Netlist Inc

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Good day, and welcome to the NetList first quarter 2023 earnings conference call and webcast. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. I would now like to turn the conference over to Mike Smarjasi. Please go ahead.

Thank you, Dave, and good day, everyone. Welcome to NetList's first quarter 2023 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 the NetList website at netlist.com. Before we start the call, I would note that today's presentation of NetList 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. NETLISD assumes no obligation to update forward-looking statements. I would now like to turn the call over to Chuck.

Good morning. Thanks, Mike. We apologize for the slight delay this morning with some technical difficulties that we had. So let's get on with the call. Last week, Netlist concluded its jury trial against Samsung in the Eastern District of Texas. The case addressed Samsung's infringement of five Netlist patents on three strategic product categories, DDR4 LR DEMS, all families of DDR5 DEMS, and high bandwidth memory, or HBM. Some brief descriptions about these products in order to better understand the scope and size of the coverage of NetList patents. DDR4 LR DEM is the highest speed and highest capacity memory for DDR4 servers manufactured today, and it was invented by NetList over a decade ago. DDR5 DEMs are the next generation of memory that just started to ship in volume and will be in production over the next decade. Years ago, Netlist created the intelligent on-DIMM power management system that allows DDR5 DIMMs to perform at higher speeds than the prior generation of DDR4 and DDR3 DIMMs, while using less power. Netlist's power management technology is now being deployed in high-end memory use for enterprise applications, as well as in the commodity-grade memory. used in all PCs operating with DDR5 memory. HBM is an acronym for High Bandwidth Memory, which is a technology that enables efficient three-dimensional stacking of multiples of memory array dies vertically to achieve an overall higher capacity. As the industry's push of traditional planar DRAM towards higher densities are constrained by the limits of physics, more and more HBMs are being used to reach the needed capacities. Netlist's unique and proprietary array stacking technologies allow HBMs to operate at lower electrical load and higher speeds while dramatically increasing their overall component capacities. Indeed, HBMs are critical to the operations of all high bandwidth compute tasks, including complex modeling driven by the latest cutting edge GPUs or large scale AI based systems like ChatGPT. Samsung has touted both DDR5 and HBM memory as their focal points for the future of their memory business. And collectively, these categories will likely account for the vast majority of Samsung's DRAM product revenues in the coming years. Both segments are very early in their product life cycles. Now on to the trial. The six-day trial resulted in a unanimous jury verdict and a decisive victory on all counts. The jury awarded Netlis $303 million in damages award against Samsung for their infringement. The verdict confirmed that all five Netlis patents had been infringed by Samsung, that none of Netlis' five patents were invalid, and Samsung willfully infringed those patents, and that money damages were owed to Netlis for the infringement of all five patents. The damages award was comprised of three components. First, the 339 patent, which read on DDR4 LR DEMS for the period of December 2021 through March 2023, and the sale of 610,000 units of infringing product. The jury awarded netless $33.2 million from Samsung. Second, for the 918 and the 054 patents, which read on DDR5 UDEMs, SODEMs, and RDEMs for the period of December 21 through March 2023 on the 918 patent. And then January 2022 through March 2023 on the 054 patent, the jury awarded net list $147.2 million for Samsung sale of 9.3 million units combined of all DDR5 DIMMs. And again, DIMM stands for Dual Inline Memory Module. And third, for the 060 and 160 patents, which read on HBMs, for the 10-month period only between May 2022 to March 2023, the jury awarded Netlist $122.8 million for Samsung's sale of $7.3 million of HBM2, HBM2e, and HBM3 components. The trial clearly highlighted the tremendous value of Netlist's patents and the unique solutions we provide. In fact, the jury saw evidence confirming that under oath, Many Samsung engineers could not point to a single commercially viable alternative for making the infringing products other than relying on Netlist's patented technologies. Nor could they point to any of the thousands of Samsung patents as covering the inventions claimed in Netlist 5 patents. We believe that these were critical pieces of evidence in the trial and a qualitative validation of the unique innovation NETLIS created years ago. In terms of next steps, the court will enter a final judgment following its assessment of post-trial procedures and filings. As all instances of infringement were found to be vocal, Chief Judge Gilstrap has the opportunity to enhance the damages awarded by the jury. This is a decision at the judge's sole discretion. There are avenues available to Samsung to appeal the jury's verdict. This is something we expect them to do and are prepared for. The deadline for anyone to file a notice of appeal is 30 days from the date of the entry of the final judgment, but that will necessarily follow post-trial briefings, which we believe will likely take a few weeks. As this ruling covers damages up to March of this year, Samsung is currently operating using netless technology without a license on these strategic products. As always, we remain open to discuss licensing of our patents with Samsung and any other party currently using our technology without permission. In light of this emphatic ruling, we expect to engage in more substantive bilateral discussions that build upon the attempts we've made in the past. Moving on to other IP-related actions, I'll now provide you a quick update that are part of NETLIS' global enforcement efforts. The case against Micron in the Eastern District of Texas, which is also before Judge Gilstrap, an address infringement for the patents that were part of the just-concluded Samsung trial, remains on schedule. claim construction is set for July 19th this year, with the jury trial currently set to begin on January 22nd, 2024. In the second set of cases against Samsung and Micron in the Eastern District of Texas, which were consolidated to streamline the pretrial process, each case involves the 912 patent and its related child patents. While the Samsung case also includes Netlist's patent number 608 relating to DDR4 LR DEMS. The addition of the 608 patent has already survived Samsung's IPR attacks. As the PTAB decided, Samsung's invalidity arguments did not have a reasonable likelihood of success. Same constructions are set for October 5, 2023 and jury trial are currently set to begin on April 15, 2024. In Germany, the infringement hearing for the Samsung case is set for September and Google hearing for November. The Micron hearing on EP660 is set for next week on May 4th. is the European analog to the U.S. 339 patent that was just the subject of our trial against Samsung in Texas and relate to DDR4 LRDEM technologies. Finally, in regards to the 912 patents IPR proceedings, as we reported on our last call, USPTO Director Vidal entered a decision in February that require the assigned PTAP board to reevaluate Netlist's request for discovery on the admitted relationship between Samsung and Google. This process has begun. Earlier this month, Netlist filed an opening brief as part of this new discovery process, set by the PTAP per Director Vidal's decision. Netlist and Samsung have since exchanged several such briefs the contents of which the Board will take under advisement as it reconsiders its previous decisions to institute an IPR claim against Claim 16 of our 912 patent. The last brief from SAMSUNG is due May 3, 2023. Accordingly, we anticipate that the Board will reach a final decision in the next month or so. Meanwhile, the underlying IPR process has been stayed by Director Vidal while the question of whether Google is a real party of interest is reconsidered. Lastly, I would like to thank the team at IRL and Manila for their tireless advocacy in the recently concluded Samsung case and the ongoing support of our investor base. Now I'll turn the call over to Gail for the financial review.

