Netlist, Inc. (OTCQB:NLST) Q3 2022 Earnings Conference Call October 26, 2022 ET
Company Participants
Mike Smargiassi – IR
Chuck Hong – CEO
Gail Sasaki – CFO
Conference Call Participants
Suji Desilva – ROTH Capital
Operator
Good morning, and welcome to Netlist Third Quarter 2022 Earnings Conference Call and Webcast. All participants will be in listen-only mode. [Operator Instructions]. Please note that this event is being recorded.
Now we’d like to turn the call over to Mr. Mike Smargiassi excuse me from investor relations. Please go ahead.
Mike Smargiassi
Thank you, Nick, and good day everyone. Welcome to Netlist’s third 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 investor 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. 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 hello, everyone. As we indicated in our last call, the memory and SSD markets are being impacted by a challenging macro environment. The pandemic-related trends that drove favorable conditions have started to unwind. And this has resulted in a glut of semiconductor inventory that has accumulated in all segments of the market. Recent commentary has highlighted weak demand and price declines for memory and SSD products.
In recent weeks, the largest memory suppliers have reported significant drops in results and lowered guidances for future quarters. Many have announced plans to substantially reduce CapEx and cut production near term to allow absorption of excess stock that has accumulated throughout the supply chain.
Netlist’s third quarter performance reflects the impact of these industry dynamics, which are expected to continue into next year. Despite this, the long term outlook for the industry remains strong, as consumer and business trends continue to support the need for more efficient and higher performance memory technologies. Recent announcements for new manufacturing facilities in the U.S. supported by large investments also highlight the long term need for advanced memory technologies.
On the product side, third quarter 2022 product revenue increased 29% from a year ago quarter, but declined significantly on a sequential basis. We did see nice growth in our branded SSD business, thanks to several large customer orders and continue to grow the qualification pipeline with Netlist SSDs. Our biggest growth opportunity however, remains our supply agreement with SK hynix. Hynix continues to expand the product lines to which we have access. And this relationship is enhancing Netlist’s ability to target new markets, and customers that are not directly supported by the major manufacturers.
Moving on to intellectual property, on our last call, I noted that Judge Seeborg of the Northern District of California had paused Netlist’s case against Google for 90 days and pushed back the Case Management Conference. Under the court’s order, the case is now stayed pending the outcome of Netlist’s action against Samsung in the Eastern District of Texas. In Delaware, following the Judge’s dismissal of most of Samsung’s claims for declaratory relief and denial of their attempt to add the 054 patent to that suit, we added Google as a party to the case. Google’s response is due on November 3. As a reminder, this action now includes three Netlist’s RDIMM patents, the 218, 523 and 595. We expect to see the court set a schedule for that action in the coming months.
In the near term Netlist is focused on the Eastern District of Texas, where there are now two actions pending against Samsung. And the first action at issue is Samsung’s infringement of three sets of Netlist patents covering LRDIMM on module power management, and high bandwidth memory, or HBM patents. That case has been assigned to the court’s magistrate for claim construction, which is set for hearing on November 4. We expect this to be an important milestone in the case as this hearing and the resulting definition of key claims of the patent would establish a clear baseline for determining infringement at trial, which is set for May 1.
In our second Samsung action in the Eastern District of Texas, at issue is Samsung’s infringement of three Netlist patents, the 912 patent and two other patents in the 912 family. Even before responding to the complaint there, Samsung filed a motion to stay the case in light of Samsung’s Ninth Circuit appeal of the adverse judgment they received in the Central District of California’s for breach of contract case, and to transfer only the 912 patent to the Northern District of California.
Chief Judge Gilstrap recently consolidated the second Samsung action, with Netlist’s second micron EDGX action on the same patents and set the matter for scheduling conference on November 17. We expect the consolidated cases to receive a joint schedule through trial sometime in early 2024. Given this recent activity, we are hopeful that Judge Gilstrap will deny Samsung’s request to transfer the 912 patent to the State case in the Northern District of California.
