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Netlist, Inc. (NASDAQ:NLST)

Q4 2013 Earnings Call

February 3, 2014, 5:00 PM ET

Executives

Corey Kinger - Brainerd Communicators, Inc.

Chun Hong - Chairman of the Board, President, Chief Executive Officer and Co-Founder

Gail Sasaki - Vice President and Chief Financial Officer

Analysts

Rich Kugele - Needham & Company

Operator

Good day, everyone, and welcome to Netlist's fourth quarter and full year 2013 earnings webcast and conference call. (Operator Instructions) At this time, I'd like to turn the conference call over to Ms. Corey Kinger of Brainerd Communicators. Please go ahead.

Corey Kinger

Thank you, Jamie, and good afternoon, ladies and gentlemen. Welcome to Netlist's fourth quarter and full year 2013 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 on the Investor Relations 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.

Chun Hong

Thanks, Corey, and good afternoon, everyone. I'm pleased to report that during 2013 we continue to make substantial progress toward our goal of transforming our business model. As you saw on the release today, we gained increasing traction in introducing our flagship product lines HyperCloud and Vault, while ramping down legacy projects.

We also took important steps towards further strengthening our intellectual property position, including a major victory in the U.S. Patent Trial and Appeals Board with regard to our seminal patents covering LRDIMM and allowances by the USPTO of critical hybrid memory patents.

In the fourth quarter, we posted a significant improvement in year-over-year results, primarily due to sizeable increases and demand for our NVvault family of products combined with our ongoing efforts to control our costs. As we look out into 2014, we believe market requirements will accelerate for both of our products and our IP.

As market demands for our product and our IP finally catch up, we are clearly moving from a products-only business to an IP centric company, with product sales and IP monetization at the core of our activities. All of our efforts in 2013 have been focused on increasing a rate of adoption of our products and technologies, and fully capitalizing on our patent portfolio.

We're now reaching a point where we see a technology paradigm shift, with our new product lines ramping and IP monetization realizable, as storage and memory performance demands increase. Our technology is ahead of the curve and readily able to address the market.

In fact, our extensive IP portfolio consisting of seminal patents defines the emerging storage and memory technology shifts we are seeing today. This shift is reflected in our fourth quarter revenue traction and margin growth.

We attained a major milestone for our NVvault family of products marked by the shipment of our 50,000 NVvault DIMM into the NAS storage market during the year. Leading storage vendors such as Cisco, Nimble Storage, Dell and Avere had designed our NVvault technology into their storage appliances, and are just beginning to ramp, as we enter 2014.

There's been a fundamental change in the way NVvault product is used in the storage space. We invented this hybrid memory product five years ago, and supplied companies like Dell and Compellent for many years. At those customers, NV was used as a data backup and disaster recovery product.

Now, the new storage companies like Whiptail, Century and Nimble Storage have found a way to leverage the PCIe channel, to use NV as a data accelerator, much like a turbo charger for storage. New important uses for the same product is at the heart of this renewed demand, a potential for accelerated demand for NV.

Further, we have been working with Intel over the past two years to take the next logical step that is enabling NV from PCIe channel to the fastest bus available, the memory channel. With this, NV will be placed alongside DRAM main memory to act as both real-time data backup as well as data acceleration.

As a result of finding these new improved applications for NV, we expect that the industry will consume NV in much higher volume over the coming years. The market for NV is expected to increase from $300 million last year to over $1 billion in 2015, and grow at a rate of 45% compounded annual growth through 2017.

This opens up very large markets for the Netlist invention. We will service this market with our own product, but there will also be industry-standard generic versions of NV for which our IP will apply. So the growth of the NV market represents both, the large opportunity for the product sales as well as patent licensing.

Our larger density 32-gigabyte HyperCloud has been qualified for both HP and IBM. During the fourth quarter, these modules became officially available for purchase, and in addition both our 16-gigabyte and 32-gigabyte HyperCloud memory modules were selected as the default memory option on IBM system x3650 M4 Virtualization Solutions. We continue to believe that volume usage of 32-gigabyte HyperCloud will materialize during 2014, as the demand for high density and high performance memory multiply from 2013 levels.

Finally, we also took important steps during the year in strengthening our team to prepare our IP assets for monetization and that was done through: one, a strategic relationship and financial backing of Fortress Investment Group; two, the addition of former Broadcom Executive, Noel Whitley, as our VP of Intellectual Property; and three, the addition of new board member, Blake Welcher, as an Executive at DTS, with an extensive background in worldwide licensing operations.

In a moment I will discuss the progress we are making in our licensing strategy, including the recent major victory at the Patent Trial and Appeals Board at the USPTO, but first let me turn the call over to Gail for the financial review for the quarter and the year's results. Gail?

