Netlist Inc

Good day and welcome to the NetList second 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. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star then one on your touchtone phone. Please note this event is being recorded. I'd like now to turn the conference over to Mike Smargiasi. Please go ahead.

Thank you, Alan, and good day, everyone. Welcome to NetList's second 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 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'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 cautionary statements contained in the press release today. NUTLESS assumes no obligation to update forward-looking statements. I would now like to turn the call over to Chuck.

Thanks Mike and hello everyone. The second quarter 2023 product revenue increased modestly from the first quarter of the year. Results continue to reflect the continuing downturn in the memory market due to oversupply of components and lower demand. On the other hand, OEMs and hyperscalers are working through their inventories and recent industry forecasts have become more optimistic. We believe the market has bottomed and anticipates sequential quarterly improvements in the company's top line over the second half of the year. As we look at the current memory landscape, there are exciting and transformational developments taking place in server memory. Netlist's IP is important in enabling these new technologies. First, DDR5. The industry transition to this new standard is underway with Intel and AMD commencing volume production of DDR5 systems earlier this year. DDR5 is expected to be the prevailing memory standard through the end of the decade, and Netlist will benefit on the product side as we supply customers with new DDR5 memory. Netlist's innovative IP for intelligent on-module power management allows DDR5 DIMMs to perform at higher speeds than prior generations. while using less power. This technology applies to all DDR5 DEM form factors for enterprise servers, PCs, and laptops. Second, artificial intelligence. The rapid rise in applications utilizing generative AI has created tremendous demand for memory chips capable of performing parallel processing. This unique hardware allows for the concurrent processing of data, which is crucial for AI's complex computing models. In turn, parallel processing requires a special kind of memory technology, high bandwidth memory, or HBM, which currently has eight times the bandwidth of traditional DRAM. To get to these densities requires that HBM, the memory, must be stacked. And once again, this is an area where netlessness technology plays a key role. And third, MRDEM, or multi-rank buffer DEMs. This next-generation ultra-fast DDR5 memory is being designed to double the throughput of existing DDR5 DIMMs, eventually delivering speeds up to 17,600 megatransfers per second. And while the standard for MR-DIMM has not been finalized, the memory industry appears poised to once again rely on many of Netlist's technologies to enable MR-DIMM's functionality. These new technologies are transforming the memory marketplace and provide a strong platform for Netlis' growth. Given Netlis' strategic supply agreement with SK Hynix, a leader in DDR5 and HBM, and our innovative IP, we believe we are well positioned to capitalize on these trends. This includes the direct supply of these products to the market and the licensing of our IP. In fact, all major memory players are calling out both DDR5 and HBM as strategic business imperatives. Today, the large memory suppliers are focused on a rapid move to higher end, premium HBM and DDR5 products to support the strong demand for generative AI. Eventually, the entire marketplace will transition to these new technologies and exponentially expand the opportunity for Netlist. On the legal front, I'd like to begin with an update on Samsung action before Chief Judge Gilstrap in the Eastern District of Texas. On April 21st, in a unanimous verdict, the jury in this case awarded Netlist $303 million in damages for Samsung's willful infringement of Netlist's seminal inventions. The case addressed Samsung's willful infringement of five Netlis patents covering three product categories, DDR4LR DIMMs, all DDR5 DIMMs, and high bandwidth memory components. Beyond confirming Netlis' entitlement to damages for Samsung's willful infringement, it confirmed that Samsung, the largest memory producer in the world, used Netlis' technology without a license in the past. As we speak, Samsung continues to accrue liability every day for willfully infringing Netlist's patents for products that will make up the bulk of its memory revenues through this decade. At the end of May, the court held a one-day bench trial that gave Samsung an opportunity to seek relief from the $303 million jury verdict. Samsung sought equitable relief from the jury's award for their infringing DDR4 and DDR5 products. We look forward to receiving the court's bench trial order, and importantly, its final judgment. We expect Samsung will seek an appeal of the court's judgment, but Netlist is confident in the strength of the verdict and the careful trial procedures the court used in this case. Now let me give you a quick update on our other global enforcement efforts. The case against Micron and the Eastern District of Texas, also before Chief Judge Gilstrap, addresses Micron's willful infringement of the same patents and same types of products that were part of the successful April Samsung trial, including DDR4LR DEMS, DDR5 DEMS, and HBM. On July 26th, we had a claim construction hearing for terms and dispute by Micron. Prior to the trial itself, the claim construction is the most important predictor of outcome in a patent infringement litigation. On the day of the claim construction hearing, Magistrate Judge Roy Payne provided a tentative set of constructions. According to these tentative constructions received that morning, The court appears to have understood and adopted almost every NETLAS construction, providing 16 out of the 17 terms at issue in NETLAS's favor. We feel the hearing went very well and now look forward to the court's entry of a favorable claim construction order. Fact discovery for this case will close September 5th with NETLAS's opening expert's report due the same day. The final pretrial conference is currently set for December 20th, with the jury trial set to begin on January 22nd, 2024. And that was the second set of cases against Samsung and Micron in the same Eastern District of Texas venue. We've begun the claim construction process and are working toward the joint claim construction hearing set for October 5th. These cases are for infringement of large volumes and significant dollars of DDR4 RDEM and LRDEM products being shipped currently and in the past. Related to the ongoing case against Samsung and Google in Delaware, the Patent Trials and Appeals Board found the netlist's favor on its 523 patent relating to DDR4 LRDEM, determining that all claims were patentable. This Delaware case continues to move forward with claim construction briefing underway and a joint claim construction hearing currently set for October 20th in that court. You may recall Netlis' second case against Micron in the Western District of Texas was stayed last year. I'm sorry, Netlis' third case against Micron in the Western District of Texas was stayed last year. after reassignment to Judge Yackel, just days before the claim construction hearing was set to take place in May 2022. That case has now been reassigned to the Austin, Texas, Judicial Docket 2 pool for cases following Judge Yackel's retirement. Our case now stands ready for reassignment to another Western District of Texas judge. Additionally, the PTAB denied Micron's petition to institute and inter-parties review of our LRDM 608 patent, and even more recently, found that three claims of NETLAS' 035 patent were valid in a final written decision. We await additional PTAB review decisions in the coming months and look forward to the reactivation of this case. In Germany, the Dusseldorf Infringement Court moved our case against Micron to 2024 in consideration of a preliminary order from the German Federal Patent Court. The hearing addressing Samsung's infringement of our EP735 and EP660 patents remains set for September 5th of this year, with the hearing against Google set to proceed in November. As always, Netlist remains open to licensing on a fair and reasonable terms with any party currently using our technology without permission. Finally, I'd like to say a few words about steps we're taking to ensure that the patent rights of NETLIS and future generations of innovators are protected. On the previous calls, I've shared with you some of our efforts to engage elected officials in California and Washington, D.C. to help us highlight the challenges with current U.S. patent law, challenges that NETLIS has repeatedly experienced firsthand. This initial outreach resulted in NETLIS working closely with members of Congress to not only help draft important new patent legislation, but to provide support as the legislation moves through the process of becoming law. The summary of these efforts is the recent introduced PREVAIL Act. The PREVAIL Act would make it harder to invalidate patents over eligibility and would rein in the ability to use the Patent Trials and Appeals Board to delay or forestall inventive practicing entities like NETLIS from stopping competing infringers. Under the PREVAIL Act, patent challengers would get just one chance at the PTAP Board. They could no longer spread out petitions over time or engage in serial IPR attacks. We are thankful that congressional representatives considered issues facing innovative operating companies like us, and that they took the time to consider suggestions for reforming our country's patent laws. If enacted in its current form, the PREVAIL Act could go a long way to protect and promote innovation and competitiveness of American inventors. Now, I will turn the call over to Gail for the financial review.

