Mike Smargiassi - Investor Relations, Brainerd Communicators, Inc. Chuck Hong - Chairman of the Board, President, Chief Executive Officer Gail Sasaki - Chief Financial Officer, Vice President of Finance, Secretary Noel Whitley - Vice President of Intellectual Property & Licensing

Richard Shannon - Craig-Hallum Bob Evans - Pennington Capital

Good day everyone and welcome to the Netlist fourth quarter earnings conference call and webcast. All participants will be in listen-only mode. [Operator Instructions]. After today's presentation, there will an opportunity to ask questions. [Operator Instructions]. Please also note that today's event is being recorded. At this time, I would like to turn the conference call over to Mr. Mike Smargiassi of Brainerd Communicators. Please go ahead.

Thank you, Jamie and good morning, ladies and gentlemen. Welcome to Netlist's fourth quarter 2014 conference call. Leading today's call will be Chuck Hong, Chief Executive Officer of Netlist and Gail Sasaki, Chief Financial Officer. We also have Noel Whitley, VP Intellectual Property and Licensing joining us today. As a reminder, our earnings release and a replay of today's call can be accessed on the Investor's 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. 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 will be filed on Form 8-K. I would now like to turn the call over to Chuck.

Thank you Mike and good morning everyone. Our 2014 performance reflects ongoing investments in driving our next generation NVvault product line into the market and investments in our IP assets and the development of HyperVault. The technologies we have developed as the pioneer of the NVDIMM are critical for the future of the enterprise computing and storage space due to its enablement on the memory channel. These markets have gained considerable industry validation and support. The Storage Network Industry Association, or SNIA, has categorized many of the DRAM/flash hybrid memory devices as a type of NVDIMM and provided the following nomenclature NVDIMM-N is a memory mapped DRAM with battery backup. NVDIMM-F is a memory map flash, DRAM is not system mapped. NVDIMM-P is a memory mapped flash and memory mapped DRAM. So we have three ways in which our shareholders could benefit from this up-and-coming category of hybrid memory products. First, we are the leader in the NVDIMM-N category with our NVvault and EXPRESSvault products. We has shipped almost half million units of this product and are awaiting our second next-generation products to come to market later this year. This market is currently projected to be a $400 million market this year and growing to a multibillion dollar market in several years as the software infrastructure for this product becomes fully developed. Representing a significant milestone in our rollout NVvault DDR3 qualified at a major HyperScale customer earlier this year, as announced previously. This followed 18 months of extensive collaboration, which led to defining the specifications for that customer's future generations of NVDIMMs, as well as customized features such as a backup power option using Netlist's power management unit. Today, we are one of two suppliers for this customer and look forward to a commencement of commercial shipments some point this year. We expect this customer to become a major customer for Netlist over the next several years. In addition, we are building off the design and development work today, while also moving forward to qualify NVvault products on additional motherboard solutions from various server vendors. As part of our efforts with HyperScale customers, we are also qualified with four different suppliers to the ecosystem and these efforts are leading to additional design in work for existing and future versions of Vault products. We are also growing the demand funnel with storage appliance makers and other potential HyperScale customers such as Twitter and Seagate with our next-generation EXPRESSvault products, EV3. We are well positioned to capture a share of this growing multibillion dollar market. Second, our NVDIMM key product HyperVault, which is our memory channel storage product, is continuing to progress nicely. Just to remind you, HyperVault is targeted initially at the fastest tiers of storage where latency is a critical issue such as online transaction processing, virtualization, big data analytics, high speed transaction processing, high performance database and in-memory database. We are also at early stages with a large mobile carrier to improve performance and functionality by using HyperVault technology. We are expecting early silicon sometime over the next few months and will be working to ready this product for production early next year. The memory channel