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Edited Transcript of NLST earnings conference call or presentation 4-Nov-19 5:00pm GMT

Q3 2019 Netlist Inc Earnings Call

Irvine Nov 23, 2019 (Thomson StreetEvents) -- Edited Transcript of Netlist Inc earnings conference call or presentation Monday, November 4, 2019 at 5:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Chun K. Hong

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

* Gail M. Sasaki

Netlist, Inc. - VP, CFO & Secretary

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Conference Call Participants

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* Richard Cutts Shannon

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

* Sujeeva Desilva

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

* Mike Smargiassi;The Plunkett Group

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Presentation

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Operator [1]

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Good day and welcome to Netlist Third Quarter 2019 Earnings Conference Call and Webcast. (Operator Instructions) Please note, this event is being recorded.

I would now like to turn the conference over to Mike Smargiassi, Investor Relations. Please go ahead.

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Mike Smargiassi;The Plunkett Group, [2]

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Thank you, Sarah, and good day, everyone. Welcome to Netlist Third 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's 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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Chun K. Hong, Netlist, Inc. - Co-Founder, President, CEO & Executive Chairman [3]

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Thanks, Mike, and hello, everyone. Since the last call, we have made significant progress in a number of key areas: first, financial performance improved sequentially for both revenue and the bottom line; second, we made further headway in the commercialization of HybriDIMM as JEDEC announced publication of the latest DIMM specifications to support NVDIMM-H; third, broadened the market for Netlist's NVMe SSD products with validation at a Tier 1 OEM and received an initial production order from a major cloud services provider; fourth, we reached a significant milestone in the company's IP campaign with the recent favorable initial determination from the ITC, which found that the SK hynix's LRDIMM server memory infringes on Netlist's standard essential patent.

Turning first to the recent news from the ITC. On October 21, we received the Notice of Initial Determination or ID from the United States International Trade Commission in regards to the company's second ITC action against SK hynix. We're very pleased with the outcome as we receive positive determinations as to the infringement and validity of Netlist's '907 patent as well as defeating SK hynix's contentions that Netlist had violated its RAND obligations to implementers of the JEDEC standards and had not met the standards for domestic industry. This was a major win for Netlist against SK hynix, who may be facing an exclusion order on the sale, sale for importation and importation into the United States of billions of dollars annually of LRDIMM products in violation of Section 337 of the Tariff Act of 1930.

The ID found that the second patent in this case, the '623, which covers RDIMM products, invalid and uninfringed. Without access to the full ID, however, Netlist does not yet have the benefit of knowing the reasons for that decision. Once we receive this document in the coming weeks, we will be able to determine, in consultation with outside counsel, the avenues to pursue appeal for this decision by the full commission.

As part of the ITC procedure, the ID is now subject to review by the ITC commissioners. Both parties can petition for review of any findings they believe are incorrect. The commission will then decide whether to review portions of or the entire ID. Once the issues under review have been briefed, the commission may affirm, set aside or modify the portions of the ID under review. These conclusions will be contained in a final determination, which is scheduled to be issued by the commission on February 21, 2020.

The multipronged campaign against SK hynix continues early next month at the Federal Circuit Court of Appeals as they will hear oral arguments by both parties and the appeal of the final determination of Netlist's first ITC action. This places us on a path for a potential determinative ruling from the Federal Circuit with regards to both validity and infringement of Netlist's '064, '434, and '501 patents and a potential to overturn the final determination of the first ITC case against SK hynix.

In the meantime, Netlist continues to improve its patent portfolio and recently received a notice of issuance from the USPTO for an important RDIMM patent, which will issue before the end of the year.

Now moving over to the product side. In regards to product sales, we booked the first production order of volume shipment of Netlist's NVMe SSDs during the fourth quarter with a major cloud services company. We believe this lays the groundwork for future significant order volumes in 2020. We also recently completed the validation process for Netlist's NVMe SSDs with a Tier 1 OEM. In testing this OEM, our product performance and latency had best-in-class results when benchmarked against other leading SSDs. This is a powerful endorsement of the high performance and significant value we bring to end users in the enterprise and data center markets.

