**Tableof Contents**

** **

**                                               **

** **

**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

** **

**FORM 10-Q**

** **

**(Mark One)**
| **x**      | **QUARTERLY REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**     |
|------------|------------------------------------------------------------------------------------------------------------|
| ** ** | ** **                                                                                                 |
| ** ** | **For the quarterly period ended  September 27, 2008**                                                |
| ** ** | ** **                                                                                                 |
| ** ** | **or**                                                                                                     |
| ** ** | ** **                                                                                                 |
| **o**      | **TRANSITION REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**    |
|       |                                                                                                       |
|       | **For  the transition period from              to** |

 

**Commission file number001-33170**

** **

****

** **

**NETLIST, INC.**

(Exact name of registrant as specified in its charter)

 

| **Delaware**                    | ** ** | **95-4812784**       |
|---------------------------------|------------|----------------------|
| State  or other jurisdiction of |       | (I.R.S.  Employer    |
| incorporation  or organization  |       | Identification  No.) |

 

**51 Discovery, Irvine, CA 92618**

(Address of principal executive offices) (Zip Code)

 

**(949) 435-0025**

**(Registrant’stelephone number, including area code)**

** **

Indicate by check mark whether the registrant (1) has filed allreports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorter periodthat the registrant was required to file such reports), and (2) has beensubject to such filing requirements for the past 90 days.  Yes x    No o

 

Indicate by check mark whether the registrant is a large acceleratedfiler, an accelerated filer, a non-accelerated filer or a smaller reportingcompany. See definition of “large accelerated filer,” “accelerated filer” and“smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check One):

 
| Large accelerated filer     o |   | Accelerated filer     o |   | Non-accelerated filer     o |   | Smaller reporting company     x |
|---------------------------------------------------|--------|---------------------------------------------|--------|-------------------------------------------------|--------|-----------------------------------------------------|
|                                              |   |                                        |   | (Do not check if a smaller                      |   |                                                |
|                                              |   |                                        |   | reporting company)                              |   |                                                |

 

Indicate by check mark whether the registrant is a shell company (asdefined in Rule 12b-2 of the Act).  Yes o   No x

 

The number of shares outstanding of each of the registrant’s classes ofcommon stock as of the latest practicable date:

 

Common Stock, par value $0.001 per share

19,855,411 shares outstanding at October 31, 2008

 

 

** **

----

**Table of Contents**

** **

**NETLIST, INC. ANDSUBSIDIARIES**

**QUARTERLY REPORT ON FORM 10-Q**

**FOR THE THREE AND NINEMONTHS ENDED SEPTEMBER 27, 2008**

** **

**TABLE OF CONTENTS**

 
| PART I.  | FINANCIAL INFORMATION                                                                                                                                    |
|---------------|----------------------------------------------------------------------------------------------------------------------------------------------------------|
| Item 1.       | Financial Statements                                                                                                                                     |
|          | Unaudited Condensed  Consolidated Balance Sheets at September 27, 2008 and December 29,  2007                                                  |
|          | Unaudited Condensed  Consolidated Statements of Operations for the Three and Nine Months Ended  September 27, 2008 and September 29, 2007 |
|          | Unaudited Condensed  Consolidated Statements of Cash Flows for the Nine Months Ended September 27,  2008 and September 29, 2007                |
|          | Notes to Unaudited Condensed Consolidated Financial  Statements                                                                                          |
| Item  2.      | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                                                              |
| Item  3.      | Quantitative  and Qualitative Disclosures About Market Risk                                                                                              |
| Item  4.      | Controls  and Procedures                                                                                                                                 |
| Item  4T.     | Controls  and Procedures                                                                                                                                 |
|          |                                                                                                                                                     |
| PART II. | OTHER  INFORMATION                                                                                                                                       |
| Item 1.       | Legal Proceedings                                                                                                                                        |
| Item 1A.      | Risk Factors                                                                                                                                             |
| Item  2.      | Unregistered  Sales of Equity Securities and Use of Proceeds                                                                                             |
| Item  3.      | Defaults  Upon Senior Securities                                                                                                                         |
| Item  4.      | Submission  of Matters to a Vote of Security Holders                                                                                                     |
| Item 5.       | Other  Information                                                                                                                                       |
| Item 6.       | Exhibits                                                                                                                                                 |

** **

**2**

----

**Table of Contents**

** **

**PART I. FINANCIALINFORMATION**

** **

**Item1. Financial Statements**

** **

**NETLIST, INC.AND SUBSIDIARIES**

**UnauditedCondensed Consolidated Balance Sheets**

**(inthousands)**

** **
| ** **                                                               | ** ** | **September 27,** | ** ** | **December 29,** | ** ** |
|--------------------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                                               | ** ** | **2008**               | ** ** | **2007**              | ** ** |
| **ASSETS**                                                               | ** ** | ** **             | ** ** | ** **            | ** ** |
| Current assets:                                                          |       |                   |       |                  |       |
| Cash and cash equivalents                                                |       | $                      | 12,081     |                  | $          | 7,182 |   |
| Restricted cash                                                          |       | 2,000                  |       | —                |       |
| Investments in marketable securities                                     |       | 9,224                  |       | 15,573                |       |
| Accounts receivable, net                                                 |       | 15,749                 |       | 12,034                |       |
| Inventories                                                              |       | 4,432                  |       | 3,333                 |       |
| Income taxes receivable                                                  |       | 595                    |       | 708                   |       |
| Deferred taxes                                                           |       | 1,254                  |       | 3,464                 |       |
| Prepaid expenses and other current assets                                |       | 902                    |       | 392                   |       |
| Total current assets                                                     |       | 46,237                 |       | 42,686                |       |
|                                                                     |       |                   |       |                  |       |
| Property and equipment, net                                              |       | 7,753                  |       | 8,191                 |       |
| Deferred taxes                                                           |       | —                 |       | 1,065                 |       |
| Long-term investments in marketable securities                           |       | 963                    |       | 7,814                 |       |
| Other assets                                                             |       | 548                    |       | 600                   |       |
| Total assets                                                             |       | $                      | 55,501     |                  | $          | 60,356 |   |
|                                                                     |       |                   |       |                  |       |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                            |       |                   |       |                  |       |
| Current liabilities:                                                     |       |                   |       |                  |       |
| Accounts payable                                                         |       | $                      | 5,238      |                  | $          | 6,697 |   |
| Revolving line of credit                                                 |       | 12,241                 |       | 4,872                 |       |
| Current portion of long-term debt                                        |       | 491                    |       | 740                   |       |
| Current portion of deferred gain on sale and leaseback transaction       |       | 118                    |       | 118                   |       |
| Accrued expenses and other current liabilities                           |       | 2,360                  |       | 2,872                 |       |
| Total current liabilities                                                |       | 20,448                 |       | 15,299                |       |
| Long-term debt, net of current portion                                   |       | 280                    |       | 638                   |       |
| Deferred gain on sale and leaseback transaction, net of current  portion |       | 137                    |       | 226                   |       |
| Total liabilities                                                        |       | 20,865                 |       | 16,163                |       |
| Commitments and contingencies                                            |       |                   |       |                  |       |
| Stockholders’ equity:                                               |       |                   |       |                  |       |
| Common stock                                                             |       | 20                     |       | 20                    |       |
| Additional paid-in capital                                               |       | 69,086                 |       | 68,109                |       |
| Accumulated deficit                                                      |       | (34,156                | )          | (23,899               | )          |
| Accumulated other comprehensive loss                                     |       | (314                   | )          | (37                   | )          |
| Total stockholders’ equity                                          |       | 34,636                 |       | 44,193                |       |
| Total liabilities and stockholders’ equity                          |       | $                      | 55,501     |                  | $          | 60,356 |   |

 

See accompanying notes.

 

3

----

Table of Contents

 

**NETLIST, INC. AND SUBSIDIARIES**

**UnauditedCondensed Consolidated Statements of Operations**

**(inthousands, except per share amounts)**

 
| ** **                                       | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|--------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                       | ** ** | **September 27,**           | ** ** | **September 29,**          | ** ** | **September 27,** | ** ** | **September 29,** | ** ** |
| ** **                                       | ** ** | **2008**                         | ** ** | **2007**                        | ** ** | **2008** | ** ** | **2007** | ** ** |
| Net sales                                        |       | $                                | 28,876     |                            | $          | 27,194 |   | $ | 60,409 |   | $ | 77,543 |   |
| Cost of sales(1)                                 |       | 26,832                           |       | 23,027                          |       | 52,575 |   | 73,850 |   |
| Gross profit                                     |       | 2,044                            |       | 4,167                           |       | 7,834 |   | 3,693 |   |
| Operating expenses:                              |       |                             |       |                            |       |   |   |   |   |
| Research and development(1)                      |       | 1,651                            |       | 1,256                           |       | 4,943 |   | 3,801 |   |
| Selling, general and administrative(1)           |       | 3,364                            |       | 4,040                           |       | 10,142 |   | 11,589 |   |
| Total operating expenses                         |       | 5,015                            |       | 5,296                           |       | 15,085 |   | 15,390 |   |
| Operating loss                                   |       | (2,971                           | )          | (1,129                          | )          | (7,251 | ) | (11,697 | ) |
| Other income:                                    |       |                             |       |                            |       |   |   |   |   |
| Interest income, net                             |       | 38                               |       | 142                             |       | 381 |   | 256 |   |
| Other income (expense), net                      |       | 13                               |       | (33                             | )          | (55 | ) | (28 | ) |
| Total other income, net                          |       | 51                               |       | 109                             |       | 326 |   | 228 |   |
| Loss before provision (benefit) for income taxes |       | (2,920                           | )          | (1,020                          | )          | (6,925 | ) | (11,469 | ) |
| Provision (benefit) for income taxes             |       | 4,502                            |       | (363                            | )          | 3,332 |   | (4,227 | ) |
| Net loss                                         |       | $                                | (7,422     | )                               | $          | (657 | ) | $ | (10,257 | ) | $ | (7,242 | ) |
| Net loss per common share:                       |       |                             |       |                            |       |   |   |   |   |
| Basic and diluted                                |       | $                                | (0.37      | )                               | $          | (0.03 | ) | $ | (0.52 | ) | $ | (0.37 | ) |
| Weighted-average common shares outstanding:      |       |                             |       |                            |       |   |   |   |   |
| Basic and diluted                                |       | 19,855                           |       | 19,689                          |       | 19,845 |   | 19,655 |   |

 

----

(1)  Amounts include stock-based compensation expense as follows:

 
| Cost of sales                       |   | $   | 44     |   | $      | 53  |   | $   | 106    |   | $ | 161 |   |
|-------------------------------------|--------|-----|--------|--------|--------|-----|--------|-----|--------|--------|---|-----|--------|
| Research and development            |   | 55  |   | 40     |   | 140 |   | 105 |   |
| Selling, general and administrative |   | 263 |   | 219    |   | 735 |   | 668 |   |

 

See accompanying notes.

 

4

----

**Tableof Contents**

** **

**NETLIST, INC.AND SUBSIDIARIES**

**UnauditedCondensed Consolidated Statements of Cash Flows**

**(inthousands)**

 
| ** **                                                                                 | ** ** | **Nine Months Ended** | ** ** |
|--------------------------------------------------------------------------------------------|------------|---------------------------------|------------|
| ** **                                                                                 | ** ** | **September 27,**          | ** ** | **September 29,** | ** ** |
| ** **                                                                                 | ** ** | **2008**                        | ** ** | **2007** | ** ** |
| ** **                                                                                 | ** ** | ** **                      | ** ** | ** ** | ** ** |
| Cash flows from operating activities:                                                      | ** ** | ** **                      | ** ** | ** ** | ** ** |
| Net loss                                                                                   |       | $                               | (10,257    | ) | $ | (7,242 | ) |
| Adjustments to reconcile net loss to net cash provided by (used in) operating  activities: |       |                            |       |   |   |
| Depreciation and amortization                                                              |       | 1,779                           |       | 1,013 |   |
| Amortization of deferred gain on sale and leaseback transaction                            |       | (89                             | )          | (89 | ) |
| Deferred income taxes                                                                      |       | 3,275                           |       | (4,577 | ) |
| Impairment of long-lived asset                                                             |       | —                          |       | 257 |   |
| Loss on disposal of assets                                                                 |       | 17                              |       | 68 |   |
| Loss on inventory adjustments                                                              |       | —                          |       | 5,063 |   |
| Facility relocation charge                                                                 |       | —                          |       | 150 |   |
| Stock-based compensation                                                                   |       | 981                             |       | 934 |   |
| Provision for bad debts                                                                    |       | 258                             |       | 51 |   |
| Changes in operating assets and liabilities:                                               |       |                            |       |   |   |
| Accounts receivable                                                                        |       | (3,973                          | )          | 7,314 |   |
| Inventories                                                                                |       | (1,099                          | )          | 8,452 |   |
| Income taxes receivable                                                                    |       | 113                             |       | — |   |
| Prepaid expenses and other current assets                                                  |       | (510                            | )          | 541 |   |
| Other assets                                                                               |       | (229                            | )          | (364 | ) |
| Accounts payable                                                                           |       | (1,459                          | )          | (2,442 | ) |
| Income taxes payable                                                                       |       | —                          |       | (706 | ) |
| Accrued expenses and other current liabilities                                             |       | (512                            | )          | (666 | ) |
| Net cash provided by (used in) operating activities                                        |       | (11,705                         | )          | 7,757 |   |
| Cash flows from investing activities:                                                      |       |                            |       |   |   |
| Acquisition of property and equipment                                                      |       | (1,077                          | )          | (5,530 | ) |
| Repayment of note receivable from stockholder                                              |       | —                          |       | 1 |   |
| Purchase of investments in marketable securities                                           |       | (6,677                          | )          | (50,944 | ) |
| Proceeds from maturities and sales of investments in marketable  securities                |       | 19,600                          |       | 33,550 |   |
| Net cash provided by (used in) investing activities                                        |       | 11,846                          |       | (22,923 | ) |
| Cash flows from financing activities:                                                      |       |                            |       |   |   |
| Borrowings on lines of credit                                                              |       | 78,999                          |       | 86,740 |   |
| Payments on lines of credit                                                                |       | (71,630                         | )          | (95,698 | ) |
| Borrowings on debt                                                                         |       | —                          |       | 290 |   |
| Payments on debt                                                                           |       | (607                            | )          | (852 | ) |
| Increase in restricted cash                                                                |       | (2,000                          | )          | — |   |
| Proceeds from exercise of stock options and warrants                                       |       | —                          |       | 161 |   |
| Reversal of unrealized excess tax benefit from exercise of warrants                        |       | (4                              | )          | — |   |
| Net cash provided by (used in) financing activities                                        |       | 4,758                           |       | (9,359 | ) |
| Increase (decrease) in cash and cash equivalents                                           |       | 4,899                           |       | (24,525 | ) |
| Cash and cash equivalents at beginning of period                                           |       | 7,182                           |       | 30,975 |   |
| Cash and cash equivalents at end of period                                                 |       | $                               | 12,081     |   | $ | 6,450 |   |
|                                                                                       |       |                            |       |   |   |
| Supplemental disclosure of non-cash investing activities:                                  |       |                            |       |   |   |
| Reclassification of other assets to property and equipment                                 |       | $                               | 281        |   | $ | — |   |
| Unrealized losses from investments in marketable securities                                |       | $                               | 277        |   | $ | — |   |

 

See accompanying notes.