Gail Sasaki

Thanks, Chuck. Revenue for the fourth quarter ended December 28, 2013, was $7.7 million compared to $6 million for the first quarter of 2012, and up by 79% consecutively. Gross profit for the fourth quarter of 2013 was $1.9 million compared to a gross profit of $837,000 in the fourth quarter of 2012 and also up 4 times consecutively.

Net loss in the fourth quarter was $1.6 million or $0.05 loss per share compared to a net loss in the prior period of $4.1 million or $0.14 loss per share, with an improvement of 48% from the prior quarter. These results include stock-based compensation in the fourth quarter of $423,000 compared with $371,000 in the prior year period, and depreciation and amortization expense of $310,000 compared with $446,000 in the prior year's fourth quarter period.

Adjusted EBITDA loss after adding back net interest expense, income taxes, depreciation, stock-based compensation and net non-operating expense was approximately $500,000 for the fourth quarter of 2013 compared to an adjusted EBITDA loss of $3.1 million for the prior year period and improved by 75% consecutively.

Operating expenses were $3.1 million in the fourth quarter of 2013, a substantial decrease from $4.7 million from the prior year's fourth quarter and down slightly also on a consecutive basis. Topline fourth quarter revenue performance beat consensus expectation by 67% and bottomline performance beat consensus by 47%.

The substantial improvement in our fourth quarter results primarily reflect an increasing demand for our NVvault family of products over the prior quarter, combined with our ongoing efforts to aggressively control our cost.

Gross profit over the next few quarters will continue to be dependent on a number of factors, including revenue, unabsorbed manufacturing capacity, change in product mix as well as higher cost of materials, some of which we may not be able to pass through in form of higher ASPs. We will continue to focus on managing our quarterly operating expenses, while targeting product execution, including strengthening our patent portfolios for both our HyperCloud and NVvault product families.

We ended the fourth quarter with cash and cash equivalents and restricted cash totaling $7.8 million, roughly in line with the $8 million at the end of the third quarter, reflecting a minimal cash burn consecutively. Year-over-year our cap cycle improved by 106 days, mainly from improved inventory turn.

We believe that the improvement in the cash cycle and momentum in product demand coupled with support from our financial partners, Fortress Investment Group and Silicon Valley Bank, will result in continued financial stability. Just as a reminder, Silicon Valley Bank provides us with a line of credit of up to $5 million collateralized by our accounts receivable.

We had untapped capacity on this receivables base line of credit for working capital needs of approximately $4 million at the end of the fourth quarter. Also during the year we closed a significant agreement with Fortress Investment Group, validating the increasing value of our patent portfolio. $9 million of availability remains under this agreement to draw, as we reached our milestone.

In closing, from a fiscal perspective, we believe we are well-positioned to grow and our focused along with the rest of the team on aggressively executing our plans.

I'll now turn it back over to Chuck.

Chun Hong

Thanks, Gail. And a major development for our company and industry, in January, the Patent Trial and Appeal Board of the U.S. Patent and Trademark Office, issued a decision upholding the validity of all 60 claims in the reexamination of our 537 patent, which was brought by Inphi Corporation.

The PTAB dismissed every single validity challenge raised by Inphi and affirm the examiners decision to allow the claims of our patent. These claims have directed to fundamental concepts of load reduction and rank multiplication, which are integral to the design of LRDIMMs.

The PTAB's decision is a significant victory for Netlist and a notable milestone and the build-out of our industry-leading patent portfolio of high performance server memory. We are unaware of any other portfolio with battle-tested patents that cover more features of the LRDIMM architecture.

In fact, we believe the 537 patent is the first patent related to high performance server memory, particularly LRDIMM to survive the rigorous of a 3.5 year reexamination all the way to a decision from the PTAB. We believe this decision by the USPTO will help accelerate our patent monetization efforts with a wide range of industry participants, as the market for LRDIMMs grow at a rapid pace.

According to the DOs and associates, the market for LRDIMMs is expected to increase from $300 million in 2013 to $1.3 billion this year and grow to $6.6 billion by 2017, a compounded annual growth rate of 108%. With this victory at the patent office validating the seminal position of our LRDIMM patent portfolio, we believe that we are in a strong position to prevail in a number of pending litigation involving high performance server memory.

In another major development last week, the USPTO issued Notices of Allowance for two more of our pending patent applications, covering core aspects of hybrid memory systems that combine DRAM and Flash memory technologies. Hybrid memory systems combine speed, endurance and reliability of DRAM with persistence high-density and low cost of Flash. The claims contained in these new patents cover innovations critical to facilitating the movement of data between a host system and a DRAM memory, and between a DRAM and Flash memory subsystems.

The rapidly expanding market for the fusion of memory and storage is an important area for our company. Enterprise Flash solutions, of which Hybrid memory modules and memory channel interface SSDs are part of, are projected to be an $8 billion market by 2017. We are proud to be a technology leader in this transformation and we see significant opportunities for current and future products as well as patent monetization.

