NETLIST, INC. AND SUBSIDIARIES
Condensed Consolidated Statements of Cash Flows (Unaudited)
(In thousands)
| | | | | | |
| | Three Months Ended |
| | March 30, | | April 1, |
| | 2024 | | 2023 |
Cash flows from operating activities: | | | | | | |
Net loss | | $ | (16,968) | | $ | (15,788) |
Adjustments to reconcile net loss to net cash used in operating activities: | | | | | | |
Depreciation and amortization | | | 85 | | | 99 |
Non-cash lease expense | | | 167 | | | 166 |
Stock-based compensation | | | 1,374 | | | 1,077 |
Changes in operating assets and liabilities: | | | | | | |
Accounts receivable | | | 33 | | | 2,300 |
Inventories | | | (3,138) | | | 1,727 |
Prepaid expenses and other assets | | | (136) | | | 261 |
Accounts payable | | | 3,211 | | | (2,098) |
Accrued payroll and related liabilities | | | 239 | | | (316) |
Accrued expenses and other liabilities | | | 915 | | | (142) |
Net cash used in operating activities | | | (14,218) | | | (12,714) |
Cash flows from investing activities: | | | | | | |
Acquisition of property and equipment | | | (37) | | | — |
Net cash used in investing activities | | | (37) | | | — |
Cash flows from financing activities: | | | | | | |
Net borrowings (repayments) under line of credit | | | 537 | | | (4,935) |
Principal repayments under finance lease | | | (54) | | | (52) |
Payments on notes payable | | | (123) | | | (146) |
Proceeds from issuance of common stock, net | | | 2,131 | | | 10,542 |
Proceeds from exercise of stock options and warrants | | | 62 | | | 264 |
Payments for taxes related to net share settlement of equity awards | | | (7) | | | — |
Net cash provided by financing activities | | | 2,546 | | | 5,673 |
Net change in cash, cash equivalents and restricted cash | | | (11,709) | | | (7,041) |
Cash, cash equivalents and restricted cash at beginning of period | | | 52,845 | | | 43,611 |
Cash, cash equivalents and restricted cash at end of period | | $ | 41,136 | | $ | 36,570 |
| | | | | | |
Reconciliation of cash, cash equivalents and restricted cash at end of period: | | | | | | |
Cash and cash equivalents | | $ | 28,736 | | $ | 34,470 |
Restricted cash | | | 12,400 | | | 2,100 |
Cash, cash equivalents and restricted cash at end of period | | $ | 41,136 | | $ | 36,570 |
(in thousands)
| | | | | | |
| | Nine Months Ended |
| | September 30, | | October 1, |
| | 2017 | | 2016 |
| | | | | | |
Cash flows from operating activities: | | | | | | |
Net loss | | $ | (10,287) | | $ | (7,308) |
Adjustments to reconcile net loss to net cash used in operating activities: | | | | | | |
Depreciation and amortization | | | 214 | | | 210 |
Interest accrued on convertible promissory note | | | 225 | | | - |
Amortization of debt discount | | | 162 | | | 163 |
Stock-based compensation | | | 940 | | | 1,094 |
Changes in operating assets and liabilities: | | | | | | |
Restricted cash | | | 700 | | | (700) |
Accounts receivable | | | (1,329) | | | (403) |
Inventories | | | (1,226) | | | (1,334) |
Prepaid expenses and other assets | | | 271 | | | 157 |
Accounts payable | | | 3,738 | | | 902 |
Accrued payroll and related liabilities | | | (435) | | | (349) |
Accrued expenses and other liabilities | | | 53 | | | 181 |
Deferred revenue | | | - | | | (6,857) |
Net cash used in operating activities | | | (6,974) | | | (14,244) |
Cash flows from investing activities: | | | | | | |
Acquisition of property and equipment | | | (78) | | | (317) |
Net cash used in investing activities | | | (78) | | | (317) |
Cash flows from financing activities: | | | | | | |
Net borrowings under line of credit | | | 1,894 | | | - |
Payments on debt | | | (348) | | | (250) |
Proceeds from issuance of common stock, net | | | 4,431 | | | 10,334 |
Proceeds from exercise of stock options | | | 182 | | | 187 |
Net cash provided by financing activities | | | 6,159 | | | 10,271 |
Net change in cash and cash equivalents | | | (893) | | | (4,290) |
Cash and cash equivalents at beginning of period | | | 9,476 | | | 19,684 |
Cash and cash equivalents at end of period | | $ | 8,583 | | $ | 15,394 |
See accompanying notes.Notes to the Condensed Consolidated Statements.
NETLIST, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Notes to Condensed Consolidated Financial Statements (Unaudited)
September 30, 2017
Note 1—Description of Business
Netlist, Inc. together withand its wholly owned subsidiaries (hereinafter collectively referred(collectively the “Company,” “Netlist,” “we,” “us,” or “our”) provides high-performance memory solutions to as the “Company” or “Netlist,” unless the context or the use of the term indicates otherwise) is a leading provider of high-performance modular memory subsystems servingenterprise customers in diverse industries that require superiorindustries. Our products, in various capacities and form factors, including our line of custom and specialty memory products, bring leading performance to empower critical business decisions. The Company hascustomers in a long historyvariety 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 wasindustries globally. Netlist also one of the first to bring NAND flash memory (“NAND flash”) to the memory channel with its 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 recently introduced a new generation of storage class memory products called HybriDIMM™ to address the growing need for real-time analytics in Big Data applications and in‑memory databases.
Due 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, in the areas of hybrid memory, storage class memory, rank multiplication and load reduction. Since its inception, the Company has dedicated substantial resources to the development 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 inlicenses 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.property.
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 instructionscondensed consolidated financial statements prepared in accordance with U.S. GAAP have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission’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, 2016,30, 2023, included in the Company’s Annual Report on Form 10-K filed with the SEC on March 31, 2017.February 23, 2024.
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 March 30, 2024 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-ownedwholly owned subsidiaries. All intercompany balances and transactions have been eliminated in consolidation.
Fiscal Year
The Company operates under a 52 or 53-week fiscal year ending on the Saturday closest to December 31. For 2017, the Company’s fiscal year is scheduledthe 52- or 53-week period that ends on the Saturday nearest to end on December 30, 2017 and31. The Company’s fiscal year 2024 will consist ofinclude 52 weeks and eachends on December 28, 2024. Each quarter of the Company’s quarters within such fiscal year 2024 will be comprised of 13 weeks. Unless otherwise stated, references to particular years, quarters, months and periods refer to the Company’s fiscal years ended in January and the associated quarters, months and periods of those fiscal years.
Use of Estimates
The preparation of the accompanying condensed consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the 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, thesereported. Significant items subject to such estimates and assumptions are subject to an inherent degree of uncertainty. Significant estimates made by management include, among others, provisionsbut not limited to, the determination of inventory reserves, allowance 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 conditionsdoubtful accounts, 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.discount rate used for lease obligation. Actual results may differ materially from these estimates which may resultthose estimates.
Recently Issued Accounting Standards
In December 2023, the FASB issued Update 2023-09, “Income Taxes (Topic 740): Improvements to Income Tax Disclosures.” This update applies to all entities that are subject to Topic 740. The amendments in material adverse effects on the Company’s consolidated operating results and financial position.
The Company believes 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 deferredthis update improve income tax assets.
Revenue Recognition
The Company generates revenue from sales of products and performance of engineering services.
Net Product Revenues
Net product revenuesdisclosures 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 Codification (“ASC”) Topic 605. Accordingly, 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 shipped for customers with shipping point terms and upon receipt for customers with destination terms, at which time title and risk of loss transferrelated to the customer. Shipping documents are used to verify deliveryrate reconciliation and customer acceptance. The Company assesses whether 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 return 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 of 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,income taxes paid information as well as the customer’s payment history.effectiveness of certain other income tax disclosures. The new standard is effective for annual periods beginning after December 15, 2024. Early adoption is permitted. This standard should be applied on a prospective basis, but retrospective application is permitted. The Company is currently evaluating the impact of adopting this new standard.
Note 3—Supplemental Financial Information
Inventories
Inventories consisted of the following (in thousands):
| | | | | | |
| | March 30, | | December 30, |
| | 2024 | | 2023 |
Raw materials | | $ | 1,438 | | $ | 4,133 |
Work in process | | | 446 | | | 274 |
Finished goods | | | 13,285 | | | 7,624 |
| | $ | 15,169 | | $ | 12,031 |
Loss Per Share
The following table shows the computation of basic and diluted loss per share of common stock (in thousands, except per share data):
| | | | | | |
| | Three Months Ended |
| | March 30, | | April 1, |
| | 2024 | | 2023 |
Numerator: Net loss | | $ | (16,968) | | $ | (15,788) |
Denominator: Weighted-average basic shares outstanding - basic and diluted | | | 254,931 | | | 235,121 |
Net loss per share - basic and diluted | | $ | (0.07) | | $ | (0.07) |
The table below shows potentially dilutive weighted average common share equivalents, consisting of shares issuable upon the exercise of outstanding stock options and warrants using the treasury stock method and the shares vesting of issuable upon the restricted stock units (“RSUs”). These potential weighted average common share equivalents have been excluded from the diluted net loss per share calculations above as their effect would be anti-dilutive (in thousands):
| | | | | | |
| | Three Months Ended |
| | March 30, | | April 1, |
| | 2024 | | 2023 |
Weighted average common share equivalents | | | 2,035 | | | 3,193 |
Disaggregation of Net Sales
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 performedtable shows disaggregated net sales by major source (in thousands):
| | | | | | |
| | Three Months Ended |
| | March 30, | | April 1, |
| | 2024 | | 2023 |
Resales of third-party products | | $ | 31,274 | | $ | 6,909 |
Sale of the Company's modular memory subsystems | | | 4,533 | | | 2,112 |
Total net sales | | $ | 35,807 | | $ | 9,021 |
Major Customers 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.Products
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 pricesnet product sales have historically been concentrated 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. The following table sets forth the percentage of net product sales made to customers that each comprise 10% or more of total product sales:
| | | | |
| | Three Months Ended |
| | March 30, | | April 1, |
| | 2024 | | 2023 |
Customer A | | 27% | | 49% |
Customer B | | * | | 12% |
Customer C | | 10% | | * |
Customer D | | 12% | | * |
| * | Less than 10% of net sales during the period. |
As of March 30, 2024, two customers represented approximately 54% and 19% of aggregated gross accounts receivables, respectively. As of December 30, 2023, two customers represented approximately 60% and 10%, respectively, of aggregate gross accounts receivables. The loss of a significant changemajor customer or a reduction in the liquiditysales to or financial position of one ofdifficulties collecting payments from these customers could have a material adverse effect on the collectability ofsignificantly reduce the Company’s accounts receivable, liquiditynet sales and futureadversely affect its operating results. The Company mitigates risks associated with foreign and domestic receivables by purchasing comprehensive credit insurance.
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 equivalentsresells certain component products to end-customers that 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 OEMsnot reached in the server, high-performance computing and communications markets, as well as from sales todistribution models of the component manufacturers, including storage customers, appliance customers, system builders and cloud and datacenter customers. For the three months ended March 30, 2024 and April 1, 2023, resales of these products represented approximately 87% and 77% of net product sales, respectively.
