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spk03: Good day and welcome to the NETLIS second quarter 2022 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 the star key followed by zero. Later, we will conduct a question and answer session and instructions will be given at that time. Please note this event is being recorded. I would now like to turn the conference over to Mr. Mike Smarjasi with the Plunkett Group. Please go ahead, sir.
spk02: Thank you and good day, everyone. Welcome to NETLIS second quarter 2022 conference call. Leading today's call will be Chuck Hong, Chief Executive Officer of NETLIS, and Gail Sasaki, Chief Financial Officer. As a reminder, the earnings release and a replay of today's call can be accessed on the investor section 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. NUTLIST assumes no obligation to update forward-looking statements. I would now like to turn the call over to Chuck.
spk01: Thanks, Mike, and good afternoon. Good morning, everyone. Throughout the second quarter, we continue to build on the solid momentum created this past year. Product revenue more than doubled over Q2 2021 to $55 million as we continue to benefit from an expanding customer base and a more diversified product line and execution on the Hynix product supply agreement. NetList also ended the quarter with a strong cash position of $61 million, providing significant flexibility to support strategic initiatives across the business, including licensing and marketing and R&D. Overall, we've been quite pleased with the company's performance in the first half of 2022. Market dynamics, including demand and pricing, were favorable throughout the period. As a result, we deliver product revenue growth of 169% and product gross profit almost double compared to the first half of last year. As we enter the second half of 2022, the memory and SSD markets are experiencing a slowing in demand, particularly in the consumer segment. Recent commentary across the semiconductor and memory industries has shown noted a pullback in pandemic-related demand and the current economic environment faces key headwinds. As a result, there has been a reduction in the growth outlook for the market, including the enterprise and data center segments. While the current environment is one of broad pessimism, the long-term consumer and business trends driving the need for more efficient and higher performance memory remain intact. and we believe we remain well positioned to capitalize on this trend. On the product side, as we stated in our last call, one of Netlist's biggest growth drivers in terms of year-over-year performance has been its relationship with SK Hynix. This has been a strong partnership that continues to grow as we take advantage of special access that has allowed us to broaden the Netlist product offering to include discrete components, EMCPs, and DDR5 memory modules, as well as to expand into markets and customers not well supported by the major DRAM manufacturers. Our ability to access products quickly allows customers to meet constrained product schedules, while smaller customers with DRAM TAMs of less than five to $10 million per year, appreciate our ability to provide indirect access to SK Hynix factory resources and support. We look forward to capitalizing on these new opportunities as the sales and marketing team deepens its understanding of these product lines and the unique needs of each customer. Moving on to intellectual property. In the Google case, Chief Judge Seaborg of the Northern District of California listened to our arguments, and in May, entered an order in NETLIS's favor on the very important issue of intervening rights for Claim 16 of the 912 patents. The judge also set forth the conclusive finding that NETLIS should be entitled to the full period of damages available under Claim 16. In parallel, Judge Seaborg denied our request to add more details to our infringement contention charting. We do not believe that this denial will have a material impact on our case, as the scope of infringement will be determined through the discovery process. Following that order, Judge Seaborg paused the case for a 90-day period and reset the case management conference in California to October 27, 2022. That pause gave us time to learn the outcome of our early motion practice in Samsung's Delaware declaratory judgment action. Just yesterday, we received an order from Judge Andrews in Delaware dismissing Samsung's claim for declaratory relief under the 912.506.339 and 918 patents and denying Samsung's attempt to add the 054 patent to his suit in Delaware. I will cover these patents in a bit more detail in a moment, but the 506, 339, 918, and 054 patents are all subject to our action against Samsung in the Eastern District of Texas, meaning Samsung will have to face us on these patents in trial in May of next year. That's been scheduled before Chief Judge Gilstrap. We are very pleased with Judge Andrews' well-reasoned explanation for his dismissal and feel that this is a significant victory in our ongoing pursuit to ensure that Samsung and Google engage on fair and reasonable terms. We now look forward to seeing how Judge Seaborg approaches case management in California over the next couple months, given the recent losses Samsung suffered in Delaware. we remain committed to seeing Google answer for its long-term infringement of our proprietary memory technologies at trial. Netlist's patent infringement action against Samsung in the Eastern District of Texas involves six patents, all distinct from the 912 patent we've asserted against Google or the 3RDEM patent Samsung cited in its Delaware action. Netlist's complaint highlights Samsung's infringement