Netlist's CEO Discusses Q4 2012 Results - Earnings Call Transcript

| About: Netlist, Inc. (NLST)

Netlist, Inc. (NASDAQ:NLST)

Q4 2012 Earnings Call

March 28, 2013 05:00 pm ET

Executives

Mike Smargiassi - IR

Chuck Hong - Chairman of the Board, President, Chief Executive Officer

Gail Sasaki - Chief Financial Officer, Vice President - Finance, Secretary

Analysts

Rich Kugele - Needham

Mark Kelleher - Dougherty & Company

Richard Shannon - Craig-Hallum

Operator

Good afternoon and welcome to the Netlist Fourth Quarter and Full Year 2012 Earnings Call and Webcast. All participants are in listen-only mode. (Operator Instructions). Please note that this event is being recorded.

I would now like to turn the conference call over to Mr. Mike Smargiassi. Please go ahead.

Mike Smargiassi

Thank you, Amy, and good afternoon ladies and gentlemen. Welcome to Netlist’s fourth quarter and full year 2012 conference call. On today's call will be Chuck Hong, Chief Executive Officer of Netlist; and Gail Sasaki, Chief Financial Officer. As a reminder, our earnings release and a replay of today’s call can be accessed under the Investors section of the Netlist website at www.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 a 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. We assume no obligation to update forward-looking statements.

During this call, non-GAAP financial measures will be discussed. Reconciliations for those directly comparable GAAP financial measures are included in the press release which was filed on Form 8-K.

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

Chuck Hong

Thanks, Mike, and good afternoon everyone. During past year, we continued to evolve our business model from one that has been primarily concentrated on customized projects for individual clients and to one that is driven by advanced multi- generational solutions that serve a broader market. We believe this will ultimately lead to a more diversified business model with higher quality revenue streams and longer product lifecycles. This transitional process is taking some time, but we are making progress and remain optimistic about our future.

As the leader in high-performance server memory technology, we seek to maximize the performance of big data applications, including simulation, analytics and virtualization. Our products are available on some of the most advanced servers from Dell, HP and IBM, and are being introduced a wide range of industries such as financial services, automotive, aerospace and oil and gas in addition to various sectors where performance and big data intersects.

In the meantime, our results have continued to reflect this transition and the business model. As we execute our strategy to introduce our new products, the contributions from our mature products has continued to decrease, 2012 results were marked by the steep decline of PERC, one customer project which has been the single largest portion of our revenues and gross profit over the past two years.

On the other hand, our shipments of HyperCloud increased during the year, recording revenues of about $3 million. Also, shipments of NV3, [BV] and VLP increased steadily throughout 2012 and into the first quarter. We expect continued progress for these new products throughout 2013 as additional major OEM qualifications were achieved in the first half of the year and the ramp picks up for HyperCloud and NV families of products. We also expect to continue to expand our IP portfolio, which is becoming an increasingly valuable component of our company.

Now, let me turn the call over to Gail for the financial review. Gail?

Gail Sasaki

Thanks, Chuck. As Chuck mentioned, our fourth quarter and full year results reflect the continued transitional period for our organization as we move forward in launching our new products while contribution from our more mature products connected to prior generation servers declined more rapidly than we had predicted.

Revenue for the fourth quarter ended December 29, 2012 was $6 million, compared to $15.4 million for the fourth quarter of 2011, and flattish consecutively. The new product lines were steady compared to the third quarter over the exception of EXPRESSvault, which doubled in revenue between quarters and we estimate will double again as we close Q1 2013.

EXPRESSvault is being used by our customers not only for its ability to protect critical data, but increasingly to resolve I/O bottleneck and in one case very recently break-through benchmark virtual desktop infrastructure record. The requirement for high performance storage access is becoming more main stream and we look forward to continued growth in our EXPRESSvault and NVvault product family during 2013.

Gross profit for the fourth quarter ended December 29, 2012 was $800,000 or 14% of revenues, compared to a gross profit of $6 million or 36.6% of revenues for the fourth quarter of 2011, mainly due to the lower revenues unabsorbed capacity as a result of these lower revenues, changing product mix and start-up cost of our new product lines.

Gross profit over the next couple of quarters is expected to be in the same range as Q4, but will be dependent on the factors just stated as well as higher cost of materials some of which may not be able to pass through in form of higher ASPs.

