]
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
⌧ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended July 2, 2022
or
◻ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from _____ to _____
Commission file number: 001-33170
(Exact name of registrant as specified in its charter)
Delaware | 95-4812784 | |
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) |
111 Academy, Suite 100 Irvine, California | 92617 | |
(Address of principal executive offices) | (Zip Code) |
(949) 435-0025
(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act: None
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ⌧ No ◻
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ⌧ No ◻
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer ⌧ | Accelerated filer ◻ | Non-accelerated filer ◻ | Smaller reporting company ☐ |
Emerging growth company ☐ |
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ◻
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ◻ No ⌧
As of July 29, 2022, there were 231,583,156 outstanding shares of the registrant’s common stock.
NETLIST, INC. AND SUBSIDIARIES
Form 10-Q
For the Quarter Ended July 2, 2022
TABLE OF CONTENTS
Page | ||||
3 | ||||
Management’s Discussion and Analysis of Financial Condition and Results of Operations | 18 | |||
24 | ||||
24 | ||||
26 | ||||
26 | ||||
52 | ||||
53 | ||||
2
PART I. — FINANCIAL INFORMATION
Item 1. | Financial Statements |
NETLIST, INC. AND SUBSIDIARIES
Condensed Consolidated Balance Sheets
(In thousands, except par value)
July 2, | January 1, | |||||
| 2022 |
| 2022 | |||
(unaudited) | ||||||
ASSETS | ||||||
Current Assets: | ||||||
Cash and cash equivalents | $ | 40,465 | $ | 47,679 | ||
Restricted cash | 20,100 | 10,800 | ||||
Accounts receivable, net of allowances of $235 (2022) and $283 (2021) | 12,328 | 12,727 | ||||
Inventories | 21,857 | 15,670 | ||||
Prepaid expenses and other current assets | 1,018 | 1,126 | ||||
Total current assets | 95,768 | 88,002 | ||||
Property and equipment, net | 1,180 | 989 | ||||
Operating lease right-of-use assets | 2,369 | 1,891 | ||||
Other assets | 319 | 294 | ||||
Total assets | $ | 99,636 | $ | 91,176 | ||
LIABILITIES AND STOCKHOLDERS' EQUITY | ||||||
Current Liabilities: | ||||||
Accounts payable | $ | 38,309 | $ | 25,887 | ||
Revolving line of credit | 8,019 | 7,000 | ||||
Accrued payroll and related liabilities | 1,430 | 1,308 | ||||
Accrued expenses and other current liabilities | 1,485 | 632 | ||||
Long-term debt due within one year | 189 | 562 | ||||
Total current liabilities | 49,432 | 35,389 | ||||
Operating lease liabilities | 1,932 | 1,593 | ||||
Other liabilities | 356 | 152 | ||||
Total liabilities | 51,720 | 37,134 | ||||
Commitments and contingencies | ||||||
Stockholders' equity: | ||||||
Preferred stock, $0.001 par value—10,000 shares authorized: Series A preferred stock, $0.001 par value; 1,000 shares authorized; none issued and outstanding | ||||||
Common stock, $0.001 par value—450,000 shares authorized; 231,488 and 230,113 shares issued and outstanding | 232 | 231 | ||||
Additional paid-in capital | 248,563 | 243,866 | ||||
Accumulated deficit | (200,879) | (190,055) | ||||
Total stockholders' equity | 47,916 | 54,042 | ||||
Total liabilities and stockholders' equity | $ | 99,636 | $ | 91,176 | ||
See accompanying Notes to Condensed Consolidated Financial Statements.
3
NETLIST, INC. AND SUBSIDIARIES
Condensed Consolidated Statements of Operations (Unaudited)
(In thousands, except per share amounts)
Three Months Ended | Six Months Ended | |||||||||||
July 2, | July 3, | July 2, | July 3, | |||||||||
2022 |
| 2021 |
| 2022 |
| 2021 | ||||||
Net product sales | $ | 55,358 | $ | 24,363 | $ | 105,558 | $ | 39,260 | ||||
License fee | — | 40,000 | — | 40,000 | ||||||||
Net sales | 55,358 | 64,363 | 105,558 | 79,260 | ||||||||
Cost of sales | 50,610 | 21,498 | 97,447 | 34,894 | ||||||||
Gross profit | 4,748 | 42,865 | 8,111 | 44,366 | ||||||||
Operating expenses: | ||||||||||||
Research and development | 2,672 | 2,060 | 5,129 | 3,184 | ||||||||
Intellectual property legal fees | 3,313 | 3,837 | 6,139 | 6,124 | ||||||||
Selling, general and administrative | 3,724 | 3,092 | 7,662 | 5,049 | ||||||||
Total operating expenses | 9,709 | 8,989 | 18,930 | 14,357 | ||||||||
Operating (loss) income | (4,961) | 33,876 | (10,819) | 30,009 | ||||||||
Other (expense) income, net: | ||||||||||||
Interest income (expense), net | 15 | (145) | 4 | (292) | ||||||||
Other (expense) income, net | (6) | 645 | (8) | 643 | ||||||||
Total other (expense) income, net | 9 | 500 | (4) | 351 | ||||||||
(Loss) income before provision for income taxes | (4,952) | 34,376 | (10,823) | 30,360 | ||||||||
Provision for income taxes | — | 6,600 | 1 | 6,601 | ||||||||
Net (loss) income | $ | (4,952) | $ | 27,776 | $ | (10,824) | $ | 23,759 | ||||
(Loss) earnings per share: | ||||||||||||
Basic | $ | (0.02) | $ | 0.13 | $ | (0.05) | $ | 0.11 | ||||
Diluted | $ | (0.02) | $ | 0.12 | $ | (0.05) | $ | 0.10 | ||||
Weighted-average common shares outstanding: | ||||||||||||
Basic | 231,298 | 215,706 | 230,922 | 210,693 | ||||||||
Diluted | 231,298 | 235,176 | 230,922 | 229,305 | ||||||||
See accompanying Notes to the Condensed Consolidated Statements.