This leads us to Micron. As with Samsung Netlist now has two cases against Micron in the Eastern District of Texas. Like the Samsung Texas matters, the first Micron action addresses Micron’s infringement of six Netlist patents covering LRDIMM, PMIC and HBM, while the second involves the 912 and two related patents. The first Micron case has claim construction set for July 2023, and trial on January 22. 2024. The Netlist case against Micron in the Western District of Texas remains stayed pending the resolution of the five IPR Micron filed again against Netlist’s four patents asserted there.
As a reminder, Micron’s petition to institute an inner party’s review of our LRDIMM — excuse me — of our LRDIMM 608 patent was denied by the PTAB. Micron’s request for rehearing was also denied.
Finally, the cases in Germany continue to make progress with final oral hearings before the court set for May 2023, for Micron, September for Samsung and November for Google. In addition to monetary damages we are also seeking injunctive relief in both Micron and Samsung matters. Netlist’s IP enforcement in the U.S. and in Europe is very active and includes many patents. These efforts are part of a comprehensive strategy to ensure that Netlist’s intellectual property is fairly licensed and compensated.
Before turning the call over to Gail, I would like to comment on the IPR process more broadly. Some of you may have seen my recent interview with IAM, the leading IP media and are aware that the current IPR process is greatly flawed and presents significant challenges to companies like us. The latest example is the PTAB’s decision to institute an IPR on our 912 patent, the patent that has been validated five times over a decade, including twice by the PTAB itself, and ultimately by the Federal Circuit Court of Appeals.
If you’re watching that action closely, we will be addressing the decision with the PTO to reinstitute the patent that has gone through such historical reexaminations. From my perspective, the changes to the Patent Law, in the form of the AIA implemented in 2012 has greatly damaged the prospects of individual inventors, legitimate patent holders and innovative companies like Netlist. Instead of filtering out obviously bad patents, the system has allowed the huge incumbent companies to routinely exploit the post-grant review system and hold out as long as possible in order to use others’ inventions for free with impunity.
There are a number of bills currently under consideration in Congress to reform the IPR process. If there is to be reformed, we strongly believe in a requirement for standing, a higher threshold for allowing IPR institution, and most importantly, a time bar. We also find it troubling that the compensation for the PTAB judges are based on a point system that incentivizes the judges to institute and ultimately invalidate quality patents. We will continue to advocate for changes in this area.
Netlist holds over 130 patents and the coverage of our patents now include memory for PCs and high end memory packages, in addition to our traditional leadership in server memory. These patents read on tens of billions of dollars of worldwide annual shipments of memory products. We are committed to our enforcement actions, and in the coming months look forward to getting these cases in front of a jury for determination of past damages and future licenses.
I’ll turn the call over to Gail for the financial review.
Gail Sasaki
Thanks, Chuck. Year-to-date net product sales of $140 million is an increase of 112% over the prior year’s nine month period. Year-to-date product gross profit dollars of $10.3 million equates to an increase of 50% over the same comparative period. Net product sales for the three months ended October 1, 2022 of $34.4 million reflects an increase of 29% compared to the same period last year. However, both third quarter product revenue and third quarter product gross profit were down consecutively, due to the worse than anticipated downturn, and the demand for memory combined with oversupply in the market.
The year-to-date increase in operating expenses compared to the prior period was mainly due to increased global investment and our sales, marketing legal and engineering teams necessary to support long term sales and R&D acceleration, patent prosecution, which was partially offset by lower litigation costs.
As a reminder, we do not formally guide, but given the continued lack of visibility within the semiconductor industry noted earlier, and in line with overall analyst commentary, we currently expect Q4 ’22 product revenue to be softer than Q3 ’22. However, as the large suppliers begin to reduce capacity and reduce supply growth, we believe the cycle will normalize. Over the long run, we continue to believe that the memory and storage industry market will remain strong.
