Netlist Inc. (OTCQB:NLST) Q2 2022 Results Conference Call August 2, 2022 12:00 PM ET
Company Participants
Mike Smargiassi – IR
Chuck Hong – CEO
Gail Sasaki – CFO
Conference Call Participants
Suji Desilva – ROTH Capital
Operator
Good day, and welcome to the Netlist Second Quarter 2022 Earnings Conference Call and Webcast. [Operator Instructions] Please note, this event is being recorded.
I would now like to turn the conference over to Mr. Mike Smargiassi with The Plunkett Group. Please go ahead, sir.
Mike Smargiassi
Thank you, and good day, everyone. Welcome to Netlist’s Second Quarter 2022 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’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. Netlist assumes no obligation to update forward-looking statements.
I would now like to turn the call over to Chuck.
Chuck Hong
Thanks, Mike, and good afternoon. Good morning, everyone. Throughout the second quarter, we continued 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 delivered product revenue growth of 169%, and product gross profit almost doubled 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 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 a 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 started – 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 it to 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 $5 million 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 Seeborg of the Northern District of California listened to our arguments and, in May, entered an order in Netlist’s favor on the very important issue of intervening rights for claim 16 of the 912 patent. The judge also set forth a conclusive finding that Netlist should be entitled to the full period of damages available under claim 16. In parallel, Judge Seeborg 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 Seeborg 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 a 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 Seeborg approaches case management in California over the next couple of 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 involved 6 patents, all distinct from the 912 patent we’ve asserted against Google or the 3 RDIMM patents Samsung cited in its Delaware action. Netlist’s complaint highlights Samsung’s infringement of 2 patents relating to Netlist’s LRDIMM technologies, 2 patents relating to Netlist’s on-module power management under the new DDR5 standard and 2 patents relating to high-bandwidth memory or HBM technologies.
Netlist is the leader in developing LRDIMM 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 6 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. In our Texas – our Samsung case is no exception there. He has already set our claim construction hearing for October 14 and as I mentioned before, the jury trial starts on May 1, 2023.
The Netlist case against Micron in the Western District of Texas is paused, pending the resolution of the 5 IPR Micron filed against Netlist. To that point, we received confirmation on July 19 that Micron’s petition to institute an interparty’s review of our LRDIMM 608 patent was denied by the PTAB. We await the PTAB’s decision on the pending challenging – pending petition challenging our NVDIMM 833 patent and will 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 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 LRDIMM patents, EP 735 and EP 660, 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 hearing 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 would mean a complete bar on Micron use or sale of all infringing LRDIMM modules within Germany. As with the U.S.-based cases, we are encouraged by the Düsseldorf 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.
Gail Sasaki
Thanks, Chuck. During the 3 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 continue 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 infringement actions. 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 ‘22 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 maintain significant financial flexibility and liquidity going forward, with close to $60.4 million remaining on the line.
And in addition, we maintain 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 Q2 ‘22, resulted in a positive cash cycle of negative 9 days. The cash cycle will continue to be key to our cash balances as we move forward.
Operator, we are now ready for questions.
Question-and-Answer Session
Operator
[Operator Instructions] And the first question will come from Suji Desilva with ROTH Capital.
Suji Desilva
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?
A –Chuck Hong
Yes, Suji. Yes. During the quarter, we released a couple of new enterprise SSD products. We also have a line of DDR5, RDIMM and LRDIMM 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. So yes, probably half a dozen new memory module products, both DDR5 and DDR4 as well as a handful of enterprise SSD products released during the quarter.
Suji Desilva
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 or the enterprise market, the expectation whether this is a shallow downturn or perhaps more pronounced. And also what’s going on with the unit pricing dynamic as things soften here?
A –Chuck Hong
Yes, I don’t – for DRAM-based memory, it’s because the supply base has consolidated over the years and the 3 major suppliers and the one – the couple minor suppliers, they are managing their inventories quite well and managing the flow of products so that it’s not disruptive to the market. So 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 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 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.
Suji Desilva
Okay. And then this question, 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 hynix 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?
Chuck Hong
Well, for us, I think – I don’t think much will change in terms of the activities, I mean, 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 there’s – things will improve in terms of our ability to get more niche, difficult-to-source products from hynix.
We’re finding more industrial, testing, military type of applications from the last 6 months of marketing work that we’ve done. So I think we’ll continue to grow the relationship and 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 lower ASPs, you have to generate higher volume in order to maintain the revenue levels.
Suji Desilva
Okay. And then, Chuck, 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?
A –Chuck Hong
Yes. I think the Google — we have currently 3 major cases; Google, Samsung and hynix. And as we stated in the script, Google is currently stayed for a 90-day period, probably another 2.5 months before the case management conference in the Northern District of California. At that point, there will be decisions made and case schedules 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 to – 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 more clarity out of the Northern District case against Google.
Samsung is on fast track to get to trial in about 9 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.
So that’s – in 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 3 parties in Germany, effectively covering most of Europe because this is a European EU patent. And there where – we would be seeking – we are seeking injunctive relief against Micron as well as 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 2 parties are probably the best patents that we’ve ever had.
Operator
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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