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Edited Transcript of NLST earnings conference call or presentation 8-Aug-19 9:00pm GMT

Q2 2019 Netlist Inc Earnings Call

Irvine Sep 16, 2019 (Thomson StreetEvents) -- Edited Transcript of Netlist Inc earnings conference call or presentation Thursday, August 8, 2019 at 9:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Chuck Hong

Netlist, Inc. - Co-Founder, President, CEO & Executive Chairman

* Gail M. Sasaki

Netlist, Inc. - VP, CFO & Secretary

* Mike Smargiassi

The Plunkett Group - IR

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Conference Call Participants

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* Joseph Newton Flynn

Craig-Hallum Capital Group LLC, Research Division - Research Analyst

* Sujeeva Desilva

ROTH Capital Partners, LLC, Research Division - Senior Research Analyst

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Presentation

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Operator [1]

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Hello, and welcome to the Netlist Second Quarter 2019 Earnings Conference Call. (Operator Instructions) Please note, this event is being recorded.

I would now like to turn the conference over to your host today, Mike Smargiassi. Please go ahead, sir.

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Mike Smargiassi, The Plunkett Group - IR [2]

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Thank you, Keith, and good afternoon, everyone. Welcome to NetList's Second Quarter 2019 Conference Call. Leading today's call will be Chuck Hong, Chief Executive Officer of Netlist; and Gail Sasaki, Chief Financial Officer.

As a reminder, the earnings release and a replay of today's call can be accessed on the Investors section of the Netlist website at netlist.com.

Before we start the call, I would note that today's presentation of Netlist results and the answers to questions may include forward-looking statements, which are based on current expectations. The actual results could differ materially from those projected in the forward-looking statements, because of the number of risks and uncertainties that are expressed in the call, annual and current SEC filings and the cautionary statements contained in the press release today. Netlist assumes no obligation to update forward-looking statements.

I would now like to turn the call over to Chuck.

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Chuck Hong, Netlist, Inc. - Co-Founder, President, CEO & Executive Chairman [3]

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Thanks, Mike, and good afternoon, everyone.

To summarize the progress in key areas in the second quarter: revenue and gross margins showed improvement on a sequential basis as server DRAM pricing started to stabilize. We also made substantial progress in the commercialization of HybriDIMM. And finally, we completed the trial against SK hynix at the United States International Trade Commission.

In regards to product sales, the market conditions for memory and SSDs improved, starting in the second quarter and this has helped with both demand and margins. Analysts expect these market conditions to be maintained through the remainder of the year. We also continued to broaden the customer base for both the Netlist SSD products as well as for our distribution products. For our enterprise NVMe SSDs, we have completed qualifications at a Tier 1 OEM, and we are currently in testing at a second major OEM and at one of the biggest hyperscale customers in the world.

We believe these efforts with large customers bode well for the future of the SSD product line. In the near term, we remain on path to see production POs in Q4 from completed qualifications earlier this year.

Our expanded product line now includes 2-terabyte to 16-terabyte SSDs, with full range of enterprise features and capacities. In addition, we are on track to introduce a 96-layer NAND-based product later this year.

Turning to HybriDIMM commercialization. We made significant progress over the past quarter on multiple fronts. The first item is the signing of a Memorandum of Understanding with a major semiconductor company. The agreement sets forth basic terms of engagement for the conversion of the HybriDIMM Media Controller into an ASIC chipset based on Netlist IP and for the partner to make and sell the ASIC media controller as well as the HybriDIMM memory module.

This is a very exciting development for us, as it brings the resources of a global semiconductor company to drive the implementation of the ASIC chipset as well as create a path for third parties, leveraging Netlist's intellectual property to bring the HybriDIMM solution to market. This is part of a broader campaign to create an ecosystem, which will drive mass-market adoption of HybriDIMM. Over the coming months, Netlist and the MOU partner will work closely on technical due diligence, with a goal of reaching a definitive agreement.

