What changed in this filing

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Item 2. Management’s Discussion and Analysis

2021-08-17 compared with 2021-05-18 · 51 added, 51 removed, 128 unchanged (44% of the section changed)

48 unchanged sentences

We also resell SSD, NAND flash, DRAM products and other component products to end-customers that are not reached in the distribution models of the component manufacturers, including storage customers, appliance customers, system builders and cloud and datacenter customers.

During the first quarter of 2021, we recorded net sales of $14.9 million, gross profit of $1.5 million and net loss of $4.0 million.

During the second quarter of 2021, we recorded net sales of $64.4 million, including a $40 million license fee, gross profit of $42.9 million and net income of $27.8 million.

We have historically financed our operations primarily with proceeds from issuances of equity and debt securities and cash receipts from revenues.

11 unchanged sentences

2021 Lincoln Park Purchase Agreement

On June 24, 2019, we entered into a purchase agreement (the “2019 Purchase Agreement”) with Lincoln Park Capital Fund, LLC (“Lincoln Park”), pursuant to which we have the right to sell to Lincoln Park up to an aggregate of $10 million in shares of our common stock over the 36-month term of the Purchase Agreement subject to the conditions and limitations set forth in the 2019 Purchase Agreement.

During the first quarter of 2021, Lincoln Park purchased an aggregate of 1,669,429 shares of our common stock for a net purchase price of $1.6 million under the 2019 Purchase Agreement.

In connection with the purchases, during the first quarter of 2021, we issued to Lincoln Park an aggregate of 129,468 shares of our common stock as commitment shares in noncash transactions.

2020 Lincoln Park Purchase Agreement

On March 5, 2020, we entered into another purchase agreement (the “2020 Purchase Agreement”) with Lincoln Park, pursuant to which we have the right to sell to Lincoln Park up to an aggregate of $20 million in shares of our common stock over the 36-month term of the 2020 Purchase Agreement subject to the conditions and limitations set forth in the 2020 Purchase Agreement.

During the first quarter of 2021, Lincoln Park purchased an aggregate of 9,544,595 shares of our common stock for a net purchase price of $7.8 million under the 2020 Purchase Agreement.

In connection with the purchases, during the first quarter of 2021, we issued to Lincoln Park an aggregate of 356,843 shares of our common stock as commitment shares in noncash transactions.

In February 2021, we completed the sales under the 2020 Purchase Agreement.

On July 12, 2021, we entered into a purchase agreement (the “2021 Purchase Agreement”) with Lincoln Park, pursuant to which we have the right to sell to Lincoln Park up to an aggregate of $17.4 million in shares of our common stock over the 36-month term of the 2021 Purchase Agreement subject to the conditions and limitations set forth in the 2021 Purchase Agreement.

Subsequent to July 12, 2021, Lincoln Park purchased an aggregate of 2,000,000 shares of our common stock for a net purchase price of $14.9 million under the 2021 Purchase Agreement.

In connection with the purchases, we issued to Lincoln Park an aggregate of 103,292 shares of our common stock as commitment shares in noncash transactions.

Paycheck Protection Program Loan

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The amount borrowed under the PPP Loan was eligible for forgiveness if we would meet certain conditions.

In May 2021, the full amounts outstanding under the PPP Loan was forgiven.

In May 2021, the full amount outstanding under the PPP Loan was forgiven resulting in a gain of $0.6 million.

Economic Conditions, Challenges and Risks

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Net Sales and Gross Profit

Net sales, cost of sales and gross profit for the three months ended April 3, 2021 and March 28, 2020 were as follows (dollars in thousands):

Net sales, cost of sales and gross profit for the three and six months ended July 3, 2021 and June 27, 2020 were as follows (dollars in thousands):

Three Months Ended

Cost of sales

Net sales include resales of certain component products, including SSDs and DRAM products, and sales of our high-performance memory subsystems.

Net sales increased by $0.3 million during the first quarter of 2021 compared to the same quarter of 2020 primarily as a result of a $1.1 million increase in sales of other small outline dual in-line memory module (“SODIMM”) and RDIMM products, partially offset by a $0.6 million overall decrease in sales of NAND flash products (including a $0.7 million decrease in resales of NAND flash products and a $0.1 million increase in Netlist’s SSD products), a $0.2 million decrease in sales of our very low profile memory subsystem products and a $0.1 million increase in sales discount.

