Netlist, Inc.
Q4 2020 Earnings Call Transcript

Published: 1 Mar 2021

[Operator:]

Good day, and welcome to the Netlist, Inc. Fourth Quarter 2020 Earnings Conference Call and Webcast. . Please note, this event is being recorded. I would now like to turn the conference over to Michael Smargiassi. Please go ahead.

[Michael Smargiassi:]

Thank you, Grant, and good day, everyone. Welcome to the Netlist Fourth Quarter and Full Year 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 a 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.

[Chuck Hong:]

Thanks, Mike, and hello, everyone. We delivered solid financial performance for the year 2020 by increasing product revenue by 81%, tripling gross profit dollars and a 3.5% decrease and operating expenses, which resulted in a 42% improvement in bottom line results compared to the prior year. We also made progress in key strategic areas. First, we were successful in expanding the customer base and creating new revenue streams and target markets through expansion of the enterprise SSD and embedded flash product lines. We also strengthened the sales and marketing teams with new leadership. Second, we made significant progress in the architecture and design of our CXL HybriDIMM product and hired key members for the R&D team to drive HybriDIMM's development in the coming quarters. And third, we made notable progress in protecting Netlist's intellectual property by advancing enforcement actions against SK hynix and Google. We entered the new year with positive momentum in all areas of the business against the backdrop of an improving memory and storage markets. From the perspective of Netlist products, the market outlook has improved since the second half of 2020. Demand from data center, enterprise and mobile segments remains strong. As these sectors continue to make heavy investments to meet the expanding needs for high-performance computing and storage in the pandemic environment. On the supply side, the global storage of semiconductors has been -- global shortage has been well documented and memory and SSDs are part of this general shortage. We expect components like DRAMs and NAND controllers, used to make our end products, to remain constrained through the first half. And we are working all avenues to secure these critical components. On the other hand, if sufficient material can be sourced, the demand in ASP environment is quite favorable, with prices for most server memory having increased by around 20% since the beginning of the year. Analysts are projecting a continuation of this environment through the first half of 2021. As the market has tightened, we have seen opportunities to increase incrementally expand business with existing customers and start qualifications with new target customers. During 2020, we expanded the Netlist NVMe SSD line with the addition of multiple products with the latest 96-layered NAND technology and leveraging out our world-class firmware optimized to handle the most demanding data center and enterprise workloads. We joined Celestica and Violin to showcase the capabilities of these products as supercomputing 2020. We will be introducing a new line of Gen 4 NVMe SSDs in the coming months. The Gen 4 products provide a faster interface to the system and superior overall performance. We have been pleased with the initial lab testing results and expect to commence sampling shortly.

[Gail Sasaki:]

Thanks, Chuck. During the 12 months ended January 2, 2021, product revenues grew from $26.1 to $47.2 million, an increase of 81%. Full year 2020 product gross profit dollars before manufacturing costs of $8 million increased by 95% compared to $4.1 million for 2019. After manufacturing costs, the net gross margins were 14.3% for the current year and 9.8% for the -- for last year. The significant increase in both revenue and gross margins was due to the overall growth of SSD revenue, including a significant contribution from new customers and the Netlist NVMe SSD product line. Revenues for the fourth quarter ended January 2, 2021, were $11.5 million compared to revenues of $9.4 million in the year ago quarter, an increase of 23% and relatively flat consecutively. Q4 '20 product gross profit percentage before manufacturing costs decreased to 15.2% compared to 20.7% for Q4 '19 and slightly down consecutively. After manufacturing costs, the net gross margins were 12.7% for the current quarter and 15.3% for last year's quarter. The difference in gross margin percentage variance between quarters reflects a more favorable DRAM and NAND market in Q4 '19 as compared to Q4 '20 across all product lines. And although we don't formally guide, industry commentary indicates improvement in the demand and pricing environment for the first half of 2021. Although there remains uncertainty still due to -- in the demand due to COVID-19. However, given Netlist's current pace and mix of bookings, we are cautiously optimistic about the first quarter's performance and expect modest growth for the first half of '20. We ended the year with cash and cash equivalents and restricted cash of $16.5 million compared to $17.5 million at the end of the third quarter. Cash burn in Q4 was approximately $2 million within our near-term target range of $1 million to $2.5 million. The current cash balance provides us with substantial runway for investments in HybriDIMM CXL as well as to execute on intellectual property portfolio activity during 2021. We have approximately $2 million remaining on the equity line if we choose to use it, which does not expire for another approximate 1.5 years. As always, we continue to very carefully manage the operational cash cycle, which for Q4 20, included increased inventory turns as we decreased days in inventory by 48% to 27 days. We kept days sales outstanding that actually increased to 40 days and that was offset by a decrease in days payable to 52 days. We continue to maintain a $5 million working capital line of credit with Silicon Valley Bank to support working capital and revenue growth.

