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Item 7. Management’s Discussion and Analysis

2022-03-01 compared with 2021-03-26 · 127 added, 236 removed, 51 unchanged (88% of the section changed)

Management’s Discussion and Analysis of Financial Condition and Results of Operation s

This section contains forward-looking statements that reflect our plans, estimates and beliefs and involve numerous risks and uncertainties, including, but not limited to, those described in the “Risk Factors” section of this Form 10-K.

Actual results may differ significantly from those contained in any forward-looking statements.

You should carefully read the “Cautionary Note Regarding Forward-Looking Statements” and “Risk Factors” sections of this Form 10-K.

The following discussion should be read in conjunction with our consolidated financial statements and accompanying notes included in Item 8 of this Form 10-K.

This section of this Form 10-K generally discusses 2021 and 2020 items and year-to-year comparisons between 2021 and 2020.

Discussions of 2019 items and year-to-year comparisons between 2020 and 2019 are not included in this Form 10-K, and can be found in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Part II, Item 7 of our Annual Report on Form 10-K for the fiscal year ended January 2, 2021.

Our fiscal year is the 52- or 53-week period that ends on the Saturday nearest to December 31.

Our fiscal year 2020 includes 53 weeks and ended on January 2, 2021 and its fiscal year 2019 included 52 weeks and ended on December 28, 2019.

The first three quarters of fiscal year 2020 each includes 13 weeks and the fourth quarter includes 14 weeks.

The four quarters of fiscal year 2019 each included 13 weeks.

Our fiscal year 2021 ended on January 1, 2022, fiscal year 2020 ended on January 2, 2021, and fiscal year 2019 ended on December 28, 2019.

All fiscal years presented in this Form 10-K, except fiscal year 2020, included 52 weeks.

Additionally, all quarters, except the fourth quarter of 2020, included 13 weeks.

Fiscal year 2020 included 53 weeks, with a 14-week fourth quarter.

Unless otherwise stated, all information presented herein is based on our fiscal calendar, and references to particular years, quarters, months or periods refer to our fiscal years ended in January or December and the associated quarters, months and periods of those fiscal years.

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Impact of COVID-19 on our Business

The impact of the coronavirus disease (“COVID-19”) pandemic will have on our consolidated results of operations is uncertain.

Although we initially observed demand increases in our products, we anticipate that the global health crisis caused by COVID-19 may negatively impact business activity across the globe.

We will continue to actively monitor the situation and may take further actions altering our business operations that we determine are in the

best interests of our employees, customers, suppliers, and stakeholders, or as required by federal, state, or local authorities.

It is not clear what the potential effects of such alterations or modifications may have on our business, consolidated results of operations, financial condition, and liquidity.

First Amendment to TRGP Agreement

On January 23, 2020, we entered into the first amendment to the investment agreement dated May 3, 2017 with TR Global Funding V, LLC (“TRGP”) (“TRGP Agreement”) to amend the recovery sharing formula related to claims against SK hynix, Inc.

a South Korean memory semiconductor supplier (“SK hynix”), for alleged infringement of our patents.

The TRGP Agreement generally provided that TRGP directly fund the costs incurred by us or on our behalf in connection with our first ITC action and certain U.S.

district court proceedings against SK hynix.

The extent of the continuing impact of the COVID-19 pandemic on our operational and financial performance is uncertain and will depend on many factors outside our control, including the timing, extent, trajectory and duration of the pandemic, the emergence of new variants, the development, availability, distribution and effectiveness of vaccines and treatments, the imposition of protective public safety measures, and the impact of the pandemic on the global economy.

We continue to monitor the situation and may take further actions altering our business operations that we determine are in the best interests of our employees, customers, suppliers, and stakeholders, or as required by federal, state, or local authorities.

As COVID-19 and its impacts are unprecedented and ever evolving, future events and effects related to the pandemic cannot be determined with precision and actual results could significantly differ from estimates or forecasts.

SK hynix License Agreement and Supply Agreement

On April 5, 2021, we entered into a Strategic Product Supply and License Agreement (the “License Agreement”) and Product Purchase and Supply Agreement with SK hynix, Inc., a South Korean memory semiconductor supplier (“SK hynix”).

Both agreements have a term of 5 years.

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 our patent portfolio.

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 February 27, 2020, 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 extend the maturity date of the borrowings under the SVB Credit Agreement from March 30, 2020 to April 30, 2021.

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.

In December 2021, after meeting the conditions set forth in the amendment, the amount available for borrowing was increased to $7.0 million and the maturity date was extended to April 29, 2022 upon our request.

2019 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 2019 Purchase Agreement subject to the conditions and limitations set forth in the 2019 Purchase Agreement.

During 2020, Lincoln Park did not purchase shares of our common stock under the 2019 Purchase Agreement.

Subsequent to January 2, 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, we issued to Lincoln Park an aggregate of 129,468 shares of our common stock as commitment shares in noncash transactions.

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 had 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.

From July 2019 through the completion of sales in July 2021, Lincoln Park purchased an aggregate of 21,120,265 shares of our common stock for a net purchase price of $10 million under the 2019 Purchase Agreement.

During the same period, in connection with the purchases, we issued to Lincoln Park an aggregate of 818,420 shares of our common stock as commitment shares in noncash transactions.

In July 2021, we completed the sales under the 2019 Purchase Agreement.

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 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.