Note 4—Credit Agreement and Standby Letters of Credit
2023 SVB Credit Agreement
On November 7, 2023, we entered into a loan and security agreement (the “2023 SVB Credit Agreement”) with Silicon Valley Bank, a division of First-Citizen Bank & Trust Company (“SVB”), which provides for a revolving line of credit up to $10.0 million. The Company performsborrowing base is limited to 85% of eligible accounts receivable, subject to certain adjustments. Borrowings accrue interest on advance at a per annum rate equal to the greater of 8.50% and the Prime Rate. The maturity date is November 7, 2025.
The 2023 SVB Credit Agreement requires letters of credit evaluationsto be secured by cash, which is classified as restricted cash in the accompanying consolidated balance sheets. As of its customers’March 30, 2024 and December 30, 2023, (i) outstanding letters of credit and restricted cash were $12.4 million and $12.4 million, respectively, (ii) outstanding borrowings were $4.4 million and $3.8 million, respectively, and (iii) availability under the revolving line of credit was $0 and $0, respectively.
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 accompanyingSupplemental condensed consolidated balance sheets. sheet information related to leases was as follows (in thousands):
| | | | | | |
| | March 30, | | December 30, |
| | 2024 | | 2023 |
Operating Leases | | | | | | |
Operating lease right-of-use assets | | $ | 1,423 | | $ | 1,590 |
Accrued expenses and other current liabilities | | $ | 578 | | $ | 617 |
Operating lease liabilities | | | 1,072 | | | 1,213 |
Total operating lease liabilities | | $ | 1,650 | | $ | 1,830 |
| | | | | | |
Finance Leases | | | | | | |
Property and equipment, at cost | | $ | 488 | | $ | 488 |
Accumulated depreciation | | | (243) | | | (219) |
Property and equipment, net | | $ | 245 | | $ | 269 |
Accrued expenses and other current liabilities | | $ | 36 | | $ | 90 |
Other liabilities | | | 6 | | | 7 |
Total finance lease liabilities | | $ | 42 | | $ | 97 |
The Company amortizes debt issuance costs overfollowing table includes supplemental information:
| | | | | | |
| | March 30, | | December 30, |
| | 2024 | | 2023 |
Weighted Average Remaining Lease Term (in years) | | | | | | |
Operating leases | | | 2.7 | | | 2.9 |
Finance leases | | | 0.7 | | | 0.7 |
| | | | | | |
Weighted Average Discount Rate | | | | | | |
Operating leases | | | 5.6% | | | 5.6% |
Finance leases | | | 4.6% | | | 4.4% |
Maturities of lease liabilities as of March 30, 2024, were as follows (in thousands):
| | | | | | |
| | Operating | | Finance |
Fiscal Year | | Leases | | Leases |
2024 (remainder of the year) | | $ | 496 | | $ | 36 |
2025 | | | 624 | | | 5 |
2026 | | | 639 | | | 2 |
2027 | | | 23 | | | — |
Total lease payments | | | 1,782 | | | 43 |
Less: imputed interest | | | (132) | | | (1) |
Total | | $ | 1,650 | | $ | 42 |
Note 7—Commitments and Contingencies
Contingent Legal Expenses
We may retain the expected termservices of the related debt using the effective interest method. Debt discounts relate to the relative fair valuelaw firms that specialize in patent licensing and enforcement and patent law in connection with our licensing and enforcement activities. These law firms may be retained on a contingent fee basis whereby such law firms are paid on a scaled percentage of 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 basisany negotiated fee, settlements 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 isjudgments awarded based on market valuehow and when available,the fees, settlements 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.judgments are obtained.
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 vesting period and the contractual expiration date of the option. This calculation is in accordance with FASB ASC Topic 718, as amended by certain SEC guidance providing for a safe harbor method in instances where the vesting and exercise terms 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.Litigation and Patent Reexaminations
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 that 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, subjectfrom time to time, a number of risks and uncertainties, including its abilityparty to achieve profitable operations due tolitigation that arises in the Company’s history of losses and accumulated deficits, the Company’s dependence on a small number of customers for a substantial portionnormal course of its net product revenues, risks relatedbusiness operations. We own numerous patents and continue to intellectual property matters, market acceptanceseek to grow and strengthen our patent portfolio, which covers various aspects of our innovations and demand for the Company’s products, and the risks described below. These risks could have a material adverse effect on the Company’s condensed consolidated financial position, results of operations and cash flows.
The Company has dedicated substantial resourcesincludes various claim scopes. We plan to the development and protection of technology innovations essentialpursue avenues 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 itsmonetize our 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 investmentswe would generate revenue by selling or licensing our technology, and we intend to vigorously enforce our patent rights against alleged infringers of time, capital and other resources into its intellectual property portfolio may not provide adequate, or any, returns.
The Company also dedicatessuch rights. We dedicate substantial resources to protecting itsand enforcing our intellectual property rights, including its pendingwith patent infringement litigationproceedings we file against third parties 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 itsdefense of our 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” or the “Board”) (see Note 7). The Company expectsWe expect these activities to continue for the foreseeable future, without anywith no guarantee that any ongoing or future patent protection or litigation activities will be successful. The Company is also subjectsuccessful, or that we will be able to litigation based on claims that it has infringed themonetize our intellectual property rights of others, against which the Company intends to defend itself vigorously. Moreover, anyportfolio.
Any litigation, regardless of its outcome, would involveis inherently uncertain, involves a significant dedication of resources, including time and costs, would divertcapital, and diverts management’s time and attention and could negatively impact the Company’s results of operations.from our other activities. As a result, any current or future infringement claims, allegations, or challenges by or against third parties, whether eventually decided in our favor or settled, could materially adversely affect the Company’sour business, financial condition orand 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 Adopted Accounting Standards
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, the FASB issued ASU No. 2016-09, Compensation-Stock Compensation (Topic 718) Improvements to Employee Share-Based Payment Accounting (“ASU 2016-09”), which is intended to simplify several aspects of the accounting for share-based payment award transactions. ASU 2016-09 is 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), including interim periods within those fiscal years with 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 standard on its consolidated financial statements and disclosures.
Note 3—Supplemental Financial Information
Inventories
Inventories consisted of the following as of the dates presented:
| | | | | | |
| | September 30, | | December 31, |
| | 2017 | | 2016 |
| | (in thousands) |
Raw materials | | $ | 1,217 | | $ | 884 |
Work in process | | | 276 | | | 47 |
Finished goods | | | 2,893 | | | 2,229 |
| | $ | 4,386 | | $ | 3,160 |
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 forth the computation of basic and diluted net loss per share, including the numerator and denominator used in the calculation of basic and diluted net loss per share, for the periods presented:
| | | | | | | | | | | | |
| | 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) |
The table below sets forth potentially dilutive common share equivalents, consisting of shares issuable upon the exercise or vesting of outstanding stock options and restricted stock awards, respectively, and the exercise of warrants, computed using the treasury stock method, and shares issuable upon conversion of the SVIC Note (see Note 5) using the
“if converted” method. These potential common shares have been excluded from the diluted net loss per share calculations above as their effect would be anti-dilutive for the periods presented:
| | | | | | | | | | | | |
| | Three Months Ended | | Nine Months Ended |
| | September 30, | | October 1, | | September 30, | | October 1, |
| | 2017 | | 2016 | | 2017 | | 2016 |
| | (in thousands) | | (in thousands) |
Common share equivalents | | | 12,803 | | | 13,601 | | | 12,941 | | | 13,150 |
The above common share equivalents would have been included in the calculation of diluted net loss per share had the Company reported net income for the periods presented.
Major Customers and Products
The Company’s product revenues have historically been concentrated in a small number of customers. The following table sets forth the percentage of the Company’s net product revenues made to customers that each comprise 10% or more of the Company’s net product revenues in the periods presented:
| | | | | | | | | | |
| | Three Months Ended | | | Nine Months Ended | |
| | September 30, | | October 1, | | | September 30, | | October 1, | |
| | 2017 | | 2016 | | | 2017 | | 2016 | |
Customer: | | | | | | | | | | |
Customer A | | * | % | * | % | | * | % | 10 | % |
Customer B | | * | % | 17 | % | | * | % | 29 | % |
Customer C | | * | % | 17 | % | | * | % | * | % |
Customer D | | 13 | % | * | % | | * | % | * | % |
Customer E | | 10 | % | * | % | | * | % | * | % |
*Less than 10% of net product revenues during the period.
The Company’s accounts receivable are concentrated with three customers at September 30, 2017, representing 21%, 16% and 11% of aggregate gross receivables, respectively. At December 31, 2016, two customers represented 27% and 11% of aggregate gross receivables, respectively. The loss of any of the Company’s significant customers or a reduction in sales to or difficulties collecting payments from any of these customers could significantly reduce the Company’s net product revenues and adversely affect its operating results. The Company tries to mitigate risks associated with foreign receivables by purchasing comprehensive foreign credit insurance.
The Company resells certain Samsung products that it purchases under the terms of the JDLA with Samsung to certain end-customers that are not reached in Samsung’s distribution model, including storage customers, appliance customers, system builders and cloud and datacenter customers. In the three and nine months ended September 30, 2017 and October 1, 2016, resales of these products represented approximately 75%, 86%, 53% and 51%, respectively, of the Company’s net product revenues.
Cash Flow Information
The following table sets forth supplemental disclosures of cash flow information and non-cash financing activities for the periods presented:
| | | | | | |
| | Nine Months Ended |
| | September 30, | | October 1, |
| | 2017 | | 2016 |
| | (in thousands) |
Supplemental disclosure of non-cash financing activities: | | | | | | |
Debt financing of insurance | | $ | 220 | | $ | 264 |
Acquisition of equipment through capital lease | | $ | - | | $ | 179 |
Issuance of shares for cashless warrant exercise | | $ | - | | $ | 1 |
Note 4—Credit Agreement
SVB Credit Agreement
On October 31, 2009, the Company and Silicon Valley Bank (“SVB”) entered into a credit agreement (as amended, the “SVB Credit Agreement”). Pursuant to the terms of the SVB Credit Agreement, the Company is eligible to borrow, in a revolving line of credit, up to the lesser of (i) 80% of its eligible accounts receivable, or (ii) $5.0 million, subject to certain adjustments as set forth in the SVB Credit Agreement. The SVB Credit Agreement requires letters of credit to be secured by cash, which is classified as restricted cash in the accompanying condensed consolidated balance sheets. As of September 30, 2017 and December 31, 2016, (i) letters of credit were outstanding in the amount of $2.4 million and $3.1 million, respectively (ii) the Company had outstanding borrowings of $2.6 million and $0.7 million, respectively, and (iii) availability under the revolving line of credit was $0.1 million and $0.8 million, respectively.
On January 29, 2016, the Company and SVB entered into an amendment to the SVB Credit Agreement to, among other things, adjust the rate at which advances under the SVB Credit Agreement accrue interest to the Wall Street Journal “prime rate” plus 2.75% (prior to such amendment, advances accrued interest at a rate equal to SVB’s most recently announced “prime rate” plus 2.75%).
