Good day, and welcome to the Netlist's Second Quarter 2021 Earnings Conference Call and Webcast. All participants will be in a 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, Investor Relations. Please go ahead.

Thank you, Sean, and good day, everyone. Welcome to Netlist's second 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.

Hi, Mike. Hello, everyone, and thank you for joining the call. Total revenues for the second quarter of $64.4 million were record for Netlist and include a combination of milestone licensing revenue and growing product sales. The execution of strategic agreements with SK hynix, which encompasses a cross-license of the parties' patents, a $600 million product supply over five years and potential technology cooperation, open up multiple avenues of long-term growth for Netlist. As a result, we exited the quarter with significant momentum in the business and with the demand for our products and intellectual property running high, we are ramping up investments in a number of areas, including sales and marketing, CXL, R&D and patent prosecution in order to fully take advantage of the secular trends, which are favorable for our business for the long-term. Turning now to the product side. Global supply for memory and storage continues to be constrained and is expected to remain short for the foreseeable future. As we had discussed on our last call, this has created a strong demand and favorable pricing environment. In turn companies with access to supply, such as Netlist have the opportunity to garner market share as well as create topline growth. After the announcement of the strategic agreements in April, we quickly began formal engagement with SK hynix for product supply. And so far, the versioning relationship is off to a good start. Netlist's sales and marketing teams are leveraging the arrangements for product supply in order to engage new customers and broaden discussions with existing customers. Based on these activities, we expect product revenue to grow through the second half of 2021. We have recently seen robust customer interests in Netlist's Gen4 NVMe SSDs as the market for enterprise drives remains constrained. These Enterprise SSDs has passed initial hardware testing and are processing well through qualifications. Initial customer feedback highlights read and write performance of our SSDs, which exceed those of competitive offerings for major OEMs. The first round of customers for Gen4 are expected to complete qualifications later this year, and we expect initial revenue before year-end. We recently commenced mass production of Gen4 SSDs and believe the superior performance of our products and the additional supply we are bringing to the market will place us in a strong competitive position in this space. Turning now to IP and legal matters. Starting with the litigation pending in the U.S. District Court for the Northern District of California against Google. There has been quite a bit of activity in the past few months. I'll provide additional detail and context, which we believe will help in the understanding of what has transpired and the process we currently expect to unfold in the case. As previously mentioned, we retained Irell & Manella in the beginning of the second quarter to represent us in the case. Irell is one of the premier patent litigation firms in the country, producing the most recent Head of the United States Patent and Trademark Office and having recently secured major judgments and settlements against Intel and Samsung in the Federal District Courts. Discovery began in earnest following the Case Management Conference in March. Unfortunately, as par for the course with Google, they failed to provide requested material to Netlist as required by the Court. As a result, there was a discovery dispute with a hearing held on June 25. During the hearing, Magistrate Judge Spero, required Google to provide a response to Netlist's discovery requests, seeking Google's position on intervening rights. Following the ruling, a stipulation was entered into in early July between the parties where Google agreed to provide all discovery related to equitable intervening rights and not to seek an early summary judgment on equitable intervening rights. The parties agreed to delay briefing related to absolute intervening rights by two weeks. On July 30, Netlist filed a motion for summary judgment to dispose of Google's intervening rights defense as to Claim 16 of the 912 patent as a matter of law. Google filed a motion for summary judgment as to absolute intervening rights. Responses will be due on September 3, while reply briefs will be due on September 17. Once the issue is fully brief, the Judge may reschedule the hearing or make a ruling based on the briefing over the coming months. We remain confident in our position that no intervening rights exist as to the Claim 16 of the 912 patent. The parties are currently engaged in early phases of discussions with the mediator. I'd like to take a moment to further expand on intervening rights and the likely process during the Google case. The defense of intervening rights allows a party whose products infringe a reissued or reexamined patent to continue to use or sell specific products under certain conditions that were made, purchased or used before the reissuance or reexamination. There are two types of intervening rights, equitable and absolute intervening rights. Absolute intervening rights provide an accused infringer with the absolute right-to-use or sell a product that was made, used or purchased before the completion of the reexamination. In the case of Netlist's 912 patent, Google is contending this date as February 8, 2021, date the certificate of reexamination published. Equitable intervening rights in contrast to absolute intervening rights, provide more limited protection. Equitable intervening rights can allow for the continued manufacture, use or sale of additional products covered by the reexamined patent. Unlike absolute intervening rights, Courts must make an equitable determination based on certain factual findings in order for equitable intervening rights to apply. During the intervening rights analysis in the Google case, the Court will determine whether or not the claims of the 912 patent are substantially identical “to the original claims”. This involves the question of whether any valid claims of the 912 patent was present in the original patent issued on November 17, 2009. As an example, in our case, Netlist contends that original Claim 16 of the 912 was not substantially changed during the 10-year reexamination process and the claim and the reexamination certificate is identical in language. Claim 16 was simply a dependent claim in the original 912 patent that was rewritten in independent form. Our motion for summary judgment of no intervening rights on Claim 16 sets out our position on this issue. On July 30, Google filed a motion to strike related to Claim 16 in an attempt to remove the claim from the litigation. Our response is due on August 13. We feel strongly about our ability to win this challenge. It is clear from this tactic that Google is taking their exposure to Claim 16 very seriously. With regard to other claims in the 912, that are currently being asserted