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B
NETLIST, INC. AND SUBSIDIARIES
Condensed Consolidated Statements of Stockholders Equity (Unaudited)
(In thousands)
Additional | Total | |||||||||||||
Common Stock | Paid-in | Accumulated | Stockholders' | |||||||||||
| Shares |
| Amount |
| Capital |
| Deficit |
| Equity | |||||
Balance, January 1, 2022 | 230,113 | $ | 231 | $ | 243,866 | $ | (190,055) | $ | 54,042 | |||||
Net loss | — | — | — | (5,872) | (5,872) | |||||||||
Issuance of common stock, net | 303 | — | 1,767 | — | 1,767 | |||||||||
Exercise of stock options | 197 | — | 138 | — | 138 | |||||||||
Stock-based compensation | — | — | 682 | — | 682 | |||||||||
Restricted stock units vested and distributed | 533 | 1 | (1) | — | — | |||||||||
Tax withholdings related to net share settlements of equity awards | (117) | — | (591) | — | (591) | |||||||||
Balance, April 2, 2022 | 231,029 | 232 | 245,861 | (195,927) | 50,166 | |||||||||
Net loss | — | — | — | (4,952) | (4,952) | |||||||||
Issuance of common stock, net | 354 | — | 1,973 | — | 1,973 | |||||||||
Exercise of stock options | 72 | — | 47 | — | 47 | |||||||||
Stock-based compensation | — | — | 790 | — | 790 | |||||||||
Restricted stock units vested and distributed | 50 | — | — | — | — | |||||||||
Tax withholdings related to net share settlements of equity awards | (17) | — | (108) | — | (108) | |||||||||
Balance, July 2, 2022 | 231,488 | $ | 232 | $ | 248,563 | $ | (200,879) | $ | 47,916 | |||||
Additional | Total | |||||||||||||
Common Stock | Paid-in | Accumulated | Stockholders' | |||||||||||
| Shares |
| Amount |
| Capital |
| Deficit |
| Equity | |||||
Balance, January 2, 2021 | 195,978 | $ | 195 | $ | 192,071 | $ | (194,886) | $ | (2,620) | |||||
Net loss | — | — | — | (4,017) | (4,017) | |||||||||
Issuance of common stock, net | 11,700 | 12 | 9,349 | — | 9,361 | |||||||||
Exercise of stock options | 476 | — | 376 | — | 376 | |||||||||
Exercise of warrants | 6,508 | 7 | 3,975 | — | 3,982 | |||||||||
Stock-based compensation | — | — | 338 | — | 338 | |||||||||
Restricted stock units vested and distributed | 501 | 1 | (1) | — | — | |||||||||
Tax withholdings related to net share settlements of equity awards | (150) | — | (276) | — | (276) | |||||||||
Balance, April 3, 2021 | 215,013 | 215 | 205,832 | (198,903) | 7,144 | |||||||||
Net Income | — | — | — | 27,776 | 27,776 | |||||||||
Exercise of stock options | 345 | — | 256 | — | 256 | |||||||||
Exercise of warrants | 588 | 1 | 375 | — | 376 | |||||||||
Stock-based compensation | — | — | 379 | — | 379 | |||||||||
Restricted stock units vested and distributed | 63 | — | — | — | — | |||||||||
Tax withholdings related to net share settlements of equity awards | (22) | — | (47) | — | (47) | |||||||||
Balance, July 3, 2021 | 215,987 | $ | 216 | $ | 206,795 | $ | (171,127) | $ | 35,884 | |||||
See accompanying Notes to the Condensed Consolidated Statements
5
NETLIST, INC. AND SUBSIDIARIES
Condensed Consolidated Statements of Cash Flows (Unaudited)
(In thousands)
Six Months Ended | ||||||
July 2, | July 3, | |||||
| 2022 |
| 2021 | |||
Cash flows from operating activities: | ||||||
Net income (loss) | $ | (10,824) | $ | 23,759 | ||
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: | ||||||
Depreciation and amortization | 157 | 65 | ||||
Interest accrued on convertible promissory notes | — | 152 | ||||
Amortization of debt discounts | — | 105 | ||||
Non-cash lease expense | 314 | 206 | ||||
Gain on extinguishment of debt | — | (643) | ||||
Stock-based compensation | 1,472 | 717 | ||||
Changes in operating assets and liabilities: | ||||||
Accounts receivable | 399 | (127) | ||||
Inventories | (6,187) | (9,073) | ||||
Prepaid expenses and other assets | 83 | (331) | ||||
Accounts payable | 12,422 | 12,014 | ||||
Accrued payroll and related liabilities | 122 | 380 | ||||
Accrued expenses and other liabilities | 609 | (97) | ||||
Net cash provided by (used in) operating activities | (1,433) | 27,127 | ||||
Cash flows from investing activities: | ||||||
Acquisition of property and equipment | (326) | (144) | ||||
Net cash used in investing activities | (326) | (144) | ||||
Cash flows from financing activities: | ||||||
Net borrowings (repayments) under line of credit | 1,019 | (2,926) | ||||
Principal repayments under finance lease | (27) | — | ||||
Payments on note payable | (373) | (167) | ||||
Proceeds from issuance of common stock, net | 3,740 | 9,361 | ||||
Proceeds from exercise of stock options and warrants | 185 | 4,990 | ||||
Payments for taxes related to net share settlement of equity awards | (699) | (323) | ||||
Net cash provided by financing activities | 3,845 | 10,935 | ||||
Net change in cash, cash equivalents and restricted cash | 2,086 | 37,918 | ||||
Cash, cash equivalents and restricted cash at beginning of period | 58,479 | 16,526 | ||||
Cash, cash equivalents and restricted cash at end of period | $ | 60,565 | $ | 54,444 | ||
Reconciliation of cash, cash equivalents and restricted cash at end of period: | ||||||
Cash and cash equivalents | $ | 40,465 | $ | 44,544 | ||
Restricted cash | 20,100 | 9,900 | ||||
Cash, cash equivalents and restricted cash at end of period | $ | 60,565 | $ | 54,444 | ||
See accompanying Notes to the Condensed Consolidated Statements.
6
NETLIST, INC. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements (Unaudited)
Note 1—Description of Business
Netlist, Inc. and its wholly owned subsidiaries (collectively the “Company” or “Netlist”) provides high-performance solid-state drives and modular memory solutions to enterprise customers in diverse industries. The Company's 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 implement Netlist’s technology.
Note 2—Summary of Significant Accounting Policies
Basis of Presentation
The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”). Certain information and footnote disclosures normally included in the condensed consolidated financial statements prepared in accordance with U.S. GAAP have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). These condensed consolidated financial statements should be read in conjunction with the condensed consolidated financial statements and notes thereto as of and for the year ended January 1, 2022, included in the Company’s Annual Report on Form 10-K filed with the SEC on March 1, 2022 (the “2021 Annual Report”).
In the opinion of management, all adjustments for the fair presentation of the Company’s condensed consolidated financial statements have been made. The adjustments are of a normal recurring nature except as otherwise noted. The results of operations for the interim periods are not necessarily indicative of the results to be expected for other periods or the full fiscal year. The Company has evaluated events occurring subsequent to July 2, 2022 through the filing date of this Quarterly Report on Form 10-Q and concluded that there were no events that required recognition and disclosures other than those discussed elsewhere in the notes hereto.
Principles of Consolidation
The accompanying condensed consolidated financial statements include the accounts of Netlist, Inc. and its wholly owned subsidiaries. All intercompany balances and transactions have been eliminated in consolidation.