GAIL HACKETT- Thanks, Chuck. During the three months that ended April 1, 2023, total revenue was $9 million from $50.2 million the prior quarter of Q122. Gross profit dollars were $0.6 million from $3.4 million in the year-ago period, and gross margin was 6.2% for Q123 compared to 7.7% in the prior year's quarter. The increase in operating expense for the first quarter was due to increase legal expense related to the number of active campaigns and recent jury trial. We do expect legal costs to remain elevated through the rest of 2023. First quarter product revenue and product margin results reflect the ongoing downturn in the market due to memory industry oversupply and a very soft demand environment, the combination of which has also resulted in price pressure. Industry experts anticipate a continuation of the current market dynamics near term, with the hope of some easing toward the end of the year. That said, the long-term outlook for the overall memory market remains very optimistic. Netlist is actively participating in qualifications in preparation for sale of new DDR5-based servers, and we believe we remain well-positioned to capitalize on the strategic SK Hynix relationship as the market improves. As a reminder, we do not formally guide, but given the lack of visibility and market dynamics as noted earlier, we currently expect our Q2 23 product revenue to be less than Q1 23. We continue to maintain strong cost controls and are proactively managing the business given the current market outlook. This included the previously announced reduction in force in January. We ended Q1 2023 with cash equivalents and restricted cash of $36.6 million compared to $43.6 million at the end of 2022. During the quarter, we proactively raised approximately $10.5 million under the $75 million equity line of credit, with close to $49 million remaining on the line. As always, we continue to very carefully manage the operational cash cycle, which for Q123 was an improvement of 119 days compared to last year's Q1. Operator, we are now ready for questions.