On March 27, 2017, the Company and SVB entered into another amendment to the SVB Credit Agreement to, among other things, (i) extend the maturity date of advances under the SVB Credit Agreement to April 1, 2018, (ii) modify the Company’s financial covenants under the SVB Credit Agreement to remove all prior financial standards and replace them with a liquidity ratio standard, (iii) remove or amend certain termination, anniversary and unused facility fees payable by the Company under the SVB Credit Agreement, and (iv) make certain other administrative changes. On April 12, 2017, the Company and SVB entered into a further amendment to the SVB Credit Agreement to, among other things, obtain SVB’s consent in connection with the Company’s rights agreement with Computershare Trust Company, N.A., as rights agent (see Note 8), and make certain administrative changes in connection with the Company’s funding arrangement with TR Global Funding V, LLC, an affiliate of TRGP Capital Management, LLC (“TRGP”) (see Note 7).
For all periods before April 20, 2017, all obligations under the SVB Credit Agreement were secured by a first priority security interest in the Company’s tangible and intangible assets, other than its patent portfolio, which was subject to a first priority security interest held by SVIC (see Note 5). Certain of these lien priorities were modified in April and May 2017 in connection with the Company’s establishment of a funding arrangement with TRGP for certain of the Company’s litigation expenses in connection with certain of its legal proceedings against SK hynix. On May 3, 2017, TRGP entered into an intercreditor agreement with each of SVIC and SVB, and on April 20, 2017 SVIC and SVB entered into an intercreditor agreement with each other (such intercreditor agreements, collectively, the “Intercreditor Agreements”). Pursuant to the terms of the Intercreditor Agreements, SVB’s security interests in the Company’s assets have been modified as follows: SVB has a first priority security interest in all of the Company’s tangible and intangible assets other than its patent portfolio and its claims underlying and any proceeds it may receive from the SK hynix proceedings; a second priority security interest in the Company’s patent portfolio other than the patents that are the subject of the SK hynix proceedings; and a third priority security interest in the Company’s patents that are the subject of
the SK hynix proceedings. See Note 7 for additional information about the funding arrangement with TRGP, the Intercreditor Agreements and the Company’s legal proceedings against SK hynix.
The SVB Credit Agreement subjects the Company to certain affirmative and negative covenants, including financial covenants with respect to the Company’s liquidity and restrictions on the payment of dividends. As of September 30, 2017, the Company was in compliance with its covenants under the SVB Credit Agreement.
Note 5—Debt
The Company’s debt consisted of the following as of the dates presented:
| | | | | | | | | | | | | | | |
| | | | | | | | | | | September 30, | | December 31, |
| | | | | | | | | | | 2017 | | 2016 |
| | | | | | | | | | | (in thousands) |
Convertible promissory note, SVIC, net of debt discount of $922 and $1,084 in 2017 and 2016, respectively | | | | | | | | | | | $ | 14,078 | | $ | 13,916 |
Accrued interest on convertible promissory note with SVIC | | | | | | | | | | | | 560 | | | 335 |
Notes payable and capital lease obligation | | | | | | | | | | | | 23 | | | 151 |
| | | | | | | | | | | $ | 14,661 | | $ | 14,402 |
Less current portion | | | | | | | | | | | | (23) | | | (151) |
| | | | | | | | | | | $ | 14,638 | | $ | 14,251 |
On November 18, 2015, in connection with entering into the JDLA with Samsung, the Company sold to SVIC the SVIC Note and the SVIC Warrant. The SVIC Note has an original principal amount of $15.0 million, accrues interest at a rate of 2.0% per year, is due and payable in full on December 31, 2021, and is convertible into shares of the Company’s common stock at a conversion price of $1.25 per share, subject to certain adjustments, on the maturity date of the SVIC Note. Upon a change of control of the Company prior to the maturity date of the SVIC Note, the SVIC Note may, at the Company’s option, be assumed by the surviving entity or be redeemed upon the consummation of such change of control for the principal and accrued but unpaid interest as of the redemption date. The SVIC Warrant grants SVIC a right to purchase 2,000,000 shares of the Company’s common stock at an exercise price of $0.30 per share, subject to certain adjustments, is only exercisable in the event the Company exercises its right to redeem the SVIC Note prior to its maturity date, and expires on December 31, 2025.
The SVIC Warrant was valued at $1,165,000, based on its relative fair value, and was recorded as a debt discount. The Company also recorded $154,000 as a debt discount for professional service fees rendered in connection with the transaction. These amounts are being amortized over the term of the SVIC Note using the effective interest method. For the three and nine months ended September 30, 2017 and October 1, 2016, the Company amortized $54,000, $162,000, $55,000 and $163,000, respectively, to interest expense in the accompanying condensed consolidated statements of operations.
In connection with the SVIC Note, SVIC was granted a first priority security interest in the Company’s patent portfolio and a second priority security interest in all of the Company’s other tangible and intangible assets. Upon issuance of the SVIC Note, the Company, SVB and SVIC entered into an Intercreditor Agreement pursuant to which SVB and SVIC agreed to their relative security interests in the Company’s assets. In May 2017, SVIC, SVB and TRGP entered into additional Intercreditor Agreements to modify certain of these lien priorities (see Note 7). Additionally, upon issuance of the SVIC Note and the SVIC Warrant, the Company and SVIC entered into a Registration Rights Agreement pursuant to which the Company is obligated to register with the SEC, upon demand by SVIC, the shares of the Company’s common stock issuable upon conversion of the SVIC Note or upon exercise of the SVIC Warrant.
The SVIC Note subjects the Company to certain affirmative and negative operating covenants. As of September 30, 2017, the Company was in compliance with its covenants under the SVIC Note.
Capital Lease and Notes Payable
The Company has purchased computer equipment through a capital lease. As of September 30, 2017, the lease requires monthly payments of approximately $12,000 and matures in December 2017.
Interest expense, including amortization of debt discounts and debt issuance costs, net of interest income, was as follows during the periods presented:
| | | | | | | | | | | | | | | |
| | Three Months Ended | | | | Nine Months Ended |
| | September 30, | | October 1, | | | | | September 30, | | October 1, |
| | 2017 | | 2016 | | | | | 2017 | | 2016 |
| | | (in thousands) | | | | (in thousands) |
Interest expense: | | | | | | | | | | | | | | | |
SVB | | $ | 5 | | $ | 13 | | | | | $ | 26 | | $ | 31 |
SVIC | | | 129 | | | 135 | | | | | | 387 | | | 394 |
Others | | | 4 | | | 14 | | | | | | 20 | | | 16 |
| | | 138 | | | 162 | | | | | | 433 | | | 441 |
Interest income | | | (3) | | | (3) | | | | | | (12) | | | (13) |
| | $ | 135 | | $ | 159 | | | | | $ | 421 | | $ | 428 |
Note 6—Income Taxes
The following table sets forth the Company’s provision for income taxes, along with the corresponding effective tax rates, for the periods presented:
| | | | | | | | | | | | | |
| | Three Months Ended | | Nine Months Ended | |
| | September 30, | | October 1, | | September 30, | | | October 1, | |
| | 2017 | | 2016 | | 2017 | | | 2016 | |
| | (in thousands) | | (in thousands) | |
Provision for income taxes | | $ | - | | $ | - | | $ | 1 | | $ | 1 | |
Effective tax rate | | | - | % | | - | % | | (0.01) | % | | (0.01) | % |
The Company evaluates whether a valuation allowance should be established against its deferred tax assets based on the consideration of all available evidence using a “more likely than not” standard. In making such judgments, significant weight is given to evidence that can be objectively verified. Due to uncertainty of future utilization, the Company has provided a full valuation allowance as of September 30, 2017 and December 31, 2016. Accordingly, no benefit has been recognized for net deferred tax assets. The Company’s effective tax rate differs from the federal statutory tax rate of 34% for the nine months ended September 30, 2017 and October 1, 2016 due to providing the full valuation allowance against net deferred tax assets.
The Company did not have any unrecognized tax benefits as of September 30, 2017 and December 31, 2016.
Note 7—Commitments and Contingencies
TRGP Agreement and Related Intercreditor Agreements
On May 3, 2017, the Company and TRGP entered into an investment agreement (the “TRGP Agreement”), which generally provides that TRGP will directly fund the costs incurred by or on behalf of the Company in connection with certain its legal proceedings against SK hynix (see “Litigation and Patent Reexaminations” in this Note 7 below), including costs incurred since January 1, 2017 and costs to be incurred in the future in the Company’s first ITC action and its U.S. district court proceedings, but excluding the Company’s subsequent ITC action and its proceedings in international courts (all such funded costs, collectively, the “Funded Costs”). In exchange for such funding, the Company has agreed that, if the Company recovers any proceeds in connection with the funded SK hynix proceedings, it will pay to TRGP the amount of the Funded Costs paid by TRGP 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 the Funded Costs 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, pursuant to the terms of a separate security agreement between the Company and TRGP dated May 3, 2017 (the “Security Agreement”), the Company has granted to TRGP (i) a first priority lien on, and security in, the claims underlying the funded SK hynix proceedings and any proceeds that may be received by the Company in connection with these proceedings, and (ii) a second priority lien on, and security in, the Company’s patents that are the subject of the funded SK hynix proceedings.
The TRGP Agreement does not impose financial covenants on the Company. Termination events under the TRGP Agreement include, among others, any failure by the Company to make payments to TRGP thereunder upon receipt of recoveries in the SK hynix proceedings; the occurrence of certain bankruptcy events; certain breaches by the Company of its covenants under the TRGP Agreement or the related Security Agreement; and the occurrence of a change of control of the Company. If any such termination event occurs, subject to certain cure periods for certain termination events, TRGP would have the right to terminate its obligations under the TRGP Agreement, including its obligation to make any further payments of Funded Costs after the termination date. In the event of any such termination by TRGP, the Company would continue to be obligated to pay TRGP the portion of any proceeds the Company may recover in connection with the SK hynix proceedings that TRGP would have been entitled to receive absent such termination, as described above, and TRGP may also be entitled to seek additional remedies pursuant to the dispute resolution provisions of the TRGP Agreement.
In connection with the TRGP Agreement, in May 2017, TRGP, SVIC and SVB entered into the Intercreditor Agreements. Pursuant to the terms of the Intercreditor Agreements, TRGP, SVB and SVIC have agreed to their relative security interest priorities in the Company’s assets, such that: (i) TRGP has a first priority security interest in the Company’s claims underlying the funded SK hynix proceedings and any proceeds that may be received by the Company in connection with these proceedings, and a second priority security interest in the Company’s patents that are the subject of the funded SK hynix proceedings, (ii) SVIC has a first priority security interest in the Company’s complete patent portfolio and a second priority security interest in all of the Company’s other tangible and intangible assets (other than the Company’s claims underlying and any proceeds it may receive from the SK hynix proceedings funded under the TRGP Agreement), and (iii) SVB has a first priority security interest in all of the Company’s tangible and intangible assets other than its patent portfolio and its claims underlying and any proceeds it may receive from the SK hynix proceedings funded under the TRGP Agreement, a second priority security interest in the Company’s patent portfolio other than the patents that are the subject of the SK hynix proceedings funded under the TRGP Agreement, and a third priority security interest in the Company’s patents that are the subject of the SK hynix proceedings funded under the TRGP Agreement. The Company consented and agreed to the terms of each of the Intercreditor Agreements.