and were amended during the reexamination process, we intend to argue that there are claims for which there was not a substantive change regardless of amendment. Judge Armstrong will review the briefing and make a determination with respect to those claims as well. It is important to note Netlist's contention with 912 not only applies to Google's FBDIMMs, but also applies to Google's make and use of DDR4 RDIMMs and LRDIMMs. This is very important as it is likely that Google has been using all of these technologies for many years. Thus a decision in Netlist's favor could significantly expand the number of years of infringement and the volume of infringing products. Returning to the current Court schedule, which is publicly available, Netlist will start exchanging materials related to claims construction in October. In November, the parties will also begin exchanging information related to Google's damages and the end of claim construction discovery will occur on December 17. After the briefing and ruling related to absolute intervening rights, the next major event in the case is the Markman hearing, also known as claim construction hearing. Netlist's opening Markman brief is due January 21, 2022. Google's response brief will be due February 4, and finally, Netlist's reply brief will be due February 11. All this briefing will bring the parties to the Markman hearing, which is scheduled for March 9 and will result in the Court ruling on the meaning of key claim terms. The Markman ruling is typically a watershed moment in patent litigation as the meaning of the claims will determine the extent of the infringement. Given the issue of validity on the challenged patent has been largely decided in Netlist's favor by the ruling of the Appellate Court last year, the definition of the claims determined by the Markman process will likely provide a strong early indication of legal outcome of this case. While the fight with Google has been long and difficult lasting more than 10 years, we remain committed to protect Netlist's intellectual property on behalf of the company and its shareholders. Historically, companies like Google that are virtual monopolies have been prone to lift their enormous market powers and resources to tap into and exploit innovations created by domain experts, such as Netlist. At times these giants are shamelessly blatant in their unauthorized use of intellectual properties owned by others. When they are challenged legally, they tend not to rely on substantive merit, but on their massive legal budgets to pursue scorched earth tactics and drag out the judicial process in an attempt to bleed the IPO in a dry. This is exactly the kind of anti-competitive behavior, which the authorities in the U.S. and EU are now addressing with Google and other big tech companies through stronger enforcement of antitrust laws. They are enacting new regulations and implementing policies to reign in abusive behavior by the global tech giants in order to promote a more fair and even playing field for players of all sizes in the tech industry and most importantly, to try to create a business climate more conducive to innovation and one that rewards innovation. Netlist is committed to fighting pervasive illegal use of its intellectual property and seeks to obtain fair, reasonable and non-discriminatory licenses for the technologies that Netlist has spent years and millions to develop. Now moving on to the Samsung case in the U.S. District Court for the Central District of California. The case continues to move forward toward a jury trial as expected. Our complaint was originally filed in May, 2020, and alleges that Samsung breached the JDLA with Netlist, entered into – on November, 2015. Netlist filed an amended complaint in July, 2020. The amended complaint seeks a declaratory judgment that in light of Samsung breaches of contract, Netlist properly terminated the JDLA along with any related licenses. If our litigation is successful, Samsung will be required to pay Netlist damages for breach of contract and will not have a valid license to our patent portfolio under the JDLA. This case is currently being led for us by Gibson Dunn. During the second quarter, Samsung asked the Court to extend the time when summary judgment motions would be due and when discovery would close in the case. These requests were denied by the Court. Samsung has also filed a motion for judgment on the pleadings. Netlist recently filed its opposition. A hearing on this motion is scheduled for August 16. In our view, Samsung has not been forthcoming throughout the discovery process in this case. Given Samsung's repeated attempts to stonewall discovery, some case deadlines could move, but at this time, we do not anticipate changes to our jury trial date. Motions for summary judgment are currently due on August 16. Fact and expert discovery will also conclude around this time. After this milestones and if we have not already prevailed on our motion for summary judgment, our full attention will be focused on the upcoming jury trial scheduled for November 30. We look forward to having our day in Court to hold Samsung accountable. In the legal proceedings for patent infringement against Micron in the Western District of Texas, where we are asserting four patents that read on NVDIMMs and LRDIMMs. We expect the Case Management Conference to take place later this fall, which will set the schedule for trial. Micron's answer to our complaint is due August 25, 2021, afterwards Netlist will be able to file a certificate of readiness with the Court. And once this is filed, the case in front of Judge Albright will begin to move forward in earnest. Micron is one of the top three manufacturers of memory modules in the world. It is well known that Micron manufactures RDIMMs and LRDIMMs and NVDIMMs among other products, which our patent portfolio applies. They have approximately similar revenues to SK hynix for these products and like SK hynix, it will be necessary for them to take a license to our standard essential patent portfolio. We are looking forward to engaging Micron in good faith so that we can license our patents in a fair, reasonable and non-discriminatory manner. –: Finally, on the patent prosecution front, two additional patents with strategic value were recently granted to Netlist. First, U.S. patent 918 abbreviated recently issued and relates to power management features found on DDR5 memory modules. As the speed and power on memory modules increased significantly at DDR5, all standard memory modules for the first time, including those used in personal computers as well as servers will require power management features embedded in the module itself. This design concept to localized power management was invented and first deployed by Netlist over a decade ago in some of our early custom designs for high-performance memory modules. The industry is now implementing those same concepts at DDR5 for off-the-shelf memory modules. The second patent is European patent, European equivalent of the 339 patent issued, EP patent 3404660 related to DDR4 LRDIMM. These two new patents add important new ammunition to the portfolio of memory and hybrid memory patents at Netlist. I'll now turn the call over to Gail for the financial review.

