DNA X, Inc.: Form 10-Q for the period ended Sep 30, 2023

Forward-Looking Statements

You should read the following discussion and analysis of our financial condition and results of operations together with “Cautionary Note About Forward-Looking Statements” and our consolidated financial statements and related notes included under Item 1 of this Quarterly Report as well as our most recent Annual Report on Form 10-K for the year ended December 31, 2022 as amended, including Part 1, Item 1A “Risk Factors.”

Company Overview

Sonim Technologies is a leading U.S.-based provider of ultra-rugged mobile devices and accessories designed specifically for task workers physically engaged in their work environments, often in mission-critical roles. As part of our expansion efforts, the Company will be introducing our Connected Solutions division which will begin launching products in 2024 in the U.S., Canada and Asia/Pacific. Connected Solutions will primarily consist of mobile hotspots, fixed wireless and USB dongle devices. In addition to this, the Company will be launching a line of consumer durable products to address consumers who need more protection in their devices without sacrificing key design elements and maintaining an attractive price point. The Company sells tablets that connect to the internet to a customer who rebrands them for sale in the U.S.

Revenues are primarily generated from sales of our mobile phones and industrial-grade accessories, predominantly to wireless carriers in the United States and Canada. We currently have products available at all three U.S. Tier-one carriers – AT&T, T-Mobile and Verizon as well as the three primary carriers in Canada – Bell, Telus and Rogers. These carriers then resell our products, along with network services, to end customers focusing on two primary end markets: industrial enterprise and public sector. Tablets are sold to a customer who resells them to a carrier in the U.S.

Given our primary sales channels in the U.S. and Canada consist of large wireless carriers, our customer base is somewhat concentrated. For the quarter ended September 30, 2023, large wireless carriers contributed 39% of our revenues, with our top three carrier customers accounting for 36%. Our tablet customer represents 50% of our revenue. During this period, smartphones constituted 30% of our revenues, feature phones 18%, and tablets 50%. We anticipate that tablet sales will continue through 2024.

While we continue to design ultra rugged phones and accessories, we are broadening our product range to appeal to a more diverse audience. Our core value proposition, which has earned us a loyal following, remains the foundation of our expanded offerings, including rugged durable phones and wireless data devices. These new products will not only expand our portfolio of products but will allow the Company to diversify our customer base into new markets. New product launches for hotspots and consumer oriented phones will begin in 2024 and sales will continue over the next few years.

Our key value proposition in the market is to incorporate specific elements of our rugged roots into our new products with added durability without sacrificing attractive design and value pricing. We believe this is an underserved market opportunity in the consumer space. Our expertise in carrier mobility leads us to a natural extension into data devices, where we can leverage our technical expertise as well as our streamlined organization to bring better quality, better specs and low cost to the marketplace.

To ensure quality, cost-effectiveness, and reliability in our supply chain, we directly manage the procurement of certain final assembly materials for our products, including memory and LCDs. To optimize costs and operational efficiency, we’ve largely outsourced manufacturing functions, software development, and quality control to third parties. Our ongoing commitment at Sonim is to maintain the exceptional durability and reliability that our brand is known for, while developing differentiated products that attract and retain a broader customer base.

Recent Developments

Recent Product Awards

The first step in selling our products through cell phone carriers is to receive a product award from the carrier. The award documents the intent of the carrier to carry the proposed product and offer it to customers through their stores or online. The carrier and Sonim agree to a launch date that is generally nine months or longer from the date of the product award. After the product award, the Company and its partners complete the design that include the unique specifications from the carrier, test the device, obtain certification from the carrier to sell the device, and begin full scale manufacturing of the product based on purchase orders issued by the carrier.

In the third quarter of 2023, the Company received six separate product awards for the new hotspot device that connects users to the internet through the 4G or 5G phone network. These devices can replace a cable modem at a much lower monthly cost, is portable, and can be used anywhere that is covered by the 4G or 5G network. These product awards are from three tier-one carriers in the U.S., one tier-one carrier in Canada, and one tier-one carrier in Australia. The Company expects to launch the hotspots with different carriers beginning in the second quarter of 2024, through the fourth quarter of 2024. Incremental revenue and incremental net income are expected once these products are launched.