As consideration for entering into the 2020 Purchase Agreement, we issued to Lincoln Park 1,529,052 shares of our common stock as initial commitment shares in a noncash transaction on March 6, 2020 and would issue up to 917,431 additional shares of our common stock as additional commitment shares on a pro rata basis in connection with any additional purchases.

We would not receive any cash proceeds from the issuance of these additional commitment shares.

During 2020, Lincoln Park purchased an aggregate of 23,400,122 shares of our common stock for a net purchase price of $12.2 million under the 2020 Purchase Agreement.

In connection with the purchases, during 2020, we issued to Lincoln Park an aggregate of 560,588 shares of our common stock as commitment shares in noncash transactions.

Subsequent to January 2, 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, we issued to Lincoln Park an aggregate of 356,843 shares of our common stock as commitment shares in noncash transactions.

From March 2020 through the completion of sales in February 2021, Lincoln Park purchased an aggregate of 32,944,717 shares of our common stock for a net purchase price of $20 million under the 2020 Purchase Agreement.

During the same period, in connection with the purchases, we issued to Lincoln Park an aggregate of 917,431 shares of our common stock as commitment shares in noncash transactions.

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

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 had 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 2021, Lincoln Park purchased an aggregate of 2,383,748 shares of our common stock for a net purchase price of $17.4 million under the First 2021 Purchase Agreement.

In connection with the purchases, during 2021, we issued to Lincoln Park an aggregate of 120,500 shares of our common stock as commitment shares in noncash transactions.

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 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.

During 2021, Lincoln Park purchased an aggregate of 1,550,000 shares of our common stock for a net purchase price of $10.9 million under the Second 2021 Purchase Agreement.

In connection with the purchases, we issued to Lincoln Park an aggregate of 20,809 shares of our common stock as additional commitment shares in noncash transactions.

Subsequent to January 1, 2022, Lincoln Park purchased an aggregate of 250,000 shares of our common stock for a net purchase price of $1.5 million under the Second 2021 Purchase Agreement.

In connection with the purchases, we issued to Lincoln Park an aggregate of 2,860 shares of our common stock as additional commitment shares in noncash transactions.

Paycheck Protection Program Loan

On April 23, 2020, we entered into an unsecured promissory note with a principal amount of $0.6 million through Hanmi Bank under the Paycheck Protection Program (“PPP”) (“PPP Loan”) administered by the Small Business Administration (“SBA”) and established as part of the Coronavirus Aid, Relief, and Economic Security Act (“CARES

The PPP Loan bears interest at 1.0% per annum and matures in April 2022 with the first six months of interest and principal payments deferred.

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

In February 2021, we applied for forgiveness of the PPP Loan.

Factors Affecting Our Performance

Trends in Net Sales

We have been substantially dependent on sales of single products or product categories.

For instance, we have historically been dependent on sales of our memory subsystem products, and in recent periods, we have been dependent on our resales of component products.

Demand for any of these products could increase or decrease at any time for a number of reasons, including new customer qualifications, changing customer requirements or preferences, product obsolescence, introduction of more advanced or otherwise superior products by us or our competitors, the ability of our customers to obtain these products or substitute products from alternate sources, customers increasing or reducing their need for these products generally, or a variety of other factors.

We have no long-term agreements or other commitments with respect to sales of any of these products.

As a result, any fluctuations in demand for these products from us would impact our sale levels and net sales.

In past years, we have experienced declines in demand for and sales of our memory subsystem products, and these declines could continue or intensify in the future.

Contrastingly, we have recently experienced marked increases in component product resales.

Because the cost of the component products we purchase for resale is added to our cost of sales for these products, our gross margin on resales of component products is generally significantly lower than our gross margin on sales of our memory subsystem products.

As a result, increases or decreases in component product resales as a percentage of our total sales have a significant impact on our gross margins.

Next-generation HybriDIMM and some of our other next-generation products may require additional time and capital investments in order to commercialize, and our development and commercialization strategies for these products, including, for instance, our work with the Joint Electron Device Engineering Council (“JEDEC”) to facilitate broad industry adoption of this new technology, may not be successful.

Our ability to obtain customer or market acceptance of these next-generation products will materially impact our net product sales and gross profits, as well as our ability to recoup our investments in developing these products.

Customer Composition and Concentrations

Our target markets are characterized by a limited number of large companies, and consolidation in one or more of these target markets may further increase this concentration.

As a result, sales to small numbers of customers have historically represented a substantial portion of our net sales, and we expect this concentration to continue.

Additionally, the composition of major customers and their respective contributions to our net sales have fluctuated and will likely continue to fluctuate from period to period as our existing and prospective customers progress through the life cycle of the products they produce and sell and experience resulting fluctuations in their product demand.

We believe our performance depends in significant part on our ability to establish and maintain relationships with and effect substantial sales to our large customers.

We do not have long-term agreements with any of our customers and, as result, any or all of them could decide at any time to increase, accelerate, decrease, delay or discontinue their purchase of our products or the component products we resell.

These fluctuations in customer demand and concentrations could significantly impact our net sales.

Product Sale Prices

The prices customers pay for the products we sell can fluctuate due to many factors, including, among others, competitive conditions in our key customer markets, changes in customer requirements or preferences, volatility in the market prices for SSDs, merging dynamic random access memory integrated circuits (“DRAM ICs” or “DRAM”), NAND flash memory (“NAND flash”) and other component products, and changes in manufacturing efficiencies or capacities.

Our industry has historically been characterized by declines in average sale prices.