Operating expenses were $4.7 million in the fourth quarter of 2012, down from $6.2 million from the prior year fourth quarter and down from $5.1 million in the third quarter of 2012, as we aggressively streamline business. Our plan is to exist the first half of 2013 with operating expenses of $2.5 million.

Adjusted EBITDA loss, after adding back net interest expense, income taxes, depreciation, stock based compensation and net non-operating expense was approximately $3 million for the fourth quarter of 2012, compared to a positive adjusted EBITDA of $718,000 for the prior year period.

Net loss in the fourth quarter was $4.1 million, or $0.14 loss per share, compared to a net loss in the prior year period of $277,000, or $0.01 loss per share. These results include stock based compensation in the fourth quarter of $371,000, compared with $397,000 in the prior year period and depreciation and amortization expense of $446,000 compared with $525,000 in the prior year fourth quarter period.

Turning to our full year results, revenues for the 12-month ended December 29, 2012 were $36.9 million, down from $60.7 million in the prior year period due to the decline in our maturing product lines as I noted earlier, which was partially offset by increased sales of our HyperCloud, VLP, new NVvault and EXPRESSvault product lines.

Gross profit for the 12-month period was $9.4 million, or 25.5%of revenues, compared to a gross profit of $20.3 million, or 33.4% of revenues for 2011. The decrease in gross profit is primarily due to accelerated declines in the PERC NVvault sales to down in second half of the year and the other reasons mentioned earlier.

Total operating expenses were $22.9 million in 2012, compared to $25.6 million in the previous year. We are currently on track to reduce total operating expenses by 40% to $14 million for the 2013 year.

We have invested heavily in our R&D over the past several years, the end result of which has been record breaking technologies, both HyperCloud and NVvault as well as senior seminal patent families covering both of these technologies. Our goal in the next phase of development will be to work with strategic partners who can mutually benefit from our product and IP leadership.

Adjusted EBITDA loss after adding back net interest expense, income taxes, depreciation, stock-based compensation and net non-operating expense was $9.6 million for the full year ended December 29, 2012, compared to an adjusted EBITDA loss of $1.5 million for the prior year period.

Net loss for 2012 was $14 million, or $0.50 loss per share, compared to a net loss in the prior full year period of $5.6 million, or $0.22 loss per share. These results include stock based compensation expense of $1.9 million for 2012 and $1.6 million for 2011, and depreciation and amortization expense of approximately $2 million for 2012 and $2.2 million for 2011.

For the full year, capital expenditures totaled $1.7 million compared to $0.7 million in 2011. The increase was for investments in equipment to support increased capacity and production volume of HyperCloud and VLP Planar-X. We anticipate spending not more than $200,000 in CapEx over the next several quarters.

We ended the year with net cash, cash equivalents and investments in marketable securities totaling $8.1 million, compared to $10.9 million at the end of the third quarter. Our cash cycle improved slightly between quarters after more than doubling over last year as we ramp the OEM supply chain for HyperCloud and VLP.

During the first quarter of this year, we continued to improve our cash cycle, mainly in decreasing days of inventory and day sales outstanding and we'll end this current March quarter with about $7.5 million in cash and a greatly reduced cash burn of about 73% to about $750,000 for the quarter from $2.8 million, which we talked about in the fourth quarter.

As discussed in our last call, during the fourth quarter, we saw lot of compliance with the net worth covenant of our credit agreement with Silicon Valley Bank, but they didn't compliance with our quick ratio covenant. We are working closely with the bank to amend our net worth covenant going forward and/or restructure the gut. We also continue to look at a number of alternatives both, financial and strategic in order to improve our working capital and our market position.

On the IP front, we have continued to expand and strengthen our patent portfolio, which represents an increasingly valuable part of our business. During the first quarter of 2013, the United States Patent and Trademark Office issued to Netlist two new U.S. patents. The newly issued patents address growing technical bottlenecks in the area of high-density server memory. As density progression of monolithic DRAM slows, server memory solutions will increasingly require technologies that can integrate a greater number of existing lower density DRAM chips in order to achieve high density modules.

