NetList Inc (NLST)

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CC 8.8.2019 transcript and audio

Netlist's (NLST) CEO Chuck Hong on Q2 2019 Results - Earnings Call Transcript

Aug. 8, 2019 10:50 PM ET

Company Participants

Mike Smargiassi – Investor Relations

Chuck Hong – Chief Executive Officer

Gail Sasaki – Chief Financial Officer

Conference Call Participants

Suji Desilva – ROTH Capital

Joe Flynn – Craig-Hallum

Operator

Hello, and welcome to the Netlist Second Quarter 2019 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] Please note, this event is being recorded.

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

Mike Smargiassi

Thank you, Keith, and good afternoon, everyone. Welcome to Netlist 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.

Chuck Hong

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 and 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.

Our enterprise NVMe SSDs, we have completed qualifications at a Tier 1 OEM and we’re 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, [Audio Dip] 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 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 month, 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 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 four days with both parties presenting witnesses and evidence relating to validity and infringement of the patents as well as through 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 this 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. And it’s final written decision, the PTAB rule that claims 40 and 41 were not invalidated. However, the PTAB rule 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.

Gail Sasaki

Thanks, Chuck. Revenues for the second quarter ended June 29, 2019, were $5.5 million compared to revenues of $8.9 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 2019 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 acquisition 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 improvements in days of working capital of nine 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.

Question-and-Answer Session

Operator

Yes, thank you. We will now begin the question-and-answer session. [Operator Instructions] And the first question comes from Suji Desilva with ROTH Capital.

Suji Desilva

Hi Chuck. Hi Gail. Congratulations on progress here. So maybe first question Chuck. The improving stability in the memory market, what would you say to key drivers of that are versus three months ago from your perspective?

Chuck Hong

Hey, Suji. I think the stock of server memory that’s been held by some of the major consumers of RDIMMs and LRDIMM. It’s starting to be worked down. So that’s one part of it on the demand side. On the supply side, there is been some plans to cut production of DRAMs by the major suppliers. So combine 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.

Suji Desilva

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

Chuck Hong

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

Suji Desilva

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

Chuck Hong

No. It is a nonexclusive agreement.

Suji Desilva

Okay, good. That’s helpful now. And then on the SSD side products, as you’re rolling those out, what kind of revenue expectations should we have the second half 2019 or is it more the first half of 2020. And what’s the magnitude of the opportunity in your mind? How would you bracket that?

Chuck Hong

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. We think it’s the beginning of production. So up to $2 million to $3 million would be an estimate through the end of the year in the first production orders. And some of that could happen potentially over the next couple months. And we expect that to continue to ramp through next year.

Suji Desilva

Okay. I 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 round versus the prior time just to help us understand and set up for that?

Chuck Hong

Yes. We mentioned in the script that we out of the four prongs of the ITC infringement validity, domestic industry in 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 four prongs, we missed infringement. That is what we’re trying to get out of this second case. And we feel pretty good about achieving that infringement.

Suji Desilva

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 burn in the next few quarters and just to understand if that starts coming down at this point?

Gail Sasaki

Sure, Suji. 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 paydown 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.

Suji Desilva

Gail, you implying the cash – net cash burn is zero in the next few quarters. Is that the way to read that?

Gail Sasaki

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

Suji Desilva

Litigation. Okay, great. All right. Great, thanks guys.

Gail Sasaki

Thanks.

Operator

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

Joe Flynn

This is Joe Flynn on for Richard. Just one more question on the SSD. I think you guys mentioned that you have over 70 customers sampling last quarter. I’m 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 of this opportunity could this open up, and do you feel confident that you can leverage just that design win or that qualification with additional Tier 1 in cloud? So just like what’s your strategy there?

Chuck Hong

Yes, Joe. The number of customers that are being engaged continues to grow. Out of those we believe one major OEM will start to water here shortly over the next couple of months. That was about a nine month qualification cycle with them. And then we – yes, we’ve got two other major customers, one hyperscale or 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 that the volumes there will be a very significant relative to the smaller system integrator qualifications that we’ve achieved over the first half of the year.

Joe as I indicated to Suji, we’re expecting to generate 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 two other major customers where we’re are testing the product. We’re hoping that we’ll see some good revenue streams from that next year.

Joe Flynn

All right. Thanks. That’s helpful. And related to the HybriDIMM MOU signed, and I know you probably can’t get into too many details because you’re still needs to be formalized, but we’re just wondering like, what kind of approach do you like planet taking here? Is this something where you think you can get an upfront payment or like anything related to like – what you’re looking for in terms of like a license, licensee fee or royalty per units and then you can offer it would be helpful?

Chuck Hong

Yes. I think that’s a good way to look at it. In fact the structure, there are some detailed structure in the business model and the engagement in the MOU. And it includes NRE payment for the access to the IP, the controller IP that we’ve developed. And then down the road it will be a running royalty per unit of AC controller 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?

Joe Flynn

I guess just quick question on the financials. I guess with the current DRAM date, do you – have you guys have any like expectations for fiscal year? I guess like with the DRAM, with Samsung kind of flat line in and $1 million to $2 million or $2 million to $3 million, as the SSD like you think you’re going be able to round up $7.5 million, $8 million run rate by year end.

Gail Sasaki

Hey, 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.

Joe Flynn

Okay. That’s all from me. Thanks.

Operator

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.

Audio can be heard here:

http://www.netlist.com/media/events/event-details/2019/Second-Quarter-2019-Earnings-Conference-Call-and-Webcast/default.aspx

https://seekingalpha.com/article/4283629-netlists-nlst-ceo-chuck-hong-q2-2019-results-earnings-call-transcript