Fiscal Year
The Company’s fiscal year is the 52- or 53-week period that ends on the Saturday nearest to December 31. The Company’s fiscal year 2022 will include 52 weeks and ends on December 31, 2022. Each quarter of fiscal year 2022 will be comprised of 13 weeks. Unless otherwise stated, references to particular years, quarters, months and periods refer to the Company’s fiscal years ended in January and the associated quarters, months and periods of those fiscal years.
Use of Estimates
The preparation of the accompanying condensed consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the amounts reported. Actual results may differ materially from those estimates.
7
Recently Adopted Accounting Guidance
In the first quarter of 2022, we adopted the Financial Accounting Standards Board (“FASB”) Accounting Standards Update (“ASU”) No. 2020-06, Debt—Debt with Conversion and Other Options (Subtopic 470-20) and Derivatives and Hedging—Contracts in Entity’s Own Equity (Subtopic 815-40): Accounting for Convertible Instruments and Contracts in an Entity’s Own Equity. This ASU amends the guidance on convertible instruments and the derivatives scope exception for contracts in an entity's own equity, and also improves and amends the related earnings per share guidance for both Subtopics. The adoption of this ASU did not have an impact on the Company’s condensed consolidated financial statements as the Company paid off its convertible debt in December 2021.
Note 3—Supplemental Financial Information
Inventories
Inventories consisted of the following (in thousands):
July 2, | January 1, | |||||
| 2022 |
| 2022 | |||
Raw materials | $ | 11,021 | $ | 4,208 | ||
Work in process | 418 | 154 | ||||
Finished goods | 10,418 | 11,308 | ||||
$ | 21,857 | $ | 15,670 | |||
(Loss) Earnings Per Share
The following table shows the computation of basic and diluted (loss) earnings per share of common stock (in thousands, except per share data):
The table below shows potentially dilutive weighted average common share equivalents, consisting of shares issuable upon the exercise of outstanding stock options and warrants using the treasury stock method, shares issuable upon conversion feature of a convertible note using the “if-converted” method, and the shares vesting of issuable upon the RSAs and RSUs. These potential weighted average common share equivalents for the three and six months ended July 2, 2022 have been excluded from the diluted net loss per share calculations above as their effect would be anti-dilutive (in thousands):
Three Months Ended | Six Months Ended | |||||||||||
July 2, | July 3, | July 2, | July 3, | |||||||||
| 2022 |
| 2021 |
| 2022 |
| 2021 | |||||
Weighted average common share equivalents | 5,419 | 19,470 | 5,911 | 18,612 | ||||||||
8
Disaggregation of Net Sales
The following table shows disaggregated net sales by major source (in thousands):
Three Months Ended | Six Months Ended | |||||||||||
July 2, | July 3, | July 2, | July 3, | |||||||||
2022 | 2021 |
| 2022 | 2021 | ||||||||
Resales of third-party products | $ | 49,168 | $ | 14,608 | $ | 94,753 | $ | 25,966 | ||||
Sale of the Company's modular memory subsystems | 6,190 | 9,755 | 10,805 | 13,294 | ||||||||
License fee | — | 40,000 | — | 40,000 | ||||||||
Total net sales | $ | 55,358 | $ | 64,363 | $ | 105,558 | $ | 79,260 | ||||
Major Customers and Products
The Company’s net product sales have historically been concentrated in a small number of customers. The following table sets forth the percentage of net product sales made to customers that each comprise 10% or more of total product sales:
Three Months Ended | Six Months Ended | |||||||
July 2, | July 3, | July 2, | July 3, | |||||
2022 | 2021 | 2022 | 2021 | |||||
Customer A | 32% | 11% | 42% | * | ||||
Customer B | * | 11% | * | * | ||||
Customer C | 23% | * | 16% | * | ||||
* | Less than 10% of net sales during the period. |
As of July 2, 2022, three customers represented 21%, 17%, and 16% of aggregated gross receivables, respectively. As of January 1, 2022, four customers represented 26%, 16%, 13%, and 13% of aggregate gross receivables, respectively. The loss of a major customer or a reduction in sales to or difficulties collecting payments from these customers could significantly reduce the Company’s net sales and adversely affect its operating results. The Company mitigates risks associated with foreign and domestic receivables by purchasing comprehensive credit insurance.
The Company resells certain 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. For the three and six months ended July 2, 2022, resales of these products represented approximately 89% and 90% of net product sales, respectively. For the three and six months ended July 3, 2021, resales of these products represented approximately 60% and 66% of net product sales, respectively.
Note 4—Credit Agreement
On October 31, 2009, the Company and Silicon Valley Bank (“SVB”) entered into a credit agreement (as the same may from time to time be amended, modified, supplemented or restated, (the “SVB Credit Agreement”)), which provided for a revolving line of credit up to $5.0 million. The borrowing base was limited to 85% of the eligible accounts receivable, subject to certain adjustments. On April 9, 2021, we entered into an amendment to the SVB Credit Agreement to accrue interest on borrowings at a per annum rate equal to the greater of 2.25% above the Wall Street Journal prime rate (“Prime Rate”) or 5.50% from the Prime Rate plus 2.75% and to extend the maturity date to December 30, 2021. In December 2021, after meeting the conditions set forth in the amendment, the amount available for borrowing was increased to $7.0 million and the maturity date was extended to April 29, 2022, upon our request.
On April 29, 2022, the Company entered into an amendment to the SVB Credit Agreement to accrue interest on advance at a per annum rate equal to the greater of 0.75% above the Prime Rate or 4.25%. The borrowing base is limited
9
to 85% of eligible accounts receivable, subject to certain adjustments, and 50% of eligible inventory. The maximum amount available for borrowing was increased to $10.0 million and the maturity date was extended to April 28, 2023.
The 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 July 2, 2022 and January 1, 2022, (i) outstanding letters of credit were $20.1 million and $10.8 million, respectively, (ii) outstanding borrowings were $8.0 million and $7.0 million, respectively, and (iii) availability under the revolving line of credit was $2.0 million and none, respectively.
Note 5—Debt
The Company’s debt consisted of the following (in thousands):
July 2, | January 1, | |||||
| 2022 |
| 2022 | |||
Notes payable | 189 | 562 | ||||
Less: amounts due within one year | (189) | (562) | ||||
Long-term debt | $ | — | $ | — | ||
Note 6—Leases
The Company has operating and finance leases primarily associated with office and manufacturing facilities and certain equipment. The determination of which discount rate to use when measuring the lease obligation was deemed a significant judgment.
