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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
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☒
| ⌧QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended September 30, 2017April 3, 2021
or
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☐
| ◻TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from _____ to
_____
Commission file numbernumber: 001-33170
NETLIST, INC.
(Exact name of registrant as specified in its charter)
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Delaware | | 95-4812784 |
Delaware
| | 95-4812784
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(State or other jurisdiction of incorporation or organizationorganization) | | (I.R.S. Employer Identification No.) |
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175 Technology Drive, Suite 150 Irvine, California | | 92618 |
(Address of principal executive offices) | | (Zip Code) |
175 Technology Drive, Suite 150
Irvine, CA 92618
(Address of principal executive offices) (Zip Code)
(949)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 and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (section (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post 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.
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Large accelerated filer ☐◻ | Accelerated filer ☐◻ | Non-accelerated filer ☐⌧ | Smaller reporting company ☒⌧ |
| | (Do not check if a
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 ☒⌧
The numberAs of May 11, 2021, there were 215,600,939 outstanding shares outstanding of the registrant’s common stock as of the latest practicable date:stock.
Common Stock, par value $0.001 per share
70,419,646 shares outstanding at November 6, 2017
See accompanying notes.
See accompanying notes.
NETLIST, INC. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements (Unaudited)
September 30, 2017
Note 1—Description of Business
Netlist, Inc. together withand its wholly ownedwholly-owned subsidiaries (hereinafter collectively referred to as(collectively the “Company” or “Netlist,” unless the context or the use of the term indicates otherwise) is a leading provider of“Netlist”) provides high-performance modular memory subsystems servingto customers in diverse industries that require superiorenterprise and storage class memory performancesolutions to empower critical business decisions. The Company has a long history of introducing disruptive new products, such as one of the first load-reduced dual in-line memory modules (“LRDIMM”) based on its distributed buffer architecture, which has been adopted by the industry for DDR4 LRDIMM. The Company was also one of the first to bring NAND flash memory (“NAND flash”) to the memory channel with its NVvault®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. The Company recentlyhas introduced a new generation of storage class memory products called HybriDIMM™HybriDIMM to address the growing need for real-time analytics in Big Data applications, in-memory databases, high performance computing and in‑memory databases.
Dueadvanced data storage solutions. The Company's NVMe SSD portfolio provides industry-leading performance offered in multiple capacities and form factors. The Company also resells SSD, NAND flash, DRAM products and other component products to the ground-breaking product development of its engineering teams, Netlist has built a robust portfolio of over 100 issued and pending U.S. and foreign patents, many seminal,end-customers that are not reached in the areasdistribution models of hybrid memory,the component manufacturers, including storage class memory, rank multiplicationcustomers, appliance customers, system builders and load reduction. Since its inception, the Company has dedicated substantial resources to the developmentcloud and protection of technology innovations essential to its business. The Company’s early pioneering work in these areas has been broadly adopted in industry-standard LRDIMM and in NVDIMM. Netlist’s objective is to continue to innovate in its field and invest further in its intellectual property portfolio, with the goal of monetizing its intellectual property through a combination of product revenues 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.datacenter customers.
Netlist was incorporated in June 2000 and is headquartered in Irvine, California. In 2007, the Company established a manufacturing facility in the People’s Republic of China (the “PRC”), which became operational in July 2007 upon the successful qualification of certain key customers.
Liquidity
The Company incurred net losses of $3.1 million and $10.3 million for the three and nine months ended September 30, 2017, respectively, and $11.2 million and $20.5 million for the fiscal years ended December 31, 2016 and January 2, 2016, respectively. The Company has historically financed its operations primarily through issuances of equity and debt securities and revenues generated from operations, including product revenues and a non-recurring engineering (“NRE”) fee from its Joint Development and License Agreement (“JDLA”) with Samsung Electronics Co., Ltd. (“Samsung”), discussed below. The Company has also funded its operations with a revolving line of credit and term loans under a bank credit facility, a funding arrangement for costs associated with certain of its legal proceedings and, to a lesser extent, equipment leasing arrangements (see Notes 4, 5 and 7).
On November 12, 2015, the Company entered into the JDLA with Samsung, pursuant to which the Company and Samsung have agreed to work together to jointly develop new storage class memory technologies including a standardized product interface for NVDIMM-P memory modules in order to facilitate broad industry adoption of this new technology. The JDLA also includes comprehensive cross-licenses to the Company’s and Samsung’s patent portfolios for the purpose of developing this product interface, grants Samsung a right of first refusal to acquire the Company’s HybriDIMM technology before it offers the technology to a third party, and grants the Company access to competitively priced DRAM and NAND flash raw materials. The Company believes Samsung represents an important strategic partner with a high level of technical capability in memory that can facilitate bringing its HybriDIMM technology to market. In connection with the JDLA, the Company received an $8.0 million NRE fee from Samsung for the joint development and received gross proceeds of $15.0 million for its issuance of a Senior Secured Convertible Note
(“SVIC Note”) and Stock Purchase Warrant (“SVIC Warrant”) to SVIC No. 28 New Technology Business Investment L.L.P., an affiliate of Samsung Venture Investment Co. (“SVIC”) (see Note 5).
On September 23, 2016, the Company completed an underwritten registered public offering (the “2016 Offering”), pursuant to which it sold 9,200,000 shares of its common stock at a price to the public of $1.25 per share. The net proceeds to the Company from the 2016 Offering were $10.3 million, after deducting underwriting discounts and commissions and offering expenses paid by the Company.
On August 22, 2017, the Company completed an underwritten registered public offering (the “2017 Offering”), pursuant to which it sold 8,500,000 shares of its common stock at a price to the public of $0.60 per share. The net proceeds to the Company from the 2017 Offering were $4.4 million, after deducting underwriting discounts and commissions and offering expenses paid by the Company.
Inadequate working capital would have a material adverse effect on the Company’s business and operations and could cause the Company to fail to execute its business plan, fail to take advantage of future opportunities or fail to respond to competitive pressures or customer requirements. A lack of sufficient funding may also require the Company to significantly modify its business model and/or reduce or cease its operations, which could include implementing cost-cutting measures or delaying, scaling back or eliminating some or all of its ongoing and planned investments in corporate infrastructure, research and development projects, business development initiatives and sales and marketing activities, among other activities. While the Company’s estimates of its operating revenues and expenses and working capital requirements could be incorrect and the Company may use its cash resources faster than it anticipates, management believes the Company’s existing cash balance, together with cash provided by the Company’s operations and borrowing availability under a bank credit facility (see Note 4) and taking into account cash expected to be used in operations and the funding to be received for certain litigation expenses (see Note 7), will be sufficient to meet the Company’s anticipated cash needs for at least the next 12 months.
Note 2—Summary of Significant Accounting Policies
Significant Accounting Policies
Basis of Presentation
The accompanying interim unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) for interim financial. Certain information and footnote disclosures normally included in the instructionsconsolidated 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’sCommission (“SEC”) Form 10-Q and Article 8 of the SEC’s Regulation S-X.. These condensed consolidated financial statements do not include all of the information and footnotes required by U.S. GAAP for complete financial statements. Therefore, these unaudited condensed consolidated financial statements should be read in conjunction with the Company’s audited consolidated financial statements and notes thereto as of and for the year ended December 31, 2016,January 2, 2021, included in the Company’s Annual Report on Form 10-K filed with the SEC on March 31, 2017.26, 2021 (the “2020 Annual Report”).
The accompanyingIn the opinion of management, all adjustments for the fair presentation of the Company’s condensed consolidated financial statements ashave been made. The adjustments are of and for the three and nine months ended September 30, 2017 are unaudited; however, they contain alla normal recurring accruals and adjustments that, in the opinion of the Company’s management, are necessary to present fairly the condensed consolidated financial position of the Company and its wholly-owned subsidiariesnature except as of September 30, 2017 and the condensed consolidated statements of operations and statements of cash flows for the nine months ended September 30, 2017 and October 1, 2016.otherwise noted. The results of operations for the three and nine months ended September 30, 2017interim periods are not necessarily indicative of the results to be expected for anyother periods or the full year or anyfiscal year. The Company has evaluated events occurring subsequent to April 3, 2021, 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 interim period.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 2021 will include 52 weeks and ends on January 1, 2022 and its fiscal year 2020 included 53 weeks and ended on January 2, 2021. The four quarters of fiscal year 2021 each includes 13 weeks. The first three quarters of fiscal year 2020 each included 13 weeks and the fourth quarter included 14 weeks. Unless otherwise stated,
Fiscal Year
The Company operates under a 52 or 53-week fiscal year ending on the Saturday closestreferences to December 31. For 2017,particular years, quarters, months and periods refer to the Company’s fiscal year is scheduled to end on December 30, 2017years ended in January and will consistthe associated quarters, months and periods of 52 weeks, and each of the Company’s quarters within suchthose fiscal year will be comprised of 13 weeks.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 reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the condensed consolidated financial statements, and the reported amounts of net revenues and expenses during the reporting period. By their nature, these estimates and assumptions are subject to an inherent degree of uncertainty. Significant estimates made by management include, among others, provisions for uncollectible receivables and sales returns, warranty liabilities, valuation of inventories, fair value of financial instruments, recoverability of long-lived assets, valuation of stock-based transactions, estimates for completion of NRE revenue milestones, and realization of deferred tax assets. The Company bases its estimates on its historical experience, knowledge of current conditions and the Company’s belief of what could occur in the future considering available information. The Company reviews its estimates on an on-going basis.reported. Actual results may differ materially from these estimates which may result in material adverse effects onthose estimates.
Recently Adopted Accounting Guidance
In the Company’s consolidated operating results and financial position.
Thefirst quarter of 2021, the Company believesadopted the following critical accounting policies involve its more significant assumptions and estimates used in the preparation of the accompanying condensed consolidated financial statements: provisions for uncollectible receivables and sales returns; warranty liabilities; valuation of inventories; fair value of financial instruments; recoverability of long-lived assets; valuation of stock-based transactions; estimates for completion of NRE and other revenue milestones; and realization of deferred tax assets.
Revenue Recognition
The Company generates revenue from sales of products and performance of engineering services.
Net Product Revenues
Net product revenues primarily consist of sales of high-performance modular memory subsystems to original equipment manufacturers (“OEMs”), Hyperscale data center operators and storage vendors.
The Company recognizes revenues in accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards CodificationUpdate (“ASC”ASU”) Topic 605. Accordingly,No. 2019-12, Income Taxes (Topic 740) Simplifying the Company recognizes revenues when there is persuasive evidence that an arrangement exists, product delivery and acceptance have occurred, the sales price is fixed or determinable, and collectability of the resulting receivable is reasonably assured.
The Company generally uses customer purchase orders and/or contracts as evidence of an arrangement. Delivery occurs when goods are shippedAccounting for customers with shipping point terms and upon receipt for customers with destination terms, atIncome Taxes, which time title and risk of loss transfereliminates certain exceptions related to the customer. Shipping documents are used to verify delivery and customer acceptance. The Company assesses whetherapproach for intraperiod tax allocation, the sales price is fixed or determinable based on the payment terms associated with the transaction and whether the sales price is subject to refund. Customers are generally allowed limited rights of returnmethodology for up to 30 days, except for sales of excess component inventories, which contain no right-of-return privileges. Estimated returns are provided for at the time of sale based on historical experience or specific identification ofcalculating income taxes in an event necessitating a reserve. The Company offers a standard product warranty to its customers and has no other post-shipment obligations. The Company assesses collectability based on the creditworthiness of the customer as determined by credit checks and evaluations, as well as the customer’s payment history.
All amounts billed to customers related to shipping and handling are classified as net product revenues, while all costs incurred by the Company for shipping and handling are classified as cost of sales.
Engineering Services
The Company provides engineering services to its customers. The Company recognizes revenue from these services when all of the following conditions are met: (1) evidence existed of an arrangement with the customer, typically consisting of a purchase order or contract; (2) the Company’s services were performed and risk of loss passed to the customer; (3) the Company completed all of the necessary terms of the contract; (4) the amount of revenue to which the Company was entitled was fixed or determinable; and (5) the Company believed it was probable that it would be able to collect the amount due from the customer. To the extent that one or more of these conditions has not been satisfied, the Company defers recognition of revenue.
Deferred Revenue
From time-to-time the Company receives pre-payments from its customers related to future services. Engineering development fee revenues, including NRE fees, are deferred and recognized ratably over the period the engineering work is completed.
Cash and Cash Equivalents
Cash and cash equivalents consist of cash and short-term investments with original maturities of three months or less.
Restricted Cash
Restricted cash consists of cash to secure standby letters of credit. Restricted cash was $2.4 million as of September 30, 2017 and related to three standby letters of credit. Restricted cash was $3.1 million as of December 31, 2016 and related to two standby letters of credit.
Fair Value of Financial Instruments
The Company’s financial instruments consist principally of cash and cash equivalents, restricted cash, accounts receivable, accounts payable, accrued expenses and debt instruments. The fair value of the Company’s cash equivalents is determined based on quoted prices in active markets for identical assets or Level 1 inputs. The Company recognizes transfers between Levels 1 through 3 of the fair value hierarchy at the beginning of the reporting period. The Company believes that the carrying values of all other financial instruments approximate their current fair values due to their nature and respective durations.
Allowance for Doubtful Accounts
The Company performs credit evaluations of our customers’ financial condition and limits the amount of credit extended to its customers as deemed necessary, but generally requires no collateral. The Company evaluates the collectability of accounts receivable based on a combination of factors. In cases where the Company is aware of circumstances that may impair a specific customer’s ability to meet its financial obligations subsequent to the original sale, the Company will record an allowance against amounts due, and thereby reduce the net recognized receivable to the amount the Company reasonably believes will be collected. For all other customers, the Company records allowances for doubtful accounts based primarily on the length of time the receivables are past due based on the terms of the originating transaction, the current business environment, and its historical experience. Uncollectible accounts are charged against the allowance for doubtful accounts when all cost-effective commercial means of collection have been exhausted. Generally, the Company’s credit losses have been within expectations and the provisions established. However, the Company cannot guarantee that it will continue to experience credit loss rates similar to those experienced in the past.
The Company’s accounts receivable are highly concentrated among a small number of customers, and a significant change in the liquidity or financial position of one of these customers could have a material adverse effect on the collectability of the Company’s accounts receivable, liquidity and future operating results.
Concentration of Credit Risk
Financial instruments that potentially subject the Company to significant concentrations of credit risk consist principally of cash and cash equivalents, and accounts receivable.
The Company invests its cash equivalents primarily in money market mutual funds. Cash equivalents are maintained with high quality institutions, the composition and maturities of which are regularly monitored by management. At times, deposits held with financial institutions may exceed the amount of insurance provided by the Federal Deposit Insurance Corporation and the Securities Investor Protection Corporation.
The Company’s trade accounts receivable are primarily derived from sales to OEMs in the server, high-performance computing and communications markets, as well as from sales to storage customers, appliance customers, system builders and cloud and datacenter customers. The Company performs credit evaluations of its customers’ financial condition and limits the amount of credit extended when deemed necessary, but generally requires no collateral. The Company believes that the concentration of credit risk in its trade receivables is moderated by its credit evaluation process, relatively short collection terms, a high level of credit worthiness of its customers (see Note 3), foreign credit insurance, and letters of credit issued in its favor. Reserves are maintained for potential credit losses, and such losses historically have not been significant and have been within management’s expectations.
Inventories
Inventories are valued at the lower of actual cost to purchase or manufacture the inventory or the net realizable value of the inventory. Cost is determined on an average cost basis which approximates actual cost on a first-in, first-out basis and includes raw materials, labor and manufacturing overhead. Net realizable value is the estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation. At each balance sheet date, the Company evaluates its ending inventory quantities on hand and on order and records a provision for excess quantities and obsolescence. Among other factors, the Company considers historical demand and forecasted demand in relation to the inventory on hand, competitiveness of product offerings, market conditions and product life cycles when determining obsolescence and net realizable value. In addition, the Company considers changes in the market value of components in determining the net realizable value of its inventory. Once established, lower of cost or market write-downs are considered permanent adjustments to the cost basis of the excess or obsolete inventories.
Property and Equipment
Property and equipment are recorded at cost and depreciated on a straight-line basis over their estimated useful lives, which generally range from three to seven years. Leasehold improvements are recorded at cost and amortized on a straight-line basis over the shorter of their estimated useful lives or the remaining lease term. Expenditures for repairs and maintenance are expensed as incurred. Upon retirement or sale, the cost and related accumulated depreciation and amortization of disposed assets are removed from the accounts and any resulting gain or loss is included in other expense, net.
Deferred Financing Costs, Debt Discount and Detachable Debt-Related Warrants
Costs incurred to issue debt are deferred and recorded as a reduction to the debt balance in the accompanying condensed consolidated balance sheets. The Company amortizes debt issuance costs over the expected term of the related debt using the effective interest method. Debt discounts relate to the relative fair value of warrants issued in conjunction with the debt and are also recorded as a reduction to the debt balance and accreted over the expected term of the debt to interest expense using the effective interest method.
Impairment of Long-Lived Assets
The Company evaluates the recoverability of the carrying value of long-lived assets held and used by the Company in its operations for impairment on at least an annual basis or whenever events or changes in circumstances indicate that their carrying value may not be recoverable. When such factors and circumstances exist, the Company compares the projected undiscounted future net cash flows associated with the related asset or group of assets over their estimated useful lives against their respective carrying amount. These projected future cash flows may vary significantly over time as a result of increased competition, changes in technology, fluctuations in demand, consolidation of the Company’s customers and reductions in average selling prices. If the carrying value is determined not to be recoverable from future operating cash flows, the asset is deemed impaired and an impairment loss is recognized to the extent the carrying value exceeds the estimated fair value of the asset. The fair value of the asset or asset group is based on market value when available, or when unavailable, on discounted expected cash flows. The Company’s management believes there is no impairment of long-lived assets as of September 30, 2017. However, market conditions could change or demand for the Company’s products could decrease, which could result in future impairment of long-lived assets.
Warranty Liability
The Company offers product warranties generally ranging from one to three years, depending on the product and negotiated terms of any purchase agreements with its customers. Such warranties require the Company to repair or replace defective product returned to the Company during the warranty period at no cost to the customer. Warranties are not offered on sales of excess component inventory. The Company records an estimate for warranty related costs at the time of sale based on its historical and estimated future product return rates and expected repair or replacement costs (see Note 3). While such costs have historically been within management’s expectations and the provisions established, unexpected changes in failure rates could have a material adverse impact on the Company, requiring additional warranty reserves and could adversely affect the Company’s gross profit and gross margins.
Stock-Based Compensation
The Company accounts for equity issuances to non-employees in accordance with FASB ASC Topic 505. All transactions in which goods or services are the consideration received for the issuance of equity instruments are accounted for based on the fair value of the consideration received or the fair value of the equity instrument issued, whichever is more reliably measurable. The measurement date used to determine the estimated fair value of the equity instrument issued is the earlier of the date on which the third-party performance is complete or the date on which it is probable that performance will occur.
In accordance with FASB ASC Topic 718, employee and director stock-based compensation expense recognized during the period is based on the value of the portion of stock-based payment awards that is ultimately expected to vest during the period. Given that stock-based compensation expense recognized in the accompanying condensed consolidated statements of operations is based on awards ultimately expected to vest, it has been reduced for estimated forfeitures. The Company estimates its forfeitures at the time of grant and revises such estimates, if necessary, in subsequent periods if actual forfeitures differ from those estimates. The Company’s estimated average forfeiture rates are based on historical forfeiture experience and estimated future forfeitures.
The estimated fair value of common stock option awards to employees and directors is calculated using the Black-Scholes option pricing model. The Black-Scholes model requires subjective assumptions regarding future stock price volatility and expected time to exercise, along with assumptions about the risk-free interest rate and expected dividends, all of which affect the estimated fair values of the Company’s common stock option awards. The expected term of options granted is calculated as the weighted-average of the vestinginterim period and the contractual expiration daterecognition of deferred tax liabilities for outside basis differences. This ASU also clarifies and simplifies other aspects of the option. This calculation is in accordance with FASB ASC Topic 718, as amended by certain SEC guidance providingaccounting for a safe harbor method in instances where the vesting and exercise termsincome taxes. The adoption of options granted meet certain conditions and where limited historical exercise data is available. The expected volatility is based on the historical volatility of the Company’s common stock. The risk-free rate selected to value any particular grant is based on the U.S. Treasury rate that corresponds to the expected term of the grant effective as of the date of the grant. The expected dividend assumption is based on the Company’s history and management’s expectation regarding dividend payouts.
Compensation expense for common stock option awards with graded vesting schedules is recognized on a straight-line basis over the requisite service period for the last separately vesting portion of the award, provided that the accumulated cost recognized as of any date at least equals the value of the vested portion of the award.
The Company recognizes the fair value of restricted stock awards issued to employees and outside directors as stock-based compensation expense on a straight-line basis over the vesting period for the last separately vesting portion of the awards. Fair value is determined as the difference between the closing price of the Company’s common stock on the grant date and the purchase price of the restricted stock award, if any, reduced by expected forfeitures.
If there are any modifications or cancellations of the underlying vested or unvested stock-based awards, the Company may be required to accelerate, increase or cancel any remaining unearned stock-based compensation expense, or record additional expense for vested stock-based awards. Future stock-based compensation expense and unearned stock-based compensation may increase to the extent that the Company grants additional common stock options or other stock-based awards.
Income Taxes
Deferred tax assets and liabilities are recognized to reflect the estimated future tax effects, calculated at currently effective tax rates, of future deductible or taxable amounts attributable to events thatthis ASU did not have been recognized on a cumulative basis in the accompanying condensed consolidated financial statements. A valuation allowance related to a net deferred tax asset is recorded when it is more likely than not that some portion of the deferred tax asset will not be realized. Deferred tax liabilities, deferred tax assets and valuation allowances are classified as non-current in the accompanying condensed consolidated balance sheets.
ASC Topic 740 prescribes a recognition threshold and measurement requirement for the financial statement recognition of a tax position that has been taken or is expected to be taken on a tax return and also provides guidance on de-recognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. Under ASC Topic 740 the Company may only recognize or continue to recognize tax positions that meet a “more likely than not” threshold.
