Good day, and welcome to the Netlist, Inc. First Quarter 2021 Earnings Conference Call and Webcast. [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, Matt, and good day, everyone. Welcome to Netlist's First Quarter 2021 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. I would now like to turn the call over to Chuck.

Thanks, Mike, and hello, everyone. Summarizing the highlights since we last reported in early March, the product sales momentum built up in the second half of last year, continued into the first quarter as evidenced by an increase in revenue of 30% on a sequential basis. We also entered into a broad strategic partnership with SK hynix, which encompasses a cross license of patents, product supply and technology cooperation, opening up numerous avenues of long-term synergistic growth. Operating expenses in the first quarter reflects a number of key investments in support of these growth opportunities, along with meeting the current surge in demand for memory and SSDs. At the end of April, we launched a new IP enforcement action against Micron as a part of a broad campaign to protect our intellectual property against unauthorized use. On the product side, the market conditions were and remain very favorable. The global chip shortage has been well documented, and this certainly applies to the memory and SSD segments of the market. Semiconductor manufacturing facilities have been impacted by a number of challenges amid the pandemic, including early capacity cutbacks, material shortages and other interruptions. And these, in turn, have significantly disrupted the global supply chain and product availability. The signs of an improving economy ahead, we expect to see strong customer demand continue into the second quarter and beyond. Demand across Netlist's core data center and enterprise segments, is strong and the strategic supply agreement with hynix puts us in an even better position to further capitalize on the favorable market conditions. As we execute on this partnership, we have significant opportunity to grow product revenue in the quarters ahead. In order to effectively execute on the supply agreement, we are making investments in sales and marketing resources in the U.S. and in Asia. We are looking to ramp quickly to secure product supply and to use that supply to deepen relationships with current customers as well as target new customer penetration. We're pleased with the progress thus far and expect revenue from the supply agreement to commence in the upcoming months and ramp through the rest of this year. We recently expanded the portfolio of Netlist branded products with the introduction of a Gen 4 NVMe SSD. Supply for these next-generation enterprise drives has been very constrained. And with many vendors currently in allocation, customers finding it difficult to source product. We are bringing much needed supply to the market and delivering superior performance with up to 50% faster sequential rights and up to 15% higher random read IOPS over offerings from major competitors. Shipments and qualifications to the enterprise market, including data centers, server, storage OEMs and system integrators are in progress. The productization of HybriDIMM on the CXL bus also continues to advance. We are building out the ASIC engineering team, adding critical design and verification resources. Across the memory industry, we're seeing significant deployment of resources my -- by major companies into CXL, and we believe we are well positioned to capitalize on this emerging industry standard. Turning now to the intellectual property. Since the start of the year, we have made significant progress in the campaign to defend Netlist's patent portfolio against infringing entities. In early April, we entered strategic agreements with hynix, settling the outstanding legal action and delivering our stakeholders significant strategic value. Last week, we broadened enforcement efforts with the commencement of legal proceedings for patent infringement against Micron, the fourth largest semiconductor company in the world. We have brought this action in the Western District of Texas asserting 4 patents that read on Micron's NVDIMMs and LRDIMMs. The 833 patent relates to clocking features found in NVDIMMs. The 035 and 608 patents relate to features found in the buffer circuits of LRDIMMs while the 314 also relates to features found in LRDIMMs and is a member of the 912 patent family. The Western District court provides a jury trial and the ability to seek both an injunction and damages. In the Google dispute in the Northern District of California, the case is moving forward per the court's stipulated schedule. We have retained Irell & Manella to represent us in this action. Irell is one of the top IP firms in the country, and we are pleased to have them lead this case. As we have noted previously, for many years, Google has manufactured and consumed billions of dollars of server memory. We believe that much of this memory infringed and continues to infringe on the 912 patent. In regards to the Samsung breach of contract dispute, we brought this action in the U.S. district court before the Central District of California, and Samsung has not lived up to their obligations under the JDLA signed in 2015. The case is proceeding as expected, and we are currently in the middle of discovery. The trial is set for November 30, 2021, and this will be a jury trial. On the patent portfolio front, we continue to methodically build Netlist's portfolio of patents and further develop patent families for DDR4, DDR5 and hybrid memory. During the quarter, U.S. patent 339, a continuation of the 907 patent related to LRDIMM issued while overcoming prior art from our previous cases. A European equivalent of this patent also received the notice of allowance this quarter. We feel confident about the validity of these patents after the received allowances over prior art. In addition, we received the notice of allowance on the U.S. patent application number 17-138766 related to power management features found in DDR5 memory modules and would expect this patent to issue in the coming months. I will now turn the call over to Gail for the financial review. Gail?