 

5

----

Tableof Contents

 

**NETLIST, INC.AND SUBSIDIARIES**

**NOTESTO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

** **

**September 27,2008**

** **

**Note 1—Descriptionof Business**

** **

Netlist, Inc.(the “Company” or “Netlist”) designs and manufactures high performance memorysubsystems for the server, high performance computing and communicationsmarkets. The Company’s solutions are targeted at applications where memoryplays a key role in meeting system performance requirements.

 

**Note 2—Summary ofSignificant Accounting Policies**

** **

*Basis ofPresentation*

* *

The interimunaudited condensed consolidated financial statements have been prepared inaccordance with accounting principles generally accepted in the United Statesof America (the “U.S.”) for interim financial information and with theinstructions to Securities and Exchange Commission (“SEC”) Form 10-Q and Article 8of SEC Regulation S-X. These financial statements do not include all of theinformation and footnotes required by accounting principles generally acceptedin the U.S. for complete financial statements. Therefore, these financialstatements should be read in conjunction with the Company’s auditedconsolidated financial statements and notes thereto for the year ended December 29,2007, included in the Company’s Annual Report on Form 10-K filed with theSEC on February 29, 2008.

 

The condensedconsolidated financial statements included herein are unaudited; however, theycontain all normal recurring accruals and adjustments that, in the opinion ofthe Company’s management, are necessary to present fairly the consolidatedfinancial position of the Company and its wholly owned subsidiaries as of September 27,2008 and December 29, 2007, the consolidated results of its operations forthe three and nine months ended September 27, 2008 and September 29,2007, and the consolidated cash flows for the nine months ended September 27,2008 and September 29, 2007. All intercompany balances and transactions havebeen eliminated in consolidation. The results of operations for the three andnine months ended September 27, 2008 are not necessarily indicative of theresults to be expected for the full year or any future interim periods.

 

*Fiscal Year*

* *

The Company operatesunder a 52/53-week fiscal year ending on the Saturday closest to December 31.For fiscal 2008, the Company’s fiscal year end is scheduled to be January 3,2009 and will consist of 53 weeks. Each of the Company’s first three quartersin a fiscal year is comprised of 13 weeks.

 

*Use of Estimates*

* *

The preparation of financial statements in conformity with accountingprinciples generally accepted in the U.S. requires management to make estimatesand assumptions that affect the reported amounts of the assets and liabilitiesand disclosure of contingent assets and liabilities at the date of thefinancial statements, and the reported amounts of revenues and expenses duringthe reporting period. Significant estimates made by management include, amongothers, provisions for uncollectible receivables and sales returns, warrantyliabilities, valuation of inventories, recoverability of long-lived assets,stock-based compensation expense and realization of deferred tax assets. TheCompany bases its estimates and assumptions on current facts, historicalexperience and various other factors that it believes to be reasonable underthe circumstances, the results of which form the basis for making judgmentsabout the carrying values of assets and liabilities and the accrual of costsand expenses that are not readily apparent from other sources. The actualresults experienced by the Company may differ materially and adversely from itsestimates. To the extent there are material differences between the estimatesand the actual results, future results of operations will be affected.

 

*RevenueRecognition*

* *

The Company’s revenues primarily consist of product sales of highperformance memory subsystems to original equipment manufacturers (“OEMs”).Revenues also include sales of excess inventories to distributors and otherusers of memory integrated circuits (“ICs”) totaling approximately $0.1 millionand $0.3 million, respectively, during the three and nine months ended September 27,2008 and approximately $0.4 million and $1.8 million, respectively, for thethree and nine months ended September 29, 2007.

 

6

----

Tableof Contents

 

The Company recognizes revenues in accordance with the SEC’s StaffAccounting Bulletin No. 104, *Revenue Recognition*(“SAB 104”). Under the provisions of SAB 104, the Company recognizesrevenues when there is persuasive evidence of an arrangement, product deliveryand acceptance have occurred, the sales price is fixed or determinable, andcollectibility of the resulting receivable is reasonably assured.

 

The Company generally uses customer purchase orders and/or contracts asevidence of an arrangement. Delivery occurs when goods are shipped forcustomers with FOB Shipping Point terms and upon receipt for customers with FOBDestination terms, at which time title and risk of loss transfer to thecustomer. Shipping documents are used to verify delivery and customeracceptance. The Company assesses whether the sales price is fixed ordeterminable based on the payment terms associated with the transaction andwhether the sales price is subject to refund. Customers are generally allowedlimited rights of return for up to 30 days, except for sales of excessinventories, which contain no right-of-return privileges. Estimated returns areprovided for at the time of sale based on historical experience or specificidentification of an event necessitating a reserve. The Company offers astandard product warranty to its customers and has no other post-shipmentobligations. The Company assesses collectibility based on the creditworthinessof the customer as determined by credit checks and evaluations, as well as thecustomer’s payment history.

 

A portion of the Company’s shipments are made to third-party inventorywarehouses, or hubs, and the Company recognizes revenue when the inventory ispulled from the hub for use in production by the customer. The Company receivesa report from the customer on a daily basis indicating the inventories pulledfrom a hub for use by the customer, and performs a daily reconciliation ofinventories shipped to and pulled by the customer to those inventoriesreflected on the customer’s reports to ensure that sales are recognized in theappropriate periods.

 

All amounts billed to customers related to shipping and handling areclassified as revenues, while all costs incurred by the Company for shippingand handling are classified as cost of sales.

 

*Cash and CashEquivalents*

* *

Cash and cash equivalents consist of cash and short-term investmentswith original maturities of three month or less.

 

*Restricted Cash*

* *

Restricted cash represents amounts pledged as collateral on anoutstanding letter of credit.

 

*Investments inMarketable Securities*

* *

The Company accounts for its investments in marketable securities inaccordance with Statement of Financial Accounting Standards (“SFAS”) No. 115,*Accounting for Certain Investments in Debt andEquity Securities*, and Financial Accounting Standards Board (“FASB”)Staff Position SFAS Nos. 115-1 and 124-1, *The Meaningof Other-Than-Temporary Impairment and Its Application to Certain Investments.*TheCompany determines the appropriate classification of its investments at thetime of purchase and reevaluates such designation at each balance sheet date.The Company’s investments in marketable securities have been classified andaccounted for as available-for-sale based on management’s investment intentionsrelating to these securities. Available-for-sale securities are stated atmarket value, and are generally based on market quotes, to the extent they areavailable. Unrealized gains and losses, net of applicable deferred taxes, arerecorded as a component of other comprehensive income (loss). Realized gainsand losses and declines in value judged to be other than temporary aredetermined based on the specific identification method and are reported inother income (expense), net in the unaudited condensed consolidated statementsof operations.

 

The Company generally invests its excess cash in money market funds andin highly liquid debt instruments of U.S. municipalities, corporations and theU.S. government and its agencies. All highly liquid investments with statedmaturities of three months or less from the date of purchase are classified ascash equivalents; all investments with stated maturities of greater than threemonths are classified as investments in marketable securities.

 

*Fair Value ofFinancial Instruments*

* *

The Company’s financial instruments consist principally of cash andcash equivalents, investments in marketable securities, accounts receivable,accounts payable, accrued expenses and debt instruments. Effective December 30,2007, the Company adopted SFAS No. 157, *Fair ValueMeasurements* (“SFAS 157”), which defines fair value, establishes aframework for measuring fair value in accordance with accounting principlesgenerally accepted in the U.S. and expands required disclosures about fairvalue measurements. Pursuant to SFAS 157, other than for certain investments inauction rate 

 

7

----

Tableof Contents

 

securities (see Note 4), the fair value of the Company’s cashequivalents and investments in marketable securities is determined based onquoted prices in active markets for identical assets (“Level 1 Inputs”). TheCompany believes that the carrying values of all other financial instrumentsapproximate their current fair values due to their nature and respectivedurations.

 

*Inventories*

* *

Inventories are valued at the lower of cost or net realizable value.Cost is determined on an average cost basis which approximates actual cost on afirst-in, first-out basis and includes raw materials, labor and manufacturingoverhead. At each balance sheet date, the Company evaluates its endinginventories for excess quantities and obsolescence. Among other factors, theCompany considers historical demand and forecasted demand in relation to the inventoryon hand, competitiveness of product offerings, market conditions and productlife cycles when determining obsolescence and net realizable value. Provisionsare made to reduce excess or obsolete inventories to their estimated netrealizable values. Once established, write-downs are considered permanentadjustments to the cost basis of the excess or obsolete inventories.

 

*Warranties*

* *

The Company offers warranties generally ranging from one to three yearsto its customers, other than on sales of excess inventory, depending on theproduct and negotiated terms of purchase agreements. Such warranties requirethe Company to repair or replace defective product returned to the Companyduring the warranty period at no cost to the customer. The Company records anestimate for warranty-related costs at the time of sale based on, among otherfactors, its historical and estimated product return rates and expected repairor replacement costs. Such costs have historically been consistent betweenperiods and in-line with management’s expectations.

 

*Stock-BasedCompensation*

* *

The Company accounts for equity issuances to non-employees inaccordance with SFAS No. 123, *Accounting for Stock-BasedCompensation* (“SFAS 123”), and EITF Issue No. 96-18, *Accounting for Equity Instruments that are Issued to Other ThanEmployees for Acquiring, or in Conjunction with Selling, Goods and Services*.All transactions in which goods or services are the consideration received forthe issuance of equity instruments are accounted for based on the fair value ofthe consideration received or the fair value of the equity instrument issued,whichever is more reliably measurable. The measurement date used to determinethe fair value of the equity instrument issued is the earlier of the date on whichthe third-party performance is complete or the date on which it is probablethat performance will occur.

 

In accordance with SFAS No. 123(R), *Share-BasedPayment*(“SFAS 123R”), employee and director stock-basedcompensation expense recognized during the period is based on the value of theportion of stock-based payment awards that is ultimately expected to vestduring the period. Stock-based compensation expense recognized in theaccompanying unaudited condensed consolidated statements of operations includes(i) compensation expense for stock-based payment awards granted prior to,but not yet vested as of December 31, 2005 based on the grant date fairvalue estimated in accordance with the pro forma provisions of SFAS 123and (ii) compensation expense for the stock-based payment awards grantedsubsequent to December 31, 2005 based on the grant date fair valueestimated in accordance with the provisions of SFAS 123R. Given thatstock-based compensation expense recognized in the unaudited condensedconsolidated statements of operations is based on awards ultimately expected tovest, it has been reduced for estimated forfeitures. SFAS 123R requiresforfeitures to be estimated at the time of grant and revised, if necessary, insubsequent periods if actual forfeitures differ from those estimates. Theestimated average forfeiture rates used by the Company are based on historicalforfeiture experience and estimated future forfeitures.

 

The fair value ofcommon stock option awards to employees and directors is calculated using theBlack-Scholes option pricing model. The Black-Scholes model requires subjectiveassumptions regarding future stock price volatility and expected time toexercise, along with assumptions about the risk-free interest rate and expecteddividends, which affect the estimated fair values of these awards. The expectedterm of options granted is derived from historical data on employee exercisesand post-vesting employment termination behavior. The expected volatility isbased on the historical volatilities of the common stock of comparable publiclytraded companies based on the Company’s belief that it currently has limitedhistorical data regarding the volatility of its stock price on which to base ameaningful estimate of expected volatility. The risk-free rate selected tovalue any particular grant is based on the U.S. Treasury rate that correspondsto the expected term of the grant effective as of the date of the grant. Theexpected dividends assumption is based on the Company’s history and expectationof dividend payouts. These factors could change in the future, affecting thedetermination of stock-based compensation expense in future periods.

 

8

----

*Table of Contents*

* *

*Income Taxes*

* *

UnderAccounting Principles Board Opinion No. 28, *InterimFinancial Reporting* (“APB 28”), the Company is required to adjustits effective tax rate each quarter to be consistent with the estimated annualeffective tax rate. The Company is also required to record the tax impact ofcertain discrete items, unusual or infrequently occurring, including changes injudgment about valuation allowances and effects of changes in tax laws orrates, in the interim period in which they occur. In addition, jurisdictionswith a projected loss for the year or a year-to-date loss where no tax benefitcan be recognized are excluded from the estimated annual effective tax rate.The impact of such an exclusion could result in a higher or lower effective taxrate during a particular quarter, based upon the mix and timing of actualearnings versus annual projections.

 

The Companyaccounts for income taxes in accordance with SFAS No. 109, *Accounting for Income Taxes* (“SFAS 109”). UnderSFAS 109, deferred tax assets and liabilities are recognized to reflectthe estimated future tax effects, calculated at currently effective tax rates,of future deductible or taxable amounts attributable to events that have beenrecognized on a cumulative basis in the consolidated financial statements. Avaluation allowance related to a deferred tax asset is recorded when it is morelikely than not that some portion of the deferred tax asset will not berealized.

 

The Companyadopted FASB Interpretation No. 48, *Accounting for Uncertaintyin Income Taxes—An Interpretation of FASB Statement No. 109*(“FIN 48”) on December 31, 2006, the first day of its fiscal 2007.FIN 48 seeks to reduce the diversity in practice associated with certainaspects of measurement and recognition in accounting for income taxes.FIN 48 prescribes a recognition threshold and measurement requirement forthe financial statement recognition of a tax position that has been taken or isexpected to be taken on a tax return and also provides guidance onde-recognition, classification, interest and penalties, accounting in interimperiods, disclosure, and transition. Under FIN 48 the Company may onlyrecognize or continue to recognize tax positions that meet a “more likely thannot” threshold.

 

*Risks andUncertainties*

* *

The Company’soperations in the People’s Republic of China (“PRC”) are subject to variouspolitical, geographical and economic risks and uncertainties inherent toconducting business in China. These include, but are not limited to, (i) potentialchanges in economic conditions in the region, (ii) managing a localworkforce that may subject the Company to uncertainties or certain regulatorypolicies and (iii) changes in other policies of the Chinese governmentaland regulatory agencies. Additionally, the Chinese government controls theprocedures by which its local currency, the Chinese Renminbi (“RMB”), isconverted into other currencies. If changes or restrictions in the conversionof RMB are instituted, the Company’s operations and operating results may benegatively impacted.

 

*Foreign CurrencyRemeasurement*

* *

The functionalcurrency of the Company’s foreign subsidiaries is the U.S. dollar. Localcurrency financial statements are remeasured into U.S. dollars using thecurrent exchange rate for monetary assets and liabilities and the historicalexchange rate for nonmonetary assets and liabilities. Expenses are remeasuredusing the average exchange rate for the period, except items related tononmonetary assets and liabilities, which are remeasured using historicalexchange rates. All remeasurement gains and losses are included in determiningnet income (loss).

 

*New AccountingPronouncements*

* *

In October 2008,the FASB issued FASB Staff Position No. 157-3, *Determiningthe Fair Value of a Financial Asset When the Market for That Asset is NotActive* (“FSP 157-3”). FSP 157-3 clarifies the application of SFAS157 in a market that is not active, and provides an illustrative exampleintended to address certain key application issues. FSP 157-3 is effectiveimmediately, and applies to the Company’s September 27, 2008 financialstatements. The Company has concluded that the application of FSP 157-3 did nothave a material impact on its consolidated financial position and results ofoperations as of and for the periods ended September 27, 2008.