Lease cost and supplemental condensed consolidated cash flow information related to operating and finance leases were as follows (in thousands):
Three Months Ended | Six Months Ended | |||||||||||
July 2, | July 3, | July 2, | July 3, | |||||||||
2022 | 2021 |
| 2022 |
| 2021 | |||||||
Lease cost: | ||||||||||||
Operating lease cost | $ | 198 | $ | 121 | $ | 396 | $ | 240 | ||||
Cash paid for amounts included in the measurement of lease liabilities: | ||||||||||||
Operating cash flows from operating leases | 170 | 121 | 319 | 240 | ||||||||
Right-of-use assets obtained in exchange for lease obligations: | ||||||||||||
Operating leases | $ | 33 | $ | — | $ | 588 | $ | — | ||||
Finance leases | 372 | — | 372 | — | ||||||||
Lease modification to increase operating lease assets | 204 | 338 | 204 | 338 | ||||||||
For the three and six months ended July 2, 2022, and July 3, 2021, finance lease costs and cash flows from finance leases were immaterial.
10
Supplemental condensed consolidated balance sheet information related to leases was as follows (in thousands):
The following table includes supplemental information:
July 2, | January 1, | |||||
2022 | 2022 | |||||
Weighted Average Remaining Lease Term (in years) | ||||||
Operating lease | 4.2 | 4.8 | ||||
Finance lease | 2.1 | 2.9 | ||||
Weighted Average Discount Rate | ||||||
Operating lease | 5.5% | 5.5% | ||||
Finance lease | 4.4% | 5.2% | ||||
Maturities of lease liabilities as of July 2, 2022, were as follows (in thousands):
Note 7 – Commitments and Contingencies
Contingent Legal Expenses
We may retain the services of law firms that specialize in patent licensing and enforcement and patent law in connection with our licensing and enforcement activities. These law firms may be retained on a contingent fee basis whereby such law firms are paid on a scaled percentage of any negotiated fee, settlements or judgments awarded based on how and when the fees, settlements or judgments are obtained.
11
Litigation and Patent Reexaminations
We own numerous patents and continue to seek to grow and strengthen our patent portfolio, which covers various aspects of our innovations and includes various claim scopes. We plan to pursue avenues to monetize our intellectual property portfolio, in which we would generate revenue by selling or licensing our technology, and we intend to vigorously enforce our patent rights against alleged infringers of such rights. We dedicate substantial resources to protecting and enforcing our intellectual property rights, including with patent infringement proceedings we file against third parties and defense of our patents against challenges made by way of reexamination and review proceedings at the U.S. Patent and Trademark Office (“USPTO”) Patent Trial and Appeal Board (“PTAB”). We expect these activities to continue for the foreseeable future, with no guarantee that any ongoing or future patent protection or litigation activities will be successful, or that we will be able to monetize our intellectual property portfolio. We are also subject to litigation based on claims that we have infringed on the intellectual property rights of others.
Any litigation, regardless of its outcome, is inherently uncertain, involves a significant dedication of resources, including time and capital, and diverts management’s attention from our other activities. As a result, any current or future infringement claims or patent challenges by or against third parties, whether eventually decided in our favor or settled, could materially adversely affect our business, financial condition and results of operations. Additionally, the outcome of pending or future litigation and related patent reviews and reexaminations, as well as any delay in their resolution, could affect our ability to continue to sell our products, protect against competition in the current and expected markets for our products or license or otherwise monetize our intellectual property rights in the future.
Google Litigations
On December 4, 2009, Netlist filed a patent infringement lawsuit against Google, Inc. (“Google”) in the U.S. District Court for the Northern District of California (the “NDCA”), seeking damages and injunctive relief based on Google’s alleged infringement of our U.S. Patent No. 7,619,912 (the “‘912 patent”) which relates generally to technologies to implement rank multiplication. The NDCA case was stayed, pending challenges to the ‘912 patent before the United States Patent and Trademark Office. Eventually, the United States Court of Appeals for the Federal Circuit confirmed the ‘912 patent’s validity on June 15, 2020, and the NDCA case stay was lifted and the case proceeded before Senior Judge Armstrong, where the parties entered cross motions for summary judgment. Of the issues in play, the parties contested the application of the defense of intervening rights to the claims at issue in the case. Afterward, the NDCA case was re-assigned to Chief Judge Seeborg of the NDCA, and the hearing for the parties’ cross motions took place on March 3, 2022. On May 5, 2022, Chief Judge Seeborg entered an Order granting Netlist, Inc.’s Motion for Summary Judgement that Claim 16 of the ‘912 patent is not subject to Google’s pleaded defense of Intervening Rights. On July 13, 2022, Chief Judge Seeborg ordered – shortly before the planned July 14, 2022 case management conference – that the case be stayed for a 90-day period, and that the case management conference be continued to October 27, 2022.
On July 26, 2022, Netlist filed a patent infringement lawsuit against Google Cloud EMEA Limited, Google Germany GmbH, Redtec Computing GmbH, and Google, Inc., seeking damages based on those defendants’ infringement of European Patents EP 2,454,735 (“EP735”) and EP 3,404,660 (“EP660”), which both generally relate to LRDIMM technologies. As of the reporting date, the Dusseldorf Court has not set an oral hearing date.
Micron Litigations
On April 28, 2021, Netlist filed a complaint for patent infringement against Micron Technology, Inc. (“Micron”) in the United States District Court for the Western District of Texas, Waco Division (Case No. 6:21-cv00431 & Case No. 6:21-cv-00430). These proceedings are based on the alleged infringement by Micron’s load reduced dual in line memory modules (“LRDIMM”) and Micron’s non-volatile dual in line memory modules (“NVDIMM”) enterprise memory modules under four U.S. patents – U.S. Patent Nos. 10,489,314; 9,824,035; 10,268,608; & 8,301,833. As of the reporting date, the case has been assigned to Hon. Judge Lee Yeakel, and the parties completed briefing on their claim construction arguments. On May 11, 2022, Judge Yeakel entered a stay of the case pending the resolution of Micron’s requested Inter Partes Review (“IPR”) proceedings against the four patents asserted by Netlist in this case (U.S. Patent Nos. 8,301,833, 9,854,035, 10,268,608, and 10,489,314). Micron filed requests to bring IPR proceedings against
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Netlist’s U.S. Patent Nos. 8,301,833, 9,854,035, 10,268,608, and 10,489,314. As of the reporting date, the PTAB granted Micron’s request for the ‘035 Patent, but denied its request for the ‘608 Patent. Netlist’s Patent Owner Preliminary Response to Micron’s requests to IPR the ‘314 patent were filed August 3, 2022, and the PTAB’s deadline to make a decision on institution for the ‘833 Patent is September 9, 2022.
On March 31, 2022, Netlist filed a patent infringement lawsuit against Micron in Germany, seeking damages based on their infringement of EP735 and EP660. On June 24, 2022, Netlist filed an extension of its Complaint requesting injunctive relief. The Dusseldorf Court set an oral hearing for the case in Dusseldorf on May 4, 2023.