of two patents relating to NETLIS's LRDEM technologies, two patents relating to NETLIS's on-module power management under the new DDR5 standard, and two patents relating to high bandwidth memory or HBM technologies. NETLIS is the leader in developing LRDEM technologies, having created many of the patents applicable to the technology. DDR5 is shortly expected to dominate the market for both server and consumer memory. HBM is the technology which is being quickly adopted for memory-intensive computing tasks. The latest generation of HBM chips are in high demand for a number of mainstream uses, including graphics and AI-assisted design and facial recognition systems. Altogether, the six patents relate to important memory technologies that will be used for years to come. Chief Judge Gilstrap of the Eastern District of Texas usually moves patent cases to trial very rapidly, and our Samsung case is no exception there. He has already set our claim construction hearing for October 14th, and as I mentioned before, the jury trial starts May 1st, 2023. The NETLIS case against Micron in the Western District of Texas is paused pending the resolution of the five IPR Micron filed against NETLIS. To that point, we received confirmation on July 19th that Micron's petition to institute an inter-parties review of our LRDM 608 patent was denied by the PTAB. We await the PTAB's decision on the pending challenging pending a petition challenging our NVDEM 833 patent, and we'll file our preliminary responses to Micron's twin petitions attacking the 314 patent. Since our first quarter call in May, we filed a new action against Micron in the Eastern District of Texas. Like the Samsung Eastern District of Texas case, this case against Micron before it's Chief Judge Gilstrap also involves DDR5 and HBM technologies. Finally, we filed cases against Micron, Samsung, and last week against Google in Germany for these companies' infringement of our European LRDEM patents, EP735 and EP660, both considered standard essential. We brought our suit against Micron and Samsung for their manufacturing and distribution of infringing modules, while we are pursuing Google's use of infringing memory modules in Germany. By their nature, German actions are different than infringement proceedings in the U.S. For example, in Germany, we will proceed in each action to a final oral hearing before the court alone. So far, we have oral hearings set for May 4, 2023, in our Micron Germany case, and September 5, 2023, in our Samsung Germany action. In addition to monetary damages, Netlist is also seeking injunctive relief in the Micron matter, receiving an injunction with me to complete bar on Micron use or sale of all infringing LRDEM modules within Germany. As with the U.S.-based cases, we are encouraged by the Dusseldorf Court's attention to our claims and its rapid scheduling of the final oral hearings next year. Now I will turn the call over to Gail for the financial review.
spk00: Thanks, Chuck. During the three months that ended July 2, 2022, product revenue increased 127%. growing to $55.4 million from $24.4 million. Product gross profit dollars were $4.7 million compared to $2.9 million in the year-ago quarter. Gross margins were 8.6% for Q2 2022 compared to 6.7% in the first quarter of 2022. The gross margin percentage positive variance between quarters is primarily due to product sales mix specifically an increase in resale product margins due to the ability to source hard-to-get products made possible by the strategic deal with SK Hynix. Operating expense for the second quarter was relatively flat consecutively. We continued to invest selectively in the sales, marketing, and engineering teams necessary to support sales and R&D acceleration. as well as in the legal fees related to IP and . As a reminder, we do not formally guide, but given the uncertainties within the memory market noted earlier and in line with the overall market, we currently expect Q3 22 product revenue to be softer than Q2 22. We continue to believe that trends in the long-term memory and storage industry market remain favorable and that we are well positioned to drive significant growth in year-over-year 2022 financial performance. We ended Q2 2022 with cash and cash equivalents and restricted cash of $60.6 million compared to $58.3 million at the end of the first quarter. We opportunistically raised approximately $2 million under the $75 million equity line of credit during Q2-22 and maintained significant financial flexibility and liquidity going forward with close to $60.4 million remaining on the line. And in addition, we maintained a $10 million working capital line of credit with Silicon Valley Bank to support revenue growth. We continue to carefully manage the operational cash cycle, which for Q222 resulted in a positive cash cycle of negative nine days. The cash cycle will continue to be key to our cash balances as we move forward. Operator, we are now ready for questions.
spk03: Thank you. We will now begin the question and answer session. To ask a question, you may press more than one on your touchtone phone. If you're using a speakerphone, please pick up your handset before pressing the keys. And to withdraw your question, please press star then 2. And at this time, we'll pause momentarily to assemble our roster. And the first question will come from Suji Da Silva with Roth Capital.
spk04: Please go ahead. Hi, Chuck. Hi, Gail. So in the earnings release, Chuck, you mentioned the product or in the prepared remarks you mentioned, The product line is diversifying to drive growth. Can you talk about what some of the newer products are that are helping drive some of the growth that are worth mentioning, noting?
