Netlist's (NLST) CEO Chuck Hong on Q1 2016 Results - Earnings Call Transcript

| About: Netlist, Inc. (NLST)

Netlist, Inc. (NASDAQ:NLST)

Q1 2016 Earnings Conference Call

May 17, 2016 05:00 PM ET

Executives

Mike Smargiassi - IR, Brainerd Communicators, Inc.

Chuck Hong - Chief Executive Officer

Gail Sasaki - Chief Financial Officer

Brian Peterson - SVP of Sales and Marketing

Analysts

Richard Shannon - Craig-Hallum

Operator

Good afternoon and welcome to the Netlist First Quarter 2016 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today's presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note, this event is being recorded.

I would now like to turn the conference over to Mike Smargiassi with Brainerd Communicators. Please go ahead.

Mike Smargiassi

Thank you, Laura and good afternoon, everyone. Welcome to Netlist’s first quarter 2016 conference call. Leading today’s call will be Chuck Hong, Chief Executive Officer of Netlist and Gail Sasaki, Chief Financial Officer. Joining Chuck and Gail today is Brian Peterson, Senior VP of Sales and Marketing. As a reminder, our earnings release and a replay of today’s call can be accessed on 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 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. 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. It’s been a great start to the year, as we focused on execution of the company's three target initiatives. One, commercialization of HyperVault technology, two, monetization of our IP portfolio, and three, the ramp of product revenues. I'll cover the first two items and then hand it over to Brian to cover the third initiative.

Let me begin by noting the tangible progress we have made towards bringing the HyperVault technology to market. The first quarter financial results reflect completion of milestones during the quarter, allowing us to recognize $3.4 million of the $8 million in NRE from the joint development agreement with Samsung. Netlist and Samsung have committed to a five-year collaboration to develop and commercialize this technology. The initial phase is on track to be completed by the end of the second quarter, culminating in a private demonstration for Samsung only of the industry's first unified memory-storage product.

The architecture of HyperVault allows terabytes of SSD storage to operate side-by-side with DRAM memory in the memory channel. CPU will no longer have to make the slow long track down to the southbridge or to the PCIe channel to fetch and write large chunks of data. Everything can be done much faster, if most of your data, both in memory and storage, can be processed from one location.

There have been other attempts to bring large amounts of storage into the memory channel, but up to now, no one has been able to figure out how to move and process that storage at the speed of memory. HyperVault does just that through a combination of breakthrough architecture and enabling software and hardware protocol. Using NAND to replicate DRAM performance is important to the industry as NAND continues to scale rapidly, while DRAM scaling has slowed.

On the demand side, in-memory computing and big data applications are exploding, but existing memory and storage hardware are straining under intense processing burdens and unable to keep up in cost effective terms. Thus, as demand grows and supply constraints converge, the need for storage cost memory will accelerate and we believe that HyperVault will emerge as the most pragmatic solution in this product category. HyperVault will utilize existing DIMM sockets and most importantly leverage existing raw materials, DRAM and NAND. With Samsung's expertise in these proven raw materials, we believe we're well positioned to bring the market -- bring to market a very cost effective product that provides unprecedented performance and data throughput and latency benefits to our customers.

In recent months, we have also turned our attention to monetizing our industry-leading patent portfolio, which continues to grow and strengthen. The reexamination of the seminal ‘537 patent recently ended with Inphi's decision to forgo further appeal to the US Supreme Court, following the Federal Circuit's denial of its request for rehearing in January of this year. This closes the book on an unprecedented five-year reexamination process and it is truly a landmark victory, as there are no other patents in this space we know of that have gone the distance. A ‘537 patent is now a highly valuable patent covering load reduction, the fundamental feature that sets LRDIMM apart from RDIMM.

The USPTO will now take the administrative steps necessary to issue a reexamination certificate later this year with the 60 validated claims. However, the ‘537 is only one of a number of battle tested seminal patents in Netlist’s LRDIMM portfolio. The ‘185 patent for example covers the fundamental distributed buffer architecture of DDR4 LRDIMM. SanDisk and Smart Modular, both challenged the validity of the ‘185 through Inter Partes Review process. In both cases, the PTAB found no basis to institute the IPR review.

We've also seen significant successes with our self-test family of patents, including the ‘434 and ‘501 patents, which cover important features widely used in many products, including LRDIMMs. The PTAB has now conducted full reviews of both patents and to date has confirmed the validity of 15 total claims across both patents.