The application of tax laws and regulations is subject to legal and factual interpretation, judgment and uncertainty. Tax laws and regulations may change as a result of changes in fiscal policy, changes in legislation, the evolution of regulations and court rulings. Therefore, the actual liability for U.S. or foreign taxes may be materially different from the Company’s estimates, which could require the Company to record additional tax liabilities or to reduce previously recorded tax liabilities, as applicable.
Research and Development Expenses
Research and development expenditures are expensed in the period incurred.
Interest Expense
Interest expense consists primarily of interest associated with our debt instruments, including fees related to the term loans, accretion of debt discounts and amortization of debt issuance costs. The Company recognizes the accretion of debt discounts and the amortization of interest costs using the effective interest method.
Risks and Uncertainties
The Company is subject to a number of risks and uncertainties, including its ability to achieve profitable operations due to the Company’s history of losses and accumulated deficits, the Company’s dependence on a small number of customers for a substantial portion of its net product revenues, risks related to intellectual property matters, market acceptance of and demand for the Company’s products, and the risks described below. These risks could have a material adverse effectan impact on the Company’s condensed consolidated financial position, results of operations and cash flows.statements.
The Company has dedicated substantial resources to the development and protection of technology innovations essential to its business, and the Company expects these activities to continue for the foreseeable future. The Company also intends to aggressively pursue monetization avenues for its intellectual property portfolio, potentially including licensing, royalty or other revenue-producing arrangements. However, the Company’s revenues are currently generated by its product revenues, and it may never be successful in generating a revenue stream from its intellectual property, in which case the Company’s investments of time, capital and other resources into its intellectual property portfolio may not provide adequate, or any, returns.
The Company also dedicates substantial resources to protecting its intellectual property, including its pending patent infringement litigation and U.S. International Trade Commission (“ITC”) proceedings against SK hynix Inc., a South Korean memory semiconductor supplier (“SK hynix”), and its efforts to defend its patents against challenges made by way of reexamination and review proceedings at the U.S. Patent and Trademark Office (“USPTO”) and Patent Trial and Appeal Board (“PTAB”) (see Note 7). The Company expects these activities to continue for the foreseeable future, without any guarantee that any ongoing or future patent protection or litigation activities will be successful. The Company is also subject to litigation based on claims that it has infringed the intellectual property rights of others, against which the Company intends to defend itself vigorously. Moreover, any litigation, regardless of its outcome, would involve a significant dedication of resources, including time and costs, would divert management’s time and attention and could negatively impact the Company’s results of operations. As a result, any current or future infringement claims by or against third parties could materially adversely affect the Company’s business, financial condition or results of operations.
The Company has also invested significant research and development time and costs into the design of application-specific integrated circuit (“ASIC”) and hybrid devices, including its NVvault family of products and most recently its next-generation HybriDIMM memory subsystem. The Company believes that market acceptance of these products or derivative products that incorporate its core memory subsystem technology is critical to its success. However, these products are subject to increased risks as compared to the Company’s legacy products. For example, the Company is dependent on a limited number of suppliers for the DRAM and ASIC devices that are essential to the functionality of these products and in the past it has experienced supply chain disruptions and shortages of DRAM and NAND flash required to create its NVvault family of products, and the Company’s products are generally subject to a product approval and qualification process with customers before purchases are made and the Company has experienced a longer qualification cycle than anticipated with some of these products, including its HyperCloud memory subsystems. These and other risks attendant to the production of the Company’s memory subsystem products could impair its ability to obtain customer or market acceptance of these products or obtain such acceptance in a timely manner, which would reduce the Company’s achievable revenues from these products and limit the Company’s ability to recoup its investments in the products.
The Company’s manufacturing operations in the PRC are subject to various political, geographic and economic risks and uncertainties inherent to conducting business in the PRC. These include, among others, (i) volatility and other potential changes in economic conditions in the region, (ii) managing a local workforce and overcoming other practical barriers, such as language and cultural differences, that may subject the Company to uncertainties or unfamiliar practices or regulatory policies, (iii) risks imposed by the geographic distance between the Company’s headquarters and its PRC operations, including difficulties maintaining the desired amount of control over production capacity and timing, inventory levels, product quality, delivery schedules, manufacturing yields and costs, (iv) the Company’s limited experience creating and overseeing foreign operations generally, (v) changes in the laws and policies of the Chinese government that affect business practices generally or restrict local operations by foreign companies, and (vi) changes in the laws and policies of the U.S. government regarding the conduct of business in foreign countries generally or in the PRC in particular, which may be more uncertain following the results of the 2016 U.S. presidential election. Additionally, the Chinese government controls the procedures by which its local currency, the Chinese Renminbi (“RMB”), is converted into other currencies, which generally requires government consent, and imposes legal and regulatory restrictions on the movement of funds outside of the PRC. As a result, RMB may not be freely convertible into other currencies at all times and the Company may need to comply with regulatory procedures to repatriate funds from its Chinese operations. Any changes to currency conversion requirements or any failure by the Company to comply with repatriation procedures and regulations could adversely affect its operating results, liquidity and financial condition.
In addition, fluctuations in the exchange rate between RMB and U.S. dollars may adversely affect the Company’s expenses and results of operations, the value of its assets and liabilities and the comparability of its period-to-period results. The liabilities of the Company’s subsidiary in the PRC exceeded its assets as of September 30, 2017 and October 1, 2016.
Foreign Currency Remeasurement
The functional currency of the Company’s foreign subsidiaries is the U.S. dollar. Local currency financial statements are remeasured into U.S. dollars at the exchange rate in effect as of the balance sheet date for monetary assets and liabilities and the historical exchange rate for nonmonetary assets and liabilities. Expenses are remeasured using the average exchange rate for the period, except items related to nonmonetary assets and liabilities, which are remeasured using historical exchange rates. All remeasurement gains and losses are included in determining net loss. Transaction gains and losses were not significant during the three and nine months ended September 30, 2017 and October 1, 2016.
Net Loss Per Share
Basic net loss per share is calculated by dividing net loss by the weighted-average common shares outstanding during the period, excluding unvested shares issued pursuant to restricted share awards under the Company’s share-based compensation plans. Diluted net loss per share is calculated by dividing the net loss by the weighted-average shares and dilutive potential common shares outstanding during the period. Dilutive potential shares consist of dilutive shares issuable upon the exercise or vesting of outstanding stock options, warrants and restricted stock awards, respectively, computed using the treasury stock method and shares issuable upon conversion of the SVIC Note (see Note 5). In periods of losses, basic and diluted loss per share are the same, as the effect of stock options and unvested restricted share awards on loss per share is anti-dilutive.
Going Concern
In accordance with ASC Subtopic 205-40, Presentation of Financial Statements-Going Concern, management evaluates whether relevant conditions and events, when considered in the aggregate, indicate that it is probable the Company will be unable to meet its obligations as they become due within one year after the date that the financial statements are issued. When relevant conditions or events, considered in the aggregate, initially indicate that it is probable that the Company will be unable to meet its obligations as they become due within one year after the date that the financial statements are issued (and therefore they raise substantial doubt about the Company’s ability to continue as a going concern), management evaluates whether its plans that are intended to mitigate those conditions and events, when implemented, will alleviate substantial doubt about the Company’s ability to continue as a going concern. Management’s plans are considered only to the extent that (1) it is probable that the plans will be effectively implemented and (2) it is probable that the plans will mitigate the conditions or events that raise substantial doubt about the Company’s ability to continue as a going concern. See the discussion under “Liquidity” in Note 1 for information about the Company’s liquidity position.
Recently AdoptedIssued Accounting StandardsGuidance
In July 2015, the FASB issued Accounting Standards Update (“ASU”) No. 2015-11, Simplifying the Measurement of Inventory (“ASU 2015-11”), which requires entities to measure inventory at the lower of cost or net realizable value. Current guidance requires inventory to be measured at the lower of cost or market, with market defined as replacement cost, net realizable value, or net realizable value less a normal profit margin. This ASU simplifies the subsequent measurement of inventory by replacing the lower of cost or market test with a lower of cost or net realizable value test. The Company adopted this guidance in the first quarter of 2017 and there was no material impact on its consolidated financial statements.
In March 2016,August 2020, the FASB issued ASU No. 2016-09, Compensation-Stock Compensation (Topic 718) Improvements to Employee Share-Based Payment2020-06, 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 2016-09”), which is intended to simplify several aspects ofamends the accountingguidance on convertible instruments and the derivatives scope exception for share-based payment award transactions.contracts in an entity's own equity, and also improves and amends the related earnings per share guidance for both Subtopics. The ASU 2016-09 iswill be effective for fiscal years beginning after December 15, 2016, including interim periods. The Company adopted this guidance in the first quarter of 2017 and
elected to continue to estimate forfeitures expected to occur to determine the amount of compensation cost to be recognized in each period; as a result there was no material impact on its consolidated financial statements.
Recent Accounting Pronouncements
In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers (“ASU 2014-09”), which was subsequently amended by ASUs 2015-14, 2016-08, 2016-10, 2016-12, and 2016-20. ASU 2014-09, as amended, supersedes the revenue recognition requirements in ASC Topic 605, Revenue Recognition, and creates a new ASC Topic 606 (“ASC 606”). ASU 2014-9, as amended, implements a five-step process for customer contract revenue recognition that focuses on transfer of control, as opposed to transfer of risk and rewards. The amendment also requires enhanced disclosures regarding the nature, amount, timing and uncertainty of revenues and cash flows from contracts with customers. Other major provisions include the capitalization and amortization of certain contract costs, ensuring the time value of money is considered in the transaction price, and allowing estimates of variable consideration to be recognized before contingencies are resolved in certain circumstances. Entities can transition to the standard either retrospectively or as a cumulative-effect adjustment as of the date of adoption. ASC 606 is effective for public entities for annual periods beginning after December 15, 2017 (fiscal year 2018 for the Company), and interim periods within the year of adoption. The Company has not yet selected a transition method but does not anticipate the adoption of ASC 606 will have a material impact on its consolidated financial statements and disclosures.
In February 2016, the FASB issued ASU No. 2016-02, Leases (“ASU 2016-02”). Under ASU 2016-02, lessees will be required to recognize the following for all leases (with the exception of short-term leases) at the commencement date: a lease liability, which is a lessee’s obligation to make lease payments arising from a lease, measured on a discounted basis; and a right-of-use asset, which is an asset that represents the lessee’s right to use, or control the use of, a specified asset for the lease term. ASU 2016-02 is effective for fiscal years beginning after December 15, 2018 (fiscal year 2019 for the Company), including interim periods within those fiscal years. Early application is permitted. Lessees must apply a modified retrospective transition approach for leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements. The modified retrospective approach would not require any transition accounting for leases that expired before the earliest comparative period presented. Lessees may not apply a full retrospective transition approach. The Company is currently evaluating the impact of adopting ASU 2016-02 on its consolidated financial statements and disclosures.
In August 2016, the FASB issued ASU No. 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments (“ASU 2016-15”), which is intended to reduce the existing diversity in practice in how certain cash receipts and cash payments are classified in the statement of cash flows. ASU 2016-15 is effective for fiscal years beginning after December 15, 2017 (fiscal year 2018 for the Company),2023, including interim periods within those fiscal years withand early adoption permitted, provided that all of the amendments are adopted in the same period. The Company is currently evaluating the impact of adopting ASU 2016-15 on its consolidated financial statements and disclosures.
In October 2016, the FASB issued ASU No. 2016-16, Income Taxes (Topic 740), Intra-Entity Transfers of Assets Other Than Inventory (“ASU 2016-16”), which requires entities to recognize the income tax consequences of an intra-entity transfer of an asset other than inventory when the transfer occurs. This amends current U.S. GAAP which prohibits recognition of current and deferred income taxes for all types of intra-entity asset transfers until the asset has been sold to an outside party. ASU 2016-16 is effective for fiscal years beginning after December 15, 2017 (fiscal year 2018 for the Company), including interim periods therein with early application permitted. Upon adoption, the Company must apply a modified retrospective transition approach through a cumulative-effect adjustment to retained earnings as of the beginning of the period of adoption. The Company is currently evaluating the impact of this new standard on its consolidated financial statements and disclosures, as well as its planned adoption date.
In November 2016, the FASB issued ASU No. 2016-18, Statement of Cash Flows (Topic 230), Restricted Cash (“ASU 2016-18”), which enhances and clarifies the guidance on the classification and presentation of restricted cash in the statement of cash flows. ASU 2016-18 is effective for fiscal periods beginning after December 15, 2018 (fiscal year 2019 for the Company), including interim periods therein with early application permitted. The Company is currently evaluating the impact of this standardguidance will have on its condensed consolidated financial statements and disclosures.statements.
Note 3—Supplemental Financial Information
Inventories
Inventories consisted of the following as of the dates presented:(in thousands):
| | | | | | | |
| | September 30, | | December 31, | |
| | 2017 | | 2016 | |
| | (in thousands) | |
| | | | | | | |
| | | April 3, | | January 2, |
| | | 2021 | | 2021 |
Raw materials | | $ | 1,217 | | $ | 884 | | $ | 2,352 | | $ | 578 |
Work in process | | | 276 | | | 47 | | | 820 | | | 2 |
Finished goods | | | 2,893 | | | 2,229 | | | 5,384 | | | 2,618 |
| | $ | 4,386 | | $ | 3,160 | |
| | | $ | 8,556 | | $ | 3,198 |
Warranty Liabilities
The following table summarizes activity related to warranty liabilities in the periods presented:
| | | | | | |
| | Nine Months Ended |
| | September 30, | | October 1, |
| | 2017 | | 2016 |
| | (in thousands) |
Beginning balance | | $ | 89 | | $ | 122 |
Estimated cost of warranty claims charged to cost of sales | | | 162 | | | 33 |
Cost of actual warranty claims | | | (119) | | | (87) |
Ending balance | | | 132 | | | 68 |
Less current portion | | | (79) | | | (41) |
Long-term warranty liability | | $ | 53 | | $ | 27 |
The allowance for warranty liabilities expected to be incurred within one year is included as a component of accrued expenses and other current liabilities in the accompanying condensed consolidated balance sheets. The allowance for warranty liability expected to be incurred after one year is classified as long-term warranty liability in the accompanying condensed consolidated balance sheets.
Computation of Net Loss Per Share
The following table sets forthshows the computation of basic and diluted net loss per share including the numerator and denominator used in the calculation of basic and diluted net losscommon stock (in thousands, except per share for the periods presented:data):
| | | | | | | | | | | | |
| | Three Months Ended | | Nine Months Ended |
| | September 30, | | October 1, | | September 30, | | October 1, |
| | 2017 | | 2016 | | 2017 | | 2016 |
| | (in thousands, except per share data) |
Basic and diluted net loss per share: | | | | | | | | | | | | |
Numerator: Net loss | | $ | (3,098) | | $ | (4,401) | | $ | (10,287) | | $ | (7,308) |
Denominator: Weighted-average common shares outstanding, basic and diluted | | | 65,644 | | | 52,454 | | | 63,056 | | | 51,301 |
Basic and diluted net loss per share | | $ | (0.05) | | $ | (0.08) | | $ | (0.16) | | $ | (0.14) |
| | | | | | |
| | Three Months Ended |
| | April 3, | | March 28, |
| | 2021 | | 2020 |
Numerator: Net loss | | $ | (4,017) | | $ | (1,542) |
Denominator: Weighted-average common shares outstanding—basic and diluted | | | 205,680 | | | 169,719 |
Net loss per share—basic and diluted | | $ | (0.02) | | $ | (0.01) |
alleges that Inphi is contributorily infringing and actively inducing the infringement of U.S. patents owned by the Company, including the ‘912 patent, U.S. Patent No. 7,532,537 (the “‘537 patent”), which relates generally to memory modules with load isolation and memory domain translation capabilities, and U.S. Patent No. 7,636,274 (the “‘274 patent”), which is related to the ‘537 patent and relates generally to load isolation and memory domain translation technologies. The Company is seeking damages and injunctive relief based on Inphi’s use of the Company’s patented technology. Inphi denied infringement and claimed that the three patents are invalid. In June 2010, Inphi requested and was later granted Inter Partes Reexaminations of the ‘912, ‘537 and ‘274 patents by the USPTO. The reexamination proceedings are described below (except for the reexamination proceeding related to the ‘537 patent, which have concluded with the confirmation of all of the claims of such patent). In connection with the reexamination requests, Inphi filed a motion to stay the patent infringement lawsuit with the Central District Court until completion of the reexamination proceedings, which was granted.
‘912 Patent Reexamination
As noted above, in On April 2010, June 2010 and October 2010, Google and16, 2019, Inphi submitted requests forfiled anInter Partes Reexamination of the ‘912 patent by the USPTO, claiming that the ‘912 patent is invalid and requesting that the USPTO reject the patent’s claims and cancel the patent. Additionally, in October 2010, Smart Modular, Inc. (“Smart Modular”) submitted another such reexamination request. On January 18, 2011, the USPTO granted such reexamination requests, and in February 2011, the USPTO merged the Inphi, Google and Smart Modular ‘912 patent reexaminations into a single proceeding. On March 21, 2014, the USPTO issued an Action Closing Prosecution (“ACP”), an office action that states the USPTO examiner’s position on patentability and closes further prosecution, and on June 18, 2014 the USPTO issued a Right of Appeal Notice (“RAN”), a notice that triggers the rights of the involved parties to file a notice of appeal to the ACP, eachPTAB’s January 31, 2019 decision upholding the validity of which confirmed the patentability of 92 of the ‘912 patent’s claims and rejected the
patent’s 11 other claims. The parties involved filed various notices of appeal, responses and requests, and on November 24, 2015, the PTAB held a hearing on such appeals. On May 31, 2016, the PTAB issued a decision affirming certain of the examiner’s decisions and reversing others. On February 9, 2017, the PTAB granted the Company’s request to reopen prosecution before the USPTO examiner and remanded the consolidated proceeding to the examiner to consider the patentability of certain of the pending claims in view of the PTAB’s May 31, 2016 decision and comments from the parties. On October 3, 2017, the examiner issued a determination as to the patentability of certain of the pending claims, which were found to be unpatentable. The proceeding will now return to the PTAB for reconsideration and issuance of a new decision. Accruals have not been recorded for loss contingencies related to theNetlist’s ‘912 patent reexamination proceedings because it is not probable that a loss has been incurred and the amount of any such loss cannot be reasonably estimated.
‘627 Patent Reexamination
In September 2011, Smart Modular submitted a request for an Inter Partes Reexamination by the USPTO of the Company’s U.S. Patent No. 7,864,627 (the “‘627 patent”), related to the ‘912 patent, claiming that the ‘627 patent is invalid and requesting that the USPTO reject the patent’s claims and cancel the patent. On November 16, 2011,June 15, 2020, the request was granted. On March 27, 2014 and June 27, 2014, the USPTO issued an ACP and a RAN, respectively, each of which rejected all of the ‘627 patent’s claims. The parties involved filed various notices of appeal, responses and requests, and on November 24, 2015, the PTAB held a hearing on such appeals. On May 31, 2016, the PTAB issued a decision affirming the decisions of the examiner. On February 9, 2017, the PTAB granted the Company’s request to reopen prosecution before the USPTO examiner and remanded the proceeding to the examiner to consider the patentability of certain of the pending claims in view of the PTAB’s May 31, 2016 decision and comments from the parties. On October 2, 2017, the examiner issued a determination as to the patentability of the pending claims, which were found to be unpatentable. The proceeding will now return to the PTAB for reconsideration and issuance of a new decision. Accruals have not been recorded for loss contingencies related to the ‘627 patent reexamination proceedings because it is not probable that a loss has been incurred and the amount of any such loss cannot be reasonably estimated.
‘274 Patent Reexamination
As noted above, in April 2010 and June 2010, Inphi submitted requests for an Inter Partes Reexamination of the ‘274 patent by the USPTO. On August 27, 2010, the request was granted. In March 2012 and June 2012, the USPTO issued an ACP and a RAN, respectively, each of which confirmed the patentability of many of the ‘274 patent’s claims. The parties involved filed various notices of appeal, responses and requests, and on November 20, 2013, the PTAB held a hearing on such appeals. On January 16, 2014, the PTAB issued a decision affirming the examiner in part, but reversing the examiner on new grounds and rejecting all of the patent’s claims. On September 11, 2015, the USPTO examiner issued a determination rejecting the amended claims. On January 23, 2017, the USPTO granted-in-part the Company’s petition to enter comments in support of its positions in the proceeding. On May 9, 2017, the PTAB issued a decision on appeal affirming the rejection of all claims. Netlist requested rehearing of the PTAB’s decision on June 6, 2017. The PTAB denied the rehearing request on August 8, 2017. Netlist expects to appeal the decision to the Court of Appeals for the Federal Circuit. Accruals have not been recorded for loss contingencies related to the ‘274 patent reexamination proceedings because it is not probable that a loss has been incurred and the amount of any such loss cannot be reasonably estimated.
Smart Modular ‘295 Patent Litigation and Reexamination
In September 13, 2012, Smart Modular, Inc. (“Smart Modular”) filed a patent infringement lawsuit against the Company in the U.S. District Court for the Eastern District of California (the “Eastern District Court”). The complaint alleges that the Company willfully infringes and actively induces the infringement of certain claims of U.S. Patent No. 8,250,295 (“the ‘295 patent”) issued to Smart Modular and seeks damages and injunctive relief. The Company answered Smart Modular’s complaint in October 2012, denying infringement of the ‘295 patent, asserting that the ‘295 patent is invalid and unenforceable, and asserting counterclaims against Smart Modular.
On December 7, 2012, the USPTO granted the Company’s request for the reexamination of the ‘295 patent. On April 29, 2014, the USPTO examiner issued an ACP confirming some claims and rejecting others, and on August 4, 2015, the examiner issued a RAN confirming all pending claims. On September 4, 2015, the Company appealed to the
PTAB. The parties involved filed various notices of appeal, responses and requests, and on September 22, 2016, the PTAB held a hearing on such appeals. On November 14, 2016, the PTAB issued a decision reversing the examiner and rejected all of the pending claims. On January 23, 2017, Smart Modular filed a request to reopen prosecution. The parties had the opportunity present evidence and arguments and the examiner issued a determination on May 8, 2017, which found all pending claims to be unpatentable. The proceeding will now return to the PTAB for reconsideration and issuance of a new decision.
