Netlist Inc

Good day, and welcome to the NetList Third Quarter 2021 Earnings Conference Call and Webcast. All participants will be in a listen-only mode. Should you need assistance, please signal a conference specialist by pressing star then zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star then one on a touchtone phone. To withdraw your question, please press star then two. Please note this event is being recorded. I would now like to turn the conference over to Mike Smarjasi, Investor Relations. Please go ahead.

Thank you, Matt, and good day, everyone. Welcome to NetList's third quarter 2021 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 of the NETLIS website at netlis.com. Before we start the call, I would note that today's presentation of NETLIS 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.

Thanks, Mike, and hello, everyone. On today's call, I'm going to first provide a legal update, then we'll cover the product side of the business in the context of the current market. We'll start with Google. As you know from our previous calls, After a 10-year battle, Netlist secured a major victory against Google last year when the Federal Circuit Court of Appeals upheld the Patent Trial Appeal Board's decision that the claims of the 912 patent are valid. We are now working to establish the fact that Google infringed our patent and that their products have been infringing since we filed suit in 2009. As part of this process, Judge Armstrong, the judge presiding over this case in the Northern District of California, will hold a hearing on November 10th to address the issue of intervening rights. When a company seeks intervening rights, it is arguing that for certain reasons it shouldn't be held responsible for infringing on a patent during a specific time period. Google alleges that it shouldn't be responsible for any infringing acts against the 912 patent that occurred before the conclusion of the reexamination just last year, a period of approximately 11 years. Google argues that because of clarifying amendments netlist made to some of the 912 patent claims during the USPTO's reexamination proceedings, it should have intervening rights between then and the Federal Circuit's 2020 ruling on the patent's validity. If the judge rules that Google can claim intervening rights, NETLIS would be limited in the scope of its assertion of the 912 patent. If the judge rules that Google has no intervening rights, Google would be subject to NETLIS' patent infringement claims and subsequent damages for infringing acts over the course of those 11 years. Alternatively, the judge could grant Google intervening rights for some claims of the 9-12, but not others. We, of course, believe that Google does not have intervening rights for the period in question and have submitted convincing arguments to that effect. We are optimistic that the court will decide in netless favor on the issue of intervening rights making way for us to pursue significant royalty payments and potentially damages for that entire period. In terms of the timeline, we would expect the court to rule sometime before the end of the year. Once the court rules on the issue of intervening rights, this case will proceed to the markment process, also known as claim construction. NETLIS will submit its opening markment brief by January 21st. Google will have until February 4th to respond, then we will have a week to respond to Google's brief. Afterwards, the Markman hearing is set to begin on March 9th. Markman hearings are held for the court to define the key terms used in patent claims. These definitions are then used to determine the extent of infringement. So the Markman ruling is typically a pivotal moment in patent litigation because the definition of claims will, in turn, inform the likely course of the legal outcome. After the Markman hearing, the case will move to jury trial where arguments from both sides will be presented to a jury regarding whether Google has used and continues to use our patented technology without a license. If Google is found to have infringed the 912 patent, it will be subject to damages for past infringement and have to purchase a license from us if it wants to keep using our technology or stop using our patented technology entirely. I should note that Judge Armstrong is the same judge who heard our original case in 2009 and is familiar with the history of our lawsuit. Let's now move on to Samsung. On October 14th, the US District Court for the Central District of California granted summary judgment in Netlis' favor. finding that Samsung had committed material breaches of contract. This is a major victory for us as the order confirmed that Samsung no longer has a valid license to Netlist patents and therefore requires a licensing agreement. The judge reached this decision after finding that there was no dispute as to any material fact in the case and therefore Netlist was entitled to judgment in its favor as a matter of law. The facts were clear and the summary judgment granted in Netlist's favor is a strong validation of the positions that we took in the case. While the court denied our request for consequential damages, the jury will decide on direct damages during the trial in the federal court in a few weeks. Direct damages include the extra money we had to pay to secure components from other suppliers instead of purchasing directly from Samsung for a certain period of time. Consequential damages would have included our lost profits from the business we could not conduct due to Samsung's failure to supply us as required under the contract. After the court issued the summary judgment, Samsung took a predictable step and filed for declaratory judgment in the U.S. District Court for the District of Delaware. asking the court to rule that Samsung does not infringe on certain of Netlist patents, and these patents are unenforceable. In the filing, Samsung alleges that Netlist did not offer reasonable and non-discriminatory licensing terms and conditions per JETIC requirements. Netlist believes that Samsung's declaratory judgment is entirely without merit, except for the fact that it is an admission that they do not have a valid license to Netlist patents. Indeed, Samsung cited as part of its justification for the filing