On June 10, 2022, Netlist filed a complaint for patent infringement against Micron in the United States District Court for the Eastern District of Texas, Marshall Division (Case No. 2:22-cv-00203-JRG-RSP). These proceedings are based on the alleged infringement by Micron’s load reduced dual in line memory modules (“LRDIMM”), Micron’s memory modules utilizing on-board power management modules (“PMIC”), and Micron’s high bandwidth memory (“HBM”) components, under six U.S. patents – U.S. Patent Nos. 8,787,060; 9,318,160; 10,860,506; 10,949,339; 11,016,918; & 11,232,054. As of the reporting date, the case has been assigned to Hon. Chief Judge Rodney Gilstrap.
On August 1, 2022, Netlist filed a complaint for patent infringement against Micron in the United States Court for the Eastern District of Texas (Case No. 2:22-cv-00294) under the ‘912 Patent, which relates generally to technologies to implement rank multiplication.
Samsung Litigations
On May 28, 2020, Netlist filed a complaint against Samsung in the United States District Court for the Central District of California for Samsung’s breach of the parties’ JDLA. On July 22, 2020, Netlist amended its complaint to seek a Declaratory Judgment that it properly terminated the JDLA in light of Samsung’s material breaches. On October 14, 2021, the Court entered summary judgment in Netlist’s favor and confirmed Netlist properly terminated the JDLA as of July 15, 2020. On February 15, 2022, the Court entered a Final Judgment in favor of Netlist on each of its three claims and confirmed conclusively that all licenses granted under the JDLA were terminated. On February 25, 2022, Samsung filed a Notice of Appeal, and the Federal Court of Appeals for the Ninth Circuit issued a Time Schedule Order on February 28, 2022, setting Samsung’s deadline to file an opening appeal brief as June 6, 2022. As of the reporting date, Samsung filed its opening brief seeking an appeal of the lower Court’s decisions. Netlist filed its response to Samsung’s appeal and its own opening cross-appeal brief on August 4, 2022.
On October 15, 2021, Samsung filed a declaratory judgement action against Netlist in the United States District Court for the District of Delaware (“DDE”), requesting in relevant part that the Delaware District Court declare that Samsung does not infringe Netlist’s U.S. Patent Nos. 7,619,912, 9,858,218, 10,217,523, 10,474,595, 10,860,506, 10,949,339, and 11,016,918. As of the reporting date, Samsung seeks leave to add U.S. Patent No. 11,232,054 (issued Jan. 25, 2022) to the action. Netlist believes Samsung’s claims levied in the DDE action meritless, and the relief Samsung requests unjustified. Netlist filed a motion seeking dismissal of Samsung’s operative DDE complaint, and an opposition contesting the inclusion of U.S. Patent No. 11,232,054 as part of Samsung’s proposed second amended complaint filing. On August 1, 2022, the Court entered an Order on the pending motions denying Samsung’s request to amend its operative complaint a second time to add a count against U.S. Patent No. 11,232,054, and granting-in-part Netlist’s motion that various causes of action be dismissed. Specifically, Judge Andrews dismissed all of Samsung’s counts related to Netlist’s U.S. Patent Nos. 7,619,912, 10,860,506, 10,949,339, and 11,016,918. As of the reporting date, the Court has not yet set a case schedule.
On November 19, 2021, Samsung filed IPR requests contesting the validity of U.S. Patent Nos. 9,858,218 (the “’218 patent”), 10,474,595 (the “’595 patent”), and 10,217,523 (the “’523 patent”). Netlist filed its initial responses to Samsung’s petitions on February 18, 2022, contesting the institution of any IPR on the grounds propounded. As of the reporting date, the PTAB has granted Samsung’s IPR requests related to the ‘218, ‘523, and ‘595 patents. Netlist filed its Patent Owner’s Response for the ‘523 IPR on August 4, 2022, and has a deadline to file its Patent Owner Responses for the ‘218 and’595 IPRs on August 15, 2022.
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On February 17, 2022, Samsung filed an IPR request contesting the validity of only claim 16 within Netlist’s U.S. Patent No. 7,619,912. Samsung then filed two additional IPR requests contesting the validity of Netlist’s U.S. Patent Nos. 10,860,506 and 10,949,339. As of the reporting date, Netlist filed its Patent Owner’s Preliminary Response for the ‘912 and ‘339 IPRs on July 21, 2022, and for the ‘506 IPR on July 28, 2022. As of the reporting date, Samsung filed two additional IPR requests contesting the validity of Netlist’s U.S. Patent Nos. 11,016,918 and 11,232,054. The PTAB issued filing dates for both, making Netlist’s deadline to file its Preliminary Responses to each on September 9, 2022 and September 8, 2022, respectively.
On June 3, 2022, Netlist filed a patent infringement lawsuit against Samsung in Dusseldorf, Germany, seeking damages for Samsung’s infringement of Netlist’s Patents EP735 and EP660. The Dusseldorf Court set an Oral Hearing date for September 5, 2023.
On December 20, 2021, Netlist filed a complaint for patent infringement against Samsung in the United States Court for the Eastern District of Texas (Case No. 2:21-cv-463) under US Patent No. 10,860,506; US Patent No. 10,949,339; & US Patent No. 11,016,918. Samsung responded to Netlist’s complaint on April 12, 2022, and Judge Gilstrap ordered a scheduling conference be set for May 18, 2022. On May 3, 2022, Netlist entered a First Amended Complaint pursuant to FRCP Rule 15, adding claims for infringement under three additional patents: U.S. Patent Nos. 8,787,060, 9,318,160, and 11,232,054. On May 4, 2022, Netlist complied with the EDTX local patent rules and served its preliminary infringement contentions on Samsung. As of the reporting date, the Court set a schedule, with a claim construction hearing set for October 14, 2022 and Trial set for May 1, 2023.
On August 1, 2022, Netlist filed a complaint for patent infringement against Samsung in the United States Court for the Eastern District of Texas (Case No. 2:22-cv-00293) under the ‘912 Patent, which relates generally to technologies to implement rank multiplication.
Other Contingent Obligations
In the ordinary course of our business, we have made certain indemnities, commitments and guarantees pursuant to which we may be required to make payments in relation to certain transactions. These include, among others: (i) intellectual property indemnities to our customers and licensees in connection with the use, sale and/or license of our products; (ii) indemnities to vendors and service providers pertaining to claims based on our negligence or willful misconduct; (iii) indemnities involving the accuracy of representations and warranties in certain contracts; (iv) indemnities to our directors and officers to the maximum extent permitted under the laws of the State of Delaware; (v) indemnities to SVB pertaining to all obligations, demands, claims, and liabilities claimed or asserted by any other party in connection with transactions contemplated by the applicable investment or loan documents, as applicable; and (vi) indemnities or other claims related to certain real estate leases, under which we may be required to indemnify property owners for environmental and other liabilities or may face other claims arising from our use of the applicable premises. The duration of these indemnities, commitments and guarantees varies and, in certain cases, may be indefinite. The majority of these indemnities, commitments and guarantees do not provide for any limitation of the maximum potential for future payments we could be obligated to make. Historically, we have not been obligated to make significant payments as a result of these obligations, and no liabilities have been recorded for these indemnities, commitments and guarantees in the accompanying consolidated balance sheets.