Smart Modular and SanDisk Litigation
On July 1 and August 23, 2013, the Company filed complaints against Smart Modular, Smart Storage Systems (“Smart Storage”) (which was subsequently acquired by SanDisk Corporation (“SanDisk”)), Smart Worldwide Holdings (“Smart Worldwide”) and Diablo Technologies (“Diablo”) in the Central District Court, seeking, among other things, damages and other relief for alleged infringement of several of the Company’s patents by the defendants based on the manufacture and sale of the ULLtraDIMM memory module, alleged antitrust violations by Smart Modular and Smart Worldwide, and alleged trade secret misappropriation and trademark infringement by Diablo. The trade secret misappropriation and trademark infringement claims against Diablo were fully adjudicated on August 17, 2016 and are no longer pending.
On August 23, 2013, Smart Modular and Diablo each filed a complaint in the San Francisco Division of the Northern District Court seeking declaratory judgment of non-infringement and invalidity of the patents asserted in the Company’s complaint. Based on various motions filed by the parties, on November 26, 2013, the Central District Court severed and transferred the patent claims related to the ULLtraDIMM memory module to the Northern District Court.
On February 12, 2014, the Northern District Court granted the parties’ joint stipulation dismissing Smart Modular without prejudice. Between June 18, 2014 and August 23, 2014, SanDisk, Diablo, and Smart Modular filed numerous petitions in the USPTO requesting Inter Partes Review of the Company’s asserted patents. All of the reviews associated with U.S. Patent Nos. 8,516,187; 8,301,833; 8,516,185 have been resolved in the Company’s favor and are no longer pending. The reviews associated with U.S. Patent Nos. 8,001,434; 8,359,501; 7,881,150; and 8,081,536 have concluded before the PTAB and the parties have appealed the decisions in these reviews to theUnited States Court of Appeals for the Federal Circuit and are awaiting decisions. On April 9, 2015,affirmed the Northern District Court stayedPTAB’s previous decision upholding the infringement proceedings as to the Company’s patents asserted against the ULLtraDIMM pending resolutionvalidity of the patent review decisions on appeal.claims in Netlist’s ‘912 patent.
SK hynix Litigation
On September 1, 2016, the Company filed legal proceedings for patent infringement against SK hynix in the ITC (the “First ITC Action”) and the Central District Court. TheThese proceedings are based on the alleged infringement by SK hynix’s registered dual in-line memory module (“RDIMM”) and LRDIMM enterprise memory products of six of the Company’s U.S. patents. On October 31, 2017, the Company filed additional legal proceedings for patent infringement against SK hynix in the ITC (the “Second ITC Action”) based on the alleged infringement by SK hynix’s RDIMM and LRDIMM products of two additional U.S. patents owned by the Company. In all of the ITC proceedings, the Company is seeking anhas requested exclusion orderorders that directsdirect U.S. Customs and Border Protection to stop allegedly infringing SK hynix RDIMM and LRDIMM products from entering the United States. In the Central District Court proceedings, the Company is primarily seeking damages.
On October 3, 2016, The First and Second ITC Actions are no longer pending and the ITC instituted an investigation of the trade practices of SK hynix and certain of its subsidiaries related to its importation, sale for importation, and/or sale after importation of RDIMM and LRDIMM enterprise memory products. On November 10, 2016, the ITC set a 16-month target date of February 7, 2018, for the investigation with a final initial determination being filed no later than October 10, 2017. Based on this target date, the ITC scheduled a hearing on the merits of the investigation which began on May 8, 2017 and concluded on May 11, 2017. On January 4, 2017, theparallel Central District Court issued a scheduling order setting various dates including a trial date of July 10, 2018. On August 16, 2017, the ITC extended the target date by 5 weeks to March 14, 2018, and extended the deadline for the final initial determination to November 14, 2017.
On October 5, 2016 and October 28, 2016, SK hynix filed motions in the Central District Court and the ITC, respectively, to disqualify the Company’s litigation counsel. The Company opposed both motions. On December 5,
2016, the Central District Court granted SK hynix’s motion to disqualify. On December 8, 2016, the Company’s substitute counsel entered appearances in the ITC and the Central District Court.
Between December 30, 2016 and January 20, 2017, SK hynix filed numerous petitions in the USPTO requesting Inter Partes Review of certain of the Company’s patents, including the patents asserted in the ITC and Central District Court. In a series of decisions issued in May, June and July, 2017, the PTAB instituted reviews of certain of these patents, including the patentsinfringement proceedings are currently asserted in the ITC and Central District Court, the last of which is scheduled to conclude no later than July 2018. On July 17, 2017, the Central District Court granted in part SK hynix’s request to stay the infringement proceedingsstayed pending further order of the court, and ordered the parties to file a joint status report shortly after the ITC issues its final initial determination.court.
On July 11, 2017, the CompanyMarch 17, 2020, Netlist filed legal proceedings for patent infringement against SK hynix and certain of its distributors in the courts of Germany and the PRC based on the alleged infringement by SK hynix’s LRDIMM of the Company’s patents in those jurisdictions. The courts in Germany and the PRC are currently handling service of process and have not yet issued a schedule for proceedings in either jurisdiction.
On October 31, 2017, the Company filed additional legal proceedings foralleging patent infringement against SK hynix in the ITCU.S. District Court for the Western District of Texas based on the alleged infringement by SK hynix’s RDIMMof Netlist U.S. Patent No. 9,858,218 and LRDIMM products of two additional U.S. patents ownedPatent No. 10,474,595 by the Company. As with the first ITC action, the Company is seeking an exclusion order that directs U.S. Customs and Border Protection to stop allegedly infringing SK hynix RDIMM and LRDIMM products from enteringmemory products. The case was assigned to the United States.Hon. Alan D. Albright and is Case No. 6:20-cv-00194-ADA. The Markman hearing in this case occurred on March 4, 2021 and the trial was scheduled for July 6, 2021. Case No. 6:20-cv-00194-ADA was dismissed on April 20, 2021 following Netlist’s settlement with SK hynix set forth below.
Morgan Joseph Litigation
On March 31, 2016, Morgan Joseph Triartisan LLC (“Morgan Joseph”)June 15, 2020, Netlist filed a complaintsecond round of legal proceedings alleging patent infringement against SK hynix in the SupremeU.S. District Court for the Western District of Texas based on the Stateinfringement of New York againstNetlist U.S. Patent No. 10,217,523 by SK hynix LRDIMM memory products. The case was assigned to the CompanyHon. Alan D. Albright and is Case No. 6:20-cv-00525-ADA. The Markman hearing in this case occurred on March 4, 2021 and the trial was scheduled for July 6, 2021. Case No. 6:20-cv-00525-ADA was dismissed on April 20, 2021 following Netlist’s settlement with SK hynix set forth below.
On April 5, 2021, Netlist entered into a Strategic Product Supply and License Agreement (the “License Agreement”) and Product Purchase and Supply Agreement with SK hynix. Both agreements have a term of 5 years. Under the License Agreement, (a) Netlist has granted to SK hynix fully paid, worldwide, non-exclusive, non-assignable licenses to certain of its officerspatents covering memory technologies and (b) SK hynix has granted to Netlist fully paid, worldwide, non-exclusive, non-assignable licenses to its patent portfolio. In addition, the License Agreement provides for breachthe settlement of contractall pending intellectual property proceedings between Netlist and related causesSK hynix with the settlement fee of action. The complaint alleges that$40 million payable to us by SK hynix, and the Company refusedparties have agreed to honor its payment obligations under a written agreement with Morgan Joseph related to the provision of financial advisory and investment banking services. Morgan Joseph is seeking compensatory damages in the amount of $1,012,500, plus punitive damages in an amount not less than $1 million, together with pre-judgment interest, costs, and fees.collaborate on certain technology development activities.
On September 15, 2016, the Company filed a motion to dismiss Morgan Joseph’s complaint for failure to state a claim. On February 15, 2017, the court granted the Company’s motion to dismiss as to all causes of action brought by Morgan Joseph.
Other Contingent Obligations
In the ordinary course of its business, the Company has made certain indemnities, commitments and guarantees pursuant to which it may be required to make payments in relation to certain transactions. These include: include, among others:
(i) intellectual property indemnities to the Company’s customers and licensees in connection with the use, sale and/or license of Company products; (ii) indemnities to vendors and service providers pertaining to claims based on the Company’s negligence or willful misconduct; (iii) indemnities involving the accuracy of representations and warranties in certain contracts; (iv) indemnities to directors and officers of the Company to the maximum extent permitted under the laws of the State of Delaware; (v) indemnities to TRGP, SVIC and 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;documents, as applicable; and (vi) indemnities or other claims related to certain real estate leases, under which the Company may be required to indemnify property owners for environmental and other liabilities or may face other claims arising from the Company’s 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 the Company could be obligated to make. Historically, the Company has 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 condensed 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 at September 30, 2017as of April 3, 2021 or December 31, 2016.January 2, 2021.
On April 17, 2017, the Company entered into a rights agreement (the(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 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 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‑outstandingthen-outstanding shares of the Company’s common stock, and (ii) 10 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 earlier of (i) the close of business on April 17, 2018, the first anniversary of the adoption of the Rights Agreement, and (ii) the date of any settlement, adjudication, dismissal with prejudice, abandonment by the Company or other conclusive and final resolution of the Company’s legal proceedings against SK hynix (see Note 7).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 the Company’sits 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 Stock2019 Lincoln Park Purchase Agreement
On May 31, 2017, the Company’s stockholders approved an amendment to the Company’s Restated Certificate of Incorporation to increase the number of shares of the Company’s common stock that it is authorized to issue from 90,000,000 to 150,000,000.
On September 23, 2016,June 24, 2019, the Company completed the 2016 Offering,entered into a purchase agreement (the “2019 Purchase Agreement”) with Lincoln Park Capital Fund, LLC (“Lincoln Park”), pursuant to which it sold 9,200,000the Company has the right to sell to Lincoln Park up to an aggregate of $10 million in shares of its common stock at a pricesubject to the public of $1.25 per share. The net proceeds toconditions and limitations set forth in the Company from the 2016 Offering were $10.3 million, after deducting underwriting discounts and commissions and offering expenses paid by the Company.
On August 22, 2017, the Company completed the 2017 Offering, pursuant to which it sold 8,500,000 shares of its common stock at a price to the public of $0.60 per share. The net proceeds to the Company from the 2017 Offering were $4.4 million, after deducting underwriting discounts and commissions and offering expenses paid by the Company.
Stock-Based Compensation
The Company has stock-based compensation awards outstanding pursuant to its Amended and Restated 2006 Equity Incentive Plan, as re-approved by2019 Purchase Agreement. As consideration for entering into the Company’s stockholders on June 8, 2016 (the “Amended 2006 Plan”), under which a variety of stock-based awards, including stock options, may be granted to employees and non-employee service providers of the Company. In addition to awards granted pursuant to the Amended 2006 Plan,2019 Purchase Agreement, the Company periodically grants equity-based awards outside the Amended 2006 Planissued to certain new hires as an inducement to enter into employment with the Company.
Subject to certain adjustments, as of September 30, 2017, the Company was authorized to issue a maximum of 10,205,566Lincoln Park 818,420 shares of its common stock pursuantas initial commitment shares in a noncash transaction on June 24, 2019 and will issue up to awards granted under818,420 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 Amended 2006 Plan. issuance of these additional commitment shares.
Pursuant to the terms2019 Purchase Agreement, on any business day and as often as every other business day over the 36-month term of the Amended 2006 Plan,2019 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 400,000 shares of its common stock, with such amount increasing as the closing sale price of its common stock increases; provided Lincoln Park’s obligation under any single such purchase will not exceed $1.0 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 plan automatically increased on2019 Purchase Agreement, the first dayCompany may direct Lincoln Park to purchase an additional amount of each calendar year from January 1, 2007 through January 1, 2016, bycommon stock that may not exceed the lesser of (i) 5.0%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 2019 Purchase Agreement. Under certain circumstances and in accordance with the 2019 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 2019 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 2019 Purchase Agreement. In all instances, the Company may not sell shares of its common stock to Lincoln Park under the 2019 Purchase Agreement if that would result in Lincoln Park beneficially owning more than 9.99% of its common stock.
The 2019 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 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 2019 Purchase Agreement. The Company has the right to terminate the 2019 Purchase Agreement at any time, at no cost to the Company.
During the three months ended April 3, 2021, Lincoln Park purchased an aggregate of 1,669,429 shares of the Company’s common stock for a net purchase price of $1.6 million under the 2019 Purchase Agreement. In connection with the purchases, the Company issued to Lincoln Park an aggregate of 129,468 shares of its common stock as additional commitment shares in noncash transactions.
2020 Lincoln Park Purchase Agreement
On March 5, 2020, the Company entered into a purchase agreement (the “2020 Purchase Agreement”) with Lincoln Park, pursuant to which the Company had the right to sell to Lincoln Park up to an aggregate of $20 million in shares of its common stock over the 36-month term of the 2020 Purchase Agreement subject to the conditions and limitations set forth in the 2020 Purchase Agreement. As consideration for entering into the 2020 Purchase Agreement, the Company issued to Lincoln Park 1,529,052 shares of its common stock as initial commitment shares in a noncash transaction on March 6, 2020 and would issue up to 917,431 additional shares of its common stock as additional commitment shares on a pro rata basis in connection with any additional purchases. The Company would not receive any cash proceeds from the issuance of these additional commitment shares.
Pursuant to the 2020 Purchase Agreement, on any business day and as often as every other business day over the 36-month term of the 2020 Purchase Agreement, the Company had the right, from time to time, at its sole discretion and subject to certain conditions, to direct Lincoln Park to purchase up to 400,000 shares of its common stock, with such amount increasing as the closing sale price of its common stock increases; provided Lincoln Park’s obligation under any single such purchase would not exceed $1.0 million, unless the Company and Lincoln Park mutually agreed to increase
Stock Options
The following table summarizes the Company’sactivity related to stock optionoptions during the three months ended April 3, 2021:
| | | | | | |
| | | | | Weighted- |
| | Number of | | Average |
| | Shares | | Exercise |
| | (in thousands) | | Price |
Outstanding as of January 2, 2021 | | | 7,519 | | $ | 1.12 |
Granted | | | 1,760 | | | 0.76 |
Exercised | | | (476) | | | 0.79 |
Expired or forfeited | | | (540) | | | 2.17 |
Outstanding as of April 3, 2021 | | | 8,263 | | | 0.99 |
Restricted Stock Units
The following table summarizes the activity inrelated to RSUs during the nine months ended September 30, 2017:April 3, 2021:
| | | | | | |
| | | Options Outstanding |
| | | | | | Weighted- |
| | | | | | Average |
| | | Number of | | | Exercise |
| | | Shares | | | Price |
| | | (in thousands) | | | |
Options outstanding at December 31, 2016 | | | 8,798 | | $ | 1.46 |
Options granted | | | 1,455 | | | 0.99 |
Options exercised | | | (267) | | | 0.68 |
Options expired/forfeited | | | (1,339) | | | 1.46 |
Options outstanding at September 30, 2017 | | | 8,647 | | $ | 1.40 |
| | | | | | |
| | | | | Weighted- |
| | | | | Average |
| | Number of | | Grant-Date |
| | Shares | | Fair Value |
| | (in thousands) | | per Share |
Outstanding as of January 2, 2021 | | | 3,037 | | $ | 0.53 |
Granted | | | 100 | | | 0.72 |
Vested | | | (501) | | | 0.54 |
Forfeited | | | — | | | — |
Outstanding as of April 3, 2021 | | | 2,636 | | | 0.53 |
The intrinsic value of stock options exercised in the nine months ended September 30, 2017 was $89,000.Stock-Based Compensation
The following table presentssummarizes the assumptions used to calculatestock-based compensation expense by line item in the weighted-average grant date fair valuecondensed consolidated statements of stock options granted by the Company during the periods presented:operations (in thousands):
| | | | | | | |
| | | Nine Months Ended | |
| | September 30, | | October 1, | |
| | 2017 | | 2016 | |
Expected term (in years) | | | 6.4 | | | 6.1 | |
Expected volatility | | | 87 | % | | 106 | % |
Risk-free interest rate | | | 2.03 | % | | 1.48 | % |
Expected dividends | | | - | | | - | |
Weighted-average grant date fair value per share | | $ | 0.73 | | $ | 0.89 | |
| | | | | | |
| | Three Months Ended |
| | April 3, | | March 28, |
| | 2021 | | 2020 |
Cost of sales | | $ | 3 | | $ | 3 |
Research and development | | | 110 | | | 47 |
Selling, general and administrative | | | 225 | | | 156 |
Total | | $ | 338 | | $ | 206 |
As of September 30, 2017,April 3, 2021, the amountCompany had approximately $2.8 million, net of estimated forfeitures, of unearned stock-based compensation, estimatedwhich it expects to be expensed from the Company’s 2017 fiscal year through the Company’s 2019 fiscal year related to unvested stock options isrecognize over a weighted-average period of approximately 2.9 years.
approximately $1.7 million, net of estimated forfeitures. The weighted-average period over which the unearned stock-based compensation is expected to be recognized is approximately 2.3 years. If there are any modifications or cancellations of the underlying unvested awards, the Company may be required to accelerate, increase or cancel any remaining unearned stock-based compensation expense or calculate and record additional expense. Future stock-based compensation expense and unearned stock-based compensation expense will increase to the extent the Company grants additional stock options or other stock-based awards.
Warrants
The following is a summary of the Company’s warrant activity for the year ended December 31, 2016 and the nine months ended September 30, 2017:
| | | | | | |
| | | | | Weighted |
| | Number of | | Average |
| | Shares | | Exercise |
| | (in thousands) | | Price |
Warrants outstanding - January 2, 2016 | | | 7,633 | | $ | 0.59 |
Warrant granted | | | - | | | - |
Warrants exercised | | | (2,709) | | | 0.47 |
Warrants outstanding - December 31, 2016 | | | 4,924 | | $ | 0.66 |
Warrant granted | | | - | | | - |
Warrants exercised | | | - | | | - |
Warrants outstanding - September 30, 2017 | | | 4,924 | | $ | 0.66 |
Note 9—Segment and Geographic Information
The Company operates in one reportable segment, which is the design and manufacture of high-performance memory subsystems for the server, high-performance computing and communications markets. The Company evaluates financial performance on a Company-wide basis.
At September 30, 2017 and December 31, 2016, approximately $61,000 and $64,000, respectively, of the Company’s long-lived assets, net of depreciation and amortization, were located in the PRC. Substantially all other long-lived assets were located in the United States.
Note 10—Subsequent Events
The Company has performed an evaluation of events occurring subsequent to September 30, 2017, through the filing date of this Quarterly Report on Form 10-Q. Based on its evaluation, there are no events, except for the matter discussed below, or discussed elsewhere in the notes hereto, which require recognition or disclosure in the condensed consolidated financial statements.
On November 13, 2017, the Company entered into an At Market Issuance Sales Agreement (the “Sales Agreement”) with B. Riley FBR, Inc. (the “Agent”) to sell shares of the Company’s common stock, with aggregate gross proceeds of up to $9,000,000, from time to time, through an “at-the-market” equity offering program under which the Agent will act as sales agent.
Under the Sales Agreement, the Company will set the parameters for the sale of shares, including the number of shares to be issued, the time period during which sales are requested to be made, limitation on the number of shares that may be sold in any one trading day and any minimum price below which sales may not be made. The Sales Agreement provides that the Agent will be entitled to compensation for its services in an amount equal to 3% of the gross proceeds from the sale of shares sold under the Sales Agreement. The Company has no obligation to sell any shares under the Sales Agreement and may suspend solicitation and offers under the Sales Agreement. The shares will be issued pursuant to the Company’s shelf registration statement on Form S-3 and the Prospectus Supplement to be filed on November 14, 2017 with the SEC in connection with the offer and sale of the shares pursuant to the Sales Agreement.
Item 2. | Management’s Discussion and Analysis of Financial Condition and Results of Operations |
Note About Forward-Looking Statements
This Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion (“MD&A”) and analysis of our financial condition and results of operations (the “MD&A”) should be read together with our unaudited condensed consolidated financial statements and the related notes included in Part I, Item 1other parts of this report, as well as the MD&A included in our Annual Report on Form 10-K for our fiscal year ended December 31, 2016, including the audited consolidated financial statements and related notes included in such report (the “2016 Annual Report”), which was filed with the Securities and Exchange Commission (the “SEC”) on March 31, 2017. In preparing this MD&A, we presume that readers have access to and have read the MD&A included in the 2016 Annual Report, pursuant to Instruction 2 to paragraph (b) of Item 303 of Regulation S-K promulgated by the SEC.
Unless the context indicates otherwise, all references to “Netlist,” the “Company,” “we,” “us,” or “our” in this MD&A and elsewhere in this report refer to Netlist, Inc., together with its majority and wholly owned subsidiaries.
Forward-Looking Statements
This discussion and analysis includes “forward‑looking 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 andor 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 discussion and analysisMD&A include statements about, among other things: our plans relating to our intellectual property, including our strategy for monetizing, licensing, expanding, and defending our patent portfolio; our expectations with respect to strategic partners, including our relationship with Samsung Electronics Co., Ltd. (“Samsung”) and the potential for commercial licensing agreements; our expectations and strategies regarding outstanding legal proceedings and patent reexaminations relating to our intellectual property portfolio, including our pending proceedings against SK hynix Inc., a South Korean memory semiconductor supplier (“SK hynix”); our beliefs regarding the market and demand for our products or the component products we resell to customers directly; and our expectations regarding our strategy, business plans and objectives, our future operations and financial position, including future 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.
| ● | 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 assumptionsother 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. GivenIn light of these risks and uncertainties, and other important factors, youour forward-looking statements should not place undue reliancebe relied on as predictions of future events. Additionally, many of these forward-looking statements. Theserisks and uncertainties are currently elevated by and may or will continue to be elevated by the COVID-19 pandemic. All forward-looking statements representreflect our estimatesassumptions, expectations and assumptionsbeliefs 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.
OverviewThe 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 2, 2021 (the “2020 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.
Overview
We are a leading provider ofprovide high-performance modular memory subsystems servingto customers in diverse industries that require superiorenterprise and storage class memory performancesolutions to empower critical business decisions. We have a long 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 recently introduced a new generation ofalso 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 in-memory databases.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 100130 issued and pending U.S. and foreign patents, many seminal, in the areas of hybrid memory, storage class
memory, rank multiplication and load reduction. Since our inception, in 2000, we have dedicated substantial resources to the development, protection and protectionenforcement 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 revenuessales 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.