storage market is heating up due to the support of the Storage Networking Industry Association and other companies interested in delivering solutions for this market. We expect that over the next few years this could be a multibillion dollar market. Our HyperVault product is expected to have significant performance advantages over the only product addressing this market today, the ULLtraDIMM. We will be working hard with major partners to bring this product to market. Third, as the leading innovator in memory technology solutions, we have developed a substantial intellectual property portfolio based on our key technologies. As you are all aware that we suffered a setback this week in our trade secret theft and breach of contract case against Diablo Technologies related to their supplier for the ULLtraDIMM. While this is disappointing and surprising, it's always difficult to predict what a jury will do when faced with a complex, highly technical case. Over the next couple weeks, we will ask the court to correct the verdict as to our breach of contract claims based on the court's very clear ruling as to the meaning of the contract which resulted in the preliminary injunction. Also at the appropriate time, we will pursue all available appeals. It is important however, that we put this in context. Our focus has always been and continues to be monetizing our IP through the sale of our products and licensing our patents. The same is true for our disputes with SanDisk and Diablo over the ULLtraDIMM. While we sought justice for what we know was clear trade secrets theft and breach of contract, the basis for any long-term settlement has always been, in our view, a patent license. The verdict in the trade secret case has no effect on the patent case which we intend to vigorously pursue. We will be in front of the same judge for the patent case which we expect to move to trial later this year or early next year. So to put this in context, our IP monetization plans are essentially unchanged. The jury verdict, while unfortunate, is a bump in the road on the path towards monetizing our valuable IP portfolio, as it grows and strengthens. Important patents are being issued and the validity of many of our existing patents are being upheld despite repeated challenges from our adversaries. For example, our 537 patent has withstood a multi-year reexamination proceeding with the U.S. PTO ultimately confirming 60 fundamental claims covering load reduction and rank multiplication integral to the design of LRDIMMs at DDR3 and DDR4. There is no other patent in the field that has survived this entire gamut of the U.S. PTO reexam process. More recently, the U.S. PTO refused for the second time to institute inter-parties review of three key patents that we have asserted against SanDisk's ULLtraDIMM in the pending patent litigation. The 185 patent relates to the fundamental distributed buffer architecture developed by Netlist years ago for HyperCloud that has now been adopted by the industry for not only DDR4 LRDIMM, but also for hybrid DIMMs such as the ULLtraDIMM, that operate on the memory channel. The other two key patents that survive two ways of IPRs arose out of our NVvault program and relate to key architectural features of NVDIMM. Again we know of no other patents that have gone through this level of patent office scrutiny. All of these rulings represent a clear validation of our intellectual property by technical experts at the U.S. PTO and it is a testament to the years of seminal development work and ongoing investment in our next-generation technology. Moving on to how we plan to convert our IP portfolio into shareholder value. We generally seek to monetize our intellectual property in three ways. One, by continuing to bring leading innovative products to market such as NVvault and HyperVault. We have introduced over 100 products since inception of the company that have resulted in over $850 million in sales. Two, by licensing our technology on friendly basis to companies that wish to bring more robust memory solutions to market on an expedited basis. Three, by pursuing legal actions against those companies that choose to use our key technologies and their products like SanDisk with its ULLtraDIMM without entering into licensing deals with Netlist on commercially reasonable terms. With respect the patent licensing, while our preference is to generate revenue streams through negotiated licensing agreements outside of the context of litigation, this often isn't possible and litigation becomes the only option to bring licensees to the table. Our patent litigation against the ULLtraDIMM from SanDisk and Diablo is one such example. Now let me turn the call over to Gail for the financial review of the fourth quarter. Gail?