Six Months Ended

Net product sales

Gross profit - product sales

Gross margin - product sales

Net sales include (i) resales of certain component products, including SSDs and DRAM products, and sales of our high-performance memory subsystems and (ii) an upfront non-refundable license fee recognized for licensing of our patents pursuant to the License Agreement with SK hynix entered into on April 5, 2021.

Net product sales increased by $13.5 million during the second quarter of 2021 compared to the same quarter of 2020 primarily as a result of a $6.8 million net increase in sales of NAND flash products (including $8.1 million increase in resales of NAND flash products and $1.2 million decrease in sales of Netlist’s SSD products) and $6.7 million increase in sales of other small outline dual in-line memory module (“SODIMM”) and RDIMM products.

Net product sales increased by $13.7 million during the first six months of 2021 compared to the same period in 2020 primarily as a result of a $7.8 million increase in sales of SODIMM and RDIMM products (a $6.2 million increase in the resales of SODIMM and RDIMM products and a $1.6 million increase in sales of our Specialty SODIMM and RDIMM products) and a $6.2 million increase in the resales of NAND flash products (including a $7.4 million increase in the resales of NAND flash products and a $1.1 million decrease in Netlist’s flash SSD products).

Net sales in all periods presented were impacted by the change in the product mix and fluctuating customer concentrations.

Gross Profit and Gross Margin

Gross profit decreased during the first quarter of 2021 compared to the same quarter of 2020 due primarily to lower gross profits on the sales of SODIMM and RDIMM products and sales of enterprise SSD products.

Gross margin (or gross profit as a percentage of net sales) fluctuates based on the change in our product mix over periods and the relative cost of the factory.

Products gross profit increased during the second quarter and first six months of 2021 compared to the same periods of 2020 due primarily to higher gross profits on the resales of NAND flash products and our Specialty SODIMM and RDIMM products, partially offset by the lower gross profits on the sales of Netlist’s SSD products.

Products gross margin (or gross profit as a percentage of net product sales) fluctuates based on the change in our product mix over periods and the relative cost of the factory.

Operating Expenses

Operating expenses for the three months ended April 3, 2021 and March 28, 2020 were as follows (dollars in thousands):

Operating expenses for the three and six months ended July 3, 2021 and June 27, 2020 were as follows (dollars in thousands):

Three Months Ended

Six Months Ended

Research and development

Percentage of net sales

Percentage of net product sales

Intellectual property legal fees

Percentage of net sales

Percentage of net product sales

Selling, general and administrative

Percentage of net sales

Percentage of net product sales

Research and Development

Research and development expenses increased during the first quarter of 2021 compared to the same quarter of 2020 due primarily to an increase in employee headcount and overhead.

Research and development expenses increased during the second quarter and first six months of 2021 compared to the same periods of 2020 due primarily to an increase in employee headcount and overhead.

Intellectual Property Legal Fees

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See Note 7 to the condensed consolidated financial statements included in Part I, Item 1 of this report for further discussion.

Pursuant to the terms of the TRGP Agreement, the legal expenses we incurred for our first action against SK hynix at the ITC and our U.S.

district court proceedings that were paid directly by TRGP were excluded in their entirety from our financial statements.

As of January 2, 2021, accumulated deficit excluded $1.7 million and $10.2 million of such legal expenses incurred in 2018 and 2017, respectively.

No further legal expenses will be paid by TRGP under this agreement.

TPGP did not fund the legal expenses incurred for our second ITC action and our proceedings in international courts as well as other District Court proceedings.

We believe that the SK hynix License Agreement falls outside the scope of the TRGP Agreement.

Intellectual property legal fees increased during the first quarter of 2021 compared to the same quarter of 2020 due primarily to higher legal expenses incurred to defend our patent portfolio internationally.

Intellectual property legal fees increased during the second quarter and first six months of 2021 compared to the same periods of 2020 due primarily to higher legal expenses incurred to defend our patent portfolio internationally.

Selling, General and Administrative

Selling, general and administrative expenses slightly decreased during the first quarter of 2021 compared to the same quarter of 2020 due primarily to a decrease in outside services.

Other Expense, Net

Other expense, net for the three months ended April 3, 2021 and March 28, 2020 was as follows (dollars in thousands):

Selling, general and administrative expenses increased during the second quarter and first six months of 2021 compared to the same periods of 2020 due primarily to an increase in employee headcount and overhead, partially offset by a decrease in outside services.

As a result of the significant increase in the value of our non-affiliate public float in recent periods, we will be transitioning to becoming a “large accelerated filer” at the end of this fiscal year ending January 2, 2022 which means that we will need to file our quarterly and annual reports on an accelerated basis and that we will need to be prepared to have our independent registered public accounting firm audit and attest to our internal control over financial reporting.