In November 2015, we entered into a joint development and license agreement (“JDLA”) pursuant to which we and Samsung have agreed to work together to jointly develop new storage class memory technologies including a standardized product interface for NVDIMM-P memory modules in order to facilitate broad industry adoption of this new technology. The JDLAWe also includes comprehensive cross-licenses to our and Samsung’s patent portfolios for the purpose of developing this product interface, grants Samsung a right of first refusal to acquire our HybriDIMM technology before we offer the technology to a third party, and grants us access to competitively priced DRAM andresell SSD, NAND flash, raw materials. The JDLA also provided for an $8.0 million non-recurring engineering (“NRE”) feeDRAM products and other component products to end-customers that we received from Samsung for the joint development and calls for potential marketing collaboration and for the exchange of potential monetary consideration as progress is made towards commercialization of our storage class memory product. Moreover, we believe Samsung represents an important strategic partner with a high level of technical capability in memory that can facilitate bringing our HybriDIMM technology to market. In connection with the JDLA, we also received gross proceeds of $15.0 million for our issuance of a Senior Secured Convertible Note (“SVIC Note”) and Stock Purchase Warrant (“SVIC Warrant”) to SVIC No. 28 New Technology Business Investment L.L.P., an affiliate of Samsung Venture Investment Co. (“SVIC”). See Note 5 to the condensed consolidated financial statements included in this report for additional information about the SVIC Note and the SVIC Warrant.
Further, in September 2016, we took action to protect and defend our innovations by filing legal proceedings for patent infringement against SK hynix and two of its subsidiariesare not reached in the U.S. International Trade Commission ("ITC")distribution models of the component manufacturers, including storage customers, appliance customers, system builders and in U.S. district court. We filed additional legal proceedings for patent infringement against SK hynix incloud and datacenter customers.
During the ITC and in the courtsfirst quarter of Germany and the People’s Republic2021, we recorded net sales of China in July and October 2017. In both of our ITC actions, we are seeking an exclusion order in the ITC that directs U.S. Customs and Border Protection to stop allegedly infringing SK hynix RDIMM and LRDIMM products from entering the United States. The evidentiary hearing in the ITC investigations occurred in May 2017, with a final initial determination expected to be issued by the ITC in November 2017. In the U.S. district court and international courts proceedings, we are primarily seeking damages. Our patents involved in the proceedings cover key features of RDIMM and LRDIMM, which we believe are strategic product lines for SK hynix that together account for a significant portion of SK hynix's total revenue and profits. We have taken steps to solidify our position and strategy in connection with our proceedings against SK hynix, including establishing a funding arrangement for our legal costs associated with these proceedings and adopting a rights agreement to implement a standard “poison pill,” which are discussed further below. See Notes 7 and 8 to the condensed consolidated financial statements included in this report for additional information about our proceedings against SK hynix, the related funding arrangement and our poison pill implementation.
We recorded total net revenues of $9.0$14.9 million, $29.8 million, $2.6 million and $14.1 million for the three and nine months ended and September 30, 2017 and October 1, 2016, respectively, and $19.7 million and $8.0 million for the years ended December 31, 2016 and January 2, 2016, respectively, and we recorded gross profit of $725,000, $2.0 million, $9,000 and $7.1 million for the three and nine months ended and September 30, 2017 and October 1, 2016, respectively, and $7.4$1.5 million and $2.1 million for the years ended December 31, 2016 and January 2, 2016, respectively. We also incurred net lossesloss of $3.1 million, $10.3 million, $4.4 million and $7.3 million for the three and nine months ended September 30, 2017 and October 1, 2016, respectively, and $11.2 million and $20.5 million for the fiscal years ended December 31, 2016 and January 2, 2016, respectively.$4.0 million. We have historically financed our operations primarily throughwith proceeds from issuances of equity and debt securities and revenues generatedcash receipts from operations, including product revenues and NRE revenues from the JDLA.revenues. We have also funded our operations with a revolving line of credit and term loans under a bank credit facility, a funding arrangement for costs associated with our legal proceedings against SK hynixfacility. See “Recent Developments” and to a lesser extent, equipment leasing arrangements. See “Liquidity and Capital Resources” below for furthermore information.
Recent Developments
SK hynix License Agreement and Supply Agreement
On April 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
On April 9, 2021, we entered into an amendment to a credit agreement dated October 31, 2009 with Silicon 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 the Wall Street Journal prime rate (“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 will be extended to April 29, 2022 upon our request, if we meet certain conditions.
Recent Developments
2019 Lincoln Park Purchase Agreement
2017 ATM Program
On November 13, 2017,June 24, 2019, we entered into an At Market Issuance Sales Agreementa purchase agreement (the “Sales“2019 Purchase Agreement”) with B. Riley FBR, Inc. (the “Agent”Lincoln Park Capital Fund, LLC (“Lincoln Park”), pursuant to which we have the right to sell to Lincoln Park up to an aggregate of $10 million in shares of our common stock with aggregate gross proceeds of up to $9,000,000, from time to time, through an “at-the-market” equity offering program under whichover the Agent will act as sales agent.
Under the Sales Agreement, we will set the parameters for the sale of shares, including the number of shares to be issued, the time period during which sales are requested to be made, limitation on the number of shares that may be sold in any one trading day and any minimum price below which sales may not be made. The Sales Agreement provides that the Agent will be entitled to compensation for their services in an amount equal to 3%36-month term of the gross proceeds from the sale of shares sold under the Sales Agreement. We have no obligation to sell any shares under the SalesPurchase Agreement and may suspend solicitation and offers under the Sales Agreement. The shares will be issued pursuant to our shelf registration statement on Form S-3 and the Prospectus Supplement to be filed on November 14, 2017 with the SEC in connection with the offer and sale of the shares pursuantsubject to the Salesconditions and limitations set forth in the 2019 Purchase Agreement.
2017 Offering
On August 22, 2017, we completed During the first quarter of 2021, Lincoln Park purchased an underwritten registered public offering (the “2017 Offering”), pursuant to which we sold 8,500,000aggregate of 1,669,429 shares of our common stock atfor a net purchase price of $1.6 million under the 2019 Purchase Agreement. In connection with the purchases, during the first quarter of 2021, we issued to Lincoln Park an aggregate of 129,468 shares of our common stock as commitment shares in noncash transactions.
2020 Lincoln Park Purchase Agreement
On March 5, 2020, we entered into another purchase agreement (the “2020 Purchase Agreement”) with Lincoln Park, pursuant to which we have the right to sell to Lincoln Park up to an aggregate of $20 million in shares of our common stock over the 36-month term of the 2020 Purchase Agreement subject to the publicconditions and limitations set forth in the 2020 Purchase Agreement. During the first quarter of $0.60 per share. The2021, Lincoln Park purchased an aggregate of 9,544,595 shares of our common stock for a net proceeds to us frompurchase price of $7.8 million under the 2017 Offering were $4.4 million, after deducting underwriting discounts and commissions and offering expenses paid by us.
Establishment of Funding Arrangement and Rights Agreement in2020 Purchase Agreement. In connection with SK hynix Proceedingsthe purchases, during the first quarter of 2021, we issued to Lincoln Park an aggregate of 356,843 shares of our common stock as commitment shares in noncash transactions. In February 2021, we completed the sales under the 2020 Purchase Agreement.
In April and May of 2017, we established a funding arrangement and a rights agreement in connection with our strategy for our proceedings against SK hynix, each of which is described below.Paycheck Protection Program Loan
TRGP Agreement
On May 3, 2017,April 23, 2020, we entered into an investment agreement (the “TRGP Agreement”)unsecured promissory note with TR Global Funding V, LLC, an affiliate of TRGP Capital Management, LLC (“TRGP”), which generally provides that TRGP will directly fund the costs incurred by us or on our behalf in connection with certain of our proceedings against SK hynix, including costs incurred since January 1, 2017 and costs to be incurred in the future in our first ITC action and our U.S. district court proceedings, but excluding our subsequent ITC action and our proceedings in international courts. In exchange for such funding, we have agreed that, if we recover any proceeds in connection with the funded SK hynix proceedings, we will pay to TRGP thea principal amount of its funding plus an escalating premium based on when any such proceeds are recovered, such that the premium will equal a specified low-to-mid double-digit percentage of the amount of TRGP’s funding and such percentage will increase by a specified low double-digit amount each quarter after a specified date until any such proceeds are recovered. In addition, we have granted to TRGP a first priority security interest in the claims underlying the funded SK hynix proceedings and any proceeds we may receive in connection with these proceedings, and a second priority security interest in our patents that are the subject of these proceedings. We have established this funding arrangement in order to provide us with increased security that we will be able to vigorously pursue our claims against SK hynix$0.6 million through their final resolution.
Rights Agreement
On April 17, 2017, we adopted a short-term rights agreement to implement a standard “poison pill.” In general terms, for so long as the rights issuedHanmi Bank under the rights agreement are outstanding, which is expected to be no longer than 12 months,Paycheck Protection Program (“PPP”) (“PPP Loan”) administered by the rights agreement prevents any person or group from acquiring a significant percentage of our outstanding capital stock or attempting a hostile takeover of our Company by significantly diluting the ownership percentage of such person or group. As a result, the rights agreement has a significant anti-takeover effect. Our board of directors approved the rights agreementSmall Business Administration (“SBA”) and established as part of our strategythe Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”). The PPP Loan bore interest at 1.0% per annum and would mature in connection with our proceedings against SK hynix,April 2022 with the intentfirst six months of
disconnecting our market capitalization from the damages calculations interest and any settlement negotiations that may develop in connection with these proceedings.
Amendments to SVB Credit Agreement
On March 27, 2017 and April 12, 2017, we entered into amendments to our credit agreement (as amended, the “SVB Credit Agreement”) with Silicon Valley Bank (“SVB”).principal payments deferred. The amendments extend the maturity date of advancesamount borrowed under the SVB Credit Agreement to April 1, 2018; modify our financial covenantsPPP Loan was eligible for forgiveness if we would meet certain conditions. In May 2021, the full amounts outstanding under the SVB Credit Agreement to remove all prior financial standardsPPP Loan was forgiven.
Economic Conditions, Challenges and replace them with a liquidity ratio standard; remove or amend certain termination, anniversary and unused facility fees payable by us under the SVB Credit Agreement; and make certain other administrative changes.Risks
Key Business Metrics
The following describes certain line items in our condensed consolidated statements of operations that are important to management’s assessment of our financial performance:
Net Product Revenues
Net product revenues consist of resales of certain component products, including NAND flash, and sales of our high-performance memory subsystems, net of a provision for estimated returns under our right of return policies, which generally range up to 30 days. Sales are made primarily pursuant to stand-alone purchase orders, which generally have no cancellation or rescheduling penalty provisions. We often ship products to our customers’ international manufacturing sites, but all of our sales to date have been denominated in U.S. dollars.
Sales to small numbers of customers have historically represented a substantial portion of our net product revenues. Additionally, the composition of major customers and their respective contributions to our net product revenues have fluctuated and will likely continue to fluctuate from period to period as our existing and prospective customers progress through the life cycle of the products they produce and sell and experience resulting fluctuations in their product demand. For instance, approximately 13% and 10% of our net product revenues in the three months ended September 30, 2017 were to two customers, each of which represented less than 10% of our net product revenues in the nine months ended September 30, 2017 and in all periods in 2016. Additionally, in the three and nine months ended October 1, 2016, approximately 17% and 17%, and 29% and 10% of our net product revenues in the respective periods were to two customers, neither of which purchased many products or contributed a meaningful portion of our revenues in the corresponding 2017 periods. We do not have long-term agreements with any of our customers. As a result, our product revenues can be materially impacted by fluctuating customer concentrations, as any or all of our customers could decide at any time to increase or decrease their purchase of our products or the component products we resell directly. In addition, the prices customers pay for products could change at any time. As a result, the loss of any of our customers, particularly our large or key customers, an increase or decrease in sales to or sale prices for any of them, including as a result of normal fluctuations in product demand or other factors, or difficulties collecting payments from any of them could materially impact our product revenues and operating results.
The component products we resell include products we purchase from Samsung and certain alternative suppliers for the purpose of resale, and excess component inventory we purchase for, but do not use in, our memory subsystems. We purchase certain products, including primarily NAND flash, from Samsung under the terms of our JDLA with Samsung in order to resell these products to end-customers that are not reached in Samsung’s distribution model, including storage customers, appliance customers, system builders and cloud and datacenter customers. We have also sourced these products from alternative suppliers to the extent sufficient product is not available from Samsung to meet customer demand. In the three and nine months ended September 30, 2017 and October 1, 2016, resales of these products represented 75%, 86%, 53% and 51%, respectively, of our net product revenues, respectively, and we expect resales of these products may continue to increase over time. We also resell excess component inventory to distributors and other users of memory integrated circuits, but these sales have historically been, and we expect will continue to be, a relatively small percentage of our net product revenues.
With respect to sales of our memory subsystems, our original equipment manufacturer (“OEM”) customers typically provide us with non-binding forecasts of future product demand over specific periods of time, but they generally place orders with us no more than two weeks in advance of the desired delivery date. Selling prices are typically negotiated monthly, based on competitive market conditions and the current price of key product components, including DRAM ICs and NAND flash. Sales of our memory subsystem products have declined in recent periods due in large part to the rapid decline in sales of our first-generation NVvault products following the loss of our former most significant NVvault customer, Dell, beginning in 2012, and the rate and degree of customer adoption of our next generation NVvault product extensions, which has been slower and smaller than expected to date. We expect these declines could continue in future periods unless and until our next-generation products gain significantly greater customer and market acceptance.
Engineering Services
Pursuant to the terms of our JDLA with Samsung, we provided certain engineering services for Samsung and received a NRE fee as compensation for these services. These fees from Samsung are the only such fees for engineering services that we have received to date, although we may in the future receive additional fees of this type, from Samsung or other customers, depending on the terms of the relationships we may develop.
Cost of Sales
Our cost of sales includes the cost of materials, labor and other manufacturing costs, depreciation and amortization of equipment expenses, inventory valuation provisions, stock-based compensation expenses, occupancy costs and other allocated fixed costs.
For resales of component products, our cost of sales also includes the cost of the products we purchase for resale from Samsung under the terms of the JDLA or from alternative suppliers on the terms we negotiate with these suppliers. As a result, our gross margin on the resale of component products, including Samsung products and excess component inventory, is significantly lower than our gross margin on sales of our own products. Accordingly, increased resales of component products as a percentage of our total product revenues have a significant negative impact on our gross margin. In addition, to the extent we are not able to procure sufficient component products for resale from Samsung under the terms of the JDLA to satisfy customer orders for these products, we would need to seek to procure these products from alternative suppliers, which may not be available on terms comparable to those we have negotiated with Samsung under the JDLA. As a result, any inability to source sufficient component products from Samsung could increase our cost of sales associated with resales of these products if we are forced to pay higher prices to obtain these products from other suppliers.
With respect to sales of our memory subsystem products, the DRAM ICs and NAND flash incorporated into these products constitute a significant portion of our cost of sales for the products, and thus our cost of sales will fluctuate based on the cost of DRAM ICs and NAND flash. We attempt to pass through these DRAM IC and NAND flash cost fluctuations to our memory subsystem customers by frequently renegotiating pricing prior to the placement of their purchase orders. However, the sales prices of our memory subsystems can also fluctuate due to competitive conditions in our key customer markets that are unrelated to the cost of DRAM ICs and NAND flash, which affects our gross margin. In addition, we have in the past experienced supply chain disruptions and shortages of DRAM and NAND flash required to create our HyperCloud, NVvault and Planar X VLP products, which can cause fluctuations in our net product revenues and gross profits associated with memory subsystem sales.
Any significant decrease in demand for our products or the component products we resell could result in an increase in the amount of excess inventory quantities on hand. In addition, our estimates of future product demand may prove to be inaccurate, in which case we may understate or overstate the provision required for excess and obsolete inventory. In the future, if our inventories are determined to be overvalued, we would be required to recognize additional expense in our cost of sales at the time of such determination. Conversely, if our inventories are determined to be undervalued, we may have over-reported our costs of sales in previous periods and would be required to recognize additional gross profit at the time such inventories are sold. In addition, should the market value of DRAM ICs, NAND flash or other component products decrease, we may be required to lower the selling prices of our memory subsystems or
component product resales to reflect the lower cost of these materials. If such price decreases reduce the net realizable value of our inventories to less than our cost, we would be required to recognize additional expense in our cost of sales in the same period. Although we make every reasonable effort to ensure the accuracy of our forecasts of future product demand, any significant unanticipated changes in demand, technological developments or the market value of DRAM ICs, NAND flash or other component products could have a material effect on the value of our inventories and our reported operating results.
Research and Development
Research and development expenses consist primarily of employee and independent contractor compensation and related costs, stock‑based compensation expenses, NRE fees, computer‑aided design software license costs, reference design development costs, depreciation or rental of evaluation equipment expenses, and occupancy and other allocated overhead costs. Also included in research and development expenses are the costs of materials and overhead related to the production of engineering samples of new products under development or products used solely in the research and development process. Our customers typically do not separately compensate us for design and engineering work involved in developing application‑specific products for them. All research and development costs are expensed as incurred. We anticipate that research and development expenditures will increase in future periods as we seek to expand new product opportunities, increase our activities related to new and emerging markets and continue to develop additional proprietary technologies.
Intellectual Property Legal Fees
Intellectual property legal fees consist of legal fees incurred for patent filings, protection and enforcement. Although we anticipate that intellectual property legal fees will generally increase over time as we continue to protect and seek to expand our patent portfolio, we expect that our intellectual property legal fees may decrease or increase at a slower rate in the near term due to the impact of the TRGP Agreement on our expense related to certain of our proceedings against SK hynix. The legal expenses we incur that are paid by TRGP pursuant to the terms of the TRGP Agreement are excluded from our financial statements in each period in which the TRGP Agreement remains in effect. In the nine months ended September 30, 2017, we excluded legal expenses of $9.3 million as a result of TRGP’s payment of these expenses under the TRGP Agreement. Pursuant to the TRGP Agreement, any settlement or other cash proceeds we may recover in the future in connection with the funded SK hynix proceedings would be reduced by the aggregate amount of legal expenses we exclude as a result of TRGP’s payment of these expenses under the TRGP Agreement, plus the premium amount due to TRGP under the terms of the TRGP Agreement at the time of any such recovery. As a result, we expect our intellectual property legal fees would be significantly higher in the period in which any such recovery occurs.
Selling, General and Administrative
Selling, general and administrative expenses primarily consist of employee compensation and related costs, stock-based compensation expenses, independent sales representative commissions, professional service fees, promotional and other selling and marketing expenses, and occupancy and other allocated overhead costs. A significant portion of our selling effort is directed at building relationships with OEMs and other customers and working through the product approval and qualification process with them. Therefore, the cost of material and overhead related to products manufactured for qualification is included in selling expenses.
Provision for Income Taxes
The federal statutory tax rate was 34% for the nine months ended September 30, 2017 and October 1, 2016. Our effective tax rate differs from the statutory rate because we provide a full valuation allowance against net deferred tax assets, and accordingly we did not recognize an income tax benefit related to losses incurred for the nine months ended September 30, 2017 and October 1, 2016.
Factors Affecting Our Performance and Business Risks and Uncertainties
Our performance, financial condition and prospects are affected by a number of factors and are exposed to a number of risks and uncertainties. SeeWe 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 discussionrisks we may face, nor can we assess the impact of certain majorall factors affectingon our performance inbusiness or the MD&A included inextent to which any factor or combination of factors could cause actual results to differ from our 2016 Annual Report, and seeexpectations. See the discussion of certain risks that we face under “Risk Factors” in Part II, Item 1A of this report.
Critical Accounting Policies and UseImpact of EstimatesCOVID-19 on our Business
The preparation of our condensed consolidated financial statements included in this report in conformity with accounting principles generally accepted in the United States requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the dateimpact of the condensed consolidated financial statements and the reported amounts of net revenues 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 on our historical experience, knowledge of current conditions and belief of what could occur in the future considering available information. We review our estimates on an on-going basis. Actual results may differ from these estimates, which may result in material adverse effectscoronavirus disease (“COVID-19”) pandemic will have on our consolidated operating 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 financial position. We believe the following critical accounting policies involvemay take further actions altering our more significant assumptions and estimates usedbusiness operations that we determine are in the preparationbest interests of our condensedemployees, 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 statements included in this report: provisions for uncollectible receivablescondition, and sales returns; warranty liabilities; valuation of inventories; fair value of financial instruments; recoverability of long-lived assets; valuation of stock-based transactions; estimates for completion of NRE and other revenue milestones; and realization of deferred tax assets.liquidity.
Our critical accounting policies and estimates are discussed in Note 2 to the condensed consolidated financial statements included in this report and the MD&A included in our 2016 Annual Report. For the nine months ended September 30, 2017, there were no material changes to our critical accounting policies.