Legal expenses incurred by the Company but paid by TRGP pursuant to the terms of the TRGP Agreement are excluded from the Company’s consolidated financial statements in each period in which the TRGP Agreement remains in effect. In the nine months ended September 30, 2017, the Company excluded legal expenses of $9.3 million as a result of TRGP’s payment of these expenses under the TRGP Agreement. Any settlement or other cash proceeds the Company may recover in the future in connection with the funded SK hynix proceedings would be reduced by the aggregate amount of legal expenses excluded by the Company 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.
Litigation and Patent Reexaminations
The Company owns numerous patents and continues to seek to grow and strengthen its patent portfolio, which covers different aspects of the Company’s technology innovations with various claim scopes. The Company plans to pursue avenues to monetize its intellectual property portfolio, in which it would generate revenue by selling or licensing its technology, and it intends to vigorously enforce its patent rights against alleged infringers of such rights. The Company dedicates substantial resources to protecting its intellectual property, including its efforts to defend its patents against challenges made by way of reexamination proceedings at the PTAB or USPTO. These activities are likely to continue for the foreseeable future, without any guarantee that any ongoing or future patent protection and litigation activities will be successful, or that the Company will be able to monetize its intellectual property portfolio. The
Company is also subject to litigation claims that it has infringed on the intellectual property of others, against which the Company intends to defend itself vigorously.
Litigation, whether or not eventually decided in the Company’s favor or settled, is costly and time-consuming and could divert management’s attention and resources. Thus, because of the nature and inherent uncertainties of litigation, even if the outcome of any proceeding is favorable, the Company’s business, financial condition, results of operations or cash flows could be materially and adversely affected. Additionally, the outcome of pending or future litigation andand/or related patent reviews and reexaminations, as well as any delay in their resolution, could affect the Company’sour ability to continue to sell itsour products, protect against competition in the current and expected markets for itsour products or license itsor otherwise monetize our intellectual property rights in the future.
Google LitigationLitigations
On December 4, 2009, the CompanyNetlist filed a patent infringement lawsuit against Google Inc. (“Google”) in the U.S. District Court for the Northern District of California (the “Northern District Court”“NDCA”), seeking damages and injunctive relief based on Google’s alleged infringement of the Company’sour U.S. Patent No. 7,619,912 (the “‘912 patent”Patent”). The current judge assigned to the case, Hon. Chief Judge Seeborg, entered an order via stipulation on October 17, 2022 staying the NDCA Google case until the resolution of a pending case filed by Netlist, Inc. against Samsung Electronics Co., Ltd., Samsung Semiconductor Inc., and Samsung Electronics America Inc. (collectively, “Samsung”) in the United States District Court for the Eastern District of Texas (“EDTX”) (Netlist, Inc. v. Samsung Elecs. Co., Ltd. et al., Case No. 2:22-cv-00293-JRG).
On July 26, 2022, Netlist filed patent infringement claims against Google Cloud EMEA Limited, Google Germany GmbH, Redtec Computing GmbH, and Google LLC (the “German Google Defendants”), seeking damages based on those defendants’ infringement of European Patents EP 2,454,735 (“EP735”) and EP 3,404,660 (“EP660”), which relatesboth generally relate to technologiesload reduced dual in line memory modules (“LRDIMM”) technologies. As of the reporting date, the German Google Defendants have submitted statements of defense. As of the reporting date, the German Federal patent Court has issued its order finding the EP735 null, and the proceedings before the Dusseldorf Court are currently stayed pending the outcome of the nullity reviews of the asserted EP patents.
On October 15, 2021, Samsung Electronics Co. Ltd. (“SECL”) and Samsung Semiconductor Inc. (“SSI”) initiated a declaratory judgement action against Netlist in the U.S. District Court for the District of Delaware (“DDE”) (Samsung Elecs. Co., Ltd., et. al. v. Netlist, Inc., Case No. 1:21-cv-01453-RGA). On September 12, 2022, Netlist amended its Counterclaims to implement rank multiplication. In February 2010, Google answered the Company’s complaint and assertedinclude counterclaims against Google LLC and Alphabet, Inc (together, “Google Delaware Defendants”). On November 15, 2022, the Company seekingGoogle Delaware Defendants responded to Netlist’s Counterclaims by filing a declarationMotion to Dismiss or alternatively to sever and stay the counterclaims. As of the reporting date, the Court heard oral arguments for the Google Delaware Defendants’ Motion to Dismiss or alternatively, Sever and Stay and Dismiss Willfulness and Indirect Infringement Allegations. On October 10, 2023, the DDE Court entered an order granting-in-part and denying-in-part SECL and SSI’s prior motion to stay the matter in light of pending Inter Partes Reviews (“IPRs”) and a Ninth Circuit appeal, in effect staying claims with respect to Netlist’s U.S. Patent Nos. 9,858,218 (the “‘218 Patent”) and 10,474,595 (the “‘595 Patent”), while allowing claims under Netlist’s U.S. Patent No. 10,217,523 (the “‘523 Patent”) to proceed. On October 20, 2023, the Court held a claim construction hearing involving all parties. As part of the hearing, the Court also sought feedback from parties as to the issue of whether the matter should be stayed pending review of the Ninth Circuit’s recent unpublished decision on the underlying Central District of California action.
requiring the assigned Board to reevaluate Netlist’s request for discovery on the admitted relationship between Samsung and Google and reassess whether Google is a “Real Party in Interest.” On June 30, 2023, the Board resumed the trial on the Samsung ‘912 Patent IPR, which now also includes Micron’s claims via joinder (see above), and scheduled the ‘912 patent is invalidPatent IPR for further substantive briefing and requestingan oral hearing on January 31, 2024. On October 17, 2023 and October 18, 2023, the PTAB issued final written decisions stating that all challenged claims of the USPTO reject‘506 and ‘339, respectively, Patents were unpatentable. Netlist filed Requests for Rehearing of the patent’s claims‘506 and cancel‘339 Patent IPR final written decisions on November 16, 2023 and November 17, 2023, respectively. On December 20, 2023, the patent. Additionally, in October 2010, Smart Modular, Inc. (“Smart Modular”) submitted another such reexamination request.Board denied Netlist’s Request for Rehearing on the ‘506 Patent IPR result. Netlist filed a Notice of Appeal challenging the Board’s final written decision for the ‘506 Patent, thus instituting an appeal before the CAFC of the ‘506 Patent IPR result (CAFC Case No. 24-1521), and as of the reporting date has not filed its Opening Appeal Brief. On February 9, 2024, the PTAB denied Netlist’s Request for Rehearing on the ‘339 Patent IPR result. Netlist filed its Notice of Appeal challenging the Board’s final written decision for the ‘339 Patent, thus instituting an appeal before the CAFC of the ‘339 Patent IPR result (CAFC Case No. 24-1707), and as of the reporting date has not filed its Opening Appeal Brief. On January 18, 2011,31, 2024, an oral hearing was conducted for the USPTO granted such reexamination requests, and in February 2011,Samsung ‘912 Patent IPR proceeding joined by Micron. On April 17, 2024, the USPTO mergedPTAB entered its final written decision for the Inphi, Google and Smart Modular ‘912 patent reexaminations into a single proceeding. On March 21, 2014,Patent IPR, finding 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 rightschallenged claim 16 unpatentable. As of the involved parties to filereporting date, Netlist has not filed a notice of appeal tochallenging the ACP, each of which confirmed the patentability of 92 ofBoard’s final written decision for the ‘912 patent’s claimsPatent IPR.
On May 17, 2022, Samsung filed two IPR petitions contesting the validity of Netlist’s ‘918 and rejected‘054 Patents. On December 6, 2022, the
patent’s 11 other claims. The parties involved filed various notices of appeal, responses Board instituted an IPR trial for the ‘054 Patent, and requests,then instituted an IPR trial for the ‘918 Patent the next day. Micron has joined these Samsung IPRs on the ‘918 and ‘054 Patents, and oral arguments were heard on November 24, 2015,September 7, 2023. On December 5, 2023 and December 6, 2023, the PTAB held a hearing on such appeals.entered final written decisions for the ‘918 and ‘054 Patent IPRs, respectively, finding in both instances that all challenged claims were unpatentable. On May 31, 2016, the PTAB issued a decision affirming certain of the examiner’s decisionsJanuary 5, 2024 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 the ‘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, 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 involvedJanuary 6, 2024, Netlist 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 PartesDirector Review of the Company’s asserted patents. All‘918 and ‘054 Patents, respectively, final written decisions. On March 18, 2024, the USPTO denied Netlist’s request for Director Review of the reviews associated with U.S.‘918 and ‘054 Patent Nos. 8,516,187; 8,301,833; 8,516,185 have been resolvedIPRs. As of the reporting date, Netlist has not filed a notice of appeal challenging the Board’s final written decision for the ‘918 or ‘054 Patent IPRs.
On June 3, 2022, Netlist filed patent infringement lawsuits against Samsung in Dusseldorf, Germany, seeking damages for Samsung’s infringement of Netlist’s patents EP735 and EP660 (“Samsung Dusseldorf Action”). An Oral Hearing was held in the Company’s favorDusseldorf Court on September 5, 2023 to determine the question of infringement specifically. The Court confirmed at the hearing that an Order would issue either staying the matter until a decision was reached on validity by the German Federal Patent Court, or a dismissal of the case if there was no infringement. On September 25, 2023, the Dusseldorf Court entered a stay of the matter until the German Federal Patent Court renders a decision in the nullity actions currently pending for EP735 and are no longer pending.EP660. The reviews associated with U.S.German Federal Patent Nos. 8,001,434; 8,359,501; 7,881,150; and 8,081,536 have concluded beforeCourt has issued its order finding the PTABEP735 null, and the parties have appealedSamsung Dusseldorf Action has been stayed pending the decisions in these reviews to the Court of Appeals for the Federal Circuit and are awaiting decisions. On April 9, 2015, the Northern District Court stayed the infringement proceedings as to the Company’s patents asserted against the ULLtraDIMM pending resolutionoutcome of the patent review decisions on appeal.nullity reviews of the asserted EP patents.
SK hynix Litigation
On SeptemberAugust 1, 2016, the Company2022, Netlist filed legal proceedingsa complaint for patent infringement against SK hynixSamsung in the ITCEDTX (Case No. 2:22-cv-00293) under the ‘912 Patent, which relates generally to technologies to implement rank multiplication. On August 15, 2022, Netlist filed its first amended complaint here, further addressing Samsung’s infringement of the ‘215 and ‘417 Patents. On October 21, 2022, Hon. Chief Judge Gilstrap ordered that this action and a parallel action by Netlist against Micron on the same patents (22-cv-00294-JRG) be consolidated and set for a joint scheduling conference on November 17, 2022, further instructing that this Samsung action be considered the “LEAD CASE” and that any further filings from either action be submitted in therefore all pretrial matters. The claim construction hearing was advanced and took place before Hon. Chief Judge Gilstrap on September 26, 2023. On November 21, 2023, the Court entered its Claim Construction Order. The final pretrial conference was held on March 6, 2024, and as of the reporting date, the Court has not set the jury trial start date.
