DNA X, Inc.: Form 10-Q for the period ended Mar 31, 2024

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 condensed 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, 2023 as amended, including Part 1, Item 1A “Risk Factors.”

Company Overview

Sonim Technologies is a leading U.S.-based provider of rugged mobile devices and accessories designed for workers physically engaged in their work environments, often in mission-critical roles. As part of our expansion efforts, the Company has introduced 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 devices that connect to the internet including mobile hotspots, fixed wireless devices and USB dongle devices. In addition to this, the Company has expanded its rugged phone portfolio by developing a next-generation rugged smartphone that is designed for enterprise, government, and small to medium businesses and expected to be sold through tier-one carriers in North America, beginning in the second half of 2024. The Company is also launching a consumer durable product in late 2024 to address consumers who need more durability in their devices without sacrificing key design elements and maintaining an attractive price point.

The Company is executing its strategy of selling new products into much larger adjacent markets including the connect solutions market, the semi-rugged phone market, and the consumer durable phone market. During the first half of 2024, the Company is in a transition period, phasing out low margin white label products and commencing selling new products through our carrier channels. These products include new hotspots in the connected solutions market, a semi-rugged smartphone that expands our customer base to small and medium sized businesses, and a new consumer durable smartphone for the low to medium priced tier of the consumer smartphone market. Revenue in the first quarter of 2024 decreased compared to the first quarter of 2023 due to this transition. However, with the launch of these new products in the second half of 2024, we anticipate significant revenue growth and improved profitability.

During the three months ended March 31, 2024, net revenues were 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. During the three months ended March 31, 2023, white label tablets were sold to a customer who resold them to a carrier in the U.S. During the three months ended March 31, 2024, white label smartphones were sold to a customer in Asia. The white label products, operating under the ODM model where Sonim designs for specific customers and outsources manufacturing, are not our core business. These ODM products typically yield lower margins and have shorter lifespans compared to Sonim’s other offerings.

With the primary sales channels in the U.S. and Canada consisting of large wireless carriers, the Company’s customer base is highly concentrated. For the three months ended March 31, 2024, large wireless carriers contributed 50% of our net revenues, with our top three carrier customers accounting for 45% of our net revenues. Our white label phones represented 46% of our net revenues while rugged smartphones constituted 33% of our net revenues and feature phones 20% of our net revenues.

While we continue to design ultra rugged phones and accessories, we have broadened our product range to appeal to a more diverse audience. Our core value proposition of the delivery of reliable quality devices, 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 also allow the Company to diversify our customer base into new markets. New product launches for mobile hotspots, a new next-generation rugged phone for a broader customer base, and our consumer-oriented phone will begin in the second half of 2024 and sales are expected to grow over the next few years.

Our key value proposition in the broader business and consumer 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 small business, prosumer and consumer spaces. 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.

Recent Developments

Recent Product Awards

The first step in selling our products through wireless telecommunications 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 includes 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.

As of the filing date of this report, Sonim has received thirteen carrier awards for the new portfolio of products: five awards for two models of mobile hotspots and eight awards for three new phones—a next-generation rugged smartphone, a next-generation rugged feature phone, and a consumer durable smartphone. Each of these products is expected to launch with tier-one carriers in the U.S., Canada, and Australia beginning in the second half of 2024. Prior to 2023, the Company received only one to two awards on average per year, in contrast to the thirteen awards it secured with the new portfolio beginning last year.

April 2024 Equity Financing

On April 29, 2024, we entered into a subscription agreement (the “Subscription Agreement”) with a single investor in connection with a private placement of 3.5 million shares of our common stock and warrants to purchase up to 3.5 million shares of our common stock for an aggregate purchase price of $3.85 million. The private placement closed on the same date. We intend to use net proceeds from the private placement for working capital and general corporate purposes. The shares of our common stock sold under the Subscription Agreement (including those underlying the warrants) may not be transferred or sold until 180 days after the closing, or ‎‎October‎ ‎29‎, ‎2024, subject to customary limited exceptions.