If sale price declines are

not offset by corresponding decreases in costs or increases in sales volume or sales of products with higher margins, these sale price declines could have a material adverse effect on our operating results.

Once our prices with a customer are negotiated, we are generally unable to revise pricing with that customer until our next regularly scheduled price adjustment.

As a result, if market prices for essential components increase, we generally cannot pass the price increases through to our customers for products purchased under an existing purchase order.

Consequently, we are exposed to the risks associated with the volatility of prices for these components and our cost of sales could increase and our gross margins could decrease in the event of sudden price increases.

Alternatively, if there are declines in the prices of these components, we may be required to reduce our selling prices for subsequent purchase orders, which may result in a decline in our net sales.

In addition, because a large percentage of our sales are often from sales to a small number of customers, these customers may exert pressure on us to make concessions in the prices at which we sell products to them.

These sale price concessions could have a material effect our net sales.

Component Product Supply

Our ability to fulfill customer orders for our memory subsystem products or the component products we resell is dependent on a sufficient supply of SSDs, DRAM ICs, NAND flash and other component products.

We have no long-term supply contracts for any of these component products.

There are a relatively small number of suppliers of these components, and we typically purchase from only a subset of these suppliers.

From time to time, shortages in SSDs, DRAM ICs and NAND flash have required some suppliers to limit the supply of these components.

In the past, we have experienced supply chain disruptions and shortages of DRAM and NAND flash required to create certain of our memory subsystem products, and we have been forced to procure the component products we resell from other suppliers to the extent sufficient product is not available from Samsung Electronics Co., Ltd.

(“Samsung”) to meet customer demand or in the event of other Samsung supply issues.

Supply shortages can occur at any time and for a variety of reasons, including, among others, spikes in customer demand that cannot be satisfied by our suppliers, any problems that arise with the supplier’s manufacturing operations or facilities that cause disruptions or delays, or any failure by the supplier to comply with the terms of its supply arrangements with us.

If we are not able to obtain components in the amounts needed, on a timely basis and at commercially reasonable prices, we may lose customers due to order delivery interruptions or failures, which could impact our net sales, and we may experience increases in our cost of sales if we are forced to procure components from alternative suppliers and are not able to negotiate favorable terms with these suppliers.

For example, with respect to Samsung, any inability to obtain sufficient component products from Samsung could increase our cost of sales for component product resales because we may not be able to make arrangements with other suppliers on financial and other terms comparable to those we have negotiated with Samsung under a joint development and license agreement (“JDLA”).

As described above, we may or may not be able to pass any such cost increases through to our customers, in which case they could materially adversely impact our results by increasing our cost of sales without a corresponding increase in our net sales.

Product Demand Forecasting

Because of the short-term nature of the commitments by many of our customers and the short turnaround times that apply to most orders, as well as our customers’ ability to cancel or defer purchase orders for any reason, we are required to make component procurement decisions based on forecasts of customer demand for the products we sell.

Our production expense and component purchase levels are to a large extent fixed in the short term.

As a result, we may be unable to adjust spending on a timely basis to compensate for any unexpected shortfall in customer orders.

If we overestimate customer demand, we may have excess component or finished goods inventory, which may not be able to be used in other products or resold and may become obsolete before any such use or resale.

If there is a subsequent decline in the prices of components, the value of our inventory would fall and we may be required to write-down the value of our component inventory, which may result in a significant increase in our cost of sales and decrease in our gross margins.

In the past, we have had to write-down inventory due to obsolescence, excess quantities and declines in

market value below our costs.

As a result, any significant shortfall of customer orders in relation to our expectations could hurt our operating results, cash flows and financial condition.

Conversely, any rapid increases in demand by our customers could strain our resources.

If we underestimate customer demand, we may not have sufficient inventory of necessary components on hand to meet that demand and we may need to try to procure additional quantities, which may not be available or may only be available at high prices or on otherwise unfavorable terms.

We also may not have sufficient manufacturing capacity at any given time to meet any demands for rapid increases in production of our memory subsystem products.

Any shortages of inventory or manufacturing capacity could lead to delays in the delivery of products, which may reduce our net sales.

In addition, if our product demand forecasts are inaccurate, we may understate or overstate the provision required for excess and obsolete inventory.

If our inventories are determined to be overvalued, we would be required to recognize additional expense in our cost of sales at the time of the determination.

Conversely, if our inventories are determined to be undervalued, we may have over-reported our costs of sales in previous periods and would be required to recognize additional gross profit at the time the inventories are sold.

Intellectual Property Protection, Enforcement and Monetization

We dedicate substantial resources to developing technology innovations we believe are essential to our business.

We intend to pursue monetization avenues for our intellectual property portfolio, potentially including licensing, royalty or other revenue-producing arrangements.

However, we have not generated any such revenue stream from our intellectual property to date.

If we are not successful in monetizing our intellectual property portfolio, we may never recoup our investments of time, capital and other resources in the development, maintenance, defense and enforcement of this portfolio, which could materially adversely affect our results of operations.

We also dedicate substantial resources to protecting and enforcing our intellectual property rights, including with patent infringement proceedings we file against third parties and defense of our patents against challenges made by way of reexamination and review proceedings at relevant government agencies.

We expect these activities to continue for the foreseeable future, with no guarantee that any ongoing or future patent protection or litigation activities will be successful.

We are also subject to litigation based on claims that we have infringed the intellectual property rights of others.

Any litigation, regardless of its outcome, is inherently uncertain, involves a significant dedication of resources, including time and capital, and diverts management’s attention from our other activities.

