Item 2. Management’s Discussion and Analysis
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Note Regarding Forward-Looking Statements
This Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) and other parts of this report include “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements are statements other than historical facts and often address future events or our future performance. Words such as “anticipate,” “estimate,” “expect,” “project,” “intend,” “may,” “will,” “might,” “plan,” “predict,” “believe,” “should,” “could” and similar words or expressions are intended to identify forward-looking statements, although not all forward-looking statements contain these identifying words.
Forward-looking statements contained in this MD&A include statements about, among other things:
● our beliefs regarding the market and demand for our products or the component products we resell;
● our ability to collect the damages awarded to us by jury verdict in our trial with Samsung;
● our ability to develop and launch new products that are attractive to the market and stimulate customer demand for these products;
● our plans relating to our intellectual property, including our goals of monetizing, licensing, expanding and defending our patent portfolio;
● our expectations and strategies regarding outstanding legal proceedings and patent reexaminations relating to our intellectual property portfolio;
● specific and overall impacts of the coronavirus disease (“COVID-19”) pandemic on our financial condition and results of operations;
● our expectations with respect to any strategic partnerships or other similar relationships we may pursue;
● the competitive landscape of our industry;
● general market, economic and political conditions;
● our business strategies and objectives;
● 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, maintain effective internal control over financial reporting; and
● the impact of the above factors and other future events on the market price and trading volume of our common stock.
All forward-looking statements reflect management’s present assumptions, expectations and beliefs regarding future events and are subject to known and unknown risks, uncertainties and other factors that could cause actual results to differ materially from those expressed in or implied by any forward-looking statements. These risks and uncertainties include those described under “Risk Factors” in Part II, Item 1A of this report. In light of these risks and uncertainties, our forward-looking statements should not be relied on as predictions of future events. Additionally, many of these risks and uncertainties are currently elevated by and may or will continue to be elevated by and may or will continue to be elevated by the COVID-19 pandemic. All forward-looking statements reflect our assumptions, expectations and beliefs only as of the date they are made, and except as required by law, we undertake no obligation to revise or update any forward-looking statements for any reason.
The following MD&A should be read in conjunction with our condensed consolidated financial statements and the related notes included in Part I, Item 1 of this report, as well as our Annual Report on Form 10-K for our fiscal year ended December 31, 2022 filed with the SEC. 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. Each of the terms the “Company,” “Netlist,” “we,” “us,” or “our” as used herein refers collectively to Netlist, Inc. and its consolidated subsidiaries, unless otherwise stated.
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Overview
Netlist provides high-performance memory solutions to enterprise customers in diverse industries. Our products in various capacities and form factors and our line of custom and specialty memory products bring leading performance to customers in a variety of industries globally and cloud service providers. Netlist licenses its portfolio of intellectual property, including solutions relating to improvements for volatile memory, non-volatile memory, computer storage, hybrid memory, and related subsystems.
During the first quarter of 2023, we recorded net sales of $9.0 million, gross profit of $0.6 million and net loss of $15.8 million. We have historically financed our operations primarily with proceeds from issuances of equity and debt securities and cash receipts from revenues. We have also funded our operations with a revolving line of credit and term loans under a bank credit facility. See “Recent Developments” and “Liquidity and Capital Resources” below for more information.
Recent Developments
Damages Award Against Samsung
On April 21, 2023, we won a $303 million damages award against Samsung Electronics Co., Ltd., Samsung Semiconductor, Inc., and Samsung Electronics America, Inc. (together “Samsung”) in the United States District Court for the Eastern District of Texas. The award resulted from a jury trial that lasted six days, and involved five Netlist patents: U.S. Patent Nos. 10,949,339, 11,016,918, 11,232,054, 8,787,060, and 9,318,160. The products found to infringe these patents were Samsung DDR4 LRDIMMs, DDR5 UDIMMs, DDR5 SODIMMs, and DDR5 RDIMMs, and HBM 2, 2E, and 3 components. As of the reporting date, post-trial proceedings are being adjudicated and a Judgement has not yet been entered. Upon entry of a Judgment, an appeal may be filed before the U.S. Court of Appeals for the Federal Circuit. Should any party file an appeal, that could cause a lengthy delay in our ability to collect a damages award from Samsung, lead to a reduction of the damages award, or lead to a remand or reversal of the jury’s verdict.