We ended Q3, 2022 with cash and cash equivalents and restricted cash of $43.4 million compared to $60.6 million at the end of the second quarter. Cash was reduced by continued investments during the quarter, plus the increase in the cash cycle by 21 days, due to an increase in days in inventory by 13 days and days sales outstanding of eight days.
We continue to maintain significant financial flexibility and liquidity going forward, with close to $60 million remaining under equity line of credit was Lincoln Park Capital and a $10 million working capital line of credit with Silicon Valley Bank. We also continue to maintain strong cost controls and will proactively manage the business given the current market outlook going forward.
Operator we are now ready for questions.
Question-and-Answer Session
Operator
Thank you. We will now begin the question-and-answer session. [Operator Instructions]. Thank you. Your first question will be from Suji Desilva of ROTH Capital. Please go ahead.
Suji Desilva
Hi, Chuck. Hi, Gail. So maybe first on the memory demand and maybe the cloud and enterprise demand. Were you surprised? You seemed like you were surprised by the decline versus what you had expected? Can you differentiate the end demand versus memory reduction dynamics here? And whether the cloud guys are taking a more cautious stance? Some of them haven’t reported as strong as one would think. So perhaps you’d give us some insight there.
Chuck Hong
Yeah, Suji. I think what we have seen from our customer base, and then with the cloud guys, is they’re sitting on a lot of inventory. They purchased in excess of their run rate demand, opportunistically during the first half of the year. And I think many of them are covered. They bought ahead. They’re covered for a couple of quarters going forward. So they have more inventory than, weeks of inventory, that they usually historically have held.
Suji Desilva
Okay, that’s very helpful. And then on the litigation front, can you talk about, for Samsung, that there’s a Delaware and a Texas effort. Which one should kind of catalyze this process more and should be watched more closely, I think, for us?
Chuck Hong
As I stated here, in the script, there’s a lot of activity in Texas, both with Samsung, and with Micron. With the trial out about six months from now, there’s a lot of discovery and deposition activity. And we’re gearing up in preparation. So I think that’s probably the most important and imminent of the cases that we have. We have Micron case, we have two cases against Micron that fairly mirrors the Samsung cases in the form of similar patents, same patents in the first case, and then similar ones, second case.
So I think, the activities in the Eastern District of Texas with claim construction coming up in a week or so, we’ve got decisions — case schedules for the second cases for both parties being set here shortly. So I think that’s the area of watch. Although the Delaware case, we now have added Google to the Samsung case, and that we believe the judge will set a Case Management Conference here shortly to set out a schedule for that as well.
Suji Desilva
Okay. And my other question was about the combining of the Google and Samsung exposure too. So are all the independent Google cases stayed right now? And is it constructive from your perspective that the two are now combined into a single case?
Chuck Hong
The Google case in the Northern District of California with the 912 patent has been stayed, as you will recall. There was a determination of intervening rights. So which means the past exposure that they have to our patent remains. That will not go away. That case will remain stayed pending the outcome of the Samsung case in the Eastern District of Texas. The Delaware case against Samsung and Google, that case is not stayed. That is still — that’s just pending a schedule.
Suji Desilva
Okay, got it. And then on the financials, Gail, maybe the litigation cost went up sequentially. Is that something we expect to stay elevated or perhaps even grow given the activity levels? Or was that sort of paying upfront for what’s going to come next?
Gail Sasaki
Yeah, we believe that we’ll try and moderate and I don’t think it’s going to increase by much over this past quarter on a quarterly basis.
Suji Desilva
Okay, and then last question for me. Did you guys hit the equity line of credit in the third quarter? If so, how much?
Gail Sasaki
No, we did not.
Suji Desilva
Okay. Thanks, guys.
Chuck Hong
All right, thanks, Suji.
Gail Sasaki
Welcome, thanks, Suji.
Operator
Thank you. That concludes our conference call for today. I thank you for attending today’s presentation. You may now disconnect.
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