Good day, and welcome to the Netlist, Inc. First Quarter 2020 Earnings Conference Call. [Operator Instructions] Please note that this event is being recorded. I would now like to turn the call conference over to Mike Smargiassi. Please go ahead.

Thank you, Debbie. Good day, everyone. Welcome to Netlist's First 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. I hope everyone's doing well and healthy in this environment. We had an excellent first quarter with revenue increasing almost twofold from a year ago period and close to 60% on a consecutive basis. We also delivered a significant improvement in gross profit and reduction in operating expenses, which translated to a decreased net loss. This financial progress is a direct result of the strong traction for Netlist's enterprise SSD product line in the data center markets, where we continue to deliver follow-on orders to a major cloud services provider and a major server OEM. The number of qualifications also continue to increase across the SSD product line for the AIC and the U.2 form factors. Also, just last month, we began sampling the new M.2 form factor, and we're on pace to complete qualifications over the coming months with several storage appliance OEMs in the high-performance computing space, and these should lead to production orders in the second half. Industry demand for enterprise SSDs remains robust as the surge in remote work is propelling demand for storage and cloud and data center applications. For the current quarter, the market continues to be in relatively tight supply. Netlist's ability to source, build and deliver products, along with our industry-leading performance offered in multiple capacities and form factors, allow us to fill supply gaps as well as meet the demanding technical requirements of customers in the high-performance segments. The memory module business is also starting to see good activity as we have recently received orders for VLPs and other specialty DIMMs from a number of long-standing customers in the military, medical and test equipment segments. After shutting down early in the year, our factory in Suzhou, China, resumed production in March and is now back to full operational capability. The supply chain for PCB and other key components, where we experienced some delays in Q1, is also getting back to normal in terms of availability and lead times. The analysts and major memory producers are projecting continued strength in the memory market in the coming quarters with DRAM and NAND supply expected to remain constrained. However, as with many businesses, visibility for the second half of the year remains limited with the uncertainties looming in the global economic environment and the impact on memory and SSD demand. That said, we believe that the sales momentum generated over the past 3 quarters and the related qualifications will put us in a good position to continue to build out our business. Now turning to HybriDIMM. The standardization efforts on the protocol continue within JEDEC. Over the past year, we have grown the membership to over 60 industry companies that have joined the efforts to standardize NVDIMM-H. Our discussion with potential partners have been limited due to the shutdown, particularly our partner in China, who is based in Wuhan. We plan to resume these discussions with them as well as other U.S.-based companies in the coming months. With the emergence of high-speed DDR5 and high core count CPUs, system memory bandwidth will be stretched beyond anything that the industry has seen. These trends will lead to increasing demand for high-capacity DIMMs, which already cost over $1,000, and continue to go up in price. Our technology enables low-cost NAND to replace these high-cost DRAM-based DIMMs at a fraction of the cost while delivering similar performance. We believe the technology will garner enormous interest from data center operators, who, today, spend hundreds of millions annually on purchases of high-density DRAM-based DIMMs. On the R&D front, we are now turning our attention to DDR5 and, over the coming months, plan to ramp up the development effort for controller design, including the RTL level coating and architectural simulation and validation. Needless to say, we are very excited about the prospects of this technology and the cost performance value it can bring to the industry. Turning now to intellectual property. On April 7, we received the ITC's final determination, which overturned the administrative law judge's findings issued in the notice of initial determination in October. This was a significant disappointment and a legal non-sequitur as the initial determination's finding deliver through an extensive and methodical ITC process that found Netlist's '907 patent to be valid and infringed by hynix's LRDIMM server memory. In the final determination, the commission changed the claim construction, which was decided during the proceedings, and overturned the findings of the ALJ. The commission essentially changed the rules of the game after the game was over, and, thus, invalidated the findings of the initial determination. We find the changing of the claim construction and the final review stage of the ITC process troubling, particularly as the substance of those changes appear to be legally incoherent. In coordination with legal counsel, we have started preparations to file a notice of appeal with the United States Court of Appeals for the federal Circuit. We have 60 days from the issuance of the final determination to file, which we both -- after which both parties will submit briefs, and hearing will be scheduled. In March, we filed new legal proceedings for patent infringement against SK hynix in the U.S. District Court for the Western District of Texas. This expanded the actions against hynix and furthers efforts to bring them to justice. The district court provides a jury trial and the ability to seek both an injunction and damages, the latter of which was unavailable to us at the ITC. The result of the recently decided case at the Federal Circuit entitled TCL versus Ericsson, any damages will be decided by the jury. We are asserting 2 new patents, the '218 and the '595 continuations of existing patent families that read on hynix's RDIMM and LRDIMMs. For the local rules in this district, we expect these proceedings to move at a quick pace and are hopeful for a Markman ruling by the end of this year or early 2021. The Markman defines the claims of the patent and normally provides good insight into the substantive issues of infringement and validity at hand. After the Markman, the proceedings would move to discovery and a trial with an expected conclusion sometime late next year. In the Google dispute, we expect the appeal proceedings to wrap up in the third quarter of this year with oral arguments at the Federal Circuit currently scheduled for June 5. As a reminder, Google has been challenging the Netlist's '912 patent for the past decade, and it is now challenging the U.S. Patent Trial and Appeals Board's final decision on validity in Netlist's favor for this patent. We continue to expect the federal circuit to affirm PTAB's decision in Netlist's favor, at which point we would motion for the stay to be lifted and the '912 infringement lawsuit against Google in the U.S. District Court for the Northern District of California to move forward. We have always viewed IP enforcement efforts as a broad campaign across multiple venues. We believe in the fundamental value of our IP portfolio and remain undeterred in our commitment to defending it despite the recent setback at the ITC. With a further buildout of Netlist's patent families for DDR4 server memory as well as the emerging DDR5 and hybrid memory, we have additional patents in the portfolio that we are examining for enforcement. I will now turn the call over to Gail for the financial review. Gail?