that its customers, including Google, have sought indemnification to cover the potential liability created by Samsung's lack of valid license to Netlist patents. Filing the declaratory judgment, which is limited in scope, Samsung is seeking relief. In the event Netlist decided to bring a patent infringement suit against Samsung in the future, The net list is patents 523, 595, 218, and the 912. Samsung has also filed IPRs on the 523, 595, and 218 patents. The 912 is not included in the IPRs. IPRs stand for inter-party re-exams. Finally, I'd like to give you a brief update on Micron. The federal court in the Western District of Texas has consolidated our two patent infringement cases against Micron. The judge has scheduled both the court hearing and a Markman hearing for March 31st, 2022. Based on the local rules of this venue, discovery will begin once the Markman hearing concludes. The fact that Judge Albright heard our patent infringement case and conducted our Markman hearing against Hynix provides the court with a certain level of technical familiarity with these patents. Moving the three cases through the legal process last quarter required an all-hands-on-deck approach as we addressed mediations, hearings, and discovery. For example, in the Samsung breach of contract case, we managed 25 depositions and processed more than 800,000 pages of discovery documents. Much of it dropped on us in the 11th hour. We believe we have a strong position in all of the cases and that our ongoing investments in the litigation will pay off in a major way. Whether through the judicial enforcement or good faith negotiations, We look forward to entering into licensing agreements with these companies, which fairly compensates Netlist and its shareholders for the value of our intellectual property. That concludes the legal update. Now, I'd like to turn your attention to the product business. As you know, the market is experiencing a period of turbulence. Memory chip stocks have retreated from a peak earlier in the year. Goldman Sachs expects PC demand to fall 12% year over year in 2022. Meanwhile, slow economic growth in China, along with a clampdown on the country's big tech, have depressed demand for memory and storage in Asia. We are seeing weak spot prices for DRAM since the end of the third quarter as supply started to exceed demand. Customers have aggressively stocked up in the first half of the year and are sitting on good amount of inventory. As a result, DRAM ASPs remain under pressure in Q4. That said, outside of DRAMs, the global chip shortage is by no means over. In fact, the Wall Street Journal last week noted that it is worsening. Hoarding is commonplace, and wait times for chip deliveries continue to lengthen. Disruption in the supply chain and marketplace are substantial, and some analysts now expect shortages to last until 2023. Our Q3 top line results reflect some of these disruptions. The revenues came in lower than anticipated due to both shortages of some components required to fill booked orders, while at the same time we saw a drop off in demand for memory modules. Bottom line loss was larger than expected, largely as a result of increased investments in R&D for CXL and increased legal expenses from the three concurrent litigations. Some of these costs were offset by the increased revenue from our Heineck Supply Agreement and by continued healthy demand for netless SSDs. While Netlist is not immune to current market turbulence, we see a number of positives that keep us in a bullish frame of mind. One of the positive trends is the change in the profile of the memory and SSD buyers. Whether they are HR and accounting firms or global service behemoths, many of the high volume customers today are cloud service providers. Companies like ServiceNow, Netflix, eBay, Twitter, Uber, LinkedIn, Instagram, or Facebook are directly configuring servers that run their applications. In the past, they used to just accept whatever server configurations that the box makers were selling. But these days, they are dictating exactly what components they want in their servers. Performance matters a great deal to most of these cloud service providers. they understand things like how quickly data gets pulled out of an SSD drive and the impact of that speed on the performance of their applications. So rather than accept what comes prepackaged, they are now telling the box builders to buy a specific memory, a certain SSD, this controller, or that CPU. It is in this context that a high-end SSD product like our N1962 NVMe SSD and really shine. The qualification process is rigorous and time consuming. It can take six months and longer to qualify a single product. That said, we think that once the cloud service provider and software as a service customers, CSP and SAS customers, learn more about our high performance products, they will start to request more of them. These companies represent the top quartile of the enterprise customer pool in terms of stickiness and the length of product life cycles, some that can extend three to four years. For the past 40 years, companies like ours have sold almost exclusively to OEMs and box builders. Today, our end customers are the companies that provide cloud services and social media platforms that businesses and consumers depend on. This is how the customer base is changing, and we believe we are well-positioned to take advantage of this evolution in the market. Closing, despite the market volatility that impacted us in Q3, we believe that Netlis is on the right track. We are bullish about the future, and we are backing it up by investing in our company's core areas, CXL controller R&D and patent licensing. We are expanding our sales and marketing organization with experienced sales and marketing talent with access to the cloud customer base. We have also begun working closely with Hynex on the supply side to explore potential cooperation on hard-to-source components for the industrial market. Over the coming quarters, we plan to refresh and expand our product line, grow the patent portfolio, and diversify the licensing revenue stream. The end goal is to extract the most out of our intellectual property and achieve strong and sustained growth. I'll now turn the call over to Gail for the financial review.