Thanks, Chuck. quarter product revenue and product margin results reflect the ongoing downturn in the market due to oversupply and a lower demand environment, which also resulted in price pressure. That said, as discussed by Chuck, the outlook for the overall memory market is improving. We believe we are well positioned to capitalize on the strategic SK Hynek supply agreement as the market rebounds. As a reminder, we do not formally guide, but given the market dynamics as noted, we currently anticipate steady growth in product revenue as we move throughout the rest of the year. We ended Q2 23 with cash and cash equivalents and restricted cash of $31.4 million compared to $36.6 million at the end of Q1. We proactively raised approximately $11 million under the $75 million equity line of credit during Q2, with close to $38 million remaining on the line. As always, we continue to maintain strong cost controls and very carefully manage the operational cash cycle, which for Q2 23 was an improvement of 80 days compared to last year's Q2. Operator, we are now ready for questions.

We will now begin the question and answer session. Our question comes from Suji Da Silva of Roth Capital. Go ahead.

Good morning, Chuck. Good morning, Gail. So on the litigation, let's start there. For Samsung, Chuck, in the event that Samsung does not settle with you, can you just walk us through the timeframe for how this would play out, the final judgment, the appeal, and so forth, so we can understand maybe where the back end of all of Samsung's effort would be or if it would be ongoing?

Yes, Suji. They have the appeal process that we're sure that they will pursue. We believe that we've got a very solid verdict. And we will, I think in over the next few weeks, we anticipate the Eastern District of Texas issuing a final judgment and which will effectively validate or ratify the jury's verdict and from there they can pursue appeal of that judgment but if they lose that appeal then then they would be responsible for willful damages on these products over the next year or two before the appeal is decided. I would note that the $300 million of judgment relates to only about a year's worth of shipment. of products that are at the infancy of their ramp, meaning DDR4 and HBM products were kind of in the first half of the first inning, those products will ramp rapidly over the next few years. So whatever the volumes were that led to the $303 million in judgment, those volumes will probably increase four, five, six times annually over the next few years. So they will be racking up enormous, enormous liability if they do not settle. So I think, you know, they are looking at all of that. And yeah, we're Obviously, you know, working through our strategy on how to, you know, how to get to a resolution.