In the third quarter of 2023, the Company also received a product award for a new ultra-rugged smartphone from a tier-one U.S. carrier. This phone is sleeker than our current ultra-rugged smartphone and will be targeted to small businesses and consumers that are exposed to challenging environments and who want a more durable phone that looks and feels like other consumer phones and has the same great features as other Android phones. This product is expected to launch in the second half of 2024.

In the third quarter of 2023, the Company also received a product award for a value 5G smartphone from a tier-one U.S. carrier. This phone looks and feels like other consumer phones and has the same great Android features. The differentiator is that it is much more durable than other phones, and it does not require a separate protective case. This product is expected to launch in the middle of 2024.

Nasdaq Minimum Bid Price Delinquency and Reverse Stock Split

On September 14, 2023, we received a letter from the listing qualifications staff of The Nasdaq Stock Market, LLC (“Nasdaq”) notifying us that Sonim is not in compliance with the minimum bid price requirement set forth in Nasdaq Listing Rule 5550(a)(2) (the “Bid Price Rule”) for continued listing. The Bid Price Rule requires listed securities to maintain a minimum bid price of $1.00 per share, and Nasdaq Listing Rule 5810(c)(3)(A) (the “Compliance Period Rule”) provides that a failure to meet the minimum bid price requirement exists if the deficiency continues for a period of 30 consecutive business days. In accordance with the Compliance Period Rule, the Company has 180 calendar days, or through March 12, 2024, to regain compliance. In order to regain compliance with the minimum bid price requirement, the closing bid price of our common stock must be at least $1.00 per share for a minimum of ten consecutive business days during this 180-day period. We will continue to monitor the closing bid price of our common stock and seek to regain compliance with all applicable Nasdaq requirements within the allotted compliance periods. We are evaluating options for regaining compliance with the Minimum Bid Rule, including seeking stockholder approval at our 2024 annual meeting of stockholders to declare and effect a reverse stock split.

Results of Operations

The following tables present key components of our results of operations for the three and nine months ended September 30, 2023, compared to results for the same period in 2022:

Net Revenues

For the three months ended September 30, 2023, net revenues increased 34% to $27.6 million, from $20.5 million for the three months ended September 30, 2022. The increase in net revenues was primarily because XP10 sales in 2023 were $6.9 million higher than the XP8, the prior version of the smartphone. The XP8 sales were lower because end customers were waiting for the upgraded XP10 that was launched in November 2022.

For the nine months ended September 30, 2023, net revenues increased 75% to $80.2 million, from $45.7 million in 2022. The increase is due to an increase of $30.0 million in tablet sales in 2023 because the tablet was not launched until the third quarter of 2022. Also, sales of the XP10 smartphone in 2023 were $12.3 million higher than the prior model smartphone (XP8) in 2022 because of upgrade demand from existing customers. This was partially offset by decreases of $4.8 million from XP5 series phones as 2022 included upgrades to the newer XP5S. In addition, flip phone sales were $2.7 million lower because 2022 included upgrades following the launch of the XP3plus in September 2021.

Gross Profit

Gross profit for the three months ended September 30, 2023 increased 69% from 2022 due to higher revenue from the XP10 that has a high profit margin.

Gross profit for the nine months ended September 30, 2023 increased 85% to $14.2 million from $7.7 million in 2022. The higher gross profit is from higher revenue from tablets and because smartphone sales were higher, and smartphones have a higher profit margin as compared to tablets and feature phones.

Operating Expenses and Net Operating Income

Net operating income for the three months ended September 30, 2023 improved by $2.6 million compared to the three months ended September 30, 2022, driven by increased gross profit of $2.3 million due to higher smartphone sales in 2023, and a $0.3 million decrease in operating expenses.

Net operating income for the nine months ended September 30, 2023 improved by $15.0 million compared to the nine months ended September 30, 2022. Gross profit improved by $6.5 million due to higher profits from tablet sales, R&D expenses decreased by $5.9 million because we had no R&D projects for the first two quarters of 2023, and general & administrative expenses improved by $2.5 million primarily because 2022 had $1.5 million in severance expenses for terminated executives, and 2023 did not have salary costs for these terminated executives.

Operating expenses are summarized as follows:

(in thousands, except %)

(in thousands, except %)

Research and Development.