We are also partnering with a major CPU vendor to validate and proliferate our SSD solutions on their platform, and there will be further news on this front in the coming weeks.

We also continue to grow the customer base for Netlist's resale in specialty DIMMs, which expanded 15% consecutively quarter-over-quarter. Although we don't guide revenue, based on October's activity, we estimate meaningful growth in both product sales and product gross margins.

Turning to HybriDIMM, we are making solid progress on both product and standardization components of our commercialization campaign. The publication of JEDEC standard for NVDIMM-H in September provides an industry standard and a necessary framework to develop a healthy ecosystem of broad-based users and suppliers for HybriDIMM. Discussions with a major semiconductor company under our memorandum of understanding are continuing as well as discussions with other potential partners for the ASIC controller. Such a partnership would bring the resources of a major semiconductor company to drive the implementation of the ASIC chipset for HybriDIMM as well as create a path for third parties to bring the HybriDIMM solution to market.

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 third quarter ended September 28, 2019, were $6.1 million compared to revenues of $5.5 million in the previous quarter and $7.2 million for the 2018 period. The decrease in top line year-over-year was directly related to the worldwide server DRAM pricing erosion versus the year ago quarter. But as we expected, we did see modest top line improvement on a sequential quarter basis, in line with the rest of the industry.

Third quarter 2019 product gross profit percentage, which is before manufacturing cost, was 12.6% compared to 12.1% for the previous quarter. After manufacturing costs, the net gross margins were 7.4% for the current quarter and 8.1% for last year's quarter. And although we don't guide, as Chuck indicated earlier, given the current pace and mix of bookings, we anticipate improvement in fourth quarter revenue compared to the third quarter as well as improvement in the product gross margin percentage compared to last quarters.

Operating expenses were $3.3 million during the third quarter, down year-to-year by 34%, as legal expenses declined 65% from the year ago period. We expect additional decreases in legal expense in the future quarters.

We ended the quarter with cash and cash equivalents and restricted cash of $8.6 million compared to $9.5 million at the end of the second quarter, a net cash change of $900,000, with $1 million paid out for litigation costs during the quarter.

We raised approximately $2.5 million during the third quarter and another $3.5 million during the quarter to date under the $10 million equity purchase agreement we entered into during June of this year.

We also continue to proactively manage the operational cash cycle, which includes improvement in days of inventory, a 15 days decrease year-over-year. In addition, we have accessibility 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 revenue growth.

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) Our 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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Chuck, Gail, congratulations on all the progress here. Maybe you can talk about the product revenue and what the impact of the memory industry supply-demand dynamic is on the DRAM, maybe even the NAND side. It seems to me things are firming up, but I'm wondering if there's a lag effect for you guys or whether you see it right away what the opportunity for the next few quarters is in the memory industry as that firms up.

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

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Thanks, Suji. We saw revenues decline in the first half of this year, with the declines in the ASP that came about as a result of the overall excess supply in the marketplace. As you noted, things are firming up, and we're starting certainly in this quarter to see a pickup in quote activity, pickup in a number of transactions as well. And the pricing hasn't gone back up, but it has -- is starting to -- the decline is starting to dissipate. And overall, the efforts to proliferate design wins across many customers for our SSDs are -- we're starting to see some of the fruits of our labor now starting this quarter. As I mentioned, we booked the first meaningful production order with a major cloud vendor and a major OEM this quarter -- or this month. And we expect that to be -- we expect that to continue with orders ongoing through the rest of next year from those customers.