Results of Operations

The following tables present key components of our results of operations (dollars in thousands):

Net Revenues

Net revenues for the three months ended March 31, 2024, decreased $9.0 million, or 35%, to $16.8 million, compared to $25.8 million for the three months ended March 31, 2023. The decrease in net revenues was primarily due to the end of life of our white label tablet product in the fourth quarter of 2023, partially offset by the introduction of our white label phone product, at the end of the fourth quarter of 2023. The first and second quarters of 2024 are expected to serve as transition periods, marked by a deceleration in our white label business and the anticipation of launching our hotspots, semi-rugged smartphone, and consumer durable smartphone.

Gross Profit and Margin

Gross profit for the three months ended March 31, 2024, decreased $1.3 million, or 30%, to $2.9 million, or 17% gross margin, compared to $4.2 million, or 16% gross margin, for the three months ended March 31, 2023. The decrease in gross profit is due to lower revenue from our white label products during the period. The increase in gross margin is due to a decrease in revenue from white label products, which have a lower profit margin.

Operating Expenses and Income (Loss) From Operations

Income (loss) from operations for the three months ended March 31, 2024, decreased $3.0 million to a loss from operations of $2.7 million compared to income from operations of $0.3 million for the three months ended March 31, 2023, driven by decreased gross profit of $1.3 million and a $1.7 million increase in operating expenses.

Operating expenses are summarized as follows (dollars in thousands):

Research and Development

Research and development (“R&D”) expenses for the three months ended March 31, 2024, increased $0.4 million to $0.5 million compared to $0.1 million for the three months ended March 31, 2023, primarily due to there being no R&D projects during the period ended March 31, 2023. In 2024 R&D expenses were related to our new hotspots, rugged phones, and consumer phone.

Sales and Marketing

Sales and marketing expenses for the three months ended March 31, 2024, increased $0.7 million to $2.5 million compared to $1.8 million for the three months ended March 31, 2023, due to headcount increases subsequent to March 31, 2023 to support sales in Europe, the Middle East, and Australia. We also hired a new VP of Marketing in the second quarter of 2023 and increased our spending on marketing to support new products that will be launched in 2024 and capture new business opportunities across Europe as a result of the ceased operations of a competitor.

General and Administrative

General and administrative expenses for the three months ended March 31, 2024, increased $0.7 million to $2.6 million compared to $2.0 million for the three months ended March 31, 2023, primarily due to an increase in personnel and consulting expenses, including stock-based compensation, as well an increase in public company filing activity that required additional legal costs and auditor fees.

Income Tax Expense

Income tax expense for the three months ended March 31, 2024, remained at $0.1 million compared to the three months ended March 31, 2023.

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 March 31, 2024, 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 $9.3 million, as of March 31, 2024. On April 29, 2024, we received $3.85 million in cash from an investor for the purchase of the Company’s shares. See Note 11 for additional information. During the three months ended March 31, 2024, our net loss was $2.9 million and our use of cash in operations was $0.2 million.

Our cash balance is expected to cover any negative cash flow that may be caused by developing new products over the next year and for our ongoing investment in personnel in Europe and our expected development of new products for Europe. Increased revenue from new products is expected to increase cash flow in the second half of 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.

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 March 31, 2024, were $9.3 million.

The following table summarizes our sources and uses of cash for the periods presented (in thousands):

Cash flows from operating activities

For the three months ended March 31, 2024, cash used in operating activities was $0.2 million, primarily attributable to a net loss of $2.9 million, partially offset by net cash provided by a change in our operating assets and liabilities of $1.5 million and net non-cash charges of $1.3 million. The change in net operating assets and liabilities was primarily due to a decrease in accounts receivable of $0.7 million and inventory of $1.7 million, partially offset by an increase in contract fulfillment assets of $1.2 million (capitalized costs for phone certifications). Non-cash charges primarily consist of $0.9 million in depreciation and amortization and $0.3 million for stock-based compensation.

For the three months ended March 31, 2023, cash used in operating activities was $4.2 million, primarily attributable to net cash used in a change in our operating assets and liabilities of $5.5 million, which was partially offset by net non-cash charges of $1.0 million. The change in our net operating assets and liabilities was primarily due to an increase in accounts receivable of $2.6 million, an increase in contract fulfillment assets of $0.7 million, and a decrease in accrued liabilities for contract fulfillment costs of $0.7 million. Additionally, accrued severance and accrued bonuses decreased by $1.4 million due to payments in the first quarter of 2023. Non-cash charges primarily consist of $0.6 million in depreciation and amortization and $0.3 million for stock-based compensation.