Our years of research and development efforts dating back to the early 2000s allow Netlist to first market -- to be first to market with disruptive new technologies like HyperCloud, NVDIMM and now HyperVault. HyperCloud was the first product to incorporate the load reduction concept disclosed in the ‘537 patent and the distributed buffer architecture disclosed in the ‘185 patent. The industry adopted the HyperCloud architecture years later for DDR4 LRDIMM, which is now being shipped in volume and will continue to grow in coming years as the limits of RDIMM technology are reached.

Netlist was also first to market with an NVDIMM product and our patent portfolio reflects our position as the earliest innovator in the field. Our NV patents have also fared well under scrutiny. For example, SanDisk and Smart Modular each challenged Netlist’s 833 and 187 patents which cover fundamental architectural features of hybrid memory. The PTAB found no sufficient basis to institute the IPR process for either the 833 or 187 patents. We anticipate that our Hybrid Memory Patent portfolio will continue to grow and strengthen and will help facilitate the company's efforts to bring new storage class memory products to market. The fact that our patent portfolio has fared so well even under the most intense scrutiny confirms our singular position as the earliest innovator in the field. Netlist continues to pursue licensing opportunities in these fast growing markets and we are having active discussions in this regard.

I would now like to turn the call over to Brian Peterson, our Senior VP of Sales and Marketing, who will provide an update on our products business.

Brian Peterson

Thank you, Chuck. I'm pleased to provide an update on our customer engagement and product traction. During my first full quarter with Netlist I have been very active in the field with customers and partners along with my team. I'm excited to see the broadened awareness of our technology which has translated into new potential customers, many of whom have reached out to Netlist based on our efforts.

Let’s jump right in with progress on our EV3 product which is our PCIe based non-volatile memory card. We have received the second round of POs from several customers who are progressing to their full system level testing with our product. These customers are preparing to launch their products with EV3 integrated later in the year. The other encouraging progress is the new uses for EV3 which we have identified in conjunction with customers and partners. These include uses in open systems tied to application specific purposes in the category of software defined solutions. This is a growing segment of the market and an exciting new opportunity for our EV3 offering.

Moving to MV4, our DDR4 NVDIMM product, we’ve seen great signs that customers are recognizing the value of our technology and we are pleased with their feedback. We have multiple customers who have or expected to place POs for system level test quantities. In fact we've doubled the amount of sample customers for our NV products since our last call. We have expanded the sample customers in both the fixed appliance space and with open system solutions, which helps increase the addressable market for our technologies since it directly ties more of the volume server shipments going into enterprises. We've also provided samples to Samsung who is our development partner for HyperVault for storage class memory but they are also now actively testing both our NV4 and our EV3 products based on the interest in the market.

Let me transition to a general summary about our technology and encouraging signs in the market. I believe it’s important to outline some of the key barriers to adoption and the positive indicators which give us confidence moving forward. These barriers include, one, understanding. First and foremost, an understanding of what this new technology can do to improve system storage and application performance over the status quo. On this topic, we've been showing customers in the market at large how they can use our technology and what it can do for them. On this front we have seen recognition from many new customers and a significant increase in the appreciation for our solutions.

HPE’s recent announcement highlights support of NVDIMMs as an interesting technology to improve system performance. Netlist has referenced in the article by the Wall Street Journal about HPE getting behind non-volatile memory is a strong sign that much broader awareness of utilization is happening across the industry. This type of activity will be a tremendous benefit in moving our efforts forward with the non-volatile memory product offerings invented by Netlist.

Number two, enablement. This requires hardware and software to enable this technology in terms of system and software readiness. Related to this, we have seen more system providers preparing to support non-volatile memory. I am pleased to report that in working the market leader in the bio space support for Netlist products is now integrated into their main bio software that is accessible to all their system vendors.

Number three, commitment. While customers may understand that technology is valuable and it can be enabled for their use, they still must take action in order to deploy the technology. This requires both investment and engineering resources and capital investment to test our products and bring to market as a part of their product offering. As indicated, we've seen customers now engaging in this stage which is exciting and we expect many more to progress to this stage in coming months based on our customer interaction.

In summary, we're encouraged by the increased awareness and progress with our customer engagements. Although it is always challenging to align all of the elements, we are confident that is more about win, not if, these products will make it into customer deployments, because understanding has progressed, enablement of the systems is real and customers are taking action that shows commitment. We will see revenue in the second half of this year from these customers and look forward to sharing more as they progress with their testing and validation and move to utilize our technology in the market.

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

Gail Sasaki

Thanks, Brian. Our first quarter 2016 financial performance reflects the benefit of the joint development agreement with Samsung and highlights the high margin NRE revenue tied to that partnership. We were able to deliver a significant improvement in profitability which highlights the power of our model going forward as we transition our business to include partnership and licensing based revenues in addition to product sales.

