Netlist Q2 2024 Earnings Report

Netlist EPS Results

• Actual EPS: -$0.06
• Consensus EPS: -$0.05
• Beat/Miss: Missed by -$0.01
• One Year Ago EPS: N/A

Netlist Revenue Results

• Actual Revenue: $36.84 million
• Expected Revenue: $37.00 million
• Beat/Miss: Missed by -$160.00 thousand
• YoY Revenue Growth: N/A

Netlist Announcement Details

• Quarter: Q2 2024
• Date: 7/30/2024
• Time: N/A
• Conference Call Date: Tuesday, July 30, 2024
• Conference Call Time: 12:00PM ET

Netlist (OTCMKTS:NLST) is a technology company specializing in the design and development of high-performance memory and storage subsystems for enterprise and data center applications. The company’s product portfolio encompasses advanced memory modules, nonvolatile memory express (NVMe) solid-state drives and intelligent memory expansion systems. These solutions are engineered to boost memory density, bandwidth and overall system performance in hyperscale, cloud computing and high-performance computing environments.

Headquartered in Irvine, California, Netlist serves customers across the Americas and Asia through a combination of direct sales and channel distribution partners. The company markets its offerings under brands such as HyperCloud memory subsystems and HyperVault storage SSDs, delivering plug-and-play modules that integrate with leading server and storage platforms. Netlist’s engineered memory architectures aim to address growing demands for faster data access, reduced latency and improved system utilization in modern IT infrastructures.

Founded in 2000, Netlist has built a portfolio of issued and pending patents covering its proprietary memory interconnects and module designs. Over the years, the company has pursued strategic agreements and legal actions to protect its intellectual property and support technology licensing opportunities. In late 2016, Netlist initiated a Chapter 11 restructuring to realign its balance sheet and emerged in 2017 with a renewed focus on operational efficiency and growth in target markets.

Led by founder and Chief Executive Officer Charles Liang, Netlist’s management team combines backgrounds in semiconductor design, system architecture and enterprise computing. The company continues to invest in research and development to evolve its memory and storage offerings, collaborating with original equipment manufacturers and system integrators to integrate its solutions into next-generation server and storage platforms.

Netlist Q2 2024 Earnings Call Transcript

Key Takeaways

• $303M against Samsung and $445M against Micron in jury awards for willful infringement of Netlist’s HBM and DDR5 patents highlight strong IP protection.
• Q2 2024 revenue jumped to $36.8M, nearly four times year-over-year, with management expecting moderate sequential growth in Q3.
• Netlist ended Q2 with $36.4M in cash plus approximately $41M available via credit lines, underlining solid liquidity and financial flexibility.
• Netlist has seven ongoing IPR appeals (with three more expected) and anticipates Federal Circuit decisions next year, reflecting legal complexities in patent defense.
• The company is advancing its AI memory product roadmap—including high-capacity DDR5 VLP/MR DIMMs and a CXL flash controller due in 1–2 years—to capitalize on growing AI computing demand.

Presentation

[Operator]

Good day and welcome to the Netlist second quarter 2024 earnings conference call and webcast. All participants will be in a 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 a touch-tone phone. To withdraw your question, please press star, then two. Please note this event is being recorded. I would now like to turn the conference over to Mike Smargiassi, Investor Relations. Please go ahead.

[Mike Smargiassi, Head of Investor Relations at Netlist]

Thank you, Betsy, and good day, everyone. Welcome to Netlist second quarter 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 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 today's press release. Netlist assumes no obligation to update forward-looking statements. I will now turn the call over to Chuck.

[Chuck Hong, CEO at Netlist]

Thanks, Mike, and hello, everyone. In the second quarter, Netlist secured two 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. First, in 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, and accordingly, the jury rendered a verdict which confirms that what we have been asserting all along, that Samsung intentionally and materially breached the agreement and no longer has a license to Netlist patents.

[Chuck Hong, CEO at Netlist]

Given this verdict, the Eastern District of Texas moved forward last week with a denial of Samsung's post-trial motions in the $303 million 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. With these actions, the court has upheld the jury's verdict and damages award, confirming that Samsung willfully infringed Netlist's patented technologies and that none of the asserted patent 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. Second, in May, Netlist won a $445 million 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.

[Chuck Hong, CEO at Netlist]

Earlier this month, Judge Gilstrap entered the final judgment, and so we have now moved on to the post-trial stage of this case. 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, two separate juries have awarded Netlist nearly $750 million in damages for willful patent infringement by two of the largest semiconductor manufacturers in the world. These are some of the largest patent damages awards 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 relatively short infringement periods, mostly between 2022 and 2023, at the beginning stages of the AI memory adoption.

[Chuck Hong, CEO at Netlist]

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 has piled up and will continue to accumulate in the months ahead. In the Eastern District of Texas, the case against Samsung is set for pretrial conference on August 23rd and trial on September 9th. 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.

