Mike Smargiassi - Investor Relations Chuck Hong - CEO Gail Sasaki - CFO

Richard Shannon - Craig Hallum Gary Mobley - The Benchmark Company Suji Desilva - Roth Capital

Good day and welcome to Netlist Third Quarter 2017 Earnings Conference Call. All CEO participants will be in listen-only mode. [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, Rachael, and good afternoon, everyone. Welcome to Netlist’s third quarter 2017 conference call. Leading 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 could 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. 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. We will start the call today with an update on our licensing efforts and actions at the International Trade Commission. Yesterday we filed our second compliant against SK hynix. I’ll also comment on our HybriDIMM commercialization efforts and plans for the Supercomputing 2017 conference in Denver. Gail will conclude our formal remarks with a review of our third quarter performance. The ITC action we commenced in September 2016 is proceeding as anticipated with the final initial determination expected on November 14. The initial determination or ID will mark a significant step in our overall effort to address Sk hynix’s pervasive and unauthorized use of Netlist’s IP. The ID role address a number of issues such as patent validity and infringement and will also include the judge's recommendation as to whether an exclusion order should issue that directs U.S. customs to stop SK hynix’s RDIMM and LRDIMM products from entering the U.S. We are pleased with how the ITC proceedings have gone thus far and look forward to seeing the ID. Further yesterday we announced the filing of a new investigation in the ITC against SK hynix server memory products which brings to the table the latest and some of the strongest patents in our portfolio. The two new patents asserted in this action add to and bolster our legal position against SK hynix. This action was taken as part of our overall strategy to address the SK hynix's prolonged and continuing infringement of our patents both in the U.S. and abroad. We have been in negotiations with SK hynix as part of the court mandated settlement proceedings and via our ongoing licensing efforts. We are resolved to achieve a resolution which fairly compensates Netlist for the full value of our intellectual property. ITC 1 is an important element of that overall strategy along with the suites filed in Germany and China. ITC 2 adds another important plan with even stronger patents. Our strategy is not dependent on a single action or event rather we will have multiple opportunities to have our IP validated over the next nine months or so in these various enforcement actions. SK hynix continues to generate historical revenues and profits and analysts estimate that SK hynix is on track to generate almost $7 billion in sales this year from RDIMM and LRDIMM, which infringe on Netlist patents. RDIMMS and LRDIMMS are among the highest margin products sold by SK hynix generating 60% plus operating margins amounting to over $4 billion in worldwide gross profit in 2017. These massive profits and historic growth in a large part powered by server memory have moved SK hynix into the position as the third largest semiconductor company in the world. SK hynix has achieved the success at least in part on the back of Netlist technology. We cannot allow them to continue to reap enormous financial benefits from using our patents without properly compensating Netlist and its shareholders. Now I would like to provide you an update on our commercialization efforts for HybriDIMM and a brief preview of the supercomputing show taking place in the week of November 13 in Denver. Over the past several weeks members of our HybriDIMM technical team has held a number of discussions and meetings with potential partners. This included a trip to Korea where we held negotiations on phase 2 of RJDLA with Samsung. We were encouraged by level of interest from Samsung as well as other potential partners we spoke with in regards to the next phase of HybriDIMM commercialization. As we take this next step with HybriDIMM, we expect to have a number of revenue opportunities which may include additional engineering related revenue and future per-unit royalties. We are pleased to have recently shipped our first HybriDIMM evaluation systems to select customers including a major ODM in Taiwan. There continues to be significant interest throughout the industry in regards to Storage Class Memory and the cost performance benefits of a product like HybriDIMM. The explosion of server memory growth driven by big data applications and hyper scale datacenters and growth of artificial intelligence are pushing Storage Class Memory to the forefront of new technology discussions in the industry. At the Supercomputing 2017, we will demonstrate HybriDIMM concurrently operating a big data storage and in memory database application in multiple access modes. MongoDB exercises HybriDIMM’s memory channel block storage capabilities while the Redis In-Memory database utilizes memory semantics to achieve a true persistent memory solution. We believe the simultaneous operations of these two applications with no impact on the memory channel is an industry first and a significant breakthrough for HybriDIMM making the live demo an important part of our efforts at SC 17. At a conference we will also be working with partners to showcase the capabilities of our NVDIMM products which are an ideal solution to meet the industry's expanded utilization of in-memory computing applications and cloud-based datacenters. In summary the growing demand for server memory which will encompass hybrid memory and storage class memory positions our products and our IP for future value creation. The HybriDIMM commercialization efforts are making good progress and the comprehensive plan to license our intellectual property is steadily moving forward with the decision from the ITC expected in two weeks. I will now turn the call over to Gail for the financial review.