Thanks, Chuck. Revenues for the first quarter ended April 3, 2021, were $14.9 million, up modestly from the year ago period, an increase of 29.7% on a consecutive basis, reflecting continued sales momentum for the first half of 2021. Q1 21 product gross profit percentage before manufacturing costs decreased to 13.1% compared to 17% for Q1 '20. After manufacturing costs, the net gross margins were 10.1% for the current quarter and 14.4% for last year's quarter. The variance in gross margin percentage between quarters reflects a temporary decreased contribution from SSDs and execution of a couple of special customer deals during the quarter. Increase in operating expense during the period is due to investments in the sales and marketing team globally to support the continued sales acceleration to take advantage of the strong demand environment and to capitalize on the strategic supply agreement with SK hynix. In addition, we are building out the R&D team with engineering talent to drive new product development and continued expansion of our IP portfolio. In order to support this expansion, we also recently entered into a new office lease agreement in Irvine, which will double our current office space.This new facility will serve as the corporate headquarters and also help research and development, U.S. sales and operations. And although we don't firmly guide, industry commentary indicates ongoing positive demand and good pricing environment for the first half of 2021. And given our current pace and mix of bookings, we expect second quarter revenue to increase very nicely over the first quarter, and we remain very optimistic for significant revenue growth for the full year 2021. We ended the quarter with cash and cash equivalents and restricted cash of $26.5 million, compared to $16.5 million at the end of the fourth quarter. Cash increased by net $10 million between Q4 and Q1 as we raised approximately $9 million on the equity line of credit, investors exercised stock options, providing an additional $4 million of cash. And on the other side, we used cash, partially to build up inventory to service increasing revenue. The current cash balance, the credit line from Silicon Valley Bank, the remaining balance that we have on our equity line of credit of $2 million plus the funds received from SK hynix recently as part of the licensing agreement, provide us with substantial runway for 2021 strategic growth plans including increased headcount in engineering, sales and marketing and the execution of intellectual property litigation and portfolio activity. Operator, we're now ready for questions.

[Operator Instructions]. Our first question will come from Suji Desilva with ROTH Capital.

Congratulations on the progress here on many fronts. So maybe you can talk Gail about the revenue composition in the first quarter. It sounds like SSDs was less than -- perhaps it could have been because of the constraints and then resales, I'm not sure how the Samsung issues impact that. So just kind of give us a sense of what's the composition of the first quarter strong revenue there?

Suji, yes, the SSDs was down slightly from last quarter as well as compared to the first quarter of '20. We don't expect that to continue because of the strong SSD demand recently. But yes, partially, it was just a matter of mix, not because we weren't able to get supply or really because of any difference in demand. I think we had a nice overall quarter, and it just ended up being slightly more of the non SSDP's. And in terms of resale versus other, I think the percentage was comparable to our previous quarter and the year ago quarter. The difference in margins was just due to just various changes across the board, but a couple of deals that are nonrecurring that we did during Q1.

Okay. And then I just want to understand the pro forma implications and the outlook of the hynix settlement both in the revenue and the cash? Is there already cash in the first quarter, ending cash balance that came from hynix? Or is that coming in the second quarter, same for the revenue, just to understand how it flows through?

Yes, the cash will show up in Q2 that came from the SK hynix deal and as well as the revenue will show up in Q2. In terms of the deal ...

And the magnitude we should expect there for hynix? The magnitude revenue we should expect there? I presume the magnitude of the revenue we should expect for hynix and agree with onetime.

Yes, will be a $40 million onetime revenue recognition during Q2. And then we should start to see some build -- slow build of the product piece as well. But probably more starting as we exit Q2.

Understood. And just so I understand the core business, aside from hynix, from the 14.9 [ph] in Jan -- in March, you expect that to grow in June. Is that correct?

Yes.

Okay. And then for the rest of the year -- and my last question, the SSDs, does the constraints caused you to undership what you had hoped to ship for the rest of the year? Is that kind of the anticipated tracking for the SSD business? Or can the constraints alleviate that you can potentially ship to demand towards the back half?

Suji, the constraint has to do with the NAND controllers. There's plenty of NAND flash components out there, but it's the controller. So we are seeing very long lead times. We are seeing more demand for SSDs, nut less SSDs, but the lead times are out 4 to 6 months. So that is going to cap our ability to ship all the demand that we've secured.

Our next question will come from Richard Shannon with Craig-Hallum.

Well Chuck, maybe just let me follow-on that last question-and-answer here regarding the SSDs. I think last quarter, you talked about you're doing roughly $10 million in SSDs, and you hope to grow that this year. Does the constraints you're seeing out there, does that give you pause that you might not be able to be -- to grow in SSDs this year? Or you still be able to do that?