 

9

----

Table of Contents

 

**Note3—Supplemental Financial Information**

 

*Inventories*

 

Inventoriesconsist of the following (in thousands):

 
| ** **      | ** ** | **September 27,** | ** ** | **December 29,** | ** ** |
|-----------------|------------|------------------------|------------|-----------------------|------------|
| ** **      | ** ** | **2008**               | ** ** | **2007**              | ** ** |
| Raw materials   |       | $                      | 1,346      |                  | $          | 1,878 |   |
| Work in process |       | 692                    |       | 425                   |       |
| Finished goods  |       | 2,394                  |       | 1,030                 |       |
|            |       | $                      | 4,432      |                  | $          | 3,333 |   |

 

*WarrantyLiability*

 

The followingtable summarizes the activity related to the warranty liability (in thousands):

 
| ** **                    | ** ** | **Nine Months Ended** | ** ** |
|-------------------------------|------------|---------------------------------|------------|
| ** **                    | ** ** | **September 27,**          | ** ** | **September 29,** | ** ** |
| ** **                    | ** ** | **2008**                        | ** ** | **2007** | ** ** |
| Beginning balance             |       | $                               | 353        |   | $ | 298 |   |
| Charged to costs and expenses |       | 86                              |       | 173 |   |
| Usage                         |       | (140                            | )          | (114 | ) |
| Ending balance                |       | $                               | 299        |   | $ | 357 |   |

 

The warrantyliability is included as a component of accrued expenses and other currentliabilities in the accompanying unaudited condensed consolidated balancesheets.

 

*FacilityRelocation Costs*

 

The followingtable summarizes the activity related to the Company’s accrual for facilityrelocation costs during the nine months ended September 27, 2008 (inthousands):

 
| ** **                    | ** ** | **Nine Months  Ended** | ** ** |
|-------------------------------|------------|-----------------------------|------------|
| ** **                    | ** ** | **September 27,**      | ** ** |
| ** **                    | ** ** | **2008**                    | ** ** |
| Beginning balance             |       | $                           | 103        |   |
| Charged to costs and expenses |       | —                      |       |
| Net payments                  |       | (54                         | )          |
| Ending balance                |       | $                           | 49         |   |

 

The liability forfacility relocation costs is included as a component of accrued expenses andother current liabilities in the accompanying unaudited condensed consolidatedbalance sheets.

 

*Comprehensive Loss*

* *

The components ofcomprehensive loss, net of taxes, consist of the following (in thousands):

 
| ** **                                                              | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|-------------------------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                                              | ** ** | **September 27,**           | ** ** | **September 29,**          | ** ** | **September 27,** | ** ** | **September 29,** | ** ** |
| ** **                                                              | ** ** | **2008**                         | ** ** | **2007**                        | ** ** | **2008** | ** ** | **2007** | ** ** |
| Net loss                                                                |       | $                                | (7,422     | )                               | $          | (657 | ) | $ | (10,257 | ) | $ | (7,242 | ) |
| Other comprehensive loss:                                               |       |                             |       |                            |       |   |   |   |   |
| Change in net unrealized loss on  investments                           |       | (287                             | )          | 25                              |       | (264 | ) | 18 |   |
| Reclassification adjustment for net  realized gain included in net loss |       | —                           |       | —                          |       | (13 | ) | — |   |
| Total comprehensive loss                                                |       | $                                | (7,709     | )                               | $          | (632 | ) | $ | (10,534 | ) | $ | (7,224 | ) |

 

10

----

Tableof Contents

 

Accumulated othercomprehensive loss reflected on the unaudited condensed consolidated balancesheets at September 27, 2008 and December 29, 2007 representsaccumulated net unrealized losses on investments in marketable securities.

 

*Computationof Net Loss Per Share*

 

Basic and dilutednet loss per share is calculated by dividing net loss by the weighted-averagecommon shares outstanding during the period. The following table sets forth thecomputation of net loss per share (in thousands, except per share data):

 
| ** **                                               | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|----------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                               | ** ** | **September 27,**           | ** ** | **September 29,**          | ** ** | **September 27,** | ** ** | **September 29,** | ** ** |
| ** **                                               | ** ** | **2008**                         | ** ** | **2007**                        | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                                               | ** ** | ** **                       | ** ** | ** **                      | ** ** | ** ** | ** ** | ** ** | ** ** |
| Numerator: Net loss                                      |       | $                                | (7,422     | )                               | $          | (657 | ) | $ | (10,257 | ) | $ | (7,242 | ) |
| Denominator: Weighted-average common shares  outstanding |       | 19,855                           |       | 19,689                          |       | 19,845 |   | 19,655 |   |
| Net loss per share, basic and diluted                    |       | $                                | (0.37      | )                               | $          | (0.03 | ) | $ | (0.52 | ) | $ | (0.37 | ) |

 

The followingtable sets forth potentially dilutive common share equivalents, consisting ofshares issuable upon the exercise of outstanding stock options and warrantscomputed using the treasury stock method, which have been excluded from thediluted net loss per share calculations above as their effect would beanti-dilutive for the periods then ended (in thousands):

 
| ** **               | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|--------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **               | ** ** | **September 27,**           | ** ** | **September 29,**          | ** ** | **September 27,** | ** ** | **September 29,** | ** ** |
| ** **               | ** ** | **2008**                         | ** ** | **2007**                        | ** ** | **2008** | ** ** | **2007** | ** ** |
| Common share equivalents |       | 919                              |       | 1,084                           |       | 902 |   | 1,519 |   |

 

The above commonshare equivalents would have been included in the calculation of dilutedearnings per share had the Company reported net income for the periods thenended.

 

*MajorCustomers*

 

The Company’sproduct sales have historically been concentrated in a small number ofcustomers. The following table sets forth sales to customers comprising 10% ormore of the Company’s total revenues for the periods presented:

 
| ** **      | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|-----------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **      | ** ** | **September 27,**           | ** ** | **September 29,**          | ** ** | **September 27,** | ** ** | **September 29,** | ** ** |
| ** **      | ** ** | **2008**                         | ** ** | **2007**                        | ** ** | **2008** | ** ** | **2007** | ** ** |
| **Customer:**   |       |                             |       |                            |       |   |   |   |   |
| Dell            |       | 47                               | %          | 75                              | %          | 57 | % | 53 | % |
| Hewlett Packard |       | 47                               | %          | *                               | %          | 34 | % | 21 | % |

 

----

* less than 10% of net sales

 

The Company’saccounts receivable are concentrated with two customers at September 27,2008 representing approximately 40% and 54% of aggregate gross receivables. Asignificant reduction in sales to, or the inability to collect receivables from,a significant customer could have a material adverse impact on the Company.

 

**Note4—Fair Value Measurements**

** **

In accordance withSFAS 157, the following table details the fair value measurements within thefair value hierarchy of the Company’s investments in marketable securities (inthousands):

 

11

----

Tableof Contents

 
| ** **                           | ** ** | ** **                  | ** ** | **Fair Value Measurements at September 27, 2008 Using** | ** ** |
|--------------------------------------|------------|-----------------------------|------------|--------------------------------------------------------------------------------------------|------------|
| ** **                           | ** ** | ** **                  | ** ** | **Quoted Prices in**                                                             | ** ** | **Significant Other** | ** ** | **Significant** | ** ** |
| ** **                           | ** ** | **Fair Value at** | ** ** | **Active Markets for**                                                           | ** ** | **Observable** | ** ** | **Unobservable** | ** ** |
| ** **                           | ** ** | **September 27,**      | ** ** | **Identical Assets**                                                                  | ** ** | **Inputs** | ** ** | **Inputs** | ** ** |
| ** **                           | ** ** | **2008**                    | ** ** | **(Level 1)**                                                                         | ** ** | **(Level 2)** | ** ** | **(Level 3)** | ** ** |
| Investments in marketable securities |       | $                           | 10,187     |                                                                                       | $          | 9,224 |   | $ | — |   | $ | 963 |   |
|                                      |            |                             |            |                                                                                            |            |  |  |  |  |  |  |  |  |

 

Fair valuemeasurements using Level 3 inputs in the table above relate to the Company’sinvestments in auction rate securities. Level 3 inputs are unobservable inputsused to estimate the fair value of assets or liabilities and are utilized tothe extent that observable inputs are not available.

 

The followingtable provides a reconciliation of the beginning and ending balances for theCompany’s assets measured at fair value using Level 3 inputs (in thousands):

 
| ** **                                                        | ** ** | **Nine Months  Ended** | ** ** |
|-------------------------------------------------------------------|------------|-----------------------------|------------|
| ** **                                                        | ** ** | **September 27,**      | ** ** |
| ** **                                                        | ** ** | **2008**                    | ** ** |
| Beginning balance                                                 |       | $                           | —     |   |
| Transfers into Level 3                                            |       | 1,002                       |       |
| Unrealized loss included in accumulated  other comprehensive loss |       | (39                         | )          |
| Purchases, sales, issuances and  settlements, net                 |       | —                      |       |
| Ending balance                                                    |       | $                           | 963        |   |

 

*AuctionRate Securities*

 

The recentdisruptions in the credit market continue to adversely affect the liquidity andoverall market for auction rate securities. As of September 27, 2008, theCompany held two investments in auction rate securities with a total purchased costof $1.0 million. These two investments represent (i) a fully insured debtobligation of a municipality and (ii) a AAA rated debt obligation backedby pools of student loans guaranteed by the U.S. Department of Education. Giventhe insufficient observable market inputs and related information available,the Company has classified its investments in auction rate securities withinLevel 3 of the fair value hierarchy. The Company has estimated the fair valueof these investments using a discounted cash flow model which includedassumptions about the credit quality and expected duration of the investments,along with discount rates affected for the general lack of liquidity. Theseassumptions reflect the Company’s estimates about the reasonable assumptions marketparticipants would likely use in valuing the investments, including assumptionsabout risk, developed based on the best information available in thecircumstances.

 

The Company doesnot believe that the current illiquidity of its investments in auction ratesecurities will materially impact its ability to fund its working capitalneeds, capital expenditures or other business requirements. The Company,however, remains uncertain as to when liquidity will return to the auction ratemarkets, whether other secondary markets will become available or when theunderlying securities may be called by the issuer. Given these and otheruncertainties, the Company’s investments in auction rate securities have beenclassified as long-term investments in marketable securities in theaccompanying unaudited condensed consolidated balance sheet as of September 27,2008. The Company has concluded that the estimated gross unrealized losses onthese investments, which totaled approximately $39,000 at September 27,2008, are temporary because (i) the Company believes that the absence ofliquidity that has occurred is due to general market conditions, (ii) theauction rate securities continue to be of a high credit quality and interest ispaid as due and (iii) the Company has the intent and ability to hold theseinvestments until a recovery in the market occurs.

 

*OtherInvestments in Marketable Securities*

 

Excluding itsauction rate securities, the gross unrealized losses on the Company’s otherinvestments in marketable securities totaled approximately $275,000 as of September 27,2008, and are generally due to the ongoing uncertainties in the credit andfinancial markets, as well as the overall current economic environment. Thefair value of these investments was determined based on Level 1 inputs,consisting of quoted prices from actual market transactions for identicalinvestments. The Company has determined that the unrealized losses on theseinvestments as of September 27, 2008 are temporary in nature. Factorsconsidered in determining whether impairments are other than temporary include (i) thelength of time and 

 

12

----

Table of Contents

 

extent to which fairvalue has been less than the amortized cost basis, (ii) the financialcondition and near-term prospects of the investee and (iii) the Company’sintent and ability to hold an investment for a period of time sufficient toallow for any anticipated recovery in market value. The fair value of theCompany’s investments in marketable securities could change significantly inthe future and the Company may be required to record other-than-temporaryimpairment charges or additional unrealized losses in future periods.

 

**Note5—Credit Agreement**

** **

In May 2008,the Company executed the Ninth Amendment to its Amended and Restated Credit andSecurity Agreement (the “Ninth Amendment”). Among other things, the NinthAmendment revised certain minimum profitability financial covenant requirementsand also eliminated the Company’s previous minimum monthly book net worthfinancial covenant requirement. Additionally, the Company’s nonrevolvingequipment financing line of credit was revised to allow the Company to borrowup to an additional maximum of $0.9 million to finance up to 80% of the cost ofequipment purchases through the end of fiscal 2008. Principal on any of theseadditional borrowings is scheduled to be repaid in 42 equal monthlyinstallments commencing January 1, 2009. Interest on the Company’sexisting and future equipment line of credit advances was payable monthly atthe prime rate. The Ninth Amendment was effective as of the beginning of theCompany’s second quarter of 2008.

 

In October 2008,the Company executed the Tenth Amendment to its Amended and Restated Credit andSecurity Agreement (the “Tenth Amendment”). Among other things, this amendmentfurther revised the Company’s minimum profitability financial covenantrequirement. The Tenth Amendment also revised the monthly interest rate chargedon future credit advances under the line of credit to the greater of (i) thesum of the prime rate plus 3% or (ii) 5%.

 

As of September 27,2008, the Company was not in compliance with its financial covenant related tominimum monthly profitability. In October 2008, in connection with theexecution of the Tenth Amendment, the Company received a waiver from its lenderfor this covenant violation. The Company cannot assure that it will not violateone or more covenants in the future. If it were to be in violation of covenantsunder its current credit agreement, the Company’s lender could choose toaccelerate payment on all outstanding loan balances. There can be no assurancethat the Company would be able to quickly obtain equivalent or suitablereplacement financing in this event. If the Company were not able to securealternative sources of funding, such acceleration would have a material adverseimpact on its financial condition.

 

The following table presents details ofinterest expense related to borrowings on the line of credit, along withcertain other applicable information (in thousands):

 
| ** **       | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **       | ** ** | **September 27,**           | ** ** | **September 29,**          | ** ** | **September 27,** | ** ** | **September 29,** | ** ** |
| ** **       | ** ** | **2008**                         | ** ** | **2007**                        | ** ** | **2008** | ** ** | **2007** | ** ** |
| Interest expense |       | $                                | 94         |                            | $          | 163 |   | $ | 180 |   | $ | 712 |   |
|                  |            |                                  |            |                                 |            |  |  |  |  |  |  |  |  |

 
| ** **                                       | ** ** | **September 27,** | ** ** | **December 29,** | ** ** |
|--------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                       | ** ** | **2008**               | ** ** | **2007**              | ** ** |
| Outstanding borrowings on the line of  credit    |       | $                      | 12,241     |                  | $          | 4,872 |   |
| Borrowing availability under the line of  credit |       | $                      | 1,304      |                  | $          | 6,366 |   |

 

Any borrowingsunder the Company’s revolving and equipment lines of credit are collateralizedby a general first priority lien against all of the Company’s assets, bothtangible and intangible.

 

**Note 6—Letters ofCredit**

** **

In June 2008,the Company entered into an agreement with its bank to issue a commercialletter of credit (“LC”) up to $2 million to support purchases of inventory froma supplier. As part of this agreement, the Company is required to pledge cashas collateral for the full amount of the LC, and thus, as of September 27,2008, $2 million is classified as restricted cash in the accompanying unauditedcondensed consolidated balance sheet.

 

In July 2008,the Company entered into a second similar agreement with its bank to issueanother commercial LC up to $2 million to support inventory purchases fromanother supplier; however this agreement was cancelled in September 2008.

