Netlist Inc
OTC:NLST
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Earnings Call Analysis
Summary
Q2-2024
Netlist's second quarter 2024 revenue soared to $36.8 million, nearly four times last year's $10 million. The company won major legal cases against Samsung and Micron, securing $303 million and $445 million respectively. These victories validate Netlist's intellectual property and highlight its strategic position in AI memory technology. Operational improvements included a significant reduction in days of inventory from 93 to 21 days. Looking ahead, Netlist expects moderate revenue growth in Q3 2024, with continued focus on margin improvements despite ongoing legal costs.
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Good day, and welcome to the Netlist Second Quarter 2024 Earnings Conference Call and Webcast. [Operator Instructions]. This event is being recorded.
I would now like to turn the conference over to Mike Smargiassi, Investor Relations. Please go ahead.
Thank you, Betsy, and good day, everyone. Welcome to Netlist's Second Quarter 2024 Conference Call. Leading today's call will be Chuck Hong, Chief Executive Officer of Netlist; and Gail Sasaki, Chief Financial Officer. As a reminder, you can access the earnings release and a replay of today's call 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 our risks and uncertainties that are expressed in the call, annual and current SEC filings and the cautionary statements contained in today's press release. Netlist assumes no obligation to update forward-looking statements.
I will now turn the call over to Chuck.
Thanks, Mike, and hello, everyone. In the second quarter, Netlist secured 2 significant legal victories that further validate the actions we have taken to protect our intellectual property. These wins advance the company's objective of entering into long-term licensing agreements with implementers of our IP, that fairly [ consists ] Netlist and its shareholders.
First, in May, the jury in Netlist's case in the Federal Court for the Central District of California. Found unanimously that Samsung materially breached the joint development and license agreement entered into in November 2015. This trial brought to light, Samsung's misconduct and bad faith actions, which were designed to harm Netlist, and accordingly, the jury rendered a verdict which confirms that we have what we have been asserting all along, the Samsung intentionally and materially breach the agreement and no longer has a license to Netlist patents.
Given this verdict, the Eastern District of Texas moved forward last week with the denial of Samsung's post-trial motions in the $303 million patent infringement jury award against Samsung. The court entered a final judgment in this case and a denial of post-trial motions brings this case to a close in the U.S. District Court.
With these actions, the court has upheld the jury's verdict and damages award, confirm that Samsung willfully infringed Netlist's patented technologies and that none of the asserted patents claims is invalid. Netlist's patents in this case, covered both high bandwidth memory or HBM and DDR5 memory technologies foundational to generative AI computing.
Second, in May, Netlist won a $445 million damages award against Micron in the Eastern District of Texas. The unanimous jury verdict found that Micron willfully infringe Netlist's patents 912 and 417. Earlier this month, Judge Gilstrap entered the final judgment. And so we have now moved on to the post trial stage of this case. After all post-trial motions are addressed by the court, Micron will have 30 days to file an appeal to the Federal Circuit Court of Appeals, and we fully expect that Micron will appeal this verdict.
I want to underscore that in just over a year, 2 separate juries have awarded Netlist nearly $0.75 billion in damages for willful patent infringement by 2 of the largest semiconductor manufacturers in the world. These are some of the largest patent damages award historically in our industry and highlight the tremendous value of the technology Netlist created. Especially in memory for AI computing.
It's also notable that the award address a relatively short infringement periods, mostly between 2022 and 2023. At the beginning stages of the AI memory adoption. In the months since the 2 verdicts, both Samsung and Micron have each shipped exponentially larger volumes of the infringing memory products for AI and their dollar exposure to our patents have piled up and will continue to accumulate in the months ahead.
In the Eastern District of Texas, the case against Samsung is set for a pretrial, conference on August 23, and trial on September 9. In this case, which we call Samsung, Eastern District of Texas II, Netlist is asserting the 912 patent along with LRDIMM patent 417, both of which relate to the infringement of large volumes of DDR4 RDIMMs and LRDIMMs.