Thanks Chuck. For the third quarter on the top-line, we once again delivered substantial year-over-year growth and our quarterly performance since we more than double product revenues from last year's third quarter. Revenues for the three months ended September 30, 2017, were $9 million, compared to revenues of $2.6 million for the 2016 period. The year-over-year increase in product revenue primarily reflects the ongoing benefit from the sale of enterprise grade high capacity SSDs and high density DRAM modules sourced from Samsung accompanied by increased orders for specialty DIMM and the steady growth in quarterly shipments for our hybrid member EV3 to Inspur. We did experience a decline in enterprise SSD revenue from the last quarter as the market has become more saturated. However, we do continue to add for our base of our over 100 new customers for these products as well as growing revenue from Samsung sourced DRAM. We also anticipate more EV3 revenue from Inspur during the first quarter and although we don't firmly guide we are currently forecasting first quarter product revenue to be better than third quarter of this year. Third quarter 2017 gross profit was 700,000, reflecting both revenue growth and a better product mix year-over-year. Overall margin dollars in Q3 17 were greater than Q2 17, even though revenue was less by $2.4 million specifically due to a higher quality margin mix which we have mentioned earlier and due to increased demand from our profitable DIMM sales which are also built by our own factory which in turn decreases the factory overhead and related charges. Net loss for third quarter was $3.1 million compared to a net loss in the prior year period of $4.4 million which is a 30% improvement year-over-year and a 20% improvement consecutively. Operating expenses were $3.7 million in the third quarter compared to $4.3 million in last year's third quarter and compared to $4.4 million in the second quarter of 2017. Expenses declined on an absolute basis across R&D and SG&A mainly due to ongoing proactive cost management. We ended the quarter with cash and cash equivalents and restricted cash of $11 million as compared to $7.6 million at the end of the second quarter. The increased cash position reflects the addition of $4.4 million of net cash from our recent offerings as well as a significant reduction in our cash burn rate. We continue to proactively manage not only our operating expenses but our overall cash cycle. As a result cash burn was $1.3 million in third quarter well below our average burn rate of $2.5 per quarter during the first half of 2017. During the third quarter we also realized the benefit of $3.3 million in reduced legal expenses from our financial arrangement with TRGP and have realized a total benefit of $9.3 million due to this arrangement to-date. Our working capital line of credit with Silicon Valley Bank has a total capacity of $5 million, capped by 18% of our eligible accounts receivable balance and is available for working capital to support the increase in our product business volumes. Finally, we will be at the Supercomputing 2017 conference in Denver taking place November 12 through the 17. In addition during that same week we will be attending the Roth Technology Corporate Access Day and the [indiscernible] conference both in New York and taking place on November 15 and 16 respectively. We look forward to seeing you at these events. Thank you for listening. Operator, we are now ready for questions.

[Operator Instruction] The first question comes from Richard Shannon with Craig Hallum, please go ahead.

Well, hi Chuck and Gail. Thank you for taking my questions. Let's start one looking at the third quarter and potential for the fourth quarter here. So it sounds like you had a little bit lower Samsung brand and revenue sales but a little bit more of Netlist products ramping up here. Can you give us a sense of scale here both on the Samsung decline here in internal products going on?

Sure. The Samsung decline of SSDs was mitigated I think by an increased, a slight increase of DRAM from Samsung and about a million dollar of specialty against an EV3.

Okay. That's helpful and then you also mentioned some expectation or some growth here in EV3 specifically from your partner Inspur out of AG, can you give us a sense of the activity going on there, is this kind of advanced sampling and qualification or these production orders and how does this translate going into 2018?

