NETLIST, INC. 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:
? specific and overall impacts of the COVID-19 pandemic on our financial
condition and results of operations;
? our beliefs regarding the market and demand for our products or the component
products we resell;
? 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 satisfy the accelerated and enhanced
disclosure obligations that will apply to us as we transition from a "smaller
reporting company" to a "large accelerated filer" in 2022; 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 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 endedJanuary 1, 2022 (the "2021 Annual Report") filed with theSEC . 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 toNetlist, Inc. and its consolidated subsidiaries, unless otherwise stated. 20 Table of Contents OverviewNetlist provides high-performance solid-state drives and modular memory solutions to enterprise customers in diverse industries. Our NVMe SSDs in various capacities and form factors and the line of custom and specialty memory products bring industry-leading performance to server and storage appliance customers and cloud service providers.Netlist licenses its portfolio of intellectual property including patents, in server memory, hybrid memory and storage class memory, to companies that implementNetlist's technology. During the third quarter of 2022, we recorded net sales of$34.4 million , gross profit of$2.2 million and net loss of$9.6 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 SK hynix Agreements OnApril 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 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
OnOctober 31, 2009 , we entered into the SVB Credit Agreement, which provides for a revolving line of credit of up to$10.0 million , as amended. The SVB Credit Agreement was most recently amended onApril 29, 2022 , and the borrowing base is limited to 85% of eligible accounts receivable, subject to certain adjustments, and 50% of eligible inventory. Borrowings accrue 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 isApril 28, 2023 , as amended.
OnSeptember 28, 2021 , we entered into theSeptember 2021 Purchase Agreement withLincoln Park , pursuant to which we have the right to sell toLincoln Park up to an aggregate of$75 million in shares of our common stock over the 36-month term of theSeptember 2021 Purchase Agreement subject to the conditions and limitations set forth in theSeptember 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 theSeptember 2021 Purchase Agreement. In connection with the purchases, we issued toLincoln Park an aggregate of 20,809 shares of our common stock as additional commitment shares in noncash transactions. During the nine months endedOctober 1, 2022 ,Lincoln Park purchased an aggregate of 650,000 shares of our common stock for a net purchase price of$3.7 million under theSeptember 2021 Purchase Agreement. In connection with the purchases, we issued toLincoln Park an aggregate of 7,168 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
21
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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.
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.
Results of Operations
Net sales and gross profit for the three and nine months ended
Three Months Ended Nine Months Ended
October 1, October 2, % October 1, October 2, %
2022 2021 Change 2022 2021 Change
Net product sales $ 34,424 $ 26,749 29% $ 139,982 $ 66,009 112%
License fee - - 0% - 40,000 (100%)
Net sales 34,424 26,749 29% 139,982 106,009 32%Gross profit - product sales$ 2,180 $ 2,508 (13%)$ 10,291 $ 6,874 50% Gross margin percentage - product sales 6% 9%
7% 10%
Gross profit $ 2,180 $ 2,508 (13%) $ 10,291 $ 46,874 (78%)
Gross margin percentage 6% 9% 7% 44%
Net Sales
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 $7.7 million during the third
quarter of 2022 compared to the same quarter of 2021, primarily as a result of a
$12.4 million increase in re-sale of SK hynix products and a $4.9 million
increase in sale of Netlist's flash and SSD products, offset by a $9.6 million
decrease in sales of low-profile memory subsystem products.
Net product sales increased by approximately $74.0 million during the first nine
months of 2022 compared to the same period in 2021, primarily as a result of a
$84.0 million increase in re-sale of SK hynix products and a $8.1 million
increase in sale of Netlist's flash and SSD products, offset by a $18.0 million
decrease in sales of low-profile memory subsystem products.
Gross Profit and Gross Margin
Product gross profit decreased by$0.3 million during the third quarter of 2022 compared to the same quarter of 2021 primarily as a result of softer pricing environment and product sales mix. Product gross profit increased during the first nine months of 2022 compared to the same period of 2021 due primarily to higher sales across all product groups. 22
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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 and nine months ended
Three Months Ended Nine Months Ended
October 1, October 2, % October 1, October 2, %
2022 2021 Change 2022 2021 Change
Research and development $ 2,550 $ 2,038 25% $ 7,679 $ 5,222 47%
Percentage of net product sales 7% 8% 5% 8%
Intellectual property legal fees
16% 32% 8% 22%
Selling, general and administrative
11% 10% 8% 12%
Research and Development
Research and development expenses increased during the third quarter and the
first nine 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
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 7 to the condensed consolidated financial statements included in Part I, Item 1 of this report for further discussion.
Intellectual property legal fees decreased during the third quarter and the first nine months of 2022 compared to the same periods of 2021 due primarily to lower legal expenses incurred to defend our patent portfolio internationally.
