Netlist Q2 2024 Earnings Call Transcript

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July 30, 2024

There are 5 speakers on the call.

Operator

Good day, and welcome to the Netlist Second Quarter 20 24 Earnings Conference Call and Webcast. All participants will be in a listen only mode. After today's presentation, there will be an opportunity to ask questions. Please note this event is being recorded. I would now like to turn the conference over to Mike Smargasse, Investor Relations.

Operator

Please go ahead.

Speaker 1

Thank you, Betsy, and good day, everyone. Welcome to Netlist's Q2 2024 Conference Call. Leading today's call will be Chuck Hong, Chief Executive Officer of Netlist and Gail Sasaki, Chief Financial Officer. As a reminder, you can access the earnings release and a replay of today's call 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.

Speaker 1

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 today's press release. Netlist assumes no obligation to update forward looking statements. I will now turn the call over to Chuck.

Speaker 2

Thanks, Mike, and hello everyone. In the Q2, Netlist secured 2 significant legal victories that further validate the actions we have taken to protect our intellectual property. These wins advance the company's objective of entering into long term licensing agreements with implementers of our IP that fairly compensate Netlist and its shareholders. 1st May, the jury in Netlist's case in the Federal Court for the Central District of California found unanimously that Samsung materially breached the joint development and license agreement entered into in November 2015. This trial brought to light Samsung's misconduct and bad faith actions, which were designed to harm Netlist.

Speaker 2

And accordingly, the jury rendered a verdict, which confirms that we have what we have been asserting all along, that Samsung intentionally and materially breached the agreement and no longer has a license to netlist patents. Given this verdict, the Eastern District of Texas moved forward last week with a denial of Samsung's post trial motions and the $303,000,000 patent infringement jury award against Samsung. The court entered a final judgment in this case and a denial of post trial motions brings this case to a close in the U. S. District Court.

Speaker 2

With these actions, the court has upheld the jury's verdict and damages award, confirm that Samsung willfully infringed Netlist's patented technologies and that none of the asserted patents claims is invalid. Netlist's patents in this case covered both high bandwidth memory or HBM and DDR5 memory, technologies foundational to generative AI computing. 2nd, in May, Netlist won a $445,000,000 damages award against Micron in the Eastern District of Texas. The unanimous jury verdict found that Micron willfully infringed Netlist's patents 912 and 417. Earlier this month, Judge Gilstrap entered the final judgment and so we have now moved on to the post trial stage of this case.

Speaker 2

After all post trial motions are addressed by the court, Micron will have 30 days to file an appeal to the Federal Circuit Court of Appeals and we fully expect that Micron will appeal this verdict. I want to underscore that in just over a year, 2 separate juries have awarded Netlist nearly $0.75 billion in damages for willful patent infringement by 2 of the largest semiconductor manufacturers in the world. These are some of the largest patent damages award historically in our industry and highlight the tremendous value of the technology Netlist created, especially in memory for AI computing. It's also notable that the award addressed at relatively short infringement periods mostly between 20222023 at the beginning stages of the AI memory adoption. In the months since the two verdicts, both Samsung and Micron have each shipped exponentially larger volumes of the infringing memory products for AI and their dollar exposure to our patents have piled up and will continue to accumulate in the months ahead.

Speaker 2

In the Eastern District of Texas, the case against Samsung is set for pretrial conference on August 23 and trial on September 9. In this case, which we call Samsung Eastern District of Texas 2, Netlist is asserting the 912 patent along with LRDIMM patent 417, both of which relate to the infringement of large volumes of DDR4 RDIMMs and LRDIMMs. In addition to these same patents that were asserted in the Micron case, for Samsung Case 2, the 608 patent, which reads on a different aspect of LRDIMM technology than the 417 is being asserted as well. I would note that the 608 was On the last call, I commented on the Patent Trial and Appeals Board, specifically the history of Netlist's 912 patent. Patent litigation and the PTAB landscape remain hostile to patent owners and innovative companies like Netlist.

Speaker 2

This can be seen in IPR statistics over the last few years as well as the extreme proposals coming out of the USPTO today. We share investors' frustration with the current process, but we are committed to defending our patents through the patent office's existing framework. We currently have 7 IPR appeals in process and expect to add 3 more in the near future. After receiving final written decision from the PTAB, parties have 30 days to file a request to challenge the result at the PTO itself. This appeal process can take several months.

