~

November 2019.

Bank and Trade Facilities - Foreign Operations

Certain of the Company's foreign subsidiaries have entered into various financing arrangements with foreign banks and other lending institutions consisting primarily of revolving lines of credit, trade facilities, term loans and export development loans. These facilities are renewed as they mature and are generally secured by a security interest in certain assets of the applicable foreign subsidiaries and supported by guarantees given by DNI or third parties. Payments under such facilities are made in accordance with the given lender’s amortization schedules.

As of ~~September 30, 2018~~March 31, 2019 and December 31, ~~2017,~~2018, the Company had an aggregate outstanding balance of ~~$28.2~~$18.9 million ~~(included in short-term debts)~~ and ~~$22.8~~$24.8 million, ~~($19.8 million included in short-term debts),~~ respectively, under such financing ~~arrangements,~~arrangements. The maturity dates and ~~the~~ interest rates per annum applicable to outstanding borrowings under these financing arrangements ~~were as~~are listed in the tables below (amount in thousands).

As of March 31, 2019

Maturity Date

Denomination

Interest rate (%)

Amount

Industrial Bank of Korea

Credit facility

04/08/2019 ~ 09/02/2019

USD

4.20 ~ 5.58

3,078

Industrial Bank of Korea

Trade finance

5/2/2019

USD

6.74

634

NongHyup Bank

Credit facility

04/10/2019 ~ 05/13/2019

USD

3.71 ~ 4.50

2,085

The Export-Import Bank of Korea

Export development loan

07/01/2019

KRW

3.44

5,405

Korea Development Bank

General loan

08/08/2019

KRW

3.48

4,394

Korea Development Bank

Credit facility

04/03/2019 ~ 07/08/2019

USD

3.64 ~ 3.91

1,552

LGUPlus

General loan

06/17/2019

KRW

1,757

18,905

As of September 30, 2018
Maturity Date Denomination Interest rate (%) Amount
Industrial Bank of Korea Credit facility 10/2/2018 - 2/4/2019 USD 3.81~4.03 $ 4,229
Industrial Bank of Korea Credit facility 10/10/2018 - 11/12/2018 USD 3.81~3.84 1,834
Industrial Bank of Korea Trade finance 10/15/2018 USD 6.82 651
Shinhan Bank General loan 3/30/2019 KRW 6.06 2,876
NongHyup Bank Credit facility 11/19/2018 - 3/4/2019 USD 3.95~4.17 852
The Export-Import Bank of Korea Export development loan 12/29/2018 KRW 3.28 6,471
The Export-Import Bank of Korea Import development loan 11/14/2018 USD 4.02 850
Korea Development Bank General loan 8/8/2019 KRW 3.48 4,494
LGUPlus General loan 6/17/2019 KRW 0 1,797
JECC Factoring AR Factoring 10/26/2018 - 12/25/2018 JPY 1.58 3,236
Shoko Chukin Bank General loan 6/28/2019 JPY 1.33 881
$ 28,171

As of December 31, 2017
Maturity Date Denomination Interest rate (%) Amount
Industrial Bank of Korea Credit facility 1/2/2018 - 5/2/2018 USD 2.89 - 3.26 $ 2,328
Industrial Bank of Korea Trade Finance 1/2/2018 - 5/23/2018 USD 4.47 - 5.97 2,401
Shinhan Bank General loan 3/30/2019 KRW 5.91 2,987
Shinhan Bank Trade finance 2/19/2018- 3/26/2018 KRW 3.90 - 4.14 3,050
NongHyup Bank (Korea) Credit facility 1/8/2018- 6/18/2018 USD 2.83 - 3.42 860
The Export-Import Bank of Korea Export development loan 2/13/2018 & 6/29/2018 KRW 3.20 - 3.28 7,570
Mitsubishi Bank (Japan) AR factoring 1/31/2018 - 5/31/2018 JPY 1.58 1,872
Shinhan Bank (India) General loan 4/24/2018 - 11/12/2018 INR 8.70 - 8.90 1,709
$ 22,777

~~Table of Contents~~

As of ~~September 30, 2018,~~March 31, 2019, the Company had ~~$6.9~~$6.7 million in outstanding borrowings and ~~$4.3~~$5.6 million committed as ~~cash collateral~~security for letters of credit under the Company's ~~$25.9~~$19.0 million credit ~~facility~~facilities with certain foreign banks. ~~On June 18,~~

As of December 31, 2018

Maturity Date

Denomination

Interest rate (%)

Amount

Industrial Bank of Korea

Credit facility

01/02/2019 ~ 05/15/2019

USD

3.96 ~ 4.36

1,982

Industrial Bank of Korea

Trade finance

02/18/2019 ~ 02/25/2019

USD

5.31 ~ 6.08

1,920

Shinhan Bank

General loan

3/30/2019

KRW

6.06

2,862

NongHyup Bank

Credit facility

01/07/2019 ~ 04/29/2019

USD

3.71 ~ 4.50

2,053

The Export-Import Bank of Korea

Export development loan

07/01/2019

KRW

3.44

6,439

The Export-Import Bank of Korea

Import development loan

02/14/2019

USD

4.31

850

Korea Development Bank

General loan

08/08/2019

KRW

3.48

4,472

Korea Development Bank

Credit facility

02/07/2019 ~ 03/06/2019

USD

3.64 ~ 3.91

1,489

LGUPlus

General loan

06/17/2019

KRW

1,789

Shoko Chukin Bank

General loan

06/28/2019

JPY

1.33

906

24,762

As of December 31, 2018, the Company had $5.5 million in outstanding borrowings and $2.6 million committed as security for letters of credit under the Company's ~~Korean subsidiary received a mutual cooperation capital loan of $1.8~~$19.0 million ~~from LGUPlus and provided a letter of guarantee of the same amount from Seoul Guarantee Insurance as collateral.~~

credit facilities with certain foreign banks.

See Note 911 Related-Party Transactions for a discussion of related-party debt.

(9)	Defined Benefit Plans

The Company provides certain defined benefit pension plans in Germany for active and former employees of Keymile and their surviving dependents. These benefits were promised upon an employee either reaching retirement age or becoming disabled. Benefits paid depend on an employee’s years of service and annual earnings. These plans were frozen as of September 30, 2003 and have not been offered to new employees after that date. Employees who were already covered by such plans ceased earning benefits under such plans from the freeze date forward. The benefit obligations are determined separately for each plan by estimating the present value of future benefits that employees have earned in prior periods. Given that all plans are frozen; the Company does not have any current service costs to recognize within its defined benefit obligation or pension expense.

The only component of pension expense relates to $0.1 million of interest expense on the defined benefit pension plans, which is recognized in Other income (loss), net in the condensed consolidated statement of comprehensive income (loss). The interest expense is determined by multiplying the defined benefit obligation by the discount rate used to determine the defined benefit obligation. Actuarial gains and losses from changes in assumptions are included in Other comprehensive loss in the condensed consolidated statement of comprehensive income (loss).

The following key actuarial assumptions were made in determining the benefit obligation:

		March 31, 2019
~~(8)~~ Discount rate		1.70%
Rate of pension increase		1.70%
Retirement age		62-64 years

As of March 31, 2019, the Company’s employee benefit obligations under the defined benefit plans is approximately $12.4 million, net of pensions assets of $3.5 million which is under a reinsurance contract policy. As of March 31, 2019, there were no cash contributions on the defined benefit plans.

(10)	Non-Controlling Interests

Non-controlling interests for the ~~nine~~three months ended ~~September 30,~~March 31, 2019 and 2018 ~~and 2017~~ were as follows (in thousands):

	Three Months Ended March 31,
	2019			2018
Beginning non-controlling interests	$	615		$	534
Net income (loss) attributable to non-controlling interests		181			34
Foreign currency translation adjustments (OCI)		(1	)		30
Ending non-controlling interests	$	795		$	598

Nine Months Ended September 30,
2018 2017
Beginning non-controlling interests $ 534
$ 416
Net income (loss) attributable to non-controlling interests 2
172
Foreign currency translation adjustments (5 ) 19
Ending non-controlling interests $ 531
$ 607

(11)
~~(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~~facility, which was fully drawn. The term loan agreement, the Company was permitted to request drawdowns of one or more term loans in an aggregate principal amount not to exceed $5.0 million. As of September 30, 2018, $5.0 million in term loans was outstanding under the facility. Such term loans maturematures in September 2021 and ~~are~~is pre-payable atat any time by the Company without premium or penalty. The interest rate ~~as of September 30, 2018~~ under this facility was 4.6% per annum.

In February 2019, the Company repaid the term loan in full plus accrued interest in connection with the entry into the PNC Facility.

In February 2016, ~~the Company~~DNS borrowed $1.8 million from DNI for capital investment, which amount was outstanding as of ~~September 30, 2018. This~~March 31, 2019. The interest rate as of March 31, 2019 under this facility was 4.6% per annum. On February 27, 2019, in connection with the entry into the PNC Facility, the Company amended the terms of this loan ~~matures in July~~to extend the repayment date to May 27, 2022.

On December 27, 2018, the Company entered into a Loan Agreement with DNI, for a $6.0 million term loan, which amount was outstanding as of March 31, 2019 ~~and bears~~with an interest ~~at a~~ rate of 4.6% per annum. ~~per annum, payable annually.~~

On February 27, 2019, in connection with the entry into the PNC Facility, the Company amended the terms of the term loan to extend the repayment date to May 27, 2022 and to terminate any security granted to DNI with respect to such term loan.

In March ~~21,~~ 2018, Dasan Network Solutions, Inc., a company incorporated under the laws of Korea (“DNS Korea”) borrowed ~~$5.8 million~~KRW6.5 billion ($5.8 million) from DNI, of which ~~$4.5 million~~KRW5.0 billion ($4.5 million) was repaid on August 8, 2018. As of ~~September 30, 2018, $1.3 million~~March 31, 2019, KRW1.5 billion ($1.3 million) remained outstanding. The loan bears interest at a rate of 4.6% ~~and matures on June 27, 2019,~~, and is secured by certain accounts receivable of DNS Korea.

On February 27, 2019, in connection with the entry into the PNC Facility, the Company amended the terms of this loan to extend the repayment date to May 27, 2022.

Interest expense on these related-party borrowings was $0.1 million and $0.2 million for the three months ended March 31, 2019 and 2018, respectively.

Other Related-Party Transactions

Sales and purchases, cost of revenue, research and product development, selling, marketing, general and administrative, interest expense and other expenses to and from related parties for the three ~~and nine~~ months ended ~~September 30,~~March 31, 2019 and 2018 ~~and 2017~~ were as follows (in thousands):

		Three Months Ended March 31, 2019
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	$	722	$	535	$	—	$	—	$	998	$	141	$	89
Tomato Soft Ltd.	100%		—		—		30		—		—		—		—
Tomato Soft (Xi'an) Ltd.	100%		—		—		—		121		—		—		—
CHASAN Networks Co., Ltd.	100%		—		—		278		21		—		—		161
HANDYSOFT, Inc.	17.63%		91		23		—		—		2		—		—
J-Mobile Corporation	90.47%		42		81		—		—		—		—		—
		$	855	$	639	$	308	$	142	$	1,000	$	141	$	250

~~Table of Contents~~

		Three Months Ended March 31, 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	$	1,246	$	1,123	$	—	$	—	$	1,022	$	196	$	66
Tomato Soft Ltd.	100%		—		—		19		—		—		—		—
Tomato Soft (Xi'an) Ltd.	100%		—		—		10		154		—		—		—
CHASAN Networks Co., Ltd.	100%		—		—		324		18		—		—		—
DASAN FRANCE	100%		202		177		—		—		—		—		—
HANDYSOFT, Inc.	17.63%		150		110		—		—		—		—		—
		$	1,598	$	1,410	$	353	$	172	$	1,022	$	196	$	66

Three Months Ended September 30, 2018
Counterparty DNI ownership Interest Sales Cost of revenue Research and product development
Selling, marketing,
general and administrative
Interest expense Other expenses
DNI (Parent Company) N/A $ 1,472
$ 1,270
$ —
$ 784
$ 112
$ 89
Tomato Soft Ltd. 100% —
27
—
—
—
—
Tomato Soft (Xi'an) Ltd. 100% —
—
119
—
—
—
Chasan Networks Co., Ltd. 100% —
260
21
—
—
—
Handysoft, Inc. 17.63% 215
208
—
2
—
—
$ 1,687
$ 1,765
$ 140
$ 786
$ 112
$ 89

