Good day. And welcome to the Netlist Third Quarter 2019 Earnings Conference Call and Webcast. All participants will be in listen-only mode. [Operator Instructions] After today’s presentation there will be an opportunity to ask questions. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Mike Smargiassi, Investor Relations. Please go ahead.

Thank you, Sarah, and good day, everyone. Welcome to Netlist third quarter 2019 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 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. Since the last call we have made significant progress in a number of key areas. First, financial performance improved sequentially for both revenue and the bottomline. Second, we made further headway in the commercialization of HybriDIMM as JEDEC announced publication of the latest DIMM specifications to support NVDIMM-H. Third, we broaden the market for Netlist’s NVMe SSDs products with validation at a Tier 1 OEM and received an initial production order from a major cloud services provider. Fourth, we reached a significant milestone in the company’s IP campaign with the recent favorable initial determination from the ITC, which found that the SK Hynix LRDIMM server memory infringes on Netlist’s standard essential patent. Turning first to the recent news from the ITC, on October 21st we received a notice of initial determination or ID from the United States International Trade Commission in regards to the company’s second ITC action against SK-Hynix. We are very pleased with the outcome as we received positive determinations as to the infringement and validity of Netlist’s 907 patent, as well as defeating SK-Hynix contentions that Netlist had violated its Rand obligations to implementers of the JEDEC standards and had not met the standards for domestic industry. This was a major win for Netlist against SK-Hynix, who may be facing an exclusion order on the sale, sale for importation and importation into the United States of billions of dollars annually of LRDIMM products in violation of Section’s 337 of the Tariff Act of 1930. The ID found that the second patent in this case, the 623, which covers RDIMM products invalid and un-infringed. Without access to the full ID however, Netlist does not yet have the benefit of knowing the reasons for that decision. Once we receive this document, in the coming weeks, we will be able to determine in consultation with outside counsel, the avenues to pursue/appeal for this decision by the full commission. As part of the ITC procedure, the ID is now subject to review by the ITC Commissioners. Both parties can petition for review of any findings they believe are incorrect. The Commission will then decide whether to review portions of or the entire ID. Once the issues under review have been briefed, the Commission may affirm, set aside or modify the portions of the ID under review. These conclusions will be contained in a final determination, which is scheduled to be issued by the Commission on February 21, 2020. The multi-prong campaign against SK-Hynix continues early next month at the Federal Circuit Court of Appeals, as they will hear oral arguments by both parties and the appeal of the final determination of Netlist’s first ITC action. This places us on a path for a potential determinative ruling from the Federal Circuit with regards to both validity and infringement of Netlist’s 064, 434 and 501 patents, and a potential to overturn the final determination of the first ITC case against SK-Hynix. In the meantime, Netlist continues to improve its patent portfolio and recently received the notice of issuance from the U.S. PTO for an important RDIMM patent, which will issue before the end of the year. Now moving over to the product side, in regards to product sales, we booked the first production order of volume shipment of Netlist NVMe SSDs during the fourth quarter with a major cloud services company. We believe this lays the groundwork for future significant order volumes in 2020. We also recently completed the validation process for Netlist’s NVMe SSDs with a Tier 1 OEM. In testing this OEM, our product performance and latency had best-in-class results when benchmarked against other leading SSDs. This is a powerful endorsement of the high performance and significant value we bring to end users in the enterprise and data center markets. We are also partnering with a major CPU vendor to validate and proliferate our SSD solutions on their platform. And there will be further news on this front in the coming weeks. We also continue to grow the customer base for Netlist’s resale in specialty DIMMs, which expand at 15% consecutively, quarter-over-quarter. Although, we don’t guide revenue, based on October’s activity, we estimate meaningful growth in both product sales and product gross margins. Turning to HybriDIMM, we are making solid progress on both product and standardization components of our commercialization campaign. The publication of JEDEC standard for NVDIMM-H in September provides an industry standard and a necessary framework to develop a healthy ecosystem of broad base users and suppliers for HybriDIMM. Discussions with a major semiconductor company under our Memorandum of Understanding are continuing, as well as discussions with other potential partners for the ASIC controller. Such a partnership would bring the resources of a major semiconductor company to drive the implementation of the AISC chipset for HybriDIMM, as well as create a path for third parties to bring the HybriDIMM solution to market. I will now turn the call over to Gail for the financial review.