Research and development (“R&D”) expenses for the three months ended September 30, 2023 were $0.7 million as compared to a negative $0.1 million for the three months ended September 30, 2022, because 2022 included a prior period adjustment to capitalize contract fulfillment costs that related to the second quarter of 2022. The 2023 quarter included internal R&D for Sonim employees who worked on the new hotspots and phones that received product awards in July 2023.

R&D expenses for the nine months ended September 30, 2023 were $0.8 million as compared to $6.8 million in 2022. R&D in 2022 was for the XP10, our upgraded smartphone, and the XP5plus, an updated feature phone. The 2023 quarter included R&D on the new hotspots and the two new phones that are expected to launch in 2024.

Sales and Marketing.

Sales and marketing expenses for the three months ended September 30, 2023 were $2.0 million or 41% higher than the three months ended September 30, 2022, due to headcount that was added in 2023 to support sales in Europe, the Middle East, and Australia. We also hired a new VP of Marketing in 2023 and increased our spending on marketing to support new products that will be launched in 2024.

Sales and marketing expenses for the nine months ended September 30, 2023 were 1% lower than 2022. Higher headcounts in the first half of 2022 offset higher headcounts in the second half of 2023. We expect Sales and Marketing expenses to increase over the next year as we support the new consumer cell phones and promote the Sonim brand.

General and Administrative.

General and administrative expenses for the three months ended September 30, 2023 decreased by $1.8 million or 47% as compared to the three months ended September 30, 2022, because 2022 included $1.2 million of severance expense, and $0.4 million in higher stock-based compensation from the acceleration of stock options for terminated employees and departing board members.

General and administrative expenses for the nine months ended September 30, 2023 decreased $2.5 million or 30% as compared to 2022 because of $1.4 million in severance expense in 2022, and $0.8 million for lower insurance premiums in 2023.

Income Tax Expense

Income tax expense increased for both the three months and nine months ending September 30, 2023 because higher net income caused higher income tax expense. This income tax expense for the U.S. is accrued as we do not expect to pay cash for a few years due to Net Loss Carryforwards for our U.S. federal taxes.

Liquidity and Capital Resources

Historically, we have funded operations from a combination of public and private equity financings, convertible loans from existing investors and borrowings under loan agreements. As of September 30, 2023, we did not have any convertible loans or any other borrowing structures in place.

Currently, our principal source of liquidity consists of cash and cash equivalents totaling $9.8 million, as of September 30, 2023. During the nine months ended September 30, 2023, our net income was $1.3 million and our use of cash in operations was $3.7 million. Our cash balance is expected to cover any negative cash flow that may be caused by developing new products over the next year. Increased revenue from new products is expected to increase cash flow in 2024. We expect to meet all obligations with existing cash and operating cash flow for a period of at least one year from the date of release of the unaudited condensed consolidated financial statements included in this Quarterly Report on Form 10-Q.

We are investigating various options to raise capital through the issuance of debt. Our ability to obtain additional financing in the debt and equity capital markets is subject to several factors, including market and economic conditions, our performance and investor sentiment with respect to us and our industry.

The accompanying condensed consolidated financial statements have been prepared on a going concern basis which contemplates the realization of assets and satisfaction of liabilities in the normal course of business. Cash and cash equivalents as of September 30, 2023, was $9.8 million, or $3.4 million lower than net cash of $13.2 million on December 31, 2022. The decrease was driven by an increase in accounts receivable of $7.9 million due to longer delivery times to the end customer for tablets and the timing of payments from carrier customers. This was partially offset by higher accounts payable of $2.1 million and net income of $1.3 million.

The following table summarizes our sources and uses of cash for the periods presented:

(in thousands)

Cash flows from operating activities

For the nine months ended September 30, 2023, cash used in operating activities was $3.7 million, primarily attributable to a net increase in our net operating assets and liabilities of $7.5 million, which was partially offset by net non-cash charges of $2.4 million and net income of $1.3 million. The change in net operating assets and liabilities was primarily due to an increase in accounts receivable of $7.9 million (due to our tablet customer and a large carrier customer), and an increase in contract fulfillment assets of $2.0 million (capitalized costs for phone certifications). These were partially offset by an increase in accounts payable of $2.1 million. Non-cash charges primarily consist of $1.2 million in depreciation and amortization, and $1.0 million for stock-based compensation.