Yes Richard. The units are growing nicely quarter-over-quarter since the beginning of the year and I think we had talked about a run-rate of million dollars a year from Inspur and we are on that run-rate now in Q4. We expect that to continue, they continue to see a lot of their server customers with EV3, so we expect the numbers to continue to go up on EV orders from Inspur first half of next year.

Okay. And is Inspur the primary partner for EV3, do you have any other channel or direct OEM customers you have visibility into ramping?

Yes, we have qualification efforts at handful of others. I think traction and visibility wise Inspur is the best customer we have.

Okay and then just quickly you have also mentioned NVDIMM doing some marketing at the SC 17 show here coming up shortly, can you give us a sense of the traction there. That looks like a market that's developing more broadly out there so kind of curious of your traction and when we might see some revenue inflection there?

We will have some announcements with some partners for NV at the Supercomputing show. We are sampling very active. There is two dozen customers around the world that are qualifying the product. I think as Skylake takes hold in the market that will start to drive the NV4 demand.

Okay. That is helpful. Let's move over to more of the licensing side little bit. Let's talk a little bit about Samsung in your HybriDIMM conversations Chuck. I wonder if you can help us describe how those conversations went recently, what are the prospects and potential timing of kind of doing a follow-on your initial JDLA?

We are making good progress as you know the JDLA phase 2 is a part of the agreement that we signed and there was always the intention to, once you get to a product functionality prove point that we would move on to commercializing the product with Samsung. We are in the middle of business negotiations on the terms of that phase 2, but there is I think high level of interest in commercializing the technology from Samsung and putting it, making the product a part of their offering. So yes, it's going to take some business negotiations. That's where we are.

Okay that's helpful. I will ask one more question and jump out of the queue for others here. Just quickly on hynix here, obviously you are within two weeks of the expected initial determination from the ITC case here. Hynix seems to have a history of settling early or just before those have been announced. Are there business discussions going on there? Is it still possibility to see a settlement occur or do you anyway can put odds on that potential, Chuck?

Yes, I mean as you can – as we stated on the script that there is ongoing negotiations that you would expect in a case like this. And the channels are open. So there is talk and a lot can happen down the wire, but we have our expectations about the value of the patent portfolio that is being infringed by hynix and they have their expectations of what that’s worth as well. So it's a matter of closing the gap in those expectations. So I don't think I can put a number on what the probabilities of the settlement prior to this initial determination, but yes there is a chance and we continue to talk.

Okay. That's fair. I think that's all the questions from me. So I will jump out of line. But thanks guys. I appreciate and we will look forward to at November 14. Thanks.

Thanks Richard.

The next question comes from Gary Mobley with The Benchmark Company. Please go ahead.

Hey guys. Thanks for taking the question. I had a question about the November 14 initial determination. So we have to really essentially check three boxes on all five patent claims right whether be it commercial, applicability and domestic industry and so if you got all three of those boxes checked on and just one of the five claims would you consider that a victory and a key point of legal leverage to compel SK hynix to get over the hump? And as a follow-on to Richard's question how far apart are you guys with SK hynix on terms it's my understanding that per public filings SK hynix has already made an offer of settlement but obviously you guys are far apart. Is it an issue, is it a monetary value issue, is it a perpetual licensing issue, do they just want to make a onetime settlement or any color on that would be helpful?

Gary, Noel is here so I think he can certainly address the first part of your question. And then we will go from there.

Yes. Hey Gary its Noel Whitley. Certainly if we check those boxes as you said validity infringement and then the ITC's specific issues of domestic industry and public interest absolutely that would be a victory. Even one plan as you know that checks those boxes would result in the judge recommending to the ITC that an exclusion order is issued. So yes, I think that we would certainly consider that a victory and would also we believe provide significant settlement momentum.

Okay. And Gail I am sorry, go ahead.

Yes Gary, I think the second half of your question as to, I don't know that we put out anything that talks about publicly the numbers that are being negotiated and we are unable to talk about that. But I think as we have indicated in the scripted remarks, the financial results that they’re recording quarter after quarter over the last year and it was same unabated going forward multi-billions of dollars of sales of RDIMMs an LRDIMMs as well as multi-billion dollar of profit generated all of that we believe are covered by number of our patents. So the magnitude of the dollars that they are generating as well the infringement should indicate what the appropriate size of the dollar of settlement that is being discussed.

