NETLIST, INC. Note About 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 and 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 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 2, 2021 (the "2020 Annual Report") filed with theSecurities and Exchange Commission (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 toNetlist, Inc. and its consolidated subsidiaries, unless otherwise stated. 20 Table of Contents Overview We provide high-performance modular memory subsystems to customers in diverse industries that require enterprise and storage class memory solutions to empower critical business decisions. We have a history of introducing disruptive new products, such as one of the first load reduced dual in-line memory modules ("LRDIMM") based on our distributed buffer architecture, which has been adopted by the industry for DDR4 LRDIMM. We were also one of the first to bring NAND flash memory ("NAND flash") to the memory channel with our NVvault non-volatile dual in-line memory modules ("NVDIMM") using software-intensive controllers and merging dynamic random access memory integrated circuits ("DRAM ICs" or "DRAM") and NAND flash to solve data bottleneck and data retention challenges encountered in high-performance computing environments. We also offer storage class memory products called HybriDIMM to address the growing need for real-time analytics in Big Data applications, in-memory databases, high performance computing and advanced data storage solutions. We are continuously developing and improving upon the HybriDIMM product while exploring opportunities with strategic partners. Our NVMe SSD portfolio provides industry-leading performance offered in multiple capacities and form factors. Due to the ground-breaking product development of our engineering teams, we have built a robust portfolio of over 130 issued and pendingU.S. and foreign patents, many seminal, in the areas of hybrid memory, storage class memory, rank multiplication and load reduction. Since our inception, we have dedicated substantial resources to the development, protection and enforcement of technology innovations we believe are essential to our business. Our early pioneering work in these areas has been broadly adopted in industry-standard registered dual in-line memory modules ("RDIMM"), LRDIMM and in NVDIMM. Our objective is to continue to innovate in our field and invest further in our intellectual property portfolio, with the goal of monetizing our intellectual property through a combination of product sales and licensing, royalty or other revenue-producing arrangements, which may result from joint development or similar partnerships or defense of our patents through enforcement actions against parties we believe are infringing them. We also resell SSD, NAND flash, DRAM products and other component products to end-customers that are not reached in the distribution models of the component manufacturers, including storage customers, appliance customers, system builders and cloud and datacenter customers. During the second quarter of 2021, we recorded net sales of$64.4 million , including a$40 million license fee, gross profit of$42.9 million and net income of$27.8 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
SK hynix License Agreement and Supply Agreement
OnApril 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"). 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 provides for the settlement of all pending intellectual property proceedings between us and SK hynix with the settlement fee of$40 million payable to us by SK hynix, and the parties have agreed to collaborate on certain technology development activities.
Amendment to SVB Credit Agreement
OnApril 9, 2021 , we entered into an amendment to a credit agreement datedOctober 31, 2009 withSilicon Valley Bank ("SVB") (as the same may from time to time be amended, modified, supplemented or restated, the "SVB Credit Agreement") to accrue interest on advances at a per annum rate equal to the greater of 2.25% above theWall Street Journal prime rate ("Prime Rate") or 5.50% and to extend the maturity date toDecember 30, 2021 . The amount 21
Table of Contents
available for borrowing may be increased to
2021 Lincoln Park Purchase Agreement
OnJuly 12, 2021 , we entered into a purchase agreement (the "2021 Purchase Agreement") withLincoln Park , pursuant to which we have the right to sell toLincoln Park up to an aggregate of$17.4 million in shares of our common stock over the 36-month term of the 2021 Purchase Agreement subject to the conditions and limitations set forth in the 2021 Purchase Agreement. Subsequent toJuly 12, 2021 ,Lincoln Park purchased an aggregate of 2,000,000 shares of our common stock for a net purchase price of$14.9 million under the 2021 Purchase Agreement. In connection with the purchases, we issued toLincoln Park an aggregate of 103,292 shares of our common stock as commitment shares in noncash transactions.
Paycheck Protection Program Loan
OnApril 23, 2020 , we entered into an unsecured promissory note with a principal amount of$0.6 million throughHanmi Bank under the Paycheck Protection Program ("PPP") ("PPP Loan") administered by theSmall Business Administration ("SBA") and established as part of the Coronavirus Aid, Relief, and Economic Security Act ("CARES Act"). The PPP Loan bore interest at 1.0% per annum and would mature inApril 2022 with the first six months of interest and principal payments deferred. The amount borrowed under the PPP Loan was eligible for forgiveness if we would meet certain conditions. InMay 2021 , the full amount outstanding under the PPP Loan was forgiven resulting in a gain of$0.6 million .