For the nine months ended September 30, 2022, cash used in operating activities was $10.1 million. The negative cash flow was primarily due to a net loss of $13.0 million and an increase in accounts receivable of $5.5 million due to large billings at quarter end. These uses were partially offset by lower prepaids of $3.4 million, higher accounts payable of $3.0 million, and lower inventory of $1.5 million.

Cash flows from investing activities

For the nine months ended September 30, 2023 and 2022, there were no significant investing activities.

Cash flows from financing activities

For the nine months ended September 30, 2023, cash provided by financing activities was $0.3 million due to $0.4 million in proceeds from the exercise of employee stock options.

For the nine months ended September 30, 2022, cash provided by financing activities was $14.4 million due to amounts received from AJP of $17.5 million for their purchase of the Company’s stock, less $3.1 million in costs.

Material Cash Requirements

There have been no material changes to our material cash requirements from those disclosed in our Annual Report on Form 10-K for the year ended December 31, 2022.

Critical Accounting Estimates

See Note 1 for critical accounting policies and estimates

Critical Accounting Estimates

Our discussion and analysis of financial condition and results of operations is based upon our condensed consolidated financial statements, which have been prepared in conformity with accounting principles generally accepted in the United States of America. Certain accounting policies and estimates are particularly important to the understanding of our financial position and results of operations and require the application of significant judgment by our management or can be materially affected by changes from period to period in economic factors or conditions that are outside of our control. As a result, they are subject to an inherent degree of uncertainty. In applying these policies, our management uses their judgment to determine the appropriate assumptions to be used in the determination of certain estimates. Those estimates are based on our historical operations, our future business plans and projected financial results, the terms of existing contracts, our observance of trends in the industry, information provided by our customers and information available from other outside sources, as appropriate.

A description of our critical accounting policies that represent the more significant judgments and estimates used in the preparation of our consolidated financial statements was provided in the Management’s Discussion and Analysis of Financial Condition and Results of Operations section of our Annual Report on Form 10-K for the year ended December 31, 2022. There have been no changes to our critical accounting policies and estimates described in the Annual Report on Form 10-K for the year ended December 31, 2022, that have had a material impact on our condensed consolidated financial statements and related notes,

Recently Issued Accounting Pronouncements

See Note 1 to our condensed consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q for recently issued accounting pronouncements.

Segment Information

We have one business activity and operate in one reportable segment.

JOBS Act

We are an emerging growth company, as defined in the Jumpstart Our Business Startups Act of 2012 (the “JOBS Act”). Under the JOBS Act, emerging growth companies can delay adopting new or revised accounting standards issued subsequent to the enactment of the JOBS Act until such time as those standards apply to private companies. We elected to use this extended transition period for complying with new or revised accounting standards that have different effective dates for public and private companies until the earlier of the date that we (i) are no longer an emerging growth company or (ii) affirmatively and irrevocably opt out of the extended transition period provided in the JOBS Act. We expect to use the extended transition period for any other new or revised accounting standards during the period in which we remain an emerging growth company. As a result, our condensed consolidated financial statements may not be comparable to companies that comply with new or revised accounting pronouncements as of public company effective dates.

We will remain an emerging growth company until the earliest of (i) December 31, 2024 (the last day of the fiscal year following May 14, 2024, the fifth anniversary of the consummation of our initial public offering), (ii) the last day of the fiscal year in which we have total annual gross revenue of at least $1.235 billion, (iii) the last day of the fiscal year in which we are deemed to be a “large accelerated filer” as defined in Rule 12b-2 under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), which would occur if the market value of our common stock held by non-affiliates exceeded $700 million as of the last business day of the second fiscal quarter of such year, or (iv) the date on which we have issued more than $1.0 billion in non-convertible debt securities during the prior three-year period. Even after we no longer qualify as an emerging growth company, we may still qualify as a smaller reporting company, which would allow us to take advantage of many of the same exemptions from disclosure requirements, including not being required to comply with the auditor attestation requirements of Section 404 of the Sarbanes-Oxley Act of 2002, as amended, and reduced disclosure obligations regarding executive compensation in our prospectuses and in our periodic reports and proxy statements.

We are a smaller reporting company as defined by Rule 12b-2 of the Exchange Act and are not required to provide the information under this item.

