Good day, and welcome to Netlist Second Quarter 2020 Earnings Conference Call and Webcast. All participants will be in a listen-only mode. [Operator Instructions] Please note that this event is being recorded. I would now like to turn the conference over to Mike Smargiassi from Investor Relations. Go ahead.

Thank you, Kate, and good day, everyone. Welcome to Netlist’s Second 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 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 spite of the impact of COVID-19 pandemic across the economy, we delivered solid financial performance compared to the prior year. Although we were not able to keep pace with the first quarter revenue growth, second quarter revenue was close to 2x compared to the year ago period. We also delivered significant improvement in gross profit, along with reduced operating expenses, resulting in a narrowing of net loss by close to 50% year-over-year. The overall demand environment for Netlist’s NVMe SSD product line declined slightly throughout the quarter after a strong start in April. While there was a solid order flow from data center and enterprise markets, including those from the major cloud services provider and server OEM customer, overall enterprise SSD demand appear to have slowed in the second half of the quarter. In the quarter, we also commenced shipment of the new M.2 form factor. These next-generation SSD drives utilize leading-edge 96-layer 3D NAND technology and build upon the success of Netlist’s 64-layer SSDs. The drives are optimized for the demanding data center and enterprise application workloads and provide the speed and endurance customers require to boost performance for caching, streaming and storage applications. Qualification, started early this year with multiple storage appliance OEMs in the high- performance computing space, are near completion. These customers are on track for production orders later this year and in early 2021. We believe industry demand for enterprise SSD will be strong over the long term, particularly with our two largest customers. Remote work and learning requirements continue to drive demand for cloud and data center applications. And the impact of COVID-19 has accelerated trend and the need for high- performance memory and storage in many segments of the economy. However, industry research recently increasingly notes that the tight supply environment of the first quarter of the year has started to loosen. And as we enter the second half of the year, visibility is limited. And the economic outlook, while having stabilized, remains uncertain. Our goal over the coming quarters is to close, depending on qualifications, on new opportunities and secure more customers like the two major ones we are currently servicing in the cloud space and overall broaden out our customer base. Turning to HybriDIMM. The standardization efforts on the protocol continue within JEDEC. Discussions with potential partners were limited in the quarter due to the environment from COVID-19, but the excitement about this technology and the cost performance value it can bring to the industry remain high. In recent months, we have decided to take the HybriDIMM technology and also port it to the emerging CXL bus. CXL is an acronym for Compute Express Link, this is a new open standard interconnect for high-speed CPU to memory, CPU to storage, designed to accelerate next-generation data center performance. CXL is built upon the PCIe, physical and electrical interface with Intel, AMD, among hundreds of others working together in a consortium. We believe that the HybriDIMM technology based on NAND is uniquely designed to provide the lowest-cost solution in the industry running on the CXL bus. We are moving HybriDIMM from an architectural and micro-architectural phase into a design implementation phase. We’re in the process of hiring a team of engineers, adding to the current R&D team in order to commence the front-end portion of the ASIC development. We have begun the RTL coding for the ASIC controller and expect to complete this work over the next three to four quarters. We have also started on building a simulation model and test bench to be able to prove out the chip design and provide the ASIC building blocks to our potential partners. We are very excited to embark on this implementation stage and mark this as an important milestone in the productization process of HybriDIMM. Turning now to intellectual property. In June, we received a significant victory in a decade-long dispute with Google as the Federal Circuit affirmed the U.S. Patent and Trial Appeals Board’s final decision, validating Netlist’s seminal ‘912 patent. In light of this ruling, the U.S. Patent and Trademark Office will move to issue the claims of the ‘912 under a reexamination certificate. We expect the reexamination certificate will be issued several months after the November expiration of Google’s appeal period to the Supreme Court. At that point, we will request the stay to be lifted in the patent infringement lawsuit against Google and the trial to resume in the U.S. District Court for the Northern District of California. With the validity of the ‘912 confirmed, this action will focus on infringement and allow us to recover current and past damages from Google related to server memory products they have manufactured and consumed and are covered by the ‘912 patent. The legal proceeding for the patent infringement suit against SK hynix in the U.S. District Court for the Western District of Texas is moving forward. In our case, we are asserting two new patents, the ‘218 and the ‘595, continuations of existing patent families that read on hynix’ RDIMM and LRDIMM. The court has scheduled a Markman hearing for December 8, 2020, and a trial commencing in the second half of 2021. In June, we expanded our action against hynix in the Western District with an additional action asserting the ‘523, a new self-test patent. The proceeding for the ‘523 will run its own independent schedule with the court. Initial responses to our filing are due August 21, and we expect to receive separate dates from the court for the Markman and trial for the second case against hynix. District court provides a jury trial and the ability to seek both an injunction and damages, which would be decided by the jury. We believe in the fundamental value of our IP portfolio and remain undeterred in our commitment to defending it. We continue to build out Netlist’s patent families for DDR4 server memory as well as the emerging DDR5 and hybrid memory. We have always viewed IP enforcement efforts as a broad campaign across multiple geographies and venues and continue to prosecute additional patents in the portfolio that we are examining for enforcement. I’ll now turn the call over to Gail for the financial review.