We have also recently received three new notices of allowance for important technologies that relate to next generation DDR4 memory. We have announced by far the largest rank multiplication and load reduction patent portfolio in the industry. As an ongoing strategic initiative, we continue to prioritize IP development. The steady issuance of new patents, the USPTO's continued validation of claims under reexamination and increasing citations of Netlist patents by industry leaders such as Micron and Google are all indicative of the inherent and growing value of our patent portfolio.

During the fourth quarter of 2012, we were first to defend our technology leadership position against the baseless patent infringement lawsuit and prevail of motion for preliminary injunction brought against us by SMART modular. We filed a request for reexamination of the SMART patent with the USPTO, and we are pleased with the very quick decision by the USPTO during the fourth quarter to reject all requested claims with the patents in light of six different combinations of prior art.

We feel strongly that the one independent claim will not survive reexamination and that the court will ultimately deny the motion for preliminary injection. We believe this was a final attempt by those infringing our rank multiplication and load reduction IP to challenge our technology leadership position as the volume of their infringing product start to ramp up in 2013.

I will now turn it over to Chuck.

Chuck Hong

Thanks, Gail. Over the past several years, we have developed a portfolio of advanced products and related IP that are targeted for the next generation server and storage systems for the cloud. These technologies mainly HyperCloud and NV, and the patents around them along with our major OEM relationships, are the main assets of Netlist.

Through our targeted patenting activities, we have invested and grown our patent portfolio, which now includes five technology groups consisting of 33 issued patents and more than U.S. and foreign pending applications in the areas of high performance high density memory subsystems and hybrid memory technologies.

The strength of our IP is exemplified by two of our patents having all of its claims repeatedly confirmed by the USPTO after almost three years of being fiercely challenged by multiple requesters to reexamination proceedings. These two patents relate to rank multiplication and load isolation technologies.

We believe that the company is ahead of the market for both, our products and our patents and the value of both will appreciate significantly over the next several years. We believe that these two flagship product lines and the patents address multi-billion dollar market opportunities.

Our goal is to position the company to maximize the value of these assets taking full advantage of our emerging leadership position as customers come to adapt our products and competitors come to need our IP over the coming years.

We know our products are extremely effective and ongoing trails continue to prove the efficacy of our investment efforts. For example, our 32-gigabite HyperCloud was a main part of the IBM system that broke the 1 million transactions per minute barrier and TPC Benchmark C testing last month.

As our partners can attest HyperCloud as a superior solution, it address the memory bottleneck by along servers and the big data applications to operate at peak performance and no other products come close to matching the results we deliver.

So, the challenge for us now is not about technology development. We've accomplished quite a bit on that front. Now, we are squarely focused on increasing the rate of adoption of our technologies and fully capitalizing on our patent portfolio. We believe that volume usage of 32 gigabyte by the OEMs and the launch of Ivy Bridge servers will both occur towards the end of this year and they will act as the two key drivers for the growth of HyperCloud over the next several years.

On the NV front, we are seeing strong demand from storage systems customers for EXPRESSvault. Our PCI-based NV card and we expect this new product to be a major component of our revenues this year. We've also seen keen interest from the OEMs in the industry in general on a future version of our NV product with more flash content. Such a product, which some are calling hybrid memory will be used as a primary memory tier in servers and therefore achieve mainstream volume at DDR4.

Having been the only company to supply NVvault to major OEMs in high volume and as the owner of seminal patents in this space, we are well positioned as the market for hybrid memory expands in the coming years.

We continue to expect the business to scale as HP and NV gain traction in the marketplace. In the near-term, we will continue to maintain a disciplined approach to managing our expenses with the goal of maintaining adequate liquidity and positioning our business for profitability as revenues begin to expand with the ramp up of our new products.

Thank you all very much for listening today, and we are now ready for questions. Operator?

Question-and-Answer Session

Operator

(Operator Instructions). Our first question comes from Rich Kugele at Needham.

Rich Kugele - Needham

Thank you. Good afternoon. A couple of questions, I guess, Gail, just to [level], can you give us what breakdown for revenue? You said the year I believe with HyperCloud about $3 million, but that would imply quite a significant drop-off sequentially, so can you just breakdown what the revenue was for the quarter? And then I have another.

Gail Sasaki

Okay. The total HyperCloud and Planar-X, the new products was about 33%. HyperCloud was about half of that and the flashback the NVvault products about 25%, and then the rest is everything else.