That's very helpful, Color Chuck, on how this liability for them kind of grows and kind of the urgency from that perspective. But how long would an appeal process, I guess, normally take according to your legal team? Just understand the timeframes of that kind of go from start to finish.

Well, the appeal would take place in the Federal Circuit Court of Appeals for patents and copyrights in Washington, D.C. It depends on their docket, but usually a year, year and a half from the trigger, from the initiation of the appeal. the case would be heard. There are, as I went through, there are two other lawsuits against Samsung in addition to the one that we've just completed. One in Texas which is coming to trial in April. Those are for different products. Those are for DDR4 LRDEMs and RDEMs, which actually make up kind of bulk of their shipment today. So these are different patents applying on different products. So it's, you know, eventually through these suits, I think we will cover 60% to 70% of their DRAM output, our patents will cover that. So it goes to the heart of their business, and yeah, it's a tremendous exposure dollar-wise.

Okay. I'm thinking two other cases. The other one is the joint Google-Samsung one, just maybe clarify that. And then can you talk about in that how the Google case lines up vis-a-vis what just – the finding for Samsung in the courts and – you know, just kind of maybe summarize that for us, it would be helpful.

Yes, the Google case is in the Northern District of California, and the judge there decided that we should first go through our dispute with Samsung before, so the case has stayed until There are rulings in the Samsung litigation before that court will pick up a Google case. Google has its own separate independent liability based on their building of memory modules for many years in the 2010s. throughout that decade on which our patents apply. They also have liability because they purchased product from Samsung, and Samsung is operating without a license. So they have multiple liabilities. But the Google case is stayed and will be taken back up once the Samsung case is regardless of whether we have a settlement, once the Samsung case is legally ruled upon, at that point the Google case can be unstayed and pursued. But the liability doesn't go away. Understood.

It's the clock ticks on that. I understand that. Okay, then on the product side, maybe, Gail, the Hynex product we sell, and Chuck, Is it more SSD now? Is it DRAM that you're reselling today with Hynex at these low levels? And how does the gross margin recover as the – which of those areas improve, and how does the gross margin track with that revenue recovery as you increase your Hynex resales?

It's mainly DRAM, Suji, but also mixed in are some SSDs. The gross margin will recover as we see demand picking up and inventories at all our customers start to minimize, which we are starting to see today. But it's still not going to be overnight. But we do see improvement.

Great. And then thanks, Gail. And then one last question for Chuck. The Gen AI trend, obviously, we'll be watching this with you guys very closely. You have a lot of memory technology that could be very important to that. Just trying to understand, Chuck, we've talked about hybrid DIMM for many years. Can you just talk about the NAND controller, that kind of arbitrageous NAND for DRAM, and if that technology or even the hybrid DIMM product itself in name has a play into this going forward, or have you kind of repositioned that technology in some of the new products you'd be planning to target Gen AI? Sure.

Yeah, Suji, I think that's an important part of what we're doing here in the R&D side. We've been working on the hybrid M, using a lot of NAND to replicate DRAM performance for the CXL bus. So the way you can distinguish an AI server from a standard enterprise server is that the AI server operates first off of a GPU, which requires hundreds of gigabytes of HBM. A standard enterprise server that's been around for 34 years do not require HBM. So that's one. And we have part of the win that we got against Samsung was on our HBM patents. The other thing is that in main memory, two other elements. So one is HBM. The other two elements are that main memory in an AI server is four to five times the capacity of a standard enterprise server. That requires, then, a move to high capacity, particularly MRDEM. And there we are in a very strong position again with dozens of patents covering MRDM. And then lastly is CXL. The AI servers, as speeds go up, they will have less memory sockets, meaning that they will have to rely on CXL memory to pull data from. And that is where we're working on, we have been for the last five years with a very large engineering staff. And we don't mention it on every call, but we've made tremendous progress there in creating a ASIC system on a chip, SOC, with the software and firmware that can bring multiple terabytes of NAND that looks to the system and operates like DRAM. So we believe that we've got a very strong position in AI servers in all three fronts. IP coverage on HBM, MRDM, and then both IP and a physical product for And that technology, we believe there are not very many companies out in the world that are working on a similar technology. So, yeah, that's the AI server front.

I appreciate the thorough walk over the landscape. Thank you, Chuck. Sure. Thanks, Gil.

Thank you, Suzy.

Thanks, Suzy.

This concludes our question and answer session. The conference has now ended. You may now hang up. Thank you for attending today's presentation.