Mike Smargiassi - IR Chuck Hong - Co-Founder and CEO Gail Sasaki - VP and CFO

Richard Kugele - Needham & Company Richard Shannon - Craig-Hallum

Good afternoon and welcome to the Netlist First Quarter 2013 Earnings Call and Webcast. All participants are in listen-only mode. (Operator Instructions). I would now like to turn the conference over to Mr. Mike Smargiassi. Please go ahead.

Thank you, Amy, and good afternoon ladies and gentlemen. Welcome to Netlist's first quarter 2013 conference call. On today's call will be Chuck Hong, Chief Executive Officer of Netlist; and Gail Sasaki, Chief Financial Officer. As a reminder, our earnings release and a replay of today's call can be accessed under the Investors section of the Netlist website at www.netlist.com. Before we start the call, I would note that today's presentation of Netlist's results and the answers to questions that may follow, 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 a 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. We assume no obligation to update forward-looking statements. During this call, non-GAAP financial measures will be discussed. Reconciliations for those directly comparable GAAP financial measures are included in the press release, which was filed on Form 8-K. I would now like to turn the call over to Chuck.

Thanks Mike and good afternoon everyone. Our first quarter results, which were in line with our expectations, continue to reflect the transitional process underway in our business model, combined with our focus on carefully managing our costs and preserving our liquidity. As we previously communicated, we are continuing to evolve our business model, from one that has been primarily concentrated on customized projects for individual clients, into one that is driven primarily by advanced multi-generational solutions, that serve a broader market. Our first quarter results were impacted by the decline of our more mature products as anticipated, which was partially offset by the increase in shipments of our new products. During the quarter, new products, HyperCloud, NetVault, EV, EXPRESSvault and VLP generated close to 50% of the quarter's revenues. All of these innovative products reflect our position, as the leader in high performance server memory technology, and are supported by our extensive IP portfolio. Now let me turn the call over to Gail, for the financial review. Gail?

Thanks Chuck. Revenue for the first quarter ended March 30, 2013 was $6 million, compared to $14 million for the first quarter of 2012 and flat consecutively. Sales from our new product lines were steady, compared to the prior quarter, while EXPRESSvault stood out as a very strong performer. Similar to the fourth quarter, we once again doubled revenue from EXPRESSvault in the first quarter. Gross profit for the first quarter of 2013 was $566,000 compared to a gross profit of $5.4 million in the first quarter of 2012, mainly due to the lower revenues, unabsorbed manufacturing capacity, as a result of the lower revenues, a changing product mix and the startup costs of our new product lines. As we discussed in our last call, gross profit over the next few quarters will be dependent on the factors just stated, as well as higher cost of materials, some of which we may not be able to pass through in form of higher ASPs. Operating expenses were $3.6 million in the first quarter of 2013, down from $6.5 million from the prior year first quarter, and down from $4.7 million in the fourth quarter of 2012, as we aggressively streamlined our business. These lower operating expenses are due in part to the successful transfer of tasks, such as test engineering, sales and financial administrative support to our lower cost China facility. This corporate initiative was started many years ago, with the establishment of the factory in Suzhou, China. We currently continue to aggressively reduce our quarterly operating expenses, as we enter the second half of the year, while remaining very focused on product execution, including additional qualifications at the OEM. Adjusted EBITDA loss after adding back net interest expense, income taxes, depreciation, stock based compensation and net non-operating expense, was approximately $2.2 million for the first quarter of 2013; compared to a positive adjusted EBITDA of $43,000 for the prior year period. Net loss in the first quarter was $3.2 million or $0.10 loss per share, compared to a net loss in the prior year period of $1.1 million or $0.04 loss per share. These results include stock based compensation in the first quarter of $434,000, compared with $523,000 in the prior year period, and depreciation and amortization expense of $418,000, compared with $535,000 in the prior year first quarter period. First quarter capital expenditures totaled $29,000. We continue to anticipate not spending more than $200,000 in CapEx over the next several quarters. We ended the first quarter with cash and cash equivalents totaling $7.7 million, which was a decrease of $500,000 from the end of the fourth quarter. During the first quarter, we improved our cash cycle significantly by 50 days or an improvement of 30%, which is mainly the result of decreasing days in inventory and improved DSOs. We anticipate continued improvement in the cash cycle during Q2, and are targeting a cash burn in the range of $1 million to $1.5 million. We continue to work closely with Silicon Valley Bank to restructure our loan covenants, term debt, and line of credit, and are in the final stages of evaluating a number of alternatives, some of which are both financial and strategic, in order to improve our working capital position. On the IP front, we received great news during the quarter from the U.S. patent and trademark office, confirming the patentability of all the claims contained in two new Netlist U.S. patents, which are now in the final stages of reexams. We refer to them as the 274 and 537 patents. Both of these patents claim innovations critical to high density server memory, by allowing load isolation buffering. The IP to intensify these patents is key to the extreme performance advantages of HyperCloud, as measured by the third party white paper, that's written by both IBM and HP, and are at the center of why our distributed architecture has been adopted by the industry, as the memory standard at DDR4. We are pleased that the USPTO examiner's final answer, after three years of our competitors trying to invalidate both patents, is that 100% of the 164 claims contained in these patents are valid. Indeed, these are seminal patents, and will become more and more valuable in the near future. I will now turn it over to Chuck.