As a result, any current or future infringement claims or patent challenges by or against third parties, whether or not eventually decided in our favor or settled, could materially adversely affect our business, financial condition and results of operations.

Additionally, the outcome of pending or future litigation and related patent reviews and reexaminations, as well as any delay in their resolution, could affect our ability to continue to sell our products, protect against competition in the current and expected markets for our products or license or otherwise monetize our intellectual property rights in the future.

Business Risks and Uncertainties

Our performance, financial condition and prospects are affected by a number of factors and are exposed to a number of risks and uncertainties.

We operate in a competitive and rapidly evolving industry in which new risks emerge from time to time, and it is not possible for us to predict all of the risks we may face, nor can we assess the impact of all factors on our business or the extent to which any factor or combination of factors could cause actual results to differ from our expectations.

See the discussion in Part I, Item 1A.

Risk Factors of this Form 10-K for more information.

The PPP Loan bore interest at 1.0% per annum and would mature in April 2022 with the first six months of

interest and principal payments deferred.

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

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

Repayment of SVIC Promissory Note

On November 18, 2015, we entered into a Senior Secured Convertible Promissory Note and Warrant Purchase Agreement, with SVIC No.

28 Technology Business Investment L.L.P., a Korean limited liability partnership (“SVIC”) and affiliate of Samsung Venture Investment Co., pursuant to which we sold SVIC a Senior Secured Convertible Promissory Note (“SVIC Note”) and a Stock Purchase Warrant (“SVIC Warrant”).

The SVIC Note had an original principal amount of $15.0 million, accrued interest at a rate of 2% per year, was due and payable in full on December 31, 2021.

The SVIC Warrant granted SVIC a right to purchase 2,000,000 shares of our common stock at an exercise price of $0.30 per share, subject to certain adjustment as set forth therein, was only exercisable in the event we exercised our right to redeem the SVIC Note prior to December 31, 2025.

We made the repayment of $16.8 million on December 27, 2021, and SVIC purchased 2,000,000 shares of common stock at an exercise price of $0.30 per share on December 28, 2021.

As a result, neither the SVIC Note nor the SVIC Warrant remained outstanding as of January 1, 2022.

Ineffective Internal Control over Financial Reporting

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 our annual or interim consolidated financial statements will not be prevented or detected on a timely basis.

In performing their audit of our internal control over financial reporting as required by Section 404 of the Sarbanes-Oxley Act of 2002, as amended, our independent registered public accounting firm concluded that our internal control over financial reporting was ineffective as of January 1, 2022 due to two material weaknesses.

The identified material weaknesses, at January 1, 2022, relate to (i) the lack of an independent board and audit committee and (ii) ineffective design and maintenance of controls over user access and program change management related to certain information technology (IT) systems that support our financial reporting processes.

While the control weaknesses identified did not result in any identified misstatements, a reasonable possibility exists that a material misstatement to the annual or interim consolidated financial statements and disclosures will not be prevented or detected on a timely basis.

In an effort to remediate the identified material weakness related to the lack of an independent board and audit committee and to enhance our internal controls, our finance and accounting personnel are continuing to follow all of the same procedures that they undertook in preparation for independent audit committee meetings on a quarterly and annual basis.

Our CEO and sole director will oversee these processes and review materials prepared by the finance and accounting staff as well as our independent auditors on a quarterly and annual basis.

In an effort to remediate the identified material weakness related to our ineffective design and maintenance of controls over user access and program change management related to certain IT systems, we hired a full-time Senior Director of IT in the fourth quarter of 2021 with a primary mandate to focus on SOX compliance and mitigation plans for 2022.

If our remedial measures are insufficient to address the material weakness, or if additional material weaknesses or significant deficiencies in our internal control over financial reporting occur in the future, we may not be able to timely or accurately report our results of operations or maintain effective disclosure controls and procedures.

If we are unable to report financial information timely or accurately, or to maintain effective disclosure controls and procedures, we could be required to restate our financial statements and be subject to, among other things, regulatory or enforcement actions, securities litigation, limitations on our ability to access capital markets, debt rating agency downgrades or rating withdrawals, or loss in confidence of our investors, any one of which could adversely affect the valuation of our common stock and our business prospects.

We can give no assurance that the measures we have taken and plan to take in the future will remediate the material weaknesses identified or that any additional material weaknesses will not arise in the future due to a failure to implement and maintain adequate internal control over financial reporting.

Results of Operations

Net Sales and Gross Profit

Net sales, cost of sales and gross profit for 2020 and 2019 were as follows (dollars in thousands):

Cost of sales

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

In 2020 and 2019, resales of component products represented 66% and 77% of net sales, respectively.

Net sales increased 81% or $21.1 million during 2020 compared to 2019 primarily as a result of a $14.0 million overall increase in sales of NAND flash products (including a $8.3 million increase in sales of Netlist’s flash SSD products and a $5.8 million increase in the resales of NAND flash products), a $7.8 million overall increase in sales of other small outline dual in-line memory module (“SODIMM”) and RDIMM products (a $5.3 million increase in the resales of SODIMM and RDIMM products and a $2.5 million increase in sales of our Specialty SODIMM and RDIMM products), partially offset by an aggregate of $0.5 million increase in sales return reserve and customer discounts.

Our product sales were impacted by fluctuating customer concentrations.

During 2020, there was one customer that accounted for more than 10% of our net sales, while during 2019, there were no customers who accounted for more than 10% of our net sales.