Note 8—Stockholders’ Equity
Serial Preferred Stock
The Company’s authorized capital stock includes 10,000,000 shares of serial preferred stock, with a par value of $0.001 per share. No shares of preferred stock were outstanding as of July 2, 2022 or January 2, 2022.
On April 17, 2017, the Company entered into a rights agreement (as amended from time to time, the “Rights Agreement”) with Computershare Trust Company, N.A., as rights agent. In connection with the adoption of the Rights Agreement and pursuant to its terms, the Company’s board of directors authorized and declared a dividend of one right (each, a “Right”) for each outstanding share of the Company’s common stock to stockholders of record at the close of
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business on May 18, 2017 (the “Record Date”), and authorized the issuance of one Right for each share of the Company’s common stock issued by the Company (except as otherwise provided in the Rights Agreement) between the Record Date and the Distribution Date (as defined below).
Each Right entitles the registered holder, subject to the terms of the Rights Agreement, to purchase from the Company, when exercisable and subject to adjustment, one unit consisting of one -thousandth of a share (a “Unit”) of Series A Preferred Stock of the Company (the “Preferred Stock”), at a purchase price of $6.56 per Unit, subject to adjustment. Subject to the provisions of the Rights Agreement, including certain exceptions specified therein, a distribution date for the Rights (the “Distribution Date”) will occur upon the earlier of (i) 10 business days following a public announcement that a person or group of affiliated or associated persons (an “Acquiring Person”) has acquired or otherwise obtained beneficial ownership of 15% or more of the then-outstanding shares of the Company’s common stock, and (ii) business days (or such later date as may be determined by the Company’s board of directors) following the commencement of a tender offer or exchange offer that would result in a person or group becoming an Acquiring Person. The Rights are not exercisable until the Distribution Date and, unless earlier redeemed or exchanged by the Company pursuant to the terms of the Rights Agreement (as amended on April 16, 2018, April 16, 2019 and August 14, 2020) will expire on the close of business on April 17, 2024.
In connection with the adoption of the Rights Agreement, the Company’s board of directors approved a Certificate of Designation of the Series A Preferred Stock (the “Certificate of Designation”) designating 1,000,000 shares of its serial preferred stock as Series A Preferred Stock and setting forth the rights, preferences and limitations of the Preferred Stock. The Company filed the Certificate of Designation with the Secretary of State of the State of Delaware on April 17, 2017.
Common Stock
September 2021 Lincoln Park Purchase Agreement
On September 28, 2021, the Company entered into a purchase agreement (the “September 2021 Purchase Agreement”) with Lincoln Park, pursuant to which the Company has the right to sell to Lincoln Park up to an aggregate of $75 million in shares of its common stock subject to the conditions and limitations set forth in the September 2021 Purchase Agreement. Concurrent with the execution of the September 2021 Purchase Agreement, the Company also entered into a registration rights agreement with Lincoln Park relating to the Company’s common stock to be sold to Lincoln Park. As consideration for entering into the September 2021 Purchase Agreement, the Company issued to Lincoln Park 218,750 shares of its common stock as initial commitment shares in a noncash transaction on September 28, 2021 and will issue up to 143,750 additional shares of its common stock as additional commitment shares on a pro rata basis in connection with any additional purchases. The Company will not receive any cash proceeds from the issuance of these additional commitment shares.
Pursuant to the September 2021 Purchase Agreement, on any business day and as often as every other business day over the term of the September 2021 Purchase Agreement, the Company has the right, from time to time, at its sole discretion and subject to certain conditions, to direct Lincoln Park to purchase up to 750,000 shares of its common stock, provided Lincoln Park’s obligation under any single such purchase will not exceed $4.0 million, unless the Company and Lincoln Park mutually agree to increase the maximum amount of such single regular purchase. If the Company directs Lincoln Park to purchase the maximum number of shares of common stock it then may sell in a regular purchase, then in addition to such regular purchase, and subject to certain conditions and limitations in the September 2021 Purchase Agreement, the Company may direct Lincoln Park to purchase an additional amount of common stock that may not exceed the lesser of (i) 300% of the number of shares purchased pursuant to the corresponding regular purchase or (ii) 30% of the total number of shares of its common stock traded during a specified period on the applicable purchase date as set forth in the September 2021 Purchase Agreement. Under certain circumstances and in accordance with the September 2021 Purchase Agreement, the Company may direct Lincoln Park to purchase shares in multiple accelerated purchases on the same trading day.
The Company controls the timing and amount of any sales of its common stock to Lincoln Park. There is no upper limit on the price per share that Lincoln Park must pay for the Company’s common stock under the September
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2021 Purchase Agreement, but in no event will shares be sold to Lincoln Park on a day the closing price is less than the floor price specified in the September 2021 Purchase Agreement. In all instances, the Company may not sell shares of its common stock to Lincoln Park under the September 2021 Purchase Agreement if that would result in Lincoln Park beneficially owning more than 9.99% of its common stock.
The September 2021 Purchase Agreement does not limit the Company’s ability to raise capital from other sources at the Company’s sole discretion, except that, subject to certain exceptions, the Company may not enter into any Variable Rate Transaction (as defined in the September 2021 Purchase Agreement, including the issuance of any floating conversion rate or variable priced equity-like securities) during the 36 months after the date of the September 2021 Purchase Agreement. The Company has the right to terminate the September 2021 Purchase Agreement at any time, at no cost to the Company.
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 the September 2021 Purchase Agreement. In connection with the purchases, we issued to Lincoln Park an aggregate of 20,809 shares of our common stock as additional commitment shares in noncash transactions. During the six months ended July 2, 2022, Lincoln Park purchased an aggregate of 650,000 shares of our common stock for a net purchase price of $3.7 million under the September 2021 Purchase Agreement. In connection with the purchases, we issued to Lincoln Park an aggregate of 7,168 shares of our common stock as additional commitment shares in noncash transactions.
Note 9—Stock-Based Awards
As of July 2, 2022, the Company had 127,406 shares of common stock reserved for future issuance under its Amended and Restated 2006 Incentive Plan (“Amended 2006 Plan”). Stock options granted under the Amended 2006 Plan generally vest at a rate of at least 25% per year over four years and expire 10 years from the grant date. RSUs granted for employees and consultants generally vest in equal installments annually and fully vest over a four-year term from the grant date.