Yes. Thanks, Chuck. As a reminder, we announced preliminary fourth quarter results on February 18 of approximately $2.5 million in revenue and a net loss in the range of $5 million to $6 million. Actual revenues for the fourth quarter ended December 27, 2014, were $2.5 million compared to $7.7 million for the fourth quarter of 2013, mainly due to the absence of NVvault sales to Dell, which had accounted for 45% of the revenue in the 2013 quarter. Gross profit for the fourth quarter of 2014, was negative $113,000 compared to a gross profit of $1.9 million in the fourth quarter of 2013, reflecting the decline in revenue and resulting unabsorbed manufacturing capacity. Net loss for the fourth quarter was $5.8 million, or $0.14 loss per share, compared to a net loss of $1.6 million or $0.05 loss per share in the fourth quarter of last year. These results include stock-based compensation in the fourth quarter of $461,000 compared with $423,000 in the prior-year period and depreciation and amortization expense of $160,000 compared with $310,000 in the prior year's fourth quarter. Adjusted EBITDA loss after adding back net interest expense, income taxes, depreciation, stock-based compensation and net non-operating expense was approximately $4.8 million for the fourth quarter of 2014, compared to an adjusted EBITDA loss of $497,000 for the prior year period. Operating expenses were $5.3 million in the fourth quarter compared to $3.1 million in last year's fourth quarter. After subtracting patent legal cost from both periods, operating expenses were up by $400,000 compared to last year's fourth quarter, mainly due to increased headcount for our HyperVault and NVvault next generation product development and the related sales and marketing. Looking at our full year 2014 performance. Revenues were $19.2 million compared to $23 million for the full year of 2013. This was down by 16% due to anticipated decreased sales to our Vault family of products to Dell, which were not entirely offset by an increase in sales of NVvault and EXPRESSvault to customers other than Dell during the 2014 year. Gross profit for the full-year 2014 was $4 million compared to a gross profit of $3.1 million in the full-year 2013, an increase of 30%, mainly due to increased sales of the higher margin NVvault during 2014. Net loss for the full year 2014 was $15.4 million or $0.38 loss per share, compared to a net loss of $10.8 million or $0.35 loss per share in the full year 2013. Without patent legal cost, the net loss would have been flat from year-to-year. These results include stock-based compensation in the full year 2014 of $2 million compared with $1.7 million in the prior year and depreciation and amortization expense of $882,000 in the full year 2014 compared with $1.5 million in the prior year. Operating expenses were $17.8 million in the full year 2014, compared to $13 million in the full year 2013. Again however, without increased patent legal cost of $4.7 million operating expenses were unchanged from the prior year. Adjusted EBITDA loss after adding back net interest expense, income taxes, depreciation, stock-based compensation and net non-operating expense was approximately $10.9 million for the full year 2014, compared to an adjusted EBITDA loss of $6.7 million for the full year 2013. Gross profit over the next few quarters will continue to be dependent on factors including revenue, unabsorbed manufacturing capacity and change in our product mix. We will continue to focus on managing our expenses and targeting product execution, including strengthening our patent portfolios for HyperVault, NVvault and our HyperCloud family. We ended the fourth quarter of 2014 with cash and cash equivalents and restricted cash totaling $11.7 million as compared to $15.2 million at the end of the third quarter. At the end of 2014, we also had untapped capacity of $900,000 on our receivables bank line of credit from Silicon Valley Bank for working capital needs and at that time access to $9 million of incremental funds under our IP bank loan agreement with Fortress Investment Group. We further strengthened our financial position in February this year. We raise net proceeds of approximately $10.4 million through a public offering of approximately 8.8 million common shares. In addition, we also amended the credit financing agreement we have in place with an affiliate of Fortress Investment Group. The amended agreement accelerated the availability of financing and enhanced Netlist's economics with Fortress by putting a cap on the financing's total patent monetization share to maximum of $9.5 million for all patent monetization during the timeframe of the agreement. While this number is not part of our annual results, our current cash position as of today is over $20 million. This will give us more than ample runway to execute on our next generation product initiatives as well as successfully prosecuting and monetizing our valuable IP portfolio. We view both the share offering and the availability of additional capital from Fortress as strong vote of confidence in our growing and strategically important product and intellectual property portfolios. I will now turn the call back over to Chuck for some concluding remarks.

Thanks, Gail. So to conclude, we remain focused on three game changing initiatives, proliferating the NVvault product line, including EXPRESSvault, bringing to market the fastest next generation hybrid memory solution the HyperVault, partnering with major industry players and monetizing our IP portfolio. While the temporary setback that happened on Wednesday may lead some to view otherwise, the future has never look brighter for Netlist as the markets for our next generation products that will be addressing rapidly growing multibillion dollar markets and our IP portfolio is becoming more valuable and getting strong validation on the patent front. In addition, many of the larger players in this industry are beginning to recognize and understand the value of our technologies and solutions and we look forward to working with them. Thank you all very much for listening and we are now ready for questions. Operator?