Thanks Gail. Over the past several years, we have developed a portfolio of advanced products and related IP, that are targeted for the next generation server and storage systems for the cloud. These technologies, mainly HyperCloud and NV and the patents around them, along with our major OEM relationships are the main assets of Netlist. As our sales indicated, we are continuing to see promising traction for EXPRESSvault, which is being used by our storage customers, not only for its ability to protect critical data, but increasingly, to resolve, I/O bottlenecks. The requirement for high performance storage access is becoming more mainstream, and we look forward to continued growth in our EXPRESSvault and NVvault products, going forward. Longer term, we are also seeing interest from the OEMs, regarding developing a future version of our NV products, with more flash content. Such products, which some are calling hybrid memory, will be used as a primary memory tier in servers, and therefore achieve mainstream volume at DDR4. Through our targeted patenting activities, we have invested and grown our patent portfolio, which now includes five technology groups, consisting of 33 issue patents, and more than 30 additional U.S. and foreign pending applications, in the areas of high performance, high density memory subsystems, and hybrid memory technologies. We believe that the company is in a leadership position, for both our products and our patents, and the value of both will appreciate substantially over the next several years. Our goal is to position the company to maximize the value of these assets, as customers adopt our products, and the competitors come to need our IP, over the coming years. We are squarely focused on increasing the rate of adoption of our technologies, and fully capitalizing on our patent portfolio. We believe that volume usage of 32 gigabyte by the OEMs and the launch of Ivy Bridge servers will both occur towards the end of this year, and they will act as the two primary drivers for the growth of HyperCloud over the next several years. We continue to expect the business to scale, as HC and NV gain traction in the marketplace. In the near term, we will continue to maintain a disciplined approach to managing our expenses, with the goal of prioritizing our cash for continuing investment in future generations of our product technologies, and enhancement of our patent portfolio. Thank you all very much for listening today, and we are now ready for questions. Operator?

[Operator Instructions]. Our first question comes from Rich Kugele at Needham and Company. Richard Kugele - Needham & Company: Thank you. Good afternoon guys.

Hi Rich. Richard Kugele - Needham & Company: I just wanted to ask a few questions, if I could. First, can we get a little bit more into EXPRESSvault, that what you are seeing from a demand perspective there, and remind us perhaps, what the ASP range is and what the leadtimes are for both EXPRESSvault and NetVault today? NVvault, I'm sorry.

Hey Rich. EXPRESSvault is a PCI version of the NetVault product, so it has the same functionality, but in a PCI card form factor. The ASP is in hundreds of dollars range, and we have seen a nice ramp and increasing demand for this product, over the last few quarters, and so we expect that to remain steady, over the next few quarters. Richard Kugele - Needham & Company: And the leadtimes? How long does it take you to go through your supply chain and build the product for people? How much inventory -- clearly, and maybe this is also partially for Gail, you've been able to extend your payables and lower your inventory, and then in that way, help offset some of the losses. But you can kind of only do that so far, so I am just trying to figure out how long the leadtimes are, given your working capital position with your supply chain?

The leadtimes are not too much more than the other products that we have, anywhere between four to six weeks. There is FPGA parts that go on to the product. There is obviously DRAMs and Flash on the product. The ASP for the product is anywhere between 250 and 350. So I think this product will continue on for 12 to 18 months, and we expect it to steady -- the demand to remain steady going forward. Richard Kugele - Needham & Company: Okay. Then Gail, could you -- I always ask this question, but could you just break down the revenue for us a little bit, for models?