In addition to these same patents that were asserted in the Micron case, for Samsung case II, the 608 patent, which reads on a different aspect of LRDIMM technology then the 417 is being asserted as well. I would note that the 608 was not instituted in the IPR filed by Micron in the Western District of Texas case.
On the last call, I commented on the Patent Trial and Appeals Board, the IPR process, and specifically, the history of Netlist's 912 patent. Patent litigation and the PTAB landscape remain hostile to patent owners and innovative companies like Netlist. This can be seen in IPR statistics over the last few years as well as the extreme proposals coming out of the USPTO today.
We share investors frustration with the current process but we are committed to defending our patents through the patent office's existing framework.
We currently have 7 IPR appeals in process. and expect to add 3 more in the near future. After receiving final written decision from the PTAB, parties have 30 days to file a request to challenge the result at the PTO itself.
This appeal process can take several months. That these appeals are denied, the PTAB will enter a final decision and denial. This then opens the window to file an appeal with the Federal Circuit Court of Appeals. For each appeal, we expect the process to take around 18 months. And so we expect to see Federal Circuit appellate rulings, on some of the IPR final written decisions and the district court judgments later next year.
Although we will not point to specific IPR's based on a thorough expert analysis of all of the final written decisions, we are confident that some of these decisions will be reversed or remanded on appeal due to clear legal and procedural errors made by the PTAB in rendering its decisions.
On the legislative front, during the second quarter, members of the Netlist legal team spent time in Washington, D.C. meeting with elected representatives and their staff to raise awareness on the status of the U.S. patent system.
Netlist's 912 patent is well known among the IP community in general, as well as with the federal officials. At 14 years, we believe it is the longest running reexam of any patent in history. The 912 has become the poster trial for the excesses of the AIA, the IPR process, PTAB abuse, and a proof point for a need for patent reform. There are 3 proposed bipartisan bills, the Prevail, the Restore and the [ Para ]. Each would address different aspects of the process, make critical reforms to curb abuses by big tech, protect patent holders and restore balance to the U.S. patent system. We will continue to work with wall makers to help support their efforts to enact these bills into law.
I will now turn the call over to Gail for a financial review.
Thanks, Chuck. Second quarter 2024 revenue was $36.8 million compared to $10 million in the year ago period. This was close to 4x greater than last year's second quarter revenue. A reflection of the recovery in the demand environment from the year ago period.
While we do not formally guide, given booking and shipping for the third quarter of 2024 to date, plus the industry outlook for continued growth we currently expect a moderate increase in revenue for the third quarter compared to the second quarter of 2024.
The decrease in operating expenses for the second quarter compared to the first quarter was primarily due to elevated legal expenses during the first quarter related to preparation for the May trials.
We expect legal costs to be flat for the third quarter and then to decrease as we exit the year. We ended the second quarter 2024 with cash and cash equivalents and restricted cash of $36.4 million. We continue to maintain financial flexibility and liquidity going forward, with a $10 million working capital line of credit with Silicon Valley Bank, and approximately $31 million available on the equity line of credit through Lincoln Park Capital.
As always, we manage the operational cash cycle very carefully with days in inventory of 21 days improved by 72 days over last year's Q2. Inventory turn increased to 18x compared to 4x from last year's quarter.
Operator, we are now ready for questions.
The first question today comes from Suji Desilva with Roth Capital.
So the Samsung appeal, Chuck, failing. Can you just give us a sense, maybe at what point in time, perhaps something like interest is accruing on those damages or when the clock starts there? Or just any other milestones in the time frame of Samsung kind of paying those damages now that the appeal has been denied?
Well, the -- Suji, thanks. The appeal for the license case, the breach of contract/license case that was held in the Central District of California. That appeal led to a reman back to district court, and that is where we prevailed once again in May. So that established that Samsung does not have a license to our patent portfolio. And based on that verdict, the judge in the Eastern District of Texas moved forward to finalize the verdict and his final order confirming the willful infringement and the $303 million in damages that were owed.