[Operator Instructions]. Our first question comes from Richard Shannon from Craig-Hallum. Please go ahead with your question.

Good morning, Chuck and Gail. How are you guys doing?

Good. How are you?

Hi, Richard.

Not too bad. Thanks. Let's see here. Maybe we can go on this in chronological order. Gail, if you could give us just a quick breakdown of your revenue buckets for the fourth quarter, that would be very helpful? The typical ones you have been giving us in the past.

Sure. Pretty much evenly spread between those categories, up 25% to EV, 25% to VLP, 25% to other industrial ODM and 25% to Flash.

Got you. Okay. Great. And then while we appreciate getting the cash balances as of yesterday, curious if you can provide us any thoughts on how you view the revenues for the first quarter since we are just a few days from finishing? Or give us any thoughts there please?

Sure. Yes. Well, the quarter is not quite over. But we are looking at a flattish quarter Q4 to Q1 with the product gross profit being slightly better due to better product mix on having sold more Vault product during this quarter.

Okay. I appreciate that. Let's see, you are going forward now and I think Chuck you mentioned re-qualifying or working on re-qualifying some of your EV products. Can you give us more clarity on when those will get done and when you will start seeing the pickup in sales from those, particularly to your storage customers?

Yes. We are getting our products, EV3 and NV3. These are all DDR3 based. EV3 is a PCIe3 card. These are getting designed in as we speak into probably half a dozen new significant customers. And we expect to see by midyear and into the second half growth in revenues from these new opportunities.

Okay. Are there new customers who design those? Or is all this re-qualifying with the existing ones using the second generation?

There are a number of new opportunities, as I mentioned, significant opportunities like Twitter and Seagate.

Okay. Great. Good to hear. Maybe moving over to the press release you put out, I believe last month, maybe it was January, regarding Microsoft using your NVvault product there. You made a quick comment and I wondered if you could give us any clarity on what you are hearing from them? Continuing engagements? Any thoughts on when you might get the first order there?

Well, we are well-positioned. We are one of two suppliers. We believe we are in a lead supplier position. But the timing of the PO is really function of how they roll out their new server and we don't control that. But currently we expect to see orders later this year, with a significant ramp in 2016.

Okay. All right. Fair enough. Maybe a couple more questions for me and I will jump out of line to see if there are other questions here. But Chuck, you mentioned opportunity with HyperVault into a mobile carrier. Wondered if you can give us some more detail on that? What level of engagement here? What are the value add? And when you might see this ultimately under fruition to see some more there as well?

Well, it's a mobile phone, let me correct that, it's a mobile phone manufacturer, one of the largest in the world. We have been working with them over the last nine months on designing HyperVault into their phones so that they can reduce the amount of DRAMs. So DRAMs obviously are very expensive. Many of these phones are now going to 3 GB of DRAM which is at a cost of $25 or so. With HyperVault, we can reduce the DRAM content significantly, thereby lowering the cost of the bill of material of that mobile phone. So it's a long process of getting it designed in, but we have been working with them for the last nine months and we continue to work with them.

Okay. All right. That sounds pretty exciting. We look forward to updates on that. Maybe a last question. I think you said that [indiscernible] on the line. I would love to get your detailed thoughts on what actions you are going to be taking regarding the recently with Diablo case, what filings you will make, what motions you will make, et cetera and the timing or perspective timing of follow-up events in eventual ruling there?

Sure, Richard. The next things that are going to happen in the court are some filings ordered by the judge, that will happen next week and that will be argued before the court on April 10. These issues revolve around what effect the jury's verdict will have on the preliminary injunction as well as touching on some of the contract issues that were in the case. Most of the, or let's say the remainder of the post-trial motions will be filed within a month of verdict. Those will cover, I am sure, a wide variety of topics, but primarily for us will be our request, our motion to the judge asking her to correct the jury's verdict on the breach of contract issues.

