What changed in this filing

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Item 2. Management’s Discussion and Analysis

2021-11-10 compared with 2021-08-17 · 68 added, 61 removed, 118 unchanged (52% of the section changed)

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● our expectations regarding our future operations and financial position, including revenues, costs and prospects, and our liquidity and capital resources, including cash flows, sufficiency of cash resources, efforts to reduce expenses and the potential for future financings;

● our ability to remediate any material weakness and maintain effective internal control over financial reporting;

● our ability to remediate any material weakness, maintain effective internal control over financial reporting and satisfy the accelerated and enhanced disclosure obligations that will apply to us as we transition from a “smaller reporting company” to a “large accelerated filer” in 2022;

● the impact of the above factors and other future events on the market price and trading volume of our common stock.

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and its consolidated subsidiaries, unless otherwise stated.

We provide high-performance modular memory subsystems to customers in diverse industries that require enterprise and storage class memory solutions to empower critical business decisions.

We have a history of introducing disruptive new products, such as one of the first load reduced dual in-line memory modules ("LRDIMM") based on our distributed buffer architecture, which has been adopted by the industry for DDR4 LRDIMM.

We were also one of the first to bring NAND flash memory ("NAND flash") to the memory channel with our NVvault non-volatile dual in-line memory modules ("NVDIMM") using software-intensive controllers and merging dynamic random access memory integrated circuits (“DRAM ICs” or "DRAM") and NAND flash to solve data bottleneck and data retention challenges encountered in high-performance computing environments.

We also offer storage class memory products called HybriDIMM to address the growing need for real-time analytics in Big Data applications, in-memory databases, high performance computing and advanced data storage solutions.

We are continuously developing and improving upon the HybriDIMM product while exploring opportunities with strategic partners.

Our NVMe SSD portfolio provides industry-leading performance offered in multiple capacities and form factors.

Due to the ground-breaking product development of our engineering teams, we have built a robust portfolio of over 130 issued and pending U.S.

and foreign patents, many seminal, in the areas of hybrid memory, storage class memory, rank multiplication and load reduction.

Since our inception, we have dedicated substantial resources to the development, protection and enforcement of technology innovations we believe are essential to our business.

Our early pioneering work in these areas has been broadly adopted in industry-standard registered dual in-line memory modules (“RDIMM”), LRDIMM and in NVDIMM.

Our objective is to continue to innovate in our field and invest further in our intellectual property portfolio, with the goal of monetizing our intellectual property through a combination of product sales and licensing, royalty or other revenue-producing arrangements, which may result from joint development or similar partnerships or defense of our patents through enforcement actions against parties we believe are infringing them.

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 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.

Netlist provides high-performance solid state drives and modular memory solutions to enterprise customers in diverse industries.

Our NVMe SSDs in various capacities and form factors and the line of custom and specialty memory products bring industry-leading performance to server and storage appliance customers and cloud service providers.

Netlist licenses its portfolio of intellectual property including patents, in server memory, hybrid memory and storage class memory, to companies that implement Netlist’s technology.

To learn more, visit www.netlist.com.

During the third quarter of 2021, we recorded net sales of $26.7 million, gross margin of $2.5 million and net loss of $10.4 million.

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

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Under the License Agreement, (a) we have granted to SK hynix fully paid, worldwide, non-exclusive, non-assignable licenses to certain of our patents covering memory technologies and (b) SK hynix has granted to us fully paid, worldwide, non-exclusive, non-assignable licenses to its patent portfolio.

In addition, the License Agreement provides for the settlement of all pending intellectual property proceedings between us and SK hynix with the settlement fee of $40 million payable to us by SK hynix, and the parties have agreed to collaborate on certain technology development activities.

In addition, the License Agreement provided for the settlement of all intellectual property proceedings between us and SK hynix and a settlement fee of $40 million paid to us by SK hynix.

In addition, the parties have agreed to collaborate on certain technology development activities.

