Netlist, Inc. (NLST) Earnings Call Transcript & Summary

Good day, and welcome to the Netlist, Inc. Third Quarter 2020 Earnings Conference Call and Webcast. [Operator Instructions] Please note that this event is being recorded. I would now like to turn the conference over to Mark -- excuse me, Mike Smargiassi with the Plunkett Group. Please go ahead, sir.

Thank you, and good day, everyone. Welcome to Netlist's Third Quarter 2020 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.

Thanks, Mike, and hello, everyone. In the third quarter, we once again delivered solid financial performance compared to the prior year. Revenue grew nearly 70% and we more than doubled our revenue for the first 9 months of the year compared to the year ago period. We also continue to see improvement in profitability as we delivered gains in gross profit, and closely managed operating expenses, resulting in a 30% reduction in the third quarter net loss. In the first half of 2020, we benefited from a solid demand environment for enterprise SSDs. While demand from data center and enterprise customers remains healthy, the second half of 2020 has seen increases in the supply of enterprise SSDs from multiple vendors. And as a result, there has been some pressure on ASPs as we moved into the fourth quarter. We continue to believe that the long-term outlook for enterprise SSDs is strong as the need for high-performance storage remains robust across numerous segments of the economy. We believe we are well positioned as we move into 2021 as we focus on expanding our customer base into targeted end markets and strengthening the Netlist SSD portfolio. In September, we expanded our product line with the first production shipment of the 96-layer NAND, high-performance NVMe SSDs. These next-generation drives provide exceptional performance and provide cost benefits to customers compared to current mainstream 64-layer NAND SSDs. The addition of TCG Opal encryption key management, a new feature provides the highest level of security for data centers as well as military and government agency end markets. We have been pleased by the initial response from customers, and the qualification started earlier this year are set to wrap up by year-end. In partnership with industry leaders, we are showcasing these SSDs at Supercomputing 2020, which kicked off virtually this week. The Digi-Key partnership we announced in October also opens a new distribution channel for Netlist products. As a trusted global supplier and resource for design engineers across industries, Digi-Key significantly expands the visibility and reach of the products we offer. Finally, in the third quarter, we took steps to strengthen the sales and marketing leadership with the appointments of Cameron Sinclair as Vice President of Sales; and Tinh Ngo as Vice President of Marketing. Both executives bring extensive industry relationships and deep knowledge of the memory business, particularly in the embedded flash and industrial DIMM space. Together, they will lead the company's efforts to expand the customer base, create new revenue streams and build out our product line. Turning now to intellectual property. The actions to defend the fundamental value of our IP portfolio continue to move forward. In the legal proceedings for patent infringement against SK hynix in the U.S. District Court for the Western District of Texas, the judge has made the decision to combine our 2 cases. There will now be a single case in which we are asserting the 218 and 595 patents, continuations of existing patent families that read on Hynix' RDIMM and LRDIMMs and the 523 patent which is a new self-test patent. The Markman hearing for the consolidated action has been scheduled for March 2021, with the trial set involving all 3 patents in December 2021. The net result of the consolidation by the court is the schedule -- is a small move in the trial date in the 218 and the 595 actions, which was originally scheduled for October, while the 523 case will be on a faster track. In the Google action, as we noted in the last call, the Federal Circuit affirmed the U.S. patent trial and Appeal Board's final decision earlier this year, validating Netlist's [ 70 912 ] patent. The appeal window to the U.S. Supreme Court to challenge that decision expires next Monday, November 16. We continue to believe an appeal of this case is unlikely to be accepted by the Supreme Court. And assuming Google does not file for appeal, the USPTO will move to issue the claims of the 912 patent under a reexamination certificate process, which we believe would take a few months. At that point, once the reexamination certificate is issued, we will immediately request the stay to be lifted in the pending patent infringement case against Google, and the trial to resume in the U.S. District Court for the Northern District of California. As we believe Google is one of the largest manufacturer and consumer of memory modules, we continue to explore the applicability of the rest of our patent portfolio to Google's activities in addition to the 912 patent. We are aggressively building out our patent portfolio while continuing to engage in discussions with implementers as well as review our options for additional enforcement actions. I'll now turn the call over to Gail for the financial review. Gail?