We will now move to the Q&A session. The first question comes from Suji De Silva with Roth Capital. Please go ahead.

Hi, Chuck. Hi, Gail. Quick questions, first of all, on the litigation. Can you talk about, with Samsung, with the appeal coming and so forth, what are What is the timeline for the follow-through on the findings of the court of the damages?

Suji, yes, as stated in the prepared remarks, the post-trial activity to get to a final judge's ruling It will take a few weeks. And then after that, they'll have 30 days to appeal. So, you know, that's a predictable thing that they will appeal. But thus far, we are confident in the jury verdict, and we have no reason to believe that there are any – substantive things that they can point to in this verdict or in the trial.

Okay. All right, Chuck, thanks for that caller. And then can you just talk about the, I guess, the next Micron-Google combined case and how that is similar and different? I'm sorry, Microsoft's Micron-Samsung case and how that's similar or different to the Samsung case?

There are there are Two separate cases. There is a separate case against Micron that will start sometime middle of the year with claim construction. Some of the activities will start over the next couple months. And those cover many of the patents that were asserted in this last case against Samsung. and cover effectively similar technologies, DDR5 power management, LRDEMS, and high bandwidth memory. So we'll be in front of the same court, and it will be the same team from our side, Every case is unique and has its own set of facts. But in general, there will be similar patents covering similar technologies. So that is against Micron. And then there is a second case against Micron and Samsung on a different set of patents that cover the current high-volume products that are at DDR4. So you can look at the trial, the case against Samsung that just concluded, really as covering technologies that are just at their inception and that will go on for the next decade. That's DDR5 and HBM. These are very strategic technologies for Samsung as well as the other major memory suppliers. And then we can look at the second set of patents that are asserted in the combined case against Samsung and Micron as covering the current high volume products that they're shipping today and going back the last four or five years.

Okay, great. And then as to the upcoming Google case, can you talk about the differences there as well and the timeframe and what are the next milestones to watch for?

The Google case in the Northern District of California has been stayed pending the outcome of the second case against Samsung. The judge determined that there was a relationship there. Google case, we also have a case against Google in the District of Delaware. That's a combined case against Samsung and Google. And that's the third case that now I'm talking about. Google has its own particular exposure, which we believe to be significant. based on its own manufacturing of memory modules over a period of what we believe to be some 10 years, going back starting in the 2010s. So that's their own specific exposure, and that's the case against them in the Northern District that we filed. And then they've got also separate exposure if they're currently buying from SAMHSA. and they do buy extensively from Samsung, those products are unlicensed products. So patent infringement obviously has to do with people that are not licensed, that are building and supplying product, but also people who are knowingly buying from suppliers and sources that are unlicensed and infringing on others' intellectual property. So there's two sets of exposure for Google, and those are involved in two separate cases. One against Google alone in the Northern District of California, and one against Google and Samsung in the District of Delaware.

Okay, Chuck. Appreciate that clarification. Last question. If I take just a simple division of the damages by the patents and then the number of units you talked about in the prepared remarks, the timeframe probably is not as relevant there. Is that a proxy for the royalty rate that can be applied across these cases, or is there something specific about the Samsung damages case that might make that calculation not particularly accurate there?

Well, that is the jury's calculation and their decision. So that is the simple math. If we want to get to a per unit royalty, reasonable per unit royalty as determined by this jury, yes, you basically do simple math, simple division of the total damages that were rewarded by the number of units. that were shipped over that period of time. I think what is relevant in terms of the period of time is it was a relatively short period of time, about anywhere between a year and a year and a half, depending on the patent and the products. And that was determined by the judge at the outset of trial. What is important to note is that those volumes for those products, LRDEM notwithstanding, LRDEM DDR4 is a fairly mature product that has been shipping for now five, six, seven years. But HBM, particularly for Samsung, which is late to the game compared to Hynix. Hynix owns about 70%. of the HBM market, but Samsung is therefore quickly trying to catch up. The HBM volumes, as well as the DDR5 product volumes, are really probably the top of the first inning. It's a baseball analogy in terms of where they are in their life cycle.

Okay. Thanks, Chuck. Thanks, Gail. Congrats on the finding from Texas.

Thanks. Thanks, Suji.

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