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.
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.
22
Table of Contents
Results of Operations
Net Sales and Gross Profit
Net sales, cost of sales and gross profit for the three and six months ended
Three Months Ended Six Months Ended
July 3, June 27, % July 3, June 27, %
2021 2020 Change 2021 2020 Change
Net product sales $ 24,363 $ 10,906 123% $ 39,260 $ 25,537 54%
License fee 40,000 - - 40,000 - -
Net sales 64,363 10,906 490% 79,260 25,537 210%
Gross profit - product sales $ 2,865 $ 1,826 57% $ 4,366 $ 3,935 11%
Gross margin - product sales 12% 17% 11% 15%
Gross profit $ 42,865 $ 1,826 2247% $ 44,366 $ 3,935 1027%
Gross margin 67% 17% 56% 15%
Net Sales
Net sales include (i) resales of certain component products, including SSDs and DRAM products, and sales of our high-performance memory subsystems and (ii) an upfront non-refundable license fee recognized for licensing of our patents pursuant to the License Agreement with SK hynix entered into onApril 5, 2021 . Net product sales increased by$13.5 million during the second quarter of 2021 compared to the same quarter of 2020 primarily as a result of a$6.8 million net increase in sales of NAND flash products (including$8.1 million increase in resales of NAND flash products and$1.2 million decrease in sales ofNetlist's SSD products) and$6.7 million increase in sales of other small outline dual in-line memory module ("SODIMM") and RDIMM products. Net product sales increased by$13.7 million during the first six months of 2021 compared to the same period in 2020 primarily as a result of a$7.8 million increase in sales of SODIMM and RDIMM products (a$6.2 million increase in the resales of SODIMM and RDIMM products and a$1.6 million increase in sales of our Specialty SODIMM and RDIMM products) and a$6.2 million increase in the resales of NAND flash products (including a$7.4 million increase in the resales of NAND flash products and a$1.1 million decrease inNetlist's flash SSD products).
Net sales in all periods presented were impacted by the change in the product mix and fluctuating customer concentrations.
Gross Profit and Gross Margin Products gross profit increased during the second quarter and first six months of 2021 compared to the same periods of 2020 due primarily to higher gross profits on the resales of NAND flash products and our Specialty SODIMM and RDIMM products, partially offset by the lower gross profits on the sales ofNetlist's SSD products. Products gross margin (or gross profit as a percentage of net product sales) fluctuates based on the change in our product mix over periods and the relative cost of the factory. 23 Table of Contents Operating Expenses
Operating expenses for the three and six months ended
Three Months Ended Six Months Ended
July 3, June 27, % July 3, June 27, %
2021 2020 Change 2021 2020 Change
Research and development $ 2,060 $ 698 195% $ 3,184 $ 1,352 136%Percentage of net product sales 8% 6% 8% 5% Intellectual property legal fees$ 3,837 $ 848 352%$ 6,124 $ 1,473 316% Percentage of net product sales 16% 8% 16% 6% Selling, general and administrative$ 3,092 $ 1,957 58%$ 5,049 $ 4,178 21% Percentage of net product sales 13% 18%
13% 16%
Research and Development
Research and development expenses increased during the second quarter and first six months of 2021 compared to the same periods of 2020 due primarily to an increase in employee headcount and overhead.
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 increased during the second quarter and first six months of 2021 compared to the same periods of 2020 due primarily to higher legal expenses incurred to defend our patent portfolio internationally.