On August 26, 2022, Samsung filed two IPR petitions contesting the validity of Netlist’s ‘060 and ‘160 Patents. On January 19, 2023, Netlist filed its Patent Owner Preliminary Responses in those proceedings. An oral hearing was held on January 11, 2024, and on April 1, 2024, the PTAB issued its final written decisions finding all challenged claims of the ‘060 and ‘160 Patents unpatentable. On May 1, 2024, Netlist requested a director review of the final written decisions.
On January 10, 2023, Samsung filed two IPR petitions contesting the validity of the ‘215 and ‘417 Patents. The Board accorded these IPRs a filing date of January 10, 2023, and Netlist filed its Patent Owner Preliminary Responses by the May 9, 2023 deadline. On August 1, 2023, the Board entered an Order instituting a trial for both of Samsung’s IPR petitions. The Board simultaneously set a schedule for briefing deadlines, and the Central District Court.date for oral arguments on May 3, 2024. On January 3, 3024, the PTAB joined the later-filed and substantially-identical Micron IPRs for the ‘215 and ‘417 Patents to Samsung’s IPRs. The proceedings are basedparties completed briefing on the alleged infringement by SK hynix’s registered dual in-line memory module (“RDIMM”)‘417 and LRDIMM enterprise memory products of six‘215 Patent IPRs and held oral arguments on May 3, 2024. As of the Company’s U.S. patents. Inreporting date, the ITC proceedings,PTAB has not yet issued its final written decisions.
On April 27, 2023, Samsung filed an IPR petition contesting the Company is seekingvalidity of the ‘608 Patent. The Board accorded Samsung’s IPR petition a filing date on June 14, 2023. On December 12, 2023, the PTAB instituted an exclusion order that directs U.S. CustomsIPR trial for the ‘608 Patent, despite having previously denied institution from Micron’s earlier-filed IPR petition of the same Patent. On December 26, 2023, Netlist filed a request for review of the institution decision by the Director of the USPTO. As of the reporting date, the PTAB and Border Protection to stop allegedly infringing SK hynix RDIMM and LRDIMM products from enteringUSPTO Director have denied Netlist’s requests. Netlist filed its Patent Owner’s Response on March 29, 2024. As of the United States. In the Central District Court proceedings, the Company is primarily seeking damages.reporting date, Samsung has not yet filed its reply.
On October 3, 2016, 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 set9, 2023, Samsung initiated 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, the 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 motionssecond declaratory judgement action against Netlist 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 appearancesDDE (Samsung Elecs. Co., Ltd., et. al. v. Netlist, Inc., Case No. 1:23-cv-01122-RGA), where it requested 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 patents 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 inrelevant part SK hynix’s request to stay the infringement proceedings 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.
On July 11, 2017, the Company 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 for patent infringement against SK hynix in the ITC based on the alleged infringement by SK hynix’s RDIMM and LRDIMM products of two additional U.S. patents owned 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 entering the United States.
Morgan Joseph Litigation
On March 31, 2016, Morgan Joseph Triartisan LLC (“Morgan Joseph”) filed a complaint in the Supreme Court of the State of New York against the Company and certain of its officers for breach of contract and related causes of action. The complaint alleges that the Company refused to honorDDE declare that Samsung does not infringe Netlist’s U.S. Patent No. 11,386,024 (the “‘024 Patent”) and that Netlist allegedly breached its paymentcontractual obligations under a written agreement with Morgan Joseph related to the provision of financial advisoryJoint Electron Device Engineering Council 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.
On September 15, 2016, the Companythus harmed Samsung as a third-party beneficiary. Netlist filed a motion to dismiss Morgan Joseph’s complaint for failurethe action on November 6, 2023. As of the reporting date, the parties have completed briefing on Netlist’s motion and the Court has yet 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.enter an order.
Other Contingent Obligations
In the ordinary course of itsour business, the Company haswe have made certain indemnities, commitments and guarantees pursuant to which itwe may be required to make payments in relation to certain transactions. These include:may include, among others: (i) intellectual property indemnities to the Company’sour customers and licensees in connection with the use, sale and/or license of Companyour products; (ii) indemnities to vendors and service providers pertaining to claims based on the Company’sour negligence or willful misconduct; (iii) indemnities involving the accuracy of representations and warranties in certain contracts; (iv) indemnities to our directors and officers of the Company to the maximum extent permitted under the laws of the State of Delaware; (v) indemnities to 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 Companywe may be required to indemnify property owners for environmental and other liabilities or may face other claims arising from the Company’sour 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 Companywe could be obligated to make. Historically, the Company haswe have not been obligated to make significant payments as a result of these obligations, and no liabilities have been recorded for these indemnities, commitments and guarantees in the accompanying 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 Septemberas of March 30, 20172024 or December 31, 2016.30, 2023.
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). On April 17, 2024, the Company appointed Equiniti Trust
Stock-Based Compensation
The following table summarizes the stock-based compensation expense by line item in the condensed consolidated statements of operations (in thousands):
| | | | | | | |
| | | Three Months Ended |
| | | March 30, | | April 1, |
| | | 2024 | | 2023 |
Cost of sales | | | $ | 21 | | $ | 18 |
Research and development | | | | 362 | | | 274 |
Selling, general and administrative | | | | 991 | | | 785 |
Total | | | $ | 1,374 | | $ | 1,077 |
As of SeptemberMarch 30, 2017,2024, the amountCompany had approximately $8.3 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 is
approximately $1.7 million, net of estimated forfeitures. Therecognize over a weighted-average period over which the unearned stock-based compensation is expected to be recognized isof 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.
Note 10—Warrants
Warrants
The following is a summary of the Company’s warrantWarrant activity for the year ended December 31, 2016 and the ninethree months ended SeptemberMarch 30, 2017:2024 is as follows:
| | | | | | |
| | | | | 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 |
| | | | | | |
| | | | | Weighted |
| | Number of | | Average |
| | Shares | | Exercise |
| | (in thousands) | | Price |
Outstanding as of December 30, 2023 | | | 11,111 | | $ | 3.20 |
Granted | | | — | | | — |
Exercised | | | — | | | — |
Expired | | | — | | | — |
Outstanding as of March 30, 2024 | | | 11,111 | | $ | 3.20 |
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—11—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,April 17, 2024, the Company entered into the Fourth Amendment. The Fourth Amendment appointed Equiniti as rights agent and amended the definition of “Expiration Date” in the Rights Agreement to extend the term for an At Market Issuance Sales Agreement (the “Sales Agreement”) with B. Riley FBR, Inc. (the “Agent”) to sell sharesadditional three year period which extended the final expiration 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 beRights issued pursuant to the Company’s shelf registration statement on Form S-3Rights Agreement from April 17, 2024 to April 17, 2027. As a result 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 SalesFourth Amendment, the Rights will expire and become unexercisable on or before the close of business on April 17, 2027, in accordance with the terms of the Rights Agreement.
Item 2. | Management’s Discussion and Analysis of Financial Condition and Results of Operations |
Note Regarding Forward-Looking Statements
This Management’s Discussion and Analysis of Financial Condition and Results of Operations
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,"“anticipate,” “estimate,” “expect,” “project,” “intend,” “may,” “will,” “might,” "plan," "predict," "believe," "should,"“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.
| ● | our beliefs regarding the market and demand for our products or the component products we resell; |
| ● | our ability to collect any damages awarded to us under Final Judgment against Samsung Electronics Co., Ltd., Samsung Semiconductor Inc., and Samsung Electronics America Inc. (collectively, “Samsung”); |
| ● | our ability to develop and launch new products that are attractive to the market and stimulate customer demand for these products; |
| ● | our plans relating to our intellectual property, including our goals of monetizing, licensing, expanding and defending our patent portfolio; |
| ● | our expectations and strategies regarding outstanding legal proceedings and patent reexaminations relating to our intellectual property portfolio; |
| ● | our expectations with respect to any strategic partnerships or other similar relationships we may pursue; |
| ● | the competitive landscape of our industry; |
| ● | general market, economic and political conditions; |
| ● | our business strategies and objectives; |
| ● | our expectations regarding our future operations and financial position, including revenues, costs and prospects, and our liquidity and capital resources, including cash flows, sufficiency of cash resources, efforts to reduce expenses and the potential for future financings; |
| ● | our ability to remediate any material weakness, maintain effective internal control over financial reporting; and |
| ● | the impact of the above factors and other future events on the market price and trading volume of our common stock. |
All forward-looking statements reflect management’s present assumptions, expectations and beliefs regarding future events and are subject to known and unknown risks, uncertainties and 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 these forward-looking statements. Theseas predictions of future events. 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.
Overview
We are a leading provider of high-performance modular memory subsystems serving customersThe following MD&A should be read in diverse industries that require superior memory performance 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 channelconjunction 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 of storage class memory products called HybriDIMM to address the growing need for real-time analytics in Big Data applications and in-memory databases.
Due to the ground-breaking product development of our engineering teams, we have built a robust portfolio of over 100 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 and protection of technology innovations essential to our business. Our early pioneering work in these areas has been broadly adopted in industry-standard 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 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.
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 JDLA 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 and NAND flash raw materials. The JDLA also provided for an $8.0 million non-recurring engineering (“NRE”) fee 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 and the related notes included in Part I, Item 1 of this report, for additionalas well as our Annual Report on Form 10-K filed with the Securities and Exchange Commission (the “SEC”) on February 23, 2024 (the “Annual Report”). All information about the SVIC Notepresented 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 SVIC Warrant.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
Further,
Netlist provides high-performance memory solutions to enterprise customers in September 2016, we took actiondiverse industries. Our products, in various capacities and form factors, including our line of custom and specialty memory products, bring leading performance to protect and defend our innovations by filing legal proceedings for patent infringement against SK hynix and twocustomers in a variety of industries globally. Netlist also licenses its subsidiaries inintellectual property.
During the U.S. International Trade Commission ("ITC") and in U.S. district court. We filed additional legal proceedings for patent infringement against SK hynix in the ITC and in the courtsfirst quarter of Germany and the People’s Republic 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 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, and2024, we recorded net sales of $35.8 million, 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$0.7 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.$17.0 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 with Silicon Valley Bank, a funding arrangement for costs associated with our legal proceedings against SK hynix and, to a lesser extent, equipment leasing arrangements.division of First-Citizen Bank & Trust Company (“SVB”). See “Liquidity and Capital Resources” below for furthermore information.
Recent Developments
Fourth Amendment to Rights Agreement
On April 17, 2024, the Company entered into a fourth amendment (the “Fourth Amendment”) to the Company’s rights agreement dated as of April 17, 2017 ATM Program(as amended from time to time, the “Rights Agreement”). The Fourth Amendment appointed Equiniti Trust Company, LLC as rights agent and amended the definition of “Expiration Date” in the Rights Agreement to extend the term for an additional three year period which extended the final expiration of the Rights issued pursuant to the Rights Agreement from April 17, 2024 to April 17, 2027. As a result and pursuant to the Fourth Amendment, the Rights will expire and become unexercisable on or before the close of business on April 17, 2027, in accordance with the terms of the Rights Agreement.