Three Months Ended September 30, 2017
Counterparty DNI ownership Interest Sales Cost of revenue Research and product development Selling, marketing,
general and administrative Other expenses
DNI (Parent Company) N/A $ 3,976
$ 3,604
$ —
$ 1,291
$ 51
Chasan Networks Co., Ltd. 100% —
257
20
—
—
Dasan France 100% 662
576
—
83
—
Dasan India Private Limited 100% —
—
—
30
—
D-Mobile 100% 1,233
1,077
—
122
—
HandySoft, Inc. 17.64% 54
12
—
6
4
Tomato Soft Ltd. 100% —
43
108
—
—
Tomato Soft (Xi'an) Ltd. 100% —
—
144
—
—
$ 5,925
$ 5,569
$ 272
$ 1,532
$ 55

Nine Months Ended September 30, 2018
Counterparty DNI ownership Interest Sales Cost of revenue Research and product development
Selling, marketing,
general and administrative
Interest expense Other expenses
DNI (Parent Company) N/A $ 3,683
$ 3,143
$ —
$ 2,950
$ 338
$ 234
Tomato Soft Ltd. 100% —
84
—
—
—
—
Tomato Soft (Xi'an) Ltd. 100% —
10
396
—
—
—
Chasan Networks Co., Ltd. 100% —
880
57
—
—
—
Dasan France 100% 202
177
—
—
—
—
HandySoft, Inc. 17.63% 473
357
—
4
—
—
$ 4,358
$ 4,651
$ 453
$ 2,954
$ 338
$ 234

~~Table of Contents~~

Nine Months Ended September 30, 2017
Counterparty DNI ownership Interest Sales Cost of revenue Research and product development Selling, marketing,
general and administrative Other expenses
DNI (Parent Company) N/A $ 16,608
$ 14,020
$ —
$ 3,491
$ 171
Chasan Networks Co., Ltd. 100% —
578
79
—
—
Dasan France 100% 1,612
1,512
—
383
—
Dasan India Private Limited⁽¹⁾
100% 6,287
4,783
—
30
—
D-Mobile⁽¹⁾
100% 3,054
1,831
—
318
—
Fine Solution 100% —
—
—
4
—
HandySoft, Inc. 17.64% 88
23
—
6
4
J-Mobile Corporation 90.47% 8
—
—
132
—
Tomato Soft Ltd. 100%
104
108

Tomato Soft (Xi'an) Ltd. 100% —
—
448
37
—
Solueta 27.21% —
—
—
—
3
$ 27,657
$ 22,851
$ 635
$ 4,401
$ 178

_{(1) As discussed above, on December 31, 2017 DNS acquired DASAN India and D-Mobile from DNI.}

The Company has entered into sales agreements with DNI and certain ~~of its~~ subsidiaries. Sales and cost of revenue to DNI and DASAN France ~~(and with respect to the first three quarters of 2017, DASAN India and D-Mobile)~~ represent finished goods produced by the Company that are sold to these related parties who sell the Company's products in Korea and France, ~~India and Taiwan,~~ respectively.

The Company has entered into an agreement with ~~Chasan~~CHASAN Networks Co., Ltd. to provide manufacturing and research and development services for the Company. Under the agreement with ~~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. Sales to DNI necessary for DNI to fulfill agreements with its customers are recorded net of royalty fees in related-party revenue.

The Company shares office space with DNI and certain of DNI's subsidiaries. Prior to the Merger, DNS, then a wholly owned subsidiary of DNI, shared human resources, treasury and other administrative support with DNI. As such, the Company entered into certain service sharing agreements with DNI and certain of its subsidiaries for the shared office space and shared administrative services. Expenses related to ~~leases~~rent and administrative services are allocated ~~and billed~~ to the Company based on square footage occupied and headcount, respectively.

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

Balances of Receivables and Payables with Related Parties

Balances of receivables and payables arising from sales and purchases of goods and services with related parties as of ~~September 30, 2018~~March 31, 2019 and December 31, ~~2017~~2018 were as follows (in thousands):

		As of March 31, 2019
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	$	810	$	—	$	722	$	9,118	$	500	$	2,068	$	141
Tomato Soft Ltd.	100%		—		—		—		—		—		10		—
Tomato Soft (Xi'an) Ltd.	100%		—		—		—		—		—		41		—
CHASAN Networks Co., Ltd.	100%		—		—		—		—		90		—		—
HANDYSOFT, Inc.	18%		88		—		—		—		2		—		—
DASAN FRANCE	100%		—		4		—		—		—		—		—
		$	898	$	4	$	722	$	9,118	$	592	$	2,119	$	141

		As of December 31, 2018
Counterparty	DNI Ownership Interest	Account receivables		Other receivables		Deposits for lease*		Loan Payable		Accounts payable		Other payables		Accrued and other liabilities**
DNI (parent company)	N/A	$	—	$	—	$	735	$	14,142	$	1,000	$	1,231	$	169
Tomato Soft Ltd.	100%		—		—		—		—		—		9		—
Tomato Soft (Xi'an) Ltd.	100%		—		—		—		—		—		41		—
D-Mobile	N/A		—		—		—		—		—		—		—
Able	100%		—		—		—		—		—		—		—
Dasan France	100%		280		65		—		—		—		—		—
Handysoft, Inc.	14.77%		303		—		—		—		654		—		—
Chasan Networks Co., Ltd.	100%		—		—		—		—		89		—		—
		$	583	$	65	$	735	$	14,142	$	1,743	$	1,281	$	169

Included in other assets related to deposits for lease in the unaudited condensed consolidated balance sheet as of March 31, 2019 and the consolidated balance sheet as of December 31, 2018.

~~Table of Contents~~

Included in accrued and other liabilities in the unaudited condensed consolidated balance sheet as of March 31, 2019 and the consolidated balance sheet as of December 31, 2018.

As of September 30, 2018
Counterparty DNI ownership Interest Account receivables Other receivables Deposits for lease * Loans Payable Accounts payable Other Payables Accrued and other liabilities**
DNI (parent company) N/A $ 1,679
$ 26
$ 738
$ 8,148
$ 1,000
$ 1,810
$ 157
Tomato Soft Ltd. 100% —
—
—
—
—
9
—
Tomato Soft (Xi'an) Ltd. 100% —
—
—
—
—
40
—
Dasan France 100% 285
65
—
—
—
—
—
HandySoft, Inc. 17.63% 175
—
—
—
216
—
—
Chasan Networks Co., Ltd. 100% —
—
—
—
86
—
—
$ 2,139
$ 91
$ 738
$ 8,148
$ 1,302
$ 1,859
$ 157

As of December 31, 2017
Counterparty DNI Ownership Interest Account receivables Other receivables Deposits for lease * Long-term debt Accounts payable Other Payables Accrued and other liabilities**
DNI (parent company) N/A $ 12,576
$ 93
$ 786
$ 6,800
$ 1,264
$ 1,859
$ 59
Tomato Soft Ltd. 100% —
—
—
—
—
18
—
Tomato Soft (Xi'an) Ltd. 100% —
—
—
—
—
54
—
Dasan France 100% 870
71
—
—
—
—
—
HandySoft, Inc. 17.63% 52
—
—
—
—
—
—
Chasan Networks Co., Ltd. 100% —
—
—
—
87
—
—
Solueta 100% —
—
—
—
—
25
—
$ 13,498
$ 164
$ 786
$ 6,800
$ 1,351
$ 1,956
$ 59

_{* Included in other assets in the condensed consolidated balance sheets as of}_{September 30, 2018}_{and December 31, 2017.}

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

~~Table of Contents~~

(12)
~~(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 loss per share is the same as diluted net loss per share for the three months ended March 31, 2019 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 March 31,
	2019			2018
Net income (loss) attributable to DASAN Zhone Solutions, Inc.	$	(1,638	)	$	107
Weighted average number of shares outstanding:
Basic		16,593			16,416
Effect of dilutive securities:
Stock options, restricted stock units and share awards		—			210
Diluted		16,593			16,626
Net income (loss) per share attributable to DASAN Zhone Solutions, Inc.:
Basic	$	(0.10	)	$	0.01
Diluted	$	(0.10	)	$	0.01

Three Months Ended September 30, Nine Months Ended September 30,
2018 2017 2018 2017
Net income (loss) attributable to DASAN Zhone Solutions, Inc. $ 1,798
$ 1,399
$ 3,321
$ (3,157 )
Weighted average number of shares outstanding:
Basic 16,683
16,382
16,425
16,380
Effect of dilutive securities:
Stock options, restricted stock units and share awards 208
—
215
—
Diluted 16,891
16,382
16,640
16,380
Net income (loss) per share attributable to DASAN Zhone Solutions, Inc.:
Basic $ 0.11
$ 0.09
$ 0.20
$ (0.19 )
Diluted $ 0.11
$ 0.09
$ 0.20
$ (0.19 )

~~During the three and nine months ended September 30, 2018, the Company~~

The first quarter of 2019 excluded ~~1.0 million, and 26~~333 thousand stock options at a weighted average exercise price of ~~$10.89, and $14.73, respectively,~~$12.63 from diluted net income per share because their effect would have been antidilutive.

(13)

Leases

~~Basic net income (loss) per share~~

The Company leases certain properties and buildings (including manufacturing facilities, warehouses, and office spaces) and equipment under various arrangements which provide the right to use the underlying asset and require lease payments for the lease term. The Company’s lease portfolio consists of operating leases which expire at various dates through 2027. At March 31, 2019, the Company had no outstanding finance leases.

The Company determines if an arrangement contains a lease at inception on January 1, 2019. The Company evaluates each service contract upon inception to determine whether it is, or contains, a lease. Such determination is made by applying judgment in evaluating each service contract within the context of the 5-step decision making process under ASC 842. The key concepts of the 5-step decision making process that the Company evaluated can be summarized as: (1) is there an identified physical asset; (2) does the Company have the right to substantially all the economic benefits from the asset throughout the contract period; (3) does the Company control how and for what purpose the asset is used; (4) does the Company operate the asset; and (5) did the Company design the asset in a way that predetermines how it will be used.

Assets and liabilities related to operating leases are included in the condensed consolidated balance sheet as right-of-use assets from operating leases, operating lease liabilities - current and operating lease liabilities - non-current.

Operating lease right-of-use assets and liabilities are recognized at commencement date based on the present value of lease payments over the lease term. Many of the Company’s lease agreements contain renewal options; however, the Company does not recognize right-of-use assets or lease liabilities for renewal periods unless it is determined that the Company is reasonably certain of renewing the lease at inception or when a triggering event occurs. Some of the Company’s lease agreements contain rent escalation clauses, rent holidays, capital improvement funding or other lease concessions.

The Company recognizes minimum rental expense on a straight-line basis based on the fixed components of a lease arrangement. The Company amortizes this expense over the term of the lease beginning with the date of initial possession, which is the ~~same~~date lessor makes an underlying asset available for use. Variable lease components represent amounts that are not fixed in nature and are not tied to an index or rate, and are recognized as ~~diluted net income (loss) per share for~~incurred.

In determining its right-of-use assets and lease liabilities, the ~~nine months ended September 30, 2017 because~~Company applies a discount rate to the ~~effects~~minimum lease payments within each lease agreement. ASC 842 requires the Company to use the rate of ~~stock options and restricted stock units~~interest that a lessee would have ~~been anti-dilutive.~~


~~(11)~~	~~Commitments and Contingencies~~

~~Operating Leases~~

to pay to borrow on a collateralized basis over a similar term an amount equal to the lease payments in a similar economic environment. The Company ~~has entered~~determines the incremental borrowing rate for each lease based primarily on its lease term and the economic environment of the applicable country or region. When the Company cannot readily determine the discount rate implicit in the lease agreement, the Company utilizes incremental borrowing rate based on the most recent debt facilities interest rates.