Selling, General and Administrative
Selling, general and administrative expenses increased during the second quarter and first six months of 2021 compared to the same periods of 2020 due primarily to an increase in employee headcount and overhead, partially offset by a decrease in outside services. As a result of the significant increase in the value of our non-affiliate public float in recent periods, we will be transitioning to becoming a "large accelerated filer" at the end of this fiscal year endingJanuary 2, 2022 which means that we will need to file our quarterly and annual reports on an accelerated basis and that we will need to be prepared to have our independent registered public accounting firm audit and attest to our internal control over financial reporting. Complying with these new requirements will require that we invest a material amount in enhancing our financial reporting infrastructure that will cause our selling, general and administrative expenses to increase materially in future periods. 24 Table of Contents Other Income (Expense), Net
Other income (expense), net for the three and six months ended
Three Months Ended Six Months Ended
July 3, June 27, % July 3, June 27, %
2021 2020 Change 2021 2020 Change
Interest expense, net $ (145) $ (150) $ (292) $ (298) Other income (expense), net 645 (2) 643 (5)
Total other income (expense), net
Interest expense, net, consists primarily of interest expense on the$15 million secured convertible note issued toSamsung Venture Investment Co. ("SVIC") ("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. During the second quarter and first six months of 2021, other income (expense), net includes the gain on forgiveness of the PPP Loan of$0.6 million . Provision for Income Taxes During the second quarter and first six months of 2021, we recorded a provision for income taxes of$6.6 million related to the Korean withholding tax incurred in connection with the upfront non-refundable license fee of$40 million from SK hynix. Our effective tax rate for the second quarter and first six months of 2021 was the same as theU.S. federal statutory rate of 21%, since the Korean withholding tax was treated as a significant unusual event for interim tax reporting.
Liquidity and Capital Resources
Our primary sources of cash are historically proceeds from issuances of equity and debt securities and receipts from revenues. In addition, we have received proceeds from NRE and licensing of our patent portfolio. As a result of our entry into the SK hynix License Agreement, we plan to use the license fee received to support our operations. We have also funded our operations with a revolving line of credit under a bank credit facility, a funding arrangement for costs associated with certain of our legal proceedings against SK hynix and, to a lesser extent, equipment leasing arrangements. The following tables present selected financial information as ofJuly 3, 2021 andJanuary 2, 2021 and for the first six months of 2021 and 2020 (in thousands): July 3, January 2, 2021 2021 Cash and cash equivalents$ 44,544 $ 13,326
Convertible promissory note and accrued interest, net 16,564 16,310 Total PPP Loan and accrued interest
- 641
Working capital 35,218 (2,726)
Six Months Ended
July 3, June 27,
2021 2020
Net cash provided by (used in) operating activities
(144) (9)
Net cash provided by financing activities 10,935 1,428
During the six months ended
25
Table of Contents
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 endedJuly 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. During the six months endedJune 27, 2020 , net cash used in operating activities was primarily a result of net loss of$3.4 million and non-cash adjustments to net loss of$1.0 million , offset by 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 accrued payroll and related liabilities, partially offset by a decrease in accounts receivable due to vigorous collection efforts. Net cash provided by financing activities during the six months endedJune 27, 2020 primarily consisted of$2.8 million in net proceeds from issuance of common stock under the 2020 Lincoln Park Purchase Agreement and$0.6 million in proceeds from the issuance of PPP Loan, partially offset by$1.6 million in net repayments under the SVB Credit Agreement. Capital Resources
2021 Lincoln Park Purchase Agreement
OnJuly 12, 2021 , we entered into the 2021 Purchase Agreement withLincoln Park , pursuant to which we have the right to sell toLincoln Park up to an aggregate of$17.4 million in shares of our common stock over the 36-month term of the 2021 Purchase Agreement subject to the conditions and limitations set forth
in the 2021 Purchase Agreement. SVB Credit Agreement OnOctober 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. OnApril 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 toDecember 30, 2021 . The amount available for borrowing may be increased to$7.0 million and the maturity date will be extended toApril 29, 2022 upon our request, if we meet certain conditions. As ofJuly 3, 2021 , the outstanding borrowings under the SVB Credit Agreement were$0.8 million with additional borrowing availability of$3.9 million . During the six months endedJuly 3, 2021 , we made net repayments of$2.9 million under the SVB Credit Agreement.
Paycheck Protection Program Loan
OnApril 23, 2020 , we entered into the PPP Loan with a principal amount of$0.6 million throughHanmi Bank under the PPP administered by the SBA and established as part of the CARES Act. The PPP Loan bore interest at 1.0% per annum and would mature inApril 2022 with the first six months of interest and principal payments deferred. The amount borrowed under the PPP Loan was eligible for forgiveness if we would meet certain conditions. InMay 2021 , the full amounts outstanding under the PPP Loan was forgiven.
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 under the 2021 Lincoln Park 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.
26
Table of Contents
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 inthe 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 2020 Annual Report and in the MD&A in our 2020 Annual Report. There have been no significant changes to our critical accounting policies since our 2020 Annual Report.
© Edgar Online, source