Thanks, Chuck. Revenues for the third quarter ended September 28, 2019 were $6.1 million, compared to revenues of $5.5 million in the previous quarter, and $7.2 million for the 2018 period. The decrease in topline year-over-year was directly related to the worldwide server DRAM pricing erosion versus the year ago quarter. But as we expected, we did see modest topline improvement on a sequential quarter basis, in line with the rest of the industry. Third quarter 2019 product gross profit percentage, which is before manufacturing cost, was 12.6%, compared to 12.1% for the previous quarter. After manufacturing costs, the net gross margins were 7.4% for the current quarter and 8.1% for last year’s quarter. And although, we don’t guide, as Chuck indicated earlier, given the current pace and mix of bookings, we anticipate improvement in fourth quarter revenues compared to the third quarter, as well as improvement in the product gross margin percentage compared to last quarter. Operating expenses were $3.3 million during the third quarter, down year-to-year by 34%, as legal expenses declined 65% from the year ago period. We expect additional decreases in legal expense in the future quarters. We ended the quarter with cash and cash equivalents and restricted cash of $8.6 million, compared to $9.5 million at the end of the second quarter, and net cash change of $900,000, with $1 million paid out for litigation costs during the quarter. We raised approximately $2.5 million during the third quarter and another $3.5 million during the quarter-to-date under the $10 million equity purchase agreement we entered into during June of this year. We also continue to proactively manage the operational cash cycle, which includes improvement in days of inventory, a 15 days decrease year-over-year. In addition, we have accessibility to a $5 million working capital line of credit with Silicon Valley Bank, providing borrowing of up to 85% of eligible accounts receivable to support working capital and revenue growth. Operator, we are now ready for questions.

[Operator Instructions] Our first question comes from Suji Desilva with ROTH Capital. Please go ahead.

Hi, Chuck. Hi, Gail. Congratulations on all the progress here. Maybe you can talk about the product revenue and what’s the impact of the memory industry supply/demand dynamic is on the DRAM maybe even the NAND side? Seems to be things are firming up, but I am wondering if there’s a lag effect for you guys or whether you see it right away, what the opportunity for next few quarters is in the memory industry as that firms up? Thanks.

Yeah. Thanks, Suji. We saw revenues declined in the first half of this year, with the declines in the ASP that came about as a result of the overall excess supply in the marketplace. As you noted, things are firming up. We are starting, certainly, in this quarter to see pick up in code activity, pick up in a number of transactions as well. And pricing hasn’t gone back up but it has starting to -- the decline and starting to dissipate. And overall, the efforts to proliferate design wins across many customers for us, our SSDs are -- we are starting to see some of the fruits of our labor now starting this quarter. As I mentioned, we booked the first meaningful production order with a major cloud vendor and a major OEM this quarter or this month, and we expect that to be a -- we expect that to continue with orders ongoing through the rest of the next year from those customers.

Okay. Great, Chuck. My second question was about the SSD customer, the cloud customer. So how long is the qualification cycle for those kind of customers typically? And once you and I presume, you are part of a multi-source sort of socket, but tell me if that’s not correct? And how would we think about the size of that opportunity for you in the 2020 timeframe for that customer perhaps?

The qualification cycle is -- has been long. We have -- that particular cloud vendor uses a major OEM server platform. And so we had to get qualified at the major OEM and then do application rack level testing at the cloud vendor. So in total it was probably about six months to nine months of qualification. Now that we are locked in, we did receive a letter of intent from that cloud vendor in recent weeks for supply of that product through the course of next year. And we hope to increase our share of that and go beyond the volumes that set out in that LOI. But we think it will be a decent volume, anywhere between $5 million to $10 million with that customer.

Okay. Great. And you are multi-sourced for these SSDs…

Yes. Yeah. Yeah. We will -- there is one other competitor in that socket. But what we have seen is that our sequential -- random and sequential read-writes of our SSDs are, we have better performance than the competition is the feedback that we receive. So we feel pretty good about where we are with that customer.

Okay. And then my other questions about on the NVDIMM-H standards that just got, I guess, ratified. How long does the ecosystem take to kind of get ready to implement this? Were they already -- was that already in motion or does that have to start now that it’s ratified? When does the ecosystem feel like it’s ready to kind of snap in NVDIMM-H parts like HybriDIMM into their systems and software…

So, Suji, to clarify, it hasn’t been ratified.

Okay.

So what happens is, so the first steps are to do what we have done here over the last nine months, which is to get an SPD, serial presence detect setting in a server, meaning that the CPU will set aside a certain number of bytes to be able to recognize a memory module as a NVDIMM-H. So we reserved our space and doing that in itself it’s very -- it’s a difficult to do through JEDEC, because there is the finite number of SPD bytes available from the CPU. So we have done that. We are now working on finishing out the protocol. And then a couple of other items which we expect to get done within the task group that we chair, which today has about 60 some odd companies as members. Once that task group has finished its work, it will go to the full committee for ratification. So that -- it’s going to take a few more quarters here for all of that. In the meantime, we will be working on the development of ASIC. But in all we are well on our way to getting this standard finalized as a standard, it will take another couple three quarters but it will happen.

Okay. That’s helpful color. And then, last question perhaps for Gail on the balance sheet. The $10 million equity agreement you have already used $5.5 million of that. Would you possibly upsize that with that particular partner investor or is that something that’s been considered discussed or at this point?