Okay. And to be clear, that's order forward to the judgment as a matter of law, is that correct?

Yes. That's correct, Richard. It's a judgment. Exactly, a JMOL.

Okay. And have you filed that yet? Or when do you expect to move for that?

The full JMOLs won't be filed until by month after the verdict. What's being filed this week is an expedited set of briefs related to, as I said, what effect the jury's verdict will have on the preliminary injunction.

Okay. All right. Fair enough. I think that's enough questions for me. I will jump the line and leave the floor momentarily. Thank you, guys.

Thanks.

Thanks, Richard.

Our next question comes from Bob Evans from Pennington Capital. Please go ahead with your question.

Good morning. Thanks for taking my questions.

Hi, Bob.

To kind of follow-up on Richard's questions, you had mentioned Seagate and Twitter as new customers. Can you give us a sense of, I believe you said timing was second half, but can you give us a sense of potential revenue contribution? Are we talking, is this a $5 million customer, $10 million customer, $3 million? Give us a sense of what that potential might be initially? And then overtime, because obviously they are very big companies?

Yes, Bob. I don't have the exact numbers for those opportunities but they are significant. And these are mostly sole-source positions. Twitter for their own as datacenters and Seagate for a company called Xyratex, which they acquired, I believe, last year. We believe they are going to be annually multimillion, pushing towards possibly tens of millions of dollars opportunities, following the second half of the year.

Okay. And that's individually, potentially tens of millions? I know now initially, but as we ramp?

Yes. I think as it gets to a steady-state run rate, it has the potential to get to eight-figure type of revenues.

Okay. And we see a greater ramp of that in 2016?

Yes. As we saw with our NV and EV products of the prior generation, once it gets designed in, they had very long lives, three-year runs. So it will start to ship this year and ramp-up really 2016 and then go out to probably 2018.

Okay. So this will have some life to it. Okay. Are you working on other, how does your pipeline look for other potential customers of this product? Is the other opportunities there?

Yes. There are many, many others companies like SolidFire, which is a big storage manufacture, up-and-coming. We are working very closely with those guys. And there are a number of other storage box vendors, database accelerator systems. So this EV3, which is a PCIe3, which is that the fastest speed on a PCI bus is looking very promising. There are probably a dozen different opportunities that we are working on. We believe about half a dozen of those will kick in the second half.

Okay. And additionally you had mentioned the mobile opportunity with a large manufacturer. Again, can you give us some sense of revenue potential? I think you said not ramping until 2016, but I am just trying to get a sense of magnitude.

Well, I think it's an enormous opportunity because these guys are among the top mobile phone manufacturers in the world and they are shipping millions and tens of millions of units of phones and potentially it could be very large unit volume, dollarwise.

Okay. Initially --

Pardon me?

Initially what type of, I mean I am just trying to get a sense of, is this initially could be $10 million or $20 million type of opportunity, growing from there?

Yes. I think it's mostly starting in 2016. There is s very long, it's a custom design in of the mobile version of the HyperVault chip into the handsets. It's a long design cycle, but we think starting in 2016, it will be a significant opportunity.

Okay. Again, any sense of magnitude there, in terms of, is that eight-figures?

Certainly has the opportunity. Yes, the potential to get to eight-figures.

Okay. And how about, are you talking to other manufacturers as well, given that if you are able to take that much cost out, is it something you can do with other manufacturers?

Currently we are working with just this one mobile phone manufacturer. And I think that will be the proof point on the technology. And then we can certainly move on to other opportunities because the cost of DRAMs continue to remain very high and the DRAM content on all mobile phones are going up. If we can replace that with Flash at a fraction of the cost, this tremendous cost savings at a time when the bill of material cost of these mobile phones are being pressured and need to continue to go down.

Okay. And final questions, any other licensing types of opportunities you are working with on your next with your Vault product or potential? Give us your thoughts strategically in terms of how you are looking to monetize that?