Okay. Thanks, Chuck. Revenues for the second quarter ended June 27, 2020, were $10.9 million compared to revenues of $5.5 million in the year ago period, an increase of almost 100%. For the first six months of the year, revenue reached $25.5 million, an improvement of 140% from the same period last year. The significant increase in the top line was due to overall growth across our product lines and follow-on production orders for Netlist NVMe SSDs from a major cloud computing vendor and a major OEM. Second quarter product gross profit percentage, which is before manufacturing costs, increased to 20.1% compared to 14.3% for Q2 2019 and compared to 17% consecutively. After manufacturing costs, the net gross margins were 16.7% for the current quarter and 7.3% for last year’s quarter. The improvement in gross margin percentage was primarily driven by product mix, which continues to include an increase in the sale of Netlist NVMe SSD products. Although we don’t guide, as Chuck noted, visibility remains limited for the second half of the year, and industry commentary indicates a relaxing of the tight supply environment. Based on current backlog and given the current pace and mix of bookings as of now, we currently anticipate third quarter revenue to be slightly down from the second quarter but still significantly higher than last year’s Q3. We continue to closely monitor the impact of COVID-19 on Netlist business during the second half of the year. We ended the second quarter with cash and cash equivalents and restricted cash of $10.4 million compared to $8.6 million at the end of the first quarter. We raised approximately $2.8 million during the second quarter under the equity line of credit. And so far, during the third quarter, we have raised an additional approximate $9 million under the same equity line. The cash raise is an important asset that 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 $11.5 million remaining on the equity line if we choose to use it, which does not expire for three years. In addition, we continue to carefully manage the operational cash cycle, which for Q2 2020 included improvement in days sales outstanding, offset by a decrease in days payable and decreased inventory turns as we paid for inventory approximately 30 days sooner than we sold it due to the need to secure inventory in a tight market. We also continue to maintain a $5 million working capital line of credit with Silicon Valley Bank to support working capital and revenue growth. Operator, we are now ready for questions.

[Operator Instructions] Our first question is from Suji Desilva from ROTH Capital. Go ahead.

Perhaps, Chuck, we can start with the Google case and what some of the key dates or time frames are from this point forward?

Yes, Suji. So we have – so we received the Federal Circuit ruling in June, and Google has through November until the expiration of their appeal window to the Supreme Court. Upon that, we’ll see if they do make that appeal. I think it’s unlikely. Not too many of these cases are accepted by the Supreme Court. After their window expires, there will be a reexamination certificate that is issued by the patent office for the ‘912 patent. And at that point, we will be able to request the stay to be lifted to resume the case in the Northern District of California. So – and we will get dates at that point on the resumption of the trial.

Okay, that’s helpful. And then on the NVMe SSDs, can you talk about what the outlook for 2020 is, whether it’s the same as before, whether it’s improved, whether any changes there to revenue?

Yes. So, as I mentioned, with the two major customers, the demand actually appears to have strengthened. After a lull in the second half of the second quarter, we are getting good forecasts, strong forecast out of the two major customers. The overall market, however, I think starting in the second half of Q2, started to soften. There was a – quite a bit of buying-ahead activity through April and early May. And then once there were double- and triple-booked orders, people – I think their demand started to – well, they pulled in the demand. So they started to issue less POs. Things have come back slightly in recent weeks, but we’re monitoring the conditions in the second half.

Okay. That color helps. And then lastly, maybe on the financials, Gail. Can you talk about the cash burn in the quarter and the expectations going forward there? And what the pro forma share count is with the activity on the equity line of credit in the third quarter? What the share count will be at the end of the quarter?

Sure. So, the cash burn in Q2 was approximately $1.5 million. And we expect that level between $1 million to $2.5 million for the near term. The share count is at about 190 million outstanding, maybe slightly more. We’ll see it – you’ll see it on the Q cover today but in that range.

All right, understood.

but in that range – okay.

And then $1.0 million to $2.5 million, Gail, that’s for the rest of the year or per quarter?