[Operator:]

. Our first question will come from Suji Desilva with ROTH Capital.

[Suji Desilva:]

Congratulations on the progress in 2020 here. I understand the outlook, COVID is still impacting your visibility. But have the supply constraints perhaps cause you to leave some revenue on the table in the fourth quarter or the first quarter relative to what you could be doing?

[Chuck Hong:]

Suji, there are some shortages of critical components like NAND controller, that is going to keep us from maximizing on the opportunity. But I think in general, we're seeing a significant uptick in demand, and we're trying to fill much of that as possible. And we've been successful, by and large, in filling much of that increase in demand.

[Suji Desilva:]

Okay. That's helpful. And then can you give us a sense of the SSD market, the NVMe SSD product line is ramping here? Can you give a sense of what kind of expectation you have in '21 for the contribution to revenue versus '20 to give a sense of how quickly it's kind of growing in? And maybe you can layer into that discussion, the embedded end market, what the timing of that coming online is for you versus data center?

[Chuck Hong:]

Yes. I think the numbers increased quite a bit. Last year, I think we were $1 million or $2 million of SSD, enterprise SSD sales in 2019. And we got, to some place, a little over $10 million, I believe, in 2020. We expect that to grow further this year. No we don't have a specific number. But I think it could grow almost quite nicely this year, just the momentum right now of our existing customers and as we bring on new customers in this environment, we're seeing more opportunities because there is a just the general shortage of product across the industry.

[Suji Desilva:]

And Chuck, the embedded opportunity versus the traditional enterprise data center opportunity, what's the timing of that coming on?

[Chuck Hong:]

Yes, yes, sorry. I missed that part of the question. Yes, I was talking -- most -- I was talking about the enterprise SSD. On the embedded flash market, that's really a new product line that we started to create or build out more robustly, starting Q4 of last year. So we're active in the marketplace. I think the market for ruggedized, military, industrial applications for embedded flash, they're quite varied. And we're seeing a lot of opportunities. So I think this year will be the first full year that we will carry that product line. So we're very helpful given the market conditions to see new opportunities.

[Suji Desilva:]

Okay. Switching over to HybriDIMM. I hear you talk about it more on this call. Can you give us a sense of what's going on with the controller development here? Is there still a partner involved? And when that controller samples becomes available for HybriDIMM?

[Chuck Hong:]

Yes. We are finish -- we finished out the architecture and specifications last year and starting with the hiring of Raj, we've -- we are now embarking on the process to code the RTL. And then towards the end of the year, we'll start to work with the back end vendor that create the actual ASIC. We have hired on quite a bit of engineers in the last couple of months, and we'll continue to add to that. I mean it's a significant effort. As to the partners, we would define partners as any major strategic customer for this product that would come in as a potential investor and a partner for this technology. We are talking to a number of people. And we'll continue those discussions until we get to an agreement. We're still early in the design process. So we still have work to do, but we're very hopeful that this will be a major kind of transformative technology in the industry with the emergence of the CXL bus.