Results of Operations
The following table presents each line item of our condensed consolidated statement of operations as a percentage of total net revenues for the three and nine months ended September 30, 2017 compared to three and nine months ended October 1, 2016:
| | | | | | | | | |
| | Three Months Ended | | Nine Months Ended | |
| | September 30, | | October 1, | | September 30, | | October 1, | |
| | 2017 | | 2016 | | 2017 | | 2016 | |
| | | | | | | | | |
Net product revenues | | 100 | % | 100 | % | 100 | % | 51 | % |
NRE revenues | | - | | - | | - | | 49 | |
Total net revenues | | 100 | | 100 | | 100 | | 100 | |
Cost of sales | | 92 | | 100 | | 93 | | 50 | |
Gross profit | | 8 | | - | | 7 | | 50 | |
Operating expenses: | | | | | | | | | |
Research and development | | 13 | | 57 | | 14 | | 35 | |
Intellectual property legal fees | | 8 | | 16 | | 7 | | 16 | |
Selling, general and administrative | | 20 | | 93 | | 19 | | 48 | |
Total operating expenses | | 41 | | 165 | | 40 | | 99 | |
Operating loss | | (33) | | (165) | | (33) | | (49) | |
Other expense, net: | | | | | | | | | |
Interest expense, net | | (1) | | (6) | | (1) | | (3) | |
Other income, net | | - | | 1 | | - | | - | |
Total other expense, net | | (1) | | (5) | | (1) | | (3) | |
Loss before provision for income taxes | | (34) | | (170) | | (34) | | (52) | |
Provision for income taxes | | - | | - | | - | | - | |
Net loss | | (34) | % | (170) | % | (34) | % | (52) | % |
Net Product Revenues, NRE Revenues, Cost of Sales and Gross Profit
The following tables present net product revenues, NRE revenues,Net sales, cost of sales and gross profit for the three and nine months ended September 30, 2017April 3, 2021 and October 1, 2016:March 28, 2020 were as follows (dollars in thousands):
| | | | | | | | | | | | | |
| | Three Months Ended | | | | | | | |
| | September 30, | | October 1, | | | | | % | | |
| | 2017 | | 2016 | | Change | | Change | | |
| | (in thousands, except percentages) | |
Net product revenues | | $ | 9,010 | | $ | 2,589 | | $ | 6,421 | | 248 | % | |
NRE revenues | | | - | | | - | | | - | | - | % | |
Total net revenues | | | 9,010 | | | 2,589 | | | 6,421 | | 248 | % | |
| | | | | | | | | |
| | | Three Months Ended | | |
| | | April 3, | | March 28, | | % |
| | | 2021 | | 2020 | | Change |
Net sales | | | $ | 14,897 | | $ | 14,631 | | 2% |
Cost of sales | | | 8,285 | | | 2,580 | | | 5,705 | | 221 | % | | | 13,396 | | | 12,522 | | 7% |
Gross profit | | $ | 725 | | $ | 9 | | $ | 716 | | 7,956 | % | | $ | 1,501 | | $ | 2,109 | | (29)% |
Gross margin | | | 8.0% | | | 0.3% | | | 7.7 | % | | | | | 10% | | | 14% | | |
Operating Activities
Net cash used in operating activities for the nine months ended September 30, 2017 was primarily the result of a net loss of $10.3 million, partially offset by (i) $1.5 million of net non-cash operating expenses, which primarily consisted of stock-based compensation, interest accrued on convertible debt depreciation and amortizationdiscounts and amortization of debt discounts,issuance costs on the SVIC Note. During the first quarter of 2021, other expense was consistent compared with the same quarter of 2020.
Liquidity and (ii) $1.8 million of net cash provided by operating activities due to changes in operating assets and liabilities, which were primarily from a $3.7 million increase in accounts payable and $0.7 million increase in restricted cash, partially offset by a $1.2 million increase in inventories and a $0.4 million decrease in accrued payroll and related liabilities. The increase in accounts payable between periods was primarily due to increased purchases of inventory. The increase in restricted cash between periods was primarily due to increasing our standby letter of credit with one vendor which is secured by restricted cash. The increase in inventories between periods was primarily due to our purchase of additional inventory to support the increase in our net product revenues. The decrease in accrued payroll and related liabilities between periods was primarily due to a reduction in headcount.
Net cash used in operating activities for the nine months ended October 1, 2016 was primarily the result of a net loss of approximately $7.3 million and approximately $8.4 million in net cash used in operating activities during the period due to changes in operating assets and liabilities, which were primarily from changes in deferred revenue, inventories, accounts payable and accrued expenses, restricted cash and accounts receivable, partially offset by approximately $1.5 million in net non-cash operating expenses primarily consisting of stock-based compensation, depreciation and amortization and amortization of debt discounts.
Investing Activities
Net cash used in investing activities for the nine months ended September 30, 2017 and October 1, 2016 was the result of our purchases of property and equipment during the periods.
Financing Activities
Net cash provided by financing activities for the nine months ended September 30, 2017 was primarily the result of (i) $1.9 million in net borrowings under the SVB Credit Agreement (ii) $4.4 million in net proceeds from the 2017 Offering and (iii) $0.2 million in proceeds from the exercise of stock options, partially offset by $0.3 million in payments of outstanding debt. Net cash provided by financing activities for the nine months ended October 1, 2016 was primarily the result of the 2016 Offering, as defined and discussed under “Capital Resources” below, pursuant to which we raised net proceeds of approximately $10.3 million.
Capital Resources
Our primary sources of cash haveare historically consisted of proceeds from issuances of equity and debt securities and revenues generatedreceipts from operations, including product revenues and NRE revenues fromrevenues. In addition, as a result of our JDLA with Samsung.entry into the SK hynix License Agreement, we plan to use the settlement fee received to support our operations. We have also funded our operations with a revolving line of credit and term loans 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.
2017 ATM Program
In November 2017, we entered into an At The Market Sales Agreement (the “Sales Agreement”) with B. Riley FBR, Inc., pursuant to which we can offer and sell our common stock, from time to time, up to aggregate sales proceeds of $9 million. The Sales Agreement is more fully described in part II – Item 5 – Other Information.
2017 Offering
On August 22, 2017, we completed the 2017 Offering for net proceeds to us of $4.4 million, after deducting underwriting discounts and commissions and offering expenses paid by us.
The following tables present selected financial information as of April 3, 2021 and January 2, 2021 and for the first three months of 2021 and 2020 (in thousands):
TRGP
| | | | | | |
| | April 3, | | January 2, |
| | 2021 | | 2021 |
Cash and cash equivalents | | $ | 21,616 | | $ | 13,326 |
Convertible promissory note and accrued interest, net | | | 16,438 | | | 16,310 |
Total PPP Loan and accrued interest | | | 643 | | | 641 |
Working capital | | | 6,925 | | | (2,726) |
| | | | | | |
| | Three Months Ended |
| | April 3, | | March 28, |
| | 2021 | | 2020 |
Net cash used in operating activities | | $ | (4,291) | | $ | (4,380) |
Net cash used in investing activities | | | (41) | | | (12) |
Net cash provided by financing activities | | | 14,322 | | | 1,289 |
During the three months ended April 3, 2021, net cash used in operating activities was primarily a result of net loss of $4.0 million and non-cash adjustments to net loss of $0.6 million, offset by net cash outflows from changes in operating assets and liabilities of $0.9 million driven predominantly by an increase in inventories due to higher purchases to support increased sales, partially offset by an increase in accounts payable. Net cash provided by financing activities during the three months ended April 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, $4.0 million in proceeds from exercise of warrants, $0.4 million in proceeds from exercise of stock options and a $1.0 million in net borrowings under the SVB Credit Agreement, partially offset by $0.3 million in payments of taxes related to net share settlement of equity awards.
During the three months ended March 28, 2020, net cash used in operating activities was primarily a result of a net loss of $1.5 million, adjusted for non-cash charges of $0.5 million, offset by net cash outflows from changes in operating assets and liabilities of $3.3 million driven predominantly by increases in accounts receivable due to higher sales and in inventories due to higher purchases to support increased sales, partially offset by an increase in accounts payable. Net cash provided by financing activities during the three months ended March 28, 2020 primarily consisted of $1.5 million in net borrowings under the SVB Credit Agreement, partially offset by $0.1 million in payments of note payable to finance insurance policies.
Capital Resources
2019 Lincoln Park Purchase Agreement
On May 3, 2017,June 24, 2019, we entered into the TRGP2019 Purchase Agreement which generally provides that TRGP will directly fund the costs incurred by us or on our behalf in connection with certain of our legal proceedings against SK hynix, including costs incurred since January 1, 2017 and costs to be incurred in the future in our first ITC action and our U.S. district court proceedings, but excluding our subsequent ITC action and our proceedings in international courts. In the nine months ended September 30, 2017, TRGP directly paid $9.3 million of legal expenses we incurred in connection with the SK hynix proceedings.
2016 Offering
On September 23, 2016, we completed an underwritten registered public offering (the “2016 Offering”),Lincoln Park, pursuant to which we sold 9,200,000have the right to sell to Lincoln Park up to an aggregate of $10 million in shares of our common stock at a priceover the 36-month term of the 2019 Purchase Agreement subject to the publicconditions and limitations set forth in the 2019 Purchase Agreement. As of $1.25 per share. The net proceedsApril 3, 2021, an aggregate of $2.0 million in shares of our common stock was available for purchases over the remaining term under the 2019 Purchase Agreement.
2020 Lincoln Park Purchase Agreement
On March 5, 2020, we entered into the 2020 Purchase Agreement with Lincoln Park, pursuant to us fromwhich we had the 2016 Offering were $10.3right to sell to Lincoln Park up to an aggregate of $20 million after deducting underwriting discountsin shares of our common stock over the 36-month term of the 2020 Purchase Agreement subject to the conditions and commissions and offering expenses paid by us.limitations set forth in the 2020 Purchase Agreement. In February 2021, we completed the sales under the 2020 Purchase Agreement.
SVB Credit Agreement
On October 31, 2009, we entered into the SVB Credit Agreement, which provides that we may borrowfor a revolving line of credit of up to the lesser of (i) 80%$5.0 million. The borrowing base is limited to 85% of eligible accounts receivable, or (ii) $5.0 million, subject to certain adjustments as set forth in the SVB Credit Agreement. The SVB Credit Agreement expiresAs of April 1, 2018.
We made net borrowings of $1.9 million under3, 2021, the SVB Credit Agreement in the nine months ended September 30, 2017, and we made no borrowings under the SVB Credit Agreement inbear interest at the nine months ended October 1, 2016. Prime Rate plus 2.75% per annum and mature on April 30, 2021.
As of September 30, 2017, we hadApril 3, 2021, the outstanding borrowings under the SVB Credit Agreement of $2.6 million. As of September 30, 2017 and December 31, 2016, we hadwere $4.6 million with additional borrowing availability of $0.4 million. During the three months ended April 3, 2021, we made net borrowings of $1.0 million under the SVB Credit Agreement of $0.1 million and $0.8 million, respectively.Agreement.
SVIC Note and SVIC WarrantPaycheck Protection Program Loan
On November 18, 2015,April 23, 2020, we issued to SVICentered into the SVIC Note and the SVIC Warrant. The SVIC Note has an originalPPP Loan with a principal amount of $15.0$0.6 million accruesthrough Hanmi Bank under the PPP administered by the SBA and established as part of the CARES Act. The PPP Loan bore interest at a rate1.0% per annum and would mature in April 2022 with the first six months of 2.0% per year, is dueinterest and payable inprincipal payments deferred. The amount borrowed under the PPP Loan was eligible for forgiveness if we would meet certain conditions. In May 2021, the full on December 31, 2021, and is convertible into shares of our common stock at a conversion price of $1.25 per share, subject to certain adjustments, onamounts outstanding under the maturity date of the SVIC Note. The SVIC Warrant grants SVIC a right to purchase up to 2,000,000 shares of our common stock at an exercise price of $0.30 per share, subject to certain adjustments, is only exercisable in the event we exercise our right to redeem the SVIC Note prior to its maturity date, and expires on December 31, 2025. Proceeds from the SVIC Note were used to repay a former loan from a different lender.PPP Loan was forgiven.
Equipment Leasing Arrangements
We have in the past utilized equipment leasing arrangements to finance certain capital expenditures. Although equipment leases did not contribute material cash during the periods covered by this report, they continue to be a financing alternative that we may pursue in the future.
Sufficiency of Cash Balances and Potential Sources of Additional Capital
We believe our existing balance of cash balance,and cash equivalents together with cash provided by our operations andreceipts from revenues, the settlement fee received under the SK hynix License Agreement, borrowing availability under the SVB Credit Agreement, the equity financing available under the 2019 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, and the funding to be received under the TRGP Agreement, will be sufficient to meet our anticipated cash needs for at least the next 12 months. Our capital requirements will depend on many factors, including, among others: the acceptance of, and demand for, our products and the component products we resell to customers directly; our levels of net product revenues and any other revenues we may receive, including NRE, license, royalty or other fees; the extent and timing of any investments in developing, marketing and launching new or enhanced products or technologies; the costs of developing, improving and maintaining our internal design, testing and manufacturing processes; the costs associated with defending and enforcing
our intellectual property rights; and the nature and timing of acquisitions and other strategic transactions in which we participate, if any.
Although we expect to be able to rely in the near term on our existing cash balance, cash provided by our operations, payments under the TRGP Agreement and borrowing availability under the SVB Credit Agreement, our estimates of our operating revenues and expenses and working capital requirements could be incorrect, and we may use our cash resources faster than we anticipate. Further, some or all of our ongoing or planned investments may not be successful and could result in further losses. Until we can generate sufficient revenues to finance our cash requirements from our operations, which we may never do, we may need to increase our liquidity and capital resources by one or more measures, which may include, among others, reducing operating expenses, restructuring our balance sheet by negotiating with creditors and vendors, entering into strategic partnerships or alliances, raising additional financing through the issuance of debt, equity or convertible securities or pursuing alternative sources of capital, such as through asset or technology sales or licenses or other alternative financing arrangements. Further, even if our near-term liquidity expectations prove correct, we may still seek to raise capital through one or more of these financing alternatives. However, we may not be able to obtain capital when needed or desired, on terms acceptable to us or at all.
Inadequate working capital would have a material adverse effect on our business and operations and could cause us to fail to execute our business plan, fail to take advantage of future opportunities or fail to respond to competitive pressures or customer requirements. A lack of sufficient funding may also require us to significantly modify our business model and/or reduce or cease our operations, which could include implementing cost-cutting measures or delaying, scaling back or eliminating some or all of our ongoing and planned investments in corporate infrastructure, research and development projects, business development initiatives and sales and marketing activities, among other activities. Modification of our business model and operations could result in an impairment of assets, the effects of which cannot be determined. Furthermore, if we continue to issue equity or convertible debt securities to raise additional funds, our existing stockholders may experience significant dilution, and the new equity or debt securities may have rights, preferences and privileges that are superior to those of our existing stockholders. If we incur additional debt, it may increase our leverage relative to our earnings or to our equity capitalization or have other material consequences. If we pursue asset or technology sales or licenses or other alternative financing arrangements to obtain additional capital, our operational capacity may be limited and any revenue streams or business plans that are dependent on the sold or licensed assets may be reduced or eliminated. Moreover, we may incur substantial costs in pursuing any future capital-raising transactions, including investment banking, legal and accounting fees, printing and distribution expenses and other similar costs, which would reduce the benefit of the capital received from the transaction.
Off-Balance Sheet Arrangements
We do not have any off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditure or capital resources that is material to investors.
Critical Accounting Policies and Use of Estimates
The preparation of our condensed consolidated financial statements in conformity with accounting principles generally accepted in the United States of America (“U.S. GAAP”) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the condensed consolidated financial statements, and the reported amounts of net sales and expenses during the reporting period. By their nature, these estimates and assumptions are subject to an inherent degree of uncertainty. We base our estimates and assumptions on our historical experience, knowledge of current conditions and our beliefs of what could occur in the future considering available information. We review our estimates and assumptions on an ongoing basis. Actual results may differ from our estimates, which may result in material adverse effects on our consolidated operating results and financial position.
Our critical accounting policies and estimates are discussed in Note 2 to the condensed consolidated financial statements in this report and in the notes to consolidated financial statements in Part II, Item 8 of our 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.
Item 3. | Quantitative and Qualitative Disclosures About Market Risk |
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Not applicable.
| ● | The price and trading volume of our common stock has and may continue to fluctuate significantly; |
| ● | We have incurred a material amount of indebtedness to fund our operations, the terms of which have required us to pledge substantially all of our assets as security. Our level of indebtedness and the terms of such indebtedness could adversely affect our operations and liquidity; |
| ● | There is a limited market for our common shares, and the trading price of our common shares is subject to volatility; |
| ● | Future issuances of our common stock or rights to purchase our common stock, including pursuant to our equity incentive plans, could result in additional dilution to the percentage ownership of our stockholders and could cause the price of our common stock to decline; |
| ● | Sales of our common stock, or the perception that such sales could occur, could cause the market price of our stock to drop significantly, regardless of the state of our business; |
| ● | Chun K. Hong has significant control over all corporate decisions that may not be in the best interest of our other stockholders; |
| ● | Anti-takeover provisions under our charter documents and Delaware law, as well as our rights agreement, could delay or prevent a change of control and could also limit the market price of our common stock; and |
| ● | We do not currently intend to pay dividends on our common stock, and any return to investors is expected to result, if at all, only from potential increases in the price of our common stock. |
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.
COVID-19 has spread globally and has resulted in authorities imposing, and businesses and individuals implementing, numerous unprecedented measures to try to contain the virus, such as travel bans and restrictions, quarantines, shelter-in-place/stay-at-home and social distancing orders, and shutdowns. These measures have impacted and may further impact our workforce and operations, the operations of our customers, and those of our respective vendors, suppliers, and partners. The ultimate impact and efficacy of government measures and potential future measures is currently unknown. In addition, the continued spread of COVID-19, or the occurrence of other epidemics could result in a widespread health crisis that could adversely affect the economies and financial markets of many countries, resulting in an economic downturn that could affect demand for our products and further adversely impact our results of operations.
There are numerous uncertainties associated with the coronavirus outbreak, including the number of individuals who will become infected, whether a vaccine or cure that mitigates the effect of the virus will be synthesized, and, if so, when such vaccine or cure will be ready to be used, and the extent of the protective and preventative measures that have been put in place by both governmental entities and other businesses and those that may be put in place in the future. Any or all of the foregoing uncertainties could have a material adverse effect on our results of operations, financial position and/or cash flows.
We have historically incurred losses and may continue to incur losses.
Since the inception of our business in 2000, we have only experienced one fiscal year (2006) with profitable results. In order to regain profitability, or to achieve and sustain positive cash flows from operations, we must reduce operating expenses and/or increase our revenues and gross margins. Although we have in the past engaged in a series of
cost reduction actions, such expense reductions alone maywill not make us profitable or allow us to sustain profitability if it is achieved, and eliminating or reducing strategic initiatives could limit our opportunities and prospects. Our ability to achieve profitability will depend on increased revenue growth from, among other things, monetization of our intellectual property, increased demand for our memory subsystems and other product offerings and our ability to expand into new and emerging markets.monetize our intellectual property. We may not be successful in any of these pursuits, and we may never achieve profitability or sustain profitability if achieved.
We may not have sufficient working capital to fund our planned operations, and, as a result, we may need to raise additional capital in the future, which may not be available when needed, on acceptable terms or at all.
We believe that, taking into account our planned activities and our sources of capital, we have sufficient cash resources to satisfy our capital needs for at least the next 12 months. However, our estimates of our operating revenues and expenses and working capital requirements could be incorrect, and we may use our cash resources faster than we anticipate. Further, some or all of our ongoing or planned investments may not be successful and could result in further losses.
Our capital requirements will depend on many factors, including, among others:
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| | the acceptance of, and demand for, our products and the component products we resell to customers directly;
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| | our success, and that of our strategic partners, in developing and selling products derived from our technology;
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| | the extent and timing of any investments in developing, marketing and launching new or enhanced products or technologies;
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| | the costs of developing, improving and maintaining our internal design, testing and manufacturing processes;
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| | the costs associated with defending and enforcing our intellectual property rights;
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| | our results of operations, including our levels of net product revenues and any other revenues we may receive, including non-recurring engineering (“NRE”), license, royalty or other fees;
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| | the amount and timing of vendor payments and the collection of receivables, among other factors affecting our working capital;
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| | our receipt of cash proceeds from the exercise of outstanding stock options or warrants to acquire our common stock;
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| | the nature and timing of acquisitions and other strategic transactions in which we participate, if any; and
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| | the costs associated with the continued operation, and any future growth, of our business.
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We expect to rely in the near term on cash provided by our operations; funds raised pursuant to recent issuances of debt and equity securities, such as our November 2015 issuance of convertible debt to an affiliate of Samsung Venture Investment Co., Samsung Venture Investment Co. (“SVIC”), and our September 2016 and August 2017 public offerings of common stock; our new funding arrangement with TR Global Funding V, LLC, an affiliate of TRGP Capital Management, LLC (“TRGP”), for costs associated with certain of our legal proceedings; and borrowing availability under our credit facility with Silicon Valley Bank (“SVB”). However, our estimates of our operating revenues and expenses and working capital requirements could be incorrect, and we may use our cash resources faster than we
anticipate. Further, some or all of our ongoing or planned investments may not be successful and could result in further losses. Until we can generate sufficient revenues to finance our cash requirements from our operations, which we may never do, we may need to increase our liquidity and capital resources by one or more measures, which may include, among others, reducing operating expenses, restructuring our balance sheet by negotiating with creditors and vendors, entering into strategic partnerships or alliances, raising additional financing through the issuance of debt, equity or convertible securities or pursuing alternative sources of capital, such as through asset or technology sales or licenses or other alternative financing arrangements. Further, even if our near-term liquidity expectations prove correct, we may still seek to raise capital through one or more of these financing alternatives. However, we may not be able to obtain capital when needed or desired, on terms acceptable to us or at all.
Inadequate working capital would have a material adverse effect on our business and operations and could cause us to fail to execute our business plan, fail to take advantage of future opportunities or fail to respond to competitive pressures or customer requirements. A lack of sufficient funding may also require us to significantly modify our business model and/or reduce or cease our operations, which could include implementing cost-cutting measures or delaying, scaling back or eliminating some or all of our ongoing and planned investments in corporate infrastructure, research and development projects, business development initiatives and sales and marketing activities, among other activities. Modification of our business model and operations could result in an impairment of assets, the effects of which cannot be determined. Furthermore, if we continue to issue equity or convertible debt securities to raise additional funds, our existing stockholders may experience significant dilution, and the new equity or debt securities may have rights, preferences and privileges that are superior to those of our existing stockholders. If we incur additional debt, it may increase our leverage relative to our earnings or to our equity capitalization or have other material consequences. If we pursue asset or technology sales or licenses or other alternative financing arrangements to obtain additional capital, our operational capacity may be limited and any revenue streams or business plans that are dependent on the sold or licensed assets may be reduced or eliminated. Moreover, we may incur substantial costs in pursuing any future capital-raising transactions, including investment banking, legal and accounting fees, printing and distribution expenses and other similar costs, which would reduce the benefit of the capital received from the transaction.
We have incurred a material amount of indebtedness to fund our operations, the terms of which have required us to pledge substantially all of our assets as security. Our level of indebtedness and the terms of such indebtedness could adversely affect our operations and liquidity.