 

13

----

Tableof Contents

 

**Note 7—Long-TermDebt**

** **

Long-term debtconsists of the following (in thousands):

 

| ** **                       | ** ** | **September 27,** | ** ** | **December 29,** | ** ** |
|----------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                       | ** ** | **2008**               | ** ** | **2007**              | ** ** |
| Obligations under capital leases |       | $                      | 166        |                  | $          | 432 |   |
| Equipment note payable to bank   |       | 580                    |       | 872                   |       |
| Notes payable to others          |       | 25                     |       | 74                    |       |
|                             |       | 771                    |       | 1,378                 |       |
| Less current portion             |       | (491                   | )          | (740                  | )          |
|                             |       | $                      | 280        |                  | $          | 638 |   |

 

Interest expenserelated to long-term debt is presented in the following table (in thousands):

 

| ** **       | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **       | ** ** | **September 27,**           | ** ** | **September 29,**          | ** ** | **September 27,** | ** ** | **September 29,** | ** ** |
| ** **       | ** ** | **2008**                         | ** ** | **2007**                        | ** ** | **2008** | ** ** | **2007** | ** ** |
| Interest expense |       | $                                | 18         |                            | $          | 58 |   | $ | 85 |   | $ | 166 |   |
|                  |            |                                  |            |                                 |            |  |  |  |  |  |  |  |  |

 

**Note 8—IncomeTaxes**

** **

The followingtable sets forth the Company’s provision (benefit) for income taxes, along withthe corresponding effective tax rates (in thousands, except percentages):

 

| ** **                           | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|--------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                           | ** ** | **September 27,**           | ** ** | **September 29,**          | ** ** | **September 27,** | ** ** | **September 29,** | ** ** |
| ** **                           | ** ** | **2008**                         | ** ** | **2007**                        | ** ** | **2008** | ** ** | **2007** | ** ** |
| Provision (benefit) for income taxes |       | $                                | 4,502      |                            | $          | (363 | ) | $ | 3,332 |   | $ | (4,227 | ) |
| Effective tax rate                   |       | 154                              | %          | (36                             | )%         | 48 | % | (37 | )% |
|                                      |            |                                  |            |                                 |            |  |  |  |  |  |  |  |  |

 

Inaccordance with SFAS 109, the Company evaluates whether a valuation allowanceshould be established against its deferred tax assets based on theconsideration of all available evidence using a “more likely than not”standard.  In making such judgments,significant weight is given to evidence that can be objectively verified. Inthe third quarter of fiscal 2008, the Company recorded a net charge to incometax expense of approximately $4.5 million related to establishing a partialvaluation allowance against its deferred income tax assets. The Company’sdetermination to record a valuation allowance was based on the recent historyof cumulative losses as well as uncertainty of the utilization of deferred taxassets in the near future. The remaining deferred tax asset of approximately$1.3 million at September 27, 2008 relates to federal taxes paid whererefund claims are expected to be made for net operating losses that can becarried back to prior years. In addition, the Company discontinued recordingincome tax benefits in the consolidated financial statements until it isdetermined that it is more likely than not that the Company will generatesufficient taxable income to realize its deferred tax assets. The Company’seffective tax rates for the three and nine months ended September 27, 2008differ from the 35% statutory rate primarily due to the establishment of thepartial valuation allowance.

 

**Note9—Commitments and Contingencies**

** **

*FederalSecurities Class Action*

 

Beginning in May 2007,the Company, certain of its officers and directors, and the Company’sunderwriters were named as defendants in four purported class actionshareholder complaints, two of which were filed in the U.S. District Court forthe Southern District of New York, and two of which were filed in the U.S.District Court for the Central District of California. These purported classaction lawsuits were filed on behalf of persons and entities who purchased orotherwise acquired the Company’s common stock pursuant or traceable to theCompany’s November 30, 2006 Initial Public Offering (the “IPO”). Thelawsuits were consolidated into a single action—Belodoff v. Netlist, Inc.,Lead Case No. SACV07-677 DOC (MLGx)—

 

14

----

Tableof Contents

 

which is currentlypending in the Central District of California. Lead Plaintiff filed theConsolidated Complaint on November 5, 2007. Defendants filed their motionsto dismiss the Consolidated Complaint on January 9, 2008. The motions todismiss were taken under submission on April 28, 2008 and on May 30,2008, the Court granted the defendants’ motions. However, plaintiffs weregranted the right to amend their complaint and subsequently filed their FirstAmended Consolidated Class Action Complaint (the “Amended Complaint”) on July 15,2008. Generally, the Amended Complaint alleges that the Registration Statementissued by the Company in connection with the IPO contained untrue statements ofmaterial fact or omissions of material fact in violation of Sections 11and 15 of Securities Act of 1933. The deadline for defendants to answer, moveto dismiss or otherwise respond to the Amended Complaint is January 9,2009. The Company believes that the allegations lack merit and intends tovigorously defend all claims asserted. However, at this time, the Company isunable to form a professional judgment that an unfavorable outcome iseither probable or remote, and it is not possible to assess whether or not theoutcome of these proceedings will or will not have a material adverse effect onthe Company. If an unfavorable outcome should eventually occur, the Company isnot at this time able to estimate the amount or range of possible loss.

 

*CaliforniaDerivative Action*

 

In August 2007,a derivative lawsuit was filed in California Superior Court for County ofOrange—Smith v. Hong, Case No. 07CC01359—against certain of the Company’sofficers and directors. This action contains factual allegations similar tothose of the federal class action lawsuit described above, but the plaintiff inthis case also asserts claims for violations of California’s insider tradinglaws, breaches of fiduciary duty, abuse of control, gross mismanagement, wasteof corporate assets, and unjust enrichment. The plaintiff seeks unspecifieddamages, equitable and/or injunctive relief and disgorgement of all profits,benefits and other compensation obtained by the defendants. The defendants inthis action have not responded to the complaint. Pursuant to a stipulation, theparties agreed to temporarily stay the action pending the ultimate decision onthe defendants’ motions to dismiss in the federal securities class action. Theparties also agreed that twenty days after the court in the federal securitiesclass action issues a final ruling as to the motions to dismiss brought in thataction, the parties will meet and confer regarding the time for defendants torespond to the complaint in this derivative action. The Company believes thatthe allegations lack merit and intends to vigorously defend all claimsasserted. At this time, however, the Company is unable to form aprofessional judgment that an unfavorable outcome is either probable or remote.Moreover, if an unfavorable outcome should eventually occur, the Company is notat this time able to estimate the amount or range of possible loss. In addition,the Company received correspondence from counsel for a purported shareholderrequesting that the Company take actions to investigate and remedy allegedwrongdoing by unidentified former and current officers and/or directors basedon allegations similar to those in the Smith v. Hong derivative case. TheCompany, through its Board of Directors, has evaluated and rejected thisrequest.

 

*Patent Claims*

 

In May 2008,the Company initiated discussions with Google, Inc. regarding theCompany’s claims that Google has infringed on a U.S. Patent assigned to theCompany relating generally to “rank multiplication” in memory modules.  On August 29, 2008, Google filed adeclaratory judgment lawsuit against the Company in United States DistrictCourt for the Northern District of California, seeking a declaration thatGoogle did not infringe on the Company’s patent, and that the Company’s patentis invalid.  The Company has not beenserved with the complaint.  The Company’sdiscussions with Google are ongoing.  Ifthose discussions do not lead to an amicable resolution, the Company intends tovigorously defend against Google’s claims, and to assert counterclaims forpatent infringement against Google.

 

*OtherObligations*

 

During its normalcourse of business, the Company has made certain indemnities, commitments andguarantees under which it may be required to make payments in relation tocertain transactions. These include (i) intellectual property indemnitiesto the Company’s customers and licensees in connection with the use, salesand/or license of Company products; (ii) indemnities to vendors andservice providers pertaining to claims based on the negligence or willfulmisconduct of the Company; (iii) indemnities involving the accuracy ofrepresentations and warranties in certain contracts; (iv) indemnities todirectors and officers of the Company to the maximum extent permitted under thelaws of the State of Delaware; and (v) certain real estate leases, underwhich the Company may be required to indemnify property owners forenvironmental and other liabilities, and other claims arising from theCompany’s use of the applicable premises. The duration of these indemnities,commitments and guarantees varies and, in certain cases, may be indefinite. Themajority of these indemnities, commitments and guarantees do not provide forany limitation of the maximum potential for future payments the Company couldbe obligated to make. Historically, the Company has not been obligated to makesignificant payments for these obligations, and no liabilities have beenrecorded for these indemnities, commitments and guarantees in the accompanyingunaudited condensed consolidated balance sheets.

 

15

----

Tableof Contents

 

**Note10—Stock Options and Warrants**

** **

*Common Stock Options*

* *

A summary of theCompany’s common stock option activity as of and for the nine months ended September 27,2008 is presented below (shares in thousands):

 

| ** **                                      | ** ** | ** **         | ** ** | **Weighted-** | ** ** |
|-------------------------------------------------|------------|--------------------|------------|---------------|------------|
| ** **                                      | ** ** | ** **         | ** ** | **Average**   | ** ** |
| ** **                                      | ** ** | **Number of** | ** ** | **Exercise**  | ** ** |
| ** **                                      | ** ** | **Shares**         | ** ** | **Price**     | ** ** |
| Options outstanding at December 29,  2007  |       | 3,746              |       | $             | 3.06       |   |
| Options granted                                 |       | 780                |       | 1.68          |       |
| Options exercised                               |       | —             |       | —        |       |
| Options cancelled                               |       | (350               | )          | 2.73          |       |
| Options outstanding at September 27,  2008 |       | 4,176              |       | $             | 2.83       |   |

 

The per share fair values of common stock options granted by theCompany in the nine months ended September 27, 2008 have been estimatedwith the following weighted average assumptions:

 
| Expected term (in years)                          |   | 5.4    |   |
|---------------------------------------------------|--------|--------|--------|
| Expected volatility                               |   | 80     | %      |
| Risk-free interest rate                           |   | 3.12   | %      |
| Expected dividends                                |   | — |   |
| Weighted-average grant date fair value per  share |   | $      | 1.13   |   |
|                                                   |        |        |        |  |

 

*At September 27,2008, the amount of unearned stock-based compensation currently estimated to beexpensed from fiscal 2008 through fiscal 2012 related to unvested common stockoptions is approximately $2.9 million, net of estimated forfeitures. Theweighted-average period over which the unearned stock-based compensation isexpected to be recognized is approximately 2.3 years. If there are anymodifications or cancellations of the underlying unvested common stock options,the Company may be required to accelerate, increase or cancel any remainingunearned stock-based compensation expense. Future stock-based compensationexpense and unearned stock-based compensation will increase to the extent thatthe Company grants additional common stock options or other stock-based awards.*

* *

*Warrants*

* *

A summary ofactivity with respect to outstanding warrants to purchase shares of theCompany’s common stock as of and for the nine months ended September 27,2008 is presented below (shares in thousands):

 
| ** **                                                       | ** ** | ** **         | ** ** | **Weighted-** | ** ** |
|------------------------------------------------------------------|------------|--------------------|------------|---------------|------------|
| ** **                                                       | ** ** | ** **         | ** ** | **Average**   | ** ** |
| ** **                                                       | ** ** | **Number of** | ** ** | **Exercise**  | ** ** |
| ** **                                                       | ** ** | **Shares**         | ** ** | **Price**     | ** ** |
| Warrants outstanding at December 29,  2007                  |       | 318                |       | $             | 1.01       |   |
| Warrants granted                                                 |       | —             |       | —        |       |
| Warrants exercised                                               |       | (97                | )          | 1.00          |       |
| Warrants cancelled                                               |       | (203               | )          | 1.00          |       |
| Warrants outstanding and exercisable at  September 27, 2008 |       | 18                 |       | $             | 1.25       |   |

 

In February 2008,certain warrant holders exercised 300,000 warrants to purchase shares of theCompany’s common stock, whereby the Company issued approximately 97,000 sharesof common stock pursuant to a net issue election and effectively receivedapproximately 203,000 shares back from the warrant holders as consideration inlieu of cash for the exercised warrants. The 203,000 shares were forfeited onthe exercise date.

 

16

----

Tableof Contents

 

**Note11—Segment and Geographic Information**

** **

The Companyoperates in one reportable segment: the design and manufacture ofhigh-performance memory subsystems for the server, high-performance computingand communications markets. The Company evaluates financial performance on aCompany-wide basis.

 

At September 27,2008, approximately $4.0 million of the Company’s net long-lived assets werelocated outside the U.S., primarily in the PRC.

 

**Item 2.    Management’sDiscussion and Analysis of Financial Condition and Results of Operations**

** **

**CautionaryStatement**

** **

*The following discussion and analysis of our financial condition andresults of operations should be read in conjunction with our UnauditedCondensed Consolidated Financial Statements and the related notes theretocontained in Part I, Item 1 of this Report. The information contained inthis Quarterly Report on Form 10-Q is not a complete description of ourbusiness or the risks associated with an investment in our common stock. Weurge you to carefully review and consider the various disclosures made by us inthis Report and in our other reports filed with the Securities and ExchangeCommission, or SEC, including our Annual Report on Form 10-K for thefiscal year ended December 29, 2007 and subsequent reports on Form 10-Qand Form 8-K, which discuss our business in greater detail.*

 

*This Report, along with similar discussions in our other SEC filings,describes some of the important risks that may affect our business, results ofoperations and financial condition. You should carefully consider those risks,in addition to the other information in this Report and in our other filingswith the SEC, before deciding to purchase, hold or sell our common stock.*

 

*This Report contains forward-looking statements that involve risks,uncertainties, estimates and assumptions. These statements are not guaranteesof future performance and are subject to certain risks, uncertainties andassumptions that are difficult to predict. Therefore, our actual results coulddiffer materially and adversely from those expressed in any forward-lookingstatements as a result of various factors. We undertake no obligation to reviseor update publicly any forward-looking statements for any reason.*

 

**Overview**

** **

We design,manufacture and sell high performance memory subsystems for the server, highperformance computing and communications markets. Our memory subsystems consistof dynamic random access memory integrated circuits, or DRAM ICs, NAND flashmemory, or NAND, and other components assembled on a printed circuit board, orPCB. We engage with our original equipment manufacturer, or OEM, customers fromthe earliest stages of new product definition, which provides us unique insightinto their full range of system architecture and performance requirements. Thisclose collaboration has also allowed us to develop a significant level ofsystems expertise. We leverage a portfolio of proprietary technologies anddesign techniques, including efficient planar design, alternative packagingtechniques and custom semiconductor logic, to deliver memory subsystems withhigh memory density, small form factor, high signal integrity, attractivethermal characteristics and low cost per bit.

 

Consistent withthe concentrated nature of the OEM customer base in our target markets, a smallnumber of large customers have historically accounted for a significant portionof our net sales. Dell and Hewlett Packard represented approximately 57% and34%, respectively, of our net sales for the nine months ended September 27,2008. Dell and Hewlett Packard represented approximately 53% and 21%,respectively, of our net sales for the nine months ended September 27,2007. Net sales to some of our OEM customers include memory modules that arequalified by us directly with the OEM customer and sold to electronic manufacturingservices providers, or EMSs, for incorporation into products manufacturedexclusively for the OEM customer. These net sales to EMSs have historicallyfluctuated period by period as a portion of the total net sales to these OEMcustomers. Net sales to Hon Hai Precision Industry Co. Ltd., an EMSthat purchases memory modules from us for incorporation into productsmanufactured exclusively for Dell, represented approximately 12% of net salesto Dell for the nine months ended September 27, 2008 and approximately 58%of net sales to Dell for the nine months ended September 29, 2007.

