Mike Smargiassi - MD, Brainerd Communicators, Inc. Chuck Hong - CEO Gail Sasaki - CFO

Suji Desilva - ROTH Capital

Good afternoon and welcome to the Netlist Third Quarter 2018 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. Please go ahead.

Thank you, Phil, and good afternoon, everyone. Welcome to Netlist's third quarter 2018 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'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. Netlist assumes 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. To summarize the achievements in the third quarter, we made significant progress in the campaign to defend and monetize Netlist's intellectual property. We received a favorable ruling from the U.S. International Trade Commission or ITC as part of the SK Hynix litigation providing momentum as we commence trials in Germany next month and in Washington D.C. in January. We also doubled the company's cash position with gross proceeds of $10 million from a registered direct offering ahead of these important events, and to invest in the marketing of the new SSD product line and the ongoing build-out of our field sales organization. Bottom-line performance in the quarter highlighted improved product margins sequentially and ongoing operational cost controls, offset by increased legal expenses associated with the upcoming trials. Taking a closer look at the licensing initiative. Actions against SK Hynix are accelerating. In Germany the December 6th trial will address infringement and other related issues with the German court's decision expected in early 2019. If the decision is in our favor an injunction may go into immediate effect in joining the sale of all SK Hynix LRDIMM products in Germany. During the quarter, we received a favorable claim construction order related to claims from both asserted patents in the second ITC action against Hynix. The administrative law judge's ruling sided with us on the key patent issues at the heart of the investigation, which provides the framework from which the ITC will ultimately decide if the patents are valid and infringed by Hynix. We believe this ruling represents a critical turning point in the dispute as it puts us in a strong position with respect to infringement, the only issue we didn't win in the first ITC case. With the meaning of the asserted patent claims having been conclusively established, the focus at the upcoming trial in Washington D.C. from January 14 to 18 will be whether the operation of billions of dollars annually of Hynix's server memory products falls within the scope of the claims. With these various actions coming to conclusion, we have moved to broaden the company's licensing activity with the appointment of Chuck Hausman as Chief Licensing Officer. Chuck brings a vast network of relationships in the Global IP monetization field and 20 years of experience in negotiation, enforcement and compliance of IP skills that are critical to our licensing program going forward. Turning now to the product update, next week Netlist's sales and marketing teams will be at Supercomputing 2018 in Dallas, Texas, where we will be highlighting Netlist's NVvault, NVMe SSDs, and the HybriDIMM Storage Class Memory offering. These solutions are specifically engineered to meet the demands of today's Big Data AI in high performance computing applications. We will be participating in a number of co-marketing activities and product demos at the Show in partnership with system manufacturers and customers. These efforts are designed to highlight and showcase the performance and cost benefits, we bring to end customers and users. In our efforts to grow the product portfolio, we've recently introduced a new line of enterprise and data center grade SSDs. These NVMe SSDs allow us to target the fastest growing part of the SSD market, which has seen a 40% compound annual growth rate. The Netlist NVMe SSDs bring a compelling blend of high performance, high endurance, and lower cost in comparison to existing solutions in the marketplace. We are currently sampling with a dozen or more storage and server customers and feedback thus far has been very positive. We expect to see many of these customers proceed to qualification and production orders during the next couple of quarters. While NVvault, we are in qualification on next-generation x86 platforms with various independent hardware suppliers. Discussions with potential ND partners are active and include enterprise storage and memory vendors and ODMs. Last week, we announced a co-marketing agreement with Nyriad. This is a relationship that started more than a year ago and has allowed us to pair Netlist NVvault with Nyriad Software to deliver superior performance and value to the market. Under the agreement, we will strengthen the relationship through ongoing marketing, engineering, and testing support. We will also become a preferred supplier to each other's respective customers. Discussions regarding the commercialization of HybriDIMM remain active with memory and ecosystem partners. We are also working with JEDEC the industry standards body to standardize HybriDIMM under the NVDIMM-H nomenclature in an effort to pave the way for broader industry adoption. I will now turn the call over to Gail for the financial review.