Thanks, Chuck. Hello, everyone. The second quarter results reflect substantial momentum across the business. Product revenue increased 64% consecutively and 123% compared to last year's quarter as we continue to benefit from the strong demand environment and ready access to products through strategic relationships. We also recognized milestone licensing revenue of $40 million resulting in total revenue of $64.4 million for the quarter. This was an almost six-fold increase from the year-ago period and our highest quarterly revenue as a public company. Total net gross profit of $42.9 million includes licensing equating to a total blended gross profit percentage of 67% for the current quarter consisting of a 100% from licensed revenue and 11.8% from products. Net product gross profit percentage of 11.8% in Q2 was up 1.7% from Q1 and down 5% compared to the prior year's quarter mainly due to a shift in the product mix resulting from the significant growth in resale revenue during the quarter. Q2 2021 product gross profit dollars before manufacturing cost increased 53.4% from the prior year’s quarter and were up 72% consecutively. And as Chuck discussed earlier, we remain very focused on growing the Netlist SSD revenue alongside the resale revenue going forward and have invested in sales and marketing resources to leverage our product performance advantage to our product offerings with current and new customers. The increase in operating expense quarter-over-quarter was mainly due to non-recurring expenses related to the SK hynix transaction, including certain legal fees and other expense of approximately $3.5 million. The remaining increase of approximately $2 million is due to increased investment in the sales, marketing, legal and engineering teams globally to support the sales, research and development and IP litigation acceleration. And although we don't firmly guide given Netlist current pace and mix of bookings, the new product supply agreement with SK hynix and favorable marketing conditions for memory and storage, we are bullish about the second half of the year and expect to see nice increases in product revenue over the current quarter. We ended the quarter with cash and cash equivalents and restricted cash of $53.4 million compared to $26.5 million at the end of the first quarter. This cash increase was mainly due to the Netlist license fee received after Korean tax withholding and related expenses from the SK hynix transaction. Subsequent to the end of the quarter, we raised an additional $20 million in cash from a combination of equity line of credit and the exercise of warrants, bringing the current cash position to over $70 million, which along with the $5 million credit line available from Silicon Valley Bank and the remaining balance on the equity line of credit of approximately $2 million. This provides us with significant runway to continue to invest in strategic growth. Finally, we continue to very carefully manage the operational cash cycle, which for Q2 2021 included increased inventory churns as well as a decrease in days sales outstanding offset by a decrease in days payable resulting in a very positive cash cycle of 2.5 days. Operator, we are now ready for questions.

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

Hi, Chuck. Hi, Gail. Congratulations on the progress here. So a couple of questions on the product side. The hynix resale opportunity, if you can do the math ends up being about $30 million a quarter versus your product revenue $24.4 million. Just wondering what remains to be done to take full advantage of that resale flow that hynix committed to you.

