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 any damages awarded to us under Final Judgment against 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;
● 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. 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 filed with the Securities and Exchange Commission (the “SEC”) on February 28, 2023 (the “ 2022 Annual Report”). 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 also licenses its intellectual property.
During the third quarter of 2023, we recorded net sales of $16.7 million, gross profit of $0.4 million and net loss of $17.3 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
2023 SVB Credit Agreement
On November 7, 2023, we entered into a loan and security agreement (the “2023 SVB Credit Agreement”) with Silicon Valley Bank, a division of First-Citizen Bank & Trust Company, which provides for a revolving line of credit up to $10.0 million. The borrowing base is limited to 85% of eligible accounts receivable, subject to certain adjustments. Borrowings accrue interest on advance at a per annum rate equal to the greater of 8.50% and the Wall Street Journal prime rate (“Prime Rate”). The maturity date is November 7, 2025.
The 2023 SVB Credit Agreement requires letters of credit to be secured by cash, which is classified as restricted cash in the accompanying condensed consolidated balance sheets. As of November 9, 2023, outstanding borrowings were $0, and availability under the revolving line of credit was $10.0 million.
The 2023 SVB Credit Agreement subjects the Company to certain affirmative and negative covenants, including financial covenants with respect to the Company’s liquidity and restrictions on the payment of dividends. As of November 9, 2023, the Company was in compliance with its covenants under the 2023 SVB Credit Agreement.
2023 Offering
On August 14, 2023, we entered into a Securities Purchase Agreement with certain investors, pursuant to which we agreed to issue and sell to the investors in a registered offering (the “2023 Offering”) an aggregate of 11,111,112 shares of our common stock and warrants to purchase up to an aggregate of 11,111,112 shares of our common stock at a per share purchase price of $2.70 per share. The 2023 Offering closed on August 17, 2023. The net proceeds to us from the 2023 Offering were approximately $28.6 million, after deducting placement agent fees and offering costs paid by us. The warrants are exercisable at any time on or after the issuance date, have a term of five years from the issuance date, and have an exercise price of $3.20 per share and contain customary 4.99%/9.99% blocker provisions.
On August 14, 2023 and in connection with the 2023 Offering, we entered into a Placement Agency Agreement (the “Placement Agreement”) with Roth Capital Partners, LLC (“Roth”), pursuant to which Roth agreed to act as the Company’s placement agent in connection with the 2023 Offering. Pursuant to the terms of the Placement Agreement, in consideration for its placement agent services, we agreed to pay Roth a cash fee in an amount equal to 4% of the aggregate gross proceeds received by us in connection with the closing of the 2023 Offering.
In addition, pursuant to the 2023 Purchase Agreement, the Company and its director and executive officers entered into the Lock-Up Agreements, pursuant to which they agreed not to offer for sale, contract to sell, or sell any shares of the Company’s common stock or any securities convertible into, or exercisable or exchangeable for, shares of the Company’s common stock, for a period of 90 days from the closing of the 2023 Offering, subject to certain customary exceptions.
The 2023 Purchase Agreement also provides that the Company may not effect or enter into any Variable Rate Transactions (as defined in the 2023 Purchase Agreement) until the six month anniversary of the closing date of the 2023
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Offering. Sales of the Company’s common stock pursuant to the September 2021 Purchase Agreement are permitted after 90 days following the closing of the 2023 Offering.
Final Judgment Against Samsung
On August 11, 2023, a final judgment was entered in the United States District Court for the Eastern District of Texas, which upheld the jury trial verdict on April 21, 2023 that awarded Netlist $303 million in damages against Samsung Electronics Co., Ltd., Samsung Semiconductor Inc., and Samsung Electronics America Inc. (collectively, “Samsung”) for their willful infringement of 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 HBM2, HBM2E, and HBM3 components. 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.
September 2021 Lincoln Park Purchase Agreement
On September 28, 2021, we entered into a purchase agreement (the “September 2021 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 $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 nine months ended September 30, 2023, Lincoln Park purchased an aggregate of 7,865,000 shares of our common stock for a net purchase price of $23.4 million under the September 2021 Purchase Agreement. In connection with the purchases, we issued to Lincoln Park an aggregate of 44,939 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.
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Results of Operations
Net Sales and Gross Profit
Net sales and gross profit for the three and nine months ended September 30, 2023 and October 1, 2022 were as follows (dollars in thousands):
Three Months Ended
Nine Months Ended
September 30,
October 1,
%
September 30,
October 1,
%
2023
2022
Change
Change
2023
2022
Change
Change
Net sales
$
16,725
$
34,424
$
(17,699)
(51%)
$
35,772
$
139,982
$
(104,210)
(74%)
Cost of sales
16,285
32,244
(15,959)
(49%)
34,533
129,691
(95,158)
(73%)
Gross profit
$
440
$
2,180
$
(1,740)
(80%)
$
1,239
$
10,291
$
(9,052)
(88%)
Gross margin percentage
3%
6%
(3%)
3%
7%
(4%)
Net Sales
Net sales include resales of certain components, modules, and other products, which include dual in-line memory modules (“DIMMs”) and solid-state drives (“SSDs”). Net sales also include sales of Netlist’s own products.
Net sales decreased by approximately $17.7 million during the third quarter of 2023 compared to the same period of 2022, primarily as a result of a $8.7 million decrease in the sale of registered DIMM (“RDIMM”) and discrete memory component products, a $5.5 million decrease in sales of Netlist’s flash and SSD products, and an $3.5 million decrease in sales of low-profile memory subsystem products.