Yeah. We actually raised about fifth at this point Suji and no we have not considered any increase to that at this point.

Got it. All right. Thanks congratulations on the progress.

Yeah. Thanks Suji.

Thanks Suji.

The next question comes from Richard Shannon with Craig-Hallum. Please go ahead.

Chuck and Gail, thanks for taking my questions as well. Let me follow-up on the NVMe SSDs here, you talked about an order from a cloud customer, I think, you mentioned, was driven through one OEM. May be if you can talk through the compendium of your other engagements so far either by cloud guys or OEMs and when you might see some success, either production orders qualifications or whatever?

So the order that we received was a meaningful size order. So, I think, we will see starting this quarter about $ million worth of new SSD sales at decent margins. So in that -- is that -- within that those dollars there is the major cloud services vendor, which is where the order is being fulfilled through a Tier 1 OEM. And then through qualification of that Tier 1 OEM we expect to get other cloud services vendors of the caliber that we are shipping to -- we are starting to ship to this quarter. There are other -- within that dollar volume for this quarter. There are other smaller OEMs, probably, two others, where we are shipping the NVMe SSDs. So, out of some 20 odd qualifications that we have achieved to-date, we are now starting to get some meaningful purchase orders and we expect that to ramp -- continue to ramp through the course of next year.

Okay. Fair enough. Chuck, I think, I may have asked you this in past quarters, but let me just ask again, so everyone can hear it. But what do you see as the market size for this -- for 2020 I know that, obviously, you are ramping up getting qualifications, but if you are, assume that you had products across the Board qualified and whatever. What do you think the TAM would look like for next year?

So, Richard, you mean the TAM for the market segment in which we are shipping into or what our portion of that would be?

The total TAM.

We think the total TAM, so to be specific, these are NVMe SSDs. So NVMe describes the interface for the SSDs that’s the protocol. The form factor of our products are AIC, HHHL meaning add in card, half height, half length. So that is the niche that we are playing in. We are bringing on M.2, which is a second form factor. And then you have got various capacity, so that the product line is, probably, half a dozen SKUs. We believe probably a market of several hundred million dollars annually for the current AIC product line that we have. It’s probably another several hundred million dollars for the M.2 products, which will bring to market later this year.

Okay. And maybe following up on one of Suji’s questions earlier at least kind of implied questions here, what kind of share could you be getting here at the early stages and is there like a terminal of share that you might think you could gather in a year or two if you continue to execute well?

I think we are targeting in the low teens in terms of market share that’s relatively conservative. As there are major vendors in the space, but many of them have either gone end of life or have deemphasized these particular form factor of the NVMe SSDs. NVMe as a category is growing rapidly and probably will become the largest category -- interface category. But I think low teens would be a reasonable target for us to have in terms of share of market.

Okay. That’s fair enough. Chuck maybe jumping over to HybriDIMM, last quarter you talked about an MoU and you said its discussions are still ongoing. What are kind of the catalysts or restrictions or obstacles in the way of moving along to the full agreement here? And what would be kind of an optimistic timeframe by which a partner could have an ASIC in the field ready to be qualified and tested?

Well, I think, I will look at that -- we can look at that kind of as two different areas. One is, trying to close an agreement with we have got a couple of potential partners. One where we have a MoU, one where we do not, but we have got a couple of potential partners. And we think, we will be able to close one of those partners over the next couple three months. And the obstacle to doing that, I think, there has been a lot of technical diligence done on that. So we are well on our way. It’s now it becomes a matter of the economic terms and that’s -- it’s just basically a negotiation process that we have got to step through. And once that is done, the parties will -- including us will embark on a design of the ASIC version or of this ASIC controller and that will probably take a good 12 months to 18 months. In parallel, we will be working on the module design. And by that time, the JEDEC standard will have been finalized. As I noted there is, we started this with a handful of members now we are up to some 60 members, 60 -- many of them being major companies and users on this NVDIMM-H task group. So once the product is available to sale we believe the ecosystem will have been formed and we will be able to start shipping product.

Okay. I think you get a sense of what you are expecting there. That’s helpful. Last question from me, probably, for Gail here on gross margins. I am assuming that the growth you are expecting for this quarter is all -- is entirely coming from the NVMe SSDs. Any sense you can give us to what kind of incremental margin we expect on the growth coming in this fourth quarter?

Sure. Yeah. I wouldn’t say that it’s completely from NVMe SSDs. We have seen some growth in the margins from the resale and the specialty DIMM areas as well. But I think probably conservatively we would be looking at about a 40% increase in the product gross margin between quarters.

Okay. That’s all I need to know. Thank you very much, guys.

Okay.

Thanks, Richard.

This concludes our question-and-answer session. The conference is now concluded. Thank you for attending today’s presentation. You may now disconnect.