For the measurement and classification of its lease agreements, the Company groups lease and non-lease components into a single lease component for all underlying asset classes. Variable lease payments include payments for non-lease components of maintenance costs. The components of lease expense are as follows:

	Three Months Ended March 31, 2019 (in thousands)
Operating lease cost	$	1,123
Variable lease cost		164
Total net lease cost	$	1,287

Supplemental cash flow information related to the Company’s operating leases for ~~certain office space~~the three months ended March 31, 2019 was as follows:

Three Months

Ended

March 31, 2019

(in thousands)

Cash paid for amounts included in the measurement of operating lease liabilities

1,304

ROU assets obtained in exchange for operating lease obligations

—

The following table presents the lease balances within the Company’s condensed consolidated balance sheet, weighted average remaining lease term, and ~~equipment, some~~weighted average discount rates related to the Company’s operating leases as of ~~which contain renewal options and escalation clauses. Estimated~~March 31, 2019 (in thousands):

Lease Assets and Liabilities
Assets:
Right-of-use assets from operating leases	$	21,193

Liabilities:
Operating lease liabilities - current	$	4,261
Operating lease liabilities - non-current		18,103
Total operating lease liabilities	$	22,364

Weighted average remaining lease term	3.48 years
Weighted average discount rate		6	%

The following table presents the maturity of the Company’s operating lease liabilities as of March 31, 2019 (in thousands):

Remainder of 2019	$	3,892
2020		4,317
2021		3,993
2022		3,860
2023		3,732
Thereafter		6,582
Total operating lease payments	$	26,376
Less: imputed interest		(4,012	)
Total operating lease liabilities	$	22,364

As of December 31, 2018, the estimated future lease payments under ~~all non-cancellable~~non-cancelable operating leases ~~with terms in excess~~as defined under the previous lease accounting guidance of ~~one year, including taxes~~ASC Topic 840, for the following five fiscal years and ~~service fees,~~thereafter are as follows (in thousands):

	Operating Leases
Year ending December 31:
2019	$	4,100
2020		3,005
2021		2,590
2022		2,664
2023		2,494
Thereafter		5,929
Total minimum lease payments	$	20,782

(14)	Commitments and Contingencies

Operating Leases
Year ending December 31:
2018 (remainder of the year) $ 1,053
2019 4,088
2020 2,998
2021 2,590
2022 2,664
Thereafter 8,423
Total minimum lease payments $ 21,816

~~Table of Contents~~

Warranties

The Company accrues warranty costs based on historical trends for the expected material and labor costs to provide warranty services. Warranty periods are generally one to five years from the date of shipment. The following table reconciles changes in the Company’s accrued warranties and related costs for the ~~nine~~three months ended ~~September 30,~~March 31, 2019 and 2018 ~~and 2017~~ (in thousands):

	Three Months Ended March 31,
	2019			2018
Beginning balance	$	1,549		$	931
Charged to cost of revenue		140			359
Claims and settlements		(194	)		(195	)
Foreign exchange impact		(11	)		(1	)
Ending balance	$	1,484		$	1,094

Nine Months Ended September 30,
2018 2017
Beginning balance $ 931
$ 878
Charged to cost of revenue 1,022
126
Claims and settlements (598 ) (195 )
Foreign exchange impact 6
14
Ending balance $ 1,361
$ 823

Performance Bonds

In the normal course of operations, from time to time, the Company arranges for the issuance of various types of surety bonds, such as bid and performance bonds, which are agreements under which the surety company guarantees that the Company will perform in accordance with contractual or legal obligations. As of ~~September 30, 2018, and 2017,~~March 31, 2019, the Company had ~~$2.9 million and $1.0~~$9.6 million of surety bonds guaranteed by third ~~parties, respectively.~~

parties.

Purchase Commitments

The Company has agreements with various contract manufacturers which include non-cancellable inventory purchase commitments. The Company’s inventory purchase commitments typically allow for cancellation of orders 30 days in advance of the required inventory availability date as set by the Company at time of order. The amount of non-cancellable purchase commitments outstanding, net of reserve, was ~~$2.4~~$3.1 million as of ~~September 30, 2018~~.

~~Payment Guarantees provided by Third Parties and DNI~~

The following table sets forth payment guarantees of the Company's indebtedness and other obligations as of September 30, 2018 (in thousands) that have been provided by third parties and DNI. DNI owns approximately 57.3% of the outstanding shares of the Company's common stock:

Guarantor Amount Guaranteed (in thousands) Description of Obligations Guaranteed
DNI $ 3,451
Borrowings from Shinhan Bank
DNI 1,726
Purchasing Card from Shinhan Bank
DNI 10,730
LC from Industrial Bank of Korea
DNI 2,157
Purchasing Card from Industrial Bank of Korea
DNI 6,000
LC from NongHyup Bank
DNI 6,170
Borrowings from Export-Import Bank of Korea
DNI 6,000
LC from KookMin Bank
DNI 5,392
Borrowings from Korea Development Bank
DNI
8,400

LC from Korea Development Bank
Industrial Bank of Korea 6,486
Borrowings and letter of credit
NongHyup Bank 3,497
Borrowings and letter of credit
Kookmin Bank 304
Letter of credit
Korea Development Bank 894
Letter of credit
Shinhan Bank 933
Purchasing Card
Industrial Bank of Korea 4,075
Performance bonds
State Bank of India 34
Performance bonds
Seoul Guarantee Insurance Co. 4,232
Performance payment guarantee*
$ 70,481

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

~~Table of Contents~~

March 31, 2019.

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.

Payment Guarantees provided by Third Parties and DNI

The following table sets forth payment guarantees of the Company's indebtedness and other obligations as of March 31, 2019 (in thousands) that have been provided by third parties and DNI. DNI owns approximately 57.2% of the outstanding shares of the Company's common stock:

Guarantor	Amount Guaranteed (in thousands)		Description of Obligations Guaranteed
DNI	$	8,400	Credit facility from Industrial Bank of Korea
DNI		2,109	Purchasing Card from Industrial Bank of Korea
DNI		1,688	Purchasing Card from Shinhan Bank
DNI		8,400	Credit facility from Korea Development Bank
DNI		5,273	Borrowings from Korea Development Bank
DNI		6,000	Credit facility from NongHyup Bank
DNI		5,036	Borrowings from Export-Import Bank of Korea
Industrial Bank of Korea		6,525	Letter of Credit
Industrial Bank of Korea		2,131	Bank Guarantee
Seoul Guarantee Insurance Co.		4,857	Performance Bond, Warranty Bond etc. (*)
NongHyup Bank		4,258	Letter of Credit
Woori Bank		2,503	Bank Guarantee
Korea Development Bank		1,552	Letter of Credit
Shinhan Bank		88	Purchasing Card
AXA Insurance Company		180	Guarantee for flexible retirement program
Polska Agencja Zeglugi Powietrznej		117	Performance Bond, Warranty Bond etc. (*)
	$	59,117

The Company is generally responsible for warranty liabilities for a period of two years with respect to major product sales and has, therefore, contracted for surety insurance for a portion of the warranty liabilities.

Legal Proceedings

~~The~~

From time to time, 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 that 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.

(15)
~~(12)~~	~~Stock Option and Other Benefit Plans~~ Income Taxes

Income tax (benefit) expense for the three months ended March 31, 2019 and 2018 ~~Employee Stock Purchase Plan~~

~~On May 22, 2018,~~was approximately $0.1 million and $0.0 million, respectively, on pre-tax loss of $1.4 million and pre-tax income of $0.1 million, respectively. As of March 31, 2019, the ~~stockholders~~income tax rate varied from the United States statutory income tax rate primarily due to valuation allowances in the United States and the mix 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~~earnings generated by the Company’s ~~existing DASAN Zhone Solutions, Inc. 2002 Employee Stock Purchase Plan.~~

wholly owned foreign subsidiaries.

The ~~ESPP authorizes~~total amount of unrecognized tax benefits, including interest and penalties, at March 31, 2019 was $0.8 million. The amount of tax benefits that would impact the ~~issuance of up~~effective income tax rate, if recognized, is $0.1 million. There were no significant changes to ~~250,000 shares of~~unrecognized tax benefits during 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,~~quarters ended March 31, 2019 and ~~ending on and including January 1, 2028 equal~~2018. The Company does not anticipate any significant changes with respect to unrecognized tax benefits within the lesser of (i) 1% of the shares outstanding on the last day of the immediately preceding calendar year and (ii) such smaller number of shares as may be determined by the Board in its sole discretion. Notwithstanding the foregoing, the number of shares of stock that may be issued or transferred pursuant to awards under the ESPP may not exceed an aggregate of 2,000,000 shares. These 2,000,000 shares have been registered pursuant to a registration statement on Form S-8 filed with the SEC on November 8, 2018.

~~Table of Contents~~

next 12 months.

(16)
~~(13)~~	Enterprise-Wide Information

The Company is a global provider of ultra-broadband network access solutions and communications ~~equipment for~~platforms deployed by advanced Tier 1, 2 and 3 service ~~provider~~providers and enterprise ~~networks.~~customers. There are no segment managers who are held accountable for operations, operating results and plans for levels or components below the Company unit level. Accordingly, the Company is considered to be in a single reporting segment and operating unit structure. The Company’s chief operating decision maker is the Company’s Chief Executive Officer, who reviews financial information presented on a consolidated basis accompanied by disaggregated information about revenues by geographic region for purposes of making operating decisions and assessing financial performance. The Company attributes revenue from customers to individual bill to countries. The following summarizes required disclosures about geographical concentrations and revenue by products and services (in thousands):

Three Months Ended Nine months ended
September 30, September 30,
2018 2017 2018 2017
Revenue by geography:
United States $ 11,125
$ 13,068
$ 41,373
$ 37,176
Canada 1,131
1,498
3,344
4,112
Total North America 12,256
14,566
44,717
41,288
Latin America 6,841
7,480
21,713
19,425
Europe, Middle East, Africa 10,425
7,378
27,264
19,134
Korea 19,609
20,520
50,844
69,032
Other Asia Pacific 22,783
16,494
63,137
29,612
Total International 59,658
51,872
162,958
137,203
Total $ 71,914
$ 66,438
$ 207,675
$ 178,491

Three Months Ended Nine months ended
September 30, September 30,
2018 2017 2018 2017
Revenue by classification:
Products $ 68,787
$ 63,257
$ 198,830
$ 169,831
Services 3,127
3,181
8,845
8,660
Total $ 71,914
$ 66,438
$ 207,675
$ 178,491

~~The~~ Company's property, plant and equipment, net of accumulated depreciation, were located in the following geographical areas as of ~~September 30, 2018~~March 31, 2019 and December 31, ~~2017~~2018 (in thousands):

	March 31, 2019		December 31, 2018
United States	$	2,910	$	3,036
Korea		1,388		1,543
Japan and Vietnam		876		910
Taiwan and India		28		29
Germany		922		—
	$	6,124	$	5,518

As of September 30,
2018

As of December 31,
2017
United States $ 3,131
$ 3,393
Korea 1,441
1,633
Other Asia Pacific 802
847
$ 5,374
$ 5,873


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

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

As of September 30, 2018, the income tax rate varied from the United States statutory income tax rate primarily due to valuation allowances in the United States and taxable income generated by the Company’s wholly-owned foreign subsidiaries.

~~Table of Contents~~

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

The Company has recognized the provisional tax impacts related to the Tax Act in the Company’s consolidated financial statements for the year ended December 31, 2017. The ultimate impact may differ from provisional amounts, possibly materially, due to, among other things, additional analysis, changes in interpretations and assumptions 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 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 before the end of the measurement period in the fourth quarter of 2018.


~~(15)~~	~~Subsequent Events~~

~~Keymile Acquisition / Share Purchase Agreement~~

On October 5, 2018, ZTI Merger Subsidiary III, Inc., a Delaware corporation, and wholly owned subsidiary of the Company (the “Purchaser”) and Riverside KM Beteiligung GmbH, a limited liability company organized under the laws of Germany (the “Seller”) entered into a Share Purchase Agreement (the “Purchase Agreement”) whereby the Purchaser agreed to purchase from the Seller all shares in Keymile GmbH (“Keymile”), a limited liability company organized under the laws of Germany, and certain of its subsidiaries, for an aggregate cash purchase price of EUR 10.25 million ($11.9 million) (the “Keymile Acquisition��). The purchase price is to be paid at closing and is subject to customary regulatory approval and satisfaction of certain closing conditions. Certain liabilities including unfunded pension liabilities are to be assumed by the Purchaser.

Keymile offers a series of multi-service access platforms for FTTx network architectures, including ultra-fast broadband copper access based on VDSL/Vectoring & G. Fast technology. The Company has pursued the acquisition to enable the strengthening of its global broadband access service market.

~~The Company has $42,000 of outstanding receivables and $59,000 of sales to Keymile as of and for the nine months period ended September 30, 2018.~~

~~Guarantee Agreement and Working Capital Facility~~

In connection with the Keymile Acquisition and the Purchase Agreement, the Company has also entered into a guarantee agreement with the Seller, dated October 5, 2018, which guarantees the purchase price of EUR 10.25 million ($11.9 million) and guarantees a working capital facility of EUR 4.0 million ($4.6 million). Both the guarantee agreement and the working capital facility are to be provided at closing of the Keymile Acquisition, which is expected to be completed in the fourth quarter of 2018.