Evaluation of Disclosure Controls and Procedures

Our management, with the participation of our principal executive and principal financial officer, has evaluated the effectiveness of our disclosure controls and procedures as defined in Rules 13a-15(e) and 15d-15(e) promulgated under the Exchange Act, prior to filing this Quarterly Report on Form 10-Q. Based on this evaluation, our principal executive and principal financial officer concluded that, as of the end of the period covered by this Quarterly Report on Form 10-Q, our disclosure controls and procedures were not effective because of the material weaknesses in internal control over financial reporting.

Material Weaknesses in Internal Control and Plan for Remediation

As previously described in Part II, Item 9A of our Annual Report on Form 10-K for the fiscal year ended December 31, 2022, we identified a material weakness in our internal controls over financial reporting related to the design and implementation of our IT general controls including a failure to document reviews of changes to user roles in our financial reporting systems and subsystems. Management has taken and continues to take significant and comprehensive actions to remediate the material weakness. Although we have made progress with the remediation of these issues, these remediation actions are ongoing.

As part of our remediation efforts, we improved our IT general controls by removing most elevated (administrator) access to financial reporting systems and by providing additional controls over administrator system access. During the three months ended September 30, 2023, we improved our IT general controls by implementing new auditable evidence of ongoing reviews of changes in user roles.

The material weakness will not be considered remediated until the applicable controls operate for a sufficient period of time and management has concluded, through testing, that these controls are operating effectively. We expect this material weakness to be fully remediated by the end of 2023.

Limitations on Effectiveness of Controls and Procedures

In designing and evaluating disclosure controls and procedures, our management recognizes that any system of controls, however well designed and operated, can provide only reasonable assurance, and not absolute assurance, that the desired control objectives of the system are met. In addition, the design of any control system is based in part upon certain assumptions about the likelihood of future events. Because of these and other inherent limitations of control systems, there can be no assurance that any design will succeed in achieving its stated goals in all future circumstances. Accordingly, our disclosure controls and procedures are designed to provide reasonable, not absolute, assurance that the objectives of our disclosure control system are met.

Changes in Internal Control Over Financial Reporting

Except for the changes related to the Company’s remediation efforts described above, there was no change in our internal control over financial reporting that occurred during the three months ended September 30, 2023 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

There are no material changes to the risk factors set forth in Part I, Item 1A, Risk Factors in our Annual Report on Form 10-K for the year ended December 31, 2022, except as set forth below.

1. The following additional risk factor shall be added supplementally:

Our entry into the data device sector could divert our management team’s attention from existing products, cause delays in launching our new products, or otherwise have a significant adverse impact on our business, operating results, and financial condition.

In August of 2023, as part of our expansion efforts, we announced an expansion of our product portfolio and introduced a new Connected Solutions division which is set to begin launching products in 2024 in the U.S., Canada, Europe, and Asia/Pacific. Connected Solutions will primarily consist of mobile hotspots, fixed wireless, and USB dongle devices. The success of this new division depends in large part on our team’s ability to correctly identify and address the market opportunity, to execute our plans to develop, manufacture, market, and sell our new family of data devices.

We will need to find efficient manufacturing capabilities of our ODM partners and processes and develop the supply chains necessary to support our expansion into the data device sector. Our production plan for this product expansion is based on many key assumptions, including that:

• we correctly estimated customer demand for our new product portfolio;
• we will be able to timely engage manufacturers for the manufacturing of these products on terms and conditions that are acceptable to us;
• manufacturers will be able to obtain needed components on a timely basis and in the necessary quantities;
• we will be able to complete the final product design for delivery to our manufacturers in a timely manner; and
• manufacturers will be able to produce these devices in a timely manner.

Our entry into these next-generation devices, and in the overall data device sector other than smartphones, may divert our management team’s attention from existing product development and may cause our inability to achieve the planned product portfolio expansion which could negatively impact our business, financial condition, and results of operations.

We have failed, and may continue to fail, to meet the listing standards of Nasdaq, and as a result, our common stock may become delisted, which could have a material adverse effect on the trading, liquidity, and market price of our common stock.

We must satisfy Nasdaq’s continued listing requirements, including, among other things, a minimum closing bid price of $1.00 per share and timely filing of all periodic financial reports, or risk delisting, which would have a material adverse effect on our business.