spk01: Yes, Suji. During the quarter, we released a couple of new enterprise SSD products. We also have a line of DDR5 products. RDEM and LRDEM memory modules that we released. We are also working on a couple of projects that are in the tester memory testing space that are custom memory modules. Yeah, probably a half a dozen new memory module products, both DDR5 and DDR4, as well as a handful of enterprise SSD products released during the quarter.
spk04: Okay, great. And then maybe you can talk about the second half outlook versus the first. Given what you're seeing in the memory industry, maybe outside consumer, the enterprise market –
spk01: you know the expectation whether this is a shallow downturn or or perhaps more pronounced and also what's going on with the unit pricing dynamic as things soften here if I don't you know for for DRAM based memory you know it's because the supply base has consolidated over the years and the three major suppliers and the one, the couple minor suppliers, they are managing their inventories, you know, quite well and managing the flow of products so that it's not, you know, disruptive to the market. So there is, you know, there's been incremental declines in the ASPs for DRAM-based modules, and we believe that DRAM-based products and We believe that will continue, you know, through the second half. Things are supposed to come back to a more balanced market in the first half of next year. NAND, on the other hand, there are many more suppliers, and it's much more of a fragmented market. So, SSD pricing is declining at a higher rate probably you know, low teens from a percentage standpoint. So for both SSDs and DRAM-based memory, we believe the second half will be softer moderately than what we've seen in the last year.
spk04: Okay. And then this question, you know, it's been the supply chain has been tight for a while. The memory company has been busy. you've been trying to partner with guys like Hynex to develop. With this slowing, does that perhaps, either the supply chain or the development resources, does that open up opportunities that were not available when things were running hotter the last few quarters in the memory market, Chuck?
spk01: Well, for us, I think, you know, I don't think much will change in terms of the, you know, the activities. I mean, the that we're engaged in, particularly with the Hynix partnership. We're now about a year into that partnership, and we're becoming more tightly coupled with Hynix and working better. So I think things will improve in terms of our ability to get more niche-y, difficult-to-source products from Hynix. We're finding more industrial, testing, military type of applications from the last six months of marketing work that we've done. I think we'll continue to grow the relationship And, you know, things won't change very much. I mean, I think we'll build on the last year of work that we've done. Albeit, we'll be doing that in a softer market. So with, you know, lower ASPs, you have to generate higher volume in order to, you know, to maintain the revenue levels.
spk04: Okay. In the check, last question on litigation, a lot of moving parts in several cases. Can you just maybe highlight for us or summarize what some of the key catalysts coming up in the next few months are so we can know what to watch for in all these key cases?
spk01: Yeah, I think the Google, we have currently three major cases, Google, Samsung, and Hynix. And as we stated in the script, Google currently stayed for a 90-day period, probably another two and a half months before the case management conference in the Northern District of California. At that point, there will be decisions made and case schedules made. set out for the Google case, because now that the intervening rights has been established, which means we can look backwards on past infringement, there's obviously a go-forward infringement as well on the part of Google. But we will get clarity then. I think the Northern District of California judge stayed the case in order to give time for the Delaware case for the judge there to take action because Google and Samsung were claiming that their cases are related. And the order, the ruling that came from Judge Andrews of Delaware last night clearly stated that the cases are not related. In fact, he dismissed and threw out all of the claims that Samsung made in relation to the 912 patent, which is at the heart of the action against Google. So that brought a lot of clarity. So I think based on that ruling last night, we will see, you know, We will see more clarity out of the Northern District case against Google. Samsung is on fast track to get to trial in about nine months. There will be a claim construction, which will set out the key terms of the case, which is usually a very important event in a patent infringement lawsuit, and that will happen in October. So we're very busy working on that, working on discovery. Right now that is where bulk of the activity is occurring. And yesterday's ruling out of Delaware made also clear that the Samsung case against, the Samsung case in the Eastern District of Texas will remain there and that it has nothing to do with what's going on in Delaware. And then lastly, the Micron case has been, the Western District of Texas case has been stayed. However, there is a case now that's been filed in front of Judge Gilstrap in the Eastern District of Texas, which will, I'm sure we'll see a case schedule on that in short order. And then we've got action against all three parties in Germany, effectively covering, you know, most of Europe because this is a European EU patent. And there were, you know, we would be seeking, we are seeking injunctive relief against Micron, as well as, you know, damages, dollar damages. So a lot going on, and we're seeing we're making steady progress. We've got a very good team. I think the patents that we have today that's being asserted against these two parties are probably the best patents that we've ever had. Great.
spk04: Appreciate the recap, Chuck. Thanks.
spk03: This concludes our question and answer session as well as our conference call for today. Thank you for attending today's presentation. You may now disconnect.
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