Well, as I mentioned on the opening script, we have a number of patents in the LRDIMM side and in fact, we believe the only patents that have gone through the complete gamut the patent office reexam process, took almost four years. So it is really, we believe, an untouchable patent from a validity standpoint and it reads very clearly on the DDR4 LRDIMM. So that's certainly a very attractive opportunity. And then three other patents that have gone through multiple IPR attempts and have come back, basically being validated by the PTAB, Patent Trial and Appeals Board, saying that these are valid patents. So that is also a very unique situation with those three patents. And they all apply on the NVDIMM as well as the ULLtraDIMM.

So given your strong patent position, outside of the Diablo, exclude the Diablo/SanDisk case, are there companies that are willing to talk and work with you as it relates to licensing opportunities? Or we are just was battling this in court?

Yes. I can't speak to specifics, but I think as these patents make their way through the reexam process, I think the industry is taking note of the strong position. Validity is a key issue in all of these patents.

Okay. All right. Thank you.

Thanks, Bob.

And our next question comes from Richard Shannon from Craig-Hallum. Please go ahead with your question.

Great. Thanks for taking my follow-up. So maybe just a few for me, probably the first couple for Gail. I missed some of your comments regarding legal expenses. So wondered if you could customize what was spend in the fourth quarter? What you think it's going to be in the first? And do you expect any meaningful amounts at least from your visibility you have over next couple of quarters?

Yes. Actually, we have classified on a separate line item on the P&L this quarter, Richard, the legal fees, so it's easier to see. But specific to the patent litigation and prosecution for Q4, we spent $2.4 million. For this quarter, I don't quite have the numbers yet. It is probably going to be in the same range, maybe higher and then going forward for the rest of the year, I expect we will probably see a slight low in Q2 and Q3 and as we gear up for the patent case, probably we will see an increase in Q4 and early 2016.

Okay. All right. Thanks for those thoughts. Second, what do you expect your gross level of debt to be reported or exiting the first quarter? And I know I have asked you this question, but feel free to restate it for the conference call. Can you remind us what covenants you have on the debt? Are there any call options or anything like that, please?

Sure. So our current debt level is just under $10 million. As we exited Q4, it was under $6 million, but we did borrow an additional $4 million from Fortress in February. There are no call options, per se. We have one covenant from Fortress that we need to maintain $500,000 in cash. That's the only covenant. And then from Silicon Valley Bank, we have the usual current ratio and minimum tangible net worth covenants and we are meeting them currently. We also however haven't borrowed any money from Silicon Valley Bank.

Okay, perfect. Let's see here, maybe I will ask a question a little more expansive than what Bob just asked you a few minutes ago. Maybe, I don't know if this is Noel or Chuck, if you can give us a sense on your whole portfolio of patent cases out there and when you expect the next major events to happen, both related to Diablo and SanDisk case as well as the other ones that are outstanding? Give us a sense of the timing of the major events, that would be great, please?

Sure, Richard. I think the easiest to talk about is the Diablo and SanDisk, the two litigations. I think we talked a little bit about the trade secret litigation. We have, as I mentioned, the briefing, the argument that's coming up on April 10 followed by the post-verdict motions. Those will take typically a few months, two to three months, to fully resolve. Then the case will be ready for appeals from both parties. As the remaining litigations, they are all currently stayed pending various re-examination proceedings. As we have reported previously, those proceedings are going very well for us, but they are lengthy and the existing litigations will not be restarted until those re-examination proceedings have been completed. And those, we are looking at, the first of those patents, the 537 that Chuck referred to earlier, that we will complete the appeals process likely by the end of the year and then I expect several more of those patents under reexamination will conclude next year.

Okay, perfect. Thank you for laying that all for me. I think that's all my questions, guys. Thank you.

Thanks, Richard.

And ladies and gentlemen, at this time, I show we have reached the end of the question-and-answer session. I would like to turn the conference call back over to Mr. Hong for any closing remarks.

Thank you all very much for your continued support and interest in Netlist and we look forward to updating you in the next quarterly call. Thank you.

Ladies and gentlemen, that does conclude today's conference call. We do thank you for attending. You may now disconnect your telephone lines.