We are also continuing to pursue an aggressive monetization strategy for unlocking the value of our intellectual property for the benefit of our shareholders, including pursuing enforcement actions in certain instances, where our IP rights are being violated. In this regard last year, we filed an amended complaint against Smart Modular, Smart Storage, Smart Worldwide Holdings and Diablo Technologies, one of Netlist's design contractors for HyperCloud.

The original complaint now alleges that the UltraDIMM product created by Diablo for Smart Storage Systems infringes five Netlist patents. The amended complaint also alleges trade secret misappropriation against Diablo, based in part on Diablo's misuse of Netlist trade secrets to create the UltraDIMM product.

And recently we added two new patents to the infringement case that are generally related to low-reduction and critical features in low latency memory modules, which were just upheld by the PTAB following their reexamination. We are vigorously pursuing these violations of our intellectual property rights.

We are also aggressively pursuing an investigation into Diablo's theft of our trade secrets. Products like the UltraDIMM, which combined DRAM and Flash technologies to improve storage performance are covered by our patents and represent a substantial market opportunity for us, a market that UBS expects to generate $1 billion in revenue by 2017, as part of an overall $10 billion market. That is why we invested in this technology and we will not let any company steal our patents and benefit from the time and money, we have spent in building our groundbreaking solutions.

So in summary, we are continuing to move forward and transitioning our business model and taking the necessary steps to unlock the value of our industry-leading products and IP assets. Both market demand for our products and our IP are starting to catch up and our results are beginning to demonstrate this progress.

Storage and memory performance demands are increasing, as social media and data-driven applications become mainstream. At the same time, our technology is ahead of the curve and readily available to address these requirements. This puts us in an optimal position to benefit, as our solutions address the market needs heads on.

We expect our momentum to continue throughout the year, as meaningful demand for our products materializes and licensing demand for our patents ultimately leads to monetization. As we execute our strategy, we will continue to maintain a disciplined approach to managing our expenses with a goal of prioritizing cash for continuing investment and future generations of our product technologies and enhancement of our patent portfolio.

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

Question-and-Answer Session

Operator

(Operator Instructions) And our first question comes from Rich Kugele from Needham & Company.

Rich Kugele - Needham & Company

Couple of question. First, Gail, can you just breakdown the revenue for us. How much was HyperCloud and the NVvault, et cetera?

Gail Sasaki

For fourth quarter our vault family EV and NV was 37%, PERC was16%, HyperCloud 10%, VLP 12% and Flash and other 24%.

Rich Kugele - Needham & Company

And where there multiple customers for the increase in NVvault business or any other color you can talk about for the sudden surge and demand there?

Gail Sasaki

Well, it was kind of a combination of some of the customers that talked about.

Rich Kugele - Needham & Company

Cisco, Nimble?

Gail Sasaki

Well, Cisco actually was not included in Q4, but we have seen orders, which will be shipping in Q1, but Nimble, Dell, Avere.

Rich Kugele - Needham & Company

And so this is really the storage solutions to pointing it in a slightly different way?

Gail Sasaki

Yes.

Rich Kugele - Needham & Company

And actually in that vein, Chuck, can you just elaborate a little more about maybe the timing of when we'll see NVvault being deployed in the memory channel instead of as PCIe?

Chun Hong

Rich, I think there is a lot of growth in the PCIe from factor, and we call that the EXPRESSvault that is actually just starting, and that will continue through 2015. And for the DRAM channel, that work was done over the last couple of years with Intel, and I think the mainstream market will adopt that solution, DDR4. But there are a number of storage companies that are looking to go with NV side-by-side with main memory starting in the second of this year.

Rich Kugele - Needham & Company

I guess I was trying to then take one step further and say it will. As you look at the business model and the puts and takes you have in these various categories and deployments of the existing technologies. When you see as the most near-term IP monetization opportunity and if you have any maybe preliminary sense on magnitude?

Chun Hong

Well, I think you've known, and it's public information, that we've had pending litigation with a number of bodies in the high performance memory space, Google N5 smart modular, so forth. We've got this latest lawsuit, which involves the UtraDIMM, involve seven patents.

So I think as we get this kind of definitive ruling out of the government, it allows us and take those validated patents back to the courts in the litigation, and reengaged, reopen the litigation, some of those litigations are stay. And then you'll have just a patent infringement litigation. I don't want to put any odds on, when it's going to happen, but we believe it's going to be substantial. We are very confident in the strength of our patents and confident in its applicability to the LRDIMM as well as UltraDIMM, and other industry generic products.

Operator

And, ladies and gentlemen, I'm showing no additional questions. That does conclude today's conference call. We do thank you for attending. You may now disconnect your telephone lines.

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