Amendment to SVB Credit Agreement

On April 9, 2021, we entered into an amendment to a credit agreement dated October 31, 2009 with Silicon Valley Bank (“SVB”) (as the same may from time to time be amended, modified, supplemented or restated, the “SVB Credit Agreement”) to accrue interest on advances at a per annum rate equal to the greater of 2.25% above the Wall Street Journal prime rate (“Prime Rate”) or 5.50% and to extend the maturity date to December 30, 2021.

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.

2021 Lincoln Park 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.

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.

First 2021 Lincoln Park Purchase Agreement

On July 12, 2021, we entered into a purchase agreement (the “First 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 First 2021 Purchase Agreement subject to the conditions and limitations set forth in the First 2021 Purchase Agreement.

During the third quarter of 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 First 2021 Purchase Agreement.

In connection with the purchases, during the third quarter of 2021, we issued to Lincoln Park an aggregate of 103,292 shares of our common stock as additional commitment shares in noncash transactions.

Subsequent to October 2, 2021, Lincoln Park purchased an aggregate of 383,748 shares of our common stock for a net purchase price of $2.5 million under the First 2021 Purchase Agreement.

In connection with the purchases, we issued to Lincoln Park an aggregate of 17,208 shares of our common stock as additional commitment shares in noncash transactions.

We completed the sales under the First 2021 Purchase Agreement in October 2021.

Second 2021 Lincoln Park Purchase Agreement

On September 28, 2021, we entered into a purchase agreement (the “Second 2021 Purchase Agreement”) with Lincoln Park, pursuant to which we have the right to sell to Lincoln Park up to an aggregate of $75 million in shares of our common stock over the 36-month term of the Second 2021 Purchase Agreement subject to the conditions and limitations set forth in the Second 2021 Purchase Agreement.

Subsequent to October 2, 2021, Lincoln Park purchased an aggregate of 650,000 shares of our common stock for a net purchase price of $4.8 million under the Second 2021 Purchase Agreement.

In connection with the purchases, we issued to Lincoln Park an aggregate of 9,111 shares of our common stock as additional commitment shares in noncash transactions.

Paycheck Protection Program Loan

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Results of Operations

Net Sales and Gross Profit

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):

Net Sales and Gross Margin

Net sales and gross margin for the three and nine months ended October 2, 2021 and September 26, 2020 were as follows (dollars in thousands):

Three Months Ended

Six Months Ended

Nine Months Ended

September 26,

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

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.

Gross margin percentage - product sales

Gross margin percentage

Net sales include (i) resales of certain 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 $16.5 million during the third quarter of 2021 compared to the same quarter of 2020 primarily as a result of a $14.2 million increase in the resale of DIMMs and components and an increase of $2.3 million of Netlist SSD and Netlist branded products.

Net product sales increased by $30.3 million during the first nine months of 2021 compared to the same period in 2020 primarily as a result of a $29.3 million increase in the resale of DIMMs and components and an increase of $1.0 million of Netlist SSD and Netlist branded products.

Product gross margin increased during the third quarter and first nine months of 2021 compared to the same periods of 2020 due primarily to higher sales across all product groups.

Product gross margin percentage decreased between the periods as a result of the change in our product mix.

Operating Expenses

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

Operating expenses for the three and nine months ended October 2, 2021 and September 26, 2020 were as follows (dollars in thousands):

Three Months Ended

Six Months Ended

Nine Months Ended

September 26,

Research and development

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Research and Development

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.

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

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.

Intellectual property legal fees increased during the third quarter and first nine months of 2021 compared to the same periods of 2020 due primarily to higher legal expenses incurred to seek damages for breach of contract of the Joint Development and License Agreement entered into between Netlist and Samsung on November 12, 2015 and to defend and enforce our patent portfolio.

Selling, General and Administrative

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.