Termination of 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 $10.0 million, as amended. The SVB Credit Agreement was most recently amended on April 29, 2022 to add 50% of eligible inventory to the previous borrowing base limited to 85% of eligible accounts receivable, subject to certain adjustments. Borrowings accrued interest on advance at a per annum rate equal to the greater of 0.75% above the Prime Rate or 4.25%. The maturity date was April 28, 2023, as amended.
On April 28, 2023, the SVB Credit Agreement terminated in accordance with its terms. In connection with the termination of the SVB Credit Agreement, on April 28, 2023, all outstanding obligations for principal, interest, and fees under the SVB Credit Agreement were paid in full and all liens securing such obligations were released.
September 2021 Lincoln Park Purchase Agreement
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 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 September 2021 Purchase Agreement.
During the three months ended April 1, 2023, Lincoln Park purchased an aggregate of 4,900,000 shares of our common stock for a net purchase price of $10.5 million under the September 2021 Purchase Agreement. In connection with the purchases, we issued to Lincoln Park an aggregate of 20,209 shares of our common stock as additional commitment shares in noncash transactions.
Subsequently, from April 2, 2023 through May 4, 2023, Lincoln Park purchased an aggregate of 1,950,000 shares of our common stock for a net purchase price of $9.2 million under the September 2021 Purchase Agreement. In
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connection with the purchase, we issued to Lincoln Park an aggregate of 17,562 shares of our common stock as additional commitment shares in noncash transactions.
Economic Conditions, Challenges and Risks
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 of certain risks that we face under “Risk Factors” in Part II, Item 1A of this report.
In recent periods, there has been a significant increase in worldwide supply of semiconductor memory and storage that has led to declines in demand and average selling prices for our products, which could materially and adversely affect our business, results of operations, or financial condition. Our suppliers generally seek to increase wafer output, improve yields, and reduce die size, which could result in further increases in worldwide supply and downward pressure on prices.
The continuing impact of the COVID-19 pandemic will have on our consolidated results of operations is uncertain. 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.
Results of Operations
Net Sales and Gross Profit
Net sales and gross profit for the three months ended April 1, 2023, and April 2, 2022 were as follows (dollars in thousands):
Three Months Ended
April 1,
April 2,
%
2023
2022
Change
Change
Net sales
9,021
50,200
(41,179)
(82%)
Cost of sales
8,461
46,837
(38,376)
(82%)
Gross profit
$
560
$
3,363
(2,803)
(83%)
Gross margin percentage
6%
7%
(0.5%)
Net Sales
Net sales include resales of certain components, modules, and other products, which include dual in-line memory module (“DIMMs”) and solid-state drives (“SSDs”). Net sales also include sales of Netlist’s own products.
Net sales decreased by approximately $41.2 million during the first quarter of 2023 compared to the same period of 2022, primarily as a result of a $29.9 million decrease in the sale of registered DIMM (“RDIMM”) and discrete memory component products, a $1.8 million decrease in sale of Netlist’s flash and SSD products, and a $9.5 million decrease in sales of low-profile memory subsystem products.
Gross Profit and Gross Margin
Product gross profit and product gross margin percentage decreased during the first quarter of 2023 compared to the same period of 2022, primarily as a result of lower sales across all product group and softer pricing environment.
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Operating Expenses
Operating expenses for the three months ended April 1, 2023, and April 2, 2022, were as follows (dollars in thousands):
Three Months Ended
April 1,
April 2,
%
2023
2022
Change
Change
Research and development
$
2,301
$
2,457
$
(156)
(6%)
Percentage of net sales
26%
5%
Intellectual property legal fees
$
11,070
$
2,826
8,244
292%
Percentage of net sales
123%
6%
Selling, general and administrative
$
3,030
$
3,938
(908)
(23%)
Percentage of net sales
34%
8%
Research and Development
Research and development expenses decreased during the first quarter of 2023 compared to the same period of 2022 due primarily to a decrease in employee headcount and related overhead.
Intellectual Property Legal Fees
Intellectual property legal fees consist of fees incurred for, patent drafting and prosecution, opposition to third-party post-grant patent proceedings, and patent enforcement and licensing. Although we expect intellectual property legal fees to generally increase over time as we continue to expand, protect and enforce our patent portfolio, these increases may not be linear but may occur in lump sums depending on the due dates of 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 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 of 2023 compared to the same period of 2022 due primarily to higher legal expenses incurred to protect and enforce our patent portfolio.