The foregoing description of the Keymile Acquisition and the Purchase Agreement, which includes the Guarantee Agreement and Working Capital Facility as exhibits, is not complete and is qualified in its entirety by reference to the full text of the Purchase Agreement, which will be filed by the Company when the Keymile Acquisition closes on a Form 8-K.

~~Wells Fargo Bank Facility~~

~~On October 22, 2018, the Company borrowed $3.0 million under the Amended WFB Facility. On October 31, 2018, the Company repaid the $3.0 million in full.~~

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

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

Forward-Looking Statements

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

~~Table of Contents~~

words such as “anticipate,” “believe,” “continue,” “could,” “estimate,” “expect,” “forecast,” “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 ~~as to~~in future periods; anticipated growth and trends in our business or key markets; cost synergies, growth opportunities and other potential financial and operating benefits of ~~the Merger;~~our acquisitions, including our acquisition of Keymile GmbH (the “Keymile Acquisition”); future growth and revenues from our products; our ability to refinance or repay our existing indebtedness prior to the applicable maturity ~~date;~~dates; future economic conditions and performance; anticipated performance of products or services; plans, objectives and strategies for future operations; anticipated cash contribution requirements for our non-U.S. defined benefit pension plans; and other characterizations of future events or circumstances, and all other statements that are not statements of historical fact are forward-looking ~~statements.~~statements within the meaning of the Securities Act and the Exchange Act. 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~~of this ~~report~~Quarterly Report on Form 10-Q and in our other filings with the Securities and Exchange Commission (the SEC). ~~Actual~~Our 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 acquisitions, including the Keymile Acquisition and any integration risks relating to acquisitions, including the Keymile Acquisition, the ability to generate sufficient revenue to achieve or sustain profitability, ~~the~~our 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 or delays the ~~ability~~purchase of products by 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 Zhone Technologies, Inc., and other factors identified elsewhere in this ~~report~~Quarterly Report on Form 10-Q 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 ultra-broadband network access solutions and communications ~~equipment for~~platforms deployed by advanced Tier 1, 2 and 3 service ~~provider~~providers and enterprise ~~networks.~~customers. We provide a wide array of reliable, cost-effective networking technologies to a diverse customer base that includes more than 900 customers in more than 80 countries worldwide. We research, develop, test, sell, manufacture and support ~~communications equipment~~platforms in five major areas: broadband access, mobile backhaul, Ethernet switching ~~mobile backhaul, passive optical~~with Software Defined Networking (“SDN”) capabilities, new enterprise solutions based on Passive Optical LAN ~~(POLAN)~~(“POL”), and ~~software defined networks (SDN)~~new generation of SDN/Network Function Virtualization (“NFV”) solutions for unified wired and wireless networks. In September 2018, our wholly owned subsidiary DASAN Network solutions, Inc., a corporation organized under the laws of the Republic of Korea (“DNS Korea”), was awarded a contract by South Korean Tier 1 service provider LG U+ to deliver DZS switches to be deployed in its 5G wireless network in South Korea. As of March 31, 2019, we employed over 670 personnel worldwide, of which approximately half are engineers or engaged in research and development.

On January 3, 2019, ZTI Merger Subsidiary III Inc., a Delaware corporation and our wholly owned subsidiary (“ZTI”), acquired all of the outstanding shares of Keymile GmbH, a limited liability company organized under the laws of Germany (“Keymile”). The aggregate cash purchase price paid for all of the shares of Keymile and certain of its subsidiaries was €10,250,000 (approximately $11.8 million). We also assumed pension obligations of approximately $12.7 million, net of pension assets of $3.5 million. Following the closing of the acquisition, Keymile became our wholly-owned subsidiary.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

For a complete description of what we believe to be the critical accounting policies and estimates used in the preparation of our ~~Unaudited Condensed Consolidated Financial~~unaudited condensed consolidated financial Statements, refer to Note 1(j), Recent Accounting Pronouncements, in the notes to our audited consolidated financial statements in our Annual Report on Form 10-K for the year ended December 31, ~~2017. Refer to~~2018, as supplemented by Note ~~1 (g)~~1(j), Recent Accounting Pronouncements, in the ~~Notes~~notes to ~~Unaudited Condensed Consolidated Balance Sheets~~our unaudited condensed consolidated financial statements in Part I, Item 1 ~~of Part I~~ of this Quarterly Report on Form ~~10-Q, for the updated accounting policy of revenue recognition upon the adoption of ASU 2014-09, "Revenue from Contracts with Customers" (Topic 606) as of January 1, 2018.~~

~~Table of Contents~~

10-Q.

RESULTS OF OPERATIONS

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

	Three Months Ended
	March 31,
	2019			2018
Net revenue:
Third parties		99	%		97	%
Related parties		1	%		3	%
Total net revenue		100	%		100	%
Cost of revenue:
Products and services - third parties		65	%		61	%
Products and services - related parties		1	%		2	%
Amortization of intangible assets		0	%		0	%
Total cost of revenue		66	%		63	%
Gross profit		34	%		37	%
Operating expenses:
Research and product development		14	%		15	%
Selling, marketing, general and administrative		20	%		21	%
Amortization of intangible assets		1	%		0	%
Total operating expenses		35	%		36	%
Operating income (loss)		-1	%		1	%
Interest income		0	%		0	%
Interest expense		-1	%		-1	%
Other income (loss), net		0	%		0	%
Income (loss) before income taxes		-2	%		0	%
Income tax (benefit) provision		0	%		0	%
Net income (loss)		-2	%		0	%
Net income attributable to non-controlling interest		0	%		0	%
Net income (loss) attributable to DASAN Zhone Solutions, Inc.		-2	%		0	%
Foreign currency translation adjustments		-2	%		1	%
Comprehensive income (loss)		-4	%		1	%
Comprehensive income attributable to non-controlling interest		0	%		0	%
Comprehensive income (loss) attributable to DASAN Zhone Solutions, Inc.		-4	%		1	%

Three Months Ended September 30, Nine Months Ended September 30,
2018 2017 2018 2017
Net revenue:
Third parties 98 % 91 % 98 % 85 %
Related parties 2 % 9 % 2 % 15 %
Total net revenue 100 % 100 % 100 % 100 %
Cost of revenue:
Products and services - third parties 65 % 58 % 65 % 53 %
Products and services - related parties 2 % 8 % 2 % 13 %
Amortization of intangible assets — % — % — % — %
Total cost of revenue 67 % 66 % 67 % 66 %
Gross profit 33 % 34 % 33 % 34 %
Operating expenses:
Research and product development 12 % 13 % 13 % 15 %
Selling, marketing, general and administrative 16 % 18 % 17 % 19 %
Amortization of intangible assets — % — % — % 1 %
Total operating expenses 28 % 31 % 30 % 35 %
Operating income (loss) 5 % 3 % 3 % (1 )%
Interest income — % — % — % — %
Interest expense — % (1 )% — % — %
Other income, net (1 )% — % — % — %
Income (loss) before income taxes 4 % 2 % 3 % (1 )%
Income tax provision 1 % — % 1 % — %
Net income (loss) 3 % 2 % 2 % (1 )%

Net Revenue

Information about our net revenue for products and services for the ~~nine~~three months ended ~~September 30,~~March 31, 2019 and 2018 ~~and 2017~~ is summarized below (in millions):

	Three Months Ended March 31,
	2019		2018		Increase		% change
Products	$	69.6	$	56.7	$	12.9		23	%
Services		4.5		2.8		1.7		61	%
Total	$	74.1	$	59.5	$	14.6		25	%

Three Months Ended September 30, Nine Months Ended September 30,
2018 2017 Increase/ (decrease) % change 2018 2017 Increase % change
Products $ 68.8
$ 63.2
$ 5.6
9 % $ 198.8
$ 169.8
$ 29.0
17 %
Services 3.1
3.2
(0.1 ) (3 )% 8.9
8.7
0.2
2 %
Total $ 71.9
$ 66.4
$ 5.5
8 % $ 207.7
$ 178.5
$ 29.2
16 %

~~Table of Contents~~

~~Information about our net~~Net revenue increased by 25% or $14.6 million for ~~North America and international markets for the three and~~ ~~nine months ended September 30, 2018~~ ~~and 2017 is summarized below (in millions):~~

Three Months Ended September 30, Nine Months Ended September 30,
2018 2017 Increase/(decrease) % change 2018 2017 Increase/(decrease) % change
Revenue by geography:
United States $ 11.2
$ 13.1
$ (1.9 ) (15 )% $ 41.4
$ 37.2
$ 4.2
11 %
Canada 1.1
1.5
(0.4 ) (27 )% 3.3
4.1
(0.8 ) (20 )%
Total North America 12.3
14.6
(2.3 ) (16 )% 44.7
41.3
3.4
8 %
Latin America 6.8
7.5
(0.7 ) (9 )% 21.7
19.5
2.2
11 %
Europe, Middle East, Africa (EMEA) 10.4
7.4
3.0
41 % 27.3
19.1
8.2
43 %
Korea 19.6
20.4
(0.8 ) (4 )% 50.9
69.0
(18.1 ) (26 )%
Other Asia Pacific 22.8
16.5
6.3
38 % 63.1
29.6
33.5
113 %
Total International 59.6
51.8
7.8
15 % 163.0
137.2
25.8
19 %
Total $ 71.9
$ 66.4
$ 5.5
8 % $ 207.7
$ 178.5
$ 29.2
16 %

~~For~~ the three months ended ~~September 30, 2018, net revenue increased 8% or $5.5 million~~March 31, 2019 compared to ~~$71.9 million from $66.4 million for~~ the same period last year. For the ~~nine months ended September 30, 2018, net revenue increased 16% or $29.2 million to $207.7 million from $178.5 million for the same period of last year. For the~~ three months ended ~~September 30, 2018,~~March 31, 2019, product revenue increased 9%by 23% or ~~$5.6~~$12.9 million to ~~$68.8~~$69.6 million from ~~$63.2~~$56.7 million ~~for the same period last year. For the nine months ended September 30, 2018, product revenue increased 17% or $29.0 million to $198.8 million from $169.8 million for~~in the same period last year. The increase ~~in net revenue for both the three and nine month periods ended September 30, 2018~~ was primarily due ~~to increased products sales~~an increase in ~~the Europe, Middle East and Africa ("EMEA") and Other Asia Pacific, primarily in India, offset by decreased~~ product sales, ~~in Korea. We also added customers in late 2017, which contributed to~~resulting from the ~~revenue increase during~~combined impact of the ~~first three quarters this year~~Keymile Acquisition, as ~~compared to the same periods last year.~~

well as our broadened geographical base and product offerings.

Service revenue represents revenue from maintenance and other services associated with product shipments. For the three months ended ~~September 30, 2018, service revenue decreased 3% or $0.1 million to $3.1 million from $3.2 million for the same period last year. For the nine months ended September 30, 2018,~~March 31, 2019, service revenue increased 2%by 61% or ~~$0.2~~$1.7 million to ~~$8.9~~$4.5 million from ~~$8.7~~$2.8 million ~~for~~in the same period last year. The increase in service revenue was primarily ~~related~~due to ~~a greater number of products under contract for maintenance and extended warranty.~~

~~International~~the Keymile Acquisition.

Information about our net revenue ~~increased 15% or $7.8 million to $59.6 million~~for North America and international markets for the three months ended ~~September 30,~~March 31, 2019 and 2018 is summarized below (in millions):

	Three Months Ended March 31,
	2019		2018		Increase/ (decrease)			% change
Revenue by geography:
United States	$	9.6	$	16.5	$	(6.9	)		(42	)%
Canada		0.9		1.0		(0.1	)		(10	)%
Total North America		10.5		17.5		(7.0	)		(40	)%
Latin America		6.6		8.0		(1.4	)		(18	)%
Europe, Middle East, Africa		18.4		7.5		10.9			145	%
Korea		15.9		12.1		3.8			31	%
Other Asia Pacific		22.7		14.4		8.3			58	%
Total International		63.6		42.0		21.6			51	%
Total	$	74.1	$	59.5	$	14.6			25	%

For the three months ended March 31, 2019, net revenue increased 25% or $14.6 million to $74.1 million from ~~$51.8~~$59.5 million for the same period last year. The increase in net revenue for three months ended March 31, 2019 was primarily due to increased revenues in the Europe, Middle East and Africa (EMEA) region due to the Keymile Acquisition, as well as increased revenues in Korea and the Other Asia Pacific regions. This increase was partially offset by the decline in revenue in the North America due to change in the buying pattern of certain customers.