Thanks, Chuck. Revenues for the third quarter ended September 30, 2018, were $7.2 million compared to revenues of $9 million for the 2017 period. Although revenues were down year-over-year and consecutively, product gross margins which were 12% this quarter benefitted from a more favorable product mix weighted more heavily towards specialty DIMMs. Factory placements and related revenue also increased by 18% year-over-year and 8% consecutively resulting in lower fixed factory costs and improved net gross profit dollars in the third quarter of $586,000, a 20% improvement over the second quarter. Although we don't guide as we did mention during last quarter's call, gross product margins have continued to expand for the last several quarters and we anticipate very further growth for the fourth quarter. Operating expenses were $5 million in third quarter compared to $3.7 million in last year's third quarter. The increase reflects increased legal activity in support of the upcoming trials. Operating expenses without litigation costs decreased by 22% from the third quarter of last year and were flat consecutively. We currently expect legal expenses to remain somewhat flat through the fourth quarter of 2018 in support of the German and ITC trials which are scheduled for December and January. We continue to proactively manage the overall cash cycle which includes access to working capital line of credit with Silicon Valley Bank and provides borrowing of about to 80% of eligible accounts receivable to support working capital and revenue growth. We ended the third quarter with cash and cash equivalents and restricted cash of $19.4 million compared to $8 million at the end of the second quarter. The improved balance sheet was supported by a registered direct offering, a convertible debt offering, and the final amount raised on the ATM facility which together generated more than $13 million in net proceeds adding a cash buffer as we enter into 2019. In September, we successfully transitioned the trading and Netlist common stock to the OTCQX market. As part of the move we retained the Netlist, NLST ticker symbol and qualified for the best market within the OTC. We remain subject to all SEC rules and regulations applicable to reporting companies under the Exchange Act and will maintain an independent board of directors with an independent audit committee and will provide annual financial statements audited by a Public Company Accounting Oversight Board Auditor and an audited interim financial reports prepared in accordance with U.S. Generally Accepted Accounting Principles. Next week we will be attending the 4th Annual ROTH Technology Corporate Access Day on Wednesday November 14th in New York City. This is a one-on-one conference and institutional investor should contact their ROTH representatives for additional details. Finally, our next scheduled earnings call will be in March of next year. At that time we will also report back on the German trial and U.S. ITC trial along with Q4 2018 and year-end results. We look forward to speaking with you then. Thank you for listening. Operator, we are now ready for questions.

Okay. We will now begin the question-and-answer session. [Operator Instructions]. The first question comes from Suji Desilva with ROTH Capital. Please go ahead.

Hi Chuck, hi Gail.

Hi, Suji.

So perhaps I can start with a -- hi, perhaps I can start with a numbers question in terms of the OpEx burden of the legal activities what will be the legal costs next few quarters that you have these tightened activities just to get a sense of the next two, three quarters spend estimate.

Yes. I think mentioned that Q4 legal costs will probably be flat and then going down in 2019 probably --

Okay. So 4Q --

Yes, fourth quarter flattish from Q3 and Q1 going down.

Okay. So 4Q should be the near-term peak again we think about it.

I don't think it will be much more than Q3.

Got it. Okay, good. And then Chuck, in terms of hiring and formalizing the licensing program I know it's looking ahead a little bit but is there opportunity for recurring royalty for your technology, for your IP, or is it just straight licenses or is too early to make that determination any thought there would be helpful?

Yes, from the beginning we have sought past damages and a lump sum payment. And then going forward it will be a quarterly recurring payment that is pretty much the standard licensing program for many of these licensees.

Okay. And then my last few questions are on the products. The NVMe SSDs you've launched what's the served vessel market there versus the overall SSD TAM how much of the SSD market are you guys addressing with these products.

Very large TAM. The overall SSD market as you probably know is in $30 million to $40 million range. NVMe is the higher end portion of that that's probably today 20% of that market but is growing rapidly and our product is a dual port, very high speed, high endurance, and the performance advantages have been seen at -- through customer testing and through various performance testing that we've done so. And we're at a lower price point than the major suppliers that are currently incumbents -- incumbents in this market.

Okay. And then my last question really is around the storage and memory systems are you going to need more partnerships like Marriott to get those -- to get ramp in, in some of these advanced memory products you have is that still something you need to get executed to help those segments grow further.

Yes. I think on the -- on the NVvault. On the NVMe SSDs I think that's where we believe because the ASPs are very high these are $1,000 plus products and it's a very large market we believe that's where we can ramp the revenues this next quarter and going forward. The NVvault we just did the partnership with Marriot. We have another partnership in the works for Asia. NVvault as you know we've worked on qualifications across the board for now many quarters. The market has yet to ramp in a significant way. So yes I think those partnerships will be helpful.

Okay, this concludes our question-and-answer session. The conference call has now concluded. Thank you for attending today's presentation. You may now disconnect.