The other part of the effort to commercialize HybriDIMM is the standardization work that is being done through JEDEC, the industry standards body for memory and much of the semiconductor industry. Netlist is currently chairing the NVDIMM-H committee, which includes representation from a broad swath of the industry, including customers, memory and storage vendors and CPU and controller suppliers. With Netlist contributing HybriDIMM IP and leading the effort, the goal is to make NVDIMM-H an industry standard and develop a healthy ecosystem of users and suppliers.

Now turning to legal update. In July, we concluded Netlist's second trial at the U.S. International Trade Commission against SK hynix. The trial lasted 4 days with both parties presenting witnesses and evidence relating to validity and infringement of the patents as well as to the presence of a domestic industry and public interest. Netlist and SK hynix have filed their respective post-hearing opening briefs and Netlist's reply brief will be due in the coming weeks.

The initial determination of the investigation is expected to be issued by October 21, 2019, which will include a determination of infringement and validity of the asserted patents and a recommendation by the Chief Administrative Law Judge, as to whether an exclusion order should be granted that would bar the importation of SK hynix's RDIMM and LRDIMM products into the United States.

As a reminder, in the first ITC action against SK hynix, we received positive determinations as to the validity of asserted patents, domestic industry and public interest. The ALJ, however, did not find infringement and that is something we hope to be successful on in the second action.

On June 27, 2019, the U.S. Patent Trial and Appeal Board, or the PTAB, issued its final written decision in regards to the 907 patent after the oral arguments in March. In its final written decision, the PTAB ruled that claims 40 and 41 were not invalidated. However, the PTAB ruled the remaining challenge claims were unpatentable. We plan to appeal this decision, and our notice of appeal is due at the end of August.

With respect to the 623 patent, we have appealed the PTAB's decision and our opening appeal brief is due September 2019. We remain confident in our positions and look forward to the hearings at the Federal Circuit.

I'll now turn the call over to Gail, for the financial review.

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Gail M. Sasaki, Netlist, Inc. - VP, CFO & Secretary [4]

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Thanks, Chuck. Revenues for the second quarter ended June 29, 2019, were $5.5 million compared to revenues of $8.9 million (sic - see press release, "$8.4 million") for the 2018 period. The decrease in top line was directly related to the worldwide server DRAM shipment decline and pricing erosion versus the year ago quarter. As we expected, we did see modest top line improvement on a sequential quarter basis, as server DRAM and SSD pricing has started to stabilize since the beginning of the year.

Second quarter 2009 product gross profit percentage, which is before manufacturing cost, was 14.3% compared to 9.7% for the second quarter 2018. This year-over-year margin percentage increase is mainly due to just-in-time inventory acquisitions for most aspects of our product business. After manufacturing costs, the net gross margins were 7.3% for the current quarter and 5.7% for last year's quarter.

And although we don't guide, given the current pace of bookings, we do anticipate continued modest improvement in third quarter revenue and product gross margin percentage.

Operating expenses were $3.7 million during the second quarter, down year-to-year and consecutively by 3% and 10%, respectively. Legal expenses declined 21% from the year ago period and we expect additional decreases in legal for the second half of the year.

We ended the quarter with cash and cash equivalents and restricted cash of $9.5 million compared to $11.8 million at the end of the first quarter; a net cash burn of $2.3 million, with $1 million paid out for litigation costs. We continue to proactively manage the overall cash cycle, which included improvement in days of working capital of 9 days consecutively and 56 days year-over-year.

In addition, we have ongoing access to a $5 million working capital line of credit with Silicon Valley Bank, providing borrowing of up to 85% of eligible accounts receivable to support working capital and continued revenue growth.

We also raised approximately $1.5 million subsequent to quarter end, under the purchase agreement that we entered into during June of this year.

Operator, we are now ready for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) And the first question comes from Suji Desilva with ROTH Capital.