Across international markets, net revenue for the three months ended March 31, 2019 increased 51% or $21.6 million to $63.6 million from $42.0 million for the same period last year, and represented ~~83%~~86% of total net revenue compared with ~~78%~~71% during the same period of 2017. International net revenue increased 19% or $25.8 million to $163.0 million for the nine months ended September 30, 2018, from $137.2 million for the same period last year, and represented 78% of total net revenue compared with 77% during the same period last year.2018. The increases in international net revenue were primarily related to the Keymile Acquisition, which increased revenues in EMEA, and increased product sales in the Other Asia Pacific, primarily in ~~India.~~

~~For both the three~~India and ~~nine months ended September 30, 2018, one customer each accounted for 11% of net revenue.~~ Vietnam.

For the three months ended ~~September 30, 2017, two~~March 31, 2019 and for the three months ended March 31, 2018, no customers represented 10% ~~and 9% (a related party)~~or more of net ~~revenue, respectively. For the nine months ended September 30, 2017, two customers represented 9% of net revenue (one of which was a related party).~~

Werevenue. However, 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.

~~Table of Contents~~

Cost of Revenue and Gross Profit

Total cost of revenue increased ~~10%~~30% or ~~$4.5~~$11.4 million to ~~$48.5~~$49.2 million for the three months ended ~~September 30, 2018,~~March 31, 2019, compared to ~~$44.0~~$37.8 million for the three months ended ~~September 30, 2017.~~March 31, 2018. Total cost of revenue was ~~67%~~66% of net revenue for the ~~three months ended September 30, 2018,~~first quarter of 2019, compared to ~~66% for~~63% in the ~~three months ended September 30, 2017. Total cost~~first quarter of revenue increased 18% or $20.9 million to $139.3 million for the nine months ended September 30, 2018, from $118.4 million for the nine months ended September 30, 2017. Total cost of revenue was 67% of net revenue for the nine months ended September 30, 2018 compared to 66% for the nine months ended September 30, 2017.2018. The ~~increase~~increases in total cost of revenue, as a percentage of sales, ~~was~~were primarily due to ~~an increase in revenues in~~ the ~~EMEA~~Keymile Acquisition, and increased product sales to 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 expenses relating to discontinued products and excess or obsolete inventory.

Research and Product Development Expenses

Research and product development expenses ~~decreased 3%~~increased 13% or ~~$0.2~~$1.2 million to ~~$8.7~~$10.2 million for the three months ended ~~September 30, 2018~~March 31, 2019 compared to ~~$8.9~~$9.0 million for the three months ended ~~September 30, 2017.~~March 31, 2018. As a percentage of sales, research and product development expenses were ~~12% for~~14% in the three months ended September 30, 2018, compared to 13% for the three months ended September 30, 2017. Research and product development expenses decreased 4% or $1.1 million to $26.3 million for the nine months ended September 30, 2018 compared to $27.5 million for the nine months ended September 30, 2017. As a percentagefirst quarter of ~~sales, research and product development expenses were 13% for the nine months ended September 30, 2018,~~2019, compared to 15% ~~for~~in the ~~nine months ended September 30, 2017.~~first quarter of 2018. The ~~decrease~~increase in research and product development expenses was primarily due to ~~cost containment initiatives and more focused product development activities.~~the Keymile Acquisition. 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 ~~decreased 5%~~increased 21% or ~~$0.6~~$2.6 million to ~~$11.1~~$15.0 million for the three months ended ~~September 30, 2018,~~March 31, 2019, compared to ~~$11.7~~$12.4 million for the three months ended ~~September 30, 2017.~~March 31, 2018. As a percentage of sales, selling, marketing, general and administrative expenses were ~~16% for the three months ended September 30,~~20% and 21% as of March 31, 2019 and 2018, compared to 18% for the three months ended September 30, 2017. Selling, marketing, general and administrative expenses increased 6% or $2.1 million to $35.2 million for the nine months ended September 30, 2018, compared to $33.1 million for the nine months ended September 30, 2017. As a percentage of sales, selling, marketing, general and administrative expenses were 17% for the nine months ended September 30, 2018, compared to 19% for the nine months ended September 30, 2017. The decrease in selling, marketing, general and administrative expenses for the three months ended September 30, 2018 was primarily related to a continued focus on our cost containment initiatives.respectively. The increase in selling, marketing, general and administrative expenses ~~for the nine months ended September 30, 2018~~ was primarily ~~related to higher personnel expenses~~ due to ~~increased headcount, as well as increased legal and outside service fees.~~

the Keymile Acquisition.

Income Tax Provision

Income tax (benefit) expense for the three ~~and nine~~ months ended ~~September 30,~~March 31, 2019 and 2018 was ~~$0.7~~approximately $0.1 million and ~~$1.1~~$0.0 million, respectively, on pre-tax loss of $1.4 million and pre-tax income of ~~$2.6 million and $4.4 million, respectively. For the three and nine months ended September 30, 2017, income tax expense was~~ $0.1 ~~million and $0.6 million, respectively, on pre-tax income (loss) of $1.5 million and $(2.3)~~ million, respectively. As of ~~September 30, 2018,~~March 31, 2019, the income tax rate varied from the United States statutory income tax rate primarily due to valuation allowances in the United States and ~~taxable income~~the mix of earnings generated by our ~~wholly-owned~~wholly owned foreign subsidiaries.

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 and acquisition 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

~~Table of Contents~~

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.

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~~

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

~~non-cash~~

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

~~other~~

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.~~as a supplemental measure.

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

	Three Months Ended March 31,
	2019			2018
Net income (loss)	$	(1,457	)	$	141
Add (less):
Interest expense, net		783			237
Income tax (benefit) expense		77			(5	)
Depreciation and amortization		1,417			699
Stock-based compensation		825			363
Acquisition costs		337			—
Inventory step-up valuation amortization		201			—
Bargain purchase gain		(334	)		—
Adjusted EBITDA	$	1,849		$	1,435

Three Months Ended September 30, Nine Months Ended September 30,
2018 2017 2018 2017
Net income (loss) $ 1,827
$ 1,387
$ 3,323
$ (2,985 )
Add:
Interest expense, net 405
227
1,127
711
Income tax expense 735
107
1,071
646
Depreciation and amortization 652
752
2,033
3,105
Stock-based compensation 617
195
1,357
670
Non-recurring merger and acquisition costs 139
—
139
—
Adjusted EBITDA $ 4,375
$ 2,668
$ 9,050
$ 2,147

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.

Although we had a net income of ~~$3.3~~$2.8 million ~~for the nine months ended September 30, 2018,~~ and $1.2 million for the ~~year~~years ended December 31, ~~2017.~~2018 and 2017, we had a net loss of $1.5 million for the quarter ended March 31, 2019 and have incurred significant losses in prior years. As of ~~September 30, 2018,~~March 31, 2019, we had an accumulated deficit of ~~$15.2~~$17.4 million and working capital of ~~$66.9~~$86.5 million. ~~In addition,~~As of March 31, 2019, we had ~~a net cash outflow from operations of $15.7 million for the nine months ended September 30, 2018. As of September 30, 2018, we had $20.0~~$20.9 million in cash and cash equivalents, which included ~~$6.0~~$12.2 million in cash balances held by our international subsidiaries, and ~~$42.3~~$57.5 million in aggregate principal amount of short-term debt ~~of which $37.3 million was in current liabilities.~~obligations, other long-term debt and long-term related-party borrowings. In addition, as of ~~September 30, 2018~~March 31, 2019, we had ~~$6.4~~$12.3 million committed as ~~cash collateral~~security for letters of credit under our revolving credit facilities, leaving ~~$21.3~~$21.7 million in aggregate ~~financing~~borrowing availability under these facilities.

Our current lack of liquidity could harm us by:

~~increasing~~

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

~~requiring~~

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

~~limiting~~

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

~~limiting its ability to complete Keymile acquisition; and~~

~~Table of Contents~~

~~influencing~~

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

~~These factors indicate that cash flows might not be sufficient for us~~

However, we plan to ~~meet~~focus on cost management, operating efficiency and restrictions on discretionary spending. In addition, if necessary, we may sell assets, issue debt or equity securities or purchase credit insurance. We may also reduce the scope of our ~~obligations~~planned product development, reduce sales and marketing efforts and reduce our operations in low margin regions, including reductions in headcount. In the first quarter of 2019, we refinanced our former Wells Fargo Bank senior secured facilities with a new term loan and revolving line of credit facility, as ~~they come due~~described more fully in Note 8 to the ~~ordinary course of business for a period of 12 months from the date of this Quarterly Report on Form 10-Q.~~

accompanying condensed consolidated financial statements.

Our ability to meet our obligations as they become due in the ordinary course of business for the next 12twelve (12) months will depend on our ability to (i) achieve forecasted results, (ii) access ~~funds approved~~capital under our existing or new credit facilities and/or to raise additional capital through ~~sales of our common stock to the~~debt or equity financing from public and/or private capital markets and (iii) effectively manage inventory procurement. If we cannot access or raise additional ~~funds~~capital when ~~we need or want them,~~needed, our operations and prospects could be negatively affected. Management’s belief that we will be able to achieve ~~these~~forecasted 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 capital requirements. If one or more of these factors do not occur as expected, it could cause us to fail to meet our obligations as they come due.

We plan to focus on capital raising, cost management, operating efficiency and restrictions on discretionary spending. In addition, if necessary, we may sell assets, issue or enter into amendments of our debt or equity securities, or purchase credit insurance. We may 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. On July 12, 2018, we entered into the A&R Domestic Credit Agreement and 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 ~~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 from the date of this Quarterly Report on Form 10-Q.~~twelve (12) months.

Operating Activities

Net cash used in operating activities ~~was $15.7~~decreased by $8.5 million to $5.0 million for the ~~nine~~three months ended ~~September 30, 2018, compared with net cash used of $0.6~~March 31, 2019 from $13.5 million for the ~~nine~~three months ended ~~September 30, 2017.~~March 31, 2018. The improvement in cash from changes in operating assets and liabilities was primarily due to collection accounts receivable at quarter-end.

Investing Activities

Net cash used in investing activities increased by $4.7 million to $4.8 million for the three months ended March 31, 2019 from $0.1 million for the three months ended March 31, 2018. This increase was primarily due to ~~changes in operating assets and liabilities, resulting in using $23.4~~the paid purchase price as a result of the Keymile Acquisition of $11.8 million, net of cash ~~for nine months ended September 30, 2018, compared to using $2.2 million~~received from the Keymile Acquisition of ~~cash for the nine months ended September 30, 2017.~~

~~Investing Activities~~

Net cash used in investing activities was $0.8 million for the nine months ended September 30, 2018 compared to net cash provided by investing activities of $0.1 million for the nine months ended September 30, 2017.

$7.1 million.

Financing Activities

Net cash provided by financing activities was ~~$15.2~~$5.1 million for the ~~nine~~three months ended ~~September 30, 2018~~March 31, 2019 compared to ~~net cash used in financing activities of $1.8~~$16.8 million for the ~~nine~~three months ended ~~September 30, 2017.~~March 31, 2018. This ~~change~~decrease was primarily due to ~~the~~extinguishment of certain debts of $22.1 million offset by proceeds from short-term and long-term borrowings of ~~$67.5~~$29.3 million, ~~offset by repayments of short-term borrowings of $53.2 million.~~

primarily from the PNC Facility (defined below).

Cash Management

Our primary source of liquidity comes from our cash and cash equivalents, which totaled ~~$20.0~~$20.9 million at ~~September 30, 2018~~,March 31, 2019, as well as our ~~credit facilities,~~PNC Bank Facility, under which we had aggregate ~~financing~~revolving line availability of ~~$21.3~~$15.0 million as of ~~September 30, 2018, and under which $6.4 million was committed as cash collateral for letters of credit as of September 30, 2018.~~March 31, 2019. Our cash and cash equivalents as of ~~September 30, 2018~~March 31, 2019 included ~~$6.0~~$12.2 million in cash balances held by our international subsidiaries.