During 2020 and 2019, our four largest customers accounted for an aggregate of 33% and 27% of our net sales, respectively.

Gross Profit and Gross Margin

Gross profit increased in 2020 compared to 2019 due primarily to higher sales and gross profits on the 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.

Net Sales and Gross Margin

Net sales and gross margin for 2021 and 2020 were as follows (dollars in thousands):

Net product sales

Gross margin - product sales

Gross margin percentage - product sales

Gross margin percentage

Net sales include (i) resales of certain component products, including DIMMs, SSDs and dynamic random access memory integrated circuits (“DRAM ICs” or “DRAM”) products, and sales of our high-performance memory subsystems and (ii) an upfront non-refundable license fee of $40 million recognized for licensing of our patents pursuant to the License Agreement with SK hynix entered into in April 2021.

Net product sales increased by $55.1 million during 2021 compared to 2020 primarily as a result of a $52.0 million increase in the resale of DIMMs and components and an increase of $3.0 million of Netlist SSD and Netlist branded products.

Product gross margin increased in 2021 compared to 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

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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 in 2020 compared to 2019 primarily as a result of an increase in employee headcount and overhead.

Research and development expenses increased in 2021 compared to 2020 primarily as a result of an increase in engineering employee headcount and overhead to support the development of the next generation HybriDIMM.

Intellectual Property Legal Fees

Intellectual property legal fees consist of legal fees incurred for patent filings, protection and enforcement.

Although we expect intellectual property legal fees to generally increase over time as we continue to protect, defend and enforce and seek to expand our patent portfolio, these increases may not be linear but may occur in lump sums depending on the due dates of patent filings and their associated fees and the arrangements we may make with our legal advisors in connection with enforcement proceedings, which may include fee arrangements or contingent fee arrangements in which we would pay these legal advisors on a scaled percentage of any negotiated fees, settlements or judgments awarded to us based on if, how and when the fees, settlements or judgments are obtained.

See Note 8 “Commitments and Contingencies” to the consolidated financial statements in Item 8 of this Form 10-K 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.

TRGP is not currently funding our legal expenses.

Intellectual property legal fees decreased in 2020 as compared to 2019 due primarily to lower legal expenses incurred to defend our patent portfolio internationally, including the costs incurred for our second ITC action and inter partes review of our patents before the U.S.

Patent and Trademark Office and a current year reversal of legal fees due to certain law firms on the settlement of liabilities owing to them.

Intellectual property legal fees consist of legal fees incurred for enforcement, protection and patent filings and prosecution.

lump sums depending on the due dates of patent filings and their associated fees and the arrangements we may make with our legal advisors in connection with enforcement proceedings, which may include fee arrangements or contingent fee arrangements in which we would pay these legal advisors on a scaled percentage of any negotiated fees, settlements or judgments awarded to us based on if, how and when the fees, settlements or judgments are obtained.

See Note 7 “Commitments and Contingencies” of the Notes to Consolidated Financial Statements in Item 8 of this Form 10-K for further discussion.

Intellectual property legal fees increased during 2021 compared to 2020 due primarily to higher legal expenses incurred to seek 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 slightly increased in 2020 compared to 2019 due primarily to an increase in sales and marketing payroll costs and related overhead and commissions and outside services, partially offset by a decrease in travel expenses.

Other Expense, Net

Selling, general and administrative expenses increased in 2021 compared to 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 transitioned to becoming a “large accelerated filer” as of January 1, 2022 which means that we need to file our quarterly and annual reports on an accelerated basis and that we 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 require us to invest a material amount in enhancing our financial reporting infrastructure that will cause our selling, general and administrative expenses to increase in future periods.

Other Income (Expense), Net

Other expense, net for 2021 and 2020 was as follows (dollars in thousands):

Interest expense, net

Other income (expense), net

Total other expense, net

Other 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, a revolving line of credit under the SVB Credit Agreement, and an unsecured convertible note with an original principal amount of $2.3 million issued to Iliad Research and Trading, L.P.

in August 2018 (“Iliad Note”), along with the accretion of debt discounts and amortization of debt issuance costs on the SVIC Note and Iliad Note.

The Iliad Note was fully converted to shares of our common stock during 2019 and there was no outstanding balance as of December 28, 2019.

As a result, during 2020 compared to 2019, the interest expense decreased.

Other income increased during 2020 as a result of a foreign exchange gain recognized upon the receipt of withholding tax refund from the Korean tax authority.

(“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.

In December 2021, we repaid the full amounts outstanding under the SVIC Note.

During 2021, other income (expense), 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 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.

Due primarily to this withholding tax, our effective tax rate for 2021 was higher at 58% than the statutory federal income tax rate of 21%.

For 2020, our effective tax rate was 0% with the statutory tax rate of 21% due primarily to our net loss and valuation allowances.

Liquidity and Capital Resources

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

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 table presents selected financial information as of and for the years ended January 2, 2021 and December 28, 2019 (in thousands):

Cash and cash equivalents

Convertible promissory note and accrued interest, net

Total PPP Loan and accrued interest

Working capital

Net cash used in operating activities

Net cash used in investing activities

Net cash provided by financing activities

Cash Flows from Operating Activities

Net cash used in operating activities for 2020 was primarily a result of a net loss of $7.3 million, adjusted for non-cash charges of $2.1 million, which primarily consisted of stock-based compensation, non-cash lease expense, interest accrued on our convertible note and amortization of debt discounts.