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Sujeeva Desilva, ROTH Capital Partners, LLC, Research Division - Senior Research Analyst [2]

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Congratulations on the progress here. So maybe first question, Chuck: the improving stability in the memory market. What would you say the key drivers of that are versus 3 months ago from your perspective?

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Chuck Hong, Netlist, Inc. - Co-Founder, President, CEO & Executive Chairman [3]

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Suji, I think the stock of server memory that's been held by some of the major consumers of RDIMM and LRDIMM are starting to be worked down. So that's one part of it, on the demand side. On the supply side, there's been some plans to cut production of DRAMs by the major suppliers. So combined, things have -- the decline has kind of flattened out in the second quarter and we expect that to continue through the rest of the year.

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Sujeeva Desilva, ROTH Capital Partners, LLC, Research Division - Senior Research Analyst [4]

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Okay. That's helpful color, Chuck. And then for the HybriDIMM China MOU you signed, congratulations on that as well. What is the time frame for progression to a more formal agreement? How long will the diligence process take, just in rough orders? Is it several months or half a year? Or any time frame would be helpful.

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Chuck Hong, Netlist, Inc. - Co-Founder, President, CEO & Executive Chairman [5]

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Yes, I think it is several months. We put a time line in place. And the expectation is to get this formalized into a binding agreement by the end of the year.

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Sujeeva Desilva, ROTH Capital Partners, LLC, Research Division - Senior Research Analyst [6]

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Okay. And just to be clear, is that arrangement exclusive with the China memory vendor or not?

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Chuck Hong, Netlist, Inc. - Co-Founder, President, CEO & Executive Chairman [7]

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No, no. It is a nonexclusive agreement.

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Sujeeva Desilva, ROTH Capital Partners, LLC, Research Division - Senior Research Analyst [8]

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Okay, that's helpful. And then on the SSD side products, as you're rolling those out, what kind of revenue expectations should we have for the second half '19? Or is it more first half '20? And what's the magnitude of the opportunity, in your mind? How would you bracket that?

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Chuck Hong, Netlist, Inc. - Co-Founder, President, CEO & Executive Chairman [9]

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We expect that the qualifications that we completed at the beginning of the year, first half of the year will start to lead to production POs. And we think it's the beginning of production, so up to $2 million to $3 million would be a estimate through the end of the year in the first production orders. And some of that could happen potentially over the next couple of months. And we expect that to continue to ramp through next year.

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Sujeeva Desilva, ROTH Capital Partners, LLC, Research Division - Senior Research Analyst [10]

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Okay. Appreciate that clarification there. And then also switching over to litigation here. What are some of the -- the next milestone is, obviously, October 21 is the ID. And can you just reframe your reasons for optimism this go around versus the prior time, just to help us understand and set up for that?

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Chuck Hong, Netlist, Inc. - Co-Founder, President, CEO & Executive Chairman [11]

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Yes. I -- we mentioned in the script that we -- out of the 4 prongs of the ITC, infringement, validity, domestic industry and public interest. On the first case, we received positive results on everything except infringement. In the second case, we refined the patents from the first case; and the children patents that were asserted in the second case, we believe are directed to getting to it to an infringement finding.

So really, out of the 4 prongs, we missed infringement and that is what we're trying to get out of this second case. And we feel pretty good about achieving that infringement.

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Sujeeva Desilva, ROTH Capital Partners, LLC, Research Division - Senior Research Analyst [12]

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Okay. Then the last question for me in terms of financials, you gave us the cash burn for the quarter. What's the expectation for cash flow in the next few quarters? And just to understand if that's coming down at this point?

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Gail M. Sasaki, Netlist, Inc. - VP, CFO & Secretary [13]

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Sure, Suji. We -- our goal for the end of Q3 is to end with the same cash balance as at Q2. I think our organic cash burn has been a little over $1 million per quarter. Anything incremental to that will be some pay down of legal expenditures. So I think for the next couple of quarters, we hope to stay around the same level as the current quarter cash balance.

