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Item 2. Management’s Discussion and Analysis

2022-08-04 compared with 2022-05-09 · 60 added, 51 removed, 109 unchanged (50% of the section changed)

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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.

During the first quarter of 2022, we recorded net sales of $50.2 million, gross margin of $3.4 million and net loss of $5.9 million.

During the second quarter of 2022, we recorded net sales of $55.4 million, gross profit of $4.7 million and net loss of $5.0 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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Recent Developments

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”).

SK hynix Agreements

On April 5, 2021, we entered into a Strategic Product Supply and License Agreement (the “Strategic Agreement”) and Product Purchase and Supply Agreement (“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 its 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.

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

In addition, the Strategic Agreement provided for the settlement of all intellectual property proceedings between us and SK hynix and a 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 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.

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

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

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

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

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

On April 29, 2022, we entered into an amendment to the SVB Credit Agreement to accrue interest on advance at a per annum rate equal to the greater of 0.75% above the Prime Rate or 4.25%.

The borrowing base is limited to 85% of eligible accounts receivable, subject to certain adjustments, and 50% of eligible inventory.

The maximum amount available for borrowing was increased to $10.0 million and the maturity date to April 28, 2023.

As of April 2, 2022, the outstanding borrowings under the SVB Credit Agreement were $4.7 million with additional borrowing availability of $0.1 million.

During the three months ended April 2, 2022, we made net payments of $2.3 million under the SVB Credit Agreement.

The maximum amount available for borrowing was increased to $10.0 million and the maturity date was extended to April 28, 2023.

As of July 2, 2022, the outstanding borrowings under the SVB Credit Agreement were $8.0 million with additional borrowing availability of $2.0 million.

During the six months ended July 2, 2022, we made net borrowings of $1.0 million under the SVB Credit Agreement.

September 2021 Lincoln Park Purchase Agreement

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Lincoln Park an aggregate of 20,809 shares of our common stock as additional commitment shares in noncash transactions.

During the first quarter of 2022, Lincoln Park purchased an aggregate of 300,000 shares of our common stock for a net purchase price of $1.8 million under the Second 2021 Purchase Agreement.

During the six months ended July 2, 2022, Lincoln Park purchased an aggregate of 650,000 shares of our common stock for a net purchase price of $3.7 million under the Second 2021 Purchase Agreement.

In connection with the purchases, we issued to Lincoln Park an aggregate of 7,168 shares of our common stock as additional commitment shares in noncash transactions.

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Results of Operations

Net Sales and Gross Margin

Net sales and gross margin for the three months ended April 2, 2022, and April 3, 2021 were as follows (dollars in thousands):

Net Sales and Gross Profit

Net sales and gross profit for the three and six months ended July 2, 2022, and July 3, 2021 were as follows (dollars in thousands):

Three Months Ended

Cost of sales

Net sales include resales of component products including DIMMs, SSDs, and dynamic random access memory (“DRAM ICS” OR DRAM) products, and sales of our high-performance memory subsystems.

Net product sales increased by approximately $35.3 million during the first quarter of 2022 compared to the same quarter of 2021, primarily as a result of a $35.2 million increase in re-sale of SK Hynix products and a $1.1 million increase in sale of Netlist’s flash and SSD products, offset by a $1.0 million decrease in sales of low profile memory subsystem products.

Product gross profit increased during the first quarter of 2022 compared to the same periods of 2021 due primarily to higher sales across all product groups.

Six Months Ended

Net product sales

Gross profit - product sales

Gross margin percentage - product sales

Gross margin percentage

Net sales include (i) resales of component products including DIMMs, SSDs, and dynamic random-access memory (“DRAM ICS” OR DRAM) products, and sales of our high-performance memory subsystems and (ii) an upfront non-refundable fee pursuant to the Strategic Agreement with SK hynix entered into on April 5, 2021.

Net product sales increased by approximately $31.0 million during the second quarter of 2022 compared to the same quarter of 2021, primarily as a result of a $36.3 million increase in re-sale of SK hynix products and a $2.1 million increase in sale of Netlist’s flash and SSD products, offset by a $7.5 million decrease in sales of low-profile memory subsystem products.

Net product sales increased by approximately $66.3 million during the first six months of 2022 compared to the same period in 2021, primarily as a result of a $71.5 million increase in re-sale of SK hynix products and a $3.2 million increase in sale of Netlist’s flash and SSD products, offset by a $8.5 million decrease in sales of low-profile memory subsystem products.

Gross Profit and Gross Margin

Product gross profit increased during the second quarter and first six months of 2022 compared to the same periods of 2021 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 and increased component product resales as a percentage of revenue.

Operating Expenses

Operating expenses for the three months ended April 2, 2022, and April 3, 2021, were as follows (dollars in thousands):

Operating expenses for the three and six months ended July 2, 2022, and July 3, 2021, were as follows (dollars in thousands):

Three Months Ended

Six Months Ended

Research and development

Percentage of net sales

Percentage of net product sales

Intellectual property legal fees

Percentage of net sales

Percentage of net product sales

Selling, general and administrative

Percentage of net sales

Percentage of net product sales

Research and Development

Research and development expenses increased during the first quarter 2022 compared to the same period of 2021 due primarily to an increase in employee headcount, related overhead and new product research.