 

**Key BusinessMetrics**

** **

The followingdescribes certain line items in our statements of operations that are importantto management’s assessment of our financial performance:

 

17

----

Table of Contents

 

*Net Sales.***Netsales consist primarily of sales of our high performance memory subsystems, netof a provision for estimated returns under our right of return policies, whichgenerally range up to 30 days. We generally do not have long-term salesagreements with our customers. Although OEM customers typically provide us withnon-binding forecasts of future product demand over specific periods of time,they generally place orders with us approximately two weeks in advance ofscheduled delivery. Selling prices are typically negotiated monthly, based oncompetitive market conditions and the current price of DRAM ICs and NAND.Purchase orders generally have no cancellation or rescheduling penaltyprovisions. We often ship our products to our customers’ internationalmanufacturing sites. All of our sales to date, however, are denominated inUnited States, or U.S., dollars. We also sell excess component inventory ofDRAM ICs and NAND to distributors and other users of memory ICs. As compared toprevious years, component inventory sales have significantly decreased as apercentage of net sales as a result of our efforts to diversify both ourcustomer and product line bases. This diversification effort has also allowedus to use components in a wider range of memory subsystems. We expect thatcomponent inventory sales will continue to represent a minimal portion of ournet sales in future periods.

 

*Cost of Sales.***Our cost of sales includes the cost ofmaterials, manufacturing costs, depreciation and amortization of equipment,inventory valuation provisions, stock-based compensation and occupancy costsand other allocated fixed costs. The DRAM ICs and NAND incorporated into our productsconstitute a significant portion of our cost of sales, and thus our cost ofsales will fluctuate based on the current price of DRAM ICs and NAND. Weattempt to pass through such DRAM IC and NAND flash memory cost fluctuations toour customers by frequently renegotiating pricing prior to the placement oftheir purchase orders. To the extent we are successful, a large majority of ourproduct cost is variable, and thus our cost of sales and gross marginpercentages may not be significantly impacted by changes in sales volume.However, the sales prices of our memory subsystems can also fluctuate due tocompetitive situations unrelated to the pricing of DRAM ICs and NAND, whichaffects gross margins. The gross margin on our sales of excess component DRAM ICand NAND inventory is much lower than the gross margin on our sales of ourmemory subsystems. As a result, a decrease in DRAM IC and NAND inventory salesas a percentage of our overall sales could result in an improved overall grossmargin. We assess the valuation of our inventories on a monthly basis andrecord a provision to cost of sales as necessary to reduce inventories to thelower of cost or net realizable value.

 

*Research and Development.***Research and development expense consistsprimarily of employee and independent contractor compensation and relatedcosts, stock-based compensation, computer-aided design software licenses,reference design development costs, patent-related fees, depreciation or rentalof evaluation equipment, and occupancy and other allocated overhead costs. Alsoincluded in research and development expense are the costs of material andoverhead related to the production of engineering samples of new products underdevelopment or products used solely in the research and development process.Our customers typically do not separately compensate us for design andengineering work involved in developing application-specific products for them.All research and development costs are expensed as incurred. We anticipate thatresearch and development expenditures will increase in future periods as weseek to expand new product opportunities, increase our activities related tonew and emerging markets and continue to develop additional proprietarytechnologies.

 

*Selling, General andAdministrative.***Selling,general and administrative expenses consist primarily of employee salaries andrelated costs, stock-based compensation, independent sales representativecommissions, professional services, promotional and other selling and marketingexpenses, and occupancy and other allocated overhead costs. A significantportion of our selling efforts is directed at building relationships with OEMsand other customers and working through the product approval andqualification process with them. Therefore, the cost of material and overheadrelated to products manufactured for qualification is included in sellingexpenses. As we continue to service existing and establish new customers, weanticipate that our sales and marketing expenses will increase. We alsoanticipate that our general and administrative expenses related to accountingand legal expenses associated with our ongoing public reporting obligationswill generally remain consistent during the remainder of fiscal 2008; however,beginning in fiscal 2009, we anticipate being subject to attestation servicesrequirements with respect to our internal control over financial reporting, theresult of which will increase such expenses in future periods.

 

*Provision (Benefit) forIncome Taxes.* Our income tax provision (benefit) isbased on the statutory federal tax rate of 35% and is typically impacted bystate taxes and permanent book-tax differences, as well as adjustments to ourdeferred tax balances through the establishment of valuation allowances whendetermined necessary.

 

**CriticalAccounting Policies**

** **

The preparation offinancial statements in conformity with accounting principles generallyaccepted in the U.S. requires us to make estimates and assumptions that affectthe reported amounts of assets and liabilities and disclosures of contingentassets and liabilities at the date of the consolidated financial statements andthe reported amounts of net sales and expenses

 

18

----

Table ofContents

 

during the reportingperiod. By their nature, these estimates and assumptions are subject to aninherent degree of uncertainty. We base our estimates on our historicalexperience, knowledge of current conditions and our beliefs of what could occurin the future considering available information. We review our estimates on anon-going basis. Actual results may differ from these estimates, which mayresult in material adverse effects on our operating results and financialposition. We believe the following critical accounting policies involve themore significant assumptions and estimates used in the preparation of ourconsolidated financial statements:

 

*Revenue Recognition.*We recognize revenues in accordance with the SEC’s Staff Accounting Bulletin No. 104,*Revenue Recognition*, or SAB 104.Under the provisions of SAB 104, we recognize revenues when there ispersuasive evidence of an arrangement, product delivery and acceptance haveoccurred, the sales price is fixed or determinable, and collectibility of theresulting receivable is reasonably assured.

 

We generally usecustomer purchase orders and/or contracts as evidence of an arrangement.Delivery occurs when goods are shipped for customers with FOB Shipping Pointterms and upon receipt for customers with FOB Destination terms, at which timetitle and risk of loss transfer to the customer. Shipping documents are used toverify delivery and customer acceptance. We assess whether the sales price is fixedor determinable based on the payment terms associated with the transaction andwhether the sales price is subject to refund.

 

Customers aregenerally allowed limited rights of return for up to 30 days, except for salesof excess inventories, which contain no right-of-return privileges. Estimatedreturns are provided for at the time of sale based on historical experience orspecific identification of an event necessitating a reserve. We offer astandard product warranty to our customers and have no other post-shipmentobligations. While these returns have historically been within our expectationsand the provisions established, we cannot guarantee that we will continue toexperience similar return rates in the future. Any significant increase inproduct failure rates and the resulting product returns could have a materialadverse effect on our operating results for the period or periods in which suchreturns materialize.

 

We assesscollectibility based on the creditworthiness of the customer as determined bycredit checks and evaluations, as well as the customer’s payment history. Aportion of our shipments are made to third party inventory warehouses, or hubs,and we recognize revenue when the inventory is pulled from the hub for use inproduction by the customer. We receive a report from the customer on a dailybasis indicating the inventories pulled from a hub for use by the customer, andperform a daily reconciliation of inventories shipped to and pulled by thecustomer to those inventories reflected on the customer’s reports to ensurethat sales are recognized in the appropriate periods. We have historically hadgood visibility into the inventories on-hand at hub locations and also what ourcustomers intend to pull within each reporting period. However, if a customerdoes not pull our inventory from its hub in accordance with the schedule itoriginally provided to us, our predicted future revenues could vary from ourforecasts and our results of operations could be materially and adverselyaffected. Additionally, since we own inventories that are physically located inhubs, our ability to effectively manage inventory levels may be impaired,causing our inventory turns to decrease, which would increase expensesassociated with excess and obsolete inventories and negatively impact our cashflow.

 

All amounts billedto customers related to shipping and handling are classified as net sales,while all costs incurred by us for shipping and handling are classified as costof sales.

 

*Warranty Reserve.*We offer warranties on our memory subsystems generally ranging from one tothree years, depending on the product and negotiated terms of purchaseagreements with our customers. Such warranties require us to repair or replacedefective product returned to us during the warranty period at no cost to thecustomer. Our estimates for warranty-related costs are recorded at the time ofsale based on historical and estimated future product return rates and expectedrepair or replacement costs. While such costs have historically been within ourexpectations and the provisions established, unexpected changes in failurerates could have a material adverse impact on us, requiring additional warrantyreserves, and adversely affecting our gross profit and gross margins.

 

*Accounts Receivable.*We perform credit evaluations of our customers’ financial condition and limitthe amount of credit extended to our customers as deemed necessary, butgenerally require no collateral. We continuously monitor collections andpayments from our customers and maintain a provision for estimated creditlosses based upon our historical experience and any specific customercollection issues that we have identified. Generally, these credit losses havebeen within our expectations and the provisions established. However, we cannotguarantee that we will continue to experience credit loss rates similar tothose we have experienced in the past.

 

Our accountsreceivable are highly concentrated among a small number of customers, and asignificant change in the liquidity or financial position of one of thesecustomers could have a material adverse effect on the collectibility of our

 

19

----

Tableof Contents

 

accounts receivable, ourliquidity and our future operating results.

 

*Inventories.*We value our inventories at the lower of the actual cost to purchase ormanufacture the inventory or the net realizable value of the inventory. Cost isdetermined on an average cost basis which approximates actual cost on afirst-in, first-out basis and includes raw materials, labor and manufacturingoverhead. We regularly review inventory quantities on hand and on order andrecord a provision for excess and obsolete inventories based primarily on ourestimated forecast of product demand and production requirements for the nextthree to six months. In addition, we consider changes in the market value ofDRAM ICs and NAND in determining the net realizable value of our raw materialinventory. Once established, any write downs are considered permanentadjustments to the cost basis of our inventories. A significant decrease indemand for our products could result in an increase in the amount of excessinventory quantities on hand. In addition, our estimates of future productdemand may prove to be inaccurate, in which case we may have understated oroverstated the provision required for excess and obsolete inventory. In thefuture, if our inventories are determined to be overvalued, we would berequired to recognize additional expense in our cost of sales at the time ofsuch determination. Likewise, if our inventories are determined to beundervalued, we may have over-reported our costs of sales in previous periodsand would be required to recognize additional gross profit at the time suchinventories are sold. In addition, should the market value of DRAM ICs and NANDdecrease significantly, we may be required to lower our selling prices toreflect the lower cost of our raw materials. If such price decreases reduce thenet realizable value of our inventories to less than our cost, we would berequired to recognize additional expense in our cost of sales in the sameperiod. Although we make every reasonable effort to ensure the accuracy of ourforecasts of future product demand, any significant unanticipated changes indemand, technological developments or the market value of DRAM ICs and NANDcould have a material effect on the value of our inventories and our reportedoperating results.

 

*Long-Lived Assets.***We review the recoverability of thecarrying value of long-lived assets on an annual basis or whenever events orchanges in circumstances indicate that the carrying amount of an asset may notbe recoverable. Recoverability of these assets is determined based upon theforecasted undiscounted future net cash flows from the operations to which theassets relate, utilizing our best estimates, appropriate assumptions andprojections at the time. These projected future cash flows may varysignificantly over time as a result of increased competition, changes intechnology, fluctuations in demand, consolidation of our customers andreductions in average selling prices. If the carrying value is determined notto be recoverable from future operating cash flows, the asset is deemedimpaired and an impairment loss is recognized to the extent the carrying valueexceeds the estimated fair market value of the asset.

 

*Stock-Based Compensation.*We account for equity issuances to non-employees in accordance with Statementof Financial Accounting Standards, or SFAS, No. 123, *Accounting for Stock Based Compensation*,and Emerging Issues Task Force Issue No. 96-18, *Accounting for Equity Instruments that are Issued to Other ThanEmployees for Acquiring, or in Conjunction with Selling, Goods and Services*.All transactions in which goods or services are the consideration received forthe issuance of equity instruments are accounted for based on the fair value ofthe consideration received or the fair value of the equity instrument issued,whichever is more reliably measurable. The measurement date used to determinethe fair value of the equity instrument issued is the earlier of the date onwhich the third-party performance is complete or the date on which it isprobable that performance will occur.

 

On January 1,2006, we adopted SFAS No. 123(R), *Share-Based Payment*,or SFAS 123R, which requires the measurement and recognition ofcompensation expense for all stock-based payment awards made to our employeesand directors based on estimated fair values. We adoptedSFAS 123R using the modified prospective transition method, whichrequires the application of the accounting standard as of January 1, 2006,the first day of our fiscal year 2006. In accordance with the modifiedprospective transition method, our consolidated financial statements for priorperiods have not been restated to reflect, and do not include, the impact ofadopting SFAS 123R.

 

We currently usethe Black-Scholes option pricing model to estimate the fair value of our commonstock option awards. While this model meets the requirements of SFAS 123R,the estimated fair values generated by it may not be indicative of the actualfair values of these awards as it does not consider certain factors importantto those awards to employees, such as continued employment and periodic vestingrequirements as well as limited transferability. The Black-Scholes modelrequires subjective assumptions regarding future stock price volatility andexpected time to exercise, along with assumptions about the risk-free interestrate and expected dividends, all of which affect the estimated fair values ofour common stock option awards. The expected term of options granted is derivedfrom historical data on employee exercises and post-vesting employmenttermination behavior. The expected volatility is based on the historicalvolatilities of the common stock of comparable publicly traded companies basedon our belief that we currently have limited historical data regarding thevolatility of our stock price on which to base a meaningful estimate ofexpected volatility. The risk-free rate selected to value any particular grantis based on the U.S. Treasury rate that corresponds to the expected term of thegrant effective as of the date of the grant. The expected dividends assumptionis based on our history and expectation of dividend payouts. We

 

20

----

Tableof Contents

 

evaluate the assumptionsused to value our common stock option awards on a quarterly basis. If factorschange and we employ different assumptions, stock-based compensation expensemay differ significantly from what we have recorded in prior periods.

 

The value of theportion of stock-based awards that are ultimately expected to vest isrecognized as expense over the requisite service periods in our financialstatements. Given that stock-based compensation expense recognized in ourfinancial statements is based on awards ultimately expected to vest, it hasbeen reduced for estimated forfeitures. SFAS 123R requiresforfeitures to be estimated at the time of grant and revised, if necessary, insubsequent periods if actual forfeitures differ from those estimates. If thereare any modifications or cancellations of the underlying unvested stock-basedawards, we may be required to accelerate, increase or cancel any remainingunearned stock-based compensation expense. Future stock-based compensation expenseand unearned stock-based compensation will increase to the extent that we grantadditional common stock options or other stock-based awards.

 

*IncomeTaxes.***Under Accounting Principles Board Opinion No. 28,*Interim Financial Reporting*, we arerequired to adjust our effective tax rate each quarter to be consistent withthe estimated annual effective tax rate. We are also required to record the taximpact of certain discrete items, unusual or infrequently occurring, includingchanges in judgment about valuation allowances and effects of changes in taxlaws or rates, in the interim period in which they occur. In addition,jurisdictions with a projected loss for the year, or a year-to-date loss whereno tax benefit can be recognized, are excluded from our estimated annualeffective tax rate. The impact of excluding these items could result in ahigher or lower effective tax rate during a particular quarter, based upon themix and timing of actual earnings versus annual projections.