On September 14, 2023, we received a letter from Nasdaq notifying us that, because the bid price for our common stock has fallen below $1.00 per share for 30 consecutive business days, we no longer comply with the $1.00 minimum bid price requirement set forth in Nasdaq Listing Rule set forth in Nasdaq Listing Rule 5550(a)(2) (the “Bid Price Rule”) for continued listing. In accordance with Nasdaq Listing Rule 5810(c)(3)(A), we were provided a period of 180 calendar days, or through March 12, 2024, to regain compliance with the Bid Price Rule. To regain compliance, the closing bid price of the Company’s common stock must be at least $1.00 per share for a minimum of ten (10) consecutive business days as required under Nasdaq Listing Rule 5810(c)(3)(A) (unless the Nasdaq staff exercises its discretion to extend this 10-day period pursuant to Nasdaq Listing Rule 5810(c)(3)(H)) during the 180-day period).

If Sonim does not regain compliance during this 180-day period, then the Nasdaq staff may grant a second 180 calendar day period to regain compliance, provided Sonim meets the continued listing requirement for market value of publicly held shares and all other initial listing standards for The Nasdaq Capital Market, with the exception of the bid price requirement. In addition, we would be required to notify Nasdaq of our intent to cure the minimum bid price deficiency during the second compliance period, which may include, if necessary, implementing a reverse stock split. To qualify, the Company would be required, among other things, to meet the continued listing requirement for market value of publicly held shares as well as all other standards for initial listing on The Nasdaq Capital Market, with the exception of the bid price requirement, and would need to provide written notice of its intention to cure the bid price deficiency during the second compliance period. However, if it appears to Nasdaq staff that we will not be able to cure the deficiency, or if we are otherwise not eligible for the additional compliance period, and we do not regain compliance by the Compliance Date, the Nasdaq Capital Market will provide written notification to us that our common stock is subject to delisting. At that time, we may appeal the delisting determination to a hearings panel pursuant to the procedures set forth in the applicable Nasdaq Listing Rules. However, there can be no assurance that, if Sonim does appeal the delisting determination by Nasdaq to the panel, such appeal would be successful.

This is not the first instance of Sonim’s non-compliance with the Bid Price Rule. We intend to actively monitor the closing bid price of our common stock and, as appropriate, will consider available options to resolve the deficiency and regain compliance with the Bid Price Rule, including potentially seeking to effect a reverse share split, if necessary. There can be no assurance that we will be able to regain compliance with respect to the current deficiency including by effecting a reverse share split, or that we will be able to maintain compliance with the Nasdaq Capital Market continued listing requirements in the future or regain compliance with respect to any future deficiencies. In the event we are delisted from Nasdaq, the only established trading market for our common stock would be eliminated, and we would be forced to list our shares on the OTC Markets or another quotation medium, depending on our ability to meet the specific listing requirements of those quotation systems. As a result, an investor would likely find it more difficult to trade or obtain accurate price quotations for our shares. Delisting would likely also reduce the visibility, liquidity, and value of our common stock, reduce institutional investor interest in our company, and may increase the volatility of our common stock. Delisting could also cause a loss of confidence of potential industry partners, lenders, and employees, which could further harm our business and our future prospects.

The financial and operational projections that we may provide from time to time are subject to inherent risks.

The projections and timelines that our management may provide from time to time (including with respect to financial or operational matters and the expansion of our product portfolio and business lines) reflect numerous assumptions made by our management with respect to our specific, as well as general business, economic, market and financial conditions, including our ability to correctly assess the demand to such products from different consumers and other matters, all of which may be difficult to predict and many of which are beyond our control.

Accordingly, there is a risk that the assumptions made in preparing the projections, or the projections themselves, will prove inaccurate or that our organic growth and expansion may be curtailed. You should be prepared for differences between actual and projected results from time to time. Our future actual results may be materially different from those contained in our projections, both as to amounts and as to timing. The inclusion of projections or timelines in this Quarterly Report on Form 10-Q or any other filing we make with the SEC or otherwise communicated to investors by us should not be regarded as an indication that we or our management or representatives considered or consider such projections and timelines to be a reliable prediction of future events, and the projections and timelines should not be relied upon as such.