These non-cash activities are offset by net cash outflows from changes in working capital balances of $2.9 million driven predominantly by a decrease in accounts payable due to lower legal expenses incurred to defend our patent portfolio internationally and a current year reversal of legal fees due to certain law firms on the settlement of all liabilities owing to them and prepaid expenses and other assets due to the settlement of refundable withholding tax from the Korean tax authority, partially offset by an increase in accounts receivable due to higher sales.

Net cash used in operating activities for 2019 was primarily a result of a net loss of $12.5 million, adjusted for non-cash charges of $2.6 million, which primarily consisted of stock-based compensation, non-cash lease expense, amortization of debt discounts and interest accrued on our convertible notes.

These non-cash activities are offset by net cash outflows from changes in working capital balances of $1.8 million driven predominantly by a $0.8 million increase in accounts receivable due to higher sales in the fourth quarter of 2019, a $0.6 million increase in inventories due to higher purchases to support increased sales, and a $0.6 million decrease in accrued expenses and other liabilities primarily from the decrease in operating lease liabilities, partially offset by a decrease of $0.5 million in prepaid expenses and other assets.

Cash Flows from Financing Activities

We believe our existing balance of cash and cash equivalents, which totaled $58.5 million as of January 1, 2022, along with cash receipts from revenues, borrowing availability under the SVB Credit Agreement, the equity financing available under the Second 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.

For a description of contractual obligations, see Note 4, “Debt” and Note 5, “Leases” of the Notes to Consolidated Financial Statements in Part II, Item 8 of this Form 10-K.

Cash Flow Summary

Our cash flows from operating, investing and financing activities, as reflected in the consolidated statements of cash flows, are summarized as follows (in thousands):

Net cash provided by (used in):

Operating activities

Investing activities

Financing activities

Net change in cash, cash equivalents and restricted cash

Net cash provided by operating activities for 2021 was primarily a result of net income of $4.8 million, non-cash adjustments to net income of $2.0 million, offset by net cash outflows from changes in operating assets and liabilities of $1.0 million driven predominantly by an increase in accounts payable, partially offset by an increase in accounts receivable and inventories.

Net cash provided by financing activities for 2021 primarily consisted of $39.6 million in net proceeds from issuance of common stock under the 2019, 2020 and First and Second 2021 Lincoln Park Purchase Agreements, $11.8 million in proceeds from exercise of stock options and warrants and $3.3 million in net borrowings under the SVB Credit Agreement, partially offset by $17.1 million in repayment of SVIC Note and other debt and $1.1 million in payments for taxes related to net share settlement of equity awards.

Net cash used in operating activities for 2020 was primarily a result of a net loss of $7.3 million, adjusted for non-cash charges of $2.1 million, offset by net cash outflows from changes in working capital balances of $2.9 million driven predominantly by a decrease in accounts payable, partially offset by an increase in accounts receivable.

Net cash provided by financing activities for 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 $0.7 million in net borrowings under the SVB Credit Agreement, partially offset by $0.4 million in payments of note payable to finance insurance policies.

Net cash provided by financing activities for 2019 primarily consisted of $6.4 million in proceeds from issuance of common stock to Lincoln Park under the 2019 Lincoln Park Purchase Agreement and $0.7 million in net borrowings under the SVB Credit Agreement, partially offset by $0.4 million in payment of note payable to finance insurance policies.

Capital Resources

2019 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 January 2, 2021, an aggregate of $3.6 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.

TRGP Agreemen t

On May 3, 2017, we entered into the TRGP Agreement, which generally provided that TRGP directly fund the costs incurred by us or on our behalf in connection with our first ITC action and our U.S.

district court proceedings against SK hynix.

On January 23, 2020, we entered into an amendment to the TRGP Agreement to alter the recovery sharing formula related to claims against SK hynix.

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.

As of January 1, 2022, $64.1 million remains available under the Second 2021 Purchase Agreement with Lincoln Park.

SVB Credit Agreement

On October 31, 2009, we entered into an SVB Credit Agreement, which provides for a revolving line of credit of up to $5.0 million.

On October 31, 2009, we entered into the SVB Credit Agreement, which provides for a revolving line of credit of up to $5.0 million.

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 January 2, 2021, the borrowings under the SVB Credit Agreement bear interest at the Wall Street Journal “prime rate” plus 2.75% per annum and mature on April 30, 2021.

As of January 2, 2021, the outstanding borrowings under the SVB Credit Agreement were $3.7 million with additional borrowing availability of $0.1 million.

During 2020, we made net borrowings of $0.7 million under the SVB Credit Agreement.

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 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.

Our capital requirements will depend on many factors, including, among others:

the acceptance of, and demand for, our products;

our levels of net product sales and any other revenues we may receive, including NRE, license, royalty or other fees;

the extent and timing of any investments in developing, marketing and launching new or enhanced products or technologies;

the costs of developing, improving and maintaining our internal design, testing and manufacturing processes;

the costs associated with defending and enforcing our intellectual property rights;

and the nature and timing of acquisitions and other strategic transactions in which we participate, if any.

However, the SVIC Note will mature at the end of December 2021, and if it is not converted into equity, we may not have adequate liquidity to repay the obligations thereunder unless we raise additional capital or enter into an amendment to the SVIC Note.

While we believe that we will be able to raise such funds or obtain an amendment to the SVIC Note, there can be no assurance that this will occur.

Although we expect to rely in the near term on our existing cash and cash equivalents balance and our primary source of cash described above, our estimates of our operating revenues and expenses and working capital requirements could be incorrect, and we may use our cash resources faster than we anticipate.