Cash flows from investing activities

For the three months ended March 31, 2024, and 2023, there were no significant investing activities.

Cash flows from financing activities

For the three months ended March 31, 2024, and 2023, there were no significant financing activities.

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, 2023.

Critical Accounting Policies and 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, 2023. 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, 2023, that have had a material impact on our condensed consolidated financial statements and related notes,

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 officer 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 effective.

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

There was no change in our internal control over financial reporting that occurred during the three months ended March 31, 2024 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, 2023, except as set forth below.

The risk factor titled “Sales of our common stock under the currently effective registration statement or the perception of such sales in the public market or otherwise could cause the market price for our common stock to decline, even if our business is doing well” is amended and restated as follows:

Sales of our common stock under resale registration statements or the perception of such sales in the public market or otherwise could cause the market price for our common stock to decline, even if our business is doing well.

Resales of our common stock may cause the market price of our securities to drop significantly. The sale of shares of our common stock in the public market or otherwise, including sales pursuant to both the effective Form S-3 Registration Statement and Prospectus, dated December 1, 2023, (the “AJP Registration Statement”) and the registration statement and prospectus we are obligated to file pursuant to the Subscription Agreement (the “Liu Registration Statement”) or the perception that such sales could occur, could reduce the prevailing market price of shares of our common stock and increase the volatility of our share price. These sales, or the possibility that these sales may occur, also might make it more difficult for us:

• to sell equity securities in the future at a time and at a price that we deem appropriate; and
• to comply with the Nasdaq listing standards with regard to the minimum bid price of our common stock.

The shares we intend to register for resale through Liu Registration Statement (assuming the exercise of the entirety of the warrants) represent approximately 14% of the outstanding shares of our common stock as of May 3, 2024, and approximately 25% of our public float as of such date. The shares of common stock offered for resale pursuant to the AJP Registration Statement represent approximately 45% of the outstanding shares of our common stock as of May 3, 2024, and approximately 85% of our public float as of such date. Until such time that this registration statement is no longer effective, the registration statement will permit the resale of these shares. As such, sales of a substantial number of shares of our common stock in the public market could occur at any time.

The risk factor titled “In prior years, we identified one material weakness in our internal control over financial reporting which, if not remediated, could have resulted in material misstatements in our financial statements” is amended and restated as follows:

We have previously reported material weaknesses in our internal control over financial reporting, which have been remediated; however, we may identify additional or new material weaknesses in the future that may cause us to fail to meet our reporting obligations, result in material misstatements in our financial statements or fail to prevent fraud.

Our management is responsible for establishing and maintaining internal control over financial reporting, disclosure controls, and compliance with the other requirements of the Sarbanes-Oxley Act and the rules promulgated by the SEC thereunder. A material weakness is a deficiency, or combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the financial statements will not be prevented or detected on a timely basis.

In prior years, we identified a material weakness in our internal control over financial reporting. While the material weaknesses related to internal controls over financial reporting previously disclosed by Sonim have since been remediated, the process of designing and implementing an effective financial reporting system is a continuous effort that requires our team to anticipate and react to changes in Sonim’s business, including its geographic expansion, to economic and regulatory environments and to expend significant resources to maintain a financial reporting system that satisfies its reporting obligations.

We cannot be certain that the measures we have taken, and expect to take, to improve our internal controls will be sufficient to ensure that our internal controls will remain effective and eliminate the possibility that other material weaknesses or deficiencies may develop or be identified in the future. If we identify future material weaknesses in our internal controls, even if quickly remediated once disclosed, investors may lose confidence in our financial statements and our stock price may decline. Implementing changes to our internal controls in connection with the remediation of any material weakness may distract our management and could require us to incur significant expenses. If we fail to remediate any material weakness, our financial statements may be inaccurate, we may be required to restate our financial statements, our ability to report our financial results in a timely and accurate basis may be adversely affected, our access to the capital markets may be restricted, our stock price may decline, and we may be subject to sanctions or investigation by regulatory authorities, which could materially and adversely affect our business and results of operations. In addition, even if we are successful in strengthening Sonim’s internal controls and procedures, in the future those internal controls and procedures may not be adequate to prevent or sufficiently identify irregularities or errors or to facilitate the fair presentation of our financial statements.