I think the controller supply constraint that we're seeing will be alleviated in the second half of the year. So I'm still very hopeful that we can grow the demand -- we are growing the demand. It's a matter of being able to fill all of that. But I think we still have time. And hopefully, the supply constraints will sort themselves out.

Okay. That is helpful. Just to parse a couple of comments regarding your views for this year. You gave us -- you talked about some growth this year. And per Suji's question, you said that the product revenues will grow in the second quarter. And then you talked about significant growth this year. I want to ask this in the same way he did, which is just looking at product revenue. Is that comment specific to product revenue? Are you talking about your total revenues for this year?

Both...

Go ahead.

Gail, I think it was talking about both the overall revenues as well as the product side. We're right now seeing a nice pace of bookings in Q2. And some of that is momentum driven due to the market conditions. But other parts are more fundamental, meaning that we've got -- we're increasing the number of slots that we're securing for both SSDs and DIMMs. So there is just good demand out there for both SSDs and memory products. But some of the higher end SSD -- higher capacity SSDs, it is supply constrained. We're not able to service all of that. On the DIMMs, we're having better luck securing that supply. The hynix supply will start to kick in probably over the next 3 months. They will have to do some reallocation internally, but they're obviously obligated to provide support of product, supply of product under the agreement. So they will follow through on that, but it will take a few months. And once that gets reallocated, we're getting product flow, second half, we should see some substantial numbers out of the hynix supply agreement in addition to the organic growth of the Netlist product line.

Okay. So as you look at your product revenues only this year, is there a mix towards Netlist branded products or towards the kind of the resale of hynix and/or Samsung products?

So we'll do $120 million annually over any -- over a 12-month period, every 12-month period, starting with the commencement of this supply agreement. Part of that supply goes towards resale, other parts go towards our components, which we will purchase to use to build our products. So we'll -- we don't know what that precise mix is going to be at this point. But our goal is to as quickly as possible to consume the entire amount that is set out by this agreement.

Okay. That's helpful. Just a couple more questions for me, Gail. On the OpEx, you're obviously making some investments here. How do we think about modeling this in future quarters here? Obviously, the first quarter number was -- had some litigation expenses in there, but how should we think about that going forward?

Yes. I think the steady state for the next few quarters in terms of operating expense will be in the $5 million to like $6 million range. We're hiring well but -- and not as quickly as we would like, but it's going to take some time to build up those resources. So yes, I think that is the best visibility I can give you right now.

Okay. That's very helpful, Gail. Chuck, my last question is on your litigation cases, and I guess I'm much more interested in the Micron case, which I didn't know about until you just mentioned it today here. Maybe talk a little bit about your approach to this case relative to your successes with the last 2 major memory makers, particularly since it's filed in the Western District of Texas. And also, what's your funding approach? Is this something you're going to fund entirely internally or other methods like you've used in the past?

So I'll address the funding first. There are various alternative funding methods and vehicles out there today. And we are taking one of those alternative approaches, whereby it should cost us a little less to get through the litigation and trial or some amount of sharing of any proceeds. It's a very good arrangement that we put together with the law firm that we have retained for the Micron case. So hopefully, it will cost us less. With this case, we've -- there's a lot of learnings that took place over all the years of litigating against hynix and then as well as Google. And I think both in terms of our legal strategy as well as the funding of it, we believe we become a little more smarter, more efficient doing that. I forgot the earlier question, Richard, if you can repeat that.

I think I'll repeat and kind of expand on it, which is think about your approach with, especially relative to Western District here? And then also, do you have any preliminary details on potential timing, assuming this goes all the way to trial and beyond? Where could this -- when could this finish up?

Well, I think the Western District of Texas is unique. We've talked about it in the past. The District Court judge, Alan Albright there is a career patent litigator before he was appointed to that bench 2 years ago. And I think he provides a fair and expedition process. Micron, as you know, is very similar to hynix, about the same size, maybe slightly smaller in terms of their exposure to our patents that's quite smaller profile than hynix, We believe our patents today that we're asserting are better and stronger because they have gone through this IPR process. They are -- some of them are continuations, meaning they are improvements of their parents. So as I said, I think we're bringing a lot of learnings from these prior litigation. So in terms of the patents, the strategies, the funding, the resources, all of that, we believe we're better off from that experience. Yes. So I think we're very hopeful with this new litigation against Micron.

This concludes our question-and-answer session, which also concludes our conference for today. Thank you for attending today's presentation. You may now disconnect.