Selling, general and administrative expenses increased during the third quarter and first nine months of 2021 compared to the same periods of 2020 due primarily to an increase in employee headcount and overhead and 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):

Other (Expense) Income, Net

Other (expense) income, net for the three and nine months ended October 2, 2021 and September 26, 2020 was as follows (dollars in thousands):

Three Months Ended

Six Months Ended

Nine Months Ended

September 26,

Interest expense, net

Other income (expense), net

Total other income (expense), net

Other (expense) income, net

Total other (expense) income, 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 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.

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

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.

During the first nine 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 recognized during the second quarter of 2021.

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, 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 July 3, 2021 and January 2, 2021 and for the first six months of 2021 and 2020 (in thousands):

In addition, we have received proceeds from non-recurring engineering and licensing of our patent portfolio, including as a result of our entry into the SK hynix License Agreement, which we use to support our operations.

We have also funded our operations with a revolving line of credit under a bank credit facility, and to a lesser extent, equipment leasing arrangements.

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

Cash and cash equivalents

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Working capital

Six Months Ended

Nine Months Ended

September 26,

Net cash provided by (used in) operating activities

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Net cash provided by financing activities

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.

During the nine months ended October 2, 2021, net cash provided by operating activities was primarily a result of net income of $13.1 million, non-cash adjustments to net income of $1.3 million, and net cash inflows from changes in operating assets and liabilities of $5.7 million driven predominantly by an increase in accounts payable due to higher inventory purchases to support increase in sales and higher legal fees to defend our patent portfolio, partially offset by an

increase in inventories.

Net cash provided by financing activities during the nine months ended October 2, 2021 primarily consisted of $26.3 million in net proceeds from issuance of common stock under the 2019, 2020 and First 2021 Lincoln Park Purchase Agreements, $11.1 million in proceeds from exercise of stock options and warrants and $0.8 million in net borrowings under the SVB Credit Agreement, partially offset by $1.0 million in payments for taxes related to net share settlement of equity awards.

During the nine months ended September 26, 2020, net cash used in operating activities was primarily a result of net loss of $5.5 million and non-cash adjustments to net loss of $1.5 million, offset by net cash outflows from changes in operating assets and liabilities of $2.9 million driven predominantly by an increase in inventories due to higher purchases to support increased sales and an increase in accounts receivable due to higher sales, partially offset by a decrease in accounts payable and accrued expenses and other current liabilities.

Net cash provided by financing activities during the nine months ended September 26, 2020 primarily consisted of $12.2 million in net proceeds from issuance of common stock under the 2020 Lincoln Park Purchase Agreement, $0.6 million in proceeds from the issuance of the PPP Loan and $0.4 million in net borrowings under the SVB Credit Agreement, partially offset by $0.4 million in payments of outstanding debt.

Capital Resources

2021 Lincoln Park 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.

First 2021 Lincoln Park Purchase Agreement

On July 12, 2021, we entered into the First 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 First 2021 Purchase Agreement subject to the conditions and limitations set forth in the First 2021 Purchase Agreement.

In October 2021, we completed the sales under the First 2021 Purchase Agreement.

Second 2021 Lincoln Park Purchase Agreement

On September 28, 2021, we entered into the Second 2021 Purchase Agreement with Lincoln Park, pursuant to which we have the right to sell to Lincoln Park up to an aggregate of $75 million in shares of our common stock over the 36-month term of the Second 2021 Purchase Agreement subject to the conditions and limitations set forth in the Second 2021 Purchase Agreement.

SVB Credit Agreement

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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.

As of October 2, 2021, the outstanding borrowings under the SVB Credit Agreement were $4.5 million with additional borrowing availability of $0.1 million.

During the nine months ended October 2, 2021, we made net borrowings of $0.8 million under the SVB Credit Agreement.

Paycheck Protection Program Loan

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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, 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.

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 First and Second 2021 Lincoln Park Purchase Agreements, 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

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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