Selling, General and Administrative
Selling, general and administrative expenses decreased during the first quarter of 2023 compared to the same period of 2022 due primarily to a decrease in employee headcount and overhead and outside services.
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Other Income (Expense), Net
Other income (expense), net for the three months ended April 1, 2023, and April 2, 2022 was as follows (dollars in thousands):
Three Months Ended
April 1,
April 2,
%
2023
2022
Change
Change
Interest income (expense), net
$
56
$
(11)
$
67
Other expense, net
(3)
(2)
(1)
Total other income (expense), net
$
53
$
(13)
$
66
508%
Interest income, net increased during the first quarter of 2023 compared to the same period of 2022, primarily as a result of a higher interest rate earned on cash balances. During the first quarter of 2023, other expense was consistent compared with the same period of 2022.
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 our entry into a Strategic Product Supply and License Agreement with SK hynix, Inc., a South Korean memory semiconductor supplier (“SK hynix”), on April 5, 2021 (the “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. We are currently seeking to obtain a new bank credit facility to replace the terminated facility we had with SVB.
The following tables present selected financial information as of April 1, 2023, and December 31, 2022 and for the first three months of 2023 and 2022 (in thousands):
April 1,
December 31,
2023
2022
Cash, cash equivalents and restricted cash
$
36,570
$
43,611
Long-term debt due within one year
301
447
Working capital
21,950
25,774
Three Months Ended
April 1,
April 2,
2023
2022
Net cash provided by (used in) operating activities
$
(12,714)
$
1,217
Net cash used in investing activities
-
(221)
Net cash provided by (used in) financing activities
5,673
(1,145)
During the three months ended April 1, 2023, net cash used in operating activities was primarily a result of net loss of $15.8 million, non-cash adjustments to net loss of $1.3 million, and net cash inflows from changes in operating assets and liabilities of $1.7 million driven predominantly by a decrease in accounts receivable and inventories, partially offset by a decrease in accounts payable due to lower inventory purchases. Net cash provided by financing activities during the three months ended April 1, 2023 primarily consisted of $10.5 million in net proceeds from issuance of common stock under the September 2021 Purchase Agreement, $0.3 million in proceeds from exercise of stock options, offset by $4.9 million in net repayments under the SVB Credit Agreement and $0.1 million in payments of note payable to finance insurance policies.
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
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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 September 2021 Purchase Agreement, $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.
Capital Resources
September 2021 Lincoln Park Purchase Agreement
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 September 2021 Purchase Agreement. As of April 1, 2023, $49.2 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 provided for a revolving line of credit of up to $10.0 million, as amended. The SVB Credit Agreement was most recently amended on April 29, 2022 to add 50% of eligible inventory to the previous borrowing base limited to 85% of eligible accounts receivable, subject to certain adjustments. Borrowings accrued interest on advance at a per annum rate equal to the greater of 0.75% above the Prime Rate or 4.25%. The maturity date was April 28, 2023, as amended.
On April 28, 2023, the SVB Credit Agreement terminated in accordance with its terms. In connection with the termination of the SVB Credit Agreement, on April 28, 2023, all outstanding obligations for principal, interest, and fees under the SVB Credit Agreement were paid off in full and all liens securing such obligations were released.
Sufficiency of Cash Balances and Potential Sources of Additional Capital
We believe our existing balance of cash and cash equivalents together with cash receipts from revenues, the equity financing available under September 2021 Purchase Agreement, funds raised through other future debt and equity offerings and taking into account cash expected to be used in our operations, will be sufficient to meet our anticipated cash needs for at least the next 12 months.
Off-Balance Sheet Arrangements
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 and Use of Estimates
The preparation of our condensed consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the condensed consolidated financial statements, and the reported amounts of net sales and expenses during the reporting period. By their nature, these estimates and assumptions are subject to an inherent degree of uncertainty. 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 our estimates, which may result in material adverse effects on our consolidated operating results and financial position.
Our critical accounting policies and estimates are discussed in Note 2 to the condensed consolidated financial statements in this report and in the notes to consolidated financial statements in Part II, Item 8 of our 2022 Annual
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Report and in the MD&A in our 2022 Annual Report. There have been no significant changes to our critical accounting policies since our 2022 Annual Report.
Text extracted from the filing as submitted to EDGAR. Formatting, tables and exhibits are simplified for reading; the original document is authoritative for anything you rely on.