Thanks, Chuck. Revenues for the third quarter ended September 26, 2020, were $10.2 million compared to revenues of $6.1 million in the year ago period, an increase of 67%. For the first 9 months of the year, revenue reached $35.7 million, an improvement of 114% from the same period last year. The significant increase in the top line was mainly due to growth of SSD revenue, including increased contribution from Netlist NVMe SSDs. Q3 '20 product gross profit percentage, which is before our manufacturing costs, increased to 15.9% compared to 12.6% for Q3 '19. After manufacturing costs, the net gross margins were 13.1% for the current quarter and 7.4% for the last year's quarter. The improvement in gross margin percentage was primarily driven by increase in the sale of SSD products quarter-over-quarter. And cumulatively, we have a 365% improvement compared to the first 9 months of last year. Although we don't guide, industry commentary continues to indicate a soft supply, causing downward pressure on average selling prices and a continued lack of visibility through the end of the year. But based on current backlog and given the current pace and mix of our bookings to date, we anticipate fourth quarter revenue to be similar to the last quarter. We ended the third quarter with cash and cash equivalents and restricted cash of $17.5 million compared to $10.4 million at the end of the second quarter. We raised approximately $9.4 million during the third quarter using the equity line of credit. Cash burn in Q3 was approximately $2 million, well within our near-term target range, which we've discussed of $1 million to $2.5 million. The current cash balance provides us with substantial runway, allowing us to continue to invest in strategic R&D as well as to execute on intellectual property portfolio activity. We have approximately $11.4 million remaining on the equity line of credit if we choose to use it, which does not expire for another 2.5 years. In addition, we continue to very carefully manage the operational cash cycle, which for Q3 20, included increased inventory turns as we decreased gross inventory by 18%, consecutively. This was offset by an increase in day sales outstanding and a decrease in days payable. We also continue to maintain a $5 million working capital line of credit with Silicon Valley Bank to support working capital and revenue growth. Finally, we will be participating in Roth Technologies Virtual Conference, 1-on-1 event this Thursday, November 12. Please contact your Roth representative, if you would like to join us, and we will look forward to connecting with you. Operator, we are now ready for your questions.

[Operator Instructions] And our first question will come from Richard Shannon with Craig-Hallum.

I guess just a couple of thoughts or questions on the outlook here in the fourth quarter. You're kind of looking for revenues to be similar to the third quarter. Is the split of sales between your new NVMe SSD and other products, is it roughly similar? Or is there a change in mix in either direction?

It will be roughly similar.

Roughly similar, okay. And then, Chuck, you had mentioned some greater downward pricing pressure on SSDs. What does this mean for your thoughts about gross margins going into the fourth quarter? And kind of where you see them going beyond that?

Yes. Richard, I think the ASP declines are in the range of -- in the teens in general, from first half into the second half of this year. And the projections are for that to stay relatively flat. It will bottom out at the end of this year and then remain flat through first half of next year. The impact to the gross profit, we're looking at anywhere from a few percentage points to 5%, 6% on the SSD products only. So I don't think, overall revenues -- for the overall product sales, the gross profit won't be impacted significantly.

Okay. And can you remind us or give us a sense of how big your NVMe SSD revenue stream is today, either in dollars or percentage terms, just roughly speaking?

Richard, I'll take that. So for the 9 months, it's been roughly about 18% of our revenue.

Okay. Okay. And Chuck, you talked about -- in your prepared remarks, and I think even last quarter about desiring to broaden your customer base with the SSDs. Can you talk about -- a little bit about your progress there, where you're seeing some interest? I think you talked about 2 larger customers you've had supporting this product line so far, and then some qualifications with storage-related OEMs last quarter, I think, with the new M.2 product. Can you kind of broadly talk about where you're seeing some interest in hopefully broadening of the customer base?

Yes. I think the M.2 products opened up a lot of doors in the storage appliance space and even some industrial space, for example, recently are getting qualified at a company that makes police car dash cams and security equipment. And that was due to M.2. So most of the qualifications that we're starting to see, the new customer applications are in the industrial and embedded space as well as storage appliance space. So that's ongoing. And then the 2 measures that we're working on, they have remained consistent in their demand and the revenue stream from the 2 major anchor customers continue to be stable.

Okay. Any ability to add either major server or cloud customers in the next couple of quarters or so? Any qualifications going on with that type of customer base?

We're obviously targeting, as we've mentioned on past calls, some of the Tier 2 cloud vendors. And we're having those discussions today. I think the progress is more with the industrial and the embedded space at this point. But we've got good contacts into the major OEMs and we continue to have those discussions.