Per quarter.

Great, all right. Thanks, guys.

You’re welcome, Suji.

Our next question is from Richard Shannon from Craig-Hallum. Go ahead.

Thank you. Hi, Chuck and Gail, how are you?

Hi, Richard.

Hi, Richard. We’re fine. Thank you.

Great. Let me follow up on the topic of Google here. Chuck, you had mentioned some specific dates that you’re looking for. What’s kind of the expected timeframe for court date set? I mean is that going to be like a year, a year and a half year out? Or could it be sooner? And then also, do you – is your anticipation that in order to have a successful business outcome with Google that you’ve got to go all the way through the legal system? Or are you constructive on the possibility of reaching a settlement before that happens?

Yes. Richard, I think we’re always open to negotiating a settlement. We’ve held discussions with really all of the parties that we’ve talked about over the years, especially in the last six to 12 months. So there is always – unfortunately, with patent licensing in this day and age, nothing really gets done without litigation, but it doesn’t mean we have to see through the entire process. This case has been – as you know, there was a patent trial on this patent and other patents with Google starting some 11 years ago. So it would be – and large chunks of that case was tried. So now, with the validity confirmed, we expect to resume that process, and so the trial process will be shorter, because the bulk of that process was done a long time ago, and all the records remain. But it will depend on when the courts – what the court docket looks like and what they provide us with the dates.

Good. And Chuck, a follow-on on this topic here with Google. Do you have a sense of the scale of infringement that Google has undertaken over this 10, 11-plus-year time frame? How do we – how does someone think about the potential opportunity or revisiting success from this situation? To what degree does it compare with, as an example, with your hynix cases or any other situation maybe you can compare it to?

Yes. Google – the point we asserted in our patent 11 years ago, it was – it became clear to us that they were manufacturing and consuming server memory modules that read on our patents. We knew it then and that’s why we filed the lawsuit. In the intervening period, while the validity of the patent was contested, they have obviously manufactured and consumed more and more of the server memory modules. They are unique in that they procure the components and build the modules and consume them themselves. We believe the scale of the infringement is significant because all that time, over 10 years has passed, and during that time, they continue to build and consume these memory modules. So yes, I think they are among the largest of the non-DRAM, non-memory manufacturers out there in the world in terms of the size of their production and consumption.

Okay. That’s fair enough, Chuck. Thank you for that. Gail maybe, a question on the financials here. You talked about a qualitative guidance here in the third quarter of down a little bit here. How should we think about the mix shift between NVMe SSDs and resale on other products? And what implications does that have for gross margins? Obviously, your revenues went down a bit in the second quarter, but gross margins were up. So, how should we think about this for the third quarter?

I think the product mix will be probably a little bit more toward our traditional resale area, but we’re still planning on a range of product margin between 16% to 20% for Q3 and Q4. We’re just working away at finalizing some deals. So that’s the best I can tell you right now.

Okay, that’s fair. Chuck, my last question for you is as we look at the NVMe SSDs, I think I’ve asked you this before, but I always like to get your updated thoughts here. What kind of a market size do you see for all the products that you’ve released to market? How big could this get over time? And you’ve talked about having two major customers, I think, one cloud operator and one server OEM. What kind of profile of customers should we expect to see added over the next couple of quarters here with qualifications?

Yes, Richard. So, to your first question, it’s – the market itself for the products that the NVMe SSDs with the three or four form factors that we’re offering, it’s a multibillion-dollar market. We know that NVMe SSDs overall is, I think, this year, about $50 billion. Our segment is the higher performance, higher-end niche. So – but that is still in the multibillion dollars. Now we’ve done very well with the couple of the major guys that are very demanding, both in terms of application and performance requirements as well as the – their logistic support that’s required to support these global customers. So what we – and we’ve done very well. Both the margin profiles on that business is also very, very attractive. So, we want to get into a handful of – secure a handful of these types of what we would call Tier 2 cloud vendors. That’s the tier below the hyperscales. These are all multibillion-dollar companies, many of them in the SaaS space. I think we’ve shown ourselves in the last year with a couple of these customers to do very, very well. We’ve executed very well. So our aim is to continue to – and we are continuing to do business development to try to secure a foothold with a few more of these customers. We do have a whole bunch of other smaller system integrators and storage appliance manufacturers that we are in qualification with. But as we view the business now about a year and a half into it with these enterprise SSDs, we’ve done best with these major guys. So that’s where the focus is right now.

Okay, that is very helpful. I think that’s all from me, guys. Thank you very much.

Thanks, Richard.

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