[Suji Desilva:]

Okay. The last question for me. On the litigation front, you're very clear on Hynix, what's going on in Western District Texas. Can you talk about the Google litigation and just outline for us what the next steps would be from here, just so we have that clearly?

[Chuck Hong:]

Yes. As I stated, we have a case management conference coming up next week, and that really kicks off the case. That is where the parties and the judge together, mainly the judge sets out the rules and the time line for various submissions of briefs. There is probably a joint statement between the 2 parties being submitted to the court a couple of days ahead of that. And once you have this case management conference, a lot will become clear as to how to the dates and the events that will take place over the course of this case. So we will know more -- quite a bit more next week.

[Operator:]

Our next question will come from Richard Shannon with Craig-Hallam Capital Group.

[Richard Shannon:]

Can you hear me?

[Gail Sasaki:]

Yes, Richard.

[Chuck Hong:]

Yes.

[Richard Shannon:]

Sure okay. Good. I had an echo there to start with. Let's see here. Maybe a numbers question, Gail, did I catch your wording right that you're expecting growth in the first half of this year? And is that compared to the first half of last year?

[Gail Sasaki:]

Good question. No -- yes, we are expecting growth in the first half of the year, and it's compared to Q4 of 2020.

[Richard Shannon:]

So the run rate of Q4, do you expect to be higher than that then?

[Gail Sasaki:]

Yes.

[Richard Shannon:]

Okay. All right. Got that. And then how should we think about gross margins? And I think maybe endemic in that question is kind of thinking about the mix and then also the kind of the commodity costs there. How should we think about SSDs relative to the Samsung revenues and other revenue streams here? And then are we expecting any sort of headwind in the cost that will allow you to keep gross margins at least at the levels that you ended last year?

[Gail Sasaki:]

Yes. I think the level of gross margin in totality will be about the same. We will benefit. We've already started to see some benefit in both sides of the business. But I think at the end of the day, it will be about the same as Q4. For the first half of the year anyway, until we get some better visibility going forward.

[Richard Shannon:]

Okay. All right. That is fair. Let's see here. Chuck, in response to the last question regarding SSDs. You talked about having some growth on a $10 million base from last year, but you didn't want to give a number yet, which I guess I get at this point. Maybe if you can characterize it another way, which is to help us understand what size of the market do you think you're addressing, you're not only with the kind of the enterprise SSDs but also in the embedded flash area? What kind of a TAM are you looking at? And over what time can you grow into a certain amount of share there?

[Chuck Hong:]

Yes, Richard, I mean we know that the overall NVMe SSD market is in the high $40 billion and $50 billion. We participate in 4 different form factors of this. We tend to be on the smaller form factors with higher capacities and higher speeds. So it's a smaller niche of that broader market. But certainly, our opportunities are -- we're addressing a TAM of multibillion dollars. It's just a matter of us securing the call slots and executing that. So there's a lot of headroom to grow. There's no doubt about that. It's just -- I think what we've done last year is just a start. It's a matter of -- I think the current couple of big customers, they continue to grow their business, and we're seeing bigger shares. But the challenge is securing multiples, many more of those types of high-growth customers.

[Richard Shannon:]

Okay. My last question on the topic of litigation here. I'd love to ask about across both of your major situations here with Hynix and Google, but any thoughts on kind of the tenor of discussions outside of the legal realm here in terms of settlement -- potential settlements? Are there are any of those going on to a more fruitful or precise degree than what you've had in the past? And I guess I'm particularly interested about Google, which is obviously, as you described in your prepared remarks, in state of limbo for 10 years here. Can you give us any sense of what's been going on there in terms of discussions as well? That would be great, please.

[Chuck Hong:]

Well, I can't speak to the specifics legally. But I think we've stated in the past, and on this prepared remarks for this call that we remain engaged with both of those parties as well as other parties.

[Operator:]

This concludes our Q&A session, and the conference has now concluded. Thank you for attending today's presentation. You may now disconnect.