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

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Okay. Great, Chuck. My second question was about the SSD customer, the cloud customer. So how long is the qualification cycle for those kind of customers typically? And once you -- and I presume you're part of a multisource sort of socket, but tell me if that's not correct. And how would we think about the size of that opportunity for you in the 2020 time frame for that customer perhaps?

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

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The qualification cycle has been long. We've -- that particular cloud vendor uses a major OEM server platform. And so we had to get qualified at the major OEM and then do application rack-level testing at the cloud vendor. So in total, it's probably about 6 to 9 months of qualification. Now that we're locked in, we did receive a letter of intent from that cloud vendor in recent weeks for supply of that product through the course of next year. And we hope to increase our share of that and go beyond the volumes set out in that LOI. But we think it will be a decent volume, anywhere between $5 million to $10 million with that customer.

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

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Okay. Great. And you're multisourced for these SSDs...

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

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We will -- there is one other competitor in that socket. But what we have seen is that our sequential -- random and sequential read/writes of our SSDs are -- we have better performance than the competition is the feedback that we've received. So we feel pretty good about where we are with that customer.

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

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Good. And then my other question is on the NVDIMM-H standard that just got, I guess, ratified. How long does the ecosystem take to kind of get ready to implement this? Were they already -- was that already in motion? Or does that have to start now that it's ratified? When does ecosystem feel like it's ready to kind of snap in NVDIMM-H parts like HybriDIMM into their systems and software...

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

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So Suji, to clarify, it hasn't been ratified. So what happens is -- so the first steps are to do what we've done here over the last 9 months, which is to get an SPD, serial presence detect, setting in a server, meaning that the CPU will set aside a certain number of bites to be able to recognize a memory module as NVDIMM-H. So we've reserved our space. And doing that in itself is very -- it's difficult to do through JEDEC because there is a finite number of SPD bites available from the CPU. So we've done that. We are now working on finishing out the protocol. And then a couple of other items which we expect to get done within the task group that we chair, which today has about 60-some-odd companies as members. Once that task group has finished its work, it will go to the full committee for ratification. So it's going to take a few more quarters here for all of that. In the meantime, we will be working on the development of ASIC. But in all, we're well on our way to getting this standard finalized as a standard. It will take another couple 3 quarters, but it will happen.

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

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Okay. That's helpful color. And then last question perhaps for Gail on the balance sheet. The $10 million equity agreement you have, you've already used $5.5 million of that. Would you possibly upsize that with that particular partner investor? Or is that something that's being considered or discussed at this point?

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Gail M. Sasaki, Netlist, Inc. - VP, CFO & Secretary [11]

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Yes. We actually raised about $6 million at this point, Suji. And no, we have not considered any increase to that at this point.

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Operator [12]

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The next question comes from Richard Shannon with Craig-Hallum.

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Richard Cutts Shannon, Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst [13]

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Let me follow up on the NVMe SSDs here. You've talked about an order from a cloud customer, I think you mentioned, was driven through one OEM. Maybe you can talk through the compendium of your other engagements so far either by cloud guys or OEMs and when you might see some success, either production orders, qualifications, whatever.

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Chun K. Hong, Netlist, Inc. - Co-Founder, President, CEO & Executive Chairman [14]

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So the order that we received was a meaningful size order. So I think we will see, starting this quarter, about $1 million worth of new SSD sales at decent margins. So in that -- is that -- within that -- those dollars, there is the major cloud services vendor, which is where the order is being fulfilled through a Tier 1 OEM. And then through qualification of that Tier 1 OEM, we expect to get other cloud services vendors of the caliber that we're shipping to -- we're starting to ship to this quarter. There are other within that dollar volume for this quarter. There are other smaller OEMs, probably 2 others, where we're shipping the NVMe SSDs. So out of some 20-odd qualifications that we've achieved to date, we're now starting to get some meaningful purchase orders, and we expect that to ramp -- continue to ramp through the course of next year.