So -- now that, that case, which was held in April last year. So it was held up from being confirmed until this license issue got resolved in California. So now that case will move to appeals to the appellate court. And it will hit their -- the appellate court, the Federal Circuit sometime next year. And the Fed circuit will likely consider that case, the patent infringement final order, along with the IPR decisions related to the patents in that case. They will likely look at all of that together sometime next year and render what effectively would be a final decision.
So if we were to prevail, and we believe we've got a good chance than the interest from the $303 million ruling, we'll continue to accrue through today and then through to the time of appeal. So hopefully, that long answer addresses your question.
It did, Chuck. And then separately on the -- what you're calling East Texas II for Samsung. Was that waiting on the Micron finding? Or is that a separate time line? And what are the implications of the Micron finding on that -- or the Samsung East Texas I on the East Texas II opportunity with the patents?
So the Samsung Eastern District of Texas, 2 case, was stayed for a while and the court confirmed now a trial date of September 9. And the court was also waiting for -- to waiting on the outcome of the California license case, the Breach of Contract case before it fixed the date for the trial for September 9.
So that's the relationship with the license case. As to the relationship with the prior Micron case, it contains the Samsung II case that's coming up in September. That trial will have the same patents that were in the Micron case. And then there's one more patent 608 that reads on the LRDIMM. So we'll have 3 patents, one more patent than the Micron case. But it will cover the same products that Samsung makes -- that Micron makes, which are the DDR4 and DDR5, RDIMMs and LRDIMMs
Got it. Okay. Good. Switching to the financial side, Gail, what are the drivers for gross margin to expand here? Help me understand the relationship there to maybe what's happening in the memory market demand pricing-wise, and what can be the target gross margin level as things improve from here?
So I think, during the first half of the year, we were -- I mean, I did mention that the inventory churn has dramatically improved. We were working through some inventory which we had sold at some lower margins. And going forward, the pricing is continuing to increase from Q2 to Q3 on much of the resale products that make up a large portion of our revenue today which will be helpful not in huge percentages but will be helpful to our margin going forward Q3 and Q4.
Target margin product margins, still, I'd say, around 5% to 6% on an average. Certainly, there are portions of our product revenue, which are much higher than that. So it will be -- our target is trying to be better than Q1 and Q2 for those reasons.
Okay. That helps Gail. Maybe last, Chuck. Maybe you can kind of step back and talk about the Netlist product road map and the update there for time frame of product sales beyond Hynix, the resales? And maybe tie that to the trends in AI memory and SSDs where is that list most levered to and the trends going on in the market today?
So AI memory is comprised of really 3 areas. One is a high bandwidth memory, and those products sit right next to the GPU in the NVIDIA and AMD GPUs. and those are manufactured, obviously, by Samsung, Micron and Hynix. Hynix as the leader. We have, as we've stated, some of the seminal technologies that we patented on HBM years ago. We don't manufacture HBMs, but we've got technologies there that are reflected in our patent.
And then you have DDR5 memory, which is standard server memory, but you need a lot more of high-capacity DDR5 memory to support AI. And our products there comprised of VLPs and MRDIMMs products that are more high capacity and specialized among the DDR5 product lineup.
And then finally, CXL. And so on the VLPs and so we've got a line of BLP products, we also will be introducing DDR5 MRDIMMs. And then finally, CXL acts as the second level of memory for these AI systems. There is a lot of demand today on -- in SSDs, because of AI memory. And that over time with the emergence of CXL should be supplanted by CXL because CXL is faster, and is memory semantics versus the SSDs. And we've been investing, we've been working on a flash-based CXL product for the last 6 years. And we have invested a lot of time and money there, and we will have a controller going -- coming out in the next year or so.
But the CXL market is still in its infancy. It will probably be another year or two before there is significant adoption in the market. So those are the 3 areas of AI memory that we participate in.
This concludes our question-and-answer session and concludes conference call. Thank you for attending today's presentation. You may now disconnect.