Net sales decreased by approximately $104.2 million during the first nine months of 2023 compared to the same period of 2022, primarily as a result of a $72.1 million decrease in the sale of RDIMM and discrete memory component products, a $11.1 million decrease in sales of Netlist’s flash and SSD products, and a $21.0 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 third quarter and first nine months of 2023 compared to the same periods of 2022, primarily as a result of lower sales across all product groups and a softer pricing environment.
Operating Expenses
Operating expenses for the three and nine months ended September 30, 2023 and October 1, 2022, were as follows (dollars in thousands):
Three Months Ended
Nine Months Ended
September 30,
October 1,
%
September 30,
October 1,
%
2023
2022
Change
Change
2023
2022
Change
Change
Research and development
$
2,268
$
2,550
$
(282)
(11%)
$
6,824
$
7,679
$
(855)
(11%)
Percentage of net sales
14%
7%
19%
5%
Intellectual property legal fees
$
12,891
$
5,577
7,314
131%
$
32,908
$
11,716
21,192
181%
Percentage of net sales
77%
16%
92%
8%
Selling, general and administrative
$
3,160
$
3,767
(607)
(16%)
$
9,515
$
11,429
(1,914)
(17%)
Percentage of net sales
19%
11%
27%
8%
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Research and Development
Research and development expenses decreased during the third quarter and first nine months of 2023 compared to the same periods 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 third quarter and first nine months of 2023 compared to the same periods 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 third quarter and first nine months of 2023 compared to the same periods of 2022 due primarily to a decrease in employee headcount and overhead and outside services.
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Other Income, Net
Other income, net for the three and nine months ended September 30, 2023 and October 1, 2022 was as follows (dollars in thousands):
Three Months Ended
Nine Months Ended
September 30,
October 1,
%
September 30,
October 1,
%
2023
2022
Change
Change
2023
2022
Change
Change
Interest income, net
$
507
$
34
$
473
$
840
$
38
$
802
Other income, net
33
82
(49)
14
74
(60)
Total other income, net
$
540
$
116
$
424
366%
$
854
$
112
$
742
663%
Interest income, net increased during the third quarter and first nine months of 2023 compared to the same periods of 2022, primarily as a result of higher interest rate earned on higher cash balances. Other income, net included a one-time gain from a sanction judgment during the third quarter and first nine months of 2022 resulting in a decrease in other income for the third quarter and the first nine months of 2023 compared to the same periods of 2022.
Liquidity and Capital Resources
Our primary sources of cash are historically proceeds from issuances of equity 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.
The following tables present selected financial information as of September 30, 2023 and December 31, 2022 and for the first nine months of 2023 and 2022 (in thousands):
September 30,
December 31,
2023
2022
Cash, cash equivalents and restricted cash
$
50,576
$
43,611
Long-term debt due within one year
—
447
Working capital
34,495
25,774
Nine Months Ended
September 30,
October 1,
2023
2022
Net cash used in operating activities
$
(40,079)
$
(17,695)
Net cash used in investing activities
—
(396)
Net cash provided by financing activities
47,044
3,054
During the nine months ended September 30, 2023, net cash used in operating activities was primarily a result of net loss of $47.2 million, non-cash adjustments to net loss of $4.2 million, and net cash inflows from changes in operating assets and liabilities of $2.9 million due to a decrease in accounts receivable and in inventories, partially offset by a decrease in accounts payable and a decrease in accrued expenses and other liabilities. Net cash provided by financing activities during the nine months ended September 30, 2023 primarily consisted of $23.4 million in net proceeds from issuance of common stock under the September 2021 Purchase Agreement, $28.6 million in net proceeds from the 2023 Offering, $0.5 million in proceeds from exercise of stock options, offset by $4.9 million in net repayments under the credit agreement between the Company and Silicon Valley Bank, dated October 31, 2009 , which was terminated on April 28, 2023 (the “2009 SVB Credit Agreement”), and $0.4 million in payments of notes payable to finance insurance policies.
During the nine months ended October 1, 2022, net cash used in operating activities was primarily a result of net loss of $20.4 million, non-cash adjustments to net loss of $3.1 million, and net cash outflows from changes in operating assets and liabilities of $0.4 million driven predominantly by an increase in inventories due to higher purchases to support increased sales and a decrease in accounts payable, partially offset by a decrease in accounts receivable and an
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increase in accrued expenses and other liabilities. Net cash provided by financing activities during the nine months ended October 1, 2022 primarily consisted of $1.0 million in net borrowings under the 2009 SVB Credit Agreement, $3.7 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 $0.6 million in payments of note payable to finance insurance policies and $1.3 million in payments for taxes related to net share settlement of equity awards.
Capital Resources
2023 Offering
On August 14, 2023, we entered into the 2023 Purchase Agreement with certain investors, pursuant to which we agreed to issue and sell to the investors an aggregate of 11,111,112 shares of our common stock and warrants purchase up to an aggregate of 11,111,112 shares of our common stock at a per share purchase price of $2.70 per share. The 2023 Offering closed on August 17, 2023. The net proceeds to us from the 2023 Offering were $28.6 million, after deducting placement agent fees and offering costs paid by us.
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 September 30, 2023, $36.3 million remains available under the September 2021 Purchase Agreement with Lincoln Park.
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 the September 2021 Purchase Agreement, funds raised through the 2023 Offering and other future 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 accounting principles generally accepted in the United States of America (“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 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.
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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.