We have incurred debt under our convertible note issued to SVIC, our credit facility with SVB, and our new funding arrangement with TRGP. In connection with these debt and other arrangements, we have granted security interests to SVIC, SVB and TRGP in our various assets, such that all of our tangible and intangible assets, including our complete patent portfolio, are subject to one or more outstanding liens held by one or more of these parties. The SVIC and SVB debt instruments and the TRGP investment agreement contain customary representations, warranties and indemnification provisions, as well as affirmative and negative covenants that, among other things, restrict our ability to:
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| | incur additional indebtedness or guarantees;
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| | make investments, loans and acquisitions;
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| | sell or exclusively license assets, including capital stock of subsidiaries;
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| | change any provision of our organizational documents;
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| | engage in transactions with affiliates;
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| | make certain decisions regarding certain of our outstanding legal proceedings without consulting with or obtaining consent from certain of these parties; and
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| | pay dividends or make distributions.
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The SVIC and SVB debt instruments and the TRGP investment agreement also include events of default, including, among other things, payment defaults, any breach by us of representations, warranties or covenants, certain bankruptcy events and certain material adverse changes. If an event of default were to occur under any of these instruments or agreements and we were unable to obtain a waiver for the default, the counterparties could, among other remedies, accelerate our obligations under the debt instrument or other agreement and exercise their rights to foreclose on their security interests, which would cause substantial harm to our business and prospects.
Additionally, incurrence and maintenance of this or other debt could have material adverse consequences on our business and financial condition, such as:
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| | requiring us to dedicate a portion of our cash flows from operations and other capital resources to debt service, thereby reducing our ability to fund working capital, capital expenditures and other cash requirements;
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| | increasing our vulnerability to adverse economic and industry conditions;
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| | limiting our flexibility in planning for or reacting to changes and opportunities in our business and industry, which may place us at a competitive disadvantage; and
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| | limiting our ability to incur additional debt when needed, on acceptable terms or at all.
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We are and expect to continue to be involved in costly legal and administrative proceedings to enforce or protect our intellectual property rights and to defend against claims that we infringe the intellectual property rights of others.
As is common in the semiconductor industry, we have experienced substantial litigation regarding patent and other intellectual property rights. We are currently involved in litigation and proceedings at the U.S. Patent and Trademark Office (“USPTO”) and Patent Trial and Appeal Board (“PTAB”) based on alleged third-party infringement of our patents, and lawsuits claiming that we are infringing others’ intellectual property rights also have been and may in the future be brought against us.
The process of obtaining and protecting patents is inherently uncertain. In addition to the patent issuance process established by law and the procedures of the USPTO, we must comply with administrative procedures of the Joint Electron Device Engineering Council (“JEDEC”) to protect our intellectual property within its industry standard-setting process. These procedures evolve over time, are subject to variability in their application and may be inconsistent with each other. Failure to comply with the USPTO’s or JEDEC’s administrative procedures could jeopardize our ability to claim that our patents have been infringed.
Our business strategy includes litigating claims against others, such as our competitors, customers and former employees, to enforce our intellectual property, contractual and commercial rights including, in particular, our patent portfolio and our trade secrets, as well as to challenge the validity and scope of the proprietary rights of others. This or other similar proceedings could also subject us to counterclaims or countersuits against us, or the parties we sue could seek to invalidate our patents or other intellectual property rights through reexamination or similar processes at the USPTO or similar bodies. Moreover, any legal disputes with customers could cause them to cease buying or using our products or the component products we resell to customers directly or delay their purchase of these products and could substantially damage our relationship with them.
Making use of new technologies and entering new markets increases the likelihood that others might allege that our products or the component products we resell infringe on their intellectual property rights. The likelihood of this type
of lawsuit may also be increased due to the limited pool of experienced technical personnel that we can draw upon to meet our hiring needs. As a result, a number of our existing employees have worked for our existing or potential competitors at some point during their careers, and we anticipate that a number of our future employees will have similar work histories. Moreover, lawsuits of this type may be brought, even if there is no merit to the claim, as a strategy to prevent us from hiring qualified candidates, drain our financial resources and divert management’s attention away from our business.
Litigation is inherently uncertain. An adverse outcome in existing or any future litigation could force us to, among other things:
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| | relinquish patents or other protections of our technologies if they are invalidated, which would enable our competitors and others to freely use this technology;
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| | compete with products that rely upon technologies and other intellectual property rights that we have developed and that we believe we have the right to protect from third-party use;
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| | accept terms of an arrangement to license our technologies to a third party that are not as favorable as we might expect;
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| | cease manufacturing and/or selling products or using certain processes that are claimed to be infringing a third party’s intellectual property;
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| | pay damages (which in some instances may be three times actual damages), including royalties on past or future sales, if we are found to infringe a third party’s intellectual property;
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| | seek a license from a third -party intellectual property owner to use its technology in our products or the component products we resell, which may not be available on reasonable terms or at all; or
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| | redesign any products that are claimed to be infringing a third party’s intellectual property, which may not be possible to do in a timely manner, without incurring significant costs or at all.
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Moreover, any litigation, regardless of its outcome, would involve a significant dedication of resources, including time and costs, would divert management’s time and attention and could negatively impact our results of operations. As a result, any current or future infringement claims by or against third parties could materially adversely affect our business, financial condition or results of operations.
We are and expect to continue to be involved in legal proceedings at the ITC and related enforcement actions to stop allegedly infringing SK hynix RDIMM and LRDIMM products from entering the United States, as well as legal proceedings in district court to seek damages for the alleged patent infringement. Our involvement in these proceedings, as well as steps we have taken to implement certain of our strategies in connection with these proceedings, subject us to a number of risks.
On September 1, 2016, we took action to protect and defend our innovations by filing legal proceedings for patent infringement against SK hynix Inc., a South Korean memory semiconductor supplier (“SK hynix”), and two of its subsidiaries in the U.S. International Trade Commission (“ITC”) and in district court. We are seeking an exclusion order in the ITC that directs U.S. Customs and Border Protection to stop allegedly infringing SK hynix registered dual in-line memory module (“RDIMM”) and load reduced dual in-line memory modules ("LRDIMM") products from entering the United States. ITC investigations typically proceed on an expedited basis. The evidentiary hearing in the ITC investigation occurred in May 2017, with a final initial determination expected to be issued by the ITC in November 2017, but there can be no guarantee that our proceedings will follow such a timeline.
Intellectual property litigation is expensive and time‑consuming, regardless of the merits of any claim, and could divert management’s attention from operating our business. Even if we are successful at the ITC, we would then need to enforce the order which is expensive, time consuming and could divert management’s attention from operating
our business. In addition, lawsuits in the ITC and in district courts are subject to inherent uncertainties due to the complexity of the technical issues involved, and we may not be successful in our actions. Moreover, if we are countersued by SK hynix and lose the suit, we could be required to pay substantial damages or lose some of our intellectual property protections. Furthermore, we may not be able to reach a settlement with SK hynix to license our patent portfolio, and even if we are able to reach a settlement, the terms of the arrangement may not be as favorable as we anticipated. Any of the foregoing could cause us to incur significant costs, decrease the perceived value of our intellectual property and materially adversely affect our business, financial condition or results of operations.
We have recently taken steps to solidify our position and strategy in connection with our proceedings against SK hynix. In May 2017, we established a funding arrangement with TRGP, which generally provides that TRGP will directly fund the costs incurred by us or on our behalf in connection with certain of our SK hynix proceedings (including our first ITC action and our U.S. district court proceedings, but excluding our subsequent ITC action and our proceedings in international courts), and in exchange for such funding, we have agreed to pay to TRGP the amount of its funding plus an escalating premium starting at a low-to-mid double-digit percentage of the amount of its funding if and when we recover any proceeds from the funded proceedings, and we have granted to TRGP a first priority lien on the claims underlying the funded proceedings and any proceeds received from the funded proceedings and a second priority lien on our patents that are the subject of the funded proceedings. We established this funding arrangement in order to provide us with increased security that we will be able to vigorously pursue our claims against SK hynix through their final resolution, but the arrangement also involves certain risks, including, among others, our obligation to use a portion of any proceeds we may receive from these proceedings to repay the funded amounts at a premium, which premium would increase the longer the proceedings remain unresolved, and our obligation to consult with or obtain consent from TRGP in connection with certain decisions or other matters relating to the SK hynix proceedings.
In addition, in April 2017, we adopted a short-term rights agreement to implement a standard “poison pill.” In general terms, for so long as the rights issued under the rights agreement are outstanding, which is expected to be no longer than 12 months, the rights agreement prevents any person or group from acquiring a significant percentage of our outstanding capital stock or attempting a hostile takeover of our Company by significantly diluting the ownership percentage of such person or group. As a result, the rights agreement has a significant anti-takeover effect. Our board of directors approved the rights agreement as part of our strategy in connection with our proceedings against SK hynix, with the intent of disconnecting our market capitalization from the damages calculations and any settlement negotiations that may develop in connection with these proceedings. However, the rights agreement may not have the intended, or any, impact on these proceedings or any related settlement negotiations, but would have the anti-takeover effect of any standard “poison pill” and thus would involve the risks associated with these anti-takeover effects, which are described elsewhere in these risk factors.
We may be unsuccessful in monetizing our intellectual property portfolio.
We have dedicated substantial resources to the development and protection of technology innovations essential to our business, and we expect these activities to continue for the foreseeable future. We also intend to aggressively pursue monetization avenues for our intellectual property portfolio, potentially including licensing, royalty or other revenue-producing arrangements. However, our revenues are currently generated by resales of component products and sales of our products and we may never be successful in generating a revenue stream from our intellectual property, in which case our investments of time, capital and other resources into our intellectual property portfolio may not provide adequate, or any, returns.
Although we may pursue agreements with third parties to commercially license certain of our products or technologies, we may never successfully enter into any such agreement. Further, the terms of any such agreements that we may reach with third-party licensees are uncertain and may not provide sufficient royalty or other licensing revenues to us to justify our costs of developing and maintaining the licensed intellectual property or may otherwise include terms that are not favorable to us. Additionally, the pursuit of licensing arrangements would require by its nature that we relinquish certain of our rights to our technologies and intellectual property that we license to third parties, which could limit our ability to base our own products on such technologies or could reduce the economic value that we receive from such technologies and intellectual property. Additionally, the establishment of arrangements to monetize our intellectual property may be more difficult or costly than expected, may require additional personnel and investments and may be a
significant distraction for management. In connection with any monetization avenues we may develop, our licenses and royalty revenue may be uncertain from period to period and we may be unable to attract sufficient licensing customers, which would materially and adversely affect our results of operations.
Our ability to establish licensing, royalty or similar revenues, and maintain or increase any such revenues we are able to establish, depends on a variety of factors, including the novelty, utility, performance, quality, breadth, depth and overall perceived value of our intellectual property portfolio, all as compared to that of our competitors, as well as our sales and marketing capabilities. If secured, licensing or royalty revenues may also be negatively affected by factors within and outside our control, including reductions in our customers’ sales prices, sales volumes and the terms of the license arrangements. If we are not successful in monetizing our intellectual property portfolio, we may never recoup the costs associated with developing, maintaining, defending and enforcing this portfolio and our financial condition and prospects would be harmed.
The vast majority of our revenues in recent periods have been generated from resales of component products, including products sourced from Samsung, and any decline in ourthese product resales of these products could significantly harm our performance.
The vast majority of our revenues in recent periods have been generated from resales of component products, including primarilySSDs, NAND flash that we purchase for the purpose of resale from Samsung and alternative suppliers. For our fiscal year ended December 31, 2016 and the nine months ended September 30, 2017, resales ofDRAM products. We resell these component products accounted for approximately 21% and 86% of our net product revenues, respectively. We purchase many of these products, including primarily NAND flash, from Samsung Electronics Co., Ltd. (“Samsung”) under the terms of our Joint Development and License Agreement (“JDLA”) with Samsung in order to resell these products to end-customers that are not reached in Samsung’sthe distribution model,models of the component manufacturers, including storage customers, appliance customers, system builders and cloud and datacenter customers. We have also sourced these products from alternative suppliers to the extent sufficient product is not available from Samsung to meet customer demand.
These component product resales are subject to a number of risks. For example, demand for these products could decline at any time for a number of reasons, including, among others, changing customer requirements or preferences, product obsolescence, introduction of more advanced or otherwise superior competing products by our competitors, the ability of our customers to obtain these products or substitute products from alternate sources (including from the manufacturer directly), customers reducing their need for these products generally, or the other risk factors described in this report. Further, weWe have no long-term purchase agreements or other commitments with respect to sales of these or any of ourthe other products.products we sell. As a result, any decrease in demand for these products from us could decline at any time,would reduce our sale levels and any reduced sales of these products could materially adversely impact our revenues. In addition, increased resalesAdditionally, opportunistic purchases of products for resale, when coupled a decrease in demand, may cause us to write off excess inventory which would adversely affect our operating performance.
We may experience supply shortages at any time and for a variety of reasons, including, among others, spikes in customer demand that cannot be satisfied, any problems that arise with Samsung’s or SK hynix’s manufacturing operations or facilities that cause disruptions or delays, including from the recent COVID-19 pandemic, or any failure to comply with the terms of the agreements regarding the supply of these products. If we choose, or if we are forced, to seek to supply the component products aswe resell from other suppliers, we may not be able to identify other suppliers that are available and able to produce the particular components with the specific product specifications and in the quantities our customers require, or we may not be able to make arrangements with any other suppliers in a percentagetimely manner to avoid delays in satisfying customer orders. Further, even if we are able to make arrangements with other suppliers for sufficient component products to replace any undersupply from Samsung or SK hynix, we may not be able to make these arrangements on financial and other terms comparable to those we have negotiated with Samsung or SK hynix. As a result, any inability to obtain sufficient component products from Samsung or SK hynix could increase our cost of sales for component product resales if we are forced to pay higher prices to obtain the products from other suppliers. Moreover, all of our totalsupply arrangements for these component products and any arrangements we may establish with other suppliers, are subject to the other supply and manufacturing risks discussed elsewhere in these risk factors.
Increased reliance on product revenues haveresales also has a significant negativesubstantial impact on our gross margin, asresults of operations. Because the cost of the component products we purchase for resale from Samsung or alternative suppliers is added to our cost of sales for these products. As a result,products, our gross margin on the resaleresales of component products is significantly lower than our gross margin on sales of our own memory subsystem products. Further, to the extent we are not able to procure sufficient component products for resale from Samsung under the terms of the JDLA to satisfy customer orders for these products, we would need to seek to procure these products from alternative suppliers, which may not be available on terms comparable to those we have negotiated with Samsung under the JDLA and may be subject to other supply and manufacturing risks discussed elsewhere in these risk factors. As a result, any inability to source sufficientincreased resales of component products from Samsung could increaseas a percentage of our cost oftotal product sales associated withhave a significant negative impact on our gross margin and gross profit. This gross margin and gross profit differential between memory product sales and component product resales of thesewould be amplified if our costs to purchase component products if we are forcedwere to pay higher prices to obtain these products from other suppliers.increase. The occurrence of any one or more of these risks could cause our performance to materially suffer.
Our performance has historically been substantially dependent on sales of NVvault, and we may never be able to replace the revenues lost from the rapid decline in NVvault sales in recent periods.
We have historically been substantially dependent on sales of our NVvault non-volatile dual in-line memory modules ("NVDIMM") used in cache-protection and data-logging applications, including our NVvault battery‑free, the flash‑based cache system. For our fiscal years ended December 27, 2014 and January 2, 2016, sales of NVvault accounted for 44% and 20% of total net product revenues, respectively. However, we have experienced a sharp decline in NVvault sales in recent periods, and sales of NVvault accounted for only 1% and 0.3% of total net product revenues in
our fiscal year ended December 31, 2016 and the nine months ended September 30, 2017, respectively. This rapid decline has been due in large part to the loss of our former most significant NVvault customer, Dell, beginning in 2012. We recognized no NVvault sales to Dell in the year ended December 31, 2016 or the nine months ended September 30, 2017, and we expect no future demand from Dell for these products. In order to leverage our NVvault technology and secure one or more new key customers, we continue to pursue additional qualifications of NVvault with other original equipment manufacturers (“OEMs”) and to target new customer applications, such as online transaction processing, virtualization, Big Data analytics, high speed transaction processing, high-performance database applications and in‑memory database applications. We also introduced EXPRESSvault in March 2011 and the next-generation of EXPRESSvault (EV3) in July 2015, and we continue to pursue qualification of the next-generation DDR3 NVvault and DDR4 NVvault with customers. Our future operating results will depend on our ability to commercialize these NVvault product extensions, as well as our other products such as HybriDIMM and other high‑density and high-performance solutions. However, HybriDIMM is still under development and may require additional investment and the services and attention of key employees who have competing demands on their available time. Further, although we believe our JDLA with Samsung may advance the development of our HybriDIMM product, our partnership with Samsung and any other steps we take to further the development of this or any of our other products could fail. Moreover, the rate and degree of customer adoption of our NVvault product extensions and other next-generation products has been slower and smaller than expected to date, and these products may never gain significant customer or market acceptance. If we are not successful in expanding our qualifications or marketing any new or enhanced products, we may never be able to secure revenues sufficient to replace lost NVvault revenues and our results of operations and prospects could be materially harmed.
We are subject to risks relating to our focus on developing our HybriDIMM and NVvault products and a lack of market diversification.for our target customer markets.
We have historically derived a substantial portion of our revenues from sales of our high‑performancehigh-performance modular memory subsystems to OEMsoriginal equipment manufacturers (“OEM”) in the server, high-performance computing and communications markets, as well as from sales of component products to storage customers, appliance customers, system builders and cloud and datacenter customers.markets. Although we expect these memory subsystems to continue to account for a portion of our revenues, we have experienced declines in sales of these products in recent periods, and these declines could continue or intensify in the future. We believe that market acceptance of these products or derivative products that incorporate our core memory subsystem technology is critical to our success, and any continued decline in sales of these products could have a material adverse impact on our performance and long-term prospects.
If we are unable to timely and cost-effectively develop new or enhanced products that meet our customers’ requirementsachieve customer and achieve market acceptance or technologies that we can monetize, our revenues and prospectusprospects could be materially harmed.
Our industry is characterized by rapid technological change, evolving industry standards and rapid product obsolescence. As a result, continuous development of new technology, processes and product innovations is necessary in
order to be successful. We believe that the continued and timely development of new products and technologies and improvement of existing products and technologies are critical to our business and prospects for growth.
In order to develop and introduce new or enhanced products and technologies, we need to:
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● | | retain and continue to attract new engineers with expertise in high-performance modular memory subsystems and our key technology competencies; |
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● | | identify and adjust to the changing requirements and preferences of our existing and potential future customers; customers and markets; |
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● | | identify and adapt to emerging technological trends and evolving industry standards in our markets; |
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● | | continue to develop and enhance our design tools, manufacturing processes and other technologies that allow uson which we rely to produce attractive and competitive products; new products or product enhancements; |
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● | | design and introduce cost-effective, innovative and performance-enhancing features that differentiate our products and technologies from those of our competitors; |
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● | | secure licenses to enable us to use any technologies, processes or other rights essential to the manufacture or use of any new products or product enhancements we may design,develop, which licenses may not be available when needed, on acceptable terms or at all; |
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● | | maintain or develop new relationships with suppliers of components required for any new or enhanced products and technologies; |
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● | | qualify any new or enhanced products for use in our customers’ products; and |
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● | | develop and maintain effective commercialization and marketing strategies. |
We may not be successful at any of these activities. As a result, we may not be able to successfully develop new or enhanced products or technology or we may experience delays in this process. Failures or delays in product development and introduction could result in the loss of, or delays in generating, net products sales or other revenues and the loss of key customer relationships. Even if we develop new or enhanced products or technologies, they may not meet our customers’ requirements, or gain market acceptance or attract monetization opportunities, as our product and technology development efforts are inherently risky due to the challenges of foreseeing changes or developments in technology, predicting changes in customer requirements or preferences or anticipating the adoption of new industry standards. Moreover, we have invested significant resources in our product and technology development efforts, which would be lost if we fail to develop successful products.generate revenues from these efforts. If any if these risks were to occur, our net product revenues, prospects and reputation could be materially adversely affected.
We face intense competition in our industry, and we may not be able to compete successfully in our target markets.
Our products are primarily targeted to OEMs in the server, high-performance computing and communications markets. In addition, we resell certain component products to storage customers, appliance customers, system builders and cloud and datacenter customers. These markets are intensely competitive, as numerous companies vie for business opportunities at a limited number of large OEMs and other customers. We face competition from DRAM suppliers, memory module providers and logic suppliers for many of our products, including EXPRESSvault, NVvault and HybriDIMM. We also face competition from the manufacturers and distributors of the component products we resell to customers, as these manufacturers and distributors could decide at any time to sell these component products to these customers directly. Additionally, if and to the extent we enter new markets or pursue licensing arrangements to monetize our technologies and intellectual property portfolio, we may face competition from a large number of competitors that produce solutions utilizing similar or competing technologies.
Some of our customers and suppliers may have proprietary products or technologies that are competitive with our products or the components we resell to them or could develop internal solutions or enter into strategic relationships
with, or acquire, other high-density memory module or component providers. Any of these actions could reduce our customers’ demand for our products or the component products we resell. SomeAdditionally, some of our significant suppliers of memory integrated circuitscould choose to sell component products to customers directly, which would adversely affect our ability to resell these products, or may be ablechoose to manufacture competitive memory subsystem products at lower costs by leveraging internal efficiencies,themselves or could choose to reduce our supply of memory integrated circuits,essential components of our products, which could adversely affect our ability to manufacture and sell our memory subsystemssubsystems.
We believe our ability to compete in our current target markets and potential future markets will depend in part on aour ability to successfully and timely basis, ifdevelop, introduce and sell at all.
Certainattractive prices new and enhanced products or technologies and otherwise respond to changing market requirements, which we may not be able to do faster and better than our competitors. Moreover, many of our competitors have substantially greater financial, technical, marketing, distribution and other resources, broader product lines, lower cost structures, greater brand recognition, more influence on industry standards, more extensive or established patent portfolios and longer standing relationships with customers and suppliers. Some of our competitors may also have a greater ability to influence industry standards than we do. Additionally, some of our competitors may have more extensive or more established patent portfolios than we do. We may not be able to compete effectively against any of these organizations.
Our ability to compete in our current target markets and future markets will depend in large part on our ability to successfully develop, introduce and sell new and enhanced products or technologies on a timely and cost-effective basis and to respond to changing market requirements. We expect our competitors to continue to improve the performance of their current products and potentially reduce their prices. In addition, our competitors may develop future generations and enhancements of competitive products or new or enhanced technologies that may offer greater performance and improved pricing or render our technologies obsolete. If we are unable to match or exceed the improvements made by our competitors,compete effectively, then our market position and prospects could deteriorate and our net product revenues could decline.