Yes. Suji, as I stated in the script, we've already engaged those guys in Korea and San Jose and the business is up and running. I think it will take a couple of quarters for us to fully maximize the entire supply of product. Some of that supply will be in a discrete component form that we will use to build our own memory modules and SSDs and others would be on a resale basis. But we're progressing well and we'll ramp that up in the coming quarters.

Okay. And then, Chuck can you speak specifically about the SSD revenue, kind of where it is now, what the 2021, 2022 run rate opportunity is for you, how that growth is progressing versus your expectations?

I think it's holding steady. The enterprise SSD is making transition from Gen3 to Gen4. So we're focused on getting our Gen4s qualified and that's happening right now. And I think we'll see – we'll start to see some bump in enterprise SSD revenues starting in the second half of this year. Gail, perhaps you can talk about the exact dollars if that's what Suji is asking.

Hi, Suji. The revenue – as Chuck got it exactly right, it is holding steady. It's been about the same over the last couple quarters, but we are anticipating growth as we exit the year. Certainly, as a percentage of revenue, it's gone down. It was at 20% last quarter, but given the growth and the resale revenue get as much smaller obviously this quarter. But our focus is to grow that area along with the resale revenue, of course. But that is our target, so we can – and continue to increase our margins.

Okay. And then on the product gross margins that expanded nicely here, what's the opportunity here? And just to understand the product gross margins are being held by the concurrent supply constraints from our pricing versus the secular mixed drivers of gross margin, the puts and takes there for the opportunity gross margin would be helpful.

Again, the opportunity is going to be in building up the Netlist SSD and other Netlist branded products. The opportunity with the hynix agreement will also play into that. For the quarter, even though the resale revenue was a much larger contribution, the total contribution of SSD revenue was still over 50% and actually the margins for SSD and total including Netlist SSDs was significantly greater than last quarter. So there is definitely an opportunity to continue to focus in those areas. We are bringing on new resources to help us with targeted customer areas and all of that is going very well.

Okay. And then two last questions on litigation. First of all, on the Google case, Chuck or Gail, what milestones should we watch for to get a sense of the breadth of products from Google that would have infringed? At what point in time would we have a sense of whether its FBDIMMs alone or FBDIMM plus LRDIMM and RDIMM?

Yes. We formally submitted our infringement contentions meaning that we are pretty clear that the 912 patent reads on RDIMMs and FBDIMMs. So we spoke about the discovery process. There is – it is just right now kind of scratching the surface. There's a lot more to discover, discovery going back 10 years. So until all of that material is made available to us via Court order, we will not have a complete handle on the true extent of the exposure. But we believe from what we know from the industry shipments, although Google is a very opaque organization, we believe that there's enormous volume of RDIMMs, LRDIMMs and FBDIMMs that they have built and consumed over those years. So the discovery will – if done properly, we'll take care of sizing of that exposure. But from a technical standpoint, from an infringement standpoint, we believe we have strong reads on those products.

Okay. Thanks. And you gave us the discovery color in the prepared remarks. Thanks for that. And then the other question is on Samsung, and just understand a couple of things there. Is it two separate efforts on your part, the breach of contract versus the future kind of re-upped licensing, are those two separate? Are they kind of one after the other in the same litigation? And second of all, how should we think about what Samsung could be to you guys in the go-forward settlement versus what you had done five years ago? Thanks.

Yes. That's a good question. The current case is a breach of contract on the entire joint development and licensing agreement that we signed with them back in 2015. The provisions in the agreement allows – makes the termination – allows the termination of the license agreement if other parts of the agreement is breached. So if the Court rules that the JDLA has been breached by Samsung, it will necessarily rule that there has been a – it will necessarily be that the license is terminated. At that point, Samsung will not have a licensed store patents going forward. And in terms of your question about the potential size or scope of future agreement with Samsung, I think there's – an easy way to look at it is Samsung is about the double the size of Micron or hynix in terms of their output of these server memory modules. Hopefully that…

Okay. It's a very helpful color, Chuck. It certainly does Chuck. Thank you. I'll pass it along. Thank you guys.

Thanks, Suji.

Thanks, Suji.

The next question today will come from Richard Shannon with Craig-Hallum. Please go ahead.

Well, hi guys. Thanks for taking my question. Maybe a couple of questions on the topic of Google here. Chuck, you mentioned in mediation with Google, have you done this in other cases litigation recently? And I mean, is there any expectation of this actually settling through the mediator? Or is it something that's historically has not and it’s just something of the motions you go through here?