Thanks, Chuck. Revenues for the first quarter ended March 28, 2020, were $14.6 million compared to revenues of $5.1 million in the year ago period, a growth of close to 3x. On a consecutive quarter basis, revenue increased by 56%. The significant year-over-year and sequential increase in the top line was due to overall growth across product lines, and follow-on production orders for Netlist NVMe SSDs from a major cloud computing vendor and a major OEM. First quarter product gross profit percentage before manufacturing costs increased to 17% compared to 12.4% for Q1 '19 and compared to 20.7% consecutively. After manufacturing costs, the net gross margins were 14.4% for the current quarter and 5.5% for last year's quarter. The improvement in gross margin percentage was primarily driven by the product mix, which, as noted earlier, continues to include an increase in the sale of Netlist NVMe SSD products. Although we don't guide, we entered the second quarter with a solid backlog. And given the current pace and mix of bookings, we anticipate second quarter revenue and gross profit dollars to be in line with the first quarter. We continue to closely monitor the COVID-19 situation and its potential impact on Netlist's business globally. As Chuck noted, the factory remains fully operational, and we experienced very limited material disruption in production or the supply chain. We ended the first quarter with cash and cash equivalents and restricted cash of $8.6 million compared to $11.7 million at the end of 2019. We continue to proactively manage the operational cash cycle, which, for Q1 '20, included improvement in day sales outstanding, offset by a decrease in days payable and decreased inventory turns, as we paid for inventory approximately 10 days sooner than we sold it due to the need to secure inventory in a tight market. We continue to maintain a $5 million working capital line of credit with Silicon Valley Bank to support working capital and revenue growth and have access to a 3-year equity line of credit with a balance of $24 million through Lincoln Park Capital. Operator, we are now ready for questions.

[Operator Instructions] The first question comes from Suji Desilva with Roth Capital.

Congratulations on the progress here. So I'll start with the litigation question then go on to a product question. So Chuck, in the press release on the litigation, obviously disappointing outcome here, but you mentioned something about questioning the objectivity. I'm just wondering if there's any -- I mean just lack of a term -- better term evidence or kind of meat to that statement? Because that seems like a fairly big accusation.

Those statements are informed by the opinions of our outside attorneys, those that have handled this case directly as well as other attorneys that we have upon review of the substance of the ruling. So when they dig into the ruling itself and the claim construction, particularly the changes to the claim construction, which was done extensively by the judge and the complete reversal of that, they did not find it typically -- legally, the legal logic was missing. And so there were some thoughts from the attorneys that the ruling was already formed based on the outcome that they were looking to find. So this is not the perspective of myself or the management here who are not legal experts. It comes from the opinions of the expert attorneys that handle this case.

Okay. Interesting. And then on the products, the -- how many customers do you expect to be shipping Netlist SSDs type of products towards -- by the end of '20 versus today? Is that one of the right metrics to think about as that segment grows?

Yes, Suji. I think that's absolutely the right segment. About a year ago, we did do a lot of qualifications, and some of those did not lead to revenues. I think what has changed now is the mix of customers that we have. Earlier on, we had a lot of system integrators and reseller types of products. As we marketed the benefits -- the high-performance benefits of our products, I think, is starting to get more opportunities at more of the storage appliance, manufacturers, high-performance computing. And I think the quality of the qualifications that we are -- we've started to achieve and undertake are better. So I think that's what we're looking forward to in the second half of the year of those qualifications leading to purchase orders and continued buildout of the sales pipeline.

Okay. That's helpful color, Chuck. I'm going to ask this next question as really kind of a bunch of questions glued together. I think they're related. Hopefully, you can understand us. But the demand -- supply/demand situation going into the second half appears to still be tight. Unclear whether from guys like Intel, whether cloud and infrastructure will continue to spend the way they're spending now with the remote work into the second half. And on top of that, I'm not sure if the module segments have supply chain constraints. I've heard about that from other areas. So I'm wondering, do you think the data center guys are building inventory kind of stock up, buy forward or ordering to end demand, and that will continue? Hopefully, all those questions make sense together.