Jury Verdict and Judgment Against Samsung
On August 11, 2023, a judgment was entered in the United States District Court for the Eastern District of Texas, which upheld the jury trial verdict on April 21, 2023 that awarded Netlist approximately $303 million in damages against Samsung for their willful infringement of five Netlist patents: U.S. Patent Nos. 10,949,339, 11,016,918, 11,232,054, 8,787,060, and 9,318,160. The products found to infringe these patents were Samsung DDR4 LRDIMMs, DDR5 UDIMMs, DDR5 SODIMMs, and DDR5 RDIMMs, and HBM2, HBM2E, and HBM3 components. Post-judgment motions are pending before the Court. Following entry of an order regarding that post-judgment briefing, an appeal may be filed before the U.S. Court of Appeals for the Federal Circuit. Should any party file an appeal, that could cause a lengthy delay in our ability to collect a damages award from Samsung, lead to a reduction of the damages award, or lead to a remand or reversal of the jury’s verdict. Additionally, as of the reporting date, all of the patents confirmed as being infringed on the jury verdict are either subject to Inter Partes Review (“IPR”) final written decisions, or an active IPR trial. The outcome of each of the IPR proceedings related to each of these patents may affect the underlying collectability of the jury award in this matter.
September 2021 Lincoln Park Purchase Agreement
On November 13, 2017,September 28, 2021, we entered into an At Market Issuance Sales Agreementa purchase agreement (the “Sales“September 2021 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 $75 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 SalesSeptember 2021 Purchase 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 September 2021 Purchase Agreement.
2017 Offering
On August 22, 2017, we completedDuring the three months ended March 30, 2024, Lincoln Park purchased an underwritten registered public offering (the “2017 Offering”), pursuant to which we sold 8,500,000aggregate of 1,240,000 shares of our common stock atfor a net purchase price toof $2.1 million under the public of $0.60 per share. The net proceeds to us from 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 in connection with SK hynix Proceedings
September 2021 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.
TRGP Agreement
On May 3, 2017, we entered into an investment agreement (the “TRGP Agreement”) 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,purchases, we will payissued to TRGP the amountLincoln Park an aggregate 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 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 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 percentage4,085 shares of our outstanding capitalcommon 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 strategyadditional commitment shares in connection with our proceedings against SK hynix, with the intent ofnoncash transactions.
disconnecting our market capitalization from the damages calculations 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”). The amendments extend the maturity date of advances under the SVB Credit Agreement to April 1, 2018; modify our financial covenants under the SVB Credit Agreement to remove all prior financial standards 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.
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.
Economic Conditions, Challenges and Risks
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 PoliciesResults of Operations
Net Sales and UseGross Profit
Net sales and gross profit for the three months ended March 30, 2024 and April 1, 2023 were as follows (dollars in thousands):
| | | | | | | | |
| | Three Months Ended | | |
| | March 30, | | April 1, | | % |
| | 2024 | | 2023 | | Change |
Net sales | | $ | 35,807 | | $ | 9,021 | | 297% |
Cost of sales | | | 35,092 | | | 8,461 | | 315% |
Gross profit | | $ | 715 | | $ | 560 | | 28% |
Gross margin percentage | | | 2% | | | 6% | | |
Net Sales
Net sales include resales of Estimatescertain components, modules, and other products, which include dual in-line memory modules (“DIMMs”) and solid-state drives (“SSDs”). Net sales also include sales of Netlist’s own products.
The preparationNet sales increased by approximately $26.8 million during the first quarter of our condensed consolidated financial statements included in this report in conformity with accounting principles generally accepted2024 compared to the same period of 2023, primarily as a result of a $24.2 million increase in the United States requires ussale of registered DIMM (“RDIMM”) and discrete memory component products, a $1.5 million increase in sales of Netlist’s flash and SSD products, and a $1.1 million increase in sales of low-profile memory subsystem products.
Gross Profit and Gross Margin
Product gross profit increased during the first quarter of 2024 compared to make estimatesthe same period of 2023, primarily as a result of higher sales across all product groups. Product gross margin percentage decreased during the first quarter of 2024 compared to the same period of 2023, primarily as a result of product sales mix.
Operating Expenses
Operating expenses for the three months ended March 30, 2024 and assumptions that affectApril 1, 2023, were as follows (dollars in thousands):
| | | | | | | | |
| | Three Months Ended | | |
| | March 30, | | April 1, | | % |
| | 2024 | | 2023 | | Change |
Research and development | | $ | 2,441 | | $ | 2,301 | | 6% |
Percentage of net sales | | | 7% | | | 26% | | |
Intellectual property legal fees | | $ | 12,540 | | $ | 11,070 | | 13% |
Percentage of net sales | | | 35% | | | 123% | | |
Selling, general and administrative | | $ | 3,116 | | $ | 3,030 | | 3% |
Percentage of net sales | | | 9% | | | 34% | | |
Research and Development
Research and development expenses increased during the reported amountsfirst quarter of assets2024 compared to the same period of 2023 due primarily to an increase in employee headcount and liabilitiesrelated overhead.
Intellectual Property Legal Fees
Intellectual property legal fees consist of fees incurred for patent drafting and disclosuresprosecution, opposition to third-party post-grant patent proceedings, and patent enforcement and licensing. Although we expect intellectual property legal fees to generally increase over time as we continue to expand, protect and enforce our patent portfolio, these increases may not be linear but may occur in lump sums depending on the due dates of contingent assetsfilings and liabilities at the date of the condensed consolidated financial statementstheir associated fees, 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 basearrangements we may make with our estimates on our historical experience, knowledge of current conditions and belief of what could occurlegal advisors in the future considering available information. We review our estimates on an on-going basis. Actual results may differ from these estimates,connection with enforcement proceedings, which may resultinclude fee arrangements or contingent fee arrangements in material adverse effectswhich we would pay these legal advisors on our consolidated operating resultsa scaled percentage of any negotiated fees, settlements or judgments awarded to us based on if, how and financial position. We believewhen the following critical accounting policies involve our more significant assumptions and estimates used in the preparation of our condensed consolidated financial statements included in this report: 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.
Our critical accounting policies and estimatesfees, settlements or judgments are discussed inobtained. See Note 27 to the condensed consolidated financial statements included in Part I, Item 1 of this report andfor further discussion.
Intellectual property legal fees increased during 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, cost of sales and gross profit for the three and nine months ended September 30, 2017 and October 1, 2016:
| | | | | | | | | | | | |
| | 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 | % |
Cost of sales | | | 8,285 | | | 2,580 | | | 5,705 | | 221 | % |
Gross profit | | $ | 725 | | $ | 9 | | $ | 716 | | 7,956 | % |
Gross margin | | | 8.0% | | | 0.3% | | | 7.7 | % | | |
| | | | | | | | | | | | |
| | Nine Months Ended | | | | | | |
| | September 30, | | October 1, | | | | | % | |
| | 2017 | | 2016 | | Change | | Change | |
| | (in thousands, except percentages) |
Net product revenues | | $ | 29,840 | | $ | 7,260 | | $ | 22,580 | | 311 | % |
NRE revenues | | | - | | | 6,857 | | | (6,857) | | (100) | % |
Total net revenues | | | 29,840 | | | 14,117 | | | 15,723 | | 111 | % |
Cost of sales | | | 27,791 | | | 6,996 | | | 20,795 | | 297 | % |
Gross profit | | $ | 2,049 | | $ | 7,121 | | $ | (5,072) | | (71) | % |
Gross margin | | | 6.9% | | | 50.4% | | | (43.6) | % | | |
Net Product Revenues
The increase in our net product revenues for the three months ended September 30, 2017 as compared to the three months ended October 1, 2016 resulted primarily from increases of $1.3 million in sales of NAND flash, primarily sourced from Samsung, and $4.4 million in sales of other small outline dual in-line memory module (“SODIMM”) and RDIMM products and $0.7 million of other very low profile (VLP) product sales. The increase in our net product revenues for the nine months ended September 30, 2017 as compared with the nine months ended October 1, 2016 resulted primarily from increases of $12.7 million in sales of NAND flash, also primarily sourced from Samsung, $9.2 million of other SODIMM and RDIMM sales, $0.6 million in other VLP product sales and $0.1 million of sales of our EV3 product.
NRE Revenues
The decrease in NRE revenues for the three and nine months ended September 30, 2017 as2024 compared to the three and nine months ended October 1, 2016 resulted from the recognitionsame period of revenues from the NRE fee for engineering services performed under our JDLA with Samsung in the 2016 period2023 due primarily to our completion of the engineering services required under the initial phase of the agreement in 2016.
Cost of Sales, Gross Profit and Gross Margin
The increase in our cost of sales for the three and nine months ended September 30, 2017 as compared to the three and nine months ended October 1, 2016 resulted primarily from increased costs associated with our increased net product revenues across all periods. The increase in our gross margin for the three months ended September 30, 2017 as compared to the three months ended October 1, 2016 resulted primarily because of a change in our product mix and more efficient utilization of our overhead costs. The decrease in our gross margin in the nine months ended September 30, 2017 as compared to the nine months ended October 2, 2016 resulted primarily from the decrease of NRE revenues from the JDLA, partially offset by increased product revenue margins.
Research and Development
The following tables present research and development expenses for the three and nine months ended September 30, 2017 and October 2, 2016:
| | | �� | | | | | | | | | |
| | Three Months Ended | | | | | | |
| | September 30, | | October 1, | | | | | % | |
| | 2017 | | 2016 | | Change | | Change | |
| | (in thousands, except percentages) |
Research and development | | $ | 1,159 | | $ | 1,463 | | $ | (304) | | (21) | % |
| | | | | | | | | | | | |
| | Nine Months Ended | | | | | | |
| | September 30, | | October 1, | | | | | % | |
| | 2017 | | 2016 | | Change | | Change | |
| | (in thousands, except percentages) |
Research and development | | $ | 4,142 | | $ | 4,940 | | $ | (798) | | (16) | % |
The decrease in research and development expenses for the three months ended September 30, 2017 as compared to the three months ended October 1, 2016 resulted primarily from decreases of (i) $0.2 million in headcount, overhead and travel expenses and (ii) $0.1 million in product research expenses.
The decrease in research and development expenses in the nine months ended September 30, 2017 as compared to the nine months ended October 1, 2016 resulted primarily from decreases of (i) $0.5 million in headcount, overhead and travel expenses (ii) $0.2 million in product research expenses and (iii) $0.1 million in professional and outside service fees.