Complying with these new requirements will require that we invest a material amount in enhancing our financial reporting infrastructure that will cause our selling, general and administrative expenses to increase materially in future periods.

Other Income (Expense), Net

Other income (expense), net for the three and six months ended July 3, 2021 and June 27, 2020 was as follows (dollars in thousands):

Three Months Ended

Six Months Ended

Interest expense, net

Other expense, net

Total other expense, net

Other income (expense), net

Total other income (expense), net

Interest expense, net, consists primarily of interest expense on the $15 million secured convertible note issued to Samsung Venture Investment Co.

(“SVIC”) (“SVIC Note”) in November 2015 and a revolving line of credit under the SVB Credit Agreement, along with the accretion of debt discounts and amortization of debt issuance costs on the SVIC Note.

During the first quarter of 2021, other expense was consistent compared with the same quarter of 2020.

During the second quarter and first six months of 2021, other income (expense), net includes the gain on forgiveness of the PPP Loan of $0.6 million.

Provision for Income Taxes

During the second quarter and first six months of 2021, we recorded a provision for income taxes of $6.6 million related to the Korean withholding tax incurred in connection with the upfront non-refundable license fee of $40 million from SK hynix.

Our effective tax rate for the second quarter and first six months of 2021 was the same as the U.S.

federal statutory rate of 21%, since the Korean withholding tax was treated as a significant unusual event for interim tax reporting.

Liquidity and Capital Resources

Our primary sources of cash are historically proceeds from issuances of equity and debt securities and receipts from revenues.

In addition, as a result of our entry into the SK hynix License Agreement, we plan to use the settlement fee received to support our operations.

In addition, we have received proceeds from NRE and licensing of our patent portfolio.

As a result of our entry into the SK hynix License Agreement, we plan to use the license fee received to support our operations.

We have also funded our operations with a revolving line of credit under a bank credit facility, a funding arrangement for costs associated with certain of our legal proceedings against SK hynix and, to a lesser extent, equipment leasing arrangements.

The following tables present selected financial information as of April 3, 2021 and January 2, 2021 and for the first three months of 2021 and 2020 (in thousands):

The following tables present selected financial information as of July 3, 2021 and January 2, 2021 and for the first six months of 2021 and 2020 (in thousands):

Cash and cash equivalents

2 unchanged sentences

Working capital

Three Months Ended

Net cash used in operating activities

Six Months Ended

Net cash provided by (used in) operating activities

Net cash used in investing activities

Net cash provided by financing activities

During the three months ended April 3, 2021, net cash used in operating activities was primarily a result of net loss of $4.0 million and non-cash adjustments to net loss of $0.6 million, offset by net cash outflows from changes in operating assets and liabilities of $0.9 million driven predominantly by an increase in inventories due to higher purchases to support increased sales, partially offset by an increase in accounts payable.

Net cash provided by financing activities during the three months ended April 3, 2021 primarily consisted of $9.4 million in net proceeds from issuance of common stock under the 2020 and 2019 Lincoln Park Purchase Agreements, $4.0 million in proceeds from exercise of warrants, $0.4 million in proceeds from exercise of stock options and a $1.0 million in net borrowings under the SVB Credit Agreement, partially offset by $0.3 million in payments of taxes related to net share settlement of equity awards.

During the three months ended March 28, 2020, net cash used in operating activities was primarily a result of a net loss of $1.5 million, adjusted for non-cash charges of $0.5 million, offset by net cash outflows from changes in operating assets and liabilities of $3.3 million driven predominantly by increases in accounts receivable due to higher sales and in inventories due to higher purchases to support increased sales, partially offset by an increase in accounts payable.

Net cash provided by financing activities during the three months ended March 28, 2020 primarily consisted of $1.5 million in net borrowings under the SVB Credit Agreement, partially offset by $0.1 million in payments of note payable to finance insurance policies.

During the six months ended July 3, 2021, net cash provided by operating activities was primarily a result of net income of $23.8 million and non-cash adjustments to net income of $0.6 million, offset by net cash inflows from

changes in operating assets and liabilities of $2.8 million driven predominantly by an increase in accounts payable due to higher purchases to support increased sales, partially offset by an increase in inventories.

Net cash provided by financing activities during the six months ended July 3, 2021 primarily consisted of $9.4 million in net proceeds from issuance of common stock under the 2020 and 2019 Lincoln Park Purchase Agreements, $4.4 million in proceeds from exercise of warrants, $0.6 million in proceeds from exercise of stock options, partially offset by $2.9 million in net repayments under the SVB Credit Agreement.