Yes. Richard, it really depends on the Court. Many judges, their local rules require a Court mandated mediation. I believe that is the case currently. And yes, it's relatively common that parties will sit down on their own as well as mandated by the Courts. I have personally been in mediation with Google and other parties. So yes, and also in front of the Magistrate Judge Spero over the years in different cases.

Okay. Fair enough. Chuck your comments on the intervening rights was interesting. As a non-lawyer, I can only understand them so far in my 15 minutes of hearing the words intervening rights here. But it sounds like there is kind of two different directions that one might interpret the potential here with Google. It sounds like if Google is successful, they'll limit the infringement timeframe to early last year when the patent was issued. Let's just ask the very simple question. Is that a correct interpretation so there'll be a fairly limited period of time?

That is correct. So yes – go ahead, Richard.

No, I didn't mean to interrupt you Chuck. Please go ahead.

Sorry, I just wanted to provide some background on intervening rights. I think there was a lot stated in the script. But on layman's terms, intervening rights is a concept that is very arcane. It’s very really brought up. There's very little case law, in fact. And it's an arcane concept within patents, but yes, I think you have the right interpretation, Richard. So this patent 912 was obviously issued many years ago on and asserted in the intervening period between then and now, some of the claims have been amended as all patents you do continuations, there are challenges and you amend them accordingly. So if the claims that were amended were issued recently. And in the course of that amendments, substantially or substantively changed, then there is an argument for intervening rights. As we've stated in the prepared remarks, the critical Claim 16 of the 912 patent were not touched. That is the claim that applies to all of these products, and it was simply shifted from a dependent claim into an independent claim form. So the substance has not been changed.

Okay. Another question on this topic here at Google, I think in the last conference call, you characterized the potential size here and in terms of billions of dollars of product that's infringed. It doesn't sound like you've gotten much of any information from Google in the past quarter here. But would you update that thought process I know just using the “billions of a very wide number”. But is that something that still holds true here or could that be conceivably even larger?

Well, again, I thank you. There are many ways to extrapolate to get to a number, one way is to know, one way is to look at all of the servers that they have installed throughout the world in their data centers and apply a average memory capacity for each server. And that's – it’s going to be a little different from server-to-server depending on the application. But I think the industry has a good sense of what the average gigabyte per server is and how many servers are out there that have been installed at least approximate numbers. So that's one way to get there. The other way is to look at the number of components, DRAM components that have been shipped over the decade and some of that data is available, DRAM components that were shipped by the major DRAM manufacturers. And there's very little that can be done with those DRAM components, given the kind of DRAM components that were shipped other than to make server memory modules. And there's really handful of server memory modules, those are the RDIMMs, LRDIMMs and FBDIMMs. So I don't think the number that we're looking at has changed, I think, it will have to be substantiated by discovery from Google.

Okay. That's helpful. Chuck here maybe a couple of other questions on a different topic. Your resale revenues are pretty strong in the second quarter. What was the driver of that? Is that sustainable? And is the margin profile of those resale products still holding true or is it improved here in a capacity constraint environment?

I think for Q2, it was a strong market. In the second half, Q2 there was strong demand especially out of China with their cryptocurrency Chia taking up a lot of SSDs and hard drives, that may have been a one-time phenomena. But the general shortage of semiconductors that's been well-documented, certainly applies to memory and storage products, and it will likely remain short for the rest of this year and probably into next year. So I think the Q2 revenues, there was very little hynix component to it. We'll see quite a bit more in Q3. I think all of that is going to contribute to good margin dollars as to the exact percentage of margins that will depend on the SKUs and whether the shortages remain as severe as it was in Q2.

Okay. That's helpful. One last question for me on your Netlist Gen4 SSDs here. Any comments you have on the customer profile and use case to the extent they're increasing or changing in any way? Or do you expect to have a similar opportunity here with Gen4?

With Gen4, we have a very good product. Gen3, we came in kind of in the seventh inning of the ball game. Gen3 has started many years ago. With Gen4, we'll be getting started right from the beginning. So I think we'll have a better opportunity to get products qualified. Our goal is to grow out the end user. Our biggest and best customer has been one of the largest end users in the cloud service provider space. We want to grow that type of customers with – for example, we are right now talking to major, major streaming guy that people know, and they require very fast sequential reads which our Gen4 product has displayed. So we have hired on a number of people that are familiar with end customers, especially the cloud service providers. And we hope that they're bringing in that their network with our product will lead to expanding sales with Enterprise SSDs.

Okay. I appreciate the perspective. That's all for me, Chuck. Thank you.

Okay. Thanks, Richard.

Thanks, Richard.

This will conclude today's question-and-answer session as well as the conference. Thank you for attending and you may now disconnect.