A limited number of relatively large potential customers dominateOur operating results may be adversely impacted by worldwide economic and political uncertainties and specific conditions in the markets we address and in which we or our strategic partners or competitors do business, including ongoing effects of the COVID-19 pandemic and the cyclical nature of and volatility in the memory market and semiconductor industry.
Changes in domestic and global economic and political conditions make it difficult for our customers, our vendors and us to accurately forecast and plan future business activities, and these conditions have caused and could continue to cause U.S. and foreign businesses to slow or decrease spending on our products and the products we resell.
In addition, sales of our products and the products we resell are dependent on demand by customers in our target markets. These markets are characterized by wide fluctuations in product supply and demand and have been cyclical in the past, which may result in substantial period-to-period fluctuations in our operating results. In addition, these markets have in the past experienced significant downturns, often connected with or in anticipation of maturing product cycles, reductions in technology spending and declines in general economic conditions. During these downturns, product demand diminishes, production capacity exceeds demand, inventory levels increase and average sale prices decline, all of which would materially adversely impact our business and operating results. In addition, because many of our costs and operating expenses are relatively fixed, if we are unable to control our expenses adequately in response to reduced product demand and sales, our gross margins and cash flows would be negatively impacted. Further, such a downturn could decrease the perceived value of our intellectual property portfolio and reduce our ability to pursue our intellectual property monetization objectives.
During challenging economic times, our customers may face challenges gaining timely access to sufficient credit, which could impair their ability to make timely payments to us. This may negatively affect our liquidity and cash flows and require us to increase our allowance for doubtful accounts. Furthermore, our vendors may face similar issues gaining access to credit, which may limit their ability to supply components or provide trade credit to us.
We cannot predict the timing, strength or duration of any economic slowdown or subsequent economic recovery, either generally or in our customer markets. If the economy or markets in which we operate experience such a slowdown, our business, financial condition and results of operations could be materially and adversely affected. The combination of our lengthy sales cycle coupled with any challenging macroeconomic conditions could compound the negative impact of any such downturn on the results of our operations.
Our lack of a significant backlog of unfilled orders and the difficulty inherent in estimating customer demand makes it difficult to forecast our short-term requirements, and any failure to optimally calibrate our production capacity and inventory levels to meet customer demand could adversely affect our revenues, gross margins and earnings.
We make significant decisions regarding the levels of business we will seek and accept, production schedules, component procurement, personnel needs and other resource requirements based on our estimates of customer demand.
intellectual property of our current design or manufacturing partner when we manufacture the products with a new design or manufacturing partner. Such an occurrence could force us to stop selling certain of our products or could expose us to lawsuits, license payments or other liabilities.
Our dependence on third-party manufacturers exposes us to many other risks, including, among others: reduced control over delivery schedules, quality, manufacturing yields and costs; the potential lack of adequate capacity during periods of excess demand; limited warranties on products supplied to us; and potential infringement or misappropriation of our intellectual property or the intellectual property of others. We are dependent on our manufacturing partners to manufacture components with acceptable quality and manufacturing yields, to deliver these components to us on a timely basis and at an acceptable cost and to allocate a portion of their manufacturing capacity sufficient to meet our needs. However, these component manufacturers may not be able to achieve these tasks. Additionally, our manufacturing partners may not continue to devote adequate resources to produce our products or the component products we resell, or continue to advance the process design technologies on which the customer qualifications of our products are based. Any of these risks could limit our ability to meet customer demand and materially adversely affect our business and operating results.
If our products or the component products we resell do not meet quality standards or are defective or used in defective systems, we may be concentrated among a small number of largesubject to quality holds, warranty claims, recalls or liability claims.
Our customers require our products and the component products we resell to meet strict quality standards. If the products fail to meet these standards, our customers may discontinue purchases from us until we are able to resolve the quality issues that are causing these failures, which we may not be able to do. These “quality holds” can be costly and time-consuming to resolve. In addition, if the products we sell are defectively manufactured, contain defective components or are used in defective or malfunctioning systems, we could be subject to warranty and product liability claims, product recalls, safety alerts or advisory notices.
Although we generally attempt to contractually limit our exposure to incidental and consequential damages, if these contract provisions are not enforced or if liabilities arise that are not effectively limited, we could incur substantial costs in defending or settling product liability claims. While we currently have product liability insurance, it may not provide coverage under certain circumstances and it may not be adequate to satisfy claims made against us. We also may be unable to maintain insurance in the foreseeable future. We believe that our financial results will dependfuture at satisfactory rates or in significant partadequate amounts.
Warranty and product liability claims, product “quality holds,” product recalls, safety alerts or advisory notices, regardless of their coverage by insurance or their ultimate outcome, could have a material adverse effect on our success in establishingbusiness, performance and maintaining relationships withfinancial condition, as well as our ability to attract and effecting substantial sales to these potentialretain customers. Even if we establish and successfully maintain these relationships, our financial results will be largely dependent on these customers’ sales and business results.
If a standardized memory solution that addresses the demands of our customers is developed, our net product revenuessales and market share may decline.
Many of our memory subsystems are specifically designed for our OEM customers’ high-performance systems. In a drive to reduce costs and assure supply of their memory module demand, our OEM customers may endeavor to design JEDEC standard DRAM modules into their new products. Although we also manufacture JEDEC modules, this trend could reduce the demand for our higher-priced customized memory solutions, which would have a negative impact on our operating results. In addition, the adoption of a JEDEC standard module instead of a previously custom module might allow new competitors to participate in a share of our customers’ memory module business that previously belonged to us.
If our OEM customers were to adopt JEDEC standard modules, our future business may be limited to identifying the next generation of high-performance memory demands of OEM customers and developing solutions that address these demands. Until fully implemented, any next generation of products may constitute a significantly smaller market, which could reduce our revenues and harm our competitive position.
If we fail to protect our proprietary rights, our customers or our competitors might gain access to our proprietary designs, processes and technologies, which could adversely affect our operating results.
We rely on a combination of patent protection, trade secret laws and restrictions on disclosure to protect our intellectual property rights. We have submitted a number of patent applications regarding our proprietary processes and technology. It is not certain when or if any of the claims in our patent applications will be allowed. As of September 30, 2017, we had 70 U.S. and foreign patents issued, one German utility model and 38 pending patent applications
worldwide. Although we intend to continue filing patent applications with respect to the new processes and technologies that we develop, patent protection may not be available for some of these processes or technologies, in which case they may remain unprotected from use by third parties, including our competitors.
Our efforts to protect our intellectual property rights may not:
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Monitoring for any unauthorized use of our technologies is costly, time-consuming and difficult. This is particularly true in foreign countries, such as the People’s Republic of China (“PRC”), where we have established a manufacturing facility and where the laws may not protect our proprietary rights to the same extent as applicable U.S. laws.
If some or all of the claims in our patent applications are not allowed or if any of our intellectual property protections are limited in scope by the USPTO, a court or applicable foreign authorities or are circumvented by third parties, we could face increased competition for our products and be unable to execute on our strategy of monetizing our intellectual property. Any of these outcomes could significantly harm our business, operating results and prospects.
Our operating results may be adversely impacted by worldwide economic and political uncertainties and specific conditions in the markets we address and in which we or our strategic partners or competitors do business, including the cyclical nature of and volatility in the memory market and semiconductor industry.
Adverse changes in domestic and global economic and political conditions have made it extremely difficult for our customers, our vendors and us to accurately forecast and plan future business activities, and these conditions have caused and could continue to cause U.S. and foreign businesses to slow or decrease spending on our products and services and the products we resell to customers directly. For instance, the current political instability in Korea could impact our operations and financial condition as a result of our dependence on Samsung, a South Korean based company, as a key supplier and strategic partner, and our ongoing legal proceedings against SK hynix. In addition, sales of our products and the products we resell to customers directly are dependent upon demand by OEMs in the server, high-performance computing and communications markets, as well as by storage customers, appliance customers, system builders and cloud and datacenter customers. These markets are characterized by wide fluctuations in product supply and demand. Additionally, these markets have been cyclical and have experienced significant downturns, often connected with or in anticipation of maturing product cycles, reductions in technology spending and declines in general economic conditions. During these downturns, product demand diminishes, production capacity exceeds demand, inventory levels increase and average selling prices decline, all of which would materially adversely impact our business and operating results. Additionally, such a downturn could decrease the perceived value of our intellectual property portfolio and result in reduced ability to pursue our goal of monetizing this portfolio.
We may experience substantial period-to-period fluctuations in our operating results due to factors affecting the markets in which we operate. A decline or significant shortfall in demand in any of these markets could have a material adverse effect on demand for our products and the products we resell to customers directly and, consequently, on our net product revenues. In addition, because many of our costs and operating expenses are relatively fixed, if we are unable to
control our expenses adequately in response to reduced product revenues, our gross margins, operating income and cash flows would be negatively impacted.
During challenging economic times our customers may face issues gaining timely access to sufficient credit, which could impair their ability to make timely payments to us. This may impair our liquidity and cash flows and require us to increase our allowance for doubtful accounts. Furthermore, our vendors may face similar issues gaining access to credit, which may limit their ability to supply components or provide trade credit to us. We cannot predict the timing, strength or duration of any economic slowdown or subsequent economic recovery, either generally or in our markets. If the economy or markets in which we operate experience such a slowdown, our business, financial condition and results of operations could be materially and adversely affected. Additionally, the combination of our lengthy sales cycle coupled with any challenging macroeconomic conditions could compound the negative impact of any such downturn on the results of our operations.
Our lack of a significant backlog of unfilled orders and the difficulty inherent in estimating customer demand makes it difficult to forecast our short-term requirements, and any failure to optimally calibrate our production capacity and inventory levels to meet customer demand could adversely affect our revenues, gross margins and earnings.
We make significant decisions regarding the levels of business we will seek and accept, production schedules, component procurement, personnel needs and other resource requirements based on our estimates of customer demand. We do not have long-term agreements with any of our customers. Instead, sales are made primarily pursuant to standard purchase orders that we often receive no more than two weeks in advance of the desired delivery date and that may be rescheduled or cancelled on relatively short notice. The short-term nature of the commitments by many of our customers and the fact that our customers may cancel or defer purchase orders for any reason reduces our backlog of firm orders and our ability to accurately estimate future customer requirements for our products or the component products we resell to customers directly. This fact, combined with the quick turn-around times that apply to most orders, makes it difficult to forecast our production and inventory needs and allocate production capacity efficiently. As a result, we attempt to forecast the demand for the components needed to manufacture our products and to resell to customers directly, but any such forecasts could turn out to be wrong. Further, lead times for components vary significantly and depend on various factors, such as the specific supplier and the demand and supply for a component at a given time.
Our production expense and component purchase levels are to a large extent fixed in the short term. As a result, we may be unable to adjust spending on a timely basis to compensate for any unexpected shortfall in customer orders. If we overestimate customer demand, we may have excess inventory of components, which may not be able to be used in other products or resold and may become obsolete before any such use or resale. If there is a subsequent decline in the prices of these components, the value of our inventory would fall. As a result, we may need to write-down the value of our component inventory, which may result in a significant decrease in our gross margin and financial condition. Also, to the extent that we order components or manufacture our products in anticipation of future demand that does not materialize or in the event a customer cancels or reduces outstanding orders, we could experience an unanticipated increase in our component or finished goods inventory. In the past, we have had to write-down inventory due to obsolescence, excess quantities and declines in market value below our costs. Any significant shortfall of customer orders in relation to our expectations could hurt our operating results, cash flows and financial condition.
Conversely, any rapid increases in demand by our customers could strain our resources and reduce our margins. If we underestimate customer demand, we may not have sufficient inventory of necessary components on hand to meet that demand. We also may not have sufficient manufacturing capacity at any given time to meet any demands for rapid increases in production of our products. These shortages of inventory and capacity could lead to delays in the delivery of our products or the component products we resell, which may force us to forego sales opportunities, reduce our net product revenues and damage our customer relationships.
Declines in our average sales prices, driven by volatile prices for components and other factors, may result in declines in our revenues and gross profit.
Our industry is competitive and historically has been characterized by declines in average sales price, based in part on market prices for DRAM ICs, NAND flash and other component products, which historically have constituted a
substantial portion of the total cost of our memory subsystems and in recent periods have constituted the vast majority of the cost of resales of these products to customers directly. Our average sales prices may decline due to several factors, including overcapacity in the worldwide supply of these components, increased manufacturing efficiencies, implementation of new manufacturing processes and expansion of manufacturing capacity by component suppliers.
Once our prices with a customer are negotiated, we are generally unable to revise pricing with that customer until our next regularly scheduled price adjustment. As a result, if market prices for essential components increase, we generally cannot pass the price increases on to our customers for products purchased under an existing purchase order. Consequently, we are exposed to the risks associated with the volatility of prices for these components and our cost of sales could increase and our gross margins could decrease in the event of price increases. Alternatively, if there are declines in the prices of these components, we may need to reduce our selling prices for subsequent purchase orders, which may result in a decline in our net product revenues.
In addition, since a large percentage of our product revenues are to a small number of customers, these customers have exerted, and we expect they will continue to exert, pressure on us to make price concessions. If not offset by increases in volume of sales or the sales of newly-developed products with higher margins, decreases in average sales prices could have a material adverse effect on our business and operating results.
Our manufacturing operations involve significant risks.
We maintain a manufacturing facility in the PRC at which we produce most of our products. This internal manufacturing process allows us to utilize our own materials and processes, protect our intellectual property and develop the technology for manufacturing. However, our manufacturing activities require significant resources to maintain. For instance, we must continuously review and improve our manufacturing processes in order to maintain satisfactory manufacturing yields and product performance, try to lower our costs and otherwise remain competitive. As we manufacture more complex products, the risk of encountering delays, difficulties or higher costs increases. The start-up costs associated with implementing new manufacturing technologies, methods and processes, including the purchase of new equipment and any resulting manufacturing delays and inefficiencies, could negatively impact our results of operations.
Additionally, we could experience a prolonged disruption, material malfunction, interruption or other loss of operations at our manufacturing facility or we may need to add manufacturing capacity to satisfy any increased demand for our products. Under these circumstances, we may be forced to rely on third parties for our manufacturing needs, which could increase our manufacturing costs, decreases our profit margin, decrease our control over manufacturing processes, limit our ability to meet customer demand and delay new product development until we could secure a relationship with a third-party manufacturer, which we may not be able to do in a timely manner, on acceptable terms or at all. If any of these risks were to occur, our operations, performance and customer relationships could be severely harmed. In addition, we may need to expand our existing manufacturing facility or establish a new facility. Any need to expand or replace our manufacturing facility would be expensive and time-consuming and could also subject us to factory audits by our customers that could themselves result in delays, unexpected costs or customer losses if we cannot meet the standards of any such audits. Further, we may not be able to replace or increase our manufacturing capacity at all. The occurrence of any of these events could have a material adverse effect on our business, financial condition and results of operations.
We depend on third parties to design and manufacture custom components for some of our products and the component products we resell to customers directly, which exposes us to risks.
Significant customized components, such as ASICs, that are used in HyperCloud and some of our other products, as well as all of the component products we resell, are designed and manufactured by third parties. The ability and willingness of third parties to enter into these engagements with us and perform in accordance with these engagements is largely outside of our control. If one or more of our design or manufacturing partners experiences a manufacturing disruption, fails to dedicate adequate resources to the production of our products or the components we purchase for resale, experiences financial instability or otherwise fails to perform its obligations to us in a timely manner or at satisfactory quality levels, our ability to bring products to market or deliver products to our customers, as well as
our reputation, could suffer and our business and prospects could be materially harmed. In the event of any failure by our component manufacturers, we may have no readily available alternative source of supply for these components, since, in our experience, the lead time needed to establish a relationship with a new design or manufacturing partner is substantial, and the time for our OEM customers to re-qualify our products with components from a new vendor is also significant. Additionally, if we need to replace one of our component manufacturers, we may not be able to do so in a timely manner, on acceptable terms or at all. Further, we may not be able to redesign the customized components used in our products to be manufactured by a new manufacturer, in which case we could infringe on the intellectual property of our current design or manufacturing partner when we redesign the custom components. Such an occurrence could force us to stop selling certain of our products or the component products we resell or could expose us to lawsuits, license payments or other liabilities.
Our dependence on third-party manufacturers exposes us to many other risks, including, among others: reduced control over delivery schedules, quality, manufacturing yields and costs; the potential lack of adequate capacity during periods of excess demand; limited warranties on products supplied to us; and potential misappropriation of our intellectual property or the intellectual property of others. We are dependent on our manufacturing partners to manufacture components with acceptable quality and manufacturing yields, to deliver these components to us on a timely basis and to allocate a portion of their manufacturing capacity sufficient to meet our needs. However, these component manufacturers may not be able to achieve or maintain acceptable yields or deliver sufficient quantities of components on a timely basis or at an acceptable cost. Additionally, our manufacturing partners may not continue to devote adequate resources to produce our products or the component products we resell, or continue to advance the process design technologies on which the qualification and manufacturing of our products or the component products we resell are based. Further, we could be exposed to liability if component manufacturers are found to infringe the intellectual property rights of others and we are held responsible for any such infringement. Any of these risks could limit our ability to meet customer demand and materially adversely affect our business and operating results.
If our products or the component products we resell do not meet quality standards or are defective or used in defective systems, we may be subject to quality holds, warranty claims, recalls or liability claims.
Our customers require our products and the component products we resell to meet strict quality standards. If these products do not meet these standards, our customers may discontinue purchases from us until we are able to resolve the quality issues that are causing us to not meet the standards, which we may not be able to do. These “quality holds” could be costly and time-consuming to resolve and could have a significant adverse impact on our revenues and operating results.
If these products are defectively manufactured, contain defective components or are used in defective or malfunctioning systems, we could be subject to warranty and product liability claims, product recalls, safety alerts or advisory notices.
Although we generally attempt to contractually limit our exposure to incidental and consequential damages, if these contract provisions are not enforced or if liabilities arise that are not effectively limited, we could incur substantial costs in defending or settling product liability claims. While we currently have product liability insurance coverage, it may not provide coverage under certain circumstances and it may not be adequate to satisfy claims made against us. We also may be unable to maintain insurance in the future at satisfactory rates or in adequate amounts.
Warranty and product liability claims, product recalls, safety alerts or advisory notices, regardless of their coverage by insurance or their ultimate outcome, could have a material adverse effect on our business, financial condition and ability to attract and retain customers.
We may become involved in non‑patent related litigation and administrative proceedings that may materially adversely affect us.
From time to time, we may become involved in various legal proceedings relating to matters incidental to the ordinary course of our business, including commercial, employment, class action, whistleblower and other litigation and claims, as well as governmental and other regulatory investigations and proceedings. Such matters can be time-consuming, divert management’s attention and resources and cause us to incur significant expenses. Furthermore,
because litigation is inherently unpredictable, the results of these actions could subject us to monetary damages or other liabilities and have a material adverse effect on our business, results of operations and financial condition.
Our indemnification obligations for the infringement by our products of the intellectual property rights of others could require us to pay substantial damages.
As is common in our industry, we have a number of agreements in which we have agreed to defend, indemnify and hold harmless our customers and suppliers from damages and costs that may arise from the infringement by our products of third-party patents, trademarks or other proprietary rights. The scope of these indemnities varies, but may, in some instances, include indemnification for damages and expenses, including attorneys’ fees. The termthe duration of these indemnification obligationsindemnities is generally perpetual after execution of an agreement, and the maximum potential amount of future payments we could be required to make under these indemnification obligationsindemnities is often unlimited. Any indemnification claims by customers could require us to incur significant legal fees and could potentially result in our payment of substantial damages, and our insurance generally would not cover these fees or damages. As a result, the occurrence of any of these risks could result inhave a material adverse effect on our business and results of operations.
We depend on a fewcertain key employees, and our business could be harmed if we lose the services of any of these employees or are unable to attract and retain other qualified personnel.
To date, we have been highly dependent on the experience, relationships and technical knowledge of certain key employees. We believe that our future success will be dependent on our ability to retain the services of these key employees, develop their successors and properly manage the transition of their roles should departures occur. The loss of these key employees or their inability to continue to provide their services could delay the development and introduction of new or enhanced products or technologies, negatively impact our ability to sell our existing products, limit our ability to pursue our other business goals and strategies and otherwise harm our business. We do not have employment agreements with any of these keyour employees other than Chun K. Hong, our President, Chief Executive Officer and Chairmansole member of our board of directors.directors, and as a result most of our employees may terminate their employment with us at any time. We maintain “Key Man” life insurance on Mr. Hong, but we do not carry “Key Man” life insurance on any of our other employees.
Our future success also depends on our ability to attract, retain and motivate highly skilled engineering, manufacturing and other technical and sales personnel. Competition for experiencedthese personnel is intense. We may not be successful in attracting new engineers or other technical personnel or in retaining or motivating our existing personnel. If we are unable to hire and retain engineerspersonnel with the skills necessary to keep pace with the evolving technologies in our markets, our ability to continue to provide our existing products and to develop new or enhanced products willand technologies would be negatively impacted, which wouldcould harm our business. In addition, a general shortage of experienced engineers or other technical personnel could lead to increased recruiting, relocation and compensation costs to attract such engineers,new recruits, which may exceed our expectations and resources. These increased costs may make hiring new engineers difficult or may increase our operating expenses.expenses or make these hires more difficult or impossible if increased recruiting costs exceed our resources.
A significant portion of our workforce consists of contract personnel. We invest considerable time and expense to train these contract personnel; however, they typically may terminate their relationships with us at any time. As a result, we may experience high turnover rates in this contract personnel workforce, which may require us to expend additional resources to attract, train and retain replacements. Additionally, if we convert any of these contract personnel intoto permanent employees, we may have to pay finder’s fees to the contract agency. These risks associated with our contract personnel workforce may involve increased costs or delays or failures in meeting customer requirements or developing new or enhanced products or technologies, any of which could materially adversely affect our business and operating performance.
We are also subject to employment laws and regulations, including the changing regulatory landscape. For example, in California, State Assembly Bill 5 (“AB5”), which went into effect in January 2020, codifies a test to determine whether a worker is an employee under California law. AB5 provides a mechanism for determining whether workers of a hiring entity are employees or independent contractors, but AB5 does not result in any immediate change in how workers are classified. If the State of California, cities or municipalities, or workers disagree with how a hiring entity classifies workers, AB5 sets forth the test for evaluating their classification. The legal and other costs associated with any misclassification of our personnel can be substantial and could materially adversely affect our results of operations and financial condition.