 

We recognizedeferred tax assets and liabilities based on the differences between thefinancial statement carrying values and the tax bases of assets andliabilities. We regularly review our deferred tax assets for recoverability andestablish a valuation allowance, when determined necessary, based on historicaltaxable income, projected future taxable income, and the expected timing of thereversals of existing temporary differences. If we operate at a loss for anextended period of time or are unable to generate sufficient future taxableincome, or if there is a material change in the actual effective tax rates ortime period within which the underlying temporary differences become taxable ordeductible, we could be required to record a valuation allowance against all ora significant portion of our deferred tax assets which could substantiallyincrease our effective tax rate for such period. Any significant changes instatutory tax rates or the amount of our valuation allowance could have amaterial effect on the value of our deferred tax assets and liabilities, andour reported financial results. In the future, if we realize a deferred taxasset that currently carries a valuation allowance, we may record a reductionto income tax expense in the period of such realization.

 

We adopted FinancialAccounting Standards Board, or FASB, Interpretation No. 48, *Accounting for Uncertainty in Income Taxes—An Interpretation of FASBStatement No. 109*, or FIN 48, on December 31, 2006, thefirst day of fiscal 2007. FIN 48 seeks to reduce the diversity in practiceassociated with certain aspects of measurement and recognition in accountingfor income taxes. FIN 48 prescribes a recognition threshold and measurementrequirement for the financial statement recognition of a tax position that hasbeen taken or is expected to be taken on a tax return and also providesguidance on de-recognition, classification, interest and penalties, accountingin interim periods, disclosure, and transition. Under FIN 48 we may onlyrecognize or continue to recognize tax positions that meet a “more likely thannot” threshold.

 

The application oftax laws and regulations is subject to legal and factual interpretation,judgment and uncertainty. Tax laws and regulations themselves are subject tochange as a result of changes in fiscal policy, changes in legislation, theevolution of regulations and court rulings. Therefore, the actual liability forU.S. or foreign taxes may be materially different from our estimates, whichcould result in the need to record additional tax liabilities or potentiallyreverse previously recorded tax liabilities.

 

**Results ofOperations**

** **

The followingtable sets forth certain consolidated statements of operations data as apercentage of net sales for the periods indicated:

 

21

----

Table ofContents

 
| ** **                                       | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|--------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                       | ** ** | **September 27,**           | ** ** | **September 29,**          | ** ** | **September 27,** | ** ** | **September 29,** | ** ** |
| ** **                                       | ** ** | **2008**                         | ** ** | **2007**                        | ** ** | **2008** | ** ** | **2007** | ** ** |
|                                             |       |                             |       |                            |       |   |   |   |   |
| Net sales                                        |       | 100                              | %          | 100                             | %          | 100 | % | 100 | % |
| Cost of sales                                    |       | 93                               |       | 85                              |       | 87 |   | 95 |   |
| Gross profit                                     |       | 7                                |       | 15                              |       | 13 |   | 5 |   |
| Operating expenses:                              |       |                             |       |                            |       |   |   |   |   |
| Research and development                         |       | 6                                |       | 5                               |       | 8 |   | 5 |   |
| Selling, general and administrative              |       | 12                               |       | 15                              |       | 17 |   | 15 |   |
| Total operating expenses                         |       | 17                               |       | 19                              |       | 25 |   | 20 |   |
| Operating loss                                   |       | (10                              | )          | (4                              | )          | (12 | ) | (15 | ) |
| Other income:                                    |       |                             |       |                            |       |   |   |   |   |
| Interest income, net                             |       | —                           |       | —                          |       | 1 |   | — |   |
| Other income (expense), net                      |       | —                           |       | —                          |       | — |   | — |   |
| Total other income, net                          |       | —                           |       | —                          |       | 1 |   | — |   |
|                                             |       |                             |       |                            |       |   |   |   |   |
| Loss before provision (benefit) for income taxes |       | (10                              | )          | (4                              | )          | (11 | ) | (15 | ) |
| Provision (benefit) for income taxes             |       | 16                               |       | (1                              | )          | 6 |   | (5 | ) |
| Net loss                                         |       | (26                              | )%         | (1                              | )%         | (17 | )% | (9 | )% |

 

***Three and Nine MonthsEnded September 27, 2008 Compared to Three and Nine Months Ended September 29,2007***

*** ***

***NetSales, Cost of Sales and Gross Profit.***

 

*The following tables present net sales, cost of sales andgross profit for the three and nine months ended September 27, 2008 and September 29,2007 (in thousands, except percentages):*

 
| ** **    | ** ** | **Three Months Ended** | ** ** | ** **             | ** ** | ** **     | ** ** |
|---------------|------------|----------------------------------|------------|------------------------|------------|----------------|------------|
| ** **    | ** ** | **September 27,**           | ** ** | **September 29,** | ** ** | **Increase**   | ** ** | **%** | ** ** |
| ** **    | ** ** | **2008**                         | ** ** | **2007**               | ** ** | **(Decrease)** | ** ** | **Change** | ** ** |
|          |       |                             |       |                   |       |           |       |   |   |
| Net sales     |       | $                                | 28,876     |                   | $          | 27,194         |       | $ | 1,682 |   | 6 | % |
| Cost of sales |       | 26,832                           |       | 23,027                 |       | 3,805          |       | 17 | % |
| Gross profit  |       | $                                | 2,044      |                   | $          | 4,167          |       | $ | (2,123 | ) | (51 | )% |
| Gross margin  |       | 7                                | %          | 15                     | %          | (8             | )%         |   |   |
|          |       |                             |       |                   |       |           |       |   |   |
| ** **    |       | **Nine  Months Ended**           |       |                   |       |           |       |
| ** **    | ** ** | **September 27,**           | ** ** | **September 29,** | ** ** | **Increase**   |       | % |   |
| ** **    | ** ** | **2008**                         | ** ** | **2007**               | ** ** | **(Decrease)** | ** ** | **Change** | ** ** |
|          |       |                             |       |                   |       |           |       |   |   |
| Net sales     |       | $                                | 60,409     |                   | $          | 77,543         |       | $ | (17,134 | ) | (22 | )% |
| Cost of sales |       | 52,575                           |       | 73,850                 |       | (21,275        | )          | (29 | )% |
| Gross profit  |       | $                                | 7,834      |                   | $          | 3,693          |       | $ | 4,141 |   | 112 | % |
| Gross margin  |       | 13                               | %          | 5                      | %          | 8              | %          |   |   |

 

*Net Sales.*** The overall decrease in our net sales duringthe nine months ended September 27, 2008 as compared to the nine monthsended September 29, 2007 was primarily driven by the slower than expectedgrowth in sales of certain of our flash and high density server modules, as well as a decline in net salesof memory subsystems used to control redundant arrays of independent disks, orRAIDs, as a result of certain key programs and designs nearing an end-of-lifein 2008. Additionally, our net sales were adversely affected to a lesser extentby the fact that during the third quarter of 2008 the market price ofmainstream DRAM IC’s decreased by approximately 32%, which affected the sellingprices of certain of our products. The decrease in our net sales during thisperiod was partially offset, however, by strong growth in our line of low-powerfully buffered dual in-line memory modules, or FBDIMMs, which experienced asignificant ramp in sales volumes to certain key OEM customers beginning in2008.

 

22

----

Tableof Contents

 

The increase in net salesfor the three months ended September 27, 2008 as compared to the threemonths ended September 29, 2007 resulted primarily from increases ofapproximately (i) $7.9 million in net sales of laptop personal computermemory subsystems, (ii) $5.9 million in net sales of our low-power FBDIMMsand (iii) $0.3 million in net sales of flash products. The above increaseswere partially offset by decreases of approximately (i) $9.6 million innet sales of memory subsystems used to control RAIDs, (ii) $1.9 million innet sales of certain high density memory modules for the server market andrelated applications and (iii) $0.8 million in net sales of memory modulesfor certain desktop-related applications.

 

The decrease in net salesfor the nine months ended September 27, 2008 as compared to the ninemonths ended September 29, 2007 resulted primarily from decreases ofapproximately (i) $20.2 million in net sales of memory subsystems used tocontrol RAIDs, (ii) $17.7 million in net sales of certain high densitymemory modules for the server market and related applications and (iii) $1.5million in net sales of memory modules for certain desktop-relatedapplications. The above decreases were partially offset by an increase ofapproximately $22.2 million in net sales of our low-power FBDIMMs.

 

Should market pricedeclines for DRAM ICs and/or NAND continue, our net sales could be adverselyimpacted in future periods as we lower prices on some products to meet marketconditions.

 

Sales of our componentinventory to distributors and other users of memory ICs represented less than1% of net sales for both the three and nine months ended September 27,2008, respectively. For both the three and nine months ended September 29,2007, such sales represented approximately 2% of our total net sales,respectively. As compared to previous years, component inventory sales havesignificantly decreased as a percentage of net sales as a result of our effortsto diversify both our customer and product line bases. This diversificationeffort has also allowed us to use components in a wider range of memorysubsystems.

 

*Gross Profit and GrossMargin.*** The decrease in gross profit and gross marginfor the three months ended September 27, 2008 as compared to the threemonths ended September 29, 2007 is substantially due to our overallproduct sales mix during this period, whereby a higher percentage of our totalnet sales were derived from lower margin products. To a lesser extent, ourgross profit was affected by the decline in selling prices of certain of ourproducts during this period, as described above.

 

The overall increase ingross profit and gross margin for the nine months ended September 27, 2008as compared to the nine months ended September 29, 2007 is primarily dueto the significant decreases in the market price of DRAM ICs during the firsthalf of 2007. These price declines negatively impacted the valuation of ourinventories, whereby we incurred a loss in the nine months ended September 29,2007 of approximately $5.1 million, which directly affected our gross marginfor this period. Additionally, as compared to 2007, our gross margin for thenine months ended September 27, 2008 was more normalized due to thegeneral stabilization of DRAM IC market prices during the first half of 2008;however, the shift in our sales mix during the third quarter of 2008, asdescribed above, adversely affected our gross margin for this period.

 

During 2008 we have alsorealized certain benefits and cost savings as a result of having transitioned amajority of our production manufacturing volume to our facility in the People’sRepublic of China. Our total production and manufacturing costs for the ninemonths ended September 27, 2008 decreased approximately 43% as compared tothe corresponding period in 2007.

 

Should the market pricesof DRAM ICs and/or NAND decline in future periods, or should our product salesmix continue to shift more toward lower margin products, our gross profit,gross margin and overall operating results could be adversely affected.

 

***Researchand Development***.

 

The following tablespresent research and development expenses for the three and nine months ended September 27,2008 and September 29, 2007 (in thousands, except percentages):

 

23

----

Tableof Contents

 
| ** **               | ** ** | **Three Months Ended** | ** ** | ** **             | ** ** | ** **   | ** ** |
|--------------------------|------------|----------------------------------|------------|------------------------|------------|--------------|------------|
| ** **               | ** ** | **September 27,**           | ** ** | **September 29,** | ** ** | ** **   | ** ** | **%** | ** ** |
| ** **               | ** ** | **2008**                         | ** ** | **2007**               | ** ** | **Increase** | ** ** | **Change** | ** ** |
| Research and development |       | $                                | 1,651      |                   | $          | 1,256        |       | $ | 395 |   | 31 | % |
|                          |            |                                  |            |                        |            |              |            |  |  |  |  |  |

 
| ** **               | ** ** | **Nine Months Ended** | ** ** | ** **             | ** ** | ** **   | ** ** |
|--------------------------|------------|---------------------------------|------------|------------------------|------------|--------------|------------|
| ** **               | ** ** | **September 27,**          | ** ** | **September 29,** | ** ** | ** **   | ** ** | **%** | ** ** |
| ** **               | ** ** | **2008**                        | ** ** | **2007**               | ** ** | **Increase** | ** ** | **Change** | ** ** |
| Research and development |       | $                               | 4,943      |                   | $          | 3,801        |       | $ | 1,142 |   | 30 | % |
|                          |            |                                 |            |                        |            |              |            |  |  |  |  |  |

 

The increase in researchand development expense in the three months ended September 27, 2008 as comparedto the three months ended September 29, 2007 resulted primarily from anincrease of approximately $0.4 million in personnel-related expenses.

 

The increase in researchand development expense in the nine months ended September 27, 2008 ascompared to the nine months ended September 29, 2007 resulted primarilyfrom increases of approximately (i) $1.1 million in personnel-relatedexpenses and (ii) $0.1 million in legal and professional services due primarilyto our increased activities in 2008 related to new product opportunities andnew and emerging markets. The above increases were partially offset primarilyby a decrease of approximately $0.2 million in expenses related to productqualification testing and various allocated overhead expenses.

 

The increases inpersonnel-related expenses are primarily attributable to an increase in thenumber of employees engaged in research and development activities since September 29,2007, as well as compensation increases.

 

***Selling,General and Administrative***.

 

The following tablespresent selling, general and administrative expenses for the three and ninemonths ended September 27, 2008 and September 29, 2007 (in thousands,except percentages):

 
| ** **                          | ** ** | **Three Months Ended** | ** ** | ** **             | ** ** | ** **   | ** ** |
|-------------------------------------|------------|----------------------------------|------------|------------------------|------------|--------------|------------|
| ** **                          | ** ** | **September 27,**           | ** ** | **September 29,** | ** ** | ** **   | ** ** | **%** | ** ** |
| ** **                          | ** ** | **2008**                         | ** ** | **2007**               | ** ** | **Decrease** | ** ** | **Change** | ** ** |
| Selling, general and administrative |       | $                                | 3,364      |                   | $          | 4,040        |       | $ | (676 | ) | (17 | )% |
|                                |       |                             |       |                   |       |         |       |   |   |
| ** **                          |       | **Nine  Months Ended**           |       |                   |       |         |       |
| ** **                          | ** ** | **September 27,**           | ** ** | **September 29,** |       |         |       | % |   |
| ** **                          | ** ** | **2008**                         | ** ** | **2007**               | ** ** | **Decrease** | ** ** | **Change** | ** ** |
| Selling, general and administrative |       | $                                | 10,142     |                   | $          | 11,589       |       | $ | (1,447 | ) | (12 | )% |

 

The decrease in selling,general and administrative expense in the three months ended September 27,2008 as compared to the three months ended September 29, 2007 resultedprimarily from decreases of approximately (i) $0.8 million inpersonnel-related expenses, (ii) $0.2 million in facility lease relocationcosts incurred in 2007 and (iii) $0.2 million in legal and professionalfees. The above decreases are partially offset primarily by increases ofapproximately (i) $0.3 million in bad debt expense, (ii) $0.1 millionin sales commission and related expenses and (iii) $0.1 million in variousallocated overhead expenses.

 

The decrease in selling,general and administrative expense in the nine months ended September 27, 2008as compared to the nine months ended September 29, 2007 resulted primarilyfrom decreases of approximately (i) $1.3 million in personnel-relatedexpenses, (ii) $0.4 million in legal and professional fees, (iii) $0.2million in commission and travel-related expenses, (iv) $0.2 million infacility lease relocation costs incurred in 2007 and (v) $0.1 million inproduct qualification, evaluation and advertising. The above decreases werepartially offset primarily by increases of approximately (i) $0.5million in various allocated overhead expenses, which include, but are notlimited to, expenses for rent, insurance and depreciation, (ii) $0.3million in bad debt expense and (ii) $0.1 million in stock compensationexpense.