Sure. Just as a follow-on to your previous question, I think what is important to note, is that on the EXPRESSvault, the high dollar items, like the Flash component and DRAM are readily available. The high IP item, which is maybe not the highest dollar component of our bill of material, is a little bit longer leadtime, because of the high IP. All right, so in terms of the breakdown, HyperCloud this quarter was about 15% of our revenue. The Vault products, about 33%, and VLPs and Planar X about 10%. Those are all of our newer product line. Richard Kugele - Needham & Company: Okay. Thank you for the color on the cash burn that's anticipated for this quarter. Would you anticipate that, as you get into Q3 and Q4, that it gets better or worse?

Based on our expectations for the traction and 32-gig HyperCloud, I would expect that's going to get a little bit harder to maintain such a small burn rate. But a lot of that was depend on the supply chain, as we were discussing. Richard Kugele - Needham & Company: Because ironically, as your sales will increase for a period of time, you could actually burn more cash, right?

Correct. That's right. As you build up accounts receivable and inventory, we are going to burn a little bit more of cash, that's right. Richard Kugele - Needham & Company: Then just lastly, just for completeness, I haven't seen anything hit the tee, but can you just update us on the listing, any comments from NASDAQ or when you stand there?

No updates really. We have formally until next year, I think we should expect to get another letter, probably sometime in August, if our stock price doesn't maintain over $1 for 10 consecutive business days before that point in time. We have several milestones that we are looking forward to over the next couple of months, which we believe will resolve that. Richard Kugele - Needham & Company: Great. Well, thank you very much.

You're welcome. Thank you.

At this time, we show no further questions. Actually I am sorry, we do have a question from Richard Shannon at Craig-Hallum. Richard Shannon - Craig-Hallum: Hi Chuck and Gail, how are you?

Good. Hi Richard. Richard Shannon - Craig-Hallum: Hi. Just a couple of quick questions for me. On your Vault products here, can you give us a sense of how many distinct customers you have, how broad is the acceptance?

Richard, are you referring to NetVault as a family, or just EXPRESSvault? Richard Shannon - Craig-Hallum: I guess, more specific on the EXPRESSvault, maybe more broadly speaking is what would be helpful?

I think on EXPRESSvault we have half a dozen customers and the list will grow over the second half of the year. For NetVault, NetVault by itself is probably another half a dozen customers, growing to a dozen customers in the second half of this year. Richard Shannon - Craig-Hallum: Okay. I guess the second question regarding your patents, you mentioned some preliminary final judgments, maybe I am getting the wording wrong here, but preliminary final judgments from the patent office on two patents. When do you anticipate those being final, and how would you compare the importance of those two specific patents, to some of the other ones that I know -- that are still, whose validity is still being resolved?

Well these two patents are very important for the load reduction technology that is being applied on HyperCloud as well as the industry standard LRDIMM and these patents are also -- as Gail mentioned, apply to the DDR4 LRDIMM standard, and they have gone through rigorous challenges at the USPTO and over the last two-three years; and they have survived those challenges, which is very rare. It's probably single-digit percentage of patents that will go through the entire process of patent reexam at the PTO with 100% of the claims validated. So the patent office is pretty much done. There is an appeals process at the patent office, which -- that remains. So I think we are very confident based on what's happened over the last three years with these patents, that we will have a very good outcome. Richard Shannon - Craig-Hallum: Okay. Is there something you think can be resolved by the end of the year?

It's hard to tell right now. I mean, it really depends on their schedule. Richard Shannon - Craig-Hallum: Okay. Fair enough, one last question for me. I think in your prepared remarks, you talked about -- anticipate competitors having to come to you for your patents, and if misquoted, I apologize for that. But when do you -- assuming all these patents, you especially referred to and perhaps others are finalized, when do you anticipate your competitors having to come to you, to license that?

I think as the market develops for LRDIMMs, as the volumes and the dollars in that market grow, without a license from us, I think there will be high level of risk to those participants that are engaged in the supply of that product. So you know, I think the DDR3 LRDIMM market is starting to grow, and in certainly at DDR4 we believe, many of our patents, both for rank multiplication and load reduction apply to that standard. So I think it will play out over time, starting perhaps end of this year. Richard Shannon - Craig-Hallum: This year. Okay. Great, I think that's all my questions. Thank you very much.

Thank you, Richard.

This concludes the question-and-answer session, and the conference has also concluded. Thank you for attending today's presentation, you may now disconnect.