Speaker 2

If these appeals are denied, the PTAB will enter a final decision and denial. The Senate opens the window to file an appeal with the Federal Circuit Court of Appeals. For each appeal, we expect the process to take around 18 months. And so we expect to see Federal Circuit appellate rulings on some of the IPR final written decisions and the District Court judgments later next year. Although we will not point to specific IPRs based on a thorough expert analysis of all of the final written decisions, we are confident that some of these decisions will be reversed or remanded on appeal due to clear legal and procedural errors made by the PTAB in rendering its decisions.

Speaker 2

On the legislative front, during the Q2, members of the Netlist legal team spent time in Washington DC meeting with elected representatives and their staff to raise awareness on the status of the U. S. Patent system. Netlist's 912 patent is well known among the IP community in general as well as with the federal officials. At 14 years, we believe it is the longest running re exam of any patent in history.

Speaker 2

The 912 has become the poster child for the excesses of the AIA, the IPR process, PTAB abuse and a proof point for a need for patent reform. There are 3 proposed bipartisan bills, the Prevail, the Restore and the PERA. Each would address different aspects of the process, make critical reforms to curb abuses by Big Tech, protect patent holders and restore balance to the U. S. Patent system.

Speaker 2

We will continue to work with lawmakers to help support their efforts to enact these bills into law. I will now turn the call over to Gail for a financial review.

Speaker 3

Thanks, Chuck. 2nd quarter 2024 revenue was $36,800,000 compared to $10,000,000 in the year ago period. This was close to 4 times greater than last year's 2nd quarter revenue, a reflection of the recovery in the demand environment from the year ago period. While we do not formally guide given booking and shipping for the Q3 of 2024 to date, plus the industry outlook for continued growth, we currently expect a moderate increase in revenue for the Q3 compared to the Q2 of 2024. The decrease in operating expenses for the Q2 compared to the Q1 was primarily due to elevated legal expenses during the Q1 related to preparation for the May trials.

Speaker 3

We expect legal costs to be flat for the Q3 and then to decrease as we exit the year. We ended the Q2 2024 with cash and cash equivalents and restricted cash of 36,400,000 dollars We continue to maintain financial flexibility and liquidity going forward with a $10,000,000 working capital line of credit with Silicon Valley Bank and approximately $31,000,000 available on the equity line of credit through Lincoln Park Capital. As always, we manage the operational cash cycle very carefully with days in inventory of 21 days improved by 72 days over last year's Q2. Inventory churn increased to 18 times compared to 4 times from last year's quarter. Operator, we are now ready for questions.

Operator

The first question today comes from Suji Desilva with ROTH Capital. Please go ahead.

Speaker 4

Hi, Chuck. Hi, Gail. Congratulations on the progress in the quarter on the litigation front. Well deserved. So, the Samsung appeal, Chuck, failing.

Speaker 4

Can you just give us a sense maybe at what point in time perhaps something like interest is accruing on those damages or when the clock starts there? Or just any other milestones in the time frame of Samsung kind of paying those damages now that the appeal has been denied?

Speaker 2

Suji, thanks. The appeal for the license case, the breach of contractlicense case that was held in the Central District of California. That appeal led to a remand back to the District Court and that is where we prevailed once again in May. So that established that Samsung does not have a license to our patent portfolio. And based on that verdict, the judge in the Eastern District of Texas moved forward to finalize the verdict and his final order confirming the willful infringement and the $303,000,000 in damages that were owed.

Speaker 2

So now that case, which was held in April last year. So it was held up from being confirmed until this license issue got resolved in California. So now that case will move to appeals to the appellate court and it will hit their appellate court, the Federal Circuit sometime next year. And the Fed Circuit will likely consider that case, the patent infringement final order, along with the IPR decisions related to the patents in that case. They will likely look at all of that together sometime next year and render what effectively would be a final decision.

Speaker 2

So if we were to prevail and we believe we've got a good chance, then the interest from the $303,000,000 ruling will continue to accrue through today and then through to the time of appeal. So hopefully that long answer addresses your question.

Speaker 4

It did Chuck. Thank you. And then separately on the what you're calling East Texas 2 for Samsung, was that waiting on the Micron finding or is that a separate timeline? And what are the implications of the Micron finding on that or the Samsung East Texas 1 on the East Texas 2 opportunity with the patents?