Selling, General and Administrative
Selling, general and administrative expenses increased during the third quarter and the first nine months of 2022 compared to the same periods 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 endedJanuary 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. 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. 23 Table of Contents Other Income (Expense), Net
Other income (expense), net for the three and nine months ended
Three Months Ended Nine Months Ended
October 1, October 2, % October 1, October 2, %
2022 2021 Change 2022 2021 ChangeInterest income (expense), net $ 34$ (125) $ 38$ (417) Other income (expense), net 82 (2) 74 641
Total other income (expense), net
Interest expense, net, in 2021 consisted primarily of interest expense on the$15 million secured convertible note issued toSamsung Venture Investment Co. ("SVIC Note") inNovember 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 third quarter and the first nine months of 2022 compared to the same periods of 2021. Other income, net increased during the third quarter of 2022 compared to the same quarter of 2021 primarily as a result of a one-time gain from a sanction judgment. During the first nine months of 2021, other income, net included the gain on forgiveness of the Paycheck Protection Program Loan of$0.6 million . This gain was recognized during the second quarter of 2021 resulting in a decrease in other income for the first nine months of 2022 compared to the same period of 2021.
Liquidity and Capital Resources
Our primary sources of cash are historically proceeds from issuances of equity and debt securities and receipts from revenues. In addition, we have received proceeds from non-recurring engineering and licensing of our patent portfolio, including as a result of our entry into the SK hynix Strategic Agreement, which we use to support our operations. We have also funded our operations with a revolving line of credit under a bank credit facility, and to a lesser extent, equipment leasing arrangements. The following tables present selected financial information as ofOctober 1, 2022 , andJanuary 1, 2022 and for the first nine months of 2022 and 2021 (in thousands):October 1 ,January 1, 2022 2022
Cash, cash equivalents and restricted cash$ 43,442 $
58,479
Convertible promissory note and accrued interest, net 1
562
Working capital 37,168 52,613
Nine Months Ended
October 1, October 2,
2022 2021
Net cash provided by (used in) operating activities
(396) (318)
Net cash provided by financing activities 3,054
36,879
During the nine months endedOctober 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 increase in accrued expenses and other liabilities. Net cash provided by financing activities during the nine months endedOctober 1, 2022 primarily consisted of$1.0 million in net borrowings under the SVB Credit Agreement,$3.7 million in 24
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net proceeds from issuance of common stock under theSeptember 2021 Lincoln Park 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. During the nine months endedOctober 2, 2021 , net cash provided by operating activities was primarily a result of net income of$13.1 million , non-cash adjustments to net income of$1.3 million , and net cash inflows from changes in operating assets and liabilities of$5.7 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, partially offset by an increase in inventories. Net cash provided by financing activities during the nine months endedOctober 2, 2021 primarily consisted of$26.3 million in net proceeds from issuance of common stock under the 2019 Purchase Agreement withLincoln Park , 2020 Purchase Agreement withLincoln Park and First 2021 Lincoln Park Purchase Agreement,$11.1 million in proceeds from exercise of stock options and warrants and$0.8 million in net borrowings under the SVB Credit Agreement, partially offset by$1.0 million in payments for taxes related to net share settlement of equity awards.
Capital Resources
OnSeptember 28, 2021 , we entered into theSeptember 2021 Purchase Agreement withLincoln Park , pursuant to which we have the right to sell toLincoln Park up to an aggregate of$75.0 million in shares of our common stock over the 36-month term of theSeptember 2021 Purchase Agreement subject to the conditions and limitations set forth in theSeptember 2021 Purchase Agreement. As ofOctober 1, 2022 ,$60.4 million remains available under theSeptember 2021 Purchase Agreement withLincoln Park .
SVB Credit Agreement
OnOctober 31, 2009 , we entered into the SVB Credit Agreement, which provides for a revolving line of credit of up to$10.0 million , as amended. The SVB Credit Agreement was most recently amended onApril 29, 2022 , and the borrowing base is limited to 85% of eligible accounts receivable, subject to certain adjustments, and 50% of eligible inventory. Borrowings accrue 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 isApril 28, 2023 , as amended. As ofOctober 1, 2022 , the outstanding borrowings under the SVB Credit Agreement were$8.0 million with additional borrowing availability of$0.2 million . During the nine months endedOctober 1, 2022 , we made net borrowings of$1.0 million under the SVB Credit Agreement.
Sufficiency of Cash Balances and Potential Sources of
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 underSeptember 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 withU.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 25
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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 2021 Annual Report and in the MD&A in our 2021 Annual Report. There have been no significant changes to our critical accounting policies since our 2021 Annual Report.
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