 

The decreases inpersonnel-related expenses are primarily attributable to a decrease in thenumber of employees engaged in selling, general and administrative activitiesof approximately 15% since September 29, 2007. The decreases in legal and

 

24

----

Table of Contents

 

professional fees areprimarily a result of the significant costs we incurred in 2007 to beginoperating as a public company, including costs related to our initialdocumentation and assessment of internal control over financial reporting, aswell as lower legal fees in 2008 related to current litigation matters sincethe majority of such expenses became reimbursable from our insurance carrier inthe current year. The increase in bad debt expense during the current year is aresult of a write-down we recorded during the third quarter of 2008 for certaincustomer accounts receivable for which collection has become uncertain.

 

***OtherIncome (Expense)***.

 

The following tablespresent other income (expense) for the three and nine months ended September 27,2008 and September 29, 2007 (in thousands, except percentages):

 
| ** **                  | ** ** | **Three Months Ended** | ** ** | ** **             | ** ** | ** **     | ** ** |
|-----------------------------|------------|----------------------------------|------------|------------------------|------------|----------------|------------|
| ** **                  | ** ** | **September 27,**           | ** ** | **September 29,** | ** ** | **Increase**   | ** ** | **%** | ** ** |
| ** **                  | ** ** | **2008**                         | ** ** | **2007**               | ** ** | **(Decrease)** | ** ** | **Change** | ** ** |
| Interest income, net        |       | $                                | 38         |                   | $          | 142            |       | $ | (104 | ) | (73 | )% |
| Other income (expense), net |       | 13                               |       | (33                    | )          | 46             |       | (139 | )% |
| Total other income, net     |       | $                                | 51         |                   | $          | 109            |       | $ | (58 | ) | (53 | )% |

 
| ** **                  | ** ** | **Nine Months Ended** | ** ** | ** **             | ** ** | ** **     | ** ** |
|-----------------------------|------------|---------------------------------|------------|------------------------|------------|----------------|------------|
| ** **                  | ** ** | **September 27,**          | ** ** | **September 29,** | ** ** | **Increase**   | ** ** | **%** | ** ** |
| ** **                  | ** ** | **2008**                        | ** ** | **2007**               | ** ** | **(Decrease)** | ** ** | **Change** | ** ** |
| Interest income, net        |       | $                               | 381        |                   | $          | 256            |       | $ | 125 |   | 49 | % |
| Other income (expense), net |       | (55                             | )          | (28                    | )          | (27            | )          | (96 | )% |
| Total other income, net     |       | $                               | 326        |                   | $          | 228            |       | $ | 98 |   | 43 | % |

 

Net interest income forthe three and nine months ended September 27, 2008 was comprised ofinterest income of approximately $0.2 million and $0.7 million, respectively,partially offset by interest expense of approximately $0.1 million and $0.3million, respectively. Net interest income for the three and nine months ended September 29,2007 was comprised of interest income of approximately $0.4 million and $1.3million, respectively, partially offset by interest expense of approximately$0.3 million and $1.0 million, respectively. The decrease in interest incomeduring 2008 as compared to 2007 was primarily due to our lower overall cash andinvestment balances on-hand during the current year. The decrease in interestexpense during 2008 as compared to 2007 resulted primarily from our loweraverage outstanding line of credit and debt balances during the current year.

 

Other expense, net, forthe nine months ended September 27, 2008 is primarily comprised of losseson certain foreign currency remeasurement transactions, partially offset byrealized gains on the sale of certain investments in marketable securities.

 

25

----

Tableof Contents

 

***Provision(Benefit) for Income Taxes***.

 

The following tablespresent the provision (benefit) for income taxes for the three and nine monthsended September 27, 2008 and September 29, 2007 (in thousands, exceptpercentages):

 
| ** **                           | ** ** | **Three Months Ended** | ** ** | ** **             | ** ** | ** **   | ** ** |
|--------------------------------------|------------|----------------------------------|------------|------------------------|------------|--------------|------------|
| ** **                           | ** ** | **September 27,**           | ** ** | **September 29,** | ** ** | ** **   | ** ** | **%** | ** ** |
| ** **                           | ** ** | **2008**                         | ** ** | **2007**               | ** ** | **Increase** | ** ** | **Change** | ** ** |
| Provision (benefit) for income taxes |       | $                                | 4,502      |                   | $          | (363         | )          | $ | 4,865 |   | 1,340 | % |
| Effective tax rate                   |       | 154                              | %          | (36                    | )%         |         |       |   |   |
|                                      |            |                                  |            |                        |            |              |            |  |  |  |  |  |

 
| ** **                           | ** ** | **Nine Months Ended** | ** ** | ** **             | ** ** | ** **   | ** ** |
|--------------------------------------|------------|---------------------------------|------------|------------------------|------------|--------------|------------|
| ** **                           | ** ** | **September 27,**          | ** ** | **September 29,** | ** ** | ** **   | ** ** | **%** | ** ** |
| ** **                           | ** ** | **2008**                        | ** ** | **2007**               | ** ** | **Increase** | ** ** | **Change** | ** ** |
| Provision (benefit) for income taxes |       | $                               | 3,332      |                   | $          | (4,227       | )          | $ | 7,559 |   | 179 | % |
| Effective tax rate                   |       | 48                              | %          | (37                    | )%         |         |       |   |   |
|                                      |            |                                 |            |                        |            |              |            |  |  |  |  |  |

 

Under Accounting Principles Board Opinion No. 28, *Interim Financial Reporting*, we are required to adjust oureffective tax rate each quarter to be consistent with the estimated annualeffective tax rate. We are also required to record the tax impact of certaindiscrete items, unusual or infrequently occurring, including changes injudgment about valuation allowances and effects of changes in tax laws orrates, in the interim period in which they occur. In addition, jurisdictionswith a projected loss for the year or a year-to-date loss where no tax benefitcan be recognized are excluded from the estimated annual effective tax rate.The impact of such an exclusion could result in a higher or lower effective taxrate during a particular quarter, based upon the mix and timing of actualearnings versus annual projections.

 

We use the liability method of accounting for income taxes as set forthin SFAS No. 109, *Accounting for IncomeTaxes*. We record net deferred tax assets to the extent we believethese assets will more likely than not be realized. In making suchdetermination, we consider all available positive and negative evidence,including scheduled reversals of deferred tax liabilities, projected futureincome, tax planning strategies, and recent financial performance includingcarryback opportunities to the extent available. In the third quarter offiscal 2008, we recorded a net charge to income tax expense of approximately$4.5 million related to establishing a partial valuation allowance against ourdeferred income tax assets. Our determination to record a valuation allowancewas based on our recent history of cumulative losses as well as uncertainty ofthe utilization of deferred tax assets in the near future. The remainingdeferred tax asset of approximately $1.3 million at September 27, 2008relates to federal taxes paid where refund claims are expected to be made fornet operating losses that can be carried back to prior years. In addition, wediscontinued recording income tax benefits in the consolidated financialstatements until it is determined that it is more likely than not that we willgenerate sufficient taxable income to realize our deferred tax assets. See Note8 of Notes to Unaudited Condensed Consolidated Financial Statements for furtherdetails.

 

**Liquidity andCapital Resources**

** **

Since ourinception, we have financed our operations primarily through issuances ofequity and debt securities and cash generated from operations. We have alsofunded our operations with a revolving line of credit under our bank creditfacility, from capitalized lease obligations, financing of receivables and fromthe sale and leaseback of our domestic manufacturing facility.

 

***WorkingCapital and Cash and Marketable Securities***

 

The following tablepresents working capital, cash and cash equivalents and investments inmarketable securities (in thousands):

 

26

----

Tableof Contents

 
| ** **                          | ** ** | **September 27,** | ** ** | **December 29,** | ** ** |
|-------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                          | ** ** | **2008**               | ** ** | **2007**              | ** ** |
| Working Capital                     |       | $                      | 25,789     |                  | $          | 27,387 |   |
|                                |       |                   |       |                  |       |
| Cash and cash equivalents(1)        |       | $                      | 12,081     |                  | $          | 7,182 |   |
| Restricted cash(1)                  |       | 2,000                  |       | —                |       |
| Short-term marketable securities(1) |       | 9,224                  |       | 15,573                |       |
| Long-term marketable securities     |       | 963                    |       | 7,814                 |       |
|                                |       | $                      | 24,268     |                  | $          | 30,569 |   |

 

----

*(1) Included in workingcapital*

 

*Our working capital decreased in the nine months ended September 27,2008 primarily as a result of a decrease in our current deferred taxbalance of approximately $2.2 million due to*theestablishment of a partial valuation allowance against certain of our deferredincome tax assets*, partiallyoffset by a combined increase in our cash and cash equivalents, restricted cashand short-term investments in marketable securities balances of approximately$0.6 million due primarily to maturities and sales of certain long-terminvestments in marketable securities.*

 

***CashProvided and Used in the Nine Months Ended September 27, 2008 and September 29,2007***

 

*The following table summarizes our cash flows for theperiods indicated (in thousands):*

* *
| ** **                                            | ** ** | **Nine Months Ended** | ** ** |
|-------------------------------------------------------|------------|---------------------------------|------------|
| ** **                                            | ** ** | **September 27,**          | ** ** | **September 29,** | ** ** |
| ** **                                            | ** ** | **2008**                        | ** ** | **2007** | ** ** |
|                                                  |       |                            |       |   |   |
| **Net cash provided by (used in):**                   |       |                            |       |   |   |
| Operating activities                                  |       | $                               | (11,705    | ) | $ | 7,757 |   |
| Investing activities                                  |       | 11,846                          |       | (22,923 | ) |
| Financing activities                                  |       | 4,758                           |       | (9,359 | ) |
| Net increase (decrease) in cash and cash  equivalents |       | $                               | 4,899      |   | $ | (24,525 | ) |

 

*Operating Activities.*Net cash used in operating activities for the nine months ended September 27,2008 was primarily a result of (i) our net loss for the period ofapproximately $10.3 million and (ii) approximately $7.7 million in netcash used by changes in operating assets and liabilities, partially offset byapproximately $6.2 million in net non-cash operating expenses, primarilycomprising deferred income taxes, depreciation and amortization and stock-basedcompensation.

 

Accounts receivableincreased approximately $3.7 million during the nine months ended September 27,2008 primarily due to timing differences for certain of our customer paymentreceipts near the end of the third quarter of 2008.

 

Net cash provided byoperating activities for the nine months ended September 29, 2007 wasprimarily a result of (i) approximately $2.8 million in net non-cashoperating expenses, primarily comprising inventory adjustments, depreciationand amortization, deferred income taxes, stock-based compensation andimpairment of long-lived assets and (ii) approximately $12.1 million innet cash provided by changes in operating assets and liabilities, partiallyoffset by a net loss of approximately $7.2 million for the nine months ended September 29,2007. The changes in operating assets and liabilities which had a significantimpact on cash provided by operating activities included (i) a decrease inaccounts receivable of approximately $7.3 million, (ii) a decrease ininventories of approximately $8.5 million and (iii) a decrease in accountspayable of approximately $2.4 million. All such decreases in operating assetsand liabilities were primarily due to the overall decline in the level of netsales and related operating activities during fiscal 2007 as compared to fiscal2006.

 

*Investing Activities.*Net cash provided by investing activities for the nine months ended September 27,2008 was primarily a result of proceeds we received from maturities and salesof certain investments in marketable securities of approximately $19.6 million,partially offset by purchases of additional investments in marketablesecurities of approximately $6.7 million. We also used approximately $1.1million in cash to purchase additional manufacturing equipment and otherproperty and equipment.

 

Net cash used ininvesting activities for the nine months ended September 29, 2007 wasprimarily a result of purchases

 

27

----

Tableof Contents

 

of additional investmentsin marketable securities of approximately $50.9 million, partially offset byproceeds we received from maturities of certain investments in marketablesecurities of approximately $33.6 million. During the same period, we also usedapproximately $5.5 million in cash primarily to purchase equipment and leaseholdimprovements for our facilities in the People’s Republic of China and inIrvine, California.

 

*Financing Activities.*Net cash provided by financing activities for the nine months ended September 27,2008 was primarily a result of approximately $7.4 million in net proceeds wereceived from net borrowings on our outstanding line of credit. This ispartially offset by (i) an increase in restricted cash balances inconnection with our pledge of $2.0 million in cash as collateral for a letterof credit and (ii) repayments of approximately $0.6 million on our longterm debt.

 

Net cash used infinancing activities for the nine months ended September 29, 2007 wasprimarily a result of approximately $9.0 million in net repayments on ouroutstanding revolving line of credit, along with net repayments ofapproximately $0.6 million on our long term debt.

 

***Capital Resources***

*** ***

Under ourrevolving line of credit, we may borrow up to the greater of 85% of eligibleaccounts receivable plus the least of (i) a percentage of eligibleinventory determined from time to time by our bank, (ii) 80% of theorderly liquidation value, as defined, of eligible inventories, and (iii) $1 million.

 

In May 2008,we executed a ninth amendment to our credit agreement, which is effective as ofthe beginning of our second fiscal quarter of 2008. Among other things, theamendment revised certain financial and other covenants of which we arerequired to comply. The amendment requires us to (i) limit capitalexpenditures under a defined annual cap, (ii) achieve certain minimummonthly profitability thresholds and (iii) maintain a minimum liquiditythreshold as of the end of each month. Additionally, the amendment revised theinterest rate on our borrowings on the revolving line of credit to fluctuatebetween the prime rate and prime plus 0.5% based our combined monthly accountbalance with the bank. Furthermore, under the amendment, our nonrevolvingequipment financing line of credit was revised to allow us to borrow up to anadditional maximum of $0.9 million to finance up to 80% of the cost ofequipment purchases through the end of fiscal 2008. Principal on any of theseadditional borrowings is scheduled to be repaid in 42 equal monthlyinstallments commencing January 1, 2009. Interest on our existing andfuture equipment line of credit advances is payable monthly at the prime rate.

 

The followingtable presents details of outstanding borrowings and availability under ourlines of credit (in thousands, except percentages):

 
| ** **                                              | ** ** | **September 27,** | ** ** | **December 29,** | ** ** |
|---------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                              | ** ** | **2008**               | ** ** | **2007**              | ** ** |
| Outstanding borrowings on the line of  credit           |       | $                      | 12,241     |                  | $          | 4,872 |   |
| Outstanding borrowings on the equipment  line of credit |       | $                      | 580        |                  | $          | 872 |   |
| Borrowing availability under the line of  credit        |       | $                      | 1,304      |                  | $          | 6,366 |   |
| Prime rate                                              |       | 5.00                   | %          | 7.25                  | %          |

 

Any borrowingsunder our revolving and equipment lines of credit are collateralized by ageneral first priority lien against all of our assets, both tangible andintangible.

 

In October 2008,we executed the Tenth Amendment to our Amended and Restated Credit and SecurityAgreement, or the Tenth Amendment. Among other things, this amendment furtherrevised our minimum profitability financial covenant requirement. The TenthAmendment also revised the monthly interest rate charged on future credit advancesunder the line of credit to the greater of (i) the sum of the prime rateplus 3% or (ii) 5%.

 

As of September 27,2008, we were not in compliance with our financial covenant related to minimummonthly profitability. In October 2008, in connection with the executionof the Tenth Amendment, we received a waiver from our lender for this covenantviolation. We cannot assure that it will not violate one or more covenants inthe future. If we were to be in violation of covenants under our current creditagreement, our lender could choose to accelerate payment on all outstandingloan balances. There can be no assurance that we would be able to quicklyobtain equivalent or suitable replacement financing in this event. If we werenot able to secure alternative sources of funding, such acceleration would havea material adverse impact on our financial condition.