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Sujeeva Desilva, ROTH Capital Partners, LLC, Research Division - Senior Research Analyst [14]

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So Gail, you're implying the net cash burn is $0, next few quarters, that way to read that?

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Gail M. Sasaki, Netlist, Inc. - VP, CFO & Secretary [15]

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Yes. Yes. Organic cash burn. The only incremental difference will be some payments of legal bills.

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Operator [16]

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And the next question comes from Richard Shannon with Craig-Hallum.

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Joseph Newton Flynn, Craig-Hallum Capital Group LLC, Research Division - Research Analyst [17]

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This is Joe Flynn on for Richard. I've got a question on the SSD. I think you guys mentioned that you have over 70 customers sampling last quarter. Just wondering if you have any update on the customers currently sampling.

And for the Tier 1 opportunity, we're just wondering like how big this like opportunity could this open up. And do you feel confident you can leverage just that design win or that qualification with additional Tier 1s in cloud? So just like what's your strategy there?

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Chuck Hong, Netlist, Inc. - Co-Founder, President, CEO & Executive Chairman [18]

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Yes, Joe. The number of customers that are being engaged continues to grow. Out of those, we believe, one major OEM will start to order here shortly, over the next couple of months. I mean that was about a 9-month qualification cycle with them.

And then yes, we've got 2 other major customers, one a hyperscaler, another major OEM that is currently testing the product. Those qualifications will take longer. But obviously, the volumes, if we're able to complete qualification, the volumes there will be very significant, relative to the smaller system integrator qualifications that we've achieved over the first half of the year.

So as I indicated to Suji, we're expecting to generate a couple, $3 million in new revenues from the SSDs before the end of the year. That's our goal. And if one of the -- and that is with the Tier 1 OEM that we've been qualified on. And then with the 2 other major customers where we are testing the product, we're hoping that we'll see some good revenue streams from that next year.

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Joseph Newton Flynn, Craig-Hallum Capital Group LLC, Research Division - Research Analyst [19]

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All right. That's helpful. And the -- related to the HybriDIMM MOU signed. I know you probably -- you guys probably can't get into too many details because you -- still needs to be formalized, but I was wondering like what kind of approach do you like plan on taking here? Is this something where you think you can get an upfront payment or like anything related to like out-up-- what you're looking for in terms of like a license legacy fee or royalty per units? Anything you can offer would be helpful.

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Chuck Hong, Netlist, Inc. - Co-Founder, President, CEO & Executive Chairman [20]

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Yes. I think that's a good way to look at it. In fact, the structure, there are some detailed structure of the business model and the engagement in the MOU and it includes an NRE payment for the access to the IP, the controller IP that we've developed. And then down the road, it will be running royalty per unit of ASIC controllers sold by this partner. So there is a short-term upfront payment component plus a running royalty component. And a significant amount of exchange of our technical information as well as their technical capability.

Joe, does that answer your question?

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Joseph Newton Flynn, Craig-Hallum Capital Group LLC, Research Division - Research Analyst [21]

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Yes, that (multiple speakers). I guess just a quick question on the financials. With the -- I guess with the current DRAM date, do you [I think as of any -- like] expectations for fiscal year. I guess like what DRAM with the Samsung kind of flatlining and our $1 million to $2 million or $2 million to $3 million with the SSD, do you think you're going to be around a $7.5 million, $8 million run rate by year-end?

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Gail M. Sasaki, Netlist, Inc. - VP, CFO & Secretary [22]

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Joe. Yes, that is certainly our goal is to end the year with that kind of a run rate between $7 million and $8 million, at least.

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Operator [23]

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Thank you. And that concludes both the question-and-answer session as well as the call. Thank you for dialing in to listen to today's presentation. You may now disconnect your lines.