Further, some or all of our ongoing or planned investments may not be successful and could result in further losses.

Until we can generate sufficient revenues to finance our cash requirements from our operations, which we may never do, we may need to increase our liquidity and capital resources by one or more measures, which may include, among others, reducing operating expenses, restructuring our balance sheet by negotiating with creditors and vendors, entering into strategic partnerships or alliances, raising additional financing through the issuance of debt, equity or convertible securities or pursuing alternative sources of capital, such as through asset or technology sales or licenses or other alternative financing arrangements.

We may not be able to obtain capital when needed, on terms acceptable to us or at all and may have the need to seek the authorization of additional shares from our stockholders, which could be costly, time-consuming and unsuccessful.

Inadequate working capital would have a material adverse effect on our business and operations and could cause us to fail to execute our business plan, fail to take advantage of future opportunities or fail to respond to competitive pressures or customer requirements.

A lack of sufficient funding may also require us to significantly modify our business model and/or reduce or cease our operations, which could include implementing cost-cutting measures or delaying, scaling back or eliminating some or all of our ongoing and planned investments in corporate infrastructure, research and development projects, business development initiatives and sales and marketing activities, among other activities.

Modification of our business model and operations could result in an impairment of assets, the effects of which cannot be determined.

Furthermore, if we continue to issue equity or convertible debt securities to raise additional funds, our existing stockholders may experience significant dilution, and the new equity or debt securities may have rights, preferences and privileges that are superior to those of our existing stockholders.

If we incur additional debt, it may increase our leverage relative to our earnings or to our equity capitalization or have other material consequences.

If we pursue asset or technology sales or licenses or other alternative financing arrangements to obtain additional capital, our operational capacity may be limited and any revenue streams or business plans that are dependent on the sold or licensed assets may be reduced or eliminated.

Moreover, we may incur substantial costs in pursuing any future capital-raising transactions, including investment banking, legal and accounting fees, printing and distribution expenses and other similar costs, which would reduce the benefit of the capital received from the transaction.

Off-Balance Sheet Arrangements.

We do not have any off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditure or capital resources that is material to investors.

Critical Accounting Policies

The preparation of our consolidated financial statements in conformity with accounting principles generally accepted in the United States requires management to make judgments, assumptions and estimates that affect the amounts reported.

Note 2 “Summary of Significant Accounting Policies” of the notes to consolidated financial statements in Item 8 of this Form 10-K describes the significant accounting policies and methods used in the preparation of our consolidated financial statements.

We base our estimates and assumptions on our historical experience, knowledge of current conditions and our beliefs of what could occur in the future considering available information.

We review our estimates and assumptions on an ongoing basis.

Actual results may differ from these estimates, which may result in material adverse effects on our consolidated operating results and financial position.

Allowance for Doubtful Accounts

We perform credit evaluations of our customers’ financial condition and limit the amount of credit extended to our customers as deemed necessary, but generally require no collateral.

We evaluate the collectability of accounts receivable based on a combination of factors.

In cases where we are aware of circumstances that may impair a specific customer’s ability to meet its financial obligations subsequent to the original sale, we will record an allowance against amounts due, and thereby reduce the net recognized receivable to the amount we reasonably believe will be collected.

For accounts receivable from our international customers, we purchase comprehensive foreign credit insurance to mitigate risks related to the collectability.

For all other customers, we record allowances for doubtful accounts based primarily on the length of time the receivables are past due based on the terms of the originating transaction, the current business environment, general economic conditions, and our historical experience.

Uncollectible accounts are charged against the allowance for doubtful accounts when all cost-effective commercial means of collection have been exhausted.

Generally, our credit losses have been within expectations and the provisions established.

However, we cannot guarantee that we will continue to experience credit loss rates similar to those experienced in the past.

Our accounts receivable are generally highly concentrated among a small number of customers, and a significant change in the liquidity or financial position of one of these customers could have a material adverse effect on the collectability of our accounts receivable, liquidity and future operating results.

We value inventories at the lower of cost or the net realizable value.

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 In December 2021, after meeting the conditions set forth in the amendment, the amount available for borrowing was increased to $7.0 million and the maturity date was extended to April 29, 2022 upon our request.

As of January 1, 2022, the outstanding borrowings under the SVB Credit Agreement were $7.0 million.

During the year ended January 1, 2022, we made net borrowings of $3.3 million under the SVB Credit Agreement.

Critical Accounting Estimates

The preparation of financial statements and related disclosures in conformity with accounting principles generally accepted in the United States and our discussion and analysis of our financial condition and operating results require our management to make judgments, assumptions and estimates that affect the amounts reported.

Note 1 “Summary of Significant Accounting Policies” of the Notes to Consolidated Financial Statements in Part II, Item 8 of this Form 10-K describes the significant accounting policies and methods used in the preparation of our consolidated financial statements.

Management bases its estimates on historical experience and on various other assumptions it believes to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities.

Sales Return Reserves

Our revenue generating activities include variable consideration which is recorded as a reduction of the transaction price based upon expected amounts at the time revenue for the corresponding product sale is recognized.

Common forms of variable consideration include limited rights of return for up to 30 days, except for sales of excess component inventories, which contain no right-of-return privileges and volume rebates for meeting established sales targets.

Estimates of variable consideration and determination of whether to include estimated amounts in the transaction price are based largely on an assessment of the anticipated performance and all information (historical, current and forecasted) that is reasonably available.