Intellectual Property Legal Fees
The following tables present intellectual property legal fees for the three and nine months ended September 30, 2017 and October 1, 2016:
| | | | | | | | | | | | |
| | Three Months Ended | | | | | | |
| | September 30, | | October 1, | | | | | % | |
| | 2017 | | 2016 | | Change | | Change | |
| | (in thousands, except percentages) |
Intellectual property legal fees | | $ | 749 | | $ | 409 | | $ | 340 | | 83 | % |
| | | | | | | | | | | | |
| | Nine Months Ended | | | | | | |
| | September 30, | | October 1, | | | | | % | |
| | 2017 | | 2016 | | Change | | Change | |
| | (in thousands, except percentages) |
Intellectual property legal fees | | $ | 2,129 | | $ | 2,255 | | $ | (126) | | (6) | % |
The increase in intellectual property legal fees for the three months ended September 30, 2017 as compared to the three months ended October 1, 2016 resulted primarily from an increase inhigher legal expenses incurred to defendprotect and enforce our patent portfolio internationally. The decrease in intellectual property legal fees for the nine months ended September 30, 2017 as compared to the nine months ended October 1, 2016 resulted primarily from a decrease in legal fees incurred for certain trade secret litigation and our establishment of the TRGP Agreement to finance the legal fees and costs incurred in the 2017 period in connection with certain of our legal proceedings against SK hynix.portfolio.
Selling, General and Administrative
The following tables present selling,Selling, general and administrative expenses forincreased during the three and nine months ended September 30, 2017 and October 1, 2016:
| | | | | | | | | | | | |
| | Three Months Ended | | | | | | |
| | September 30, | | October 1, | | | | | % | |
| | 2017 | | 2016 | | Change | | Change | |
| | (in thousands, except percentages) |
Selling, general and administrative | | $ | 1,780 | | $ | 2,398 | | $ | (618) | | (26) | % |
| | | | | | | | | | | | |
| | Nine Months Ended | | | | | | |
| | September 30, | | October 1, | | | | | % | |
| | 2017 | | 2016 | | | Change | | Change | |
| | (in thousands, except percentages) |
Selling, general and administrative | | $ | 5,645 | | $ | 6,822 | | $ | (1,177) | | (17) | % |
The decrease in selling, general and administrative expenses for the three months ended September 30, 2017 as2024 compared to the three months ended October 1, 2016 resultedsame period of 2023 due primarily from decreases of (i) $0.4 millionto an increase in salesemployee headcount and marketing headcount costs and related overhead and travel expenses and (ii) $0.3 million in fees for outside services, partially offset by a $0.1 million increase in bank fees related to the SVB Credit Agreement.services.
The decrease in selling, general and administrative expenses for the nine months ended September 30, 2017 as compared to the nine months ended October 1, 2016 resulted primarily from decreases of (i) $1.0 million in sales and marketing headcount costs and related overhead and travel expenses, (ii) $0.1 million in advertising and product evaluation costs, and (iii) $0.1 million in fees for outside services, partially offset by a $0.1 million increase in bank fees related to the SVB Credit Agreement.Other Income, Net
Other Expense, Net
The following tables present other expense, net for the three and nine months ended September 30, 2017 and October 1, 2016:
| | | | | | | | | | | | |
| | Three Months Ended | | | | | | |
| | September 30, | | October 1, | | | | | % | |
| | 2017 | | 2016 | | Change | | Change | |
| | (in thousands, except percentages) |
Interest expense, net | | $ | (135) | | $ | (159) | | $ | 24 | | 15 | % |
Other income, net | | | - | | | 19 | | | (19) | | 100 | % |
Total other expense, net | | $ | (135) | | $ | (140) | | $ | 5 | | 4 | % |
| | | | | | | | | | | | |
| | | Nine Months Ended | | | | | | |
| | September 30, | | October 1, | | | | | % | |
| | 2017 | | 2016 | | Change | | Change | |
| | (in thousands, except percentages) |
Interest expense, net | | $ | (421) | | $ | (428) | | $ | 7 | | 2 | % |
Other income, net | | | 2 | | | 17 | | | (15) | | 88 | % |
Total other expense, net | | $ | (419) | | $ | (411) | | $ | (8) | | (2) | % |
Interest expense, net, for the three and nine months ended September 30, 2017 and 2016 consisted primarily of interest payments under the SVIC Note and the SVB Credit Agreement, and the decrease between periods resulted primarily from lower amortization expense on the SVIC note and a reduction of interest expense on the SVB Credit Agreement, due to lower unused credit line fees.
Other income, net for the three and nine months ended SeptemberMarch 30, 20172024 and OctoberApril 1, 2016 consisted primarily2023 was as follows (dollars in thousands):
| | | | | | | | |
| | Three Months Ended | | |
| | March 30, | | April 1, | | % |
| | 2024 | | 2023 | | Change |
Interest income, net | | $ | 377 | | $ | 56 | | |
Other income (expense), net | | | 38 | | | (3) | | |
Total other income, net | | $ | 415 | | $ | 53 | | 683% |
Interest income, net increased during the first quarter of the settlement of an insurance claim in 2016 related to our facility in the PRC.
Provision for Income Taxes
Our provision for income taxes was immaterial in all periods presented
The federal statutory rate was 34% for the three and nine months ended September 30, 2017 and October 1, 2016. In all periods presented, we continued to provide a full valuation allowance against our net deferred tax assets, which consist primarily of net operating loss carryforwards. In these periods, our effective tax rate differed from the statutory rate primarily due2024 compared to the valuation allowancesame period of 2023, primarily as a result of higher interest rate earned on newly generated loss carryforwards.higher cash balances. Other income, net included sublease income for our warehouse space located in Irvine, California during the first quarter of 2024.
Liquidity and Capital Resources
Liquidity generally refers to the ability to generate adequate amounts of cash to meet our cash needs. We require cash to fund our operating expenses and working capital requirements, to make required payments of principal and interest under our outstanding debt instruments and, to a lesser extent, to fund capital expenditures.
Working Capital
The following table presents working capital and cash and cash equivalents as of September 30, 2017 and December 31, 2016:
| | | | | | |
| | September 30, | | December 31, |
| | 2017 | | 2016 |
| | (in thousands) |
Current assets(1) | | $ | 20,152 | | $ | 19,253 |
Current liabilities | | | 11,315 | | | 6,210 |
Working capital(1) | | $ | 8,837 | | $ | 13,043 |
| (1)
| | Includes cash and cash equivalents of $8,583 and $9,476 as of September 30, 2017 and December 31, 2016, respectively.
|
Our working capital decreased by $4.2 million during the nine months ended September 30, 2017. Our current assetsincreased by $0.9 million primarily from a $1.2 million increase in inventory costs to support the increase in our net product revenues and a $1.3 million increase in accounts receivable primarily related to increased product revenues, partially offset by a $0.9 million decrease in cash and cash equivalents attributable to our use of cash to fund our operations and by the net proceeds received from the 2017 Offering and a $0.7 million decrease in restricted cash that collateralized a standby letter of credit with one vendor. Our current liabilities increased by $5.1 million primarily from a $3.7 million increase in accounts payable to purchase inventory and from legal expenses to defend our intellectual property and a $1.9 million increase in our borrowings under the SVB Credit Agreement to fund our operations, partially offset by a $0.4 million decrease in accrued payroll and related liabilities.
Cash Flows
The following table summarizes our cash flows for the nine months ended September 30, 2017 and October 1, 2016:
| | | | | | |
| | Nine Months Ended |
| | September 30, | | October 1, |
| | 2017 | | 2016 |
| | (in thousands) |
Net cash provided by (used in): | | | | | | |
Operating activities | | $ | (6,974) | | $ | (14,244) |
Investing activities | | | (78) | | | (317) |
Financing activities | | | 6,159 | | | 10,271 |
Net change in cash and cash equivalents | | $ | (893) | | $ | (4,290) |
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 amortization and amortization of debt discounts, 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 revenuesrevenues. In addition, we have received proceeds from our JDLAentry into a Strategic Product Supply and License Agreement with Samsung.SK hynix, Inc., a South Korean memory semiconductor supplier (“SK hynix”), on April 5, 2021 (the “Strategic Agreement”), which we use to support our operations. We have also funded our operations with a revolving line of credit and term loans under a bank credit facility with SVB.
August 17, 2023. The net proceeds to us from the 20162023 Offering were $10.3$28.6 million, after deducting underwriting discounts and commissionsplacement agent fees and offering expensescosts paid by us.
SVB CreditSeptember 2021 Lincoln Park Purchase Agreement
On October 31, 2009,September 28, 2021, we entered into the SVB CreditSeptember 2021 Purchase Agreement with Lincoln Park, pursuant to which provides that we may borrowhave the right to sell to Lincoln Park up to the lesseran aggregate of (i) 80% of eligible accounts receivable, or (ii) $5.0$75.0 million subject to certain adjustments as set forth in the SVB Credit Agreement. The SVB Credit Agreement expires April 1, 2018.
We made net borrowings of $1.9 million under the SVB Credit Agreement in the nine months ended September 30, 2017, and we made no borrowings under the SVB Credit Agreement in the nine months ended October 1, 2016. As of September 30, 2017, we had outstanding borrowings under the SVB Credit Agreement of $2.6 million. As of September 30, 2017 and December 31, 2016, we had borrowing availability under the SVB Credit Agreement of $0.1 million and $0.8 million, respectively.
SVIC Note and SVIC Warrant
On November 18, 2015, we issued to SVIC the SVIC Note and the SVIC Warrant. The SVIC Note has an original principal amount of $15.0 million, accrues interest at a rate of 2.0% per year, is due and payable in full on December 31, 2021, and is convertible into shares of our common stock at a conversion priceover the 36-month term of $1.25 per share,the September 2021 Purchase Agreement subject to certain adjustments, on 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 exercisableconditions and limitations set forth in the event we exercise our right to redeemSeptember 2021 Purchase Agreement. As of March 30, 2024, $34.1 million remains available under 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.September 2021 Purchase Agreement with Lincoln Park.
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 the cash provided byreceived under the Strategic Agreement with SK hynix, proceeds from issuances of debt and equity securities, including our operations andequity line with Lincoln Park, cash receipts from revenues, borrowing availability under the 2023 SVB Credit Agreement, the equity financing available under the September 2021 Purchase Agreement, funds raised through future equity offerings and taking into account cash expected to be used in our operations, 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 Annual Report and in the MD&A in our Annual Report. There have been no significant changes to our critical accounting policies since our Annual Report.
and decisions about significant issues, such as claim construction, patent validity, infringement, jurisdiction and other matters, almost 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,which are subject to an appeal process that are typically lengthy and unpredictable. Moreover, the ruling or decision in one proceeding is not necessarily indicative of rulings or more outstanding liens held by one or moredecisions that may be issued in another proceeding, even if the factual and legal matters are similar. We expect that various courts and agencies will issue significant rulings in several of these parties. The SVIC and SVB debt instrumentsour proceedings within the next year, 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 wouldthose rulings may cause substantial harmvolatility in our stock price. Regardless of the outcome of our actions to enforce our businessintellectual property rights, we expect to continue to invest financial and prospects.management resources in pursuing the actions and related appeals, which may require that we obtain additional capital.
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 costlyother 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” or the “Board”) 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,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 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 USPTOU.S. Patent and Trademark Office (“USPTO”) or similar bodies. Moreover,Further, 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.
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 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. Any failure to comply with the USPTO’s or JEDEC’s administrative procedures could jeopardize our ability to pursue patent infringement claims.
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 uponon 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 uponon 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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receive little or no returns for our time and capital investments in the litigation; |
| ● | | 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 -partythird-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. |
Moreover, any litigation, regardless of its outcome, would involveinvolves a significant dedication of resources, including time and costs, would divertcapital, and diverts management’s time and attention and could negatively impactfrom our results of operations.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 orand results of operations.