~~Table~~

PNC Bank Facility

On February 27, 2019, DZS and ZTI (collectively, the “Borrowers”), and certain direct and indirect subsidiaries of ~~Contents~~

~~WFB Facility~~

the Borrowers, as guarantors, entered into that certain Revolving Credit, Term Loan, Guaranty and Security Agreement (the “Domestic Credit Agreement”) and that certain Export-Import Revolving Credit, Guaranty and Security Agreement (the “Ex-Im Credit Agreement,” and together with the Domestic Credit Agreement, the “Credit Agreements”), in each case with PNC Bank, National Association (“PNC”) and Citibank, N.A. as lenders, and PNC as agent for the lenders (the “PNC Facility”), which replaced our former senior secured credit facilities with Wells Fargo Bank ~~Facility~~

~~On July 12, 2018, we entered into the A&R Domestic~~(the “Former WFB Facility”).

The Credit ~~Agreement~~Agreements provide for a $25.0 million term loan and ~~the A&R Ex-Im Credit Agreement with WFB, which amended and replaced our existing senior secured~~a $15.0 million revolving line of credit ~~and letter~~(including subfacilities for Ex-Im transactions, letters of credit ~~facilities with WFB~~ and ~~revised certain reporting and compliance provisions.~~swing loans). The ~~Amended WFB Facility provides for a~~amount we are able to borrow on the 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~~at any time is based on eligible accounts receivable and ~~inventory,~~other conditions, less ~~the amount committed as cash collateral for letters of credit. The amounts borrowed~~certain reserves. Borrowings under the ~~Amended WFB~~PNC Facility ~~bears~~bear interest ~~payable monthly,~~ at our option, at either (i) a ~~floating~~base rate equal to the ~~three-month~~highest of the federal funds rate plus 0.50%, PNC’s prime rate, or the daily LIBOR rate plus 1.00%, or (ii) the LIBOR rate for the applicable interest period, subject to a floor of 1.00% (with respect to the term loans only), plus in each case, an applicable margin. The applicable margin ~~based on our average excess availability (as calculated~~for term loans is 5.00% for base rate loans and 6.00% for LIBOR rate loans, and the applicable margin for borrowings under the ~~WFB Facility). To maintain availability~~revolving line of credit is 1.50% for base rate loans and 2.50% for LIBOR rate loans.

We used a portion of the funds borrowed from the term loan under the ~~Amended WFB Facility, we pay a commitment fee on the unused portion. The commitment fee is 0.25% per annum and is recorded as~~Credit Agreements to (i) repay $5.0 million in principal amount of existing related-party indebtedness with DNI plus accrued interest, ~~expense. The maturity date of the Amended WFB Facility is July 12, 2021.~~

~~As of September 30, 2018, we had $6.0~~(ii) repay $1.5 million in outstanding borrowings plus accrued interest and fees and cash collateralize $3.6 million in outstanding letters of credit under ~~its~~the Former WFB Facility, and ~~2.1~~(iii) repay $5.6 million ~~was committed as cash collateral~~short-term debt in Korea and Japan. We intend to use the remaining funds for ~~letters of credit. Subsequent to the end of the quarter, we repaid $6.0 million in borrowings~~ongoing working capital needs. Obligations under the WFB Facility. Based on our eligible accounts receivable and inventory, we had $6.5 million of financing availability under the WFB Facility as of September 30, 2018. The interest rate on the WFB Facility was 4.4% at September 30, 2018.

~~Our obligations under the Amended WFB Facility~~Credit Agreements are secured by substantially all of ~~our~~the personal property assets of the Borrowers and ~~those of our~~the subsidiaries that guarantee the ~~Amended WFB Facility,~~Credit Agreements, including their intellectual property.

The Credit Agreements contain certain covenants, limitations, and conditions with respect to the Borrowers and their subsidiaries, including a maximum leverage ratio, a minimum fixed charge coverage ratio, and a minimum liquidity covenant, as well as financial ~~covenants,~~reporting obligations, and customary ~~affirmative~~events of default. If an event of default occurs, the agent and ~~negative covenants. If we default under the Amended WFB Facility due to a covenant breach or otherwise, after any applicable grace periods. WFB may~~lenders will be entitled to ~~among other things, require~~take various actions, including requiring the immediate repayment of all outstanding amounts under the Credit Agreements, terminating commitments to make additional advances and ~~sell our~~selling the assets of the Borrowers and their subsidiary guarantors to satisfy the obligations under the ~~Amended WFB Facility. As of September 30, 2018, we~~Credit Agreements. We were in compliance with the covenants under the ~~Amended~~Credit Agreements as of March 31, 2019.

As of March 31, 2019, we had $25 million in outstanding term loan borrowings under its PNC Facility, and no outstanding borrowings under the revolving line of credit. The interest rate on the PNC Facility was 8.63% at March 31, 2019.

Former Wells Fargo Bank Facility

On February 27, 2019, in connection with the entry into the PNC Facility, we repaid $1.5 million in principal amount of outstanding borrowings plus accrued interest and fees under the Former WFB Facility, cash collateralized $3.6 million outstanding letters of credit under the Former WFB Facility, and terminated the Former WFB Facility.

Working Capital Loan

On October ~~22,~~1 2018, ~~we borrowed $3.0~~as a condition for the Keymile Acquisition, the former stockholder of Keymile extended a €4.0 million ~~under~~($4.5 million as of March 31, 2019) working capital loan to Keymile. The working capital loan bears interest at a rate of 3.5% per annum and is scheduled for repayment in two equal installments. The first payment of $2.2 million was made in April 2019 and the ~~Amended WFB Facility. On October 31, 2018, we repaid $3.0 million~~balance is due in ~~full.~~

November 2019.

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~~as they mature and are generally secured by a security interest in certain assets of the applicable foreign subsidiaries and supported by guarantees given by DNI or third parties. Payments under such facilities are made in accordance with the given lender’s amortization schedules. As of ~~September 30, 2018~~March 31, 2019 and December 31, ~~2017,~~2018, we had an aggregate outstanding balance of ~~$28.2~~$18.9 million and ~~$22.8~~$24.8 million, respectively, under such financing arrangements, and the interest rate per annum applicable to outstanding borrowings under these financing arrangements ranged from ~~1.3%~~0% to ~~6.82%~~6.74% as of ~~September 30, 2018, 1.58% to 8.90% and December~~March 31, ~~2017.~~

2019.

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~~facility, which was fully drawn. The term 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 30, 2018, $5.0 million in term loans was outstanding under the facility. Such term loans maturematures in September 2021 and ~~are~~is pre-payable at any time by us without premium or penalty. The interest rate ~~as of September 30, 2018~~ under this facility was 4.6% per annum.

~~Also,~~ In February 2019, we repaid the term loan in full plus accrued interest in connection with the entry into the PNC Facility.

In February 2016, DNS borrowed $1.8 million from DNI for capital investment, ~~in February 2016,~~ which amount was outstanding as of ~~September 30, 2018. This~~March 31, 2019. The interest rate as of March 31, 2019 under this facility was 4.6% per annum. On February 27, 2019, in connection with the entry into the PNC Facility, we amended the terms of this loan ~~matures in July~~to extend the repayment date until May 27, 2022.

On December 27, 2018, we entered into a Loan Agreement with DNI for a $6.0 million term loan, which amount was outstanding as of March 31, 2019 ~~and bears~~with an interest ~~at a~~ rate of 4.6% per ~~annum, payable annually.~~

annum. On February 27, 2019, in connection with the entry into the PNC Facility, we amended the terms of the term loan to extend the repayment date until May 27, 2022 and to terminate any security granted to DNI with respect to such term loan.

On March ~~21,~~27, 2018, DNS Korea borrowed ~~$5.8 million~~KRW6.5 billion ($5.8 million) from DNI, of which ~~$4.5 million~~KRW5.0 billion ($4.5 million) was repaid on August 8, 2018. As of ~~September 30, 2018, $1.3 million~~March 31, 2019, KRW1.5 billion ($1.3 million) remained outstanding. The loan bears interest at a rate of 4.6% ~~and matures on June 27, 2019,~~, and is secured by certain accounts receivable of DNS Korea.

On February 27, 2019, in connection with the entry into the PNC Facility, we amended the terms of this loan to extend the repayment date until May 27, 2022.

Interest expense on these related-party borrowings was $0.1 million and ~~$0.3~~$0.2 million infor the three ~~and nine~~ months ended ~~September 30, 2018.~~

~~Table of Contents~~

March 31, 2019 and 2018, 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.

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 30, 2018, one~~March 31, 2019, no customer ~~represented 12%~~accounted for 10% or more of net accounts receivable, ~~respectively,~~ and receivables from customers in countries other than the United States represented ~~89%~~92% of net accounts receivable. ~~Additionally, Dasan Networks Japan has factoring arrangements in relation to certain accounts receivable with certain financial institutions as of September 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.

Contractual Commitments and Off-Balance Sheet Arrangements

At ~~September 30, 2018,~~March 31, 2019, our future contractual commitments by fiscal year were as follows (in thousands):

			Payments due by period
	Total		2019		2020		2021		2022		2023		Thereafter
Operating leases payments	$	26,376	$	3,892	$	4,317	$	3,993	$	3,860	$	3,732	$	6,582
Other lease payments		726		465		226		35		—		—		—
Purchase commitments		3,137		3,137		—		—		—		—		—
Foreign debts		23,393		23,393		—		—		—		—		—
PNC debt		25,000		1,875		2,500		3,437		17,188		—		—
Long-term debt-related party		9,118		—		—		—		9,118		—		—
Royalty obligations		144		144		—		—		—		—		—
Total future contractual commitments	$	87,894	$	32,906	$	7,043	$	7,465	$	30,166	$	3,732	$	6,582

Payments due by period
Total 2018 2019 2020 2021 2022 Thereafter
Operating leases $ 21,816
$ 1,053
$ 4,088
$ 2,998
$ 2,590
$ 2,664
$ 8,423
Purchase commitments 2,403
2,403
—
—
—
—
—
Short-term debt - bank and trade facilities 34,171
34,171
—
—
—
—
—
Short-term debt - related party 3,148
3,148
—

—
—
—
—
Long-term debt -related party 5,000
—
—
5,000
—
—
Other payable - related party 1,859
1,859
—
—
—
—
—
Royalty obligations 250
250
—
—
—
—
—
Total future contractual commitments $ 68,647
$ 42,884
$ 4,088
$ 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 ~~are~~will be 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 30, 2018.~~

March 31, 2019.

Short-term Debt

Our short-term debt obligations have been recorded as liabilities on our balance sheet, and as of March 31, 2019 are comprised of ~~$28.2~~$18.9 million in outstanding borrowings under the credit facilities of our foreign subsidiaries, ~~and $6.0~~$2.5 million in outstanding borrowings under the ~~WFB~~PNC Facility asand $4.5 million in outstanding borrowings under a working capital loan from the former stockholder of ~~September 30, 2018.~~Keymile. 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, we repaid $6.0 million in borrowings under our WFB Facility.~~ At ~~September 30, 2018,~~March 31, 2019, the interest rate per annum applicable to outstanding borrowings under the trade facilities of our foreign subsidiaries ranged from ~~1.3%~~0% to ~~6.8%~~6.74% and was ~~4.4%~~8.63% under the ~~WFB Facility.~~PNC Facility and 3.5% for the working capital loan. See above under "Cash Management" for further information about these facilities.

~~Table of Contents~~

Related-Party Debt

As of ~~September 30, 2018,~~March 31, 2019, we had ~~borrowed~~ an aggregate of ~~$8.1~~$9.1 million in outstanding borrowings from DNI, which consisted of a ~~$5.0~~$6.0 million unsecured subordinated term loan facility which matures in ~~September 2021,~~May 2022, a $1.8 million loan for capital investment which matures in ~~July 2019~~May 2022, and KRW 1.5 billion ($1.3 million) outstanding under a secured loan ~~outstanding of $1.3 million~~to DNS Korea which matures in ~~June 27, 2019.~~May 2022. All three loans bear interest at a rate of 4.6% per annum.

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

RECENT ACCOUNTING PRONOUNCEMENTS

Please refer to Note ~~1(g)~~1(j) to the unaudited condensed consolidated financial statements included in ~~part 1,~~Part I, Item 1 of this ~~report.~~

Quarterly Report on Form 10-Q.

~~Item 3.~~

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 financial deposit and money market accounts. Cash and cash equivalents are principally held with various domestic and international 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.

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.

~~For the three and nine months ended September 30, 2018, one customer each accounted for 11% of net revenue, respectively.~~

For the three months ended ~~September 30, 2017, two customers~~March 31, 2019 and 2018, no single customer accounted for 10% or more of net revenue.

receivable.