Yes. I think the tight market, partly at the beginning of the year, was driven by China, which is obviously a major part of the supply chain for semis and computing equipment was shut down for several months. So catching back up and backfilling the supply that was -- the demand that was not being met is what led, I believe, to robust market in the first quarter of this year. We're still seeing good demand. I think along with that, you mentioned the data centers, I think there was a strong demand from the data centers. There was a lull of activity from the hyperscalers and the data centers in the first part of last year, and then that started to pick up at the end of last year. It remains to be seen what's going to -- whether that's going to continue in the second half.

Okay. Good. That color helps. And then lastly, I heard you talking about DDR5 more aggressively this call. I'm wondering if because of all the activity here, if that time line is still as is or whether you're seeing that potentially being pulled in, if that's even technically possible.

I don't think it's being pulled in. I think they're on schedule to release DDR5 DRAMs, the activities of the standardization across devices and modules at JEDEC on DDR5. It's more active now. We believe that, that is a sweet spot for the HybriDIMM. So we have started internally to do more of the coding and the development work specifically related to the ASIC controller. So that activity is starting up for us right now.

Okay. And then last question on the HybriDIMM partner. I think Wuhan, you mentioned, is -- you say the requirement of face-to-face meetings kind of preclude resuming progress there or should we think of it happening sooner?

Well, I think some of it -- they were down for a long time. But some of it can be done remotely via video calls and whatnot. But as you get into technical details, it's -- nothing beats a face-to-face, but we'll be resuming those as well as activities with other potential partners based in the U.S.

Our next question comes from Richard Shannon with Craig-Hallum.

Maybe I'll start one on the first quarter results with Gail. Your revenue growth sequentially was very nice, but the gross margins actually came down. I think you mentioned some mix here. Maybe you can kind of unpack that a little bit and help us understand there. Was there more Samsung sales? Or was it just a different mix than the Netlist-built products? Or help us understand that, please.

Sure. Yes, there was more of the resale business in Q1 versus Q4. So there's about -- well, there's $5 million increase between the 2 quarters and about $5 million of that -- or $4.7 million of that was the resale business. So the mix did change, although the Netlist SSD business did grow, but not by as much. So that is the...

Can you give us a sense of how big the NVMe SSD business is today? Is this more than a couple of million dollars? I could probably infer, but I wonder if you could characterize it a little bit more tightly for us.

Today, it is about 2, and it is anticipated to grow beyond that. So we're expecting some -- a nice growth in Q2 and beyond.

Okay. So naturally, going into my next question on the second quarter guide, you were talking about roughly flat. So NVMe is growing. Does that mean the resale products is down? Or is there something else that's driving that?

We are planning on less resale dollars so far, but the demand has been very high. So I'm not quite sure how the percentages will all work out in terms of the various parts of our business. But I think everything is looking strong. But given the environment, we've just felt -- we feel that soft guiding to inline is the most accurate thing to do at this point for the overall...

That's helpful to understand your assumptions. Chuck, maybe moving on over to you on the NVDIMM SSDs. Any sense if you can give us kind of your share allocations, just your view of the TAM? Any different than maybe you talked about 2 or 3 quarters ago? And how many customers do you expect to really be driving the bulk of the growth? Is there 1 or 2 customers? Or does it expand to like 5 to 10? Or how should we think about the kind of the pipeline and sales development over the next few quarters?

Yes, Richard, I think 5 to 10 is a good number. Of those, by the end of the year, if we can be shipping qualified and shipping into 10 customers that are either Tier 2 cloud providers or major -- or we're currently shipping to a major OEM, but smaller OEMS, storage appliance guys, for example. I think that would be a good achievement and would be reflected in higher revenues from where we are today.

Okay. So as you look out a few quarters, Chuck, do you expect more opportunity with storage appliances and related products or with server and cloud opportunities?

Both. We have, right now, probably 4 or 5 storage appliance guys in qualification. And we expect those to go to production in the second half. We are talking to a couple of other major cloud guys -- Tier 2 cloud guys right now. Those take longer, but they are higher-margin businesses. So those 2 are the big groups. The other group was the system integrators. And there, it's -- the margins are smaller, and the demand visibility is lower. So the Tier 2 cloud and the storage appliance, box builders, OEMS, those are the 2 major segments that we're targeting.

Okay. That's helpful. My last question, back to Gail, on the numbers here as we look forward and try to get a sense of what the breakeven model looks like. How should we think about an OpEx level here? I think we've gotten over the hump of some larger litigation expenses. How should we think about the OpEx level? And then do you have a thought process of how people should think about where revenue level and what gross margin will be to get to breakeven?

Sure. The OpEx, I think we'll see some growth in sales and marketing area, for headcount, not -- I think we've talked about a few heads in the past. And other than that, it should be pretty flat going forward. And in terms of breakeven, I think the way to think about it is if we can do -- we would hope to be in the range of 16% to 20% product margins throughout the year. And I think given that we have -- we'll be covering about $3 million to $3.5 million OpEx, I think you can kind of back into it, that we would need about $13 million to $15 million of revenue with a healthy product margin in the range of 17% to 20%. Is that helpful?

Yes, that's very helpful.

This concludes the question-and-answer session and the conference for today. Thank you for attending today's presentation. You may now all disconnect.