We are Additionally, the outcome of pending or future litigation and expectrelated patent reviews and reexaminations, as well as any delay in their resolution, could affect our ability to continue to be involved in legal proceedings at the ITC and related enforcement actions to stop allegedly infringing SK hynix RDIMM and LRDIMMsell our 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 subsidiariescompetition in the U.S. International Trade Commission (“ITC”)current 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 exchangemarkets 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 royaltylicense 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.rights in the future.
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 revenuesnet product sales in recent periods have been generated from resales of component products, including products sourced from Samsung,SK hynix, and any decline in ourthese product resales of these products could significantly harm our performance.
The vast majority of our revenuesnet product sales in recent periods have been generated from resales of componentcomputer memory and storage components and products, including primarilybut not limited to SSDs, 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 of these component products accounted for approximately 21% and 86% of our net product revenues, respectively.DIMMs. 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 theseany computer memory or storage 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 with 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 SK hynix’s manufacturing operations or facilities that cause disruptions or delays, 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 SK hynix, we may not be able to make these arrangements on financial and other terms comparable to those we have negotiated with SK hynix. As a result, any inability to obtain sufficient component products from 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 costtotal product sales have a significant negative impact on our gross margin and gross margin percentage. This gross margin and gross margin percentage differential between memory product sales and component product resales would be amplified if our costs to
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 dominate the markets for the products we sell.
Our targetSemiconductor memory and storage markets are characterized by a limited number of large companies. Consolidation in one or more of our target markets may further increase this industry concentration. As a result, we anticipate that sales of our products and the component products we resell will continue to be concentrated among a small number of large customers in the foreseeable future. We believe that our financial results will depend in significant part on our success in establishing and maintaining relationships with and effecting substantial sales to these potential 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 revenues 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,highly competitive which could reduce our revenuesmaterially 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.business, results of operations, or financial condition.
We relyThe semiconductor memory and storage markets are generally highly competitive and companies may use aggressive pricing to obtain market share. Our suppliers may seek to increase wafer output, improve yields, and reduce die size, which could result in significant increases in worldwide supply and downward pressure on prices. Increases in worldwide supply of semiconductor memory and storage also result from fabrication capacity expansions, either by way of new facilities, increased capacity utilization, or reallocation of other semiconductor production to semiconductor memory and storage production. Increases in worldwide supply of semiconductor memory and storage could lead to declines in average selling prices and a combination of patent protection, trade secret lawsdecrease in short-term and/or long-term demand resulting in industry oversupply 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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| | prevent challenges to or the invalidation or circumvention of our intellectual property rights;
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| | 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;
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| | prevent disputes with third parties regarding ownership of our intellectual property rights;
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| | prevent disclosure of our trade secrets and know‑how to third parties or into the public domain;
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| | result in valid patents, including international patents, from any of our pending or future applications; or
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| | otherwise adequately protect our intellectual property rights.
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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 harmmaterially adversely affect our business, operating results and prospects.of operations, or financial condition.
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 changesChanges in domestic and global economic and political conditions have mademake 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.United States 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. resell.
In addition, sales of our products and the products we resell to customers directly are dependent uponon demand by OEMscustomers in the server, high-performance computing and communications markets, as well as by storage customers, appliance customers, system builders and cloud and datacenter customers.our target markets. These markets are characterized by wide fluctuations in product supply and demand. Additionally,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 been cyclical and havein 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 sellingsale 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,demand and sales, our gross margins, operating incomemargin and cash flows would be negatively impacted. Further, such a
To date, allthe majority of our net product revenuessales have been denominated in U.S. dollars. In the future, however, some of our net product revenuessales may be denominated in Chinese Renminbi (“RMB”).RMB. The Chinese government controls the procedures by which RMB is converted into other currencies, which generally requires government consent. As a result, RMB may not be freely convertible into other currencies at all times. If the Chinese government institutes changes in currency conversion procedures or imposes additional restrictions on currency conversion, our operations and our operating results could be negatively impacted. In addition, Chinese law imposes restrictions on the movement of funds outside of the PRC. If we need or decide to repatriate funds from our Chinese operations, we would be required to comply with the procedures and regulations of applicable Chinese law. Anylaw, and any failure to so comply with these procedures and regulations could adversely affect our liquidity and financial condition. Further, if we are able to repatriate funds from our Chinese operations, these funds would be subject to U.S. corporate income tax.taxes. In addition, fluctuations in the exchange rate between RMB and U.S. dollars may adversely affect our expenses, and results of operations, the value of our assets and liabilities and the comparability of our period-to-period results.
Our international operations and sales are subject to a number of additional risks, including, among others, timing and availability of export licenses; difficulties in accounts receivable collections; difficulties managing distributors; lack of a significant local sales presence in a number of markets; difficulties obtaining government approvals; compliance with anti-bribery, data protection and other applicable U.S. and foreign laws, including the U.S. 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 margin 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
imposes additional sales practice requirements on broker-dealers that sell low-priced securities to persons other than established customers and institutional accredited investors. For transactions covered by this rule, a broker-dealer must make a special suitability determination for the purchaser and have received the purchaser’s written consent to the transaction prior to sale. Consequently, the rule may affect the ability of broker-dealers to sell our common stock and affect the ability of holders to sell their shares of our common stock in the secondary market. To the extent our common stock is subject to the penny stock regulations, the market liquidity for the shares will be adversely affected.
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.
We have historically funded our operations in large part with proceeds from equity and convertible debt financings, and we expect to continue to do so in the future. In addition to capital-raising purposes, we may also issue securities from time to time at prices and on other terms as we determine for acquiring other businesses or assets in exchange for shares of our common stock or other securities, issuing securities to collaborators in connection with strategic partnerships, attracting and retaining employees with equity compensation, or other purposes. If we sell these shares at a price that a stockholder may deem acceptable.
Our resultscommon stock or other equity or convertible debt securities in the future, our then-existing stockholders could be materially diluted by such issuances and new investors could gain rights, preferences and privileges senior to the holders of operations fluctuate significantly and are difficult to predict, and any failure to meet investor or analyst expectationsour common stock, which could cause the price of our common stock to decline.
Our operating results have fluctuatedSales 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.
As of March 30, 2024, there were 255,588,584 shares of our common stock outstanding. In addition, 3,616,227 shares of our common stock are subject to outstanding stock options, 2,766,732 shares of our common stock are subject to outstanding unvested restricted stock units, and 11,111,112 shares of our common stock are subject to outstanding warrants. All outstanding shares of our common stock are eligible for sale in the past,public market under applicable federal securities laws, subject in certain cases to the requirements of Rule 144 under the Securities Act of 1933, as amended, and we expect they will continue to fluctuate from period-to-periodshares issued upon the exercise or conversion of outstanding stock options, warrants or convertible notes may also be eligible for sale in the future duepublic market, to a variety of factors, many of which are beyond our control. Factors relating to our business that may contribute to these fluctuations include, among others, the amount and timing of sales of products, the prices we charge for products, changes in product mix, customer mixextent permitted by Rule 144 or other similar factors, the rate and timing of our billing and collections cyclesapplicable securities laws and the timingprovisions of the applicable stock option, warrant and amount of our commitments and other payments, as well as the other risk factors described in this report. In addition, our resultsconvertible note agreements. If these shares are sold, or if it is perceived that they may be impacted by events that do not recur regularly,sold, in the same amounts or at all in other periods, including events that may result in our incurrence of cash or non-cash charges or gains in certain periods. These fluctuations in our operating results may render period-to-period comparisons less meaningful, and investors should not rely onpublic market, the results of any one period as an indicator of future performance. If our results of operations in any period fall below the expectations of securities analysts or investors, thetrading price of our common stock could decline substantially. fall.
As a result of the sole director, Chun K. Hong has significant fluctuations of our operating results in prior periods, period-to-period comparisons of our operating results may not be meaningful and investors in our common stock should not rely on these comparisons.
Our principal stockholders have significant voting power and may take actionscontrol over all corporate decisions that may not be in the best interest of our other stockholders.
As of November 6, 2017, 7.2% of our outstanding common stock was held by our directors and officers, including 6.9% held by Chun K. Hong, ourOur President, Chief Executive Officer and Chairmanthe sole member of our board of directors. As a result, Mr.directors, Chun K. Hong, has the ability to exert substantial influencecontrol over all matters requiring approval by our stockholders and our board of directors, including the election and removal of directors, any proposed merger, consolidation or sale of all or substantially all of our assets and other significant corporate transactions. This concentration of control could be disadvantageous to other stockholders with interests different from those of Mr. Hong.
Anti-takeover provisions under our charter documents and Delaware law, as well as our recently adopted rights agreement, could delay or prevent a change of control and could also limit the market price of our common stock.
Our certificate of incorporation and bylaws contain provisions that could delay or prevent a change of control of our Company or changes in our board of directors that our stockholders might consider favorable. In addition, these anti-takeover provisions could limit the price that investors would be willing to pay for shares of our common stock. The following are examples of the anti-takeover provision that are included in our certificate of incorporation and bylaws as currently in effect:favorable, including:
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| | our board of directors is authorized, without prior stockholder approval, to designate and issue preferred stock, commonly referred to as “blank check” preferred stock, which may have rights senior to those of our common stock; |
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| | stockholder action by written consent is prohibited; |
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| | nominations for election to our board of directors and the submission of matters to be acted upon by stockholders at a meeting are subject to advance notice requirements; and |
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| | our board of directors is expressly authorized to make, alter or repeal our bylaws. |
In addition, we are governed by the provisions of Section 203 of the Delaware General Corporation Law, which may prohibit certain business combinations with stockholders owning 15% or more of our outstanding voting stock. Further, in April 2017, we adopted a rights agreement that would, under certain specified circumstances and for so long as the rights issued under the rights agreement are outstanding, give the holders of our common stock the right to acquire additional shares of our capital stock, which would make it more difficult for a third party to acquire a significant percentage of our outstanding capital stock or attempt a hostile takeover of our Company.
These and other provisions in our certificate of incorporation and bylaws and of Delaware law, as well as the existence of our rights agreement, could make it more difficult for stockholders or potential acquirers to obtain control of our board of directors or initiate actions that are opposed by our board of directors, including a merger, tender offer, proxy contest or other change of control transaction involving our Company. Any delay or prevention of a change of control transaction or changes in our board of directors could prevent the consummation of a transaction in which our stockholders could receive a substantial premium over the then-current market price for our common stock. In addition, these anti-takeover provisions could reduce the price that investors are willing to pay for shares of our common stock.
We do not currently intend to pay dividends on our common stock, and any return to investors is expected to come,result, if at all, only from potential increases in the price of our common stock.
We intend to use all available funds to finance our operations. Accordingly, while all decisions about dividends are at the discretion of our board of directors, we have never declared or paid cash dividends on our capital stock in the past, and we have no intention of declaring or paying any such dividends in the foreseeable future. As a result, any return to investors is expected to result, if at all, only from potential increases in the price of our common stock.
We intend to use all available funds to finance our operations. Accordingly, while payment