 

28

----

Tableof Contents

 

As of October 31,2008, the prime rate was 4.0% and our outstanding borrowings on our line ofcredit was approximately $1.4 million.

 

We have in thepast utilized equipment leasing arrangements to finance certain capitalexpenditures. Equipment leases will continue to be a financing alternative thatwe may pursue in the future.

 

*Letter ofCredit*

 

In June 2008,we entered into an agreement with our bank to issue a commercial letter ofcredit, or LC, up to $2 million to support purchases of inventory from asupplier. As part of this agreement, we are required to pledge cash ascollateral for the full amount of the LC, and thus, as of September 27,2008, $2 million is classified as restricted cash in the accompanying unauditedcondensed consolidated balance sheet.

 

*AuctionRate Securities*

 

The recentdisruptions in the credit market continue to adversely affect the liquidity andoverall market for auction rate securities. As of September 27, 2008, weheld two investments in auction rate securities with a total purchased cost of$1.0 million. These two investments represent (i) a fully insured debtobligation of a municipality and (ii) a AAA rated debt obligation backedby pools of student loans guaranteed by the U.S. Department of Education. Giventhe insufficient observable market inputs and related information available, wehave classified our investments in auction rate securities within Level 3 ofthe fair value hierarchy as set forth in SFAS No. 157, *Fair Value Measurements*, or SFAS 157. Wehave estimated the fair value of these investments using a discounted cash flowmodel which included assumptions about the credit quality and expected durationof the investments, along with discount rates affected for the general lack ofliquidity. These assumptions reflect our estimates about the reasonableassumptions market participants would likely use in valuing the investments,including assumptions about risk, developed based on the best informationavailable in the circumstances.

 

We do not believethat the current illiquidity of our investments in auction rate securities willmaterially impact our ability to fund our working capital needs, capitalexpenditures or other business requirements. However, we remain uncertain as towhen liquidity will return to the auction rate markets, whether other secondarymarkets will become available or when the underlying securities may be calledby the issuer. Given these and other uncertainties, our investments in auctionrate securities have been classified as long-term investments in marketablesecurities in the accompanying unaudited condensed consolidated balance sheetas of September 27, 2008. We have concluded that the estimated grossunrealized losses on these investments, which totaled approximately $39,000 at September 27,2008, are temporary because (i) we believe that the absence of liquiditythat has occurred is due to general market conditions, (ii) the auctionrate securities continue to be of a high credit quality and interest is paid asdue and (iii) we have the intent and ability to hold these investmentsuntil a recovery in the market occurs.

 

*OtherInvestments in Marketable Securities*

 

Excluding ourauction rate securities, the gross unrealized losses on our other investmentsin marketable securities totaled approximately $275,000 as of September 27,2008, and are generally due to the ongoing uncertainties in the credit andfinancial markets, as well as the overall current economic environment. Thefair value of these investments was determined based on quoted prices from actualmarket transactions for identical investments. We have determined that theunrealized losses on these investments as of September 27, 2008 aretemporary in nature. Factors considered in determining whether impairments areother than temporary include (i) the length of time and extent to whichfair value has been less than the amortized cost basis, (ii) the financialcondition and near-term prospects of the investee and (iii) our intent andability to hold an investment for a period of time sufficient to allow for anyanticipated recovery in market value. The fair value of our investments inmarketable securities could change significantly in the future and we may berequired to record other-than-temporary impairment charges or additionalunrealized losses in future periods.

 

We believe ourexisting cash and investment balances, borrowing availability under our bankcredit facility, and the cash expected to be generated from operations, will besufficient to meet our anticipated cash needs for at least the next12 months. However, during challenging economic times we may face issuesgaining timely access to sufficient credit, which could result in our inabilityto meet certain of our financial obligations and other related commitments. Ourfuture capital requirements will depend on many factors, including our levelsof net sales, the timing and extent of expenditures to support research anddevelopment activities, the expansion of manufacturing capacity bothdomestically and internationally and the continued market acceptance of ourproducts. We could be required, or may choose, to seek additional fundingthrough public or private equity or debt financings. In addition, in connectionwith any future acquisitions, we may require additional funding which may beprovided in the form of additional debt or equity financing or a combinationthereof. These additional

 

29

----

Tableof Contents

 

funds may not beavailable on terms acceptable to us, or at all.

 

*NewAccounting Pronouncements*

 

In October 2008,the FASB issued FASB Staff Position No. 157-3, *Determiningthe Fair Value of a Financial Asset When the Market for That Asset is NotActive*, or FSP 157-3. FSP 157-3 clarifies the application of SFAS157 in a market that is not active, and provides an illustrative exampleintended to address certain key application issues. FSP 157-3 is effectiveimmediately, and applies to our September 27, 2008 financial statements.We have concluded that the application of FSP 157-3 did not have a materialimpact on our consolidated financial position and results of operations as ofand for the periods ended September 27, 2008.

 

***Off-Balance SheetArrangements***

*** ***

***We do not have any relationships with unconsolidatedentities or financial partnerships, such as entities often referred to asstructured finance or special purpose entities, which would have beenestablished for the purpose of facilitating off-balance sheet arrangements orother contractually narrow or limited purposes. In addition, we do not have anyundisclosed borrowings or debt, and we have not entered into any syntheticleases. We are, therefore, not materially exposed to any financing, liquidity,market or credit risk that could arise if we had engaged in such relationships.***

*** ***

**Item 3.**                          Quantitative and QualitativeDisclosures About Market Risk

** **

***As a SmallerReporting Company, we are not required to make any disclosure pursuant to thisItem 3.***

*** ***

**Item 4.**                          Controls and Procedures

** **

***Not Applicable.***

*** ***

**Item 4T.**                 Controls and Procedures

** **

*(a) Evaluation ofDisclosure Controls and Procedures.* We carried out anevaluation, under the supervision and with the participation of our management,including our principal executive officer and principal financial officer, ofthe effectiveness of the design and operation of our disclosure controls andprocedures (as defined in Rules 13a-15(e) and 15d-15(e) of theSecurities Exchange Act of 1934, (“Exchange Act”)) as of the end of our fiscalquarter ended September 27, 2008. Based upon that evaluation, ourprincipal executive officer and principal financial officer concluded that ourdisclosure controls and procedures are effective to provide reasonableassurance that information required to be disclosed by us in reports that wefile or submit under the Exchange Act (i) is recorded, processed,summarized and reported within the time periods specified in the SEC’s rules andforms and (ii) is accumulated and communicated to our management,including our principal executive officer and principal financial officer asappropriate to allow timely decisions regarding required disclosure.

 

*(b) Change in internal controls over financial reporting.* During the fiscal quarter that ended September 27,2008, there have not been any changes in our internal control over financialreporting (as defined in Rules 13a-15(f) and 15d-15(f) under theExchange Act) that have materially affected, or are reasonably likely tomaterially affect, our internal control over financial reporting.

 

***InherentLimitations on Internal Control***

 

A control system, no matter how well conceived andoperated, can provide only reasonable, not absolute, assurance that theobjectives of the control system are met. Further, the benefits of controlsmust be considered relative to their costs. Because of the inherent limitationsin all control systems, no evaluation of controls can provide absoluteassurance that all control issues and instances of fraud, if any, have beendetected. These inherent limitations include the realities that judgments indecision making can be faulty, and that breakdowns can occur because of simpleerrors. Additionally, controls can be circumvented by the individual acts ofsome persons, by collusion of two or more people, or by management override ofthe control. The design of any system of controls is also based in part uponcertain assumptions about the likelihood of future events, and there can be noassurance that any design will succeed in achieving its stated goals under allpotential future conditions. Because of the inherent limitations in acost-effective control system, misstatements due to error or fraud may occurand not be detected.

 

30

----

Tableof Contents

 

**PART II. OTHER INFORMATION**

 

**Item 1.**                          Legal Proceedings

** **

The informationset forth in the sections entitled Federal Securities Class Action,California Derivative Action and Patent Claims under Note 9 of Notes toUnaudited Condensed Consolidated Financial Statements, included in Part I,Item I of this Report, is incorporated herein by reference.

 

**Item 1A.**                 Risk Factors

** **

***As a Smaller Reporting Company, we are not required to makeany disclosure pursuant to this Item 1A; however, we have included the riskfactor directly below given the current macroeconomic environment in which weare currently operating. Please also refer to the Risk Factors set forth in Part I,Item 1A of our Annual Report on Form 10-K for the fiscal year ended December 29,2007 filed with the Securities and Exchange Commission on February 29,2008.***

*** ***

**Ouroperating results may be adversely impacted by worldwide economic and politicaluncertainties and specific conditions in the markets we address, including thecyclical nature of and volatility in the memory market and semiconductorindustry.**

 

Recently general worldwide economic conditions have experienced adownturn due to the credit conditions impacted by the subprime-mortgage turmoiland other factors, slower economic activity, concerns about inflation anddeflation, increased energy costs, decreased consumer confidence, reducedcorporate profits and capital spending, adverse business conditions and liquidityconcerns in the memory market, recent international conflicts and the impact ofnatural disasters and public health emergencies. These conditions make itextremely difficult for our customers, our vendors and us to accuratelyforecast and plan future business activities, and they could causeU.S. and foreign businesses to slow spending on our products and services,which would delay and lengthen sales cycles. Furthermore, during challengingeconomic times our customers may face issues gaining timely access tosufficient credit, which could result in an impairment of their ability to maketimely payments to us. If that were to occur, we may be required to increaseour allowance for doubtful accounts and our days sales outstanding would benegatively impacted. We cannot predict the timing, strength or duration of anyeconomic slowdown or subsequent economic recovery, worldwide, or in the memorymarket and related semiconductor industry. If the economy or markets in whichwe operate do not continue at their present levels, our business, financialcondition and results of operations will likely be materially and adverselyaffected. Additionally, the combination of our lengthy sales cycle coupled withchallenging macroeconomic conditions could have a synergistic negative impacton the results of our operations.

 

**Item 2.**                          Unregistered Sales of EquitySecurities and Use of Proceeds

** **

None.

 

**Item 3.**                          Defaults Upon SeniorSecurities

** **

None.

 

**Item 4.**                          Submission of Matters to aVote of Security Holders

** **

None.

 

**Item 5.**                          Other Information

** **

None.

 

31

----

**Table of Contents**

 

**Item 6.**                         Exhibits

 
| **Exhibit** | ** ** | ** **                                                                                                                                                                                                                                                               |
|-------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| **Number**  | ** ** | **Description of Document**                                                                                                                                                                                                                                    |
|        |       |                                                                                                                                                                                                                                                                     |
| 3.1(1)      |       | Restated Certificate of Incorporation of  Netlist, Inc.                                                                                                                                                                                                             |
|        |       |                                                                                                                                                                                                                                                                     |
| 3.2(1)      |       | Amended and Restated Bylaws of Netlist, Inc.                                                                                                                                                                                                                        |
|        |       |                                                                                                                                                                                                                                                                     |
| 10.1(2)     |       | Tenth Amendment to Amended and Restated  Credit and Security Agreement, dated October 30, 2008, by and among  Netlist, Inc., a Delaware corporation, Netlist Technology Texas, L.P., a  Texas limited partnership, and Wells Fargo Bank, National Association. |
|        |       |                                                                                                                                                                                                                                                                     |
| 31.1(2)     |       | Certification of Chief Executive Officer  pursuant to Rule 13a-14(a) and Rule 15d-14(a) of the  Securities Exchange Act, as Amended.                                                                                                                 |
|        |       |                                                                                                                                                                                                                                                                     |
| 31.2(2)     |       | Certification of Chief Financial Officer  pursuant to Rule 13a-14(a) and Rule 15d-14(a) of the  Securities Exchange Act, as Amended.                                                                                                                 |
|        |       |                                                                                                                                                                                                                                                                     |
| 32(3)       |       | Certification of Chief Executive Officer  and Chief Financial Officer pursuant to 18 U.S.C. 1350, as adopted pursuant  to Section 906 of the Sarbanes-Oxley Act of 2002 and furnished herewith  pursuant to SEC Release No. 33-8238.                           |

 

----

(1)         Incorporatedby reference to the corresponding exhibit number of the registration statementon Form S-1 of the registrant (No. 333-136735) filed with theSecurities and Exchange Commission on October 23, 2006.

 

(2)         Filedherewith.

 

(3)         Theinformation in Exhibit 32 shall not be deemed “filed” for purposes of Section 18of the Securities Exchange Act of 1934, as amended, (the “Exchange Act”), orotherwise subject to the liabilities of that section, nor shall they be deemedincorporated by reference in any filing under the Securities Act of 1933, asamended, or the Exchange Act (including this Report), unless Netlist, Inc.specifically incorporates the foregoing information into those documents byreference.

 

32

----

Table of Contents

 

**SIGNATURES**

 

Pursuant to the requirements of the SecuritiesExchange Act of 1934, the Registrant has duly caused this report to be signedon its behalf by the undersigned thereunto duly authorized.

 
| Date: November 6, 2008 |       | NETLIST, INC.                               |
|-----------------------------|------------|---------------------------------------------|
|                        |       | a Delaware corporation                      |
|                        |       | (Registrant)                                |
|                        |       |                                        |
|                        | By:        | /s/ Chun K.  Hong                           |
| ** **                  | ** ** | **Chun K.  Hong**                           |
| ** **                  | ** ** | **President,  Chief Executive Officer and** |
| ** **                  | ** ** | **Chairman  of the Board**                  |
| ** **                  | ** ** | **(Principal  Executive Officer)**          |
| ** **                  | ** ** | ** **                                  |
| ** **                  | ** ** | ** **                                  |
|                        | By:        | /s/ Gail  Itow                              |
| ** **                  | ** ** | **Gail  Itow**                              |
| ** **                  | ** ** | **Vice  President and Chief Financial**     |
| ** **                  | ** ** | **Officer**                                 |
| ** **                  | ** ** | **(Principal  Financial Officer)**          |

 

33

----

Table of Contents

 

**EXHIBITINDEX**

 
| **Exhibit** | ** ** | ** **                                                                                                                                                                                                                                                               |
|-------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| **Number**  | ** ** | **Description of Document**                                                                                                                                                                                                                                    |
|        |       |                                                                                                                                                                                                                                                                     |
| 10.1        |       | Tenth Amendment to Amended and Restated  Credit and Security Agreement, dated October 30, 2008, by and among  Netlist, Inc., a Delaware corporation, Netlist Technology Texas, L.P., a  Texas limited partnership, and Wells Fargo Bank, National Association. |
|        |       |                                                                                                                                                                                                                                                                     |
| 31.1        |       | Certification of Chief Executive Officer  pursuant to Rule 13a-14(a) and Rule 15d-14(a) of the  Securities Exchange Act, as Amended.                                                                                                                 |
|        |       |                                                                                                                                                                                                                                                                     |
| 31.2        |       | Certification of Chief Financial Officer  pursuant to Rule 13a-14(a) and Rule 15d-14(a) of the  Securities Exchange Act, as Amended.                                                                                                                 |
|        |       |                                                                                                                                                                                                                                                                     |
| 32          |       | Certification of Chief Executive Officer  and Chief Financial Officer pursuant to 18 U.S.C. 1350, as adopted pursuant  to Section 906 of the Sarbanes-Oxley Act of 2002 and furnished herewith  pursuant to SEC Release No. 33-8238.                           |

 

34

----