Returns for products sold are estimated using the expected value method and are recorded as a reduction in reported revenues at the time of sale based upon historical product return experience and is adjusted for known trends to arrive at the amount of consideration to which we expect to receive.

Estimated amounts are included in the transaction price to the extent it is probable that a significant reversal of cumulative revenue recognized will not occur when the uncertainty associated with the variable consideration is resolved.

Inventories are valued at the lower of cost or the net realizable value.

Cost is determined on an average cost basis which approximates actual cost on a first-in, first-out basis and includes raw materials, labor and manufacturing overhead.

Net realizable value is the estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation.

On a regular basis, we evaluate inventory balances for excess quantities and obsolescence by analyzing estimated demand, inventory on hand, sales levels and other information and reduce inventory balances to net realizable value for excess and obsolete inventory based on this analysis.

Once established, lower of cost or net realizable value write-downs are considered permanent adjustments to the cost basis of the excess or obsolete inventories.

Impairment of Long-Lived Assets

We evaluate the recoverability of the carrying value of long-lived assets held and used by us in our operations for impairment on at least an annual basis or whenever events or changes in circumstances indicate that their carrying value may not be recoverable.

When such factors and circumstances exist, we compare the projected undiscounted future net cash flows associated with the related asset or group of assets over their estimated useful lives against their respective carrying amount.

These projected future cash flows may vary significantly over time as a result of increased competition, changes in technology, fluctuations in demand, consolidation of our customers and reductions in average sale prices.

If the carrying value is determined not to be recoverable from future operating cash flows, the asset is deemed impaired and an impairment loss is recognized to the extent the carrying value exceeds the estimated fair value of the asset.

The fair value of the asset or asset group is based on market value when available, or when unavailable, on discounted expected cash flows.

Warranty Liability

We offer product warranties generally ranging from one to three years, depending on the product and negotiated terms of any purchase agreements with our customers.

Such warranties require us to repair or replace defective product returned to us during the warranty period at no cost to the customer.

We evaluate inventory balances for excess quantities and obsolescence on a regular basis by analyzing estimated demand, inventory on hand, sales levels and other information and reduce inventory balances to net realizable value for excess and obsolete inventory based on this analysis.

At the point of the write-down recognition, a new, lower cost basis for that inventory is established, and subsequent changes in facts and circumstances do not result in the restoration or increase in that newly established cost basis.

We offer standard product warranties generally ranging from one to three years to our memory subsystem products customers, depending on the negotiated terms of any purchase agreements, and has no other post-shipment obligations or separately priced extended warranty or product maintenance contracts.

These warranties require us to repair or replace defective product returned to us during the warranty period at no cost to the customer.

Warranties are not offered on sales of component products.

We record an estimate for warranty related costs at the time of sale based on our historical and estimated future product return rates and expected repair or replacement costs.

While such costs have historically been within management’s expectations and the provisions established, unexpected changes in failure rates could have a material adverse impact on us, requiring additional warranty reserves, and could adversely affect our gross profit and gross margins.

Estimated future warranty costs are recorded in the period in which the sale is recorded and are included in cost of sales in the consolidated statements of operations.

Stock-Based Compensation

Stock-based awards are comprised principally of stock options, restricted stock awards (“RSAs”) and restricted stock units (“RSUs”).

Stock-based compensation cost is measured at the grant date based on the fair value of the award and is recognized as an expense over the requisite service period, which is the vesting period, on a straight-line basis, net of estimated forfeitures.

Stock-based compensation cost is measured at the grant date based on the fair value of the award

and is recognized as an expense over the requisite service period, which is the vesting period, on a straight-line basis, net of estimated forfeitures.

We use the Black-Scholes option pricing model to determine the grant date fair value of stock options.

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The grant-date fair value of RSAs and RSUs equals the closing price of our common stock on the grant date.

Deferred income tax assets and liabilities are recognized for temporary differences between the financial statement carrying amounts of assets and liabilities and the amounts that are reported in the income tax returns.

Deferred taxes are evaluated for realization on a jurisdictional basis.

We record valuation allowances to reduce deferred tax assets

to the amount that is more likely than not to be realized.

In making this assessment, management analyzes future taxable income, reversing temporary differences and ongoing tax planning strategies.

Should a change in circumstances lead to a change in judgment about the realizability of deferred tax assets in future years, we will adjust related valuation allowances in the period that the change in circumstances occurs, along with a corresponding increase or charge to income.

Uncertain Tax Positions

We recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained upon examination by the taxing authorities based on the technical merits of our position.

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The amount of unrecognized tax benefits is adjusted as appropriate for changes in facts and circumstances, such as significant amendments to existing tax laws, new regulations or interpretations by the taxing authorities, new information obtained during a tax examination, or resolution of an examination.

We recognize both accrued interest and penalties associated with uncertain tax positions as a component of provision for income taxes in the consolidated statements of operations.

The application of tax laws and regulations is subject to legal and factual interpretation, judgment and uncertainty.

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or foreign taxes may be materially different from our estimates, which could require us to record additional tax liabilities or to reduce previously recorded tax liabilities, as applicable.

Recent Accounting Pronouncements

Recent Accounting Standards

See Note 1 “Summary of Significant Accounting Policies” of the Notes to Consolidated Financial Statements in Item 8 of this Form 10-K for further discussion.

Quantitative and Qualitative Disclosures About Market Risk

Not applicable.

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-K

Item 7. Management’s Discussion and Analysis