Understood, okay. If I am not mistaken on your last earnings call you mentioned that total revenue would grow sequentially and so obviously it didn't and I am just curious what was the major contributing factor to the shortfall and if it is related to tight supply of NandFlash or Solid State Drives or if it's relating to the saturation as you mentioned. Does that point to lack of diversification in the customer base where you are shipping an extraordinary amount to one or two specific customers?

I will answer that last question first. The answer to that is no. We have been building a very strong and diverse customer base and in the prepared remarks I did mention that a particular type of SSD has become more widely available to the market and we were selling quite a bit of that over the last year. However, as you know there is many different types of SSDs in this enterprise grade and we have also been selling, making up for that by a large volume of DRAM sales. And what we call more synergistic sales because we do have access to the raw materials from Samsung being able to build specialty DIMMs for our several customers that have been requesting it and we are seeing an increase in EV3.

Got you. Okay. I appreciate the answers. That's all the questions I have. Thank you.

Thanks Gary.

The last question comes from Suji Desilva with Roth Capital. Please go ahead.

Hi Chuck, hi Gail congrats on getting the cash burn down here. Can we talk, the customers you mentioned 2,000 customers qualifying is that specifically the comment on HybriDIMM or more on the -- general comment on the products you have and maybe what the timeframe that some of those could convert into program?

That was – hey Suji, those were in regards to NV.

Okay. That's helpful. Do you have comparable number for HybriDIMM I know you said talking beyond Samsung to several folks. Is it in hands, is it two or three, is it couples, is it handful just to understand the breadth of the opportunity there?

Well, there the products would be, the HybriDIMM would be evaluated, it's a technical evaluation by potential customers and partners and we are talking to half a dozen very large players around the world. And most of those conversations is about taking this technology and creating an [ASIC] controller version of the FPJ controller we have today. And then making that ASIC controller and then putting it into a DAM and selling to DAM. So it is worth the big players that are out there and we don't know whether it will be an exclusive arrangement or non-exclusive, but we have significant interest from these major players.

Just a follow-up here that’s the controller technology Chuck would be made available to these partners through a licensing arrangement as opposed to product arrangement, is that –?

Yes that's correct. Yes it would be, it's all the RTL codes that we have on the controller, the architecture, the software driver, yes all of these things would be shared. We would ill consult until the technology, we would own the technology but we would transfer the know-how to these partners.

Okay and then the announcement yesterday, the second ITC effort, can you just talk about how that interplays with authority inflating the first ITC effort in trying to get a settlement from hynix just to understand the dynamics between the two or they two separate paths really that they would go on and not really inter-related?

Well that Noel will handle that one Suji.

Hi Suji. Yes, they are obviously related, the patents are similar. The patents are related but the actions are not. They are different patents obviously the first action is nearly big. We expect a decision in a couple of weeks. The second action will run along a similar timeframe as the first did likely a little faster because it's a smaller case but we don't, from a legal perspective we don't expect much interplay between the first and the second actions.

Okay and then a last question looking ahead to Supercomputing conference things like that just what are the trends you are seeing from the customers is kind of like comes out here, is there key describe in terms of density of DU and customers are looking for other architectures that you are seeing, people kind of gravitate toward as you try to help them solve kind of the bottlenecks there? Thanks.

Yes. So I think, there has been a lot written about the server memory going through the roof, the growth of high density server memory for hyper skill datacenters is in large part was striving the overall DRAM demand. But it is at the expense of the customers because of the prices of high density, high capacity, server modules has become exorbitant prohibitively high. So that's where storage class memory comes in because you are creating similar capabilities and densities, performance and capacities of DRAM at fraction of the cost. And there lies the value and overtime I think Intel if they do come into the market as they stated next year with their 3D cross point memory module solution, I think that will really lead to the adaption of storage class memory and a shift from high density DRAM base modules more to storage class memory. NVDIMMs are also, they have got a role to play there. That would be a part of I think some of the displacement of high capacity server modules into NV. So, I think server memory content getting to historical levels in the last year and a half is, it bodes well for the opportunity with storage class memory and NV.

Great. Thanks for the color Chuck.

This concludes our question-and-answer session and the conference. Thank you for attending today’s presentation, you may now disconnect.