Stock Options
The following table summarizes the activity related to stock options during the six months ended July 2, 2022:
Weighted- | ||||||
Number of | Average | |||||
Shares | Exercise | |||||
(in thousands) |
| Price | ||||
Outstanding as of January 1, 2022 | 5,899 | $ | 0.88 | |||
Granted | — | — | ||||
Exercised | (269) | 0.69 | ||||
Expired or forfeited | (474) | 0.73 | ||||
Outstanding as of July 2, 2022 | 5,156 | $ | 0.91 | |||
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Restricted Stock Units
The following table summarizes the activity related to RSUs during the six months ended July 2, 2022:
Weighted- | ||||||
Average | ||||||
Number of | Grant-Date | |||||
Shares | Fair Value | |||||
(in thousands) | per Share | |||||
Outstanding as of January 1, 2022 | 2,228 | $ | 1.36 | |||
Granted | 2,447 | 4.32 | ||||
Vested | (583) | 0.74 | ||||
Forfeited | (40) | 4.43 | ||||
Outstanding as of July 2, 2022 | 4,052 | $ | 3.21 | |||
Stock-Based Compensation
The following table summarizes the stock-based compensation expense by line item in the condensed consolidated statements of operations (in thousands):
Three Months Ended |
| Six Months Ended | ||||||||||
July 2, | July 3, | July 2, | July 3, | |||||||||
2022 | 2021 | 2022 | 2021 | |||||||||
Cost of sales | $ | 16 | $ | 4 | $ | 19 | $ | 7 | ||||
Research and development | 215 | 168 | 391 | 278 | ||||||||
Selling, general and administrative | 559 | 207 | 1,062 | 432 | ||||||||
Total | $ | 790 | $ | 379 | $ | 1,472 | $ | 717 | ||||
As of July 2, 2022, the Company had approximately $10.9 million, net of estimated forfeitures, of unearned stock-based compensation, which it expects to recognize over a weighted-average period of approximately 3.4 years.
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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:
| ● | 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 ended January 1, 2022 (the “2021 Annual Report”) filed with the Securities 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 to Netlist, Inc. and its consolidated subsidiaries, unless otherwise stated.
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Overview
Netlist 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 implement Netlist’s technology.
During the second quarter of 2022, we recorded net sales of $55.4 million, gross profit of $4.7 million and net loss of $5.0 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. See “Recent Developments” and “Liquidity and Capital Resources” below for more information.
Recent Developments
SK hynix Agreements
On April 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
On October 31, 2009, we entered into the SVB Credit Agreement, which provided for a revolving line of credit of up to $5.0 million. The borrowing base was limited to 85% of eligible accounts receivable, subject to certain adjustments as set forth in the SVB Credit Agreement. On April 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 to December 30, 2021. The amount available for borrowing was increased to $7.0 million and the maturity date was extended to April 29, 2022 upon our request, if we meet certain conditions.
On April 29, 2022, we entered into an amendment to the SVB Credit Agreement to accrue interest on advance at a per annum rate equal to the greater of 0.75% above the Prime Rate or 4.25%. The borrowing base is limited to 85% of eligible accounts receivable, subject to certain adjustments, and 50% of eligible inventory. The maximum amount available for borrowing was increased to $10.0 million and the maturity date was extended to April 28, 2023.
As of July 2, 2022, the outstanding borrowings under the SVB Credit Agreement were $8.0 million with additional borrowing availability of $2.0 million. During the six months ended July 2, 2022, we made net borrowings of $1.0 million under the SVB Credit Agreement.
September 2021 Lincoln Park Purchase Agreement
On September 28, 2021, we entered into a purchase agreement (the “Second 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 Second 2021 Purchase Agreement subject to the conditions and limitations set forth in the Second 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 the Second 2021 Purchase Agreement. In connection with the purchases, we issued to
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Lincoln Park an aggregate of 20,809 shares of our common stock as additional commitment shares in noncash transactions. During the six months ended July 2, 2022, Lincoln Park purchased an aggregate of 650,000 shares of our common stock for a net purchase price of $3.7 million under the Second 2021 Purchase Agreement. In connection with the purchases, we issued to Lincoln 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 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
Net sales and gross profit for the three and six months ended July 2, 2022, and July 3, 2021 were as follows (dollars in thousands):
Three Months Ended | Six Months Ended | |||||||||||||||
July 2, | July 3, | % | July 2, | July 3, | % | |||||||||||
| 2022 |
| 2021 |
| Change |
| 2022 |
| 2021 |
| Change | |||||
Net product sales | $ | 55,358 | $ | 24,363 | 127% | $ | 105,558 | $ | 39,260 | 169% | ||||||
License fee | — | 40,000 | (100%) | — | 40,000 | (100%) | ||||||||||
Net sales | 55,358 | 64,363 | (14%) | 105,558 | 79,260 | 33% | ||||||||||
Gross profit - product sales | $ | 4,748 | $ | 2,865 | 66% | $ | 8,111 | $ | 4,366 | 86% | ||||||
Gross margin percentage - product sales | 9% | 12% | 8% | 11% | ||||||||||||
Gross profit | $ | 4,748 | $ | 42,865 | (89%) | $ | 8,111 | $ | 44,366 | (82%) | ||||||
Gross margin percentage | 9% | 67% | 8% | 56% | ||||||||||||
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 $31.0 million during the second quarter of 2022 compared to the same quarter of 2021, primarily as a result of a $36.3 million increase in re-sale of SK hynix products and a $2.1 million increase in sale of Netlist’s flash and SSD products, offset by a $7.5 million decrease in sales of low-profile memory subsystem products.
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Net product sales increased by approximately $66.3 million during the first six months of 2022 compared to the same period in 2021, primarily as a result of a $71.5 million increase in re-sale of SK hynix products and a $3.2 million increase in sale of Netlist’s flash and SSD products, offset by a $8.5 million decrease in sales of low-profile memory subsystem products.
Gross Profit and Gross Margin
Product gross profit increased during the second quarter and first six months of 2022 compared to the same periods of 2021 due primarily to higher sales across all product groups. 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 six months ended July 2, 2022, and July 3, 2021, were as follows (dollars in thousands):
Three Months Ended | Six Months Ended | |||||||||||||||
July 2, | July 3, | % | July 2, | July 3, | % | |||||||||||
| 2022 |
| 2021 |
| Change | 2022 |
| 2021 |
| Change | ||||||
Research and development | $ | 2,672 | $ | 2,060 | 30% | $ | 5,129 | $ | 3,184 | 61% | ||||||
Percentage of net product sales | 5% | 8% | 5% | 8% | ||||||||||||
Intellectual property legal fees | $ | 3,313 | $ | 3,837 | (14%) | $ | 6,139 | $ | 6,124 | 0% | ||||||
Percentage of net product sales | 6% | 16% | 6% | 16% | ||||||||||||
Selling, general and administrative | $ | 3,724 | $ | 3,092 | 20% | $ | 7,662 | $ | 5,049 | 52% | ||||||
Percentage of net product sales | 7% | 13% | 7% | 13% | ||||||||||||
Research and Development
Research and development expenses increased during the second quarter and first six 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.
The decrease in intellectual property legal fees during the second quarter of 2022 compared to the same quarter of 2021 resulted primarily due to lower legal expenses incurred to defend our patent portfolio internationally. During the first six months of 2022, intellectual property legal fees were consistent compared with the same period of 2021.
