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 Electronics Co., Ltd., Samsung Semiconductor Inc., and Samsung Electronics America Inc. (collectively, “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 23, 2024 (the “ 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, including our line of custom and specialty memory products, bring leading performance to customers in a variety of industries globally. Netlist also licenses its intellectual property.
During the first quarter of 2024, we recorded net sales of $35.8 million, gross profit of $0.7 million and net loss of $17.0 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 with Silicon Valley Bank, a division of First-Citizen Bank & Trust Company (“SVB”). See “Liquidity and Capital Resources” below for more information.
Recent Developments
Fourth Amendment to Rights Agreement
On April 17, 2024, the Company entered into a fourth amendment (the “Fourth Amendment”) to the Company’s rights agreement dated as of April 17, 2017 (as amended from time to time, the “Rights Agreement”). The Fourth Amendment appointed Equiniti Trust Company, LLC as rights agent and amended the definition of “Expiration Date” in the Rights Agreement to extend the term for an additional three year period which extended the final expiration of the Rights issued pursuant to the Rights Agreement from April 17, 2024 to April 17, 2027. As a result and pursuant to the Fourth Amendment, the Rights will expire and become unexercisable on or before the close of business on April 17, 2027, in accordance with the terms of the Rights Agreement.
Jury Verdict and Judgment Against Samsung
On August 11, 2023, a 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 approximately $303 million in damages against 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. Post-judgment motions are pending before the Court. Following entry of an order regarding that post-judgment briefing, 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. Additionally, as of the reporting date, all of the patents confirmed as being infringed on the jury verdict are either subject to Inter Partes Review (“IPR”) final written decisions, or an active IPR trial. The outcome of each of the IPR proceedings related to each of these patents may affect the underlying collectability of the jury award in this matter.
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 three months ended March 30, 2024, Lincoln Park purchased an aggregate of 1,240,000 shares of our common stock for a net purchase price of $2.1 million under the September 2021 Purchase Agreement. In connection with the purchases, we issued to Lincoln Park an aggregate of 4,085 shares of our common stock as additional commitment shares in noncash transactions.
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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.
Results of Operations
Net Sales and Gross Profit
Net sales and gross profit for the three months ended March 30, 2024 and April 1, 2023 were as follows (dollars in thousands):
Three Months Ended
March 30,
April 1,
%
2024
2023
Change
Net sales
$
35,807
$
9,021
297%
Cost of sales
35,092
8,461
315%
Gross profit
$
715
$
560
28%
Gross margin percentage
2%
6%
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 increased by approximately $26.8 million during the first quarter of 2024 compared to the same period of 2023, primarily as a result of a $24.2 million increase in the sale of registered DIMM (“RDIMM”) and discrete memory component products, a $1.5 million increase in sales of Netlist’s flash and SSD products, and a $1.1 million increase in sales of low-profile memory subsystem products.
Gross Profit and Gross Margin
Product gross profit increased during the first quarter of 2024 compared to the same period of 2023, primarily as a result of higher sales across all product groups. Product gross margin percentage decreased during the first quarter of 2024 compared to the same period of 2023, primarily as a result of product sales mix.
Operating Expenses
Operating expenses for the three months ended March 30, 2024 and April 1, 2023, were as follows (dollars in thousands):
Three Months Ended
March 30,
April 1,
%
2024
2023
Change
Research and development
$
2,441
$
2,301
6%
Percentage of net sales
7%
26%
Intellectual property legal fees
$
12,540
$
11,070
13%
Percentage of net sales
35%
123%
Selling, general and administrative
$
3,116
$
3,030
3%
Percentage of net sales
9%
34%
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Research and Development
Research and development expenses increased during the first quarter of 2024 compared to the same period of 2023 due primarily to an increase 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 2024 compared to the same period of 2023 due primarily to higher legal expenses incurred to protect and enforce our patent portfolio.
Selling, General and Administrative
Selling, general and administrative expenses increased during the first quarter of 2024 compared to the same period of 2023 due primarily to an increase in employee headcount and overhead and outside services.
Other Income, Net
Other income, net for the three months ended March 30, 2024 and April 1, 2023 was as follows (dollars in thousands):
Three Months Ended
March 30,
April 1,
%
2024
2023
Change
Interest income, net
$
377
$
56
Other income (expense), net
38
(3)
Total other income, net
$
415
$
53
683%
Interest income, net increased during the first quarter of 2024 compared to the same period of 2023, primarily as a result of higher interest rate earned on higher cash balances. Other income, net included sublease income for our warehouse space located in Irvine, California during the first quarter of 2024.
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. We have also funded our operations with a revolving line of credit under a bank credit facility with SVB.
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The following tables present selected financial information as of March 30, 2024 and December 30, 2023 and for the first three months of 2024 and 2023 (in thousands):
March 30,
December 30,
2024
2023
Cash, cash equivalents and restricted cash
$
41,136
$
52,845
Debt due within one year
377
—
Working capital
9,043
22,289
Three Months Ended
March 30,
April 1,
2024
2023
Net cash used in operating activities
$
(14,218)
$
(12,714)
Net cash used in investing activities
(37)
-
Net cash provided by financing activities
2,546
5,673
During the three months ended March 30, 2024, net cash used in operating activities was primarily a result of net loss of $17.0 million, non-cash adjustments to net loss of $1.6 million, and net cash inflows from changes in operating assets and liabilities of $1.1 million driven predominantly by an increase in accounts payable due to higher legal fees to defend our patent portfolio and an increase in accrued expenses and other liabilities, partially offset by an increase in inventories due to higher purchases to support increased sales. Net cash provided by financing activities during the three months ended March 30, 2024 primarily consisted of $0.5 million in net borrowings under the 2023 SVB Credit Agreement (as defined below), $2.1 million in net proceeds from issuance of common stock under the September 2021 Purchase Agreement, offset by $0.1 million in payments of notes payable to finance insurance policies.
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 2023 SVB Credit Agreement and $0.1 million in payments of notes payable to finance insurance policies.
Capital Resources
2023 SVB Credit Agreement
On November 7, 2023, we entered into a loan and security agreement (the “2023 SVB Credit Agreement”) with SVB, 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.
As of March 30, 2024, the outstanding borrowings under the 2023 SVB Credit Agreement were $4.4 million with no availability under the revolving line of credit. During the three months ended March 30, 2024, we made net borrowings of $0.5 million under the 2023 SVB Credit Agreement.
2023 Offering
On August 14, 2023, we entered into a Securities Purchase Agreement (the “2023 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
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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 March 30, 2024, $34.1 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 the cash received under the Strategic Agreement with SK hynix, proceeds from issuances of debt and equity securities, including our equity line with Lincoln Park, cash receipts from revenues, borrowing availability under the 2023 SVB Credit Agreement, the equity financing available under the September 2021 Purchase Agreement, funds raised through 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 Annual Report and in the MD&A in our Annual Report. There have been no significant changes to our critical accounting policies since our 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.