Research and development expenses increased during the second quarter and first six months of 2022 compared to the same periods of 2021 due primarily to an increase in employee headcount, related overhead and new product research.

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 first quarter 2022 compared to the same period of 2021 primarily due to our continued efforts to defend and enforce our patent portfolio.

The decrease in intellectual property legal fees during the second quarter of 2022 compared to the same quarter of 2021 resulted primarily due to lower legal expenses incurred to defend our patent portfolio internationally.

During the first six months of 2022, intellectual property legal fees were consistent compared with the same period of 2021.

Selling, General and Administrative

Selling, general and administrative expenses increased during the first quarter of 2022 compared to the same period of 2021 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 are a “large accelerated filer” as of the end of fiscal year ended January 2, 2022 which means that we need to file our quarterly and annual reports on an accelerated basis and that we are required to have our independent registered public accounting firm audit and attest to our internal control over financial reporting.

Selling, general and administrative expenses increased during the second quarter and first six months of 2022 compared to the same periods of 2021 due primarily to an increase in employee headcount and overhead and outside services.

and annual reports on an accelerated basis and that we are required to have our independent registered public accounting firm audit and attest to our internal control over financial reporting.

Complying with these requirements requires 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 Expense, Net

Other expense, net for the three months ended April 2, 2022, and April 3, 2021 was as follows (dollars in thousands):

Other Income (Expense), Net

Other income (expense), net for the three and six months ended July 2, 2022, and July 3, 2021 was as follows (dollars in thousands):

Three Months Ended

Interest expense, net

Other expense, net

Total other expense, net

Six Months Ended

Interest income (expense), net

Other (expense) income, net

Total other (expense) income, net

Interest expense, net, in 2021 consisted primarily of interest expense on the $15 million secured convertible note issued to SVIC 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.

The SVIC note was paid off in the fourth quarter of 2021 resulting in a decrease in interest expense for the first quarter of 2022.

During the first quarter of 2022, other expense was consistent compared with the same quarter of 2021.

The SVIC note was paid off in the fourth quarter of 2021 resulting in a decrease in interest expense for the second quarter and first six months of 2022.

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

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 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.

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 Strategic 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 April 2, 2022, and January 1, 2022 and for the first three months of 2022 and 2021 (in thousands):

The following tables present selected financial information as of July 2, 2022, and January 1, 2022 and for the first six months of 2022 and 2021 (in thousands):

Cash, cash equivalents and restricted cash

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Working capital

Three Months Ended

Six Months Ended

Net cash provided by (used in) operating activities

Net cash used in investing activities

Net cash (used in) provided by financing activities

During the three months ended April 2, 2022, net cash provided by operating activities was primarily a result of net loss of $5.9 million, non-cash adjustments to net loss of $0.9 million, and net cash inflows from changes in operating assets and liabilities of $6.2 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, and a decrease in accounts receivable.

Net cash used in financing activities during the three months ended April 2, 2022 primarily consisted of $1.8 million in net proceeds from issuance of common stock under the Second 2021 Lincoln Park Purchase Agreements, $0.1 million in proceeds from exercise of stock options, offset by $2.3 million in net repayments under the SVB Credit Agreement and $0.6 million in payments for taxes related to net share settlement of equity awards.

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

to support increased sales, partially offset by an increase in accounts payable.

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

Net cash provided by financing activities

During the six months ended July 2, 2022, net cash used in operating activities was primarily a result of net loss of $10.8 million, non-cash adjustments to net loss of $1.9 million, and net cash inflows from changes in operating assets and liabilities of $7.4 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, and a decrease in accounts receivable, partially offset by an increase in inventories.

Net cash provided by financing activities during the six months ended July 2, 2022 primarily consisted of $1.0 million in net borrowings under the SVB Credit Agreement, $3.7 million in net

proceeds from issuance of common stock under the Second 2021 Lincoln Park Purchase Agreement, $0.2 million in proceeds from exercise of stock options, offset by $0.4 million in payments of note payable to finance insurance policies and $0.7 million in payments for taxes related to net share settlement of equity awards.

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.

Capital Resources

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On September 28, 2021, we entered into the September 2021 Purchase Agreement with Lincoln Park, pursuant to which we have the right to sell to Lincoln Park up to an aggregate of $75.0 million in shares of our common stock over the 36-month term of the September 2021 Purchase Agreement subject to the conditions and limitations set forth in the Second 2021 Purchase Agreement.

As of April 2, 2022, $62.4 million remains available under the September 2021 Purchase Agreement with Lincoln Park.

As of July 2, 2022, $60.4 million remains available under the September 2021 Purchase Agreement with Lincoln Park.

SVB Credit Agreement

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.

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

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

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.

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