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Richard Cutts Shannon, Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst [15]

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Okay. Fair enough. Chuck, I think I may have asked you this in past quarters, but let me just ask it again so everyone can hear it. But what do you see is the market size for this -- for 2020? I know that, obviously, you're ramping up getting qualifications. But if you are -- assuming that you had products across the board, qualified and whatever, what do you think the TAM would look like for next year?

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Chun K. Hong, Netlist, Inc. - Co-Founder, President, CEO & Executive Chairman [16]

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So Richard, you mean the TAM for the market segment in which we're shipping into or what our portion of that would be?

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Richard Cutts Shannon, Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst [17]

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The total TAM.

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

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We think the total TAM -- so to be specific, these are NVMe SSDs. So NVMe describes the interface for the SSDs. That's the protocol. The form factor of our products are AIC, HHHL, meaning, add-in-card; half height, half length. So that is the niche that we're playing in. We are bringing on M.2, which is a second form factor. And then you've got various capacities. So the product line is probably half a dozen SKUs. We believe it's probably a market of several hundred million dollars annually for the current AIC product line that we have. It's probably another several hundred million dollars for the M.2 product, which we'll bring to market later this year.

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Richard Cutts Shannon, Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst [19]

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Okay. And maybe following up on one of Suji's questions earlier, at least kind of implied questions here. What kind of share could you be getting here at the early stages? And is there like a terminal share that you might think you could gather in a year or 2 if you continue to execute well?

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

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I think we are targeting in the low teens in terms of market share. That's relatively conservative. As you know, there are major vendors in this space, but many of them have either gone end-of-life or have deemphasized these particular form factor of the NVMe SSDs. NVMe, as a category, as you know, is growing rapidly and probably will become the largest category, interface category. But I think low teens would be a reasonable target for us to have in terms of share of market.

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Richard Cutts Shannon, Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst [21]

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Okay. That's fair enough. Just maybe jumping over to HybriDIMM. Last quarter, you talked about an MOU, and you said that the discussions are still ongoing. What are kind of the catalysts or restrictions or obstacles in the way of moving along to a full agreement here? And what would be kind of an optimistic time frame by which a partner could have an ASIC in the field ready to be qualified and tested?

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Chun K. Hong, Netlist, Inc. - Co-Founder, President, CEO & Executive Chairman [22]

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I think I look at that -- we can look at that kind of as 2 different areas: one is trying to close an agreement with -- we've got a couple of potential partners, one where we have an MOU, one where we do not, but we've got a couple of potential partners. And we think we will be able to close one of those partners over the next couple 3 months. And the obstacle to doing that -- I think there's been a lot of technical diligence done on that. So we're well on our way. It's now -- it becomes a matter of the economic terms and that's just basically a negotiation process that we've got to step through. And once that is done, the parties will -- including us, will embark on a design of the ASIC version or of this ASIC controller, and that will probably take a good 12 to 18 months. In parallel, we'll be working on the module design, and by that time, the JEDEC standard will have been finalized. As I noted, there's -- we started this with a handful of members, now we're up to some 60 members, many of them being major companies and users on this NVDIMM-H task group. So once the product is available to sale, we believe the ecosystem will have been formed, and we'll be able to start shipping product.

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Richard Cutts Shannon, Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst [23]

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Okay. I think you get a sense of what you're expecting there. That's helpful. Last question for me, probably for Gail here on gross margins. I'm assuming that the growth you're expecting for this quarter is all -- is entirely coming from the NVMe SSDs. Any sense you can give us on what kind of incremental margin we expect on growth coming in this fourth quarter?

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Gail M. Sasaki, Netlist, Inc. - VP, CFO & Secretary [24]

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Sure. Yes, I wouldn't say that it's completely from NVMe SSDs. We've seen some growth in the margins from the resale and specialty DIMM areas as well. But I think probably conservatively, we'd be looking at about a 40% increase in the product gross margin between quarters.

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Operator [25]

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This concludes our question-and-answer session. The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.