Speaker 2

So the Samsung Eastern District of Texas 2 case was stayed for a while and the court confirmed now a trial date of September 9. And the court was also waiting for to waiting on the outcome of the California license case, the breach of contract case before it fixed the date for the trial for September 9. So that's the relationship with the license case. As to the relationship with the prior Micron case, it contains the Samsung 2 case that's coming up in September. That trial will have the same patent that were in the Micron case.

Speaker 2

And then there's one more patent, 608 that reads on the LRDIMM. So we will have 3 patents, one more patent than the Micron case. But it will cover the same products that Samsung makes that Micron made makes, which are the DDR4 and DDR5 RDIMMs and LRDIMMs.

Speaker 4

Got it. Okay, good. Switching to the financial side, Gail, what are the drivers for gross margin to expand here? Help me understand the relationship there to maybe what's happening in the memory market demand pricing wise? And what can be the target gross margin level as things improve from here?

Speaker 3

So I think during the first half of the year, we were I mean, I did mention that the inventory churn has dramatically improved. We were working through some inventory which we sold at some lower margins. Right. And going forward, the pricing is continuing to increase from Q2 to Q3 on much of the resale products that make up a large portion of our revenue today, which will be helpful. Not in huge percentages, but will be helpful to our margin going forward in Q3 and Q4.

Speaker 3

Target margin, product margins, still I'd say around 5% to 6% on an average. Certainly, there are portions of our product revenue which are much higher than that. So it will be our target is going to be better than Q1 and Q2 for those reasons.

Speaker 4

Got it. Okay. That helps you. Maybe last Chuck, maybe you can kind of step back and talk about the Netlist product roadmap and the update there for timeframe of product sales beyond Hynix, the resales? And maybe tie that to the trends in AI memory and SSDs where is Netlist most levered to in the trends going out in the market today?

Speaker 4

Thanks.

Speaker 2

So AI memory is comprised of really 3 areas. 1 is high bandwidth memory and those products sit right next to the GPU in the NVIDIA and AMD GPUs. And those are manufactured obviously by Samsung, Micron and Hynix, Hynix as the leader. We have, as we have stated, some of the seminal technologies that we patented on HBM years ago. We don't manufacture HBMs, but we've got technologies there that are reflected in our patents.

Speaker 2

And then you have DDR5 memory, which is standard server memory, but you need lot more of high capacity DDR5 memory to support AI. And our products there comprise of VLPs and MRDIMMs, products that are more high capacity and specialized among the DDR5 product lineup. And then finally, CXL. So on the VLPs and so we've got a line of VLP products, we also will be introducing DDR5 MR DIMMs. And then finally, CXL acts as the 2nd level of memory for these AI systems.

Speaker 2

There is a lot of demand today on the in SSDs because of AI memory And that over time with the emergence of CXL should be supplanted by CXL, because CXL is faster and is memory semantics versus the SSDs. And we've been investing. We've been working on a flash based CXL product for the last 6 years. And we have invested a lot of time and money there. And we will have a controller coming out in the next year or so.

Speaker 2

But that CXL market is still in its infancy. It will probably be another year or 2 before there is significant adoption in the market. So those are the three areas of AI memory that we participate in.

Speaker 4

Very helpful overview, Chuck. Thanks, Chuck. Thanks, Gail.

Speaker 2

Okay. Thank you.

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Key Takeaways

  • Netlist secured two significant legal victories with a $303 million award against Samsung and $445 million against Micron for willful patent infringement, totaling nearly $0.75 billion.
  • Patents cover foundational high bandwidth memory (HBM) and DDR5 technologies used in generative AI computing, and continued infringing shipments by Samsung and Micron will increase Netlist’s licensing and damages exposure.
  • Netlist’s third major case, Samsung Eastern District of Texas 2, is set for trial on September 9, 2024, asserting three patents including a new LRDIMM technology patent, potentially leading to further damages awards.
  • Second quarter 2024 revenue rose to $36.8 million—nearly four times last year’s level—with management expecting a moderate increase in Q3 and aiming for product gross margins around 5–6%.
  • Netlist is navigating a hostile Patent Trial and Appeal Board environment with seven IPR appeals in process and is actively lobbying for bipartisan patent reform bills (Prevail, Restore, PERA) to strengthen the U.S. patent system.
AI Generated. May Contain Errors.
Earnings Conference Call
Netlist Q2 2024
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