Revenues for the first quarter ended April 2, 2016 was $4.6 million compared to revenues of $2.1 million for the first quarter ended March 28, 2015, an increase of 118% year-over-year and an increase of 58% from the previous quarter. Total revenue includes $3.4 million in NRE earned from our joint development agreement with Samsung. The NRE will be recognized as we execute on product development work under the partnership and is on pace to being fully earned by the end of June 2016.

Revenue from sales of our products was $1.1 million in the quarter which was shy of our plan for revenue dollars, but in line with our gross profit expectations due to a better product mix. We currently expect a modest uptick in product revenue in the second quarter.

Gross profit for the first quarter ended April 2, 2016 was $3.5 million, a 75% gross margin compared to $700,000, 33% for the first quarter of 2015.This significant increase reflects the profit earned from the Samsung NRE plus lower factory cost during the most recent quarter.

Net loss for the first quarter was $1.4 million or $0.03 loss per share compared to a net loss in the prior year period of $6.5 million or $0.14 loss per share. These results include stock-based compensation expense of $500,000 for the first quarter of 2016 as well as for the first quarter of 2015.

Adjusted EBITDA loss after adding back net interest expense, income taxes, depreciation, stock-based compensation and net non-operating expense was a loss of $800,000 for the 2016 first quarter, compared to an adjusted EBITDA loss of $5.3 million for the prior-year period.

Operating expenses were $4.7 million in the first quarter of 2016 compared to $6.7 million in last year’s first quarter, a 30% decrease year-over-year. During the first quarter, we continued to make targeted investments focused on HyperVault development and marketing, licensing and enforcement efforts, as well as worldwide sales and marketing for NV4 and EV3. As an example, we opened a sales and marketing office in Seoul to grow and service Asia-Pacific sales as well as to support the Samsung partnership.

We ended the quarter with cash and cash equivalents and restricted cash of $15.3 million, as compared to $20.1 million at the end of the fourth quarter. Cash used in the quarter included the funding of operations and pay down of some one-time liability. We will remain disciplined in managing our expenses, while continuing to invest in future growth. We continue to have a much stronger balance sheet as a result of the collective actions executed last quarter, which includes the $15 million of long-term convertible debt from Samsung.

The terms of which make us essentially debt free with no debt service payments and automatic conversion to equity on these dollars at the end of six-year of the six-year term, and no restricted financial or operating covenants nor any anti-dilution protection for Samsung.

During the first quarter, we also renewed our working capital line of credit with Silicon Valley Bank, under a more favorable churns, including a better interest rate, along with elimination and relaxation of financial covenants. The line continues to have a total capacity of $5 million limited by 80% of our accounts receivable balance.

Before turning the call back to Chuck, I would like to announce that we will be presenting at B. Riley & Company’s 17th Annual Investor Conference next Thursday, May 26, and we look forward to meeting with many of our institutional investors there.

I will now turn the call back over to Chuck for concluding remarks.

Chuck Hong

Thanks, Gail. As the industry continues its transition to hybrid and storage class memory, we believe our strategy with its products, strategic partnerships and licensing efforts allows us to bring innovative solutions to market. Our partnership with Samsung to design and market HyperVault storage class memory is advancing. And as our patent portfolio continues to grow and strengthen, we are focused on capturing licensing opportunities as well as leveraging our IP assets to drive the adoption of breakthrough products in the marketplace.

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

Question-and-Answer Session

Operator

[Operator Instructions] And our first question will come from Richard Shannon of Craig-Hallum.

Richard Shannon

Chuck, Gail and Brian, thank you for taking my questions. Well, the prepared remarks here got a number of questions on some of these topics you brought up here and I guess in no particular order. Chuck, maybe let’s delve into the progress and your confidence level on the HyperVault demo you are doing with Samsung, it sounds like you’re pretty confident this is going to finish here in the second quarter. Can you give us a sense of why you have so much confidence? And also, does that – how does that lead to follow-on agreements with Samsung, is that a kind of automatic, or is that negotiation after completion of the demo?

Chuck Hong

Okay, Richard, I think we can take that in reverse order. In terms of what can happen after validating the technology, we go back to the joint development agreement that we have and that calls out for joint development activities between the two parties and we set out a number of milestones in that process. And once those milestones are achieved, there is a second phase potentially of this agreement. There is a refusal of first right that Samsung has to potentially acquire the technology. There is also the possibility of a commercial relationship based on the technology. So that is laid out in the agreement itself.