Interest Rate Risk

Our exposure to market risk for changes in interest rates relates primarily to our variable rate outstanding debt. As of ~~September 30, 2018,~~March 31, 2019, our outstanding ~~short-term~~variable-interest debt balance was ~~$37.3~~$43.9 million, which consisted of principal amount of borrowings under the short-term credit facilities of our foreign subsidiaries ~~DNI~~ and borrowings under the ~~WFB~~PNC Facility (all of which bear interest at a variable rate). ~~Amounts~~As of March 31, 2019, amounts borrowed under our short-term credit facilities bore interest ranging from ~~1.3%~~0% to ~~6.82% as of September 30, 2018~~6.74%, and amounts borrowed under the ~~WFB~~PNC Facility bore interest at ~~4.4%~~8.63%. Assuming the outstanding balance on our variable rate debt remains constant over a year, a 1% increase in the interest rate would decrease pre-tax income and cash flow by approximately ~~$0.3~~$0.4 million. AsIn addition, as of ~~September 30, 2018, our~~March 31, 2019, we had an aggregate of $13.6 million in outstanding ~~long-term debt balance was $5.0 million and consisted of loans~~borrowings from DNI and ~~its affiliates (which~~Riverside (all of which bear interest at a fixed ~~rates)~~rate of 4.6% and 3.5%, respectively).

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, 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.

We have performed a sensitivity analysis as of ~~September 30, 2018~~March 31, 2019 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 ~~approximately $3.0~~$5.3 million at ~~September 30, 2018~~.March 31, 2019. 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.

~~Table of Contents~~

~~Item 4.~~

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)~~“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 Chief Executive 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 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 30, 2018,~~March 31, 2019, the end of the period covered by this ~~report.~~Quarterly Report on Form 10-Q. The evaluation was done under the supervision and with the participation of management, including our Chief Executive Officer and our Chief Financial Officer. Based upon this evaluation, our Chief Executive 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, ~~2017~~2016 and that have not yet been ~~fully~~ remediated, as described below, our disclosure controls and procedures were not effective as of ~~September 30, 2018.~~

March 31, 2019.

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. 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 in our internal control over financial reporting as of December 31, 2016 which continued to exist at December 31, ~~2017.~~2018. 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, ~~2017.~~

2018.

As of the date of this ~~report,~~Quarterly Report on Form 10-Q, we are ~~continuing to re-assess~~re-assessing the design of our ~~internal~~ controls ~~over financial reporting~~ and ~~to modify~~modifying processes related to the accounting for significant and unusual transactions as well as enhancing monitoring and oversight controls in the application of ~~relevant~~ accounting guidance related to such transactions. In connection therewith, we have hired ~~various accounting, operational and financial planning and analysis resources, we have begun designing and implementing additional processes and controls~~ and we ~~are in the early stages of formalizing our project plan and updating the documentation of our business process flows and related internal control over financial reporting. We~~ anticipate that we will ~~continue to~~ hire additional accounting personnel with relevant skills, training and experience, and conduct further training of our 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~~Integration activities related to the Keymile Acquisition may lead us to modify certain internal controls in future periods.

~~Table of Contents~~

Inherent Limitations on Effectiveness of Controls

Our management, including our Chief Executive 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 ~~errors~~error 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 ~~our company~~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.

~~Table of Contents~~

PART II. OTHER INFORMATION

~~Item 1.~~

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.~~

Item 1A.

Risk Factors

In addition to the other information set forth in this ~~report,~~Quarterly Report on Form 10-Q, 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, ~~2017,~~2018, which could materially affect our business, financial condition or future results. ~~Except as set forth below, there~~There have been no material changes to the risk factors ~~we previously disclosed~~described in the "Risk Factors" section in our ~~filings, including the~~Annual Report on Form 10-K ~~filed~~ for the year ended December 31, ~~2017 with the SEC.~~2018. The risks described in our Annual Report on Form 10-K ~~however,~~ 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.

~~We may need or want to raise or access additional funds to fund~~

Our amended and restated bylaws provide that the Court of Chancery of the State of Delaware will be the sole and exclusive forum for substantially all disputes between us and our ~~ongoing operations and to complete~~stockholders (except for causes of action arising under the ~~Keymile acquisition and these funds may not be available to us when we need them. If we cannot raise additional funds when we need or want them,~~federal securities laws), which could limit our ~~operations and prospects could be negatively affected.~~

~~We need sufficient capital to fund our ongoing operations and to complete the Keymile acquisition. Our~~stockholders’ ability to ~~meet~~obtain a favorable judicial forum for disputes with us or our ~~obligations will depend~~directors, officers, or employees.

Our amended and restated bylaws (our “Bylaws”) provide that the Court of Chancery of the State of Delaware is the sole and exclusive forum for:

•

any derivative action or proceeding brought on behalf of the Company;

•

any action asserting a claim of breach of a fiduciary duty owed by any director, officer, employee or agent of the Company to the Company or the Company’s stockholders;

•

any action asserting a claim against the Company arising pursuant to any provision of the General Corporation Law of the State of Delaware, the Certificate of Incorporation or the Bylaws; and

•

any action asserting a claim against the Corporation governed by the internal affairs doctrine, in each such case subject to said Court of Chancery having personal jurisdiction over the indispensable parties named as defendants therein;

provided, that with respect to any derivative action or proceeding brought on our behalf to enforce any liability or duty created by the Exchange Act or the rules and regulations thereunder, the exclusive forum will be the federal district courts of the United States. The exclusive forum provision in our Bylaws does not apply to resolving any complaint asserting a cause of action arising under the Securities Act.

These exclusive forum provisions may limit a stockholder’s ability to ~~access funds approved under existing or new credit facilities and~~bring a claim in a judicial forum that it finds favorable for disputes with us or our ~~ability~~directors, officers, or other employees, which may discourage lawsuits against us and our directors, officers and other employees. If a court were to ~~raise~~find the exclusive forum provision in our Bylaws to be inapplicable or unenforceable in an action, we may incur additional ~~capital through sales~~costs associated with resolving the dispute in other jurisdictions, which could seriously harm our business. For example, the Court of our common stock to the public. We cannot be certain that additional funds will be available to us on favorable terms when required, or at all. If we cannot raise additional funds when we need them, our financial condition, results of operations, business and prospects could be materially and adversely affected.

~~We face exposure to foreign currency exchange rate fluctuations.~~

~~We currently operate a limited hedging program to mitigate the impact of foreign currency exchange rate fluctuations. The use of such hedging activities may not offset any or more than a portion~~Chancery of the ~~adverse financial effects~~State of ~~unfavorable movements in foreign currency exchange rates over~~Delaware recently determined that the ~~limited time~~exclusive forum provision of federal district courts of the ~~hedges are in place. Moreover,~~United States for resolving any complaint asserting a cause of action arising under the ~~use of hedging instruments~~Securities Act is not enforceable. However, this decision may ~~introduce additional risks if we are unable to structure effective hedges with such instruments, which could adversely affect our financial condition~~be reviewed and ~~operating results.~~

ultimately overturned by the Delaware Supreme Court.

~~Item 6.~~

Item 6.

Exhibits

~~Table of Contents~~

EXHIBIT INDEX

Exhibit Number		Description

~~Exhibit~~ ~~Number~~ 10.1	~~Description~~	Revolving Credit, Term Loan, Guaranty and Security Agreements, dated as of February 27, 2019, by and among DASAN Zhone Solutions, Inc. various of its subsidiaries and PNC Bank, National Association and Citibank, N.A
10.2		Export-Import Revolving Credit, Guaranty and Security Agreement dated as of February 27, 2019, by and among DASAN Zhone Solutions, Inc. various of its subsidiaries PNC Bank, National Association and Citi Bank, N.A.
10.3		Amendment 1 to Loan Agreement, dated February 25, 2019, by and between DASAN Networks, Inc. and Dasan Network Solutions, Inc. under existing loan agreement for KRW6.5 billion
~~31.1~~ 10.4		Amendment 1 to Loan Agreement, dated February 25, 2019, by and between DASAN Zhone Solutions, Inc. and Dasan Networks, Inc., under existing loan agreement for $6.0 million
31.1		Certification of Chief Executive Officer Pursuant to ~~Securities Exchange Rules~~Rule 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 ~~Securities Exchange Rules 13a14(a)~~Rule 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 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~~

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 8, 2018~~May 10, 2019
	By:	/s/ IL YUNG KIM
	Name:	Il Yung Kim
	Title:	President and Chief Executive Officer

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



~~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)



Large accelerated filer	¨ ☐	Accelerated filer	¨ ☐
Non-accelerated filer	¨ ☒	Smaller reporting company	x ☒
		Emerging growth company	¨ ☐



Title of each class	Trading Symbol(s)	Name of each exchange on which registered
Common stock, $0.001 par value	DZSI	The Nasdaq Stock Market LLC
As of May 5, 2019, there were 16,607,157 shares outstanding of the registrant’s common stock, $0.001 par value.



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


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

		Page

		~~Page~~
PART I. FINANCIAL INFORMATION

Item 1.	Financial Statements	4 3
	Unaudited Condensed Consolidated Balance Sheets	5 3
	Unaudited Condensed Consolidated Statements of Comprehensive Income (Loss)	6 4
	Unaudited Condensed Consolidated Statements of Stockholders' Equity and Non-Controlling Interest	5
	Unaudited Condensed Consolidated Statements of Cash Flows	7 6
	Notes to Unaudited Condensed Consolidated Financial Statements	8 7
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	28 26
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	37 34
Item 4.	Controls and Procedures	38 34

PART II. OTHER INFORMATION

Item 1.	Legal Proceedings	40 36
Item 1A.	Risk Factors	40 36
Item 6.	Exhibits	41 37
	Signatures	42 38

	March 31, 2019			December 31, 2018
Current assets:
Cash and cash equivalents	$	20,872		$	27,709
Restricted cash		9,165			7,003
Accounts receivable, net
Third parties		68,747			71,034
Related parties		898			583
Other receivables
Suppliers and others		13,053			12,923
Related parties		4			65
Inventories		39,718			33,868
Contract assets		17,160			11,381
Prepaid expenses and other current assets		4,706			4,185
Total current assets		174,323			168,751
Property, plant and equipment, net		6,124			5,518
Right-of-use assets from operating leases		21,193			—
Goodwill		3,977			3,977
Intangible assets, net		16,530			5,649
Deferred tax assets		2,685			2,752
Long-term restricted cash		611			936
Other assets		3,883			2,424
Total assets	$	229,326		$	190,007
Liabilities, Stockholders’ Equity and Non-controlling Interest
Current liabilities:
Accounts payable - trade
Third parties	$	37,199		$	36,865
Related parties		592			1,743
Short-term debt - bank and trade facilities		25,081			31,762
Other payables
Third parties		1,905			1,792
Related parties		2,119			1,281
Contract liabilities - current		3,563			8,511
Operating lease liabilities - current		4,261			—
Accrued and other liabilities		13,056			11,517
Total current liabilities		87,776			93,471
Long-term debt
Bank and trade facilities		21,201			—
Related party		9,118			14,142
Contract liabilities - non-current		1,875			1,801
Deferred tax liabilities		1,041			—
Operating lease liabilities - non-current		18,103			—
Pension liabilities		12,394			—
Other long-term liabilities		1,721			2,739
Total liabilities		153,229			112,153
Commitments and contingencies (Note 14)
Stockholders’ equity and non-controlling interest:
Common stock, authorized 36,000 shares, 16,596 and 16,587 shares outstanding as of March 31, 2019 and December 31, 2018 at $0.001 par value		16			16
Additional paid-in capital		94,017			93,192
Accumulated other comprehensive loss		(1,316	)		(192	)
Accumulated deficit		(17,415	)		(15,777	)
Total stockholders’ equity		75,302			77,239
Non-controlling interest		795			615
Total stockholders’ equity and non-controlling interest		76,097			77,854
Total liabilities, stockholders’ equity and non-controlling interest	$	229,326		$	190,007