Rich Kugele - Needham

Okay. So, what is the update on HyperCloud specifically, are you expecting any increase in business in the first half, or do you think that the customers are waiting for either DDR4 or the next Intel platform?

Chuck Hong

Rich, with HyperCloud, we expect the business to ramp throughout the course of this year with the emergence of 32 gigabyte density. As you know the 32 gigabyte is qualified and started to ship at IBM in small quantities and that same 32 gigabyte is in qualification at HP and it's progressing well thus far, and we believe that will lead to a ramp of that product over the course of this year. 32 gigabyte has been slowed to ramp due to the high pricing. It's priced at somewhere in the range of $1,500 per module at the OEMs. That will come down over the course of this year, which will enable the demand to increase on that.

Rich Kugele - Needham

Okay. And actually, perhaps that has explained. The comment that Gail, that you made about higher cost impacting gross margin potentially in the first half, is that what you are referring to?

Gail Sasaki

I was actually referring to the cost of DRAM, which does impact slightly to ASPs, but I wasn't necessarily meaning to imply that was going to impact what our customers charge for their customers and I think that's what Chuck was referring to.

Rich Kugele - Needham

Okay.

Gail Sasaki

And our products have a premium base. They priced it at a premium and we need them to price it more competitively and then we believe that will help to start the traction.

Rich Kugele - Needham

Have they given any indications that they will start to be more aggressive with the pricing?

Chuck Hong

For 32 gigabyte has come down in general over the last three, four months, and they brought down our premium over the LRDIMM slightly over that same time, so I think that the gap will decrease. And in general, the 32 gigabyte price point will come down and that should lead to increase in demand.

Rich Kugele - Needham

Okay. Then just lastly from burn perspective, I just want to make sure I am getting this clearly. So, you are saying that for the first quarter you've brought the burn down to about $750,000. Is that correct?

Gail Sasaki

That's correct.

Rich Kugele - Needham

Do you think you can continue to improve that as the year progresses or should we assume that that's the steady state until revenue materially picks up?

Gail Sasaki

Yes. Latter, I mean, I think the future quarters will be dependent on the supply chain other products ramp, but until then I think we can maintain this level.

Rich Kugele - Needham

Okay. All right. Thank you very much.

Gail Sasaki

Okay. Thank you.

Operator

Our next question comes from Mark Kelleher at Dougherty & Company.

Mark Kelleher - Dougherty & Company

Thanks. Rich asked a lot of the questions that I was going to ask, but a couple of follow-up. How much Dell was in the quarter? Were there any?

Gail Sasaki

Yes. There was. Hi, Mark.

Mark Kelleher - Dougherty & Company

Hi. How much Dell?

Gail Sasaki

It was right about what we kind of predicted last quarter was about 10%.

Mark Kelleher - Dougherty & Company

Okay. About the same amount as the previous quarter?

Gail Sasaki

Actually there was no Dell in the previous quarter, so and we talked about what might this quarter be in the last call and we kind of thought about it would be less than $1 million.

Mark Kelleher - Dougherty & Company

Okay. So, just as we look at the September quarter, where there was no Dell, and now we look at the Dell in this quarter, but we are still down slightly, but down in revenue. What else was kind of fading off in the quarter?

Gail Sasaki

We had a category of products that, I think, just one of our customers maybe over inventories installed, and so we saw a decrease there, but everything else was sort of flattish.

Mark Kelleher - Dougherty & Company

Would that inventory position be better position to drive additional revenue in Q1? That buying in Q1?

Gail Sasaki

I think we saw kind of maintaining a flattish also between quarters, but I don't quite know yet. I mean, actually we are not really done with the Q1, so we'll report on that next quarter.

Mark Kelleher - Dougherty & Company

No guidance for Q1 on the last day of Q1?

Gail Sasaki

Well, I think they view always the cash number. I think overall revenue will probably be produced last between quarters at this point.

Mark Kelleher - Dougherty & Company

And then do we continue flat through June or where is the inflection point? When do we start to see those price points come down enough, so we can drive some revenue or see some adoption by IBM a little bit more or HP get qualified? Where in the year? Is that at the end of the year, so it's really kind of a waiting game this year?