Selling, General and Administrative
Selling, general and administrative expenses increased during the second quarter and first six 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 ended January 2, 2022 which means that we need to file our quarterly
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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.
Other Income (Expense), Net
Other income (expense), net for the three and six months ended July 2, 2022, and July 3, 2021 was as follows (dollars in thousands):
Three Months Ended | Six Months Ended | |||||||||||||||
July 2, | July 3, | % | July 2, | July 3, | % | |||||||||||
| 2022 |
| 2021 |
| Change | 2022 |
| 2021 |
| Change | ||||||
Interest income (expense), net | $ | 15 | $ | (145) | $ | 4 | $ | (292) | ||||||||
Other (expense) income, net | (6) | 645 | (8) | 643 | ||||||||||||
Total other (expense) income, net | $ | 9 | $ | 500 | 98% | $ | (4) | $ | 351 | 101% | ||||||
Interest expense, net, in 2021 consisted primarily of interest expense on the $15 million secured convertible note issued to SVIC in November 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 second quarter and first six months of 2022. During the second quarter and first six months of 2021, other (expense) income, net, included the gain on forgiveness of the PPP Loan of $0.6 million.
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 of July 2, 2022, and January 1, 2022 and for the first six months of 2022 and 2021 (in thousands):
July 2, | January 1, | |||||
| 2022 |
| 2022 | |||
Cash, cash equivalents and restricted cash | $ | 60,565 | $ | 58,479 | ||
Convertible promissory note and accrued interest, net | 189 | 562 | ||||
Working capital | 46,336 | 52,613 | ||||
Six Months Ended | ||||||
July 2, | July 3, | |||||
| 2022 |
| 2021 | |||
Net cash provided by (used in) operating activities | $ | (1,433) | $ | 27,127 | ||
Net cash used in investing activities | (326) | (144) | ||||
Net cash provided by financing activities | 3,845 | 10,935 | ||||
During the six months ended July 2, 2022, net cash used in operating activities was primarily a result of net loss of $10.8 million, non-cash adjustments to net loss of $1.9 million, and net cash inflows from changes in operating assets and liabilities of $7.4 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 receivable, partially offset by an increase in inventories. Net cash provided by financing activities during the six months ended July 2, 2022 primarily consisted of $1.0 million in net borrowings under the SVB Credit Agreement, $3.7 million in net
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proceeds from issuance of common stock under the Second 2021 Lincoln Park Purchase Agreement, $0.2 million in proceeds from exercise of stock options, offset by $0.4 million in payments of note payable to finance insurance policies and $0.7 million in payments for taxes related to net share settlement of equity awards.
During the six months ended July 3, 2021, net cash provided by operating activities was primarily a result of net income of $23.8 million and non-cash adjustments to net income of $0.6 million, offset by net cash inflows from 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 ended July 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.
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 Second 2021 Purchase Agreement. As of July 2, 2022, $60.4 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 $5.0 million. The borrowing base was limited to 85% of eligible accounts receivable, subject to certain adjustments as set forth in the SVB Credit Agreement. On April 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 to December 30, 2021. The amount available for borrowing may be increased to $7.0 million and the maturity date was extended to April 29, 2022 upon our request, if we meet certain conditions.
On April 29, 2022, we entered into an amendment to the SVB Credit Agreement to accrue interest on advance at a per annum rate equal to the greater of 0.75% above the Prime Rate or 4.25%. The borrowing base is limited to 85% of eligible accounts receivable, subject to certain adjustments, and 50% of eligible inventory. The maximum amount available for borrowing was increased to $10.0 million and the maturity date was extended to April 28, 2023.
As of July 2, 2022, the outstanding borrowings under the SVB Credit Agreement were $8.0 million with additional borrowing availability of $2.0 million. During the six months ended July 2, 2022, we made net borrowings of $1.0 million under the SVB Credit Agreement.
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, borrowing availability under the SVB Credit Agreement, the equity financing available under September 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.
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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 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.
Item 3. | Quantitative and Qualitative Disclosures About Market Risk |
Foreign Currency Exchange Risk
All of our sales and the majority of our expenses are denominated in U.S. dollars. Since we operate in the People’s Republic of China, a percentage of our operational expenses are denominated in RMB and exchange volatility could positively or negatively impact those operating costs. Additionally, we may hold certain assets and liabilities in local currency on our consolidated balance sheet. As the operational expenses in RMB is immaterial, we do not believe that foreign exchange volatility has a material impact on our current business or results of operations.
Item 4. | Controls and Procedures |
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed by us in reports we file or submit under the Securities Exchange Act of 1934, as amended (the “Exchange Act”) is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosures.
Our management conducted an evaluation, with the participation of our principal executive officer and principal financial officer, of the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) promulgated under the Exchange Act) as of the end of the period covered by this report. Based on this evaluation, due to the elimination of our audit committee in August 2020 and ineffective program change management related to certain information technology (IT) systems that support the Company’s financial reporting processes, our principal executive officer and our principal financial officer concluded that our disclosure controls and procedures were not effective as of July 2, 2022.
Notwithstanding the material weakness in our internal control over financial reporting, we have concluded that the unaudited condensed consolidated financial statements included in this Form 10-Q fairly present, in all material respects, our financial position, results of operations and cash flows for the periods presented in conformity with U.S. GAAP.
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Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting that occurred during the quarter ended July 2, 2022 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Remediation Initiatives
In an effort to remediate the identified material weaknesses and enhance our internal controls related to our lack of an independent board and audit committee, we continue to maintain our financial reporting process we followed to prepare consolidated financial statements in accordance with U.S. GAAP for audit committee meetings on a quarterly and annual basis. We engage all departments groups to identify risks to the achievement of our goals as a basis for determining how the risks should be managed. In an effort to remediate the identified material weakness related to our ineffective design and maintenance of controls over user access and program change management related to certain IT systems, we hired a full-time Senior Director of IT in the fourth quarter of 2021 with a primary mandate to focus on SOX compliance and mitigation plan for 2022. Our Chief Executive Officer and sole director will oversee the process to ensure all required disclosures are made in our consolidated financial statements on a quarterly and annual basis.
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PART II. — OTHER INFORMATION
Item 1. | Legal Proceedings |
The information under “Litigation and Patent Reexaminations” in Note 7 to the condensed consolidated financial statements included in Part I, Item 1 of this report is incorporated herein by reference.
Item 1A. Risk Factors
Risks Related to Our Business, Operations and Industry
| ● | We face risks related to the impact of the COVID-19 pandemic and the related protective public health measures; |
| ● | We have historically incurred losses and may continue to incur losses; |
| ● | The vast majority of our net product sales in recent periods have been generated from resales of component products, including products sourced from Samsung and SK hynix, and any decline in these product resales could significa |