Foreign Corrupt Practices Act and similar anti-bribery laws in the non-U.S. jurisdictions in which we operate, as well as a wide variety of other complex foreign laws, regulations and treaties; and potentially adverse tax consequences. In addition, the United States or foreign countries may implement quotas, duties, tariffs, taxes or other charges or restrictions on the importation or exportation of our products or the component products we resell, which could lead to a reduction in sales and profitability in that country. The implementation of tariffs by the United States on goods manufactured in other countries, including PRC, could cause the costs of our products to increase, which could significantly impair the gross profit we receive and thereby harm our operating results significantly.
In addition, international turmoil and the threat of future terrorist attacks both domestically and internationally, have contributed to an uncertain political and economic climate, both in the United States and globally, and have negatively impacted the worldwide economy. The economies of the PRC and other countries in which we make sales have been highly volatile in the recent past,years, resulting in significant fluctuations in local currencies and other instabilities. These conditions could continue or worsen, which could adversely affect our foreign operations and someour performance. The occurrence of our customers or suppliers and our performance.
Our international sales are subject to a number of additionalthese risks including regulatory risks, timing and availability of export licenses, difficulties in accounts receivable collections, difficulties in managing distributors, lack of a significant local sales presence, difficulties in obtaining governmental approvals, compliance with a wide variety of complex foreign laws and treaties and potentially adverse tax consequences. In addition, the United States or foreign countries may implement quotas, duties, tariffs, taxes or other charges or restrictions upon the importation or exportation of our products or the products we resell to customers directly, leading to a reduction in sales and profitability in that country. This risk of increased trade barriers or charges has become more pronounced following the results of the recent U.S. presidential election, as the trade policies of the current U.S. presidential administration, including withdrawal from the Trans-Pacific Partnership and proposed revision to the North American Free Trade Agreement, could threaten or otherwise have a significant negative effect on our ability to continue to conduct our international operations in the manner and at the costs as we have in the past. Any increased costs or regulatory obstacles with respectrelated to our international operations, including our manufacturing facility in the PRC and our international sales, could have a material adverse effect on our business, financial condition and prospects for growth.
Our operations could be disrupted by power outages, natural disasters or other factors.
Due to the geographic concentration of our manufacturing operations in our PRC facility and our small number of component suppliers, including Samsung for the majority of the component products we resell to customers directly, a disruption resulting from equipment or power failures, quality control issues, human errors, government intervention or natural disasters, including earthquakes and floods, could require significant costs to repair and could interrupt or interfere with the manufacture of our products or the component products we resell to customers directly and cause significant delays in product shipments, which could harm our customer relationships, financial condition and results of operations. In July 2014, our PRC facility suffered water damage as a result of heavy rain and floods, which forced us to temporarily halt manufacturing at the facility while necessary repairs or replacements were made to the facility and to certain of our manufacturing equipment. This incident caused us to incur additional expenses, as we shifted our manufacturing activities to a third-party facility in the PRC to mitigate the disruption in product shipments to our customers. While we believe we were able to contain this disruption, we may not be able to secure alternative manufacturing capabilities if manufacturing at the PRC facility is disrupted in the future, in which case our relationships with our customers could be materially harmed. Additionally, while we were able to favorably resolve our claim with our insurance carrier with respect to the damage to our facility cause by the July 2014 incident, we may not experience the same outcome if a similar event occurs in the future, in which case we would be forced to bear the significant costs to repair any damage to our manufacturing equipment and facility.
Difficulties with our global information technology systems, including any unauthorized access, could harm our business.
Any failure or malfunctioning of our global information technology systems, errors or misuse by system users, difficulties in migrating stand-alone systems to our centralized systems or inadequacy of the systems in addressing the needs of our operations could disrupt our ability to timely and accurately manufacture and ship products, divert management’s and key employees’ attention away from other business matters and involve significant costs and other resources to repair or otherwise resolve, any of which could have a material adverse effect on our business, financial condition and results of operations. Any such event could also disrupt our ability to timely and accurately process, report and evaluate key operating metrics and key components of our results of operations, financial position and cash flows and could adversely affect our ability to complete other important business process, such as maintenance of our disclosure controls and procedures and evaluation of our internal control over financial reporting.
We store data about our business, including certain customer data, information about our and our customer’s intellectual property and other proprietary information, on our global information technology systems. While our systems includes security measures designed to prevent unauthorized access, third parties may circumvent these measures and gain unauthorized access to our systems. This unauthorized access could be the result of employee error, employee malfeasance or other causes, including intentional misconduct by computer hackers. Because the techniques used to gain unauthorized access to information technology systems evolve frequently and generally are not recognized until successful, we may be unable to anticipate these techniques or to implement adequate preventative measures. Any
security breach could result in disruption to our business, misappropriation or loss of data, significant resources to correct, loss of confidence in us by our customers, damage to our reputation, legal liability and a negative impact on our performance.
Our failure to comply with environmental and other applicable laws and regulations could subject us to significant fines and liabilities or cause us to incur significant costs.
We are subject to various and frequently changing U.S. federal, state and local and foreign laws and regulations relating to the protection of the environment, including laws governing the discharge of pollutants into the air and water, the management and disposal of hazardous substances and wastes and the clean-up of contaminated sites. In particular, some of our manufacturing processes may require us to handle and dispose of hazardous materials from time to time. For example, in the past our manufacturing operations have used lead-based solder in the assembly of our products. Today, we use lead-free soldering technologies in our manufacturing processes, as this is required for products entering the European Union. We could incur substantial costs, including clean-up costs, civil or criminal fines or sanctions and third-party claims for property damage or personal injury, as a result of violations of or noncompliance with these and other environmental laws and regulations. Although we have not incurred significant costs to date to comply with these laws and regulations, new laws or changes to current laws and regulations to make them more stringent could require us to incur significant costs to remain in compliance.
We are also may be subject to a variety of laws and regulations relating to other matters, including workplace health and safety, labor and employment, foreign business practices (including the U.S. Foreign Corrupt Practices Act and applicable foreign anti-bribery laws), data protection, public reporting and taxation, among others. It is difficult and costly to manage the requirements of every authority having jurisdiction over our various activities and to comply with their varying standards. Additionally, any changes to existing regulations or adoption of new regulations may result in significant additional expense to us andor our customers. For example, the current presidential administration and Congress have proposed to make substantial changes to the taxation of business entities, but there remains significant lack of clarity regarding the likelihood, timing and details of any such tax reform or the impact of any potential tax reform on our or our customers’ respective businesses or results. Further, our failure to comply with any applicable laws and regulations may result in a variety of administrative, civil and criminal enforcement measures, including monetary penalties or imposition of sanctions or other corrective requirements, any of which could materially adversely affect our reputation and our business.
Regulations related to “conflict minerals” may cause us to incur additional expenses and could limit the supply and increase the cost of certain metals used in manufacturing our products.
In August 2012,The U.S. Congress has enacted laws, and the SEC has adopted rules, requiring disclosure of specified minerals, known as conflict minerals, that are necessary to the functionality or production of products manufactured or contracted to be manufactured by public companies. TheThese laws and rules require companies to verify and disclose whether or not such minerals, as used in a company’s products or their manufacture, originate from the Democratic Republic of Congo or an adjoining country. Because our products contain certain conflict minerals and we or our manufacturers use these conflict minerals in the manufacture of our products, we are required to comply with these laws and disclosure rules. To comply, with the rules, we are required to conduct a reasonable country of origin inquiry each year and, depending on the results of that inquiry, we may be required to exercise due diligence on the source and chain of custody of conflict minerals contained in or used to manufacture our products. Such due diligence must conform to a nationally or internationally recognized
an attestation report from our independent registered public accounting firm may identify significant deficiencies or material weaknesses inas to our internal control over financial reporting. If we fail to maintain an effective system of internal control over financial reporting or if management or our independent registered public accounting firm discover material weaknesses, we may be unable to produce reliable financial reports or prevent fraud, which could harm our financial condition and results of operations, result in a loss of investor confidence and negatively impact our stock price. Further, our
Our Section 404 evaluations may lead us to conclude that enhancements, modifications or changes to our internal control over financial reporting are necessary or desirable. Implementing any such changes would divert the attention of management, could involve significant time and costs and may negatively impact our financial results.
If we do not effectively managereporting functions during the transition, any future growth we may experience, our resources, systems and controls may be strained andof which could have a material negative effect on our results of operations may suffer.
Any future growth we may experience could strain our resources, management, information and telecommunication systems and operating and financial controls. To manage future growth effectively, including any expansion of volume in our manufacturing facility in the PRC, we must be able to improve and expand our systems and controls. We may not be able to do this in a timely or cost-effective manner. In addition, our officers have relatively limited experience in managing a rapidly growing business. As a result, they may not be able to manage any future growth we may experience. Any failure to manage any growth we may experience or improve or expand our existing systems and controls, or unexpected difficulties in doing so, could harm our business.
If we acquire businesses or technologies or pursue other strategic transactions in the future, these transactions could disrupt our business and harm our operating results and financial condition.
Risks Related to Intellectual Property and Litigation
We evaluate opportunitiesmay be unsuccessful in monetizing our intellectual property portfolio.
We dedicate substantial resources to acquire businesses or technologies ordeveloping technology innovations we believe are essential to our business. We intend to pursue other strategic transactions, including collaboration or joint development arrangements such as our JDLA with Samsung that might complement our current product offerings or enhancemonetization avenues for our intellectual property portfolio, potentially including licensing, royalty or technicalother revenue-producing arrangements. However, we have not generated any such revenue stream from our intellectual property to date, and we may never be successful in achieving this objective.
Although we may pursue agreements with third parties to commercially license certain of our products or technologies, we may never successfully enter into any such agreement. Further, the terms of any such agreements we may reach with third-party licensees are uncertain and may not provide sufficient royalty or other licensing revenues to us to justify our costs of developing and maintaining the licensed intellectual property or may otherwise include terms that are not favorable to us. Additionally, the pursuit of licensing arrangements would require by its nature that we relinquish certain of our rights to our technologies and intellectual property that we license to third parties, which could limit our ability to base our own products on such technologies or could reduce the economic value we receive from such technologies and intellectual property. Additionally, the establishment of arrangements to monetize our intellectual property may be more difficult or costly than expected, may require additional personnel and investments and may be a significant distraction for management.
Our ability to establish licensing, royalty or similar revenues, and maintain or increase any such revenues we are able to establish, depends on a variety of factors, including, among others, the novelty, utility, performance, quality, breadth, depth and overall perceived value of our intellectual property portfolio, all as compared to that of our competitors, as well as our sales and marketing capabilities. We have no experience acquiring other businessesEven if we are able to secure these revenues, they may be negatively affected by factors that are entirely or technologies. Acquisitionspartially outside our control, including reductions in our customers’ sales prices, sales volumes and the general state of their business, as well as the terms of the license arrangements.
If we are not successful in monetizing our intellectual property portfolio, we may never recoup our investments of time, capital and other strategic transactions entail a numberresources in the development, maintenance, defense and enforcement of risksthis portfolio, which could materially harm our financial condition and prospects.
We are and expect to continue to be involved in other legal and administrative proceedings to enforce or protect our intellectual property rights and to defend against claims that we infringe the intellectual property rights of others.
As is common in the semiconductor industry, we have experienced substantial litigation regarding patent and other intellectual property rights. We are currently involved in litigation and proceedings at the U.S. Patent and Trademark Office (“USPTO”) and Patent Trial and Appeal Board based on alleged third-party infringement of our patents, and lawsuits claiming we are infringing others’ intellectual property rights also have been and may in the future be brought against us.
Our business strategy includes litigating claims against others, such as our competitors and customers, to enforce our intellectual property, contractual and commercial rights, including, in particular, our patent portfolio and our trade secrets, as well as to challenge the validity and scope of the proprietary rights of others. This or other similar proceedings could adversely affectalso subject us to counterclaims or countersuits against us, or the parties we sue could seek to invalidate our business and operating results, including, among others:
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| | difficulties in integrating the operations, technologiespatents or other intellectual property rights through reexamination or similar processes at the USPTO or products of acquired companies or working with third parties with which we may partner on joint development or collaboration relationships;
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| | the diversion of management’s time and attention from the daily operations of the business;
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| | insufficient increases in revenues to offset increased expenses associated with an acquisition or strategic transaction;
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| | difficulties retaining business relationships with our existing suppliers and customers or the suppliers and customers of an acquired company;
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| | overestimation of potential synergies or a delay in realizing these synergies;
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| | entering markets in which we have no or limited experience and in which competitors have stronger market positions;
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| | the potential loss of key employees of our Company or an acquired company;
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similar bodies. Further, any legal disputes with customers could cause them to cease buying or using our products or the component products we resell or delay their purchase of these products and could substantially damage our relationship with them.
Moreover, our ability to continue to pursue this strategy depends on our ability to obtain and protect patents, which is governed by an uncertain process. In addition to the patent issuance process established by law and the procedures of the USPTO, we must also comply with administrative procedures of the JEDEC to protect our intellectual property within its industry standard-setting process. These procedures evolve over time, are subject to variability in their application and may be inconsistent with each other. Any failure to comply with the USPTO’s or JEDEC’s administrative procedures could jeopardize our ability to claim that our patents have been infringed.
Making use of new technologies and entering new markets increases the likelihood that others might allege that our products or the component products we resell infringe their intellectual property rights. The likelihood of this type of lawsuit may also be increased due to the limited pool of experienced technical personnel that we can draw on to meet our hiring needs. As a result, a number of our existing employees have worked for our existing or potential competitors at some point during their careers, and we anticipate a number of our future employees will have similar work histories. Moreover, lawsuits of this type may be brought, even if there is no merit to the claim, as a strategy to prevent us from hiring qualified candidates, drain our financial resources and divert management’s attention away from our business.
Litigation is inherently uncertain. An adverse outcome in existing or any future litigation could force us to, among other things:
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● | relinquish patents or other protections of our technologies if they are invalidated, which would enable our competitors and others to freely use this technology; |
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| compete with products that rely on technologies and other intellectual property rights that we believe we have the right to contingent liabilitiesprotect from third-party use; |
| ● | accept terms of an acquired company;arrangement to license our technologies to a third party that are not as favorable as we might expect; |
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● | receive little or no returns for our time and capital investments in the litigation; |
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| cease manufacturing and/or selling products or using certain processes that are claimed to be infringing a third party’s intellectual property; |
| ● | pay damages (which in some instances may be three times actual damages), including royalties on past or future sales, if we are found to infringe a third party’s intellectual property; |
| ● | seek a license from a third-party intellectual property owner to use its technology in our products or the component products we resell, which may not be available on reasonable terms or at all; or |
| ● | redesign any products that are claimed to be infringing a third party’s intellectual property, which may not be possible to do in a timely manner, without incurring significant costs or at all. |
Moreover, any litigation, regardless of its outcome, 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 or not 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.
If our proprietary rights are not protected, our customers or our competitors might gain access to our proprietary designs, processes and technologies, which could adversely affect our operating results.
We rely on a combination of patent protection, trade secret laws and restrictions on disclosure to protect our intellectual property and other proprietary rights. We have submitted a number of patent applications regarding our proprietary processes and technology, many of which have resulted in issued patents. For our pending patent applications, it is uncertain when or if any of the claims in these applications will be allowed or result in issued patents,
in which case the technologies or processes sought to be patented would remain unprotected from use by third parties. In addition, although we intend to continue filing patent applications with respect to new processes and technologies we develop, patent protection may not be available for some of these processes or technologies. Further, even if we are successful in obtaining patent protection, these protections could be limited in scope by the USPTO, a court or applicable foreign authorities or challenged by third parties by way of review or reexamination proceedings and subsequently invalidated, which would reduce the protections these patents are able to provide. Moreover, patent protection is limited as to duration and all of our issued patents will eventually expire, at which time the previously protected technologies would become widely available for use by third parties, including our competitors.
Despite our efforts to protect our intellectual property rights, these efforts may not:
| ● | prevent challenges to or the invalidation or circumvention of our intellectual property rights; |
| ● | keep our competitors or other third parties from independently developing similar products or technologies, duplicating, reverse engineering or otherwise using our products or technologies without our authorization or designing around any patents that may be issued to us; |
| ● | prevent disputes with third parties regarding ownership of our intellectual property rights; |
| ● | prevent disclosure of our trade secrets and know-how to third parties or into the public domain; |
| ● | result in valid patents, including international patents, from any of our pending or future applications; or |
| ● | otherwise adequately protect our intellectual property rights. |
Moreover, monitoring for any unauthorized use of our technologies is costly, time-consuming and difficult. This is particularly true in foreign countries, such as the PRC, where we have established a manufacturing facility and where the laws may not protect our proprietary rights to the same extent as applicable U.S. laws.
If some or all of the claims in our patent applications are not allowed, if any of our issued patents or other intellectual property protections are limited, invalidated or circumvented by third parties, or if we are not able to obtain extensions of existing patents upon their expiration or issuance of new patents to maintain protections provided by expiring patents, we could face increased competition for our products and technologies and be unable to execute on our strategy of monetizing our intellectual property. Any of these outcomes could significantly harm our business, operating results and prospects.
We may become involved in non-patent related litigation and administrative proceedings that may materially adversely affect us.
From time to time, we may become involved in various legal proceedings relating to matters incidental to the ordinary course of our business, including commercial, employment, class action, whistleblower and other litigation and claims, as well as governmental and other regulatory investigations and proceedings. Such matters can be time-consuming, divert management’s attention and resources and cause us to incur significant expenses. Furthermore, because litigation is inherently unpredictable, the results of these actions could subject us to monetary damages or other liabilities and have a material adverse effect on our business, results of operations and financial condition.
Risks Related to Capitalization and Financial Markets
We may not have sufficient working capital to fund our planned operations, and, as a result, we may need to raise additional capital in the future, which may not be available when needed, on acceptable terms or at all.
To support our activities in the near term, we expect to rely on cash generated from our business, the cash received under the SK hynix License Agreement and proceeds from issuances of debt and equity securities, including our equity lines with Lincoln Park, and borrowing availability under our credit facility with SVB. Taking into account our planned activities and sources of capital, we believe we have sufficient cash resources to satisfy our capital needs for at least the next 12 months. However, our estimates of our operating revenues and expenses and working capital requirements could be incorrect, and we may use our cash resources faster than we anticipate. Moreover, our SVIC Note will mature in December 2021, and if it is not converted into equity, the repayment will significantly deplete our cash resources unless we raise additional capital or enter into an amendment to the SVIC Note. Further, some or all of our
ongoing or planned investments may not be successful and could further deplete our capital without immediate, or any, cash returns.
Our capital requirements will depend on many factors, including, among others:
| ● | the costs associated with maintaining, defending and enforcing our intellectual property rights; |
| ● | the acceptance of, and demand for, our products and the component products we resell to customers; |
| ● | our success, and that of our strategic partners, in developing and selling products derived from our technology; |
| ● | the extent and timing of any investments in developing, marketing and launching new or enhanced products or technologies; |
| ● | the costs of developing, improving and maintaining our internal design, testing and manufacturing processes; |
| ● | our results of operations, including our levels of net product sales and any other revenues we may receive, including non-recurring engineering, license, royalty or other fees; |
| ● | the amount and timing of vendor payments and the collection of receivables, among other factors affecting our working capital; |
| ● | our receipt of cash resourcesproceeds from the exercise of outstanding stock options or warrants to fund an acquisitionacquire our common stock; |
| ● | the nature and timing of acquisitions or other strategic transaction,transactions or dilutionrelationships in which we engage, if any; and |
| ● | the costs associated with the continued operation, and any future growth, of existing stockholders or increased leverage relative to our earnings or to our equity capitalization if we issue debt or equity securities to fund the transaction;business. |
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| | adverse tax consequences; and
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| | incurrence of material charges, such as depreciation, deferred compensation charges, in-process research and development charges, the amortization of amounts related to deferred stock-based compensation expense and identifiable purchased intangible assets or impairment of goodwill.
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If anyUntil we can generate sufficient revenues to finance our cash requirements from our operations, which we may never do, we may need to increase our liquidity and capital resources by one or more measures, which may include, among others, reducing operating expenses, restructuring our balance sheet by negotiating with creditors and vendors, entering into strategic partnerships or alliances, raising additional financing through the issuance of debt, equity or convertible securities or pursuing alternative sources of capital, such as through asset or technology sales or licenses or other alternative financing arrangements. Further, even if our near-term liquidity expectations prove correct, we may still seek to raise capital through one or more of these risks were to occur,financing alternatives. However, we may not be able to realizeobtain capital when needed or desired, on terms acceptable to us or at all.
Inadequate working capital would have a material adverse effect on our business and operations and could cause us to fail to execute our business plan, fail to take advantage of future opportunities or fail to respond to competitive pressures or customer requirements. A lack of sufficient funding may also require us to significantly modify our business model and/or reduce or cease our operations, which could include implementing cost-cutting measures or delaying, scaling back or eliminating some or all of our ongoing and planned investments in corporate infrastructure, research and development projects, legal proceedings, business development initiatives and sales and marketing activities, among other activities. Modification of our business model and operations could result in an impairment of assets, the intended benefitseffects of an acquisitionwhich cannot be determined. Furthermore, if we continue to issue equity or strategic transactionconvertible debt securities to raise additional funds, our existing stockholders may experience significant dilution, and the new equity or debt securities may have rights, preferences and privileges that are superior to those of our operating results, financial conditionexisting stockholders. Additionally, because our common stock is no longer listed on The Nasdaq Capital Market, the challenges and risks of equity financings may significantly increase, including potentially increasing the dilution of any such financing or decreasing our ability to affect such a financing at all. If we incur additional debt, it may increase our leverage relative to our earnings or to our equity capitalization or have other material consequences. If we pursue asset or technology sales or licenses or other alternative financing arrangements to obtain additional capital, our operational capacity may be limited and any revenue streams or business prospects couldplans that are dependent on the sold or licensed assets may be materially negatively affected.reduced or eliminated. Moreover, we may incur substantial costs in pursuing any future capital-raising transactions, including investment banking, legal and accounting fees, printing and distribution expenses and other similar costs, which would reduce the benefit of the capital received from the transaction.