Chuck Hong

Mark, as I explained to Rich about where we are with HyperCloud qualification and pricing, I think it's middle of the year. We've been in qualification with HP on multiple platforms for HyperCloud for now many, many quarters and we are right at the end of this, so we expect over the next couple of months to conclude that qualification and HP's volumes are much higher historically. They are the single largest consumer of high-density server memory in the world by far, so we expect that business to kick in about mid-year once the qualification is done over the next couple of months. We expect IBM's 32 gigabyte, which just started to ship in small volumes, but at $1,500 per unit, there is an issue with demand elasticity that will probably, they'll have to bring it down into sub-$1,000, which we expect that to happen through the course of the first half of this year. So, the second half should be where we would see some good demand on 32-gigabyte HyperCloud.

Mark Kelleher - Dougherty & Company

Okay. That's all I have got. Thanks.

Gail Sasaki

Thanks, Mark.

Operator

Our next question comes from Richard Shannon at Craig-Hallum.

Richard Shannon - Craig-Hallum

Hi, Chuck and Gale. How are you?

Chuck Hong

Hi, Richard.

Gail Sasaki

Hi, Rich.

Richard Shannon - Craig-Hallum

Just a clarification and a follow-up question, so Chuck, I just wanted to kind of summarize what I heard in response to the couple of last questions regarding HyperCloud. So, it sounds like you are expecting the inflection point to happen from the 32 gigabyte perspective once ASPs hit $1,000 or less, and that you expect that to happen before Ivy Bridge starts to ramp later this year. Did I capture that correctly?

Chuck Hong

Yes. That is correct.

Richard Shannon - Craig-Hallum

Okay. And, when would you expect Ivy Bridge to kind of continue that pattern or could that be yet another step-up after that?

Chuck Hong

We will have products that will go into Ivy Bridge. We are working on that qualification as well. The qualification at Hewlett-Packard that we've been talking about for many quarters now that is on the current Sandy Bridge and Sandy Bridge will continue to ship really through the course of 2014. Ivy Bridge starts at the end of this year and probably go through 2015. So, yeah, both are items I think that will be impetus to creating demand for 32 gigabyte HyperCloud.

Richard Shannon - Craig-Hallum

Okay. So, you said you don't have any qualifications with HP and Ivy Bridge. Do you have call starting with or are you underway with IBM and Ivy Bridge?

Chuck Hong

We are very close. We're just following the industry cycle on that. Obviously, on Sandy Bridge, our qualification extended beyond the industry window. On Ivy Bridge, we are working with IBM on the qualification. And, once we are done with Sandy Bridge at HP, we'll work with them on Ivy Bridge qualification.

Richard Shannon - Craig-Hallum

Okay. All right. Fair enough. Chuck, a follow-up to any of your comments not too longer regarding HP being by far the biggest consumer of high density server memory, you know, kind of looking far out or what you've seen historically, what kind of split would you expect just between those two. Is it like 2 to 1 or 3 to 1 HP advantage, or how do you compare that?

Chuck Hong

We won't know until the product ramps and I was referring to the historical consumption between HP, IBM in terms of high density server memory. We know that HP dollar-wise as well as particular unit-wise, they ship many more servers. IBM, they've also historically have consumed a higher percentage of high density server memory, so maybe the factor is 3 to 1, 4 to 1. That's a historical reference point and we'll have to see if HyperCloud follows that same pattern.

Richard Shannon - Craig-Hallum

Okay. Well, that's a good starting point. Thanks for that. Question on EXPRESSvault. You talked about that doubling in the fourth quarter and again in the first quarter. Can you characterize how many customers enter platforms that are driving this both last quarter and this quarter and maybe throughout this year? How do you see that going?

Chuck Hong

I think we have about four to five customers that are all in the storage space, many of them doing virtualization storage, data acceleration, that type of thing and we expect the business to grow. There are new customers and qualification. The product has been very well received. It's a plug 'n play into a PCI slot, and it is an integral part of the storage systems where the data is critical. So, we're very excited about that product taking off over the last couple of quarters and we expect it to continue to ramp through the course of this year.

Richard Shannon - Craig-Hallum

Okay. Great. I think that's all for me. Thanks a lot, guys.

Chuck Hong

Okay. Thank you, Richard.

Gail Sasaki

Thank you.

Operator

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.

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