[Chuck Hong, CEO at Netlist]

I would note that the 608 was non-instituted in the IPR file by Micron in the Western District of Texas case. On the last call, I commented on the Patent Trial and Appeal Board, the IPR process, and specifically the history of Netlist's 912 patent. Patent litigation and the PTAB landscape remain hostile to patent owners and innovative companies like Netlist. 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 seven IPR appeals in process and expect to add three more in the near future. After receiving final written decisions from the PTAB, parties have 30 days to file a request to challenge the result at the PTO itself.

[Chuck Hong, CEO at Netlist]

This appeal process can take several months. If these appeals are denied, the PTAB will enter a final decision and denial. Then it 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.

[Chuck Hong, CEO at Netlist]

On the legislative front, during the second quarter, members of the Netlist legal team spent time in Washington, D.C., 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. 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 three 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.

[Chuck Hong, CEO at Netlist]

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.

[Gail Sasaki, CFO at Netlist]

Thanks, Chuck. Second quarter 2024 revenue was $36.8 million, compared to $10 million in the year-ago period. This was close to four times greater than last year's second 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 third quarter of 2024 to date, plus the industry outlook for continued growth, we currently expect a moderate increase in revenue for the third quarter compared to the second quarter of 2024. The decrease in operating expenses for the second quarter compared to the first quarter was primarily due to elevated legal expenses during the first quarter related to preparation for the May trials. We expect legal costs to be flat for the third quarter and then to decrease as we exit the year.

[Gail Sasaki, CFO at Netlist]

We ended the second quarter 2024 with cash and cash equivalents and restricted cash of $36.4 million. We continue to maintain financial flexibility and liquidity going forward with a $10 million working capital line of credit with Silicon Valley Bank and approximately $31 million 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 turn increased to 18x compared to 4x 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.

[Suji Desilva, Managing Director and Senior Research Analyst at Roth Capital]

Hi, Chuck. Hi, Gail. Congratulations on the progress in the quarter on the litigation front. Well-deserved. So the Samsung appeal, Chuck, failing, can you just give 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 timeframe of Samsung kind of paying those damages now that the appeal has been denied?

[Chuck Hong, CEO at Netlist]

Well, Suji, thanks. The appeal for the license case, the breach of contract/license 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 million in damages that were owed. So now that case, which was held in April of 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 the appellate court, the Federal Circuit, sometime next year.

[Chuck Hong, CEO at Netlist]

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

[Suji Desilva, Managing Director and Senior Research Analyst at Roth Capital]

It did, Chuck. Thank you. And then separately on 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?

[Chuck Hong, CEO at Netlist]

So the Samsung Eastern District of Texas 2 case was stayed for a while, and the court confirmed now a trial date of September 9th. And the court was also waiting on the outcome of the California license case, the breach of contract case, before it fixed the date for the trial for September 9th. 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 patents that were in the Micron case. And then there's one more patent, 608, that reads on the LRDIMM. So we'll have three patents, one more patent than the Micron case. But it will cover the same products that Samsung makes, that Micron makes, which are the DDR4 and DDR5 RDIMMs and LRDIMMs.

[Suji Desilva, Managing Director and Senior Research Analyst at Roth Capital]

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 market demand pricing-wise, and what can be the target gross margin level as things improve from here?

[Gail Sasaki, CFO at Netlist]

So I think during the first half of the year, we were, I mean, I did mention that the inventory turn has dramatically improved. We were working through some inventory, which we had sold at some lower margins. And going forward, the pricing is continuing to increase from Q2-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, Q3 and Q4. Target margin, product margins, still, I'd say around 5%-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.

[Suji Desilva, Managing Director and Senior Research Analyst at Roth Capital]

Got it. Okay. That helps, Gail. 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 on in the market today? Thanks.

[Chuck Hong, CEO at Netlist]

So AI memory is comprised of really three areas. One 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've 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. And then you have DDR5 memory, which is standard server memory, but you need a 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. And so on the VLPs, and so we've got a line of VLP products. We also will be introducing DDR5 MRDIMMs.

[Chuck Hong, CEO at Netlist]

And then finally, CXL acts as the second level of memory for these AI systems. There is a lot of demand today on the NSSDs 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 six 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. But that CXL market is still in its infancy. It will probably be another year or two before there is significant adoption in the market. So those are the three areas of AI memory that we participate in.

[Suji Desilva, Managing Director and Senior Research Analyst at Roth Capital]

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

[Chuck Hong, CEO at Netlist]

Okay. Thank you.

Participants

Executives

• Chuck Hong, CEO
• Gail Sasaki, CFO
• Mike Smargiassi, Head of Investor Relations

Analysts

• Suji Desilva, Managing Director and Senior Research Analyst at Roth Capital