In terms of your first part of your question, as to where we sit in the development, we are hitting the milestones that we have set out. There are various points where you can confirm the architecture or you can confirm the functionality of the product and then the performance levels of the product. So at this point, we are on pace to hit those milestones. And as we indicated, in the prepared remarks, we are planning to finish out the development by the end of this quarter and conduct a demonstration of the functionality and the performance. So that’s where we stand.

Richard Shannon

Okay. Appreciate that. Maybe a couple of questions for Brian based on his prepared remarks. Let’s see here, Brian, I wanted to make sure I understood your statements about expecting to see some I guess – probably didn’t get the language right, but more meaningful revenues, net product revenues in the second half of the year. Can you be more specific in case I, hopefully I didn’t - more specific on which product you expect to be ramping first and which one in higher trajectory and where do you expect those to ramp?

Brian Peterson

So it was a bit blended there, Richard, I think that wasn't necessarily by design but it is because we are seeing customer testing stages lining up in sync as they are moving forward with that. So, as I indicated in our previous call, the overall potential revenues for EV3 and NV4 are hard to identify in [tight] [ph] terms but EV3 will be something that will be a product that carries for us for years forward. As I've mentioned, we have some additional use cases that can be used that will also go into other existing environments as opposed to going into new installations, where NV4 does need to go into new system installations. So that's where I think the difference would be is that if EV3 has potential that could carry it forward and make it even a larger market opportunity based on being able to drop into existing installed environments where NV4 does need to be tied and enabled with new system environments.

Richard Shannon

Brain also on the topic specifically on NV4, curious if you’re seeing any other companies either talking about and/or trialing competitive technologies. And also I think in your prepared remarks you talked about the article in the Wall Street Journal several weeks ago citing HP being interested in the technology. Has that driven any customers or potential customers to you because of that specifically?

Brian Peterson

Yes, it has, so I think trying to be cautious about my statement. I can say at this point in the short-term that I've been here that we have been able to meet with essentially every server and storage manufacturer out there, so that includes obviously the large multinational ones, it also includes ODMs and smaller appliance providers that are putting together other system solutions. So the awareness is definitely helping and it's helping as I'd indicated that people are coming to us, it's not just push on our side which is great exciting and just continuously give us more confidence that we will be able to move forward with customers now and preparing for future deployments.

Richard Shannon

And just anything on the competition side, are you seeing any other offerings either slideware or in real demonstrations being shown out there in the market?

Brian Peterson

Well, we are - for NV4, we are definitely seeing people out there, we are actually in the stage of, we introduced our product in January, which is later than some people had a DDR4 product in the market. The good news there although we were a bit late was that many of these deployments had not started yet. So we were able to intercept and get into the middle of the -- into the mix, and try and compete for those sockets and with those customers. As it relates to EV3 there's really one main competitive product and that was part of the company that was recently acquired. So we're seeing actually some of those customers who are utilizing that product that are coming to us also given concerns that that may not be a product line that the larger corporation is investing in the long term.

Richard Shannon

Maybe a question back to Chuck, you referenced the patents’ progress over the last quarter, curious what steps you take going forward, I think you mentioned something about and you put this in your press release about waiting for the patent issue via the administrative steps that the PTO takes. Once that issue is - what's your - what are the steps to go through and what kind of timeframe do you expect to see some external signs of success in licensing one or more patents?

Chuck Hong

Richard, I think we’ve indicated in the past that we continue to have discussions. We are making progress in these discussions, although given the nature of negotiations we can't talk in much detail. But in terms of indications publically I think the investors and the industry will only find out as to the result after we make them public. We are having active negotiations at this time.

Richard Shannon

May be I'll just throw a couple last quick financial questions to Gail. Gail, I think in your prepared remarks you talked about some improvement in product revenues in the second quarter, can you give us a sense of the scale of improvement?

Gail Sasaki

I'll hand that over to Brain.

Brian Peterson

So, I think Gail's comments were tied to the fact that at this rate in our current quarter we're on pace to be able to surpass the revenue in Q1. As indicated, we'll be able to do that at least modestly and we'll see that as the path that will help us getting on the revenue rolling in the direction we’d like to in the second half.

Richard Shannon

And to be clear, is that - when you talk about revenues, is that total revenues or product revenues?

Brian Peterson

I was referring to product revenues.

Richard Shannon

Gail, one last question from me and I'll jump out of the line. What kind of cash burn do you expect for the second quarter?

Gail Sasaki

For the next quarter probably looking at in the range of $4 million, with a decrease as we go into the second half, we believe with our net cash [indiscernible] line of credit, we definitely have sufficient runway to perform on these - the various initiatives which we discussed today.

Operator

And this concludes our question-and-answer session. The conference is now concluded, thank you attending today's presentation, you may now disconnect.

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