	September 30, 2018			December 31, 2017
Assets
Current assets:
Cash and cash equivalents	$	20,028		$	17,475
Restricted cash	7,825			12,425
Accounts receivable - trade, net
Third parties	58,880			48,257
Related parties	2,139			13,498
Other receivables
Suppliers and others	28,097			12,494
Related parties	91			164
Inventories	45,457			25,344
Prepaid expenses and other current assets	12,256			3,652
Total current assets	174,773			133,309
Property and equipment, net	5,374			5,873
Goodwill	3,977			3,977
Intangible assets, net	5,933			6,785
Non-current deferred taxes	2,895			2,954
Long-term restricted cash	847			1,512
Other assets	1,400			4,717
Total assets	$	195,199		$	159,127
Liabilities, Stockholders’ Equity and Non-controlling Interest
Current liabilities:
Accounts payable - trade
Third parties	$	52,943		$	31,441
Related parties	1,302			1,351
Short-term debts
Bank and trade facilities	34,171			19,790
Related party	3,148			—
Other payables
Third parties	1,769			2,032
Related parties	1,859			1,956
Contract liabilities - current	2,394			3,279
Accrued and other liabilities	10,315			11,174
Total current liabilities	107,901			71,023
Long-term debts
Bank and trade facilities	—			2,987
Related parties	5,000			6,800
Contract liabilities - non-current	1,851			1,883
Other long-term liabilities	2,677			2,667
Total liabilities	117,429			85,360
Commitments and contingencies (Note 11)
Stockholders’ equity and non-controlling interest:
Common stock, authorized 36,000 shares, 16,566 shares and 16,410 shares outstanding as of September 30, 2018 and December 31, 2017 at $0.001 par value	16			16
Additional paid-in capital	92,408			90,198
Accumulated other comprehensive income	5			1,871
Accumulated deficit	(15,190		)	(18,852		)
Total stockholders’ equity	77,239			73,233
Non-controlling interest	531			534
Total stockholders’ equity and non-controlling interest	77,770			73,767
Total liabilities, stockholders’ equity and non-controlling interest	$	195,199		$	159,127



	Three Months Ended						Nine Months Ended
	September 30,						September 30,
	2018			2017			2018			2017
Net revenue:
Third parties	$	70,227		$	60,513		$	203,317		$	150,834
Related parties	1,687			5,925			4,358			27,657
Total net revenue	71,914			66,438			207,675			178,491
Cost of revenue:
Products and services - third parties	46,565			38,301			134,234			95,103
Products and services - related parties	1,765			5,569			4,651			22,851
Amortization of intangible assets	153			153			459			459
Total cost of revenue	48,483			44,023			139,344			118,413
Gross profit	23,431			22,415			68,331			60,078
Operating expenses:
Research and product development	8,655			8,939			26,346			27,462
Selling, marketing, general and administrative	11,106			11,661			35,212			33,096
Amortization of intangible assets	131			154			393			1,191
Total operating expenses	19,892			20,754			61,951			61,749
Operating income (loss)	3,539			1,661			6,380			(1,671		)
Interest income	42			36			203			82
Interest expense	(447		)	(263		)	(1,330		)	(793		)
Other income (expense), net	(572		)	60			(859		)	43
Income (loss) before income taxes	2,562			1,494			4,394			(2,339		)
Income tax expense	735			107			1,071			646
Net income (loss)	1,827			1,387			3,323			(2,985		)
Net income (loss) attributable to non-controlling interest	29			(12		)	2			172
Net income (loss) attributable to DASAN Zhone Solutions, Inc.	$	1,798		$	1,399		$	3,321		$	(3,157	)

Foreign currency translation adjustments	391			(284		)	(1,839		)	1,782
Comprehensive income (loss)	2,218			1,103			1,484			(1,203		)
Comprehensive income (loss) attributable to non-controlling interest	16			(14		)	(3		)	191
Comprehensive income (loss) attributable to DASAN Zhone Solutions, Inc.	$	2,202		$	1,117		$	1,487		$	(1,394	)

Net income (loss) per share attributable to DASAN Zhone Solutions, Inc.
Basic	$	0.11		$	0.09		$	0.20		$	(0.19	)
Diluted	$	0.11		$	0.09		$	0.20		$	(0.19	)

Weighted average shares outstanding used to compute basic net income (loss) per share	16,683			16,382			16,425			16,380
Weighted average shares outstanding used to compute diluted net income (loss) per share	16,891			16,382			16,640			16,380



	As of January 1, 2018
	Balance after adoption of ASC 606			Adjustments				Balance without adoption of ASC 606
Assets
Accounts receivable, net	$	62,099		$	344		⁽¹⁾	$	61,755
Inventories	25,239			(105		)	⁽²⁾	25,344
Liabilities
Contract liabilities - current	3,038			(241		)	⁽²⁾	3,279
Accrued and other liabilities	11,518			344			⁽¹⁾	11,174
Contract liabilities - non-current	1,711			(172		)	⁽²⁾	1,883
Stockholders’ equity
Accumulated deficit	(18,544		)	308				(18,852		)



	As of September 30, 2018
	As reported			Adjustments					Balance without adoption of ASC 606
Assets
Accounts receivable, net	$	61,019		$	(5,356	)	⁽¹⁾	⁽³⁾	$	66,375
Inventories	45,457			62			⁽²⁾		45,395
Prepaid expenses and other current assets	12,256			5,984			⁽³⁾		6,272
Liabilities
Contract liabilities - current	2,394			(75		)	⁽²⁾		2,469
Accrued and other liabilities	10,315			628			⁽¹⁾		9,687
Contract liabilities - non-current	1,851			36			⁽²⁾		1,815
Stockholders’ equity
Accumulated deficit	(15,190		)	101					(15,291		)



	Three Months Ended September 30, 2018
	As reported			Adjustments		Balance without adoption of ASC 606
Net revenue	$	71,914		$	386	$	71,528
Cost of revenue - products and services	48,483			5		48,478
Gross profit	23,431			381		23,050
Income tax expense	(735		)	—		(735		)
Net income	1,827			381		1,446



	Nine Months Ended September 30, 2018
	As reported			Adjustments			Balance without adoption of ASC 606
Net revenue	$	207,675		$	39		$	207,636
Cost of revenue - products and services	139,344			(62		)	139,406
Gross profit	68,331			101			68,230
Income tax expense	(1,071		)	—			(1,071		)
Net income	3,323			101			3,222

Delaware		22-3509099



Item	Balance Sheet Location	September 30, 2018		January 1, 2018		$ change			% change
Contract assets	Prepaid expenses and other current assets	$	5,984	$	—	$	5,984		—
Contract liabilities - current	Contract liabilities - current	2,394		3,038		(644		)	(21	)%
Contract liabilities - non-current	Contract liabilities - non-current	1,851		1,711		140			8	%



	September 30, 2018
	Gross Carrying Amount		Accumulated Amortization			Net
Developed technology	$	3,060	$	(1,276	)	$	1,784
Customer relationships	5,240		(1,091		)	4,149
Backlog	2,179		(2,179		)	—
Total intangible assets	$	10,479	$	(4,546	)	$	5,933



	December 31, 2017
	Gross Carrying Amount		Accumulated Amortization			Net
Developed technology	$	3,060	$	(816	)	$	2,244
Customer relationships	5,240		(699		)	4,541
Backlog	2,179		(2,179		)	—
Total intangible assets	$	10,479	$	(3,694	)	$	6,785



		As of December 31, 2017
		Maturity Date	Denomination	Interest rate (%)	Amount
Industrial Bank of Korea	Credit facility	1/2/2018 - 5/2/2018	USD	2.89 - 3.26	$	2,328
Industrial Bank of Korea	Trade Finance	1/2/2018 - 5/23/2018	USD	4.47 - 5.97	2,401
Shinhan Bank	General loan	3/30/2019	KRW	5.91	2,987
Shinhan Bank	Trade finance	2/19/2018- 3/26/2018	KRW	3.90 - 4.14	3,050
NongHyup Bank (Korea)	Credit facility	1/8/2018- 6/18/2018	USD	2.83 - 3.42	860
The Export-Import Bank of Korea	Export development loan	2/13/2018 & 6/29/2018	KRW	3.20 - 3.28	7,570
Mitsubishi Bank (Japan)	AR factoring	1/31/2018 - 5/31/2018	JPY	1.58	1,872
Shinhan Bank (India)	General loan	4/24/2018 - 11/12/2018	INR	8.70 - 8.90	1,709
					$	22,777



	Nine Months Ended September 30,
	2018			2017
Beginning non-controlling interests	$	534		$	416
Net income (loss) attributable to non-controlling interests	2			172
Foreign currency translation adjustments	(5		)	19
Ending non-controlling interests	$	531		$	607



		Three Months Ended September 30, 2018
Counterparty	DNI ownership Interest	Sales		Cost of revenue		Research and product development		Selling, marketing, general and administrative		Interest expense		Other expenses
DNI (Parent Company)	N/A	$	1,472	$	1,270	$	—	$	784	$	112	$	89
Tomato Soft Ltd.	100%	—		27		—		—		—		—
Tomato Soft (Xi'an) Ltd.	100%	—		—		119		—		—		—
Chasan Networks Co., Ltd.	100%	—		260		21		—		—		—
Handysoft, Inc.	17.63%	215		208		—		2		—		—
		$	1,687	$	1,765	$	140	$	786	$	112	$	89



		Three Months Ended September 30, 2017
Counterparty	DNI ownership Interest	Sales		Cost of revenue		Research and product development		Selling, marketing, general and administrative		Other expenses
DNI (Parent Company)	N/A	$	3,976	$	3,604	$	—	$	1,291	$	51
Chasan Networks Co., Ltd.	100%	—		257		20		—		—
Dasan France	100%	662		576		—		83		—
Dasan India Private Limited	100%	—		—		—		30		—
D-Mobile	100%	1,233		1,077		—		122		—
HandySoft, Inc.	17.64%	54		12		—		6		4
Tomato Soft Ltd.	100%	—		43		108		—		—
Tomato Soft (Xi'an) Ltd.	100%	—		—		144		—		—
		$	5,925	$	5,569	$	272	$	1,532	$	55



		Nine Months Ended September 30, 2017
Counterparty	DNI ownership Interest	Sales		Cost of revenue		Research and product development		Selling, marketing, general and administrative		Other expenses
DNI (Parent Company)	N/A	$	16,608	$	14,020	$	—	$	3,491	$	171
Chasan Networks Co., Ltd.	100%	—		578		79		—		—
Dasan France	100%	1,612		1,512		—		383		—
Dasan India Private Limited⁽¹⁾	100%	6,287		4,783		—		30		—
D-Mobile⁽¹⁾	100%	3,054		1,831		—		318		—
Fine Solution	100%	—		—		—		4		—
HandySoft, Inc.	17.64%	88		23		—		6		4
J-Mobile Corporation	90.47%	8		—		—		132		—
Tomato Soft Ltd.	100%			104		108
Tomato Soft (Xi'an) Ltd.	100%	—		—		448		37		—
Solueta	27.21%	—		—		—		—		3
		$	27,657	$	22,851	$	635	$	4,401	$	178



	Three Months Ended September 30,				Nine Months Ended September 30,
	2018		2017		2018		2017
Net income (loss) attributable to DASAN Zhone Solutions, Inc.	$	1,798	$	1,399	$	3,321	$	(3,157	)
Weighted average number of shares outstanding:
Basic	16,683		16,382		16,425		16,380
Effect of dilutive securities:
Stock options, restricted stock units and share awards	208		—		215		—
Diluted	16,891		16,382		16,640		16,380
Net income (loss) per share attributable to DASAN Zhone Solutions, Inc.:
Basic	$	0.11	$	0.09	$	0.20	$	(0.19	)
Diluted	$	0.11	$	0.09	$	0.20	$	(0.19	)



	Operating Leases
Year ending December 31:
2018 (remainder of the year)	$	1,053
2019	4,088
2020	2,998
2021	2,590
2022	2,664
Thereafter	8,423
Total minimum lease payments	$	21,816



Guarantor	Amount Guaranteed (in thousands)		Description of Obligations Guaranteed
DNI	$	3,451	Borrowings from Shinhan Bank
DNI	1,726		Purchasing Card from Shinhan Bank
DNI	10,730		LC from Industrial Bank of Korea
DNI	2,157		Purchasing Card from Industrial Bank of Korea
DNI	6,000		LC from NongHyup Bank
DNI	6,170		Borrowings from Export-Import Bank of Korea
DNI	6,000		LC from KookMin Bank
DNI	5,392		Borrowings from Korea Development Bank
DNI	8,400		LC from Korea Development Bank
Industrial Bank of Korea	6,486		Borrowings and letter of credit
NongHyup Bank	3,497		Borrowings and letter of credit
Kookmin Bank	304		Letter of credit
Korea Development Bank	894		Letter of credit
Shinhan Bank	933		Purchasing Card
Industrial Bank of Korea	4,075		Performance bonds
State Bank of India	34		Performance bonds
Seoul Guarantee Insurance Co.	4,232		Performance payment guarantee*
	$	70,481



	As of September 30, 2018		As of December 31, 2017
United States	$	3,131	$	3,393
Korea	1,441		1,633
Other Asia Pacific	802		847
	$	5,374	$	5,873