During the six months ended June 27, 2020, net cash used in operating activities was primarily a result of net loss of $3.4 million and non-cash adjustments to net loss of $1.0 million, offset by net cash outflows from changes in operating assets and liabilities of $0.4 million driven predominantly by an increase in inventories due to higher purchases to support increased sales and accrued payroll and related liabilities, partially offset by a decrease in accounts receivable due to vigorous collection efforts.

Net cash provided by financing activities during the six months ended June 27, 2020 primarily consisted of $2.8 million in net proceeds from issuance of common stock under the 2020 Lincoln Park Purchase Agreement and $0.6 million in proceeds from the issuance of PPP Loan, partially offset by $1.6 million in net repayments under the SVB Credit Agreement.

Capital Resources

2021 Lincoln Park Purchase Agreement

On June 24, 2019, we entered into the 2019 Purchase Agreement with Lincoln Park, pursuant to which we have the right to sell to Lincoln Park up to an aggregate of $10 million in shares of our common stock over the 36-month term of the 2019 Purchase Agreement subject to the conditions and limitations set forth in the 2019 Purchase Agreement.

As of April 3, 2021, an aggregate of $2.0 million in shares of our common stock was available for purchases over the remaining term under the 2019 Purchase Agreement.

2020 Lincoln Park Purchase Agreement

On March 5, 2020, we entered into the 2020 Purchase Agreement with Lincoln Park, pursuant to which we had the right to sell to Lincoln Park up to an aggregate of $20 million in shares of our common stock over the 36-month term of the 2020 Purchase Agreement subject to the conditions and limitations set forth in the 2020 Purchase Agreement.

In February 2021, we completed the sales under the 2020 Purchase Agreement.

On July 12, 2021, we entered into the 2021 Purchase Agreement with Lincoln Park, pursuant to which we have the right to sell to Lincoln Park up to an aggregate of $17.4 million in shares of our common stock over the 36-month term of the 2021 Purchase Agreement subject to the conditions and limitations set forth in the 2021 Purchase Agreement.

SVB Credit Agreement

1 unchanged sentence

The borrowing base is limited to 85% of eligible accounts receivable, subject to certain adjustments as set forth in the SVB Credit Agreement.

As of April 3, 2021, the borrowings under the SVB Credit Agreement bear interest at the Prime Rate plus 2.75% per annum and mature on April 30, 2021.

As of April 3, 2021, the outstanding borrowings under the SVB Credit Agreement were $4.6 million with additional borrowing availability of $0.4 million.

During the three months ended April 3, 2021, we made net borrowings of $1.0 million under the SVB Credit Agreement.

On April 9, 2021, we entered into an amendment to the SVB Credit Agreement to accrue interest on advances at a per annum rate equal to the greater of 2.25% above the Prime Rate or 5.50% and to extend the maturity date to December 30, 2021.

The amount available for borrowing may be increased to $7.0 million and the maturity date will be extended to April 29, 2022 upon our request, if we meet certain conditions.

As of July 3, 2021, the outstanding borrowings under the SVB Credit Agreement were $0.8 million with additional borrowing availability of $3.9 million.

During the six months ended July 3, 2021, we made net repayments of $2.9 million under the SVB Credit Agreement.

Paycheck Protection Program Loan

4 unchanged sentences

Sufficiency of Cash Balances and Potential Sources of Additional Capital

We believe our existing balance of cash and cash equivalents together with cash receipts from revenues, the settlement fee received under the SK hynix License Agreement, borrowing availability under the SVB Credit Agreement, the equity financing available under the 2019 Lincoln Park Purchase Agreement, funds raised through other future debt and equity offerings and taking into account cash expected to be used in our operations, will be sufficient to meet our anticipated cash needs for at least the next 12 months.

We believe our existing balance of cash and cash equivalents together with cash receipts from revenues, borrowing availability under the SVB Credit Agreement, the equity financing available under the 2021 Lincoln Park Purchase Agreement, funds raised through other future debt and equity offerings and taking into account cash expected to be used in our operations, will be sufficient to meet our anticipated cash needs for at least the next 12 months.

Off-Balance Sheet Arrangements

12 unchanged sentences

Compared sentence by sentence after normalising whitespace, quotation marks, case and digits, so re-formatting and restated figures do not read as changed language. Wording changes appear as one removal and one addition. The current filing and the prior one are authoritative.

What changed 10-Q

Item 2. Management’s Discussion and Analysis